What's in Store for CenturyLink?

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2011 was a transformative year for CenturyLink (NYS: CTL) , the third-largest telecommunications company in the United States behind AT&T and Verizon Communications. The company closed on its acquisition of Qwest Communications in April and in July, it acquired Savvis, a global player in cloud infrastructure and hosted IT solutions. As of the third quarter, the combined entity included 14.8 million access lines, 5.5 million broadband customers, about 1.8 million video customers, and a national fiber network of about 210,000 route miles.

For a while now, the name of the game for many telecom players has been consolidation. These acquisitions add to revenue and hopefully reduce operating expenses through synergies. If that were the only thing that happened, these companies would be jumping for joy. What's different is that in addition to these things, many of these telecoms are dealing with slowly declining revenue as wireless connectivity continues to eat into landlines.

The acquisition of Qwest Communications played out something like that. CenturyLink expects to realize $575 million of operating expense synergies after it's fully integrated. The run rate at the end of 2011 was about $200 million, with the remainder of the synergy to be realized in another three to four years. Combined with earlier acquisitions, the company expects to achieve operating expense synergies of about $1 billion annually, hardly chump change.

Growth strategy
Reducing operating expenses is great, but it's even better to grow revenue. CenturyLink's growth strategy is four-fold.

The first initiative is through broadband expansion and upgrades. The company added almost 57,000 high-speed Internet subscribers in the third quarter, up from 12,000 added in the second quarter. There's also the fiber-to-the-node expansion, which will pass 5.75 million homes by the end of the fourth quarter. This is expected to boost customer bandwidth, which is important in today's data-hungry world.

Second, the company's fiber-to-the-tower initiative is designed to provide fiber to wireless towers in areas covered by CenturyLink. The company has long-term agreements with major wireless providers to support this initiative. While this cannibalizes its existing copper-based service, there should be revenue expansion in the future as bandwidth usage is virtually certain to go up.

Third, the company hopes to cross-sell the Savvis services to the enterprise customer base acquired through the Qwest merger. The hope here is to actually accelerate the growth rate of Savvis by exposing it to new potential customers.

Finally, CenturyLink hopes to expand its Prism TV service, which is available in about a million homes so far. Only 50,000 customers were subscribers at the end of the third quarter, but that represents a 25% quarterly increase. By expanding to at least one Qwest market in 2012, the company hopes to grow this IP TV service going forward.

Through its growth initiatives, the company's ultimate goal is to stabilize and grow its revenue. The revenue is expected to decline less in 2012, and the company hopes to stabilize it by 2013 or 2014. The operating expense synergies should shield the company's cash generation ability somewhat, but revenue growth is the ultimate goal.

The landline phone business is a declining one, but it's nice to see a telecom invest in broadband and fiber, which at least positions the company to benefit from increased data usage in the future. Revenue growth in the medium term is far from guaranteed, but the growth plan is a reasonable one.

Foolish bottom line
CenturyLink pays a healthy quarterly dividend of 72.5 cents, which amounted to a free cash flow payout ratio of about 50% in 2011. The dividend's quite safe for the time being, but there are many things to watch, including revenue growth, ongoing operating expense reduction, and continued growth in broadband subscribers, cloud services, and the company's Prism TV offering. If the company can meet its long-term growth goals, it may further grow its juicy dividend in the future.

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At the time this article was published Paul Chi is an analyst on the Fool's Alpha and Duke Street services. You can follow him on Twitter to stay up-to-date on his latest market commentary. Paul and Matt Argersinger co-manage the Street Fighter portfolio, where they look for cheap, unloved stocks with home run potential. Paul has no positions in any companies mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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