Suffering shareholders of the telecoms company CenturyLink (LUMN) got a boost on May 8 when activist investor Keith Meister revealed a 5.5% stake in the company, calling the shares undervalued by at least 40% and offering some "friendly" advice on management succession as the company merges with Level 3 Communications (LVLT).
As both I and fellow Fool Steve Symington have written before, CenturyLink's merger with Level 3 is a smart idea. The merger could turn CenturyLink from a struggling business -- that may have to cut its 9% dividend -- into a thriving one with plenty of dividend coverage and growth prospects. The key, though, is that the merger actually goes through, and that integration is successful. Meister shares this view, with a few other insights as well.
Start Tom Brady
Keith Meister is an activist and is known for taking on management teams. His take on CenturyLink is not the typical activist move of fixing a bad business. Rather, Meister merely suggests that Level 3's CEO, Jeff Storey, remain an executive to help oversee the integration. The succession plan as of now is for Story to join the board of the combined companies, but not in an executive role. Meister doesn't think CenturyLink CEO Glenn Post is a bad executive. Rather, he wishes to see both in hands-on roles at the combined company.
This is because Storey has had a great track record at Level 3. Meister notes that since Story became CEO in 2013, Level 3 stock has risen 175%, beating the S&P 500 by a whopping 125%. "If you're the New England Patriots," Meister said, "you are going to start Tom Brady."
I hope Meister is aware that Storey may be taking a step back due to a heart condition that sidelined him in February of 2016; however, assuming Storey's health is OK, I'd agree with Meister. Level 3's recent record has been much better than CenturyLink's.
Why Meister believes it's mispriced
Meister has a few theories as to why the stock is mispriced. Mostly, CenturyLink's recent earnings were bad, showing an increased deterioration of its legacy businesses, even as its new businesses such as high-bandwidth enterprise services showed growth. Mr. Market, Meister contends, does not have the imagination to picture how much better the merged company will be. Since the deal announcement, CenturyLink's stock is down 10%-25% from where it was prior, despite the merger making the stock a better bet. That doesn't make much sense to Meister.
Moreover, Meister believes people are mistakenly comparing CenturyLink to Frontier Communications (FTR), which just cut its dividend 62%, and which some investors believe is going bankrupt.
However, Meister notes that Frontier is regional, which puts it at a scale disadvantage to CenturyLink and other competitors. Moreover, it is dealing with a poor integration of Verizon's wireline businesses in California, Texas, and Florida. Finally, the company only has 42% of its customers as Enterprise, which Meister believes are much "stickier" customers than consumers. Post-merger, CenturyLink and Level 3 will have 76% enterprise exposure, which Meister believes is a much higher-quality earnings stream.
Meister knows telecom
Meister has had a good history with telecom stock picks. His firm, Corvex Capital, had success with telecom investments in ABVT, which was later acquired by Zayo (ZAYO), and TW Telecom, which was acquired by Level 3 back in 2014. Meister now believes the Level 3 and CenturyLink merger will yield another win for his fund.
Given Meister's seal of approval, as well as Steve's and my own optimism regarding the deal, I think he may be onto something. The trick, of course, is obviously for the deal to go through, and then for the integration to go well. Those are always risks, especially with a merger of two $30 billion companies that will carry significant debt post-merger.
Bottom line: CenturyLink's stock took a hit after earnings, but a big hedge fund manager shining the light on the potential opportunities of its merger with Level 3 is giving shareholders hope for better times ahead.