Shares of Lumen Technologies (-10.29%) experienced a significant decline on Tuesday, dropping 9.1% by 2:23 p.m. EDT.
This company, burdened with substantial debt, saw its stock become troubled earlier in the year. A deal to extend its debt maturities, alongside long-term agreements for AI (artificial intelligence) networking, led to a surge in its stock price in early August.
However, soon after this surge, critics began expressing doubts about the potential for an AI-driven turnaround. Today, another short-seller expressed skepticism regarding the actual impact of these AI deals on alleviating the company’s significant debt burden. This marks the second short-seller to release such a note in just a week’s time, exacerbating general market apprehensions and contributing to a significant drop.
Hedgeye Raises Concerns Over Lumen’s Debt and Cash Flow
On Tuesday, Hedgeye, a stock-recommendation firm, released a note advising investors to short Lumen. The note reiterated familiar worries about Lumen’s high debt levels and deteriorating financial metrics. Specifically, Hedgeye highlighted Lumen’s elevated debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio of 4.3 and its “limited” ability to generate free cash flow. Although the company’s strategy to extend its debt maturities to 2029 provides management with more leeway for a turnaround, the short-seller expressed doubts about the company’s declining core business recovering in time.
This note from Hedgeye follows a similar report from another short-seller at the end of August, which also raised concerns about Lumen.
The short-sellers suggested that Lumen’s announcement of $5 billion in new AI-related deals and an additional $7 billion in potential AI “opportunities” was timed to obscure ongoing financial struggles, coming just ahead of their second-quarter results.
In the second quarter, Lumen continued to face challenges, with revenues dropping by 10.7%. While management mentioned that about 36% of this decline was due to divestitures, the business overall is still experiencing a high-single-digit decline. Management emphasized two growth areas: its “growth” portfolio for enterprise clients, which grew 1.5% year over year, and its fiber-to-the-home consumer product, which saw a 14.6% increase.
The issue is that these growth areas still represent a small portion of the business, while the bulk of Lumen’s product revenue continues to decline. Lumen also reported a $156 million free cash flow loss in the quarter. Although management projected $1.1 billion in positive free cash flow for the year, $700 million of that is expected from a one-time tax refund.
It’s important to note that Lumen has approximately $18.9 billion in debt and pension liabilities.
Investors Should Be Cautious About an AI Turnaround
Investors might consider Lumen a value stock, given its distressed valuation and potential to benefit from increased AI network spending. However, caution is advised. The new $5 billion AI-related Private Connectivity Fabric deal is expected to unfold over three to four years, according to the company’s quarterly report, and will require additional spending by Lumen. This translates to about $1.25 billion in revenue per year, with uncertain profitability.
This is in comparison to the $13.7 billion in revenue Lumen generated over the past 12 months. However, these “new” revenue streams need to compensate for the decline in older technologies, so it’s unlikely that Lumen will achieve a 10% increase in its top line from this deal alone.
In conclusion, Lumen’s turnaround is far from guaranteed, even with promising new AI revenue. Therefore, investors should remain skeptical and consider the short-sellers’ reports before making investment decisions.
