To briefly recap, Windstream is a provider of wired telephone and DSL Internet services. Its primary markets are the rural areas in the southern and southwestern United States. It was formed in 2006 by the merger of the fixed line business of Alltel with Valor Communications. Like many telecommunication companies, Windstream offers a bundle of services that include local and long-distance calling, broadband Internet access as well as cable television. The fixed line business has generally been affected by a combination of competing technologies such as mobile phones and voice-over-Internet-protocol (Voip). In addition, the major cable TV companies such as Comcast and Time Warner are competing to provide households with broadband Internet services. Because of the predominantly rural market which Windstream service and which is traditionally slow to adapt to new technology, Windstream has been relatively sheltered from these threats so far.
The telecommunication industry in the U.S. is highly competitive and dominated by the three major players, namely AT&T (T), Sprint-Nextel (S) and Verizon (VZ) which cumulatively account for a little less than a third of the total revenues in the business. There are a host of smaller regional players who are competing fiercely for business and using innovation and a redefinition of the role of telecommunications to grab market share from the more established players. Windstream is a midcap regional telecommunications company with a market cap of just under $7 billion that offers yield investors a great investment opportunity because the dividend payout of $1 works out to a yield of well over 8% based on current market prices. Now the dividend has been held steady since 2006, it remains to be seen whether the dividend can be held at the current level without being forced to reduce unless the company is able to generate substantial additional revenues. The company has shown a year-on year revenue growth of over 23% which is substantially higher than both AT&T and Verizon. Sprint Nextel has shown negative earnings and is expected to show losses again in the year 2012.
In an attempt to broaden the scope of services, diversify its sources of revenue, and stay ahead of its more established rivals, Windstream has made several clever acquisitions such as D&E Communications, Iowa Telecom, NuVox, Lexcom, Kentuck Data Link and Norlight. The $2.3 billion takeover of Paetec last year is expected to add around $2 billion yearly in revenues and the net effect of all these acquisitions will mean that almost 70% of Windstream revenues will come from services that are not based on landlines. The Paetec acquisition is also expected to result in significant tax breaks because of the losses carried forward on its books. Cost savings from this acquisition are expected to be in the region of $100 million every year. All of these moves have a Windstream in a strong position to cope with the inevitable decline of landline revenues. In addition, I expect that the economies of scale and the cost synergies that will accrue when these acquisitions have been fully integrated and go a long way in rationalizing the cost structure of the company. Windstream also expects to incur capital expenditure of around $1 billion in the current fiscal to continue to improve its technology base.
A major focus area for Windstream and where it is well ahead of its competitors has been in the high-growth potential area of cloud computing. Its expansion in the cloud computing space has been innovative and aggressive and big bets have been placed on the business potential with the acquisition in particular of Norlight and Hosted Solutions. Other telecommunication companies have been much slower in making their moves in cloud computing and are only now getting themselves ready for these services. The strategy of shifting from traditional telecom services to the newer technologies make a lot of sense to me because of the better margins and revenues that premier value-added services should hopefully provide.
The Windstream acquisition spree has had its impact on the financial position of the company. On the positive side, the net worth of the company has increased sharply over the last year and the generation of operating cash flows should also increase substantially when the acquisition synergies are fully realized. However, on the negative side, the acquisitions have led to a substantial debt burden which is currently around $9 billion and has led to at least one credit rating agency downgrading the credit rating of Windstream recently. To be fair, I should tell you that more than 50% of this debt is not due for repayment until 2017 which gives the company plenty of elbow room to generate the cash for debt servicing. The company is also looking seriously at debt rescheduling options to minimize the impact on business operations.
Despite the dividend yield, which may or may not last, Windstream should essentially be regarded as a speculative play on new technology and its ability to satisfy subscribers. If cloud computing turns out to be as big as many people think, investors in Windstream could profit handsomely. However, it will take time for the company to execute that strategy and integrate its acquisitions and it is quite likely that you may see sharp gyrations in the stock price for the next couple of years. You will need to be a long-term investor with lots of patience to remain invested in the company's stock. An area of focus will continue to remain the predominantly rural nature of the company's markets because of the regulations (both state and Federal Communications Commission (FCC)) that could limit the pricing to customers. If you have an existing investment, I would recommend a hold without adding to the investment until it becomes clear how the diversification strategy is playing out.