By Michael Goldstein
Investors and non-investors alike are familiar with the two mega-cap telecommunications stocks, AT&T (T) and Verizon Communications (VZ). Less familiar is the third largest company is the sector, CenturyLink (CTL). With a market cap of $23 billion, CenturyLink is well into large-cap territory. All three of these large telecommunications companies are high yield dividend stocks. However, CenturyLink currently pays a significantly higher yield than either AT&T or Verizon.
Once a small, regional telephone company, CenturyTel became CenturyLink when it acquired Embarq corporation, closing the deal in 2009. In 2010, the company agreed to acquire Quest Communications and the transaction closed early in 2011. Later in 2011, CenturyTel completed its acquisition of Savvis, Inc. The results of this buying spree is the $20 billion company you see today and one of the largest providers of fiber optic cable capacity, cloud infrastructure, hosted IT services and multi-channel retail telecommunications services. The company is using its thousands of miles of fiber optic cable to now offer digital cable TV services in selected regions. CenturyLink labels itself as America's fastest growing broadband company, offering high speed services to both businesses and retail customers.
Since the acquisitions, revenue has increased dramatically for CenturyLink, from $2.2 billion in 2008 to $4.3 billion in 2009, to $6.1 billion in 2010 to a projected $18.7 billion in 2011. Revenue growth will likely flatten out in 2012. Therefore, the company must now focus on squeezing the projected synergistic savings out of the merged companies. Management has targeted $1 billion per year in savings with the new, larger CenturyLink. As an indicator, for Q3 2011, pro-forma expenses of $3.99 billion were down slightly from pro-forma expenses of $4.02 billion. The pro-forma numbers are the combined expenses of the merged companies, before and after the acquisitions. The third quarter earnings release stated the company would achieve $375 million in operating savings in 2011. The results of the merger activity make CenturyLink a national level player in telecommunications plus cloud and IT services. The company currently has a strong positive cash flow - approximately $900 million per quarter - with room for both revenue growth and expense savings.
Investors will take a closer look at CenturyLink for the dividend, with the stock sporting a current yield of 7.8%. In mid-2008 the company increased the regular quarterly dividend by a factor of 10 - going from 6.75 cents per quarter to 70 cents quarterly. The dividend increase was a corporate change in policy away from primarily returning cash to shareholders in the form of share buy-backs to a policy of paying an above market dividend. The increase put CenturyLink's dividend yield above 7%. At the beginning of 2010, the dividend was increased to 72.5 cents and it has remained at that rate through the end of 2011. The current dividend is approximately 50% of pro-forma annual free cash flow of $3.5 billion.
Here are the current dividend yields of the three large telecom companies:
- AT&T: 5.9%
- Verizon: 5.3%
- CenturyLink: 7.8%
Both AT&T and Verizon Communications have long histories of annual dividend increases. The CenturyLink high yield history goes back just four years with a single dividend increase. Since CenturyLink instituted its higher dividend policy, the share price of CenturyLink has returned negative 2%, AT&T is down 4% and Verizon has gained 6%. Remember that there was a serious bear market during that period. A growing dividend but lower yield seems to be a wash against a higher yield with a stable dividend.
From this angle, the investment potential for CenturyLink is attractive. The dividend is covered two times by free cash flow. Cost savings resulting from the recent flurry of acquisitions has the potential to increase the cash flow by 20% to 25%, even if revenue is flat. If the company can generate growth in its high margin high speed Internet and digital cable TV services, free cash flow and net income could expand further.
I would expect CenturyLink's board of directors to start increasing the dividend rate, especially if the company has no more large acquisition plans. Over the last four years, the corporate leadership has followed a plan to turn the company into a major player in the telecommunications sector. It appears the plan has worked, but shareholders have not yet participated - outside of the very nice dividend payments.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
