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. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 20-22
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
Executive Vice President, 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
Executive Vice President, Chief
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
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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/
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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
Strategic Services $3,722 $5,953 $6,173 $6,350
Legacy Services $2,509 $4,540 $4,267 $3,998
Data Integration $408 $665 $651 $686
Total Revenue (Business) $6,639 $11,158 $11,091 $11,034
Consumer Segment
Strategic Services $2,532 $2,474 $2,650 $2,850
Legacy Services $5,171 $3,681 $3,349 $3,140
Data Integration $129 $7 $5 $4
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.
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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
Executive Vice President,
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
Executive Vice President,
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
II. Financial Performance Analysis
COMPANY ANALYSIS AND VALUATION
CenturyLink
Table of Contents
I. The Company, Industry, and Competitors
II. Financial Performance Analysis
Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 23-24
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
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
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
DuPont Analysis: Total Asset Turnover
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
ATNI 5.4 35.21 5.48 2.56 6.03 CCOI 0.11 8.33 -0.71 1.55 0.18 CNSL 0.76 1.74 0.38 2.2 2.68 CTL 1.51 -0.45 1.41 1.47 4.25
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
ATNI 7.29 63.78 15.57 7.54 14.26 CCOI 0.57 32.09 -2.63 4.78 0.45 CNSL 6.41 22.03 6.47 48.34 46.09 CTL 4.79 -1.31 3.86 3.76 9.92
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
ATNI 7.08 50.11 9.83 5.73 9.95 CCOI 4.76 13.2 4.13 6.64 3.32 CNSL 4.41 6.19 5.67 6.21 7.61 CTL 6.53 3.72 6.55 6.79 12.05
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
ATNI 40.7 36.58 26.75 19.76 21.7 CCOI 32.47 31.74 29.46 32.39 27.22 CNSL 39.32 43.74 35.52 42.17 41.18 CTL 29.83 24.73 30.84 30.1 47.1
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
ATNI 4.34 3.9 1.61 1.26 1.12 CCOI 5.66 2.47 5.44 5.71 2.13 CNSL 0.86 0.75 0.75 1.97 1.8 CTL 0.91 0.89 0.79 0.88 1.13
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
ATNI 3.64 3.26 1.32 0.9 0.7 CCOI 5.35 2.33 5.24 5.5 1.92 CNSL 0.66 0.57 0.61 1.76 1.54 CTL 0.54 0.49 0.47 0.52 0.98
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.
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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.
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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
39 | P a g e
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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
DuPont Analysis: Total Asset Turnover
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
COMPANY ANALYSIS AND VALUATION
CenturyLink
Table of Contents
I. The Company, Industry, and Competitors
II. Financial Performance Analysis
III. Cost of Capital, Capital Structure Analysis and Distributions
Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 45-46
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. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 50-51
Payout Policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 51
IV. Financial Statements Forecasts
V. Cash Flow Valuation
VI. Relative (Multiples) Valuation Analysis
VII. Summary and Conclusions
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%.
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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
COMPANY ANALYSIS AND VALUATION
CenturyLink
Table of Contents
I. The Company, Industry, and Competitors
II. Financial Performance Analysis
III. Cost of Capital, Capital Structure Analysis and Distributions
IV. Financial Statements Forecasts
Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 52-53
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
V. Cash Flow Valuation
VI. Relative (Multiples) Valuation Analysis
VII. Summary and Conclusions
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
Liabilities and Equity
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
Liabilities and Equity
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
proportion of sales.
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
proportion of sales.
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
Estimated price for 11/19/2015 =
$35.95
Projected ROIC at horizon
= 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
Estimated price for 11/19/2015 =
$28.07
Projected ROIC at horizon
= 5.4%
COGS/Sales:
Base Case: Same assumption used in the model.
COGS / Sales 37.7% 43.5% 43.4% 43.43% 40.16% 3 0.50
Estimated price for 11/19/2015 =
$33.48
Projected ROIC at horizon
= 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
Estimated price for 11/19/2015 =
$42.85
Projected ROIC at horizon
= 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
Estimated price for 11/19/2015 =
$20.94
Projected ROIC at horizon
= 5.2%
SGA/Sales:
Base Case: Same assumption used in the model.
