Regional telecom Windstream Holdings (WINMQ) has a lot going for it. Windstream is refocusing on business-grade services as its consumer sales fall away, and kicking out its networking assets into a real estate investment trust could unlock a far more flexible business model. And at 9%, Windstream offers the richest dividend yield among the entire S&P 500 (INDEX: INX) index.
Investors have been noticing these potential value drivers. Windstream shares have gained 39% year to date, which is more than five times the returns on the S&P 500 in 2014.
But it's not all wine and roses for Windstream and its investors. Let's consider the three biggest reasons why Windstream stock might reverse its positive momentum in the foreseeable future.
Don't forget that crushing debt load
Windstream offers one of the richest dividends around, but the company is extreme in another, far less flattering, respect: It's hard to find a public company that's deeper in debt than Windstream.
Windstream's long-term debt balance is 14.6 times larger than its stockholder equity. Going back to the S&P 500, that's the fourth-largest long-term debt to equity on the index. It's also far and away wider than the debt-to-equity ratios of other capital-intensive telecoms. Verizon's (VZ 0.90%) debt stops at 7.2 times its equity. Closer Windstream rivals CenturyLink (LUMN -0.76%), and Frontier Communications (FTR) are sitting pretty with debt-to-equity ratios of 1.3 and 2.0, respectively.
And it gets worse. Unlike its regional telecom peers, Windstream's debt ratio has skyrocketed in recent years, and still climbs higher in almost every quarterly report:
WIN Debt to Equity Ratio (Quarterly) data by YCharts
Verizon follows along in 2014 thanks to its huge $130 billion buyout of the Verizon Wireless joint venture. That deal rested on nearly $60 billion of fresh debt, which shows up as a hockey stick in these charts.
But short of that megadeal, Windstream stands head and shoulders above nearly any debt-riddled company you'd care to mention. Windstream is using cash flows to pay down its debt, but shareholder equity is actually shrinking even faster.
Can Windstream really afford that super-rich dividend?
For those playing along at home, you'll note that Windstream offers a fantastic dividend yield -- but no dividend growth to speak of.
Windstream's quarterly dividend has stayed put at $0.25 per share since 2007. That's 32 payouts in a row of exactly the same size. Ask any income investor, and you'll get an earful about how dividends are supposed to grow over time. That's kind of what makes the long-term magic happen. And Windstream just doesn't deliver on that income-generating promise.
On the upside, Windstream's payouts also held steady while Frontier and CenturyLink slashed their dividends in recent years. Avoiding that cardinal sin is helpful. Still, dividend investors really prefer to see dependable payout growth.
WIN Free Cash Flow (TTM) data by YCharts
Windstream really needs that REIT restructuring to happen
All of the above boils down to one simple and quite chilling conclusion.
Windstream's REIT restructuring plan isn't just a good idea. It's pretty much a requirement.
Investors love the REIT idea because it sets nearly half of those massive debt loads aside in one company while operations go to the other side. "This transaction will make Windstream a more nimble competitor in today's increasingly dynamic communications marketplace and accelerate deployment of advanced communications services," said Windstream CEO Jeff Gardner when the REIT spin-off was first announced.
Take these effects away, and Windstream gets backed into a corner.
Suffocating under its own weight, Windstream would have to consider other exit strategies. The company might merge with Frontier or CenturyLink in a pure cost-cutting move. Or private equity investors could take the company private at a large discount to current prices, renegotiate or even cancel its largest bond issues, and then sell Windstream for parts like a stolen car.
The best outcome is most certainly the REIT transaction. But Windstream hasn't quite collected all the go-ahead notes it needs from regulators, investors, and telecom industry bodies. Until that happens, you can think of this catalyst as a Sword of Damocles hanging over Windstream's head until the REIT transformation gets its final signature.
