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Is CenturyLink, Inc. (CTL) a Buy?

A graphic depicting a modern urban telecom network

Major transformations are rarely easy. Such is the case with legacy telecom CenturyLink (NYSE: CTL) , which has struggled with declining revenue and high debt as it tries to turn its business around. The company's recently completed acquisition of Level 3 Communications is a high-stakes gamble aimed at making the onetime regional telecom a global, cutting-edge player in its industry.

CenturyLink's stock experienced a bit of a recovery last December, after falling to its lowest levels in over 20 years. Here's a look at whether the company's bulls are justified in their optimism.

The future is fiber

There's no future in being a regional, legacy telecom in a world full of smartphones. There is, however, much potential in owning a huge global network stuffed with modern communications infrastructure.

This is a major reason why CenturyLink signed a deal valued at a whopping $34 billion for Level 3 and patiently waited over a year for the deal to close. The new CenturyLink -- which, by the way, will be led by Level 3 president and CEO Jeff Storey -- is going to be a big name in fiber infrastructure. All told, it will own around 450,000 route miles of fiber, be active in over 60 countries, and connect more than 100,000 buildings.

A graphic depicting a modern urban telecom network

Image source: Getty Images.

That lifts CenturyLink to the level of the two mighty U.S. telecoms, AT&T (NYSE: T) and Verizon (NYSE: VZ) , in terms of fiber asset volume. AT&T holds around 410,000 fiber route miles, while Verizon's mileage is over 500,000.

A big fiber grab aligns with the coming of 5G connectivity in the very near future for a world that has become increasingly hungry for large amounts of data transmitted quickly -- and increasingly, via mobile devices. So the Level 3 acquisition was a sensible move on CenturyLink's part.

The problem is, it was an expensive move for a company that's having increasing difficulty with its finances. CenturyLink is a legacy telecom, and its revenue has eroded as customers opt for more modern services -- the annual top line dropped for five years in a row . In 2016, it was $17.47 billion, down from 2012's $18.38 billion.

This has negatively affected profitability, and operating and free cash flow (FCF). All three line items have been on the decline recently, while the company maintains a generous dividend that's increasingly unaffordable. Witness the sharp increase in the cash dividend payout ratio :

CTL Cash Dividend Payout Ratio (TTM) data by YCharts.

That 250%-plus increase blasts CenturyLink well above even AT&T's triple-digit figure (127%), and is more than three times Verizon's 73%.

The integration of Level 3 will certainly help, particularly considering that the new asset's annual FCF is running at around $1 billion these days. (CenturyLink's latest full-year figure is $1.6 billion; the dividend costs it nearly $1.17 billion per year.) Also, CenturyLink says it'll save nearly $1 billion in costs, thanks to synergies between the two companies.

However, CenturyLink has issued shares to help fund the deal, and the holders of that stock want their dividends, too. The extra shares will add around $1.1 billion to total annual dividend expenses at the current payout level. So in short, the future of the current dividend is hazy.

Meanwhile, the sizable CenturyLink and Level 3 deal will take some time and expense to fuse together. CenturyLink bulls are apt to be gazing further down the road when the two are integrated and 5G services start to be rolled out at meaningful levels. The bulked-up company's big fiber network will be a crucial set of pipes carrying all that data.

Dividend doubts

An investment in CenturyLink is basically a play on hope and a long-term throw. Management has implied that it'll maintain the dividend . However it's very possible the finances won't be sufficient to do that, even with the integration of profitable and cash-generating Level 3. And while a cut in the payout will help fundamentals, it will probably hammer the stock price.

Although I like the direction CenturyLink is heading in, and I admire its boldness in netting Level 3, there are too many uncertainties about the company's future -- particularly in respect to the dividend. This story might have a happy ending years from now, but that's far from a certainty. At the moment, this stock isn't a buy for me.

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Eric Volkman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Verizon Communications. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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