CenturyLink Valuation Project

I. The Company, Industry, and

Competitors

COMPANY ANALYSIS AND VALUATION

CenturyLink

Table of Contents

I. The Company, Industry, and Competitors

Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 1-2

Business Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 3

Brief Company History. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 3-4

Operating Segments and Products. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 4-10

Industry Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 10-13

Corporate Control. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 14-19

Financial Analyst Rankings & Opinion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .0-22

II. Financial Performance Analysis

III. Cost of Capital, Capital Structure Analysis and Distributions

IV. Financial Statements Forecasts

V. Cash Flow Valuation

VI. Relative (Multiples) Valuation Analysis

VII. Summary and Conclusions

Century Link: The Company, Industry, and Competitors

2014 Operating Revenue by Segment:

Morgan Stanley Earnings Estimates Year 2015 2016 2017

Revenue $17,765 (-1.48%) $17,623 (-.80%) $17,572 (-.29%) Free Cash Flow $2,537 $1,272 $1,533

Earnings Per Share $2.49 $2.31 $2.40

Industry revenue is projected to decline 1.4% annually between 2015 and 2020 o CTL’s revenue is expected to decline slower than the industry (.86% annual decline over

next three years) due to its development into new markets such as cloud services Wall Street Analysts’ Opinions

Buy Buy/Hold Hold Hold/Sell Sell 6 2 8 1 0

94% of analysts recommend either a buy or hold strategy while only 6% recommend a hold/sell

54%

42%

4%

Strategic Services Legacy Services Data Integration

Developing Areas of Business Cloud Computing & Services IT Services/Big Data Advanced Predictive Analytics

CTL’s Three Business Segments Strategic services are services with strong and/or growing demand including:

Private Line Connections Managed Hosting & Services Ethernet

Legacy services are traditional voice, data, and networking services provided with copper-wire infrastructure and include:

Local/Long-Distance Voice ISDN and WAN

Data Integration services include: Network Management Installation & Maintenance Fiber Optic Networks

Recent Mergers & Acquisitions In 2011, CTL merged with Qwest to expand infrastructure and customer base (118% revenue increase) CTL acquired AppFog and Tier3 in 2013 in order to expand its cloud platform and services 2014 acquisitions included DataGardens and Cognilytics, which are focused on big data and advanced

predictive analytics In 2015, CTL acquired Orchestrate to enhance its cloud platform and database as a service (DBaaS)

capabilities

Primary Areas of Business Voice & Data Communications Television (Prism TV & partnership w/ DirecTV) Home/Business Security Services Broadband Internet via Fiber Optic Plant

Executive Compensation

Name and Principal

Position

Year

Salary

Bonus

Restricted

Stock

Awards(1)

Non-Equity

Incentive Plan

Compensation(2)

Change in

Pension

Value(3)

All Other

Compensation(4)

Total

Glen F. Post, III

Chief Executive Officer and President

2014

$ 1,100,000

$ —

$ 9,581,227

$ 1,597,200

$ 745,535

$ 107,486

$ 13,131,448

2013

1,100,000

—

6,086,446

1,683,000

—

123,801

8,993,247

2012

1,047,606

—

5,157,049

1,767,836

649,156

103,392

8,725,040

Karen A. Puckett

President, Global Markets

2014

725,000

—

2,917,475

771,980

483,645

59,910

4,958,010

2013

725,000

—

2,106,061

854,123

—

53,845

3,739,029

2012

684,562

—

2,250,332

1,015,837

411,822

42,838

4,405,391

R. Stewart Ewing, Jr.

Executive Vice President, Chief

Financial Officer and Assistant

Secretary

2014

650,000

—

1,992,894

692,120

462,796

44,710

3,842,520

2013

650,000

—

1,438,623

729,300

—

55,769

2,873,692

2012

616,105

—

1,744,036

914,696

415,853

38,595

3,729,286

Stacey W. Goff


Administrative Officer, General

Counsel and Secretary

2014

520,890

—

1,609,657

611,942

339,053

45,600

3,127,142

2013

500,000

—

1,106,631

561,000

—

37,527

2,205,158

2012

450,096

—

1,293,966

526,336

220,263

15,965

2,506,626

Aamir Hussain(5)

2014

85,892

100,000 (6)

2,486,653

83,144 (7)

—

344,945

3,100,634


Technology Officer

Industry Growth

IBISWorld projects that the industry revenue is expected to decline at an annual rate of 1.4% over the next five years and also that the number of establishments is forecasted to decline at an annual 3.3% over the same period.

CEO compensation was calculated against AT&T and Verizon which are significantly larger.

CTL currently maintains the same top management from XXXX.

CTL pays Glen Post 50% of its total compensation to Executives

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Business Description

CenturyLink is the third largest telecommunications company in the United States where it

owns 12.4 million access lines, operates in 37 different states, and is the incumbent provider of

telephone services in 12 states: these include Colorado, Arizona, Washington, Minnesota,

Florida, North Carolina, Oregon, Iowa, Utah, New Mexico, Missouri, and Nevada. The company

provides a variety of voice and data services including, but not limited to, local and long

distance voice (wireless/wired), broadband, private line, Multi-Protocol Label Switching (MPLS),

managed hosting, colocation, network access, and video services.

Brief Company History

Acquisition History

July 1, 2009: CenturyLink purchased Embarq Corporation for $6.1b to obtain its data, internet, video, and voice services. This required CTL to take on an additional $4.9b of in long term debt.

April 1, 2011: CenturyLink acquired Qwest in a $12.7b debt financed reverse merger in order to double its market share and number of access lines.1

Q4 2014: CenturyLink bought DataGardens, a disaster recovery firm, and an undisclosed second firm for $95m in order to expand into cloud services.2

2015: CenturyLink purchased Orchestrate to obtain its Database-as-a-service (DaaS) infrastructure as well as to further expand into cloud services.

Law Suits

CenturyLink is being sued for failure to clear trouble reports in a timely manner. Close to one third of CenturyLink’s downed lines are repaired to slowly according to local legislation.3

CenturyLink is being sued for stock price manipulation by Pomerantz Grossman Hufford Dahlstrom & Gross LLP in a class action lawsuit. Dahlstrom & Gross claim that top management artificially raised CTL’s stock price by giving out dividends that were not sustainable and during this period the controllers exercised an unusually large number of stock options. The eventual change in dividend policy caused a 22% drop in stock price and caused 70 million transactions of stock to be fraudulent.4

1 http://www.denverpost.com/ci_17704874 2 http://venturebeat.com/2014/12/08/why-centurylink-just-bought-disaster-recovery-company-datagardens/ 3 http://flatheadbeacon.com/2015/07/21/montana-regulator-to-sue-centurylink-for-slow-response-times/

4 https://www.battea.com/class-action-claim/527-securities-class-action-claim-launched-against-centurylink.html

http://www.denverpost.com/ci_17704874

http://venturebeat.com/2014/12/08/why-centurylink-just-bought-disaster-recovery-company-datagardens/

http://venturebeat.com/2014/12/08/why-centurylink-just-bought-disaster-recovery-company-datagardens/

http://flatheadbeacon.com/2015/07/21/montana-regulator-to-sue-centurylink-for-slow-response-times/

http://flatheadbeacon.com/2015/07/21/montana-regulator-to-sue-centurylink-for-slow-response-times/

https://www.battea.com/class-action-claim/527-securities-class-action-claim-launched-against-centurylink.html

https://www.battea.com/class-action-claim/527-securities-class-action-claim-launched-against-centurylink.html

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CenturyLink and other ISPs (Internet Service Providers) are suing the FCC for net neutrality. CenturyLink is claiming that being listed as a Common Carrier is illegal according to net neutrality and deserves to be listed as a different entity. This case is not about CTL discriminating about the payments for priority treatment or blocking entities. The head of the FCC believes CenturyLink is expected fail in the court of law. However, this case marks a continuing effort by the entire industry to shirk the regulations of net neutrality because how limiting net neutrality is to its profits. If CenturyLink wins in repealing net neutrality the potential revenues are tremendous.5

Events (Possible, Probable or guaranteed to cause an impact of firm value)

In 2011 the Supreme Court ruled that consumers can be bound to contracts that prohibit the use of class action lawsuits against the company. This effects CenturyLink because this ruling makes contract violation costs much lower because customers must make claims separately and thus bear the cost of legal advice separately as well. CenturyLink does take advantage of arbitration clauses.6

CenturyLink Operating Segments and Products

Product Lines:

Strategic –Services that management believes are most important to the future performance of the company and show either strong or growing demand. These services include:

- Broadband: Allows customers to connect to the internet via existing telephone lines or fiber optic cables. Substantially all broadband subscribers are located within the ILEC.

- Private Line: A direct circuit or channel specifically designed for connecting two or more sites for a secure high speed connection. Frequently used for the transmission of large amounts of data and includes some wireless backhaul.

- MPLS: Standing for Multi-Protocol Label Switching, MPLS is a standard data networking technology used to support real-time voice and video. It allows network operators the ability to divert and route traffic around link failures, congestion, and bottle necks.

- Managed Hosting: Includes provision of centralized information technology infrastructure and a variety of managed services including loud and traditional computing, application management, back-up, storage, and other advanced services including planning, design, implementation, and support services.

- Ethernet: Point-to-Point (P2P) and multi-point configurations that facilitate data transmissions across metropolitan areas and WANs (Wide Area Networks). It is also

5 http://www.multichannel.com/news/policy/centurylink-sues-fcc-over-open-internet-order/389866

6 http://www.cnet.com/news/why-you-cant-sue-your-wireless-carrier-in-a-class-action/

http://www.multichannel.com/news/policy/centurylink-sues-fcc-over-open-internet-order/389866

http://www.multichannel.com/news/policy/centurylink-sues-fcc-over-open-internet-order/389866

http://www.cnet.com/news/why-you-cant-sue-your-wireless-carrier-in-a-class-action/

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used to provide transmission services to wireless service providers that use CenturyLink’s fiber-optic cables for its wireless towers.

- VoIP: Voice over Internet Protocol is a real-time, two-way voice communication service that originates over broadband connection and often terminates on the PSTN.

- Managed Services: A blend of services including network, hosting, cloud, and IT services, typically combined with customer premise equipment. These services include development of solutions to customer’s communication requirements, end-to-end deployment, and ongoing management of the solution for the customer.

Legacy – Traditional voice, data, and networking services that are provided with copper-wire infrastructure. These services include:

- Local Voice Service: Local calling services for consumers and businesses that for an additional monthly fee include call forwarding, caller identification, conference calling, voice mail, selective call ringing, and call waiting. This also includes non-recurring services like wire installation, maintenance services, service activation/reactivation. Finally, this includes the sale of Unbundled Network Elements (UNEs) which allow wholesale customers access to our network to provide service on its own networks

- Long Distance Voice: Long-distance and toll-free services. International long-distance services include calls that either terminate or originate in the United States

- ISDN: Stands for Integrated Services Digital Network, which uses telephone wires to support voice, video, and data applications

- WAN: Allows local communications networks to link to other networks in remote locations

- Switched Access Services: Various forms of switched access services to wireline and wireless service providers for the use of CenturyLink’s network to originate and terminate its interstate/intrastate voice transmissions

Data Integration – Services include network management, installation, and maintenance of data equipment and the building of proprietary fiber-optic broadband networks for governmental and business customers.

Operating Segments:

Business – The provision of strategic, legacy, and data integration products to enterprise, wholesale, and governmental customers. It also includes the sale of private line and IT products.

Consumer – the provision of strategic and legacy products to residential customers.

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Revenue Per Operational Segment ($ in Millions)

Total 2011 2012 2013 2014

Revenue $14,471 $17,320 $17,095 $17,028

Cost of Revenue $6,623 $8,147 $8,167 $8,509

Gross Profit $7,848 $9,173 $8,928 $8,519

Total Gross Margin 54% 53% 52% 50%

% Growth/Loss 20% -1% -0.39%

Consumer Segment

Revenue $5,384 $6,164 $6,004 $5,994

Cost of Revenue $1,972 $2,418 $2,359 $2,420

Gross Profit $3,412 $3,746 $3,645 $3,574

Gross Margin 63% 61% 61% 60%

% Growth/Loss 14% -3% -0.17%

Business Segment

Revenue $9,087 $11,156 $11,091 $11,034

Cost of Revenue $4,651 $5,729 $5,808 $6,089

Gross Profit $4,436 $5,427 $5,283 $4,945

Gross Margin 49% 49% 48% 45%

% Growth/Loss 23% -1% -1%

Source: CTL 2014 and 2015 10-Ks

The revenue per operational segment is provided for the past four years in order to analyze each segment’s effectiveness. Important facts to consider are:

- Total gross margin decreased over the past five years in spite of consolidation during that same period. Consolidation in this industry is supposed to reduce operating costs, yet cost of revenue is increasing.

- CenturyLink only performed slightly better than the estimated 2.4% annual decline in industry revenue in 2013 and 2014. This shows CenturyLink is not able to substantially offset industry losses with recent acquisitions.

- Gross margin decreased in both Operational Segments over the past five years o Revenue in the Consumer Segment grows briefly in 2012 and slumps in 2013

and 2014. Furthermore, cost of revenue increases during this slump. This implies that CenturyLink’s operations are slipping for its consumer segment.

o While revenue in the Business Segment changed in much the same way as the consumer segment’s revenue, the cost of revenue is growing much faster for the Business Segment. This implies CenturyLink’s operations for this segment are slipping as well.

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Revenue By Product Line ($ in Millions)

2011 2012 2013 2014

Strategic Services $6,313 $8,427 $8,823 $9,200

Legacy Services $7,621 $8,221 $7,616 $7,138

Data Integration $537 $672 $656 $690

Total Operating Revenues $14,471 $17,320 $17,095 $17,028

Source: CTL 2014 and 2015 10-Ks

Revenue By Product Line ($ in Millions)

Business Segment 2011 2012 2013 2014


Legacy Services $2,509 $4,540 $4,267 $3,998


Total Revenue (Business) $6,639 $11,158 $11,091 $11,034

Consumer Segment


Legacy Services $5,171 $3,681 $3,349 $3,140


Total Revenue (Consumer) $7,832 $6,162 $6,004 $5,994

Source: Bloomberg

The two preceding charts show how each product line contributes to revenue, with the second breaking down each product line into its appropriate operating segment. From this, it is quickly seen that:

- Strategic and Legacy Services are about even in terms of contribution to revenue, while data integration is almost negligible in comparison

- Strategic services are growing in both segments, while legacy services are declining; o The increase in legacy services in 2012 is the result of consolidation, not an

increase in subscribers. - Data integration sharply declined in the consumer segment, raising potential

concern - Overall, growth in business segment revenue quickly outpaced the consumer

segment; this is rather strange given the industry

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To better visualize the relationship between the product lines and each product lines contribution to revenue, the above pie chart easily summarizes the data. It is calculated using the average contribution to revenue over the past four years. Now it is even more apparent how negligible data integration is and how the business segment dominates sales.

Strategic (Business)33%

Strategic (Consumer)16%

Legacy (Business)23%

Legacy (Consumer)24%

Data Integration (Business)

4%

Data Integration (Consumer)

0%

Average Revenue by Product Line

Strategic (Business) Strategic (Consumer) Legacy (Business)

Legacy (Consumer) Data Integration (Business) Data Integration (Consumer)

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CenturyLink Income Statements

For the Years Ended Dec. 31, 2011 - Dec. 31, 2014

2011 2012 2013 2014

Operating Expenses:

Depreciation and Amortization 26.23% 26.01% 25.10% 24.56%

Cost of Goods Sold 41.20% 41.57% 41.49% 43.51%

Impairment of Goodwill 6.03%

Total Operating Expenses 86.81% 85.24% 91.97% 86.63%

Selling General and Administrative Expenses 19.38% 17.65% 19.35% 18.56%

Operating Income 13.19% 14.76% 8.03% 13.37%

Non-Operating Expenses: 0.00% 0.00% 0.00% 0.00%

GL On Early Ext of Debt -Non-Op 0.97% -0.06% 0.00%

Income Tax Expense (Benefit) 2.44% 2.57% 2.56% 1.87%

Other Non-Operating Income -0.33%

Income Before XO Items 3.73%

Interest Expense 6.98% 7.18% 7.17% 7.27%

Other Non-Operating (Income)/Expense - Net 0.03% -0.19% -0.06%

Income Before Income Taxes 6.18% 6.80% 1.24% 6.16%

Earnings:

Basic & Diluted EPS Before XO Items 0.01%

Diluted EPS 0.01% 0.00% 0.01%

Weighted Avg. Shares - Diluted 3.48% 3.39% 3.32% 3.16%

Basic & Diluted EPS 0.01%

Basic EPS 0.01% 0.00% 0.01%

Dividends Per Share 0.02% 0.01%

Weighted Avg. Shares - Basic 3.47% 3.38% 3.32% 3.15%

Net Income 3.73% 4.23% -1.32% 4.28%

Source: Bloomberg

Above is the Common-Size Income Statement from CenturyLink from 2011-2014, which is provided in order to determine the major cost components in the firm’s financials. The largest component in CenturyLink’s cost structure is the cost of servicing its lines, which accounted for an average of 41.97% revenue and is showing signs of growing. Not surprising considering the industry, depreciation and amortization make up a large amount of the operating cost with an average of 25.48% of revenue. Because these are non-cash expenses disregard this as irrelevant except to the extent that the company reflects continued investment in network infrastructure.

In order to accurately assess CenturyLink’s performance and determine its value it is necessary to understand the telecommunications industry and how CTL measures up to its competitors.

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Therefore, the Wired Telecommunications Industry is examined insofar that it aids effective analysis of the company.

Industry Analysis

Brief Industry Summary

Over the past five years, the Wired Telecommunications Industry continues to lose relevance as improvements in wireless technology, market saturation of mobile devices, and the proliferation of cost effective product substitutes (most notably VoIP) emerged to cede its market share. IBISWorld projects that the industry revenue is expected to decline at an annual rate of 1.4% over the next five years and that the number of establishments is forecasted to decline at an annual 3.3% over the same period. Even worse, the continual decline in subscriber access lines also effects economies of scale, making it ever more difficult to maintain profitability of wired voice services. The only factor that is allowing firms in this industry to stay relevant is the booming demand for high-speed broadband internet which offsets the loss in revenue from customers switching to wireless alternatives. Nevertheless, it is projected that as more wireless companies switch to 4G LTE over the next five-year period consumers no longer choose fiber-optic broadband internet over wireless solutions, as the options feature the same bandwidth, data transfer, and download speeds for approximately the same cost2.

As a consequence of these trends, industry giants (AT&T and Verizon) are increasingly focused on extending the companies fiber-optic networks to provide high speed internet to more subscribers while demand is still booming, take advantage of the unregulated VoIP services, and to capitalize on the burgeoning Internet Protocol Television Services (IPTV: Streaming television, movies, etc.). Furthermore, industry leaders are aiming to increase investment in wireless services as companies in that segment of the telecommunications are barely able to keep up with growing demand for mobile internet. The strategies of the industry leaders heavily imply that for companies in this industry to stay relevant companies must be able to make the transition from wired to wireless while also showing a robust network infrastructure to overcome capacity limits and to profit from the predicted increase in demand for backhaul services.

