A Dive Into Lumen’s Stabilization Guidance (NYSE:LUMN)

This will be my third article on Lumen (NYSE:LUMN) and while the thesis hasn’t changed I will use this article to dive into Lumen’s financials to counter the bear argument that Lumen is essentially in run-off mode and Growth capex is really just opex in disguise. To refresh my basic bullish thesis, Lumen is priced like creditors are knocking on the door while, in reality, they generate enough cash to not only service ~$1.2B in interest payments but a further ~$3B+ in capex of which only ~$0.5B is earmarked as maintenance. In other words, ~$2.5B+ of CAPEX is earmarked for growth and some of this could be shifted to interest payments “if necessary”.

I’ve pointed out in previous articles that I value contrarian opinions and that the skeptics on the LUMN S.A. comments tend to be highly sophisticated bond investors so I don’t take their skepticism lightly. That said debating the skeptics feels like Bizzaro World because the counter to my argument that the amount of cash they generate precludes a default on interest payments and they are in no danger of tripping covenants is the bond market says they are going BK so they are going BK. Normally it’s the sophisticated debt-type investors telling dumb retail equity investors that cash flow is telling a different story than the share price would imply and it’s the dumb equity investor who reply “the market says I’m right so I’m right”.

The heart of my thesis that Lumen is not going belly up is twofold. Lumen divested a number of businesses in 2022 with the stated intent of not reducing leverage but to shed enough declining businesses to give the growing part of the total enterprise a chance to catch the declining part. To start 2023 New CEO Kate Johnson and recent CFO hire Chris Stansbury issued guidance for Revenues to stabilize exiting 2024 and shift to growth in 2025. Chris Stansbury qualified this guidance as only relying on things in their line of sight and not including growth. I.R. clarified to me that “no growth” meant only contributions for products and services that existed at the start of 2023. The Mile High picture is that simple math suggests that at “SOME” point the growing portions of the business will converge with the declining portions and if this happens before they get to the point where servicing debt payments is a realistic concern BK will be off the table and the market can start giving them credit for the value of Growth CAPEX.

Since the stabilization guidance started at the beginning of 2023 I wanted to try to figure out how actual 2023 results track guidance but the divestitures in 2022 complicate this. Lumen provides a Trending Schedule on their website that includes revenues from divestitures in 2022 and also the revenues from post-closing agreements in 2023. Subtracting divested business revenues from 2022 Q’s and post-closing agreement revenues from 2023 Q’s should give an apples to apples Y/Y comparison and based on an exchange with I.R. I think this is what Lumen is doing internally.

For my own purposes, I combined the first 3 quarters of 2023 adjusted for divestitures together to get a sense of how 2023 has progressed to date. I will provide tables with different results below starting with the Growth portions of the business:

Business Segment Growth:

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Mass Markets Growth (Fiber Broadband):

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Total Enterprise Growth (Business + Mass Markets):

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I combined all of the components of the Business Segment in managed decline together to simplify this portion of my exercise and here are the results of the managed decline Y/Y comparisons.

Business Segment Managed Decline:

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Mass Markets Managed Decline:

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So the big picture from this exercise is that there is growth inside of the total enterprise and it’s respectable but it’s more than offset by the managed decline portions of the business at this time. The heart of the bear argument is that the ~$2.5B+ per year that Lumen spends on Growth gets them nothing and it’s really just an operating expense, and therefore, the declines will continue until they are forced into Chapter 11. The proof is the bond markets imply this is so and therefore it is so. ROI is a completely different topic that I have no opinion on but there is growth inside the total enterprise that will converge with managed decline at some point in time regardless of what the bond and stock markets imply.

My next exercise was to use the growth/ decline rates from Q1-Q3 2023 to project Q4-2023 and use this to ballpark 2023 total in order to compare to the stabilization guidance to start 2023.

Q4-2023 Pro Forma:

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Q4-2022 was not a good quarter so Q4-2023 will have an easy comp. The $3,541 pro forma Q4-2023 estimate would be a (-6.0%) decline over Q4-2022 adjusted $3,767.

