Stig Brodersen (00:04:02):

And we have introduced you to Robert Leonard, the host for Real Estate Investing and Millennial Investing. We met him at the Berkshire Hathaway 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 then just hire people if we… Whoever we run into, that’s not how it is.

Stig Brodersen (00:04:26):

It’s just one of those where you meet people, you start to network and you just meet the nicest and best people out there in Omaha at that meeting. It’s just the most authentic and genuine people. So we met up there, kept in touch and one thing led to another and now you’re a new co-host for We Study Billionaires. Talk about coincidence.

Trey Lockerbie (00:04:47):

That’s right. 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.

Stig Brodersen (00:05:16):

I guess the audience might be sitting out there thinking, okay cool, this new Trey dude sounds real cool, is We Study Billionaires now going to be different, it’s Stig and Trey now or what’s the game plan here? How is this going to be different with you, Trey?

Trey Lockerbie (00:05:34):

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 treyattheinvestorspodcast.com. 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.

Stig Brodersen (00:06:12):

Fantastic. And I just wanted to address one thing here before we jump into the interview here today, Preston is still going to be here. Actually already next week, we’re speaking with Eth 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, it’ll probably be very similar to what you’ve seen so in the past. And so that’s how I 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 Trey will bring to the team. So that’s sort of like our starting point. As you probably heard that on the feed the other day, Preston, he’s working on this new beacon show and 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 We Study Billionaires. So anything else, Trey, we need to talk about before we jump into the episode?

Trey Lockerbie (00:07:04):

I think you nailed it Stig. I’m not trying to fill Preston shoes. 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.

Stig Brodersen (00:07:15):

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 did with Ben and Eugene from Cove Street Capital. Ben and Eugene, thanks for joining Trey and me here today to talk about Lumen and Investors Podcast. How are you guys?

Ben Claremon (00:07:36):

Thanks for having us on.

Stig Brodersen (00:07:37):

All right, Trey, you have the first question.

Trey Lockerbie (00:07:40):

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 become a little bit recently in place.

Ben Claremon (00:07:52):

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 late ’90s and remember people laying a bunch of sub C fiber from New York to Spain and across the Atlantic and across the Pacific Level 3 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 overbuilt, Global Crossing went bankrupt. I mean, there was just a lot of mess, but lo and behold years and years later, guess what? The internet is bigger than anyone ever thought. And so Level 3 was a roll-up that included Level 3’s assets, a company called Global Crossing, a company called Time Wire Telecom is a mix of what we would call kind of like domestic US fiber underground.

Ben Claremon (00:08:48):

And then there’s a bunch of some sea fiber that connects end points all around the world. And so we love this company that’s run by a guy named Jeff Storey. We were Level 3 shareholders when the merger with CenturyLink was announced. And we looked at it and we said to ourselves, Jeff Storey looks like he’s retiring. He’s the guy that we like. We focused a lot on management at Cove 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 3 with a legacy CenturyLink business. CenturyLink is just basically a rural telecom. So if you think about the company’s based in Louisiana, I think about rural Louisiana, they’re the telco there.

Ben Claremon (00:09:33):

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 a TV, that’s where you’re buying it from. And without any question, that’s a shrinking business. So you have a global growing asset heavy, almost irreplaceable asset business in Level 3 and you have a slowly shrinking, melting ice cube in CenturyLink, jam them together. And what could go wrong? Well, a lot can go 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 COO of the new company. And then quickly it became clear that the CenturyLink guys had no idea what they were doing.

Ben Claremon (00:10:24):

And Jeff Storey 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 you getting a 10.3% yield? It 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 3 and two thirds CenturyLink. And so just our 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.

Ben Claremon (00:11:10):

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 is somewhat slightly less than we would expect going forward growth that you’re going to see at Level 3. And so Wall Street doesn’t know what to do with that. That’s why we see such a large undervaluation. Eugene will get into a lot about that going forward. 

So I think in terms of a way of framing investment 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 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 will be really interesting for people.

Trey Lockerbie (00:11:55):

So let me get this straight, Level 3 has a lot of promise and a great management team with Jeff Storey and then they merge with CenturyLink, which is now 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?

Eugene Robin (00:12:18):

Great question about why the deal even happened? The short of it is Level 3 was offered a lot of money to consummate the marriage. We were Level 3 shareholders and we’re 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 Glen 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 entity by any means.

