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CenturyLink (CTL) Dividend Cut Roils Telecom Space; Cash Flow & Taxes an Issue

February 14, 2013 10:18 AM EST Send to a Friend
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Yesterday CenturyLink (NYSE: CTL) shocked investors by cutting its dividend by 25 percent to 54 cents from 72.5 cents. Investors reacted by sending shares lower by 20 percent, a violent reaction considering the $2 billion buyback the company announced in place of the dividend. In fact, management indicated it was actually returning more cash to shareholders with this structure. What gives?

The motivation behind the dividend cut relates to management's plans to keep the dividend payout ratio at less than 60 percent of free cash flow. Unfortunately it expects free cash flow to fall due to the impact of declines in legacy revenues, along with a lower level of "incremental synergies".

Analyst Thomas Seitz of Jefferies described the move as follows:

“We believe the key motivation for management to cut the dividend was to maintain the coverage ratio around 60%, after CTL becomes a full cash tax payer in 2015. Management got ahead of the FCF drop and cut the dividend well in advance. Despite the increased return of capital to shareholders, CTL expects to maintain leverage below 3.0x."

Nomura’s Mike McCormack had more critical comments.

"Management's outlook confirmed our concerns of limited cash flow flexibility, a product of a changing revenue mix, lower incremental synergy savings, and higher capital spending. Guidance for capital spending was worse than our forecast. This leads to a declining outlook for free cash flow in 2013, which worsens as CenturyLink becomes a full cash tax payer in 2015."

Interestingly, Windstream (Nasdaq: WIN) - which boasts a 10% yield - opened 9 percent lower on Thursday, suggesting CenturyLink comments are creating a degree of panic in the telecommunications space. Shares of Frontier Communications Corporation (Nasdaq: FTR) are also lower - it currently yields 8.6%.




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