CTL - CenturyLink

[Valuehalla]

From the transcript of the conference call:

 

"As I mentioned earlier, our initiatives around improving our capital planning and deployment processes have resulted in lighter capital expenditures. With that in mind, we now expect full year 2018 capital expenditures of $3.15 billion to $3.25 billion, which is lower than the original outlook of 16% of total revenues. Primarily driven by lower capital spending, we are updating our full year 2018 outlook for free cash flow to $4 billion to $4.2 billion from $3.6 billion to $3.8 billion.

 

I'd also like to point out that based on our free cash flow outlook, our dividend payout ratio as a percent of free cash flow is expected to be in the mid-50s this year. Keep in mind, in 2018 we had approximately $300 million of aggregate one-time cash flow benefit from the tax refunds, net of higher pension contribution we made this year and the bonuses paid to Level 3 employees in 2017 versus 2018. Excluding the benefit that I mentioned and if our capital expenditures were around 16% of total revenue, our payout ratio would have been in the low 70s.

 

We are pleased with the improvement in our payout ratio compared to last year and remain comfortable with the dividend. I'll summarize by emphasizing Jeff's earlier comments. Having just passed the one-year mark, we feel good about our synergy achievement, margin expansion and focus on profitable growth."

 

 

When they announced the acquisition in 2016 they said, for the first 4 years they will have NOLs that reduce the tax for 650 to 675 M per year.

 

 

[Valuehalla]

CTL development in 2018:

 

                                        Q1                              Q2                                  Q3

 

Revenue                          5,945 B                        5,902 B                          5,818 B

 

EBITDA                            2,074 B                          2,111 B                          2,228 B

 

adj. EBITDA                      2,181 B                        2,271 B                          2,287 B                       

 

EBITDA Margin                  34,9 %                          38,5 %                          39,3 %

 

Lomg Term Dept                36,94 B                          36,78 B                          35,749 B

 

NetDept to adj EBITDA          x 4.3                            x 4.2                            x 4.1

 

Operat. CF                        1,667 B                          1,58 B                            1,787 B

 

FCF                                    852 M                            811 M                            1,103 B

 

EPS                                    0,11                              0,27                              0,25

 

Markt Cap

(at day figures came out)      19,464 B                      20,02 B                            22,08 B

 

Market Cap today: 20,43 B

 

[petec]

Thanks Valuehalla. Good summary. (Although if I’m being cheeky I’d rather net debt than long term debt!).

 

What do you draw from these figures? How do you feel about long term (3y+) ebitda growth prospects? And do you agree with my assumption that sustainable free cash flow is currently running at $3.2bn?

[Valuehalla]

I feel positive with the figures in 2018.

 

But i am disaponted about revenue. In 2017 I made a calculation, based on all small revenue segments and i came to the result that revenue per quarter shall come in above 6B in 2018. That came not true.

 

Since Storey is CEO they do not announce increasing revenue anymore, just growing EBITDA and FCF, which came true over the 3 quarters in 2018. In case of LVLT they did the same agenda and in the end they increased even slightly the revenue. But nobody knows, if it will happen again in same way.

 

If the FCF is above 3,1 B in 2019 the company is still cheap. It remains the negative that it can be a value trapp. Revenue can shrink more and more over time. Thats a risk.

 

The FCF above 4 B for 2018  clearly looks like a one time effect.

 

But i am not sure about the meaning of the quote in the call, thats why i published it.

It could also mean that there are one time negative effects (pension fund and bonus) beside the positive effect tax refund ? And the one time positive effect is in total net just 300 B ?  (that would be great) On the other hand, that would not go along with mid 70s for payout ratio...

 

I am not english native speaker, how do you interprete the quote?

[petec]

I read it very clearly as two effects, $300m for tax/other and another timing effect as copper capex falls before fibre capex ramps. Ex those two effects div/fcf is low 70s, or 3.2bn.

 

My issue is that I don’t know enough about the industry as a whole - who they’re competing against, why customers choose different providers, and therefore who might win. I’ve always known I didn’t know enough about that but as headline revenue trends worsen I worry more.

 

3.2bn is 16% yield which is cheap but not that cheap if this cant grow.

[Guest longinvestor]

This is an investment case of trust in management. Make that Storey. But they have great assets but overbuilt (35B today) with the attendant debt load.. This is why Buffett never touches anything like this.

[petec]

If I was Buffett I’d be looking at buying this outright, refinancing the debt stack 100bps cheaper, and riding the free cash wave ;)

[Guest longinvestor]

If I was Buffett I’d be looking at buying this outright, refinancing the debt stack 100bps cheaper, and riding the free cash wave ;)

That speculation has been alive for 20 years. I wish it’d happen. Todd / Ted?

