CenturyLink to Underperform

We are downgrading our long-term recommendation on CenturyLink Inc. (CTL - Analyst Report) to Underperform from Neutral.

Although the third-largest U.S. landline operator continues to grow its broadband customer base and associated revenues, it remains challenged by the decline in fixed voice access lines. The company faces intense competition from cable TV operators who are aggressively offering traditional voice service through their networks.

The company’s first quarter earnings also failed to impress. Earnings per share surpassed the Zacks Consensus Estimate by 4 cents aided by the synergies from Embarq but fell year over year.

Revenue remained depressed year over year due to access line losses, lower access revenues and migration from fixed lines to wireless. Total access lines dropped 7.5% from the year-ago quarter.

Acquisitions and mergers will provide CenturyLink a competitive edge over its two major rivals –– AT&T Inc. (T - Analyst Report) and Verizon Communications Inc. (VZ - Analyst Report). While the merger with Embarq and Qwest as well as the pending Savvis Inc. (SVVS) acquisition may yield a number of operational benefits and cost synergies, significant integration challenges may impede future operating performance.

The integration of Qwest will incur approximately $650 million to $800 million of operating costs over three to five years and approximately $150 million to $200 million of one-time capital costs. CenturyLink has to integrate several systems and procedures, including re-branding, billing, management information, purchasing, payroll and benefits, fixed asset, lease administration and regulatory compliance. In addition, the combined company will have to expand its services to large urban areas where CenturyLink has limited operating experience.

Moreover, the company continues to operate with a high debt level (roughly $7.2 billion), which is further burdened by the assumption of approximately $5.8 billion in Embarq debt. The Qwest buyout will significantly increase CenturyLink’s debt, thereby further impairing its balance sheet.

CenturyLink remains focused on investing in broadband services to expand network capacity and on improving returns to its shareholders through healthy dividend payouts. Over the last five years, the company returned almost 28% to its shareholders in the form of dividends. The company paid approximately $878 million in fiscal 2010 through cash dividends with a 54% payout ratio. However, this is considered to be the lowest payout ratio in the industry.

However, for the short term, the stock retains a Hold rating with a Zacks #3 Rank.

Read the full analyst report on CTL

Read the full analyst report on T

Read the full analyst report on VZ

Read the full analyst report on SVVS