Windstream (WIN) Ratings, Outlook Affirmed by Moody's Amid EarthLink (ELNK) Merger
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Moody's Investors Service, ("Moody's") said that Windstream Services, LLC ("Windstream") announcement of a definitive agreement to purchase EarthLink Holdings Corp. ("EarthLink") will not immediately impact the ratings of either company. Windstream (B1 stable) plans to acquire EarthLink (B2 stable) in an all-stock merger valued at approximately $1.1 billion, including EarthLink's existing debt. At transaction close, Windstream plans to repay all of EarthLink's existing debt, at which time Moody's would withdraw all of EarthLink's ratings.
Windstream expects to achieve $110 million in operating expense savings over a three year period following deal close. The cost savings will boost Windstream's free cash flow, but higher dividends resulting from stock issued to finance the deal will consume around half of the benefit.
EarthLink's revenues have faced pressure from its weak competitive position and its legacy consumer internet services business, which remains a source of cash but also sunset business. For the third quarter of 2016, EarthLink's revenue fell 13% and EBITDA (as reported, including adjustments) fell by 18% versus the third quarter of 2015. EarthLink's B2 rating reflects Moody's expectation of continued revenue weakness, but success with cost cutting, CAPEX restraint, and asset sales of non-core low margin businesses to improve cash flows and de-lever. These activities have enabled the company to maintain a reasonable capital structure and good liquidity. Windstream will inherit these challenges, which we believe could undermine the expense savings and other merger benefits over time.
Windstream's B1 corporate family rating reflects its scale as a national wireline operator with a stable, predictable base of recurring revenues, offset by high leverage, a declining top line and margin pressure. The rating incorporates Moody's view that Windstream's leverage will remain around 5x Debt to EBITDA (Moody's Adjusted) for the next several years. We believe that Windstream faces a continued erosion of EBITDA and cash flows as a result of prior underinvestment. We expect EBITDA to decline in the low single digit percentage range for the next several years, although some of this impact could be offset by expense reduction or the benefits of greater investment into the consumer segment.
Moody's could raise Windstream's ratings if leverage were to be sustained below 4.5x (Moody's adjusted) and free cash flow to debt were in the mid-single digits percentage range. Moody's could lower the ratings if leverage were to be sustained above 5.25x (Moody's adjusted) or free cash flow is negative, on a sustained basis. Additionally, the ratings would face downward pressure if capital investment is reduced below the level sufficient to improve the company's competitive position or cost structure.
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