Frontier: Reverse Split Fears Overblown

Summary

• Frontier Communications completed a reverse split on Monday.
• The stock has been absolutely beat up due to this move and a dividend cut.
• The market needs to focus back on cash flows.

Back in May, my thought was that Frontier Communications (FTR) was attractively priced below $1.50. My major concern in owning the telecom stock was a lingering shakeout from the dividend cut and reverse split that has the stock hitting new lows now.

The stock fell further following a presentation at the Sohn Conference that called Frontier a good short. The question is whether the reverse split on July 10 was the move that will finally create a bottom in Frontier.

Josh Resnick from Jericho Capital made the claim that Frontier was headed to zero. Such a move would make the stock a great short even trading at a price effectively below $1.

He made the suggestion that Frontier is going bankrupt based on the step to cut the dividend. As mentioned in my last research article, hedge funds and algorithm trading use dividend cuts to press shorts no matter the logic in the move.

Effective Monday, Frontier completed the 1-for-15 reverse stock split. The stock initially traded around $15 or the equivalent of $1 before the split. The stock has now crossed below $15 with another large 7% loss typical of the normal negativity surrounding a reverse split. For most situations, such a split allows more shorts.

Back in May, the company cut the dividend by 62% while maintaining the forecast for 2017 free cash flows of $800 million to $1,000 million. Frontier made the cut to save cash to pay down debt which would reduce the bankruptcy risk suggested by the price collapse.

Considering the telecom didn't cut the cash flow forecasts, one can track a large portion of the declines since May 2 on the capital actions. The stock has fared far worse than CenturyLink (CTL) and Windstream (WIN) during the last few months. Frontier is down over 50%.

FTR data by YCharts

Naturally, the company wouldn't cut the dividend if business was rosy and growing. Fellow contributor Blue Harbinger highlighted how investors had high confidence in near-term bonds. The issue was longer-term bonds dated after 2020 that the company recently made a move to resolve with a $1.15 billion tender offer that in essence rolls over 2020 debt to 2024 for a lower rate.

Source: Frontier Q117 presentation

Frontier has a goal of reducing the leverage ratio from 4.39x to 3.5x by year-end 2021. Based on the current maturities, the biggest issue didn't start occurring until 2020 and the recent tender offer solves a lot of that issue.

The market though seems confused. Frontier had free cash flow over the TTM of over $900 million. If the company applied these funds to paying down debt, does the telecom even have a problem?

The key investor takeaway is that the market has absolutely overblown the recent capital actions. Frontier now offers an incredible 17% dividend and is making some solid moves to cut leverage ratios. The stock is interesting below $15.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FTR over 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.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

Comments

[Stone Fox Capital]

The $0.60 divy declared should change the momentum in the stock.

[The Owl]

Stone Fox Capital, I was remiss in letting you know that you wrote a great article, articulating the key issues concerning Frontier Communications. I meant to comment earlier and just got distracted with the commentary (which was fun).

Obviously, there are market participants on both sides of this issue, appearing to be negative in the (vast) majority.

However, with all due respect, I don't think that the dividend will do it or will provide any confidence whatsoever. A dividend paid works as a non-event; on the other hand, failure to pay a dividend would be a message. A "cut the dividend to pay down debt" at this point would be a disaster. FTR's board played their dividend cut card and did not take it to zero and they had their single chance. Do it now and it will just justify the bears view of the stock. FTR continuing to pay the dividend will just represent to the majority that "they are paying a dividend that they cannot afford". Given that it is a return of capital, there is a point to be made here, but simply in terms of cash flow, FTR has and will continue to have, given historical revenue trends, the ability to pay down debt and continue the dividend at the current rate.

In my view, you are not going to get movement until the revenue stabilizes. I am guessing but I don't expect a slowdown in revenue declines until 4Q. I would love it if it came sooner but I am not holding my breath. I expect a 2-2.5% revenue decline and I am relatively positive on the name.

At some point,however, Frontier will stabilize the revenue and the "over/under" will be so low that they will beat it even with mediocre performance.

