Frontier Communications Accepts Government Funding

Jul.27.12 | About: Frontier Communications (FTR)

Earlier this month Frontier Communications (FTR) announced that it had accepted $71.9 million from the Federal government to increase deployment of broadband services in some of its rural territories. The funds came from the Federal Communications Commission ("FCC") through its Connect America Fund ("CAF"). The CAF was discussed by FCC Chairman Julius Genachowski in a wide ranging speech last October. Genachowski said the CAF would 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.

What is not at all from the announcement is what commitments are being made by Frontier in terms of additional capital, manpower, service commitments, maintenance, time frames, etc. Frontier noted:

By accepting this funding, Frontier has pledged to provide broadband service to an additional 92,876 households covering more than half of the 27 states it serves, ensuring rural customers in states such as Michigan, Oregon,Washington and West Virginia have access to broadband connectivity.

That's a very specific number of households! It also means that Frontier is receiving just under $775 per household to run the lines to these potential consumers.

When Genachowski spoke about the CAF, he also stated that its purpose was to provide service to areas that would otherwise not be served:

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.

It is difficult to determine if any of these 92,876 households could have been profitably serviced by Frontier without the benefit of the CAF. From that perspective, it is good for the households and consistent with the tradition of the USF. However, from an investor's perspective, it could indicate that there is limited incremental profit potential from these consumers.


The company may shed some additional light on the program during its upcoming conference call in early August. However, it is a bit surprising that Frontier is committing resources at this time to these incremental households.

Frontier is a company that many investors hold for its 11% dividend, a dividend that has been cut twice since its major acquisition of Verizon's (VZ) rural businesses. It is also a company that has yet to demonstrate that its acquisition of Verizon's rural business can be well managed and integrated. Frontier has recently converted the remaining nine states from its acquisition to its legacy systems and was expected to begin running promotions on bundled services. These bundled promotions would be expected to stem line losses, reduce churn and increase revenues; that would seem to be a far better use of the company's resources than investing any resources funded by the CAF.

Disclosure: I am long FTR, VZ.

Additional disclosure: I also have sold $4 and $5 covered calls against a portion of my Frontier position.