Steeny, BARRON'S ON CABLE/FIBEROPTICS. COVER ARTICLE.
June 14, 1999
No Mercy
Level 3's Jim Crowe wants to crush his foes in the fiberoptic
wars
By Jonathan R. Laing
Small wonder that Jim Crowe is known as the Baron of Broadband in the
high-profile, hotly-competitive telecommunications industry.
While an employee of Peter Kiewit Sons' in the
late-'Eighties, Crowe spearheaded an effort by
the Omaha-based construction firm to lay
fiberoptic cable under the streets of dozens of
major business centers in the U.S. and Europe.
The idea was to offer bandwidth-hungry
businesses a money-saving way to route their
voice and data traffic past the Bells and other
local monopoly providers. The Bells, of course,
loathed Crowe and his renegade unit, MFS
Communications, for skimming the cream off their
customer base.
Reminded of this during a recent interview, a
chuckling Crowe says, with a refreshing touch of
malice: "As if the Bells haven't been
cream-skimming for years by concentrating their efforts on the affluent
metropolitan markets, while relegating the remote rural areas of the U.S. to
independent phone carriers."
MFS's business boomed, and Wall Street soon took notice. Between the time
the stock went public in 1993 and Crowe and Kiewit sold MFS to
WorldCom for $14.3 billion three years later, the shares jumped sixfold.
Crowe and Kiewit Chairman Walter Scott together walked off with nearly
$700 million in WorldCom stock and options.
Now, Crowe is back with an even more audacious broadband venture after a
brief tenure as a senior executive at WorldCom. Called Level 3
Communications, this other spinoff from Kiewit proposes nothing less than to
build a huge broadband trunk-line network over the next three to four years.
It would span some 24,000 miles, blanketing the U.S. and, with the help of
under-ocean cable, reaching much of Western Europe and key business
centers in Asia. This spider web of inter-city and continental routes would, in
turn, link up with Level 3 local loops in some 70 business centers on three
continents and even extend its fiberoptic filaments into high-traffic office
buildings. End-to-end connectivity, in other words, with a pipe offering
unmatched capacity and speed.
It's a grandiose scheme reminiscent of the 19th century railroad construction
boom. Interestingly, many of the trenches carrying the new fiberoptic pipelines
of companies like Level 3 and rivals such as Qwest Communications
International and IXC Communications, are even following the right-of-ways
of the old Southern and Union Pacifics, the Santa Fe and the Burlington.
Shared terminology only strengthens the parallels. Both industries carry
"traffic" from local "feeders" to "trunklines" and back, employing elaborate
"switching" systems.
Qwest's founder and controlling shareholder, Philip Anschutz of Denver, was
even a railroad magnate before getting into telecom. Transporting bits has
proven a lot more lucrative than carrying coal, lumber or wheat. His holding in
Qwest has a market value exceeding $14 billion.
Crowe, of course, is counting on Level 3's fledgling network to catch the curl
of surging Internet flow and the convergence of phone, data and video traffic
on to single networks. "We're not looking to get just 4% or 5% of the
traditional vertically integrated telephony market and be content to live in
AT&T's shadow," he avers. "We think that technological change is in the
process of blowing the telecommunications industry apart and that we can be
the dominant, low-cost player in the business of transporting data."
A bold ambition, indeed. Even Crowe concedes that it won't be a slam dunk
for Level 3. For one thing, high-capacity fiber networks have proliferated in
recent years with companies like Qwest, IXC, Frontier Communications,
GTE and the Williams Cos. near completing extensive inter-city networks of
their own. The dominant oligarchs AT&T, MCI WorldCom and Sprint have
large fiber networks, too, though antiquated and high-cost. Even utility
companies like Enron and Montana Power are in the fiber game.
Much of this fiber lies "unlit" (unused) in conduits, stockpiled for future
demand. Moreover, breakthroughs in laser technology, signal multiplexing and
fiber technology promise to expand the traffic capacity of lit fiber strands by
many multiples.
