We Study Billionaires - The Investor’s Podcast Network - TIP326: Intrinsic Value of Lumen with Ben Claremon and Eugene Robin (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's episode, we sit down with Ben Claremont and Eugene Robin from Coastreet Capital. We discuss Lumen Technology, the stock tickers LUMN, and it's a new name for a merged entity between Level 3 and CenturyLink. We discuss how Level 3 holds the hidden upside value while only being one-third of the new entity, and Central Link's dying business model is distracting the market attention. Ben and Eugene makes a great case for why there may be a certain. special situation of matunty right around the corner. There could be a catalyst for the stock

Starting point is 00:00:35 price to soar. And before we jump into the episode, we also welcome our new co-host, Trey Lockerbie. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey everyone, welcome to The Investors Podcast. I'm your host, Stig Broderson. Today I'm even more excited than you are used to see me. I am not accompanied by my co-host, President Pesh. Instead, I'm here with our new co-host, Trey Lockerbie. Trey, how are you doing today? Stig, I am thrilled and honored to be the new co-host of We Study Billionaires.

Starting point is 00:01:28 I'm sure the audience has a lot of questions. I'm going to leave that. to you, but I can just only say how grateful I am and excited about this opportunity. And we are equally as excited to bring you on, Trey, because you have been here for, actually, almost since the very beginning. So perhaps the audience, at least the most shrewd listeners, might be able to recognize your voice, even though it's a, it might be a tall order. So perhaps you can explain to the audience, what do I mean by that? That's exactly right. So I actually am, I believe the call in questioner on episode maybe two or three of we study billionaires. So I have been listening since day one. I haven't missed a week. I listen to this show every week and have

Starting point is 00:02:11 for the last, I don't know, six years now. So it started for me with my journey into investing. I'm an entrepreneur at heart. I've started multiple businesses and multiple industries, started in entertainment now in the beverage industry. And through all, that, I took Buffett's advice where he said he's a better businessman because he's an investor and a better investor because he's a businessman. So I found this positive feedback loop of sorts of continuing to study investing, even though I don't have a finance degree or MBA. I did it all sort of on my own. And along the way, I really got deep into value investing and I read every single book there is on Warren Buffett. And through all of that, this phrase kept popping up over

Starting point is 00:03:01 and over again, and it was intrinsic value, right? What is the intrinsic value? And that led me to this journey of Buffett's books, the original course by this network. And when I finished the course, I believe we study billionaires episode one had just launched. And I jumped right in, and I've been following along ever since. And Stig, I believe, speaking of Buffett, we met at the Berkshire Hathaway meeting, I think, in 2016? Yeah, that's right. And back in 2016, I think our community at that point in time, well, I think the first time was there, that was back in 2014.

Starting point is 00:03:34 That was with Preston and his dad. So we've grown a lot since then, 2016. We were probably like, I don't know, 20 people or something like that. At least it was so small that everyone still knew each other and like knew everyone's first name. And so I remember, like, we met at dinner and we just get to talk and people might be like, that sounds like a bit of a familiar story. You're talking about Berksa Heatherway. You're dressed a lot of times on the show. And we have introduced you to Robert Leonard, our host for real estate

Starting point is 00:04:04 investing and millennial investing. We met him at the Berksie Hellerway event too. It was a different year. And then again, another year, we met Sean Murray, our host for The Good Life. So this is not a conscious hiring strategy at all. It's not like we will go to Omaha once a year and they just hire people if we whoever run into that's not how it is. It's just one of those

Starting point is 00:04:25 where you meet people like you start to network and you just meet the nicest best people out there in Omaha at that meaning it's just the most authentic and genuine people. So, you know,

Starting point is 00:04:35 we met up there, kept in touch and you know, one thing led to another and now you are a new co-host for Restority Billioness. Talk about coincidence. That's right.

Starting point is 00:04:45 It's definitely a certain tribe that shows up in Omaha every year for the Berkshire Hathaway meeting. My wife would probably call it the most boring concert in the world, right? It's not for everybody. And those who are crazy enough to make the flight and trek and journey out to Omaha, it's a certain breed. And I think that's why we all clicked when we first met each other. We're just sort of in that brotherhood of this journey to figure out how to solve this puzzle of what makes a good investment. I guess the audience

Starting point is 00:05:14 might be sitting out there thinking, okay, cool. You know, this new trade dude sounds real cool. Cool. Is we study billionaires now going to be different? You know, it's taken Tray now, or like, what's the game plan here? How is this going to be different with you, Trey? Well, my mission is to not change the show. I mean, I'm a long-time listener, and my mission is to preserve the quality that everyone knows as we study billionaire and what has made it a success to date. And I'd only like to incrementally add value over time, hopefully by bringing a unique perspective given my very atypical career background. So that's my ultimate mission. And I am more than happy to take honest feedback. So you can reach me at Trey at theinvestorspodcast.com.

Starting point is 00:06:01 I only ask that you be nice. I'm just getting started, right? But I do want honest feedback. I want to ensure that I'm providing as much value for you as possible. Fantastic. And I just wanted to address one thing here before we jump into the interview here today. Preston is still going to going to be here. Actually, already next week, we're speaking with Ed Harrison, and Preston will be on that call. So sometimes Trey will join me here on the show. Other times, Preston will, you heard about Trey's background. You would probably be very similar to what you've seen so in the past. And so that's sort of like the gameplay move forward, but we are really just testing a lot of different formats. We are very excited about the new energy that

Starting point is 00:06:39 Trey will bring to the team. So that's sort of like our starting point. As you probably heard there in the video other day, you know, Preston. He's working on this new Bitcoin show, and you know, you will have, from time to time, you'll have new episodes on that too. So Preston will still be doing that and he will still be on Weister Billionaire. So anything else, Trey, we need to talk about before we jump into the episode? I think you nailed it, Stick. I'm not trying to fill Preston's shoes and I'm not replacing him. He's still very much part of this show. I think I'm just sort of opening up the discussion a little bit broader and hopefully adding a unique perspective.

Starting point is 00:07:12 Fantastic. Trey, I'm just excited for you to join, Preston and me and the rest of the community on this journey. All right, let's jump into the interview that Trey and I dip with Ben and Eugene from Coch Street Capital. Ben and Eugene, thanks for joining Trey and me here today to talk about Lumen on the Amherst's podcast. How are you guys? Thanks for having us on.

Starting point is 00:07:35 All right, Trey, you have the first question. Okay, so there's a lot to unpack with Lumen. So I need to start with just a general overview about the company and kind of the structure that's just because... come a little bit recently in place. We were, as a firm, we own Level 3 communications, which was also a roll-up of different assets. If anybody was around in the early 2000s or in late 90s and remember people laying a

Starting point is 00:08:04 bunch of sub-sea fiber from New York to Spain and across the Atlantic and across the Pacific, level three and Global Crossing were exciting companies back then because of the idea that there's going to be this huge internet and we're going to need all this connectivity. We're going to need all this fiber that's connecting continents. Well, there was an overbill, global costing went bankrupt. I mean, there was just a lot of mess. But lo and behold, years and years later, guess what? The internet's bigger than anyone ever thought.