I next added up the Q1 to Q3 2023 buckets to the proforma Q4-2023 estimate to project 2023 full year:

2023 Projected Total:

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Adjusted 2022 total was $15,477 so the projected $14,135 for 2023 would represent an (-8.67%) Y/Y decline; however, it’s about mid-point of the revenue range of $13.9B to $14.4B that management projected with their stabilization guidance at the start of the year. In the years prior to 2022 total enterprise revenue declines averaged ~4% to 5% so this is an increase in the decline rate after the divestitures that were done to decrease the decline rate and it would certainly explain why the stock cratered on the announcement of this guidance. Q4-22 was a bad quarter so I suspect they will beat my projection but it won’t be enough to change the total decline much.

Since everything is essentially riding on management’s stabilization guidance the point of the above exercises was to get a sense of whether the stabilization guidance was realistic. Obviously having the revenue decline rate almost double after substantial divestitures that were supposed to decrease the decline rate is not heartening but the fact that it looks like they will hit the mid-point or higher of their guidance suggests they correctly factored in whatever is going on in 2023.

One of the basic problems trying to analyze Lumen is the Business Segment which represents 80% of revenues is a black box to me and as recent comments from Chris Stansbury suggest to the analyst community in general. CFO Chris Stansbury pointed out at a recent investor conference that his biggest shock from their recent Q3-23 earnings conference call was that there was not a single question about Business Segment. The only questions about operations were in regard to their Mass Markets Fiber Broadband roll out which represents a small portion of Mass Markets 20% share of the total. He recognized that the Business Segment was a black box to everyone and has promised to start providing trackable metrics so that the investment community can start seeing how their results track guidance. I am going to provide some comments below from Chris Stansbury at a recent investor conference that I think might shed some light on actual catalysts for stabilization:

We will — I mean, I do not want to confuse anyone. We will continue to see revenue declines until ’25, because we’re trying to turn around an ocean liner that has been really in fairly mid- to high-single-digit decline for the last number of years. Our rate of decline when you adjust for divestitures is probably in the 4% to 5% range, which I think is better than the broader competitive set. But that will improve, that rate of decline will improve as we get into the back half of the year, which should show the market line of sight to our point of inflection in ’25.

No. If anything, if I were to break it apart between large enterprise, mid-markets, public sector, public sector is much longer lead times between sale and revenue, big, big deals. We’ve won a number of large deals recently and that will visibly hit revenue in the second half of next year.

Large deals that will be contributing new revenues in the second half of 2024 sound like something that might have been “in the line of sight” he referred to when qualifying the stabilization guidance going into 2023. In addition to this simple math suggests that as the declining portion of the business gets smaller and the growing portion gets bigger the decline rate should slow. I took the pro forma Q4-23 projection and used the exact same growth/decline rates from Q1-Q3 2023 to ballpark Q4-24 or exiting 2024. I got Q4-24 revenues of $3,387 or a (-4.35%) decline over my pro forma Q4-23 which suggests the decline run rate would be cut in half just extrapolating the current growth/ decline rates to Q4-24.

The risk to my thesis is that the acceleration in the decline rate over 2023 was not an aberration and the business does not stabilize before their ability to service debt becomes a realistic issue and they actually are forced into Chapter 11. On a different note, the only real catalyst for a forced Chapter 11 filing is half their debt is due in 2027. There is an agreement to extend this to 2029 at the cost of a modest increase in total interest payments which in itself suggests their situation is not as dire as markets imply. However they need to negotiate some issues with banks and the deadline had to be extended from the end of December 2023 to the end of January 2024. Not as heartening.

The point of my math was to try to get a sense of where they stand in relation to the stabilization guidance and also get some idea of what the catalyst behind it might be. While the fact that it looks like the organic revenue decline rate actually about doubled in 2023 was a shocker the fact that they will likely hit the mid to high end of 2023 revenue guidance gives me some comfort that this was factored into the stabilization guidance and whatever went on is temporary. The remark about large deals contributing new revenue in the second half of 2024 gives me additional comfort that there were real catalysts baked into the stabilization guidance as the qualification that it was based on “things in their line of sight” suggested. I remain bullish but I can see now why the market freaked out when the guidance was issued and why the market isn’t going to give management any credit until they provide concrete evidence that they will hit their stabilization guidance or at least stabilize well before their ability to service their debt becomes a realistic issue.