CenturyLink May be A Piece of a Telecom Dividend Investing Strategy; Winstream Probably Is Not

CenturyLink (CTL) is a communications company providing voice, internet and data services across the US. Having a market capitalization of over $26 billion, it is among the largest US telecom companies - and larger than Time Warner Cable (TWC) or half the size of Comcast (CMCSA). It is not as highly leveraged as some of its competitors – its debt to equity ratio is 0.76, as opposed to 1.36 for VZ and 1.59 for FTR. The company’s revenues have grown substantially (to $7 billion in 2010 from $2.6 billion in 2008) and so has its cash flows in the past two years. Its dividend history shows that the stock has been fairly stable in its payments. During 2008, having maintained a stable dividend of about $0.25 for almost 7 years, its dividend shot up to $2.5 per share and it has been steady at $2.9 since 2010.

Adding more promise to its growth, CTL completed the acquisition of Savvis on Friday, July 15, 2011. Savvis Inc is a software solution provider that specializes in hosting and collocation services. CTL will start operating its cloud services under Savvis and will eventually integrate its hosting business with the firm. CTL expects to generate over half its revenues from business clients after the integrsation is complete. It recent merger with Qwest combined with this acquisition, makes it the third largest telecom operator in the US.

CTL’s strong balance sheet, its growth in the last two years and its commitment to growing its business through recent M&A suggest that it is a promising investment, not only for its dividend but also for capital appreciation.

Windstream Corporation provides local telephone, internet, long distance and network access services in rural areas in the US. WIN has been paying out a $1 per share dividend since the middle of 2007, although its ability to continue paying these dividends concerns me. Its revenues increased during 2010 after a slump the year before but basic EPS declined from 0.76 in 2009 to 0.66 in 2010. It increased capital investments during 2010, but these investments impact on income has yet to materialize. Net income in Q1 2011 was $23.5 million, down from $77 million on average in each quarter last year. Net cash flow fell during 2010 and the firm recorded over one billion in negative cash flow. Cash flow has dropped due to lower cash from investing and financing activities.

WIN has total debt of $7.3 billion, and with just $11 billion worth of assets, it is highly leveraged. The company’s debt is rated BB- by S&P. The 5-Yr CDS on the company’s debt traded at 338 basis points (bps) as of July 15, which means that it costs about $33,800 annually to insure $1 million worth of debt of Windstream Corp. The industry average 5-Yr CDS spread is 221 bps. A good look at the balance sheet and the debt of the firm shows that should WIN default on its debt, most of the assets will be used up paying creditors, who have higher priority over stock holders. WIN might be able to generate higher revenues with its recent capital investments, but with falling cash flow and earnings, accompanied by a volatile divided yield, investing in WIN may not be worth its 8% yield.

An equally weighted portfolio of AT&T, Verizon and CenturyLink can provide good exposure to the telecom sector with a fairly stable yield of about 6%. Frontier Communications is a good investment for the high return seeking investor with a fair risk appetite. Windstream Corp, however, might not be a good stock to invest in, at least not until the end of Q3 2011.