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					Fin 573 | Steven Nicholas | May, 17 2010

CenturyLink (CTL)
Sell Report
Table of Contents:
   I. Introduction
  II. Company Profile
        A. Company description
        B. Business Strategy
 III. Industry Profile
        A. Wireline Industry
        B. Regulation
        C. Competition
        D. Industry Trends
        E. Opinion on Industry
 IV. Critical and Decisive Elements
        A. Current Situation
        B. Future Outlook
  V. SWOT Analysis
        A. Strengths
        B. Weaknesses
        C. Opportunities
        D. Threats
 VI. Assessment by Professional Analysts
VII. Assessment and Valuation
        A. Original Purchase Decision
        B. Recommendation
        C. Valuation
VIII. Appendix
        A. Valuation
        B. Coverage Maps

CenturyLink is the 4th largest telecommunications company in the USA measured by the
 amount of access lines it owns. Its operations are Company           Access lines (2009)1
predominantly in rural areas in the USA. About 36% 1. AT&T            48 million
of its revenues are earned through its declining voice 2. Verizon     34 million
services while high speed internet services, the main 3. Qwest        11 million
operational source of growth, currently consists of 4. CenturyLink 7 million
24% of the revenue portfolio.

Recommendation: Weak Sell; The main reason for my sell position is the reliance on the
declining wireline industry and price pressured network access segment for a major portion
of revenue (62.2%) and the dependence on mergers and acquisitions for growth.

Company Profile
Company Description
CenturyLink operates 7 million telephone access lines making it the 4 th largest
telecommunications company in the USA. CTL provides DSL broadband internet to 2.2
million customers and digital television to over 500,000 customers. CTL operates in 33 states
in mostly rural to small and midsized towns. Its services are divided into three categories,
Personal/individual customers, businesses and wholesale.2 CenturyLink’s main revenue
streams are voice services, network access services and data. The remainder comes from
fiber transport services and other minor sources.3
Voice services are traditional fixed line telephone Revenue Source Revenue Portion
services. Although it is the biggest source of revenue,                     2009      2008
the fixed line telephone business is in decline. Voice                      36.7 % 33.6 %
Network Access includes providing network usage for Network Access 25.5 % 31.6 %
other carriers, which CenturyLink is legally required to Data               24.2 % 20.2 %
do according to the Telecommunications Act of 1996.       Fiber transport 3.5 %       6.2 %
It also includes Universal Service Funds (USF), which Other                 10.1 % 8.4 %
are government subsidies for providing telecommunication services in rural and underserved
areas. Data encompasses Centurylink’s high speed internet services (DSL). About 89% of its
lines are broadband enabled, which is the industry’s main source of growth. Centurylink
owns about 10,300 miles of fiber network in 10 metropolitan markets as a result of a asset
purchase in June 2005. Since the purchase Centrurylink has sold some of these assets to
other operators. This is a relative minor portion of revenues, but may be a source of future
potential growth.4 CenturyLink has had irregular investments in its fiber network since 2002
when it sold its wireless business to ALLTEL to become a pure-play rural local exchange

  Todd Rosenbluth, „Standard & Poor’s Industry Servey, Telecommunications: Wireline” September 2009 and
AT&T corporate website. <http://www.att.com/gen/investor-relations?pid=5711>
  CenturyLink. “2009 Review and CEO’s message.” <http://ir.centurylink.com>.
  CenturyLink. “Fourth Quarter Earnings Report 2009” <http://ir.centurylink.com>.
  CenturyLink, “10-K”. <http://ir.centurylink.com>.

The 2009 merger with Embarq has significantly extended CTL’s telephone network to more
than double its size, especially on the east coast, Florida and Las Vegas.5 The main
competition CenturyLink faces is from cable and wireless companies. Cable companies have
an established network providing cable services and are now entering into the
telecommunication market, offering broadband and VoIP phone services. This is threatening
Centurylink’s market share. As wireless services are increasing in availability and decreasing
in cost, consumers are dropping their fixed line phone services and switching to wireless.
This is one of the main reasons for the decline in access lines.

Business Strategy
Phone companies have traditionally had a geographic monopoly, due to the high cost of
developing a network. This is especially true for the more unattractive rural markets. Since
the Telecommunication Act of 1996 telecom companies have had to open up their networks
to other carriers, which dramatically increased competition. However the geographic
mindset remained and Centurylink like other carriers focus on specific geographic regions.

