Service Expansion, New Markets, Copious Cash Flow, Buybacks, 5.3% Dividend and Reasonable Valuation Offer Significant Upside

CenturyLink Inc (BYSE: CTL) is a Monroe, Louisiana, based Local Exchange Carrier (LEC) and Internet Service Provider (ISP), and is the third largest integrated telecommunications company in the U.S. after AT&T and Verizon (by lines served). CenturyLink operates four business segments: Consumer, Business, Wholesale and Data Hosting. The company serves over 33,000 business and government clients in North America, Europe and Asia, and offers calling, broadband, hosting, video, wireless, data integration and professional services, and leases office space in its buildings, warehouses and other properties. Most recently, the company entered the cloud infrastructure market and provides cloud-based IT solutions to enterprise clients. The company was founded in 1968 and is a component company of the S&P 500 index of the 500 largest corporations in the U.S.

Over the years, the company has grown through a series of acquisitions that expanded services and territory far beyond its roots as a Rural Local Exchange Carrier (RLEC). In April 2010, the company merged with Qwest Communications (a Baby Bell formerly known as US West) and became the third largest telco in the U.S. with services offered in 37 states. In July 2011, it acquired Savvis Inc. and gained a foothold in the growing managed hosting and cloud infrastructure space.

Following a flat revenue growth Q3, shares pulled back about 6%, significantly more than strategic business and consumer trend fundamentals justify, so shares offer compelling value at current levels. This is a free cash flow and capital returns play (through dividends, buybacks) without the wireless competitive and related capital investment concerns of AT&T (T) or Verizon (VZ). The company could also garner about $5 per share in tax savings if it converts to a REIT down the road. In addition, strong demand will boost revenue with price hikes expected in Q1 2015 and additional revenue from its Savvis cloud services.

Shares up 27% as CenturyLink Delivers

As of 11/14/2014, CenturyLink shares traded at $40.79 per share, up 28% over the past year, giving the company a $23.3 billion market capitalization. Shares are near the upper-end of their 52 week range of $27.93 – $45.67, and ahead of the company’s 50-day moving average ($40.17) and 200-day moving average ($38.65).

At $40.79 per share, CenturyLink has a price-to-earnings ratio of 28.5x and trades at an attractive 4.5x cash flow, making valuation attractive over the long run given the company’s strong profit margins and history of dividend payouts and share buybacks.

Shares trade at valuation ratios that are lower than competitors AT&T and Verizon.

Stock Repurchases and 5.3% Dividend Yield Offer Strong Income Upside

In February 2014, CenturyLink’s Board of Directors authorized a $1 billion share repurchase program for 24 months. The repurchase program will go into effect after the company completes a prior $2 billion share purchase program announced in February 2013. As of February 11, 2014, the company had repurchased 50.8 million shares for an aggregate amount of $1.7 billion under its 2013 program. The company’s strong free cash flow and solid balance sheet enable buybacks that return value to shareholders. In 2015, the company will likely buy back about 2.7% of its outstanding shares, and repeat buybacks at the 2.7% level in 2016.

In Q3 2014, the company bought back 1.7 million shares for $64 million.

CenturyLink’s Board of Directors declared a Q4 2014 cash dividend of $0.54 per share ($2.16 annualized, for a 5.3% dividend yield), payable December 5, 2014, to shareholders on record November 24, 2014. The company has paid 96 consecutive quarterly cash dividends since 1990.

Growing National and International Service Footprint

CenturyLink has 57 global data centers, 170 third party data centers, 430,000 miles of network fiber, 26 petabytes of data storage managed, 2.4 million square feet of raised floor space and network backbones with data transfer speeds of up to 100 gigabytes per second.

Comprehensive Portfolio Serves Customers of All Sizes

CenturyLink serves residential, business and government customers of all sizes. For residential consumers, CenturyLink offers Internet, television, home phone and home security products. The company offers four levels of Internet speeds ranging from 1.5 megabits per second to 40 megabits per second, to meet the specific needs of its customers.

CenturyLink offers television service through its Prism TV subsidiary (over high-speed fiber optic lines) and has partnered with DIRECTV (DTV) to provide bundled service in areas beyond Prism TV’s fiber footprint.

The company provides landline telephone service and has partnered with Verizon Wireless to offer bundled landline + mobile calling plans. CenturyLink offers unlimited nationwide and international calling plans that can be bundled with digital TV services.

CenturyLink also provides home security alarm monitoring systems through its Smart Home service that offers video monitoring, temperature and lighting management, home security and touch screen control.

Management recently announced an expansion of 1 gigabit per second service to new residential and business customers in 16 cities across the nation. The service leverages the company’s ultra-fast core fiber network and data center locations.

For small business customers, CenturyLink additionally offers managed office services such as Polycom IP VVX 300/400 business phones, Microsoft (MSFT) Office 365, cloud services and remote IT support.

CenturyLink also provides solutions to large enterprise clients with tailored solutions for industries such as financial services, education, healthcare, retail and government. Services include cloud, data, managed services, multi-layered network security and voice solutions. The company recently expanded its global managed hosting services in China for multinational corporations.

