May 10, 2016 - 12:20pm EST by
2016 2017
Price: 9.00 EPS 0 0
Shares Out. (in M): 99 P/E 0 0
Market Cap (in $M): 981 P/FCF 0 0
Net Debt (in $M): 10,487 EBIT 547 0
TEV ($): 11,468 TEV/EBIT 21Windstream offers telecommunication services to residential an 0
Borrow Cost: Tight 15-50% cost

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Windstream (WIN) offers telecommunication services to residential and business customers in rural communities in the U.S.  The company provides voice, internet, video and enterprise data service in 21 states.

WIN was written up by Kruger before.  Please read his bull case for background.

The business is struggling

Organic revenue growth, excluding the effects of M&A, has been negative each year since 2007.  WIN did several acquisitions (Paetec, Iowa telecommunication, Q-Comm) to stem the loss in revenue but nothing has worked so far.  This is a capital intensive, high fixed cost business, thus operating leverage is high.  5 yr avg organic growth for revenue and OIBDA were negative 1.5% and 2.3% respectively.  1Q16 organic growth was negative 0.5%.

Enterprise, the only bright spot, is not large enough to offset the decline of other segments

After recent restructuring, the service business is now divided into 5 segments; Consumer and Small Business ILEC, Carrier, Enterprise, Small Business CLEC, Regulatory & Other.  Enterprise, is the only segment that is growing its revenue. 

Unfortunately for WIN, the Enterprise business is not large enough to offset the decline of the other segments.  On a T12M basis, Enterprise is about 35% of revenue 13% OIBDA.  Its operating margin is the lowest, at around 10 – 12%.  For context, the margins for Carrier and the ILEC business are 72 – 74% and 56 – 60% respectively.

In FY 2011- 13, the breakdown for Service operating results were sorted into 4 segments; Business, Consumer, Wholesale and Other.  The breakdown has changed in FY 2014 and again in 2015, so comparison is difficult.  I believe the change is partly due to restructuring, the wireline spinoff, but mainly to move numbers around to highlight positive organic growth.  I have reorganized the numbers into earlier format for comparability.  Reconciliation are provided in Appendix A.

Organic Rev Growth

FY 2011

FY 2012

FY 2013

FY 2014

FY 2015






























Service Overall
















Total Revenue







2015 Business revenue was $3,465mm, consumer $1,251mm, wholesale $726mm, other $25mm, product $167mm.  Enterprise is in the Business segment.

Outlook for Enterprise

The Enterprise space is highly competitive, hence the low margins.  WIN’s Enterprise does not have enough scale to stand on its own.  Organic growth should be closer to 3% than 5%.  (with 1% number of customer growth, 2% revenue per user growth).  However, given WIN’s leverage (explain below), I doubt if the necessary capex can be funded to achieve this.

The Debt is too heavy; current capital structure is unsustainable

Legacy voice and low bandwidth data business are in secular decline.  Capital investment in high bandwidth is necessary for WIN to maintain competitiveness.  As such, capex is not “growth capex”, it’s maintenance capex and OIBDA overstates income.

My definition of Adjusted Operating Income = GAAP operating income + Depreciation + operating lease payment – net capex.  Details are provided in Appendix B.

Reported Debt + LT lease (CSAL and pension plan failed sales leaseback discounted to PV) = $6,561mm.  My definition of Adjusted Debt = reported debt + nominal LT lease + nominal operating lease = $11,469mm.  Adjusted net Debt (net of cash and CSAL stock at $23.4/share) is $10,708mm.  This assumes WIN can sell all its CSAL stock without price impact.

I believe using PV for the leases sounds nice in theory but is out of touch with reality in WIN’s case.  First, the ability to repay, adjusted operating income, is a nominal measure.  Second, the counterparty, the lessor, would not reduce or increase contractual rent payment just because the cost of capital of the lessee changes.

Adjusted Operating Income for 2015 was $915mm and operating margin was 15.9%.  Margins is trending down because the high margin legacy business is declining and the low margin Enterprise is growing.  If somehow Enterprise Service grows 5%, and miraculously, all other segments revenue stop declining, margins go back up to 20%, revenue would stabilized at $5,730mm and adjusted operating income would be $1,146mm.  

Adjusted net debt / normalized adjusted Operating Income is 9.3x in an upside scenario.  How much would one pay for a telecom business with legacy issues, secular revenue pressure, and constant capex requirement?  May be 6x, or 7x?  A generous 10x imply a stock price of $7.7.

The most valuable assets are already spun-off

The biggest risk in this type of short is if a takeout offer.  However, this would not happened because the wirelines, the crown jewel, are spun-off into CSAL already.  So WIN has zero appeal to other telecom players.  For private equity players, the leverage is too high for an LBO. 

I believe the equity is worthless.  A restructuring is necessary and I do not know what’s left for shareholders without the wirelines.

Management is oblivious to its situation

Management’s behaviour actually gave me conviction to this idea.  If management truly understands how dire the situation is, the dividend and the buyback program should be cancelled, and all cash after capex should go to debt repayment because the company’s survival depends on it.

But instead they commit to the 60 cent dividend and spent $75mm buying back stock.  Yes, they bought at $5.94 and the stock is now at $9.  On surface this seems sensible.  But keep in mind a stock buyback is value-destructive if transact at above intrinsic value.  The $9 stock price today is incidental.


·         Timing is uncertain.  Near term maturities are taken care of.

·         WIN can withhold capex for a year, temporary inflating operating income.

·         CSAL could have a blue sky scenario, providing funds for WIN.

Appendix A

Business = Carrier Service + Wireless TDM + Small Business ILEC + Small Business CLEC + Enterprise

Consumer = Consumer ILEC + Consumer CLEC, ILEC only in FY 2015

Wholesale = Pass through + USF + switched access + wholesale voice, data, misc.

Appendix B

FY 2015




product sales






service COGS



product COGS






capex adjustment



operating lease payment






merger cost



restructuring charges



Adjusted Operating Income





Additions to PPE



Network expansion by grants


capitalized interest



grant funds received



changes in restricted cash







·         Capex adjustement = depreciation – capex

·         Operating lease add-back is to treat all lease payment as financing cost









I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Dividend cut

Continue revenue decline

Margins contraction

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