Reason for Report: 2Q14 Earnings Update

Sep 18, 2014

Windstream Corporation (NYSE: WIN) $11.07

Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.

Prev. Ed: Jun 5, 2014; 1Q14 Earnings Update

Brokers’ Recommendations: Neutral: 75.0% (9 firms); Negative: 25.0% (3); Positive: 0.0% (0) Prev. Ed.: 6, 4, 1

Brokers’ Target Price: $9.89 (↑$1.82 from the last edition; 7 firms) Brokers’ Avg. Expected Return: (10.7%)

Note: A Flash Update was done on Aug 7, 2014; 2Q14 Earnings Update

Portfolio Manager Executive Summary

Windstream Holdings Inc. (WIN) provides rural communication services including local, long distance voice, high-speed Internet and video to both residential and business markets in 16 states. The company operates through its sole Wireline segment.

Of the 12 firms in the Digest group covering the stock, 9 assigned neutral ratings while 3 provided negative ratings. None of the firms rated the stock positively. The target prices range from $6.00 to $12.00, with the average being $9.89.

The following is a summarized opinion of the diverse brokerage viewpoints:

Cautious: Neutral or equivalent outlook (9/12 firms): These firms remain on the sidelines in view of competitive pressure, as well as continued access-line erosion faced by Windstream, partially offset by ARPU growth. Loss of market share in the small business segment is likely to be detrimental to the company’s future growth. The firms, however, are optimistic that the REIT conversion will stimulate growth for Windstream endowing it with a favorable capital structure. Moreover, Windstream’s growing data center colocation and stable broadband business, particularly in the consumer division, bodes well for the company. Additionally, the firms expect Windstream to increase its market share with enterprise customers.

Bearish: Sell or equivalent outlook (3/12 firms): These firms believe that the REIT conversion highlights the carrier’s need for higher capital expenditure, which will offset the benefits of restructuring. Further, they believe the spin-off is an intelligent way to cut dividend and expect the new Windstream to trade at a significant discount compared to its peers. They are apprehensive about the company’s fate in the coming months in anticipation of competitive pressure, loss of small business customers as well as continued access-line erosion. The firms also believe that the cut in capital expenditure and cash taxes failed to lift the cash flow outlook, suggesting 2H14 EBITDA pressure. All these factors taken together force these firms to remain bearish on the company.

A) Windstream has formed a new publicly traded company Windstream Holdings Inc., which commenced trading on Nasdaq under the existing ticker symbol "WIN". Windstream Holdings, Inc. is now the parent company of Windstream Corp. and its subsidiaries.

B) Windstream is the sixth-largest U.S. carrier and the third largest rural incumbent local exchange carrier (ILEC), servicing 3.21 million access lines and 1.15 million high-speed Internet customers. The company also operates about 118,000 fiber route miles.

C) The company's largest markets include Lincoln, Lexington, Sugarland & Texarkana, and Concord.

D) The company continues to invest in long-term growth initiatives such as fiber-to-the-tower (FTTT) deployment, data center expansion and broadband network capability to support incremental revenue. With the rise in demand and contract wins, Windstream is ramping up its FTTT constructions. Windstream completed the construction of approximately 4,700 towers and 400 more are presently under construction.

E) The company completed its acquisition of PAETEC Holding Corp. on Dec 1, 2011. Apart from financial benefits, the company has also gained significant momentum in its enterprise market with nation wide coverage of fiber network cables. The acquisition increased the opportunities in cloud computing and managed services. Windstream is also planning to introduce customized business solutions that will help improve its competitive position in the industry.

F) Management expects capital expenditure for 2014 in the range of $800–$850 million and adjusted free cash flow of $775–$885 million.

G) The company has one of the highest dividend yields in the industry. In 2014, Windstream expects dividend payout ratio (as a percentage of estimated free cash flow) of 68–78%.

