Last week, CenturyLink (LUMN) and Level 3 Communications (LVLT) inched closer to sealing their merger, nearly one year after the deal was announced.
The Department of Justice approved the merger, though it also had some conditions: The combined company must divest certain assets in Albuquerque, N.M.; Boise, Idaho; and Tucson, Ariz. It must also sell 24 strands of "dark fiber" -- unused fiber strands that can be leased to other companies wishing to stream data over its network.
The divestitures shouldn't have too great an impact on the combined company. And after the $25 billion merger CenturyLink will be a huge global telecom service provider:
Image source: CenturyLink.
The companies could use the money from these divestitures to fund the other conditions the state of California imposed last week. The Public Utility Commission of California has been dragging its heels this summer, forcing the merger to be delayed past the initial self-imposed date of the third quarter 2017, but it will advocate for approval later this month on condition that CenturyLink invest $323 million in California over the next three years, along with a few other requirements.
What's with the stock?
Both CenturyLink and Level 3 surged on the news but the stocks remain just above their 52-week lows. Given that the merger seems to be a virtual certainty at this point -- though it still needs to "officially" clear the California Public Utilities Commission, as well as the Federal Communications Commission -- this may seem strange. Both I and other Fool writers believe the merger will be transformative.
One reason for the depressed price could be the recent downgrade from Barclays analyst Amir Rozwadowski, who lowered his price target on CenturyLink from $23 to $19 and on Level 3 from $59 to $53. Rozwadowski believes that "improved clarity on lingering questions surrounding the joint entity's strategic priorities, how it plans to navigate notable technology changes, the trajectory of end market demand, size and scope of synergy upside, and capital allocation plans would serve as a net benefit for helping the company recapture the narrative and provide a necessary realignment of investor expectations."
His call basically stems from general uncertainty around strategic investments, a "soft" (i.e., low demand) enterprise market, and the potential for the new management team to cut the dividend. Challenging telecom conditions, as seen in the recent stock performance across the sector, was a catalyst for the merger in the first place, so it's also possible things will get worse for the combined entity before they get better.
Image source: Getty Images.
Why I'm optimistic
All this being said, I'm still optimistic about the combined companies' prospects. While the 11% dividend may be cut, it will most certainly not be cut entirely. As a shareholder, I also have trust in future CEO Jeff Storey. Should he decide to cut the payout, it will probably be the correct move, and Storey's successful tenure at Level 3 suggests investor confidence would be well placed. The combined company will not only have a lengthy integration process, but it will also have to ramp up its strategic product offerings while being heavily indebted. If more cash flow goes toward these higher priorities, I'm OK with that.
There's also the possibility that the "uncertainty" is only that, and that the company will generate enough synergies to preserve the payout. While Roswadowski is uncertain about a lack of recent communication, probably a result of the impending closing, management did lay out $975 million in projected synergies across three specific areas when the deal was announced one year ago.
Moreover, activist investor Keith Meister has gotten everything he's wanted from the company and recently upped his bet on CenturyLink shares in August. Given the potential turnaround upside, aggressive investors should be comfortable with a little uncertainty in the medium term and hang on to their shares.