[petec]

Won’t happen but nice to dream!

[Cigarbutt]

Long term vs short term opportunity question here.

 

Holding Fairfax in the past, the fact that they held LVLT securities for long periods always made me feel uneasy.

 

Looking at past comments made by longinvestor, it seems that concerns are shared about long term performance of these heavily indebted entities in cyclical capacity businesses. Even if Mr. Buffett had a close connection with Mr. Walter Scott and even if the 2002 environment was compelling for the LVLT distressed bonds, he "only" committed 100M and sold (with something like a 100% profit) after holding the convertible bonds for about only a year.

 

-A potential question for those holding CTL about the pension plan underfunding:

 

How does one discount for this and do you take into account different cash flow scenarios given that the thesis seems to rest a lot on the "safety" of the dividend?

 

In 2011, CTL benefitted from legislative "relief", basically "adjusting" discounting analysis and allowing smoothing of cash flow requirments to deal with underfunding. Then PBO=13,60B, PA=11,81 and underfunding=1,78B. The relief measures helped but in no way changed the amounts that ultimately need to be paid. At year end 2017, PBO=13,12B, PA=11,06B and underfunding=2,06B. In 2017, the funding ratio made it to 86,0% (vs 81,1% the year before). Not often discussed in investing circles but, from an actuarial and statistical perspective, the part of the curve around 80 to 85% sits very close to an area where non-linear events can occur. During 2018, CTL has contributed 100M + 400M to the pension plan but it seems that the second contribution corresponds pretty much to a mirror image of a non-recurrent tax inflow occurring in Q3.

 

So, even under a very favorabe environment and in the context of non-recurrent events, CTL seems to be pretty much where it was in 2011.

 

These days I read "Trade like Warren Buffett" by James Altucher and find it refreshing since we don't usually think of Mr. Buffett as a "trader" even though he may be.

 

[petec]

Simple answer is I add the pension deficit to the debt.

 

Do you have the figure for cumulative contributions from 2011 to 2017? And do your figures adjust for the addition of the LVLT deficit (I assume that pension was in deficit).

 

Why do you consider the conditions to have been so favourable? My understanding was that low rates were unfavourable for deficits due to the impact of lowered discount rates on long term liabilities. Am I wrong?

 

As an aside, I don’t think the investment case rests on the dividend. I think it rests on the FCF yield. I wish they’d cut the damned dividend and delever because I see the debt as an existential threat in the bear case.

 

The issue I have with the FCF yield argument is I can get similar yields elsewhere with less risk, in businesses where I don’t have to trust management that the revenue declines are down to unprofitable revenues and that I don’t actually own a melting iceberg. Then again, if they’re right and they can achieve any level of sustainable ebitda growth, this is a steal.

[Cigarbutt]

Simple answer is I add the pension deficit to the debt.

 

Do you have the figure for cumulative contributions from 2011 to 2017? And do your figures adjust for the addition of the LVLT deficit (I assume that pension was in deficit).

 

Why do you consider the conditions to have been so favourable? My understanding was that low rates were unfavourable for deficits due to the impact of lowered discount rates on long term liabilities. Am I wrong?

 

As an aside, I don’t think the investment case rests on the dividend. I think it rests on the FCF yield. I wish they’d cut the damned dividend and delever because I see the debt as an existential threat in the bear case.

 

The issue I have with the FCF yield argument is I can get similar yields elsewhere with less risk, in businesses where I don’t have to trust management that the revenue declines are down to unprofitable revenues and that I don’t actually own a melting iceberg. Then again, if they’re right and they can achieve any level of sustainable ebitda growth, this is a steal.

When I looked (stopped in 2015), CTL contributed 100M in each year, 2015, 2016 and 2017. As far as I recall, the LVLT pension funding was not a material issue (maybe some stuff from Global Crossing?).

 

For the discount rate, you are correct because lower discount rates render the obligation larger (higher value of PBO and higher current service costs). But, in a period where appraisal on the asset side is said to correlate so tighly (gravity concept) with interest rates, rules that I allude to in the previous post allow to build a gap between the discount rate used for PBO and the risk-free rate (rules allow to take a longer term perspective ie 25 years) with the idea that this gap will close over time. Risk-free interest rates since 2011 have remained low (maybe this is changing?) but the discount rates used have had a tendency to decrease less. So, in a way, there is a "gap" that has been built which will have a tendency to act as a negative margin of safety going forward as the values will tend to converge under any scenarios. There eventually may be a limit to the amend and extend process.

 

I understand your comment about the dividend and value your fundamental assessment but would like to mention that sometimes (not saying this necessarily applies to CTL though), the best time to buy such an opportunity is when the company announces a dividend cut and the market attributes a lower value whereas the intrinsic value for the interested observer may not change, giving rise to a potential opportunity. Is this happening with GE?