Don't expect relief until 2018 and you won't be disappointed. If it comes sooner, great, but if you are in this name, you had better dig in for the long haul. I have, focused on getting to conversion in 2018.

What the dividend does do is cost shorts money. Given 25,354K shares short, shorts will be coughing up about $15,212K to cover the upcoming dividend (if they stay short).

Nice job, well done, take care..................... Owl

[tennvol_30736]

Any thoughts on the new Coriant technology being deployed by Frontier in the news release today?

[tennvol_30736]

Any thoughts from anyone on the new Coriant technology Frontier is deploying in Connecticut?

[w.sak]

I lost 75% , $$150 K in oil, & then I bought FTR & lost 80 %. I will not go to the docs for a check up till next year, my amnesia needs to progress !!!!

[kalboking]

Me too i bought linn mhr orig all went bankrupt then i bought ftr. Im jinxed

[w.sak]

I wish us luck, this has been a long devastating bad luck run !!

[bond006]

I originally invested in FTR because it was an established 80 year old regional telecommunications company that rewarded shareholders…all was copacetic until management decided to "go for it"…So does FTR still have what is takes to survive and thrive based on the following parameters of a worthy stock investment...1) free cash flow...for the time being , yes but "things" have changed 2) dividends and/or share buybacks that reward shareholders...for the time being, yes; though a reduction in dividends was not part of "the plan" 3) great balance sheet...for the time being yes…companies with more debt than cash can still be considered to have a great balance sheet if the company earns so much money that their debt payments are easily covered…but in 2020 not so much 4) consistent profit margin...adjusted EBITDA margins Q3'16 39.6%, Q4'16 40% and Q1"17 39.2%…so far so good 5) return on "new" investments…to early to tell…and for grins let's add 6) employee morale, currently struggling and this may be the most worrisome of all…for without a motivated crew the ship is lost…Dan are you listening?

http://bit.ly/2sJ2etH

…time will tell whether or not this ends well because, as Wiley Coyote said, "I was just shifting gears when I hit the wall"…wall of debt that is. My motto as a manager was "future work follows good work"...in this case "future customers follow competitive pricing and good service" and good service follows inspired leadership...and the jury is still out on that one…in the mean time I reduced my position size and are no longer reinvesting dividends.

[rymryder]

Should I participate in the odd lot buyback of ftr? Never received an offer before

[bond006]

the key metric is the yearly debt service to free cash flow or debt service coverage ratio...need to see steady improvement in this ratio...the higher the better too...this should get really interesting starting in 2020 unless refinancing and deleveraging is successful...let's hope so.

[Stone Fox Capital]

Refinancing has already started and deleveraging is next.

[tennvol_30736]

No. The key metrics are: $3.2 billion ebitda, subtract interest expense, capex, add cost savings, dividend savings = what do you get? Substantially, all maturities the next four years are paid out of free cash flow or debt already tendered. Unlike most, I think FTR is in an excellent position to gain broader traction into these markets. It may take 6-18 months. It is going to happen. Time is on their side to segment their markets accurately. This will be a very nice compounded security beaten down by the derivative traders. All I can say is thanks to the gamblers.

[tennvol_30736]

I'll add CFRA states FTR has" strong cash flows to support its dividend policy."

That compounds above 15%. Not a bad long term investment or as part of retirement income.

CFRA for those who don't know, bought the S& P 500 research organization and is one of the largest independent financial research organizations.

[noalpha]

press release."NORWALK, Conn.--(BUSINESS WIRE)-- Frontier Communications Corporation (NASDAQ:FTR) today announced that John Maduri, a telecommunications expert with 30 years in the industry, has been named to the position of Executive Vice President, Consumer Sales, Marketing & Product. Maduri will join the Company on July 24 and succeed Cecilia McKenney, who is leaving Frontier to pursue other opportunities.
"John brings a wealth of impressive industry experience to a critical role at Frontier," said Dan McCarthy, Frontier's President and CEO. "Focusing on consumer sales is a top priority for us and John's leadership and remarkable track record will ensure that we continue to improve customer acquisition, care and retention. He will play an integral part in driving our many consumer-focused initiatives to improve results."

