Short Candidates for Contrarians, Part 3: CenturyLink, Inc. (CTL), Coach, Inc. (COH)

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This is the third in a series reviewing the favorite short candidates of the AdvisorShares Ranger Equity Bear ETF (NYSEMKT: HDGE), co-managed by John Del Vecchio and Brad Lamensdorf. The managers have a background in forensic accounting and analyze factors such as earnings quality and relative strength to determine which shares to short.

The fund is down 33 percent from its 52-week high as the market gains ground. But with the Dow near an all-time high, contrarian investors may be looking for ways to hedge portfolios against a market correction. The first two parts of this series covered the fund’s top six short positions at the end of January. They are available here and here.

Since then, perhaps in anticipation of Chipotle’s earnings report Tuesday, the fund reduced its short position in the restaurant chain from 5 to 3 percent. As a result, Chipotle fell from the fund’s second-largest position to its seventh. This post will cover the three largest positions not previously covered.

CenturyLink, Inc. (NYSE:CTL)CenturyLink, Inc. (NYSE:CTL)

CenturyLink, Inc. (NYSE:CTL) was a 3.3 percent short position as of Feb. 4, making it the fund’s sixth-largest. You might need to be a forensic accountant to make sense of its balance sheet after the rollups of Embarq, Qwest and Savvis over the past several years, consolidating its local exchange business and venturing into internet service and cloud computing.

It is now the third-largest telecom company in the U.S., but its legacy residential wireline business is declining rapidly as wirelessly-connected households abandon the landline. Total revenues declined by $25 million in the third quarter of 2012 compared to the year-earlier period.

Considering some $21 billion in transactional goodwill, nearly $20 billion of debt and a 7 percent dividend, it’s easy to imagine a scenario in which economic headwinds and a declining legacy business produce a financial crunch. Jeremy Phillips of The Motley Fool highlighted some of the financial metrics to watch out for more than two years ago.

Century Link wants to leverage the high-capacity fiber network it acquired with Qwest to become an essential part of internet infrastructure, enabling enterprise clients to run high-bandwidth applications through its fat pipes. It hopes that its enterprise business, including cloud computing, takes up the slack for the declining residential landline business.

The key to Century Link’s stock price is maintaining the hefty $2.90 per share dividend. The share price has been locked in a range between $25 and $50 for more than 10 years, so buyers probably aren’t betting on capital appreciation. In a race between the decline of its legacy business and the growth of its internet business, HDGE is betting on the decline. Short interest in Century Link represented 5.6 percent of the float in January.

“Century Link is a new position for us,” Lamensdorf told CNBC earlier this year. “This is the old Qwest-Savvis rollup, land lines and internet service. The way that we found this company is we were screening cash flow, and the dividend on this company takes 90 percent of their entire cash flow. We started doing a lot more work on it and we found a lot of poor cash flow items involved with the cash flow number that they’re feeding to us. We think that cash flow number is pretty questionable.”

Even with interest rates near zero, Lamensdorf said Century Link is unable to use traditional debt instruments to raise funds to pay the dividend because it is so highly leveraged already.

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