(FORTUNE Magazine) – On the south side of Omaha, less than a mile west of the Missouri River, sits one of that city's leading tourist attractions: the famed Omaha zoo. Sure, there are those who will quietly snicker at the notion of Nebraska having a top-notch zoo--coastal snobs, no doubt, who think the fairest fauna are limited to the Bronx or to San Diego. But Omaha has one damn fine zoo. Trust us on that.

It wasn't until the 1970s, however, that the zoo--founded nearly a century earlier with a pair of bison on loan from Buffalo Bill--truly became a star attraction. That's when Omaha's most beneficent citizen lassoed the local business community into donating tens of millions of dollars. The same businessman, for that matter, was also a driving force behind the city's new art museum, the engineering institute, and the Nebraska game and parks foundation.

Here--and especially if you're a longtime reader of FORTUNE--you might be guessing that this citizen-philanthropist is none other than Warren Buffett, the Oracle of Omaha, the legendary investor and grand pasha of Berkshire Hathaway, who is certainly the city's (and perhaps history's) most famous businessman. But you'd be wrong. This isn't a Buffett story. (Sorry.) In fact, while locals hold Mr. Buffett in the highest regard, he is not perceived as Omaha's primary benefactor. That distinction goes to Omaha's other eminence grise--an unflappable, balding 71-year-old named Walter Scott.

Round-shouldered and with the slightest paunch, the city's first citizen has something wonderfully avuncular about him. He has a quiet dignity. As much as Buffett is sage and statesmanlike in his public appearances, Scott--who made his fortune as a construction company executive building highways, tunnels, and dams--is salt of the earth. Buffett, a close friend for decades, has a simple phrase that pretty much sums up Scott: "Walter is a builder."

Indeed, it is this image that makes Scott's other daytime role even more strange and compelling. For Omaha's civic guardian is also the protagonist in the astounding tale of telecom networking company Level 3, a modern business saga befitting Homer--an epic that ropes in not just Buffett (yes, he's in it after all) but also Bill Gates, billionaire Craig McCaw, and famed fund manager Bill Miller. In its twists and turns you'll find WorldCom's embattled ex-CEO Bernie Ebbers and Salomon Smith Barney's scandal-tainted telecom analyst Jack Grubman, once one of the hottest stars on Wall Street. At its heart is the rise and fall of the easy-money Internet, the spectacular collapse of the telecom sector--a failure that gets more colossal and dispiriting every day--and billions of dollars of losses by ordinary investors in a single, 723,000-strong city on America's Great Plains. (For more on WorldCom, see "Is There Any Way Out of the Telecom Mess?")

But more amazing, perhaps, is that plainspoken Walter Scott, as founder and chairman of Level 3, may actually have one of the few tickets out of this mess. When all is said and done, his company--and yes, here's our Homeric finale--may actually...survive. It may even be that a host of investors from the Cornhusker State, who clung faithfully to the stock as it fell from $130 to $30 to $3, will actually get back a tiny portion of their investment.

Not that this is a fairy tale. We should point out at the start that Level 3--which has seen its market cap sink from $44 billion in March 2000 to $1.3 billion today--will never return to the lofty levels of the bull market. Those heady days simply aren't coming back. But of all the so-called telecom infrastructure companies now on life support, Scott's Level 3 may actually have the best shot of breathing in the next two years.

In fact, as FORTUNE went to press, rumors were floating around that outside investors were about to make a sizable cash infusion into the company--perhaps hundreds of millions of dollars in equity. That, of course, speaks volumes in this environment. There are reasons for this unthinkable optimism--technological, management, and yes, even accounting reasons. But in the oddest twist, the biggest thing Level 3 has going for it are the shareholders who have seemingly lost everything: mostly, the good citizens of Omaha. Remarkably, perhaps even incredibly, they remain true to Walter Scott.

The local Lexus dealer. A prominent banker. The founder of a credit card company. The nephew of Warren Buffett. Each of them is out a bundle. There are hundreds, probably thousands of investors in Omaha who have suffered combined losses in Level 3 stock equal to tens of billions of dollars. "I personally know at least five people who've lost $20 million or more in this stock," says Ron Carson, head of local investment firm Carson Wealth Management.

