Since July, Lumen Technologies is up over 500% and most of this rise occurred following the company’s Q2 earnings report. Given the exceptional and sudden performance, we looked at Lumen more closely.
The company provides fiber connections for high-speed transmission between data centers. Generative AI demands at least ten times more fiber connections within data centers, along with a strong fiber network to enable fast information transfer between these data hubs.
With the largest intercity fiber network in North America, Lumen is positioning itself as a key fiber provider for data centers and recently secured $5 billion in new contracts from clients, including Microsoft and the US Defense Information Systems Agency.
After suffering years of declining revenue and profits, Lumen is undergoing a turnaround as its fiber network provides the backbone for the AI economy. With that said, other segments weigh on Lumen and the company will not return to growth for some time.
Company Overview
Lumen Technologies is a telecommunications company that provides communications and data services to businesses, government agencies, and residential customers. Its business can be split into two sales channels: its business segment and its mass markets (primarily residential) segment.
The business segment operates under the flagship Lumen brand while the mass markets segment operates under Quantum Fiber for fiber-based broadband services and CenturyLink for copper-based broadband services. Lumen’s business segment has grown to 79% of revenue in FY’23, up from 72% in 2021.
The CenturyLink brand has been around since 1930, and was renamed Lumen Technologies in 2020 to reflect the shift away from the shrinking copper-based CenturyLink broadband business.
Largest Intercity Fiber Network
Lumen’s primary advantage comes from its scale with over 450,000 route miles of fiber optic cable globally that make it the largest ultra-low-loss intercity fiber network in North America.
It is further investing to more than double its intercity fiber miles by 2026, signing an agreement with fiber optic manufacturer Corning to reserve 10% of its global fiber capacity for each of the next two years.
Some of its key advantages include its use of a multi-conduit system which allows it to deploy fiber quickly and more economically than competition, and having 25% less optical loss than competition which decreases equipment costs.
The scale of Lumen’s fiber optic network was one of the key reasons it was able to secure $5 billion in new deals for its Private Connectivity Fabric (PCF) service, including with hyperscaler Microsoft. PCF is a custom network that includes dedicated access to existing fiber in the Lumen network, the installation of new fiber on existing and new routes, and the use of Lumen’s new digital services. Lumen notes that it is in talks to secure an additional $7 billion in AI-related sales opportunities and sizes the market as $50 to $60 billion, growing 4% to 5% annually.
The announcement of additional AI-related sales opportunities, as well as significantly raising its FY’24 free cash flow guidance from $100 to $300 million to $1.0 to $1.2 billion has contributed to Lumen’s outsized 3-month stock returns.
Business Segment (79% of FY’23 revenue)
As stated, Lumen is going through double-digit declines in revenue and it will be some time before the company returns to growth.
The business segment is comprised of four product and service categories denoting their stage of investment: Grow (a focus on new investments), Nurture (more mature offerings), Harvest (generating cash), and Other.
The Grow segment is the largest, comprising 41% of business revenue in Q2’24. If we back out international revenue, which experienced a (-70.5%) YoY decline due to the divestiture of Lumen’s EMEA business in November 2023, then Grow grew 1.5% YoY in Q2.
Nurture experienced the largest revenue decline at (-12.1%) YoY and is the second largest segment, comprising 29% of business revenue. The Nurture segment is comprised of mature offerings that are ex-growth where the focus is on improving margins.
Finally, the Harvest segment includes legacy services that have grown out of the Nurture phase and are managed to maximize cash. This segment experienced a (-10.6%) YoY revenue decline and comprises 22% of business revenue.
The Harvest segment has experienced the largest decline as a percentage of revenues over the last year, although all segments have seen revenue decline in absolute terms.
Mass Markets Segment (21% of FY’23 revenue)
The mass market segment is comprised of Lumen’s services for residential, small business, and government customers. This segment is split into three categories dependent on the type of service provided.
The Fiber Broadband (Quantum Fiber) segment serves high-speed internet through fiber infrastructure and is the fastest growing segment in the company at 14.6% YoY growth in Q2, comprising 26% of total Mass Markets revenue, up from 21% in the previous year’s quarter.
