2023-11-06 03:26:10 ET
Summary
- Lumen Technologies' stock is trading at multi-decade lows, suggesting the market is pricing it for imminent bankruptcy.
- The company seems to be largely on track for its turnaround plans based on the Q3 earnings release.
- Amid a controversial creditor agreement, LUMN secured some fresh capital and more time before maturities, in exchange for higher interest payments.
Lumen Technologies ( LUMN ) is a telecommunications company that is currently trading at multi-decade lows and it appears as if the market is pricing it for imminent bankruptcy.
Since our last article just a month ago, LUMN's common stock experienced some volatility leading up to the Q3 earnings release but closed just slightly above the price at the publication of our last article. However, as a response to the Q3 earnings release and the creditor agreement that was announced, the stock dropped sharply, closing at under $1.
In our last article, we talked in-depth about the history of the company and its stock. We thoroughly examined the company's turnaround plan there. In case you have not read our previous article on LUMN, please check it out here . In this article we want to focus on the new information and whether the narrative of a turnaround still holds up after the latest news.
News since our last article
On 10th October, Lumen announced the sale of select CDN customer contracts to Akamai. While the two companies have not revealed the agreed-upon purchase price, a rough guess we came up with in a comment resulted in an estimated price of $100m. This sale further demonstrates the company's willingness to sell off non-core assets, presumably to reduce debt.
On 25th October, Lumen announced a $400m award from the state of California as part of the "Broadband for All" initiative. The investment incentivises Lumen to bring middle-mile connectivity to " hundreds of California communities by the end of 2026 ". While there is limited information available regarding the details of this award, it shows Lumen's ability to secure government deals.
In light of the massive $42b+ federal BEAD program , and also billions in state grants, government incentives can be a big contributor to the TelCo companies. In their Investor Presentation outlooks, Lumen specifies that their projections exclude the impacts of BEAD. So, any success in securing these awards is extra .
Also on 25th October, Lumen announced their solutions for Zoom. While there is also little information available for this and generally, it probably won't become a core-product for the company, it shows Lumen's continued willingness to partner with industry giants to provide value to customers.
Another partnership was announced on 31st October. The partnership with data center industry-giant Equinix (NASDAQ:EQIX) will "enable Equinix's 10,000 customers to instantly buy (...) Lumen® NaaS services." In past communication, the company repeatedly emphasised its NaaS services as a flagship offering in its B2B growth segment.
However, here it is important to note that providing many different products and offerings, that each might not be significant revenue drivers, could come across as desperate. As long as no clear revenue numbers are known for any of their new products, future product releases are neutral to our outlook. This stance also applies to products mentioned in our previous article, where no further revenue numbers have been shared in the company's Q3 release.
In their Q3 2023 earnings release , the company confirmed the 1st of November as the expected closing date of their EMEA divestiture deal. In recent communication the company still didn't publicly say whether the deal will close this year or in 2024. The deal will generate $1.5b in net after-tax proceeds, enough to almost completely cover their combined maturities of ~$1.8b until 2025.
Lumen Maturity Profile (Lumen Investor Day)
Lumen's Q3 earnings in numbers
Revenue, Adjusted EBITDA, Cash Flow, and CAPEX were reported largely in line with expectations, based on the outlook Lumen gave in their 2023 Investor Day.
Lumen Outlook (Lumen Investor Day)
The company reported revenue of ~$3.6b in Q3 2023 and a total of ~$11b for the first nine months of the year, Adjusted EBITDA of ~$1b in Q3 2023 and a total of ~$3.3b for the first nine months of the year and free cash flow of ~$38m in Q3 2023 and a total of ~$35m (excluding around $938m in cash tax related to previous divestitures, read more in their Q2 release ) for the first nine months of the year.
With total revenue declining only 0.5% Q/Q in the current quarter, the company seems to be making some progress in slowing down the revenue decline. However, the biggest factor was increased public sector revenue Q/Q. In the earnings call, it was also hinted that some of the revenue was due to "one-timers" in the form of "IT solutions and equipment", so possibly the decline would have been steeper without these one-off factors. Noteworthy also is that the "Grow" business segment of the company, which is supposed to be the main growth driver, declined 1% Q/Q.
