Shortly after the management team at Centurylink (NYSE: CTL) announced a US$6.4Bn write down of goodwill, the company announced that they will be doing a strategic review of their consumer business. The strategic review could lead to a spin off of the consumer business as an independent publicly traded company or an all out sale of the company to an independent buyer. The consumer business is a US$5.3Bn business that has seen some rough times recently with revenues declining by 6% in the last 3 years.

CenturyLink The Company

After consummating the Level III acquisition in 2017, Centurylink today is a multinational communications service provider that offers networking services, IT consulting services, and the infrastructure and software that facilitates voice collaboration across different geographies. A small sub-segment of the business, provides live tv services to residential customers using the same infrastructure that the company uses for its networking services. Enterprise wide revenues was US$23Bn in 2018, with segment adjusted EBITDA of approximately US$10.5Bn. The company is organized into four business units, most of which offers the ability to 'cross-pollinate' other business lines: IP and Data Services, Transport and Infrastructure, Voice and Collaboration, and IT and Managed Services.

IP and Data Services: This business unit offers customized private networking services to governments, businesses, and service providers that allows the transmission of video, voice, and data over a primary secure network. Along with private networking, the company also provides ethernet networking services across point-to-point and multi-point interfaces that facilitate "data transmissions across metropolitan areas and larger enterprise-class wide area networks". Finally, this division provides internet protocol - global internet access across 60 countries - and video tv services - the Prism TV service, and satellite digital television under an arrangement with DIRECTV to residential customers.

Transport and Infrastructure: The Transport and Infrastructure business unit offers broadband services over existing telephone line or fibre-optic cables; private line - a direct circuit or channel specifically dedicated to connecting two or more organizational site; Wavelength based services where scalable high bandwidth optical networks is contracted out for communication purposes or for providing high-speed access to cloud computing resources; Colocation and Data Center Services which includes dedicated hosting and cloud services to more complex managed solutions, such as disaster recovery, business continuity, and applications management support; Dark fibre connections to large enterprises that are interested in building their networks on this particular technology. As part of the suite of hardware products offered here, the company has a team of experts that provide the necessary consultation services to integrate all the software and hardware.

Voice and Collaboration: Voice and collaboration covers a range of voice transmission services offered to residential and business customers that includes Primary Rate Interface service, local inbound service, switched one-plus, toll free, long distance and international services. In addition, the company offers Voice Over IP (VoIP) for a broad range of local and enterprise voice and data services including VoIP enhanced local service, Hosted VoIP, long distance service, and toll-free service, all provided to enterprise and residential customers.

IT and Managed Services: According to the company's 10-K, IT and Managed Services covers customized technology solutions for customers, solutions that are often managed on an ongoing basis. They represent a blend of network, hosting, cloud, and IT services that typically require ongoing support such as managing applications, operating systems and hardware.

Centurylink Revenue By Business Units (US$Mn)

Key Assets

A key ingredient in the competitive strength of the company lies in the breath and depth of the network that they own or lease. It is this network that allows the company to cost effectively provide networking and communication services without facing high connectivity fees. According to the company they have the following:

  1. Approximately 450,000 route miles of fiber optic plant
  2. Approximately 910,000 miles of copper plant
  3. More than 360 colocation facilities and data centers globally
  4. Approximately 37,500 route miles of subsea fiber optic cable systems
  5. More than 150,000 Fiber On-net buildings
  6. Multiple gateway and transmission facilities used in connection with operating our network throughout North America, Europe and Latin America
  7. Central office and other equipment that enables us to provide telephone service as an incumbent local telephone company ("ILEC") in 37 states

The Spin-Off

Centurylink disclosed that they are pursuing strategic alternatives for their consumer business in its Q1 of FY-19 conference call in which they also disclosed a Q1 loss of US$6.17Bn on account of a non-cash $6.5 billion goodwill impairment charge. Adjusting for the goodwill write-off the company saw fairly solid growth in EBITDA and in EBITDA margins. According to the company:

we believe we have assembled an extremely valuable collection of fiber-based assets that are very capable of supporting future revenue growth and continued market share gains. Now at the same time, we are intently focused on those growth opportunities. We also continue to evaluate our asset portfolio to assess whether there are better ways to create shareholder value. Generally speaking in making these assessments, the more enterprise focused, network-related, fiber-based and growth oriented product line is the more core it is to our future. As I briefly mentioned on our fourth quarter call, we've been open to looking at assets like our consumer business. We now -- have now engaged advisors to assist us in that review. Let me be clear, we are early in what I expect to be a lengthy and complex process. During our review, we will not modify our normal operations or our investment patterns. I can't predict the outcome or the timing of this work or if any transactions will come from it at all. Our focus though is value maximization for shareholders. If there are better paths to create more value with these assets, we will pursue them.

The consumer business has a bigger margin than does the enterprise segment which is a big positive, at the same time, as alluded to in management's commentary, the consumer business is declining at a material pace. Over the last 3 years, revenues have declined by CAGR of approximately 6%, while adjusted EBITDA declined by approximately 2.9% on the back aggressive expenditure cuts.

Relative Performance of Centrylink's Consumer and Enterprise Segments (US$Mn)

Centurylink's consumer business segment is split differently to that of the enterprise business segment with Transport and Infrastructure, and Voice and Collaboration subsegments taking up the two largest shares of the overall group.

Market Response

The market response so far has been minimal. The stock of Centurylink (NYSE: CTL) has been in a free fall since September 2018 where it was at US$23.86 per share. The stock bounced off a 52 -week low of US$9.64 before recovering to approximately US$11.30 per share on June 17, 2019. Since the company first announced the idea of a strategic review for the consumer business division at the end of Q4 in January 2019, the stock has fallen by more US$3.0 per share.

One analyst has actually concluded that a spin-off of the consumer business is value destroying, as it comes with large dis-synergies that will likely impact both parent co and spin co. MoffettNathanson stated that the spin-off is bad for business because of the fact that dividing the network and other key assets that are used in the consumer and business sides of the company would reduce enterprise value by US$300Mn to US$600Mn. The analyst also pointed out that there are regulatory concerns around whether the company would receive the necessary approvals from the state public utility commissions.

Final Remarks

Centurylink's proposed spin off of the consumer business is coming at a time when there are concerns about whether there will be a recession in the USA, and just after the company recorded a US$6.4Bn write down of goodwill. These events would lead one to question the motives behind the spin-off. On the face of it, it appears to be a knee-jerk reaction to dispose a business that is facing a cyclical downturn in demand. On the other hand, the business is evidently in decline for the last 3 years, as such it quite likely that the company is facing a structural change in industry dynamics that could potentially lead to permanent value destruction if left unattended, and management may feel they don't have the wherewithal to address these issues. Nevertheless, it is still early days and management has clearly stated that they could hold on to the business for longer if a value enhancing play is not clear cut.