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Industry Dashboard

Source: IBISWorld’s Wired Telecommunications Industry Report

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From the Industry Dashboard the major trends unfolding in the Wired Telecom Industry are evident. How CenturyLink is assessed depends on how well positioned the firm is to adapt to and capitalize on these trends. Some of the most important trends include:

- Voice services declined to a 30.2% share of the industry revenue whilst data and network services increased to 69.8% of industry revenue

o Demand for internet access shot through the roof as a greater portion of financial and transactional services are moving online. The demand for broadband connections is expected to increase through 2015

o Wholesale Network Access’ contribution to industry revenue is expected to increase over the next five years as available bandwidth becomes a valuable commodity

Incumbent Local Telecommunications providers are not regulated on the prices the companies charge ISPs and wireless providers to use its networks for any service. Hence, this is an opportunity to raise prices as demand increases.

o The Other portion of industry revenue is primarily composed of IPTV, whose contribution to industry revenue is anticipated to expand over the next five years

AT&T and Verizon continue to expand influence in these services in hopes to gain market dominance during the industry transition

- While the number of mobile internet connections is expected to reach its peak at some point in time, the rate at which these connections are growing does not seem to be slowing

o This is crucial when you take into consideration that mobile internet connections are the greatest threat to the industry aside from VoIP.

Key Success Factors:

Here is a brief analysis on the most essential factors firms need to succeed in this industry and

how well CenturyLink is doing with these factors.

1. Providing backhaul capacity for mobile phone providers

o While CenturyLink operates 12.1 million access lines most of its network

infrastructure is copper wire, which is inferior in terms of data transfer speeds

and bandwidth vs fiber optic cabling.

According to CTL’s 2015 10-K, “As of Dec. 31, 2014, we maintained

approximately 1.1 million miles of copper plant and approximately 177

thousand miles of fiber-optic plant.” Hence, in order to really capitalize

on this opportunity the company needs to invest in the improvement of

its network which is expected to cost a lot of time and money

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2. Must offer a diversified range of products

o CenturyLink does a good job of providing a diverse bundle of products and the

company also allows customers to choose which services to bundle. The only

issue with this key success factor is that the price in which CTL offers these

services are not as low cost as its larger competitors, whose price structures and

better infrastructure allows the company to charge lower prices.

3. Accessibility to customers

o CenturyLink does not receive the best brand recognition or brand equity with its

consumer segment, but the company is doing particularly well with business

clients. Considering the fact that Business clients in this industry are a source of

stability (long-term contracts) this allows CTL to continue investing in its

infrastructure and in direct advertising to the consumer segment

o Furthermore, the business segment’s share of industry revenue is going to

increase over the next five years whilst the Consumer Segment’s share is likely to

decrease

4. Ability to allocate service to area of greatest need

o While it is difficult to fairly assess CenturyLink’s competence at this factor, the

fact that most of CTL’s network is copper wired does limit its ability to provide

the best service even when the network isn’t too heavily taxed. Hence, it is

reasonable to assume that while CTL is able to some extent manage its network

the possibility that other firms with better infrastructure can do this more

effectively with less effort. CenturyLink admits this in its 10-K.

Basis of Competition

Competition in the Wired Telecom industry takes three forms: price, integrated services, and

service quality/reliability. Because it is very difficult for most consumers to differentiate the

quality between two wired telecom firms, customers make a purchasing decision based on the

price. If one firm provides a wider range of services for a smaller price then the consumer is

much more likely to purchase a plan with that company. This then leads to the second form of

competition in the industry of integrated services or “bundles”. Businesses and consumers

alike show a preference for just one provider for all the businesses and consumers

communication needs as opposed to many different ones. Hence, the more services that a firm

can offer the more valuable its service is perceived by customers/businesses. For business and

governmental clients, service reliability and quality are much more important than price.

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Corporate Control (Share Ownership and Management)

Glen F. Post III - CEO, President, Director:

Current Chief Executive Officer, President, and Director of

CenturyLink, Glen F. Post III, is with CTL since 1976 (39 years). Post

graduated from Louisiana Tech University in 1976 with a Bachelor’s

in Accounting and an MBA in Business Administration. CenturyLink

was Glen Post’s first job out of college, and he quickly worked his

way up the corporate ladder being named Vice President in 1982.

Post continued to climb the corporate ladder, and was appointed

as Chief Executive Officer (CEO), President, and Vice Chairman of the Board in 1992. The

following list shows the positions Glen Post held since joining CTL in 1976:

1976 – Joined CenturyLink

1982 – Appointed as Vice President

1984 – Senior Vice President and Treasurer

1985 – Board of Directors

1986 – CFO and Senior VP

1988 – COO and Executive VP

1990 – COO and President

1992 – CEO, President, and Vice Chairman of the Board

2002 – CEO and Chairman of the Board

2009 – CEO and President

Post held positions including COO, CFO, and Treasurer for CenturyLink, so he shows a strong

understanding of operations, accounting, and finances in the telecommunications industry.

Post’s position as CEO at CenturyLink for 23 years allowed him to grow CTL’s revenues to over

$18 billion in 2014, up from $360 million in 1992 when first appointed as CEO. Furthermore, in

ten years, Post was able to lead CTL, through the acquisitions of Qwest and Embarq, from the

8th to the 3rd largest telecommunications company in the United States. Due to Post’s

performance, his fixed salary increased by 13.6% for 2015 bringing his annual fixed salary to

$1,250,000 (up from $1,100,000 for 2014). In 2014, Post additionally earned a performance-

based salary of $1,597,200. Restricted stock awards totaled $9,581,227 while pension increased

by $745,535, and other compensation was $107,486. This brought Post’s 2014 aggregate salary

and benefits to $13,131,448, which showed a 46% increase over his 2013 salary and benefits of

$8,993,247.

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R. Stewart Ewing Jr. – CFO, Executive VP, Assistant Secretary:

Chief Financial Officer, Executive Vice President, and Assistant Secretary,

R Stewart Ewing Jr., is with CenturyLink since 1983 when first appointed

as Vice President of Finance. Ewing holds a Bachelor’s degree in Business

from Northwestern State University in Louisiana. Ewing’s positions at CTL

since 1983 include:

1983 – VP of Finance

1984 – VP and Controller

1989 – CFO and Senior VP

1999 – CFO and Executive VP

2009 – CFO, Executive VP, and Assistant Secretary

Ewing played an important role in the acquisition strategy of CenturyLink by negotiating all

stages of the purchase agreements. This includes anything from legal to regulatory matters, as

well as folding new companies into CTL’s corporate philosophy and structure. Stewart’s fixed

salary for 2014 is $650,000 and total compensation is $3,842,520. Nearly 50% of his 2014 total

compensation came in the form of Restricted Stock Awards.

Aamir M. Hussain – Chief Technology Officer, Executive

VP

As Chief Technology Officer and Executive Vice President, Aamir

Hussain is with CenturyLink since October 2014. Aamir holds a

Master’s Degree in Electrical Engineering from Georgia Institute of

Technology. Before joining CTL in 2014, Hussain worked in the

Netherlands as Liberty Global’s managing director and chief

technology officer for Europe. He also held technology and

leadership roles in other telecommunications firms including Qwest (acquired by CenturyLink),

TELUS, Motorola, and Samsung. As Chief Technology Officer for CenturyLink, Hussain and his

team are responsible for designing, delivering, and implementing next generation products,

services, and technologies essential to the company’s strategic growth goals. Hussain only

worked for CTL for three months in 2014, and as such his fixed salary is only $85,892 and

received a cash-signing bonus of $100,000. His 2014 total compensation was $3,100,634 with

over 75% of the compensation coming in the form of Restricted Stock Awards.

16 | P a g e

Girish K. Varma – President, Global IT Services, New

Market Development

In 2011, Girish K. Varma joined CenturyLink as Executive Vice

President and Information Technology Services. In 2014, he was

promoted to President and given the title of Global IT Services as

well as New Market Development. Prior to joining CenturyLink,

Varma was Senior VP and Chief Information Officer at Qwest.

When Qwest was acquired by CTL in 2011 Varma got hired to work

at CenturyLink. Other notable positions Varma held include:

IBM – VP of Global Application Services

AT&T – VP and Chief Information Officer

Bell Laboratories – VP of Information Technologies

Varma not only shows a lot of experience in the telecommunications industry, but he also held

positions with major competitors including Qwest and AT&T. He graduated with a Masters

Degree from Banaras Hindu University in India, as well as a PhD from the City University of New

York. Additionally, Varma received numerous awards for business achievement and software

excellence. Varma’s salary and compensation plan are not listed on CTL’s 2014 proxy

statement.

Stock Ownership Requirements:

Under CenturyLink’s stock ownership guidelines, all executive officers are required to own CTL

stock at market value equal to a multiple of their annual fixed salary. CEO Glen post is required

to own six times his annual salary of $1,100,000, or a market value of $6,600,000 in stock. As of

the end of 2014, CEO and President Glen Post owned a total of $42 million in stock, which is

over six times higher than the target ownership level. All other executive officers are required

to hold three times their annual salary in the form of stock valued at market value. Other

executive officers at CenturyLink held an aggregate of $26.3 million in CTL stock; their stock

holdings are 350% higher than the aggregate target ownership for executive officers. All

executive officers met the stock ownership requirements for 2014, with most officers

significantly exceeding their requirement. The excess ownership of stock over the requirement

indicates that current management and executive officers show optimistic growth projections

for the future.

Outside Directors are also subject to stock ownership requirements equal to five times the

annual cash retainer. The 2014 annual cash retainer is $65,000, so outside directors were

required to hold at least $325,000 at market value in common stock. At the end of 2014, two

directors failed to meet this requirement; the remaining directors held significantly more stock

than the directors were required to. Again, this excess ownership is a potential signal that CTL

expects strong earnings growth in the future.

17 | P a g e

CTL Compensation Plan & Comparable Companies

To compare CenturyLink’s compensation plan a larger company (based on 2014 revenues),

Verizon, as well as a smaller company, Level 3 Communications were examined. CenturyLink

compensates executive officers six different ways; a base salary (fixed annual income), a short-

term incentive bonus (non-equity incentive plan), time-based restricted stock, performance-

based restricted stock, pension, and other compensation. The following table breaks down the

characteristics of executive compensation.

Pay Element Characteristics

Salary

Annual Fixed Income (Guaranteed Salary)

Short-Term Incentive Bonus

Based on achievement of annual performance measures. Half of these payments are based on Operating Cash Flows (OCF) and the other half are based on core revenue. The committee can make adjustments based on performance against individual objectives.

Time-Based Restricted Stock

Annual long-term equity rewards that vest based on years of service as an executive at CTL

Performance-Based Restricted Stock

Long-term annual variable rewards that vest three years from the date of grant. Half of the shares are based on CTL’s relative three-year performance vs. CTL’s custom total shareholder return industry peer group and the other half based on a three-year revenue target.

All Other Compensation

Comprised of personal use of aircraft, reimbursements for physical examinations, reimbursements for leased vehicles, and relocating executives and their families.

Verizon (VZ) uses a very similar compensation structure, however, VZ uses different metrics to

determine performance-based compensation. Verizon metrics include adjusted EPS (50% of

bonus), FCF (25%), total revenue (20%), as well as diversity and sustainability (5%). Likewise,

Level 3 Communications uses a similar compensation structure with a difference in

performance-based metrics used to determine annual variable compensation. Below is a table

that summarizes the CenturyLink executive compensation:

18 | P a g e

CenturyLink Summary Compensation Table

Name and Principal

Position Year Salary Bonus

Restricted

Stock

Awards(1)

Non-Equity

Incentive Plan

Compensation(2)

Change in

Pension

Value(3)

All Other

Compensation(4) Total

Glen F. Post, III

Chief Executive Officer and

President

2014 $ 1,100,000 $ — $ 9,581,227 $ 1,597,200 $ 745,535 $ 107,486 $ 13,131,448

2013 1,100,000 — 6,086,446 1,683,000 — 123,801 8,993,247

2012 1,047,606 — 5,157,049 1,767,836 649,156 103,392 8,725,040

Karen A. Puckett

President, Global Markets

2014 725,000 — 2,917,475 771,980 483,645 59,910 4,958,010

2013 725,000 — 2,106,061 854,123 — 53,845 3,739,029

2012 684,562 — 2,250,332 1,015,837 411,822 42,838 4,405,391

R. Stewart Ewing, Jr.

Executive Vice President,

Chief Financial Officer and

Assistant Secretary

2014 650,000 — 1,992,894 692,120 462,796 44,710 3,842,520

2013 650,000 — 1,438,623 729,300 — 55,769 2,873,692

2012 616,105 — 1,744,036 914,696 415,853 38,595 3,729,286

Stacey W. Goff


Chief Administrative

Officer, General Counsel

and Secretary

2014 520,890 — 1,609,657 611,942 339,053 45,600 3,127,142

2013 500,000 — 1,106,631 561,000 — 37,527 2,205,158

2012 450,096 — 1,293,966 526,336 220,263 15,965 2,506,626

Aamir Hussain(5) 2014 85,892 100,000 (6) 2,486,653 83,144 (7) — 344,945 3,100,634


Chief Technology Officer

CEO of CenturyLink, Glen Post, received $13,131,448 in total compensation for 2014, which indicates a 46% increase over his 2013 compensation. This large increase in compensation is mostly from Restricted Stock Awards due to strong three-year performance relative to the custom total shareholder return industry peer group. In 2014, Verizon’s CEO and chairman, Lowell Macadam, received $18,306,509 in total compensation, or nearly 40% more than Glen Post of CenturyLink. Level 3 Communications President and CEO, Jeff Storey, received $10,850,861 in total compensation in 2014, which is only 17% less than Glen Post. The trend continued for each company’s top five paid executives; Verizon executives aggregate total compensation was about 45% more than CenturyLink, and Level 3’s executives total compensation was about 15% less than CenturyLink.

19 | P a g e

The above pie chart breaks down the percentage of total compensation for CenturyLink’s CEO

Glen Post. 73% of his salary is based on time-based restricted stock and performance-based

restricted stock. Since Post is CEO of CenturyLink for 23 years a lot of his compensation comes

from time-based compensation, which vest based on years of service as an executive with CTL.

Furthermore, strong three year performance based on core revenue and custom shareholder

return industry peer group.

Conclusion:

CenturyLink’s executive officers compensation relies heavily on performance relative to the

industry, operating cash flows, as well as their effectiveness of generating returns for

shareholders. Over 55% of executives aggregate salaries come in the form of long-term stock

rewards; this ensures their compensation is tied to shareholder interest, and prevents

executives from managing earnings in such a way that destroys shareholder value in the long-

term. Furthermore, executives are required to hold a multiple of their salary in common stock

at market value. This also encourages executives to ensure that shareholder value is added and

not simply managing earnings for their own benefit. CEO Glen Post held nearly 700% more

stock than required, and other executives held 350% more than required. Their excess holdings

in CenturyLink stock are a potential indication that officers and management show strong

earnings forecasts in the future.

Comparing CenturyLink’s executive compensation to Verizon and Level 3 indicated that

CenturyLink’s executives are well-compensated, but not over compensated. All three

companies use similar compensation structures, with CenturyLink executives compensated

about 45% less than Verizon and only 15% more than Level 3 Communications.

8%

73%

12%

6%

1%

CTL CEO Compensation (2014)

Salary

Restricted Stock Awards

Non-Equity Incentives

Change in Pension

Other

20 | P a g e

CenturyLink Financial Analyst Rankings & Opinion

Negative Earnings Surprise:

In Q2 CenturyLink failed to meet the Street Consensus for earnings across the board, with the

most notable discrepancies being EBITDA roughly 4% below estimates and Operating Cash Flow

Margins falling short 1.3%. While most of these discrepancies are relatively small, the

discrepancies still merited a small readjustment in Q3 earnings estimates as well as a decrease

in forecasted earnings for FY2016 and FY2017. Because each analyst report shows a slightly

different perspective on the cause of the revenue shortfall and the implications for the firm,

two professional earnings forecasts are listed along with the analyst’s expectations on

CenturyLink’s coming performance.

JPMorgan Analyst Report Highlights:

JPMorgan: CTL Earnings Estimates

$ in mm 2015E 2016E %Change Y/Y

Revenue $17,753 $17,694 -0.33%

EBITDA $6,703 $6,557 -2.18%

Operating Cash Flow $5,399 $4,060 -24.80%

Free Cash Flow $3,373 $1,843 -45.36%

EPS $6.06 $3.41 -43.73% Source: Thomson One Database

For the sake of clarity the earnings portion of JPMorgan’s two-year forecast for CenturyLink are

provided. Key take away facts from this table and analyst report are:

JPMorgan projects that CenturyLink is forecasted to continue to decline in revenue and

profitability as its Legacy Services continue to lose relevance and its Strategic Services

are forced to maintain low margins due to intense competition.

Despite the fact that CenturyLink’s payout ratio is projected to reach 90% in 2016 it

won’t mean much as the company is projected to lose a whopping 45.36% in free cash

flow that year.

Due to declining profitability, projected deterioration in the economic fundamentals

of the industry, and CenturyLink’s inability to improve on operating metrics in recently

acquired Qwest territories JPMorgan remains neutral on the stock.

o Yet paradoxically JPMorgan maintains its price target of $30.00 as JPMorgan

expect the market to continue to overvalue CenturyLink’s earnings potential.

21 | P a g e

Morgan Stanley Analyst Report Highlights:

Morgan Stanley Research put together an excellent analyst report that provides a more in-

depth analysis of CenturyLink’s performance over the past four years as well as a two year

forecast. This makes it a perfect addition to the background industry analysis, which also takes

place from 2010-2020. First all of the relevant tables from Morgan Stanley’s Report are

provided.

Morgan Stanley: CTL Earnings Estimates Revision

2015E

Adjusted Previous % Change

Revenue $17,765 $17,914 -0.83%

EBITDA $6,741 $6,935 -2.80%

Free Cash Flow $2,537 $2,556 -0.74%

Earnings Per Share $2.49 $2.71 -8.12%

Morgan Stanley: CTL Earnings Estimates Revision (Cont.)

2016E 2017E

Adjusted Previous % Change Adjusted Previous % Change

Revenue $17,623 $17,932 -1.72% $17,572 $17,988 -2.31%

EBITDA $6,483 $6,837 -5.18% $6,414 $6,676 -3.92%

Free Cash Flow $1,272 $1,273 -0.08% $1,533 $1,565 -2.04%

Earnings Per Share $2.31 $2.76 -16.30% $2.40 $2.74 -12.41%

Morgan Stanley: Dividend Yield Forecasts

2015E 2016E 2017E

AT&T 5.4% 5.5% 5.6%

Verizon 4.8% 4.9% 5.1%

CenturyLink 7.8% 7.8% 7.8%

Frontier 8.1% 8.1% 8.1%

Windstream 10.6% 10.6% 10.6%

TDS 1.8% 1.9% 2.0% Source: Thomson One Database

From a quick look it is easy to identify a few major facts from the above tables:

While adjustments are mostly minor across the board, Morgan Stanley also projects

major declines in CenturyLink’s profitability as seen by the predicted 49.86% decrease

in FCF from 2015 to 2016 and an overall decrease of 39.57% from FY2015 to FY 2017.

o However, Morgan Stanley projects that FCF is expected to increase shortly

thereafter in FY2017 as CenturyLink gets a grip on its operating segments. This

potentially indicates a turnaround

22 | P a g e

Adjustments to EBITDA are relatively large verifying JPMorgan’s statement on

CenturyLink’s declining EBITDA margins via cross examination

o While adjustments to EPS were the largest the overall decrease over the next

two years is small compared to the decrease in FCF.

Nevertheless, this is extremely problematic, as CenturyLink needs to

increase its payout ratio to avoid its shareholders sinking an earnings

drop dramatically. This comes at the cost of CenturyLink making the

much needed investments in its infrastructure to stay relevant.

From the Dividend yield forecasts it is evident that the top competitors (ATT and

Verizon) are growing in dividend yield whilst CenturyLink struggles to maintain its

dividend yield.

