Uniti Group, 9.5% Yield-To-Maturity, Maturing October 2023
This week, Durig Fixed Income (FX2) look at an issuer in the ever-expanding telecommunications industry. Formerly known as Communication Sales & Leasing, Uniti Group Inc (UNIT) is an internally managed real estate investment trust (REIT) that was spun-off of Windstream Holdings (WIN) in April of 2015. Currently operating in four business segments (Leasing, Fiber Infrastructure, Towers, and Consumer CLEC), Uniti qualifies as a REIT for US federal income tax purposes as long as it distributes 90% of its taxable income to its stockholders. As a consequence of S&P’s rating cut to Windstream Holdings, a simultaneous ratings cut was assigned to Uniti Group. However, for a numerous reasons which will be outlined below, we believe the spillover of the market’s recent punishment of Windstream onto Uniti has resulted in a nicely discounted price of about 95 for Uniti’s 8.25% couponed bonds, 2023 bonds. That price results in a high yield to maturity of nearly 9.5%, from an issuer that in 2½ years of operations that has:
Increased annual revenues from about $700 Million to about $975 Million.*
Increased adjusted EBITDA from about $650 Million to about $785 Million.*
Reduced its revenue dependency on Windstream from 98% to about 70%.
Increased its significant backlog of revenue under contract, to about $2 Billion over 12 years (average remaining.)
Strong infrastructure growth potential due to low 4G/5G penetration.
*Pro forma for NMS, Hunt, and Southern Light.
Despite the market’s recent discount of Uniti’s securities due to its affiliation with Windstream, Uniti retains the ownership of its networking assets, and should continue to thrive no matter the outcome of Windstream’s current challenges. With Internet traffic projected to grow at a compound annual growth rate of 24% through 2021, Uniti’s assets have tremendous value, notwithstanding the revenues from Windstream. Assets can be re-leased to other communications providers, if and when needed. In addition, recent insider buying of Uniti’s stock shines a positive rather than negative light on the company. Therefore, we see Uniti’s 2023 bonds as an excellent opportunity for fixed-income investors looking for strong cash flow, higher yields, and diversification into the telecom industry. Therefore, we are targeting these bonds for addition to our Durig Fixed Income 2 (FX2) managed income portfolios, the aggregated third quarter 2017 performance of which is shown below.
Uniti posted its financial results for the three month period ending June 30, 2017 (Q2). These results show the company continuing its growth since its spin off from Windstream two years ago.
For Q2, total revenues increased from $188.6 million in Q2 2016 to $213.0 million in 2017, an increase of 13%.
For the six months ending June 30, 2017, total revenues increased 16.9%, from $363.3 million in the same period of 2016 to $424.5 million in 2017.
For the six months ending June 30, 2017, the company posted a 6.8% increase in net cash provided by operating activities, growing from $183.8 million in 2016 to $196.4 million in 2017).
- In Q2, Uniti completed its acquisitions of Southern Light and Hunt Telecom. Collectively, these acquisitions are projected to add $98 million in adjusted EBITDA for the six months following the acquisition date of July 3, 2017.
About the Issuer
Incorporated in 2014 and based in Little Rock, Arkansas, Uniti Group was formed as a spin-off from Windstream Holdings, Inc. in April of 2015. Windstream is a provider of advanced network communications and technology solutions for consumers and businesses.
Uniti has changed to an umbrella protected real estate investment trust (UPREIT) in 2017, and remains focused on the acquisition and construction of mission-critical communications infrastructure such as fiber, wireless towers and ground leases for the communications industry. As of July 3, 2017, Uniti owns 4.8 million fiber strand miles, 631 wireless towers, and other communications real estate throughout the United States and Mexico. Uniti collaborates with operators to develop assets while relieving them of the burden of raising investment capital. Unlike a private equity or venture fund, the company does not take an ownership interest in or exercise control over operations. Operators gain access to a vast reserve of capital along with the freedom to use it in ways that best suit their strategic objectives. Uniti has four reportable business segments:
- Uniti Fiber – Uniti Fiber is a leading provider of infrastructure solutions, including cell site backhaul and small cell for wireless operators and Ethernet, wavelengths and dark fiber for telecom carriers and enterprises.
- Uniti Towers – Uniti Towers offer solutions and services to keep wireless carriers on air, including colocation, small cell and backhaul needs.
- Uniti Leasing – Uniti is engaged in acquiring mission-critical communications assets and leasing them back on either an exclusive basis (triple net) or shared tenant basis.
- Consumer CLEC –This segment includes Talk America.
What About Windstream?
As many investors are aware, Uniti stock and bonds have taken a hit recently due to a challenge from a Windstream (WIN) bond investor claiming that the 2015 spin-off of Uniti (then Communication Sales and Leasing) violated terms of Windstream’s debt and amounts to a default. Windstream has now asked a judge to rule that its 2015 spin-off and asset transfer of Uniti was legitimate and did not constitute a default. While the jury is still out (literally), it’s important to consider a few material items where Windstream and Uniti are concerned.