Eugene Robin (00:12:54):

And it was larger only in the end profit sense than Level 3. However, the actual valuation was skewed towards 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 part of my friends screwed are the shareholders of the company that’s trading at five times. So we as shareholders of Level 3 didn’t care because we were getting a fantastic value for our investment and the CenturyLink shareholders, well, they took it in the pants.

Trey Lockerbie (00:13:34):

This actually reminds me of almost like Berkshire Hathaway, right? A dying textile business. Buffet overtakes this textile business that’s ultimately failing and chooses to take some capital and buy stuff like insurance companies that’s going to throw 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 3 that has more staying power and perhaps more scalability over time?

Eugene Robin (00:14:05):

That’s exactly what the pitch was to the CenturyLink board when they discussed the acquisition. Currently, it is 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 5% a year on a cash flow basis. And the good side, the Level 3 side is growing. 

And yes, if Glen Post was Warren Buffet, I would say that’d be a 100% accurate in terms of the comparison but unfortunately for CenturyLink shareholders, Glen Post was the farthest thing from Buffet, 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 Storey 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 3 shareholders.

Eugene Robin (00:14:57):

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 Storey back in or we’re going to vote you out anyway.” So to say that the deal was loved, it would be the farthest thing from the truth. From day one, it was very contentious and it’s taken Jeff Storey three years to basically reconfigure the entity to be effectively Level 3 again, from a management perspective, obviously not from a revenue mix perspective, but certainly from people who make decisions on a day-to-day basis.

Stig Brodersen (00:15:31):

And that ties into my next question, when did the merger close?

Ben Claremon (00:15:35):

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. I think the stock went from, I think it was like 28, $29 to 18, 19. So I mean, clearly there were concerns about whether this deal made any sense.

Stig Brodersen (00:15:54):

So let’s talk about the new entity, how does it make money and who are the customers?

Eugene Robin (00:15:59):

I will answer the question in a consolidated fashion even though there are really two different parts of 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. How do we get to that point, right? We have a building that’s wired with fiber. We have a fiber running somewhere. 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 runs from LA to New York and get into someone’s building. 

So Level 3 at its core was exactly that. They own metro loops of fiber within most of the large cities in not only in the United States, but in the world. And they had what’s called on net buildings, which is a fancy way of saying their own fiber assets and copper. Sometimes wiring was inside the commercial building that we’re in.

Eugene Robin (00:16:53):

And when we go ahead and choose the internet provider that we want, we could choose Level 3 as the effective internet provider. So that’s the IP services side. 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 owning the underlying fiber networks. 

So there are a lot of brokers out there, even folks like Verizon, or sometimes even Comcast while they have the end points wired up, they don’t have a way for you to actually… Isn’t that 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 multi-national, how do you get that transit data from LA to Sao Paulo while you have to run through someone else’s fiber network?

Eugene Robin (00:17:42):

And so that business is called wholesale where you open up your strands of fiber to other people’s traffic. So that’s another way that they make money. Then you have what I would consider to be higher end service on top of the fiber. So these are things like security fancy terms called SDYN 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 they’re effectively ways for companies to minimize the use of their end servers by cashing or keeping copies stored more locally of commonly accessed media. Netflix has now their own CDN networks, the largest competitor that would be Akamai, a fantastic company that’s publicly traded.

Eugene Robin (00:18:38):

So 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 of different legs there. They also have just 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 $600 million a year that’s basically a subsidy to allow for people like in the sticks in Louisiana or Kansas, Arkansas, 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 that you need connectivity, and you’re not going to incentivize a private company to lay connectivity down on its own to a count of 50 people, right?

Eugene Robin (00:19:32):

So how do you get those 50 people connected to the internet? You provide subsidy. So the way that CenturyLink made money 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, Ben has just mentioned, is broadband connectivity. They have fairly extensive, I’m saying it’s like $1.6 billion business connecting households to the internet. So it’s not a 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 installed base to be basically a derivative of a coaxial cable. So competing with friends and 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 by 1.7% or something like that.

Eugene Robin (00:20:31):

That’s another consumer legged. Then they have the real problem. And this is a problem that affects almost all like C telcos. They have a voice business that I think was 1.9 billion, I want to say. So that voice businesses, as you can imagine, are 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 from some bizarre regions is because the cable companies would like to bundle them together. 