Starting point is 00:08:32 And so level three was the roll-up that included level three's assets, a company, Global Crossing, a company called Time Warner Telecom. It's a mix of what we would call kind of like domestic U.S. fiber, like underground. And then this is a bunch of subc fiber that connects endpoints all around the world. And so we love this company that's run by a guy named Jeff Story. We were level three shareholders when the merger with CenturyLink was announced. And we looked at it and we said to ourselves, Jeff Story looks like he's retiring. He's the guy that we like.

Starting point is 00:09:04 We focus a lot on management at Coop Street. And we looked at the management team at CenturyLink. And we said, this is not a group of people who we feel confident and don't necessarily think they understand what they're buying. I think that has proven to be the case as we'll get into. But what is it now? So you have level three with a legacy CenturyLink business. And CenturyLink is just basically a rural telecom. So if you think about the company's based in Louisiana, think about rural Louisiana,

Starting point is 00:09:29 they're the telco there. And so if you need phone, if you need a really slow internet connection, which is probably DSL, there's no fiber in these areas. And if you need TV, that's where you're buying it from it. And without any question, that's a shrinking business. So you have a global growing, asset heavy, almost irreplaceable asset business in level three, and you have a slowly shrinking, melting ice cube in CenturyLink. Jam them together. And what could go wrong? Well, a lot can go

Starting point is 00:09:58 wrong. And so we are now a number of years into this merger. It closed in, I think, October 2017. And a fair amount has happened. The old management team, unsurprisingly, is gone. It was 25 million plus. So he didn't need the money. They kind of begged him to come in as CEO of the new company. And then quickly it became clear that the CenturyLink guys had no idea what they were doing. And Jeff Story is now the CEO. So getting to management, we like management. And so that's a big part of our investment premise and research. So you have management in place. What is it now? It's about a $10.6 billion market cap company. It has a 10.3% dividend yield, which for your listeners might be kind of interesting. Where else in the world are getting a 10.3% yield?

Starting point is 00:10:41 has about $35 billion in debt, which is a lot, and we'll talk about that and why we don't think that's a problem. And the business is essentially one-third level three and two-third century link. And so just a frame why this is interesting is that our general thought is that Wall Street doesn't do a good job with two things. One, a good business and a bad business together. And the other thing is a business that is shrinking. The top line has been shrinking, And that's because you have the melting ice cube in CenturyLink that is kind of overtaking the potential growth that you said that we somewhat slightly less than we would expect for going forward growth that you're going to see a level three. And so Wall Street doesn't know what to do with that. That's why we see such a large undervaluation.

Starting point is 00:11:26 Eugene will get into a lot about that going forward. So I think in terms of where, of framing this investment, it is one of the most dislocated things we've ever seen in our careers. We scratch our heads every day being like we just don't understand what they're. the market's thinking. The dividend yield, I think, would imply that people don't think it's sustainable, the current dividend, and we'll get into that and why we think the dividend is sustainable. And then we'll get into what we think it's worth, which I think is why this should be really interesting for people. So let me get this straight. Level three has a lot of promise and a great management team with Jeff's story. And then they merge with CenturyLink, which is now

Starting point is 00:12:02 two-thirds of the new business. But it's sort of this melting ice cube, as you've put it, because it's sort of a dying industry. So what was the impetus for the merger and why is CenturyLink such a big portion of the new business? Great question about why the deal even happened. The short of it is level three was offered a lot of money to consummate the marriage. We were level three shareholders and were happy to take the premium that was offered to us and we sold out as Ben mentioned as soon as we realized that the surviving entity would be controlled by Glenn Post, who was the CEO of CenturyLink. The reason why the combined company is predominantly CenturyLink is because it was at the time a $17 billion revenue company. This was not a tiny

Starting point is 00:12:50 entity by any means, and it was larger only in the profit sense than level three. However, the actual valuation was skewed towards the level. It's a bizarre artifact. This is basically like a company that was trading at, let's say, five times, buying a company that was trading at 12 times. And typically, the people who get, pardon my French, screwed, are the shareholders of the company that's trading at five times. So we, as shareholders of level three, didn't care because we were getting a fantastic value for our investment. And the CenturyLink shareholders, well, they just took it in the pants. This actually reminds me of almost like Berkshire Hathaway, right, a dying textile business. Buffett overtakes this textile business that's

Starting point is 00:13:40 ultimately failing and chooses to take some capital and buy stuff like insurance companies that's going to throw off some cash and kind of fuel the future of Berkshire Hathaway and made it into this conglomerate. Is it kind of the right way to think about this where CenturyLink sort of has a dying industry and they see the writing on the wall so they make this investment in something like level three that has more staying power and perhaps more scalability over time? That's exactly what the pitch was to the CenturyLink board when they discussed the acquisition. Currently, it's also still a truism to say that while it is a melting ice cube, the ice cube is melting at, let's say, three to five percent a year on a cash flow basis, and the good side, the level three side is growing. And yes, if Glenn Post was Warren Buffett, I would say that would be 100 percent accurate in terms of the comparison.

Starting point is 00:14:28 But unfortunately, for Century League shareholders, Glenn Post, was the farthest thing from Buffett, which is just a little bit of a nuance, and Ben kind of alluded to it. But the combined entity when investors woke up and realized that Jeff Story was not going to be the CEO, there was a rebellion within the shareholders because part of the deal also gave stock of the new entity to level three shareholders. And those folks said, there's no way that we're going to allow you. the CenturyLink management team to manage this going forward. So you better bring Story back in or we're going to vote you out anyway. So there is a, to say that the deal was loved, it would be

Starting point is 00:15:09 the farthest thing from the truth. From day one, it was very contentious. And it's taken Jeff's story three years to basically reconfigure the entity to be effectively level three again from a management perspective, obviously not from a revenue mix perspective, but certainly from the people who make decisions on a day-to-day basis. And that ties into my next question. When did the merger close? The merger closed in 2017. And it's interesting, if you look at the stock price between the deal announcement day and the deal closing day, it was just down.

Starting point is 00:15:41 I think the stock went from like, I think it was like $28, $29 to $1819. So, I mean, clearly there were concerns about whether this deal made any sense. So let's talk about the new entity. How does it make money and who are the customers? I will answer the question in a consolidated fashion, even though there are really two different parts of the business. The core of it is called IP services, and IP services is a fancy way of saying connectivity. So I'm sitting in this office speaking to you right now via video link through the internet.

Starting point is 00:16:12 How do we get to that point, right? We have a building us wired with fiber. We have a fiber running somewhere. Well, you're in LA, so it doesn't have to go that far. But again, if you were across the country, it would go through a fiber line that run from L.A. to New York and get into someone's building. So level three at its core was exactly that. They own metro loops of fiber within large, most of the large cities, not only in the United States, but in the world. And they had what's called on-net buildings, which is a fancy

Starting point is 00:16:43 way of saying their own fiber assets and copper sometimes wiring was inside the commercial building that we're in. And when we go ahead and choose the internet provider that we want, we could choose level three as the effective internet provider. So that's the IP services site. Then they have what I would call, they refer to it as wholesale, but if you think about it, obviously there are many companies out there who sell internet connectivity to the point customer without actually having, owning the underlying fiber networks. So there are a lot of brokers out there, even folks like Verizon or sometimes even Comcast.

