Source: Windstream.
Windstream Holdings (WIN +0.00%) missed Wall Street's earnings targets by a slim margin in the third quarter with sales flat year-over-year. That's not a terrific combination if you want to impress investors. Share prices fell nearly 10% in the three days following the release and have hardly recovered in the four weeks since then.
But numbers rarely tell the whole story about a business as complex as Windstream's. Alongside the disappointing earnings report, Windstream's management sat down for a phone conference with analysts to dig deeper into what's happening at the company. Here are five things Windstream's management wanted to tell investors that day, giving us a far more nuanced view of the current state of affairs. Let's start with some insights on the pending REIT spin-off.
This REIT conversion isn't about lower taxes
The primary motivation for becoming a real estate investment trust is to lower tax payments. Data security veteran Iron Mountain, for example, used to pay effective tax rates of more than 30%, sometimes spiking above the 50% mark. Then it converted into a REIT structure at the start of fiscal 2014, and now management aims to hold effective tax payments at roughly 15% of pre-tax income for the foreseeable future.
But Windstream marches to a different tune.
"We found opportunities to improve our cash taxes which we now expect to be less than $15 million in 2014," said Windstream CFO Tony Thomas after the second quarter report. Four months later, the picture firmed up even further.
"Cash taxes [for fiscal year 2014] are now expected to be less than $10 million," said interim CFO Bob Gunderman during the third quarter phone conference.
For a company reporting more than $250 million in quarterly free cash flows on sales of $1.4 billion, that's already a very low tax cost. Remember, these are pre-REIT numbers, not the post-conversion plan.
In fact, the REIT transaction won't make much of a difference to Windstream's total tax bills. As Thomas noted later in the call, "the tax savings are only 49%." That's much less than the roughly 70% effective tax cut Iron Mountain enjoyed and not a significant line item on Windstream's income statement either way.
Windstream CEO Jeff Gardner. Source: Windstream.
The real reason to go REIT
If not for tax reasons, why is Windstream taking the trouble to create a brand new REIT, which will hold most of the company's networking assets while trading under a separate (as yet unnamed) ticker?
"Windstream's strategy remains focused on providing advanced communication services to business, and this transaction better positions Windstream to improve its competitive position and accelerate its growth," said Windstream CEO Jeff Gardner. "The REIT will produce strong, stable cash flows, supportive of an attractive dividend while providing the opportunity to grow and diversify over time ... Given the compelling consumer benefits resulting from increased network investment, combined with a meaningful decrease in Windstream's outstanding debt, we are confident that we will receive all necessary approvals."
Gardner hopes to unlock competitive advantages by splitting his company into two distinct parts, allowing each entity to focus on its respective core business. The networking and service asset reserves should benefit from stronger separation.
But wait -- there's more!
So what's changing, then?
Later on during the conference, Gardner explained:
First, you've got to remember that we are not giving up any control of our network with this transaction. We are running our network, we're engineering our network the very same way that we do today. So in terms of -- it's not going to be any -- it's not going to factor in to our strategy about how we run our business or serve our customers. Our technicians are going to continue to run that network, and there'll be no change from our customers' perspective. Why we chose to do it as a spinoff was more about shareholders and the ability to provide shareholders the full access to realize value creation from that.
As we can see, the REIT transaction won't change much from a Windstream customer's perspective. The move is more about serving investors better -- meaning both shareholders and creditors. It's really about increasing transparency into how money flows through the two asset classes and giving investors the opportunity to focus on the Windstream operation that better fits their portfolio.
Mixing up the recipe
In other news, Windstream is reshaping its business mix.
"Enterprise locations grew by 3.6% and average revenue per business customer grew by 10%," Gunderman said. "We are successfully moving up-market by focusing on solutions that combine our data and voice transport and networking capabilities with higher-value offerings such as managed and hosted services."
Meanwhile, small business customers are signing off from Windstream's services and consumer sales are flat year-over-year. Windstream is reaching for higher-margin enterprise customers with large data needs and matching budgets, at the cost of sacrificing smaller and less profitable accounts.
The road ahead
At the end of the call, Gardner signed off with this flourish:
We continue to see healthy demand for our broad suite of enterprise services and are well positioned in growth areas such as: Internet Protocol, next-generation data, multi-protocol label switching, Unified Communications, data center and cloud services, with well-established offerings in each area. In addition, we're seeing solid and improving results in our consumer channel. We believe that this progress, in combination with the REIT spin-off and other strategic initiatives that we are pursuing, will continue to increase shareholder value over time.
Gardner focused on next-generation data services and more efficient infrastructure technologies, saying nothing about improved consumer products. It appears Windstream has found its true calling in high-end corporate clients and will continue to drive toward that target market.
All things considered, I like where Windstream currently stands. As detailed above, the company is working hard to redefine its core markets, while unlocking additional value through an innovative REIT reorganization that isn't all about reducing taxes. For these reasons, alongside an overdone share price correction, I recently tapped Windstream as one of the top stocks to buy in December.
