Is it possible to take a group of wireline carriers, roll them up and cost cut your way to greater and everlasting profits? I present to you two opposing viewpoints on the merger between CenturyLink (formerly CenturyTel) and Qwest. One is glowingly positive and one is quite negative. The positive story is from Barron's, a source which I trust a great deal - the other from TMCnet blogger Peter Radizeski who is also a source I know to be spot on.
But who is right? It will be tough to decide but I will do my best to present both opinions and help you make the decision for yourself.
According to Jay Palmer at Barron's, CenturyLink has rising profits, increasing cash flow and a dividend yield of 8.8%. Generally speaking though - when a dividend yield is so much higher than average it signals a lack of confidence in a company's shares. But let's put that worry aside for a moment as neither writer addressed this issue but it did stand out to me.
To support the article, Palmer has this to say:
"This is clearly a value stock," says John Apruzzese, a partner in Evercore Wealth Management. "It may be counterintuitive, especially given that industry revenues are falling and are expected to continue falling, but CenturyLink's stock has considerable appeal."
He further explains past deals and how well they went. He even quotes Glen Post, CenturyLink's president and CEO, "Deals like Embarq and Qwest ultimately deliver considerable savings and synergies. Integration
Then Palmer opens up the premise of a positive future to criticism when he says:
In theory, DSL has a big disadvantage, compared with cable: slower Internet-connection speeds. But that isn't always the case, in part because cable users in a local area share the same "pipe," and speeds slow when lots
And this is where Radizeski pounces. He explains that he does believe the company is innovating and moreover that DSL is limited in speed over longer distances. Here is an excerpt:
Cost cutting to make the balance sheet look good - and so you can pay down some debt - does not make for a good long term company. CenturyTel, Embarq and Qwest are all missing the same three puzzle pieces: lack of a wireless strategy, a cellular play, and a fiber-to-the-X project. Couple that with a declining wireline customer base and huge debt. What a great pie!
I look at rural IOC player, ITS, who has rolled out innovative landline products, as a shining example of what these 3 ILECs are not. (Hint: Innovative).
More support from Palmer:
"THE METRICS AREN'T THE SAME for DSL and cable, but, when you get right down to it, the two technologies are very competitive. And CenturyLink is in a good position to grow this business and data revenue," says Evercore's Apruzzese. "Right now, the company is selling data services to just over 30% of subscribers. I see this going to 37% this year, and well over 40% by the end of 2011."
Explains Post: "Data will grow larger and larger. It's where the future is."
In the current year, the Embarq acquisition probably will boost CenturyLink voice revenue 35%, to about $2.7 billion. Data revenue probably will rise almost 60%, to $1.9 billion, while sales of network access to businesses will climb 25%, to $1.4 billion. Overall, this will boost sales 40%, to about $7 billion.
Then Radizeski delivers his knockout punch:
Qwest numbers looked like this: Its 2009 Net income was $662 million and Q1 2010 net income was $38 million (so maybe $120M). That's a drop. If these markets are so profitable, why is VZ giving them away? I get that there is some economies of scale. It does not fix the big 2 issues: Rural Broadband penetration and the Wireless issue.
Rural Broadband. Stimulus money aside, how does CenturyQwest deliver high-speed broadband to its rural market in a profitable manner? Unlike Ma and Pa Bell, Qwest didn't have an FTTX project going. The analysts are betting on data revenue to replace voice revenue, but you have to offer more than 3 MB, which is all that Frontier is promising to the FCC. 3 MB?! Really?
Without fiber, you are just a sales force for a DBS outfit (DISH or DirecTV). How profitable can that be?
Wireless (or lack there of). CenturyLink would have been better served buying MetroPCS, Leap or even Sprint. The FCC feels that wireless is the future. So does Ma and Pa Bell. More than 15% of households do not have a landline. ILEC's don't exactly market Naked DSL because they still want the voice lines (for ARPU, Inter-Carrier Comp, and subscriber numbers for Wall St.). The millennials don't even use voice on their cell phones. So how do you replace all that voice revenue?
Let's take one former Embarq county in Florida. The stimulus grant to deliver broadband went to one of my clients. Rapid Systems will blanket the county with WiMax from Motorola. Embarq has never known competition in this county - no cableco. Embarq was not improving the DSL penetration or speed to this county. Now they are about to get slapped. Monopoly thinking doesn't work in this new economy. What if that happens in 50 more counties? What does that do to the analysts dreams?
Analysts are writing about what a great stock deal this is. I'm writing about whether these types of mergers will ultimately end up looking like Fairpoint. That doesn't help the economy or the consumer.
If you read these pieces carefully you see the difference in the short-term and long-term views. As a referee I should point out that Peter is obviously right about the macro trends. Then again, there is no reason why CenturyLink can't start rolling out new and innovative services - this is as easy as copying the other guy. In addition there is the potential for wireless acquisitions in the future.
Then there is the economy -the company will likely be able to generate more savings across the board in this economic environment than when things are strong. Think real estate costs, equipment, staffing and even office supplies can be negotiated to save money these days. And if you've been buying companies, integrating them and know how to cut costs, you likely get better at it each time you acquire.
Moreover, will new technologies come out which will extend DSL in ways we can't envision today? If history is a guide, the answer is yes.
Peter has many good points and perhaps his most intelligent one is the following (repeated intentionally from above):
Wireless (or lack thereof). CenturyLink would have been better served buying MetroPCS, Leap or even Sprint. The FCC feels that wireless is the future. So does Ma and Pa Bell. More than 15% of households do not have a landline. ILEC's don't exactly market Naked DSL because they still want the voice lines (for ARPU, Inter-Carrier Comp, and subscriber numbers for Wall St.). The Millennials don't even use voice on their cell phones. So how do you replace all that voice revenue?
Wireless is certainly the future - this was never in question by anyone but you have to wonder why CenturyLink didn't see it that way. Who knows, though - they could be planning their next wireless deal as you read this. Expect full coverage on the company's activities going forward.