2023-07-18 10:25:11 ET
Summary
- The telecom sector, including Lumen Technologies, has been hit by a report about potentially dangerous lead-covered cables in legacy phone networks, which could require costly cleanups.
- Analysts estimate that cleanup costs could reach $59 billion, with AT&T expected to bear the brunt due to its size; Lumen's exposure could exceed $8 billion, over four times its market cap.
- Lumen's shares have fallen to a multi-year low and the issue could potentially affect the stock for years; the company's planned share buyback could be cancelled due to this exposure.
Over the past few days, the telecom sector has been hit rather hard. Recently, the Wall Street Journal published a report regarding lead-sheathed cables in legacy phone networks. One of the names hit hardest has been Lumen Technologies ( LUMN ), a name I've frequently covered on this site. Today, I wanted to examine the news and discuss the potential impact for investors.
The WSJ report stated that these companies installed potentially dangerous lead-covered cables overhead on poles, in soil, and underwater. They will likely need to take steps to make areas environmentally safe, which could be very costly over time. Some of this could be covered by US government spending to upgrade infrastructure and provide better digital connectivity to all residents. However, the rest of the cleanup could be extremely costly according to analysts at New Street Research:
According to the New Street estimates – there are roughly 48 million homes and offices connected to cabling that still contains potentially dangerous levels of lead. The firm estimates some of those locations will be cleaned up amid government spending to cross the digital divide . But, for the remainder, the New Street analysts estimate a total cleanup cost of $59 billion.
The current thought process is that AT&T ( T ) would be hit the hardest in terms of total costs, because it is the biggest player in this space. Verizon ( VZ ) would have a meaningful liability as well. The two giants, along with Lumen, have seen their stocks whacked in recent trading days as the chart below shows, with Lumen seeing the biggest impact.
AT&T and Verizon are the strongest players in the space, with decent free cash flow, so they should be able to handle this potential issue a bit more. However, Lumen's exposure could be over $8 billion according to estimates , which right now is more than 4 times the company's entire market cap. That's likely the reason why Lumen shares have been hit the hardest, with Monday's fall sending the stock to a new multi-year low.
It was just a few weeks ago when I covered Lumen previously that I talked about something needing to give with this stock. At that time, I discussed the possibility of management using its authorized share repurchase plan to significantly reduce the number of shares outstanding. As part of that plan, I was modeling that the company would use its sale proceeds from the EMEA asset sale for buybacks and not debt repurchases.
Part of the reason I thought this buyback could be accomplished was that management was expecting Lumen to return to positive free cash flow in the coming years. As the graphic below shows, the midpoint of each year's respective guidance suggests $1 billion in free cash flow through 2027, which would more than offset some of the extra interest from not paying back debt currently to favor the buyback. If there is any meaningful exposure here, I think Lumen could cancel the rest of the buyback, which would eliminate a potential major upside catalyst.
The company is scheduled to report Q2 results after the close on August 1st. My key question for management now would be, do you expect any exposure here, and if so, how much? Also, does some of the company's capital expenditure guidance for the coming years involve replacing any of this legacy infrastructure, this reducing the potential liability? The answers to those questions likely will go a long way towards determining whether the recent share drop will continue or if they can recover a bit.
After Monday's decline, Lumen shares are trading at less than 4.48 times this year's currently expected adjusted earnings. That's quite a bit of a discount to the two industry giants, as AT&T fetches over 5.55 times and Verizon goes for 6.72 times. I mentioned previously that it is not surprising that Lumen goes for a discount given those two names are in a much stronger financial situation currently, and both are paying decent dividends. However, Lumen could trade to an even bigger discount moving forward if its potential exposure here relative to its overall size is much larger than the other two companies.
Until we get more clarity from Lumen management, I will continue to rate the name a hold. However, I am very close to downgrading shares to a sell, whereas I would have previously considered an upgrade to buy had a major buyback gone through and overall results started to improve. For the short term, this lead cable issue is now a major negative risk for Lumen shares and could potentially be an overhang on the stock for years to come.
In the end, Lumen shares have dropped to a new multi-year low after a WSJ report regarding lead sheathed cables. Legacy telecom infrastructure could be a major problem for companies in the space, with analysts suggesting a total cleanup of dangerous cables could cost tens of billions of dollars. With Lumen being a small name here with a debt heavy balance sheet, this is an issue that could set back the company for quite some time. For those hoping that the worst was behind use for Lumen, this is a major speed bump in that process.
For further details see:
Lumen: Another Major Potential Risk