Lumen Technologies And Its Looming Maturities (NYSE:LUMN)

There are thousands of companies in the U.S. stock market, but most investors’ interest is focused either on the largest of them or on the “obviously misunderstood” ones. By the second category, I mean a set of companies that are too cheap (or too expensive) by various standards but continue to fall in price (or grow) no matter how high the likelihood of the opposite is.

Lumen Technologies (NYSE:LUMN) falls into the second category, judging by the activity in the comments on articles about this company here on Seeking Alpha (or other platforms). I propose to figure out whether everything is so clear in this story.

Lumen Technologies, one of the largest telecommunications carriers in the United States, possesses an extensive network of 450,000 route miles of fiber, including 35,000 route miles of subsea fiber connecting Europe, Asia, and Latin America. This facilities-based technology and communications company offers integrated products and services under the Lumen, Quantum Fiber, and CenturyLink brands to both business and residential customers domestically and internationally.

The firm operates in 2 segments, Business (79% of total revenue) and Mass Markets (21%), providing a wide range of services, including compute and application solutions, IP and data services, fiber infrastructure services, and voice-related services.

Although LUMN operates in such fast-growing segments and has been operating there for a long time, its stock price falls along with sales and EBITDA and the business has lost 96% of its market capitalization in the last 10 years:

Moreover, the observed decline in operational and financial indicators continues to worsen. In Q2 2023, Lumen Technologies reported revenue numbers that were roughly in line with estimates (missed by <$2 million), but with a significant year-over-year decline of ~20.6%. Bot the Business revenue and Mass markets revenue declined sequentially, with various factors contributing to these declines, including a reduction in legacy voice revenue and the impact of divestitures. Additionally, public sector revenue faced challenges due to lower other revenue and changes in product offerings, the firm’s CFO noted during the latest earnings call.

However, there was a slight uptick in revenue from fiber broadband by 3.3%, but it’s just a bit over 20% of Mass markets’ sales, so it didn’t change the whole picture:

The overall financial performance was negative, with a sharp drop in EBITDA and a severely reduced EBITDA margin. Free cash flow turned negative due to substantial capital expenditures.

The company’s FY2023 guidance remained relatively unchanged (except for the SBC expenses, which are going to be lower, based on the updated version), and the outlook for FY2024 suggests further revenue decline and challenges, particularly in terms of EBITDA and increasing debt levels.

And here I want to go back to where I started – why LUMN is attracting investor attention as it falls lower and lower.

The fact is that the company’s market capitalization today is about $1.33 billion, while total assets on the balance sheet are >$36 billion, although actively declining. Total debt including current maturities is ~$20 billion, so LUMN’s enterprise value is nearly $21 billion.

The hardest part is getting rid of debt and old assets, but LUMN has a 3-step plan – during the latest earnings call, CEO Kate Johnson shared insights into it.

First off, there’s a strong emphasis on “Securing the Base,” which involves transitioning customers from legacy telecom platforms to more modern ones to elevate customer experiences and increase their lifetime value. Early results have shown significant progress, with new talent and digital tools leading to improvements in the pipeline and close rates, along with the successful closure of record-breaking deals.

The second pillar, “Drive Commercial Excellence,” targets consistent execution across Lumen’s core businesses, with a focus on achieving growth rates at or above market levels. The company has added ~250,000 fiber-enabled locations this year and is on track to meet or exceed its annual targets. They are utilizing advanced tools like AI and data analytics to streamline sales processes, significantly reducing sales cycle times and enhancing customer onboarding.

Lastly, Lumen is committed to innovation for growth, exemplified by the development of breakthrough technologies such as ExaSwitch, a high-capacity optical interconnection platform created in collaboration with major hyperscalers, and Lumen Internet on Demand, an offering that provides customers with unprecedented flexibility in how they purchase, use, and manage networking services. The success of these innovations is evident, with Lumen Internet on Demand already being oversubscribed, Kate Johnson added.

I agree that it is too early to fully assess how well the new executive team led by Kate Johnson will be able to implement this plan. However, we already have data for the last 3 quarters that Kate has held office. And in that time, as far as I can tell from the financial statements, little has changed. Yes, the current ratio has increased from 1.13 to 1.23 over the last 3 quarters, but other liquidity ratios have deteriorated, and the operating cash flow ratio has generally fallen to negative:

The debt ratios look even worse: The leverage ratio has risen to almost 9x in the last quarter (based on Seeking Alpha data), and interest coverage has fallen from 1.82 to 1.18 in the last 3 quarters (i.e., by more than 35%).

Although gross profit margin has risen sharply quarter-over-quarter, we don’t see any positive year-over-year changes. And the operating profit margin shows no signs of improvement over the last 2 years.

Due to the combination of these factors, as well as the overall dismal actual financials for the most recent quarter, LUMN was downgraded to “B-” with a negative outlook by Fitch in late August. Lumen still has ~$1.85 billion in debt maturing in FY2025. This includes $200 million from Lumen’s revolving credit facility, which matures in January 2025. Beyond that, Lumen has much more debt totaling $9.4 billion that matures in 2027.

Of course, the upcoming sale of the EMEA business for $1.8 billion in cash [to be completed in late 2023 or early 2024] will help pay off the 2025 maturity, but what to do with $9.4 billion two years after that? There is a growing risk that Lumen might have to resort to distressed debt exchanges, a situation where they may need to negotiate with bondholders to restructure or extend the debt.

With the momentum we are now seeing in the company’s financial analysis, I don’t think the discrepancy between LUMN’s market capitalization and its enterprise value should be the only deciding factor in purchasing the stock today.

Moreover, other peers have much more stable financial performance – at least relative to debt. At the same time, they do not cost much more, and at the same time, they pay dividends.

The Verdict

The fact that LUMN has lost a colossal amount of shareholders’ equity over the past few years cannot leave “knife-catchers” indifferent – everyone is trying to predict the bottom of the LUMN share price and be the first to jump on this turnaround bandwagon. The sad truth is that it makes no sense to look for the bottom when a company has so much debt and the maturities are hanging around the corner [what are 2025 and 2027 in terms of time for a 55-year-old company?] and its financial performance is getting worse every quarter. Yes, a slight improvement in financials or a reduction in any of the existing risks should lead to a rapid increase in LUMN’s market cap – I understand this. But ask yourself a question: are you willing to buy stock in a company whose revenue and earnings per share are expected to decline every year for the next few years?

But there are other opinions about LUMN – many authors see a fairly favorable risk-reward in buying the stock today near its multi-year lows. I don’t believe that, but I understand their reasoning and agree that LUMN is heavily oversold and therefore very sensitive to the slightest positives.

That’s why I rate LUMN a “Hold” this time around.

Thanks for reading!