CTL - CenturyLink

[petec]

How much does this worry you?

[Valuehalla]

Doenst worry me at all. If Jeff Storey would leave additionally, it would worry me.

[Guest longinvestor]

I will worry if they change the tune he sang as recently as last week. So far nothing but greener pastures for him. Wildcard could be if they ink some revenue deal with TMUS. Or something bigger with Masa down the road.

[petec]

So after spending a lot of time trying to understand the downside I’ve started to think more about the “what if it all goes right” scenario.

 

1) margins rise 500-700bps off a base of 36%. Round numbers, that gets you to 9-10bn in ebitda. At those levels free cash flow after the dividend is $1-2bn and you need to pay down $1-4.5bn of debt to get to the middle of the 3-4x target leverage range. So best case scenario you can start buying back stock in about a year.

 

2) clearly there are legacy revenues that will continue to decline. But, data is the fastest growing thing on earth today (I heard an IBM stat that 90% of the data on earth was created in the last 2 years, and we’ve barely got started). If you own the pipes the data flows down is it *really* so hard to believe you might be able to grow revenues at a couple of percent a year? And if you can do that, maybe you can grow ebitda at 5%. Not in the next couple of years, when ebitda growth will come from margins not revenues + operating leverage. But long term.

 

3) if you can grow ebitda at 5% or $500m a year, you can borrow $1.75bn to keep at 3.5x levered. Add FCF after the dividend and you get to a buyback of $3.5bn in round numbers. That’s 15% of the company, annually, at the current price. In addition to a 10% dividend.

 

4) Would that company trade at 10x FCF? 15x? That would be a double or a triple.

 

I’m not saying this is a base case, but one has to frame upside as well as downside. Please shoot holes in this - I want to know why it can’t happen.

 

[petec]

I will worry if they change the tune he sang as recently as last week. So far nothing but greener pastures for him. Wildcard could be if they ink some revenue deal with TMUS. Or something bigger with Masa down the road.

 

How would you envisage a revenue deal with TMUS working?

[Guest longinvestor]

I will worry if they change the tune he sang as recently as last week. So far nothing but greener pastures for him. Wildcard could be if they ink some revenue deal with TMUS. Or something bigger with Masa down the road.

 

How would you envisage a revenue deal with TMUS working?

 

CTL simply takes over Sprint's enterprise business / customers. It has been a continuous drag for Sprint. There was a rumored deal like this some 5 or so years ago. Sprint apparently didn't want to, because LVLT was not in a good enough financial shape. Times have changed. Everyone, including VZ/T is losing share in enterprise to CTL (LVLT).

 

[petec]

I will worry if they change the tune he sang as recently as last week. So far nothing but greener pastures for him. Wildcard could be if they ink some revenue deal with TMUS. Or something bigger with Masa down the road.

 

How would you envisage a revenue deal with TMUS working?

 

CTL simply takes over Sprint's enterprise business / customers. It has been a continuous drag for Sprint. There was a rumored deal like this some 5 or so years ago. Sprint apparently didn't want to, because LVLT was not in a good enough financial shape. Times have changed. Everyone, including VZ/T is losing share in enterprise to CTL (LVLT).

 

Thanks. What’s the easiest way to track share changes? Does anyone aggregate data or are you getting that from tracking all companies?

[Guest longinvestor]

So after spending a lot of time trying to understand the downside I’ve started to think more about the “what if it all goes right” scenario.

 

1) margins rise 500-700bps off a base of 36%. Round numbers, that gets you to 9-10bn in ebitda. At those levels free cash flow after the dividend is $1-2bn and you need to pay down $1-4.5bn of debt to get to the middle of the 3-4x target leverage range. So best case scenario you can start buying back stock in about a year.

 

2) clearly there are legacy revenues that will continue to decline. But, data is the fastest growing thing on earth today (I heard an IBM stat that 90% of the data on earth was created in the last 2 years, and we’ve barely got started). If you own the pipes the data flows down is it *really* so hard to believe you might be able to grow revenues at a couple of percent a year? And if you can do that, maybe you can grow ebitda at 5%. Not in the next couple of years, when ebitda growth will come from margins not revenues + operating leverage. But long term.

 

3) if you can grow ebitda at 5% or $500m a year, you can borrow $1.75bn to keep at 3.5x levered. Add FCF after the dividend and you get to a buyback of $3.5bn in round numbers. That’s 15% of the company, annually, at the current price. In addition to a 10% dividend.

 

4) Would that company trade at 10x FCF? 15x? That would be a double or a triple.

 

I’m not saying this is a base case, but one has to frame upside as well as downside. Please shoot holes in this - I want to know why it can’t happen.

