CenturyLink: Trying To Turn A Negative Into A Positive

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About: CenturyLink, Inc. (CTL)
by: Brad Kenagy
Summary

CenturyLink recently reported revenues declines in every segment.

CenturyLink started a strategic review for its consumer unit.

The technicals point to the possibility of a short-term bounce in the stock.

It has been a little over two months since I posted my first article on CenturyLink (CTL) and as of the close today, shares are down just over 10% and at the recent lows were down over 15%. There have been a number of developments that occurred since my article was posted. Those include CenturyLink reporting earnings and the initiation of a strategic review of their consumer unit.

Consumer business review

In their earnings press release, came the news that CenturyLink was looking at strategic options for its consumer business. The following quote says the unit is profitable, and contributes to free cash flow. The table below shows a breakdown of all the revenue segments that CenturyLink reports and as you can see the consumer business is the second largest source of revenue for CenturyLink.

Our Consumer business continues to make significant contributions to our profitability and Free Cash Flow and we are performing well where we are investing,” said Storey. “We are comfortable operating this business for the long term, but the strategic review will help us better understand whether there are opportunities to better maximize the value of this asset. ~CTL earnings release

CTL Q1 2019 earnings release

The problem with the consumer business can be seen in the following charts and tables. The first table below shows consumer revenues have been down significantly year/year. The second chart below shows the steady decline in consumer broadband subscribers over the last two years. Finally, the third chart shows a breakdown of the subcategories that make up the consumer segment. As you can see, broadband revenues are essentially flat and the other areas all showed declines. These data points are the likely motivation for CenturyLink to do their strategic review of the consumer business.

Consumer Revenue

Y/Y Change

Q2 2017

$1,436,000,000.00

Q3 2017

$1,420,000,000.00

Q4 2017

$1,401,000,000.00

Q1 2018

$1,569,000,000.00

Q2 2018

$1,352,000,000.00

-5.85%

Q3 2018

$1,355,000,000.00

-4.58%

Q4 2018

$1,285,000,000.00

-8.28%

Q1 2019

$1,441,000,000.00

-8.16%

CTL quarterly results

CTL quarterly results

In the table below, you will notice the total for consumer revenues are different from the total for consumer revenues in the table above. As is noted below, CTL did a change in January 2019 for revenue reporting categories, so the information is different in this table compared to what was shown in historical earnings reports for consumer revenue. Either way, both methods show the continued deterioration in the segment.

*Data in millions

Consumer

1Q19

4Q18

3Q18

2Q18

1Q18

Broadband

$722

$703

$702

$705

$712

Voice

$489

$505

$565

$546

$557

Regulatory

$159

$180

$181

$185

$183

Other

$71

$79

$91

$105

$117

Total Consumer Revenue

$1,441

$1,467

$1,539

$1,541

$1,569

CTL supplemental information

Lack of revenue growth

The problems with CenturyLink go beyond just the consumer business. There is a company wide lack of revenue growth. The first table below shows a breakdown of revenues by segment and all the segments were down y/y. The second chart really puts into perspective the scope of the company wide issues with CenturyLink. There are five segments, each with four subcategories, so 20 total subcategories. Of those, 14 had revenues above $100 million in Q1 and those 14 subcategories accounted for over 94% of revenues, which means they are the key for the company. Of those 14 subcategories, 10 posted lower revenues y/y, which is not good. Going forward this will be something to watch and see if the trend of declining revenues in these subcategories can be slowed, stopped or reversed.

CTL Q1 2019 earnings release

CTL supplemental information

Adjusted EBITDA

One of the biggest things the bulls point out is the fact that adjusted EBITDA increased year/year. While that is true, that comes in the face of declining revenues y/y for every business segment. When I examined the data, it is easy to see how adjusted EBITDA was able to expand, while revenues declined: Cost cutting. Adjusted EBITDA increased $154 million y/y, while at the same time SG&A decreased by $177 million. Bulls will say this is to be expected given the synergies and cost cutting measures of the Level 3 deal that are still being done. My response to that sentiment is eventually there will be a point where there are not any more costs to cut. I think CenturyLink is closer to that point than some might think.

