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Fitch Affirms Windstream's IDR at 'BB-'; Outlook Revised to Negative
August 18, 2017 / 2:49 PM / in 2 months

Fitch Affirms Windstream's IDR at 'BB-'; Outlook Revised to Negative

(The following statement was released by the rating agency) NEW YORK, August 18 (Fitch) Fitch Ratings has affirmed the 'BB-' Long-Term Issuer Default Ratings (IDRs) of Windstream Services, LLC and its subsidiary Windstream Holdings of the Midwest, Inc. The Rating Outlook is revised to Negative from Stable. A complete list of rating actions follows at the end of this release. Windstream had approximately $5.6 billion of debt outstanding as of June 30, 2017. The Negative Outlook reflects slower-than-anticipated revenue and EBITDA stabilization for Windstream versus previous expectations. Fitch had expected Windstream to return to revenue growth in 2019, excluding the EarthLink merger and Broadview acquisition (the transactions). While Fitch expects cost synergies from the transactions to drive EBITDA stabilization by the end of the forecast, we do not expect revenue to return to growth over the forecast horizon. The slower path to revenue growth is mainly attributable to headwinds in the legacy businesses, including those acquired from EarthLink and Broadview. Fitch has revised its negative rating sensitivity for adjusted leverage to 5.5x from 5.7x-5.8x to reflect the challenging competitive and business environment, which, in turn, has led to continued delays in the return to revenue and EBITDA stability. Fitch expects total adjusted debt/EBITDAR will decline to the mid-5x range by the end of 2018 as cost synergies are realized from both transactions and will remain relatively flat over the remainder of the forecast horizon. We believe the enhanced financial flexibility provided by the elimination of Windstream's dividend (net of cash used towards the $90 million share repurchase program) serves as an additional avenue for modest deleveraging. KEY RATING DRIVERS Near-Term Pressures The company has experienced some pressure in the wholesale and CLEC segments as a result of competition and declining legacy services. Excluding the transactions, Windstream experienced a decline of 3.4% in service revenue in 2016. Sequential revenues have been relatively stable in the ILEC consumer and small/medium business segment, and the enterprise segment. Including the transactions, Fitch's base case assumes organic revenues continue to decline over the forecast horizon, albeit at a slowing pace. Revenue Mix Changes Windstream derives approximately two-thirds of its revenue 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 will be 5.8x in 2017, including both transactions. Fitch expects total adjusted debt/EBITDAR will decline to the mid-5x range by the end of 2018 as cost synergies are realized from both transactions and will remain relatively flat over the remainder of the forecast horizon. The enhanced financial flexibility provided by the elimination of Windstream's dividend (net of cash used for share repurchases) serves as an additional avenue for modest deleveraging. In calculating total adjusted debt, Fitch applies an 8x multiple to the sum of the annual rental payment to Uniti Group Inc. plus other rental expenses. Cost Synergies Support EBITDA Stabilization Windstream anticipates realizing more than $180 million of annual run-rate synergies three years after the close of the EarthLink merger and Broadview Networks acquisition (the transactions): $155 million in operating cost savings and $25 million in capital spending savings. Windstream expects to realize $115 million in operating cost synergies after two years following the transactions, with roughly $40 million-$50 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 transactions. Integration Key to Success Fitch believes there are potential execution risks to achieving the operating cost and capital expenditure synergies following the close of the transactions. 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, benefits are gradually expected to be realized by IT and billing system cost savings. DERIVATION SUMMARY Windstream mainly targets small and mid-sized business (SMB) customers, and competes in a highly fragmented space with smaller and larger peers. Cable operators are increasingly focused on medium-sized businesses and compete against Windstream in the SMB segment. Cable operators can also target other larger regional customers, including governments and universities. Larger wireline operators typically focus on enterprise customers, slightly reducing the level of competition in the SMB market for Windstream. Windstream has a weaker competitive position in the higher-margin enterprise market based on the scale and size of its operations. Larger companies, including AT&T Inc. ('A-'/RWN), Verizon Communications Inc. ('A-'/Stable), and CenturyLink, Inc. ('BB+'/RWN), have an advantage with national or multinational companies given their extensive footprints in the U.S. and abroad. Fitch