Alright, my research has been done and now I’m going to spell it out for all of you apes. Why Lumen Technology ($LUMN), will run soon as investors realize what the intrinsic value is in this company. There is a hidden catalyst that will be occuring in the near future, which makes this an excellect value stock to hold.What is $LUMN?
In the early 2000s or late ’90s two companies were laying a bunch of sub C fiber from New York to Spain and across the Atlantic and across the Pacific. It was Level 3 and Global Crossing because of the idea that there’s going to be this huge internet they would need all this connectivity that’s connecting continents.
Unfortunately, Global Crossings overbuilt and went bankrupt at the time. There was just a lot of mess, but lo and behold years and years later, guess what? The internet is bigger than anyone ever thought. And so Level 3 was a roll-up that included Level 3’s assets, Global Crossing, and Time Wire Telecom. Level 3 now owns what we would call domestic US fiber underground connecting end points across the world.
Lumen is the name for a merged entity between Level 3 and CenturyLink. Level 3 is the company that holds the hidden value in $LUMN. Currently Level 3 is 1/3 of the new entity and CenturyLink’s dying business model is what’s hurting the market value.Cove Street Investors
The investors fell in love with Jeff Storey the CEO of Level 3. If you look into Jeff Storey it appears that he was set to replace the CEO Glen Post of CenturyLink whom was retiring shortly. The investors from Cove Street were weary of the management team at CenturyLink and told Jeff, this is not a group of people they felt confident with and don’t necessarily think they understood what they’re buying. However, the old CEO Glen Post of CenturyLink stayed on as a board member directing the company until January 2020 https://www.fiercetelecom.com/telecom/former-ceo-post-steps-down-from-centurylink-s-board-directors. The investor worry has proven to be the case.
https://preview.redd.it/ugujihnqjox71.jpg?width=847&format=pjpg&auto=webp&s=f85ac44287a90344ec1ab2ad91c57ad6a1afed9aWhat was the impetus for the merger and why is CenturyLink such a big portion of the new business?
Level 3 was offered a lot of money. The Level 3 shareholders were happy to take the premium that was offered. The investors sold out, as soon as they realized that the surviving entity would be controlled by Glen Post. The reason why the combined company is predominantly CenturyLink is because it was at the time a $17 billion revenue company. This was not a tiny entity by any means.
It was larger only in the end profit sense than Level 3. However, the actual valuation was skewed towards Level 3… This is basically a company that was trading at, let’s say, five times buying a company that was trading at 12 times. The people who get screwed are the shareholders of the company that’s trading at five times. Shareholders of Level 3 didn’t care because everyone was getting a fantastic value for their investment and the CenturyLink shareholders, well, they took it in the pants.
That’s exactly what the pitch was to the CenturyLink board when they discussed the acquisition. Currently, it is also still a truism to say that while it is a melting ice cube, the ice cube is melting at, let’s say, three to 5% a year on a cash flow basis. And the good side, the Level 3 side is growing.
So you have a global growing asset heavy, almost irreplaceable asset business in Level 3 and you have a slowly shrinking, melting ice cube in CenturyLink, jam them together and what could go wrong? Well, a lot can go wrong.
From day one, it was very contentious and it’s taken Jeff Storey 3 years to reconfigure the entity to be effectively Level 3 again, from a management perspective, obviously not from a revenue mix perspective, but certainly from people who make decisions on a day-to-day basis. However, it was prevented by Glen Post, whom stayed on the board.What is $LUMN now?
You have Level 3 with a legacy CenturyLink business. CenturyLink is just basically a rural telecom. Think of rural Louisiana, they’re the telecom there. So, if you needed phone service or a really slow internet connection, which is probably DSL, because there is hardly no fiber in these areas and if you need a TV, that’s where you’re buying it from. And without any question, that’s a shrinking business.
Jeff Storey is now the CEO of $LUMN, the old CenturyLink management team unsurprisingly is gone. Investors love management. Management is always a big part of any investment premise and research. So you now have management in place that investors love.
Check out their website does this look like a melting ice cube such as CenturyLink?
In March 2023, Lumen partners with IBM to use their satellites to provide cloud services in any environment.