The city feels their collective pain. Sales at Borsheim's, the high-end jewelry store that Buffett's Berkshire Hathaway owns, were down in 2001 for the first time ever, in part because locals were pinched by losses in Level 3. But the economic fallout appears to be manageable. The more significant effect may be psychological. Investing meltdowns just aren't supposed to happen in Omaha. This is a town where business leaders have impeccable ethics, and the smarts to go with them. This is a town strewn with multimillionaires and comfortable retirees. This is a town where investing is for the long haul. "There's a lot of pride in Omaha. It has a great work ethic, the Midwest work ethic you hear about," says Level 3 investor Denny Walker. To people like Walker, Level 3 wasn't so much a highflier of the bull market, it wasn't even so much a stock. It was an Omaha company--a company in a town, as locals like to remind you, that has five FORTUNE 500 names based there.

If you haven't been there, Omaha is probably different from what you imagine. It's more wooded than bare; hilly, not flat. What is likely to be close to your preconceptions, however, are the steak houses. There are loads of them in this erstwhile cattle town, everything from meccas like Piccolo Pete's and Johnny's to (sacrilege!) a couple of Outbacks. And then there's Gorat's.

Gorat's is rustic and dark, but the food is good, and not surprisingly it's a terrific value. It's Warren Buffett's favorite restaurant in town, where he has held more than a few high-powered tete-a-tetes over the years. Gorat's is the perfect place to sit down, enjoy a nice cut of beef, and ask Buffett (who, for the record, orders a T-bone and a Cherry Coke) about his dear friend Walter Scott.

While he never discusses his stock holdings, Buffett is happy to talk about Scott. And over a long, rambling conversation and a three-course, two-hour dinner, Buffett's affection for his fellow Omahan becomes clear. "A lot of people like to make simple things complex. Walter does the opposite. He has an ability to cut through what's complicated," says Buffett, picking at some cottage fries. "He is also a man who gives you his word, and that's it. He is a person of great integrity. People here have tremendous respect for him."

Buffett and Scott both work in the Kiewit Plaza building, which is high on a hill overlooking the city. Scott has been on the Berkshire board since 1988--for a time he was the company's one-man audit committee. But their ties go back even further. "I first got to know Walter when we were teenagers, really," Buffett says. "We both had a crush on the same girl, Carolyn Falk. She was the daughter of my father's [business] partner. Walter won her, and they ended up getting married." Hardly the way to kick off a lifelong friendship, but Buffett and Scott grew close over the years as their careers blossomed more or less simultaneously.

With such a longstanding relationship, Buffett must have invested in Level 3 stock, right? "I won't comment on that," he says, working on a chocolate sundae. Which means either he doesn't own any, or the amount he owns is too small to disclose in Berkshire's financial statements. Or he could own its bonds. Things could change, of course. When Berkshire Hathaway vice chairman Charlie Munger was asked at his company's annual meeting in May whether he would buy Level 3, he replied, "It's very hard to guess the future, but it's conceivable. We have a history of occasionally wading in when no one else will."

What Level 3 does isn't easy to understand, given that even the most basic explanations are laced with new-economy jargon. But here's how it works in the simplest terms: It sells broadband capacity on its spanking-new fiber-optic network. Most of Level 3's customers are big-kahuna Internet service providers (ISPs) and portals, such as AOL (its biggest customer), Microsoft, and Yahoo, which require highly advanced transmission lines to send reams of data at lightning speeds. Let's say you're an MSN customer and you live in a city where Microsoft uses Level 3's network. When you click on any Web address, the signal goes from your computer through Level 3's network to MSN servers and then back again--except for the so-called last mile, it never passes through copper wire or even a circuit switch. The passage is instant.

The technology, by most expert accounts, is impressive. It's both low-cost and easily upgradable. "The Level 3 network is considered to be better, thanks to an automated system that can add fiber capacity," says Eli Noam, a professor of finance and economics at Columbia University Business School.