Starting point is 00:17:21 While they have the endpoints wired up, they don't have a way for you to actually is the way the internet works, right? Just because you can plug in your cable modem doesn't mean that you connect to Sao Paulo, right? If you have a multinational, how do you get that transit data from L.A. to South Paulo? Well, you have to run through someone else's fiber network. And so that business is called wholesale where you open up your strands of fiber to other people's traffic. That's another way that they make business money. Then you have what I would consider to be higher-end services on top of the fiber.

Starting point is 00:17:53 So these are things like security, fancy terms called SD-WAN and MPLS. And I'm happy to talk about what those are if you really want to know. And then things like content delivery networks, which are actually how we as consumers consume things like Netflix videos and even get our updates from Microsoft or like games and things like that. So there are effectively ways for companies to minimize the use of their end servers by caching or keeping copies local store more locally of commonly accessed media. Netflix has now their own CDN networks.

Starting point is 00:18:31 The largest competitor there would be Akamai, fantastic company that's publicly traded. So, yeah, that's another one of their services. Then when you go down the stack a little bit further, you get into what we would consider consumer. So consumer and Ben already kind of touched on it. They have a couple different legs there. They also have a, this is kind of a bizarre aspect of being in rural America, but there's actually regulatory revenue that they receive from the federal government to the tune of five to six hundred

Starting point is 00:18:59 million dollars a year. That's basically a subsidy to allow for people like in the sticks in Louisiana or Kansas, Arkansas, wherever, wherever there isn't fiber or the ability to get high-speed internet, to get internet at all. And what people don't realize is this country is so vast so that you need connectivity and you're not going to incentivize a private company to lay connectivity down on its own to a town of 50 people, right? So how do you get those 50 people connected to the internet? You provide subsidy. So the way that Central Link made money for many, many years and still does to some extent is to get basically free taxpayer dollars. So that's roughly $500 million right now. Another thing is obviously, when I just mentioned it, is broadband connectivity.

Starting point is 00:19:47 They have fairly extensive, I'm saying I'm, it was like $1.6-ish billion business connecting households to the internet. So it's not 100% fair to say that it's all DSL copper. They did over the course of many, many years spend money to transition a lot of their install base to be basically a derivative of coaxil cable, so competing with people like Charter and Comcast. So they do have actually, believe it or not, a pretty stable, broadband customer base. And when I say stable, it's plus or minus 2% growth. Some years they might be slightly down. Other years, like last year, I think they were up like 1.7% and something like that.

Starting point is 00:20:28 That's another consumer leg. Then you have the real problem, and this is a problem that affects almost all legacy telcos. They have a voice business that I think was $1.9 billion, I want to say. So that voice business is, as you can imagine, going to be effectively zero over time because many of us don't have home phones anymore. And the only reason why people get them for some bizarre reason is because the cable companies would like to bundle them together. But in essence, I mean, I think I had a home phone number.

Starting point is 00:21:00 I didn't even know what it was for many years and I don't anymore. But that's happening across the country. And obviously, the decline rate there is pretty intense. We're talking 15 to 20 percent year over year. that business, the reason why that matters is you would think that, well, that seems like a silly business to be in, but remember, it's 100% profit, right? So you've had phone lines laid over a course of 50 to 80 years. You don't have to really invest in them. It's just people pay you every single month for this phone service that most people now with cell phones don't really need.

Starting point is 00:21:32 So that is the other part of the consumer that's obviously been what's dragged down Centering Link in total. And then you have another. call it the small and medium-sized businesses, which the services there run the gamut from connectivity of broadband to voice and that they're also having obvious issues just in terms of being able to sustain their top line while every single year getting price downs on the connectivity side as well as the teleco's telephone service. That's kind of like it's a very broad range of ways that they make money. Some of them growing and good, other ones obviously shrinking and bad. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:26:21 This is a very complex company. I'm curious, Eugene, if you went to, you know, my son's in kindergarten, if you went to his kindergarten class to talk about Lumen, what would you say to them, how would you tell them that it makes money? They make money by connecting people to the internet. I see that they also offer cloud solutions. Does that make them a competitor to Amazon Web Services and Microsoft? Yes and no. This is a long story too. They have a lot of data center assets, three to 400 data centers that they basically run for their customers. They can

Starting point is 00:26:56 partner with AWS in some cases to offload some forms of traffic and data aggregation. But for the most part, they provide what's called edge connectivity solutions to businesses that don't necessarily want to be 100% on AWS or 100% on Azure or 100% on their own internal data warehouse has been mainly because of cost. The short answer is yes, they do compete, but certainly not. not in any sort of the same scale. It's more of an add-on service to their core IP connectivity service. You can think of it that way.

Starting point is 00:27:34 So as we're looking at the new structure, the top line growth of Lumen is pretty spotty. It has averaging, say, 5% over the past five years. Top line was down 4.5% though in 2019. And this was at a point in time where the economy was still hot and before COVID-19 had. So I'm curious where the loss is coming from. Two main buckets. So I mentioned that they provide wholesale connectivity to people who use their underlying network as a highway of sorts.

Starting point is 00:28:07 It's like a toll road. And every single year, the toll's paid to get onto that toll road go down in price. While we may not be laying any new transatlantic fibers, what's happened over the course of 20 years is that the actual hardware systems on each side of the fiber line continue to get upgraded every single, let's say, 12 to 18 months to a new generation. And I'm not going to geek out on your listeners, but it's effectively, just think of it as like a string cheese. Like, they figure out a way to pull the string cheese ever so more thinly and to create more strands effectively of that string cheese from the same block of cheese they had from the last

Starting point is 00:28:47 10 years. Okay. Did it appropriate to whittle this down as somewhat of a telecommunications company? And if so, there are a lot of competitors in that space, even though it's a very broad industry. I'm curious who you consider to be the direct competitors for Lumen and what advantage exactly does Lumen have over them. I mean, I think if you talk to the company, we see little competitors here and there, but domestically, it's really AT&T and Verizon. The other legacy. telephiles who have just massive customer bases and are connecting people all over the country. I think outside the U.S., if you're thinking about, like, who else has the ability to have, to connect people from the U.S. to EU, for example, I mean, Orange, right, Eugene and British Telcom,

Starting point is 00:29:36 Colt. Colt. Fiber asset owners. Yeah, people who have a lot of physical assets in the ground. And so I guess the one thing to think about is that, yes, of course there's competition, but there are certain barriers to entry as well, right? When you've already laid the fiber, you have a cost base that it makes it very, very difficult for someone to come in and build another whole, you know, strand of fiber to compete with you because they've got to spend

Starting point is 00:30:00 the cap, they have to put in the capital, they have to put, you know, they have manpower associated with that, and then they have to compete with you on pricing. And you can, your assets already in the ground, right? And so your ability to price lower gives you the opportunity to keep competitors out. The other thing is that the total address market continues to grow. Let's think of COVID, just for example, like what has COVID? COVID's done a lot of awful things, obviously. One of the things that has done for internet connectivity is like everybody's on Zoom, everyone's doing video conference calls. We were talking to one of our CEOs just yesterday, and he was talking about the growth they've seen in average usage per household has gone up to something like

Starting point is 00:30:38 250 gigabytes per household per month. And so the usage and the amount of traffic that is flowing is going up almost exponentially now because of COVID. Now, that growth rate will come down. And, you know, maybe as we start to travel more, the numbers won't grow quite as much. But the total addressable market is growing. And so it's not like you have this melting, you know, the whole market is shrinking and then you have issues with CenturyLink and level three. The connectivity business will continue to grow as people demand faster speeds, more bandwidth, more capacity, and then more security and other end point and edge services that CenturyLink offers. So we don't look at this as like some winner take all fixed pie or shrinking pie that they have to compete to win.

