2023-12-12 11:15:02 ET
Summary
- Lumen's recent debt restructuring deal, which the market has embraced in full stride, creates an inconsistency between the turnaround strategy of the company and its actions.
- Lumen's potential for growth in the fiber segment - the only consumer product to register growth in recent years - has come into question.
- Lumen's revenue has been shrinking for the past five years, and a return to growth is unlikely in the foreseeable future.
- In the past, telecom companies wanted to control the entire network infrastructure to provide high-quality services to their enterprise clients. Today, the tables have turned.
- Lumen's valuable network assets may never earn the desired returns because of the monetization challenges the industry is facing today.
I was a Lumen Technologies, Inc. ( LUMN ) bull until recently. Last April, I was forced to downgrade the stock as I thought the execution of Lumen's turnaround strategy was below par at the time. I was spooked by negative earnings revisions as well. Soon after downgrading the stock, I cut my losses and moved on. In hindsight, that does not seem a bad decision.
Hovering around the $1.40 mark, it seems like Lumen stock has nowhere else to fall. Looks can be deceiving, though, and I believe there is more pain on the cards.
The Recent Debt Restructuring Deal Is A Blow To Growth Investors
I am a growth investor. I don't hesitate to strategically invest in income-producing assets nor to hold cash when it seems the best option, but in general, I prefer investing in companies with a long runway to grow at the right price.
The debt restructuring deal Lumen announced on October 31 has improved the market sentiment toward the company, evident from the 16% gain in LUMN stock in the last 30 days. Fellow SA contributor Jeremy LaKosh did a deep dive on the debt restructuring on November 6 and concluded that this decision poses risks to investors.
I am not going to repeat the same points here as I fully agree with his analysis. All that investors need to know is Lumen reached an agreement with some of its creditors holding $7 billion in debt to push back maturities, giving the company more breathing space from maturities falling in 2027. Lumen also received $1.2 billion in fresh capital in long-term debt as part of the agreement with the creditor group. With this debt restructuring, Lumen's interest expense will surge by around $150 million annually.
When I took a stake in Lumen a couple of years ago, my investment thesis was centered around the company's potential to utilize its high-value assets to penetrate more households with its fiber broadband solutions. The management, for more than two years until the last quarter, has been projecting strong growth from the fiber segment. To achieve such growth, the company pledged to invest aggressively in expanding its reach. Today, the opposite is happening with Lumen planning to reduce capital expenditures by $200-$300 million to direct toward covering the incremental interest expenses resulting from the debt restructuring.
It baffles me how Lumen management reached a deal that would cut its limbs. The only explanation is that they predicted Lumen will not be able to generate the cash flows needed to cover debt repayments when they become due in 2027, which prompted them to take action today to extend the time Lumen has to operate as a going concern. Just because Lumen will survive to live another day, it does not become an attractive investment.
As a growth investor, I am not comfortable with the inconsistency in the execution of Lumen's turnaround plan. Fiber being the only growth driver in Lumen's mass market segment in recent years, I would be wary of any decision that could potentially impact growth in this segment.
During the Q2 earnings call , CEO Kate Johnson said:
Success here looks like growing at or greater than market rates wherever we compete. In our mass market segment, we've added approximately 250,000 fiber-enabled locations year-to-date in 2023, and we're confident that we can meet or exceed our plan of 500,000 for the year.
On the Q1 earnings call , she said:
In the first quarter of 2023, we saw net enablement growth accelerate with March enablement eclipsing January enablement by more than double. This gives us confidence that we'll meet or exceed our 2023 enablement target of 500,000 locations.
By the time Lumen's management sat down for the third-quarter earnings call , the stance had changed, and CFO Chris Stansbury used language that suggests the company is happy with around 500,000 new homes passed annually. There was no mention of exceeding this target anymore.
He went on to claim that this level of enablement will still be ahead of the competition - which may very well be the case given today's economic environment - but this is not a good enough reason, in my opinion, to slash the CapEx budget as much as they did after completing a debt restructuring deal that puts extra pressure on the company's cash flow profile.
The debt restructuring deal, sooner rather than later, will prove to be a massive blow to the company's growth plans. In my opinion, the deal clearly signals management's concerns regarding the company's potential to successfully execute its turnaround plan.
Return To Growth Is A Distant Reality
Lumen's revenue has shrunk in each of the last five years. That's not a good sign to start with. Adding to woes, a return to growth does not seem likely in the foreseeable future.
To understand the root cause of Lumen's existential crisis, we need to look at recent technological advancements.
Lumen is truly a global leader in serving worldwide data transformation needs. The company's fiber mile network, spread across approximately 450,000 route miles, is among the best in the business. This means that Lumen's assets form the backbone of the Internet. In the past, telecom companies wanted to control the entire network infrastructure to provide high-quality services to their enterprise clients. Today, the tables have turned because of technological advancements, diminishing the monetization potential of valuable network infrastructure.
- The growth of software-defined networking: SDN enables the programmability of network infrastructure, allowing for centralized control and management. This helps telecom companies offer customizable solutions to enterprises without the need to physically reconfigure hardware.
- The popularity of Infrastructure-as-a-Service solutions: Telecom companies leverage cloud providers to offer IaaS, enabling enterprises to access computing resources, storage, and networking on a pay-as-you-go basis. This eliminates the need for enterprises to invest in and maintain their own infrastructure.
- 5G technology: 5G brings enhanced network capabilities, including higher bandwidth, lower latency, and the ability to support a massive number of connected devices. This means that more bandwidth can be offered with the same level of physical capacity.
The rise of edge computing and the growing use of network functionality outsourcing are also reasons behind the challenges faced by network infrastructure owners, including Lumen.
After diversifying several consumer assets, since 2022, Lumen has been primarily focusing on the enterprise segment of its business. The company faces substantial competition in this sector, and growth has been non-existent for many quarters now.
Exhibit 1: QoQ revenue change
Q3 earnings presentation
The consumer business - what is left of it - faces challenges as legacy broadband services and the voice business continue to lose appeal. The one bright spot in fiber broadband may also fail to make a meaningful impact on overall revenue at a time when the company is planning to cut down CapEx.
Taking all of these challenges into account, analysts don't expect Lumen to return to growth anytime soon.
Exhibit 2: YoY revenue growth expectations
With the company's turnaround strategy still failing to gain any momentum, I believe Lumen is uninvestable today.
Takeaway
Lumen may survive longer than some bears projected aided by the recent debt restructuring deal. That does not make LUMN investable, though. The only way shareholders will walk with a profit after doubling down on LUMN stock at these prices is if a large telecom company decides to bid for the valuable assets owned by Lumen. I am not one to make investment decisions based on wishful thinking, so I will steer clear of Lumen.
For further details see:
Lumen Stock: There's More Pain Ahead; Run