Windstream (WIN) recently announced that a bondholder of the 6.375% notes due 2023 has submitted a written claim that WIN has defaulted. This claim was based on allegations that the spinoff of CSAL, now Uniti Group (UNIT), violated the terms of the note which restrict the conditions in which WIN can perform a sale and leaseback transaction.
Shares of both stocks are down materially on the news (intraday 9/26/17).
First of all, let me confess to being a layman on legal issues. I am a REIT analyst, not a lawyer so there could be subtleties that I am missing which could affect the outcome of this litigation. Throughout our analysis, I will provide links to the referenced documents so perhaps someone with a better legal mind can catch on and share with other readers if I have made any errors.
This article will be from the perspective of someone who is long UNIT, so it will be more focused on the indirect implications for Uniti rather than the direct implications for WIN.
While the press release leaves the bondholder anonymous, we are fairly confident it is Aurelius Capital, a hedge fund known for buying distressed debt and trying to extract value through litigation. Our evidence for this identification is based on management’s pre-emptive response upon Aurelius obtaining a position in the note in question.
Allegations and defense
Windstream has responded to the allegations with claims of debt covenant compliance. Specifically, they say
“The transactions did not constitute a Sale and Leaseback Transaction, and the Company asserts no default occurred”
I actually disagree with Windstream here. The language set forth in the document (8-K) which details the terms of the notes is sufficiently vague that I think the spinoff would be considered a sale and leaseback transaction. Here is the language used:
“ Sale and Leaseback Transaction means, with respect to any Person, any transaction involving any of the assets or properties of such Person whether now owned or hereafter acquired, whereby such Person sells or otherwise transfers such assets or properties and then or thereafter leases such assets or properties or any part thereof or any other assets or properties which such Person intends to use for substantially the same purpose or purposes as the assets or properties sold or transferred.”
Since it was a spin-off, WIN did not technically sell the assets, but I think it would count as assets being ‘otherwise transferred’. Thus, I think WIN is wrong in suggesting it was not a sale and leaseback.
That being said, a sale and leaseback does not automatically constitute a default on the note as the same 8-K details the conditions in which a sale and leaseback is ok. We have pasted the language below.
Section 4.09 stipulates that it cannot cause debt to be greater than 4.5 to 1. This was not violated at the time of the spin-off and in fact, even now that WIN is distressed, debt is still not greater than 4.5 to 1. Since no liens were incurred as a result of the spin-off, I think I-B is passed as well.
Fair market value is sufficiently subjective that WIN should be able to defend this if it goes to court. Finally, WIN passes criteria III as the proceeds of sale from the retained UNIT stock went largely to paying down debt and/or buying replacement assets like Broadview.
While I do think the spinoff would have counted as a sale and leaseback transaction, I think it passed the criteria for the type of sale and leaseback transaction that would be allowed under the stipulated note covenants.
Some of this legal language has room for interpretation and I am not the sharpest instrument for the job, so although I think WIN is safe from this litigation, please take my opinion with a grain of salt. I am comforted, however, to know that a couple of professional legal teams seem to agree with me. According to Debtwire, WIN’s corporate counsel, Skadden Arps, has reaffirmed that the spin-off was kosher regarding debt covenants. WIN hired a second unnamed legal team to come in and review the situation and this second team had the same conclusion.
Both of these legal reviews took place in the days and weeks before the letter from Aurelius, so I suspect that given the hedge fund’s reputation, WIN saw the letter coming and built their legal defense early as soon as Aurelius was known as an investor in the bond.
What if I’m wrong?
I find it useful to also explore what could happen in the event that I am wrong and Aurelius succeeds in declaring a default. Essentially what would happen is it would accelerate the 2023 maturity to the near term. The bond in question is the 6.38% coupon shown below.
I do not think WIN would struggle to pay the 2023 debt, but with the $ 586mm coming due now instead of in 2023, it would become significantly more difficult for WIN to service its $ 700mm coming due in 2020.
If this happens, I think WIN will be relying on asset sales to pay the debt wall, so its fate would rely on being able to get a good price. Infrastructure assets are in high demand right now so that bodes well for them, but the buyers may sense the urgency in WIN which could hurt its negotiating power.
While unlikely, I think it is plausible that WIN could be sent into chapter 11 bankruptcy at the 2020 maturity if the 2023 has to be paid before then.
What does this mean for UNIT?
UNIT’s lease is senior to the senior debt and as a master lease would be assumed or rejected in its entirety in the bankruptcy court. Thus, the fate of the lease payments rests in the mission-critical nature of the assets. At this point, WIN is highly dependent on the fiber owned by UNIT for its revenues, so we suspect the debtors would choose to honor the lease in order to keep the revenues flowing.
Something to keep an eye on is how much WIN is able to diversify away from the UNIT assets. Perhaps new business segments for the enterprise will be more software or IT service based and less reliant upon the pure connectivity of fiber. Once the service side of WIN hits a critical mass, it could become plausible for them to reject the UNIT lease in a bankruptcy court.
At this point, I do not think WIN is anywhere near that level of diversification, it is merely something on which we should keep an eye.
With UNIT dipping nearly 10% on the news off of an already reduced price, I bought more UNIT. At a nearly 15% dividend yield fully covered by AFFO, a significant amount of negative future events are already priced in. If WIN can successfully fend off Aurelius, UNIT should get a nice pop in its share price.
Disclosure: 2nd Market Capital and its affiliated accounts are long UNIT. I am personally long UNIT. This article is provided for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer. The information contained in this article is impersonal and not tailored to the investment needs of any particular person. It does not constitute a recommendation that any particular security or strategy is suitable for a specific person. Investing in publicly held securities is speculative and involves risk, including the possible loss of principal. The reader must determine whether any investment is suitable and accepts responsibility for their investment decisions. Dane Bowler is an investment advisor representative of 2MCAC, a Wisconsin registered investment advisor. Commentary may contain forward-looking statements which are by definition uncertain. Actual results may differ materially from our forecasts or estimations, and 2MCAC and its affiliates- cannot be held liable for the use of and reliance upon the opinions, estimates, forecasts and findings in this article.
Disclosure: I am/we are long UNIT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.