Level 3 at its core was IP services. IP services is a fancy way of saying connectivity. If you were across the United States, it would go through a fiber line that runs from LA to New York and get into someone’s building. They own metro loops of fiber within most of the large cities in not only in the United States, but in the world. And they had what’s called on net buildings, which is a fancy way of saying their own fiber assets and copper. Sometimes wiring was inside the commercial building that we’re in. Now $LUMN provides Internet Services, but also owns the underlying fiber across the world. In fact another part of their business model is to whole sale their fiber network to other IP providers. They also provide content deliver networks, for our upvotes, streaming videos, etc..
They have a lot of data center assets, three to 400 data centers that they basically run for their customers. They partner with AWS in some cases to offload some forms of traffic and data aggregation. Provide what’s called the edge connectivity solutions to businesses that don’t necessarily want to be a 100% on AWS or 100% on Azure or 100% on their own internal data warehouse has been mainly because of costs. They compete on a smaller scale for cloud services, more of an add on service to their core IP connectivity service if you can think of it that way.
They also provide wholesale connectivity to people who use their underlying network as a highway of sorts. And it’s like a toll road and every single year that the tolls pay to get onto that toll road go down in price while they may not be laying any new transatlantic fibers, what’s happened over the course of 20 years is that the actual hardware systems on each side of the fiber line continued to get upgraded every single let’s say 12 to 18 months to a new generation. Just think of it as like a string cheese. Like if they’ve figured out a way to pull the string cheese ever so more thinly and to create more strands effectively of that string cheese from the same block of cheese they had from the last 10 years.
Top line growth of Lumen is spotty. It has been averaging say 5% over the past five years, top line was down 4.5% in 2019 at the point in time where the economy was still hot and before COVID-19 hit.
I believe we’re exiting the last bear phase and entering into a new bull phase. After the earnings on 11-03-2023 many investors agree.Century Link Problems
1.9B Voice business. Effectively zero over time, because many of us don’t have home phones anymore. The only reason anyone would get one now adays would be if the cable company bundled it into a package.
The decline rate there is pretty intense. We’re talking 15 to 20% year over year. The reason why that matters is you would think that, well, that seems like a silly business to be in, but remember it’s a 100% profit?
Lines laid over a course of 50 to 80 years, don’t have to invest in them as just people pay every single month for this phone service that most people now with cell phones don’t really need.
Small and mid-size businesses hard to sustain their top line while every single year they have to bring down prices on connectivity side as well as the Telcos telephone service.Who are $LUMN’s competitors?
In the USA 18T and Verizon, the other legacy Telcos
Outside the US if you’re thinking about like who else has the ability to connect people from the US to EU, for example, ORAJ, Eugene and British Telecom.
There’s competition, but there are certain barriers to entry… When you’ve already laid the fiber, there is a cost base that it makes it very, very difficult for someone to come in and build another whole strand of fiber to compete with you because they’ve got to spend the capital and associate the manpower to it, then compete with you on pricing and your assets are already in the ground. So, $LUMN can always price lower to knock competitors out of the market.
In fact $LUMN surpassed AT&T as a market leader in Ethernet
The connectivity business will continue to grow as people demand faster speeds, more bandwidth, more capacity, and then more security and other new kind of endpoint and edge services that CenturyLink offers. Level 3 side isn’t growing as fast as detecting whatever that trades at 20 times revenue. But there is core growth at Level 3, which I think is what the market doesn’t understand and you have shrink to grow at CenturyLink, which is shrink the parts that are shrinking eventually start to be a smaller part of the total. There are parts within CenturyLink that are growing, which is the broadband side start to grow.
Decline are abating and there are almost no more decline at all. Cost to the degree that their margins are higher and their cash flows are growing. Even if their top line is shrinking the revenue line, and cash flows are growing. And that’s the inflection point. The inflection point will be where no growth parts of the company no longer overwhelm the growing parts. Wall Street will then see a growing business that generates an enormous amount of free cash flow that has a great ability to deliver and trades at a multiple and nothing trades that in terms of how low it is.
Jeff Storey’s performance, his free cash flow number. So the weird thing about this company is that given that Level 3 has publicly traded debt, Level 3 also still puts out its own independent financials. So while you can have a consolidated illumine 10K, you could also look at the annual results for the underlying Level 3 business, which allows you to break apart Level 3 from legacy CenturyLink.
