CTL - CenturyLink

[peridotcapital]

The intrinsic value of the business is not impacted by the dividend payout ratio. Accordingly, I commend management for making the right call. If the market is unwilling to give you credit for the dividend coverage you are offering (a 15% yield proves it was not), you are only hurting investors by sticking to it. While some folks will sell on this news, the stock will probably be above today's close in the coming months. With $3 of free cash flow per share, the stock is not going to stay at $13 with a mid 30% payout ratio.

 

FD: Buying CTL in the after hours session.

 

 

How do you get the $3 FCF number? Their capex is almost equal to their depreciation.

 

I'm just using the financial expectations management has laid out. You can also casually look at a $1 dividend and a future payout ratio in the 30's (implies ~$3 or FCF).

 

FCF was more like 3.50 in 2018 but capex is going up in 2019 and there were some one-off benefits in 2018. The big question longer term is whether they can grow FCF per share, as Story likes to focus on, or if the business headwinds will offset the integration/operational improvements. If $3 is real and goes higher in 2020 and beyond, the stock will head into the 20's. If $3 becomes 2.75, becomes 2.50 etc as the years pass, the stock is going to always have a crazy high FCF yield as it will be seen as a melting ice cube.

[dwy000]

would seem the issue is more the revenues than the FCF.  There's only so much cost you can take out.  Even at $4bn of FCF per year it will take 9 years just to repay the existing debt.  At the current revenue trajectory, FCF is going to start to decline and at some point rapidly.  Their going to lose access to the debt market at any rational interest rate and the new debt will limit dividend leakage.  Unless the top line stabilizes I don't know that this is investable.

[Valuehalla]

Hi Tylerburden, thx for your comment.

 

The outlook for 2019  makes it not worth to stay longer invested in CTL, all what they said in the past 30 month came not true. The outlook for 2019 consists not of an increasied FCF and/or EBITDA. Not talking about revenue.

 

A few times they changed the accounting for revenue. This time again. Its not possible to follow it up. Last year, after Q4 2017, i did a prognose based on all the different revenue segments of CTL & LVLT  (I published that here). It looked likely, that they can stop the decrease over some time. The revenue figures came not in with the expected development. Always the same storries about renegotiated unprofitable contracts, FX headwinds and one time effects.

 

Revenue and EBITDA outlook for 2019 is lower than CTL/LVLT standalone figures, when the acquisition was announced. FCF outlook for 2019 is app on same level, but much lower than their outlook given before the acquisition. Since the acquisition was made, all incoming data till now got clearly worse than predicted.

 

And now the total management turnaround concerning Divi and capital allocation, after being totally committed to the divi "over the next few years". A total disgrace !

 

If revenue will be more or less easy to stabilize, FCF and EBITDA will increase clearly even by some costcuttings. They can easily go on with the divi and they can go on deleveraging on their path as announced in the past.

 

There is clearly no positive development till now imo & totally not any trust is left on my side.

[petec]

Cutting the dividend increases my trust in management, because it's so obviously a sensible thing to do. The market never valued the stock at less than a 10% yield, so I don't think it was trading at 15% because of fears around a dividend cut. The issue is whether it's a melting ice cube.

 

2017 proforma ebitda was $8.74bn. The midpoint of the 2019 guide is $9.1bn. So We have got $350m growth for $850m in cost cuts. That suggests $500m in "lost" ebitda, and at solid margins. I'm not surprised by the fact that some of the lost revenue was unprofitable - we always knew, for example, that legacy voice had high margins - but I am a little surprised by the magnitude.

 

On the cost side, the additional $0.8-1bn of cost outs is clearly a positive and I suspect there is more to come - they say they are "transforming" the company and this is a single digit percentage of costs. However, I don't know how much of it is factored into the 2019 guide, which is key, because if the 2019 guide is dependent on these additional cost outs then the underlying ebitda is eroding very fast. I need to see if they discussed that on the call.