Starting point is 00:31:21 That's what we like about the level three side is that we do think that this isn't growing as fast as detecting whatever that, you know, trades at 20 times revenue. But we do see core growth, which I think is what the market doesn't understand is that what you have is that you have a core growth at level three. You have what we'd call shrink to grow at CenturyLink, which is shrink the parts that are shrinking eventually start to be a smaller part of the total. and then the parts within CenturyLink that are growing, which is the broadband side start to grow. And then so either the decline abates or there's no more decline at all.

Starting point is 00:31:52 But in the meantime, you've cost to the degree that your margins are higher and your cash flows are growing. So even if your top line is shrinking, the revenue line, your cash flows are growing. And that's the inflection point, whether we'll get into this, whether this is one entity or multiple of entities over time. The inflection point will be where the no growth, no growth parts of the company no longer overwhelm the growing parts. And all of a sudden, Wall Street sees a growing business that generates an enormous amount of free cash flow that has a great ability to de-lever and trades at a multiple that nothing trades at in terms of how low it is. So just to kind of make sure I understand that, if we talk about level three, which is sort

Starting point is 00:32:30 of the fiber part of this business, that's laid all the fiber underground and creating all this connectivity, that investment has a certain cost basis to it. And as you just said, more and more people are getting onto the internet. So they've got this kind of fixed costs from laying out all this investment into fiber. And the more and more people get on the internet, the more money they make with this fixed costs. And therefore, they're going to start throwing off a lot more free cash flow that they can use to pay off their debt as they become more profitable.

Starting point is 00:32:57 Is that sort of the right way to think about it? Yes. In a nutshell, that's exactly right. You use the legacy business. You effectively milk it for the cash flows. You reinvest part of the cash flows into the growing side. and you pay down debt to deliver the company while refinancing that debt to decrease your cost of debt as well as cost of capital.

Starting point is 00:33:20 Now that we're on the topic of debt, let's dig more into it. I'd like to focus on the interest coverage ratio. And this is the ratio that determines how easily a company can pay interest expenses on outstanding debt. And it's calculated by dividing a company's operating income by its interest expense. So whenever I do the math, I come up with. an interest coverage ratio around two, and obviously the higher the ratio, the better. And we would typically like to see at least five if not 10, if a company is conservatively

Starting point is 00:33:50 financed. How concerned are you about the low coverage ratio? We're conservative investors, so debt and potential inability to cover your interest payments are a major concern. And I think the market overall is concerned about the debt level. Let's talk about that, right? Because not all debt's created equally and not all situations are the same. So this company has the ability to generate an enormous amount of free cash flow. And so that is one way in which this problem will alleviate itself. We don't think it's a current problem, but every day this company is generating cash. And what are they doing? They're paying down debt and they are refinancing their debt as well. As Eugene said, their interest savings from the

Starting point is 00:34:29 things they've done are in the hundreds of millions of dollars just because they're pushing out their maturities and they're also lowering their cost of debt. That is helpful. I look at the numbers that you have that you quoted, we would calculate it slightly differently because just because there's so much capital associated with this business, which is they have to spend to keep the physical assets up to date and also to expand. And so slightly different metric, which would be EBITDA, which is a kind of a proxy for cash flow minus capital expenditures over divided by interest expense. And that number is more like two and a half, which is, again, these numbers are, are they stellar? Absolutely not. is that certainly a concern of the market, 100%. Our contrarian perception here is that there's

Starting point is 00:35:12 an inflection point in terms of growth that is upcoming. The capital that they are spending now will continue to generate even better returns because they're much more targeted their capital expenditures and the cash flows they generate can more than offset where they can pay down debt, they can pay a dividend, they can pay their interest. And then over time as EBITDA grows, which is kind of the cash flow metric that we're using here to measure the debt, as EBAEA. EBITDA grows and that debt profile, the total amount of debt declines, then those numbers are going to start looking a lot better. Right now, on a net debt to EBITDA basis, EBITDA being our proxy for cash flow,

Starting point is 00:35:47 they're at 3.7 times, which is certainly not that high. I mean, we think anything over five times, I mean, depending on the business, but five times there's a number where you start to have to really worry about it. Given the cash flow profile, given that management is absolutely hell-bent on paying down debt, given their ability to reduce their total interest expense, and, you know, they're And the corollary to that or what happens associated with that is that you get higher free cash flow. There's a virtuous cycle of debt pay down and lower debt costs and then better ratios that we think will be really helpful for the stock. So we never want to downplay how much risks are associated when you're talking about $35 billion in debt and a business that has a shrinking component.

Starting point is 00:36:27 But I think our contrarian perception is that there is that it is nowhere near a big issue as people are giving it. So you pointed out that the management is aggressively cost cutting and also refinancing the high yield debt. So that brings us to CEO Jeff Story. Jeff Story is an interesting character in this story because he was CEO of Level 3, the smaller portion of this now merged company. And before that, he had experienced that companies like Cox and Will Tell. And you mentioned you have a lot of faith in Jeff specifically.

Starting point is 00:36:57 So I'd like to cover him a little bit more. How do you measure his performance and how much do you fact? management qualitatively and the overall valuation of the company? In terms of measuring his performance, I would point people strictly to the free cash flow number. So the weird thing about this company is that given that level three has publicly traded debt, level three also still puts out its own independent financials. So while you can have a consolidated aluminum 10K, you could also look at the annual. results for the underlying level three business, which allows you to break apart level three

Starting point is 00:37:38 from Legacy CenturyLink. Just give your viewers some metrics behind how to judge Jeff Story. When Story came in to be the CEO of the combined entity, the Legacy Century Link had a free cash flow number of roughly $1.627 billion that was in 2016. He came in at the end of 17, so let's just use 18 as a starting point. From 18 and 19, he's effectively stabilized and slightly even grown free cash flow while at the very same time, CenturyLink has lost, call it 10 to 12% of its top line. So how do you judge Jeff's story?

