A New AI Darling? Lumen Soars Over 500% Since July, Here's What You Need to Know

Kate Johnson, CEO of Lumen Technologies, believes that this is just the beginning of a significant opportunity for Lumen, as it will lead one of the largest expansions in the history of the internet：

Before the announcement of the performance in early August, the stock had risen for 16 consecutive trading days, setting a new record for the longest continuous increase in the company's history. On August 6th, the day of the earnings release, the stock surged more than 93% in a single day, driven by better-than-expected current earnings and free cash flow guidance.

Specifically, Lumen reported second-quarter revenue of $32.68 billion, exceeding analysts' expectations of $32.46 billion. The adjusted loss per share was 13 cents, significantly lower than the expected 6 cents loss. The second-quarter free cash flow was -$156 million, still negative but significantly narrowed compared to the same period last year. However, the company raised its full-year 2024 free cash flow guidance from the previous range of $100 to $300 million to $1.0 to $1.2 billion, which greatly boosted optimism.

Due to high debt, weak cash flow performance, and unfavorable long-term growth prospects, Lumen had a heavily crowded short position before, with the percentage of float shorted approaching 20% at one point earlier this year. The stock price surge since July has triggered a massive "short squeeze," forcing short sellers who bet on the stock's decline to cover their positions, further driving up Lumen's stock price significantly. According to Ihor Dusaniwsky, the managing director of predictive analytics at S3 Partners, profitable "shorts saw a drastic reversal of fortunes" in July with the trades down around $220 million.

Some people are drawing parallels with the surge of Super Micro Computer, whose stock has also increased more than fivefold since late April 2023. A short squeeze has also played a role as the short interest in the stock has significantly declined. However, whether Lumen can replicate the success of Super Micro Computer depends on whether the company can truly demonstrate its position as a beneficiary of the artificial intelligence wave, just like Super Micro Computer did, by delivering solid performance to the market.

Citi analyst Michael Rollins believes Lumen's business wins should be an incremental positive for the shares, as the announced $5 billion new business and the anticipated $7 billion business channel, which are expected to provide financial flexibility and ultimately reduce the net debt leverage ratio, thereby improving future financial performance.

TD Cowen said Lumen's mixed results for the second quarter were trumped by an update on its GenAI wins. While there are still some uncertainties, the company is set to receive meaningful upfront cash from hyperscalers, which will be used to fund meaningful buildouts.

Goldman Sachs analyst James Schneider acknowledges the significant risk of declining traditional business, yet he believes that Lumen's latest business announcement provides the company "with a well-defined, long-dated stream of cash flows that is accretive to the equity."

MoffettNathanson points out that despite Lumen's recent partnerships with Microsoft and Corning, the company is still facing steep revenue declines in its existing business.

According to Sebastiano Petti, an analyst at JPMorgan, Lumen's potential for additional fabric artificial intelligence deals could improve investor sentiment and and drive positive estimate revisions.

According to Matthew Dolgin, an analyst at Morningstar, although the Corning agreement represents a hopeful growth opportunity, he is reserved about how much the agreement will actually change the company's short-term development trajectory. Chris Lau, an analyst at Seeking Alpha, rates Lumen as a "strong buy," but also points out that the company needs to solidify the additional $7 billion in revenue to justify the recent stock price increase. Moreover, LUMN's market share within the communications services industry stands at only 5.03% for the 12 months ending in Q1 2024.

Despite the recent optimistic turnaround in sentiment surrounding Lumen, the company still needs to prove to the market with more contracts that it can overcome the decline in traditional business and restore consistent profitability, positive cash flow, and ultimately alleviate the pressure from its massive debt. As Nick Del Deo from Moffett Nathanson reminds us, any obstacles or poor execution in new revenue opportunities and cost reductions will undermine Lumen's current stock price.

1. Negative Cash Flow and Mountain of Debt:Lumen's cash flow has been declining, and the second-quarter free cash flow has not turned positive yet. As of June 2024, the company only has $1.495 billion in cash on its books, which is a concern considering its staggering $20 billion debt.

2. Legacy Business Declines and Onerous Cost Structure:The decline in traditional business, as the industry shifts towards new communication methods, has significantly impacted Lumen's sales, and its burdensome cost structure makes it difficult for the company to cope with this headwind. Analysts project that the company's sales in 2024 will be $12.9 billion, only half of its peak in 2018.

3. The contribution of the $5 billion in new orders may take 3-4 years to materialize, while capital expenditure pressure erodes short-term profitability: Nick Del Deo estimates that about 90% of the new $5 billion transaction value will be realized in the next three to four years. However, this will require an initial capital expenditure and operating costs of $3.5 billion, in addition to interest expenses and taxes. Considering the scale of losses in Lumen's traditional business, the annual cash flow contribution from AI new transactions may be relatively weak. But Nick Del Deo also points out that the data center business has long-term potential and as the company passes the initial investment phase, the profitability of new contracts will eventually improve, which is good news.