Uniti & Windstream Merger
Uniti Group Inc. (NASDAQ:UNIT) is merging with Windstream. Things rarely come in such a perfect full circle in the capital markets as this one. UNIT was spun out of Windstream as a REIT almost 10 years back. The transaction was touted as the best thing since sliced bread and designed to provide "income investors" a solid stream in the era of ZIRP.
Windstream, a leading provider of advanced network communications, today announced plans to spin off certain telecommunications network assets into an independent, publicly traded real estate investment trust (REIT). The transaction will enable Windstream to accelerate network investments, provide enhanced services to customers and maximize shareholder value. The transaction will allow the REIT, which will own Windstream's existing fiber and copper network and other fixed real estate assets, to expand its network and diversify its assets through acquisitions.
"This transaction will make Windstream a more nimble competitor in today's increasingly dynamic communications marketplace and accelerate our deployment of advanced communications services," said Jeff Gardner, president and CEO of Windstream. "Additionally, the REIT will have geographically diverse, high-quality assets and sustainable cash flows with the ability to grow and diversify over time."
The tax-free spinoff will enable Windstream to realize significant financial flexibility by lowering debt by approximately $3.2 billion and increasing free cash flow to accelerate broadband investments, transition faster to an IP network and pursue additional growth opportunities to better serve customers.
Source: UNITI 2014
The capital markets rejoiced and Seeking Alpha authors were all too happy to slap buy ratings on this high-yielder. After all, who in their right mind could argue that data usage would go down? Who would bet against "mission-critical" fiber?
But after an 83% price drop and a negative 61% total return since inception, we are thinking the bulls have dialed back on the Kool-Aid. Probably.
But the same teams that bought you the spin-off of the twenty-first century are now arguing that a merger is in your best interest.
"As a combined company, we will continue our disciplined growth trajectory while expanding FTTH buildouts and significantly improving our overall financial profile. The demand for fiber broadband has never been greater, and Uniti is now expanding its reach into FTTH with an attractive scaled platform. The combination of Uniti and Windstream also removes several dis-synergies that exist in the current landlord/tenant relationship and greatly enhances Uniti's optionality for strategic initiatives.
Source: UNITI Today (emphasis ours)
Dis-synergies will be removed. Can't argue with that. Or can you? Let's look at the Q1-2024 results from UNIT and go over the setup for this merger.
Uniti Q1 2024 Earnings Results
UNIT led off the presentation with the strategic fiber revenue slide showing the consistent year-over-year growth.
This was followed by the one displaying cash yields on the second tenant in the high double-digits.
This is the standard playbook whether you look at UNIT or the tower REITs like American Tower Corporation (AMT), Crown Castle Inc. (CCI) and SBA Communications Corporation (SBAC). The key difference is that UNIT is still not growing where it matters. In fact, all three relevant metrics declined year over year.
UNIT also updated its 2024 consolidated outlook and
Marginal decline from the outlook presented 3 months back. The AFFO per share is expected to be 1 cent lower. We think there are serious headwinds to even this outlook as the economy weakens and the full impact of the interest rate hikes flows through on UNIT. Let's see what UNIT wrote about the merger.
Under the terms of the agreement, Uniti shareholders will receive approximately 62% of the outstanding common equity of the combined company. Windstream shareholders will receive $425 million of cash, $575 million of preferred equity in the new combined company, and common shares representing approximately 38% of the outstanding common equity of the combined company. Windstream shareholders will additionally receive non-voting warrants to acquire up to 6.9% of common shares of the combined company.
Source: UNITI Today
The combined company will not look anything like a REIT but will be primarily a telecom which owns its own fiber network.
Sure the rest of that fiber network will have some growth potential, but we have yet to see any meaningful growth in the last five years, so we won't hold our breath. Of course, no synergy slide would be complete without a few "AI" mentions.
That same AI of course that is growing so strongly that UNIT lowered its AFFO outlook for 2024. But the profile of the combined company is far more interesting to us. You will notice that the two independent companies generate about the same amount of adjusted EBITDA, but they come from vastly different revenue bases.
It is also interesting that UNIT classifies all of its capex as recoverable growth capex, while Windstream does not. The combined company will be running a 4.8X debt to EBITDA with $8.0 billion of total debt. How bad is 4.8X debt to EBITDA? Well, it is lower than the 6.0X that UNIT ran. But keep in mind that Lumen Technologies, Inc. (LUMN) began its journey to the (almost) penny stock status and negotiated debt exchanges from a debt to EBITDA of 4.2X.
What works for a REIT (the 6X range) is not remotely applicable to what level a telecom can generate cash from. Even the very large monopolies of AT&T Inc. (T) and Verizon Communications Inc. (VZ) have focused on a sub 3.0X debt to EBITDA target. You cannot run these numbers on telecoms, but we will see if the secondary growth from UNIT's side, can offset these pressures.
Is UNIT Stock A Buy/Sell/Hold Now?
The positive here is that the very long-term existential risk for UNIT is removed. In case you forgot, Windstream was insisting until recently that their renegotiated lease terms allowed them to create a greater than 50% rent reduction after 2030.
If that happened, UNITI common was an egg and the unsecured debt would likely take a 50% haircut as well. That of course was a negotiating tactic for this merger, and it worked. What happens next will depend to some extent on the broader markets. But we think the slow realization here will be that the REIT status will make an exit. With that, the dividend is likely to go to zero as well. We don't have the finer details on Windstream's financials, but they are not going for this because their business is booming, and they want to share the largesse with UNIT shareholders. We continue to rate UNIT a Sell.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult a professional who knows their objectives and constraints.
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