Starting point is 00:38:22 Will you judge him by the fact that within that melting ice cube, he's managed to cut enough costs to effectively stabilize free cash flow in the face of a shrinking top line number, which is an impressive thing and goes back to something that we've mentioned several times, which is kind of cost-cutting chops. That's one way to measure them. The other way to measure them is we internally will have a metric that we track, which is called our NOPAT return on invested capital. Since he took over the entity, that Roick measure has gone up from,

Starting point is 00:38:53 Roeck is a return on invested capital has gone up from, call it, 8 to 9% when the old legacy century old management team ran things to roughly 12 to 13%. Again, this is a way for us to kind of back of the on-world gauge whether or not whatever he's doing, including the CAPEX that he's spending, is that a net positive for shareholders. I would point to both of those things as showing people that this person is a fantastic leader. when it comes to cutting down unnecessary inefficient fat that a larger corporation might have, as well as deploying the next marginal dollar into the highest and best use for the underlying shareholders.

Starting point is 00:39:38 What's happened to the stock price? It's been a disaster. And for us, that's the opportunity. You have good management with a business that's about to an inflection point and a trading at evaluation that is way below what we think it should be or what comparable companies trade at. But to get to your question, these are independent decisions. decisions within our process. We evaluate the business separately from the people, separately from the valuation, because we want all three pillars to be pointing in the right direction. And so

Starting point is 00:40:03 we've done a fair amount of work on Jeff over the number of years, and we don't have any concerns that he's not completely aligned with shareholders. I'll point out that he was going to retire, who is basically forced to come back into this role. He's 59 years old. I don't think he wants to do this forever. I'm going to put it out there that this is not public information. They haven't said it what I'm saying, but our supposition based on the name change, the branding change, is that the company is in the middle of a long process of actually undoing this merger. Because very simply, as Eugene was talking about, a business like CenturyLink should trade it a lower multiple, a business like level three should trade a higher multiple and suggest comparable transactions

Starting point is 00:40:49 a much higher multiple. And those two businesses don't work together in Wall Street's mind. But if you separate them, basically undoing what was an ill-fated marriage from the very beginning, that's how you create a lot of value for shareholders. And so they haven't said that specifically, but I do think that you've seen signs that they've been very thoughtful about that. And And when we've talked to the company, they have expressed an openness to do anything that adds value for shareholders, including transactions, spinoffs, things that would be more of a catalyst for value creation. And I would just add to that in terms of we do a lot of work on proxies and people tend

Starting point is 00:41:30 to skip over proxy materials, I feel to their detriment. And proxies are fantastic ways for investors to get a sense of what is this person that's the head of the company. How are they incentivized? So what are they going to focus on? So Jeff Storries incentives are threefold. One, most of this comp comes in the form of things tied to EBITDA and free cash flow growth. I believe it's 90% of a short-term comp is based on that. And I believe he has restricted stock issuances that are also based on the EBITDA profile of the company. That's one. Two, after the merger, I think he was. wound up owning 3 million shares, if not a little bit more. So you can do that math, right? So

Starting point is 00:42:14 a stock that used to be $25 to him is a whole heck of a lot of money. It doesn't matter even if you're a billionaire, you'd still think $75 million is a lot of money. So he's incentivized just from long-term shareholder ownership. And the last part is I think that the board also added in a TSR total stock return long-term compensation metric, which means that while you can argue that he's done a fantastic job on the operating side and, you know, he's done all those cost cuts and stabilized cash flows and then all these things. Yet, if the shareholders aren't getting the benefit of all of that, he's not going to get paid at all, which goes back to Ben's point about should this be actually kind of split back up into two different entities? And I'm guessing Jeff's

Starting point is 00:43:01 story would be 100% for it because he certainly would benefit greatly, personally. Very interesting. So let's go back. to the business and let's pretend that you're stuck on a remote island and you only had a scorecard with you and it was all you had to track that performance. Which three key metrics would you put on that card? We look at the following three. One, revenue growth for their enterprise segment. It's very important because that's also a fantastic proxy for how level three's core core assets are doing, which again, going back to how we think about it are the jewel here that's kind of obscured by a declining legacy site. So that's one. Two, the free cash flow

Starting point is 00:43:45 generated by the company is irrespective, as I mentioned on the legacy CTL or CenturyLink performance, irrespective of declines and revenue, Jeff Story has managed to actually grow free cash flow in the face of all that. So we also track in the way that, so you're looking at, so you're listeners know the way that we look at free cash flow is simply the gap cash flow from operations minus the capital expenditures. So that's just, it's a pretty simple way to judge the business. It's also incredibly important because that also is a way to measure how fast they can pay down debt and kind of your margin of safety versus that large debt load, as you pointed out previously. So that's two. Thirdly, honestly, I just make sure that the legacy decline.

Starting point is 00:44:34 is within a comfortable variance. And what I mean by that is if the legacy century-link mix of revenues is somewhere between, call it, negative 3 and negative 6%, that's okay. If it's greater than negative 6% on a year-year basis, that's when some red flags start coming up because just judging by the cost cutting over the past several years, you kind of, that's basically what Jeff Storries assuming internally himself. And so as long as it's within that kind of a decline range, those are the three things that we kind of follow. I don't know.

Starting point is 00:45:11 I think margins. So the two other things that we focus on four key variables at our firm. So we don't want to overload people with variables, but margins because if your revenue is shrinking, that's never good. But if your margins are improving and your cash flows are improving, that's a sign of underlying strength in the business that's kind of not seen in the top line. And then they have very large synergy slash cost cutting targets that we are continuing to track. I mean, we're talking, it's a billion plus now. I think they've talked about in terms of the total synergies between CenturyLink and Level 3 and the cost cuts that are associated with that.

Starting point is 00:45:45 So those are the things that we're tracking over time and they all kind of flow into each other margins and free cash flow. I do want to mention one other the thing, Eugene was talking about incentives. I was just looking at their proxy statement, which, by the way, since we didn't discuss, which is just the annual data sent to shareholders about who's on the board. who's up for a reelection on the board, corporate governance, and then compensation, but also in the proxy statement, there is a change in control clause, which is like, if this company gets sold, how much does the CEO make? Well, there's $16 million in severance for Jeff Story, if the company

Starting point is 00:46:17 gets sold. And based on the stock price, I think it's probably December 31st, it was $44 million if the company were sold. So getting back to incentives, does he have an incentive to maybe transact this company? I think the 44 million reasons. why there could be a value-creating transaction of some kind in our near future. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business.

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Starting point is 00:50:09 do you think there might be a threat to broadband dying at the hand of satellite internet technology? Eugene and I are laughing about this because we could literally do an entire podcast on this subject. One of our largest position is Viasat, which competes directly with SpaceX. And so I think in terms of the people who are in a good position to answer that question, I think you're talking to the right people. So I'll hand it over to Eugene to discuss not necessarily Viasat, but the potential disruption and risk at Century Lincoln and Level 3 to satellite broadband. I'm going to just sum up by saying no. And what I mean by that is Starlink is a fantastic money raising scheme for Elon to inject capital to SpaceX. It is at the very moment, inconceivable, that they could

Starting point is 00:51:03 serve more than one to maybe two million users in total across their entire network if they launch their 4,400 satellites. So I just want to be crystal clear about this. The hype machine that Starlink and SpaceX has is a fantastic tool that very two companies can possess because it allows them to raise incredibly cheap equity at valuations that are literally sky high, right? So that's something that no one can discount. I do believe he's going to build this constellation, and I do believe that is still uneconomic. And whatever they want to put out in terms of PR, at the very best, you're looking at a million

Starting point is 00:51:45 in like home users. Just so your listeners understand, originally, you know, Starlink was supposed to be, oh, this is going to buttress backhaul 5G infrastructure. That sales pitch was deleted over the past year and a half. Then it was going to be, you know, this worldwide, we're going to deliver internet connectivity to every single person in Africa. And, okay, so that's no longer mentioned.