[naplesaustinnyc]

New guy start date is July 24

[RandomOne]

Is this new guy have a name and what position is he filling?

[timctx]

Go the company web site an look at press releases.

[thegatorkid1]

Dem shortz got all blowed up...

[w.sak]

What happened with the new guy someone said came in ??

[Contrarian724]

I am looking for some volatility when the restricted stock begins to be released. That may be the time to go long if a spike down occurs assuming one thinks the stock's prospects look reasonable at that time. I guess we will find out soon.

The second restricted stock release may even be more volatile. Not sure why anyone would buy now unless they are sure the restricted stock releases will have no effect on the stock price and who knows that?

[The Owl]

Contrarian724,

I am unaware of one addition of shares. The conversion of 19,250K shares of Preferred will be converted into 20/15ths of a common share for each preferred share, yielding 25,666K common shares, resulting in an increase in common share count from about 78,533K to about 104,200K. That is the only addition of shares that I am aware of.

Please also be aware that there is a short interest of 21,816K shares as of June 30th settlement, 85% of the total of shares to be added through the conversion of the preferred in one year. So the "plunge" about which you speculate may have already happened as people have shorted the stock, either anticipating a downdraft and being able to cover through cheaper future common due to dilution, or they are hedged long FTRPR, short FTR to simply capture the difference in income. Either way, the increase in shares may have already happened and may have already done most of the market price damage.

So you might buy now if you believe that the market price damage has already been done and you want to collect the dividend streams from either FTRPR of 44% ($11.125/share on a $25 share price) or from FTR of 16% ($2.40 div on a $14.72/share price), that is who might buy the stock.

Is all of the impact in the price of the stock? As you would say, who knows, but the extraordinarily high income stream should help to compensate for the high perceived risk.................... Owl

[tt5423]

why would these events have any effect? do you think the market does not know about these?

[cbroncos]

Is the dividend really $2.40? Or is that not what they have paid out in the last 12 months?

[Rachet56]

Benzinger.com reporting this morning of FTR take over chatter

[jz10]

Who is dumb enough to buy out FTR at full price when all of its securities are trading at a discount?

[timctx]

If there is money to be made there are ways to structure deals to screw existing holders. Equity injection with enough open market bond transactions to bully any other holders without triggering make wholes or pref clauses. Who knows what is going on. Total silence from the company.

[The Owl]

jz10, you are looking at it from an investment perspective.

The answer to your question could be: a strategic buyer.

I am in no way suggesting that this is the case, but frequently, what appears to be stupid to investors makes perfect sense to a strategic buyer and I have been on both sides of those discussions.

I have absolutely no standing or capability to assess Frontiers networks to determine if they could fill strategic holes in anothers network. I suspect this is not the case. However, frequently, a purchase of an ordinary business with average returns may suddenly fit spectacularly well within a larger entity, with much of the fixed cost stripped out and providing an incremental chunk of revenue, with earnings much higher than the independent company with lower fixed.

That is a potential answer. Whether it is THE answer is highly uncertain to unlikely. I wanted to answer your question in general, however.

Your question just suggests, again, that people stop focusing on rumors and focus on business fundamentals............. Owl

[BobbyFogle]

I sure someone has mentioned this in the past but something doesn't smell right with this Verizon deal. Either FTR management is completely incompetent or Verizon together with help of JPMorgan completely screwed FTR. There have been plenty of acquisitions that have gone bad in the past but this one has eroded over $6 Billion in equity value in just TWO years. FTR should take JP Morgan to court and claw back all the fees they paid or at least expose whoever advised them. In addition, FTR board should be held accountable for this disaster.

[David Hsu]

BobbyFogle. Watch this 10 minute video. http://cnb.cx/2uhqR1S

[sojorat]

I agree. How can you lose 20% of customers within one year? Obviously Frontier didn't protect themselves from the aggressive marketing Verizon did to boost numbers before the deal. Or protect themselves from all the accounts that weren't paying. Were was the investment banking guys helping FTR. This case should be taught in every business class in college.