 

On revenues, while the decline decelerated from 3q (driven by business) it's still steep. What I don't have a clear grasp on is whether something's shifted in the competitive environment. The industry has consolidated so much I assumed things would improve a little. Either they haven't or, when we get past the phase of cutting unprofitable revenue in legacy CenturyLink business segments, things will start to look better quite fast.

 

[Valuehalla]

Petec, tbe acquisition was announced in late 2016. The standalone figures for 2016 were:

 

                            LVLT                          CTL                    TOTAL

Revenue              8,172 B                      17,47 B              25,642 B

EBITDA                2,865 B                        7,00 B                9,865 B     

FCF                      1,1 B                          1,817 B              2,917 B

 

For 2017 FCF outlook was given with app 3 B

 

What has improved since than till now, 24 month later?

Where are the synergies, NOLs, taxreform, costcuts if you look on the given outlook for 2019?

 

 

 

 

[Guest longinvestor]

I’m not out but have lightened up my holdings. I can say a lot as this stock has taught me a lot. It’s all about how tough telecom is, the capital required to just remain where you are. Thanks to competition incremental capital inures to the consumer. It pays to listen to the Omaha boys, no need to learn the same lessons for yourself.

 

All that said I feel lucky to be able to have the opportunity to buy Berkshire at the same price as the company is.

[kab60]

I think it's interesting how they wan't to get leverage down to 2.75-3.25x. Doesn't exactly scream confidence in growing revenue.

[tylerdurden]

Petec i think ctl was trading above 24 last august so that’s less than 9 perc yield i guess. Anyways my issue is the management’s credibility. If this was on the table they should not have communicated that full commitment to the dividend. The call was like a joke too. They can not even answer why they picked the new leverage level which is not very different from previous target of low 3x. I dont care whether you put a timeframe or anything.

 

All i hope is with the new flexibility in capex they can show some increase in enterprise revenue. Isn’t this the main pillar of this story? We all know consumer business is screwed. If they can show some stabilization stock price should recover. I also hope they were conservative again with their cost cutting estimates and they can accelerate as it was in the first phase. Perhaps i am too much hopeful. We’ll see :)

 

I can not blame revenue loss on the management. There are clearly big headwinds however they need to show some progress on enterprise revenues...

[petec]

Petec, tbe acquisition was announced in late 2016. The standalone figures for 2016 were:

 

                            LVLT                          CTL                    TOTAL

Revenue              8,172 B                      17,47 B              25,642 B

EBITDA                2,865 B                        7,00 B                9,865 B     

FCF                      1,1 B                          1,817 B              2,917 B

 

For 2017 FCF outlook was given with app 3 B

 

What has improved since than till now, 24 month later?

Where are the synergies, NOLs, taxreform, costcuts if you look on the given outlook for 2019?

 

I wasn't thinking of 2017 - maybe I should have been but the businesses weren't run as one for most of 2017, and nor were they run by Storey who I rate better than Post.

 

I was comparing with 2018. The original FCF guide for 2018 was $3.15-3.35bn, but that included a lot of one-offs like tax refunds and incentive payment timings. They didn't quantify these but nor did they disagree with an analyst on the 4q call who calculated them at $550m. So at the midpoint, the guide was really $3.25-0.55=2.7bn. The new guide is $3.25 at the midpoint, so 20% up.

 

Now obviously FCF growth is much smaller than the combined benefits of the things you mention - synergies etc. But we always knew revenues would shrink before they grew. Your estimates for when revenues would turn were too optimistic, as were mine. That's the fundamental problem here. However the declines decelerated in this quarter. If that's a trend then it's very positive with the stock trading on a 25% FCF yield. On the call they're clear that half the consumer business is growing and 75% of the business business will grow "over time". They're also clear (as they have always been) that they expect capex to drive growth.

 

But this one definitely does make my head hurt - keep challenging me with numbers!

[petec]

Petec i think ctl was trading above 24 last august so that’s less than 9 perc yield i guess. Anyways my issue is the management’s credibility. If this was on the table they should not have communicated that full commitment to the dividend. The call was like a joke too. They can not even answer why they picked the new leverage level which is not very different from previous target of low 3x. I dont care whether you put a timeframe or anything.