notes that CenturyLink will become the second largest enterprise service provider after it acquires Level 3 Communications, Inc. (LVLT; 'BB'/Stable), which is expected to close at the end of 3Q17. In comparison to Windstream, AT&T and Verizon maintain lower financial leverage, generate higher EBITDA margins and FCF, and have wireless offerings that provide more service diversification. Fitch also believes Windstream will have a weaker FCF profile than CenturyLink following the LVLT acquisition, as CenturyLink's FCF will benefit from enhanced scale and LVLT's net operating loss carryforwards. Windstream has less exposure to the more pressured residential market compared to its rural local exchange carrier (RLEC) peer, Frontier Communications Corp. ('B+'/Stable). Within the residential market, RLECs face wireless substitution and competition from cable operators with facilities-based triple-play offerings, including Comcast Corp. ('A-'/Stable) and Charter Communications Inc. (Fitch rates Charter's indirect subsidiary, CCO Holdings, LLC, 'BB+'/Stable). Cheaper alternative offerings such as Voice over Internet Protocol (VoIP) and over-the-top (OTT) video services provide additional challenges. RLECs have had modest success with bundling broadband and satellite video service offerings in response to these threats. As of year-end 2016, roughly 60% of Windstream's footprint overlapped with a national cable operator. No country-ceiling, parent/subsidiary or operating environment aspects impact the rating. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Windstream: --Revenue and EBITDA include the EarthLink merger as of Feb. 27, 2017 and the acquisition of Broadview on July 28, 2017. --Revenues total $5.9 billion and $6 billion in 2017 and 2018, respectively. Fitch expects organic revenue to continue to decline over the forecast horizon, albeit at a slowing pace. --2017 EBITDA margins are in the range of 22% to 23%, including the annual rental payment as an operating expense. Fitch expects EBITDA margins to expand by roughly 100 bps in 2018 as Windstream cost synergies are realized. --Fitch assumes Windstream will benefit from synergies post-acquisition, and has moderately reduced the amount of operating cost synergies from the $155 million anticipated by Windstream over the next three years. --Fitch expects total adjusted debt/EBITDAR will decline from 5.8x at year-end 2017 to the mid-5x range by the end of 2018 as cost synergies are realized from both transactions. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Stabilization of the Rating -The company sustains total adjusted debt/EBITDAR under 5.5x. Fitch has revised the negative adjusted leverage threshold to 5.5x from 5.7x-5.8x owing to the challenging competitive and business environment. -Revenues and EBITDA would need to stabilize on a sustained basis. -Fitch would also need to see progress by Windstream in executing the integration of its recent transactions prior to stabilizing the rating. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -A negative rating action could occur if total adjusted debt/EBITDAR is 5.5x or higher for a sustained period. -The company no longer makes progress toward revenue and EBITDA stability due to competitive and business conditions. LIQUIDITY The rating is supported by the liquidity provided by Windstream's $1.25 billion revolving credit facility (RCF). At June 30, 2017, approximately $475 million was available. Revolver availability was supplemented with $25 million in cash at the end of 2Q17. 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. Outside of annual term-loan amortization payments, Windstream does not have any material maturities until 2020. Maturities in 2020 total $1.5 billion, including $750 million outstanding on the revolver at June 30, 2017. Fitch believes that Windstream's announcement in August 2017 to eliminate its dividend provides enhanced financial flexibility. We estimate post-dividend FCF in 2017 will range from $0 to negative $50 million, including integration capex and $50 million of spending related to the completion of Project Excel. Fitch expects capital spending to return to normal levels in the 13%-15% range after 2017 and for the company to return to positive FCF in 2018, with FCF margins in the low single digits over the forecast. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Windstream Services, LLC --IDR at 'BB-'; --$1.25 billion senior secured revolving credit facility due 2020 at 'BB+/RR1'; --Senior secured term loans at 'BB+/RR1'; --Senior unsecured notes at 'BB-/RR4'. Windstream Holdings of the Midwest, Inc. --IDR at 'BB-'; --$100 million secured notes due 2028 at 'BB-/RR4'. The Rating Outlook is revised to Negative from Stable. Contact: Primary Analyst Constance 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 David Peterson Senior Director +1-312-368-3177 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'. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. 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