EUR 850.00 For Business Accounts Only

Morningstar | Uniti Reports a Subpar 1Q, but Operating Results Mean Little Relative to Fate of Windstream Lease

No-moat Uniti's first-quarter sales were below our expectations, leading to a shortfall on EBITDA as well, despite the margin being slightly better than we projected. However, in our view, near-term operating results are virtually meaningless as the Windstream bankruptcy lurks. We think justified market doubts about future payments Uniti may receive on its Windstream lease and Uniti's ability to remain solvent while the Windstream lease is unsettled are the sole reasons the stock trades as low as it does. We estimate that every 5% reduction to the lease payments results in a $2 movement on our $13 per share fair value estimate. Quarterly fluctuations in other businesses are too small to move the needle in comparison. We are maintaining our fair value estimate, which assumes a 25% reduction in Windstream lease payments beginning in 2020, but we acknowledge that the level of the ultimate haircut is unknowable, and we will likely have to adjust our fair value estimate after the Windstream case is settled.

Revenue grew 6% year over year, below the 9.5% we projected, due entirely to a shortfall in the fiber segment, which accounts for nearly 30% of Uniti's total revenue and 15% of its EBITDA. However, the firm has several fiber projects it expects to complete this year, and it maintained its full-year fiber guidance, so we are not changing our outlook for the remainder of the year. We project 6% consolidated revenue growth in 2019, taking into account the Latin American tower portfolio Uniti sold in April and the sale of its Fiber Midwest operations to Macquarie, which we model to occur in the fourth quarter.

Uniti's adjusted 76.7% EBITDA margin in the quarter was 60 basis points higher than we projected, but we attribute that to the fiber segment shortfall as well. The leasing segment, which includes Windstream and other sale-leaseback transactions, has nearly 100% margins, so any shift in the business toward that segment results in higher consolidated margins.

We project consolidated EBITDA margin to contract by nearly 10 percentage points over the next 10 years, due to a shift away from the leasing business rather than profit headwinds. We forecast leasing to make up less than 50% of sales in 2028, down from nearly 70% in 2018.

We think management would like to do more large sale-leaseback transactions, which would keep the firm weighted toward the leasing segment, but under current conditions, we don't believe it has the access to capital that would be required. The firm executed one small sale-leaseback transaction in the quarter, acquiring the network of Southern Fiber Net in southern Georgia. Uniti acquired 1,800 fiber strand miles for $6 million and simultaneously entered a 20-year lease that will bring $570,000 in annual rent payments with a 2% escalator, resulting in a 9.5% initial cash yield. We think deals such as this one are phenomenal for Uniti, but we have doubts about its ability to find and finance larger ones. For perspective, this deal is less than 0.1% the size of the Windstream lease.

There was no new news regarding Windstream, though we did get confirmation that Windstream has continued making full payments on time. As previously announced, Windstream has a June 25 deadline to accept or reject the lease in full, but it can extend the deadline through Sept. 23. We maintain that the most likely outcome is that Uniti and Windstream come to a voluntary agreement to reduce the level of payments, as both sides have substantial leverage. Losing the Windstream lease entirely would likely drive Uniti itself into bankruptcy in short order. On the other hand, we believe Windstream has no realistic alternative to Uniti's network that would allow it to meet its obligation to act as the carrier of last resort in many of its markets. A voluntary agreement for Uniti to accept a lower payment would alleviate the complications that would arise from a Windstream lease rejection and subsequent efforts to start from scratch in procuring its network.