In recent years, Lumen Technologies (LUMN -5.81%) -- formerly known as CenturyLink -- has refocused its business away from its legacy landline and copper-wire DSL franchises. Instead, it made a big bet on high-speed fiber-based internet services with its $34 billion acquisition of Level 3 Communications. And since early 2019, it has moved aggressively to repay debt incurred as part of that transaction.
These moves haven't paid off for shareholders so far. Indeed, Lumen stock has lost more than half of its value over the past five years. Even after accounting for its high dividend, the company has posted a lousy total return of -34% during that period.
Lumen Technologies stock performance and total return, data by YCharts.
The stock's long-term downward trend has enabled Lumen to claim the dubious distinction of highest-yielding S&P 500 stock, despite having cut its dividend by more than 50% in 2019. However, management hopes to make a clean break from the past by selling some of Lumen's legacy assets. Let's see what that might mean for the company.
Management grows frustrated
Lumen owns about 450,000 route miles of fiber: a valuable asset for the future of computing. By contrast, its copper-based telecom business is in long-term decline. Every year, more and more people (and businesses) drop traditional landline phone service. Additionally, DSL speeds over copper-wire connections are too slow to be competitive, leading to persistent subscriber losses.
This combination of growth assets and declining businesses makes Lumen hard to value. At the company level, revenue and EBITDA have sagged in recent years, contributing to the stock's poor performance.
A year ago, management argued that the stock was significantly undervalued on a sum-of-the-parts basis. However, the company's efforts to better highlight the contributions from the growing and declining parts of its business haven't led to a big turnaround for Lumen stock.
Source: CenturyLink/Lumen June 2020 investor presentation (slide 18).
As a result, management has become increasingly frustrated with the stock's valuation. During Lumen's most recent earnings call, CEO Jeff Storey reiterated his view that the stock trades at a deep discount to the value of its assets. He also emphasized the company's interest in selling non-core assets "to unlock value in our business, further accelerate deleveraging, and implement potential buyback programs."
A deal may be within reach
Despite management's interest in selling non-core assets, it wasn't clear whether anybody was interested in buying them -- until last week. Private-equity firm Apollo Global and Lumen are negotiating a potential $5 billion-plus sale of Lumen's consumer assets in certain states, according to a recent Bloomberg report.
Lumen's consumer segment generated about 30% of its adjusted segment EBITDA last year. Based on the reported deal price, the company would be keeping a substantial chunk of this business. In all likelihood, it wants to hold on to regions where it has invested in fiber upgrades while exiting parts of the country where it still offers primarily or exclusively copper-based services.
For long-term investors, the price of any deal is crucial. Five times EBITDA would probably be a fair price for copper-wire assets. If Apollo Global demands a significantly lower price, Lumen would be better off standing pat and continuing to use cash flow from its declining businesses to reduce its debt and pay its lofty dividend.
Image source: Getty Images.
What to expect
Even at a price of 5 times EBITDA, selling copper-wire consumer assets would inevitably reduce Lumen's earnings and cash flow. But with expected adjusted free cash flow of $2.8 billion to $3 billion this year, Lumen can absorb the cash flow impact of a $5 billion asset sale while still easily covering its $1.1 billion of annual dividend payments.
Meanwhile, the proposed asset sales would make Lumen stock more attractive to investors for two reasons. First, the asset sale proceeds would allow the company to complete its debt reduction plan quickly, potentially enabling it to resume buybacks within the next year. Second, by divesting assets with declining revenue and EBITDA, Lumen can return to growth sooner (albeit from a lower base). Both factors should help Lumen stock achieve a higher earnings multiple.
Additionally, Lumen has nearly $2.6 billion of debt maturing within the next 12 months, plus another $1.6 billion of high-cost debt that can be called (repaid early) over that period. Thus, depending on the timing of any asset sales, it could quickly use the proceeds to further reduce its debt.
Lumen doesn't need to sell assets to deliver good results for long-term investors. Over time, its fiber-based businesses should eventually drive a return to growth that would reignite investor interest. Still, asset sales at the right price could accelerate Lumen's return to growth -- and the stock's turnaround.