But it wasn't the newfangled bells and whistles that impressed so many of Level 3's early investors. It was the founder. Says Omaha attorney Thomas F. Dowd, who hasn't sold a share even as his paper losses have exceeded $1.3 million: "Walter Scott is the reason, probably, that most Omahans put so much money in the stock."

Fiber optics is light years from where Walter Scott began his career 54 years ago, when he took a job at Peter Kiewit Sons' construction. Dutch immigrant Peter Kiewit founded the business in 1884 and began building things like the majestic ten-story Livestock Exchange Building in Omaha's meatpacking district. The company went on to construct enormous projects such as the Fort McHenry tunnel beneath Baltimore Harbor and the Flaming Gorge Dam in Utah. Kiewit also built much of the Interstate Highway System in the West. When Scott became CEO in 1979, the company was generating tremendous amounts of cash, as it still is today. That helped account for the bountiful rise in Kiewit's privately held stock, which was bought by younger employees at less than book value and sold by retiring employees back to the company, also at less than book.

Kiewit always generated more cash than it could use, so the company was forced to invest outside the construction business. Over the years, Kiewit bought into coal mines, toll roads, and cable TV, but in the 1980s the company began to focus its investments on the telecommunications business. At the fore of this move was Jim Crowe, who came to Kiewit from Morrison Knudsen before that giant construction company famously went bust.

Though a man blessed with serious brainpower, an intense vision, and a physical presence to match, Crowe, who is Level 3's CEO, is not as beloved as Scott is in Omaha. Detractors whisper that unlike Scott he is a bit of a spendthrift, and likes to collect fancy houses--he's got them in Idaho, Arizona, and Colorado. Still, he commands respect. When you meet Crowe you aren't surprised to learn that his father, Henry Crowe, was a highly decorated World War II Marine Corps major. Jim Crowe didn't go into the service himself, but he does have a military bearing.

At Crowe's urging, Kiewit bought a company called Metropolitan Fiber Systems, which built circuit-switch and fiber-optic networks for phone companies. By 1987, the company was renamed MFS and was building its own networks. It quickly became one of the nation's biggest CLECs, or competitive local-exchange carriers. Then, in 1993, MFS was spun out of Kiewit and taken public, a move that greatly boosted the net worth of Kiewitites who had bought into MFS before its public offering. That was the first time many Omaha investors got rich off a Scott venture.

The good times were just starting. The Internet was about to raise the financial stakes exponentially.

Every two years a group of about 50 Buffett intimates, including Scott and Bill Gates, gather at a venue for an informal multiday potlatch. In 1995 the location was Ireland's K Club, a splendid estate turned into a hotel and golf course. Gates gave a talk about how the Internet would be a revolutionary force and how he was repositioning Microsoft to meet that challenge. He also mentioned that the Net could destroy the businesses of traditional phone companies. That got Scott's attention. "Yes, Bill's talk is probably what got us thinking about the Internet," acknowledges Scott.

Scott and Crowe concluded that they should find a business that played off the infrastructure of the Net and wed it to MFS. The most attractive buy was an "Internet backbone" company named UUNet, then headed by John Sidgmore (who's now CEO of WorldCom). In April 1996, MFS bought UUNet for $2 billion, a record price for an Internet company. Meanwhile, down in Mississippi, WorldCom CEO Bernie Ebbers must have watched mushrooming MFS with some alarm. MFS looked to be a step ahead of his burgeoning empire. Ebbers had a solution: Buy MFS! In late August he offered an astonishing $14 billion of WorldCom stock for MFS.

The buyout was a boon for hundreds of longstanding Kiewit employees. "People made a bunch of money on MFS," says Omaha investor Ron Carson. "That set the stage for people buying Level 3. It reinforced the idea that Kiewit never misses. But people began to think about it like you could get rich overnight."

Scott put Crowe in charge of what was called Kiewit Diversified Services--basically all of Kiewit's businesses and investments in companies other than construction. Crowe hatched a plan to build a new company like MFS from the ground up--but this time it would construct a long-haul fiber-optic-only network based on Internet protocol. He rehired 18 of his former key MFS lieutenants from WorldCom and got to work.

