CenturyLink Agrees to Acquire Level 3 at a Big Premium
The decision to acquire Level 3 Communications is not entirely unreasonable, and putting these companies together makes good strategic sense.
At first glance, CenturyLink's (CTL) decision to acquire Level 3 Communications looks expensive, but not entirely unreasonable. Putting these companies together makes good strategic sense, in our view, as both serve business customers in a very competitive market. In addition to traditional rivals AT&T and Verizon, Comcast, Charter, and other cable firms are expanding their presence in the business services market, working to steadily increase the size of the customers they can serve. A combined CenturyLink/Level 3 should be better positioned to handle this environment.
CenturyLink’s offer of $66.50 per share for Level 3 is a roughly 40% premium to where the shares were trading prior to rumors of a deal surfacing. A premium of this magnitude ($7 billion in equity value) is likely warranted, given the significant cost savings this deal presents (management expects $975 million annually), the strategic benefits of the combination, and the ability to use Level 3’s net operating losses to reduce taxes over the next several years.
However, our hang-up on valuation stems from the fact that CenturyLink is using its shares to fund 60% of the purchase price, with a fixed exchange ratio that assumes CenturyLink shares are worth $28. We currently value CenturyLink significantly higher, at $36 per share. At our CenturyLink fair value estimate, the purchase price rises to nearly $78 per Level 3 share, a 65% premium equal to about $11 billion. We are still evaluating the deal, but as of now, we expect to reduce our CenturyLink fair value estimate by around 10%.
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Michael Hodel does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.