 

I will bite. #1 and #3 are possible and that’s all that they are focused on.

 

#2: Telecom is brutal and total revenues of the industry remains capped. So they have to take share. There’s just too much capacity and too much clout in the last mile. CTL has been building out their own last mile in enterprise. This was a late realization and brought to LVLT by Storey. Revenues have grown slowly and it’s always offset by legacy shrinkage and price compression. Revenue growth? Nada.

 

In all of this, something that is glossed over is that by buying CTL, we are sitting on the two best fiber backbones in QWest and LVLT. We now wait for the industry to consolidate down to the last man standing. I will be dead before then

[petec]

The only problem with that is that (3) doesn't work without (2) - in the long run you can't grow ebitda without growing revenues. Storey is quite clear that in the long run they need to be an enterprise revenue growth company (e.g. comments at GS Communacopia conference recently).

 

Also, I'm very aware of the quality of the backbone but I never know how to think about that in value terms given that backbone capacity doesn't seem to be limited - the barrier to entry is cost of overlay in the last mile, as far as I can tell. Am I wrong, and can you elaborate on how you think about the value of the backbone?

[Valuehalla]

CenturyLink has named Neel Dev executive VP and chief financial officer.

 

The move's effective immediately; Dev has been interim CFO since Sunit Patel left the company in September.

 

He's another exec with experience at Level 3, where he spent 13 years prior to the CenturyLink acquisition.

 

He has previously served as CenturyLink group VP of finance.

[Guest longinvestor]

The only problem with that is that (3) doesn't work without (2) - in the long run you can't grow ebitda without growing revenues. Storey is quite clear that in the long run they need to be an enterprise revenue growth company (e.g. comments at GS Communacopia conference recently).

 

Also, I'm very aware of the quality of the backbone but I never know how to think about that in value terms given that backbone capacity doesn't seem to be limited - the barrier to entry is cost of overlay in the last mile, as far as I can tell. Am I wrong, and can you elaborate on how you think about the value of the backbone?

In the long run sure. My money is in this for the sole reason that these valuable assets are a part of the furniture when the industry is fully consolidated.In the meantime, Storey is doing the absolutely right thing in improving the margin profile of revenues. I am tickled to get paid a fat dividend while waiting. At 10+% it’s quite satisfactory.

[Valuehalla]

3Q 2018 Earnings are out:

 

http://ir.centurylink.com/file/Index?KeyFile=395695567

 

- Again positive surprise: Great Cash Flow figures; FCF comes in much higher than expected, primarily driven by lower capex but also by better margins

- Full year 2018 outlook AGAIN raised for FCF to 4,0 to 4,2 B !

- CF from Operations up to 1,787 B from 1,582 B in Q2 ( = 13 % up)

- Full year 2018 outlook confirmed for EBITDA at 9 to 9.15 B

- Capex will be 3,15 to 3,25 B in 2018, not 16 % of the revenue

- MarketCap was 22,08 B on 21.08 $ closing price today,

- Although after hour the share price dropp 6 %

- Revenue was 5,818 B in Q3 (5,902 B in Q2)

- Imporved EBITDA margins 39,3 % from 38,5 % in Q2 and 35,5 % a year ago

- Free Cash Flow: 1,103 M in Q3 (811 M in Q2); expected outlook for FCF 2018 increased to 4,0 to 4,2B (till now 3,6 to 3,8 B)

- For the dividend (2,3 B per year) that means the payout ratio will be app 56 % of FCF. So payout ratio is massively down with that FCF figures in comparison to the past.

- net debt to adj EBITDA ratio down to 4.1 (4.2 x in previous quarter), target 3 to 4 times

- Long-Term Debt & Credit Facilities down to 35,749 B down from 36,878 B at end of Q2

  (36,94 B at end of Q1 18 and 37,238 B end Q4 17)

 

Conference call:

- focus on profitable revenue, low margin contracts were and will be canceled

- revenue decline comes from unprofitable contracts

- good progress with synergies and integration, ahead of the expectations

- expect lower expenses

- expect further growing EBITDA & margins

- Price for life product now generates 50% of the cunsumer revenue, which simplifies the handling, reduce costs

- Capex 13 % of total revenue, reduced capex in copper plant and incraesed in fiber footprint. Longterm capex will be at 16% of revenue.

- They "remain comfortable with the dividend"!

- The focus of the management will move from integration to business transformation now

- 5G is part of CTLs network expanding strategy

- head count: app 52,500 a year ago and app 46,000 now

 

Transcript:

https://finance.yahoo.com/news/centurylink-inc-ctl-q3-2018-032900932.html?.tsrc=applewf

 

[marazul]

numbers look very good, why is the stock down afterhours?