[bondsmoker]

Yeah, whenever bidding on a company that has as its main asset a customer list, I work into it that part of the purchase price is due at some point in the future (1+ years out) based on the remaining customers.

Otherwise, you end up in this kind of mess - paying for customers that you didn't really get.

[timctx]

The problem is that buying any size of the debt will drive the prices back up. The market is not very liquid. A buyer could probably get a few billion at a discount but nowhere near the full float. Only later dated maturities have large discounts.

[Michael Matejov]

Later dated maturities should be bought back by management. And other, with sooner maturities just refinanced when they get to better situation with debt/ebitda etc...

[bondsmoker]

Company buybacks of discounted late-maturity bonds seems enticing, and many equity holders (and bond holders) would like to see it - but its a riskier strategy than pushing near-term maturities out as far as possible.

A potentially higher-yielding strategy - but riskier.

[The Owl]

Agree 100%. Push near-term maturities out as far as possible while one tries to reduce overal level.

And.......senior secured is all due in next 5 years. Hit those for sure.

With recent maturity tenders, I think that FTR could simply sweep up debt as it matures with the cash flow that they have into either 2020 or 2021 (I need to check my notes). At that point, having reduced leverage ratio, they should be able to roll some 2020-2021 debt and redeem some.

[glass-half-full]

everyone talks about ev being 19 billion. although technically that is true with about 1.5b equity (including preferred conversion) and 17.5 billion debt. but keep in mind that the value of debt is also set by the market. currently although on paper debt is about 17.5b but you can buy it on open market for maybe 12.5 billion. that brings the ev of frontier to be about 14b. if I had 14b, I would definitely buy frontier and all of its debt. I would be able to make 3.8b (ebidta) - 1.2b (capital expenditure) = 2.4 b in first year. even if revenue goes down by 4.5% a year, second year I would get 2.3 billion. it will take about 5 to 6 years to make original investment back. everything after 6 years is gravy. frontier is unbelievably undervalued as a whole. no matter if you buy stock or preferred or debt, the downside is very very low while upside is significant. I recommend you have a mixture of stock and bond and make yourself rich with very manageable risk.

[bondsmoker]

Problem is, you can't buy ALL of Frontier's debt at the recent market prices.

Bonds are very thinly traded - market trades aren't indicative of what the the entirety of an issuance can be bought for.

If a buyer wanted to take down Frontier in full - they'd have to pay full par value for the bonds - $17.5 Billion. Only after that would anything accrue to the equity.

Remember, bonds are senior to equity.

[glass-half-full]

you are right. good thing is that as small incestor we can take advantage of market distortion. when you buy stock, you are buying at market price, which values the market cap at 1billion. when you buy bond, since the price is 60 cents on the dollar, you are essentially paying for a much lower enterprise value. the point is even if frontier goes to bankcrupt, since the bonds are bought with such discount,you will pribably get your money back and more. look at the charter bankruptcy, the equity holder got wiped out but the bond holder got a mix of new bond and equity of new charter. based on current charter stock price the buyer of bonds before charter bankruptcy not only for their money back but made a lot of money because part of their bond becomes equity of new conpany. so bottom line is if frontier goes bankrupt or not bondolder will be handsomely paid back over time. just that there will be a period of not very liquid investment. however the upside is also limited for bondholders. that is why I recommend a mixture of bond and stock for frontier in case frontier does well in the future

[vinny b.]

FTR THIS DOWN TREND CAN NOT CONTINUE
This would be the title of my article. Sooner or latter the stock will revert to the mean. Lets not talk about book value for a moment. All that needs to take place is for the shorts to lose control of the story and that could happen in Aug. I have seen this story before with ELNK price was going down to around 3 I was wondering is it a buy. I did not think so because it was losing money. A month or so latter elnk went to 4 so what changed. Apparently they were paying down debt but still losing money so I passed again. Then they when up to 7.5 this must be a good time to short and I did for a little gain. Then it went up to 9 and was bought out by WIN around 7 or 8 don't remember. This is what ftr is going through right now the last 3 quarters ftr debt has gone down 77mill and that is only going to accelerate going forward.
The analyst are predicting -.06 to -.08 in pre- split earnings but I would not be surprised if earnings were break even to slightly lower. With the.065 div cut per quarter and the savings on interest ftr earnings may be better than expected. So the co. does not have to smash it out of the ball park this quarter a single or a double can be enough to change this story. By the way rgperrn short squeeze began today 7-13-17.

