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UBS Says These Four RLECs May Also Thrive as Telecom REITs

The blockbuster announcement the other day that Windstream Holdings Inc. (NYSE: WIN) is planning to reform part of the company as a real estate investment trust (REIT) surprised the market and the stock took off for investors, who sadly saw most of the gains returned. For the high-yielding rural local exchange carriers (RLECs), the transformation of some assets to REIT status makes tremendous sense from a taxation standpoint, and other companies may be right behind in the transformation.

Windstream reported its plans to spin-off its fiber and copper network, and its real-estate assets (excluding data centers and equipment) into a publicly traded REIT, pending regulatory approval. In a new research report, the telecommunications team at UBS thinks that the other RLECs might also be inclined to follow the same path.

Here are the four RLECs that may choose to go the REIT route to improve their tax situation for shareholders.

Cincinnati Bell Inc. (NYSE: CBB) provides integrated communications solutions, including local and long distance voice, data, high-speed Internet, video and wireless services, that keep residential and business customers in Greater Cincinnati and Dayton connected with each other and with the world. In addition, enterprise customers across the United States rely on CBTS, a wholly owned subsidiary, for efficient, scalable office communications systems and end-to-end IT solutions.

Cincinnati Bell owns approximately 44% of CyrusOne, which provides best-in-class data center colocation services to enterprise customers through its facilities with fully redundant power and cooling solutions that are currently located in the Midwest, Texas, Arizona, London and Singapore. These are the assets likely destined for REIT status. The Thomson/First Call consensus price target for the stock is $4.19. Shares closed Wednesday at $3.92.

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CenturyLink Inc. (NYSE: CTL) is the largest of the RLECs and is expected to get a large dose of government money to provide Internet service in rural areas. Analysts believe the company is expected to get the largest chunk of the money, at $497 million. This compares to $350 million in frozen support it received in 2013.

The company is one of the largest telecommunications firms in the United States and a global leader in cloud infrastructure and hosted IT solutions for enterprise customers. Again, these are assets that could be headed for REIT land. Investors are paid an outstanding 5.9% dividend from the company, which looks to be sustainable. The consensus price target is $34.50. CenturyLink closed Wednesday above that figure at $39.77.

Frontier Communications Corp. (NASDAQ: FTR) is another company designated to get a large chunk of government money to provide rural Internet service. Frontier stands to receive $303 million from the government this year, should it choose to participate. It received support of $150 million in 2013.

The company offers broadband, voice, satellite video, wireless Internet data access, data security solutions, bundled offerings, and specialized bundles for residential customers, small businesses and home offices, and advanced communications for medium and large businesses in 27 states. Investors receive a large 7% dividend. The consensus price target is $5.73. Frontier closed trading Wednesday at $6.65.

Telephone & Data Systems Inc. (NYSE: TDS) provides wireless; cable and wireline broadband, TV and voice; and hosted and managed services to approximately 5.8 million customers nationwide through its business units, U.S. Cellular, TDS Telecom, OneNeck IT Solutions and Baja Broadband.

Assets that could be headed for REIT status include the cloud computing, colocation, hosted application management, and hosted and managed services; and planning, engineering, procurement, sales, installation and management of information technology infrastructure hardware solutions, as well as printing and distribution services. The company pays investors a 2.1% dividend. The consensus price objective is $34.75. The stock closed at $25.28.

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While RLECs have about 6% of the total U.S. telecom business, they are critical as they are the only companies in many cases providing services in rural areas. Rolling assets into REIT spin-offs may make great sense for tax reasons, and it help to support current dividend payouts.