OREANDA-NEWS. Fitch Ratings has downgraded the ratings for Communications Sales & Leasing, Inc. (CS&L) and its co-issuer CSL Capital, LLC, including the long-term Issuer Default Ratings (IDR) to 'BB-' from 'BB'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.

The downgrade of CS&L's ratings follows Fitch's downgrade of the long-term IDRs of CS&L's primary customer, Windstream Services, LLC (Windstream) and its subsidiaries on March 15, 2016 to 'BB-'. Windstream will still account for a very high proportion of CS&L's revenues even after the acquisition of PEG Bandwidth (which will provide approximately 10% of revenues on a pro forma basis). The Windstream downgrade resulted from Fitch's revision to its rating sensitivities for Windstream and other wireline-only operators to reflect the continued secular effects of competition, which, in turn, has led to continued delays in the return to revenue and EBITDA stability (as discussed in the Windstream Rating Action Commentary).

KEY RATING DRIVERS

PEG Bandwidth Acquisition: In January 2016, CS&L entered into a definitive agreement with Associated Partners Entities to purchase PEG Bandwidth for $409 million. The transaction value is approximately 12x of PEG Bandwidth'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 and is expected to close during the early second quarter of 2016.

Transaction Increases Leverage: CS&L's financial leverage is expected to rise 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 5.5x at the end of the fourth quarter 2015. 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 approximate 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, under which Windstream has exclusive access to the assets. The lease is currently expected to approximate $653 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 that 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 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-' long-term 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 (Holdings) and that 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 approximately 66% of revenue from enterprise services, consumer high-speed internet services and its carrier customers (core and wholesale), which all have growing or stable prospects. Certain legacy revenues remain pressured, but revenues should stabilize as they dwindle in the mix. 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.

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.