Lumen (LUMN): FAQ and the Lumen Rubik's Cube

Davis Hebert, CFA – Senior Analyst - Telecom and Cable
Morgan White – Analyst - Telecom and Media

  • Level 3 and Qwest represent the largest operations of LUMN. We have received many questions about our EBITDA assumptions within Lumen. We believe Level 3 ($1.95bn 2023E EBITDA incl. EMEA) and Qwest ($2.65bn 2023E) represent the largest sources of cash flow within the Lumen umbrella. We believe Qwest can be further broken down by the ILEC held at Qwest Corp. ($1.75bn 2023E) and enterprise/wholesale at Qwest Communications Company, LLC ($0.9bn 2023E). Finally, we think the legacy CTL and EQ ILECs not sold to Brightspeed are a low-single-digit % of EBITDA ($170mn 2023E). Should we get any additional disclosures from Lumen on intercompany accounting or otherwise, we may revise these figures.
  • Level 3 debt is only supported by Level 3 subs, Lumen 1L has wider support. Lumen 1L debt is supported by guarantees from material non-regulated CenturyLink subsidiaries, with the exception of Level 3 and Qwest Corp. (regulated entity). However, Lumen 1L instead has pledges of stock from both Wildcat Holdco, LLC, the direct parent of Level 3 and Qwest Services Corp., the direct parent of QC. Level 3 debt lacks access to any other subsidiaries in the LUMN structure.
  • Qwest consists of longhaul CLEC (Qwest International) and 14-state ILEC out (housed in Qwest Corp). We think there has been a lot of confusion around the content of the Qwest operations. We believe QC is primarily the 14-state ILEC (formerly US West), which also serves Lumen affiliates in various backoffice capacities (booking intercompany revenue for those services). We believe that Qwest, outside of the QC entity, also owns a national fiber network that generates additional EBITDA, which we believe to be a large portion of Lumen’s business segment outside of Level 3.
  • LUMN priority debt capacity limited to 3.25x plus $2 billion in baskets. Lumen defines “priority debt” as any debt issued at Level 3 and/or Qwest if it is not payment subordinated, and debt at the Lumen level that is either secured or guaranteed by Lumen’s subsidiaries on a senior basis. As of 4Q22, we estimate Lumen’s priority leverage to be 3.0x, leaving 0.25x of a turn of priority debt capacity under the ratio test, or approximately $1.4 billion. We believe the Level 3 exchange ($1.1bn) would use up most of this basket but could leave $2 billion available in other carveouts ($1.5bn accordion and $0.5bn general liens) for upsizes or additional exchanges.
  • LVLT secured 4x test could apply in an uptier exchange within the LVLT box. We previously outlined that Level 3 may have $3.8 billion of secured capacity available when measured under the 4x secured incurrence test. While the 3.25x Lumen priority leverage covenant is a limiting factor for Lumen/Level 3 exchanges, we think the company could also look at Level 3 uptier exchanges (i.e., secured Level 3 debt for unsecured debt), where the 4x incurrence covenant would be more relevant. We think this capacity will shrink to ~$2.1 billion as Level 3 EBITDA contracts. Lumen disclosed it would consider more exchanges, which makes it all the more challenging to assess relative value in the structure. It is an open question whether the market could bear additional Level 3 secured debt with yields now approaching 11%.

Recent Feedback on Exchange

For a more detailed report on the exchange mechanics, see here: Lumen (LUMN): Level 3 Alarm Fire

Since this report, Lumen and Level 3 bonds have further weakened, with the Level 3 secured bonds now close to 11% YTW. This implies that the exchange bonds could trade well below par to reflect comparable value (we suspect close to 90). Lumen bonds initially rallied toward the exchange prices, but have since faded again — we believe part of the move reflects the perceived haircut that bondholders would take on the exchange, as well as the new Level 3 bonds likely trading below par. 

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