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Frontier Communications Corporation (NASDAQ:FTR)

Deutsche Bank Leveraged Finance Conference

October 2, 2013 12:05 AM ET

Executives

Robert Starr - SVP and Treasurer

Analysts

Anthony Klarman - Deutsche Bank

Question-and-Answer Session

Anthony Klarman - Deutsche Bank

We are going to get started, sorry about the delay, again my name is Anthony Klarman, I cover Telecom, Cable and Satellite for DB and want to thank everybody for coming. This is going to be just a moderated Q&A session. We've got 28 minutes left, so we'll do it in a more rapid fire way than we have before. With us here from Frontier today is the Company's Treasurer, Robert Starr and I'm going to just hop right into the questions.

Robert can you just talk to us a little bit about, again remind us of just the underlying core trends in the Verizon properties and how you've seen those trends change overtime and where you think ultimately you can get that sort of cohort of properties to rubble to the existing Frontier base?

Robert Starr

Sure, compared to our legacy properties in which we have very high penetration rates, the Verizon properties which were acquired in 2010 had much lower market share and we think that's really the white space for us. We have put a lot of money into our backbone, we built out speeds and we built outreach to a lot more customers in those areas, and as a result the simplified packages that we put out now, the value proposition in our bundles are making it so that we are really getting some very good traction in trying to bring the market share on those properties to a much higher level.

Anthony Klarman - Deutsche Bank

And I guess can you talk a little about ultimately how you view further consolidation of similar assets like that, it's a business of scale, I think you over achieved your synergy expectations with Verizon, obviously once you got in there. And saw what you're able to do, is that -- do you feel like you need to actually sort of bulk up and bolt on more or are you looking at additional opportunities outside of the residential access line space?

Robert Starr

Well I mean there's a lot of discussion about consolidation in the industry, and I suspect we'll see that. Right now we think there's a lot of white space in the business for ourselves in terms of growing our market share, trying to upsell folks to higher speeds, selling on the additional products like our Frontier Secure. So while there may be opportunities out there to increase scale, I think right now, we've got our heads down and we're focused on just improving our business -- all the white space that we see in front of us.

Anthony Klarman - Deutsche Bank

Turning over to the audience, maybe get some questions from them. Anybody wants to start with a question before we move on? Everybody's being shy.

So if you could talk a little bit about your capital structure, obviously you're outside of your leveraged target or net leverage goal and maybe it’s the right way to say it and not a target. How long do you envision it taking you to get down to that level, and is that the point, how much farther or closer towards that level do you feel like you need to be to be in a position where you can think about bigger bytes in organic growth and M&A?

Robert Starr

Well our target is 2.5 times net debt to adjusted EBITDA, and there is no specific timeframe to get to that, I think it isn’t a target number it's something that our executive management and our Board discuss frequently. And so we would like to get there, but our basic capital allocation model is to make sure that we use our free cash flow first and foremost to put money into our network and to make sure that have a very reliable speeds and capacity for our customers. Next we want to make sure we protect our dividend, so we want to keep our payout dividend ratios at a very attractive level.

And then we're going to take all of our residual free cash flow and we're going to think about how to best use it to pay down debt and hit those leverage targets. We did a large debt offering earlier this year and we did a whole bunch of liability management transactions and we've really cleared the path for our debt for the next many years, so we don’t have to be in the market until at least 2017, 2018. And so between the cash on balance sheet and our free cash flow generation, we really feel as if it's a very manageable number for us.

In terms of what leverage would be appropriate for an acquisition, I think if there was an M&A opportunity that made sense, I think we'd look at it based on the merits of what that does for our business and our opportunities going forward and not necessarily where it moves the needle on the leverage. But it's a little hard to talk about transactions when there really isn't one out there for me to speak to.

Anthony Klarman - Deutsche Bank

Yes, I mean there's been talk of potentially the larger ILECs selling some of their residential lines to free up capital to deploy elsewhere. And I guess just theoretically and this goes to the other question that I had is, are you still at a point where economies of scale benefit the business and how do you think about the fact of just getting bigger when in fact the guys who are really big in the ILEC space are actually talking about getting smaller or potentially exiting that space?