 

All i hope is with the new flexibility in capex they can show some increase in enterprise revenue. Isn’t this the main pillar of this story? We all know consumer business is screwed. If they can show some stabilization stock price should recover. I also hope they were conservative again with their cost cutting estimates and they can accelerate as it was in the first phase. Perhaps i am too much hopeful. We’ll see :)

 

I can not blame revenue loss on the management. There are clearly big headwinds however they need to show some progress on enterprise revenues...

 

Fair point re yield but I still don't think the predominant driver of the selloff since was fears over the dividend. It was primarily a revenue/leverage issue.

 

I agree they shouldn't have committed so strongly to the divi - I have argued that consistently. That's why I think changing the policy enhances their credibility.

 

Most companies I know don't have a clear rationale for their leverage level. They might have a ceiling from the rating agencies etc., but it's always a bit of a judgement call. CTL have been talking to the bottom end of the 3-4x range for a long time and this really only cements that. They also talked about prepping the company for acquisitions in 3 years so I think this is intended to give space for that.

 

I agree with your comments on revenues.

[LightWhale]

1. While Valuehalla's numbers are correct, they are only half of the equation. The other half is price, which is 50% lower than when the merger was announced. So yes, we get somewhat lower value, but we pay far less to buy it.

 

2. If revenue did not decline at all from Q1, it would be 350m higher for 2018. Assume that 1/4 of the decline is management volitionally disposing of lousy contracts. That leaves 270m of lost revenues a year. If that continues linearly, whereas transformation efforts save 800m annually (and cost a one time 550m over 3 years), EBITDA should grow by 350m even in the face of revenue shrinkage.

 

[LightWhale]

The “transformation” (as distinct from the merger synergies) seems to go deeper than putting two companies together. It’s more about simplifying and digitalising so customers don’t call you etc. If they get that right it could be a big number. $250m is less than 2% of the cost base. I’m betting they can exceed that.

 

 

Nice call, BTW

[petec]

2. If revenue did not decline at all from Q1, it would be 350m higher for 2018. Assume that 1/4 of the decline is management volitionally disposing of lousy contracts. That leaves 270m of lost revenues a year. If that continues linearly, whereas transformation efforts save 800m annually (and cost a one time 550m over 3 years), EBITDA should grow by 350m even in the face of revenue shrinkage.

 

And revenue shrinkage *ought* to slow at some point as a) management run out of lousy contracts to cut and b) declining legacy revenues shrink in the mix vs stable/growing ones. They broke out broadband within consumer now - first time I have seen that although I haven't looked hard - and if the whole of the rest of consumer went to zero tomorrow it would be a 3.5% hit to total revenues and an absolute maximum of 9% hit to ebitda (assuming it's 100% margin which it's not). So really, 99% of the debate comes down to whether growth in $12bn of medium/small/enterprise/international/global revenue (which grew q/q for the first time in a while) can offset shrinkage in $5bn of wholesale revenue.

[walkie518]

Petec i think ctl was trading above 24 last august so that’s less than 9 perc yield i guess. Anyways my issue is the management’s credibility. If this was on the table they should not have communicated that full commitment to the dividend. The call was like a joke too. They can not even answer why they picked the new leverage level which is not very different from previous target of low 3x. I dont care whether you put a timeframe or anything.

 

All i hope is with the new flexibility in capex they can show some increase in enterprise revenue. Isn’t this the main pillar of this story? We all know consumer business is screwed. If they can show some stabilization stock price should recover. I also hope they were conservative again with their cost cutting estimates and they can accelerate as it was in the first phase. Perhaps i am too much hopeful. We’ll see :)

 

I can not blame revenue loss on the management. There are clearly big headwinds however they need to show some progress on enterprise revenues...

 

Fair point re yield but I still don't think the predominant driver of the selloff since was fears over the dividend. It was primarily a revenue/leverage issue.