Analyst Rankings and Buy/Sell/Hold Recommendations:

Wall Street Analyst Opinions

Buys Buy/Holds Holds Hold/Sells Sells

6 2 8 1 0

Source: S&P Capital IQ

Wall Street Analyst opinions are provided above regarding CenturyLink in order to gauge what

the market’s perspective on the company is. The key takeaways from this table is:

Because CenturyLink is paying and expected to continue to payout most of its free cash

flow the majority of Wall Street Analysts agree to buy and/or hold the stock despite

serious issues with business and economic fundamentals

o Consensus on Wall Street is that CenturyLink is expected to continue to be

overvalued for quite some time and not to short the stock until more dividend

revenue is earned

o If not overvalued, Wall Street also believes in CenturyLink’s ability to push

through its operating struggles and eventually capitalize on the market position

in time.

This follows from Morgan Stanley’s two year projection for CenturyLink’s

free cash flow to rebound



CenturyLink

Table of Contents




Year over Year (YoY) Growth Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 25-26

Average Growth Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 27-28

Financial Ratio Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 29-36

Price Performance Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 38-44






Executive Summary: Financial Ratio and Price Performance Analysis

Price Performance

CenturyLink (CTL) underperformed both the SPX and RGUST14

CTL’s price performance for the past decade is mediocre with respect to its peer group and CTL’s returns are

positive but negligible.

o CTL’s last twelve month performance is the worst in its peer group for both pure price performance

and ratio performance

CTL is the bottom of its peer group, due to poor acquisition performance including a $1.1

billion impairment of goodwill, with a price of $63.03 vs. the top performer Vonage Holdings

(VG) with price $192.55 and median performer Cogent (CCOI) with price $92.45.

Financial Performance d

0

0.5

1

1.5

2

2.5

3

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Altman Z-Score Annual Trend

Values below the red indicates impending

financial distress/equivalently bankruptcy

CTL continued to decline in the Altman Z-score

and the cause of primary drivers are as follows:

I. The merger with Qwest doubled CTL’s

assets but, earnings before interest

and taxes remained constant

II. CTL took on debt to pay for Qwest

which means retained earnings relative

to its assets decreased

III. Revenue was largely unaffected by the

merger despite its assets doubling

DuPont Analysis

DuPont analysis reveals that the primary cause of declining return on equity is loss of net margin

CTL continues to take on more debt which is common for the industry

CTL maintained and kept its total asset turnover ratio consistent over the last decade despite large mergers and acquisitions with Qwest, Embarq and others

CTL’s acquisition of Qwest led to an inability to control costs (COGS & SGA), which is destroying profitability.

o The 72% decrease in profit margin in 2011 and the 131% decrease in 2013 due to a $1.092b impairment

of goodwill are the primary cause of the 114% decrease in return on equity during 2011-2013.

o Even without extraordinary items CTL’s profit margin dropped 48.6% between 2012 and 2013 however

in 2013-2014 the profit margin rose 59.9%. If CTL continues to earn future losses its losses on the

Income statement are expected to be magnified because of future impairments.

o Furthermore, operation’s failure to capitalize on the Qwest acquisition pushed CTL into financial

distress as shown in the Altman Z-Score annual trend (anything below the red line indicates distress).

Despite the rebound in 2014, CTL made little progress towards mitigating distress

CTL’s financial performance in terms of ratio and growth analysis is summarized as follows:

o Revenue growth is 29.38% per year compared to top performer J2 Global with 19.52% average

o Interest coverage of 1.84 is three times less than the industry average; this is problematic given their

lack of profitability

o CTL’s TATO is worse than its main competitors, indicating an inefficient use of acquired assets

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

DuPont Key Drivers

Profit Margin Return on Equity0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

DuPont Analysis: Equity Multiplier

0.00x

0.10x

0.20x

0.30x

0.40x

0.50x

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

DuPont Analysis: Total Asset Turnover

0.00x

0.10x

0.20x

0.30x

0.40x

0.50x

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014


25 | P a g e

Ticker Company

CTL CenturyLink

ATNI Atlantic Tele-Network

CCOI Cogent Communications Holdings

CNSL Consolidated Communications Holdings

FTR Frontier Communications Corp

JCOM J2 Global Inc.

TU TELUS Corp

VG Vonage Holdings Corp

WSTC West Corp

Industry Industry Averages

Year-over-Year Growth Performance

Growth performance year over year (YoY) examines the annual growth rate of revenue,

operating income, net income, and earnings per share between 2010 and 2014.

Ticker 2014 2013 2012 2011 2010

ATNI 14.86 -60.5 -2.35 22.62 156.16

CCOI 9.2 9.78 3.76 15.98 11.71

CNSL 5.68 19.49 34.52 -2.37 -5.61

FTR 0.23 -4.99 -4.41 38.06 79.31

Revenue Growth % JCOM 15.02 40.23 12.49 29.27 4

TU 5.21 3.8 5.04 6.32 1.8

VG 4.81 -2.36 -2.44 -1.66 -0.45

WSTC -17.4 1.81 5.89 4.32 0.52

CTL -0.35 -1.53 19.71 118.01 41.56

ATNI 33.54 -35.57 80.02 44.32 -45.07

CCOI 16.78 49.04 -15.17 139.93 - CNSL -12.03 94.13 -14.64 -5.07 -6.8 FTR -16.39 -0.65 9.73 16.53 27.36 Op. Income Growth % JCOM 6.15 8.18 19.28 30.82 -0.52

TU 7.54 5.13 7.06 3.14 7.86 VG -8.68 -18.98 -44.47 22.4 66.17

WSTC -3.92 0.43 2.15 11.41 4.88 CTL 65.86 -46.44 33.98 -1.7 67.05 Industry 9.87 6.14 8.66 29.09 15.12

26 | P a g e

Ticker 2014 2013 2012 2011 2010

ATNI -84.55 537.04 124.52 -43.32 8.2

CCOI -98.59 1027.35

CNSL -51.1 446.29 -78.64 -18.64 30.88

FTR 17.78 -17.42 -8.67 -2 26.4

Net Income Growth %

JCOM 16.56 -11.56 5.94 38.19 24.27

TU 10.12 -1.82 8.12 17.44 4.01

VG -28.36 -22.76 -91.05

WSTC 10.62 14.07 -1.53 111.42 -31.65

CTL 423.01 -130.76 41 -52.9 -8.93

Industry 23.94 101.64 -0.039 134.69 7.60

ATNI -84.73 529.71 121.99 -43.15 6.9

CCOI -98.35

CNSL -53.95 406.67 -82.95 -19.27 29.76

FTR 18.18 -15.38 -13.33 -34.78 -39.47

EPS Growth % JCOM 13.16 -12.64 7.41 34.25 22.3

TU 14.93 -0.25 7.75 16.15 2.55

VG -30.77 -18.75 -90.53

WSTC 3.93 -10.1

CTL 440 -132 16.82 -65.81 -3.1

Industry 24.71 93.41 4.69 18.77 3.16

In 2010 and 2011, CTL outpaced the revenue growth of many of its competitors due to the

acquisition of Savvis in 2009 and merger with Qwest in 2011. However, CenturyLink saw

declining revenue growth in 2013 and 2014. Operating income decline in 2013 is due to the

company’s $1.092 billion impairment of goodwill; CTL impaired its goodwill because of poor

performance post-merger with Qwest. CTL’s net income growth is not stable as the company

recently experienced periods of negative net income growth, mainly caused by impairment of

goodwill in 2013.

27 | P a g e

Average Growth Performance

Ticker Three Year

Average Five Year Average

Ten Year Average

ATNI -23.77 6.83 14.89 CCOI 7.55 10.01 15.33 CNSL 19.32 9.37 8.96 CTL 5.51 29.38 22.31

Revenue Growth % FTR -3.09 17.64 8.09 JCOM 21.97 19.52 18.87 TU 4.68 4.42 4.64 VG -0.05 -0.46 26.98 WSTC -3.79 -1.36 6.19

Industry 4.68 9.37 14.89

ATNI 15.7 4.19 7.83 CCOI 13.87

CNSL 13.39 5.22 10.06 CTL 5.97 14.34 12.32 OP Income Growth % FTR -3.04 6.23 5.41

JCOM 11.06 12.26 15 TU 6.57 6.13 5.11 VG -25.66 -3.52 WSTC -0.48 4.55 6.08

Industry 4.15 6.18 8.83

ATNI 30.24 6.26 14.79 CCOI -52.72

CNSL -17.06 -9.56 CTL 10.45 3.59 8.63 Net Income Growth % FTR -3.87 1.93 6.3 JCOM 2.98 13.4 14.77

TU 5.34 7.38 9.68 VG -63.27

WSTC 7.5 12.42 3.42 Industry 2.98 5.06 9.60

ATNI 28.76 5.35 12.06 CCOI -51

CNSL -26.46 -16.06 CTL 8.32 -15.89 -5.56

EPS Growth % FTR -4.66 -19.31 -5.55 JCOM 2.02 11.76 15.05 TU 7.3 8.03 11.4 VG -62.38

WSTC 1.27 Industry -1.32 -4.35 5.48

28 | P a g e

Again, it is easy to see that Century Link is greatly outperforming its competitors in terms of

revenue growth due to recent mergers and acquisitions. However, the table clearly shows the

issues with CTL’s operating expenses as a proportion of sales. Assuming operating income grew

at the same pace as sales growth it is expected that operating income average 29.38% per year

over the last five years. In reality, operating income only grew by 14.34% per year, which shows

that sales growth outpaced operating income growth by 104.9%. In 2013, impairment of

goodwill (expense of $1.092 billion) caused operating income and net income to suffer. Also,

SG&A and other operating expenses peaked in 2013 and are since declining. In the most recent

six quarters, CTL successfully decreased its operating expenses, which is helping operating

income growth catch-up to sales growth.

Average Growth Performance Analysis:

As shown in the growth performance section, CenturyLink (CTL) merged with Qwest in April

2011, which increased net sales by 118%. This merger forced CTL to change its capital structure

as CTL is taking on more debt. The telecommunications industry continues to grow more

competitive since the Telecommunications Act of 1996, which is meant to stimulate

competition in the industry. CTL’s changing capital structure lead to large interest expenses and

increased the risk of the firm.

29 | P a g e

Profitability Ratios

Ticker 2014 2013 2012 2011 2010

ATNI 14.32 106.45 6.6 2.87 6.21 CCOI 0.21 16.29 -1.34 2.47 0.25 CNSL 2.37 5.12 1.12 7.6 8.5 CTL 4.28 -1.32 4.23 3.73 13.46

Profit Margin % FTR 2.78 2.37 2.73 2.85 4.02

JCOM 20.76 20.65 32.74 34.76 32.52 LVLT 4.63 -1.73 -6.62 -17.45 -17.04 RNG -21.98 -28.72 -30.9 -17.63 -14.55 TU 11.95 11.42 12.07 11.72 10.6

VG 2.33 3.41 4.31 47 -9.45 Industry 2.74 2.02 1.03 2.87 3.45

ZAYO -11.53 -15.96 -13.66 -0.33

ATNI 25.4 21.9 13.4 7.3 6.2 CCOI 14.2 13.3 9.8 11.9 5.8 CNSL 14.3 17.2 10.6 16.7 17.2 CTL 13.37 8.02 14.76 13.19 29.25

Op. Profit Margin % FTR 17.2 20.6 19.7 17.2 20.3 JCOM 31.1 33.7 43.7 41.2 40.7 LVLT 14.9 10.5 9 1.2 -2.5 RNG -20.56 -25.56 -29.54 -17.55 -14.52

TU 20 19.5 19.3 18.9 19.5 VG 5.5 6.3 7.6 13.4 10.7 Industry 13.45 11.86 11.75 12.91 13.26

ZAYO 12.55 4.99 10.91 18.59


Return on Assets % FTR 0.75 0.66 0.78 0.85 1.23 JCOM 8.7 10.1 14.77 19.39 17.55 LVLT 1.86 -0.83 -3.18 -7.02 -7.14 RNG -28.99 -44.21 -77.81

TU 6.36 6.16 6.53 6.17 5.35 VG 3.08 4.75 6.58 98.97 -29.16 WSTC 4.34 4.13 3.75 4.09 1.99 ZAYO -3.86

Industry 1.69 2.94 1.41 2.38 0.27

30 | P a g e

Ticker 2014 2013 2012 2011 2010


Return on Equity FTR 3.45 2.76 3.19 3.1 5.53 JCOM 16.29 16.53 21.16 23.28 21.63 LVLT 8.08 -8.44 -35.6 -145.95 -372.46 RNG -60.42 -144.99 -4634.71

TU 18.42 16.48 17.34 15.54 13.2 VG 5.94 8.58 11.8 481.45 ZAYO -35.06

Industry 5.94 12.53 5.17 7.54 11.56


ROI (Operating) FTR 5.44 4.63 4.56 4.38 5.25 JCOM 10.51 12 15.53 23.08 20.32 LVLT 7.38 6.77 5.87 0.65 -1.36 RNG -41 -68.68 -286.12

TU 10.78 10.64 10.89 10.54 9.94 VG 4.99 7.52 10.5 178.43 WSTC 15.95 17.3 17.7 18.31 16.69 ZAYO 1.57

Industry 3.20 7.52 6.55 6.72 9.31


EBITDA Margin FTR 35.47 35.06 35.08 34.17 36.56 JCOM 33.7 33.32 45.33 43.09 42.92 LVLT 23.67 20.67 15.93 14.65 17.89 RNG -16.31 -19.8 -24.1 -12.91 -11.95 TU 20.02 19.63 19.63 19.18 19.11

VG 7.45 6.89 7.89 12.02 -3.86 WSTC 22.65 21.37 22.24 23.17 19.96 ZAYO 31.46 31.14 36.76

Industry 23.61 22.59 23.14 23.80 23.61

31 | P a g e

In the two years prior to CenturyLink’s merger with Qwest, CTL averaged a 13.24% profit

margin and a 27.02% operating profit margin; the following four years yielded an average profit

margin of 2.73% and operating margin of 12.34%. However, CTL’s negative 1.32% profit margin

in 2013 is negatively impacted by the impairment of goodwill in the amount of $1.092 billion

(6.03% of 2013 sales). By excluding 2013, CTL averaged a 4.08% profit margin since the merger

compared to an average industry profit margin of 4.42%. Although profit margins dropped

significantly after the merger, CTL’s profit margin is still within the average industry profit

margins. A similar trend continues with the other profitability measures; there is a drop-off in

financial performance after the merger, but even after the drop-off CTL is still performing as

well as the industry and other competitors.

Liquidity Ratios

Ticker 2014 2013 2012 2011 2010

ATNI 0.69 -0.77 1.19 0.93 1.05 CCOI 0.72 0.84 1.61 1.69 1.84 CNSL 1.37 1.26 1.07 1.61 1.5 CTL 1.25 1.23 1.41 1.67 1.5

OCF Ratio FTR 0.9 1.05 1.13 1.2 1.33 JCOM 1.29 1.99 2.49 2.61 2.22 LVLT 0.69 0.44 0.33 0.29 0.27 RNG -0.18 -0.49 -0.45

TU 1 0.95 0.87 0.64 0.76 VG 0.49 0.45 0.6 0.74 1.17 WSTC 0.87 0.8 0.73 0.89 0.85 ZAYO 1.86 2.16

Industry 0.91 0.83 1.00 1.23 1.25


Current Ratio FTR 0.98 1.24 1.34 1.07 0.78 JCOM 4.05 3.39 4.78 3.68 2

LVLT 0.78 1.01 1.02 1.03 1.02 RNG 2.09 2.45 0.99 0.77

TU 0.62 0.71 0.63 0.53 0.35 VG 0.62 0.8 0.81 0.61 0.65

WSTC 1.65 1.8 1.66 1.49 1.59

ZAYO 1.58 1.08

Industry 2.01 1.71 1.80 1.73 1.26

32 | P a g e

Ticker 2014 2013 2012 2011 2010


Quick Ratio FTR 0.94 1.18 1.2 0.8 0.57 JCOM 3.9 3.18 4.57 3.41 1.66 LVLT 0.68 0.9 0.94 0.94 0.91 RNG 1.96 2.16 0.73 0.29 TU 0.47 0.55 0.48 0.4 0.25 VG 0.36 0.54 0.63 0.37 0.49 WSTC 0.82 1.47 1.35 1.2 1.26

ZAYO 1.01 0.55

Industry 1.69 1.43 1.59 1.46 1.03

CTL’s operating cash flow (OCF) ratio shows that it is generating enough operating cash flow to

cover its current liabilities. Between its competitors, CTL is one of only two companies to

maintain an OCF ratio over 1.0 in the most recent five years. CenturyLink is effectively

minimizing current liabilities and still generating good operating cash flows. Despite its effective

use of current liabilities, the company does not use many current assets either. CTL’s poor

current and quick ratios expose a potential liquidity issue; deferred taxes make up 24.6% of

Century Link’s current assets, which is, in part, why CTL shows the lowest quick ratio between

its competitors. CTL’s worst liquidity ratios are in 2012 after the company acquired Qwest due

to higher amounts of short-term debt which Century Link used to finance the merger. Since

2012, CTL’s ratios are trending up towards the average industry trends. Although CTL’s liquidity

ratios are still below average and indicate potential liquidity issues, the company is generating

enough operating cash flows to cover short-term liabilities.

33 | P a g e

Leverage Ratios

Ticker 2014 2013 2012 2011 2010

ATNI 0.05 0.75 0.87 0.96 CCOI 7.11 2.06 2.41 2.28 1.16 CNSL 4.21 8.2 9.16 20.69 13.2 CTL 1.34 1.17 1.01 1.03 0.76

LT Debt to Equity FTR 2.59 1.94 2.04 1.84 1.54 JCOM 0.72 0.35 0.41

LVLT 1.73 5.9 7.27 7.03 RNG 0.09 0.39 184.94

TU 1.21 0.93 0.74 0.73 0.67

VG 0.42 0.32 0.08 0.19 Industry 2.48 2.59 20.88 4.33 3.05 ZAYO 7.79 4.65

ATNI 0.06 0.8 0.96 1 CCOI 7.29 2.56 2.47 2.36 1.21 CNSL 4.24 8.27 9.23 20.91 13.21 CTL 1.38 1.22 1.07 1.05 0.76

Total Debt to Equity

FTR 2.67 2.01 2.18 1.86 1.59

JCOM 0.72 0.35 0.41

LVLT 1.78 5.93 7.46 7.08 RNG 0.27 0.55 96.89

TU 1.26 0.98 0.87 0.93 0.83 VG 0.49 0.4 0.18 0.3 Industry 2.55 2.70 1.63 1.46 3.10 ZAYO 7.84 4.69

ATNI 203.75 5.28 6.4 3.12 4.07 CCOI 0.87 1.18 0.9 1.08 0.97 CNSL 1.1 1.21 0.74 1.27 1.3 CTL 1.84 1.12 2.06 1.89 3.7 Interest Coverage FTR 1.18 1.45 1.44 1.36 1.49

JCOM 5.97 8.25 22.4

LVLT 1.55 1.03 0.79 0.07 TU 5.17 4.93 6.16 5.05 4.04 VG 7.23 8.38 10.99 6.85 1.98 WSTC 2.46 2.06 1.76 1.74 1.66 ZAYO 0.28 0.54 1.38

Industry 1.84 3.22 5.00 2.49 2.40

34 | P a g e

Leverage Ratios (cont.)

