October 20, 2017 / 2:44 PM / a year ago

Fitch Maintains Windstream's IDR and Related Issue Ratings on Rating Watch Negative

(The following statement was released by the rating agency) CHICAGO, October 20 (Fitch) Fitch Ratings has maintained the Long-Term Issuer Default Ratings (IDRs) and issue ratings of Windstream Services, LLC and its subsidiary, Windstream Holdings of the Midwest, Inc. (WHM) on Rating Watch Negative following the company's announcement of debt-exchange offers. A full list of rating actions follows at the end of this release. Fitch does not consider the proposed debt exchange as a distressed debt exchange (DDE), since the offers do not result in a material reduction in the terms compared with the original contractual terms on the offered notes. The new 6 3/8 notes will be exchanged at a premium that more than offsets the reduction in coupon. The exchange for the new 8.625% secured notes is at a discount but is accompanied by a higher coupon rate and a higher ranking in priority of payments within the capital structure. On Oct. 18, 2017, Windstream announced certain debt offers and consent solicitations with respect to the company's 7.75% senior notes maturing in 2020 (the 2020 notes), 7.75% senior notes maturing in 2021 (the 2021 notes), 7.5% senior notes maturing 2022 (the 2022 notes) and 7.5% senior notes maturing in 2023 (the 2023 notes). The 2022 notes and 2023 notes are offered in exchange for the new 6 3/8% notes maturing in 2023. The offer for the 2021 notes provides an option to exchange for new 6 3/8% notes or new 8.625% senior secured notes, subject to certain conditions. The 2020 notes are offered in exchange for the new 8.625% senior secured notes, subject to a cap of $50 million on the aggregate amount issued in exchange for 2020 notes. Fitch's Distressed Debt Exchange Rating Criteria provides that a debt restructuring is classified as a DDE when both the following conditions apply: the restructuring imposes a material reduction in terms compared with the original contractual terms; and the restructuring or exchange is conducted to avoid bankruptcy, similar insolvency or intervention proceedings, or a traditional payment default. Windstream has also solicited consents from holders of the aforesaid notes for waiver of the alleged defaults with respect to spin-off transactions with Uniti Group, Inc. and amend indentures governing these notes to give effect to such waivers and amendments. Fitch placed Windstream on Rating Watch Negative on Sept. 27, 2017 in connection with the receipt of the notice of default. Windstream is defending the allegations and has filed a legal proceeding on the matter. Fitch will resolve the Negative Watch following the resolution of the pending litigation and conclusion of the debt-exchange offer. KEY RATING DRIVERS Near-Term Pressures: 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. The company has experienced some pressure in the wholesale segment, as well as the small/medium business competitive local exchange carrier 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 for 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/EBITDA will be 5.8x in 2017, including the EarthLink merger and Broadview acquisition. Fitch expects total adjusted debt/EBITDA will decline to around mid-5x by the end of 2018 as cost synergies are realized from both transactions and remain relatively flat over the remainder of the forecast horizon. 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, cost savings are gradually expected to be realized by IT and billing systems. DERIVATION SUMMARY Windstream has a weaker competitive position based on scale and size of its operations in the higher-margin enterprise market. 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 third quarter 2017 (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 volatile 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 affect the rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --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%-23%, including the annual rental payment as an operating expense. Fitch expects EBITDA margins to expand by roughly 100bps 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/EBITDA will decline from 5.8x at year-end 2017 to around 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 Positive Rating Action --The company sustains total adjusted debt/EBITDAR under 5.5x. Fitch has revised the negative leverage threshold down 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 on 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. --Any negative developments related to the outcome of the receipt of notice of default. 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. The 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, when they total $769 million, including $750 million outstanding on the revolver at June 30, 2017. Fitch estimates 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 maintains the following ratings on Rating Watch Negative: Windstream Services, LLC --Long-Term IDR 'BB-'; --$1.25 billion senior secured revolving credit facility due 2020 'BB+/RR1'; --Senior secured term loans 'BB+/RR1'; --Senior unsecured notes 'BB-/RR4'. Windstream Holdings of the Midwest, Inc. --Long-Term IDR 'BB-'; --$100 million secured notes due 2028 'BB-/RR4'. Contact: Primary Analyst Salonie Sehgal Associate Director +1-312-368-3137 Fitch Ratings, Inc. 70 W. Madison St. 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. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Distressed Debt Exchange Rating Criteria (pub. 13 Jun 2017) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Parent and Subsidiary Rating Linkage (pub. 31 Aug 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. 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