Windstream to Spin Off a Network REIT?

July 29th, 2014 by · 24 Comments

In a proposed move that could shake up the way the industry looks at its assets, Windstream today announced plans to spin off some assets into a Real Estate Investment Trust (REIT). When I saw the headline, I figured it was their data center assets & business al la Equinix etc, but it is not about colo at all. They are actually looking to put their fiber and copper network assets into a publicly traded REIT.

They already have their "private letter ruling" from the IRS in hand, something that can take a while. Basically, Windstream wants to spin off its fiber and copper network assets and other related real estate into a publicly traded, independent entity. Windstream would then have a long term triple-net exclusive lease, paying some $650M per year to the new entity.

Windstream's debt would be reduced by some $3.2B, helping them deleverage. Windstream's CFO Tony Thomas would move over to its CEO, while director Francis X. "Skip" Franz would be the chairman of the board. The new REIT would have some 25 employees.  Windstream would still be actually operating the assets, it just wouldn't own them -- at least I don't think a REIT with 25 employees is going to be doing truck rolls.

I'm still wrapping my head around this one. While REITs are largely about maximizing tax benefits, I wonder if adopting this new structure will have longer term implications for how Windstream looks at network investments. Just how independent would it turn out in practice? And I wonder if others may follow the same path if Windstream gets the IRS green light.

Windstream says that the REIT may be able to expand and diversify via acquisition. Indeed, I think one of the main reasons Windstream hasn't been more acquisitive lately is that the multiples of its legacy business make it hard to justify paying for fiber assets at current prices. The new entity might approach that problem from a different, more flexible perspective.

Categories: Fiber Networks · Financials

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24 Comments So Far


  • Profile photo of David Rohde David Rohde says:

    I’m also trying to wrap my head around this. I believe that REITs are required to devote 90%+ of their income to shareholder dividends. That doesn’t sound like a strategy to maximize network investments in the long run. This may be a short-term fix for debt reduction and capex elsewhere but dodgy in the longer term. Any insight from anyone here appreciated.

  • Sur E Gato says:

    Yes, the 90% is true, but they overriding reason is the REIT will pay no income tax.

  • Anonymous says:

    so the sum of the parts ends up being greater than the whole??
    why wouldn’t every LEC follow suit?

  • en_ron_hubbard says:

    The major reason for a splitting up of assets such as this is the increase in value as an entire new class of (yield oriented) investors come in. EBITDA that was embedded in the original company and valued at 6x will get a value in the 13-15 range. That’s the rationale and tax shield is secondary since it comes with the 90% dividend distribution requirement.

  • Profile photo of David Rohde David Rohde says:

    Thanks all – so my point is precisely that not every telco would do this because it’s a capital-intensive business where capex may vary up and down somewhat but the need is always there. Giving away almost all the cash the business throws off doesn’t sound very user-friendly. As for whether the spin-off proceeds help the near-term investment needs or meet a pressing internal balance sheet issue, one suspects the latter is the driving force.

  • Anonymous says:

    Not understanding the financial charade of this move, but as a former executive, this is what I do know. The acquisitive nature over the past few years has been destructive to both operations and culture. Money has been seriously wasted and good people have been either let go or left altogether. They are paying 401K matches in company stock due to cash flow. Morale is very low and leadership is lacking. It will interesting to see if anything else follows this move functionally or from a leadership perspective. Otherwise, my sense is its a patch to continue to find a suitor to sell the business to. I heard that recently CenturyLink walked away during negotiations and it was not pretty. Level 3 was also taking a look but obviously went with TWT.

    • Anonymous says:

      I hear that CTL is looking at ELNK. If this is true please send them my way … i have some land in the swamp lands in florida for sale. ELNK is a hot mess. Worst management team. Horrific back office IT systems. Incompetent finance teams who make stuff up. Amateur sales leadership top to bottom.

  • Rob,

    Don’t other REITs have multiple tenants?

