Looking At The Limits Of Frontier's Growth Potential

| About: Frontier Communications (FTR)

Frontier Communications (NYSE:FTR) has been suffering from a declining customer base and contracting revenues. As a wire line service provider, FTR might be losing customers as they simply cut the cord and go wireless. Without question, this is probably the case for at least some defections. FTR noted in its 2012 10-K this possibility:

Our competitors include competitive local exchange carriers, Internet service providers, wireless companies, VoIP providers and cable companies that may provide services competitive with the services that we offer or intend to introduce. We also believe that wireless and cable telephony providers have increased their penetration of various services in our markets. We expect that we will continue to lose customers and that competition will remain robust.- FTR 2012 10-K

However, FTR also notes that it primarily serves rural areas in 27 states. A deeper analysis of demographic trends shows an even more worrying picture for customer growth and provides some additional perspective on how much growth investors should expect.

Frontier's Business is Mostly Concentrated in Low Growth States

Also available from the 2012 10-K is a state-by-state breakdown of its residential customers. One can compare FTR's business in these states with the overall population growth of that state. The following table shows this analysis.

State Population Growth Rates
State Residential Customers - 12/31/2012 Percent of Total State Growth Rate (27 month period) State Growth Rate (Annual average)
WV 350,070 12.1% 0.1% 0.1%
NY 292,754 10.1% 3.1% 1.4%
IN 285,571 9.9% 0.8% 0.4%
IL 273,409 9.5% 0.3% 0.2%
OH 258,730 9.0% 0.1% 0.0%
MI 208,414 7.2% 0.1% 0.0%
WA 199,034 6.9% 2.6% 1.1%
WI 141,472 4.9% 0.7% 0.3%
PA 136,370 4.7% 0.5% 0.2%
OR 134,796 4.7% 1.8% 0.8%
MN 107,456 3.7% 1.4% 0.6%
NC 103,950 3.6% 2.3% 1.0%
CA 78,121 2.7% 2.1% 0.9%
AZ 73,870 2.6% 1.7% 0.8%
ID 54,960 1.9% 1.8% 0.8%
SC 44,781 1.6% 2.1% 0.9%
Other states 143,305 5.0% 1.8% 0.8%
Total 2,887,063 100% 1.2% 0.5%
United States NA NA 1.8% 0.8%

Source: FTR 2012 10-K, Wikipedia for population growth rates based on 2010 U.S. Census data and estimates. The first growth column reflects state growth over a 27 month period from April 2010 to July 2012. The second column is an annualization of that number. Other states include TN, NV, IA, NE, AL, UT, GA, NM, MT, MS, and FL.

The first observation is that when weighted by percent of residential customers, it appears the FTR's territory is growing more slowly than the U.S. as a whole - not a good situation. With the exception of New York, all of the top states exhibit low growth, with West Virginia, leading the way.

Rural Areas Grow Even More Slowly

However, FTR is also focused on rural areas. U.S. Census data shows that rural areas tend to grow more slowly than urban areas. This trend should further challenge FTR. The following table shows some basic demographic trends for the U.S. as a whole:

U.S. Population (Millions) and Growth
Area Annual Growth Rate Population 2010 % Population 2000 %
Urban 1.15% 249.3 80.7% 222.4 79.0%
Rural 0.07% 59.5 19.3% 59.1 21.0%
Total 0.93% 308.7 100.0% 308.7 100.0%

Source: U.S. Census

The key note here is that rural areas are growing much more slowly than urban areas. In fact, these areas are barely growing with a rate of 0.07% almost a full percentage point less than the overall growth rate and a full point less than Urban area growth rates.

This allows us to return to the earlier table and layer in considerations of the mix of rural and urban population and the spread in growth rates. The following table shows the states with overall growth rates, the percent that is rural and then the implied rural area growth rate.

Rural Area Growth Rates by State
State Percent of Total Residential Customers Annual State Growth Rate % Rural Estimated Rural Growth Rate*
WV 12.1% 0.1% 51.3% -0.5%
NY 10.1% 1.4% 12.1% 0.4%
IN 9.9% 0.4% 27.6% -0.4%
IL 9.5% 0.2% 11.5% -0.8%
OH 9.0% 0.0% 22.1% -0.8%
MI 7.2% 0.0% 25.4% -0.8%
WA 6.9% 1.1% 16.0% 0.2%
WI 4.9% 0.3% 29.8% -0.5%
PA 4.7% 0.2% 21.3% -0.6%
OR 4.7% 0.8% 19.0% -0.1%
MN 3.7% 0.6% 26.7% -0.2%
NC 3.6% 1.0% 33.9% 0.3%
CA 2.7% 0.9% 5.0% -0.1%
AZ 2.6% 0.8% 10.2% -0.2%
ID 1.9% 0.8% 29.4% 0.0%
SC 1.6% 0.9% 33.7% 0.2%
Other states 5.0% 0.8% 27.6% 0.0%
Total 100% 0.5% NA -0.3%

Source: U.S. Census, FTR 2012 10-K, Author Calculations.

The estimated rural growth rate is based upon comparing the spread from the national picture, the state growth rate, and the portion of the state living in rural areas. So, the higher the state's rural population percentage, the closer the rural growth rate will be to the total state growth rate. These figures would match in a state with 100% rural population. So note in West Virginia, where the split is about 50/50 the spread from rural to total is just 0.6%. However, in New York, where the rural population is just 12% of the state population, the spread is about 1.0%. One should also note that, as expected, states with good population growth rates, may also have positive growth rates in the rural areas. For example, New York, and Washington, have total state growth rates of 1.4% and 1.1% respectively. Thus, the math shows that the estimated rural growth rates are also positive. It should be noted that this approach requires some estimation and it is quite possible that populations in rural New York, are also shrinking. There is good data from the census for 2010, but not comparable data for 2000. It also assumes that the relative spread in growth between rural and urban areas is similar in all states and thus reflective of the national average.

Frontier Faces Challenging Demographics

So FTR has a bulk (about 64%) of its residential customers, and thus its operations, in low-growth states (i.e., states with growth below the national figure). This includes four of its top five states and seven of its top 10 states by residential customer count. Furthermore, there is a strong possibility that its overall potential customer base is shrinking (when looking at just rural areas) as the rural populations in these low-growth states grow at an even slower pace than the overall state. Note that this last point is a very key assumption, that while true at a national level, might not hold for all individual states.

I would think that FTR is aware of this challenge since core parts of its platform include increasing customer loyalty to minimize customers losses as well as selling additional services, e.g., broadband, to current customers. Furthermore, to combat the challenge of wire cutting, FTR is offering wireless broadband solutions in select areas. So the bet on FTR has to be around selling more services to existing customers or expanding into new areas since the demographic tide is largely against it. For me, I'm very skeptical on this bet.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.

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