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Windstream Corporation (WIN) is a provider of advanced network communications, managed services, and cloud computing services to businesses, as well as voice and broadband services to consumers. The stock is trading at close to all-time lows with a juicy dividend yield of 12.7%.

WIN Chart

I believe that the dividend is not sustainable. A dividend cut is probably already priced in. I further caution investors that the company may soon face severe stress due to the increased debt levels. Windstream has managed to pay an annual dividend of $1/share every year since 2007. It did not cut its dividend even in 2009 when the stock price hit $7. We have to look at the underlying financials to determine whether it is sustainable going forward.

Windstream acquired several companies in the past three years to transform its business:

  1. NuVox in early 2010
  2. Hosted Solutions in December 2010
  3. Q-Comm in December 2010
  4. PAETEC Holding Corp. in November 2011
  5. Iowa Telecom in June 2010
  6. Lexcom in December 2009
  7. D&E Communications in November 2009

In 2010 and 2011, Windstream spent $4.08 billion in acquiring other firms and assuming or paying down $2.8 billion worth of debt. Did the acquisitions really transform the company, and how did it manage to spend so much money on acquisitions and yet keep the dividend intact?

A consolidated account of the acquisitions is as shown below:

Company Acquired (All figures in $ millions)PAETECHosted SolutionsQ-CommNuVoxIowa TelecomTotal
Total Assets3013.5321.91002.7764.41333.46435.9
Customer Lists83087.8292.5 1210.3
Goodwill653.3175.7358270.5552.22009.7
Total Liabilities2171.59.14523817993812.6
Total Debt Repaid or assumed (Total)1643.7 266.2260628.92798.8
Total Acquisition Cost2400312.8450.7383.4534.44081.3
Shares issued to finance acquisition (No. Of Shares)70020.618.726.7136
Common Stock Issued ($ millions)8420271.6185280.81579.4
Cash Paid1558312.8179.1198.4253.62501.9
% of Financing with Equity Dilution35.08%0.00%60.26%48.25%52.54%38.70%

Windstream financed 38.7% of the total costs of its acquisitions by issuing 136 million new shares. This has increased the weighted average number of shares outstanding from 468 million in 2010 to 584.5 million in 2012, a 25% increase in two years. To maintain a dividend of $1/ share, the company will now have to pay out $588 million vs. 464.6 million in 2010 with an increased interest expense as discussed below.

From 2010 to 2011, the long-term debt and lease obligations increased by 23% from $7.365 billion to $9.053 billion. The figure now stands at $8.93 billion. The total debt has a shorter weighted maturity of 5.4 years with a weighted cost of 7%. It is surprising to see that despite a fall in the cost of debt from 7.4% to 7%, the total interest expense has risen 12% year over year in 2012.

201220112010
Total long term Debt & capital leases8934.49053.27365.5
Increase in debt-1.31%22.91%
Weighted Maturity5.4 years6 years
Weighted average interest cost7%7.50%
Total Interest Expense625.1558.3521.7
Increase in interest expense11.96%7.02%
Weighted Average shares to calculate EPS (in millions)584.5512.7468
Increase in No. Of Shares14.00%9.55%
Dividends paid (in millions)588.00509.60464.60
Increase in Total Dividends paid15.38%9.69%

While the company's assets have increased from $11.3 billion in 2010 to $13.982 billion in 2012, the net income has actually decreased from $312 million to $168 million. This is because the costs (excluding depreciation) have risen by 100%.

2010 to 2012
Increase in Revenues65.90%
Total Increase in costs96.80%
Increase in depreciation87%
Increase in costs (excluding depreciation)100%
Increase in Assets23.70%

The deficit between EPS and the dividend per share is currently being filled by new equity, debt issuance, and depreciation. But since the debt has risen significantly and the earnings have not quite kept pace, it is difficult to see how the company can keep up the promise.

Revenues6156.34281.23710.7
Operating income887.5963.51033.5
Net Income168169.5312.7
EPS0.280.320.66
Dividend per Share111

As per the debt covenants, the company has to maintain a minimum interest coverage ratio (ICR = Adjusted EBIDTA/Adjusted Interest Expense) of 2.75 and a maximum leverage of 4.5 (Total Debt/Adjusted EBIDTA) to pay dividends to the shareholders.

As of March 2013, the total current assets are at $1.1 billion whereas the current liabilities (excluding accrued dividends) are at $1.956 billion, of which $ 888 million is current maturities of long-term debt and capital lease. The ICR has fallen from 3.7 to 3.57 and the leverage ratio is at 3.76. The company has taken several steps in the past to ensure that these ratios are maintained. According to the latest Form 10K (FY 2012):

During 2011, we contributed 10.8 million shares of our common stock to our qualified pension plan to meet our remaining 2011 and expected 2012 obligation, which allowed us to preserve cash and manage overall net debt leverage. At the time of the contribution, these shares had an appraised value, as determined by an unaffiliated third party valuation firm, of approximately $135.8 million. The pension trust subsequently sold all 10.8 million shares for approximately $133.5 million

Windstream uses sum of digits method to calculate depreciation on some of its assets, thereby increasing depreciation costs in the near term. Depreciation has increased by 87% from $693.7 million in FY 2010 to $1.297 billion, while assets have increased by only 23.7%. This has enabled the company to keep the ICR and leverage ratio within acceptable level and allowed the company to pay dividends. Thus, the company was able to pay dividends by saving taxes on higher depreciation costs and reducing cash-based pension contribution and other such measures.

Conclusion

Windstream has acquired a lot of "assets" by issuing new equity and debt. These assets are not generating increased profits. To keep this going, it will have to acquire more assets and/or increase capital expenses, as well as depreciate the costs.

But unless the company cuts its operating costs and creates real earnings, dividends are not sustainable. Investors may look at the senior secured debt tranches if they are seeking exposure to this company.

(Sources: Form 10Qs and Form 10Ks)

Source: Windstream - Dividend Cut Inevitable, Probably Priced In