We have upgraded our long-term rating on CenturyLink Inc. (CTL) to Neutral from Underperform on the back of synergies expected from Embarq, Qwest and Savvis acquisitions.
We believe acquisitions and mergers will provide CenturyLink an edge over its two major rivals –– AT&T Inc. (T) and Verizon Communications Inc. (VZ). CenturyLink generated roughly $350 million of synergies during the second quarter and expects annual synergies of $375 million. The Qwest acquisition would generate annual synergies of approximately $625 million over the next three to five years. Of the total, $200 million of synergies are expected by this year.
Further, the Savvis buyout marks CenturyLink’s entry into the cloud computing business, which is growing by leaps and bounds. The purchase would improve the company’s revenue, EBITDA and free cash flow, and would generate cost synergies of roughly $70 million.
While the three acquisitions may yield a number of operational benefits and cost synergies, significant integration challenges may impede future operating performance. In addition, the acquisitions would increase the company’s operating cost going forward.
With respect to falling fixed voice access lines, the third-largest U.S. landline operator is working on a number of initiatives to curtail access line losses. This should also work in favor of the company’s future revenue and earnings. The company is bundling integrated services, promoting new services such as video, managed hosting and colocation services, gaining new wireless spectrum from FCC and improving its infrastructure.
Besides these positive factors, CenturyLink would remain depressed in the upcoming quarters. The company faces intense competition from cable TV operators, which are aggressively offering traditional voice services through their networks. Further, the company continues to operate with a high debt level that currently stands at roughly $19.7 billion compared with $7.3 billion at the end of 2010. The acquisitions of Embarq, Qwest and Savvis have significantly elevated CenturyLink’s debt level, thereby impairing its balance sheet.
Moreover, the company’s second quarter earnings failed to impress. Earnings per share came nowhere near the Zacks Consensus Estimate and the year-ago earnings. Higher-than-expected depreciation and amortization expenses related to the Qwest acquisition were responsible for the lackluster performance. However, the acquisition led to improved revenue during the quarter.
For the short term, the stock retains a Hold rating with the Zacks #3 Rank.
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