Robert Starr

I mean we're very focused on cost savings, I think economy scales do make sense, but at the moment really the focus has been on our business that's in front of us and all opportunities that are in front of us. And we all know that everything is sellable at a particular price and so if opportunities arise we'll take a look at them.

Anthony Klarman - Deutsche Bank

From the audience, any other questions, yes Brett.

Unidentified Analyst

[Indiscernible] Can you talk a little bit about your product in the residential space versus your competitors; it seemed that the residential model was all about running broadband into the homes. What are you building up against in your market to maybe help differentiate that to get more familiar with [indiscernible]?

Robert Starr

Well about 95% of our customers also have access to cable, so cable is a competitor in pretty much all the markets. We're trying to provide customers with a very simple offer, one they can quickly understand and appreciate, so we currently have no contract, no termination fees, no modem fees, no surcharges, we guarantee the price to them for two years and importantly no step up charges so this is what we do see from our competitors. So, when we talk to our customers about the value proposition, about the fact that they are going to have a very competitively priced product for the next two years, it’s really resonating with them very well.

If they want to take it up to higher speeds, they can -- our basic product is a 6 Meg product and that’s what a majority of our customers take. But 43% of our footprint can get 20 plus Meg speeds right now. And during the first quarter 15% of our customers opted for a higher speed, in the second quarter it was about 20%. So that tells you two things; number one, we are providing the speed that our customers want but also it shows you the opportunity that we have to upsell them and get to higher MRC when they go to 12 Meg it’s $10 per month, when they go to 20 it’s an additional $10 per month.

Unidentified Analyst

And can you talk a little bit about the CapEx program how you think about the correct CapEx level for the Company and what you think you can accomplish in terms of a broadband network build [indiscernible]?

Robert Starr

So, the CapEx budget has been quite high for several years, it came down to 750 million last year and this year’s range is 625 to 675. We think that there is some opportunity to actually reduce that again next year while achieving everything that we want to achieve. And the reason for that is because we’ve been doing build out for reach for a number of years now. We’ve taken it up from 60% in the Verizon properties up to about 89%. And we also have CAF money that we’ve received that helps us build out, we received $72 million in the CAF 1 -- Phase I and that enabled us to build out to an additional 92,000 homes. So we’ve done a lot of the reach and that’s much more expensive than the expenditures for speed.

In addition, we’re doing -- we have CapEx expenditures this year for the tower build out and we think that’s going to be wrapped up pretty much by year-end maybe going into the first part of next year. And so there is another opportunity for -- or a place where the CapEx budget may come down, but we are very focused on continuing to spend in enhancing speeds to our customers.

Anthony Klarman - Deutsche Bank

Yes, and I guess maybe as a follow-up question to one that Brett asked, a lot of cable and wireless companies have been here presenting over the course of two days. And there is a lot of talk about mobile video and video delivery outside the home. And ultimately how mobile is sort of going to take over the marketplace and one of the things that people have asked is, is there a potential threat from LTE, if LTE winds up getting built out 200 million and then 250 million and then 280 million pops. Is there the potential for further displacement of some of the maybe slower DSL type speed, access lines? And how do you view potentially wireless as part of a longer-term threat and is there an opportunity for you to partner with people to address that?

Robert Starr

LTE is out there, people are using their wireless it does have capacity constraints. It is expensive. We’re finding that a lot of people prefer to use their wireless, but then when they get to the home they offload that data onto our network because they’re not going to be [indiscernible] in the same way as on the wireless. And so while it is another technology and it is the competitor in that respect, we haven’t seen it as a major threat just yet.

Anthony Klarman - Deutsche Bank

Yes, is ether one other one in the audience [indiscernible]?

Alright, you mentioned the dividend earlier and you guys have already taken the proactive step of changing your dividend payout when you announced that initiative a while back. But you mentioned that the Board has a lot of conviction around maintaining dividend pay on, I think you even sort of tiered it ahead of the debt reduction with the free cash flow in terms of priorities. How do you, I guess how do you come to the view that you’re not just better off redeploying the money that you would have spent on dividend in some of the higher return CapEx projects that you could be doing like whether it’s fiber-to-the-tower or other types of high return on investment forms of CapEx?