 

I agree they shouldn't have committed so strongly to the divi - I have argued that consistently. That's why I think changing the policy enhances their credibility.

 

Most companies I know don't have a clear rationale for their leverage level. They might have a ceiling from the rating agencies etc., but it's always a bit of a judgement call. CTL have been talking to the bottom end of the 3-4x range for a long time and this really only cements that. They also talked about prepping the company for acquisitions in 3 years so I think this is intended to give space for that.

 

I agree with your comments on revenues.

 

absolutely think Storey is somewhat of a deal junkie and the divi cut might be behind the effort to build the business more by acquisition than by organic mechanisms or even to reduce debt

 

it's disappointing that management turned on a pin, it's more disappointing that they were so adamant...perhaps this is why the CFO left for T-Mobile, an internal squabble regarding the dividend and now they're saying the cut was a result of an enhanced deleveraging plan?

 

the debt schedule shows a lot coming due in a couple years...I would think kicking the can would be feasible, but if rates rise, interest expense will eat pretty deeply into FCF

 

I am conflicted...it's cheaper here than ever before and the company will be in a far stronger financial position; this was a hard decision to make and in some ways it wasn't necessary.

 

At the same time, I have lost confidence in Storey's ability to assess the landscape. 

 

The board here, too, appears very conflicted with strong arguments on both sides.  Perhaps neither building nor selling a position is the best course of action...

[txvalue]

2. If revenue did not decline at all from Q1, it would be 350m higher for 2018. Assume that 1/4 of the decline is management volitionally disposing of lousy contracts. That leaves 270m of lost revenues a year. If that continues linearly, whereas transformation efforts save 800m annually (and cost a one time 550m over 3 years), EBITDA should grow by 350m even in the face of revenue shrinkage.

 

And revenue shrinkage *ought* to slow at some point as a) management run out of lousy contracts to cut and b) declining legacy revenues shrink in the mix vs stable/growing ones. They broke out broadband within consumer now - first time I have seen that although I haven't looked hard - and if the whole of the rest of consumer went to zero tomorrow it would be a 3.5% hit to total revenues and an absolute maximum of 9% hit to ebitda (assuming it's 100% margin which it's not). So really, 99% of the debate comes down to whether growth in $12bn of medium/small/enterprise/international/global revenue (which grew q/q for the first time in a while) can offset shrinkage in $5bn of wholesale revenue.

 

I still disagree a bit on revenue. I think the decline is more structural than simply letting bad contracts go.  You are correct on the enterprise item but I think you should really take into account the pricing pressue that will be present for bandwidth as contracts come up for renewal. Yes companies will need more bandwidth, but the price of that bandwidth is constantly declining as other competitors try to take share.

 

[Spekulatius]

It should be noted that CTL‘s EV actually probably increased after the dividend cut- the trades debt jumped by ~8% in price. Wealth was simply transferred from equity to bond holders.

[Valuehalla]

Mason Hawkins reduced his position

 

http://ofchq.snl.com/cache/396748719.PDF

[tylerdurden]

Since there are no clear cut answers in the world of 'high corporate finance" :-), I guess the company just wanted to try a different path and see whether it'll stick with investors. They tried full commitment on dividend for a while and the stock didn't react so they are trying this new approach to see whether the investors would actually like it better.

 

Valuehalla, It seems Mason Hawkins decreased marginally but they sounded confident about CTL in their annual letter. I'd guess they sold some earlier in the quarter to pick up some other names. Also these 13f reports could be sometimes confusing. They manage some separate accounts too for their customers I believe so any customer who wants to sell independently could also show in their overall 13F reports.

 

In terms of competition, management says they don't see anything out of the ordinary. The assets they own should give them at least some pricing power hopefully. With the new flexibility on capex perhaps they can compete better too. There has been some consolidation in the industry so you'd expect some pricing power because of that as well but these are all assumptions of course...

[dyow]

Not sure why people are bullish on the dividend cut.

 

Cutting the dividend after positively confirming the dividend is safe is a big hit to the credibility of the CEO.  The same CEO you are relying on for the integration.  The same CEO analysts/shareholders will always doubt going forward.