Starting point is 00:52:09 So what are they concentrating on it? They're going to roll it out to rural America at $80, per month, instant plans with maybe 100 megabit per second connectivity. So translated in a different way, like, we're sitting in an office where our download speeds are, well, I mean, we obviously pay for a much higher tier, but they're already two to two and half times of that. So for us to transition to use Starlink and from a business services perspective is laughable. And the silliest thing I've ever come across. And again, I think Elon has stop saying some things that he used to say maybe two or three years ago, because the reality

Starting point is 00:52:49 is no Leo constellation has ever survived. And irrespective of how good he is in first principles and getting costs down and effectively having the lowest launch costs with SpaceX, which is a fantastic technological advancement, he still will never, ever be economic against fiber in the ground around the world that's already in existence. Remember, he has to spend eight and a half to 12 and a billion depending upon which estimate use to launch all this. Fibor's already there. So I wish him luck is, again, it's, I think a good thing in general for space and space tech. And I'm a big, I'm just a big fan boy of that's general area. But the ability for him to disrupt the current connectivity environment is the most absurd thing I've ever come across in my entire life. It's not to

Starting point is 00:53:38 say that Central Link has no exposure to things like 5G. I think 5G is an actual fundamental shift in the way that internet connectivity could be delivered not only consumers, but also businesses. And if Verizon is correct in their massive buildout and plans for a true 5G network, which we have yet to see, but it is slowly being launched, you know, city by city. If they're correct, then they could actually compete with and possibly even displace incumbents such as Comcast and charter and level three from, as I mentioned before, the on-net wired buildings, right? So if you have, instead of connecting to our local cabinet that has the fiber running to the premises from the street, I could just contract out with Verizon.

Starting point is 00:54:31 They'll come in and put in a router, a wireless router effectively to connect to their 5G network, which supposedly could get ridiculously fantastic speeds. Now, as a counter to all this, the way that 5G works is you still have to have base stations connected via fiber to the backbone of the internet. So irrespective, Verizon is not going to lay down their own fiber network. They actually been pretty adamant about investing primarily in wireless. So those bits of information will have to run over other people's connectivity. And you can make an argument that Level 3's Metro loop,

Starting point is 00:55:06 of fiber will become ever more in demand and also valuable in that kind of 5G revolutionary world. I want to touch on that. So as someone who doesn't understand 5G all that well, what I'm hearing is that level three might be at risk because they might have to compete with other companies entering the 5G space, but they also might have an advantage because they have this network of fiber already laid that might benefit or be needed, actually, for the expansion of 5G. It's a great summary, exactly.

Starting point is 00:55:38 And we should level set here. So we are in a major city in Los Angeles. I have a Verizon phone with 4G, and I can't even get phone calls in this building. I mean, I'm just saying like, and if you drive between L.A. and Las Vegas, good luck getting a signal, good luck getting 4G. I just think we are many, many years away from a ubiquitous 5G network that can compete with fiber. I mean, maybe in certain very dense areas in cities like New York City, I mean, I think there's all kinds of questions about how well 5G waves will travel through buildings and stuff like that. It's not completely far-fetched, but I don't think it's within the investment time horizon of most of us or most of your listeners.

Starting point is 00:56:22 That could be a major threat. Another thing I want to clarify, when we talk about connectivity for level three business services within CenturyLink, we're not talking about, you know, a company like ours. We're a point customer meeting. We just need to get on the internet. We have one office. We're not international. It's not a big deal, right? Who we use it.

Starting point is 00:56:42 We treat it as a true commodity. For a multinational corporation that has, let's say, 20 different offices around the world, their tech people don't want to deal with 20 different vendors. In effect, there are only a few companies around the world in Level 3 being one of them that can come into a, you know, a GE and say, hey, look, you need to have a dedicated connectivity that network spanning five continents and 23 cities. We'll do it for you because we have assets in every single one of your locations. That's the actual sales pitch that they bring to the table. So 5G, yes, could it be disruptive for small and medium-sized businesses such as ours? Sure. Is it going to affect the Fortune 500s?

Starting point is 00:57:25 No. So people are bombarded with these acronyms and new technologies. And for the most part, the new 5G newfangled connectivity technologies are geared towards individuals, consumers, appoint customers that just need connectivity and treat connectivity as a commodity, not multinational corporations that actually need a dedicated network that can survive outages and things like that. So there are effectively two different markets when you talk about business connectivity services. I think I just want to make sure that people understand that level three isn't just they're not selling to people like us. So, guys, let's talk about the dividend. Lumen cut the dividend half in 2019, and the pay rate

Starting point is 00:58:12 since then haven't seemed to be sustainable. They've been going over 100%. Given that earnings were negative in 2019, is it wise that they cut the dividend? And I guess the second part is, whenever we talk about a dividend, what is the key thing that you're looking for? from evaluation perspective, we are focused on free cash flow, right? And so what you do with that free cash flow is important, whether you're paying down debt, whether you're paying a dividend, but we're valuing the company based on the free cash flows. It can generate kind of agnostic to where it goes, at least from a pure valuation perspective. So the dividend, as Eugene said, if people wouldn't hate it as much as they would if they cut the dividend to zero, we would be okay

Starting point is 00:58:55 with that because then it would allow you to continue that virtuous circle of generate free cash, pay down debt, reduce your interest expense, reduce your cost of debt, generate more free cash flow. That's the virtuous circle that we are trying to get that benefits all shareholders because all that free cash flow eventually pays down debt and then all of that value accrues to the equity holders. So we don't use it as a, we're not valuing the company, say this company should have a 7% yield and, you know, based on that, it's worth X dollars. We're not doing that. We care a lot about capital allocation. We care a lot about what management decides to do with that free cash flow. And the dividend, I think it's a nice to have. If the stock does nothing

Starting point is 00:59:37 for a year and at least you get a 10% dividend, that's a nice thing to have. But, you know, as we'll get into the valuation, the real upside here is based on maybe some of the parts analysis, a discounted cash flow analysis that is suggestive of a much. much, much higher value. And the dividend in the meantime is just a nice thing to have, assuming it's sustainable. And I think whether it's our projections of what interest costs are going to be, how much they can day down in debt, or just the general free cash flow generating abilities of this company, we're not really worried about it at this current point. So would it be a negative if they cut it? I don't know. Sometimes the stock already embeds another dividend cut. We actually

Starting point is 01:00:17 don't think that's going to happen. And so it's a, if you're an individual investor and you're looking at a business that you think is undervalued and has a 10% yield, that's just gravy on top. Let's talk about the fair value of Lumen technology and what we call the intrinsic value. I typically use a discounted cash flow or internal rate or return model for calculating intrinsic value, and the free cash flow was actually down in 2019, but seems to be stabilizing with some pretty conservative estimates about how I project the free cash flow to grow over time, meaning a 30% probability, let's say that the free cash flow just stays flat and doesn't grow from here. I'm still seeing an impressive internal rate of return in the double digits.