Ticker 2014 2013 2012 2011 2010

ATNI 7.77 9.17 11.55

CCOI 2.47 2.64 2.57 2.79 4.3

CNSL 3.05 3.01

CTL 5.22 4.62 5.68 5.64 6.27

EBITDA to Int. Coverage

FTR 2.82 3.22 3.28 3.46 3.19

LVLT 2.78 2.26 1.81 1.2 1.33

RNG -17.35 -5.95 -18.39 -65.15 -32.74

TU 9.25 8.99 10.32 10.02 6.99

VG 14.54 13.49 16.36 8.96 3.05

WSTC 3.41 2.63 2.43 2.37 2.34

ZAYO 1.94 2.14 3.05

Industry 2.79 3.78 3.49 3.26 3.12

CenturyLink’s long-term debt to equity ratio is steadily rising subsequent to the merger with

Qwest and the acquisitions of Savvis and Embarq. Not only did CTL use long-term debt to

finance the mergers and acquisitions, but the company is also using long-term debt to buy back

stock. The main concern for CTL is the fact that its interest coverage ratio is nearly three-times

lower than the industry average. CTL’s most recent interest coverage of 1.84 is more than

enough to cover its 2014 interest expense, however, in a bad year, CTL is prone to potentially

failing to generate enough EBIT to cover its interest. Since the wired telecommunications

industry requires a lot of capital and assets, CTL’s depreciation expense is very high. As

depreciation is a non-cash expense, EBITDA is a better measure for interest coverage. Looking

at EBITDA to interest coverage, CTL appears to be generating enough EBITDA to cover its

interest expense.

35 | P a g e

Asset Efficiency Ratios

Ticker 2014 2013 2012 2011 2010

ATNI 0.4x 0.38x 0.33x 0.83x 0.89x CCOI 0.52x 0.5x 0.51x 0.53x 0.63x CNSL 0.37x 0.32x 0.34x 0.34x 0.31x CTL 0.35x 0.34x 0.33x 0.39x 0.32x Total Asset Turnover FTR 0.28x 0.27x 0.28x 0.28x 0.3x JCOM 0.39x 0.42x 0.48x 0.45x 0.56x LVLT 0.4x 0.48x 0.48x 0.4x 0.42x RNG 01.32x 01.54x 02.52x

TU 0.5x 0.53x 0.54x 0.54x 0.53x

VG 01.36x 01.32x 01.39x 01.53x 02.11x WSTC 0.61x 0.77x 0.79x 0.8x 0.79x ZAYO 0.24x

Industry 0.56x 0.62x 0.73x 0.61x 0.69x

ATNI 07.66x 07.43x 05.42x 010.47x 011.59x CCOI 012.05x 011.93x 012.74x 012.93x 012.54x CNSL 010.55x 09.81x 010.88x 010.7x 09.66x CTL 09.1x 09.29x 09.47x 011.52x 010.07x

A/R Turnover FTR 010.7x 09.68x 09.91x 08.72x 08.85x JCOM 08.31x 07.54x 09.96x 013.18x 018.09x LVLT 09.61x 09.1x 09.34x 09.5x 012.44x

RNG 041.12x 055.97x 073.12x

TU 09.52x 08.67x 07.55x 07.82x 09.58x VG 037.47x 046.17x 041.39x 044.37x 052.64x WSTC 05.51x 06.x 06.13x 06.39x 06.56x ZAYO 01.29x

Industry 09.57x 09.29x 09.91x 010.59x 010.83x

ATNI 01.15x 01.08x 0.83x 01.59x 01.6x CCOI 01.11x 01.08x 01.07x 01.02x 01.04x CNSL 0.73x 0.63x 0.67x 0.81x 01.09x CTL 0.97x 0.96x 0.95x 01.09x 0.97x Fixed Asset Turnover FTR 0.67x 0.6x 0.65x 0.67x 0.69x JCOM 16.98x 17.26x 20.5x 21.82x 23.58x

LVLT 0.75x 0.77x 0.78x 0.64x 0.66x RNG 010.42x 09.53x 08.69x

TU 01.35x 01.36x 01.37x 01.35x 01.33x VG 019.44x 017.06x 014.7x 013.21x 011.84x WSTC 06.21x 07.36x 07.35x 07.2x 07.08x ZAYO 0.43x

Industry 01.13x 01.08x 01.07x 01.22x 01.21x

36 | P a g e

CTL shows worse asset turnover (TATO) than the industry average and many of its competitors;

this is due to the infrastructure and equipment required in the telecommunications industry.

However, CTL’s total asset turnover is worse than its main competitors, which indicates CTL is

not efficiently using its assets to generate sales. Property, plant & equipment (PP&E) turnover

for CTL is much better than its total asset turnover; CTL is using its net fixed assets more

efficiently than total assets. The large difference between its TATO and PP&E turnover is

explained by goodwill. CenturyLink’s total assets equal $50.1 billion, and goodwill makes up

$20.7 billion, or 41.32% of its total assets. Since goodwill isn’t a tangible asset, PP&E is a better

measure of CTL’s effectiveness at turning assets into sales. Century Link’s PP&E turnover is still

worse than its competitors, so CTL is not effectively turning over its assets as compared to its

competitors.

Financial Ratio Analysis Conclusion

It is evident that CTL’s merger with Qwest caused many of its ratios to worsen, including profit

margin, operating profit margin, quick ratio, interest coverage, and ROE. Despite the negative

effects of the merger with Qwest, CTL’s ratios are trending upwards post-merger with Qwest.

Even with the company’s poor performance over the last three-year period as compared to pre

Qwest, CenturyLink shows average performance when benchmarked against its competitors

and the industry averages. As CenturyLink wraps up its employee-retraining program, it is

expected that operating profit margin, and profit margin is projected to rebound. However, CTL

must find a way to lower its cost of revenue and use its assets more efficiently in order to

restore the company’s performance to pre Qwest metrics.

37 | P a g e

Price Performance Analysis

Relative Strength Indices

Relative strength indices compare the price performance of several securities relative to an index by plotting the end of the day price of the

securities divided by the end of the day value of the index. This allows analysts to quickly rank the price performance of the target – in this case

CenturyLink – amongst comparable companies. The following relative strength indices reflect price performance for the last twelve months with

respect to the Russell 3000 Wired Telecommunications Subsector (RGUST14) and the S&P 500 (SPX). **Note: Charting all comparable

companies requires two graphs because Bloomberg only allows for eight companies to be compared at a time.

38 | P a g e

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40 | P a g e

41 | P a g e

Summarized Monthly Price Performance for Stock Universe

For the Past Ten Years

CTL Top Performance in Stock Universe Industry Average Market

Average Return 0.05% 2.02% 0.63% 0.44%

Total Return 0.15% 0.77% 0.49% 0.36%

Standard Dev. 6.07% 6.07% 5.31% 3.93%

Cf. of Variation 6.06% 6.06% 5.28% 3.92% Source: Bloomberg Terminal. See Appendix for complete table

DuPont Analysis

DuPont Component Analysis

Year PM % ΔPM % TATO ΔTATO % EM ΔEM % ROE % ΔROE %

2005 13.49 - 0.32x - 2.146 - 9.23 -

2006 15.12 12 0.32x 1 2.3319 9 11.35 23

2007 15.75 4 0.34x 6 2.4007 3 12.86 13

2008 14.07 -11 0.32x -7 2.6094 9 11.61 -10

2009 13.01 -8 0.32x 2 2.3834 -9 10.01 -14

2010 13.46 3 0.32x -2 2.2844 -4 9.71 -3

2011 3.73 -72 0.39x 24 2.6955 18 3.95 -59

2012 4.23 13 0.33x -15 2.8006 4 3.95 0

2013 -1.32 -131 0.34x 3 3.0124 8 -1.36 -134

2014 4.28 324 0.35x 3 3.338 11 5.06 372

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

DuPont Analysis: Key Driver of Decline

Profit Margin Return on Equity

42 | P a g e

DuPont Analysis (cont.)

2.00

2.20

2.40

2.60

2.80

3.00

3.20

3.40

3.60

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

DuPont Analysis: Equity Multiplier

0.26x

0.28x

0.30x

0.32x

0.34x

0.36x

0.38x

0.40x

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014


43 | P a g e

Key Takeaways:

DuPont analysis reveals that the primary cause of declining return on equity is loss of net margin

o The acquisition of Qwest led to the 73% decline in profit margin in 2011 due to CenturyLink’s inability to address Qwest’s cost structure issues within the same year

o The 131% decrease in profit margin is due to an extraordinary impairment loss of $1.092b to goodwill on acquired assets. This sends a clear message that the Qwest merger fails to live up to the expectations of acquirer

Indicates the possibility of future impairments if operations do not see significant improvement

Declining profitability is problematic given the steady increase in leverage averaging to 5.44% annually

Free cash flow is included in the analysis to show that CenturyLink is not just suffering a significant decline in accounting income

o Despite the rebound in profit margin in 2014 FCF continues to decline and is projected by Morgan Stanley to decline by 50% in 2016.

o CTL’s main priority needs to be on growing its FCF

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

DuPont Analysis: Accounting Income and Cash Flow Decline

Profit Margin Free Cash Flow

44 | P a g e

Altman Z-Score Trend Analysis

Key Takeaways:

Declining net margins as a result of acquisitions is the primary driver behind CenturyLink’s trend toward financial distress

o The largest declines in the Altman Z-score take place in 2008 and 2011, both of which are years that CenturyLink acquired new companies

o CenturyLink’s strategy to grow via acquisition is unsustainable if the company cannot find ways to improve the profit potential of the firms it purchases

o CenturyLink faces the possibility of bankruptcy if it cannot find a ways to generate more cash flow

0

0.5

1

1.5

2

2.5

3

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Altman Z-Score Annual Trend

Altman Z-Score Financial Distress Threshold

III. Cost of Capital, Capital Structure

Analysis and Distributions


CenturyLink

Table of Contents





Historical Cost of Debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 47

Historical Cost of Equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 47-48

Internal Equity Cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 48-49

Capital Structure Weights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 49-50

Forecasted Cost of Capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .-51

Payout Policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 51





45 | P a g e

Executive Summary: Cost of Capital, Capital Structure Analysis and Distributions

In 2014, the capital structure was composed

of 58.16% debt and 41.84% equity.

Cost of Debt 6.58%

Tax Rate 35.6%

After-Tax Cost 4.24%

Cost of Equity 9.87%

WACC 6.59%

Cost of outstanding debt at the end

of fiscal year 2014 is 6.58%.

CTL’s ten-year historical tax rate of

35.6% yields an after-tax cost of debt of

4.24%.

Combined with its 9.87% cost of

equity, CTL’s historical WACC is 6.59%.

CenturyLink’s WACC is currently declining from its historical average, due to an increasing

amount of financial leverage.

o Also, the company’s WACC is declining due to a low risk-free rate as compared

with the risk-free rate when CTL issued its outstanding debt.

CTL’s target capital structure consists of

60% debt and 40% equity.

Cost of LT Debt 5.35%

Cost of ST Debt 3.72%

Tax Rate 35.6%

After Tax LT Debt 3.45%

After Tax ST Debt 2.4%

Cost of Equity 9.87%

WACC 5.997%

CTL’s target capital structure shows

a forecasted WACC of 5.997%.

Forecasted cost of equity is based

upon 2.87% risk-free rate, 1.166 trailing-twelve month beta, and a market risk premium of

6.00%. Cost of L-T debt is calculated using the 2.87% risk-free rate plus a 2.48% spread due to CTL’s

BB rating from Moody’s. Cost of S-T debt is calculated by a prime rate of 3.25% plus a .47% risk-adjusted spread

58%

42%

Historical Capitalization

Debt

Equity

58%

2%

40%

Target Capital Structure

LT Debt

ST Debt

Equity

46 | P a g e

Un-levering and Re-levering Beta

𝜷𝒖𝒏𝒍𝒆𝒗𝒆𝒓𝒆𝒅 =𝑳𝒆𝒗𝒆𝒓𝒆𝒅 𝑩𝒆𝒕𝒂

𝟏 + (𝟏 − 𝑻𝒂𝒙 𝑹𝒂𝒕𝒆) ∗ (𝑫𝑬)

𝜷𝒖𝒏𝒍𝒆𝒗𝒆𝒓𝒆𝒅 = 𝟏. 𝟏𝟔𝟔

𝟏 + (𝟏 − 𝟎. 𝟑𝟓𝟔) ∗ 𝟏. 𝟑𝟗= 𝟎. 𝟔𝟏𝟓𝟑

𝜷𝒓𝒆𝒍𝒆𝒗𝒆𝒓𝒆𝒅 = 𝜷𝒖𝒏𝒍𝒆𝒗𝒆𝒓𝒆𝒅 ∗ (𝟏 + ((𝟏 + 𝑻𝒂𝒙 𝑹𝒂𝒕𝒆) ∗ (𝑫

𝑬)))

𝜷𝒓𝒆𝒍𝒆𝒗𝒆𝒓𝒆𝒅 = 𝟎. 𝟔𝟏𝟓𝟑 ∗ (𝟏 + (𝟏. 𝟑𝟓𝟔 ∗ 𝟏. 𝟑𝟗)) = 𝟏. 𝟕𝟕𝟒

Un-levering CTL’s beta based on its current capital structure shows an un-levered beta of

0.6153. o Its re-levered beta, based on a target capital structure of 60% debt and 40% equity

(1.5 D/E ratio), is 1.774.

Internal Cost of Equity

𝒓𝒆𝒙𝒊𝒔𝒕𝒊𝒏𝒈 𝒆𝒒𝒖𝒊𝒕𝒚 = (𝑫𝟏

𝑷) + 𝒈

𝒓𝒆𝒙𝒊𝒔𝒕𝒊𝒏𝒈 𝒆𝒒𝒖𝒊𝒕𝒚 = (𝟐. 𝟏𝟔

𝟐𝟔. 𝟖𝟏) + 𝟓% = 𝟏𝟑. 𝟎𝟔%

𝒓𝒏𝒆𝒘 𝒆𝒒𝒖𝒊𝒕𝒚 = (𝑫𝟏

(𝑷 ∗ (𝟏 − 𝑭𝒍𝒐𝒕𝒂𝒕𝒊𝒐𝒏 𝑪𝒐𝒔𝒕))) + 𝒈

𝒓𝒏𝒆𝒘 𝒆𝒒𝒖𝒊𝒕𝒚 = (𝟐. 𝟏𝟔

(𝟐𝟔. 𝟖𝟏 ∗ (𝟏 − 𝟎. 𝟎𝟓)) ∗ 𝟓% = 𝟏𝟑. 𝟒𝟖%

CenturyLink’s Payout Policy

CTL is committed to paying the $.54 quarterly dividend and is continually paying the same

quarterly dividend since 2013.

o Its average payout ratio is 53.2% over the last ten years.

o However, in the years 2009-2012, following and preceding CTL’s merger with

Qwest, CTL’s payout ratio averaged 75.26%.

47 | P a g e

Historical Cost of Debt

For the 2014 fiscal year, CenturyLink’s cost of debt can be broken down as shown in the

following table. Total debt includes $20.121 billion of long-term debt as well as a current

portion $550 million and unamortized discounts of $111 million.

CenturyLink Cost of Debt (2014)

Debt

Amount

($mm)

YTM Weights

Weighted

Avg.

CTL Senior Notes $7,825 6.26% 0.3765 2.36%

Credit Facility $725 2.27% 0.0349 0.08%

Term Loan $380 2.42% 0.0183 0.04%

Qwest Senior Notes $7311 7.25% 0.3518 2.55%

Qwest Senior Notes $981 7.13% 0.0472 0.34%

Embarq Senior Notes $2669 7.54% 0.1284 0.97%

Mtge. Bonds – Embarq $232 7.95% 0.0112 0.09%

Other LT Debt – Embarq $150 9.00% 0.0072 0.06%

Capital Lease & Other $509 3.50% 0.0245 0.09%

Total Debt $20,782 1.00 6.58%

CTL’s 2014 corporate tax rate was 30.5%, so after tax cost of debt is: 6.58 x (1-.305) = 4.57%.

However, its average tax rate over the past ten years (excluding 2013’s tax rate of 207% due to

negative earnings) is 35.6%, which gives an after tax cost of debt of 4.24%.

CenturyLink’s capital structure is consistently increasing since its merger with Qwest in 2011,

which caused the company to take on additional debt. CTL’s total debt to equity (D/E) ratio in

2014 is 1.39, up from only 0.76 in 2010. Industry D/E is trending downwards with a 2014 ratio

of 2.28 compared to 3.10 in 2010. CTL’s debt to equity ratio of 1.39 shows it is currently

financed with 58.16% debt, compared to 67.46% for the industry. However, because the

industry is trending downwards it is assumed solvent companies in the industry are attempting

to target D/E ratios of 1.5, or 60% debt to 40% equity.

Historical Cost of Equity

To calculate CenturyLink’s cost of equity, the capital asset pricing model (CAPM) is used to

determine shareholders required return. The equation for CAPM is as follows:

𝒓𝒆𝒒𝒖𝒊𝒕𝒚 = 𝒓𝒇 + (𝜷 ∗ 𝑹𝒑)

48 | P a g e

𝒓𝒆𝒒𝒖𝒊𝒕𝒚 = 𝟐. 𝟖𝟕% + (𝟏. 𝟏𝟔𝟔 ∗ 𝟔%) = 𝟗. 𝟖𝟕%

The 30-year US Treasury bond on Friday October 16, 2015 was yielding 2.87%, which is used as

the risk free rate. A long-term bond was chosen because stocks are on-going securities, and

discounted cash flow analysis considers cash flows that are 30 years and further into the future.

CTL’s beta of 1.166 is calculated as the monthly stock price for the trailing twelve months (TTM)

regressed against the S&P500. The TTM data was used because CTL’s beta is consistently

trending up over the last five years due to increased debt and risk after the merger with Qwest

in 2011. A market risk premium of 6.0% was used based on historical market risk premiums, as

there is no basis to expect any significant changes in the MRP.

However, beta is expected to change as the company’s debt to equity ratio changes. Un-

levering and re-levering beta with the new capital structure shows the expected beta as CTL

takes on more debt. With an expected D/E ratio of 1.5, beta can be calculated with the

following equations:

𝜷𝒖𝒏𝒍𝒆𝒗𝒆𝒓𝒆𝒅 =𝑳𝒆𝒗𝒆𝒓𝒆𝒅 𝑩𝒆𝒕𝒂

𝟏 + (𝟏 − 𝑻𝒂𝒙 𝑹𝒂𝒕𝒆) ∗ (𝑫𝑬)

𝜷𝒖𝒏𝒍𝒆𝒗𝒆𝒓𝒆𝒅 = 𝟏. 𝟏𝟔𝟔

𝟏 + (𝟏 − 𝟎. 𝟑𝟓𝟔) ∗ 𝟏. 𝟑𝟗= 𝟎. 𝟔𝟏𝟓𝟑

𝜷𝒓𝒆𝒍𝒆𝒗𝒆𝒓𝒆𝒅 = 𝜷𝒖𝒏𝒍𝒆𝒗𝒆𝒓𝒆𝒅 ∗ (𝟏 + ((𝟏 + 𝑻𝒂𝒙 𝑹𝒂𝒕𝒆) ∗ (𝑫

𝑬)))

𝜷𝒓𝒆𝒍𝒆𝒗𝒆𝒓𝒆𝒅 = 𝟎. 𝟔𝟏𝟓𝟑 ∗ (𝟏 + (𝟏. 𝟑𝟓𝟔 ∗ 𝟏. 𝟑𝟗)) = 𝟏. 𝟕𝟕𝟒

These formulas show that beta without any financial leverage is 0.6153. However, with 60%

debt (1.5 D/E ratio) CTL’s beta rises to 1.774.

