Windstream – To sell or not to sell

December 12, 2010

Some people think the reason for value investing’s unpopularity is that it’s pretty boring. No excited conversations with analysts, no being wined and dined by management, no building of gleaming, elegant, projections going years into the future; just you and your calculated value to compare to market prices. However, this approach led me to buy Windstream (WIN), which I originally picked up in May and June of 2009 when the market was recovering, at an average price of about $8.60, and with the current price of $14 I’m sitting on about a 60% gain plus having taken down an 11.5% yield for the last year and a half. I don’t actually consider that boring, but I am reliably informed that these results aren’t typical, although there’s no reason why they shouldn’t be.

But I’m not writing this just to brag; the fact that Windstream is now at the highest price it’s been for some time and I need to consider whether I should get out or not. Certainly Windstream offers one of the highest dividends in the market that I view as stable and sustainable and so the question might be asked if I get out of Windstream what would I put my money into instead? However, there is no shame in holding cash until a better opportunity comes along, and a stock should cheap on its own merits and not simply as compared to something else.

Now, a high dividend payment is indicative of earnings stability, as the market tends to punish the prices of companies that cut their dividends (although counterexamples can be found in 2008), and managers are aware of this. However, I view high and sustainable free cash flow as a sine qua non of an equity investment, not a bonus, and so I would be unwilling to attach a premium to it.

The free cash flow picture of Windstream is complicated in that they have gone through many acquisitions of smaller companies recently, most of which have been privately held and therefore have no publicly available financial statements, and the summarized financial data do not give sufficient information to calculate free cash flow, regardless of synergy. The new and undigested acquisitions may have something to contribute to earnings, and certainly give rise to integration costs that should be viewed as nonrecurring.

So, in 2007, free cash flow net of nonrecurring costs were $610 million. In 2008, the figure was $604 million. In 2009 it came to $594.7, and in 2010 year to date it comes to $503 million, which is $670 million on an annualized basis. Of course, Windstream has issued a number of shares to pay for its acquisitions, so free cash flow per share has not necessarily improved.

Currently, there are 483.5 million shares of Windstream outstanding at a price of $14 each, producing a market cap of $6.77 billion. This is a multiple of almost exactly 10x current free cash flows. Ten times earnings I consider a fair price, not necessarily a cheap price to pay, particularly as I am skeptical about most growth opportunities to the point that I generally try to avoid projecting any growth at all in order to justify a purchase. Of course, in this low interest rate environment a high free cash flow yield like Windstream’s might justify a higher multiple, but such a view easily sets off a slippery slope.

So, I am not inclined to sell Windstream yet, but I would consider selling if the price moves significantly higher.

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