Robert Starr

Well, when we think about capital allocation we do think about the CapEx first and foremost. So we have been doing fiber-to-the-tower. We have been doing a lot of built out for reach where we’re focused on speed now. I think we think about what is the right amount of CapEx for our business first and then the second thing we’ll look at is to protect the dividend. And look we’re pushing on all ends of the business. We’re trying to push the revenue trajectory to flat and hopefully take it further to a growth point at some point in the future. Those trends have been really working in our favor, recently the decline in revenue for residential was only 0.3% in the last quarter and was only 0.4% to business. So we’re seeing some really good traction there and we’re hoping to turn that to flat and then growth.

On the expense line, we keep pushing for savings. There are a lot of initiatives underway. We targeted net savings this year of $100 million. We’ll reinvest back into our business but we are still focused on cost savings. As I mentioned the CapEx budget we want to make sure we do the right amount of investment, but we think that after all the expenditures we made in the past year as we actually have an opportunity to bring it lower.

Anthony Klarman - Deutsche Bank

Your margins are already relatively high when you look at yourself versus the peers which seem to imply the business has run relatively efficiently. Where are you pulling these costs from?

Robert Starr

Well, there are a lot of opportunities following the Verizon acquisition and we’ve gone through and achieved most of those synergies. The 100 million from this year had to do with a few things, so we are both wage and non-wage. On the wage side at the year-end, we took out 646 headcount some of that were people that we had actually had it on at the time of the acquisition to help the integration and the conversion. There were additional reductions in the first part of this year some of it were retirements and attrition and some of it was consolidation as well.

On the non-wage front there are a lot of opportunities to do process redesign to think about how orders flow through our system to get rid of the redundancies, improve efficiency. I actually operate the real-estate and facilities division, so through the acquisition we picked up properties, in some places we have an owned property and a leased property in the same city and we think about which one we should be consolidated into? So cost savings is part of the DNA of this firm and it’s a continuous process and we're always looking for ways to reduce expenses.

Procurement is another area where we think there are opportunities in renegotiating contracts with our vendors, and for all types of outsource processes whether it's maintenance of our properties et cetera.

Anthony Klarman - Deutsche Bank

Any others before we move other topics? Go ahead Brett.

Unidentified Analyst

How do you think about your residential [indiscernible] particularly [indiscernible] your own video service like [indiscernible]?

Robert Starr

Well, we do have several properties that we acquired from Verizon which are FiOS, but that's a relatively small portion of our total footprint. And then we use DISH as our primary TV sales tool these days. It's selling very well, we have about 380,000 customers, it's a very attractively priced product for our customers, and it helps us to sell a triple play. We are thinking carefully about something that is over the top, it’s something that we have been thinking about, there are some discussions that are going on with executive management and hopefully we'll have some type of product like that in the future. But there is nothing for us to announce right now.

Anthony Klarman - Deutsche Bank

But are there other network investments that you need to make along the way, in other words as you are thinking about the CapEx and planning for the network spend, are you trying to future proof sort of the network to some extent and sort of spend the areas, spend CapEx in the areas that will be accommodated to things like a potential OTT strategy or other forms of investment?

Robert Starr

Yes sure, I mean a lot of that was done already when we first took on the Verizon acquisition, a lot of money was spent on the background and we have built in a lot of capacity so that we wouldn't be going back every year and having to build that out. But of course as demands go up and there as people need higher speeds we continue to put more money into the backbone.

Anthony Klarman - Deutsche Bank

Yes. And then maybe as a follow on to that, just from a competitive perspective there is a lot of talk about the macro economy and the growth recovery. How levered are you do you think in terms of the future pace of the recovery and the macroeconomic variables as we think about the inflationary pressures as they work their way into the system and further improvements in housing and housing starts. How levered are you to those variables and does that help provide some stability to the access line churn numbers?