Kiewit's privately held class C shares, which tracked its construction business and made so many of its employees rich, could be owned only by Kiewit employees. (Sources say that the annual compound appreciation of C shares has been more than 20% over the years.) In 1992 the company issued class D shares that tracked its diversified business. ('C' for construction. 'D' for diversified.) D shares were thinly traded, but they could be owned by non-Kiewitites. Knowing someone in Omaha was the best way to get your hands on some.

Scott and Crowe agreed that, as with MFS, it made sense to separate Kiewit Diversified Services from the construction company. For the new company, they chose the name Level 3, which refers to the seven-layer Open Systems Interconnect network model. The point was that Level 3 would focus on the bottom three levels: the first being the physical layer of fiber itself; the second, the optical layer, or the signal; and the third layer, the Internet Protocol, which in a sense is the language by which the signal is sent. Despite the mysterious name (or perhaps because of it!), "there was a tremendous amount of buzz in Omaha about Level 3," says a local businessman. "You'd hear about a block of stock for sale and then it would be sold, like that."

One person who got in early was Buffett's nephew Tom Rogers. Rogers, a local venture capitalist who works out of a renovated office in an old building in downtown Omaha, bought the stock before it was publicly traded on Nasdaq. "I remember the lady who cuts my hair asking me about the stock," recalls Rogers, who says he still owns "truckloads" of shares. "I paid my personal trainer in Level 3 shares instead of cash. I really wanted him to own this stock," he says.

On April Fool's Day 1998, Level 3 began trading on Nasdaq. The company sold a few nontelco businesses to raise more cash, but it hung on to the coal mines and a toll road for cash flow. Meanwhile, Craig McCaw's Internext venture jumpstarted the company by buying $700 million of network capacity. By the following year Level 3's stock was soaring.

It didn't hurt, of course, that Salomon Smith Barney's superstar telco analyst Jack Grubman began coverage of Level 3 with an outperform rating. In his first full report, Grubman wrote glowingly, "Level 3 is a great play on bandwidth...[which] will be chronically scarce. Capacity actually creates demand in this business...bandwidth-centric names are good values at any price since nobody can predict the true demand caused by growth." Grubman even offered a homespun analogy about Level 3's limitless prospects: "Like the attic of a house gets filled, no matter how much bandwidth is available, it will get used."

Still, for all the enthusiasm on Wall Street, Level 3's hardiest fans were right back home in Omaha. Roger Bendet, the general manager of Lexus of Omaha on the city's western edge (which is out near Boys Town, of Spencer Tracy and Mickey Rooney fame), didn't hesitate to jump in. Neither did Denny Walker, founder of Memberworks, a company that processes credit cards. "I first got in at about $10, when it was a Kiewit stock," he says. "We bought about 10,000 shares, kept those, and bought more. We own about 15,000 now."

As expected, Level 3's network build-out was impressive. Crowe secured rights of way from big railroads, including Union Pacific, which is based in--you guessed it--Omaha. Level 3 dug trench, laid cable, and burned through billions of dollars furiously, crossing the Mississippi three times and completing the 16,000-mile North American section in 30 months. Speed was critical because other companies were building networks too. It was not unlike the race to complete the railroads in the old West.

Through 1999 and 2000, quarterly sales raced ahead from $100 million to over $400 million. Meanwhile, Grubman had raised his rating to "1S" (buy speculative) and put a $130 price target on the stock. Soon the go-go mutual funds were loading up on shares. In March 2000, Janus owned 20 million shares of Level 3, Fidelity owned ten million, and Putnam held seven million.

On March 10, the stock hit $130, just as Grubman had said it would! On that day Level 3 had a market cap of some $44 billion--about $4 billion more than General Motors. "The feeling at that time was that Level 3 was a gold mine that was never going to end," says a significant local investor. "If you didn't own the stock, you looked foolish."

Omaha used to be home to another can't-miss stock: an energy-trading company called Enron. Many retired Enron employees still live in the area, and they've hung on to the stock. "I had one family come in and say, 'Dad told Mom before he died never to sell Enron because it was a utility and she could live off it forever,'" says Carson. "It's been devastating." Another big local holding is WorldCom (converted from MFS shares).