Starting point is 01:01:01 I'm curious, what do you consider to be the intrinsic value of Lumen? And how do you go about calculating that? I'm just going to give just a little bit of a background or some clarity on how we value companies. And I'm going to hand it to Eugene to talk about the valuation. So as a firm, we try to triangulate value. Every firm has an intrinsic value. But as it an investor as you're doing a number of analyses to get that number, it's not like someone rings a bell and says, hey, you hit the intrinsic value. It can be a moving target. Businesses change, management changes, capital allocation changes, all of those things can

Starting point is 01:01:35 affect intrinsic value. So we triangulate. So we typically use discount cash flow analysis in a company like this where we think that there are assets that are separable. We'll use some of the parts, value level three separately from CentralLink. And then we'll use a typical multiples analysis like, okay, other businesses trade this multiple. So, you know, what multiples should this trade at based on the margins and returns? And then if you have three legs to your valuation stool and they're all pointing to a massive dislocation in terms of undervaluation, when you combine that with a pretty good business, at least on the level three side and good management, that's the holy grail for us.

Starting point is 01:02:10 And that's why this is one of our largest positions. So I'm going to hand it to Eugene to talk about how we think about intrinsic value. and we're going to focus on the sum of the parts, but we can also talk about the DCF as well, because those numbers are very compelling. So starting, you know, again, the way that we looked at it was really, you know, it's a tale of two cities. There's the core level three and there's core Centri Link. And as I mentioned before, because level three has publicly traded debt,

Starting point is 01:02:38 we can actually arrive at a very accurate snapshot of its underlying financial conditions through his public violence. So if you look at the, I'll just use 2019 numbers because obviously 2020 is a special year and certainly bizarre in many ways, but it'll just use 2019 in the starting point. So from 2019 numbers, you have 8.2 billion in revenue, roughly, and about 2.8 billion of EBITDA, which for us, given how we approach the value of this company, is an important metric when we get to kind of like private market value or valuation approach based on, similar transactions. So if we take that $2.8 billion and we look at deals within the space

Starting point is 01:03:20 that have happened over the past, let's call it 18 months. We try to keep it somewhat more relevant versus, you know, things that traded maybe seven or eight years ago. We look at QT buying ZAO at 12.1 times. We look at Alta selling their light path, sediary, or 14.6 times. Look at actually something that hit, it goes this week, GGT, which was a big roll-up of various parts, but they had two fiber assets called Hibernia and Inter-Row that they just agreed to sell for roughly about 12.8 times. And all these are EBITDA earnings before interest in tax depreciation. So if we use those sort of private market values for fiber-heavy assets that, you know, have pretty good business connectivity and also add-on services, we arrive at, you know, a valuation range for

Starting point is 01:04:15 the core level three of somewhere between, call it, $31 and $36 billion for that business. And just so you know, when CenturyLink bought level three was it three years ago, roughly now, they paid, I think it was $34 billion, correct? $34 billion was the number. Let's just assume that no value was added for three years, which I would disagree with because I think this is one of those companies that gets more valuable going back to Woodbuff, believes in compounds right value every single year. Let's just say it's 34 billion, right? It's kind of the midpoint of that valuation range I just said anyway. So at $34 billion, what are you getting?

Starting point is 01:04:53 They have about $34 billion in debt. So that takes out the entire debt stack just from the level three assets, meaning that if you subtract out that EBITN number that I said, that $2.8 billion, which comes directly from public filings, not adjusted, no magic, you know, nonsensical, whatever billion, adjustments that people make, you get the legacy century link of 5.8 billion EBITDA for free. Well, not for free. It's what I think the left is over at 10 billion. So you're getting it at 1.7 times roughly. 1.7 times EBITDA.

Starting point is 01:05:30 Or that another way, I mentioned before, CenturyLink had 1.75 billion in free cash flow. You're getting it at what, five times free cash flow. that is insanely cheap valuation for entity, even if it is, let's say, declining at two to three percent. Our premise also, your listeners understand, is that if you look in history, yes, the core of CenturyLink is declining. And I think I mentioned this before that their major problem really is their legacy voice that's just going to effectively become zero over time. So that revenue, as it becomes smaller and smaller, will affect the company less and less. And at some point, in my model, I think it's about six years out, there will be a point where the decline rate there will not be big enough to supersede the growth of core broadband

Starting point is 01:06:25 plus small business services plus some of the other kind of regulatory income that the Central Link has. So, assuming that this is not a perpetual decliner to zero, you have a valuation that is so low that, I mean, it's just, it's really hard to reconcile the value for what you get the leftover century link versus the reality. I mean, literally almost anything that you can think of, trades, even if it's declining at four and a half to five times. And if you did that math, right, if you just said, okay, let's say you did that $34 billion dollar valuation for level three and you put a four times, right? I'm not even going to go crazy.

Starting point is 01:07:07 Let's put a four times EBITDA multiple. You're looking at about a $21 stock. If you put it at five times multiple, you're looking at a $26 stock. So our premise really is that as long as people wake up to the fact that the core assets of level three are worth what they are worth in the private market, let's say it's around $34 billion. And as long as people apply even some modicum of multiple to the remaining century-link assets, you have a completely insane risk reward from $9.50 or whatever it's trading at today. So that's kind of our some of the parts look at how to value, approach value in the company. And again, for us, it's more about margin of safety. So our margin of safety really is that look,

Starting point is 01:07:59 If someone offered me $1.7 billion today, at $1.7 billion in cash flow today, and I only have to pay $10 billion to get it, I would take that bet. That's it in a nutshell. So, guys, definitely correct me if I'm wrong here. Whereas it sounds like this kind of cash flow is a part of evaluation, you also really much focus on a colleague Benjamin Graham asset-heavy valuation. This is not a software company that has whatever, 20 salespeople, and a few people in one office and no assets. I mean, this is a very asset-heavy company,

Starting point is 01:08:34 and there are any number of precedential transactions or how people value these assets. And I will note, although it is something that we approach with some trepidation, but there have been hundreds of billions of dollars raised in private infrastructure funds. Insurance companies need yield, and there are these vehicles that are being raised by either it's Blackstone or someone on like McCory or Brookfield, for example, that have whatever, $10, 20, 30 billion in money that goes physical infrastructure. And what does level three have is some of the most envious fiber infrastructure assets in the entire world?

