Windstream’s Fiber & Copper REIT

I’m just fascinated by this move by Windstream (articles from Bloomberg and WSJ) to spin off their physical network assets into a new entity.  Windstream is taking their fiber and copper assets and reclassifying them as real estate and spinning them off, raising some cash to pay down their mountain of debt and improve their cash flow.

While the press is up in arms about this move as some more of corporate America’s tax chicanery (New York Times with the outrage and the retort by Forbes), I think there is a more interesting aspect of this, at least from a telecom cost perspective.  If more telecom companies follow suit, bandwidth truly becomes a commodity, sold as white label bandwidth in bulk to carriers and put into corporate structures that resemble utilities or resource extraction LLPs. It is interesting to note that the Windstream spin-off will have a total of 25 employees running a $650M a year operation – similar in staffing to a REIT managing apartments, or a natural gas pipeline.

The end result could be less pressure from the likes of Verizon and AT&T to throttle bandwidth from companies like Netflix, helping the Net Neutrality cause. I say this because if the carriers are simply leasing white label bandwidth from a telecom REIT or REITs, they may not need to worry as much about spare capacity, peak load times, or intercity routing when pricing services for customers. Similarly, the barrier to entry for new carriers is lowered even further, as you just need to cut a check instead of lay miles of fiber to get in the game, putting further pressure on pricing and on carriers to differentiate their offerings to deliver value to their customers.

For our business customers, this financial maneuver signals that telecom costs will continue their downward slide.

Two CLECs, One Cup of Consolidation

Industry consolidation continues as another player is snapped up.  tw telecom purchase price of $5.7B as reported by the NYT, who capitalized the spelling of ‘tw telecom’ like a bunch of barbarians.

As tw telecom is a Local Exchange Carrier in the grand tradition of ye olde AT&T and Verizon, (the cable TV and internet assets stayed with TimeWarner Cable in the spinoff), we won’t be seeing anything too radical come out of this merger such as a combination of cable and telephone network connections in a billing package.

Level3 is better at long haul internet and companies with large, distributed footprints, and tw telecom is in the trenches providing smaller companies with phone and internet service in US cities. If you were with Level3 for a corporate internet and WAN plan, maybe you can get a more consistent menu of services across locations with tw telecom provisioning in the future. If you were with tw telecom, you were probably too small to care about Level3 getting you MPLS connectivity across an ocean.

On a personal/anecdotal note, we like Level3’s responsiveness when we worked with them on a 60+ location telco rollout, and we find that tw telecom’s local sales and service staff are very polished and responsive.  In our home market of SoCal, we bump into tw telecom more than we do Level3, which is the local/national split that is going to result in oodles of synergy as per this Marketwatch article.

Now, some random comments on the numbers.

  • So total EBITDA will increase by $200M from synergy. tw telecom currently makes $125M a quarter in EBITDA ($500M/yr).  So 11x earnings (8x earnings counting synergy) and assumption of $2B in debt. Level3 loses money every year.
  • tw telecom net income is $36M on $1,560M in revenue in 2013. 2.3% margin. That is pretty stellar in telecom. Again, Level3 loses money every year.
  • Combined market share is 6% per the WSJ. Not bad, but still small in a commodity business with shrinking margins.
  • Level3 says they can cut costs by $2.2B in the WSJ article… not sure if that is over 10-11 years to get your $200M/yr savings number or if we have very different stats popping up. Level3 is spending on average $699M on interest expenses on its own debt.
  • WSJ says that savings on cross-connect fees is the big win here, where Level3 won’t have to farm out local connections as often if they own a CLEC like tw telecom. I’d think tw telecom’s fiber rollout is another huge part of this, as they can offer end-to-end fiber that would be a real differentiator over other carriers that are making a network of copper and fiber connections.
  • Level3 CFO has said corporate data prices have stabilized.  Interesting, but we think fiber rollouts will keep putting downward pressure on data prices. Maybe not so much at the league Level3 plays in, though I would think those are the smartest, toughest customers.
  • Important to note again that Level3 does not really make any money. At least not Net Income by GAAP standards.  In terms of cash flow, they are all over the place.
  • The budget for R&D for both companies is zero.  Not one penny put into research. In case you were wondering if they are utilities or high tech companies.
  • Looking at Level3’s balance sheet, you have $8b in debt offset by $8b in property. This explains why anyone would lend them money, I suppose. The new entity will have $10B in debt and $800M in interest payments a year assuming things hold steady.

If I was looking at either company, I might be a little nervous, because sometimes mergers in telecom are messy.  That said, there is not all that much overlap with these two, at least in our market. Who knows, maybe Level3 will benefit from working with a more efficient operator.