Fitch Affirms Communications Sales & Leasing Rating at 'BB'; Outlook Stable
The rating action follows the announcement by CS&L that it has entered into a definitive agreement with Associated Partners Entities to purchase PEG Bandwidth, LLC (PEG) for $409 million. Transaction value is approximately 12x of PEG's last-quarter annualized adjusted EBITDA. CS&L will finance the deal with a combination of available cash on hand, borrowings under CS&L's revolver, common stock and convertible preferred stock. The transaction is conditioned upon necessary regulatory approval that is expected to occur early in the second quarter of 2016 (2Q16).
KEY RATING DRIVERS
Transaction Increases Leverage: The affirmation reflects an expected increase in CS&L's financial leverage as a result of the PEG Bandwidth acquisition. On a pro forma basis, Fitch expects gross leverage (total debt-to-EBITDA) of approximately 5.8x at the time of transaction closing assuming 50% equity treatment for the preferred stock. This compares to leverage of approximately 5.6x at the end of 3Q15. Based on management comments about opportunities within a robust transaction pipeline and desire to diversify across various asset classes, Fitch anticipates that CS&L will announce further transactions. As these opportunities come to fruition, Fitch expects CS&L to finance any transaction such that gross leverage should remain relatively stable, with some fluctuations due to M&A activity, and should be in the mid-5x range over the longer term.
Very Stable Cash Flow: Nearly all of CS&L's current revenues consist of revenues under a master lease with Windstream Holdings Inc. (Windstream), under which Windstream has exclusive access to the assets. The lease is expected to be around $650 million annually. Pro forma for the transaction, PEG should represent approximately 10% of CS&L's revenues and would operate as a taxable REIT subsidiary. Fitch expects CS&L to have very stable cash flows, owing to the fixed (and modestly increasing) nature of the long-term lease payments and Windstream's responsibility for expenses under the triple-net lease. The term of the master lease is for an initial term of 15 years. There is some risk at renewal that under the 'any or all' provision at renewal Windstream could opt not to renew markets, or could renegotiate terms at such time for those markets.
However, this renewal risk would be at least 15 years in the future, and up to 20 if Windstream exercises an option to have CS&L fund certain capital spending projects. Fitch expects all markets to be renewed under the master lease, since Windstream would either have to incur significant capital expenditures to overbuild CS&L or find a buyer for its operating assets (routers, switches, etc.) and successor tenant for its leased assets. Protection is provided to CS&L by the terms of the master lease, which could require Windstream to sell its operating properties in the event of default. CS&L's facilities would be essential to the operations of Windstream on a going-concern basis, or as a successor company.
Geographic Diversification: Windstream's operations subject to the master lease are geographically diversified among 37 market areas. The indivisible nature of the master lease mitigates the effect of a weak market area(s) on CS&L. About two-thirds of the fiber and copper route miles are located in Georgia, Texas, Iowa, Kentucky and North Carolina. PEG's fiber network serves seven markets in the Northeast Mid-Atlantic, Illinois and South Central regions.
Tenant Concentration: The master lease with Windstream provides a steady, although undiversified cash flow stream. Therefore CS&L's IDR is initially capped at Windstream's 'BB' IDR until CS&L strikes deals with other companies to meaningfully diversify its operations through transactions where 25%-30% of its revenue is derived from tenants with a credit profile materially stronger than Windstream's. Fitch views the PEG transaction positively as it begins to diversify CS&L's revenue base.
Seniority: Fitch notes that CS&L's master lease is with Windstream Holdings and that Windstream Holdings is subordinate to the operations at Windstream Services. However, Fitch believes CS&L's assets will be essential to Windstream Services operations and a priority payment.
Tenant's Business: Windstream derives more than 70% of revenues from business services (including the carrier market) and consumer broadband markets. At the same time, there is still secular pressure on legacy voice and regulatory-derived revenues (switched access and universal service funding). As the legacy revenues dwindle in the mix, there will be less pressure on revenues going forward. The company has positioned its business service offerings to target mid-sized businesses. For a pure wireline operator, Windstream's revenues are somewhat more diversified than other wireline operators, as acquisitions have brought additional business and data services revenue. PEG, which is focused on less competitive tier II or tier III markets, generates approximately 80% of revenues from long-term contracts with three national wireless operators. With nearly 80% of network capacity available, PEG has good growth potential through near-net cell-site backhaul opportunities, wholesale, enterprise and E-Rate.
No Material Near-Term Maturities: CS&L does not have any maturities for four years at the earliest, with the revolver having the shortest maturity in 2020. The remaining term loan and note issuances have maturities in 2022 and 2023, respectively.
Equity Treatment Considerations
Fitch gives CS&L's preferred stock 50% equity treatment based on methodology outlined in Fitch's hybrid debt criteria report. Key attributes for the instrument includes the ability to defer coupon payments, cumulative nature of the dividend, effective maturity of at least five years and no coupon step-ups.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for CS&L include the following:
--CS&L will finance the transaction with a mix of cash ($315 million), stock (1 million CS&L shares and convertible preferred stock ($87.5 million).
--CS&L's primary revenue stream will be the payments received from Windstream under the master lease and will be approximately $650 million annually. Fitch assumes Windstream will request CS&L finance $50 million of capital spending over the next five years per the terms of the master lease, generating additional revenue.
--Virtually all capital spending consists of investments requested by Windstream. CS&L is expected to distribute all REIT earnings to shareholders.
--CS&L will target long-term gross leverage in the mid-5x range.
RATING SENSITIVITIES
Positive Action: A positive action is unlikely in the absence of an upgrade of Windstream, although an upgrade could be considered if CS&L targets debt leverage of 5.25x or lower and 25%-30% of its revenue is derived from tenants with a credit profile materially stronger than Windstream's.
Negative Action: A negative rating action could occur if debt leverage is expected to approach 6x or higher for a sustained period. In addition, a downgrade of Windstream would likely result in a similar downgrade of CS&L in the absence of greater revenue diversification. Also, the acquisition of assets and subsequent leases to tenants that have a weaker credit and operating profile than Windstream could affect the rating, if such assets are a material proportion of revenues.
LIQUIDITY
CS&L's $500 million revolving credit facility that matures in 2020 provides sufficient backstop for liquidity needs. Fitch expects CS&L will restore revolver availability following transactions by terming out borrowings over time by more permanent means of equity and debt funding. Cash was $210 million at the end of 3Q15.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings for CS&L and CSL Capital, LLC:
--IDR at 'BB'
--Senior secured revolving credit facility due 2020 at 'BBB-/RR1';
--Senior secured credit facility due 2022 at 'BBB-/RR1';
--Senior secured notes at 'BBB-/RR1';
--Senior unsecured notes at 'BB/RR4'.
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