Robert Starr

Well we have seen some growth coming out of new housing starts, so that was nice. Look we're trying to provide a very attractive product to our customers, a really good value and at the right speeds. And I think as long as we're doing that we will benefit from the change in the macro economy to the greatest extent that we can.

Anthony Klarman - Deutsche Bank

A question that I forgot to raise earlier was one of potential non-core or other assets sales by you and you mentioned some of the real-estate stuff that you are doing in trying to figure out the ways to monetize that. Now that you have had Verizon and you fully integrated that asset, have you looked at the footprint and sort of thought about other non-core pieces of the current footprint that really will never operate at the same level of efficiency as either the Verizon acquired properties or the core properties, and our asset sales potentially a way to accelerate some of the deleveraging to get you down towards the 2.5 number?

Robert Starr

I mean we do look at it, there are a few opportunities in the real-estate portion or properties that we manage or operate, but nothing material.

Anthony Klarman - Deutsche Bank

Any more from the audience? Right so I guess as we look at the next several years, one of the questions that I think frequently comes up is the timing of the CapEx cycle. And you mentioned about how CapEx was at relatively elevated levels, you were spending a lot on integration CapEx with respect to Verizon and those numbers you have guided are going to come down. But technological innovation doesn't slowdown and we have heard everyone talking about the next wave of capital investment.

How do you think about what the cycle looks like and when do you think you will have to be back in reinvesting in either speeds, because it seems like if you look at FiOS and U-verse in some of their markets, the real differentiating factor right now that customer seem to be willing to be pay for is speed. So when do you have to get back to sort of the CapEx investment cycles to get the speed up to where you want it to be, to be competitive?

Robert Starr

Well you are right, people do care about speeds, speed is important but it's not always the only thing. Majority of our customers take a 6 Meg product, and that gives us the opportunity to sell them to some of the higher speeds that we're providing today. But not every customer needs those high speeds. We have built out the backbone with lots of opportunity for speeds and capacity. And the build out of speed is a much lower cost proposition than it is to build out for reach. We do it using IP DSLAMs, we put fiber to the node deeper into the footprint, we put on a relatively low cost electronics and you are able to take speeds up quite dramatically. We can also use bonding, a pair bonding of the copper pair. So there are a variety of ways that we can take the speeds up and we're focused on that. But as I mentioned it's just a lower cost proposition.

Anthony Klarman - Deutsche Bank

So is it also scalable such that to the extent everyone starts to have a 20 megabit per second experience or a 25 or 30. I mean it seems like if you listen to the content providers, they are all going to find ways to be sending more -- higher bandwidth content down to the consumers and that's what everyone is trying to push for other network investments that you are making scalable such that you can kind of scale those speeds to consumers as they start demanding even higher speed and usage?

Robert Starr

Yes. The backbone is strong and can carry a high speed and so it’s a matter of just continuing to use these fiber to the node build outs. We don’t do it across the entire footprint, but we do it wherever we think there is an opportunity for ourselves and where we’re seeing the demand for the higher speeds. And also the CAF 1 Phase II we’ve applied for about $17 million of that fund and that is all dedicated to providing higher speeds to what they consider under-served customers those are the customers that have 3 Meg or less.

Anthony Klarman - Deutsche Bank

And I guess what is the issue in some of the more rural areas or what is the experience of -- you mentioned I think the average was around six?

Robert Starr

6 Meg is the basic service that we provide and the supplies that most of our customers take.

Anthony Klarman - Deutsche Bank

And is that the same in some of the more suburban markets as opposed to rural or some of those markets actually not caught up to the speed levels yet?

Robert Starr

Well I don’t know that I would exactly characterize it that way. I think that we just look for where the opportunities are to take those speeds up where we see the opportunity for us to sell higher speeds and where we see the demand coming. And then it’s very easy for us to allocate a portion of our CapEx budget to go after that and in a relatively short period of time and in a relatively low cost turn up to speeds.

