It's not official yet, but it's starting to look awfully like fiber network operator Level 3 Communications (NYSE: LVLT) and internet services provider CenturyLink (NYSE: CTL) are
Wall Street is starting to warm to the deal as well. This morning, no fewer than three separate stock analysts chimed in with thoughts about the proposed merger, and one of them climbed out on a limb and upgraded Level 3 shares on the belief the merger will, in fact, come to pass.
Here are three things you need to know about it.
1. The upgrade
Let's start with the actual upgrade. This morning, analysts at Oppenheimer (
Oppenheimer says the combination of CenturyLink's business with Level 3 could result in a "powerful combination," but argues that even without a merger, Level 3 has made progress in growing its free cash flow output, and is worth buying in its own right.
2. The deal
Quoting from a report by JPMorgan (
So far, therefore, the analysts are broadly in agreement about the potential for profit in Level 3 stock.
3. The reasons for the deal
Our third bit of Wall Street insight this morning comes from UBS (the most successful of the three analysts named so far, with a
According to UBS, Level 3 possesses "sizable" net operating loss carryforwards that CenturyLink could use to decrease its income tax liabilities in future years. UBS also highlights the growing free cash flow at Level 3 ($950 million in cash profits generated over the past year, according to data from
The most important thing: Valuation
Do all these arguments in favor of a merger between Level 3 Communications and CenturyLink make sense? It's hard to be sure, but the numbers do look attractive at first glance. Here's why:
Combining Level 3's $3.6 billion in annual profit with CenturyLink's near $1 billion -- with another $1 billion in "synergies" tossed in -- implies a combined company could earn roughly $5.6 billion annually in net profit. At $62 billion in debt-adjusted market capitalization, that works out to a P/E ratio of just 11.1 on the hypothetical combined company, which sounds pretty cheap.
Valued on free cash flow, the deal seems only slightly less attractive. CenturyLink does $2.4 billion in annual free cash flow, and Level 3 just under $1 billion. Another $1 billion in savings implies free cash flow of $4.4 billion-ish for a combination of the two companies, and results in an enterprise-value-to-free-cash-flow ratio of 14.1.
Of course, these valuations both assume that the promised "synergies" will materialize. But if they do, then I have to admit: Wall Street's enthusiasm for this deal has merit. And the investors who are buying Level 3 Communications stock, and CenturyLink stock, too, just might be on to something.
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