[Rachet56]

I agree and shorts know it's not going to take much of any moderate improvement to move the stock higher. They will cover before the earnings call. Not worth the risk. And if FTRreports another turd there be plenty of time to ride it down just like this quarter.

[David Hsu]

misom0000. Don't count on a takeover. The bonds have change in control provisions that require FTR to repay 101% of the principal value (plus accrued interest). Owl mentioned something similar for the FTRPR. So, a buyer would have to come up with $22 billion ($18 for the debt, $2 for preferred, $2 for the common equity) to make it work. This is for a company with approximately $3.5 billion EBITDA which is a 6.3 EV/EBTIDA ratio, which is not very cheap given the shrinking revenue base. Not saying impossible, just seems unlikely.

If you are a shareholder (common or preferred) you're betting on a business turnaround. That's the only path out.

[Michael Matejov]

David - ah thanks. If it is true, then the condition are really bad for takeover chance, I do not count on it, just think about it as possibility..

This stock get really undervalued...

Another question, can this guys buy own debt in the open market?

I am long FTRPR with average $51.68 (plus already get some dividend on the way, so I am around $47)

[sojorat]

I dont think you are correct. The current EV/ebitda is 19 bil/3.8 bil in ebitda. 5x. I dont know where you are getting 6.3x. You must be counting charges but a buyer wouldn't. Also i don't think all the bonds have that provision. Maybe just unsecured.

[sojorat]

Also any buyout would have to be at least $4. At $4 the preferred's are trading $80. There are 20mil pref shares outstanding so they would have to pay $400 million more to buy the preferred shares at par. That is not a deal breaker

[Michael Matejov]

Hi Guys, one question.

What do you think about takeover of this company, isn't it worth 2B (at price $28) for 1B FCF company?

If this starts once raise, from maybe $10 ($777 mil. market cap, 24% dividend), it will explode under short squeeze I think, any opinions?

[SeattleGoldMiner]

Owl.. As a general question: If you were the COO of FTR and you see the stock trading at $13.50 offering a $2.40 dividend (17.8%) do you say to yourself..

Hmmm...If I cut the dividend again (with the rationale of having more free cash flow dedicated to debt reduction) so that I am giving a 10% yield, will it really make any difference IN THE NEXT 2-3 years in my share price since a 10% yield still places me in the top 1% of yielders, but my coverage ratios will start to look better, I will be able to deleverage faster and THEN in 2-3 years people may actually buy my stock for the 10% yield from a more stable company instead of being stuck in my stock with a 17.8% yield (and a lot of uncertaintly) because they owned it higher??

As a partial answer to my own question, I have to believe that if the COO does not feel the dividend really makes a difference in the share price (at a given point in time) AND the after-tax dollars are used to pay off debt rather than the dividend, I would certainly lean towards the 10% dividend (i.e. that the stock price and dividend cuts have become a self-fulfilling prophecy due to the decline in the price of the stock!)

In addition I see NO reason for buying FTR rather than FTRPR if you believe that FTR makes a decent investment at current price levels. You pay $23.80 and you get $11.12 GUARANTEED dividend (well, as guaranteed as anything short of Chapter 11), and on June 29, 2018 you get 1.33 shares of the "new" FTR at roughly $9.50/share (a significant discount to the $13.50 current share price). You get the full upside of FTR common over that period (if it should move up) and you have a buffer to the downside. Also, if a "black swan" credit event should occur, you would be a tiny bit higher in the stack (although these days they wipe out Preferred with the same impunity as they do common in most cases!)

[The Owl]

SeattleGoldMiner, thank you for your note.

OK, you may know the answer to your question already as, in earlier notes, I had recommended a lower dividend.

