Level 3’s Analyst Day: Playing Chess

As mentioned in Monday’s blog, I attended Level 3’s analyst meeting on Tuesday in New York. The negativity associated with the post-bubble environment is subsiding as supply and demand come back into balance. Speaking with Kevin O’Hara, Level 3’s president, in the beginning of the decade, Level 3 had some 26 networks it had to compete with, now it is down to 6. So a lot of excess capacity is gone.

Another positive from the meeting was Level 3 CEO Jim Crowe’s consistency regarding the company’s business and its target markets. I focused on this in detail in the our September and November newsletters. Basically, the technological forces that have driven the advancement of the semiconductor and the network is now driving change in the communications industry. Regulation no longer drives network construction, but innovations does.

After five hours of speaking with management, listening to presentations and reviewing over 100 slides, there are certain points that stand out:

• Level 3 is truly the only company that has built a continuously upgradeable network, meaning as new fiber technology comes to market, its conduit approach will provide it with a competitive advantage. (You have to review abovementioned newsletters to understand this.)
• The bandwidth-consumption trend continues: The movement from email to music to video is happening. If you or your child has a video ipod, you see this first hand. An interesting stat–standard television transmission uses 450x the bandwidth of an email. High definition TV will consume 3,000 x the bandwidth of an email. As per unit pricing drops for bandwidth, these newer applications can become available. Level 3 should lead this price-performance curve.
• Comcast indicates that a large percentage of its network capacity is used by bittorrent.com, a video peer-to-peer network, similar to Napster in the 1990s with music. As Napster’s distribution method was found to be illegal, there will be issues about bittorrent’s distribution of video, but as we see with Apple’s perfectly legal success with music, these new technologies (whether legal or not) accurately forecast where the market is going. And the market is moving to higher bandwidth applications. In this case, Comcast provides access to the Internet at the local level, but uses Level 3’s network for the longer haul transmission. Network providers cannot afford to build both local and long haul capacity.
• 55% of of network traffic is now peer-to-peer and 20% is streaming video or music. More support of high bandwidth consumption applications.

Technology success has been obtained by understanding the philosophical forces behind it. As with Moore’s Law and Metcalfe’s Law, Level 3 seems to understand this better than anyone else in the industry. It is a game of chess, can the relatively new up-start lead by Jim Crowe out maneuver the old-time baby bells. I think he will. This most likely is the very early stages of an industry recovery, even though the stock has moved up considerably the last week, this stock should be held on to for a long time.

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