By Antonio Velardo
The stock of Lumen Technologies, Inc. (NYSE:LUMN) has recently faced selling pressure due to the suspension of its dividend, which has led to ETFs and hedge funds dedicated to dividend-paying stocks pulling back their ownership position from LUMN.
Our investment thesis for Lumen Technologies is that while the company's debt is a significant concern, the recent divestiture of non-core assets, and the resulting influx of cash, combined with the appointment of a new CEO with a strong background, presents an opportunity for potential growth. However, due to the high level of risk involved, we recommend taking a cautious approach and limiting any investment to a 1% position, at least until we get some clarity of what the future holds.
Lumen Technologies, Inc., formerly known as CenturyLink, is a global communications company offering cloud infrastructure and managed services to businesses, governments, and consumers. The company was founded in 1968 and is headquartered in Monroe, Louisiana.
Throughout its history, Lumen has acquired several companies and expanded its portfolio of services to include network connectivity, data centers, cloud computing, managed IT services, cybersecurity, and communication solutions.
The company supplies services in mainly three segments: Communications, IT Services, and Global Connectivity. Its Communications segment supplies broadband, video, and voice services to residential and business customers. The IT Services segment provides data center, cloud, and managed services, while the Global Connectivity segment provides network services to global enterprise customers.
LUMN operates under three brands:
As the technology industry continues to evolve, Lumen is positioning itself as a leader in the new digital landscape by investing in its network and expanding its portfolio of solutions. With a commitment to innovation and a focus on customer satisfaction, Lumen is poised to continue growing and evolving in the years to come.
As of 2021 year-end, Lumen had 190k on-net buildings and 500k route miles of fiber optic cable globally. They’re among the largest providers of communications services to domestic and global enterprise customers. They provide services in over 60 countries and serve clients in various industries, including healthcare, finance, education, and government. Most of their revenue is derived in the United States.
Lumen has been punished by the market for quite some time now, the main reason being their inability to grow meaningfully due to the decrease in demand for landline and legacy services. Their revenue growth is a disappointing 7% over a period of 9 years.
The proportion of debt over equity is also at a very alarming point, with debt roughly five times the market cap. With debt being that high, Equity acts as a derivative and renders measures of WACC useless. Also, with the possible debt repayments, any measure of WACC at this point in time would not be very meaningful. Therefore, we won’t be using our traditional measures of valuation like EPV, DCF, etc.
Lumen has been trying to transform its business model from a telecommunication company to a technological company by entering the sectors like Hybrid IT and Cloud, Edge Computing, etc.
This shows Lumen’s will to keep up with the technological advancements and transform itself into a tech company. The recent change in management is also a very positive sign in this regard as new CEO Kate Johnson brings some very meaningful expertise for Lumen in solving their two main problems, Growth, and Transformation. Kate Johnson was the president of Microsoft (MSFT) for US operations and is famous in her industry for leading growth projects.
Historically Lumen’s strategy has been to return the capital to shareholders in the form of dividends, and share buybacks have returned roughly $19b to shareholders. Although often perceived as a positive sign, this strategy has hindered their growth potential.
The recent suspension of dividends and sale of non-core assets highlights Lumen’s eagerness to turn things around. Till today, Lumen has announced three divestments, the sale of Latin America operations for $2.7b, which was completed in Q3 of 2022, the sale of ILEC business for $7.5b to be completed in Q4 2022, and the sale of some Europe, the Middle East, and Africa operations for $1.8b with an expected completion by the end of 2023.
There are three possible ways Lumen can spend this incoming money, debt repayments which would be very welcome since they are getting killed on the interest expense front with such an overleveraged capital structure; below, attached is the change in interest rates on their outstanding debt. Another possible usage would be share repurchases since they have a $1.5b of plan in place. The third and the riskiest usage, in our opinion, would be spending it all out on growth. We understand the eagerness to spend on growth, but right now, a balance between spending on growth and debt repayments would be ideal. One of the assuring things in this regard is that the recent $2.7b from the sale of Latin America operations was spent on repaying debt.
We wanted to do the asset valuation of this stock to have a clear idea of the value, but the problem was calculating internally generated intangibles, namely the customer portfolio using a number of subscribers like we did in our last report on Meta (META), since a part of LUMN’s business is based on subscriptions, but that segment is roughly around only 28% of the total revenue, and the number of subscriptions also include the subscribers of ILEC business which is being sold.
If we look at the bond pricing, the risks of holding LUMN can also be highlighted there, with the bond market pricing at a huge discount on all of the bonds across the curve.
To sum things up, there's the planned sale of its European business at 11 times EBITDA (compared to the current company value of 5 times EBITDA), a $1.5 billion share buyback authorization, and the completion of the previously announced sale of part of its consumer business to Apollo in October. These actions should result in a more streamlined business portfolio and a stronger financial position. Additionally, it is expected that there will be further positive moves to separate the legacy Level 3/Qwest business from the quality local market assets.
To summarize, we like the turnaround story, but being prudent investors, we recognize that LUMN is very risky, and the road ahead will likely be cleared as we go along. Right now, the appointment of a new CEO with expertise in leading growth projects and an impressive experience in the tech industry can help with growth problems and in the transformation to more of a tech company. A recent drop in the stock because of the dividend suspension and emerging catalysts in the form of the sale of non-core assets and the repayment of debt indicates that a speculative position in LUMN of around 1% of the portfolio is not very ill-reasoned.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.