 

It also shows lack of confidence in the business prospects and future cash flows.  Remember the yield was high because of the stock price, not because the payout ratio was too high.  My opinion is that this type of company should be paying most of their income as dividends - this is not a growth stock.

 

You could say it is priced in at 20% FCF yield but the act of cutting the dividend tells you that 20% yield may not be 20% in a few years.

 

To me the dividend was the indirect thesis for the investment. maintaining the dividend meant cash flows were increasing, which was the point of the integration.  Cutting the dividend telegraphs that cash flows are not what they projected and if cash flows decrease why invest here.  Even if they de-lever it doesn't mean much if CFs are shrinking.

[dyow]

Mason Hawkins reduced his position

 

http://ofchq.snl.com/cache/396748719.PDF

 

They have been selling everything.  Check their filings.  They only had 5% cash at year end. and their fund has been doing poorly and they are getting redemptions.  Another stock i follow CNX has also gotten crushed recently which was a big holding of theirs....now with CTL (their largest holding) going against them i am sure investors aren't happy. 

 

Oh and here is what they said about CTL's dividend in their annual letter recently "The dividend moved back up to a mid-teens yield with minimal chance of any cut.".......only to have CTL cut the dividend a couple weeks after. 

 

Wasn't southeastern very active in pushing for the CTL and Level 3 merger? How can you be so actively involved and misread the situation so badly?  These guys don't seem to be in touch with reality.  If they did push for the merger, you have to wonder how good that analysis was considering how badly they misjudged the safety of the dividend.

[Spekulatius]

Hi Tylerburden, thx for your comment.

 

The outlook for 2019  makes it not worth to stay longer invested in CTL, all what they said in the past 30 month came not true. The outlook for 2019 consists not of an increasied FCF and/or EBITDA. Not talking about revenue.

 

A few times they changed the accounting for revenue. This time again. Its not possible to follow it up. Last year, after Q4 2017, i did a prognose based on all the different revenue segments of CTL & LVLT  (I published that here). It looked likely, that they can stop the decrease over some time. The revenue figures came not in with the expected development. Always the same storries about renegotiated unprofitable contracts, FX headwinds and one time effects.

 

Revenue and EBITDA outlook for 2019 is lower than CTL/LVLT standalone figures, when the acquisition was announced. FCF outlook for 2019 is app on same level, but much lower than their outlook given before the acquisition. Since the acquisition was made, all incoming data till now got clearly worse than predicted.

 

And now the total management turnaround concerning Divi and capital allocation, after being totally committed to the divi "over the next few years". A total disgrace !

 

If revenue will be more or less easy to stabilize, FCF and EBITDA will increase clearly even by some costcuttings. They can easily go on with the divi and they can go on deleveraging on their path as announced in the past.

 

There is clearly no positive development till now imo & totally not any trust is left on my side.

 

I can understand why one would sell on the news. I am myself inclined to sell when my investment thesis is proven incorrect, almost regardless of value perception. Empirically, I found that “thesis shift” does not work well and the fact that one was wrong to begin with either means that one was wrong assessing the business or the business has changed for the worse. Either one is a reason to sell.

 

FWIW, some long CTL bonds were up from 82.5% to 90% today, so the bond investor like the dividend cut.

[tylerdurden]

Not sure why people are bullish on the dividend cut.

 

Cutting the dividend after positively confirming the dividend is safe is a big hit to the credibility of the CEO.  The same CEO you are relying on for the integration.  The same CEO analysts/shareholders will always doubt going forward.

 

It also shows lack of confidence in the business prospects and future cash flows.  Remember the yield was high because of the stock price, not because the payout ratio was too high.  My opinion is that this type of company should be paying most of their income as dividends - this is not a growth stock.

 

You could say it is priced in at 20% FCF yield but the act of cutting the dividend tells you that 20% yield may not be 20% in a few years.

