Lumen Plunges on Its Dividend Cut: Is the Stock Now a Bargain or a Value Trap?

When Lumen Technologies (LUMN 0.83%) closed its two asset sales and appointed a new CEO over the past couple of months, it seemed highly probable that the company would cut its dividend. Yet even after big year-to-date declines in anticipation of the news, the stock fell another 15% after Wednesday night's earnings release, in which it announced the cut.

Is this a sign of Lumen's impending demise, or can the business be turned around? With a new CEO and a better balance sheet thanks to recent asset sales, Lumen could be an interesting stock for deep-value investors, as dividend seekers sell off their shares.

A leaner company with a better balance sheet

The dividend cut was probably necessary, as the sales of the Latin American business in the third quarter and the sale of its Incumbent Local Exchange Carrier (ILEC) business in 20 U.S. states in the fourth quarter will lower the company's overall cash flow, while proceeds will go toward paying down debt and investing in newer growth areas.

Lumen could use some growth. In the third quarter, revenue continued to decline, falling 5% on a pro forma adjusted basis, and adjusted earnings before interest, taxes, depreciation, and amortization fell 11.4% over the prior-year quarter.

Grow, Nurture, and Harvest

Yet within Lumen, which sells a wide range of connectivity products to enterprises and consumers, there are some segments that are growing. For businesses, management began breaking out its different products along the lines of Grow, Nurture, and Harvest in the recent presentation. 

As the names indicate, Lumen is investing behind products in the Grow category. Nurture encompasses more-mature products. Harvest products, such as landline phones, are in decline, and Lumen is milking them for cash.

Data source: Lumen. YOY = year over year. N/A = not applicable.

On the plus side, even though the Grow category doesn't represent the majority of revenue, it is still the largest segment. That means there could be a point in the future when its growth might offset declines in the other segments. Moreover, the segment's "direct margin," which the company defines as revenue minus fixed and variable costs (and which one would assume is akin to gross margin), is higher than the other segments.

On the other hand, the Nurture segment appears to have disappointing performance. It's not only lower margin, but did even worse than the Harvest segment, which is supposed to be in greater decline. Overall, the enterprise segments were a mixed picture in the third quarter.

Consumer markets are dependent on the fiber buildout

Similarly, Lumen broke out its consumer segment, which also has a mix of growing fiber products and declining legacy broadband and voice products.

Data source: Lumen. YOY = year over year.

Fiber broadband appears to be a success. The only problem: Fiber is expensive to lay down and build. That's another reason for the asset sales and dividend cut, since the new fiber build is a key element of Lumen's turnaround plan.

A dividend cut is difficult, but Lumen should be better off

Lumen isn't totally cutting off shareholder returns. On the earnings release, management also announced a $1.5 billion two-year share repurchase program even as it scrapped the roughly $1 billion annual dividend.

Now that Lumen's stock has sold off so much on the disappointing yet predictable dividend cut, those share repurchases could be very good as value-adds, since the stock seems quite cheap.

But that's only true if the business has enduring value, which means stabilizing revenue and profit growth. While there are some hopeful signs on those fronts with the success of the Grow enterprise segment and fiber broadband business, there is still a way to go for those businesses to outrun the declining segments.

The good news is that the dividend cut will allow Lumen's new management team to have flexibility to deploy capital either to growth projects, debt paydowns, or share repurchases as management sees fit. That will require lots of savvy capital allocation in the quarters ahead.

Lumen will probably be in the penalty box with investors for a while, so there might not be a need to buy the stock in the aftermath of the cut. However, investors should monitor Lumen and its different segments' trajectories. If a path to stabilizing revenue appears, the stock could be a deep-value bargain. As of now, though, the jury is out.