Closing Out EarthLink In Favor Of Communications Sales & Leasing; Exiting PayPal

by: Hazel Capital

Every month or so I take a hard look at my portfolio. In addition to exiting RAD, last week I closed out of EarthLink (NASDAQ:ELNK) and PayPal (NASDAQ:PYPL).

ELNK-WIN is Less Attractive than CSAL At Current Spread

EarthLink had appreciated a bit since my initial purchase, and while I still believe it is cheap, I prefer to play Windstream (WIN) via Communications Sales & Leasing (CSAL). With the deal spread between ELNK-WIN having narrowed significantly to <2%, I saw no reason to keep holding. I took my gains and exited. I prefer CSAL because it weirdly still pays a higher dividend than WIN, yet sits higher in the capital structure than Windstream stock.

These are the kinds of spin-out situations which Joel Greenblatt loves. Not only did WIN spin-out an entirely different investment industry classification (telecom -> REIT), but in doing so it went from being a mid-cap stock to a small-cap. This resulted in both stocks being undervalued significantly post-spin as investors hit the Nope button, likely due to size/sector fund investment limitations.

CSAL pays a 9% dividend currently vs triple-net REIT peers at 5-7%. WIN pays a 7.8% dividend currently...despite sitting lower in the cap structure. This. Makes. No. Sense. I don't know of any other REIT-Customer dividend spread quite like it. CSAL is also significantly exposed to WIN revenue, but if WIN were to go bankrupt, CSAL would still own the copper/fiber assets and should still be collecting lease payments throughout any bankruptcy process. Bond investors in Windstream do not appear to believe that bankruptcy is on the horizon currently.

A lot has happened in the REIT space with the REITs now designated as a separate sector within Financials. As REIT-focused funds get more comfortable with CSAL we should eventually see solid share price appreciation, offset by some potential interest rate hike headwinds. I consider CSAL to be relatively macro safe. If the economy turns south, people will still need internet and telephone service. They are much more likely to stop buying new clothes and computers than to stop what is effectively a utility these days.

With interest rate rises lurking in the horizon, and CSAL being a very unique REIT I think it could be another 1-2 years before the stock achieves a fair value. To the extent that CSAL can minimize WIN exposure through further deals, that should be good for the stock, but management has been cagey there. I'm willing to sit back and collect the 9% dividend in the meantime. It is currently one of my largest positions.

PayPal Operating Momentum is Slowing, Deals with Credit Card Holders is Meh

PYPL operating momentum appears to have slowed a bit year-over-year, and having gained 23%, I am happy to exit. I think the deals last year with Visa (NYSE:V) and MasterCard (NYSE:MA) were only so-so, and while recent AMZN news could be good, I suspect Amazon (NASDAQ:AMZN) will drive a hard-bargain.

I appreciate the potential of Venmo (how many times have you heard the term "I'll just Venmo you."?) I don't know how or when PYPL monetizes it without losing customers. So I've chosen to move to the sidelines for now. From a valuation perspective the stock is not cheap at 1.4x PEG and >18x EV/EBITDA. I like PayPal/Venmo as brands but I'm just not excited about the fundamentals or the general business direction currently.

Maybe I'm missing something here?

New Buys

OK I'll bite on the community banks thesis which others have described. I'm looking hard at a few now and will write more about that later. I also bought some International Seaways (NYSE:INSW) - an undervalued spin-out from Overseas Shipholding Group (NYSE:OSG). More to follow.