OVERVIEW

Windstream Holdings II, LLC (WIND) faces an uphill battle as it attempts to reorient its business model away from secularly declining legacy services. In 4Q23, WIND’s total revenue declined 8.2% year-over-year (YoY) to USD 967m (below our estimate of USD 982m) and its liquidity declined 8.4% sequentially to USD 385m (above our estimate of 360m). Pro-forma adjusted EBITDA declined 16% YoY and 5% sequentially to USD 214m. The company has yet to turn the tide against weak profitability and persistently down-trending revenue, and we believe it will require additional restructuring if it does not raise significant external capital or execute a recombination transaction with Uniti Group Inc. (UNIT). WIND has weak asset coverage due to the 2015 spin-off of UNIT and associated sale/leaseback of a large portion of WIND’s telecommunications infrastructure assets. The Wholesale business is one of the company’s relatively few monetizable assets.

WIND’s strategy is to make significant capital investments (partially funded by UNIT) to improve the economics of its Kinetic/ILEC-focused segment to offset declines in other services. Chronic underinvestment and high leverage prior to the 2019 bankruptcy contributed to an erosion in its competitiveness. Stabilizing operations in its Enterprise segment is particularly critical, and it is unclear whether improving cost structure and lowering interconnection expenses while simultaneously converting customers to more profitable cloud-based networking solutions can mitigate secular declines. WIND’s future largely hedges on accelerating its fiber broadband expansion to capture a larger share of the broadband internet market. It may be unable to successfully stem long-term secular declines through investments in upgrading its network, and innovation may further erode its competitiveness (e.g., SpaceX’s Starlink). However, the company benefits from secular growth in data/broadband consumption along with overall demand for broadband internet services, and trends in generative AI and the need for reliable bandwidth could provide a considerable tailwind.

As discussed in our 3Q23 report, we believed that WIND and Uniti Group Inc. (UNIT) were actively contemplating a recombination transaction. In mid-February, Bloomberg reported that merger talks were underway between the companies involving a possible stock-based transaction in which UNIT would remain publicly traded. Investors appear to have viewed the news favorably as WIND’s capital structure traded up following the news, while the common unit price increased slightly to USD 10.7 from USD 10.2. Our 3Q23 valuation analysis showed that the USD 1,400m 1L notes due 2028 were particularly undervalued relative to our model. The notes have traded up to 92 from 80 in November, in our view reflecting confidence that a recombination transaction will address medium-term liquidity and restructuring concerns. While our valuation methodologies still indicate that WIND’s unit price of USD 10.7 is overvalued by around 40%-50%, we believe this is driven primarily by significant cash burn related to onerous cash rent under its lease obligations with UNIT. WIND may be fairly valued or undervalued if the lease expense is meaningfully reduced following the 2030 lease renegotiation and if it successfully stabilizes its revenue and EBITDA and returns to a posture of modest growth.

FINANCIAL PERFORMANCE & DEBTWIRE PROJECTIONS

Under our base case, we project that the company will burn USD 79m of cash over the next twelve months (NTM) resulting in liquidity of USD 307m on 31 December 2024. In March 2024, the company entered into a definitive agreement to sell unused IPv4 addresses for USD 100m in cash, which it expects to close in 1H24. We assume that the April 2030 renegotiation of the master lease agreements (MLAs) with UNIT will result in a reduction of annual cash rent to USD 485m from approximately USD 694m (WIND estimates as low as USD 200m while UNIT estimates as high as USD 800m). We believe this level of annual cash rent represents the most mutually beneficial outcome and is the highest probability result of negotiations between the two parties. We also assume all maturities will be refinanced through the end of the projection period.

Our base case shows that cash rent before the lease renegotiation is unsustainable for WIND, and that it will deplete its liquidity in 1H 2026 as Growth Capital Improvement (GCI) and settlement payments from UNIT roll off. To fund this shortfall, we assume WIND will execute a previously considered sale of its Wholesale unit in 4Q25 for USD 1.5bn in proceeds. The bifurcation of its leases with UNIT along with recent leadership changes should help facilitate an asset sale. However, a merger with UNIT is a more likely avenue to address this liquidity shortfall. If WIND successfully raises the level of external capital required to remain a going concern, our base case shows that it will achieve positive free cash flow in 2Q30 and generate a cumulative of USD 1.0bn of adjusted levered free cash flow from 2Q30 through 2035. Additionally, its net leverage will moderate from 3.1x in 1Q30 to 1.1x in 2035 offering the possibility of meaningful deleveraging.

