CenturyLink’s CEO successor plans are encouraging, but Q2 outlook remains weak, says Cowen

CenturyLink earnings
CenturyLink continued to see pressure in its consumer business during the first quarter.

CenturyLink’s choice to name Jeff Storey as the next CEO following the departure of Glen Post in 2019 is a positive development in that he will not only guide the merger with Level 3, but the company will face a number of near-term revenue challenges in its business and consumer units, according to analysts.

Cowen and Company said in a research note that Storey’s presence will add long-term value to the combined company.

Jeff Storey (Level 3)
Jeff Storey

“With an immediate appointment to COO, we believe Storey will play an active and positive role in the merger integration, reversing low morale, and shaping the enterprise-focused LT strategy,” Cowen said. “We view the move as incrementally positive.”

RELATED: CenturyLink taps Level 3’s Storey to be CEO when Post retires in 2019

However, Cowen added that Storey will face near-term challenges serving as COO of the company as Cowen and other financial analysts say CenturyLink will post unfavorable results in the second quarter and overall for 2017.

“We still expect weak 2Q17 results (and a weak year for that matter) from CenturyLink, and it’s difficult to assess the bottom in which Mr. Storey will need to manage from as a starting point for our valuation,” Cowen said.

Consumer segment challenges

A key challenge Storey will face when he takes over the new CenturyLink in 2019 revolves around how he will handle the consumer business.

Unlike CenturyLink, Level 3 was focused solely on selling services to businesses and wholesale products to other service providers.

Cowen said that CenturyLink going forward will face ongoing competition from cable, which is upgrading its hybrid fiber coax (HFC) plant with DOCSIS 3.1 to deliver 1 Gbps and higher speeds, and the eventual emergence of 5G wireless.

“Level 3 did not have a Consumer business, and re-shifted focus away from SMB last summer (mostly inherited by tw telecom), areas that while admittedly a smaller portion of the overall pro-forma revenue mix, are undergoing a period of fundamental uncertainty as outsized legacy declines continue, cable continues to compete, and 5G fixed wireless could be a longer-term threat in larger markets,” Cowen said. “CenturyLink hopes its ongoing copper bonding/vectoring buildout can drive inflection, although timing and magnitude remain uncertain, in our view.”

CenturyLink continued to see pressure in its consumer business during the first quarter as segment revenues were $1.41 billion, down 5.2% from first quarter 2016, primarily due to a decline in legacy voice revenues, as well as lower satellite video revenues.

Total strategic consumer revenues were $764 million in the quarter, down 1.3% from the first quarter of 2016, due primarily to the restructuring of a satellite video services contract.

In order to offset declines in consumer TDM-based voice, CenturyLink is focused on extending higher speed service to more households in its network footprint via a mix of copper-based technologies like G.fast and FTTH.

CenturyLink is now offering 100 Mbps to 3.5 million homes, while 9 million homes have access to speeds of 40 Mbps and above, representing an increase of what CenturyLink said was 200,000 addressable locations in each tier during the quarter.

Glenn Post (CenturyLink)
Glen Post

Post said during the company's earnings call that in the areas where it is offering 40 and/or 100 Mbps, the telco is attracting more broadband customers and driving up average revenue per user (ARPU).

MPLS, SD-WAN pressures

While CenturyLink’s business services segment will certainly benefit from Storey’s experience and the addition of Level 3’s assets, the service provider has seen some revenue pressures in the segment.

During the first quarter, CenturyLink reported that enterprise segment revenues were $2.36 billion, down 3.5% from first quarter 2016. The service provider attributed the decline to legacy revenue losses, which was partially offset by 4.2% growth in high-bandwidth data services revenues. Total strategic revenues were $1.08 billion in the quarter, up 2.9% from first quarter 2016.

“The Business side is more encouraging as this is where Mr. Storey and Level 3 assets can make immediate positive impacts,” Cowen said.

Cowen added that the declines are worrisome because CenturyLink has yet to deliver on business segment forecasts.

“The deceleration is clearly a concern, and while management claims that the 1H17 bookings funnel remains very robust that will translate into a notable 2H17 rebound, we believe CenturyLink is in the midst of a 'show me' story especially considering the company missed guidance the past two years,” Cowen said.

Another key concern is the slowdown in cash cow services like MPLS, particularly as new offerings like SD-WAN take hold in the longer-term.

One of the main issues that launching SD-WAN poses for incumbent players like CenturyLink is that it could potentially cannibalize their lucrative MPLS/private line business lines. At the same time, incumbent providers need to have SD-WAN in their arsenal to ward off competition from CLECs and even cable operators like Comcast, which recently launched an SD-WAN beta trial.  

Already, CenturyLink and more recently Level 3 have rolled out their own flavors of SD-WAN services, moves that Cowen says are “in some ways opportunistic, but in others as a defensive move.”

“Level 3 may still see opportunity as they continue to steal share, MPLS migration may decline but so would costs, and it would vastly increase the footprint,” Cowen said. “However CenturyLink MPLS could be under pressure, or at the very least measurably limit the incumbent CenturyLink MPLS business which is already showing signs of deceleration up ~4% Y/Y.”

Despite the near-term challenges, Cowen said that “if Storey can integrate, manage, and operate CenturyLink’s assets similar to the Level 3 business, then the company can see a compelling valuation inflection.”