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Morningstar | Uniti Slashes Dividend but Downplays Risk From Windstream Bankruptcy; Outlook Disappoints Us. See Updated Analyst Note from 21 Mar 2019

As we thought would be necessary, Uniti cut its $0.60 quarterly dividend, bringing it to $0.05 this quarter, as the firm fights for its survival in the wake of Windstream's bankruptcy (Windstream accounts for two thirds of Uniti's revenue). To avoid breaching debt covenants that would have been triggered by Uniti failing to receive going concern confidence from its auditor, Uniti agreed to limit dividends. Despite the cut, management maintained a positive outlook regarding Windstream, implying that it doesn't expect major changes to payments it receives. We caution investors against putting too much faith in that outcome, as we believe management may need to project the outlook publicly to avoid weakening its hand in negotiations. It's difficult to quantify the amount, but we think it's likely Uniti will take a material haircut on its Windstream revenue--we continue to price a 25% cut beginning in 2020. Although our take on the Windstream situation is unchanged, management's outlook for the rest of the business leads us to temper our long-term margin expectations in the firm's fiber segment and return profile on the company's towers. Consequently, we are reducing our $16 fair value estimate to $13 while maintaining our no-moat rating.

Technically, Windstream must either accept or reject the lease in full by Sept. 23, 2019. Management conveyed it doesn't believe Windstream can reject due to its need for Uniti's network, and any negotiation would result in Uniti receiving fair consideration for concessions. We feel that oversimplifies things, given Uniti's dependence on the lease--a rejection of the lease would likely drive Uniti to bankruptcy immediately. With such leverage for Windstream's bankruptcy representative, we maintain that Uniti will be forced to relinquish significant revenue. However, given the relative magnitude of this revenue, any deviation from the 25% cut would materially swing our fair value estimate ($3-$4 for every 10 percentage points).

Uniti continues executing in the rest of its business, but without the ability to make large acquisitions, it cannot sufficiently diversify (the firm had been relying on issuing equity to fund diversification efforts, but the currently depressed stock price effectively forecloses that opportunity). For 2018, fiber revenue grew to nearly $300 million (22% of total sales), up over 40% from 2017 and enhanced by the purchase of 30 dark fiber routes from CenturyLink and a couple smaller acquisitions. The firm continues to expand its small cell and fiber footprint and is expecting double-digit fiber revenue growth again in 2019. Uniti is also continuing to expand its U.S. tower portfolio, and it expects the sale of its Latin American towers to be completed at the beginning of the second quarter. Tower revenue grew 45% in 2018 but accounts for less than 2% of sales.

Despite promising growth in fiber and towers, we were disappointed with the segments' profit profiles. The firm's consolidated 2019 EBITDA outlook ($819 million to $828 million) did not vary much from our projection ($834 million), but that's the result of the leasing segment, which includes Windstream revenue and has very stable margins, currently driving over 85% of EBITDA. We forecast fiber and towers to be the growth drivers longer term, so lower margins in those segments have greater effects in future years, as we project them to make up about one third of total EBITDA by 2028.

Fiber adjusted EBITDA margin expanded by over 100 basis points in 2018, and we thought it would jump even more in 2020. However, the firm's revenue and adjusted EBITDA outlook implied margin contraction in the segment of over 400 basis points, which we attribute to footprint expansion that is likely preventing operating leverage and lower margins on recently acquired businesses. We are reducing our fiber margin forecast by about 300 basis points annually, as we now believe operating leverage will build from a lower base. Similarly, management's outlook for tower EBITDA fell below our projections. The segment became profitable for the first time in 2018, and we expected another big step up in 2019. Instead, management's outlook called for only $1 million in tower profits. We expect volatility to be reduced and margins to rise after Uniti exits Latin America, but we think incremental returns will rise more slowly than we previously expected. In total, we are reducing our 2019 adjusted EBITDA forecast to about $828 million, and our 2028 margin estimate will be close to 300 basis points below our current 72% projection.