In addition, Level 3 remains something of a financial high-wire act. The
company expects to chew through some $8 billion-$10 billion in operating
expenses and, mainly, its frantic buildout. (So far, it's completed just 1,400 of
its planned 16,000-mile U.S. inter-city network, for example.) It doesn't
expect to generate sufficient cash flow to self-fund continued expansion until
the year 2003 or so.
The company already has funded much of this capital cost through assets that
Kiewit contributed, a wildly successful junk bond and equity offering and
construction cost-sharing agreements with such respected telecom operators
as Craig McCaw's Next group and Great Britain's Colt Telecom. Still, any
shortfalls in anticipated revenues may make it difficult for Level 3 to raise the
additional $2 billion-$3 billion it will require to finish its planned network.
This year, for example, some two-thirds of its expected $500 million in
revenues will come from a coal mining operation, a cable-television and
telephone company and a computer outsourcing firm that Kiewit left inside
Level 3 to tide it over during its early years. Even the rosiest Wall Street
projections don't show Level 3 turning cash flow positive until 2002 or
earning a profit until 2004.
Finally, Crowe is making a huge bet that Level 3 can siphon a share of
high-margin voice and fax telephone traffic from long-entrenched players like
AT&T and MCI WorldCom by using a lower-cost but yet-to-be-perfected
technology employing Internet Protocol.
With all this, a number of Wall Street analysts fervently believe in Crowe and
Level 3's ability to deliver. Indeed, the stock, which began trading on Nasdaq
in April 1998 around 30, vaulted to more than 100 in April this year before
settling back to the low 70s last week. At current prices, Crowe has seen his
$60 million investment in Level 3 rise to around $850 million, while the shares
of Walter Scott, chairman of Level 3 and chairman emeritus of Peter Kiewit,
are worth about $2.7 billion.
Even with the stock's recent decline, Level 3 boasts a market capitalization
(stock price times shares outstanding) around $25 billion. While only a
fraction of AT&T's market cap of over $200 billion and Southwest
Bell/Ameritech's $180 billion, Level 3's market value is still extraordinary for
what, in essence, is a startup. Sprint, for example, has a cap of roughly $50
billion despite its years of profitability and revenue growth.
Yet many telecom analysts deny that Level 3 is overvalued. David Barden of
J.P. Morgan Securities argues that the low-cost bandwidth that Level 3 will
offer should result in exponential gains in the company's revenues and
profitability. He sees Level 3's communications revenues growing at a 60%
compound annual rate over the next five years and at a 45% yearly clip over
the next 10. He comes up with a fair value (based on market cap plus net
debt) of about $80 a share by year-end, based on his conservative
discounting of future cash flow, which he expects to ramp up from a negative
$348 million this year to a positive $7 billion in 2008.
He also asserts that the stock should at least double over the next two to
three years, based on the company's net investment of $7 billion in property,
plant and equipment at the end of 2001. Prevailing market caps in the telco
industry currently run around seven times net fixed assets. Seven times seven
is, of course, 49.
And, Barden contends, broadband companies like Level 3 will be attractive
takeover targets, especially to Bell companies looking to offer high-speed
Internet access and long-distance service once regulatory strictures are
removed. Last week, for example, BellSouth disclosed that it is considering
buying the 90% of Qwest it doesn't already own. (Qwest itself also is
rumored to be considering buying US West.) Companies including SBC
Communications, Intel and a Mexican phone carrier plan to make substantial
investments in Williams Cos. once the telecommunications subsidiary of the
natural-resources company goes public, as it soon plans to do.
"Level 3's state-of-the-art network will be enabling technology that will help
unleash incredible demand growth and devour any excess capacity," Barden
insists. "If you look at how cellular telephony has surpassed even the most
aggressive growth forecasts of analysts like me, you'll get a notion of what lies
ahead for broadband on a much bigger scale. I think that lightning is going to
strike twice for Jim Crowe because nobody can build networks like he can."
