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Windstream to Spin Off Some Assets Into Publicly Traded REIT

5 min read

Windstream Holdings Corp. of Little Rock said Tuesday that it will spin off certain assets, mainly its fiber and copper network, into a publicly traded real estate investment trust, a move it says will lower its debt by $3.2 billion but also reduce its attractive dividend by 30 percent.

“The transaction will enable Windstream to accelerate network investments, provide enhanced services to customers and maximize shareholder value,” the company said in a news release. “The transaction will allow the REIT, which will own Windstream’s existing fiber and copper network and other fixed real estate assets, to expand its network and diversify its assets through acquisitions.”

Windstream said customers will see no change in their rates or service as a result of the deal. It announced details in a regulatory filing and published a fact sheet on the transaction here (PDF).

CEO Jeff Gardner said the move will make the telecommunications firm “a more nimble competitor” in the marketplace. The new REIT’s CEO will be Tony Thomas, who is currently Windstream’s CFO. Francis X. “Skip” Frantz, a Windstream director, will become the new entity’s board chairman. The REIT will have about 25 employees and raise about $3.5 billion in debt.

The spinoff will also alter Windstream’s long-standing, annual $1 dividend, the sustainability of which has been questioned by analysts but which Gardner had said was prudent as recently as the May shareholders meeting. After the transaction is complete, investors will see their total dividends reduced to 70 cents per share between the two companies. Windstream will pay 10 cents; the REIT will pay 60 cents. Whether those dividends would be fully taxable was not immediately clear; the IRS ruled that about two-thirds of Windstream’s 2012 dividend was not taxable because it represented a “return of capital” rather than a distribution of profit and the same was true of 51 percent of the 2013 dividend.

Windstream’s $1 annual dividend has been a key selling point to investors. In a conference with analysts on Tuesday, Gardner said the new dividend makes sense given Windstream’s competitive environment. He said the company thinks it struck the right balance between returning money to shareholders and retiring debt.

Shares of Windstream (NYSE: WIN) were trading up more than 19 percent on Tuesday morning to about $12.55 per share.

The Deal

Per the deal, Windstream will spin off assets including its fiber and copper networks and other real estate as a REIT, which will lease use of the assets to Windstream. The deal will happen through a “long-term triple-net exclusive lease” with an initial estimated rent payment of $650 million per year. Windstream said less than 25 percent of its assets will become part of the new REIT. The company’s data centers will remain with Windstream Holdings Corp.

Publicly traded REITs sell on major exchanges and invest directly in real estate. They also receive special tax considerations and can offer investors high yields. Windstream says its REIT will distribute “at least” 90 percent of its annual taxable income as dividends to shareholders.

Windstream’s board approved setting up the REIT after receiving a favorable private letter ruling from the Internal Revenue Service.

Other telecommunications companies have set up REITs using assets like cell towers and data centers. In an interview with Arkansas Business, Gardner said a REIT of this asset class — copper and fiber optics — is the first of its kind.

Given the favorable letter from the IRS, Gardner said he’s confident Windstream will clear its multiple regulatory hurdles, including approval from multiple state public utility commissions. The spinoff is expected to occur in the first quarter of 2015.

“I think it’s going to be very attractive to these regulatory agencies,” Gardner said, citing transaction’s benefits to customers and debt payment.

By paying down debt, the company said the tax-free arrangement will increase free cash flow, allowing Windstream “to accelerate broadband investments, transition faster to an IP network and pursue additional growth opportunities to better serve customers.” The company said the deal will allow it to improve its networking and offer faster broadband speeds and “more robust performance to consumers.” It said it will expand availability of 10 Mbps Internet service to more than 80 percent of its customers and more than double the availability of 24 Mbps Internet service by 2018.

In the end, Windstream executives say they will have will have cut debt, increased company cash flow and allowed themselves greater strategic flexibility. They will also have created two companies with different goals.

Windstream Holdings will be a “growth-focused enterprise” telecommunications services provider, the company said, while the REIT will be a “yield-oriented company” looking to diversify through acquisition. 

Gardner told Arkansas Business that with Windstream itself as the REIT’s first “large tenant,” the new entity will seek to buy the copper and fiber assets of other telecommunications firms, growing the REIT and its earnings for investors.

‘Confusing’ Or ‘Game Changer’

Analysts on Tuesday’s conference call were intrigued by the deal and its implications for the telecommunications industry.

“The whole market’s trying to understand this,” Merrill Lynch analyst David Barden told executives during the call’s question-and-answer period. “I mean, are cable companies going to be doing this? Are telecom companies going to be doing this?”

Jennifer Fritzsche, an analyst with Wells Fargo, called the deal “a very confusing transaction.” But she said the move is a positive one for Windstream shares. “It simplifies WIN’s core business focus and capital structure,” she said in a research note.

Tim Horan of Oppenheimer & Co. said in his own note that, despite “high regulatory barriers,” the deal “will be a game changer for the valuation of non-REIT infrastructure stocks in our industry.”

Other industry watchers said Windstream’s deal might encourage others, including CenturyTel, Verizon and AT&T, to explore REITs of their own.

In a news release, Moody’s Investors Service said it believes the transaction will improve Windstream Holdings’ cash flows by about $160 million in 2015. Beyond next year, Moody’s expects Windstream to continue to achieve “stronger cash flow results than its current structure due.”

“The improved free cash flow profile will give Windstream the ability to continue to invest in its business, a key constraint of its prior capital allocation practice which Moody’s believed had placed the company’s ability to invest at risk,” Moody’s said. 

Windstream, originally the wireline division of Alltel Corp. that was spun off eight years ago, has been transitioning away from traditional telephone services to business services, and those strategic growth products now account for more than 70 percent of revenue. 

The Fortune 500 company has more than $6 billion in annual revenue and provides services including cloud computing and managed services, to businesses nationwide. It also offers broadband, phone and digital TV services to consumers mainly in rural areas.

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