How Risky Is Frontier Communications Corporation?

Image source: Frontier Communications.

Telecom specialist Frontier Communications (FTR) has seen plenty of change over the past decade. Major acquisitions have led to large increases in its customer counts, and have upped the ante for Frontier in needing to execute well in order to retain those customers and justify the immense amounts it has spent to bring them into the fold. Frontier has the ability to be successful, but it also faces several risks that could become impediments to its future growth. Below, we'll take a look at three of the major risks that Frontier Communications faces and how concerned investors should be.

Dividend risk

One of the most common threats that analysts discuss about Frontier Communications is the possibility that the company might reduce its dividend. The fact that Frontier currently pays a dividend yield of 9% lends some support to their concern, especially in light of the company's history of past dividend cuts. On two separate occasions in the early 2010s, Frontier made reductions to its payout, and all told, the company slashed its overall quarterly dividend by 60% by 2012.

So far, Frontier has done its best to reassure investors that it doesn't intend any further reductions to its payout. In fact, Frontier actually increased its dividend in early 2015, albeit with a small half-penny bump to its quarterly payout. Although many investors look at the alarming shortfall of GAAP earnings to support the current payout rate, Frontier has based its dividend payments on cash flow for years, and the increase early last year came in a period in which the telecom's cash flow levels were improving following major acquisitions.

For now, most investors seem comfortable that Frontier will at least sustain its dividend at current levels. However, any adverse performance that hurts cash flow could reverse that optimism quickly.

Market risk

Most stocks fall if the overall stock market performs badly. However, some stocks are more sensitive to the market than others. The metric known as beta helps measure how much a stock will react to market movements.

Frontier Communications currently has a beta of 0.66, which indicates that its movements are about two-thirds as volatile as the overall market. The measure doesn't mean that Frontier stock will always move precisely by two-thirds of the percentage change in the S&P 500, but it does suggest that factors like dividend yield make it less exposed to the same forces that move the broader stock market. Based on the beta measure, more of Frontier's risk appears to be company-specific than tied to the broader market.

Execution risk

The biggest risk that Frontier faces stems from its acquisition strategy. Whenever the company acquires customers from another company, it faces a huge logistical challenge in migrating those customers onto its own service platforms. When that process doesn't go smoothly, it can lead to those customers choosing not to stay with Frontier.

Recently, Frontier reported its first results following its $10.5 billion acquisition of customers in Texas, Florida, and California from Verizon (VZ 0.98%). The deal included 3.3 million voice connections, 2.1 million broadband consumer connections, and 1.2 million subscribers to the FiOS video service. During the quarter, the number of disconnects increased slightly, with a 14% rise on the FiOS side of the business and 5% from non-FiOS operations. Gross FiOS additions fell by nearly three-quarters, offsetting a gain of nearly a fifth outside of FiOS. Frontier blamed those results on a temporary suspension of its marketing efforts, but it will be important for investors to see a return to growth in that vein in order to reassure them that the trend won't become longer-lasting.

At the same time, Frontier managed to maximize its savings from synergy-related cost reductions. During the quarter, the telecom found synergies of about $1 billion annualized, which was nearly double what it had expected to post. Frontier boosted its total target for cost savings to $1.25 billion, up by more than half a billion dollars from its most recent previous estimate.

By gradually ramping up marketing, offering similar deals to what Verizon did, and making changes as minimal as possible, Frontier thinks it can keep as many customers as possible. Having learned from past acquisitions what works and what doesn't, Frontier is familiar with the risks involved, as well as the potential rewards.

These three risks aren't the only ones that Frontier Communications faces. However, they're the most important for Frontier to overcome if it wants to deliver the hefty returns that shareholders expect from the telecom company.