From 2008 to 2012, CenturyLink (NYSE:CTL) had a reputation for sporting some of the high dividend yields in the market, taking advantage of the plentiful cash-flow aspects that companies throughout the industry use to bolster their payouts. Yet in early 2013, CenturyLink decided to cut its dividend, slashing its payout by about 25%. Investors immediately panicked, abandoning the stock and sending shares plunging.
Yet what many neglected to notice was that at the same time it cut its dividend, CenturyLink authorized a share buyback of $2 billion. As a result, the stock's plunge actually made CenturyLink's buyback even more effective than it otherwise would have been, and the company's addition of an extra $1 billion repurchase authorization earlier this year shows that CenturyLink remains committed to a new way of returning capital to shareholders. Let's look at CenturyLink's share repurchase program and whether it will continue to produce impressive returns for the company going forward.
How CenturyLink created its own good timing
In hindsight, the most surprising thing about CenturyLink's strategic move is that so many dividend investors didn't understand it. Typically, when a company cuts a dividend, the reason is that it has no choice for cash-flow reasons. That's why share prices often plunge so far after a dividend cut, as investors not only suffer the loss of income but also reassess the overall chances for the success of the business as a whole.
In CenturyLink's case, though, all the company did was to reallocate how it returns capital to shareholders. As a result, panic-stricken dividend investors who sold off their shares did the company a huge favor, allowing CenturyLink to deploy its initial $2 billion to buy more shares than it would have if prices had stayed the same or climbed. Indeed, that good fortune lasted through the early part of this year, with investors only recently having caught on to CenturyLink's sharp tactics and bidding up shares as a consequence.
Are buybacks hurting CenturyLink's prospects?
Decisions about what to do with excess capital won't have a real impact on CenturyLink's fundamental business, and the telecom company still faces plenty of challenges on that front. Like peers Windstream (NASDAQ:WIN) and Frontier Communications (NASDAQ:FTR), CenturyLink has relied on old-style landlines to provide a substantial chunk of its revenue, and as customers move away from older technology, the whole industry has seen its voice-related sales suffer. But CenturyLink has done a better job of holding on to its landline customers than Frontier and Windstream, and business revenue has also contributed to relative strength for CenturyLink over its peers.
Moreover, spending money on buybacks had no impact on CenturyLink's pricing power. In its most recent quarter, CenturyLink added about 16,000 customers for its Prism TV service, and price increases for some of its other services helped boost overall sales. That's been a key contributor in helping the company sustain its revenue levels even as Frontier and Windstream have seen declines.
The magic of lower dividends
CenturyLink obviously took a lot of heat for its dividend cut, but the buybacks give the telecom more flexibility in timing when it returns capital to shareholders. By taking advantage of opportunistic periods of weak share prices, CenturyLink has already gotten more from its buyback program than it would have simply by returning cash to shareholders.
Moreover, it's not as though CenturyLink stopped paying a dividend entirely. Even at its lower level, Windstream's dividend yield is still 5.5%. That's substantially less than Frontier and Windstream, but it's markedly higher than most of its other telecom peers. Moreover, the balance between buybacks and dividends more closely resembles the capital-allocation strategies its larger competitors use.
What's next for CenturyLink?
Perhaps the most interesting speculation about CenturyLink is its potential to go well beyond the traditional telecom industry. Earlier this month, reports surfaced that CenturyLink might seek to buy out Rackspace Hosting (NYSE:RAX), which would add cloud computing and website hosting to its arsenal of business products. The move would be a continuation of the strategy CenturyLink followed in buying Savvis in 2011.
Purely from the standpoint of buyback efficiency thus far, CenturyLink has had impeccable timing. If it can figure out how to keep growing in more promising areas, though, then CenturyLink's gains to date could turn out to be just the tip of the iceberg.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Rackspace Hosting. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.