[petec]

numbers look very good, why is the stock down afterhours?

 

Because the revenue and OCF figures aren’t good. The FCF beat is on lowered capex only. Call commentary will be key.

[Valuehalla]

Operating Cash Flow was up 13 % from last quarter, FCF up 36 %.

 

What do you guys out there think about the figures and the conferencecall ?

 

To me everything looks good.

[petec]

Operating Cash Flow was up 13 % from last quarter, FCF up 36 %.

 

What do you guys out there think about the figures and the conferencecall ?

 

Several headlines reporting that OCF was below the lowest est. There may be something non-comparable about that as it looked fine in absolute terms to me.

 

Haven’t listened to the call. What did they say about why capex is down?

 

Revenues does worry me somewhat.

[Valuehalla]

They shall increase the dividend by 1 cent, that would be a positive sign.  :) There is enough room to do so.

[petec]

Ugh. I’d far rather they paid down debt. The dividend is already way too high, until they prove they can stabilise revenue.

[SI]

They did say why the capex is down, they refuse to extend the copper plant.

 

Debt is also moving down rapidly - debt was $39bn when deal closed, net debt 35.4 now and they put a half billion in to basically fully fund the pension. Assuming Tuesday’s ebitda growth guide is intact for the next twelve months, 9.1bn maybe is 9.3bn. Remember sunit guided ebitda growth each year for the next 5 so that was clearly a plan.

 

Anyway, If they don’t find any more reusable equipment as they did this year, have no more tax efficiencies and are done consolidating real estate, you are looking at 3.7x net debt to ebitda by this time next year. My guess is in the low 3s the mkt will start valuing the company more on fcf to the equity than free cash to the firm - maybe that takes 3-4 years but that is where the value will be created. That time frame to me rhymes with tmus bs cleanup post sprint, that should leave them ready and able to shore up the most critical part of its supply chain and bring a complete sales offering against t and vz by acquiring ctl.

[Guest longinvestor]

They did say why the capex is down, they refuse to extend the copper plant.

 

Debt is also moving down rapidly - debt was $39bn when deal closed, net debt 35.4 now and they put a half billion in to basically fully fund the pension. Assuming Tuesday’s ebitda growth guide is intact for the next twelve months, 9.1bn maybe is 9.3bn. Remember sunit guided ebitda growth each year for the next 5 so that was clearly a plan.

 

Anyway, If they don’t find any more reusable equipment as they did this year, have no more tax efficiencies and are done consolidating real estate, you are looking at 3.7x net debt to ebitda by this time next year. My guess is in the low 3s the mkt will start valuing the company more on fcf to the equity than free cash to the firm - maybe that takes 3-4 years but that is where the value will be created. That time frame to me rhymes with tmus bs cleanup post sprint, that should leave them ready and able to shore up the most critical part of its supply chain and bring a complete sales offering against t and vz by acquiring ctl.

Completely aligned with your view. TMUS plus CTL will be super competitive with VZ and T. In Masayoshi Son’s hands this could be a global player like few others. Now I am getting ahead a bit.

[Valuehalla]

CTL is extremly cheap now and a strong buy!

 

After the Q3 figures were published yesterday, I digged again in the old numbers of 2016, when the acquisition was announced and how the figures of CTL and LVLT standalone were at these times.

 

The progress and the development till today is great.

 

The fundamentals today are that CTL has just a marketcap of 22 B, but a FCF of 4,0 to 4,2 B, an EBITDA of 9 B, Net longterm debt of 35,749 B and a revenue of app 23 B in 2018

 

The 4 B FCF in 2018 is after tax, after capex, just before dividend. Dividend needs 2,3 B per year to pay it: So payout ratio app 56 %

 

With a 2,16 $ dividend p.a./ share, the dividend rate is now more than 10 %

 

A comfortable pillow to sit and wait. The management is committed to pay the dividend.

 

In 2016, when the acquisition was announced, it looked like this for the full year 2016:

 

Revenue:    LVLT  8,17 B        and      CTL 17,47 B          in total 25,642 B

EBITDA:      LVLT  2,865 B      and      CTL 7 B                in total  9,865 B

FCF:            LVLT  1,1 B          and      CTL 1,817 B          in total 2,9 B

Net Debt:      LVLT 9,19 B        and        CTL 19,7 B          further app 10 B was added for the acquisition, so in total 40 B

 

From the beginning on, the new CEO Jeff Storey announced to increase FCF, margins and EBITDA. Always making clear, they will loose unprofitable revenue. Storey was CEO at LVLT before and did there the same agenda, which he is executing now in CTL: better FCF and margins on lower revenue.

