This Time It's Different is the title of a book by Reinhart and Rogoff that carries the subtitle "Eight Centuries of Financial Folly." The basic premise is that each time a new crisis appears, experts will claim everything is now going to be fine and it won't happen again. And, each time they are proven wrong. Is something similar happening with Frontier Communications (NYSE:FTR), or is it really different this time?
A month ago Frontier was trading at $4.59 just before it released fourth quarter and full year results. The following day it closed at $5.08, a gain of more than 10%. It didn't stop there, and hit a multi-year high of $5.47 on the first day of Spring. It's a price the shares hadn't seen since December of 2011 when the company was still paying a $0.75 dividend. At that time, the company was in the early stages of an expensive integration and upgrade of properties acquired from Verizon Communications (NYSE:VZ) in the middle of 2011.
The challenge with the Verizon properties was disparate billing systems, a network that required significant capital investment and ongoing customer losses. The strategy was to unify the billing systems, improve the network and increase broadband speed and access to customers in the acquired properties. It would take until the first quarter of 2013 before the company would be able to demonstrate that its strategy was working. Before it got there, it also had to cut the dividend from $0.75 to $0.40 in early 2012.
Even with the increase in the share price and the cut in the dividend, the yield remains attractive. At a recent price of $5.41, that yield is 7.4%, one of the more attractive in the traditional telecom sector. The five largest companies - AT&T (NYSE:T), CenturyLink (NYSE:CTL), Frontier, Verizon , and Windstream (NASDAQ:WIN) have little in common other than those attractive yields and a large, and declining, land line business.
AT&T and Verizon are by far the largest of the group and have dominant wireless businesses in addition to their land lines. They also have the lowest dividend yields and the most consistent dividend histories. AT&T may be the most attractive of the group from a dividend perspective. It has a current yield of 5.4% and has been increasing the annual payout each year for 3 decades. While some of those increases have been quite small, the amount has doubled in the past 16 years. Verizon has the lowest yield at 4.5%, and for quite some time its dividend had not been increased at all. Over the past 7 years, however, its quarterly dividend has increased just over 30%.
CenturyLink, like Frontier, also surprised investors when it cut its dividend 25% in 2013. Its dividend yield is right in the middle of the group at 6.9%. CenturyLink has chosen to diversify and expand its hosted solution and cloud infrastructure business with its acquisitions of Savvis and Tier 3. Windstream, with its 11.9% yield, has also been diversifying its business with hosted solutions and building out its data center presence. The company steadfastly maintains the importance and sustainability of the dividend despite the market giving it such a high yield, a sure signal of disbelief. On the recent conference call, the dividend was mentioned a dozen times, and Windstream CEO Jeff Gardner ended the call with the following statement:
It is our continued belief that our capital allocation strategy strikes the right balance among investing in the growth drivers of the business, paying an attractive dividend to our shareholders and reducing debt over time.
I would point out that the Windstream statement about dividends is actually somewhat less positive than it has been in the past. In a prior article I noted that there was a slide on the company website titled "THE WINDSTREAM DIFFERENCE" with the subtitle "Why invest in Windstream?" The number one reason on that chart stressed the dividend:
Returning Capital to Shareholders
The best way for us to create value for our shareholders is by returning capital in the form of our dividend. Our business model supports our $1 annual dividend payment through consistent cash generation and the improving trajectory of our financial performance.
It is a slide that is now much more difficult to find on the company website. Although the link works, I could not find the referenced slide without it.
Frontier's dividend has also been called into question as the customer losses and revenue declines continued following its acquisition of the Verizon properties. Unlike Windstream and CenturyLink, Frontier focused on upgrading its network and improving the speeds available in its footprint. While the customer losses have continued, the company has gradually been reducing the rate of loss and has had solid successes in marketing its broadband products.
