OREANDA-NEWS. Fitch Ratings has assigned a 'BB/RR2' issue rating to Level 3 Financing, Inc.'s (Level 3 Financing) issuance of senior unsecured notes due 2026. Level 3 Financing is a wholly owned subsidiary of Level 3 Communications, Inc. (LVLT). The Issuer Default Rating (IDR) for both LVLT and Level 3 Financing is 'BB-' with a Stable Rating Outlook. LVLT had approximately $11 billion of consolidated debt outstanding on Dec. 31, 2015.

Proceeds from the senior note offering are expected to be used to redeem $775 million outstanding aggregate principal amount of Level 3 Financing's 7% senior notes due 2020. The notes currently have $775 million aggregate principal amount outstanding. The new notes will rank pari passu with Level 3 Financing's existing senior unsecured indebtedness. Outside of the extension of the company's maturity profile and an expected reduction of interest expense related to this transaction, LVLT's credit profile has not substantially changed.

KEY RATING DRIVERS

Leverage on Target: LVLT remains committed to deleveraging to the low end of its target of between 3x to 4x net leverage. The enhanced scale and ability to generate meaningful free cash flow (FCF) resulting from TWTC reinforces Fitch's expectation for further strengthening of LVLT's credit profile. The company's leverage was 4.2x as of the latest 12 month (LTM) period ended Dec. 31, 2015 as the company is clearly operating within its net leverage target. Fitch foresees LVLT leverage will further strengthen during 2016 with leverage approximating 3.8x by year-end 2016.

Strengthening Credit Profile: LVLT's credit profile continues to improve in line with Fitch's expectations as the company capitalizes on its on-going revenue mix transformation, growing high-margin core network services revenues, and the cost and revenue benefits associated with the TWTC acquisition. Fitch anticipates LVLT's credit profile will continue to strengthen over the ratings horizon as the company benefits from anticipated EBITDA growth, strong FCF generation and modest debt reduction.

Synergies Fuel Margin Expansion: The integration of TWTC is LVLT's highest priority as an organization and the key integration and synergy assumptions the company disclosed when the transaction was announced remain unchanged. The company has realized cost synergies faster than Fitch's expectations. Since the transaction closed, Level 3 has achieved approximately $216 million of annualized run rate EBITDA synergies through the end of 2015, which exceeds its target of $140 million by the end of the first quarter of 2016 (1Q16) and $200 million total.

FCF Enhances Credit Profile: LVLT is poised to generate sustainable levels of FCF (defined as cash flow from operations less capital expenditures and dividends). Fitch believes the company's ability to grow high-margin core network services (CNS) revenues coupled with the strong operating leverage inherent in its operating profile position the company to generate consistent levels of FCF. Fitch anticipates LVLT FCF generation will exceed 11% of consolidated revenues by year-end 2016 on a pro forma basis.

Revenue Mix Transformation Proceeding: LVLT's operating strategies are aimed at shifting its revenue and customer focus to become a predominantly enterprise-focused entity. The company's network capabilities, in particular its strong metropolitan network along with a broad product and service portfolio emphasizing IP-based infrastructure and managed services, provide the company with a solid base to grow its enterprise segment revenues.

Strong Operating Leverage: The products and services LVLT sells combined with its strategy to sell services 'on net' enable the company to generate significant operating leverage. At scale, the services sold within this business segment generate 60% incremental EBITDA margins. From Fitch's perspective, the company must be successful in growing the CNS revenue base to improve its credit profile and generate FCF.

Overall, Fitch's ratings incorporate LVLT's improving competitive position while acknowledging its smaller market share and lack of scale relative to larger and better capitalized market participants. The ratings for LVLT reflect the company's strong metropolitan network facilities position relative to alternative carriers, as well as the diversity of its customer base and service offering, and a relatively stable pricing environment for a significant portion of its service portfolio.

Outside of material change to its financial strategy, ratings concerns center on event-driven merger and acquisition activity and the resultant increase in integration risks, and the sensitivity of the company's operating profile to the effects of a weaker economic outlook or a more competitive operating and pricing environment. Fitch expects that M&A activity will remain a key component of LVLT's overall growth strategy. M&A is expected to focus on building incremental network and product capabilities and building scale in Europe and Latin America.

