1 Perspective on the Carrier Market: Is there light at the end of the tunnel? Sureel Choksi Level 3 Communications

2 Life a Year Ago

3 Summary of the Past Year

4 Only a portion of the market caps of all of these companies are known from 11/00 (Level3, Global Crossing, ITC Deltacom, MFN, and Neon). Their average loss from 11/5/00 to 5/10/01 was 70%. The other companies market cap of 11/5/00 was calculated based on this average loss. Market Value of Emerging Carriers 1-year decline from $168B to $14B

5 Wall Street’s Perspective “It’s the end of the world as we know it” - REM

6 Reality “Rumors of our demise are greatly exaggerated” - Mark Twain

7 Today’s Agenda  What went wrong in the communications services industry?  Current state of the carrier market  Wall Street perspective  What should carriers do in this environment?  Where does Level 3 fit into all of this?

8 What Went Wrong?  The 1996 Telecom Act opened the market for competition  Investment thesis:  Demand for bandwidth is unlimited  Incumbents were viewed as slow-moving  Improvements in optics and IP fundamentally changed economics of communications  Assets are worth at least 2-3x cost for facilities-based carriers  Capital markets for capital intensive communications industry were free flowing  Over $150 billion in capital raised by emerging communications providers in 1999 and 2000

9 Early Signs of Trouble  Capital availability was virtually unlimited  Several “me too” business plans  Sum of companies’ projections were 2x market size  Dot-com fever spread to communications industry  Liberal interpretations of the term “fully funded”  Financial engineering by certain companies

10 Evidence of the “Me Too” Phenomenon  Europe as an example (1) :  29 long haul networks constructed or partially constructed in Europe  21 consist of swapped fiber and/or limited reach  8 are conduit-based networks  Approximately 40% are financially distressed today  At least 8 are in the process of shutting down or exiting  Consolidation activity is limited to date (1) Source: Level 3 Analysis

11 Catalysts to the Decline A “perfect storm” of:  The dot-com growth followed by implosion  Slowing economy  Bandwidth supply / demand imbalance  Shutdown of the capital markets to newer carriers  Reduced revenue projections exposed significant funding gaps for certain companies

12 What Happened to Bandwidth Demand? First, the bad news: n Demand was “exaggerated” by emerging carriers and dot-coms n Companies were purchasing bandwidth well in advance in anticipation of exponential growth that did not materialize n Economic downturn has reduced short-term demand n As a result, there is generally a supply / demand imbalance

13 What Happened to Bandwidth Demand? Now, the good news: n End user demand for bandwidth continues to grow at a rapid rate n Even the most bearish industry assessments of unit growth are % per year n The industry is under-investing in capacity n Supply / demand imbalance is temporary

14 Affected Sectors Emerging fiber backbone carriers CLECs / DLECs / BLECs ISPs Colocation / Hosting LD carriers, wireless companies, RBOCs and PTTs are in a separate category

15 Chapter 11  Over 50 emerging carriers have filed Chapter 11 in the past 12 months (1), including:  360 Networks  Exodus  Iaxis  Viatel  Winstar  PSINet  Most companies facing liquidation rather than a reorganization  Teligent  Covad  Rhythms  Northpoint  ICG (1) Source: JP Morgan Securities

16 Current Wall Street Perspectives n Shaken investor confidence as a result of unexpected bankruptcies and liquidations n Too much competition and too much leverage n Market is unable to differentiate between winners and losers n Timing of economic recovery is uncertain n The result….

17 The Dichotomy of Market Views  The market is struggling to value emerging carriers  Banks, bondholders and equity investors have widely diverging views  Level 3 capital structure: 10x difference!

18 What are Carriers Doing in This Difficult Environment?  Scaled back business plans  Back to basics  Focusing on sales to customers that can pay their bills  Differentiate through operational capabilities, not pricing  Reducing expenses to weather the storm  SG&A  Capital Expenditures  Selling non-core assets  Restructuring the balance sheet  Consolidation?

19 Capital Spending Projections  A recent Bernstein Research report provided capital spending projections.

20 What Role will Consolidation Play?  “Elimination” will outpace consolidation  Most distressed companies will be forced to liquidate at 5 to 20 cents on the dollar  Acquisitions will be focused on acquiring valuable customer relationships, as opposed to network assets  Major industry consolidation would require restructurings  High yield 101% change of control provisions would have to be waived

21 There is Good News…  There will be fewer competitors  Those that survive will prosper  The economy will improve  The supply demand imbalance is temporary

22 What Factors Will Determine Who Survives and Prospers?  Realism  Liquidity  Ability to restructure balance sheet to create value  Ability to generate cash flow (versus revenue growth)  Focus on areas of competitive advantage  Operational capability

23 Why Level 3 is Well Positioned  See previous slide!