Lumen Technologies

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

A telecommunications company providing integrated network, cloud, and edge solutions, facing a rapidly evolving competitive landscape and declining revenues in its legacy business.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Lumen Technologies (LUMN), formerly known as CenturyLink, is a technology and communications company that provides a broad array of integrated products and services, both domestically and globally. They have a large portfolio of services that include network, cloud, security, and voice solutions, which means their operations are really broad and complex.

Business Overview

Lumen operates under three main business segments:

Business: This segment includes core network services, such as IP, ethernet, wavelengths, SD-WAN, and managed network services which are targeted toward large enterprise and mid-market customers.
Mass Markets: The focus here is on providing voice and broadband services to residential and small business customers. This is their legacy business.
Wholesale: This focuses on selling a multitude of communications services to other carriers and service providers.

Their business has been changing rapidly, in the second half of 2022 they sold parts of their LALA (Latin America) business, and later their EMEA (Europe, Middle East, and Africa) businesses. These moves are crucial as it demonstrates their desire to transform and optimize their operations, rather than staying put in their legacy business.

Industry Trends & Competitive Landscape

The telecommunications industry has been experiencing rapid changes in recent years, primarily due to technological advancements and shifting consumer preferences. Customers now expect faster and more reliable internet connectivity and a variety of digital services. Competitively, the industry is very intense, facing disruption from newer technologies and the emergence of cloud-based alternatives, plus established companies like Verizon, AT&T, and Comcast.

Intense Competition: The market is crowded with many players, forcing companies to offer competitive prices and innovative solutions. Smaller companies are finding it harder to compete.
Technological Advancements: The industry is continually shifting due to newer tech like 5G, fiber optics, and cloud computing, and companies must be agile to adapt to those. The demand for cloud and digital services creates both opportunity and risk for telcos.
Price Pressures: In particular, commodity products in the business and mass market segment face declining prices, and these services have low or negative growth. Therefore, businesses must make them more innovative and cost effective.

Financial Analysis

LUMN’s financial situation shows signs of strain. They are operating in an industry that is struggling to compete with other players, they have many legacy assets that are getting written down, and have massive amounts of debt that they are struggling to pay down. In their recent financial reporting they have reported declining revenue, negative earnings, and increased interest rates.

Declining Revenue: Overall revenue has been declining year-over-year across the three primary business segments due to reduced demand for legacy services and increased competition.
Profitability Challenges: Operating margins have been squeezed by pricing pressures and the cost of investing in the new technologies. They are struggling to compete in both of their core markets, mass markets and business segments.
High Debt Burden: Lumen is highly leveraged, with a substantial amount of long-term debt which is now more expensive than before, and will be hard to pay down at the current trajectory. The increased cost of debt and reduced profitability have strained the companies capacity to invest in growth initiatives.
Cost Cutting: They have been restructuring, laying off large numbers of employees and implementing other ways to cut costs to improve their profitability, though it has created disruption and uncertainty in the business.
Investments in Growth: While managing costs, Lumen is still trying to grow by investing in fiber network upgrades and edge computing infrastructure. These are high capital intensive investments.

Moat Assessment - 2 / 5

Based on the company’s business, and the factors that are currently impacting it, the company receives a “2” as the moat rating. The company has some advantages, but they are being eroded and are not strong enough to ward off competition.

Intangible Assets (Narrow Moat): They have a big network of fiber across the United States, which has some limited moat as it can be harder to replicate due to legal reasons and cost of deploying the network. Though they are rapidly expanding it, other telecommunications companies already have a very wide network. Therefore their edge is being diminished. They have a recognizable brand, but it’s not necessarily a valuable moat in the telecommunications market.
Switching Costs (Weak): Many of their products don’t have strong switching costs, because customers are often willing to change providers if they find a better price. They are making efforts to integrate their products, but it is a continuous process that is still in the early stages.
Network Economics (Weak): Some of their products, like their data centers, benefit from the network effect. The more data they store and transfer, the more valuable it becomes. However, these network effects are not really strong, since other companies are rapidly expanding in this field as well.
Cost Advantage (Weak): Although they have made progress in cost cutting, this is largely to offset the decreasing revenue. They don’t really have a durable cost advantage over their main competitors, so when competing in commodity businesses, they will get beaten up by competitors with stronger finances.

Risks to Moat and Resilience

Lumen’s moat and business face legitimate risks that could affect it in the future.

Technological Disruption: Their legacy business faces disruption from newer technologies, and they may be unable to pivot to the newer technologies quickly. They are facing competition from companies with cutting edge software solutions for their business, and their own core offerings are becoming less profitable.
Intense Competition: They face intense competition from large companies like AT&T, Verizon, and cable providers, putting pressure on their profitability.
High Debt Burden: Their massive debt payments can be a massive hurdle to growth, and could ultimately lead to bankruptcy in case of major business downturn.
Regulation and Legal Challenges: The company operates in a heavily regulated industry and must remain compliant with existing regulations. Failure to comply may cause disruption in operations.
Economic Conditions: The company’s performance is directly affected by overall economic growth. Economic slowdown may result in decreased demand for their products and services.
Operational and Execution Challenges: Management is attempting to transform the company and transition to cloud-based and data center services, which carries its own operational and execution challenges. They must make acquisitions that add value and not diminish it. They also must hire and retain the right talent and manage the new and old parts of the business effectively.
Declining Legacy Business: They are a communications company whose legacy business is undergoing massive disruption. They are trying to pivot to newer businesses, but the time they have is running out and they have not yet shown evidence of success in making that change.
Customer Consolidation: Their customer base is consolidating in many areas, meaning they are under increased pressure to agree to lower prices.

Understandability - 3 / 5

Understanding Lumen requires a certain amount of technical know how, making the business only moderately complex. Its core businesses are in telecommunications, but they also have cloud, security, data storage and other services, that need to be understood at least on a high level to be able to predict the trajectory of the business. The company structure, with its various segments, can also be somewhat confusing.

Balance Sheet Health - 2 / 5

Lumen’s balance sheet health is concerning. It is characterized by high debt levels which have continued to rise, and they have massive debt repayment obligations in coming years. Their ability to maintain profitability at the current trajectory has been diminished with increasing interest rates and decreasing revenues, making debt repayments more and more concerning. Therefore, they are in a rather precarious financial state.

High Debt-to-Equity Ratio: The company’s high debt level leaves it very exposed to interest rate fluctuations. They are currently struggling to stay profitable, let alone paying back large amounts of debt that they carry.
High Debt levels Their debt level is just too high, especially with decreasing revenues, and this presents a massive risk to the stability of the company.
Negative Cash flows Their free cash flows have often turned negative recently, which does not help in paying off their debt.
Negative Net Income The company’s earnings are frequently not positive, signaling lack of profitability, and may be an indication of weak business models.

In conclusion, Lumen Technology has some positive traits in the form of a large infrastructure and presence, but faces many serious challenges, like rapid technological disruption and a high debt load. The management seems to be taking the right action, but it remains to be seen if they are able to transition the company to profitability. There’s no reason to believe that the stock will continue to go down, but the outlook is highly uncertain.