General Outlook

Windstream’s strategy to improve revenue mix with an emphasis on broadband and business continues to yield improving revenue trends in both business and consumer channels. However, its wholesale channel remains under pressure due to lower switched access revenues and suspension of certain products. According to the firms, the company’s focus on expanding its broadband business via acquisitions and investments in fiber-to-the-cell projects and data center expansion are expected to propel growth, going forward. Further, Windstream’s deleveraging initiatives and refinancing activities are expected to generate healthy cash flows, subsequently attracting investors through the potential for a high dividend payout.

Sep 12, 2014

Overview

Headquartered in Little Rock, AR, Windstream Holdings Inc. is one of the largest U.S. rural local exchange carriers (RLEC), primarily operating in rural communities in the southern and southwestern parts of the U.S. Windstream, together with its various subsidiaries, provides local and long distance phone service and high-speed Internet services to residential and business customers across 29 states. The company also offers digital television service and a vast range of IP-based voice and data services as well as advanced phone systems and equipment to businesses and government customers. Windstream is offering voice and data service with other services provided by its subsidiaries, including long distance and Internet services.

Zacks Investment Research Page 2 www.zackspro.com Windstream reorganized its operations in 1Q09 and integrated its Product Distribution segment into its wireline operations. Through its product distribution subsidiary Windstream Supply LLC (Windstream Supply), the company offers a large variety of telecommunications-related products to affiliated and non- affiliated communication companies. As a result of the restructuring, Windstream currently has only one operating segment, the Wireline Segment. The Wireline Segment consists of the company’s retail and wholesale telecommunications services and operates local and long-distance telephone services, data and special access, switched access and interconnection, high-speed Internet and video services. Windstream primarily books revenues from its local wireline services and switched access and interconnection fees.

The analysts have identified the following factors for evaluating the investment merits of WIN:

Key Positive Arguments Key Negative Arguments  Diversification: The competitive local exchange  Access Line Losses: Competition from wireless carrier (CLEC), fiber network, and data center carriers is likely to continue to cause access line acquisitions are likely to continue to provide losses, which could adversely affect the operating additional expansion opportunities for Windstream, results of Windstream. thereby further diversifying the business away from  Competitive Threats: Competition will continue to declining sources of revenue. intensify and may result in reduced revenues. The  High Returns: The company provides data center company faces competition from many products to its small business and government communication service providers, including cable customers that will likely drive strong returns going operators offering video, data and Voice-over- forward. Internet Protocol (VoIP) products, wireless  Broadband Growth: Windstream continues to carriers, long distance providers, competitive local invest in its broadband network to offer faster exchange carriers, Internet providers and other speeds in its high-speed Internet offerings that will wireline carriers. aid in developing enhanced services and bundled  Debt-Loaded Balance Sheet: The acquisitions product offerings. have strained the balance sheet as the company is  Acquisitions: Windstream continues to acquire predominantly funding most of them through debt. smaller rural carriers to expand its customer base.  Regulatory Funding: Windstream continues to The acquisitions will stimulate the company’s experience a decline in subsidy payments growth going forward. received from the Federal Universal Service Fund  High Dividend: Windstream’s healthy free cash (USF), which represents an important source of its flow, mostly generated through the ongoing cost- access revenues. cutting initiatives, will support the high dividend  Leverage: Additional acquisitions can impact the payout. company’s leverage position which in turn can impact its cash flow position.

For more information on the company, please visit its website: www.windstream.com

Note: Windstream’s fiscal year coincides with the calendar year. Sep 12, 2014

Zacks Investment Research Page 3 www.zackspro.com Long-Term Growth

Going forward, the firms believe Windstream will remain focused on expanding its service offerings to businesses with VoIP services, data bundles, cloud and managed services; data center co-location; fiber transport as well as increasing distribution channels. The company has also revealed plans to expand its Carrier Switched Ethernet services across the U.S. These initiatives, along with disciplined expense management will lead to improving revenue trends.

Notably, Windstream is planning to spin off some of its network assets to form a publicly traded real estate investment trust (REIT). The spin-off is expected to boost the company’s financial strength and support network development. In terms of infrastructural development, with the new spin-off, the company aims to offer faster broadband speeds and more robust performance to its consumers. The financial synergies arising from the divestiture will allow the company to expand the availability of 10 Mbps Internet service to more than 80% of its customers by 2018. The tax-free transaction will enable Windstream to gain significant financial felicity by reducing its debt by approximately $3.2 billion and stimulate free cash flow. Additionally, the new REIT will offer significant benefit to shareholders through an attractive dividend, and generate revenue synergies through investments, acquisitions and lease escalation. Subject to customary regulatory approvals, the company expects to close the transaction in 1Q15.