*Green box by author

CTL Q1 2019 earnings release

The data in the table below shows the percentage of revenues that SG&A account for. The companies I compared CenturyLink to were AT&T (T), Verizon (VZ), Frontier (FTR), and Zayo Group (ZAYO). The reason I included Zayo Group is that another author in an article on CenturyLink used the valuation of Zayo as a comparison to CenturyLink. As you can see, CenturyLink already spends the least on SG&A out of the companies I examined, which to me shows there is not a whole lot more cost cutting that can occur.

CTL

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Revenue

$5,945

$5,902

$5,818

$5,778

$5,647

SG&A

$1,109

$1,115

$967

$974

$932

SG&A % of Revenues

18.65%

18.89%

16.62%

16.86%

16.50%

T

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Revenue

$38,038

$38,986

$45,739

$47,993

$44,827

SG&A

$7,897

$8,684

$9,598

$10,586

$9,649

SG&A % of Revenues

20.76%

22.27%

20.98%

22.06%

21.52%

VZ

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Revenue

$31,772

$32,203

$32,607

$34,281

$32,128

SG&A

$6,844

$7,605

$7,224

$9,410

$7,198

SG&A % of Revenues

21.54%

23.62%

22.15%

27.45%

22.40%

FTR

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Revenue

$2,199

$2,162

$2,126

$2,124

$2,101

SG&A

$464

$480

$452

$450

$467

SG&A % of Revenues

21.10%

22.20%

21.26%

21.19%

22.23%

ZAYO

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Revenue

$649

$659

$641

$639

$647

SG&A

$118

$122

$122

$126

$128

SG&A % of Revenues

18.18%

18.51%

19.03%

19.72%

19.78%

Table data from Gurufocus

CenturyLink and Level 3 historical data

The following table and two charts show CenturyLink and Level 3 were lacking growth prior to their combination. From my title, the “0” represents Level 3, because as you can see below, revenues were essentially flat from Q1 2015 until Q3 2017. The “-1” from my title represents CenturyLink because they had consistently been posting negative y/y growth in revenues leading up to the combination. I also included operating income to show that operating income growth slowed to near zero for Level 3 prior to the deal and operating income growth for CenturyLink was negative. The two charts below the data table are simply the data in the tables put into visual form. Simply put, when CenturyLink and Level 3 combined, it is easy to see why there has been no growth in revenues. There are two ways to change -1 + 0 into a positive. The first is to get rid of the negative or the second is to find someone positive to buy. As I noted above, CenturyLink is conducting a strategic review of their consumer business, which if they sell or divest it, would help get rid of the negative part of the equation. As far as finding something positive to buy, that is a stretch given the amount of debt CenturyLink has and their focus on reducing leverage.