    Wouldn’t the capital markets call for this REIT to maximize ROI and increase payouts by letting others buy wholesale access.

    Questions abound around the $3.3bn network valuation and $650m annual “lease” payments.

    Michael

  • Anonymous says:

    Although I believe this odd maneuver is driven solely for financial purposes, I highly doubt financial purpose has to do with income taxes. (See bottom of this post for NOL discussion from WIN’s most recent 10k.)

    WIN is paying $3.5b to “retire” $3.2b in debt. (WIN reports $8.6b of long term debt on its balance sheet.) According to the PR The WinREIT will have $3.5b in debt (used to pay $3.2b to creditors), but WIN will pay WinREIT annual rent of $650m. If you do the math, that’s quite a deal for the WinREIT. $650m on $3.5b is 18.6%. Since the REIT pays out 90% of the $650m in “rent” or $585m to WinREIT shareholders, WinREIT holders will earn 17%. That’s quite a deal for WinREIT holders when you consider that the weighted average cost of WIN’s outstanding debt was well below 10%. Now one very important missing component to the WinREIT is how WinREIT will be priced and how many outstanding share will be issued. If WinREIT is valued $3.5b it will carry a dividend of dividend of 17%, but if valued at $7b it will carry a dividend of 8.5%.

    I’m still at a complete loss as to what’s driving this decision other than that this is part of WS’s long running Asset Back Securitization trend. (Mortgages, student loans, auto loans, commercial rents, natural gas and oil wells, etc.)

    Unless I’m completely off base I don’t really see how this is a particularly good deal for WIN shareholders because from WIN’s perspective (not WinREIT’s) they’re paying $650m annually and only retiring $3.2b of its $8.6b in debt. So essentially, WIN is paying 18.6% on $3.2b. WHAT AM I MISSING?

    Carry Forward Net Operating Losses discussion from Windstream’s most recent 10K :

    “At December 31, 2013 and 2012, we had federal net operating loss carryforwards of approximately $1,545.6 million and $1,660.0 million, respectively, which expire in varying amounts from 2021 through 2031. The loss carryforwards at December 31, 2013 were primarily losses acquired in conjunction with our mergers with Valor Communications Group, Inc. (“Valor”), NuVox, Iowa Telecom and PAETEC. The 2013 decrease is primarily associated with the amount utilized for the year. At December 31, 2013 and 2012, we had state net operating loss carryforwards of approximately $2,001.2 million and $2,116.4 million, respectively, which expire annually in varying amounts from 2014 through 2032. The loss carryforwards at December 31, 2013 were primarily losses acquired in conjunction with our mergers with Valor, CTC, D&E, Lexcom Inc. (“Lexcom”), NuVox, Iowa Telecom, Q-Comm and PAETEC. The 2013 decrease is primarily associated with the amount utilized for the year. Federal and state tax rules limit the deductibility of loss carryforwards in years following an ownership change. As a result of these limitations or the expected lack of sufficient future taxable income, we believe that it is more likely than not that the benefit from certain federal and state loss carryforwards will not be realized prior to their expiration. We establish valuation allowances when necessary to reduce deferred tax assets to amounts expected to be realized. Therefore, as of December 31, 2013 and 2012, we recorded valuation allowances of $84.9 million and $85.9 million, respectively, related to federal and state loss carryforwards which are expected to expire before they are utilized. The amount of state tax credit carryforward at December 31, 2013 and 2012, was approximately $22.2 million and $20.4 million, respectively, which expire in varying amounts from 2014 through 2027. “

    • en_ron_hubbard says:

      Mr. or Mrs. Anonymous,

      With respect, I think you are making some factually wrong assumptions, and one very significant conceptual error in looking at the transaction.

      First, the obligation to distribute 90% relates to 90% of “taxable income” and not revenue. It is therefore calculated after deducting opex/interest expense and tax shield from depreciation and amortization. This leaves cash flow for asset replacement and growth cap.

