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Lumen Technologies: Buy the Dip?

Motley Fool - Mon Dec 11, 2023

To get Warren Buffett-like returns, deep value opportunities are one of the places one should look. When a company that most have discarded or ignored changes its fortunes for the better, the prospect of outsize stock returns is large. After all, Buffet once said, "You pay a very high price in the stock market for a cheery consensus."

Lumen Technologies(NYSE: LUMN) is certainly out of consensus, down 72% on the year and 97% below its all-time high. The company, which is a provider of network services and other fiber optic-based technologies, has certainly had a rough go. But with a new CEO in the beginning stages of her turnaround plan, is the stock a bargain-priced buy on this dip or value trap?

Kate Johnson's turnaround plan

It has been exactly one year since ex-Microsoft executive Kate Johnson became the CEO of Lumen. Microsoft is a highly capable company to say the least, so her arrival provided hope for Lumen's turnaround efforts.

Johnson believes some of those efforts are already bearing fruit. On the recent conference call with analysts, Johnson noted improvements along several internal metrics, including the addition of 2,500 new customers since the start of the year, a 14% increase in Lumen's seller productivity, and the fact that existing customers bought 16% more of Lumen's newer products labeled under a category segment management has titled Grow. In addition, Johnson noted a big win in the digital inclusion government-funded broadband expansion program for the state of California.

Lumen is also upping its innovation game, with the advent of a new network-as-a-service (NaaS) product called Lumen On Demand. Like in cloud computing, this new type of dynamic revenue model will be based on consumption, allowing customers to only pay for what they use and not just a flat subscription fee. Johnson noted this new product is already in anchor customers across 13 industries.

Finally, Lumen recently reached a deal with creditors that hold $7 billion of the company's debt. In 2027, Lumen had a large maturity "tower" in which a lot of its debt would come due. Yet after the agreement with debtors, Lumen will have pushed out many of its maturities farther out, giving Johnson more breathing room to execute her turnaround. Moreover, the existing debtors agreed to fund another $1.2 billion in senior debt to the company -- a show of confidence in Johnson and Lumen.

But there are risks to the debt deal and Lumen stock

While the new debt deal is a positive in terms of buying time, it's also somewhat of a negative, in that the new extended debt will come with higher interest rates, and the new $1.2 billion in financing will also increase Lumen's interest costs.

As a result, Lumen now plans to decrease its capital expenditures by about $200 million to $300 million per year relative to the amount outlined at its June Investor Day. That will largely come out of investing in Lumen's consumer fiber broadband business, where Lumen has seen a slowdown in adoption. The slower fiber consumer internet uptake jells with the slowing growth other broadband providers have been seeing recently, so this is not just a Lumen problem. For the consumer unit, management now expects to focus on selling into its existing fiber footprint and not building as many new passings.

Those decreased investments could hamper growth, and extend or impair the consumer unit's turnaround. While Lumen's enterprise unit is much bigger and more important, it's still a potential headwind to growth.

In addition to the added interest rate burden, and despite the positive metrics Johnson outlined in her remarks, Lumen's trajectory is still currently lower, as older technology products decline and customers churn. Last quarter, revenue slipped 5.2% after accounting for the company's EMEA business divestiture, and was down 0.5% quarter over quarter. But adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) fell even more by just over 20%, as the company made increased investments on a declining revenue base. This year's free cash flow is expected to be between $0 and $200 million, which is not very much. But remember, that doesn't include stock-based compensation, a real cost to shareholders, of another $65 million.

That's not great for a company that still has nearly $20 billion in debt -- a high load that's set to grow by another $1.2 billion per the new creditor agreement. That's especially high in relation to Lumen's distressed market cap of just $1.5 billion.

Lumen's turnaround is an interesting opportunity, but it's too soon to invest

Bankruptcy risk is still on the table, and much will depend on Johnson's turnaround efforts. The good news is that since debt maturities have been pushed out, she has time to implement the new plan.

At the June investor day, management laid out its forecast for EBITDA to fall in 2024 and remain flattish in 2025, as the company will lose the profits from the businesses it divested this year and last year, and its turnaround products need time to overcome declining legacy products. But profits are forecast to step up in 2026 and 2027.

The problem is, investors may remain on the sidelines until that happens. Since that won't be for about two years, investors may want to watch this story from the sidelines until evidence of that turnaround manifests itself. Otherwise, the debt-burdened stock is currently still too dangerous.

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Billy Duberstein has positions in Microsoft. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Microsoft. The Motley Fool has a disclosure policy.

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