2023-12-14 02:14:12 ET
Summary
- Lumen Technologies reached a debt deal with investors, causing its stock price to drop and further burden its balance sheet.
- The company's high levels of debt relative to earnings and free cash flow make it financially difficult to sustain.
- LUMN has announced a debt restructuring plan and plans to invest in its business to revive its free cash flow, but its core business is struggling.
Lumen Technologies, Inc. ( LUMN ) reached a new debt deal with investors about a month ago which not only caused Lumen's stock price to drop to new all-time lows but which will further burden the company's balance sheet.
Since asset sales and depressing levels of free cash flow have weighed down Lumen Technologies' stock to the below $2 level and since I am having a hard time mapping out a profitable path for the telecommunications company. As a consequence, I am cutting my losses here for tax-loss purposes and modifying my stock classification for Lumen Technologies to Sell.
My Rating History
I adopted a more neutral stance on the broadband company in July which was precipitated primarily by surging interest rates and which led, in my view, to a weak business setup.
Higher key interest rates translated into an incremental burden for Lumen Technologies which carries a substantial amount of unhedged, floating-rate debt on its balance sheet.
Though inflation has trended downward lately, I think that the company's debt restructuring further amplifies Lumen Technologies' existing problems.
With weak free cash flow present as well, I think it is time to cut my losses and move on.
Debt Situation Set For Further Deterioration
Lumen Technologies cut a deal with some of its debt investors, including BlackRock, Pacific Investment Management, Silver Point Capital and others that lays out terms for a major debt restructuring and includes the assumption of new debt.
The main problem with Lumen Technologies is that the company has too much debt relative to its earnings and free cash flow capacity which makes the present amount of debt financially difficult to sustain.
Lumen Technologies had $19.7 billion in long-term debt on its balance sheet at the end of the third quarter and the central bank's big change in rate policy since 2022 has pushed the telecommunications company into a corner: Lumen's high-cost, floating-rate debt has weighed heavily on the company's valuation.
Part of the total $19.7 billion of long-term debt is $7.8 billion (yellow highlights in the table below) of floating-rate debt that is costing the company more money. This floating-rate debt is unhedged, meaning any additional increase in interest rates will cost the company more money as well.
Most (88%) of Lumen Technologies' total long-term debt matures after 2027, but the amount is in desperate need to take some corrective action.
Lumen Technologies' financial problems have been made worse by the fact that it sold assets last year which also led to a substantial decline in free cash flow.
For the present year, for instance, Lumen Technologies expects between $0 and $200 million in free cash flow. This debt is expected to cost $1.2 billion in interest expenses this year and probably around the same amount next year. In 3Q-23, Lumen Technologies' free cash flow was just about $43 million and the company paid a whopping $320 in cash interest.
With a decline in free cash flow, a result of recent asset sales also comes a reduced ability to support Lumen Technologies' substantial $20 billion debt.
To find a solution to its problems, Lumen Technologies announced that it cut a deal with its financing partners to restructure its debt: some of the company's creditors have agreed to provide $1.2 billion of new financing that Lumen Technologies will invest in the business to resuscitate its free cash flow.
This business includes the VoIP, IP, and managed security businesses which the company wants to grow from an estimated 41% sales portion in 2023 to 59% by 2027. These portions of Lumen Technologies have seen a 1% QoQ sales decline in 3Q-23 and it remains doubtful if the telecommunications company can actually pull off a turnaround in its core business.
In order to appeal to its shareholders (and creditors), Lumen Technologies also laid out its goal to slash 4% of its workforce which the CEO estimated to yield $300 million in cost savings. Be that as it may, Lumen Technologies' business is not in a healthy shape, this much is clear.
Valuation Multiples May Continue To Compress
The $20 billion in long-term debt stands in glaring contrast to Lumen Technologies' equity market value which has collapsed to just $1.5 billion.
Lumen Technologies' total enterprise value (including all debt) is presently $21.4 billion. This is the equivalent of 14.3x equity or 107x the top estimate for 2023 free cash flow ($200 million). The precariousness of Lumen Technologies' debt situation, I think, should be taken very seriously.
Lumen Technologies reaffirmed its free cash flow outlook for 2023 in the third quarter which gives an indicative range of $0-200 million. This guidance implies a free cash flow multiple of 7.5x ($200 million estimate) and of 15x ($100 million estimate). The multiples may continue to contract if the market loses hope that Lumen Technologies' core business can be turned around.
High Short Interest And Other Risks
Lumen Technologies is highly shorted which is not great for either the telecommunications company or its investors. In November, 148 million shares were shorted out of a total float size of 989 million. This means that about 15% of the company's float is sold short.
The explanation for the high short-interest ratio lies in Lumen Technologies' large financial debt which has weighed heavily on investor sentiment. I think that Lumen Technologies has a high chance of drifting towards a Chapter 11 filing.
My Conclusion
I am cutting my losses with Lumen Technologies, a broadband company that I once held in high esteem and expected a lot from.
But the present trajectory is not a good one and the deal with some of the company's creditors is, in my mind, more bad than good because it packs even more debt on Lumen Technologies' already burdened balance sheet.
Lumen Technologies is already crushed by its (floating-rate) debt and the $1.2 billion of newly issued debt is going to make things worse.
Lumen Technologies has said that it will invest this debt into the company's growth, but even the growth-classified businesses are struggling to see any kind of real sales growth.
For tax-loss harvesting purposes, I have cleaned Lumen Technologies out of my portfolio and modified my stock classification to Sell.
For further details see:
Lumen Technologies: Time To Cut My Losses (Downgrade)