Company’s dividends remain safe and secure.
Acquisition of Connecticut business paints a compelling outlook.
Growth in broadband subscribers will continue.
Many believe rural local exchange carriers (RLECs) have been fighting a lost cause as consumers make the shift towards wireless networks. This seems true if we look at a decline of 5.9% in traditional legacy revenues for Frontier (NASDAQ:FTR). The company is trying to offset these declining revenues by ensuring growth in high speed Internet and TV customers. I believe it is just a matter of time before it will find an inflection point, and growth in strategic revenues will be enough to mitigate the negative impact of voice services.
Broadband momentum has continued, as the company added 37K new broadband customers in 1Q'14. It has also increased the price of its standalone broadband service by $5, which will help improve revenue trends. Frontier has a strong network, with 10% of the network being fiber-to-home, 53% has the ability to support speeds of 20megs or better, and 74% can support 12megs or better. This means the company has managed to build a strong network and can leverage it to cater to consumer demands in future as data usage grows. It is ranked higher than Verizon (NYSE:VZ) FiOS and AT&T(NYSE:T) U-verse in the ISP speed index for May.
Acquisition of Connecticut wireline business
Frontier is looking to increase its scale through M&A. Currently, the company is looking to acquire AT&T's Connecticut wireline business. In the recent Morgan Stanley Leveraged Finance conference, it has given updates on the Connecticut acquisition. The $2 billion deal will help Frontier enhance its customer base by almost 450,000 data and 900,000 voice customers. It will also help enhance EBITDA by $525 million if we include all synergies.
Frontier is planning to raise $1.9 billion through debt financing. Of this, $350 million will come from a floating rate A term loan and the remaining $1.55 billion will be raised through high yield un-secured debt. This will definitely raise leverage, but I believe it is necessary to completely offset the decline in legacy revenue, which contributes nearly half to total revenues.
Although T's wireline business is on the decline, I believe FTR will be able to manage it more effectively and efficiently than T because its expertise is regarding the wireline segment rather than the wireless business. It is also expected that the company will spend $60 million to enhance the network capability to attract customers who demand high broadband speeds. Also, it can offer bundled offers, which include cable, TV and phone services, to attract landline customers.
Frontier is yielding 7.10%, which is the primary attraction for income seekers, and most importantly the company is committed to maintaining its dividends. The company has managed to maintain a decent payout ratio as shown in the table below. Also, it is structuring its expansion plans (like Connecticut transaction) in such a way so as to enhance its free cash flows while maintaining its outstanding shares count.
On the same lines, CenturyLinK (NYSE:CTL) has also managed to keep its payout ratio in check, which indicates that investors should not worry about dividend cuts. However, Windstream (NASDAQ:WIN) is struggling and it will be difficult for the company to maintain its current dividends because it operates in a capital intensive industry and it needs to save money to grow. Dividend payments are an important growth driver for these companies and any instability in dividend payment has a significant impact on the stock price.
Free cash flows (CFO-Cap-ex)
Payout ratio (Div/FCF)
Source: Company Reports
My price target of $5.89 is based on the 6.3x expected 2015 EV/EBITDA as shown in the table below. Currently, the stock is trading at $5.70, which means price appreciation of nearly 3%.
Expected 2015 EBITDA
$ 2,225 million
Enterprise value=$14,017 million
Total Debt= $ 8,125million
Total Value to firm - Total Debt = Total Equity value
$14,017- $8,125= $5,892 million
Share Outstanding = 999.46 million
Target Price = Total Equity Value/Share Outstanding
$5.89 = $5,892/999.46
I believe dividends are safe and income-seeking investors should buy the stock. The acquisition of the Connecticut and broadband momentum paint a compelling story for FTR. The company should also focus on growing organically along with M&A by offering higher broadband speeds, reducing wireless backhaul, competitive pricing and bundled products.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.