Then there's Level 3--which by April 2000 was getting a reality check. The company's big-spending customers, those Internet companies and CLECs, hit the wall. Sales began to wilt, and then so did Level 3's share price. In just one year the stock sank 90%, to $13 a share. (Only then did Grubman cut his price target, from $130 down to $20.)

The problem, as most of us can recite by now, was a sudden glut of capacity. The attic, it seems, wasn't ever going to fill up. If Level 3 had been the only player building a fiber-optic network, it would be hailed as a great success story. But the old telcos--AT&T, WorldCom, and Sprint--were adding broadband capacity to their networks, and upstarts like Global Crossing, Williams, Broadwing, and Qwest were churning out entirely new networks. No question, Level 3 had a great network, says Scott Cleland, an analyst with the Precursor Group. "But it's like a great racetrack. You still need the fans. You still need the customers. And companies like AT&T and Qwest started with customers."

What's more, advances in technology (particularly something called DWDM--dense wave division multiplexing--that can increase the capacity of a strand of fiber by 200 times) caused the cost of adding bandwidth to a network to fall by 99% from 1995 to 2000. Level 3 stock continued to plummet, dropping to $3 in a three-month period.

Still, investors like Omaha lawyer Thomas Dowd, who owns 89,000 shares, hung in. "Granted, it's an industry with problems," Dowd says with remarkable peace of mind. "Crowe told us a long time ago that there would be a tremendous shakeout, but that the survivors are going to have wonderful businesses."

Many of his fellow Omahans are in deep too. One man sold his entire business for $20 million to buy Level 3 stock. Those shares today are worth only $3.5 million. Others made the mistake of building grand homes on the strength of their paper holdings. "I had a neighbor," says one knowledgeable Omahan, "who built a house for $2 million [that's a lot of house in Omaha] borrowed against Level 3 stock. He had a margin call and had to sell it for $1.5 million. He didn't live in the house a single day."

"It's embarrassing to talk about," acknowledges money manager Carson, who won't reveal the exact amount he himself owns. "It's a lot," he concedes. "It was enough money at the peak so that I wouldn't have to work again."

So, did Scott and Crowe bail out of the stock, you wonder? With Scott, the answer is an emphatic no. He has sold next to nothing. With Crowe, the answer is yes--to a point. In 2000, Crowe announced he would begin a regular program in which he would sell a set number of shares, 2,000 to 4,000, a day. As of last June, he had sold about one million shares worth $50 million (giving him an average selling price of $50.) Then he suddenly dumped nearly three million shares. Why? "In the beginning I borrowed money to buy $55 million of Level 3 stock," Crowe explains. "I needed to pay off that debt." And guess who was the buyer of the stock? None other than Walter Scott, who purchased 2.95 million shares from Crowe at $6.75 each, for a total of $19 million. Since then Crowe hasn't sold a share, and he still owns almost ten million shares.

Today, with Level 3's stock below $5, its market cap is down to $1.3 billion (GM's is $30 billion, by the way). As for those three big institutional holders: Janus now owns 550,000 shares, Fido 74,000, and Putnam 10,000. Of the 37 million shares those fund giants once owned, 36.4 million have been sold off.

And guess who bought those shares? No question, many were picked up by Omahans who were dollar-cost averaging the stock, or in some cases doubling up as the stock went down. Almost every Level 3 shareholder we spoke with for this article--Rogers, Dowd, Carson, and others--acknowledged buying the stock as it fell. By FORTUNE's best estimates, perhaps as much as $20 billion--nearly half of Level 3's stock market value at its peak--was lost, on paper at any rate, by Omaha shareholders.

"I saw Walter Scott at a function recently," says one Omaha businessman. "And some guy came right up to him and asked him, 'Hey, what's going on with Level 3? The guy wasn't agitated or anything, but Walter left right after that." Clearly it's tough for Scott, whose own holdings have fallen a jaw-dropping $4.2 billion, to $200 million. "There are some that bought stock at a very high price," says Scott, nodding his head. "I've never had anybody get mad at me or anything. That doesn't mean it won't happen. It's just that I haven't had anybody yet."

