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Tickers in this Article: MER, lvlt, glbc, bwng, twtc, cogt, ftgx, t, vz
Last week, the Wall Street Journal reported that some investors think it is a good time to scoop up shares of the fiber optic network provider. Echoing this sentiment, Merrill Lynch (MER) has upgraded Level 3 Communications' (LVLT) shares to Buy from Neutral, with a target price of $6.50. But I don't buy it.

With the stock down 28% since it hit $5.72 at the beginning of May, Level 3might spell a short-term trading opportunity. But investors, ask yourselves, do you really want to buy a piece of what is still a problem-plagued company? Struggling with a flimsy business model, fierce competition and a crushing debt load, Level 3 isn't worth the risk.

Level 3 must struggle with dismal market economics. There is still an overabundance of fiber-optic networks – the bulk of available bandwidth has gone unused for years and can be activated quickly and relatively cheaply.

Last year, Level 3 experienced price compression of 30-50% and racked up net losses of $687 million.

The company reckons consumer demand for video downloads and Internet telephony will take up more and more of the surplus -- but that is going to take years.

Level is eyeball deep in competition. Global Crossing (GLBC), Broadwing (BWNG), Time Warner Telecom (TWTC), Cogent (COGT) and Fibernet (FTGX) are just a few of the small-to-mid-cap publicly-listed players trying to eke out a living in the fiber-optic market. What's more, Level 3 competes with AT&T (T) and Verizon (VZ), two telecom giants with ample resources to inflict pain in the marketplace.

In an effort to eliminate some competition and beef-up revenues, Level 3 has been frantically buying-up private fiber optic players. Last fall it spent nearly $1 billion in stock and cash on WilTel Communications, Progress Telecom and ICG Networks. In the latest quarter it announced the purchases of TelCove Inc. and Looking Glass Networks for an additional $1.4 billion in cash and stock. Level 3 may not be finished with the buying spree.

The acquisitions have largely been financed by issuing shares and high interest junk bonds, adding to Level 3's huge debt pile -- now sitting at $6.7 billion, or nearly double its $3.4 billion market capitalization. That disheartening debt load leaves Level 3 with an ugly debt-to-equity ratio of 120%, and a negative $0.65 per share book value.


Miraculously, Level 3 has managed to manoeuvre the capital markets, avoiding numerous cash liquidity crises. But it's not clear whether the company can keep it up indefinitely. My own back-of-the envelope calculations suggest Level 3 will have about $500 million in cash in 2010, the same year a $2.2 billion debt payment comes due. Investors face the prospect more share-diluting equity issues, or reduced ownership through another debt issue, or, even worse, the possibility of bankruptcy.

Wall Street analysts point out that Level 3 trades at about 3 times network sales, a substantial discount to Time Warner Telecom. But that's no reason to think the company is a worthy investment. Level 3 remains a gamble, with more than its fair share of risk.

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