Ignore The Cloud Hype: CenturyLink Is Overpriced

| About: CenturyLink, Inc. (CTL)
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CenturyLink (NYSE:CTL) reported that its subsidiary Savvis will be buying the assets of information technology outsourcing business of Ciber (NYSE:CBL). Based on the company's website, Ciber is a global provider of information technology, business consulting and outsourcing business. Its major clients span to various industries such as energy, utilities, telecommunications, retail and financial services. These are mostly top-notch clients that include IBM (NYSE:IBM), Abbott Laboratories (NYSE:ABT) and Allianz. Despite this development, I believe CenturyLink should be avoided for the time being. Below, I will show how CenturyLink is currently both overhyped and overpriced.

Under the terms of the agreement, CenturyLink will pay $7 million to buy the assets from Ciber. These assets include infrastructure, technology and facilities across several locations the company operates in. Although IT outsourcing seems to be a laggard for Ciber, it made up 9% of the company's total revenues for the fiscal year 2011. It was able to turn around its operations for the period as it initiated cost-cutting measures during the year. In my view, the sale of these assets is in line with Ciber's plan to manage its costs on its information outsourcing business, noting the losses it has incurred in the prior fiscal year. As I will explain in detail below, this looks like a win-win situation for both parties.

The partnership with Ciber follows their existing agreement in 2011 where Ciber will benefit from Savvis' physical infrastructure of more than 50 data centers and network. Based on this agreement, Ciber will continue to serve its clients with application development and outsourcing services. Savvis is also expected to provide support to Ciber in terms of infrastructural facilities.

The deal is expected to close in the fourth quarter of this year, pending regulatory approvals. Savvis is also expected to hire 750 employees from Ciber, assuring CenturyLink's management that the transition will be as smooth as possible. This shortens the learning curve for Savvis employees in terms of driving these newly acquired assets into efficient levels.

Savvis expansion is good for CenturyLink's future growth

The acquisition is expected to boost Savvis' existing information technology outsourcing business through Ciber's global reach. This will also enhance the company's capabilities in cloud services and customer support.

Savvis has been in expansion mode recently. The company has opened new data centers in Singapore and London, as well as expanding its existing data centers in the U.S. It plans to expand in California, New Jersey and Dallas. It has also launched new products such as Savvis Symphony Virtual Private Data Center cloud services in select regions. This is a cloud-type solution that allows users to create customized data centers with predefined service levels for multiple customers under the same cloud. The result is longer-term benefits for the client, including increased data security and cost reduction.

It seems that CenturyLink made the right decision when it purchased Savvis last year. With the acquisition, it is well positioned to gain traction from the cloud computing business, which has significantly grown through the years. Major tech players like AMZN (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT) and IBM have dominated the cloud computing space. Its Savvis acquisition puts CenturyLink in the major league. According to Network World, cloud computing is set to explode this year. However, the main issues with cloud hosting service providers are their reliability and security. I believe that the acquisitions will cement Century Link's competitive position in the industry.

In its latest annual report, Savvis contributed $483 million in revenues for the fiscal year 2011. This translates to a net income of $103 million, or net income margin of 21%. In terms of percentage contribution, this translates to 1.29% of the total net income. While this may seem insignificant, Savvis will definitely play a key role in charting CenturyLink's future.

Both Amazon and IBM cloud computing services have performed better than expected. Amazon Cloud Service revenues are lumped under as "Other Revenues" where it contributed $1.58 billion for the fiscal year 2011. There are estimates that cloud services generated roughly $678 million. This translates to a year-on-year growth of 66%. Like CenturyLink, Amazon Cloud Service contributes to merely 3% of its total revenue. However, this segment has been the main growth driver for the recent quarterly filings. Moving forward, its cloud service could hit the $1 billion mark.

IBM SmartCloud has followed a similar path. It has gained traction with around $100 billion transactions for the fiscal year 2011. Its Cloud Services revenues fall under Global Business Services segment. This contributed $19.28 billion, a growth of 28% compared to the same period last year. According to its annual report, the cloud service revenues alone have increased 3-fold over the previous years.

By contrast, Microsoft's revenue from cloud service is still a question. Its online division posted quarterly loss of around $494 million. Management believes that growing its market share and managing its expenses will reverse its operating losses for this segment. It is planning to adopt an "all-in" cloud strategy, primarily centered on subscription-based services to large and small businesses.

It's a Long Path for CenturyLink

For the last five years, CenturyLink has grown its earnings by 44% per year. Its margins have fallen significantly from 29% in 2002 to 13% in 2011. Its traditional businesses have declined due to tough competition in the telecommunications space. In my view, the company needs to refocus its energies into business services that offer better margins such as cloud computing. However, it will take a while before these business services will have a significant impact on the profitability of the group.

The stock is currently trading at 43 times earnings. This seems ridiculous considering that earnings per share have fallen by 19% over the last five years. I think fair value is around 15 times earnings. The company has forecasted earnings to decline by 8% this year. Conversely, its peers are trading lower. Windstream (NASDAQ:WIN) is currently trading at 25 times earnings. IBM is trading at 12 times earnings, while Microsoft is trading at 14 times earnings.

Investors should wait until valuations appear attractive for CenturyLink. It should also assess whether the cloud computing service will really be a strong revenue driver in the future. For now, CenturyLink appears overpriced relative to its future prospects.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.