Description

Recommendation: Buy Uniti Group (UNIT) stock at current prices.

Thesis: UNIT is a post-reorg special situation that is mis-priced due to the bankruptcy-taint of their key customer Windstream (WIN). The market does not fully appreciate that Windstream has restructured their balance sheet and no longer has any credit/liquidity risk and is having success executing a fiber-upgrade playbook which is stabilizing subs, revenue, and EBITDA. With the Windstream turn-around underway, UNIT management has publicly stated that they will address the discount that UNIT trades at relative to intrinsic value through a transaction that will unlock value. With a previously reported opening bid from EQT/ZAYO of $15 last summer (which was rejected by UNIT management on valuation), and a very active private market for digital infrastructure assets, I believe there could be an event in the next ~6 months that re-rates the stock to the high teens.

Price Target: I believe downside is protected by highly predictable cash flow and a low current multiple of 8x AFFO and a 4.75% dividend yield. I believe the private market value of UNIT is 15-20x EBITDA for their fiber assets and ~10x EBITDA for the WIN-Lease resulting in a target price of $18 or 30% upside. Note: management argues (see valuation slide from their earnings presentation below) that the value of the WIN-Lease cash flows should be at least 12x EBITDA which would imply a value for UNIT of ~ $24/share (70% upside).

Situation Overview:

·       UNIT is the product of an ill-fated transaction during the REIT-conversion wave of 2013-2015 to try and unlock value out of a declining rural telecom company (WIN) through an opco-propco transaction. While WIN managed through the secular challenges of a copper telco, their 2019 bankruptcy filing was as a result of a legal ruling that their opco-propco transaction actually violated a covenant in WIN’s debt, accelerating the bond which they were unable to repay.

·       WIN is now restructured with only 1.7x net leverage and no maturities until 2027 and has accelerated capex to upgrade their network to fiber which has resulted in positive broadband subscriber growth and stabilizing revenue/EBITDA.

·       UNIT owns the assets and WIN has a triple net lease to be the opco through 2030.

Why the opportunity exists:

·       UNIT will never trade well in the public markets. It’s a ~single-tenant triple net lease REIT and the tenant has been through bankruptcy.

·       EQT approached UNIT and WIN last year to acquire both companies, recombine them, and accelerate the fiber overbuild strategy. I agree that a recombination of UNIT/WIN maximizes total value for all stakeholders.

·       When a bid/ask spread developed between EQT and how UNIT/WIN would split the value, WIN believed that they would be best served to launch a PR campaign to talk down the value of UNIT’s stock price by sowing seeds of uncertainty of how the lease would renew in 2030. Many market participants moved on to avoid the brain damage of debating how a contract would be interpreted in 8 years by an independent appraiser. Having done the work, I am convinced the lease will renew at similar rates to current and the debate is really a private negotiation that has been made public over how the pie should be split.

Risks:

·       Current operating momentum at WIN reverses and their creditworthiness as a tenant is called into question.

·       There is no monetization of the WIN-leased assets due to an inability for buyer and seller to agree on value and UNIT remains a value trap.

Business Background: UNIT is a REIT created through the spin-off of telco assets (primarily fiber, legacy copper networks, real estate) from Windstream (WIN) in 2015. A substantial portion of UNIT’s revenue is derived from WIN (~66% in FY’21) in connection with the WIN-Lease post-WIN’s emergence from bankruptcy in 2020. The telco industry is marked by growing demand in data consumption, which warrants the need for fiber (thin glass filaments enabling next-gen capabilities requiring higher speed and throughput) upgrades to legacy copper networks which are in secular decline. UNIT operates through 2 business segments (segment split as % of FY’22 Consolidated Management Guide ex-corporate):

·       Uniti Leasing (73% Revenue / 87% EBITDA): Engages in the acquisition/construction of communications infrastructure and leasing them back to telco operators on a LT basis, generating recurring leasing revenue with built-in escalators. Segment revenue growth is in the LSD range after uplift from value accretive growth investments ($1.75bn through 2029 under a set schedule) that UNIT needs to reimburse WIN for but would thereafter own. EBITDA margins are high (97-98%) as contracts are structured through triple-net lease arrangements, in which the tenant pays for the bulk of associated costs (maintenance and repairs to PPE, property taxes, insurance). Excluding the above growth investments, UNIT’s business model requires minimal working capital and capex, and generates highly predictable cash flow.

·       Uniti Fiber (27% Revenue / 13% EBITDA): Provides communication solutions through fiber network to consumer, enterprise and wholesale customers, to accelerate growth and diversify revenue streams in an environment where fiber is undergoing secular growth and ubiquitous in communication infrastructure end markets. Revenue growth is indexed on secular trends / customer mix and is expected to grow at LSD to MSD. EBITDA margin is in the 40% range, with capital intensity expected to decline from 50%+ in FY’21 to mid-30% as the business goes through a period of elevated fiber builds.

UNIT Management Valuation Slide

Catalyst

Sale of part or all of the company.