Windstream is expected to register high profits in the coming quarters on the back of its strong national footprint plus strategic growth across segments and a capital efficient business model. The company is optimistic about gaining long-term success on the back of improving sales, cost-cutting initiatives and planned pricing initiatives.

With a growing demand for enterprise products, Windstream expanded its Advanced Application Reporting (AAR) product countrywide for IT professionals. The expansion will boost customer accretion, primarily in the enterprise segment that would in turn drive revenue growth. Windstream also plans to introduce customized business solutions that will improve its competitive position.

The firms believe that the company’s strategic position will improve by further shifting its revenue mix to business and broadband, expanding service offerings, increasing wireless data backhaul services and offering managed services, cloud computing and co-location. Windstream opened three data centers last year and recently opened another one in Charlotte, NC. The company plans to expand the new center by more than 20,500 square feet in a phased manner. These units are being constructed to cope with the growing demand for data center and cloud-based services from customers all over the nation. On the other hand, the firms expect the company’s capital expenditure to decrease in the future and lower its interest expenditure thus providing the opportunity to improve shareholder returns.

Further, the company will continue to invest in long-term growth initiatives such as FTTT deployments, data center expansions and broadband network capabilities that will fuel revenue growth. The firms expect investments in the fiber and broadband along with recent acquisitions to enhance Windstream’s long-term financial and operational performances. Windstream expects cash taxes to escalate in 2015 as compared to 2014, which could hurt the company’s free cash flow. However, if bonus depreciation is extended to 2015, its cash tax liability will decrease, resulting in lowering of the pay-out ratio. Sep 12, 2014

Zacks Investment Research Page 4 www.zackspro.com Target Price/Valuation

Provided below is the summary of valuation or target price:

Rating Distribution Positive 0.0%↓ Neutral 75.0%↑ Negative 25.0%↓ Digest High $12.00↑ Digest Low $6.00 Avg. Target Price $9.89↑ Total No. of Analysts with Target Price/Total 7/12

Risks to the achievement of target price include continued strong competition from both wireless and cable companies, potential changes to universal service fund, compensation subsidies, changes to dividend tax law, and integration risks.

Recent Events

On Aug 7, 2014, Windstream reported 2Q14 adjusted earnings per share (EPS) of $0.03, short of the Zacks Consensus Estimate of $0.08 and also lower than the 2Q13 number of $0.07.

Pro forma revenues decreased 2.4% year over year to $1,466 million in 2Q14 which lagged the Zacks Consensus Estimate of $1,475 million. Total service revenue fell 27.7% while Product revenue reduced 8% year over year.

On Aug 6, 2014, the company’s board of directors announced a quarterly dividend of $0.25 per share, payable on Oct 15, 2014 to shareholders of the record on Sep 30, 2014.

Revenues

According to the company press release, revenues decreased 2.4% year over year to $1,466 million in 2Q14. Total Service revenues fell 27.7% while Product sales reduced 8% year over year.

Subscribers: During 4Q13, total access lines, which include voice lines, high-speed Internet and digital television customer, decreased 5.1% year over year to 3.21 million. Voice lines and digital television customers witnessed a year-over-year decline of 6.3% each, while high-speed Internet fell 5% year over year.

Outlook

Windstream expects business revenues to grow in 2014 based on the steps taken to improve both sales and service delivery. Management also anticipates a 8–9% decline in wholesale revenues in 2014 owing to lower intrastate access rate and fewer minutes of use. Continuous migration from traditional voice to IP services will also affect its performance going forward. As a result, the company expects revenues to be down 2.5% to up 1% year over year in 2014.

