Description

1. Summary

Uniti group is a specialty REIT that is engaged in construction and providing telecom infrastructure such as fiber and wireless towers. It is both a recession proof and corono-virus proof business but is currently valued at a distressed level (8X EV/EBITDA), as opposed to the 20X+ level where other public traded tower or data center REITS (closest comparables) are valued at. The main reason is that Uniti’s biggest tenant (70% of EBITDA), Windstream, is currently in bankruptcy, and there was a master lease dispute between Uniti and Windstream that could jeopardize Uniti's survival. There was already a write up for this story in VIC back in Nov 2019, which I recommend for reading. What I will focus my write up is on what has happened since then, and why the risk/reward has improved yet the common stock price ($6.65 as of the time my writing) has barely changed comparing to Nov 2019 ($6.46). 

2. What happened since Nov 2019

Back in Nov 2019, Uniti was in mediation with Windstream over the lease dispute because Windstream filed a complaint that argues the master lease is not a true lease and should be treated as a secured financing. A trial was scheduled for March 2020. Should the mediation fail and the two parties go to trial and Judge Drain rule the lease as a financing, Uniti would become a lender instead of a landlord and Windstream could stop rent payment immediately, which would lead to Uniti filing BK as well.

Mediation did fail temporarily in Nov 2019, most likely because both parties were trying to play a chicken game, and then they resumed negotiation in December.

In early Feb 2020, Uniti successfully refinanced $2B of its term loan to push the maturity date to 2025, and obtained waiver from the lenders under its senior secured credit facilities that waives any potential default that would arise if the Company’s financial statements for 2019 include a “going concern” statement. This was very positive for Uniti, especially at a time when there is no settlement of lease dispute.

In late Feb 2020, Uniti and Windstream successfully reached a settlement in mediation.The key terms are: 

1. There is NO rent reduction for the master lease

2. Uniti will commit to fund $175M/year GCI capex at Windstream for 10 years. That is a lot of money but two key points are, first this capex is spent on Uniti’s property (upgrade from copper to fiber, which will appreciate in value over time), and second, it will earn a 8% annual return paid by Windstream

3. Uniti will pay $400M in total cash to Windstream first lien creditors over five years and acquire $30M EBITDA.

4. Uniti will sell 39M common shares (20% dilution) to Windstream first lien creditors (mainly hedge fund Elliott management)  for $6.33/share.

Although this settlement implied that Uniti made a big concession in negotiation, it took BK off the table and allowed Uniti to put behind all this mess so that it can focus on its business and growth again, which would let Uniti be valued at normal level instead of distressed level. As a matter of fact, after the settlement announcement, Uniti's common stock recovered to a high of $10.94/share at the end of Feb, 2020, which shows what the market would value the post-settlement Uniti at. In addition, the $6.33 purchase price by Elliott also indicated what they thought of as a bargain price for Uniti common.

Then in March the “corono virus crash” happened. Everything went down, including Uniti’s common, which sank to $5/share.

In April, Windstream filed their Chapter 11 re-org plan. To most people’s surprise, not only the equity, but also the second lien and unsecured debt holders are going to be wiped out, only left recovery for the first lien of Windstream.

As of today (May 1, 2020), Uniti’s common is traded at $6.65/share, still way below the $10.94 price after the settlement announcement, and pretty close to the Elliott purchase bargain price of $6.33.

3. Why current opportunity exist

We think Uniti common price is still lagging because of three things (1) the uncertainty of when the lease is finally assumed (2) the fear of renegotiation of terms of settlement (3) uncertainty of Windstream exiting of BK.

Windstream’s second lien and unsecured holders, facing the fate of being wiped out and having nothing to lose, are strongly against the Uinti lease settlement and are asking for a trial, hoping to extract some value out of it. As a matter of fact, originally after the mediation settlement, Judge Drain set a hearing for April 3 to approve the assumption of the lease, but that date was later changed several times and now scheduled on May 7. We don’t know what Judge Drain will do on May 7. He could dismiss the trial and approve the assumption of the lease (which will be great for Uniti), or send Windstream and Uniti back to negotiation, or set to trial. Both of the latter two outcomes will spook the market, but unlikely to happen in our opinion.  Here is why:

1. On April 20, Windstream filed a “definitive document” (dock 1697) which reiterates the support of the first lien (92%) for the lease settlement.

2. On April 30, Windstream filed a “chapter 7 vs chapter 11 analysis” (dock 1722), which shows that in liquidation pretty much none of the capital structure has any recovery, but under the chapter 11 re-org plan even the first lien has only 67% recovery. In other words, the second lien and unsecured are both deep out of the money because the first lien is impaired significantly. Even if they were able to use the litigation as a threat to extract more concessions out of Uniti, it won’t be enough to give them meaningful recovery.

