Telecom (Wireless & Wireline): Jason Kim

Sector View:

We have a Neutral coverage view on Telecom. Wireless trading levels continue to be driven by the market’s pricing of the probability of success of the TMUS/S merger and while we take no view on the probability or possibility of a merger, we do note that postpaid adds have been strong and ARPU has stabilized so far this year.

In the wireline space, after strongly correlated 2017 operational performance, we’ve seen the opposite story play out through 2018 - with the new RLEC story being about diverging performance. The CTL story has been dominated by synergy realization and shedding of unprofitable contracts, which have driven worse than expected revenue performance across its segments but margin performance has been much better than expected. We believe the topical discussion through 2019 will not be how significant cost extractions can be, but more can top line trends inflect. For WIN, the company has shown some positive operational trends, however the story continues to be driven by the bondholder litigation and the realization of asset sales, neither of which has gained much traction up to this point. Finally, FTR‘s EBITDA performance has been modestly better than we had expected for 2018, but subscriber metrics have not showed a sustained level of improvements. While our fundamental outlook hasn’t changed much throughout the year, bond valuations have, as the structure has sold off significantly since the beginning of October. This has prompted us to upgrade FTR to OP from IL recently as we look for attractive total return opportunities.

Source: Company data, Goldman Sachs Global Investment Research

Trade idea: Buy FTR 10.5s of 2022 (CTF) and FTR 7.125s of 2023 (Legacy) as a

package. We view the CTF 10.5s of 22 and legacy 7.125s of 2023 as the best way to express a long in the structure given the variety of outcomes the company could experience. We estimate IRRs would be in the 5-13% (with the legacy 2023s having better IRRs given much lower dollar price net of coupon differences) if the management team does not engage in any liability management activities before the 2022 maturity wall. Should management implement a transaction, we believe these bonds both benefit disproportionately. The CTF 10.5s’ final maturity means that the entire issue needs to be addressed as opposed to possibly only partially in the case of the CTF 11s of 2025. The legacy 2023s mature just 4 months after the CTF 10.5s of 2022 and we do not believe the company will go through major liability management exercises targeting the 2022 maturities only to have an $850 mn maturity just 4 months afterwards.

Recent valuation reset lower the bar: FTR bonds are down 8-12 points since the start of October, which we primarily attribute to crowded positioning amongst HFs. We believe FTR has been a core net long position for the credit/distressed HF community for some time. 3Q18 results were mixed with better EBITDA performance offset by weaker data net adds vs. our expectations. While the management team did reduce its 2018 guidance, we did not view the cut as surprising based on our conversation with investors. We estimate that every $100 mn in EBITDA equates to 4-5 points in bond recovery. Therefore the drop in bond prices over the past two months effectively close the gap between market implied EBITDA vs. our estimates in the outer-years, which we believe reduces the risk that FTR structure underperforms should fundamentals disappoint vs. Bloomberg consensus.

Key risks to our view: Downside risks include larger subscriber losses and margin compression from top-line pressure and negative mix change.

Goldman Sachs and/or one of its affiliates is acting as a financial advisor in connection with an announced strategic matter involving the following company or one of its affiliates: Tenet Healthcare Corporation