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This Company Might Cut Its Dividend, but Its Stock Could Soar

By Billy Duberstein – Aug 18, 2021 at 6:53AM

Key Points

  • Lumen Technologies announced two large asset sales last month.
  • The company will invest in proven growth initiatives with the cash.
  • But larger growth investments may crowd out the 8.3% dividend.

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Could a dividend cut actually help this telecom's lagging stock price?

Shares of Lumen Technologies (LUMN 3.52%) fell after its recent earnings report, along with a few other major announcements regarding large asset sales. Earnings did not show anything unexpected, and the company's announced divestitures were at good multiples, likely good news for the stock.

Yet in spite of those positives, management also hinted that the company's current 8.3%-yielding dividend might not be appropriate after it executes those asset sales. While Lumen did not announce a dividend cut yet, even hinting at a potential cut made investors nervous, sending shares down.

However, based on management's new plan, this telecom stock could have material upside even if it cuts its payout to shareholders.

Woman on her phone in front of a map of a city on the wall.

Image source: Getty Images.

Preparing the investor base for a slimmed-down company

Just before earnings, Lumen announced two major divestitures: It agreed to sell its Latin American business to alternative investment firm Stonepeak for $2.7 billion, and to sell its incumbent local carrier (ILEC) business in 20 states to funds managed by private equity firm Apollo (APO) for $7.5 billion, including $1.4 billion in debt.

Even better, the $1.4 billion in debt Lumen is laying off to Apollo is some of the company's highest-yielding debt, so Lumen will also save a lot in interest costs.

In the wake of these transactions, which management expects to close in the first half of 2022, Lumen will off-load some higher-cash-flow but lower-growth assets to others, while retaining assets that have a better growth profile. In addition, CEO Jeff Storey announced the company would be stepping up investments in fiber-optic cable with the new cash, as modern fiber investments have yielded clear results in the recent past. In addition, given the low price of the company's stock relative to its cash flow, management also announced a $1 billion share repurchase program over two years.

But in light of the higher fiber-optic investments and the repurchase, Storey also noted: "with these transactions, the profile of our business is changing and will change rapidly going forward as we lean into investing for growth and continuing to rationalize the portfolio. I do realize that will put pressure on our dividend after we close these transactions and the further we get into our investment program."

Obviously, a statement like that will make investors nervous that the company will cut its dividend, once these transactions take place next year.

But a dividend cut could help the stock long term

Lumen just increased its free cash flow projections for 2021 to a range of $3.1 billion to $3.3 billion, and its market cap is only $13.3 billion, for a ratio of price to free cash flow in the low 4 range, which is very cheap. Obviously, the company's $31.5 billion in debt is also weighing on the stock, but that's still a ratio of enterprise value to free cash flow of 14. That's still pretty cheap...if Lumen can figure out a way to grow again. 

In that light, investments in growth and the share repurchase make a lot of sense. Investing in proven fiber projects to enable quicker growth should increase the intrinsic value of the stock, and repurchasing shares at a discount to intrinsic value will also be a value-add for shareholders.

Of course, this might come at the expense of the dividend. While the company isn't cutting its dividend now, it very well might once the transactions close. Yet if recent history is any guide, telecom stocks without dividends that have instead chosen to invest in growth and make share repurchases (such as Charter Communications) have done much better than telecoms like AT&T that have paid out a high dividends perhaps at the expense of growth investments and efficient repurchases.

Lumen's revenue has been declining as mature technologies decline while new technologies in fiber, edge computing, and cybersecurity ramp up. However, off-loading low-growth businesses to invest in newer growth segments will transform the business model.

If Lumen becomes more like Charter and less like AT&T, the stock could go up a lot. But shareholders may have to sacrifice the dividend entirely or in part to see those gains. It's unclear what shares will do as investors wait for a possible cut, but long-term investors should be encouraged by what looks like a better business strategy.

Billy Duberstein owns shares of AT&T, Charter Communications, and Lumen Technologies and has the following options: long January 2023 $12 calls on Lumen Technologies. His clients may own shares of the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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