Windstream does not do it Again (Iowa Telecommunications Services)

November 24, 2009

Windstream has announced their fourth acquisition since they started, this time for  Iowa Telecommunications Services for 1.1 billion, consisting of 26.5 million shares of stock, $260 million in cash, and assuming $600 million of debt. The target firm has 256,000 access lines, 95,000 high speed Internet customers, and 26,000 digital TV customers, which the article mentions (perhaps with some prompting by Windstream) as the focus of Windstream’s current business plan.

Big fish eat little fishHowever, it seems to me that this acquisition is unlike the other three purchases. In those cases, the price paid, if you indulged management’s optimism about synergies, and taking into account the excess of depreciation over capital expenditures, you still wound up with a price/free cash flow of around 10. Here, Windstream claims that about 8% of the purchase price consists of tax loss harvesting (which the Tax Code has very Byzantine rules about, but for 8% it is not the driver of the transaction so I wouldn’t be too worried).  But of the other 92%, I find that net income plus depreciation minus capital expenditures comes to an average about 50 million a year, which, given the $530 million paid for the equity is close to 10 but not quite there.

However, Iowa Telecom has also been a ravenous acquirer of other companies, and if we take those into account they eat up almost all the firm’s free cash flow for the last few years. It is possible that Iowa Telecom got what it paid for, but I am not entirely convinced. I would like to know if these acquisitions were motivated by necessity or strategy, since necessity places them more along the lines of a capital expenditure and therefore they would eat into free cash flow.

As for the assumption of debt, Iowa Telecom’s 600 million in debt was financed at fixed or variable rates that have recently run about 5-6%, representing an extra 31 million in cash flow to the firm. However, the lenders that made the financing provision made their deal with Iowa Telecom, not with Windstream, so rather than stepping into their shoes Windstream is going to have to refinance, and Windstream’s own interest rate, based on their latest private placement of notes, is closer to 8%. So, 387.5 million of that transaction can be financed from Iowa Telecom’s existing interest layout, but the rest of the debt, representing 17 million a year, will have to be financed elsewhere, and taking that out of the 50 million in free cash flow to equity (after taxes) leaves only about 38-39 million, for a price/free cash flow to equity of 13.8, which is worse than what Windstream had before the merger, and Windstream’s other acquisitions, provides. But at least Iowa Telecom is a public company so we can see the numbers for ourselves.

Windstream also claims that they will get $35 million a year in synergies out of the deal, and indeed they may. They were expecting a similar amount of synergy out of the Nuvox deal, which was smaller, so it could be more achievable in this case, but again, synergy is a thing that you believe in when you see it, because synergy is also the preferred method of the staff of acquisitive CEOs to make an unattractive deal look more attractive. And even when synergy does arrive when the acquisition and integration are sorted out, it may not be clear which acquisition it goes to.

So, to review, 80 million in free cash flow to firm, minus 48 million a year from the debt they take on and refinance, minus 21 million from the cash they paid (cash that could also be used to pay down debt), minus 26 million for the equity (from the dividends, but even without the dividends this is about their implied cost of equity), comes to minus 15 million, which has to be made up with “synergy.” I worry with this acquisition that Windstream’s management is more interested in building a bigger company than a better company. I would like to see them going through a trimming phase after this acquisition phase, where they sell off some of the properties or regions that are strategically unnecessary or financially weak. If not I may have to reconsider the attractiveness of the dividend given the safety of the firm. And their next acquisition really should be better than this one, for the sake of market perception.

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