 

I will follow this idea but have to admit it is too complicated for me. Also, I often wonder about the situations where dividends are maintained when the most sensible thing to do would be to lower leverage to more reasonable levels. I wonder because of the of asymmetric reward that management may collect if things go well.

[kab60]

I've been tempted by this story and even though it's completely irrational the yield has probably played a role. I think it's really important to stay intellectually honest here, because the yield means nada to the intrinsic value. I'd also venture that with a new CFO on board it will be easier for them to slash it.

[walkie518]

I'd also venture that with a new CFO on board it will be easier for them to slash it.

I disagree here.

 

I don't think the new CFO is detailing a different Storey

 

Despite rev decline, cash flow is ok, last 9 months shows $5B of cash flow against $2B of capex... back of the env, this keeps div intact ($1.7B/9 months) and whatever is left can go to debt pay down

[matts]

I'd also venture that with a new CFO on board it will be easier for them to slash it.

I disagree here.

 

I don't think the new CFO is detailing a different Storey

 

Despite rev decline, cash flow is ok, last 9 months shows $5B of cash flow against $2B of capex... back of the env, this keeps div intact ($1.7B/9 months) and whatever is left can go to debt pay down

 

I see what you did there 8)

[kab60]

I'd also venture that with a new CFO on board it will be easier for them to slash it.

I disagree here.

 

I don't think the new CFO is detailing a different Storey

 

Despite rev decline, cash flow is ok, last 9 months shows $5B of cash flow against $2B of capex... back of the env, this keeps div intact ($1.7B/9 months) and whatever is left can go to debt pay down

I might be reading too much into it but I wasn't convinced when they talked about the divy. Agree cashflows look strong as well as ebitda margins increasing, but debt is high, operating leverage is high and revenues are shrinking. Do we think all or most of the revenue they lost is simply turning away bad business? I don't know but ain't comfortable.

[Valuehalla]

That the FCF is up on a one time effect to 4 to 4,2B in 2019 is a positiv news.

 

I can not understand what is negative on it. If we deduct 2,3 B for the dividend payout from the FCF, 1,7 to 1,9 B is left to reduce the debt. That is a big part of total debt.

 

Longterm debt is now already at 35,749 B, down from 37,238 B end Q4 17. Delta = 1,489 B within 9 month!

So within 9 month, thy reduced longterm debt app 4%.

 

EBITDA margins and EBITDA are growing. The reaction of the market - CTL down 10% on the day after the figures came out - is crazy and a good opportunity to buy.

 

Here is a good article diving a little deeper into it:

 

https://seekingalpha.com/article/4221517-centurylink-another-bizarre-reaction?dr=1

 

[petec]

That the FCF is up on a one time effect to 4 to 4,2B in 2019 is a positiv news.

 

I can not understand what is negative on it. If we deduct 2,3 B for the dividend payout from the FCF, 1,7 to 1,9 B is left to reduce the debt. That is a big part of total debt.

 

Longterm debt is now already at 35,749 B, down from 37,238 B end Q4 17. Delta = 1,489 B within 9 month!

So within 9 month, thy reduced longterm debt app 4%.

 

EBITDA margins and EBITDA are growing. The reaction of the market - CTL down 10% on the day after the figures came out - is crazy and a good opportunity to buy.

 

Here is a good article diving a little deeper into it:

 

https://seekingalpha.com/article/4221517-centurylink-another-bizarre-reaction?dr=1

 

There's nothing negative about a one time benefit but we can't use it to value the company. Sustainable FCF is therefore key to focus on.

 

As I mentioned above you need to look at net debt not long term debt. Long term debt can come down while net debt goes up, so it's important. Net debt has fallen $700m this year - good, but not great, especially in a year with a roughly $1bn one off FCF benefit. It's quite possible that sustainable FCF, after the dividend and benefit obligation payments, is just a few hundred million. That's not a lot of debt paydown if ebitda stalls. And ebitda WILL stall if they can't stabilise revenues, because you can't cut costs forever. So right now an awful lot hinges on management's promise that the lost revenues are unprofitable. That implies that profitable revenues are flat to growing, but they don't actually say that, which worries me, because I don't know enough about the underlying drivers and competitive dynamics to get comfortable that revenue declines can be halted.

 

It seems to me that what Storey refers to as the transformation process is really going to be far more important than the integration process. 

[Valuehalla]

Thx a lot for your comments Petec. I agree on your view.

 

How did you calculated net debt?

How high is net debt now?

[petec]

Thx a lot for your comments Petec. I agree on your view.

 

How did you calculated net debt?

How high is net debt now?