Internal Equity Cost

Internal cost of existing equity is calculated as next year’s dividends divided by price of the

stock, whereas internal cost of new equity is calculated as next year’s dividends divided by price

time’s one minus the flotation cost. The equations are as follows:

𝒓𝒆𝒙𝒊𝒔𝒕𝒊𝒏𝒈 𝒆𝒒𝒖𝒊𝒕𝒚 = (𝑫𝟏

𝑷) + 𝒈

𝒓𝒆𝒙𝒊𝒔𝒕𝒊𝒏𝒈 𝒆𝒒𝒖𝒊𝒕𝒚 = (𝟐. 𝟏𝟔

𝟐𝟔. 𝟖𝟏) + 𝟓% = 𝟏𝟔. 𝟎𝟔%

49 | P a g e

𝒓𝒏𝒆𝒘 𝒆𝒒𝒖𝒊𝒕𝒚 = (𝑫𝟏

(𝑷 ∗ (𝟏 − 𝑭𝒍𝒐𝒕𝒂𝒕𝒊𝒐𝒏 𝑪𝒐𝒔𝒕))) + 𝒈

𝒓𝒏𝒆𝒘 𝒆𝒒𝒖𝒊𝒕𝒚 = (𝟐. 𝟏𝟔

(𝟐𝟔. 𝟖𝟏 ∗ (𝟏 − 𝟎. 𝟎𝟓)) ∗ 𝟓% = 𝟏𝟑. 𝟒𝟖%

CenturyLink’s internal cost of equity of 13.06% for its existing equity based on next years

projected dividends of $2.16 and a 5% growth thereafter. Cost of new equity is calculated by

adding flotation costs to cost of equity, which yields a cost of new equity of 13.48% based on

5% flotation costs.

Weights

Ticker D/E Ratio

CTL 1.40

ATNI 0.05

CNSL 5.04

FTR 1.58

JCOM 0.70

RNG 0.21

TU 1.57

VG 0.24

ZAYO 3.06

Industry Avg 1.52

CTL’s market debt to equity (D/E) ratio is 1.39 according to Thompson One. CTL’s book value of

D/E from its 2014 financial statements was 2.338.

The graph and chart above are the companies and the D/E ratios of CTL and its competitors.

The data excludes Cogent Communications (CCOI) because the companies D/E ratios were

much too high. CCOI showed a drop in its stock price and is at risk of being insolvent which put

its D/E ratio to 26.079. CCOI was removed from the data set for being excessively high. West

Corp’s (WSTC) D/E ratio of -5.5239, which is also removed from the data set for moving the

mean too much.

50 | P a g e

Ultimately, the industry average and the target D/E ratio that estimates CTL’s target is 1.50 and

implies CTL is able finance new acquisitions and operations through debt. However, looking at

its interest expense as compared to total revenue, CTL is very conservative with how it acquires

debt in the near future. Despite the high D/E ratio in the industry, CTL cannot ignore basic rules

of solvency and must exercise caution and take on additional debt when revenues rise.

Forecasted Cost of Capital

CTL’s weighted average cost of capital (WACC) is calculated by multiplying the cost of each part

by the weight of each part.

Forecasted Cost of Debt

CTL’s target weights are 60% debt and 40% equity, similar to its competitors; the company’s

target structure of debt is 58% long-term debt, and 2% short-term debt. CTL retired all

preferred stock in 2010 and does not intend to issue more. Moody rates CTL debt at BB and

generates a spread of 2.48% on long-term bonds. The risk free rate is 2.87%, the yield on US

Treasury Bills on October 16, 2015, which shows a cost of long-term of 5.35%, or 3.45% after-

tax cost of long-term debt. The company’s short-term debt is calculated by the prime rate of

3.25% + a risk-adjusted spread of .47%. This calculates a cost of short-term debt of 3.72%, or

2.40% after tax cost of short-term debt.

𝒓𝑳𝑻 𝒅𝒆𝒃𝒕 = (𝟐. 𝟖𝟕% + 𝟐. 𝟒𝟖%) ∗ (𝟏 − 𝟎. 𝟑𝟓𝟔) = 𝟑. 𝟒𝟓%

𝒓𝑺𝑻 𝒅𝒆𝒃𝒕 = (𝟑. 𝟐𝟓% + 𝟎. 𝟒𝟕%) ∗ (𝟏 − 𝟎. 𝟑𝟓𝟔) = 𝟐. 𝟒𝟎%

Forecasted Cost of Equity

CTL’s cost of equity was calculated using the capital asset pricing model (CAPM). The equation

is

𝒓𝒆𝒒𝒖𝒊𝒕𝒚 = 𝒓𝒇 + 𝜷 𝑹𝒑

𝒓𝒆𝒒𝒖𝒊𝒕𝒚 = 𝟐. 𝟖𝟕% + 𝟏. 𝟏𝟔𝟔 ∗ 𝟔% = 𝟗. 𝟖𝟕%

The risk free rate is the 2.87%, the market risk premium is 6%, and the trailing twelve month

(TTM) beta for CTL is 1.166. The TTM beta best approximates its beta is because it captures a

data set that minimizes noise of daily returns of closer betas and represents the current

volatility better than longer views. The Qwest merger caused increased volatility because of

51 | P a g e

predictions while before that acquisition CTL’s beta is much less correlated to the market. Once

calculated the cost of equity becomes 9.87%.

𝑾𝑨𝑪𝑪 = 𝒘𝒆𝒒𝒖𝒊𝒕𝒚 ∗ 𝒓𝒆𝒒𝒖𝒊𝒕𝒚 + 𝒘𝑳𝑻 𝒅𝒆𝒃𝒕𝒓𝑳𝑻 𝒅𝒆𝒃𝒕 + 𝒘𝑺𝑻 𝒅𝒆𝒃𝒕𝒓𝑺𝑻 𝒅𝒆𝒃𝒕

𝑾𝑨𝑪𝑪 = 𝟎. 𝟒 ∗ 𝟗. 𝟖𝟕% + 𝟎. 𝟓𝟖 ∗ 𝟑. 𝟒𝟓% + 𝟎. 𝟎𝟐 ∗ 𝟐. 𝟒% = 𝟓. 𝟗𝟗𝟕%

Once combined CTL’s forecasted total cost of capital becomes 5.997%. It is forecasted that

CTL’s capital structure is not expected to change significantly in the short term because CTL is

close to the target capital structure and its interest expense compared to gross profit is high.

Payout Policy

CTL is committed to paying the $0.54 quarterly dividend and is continually paying the same

quarterly dividend since 2013. CTL is showing resilience to changing that dividend because of

falling stock prices. CTL’s payout ratio proves to be somewhat chaotic between years. Its

average is 53.2% over the last ten years. However, in the years 2009-2012, following and

preceding CTL’s merger with Qwest, CTL consistently paid out 75.26%.

IV. Financial Statement Forecasts


CenturyLink

Table of Contents






Pro Forma & Projected Financials. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 54-59

Growth and Fade Rate Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 60-70

Projected Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 71-72

Projected DuPont Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 73-75

Projected Altman Z-Score Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 76

Sensitivity & Scenario Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 77-80




54 | P a g e

Pro Forma & Projected Financial Statements

Historical Income Statements

2014 2013 2012 2011 2010 2009 2008 2007 2006 2005

Revenue 18,031 18,095 18,376 15,351 7,042 4,974 2,600 2,656 2,448 2,479

Costs of goods sold 7,831 7,492 7,635 6,258 2,366 1,752 955 935 880 822

Sales, general & administrative expense

3,311 3,464 3,115 2,575 1,059 934 399 389 369 389

Depreciation 4,428 4,541 4,780 4,026 1,434 975 524 536 524 532

Operating profit 2,461 2,598 2,846 2,492 2,183 1,314 721 796 675 736

Interest expense 1,358 1,339 1,362 1,097 557 370 202 213 196 202

Interest income 0 0 0 0 0 0 0 0 0 4

Non-operating income 0 0 (1) (2) (7) (1) 0 0 0 (8)

Earnings before taxes 1,110 224 1,250 948 1,532 815 560 619 591 533

Tax expense 338 463 473 375 583 302 194 201 221 203

Net income before extra. items 772 (239) 777 573 949 513 366 418 370 330

After-tax extraordinary income 0 0 (1) (2) (7) 135 0 0 0 (5)

Net income 772 (239) 776 571 942 647 366 418 370 325

Dividends-- preferred 0 0 0 0 (0) (0) (0) (0) (0) (0)

Dividends-- common 1,228 (1,301) (1,811) (1,556) (878) (561) (220) (29) (29) (31)

Additions to RE (456) 1,062 2,587 2,127 1,820 1,208 586 447 399 357

55 | P a g e

Projected Income Statements

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Revenue 18,031 17,967 17,911 17,871 17,866 17,940 18,192 18,446 18,705 18,966

Costs of goods sold 7,831 7,803 7,482 7,285 7,174 7,204 7,305 7,407 7,511 7,616

SGA 3,311 3,299 3,165 3,083 3,037 3,050 3,093 3,136 3,180 3,224

Depreciation 4,428 4,359 4,102 3,917 3,822 3,870 3,793 3,847 3,900 3,955

Operating profit 2,461 2,505 3,162 3,585 3,832 3,817 4,001 4,057 4,113 4,171

Interest expense 1,358 1,454 1,753 1,755 1,747 1,741 1,757 1,752 1,777 1,775

Interest income 0 0 60 65 72 77 78 80 76 81

Non-operating income 0 0 0 0 0 0 0 0 0 0

Earnings before taxes 1,110 1,052 1,468 1,896 2,157 2,152 2,322 2,384 2,412 2,477

Tax expense 338 374 523 675 768 766 827 849 859 882

Net income before extraordinary items

772 677 945 1,221 1,389 1,386 1,495 1,536 1,553 1,595

After-tax extraordinary income 0 0 0 0 0 0 0 0 0 0

Net income 772 677 945 1,221 1,389 1,386 1,495 1,536 1,553 1,595

Dividends-- preferred 0 0 0 0 0 0 0 0 0 0

Dividends-- common 1,228 1,224 1,220 1,217 1,217 1,222 1,239 1,256 1,274 1,292

Additions to RE (456) (546) (274) 4 172 164 256 279 280 304

56 | P a g e

Projected Income Statements (Cont.)

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034

Revenue 19,232 19,501 19,774 20,051 20,332 20,616 20,905 21,198 21,494 21,795 22,101

Costs of goods sold 7,723 7,831 7,941 8,052 8,164 8,279 8,395 8,512 8,631 8,752 8,875

SGA 3,269 3,315 3,362 3,409 3,456 3,505 3,554 3,604 3,654 3,705 3,757

Depreciation 4,010 4,066 4,123 4,181 4,240 4,299 4,359 4,420 4,482 4,545 4,609

Operating profit 4,229 4,289 4,349 4,410 4,471 4,534 4,597 4,662 4,727 4,793 4,860

Interest expense 1,725 1,544 1,566 1,588 1,610 1,632 1,655 1,678 1,701 1,725 1,749

Interest income 110 317 342 369 396 424 454 485 517 550 584

Non-operating income 0 0 0 0 0 0 0 0 0 0 0

Earnings before taxes 2,614 3,061 3,125 3,191 3,258 3,326 3,397 3,469 3,543 3,618 3,696

Tax expense 931 1,090 1,113 1,136 1,160 1,184 1,209 1,235 1,261 1,288 1,316

Net income before extraordinary items 1,684 1,972 2,013 2,055 2,098 2,142 2,187 2,234 2,281 2,330 2,380

After-tax extraordinary income 0 0 0 0 0 0 0 0 0 0 0

Net income 1,684 1,972 2,013 2,055 2,098 2,142 2,187 2,234 2,281 2,330 2,380

Dividends-- preferred 0 0 0 0 0 0 0 0 0 0 0

Dividends-- common 1,310 1,328 1,347 1,366 1,385 1,404 1,424 1,444 1,464 1,484 1,505

Additions to RE 374 643 666 689 713 738 764 790 818 846 875

57 | P a g e

Historical Balance Sheets

2014 2013 2012 2011 2010 2009 2008 2007 2006 2005

Assets

Cash 128 168 211 128 173 162 243 34 26 159

Inventory 132 167 125 0 33 36 9 9 7 7

Accounts receivable 1988 1977 1959 1979 815 801 230 223 227 237

Other short-term operating assets 1328 1595 1318 1416 122 125 73 26 30 20

Short-term investments 0 0 0 0 0 0 0 0 0 0

Total current assets 3576 3907 3613 3523 1143 1124 555 292 290 423

Net plant, property, & equipment 18433 18646 19032 19436 8754 9097 2896 3108 3109 3304

Other long-term operating assets 27295 28411 30579 32324 11778 11965 4463 4520 3781 3758

Long-term investments 843 823 796 856 363 377 340 264 261 277

Total assets 50147 51787 54020 56139 22038 22563 8254 8185 7441 7763

Liabilities and Equity

Accounts payable 1226 1111 1207 1399 300 395 135 120 129 104

Accruals 950 989 1039 1017 482 747 243 224 214 171

Other operating current liabilities 0 0 0 0 0 0 0 0 0 0

All short-term debt 1742 2309 2349 1603 428 959 180 498 374 471

Total current liabilities 3918 4409 4595 4019 1210 2100 558 842 717 746

Long-term debt 21368 21385 20648 22615 7506 7254 3331 2799 2486 2468

Deferred taxes 4030 4753 3644 3823 2369 2257 854 811 673 670

Preferred stock 0 0 0 0 0 0 0 7 7 8

Other long-term liabilities 5808 4049 5844 4855 1312 1491 348 323 373 261

Total liabilities 35124 34596 34731 35312 12397 13102 5091 4782 4258 4153

Par plus PIC Less treasury 14876 17125 18004 18508 6339 6228 17 157 33 251

Retained earnings 147 66 1285 2319 3302 3233 3146 3245 3151 3358

Total common equity 15023 17191 19289 20827 9641 9461 3163 3402 3184 3609

Total liabilities and equity 50147 51787 54020 56139 22038 22563 8254 8185 7441 7763

58 | P a g e

Projected Balance Sheets

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Assets

Cash 128 128 127 127 127 127 129 131 133 135

Inventory 132 132 131 131 131 131 133 135 137 139

Accounts receivable 1,988 1,981 1,975 1,970 1,970 1,978 2,006 2,034 2,062 2,091

Other short-term operating assets 1,328 1,323 1,397 1,394 1,394 1,399 1,419 1,439 1,459 1,479

Short-term investments 0 4,579 5,025 5,516 5,907 5,995 6,161 5,787 5,934 6,104

Total current assets 3,576 8,142 8,655 9,138 9,528 9,631 9,848 9,525 9,725 9,948

Net plant, property, & equipment 18,433 18,147 18,174 18,320 18,730 19,735 20,011 20,291 20,575 20,863

Other long-term operating assets 27,295 27,198 26,168 25,167 24,218 23,372 22,740 23,058 23,381 23,708

Long-term investments 843 840 837 836 835 839 851 862 874 887

Total Assets 50,147 54,327 53,834 53,459 53,310 53,576 53,449 53,737 54,556 55,406


Accounts payable 1,226 1,222 1,218 1,215 1,215 1,220 1,237 1,254 1,272 1,290

Accruals 950 947 944 942 941 945 958 972 985 999

Other operating current liabilities 0 0 0 0 0 0 0 0 0 0

All short-term debt 1,742 2,225 2,002 1,771 1,547 1,344 1,128 933 946 959

Total current liabilities 3,918 4,394 4,163 3,928 3,703 3,509 3,323 3,159 3,203 3,248

Long-term debt 21,368 25,702 25,855 25,867 25,916 26,290 26,399 27,043 27,420 27,802

Deferred taxes 4,030 3,967 3,973 4,005 4,095 4,315 4,375 4,436 4,498 4,561

Preferred stock 0 0 0 0 0 0 0 0 0 0

Other long-term liabilities 5,808 5,787 5,640 5,453 5,217 4,921 4,554 4,021 4,077 4,134

Total liabilities 35,124 39,851 39,632 39,253 38,932 39,034 38,650 38,659 39,198 39,745

Par plus PIC Less treasury 14,876 14,876 14,876 14,876 14,876 14,876 14,876 14,876 14,876 14,876

Retained earnings 147 (399) (674) (670) (498) (334) (77) 202 482 785

Total common equity 15,023 14,477 14,202 14,206 14,378 14,542 14,799 15,078 15,358 15,661

Total liabilities and equity 50,147 54,327 53,834 53,459 53,310 53,576 53,449 53,737 54,556 55,406

59 | P a g e

Projected Balance Sheets (Cont.)

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034

Assets

Cash 137 138 140 142 144 146 148 150 153 155 157

Inventory 141 143 145 147 149 151 153 155 157 160 162

Accounts receivable 2,120 2,150 2,180 2,211 2,242 2,273 2,305 2,337 2,370 2,403 2,437

Other short-term operating assets 1,500 1,521 1,542 1,564 1,586 1,608 1,631 1,653 1,677 1,700 1,724

Short-term investments 6,342 6,847 7,373 7,920 8,489 9,081 9,696 10,335 10,999 11,689 12,406

Total current assets 10,240 10,800 11,381 11,984 12,610 13,259 13,932 14,631 15,355 16,107 16,885

Net plant, property, & equipment 21,155 21,451 21,752 22,056 22,365 22,678 22,996 23,318 23,644 23,975 24,311

Other long-term operating assets 24,040 24,377 24,718 25,064 25,415 25,771 26,131 26,497 26,868 27,244 27,626

Long-term investments 899 912 925 937 951 964 977 991 1,005 1,019 1,033

Total Assets 56,334 57,539 58,775 60,042 61,340 62,672 64,037 65,437 66,872 68,345 69,855


Accounts payable 1,308 1,326 1,345 1,363 1,382 1,402 1,421 1,441 1,461 1,482 1,503

Accruals 1,013 1,027 1,042 1,056 1,071 1,086 1,101 1,117 1,132 1,148 1,164

Other operating current liabilities 0 0 0 0 0 0 0 0 0 0 0

All short-term debt 972 986 999 1,013 1,027 1,042 1,056 1,071 1,086 1,101 1,116

Total current liabilities 3,293 3,339 3,386 3,433 3,481 3,530 3,579 3,629 3,680 3,731 3,783

Long-term debt 28,189 28,581 28,979 29,382 29,791 30,205 30,625 31,050 31,482 31,919 32,362

Deferred taxes 4,625 4,690 4,756 4,822 4,890 4,958 5,028 5,098 5,169 5,242 5,315

Preferred stock 0 0 0 0 0 0 0 0 0 0 0

Other long-term liabilities 4,192 4,251 4,310 4,371 4,432 4,494 4,557 4,621 4,685 4,751 4,818

Total liabilities 40,299 40,861 41,430 42,008 42,593 43,187 43,788 44,398 45,016 45,643 46,278

Par plus PIC Less treasury 14,876 14,876 14,876 14,876 14,876 14,876 14,876 14,876 14,876 14,876 14,876

Retained earnings 1,159 1,802 2,468 3,158 3,871 4,609 5,373 6,163 6,980 7,826 8,701

Total common equity 16,035 16,678 17,344 18,034 18,747 19,485 20,249 21,039 21,856 22,702 23,577

Total liabilities and equity 56,334 57,539 58,775 60,042 61,340 62,672 64,037 65,437 66,872 68,345 69,855

60 | P a g e

Growth and Fade Rate Analysis

Sales Growth Rate

Since 2005, CenturyLink is

averaging 30.4% sales growth due

to its M&A of Savvis, Qwest, and

Embarq, which increased revenue

from $2.6 billion in 2008 to $18.4

billion in 2012. However, this sales

growth is not expected to continue

as CTL is nearing its target capital

structure, leaving no room for

additional debt to finance M&A. AT&T recently reconsolidated in 2007 and is growing at an

average annual rate of 1.56% since its reconsolidation. Based on AT&T’s average growth rate,

CTL’s growth rate is expected to increase at an average rate of 1.4%. The telecommunications

industry is projected to decline at an average annual rate of 1.4% from 2015 to 2020. A fade

rate of -.80 is used because of CTL’s 2014 sales growth of -.35%. CenturyLink is expected to

experience negative sales growth until 2018, at which point its growth is forecasted to quickly

increase to the 1.4% long-term growth rate.

