It’s been a few months since my last write up on Seeking Alpha. Since October 2020 I think. You can read the full thing on Seeking Alpha. They hold the rights. Below are just quick notes and I suggest to read the full thing to get the proper picture of the company and opportunity.
Q1 2021 hedge fund letters, conferences and more
Disclosure: I’m long Lumen Technologies Inc (NYSE:LUMN).
I found out about Lumen Technologies through a Globe and Mail article discussing Francis Chou’s Stonetrust investments. Stonetrust Commercial is an insurance company in the U.S. and like most insurance companies they make money through disciplined underwriting and properly investing the float. It turned out that Lumen is a large holding. Who still has a landline? Why would Francis want to own a dying copper landline business? I had to look to deeper into this.
Lumen Technologies: A Value Investor's Favorite Stock
It turns out that the stock is a favorite of some other old school value investors such as Dr. Michael Burry from Scion Asset Management, Prem Watsa from Fairfax Financials, and Mason Hawkins from Southeastern Asset Management. Something must attract them.
Lumen Technologies has 1.1 billion shares that trades at $12.70 a share with a market cap of $13.9b. Lumen distributes a fat 7.9% dividend yield or $1 annually which indicates that the market is not too hot on the company. Lumen distributes a fat 7.9% dividend yield. It looks safe. It’s covered by free cash flow of $2.8b-$3.0. That’s enough to cover the $1.1b in annual dividend distribution. Management has reiterated their commitment. Of course that’s never guarantee, but more a signal of confidence to the market.
The market is currently valuing Lumen at 5x adjusted EV/EBITDA, 8.2x 2021E earnings, and 4.7x price to free cash flow per share of $2.74, my preferred metric. This implies a 21% FCF yield. When it comes to a company like Lumen, that has a lot of debt and D&A, measuring the right amount of cash left should take precedence over earnings.
The depressed valuation, a market revaluation of their core assets, an improved profitability profile and balance sheet, and potential growth is what probably attracted these value investors.
Background
Lumen Technologies, formerly CenturyLink, provides communications and network services as well as security, cloud solutions, voice and managed services. CenturyLink and Quantum Fiber for residential and small businesses. Lumen for enterprises.
The firm owns 450,000 miles of fiber. It’s one of the largest fiber optics network in the world. Most of it comes from their acquisition of Level 3 in 2017. It’s a Tier-1 network. That’s the network with the most connections. You need to pay for access. This is their competitive advantage. Lumen sells (wholesale) high bandwidth fiber optic long haul links to other carriers.
Remember the old Internet as a “superhighway” analogy, well Lumen is one of the major highways. Lumen is among the largest network providers in the world. If their network fails, it takes jump a huge part of the Internet with them.
Their massive fiber network and infrastructure acts as a moat. It’s too expensive to build and to develop it against the experts in the field. Fiber businesses are attractive because once it’s built, the “maintenance” or “sustaining” capex is relatively limited, and that drives FCF.
Fiber Infrastructure Network Value
The value of Lumen’s fiber infrastructure network is not recognized by the market given the FCF yield of 21.5%. Lumen is looking to monetize their recently completed 3-year investment program and the 7.9% dividend yield looks safe. The downside is protected by the value of its fiber network (the cost to build a similar network is probably hundreds of billions) and recent large transactions for fiber peers were at double-digit EBITDA multiples.
Lumen is the new name for CenturyLink since September 2020. The rebranding comes with a new business strategy that goes beyond just offering connection services. They recently launched the Lumen Platform to run cloud and edge computing applications. Lumen is betting that the platform will fuel growth.
The Lumen Platform is a move beyond providing basic connectivity. It has the capabilities that go beyond providing just internet service. With the Lumen Platform, it will level its fiber infrastructure to provide software or other needs “as a service.” Practically, what we are seeing is the evolution from telecom company (CenturyLink) to tech company (Lumen).
A lumen is a measure of the brightness of light and the name pays homage to their fast global fiber network foundation.
5G Will Enhance Fiber's Importance
It’s a myth that 5G will not kill fiber. Instead it will enhance it’s importance. 5G requires a lot more cell towers, a lot more bandwidth, and will need to be connected to a wired network. The explosion in data use, particularly mobile, could make fiber assets much more lucrative. 5G needs a fiber network that can power it through multiple contact points, and help it reconnect through physical barriers.
Edge computing. Of all the new products Lumen is launching, the Lumen Edge Compute will be one of the main drivers of future growth. I think there’s a part of the cloud story that’s overlooked and that is edge computing. With the 5G rollout, edge computing is two words we will be hearing a lot more in the coming years. Edge computing places processing power closer to where data is being created in the physical world. Edge computing is a complement to the cloud by solving issues of latency, bandwidth, autonomy, or compliance.
One great driver for edge computing is reduced latency (much faster computing speed means reduced waiting time). The more processing can do at the edge level, the less you have to rely on the cloud, and the faster the computing
Lumen has a lot of debt and makes up most of the enterprise value of $45b. With debt there’s what you owe and what you need to pay. They have been aggressive to pay down the debt over the years. Q4-2020 long-term debt stands at $31.8b. In 2020 alone Lumen managed to reduce net debt by approximately $1.6 billion and reduced leverage to 3.6x net-debt-to-adjusted.
If I applied a price to sale multiple of 0.8x to 1x on depressed sales ($19b vs $20b actual), you are looking at a 9% to 36.4% gain. If Lumen manages to grow their sales, it will warrant a higher multiple.
If we assume a 15% FCF yield (6.6x FCF), Lumen would return 34%. If Lumen manages to grow, it warrants a minimum multiple of 10x FCF, and this would imply a return of 115%.
It won’t happen overnight. I don’t expect a significant short-term boom in revenues from their investments. This is a long term play. Instead I picture a slow rising trickle of revenue growth as the country upgrades the wireless network to support 5G standards.
Higher Stock Price
Three-pronged approach to higher stock price:
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- Market revaluation of fiber network and assets to more reasonable level. The cost and importance of building it should be the floor.
- An improvement of the business. Growth + more profit + more FCF + less debt = higher stock price. Right now the market is not confident in Lumen. The mood is bad. Better results will change the mood.
- Financial engineering. Selling off assets at higher than market prices to pay down the debt. Refinancing expensive debt at cheaper interest rate. Synergies from Level 3 acquisition. NOL that’s in the bank etc…
Ultimately, results will drive the stock price. Even with a conservative approach, I think there’s material upside if Lumen converts on the opportunities it sees and little downside if it misses. The negative is already priced in. Meanwhile you have an opportunity to buy a company with irreplaceable assets that’s considered cheap on many different metrics.
This is the quick notes. Here’s the full thing.
Article by Brian Langis