In Q1 of 2013 Frontier had 28,200 broadband net adds, more than it had in all of 2012. While those results were aided by an Apple gift card promotion, Q2 was even more impressive as the total reached 29,500, followed by 26,800 in Q3 and 27,800 in Q4. The company credited much of the success to a simplified pricing plan of $19.95/month if part of a bundled offering, or $29.95/month as a standalone product of the 4Mbps speed. It was an all inclusive plan with no long-term contract or separate charges for a modem.
And, it's a success that has continued into the first quarter of 2014. On the recent year end call that took place on February 24th, the following statements were made by Frontier management. CEO Maggie Wilderotter said:
In aggregate, we increased our residential broadband market share by nearly one and a half points for the year, as Dan will discuss shortly that momentum continues in 2014...
...We also just launched our new Frontier Secure with broadband bundles in early January and they're off to a good start. Our major alternate channel partners started to offer Frontier Secure bundles to new customers and results thus far have been solid.
President and COO Dan McCarthy added:
We continue to see excellent response from our customers and we have enjoyed strong momentum thus far in 2014.
During the Q&A, in response to whether the strong growth would be repeated in 2014, the responses were even more positive:
Wilderotter: ...I think our momentum that we've seen so far in the first quarter is continuous to what we saw in '13. So we feel good about the momentum, we feel good about staying the course.
McCarthy: I would echo what Maggie said. I think that we absolutely replicate those results and maybe hopefully improve upon on them going forward. ...I think some of the big improvements we're going to get from a net perspective if you put aside the sales side, it's focusing on retention. So, we have structured programs there really about trying to improve the retention of customers and that's how we hope to really energize the net results as we go through the year.
Following the earnings call, CFO John Jureller spoke at two analyst conferences on March 5th and 10th, and Treasurer Robert Starr presented on March 19th. On each occasion the executives reiterated the statements about the strength continuing into the first quarter. Since Starr made his comment with less than two weeks to go in the quarter, there is every reason to expect continued improvement in the first quarter.
Acquisition of Connecticut Business from AT&T
At the end of 2013 Frontier agreed to acquire AT&T's wireline business in Connecticut for $2 billion in an all-cash transaction. In late February Frontier received notice that it had cleared one of the regulatory hurdles for the merger:
The expiration of the HSR Act waiting period satisfies one of the conditions of the completion of the transaction, which remains subject to other customary conditions, including the approval of the Federal Communications Commission and the Connecticut Public Utilities Regulatory Authority.
It remains to be seen how quickly the other reviews will be completed, although Frontier still expects the transaction to be finished in the latter half of 2014. It should be noted that Frontier is moving ahead as though there will be no issues. It has entered into a $1.9 billion bridge term loan facility and is proceeding with integration preparation, working with its counterparts at AT&T to ensure a smooth transition.
The company expects the transaction to be accretive to cash flow in 2015, its first full year of ownership. Furthermore, the transaction is expected to improve the company's dividend coverage by 5 percentage points.
The perception about the sustainability of Frontier's dividend is critical to the share price. Management has made statements about the security and dividend coverage in the past, and failed to live up to those statements. The market appears to have bought into the program by bidding up the share price to levels it hasn't traded at in well over two years.
With the yield at 7.4%, there is still risk priced into the dividend. That also means that there is room for share price appreciation if the company can continue to demonstrate that the dividend is secure. This will largely depend on the acquisition from AT&T and the continued success in broadband.
It remains to be seen if the FCC or Connecticut regulatory authorities place conditions on the acquisition of the AT&T property that will reduce its attractiveness, and close attention should be paid to the process. It will also be important that the company achieves the cost savings it anticipates and that the integration goes smoothly. As with any acquisition, there is risk, although this one appears to have a reasonable margin of safety, a margin that was lacking in the Verizon transaction.
It is also very important that Frontier maintains the progress it has been making in gaining broadband market share. This will be key to halting customer losses and eventually reversing that trend. For now, all indications are that the broadband strategy is succeeding, and as a result, investors should see solid results in Q1 and continued improvements throughout 2014. And, just maybe, it is different this time.
Disclosure: The author is long FTR, T, VZ, WIN. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have calls written against a portion of my FTR position.