Lumen Stock Has Been on a Wild Ride. Is It a Buy?

Key Morningstar Metrics for Lumen Technologies

• Fair Value Estimate: $5.00
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: Very High

After a year of flatlining as a stock, Lumen Technologies LUMN is suddenly swinging weekly (sometimes daily) by double-digit percentages and has roughly quintupled in price since late July.

Investors eyeing Lumen—one of the largest telecommunications carriers in the United States—as a way to play the artificial intelligence boom might want to get used to this kind of volatility. “Near-term moves will be supercharged,” says Matthew Dolgin, senior equity strategist at Morningstar, who follows the stock.

Lumen’s stock is now up more than 200% since the start of the year. Shares in the Denver-based company collapsed in 2022, going from north of $10 per share to less than $2 in 2023. Until last month, the stock was dead money, bouncing largely between $1 and 2$ for over a year. Investors believed Lumen was at risk of falling into bankruptcy.

In late July, the company announced it had signed deals to build fiber networks, including one to help expand Microsoft’s MSFT network capacity for its data centers—a critical element of the infrastructure needed for AI technology. With these contracts promising a massive cash injection, the stock surged to nearly $6 per share. From these deals, “Lumen will receive a significant portion of cash up front,” notes Dolgin. ”So while the deals themselves may not be overwhelmingly accretive to operating performance, they give a lifeline that makes bankruptcy materially less likely.”

Lumen’s 2022 Collapse

Dolgin notes that with a fiber network business model largely built on traditional telecom revenue, the company “has been in long-term decline. From 1998 through 2014, the stock bounced mainly between $30 and $45 per share.”

Central to investor concerns has been Lumen’s big overhang of debt. In 2017, the company (then named CenturyLink) acquired Level 3 Communications. Dolgin says this was essentially doubling down on legacy telecom businesses facing headwinds when growth was shifting to mobile networks and more modern technology. At the same time, it brought enterprise-focused business into its own consumer-focused business. With the deal, Lumen’s debt load doubled to roughly $38 billion.

Before 2022, Dolgin explains, the company expanded margins, keeping operating profit relatively stable despite falling revenue and generating relatively high free cash flow. That year, Lumen sold off a significant portion of its ILEC business, an incumbent local telecom provider. Expectations were that the sale would further revenue growth. Instead, “things looked worse,” he says. “Margins came down substantially. The sales trajectory did not improve at all, and in some quarters backtracked. A new management team came in with a plan that led them to say margins would deteriorate further before they got better, and the company wouldn’t generate material amounts of free cash flow over the next few years. Management of the debt has gotten more difficult, considering the declining business.” Meanwhile, free cash flow has let the company reduce debt.

Lumen operates in a highly competitive environment. Companies like AT&T T and Verizon VZ provide similar network capacity and services. In addition, cable providers and other telecom companies, such as broadband provider Cogent Communications CCOI, are competitors in some areas.

Lumen Stock Valuation

Dolgin says he expects Lumen’s business to improve and “survive as a growing concern.” However, “it will be several years before the firm returns to top-line growth, and we think margins will get back to the path of expansion by 2025.”

With the stock now trading just south of $6 per share and carrying a fair value estimate of $5, Lumen is fairly valued, according to Dolgin. In the meantime, investors should expect Lumen stock to stay “extremely volatile,” he says. “The leverage on the equity relative to enterprise value almost ensures that with any bit of good or bad news, the stock will react violently. It would not surprise me to see the stock move up another 100% from here, but it would also not surprise me if it loses 50%.”

The following are highlights of Dolgin’s current outlook for Lumen and its stock. The full report on Lumen and more of his coverage are available here.

Fair Value Estimate for Lumen Technologies

With its 3-star rating, we believe Lumen’s stock is fairly valued compared with our long-term fair value estimate of $5, which implies an enterprise value/adjusted EBITDA multiple of 5.5 based on our 2024 estimates.

We project Lumen’s fourth-quarter 2023 sale of its Europe, Middle East, and Africa business to lead to a sales decline of about 10% in 2024. We then expect sales to fall about 5% in 2025 and gradually improve to nearly flat by 2028. We think challenges will remain, but as more legacy revenue peels off, Lumen has some growth areas that will become more meaningful drivers of consolidated results.

More than 75% of Lumen’s revenue comes from business customers, and many of the legacy revenue streams in the segment, such as voice and private networks, are in decline. However, we think solutions like software-defined networks, security, and edge solutions can grow. At the end of 2023, those growth areas made up only about 40% of revenue in the segment. We project those businesses to grow in the low single digits annually, resulting in them constituting about 50% of segment revenue by 2028 and stabilizing the sales declines by that time.

Read more about Lumen Technologies’ fair value estimate.

Economic Moat Rating

We do not assign Lumen an economic moat. While its vast fiber network and breadth of services could logically lead to cost advantages or customer switching costs, the legacy business has weighed on returns on invested capital, which have averaged about 7% since the Level 3 merger in 2017. We expect the legacy business to perpetually decline, replaced by newer technologies that enable more competitors and are less lucrative.

Read more about Lumen Technologies’ economic moat.

Financial Strength

Lumen maintains a high leverage ratio and has a declining business. While we still believe it is in poor financial health, we don’t think liquidity is a near-term concern, as the firm recently signed several large deals that have brought a cash infusion, and it has no debt maturing before 2025 and only 10% maturing before 2027. We don’t expect the firm will need to roll over debt until 2029, so we think it has until then to show progress or consider selling some of or all its business.

In the past several years, Lumen has prioritized paying down debt and extending maturities, which it did during the very opportune times of 2020 and 2021. The firm reduced its debt load from nearly $38 billion at the end of 2017 to under $29 billion at the end of 2021. After divesting three sizable business lines in 2022 and 2023, Lumen used proceeds to pay down more debt and ended 2023 with under $18 billion in net debt.

Read more about Lumen Technologies’ financial strength.

Risk and Uncertainty

Our Uncertainty Rating for Lumen is Very High, but we believe bankruptcy is less likely following a series of deals with major tech companies to build private networks, which will provide a cash infusion. Lumen’s business has long been in decline, and it has a very high debt load. The firm has added debt and taken on more onerous terms to buy time for a turnaround. If management’s vision is even partially successful, we believe Lumen would become extremely undervalued. But if business continues deteriorating as it has, combined with the capital spending management is undertaking to facilitate improvement, we think it’s likely the firm would find itself in a death spiral.

Read more about Lumen Technologies’ risk and uncertainty.

LUMN Bulls Say

• Lumen’s deals with Microsoft MSFT and others to build private networks for artificial intelligence needs put the firm on a much stronger financial footing.
• After several business divestitures over the past few years, Lumen is more focused and better positioned for a turnaround as it helps meet rising demand for data networks.
• Lumen’s debt-laden capital structure can give the stock a significant upside with only slight improvements to the company’s business.

LUMN Bears Say

• Lumen’s huge debt load leaves it in a dangerous financial position if operating results don’t improve.
• With a substantial amount of Lumen’s sales coming from landline phones and other legacy services, sales and profits will continue to decline for the foreseeable future.
• Lumen intends to ramp up investment in its business, which has been in secular decline. This could be a waste of cash that could instead go to shareholders or debt reduction.