America's Rural-Phone Industry Is Facing a$48 Billion Debt CrisisBy and
Eroding businesses threaten dividends, challenge recovery hope
Looming debt payments compounded by dip into distressed levels
Some of the biggest landline phone providers in the U.S., from Connecticut to Arizona, are running headlong into a debt crisis after borrowing heavily to add more territory and then failing to escape the industry’s decline.
CenturyLink Inc., Frontier Communications Corp. and Windstream Holdings Inc. -- the three largest rural phone carriers -- have lost 8 percent of their lines in the past year alone as people abandon home-phone service for more convenient wireless plans. The companies have merged with equally weak peers and drained dwindling cash reserves in an effort to pay dividends.
Their bonds have plunged, with some of Frontier’s trading as low as 73 cents on the dollar and Windstream’s for as little as 65 cents. CenturyLink is in better shape, but some of its notes now trade at about 95 cents, down from more than 106 cents in July.
In a pattern familiar across any number of struggling industries, from shopping malls to print media, rural phone companies have fallen victim to new technologies, shifting consumer patterns, and declining populations. The warning signs seem obvious in retrospect, and investors are questioning whether efforts to change course are too late. CenturyLink, Windstream and Frontier have more than $48 billion of corporate debt on their combined balance sheets, with about $6.5 billion maturing by 2020.
“This has been the worst year for these companies, and even if they get it behind them, they face enormous debt maturity levels,” said Greg Williams, an analyst with Cowen & Co. “It could be that they’ll just be getting the businesses up to speed as they hit the wall.”
Representatives for CenturyLink and Windstream both said the companies have grown beyond their rural landline roots by expanding offerings to reach business customers with features like cloud services to improve the mix of revenue.
“We are strong believers in the quality of our assets,” said Brigid Smith, a Frontier spokeswoman. “We have begun to deliver substantially improved trends,” she said. “And we are positioned as a long-term player in the telecom industry.”
Shares of Frontier and Windstream are near all-time lows, while CenturyLink is the cheapest it’s been in 20 years. CenturyLink said on Nov. 9 it wouldn’t meet its forecasts for the year as more people are giving up landlines, putting the dividend in doubt and sending shares and bonds plummeting.
Shares of Windstream fell as much as 2.7 percent in New York on Monday, while CenturyLink declined as much as 1.1 percent. The two stocks later erased their losses and edged higher. Frontier rose as much as 7.8 percent.
Frontier exacerbated its problems by scooping up assets from bigger carriers that are now in much better shape. In 2009, the company acquired 4.8 million phone lines from Verizon Communications Inc. in Idaho, Michigan, Oregon and other states for $5.25 billion. In 2014, Frontier bought AT&T Inc.’s Connecticut business for $2 billion. Then in 2015, the company got an additional 3.7 million lines from Verizon in California, Florida and Texas for $10.5 billion.
The decline of the landline has also affected AT&T and Verizon, the two biggest phone companies in the country, but they have powerful wireless businesses and serve corporate customers in the nation’s biggest cities, muting the impact. AT&T is also the largest U.S. pay-TV provider.
The challenge for the rural companies is getting wary bond investors on board with refinancing to extend debt maturities, buying more time to create growth, said Moody’s Investors Service analyst Mark Stodden. To do so, they’ll need to prove the long-term sustainability of their business models.
“In order to refinance upcoming maturities, you’ve got to convince bond investors who are presented with the opportunity to buy seven- or 10-year bonds that the company’s going to be around in seven years,” Stodden said.
Investors are already demanding more protection for new junk telecom bonds than for high-yield bonds from other sectors, according to a Monday report on covenant quality from Moody’s. Telecom bonds issued since January 2013 have had tighter terms in their documents, reflecting industry stress and higher leveraging risk, according to the report.
Debt loads for the rural carriers have swelled to about four or five times their annual earnings -- not as “outrageously high” as distressed companies in some other industries, but enough to raise concerns, Stodden said.
In the meantime, phone carriers have to consider weaning investors off the one thing that’s kept many holding on to shares: dividends. That’s sacrilege to shareholders, as Windstream demonstrated in August when it halted payments, sending the stock down 36 percent. Dividend funds represent more than half the equity investors that own the stock, Williams said.
Frontier and CenturyLink are still paying dividends, but the sustainability of such payments is in doubt because the companies need to dig out of a rut, and each step toward recovery at this point is very steep, Williams said.
“First they need revenue to stabilize before margins can stabilize, and margins need to be stable enough to generate cash flow to pay the dividend,” Williams said.
Of the rural carriers, Windstream and Frontier face the most acute financial risk, according to Stodden, as earnings decline at a rate in the high single digits and interest payments come due.
Moody’s rates Frontier the lowest of the landline phone companies it tracks after a Nov. 2 downgrade to B3, six levels below investment grade. The Norwalk, Connecticut-based company has $18 billion of debt. About $1.3 billion will mature in the next two years, and Frontier had $286 million of cash on its balance sheet as of Sept. 30.
Windstream, which Moody’s cut on Nov. 3 to B2, five levels below investment grade, is facing added pressure from a litigious creditor. Hedge fund Aurelius Capital Management is claiming that the rural phone service provider defaulted on its debt during a 2015 spinoff. The company has completed an exchange offer and consent solicitation deal intended to stymie those claims, but Aurelius also plans to challenge that deal in court.
Aside from the “existential threat” from Aurelius’s default claims and litigation, Windstream still needs to resolve an “over-leveraged balance sheet amid deteriorating financial results,” Bloomberg Intelligence analysts wrote in a Nov. 3 report. The Little Rock, Arkansas-based company may face $2.6 billion of debt maturities in 2020, with about $800 million due under its revolver.
Other industry players may face less immediate pressure, but they’re still taking active steps to try to combat the slow industrywide decline. Consolidated Communications Holdings Inc. bought another struggling rural phone operator, Fairpoint Communications Inc., in July. The deal is one of a string of industry moves to combine fiber-optic telecom assets across the U.S as consumers switch to mobile phones or digital voice service offered by cable companies. The combined company had more than $2 billion of debt as of Sept. 30.
Similar deals to consolidate wireline assets include Windstream’s purchase of EarthLink Holdings Corp. and CenturyLink’s acquisition of fiber-infrastructure giant Level 3 Communications Inc. for $34 billion, which was completed this month. Monroe, Louisiana-based CenturyLink had about $25 billion of debt as of Sept. 30. Moody’s rates CenturyLink Ba3, three levels below investment grade.
Loans issued by CenturyLink to fund its acquisition of Level 3, one of the biggest new issues of the past year, have fallen from par and trade around 95 to 97 cents on the dollar, according to Bloomberg data.
Under the decaying landline phone businesses are vibrant fiber-optic networks that can serve as the core of new revenue to help revitalize these companies, said Jennifer Fritzsche, an analyst with Wells Fargo Securities Inc.
“It’s the big pipes that matter, the fiber capacity these companies have is going to be important to future networks,” Fritzsche said.
But the frenzy of fiber deals can only solve the problem if those assets deliver revenue growth to make up for the declines in landlines.
“These are melting ice cubes -- there’s no cliff event for these businesses,” Stodden said. “But right now, they haven’t proven they can stop melting.”
— With assistance by Lisa Lee