Although we see that CenturyLink (CTL) is the primus inter pares of the rural telecom sector we have also been covering its two largest competitors Frontier Communications Corporation (FTR) and Windstream Corporation (WIN). Windstream's shares have generated a negative 20% total return in 2012. Because Windstream's shares have been beaten so badly throughout 2012, we can't help but take notice of the 11.5% dividend yield that the shares are offering. In our August report on Windstream we discussed how we considered replacing CenturyLink in our portfolio with Windstream and that we were glad that we stuck with our blue chip rural telecom CenturyLink. We're probably going to have to reconsider at the end of the year mainly because Windstream may be a contrarian play as its former champion Jim Cramer has switched his support to CenturyLink recently. We're also going to evaluate it further as the company is in the midst of a heavy capital investment program.
Source: Bloomberg LP
Windstream recently reported Q3 2012 adjusted EPS of $.12/share, which was a penny shy of meeting the analyst consensus and was a decline from the $.19 GAAP EPS achieved in Q3 2011. WIN's pro forma revenue declined by 0.83% in Q3 2012 versus Q3 2011 and although this was an improvement from the 1.18% achieved in Q2 2012, it was not as good at the 0.5% achieved in Q1 2012. This is worse than the 1.3% achieved at CenturyLink because WIN had acquired the business communications and cloud services firm PAETEC (PAET) last year. CenturyLink has also acquired a cloud services firm in 2011 (Savvis). However Savvis only represented 5% of its revenue whereas PAETEC represented 25% of Windstream's revenue. One piece of good news for Windstream stakeholders is that Windstream continues to generate the narrowest year-over-year decline in its access lines than CenturyLink and Frontier, as well as AT&T and Verizon.
Despite the heavy emphasis Windstream has made towards strategic communications services the number of High-Speed Internet and integrated Services customers only increased by 1.39% year-over-year and increased by 50bp in the linked quarter. CTL's 4.1% and FTR's 1.56% year-over-year growth rates exceeded Windstream's. WIN's internet growth was weaker than the 2.3% growth at Verizon but at least it was better than a 50bp decline that AT&T (T) saw. However, AT&T still has more Internet customers than Verizon, CenturyLink and Windstream combined.
Another area that Windstream is leading its rural telecom peers is the digital television segment. Until Frontier recently discontinued offering DirecTV as part of its bundles, all three companies had satellite television partnerships with DISH Network (DISH) and DirecTV (DTV). Windstream and CenturyLink also offer a proprietary digital television service. However, this is a case of good news and bad news. The good news is that Windstream has more than four times as many digital TV customers as CTL. The bad news is that Windstream's digital TV growth has stagnated while CenturyLink's PRISM TV growth has been steadily picking up. CenturyLink's PRISM TV service has seen its customer count nearly double in the last 12 months whereas Windstream's digital television subscriber count has stagnated.
Windstream's Business revenues grew by 2.7% in Q3 2012 on a pro forma basis versus the prior year's comparable quarter and reached $906.4M. The key driver for Windstream Business revenues continues to be its data and integrated services, which has offset the continued decline in voice and long distance services. Data and integrated service revenues became the largest revenue source for Windstream Business in Q1 2011 and have reached $388.4M in the quarter (9% year-over-year growth). Product sales grew by 6% and reached $64.7M in the period. More than two-thirds of its product sales are sold to business customers rather than retail consumers.
Source: Windstream Financial Supplement
The company also saw a slight reduction in its operating expenses excluding the impact of depreciation and amortization expenses. Quarterly depreciation and amortization expense has crept up 16% since Q2 2011 and reached $326.4M in Q3 2012. This was due to the PAETEC acquisition in 2011 as well as WIN's increased capital expense build-out in 2012. Unfortunately, WIN's cost cuts and business revenue growth was not enough to offset a steady 2.75% decline in consumer service revenues and the continued erosion of wholesale revenues, which declined by 9.6% year-over-year versus Q3 2011.
Source: Windstream Financial Supplement
Windstream generated nearly $407M in operating cash flows during the quarter and nearly $77M in free cash flows. Windstream's free cash flows would be higher except for planned capital investment expenditures this year. Windstream expects its CapEx to decline after this year as well as cash interest expenses and is targeting increased free cash flows in 2013. Over 36% of Windstream's CapEx in 2012 was due to its fiber-to-the-tower ramp-up as well as integration of PAETEC. Windstream declared its 26h straight quarter of a $.25/share dividend and this represents a 11.5% yield based on the November 8th intraday price of $8.70/share. Windstream has $1.12B in upcoming debt maturities and has a $1.25B revolving credit line to pay it down. The company has generated $669M in adjusted FCFs in the first nine months of 2012 and it had a 66% payout ratio based on its dividend payments in relation to adjusted FCFs. We believe that the company will generate a similar level of adjusted FCFs in 2013 to enable it to sustain its $1/share annualized dividend and to chip away at its $9B in debt.
In conclusion, Windstream is at a much better entry point now at $8.70/share than the $12/share price when we were contemplating it in December and the $9.30 it was trading at in August. We can't believe that the company's shares have been beaten up beyond recognition in 2012 and even in 2011. Although we are not pleased that the company has reduced its adjusted OIBDA by $20M-70M for the full year of 2012 and is continuing to struggle in the wholesale market, we believe that a potential perfect pitch for Windstream will be coming any day and we're going to be watching for it. We're interested in seeing if the promotional activity the company is planning for Q4 2012 will help it get its groove back. One thing we believe management must do is sign a wireless resale agreement with Sprint (S) in order to match what CenturyLink has with Verizon and Frontier has with AT&T.
Source: Bloomberg LP
Disclosure: I am long CTL.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.