[Guest longinvestor]

CTL is extremly cheap now and a strong buy!

 

After the Q3 figures were published yesterday, I digged again in the old numbers of 2016, when the acquisition was announced and how the figures of CTL and LVLT standalone were at these times.

 

The progress and the development till today is great.

 

The fundamentals today are that CTL has just a marketcap of 22 B, but a FCF of 4,0 to 4,2 B, an EBITDA of 9 B, Net longterm debt of 35,749 B and a revenue of app 23 B in 2018

 

The 4 B FCF in 2018 is after tax, after capex, just before dividend. Dividend needs 2,3 B per year to pay it: So payout ratio app 56 %

 

With a 2,16 $ dividend p.a./ share, the dividend rate is now more than 10 %

 

A comfortable pillow to sit and wait. The management is committed to pay the dividend.

 

In 2016, when the acquisition was announced, it looked like this for the full year 2016:

 

Revenue:    LVLT  8,17 B        and      CTL 17,47 B          in total 25,642 B

EBITDA:      LVLT  2,865 B      and      CTL 7 B                in total  9,865 B

FCF:            LVLT  1,1 B          and      CTL 1,817 B          in total 2,9 B

Net Debt:      LVLT 9,19 B        and        CTL 19,7 B          further app 10 B was added for the acquisition, so in total 40 B

 

From the beginning on, the new CEO Jeff Storey announced to increase FCF, margins and EBITDA. Always making clear, they will loose unprofitable revenue. Storey was CEO at LVLT before and did there the same agenda, which he is executing now in CTL: better FCF and margins on lower revenue.

 

Munger has often said that there are customers who you’re better off not having. In the case of CTL it’s entire biz segments that are worth jettisoning. The cost avoidance is huge which we heard one example of. Copper capital investment. Now the legacy CTL has loads of such shitty revenues. Why I posted earlier that total revenue growth is unrealistic for a while. They have to cut cost while growing profitable revenues. Wishing it different is futile.

[petec]

CTL is extremly cheap now and a strong buy!

 

After the Q3 figures were published yesterday, I digged again in the old numbers of 2016, when the acquisition was announced and how the figures of CTL and LVLT standalone were at these times.

 

The progress and the development till today is great.

 

The fundamentals today are that CTL has just a marketcap of 22 B, but a FCF of 4,0 to 4,2 B, an EBITDA of 9 B, Net longterm debt of 35,749 B and a revenue of app 23 B in 2018

 

The 4 B FCF in 2018 is after tax, after capex, just before dividend. Dividend needs 2,3 B per year to pay it: So payout ratio app 56 %

 

With a 2,16 $ dividend p.a./ share, the dividend rate is now more than 10 %

 

A comfortable pillow to sit and wait. The management is committed to pay the dividend.

 

In 2016, when the acquisition was announced, it looked like this for the full year 2016:

 

Revenue:    LVLT  8,17 B        and      CTL 17,47 B          in total 25,642 B

EBITDA:      LVLT  2,865 B      and      CTL 7 B                in total  9,865 B

FCF:            LVLT  1,1 B          and      CTL 1,817 B          in total 2,9 B

Net Debt:      LVLT 9,19 B        and        CTL 19,7 B          further app 10 B was added for the acquisition, so in total 40 B

 

From the beginning on, the new CEO Jeff Storey announced to increase FCF, margins and EBITDA. Always making clear, they will loose unprofitable revenue. Storey was CEO at LVLT before and did there the same agenda, which he is executing now in CTL: better FCF and margins on lower revenue.

 

Proforma predeal ebitda at $9.9bn suggests we’ve lost several hundred million in ebitda despite huge synergies. That doesn’t sound right?!

 

 

[petec]

 

Munger has often said that there are customers who you’re better off not having. In the case of CTL it’s entire biz segments that are worth jettisoning. The cost avoidance is huge which we heard one example of. Copper capital investment. Now the legacy CTL has loads of such shitty revenues. Why I posted earlier that total revenue growth is unrealistic for a while. They have to cut cost while growing profitable revenues. Wishing it different is futile.

 

Yes. I should have been explicit in our earlier debate that I was discussing growing ebitda-profitable revenue, not overall revenue. The problem is it’s virtually impossible to know if that’s happening.

[petec]

Just listening to the call. They are pretty explicit that the capex beat vs guide is not recurring. Guide for future years remains 16% of revenues. Plus there’s $300m of fcf one offs in 2018 (tax refunds etc). They made a comment that excluding one offs and at 16% capex, div/fcf would be in the low 70% range, implying sustainable run rate FCF is about $3.2bn.

 

On the positive side more of that FCF will go to debt reduction if they don’t have to make more pension plan contributions.