      Second, you cant look at this restructuring as creating two companies with different ownership. If you are a current WIN shareholder then you will be distributed a share of the REIT and you don’t need to sell it. You own the same assets– just reconfigured in a way that creates incremental value. That is a good thing for the WIN shareholders and it was reflected in the significant uptick in value.

      If this works, below is a link to the slide show describing the transaction
      http://www.sec.gov/Archives/edgar/data/1282266/000128226614000039/finalinvestorpresentatio.htm

  • Anonymous says:

    This deal is so bad for WIN that I can’t believe any self-respecting CEO would go along with it.

    WIN was paying between $225m-$250m in debt service on the $3.2b they’re retiring. Now WIN will pay $650m/yr to use the exact same set of assets. Some WS I-banker convinced WIN CEO & board that

    This deal is the equivalent of your mortgage company offering to buy your home and then rent it back to you at 2.5x your current mortgage payment.

    Strip away all the complex capital structure gobbledy-gook and this transaction results in an annual net cash OUTflow increase of an astounding $400m/yr for WIN. Effectively, someone’s figured out a way to take $256m/yr in debt service and turn it into $650m/yr of “rent” by shuffling some papers through the SEC and the IRS.

    • @anonymous (why not identify yourself?) what are the possibilities for the asset to generate more revenue as a standalone entity?

    • en_ron_hubbard says:

      Same comment as above– you simply must look at this from the perspective of a WIN shareholder who has the opportunity to keep both securities. Nothing has really changed except a division of assets that creates incremental value. That’s a good thing.

      • @ron, agreed, nothing has changed “at present”. But “going forward” don’t you believe there is a high probability of change?

        Especially as we look at the fundamental challenges “edge” access providers, who lack a complete view of demand, face with respect to developing low-cost ubiquitous access and connectivity for 4K VoD, 2-way HD video collaboration, Mobile First, and IoT demand and supply trends/ecosystems?

        My point is that “core” content and application providers can do that. And Windstream’s management appears to have taken the first step down that road.

        • en_ron_hubbard says:

          Michael– yes there will be change in ownership as , for example, Win shareholders sell their REIT position– but that is elective. You are also right in observing that it allows management of the respective companies to focus better on developing their different asset bases.

          If I have an issue regarding this reconfiguration it is that the REIT is almost completely dependent on the credit of the new WIN– the triple net $650 p.a. lease payments will represent almost all of revenue for a good number of years. But again viewed holistically nothing has really changed.

          • Anonymous says:

            en_ron, (I wrote the anonymous post) and, yes, I agree with part of what you say, that WIN holders will also, initially, be WinREIT shareholders. I also agree with those that noted how that will change and that WinREIT and WIN interests will diverge at some point.

            But let’s look at the mechanics of this deal. WIN eliminates $3.2b of debt from balance sheet on which they were paying roughly $250m/yr in interest. WinREIT will float $3.5b in new debt and presumably pay creditors rougly the same $250m/yr, assuming refi coupon rate on WinREIT’s $3.5b is lower than the coupon rate on WIN’s $3.2b being retired.

            But WIN will have to pay WinREIT $650m/yr in rent, of which $250m/yr will go to the WinREIT creditors i.e., bondholders of the $3.5b. The other $400m goes to WinREIT. Since WinREIT has only 25 employees there’s not much in the way of opex. The bulk of that $650m is for distribution and future upgrades (after year 3) will be recovered through higher rent charges to WIN.

            WIN’s income statement will take an enormous hit (to the tune of an incremental $400m/yr — the difference between the $650m/yr in “rent” they now pay WinREIT and the $250m/yr in debt service they’re no longer paying).

            Now, looking at this from an employee perspective, if I were a sr. manager (not necessarily at EVP level) I have to ask myself how bonus targets will be set. After all, there’s $400m/yr more leaving the WIN bank account (and going to WinREIT) than the year before. Also, if WIN’s sr. managers are granted RSUs, will they be granted RSUs in both WIN and WinREIT? If not, WIN risks losing top talent b/c over time, I suspect, WinREIT will outperform WIN.