Fade Rate Analysis: CenturyLink’s convergence to a long-term growth rate of 1.4% annum is

expected to be slower from 2016-2018 due to management’s transition to the Data Hosting

segment as the primary driver of profitability/growth in the firm. Hence, the fade rate of -0.80

is used in the model to reflect this trend of slower convergence from 2016 to 2018.

COGS/Sales

CTL’s ten-year historical average of

COGS as a percent of sales is

37.7%, however, its COGS/Sales

spiked to 41.55% subsequent to

the merger with Qwest. The

increase in COGS as a percent of

sales is due to CTL’s entrance into

more competitive urban markets

where the company is now

competing with Comcast and Cox.

This increase in competition is estimated to keep CTL’s cost of revenue above 40%, so expected

long-term cost of revenue is 40.16%. As CTL reaches positive sales growth in 2019 the company

is able to use its assets more efficiently to generate sales, which is expected to drive cost of

-20.00%

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

140.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Sales growth rate Historical

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

50.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

COGS / Sales Historical

61 | P a g e

revenue down to 40.16% from its current rate of 43.4%. The fade rate of .50 is used because

cost of revenue is expected to gradually decline to 40.16% in 2019 when CTL reaches positive

sales growth.

Fade Rate Analysis: CenturyLink’s cost of revenue is forecasted to be 40.16% fairly quickly as

the vertical marketing retraining program comes to an end in 2015 and sales begin to increases

across all segments – most notably data Hosting. In addition to the short period of three years

until long-term convergence, a fade rate of 0.50 is used to reflect a sharp decline in COGS /

Sales in 2016 and 2017.

SGA/Sales

CenturyLink’s SGA/sales is steadily

increasing since its acquisition of

Embarq in 2009 and merger with

Qwest in 2011. CTL is currently

wrapping up its retraining program

which it initiated due to high

employee growth from its M&A.

When CTL finishes its retraining

program it is forecasted that the

company’s SGA is going to return

to 17%, slightly above the ten-year average of 16.6%. A fade rate of .50 shows that the

company’s cost of SGA is projected to sharply decline in the next three years as it finishes the

retraining program.

Fade Rate Analysis: Similar to cost of revenue, SGA is projected to swiftly converge to its long-

term proportion of sales given that the marketing retraining program ends in 2015. In addition

to its three-year term until convergence, a fade rate of 0.50 is used to coincide with the sharp

decline in COGS/Sales in 2016 and 2017.

Depreciation/Net PPE

CTL’s depreciation is forecasted to

remain around its ten-year

average of 18.96% as CTL is not

expected to see significant growth

in revenue nor acquire firms with a

lot of tangible assets in place.

Therefore, CTL’s depreciation as a

percent of PPE is expected to

decrease from the current rate of

24.02% to the company’s historical

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

SGA / Sales Historical

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Depreciation / Net PPE Historical

62 | P a g e

average of 18.96%. Depreciation is forecasted to reach long-term levels in five years with a fade

rate of .20. The fade rate shows that CTL’s depreciation is expected to decline quickly in the

near future and even out as it nears the long-term average.

Fade Rate Analysis: The rate at which CenturyLink’s depreciation is forecasted to fall back to

its historical average is linear as there is no reason to assume that it occurrence is slower or

faster. Implicit in the assumption that Depreciation/Net PPE returns to its historical average is

the belief that bonus depreciation is expected to continue indefinitely until new information

demonstrates otherwise.

Cash/Sales

Historically, CenturyLink runs its

business with minimal cash on the

books, with average cash to sales

percentage of 2.7%. The average is

brought up by 2005 and 2008

when CTL held unusually large

amounts of cash. CTL’s most

recent cash to sales is .71% with a

trend of only .1%. Since there is no

clear trend in CTL’s cash to sales it

is forecasted that .71% is the company’s long-term rate for cash to sales.

Fade Rate Analysis: The fade rate for cash/sales is irrelevant as the period until the long-term

proportion of sales is zero years. In other words, cash is already at its long-term proportion of

sales.

Inventory/Sales

As CTL is in the services industry

the company does not hold a lot of

inventory, which is shown by its

ten-year average of .47%

inventory to sales. The company’s

2014 inventory to sales was .7%,

which increased to above average

subsequent to its merger with

Qwest. The merger with Qwest

required CTL to hold more

inventory due to its entrance into more competitive markets, especially in the TV services

sector. CTL is forecasted to hold inventory consistent with its 2014 inventory to sales of .73%.

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Cash / Sales Historical

0.00%

0.10%

0.20%

0.30%

0.40%

0.50%

0.60%

0.70%

0.80%

0.90%

1.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Inventory/ Sales Historical

63 | P a g e

Fade Rate Analysis: The fade rate for inventory/sales is irrelevant as the period until the long

term proportion of sales is zero years. In other words, inventory is already at its long-term

proportion of sales.

Accounts Receivable/Sales

CTL’s accounts receivable to sales

is consistently around 10% to 12%

with a ten-year historical average

of 10.93%. It’s A/R to sales is not

projected to deviate from its

historical average, so a long term

rate of 10.93% A/R to sales is used.

Fade Rate Analysis: The fade rate

for accounts. rec./sales is

irrelevant as the period until the long term proportion of sales is zero years. In other words,

accounts receivable is already at its long-term proportion of sales.

Other Short Term Op Assets/Sales

Other short term operating assets

to sales is 3.8% based on the ten-

year historical average, however,

this ratio increased significantly

subsequent to the merger with

Qwest in 2011. For 2014, CTL’s

other short term operating assets

to sales is 7.37% with a trend of

9.2%. CTL’s average short term

operating assets to sales is

averaging 7.8% post merger with Qwest. As such, it is forecasted that the long-term rate is

7.8%, which is expected to be reached in one year with a fade rate of one.

Fade Rate Analysis: Given that the period to convergence with the long-term proportion of

sales is one year the fade rate is irrelevant.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Accts. rec. / Sales Historical

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Other short term operating assets/Sales

Historical

64 | P a g e

Net PPE/Sales

CTL’s net PPE to sales historical

average over ten-years is 123.1%

with a trend of 105.6% and a 2014

rate of 102.2%. The company is

increasingly generating more sales

relative to net PPE since the

merger with Qwest, which is

causing net PPE to sales to trend

downwards. It is forecasted that

CTL’s long-term net PPE/sales is

103% and the company is expected to reach that rate in four years time with a -.80 fade rate as

the current rate of 102.2% is estimated to slowly converge to 103%.

Fade Rate Analysis: Since CenturyLink is projected to continue to acquire non capital intensive

companies and these acquisitions are expected to boost growth in revenue, it is expected the

net effect on Net PPE/Sales to balance out at 103% in five years. Furthermore, it is forecasted

that growth in Property, Plant, and Equipment to exceed the growth in revenue until

convergence, hence a fade rate of 0.80 is used to model Net PPE/Sales capping out at 103%

quickly.

Other Long-term Assets/Sales

CTL’s other long-term operating

assets to sales is averaging 174.1%

over the last ten-years with a 2014

rate of 151.4%. CenturyLink

includes goodwill in its other long-

term operating assets, and a 2013

impairment of goodwill in the

amount of $1.092 billion caused

the company’s other long-term

operating assets to sales to

decreases. CTL is forecasted to impair more goodwill in the future due to poor performance

following the merger with Qwest; rather than adding synergies, CTL entered a more

competitive market which caused profitability to drop by 270%. Since CTL is expected to write

down goodwill, the company’s long-term rate for other long-term operating assets to sales is

forecasted to be 131%. This long-term rate of 131% is projected to take effect in five years with

a fade rate of zero.

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

140.00%

160.00%

180.00%

200.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Net PPE / Sales Historical

0.00%

50.00%

100.00%

150.00%

200.00%

250.00%

300.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Other long-term op. A. / Sales

Historical

65 | P a g e

Fade Rate Analysis: It is expected that there is continued impairment of CenturyLink’s goodwill

in the next five years but don’t know precisely when this impairment occurs. Hence, a fade rate

of 0.00 is used to impair goodwill linearly akin to depreciating an asset.

Accts Payable/Sales

CTL’s ten-year average accounts

payable to sales are 6% with the

most recent year (2014) at 6.8%. It

is not expected that CTL’s account

payable to change apart from

normal annual fluctuations, so the

long-term rate is assumed to be

6%, which the company is

expected to reach in one year with

a fade rate of zero.

Fade Rate Analysis: The fade rate for accounts pay./sales is irrelevant as the period until the

long term proportion of sales is zero years. In other words, accounts payable is already at its

long-term proportion of sales.

Deferred Taxes/Net PPE

CTL’s deferred taxes as a

percentage of net PPE are 23.6%

over the last ten-year period, and

21.86% in 2014. Forecasting shows

that CTL is expected remain

around its current deferred tax to

net PPE rate of 21.86% as congress

is expected to continue with bonus

depreciation and CTL maintains its

tax deferments.

Fade Rate Analysis: The fade rate for deferred taxes is irrelevant as the period until the long

term proportion of sales is zero years. In other words, deferred taxes is already at its long-term


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Accts. pay./ Sales Historical

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Deferred taxes/Net PPE Historical

66 | P a g e

Marginal Tax Rate

CTL’s ten-year historical average

marginal tax rate is 53.2%,

which is significantly skewed

due to a 2013 tax rate of 207%

caused by negative earnings. In

2014, CTL paid taxes of only

30.5%, which is below its

average tax rate of 35.6% when

the outlier (2013 fiscal year) is taken out of the ten-year historical average. As such,

CenturyLink’s forecasted long-term marginal tax rate is 35.6% since it is not expected for CTL to

continuously pay a 207% marginal tax rate. CTL is expected to reach its long-term marginal tax

rate in 2015 with a fade rate of zero.

Fade Rate Analysis: The fade rate for marginal tax rate is irrelevant as the period until long

term convergence is zero years. In other words, the marginal tax rate is already at its long term

value.

Other Long-term Liabilities/Sales

CTL’s ten-year historical average

other long-term liabilities to sales

is 21.8% with a most recent rate of

32.21%. This rate is trending

upwards since the merger with

Qwest due to the need to take on

more debt and liabilities to fund

the merger. As CTL is close to its

target capital structure it is

forecasted that other long-term

liabilities is going to trend back down to its historical average of 21.8%. CTL is expected to reach

its long-term rate in six years with a fade rate of -.30, which shows CTL is forecasted to trend

towards average over the next four years, after which it the ratio is expected to sharply decline

to the long-term rate of 21.8%.

Fade Rate Analysis: The fade rate for other long-term liabilities/sales is irrelevant given that

the proportion is currently at its long-term proportion of 0%.

0.00%

50.00%

100.00%

150.00%

200.00%

250.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Marginal tax rate Historical

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

2000 2005 2010 2015 2020 2025 2030 2035 2040

Other long-term liab. / Sales

Historical

67 | P a g e

Accruals/Sales

The fade rate for accruals/sales is

irrelevant as the period until the

long term proportion of sales is

zero years. In other words,

accruals is already at its long-term


Average Tax Rate:

The fade rate for average tax rate

is irrelevant as the period until the

long term proportion of sales is

zero years. In other words, the

average tax rate is already at its

long-term proportion of sales.

Dividend Growth Rate

A fade rate of -0.10 is used for the

convergence to a steady growth

rate in CenturyLink’s dividend in

order to capture the low expected

payout in 2016. This low payout is

caused by the $931mm in tax

deferments CenturyLink is most

likely going to pay that year.

68 | P a g e

Long-Term Debt/Market Value

There is no justifiable reason for

the convergence to steady state

long-term debt/market value to

occur at a slower/faster rate than

linear. Hence, a fade rate of zero

is used to capture a linear trend.

Coupon Rate on Preferred

Stock

The fade rate for the coupon on

preferred stock is irrelevant given

the assumption that CenturyLink

is no longer expected to maintain

preferred stock in its

capitalization.

Perm. Component of Short-

Term Debt/MV

There is no justifiable reason for

the convergence to the long-term

proportion of permanent short-

term debt/MV to occur at a

slower or faster rate than linear.

Hence, a fade rate of zero is used

to capture a linear trend.

69 | P a g e

Non-op. Inc./Sales

The fade rate is irrelevant given

that the proportion is currently at

its long-term value of 0%.

Extraordinary Income/Sales

Since extraordinary income is

difficult to forecast accurately to

any degree of accuracy, its

average value is assumed to

equal zero.

Long-term Investments/Sales:

The fade rate for long-term

investments/sales is irrelevant

given that the proportion is

currently at its long-term

proportion of 0%.

70 | P a g e

Short-term Interest rates

Since the American economy is

sluggishly recovering, a fade rate

of -2.00 is used to reflect the

assumption that short term

interest rates won’t recover to its

pre-financial crisis level for

another ten years.

Interest Rate on All Current Debt

The fade rate for the interest rate

on all current debt is irrelevant

given that current interest rate is

already at its long-term value.

71 | P a g e

Projected Financial Ratios

This section demonstrates the results of the fade decisions on CTL’s future financial ratios. Each

graph predicts 10 years into the future to a date of 1/1/2025. This date gives the best time

frame because it falls after the time CTL is expected to go into horizon value.

This graph observes a decreasing Debt to Equity ratio as CTL tends to reach its projected target.

Lowering debt means its interest coverage ratio gets stronger as earnings before taxes out

paces interest expense. The key take-away here is CTL lowers leverage and increases overall

firm security as time goes on.

0.000

0.500

1.000

1.500

2.000

2.500

3.000

Pro Forma Leverage Ratios

Interest Coverage D/E

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

Pro Forma Liquidity Ratios

Current Ratio Quick Ratio Cash Ratio

72 | P a g e

This graph shows CTL’s rise from relative uncertainty about covering current liabilities to a very

confident position. The current and quick ratios remain extremely close because CTL does not

carry much inventory. This graph also demonstrates the increase coverage of the cash ratio.

The fade rate for cash remains constant over this time period but, CTL becomes more efficient

with its current liabilities. The key take-away here is CTL becomes more able to cover current

liabilities as time goes on.

This graph explores CTL’s future profitability. Its gross margin increases within the next 4 years

but, eventually reaches a constant ratio in 5 years. Proportionally its operating margin increases

and holds itself constant at 5 years as well. This phenomena occurs because CTL settles into the

merger with Qwest and becomes more efficient with its operations as time goes on. Most

importantly the net margin continues to increase beyond gross and operating margins as

management becomes leaner and overlap roles get eliminated from its huge mergers.

0.000

0.050

0.100

0.150

0.200

0.250

0.300

0.350

0.400

0.450

Pro Forma Profitability Ratios

Gross Margin Operating Margin Net Margin

73 | P a g e

Projected DuPont Analysis

Projected DuPont Component Analysis

Year PM % ΔPM % TATO ΔTATO % EM ΔEM % ROE % ΔROE %

2015 1.54 - 0.36x - 3.34 - 1.85 - 2016 1.23 -20.15 0.34x -4.48 3.62 8.52 1.53 -17.23 2017 1.85 50.40 0.34x -0.16 3.68 1.65 2.33 52.64 2018 2.40 30.01 0.34x -0.18 3.67 -0.25 3.02 29.44 2019 2.80 16.56 0.34x -0.16 3.62 -1.49 3.46 14.64 2020 2.98 6.39 0.34x 0.06 3.55 -1.84 3.62 4.48 2021 3.18 6.70 0.34x 0.67 3.48 -2.11 3.81 5.15 2022 3.21 0.79 0.34x 0.12 3.42 -1.60 3.78 -0.71 2023 3.18 -0.78 0.34x -0.43 3.39 -0.98 3.70 -2.18 2024 3.20 0.75 0.34x -0.46 3.35 -1.04 3.67 -0.76 2025 3.31 3.16 0.34x -0.57 3.31 -1.28 3.71 1.26 2026 3.75 13.37 0.34x -1.03 3.23 -2.28 4.07 9.63 2027 3.74 -0.19 0.33x -1.04 3.16 -2.23 3.93 -3.43 2028 3.73 -0.19 0.33x -1.05 3.09 -2.17 3.80 -3.38 2029 3.73 -0.19 0.33x -1.06 3.03 -2.12 3.67 -3.34 2030 3.72 -0.19 0.32x -1.07 2.96 -2.06 3.55 -3.29 2031 3.71 -0.19 0.32x -1.07 2.90 -2.01 3.44 -3.25 2032 3.70 -0.19 0.32x -1.08 2.85 -1.97 3.33 -3.21 2033 3.70 -0.19 0.31x -1.09 2.79 -1.92 3.22 -3.17 2034 3.69 -0.19 0.31x -1.10 2.74 -1.88 3.12 -3.14 2035 3.68 -0.19 0.30x -1.11 2.69 -1.83 3.02 -3.10

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035

Key Driver of Return on Equity

Profit Margin Return on Equity

74 | P a g e

2.00

2.20

2.40

2.60

2.80

3.00

3.20

3.40

3.60

3.80

4.00

2014 2019 2024 2029 2034

CTL: Projected Equity Multiplier

0.20x

0.22x

0.24x

0.26x

0.28x

0.30x

0.32x

0.34x

0.36x

0.38x

2014 2019 2024 2029 2034

CTL: Projected Total Asset Turnover

75 | P a g e

Key Takeaways:

Projected profit margin is the key driver behind the growth in return on equity up until

2026, whereas the projected equity multiplier is the key driver behind return on

equity’s decline from 2026 onwards

o The increase in profit margin from 2015 to 2026 captures the improvement in

current profitability as CenturyLink grows into its niche market for data hosting

services.

The decline from 2026 to 2035 is reflects how competitive pressures in

the IT industry are expected to steadily reduce CenturyLink’s

profitability in the long run

o The steady decrease in the equity multiplier is caused by the growth in total

assets exceeding the growth in equity once CenturyLink hits its target weight of

debt

Free cash flow profitability is projected to peak in 2019 and to continuously decay in

the long run. This fully captures three important events in CenturyLink’s near future:

o The ultimate decline of the company’s legacy services for both the consumer and

business markets

o The market saturation of wireless services and demand for broadband services

o The maturation of the IT industry in which CTL competes for majority of the

company’s revenue in the long run

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

2014 2019 2024 2029 2034

DuPont Analysis: Accounting Income vs Free Cash Flow

Profit Margin FCF Margin

76 | P a g e

Projected Altman Z-Score Trend Analysis

Key Takeaways:

Despite CenturyLink’s projected improvement in profitability the firm still remains in

danger of bankruptcy.

o Furthermore, CenturyLink is not expected to exceed the financial distress cutoff

without significant improvement to its long run profitability and/or establishing

a significant competitive advantage for the long run

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035

CTL: Altman Z-Score

Z-Score Financial Distress Cutoff

77 | P a g e

Sensitivity and Scenario Analysis of Key Drivers

Sales Growth:

Base Case: Same assumption used in the model.

Sales growth rate 30.4% 34.1% -0.4% -0.35% 1.40% 5 -0.80

Estimated price for 11/19/2015 =

$33.48

Projected ROIC at horizon

= 6.0%

Best Case Scenario: CenturyLink becomes a serious competitor in the growing IT sector and achieves a

sales growth rate of 2.5% by increasing its market share in this sector.

Sales growth rate 30.4% 34.1% -0.4% -0.35% 2.5% 5 -0.80


$35.95


= 6.2%

Worst Case Scenario: CenturyLink fails to realize potential of its Data Hosting segment and contracts at

a long-term rate of -2.5% until being acquired.

