Lumen: Blood On The Street (NYSE:LUMN)

Lumen Technologies, Inc. (NYSE:LUMN) has consolidated constructively after a disastrous FQ3 earnings release, where it “eliminated its dividend” and moved its capital allocation priorities into share buybacks.

The company’s strategic change was necessary as it’s repositioning for growth execution moving ahead. As such, the company needs to manage its resources appropriately, given intensifying macroeconomic headwinds that could crimp its ability to invest if it retained its dividend strategy.

With its $1.5B share buyback program, the company has the flexibility of deploying it within a two-year window. While we assessed that it’s a credible move given the current interest rate regime to conserve cash flow, dividend investors who relied on LUMN for income investing likely bailed out in droves.

As such, we believe that the capitulation by income investors has likely been contemplated at LUMN’s November/December lows.

Hence, the critical question facing investors now is whether management is competent enough to execute its growth priorities, even as recessionary headwinds are starting to hit enterprise/business customers.

As an integrated Telco company, Lumen has higher exposure to its business customers, as they accounted for more than 73% of its FQ3 revenue. Hence, we believe management is focused on improving its execution in this segment, as CEO Kate Johnson articulated:

And then now, for the first time ever, [we have] a leader running the team to serve SMB and mid-market. The mid-market motion is completely different than the enterprise motion. And so it got starved a little bit in the process. Now we see a huge opportunity there to invest and go after that segment with the right leadership, and it’s going to 100% depend on our ability to build and nurture a partner ecosystem to help us cover those customers. (Citi’s 2023 Communications, Media & Entertainment Conference)

Hence, the critical question facing investors is whether they believe that Lumen is well-positioned to go after growth, even as its revenue growth has declined.

Wall Street analysts have likely penciled in their bear case estimates, expecting the company’s adjusted EBITDA profitability to continue coming under considerable pressure.

Accordingly, Lumen is projected to post an adjusted EBITDA growth of -19% in FY22 to $6.85B. Hence, it’s markedly below the company’s midpoint guidance of $7B, maintained in its most recently reported quarter.

As such, we believe Lumen has been proffered a “lower bar” to cross in its upcoming Q4 card. Notwithstanding, Lumen still needs to prove its ability to generate growth given a forthcoming recession.

However, with the Street expecting a further 22% YoY fall in its adjusted EBITDA for FY23, management has the opportunity to defy the Street’s outlook and lift buying sentiments.

LUMN last traded at an NTM EBITDA of 5.7x (10Y average: 5.6x), which surged from its lows of 2021 as its forward estimates were slashed. However, it still trades at a discount against its peers’ median of 6.65x (according to S&P Cap IQ data). Hence, LUMN is no longer expensive.

But is the valuation discount justified? We believe the company’s move to prioritize growth in favor of its dividend strategy has likely introduced higher execution risks for investors to assess.

It’s a factor that Johnson also highlighted:

So the first thing is [developing] customer obsession. I’ve talked a lot about that. That’s building a muscle that will serve us well for growth. But investing for growth, these are parts of the company that have been starving for a long time. Sales and marketing, when you’re operational efficiency focused, you tend not to spend nearly enough on sales and marketing. The next thing is building a reliable execution engine. And that’s everything from product invention to launch all the way through the life cycle to selling and supporting customers. So you’ll see us really fine-tuning our execution engine there. (Citi’s conference)

Therefore, we believe Lumen’s near- and medium-term challenges are far from over as the company works on its transformation and growth priorities. However, we assessed that the capitulation toward its December lows has likely baked in these headwinds, coupled with the likely departure of income investors. As such, it should augur well for LUMN’s recovery from its well-oversold levels.

Rating: Speculative Buy (Reiterated), with a reduced price target of $6.5.

Note: As with our speculative ratings, investors must consider appropriate risk management strategies, including pre-defined stop-loss/profit-taking targets, within an appropriate risk exposure.