Selected Revenue Metrics (Lumen Q3 Earnings Release)
The CFO also announced "a tax refund of approximately $900 million" the company expects to receive. $200m of the refund will be applied to pay 2023 estimated taxes and the company is "expecting a cash refund of approximately $700 million in the first quarter of [2024]". The company has been posting large losses over the years and this refund "is in part due to an accelerated use of [their] NOLs".
While reaffirming their full-year 2023 outlook on metrics including Adjusted EBITDA, the company's CFO provided further information on EBITDA pressures in the third quarter relative to the solid revenue in the earnings call . Some of the factors named for the EBITDA pressures were "a tough economic environment" and also the ongoing business "transition".
The CEO has also announced "immediate actions, which will result in about 4% fewer people inside the company. (...) Along with additional optimisation initiatives [this], will generate annualised savings of approximately $300 million."
Another headwind both the CFO and also the CEO mentioned was "noise in the market regarding creditor discussions". They seem to imply that customers might have been hesitant spending with Lumen due to the open questions on their 2027 maturities and bankruptcy rumours. A comprehensive creditor agreement the company has announced together with the earnings release seems to be the company's attempt to address some concerns regarding their debt structure.
The Creditor Agreement
The announced agreement was reached with creditors holding a combined of over $7b of Lumen's outstanding debt. The CFO summarised the agreement as follows:
The transaction will extend a large portion of our debt maturities and remove questions regarding the company's compliance with these debt covenants. The creditor group will also provide $1.2 billion of new financing.
As can be seen on the 8-K filing for the agreement, the whole deal structure is very complex in nature as it affects many different loans across different legal entities. On a high-level our understanding of the agreement consists of following points:
- The creditor group provides a new loan of $1.2b (net cash available to the company will be closer to $1b), at a high net interest rate.
- Most existing Lumen HoldCo and Level3 creditors get the chance to exchange their existing loans to newly issued loans at 100% principal amount, with higher interest payments across the board.
- The maturities are pushed out around 2 years further and also often split into 50% yearly tranches.
- Some of the debt covenants are adjusted, presumingly to clear up previously-raised questions of the company's compliance with covenants.
While we are no experts on debt structures, we believe this agreement is a net-positive for the company. On a high-level, the company is agreeing to pay higher interest rates in order to remove revenue headwinds they experienced from the market rumours and also to gain more time to perform their turnaround.
Between the announced divestitures, the $700m tax windfall, and the remaining possibility of buying back debt at a discount, we believe the company will have the ability to afford to pay elevated interest rates and other costs from this agreement for now.
The CFO also made clear in the conference call that their forecasts already had higher interest expenses included in the models. The main change the agreement brings is that interest expense is increasing sooner. To offset the higher interest rate the CFO answered an analyst's question that "[they] will be cutting back on CapEx in the $200 million to $300 million range over the next few years to compensate for [the higher interest rates]". Specifically, the company will not increase its rate for the 2024 FTTH buildout, but keep the pace of 500,000 enablements a year.
Conclusion
Based on the numbers posted in their Q3 release, we still believe the company seems to be on track with its turnaround plans. A slow revenue decline and several initiatives including further divestitures of non-core assets, the government-funded project deal, and further partnerships are positive signs for the long-term stabilisation of the company.
As always, it is still important to keep the risks connected to a Lumen equity investment in mind. Higher interest payment and other costs of the creditor agreement are putting further pressure on the company for the short- and medium-term. The stock is now trading at extremely distressed levels, a sign that the market still does not believe the company's turnaround story.
Again, with the stock closing under $1 and a lot of mistrust from the market, the risk and possible volatility cannot be overstated. Compared to our last article we are also much more cautious now.
We reiterate a very cautious buy rating for the common stock, as a high-risk high-reward bet with a possibility of total capital loss. In the next couple of months, we are closely following further information and reaction to the creditor agreements and any information on how some of the company's new growth products perform.
For further details see:
Lumen: Still A Cautious Buy After Controversial Creditor Agreement And Q3 Earnings