CenturyLink (NYSE: CTL) posted not-so-hot numbers in its recent earnings release. While the legacy telecom is generating cash flows and paying a fat dividend yield, its overall metrics are declining as it attempts to make a technology transition to more modern networking services.
For the full year 2016, operating revenues decreased 2.2% to $17.5 billion. Operating income decreased a much more alarming 13%, to $2.3 billion, as the revenues from strategic growth areas were lower-margin than those of the legacy wireline and low-data services. Operating cash flow declined 7.1%, and adjusted net income declined 5.9%, from $2.71 to $2.45.
Furthermore, the company forecasts continued declines in 2017. The midpoint of guidance is for revenues of $17.25 billionand adjusted net income of $2.20, which would be barely enough to cover the current $2.16 dividend.
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Given these declines, what's the one number that should concern CenturyLink shareholders the most? I would argue it's not actually in either its financials, nor in those of its acquisition target, Level 3 Communications (NYSE: LVLT). I would argue the main number to focus on is 50%, as anything over that will be a necessary win as the companies work to win approval from various groups for CenturyLink to acquire Level 3. Less than a majority in favor of the acquisition would be a stumbling block for CenturyLink.
CenturyLink's pending merger with Level 3 requires shareholder approval, as well as the thumbs-up from the FCC and other agencies. And while a business-friendly Trump administration would seem to make approval more likely, nothing is guaranteed. In fact, both the Justice Department as well as the Department of Homeland Security asked the FCC to postpone its review while those agencies perform their due diligence on the national security implications of the deal. This is due to Level 3's international licenses in both Europe and Latin America.
Furthermore, certain Level 3 shareholders are suing the company, alleging that Level 3 did not adequately determine if a better offer was available. Shareholders are also claiming they were not privy to more detail on financial projections, which the plaintiffs deem necessary to render an opinion on the merits of the buyout.
Deal in the works
To be sure, neither of these factors appear to be a serious threat to the deal. The new administration is very business-friendly, and the offer from October, which promises Level 3 shareholders $26.50 per share and 1.4286 shares of CTL stock for each Level 3 share they own, implied a per-share purchase price that in October was 42% above Level 3's closing price before speculation about the transaction broke.
CenturyLink appears to need this deal desperately, as the increased scale, estimated $1 billion in synergies, $10 billion in Level 3 net operating losses (which may be used to offset taxes for several years), and the international footprint Level 3 possesses can be used to stave off secular declines in Centurylink's legacy businesses. And without majority approval from the FCC, Justice Department, Department of Homeland Security, Level 3 shareholders, as well as its own shareholders, this much-needed boost might not arrive. Without the acquisition, CenturyLink seems to be staring into a very challenging operating environment that could possibly threaten the viability of its dividend as early as this year.
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