Lumen Technologies

Lumen's second-quarter revenue declined 9%, or 3% excluding the residential fiber network sale. Enterprise revenue was down less than 2% year over year versus an average decline of 4% in recent quarters. However, Lumen again announced no new fiber deals. EBITDA contracted in line with revenue.

Why it matters: The lack of new fiber agreements for a second quarter in a row is disappointing but not overly surprising. Other firms have pushed into this business as the artificial intelligence buildout boom has progressed. Management indicated that deals requiring new investment are now priced to deliver very poor returns. Lumen has done well to monetize its unique assets, but other firms hold large network footprints as well and are rapidly building fiber. Verizon, for example, announced a $1 billion dark fiber agreement with Google this quarter and said that it expects to close additional deals this year. Management noted that high-capacity wavelength service revenue increased 11% and orders were up 35%. Lumen is the leader in this area, which allows customers to connect to data centers, but its performance is tough to gauge because the firm has shifted lower-capacity wavelength circuits to the legacy revenue bucket.

The bottom line: We maintain our $7.50 fair value estimate and no-moat rating for Lumen Technologies.

Key stats: Free cash flow totaled $327 million excluding restructuring costs during the quarter, benefiting from the timing of fiber deal cash collections and $139 million of tax refunds. Lumen maintained its free cash flow forecast for the year, implying about $1 billion during the second half. This figure could be hard to hit as spending tied to the fiber deals outpaces collections, but the firm expects to receive additional tax refunds. In any case, the core business is still not a reliable cash generator yet.

Our $7.50 fair value estimate assumes Lumen generates solid free cash flow over the next few years, as it collects upfront cash payments under its private connectivity fabric infrastructure agreements, offset in part by required network investments.

Lumen has announced about $13 billion of infrastructure agreements since 2024. These contracts likely extend for about 20 years, so revenue will be recognized gradually even though most cash is received upfront. A portion of the proceeds from these deals will be invested over the next few years to expand the network to new locations. In total, we assume Lumen receives more than $14 billion in advance PCF payments through 2035. We expect these receipts to be heavily weighted toward the next five years, and we assume 60% of these payments will be dedicated to capital spending over the next decade.

Outside of increasing recognition of noncash deferred revenue tied to infrastructure sales, we expect Lumen to struggle to drive top-line growth, as declines in legacy enterprise products and its remaining consumer segment outweigh growth in new services. We forecast average enterprise segment revenue to decline 2% annually on average through 2030, or nearly 3%, excluding the recognition of infrastructure revenue. We then expect 1% growth through 2035. These estimates reflect our view that even newer service offerings, like wavelengths and dedicated internet access, will remain extremely price-competitive.

We expect capital spending in 2026 to top 30% of revenue, with about a third attributable to the infrastructure agreements. As these networks are completed, we think Lumen can operate with capital spending at a midteens percentage of revenue over the longer term.

We forecast the adjusted EBITDA margin, excluding severance and other restructuring charges, to reach 30% in 2026, up from 27% in 2025. Management has stated that it can return adjusted EBITDA margins to the mid-30% level over the next couple of years, with annual cost savings tied to current initiatives reaching $1 billion, or more than 10% of total expenses excluding depreciation and amortization. We assume the adjusted EBITDA margin reaches 35% by 2030 and continues to build to 38% over the longer term. As revenue shifts toward higher-margin infrastructure and connectivity offerings, including amortized infrastructure sales, we believe this level of margin expansion is reasonable to assume.

We don't believe Lumen holds competitive advantages that will enable it to earn excess returns reliably. The firm possesses a vast telecom network, but few of its assets are differentiated enough to command adequate pricing power to offset the persistent decline in the legacy services it offers.

While Lumen’s fiber network and breadth of services could logically lead to cost advantages or customer switching costs, the decline in legacy services revenue has pulled total revenue steadily lower, causing margins to contract persistently. Returns on invested capital have averaged only about 4% since the 2017 Level 3 merger. We expect legacy offerings to continue declining, offsetting growth in newer technologies. A shift toward higher-margin infrastructure and on-network services and ongoing cost-cutting efforts should allow profitability to improve. However, we don't have confidence in Lumen's ability to deliver excess returns on capital in the future, especially considering the full cost of acquiring its network, much of which has been written off.

Lumen sets itself apart with its extensive long-haul fiber network. With 360,000 route miles in its terrestrial and subsea transcontinental network, it has capabilities that few other companies can match. It is one of the worldwide leaders in serving data transportation needs. Essentially, as one of the few Tier 1 networks worldwide, Lumen is a key contributor that makes up the backbone of the internet. Enterprises use Lumen’s services to transport data for internal purposes and to reach the public.

However, modern technologies allow other firms to meet subsets of enterprise customers’ needs without controlling all underlying network infrastructure. While a physical network like Lumen’s is necessary, numerous firms own or otherwise have access to network capacity between major demand points, like large office buildings and data centers. Technology now allows for much greater bandwidth within the same unit of physical capacity, like a fiber strand. While Lumen owns some unique assets, pricing pressure will likely persist across the substantial majority of its business.

Lumen has been a beneficiary of surging data center demand, fueled by investments in AI. The firm has secured $13 billion in so-called private connectivity fabric deals since the beginning of 2024. Its PCF is a customizable network solution, combining existing dark fiber—that is, raw fiber cabling between two points without the equipment needed to create a functional network, its extensive network of empty conduits, and other network assets with newly constructed routes. The firm's unique combination of assets has attracted the operators of hyperscale data centers that need guaranteed connectivity across their networks of data centers, delivered as quickly as possible.

These long-term PCF deals will likely be a key driver of reported revenue and profits over the coming decade. Lumen receives large upfront capital payments for access to existing infrastructure and to fund the construction of new network assets. Revenue will be realized over the lives of these contracts, running up to 20 years. We suspect around 60% of the proceeds from PCF agreements will need to be spent on the network. As a result, PCF sales are akin to asset sales with relatively small recurring service agreements. These deals are certainly important, vastly improving Lumen's financial position, but they don't give us confidence in its ability to generate consistent returns on capital over time.

Lumen holds unique network assets. Extensive unused conduit between major markets and diverse network routes will continue to attract demand from hyperscale data center firms.

The hyperscale data center deals are only the beginning. Lumen will be a major beneficiary of AI investment as firms rush to secure networking capacity.

Divesting the consumer fiber network repaired the balance sheet and sharply reduced future capital spending needs. As financial uncertainty fades, investors will be willing to pay more for Lumen's shares.

The data center connectivity agreements only provide a one-time boost to cash flow. Lumen's debt load remains large, leaving it in a dangerous financial position if operating results don't improve.

Most revenue still comes from legacy offerings, such as landline phone service and private connections, which will decline for the foreseeable future. With prices for more modern services perpetually falling, Lumen won't return to revenue growth anytime soon.

Lumen's decision to keep the old copper phone network was a mistake. The cost to operate this network is enormous.