Lumen Technologies, Inc. (NYSE:LUMN)’s shares dropped below $1.00 after the telecom released a statement which said that the telecom has negotiated additional financial flexibility with creditors that hold approximately $7B of the company’s debt. A day after that, Lumen submitted its third quarter earnings sheet, which fell widely short of expectations. While Lumen also completed the sale of its EMEA business to Colt Technology Services for $1.8B in cash, the debt restructuring is a major negative and changes the investment thesis entirely. Lumen may be nearing a point of no return, and the telecom faces not only the risk of a stock delisting, but also of a potential bankruptcy!
Previous rating
In my last work on Lumen, I downgraded the telecom from strong buy to hold — Rapidly Deteriorating Situation — due to the company reporting a large impairment charge which eroded Lumen’s equity position and which caused a surge in its leverage ratio. I now am downgrading to sell due to Lumen’s debt restructuring that was just announced.
Lumen missed EPS expectations by a wide margin
Lumen reported total revenues for the third-quarter of $3.64B, which came in slightly better than expected. The telecom also reported a per-share loss of $0.09 compared to an expected gain of $0.06 per-share.
Source: Seeking Alpha
Third-quarter results
Lumen sold a number of assets in the last two years that were meant to allow the telecom to focus on its transformation and become more of a fiber broadband play. Asset divestitures have led to a rather significant decline of Lumen’s revenue base as a result, but the third quarter revenue decline has been rather moderate: Lumen’s top line fell 0.5% in Q3’23, and the Enterprise market segment actually saw 1.1% quarter-over-quarter growth to $2.1B.
Source: Lumen
Lumen’s consolidated top line declined rapidly last year, as the company decided to shrink its asset footprint and use proceeds to repay debt. The broadband segment remained a bright spot for Lumen, however, although the progress the company is making in this regard (higher revenues, expanding the number of enabled locations) is overshadowed by Lumen’s debt restructuring.
Broadband momentum
Lumen’s fiber broadband revenues soared 21.7% year-over-year in Q3’23 to $162m as the company signed on new subscribers and is adding to its enabled locations network. In Q3’23, Lumen had 3.5M enabled locations compared to 3.4M in Q2’23. Subscribers totaled 896 thousand, and the telecom added 19 thousand new subscribers in the third-quarter.
Source: Lumen
The share of broadband revenues increased 1 PP quarter over quarter to 32% as well, indicating that fiber broadband as a revenue source has become significantly more important to the telecom in the last year. While Lumen clearly has continual momentum in broadband, the market now seems way more concerned about the company’s debt situation, for good reason.
Source: Lumen
Lumen completes asset sale to Colt, debt balance needs to be reduced
Lumen has sold assets in order to repay the large amount of debt it carries on its balance sheet. The most recent asset divestiture was related to Lumen’s European, Middle Eastern, and African business to Colt Technology Services for $1.8B in cash, which was just completed. Lumen agreed to sell its legacy telecom assets for 11X adjusted EBITDA last year, and the cash inflow of $1.8B will be applied to repay some of Lumen’s outstanding debt.
Lumen said in a separate press statement before the Q3’23 earnings release that it had reached an agreement with creditors owing $7.0B worth of the company’s debt to extend debt maturities. The company also said these creditors agreed to provide $1.2B in additional liquidity through new long term debt for Lumen.
The debt situation is a bleeding wound for Lumen, and although the telecom has shrunk its size, its debt is still far too high… and now set to further increase. Lumen owed $19.7B in long-term debt as of the end of the September quarter, showing only a relatively small decline of $678M compared to the end of FY 2022. With this much debt hanging off Lumen, while the value of the equity has gotten crushed, the telecom is in a very bad spot.
Lumen’s valuation reflects growing bankruptcy risk
Lumen’s valuation has crashed as the telecom sold off assets and shrunk its business, but its debts remain high relative to the equity value — Lumen had $19.7B in long-term debt compared to just $2.2B in equity in September –which is what explains the massive value destruction that has taken place this year.
Even in a sector that traditionally sees low earnings multipliers — due to the fact telecom is a low-growth business — Lumen recently stood out with a low P/E ratio of only 4.2X. Right now, Lumen is trading at a P/E ratio of 7.9X… which is below its 1-year average P/E ratio of 9.9X.
AT&T (T) and Verizon Communications (VZ) are both priced at lower P/E ratios, but both companies have much better free cash flow (“FCF”) prospects and larger businesses to fall back on: AT&T especially is a great deal for dividend investors right now, in my opinion, because the Q3’23 earnings report proved the naysayers wrong and the telecom raised its FCF guidance. Verizon also crushed it and is trading at a solid 7.3% yield.
Risks with Lumen
With approximately $20.0B in long-term debt and Lumen seeking even more debt in the short term to finance its operations, I believe the writing for a potential bankruptcy is already on the wall. Additionally, Lumen’s shares may get delisted from the stock exchange if the share price remains below $1.00 for a period of thirty days. The risks of a delisting and of a bankruptcy are possibly at their highest ever, and thus I am adjusting my rating to sell.
Final thoughts
The extension of debt maturities as well as the fact that Lumen is seeking additional financial flexibility indicates that the situation at the company is much more dire than I initially thought. With Lumen requiring more financial help, the telecom is now merely a restructuring play with a high risk of going out of business altogether. The debt restructuring agreement is not a good development for shareholders and it puts the remaining equity value at risk as well. Other telecom investments, like AT&T and Verizon, offer dividend investors high free cash flow and dividend income, while Lumen is nearing a point of no return: potential bankruptcy.
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