Can Windstream Maintain Its Monster Dividend?

Jun. 6.12 | About: Windstream Holdings, (WIN)

Windstream (NASDAQ:WIN) is a player in the rural telecommunications market. It provides wireline broadband services, telephone services, managed services and cloud computing. The company does not have wireless services as part of its business offerings. The stock is currently paying a monster 10.9% dividend yield. Looking at the competition, AT&T (NYSE:T) pays 5.2%, Vodaphone (NASDAQ:VOD) pays 7.4%, while CenturyLink (NYSE:CTL) pays 7.8%. Market watchers wonder if the dividend is sustainable and if there is any significant upside potential. There are two major reasons Windstream's dividend is under pressure. First, the company has seen a steady increase in debt over the past several years. Second, the company faces stiff competition from AT&T and CenturyLink, who have seen strong growth in market share in their wireless service segments.

Windstream's first quarter 2012 results showed revenues from all sources of $1.55 billion, a half a percent increase from the same period in the previous year. Business services saw a 3.2% increase from the first quarter of 2011. Consumer broadband services saw a 5.9% increase on a year over year basis. The first quarter showed robust sales figures for the business and household segments.

The PAETEC acquisition has provided great opportunities in the business channel, and the consumer business is seeing solid returns from broadband services. Business services showed revenue of $897 in the quarter. Broadband sales provided $113 million in revenue in the same quarter. Business and consumer broadband revenues accounted for almost 68% of all revenues during the first quarter. The company had capital expenditures of $223 million in the first quarter, representing an 8.1% increase from the same period in 2011. Windstream reported operating income of $253 million and net income of $65 million, or $0.11 per share. This compares to net income of $29 million, or $0.06 per share, in the first quarter of 2011. The company had $14 million in after tax merger and integration expenses. It also had an after tax gain of $1 million in relation to the early retirement of debt.

Cloud computing assists companies in evolving business models to create new products and services and new methods of relaying information and entertainment. The object of the cloud computing exercise is to increase efficiency and reduce costs. The goal for the customer is to reduce spending on infrastructure costs. The provider spreads the cost over multiple clients and is the best alternative in the current market environment.

Windstream currently operates primarily on a rural scale in the U.S. Its acquisition of PAETEC has moved it into the national and international markets in terms of managed services and cloud computing. Yet, Challenges to Windstream going forward include competition from larger wireless carriers gaining market share, and cable operators who will introduce inexpensive, reliable VoIP products. The growth strategies of the company may be limited to the cloud computing markets which are now reaching saturation and losing the "it" factor as the next big thing in communications.

The lack of wireless services presents the biggest risk to Windstream, as land line business will continue to decrease over time, and customers will adapt to a wireless only alternative in its place. Universal subsidies to land line operators are fading out. This previously high margin revenue stream is not going to be available in the same amounts as it was in the past, and Windstream will have to grow in other areas to adapt to the absence of these subsidies. Further acquisitions will show more dilution as opposed to growth and capital expenditures and integration costs could have a negative impact on the company's future earnings. If the company can make acquisitions with more speed and with less investment, the company will succeed and the share price will show gains.

Windstream's acquisition strategy also puts its monster 10.9% dividend in jeopardy if the company continues to use its cash to make acquisitions for growth. Its biggest competitors in all facets of its business are AT&T and Vodafone. It also faces competition from CenturyLink. The positive aspects of Windstream's current operations are its program of deleveraging its assets and refinancing its debt load. The company's concentration in rural markets demonstrates less competition than urban markets, which is favorable to increased margins and cash flows in the coming years.

A Forbes article shows the insider buying activity of officers and directors of Windstream, and by all accounts, this is a positive endorsement of the share price at current levels. There are many things in play here, mostly having to do with the current dividend yield. It is true that the adage on Wall Street is that there is only one reason why insiders buy stock: because they believe the price will increase. At this "sell in May and go away" point in the cycle each year within the capital markets, the insiders are bargain hunting and attaining higher yields. How long the insiders intend to hang on to the shares remains a mystery.

Windstream is currently viewed as more of an income investment than a capital appreciation investment. Windstream has to demonstrate that it has the ability to continue its acquisition program for growth and that it can manage integration costs and sustain its high dividend. If the dividend is cut for any reason, and it may very well be, investors will likely dump the stock and run. The telecom industry itself is not a high growth business.

While Windstream does have the ability to handle the dividend and debt load at present, and has made no overtures or indications that it will cut the dividend in the past four and a half years, this may not be the case for long. The larger companies, such as AT&T, CenturyLink and Verizon have more realistic yields and less volatile stock prices. Windstream is for an investor with a high risk tolerance. Going into the ex dividend date in June, expect to see share prices decrease to increase the yield, barring any exceptionally good news from the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.