According to telco analyst Tom Friedberg of Janco Partners, an
Englewood, Colorado-based securities firm, Level 3 now boasts as close to a
"bulletproof" balance sheet as any new company. Friedberg says it has
enough financing in place to get the bulk of its network up and running over
the next three years. And, he adds, Level 3's shiny technology could make it
the low-cost competitor in its markets.
But in Friedberg's view, Level 3's biggest edge
comes from the charismatic Jim Crowe and the
battle-tested but young management team he has
assembled. Some 18 of his top 20 executives filled similar slots at MFS. Most
made enough as result of the WorldCom buyout to retire comfortably. Yet
they all answered Crowe's call when he was putting Level 3 together. All are
working for modest salaries, leavened by fat stock-option packages that may
be the most shareholder-friendly in Corporate America. The exercise price of
the quarterly awards is indexed to the S&P 500. Level 3 must beat the
popular stock-market index for the executives, including Crowe, to get
anything.
"At this point, Level 3 is largely nothing but Jim Crowe's vision and will remain
so for the next year or two. Yet there's nobody better in conveying a story to
both his employees and Wall Street and making people believe than Crowe.
It's a heck of a lot easier to justify Level 3's stock valuation than that of most
Internet stocks because Crowe has cash, a believable strategy and has
delivered huge wealth before," Friedberg observes.
Barron's got a taste of the evangelistic Crowe style during a free-wheeling
two-hour interview with the pug-nosed 49-year-old at the Kiewit's
nondescript headquarters building in Omaha. Crowe was preparing to move
to Denver, where Level 3 is completing a $70 million campus headquarters
complex in the foothills of the Rockies.
Many of his gifts were in ample evidence. An engineering grad of Rensselaer
Polytechnic Institute in Troy, New York, he has a firm grasp of the
technology of the telecommunications and computer industries. Yet he's able
to express himself in clear layman's language without resort to the jargon or
acronyms of the average Bellhead. He has a sophistication about the
intricacies of business strategies, earnings models and the care and feeding of
Wall Street that go far beyond anything he might have picked up earning his
MBA on weekends at California's Pepperdine University. He has an
irreverent sense of humor, particularly when talking of his past or his
competition. Why did he end up at Rensselaer? "I liked the fact that the
drinking age [in New York State] was just 18 at the time," he answered. And
what of the monopoly status that the Bell system and so many national phone
carriers around the world enjoyed for so many years? "It was based on the
mistaken notion that they needed protection as natural monopolies because of
the capital intensity of their operations. Yet what society ended up getting in
return for its trouble was waste, inefficiency and sluggish innovation."
Cover Story, Part 2
No Mercy, Part 2
Cover Story, Part 1
But perhaps Crowe's forte has been his ability to grasp the big, strategic
picture in an industry where change seems to be moving at warp speed. For
example, he claims that the very technological makeup of Level 3 was a direct
result of an "epiphany" he had in 1995. Flipping through a consultant's report,
he came across a chart that fairly took his breath away. It showed that the
cost to fax a 42-page document over AT&T phone lines from New York to
Tokyo cost $28.83 at the time, compared with just 9.5 cents to e-mail the
very same document.
"I realized that we were about to witness a technological shift -- as
fundamental as the change from the telegraph to the telephone or the
mainframe to the PC -- and that I'd better be in front of the wave or risk
being left behind," he recalls. "The old phone system of twisted copper wires
and antiquated optical fiber, which had served us for so many decades, was
destined to go the way of the dinosaur in the face of the vastly superior, new
Internet Protocol-based networks.
The root advantage of Internet Protocol networks is simple. Traditional phone
networks rely on a 100-year-old methodology called circuit-switching to
connect two parties, whether they are at either end of a long-distance call, a
fax or a data exchange. An entire line or circuit is tied up for the duration of
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