For growth opportunities Centruylink looks to Mergers and Acquisitions. Its latest merger
with Embarq has been the largest in the companies history and the announced merger with
Qwest will be larger still. CenturyLink wants to position itself as a premier provider of voice,
broadband and video services. CentruyLink recognizes that there is an industry transition
away from telephone voice services towards broadband. By expanding its broadband and
investing in a fiber network Centurylink is trying to adapt the company to the changing
industry. Recently it has also begun offering Internet Protocol TV (IPTV) and wireless
broadband to expand its product portfolio.

CenturyLink’s business model is focused on providing good customer service. It is divided up
into a decentralized regional operating model that is close to customers in order to provide a
close and personal service.
It has three main business segments; commercial, residential and wholesale. The biggest of
these three seems to be residential customer, although individual figures are not available.

Industry Profile
Wireline Industry
The Telecommunications Industry is primarily a service industry, offering internet, cable TV,
long-distance and local telephone services and wireless communications. Telephone services
are provided through so called access lines. The fixed line telecom market in the US
generated 2008 total revenues generated of $122.4 bn in 2008. This represents a decline in
the industry of -3.1% CARC (compounded annual rate of change) for the years 2004-2008.
Consumption volumes have also decreased -1.7% CARC over the same period. Forecasted for
the years 2008-2013 is a CARC of -2.8%. Nevertheless from 2007 – 2008 the fixed line
industry experienced a growth of 1.2% in revenues.6
The various data services are provided via fiber-optic broadband networks, which has been
the main development in the wire line industry over the past decade. A further recent
technology development is the advance of wireless technology especially 3G and 4G.
  Embarq was spun off during the Sprint-Nextel merger in 2004 as an independent local telephone company.
CenturyLink. “Company Information Timeline.”
  Datamonitor, Fixed Line Telecom Industry Profile: United States, 1 November 2009

The telecommunications industry is regulated by state as well as a federal regulation. The
most important regulatory body is the Federal Communication Commission (FCC). Many
state regulators recently opened the video market to telecommunications companies
through allowing state wide franchise agreements. This increased the basis of competition
between telecommunication companies and cable companies.
Since the 1980’s the market has undergone significant deregulation, increasing the
competition and services in the industry, the most significant being the break up of the AT&T
monopoly and the Telecommunications Act of 1996. The Telecommunications Act
established among other things the Universal Service Fund (USF) which helps make
telecommunication services available to low income families and rural areas. Each
telecommunications company is required to contribute a certain amount. In 2008
CenturyLink received $320 mil from the USF to support its rural operations.

The telecommunications industry is highly competitive and mainly competing on price.
Opportunities in the Industry are the development and growing availability of broadband
technology, and wireless services. The main competitors in the telecommunication industry
are wireless service providers and cable companies. A lot of wireline telecommunications
companies have integrated wireless services to meet this competition. However CenturyLink
sold its wireless operations in 2002 and is no longer offering this service. Cable companies
currently hold the largest market share in the broadband market, which is the industry’s
fastest growing opportunity.

Industry Trends
The telecommunication wireline industry is highly saturated. The main access line additions
are coming from additional lines for children or families. Growth in the industry is situated
around wireless and broadband technology. From June 2007 to June 2008 the number of
high speed internet lines grew by 31%.
Demand for fixed lines is low because wireless services are becoming cheaper and more
available. With the sluggish economy more people have been cutting their fixed line to
utilize their mobile plans better. Telecommunications companies are also bundling their
video, internet and phone services together to provide customers with a one-stop-shop for
everything they need.

There is a regulatory push to increase broadband availability, especially in rural areas. This is
an opportunity especially for companies, like CenturyLink who already operate mainly in
rural areas.

The trend towards mergers and acquisitions among peers in the telecom industry is
attributable to the large network investment necessary for a telecom company to enter into
a new regional area organically. In July 2009 CentruryTel aquired the telecommunication
company Embarq, the fourth largest telecom provider to form CentruryLink. This enabled
CenturyTel to expand its services into east coast states, such as Florida, where it did not have
a previous network presents.

Opinion on Industry
Due to the upcoming regulatory push to the development of the broadband network in the
US I believe there is opportunity for growth in this area. However it might take a few years
for the FCC to resolve how to encourage this development. Further growth is will be in
wireless technology.
The telecommunications industry is a mature market. However due to our dependence on
technology to communicate and the growing need to be connected to the internet the
telecommunications industry will continue to develop and remain vital in the long term.
The fixed line telecom market will continue to decline in is a shrinking industry. Access line
losses are inevitable and hurting profits of companies, like CenturyLink, that rely heavily on
this segment.