But in essence, I mean, I think I had a home phone number and I didn’t even get 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% year over year. The reason why that matters is you would think that, well, that seems like a silly business to be in, but remember it’s a 100% profit, right?

Eugene Robin (00:21:20):

So you’ve had some lines laid over a course of 50 to 80 years, you don’t have to really invest in them as just people pay you every single month for this phone service that most people now with cell phones don’t really need. So that is the other part of the consumer that’s obviously been what’s dragged down CenturyLink in total. And then you have another we 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 you’re getting price downs on the connectivity side as well as the Telcos 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.

Trey Lockerbie (00:22:11):

So as I said earlier, a lot to unpack here, right? This is a very complex company. I’m curious, Eugene, 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?

Eugene Robin (00:22:26):

They make money by connecting people to the internet.

Trey Lockerbie (00:22:30):

I see that they also offer cloud solutions, does that make them a competitor to Amazon Web Services and Microsoft?

Eugene Robin (00:22:38):

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 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 the edge connectivity solutions to businesses that don’t necessarily want to be a 100% on AWS or 100% on Azure or 100% on their own internal data warehouse has been mainly because of costs. The short answer is yes, they do compete, but certainly not in any sort of the same scale. It’s more of an add on service to their core IP connectivity service if you can think of it that way.

Stig Brodersen (00:23:27):

So as we were 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 point in time where the economy was still hot and before COVID-19 hit. So I’m curious where the loss is coming from.

Eugene Robin (00:23:50):

Two main buckets. So I mentioned that they provide wholesale connectivity to people who use their underlying network as a highway of sorts. And it’s like a toll road and every single year that the tolls pay 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 continued 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 if they’ve figured 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 10 years.

Trey Lockerbie (00:24:41):

Okay. Is 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?

Ben Claremon (00:25:02):

I mean I think if you’ve talked to the company, we see little competitors here and there, but domestically it’s really 18T and Verizon, the other legacy Telcos who have just massive customer bases and are connecting people all over the country. I think outside the US if you’re thinking about like who else has the ability to connect people from the US to EU, for example, I mean, ORAJ, Eugene and British Telecom.

Eugene Robin (00:25:29):

Colt fiber asset owners.

Ben Claremon (00:25:31):

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 strand of fiber to compete with you because they’ve got to spend the cap.

They have to put in the capital, they have manpower associated with that. And then they have to compete with you on pricing and your assets are 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 addressable market continues to grow. Let’s think of COVID just for example, like what has COVID… COVID has done a lot of awful things obviously.

Ben Claremon (00:26:16):

One of the things that it 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 250 gigabytes per household per month. And so the usage and then amount of traffic that is falling is going up almost exponentially now because of COVID. 

Now that growth rate will come down and 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, the whole market is shrinking, and then you have issues with CenturyLink and Level 3.

Ben Claremon (00:26:54):

The connectivity business will continue to grow as people demand faster speeds, more bandwidth, more capacity, and then more security and other new kind of endpoint 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. That’s what we like about the Level 3 side is that we do think that this isn’t growing as fast as detecting whatever that 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 core growth at Level 3, you have what we 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 this parts within CenturyLink that are growing, which is the broadband side start to grow.

Ben Claremon (00:27:40):

And then so either the decline abates or there’s no more decline at all. 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 entities over time, the inflection point will be where 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 deliver and trades at a multiple and nothing trades that in terms of how low it is.

Trey Lockerbie (00:28:16):

So just to kind of make sure I understand that. If we talk about Level 3 which is sort 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 cost. 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. Is that sort of the right way to think about it?

Eugene Robin (00:28:51):

Yes. In a nutshell, that’s exactly right. You use the legacy business you effectively milk it or 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.

Stig Brodersen (00:29:13):

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 financed, how concerned are you about the low coverage ratio?

Ben Claremon (00:29:48):

We’re conservative investors. So debt and potential inability to cover 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 that’s created equally and not all situations are the same. So this company has 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 things they have 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 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.

