|Shares Out. (in M):||589||P/E||15.2x||13.3x|
|Market Cap (in $M):||4,975||P/FCF||8.3x||6.3x|
|Net Debt (in $M):||9,261||EBIT||1,111||1,223|
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The net effect is that I estimate the company will go from a dividend payout ratio of about 71% on its preferred adjusted free cash flow calculation and 99% on GAAP in 2012 to 75% on adjusted free cash flow and 77% on GAAP in 2013. While this dividend payout ratio still looks uncomfortably high, it is important to recognize that it will look very high in Q1 and Q2 as the last of the FTTT capex is made, and then ramp down to show a sustainable-looking 63% of GAAP by Q3 of next year. A table detailing the quarterly company defined free cash flow, GAAP free cash flow and a reconciliation between them is provided below. Showing a mere 63% GAAP dividend payout ratio in Q3 of next year could provide a significant catalyst to the stock, and may put to rest questions of dividend sustainability for the time being.
Management and Insider Behavior
I always try to pay more attention to what a company's management team does rather than what it says. On this front, WIN's management team seems to really believe that they have successfully transformed the business and can sustain the dividend going forward. In every public forum, CEO Jeff Gardner has adamantly stated that the dividend will not be cut. Since May of 2012 he has spent over $760K purchasing 83.5K shares in the open market at prices ranging from $10.00 to $8.27. CFO Anthony Thomas has purchased 35K shares for $340K. Chairman Dennis Foster has purchased 65K shares for over $621K. Maybe they were all just sick of earning less than 20 bps in their savings accounts and foolishly reached for yield. Clearly, many of the purchases were too early. However, all these executives are respected industry vets involved with Alltel prior to Windstream so they know where the bodies are buried.
Regarding a potential dividend cut, many investors seem to believe that a dividend cut may become a self-fulfilling prophecy if the stock price gets low enough, reasoning that a certain yield the company may decide it's cheaper to cut the dividend and buy back stock or de-lever. Other than the insider purchases and unequivocal public statements by Jeff Gardner, I would also point you to recent history. WIN's stock spent the financial crisis trading around current levels and even dipped below $7. The company had plenty of time to cut the dividend due to yield or just general fear of economic conditions, but did not. And this was before the company had a line-of-sight to eventual revenue growth.
It's also worth noting that the company has fairly liquid debt. All of the company's major debt issues trade over par according to Bloomberg and fixed income investors seem unconcerned with the company's financial stability. This is a great time to be an issuer of high yield debt and the company has access to plenty of liquidity. The company has $1.5B of debt capacity in the form of a secured facility, more than enough to pay off the $1.1B of maturities in 2013 although I personally think they should term out the debt and lock in these interest rates for a long time. They could use the revolver to pay the dividend if they had to and their IR has told me they have gotten zero pressure from the credit rating agencies to reduce the dividend.
Scenario Analysis and Conclusion
To simplify things a bit, I think there are three basic scenarios that could play out:
While I think the bullish case is most likely to play out, averaging across the three scenarios still yields a significantly positive expected return of 26% (average of 77% bullish case + -11% bearish case + 12% status quo). To me, the risk/reward clearly favors being long. If the shorts ever decided they needed to get out of the way or get sick of paying a 12% annual dividend to be short, I think WIN could move up in a hurry.
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