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We were previously bullish on Lumen Technologies (NYSE:LUMN) stock due to the deep value that we felt was embedded in the company’s share price and believed that the company had at least two viable paths towards unlocking it. As we stated in a recent public article on the stock:
[LUMN doesn’t] impress us when it comes to the strength of its business models or track record…However, LUMN is cheap relative to the intrinsic value of its businesses and assets. Furthermore… management is openly considering selling additional assets in order to unlock further value embedded in its current valuation. As a result, LUMN… could potentially generate considerable upside for current shareholders if management can effectively sell more of its assets, or even the entire company. As a result, we rate… LUMN a Strong Buy.
However, since then our investment thesis has pretty much fallen apart. We recently contacted the company with a list of questions and in a recent note that we shared with members of High Yield Investor a few days ago, we discussed our takeaways from that discussion.
While LUMN did not say anything explicitly in our correspondence that caused us to sell, it was more what they did not say. First and foremost, their sudden change in disposition towards us (we had previously spoken with them on the phone several times and they seemed very willing and open to speaking with us about their business) to one where they are now only willing to correspond via email, was a yellow flag for us. On top of that, their answers were essentially non-answers.
For example, they did not clearly answer our question about whether or not inflation was negatively impacting their growth profile and instead simply made a vague statement that costs are up, and the CapEx budget remains the same. As a result, we can only conclude that this means that actual real growth in terms of assets installed is declining.
Furthermore, when asked about impacts from consumer demand, they merely repeated what they said on their last earnings call: they are seeing customers being more thoughtful in their buying decisions, but we are not seeing any meaningful change in customer cancellations. We take this to mean: no growth to speak of and a continued status quo of declines across their business, though perhaps not accelerating declines either. Not good.
Most concerning to us were the comments on the dividend, where they dodged our question about the $1 annualized payout no longer being stated as a priority on their investor deck and simply said that the #1 priority is investing for growth and that the CEO mentioned that they are also returning cash to shareholders through a dividend while remaining committed to a healthy balance sheet. In other words, LUMN is dodging this question and appears to be keeping the option open – if not outright planning – to cut the dividend. If they were truly fully committed to the $1 per share annualized dividend, they would have said so explicitly in response to this question. While we do think a dividend cut is already priced in to some extent, it is still very possible that the stock will get hit further – or at the very least not recover as quickly as it would have otherwise – if the dividend gets slashed. Already since we published this note, the stock has taken a beating from a Wells Fargo analyst coming to a similar conclusion.
Why The Investment Thesis Is Broken
In addition to this unimpressive set of responses to our questions, we honestly feel that the investment thesis is just about broken here. There are two paths to unlocking the upside at LUMN:
(1) Successfully generating strong returns from the growth investments and – when combined with selling off non-core assets – returning the business to organic topline growth.
(2) Successfully selling off a considerable number of assets/businesses at attractive enough multiples to unlock considerable value for shareholders given that the share price trades at a steep discount to the estimated private market value of the underlying assets.
However, with the macroeconomic environment deteriorating and having a negative impact on demand growth for LUMN’s products and services while simultaneously driving up costs, we see the path towards generating topline growth as hitting a speed bump and is not something we want to bet on, especially given the attractively priced opportunities elsewhere.
As a result, that leaves the ability to sell off assets at accretive valuations as the most likely path towards unlocking value for shareholders. As we said in our last quarterly update on LUMN:
we are nonplussed by the business and management, but the valuation remains compelling and the potential to unlock value for shareholders via asset sales is quite promising.
However, we see this path as becoming increasingly challenging, given that interest rates have risen considerably, which not only make private equity acquisitions of such assets more expensive, but will also likely suppress valuations for such assets. Furthermore, with the global economy – especially Europe – entering an economic downturn, many investors will likely be increasingly reluctant to make a major acquisition. Given that LUMN’s European assets were rumored to be one of the most likely disposition candidates, the macroeconomic and geopolitical situation in Europe makes it less likely that LUMN will be able to strike a deal for those assets on highly favorable terms for shareholders. Perhaps most telling of all is the fact that there was not enough secondary interest in the debt for Apollo’s (APO) recent acquisition of some of LUMN’s telecom and broadcom assets., forcing the underwriting banks to provide the financing for the acquisition.
While we still view LUMN as undervalued, our conviction in the investment thesis and path to unlocking value for shareholders has weakened considerably. At a time when there is a plethora of other attractive opportunities in the marketplace, we believe our capital is better allocated elsewhere. Furthermore, this year – despite the considerable share price weakness – there have been absolutely no insider purchases.
Investor Takeaway
Given all of this, we closed our position in LUMN a few days ago at $8 per share and recycled the capital into a much more promising opportunity that has declined even more than LUMN in recent months, pays out a high-single-digit percent dividend yield that is well covered by earnings and has seen heavy insider buying in recent weeks at prices meaningfully above the current share price.
While it is never fun to take a loss on a position, we also want to remain disciplined by selling a position once we no longer have strong conviction in our investment thesis, especially when there are plenty of other opportunities that are similarly undervalued where we also have much greater conviction in the investment thesis.
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