When Storey came in to be the CEO of the combined entity, the Legacy CenturyLink had a free cash flow number of roughly $1.6b to $7b, that was in 2016. He came in at the end of 17. So we’ll just use 18 as a starting point. From 18 and 19, he’s effectively stabilized and slightly even grown free cash flow while at the very same time CenturyLink has lost call it 10 to 12% of its top line. Within that melting ice cube, he’s managed to cut enough costs to effectively stabilize free cash flow in the face of a shrinking top-line number, which is an impressive thing.
Jeff Storey’s incentives are three-fold. His comp comes in the form of things tied to EBITDA and free cash flow growth. 90% of a short-term comp is based on that. He also has a restricted stock issuances that are also based on the EBITDA profile of the company. He currently owns three million shares? So a stock that used to be $25 to him is a whole heck of a lot of money.
The board of $LUMN also added in a TSR total stock return long-term compensation metric, which means that while you can argue that he’s done a fantastic job on the operating side and he’s done all the cost cuts and stabilized cash flows and all these things yet, if the shareholders aren’t getting the benefit of all of that, he’s not going to get paid at all.
If the stock does nothing for a year and at least you get a 10.3% dividend (next one on Nov 18th), that’s a nice thing to have, but as we’ll get into the valuation, the real upside here is based on some of the parts analysis, a discounted cash flow analysis that is suggestive of much, much higher value. And the dividend in the meantime is just a nice thing to have assuming it’s sustainable.
There was an earnings call on 11/3/2021 and here are the results from it:
LUMEN TECHNOLOGIES REPORTS THIRD QUARTER 2023 RESULTS
⦁ Q3 EARNINGS PER SHARE $0.49 EXCLUDING ITEMS
⦁ Q3 EARNINGS PER SHARE $0.51
⦁ Q3 REVENUE $4.887 BILLION
⦁ Q3 EARNINGS PER SHARE VIEW $0.38, REVENUE VIEW $4.90 BILLION — REFINITIV IBES DATA
We’re now starting to get analysts from CNBC stating this should be trading in the mid-to-high 20’s. This company should also benefit from the infrastructure bill.
Now Citigroup also posted a PT of $13, which I don’t believe they understand how to price this company properly.
Inv H&S validated with a $28 upside target. It’s obviously clear that the investors dont’ know how to price this company properly. Hopefully this DD will bring some light into that.Why the debt isn’t a problem
Usually while looking into debt you focus on the interest coverage ratio. And this is the ratio that determines how easily a company can pay interest expenses on outstanding debt. It’s calculated by dividing a company’s operating income by its interest expense. $LUMN’s interest coverage ratio is at a 2. Obviously the higher the ratio, the better. And we would typically like to see at least five, if not 10. Yes, this looks horrible to investors, but what if you look at debt with a different metric.
EBITDA, which is a kind of a proxy for cash flow minus capital expenditures divided by interest expense. And that number is more like 3.5 and a half, which is… Again these numbers, are they stellar? Absolutely not. Is that certainly a concern of the market? 100%. $LUMN’s perception is that there’s an inflection point in terms of growth that is upcoming. The capital that they are spending now will continue to generate even better returns because they’re much more targeting their capital expenditures and the cash flows they generate can more than offset. Well, they can pay down debt, they can pay a dividend, they can pay their interest, and they just annouced a 1B $ buy back on shares.
There’s a virtuous cycle of debt paid down and lower debt costs. The EBDITA has been growing year over year and the new management is focused on paying down debt. Right now on a net debt EBITDA basis, EBITDA being their proxy for cash flow, they’re at 3.7 times, which is certainly not that high.
When CenturyLink bought Level 3 it was almost 4 years ago? They paid $34B for the acquisition. Let’s just assume that no value was added for three years, which I would disagree with, because I think this is one of those companies that gets more valuable over time. Going back to Warren Buffet, he believes in no compounds right value every single year. They have about 30 billion in debt. So that takes out the entire debt stack just from the Level 3 assets. Meaning that if you subtract out that EBITDA number 2.8 billion, which comes directly from public filings not adjusted and no magic nonsense of core whatever billion different adjustments that people make, you get at the legacy CenturyLink of 5.8 billion EBITDA almost for free.
