CenturyLink, Inc. (CTL) has recently announced debt offering of 5.8% unsecured senior notes of 1.4 billion and 7.65% unsecured senior notes of $650 million. The proceeds from this debt issue is expected to be used for the funding of its wholly owned subsidiary, Embarq Corporation's tender to purchase $2.05 billion outstanding notes due in 2013 and 2016.
CenturyLink’s balance sheet remained distressed at the end of fiscal 2011, with a heavy debt and declining cash balance. The company ended fiscal 2011 with a long-term debt position that more than doubled within a year’s span to $22 million.
Additionally, cash flows remained low at $128 million compared to $173 million in 2010. All these factors indicate a degree of operating risk despite the company’s solid revenue generating capacity through diversified product offerings.
We believe that the acquisition of Embarq, Qwest and Savvis increased CenturyLink’s debt level, thereby impairing its balance sheet. The company acquired Embarq Corporation in July 2009, Denver-based Qwest Communication in April 2011 and Savvis Inc. in July 2011.
Despite a whopping 162% jump in fourth quarter revenues, the company reported a steep decline of 59% in its pro forma earnings given expenses related to the Qwest and Savvis acquisitions. Going forward, any meaningful declines to the revenue stream beyond management’s expectation, or exacerbating costs including impediments with respect to payment collection, may further impair balance sheet conditions.
CenturyLink has already projected that the integration of Qwest operations into its business will impact its operating costs over the long term. The integration will incur approximately $650 million to $800 million of operating costs over three to five years and approximately $150 million to $200 million of one-time capital costs.
However, we expect synergies arising out of these deals to largely offset these headwinds. The company completed the final phase of converting Embarq customers into its systems in July 2011 and expects the full integration to be completed by the end of this year, with annual synergies of $375 million.
The Qwest acquisition would generate annual cost and capital expenditures synergies of approximately $575 million and $50 million, respectively, over three to five years. Of the total, $200 million of synergies are expected by the end of this year.
Further, the Savvis acquisition marks CenturyLink’s entry into the cloud computing business, which is growing in leaps and bounds. The acquisition strengthened CenturyLink’s footprint in the hosting managed cloud services business to 50 data centers in North America, Europe and Asia. The acquisition will be accretive to CenturyLink’s free cash flow in the initial year and would generate cost synergies of roughly $70 million.
We believe that the three acquisitions would generate annual synergies of $1 billion when fully realized. These acquisitions bequeathed several additional benefits plus greater scale and operational efficiencies, providing a competitive edge over AT&T Inc. (T) and Verizon Communication (VZ).
We have a long-term Neutral recommendation on the stock. For the short term (1–3 months), CenturyLink retains a Zacks #3 Rank.
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