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Morningstar | Windstream Provides Update on Bankruptcy Proceedings and View of Uniti Lease With 1Q Results

No-moat Windstream released first-quarter results that highlighted some of the challenges its business faces but were consistent with recent trends. The unsurprising results also had some encouraging items, including accelerating growth in its consumer broadband base and continuing strides in enterprise strategic services. In addition, management provided its view on the Uniti network lease, which Windstream must accept or reject by June 25 (although we expect Windstream to invoke its right to extend the deadline by three months). We are leaving our fair value estimate under review during bankruptcy proceedings, but there's no change to our view that we would not recommend Windstream stock at any price.

Windstream is required to either accept or reject its Uniti lease in full, but we maintain that the two firms will voluntarily renegotiate the lease to reduce Windstream's payments, as we think the lease is vital to both parties. We continue to estimate a 25% reduction to the lease payments, which is what our $13 Uniti fair value estimate is based on, but we acknowledge it is impossible to precisely project.

Windstream management indicated that it believes the annual lease payments, which extend to 2030, are "significantly above market," and the value of the assets is rapidly declining, largely due to the network's heavy copper makeup. We see the firm's implication that it finds the lease unattractive as merely a negotiating tool to entice Uniti to bargain. Regardless of quality, we think Windstream has no realistic alternative to using Uniti's network. As a carrier of last resort, Windstream is obligated to provide service in numerous geographies, and we don't see a feasible alternative to Uniti's network that allows Windstream to meet those obligations. However, we doubt Uniti could stay solvent if it completely lost the Windstream lease, which accounts for about 70% of Uniti's total revenue, so it can't play hardball.

Adjusted for the sale of its consumer CLEC (competitive local exchange carrier) business, Windstream's year-over-year revenue declined 6%. While revenue for all segments declined from last year's first quarter, consumer revenue and strategic enterprise revenue were the bright spots and, in our view, the firm's most promising businesses long term.

Consumer revenue fell 1% year over year, but the decline was mostly attributable to voice. Consumer high-speed Internet revenue was flat versus the same quarter last year, but the firm added over 11,000 new customers in the quarter, marking Windstream's best quarter since 2011 by that metric and the firm's fourth straight quarter of customer growth. Lower average revenue per user offset the 3% year-over-year growth in customers. We think Windstream will be able to grow Internet revenue in the future.

Enterprise strategic services, which includes software-defined wide area networking, or SD-WAN, and unified communications as a service, or UCaaS, continued rapid growth off a low base, rising over 8% sequentially and 44% year over year. We think the firm will be able to maintain similar levels of growth for several years, but strategic services still account for less than 10% of enterprise revenue. Double-digit year-over-year revenue declines in other enterprise revenue streams led to enterprise revenue contraction of 8% year over year. With strategic services continuing to cannibalize higher-revenue enterprise alternatives, such as MPLS (multiprotocol label switching), we think revenue declines will continue.

The firm's adjusted EBITDA margin contracted by 170 basis points versus last year's first quarter, due primarily to higher cost of services and the sale of the consumer CLEC business, which was relatively higher margin. We think margins will expand from here, as a continuing shift towards strategic from legacy enterprise services should allow the firm to cut costs.