Where will Lumen Technologies stock be in a year?

Lumen Technologies (LIGHT 1.50%)the telecommunications company formerly known as CenturyLink seemed to be in dire straits just a few years ago. Its revenues were falling, it was posting steep losses and it suspended its dividend in 2022.

But over the past 12 months, Lumen shares have surged 374% on the back of a new AI infrastructure offering with Microsoft breathed new life into his business. Could those tailwinds propel the stock even further over the next year?

Image source: Getty Images.

What happened to Lumen before his deal with AI?

Lumen is one of the largest wireline service providers in the United States. Unlike AT&T and Verizonwhich expanded its wireless networks to reduce its reliance on cable connections, Lumen avoided the wireless market and expanded its cable business through a series of mergers and acquisitions.

Lumen expected to generate slow but steady growth as economies of scale kicked in. It has also expanded its faster fiber networks and included more cloud, security and collaboration services in its cable business plans.

Lumen’s smaller fiber business grew, but that growth was offset by the persistent decline of its wireline business segment. As a result, its annual revenue has declined for the past five consecutive years. Over the past two years, its adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) margins have narrowed and it has posted steep losses.

Data source: Lumen Technologies. * Excluding special items.

That’s why Lumen stock fell below $1 in June. But in July, its stock rose after Microsoft, which owns Azure, the world’s second-largest cloud infrastructure platform, signed a new network and fiber deal with Lumen. Through this partnership, Lumen will modernize Azure infrastructure to support the future growth of its cloud and AI services. Lumen also signed an agreement with Corning to ensure a constant supply of fiber optic cables for those large upgrades.

What’s next for Lumen?

In early August, Lumen claimed to have secured $5 billion in new contracts (including the Microsoft deal) related to the AI ​​connectivity market. It also said it was in “active discussions” to “secure an additional $7 billion in sales opportunities” and would aim to “more than double our intercity network miles over the next five years.”

Based on these claims, Lumen could potential generates $5 billion to $12 billion in revenue over the next five years ($1 to $2.4 billion annually) from its new AI contracts. That would equate to 7% to 16% of its revenue in 2023, but it’s unclear whether these tailwinds can fully offset the secular decline of its non-AI business segment.

Analysts expect Lumen’s revenue to decline 11% to $13 billion in 2024, followed by a milder 4% decline to $12.4 billion in 2025, as the macro environment heats up, expands its fiber business and recognizes more revenue from its AI contracts.

However, Lumen plans to “pull back” some of its planned 2026 and 2027 spending through 2025 to meet these new AI data center offerings. As a result, adjusted EBITDA is expected to decline from $4.6 billion in 2023 to $3.9-4 billion in 2024. Analysts expect adjusted EBITDA to decline to $3.9 billion in 2024 and to decline to $3.7 billion in 2025.

These weak expectations indicate that the Lumen business will not experience a rapid recovery in the coming year. It also still has $18.4 billion in long-term debt and a staggering debt-to-equity ratio of 70. However, its new contracts are expected to increase its free cash flow (FCF) by to a negative $878 million in 2023 to a positive $1 to $1.2 billion in 2024. It also had $1.5 billion in cash and cash equivalents at the end of its most recent quarter.

Where will Lumen stock be in a year?

Lumen isn’t going bankrupt anytime soon, and its stock still looks undervalued compared to its peers. With an enterprise value of $23.4 billion (which includes all long-term debt), it trades at just 1.8 times this year’s sales and 6 times adjusted EBITDA. By the same measure, AT&T and Verizon trade at 6.3 and 6.8 times this year’s sales, respectively.

However, Lumen stock can only be considered cheap if it actually grows its revenue, maintains positive FCF and becomes profitable again. We probably won’t know if it will be able to achieve all of these goals in the next four quarters.

So for now, I expect Lumen stock to trade primarily on near-term news regarding its AI-oriented businesses and the broader AI market. Its downside potential could be limited by investors’ hopes for its future growth, but its upside potential could also be limited by concerns about its persistent losses, shrinking margins and high debt. Therefore, I still expect Lumen stock to trade sideways and likely underperform the industry’s top earners over the next year.