Starting point is 01:09:14 And so we're not going to put a lot of credence in the idea that someone's going to pay some insane multiple for level three. But our point is that there are a lot, there's a lot of demand for certain assets. So this is there some of the parts analysis, which is in a way, it's a, what would someone else paid for just the assets of this company. What is that compared to the stock price? And so that's how we get those numbers. But I was just playing around with our DCF a little bit. And we put a nine and a half percent whack, which I think is with the 30 year treasuries at 1.67 and nine and a half percent whack is a very, very, very conservative number. We're getting with zero percent perpetual

Starting point is 01:09:48 growth and then a perpetual decline in the voice business, as Eugene said, you're still getting high teens. I think that's a very conservative valuation and you have a $9 stock. So it's just like, Any way you look at it, the stock is undervalue. So then the question is, what are we missing or what is the market missing? And our point, one, the market does very poorly with things that are shrinking. Shrink to grow is not something the market handles well. And the market is also not good with a, are not good at valuing a growing, cash flow generative asset within a shrinking total top line attached to a shrinking business. That's why there's spins and that's why there are our asset sales that can, you know, kind of highlight value. So to some extent, there is a

Starting point is 01:10:29 catalyst in our future, we believe. And that's where you're going to, some of the value that we're discussing is going to be surfaced. But it's going to take some patience. I mentioned that we have this hypothesis that the company's in the middle of splitting these two companies up. And it's messy. This was a messy merger. There are a lot of physical assets. There are little things like you have to figure out transfer pricing in between, if you sell your fiber assets, if the company split, the split off company is still using the fiber assets, you have to figure out transfer pricing. And so it's not saying it's simple. But given, this is a company that people know Seattle Seahawks Stadium is a century link field, right? And so this is a company people

Starting point is 01:11:09 know we have a CEO who is highly incentivized to create value for shareholders, who's done it before. And one more point, you go to their June 2020 presentation for the first. For the The first time we'd ever seen, they put in a slide that said, hey, we know we have a $10 stock, but here are some appropriate multiples we have for our two businesses. And so they did exactly what Eugene did. They split level three, and they split the Legacy CenturyLink. And they said, hey, so you have $3 billion in EBITDA here at level three, you have $6 billion in EBITDA at CenturyLink.

Starting point is 01:11:40 Let's put just conservative multiples on those illustrative of what this company could be worth. And so this is a company that had a $10 stock that was saying we think we're worth $24 to $35. I mean, these are numbers that you almost don't put out there because people think that's so crazy. If you think of a long-term return to the stock market over 200 years is like 6 to 7% per year, and you're talking about a single security that could have three times upside based on the company's valuation, you don't see that that often. And so we rack our brains to figure out what other people are thinking. We understand what we think the market misses here.

Starting point is 01:12:13 And so now we're patiently waiting for a good capital allocator who has a history of creating value for shareholders to create the catalyst that makes this a very, very lucrative investment for us and our investors. And it sounds to me like the catalyst you have in mind is some kind of special situation where they might break apart the merger and spin off one part of the assets. Is that correct? Some kind of value creating structure, whether they, Eugene mentioned the Altis sale of their assets.

Starting point is 01:12:41 They actually only sold 50%. So Morgan Stanley Infrastructure Fund bought 50% of Altis's fiber assets. and Altis has really attractive assets in New York City. But, you know, we talked to the company, this is Lumen, and we asked them, so was there anything unique about Altis's assets? And they said, you know what? Even if we own those assets, we wouldn't even add to what we own in New York City. I mean, it's just, and that went off almost 15 times even done.

Starting point is 01:13:07 They don't even have to monetize all the fiber assets. They could do half. They could split the companies in two. They could sell the consumer business, which was something that's been floated. So private equity company would buy it for a little multiple levered up and then they get the return. So there are a number of different ways that they could do this. The question is, are they going to do it? And what's holding them back? And our answer to the second question is, it's just time, right? In the middle of COVID, you're not going to sell physical assets. People couldn't even

Starting point is 01:13:36 visit the assets until very recently. So anything that was happening in January has been put on hold. But our sense is that the rebranding is just the first sign getting rid of the central link name, calling this company Lumen, saying that you're more of a tech company. The writing's on the wall. This is going to happen. And then the question is, what is it worth? What is someone willing to pay for it? And that's kind of what we are, as we're sitting here, clipping a 10% coupon.

Starting point is 01:14:02 We're hoping that the numbers are anywhere near what our research was suggested. So the last thing I like to do after I found something that I think is undervalued is look at the momentum. Before finally buying something, I track the momentum, which you can do at the Investorspodcast.com. We have the TIP finance tool with a great momentum feature. Basically, what it's doing is it's tracking the price volatility historically and finding the range, the normalized range, and seeing if it's training inside or outside of that range. When I look at that indicator on our website, it's red, right?

Starting point is 01:14:37 So I typically wait to see if that price momentum changes into a green indicator showing positive price movement. The reason I do that is mainly because with value investing, oftentimes you can find something like a value trap or what's also known as a falling knife, where the market could potentially just continue to discount and discount and to press the stock price indefinitely. We really don't know when that catalyst you mentioned is going to come along. So it's wise to consider the price momentum. But I think this is pretty unique because you do point out that while you're waiting, you are collecting a 10% dividend yield. And I think that's pretty uncommon and something to kind of potentially make you a little bit more patient as you hold the stock and something to consider.

Starting point is 01:15:20 Is that anything? I'm just curious about price momentum. Is that something you've ever factored into your own investing strategy? It's not something we consider. I mean, we're looking at, we run a concentrated portfolio of securities and we're focused on the business value in people. And when we see large margin of safeties, we act with conviction. Are there opportunities? I mean, the things you're saying are absolutely correct. I might just point out here that when you're investing in situations where there's a special situation or where there's a

Starting point is 01:15:47 catalyst, you may get terribly negative price momentum until one day it goes the other way. So there are a million different ways. And at that point, you're too late. Yeah, no, in that point, you're too late. If there was a transaction here that valued the consumer at seven times EBITDA, which is where Cincinnati Bell went out, which is maybe had some slightly better assets than the consumer business at CenturyLink. But still, seven times multiple would be a hugely attractive multiple for the CenturyLink business. And then you'd be left with the, we think, a really good level three assets. So there is a risk towards just waiting for things to get better because, listen, within financial

Starting point is 01:16:22 markets, there's a pendulum that swings between greed and fear. Right now, there's a lot of fear when associated with CenturyLink and Level 3 and Lumen. And so the question is, is that founded or unfounded, our sense is that even a slight shift in that pendulum going back a little bit towards greed could still be very much on the fearful side. But given the leverage, given the degree of undervaluation, just a slight change in what people think about this could be enormously accretive for shareholder. So I understand what you're talking about. it's just not something that we really incorporate in our analysis.

Starting point is 01:16:57 I really appreciate you guys coming on the show and sharing all this amazing knowledge. You're obviously experts in the space and we've gone really deep on this particular stock. So I can't wait to do this again with you guys. I would love to pick something else and dive in on something maybe in the satellite space someday. That was really interesting. But until then, thank you so much for coming on the show. I really appreciate it.

Starting point is 01:17:20 Thanks a lot for having us. That was all that Trey and I had for this week's episode of The Amherstors podcast. Preston and I will be back next weekend with a new episode. Have a good one, guys. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional.

Starting point is 01:17:45 This show is copyrighted by the Investors Podcast Network. Written permissions must be granted before syndication or re-bord. podcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP326: Intrinsic Value of Lumen with Ben Claremon and Eugene Robin (Business Podcast)

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