Centurylink Inc (CTL) Stock: An 8% Yielding Internet Play?

CenturyLink stock sinks as it buys yet another company -- Level 3 (LVLT) -- to expand its core internet services

CenturyLink Inc (NYSE:CTL), which became a regional Bell company in 2010 after buying the parent of US West, is moving further into the Internet core. The company announced it would buy Level 3 Communications Inc. (NASDAQ:LVLT) for $34 billion, including debt, and CTL stock is sinking sharply as a result.

Centurylink Inc (CTL) Stock Is Becoming a High-Yield Internet Play

The price is a 50% premium for Level 3 shareholders over the Oct. 6 price, but they had seen the value of their holdings fall by over 18% between July and late October.

LVLT shares spiked by more than 10% on Oct. 27, when the Wall Street Journal first reported advanced talks were underway, and 4% more on Oct. 28. They were up another 7% in pre-market trade before the deal was announced today.

The deal values Level 3 at $69.92. It comes to $26.50 in cash plus 1.4286 CTL share for each Level 3 share. The combined company will continue to be headquartered in Monroe, La.

There may be skepticism about this deal being approved by regulators. LVLT shares opened around 20% below the price of the deal.

MCI With a Twist

Like Bernie Ebbers’ LDDS, which crashed and burned after buying MCI in 1998, CenturyLink was initially a collection of small telephone carriers, local monopolies that filled gaps in the old Bell System.

CTL had been buying other phone companies for nearly 30 years under the name CenturyTel, before taking its current name in 2009. Obtaining Qwest, parent of US West, in 2010 left its own shareholders with just 50.5% of the new entity.

Since the Qwest deal, CenturyLink’s managers have changed their merger strategy, buying cloud and Internet companies like Savvis, AppFog, Tier3 and Cognilytics.

The Level 3 deal continues that trend, but with a twist that Qwest shareholders should be familiar with, in that the company being acquired is worth more, right now, than the company doing the acquiring.

Thus, as with the Qwest deal, CenturyLink shareholders will have barely more than half the equity in their new company, as about 513 million new shares are being created in the stock portion of this transaction. Currently, there are 546 million shares of CTL stock outstanding.

To complete the transaction, CenturyLink must also find $9.5 billion in cash. It had only $191 million in cash at June 30, with a balance sheet that already had $18.1 billion in long-term debt lifting $47 billion in assets.

After the deal is done, the combined company will have over half its assets under debt. However, CenturyLink said it intends to continue its dividend, 54 cents per share, a current yield of 7.9%, which would cost it over $700 million each quarter once the new shares are issued.

Level 3 had not been paying a dividend.

Core Prices Must Rise

The joke on CNBC after the deal was announced was that this is “two drunks holding one another up.” But the financial strengths of the two companies should complement one another.

Both companies announced earnings along with the deal, and the news was not good. CenturyLink said its profits were down from last year, and at 28 cents per share can’t sustain the 54 cent dividend on their own. Level 3 showed lower core revenue than a year ago but it managed to earn $143 million on $2.033 billion in sales, 40 cents per share. The company’s earnings release emphasized it had free cash flow of $281 million.

LVLT also has substantial past losses on its books, which should help the combined company shield earnings from taxes going forward, which can go into the dividend.

What this tells me is that prices in the internet core must rise, and that the core, which had been one of the most price-competitive areas of the Internet service business, could become a shared monopoly under CenturyLink, AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ), which eventually bought MCI.

Whether that prospect brings antitrust lawyers calling from Washington is unclear, but it seems to be why arbitrageurs were not piling into Level 3 as trade opened Oct. 31.

In any case, the deal could take a year to clear.

Dana Blankenhorn is a financial journalist and author of the science fiction story Into the Cloud. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2016/10/centurylink-inc-ctl-stock-high-yield-internet-level-3-lvlt-iplace/.

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