Lumen Technologies Stock Q3: Painful Debt Restructuring (Rating Downgrade) (NYSE:LUMN)

One of the worst performing names in recent years has been Lumen Technologies (NYSE:LUMN), with shares losing a majority of their value in the past five years. As the company has worked to reduce its massive debt pile, a series of asset sales have sent revenues plunging. On October 31, the company reported its third quarter results, while also announcing a major debt restructuring plan that will add a lot of near term interest expense pain.

For Q3, total revenues came in at $3.64 billion, which was slightly ahead of street estimates, and actually was the largest top line beat in three years. Unfortunately, the number was down 17% over the prior year period. While multiple asset divestitures were the main culprit, more than a quarter of the drop was due to other declines in the business. Management did mention that some of its revenue weakness was due to questions over the company’s financial situation and its future, which I’ll get to in a bit. Total revenues are expected to further decline through 2024, with another asset sale being finalized this week and some headwinds from macroeconomic softness. The company did highlight some areas of progress as compared to Q2 as seen below:

As I’ve covered over the past few years, Lumen has done a great job of improving its balance sheet. After the Level 3 acquisition, total debt was more than $37 billion, and that number has been nearly halved since. Unfortunately, that’s been a main reason why revenue drops have occurred. The recent surge in US interest rates has added to the pain with about half of the company’s debt being variable rate, and a chunk of interest rate hedges expiring last year.

Along with the company’s earnings report, Lumen announced that it had entered into a transaction services agreement with a bunch of its creditors. It’s a very complex deal, but the key is that a portion of the company’s debts will see their maturities pushed back a couple of years, but as a result they will contain much higher interest rates. Lumen also will receive $1.2 billion in new debt capital, but only get about a billion after subtracting out costs. The EMEA divestiture is expected to close this week as well, with those proceeds going to debt repayment. In the company’s deal filing, a couple of other pieces of information were disclosed, summarized here:

• Company will pull forward some of its net operating losses and receive a tax refund of around $900 million – $200 million to be used for this year’s taxes, and Lumen is expecting a cash refund of approximately $700 million in Q1 2024. This cash benefit is expected to be offset in the outer years by other cash and tax impacts such that the cumulative benefit is mid $600 million through 2027.
• While the cumulative free cash flow impact through 2027 remains within the cumulative range previously disclosed, cumulative free cash flow is currently expected to be toward the low end of the range.

As a result of the revenue weakness and higher interest expenses, Lumen has had to do some restructuring to future plans as detailed on the conference call. First, about 4% of the company’s workforce will be cut, which is expected to generate annualized savings of approximately $300 million. Additionally, the company will be cutting back on capital expenditures in the $200 million to $300 million range over the next few years. A part of this pullback will be a lowering of the amount of fiber deployments the company is targeting moving forward. Management will provide an updated forecast for 2024 at the next earnings report.

Obviously, there are a lot of moving parts here, and we won’t likely see the full financial impact of the initial transaction for another couple of months. I am cutting my rating on the stock today to a sell, primarily because the situation here appears worse than previously thought, meaning that the equity here might not be worth anything in the end. Management is going to cut back on operating expenses and reduce future capex, along with getting a big tax refund, yet it still is essentially lowering its free cash flow guidance for the next couple of years. I understand that the extra interest costs here are a big part of that, and this debt deal was likely needed just to survive, but more cash flow was needed for better growth, more debt repayments, or even perhaps a small share repurchase plan.

So what would get me back to a hold rating for Lumen? Well, I first need to see the full set of 2024 guidance, along with any additional commentary on future years. Second, I need to see some of these revenue trends show more than just a quarter of even small improvement. I also need to see how the balance sheet and debt situation truly looks after all of this. Finally, I need to see the stock show it can stay above $1 a share, because if it falls below that, a reverse split may be needed, and history tells us that a reverse split will likely add even more pain. Should the stock rally from here, I might consider an upgrade if management were able to bring in some fresh capital via the equity route, although with a market cap of only $1.5 billion going into the earnings report, it would have to be a major jump for an equity raise to make a decent dent here.

In the end, Lumen announced some okay Q3 results this week but the major news was its debt restructuring plan. The overall business is doing worse than previously thought, and it will take cuts to capital expenditures and the employee count to offset a new wave of interest expenses. While the latest news will quiet any potential bankruptcy talk for the near term, this business is nowhere near out of the woods just yet, and equity holders could still be wiped out if this new plan doesn’t work out in the coming years. I cannot recommend holding this name until we get even the smallest indication that there may be some light at the end of the tunnel.