Lumen Technologies (LUMN 1.47%) shareholders have gotten used to disappointment in recent years. Shares of the telecom company -- formerly known as CenturyLink -- have fallen 75% since the beginning of 2015. Even including the benefit of Lumen's high dividend, investors who bought the stock seven years ago have lost more than half of their money.
Lumen stock took its latest plunge last week after the company projected that adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) will fall dramatically in 2022. The shares sank 21% in the final two days of the week.
Lumen stock performance, data by YCharts.
However, Lumen is in the early stages of a promising multiyear turnaround effort centered around selling less attractive assets and ramping up investments in its remaining business. That makes the stock's recent pullback a good buying opportunity for patient investors.
A slightly disappointing quarter
Lumen recorded $4.85 billion of revenue in the fourth quarter: down from $5.13 billion a year earlier and just below the analyst consensus of $4.86 billion. Excluding special items, adjusted EBITDA totaled $2.09 billion for the quarter and $8.44 billion for 2021 as a whole. This was within Lumen's full-year guidance range of $8.4 billion to $8.6 billion, albeit below the midpoint of the range.
Despite the EBITDA decline, adjusted earnings per share (EPS) jumped 21% year over year to $0.51, just shy of the average analyst estimate of $0.53. An accounting change related to Lumen's asset sale plans drove most of this improvement, but interest expense also fell.
More encouragingly, Lumen generated $3.74 billion of adjusted free cash flow in 2021: above the midpoint of its most recent guidance and much better than its initial outlook of $2.8 billion to $3 billion. Overall, Lumen's Q4 results were slightly disappointing, but not bad enough to explain the stock's recent wipeout.
Guidance spooks investors
Lumen's guidance was far more concerning for most investors. Management projected that adjusted EBITDA will fall more than 20% to between $6.5 billion and $6.7 billion this year.
Investors should have been prepared for a sharp drop in earnings. The end of the CAF II broadband subsidy program will reduce annual adjusted EBITDA by about $500 million going forward. Additionally, Lumen has agreed to sell over $10 billion of assets this year, which will reduce annualized EBITDA by about $1.7 billion. Management's guidance assumes that the asset sales close around the middle of 2022, which implies a loss of $800 million to $900 million of EBITDA this year.
Image source: Getty Images.
Even after adjusting for those factors, management's guidance implies that underlying adjusted EBITDA may fall by about $500 million in 2022. To some extent, that reflects near-term cost pressures from the divestitures and increased spending on growth initiatives. However, the forecast also highlights the ongoing revenue and earnings pressure in some of Lumen's legacy businesses.
Additionally, Lumen expects free cash flow to retreat to a range of $1.6 billion to $1.8 billion, as it plans to ramp up capital expenditures despite lower expected EBITDA. This sparked new fears that the popular high-yield stock could be forced to cut its payout for the second time in recent years.
The future is brighter than it seems
Lumen's adjusted EBITDA will fall again in 2023 as it absorbs the rest of the hit from its planned asset sales. However, it is well positioned to return to revenue and EBITDA growth thereafter.
First, the assets Lumen is selling are less attractive than the ones it is keeping. Most notably, it is selling a sizable chunk of its traditional U.S. telecom operations, which mainly generate revenue from phone service and slow DSL internet connections: two businesses in rapid decline.
Second, Lumen is dramatically accelerating its investments in upgrading copper wires to fiber in its remaining telecom footprint. That will expand its fiber footprint from 2.6 million addresses today to 12 million or more by the late 2020s. Fiber upgrades will drive significant growth in Lumen's broadband business, helping it acquire more customers at higher prices.
Third, the company's long-term growth initiatives around edge computing and other business-focused services should gradually gain traction, offsetting ongoing declines in legacy enterprise voice services.
The net result is that revenue, EBITDA, and free cash flow will likely return to sustainable growth in a couple of years. Meanwhile, Lumen will be able to use its asset sale proceeds to pay down a lot of high-cost debt. That will support a rebound for Lumen stock over the next several years.