3. Elliott is in the driver seat of the Windstream re-org plan. It used to own $450M of second lien and $450M of unsecured in face value, but then it has changed its game plan by building a massive $1.1B (50%) of first lien position in Windstream to gain control. There is also a rights offer to raise more cash for the post-BK Windstream, and only first lien is allowed to participate. So clearly their plan is to sacrifice second lien and unsecured to rebuild a more sustainable Windstream and get their return from their first lien and the new Windstream equity position.

4. Judge Drain has encouraged the parties to settle instead of trial from the very beginning. After a 6-month lengthy negotiation followed by a settlement reached by judge Drain’s hand-picked mediator, why would Judge Drain now want to have them go for trial? It is more likely that he will choose to approve the Uniti lease settlement (which has first lien's support) and cram down the second lien and unsecured class (if they vote against the re-org plan).

5. Even if they go to trial, Uniti is likely to win because the lease is a true lease. The previous VIC writeup has done a good job of explaining why so I won’t go through it again. But I just want to ask this simple question - Windstream (and Elliott) has hired K&E, which is the top law firm for BK. If they had seen any good chance that the lease really could be recharacterized as a financing, why would they have gone through all this painful mediation process and eventually had to change their game plan to sacrifice Elliott’s second lien position? Why didn’t they go for trial much earlier?  

4. Impact of Settlement on Valuation of Uniti

Given that Uniti made a big concession in the settlement, a big question is what the impact of it is on Uniti’s fair value. The biggest item is the $175M/year GCI CAPEX commitment for 10 years. Some people say this is equivalent to a $175M rent/EBIDTA reduction. We disagree and here is why:

1. As we said earlier, this $175M CAPEX is spent to improve Uniti’s asset (upgrade from copper to fiber), which will increase the value of the asset over time as fiber is more and more desirable. It also earns 8% return.

2. Before this whole mess, Uniti was spending $280M/year on growth CAPEX ($180M for Uniti fiber and $100M for Uniti tower) in 2019, trying to diversify away from Windstream. After the settlement, Uniti’s growth strategy has dramatically changed. If you take a look at their recent 2019 4Q presentation in March 2020, they have raised cash by selling 486 of 672 towers for $190M and expect $0 net CAPEX for towers in 2020. They are also reducing the CAPEX spending on Uniti fiber from $180M to $105M. All these reductions on CAPEX will make room for the $175M GCI. So it is close to net neutral.

3. A post-BK new Windstream will have debt cut down from $5b to $2b, injection of new cash from right offer, and Uniti’s contribution of $175M/year for CAPEX. All these will make the new Windstream a much more healthy tenant. In such a case, there is really no urgent need for Uniti to diversify away from Windstream. We expect Uniti to focus on re-lease the fiber asset and stop spending on the tower business, which eventually will limit their growth CAPEX spending only to the GCI for Windstream.

4. Our rough estimate of the new normalized Uniti’s FCF would be like this: $850M (EBITDA) -  $420M(interest) -$220 (GCI + maintain CAPEX) = $210M FCF. Over the next 5 years, they will have to pay $80M /year in cash to Windstream as part of the $400M cash settlement. So they will end up with $210-80=130M cash for distribution, which is about $0.50/share/year considering the 20% dilution, it is also inline with that the company declared in March. This does not factor in any future revenue growth through re-leasing of the fiber asset at 90% ebitda margin. Before Windstream’s BK, Uniti has always been traded at a 10%+ yield because of the perception of the weakness in Windstream. After Windstream exit BK, we expect Uniti will trade at a much lower dividend yield (5% or lower), which will translate to a share price of $10 or higher. If the market chooses to value Uniti on a higher EV/EBITDA basis (e.g. 15X), it will translate to much higher share price. But for now, we tend to be conservative.

5. Conclusion

Back in Nov 2020 when Uniti was first written up at VIC, Uniti was fighting against Windstream and its largest stake holder Elliott management. With a lease settlement and re-org plan filed for Windstream, Uniti are now on the same side with first lien and Elliott, and together they are fighting against the second lien and unsecured holders of Windstream. At $6.65/share, market present you an opportunity to buy a recession and corono-virus proof telecom infrastructure REIT at close to Elliott management’s bargain price of $6.33/share, and there is an immediate catalyst (May 7 hearing) coming up that may drive the share price to $10 within a few weeks.

6. Risk

Existing lease settlement is renegotiated.

Uniti goes into trial and loses the litigation.

Windstream fails to exit BK.

Catalyst

Lease assumption is approved on May 7th by judge Drain. 

Windstream exit BK later in the year.