Should We Follow Insiders Into Windstream?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There is a company which is trading around its 52-week low and insiders have been accumulating its shares. Does it sound interesting to you? To me, yes! That is the case of Windstream (NASDAQ: WIN). At the end of March, Windstream traded at around $7.90 per share while its 52-week low was $7.86 per share. The stock has advanced a bit to nearly $8.8 per share.

Since the beginning of March, the CEO and other directors have bought around 50,500 shares in the company, with total transaction value of more than $410,000. Let’s take a closer look at Windstream to see whether or not we should follow the insiders.

Business snapshot

Windstream is the provider of advanced communications and technology solutions, including managed services and cloud computing to enterprises in 48 states in the U.S. and the District of Columbia. Windstream currently has a robust and flexible network of 115,000 miles of fiber optic plant, operating 23 data centers across the country.

The majority of its revenue, $3.6 billion, or 60.7% of total 2012 revenue, was from service to business customers. Service to consumers revenue ranked second at around $1.34 billion in 2012. In 2012, Windstream had around 638 customers, of which 460 were small businesses.

Increasing revenue but declining profit

Interestingly, over the past five years, while Windstream’s revenue has been on the rise, from $3.18 billion in 2008 to $6.16 billion in 2012, its net income has dropped significantly, from $413 million to only $168 million during the same period. The decline in the net income was due to the significant increase in the cost of revenue, SG&A, interest expense, and depreciation and amortization.

As depreciation and amortization cost is a non-cash expense, its operating cash flow has witnessed consistent growth in the past five years, from $1 billion to nearly $1.8 billion. Its free cash flow has been consistently positive, fluctuating in the range of $527 million-$823 million. In 2012, its free cash flow stayed at $676 million.

Weak balance sheet

As Windstream incurred a lot of interest expense, its leverage level is quite high. That would make value investors worried. As of December 2012, Windstream recorded more than $1.1 billion in total stockholders’ equity, only $132 million in cash, and as much as $8.11 billion in long-term debt and capital lease obligations.

In addition, the company had more than $880 million in current maturities of long-term debt and capital lease obligations. Because Windstream has been growing via mergers & acquisitions, it also had a huge goodwill and intangible assets of more than $6.6 billion. Thus, the tangible book value was negative at nearly $9.5 per share.

Generating the highest operating margin among peers

At around $8.50 per share, Windstream is worth around $5 billion. The market values the company at 6.1 times EV/EBITDA. It seems to be much more profitable with much higher operating margin than its bigger peers, including AT&T (NYSE: T) and Sprint Nextel (NYSE: S).

Sprint has the lowest operating margin of only 0.9%, while AT&T has an operating margin of 10.2%. Windstream is the most profitable with more than 15.9% in operating margin.

Among the three, AT&T is the biggest company with the highest valuation. At $38 per share, AT&T has a total market cap of around $208 billion. The market values AT&T expensively at 9.5 times EV/EBITDA. Sprint is the cheapest valued of the trio. At $6.30 per share, Sprint is worth around $18.9 billion on the market. The market values Sprint Nextel at around 5.1 times EV/EBITDA.

But high leverage keeps me away

I am worried about Windstream's overleveraged balance sheet, with a debt/equity ratio of as much as 7.3, while AT&T and Sprint Nextel’s debt/equity ratio is only 0.7 and 3.4, respectively. Thus, even though insiders have accumulated Windstream shares in the past month and the business has been generating good cash flow, I would stay away from Windstream at its current price. 

Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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