*Table data in millions

LVLT

CTL

Revenue

Y/Y Change

Revenue

Y/Y Change

Q1 2015

$2,053.00

Q1 2015

$4,451.00

Q2 2015

$2,061.00

Q2 2015

$4,419.00

Q3 2015

$2,062.00

Q3 2015

$4,554.00

Q4 2015

$2,053.00

Q4 2015

$4,476.00

Q1 2016

$2,051.00

-0.10%

Q1 2016

$4,401.00

-1.12%

Q2 2016

$2,056.00

-0.24%

Q2 2016

$4,398.00

-0.48%

Q3 2016

$2,033.00

-1.41%

Q3 2016

$4,382.00

-3.78%

Q4 2016

$2,032.00

-1.02%

Q4 2016

$4,289.00

-4.18%

Q1 2017

$2,048.00

-0.15%

Q1 2017

$4,209.00

-4.36%

Q2 2017

$2,061.00

0.24%

Q2 2017

$4,090.00

-7.00%

Q3 2017

$2,059.00

1.28%

Q3 2017

$4,034.00

-7.94%

Operating Income

Y/Y Change

Operating Income

Y/Y Change

Q1 2015

$316.00

Q1 2015

$649.00

Q2 2015

$350.00

Q2 2015

$549.00

Q3 2015

$327.00

Q3 2015

$656.00

Q4 2015

$338.00

Q4 2015

$751.00

Q1 2016

$362.00

14.56%

Q1 2016

$688.00

6.01%

Q2 2016

$374.00

6.86%

Q2 2016

$647.00

17.85%

Q3 2016

$354.00

8.26%

Q3 2016

$593.00

-9.60%

Q4 2016

$354.00

4.73%

Q4 2016

$403.00

-46.34%

Q1 2017

$337.00

-6.91%

Q1 2017

$631.00

-8.28%

Q2 2017

$353.00

-5.61%

Q2 2017

$367.00

-43.28%

Q3 2017

$355.00

0.28%

Q3 2017

$487.00

-17.88%

Level 3 and CenturyLink SEC filings

Level 3 and CenturyLink SEC filings

Level 3 and CenturyLink SEC filings

General Electric similarities

In my opinion, CenturyLink shares a number of similar traits with General Electric (GE) prior to the CEO change at GE. The similarities are they both have business units in decline, both had bad PR (Engine blades for GE, 911 outage for CTL), underperformed their sector and have (had in GE’s case) a CEO disliked by investors. I already covered the declining consumer business for CenturyLink and the bad PR has already been covered elsewhere, so for the remainder of this section, I will covering the underperformance vs. their respective sectors and investors dislike of management (previous management for GE).

Relative Performance

The first chart below shows the relative performance of GE compared to the Industrial Select Sector SPDR ETF (XLI). As you can see, when the blue line is declining, that means GE is underperforming. GE had years and years of underperformance compared to its peer group. The second chart below shows the relative performance of CTL compared to the iShares U.S. Telecommunications ETF (IYZ). Just like with GE, CTL has consistently underperformed its peer group.

ThinkorSwim

ThinkorSwim

Opinion of management

When the firing of former GE CEO John Flannery occurred, shares of General Electric responded favorably (7.10% increase). After the announcement was made, and even prior to that, users on Seeking Alpha did not have the best opinion of John Flannery. Similarly, users on Seeking Alpha do not have a favorable opinion of CTL CEO Jeff Storey, because of his comments on the dividend and then the subsequent cutting of the dividend 3 months later.

We are pleased with the improvement in our payout ratio compared to last year and remain comfortable with the dividend. - CEO Jeff Storey, Q3 2018 earnings call

For a future picture of what might happen with CTL, GE was doing ok with new CEO Larry Culp until the overall market went in the tank in Q4, but since the bottom in December, GE has significantly outperformed the S&P 500. This outperformance is due to the new CEO Larry Culp starting to outline his plans for GE and there are the initial signs of a turnaround. For CTL to get to that point of showing signs of outperformance, management needs to rebuild investor trust that was lost after the dividend cut. To do that, they need to show they have a path to revenue growth and/or consider what GE did: A change in management. If a change in management were to occur, I could see a similar reaction occurring where the stock price jumped.

Yahoo Finance

Would I ever buy CenturyLink?

Yes, I would consider buying shares of CenturyLink sometime in the future. However, two important conditions would need to happen before I would even consider purchasing shares. The first condition is that the company would have to sell/divest its consumer business because it has been and continues to be a drag on their results. If they were to sell or divest the unit, it would be a double benefit because they would be jettisoning a declining business and likely reducing their debt. The second condition that would need to be met is the hiring of an outside CEO who would be focused on growth. By outside CEO, I mean not someone from CenturyLink or not someone that was with Level 3 Communications. As I showed in the review of historical revenue and operating income section above, neither CenturyLink nor Level 3 provided any or very little growth in either metric prior to the deal closing. As I noted in the GE section above, when they hired an outside CEO the stock reacted favorably and I suspect there would be a similar reaction with shares of CenturyLink.

Technical Outlook

Even in the face of all the negatives I outlined above, there is a green shoot in the form of an appealing technical outlook that points to a potential recovery in the stock price. The chart below shows the MACD is very close to turning positive and the RSI is at oversold levels. Given these technical factors, I expect that shares of CenturyLink could see a decent bounce over the next three months. This bounce would be purely technical, because the underlying fundamentals do not support a higher stock price. Therefore, if/when the bounce occurs, that might give investors a second chance to “fold ’em” if a previous opportunity to do so was missed. Baring something happening with their consumer business or a significant improvement in the next earnings report, I believe after a bounce occurs, CenturyLink will again test the $10 level.

*Chart Scale is weekly

ThinkorSwim

Closing Thoughts

In closing, CenturyLink has a number of issues that have caused the stock price to be at levels not seen since 1994. I believe they started down the correct path by looking at their options for their consumer business, but only time will tell if they actually do something with the unit. In the short-term, I am expecting a technical bounce because of oversold conditions, but after that occurs, barring a change with the consumer unit or management, I expect shares will once again test the $10 level.

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