CenturyLink Slips to Neutral

We have downgraded our long-term rating on CenturyLink Inc. ( CTL - Analyst Report ) to Neutral from Outperform following a lackluster fourth quarter.

The company’s bottom line missed the Zacks Consensus Estimate by 6 cents in the fourth quarter and plunged 26.7% from the year-ago earnings. The downfall was due to steeper operating expenses and lower legacy voice and access revenues, given loss of customers and lower minutes of use that clouded over higher strategic revenues.

The Embarq, Qwest and Savvis acquisitions have increased the company’s operating cost and debt, which is diluting earnings in the near term. The integration of Qwest operations with CenturyLink will incur approximately $650-$800 million of operating costs over two to four years and approximately $150 million to $200 million of one-time capital costs.

In addition, CenturyLink has to integrate several systems and procedures of the acquired assets including re-branding, billing, management information, purchasing, payroll and benefits, fixed asset, lease administration and regulatory compliance. As a result, the combined company might have to expand its services to large urban areas where CenturyLink has limited operating experience, which might hurt its profitability in the future.

However, we believe the acquisitions and mergers would provide excess synergies going forward and boost the company’s competitive position against its two major rivals –– AT&T Inc. ( T - Analyst Report ) and Verizon Communications Inc. ( VZ - Analyst Report ) thus driving future growth. The three acquisitions are expected to generate annual synergies of $1 billion when fully realized.

Additionally, CenturyLink witnessed a slower rate of revenue decline in 2011 and expects the trend to continue this year and in the next. The third-largest U.S. landline operator is working on a number of initiatives to curtail access line losses. The company is bundling integrated services, promoting new services such as video, gaining new wireless spectrum from Federal Communications Commission and improving its infrastructure. These should work in favor of the company’s future revenue and earnings.

Furthermore, CenturyLink’s sustained focus on investing in four areas –– broadband expansion, fiber cells, cloud computing and Prism TV –– will serve as a major catalyst for revenue growth over the next few years. Additionally, the company offers higher returns to its shareholders through healthy dividend payouts, backed by strong free cash flow, inspiring our optimism on the stock.

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