Will AT&T, Verizon follow Windstream down the REIT asset path?
Windstream got the attention of the telecom world and financial community on Tuesday when it announced that it would spin off parts of its network assets into an independent Real Estate Investment Trust (REIT). Not surprisingly, this development quickly fueled speculation that other service providers could, or are considering, a similar move.
Under its agreement, Windstream will spin out certain assets, including its fiber and copper networks and other real estate, as a REIT, which will lease the assets to Windstream through a long-term triple-net exclusive lease with an initial estimated rent payment of $650 million per year.
A key provision of the REIT deal is that Windstream has pledged to expand the availability of its 10 Mbps service to more than 80 percent of its customers by 2018. In addition, it will double the availability of its 24 Mbps speed tiers by 2018, extending the service to more than 30 percent of its customers. However, 24 Mbps trails the 100-plus Mbps that cable operators can deliver today.
Existing and new business customers could also benefit because the telco said it could more rapidly offer new IP and fiber-based services and accelerate fiber expansion into more buildings.
"This transaction is going to allow us to transition faster to IP, which will make us a more competitive enterprise player," said Windstream CEO Jeff Gardner. "We're having success in that mid-sized segment in between where the cable guys are entering the market and where the traditional players are focusing on global customers."
In addition to Windstream, the REIT could be used by other service providers looking to lower debt by renting its copper and fiber facilities. At this point, the service provider has not reached out to other providers about striking any agreements.
The deal isn't without its challenges. Although Windstream already gained a private letter ruling (PLR) regarding the tax-free nature of the spinoff and the qualification of the network assets as real property for REIT purpose, it still has to gain multiple state regulatory approvals. It's also unclear how they would view the separation of the network assets.
Financial analysts said that while other large telcos like AT&T (NYSE: T) and Verizon (NYSE: VZ) could look at a REIT spinoff, it would likely be more complex.
Credit Suisse said in a report that although AT&T and Verizon are looking at a similar structure, it would not likely happen in the near-term.
"We believe AT&T and Verizon are evaluating a similar strategy, but have the advantage of waiting to see how the Windstream transition plays out," wrote Credit Suisse in a report. "Given the RBOCs' strong balance sheets and solid operational performance, there's less pressure to implement such a strategy immediately."
Kevin Smithen, an analyst with Macquarie Capital (USA), expressed a similar view, adding that not only would such a deal be more complex but it would also give competitors free rein to use their last mile fiber network facilities.
"Logistically, WIN's REIT conversion is simpler than for its larger peers as T and VZ, for example, will need to get individual State PUC approvals, and would have to prepay pension liabilities," Smithen wrote in a report. "Additionally, if T and VZ spin off their U-Verse and FiOS infrastructure, cable competitors and metro fiber players will have access to those assets (or S, T-Mo and DISH access to their cell sites/backhaul)."
It did not take long for analysts to press other service providers if they are considering a similar structure.
Level 3 Communications was asked this question during its second-quarter earnings call on Tuesday.
Sunit Patel, CFO of Level 3, said that while the company sees the potential in what Windstream is doing, they have "no current plans on becoming a REIT but certainly a very interesting development with the ruling from the IRS, so we'll just monitor that over the next few quarters."
Service providers structurally separating their network and operating assets is nothing new. A number of international service providers, including Telstra, Telecom New Zealand and BT (NYSE: BT), have already gone this process. However, those service providers were driven by regulatory mandates from each government--not for tax savings.
While it's unclear if other large service providers will follow Windstream, it's clear that the company has gotten the attention of the telecom industry's key players during what has been a time of rapid consolidation.--Sean