Telecom & Wireless

Why Analysts Are Looking Higher to the CenturyLink and Level 3 Merger

CenturyLink Inc. (NYSE: CTL) remains a rather controversial stock, even after its acquisition of Level 3 Communications Inc. (NYSE: LVLT). This carrier comes with a massive $2.16 annualized dividend, which generates a current dividend yield of 8.4%. It turns out that several analysts have been making big calls here ahead of earnings.

24/7 Wall St. has followed some of these high-yield dividend payers for years. Many of these high-yield dividend structures are often very hard to follow. After all, they can come from EBIT measures and distributable cash flows rather than from a traditional earnings per share measurement that investors are used to.

CenturyLink has scheduled its earnings report for Wednesday, February 8, 2017. That leaves a couple of weeks before many things will be stated by the company. When considering this merger with CenturyLink as the acquirer, it is important to keep in mind that Level 3 has a market cap of $21.3 billion, versus $14 billion for CenturyLink.

One such consideration is obviously that CenturyLink is a heavily shorted stock. At the end of December, its short interest was a massive 71,133,000 shares (over 10% of its entire float).

On January 25, 2017, Jefferies raised CenturyLink’s rating to Hold from Underperform. Other analyst calls have recently been made by Merrill Lynch, S&P, JPMorgan and Macquarie.

When Jefferies upgraded CenturyLink, the firm also raised its official price target to $26 from $20. In effect, the analysts now see a price that is slightly higher than the current share price, rather than one with is about 20% under the current share price. The key takeaway from Jefferies:

We are upgrading shares of CenturyLink from Underperform to Hold as NOLs and synergies from the pending acquisition of Level 3 reduce the near-term risk to the dividend. The implied 8.3% dividend yield provides support for the stock, in our view. Our prior outlook hinged on challenging fundamentals and an inconsistent dividend policy. CenturyLink faces on-going secular and competitive pressures; however, the combination should lead to meaningful financial benefits and accretion.

Merrill Lynch said in its most recent telecom and data center research tome:

We estimate ’17 revenue of $17.2b (consensus of $17.2 billion) and EBITDA of $6.36 billion (matches consensus) …. We estimate the deal, using a blended average 5% pre-tax cost of debt, could be 44% accretive to CenturyLink’s free cash flow per share in Year 1 (2018E) …. CenturyLink announced a deal to sell the majority of its data center business to a consortium. … We will look to the call for any insight CenturyLink can provide on the potential benefits from tax reform.

Standard & Poor’s issued a refresh to its research on January 21. Its rating is Buy and it has a $28 price target. S&P said at the time:

Our Buy opinion reflects the pending Level 3 Communications (LVLT 54 Buy) deal, CTL’s attractive dividend stream (over 8% yield) and our view of fundamentals. We remain cautious about ongoing legacy declines and higher cash taxes next year, but see higher growth in strategic revenues. We think the pending acquisition of Level 3 Communications will further leverage CTL s balance sheet but note benefits from cost synergies, free cash flow improvement and potential usage of LVLT s near $10 billion in net operating losses (NOLs). We also think the combination offers CTL a greater geographic footprint and scale (more than 2/3 of combined revenue in strategic growth areas).

Right at the start of 2017, JPMorgan raised its rating to Overweight with a $28 price target. That was based on a 9.1% dividend yield and on revenue stability. JPMorgan’s investment thesis and valuation were noted in that report as follows:

We now have more confidence in the value of CenturyLink due to the positive implications of the Level 3 deal. We believe the Level 3 deal is a significant positive for CenturyLink as it brings a higher enterprise mix (~75% of pro forma revenue), increased scale, revenue and EBITDA stability, and tax protection to help CenturyLink pay its dividend. Despite the benefits, CenturyLink’s dividend yield is at record levels vs the 10 year Treasury as well as T/VZ dividend yields. … We maintain our year-end 2017 price target of $28. We reached our price target by our DCF analysis, which assumes a 0% terminal growth rate and 7.0% discount rate.

At the end of December, Macquarie called the CenturyLink and Level 3 merger a “Wild Cat Merger.” Its view was a mere Neutral rating at the time, but the price target was listed as $30, compared with a current share price of $24.06. The firm did note at the time that the company’s own S-4 filing projections were slightly above its own estimates and that it sees room for upside.

CenturyLink shares were last seen up 0.6% at $25.72 on Wednesday, in a 52-week range of $22.86 to $33.45 and with a consensus analyst target price of $28.08.

Level 3 shares were up 0.3% to $59.15. Its 52-week range is $41.73 to $59.31, and it has a consensus target price of $62.31.

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