Ben Claremon (00:30:42):

And so slightly different metric, which we EBITDA, which is a kind of a proxy for cash flow minus capital expenditures divided by interest expense. And that number is more like two and a half, which is… Again these numbers, are they stellar? Absolutely not. Is that certainly a concern of the market? 100%. Our contrarian perception here is that there’s 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 targeting their capital expenditures and the cash flows they generate can more than offset. Well, they can pay down debt, they can pay a dividend, they can pay their interest.

Ben Claremon (00:31:20):

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 EBITDA grows and the total amount of debt declines, then those numbers are going to start looking a lot better. Right now on a net debt EBITDA basis, EBITDA being our proxy for cash flow, they’re at 3.7 times, which is certainly not that high. I mean, we think depending on the business, five times is a number where you start to have 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 the corollary to that or what happens associated with that is that you get higher free cash flow.

Ben Claremon (00:32:02):

There’s a virtuous cycle of debt paid 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. But I think our contrarian perception is that it is nowhere near a big as an issue as people are giving it.

Trey Lockerbie (00:32:26):

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 Storey. Jeff Storey 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 experience in companies like Cox and WilTel. And you mentioned you have a lot of faith in Jeff specifically. So I’d like to cover him a little bit more. How do you measure his performance and how much do you factor management qualitatively in the overall valuation of the company?

Eugene Robin (00:33:00):

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 3 has publicly traded debt, Level 3 also still puts out its own independent financials. So while you can have a consolidated illumine 10K, you could also look at the annual results for the underlying Level 3 business, which allows you to break apart Level 3 from legacy CenturyLink. 

To just give your viewers some metrics behind how to judge Jeff Storey, when Storey came in to be the CEO of the combined entity, the Legacy CenturyLink had a free cash flow number of roughly 1.6 to $7 billion, that was in 2016. He came in at the end of 17. So we’ll 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.

Eugene Robin (00:34:13):

So how do you judge Jeff Storey? 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 it goes back to something that we’ve mentioned several times, which is his kind of cost cutting chops. That’s one way to measure him. The other way to measure him is we internally will have a metric that we track, which is called ROIC return on invested capital, since he took over the entity that ROIC measure has gone up from… ROIC is return on invested capital has gone up from call it eight to 9% when the old legacy CenturyLink management team ran things to roughly 12 to 13%.

Eugene Robin (00:34:56):

Again, this is a way for us to kind of back of the envelope gauge whether or not whatever he’s doing, including the cut-costs 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.

Ben Claremon (00:35:31):

What’s happened to 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 trading at a valuation 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 within our process. We evaluate the business separately from the people or separately from the evaluation, because we want all three pillars to be pointing in the right direction. And so 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, he was 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.

Ben Claremon (00:36:29):

Because very simply as Eugene was talking about, a business like CenturyLink should trade at a lower multiple, a business like Level 3 should trade at a higher multiple and to adjust some comparable transactions 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 you think that you’ve seen signs that they’ve been very thoughtful about that. 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.

Eugene Robin (00:37:16):

And I would just add to that in terms of we do a lot of work on proxies. People tend 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 head of the company, how are they incentivized? So what are they going to focus on? So Jeff Storey’s incentives are three-fold. 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 a restricted stock issuances that are also based on the EBITDA profile of the company. That’s one. Two, after the merger, I think he wound up owning three million shares, if not a little bit more, so you can do that math, right? So a stock that used to be $25 to him is a whole heck of a lot of money.

Eugene Robin (00:38:12):

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 he’s done all the cost cuts and stabilized cash flows and 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 Storey would be a 100% for it because he certainly would benefit greatly personally.

Stig Brodersen (00:38:59):

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?

Eugene Robin (00:39:14):

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 3 core assets are doing, which again, going back to how we think about it are the Juul here that’s kind of obscured by a declining legacy side. So that’s one. Two, the free cash flow generated by the company. Because irrespective, as I mentioned on the legacy CTL CenturyLink performance, irrespective of declines in revenue, Jeff Storey has managed to actually grow free cash flow in the face of all of that. 

So we also tract in the way that… So your listeners know the way that we look at free cash flow is simply the gap cash flow from operations minus the capital expenditures. So 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.

Eugene Robin (00:40:19):

So that’s two. Thirdly, honestly, I just make sure that the legacy decline is within a comfortable variance. And what I mean by that is if the legacy CenturyLink mix of revenues is somewhere between call it negative three and negative 6%, that’s okay. If it’s greater than negative 6% on a year over year basis, that’s when some red flags start coming up because just judging by the cost cutting and over the past several years, that’s basically what Jeff Storey’s 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 in. I don’t know.

