CenturyLink: Telecom to TV

08/26/2013 7:00 am EST

Focus: STOCKS

Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

Generally, investors do not look kindly on dividend cuts. That's why we were not surprised to see shares of this company tank in February, after the company cut its dividend by 25%, notes Taesik Yoon, editor of Forbes Investor.

But not all dividend cuts are created equal. For CenturyLink (CTL), it was part of a major revision to its capital allocation strategy that also included a substantial $2 billion share repurchase authorization through February 2015.

This suggests there's a good chance that the company will actually return more money to shareholders over the next two years, than prior to the announcement.

Thus, any concern regarding the health of future cash flows is both premature and exaggerated in our view. That's why we see the sell-off as an overreaction and believe CTL offers compelling value at the current price.

CTL is the third largest telecom company in the US. It provides communications and network services to residential, business, governmental, and wholesale customers and is a global leader in cloud infrastructure and hosted IT solutions.

Q1 operating revenues declined 2.1% year-over-year to $4.51 billion, primarily due to the loss of access lines, as traditional wireline services continue to be displaced by newer competitive products and services.

We believe much of the concern that materialized after the reduction in dividends continues to weigh on share value.

Had the dividend cut been the only action announced, we would share this concern. But it was only part of a revised capital allocation strategy, which also included a substantial share repurchase authorization, allowing CTL to buy back up to $2 billion in stock through February 2015.

If fully executed, the company will actually return significantly more money to shareholders during this period, than if it were to simply maintain its prior dividend payout.

In fact, since initiating its buyback program in February, CTL has repurchased 19.2 million shares for $682 million, representing 3% of total shares outstanding, while also paying $341 million in dividends through May 7.

Collectively, this represents $1.02 billion in total cash returned to shareholders, which is more than double the $454 million the company would have paid out in dividends prior to the cut. This is a key reason why we believe this concern is well overblown.

Investors may also be underestimating CTL's prospects for the remainder of 2013 and over the longer term.

The firm enjoyed better-than-expected net broadband subscriber additions. Demand for networking and hosting services from business customers was also strong.

For the consumer market, CTL recently announced the launch of a one gigabit pilot service in Omaha, which is expected to reach about 48,000 addressable homes once completed by Q4 and could result in additional growth if successful.

IPTV also continues to offer further growth opportunities—especially as CTL enhances its features by introducing new functionality, such as expansion of its TV Everywhere capabilities and video-on-demand library.

We also expect its Prism TV service to continue expanding, as more customers realize the compelling entertainment alternative the service presents over cable TV.

With just 10% penetration in available markets and with 50% of customers added being new to CTL, Prism TV offers growth from both existing and new subscribers.

In fact, the company believes that the soft launch of Prism TV in Phoenix, Colorado Springs, and Omaha in the first half of the year, coupled with expected commercial launches in the second half, positions CTL for additional video subscriber growth in 2014.

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