Sales growth rate 30.4% 34.1% -0.4% -0.35% -2.5% 5 -0.80


$28.07


= 5.4%

COGS/Sales:


COGS / Sales 37.7% 43.5% 43.4% 43.43% 40.16% 3 0.50


$33.48


= 6.0%

78 | P a g e

Best Case Scenario: CenturyLink is able to reduce its cost of revenue to its ten-year historical average

before the company’s merger with Qwest. However, this is an unlikely scenario since CTL entered into

more competitive markets after merging with Qwest.

COGS / Sales 37.7% 43.5% 43.4% 43.43% 37.7% 3 0.50


$42.85


= 6.7%

Worst Case Scenario: Although CenturyLink’s cost of revenue is trending down subsequent to its merger

with Qwest, it is possible that CTL is unable to decrease its cost of revenue below its most recent rate of

43.4%.

COGS / Sales 37.7% 43.5% 43.4% 43.43% 43.5% 3 0.50


$20.94


= 5.2%

SGA/Sales:


SGA / Sales 16.6% 18.7% 18.4% 18.36% 17.00% 3 0.50


$33.48


= 6.0%

Best Case Scenario: CenturyLink is able to reduce its selling, general, and administration expense to its

ten-year historical average prior to the merger with Qwest as CTL wraps up its employee-retraining

program.

SGA / Sales 16.6% 18.7% 18.4% 18.36% 16.6% 3 0.50


$35.05


= 6.2%

79 | P a g e

Worst Case Scenario: CTL’s SGA expense remains constant at its most recent value of 18.36% due to the

possibility that the company requires a higher percent of SGA to sales due to its entrance into more

competitive markets since its merger with Qwest.

SGA / Sales 16.6% 18.7% 18.4% 18.36% 18.4% 3 0.50


$26.82


= 5.6%

Net PPE/Sales:


Net PPE / Sales 123.1% 105.6% 102.2% 101.00% 110.00% 4 -0.80


$33.48


= 6.0%

Best Case Scenario: CenturyLink is able to use its net PPE more efficiently to generate sales, which

allows the company to increase sales without incurring the expenses associated with purchasing more

assets.

Net PPE / Sales 123.1% 105.6% 102.2% 101.00% 102.23% 4 -0.80


$40.46


= 6.6%

Worst Case Scenario: CenturyLink is only able achieve a long-term constant growth rate of 1.4% by

purchasing additional assets or acquiring firms at a faster rate than 1.4%. As such, this causes CTL’s net

PPE relative to sales to increase to its ten-year historical average of 123.14%, which decreases the

intrinsic value to $21.59.

Net PPE / Sales 123.1% 105.6% 102.2% 101.00% 123.14% 4 -0.80


$21.59


= 5.1%

80 | P a g e

Sensitivity and Scenario Analysis Summary

Price Sensitivity: ±

1%

Best Case

Scenario

Δ Price Worst Case

Scenario

Δ Price

Sales Growth ± 1.84 35.95 1.57 28.07 -6.31

COGS/Sales ± 4.22 42.85 8.47 20.94 -13.44

SGA/Sales ± 4.22 35.05 0.67 26.82 -7.56

Net PPE/Sales ± 1.29 40.46 6.08 21.59 -12.79

Cost of revenue and SGA as a percentage of sales are the most sensitive a one percentage change in the

inputs. A 1% change in the inputs causes an intrinsic price change of $4.22, which shows that accurate

forecasts are implicit to the reliability of the model. This exposes potential issues with the model; the

model is prone to user bias as almost any value is able to be entered to compute any possible price. By

changing the forecasted cost of revenue to its most recent value of 43.4% calculates an intrinsic value of

only $20.94, which is 37.46% lower than the intrinsic value of $33.48 using a forecasted cost of revenue

of 40.16%. By making a small change to the inputs in the model, CenturyLink suddenly appears

overvalued in the market.



CenturyLink

Table of Contents







Free Cash Flow to Firm (FCFF) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 83-84

Adjusted Present Value (APV) Valuation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 84-85

Free Cash Flow to Equity Valuation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 85-86

Issues with the Model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 86



81 | P a g e

Executive Summary: Cash Flow Valuation Methods

FCFF Valuation Method

Most recent actual fiscal year end 12/31/2014

Target valuation date 11/19/2015

Most recent fiscal year-end prior to target date 12/31/2014

Number of days from target to fiscal year-end prior to target 323.00

Value of operations on target date 47,117

Value of investments on target date 4,892

Total value of firm on target date 52,009

Value of debt, preferred stock, and other non-operating liabilities on target date 33,163

Value of equity on target date 18,846

Number of shares on target date 563

Price per share on target date $ 33.48

Entity Valuation (FCFF) discounts CTL’s free cash flows back to present value using CTL’s

forecasted WACC of 5.997%.

o Its V-ops of $47,117 is added to value of investments to compute a total firm

value of $52.009 billion on November 19, 2015.

o CTL’s high leverage causes a large deduction in the value of equity due to its

$33.16 billion value of debt and other non-op liabilities

APV Method






Value of investments on target date 840





Price per share on target date $ 33.30

Similar to entity valuation, APV discounts CTL’s free cash flows back to present value,

however, APV uses the unlevered cost of equity of 7.12%.

o Financial leverage is then taken into account through the tax shield.

CTL’s tax shield of $8.197 billion is added to the unlevered value of ops to calculate a

total value of operations of $

47.02 billion

o As with FCFF valuation, CTL’s high leverage significantly reduces the value of

equity due to its $29.11 billion value of debt and other non-op liabilities

82 | P a g e

Valuation Method Price Per Share Under/Overvalued (Amount)

Market Value $28.43 -

FCFF Intrinsic Value $33.48 Undervalued by $5.05

APV Intrinsic Value $33.40 Undervalued by $4.87

FCFE Value N/A Overvalued by $28.43 Entity valuation and APV valuation both show that CenturyLink is undervalued in the market.

FCFE valuation computes a negative intrinsic value and therefore shows CTL as overvalued in

the market.

Best Cash Flow Valuation Method for CTL

The strongest cash flow measure for CenturyLink is entity valuation because the company is

close to its target capital structure, so WACC is an appropriate discount rate to discount CTL’s

cash flows at. However, APV is also a good measure of CTL’s intrinsic value due to the

company’s high financial leverage. Value of unlevered operations is significantly lower than the

value of leveraged ops, but CTL’s large tax shield is an important driver of value in APV. Since

CTL is close to its target capital structure, APV computes a value of $33.30, only $.18 less than

the value derived from entity valuation. FCFE valuation yields a negative valuation due to CTL’s

high leverage; this drives up the company’s cost of equity to 9.87%. Discounting CTL’s cash

flows with cost of equity shows a negative valuation because it is too high of a discount rate.

$28.43

$33.48 $33.30

$25.00

$26.00

$27.00

$28.00

$29.00

$30.00

$31.00

$32.00

$33.00

$34.00

Market Value FCFF APV

Valuation by Method

83 | P a g e

Free Cash Flow to Firm (FCFF) Valuation

A company’s free cash flow to firm is calculated as net operating profit after tax (NOPAT) minus

investment in operating capital. In FCFF valuation, also known as entity valuation, these free

cash flows are then discounted back to present values at the firms WACC. Once the company

reaches constant growth, terminal value is determined by FCF x (1+g) / (WACC – long-term

growth); terminal value is then discounted back to present value at the WACC. Adding the

terminal value and horizon value provides the value of the operations at the target date. Value

of investments is then added to the value of operations to get total firm value. Next, the value

of debt, preferred stock, and other non-op liabilities are subtracted from total firm value to

calculate the value of equity. In the last step of FCFF valuation, the value of equity is divided by

total shares outstanding to compute the intrinsic value per share of stock.

Price per share on target date Most recent actual fiscal year end 12/31/2014










Price per share, target date $ 33.48

FCFF valuation discounts CTL’s cash flows at its weighted average cost of capital of 5.99%, and

computes a value of operations of $47.117 billion. CTL’s $4.89 billion in investments is added to

the value of ops to get a total firm value of $52.009 billion. Value of debt and other non-op

liabilities of $33.16 billion are subtracted from the value of the firm, which computes a value of

equity of $18.846 billion. Value of equity is divided by 562.99 million shares of common stock

for an intrinsic value of $33.48 per share on the target date of November 19, 2015. As of close

on November 11, 2015 CTL’s market value is $28.43 per share, which shows that CTL is

currently undervalued in the market.

FCFF Intrinsic Value (11/19/15) $33.48 – Market Value (11/11/15) $28.43

Difference (IV – MV) $5.05

Undervalued by $5.05

84 | P a g e

CenturyLink’s intrinsic value of $33.48 per share of stock and market value of $28.43 shows that

CTL is undervalued by $5.05 in the market, or 17.76%. Assuming the company’s MV converges

to its intrinsic value, the expected capital gains yield is 17.76%.

Drivers of Value:

CenturyLink’s main driver of value is its value of operations of $47.17 billion due to its FCF’s of

$2.05 billion when the company reaches a long-term growth rate of 1.4% in 2021. CTL’s value of

investments is also a strong driver of value, as investments represent 9.4% of total firm value.

However, CTL’s high financial leverage leads to a $33.16 billion value of debt and other non-op

liabilities, which leads to a significant reduction in value.

Entity valuation is a strong measure of CTL’s intrinsic value due to its high financial leverage,

which brings its WACC to only 5.99%. CTL is nearing its target capital structure so its current

WACC is an accurate measure of the company’s expected long-term weighted average cost of

capital. WACC is an appropriate discount rate for CTL because of its high leverage; using cost of

equity as a discount rate causes CTL to appear overvalued due to the higher risk of its equity.

Adjusted Present Value (APV) Valuation

Adjusted present value is a similar valuation measure to entity valuation, however, APV

accounts for changes in capital structure. As with FCFF valuation, APV discounts the company’s

free cash flows to present value; APV uses unlevered cost of equity as the discount rate rather

than WACC, which is used in entity valuation. APV then accounts for financial leverage by

adding the present value of the tax shield to unlevered value of operations to get total value of

ops. Once the value of ops is calculated, APV determines intrinsic value just as entity valuation;

investments are added to value of ops, then value of debt and other non-op liabilities are

subtracted. This yields the value of equity, which is divided by shares outstanding to calculate

the intrinsic value per share.

Price per share on target date APV








Value of debt, preferred stock, and other nonoperating liabilities on target date 29,111




85 | P a g e

CTL’s unlevered value of operations at the end of fiscal year 2014 is $38.154 billion based on an

unlevered cost of equity of 7.12% and its tax shield value of $8.197 billion is added to unlevered

value of the ops. Adjusted for half-year conversion, this calculates a value of operations of

$47.02 billion on November 19, 2015. Total firm value minus debt and other non-op liabilities

computes a value of equity of $18.749 billion. Divided by the company’s 562.99 million shares

outstanding yields an intrinsic value per share of $33.30, only $.18 less than entity valuation. As

such, CTL’s APV intrinsic value shows that the company is undervalued in the market by $4.87

as based on a closing price of $28.43 as of 11/11/15.

APV Intrinsic Value (11/19/15) $33.30 – Market Value (11/11/15) $28.43

Difference (IV – MV) $4.87

Undervalued by $4.87

CTL’s APV valuation of $33.30 represents an undervaluation in the market by $4.87; this shows

that CenturyLink is undervalued by 17.13% of market value.

Drivers of Value:

Due to CTL’s high leverage, the company’s tax shield is projected to be $8.245 billion as of the

end of fiscal year 2015. This large tax shield is an important driver in CTL’s APV valuation of

$33.30 as its tax shield represents 17.37% of total firm value.

Adjusted present value is also a strong measure of CTL’s intrinsic value since the company is

highly levered and close to its target capital structure of 60% debt and 40% equity. CTL is

currently financed with 40.8% equity, which shows that CTL’s cost of capital is expected to

remain relatively constant. APV valuation computes an intrinsic value only $.18 lower than

entity valuation due to its similar discount rate used when the tax shield is added into APV.

Free Cash Flow to Equity (FCFE) Valuation

CTL’s free cash flow to equity valuation computes a negative intrinsic value for CTL because the

company is highly levered. Its horizon ROIC is 5.99%, equal to the company’s WACC of 5.99%,

and cost of equity is 9.87%. Discounting CenturyLink’s FCFE by the cost of equity yields a

negative valuation because cost of equity is significantly higher than the company’s long-term

return on invested capital. Furthermore, CTL’s long-term FCFE is lower than its FCFF because

the company is nearing its target capital structure and net borrowing is expected to slow down

quickly once CTL reaches its target capital structure.

86 | P a g e

Drivers of Value:

Due to CTL’s negative FCFE valuation, there are no drivers of positive value, but rather strong

drivers that lead to a reduction in value. CenturyLink’s’ cost of equity of 9.87% causes the

largest reduction in value because its ROIC is 5.99% and long-term growth is only 1.4%. The

company’s cost of equity causes the value of debt and other non-op liabilities to exceed total

firm value, which computes a valuation of $(1.12) on the target date.

Issues with the Model

The financial model used for cash flow valuation is subject to user bias, and allows the user to

compute almost any intrinsic value. Since the model uses a significant amount of inputs, it

enables the user of the spreadsheet to change a combination of values that cause large changes

to the intrinsic value. For example, using different inputs for CenturyLink allowed for a

calculated range of intrinsic values anywhere from negative $20 to as high as $80.

VI. Relative (Multiples) Valuation

Analysis


CenturyLink

Table of Contents







Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 87

Valuation Methodology. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 88

Comparable Companies List. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 89-98

Multiples Valuation Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 99


87 | P a g e

Executive Summary: Relative Multiples Valuation Analysis

Comparable Multiples Summary

Valuation Ratio CTL Average LVLT WSTC CNSL FTR TU CCOI ATNI VG ZAYO JCOM

P/E 20.83 27.12 31.43 9.84 31.29 32.46 17.47 - 27.37 43.29 - 30.08

P/S 0.86 2.58 1.91 0.77 1.37 1.02 2.16 3.41 3.59 1.42 4.35 5.20

P/B 1.05 9.02 2.46 - 3.80 1.02 3.48 60.26 1.93 3.42 4.99 4.06

P/FCF 6.83 26.25 38.40 6.82 13.51 11.92 24.40 65.25 7.83 13.65 79.91 20.24

P/CF 2.97 8.97 10.07 4.83 5.05 4.28 7.33 18.28 5.65 11.78 9.72 18.67

Summary Statistics and Valuation Benchmarks

Valuation Ratio Average Standard Deviation Median S&P 500 Industry

P/E 27.12 9.22 28.73 17.95 60.73

P/S 2.58 1.56 2.16 1.78 1.35

P/B 9.02 16.49 3.64 2.72 6.15

P/FCF 26.25 23.76 16.94 - 19.57

P/CF 8.97 5.18 8.15 11.04 6.77

CenturyLink's Value Using Multiples

Estimated Value using P/E P/S P/B P/FCF P/CF Avg. Price

Average 36.72 84.65 242.36 108.42 85.20 111.47

Sample Median 38.90 70.77 97.71 69.98 77.42 70.95

Industry 62.75 14.67 19.11 20.89 21.16 27.72

S&P 500 24.14 58.05 72.60 - 104.21 64.75

The best price multiple to estimate CenturyLink’s value is the P/E multiple because:

o It is the only price multiple among the comparable companies that is not

overvalued on average with respect to the industry and the S&P 500

This means CenturyLink’s estimated value using P/E is less likely to be

overvalued

Using the t-statistic with ten degrees of freedom, the 95% confidence price range for

CenturyLink is given by:

𝐶𝑒𝑛𝑡𝑢𝑟𝑦𝐿𝑖𝑛𝑘′𝑠 𝑃𝑟𝑖𝑐𝑒 𝑅𝑎𝑛𝑔𝑒 = (31.68 ≤ 𝑃 ≤ 41.75)

88 | P a g e

Valuation Methodology:

The following steps were taken in order to conduct multiples analysis for CenturyLink:

1. Create a group of comparable companies

From the Russell 3000 Wired Telecommunication Subsector Index (RGUST14)

companies with a market capitalization of $1B - $20B are chosen to ensure that

the firms are of the same size and maturity as CenturyLink.

2. Add any additional companies with guidance from senior banker

Bloomberg Intelligence (BI) is used as a proxy for a senior banker's experience,

where BI Peers of CenturyLink with market capitalizations of $1B - $20B are

included in the list of comparable companies

3. Brief analysis of each company

This includes key statistics, recent price performance, company profile, and a

brief description of each firm to understand how they compare to CenturyLink

4. Determine the relevant price multiples to use in the analysis and compile data

The following price multiples were used in this analysis:

i. P/E

ii. P/S

iii. P/B

iv. P/FCF

v. P/CF

Comparable Companies Short List:

1. Atlantic Tele-Network Inc. (ATNI)

2. Cogent Communications Holdings Inc. (CCOI)

3. Consolidated Communications Holdings, Inc. (CNSL)

4. Frontier Communications Corp. (FTR)

5. J2 Global Inc. (JCOM)

6. Level 3 Communications Inc. (LVLT)

7. TELUS Corporation (TU)

8. Vonage Holdings Corp. (VG)

9. West Corporation (WSTC)

10. ZAYO Group Holdings Inc. (ZAYO)

89 | P a g e

Comparable Companies Expanded List:

Atlantic Telecommunications Network

Source: Morningstar

Brief Description: ATNI provides telecommunications services to rural, niche, and other under-served markets and geographies. It provides both wireless and wireline connectivity to residential and business customers, as well as providing a range of wireless solutions, local exchange services, and broadband internet services.

ATNI Price Multiples

P/E P/S P/B P/FCF P/CF

27.37 3.59 1.93 7.83 5.65

Net Five Year Growth: Revenue Growth – 6.83% Op. Margin – 4.19% PM Growth – 6.26% EPS Growth – 5.35%

Company Profile: CEO/President: Michael T. Prior CFO/Treasurer: Justin D. Benincasa Stock Type – Slow Growth/Small Growth Employees – 1,000 Primary Products – Wireless and Broadband Internet

Key Statistics (TTM): Market Cap – $1.2B Shares Outs. – 16.06M Revenue – $361M Net income – $25M EPS – 1.58 Dividend Yield – 1.53% Beta – 0.84

90 | P a g e

Cogent Communications Holdings Inc.

Source: Morningstar

Brief Description: CCOI is an optical Internet service provider that delivers ultra-high speed internet access and transport services. It serves businesses in the multi-tenant marketplace and service providers located in major metropolitan areas across the United States.

CCOI Price Multiples


- 3.41 60.26 65.25 18.28


Company Profile: CEO/Chairman/President: David Schaeffer CFO/Treasurer: Thaddeus G. Weed Stock Type – High Yield Employees - 772 Primary Products – Fiber Optic Broadband

Key Statistics (TTM): Market Cap – $1.5B Shares Outs. – Revenue – $400M Net income – $2.1M EPS – 0.05 Dividend Yield – 4.08% Beta – 0.66

91 | P a g e

Consolidated Communications Holdings, Inc.

Source: Morningstar

Brief Description: CNSL provides local and long distance telephone, digital telephone, high-speed Internet access, and digital television services to individuals and businesses in California, Illinois, Iowa, Kansas, Minnesota, Missouri, North/South Dakota, Pennsylvania, Texas, and Wisconsin.

