Contrary to many investors' expectations, CenturyLink's (NYSE: CTL) stock has been pummeled recently, even after completing its transformative acquisition of Level 3 Communications. With its heavy debt load and dividend yield now around a whopping 15%, many are speculating CenturyLink's $2.16 per share annual dividend might be cut.
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Still, on its first post-merger earnings call, incoming CEO Jeff Storey said, "As I look at our financial plans over the next few years, I'm confident about our ability to meet the dividend obligation and believe it is an important component of our equity story."
So, let's dig into the numbers and see if "Storey's story" checks out.
One metric favored by investors in the telecom space is EBITDA, or earnings before interest, taxes, depreciation, and amortization. Telecom can be a capital-intensive business that can run in cycles, with some years requiring heavy investment in fixed assets, and other years where there's less spending, so adding back depreciation and amortization can give a real sense of operating cash flow before all other obligations.
In the first earnings release as a combined company, management broke down the earnings between CenturyLink and Level 3. Starting with CenturyLink, EBITDA was down 12.5%; however, that included May's sale of the company's co-location business. In the most recent quarter, (without the colocation business), CenturyLink's adjusted EBITDA came in at $1.39 billion. Since this is the first full quarter without the co-location business, let's just annualize this number: the quarterly adjusted EBITDA times four equals $5.58 billion.
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As for Level 3, the company's trailing twelve-month EBITDA was $2.94 billion, growing 5% year-over-year last quarter, adjusted for acquisition expenses.
So, combined, the companies made about $8.53 billion in EBITDA over the past twelve months. But the story doesn't stop there. Management also expects the combined companies to realize $850 million in operational synergies, realized over three years.
Since investors are worried about a dividend cut in the near-term, let's anticipate $280 million of synergies this year (or one-third of total synergies), bringing the combined EBITDA to $8.81 billion.
The company is estimated to realize capital expenditure synergies to the tune of $125 million over three years. One-third of that is about $41.7 million, which I'll subtract from this year's total. Annualizing the recent quarter's capital expenditures for CenturyLink comes to $2.99 billion. Meanwhile, Level 3 spent $1.34 billion in capital expenditures over the past 12 months. So, this year's capital expenditures should equal $2.99 billion plus $1.34 billion minus $41.7 million, which equals $4.29 billion.
Interest and taxes
For interest expense, using the same methodology, CenturyLink paid $362 million in interest expense last quarter. Annualizing this number gives us an estimated full-year interest expense of $1.44 billion. In addition, Level 3 expects to pay $520 million for the full year 2017, for a combined interest expense of $1.96 billion.
That's where the expenses should end, however, the combined company will likely not have to pay any taxes for the foreseeable future. This is because Level 3 has over $9 billion in net operating losses (NOLs) from prior years of operation. Companies can use these losses to offset their taxable income today, so these NOLs should shield CenturyLink from taxes for the next few years at least.
As part of the merger, Level 3 shareholders received 60% of their stake in CenturyLink shares, with Level 3 shareholders receiving 1.4286 CenturyLink shares for every Level 3 share they owned, in addition to cash. That means the combined company has about 1.07 billion shares outstanding.
So, to sum up:
|Metric||EBITDA||- Capital Expenditures||- Interest Expense||/ Shares Outstanding||= FCF Per Share|
|Combined Company||$8.813 billion||$4.288 billion||$1.968 billion||1.07 billion||$2.39|
By my calculations, it looks as though the combined company's $2.39 in free cash flow per share covers the $2.16. That's not a great margin of safety but does at least backup management's claim.
Of course, that assumes that the combined company can continue to stabilize revenues, which have been falling at CenturyLink but growing at Level 3. As of now, however, it looks as though the dividend is covered, even at its sky-high 15% yield. Just be aware it's not the safest dividend -- far from it.
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