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FRONTIER COMMUNICATIONS (FTR) 2011 HIGHS A POSSIBLE TARGET?

|Includes: Frontier Communications Corporation (FTR)

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Executive Summary

 

  • Range bound $4.00 - $5.00 for most of 2013 stock has broken out solidly to the upside in the last month.
  • Pays 7% dividend, free cash flow is covering this payout and should be able to maintain for the next few years. Cash flow was re-affirmed in the latest earnings report.
  • Potential acquisition target for another Teleco or Multimedia company?

Research Detail

Telecommunications as a sector, from its 2010 peak declined to a bottom in mid 2012. Since that time the sector has been riding a wave of generally positive market action working steadily back uphill. Frontier has benefitted from the market trend as well as its own prodigious cash flow which is has been using to pay a 7% dividend back to shareholders. At its recent close of $6.06 (5/9/14) it is right on its 52 week high and trading strongly in the face of recent market weakness (FTR 1 month performance +10.38% S&P 500 1 month performance + 0.34%) Given the state of the overall market we would be quite content to own Frontier at these price levels, and would similarly give serious thought to increasing a position should the stock pullback into the $5.40-$5.50 area. If the pricing were unable to hold the $5.00 area that would be a spot where we would be uncomfortable adding and would look to lighten or close a position if still long.

The company has a large footprint in rural and semi-rural areas. This footprint resulted in adding 112,250 new broadband subscribers, an increase of 6% on the year. The local and long distance business is shrinking, but to the company's credit, they seem to be able to play to their strength in data and grow that segment. The management team is also executing well on controlling costs as operating expenses for 2012 decreased 11% and in 2013 decreased 3% as costs and redundancies related to the 2010 acquisition of certain business from Verizon were absorbed and redundancies continue to be eliminated. We think this combination of growth and cost control sets up the company as a fairly attractive target for another data provider. The customer base that Frontier has cultivated is one where the cost to obtain the customer is relatively high and the margins per customer are also high, especially compared to more densely populated (competitive) areas. This makes a compelling case for a larger competitor looking to flesh out their coverage simply to "buy" rather than build. We could see a price in the $8.00 - $8.30 range, a ~35% premium to recent prices on a takeover bid. Potential suitors could be Charter Communications (NASDAQ:CHTR), Windstream Holdings (WIN), or Century Link (NYSE:CTL).

On 2/25/14, the company broke out strongly from a nearly 19 month trading range on 3.5x its average volume. There was a good bit of short interest prior to this break out, though it has been falling, with 16 days to cover just prior to the move up. We feel this was a factor in the move, though not the main driver. The recent earnings report was a mixed bag, but over all was seen positively by investors. To our eye this is a major plus given the beating that technology and growth stocks have been taking on any sign of weakness. The earnings combined with the factors we outline above seem to suggest to us that this company is in the process of executing on two separate paths, both of which will grow the share price in the near to mid-term. Looking at the price run through this lens we see investors trying to position themselves to take advantage of these catalysts in the company. Should any of the three scenarios play out (short squeeze, takeover offer, organic growth / continued cost control) there would most probably be a positive change in the stock price, perhaps a very significant one. To us the piece that makes all of this very compelling is that we are getting paid 7% or so to watch things happen. This makes it easy to wait a few quarters and see how things play out in the market overall and in Frontier Communications specifically.

Disclosure - We are long FTR from 2/18/14 and may add or subtract from our position in FTR over the next 1-5 business days

Disclosure: I am long FTR.