            I do concede some of the points you make. However, there is no doubt that essentially I-bankers have turned roughly $250m/yr in debt service into $650m in rent. Although initially b/c WIN & WinREIT shareholders may be the same, this seems irrelevant, I don’t believe it is. Over time, WinREIT will bleed WIN and I don’t know why I’d want to hold WIN shares over WinREIT shares.

            • en_ron_hubbard says:

              Yet I feel very confident in saying that as a WIN shareholder you are “happier” today than you were on Monday. Significant incremental value has been sucked out of a wrinkly old fruit.

              If you don’t like the rejiggering then, if you are a shareholder, you are completely free to sell the part you don’t much like. For myself, I don’t own it, and don’t like either business model so will not be buying. Best.

  • @ron, yes, the two business models are inter-dependent in the foreseeable future.

    So the question is how long before their own supply-demand forces (layers 1-2 at the edge vs layers 3-7 at the core and edge) force divergence.

    As a former analyst I used to say that betting on a stock’s value 1 year out is a function of the market’s expectations at that point in time. Those expectations are driven by management’s perspectives 6-18 months beyond that point, which in turn are driven by where they are making strategic bets another 12-24 months beyond that.

    So really, you end up looking 3-5 years out to make an accurate 1 year prediction. That’s what makes this divestiture so exciting!

  • Anonymous says:

    This deal is pure financial alchemy, converting $250m/yr in debt service into $650m/yr of rent. If people don’t see this, they are completely mesmerized by the financial engineering wizardry, not the raw elements of this transaction.

    This event does not enhance by one iota Windstream’s operations, marketing, branding, customer experience, vendor relationships, etc. (Every response to this comment will say “we never said it would.”) Yet the very same people who will say we never said it would improve one thing about Windstream’s operations, marketing, branding, customer experience, etc., somehow will say this REIT will unlock serious amounts of value?

    We’re not talking about a company with multiple lines of business where the fresh new fast growth line of business is underappreciated because a stodgy slow growth line of business obscures its value. We’re talking about waving a magic wand, filing some paper work with the IRS and the SEC and POOF we create value.

    Every dollar of value WinREIT enjoys, WIN should lose. Now, that may not immediately happen b/c some analysts will convince gullible investors in some HumptyDumptyian & Rumpelstiltskinian way that the naked emperor has clothes and that they’ve figured out a way to spin straw into gold, respectively.

    If WIN was a wrinkly old piece of fruit to use En_Ron’s characterization, it still is. This transaction does nothing to hydrate it.

  • Anonymous says:

    So over the last 4 consecutive quarters WIN’s revenues have shrunk. As employees, investors, creditors, customers and vendors, how exactly are we supposed to interpret this arrangement as anything other than a magician’s trick to distract us from the train wreck going on inside the company?

    I mean, if the biggest idea the CEO has come up with to create value is bringing in an I-banker to sell the board on some convoluted financing scheme that doesn’t solve a single problem ailing WIN (the telecom company), shouldn’t the board be asking why the f$#% did we pay Gardiner $2m+ last year.

    The board should have announced Gardiner’s sacking coincident with the news of the Winstream REIT. At least investors & stakeholders would have felt encouraged that the board understands financial chicanery alone won’t solve WIN’s problems.

    But we know that’s not the way this really works. When Gardiner parachutes out of WIN fully vested and complete with severance package, he’ll leave as a pioneer. He’ll tour with I-bankers to show other telcos and utilities how to create value w/o improving service by a lick.

    After all, isn’t that the true art of capitalism, legally raiding corporate coffers to line the pockets of the CEO, CFO, the Board and the investment bankers? I can’t think of a more noble purpose.

  • Profile photo of PB PB says:

    What impact would this have from a M&A perspective?

    Could someone buy the REIT without having to deal with the rest of it?

    • Anonymous says:

      That’s a great question. Depending on the contractual relationship between WIN and WinREIT it almost acts like a poison pill.

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