Uniti derives a significant portion of its revenues from a triple net master lease where Uniti owns a majority of the fiber and copper on which Windstream delivers its services, although Uniti’s reliance on Windstream revenues is expected to decline, as voiced by Uniti CEO, Kenny Gunderman in an investor conference call in April of 2017. An important feature of this lease is that it is indivisible – WIN has to accept it in full or not at all. In other words, it can’t split out the most lucrative markets and leave the others behind. As a result, WIN cannot continue to operate without this lease. On the other hand, Uniti may find new a lessee to operate in place of Windstream if they do not accept.
Secondly, markets have reacted sharply to the recent challenge to Windstream regarding the Uniti spin-off and the fact that it recently suspended its dividend. This has resulted in not only decreasing the value of both WIN’s stock and bonds, but it has similarly affected Uniti’s stock and bonds. Clearly, it appears as if the markets are wary of what happens next for these two companies as they are closely integrated with each other.
In light of these items, it is important to consider the possibilities. First, the court rules in favor of Windstream and the company continues in the status quo. WIN currently faces some challenges – weak operating performance and high leverage. However, it has just completed the acquisition of Earthlink which it predicts will deliver $180 million in operational synergies. Add to this the recent dividend cut, which frees up in excess of $100 million annually. This should enable WIN to continue paying the lease as well as service its debt. If the court rules against WIN, reorganization is infinitely more likely. But even in this scenario, the lease could remain intact, WIN’s debt is restructured and WIN emerges post-restructuring as a healthier company. If WIN were to dissolve completely, Uniti would still own the networks, which would no doubt become a lucrative acquisition for a competitor looking to expand its market presence.
Since the beginning of August 2017, Uniti board members have purchased 15,700 shares of Uniti stock, valued at $235,000 (at $15 per share). Increasing stock purchases from a company’s insiders often is an outward sign that there is a closely held belief of pending positive developments for the company. One can only watch and wait, but the increase in insider trading is encouraging.
Connectivity Growth Projections
A recent report from Cisco shows the explosive growth in networking and connectivity that is forecasted over the next four years. Here are some of the projections from this report:
Overall, internet traffic will grow at a Compound Annual Growth Rate (CAGR) of 24 % from 2016 to 2021.
Smartphone traffic will exceed PC (personal computer) traffic by 2021.
Traffic from wireless and mobile devices will account for more than 63% of total IP traffic by 2021.
- The number of devices connected to IP networks will be three times as high as the global population in 2021.
From these statistics, it’s easy to see that our world continues to become more and more connected, at all times and in all places. Data consumption continues to increase exponentially. In order to meet the rising demand, networks need to be continuously upgraded and wireless carriers will continue to need additional fiber backhaul. Uniti can provide all of these services to a growing market.
Increased Utilization of Existing Cell Towers
With data usage at a global high and expected to continue growing at a rapid pace, existing cell towers can be viewed somewhat as a “goldmine”. This is due to many existing towers leasing to multiple carriers/services, and as these assets depreciate their utilization only increases, making these towers very profitable. This effect is compounded in regions where regulation prohibits or impedes the construction of new cell towers, leading to even heavier utilization of existing towers.
Interest Coverage and Liquidity
Interest coverage is of paramount importance to bondholders as it measures an issuer’s ability to service its debt. While Uniti’s interest coverage is not as robust as some of the other issuers we have profiled, the company continues to meet its debt obligations. For Q2, Uniti had operating income (without non-cash depreciation charge) of $86.2 million and interest expense of 75.1 million for an interest coverage ratio of 1.2x.
Uniti showed an unusually high level of cash at the end of Q2 of $934 million, but most of this was in the process of being redirected for the recent acquisitions of Southern Light and Hunt Telecom. After accounting for the cash for acquisitions, the company had $172 million in cash and an additional $515 million undrawn on its revolving credit agreement.
The risk for bondholders is somewhat tied to the outcome of the challenge to Windstream as well as Uniti’s ability to continue to build out and diversify its revenue streams away from its Windstream lease. At a recent industry conference, Uniti’s CFO Mark Wallace said that within two years, non-Windstream revenues are projected to be 50% of total revenues. The earlier discussion in this article outlines the possibilities for Windstream, and by relation, the possible outcomes for Uniti. Uniti owns the hard assets which have tremendous value, either to Windstream, or in their absence, another telecom provider. The markets have, seemingly, already passed judgement on both companies, with adverse effects on both stocks and bonds. There is still value in Uniti, with or without Windstream. In light of this, the 9.5% yield-to-maturity currently offered on Uniti’s 2023 bonds appears to outweigh the risks identified.
Summary and Conclusion
There is no question that Uniti and Windstream are intricately linked. The markets have reacted accordingly to the challenge presented to Windstream from one of its bond investors. However, with Uniti as owner / landlord and Windstream as tenant in this scenario, Uniti will still emerge from whatever outcome with the hard assets intact. Just as a landlord can re-lease his property, Uniti can re-lease its networks to another competitor looking to increase its market share. If Windstream continues in any capacity, it will need access to Uniti’s networks to continue to operate. Consequently, we think Uniti’s 2023 bonds will provide investors with good cash flow, superior yields, and excellent diversification into the telecom industry. Therefore, we have marked these 9.5% yield-to-maturity notes for addition to our FX2 managed income portfolios, the averaged benchmarked performance of which is shown above.
Issuer: Uniti / CSL Capital
Bond Coupon: 8.250%
Yield to Maturity: ~9.48%
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Disclosure: Durig and certain clients may have positions in Uniti 2023 bonds.
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