The Windstream / Uniti Mess

I’ve been fielding a lot of questions asking about the controversy between Windstream and Uniti. Most people seem to be fuzzy about the relationship between the companies. I’ll try my best to explain the mess that these two companies have created.

Windstream decided in January 2014 to spin off its assets into a REIT, which is a real estate investment trust, a formal kind of investment vehicle defined by law. A REIT generally owns real estate like apartment buildings, shopping malls, or perhaps specialty real estate like storage buildings or college dorms. REITs sell ownership shares to the public, similar to stocks. An investor in a REIT is making a real-estate investment while gaining safety by spreading risk across multiple properties. A REIT is generally expected to pay significant dividends.

Windstream was a traditional mostly family-owned regulated telco. Windstream moved its fiber and copper assets to a REIT owned by the newly-formed Uniti. In the split of assets, Robert Gunderman remained as CFO of Windstream while his brother Kenneth become CEO of Uniti. The Uniti REIT is attractive to investors because Windstream pays roughly $650 million per year in ‘rent’ to Uniti for use of the network. Since formation, Uniti has added other assets to the portfolio, but the Windstream assets still represent 70% of its assets.

The current mess was triggered when Aurelius Capital, a lender to Windstream, filed a lawsuit claiming that the REIT arrangement was a violation of Windstream’s corporate bonds. Windstream immediately filed for bankruptcy earlier this year when a judge ruled in favor of Aurelius Capital.

Windstream and Uniti immediately went to mediation to try to resolve the issues raised by the Aurelius Capital lawsuit. Recently it became clear that the two companies could not resolve the issues, and Windstream and Uniti are now going to court to decide the future of the REIT arrangement.

The court case is mostly going to have to resolve an accounting issue. At issue is the question of whether the payments from Windstream to Uniti are rent or if they are instead a disguised financing arrangement. This difference is vital to the survival of Windstream and Uniti. If the payments are rent, as Uniti maintains, then Windstream would have to pay rent before they make debt payments to Aurelius Capital and others. Further if the payments are rent then Wondstream would have to continue to pay Uniti to use the network. However, if the payments to Uniti are considered to be a financing arrangement, then those payments become unsecured debt and go to the end of the line in payment priority.

The ‘rent’ payments to Unity equate to a $6.9 billion long-term liability of Windstream. The company has another $4.8 billion in senior debt and $1.5 billion of unsecured debt. If a court decides that the payments to Uniti are rent, then the bankruptcy court is likely to erase some of the debt owed to Aurelius Capital and others. However, if the payment due to Uniti are unsecured debt, then a bankruptcy court is likely to erase some of the Uniti debt, which would put Uniti out of business.

Windstream would see a huge windfall if they could walk away from some or all of the Uniti payments – however, they’d be in the awkward position of not owning their networks. It’s hard to picture what happens to the networks if Uniti goes bankrupt.

There are several factors that the courts will use to determine if the Uniti payments are more like debt or rent. For example, rent is generally determined by fair market value of the property. The copper networks are nearing end-of-life and it’s hard to argue that the annual payments to rent copper shouldn’t be declining. However, the payments from Windstream to Uniti increase every year during the 35-year lease term. When examining all of the arguments made in this case, from an accounting perspective it seems that Windstream has the stronger arguments – but the courts will have to decide.

If Windstream is required to continue the full payments to Uniti, the telco will be cash-strapped for the foreseeable future. It seems that Windsteam feels confident they will win the lawsuit because they recently announced a plan to bring gigabit fiber to 60% of its customer base over the next 10 years, predicated upon getting out from under the Uniti debt payments. This means that the broadband future for a lot of communities rides upon the court deciding that the Uniti payments are debt and not rent.