Critical and Decisive Elements
Current Situation:
CenturyLink continues to lose access lines. Losses for 2009 were 8.6%, in its Q1 report CTL
announced it lost fewer than expected lines, (126,000 compared to Q1 ’09: 140,000 7) but
CTL expects this to continue at a rate of 6.5% - 7.5%. This has an adverse effect on CTL’s
revenues as it currently makes up over a third of its revenues.8 These losses are largely due
to wireless substitution, which has been increasing in the slowing economy as consumers are
realizing that they do not need both services.

CenturyLink is targeting high speed broadband solutions – the service with the biggest
growth. The broadband plan of the Federal Communications Committee is changing the
current structure of federal support for developing rural broadband networks. This causes
for some uncertainty in CTL’s future as it is expected that subsidies towards fixed telephone
lines will decrease and the funds used to promote development and expansion of broadband
networks in underserved regions.9

CTL is continuing to integrate the acquired Embarq network. CTL said it realized $40 million
cost savings from synergies in the 4th quarter 2009 and is expecting to realize further $200m
in savings during 2010.10

Future Outlook: Qwest Merger
On April 22, 2010 CenturyLink announced the acquisition of Qwest (Q), Americas third
largest telecom company. The merger values Qwest at $22.4 bn. This is an all stock deal in
which Qwest investors receive 0.1664 CTL shares for every Q share this values Qwest’s
equity at 10.6bn, a 15% premium. The merger creates the third largest fixed line carrier with
approximately 5 million broadband customers, 17 million access lines and a fiber network of
173,000 miles. AT&T (T) and Verizon (VZ) the nation’s two biggest telecom providers are
primarily focusing on their wireless businesses for growth.
CTL expects synergies to result in $575 million annual operating cost synergies fully
realizable three to five years after closing (2011) and annual CapEx syergies of $50 million
within 1 – 2 years after closing. These synergies are largely achieved by reducing corporate

  CenturyLink, “First Quarter Earnings Report 2010” <http://ir.centurylink.com>.
  CenturyLink. “Fourth Quarter Earnings Report 2009” <http://ir.centurylink.com>.
  FCC. “Executive Summary, National Broadband Plan.” <www.broadband.gov/plan/executive-summary/>.
   CenturyLink. “Fourth Quarter Earnings Report 2009” <http://ir.centurylink.com>.

overhead, eliminating duplicate functions and systems and increased operating
efficiencies.11 The combined company has a pro-forma $3.8 billion FCF in 2009 which is a
comfortable amount to pay the $1.7 billion dividend, reinvest and de-lever the company.
Analysts following the company see the merger as a positive move and will result in a good
competitive position in the industry.12
This merger will moves CTL into data, long distance markets, making up 25% of its combined
revenues (currently only 11% of CTL revenues). The long distance segment and corporate
customer accounts are areas of growth and both are part of Qwest’s strength.13

The future of the company lies in high speed internet and data transfer, for which the Qwest
merger is a strategic acquisition to position CenturyLink in the market.
Like CenturyLink Qwest operates in the fixed line telecom sector and
 offers broadband, telephone                              Qwest14            CenturyLink15
and Satellite television services. Market cap             $ 9.09 billion     $ 10.31 billion
Additionally      Qwest           has Revenue             $ 12.31 billion    $ 4.97 billion
partnership with Verizon wireless Net Income              $ 662 million      $ 512 million
enabling it to offer wireless Current assets              $ 4.6 billion      $ 1.12 billion
services, which is considered Long term debt              $ 12 billion       $ 7.2 billion
important for the future of the P/E                       $ 18.71            $ 10.76
combined company. Qwest is EPS                            $ 0.29             $ 3.25
renown for its national fiber- Dividend                   $0.32 (6.11%)      $ 2.90 (8.40%)
optic network, which is the Employees                     30,138             6,500
crown-jewel of the company.
Furthermore it has significant presence among corporate customers servicing about 95% of
the Fortune 500 companies.
Qwest telephone network services predominantly the western USA, with the exception of
Nevada and California. Qwest coverage area will significantly enlarge CenturyLink’s network.
Qwests has $12bn of debt on its books, of which about $5.8bn is due in the next 3 years. This
is the main reason that has compelled Qwest to seek a buyer, opting for a merger before
being forced to sell off its fiber assets.

