Lumen Stock: Destruction Is Nearly Over (NYSE:LUMN)

Lumen Technologies, Inc. (NYSE:LUMN) shares are down nearly 60% over the last year, but the downtrend may finally be nearing its end. Latest data reveals that short unwinding in the last reporting cycle was the highest in Lumen Technologies amongst other telecom companies. This suggests that market participants perceive the stock to be fairly valued at current levels, with little downside potential from here onwards. This should come as a reassuring sign to existing shareholders that the downtrend may be nearing its end and that the stock price will start stabilizing in the coming weeks. Let’s take a closer look.

Rapid Short Unwinding

Let me start by saying that short interest is the total number of short positions that are open and are yet to be covered at the end of every bi-monthly reporting cycle. A sharp increase in the metric usually happens once market participants increase bearish bets against a given stock. Conversely, a sharp decline in the metric usually occurs as traders actively cover their bearish bets against a stock once they believe it to have become fairly or even undervalued. So, the short interest metric helps us in gauging the Street’s ever-evolving market sentiment pertaining to any given stock.

In Lumen’s case, its short interest at the end of the last cycle amounted to 139.4 million shares. To put things in perspective, this is down 10.5% sequentially and down 15.5% from its October highs. This points to a rapid short unwinding in the company. This discussion is particularly important because roughly 13.6% of Lumen’s entire float stood shorted at the end of the last reporting cycle. A prolonged short covering might as well result in significant buying into Lumen and lift up its distressed stock price.

But I wasn’t quite content with drawing a conclusion based on just a couple of data points. So, I pulled up the short interest data for 30 other telecom stocks that are also listed on U.S. bourses to get a wider perspective on the matter. After all, if a broad swath of traders is actively covering its short positions in the majority of telecom stocks, then it’d be an industry phenomenon and not necessarily a big discussion point for Lumen.

But that wasn’t quite the case here.

Interestingly, just 13 stocks in our study group saw a reduction in their short interest figures, while the remaining 17 stocks registered a short buildup. This suggests that market participants grew bearish on the telecom services industry in general but made sure to particularly wind up their short positions in Lumen Technologies. This is a stark change of stance towards a stock that’s constantly being berated in various online investing forums.

All this now leads us to an important question – why are market participants winding up their short positions in Lumen and what does it mean for the company’s shareholders?

Reasons for Optimism

There are broadly 3 reasons, in my opinion, that encouraged shorts to back out from Lumen Technologies. First, the stock is down nearly 60% over the last year and over 30% in the last quarter alone. As a result, the stock is now trading at an EV-to-EBITDA multiple of 4x and Price-to-Sales multiple of just 0.3x, both of which are considerably lower than many of Lumen’s other prominent peers. This incessant selloff seems to have gone on for a bit too long, and it has pushed Lumen lower into the undervalued territory, leaving miniscule downside potential for short-side traders.

Secondly, Lumen’s top brass has initiated a rather aggressive share buyback program. They eliminated the dividend payments and earmarked $1.5 billion for share repurchases with a 2-year time window. This, in my opinion, will have a two-fold effect.

1. The company has a market capitalization of roughly $5.5 billion at the time of this writing. This means Lumen can repurchase about 27% of its total shares outstanding at the current stock price. Anyone looking to cover short positions would have to compete with Lumen’s aggressive share buybacks and might not get an attractive fill for their buy orders.
2. Also, with a quarter of its shares repurchased and eventually extinguished, Lumen would have to pay a lot less in gross dividend payments should it resume dividends in the future.

So, in essence, this share repurchase plan stands to improve Lumen’s balance sheet in the long run whilst also thwarting short-driven selling pressure.

Besides, Lumen’s top brass intends to reinvest its remaining cash flows towards growth initiatives and drive growth. They’re also looking to divest non-core and/or low-growth assets to deleverage their balance sheet further. To put things in perspective, the company had over $25 billion in debt, and its interest expenses for the last twelve months amounted to $1.42 billion. Needless to say, paring down debt would reduce the interest burden on the company and free up capital for growth initiatives and/or reinstate dividend payouts in the future.

Overall, it’s Lumen’s rejig that has resulted in a sharp decline in shorting activity. Short-side market participants are probably better off targeting other businesses that are poorly managed, have deteriorating business prospects, and don’t have a turnaround plan in place.

Final Thoughts

I’d like to caution readers that short interest data is based on trades that have already taken place in the past, and it isn’t always indicative of future price action. Having said that, if market participants truly believed Lumen’s shares had ample downside potential even still, like the bears suggest, then they would have stacked up more short positions in the name in a bid to profit off of their high conviction short-side play. But that clearly isn’t the case here, and traders have actively wound up their short positions instead.

Therefore, I’m of the view that the time for panic selling and cutting losses in Lumen has passed. The company’s decision to slash its dividends in the first week of November was undeniably a shock and resulted in a sharp selloff. But Lumen Technologies, Inc. stock has declined nearly 25% since then, and much of the tax harvesting should now be over. So, I believe that with this active short unwinding, an aggressive share repurchase program in the works, and an emphasis on debt repayments, Lumen Technologies, Inc. is an attractive buy for investors with a multi-year time horizon. Good Luck!