Leverage and Financial Policy

The focus of LVLT's capital structure strategy is to strengthen the company's overall credit profile and efficiently manage its maturity profile. LVLT remains committed to deleveraging to the low end of its target of between 3x and 4x on a net debt basis. The pace of further deleveraging will largely depend on the company's ability to leverage cost synergies and capitalize on incremental EBITDA growth stemming from the positive operating momentum within LVLT's CNS segment.

Total debt outstanding as of Dec. 31 2015 was approximately $11 billion, reflecting a modest 3% decline relative to the $11.4 billion of debt outstanding as of Dec. 31, 2014. LVLT's outstanding debt materially increased during 2014 to facilitate the tw telecom acquisition. Leverage as of the LTM period ended Dec. 31, 2015 was 4.2x and is expected to decrease to 3.8 by year-end 2016.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case include:
--LVLT continues to optimize network expenses and leverage the cost synergies related to its acquisition of tw telecom.
--CNS revenue growth ranging between 2% and 3% driven by continued strong growth within the company's North American Enterprise segment.
--LVLT's network access margin (gross margin) growing to over 67% by year-end 2017.
--Capital expenditures will approximate 15% of consolidated revenues.
--FCF generation exceeding 10% and 12% during years ended 2016 and 2017, respectively.
--Debt levels are expected to remain relatively consistent and Fitch anticipates that LVLT will repay the floating-rate notes due 2018 ($300 million outstanding Dec. 31, 2015) with available cash on hand.

RATING SENSITIVITIES

What Could Lead to a Positive Rating Action:

Positive rating action would likely coincide with the expectation that Level 3 will maintain leverage at 3.5x or lower while consistently generating positive FCF with FCF/adjusted debt of 8% or greater. Additionally the company will need to demonstrate positive operating momentum characterized by consistent core network services revenue growth, gross margin expansion, no material delays in achieving anticipated cost synergies, and lack of a material erosion of revenue churn.

What Could Lead to a Negative Rating Action:

Negative rating actions are more likely to coincide with a perceived weakening of LVLT's operating profile, as signaled by deteriorating margins and revenue erosion brought on by difficult economic conditions or competitive pressure. Additionally, negative rating actions could result from discretionary management decisions including, but not limited to, execution of merger and acquisition activity that increases leverage beyond 5x in the absence of a credible deleveraging plan.

LIQUIDITY

LVLT reported $626 million of FCF generation during the LTM ended Dec. 31, 2015. Based on public guidance, the company expects to generate FCF ranging between $1.0 billion and $1.1 billion during 2016, which is in line with Fitch's expectations. Looking forward, FCF generation should accelerate as integration costs diminish and cost synergies materialize. Fitch anticipates LVLT FCF generation will exceed 12% of consolidated revenues by year-end 2017. In addition to LVLT's positive operating momentum driving EBITDA growth, additional factors such as interest expense savings derived from capital market activities and on-going operating cost optimization efforts position the company to grow FCF during the ratings horizon.

Fitch believes that LVLT's liquidity position is adequate given the rating and that overall financial flexibility is enhanced with positive FCF generation. The company's liquidity position was primarily supported by cash carried on its balance sheet, which as of Dec. 31, 2015 totaled approximately $854 million and expected FCF generation. Importantly, there are no restrictions on the company's ability to repatriate foreign cash (other than the conversion and repatriation restrictions existing in Venezuela and Argentina) to fund domestic operations including debt service. The company does not maintain a revolver, which limits its financial flexibility in Fitch's opinion.

LVLT's maturity profile is manageable within the context of FCF generation expectations and access to capital markets. The company does not have material scheduled maturities during the remainder of 2016, and the next scheduled maturity is not until 2018 when approximately $300 million of debt is scheduled to mature.

FULL LIST OF RATING ACTIONS

Fitch currently rates LVLT as follows:

LVLT
--IDR 'BB-';
--Senior unsecured notes 'B+/RR5'.

Level 3 Financing, Inc.
--IDR 'BB-';
--Senior secured term loan 'BB+/RR1';
--Senior unsecured notes 'BB/RR2'.

The Rating Outlook is Stable.