5 Things Windstream Holdings' Management Wants You to Know

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Shares of Windstream Holdings have been crushing the market in 2014. The stock has soared 46% higher year to date, on a dividend-adjusted basis, while the S&P 500 index only gained 8%.

WIN Total Return Price Chart

WIN Total Return Price data by YCharts

The company stands at a crossroads right now. Windstream's business performance doesn't exactly match the company's dazzling stock chart. A game-changing conversion into a real estate investment trust (REIT) is about to reshape Windstream's entire business model.

To gain more insight into what's driving Windstream at this moment, I dove into the company's latest earnings call. Here are five of the most poignant management insights I found.

Source: Windstream

What, exactly, will the new REIT manage?

The majority of the assets are fiber and copper distribution systems. We're also including the central office buildings. Importantly, as we noted, the IRS has confirmed that these assets are ratable assets but the other point, these are long lived assets. So as you think about them as an opportunity to invest, they should be looked at as assets that have a long life. A lot of the other assets that are maintained by Windstream are the electronics and the other equipment that are not ratable but enable the distribution system to work.

--Tony Thomas, Windstream CFO

So the REIT will manage almost anything related to real estate assets, with an eye toward long-haul returns. Meanwhile, the New Windstream operation manages the networking equipment inside. That includes refreshing the machinery to keep up with new networking technologies, and is more of a growth-focused operation than a long-life asset play.

It's a very simple division, but an effective idea nonetheless. Dividend investors should love the REIT but might hate the riskier service-and-technology business. Growth investors with a lower sensitivity to risk will lean in the opposite direction. And when the separation is complete, each investor can buy shares in one or the other of these very different business models, according to preferences and investing strategies.

Debt, liquidity, and leverage

We ended the quarter with ample liquidity comprised of $640 million in revolver availability and $55 million in cash. Net leverage was 3.9 times adjusted OIBDA [profits]. As part of the spin-off transaction, we expect Windstream to reduce debt by $3.2 billion and lower leverage. Following the transaction, Windstream will have a leveraged target of three times OIBDA.

--Tony Thomas, Windstream CFO

Many REIT conversions are simply aimed at lowering tax payments. Not this one. Windstream is unlocking asset-based value and restructuring its massive debt load in a game-changing way.

This is important because Windstream's $8.7 billion long-term debt load results in massive interest payments. In the second quarter, 86% of Windstream's EBIT income was funneled into interest payments. Anything that helps Windstream lighten this anchor around its neck will boost bottom-line profits and give the company more room to try new business ideas.

Meanwhile, the REIT unit won't mind the debt so much because it won't be expected to grow earnings all that fast. Big dividend payers with dependable revenue streams can get away with that sort of thing -- and Windstream's REIT will qualify on both counts.

Source: Windstream

Cash flow progress

For the first half of 2014, we generated adjusted free cash flow of $440 million, up 6% over the same period last year due to declining fiber-to-the-tower investments and lower cash interest.

We have returned over $300 million to our shareholders in the form of dividends during this period.

--Tony Thomas, Windstream CFO

Pulling fiber-optic networks out to cell towers has been a drag on Windstream's free cash flows for years, but these expensive installations are finally slowing down. Tower operators and their wireless telecom customers like fiber connections, because they are essential to modern 3G and 4G broadband services. The old bundle of copper-based T1 lines can only handle 1.5 megabits per second, while a single fiber line can carry many gigabits. These upgrades remove a major bottleneck from the wireless data experience, and network carriers insist on fiber in new installations nowadays.

So this was an important project for Windstream, which will provide the foundation for carrier service sales for decades to come. All the same, removing that capital expense pressure from the cash flow statement will boost Windstream's cash flows and support its generous dividend payouts.

Focus on business services

We continue to position our enterprise business to achieve a targeted long term growth rate of 2% to 4% while improving the stability of our consumer channel. We have expanded our business marketing programs to strengthen sales and are seeing continued solid sales momentum and positive trends supporting our efforts to move upmarket. [...]

We're proactively taking steps to accelerate business revenue growth. We have made many positive changes throughout the organization to improve both sales and service delivery. While these changes take time to gain traction we are encouraged by the positive impact we have experienced thus far in 2014.

--Jeff Gardner, Windstream CEO

This is a core strategy for Windstream nowadays. Management expects the consumer division to shrink over time as landline phone services fall out of favor, mitigated by demand for high-speed Internet services. But the business segment is different. From small business operations to giant enterprises, there's still a place for centrally managed phone systems with dependable, high-quality voice services.

With or without the REIT conversion, this is where Windstream is spending most of its research and marketing dollars. Why chase the fickle consumer when you can track down corporate accounts that will stay around for the long haul?

Consumer broadband

We implemented certain pricing actions during the second quarter which contributed to a sequential revenue growth of $4 million. Consumer broadband units were down by 17,000 due largely to seasonal weakness in the second quarter.

Importantly, broadband revenue was $121 million -- up slightly, driven by the price increases and continued growth in broadband speeds and vertical services.

--Tony Thomas, Windstream CFO

That being said, the consumer segment still matters. As business-focused as Windstream is these days, the company hasn't abandoned its consumer-level subscribers.

In the second quarter, Windstream's consumer broadband business fights a seasonal dip, and lost a few customers. But thanks to modest price increases and up-selling consumers to higher broadband speeds, revenues actually ticked up slightly.

The company isn't likely to keep raising prices every quarter, but look for Windstream to continue pushing add-on Internet features and higher broadband speeds to existing subscribers.

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The article 5 Things Windstream Holdings' Management Wants You to Know originally appeared on Fool.com.

Anders Bylund has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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