CenturyLink levers up to acquire Level 3 but expects quick de-levering due to cash-flow generation

By Paul Deckelman

New York, Jan. 4 – CenturyLink, Inc. plans to incur increased debt leverage to help finance its recently announced acquisition of sector peer Level 3 Communications, Inc. – but the Monroe, La.-based telecommunications company believes that it will be able to de-lever fairly rapidly, utilizing the increased cash flow the combined company will generate.

“Although we lever up to 4 times debt to EBITDA, or 3.7 times debt to EBITDA on an assumed run-rate synergies basis,” CenturyLink’s executive vice president and chief financial officer, R. Stewart Ewing Jr., told participants at a Las Vegas financial conference on Wednesday, “it de-levers fairly quickly with the free cash flow, such that we can get back down to our target leverage of about 3 times [debt-to-EBITDA] within about a four-year period.”

Ewing, appearing at the Citigroup Internet, Media and Telecom Conference along with Jeff K. Storey, the president and chief executive officer of Broomfield, Colo.-based Level 3, said that the two companies expect to achieve “about $850 million of operating expense synergies, which is about 5% of op ex [operating expenses] on a pro-forma basis, which is in line with what we’ve achieved in the past and what Level 3 has achieved in the past as well.”

He also noted that the two companies expect to generate an additional $125 million of capital expenditure synergies, “so [there are] significant synergies” from the pending transaction.

When the combination of the two telecom companies was announced on Oct. 31 last year, CenturyLink said in its joint news release that it “expects the transaction to be accretive to free cash flow in the first full year following the close of the transaction and significantly accretive on an annual run-rate basis thereafter.

“Furthermore, the transaction will be accretive to CenturyLink's existing growth profile with additional upside opportunities, including the ability to deploy CenturyLink's and Level 3’s product portfolio across the combined customer bases. With increased network scale, and dense local metro areas and global reach, the combined company will be positioned to further expand internationally.”

Financing plans for merger

During the Citigroup conference, Ewing was asked about the planned financing of the proposed combination.

CenturyLink will acquire Level 3 in a cash-and-stock transaction valued at about $34 billion, including the assumption of debt. Under terms of the agreement, Level 3 shareholders will receive $26.50 per share in cash and a fixed exchange ratio of 1.4286 shares of CenturyLink stock for each Level 3 share they own, which implies a purchase price of $66.50 per Level 3 share, based on a CenturyLink $28.00-per-share reference price, and a premium of some 42% over Level 3’s pre-announcement stock price in the mid $40s.

Upon the closing of the transaction, CenturyLink shareholders will own about 51% of the combined company and Level 3 shareholders will own the remaining roughly 49%.

CenturyLink said at the time of the merger announcement that it intends to finance the cash portion of the transaction and pay related fees and expenses through a combination of cash on hand at CenturyLink and Level 3, and about $7 billion of additional debt.

CenturyLink said that it had received financing commitments from Bank of America Merrill Lynch and Morgan Stanley & Co. LLC totaling some $10.2 billion for new secured debt facilities, comprised of a new $2 billion secured revolving credit facility and $8.2 billion of other secured debt facilities, including the refinancing of debt expected to mature prior to closing of the transaction.

All existing debt of Level 3 is expected to remain in place at Level 3, and Level 3 will not incur any incremental debt or guarantee any debt of CenturyLink to finance the transaction, the announcement said.

Ewing said Wednesday that the financing will include the $2 billion revolver, which he expects will be undrawn at the time the deal closes – currently expected to be Sept. 30 – and a $1.5 billion term loan A facility.

Besides that, he said that “we’re looking at the term loan B markets and the note markets, all secured financing, and as we get a little better line of sight on the closing timeframe and the approval process, we’ll try to pull the trigger on the financing a pretty good bit in advance of the actual closing, just so we can be prepared.”

Ewing went on to say that it’s “a good transaction” for both groups of shareholders, citing the expected synergies.

He also noted substantial tax benefits from the combination, pointing out that “CenturyLink is about to become a cash taxpayer, as we have utilized all of the net operating loss carryforwards that we picked up from Qwest.” CenturyLink acquired the Denver-based former Qwest Communications International, Inc. in a $12 billion transaction completed in April of 2011.

Ewing said that Level 3 “has $10 billion of net operating loss carryforwards, of which we think we can use about $2 billion a year, which will translate into about $650 million or so a year in cash tax savings.

He further mentioned that the merger is expected to be free cash-flow accretive, “so it helps our dividend-payout ratio to where in the fourth year we can get back down to about a 60% dividend-payout ratio.”

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