Ben Claremon (00:41:03):

I think margins. So the two other things that… We focus on four key variables at our firms. 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/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. 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.

Ben Claremon (00:41:42):

I do want to mention one other thing. Eugene was talking about incentives, I was just looking at their proxy statement, which by the way, since we had didn’t discussed, which is just the annual data sent to shareholders about who’s on the board, who’s up for 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 Storey if the company gets old and based on the stock price, I think at probably December 31st, he was $44 million if the company was 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.

Trey Lockerbie (00:42:29):

So this might seem a little far-fetched today, but companies like SpaceX are gunning to put up cheap satellite internet. So within the next five to 10 years, do you think there might be a threat to broadband dying at the hand of satellite internet technology?

Ben Claremon (00:42:45):

Eugene and I are laughing about this because we can 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 risks at CenturyLink and Level 3 to satellite broadband.

Eugene Robin (00:43:14):

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 serve more than one to maybe two million users in total across their entire network if they launched 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 few companies can possess because it allows them to raise incredibly cheap equity, add 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 home users. Just so your listeners understand originally Starlink was supposed to be, oh, this is going to buttress back haul 5G infrastructure that sales pitch was deleted over the past year and a half.

Eugene Robin (00:44:29):

Then there was going to be this worldwide, we’re going to deliver internet connectivity to every single person in Africa. And so that’s no longer mentioned. So what are they concentrating on? They’re going to roll it out to rural America at $80 per month in some plans with maybe a 100 megabit per second conductivity. So translated in a different way, we’re sitting in an office where our download speeds are… Well, I mean, we’re obviously pay for a much higher tier, but they’re already two to two and a half times 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.

Eugene Robin (00:45:12):

And again, I think Elon has stopped saying some things that he used to say maybe two or three years ago, because the reality is no real constellation has ever survived and irrespective of how good he is at first principles and getting costs down and be 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 spend eight and a half to 12 and a half billion depending upon which estimate you use to launch all of this. Fiber is already there. So I wish him luck because again it’s I think a good thing in general for space and space tech and 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.

Eugene Robin (00:46:07):

It’s not to say that CenturyLink 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 that Verizon is correct in their massive build-out and plans for a true 5G network, which we’re yet to see, but it is slowly being launched 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 3 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 can just contract out with Verizon, they’ll come in and put in a wireless router effectively to connect to their 5G network, which supposedly could get ridiculously fantastic speeds.

Eugene Robin (00:47:09):

Now, as a counter to all of 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’re actually 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 a Level 3’s metro loops of fiber will become ever more in demand and also valuable in that kind of 5G revolutionary world.

Trey Lockerbie (00:47:43):

I want to touch on that. So as someone who doesn’t understand 5G all that well, what I’m hearing is that Level 3 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.

Eugene Robin (00:48:04):

It’s a great summary. Exactly.

Ben Claremon (00:48:07):

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 LA 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 farfetched, but I don’t think it’s within the investment time horizon of most of us or most of your listeners that could be a major threat.

Eugene Robin (00:48:53):

Another thing I want to clarify, when we talk about connectivity for Level 3 business services within CenturyLink, we’re not talking about a company like ours, we’re out-point customer meaning we just need to get on the internet. Like we have one office, we’re not international. It’s not a big deal who we use. We treat is 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 and Level 3 being one of them that can come into a GE and say, “Hey look, you need to have a dedicated connectivity networks 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 size businesses such as ours? Sure.

Eugene Robin (00:49:52):

Is it going to affect to the Fortune 500s? 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 point, 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 they’re effectively two different markets when you talk about business continuity services. And I think I want to make sure that people understand what Level 3 is and just they’re not selling to people like us.

Stig Brodersen (00:50:34):

So guys, let’s talk about the dividend. Lumen cut the dividend to half in 2019 and the paired ratio since then haven’t seemed to be sustainable. They’ve been going over 100%. Given that earnings were negative 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?

Ben Claremon (00:50:59):

From a valuation 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 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 of that free cash flow eventually pays down debt and then all of that value increase to the equity holders.