The Other Broadband (CenturyLink) segment uses slower, copper-based infrastructure under the legacy CenturyLink brand. This segment is rapidly shrinking as customers switch to fiber, seeing a (-16.1%) YoY decline in Q2.
Finally, the Voice and Other is comprised of phone services and government programs. This segment also saw an (-11.7%) YoY decline in Q2.
Financials
Lumen has seen years of declining revenues as the company failed to diversify itself away from its declining CenturyLink segment. Although revenue is expected to continue to decline in the coming quarters and years, Lumen’s Quantum Fiber business is growing and partially offsetting the decline in CenturyLink.
The over $5 billion in AI-related Private Connectivity Fabric (PCF) deals is also expected to reignite growth in the Business segment, with management guiding for the public sector to return to sustainable growth later this year, followed by mid-market then large enterprise. However, the overall business is not expected to return to growth until 2027 according to consensus estimates.
The cash flow from the AI-related PCF deals are also expected to close any FCF deficit between now and when the company reaches sustainable positive FCF, assuaging liquidity concerns despite the high debt load and decreasing margins.
Revenue
- Q2 revenue fell by (-10.7%) YoY to $3.27 billion, beating expectations by 0.58%. This compares to Q1 revenue decline of (-12%) for revenue of $3.29 billion. Next quarter is expected to decline further at (-11.5%) YoY to $3.22 billion
- 2023 revenue fell by (-16.7%) YoY to $14.56 billion. This compares to 2022 revenue decline of (-11.2%) for revenue of $17.48 billion. In 2024, the revenue decline is expected to narrow to (-10.9%) YoY to $12.97 billion and (-4.3%) YoY in 2025 to $12.41 billion
- The majority of the $5 billion in Private Connectivity Fabric solution sales is expected to be recognized over the next 3 to 4 years
Margins
While Lumen has consistently generated positive adjusted EBITDA, its margins have consistently declined. The company has reported large one-time GAAP losses stemming from goodwill impairments in Q4’23 and Q2’23.
Management expects the trend to continue and guided for adjusted EBITDA to fall further in 2025 as they pull forward some expenses due to their improved liquidity profile. However, this is part of their goal to take out $1 billion in costs from the business by the end of 2027 by unifying four enterprise networks into one. As a result, they expect a significant rebound in adjusted EBITDA in 2026, followed by YoY growth.
- Q2’24 gross profit declined (-39%) YoY to $1.62 billion. Q2 gross margin was 49.4%, decreasing from 52.5% in the same quarter last year and 49.8% in the previous quarter
- Q2 operating income increased to $135 million from loss of (-$8.42) billion in the year ago quarter which was affected by goodwill impairment charges. Q2 operating margin was 4.10%, up from (-230%) in the same quarter last year when there was a loss of $8 million, but up from 1.40% in the previous quarter
Adjusted EBITDA declined (-17.7%) YoY to $1.01 billion, representing a 30.9% margin, down from 33.6% last year but up from 29.7% last quarter.
Management guide for FY’24 adjusted EBITDA is in the range of $3.9 to $4.0 billion, slightly down from their previous guide of $4.1 to $4.3 billion issued in Q1 as Lumen pulled forward some investments associated with its business transformation.
Lumen management guided for 2025 adjusted EBITDA below 2024 levels, with a significant rebound in 2026 and growing thereafter, they note that they will provide more detailed guidance in their Q4’24 call in February 2025.
- Net income was (-$49) million or (-1.5%) of revenue compared to (-$8.736) billion or (-238.6%) of revenue in the same period last year due to a non-cash goodwill impairment charge of $8.793 billion
- Adjusted net income was (-$124) million or (-3.8%) of revenue compared to $98 million or 2.7% of revenue in the same period last year
EPS
Lumen is expected to remain unprofitable on a GAAP and adjusted EPS basis due to its interest expense burden.
- Q2 GAAP EPS improved to ($0.05) from ($8.88) last year and beat estimates of ($0.11). Adjusted EPS fell from $0.10 last year to ($0.13) and missed estimates of ($0.04)
- Analysts expect adjusted EPS to grow 4.6% YoY to ($0.09) in Q3 and to ($0.06) in Q4
- Analysts expect 2024 adjusted EPS to decline from $0.20 in 2023 to ($0.32)
Cash Flow and Balance Sheet
One of the primary risks to Lumen has been its high debt load, with debt of $18.6 billion, for a debt-to-equity ratio of 39.9x.