SWOT Analysis:
Strengths:                                            Opportunities:
High dividend yield ($2.90; 8.50%)                    Main growth opportunities lie in acquisitions
Rural focus                                           and broadband

Weaknesses:                                           Threats:
Access line losses                                    Regulatory changes
Network division under price pressure                 Wireless competition
                                                      Increased competition in new urban markets

   CenturyLink & Qwest, “About the Transaction”, <www.centurylinkqwestmerger.com>, accessed 5 June 2010
   “CTL & Q Merger Conference Call Transcript”, <www.centurylinkqwestmerger.com>, accessed 5 June 2010
   Helen Thomas and Alan Rappeport, “CenturyLink and Qwest unvail merger“, Financial Times, 22 April 2010
   MSN Moneycentral, Qwest (Q) financials, <http://moneycentral.msn.com>
   MSN Moneycentral, CentruryLink (CTL) financials, <http://moneycentral.msn.com>

High dividend yield ($2.90; 8.50%)
CTL is offering investors a high dividend yield. Analysts believe that CentruyLink has the cash
flow necessary to support this high dividend. Over the past years CTL has been raising its
dividends, the last raise being in February 2010 to $ 0.725 per quarter.

Rural focus
CenturyLink operates mainly in rural areas. This is beneficial since these areas are less
contested by competitors. Due to the regional focus CTL is eligible to receive USF subsidies
to support the development of telecommunication services in these areas. However CTL’s
merger with Embarq and the announced merger with Qwest dilute this rural position as
Embarq had strong market positions in Las Vagas and Orlando and Qwest is present in many
of the nations larger cities with its fiber network, such as Denver, Los Angeles, Chicago,
Portland, Seattle.

Access line losses
Access line losses continue to erode CTL’s revenues. CTL’s growing broadband business may
compensate for some of these loses. These loses are a macroeconomic development and not
unique to CenturyLink.

Price Pressure in Network Access division
Other carriers are complaining about the prices of the network access to state governments.
This is putting pressure on states to further lower the access prices CTL is allowed to charge
for its network usage. This may cause to further dilute CTL’s revenue stream

Acquisitions and Broadband         Acquisitions
Main opportunities for growth      2000 Purchased 490,000 access lines
lie   in     acquisitions    and   2002 Purchased 650,000 access lines
broadband expansion. CTL has       2002 Sold wireless business
predominately chosen to grow       2005 Bought KMC fiber network in 16 metropolitan
through acquisition and has                markets
had a steady stream of             2007 Bought Madison River (164,000 access lines)
acquisitions since the 2000s.      2009 Bought Embarq (5.4m access lines; 1.7m
                                           broadband customers
                                   2010 Announced Qwest merger (10 m access lines)
Data currently makes up about
24.2% of CTL’s revenue. This portion has been growing over the past few years. The
announced Qwest merger will be a big push to increase CTL’s broadband potential.

Regulatory Changes and slow economy
Regulatory changes to the USF support may mean lower federal funds as money moves to
subsidize broadband expansion. The price pressure on network access prices is also largely
regulatory driven.

The slow economy is motivating many consumers to cancel their wire line phone services
and in order to only pay for the preferred wireless. This is a big threat to CTL’s customer
base, especially as wireless services are increasing their reach.

Increases competition in urban markets
As CTL is moving into more urban markets through its Embarq and upcoming Qwest
acquisition it will face tougher competition from other incumbent telecom operators. This
more fiercely contested market area further threat to CTL revenue.
Competition from cable and wireless operations is also adding pressure to CenturyLink.

Assessment by Professional Analysts:
Standard and Poors which has a hold rating on CTL, assigns it a medium risk due to its
relatively strong balance sheet and cash flow generation being off-set by high market
competition and the integration of Qwest. Regulatory changes coming from the FCC and an
increase in customer and line losses add to the risk that CTL bears. Despite synergies
resulting from the Embarq merger the S&P believes that CTL will face further earnings
pressure in 2010. The Qwest merger, which is expected to be completed in 2011 will bring
new opportunities for broadband development and cost synergies as well as the additional
risk of tougher competition in urban markets and a high debt leverage. In the near future the
S&P believes that DSL development will not be able to outweigh declining revenues from
access line losses, pressure in voice services and lower USF funding. Even so the S&P believes
the shares and dividend yield of around 8% to be fairly valued and that CTL will continue to
generate sufficient cash flow to support its dividends and capital investments.16

Currently there are 17 Analysts that publish their recommendation.
Rank                           No. of opinions No. of opinions
                               current month      previous month
Strong buy (Buy)               5                  6
Buy (buy/Hold)                 5                  6
Hold                           4                  3
Under perform (weak hold) 1                       1
Sell                           0                  0
No opinion                     2                  1
Source: Yahoo! Finance and S&P Stock Report.