CNSL Price Multiples


31.29 1.37 3.80 13.51 5.05

Net Five Year Growth: Revenue Growth – 9.37% Op. Margin – 5.22% PM Growth – (9.56%) EPS Growth – (16.06%)

Company Profile: CEO/Director: C. Robert Udell CFO/Senior Vice Pres.: Steven L. Childers Stock Type – High Yield Employees – 1,960 Primary Products – Wired/wireless Internet Access and Voice Services

Key Statistics (TTM): Market Cap – $1B Shares Outs. – Revenue – $800M Net income – (16.3M) EPS – (0.33) Dividend Yield – 7.44% Beta – 0.95

92 | P a g e

Frontier Communications Corp.

Source: Morningstar

Brief Description: FTR provides communications services to residential and business customers in rural areas, and small to medium-sized towns and cities in the United States. It offers a variety of voice, data, Internet, and television services and products.

FTR Price Multiples


32.46 1.02 1.02 11.92 4.28

Net Five Year Growth: Revenue Growth – 17.64% Op. Margin – 6.23% PM Growth – 1.93% EPS Growth – (19.31%)

Company Profile: CEO/Director: Danial McCarthy CFO/Exec. Vice Pres.: Cecilia K. McKenney Stock Type – Distressed Employees – 18,600 Primary Products – Wired/Wireless Internet Connection and Voice Services

Key Statistics (TTM): Market Cap – %5.5B Shares Outs. – 1,168.21M Revenue – $5.5B Net income – ($79.1M) EPS – (0.14) Dividend Yield – 8.72% Beta – 0.72

93 | P a g e

J2 Global Inc.

Source: Morningstar

Brief Description: JCOM provides cloud-based communications and storage message services, as well as online fax, virtual voice, hosted email, email marketing, online backup, and unified communications services.

JCOM Price Multiples


30.08 5.20 4.06 20.24 18.67


Company Profile: CEO: Nehemia Zucker CFO/President: R. Scott Turicchi Stock Type – Slow Growth Employees – 1,410 Primary Products – Voice and Cloud Services

Key Statistics (TTM): Market Cap – $3.8B Shares Outs. – 48.52M Revenue – $700M Net income – $100M EPS – 2.67 Dividend Yield – 1.54% Beta – 1.20

94 | P a g e

Level 3 Communications Inc.

Source: Morningstar

Brief Description: Level 3 Communications Inc. is a facilities based provider of a broad

range of integrated communications services.

LVLT Price Multiples


31.43 1.91 2.46 38.40 10.07

Net Five Year Growth: Revenue Growth – 12.49% Op. Margin – Missing Data PM Growth – Missing Data EPS Growth – N/A

Company Profile: CEO/Director/Pres.: Jeffrey K. Storey CFO/Exec. Vice Pres.: Sunit S. Patel Stock Type – Speculative Growth Employees – 13,500 Primary Products –

Key Statistics (TTM): Market Cap – $18.1B Shares Outs. – 356.27M Revenue – $8.1B Net income – $200M EPS – 0.51 Dividend Yield – N/A Beta – 1.43

95 | P a g e

TELUS Corp.

Source: Morningstar

Brief Description: TU is a telecommunications company providing a variety of communications products and services which include voice, data, Internet, and wireless services to businesses and consumers in Canada.

TU Price Multiples


17.47 2.16 3.48 24.40 7.33


Company Profile: CEO/Director/Pres.: Joseph M. Natale CFO/ Exec. Vice Pres.: John R. Gossling Stock Type – Unclassified Employees – 43,670 Primary Products – Wired/wireless Internet Access and Voice Services

Key Statistics (TTM): Market Cap – $18.6B Shares Outs. – 600.09M Revenue – $9.2B Net income – $1.1B EPS – 1.78 Dividend Yield – 4.24% Beta – 0.94

96 | P a g e

Vonage Holdings Corp.

Source: Morningstar

Brief Description: VG offers technology that uses customers’ existing high-speed Internet

connection (VoIP) to make and receive phone calls worldwide with a touch-tone telephone.

*Note: This firm is included in comparable companies as direct competitor to wired/wireless

telecommunications given that VoIP is an unregulated and more affordable alternative.

VG Price Multiples


43.29 1.42 3.42 13.65 11.78

Net Five Year Growth: Revenue Growth – (0.46%) Op. Margin – (3.52%) PM Growth – Missing Data EPS Growth – Missing Data

Company Profile: CEO/Director: Alan Masarek CFO/Treasurer: David T. Pearson Stock Type – Slow Growth Employees – 1,400 Primary Products – VoIP Services for Pre-existing Internet Connections

Key Statistics (TTM): Market Cap – $1.4B Shares Outs. – 213.56M Revenue – $900M Net income – $24.9 EPS – 0.11 Dividend Yield – N/A Beta – 0.23

97 | P a g e

West Corporation

Source: Morningstar

Brief Description: WSTC primarily offers communications services and infrastructures systems such as conferencing services, including on-demand automated conferencing, operator assisted services, internet conferencing services, and video conferencing services. West conducts business operations worldwide.

WSTC Price Multiples


9.84 0.77 - 6.82 4.83

Net Five Year Growth: Revenue Growth – (1.36%) Op. Margin – 2.87% PM Growth – 12.42% EPS Growth – Missing Data

Company Profile: CEO/Chairman: Thomas B. Barker CFO/Treasurer: Jan D. Madsen Stock Type – Slow Growth Employees – 9,700 Primary Products – Video and Voice Services

Key Statistics (TTM): Market Cap – $2.1B Shares Outs. – 83.22M Revenue – $2.3B Net income – $200M EPS – 2.26 Dividend Yield – 3.52% Beta – 0.80

98 | P a g e

ZAYO Group Holdings Inc.

Source: Morningstar

Brief Description: ZAYO is a global provider of bandwidth infrastructure services, including dark fiber, wavelengths, SONET, Ethernet, IP services, and carrier-neutral colocation and interconnection.

ZAYO Price Multiples


- 4.35 4.99 79.91 9.72

Net Five Year Growth: Revenue Growth – Missing Op. Margin – Missing data PM Growth – Missing data EPS Growth – Missing data

Company Profile: CEO/Chairman: Daniel P. Caruso CFO/Vice Pres.: Ken Desgarennes Stock Type – Cyclical Employees –1,897 Primary Products – Fiber Optic, Broadband, and Colocation

Key Statistics (TTM): Market Cap – $5.9B Shares Outs. – 244.87M Revenue – $1.4B Net income – (60M) EPS – (0.25) Dividend Yield – N/A Beta – 0.00

99 | P a g e

Comparable Multiples Summary

Valuation Ratio CTL Average LVLT WSTC CNSL FTR TU CCOI ATNI VG ZAYO JCOM

P/E 20.83 27.12 31.43 9.84 31.29 32.46 17.47 - 27.37 43.29 - 30.08

P/S 0.86 2.58 1.91 0.77 1.37 1.02 2.16 3.41 3.59 1.42 4.35 5.20

P/B 1.05 9.02 2.46 - 3.80 1.02 3.48 60.26 1.93 3.42 4.99 4.06

P/FCF 6.83 26.25 38.40 6.82 13.51 11.92 24.40 65.25 7.83 13.65 79.91 20.24

P/CF 2.97 8.97 10.07 4.83 5.05 4.28 7.33 18.28 5.65 11.78 9.72 18.67

Summary Statistics and Valuation Benchmarks

Valuation Ratio Average Standard Deviation Median S&P 500 Industry

P/E 27.12 9.22 28.73 17.95 60.73

P/S 2.58 1.56 2.16 1.78 1.35

P/B 9.02 16.49 3.64 2.72 6.15

P/FCF 26.25 23.76 16.94 - 19.57

P/CF 8.97 5.18 8.15 11.04 6.77



Average 36.72 84.65 242.36 108.42 85.20 111.47

Sample Median 38.90 70.77 97.71 69.98 77.42 70.95

Industry 62.75 14.67 19.11 20.89 21.16 27.72

S&P 500 24.14 58.05 72.60 - 104.21 64.75

The tables above indicate that the best multiple to estimate CenturyLink’s value is the P/E

multiple because It is the only price multiple that is not overvalued on average with respect to

the industry and the S&P 500. This means that it is less likely that the computed price using

average P/E in the sample is overvalued with respect to its industry and the market.

Hence, using the t-statistic with ten degrees of freedom the 95% confidence price range for

CenturyLink is given by:

𝐶𝑒𝑛𝑡𝑢𝑟𝑦𝐿𝑖𝑛𝑘′𝑠 𝑃𝑟𝑖𝑐𝑒 𝑅𝑎𝑛𝑔𝑒 ∶= (36.72 ± 𝑡𝜎

√𝑛) = (31.68 ≤ 𝑃 ≤ 41.75)



CenturyLink

Table of Contents








Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 100-101

Mergers and Acquisitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 102

Drivers of WACC. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 102-103

Assumptions Used In Model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 103

Cash Flow Valuation Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 103-105

DuPont and Altman Z-Score Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 106-108

Relative Valuation Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 108

100 | P a g e

Executive Summary: Summary and Conclusions

Mergers and Acquisitions

CenturyLink’s recent acquisitions of DataGardens, Cognilytics, and Orchestrate affect CTL’s long-term growth rate as the company enters new markets including cloud computing & services, big data, and predictive data analytics.

Drivers of WACC

CTL’s forecasted WACC of 5.997% is an important factor in cash flow valuation. The main drivers of CTL’s WACC are its target capital structure of 60% debt and 40% equity, its cost of equity of 9.87%, after-tax cost of long-term debt of 3.45%, and after-tax cost of short-term debt of 2.4%.

Assumptions Used in Model

A few important drivers of cash flow valuation for CenturyLink are long-term revenue growth rate, COGS/Sales, and SGA/Sales. Constant revenue growth is projected to be 1.4%, COGS/Sales is forecasted to decline to 40.16% from its current rate of 43.4%, and SGA/Sales is expected to decline to 17.0% as CTL wraps up its employee-retraining program.

Entity valuation and APV

both show CTL as undervalued

in the market.

FCFE returned a negative

valuation (overvalued) due to

CTL’s cost of equity of 9.87%.

Entity valuation is the

strongest valuation method for

CTL, as its WACC of 5.997% is an

appropriate discount rate.

o APV shows a similar

valuation to FCFF since CTL is

nearing its target capital

structure

Valuation Method Price Per Share Under/Overvalued (Amount)

Market Value $28.43 -

FCFF Intrinsic Value $33.48 Undervalued by $5.05

APV Intrinsic Value $33.40 Undervalued by $4.87

FCFE Value N/A Overvalued by $28.43

Entity valuation shows that CTL is undervalued in the market by $5.05, while APV

calculates the company as undervalued by $4.87.

$28.43

$33.48 $33.30

$25.00

$26.00

$27.00

$28.00

$29.00

$30.00

$31.00

$32.00

$33.00

$34.00

Market Value FCFF APV

Valuation by Method

101 | P a g e

Multiples Valuation Analysis



Average 36.72 84.65 242.36 108.42 85.20 111.47

Median Sample 38.90 70.77 97.71 69.98 77.42 70.95

Industry 62.75 14.67 19.11 20.89 21.16 27.72

S&P 500 24.14 58.05 72.60 - 104.21 64.75

The best estimate for CenturyLink’s price range is calculated using the P/E ratio which shows the

lowest standard deviation. Hence, CenturyLink’s price range is $31.78 – $41.75 using the t

statistic.

o Similar to cash flow valuation, relative valuation shows that CTL is undervalued in the

market.

Multiples forecast CTL is undervalued in the market by a range between $3.35

and $13.32.

Conclusion:

Both cash flow and relative valuation methods show that CTL’s intrinsic value is higher than the

market price of $28.43. Therefore, by all valuation measures excluding FCFE, CenturyLink is

undervalued in the market.

FCFE yields a negative valuation for CenturyLink due to the company’s high financial

leverage; using its cost of equity of 9.87% causes the present value of cash flows to

appear lower than CTL’s value of debt and other non-op liabilities.

However, despite the valuation methods projecting that CenturyLink is undervalued by a range

between 11.78% and 46.85% of market value, analysts remain skeptical about CTL’s future

growth potential.

Wall Street Analyst Opinions

Buys Buy/Holds Holds Hold/Sells Sells

6 2 8 1 0

Source: S&P Capital IQ

58.82% of 17 analysts currently recommend a hold strategy while 35.3% recommend a buy strategy.

Assuming CTL is able to achieve its expected constant growth rate of 1.4%, CTL appears as a strong buy

especially considering the company’s dividend policy. However, CenturyLink remains a risky stock

purchase due to its high financial leverage and inability to reign in its cost of revenue and SGA expenses

since its merger with Qwest.

102 | P a g e

Mergers & Acquisitions

DataGardens

CenturyLink’s acquisition of DataGarden marks a move to further CTL’s interest in cloud

computing and storage. DataGarden’s primary service is as a backup servers and information to

aid in a client’s recovery during disasters. This merger allows CTL to provide its business clients

with more reliable servers that utilize data insurance from disasters on the IT side of

operations. This merger is relatively small to the whole. According to Forbes Magazine’s Ben

Kepes, “Interestingly it looks like DataGardens hasn’t picked up any significant funding – with

that context, this deal looks like a good one for the founders.” Others suggested that this deal

was made for future developments that result from the disaster recovery services that

DataGarden offers. Ben Kepes remains skeptical about the future pay offs of this gamble CTL

made. This merger is viewed as an base expansion of operations and assumed to not yield

results very much different from CTL’s ROIC because this acquisition is part of CTL’s broader

plan of expanding into Cloud technology.

Cognilytics

CenturyLink’s acquisition of Cognilytics helps CTL provide Big Data analytics for mid and large

sized companies. Cognilytics specializes in predictive analytics by using large data sets to make

educated assumptions. There exists little information from credible news sources about this

acquisition. Much like DataGarden this acquisition is CTL’s continued intention of breaking into

new technology and looking toward cloud solutions.

Orchestrate

In 2015 CenturyLink made only one new acquisition and like its other previous acquisitions

Orchestrate is another small company focused on Data base services. Most of the literature

about this merger is either embellishments from management or highly technical articles

geared for engineers. In other words, credible business sources are not making comments on

this merger. CTL’s acquisition strategy is more of a research and development arm of future

operations. Its strategy is to just buy already proven technologies that it can incorporate into

service packages to gain a competitive edge.

Drivers of WACC

The primary drivers of CTL’s WACC are its bond rating and market risk premium. The bond

rating carries the most weight because CTL carries debt to equity ratio of 2 to 1 and any change

in its bond spread results in a large change in its WACC. The market risk premium drives prices

and expectations among different investors. However, the market risk premium is highly

dependent on time period, industry, variance with the whole market, variance with commonly

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compared indices, changes in government bond yields, and investor expectations of each of

these variables. This is a weakness of the capital asset pricing model and introduces a larger

variance between analyst opinions. Ultimately, professional judgement became key in

evaluating how the multitude of these variables adjusted CTL’s WACC.

Assumptions Used in Model

Constant Growth Rate:

CenturyLink’s expected long-term constant growth rate of 1.4% is an important factor in cash

flow valuation. The company’s long-term growth rate of 1.4% determines the free cash flows

available, and greatly affects the value of operations.

COGS/Sales:

Cost of goods sold, as a percent of sales is also an important driver in the valuation of

CenturyLink. The company’s merger with Qwest in 2011 caused COGS/Sales to increase from its

ten year average of 37.7% to its most recent of 43.4%. Using the historical average of 37.7%

yields an intrinsic value of $42.87, whereas, the most recent 43.4% shows an intrinsic value of

only $20.96, all else constant. As CTL reaches positive sales growth in 2019 it is projected that

the company’s COGS is expected to trend down to 40.16%.

SGA/Sales:

Selling, general, and admin, as a percent of sales also significantly affects the valuation of

CenturyLink. CTL’s ten year historical average of 16.6% leads to an intrinsic value of $35.00.

However, the company’s historical average is not an accurate representation due to its merger

with Qwest. CenturyLink’s most recent SGA/Sales of 18.4% is expected to decline to 17.0% as

CTL finishes its employee-retraining program.

Cash Flow Valuation Methods

Summary of Valuation Methods:

Market Value Entity Valuation APV FCFE

$28.43 $33.48 $33.30 N/A

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Entity Valuation (FCFF):

Entity valuation is the most accurate measure of intrinsic value for CenturyLink with an

expected intrinsic value of $33.48 on the target date of November 19, 2015. Entity valuation is

a strong measure of CTL’s value because the company is highly levered; WACC is the best

representation of CTL’s discount rate. CenturyLink’s strong cash flows and growth rate of 1.4%

lead to a value of operations of $47.117 billion, which is the largest driver of value. However,

the company’s debt and other non-op liabilities value of $33.16 billion significantly reduce

value.

Price per share on target date FCFF



Most recent fiscal year-end prior to

target date 12/31/2014

Number of days from target to fiscal

year-end prior to target 323.00




Value of debt, preferred stock, and

other nonoperating liabilities on target

date 33,163




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Adjusted Present Value (APV):

APV is also an accurate measure of CTL’s intrinsic value, with a computed value of $33.30 on

11/19/15. CTL is close to its target capital structure of 60% debt (currently financed with 59.2%

debt), so the intrinsic value calculated by APV is only $.18 less than entity valuation. Since

CenturyLink is highly levered, the present value of the company’s tax shield is an important

driver of value as the tax shield accounts for 17.37% of total firm value. Its unlevered cost of

equity of 7.12% and large tax shield leads to value of the ops of $47.02 billion. As with FCFF

valuation, the value of debt causes a large reduction in the value of equity.

Price per share on target date APV



Most recent fiscal year-end prior to target

date 12/31/2014

Number of days from target to fiscal year-

end prior to target 323.00




Value of debt, preferred stock, and other

nonoperating liabilities on target date 29,111




Free Cash Flow to Equity (FCFE):

FCFE is the worst measure of value for CTL as it shows a negative valuation of $(1.12) on the

target date. CTL’s high leverage leads to a high cost of equity; discounting the company’s free

cash flow to equity by its cost of equity causes the total firm value to be less than the value of

debt and other non-op liabilities. Since total firm value is less than the value of debt, CTL’s FCFE

shows a negative valuation.

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Complete DuPont Analysis

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Key Driver of Return on Equity

Profit Margin ROE

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Accounting Income vs Free Cash Flow

Profit Margin FCF

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Key Takeaways:

CenturyLink’s FCF/profit margin is projected to reach a steady state of 3.38% in 2026 as the

result of its transition from higher margin legacy services to wireless and data hosting services

o Return on Equity continues to decline at an average annual rate of (0.09)% following

2026 in spite of steady state profitability

CenturyLink’s leverage decreases at an average annual rate of (1.31)% from 2017 onward

o This is because all future firm acquisitions of involve small cap IT companies which

require no additional debt to acquire

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Historical and Projected Equity Multiplier

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Complete Altman Z-Score Analysis

Key Takeaways:

CenturyLink continues to face the threat of bankruptcy despite revenue growth stability and

consistent profitability.

This is unlikely to change given that the annual improvement in Z-score begins to decline in

2028, decreasing from an annual growth rate of 2.26% to 1.99%.

o This means that long-term steady state Z-score falls below the 1.8 threshold for financial

distress

Price Multiple Analysis



Average 36.72 84.65 242.36 108.42 85.20 111.47

Median Sample 38.90 70.77 97.71 69.98 77.42 70.95

Industry 62.75 14.67 19.11 20.89 21.16 27.72

S&P 500 24.14 58.05 72.60 - 104.21 64.75

The best estimate for CenturyLink’s price range is calculated using the P/E ratio which shows the lowest

standard deviation. Hence, CenturyLink’s price range is $31.78 – $41.75 using the t statistic.

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Altman Z-Score Trend:2005 - 2035

Z-Score Financial Distress Threshold

CenturyLink Valuation Project

Documents

Transcript of CenturyLink Valuation Project