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Last week CenturyLink, Inc. (CTL) did the unthinkable by slashing the dividend in favor of a more flexible stock buyback program. In response, investors slashed the stock price 26% to correspond with the dividend cut. Were investors being rational?

Per the company, it is the third largest telecommunications provider in the United States and is recognized as a leader in the network services.

Revised Capital Allocation Strategy

The company announced the following revised capital allocation plans:

  • Authorized the repurchase of up to an aggregate $2.0 billion of the company's outstanding common stock. The company expects to complete the program by its scheduled termination date of February 13, 2015.
  • Intention to revise the company's quarterly dividend rate to $0.54 from $0.725 per share. The board expects to approve this new rate at its next regularly scheduled meeting on February 26, 2013, with the change effective with the March 2013 quarterly dividend payment.
  • Expects to utilize a portion of its free cash flow generated in 2013 and 2014 to repay debt and maintain leverage at less than 3.0 times EBITDA

The media outlets initially played this announcement as a dividend cut only that fed into the fears of investors that the wireline focused company was struggling. The odd part is that the stock sold off so much considering the constant debate on whether the high dividend yield of around 7% was sustainable.

Now with the massive stock plunge, new investors get a dividend yield of roughly 6.5% along with the company promising to repurchase 10% of the outstanding stock at the current valuation plus pay down debt.

Dividends Versus Buybacks

The heart of the stock selloff is the debate of dividends versus stock buybacks. For whatever reason, investors have the mindset that a company that mind numbingly paying dividends is preferred over a capital allocation strategy that allows the board of directors the flexibility to utilize dividends or buybacks depending on the market conditions and stock price.

The company reported roughly 622M shares outstanding suggesting the dividend cut of $0.74 per year would save $460M in annual dividend payments. Conversely, the company now plans to spend $1B a year on share buybacks. Simple math suggests the company will now spend over $500M more on returning capital to shareholders.

Bottom Line

The management of CenturyLink made a brilliant capital allocation strategy that should benefit new investors. Existing investors aren't likely to be in a good mood considering the stock plunged back to levels not seen since the end of 2011.

For new investors, not only is the plan to return more capital to them, but also the stock is over 20% cheaper after the announcement. Smart investors will take advantage of this situation that could only occur in the bizarre stock market stuck in tradition and not facts. Returning more capital to investors and paying down debt is much preferred over keeping the absurd tradition of not cutting the dividend.

Source: Did CenturyLink Just Become A Gold Mine To New Investors?

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.