However, Lumen has seen a significant improvement in cash flow and liquidity recently. Since Q2’23, it has addressed over $15 billion of debt and extended $10 billion of maturities as well as securing access to $2.3 billion in new liquidity.
With the company guiding for free cash flow guide of $1.0 billion to $1.2 billion for FY’24, liquidity is not much of a near-term concern.
The management guide for FY’24 FCF is in the range of $1.0 to $1.2 billion, significantly improved from their previous guide of $100 to $300 million issued in Q1.
- Operating cash flow was $511 million or 15.6% of revenue compared to (-$100) million or (-2.7%) of revenue in the same period last year
- Adjusted free cash outflow was (-$156) million or (-4.8%) of revenue compared to (-$896) million or (-24.5%) of revenue last year
- Capex was $753 million compared to $796 million in the same period last year. The management guide for FY’24 capex is in the range of $3.1 to $3.3 billion, up from their previous guide of $2.7 to $2.9 billion issued in Q1
The company had cash of $1.5 billion and debt of $18.6 billion compared to $1.58 billion and $18.68 billion in the previous quarter. The company is guiding for net cash interest of $1.15 to $1.25 billion in 2024
Valuation
Due to the stock being up over 500% in three months, Lumen is trading at its historic averages, which reflect revenue declines, unprofitability, and liquidity concerns with its high debt load. It currently trades at a P/S multiple of 0.42x and a forward P/S ratio of 0.46x which is below its 5-year average of 0.44x. Notably, telecom companies such as AT&T are trading at 1.3x and Verizon at 1.4x.
Lumen trades at a forward EV/EBITDA multiple of 6.0x. While Adjusted EBITDA is expected to decline further in 2025, management guided for a “significant rebound” in 2026, followed by growth thereafter as previously mentioned.
Risks
Lumen’s largest risk stems from its declining revenues in combination with the interest burden from its debt. The stock went through a 98% peak-to-trough drawdown as liquidity became a key concern prior to the large AI-related contracts it recently landed.
However, the details around the $5 billion of AI-related PCF contracts remain high-level and the contribution is front-loaded, meaning the majority of the revenue and cash flow associated with these contracts will be recognized in the next 3-4 years, so Lumen needs to continue to win new business to extend its growth.
Finally, Lumen operates in a very competitive industry with large competitors like AT&T and Verizon that are investing heavily in their own fiber networks. Both companies are much larger than Lumen and thus pose a significant threat to Lumen’s ability to land more contracts and continue to pay off debt.
Technical Analysis
Lumen is up over 600% since July. This is an unusually large move in such a short amount of time. To understand if this is the start of a new, multi-year uptrend, we will need to look at Lumen’s trend on a much larger timeframe.
LUMN has been trading since the 1979s (due to CenturyLink). From its IPO into the 2000 top, it traced a perfect 5 wave pattern that took decades to complete. What always follows a 5 wave pattern is a 3 wave retrace of the same degree. The problem with the retrace that followed was that it lasted 23 years and retraced 98% of the uptrend. This is a very deep and long, which warrants caution until Lumen can further prove itself.
We need to see the pattern off the 2023 low turn into another 5 wave pattern to signal a new uptrend is starting. So far, it’s only 3 waves higher. For now, we need to see any weakness hold over $2.70 and then make a new high to meet this criterion. If we can see a new 5 wave pattern develop off the 2023 low, it will imply a new and investable uptrend has started.
Conclusion
It is not often that you see a century-old company at the forefront of new secular trends, but Lumen’s large and hard-to-replicate network of fiber assets is proving important as data center customers look to ever-increasing amounts of data with fast transmission to train AI models.
After concerns of potential bankruptcy in recent years, Lumen has successfully capitalized on recent AI-related contracts to stabilize its liquidity position as the company looks to return to growth in coming years. While the idea remains speculative given the high leverage, competition, and the lack of details surrounding the new contracts, Lumen could see a continuation of its rally if management is able to execute.
The I/O Fund has no plans to enter Lumen at this time.
This analysis is a preview of what you can expect in our upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier November/December. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier November/December. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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