We expect that total revenues will be flat through 4Q24 but will rise by 10% through YE 2035 to USD 1.06bn. Moreover, we expect WIND’s changing revenue mix and measures to cut costs and improve operating efficiencies will lead pro-forma adj. EBITDA margin to increase to 30% in 2035 from 22% in 4Q23. We project that pro-forma adj. EBITDA will slightly rise over the NTM to USD 225m in 4Q24 (versus USD 214m in 4Q23), decline to USD 164m in 4Q25 following the sale of the Wholesale unit and the end of settlement payments from UNIT, before rising to USD 329m in 4Q35 as strategic initiatives bear fruit and the 2030 lease renegotiation significantly improves cost structure and profitability.

However, in a low-case scenario that assumes slower addition of next-gen high-speed customers, more rapid attrition of existing DSL high-speed customers, slower growth in average revenue per high-speed internet customer, a more modest ramp up of strategic revenues in its Enterprise segment, and a sale of its Wholesale unit for USD 1.5bn in proceeds, we show that WIND will violate its 3.5x leverage covenant in 2Q26 and fully deplete its liquidity in 1Q30. In this scenario, a reduction of annual cash rent under the MLAs to USD 485m in 2030 still leads to an unsustainable cost structure that would only be alleviated with a further reduction of annual cash rent. If the Wholesale unit is not sold and the company does not either merge with UNIT or find another significant source of external capital, we show WIND could deplete its liquidity as soon as 1Q26.

WIND’s investments under its fiber-to-the-home (FTTH) strategy designed to overbuild its ILEC copper network with fiber were the foundation for a 2.7% increase YoY in Kinetic consumer service revenues to USD 1,179m in 2023, but total Kinetic revenues declined 0.5% to USD 2,219m due to declines in other legacy services. In our base case, we show Kinetic revenues will decline by 1.0% through 1Q26 as its strategic investments continue to alter its customer composition, but that revenue will rise by 19% through 2035. In our low case, we show Kinetic revenues will decline by 7% through 1Q26 and decline by 22% through 2035. The FTTH strategy has resulted in the construction of 25,500 fiber route miles and 24.4% of the copper network overbuilt with fiber, and UNIT management expects half of the legacy copper network will be overbuilt with fiber by 2030. Inflation in labor and materials costs and supply chain issues may adversely impact the company’s FTTH buildout.

WIND continued to see steep deterioration in operating results in its Enterprise segment, with 2023 revenues down 17% YoY to USD 1,416m. Improving Strategic revenues to offset declines in legacy services is a key focus of the company, which we expect will comprise around 85% of total Enterprise segment service revenues in 2035. Likewise, strength in its Wholesale segment is likely to play a critical role in the company’s efforts to both offset declines in its Enterprise segment and to generate liquidity through an asset sale.

WIND has clearly been laying the groundwork for a potential sale, and in February 2023 it was reported that WIND had retained advisors to shop a sale of its Wholesale business with an estimated valuation of between USD 1bn and USD 2bn. Using the Wholesale unit’s 3Q23 LTM contribution margin of USD 194m as a loose proxy for adjusted EBITDAR (and our expectation of modest growth through 2025), we think it is feasible that a future sale could generate proceeds of somewhere around USD 1.0bn to USD 1.8bn with a multiple in the 5x-8x range. However, it is unclear if there is an active sale process.

VALUATION

At its current unit price of approximately USD 10.7 (sourced from Markit as of 27 March 2023), WIND appears to be overvalued by around 40%-50% based on the output from our discounted cash flow analysis. Likewise, our valuation waterfall shows that WIND’s entire capital structure receives a full recovery but that its implied equity value is approximately 80% lower than its current unit price. We believe the output of these valuation methodologies reflects the unsustainability of WIND’s business model through 2030 due primarily to onerous cash interest under the MLAs. Our DCF model shows WIND’s intrinsic enterprise value is approximately USD 2.6bn versus an enterprise value of USD 3.2bn based on current market values of its capital structure and equity.

