Lumen Earnings: Signs of Stabilization and Optimistic Rhetoric With a Long Road Ahead

It appears Lumen LUMN sufficiently prepared the market for a year of atrocious financial metrics as first-quarter results were generally in line with—but not much better than—the very low bar management has set for 2023. We did see a couple of encouraging nuggets and we thought the new management team struck a more optimistic tone regarding its long-term plan. We’ve acknowledged the impaired performance that we expect from Lumen over the long term, but we still think the market is too pessimistic in seemingly predicting a death spiral. Unless management’s plan is such a flop that Lumen’s cash flow continues to deteriorate from here, we think the stock is materially undervalued relative to our $5 fair value estimate.

On a pro forma basis to account for last year’s divestitures, first-quarter revenue declined 4.7% year over year, which was an improved rate of decline relative to the prior two quarters. However, impaired profit margins and cash flow were the bigger factors that contributed to our fair value estimate reduction after last quarter, and both were as bad as expected. Still, they were consistent with management’s plan to spend to return to growth. The adjusted EBITDA margin of 33.5% in the quarter was not comparable with last year’s 42%, which was not adjusted for the divestitures, but it contracted by more than 3 percentage points from last quarter. Free cash flow came in at negative $75 million.

Considering the divestitures, we don’t expect Lumen’s margins or cash flow to get anywhere near last year’s levels for the foreseeable future, but both are artificially depressed right now. Management is spending to migrate customers from legacy services to more modern solutions and rapidly expand its fiber footprint. These are not short-lived projects, so we expect little improvement over the next couple of years, but we don’t think they’re a normalized reflection of where Lumen’s business currently stands.