The first couple of months of this year were particularly grim for Level 3. On Jan. 29 the company, which had earlier moved its headquarters to Broomfield, Colo., to attract more skilled engineers, took a $3.2 billion impairment charge, adjusting the value of its assets downward by that amount. Revenue has also been lagging. In the latest quarter, Level 3 had sales of $386 million and operating expenses (which includes debt service) of $725 million. With $5.9 billion of debt on its books, Level 3's annual interest costs alone are around $516 million.

Crowe and his sales force have had some luck luring bigger and more stable customers, including SBC and Cox Communications. Says Jay Rolls, vice president of data engineering at Cox: "As soon as we inked a contract with them, the Level 3 guys showed up and stayed for two days straight until we were up and running. When we called up our other provider, a big player, they basically asked, Why are you bothering us?" Still, the high-tech economy remains weak, and other customers are pulling the plug. Level 3 estimates that some 15% of its recurring revenue is at risk, and that two-thirds of those sales will be disconnected within several months. "Level 3 is in a tough situation because its whole model is based on underpricing the competition--which they can do, but it puts huge pressure on them," says Precursor's Scott Cleland.

Mainstream Wall Street clearly agrees. Merrill Lynch, for one, just downgraded the stock to a sell. Nor do the capital markets seem sanguine about Level 3's prospects. The company's benchmark 9.125% bonds trade around 48 or 50 cents on the dollar and yield 27%. Market observers say at those prices the bond market is betting the company is headed for bankruptcy. "The stock is trading at $4," says one powerful money manager. "Typically the equity markets get these things wrong, so the trade to make would be to short the stock and go long the bonds."

But is Level 3 really in such dire straits? The most surprising twist in this saga is that it just might not be. In fact, there's at least one high-profile investor fishing around in Level 3's equity, Legg Mason's superstar Bill Miller--the only fund manager to beat the S&P 500 11 years in a row. At a recent lunch in Manhattan, Miller, who won't say how big his position is, remarked, "Well, as the saying goes, it's not going to go bankrupt tomorrow, though it's priced as such. But even if it does go bankrupt, it won't be for several years." Another well-regarded money manager, Staley Cates of Longleaf Partners, makes a similar point. As Cates, who is long on Level 3 bonds, put it in a recent conference call: "All that matters to us is [the bonds'] cash flow. Level 3's cash position today of over $1 billion sees us through a good number of quarters before we think there's a true liquidity problem."

Yes, about that cash position. Level 3 has $2.78 in cash per share, enormous in this environment. If you assume that's enough liquid fuel to make it through to the next upswing in the high-speed Internet business, then the company may have a big strategic advantage over its rivals. One called "survival."

Another issue in this market is whether this company has even a whiff of the accounting or other ethical improprieties that have tainted so many other telcos. Buffett and many others stand by Scott as the ultimate straight-shooter. But even Scott seems taken aback by the headlines around him, to the point that he hedges his take on his own company. "In this environment," says Level 3's chairman, "you never can guarantee 100%. I mean, we knew a lot of the things that were going on. We did not participate.... I'm comfortable that our integrity is together. That doesn't mean somebody couldn't go in and find something, but we have always tried to be as open and straightforward as possible."

To that end, Scott won't even guess at the correct valuation of Level 3. "I don't have any idea," he says, when pressed. "I don't know. I don't think you can evaluate it today. I don't know what it's worth. Have no idea."

But if actions speak louder than "I don't knows," Scott believes Level 3 is worth more than its share price. Through the purchase of some warrants, he has effectively invested more money in the company within the past three or four months. "If just keeping my stock is any indication," he says, "I guess you'd have to say I'm convinced Level 3 will make it."

Many Omahans are even greater believers in their savior's leadership. "In the long term, people are the most valuable, and they've got the people," explains Omaha investor Denny Walker, who still clings faithfully to his 15,000 shares. "I never wavered," he says.

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