 

To me the dividend was the indirect thesis for the investment. maintaining the dividend meant cash flows were increasing, which was the point of the integration.  Cutting the dividend telegraphs that cash flows are not what they projected and if cash flows decrease why invest here.  Even if they de-lever it doesn't mean much if CFs are shrinking.

 

I agree regarding the impact on Management’s credibility however it seems to me they feel like they needed to try a new approach since commiting to the dividend didn’t work out for the share price for more than a year now. Who knows what banker is pitching what to these guys. Or someone at the board (un)justifibly thinks the problem was the debt level and he seemed right unfortunately until now. To me it’s all about revenue stabilization. If they can do that with higher or lower dividend this should go back up. Cutting the dividend providing more flexibility for capex could potentially help but we’ll see i guess...

[tylerdurden]

Mason Hawkins reduced his position

 

http://ofchq.snl.com/cache/396748719.PDF

 

They have been selling everything.  Check their filings.  They only had 5% cash at year end. and their fund has been doing poorly and they are getting redemptions.  Another stock i follow CNX has also gotten crushed recently which was a big holding of theirs....now with CTL (their largest holding) going against them i am sure investors aren't happy. 

 

Oh and here is what they said about CTL's dividend in their annual letter recently "The dividend moved back up to a mid-teens yield with minimal chance of any cut.".......only to have CTL cut the dividend a couple weeks after. 

 

Wasn't southeastern very active in pushing for the CTL and Level 3 merger? How can you be so actively involved and misread the situation so badly?  These guys don't seem to be in touch with reality.  If they did push for the merger, you have to wonder how good that analysis was considering how badly they misjudged the safety of the dividend.

 

With what’s going on with cnx and even with their ge investment or agn nothing has been working for these guys lately. How about this poison pill type of decision taken by CTL for protecting NOLs? Is that a coincidence they announce it with the div cut? Any ideas anyone?

[LightWhale]

It also shows lack of confidence in the business prospects and future cash flows.  Remember the yield was high because of the stock price, not because the payout ratio was too high.  My opinion is that this type of company should be paying most of their income as dividends - this is not a growth stock.

 

There's another way to view it, that jumps right out of the numbers - the lower bound of 3.1B FCF, with a 2.3B div, leaves 800m. That easily covers interest payments. But it does not leave enough for transformation, which is front-loaded with expenses whereas value accrues later. But the transformation numbers are new info, and actually stem from fulfilment of integration synergies sooner than promised. So now they need extra 450-650m of cash to create >800m of recurring EBITDA gain. Sounds like a reasonable capital allocation plan. Considering the manner and pace that integration synergies materialised, would you give up that opp just to maintain the dividend?

 

And that's not to say that the results are not a mixed bag. And certainly if one subscribed to Longinvestor's view that the industry is up to a Sisyphean task, investing in CTL would not make much sense.

[dyow]

It also shows lack of confidence in the business prospects and future cash flows.  Remember the yield was high because of the stock price, not because the payout ratio was too high.  My opinion is that this type of company should be paying most of their income as dividends - this is not a growth stock.

 

There's another way to view it, that jumps right out of the numbers - the lower bound of 3.1B FCF, with a 2.3B div, leaves 800m. That easily covers interest payments. But it does not leave enough for transformation, which is front-loaded with expenses whereas value accrues later. But the transformation numbers are new info, and actually stem from fulfilment of integration synergies sooner than promised. So now they need extra 450-650m of cash to create >800m of recurring EBITDA gain. Sounds like a reasonable capital allocation plan. Considering the manner and pace that integration synergies materialised, would you give up that opp just to maintain the dividend?

 

And that's not to say that the results are not a mixed bag. And certainly if one subscribed to Longinvestor's view that the industry is up to a Sisyphean task, investing in CTL would not make much sense.

 

I'm not too sure what you mean, if they needed 450-650M after the synergies were reached to create extra ebitda, whether they reached the goal early or not, doesn't that mean the dividend was always in trouble to begin with?

 

Either way i wouldn't buy this stock even at these levels.  It might be cheap but i think it will stay cheap.