11 polled analysts arrived at a 12 month mean target price of $37.45, with a high of $42 and
a low of $29. Generally the stock is perceived to have low volatility.17

Assessment and Valuation
Original Purchase decision
CTL was purchased on the 1st December, 2009 for $36.36. The main reasons for the purchase
were CTL’s dividend yield of 8%, its financial stability and potential for future growth. Its
target price was calculated to be: DCF: $50, Relative Valuation: $47.1418

   Standard & Poors, “Stock Report: CentruyTel, Inc”. May 29, 2010
   Yahoo! Finance, Analyst Opinion CTL, <finance.yahoo.com> accessed on 4th June, 2010
   Loomis, Jon. “Memorandum for Incoming Telecom Manager.” 6. December 2009.

Recommendation: Sell
The main reason for my sell position is the reliance on the declining wireline industry for a
major portion of revenue, dependence on mergers and acquisitions for growth and the high
additional $12bn of debt that will be inherited with the Qwest merger.

CenturyLink’s revenue is expected to decline by 6.5% - 7.5% in 2010, mainly due to declining
voice services.

My prediction is that in the short term CTL will experience turbulence as it is integrating the
recently acquired companies (Embarq and Qwest), restructuring and gaining synergies.
Providing everything goes as planned, I believe that the announced acquisition of Qwest is
strategic in the long term and will position CTL for further growth opportunities. This will
also help CenturyLink to focus on growing its data and broadband business which will in the
long term have to make up the majority of the revenues in order for CTL to stay competitive
and in business. However in my view it is currently relying heavily on mergers and
acquisition to generate growth.

CenturyLink pays a high dividend yield of 8.5% and will continue to do so. CTL’s current
operations provide enough cash flow for it to sustain this dividend. Being higher than the
cost of equity of 8.4% this could be reason enough to hold the company as an investment
stock, however limited future growth and a fair valuation for the combined company of
$37.22 (current stock price CTL = $33.33; Q = $5.21) have motivated me to recommend a sell
on all or part of our CTL holding to make room for a company with greater growth

My DCF calculation values CTL (not including the merger) at $5.20; its current price is $34.33.
Including the merger with Qwest and assuming a fair market value of the stock before the
merger announcement I value the new combined company at $37.22. This is considered a
fair value. (see Excel valuation and appendix for further information)

Valuation of Merger

Assumption: Market valued CenturyLink and Qwest fairly before merger announcement.
Indication to support this assumption: Trade volume was low and flat.

Merger announcement: 22 April 2010

Prices as of 21 April 2010                                       (source: reuters.com/finance/stocks)

                                                                 CTL                    Qwest
Price                                                                     $   36.20             $    5.24
Shares Outstanding                                                            300.4              1736.23
Market Cap                                                               $10,874.48             $9,097.85

The merger is a share only exchange. 1 Qwest share is traded in for 0.1664 CTL shares.
Merger share exchange                                                        0.1664                     1
No. of CTL shares                                                             300.4             288.90867
Combined share amount outstanding                                             589.308672
Combined market value                                                         $19,972.33
Combined stock price (market cap / shares outstanding)                        $    33.89
Combined stock price does not including synergies

Synergies of Integration
Expected annual operating cost savings $575 million fully realized 3 to 5 years after close
annual CapEx synergies of 50 million realized in 1 - 2 years after close
On time operating costs of $650 - $800 mil and $150 - $200 mil one time capital costs to achieve
Network doubles, customer base increases, pro-forma revenues increase substantially. The combined
company will have greater financial resources and a more diversified revenue base.
S&P announced that it might down grade CenturyLinks credit rating due to high combined debt,
However Qwest will be aggressive in its de-leverageing in 2010 and 2011. CTL wants to retain its
Investment grade rating, and is confident that it is in a position to do that post-close
Large Fiber optic network spanning 173,000 miles
Large broadband offering and increase in broadband customers to 5 million, 17 million access lines and
servicing 95% of Fortune 500 companies

Current Price                                                     $    34.33
+15%                                                              $    39.48
- 15%                                                             $    29.18

NPV of synergies                                                          $1,962.76
Value of Combined Company                                                $19,972.33
add NPV of synergies                                                     $21,935.09
Value per share                                                                $37.22

Coverage Map CenturyLink (including Embarq merger)

Coverage map CenturyLink and Qwest


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