Upgrading Level 3 to Accumulate; One Shoe Left to Drop

We are upgrading LVLT to an Accumulate rating since we think that the recent management changes will finally put the company on the right path to improving sales, provisioning and cash flow. LVLT announced major management changes this morning with President and COO Kevin O’Hare stepping down immediately. Sunit Patel has been reinstated as CFO and Neil Hobbs—who had been elevated in charge of sales and provisioning over the last six months--will assume some of Kevin’s responsibilities and become Executive VP of Operations. We see these changes as very constructive for Level(3) since we have been hearing very good things about Neil Hobbs internally. Since Kevin O’Hare was COO, most of the provisioning issues and loss of enterprise sales force happened on his watch.

Regarding our reference to “one shoe left to drop,” we think that consensus estimates for EBITDA at $950m are still too high and need to be adjusted down...Our EBITDA estimate for 2008 is $884 million, which is below LVLT’s guidance of $950 – 1100 million. LVLT recently changed its guidance from quarterly to annual guidance, but we would expect them to have to change their annual guidance range after the first or second quarter...Looking forward, we think that LVLT has started to turn the corner operationally and will gradually show accelerating core telecom sales and improving margins. We have been hearing positive anecdotes from current and past employees on more discipline on capex and on cost control.

With the stock slightly below $2.00/share it is still priced at 10x 2008 EBITDA, but we think the company is turning the corner and will be free cashflow on a sustainable basis in the second half of 2008. We do not think that Level(3) will be forced into bankruptcy since they do not have any near term debt maturities in 2008, and should be able to refinance their 2009-2010 debt maturities if they can show provisioning improvements...Our near term price target is $3/share which is 8.5x our 2009 EBITDA estimate.Longer term, we think that EBITDA margins can improve to the mid 20% range and that LVLT will be able to refinance its debt at more attractive rates, so the stock can continue to move higher if they can grow sales profitably.