SGA / Sales 16.6% 18.7% 18.4% 18.36% 17.00% 3 0.50
Estimated price for 11/19/2015 =
$33.48
Projected ROIC at horizon
= 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
Estimated price for 11/19/2015 =
$35.05
Projected ROIC at horizon
= 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
Estimated price for 11/19/2015 =
$26.82
Projected ROIC at horizon
= 5.6%
Net PPE/Sales:
Base Case: Same assumption used in the model.
Net PPE / Sales 123.1% 105.6% 102.2% 101.00% 110.00% 4 -0.80
Estimated price for 11/19/2015 =
$33.48
Projected ROIC at horizon
= 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
Estimated price for 11/19/2015 =
$40.46
Projected ROIC at horizon
= 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
Estimated price for 11/19/2015 =
$21.59
Projected ROIC at horizon
= 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.
V. Cash Flow Valuation
COMPANY ANALYSIS AND VALUATION
CenturyLink
Table of Contents
I. The Company, Industry, and Competitors
II. Financial Performance Analysis
III. Cost of Capital, Capital Structure Analysis and Distributions
IV. Financial Statements Forecasts
V. Cash Flow Valuation
Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 81-82
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
VI. Relative (Multiples) Valuation Analysis
VII. Summary and Conclusions
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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
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 47,020
Value of investments on target date 840
Total value of firm on target date 47,860
Value of debt, preferred stock, and other non-operating liabilities on target date 29,111
Value of equity on target date 18,749
Number of shares on target date 563
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
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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
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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
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, 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
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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
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 47,020
Value of investments on target date 840
Total value of firm on target date 47,860
Value of debt, preferred stock, and other nonoperating liabilities on target date 29,111
Value of equity on target date 18,749
Number of shares on target date 563
Price per share, target date $ 33.30
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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.
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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
COMPANY ANALYSIS AND VALUATION
CenturyLink
Table of Contents
I. The Company, Industry, and Competitors
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
Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 87
Valuation Methodology. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 88
Comparable Companies List. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 89-98
Multiples Valuation Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 99
VII. Summary and Conclusions
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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)
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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)
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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
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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
P/E P/S P/B P/FCF P/CF
- 3.41 60.26 65.25 18.28
Net Five Year Growth: Revenue Growth – 10.01% Op. Margin – 13.87% PM Growth – 16.18% EPS Growth – 15.45%
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
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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
P/E P/S P/B P/FCF P/CF
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
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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
P/E P/S P/B P/FCF P/CF
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
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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
P/E P/S P/B P/FCF P/CF
30.08 5.20 4.06 20.24 18.67
Net Five Year Growth: Revenue Growth – 19.52% Op. Margin – 12.26% PM Growth – 13.40% EPS Growth – 11.76%
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
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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
P/E P/S P/B P/FCF P/CF
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
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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
P/E P/S P/B P/FCF P/CF
17.47 2.16 3.48 24.40 7.33
Net Five Year Growth: Revenue Growth – 4.42% Op. Margin – 6.13% PM Growth – 7.38% EPS Growth – 8.03%
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
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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
P/E P/S P/B P/FCF P/CF
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
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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
P/E P/S P/B P/FCF P/CF
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
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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
P/E P/S P/B P/FCF P/CF
- 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
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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 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)
VII. Summary and Conclusions
COMPANY ANALYSIS AND VALUATION
CenturyLink
Table of Contents
I. The Company, Industry, and Competitors
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
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
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Multiples Valuation Analysis
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
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.
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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
103 | P a g e
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
104 | P a g e
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 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 nonoperating liabilities on target
date 33,163
Value of equity on target date 18,846
Number of shares on target date 563
Price per share, target date $ 33.48
105 | P a g e
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 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 47,020
Value of investments on target date 840
Total value of firm on target date 47,860
Value of debt, preferred stock, and other
nonoperating liabilities on target date 29,111
Value of equity on target date 18,749
Number of shares on target date 563
Price per share, target date $ 33.30
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.
106 | P a g e
Complete DuPont Analysis
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Profit Margin ROE
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Accounting Income vs Free Cash Flow
Profit Margin FCF
107 | P a g e
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
108 | P a g e
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
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
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
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