Addressing An Existential Threat To This Telecom

Summary

• The telecom sector is wrought with competition for consumer and business clientele and Frontier communications has been decimated in recent years.
• There are two main issues the company has to address in our view to improve its financial position and longevity.
• The dividend should have been eliminated much sooner despite the pain it caused those chasing high-yield.
• The top line can improve if and only if the churn is properly addressed.
• The continued losses are an existential threat to the company and its balance sheet.

The telecom sector is full of intense competition for consumer and business clients. Many of the players in this space have been operating under immense pressure in recent years and this is quite true for Frontier Communications Corporation (NASDAQ:FTR).

This telecom just reported Q4 earnings and while the quarter was better than we expected in some regards, the stock took another absolute beating. While there are many takeaways from this quarter, we are focused on two which we would like to discuss in the present column, both of which are major issues and both of which we feel if improved upon, would be bullish for the stock.

The first issue is the dividend and we have opined on numerous occasions that the dividend would be cut and cut and eventually eliminated. Second and perhaps more importantly the loss of customers continues to be unsustainable. The company absolutely must address the latter or investors will continue to suffer.

We have been overtly bearish, but what would change that?

There is no denying that we have been overtly bearish on the company and the stock. For over two years we have issued bearish warnings time and again. While we hate to see anyone lose money, we have been warning you to stay away from this name. Finally, it came to a pass in August. We had enough and said "get out while you can." The stock has continued to suffer:

Source: Yahoo finance

That said, we believe that the company can start to right the ship if it got a handle on the dividend and its loss of customers. A clear improvement in both issues would be long-term bullish in our opinion.

The dividend

The dividend has long been a concern for us and it was cut time and again. We strongly argued on many occasions that the dividend had to be cut, if not eliminated. We realize that the high-yield that was being offered by this stock was very enticing for many, but it was a yield trap, as the stock continued to fall, bringing the yield higher, despite numerous dividend cuts.

What were they thinking paying the dividend for so long? The most bullish development for the company in some time has just occurred. The time has finally come and the dividend has been eliminated. This is very strong news for the company and its shareholders in our opinion.

But why? Sure, it hurts that those chasing yield just got burnt, but the dividend elimination is truly good news for the overall health of the company long-term. The dividend elimination was long overdue. As the company takes time to implement its strategy, it voted to suspend the dividend on common shares to save money. Finally. The suspension will make available an additional $250 million annually, which helps, but is only a drop in the bucket.

What will this additional cash mean? It is very positive. However, the debt situation is rather troublesome. The company has almost $18 billion in debt outstanding that costs the company over $375 million in quarterly interest costs. Ouch. The savings from not paying dividends will help pay about 2% of debt all things considered, depending how the company manages its future debt obligations. Keep in mind, the company will probably continue to add more debt in the short-term.

Frontier picked up another $100 million plus worth of unsecured debt in the quarter and the company finished the year with just over $362 million in cash on hand. Ultimately, we believe this dividend elimination, although overdue, was a critical step in improving the balance sheet. The next step, which is even more critical, is to address customer churn.

Customer loss is an existential threat to the company

The loss of customers continues to drive down revenues. This is an undeniable fact and the trajectory of the top line is negative:

Source: SEC filings, chart made by author in excel

As the top line continues to deteriorate, the company will continue to fight an uphill battle. While pricing can help soften the blow, the loss of customers is driving this top line deterioration. As the top line is the starting point for all things financial, this problem must be address and it starts with taking meaningful steps to address customer loss.

Overall churn

The loss of customers and the high turnover has been a major detriment to the company. We now believe there is some reason to be hopeful here, but there is a lot of work to be done. Customer churn slowed in the quarter to 1.98% and improved from 2.08% last quarter. This also is down from the 2.28% in the quarter before that.

We want to add that this Q4 result was better than our projections for 2.0%, which we previously arrived at based on the trajectory of the company, its ongoing competitor's promotions and the initiatives undertaken to slow customer churn.

More needs to be done, but we were pleased with the result relative to our expectations. However, that still means customers are leaving. Let us investigate further into where the losses are stemming from.

Residential customers

At the end of the quarter, Frontier had 4,397,000 residential customers:

Source: SEC filings, chart produced by author in excel

As you can see the declines continue. Coming into 2017, there were 4,891,000 residential customers. These continued declines are a fundamental weakness in this name. You simply cannot invest in the company until this trend stabilizes.

As we mentioned previously, pricing can offset some of these losses. We believe the company must do more with its promotion and packaging to attract and keep customers, while simultaneously offsetting revenue losses from customers who leave the company.

The trajectory for residential revenue may be beginning to flatten out. Total residential revenue was $1.09 billion for Q4 2017, compared to $1.10 billion last quarter. The average monthly residential revenue per customer has fallen too in many quarters, however this was one positive piece of news. Average monthly revenue per residential customer rose from $80.91 last quarter to $81.61. While the increase is welcomed, keep in mind that this is still down from the mid $80s almost a year ago.

Business customers

While residential customers are key, we cannot ignore the higher margin business clientele. Unfortunately, the company continues to lose business customers as well:

Source: SEC filings, chart made by author in excel

This is another painful pattern. Frontier lost another net 10,000 customers. It is now down to just 453,000 business-based customers. The company entered the year at 502,000 business customers. Folks, this is a 10% decline in the business customer base in 2017. This cannot continue.

Slowing and stopping these losses is of paramount importance. With this loss of customers, business revenues were down, once again. Total revenue from business-based customers was $941 million in Q4 2017, vs. $ 958 million last quarter. Average monthly revenue per business customers also continued to fall, which means pricing was not a benefit. What is more, broadband, once a segment of strength, continues to see losses.

Broadband woes

It is somewhat disturbing to see the residential and business customer losses, but we are also still concerned about broadband. Prior to 2017, broadband was rather stable. However, the losses continued through 2017:

Source: SEC filings, chart made by author in excel

At the end of the quarter, the company had 3,938,000 broadband customers. This is a decline of another 62,000 subscribers from the 4,000,000 at the start of the quarter. This was also down from 4,271,000 broadband customers to start the year.

The simple message here is that these losses are unsustainable. Customer loss is crippling the company and it has weighed on the top line with very few signs of slowing down. The customer losses are across the board, in all segments and until this is solved, we believe that Frontier stock will remain pressured.

Our view

There are many other issues worth considering for this company, but in our opinion the most critical is stopping customer losses, which will be a major step in improving the balance sheet of the company. The top line revenue is the starting point for cash flow. The elimination of the dividend was also a long overdue step in improving the ability to service the debt for the company.

We believe that anything the company can do to improve its balance sheet is bullish. As of this moment, the Street is slowly bidding the stock higher off the lows following the dividend elimination announcement. At the present juncture we still see no reason to buy the stock, but do believe the company is moving in a positive direction.

It is our view that Frontier simply needs to be much more aggressive in retaining customers and for 2018 we will be focused on the company's action to reduce churn, while stabilizing the top line. In the interim, there are many better places to park your money. When would we buy? When the company demonstrates that the trajectory of customer loss has reversed. Until then, we are out.

Analyst’s Disclosure: I/we 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.