2023-11-06 03:24:07 ET
Summary
- Lumen Technologies has reached an agreement with creditors to restructure its debt, including the issuance of $1.2 billion in new first-lien indentures.
- LUMN plans to reduce its workforce by 4% and cut capital expenditures to cover the additional $150 million in annual interest expense.
- The proposed debt restructuring has led to credit rating downgrades and may require a distressed debt exchange, posing risks for investors.
Last week, Lumen Technologies ( LUMN ) announced its third quarter earnings . While there are things to highlight in the report, the announcement that the company has reached an agreement with a group of creditors to restructure a significant portion of its debt and 2027 maturity wall is worth digging into as it has far-ranging implications compared to this quarter's earnings. Lumen debt reacted by selling off and creating a wide variety of yield spreads, some exceeding 30%. The crux of the agreement is $1.2 billion in new financing, but after reviewing the transaction agreement , which is pending approval from other creditors, there are several considerations investors should take before acting.
FINRA
The transaction agreement provides ten exhibits that are all parts of the debt restructuring. The first is the issuance of $1.2 billion in new first-lien indentures that will mature in November of 2029 with an interest rate of 11%. Secondly, the $2.4 billion term loan had its maturity deferred from 2027 to a split between 2029 and 2030 in exchange for a 25 basis point increase in the interest rate.
The third and fourth exhibits are proposals to do debt exchanges for the 3.4% 2027 and 3.875% 2029 notes. The company is proposing an exchange for 100% principal in new 10.75% notes maturing in 2029 and 11% notes maturing in 2030. The fifth exhibit is a consent agreement for the recently issued 10.5% secured notes due in 2030, basically seeking a blessing from these holders for the debt deal. These three exhibits should be approved considering the premium being placed on the coupon payments in exchange for no principal reduction and no changes to the 2030 secured notes.
The sixth exhibit is the greyest in terms of certainty. The company is proposing that $4 billion worth of notes maturing from 2027 to 2029 be swapped for four similar notes with the same maturity dates but a 25-basis point coupon premium. The crux here is that the company only wants $2 billion of notes tendered, likely to obtain a majority consent to dismiss any negative covenants. For the purposes of estimating the outcome, I am assuming each note will be 50% tendered.
The seventh exhibit is the refinancing of the revolving line of credit into a super-priority revolver. The details here are grey as well, but currently, only $75 million is drawn on their existing revolver, so the important detail yet to be determined will be the capacity as it will speak to liquidity. The eighth exhibit is the refinancing of three term loans totaling more than $5 billion maturing in 2025 and 2027. The new term loans will mature in 2029 and 2030 with $800 million less principal due to a cash paydown ($4.3 billion).
The ninth exhibit involves the refinancing of approximately $1.75 billion of 4% 2027 maturing and 5.125% 2026 maturing notes into two 4.25% notes maturing in 2029 and 2030 with a little over $1 billion in total principal between the two. From there, the company estimates that $500 million will remain in the existing notes and $188 million of cash will be used to reduce principal.
The tenth exhibit mentions the $800 million paydown in term loans, but I did not include that in my estimates because I believe the paydown in exhibit eight meets that declaration. It is possible that an additional paydown could occur, but I want to estimate the company's highest possible interest expense exposure. The second portion of the exhibit involved the payoff of the Qwest term loan maturing in 2027 for $215 million.
Based on the exhibits and estimates, Lumen is refinancing just under $16 billion of total debt from an annual interest expense of $1.02 billion to $1.17 billion. The cash outlay in the refinancing is just under $1.2 billion, which appears to represent the usage of the funds from the first lien indenture. So, where is the company going to come up with the funds to cover the additional $150 million in annual interest expense?
Lumen will start by reducing the workforce by 4%, creating an annualized savings of $300 million, but that's not everything. During the earnings call, the CFO mentioned that capital expenditures will be reduced by $200 to $300 million over the next few years. The reduction in capital expenditures comes from the company's decision to shift towards higher return investments in the Mass Market segment of their business.
As mentioned previously, the company's debt sold off in response to the debt restructuring proposal, trading at higher yields. Additionally, Fitch downgraded Lumen to CCC- and placed a negative watch on the company. While the credit ratings agency notes the turnaround risk as a reason for downgrade, the primary reason appears to be that the proposed debt restructuring may require a distressed debt exchange, which would lead to further downgrades ( see Geo Group ).
Whether investors are shareholders, unsecured, or secured noteholders, there are other considerations that need to be made prior to deciding a course of action. While the debt maturity profile has shifted considerably from 2027 to 2029 and 2030, the company still faces $1 billion in debt maturities between now and the end of 2026 and an additional $1 billion in 2027.
SEC 10-Q Data & Author Spreadsheet
While the company may be able to generate the cash flow needed to pay these maturities down, it's important to note that new covenants place limitations on refinancing these debts. According to the covenants, the company will have the authority to engage in $1 billion in new subordinated debt as long as 50% of the proceeds are utilized to pay down more senior debt. The same covenant exists in the $500 million authorization towards a receivable facility. Therefore, any dollar of unsecured debt coming due that requires refinancing will require $2 in new debt to compensate the principal of the secured lenders.
Investors may feel the company now has ample time to turn operations around, but it's important to note that secured lenders are not going to consent to $2 billion in principal payments leaving the company between now and the end of 2026 unless they see results. In the third quarter earnings call, Lumen's CFO mentioned that revenue trends should begin improving in mid-2024. Secured lenders are going to expect the company to follow management projections and guidance through this transition.
If the company does not begin to deliver on the turnaround in 2024 by meeting expectations, we can expect the secured lenders to once again step in, this time it may be in the form of distressed debt exchanges towards unsecured noteholders or a prepackaged bankruptcy. Despite the maturity wall being pushed out, investors should also not fall for the free rider trap in the 2025 or 2026 notes ( see Diebold ). When fourth quarter earnings get released this winter, investors will need to examine the 2024 guidance compared to the forecast presented at Investor Day to make sure everything is proceeding as expected.
As an investor in unsecured debt maturing in 2039, I am in a holding pattern until I see 2024 guidance and compare it to previous company forecasts. From there, if I feel good about a mid-2024 turnaround, I may buy more unsecured debt or take a position in the secured debt if it is yielding over 11%. Additionally, I want to see how the debt transaction finalizes because approval is not guaranteed and failure to consummate this deal could have additional consequences for investors. Overall, I'm still comfortable with my holdings in 2039 maturing unsecured debt.
For further details see:
Lumen Technologies: A Deep Dive Into The Proposed $16 Billion Debt Restructuring