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Fitch Rates Windstream's New Term Loan 'BB+/RR1'; Outlook Stable
February 21, 2017 / 7:41 PM / 10 months ago

Fitch Rates Windstream's New Term Loan 'BB+/RR1'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, February 21 (Fitch) Fitch Ratings has assigned a 'BB+/RR1' rating to Windstream Service, LLC's (Windstream; NASDAQ: WIN) issuance of $580 million of senior secured term loans due 2024. Term loan proceeds were used to repay the $572 million amount outstanding under its senior secured tranche B5 term loan due 2019. Windstream's Issuer Default Rating (IDR) is 'BB-', and the Rating Outlook is Stable. KEY RATING DRIVERS Merger with EarthLink: Windstream reached an agreement to merge with EarthLink Holdings Corp. (EarthLink) in an all-stock transaction with a total value, including debt, of approximately $1.1 billion. Windstream will refinance approximately $436 million of EarthLink's outstanding debt with $450 million of incremental senior secured tranche B6 term loans that will be drawn at the transaction's close. Fitch expects EarthLink to become a guarantor of Windstream's credit facilities and senior unsecured notes. The transaction is expected to close in the first half of 2017, following customary shareholder and regulatory approvals. Windstream anticipates realizing more than $125 million of annual run-rate synergies three years after the close of the merger: $110 million in operating cost savings and $15 million in capital spending savings. Windstream expects to realize $50 million in synergies in each of the first two years following the merger, with the remaining $25 million to be realized by the end of year three. In its base case assumptions for Windstream, Fitch has assumed moderately lower cost savings in each of the three years following the merger. Windstream also expects to benefit from net operating loss carryforwards that are estimated to have a net present value of approximately $95 million at the close of the transaction. Fitch believes there are strategic benefits to the transaction, with both companies focused on growing their enterprise services business. The combined network of the company will consist of approximately 145,000 route miles of fiber, positioning the company as one of the largest network providers in the U.S. Fitch believes there are potential execution risks to achieving the operating cost and capital expenditure synergies following the close of the merger. Initial savings are expected to be realized from reduced selling, general and administrative savings as corporate overheads and other public company cost savings arise. Over time, the company is expected to realize the benefits of lower network access costs as on-network opportunities lower third-party network access costs. Finally, cost savings are gradually expected to be realized by IT and billing system cost savings. In Fitch's view, the transaction is beneficial to Windstream's credit profile, as the transaction will reduce the company's leverage modestly following the close of the transaction, with further potential improvements arising as synergies are realized. Synergies are also expected to contribute to an improving FCF profile in 2017 and beyond. Near-Term Pressures: In the first nine months of 2016, Windstream experienced a decline of less than 3% in adjusted service revenue (adjusted for disposed businesses). Since the beginning of the year, sequential revenues have been relatively stable in the consumer and small/medium business segment, and the enterprise segment. The company has experienced some pressure in the wholesale segment, as well as the small/medium business competitive local exchange carrier segment. Fitch's base case (excluding the EarthLink acquisition) assumes EBITDAR returns to growth in 2018 and revenue growth turns positive in 2019. Revenue Mix Changes: Windstream derives approximately two-thirds of its revenues from enterprise services, consumer high-speed internet services and its carrier customers (core and wholesale), which all have growing or stable prospects in the long term. Certain legacy revenues remain pressured, but Windstream's revenues should stabilize gradually as legacy revenues dwindle in the mix. Leverage Metrics: Fitch estimates total adjusted debt/EBITDAR was approximately 5.4x in 2016 and will be 5.1x in 2017. Fitch's estimates include the debt reduction associated with the June 2016 monetization of Windstream's remaining 19.6% stake in Communications Sales & Leasing (CSAL) via two debt-for-equity exchanges. The disposition of shares retired approximately $672 million in debt. In calculating total adjusted debt, Fitch applies an 8x multiple to the sum of the annual rental payment to CSAL plus other rental expenses. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for the issuer include: --In 2016, Fitch estimates service revenues were approximately the mid-point of Windstream's guidance of $5.275 billion to $5.425 billion. Fitch assumes revenues decline in the 1% to 2% range in 2017, with revenues flat in 2018. --2017 EBITDA margins are in the range of 23% to 24%, including the annual rental payment as an operating expense. --Fitch assumes capital spending in 2016 was in line with company guidance ranging from $1 billion to $1.05 billion, including $200 million for Project Excel. Cash taxes are not expected to be material. Capital intensity is expected to range from 15%-16% in 2017, including Connect America Fund II spending and a partial-year amount for EarthLink at the low end of its 2016 capital expenditure guidance (no guidance has been provided for 2017). --The EarthLink acquisition closes July 1, 2017 and that EarthLink's revenues and EBITDA continued to be pressured in 2017 before stabilizing in 2018. Fitch assumes Windstream will benefit from synergies post-acquisition, and has moderately reduced the amount of operating cost synergies from the $110 million anticipated by Windstream and that it will be achieved over a three-year period. Windstream estimates the cost to achieve synergies will total $125 million, and Fitch has assumed approximately $75 million in 2017 and $50 million in 2018. RATING SENSITIVITIES Positive Trigger: A positive action could occur if total adjusted debt/EBITDAR, which will be used as the primary metric, is sustainable under 5.2x to 5.3x. Additionally, revenues and EBITDA would need to stabilize or demonstrate a return to growth on a sustained basis. Fitch would also need to see progress on execution of the integration of the two companies prior to taking a positive rating action. Negative Trigger: A negative rating action could occur if total adjusted debt/EBITDAR is 5.7x to 5.8x or higher for a sustained period, or if competitive and business conditions were such that the company no longer makes progress toward revenue and EBITDA stability. LIQUIDITY The rating is supported by the liquidity provided by Windstream's $1.25 billion revolving credit facility (RCF). At Sept. 30, 2016, approximately $601 million was available. The revolver availability was supplemented with $61 million in cash at the end of 3Q16. The $1.25 billion senior secured RCF is in place until April 2020. Principal financial covenants in Windstream's secured credit facilities require a minimum interest coverage ratio of 2.75x and a maximum leverage ratio of 4.5x. The dividend is limited to the sum of excess FCF and net cash equity issuance proceeds subject to pro forma leverage of 4.5x or less. The new terms will refinance the $572 million of tranche B5 term loans maturing in 2019. As such, Windstream does not have any material maturities until 2020. In 2016, Fitch estimates post-dividend FCF ranged from negative $200 million to negative $250 million, including expected spending of $200 million in 2016 on Windstream's Project Excel. In 2017, Fitch expects capital spending to return to normal levels on the completion of Project Excel, and for the company to return to positive FCF in 2017, including the effect of the merger with EarthLink. Contact: Primary Analyst Connie McKay Associate Director +1-312-368-3148 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst John Culver, CFA Senior Director +1-312-368-3216 Committee Chairperson Bill Densmore Senior Director +1-312-368-3125 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Date of Relevant Rating Committee: Nov. 7, 2016 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Fitch has adjusted the financial statements to treat the communications network lease as an operating lease. On the income statement, the network lease has been added as rent expense and the interest associated with the lease was removed from interest expense. On the cash flow statement, rent expense was moved to 'Operating cash flows' from 'Financing cash flows'. Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers - Effective from 7 April 2016 to 21 November 2016 (pub. 05 Apr 2016) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. 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