Windstream's (WIN +22.3%) plans to spin off some of its telecom network assets into a REIT (following a favorable IRS ruling) has lit a fire under U.S. telecom carriers, as investors bet more REIT announcements will happen. Some might also be hoping REIT spinoffs spark additional M&A activity in an industry that has seen plenty of it.
Frontier (FTR +15.8%) and CenturyLink (CTL +8.1%) are also off to the races, and AT&T (T +3.9%), Verizon (VZ +1.9%), and Sprint (S +2%) aren't doing badly either.
Other gainers include Alaska Communications (ALSK +5.2%), TDS (TDS +4.1%), and Lumos Networks (LMOS +5.5%), as well as Level 3 (LVLT +5.9%) and merger partner TW Telecom (TWTC +5.2%). Level 3 posted a Q2 beat this morning.
Windstream's spinoff will feature its fiber/copper networks and other real estate. The company expects to retire $3.2B in debt following the spinoff (expected to close in Q1 2015), and to have the REIT raise $3.5B in debt.
Windstream plans to have an aggregate annual dividend of $0.70/share following the spinoff ($0.60 for the REIT, $0.10 for Windstream proper). That's down from a current $1.00/share.
"TWTC has a very dense fiber metro base, and I think combined with LVLT domestic and international long-haul routes, the company will be able to deliver a new level of fiber connectivity around the world," says Stephens' Barry McCarver, offering an upbeat view of the Level 3 (LVLT -4.1%)/TW Telecom (TWTC +7.3%) deal.
But others on the Street weren't as thrilled about the price, which at announcement time represented a 26% premium to where TW closed on Thursday, before a BrightWire report about Level 3's interest arrived.
Light Reading's Carol Wilson notes the deal significantly boosts Level 3's enterprise/Ethernet reach, and that TW has a stellar reputation. "Twice in the past year I've had executives from tw telecom competitors volunteer the fact that they purposely avoid going head-to-head with that particular service provider."
Level 3 is offering $10 in cash and 0.7 shares for each TW share. The company has already lined up $3B in financing; it had $7.8B in net debt at the end of Q1.
Level 3 expects $240M/year in cost synergies ($200M adjusted EBITDA, $40M capex), and sees $170M in integration costs. TW shareholders will own 29% of the merged company. TW CEO Larissa Herda will be stepping down once the deal closes in Q4.
TW (current market cap of $4.5B) has a large nationwide fiber network (connects 20K+ commercial buildings) that would bolster Level 3's own network, and bills itself of the top 3 U.S. business Ethernet providers. Both companies are based out of Colorado.
BrightWire states Level 3 was also interested in TW back in 2012, when the company (per reports) hired Evercore to explore its options. But Level 3 is in much better shape today to make a bid.
Speculation that Level 3 could bid for TW has been around for a while.
Akamai (AKAM +2.9%) and Level 3 (LVLT +0.4%), pressured lately by reports Apple and Comcast are planning to launch CDNs, are higher today, though Level 3 has given back some of its early gains. Limelight (LLNW +1.4%) is also up.
Dan Rayburn has reported Apple, a major Akamai customer, is busy building out a large CDN infrastructure to deliver its content, and is also negotiating direct peering/interconnection deals with top ISPs. He originally wrote about Apple's CDN ambitions in February.
Rayburn also reports Comcast has joined the ranks of carriers building its own last-mile CDN. He thinks some content owners who use Comcast's service might "pay 20%-40% less than what they pay now," given Comcast already owns the network on which the CDN is being built.
Akamai, which still claims the world's biggest CDN and proprietary routing algorithms, has tried to counter the carrier CDN threat by striking partnerships - its client list includes AT&T, Telefonica, and Orange. It has also been trying to lower its dependence on a commodity media delivery business (includes sales to Apple) that's seeing intense price pressure.
The Federal Communications Commission is due to vote today on a proposal to formally allow some "commercially reasonable" deals that would enable Internet content companies to pay fees so that their traffic receives priority on the network.
Facebook (FB), Twitter (TWTR) and Google (GOOG, GOOGL) are among those opposed to "pay-for-priority," while Netflix (NFLX) is strongly in favor of net neutrality as well. The latter has reluctantly forged "direct-peering" agreements that remove bottlenecks between networks and ensure that its contents streams more smoothly.
Advocates of net neutrality fear that pay-for-priority will lead to "fast lanes" for corporations that can afford it and slower traffic for others, and some even want Internet providers to be reclassified as utilities, as is the case with telephone operations.
Meanwhile, the FCC is also scheduled to decide on rules for the sale of low-frequency airwaves to wireless carriers, with the regulations expected to limit how much Verizon (VZ) and AT&T (T) can purchase.
Level 3 (LVLT +9.6%) has hiked its 2014 adjusted EBITDA guidance to 14%-18% growth from a prior 11%-14%. Free cash flow guidance has been hiked by $25M to $250M-$300M.
Adjusted EBITDA rose 23% Y/Y in Q1 to $458M, and adjusted EBITDA margin by 480 bps to 28.5%. Unlevered cash flow grew to $106M from $28M, and free cash flow improved to -$22M from -$162M.
A 40 bps Q/Q and 170 bps Y/Y increase in gross margin contributed to the EBITDA growth. As did a 7% Y/Y drop in SG&A spend to $537M.
Core network service (CNS) revenue (over 90% of total revenue) grew 6.6% Y/Y in Q1, an improvement from Q4's 4.1% clip. Wholesale/other revenue fell 26% due to voice weakness.
CNS growth was fueled by a 10% Y/Y increase in IP and data services revenue to $573M, and a 5.5% increase in transport/fiber revenue to $502M. The divison's voice revenue grew only 0.4% to $237M, and its colocation/data center revenue 2.1% to $145M.
Level 3 ended Q1 with $7.8B in net debt, roughly even with Q4. Shares have made new 52-week highs.
Direct peering deals such as the one Netflix (NFLX -3.7%) struck with Comcast are a "toll to the powerful ISPs to protect our consumer experience," says Reed Hastings in a much-discussed blog post calling for tougher net neutrality rules to "protect an open, competitive Internet."
Though analysts have argued the Netflix/Comcast deal could actually lower Netflix's bandwidth costs, Hastings declares action is needed to keep cable/phone duopolies from having undue leverage against Web service providers.
He dismisses ISP complaints about Netflix's huge downstream volumes by arguing Netflix doesn't get a cut of the high-margin broadband revenue ISPs generate, and by noting ISPs don't pay fees for services (e.g. online backup) that generate heavier upstream volumes.
Level 3 (LVLT -0.6%) and Cogent (CCOI -0.6%), each of whom get charged by ISPs for acting as intermediaries for the likes of Netflix (assuming no direct peering), also call peering a neutrality issue. Today, Cogent offered to pay for capacity upgrades at ISP peering points in lieu of service payments, while arguing ISPs should ultimately be regulated as common carriers.
Dan Rayburn isn't sold on Hastings' arguments. "Netflix likes to make it sound like there is only one way to deliver videos on the Internet when in fact, there are multiple ways ... the company that should be blamed will be different depending on the business situation."