Business and history
CenturyLink (CTL, Financial) is one of the largest global provider of integrated telecommunication services including VPN, Ethernet, hybrid networking and IP services. Incorporated in Louisiana in 1968, the company currently owns 450,000 route miles of fiber optic cable around the world. Around 74% of its total revenue derived from sales to enterprises, while sales to residential customers accounted for only 23% of the total revenue.
Why CenturyLink?
What is attractive about this company is its recent hiccups in the market; it trades at its 27-year low. With a very low price, the dividend yield shot up to as much as 10%. The market irrationality is that while the operating income has been increasing, the stock market price has been decreasing.
In CenturyLink's recent 10-K filing, its auditor KPMG noted that there is material weaknesses in the company’s internal control. The whole market seems to be freaking out, selling down the stock further.
But, in the Public Company Accounting Oversight Board, they give the definition of “material weakness” in the company’s financial statement: “A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.”
With this issue, the auditor wants to point out that CenturyLink might not detect future internal control errors properly. Of course, even with the right procedures, the internal control error might not be eliminated completely. That is why we can conclude that the recent market selloff is quite irrational.
Financial strength
Many investors have worried about the high financial leverage that CenturyLink employs. As of December 2018, it had only $19.8 billion in equity, but the long-term debt amounted to $35.4 billion. Thus, its interest-bearing debt is near twice the equity. Around $4.3 billion of debt will be matured by the end of 2021. In addition, the company is required to pay $164 million per year in principal payments until maturity. With the five-year average free cash flow at $2 billion per year, CenturyLink can likely meet the debt payments quite easily.
Moreover, the company has managed to reduce its financial leverage over time. Since the first quarter of 2018, its net debt to adjusted Ebitda has come down, to only 3.9x from 4.3x. In the next three years, the management committed to the plan of reaching the target leverage of only around 2.75x to 3.25x. For the full year 2019, it expects to generate around $9 billion to $9.2 billion in adjusted Ebitda, with free cash flow of $3.1 billion to $3.4 billion.
Management
Jeff Storey became CenturyLink’s CEO in May 2018. Storey is a, experienced executive in the telecommunication industry. Since 2002, he has been an executive at several big telecommunication companies, including the CEO of WilTel Telecommunication Group, a president of Leucadia Telecommunications Group, and chief operating officer and CEO of Level 3 Communications. At the time of writing, Storey owned more than 2.4 million shares of CenturyLink (around 2% of the company’s total share outstanding), worth more than $25 million at the current depressed price. Thus, if CenturyLink’s share price can come back to $40 per share, his holding would be worth $100 million. His personal holding in CenturyLink provides muchf incentive for him to contribute to the company.
Key Assets
The most important asset of CenturyLink is its huge fiber network across the world. It is sure that the amount of data transmitted around the globe will increase at a great rate. Thus, we need a lot of bandwidth with great infrastructure to transmit a huge amount of data in a fast and smooth way, without any friction. AI and big data will definitely require great infrastructure to operate sustainably. CenturyLink’s fiber network will be the key infrastructure for this worldwide technology evolution.
Outlook and valuation
According to average analysts’ estimates, at the end of this year, CenturyLink might earn $1.30 per share in earnings. The five-year average price-earnings ratio is 18.77x. If CenturyLink is valued at 16x earnings at the end of this year, with earnings per share of $1.30, CenturyLink would be valued at nearly $21 per share in the market -- a 100% return from the recent price. This return does not include the high-yield dividend payment to investors. In 2019, CenturyLink expects to pay more than $1 billion in dividend, or $1 per share, with an additional return of nearly 10%.
Insider purchase
With the price at a multiyear low, both the CEO and chief financial officer stepped in and bought the shares. Storey bought 50,000 shares at $9.8 per share, and the chief financial officer Dev Indraneel bought 15,000 shares at a similar price. Those insider buys will definitely bring more confidence to investors.
Risks
Interest rate risks: CenturyLink has a heavy debt burden, which can drag the company down fast if its operating performance faces short-term difficulties. Potential higher interest rate risks mean higher interest payments on the huge debt burden that CenturyLink carries now. Higher interest payment might would mean a reduction in dividend payments to shareholders. But, the company is taking actions to gradually reduce its debt burden over time.
Technology risks: If in the future a new technology for transmitting data is faster and more efficient than the existing fiber network technology, that would be a huge threat to CenturyLink. But that threat is not in sight at the moment, and the fiber network is still the only option for high-speed data transmission.
Conclusions
With a high dividend yield, a valuable fiber network asset, recent insider purchases and a potential capital gain, CenturyLink is a buy now.
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