My premise is that as long as people wake up to the fact that the core assets of Level 3 are worth what they are worth in the private market for, let’s say, around $30 billion. Let’s apply even some modicum of multiple to the remaining CenturyLink assets, you have a completely insane risk reward from 950 or whatever it’s trading at today. For margin of safety is that if someone offered me $1.7 billion in cash flow today, and I only have to pay 10 billion to get it, I would take that bet. That’s it in a nutshell.The Catalyst!
I’ll point out that Jeff Storey was going to retire, he was basically forced to come back into this role. He’s 59 years old. He doesn’t want to do this forever. Although, it’s not public information they haven’t said it, but supposition based on the name change, the branding change is that the company is in the middle of a long process of actually undoing this merger.
CenturyLink should trade at a lower EBDITA multiple, a business like Level 3 should trade at a higher EBDITA multiple and to adjust some comparable transactions a much higher multiple. These two businesses don’t work together in Wall Street’s mind. But if you separate them, basically undoing what was an ill-fated marriage from the very beginning, that’s how you create a lot of value for shareholders.
In fact since Lumen is such an asset heavy company they’re looking at how they should split the assets. There are a number of different ways that they could do this. The question is, are they going to do it? And what’s holding them back? In the middle of COVID, you’re not going to sell physical assets. People couldn’t even visit the assets until very recently. This also includes the naming rights to the Seattle Seahawks stadium.
The rebranding is just the first sign, getting rid of the CenturyLink name, calling this company Lumen, saying that you’re more of a tech company, the writing’s on the wall, this is going to happen. And then the question is, what is it worth? What is someone willing to pay for it? And that’s kind of as we’re sitting here clipping a 10.3% coupon, it’s obvious the numbers are a lot higher than has been anticipated.
Although it’s not public knowledge yet, but I do you think that you’ve seen signs that they’ve been very thoughtful about that. $LUMN has expressed an openness to do anything that adds value for shareholders, including transactions, spinoffs, things that would be more of a catalyst for value creation.
I was just looking at their proxy statement, which by the way is just the annual data sent to shareholders about who’s on the board, who’s up for reelection on the board, corporate governance and then compensation, but also in the proxy statement, there is a change in control clause, which is like, if this company gets sold, how much does the CEO make? Well, there’s $16 million in severance for Jeff Storey if the company gets sold and based on the stock price, I think at probably December 31st, he was $44 million if the company was sold. So getting back to incentives, does he have an incentive to maybe transact this company? I think the 44 million reasons why there could be a value creating transaction of some kind in our near future.
Lumen Technologies is two businesses combined CenturyLink and Level3. CenturyLink is a dying telecom business and the melting icecube of the two businesses. Level 3 is a connectivity business, which also compete with smaller cloud services. The merger occured and the investors didn’t like Glen Post the CEO of CenturyLink who sat on the board of Lumen, he’s gone as of Jan 2020 and Jeff Storey is now the CEO of Lumen and driving the business in the right direction, the financials show it. Lumen owns the majority of the fiber network that connects the united states and transalantic, when acquisition occured it was valued at 34b. A lot has been done since the acquisition, so I believe it is valued a lot higher than 34b. Lumen currently is 30b in debt (which is equal to their assets), but the debt is being paid down, they do a share repurchase program (recently filed a 13D/A on Nov 1st for it for 1B)and a 10.3% dividend (coming up on Nov 18th). The catalyst is in the proxy statement where the current CEO would get a 44 million payout if the company is sold and split. CenturyLink & Level 3 were and illfated marriage from the beginning which is why the investors in the spac sold out to burn CenturyLink in the beginning. The new CEO has been paying down debt increasing the free cashflow & ebdita quarter after quarter. There was an earnings call 11-03-2023 and quarter after quarter the company continues to improve. There is nothing but greatness in the future for Lumen. Level 3 will be valued a lot more without CenturyLink as burden and it’s starting to become more obvious to investors. It’s also very obvious that investors are confused on how to price this asset heavy company properly with CenturyLink dragging down $LUMN. I truely believe this is a hidden gem to hold for the long term, you’re starting to see analysts price their targets from $13, $25, $28, the buy back program also shows how they believe how undervalued the shares are. It’s only going to get better for Lumen once they get rid of the melting ice cube known as CenturyLink.
This article was written by u/DoomsdayMcDoom