Ben Claremon (00:51:47):

So we don’t use it as a… We’re not valuing the company, say, this company should have a 7% yield and 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 for a year and at least you get a 10% dividend, that’s a nice thing to have, but 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 much, much higher value. And the dividend in the meantime is just a nice thing to have assuming it’s sustainable.

Ben Claremon (00:52:28):

And I think whether it’s our projections of what interest costs are going to be, how much they can pay 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 in other dividend cut, we actually don’t think that’s going to happen. And so 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.

Trey Lockerbie (00:52:57):

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 of 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. I’m curious, what do you consider to be the intrinsic value of Lumen and how do you go about calculating that?

Ben Claremon (00:53:37):

Well, I’m just going to give just a little bit of a background or some clarity on how we value companies then 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 an investor, as you’re doing a number of analysis 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 affect your intrinsic value. So we triangulate.

Ben Claremon (00:54:07):

So we typically use discounted cash flow analysis. In a company like this where we think that there are assets that are separable, we’ll use the sum of the parts, value Level 3 separately from CenturyLink and then we’ll use a typical multiples analysis like, okay, other businesses trade is this multiple, so what multiple 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 Level 3 side and good management, that’s the holy ground for us. 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. 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.

Eugene Robin (00:54:53):

So starting again, the way that we’ve looked at it was really it is a tale of two cities. There’s the core Level 3 and then there’s core CenturyLink. And as I mentioned before, because Level 3 has publicly traded debt, we can actually arrive at a very accurate snapshot of its underlying financial conditions through its public filings. 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 I’ll just use 2019 as a starting point. So from 2019 numbers, you have 8.2 billion 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.

Eugene Robin (00:55:46):

So if we take that $2.8 billion and we look at deals within the space that have happened over the past, let’s call it 18 months, we try to keep it somewhat more relevant versus things that traded maybe seven or eight years. We look at EQT buying Zayo at 12.1 times, we look at LOTA selling their light path sidiary for 14.6 times. Look at actually something that hit I think it was this week GTT, which was a big roll up of various parts, but they had two fiber assets called Hibernia and Interoute that they just agreed to sell for roughly about 12.8 times. And all these are EBITDA earnings before interest tax depreciation. So if we use those sort of private market values for fiber heavy assets that have pretty good businesses, connectivity, and also add on services, we arrive at evaluation range for the core Level 3 of somewhere between call it 31 and $36 billion for that business.

Eugene Robin (00:56:52):

And just so you know, when CenturyLink bought Level 3, was it three years ago roughly now? They paid, 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 Warren Buffet believes in no compounds right value every single year. Let’s just say it’s 34 billion, right? It’s kind of the mid point of that valuation range I just said, anyway. So at $34 billion, what are you getting? They have about 34 billion in debt. So that takes out the entire debt stack just from the Level 3 assets. Meaning that if you subtract out that EBITDA number that I said that 2.8 billion, which comes directly from public filings not adjusted and no magic nonsense of core whatever billion different adjustments that people make, you get at the legacy CenturyLink of 5.8 billion EBITDA for free.

Eugene Robin (00:57:51):

Well, not for free. Well, I think the leftovers are 10 billion. So you were getting it at 1.7 times roughly. 1.7 times EBITDA, or that another way I mentioned before, CenturyLink had 1.75 billion in free cash flow. You’re getting it at five times free cash flow. That is insanely cheap valuation for anything. Even if it is, let’s say, declining at two to 3%, our premise also your listeners understand is that if you look in history, the core of CenturyLink is declining. And I think I mentioned this before that their major problem really is their legacy voice as 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 plus small business services plus some of the other kind of regulatory income that CenturyLink has.

Eugene Robin (00:59:01):

So assuming that this is not a perpetual decliner to zero, you have a valuation that is solo that, I mean, it’s really hard to reconcile the value for what you get the leftover CenturyLink 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 valuation for Level 3 and you put a four times, right? Listen, I’m not even going to go crazy. 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.

Eugene Robin (00:59:46):

So our premise really is that as long as people wake up to the fact that the core assets of Level 3 are worth what they are worth in the private market for, let’s say, around $34 billion. And as long as people apply even some modicum of multiple to the remaining CenturyLink assets, you have a completely insane risk reward from 950 or whatever it’s trading at today. So that’s kind of some of the parts we look at how to value or 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, if someone offered me $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.