Our base case projections show WIND will incur negative unlevered free cash flow from 2025 through 2029. If WIND successfully achieves its strategic objectives to stabilize revenue and EBITDA, raises adequate external capital to bridge the period to 2030, and cash rent is meaningfully reduced after 2030 (as we assume in our base case), we expect that WIND’s unit price would be undervalued at current levels. We believe the outputs from our models imply that a recombination with UNIT would be value accretive to WIND unitholders.

Under our low-case scenario, our valuation methodologies indicate that WIND will have limited or no equity value. However, our valuation waterfall shows that at a 3.0x to 4.0x EV/EBITDA multiple the super priority credit facility, the super priority first out term loan, and the 1L TLB would receive a full recovery while the 1L notes would receive a 23%-38% recovery.

WIND is currently trading at an NTME EV/PF adj. EBITDA multiple of 3.8x which is lower than the peer median of 6.9x reflecting WIND’s relatively low EBITDA margin, its persistently declining revenue and EBITDA and lingering restructuring risks, and its weak asset coverage and onerous lease obligations resulting from the sale/leaseback transaction with UNIT.

Using a discounted cash flow analysis as our primary methodology along with reasonable long-term operating assumptions (a reduction in annual cash rent from the lease agreements to USD 485m after 1Q30, CapEx falling from 27% of revenue to 16%, total revenue CAGR of 2.8% from 2023 through 2035, and pro-forma adjusted EBITDA margin expansion from 23% in 2023 to 30% in 2035) and financial assumptions (9% WACC, 4.2x terminal EV/EBITDA multiple, and 0.5% terminal UFCF growth rate), WIND appears to be overvalued by around 40-50% in our sensitivity tables.

Using the output from our discounted cash flow analysis that shows WIND’s intrinsic enterprise value is approximately USD 2.1bn to USD 2.6bn at a 3.0x-4.0x terminal EV/EBITDA multiple and a 9% WACC, our valuation waterfall shows that the super senior revolving credit facility, the super priority first out term loan, and the 1L TLB all receive a full recovery, the 1L notes receive an 84%-100% recovery, and the implied market value of equity is between zero and USD 1.6. All debt in WIND’s capital structure traded up after Bloomberg reported that a recombination transaction was under consideration. In particular, the USD 1,400m 1L notes due 2028 are trading at 92 from 80 in November, which we believe reflects investors’ expectation that a merger with UNIT could address medium-term liquidity and restructuring risks.

COMPANY DESCRIPTION

Windstream Holdings II, LLC (WIND) is a Little Rock, AK-based privately held communications and software company.

For additional background on WIND, please see our 2Q23 and 3Q23 reports.

WIND emerged as a private entity following a litigation-induced Chapter 11 restructuring process on 21 September 2020. The restructuring allowed it to reduce its debt by 63% to USD 2.15bn. In 2015, Uniti Group, Inc. (UNIT) was created as a spin-off from Windstream Holdings, Inc. (predecessor entity). Pursuant to the spin-off, WIND contributed telecommunications assets including fiber and copper networks and other real estate to UNIT and entered into a triple-net lease agreement through which the contributed telecommunications and distribution systems were leased back to WIND. Aurelius Capital Management (infamous for their battle with the government of Argentina) took positions in WIND’s debt consisting of a long position via bond purchases and a short position via credit default swaps. In 2017, two years after the spin-off and sale leaseback transaction, Aurelius issued a notice of default alleging the 2015 transaction violated WIND’s indentures. In February 2019, WIND filed voluntary petitions for reorganization under Chapter 11 after the Southern District of New York ruled that the spin-off and transfer of assets to UNIT violated the sale-leaseback covenant in WIND’s indentures and constituted an event of default. In accordance with the settlement, UNIT is obligated to pay WIND USD 490.1m in cash in equal installments over 20 quarters and to reimburse WIND for an aggregate of USD 1.75bn of Growth Capital Improvements (GCIs), both beginning in October 2020. Elliot Investment Management LP became WIND’s largest unitholder upon emergence from the restructuring.

Following the restructuring the amended master lease agreements are now bifurcated into two structurally similar but independent agreements, one governing network facilities within ILEC markets and one facilities within CLEC market areas. This bifurcation more closely aligns with WIND’s Kinetic (ILEC) and Enterprise and Wholesale (CLEC) business units and may help facilitate the disposition of either of these businesses in the future.