The need for high-speed internet has become an essential necessity for most of the world's population. And the complaints by consumers that their broadband speeds are not fast enough is universal. One would think a company that owns and is building out high-speed fiber products would make a great investment, but that has not been the case for Lumen Technologies Inc. (LUMN, Financial).
The facilities-based technology and communications company provides broadband, fiber, cloud services, IT solutions, unified communication and collaboration solutions, colocation and data center services, content delivery services and managed security services.
The company also provides fiber infrastructure services, comprising high bandwidth optical wavelength networks and unlit optical fiber. As of the end of 2022, Lumen served approximately 3.1 million broadband subscribers.
Formerly known as CenturyLink, the company changed its name to Lumen Technologies in September 2020. It was founded in 1968 and currently has a market capitalization of $4 billion.
Recent news
The company has historically carried high levels of debt and has been attempting to delever the balance sheet in recent years. In October, it closed on the sale of its local carrier operations for $7.5 billion and in November, announced the sale of its Europe, Middle East and Africa business for $1.8 billion. The latter transaction is expected to be accretive as the deal is being done at 11 times Ebitda and Lumen is selling for half of that multiple.
Legendary value investor and long-time Lumen owner Mason Hawkins (Trades, Portfolio) stated in the Longleaf Small-Cap Fund's fourth-quarter letter that: “This long-term position had a history of managing costs and producing steady free cash flow under the leadership of former CEO Jeff Storey, but its organic revenue growth has been disappointing for a few years and its cash flow began to disappoint recently. The recent moves are creating a clearer business mix and stronger balance sheet, and we believe we could see additional positive moves to finally separate the legacy Level 3/Qwest business from the remaining quality local market assets.”
Financial review
Lumen reported fourth-quarter and full-year 2022 results on Feb. 7, which were somewhat disappointing. Total revenue declined 5.5%, driven by a 7.6% decline in the Mass Markets segment and a 5% decline in the Business segment. Ebitda declined to $1.4 billion from $1.5 billion in the prior-year period. The growth in fiber broadband was a highlight for the quarter, in which subscribers increased by 97,000 and revenue increased 18.4%.
Cash on the balance sheet at year end was $1.25 billion and total debt stood at $20.6 billion. The leverage ratio was reduced to 3.7 times after a gross debt reduction of almost $10 billion in 2022.
Valuation
The company provided disappointing 2023 guidance in its year-end earnings release. Adjusted Ebitda is expected in the range of $4.6 billion to $4.8 billion and free cash flow is expected to be in the range of zero to $200 million. This guidance was very disappointing as the company has typically generated strong levels of free cash flow. In 2022, free cash flow was $1.7 billion and in 2021, the amount was $3.6 billion. Building out a fiber network is an expensive proposition and capital expenditures are expected to be approximately $3 billion this year.
Consensus analyst earnings per share estimates are 31 cents for 2023 and 27 cents for 2024, which creates a low forward price-earnings ratio of 12.4 this year. The current enterprise value/Ebitda ratio is approximately 5.
The GuruFocus discounted cash flow calculator creates a value close to today's stock price using earnings of 31 cents per share as the starting point and a 5% long-term growth rate.
Lumen eliminated its dividend in the fourth quarter of 2022 and instead enacted a $1.5 billion two-year share repurchase plan. Of course, with possibly zero free cash flow this year, share buybacks may not occur.
Guru trades
Gurus who have purchased or added to their positions in Lumen stock in the past couple quarters include Jeremy Grantham (Trades, Portfolio) and Jim Simons (Trades, Portfolio)' Renaissance Technologies. Investors who have reduced or sold out of their positions include Hawkins' firm, Mario Gabelli (Trades, Portfolio) and Arnold Van Den Berg (Trades, Portfolio).
Summary
Lumen's stock has declined almost 70% from its 52-week high, which may represent an interesting opportunity for investors. Often when a company eliminates its dividend, it can be a good time to invest as disappointed dividend investors have already sold out. In addition, the cash flow freed up from the dividend cut can be deployed to strategic investments, debt repayment or share repurchases.
These fixes will not happen overnight, as CEO Kate Johnson recently said, “First, on Ebitda and capex, we are leaning into our growth and optimization priorities and Chris will provide financial details of these initiatives shortly. We believe these investments are critical to position Lumen for strong execution and scalable sustainable growth. And we expect revenue and Ebitda stability in less than two years.”
If the company begins to generate negative free cash flow, then it is possible the equity may be worth very little. Nonetheless, the need for high-speed fiber is not going away and it may be prudent for investors to keep an eye on the stock.