Stig Brodersen (01:00:40):

So guys definitely correct me if I’m wrong here. Whereas it sounds like discounted cash flow is a part of evaluation, you also really much focus on, I call it, Benjamin Graham asset heavy valuation.

Ben Claremon (01:00:53):

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, 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 like McCorey or Brookfield, for example, that have whatever, 10, 20, $30 million in money that goes physical infrastructure. And what does Level 3 have? Who’s some of the most envious fiber infrastructure assets in the entire world?

Ben Claremon (01:01:43):

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 3. But our point is that there’s a lot of demand for certain assets. So this is their some of the parts analysis, which is in a way it’s what would someone else pay for just the assets of this company? What does that compare 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 treasury at 1.67 and nine and a half percent whack as a very, very conservative number. We’re getting even with 0% per perpetual growth, and then a perpetual decline in the voice business, as Eugene said, you’re still getting high teeds.

Ben Claremon (01:02:23):

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 undervalued. 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 at valuing a growing cash flow generator of asset within a shrinking total top line attached to a shrinking business. That’s why there’re spins and that’s why there are asset sales that can kind of highlight value. So to some extent, there is a 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.

Ben Claremon (01:03:07):

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 that 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 I’m not saying it’s simple, but given this is a company that people know, Seattle Seahawks Stadium is a CenturyLink field, right? And so this is a company people 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 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.”

Ben Claremon (01:03:58):

And so they did exactly what Eugene did. They split Level 3 and they split the legacy CenturyLink. They said, “Hey, so you have three billion in EBITDA here at Level 3, you have six billion EBITDA at CenturyLink, let’s put just conservative multiples on those illustrative of what these companies 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 of the stock market over 200 years is like six 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 often. And so we rack our brains to figure out what other people are thinking. We understand what we think the market misses here 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.

Trey Lockerbie (01:04:55):

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?

Ben Claremon (01:05:05):

Some kind of value creating structure, whether they, Eugene mentioned the LTC’s sale of their assets, they actually only sold 50%. So Morgan Stanley infrastructure fund bought 50% of LTC’s fiber assets, and LTC has really attractive assets in New York City. But we talked to the company that was Lumen and we asked them, “So was there anything unique about LTC’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.” And that went off almost 15 times EBITDA. 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 low multiple levered up, and then they get the return.

Ben Claremon (01:05:50):

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 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 CenturyLink 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 as we’re sitting here clipping a 10% coupon, we’re hoping that the numbers are anywhere near what our research would I suggest.

Trey Lockerbie (01:06:35):

So the last thing I like to do after I’ve 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 theinvestorspodcast.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 trading inside or outside of that range. When I look at that indicator on our website, it’s red, right? 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 depress the stock price indefinitely. We really don’t know when that catalyst you mentioned is going to come along.

Trey Lockerbie (01:07:32):

So it’s wise to consider that 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. I’m just curious about price momentum, is that something you’ve ever factored into your own investing strategy?

Ben Claremon (01:07:55):

It’s not something we consider. I mean, we’re looking at we were on a concentrated portfolio of securities and we’re focused on the business valuing 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, but I’d just point out here that when you’re investing in situations where there’s a special situation or where there’s a catalyst, you may get terribly negative price momentum until one day it goes the other way. So there are a million different ways you can-

Trey Lockerbie (01:08:23):

And at that point you’re too late.

Ben Claremon (01:08:24):

Yeah. No, at that point 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 in the consumer business at CenturyLink, but still a seven times multiple would be a hugely attractive multiple for the CenturyLink business and then you’d be left with really good Level 3 assets. So there is a risk towards just waiting for things to get better because listen, within financial markets, there’s a pendulum that swings between greed and fear. Right now there’s a lot of fear associated with both 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 even the leverage given the degree of undervaluation just a slight change of what people think about this could be enormously creative for shareholders. So I understand what you’re talking about, it’s just not something that we really incorporate in our analysis.

Trey Lockerbie (01:09:27):

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 gotten 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.

Ben Claremon (01:09:49):

Thanks a lot for having us.

Stig Brodersen (01:09:51):

That was all the train I had for this week’s episode of the Investors Podcast. Preston and I will be back next weekend with a new episode. Have a good one, guys.

Outro (01:10:01):

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