 

I'm just using LT debt + ST debt - cash. You could do more complex calculations including any leases and unfunded benefit obligations but this calc captures most of what you need. So: $35,749+$778-$390 = $36,137, down from $37,175 at year-end (the q4 number does include some leases that seem to have gone away). So actually closer to $1bn paydown in 9 months, not $700m, but driven by some one offs.

 

There's another $3.7bn in other ST assets - I ought to delve into the notes and see what those are but presumably they are not near-cash items or they'd be disclosed as such.

[Valuehalla]

As expected, CTL declared quarterly dividend: 0,54$ per share will be paid on 7th Dec

 

Thats 2,16$ per year = 11,3% divi rate p.a. on the share price of 19,07 $ (yesterday)

 

All as expected and announced from the management.

 

Since 2 years we saw sensless debates about "how safe is the divi", although payout ratio went massivly down from high 70th to mid 50th now and although all the time management was totally committed to the divi.

[petec]

As expected, CTL declared quarterly dividend: 0,54$ per share will be paid on 7th Dec

 

Thats 2,16$ per year = 11,3% divi rate p.a. on the share price of 19,07 $ (yesterday)

 

All as expected and announced from the management.

 

Since 2 years we saw sensless debates about "how safe is the divi", although payout ratio went massivly down from high 70th to mid 50th now and although all the time management was totally committed to the divi.

 

Out of interest why are you so focussed on the dividend? The dividend bears no relation to the intrinsic value of the company and if it is too high relative to long term sustainable cash flow then it represents a material threat to equity holders. The fact that they insist on paying it might indicate confidence, or it might indicate stupidity. The equity value in 5 years' time might well be far higher with a lower dividend and lower debt than it is with a higher dividend and higher debt. And you need to own it for 9 years to make your investment back in dividends, so if equity value is meaningfully impaired in 5 you're done for.

 

The payout ratio has not gone into the 50's on a sustainable basis: they were very clear on the call that it's in the low 70's excluding one offs, so there hasn't been a lot of progress on that front.

[matts]

I would guess that there is some overhang on the stock price because some investors (not many anymore) think it will get cut and the stock will take a big hit. But I agree with you, it's not a dividend story as far as value is concerned. I'm long the stock and I find Valuehalla's take on events a bit too rosy. There are real risks to this thesis. And the thing is, if all those revenue losses are not just unprofitable contracts, but you know, real business, it's not something Storey can be pinned on. He can just keep singing the same tune for a few more quarters regardless of what is really going on, while the stock drifts lower. Yes, he takes a financial hit when the stock falls, but my point is this is one of those situations where you will never prove that management misled investors.

[Cigarbutt]

^Just finished reviewing and updating. Too hard pile (business and room for error).

The last input was the following, which I thought useful in terms of different potential scenarios analysis:

https://deconstructingrisk.com/2018/11/13/ctl-pain-before-gain/

Good luck to all.

[Valuehalla]

As expected, CTL declared quarterly dividend: 0,54$ per share will be paid on 7th Dec

 

Thats 2,16$ per year = 11,3% divi rate p.a. on the share price of 19,07 $ (yesterday)

 

All as expected and announced from the management.

 

Since 2 years we saw sensless debates about "how safe is the divi", although payout ratio went massivly down from high 70th to mid 50th now and although all the time management was totally committed to the divi.

 

Out of interest why are you so focussed on the dividend? The dividend bears no relation to the intrinsic value of the company and if it is too high relative to long term sustainable cash flow then it represents a material threat to equity holders. The fact that they insist on paying it might indicate confidence, or it might indicate stupidity. The equity value in 5 years' time might well be far higher with a lower dividend and lower debt than it is with a higher dividend and higher debt. And you need to own it for 9 years to make your investment back in dividends, so if equity value is meaningfully impaired in 5 you're done for.

 

The payout ratio has not gone into the 50's on a sustainable basis: they were very clear on the call that it's in the low 70's excluding one offs, so there hasn't been a lot of progress on that front.

 

THX Petec for comments. The management is not only commited to the dividend. They said clearly during all last conference calls: They will increase EBITDA, EBITDA margins and FCF....(from year to year & over the next few years !!!) and they will eliminate unprofitable revenue and they will reduce debt. All of this happened till now. I have no reason to doubt.

 

It is more likely that they know what they are doing and predicting and its more unlikly they do a fraud to us investors by telling lies.

 

We will get next guidance for whole 2019 already in app 3  moth. Than we know more about FCF in 2019 and payout ratio.

For today i am happy we are in the mid 50th.

 

Even if you bought CTL on the high price levels, two years ago - after the aqcuisition was announced - around 25 $ ... you dont have a big loss today, cause you got already 2 times 2,16$ dividend. Not talking about the scenario, if you invested when the price was down mid 13$ in Nov 2017. Or in other words from 9 years, 2 years are already done.