High-yield/macroeconomics (fka YIELD)

[Democritus_of_Abdera]

IWA’s management presented at the Raymond James Annual Institutional Investor Conference on March 4.

The 30 minute presentation provides a good overview of the company and its competitive position. A major theme of the presentation was that free cash flow (hence, dividend coverage) is stable and predictable. As to be expected, there was no breaking news; most of the essential information presented can be found in the recent 10K. However, I did learn for the first time that their debt is rated Ba3 (Moody’s) and BB- (S&P).

By focusing upon predictability as an outcome, the CEO and CFO have turned some lemons into lemonade. In particular, IWA has been adversely affected by regulatory constraints that were imposed upon GTE Midwest Inc (as a large interstate telecom) prior to the divestiture of its Iowa rural operations in 1999. IWA’s management argues that two of the constraints have a favorable impact, i.e. they make cash flow predictable because of reduced exposure to negative regulatory change. These constraints are the price caps placed upon GTE Midwest as a consequence of the CALLS Order and the limited ability to obtain subsidies through the Universal Service Fund.

The audio portion of the presentation can be found at: http://ir.iowatelecom.com/phoenix.zhtml?p=irol-eventDetails&c=182669&eventID=1782158#

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Background related to the CALLS Order:

The FCC places price caps on interstate access charges made by large incumbent local exchange carriers (ILECs). IWA’s ILEC, although small, has been subject to the price caps because it assumed GTE’s obligations when it was formed from the divestiture of GTE Midwest in 1999.

The FCC price caps reflect a proposal put forth by The Coalition for Affordable Local and Long Distance Service (“CALLS Order”). The CALLS Order reduces rates for switched access services to meet specific target levels that more closely approximate the cost of providing those services. On the other hand, the CALLS Order permits recovery of a greater proportion of local costs by increasing the subscriber line charge levied on end users.

As a related issue, IWA is currently a party to an industry intercarrier compensation reform proposal under consideration by the FCC—the proposal known as the Missoula Plan, filed with the FCC on July 24, 2006. The outcome of the FCC’s proceedings is uncertain, but it could result in significant changes to the way in which IWA receives compensation from other carriers and end users.

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Background related to Universal Service:

The FCC maintains a “Universal Service” program, to ensure that affordable, quality telecommunications services are available to all citizens. The Universal Service program pays support to rural local exchange carriers for which the costs of providing basic telephone service are significantly higher than the national average.

Although IWA’s ILEC is certified as an eligible communications carrier by the Iowa Utilities Board, it does not receive high-cost Universal Service support because the historical cost of relevant portions of the IWA network are lower than the national average. This historical cost is largely based on the recorded amounts that transferred with IWA’s acquisition of exchanges from GTE Midwest Incorporated.

The CALLS Order provided for a phase-out of implicit Universal Service support mechanisms (which had, in part, relied on setting rates for interstate access above cost). In order to be have more explicit subsidy mechanisms, the CALLS Order created an Interstate Access Support fund as part of the Universal Service Fund. In 2007, IWA’s ILEC received approximately $4.7 million in Universal Service support from this portion of the fund.

IWA’s CLECs are certified to offer service in all Iowa exchanges served by Qwest. Qwest receives no high cost support and no Interstate Switched Access Support for the exchanges served IWA’s CLECs, therefore IWA CLECs also do not receive Universal Service support.