Anthony Klarman - Deutsche Bank

And have you seen much from either of the satellite guys whether it’s the HughesNet or the ViaSat, do you see them much in any of your markets. They’re obviously much more rural than a Rochester for example so that wouldn’t be a very effective competitor. But in some of the smaller markets do you see some encroachment given that they’re each launching new generations of satellites and are talking about much higher throughput speeds on some of the broadband that they’re going to be able to offer in the territories and are potentially going to be able to do it nationwide?

Robert Starr

We have partnered with Hughes. So, we are selling that product into approximately a 10% of our footprint that doesn’t currently have a terrestrial product. It’s a very nice add on product it provides very nice speeds 5 to 15 Meg it’s a little bit more expensive than the terrestrial product. But for people that don’t have that service otherwise it gave us an ability to sell a product into that part of the network or that part of the footprint. So, we’re already utilizing that, I wouldn’t say it’s a material portion of the net-adds that we picked up in the first half of this year, but it’s certainly a nice add-on to our product set?

Anthony Klarman - Deutsche Bank

And then how about the opportunity in commercial, commercial is something that most people have talked about as seeing some green shoots for growth, what types of investments have you made in commercial and what portion of that as we think about CapEx and maybe you can even include fiber to the tower as a sort of non-residential maybe we call it. What’s the level of investment as we look at total CapEx that you are directing towards non-residential investments or sort of growth investments?

Robert Starr

Well the CapEx budget for this year includes the build out to the towers and for the towers that we will be building out to that we haven’t already. It should be wrapped up by the end of this year. So that’s part of the reason why I mentioned that we have some opportunity perhaps taking the CapEx budget down in the future years. I think our big opportunity is in the small business customer space, we right at the end of the second quarter came out with brand new bundles the simplified offer. We had speeds that go up to 40 Meg for the small business customer and we started to sell that it was very early days there, but we saw some good traction.

And one of the things we also used on the residential side if I can digress that for one second is we used these alternative channels, aggregators and they provided about 30% of the adds that we got through the first half of the year. We haven’t quite used that on the business side just yet and we’re hoping to roll that out in the back half of this year. So, now that we have the simplified bundles for this small business customer, we have a very attractively priced product, we have speeds that the customer wants and if we can also get the aggregators working, I think we’re going to have a very good opportunity there.

Anthony Klarman - Deutsche Bank

Cable has [started] the opportunity in the SME space, and as you think about the speeds and the network that you’re offering, is cable able to offer a similar and if to the extent they are, does it come down to you and cable sort of battling out on price, for growth in the commercial segment?

Robert Starr

Cable is clearly the competitor on the small business customer that’s part of the market we’re going after as well and we think we’re going to get some traction there by using that same basic strategy that we use on the residential side. It’s a very attractively priced product; it gives them the opportunity to grow their voice lines if that’s what they need. The offer is simple and that we think that we haven’t exploited yet the aggregators and additional alternative channel. So, I think that we’re going to have a good opportunity there.

Anthony Klarman - Deutsche Bank

And what is the opportunity for wireless. I was asking this question, more about mobile video but as you think about bundles and on the residential side bundles, are there chances or opportunities for you to sort of put wireless more meaningfully into the bundle through partnerships or other types of MVNO opportunities?

Robert Starr

Well, we have an AT&T mobility trial and this is where we sell to customers. The AT&T handsets and wireless product bundled with our broadband. It’s still under trial phase, but we are looking to hopefully expand that.

Anthony Klarman - Deutsche Bank

But I guess what are economics, are they such that it’s kind of margin neutral to you, if in fact did you push that out farther into the network or is it slightly margin dilutive given what your margins are already relatively high and it’s more of a defensive strategy to kind of increase the bundle and keep churn obviously churn goes lower as yet more to the bundle?

Robert Starr

Well, I mean it’s in the trial phase still so it’s hard to talk about margin, but it's an additional opportunity for us to go out and sell our broadband network.

Anthony Klarman - Deutsche Bank

Well I tried to go quickly and we're unfortunately almost still out of time. Are there any other last questions from the audience? Great, well thank you very much Robert.

Robert Starr

Thank you.

Anthony Klarman - Deutsche Bank

Thank you.

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