I did not recommend a dividend of zero as I am sensitive that there are a lot of savers and retirees who were forced into buying income equity over the past eight years as the income from traditional savings vehicles have all been savaged by the ZIRP policy. Keeping some dividend in place allows them some income "air" while providing significant funds back to the company through the reduction of the dividend.

In addition, the company needed to communicate a dividend policy to equity holders. I had made and repeated a joke (that is, in my mind, not a joke) several times that the current board will get one dividend cut as the second should be made by their replacements. The company had a chance to set the policy anywhere they wanted. I had suggested $0.12/share ($1.80/new share), still not insignificant relative to the at-that-time price, but providing incrementally more funds back to accelerate debt repayment. To me, that was the right balance, given that I was shading to the side of less distribution and more debt repayment.

So I understand your sentiment about eliminating the dividend, to which we will return below, but understand that many equity owners are apparently still hanging around to continue to collect. To completely eliminate the dividend would be the last slash at them, cutting them completely off from income for an income vehicle. I might suggest that keeping the good will (to the extent that Frontier can after all that has happened) by maintaining some dividend is probably in the best long-term interest of the company. If I were the CFO, I would want to keep the dividend in place to at least have a claim as an income security, to keep a core cadre of loyal investors (and there remain some) in place as a base to rebuild shareholder support.

Keep in mind that if the company were to completely cut the dividend, that would have sent a signal that distress was more serious and the bears would have an additional argument that Frontier was done. That may have done even more damage and might have bolstered the bears even more, although at this point it looks like they are full throttle anyway.

In fact, I thought it was a bit encouraging when the dividend was set a bit higher than at least I expected and appeared to be an expression of confidence that their plan will work. The board knows that it has now set the path for distributions for the foreseeable future and cannot jerk it around because they did not look ahead far enough.

If I were the only owner of FTR and it were my company and did not have to consider the needs of a currently vulnerable group of people, I would have recommended strongly the elimination of the dividend as well as a supreme focus on debt repayment. Paying down debt not not only reduces the leverage, but provides a guaranteed 8.6% return on average on my money (the blended interest rate). I suspect that this rate of return is better than the rates of return on assets purchased, to this point, at least. That may, or may not, turn out to be the case long-term. The good news is that it requires no skill to deliver a guaranteed 8.6% return other than to write checks to redeem debt, for those worried about the competency of the management (which I do not, but again, I find myself in a distinct minority).

You partially answered the question about FTRPR vs FTR above and, given that you are a well-read commentator, I believe that you know what my answer will be. Just look at my actions: I own FTR by owning FTRPR for exactly the reasons that you cite, plus one additional reason:

my worry is that FTR gets taken out before the investing public understands the turnaround. This will make permanent what is potentially a temporary impairment of value in FTR. FTR cannot be practically taken out between now and conversion due to the "Fundamental Change" provision in the covenants of the Preferred. In turn, this means that the company has a year to turn things around and demonstrate that the revenue declines are a result of the disruption due to the acquisition and that it can return to more historic rates of slow decline or even, dare I suggest, stabilize revenue or show a gradual growth. OK, OK, I would be happy with stability, you got me on that one.

So my answer to your question is: Yes, in my mind, FTRPR is the method of choice to participate in the recovery of FTR, if you believe that it will happen and you believe in the strength of their cash flow, which I obviously do.

Thank you for the extended, thoughtful note. I hope it was answered to your satisfaction............. Owl

[tt5423]

Owl, are you saying the Fundamental Change provision prohibits an acquisition of FTR until after the conversion date?

[tennvol_30736]

Most analysts feel that FTR has a clear path of strong cash flows, 40% Ebitda levels that generate free cash flows of $1.9 billion over the next several years. This when combined with $1 billion in cost synergies achieved within the last 12 months, expected additional cost synergies ($350) million, per presentation, $300 million savings in common dividends, an additional $100 million savings on pfds beginning, 7/18, a strong retail shareholder base that is dividend oriented, another dividend cut will not occur and furthermore is unnecessary. Add to that the tenders of debt recently.