Zacks Investment Research Page 5 www.zackspro.com Windstream executed an expanded advertisement campaign to improve brand awareness, which will lead to sales growth. Further, the carrier has rolled out certain price increases, which according to the firms will improve the prospect of business revenues in 2H14. Further, Windstream’s effort to merge its billing, provisioning and sales management system into a single platform will allow the carrier to efficiently manage its enterprise customers, thus driving sales. The company expects to convert the remainder of PAETEC systems by the end of this year.

Windstream continues to expand its broadband network to meet the unprecedented demand for data from both business and consumer. Apart from that, the investment in IP (Internet Protocol) services and fiber expansion will transform Windstream into an enterprise focus company with enhanced capabilities.

The firms believe that the company is well poised to take advantage of a number of growth opportunities such as fiber-to-the-tower (FTTT) deployment and broadband network capability. The company also expects capital investments in the FTTT business to reduce in 2014 and targets to finish the year with 5,200 towers. With respect to broadband expansion, Windstream has reached out to 38,000 new homes and expects to complete the stimulus project this year by bringing broadband services to 75,000 new homes. These new investments will allow Windstream to retain its competitiveness in rural regions by offering higher speed and capacity along with additional revenue opportunities via incremental service sales. However, the firms believe that the merger between large cable companies could put pressure on CLEC (competitive local exchange carriers) carriers like Windstream, particularly for its enterprise business.

Further, the company’s focus on adding a number of data centers, employing efficient sales people to boost revenues and render greater customer satisfaction while focusing on channel business will likely generate higher revenues. Data centers will manage Windstream’s offering of cloud computing, dedicated hardware, data storage and managed services. This will aid the company in extending services to business customers more efficiently and at a lower cost. Recently Windstream opened a new 20,000 square feet facility in Chicago and is well equipped to support its new storage service powered by EMC Corporation.

The company is focused on increasing wireless data backhaul services and offering managed services, and co-location, which remain accretive to its near-term growth. A major initiative for Windstream in 2014 will be to deploy a 100 gig solution across its long haul network to meet the growing bandwidth demand of its enterprise customers.

Further, decline in small business customers poses a major concern for Windstream. The firms believe that the large business customer wins are not enough to offset the company’s loss from small ones, which is thus dragging its business down. The cautious firms believe until the company manages to increase large business customers, business will remain essentially flat. Further, some firms believe that the company could face increased competition as cable MSOs target small business customers over the coming years. This in turn could reduce broadband ARPUs going forward.

Margins

According to the company press release, adjusted OIBDA (excluding non-cash pension expense, non- cash stock-based compensation and restructuring charges) was $543.4 million in 2Q14, down 6.5% year over year.

Outlook

The firms believe that revenue growth is the key to margin improvement. Some of the firms expect higher cost experienced in 2Q14 to remain elevated, thus affecting margins. However, investments done on promotional activities are expected to generate future revenues by stimulating market demand. These firms

Zacks Investment Research Page 6 www.zackspro.com believe that the steep access charge rate reduction that the company witnessed in 2013 has passed and the future reduction is expected to be thinner, thus impacting the margins lesser.

Some firms believe that the carrier will use the FCF to reduce its leverage thus lowering the interest expenses and enhancing profitability. The $3.2 billion reduction in debt as part of the spin-off along with the refinancing activities of 2013 will lower the cash interest by $45 million during 2014. However, the firms also expect margins to remain under pressure owing to loss of high margin voice revenues.

Earnings per Share

According to the company press release, adjusted EPS was $0.03 in 2Q14, which was lower than $0.07 reported in 2Q13.

Outlook

According to the firms, the REIT conversion will lead to cash flow savings in addition to lower dividend, which will be reinvested thus boosting the return prospect. Further, Windstream expects its cash taxes to be lower to the tune of $15 million in 2014, thereby boosting the bottomline. Sep 12, 2014

Sep 12, 2014

Research Analyst Kaustav Sarkar Copy Editor Anindita Sinha Content Ed. Pinky Ghosh Lead Analyst Pinky Ghosh QCA Nalak Das No. of brokers reported/Total 12/12 brokers Reason for Update 2Q14 Earnings

Zacks Investment Research Page 7 www.zackspro.com