Windstream Corp. (WIN), the fifth largest local telephone carrier in the U.S., agreed to buy Q-Comm Corp., a privately held fiber-optic network operator, for $515 million plus debt. The acquisition is in sync with the consolidation trend in the telecommunication sector.

Windstream will acquire Q-Comm’s two subsidiaries, Kentucky Data Link Inc. (KDL), a fiber services provider in 22 states, and Norlight Inc., which provides local exchange services mainly in the Midwest.

As a part of the transaction, Windstream plans to pay about $278 million in cash and issue 20.6 million common shares valued at $237 million based on Windstream’s closing share price on August 17. In addition, Windstream will repay the estimated Q-Comm debt balances of approximately $267 million. The transaction has been approved by the boards of both the companies and is expected to close in the fourth quarter of 2010.

Broadband Internet remains a significant growth engine for Windstream. The acquisition of Q-Comm will enhance Windstream’s growth prospects in broadband and enterprise businesses. The company expects to achieve annual synergies of approximately $25 million from the acquisition.

Windstream will invest $20 million on the expansion of its fiber-optic network in order to support its wholesale business to wireless carriers and expand its opportunities in wireless backhaul. Near-term investments in wireless backhaul and enterprise businesses are intended to maximize Windstream’s long-term business potential. Though the higher investment will result in slight free cash flow dilution in the near term, it will lead to a significant free cash flow accretion in the long term.

Windstream’s healthy free cash flow, mostly generated through the ongoing cost-cutting initiatives, will support the high dividend payout at least over the near term. The company is currently paying an annual dividend of $1.00 per share. This represents a high dividend yield of approximately 8.7% compared with its peers AT&T (T) and Verizon Communication (VZ). Both companies have dividend yields of approximately 6%.

Windstream offers a wide range of attractive services in an effort to boost customer retention and fend off competition. In keeping with this, the company is marketing Triple-Play services that combine voice (local/long-distance), video and broadband Internet services to its residential customers. Moreover, the company is expanding the coverage of its next-generation VoIP solutions and acquiring smaller rural operators to expand its customer base and revenues.

However, wireless services from Tier-1 carriers such as AT&T and Verizon and broadband services by leading cable operators such as Comcast (CMCSA) and Time Warner Cable (TWC) are impeding Windstream’s addressable market. Windstream’s significant debt exposure, which is further intensified by its acquisition-related activities, is also a cause for concern.

We are currently maintaining our Neutral recommendation supported by the Zacks #3 (‘Hold’) Rank.

Zacks Investment Research

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