Seeking Alpha

The Old Dividend Is Never Coming Back At Uniti

About: Uniti Group Inc. (UNIT), WINMQ
by: Trapping Value
Trapping Value
Deep Value, special situations, REITs, dividend investing

Uniti continues negotiations with Windstream.

We think the chances of a 10-20% rent cut are exceptionally strong.

But even if the lease is maintained, Uniti has zero chance of going to old dividend payments.

Uniti Group, Inc. (UNIT) reported Q3-2019 results, and the results were slightly below expectations. While the market glanced briefly at the results, investor eyes have been deeply glued on the main course, i.e. the lease negotiation between Windstream Holdings (OTCPK:WINMQ) and Uniti. We want to take a look at the results and explain why even if everything does work out, Uniti will not be restoring the dividend to its former glory.

Q3-2019 results

While investors may cheer the steadily rising revenues this quarter, we would want to start by pointing out that literally every single cash expense category went up faster than revenues.

Source: Uniti Q3-2019 results

Uniti's adjustments from net income to funds from operations (FFO) and Adjusted Funds From Operations (AFFO) are pretty straight forward. The current quarter showed $98.7 million in AFFO, which was down 13% from last year.

Source: Uniti Q3-2019 10-Q

Uniti deducted just $6.27 million in maintenance capex to reach its AFFO of $310.78 million for the year to date. Interestingly, the actual capital expenditures were $264.86 million.

Source: Uniti Q3-2019 10-Q

We know our readers are bursting out of their seats to say that this difference is actually "growth" capital expenditures, and we think they are hitting it on the nose in a sense. This capex does increase revenues. But we think of two things here. The first being can this be ever dialed down? If not, with this cost of capital, it is a big problem. The second is that with Windstream still being the largest single customer for Uniti, we would wonder if that growth will ever materialize for the company down the line. By that, we mean that Uniti may not collect everything it hopes to from Windstream.

Quarter-end metrics and dividends

At quarter-end, Uniti had its leverage ratio near 6.3x based on Net Debt to Annualized Adjusted EBITDA. We think that is rather high considering that Windstream is a five-lettered stock trading near 20 cents. The company did declare a quarterly cash dividend of $0.22 per common share to meet its REIT requirements, but we would not expect regular payments of that nature in 2020. In fact assuming Windstream does not get the base rent lowered, we would expect Uniti to pay the higher of what is required under REIT rules or free cash flow. The latter we estimate to be around $95-100 million total in 2020 or 50 cents/share a year.

Windstream still has issues

While investors may fret over the exact nature of the rent cut, we worry about how long Windstream can continue hemorrhaging revenues. Revenues have gone down every single quarter. OIBDAR (Operating Income Before Depreciation, Amortization & Rent to Uniti) has also decreased significantly, and in spite of all the steps taken, it matches the declines in revenues.

Source: Windstream Q3-2019 presentation

Further, we would focus on what is left after paying rent to Uniti and after capital expenditures.

Source: Windstream Q3-2019 presentation

Let's forget about the interest being paid here. If you take the most recent quarter and cut OIBDAR by 10%, then you have a negative cash flow after rent and capex, even if Windstream does not pay a dime of interest. That is a problem, and the key reason we think that a lot, and we really mean a lot, has to go right for Uniti to pay even a cent above the minimum REIT rules. The best case for Uniti's equity is to support Windstream in any way possible and that would include a rent cut.

Conclusion and a trade

The $2.40 cent dividend likely will only happen if the late Mugabe's spirit takes over the US printing presses. Outside that, we see no outcome where the old dividend or anything close to it comes back. But what if you want to speculate and aim for the stars? We do have one trade suggestion for the bold trader.

A ratio call spread.

Source: Random Walk Trading

We would buy 1 May 2020 call $10 strike and sell twice as many $15 calls for net break-even entry.

Source: Seeking Alpha

Should the best case transpire, Uniti's stock should rise and any at expiration price between $10-15 becomes your profit with maximum profits at $15. Between $15.00 and $20.00, your profits decrease steadily reaching a zero number at exactly $20.00. You will only lose money on this should Uniti shares rise over $20 before May expiration. We think that is extremely unlikely. Outside that gamble, we would stick with the unsecured bonds on Uniti as the only way to play this game.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.


HDO is long the Uniti unsecured bonds.