EUR 850.00 For Business Accounts Only

Morningstar | Windstream's Trial Loss Marginally Increases Its Bankruptcy Risk and Has Implications for Uniti

On Feb. 15, 2019, District Court Judge Jesse Furman issued his ruling in favor of Aurelius in its trial against Windstream. He found that Windstream violated debt covenants when it spun off Uniti; Windstream did not legitimately issue new bonds with its attempt to negate the default; and Aurelius is entitled to a money judgment of over $300 million. We expect Windstream to appeal the decision, so we don't believe any repercussions are imminent. However, although we expected an appeal regardless of the outcome and therefore see this as an intermediate step rather than a conclusion, we believe Windstream is in a worse position as an appellant, and the risk, of an unfavorable outcome is increased. More consequentially, we think an ultimate finding that Windstream is in violation will constitute a breach of its other bonds' covenants, which would likely drive Windstream into bankruptcy.

Though we did not expect Windstream to lose this trial, we felt it was in danger of bankruptcy nonetheless, hence our bear-case fair value estimate of zero and extreme uncertainty rating. We maintain that we would not recommend no-moat Windstream at any price, and we will reduce our $4.50 fair value estimate by $1-$2 to account for a higher probability of bankruptcy.

From an investor's perspective, this decision is more consequential to our view on Uniti, which derives about two thirds of its total revenue and over 85% of its EBITDA from the Windstream lease. We had already forecast a haircut (5%) to Uniti's rental revenue from Windstream in our base case starting in 2020, despite the payments being contractually guaranteed. We felt that even if Windstream prevailed at trial, its financial position would not allow the full payment, and Uniti would renegotiate rather than deal with a bankrupt tenant. Given the increased odds we now see for a Windstream bankruptcy, we are increasing our haircut to 15% in 2020, so we plan to reduce our fair value estimate on no-moat Uniti by $2 to $21.

We think the effects of this decision on Uniti are much less straightforward than they are for Windstream. First, we believe Uniti's lease agreement requires Windstream to make all payments in full, and in bankruptcy, it would either have to reject or accept the contract in full—with no haircut to rental payments. We don't believe it's that simple in practice. Despite our belief that Windstream would be legally mandated to continue operating and would need Uniti's assets to do so, we believe that Uniti would ultimately receive reduced payments. Even if Uniti would not willingly agree to that, Windstream could reject the lease, and we see no way that Uniti would choose not to welcome Windstream back, given Uniti's reliance on Windstream.

We also think Uniti is affected immediately, even though the appeal will be pending, and we don't expect an outcome before 2020. Uniti pays a very high dividend—well above what it is required to pay to maintain REIT status—and it relies on issuing equity to fund its growth and diversification. We expect the added uncertainty will weigh on Uniti's stock, and it will choose not to issue equity at depressed levels. We had been projecting a 25% dividend cut in 2020, but now think it will be more likely to cut in 2019, and we will model in a 35% cut, to $1.56 annually from $2.40. We had not been modeling substantial acquisitions to diversify its leasing segment, so we believe the cut will be sufficient to remove any liquidity concerns prior to Windstream exhausting its appeals. Even if Windstream ultimately loses, we don't think liquidity will be a problem for Uniti unless it loses the Windstream contract completely or takes a haircut of around 25%.