Lumen Technologies: Few Things Go To Zero (NYSE:LUMN)

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Lumen Technologies (NYSE:LUMN), is a stock I have been in and out of for some time. When the stock had a massive yield and enough cash flow to cover it, I was suckered into the bet in the $10 a share range. I followed Michael Burry and Scion that showed a large, but temporary position in the company. It seemed logical at the time. Lots of assets but lots of debt. A melting ice cube that was able to selectively liquidate assets on the private market for larger multiples of EBITDA than the market was paying for in the stock market.

Then rate hikes happened. Rolling over large sums of debt went from being feasible to a crisis on the horizon. CEOs changed from Jeff Storey to Kate Johnson. The dividend was subsequently cut from massive to zed. This was the right choice, in my view, but also my trigger to get out with minimal losses. Now that the company is priced for bankruptcy, the margin of safety looks big enough to start wading back in.

96% off the high, this thing is in panic mode. All hands on deck to throw this overboard. I think this is one of the more amazing thrashings you'll find in the stock market of a legitimate, profitable company with valuable assets.

Lumen is one of the larger communications providers. Their business consists of three parts:

"We conduct our operations under the following three brands:

• "Lumen," which is our flagship brand for serving the enterprise and wholesale markets

• "Quantum Fiber," which is our brand for providing fiber-based services to residential and small business customers 5

• "CenturyLink," which is our long-standing brand for providing mass-marketed legacy copper-based services, managed for optimal cost and efficiency."

Century Link is the most hated of the bunch by the market. The legacy copper-based services have been deemed worthless by many, yet they continue to generate revenue and profits. The fiber network is what got the company into the current kerfuffle, buying Level 3 back in 2017 with a lot of debt. This is the very debt load that now threatens to break the back of the company.

The Graham Number

When something is both profitable and trading well below book value, I like to see how far it is trading below the Graham Number, or the price at which the P/E times the P/B does not cross 22.5. Our inputs are as follows:

While many unpopular companies never make it back to their Graham Number intrinsic value, being priced at only 20% of that value leaves a pretty wide chasm of safety in my view.

A good indicator of credit quality and the ability to pay debts is the EBIT to net interest coverage, in this case, we have the following:

2 X is about the bare minimum lenders would want to see, and 3 X or better is what Lumen should be shooting for. With frantic debt reductions, it's a race between choosing which assets to liquidate to improve their coverage while not ruining EBIT by a larger margin than interest reduction.

The correlation between total assets and total long-term debt is very evident. The two mimic each other's patterns on this chart. I believe an equilibrium will exist, at which point Lumen achieves a net interest coverage by EBIT of 3 X or better. At that point, Kate Johnson can focus more on stabilizing the business versus liquidating it.

The company has total liabilities equaling $34 Billion, down significantly from the high of $51 Billion in 2019. Looking at gross PPE and current assets, we have $39.6 Billion in gross property, plant, and equipment to go along with $5.4 Billion in current assets. Factoring out depreciation, the possible value of all hard assets could be as much as $45 Billion. If we are more pessimistic and believe the PPE is valued at net asset value, then we have about $19.3 Billion in hard asset value plus the current assets, or about $25 Billion total.

The optimist in me says the prior is more correct regarding the assets. To be conservative, let's say they could be eventually liquidated minus costs and commissions at $40 Billion, that still leaves $6 Billion on the table. The company currently has a market cap of only $1.84 Billion. In this assumption, the company would be trading at 30% of its net hard asset value. Paying less than 2/3 of the hard asset value of a company was one of Benjamin Graham's ultimate margins of safety. I am of the opinion that Lumen Technologies qualifies, even if we are more pessimistic about the hard asset market value of the company.

If we assume even $5 Billion left after complete liquidation, that would still amount to $5.09 in net hard assets per share with 982 million shares outstanding.

Share dilution would be the ripcord that would damage this buy thesis and margin of safety. However, the trailing 5-year trend line in shares outstanding shows no share dilution, rather we have share reduction.

Doing a quick analysis of what the cost of debt looks like currently for Lumen, let's observe the following.

6.4% is expensive and typical of lower credit ratings.

From a recent Fitch downgrade:

Fitch Ratings - Chicago - 27 Mar 2023: Fitch Ratings has downgraded Lumen Technologies, Inc.'s and its subsidiaries Long-Term Issuer Default Rating (IDR) to 'B' from 'BB'. The Rating Outlook is Negative.

The rating action results from continued secular challenges and its effect on the company's revenue profile posed by migration to newer products and services from legacy offerings. Additionally, the increased investments over the next year under growth and optimization programs, and to some extent, inflationary factors will impact expected results. These factors are partly offset by the potential for improved longer-term competitive positioning and a refocusing on the enterprise business by the new management team, though the near term is not without execution risk.

Fitch has assigned a 'BB'/'RR1' rating to Level 3 Financing, Inc.'s offering of up to $1.1 billion of first lien 10.5% notes due 2030.

The Level 3 Financing offering at 10.5%, 7-year notes were not a positive for the stock or the overall weighted cost of capital. This started the next leg down in price action. However, let's keep in mind that $1.1 Billion is only 5.6% of the overall long term debt capital stack. This will raise the cost of capital, but the market reacted as if they just completely refinanced the house.

MRQ Lumen 8K

One day, maybe, the market will realize that the recreation of Lumen's assets would be difficult if not impossible in the near term. The counterargument is sure, they could be bought at bankruptcy, no big deal. However, the margin of safety between the hard assets per share value and the current share price could eventually be viewed logically. 5G is expanding, and Lumen's assets might not be as illiquid as the market is assuming.

MRQ Lumen 8K

Reducing net leverage of adjusted EBITDA down to 3.3X, or dropping a whole factor, would be very positive. To execute this 4-year plan, revenue needs to stabilize and grow slightly in this model. If executed, the market could reassess the asset value multiples.

MRQ Lumen 8K

Speaking of the above revenue stabilization, the three-tier plan seems logical. Harvest the legacy, maintain the existing data networks, and grow the in-demand segments of the business, especially the cybersecurity businesses which I think have a lot of potential growth in the future.

From Howard Mark's The Most Important Thing:

I think it's essential to remember that just about everything is cyclical. There's little I'm certain of, but these things are true: Cycles always prevail eventually. Nothing goes in one direction forever. Trees don't grow to the sky. Few things go to zero. And there's little that's as dangerous for investor health as insistence on extrapolating today's events into the future.- The Most Important Thing pp 67.

Furthermore:

When things are going well and prices are high, investors rush to buy, forgetting all prudence. Then, when there's chaos all around and assets are on the bargain counter, they lose all willingness to bear risk and rush to sell. And it will ever be so.- The Most Important Thing pp 73

Considering the fear around this stock, the biggest risk is ourselves. Lumen has the EBIT to cover interest and assets that most likely have a private market value well above the total liabilities. The biggest risk is how long can you hang on. I'm buying again, slowly but surely. We have time to accumulate.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of LUMN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. The information provided in this article is for general informational purposes only and should not be considered as financial advice. The author is not a licensed financial advisor, Certified Public Accountant (CPA), or any other financial professional. The content presented in this article is based on the author's personal opinions, research, and experiences, and it may not be suitable for your specific financial situation or needs.

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