Investor Alert: Is Windstream Holdings, Inc's Dividend About to Be Cut?

Windstream Holdings (WIN +0.00%) pays a tremendously generous dividend. At 12.3%, its yield is in fact the second-highest among the S&P 500's (^GSPC +0.80%) components.

But the company is heading into uncharted waters. Windstream is about to spin off its networking assets into a separately traded real estate investment trust, or REIT, structure. Which of course begs the question: will this be the end of Windstream's abundant dividend payouts?

The answer depends on how you approach the stock. Let's take a look at three important options.

Option 1: Hold your existing Windstream shares
This is a simple choice. Windstream's management has been pretty clear about what's going to happen under this scenario: The annual dividend payouts of $1 per share under the existing stock will shrink to $0.70 per share in 2015.

The share counts will change drastically. Existing shareholders will receive one REIT share for every four Windstream Holdings stock certificates. Furthermore, there will be a reverse stock split, splicing Windstream's shares in a 6-for-1 ratio.

The exact share counts won't matter much, save for meeting the listing requirements of the major stock exchanges, but the dividend math will look very different.

The REIT stock will offer most of the new payouts. For each Windstream share you hold today, the REIT vehicle will pay dividends of $0.60 over the coming year. The other stock -- let's call it Windstream's service stock -- will drop its dividend policy all the way to $0.10 per current share. Translating these figures into post-split numbers, the REIT will pay $2.40 per share and the operating stock stop as $0.60 per share.

Despite all these accounting acrobatics, however, the dividend will indeed drop to $0.70 per current Windstream share. It's a 30% drop, which will reduce the effective yield by the same amount.

All things considered, the effective yield on Windstream shares bought today will drop to a still generous but far less impressive 8.4%. It'll still beat any savings account you'd care to mention, and I still think that Windstream is a valid and interesting investment under these circumstances.

Option 2: Wait and buy only the REIT stock
If you don't already own Windstream shares, or if you would like to change your exposure to the company once it splits in two, you'll soon be able to buy only the dividend-focused REIT.

The mechanics of this will depend on how the market actually reacts to the new pair of companies. Windstream's management has provided some estimates, tied to the operating company's plan to keep 20% ownership of the REIT and sell it all on the open market.

Assuming that these estimates are in the right ballpark, here's how the math works out after doing the reverse splits (sounds like a painful gymnastics routine) and everything else:

Data source: Windstream.

So waiting until later seems likely to give you a lower effective yield than buying Windstream before the split.

How is that possible? Well, you'll note that the two new market caps add up to $1 billion more than the current one. That's because Windstream will use this transaction to restructure its finances, retiring nearly half of its $8.6 billion long-term debt. Besides, investors are expected to prefer the flexibility of the new corporate setup, unlocking another chunk of additional value.

When you raise market values and share prices, dividend yields go down. And let's not forget that Windstream expects market prices on the operating stock to drop while the REIT should rise in value thanks to its generous payouts. All of that happens after the split but before you can get your hands on shares in the open market. That's why you'd end up with a higher effective yield by buying Windstream shares today and waiting for the split.

The third way
The REIT stock is likely to grow its dividends faster than the operating company over the long run. It's kind of what REITs do, and the asset-heavy structure of this new stock sets it up for exactly that kind of dividend-friendly future.

Still, I'd argue that income investors would be better off buying Windstream stock before the split rather than afterwards. You could always sell the operating stock, then turn around and invest that capital in more of the REIT stock.

Once again assuming that Windstream's own estimates are on target, here's what would happen if you had $10,000 to invest. With that, you could afford about 1,200 Windstream shares today, splitting into 200 Windstream Operations and 300 Windstream REIT shares. Sell the operating stock for $1,980 and buy 59 REIT shares for a grand total of 359 stubs.

This way, you'd receive $862 in dividend payments this year, up from the $840 you'd get from just holding on to both stocks. More importantly, you'd be much better off than simply buying the 300 REIT shares you'd be able to afford in market prices after the split. The additional deal value basically gives you another 59 share for free.

Of course, all of this goes up in smoke if Windstream's estimates are way off in left field. For those doing the math at home, the idea of buying shares now and rebalancing later makes more sense if share prices rise higher than expected on the REIT and/or stay lower on the other side of the equation.

But the people doing this analysis arguably know the business and its value better than anyone else, with additional input from the financial pros at Merrill Lynch, J.P Morgan, and privately held investment bank Stephens Inc. There's a decent chance that these post-split estimates are close to the mark. So I'm sticking to my numbers until proven wrong.