Data Center Expansion Drives Service, Revenue Growth in Targeted Geographies

CenturyLink is focused on growing its data centers and recently built new data centers in Minneapolis, Toronto, Phoenix and Hong Kong. Additionally, the company expanded its data centers in Chicago and Irvine.

Its latest state-of-the-art data center, TR3, is the second in Toronto and the fourth in Canada. TR3 features 100,000 square feet of raised floor space, Uptime Institute Tier III certification and support for up to 5 megawatts of IT load. The company also opened a 30,000 square feet cloud development center in Seattle.

Strategic Partnerships Offer Competitive Advantages, Growth Opportunities

In October 2014, CenturyLink announced a strategic partnership with Switch SUPERNAP, a super-scale technology solutions company, to establish CenturyLink’s presence on Switch’s 1.7 million square-foot data center campus which is the only Uptime Institute Tier IV Gold certified data center. With the partnership, Switch will gain access to CenturyLink’s global data centers as well as its portfolio of services.

Also in October 2014, CenturyLink and global communications equipment provider Alcatel-Lucent (ALU) released their jointly-developed 7950 Extensible Routing System (XRS) Internet Core Router, giving CenturyLink an end-to-end managed IP/MPLS network solution. The 7950 XRS has increased speed and capacity to meet ever-growing data and video demand. The system can forward 16 terabits of data per second while consuming only 1 watt per gigabit switch capacity.

In November 2014, CenturyLink was selected to upgrade fashion boutique BCBG Max Azria Group’s communications network across 400 U.S. locations with multi-protocol data switching, VolP and in-store WiFi. BCBG also has locations in Canada, Asia and Europe and expects to partner with CenturyLink in these markets in the future.

Long-Term Leadership: Only Three CEOs in 75 Years

Glen Post III is President and Chief Executive Officer of CenturyLink, a position he has held for 21 of his 37 years with the company. As CEO, Post has overseen multiple divestures and acquisitions, and successfully grown CenturyLink into the third largest telecommunications company in the nation.

Stewart Ewing is Executive VP and Chief Financial Officer of CenturyLink, a position he has held since 1989. Ewing is integral in the company’s strategic acquisitions and manages all accounting, treasury, supply chain, real estate and audit matters.

Karen Puckett is Executive VP and Chief Operating Officer of CenturyLink, a position she has held since joining the company in 2000. Puckett has over 30 years of telecommunications experience and was responsible for growing the company’s local operating model to 37 states. She manages all marketing, sales, service delivery and customer service initiatives.

CenturyLink’s seasoned and stable management team has proven itself through large strategic and growth-oriented acquisitions while maintaining fiscal discipline and delivering dividend income and buybacks. Over the past few years, CenturyLink has positioned itself strongly to capitalize on emerging high-margin business opportunities, which bodes well for long-term shareholders.

Third Quarter Swings to Solid Profit after Steep Year-Ago Loss

On November 5, 2014, management released Q3 results for the three months ended September 30, 2014. For the quarter, the company had operating revenues of $4.51 billion, flat compared to Q3 2013. A 4.4% increase in strategic services revenues and a 13.5% increase in data integration revenues were offset by a 6.5% decrease in legacy services revenues on lower access line (land line) customers. Strategic revenue increases were driven by an increase in enterprise and residential high- speed data services, hosting and Prism TV growth. Core business revenues have increased in six of the past seven quarter on high demand for bandwidth-intensive services and solid bookings. Higher strategic revenue led to higher CPE costs (customer premise equipment such as modems, routers and set-top boxes) and higher content syndication expenses to serve growing Prism TV subscribers.

For Q3 2014, the company reported Adjusted Net Income of $359 million, down 4.3%. On a GAAP basis, the company swung to an operating profit of $619 million in Q3 2014 from an operating loss of $685 million in Q3 2013, with net income of $188 million, or $0.33 per share, with lower average shares outstanding relative to the year-ago quarter. In the quarter, CenturyLink added 14,000 Prism TV customers for a total of 229,000 subscribers.

The company reported operating cash flow of $1.75 billion with a 39% margin and free cash flow of $780 million for the quarter. Cash flow margins were impacted by lower access line revenues.

As of September 30, 2014, CenturyLink had $734 million in cash and cash equivalents, $50.64 billion in total assets, $19.98 billion in long-term debt and $16.45 billion in stockholders’ equity.

Updated Guidance for the Fourth Quarter

For Q4 FY2014, management expects adjusted earnings of $0.59 – $0.64 per share, operating revenues of $4.44 billion – $4.49 billion and operating cash flow of $1.75 – $1.80 billion. The company’s strong operating cash flow position and its low valuation multiple to cash flow make shares very attractive for the long run.

Summary

As the third largest telecommunications company in the U.S., CenturyLink is focused on expanding its services and geographical presence to new markets while leaving the more competitive wireless segment to competitors AT&T and Verizon. CenturyLink has strong upside growth potential with networks and solutions for the EMEA and Asia Pacific markets. In parallel, management is laser-focused on improving margins and using its cash flow to better position the company for growth and investor returns. This is a great play for income-seekers with relatively low revenue risk.

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