Frontier Communications: A High Yield, And Still A Long-Term Hold

| About: Frontier Communications (FTR)

It has only been a week since Seeking Alpha published an article of mine on Frontier Communications (NYSE:FTR). I had planned on waiting until after the company's earnings release and quarterly conference call early next month before writing a follow-up. However, Frontier has been in the news quite a bit in the past week, and investors should find some of this information useful in assessing their holdings.

Frontier is one of the highest-yielding dividend stocks, paying a $0.75 dividend that yields about 12.5% on its $6 share price. In the current low-interest-rate environment, a double-digit yield is the market's way of telling us that there is risk in this stock. And, as a result, Frontier is a stock that generates a lot of interest and strong feelings on both sides. In the prior article I noted a downgrade at the same time that management was affirming its commitment to maintaining and growing the dividend, and in the intervening week Seeking Alpha has published at least ten Frontier-related articles.

For those that follow Jim Cramer, there is the same dichotomy. An October 3 article on Seeking Alpha noted that Cramer recommended avoiding the stock. A week later on Mad Money recap: "Cramer is giving the company the benefit of the doubt when it says it will make the dividend. Therefore, he recommends owning it."

Then, there was the note that Citigroup (NYSE:C) lowered its price target to $6 from $7.50, although it maintained a hold rating. And on Friday, there was an upgrade by DADavidson from underperform to neutral. If all the changes in recommendations aren't enough to confuse the average investor, what do you do when a lawsuit against the company is reported?

A column by Steve Alexander in the Minneapolis Star Tribune reported that 4 customers had filed suit in US district court over pricing irregularities and were seeking class action certification. The article noted the suit was filed by "Internet customers who allege the telecom company inflated their bills with unrelated or undisclosed fees" and that "three Minnesota Internet customers and one from New York state allege fraud, breach of contract, deceptive practices, false advertising and violations of the Federal Communications Act and the Internet Tax Freedom Act."

This lawsuit appears to be more of an annoyance than anything meaningful, but what investor wants headline risk in their holdings? Far more interesting was a speech given on October 6, by FCC Chairman Julius Genachowski. He spoke about proposed changes to the Universal Service Fund -- "Connecting America: A Plan To Reform and Modernize the Universal Service Fund and Intercarrier Compensation System."

It was a wide ranging report on findings by the FCC staff about the changing nature of telecommunications and a need to update the fund and redefine its purpose. The Universal Service Fund is comprised of charges levied on all phone bills. According to the FCC website the purpose of the “Federal Universal Service Fee” or “Universal Connectivity Fee” is described as follows:

Because telephones provide a vital link to emergency services, to government services and to surrounding communities, it has been our nation’s policy to promote telephone service to all households since this service began in the 1930s. The USF helps to make phone service affordable and available to all Americans, including consumers with low incomes, those living in areas where the costs of providing telephone service is high, schools and libraries and rural health care providers. Congress has mandated that all telephone companies providing interstate service must contribute to the USF. Although not required to do so by the government, many carriers choose to pass their contribution costs on to their customers in the form of a line item, often called the “Federal Universal Service Fee” or “Universal Connectivity Fee.”

A Bloomberg article reported that the fund paid out $4.3 billion in 2010 and a coalition led by Verizon (NYSE:VZ) and AT&T (NYSE:T) asked the FCC to reduce these fees "which can amount to as much as $8 billion annually." The article also noted that "The fund is financed by charges on long-distance calls paid by telephone subscribers, and it subsidizes companies including Windstream Corp. (NASDAQ:WIN) and Frontier Communications Corp." Any changes to the USF should be of concern to Frontier, its customers and its investors.

Genachowski noted that the fund is outdated, can pay out more than $20,000 per year to support phone lines to a single customer, and needs to be changed. He would like to create a "Connect America Fund" with the objective of using the new fund to promote broadband access to areas where it is currently unavailable. This could turn out to be a benefit to Frontier, which is building out its broadband access anyway.

The reform and adoption of this new Connect America Fund is positioned as a panacea to a host of issues. By connecting millions of Americans with broadband, the plan will benefit:

...individual consumers, our national economy, and our global competitiveness. It will spur billions of dollars in private investment and very significant job creation, starting with construction workers who would build out this new infrastructure, and it would do so soon. It will provide a platform for entrepreneurs in rural America to start and grow small businesses, allowing them to reach customers across the globe and boost efficiency and productivity through cloud computing. It will save businesses that otherwise couldn't exist in small-town America, and it will create new jobs in those communities.


If adopted, our plan will not only drive economic growth in rural America, it will also significantly increase the size of America's overall online marketplace, benefiting businesses and consumers nationwide. For students who are now unserved by broadband, it will bring connection to a world of knowledge and enable the use of digital textbooks and other interactive learning tools at home. For seniors and others now unserved by broadband, it will bring access to basic health information online, and enable people with chronic health conditions to access remote monitoring technologies where they live. In times of emergency, rural citizens will have a new lifeline to communicate with family, friends, and first responders.

One thing is certain if Genachowski is able to implement the plan. He noted that there would be a more complex formula to determine payouts to rural broadband providers:

For all elements of the Connect America Fund, we will ensure that support isn't used to supplant private investment. Funding will be targeted exclusively at areas without an unsubsidized competitor, and where support is needed to extend or sustain broadband networks, eliminating wasteful spending and promoting healthy competition. And funding will be conditioned upon complying with rigorous obligations to serve the public and meet the goals of universal service...

In the Connect America Fund, some price cap areas will be subject to competitive bidding quickly, and others will shift to competitive bidding in later years. Price cap carriers are companies subject to USF and ICC rules that, as currently structured, reward them for operating efficiently, but not for investing in broadband.

The plan is positioned as fiscally responsible, good for business, good for education, good for consumers - it seems like everyone wins. So what could go wrong? From the Bloomberg article cited above:

The plan outlined by Genachowski today left a number of questions unanswered, Art Brodsky, a spokesman for Washington- based advocacy group Public Knowledge, said in an e-mail.

“There is still a big question mark whether the FCC has the authority to deal with broadband as the Chairman wants to do,” Brodsky said.

In the current Washington environment, it would be nearly impossible for the FCC to implement its proposals if Congressional approval via a new telecommunications act is required, but it's certainly worth keeping an eye on.

I will be listening to see if these proposals are addressed in the upcoming conference call, and unless I hear some surprises, I intend to maintain Frontier as one of my long-term holdings.

Disclosure: I am long FTR, T, VZ, WIN. I may day-trade in and out of FTR at any time, and may open or close covered calls against any of my positions.