Buy, Sell, or Hold Frontier Communications?

Like getting paid money to do nothing? Well, then you must love Frontier Communications (NYSE: FTR  ) ! Last year the company paid out $1 in dividends per share, enough cash to represent a massive 13.7% yield at current prices. Does that sound too good to be true? Well, it was. The company had to cut its dividend to $0.75 per share, which is "only" a 10.3% yield going forward. The horror!

Should dividend-focused investors be looking to Frontier as an all-star candidate for their portfolio? Is a dividend of this size sustainable? To discern this, here's a list of reasons to buy, sell, or hold Frontier Communications.

Buy

  • Unparalleled efficiency: Frontier's business isn't glitzy; it provides phone, data, and video service to a largely rural customer base. Revenue has been largely flat since 2004 because of steadily declining phone service sales and competition from larger cable companies like Time Warner Cable (NYSE: TWC  ) and Comcast (Nasdaq: CMCSA  ) . However, through a relentless focus on efficiency, the firm continues to produce industry-leading operating cash flow margins. Frontier also recently closed on a major deal to acquire a host of assets from Verizon (NYSE: VZ  ) . The transaction actually improves the firm's balance sheet and triples Frontier's size. Verizon wanted to shed rural assets to focus on urban areas where it can sell its FiOS services, and rural-centric Frontier was a happy buyer. If Frontier can effectively operate Verizon's assets at the same level as its own, the company will be a huge winner across the coming years.

Sell

  • Is the dividend safe? As mentioned earlier, one of the most popular reasons to own Frontier is its attractive dividend yield. Among traditional phone companies, Frontier's dividend isn't entirely unique. Qwest (NYSE: Q  ) sports a 5.8% trailing dividend yield, and in the international space Telecom Corp. of New Zealand (NYSE: NZT  ) sports a trailing 12.6% yield. These operators all face pressure trying to keep phone subscribers as consumers increasingly cut landlines in favor of cell phones and have few growth opportunities. If you can't put the money to use, ship it back to shareholders.

    Is Frontier's amazing dividend safe, though? In the past 12 months, the company generated $448 million in free cash flow and paid $313 million in dividends. Its balance sheet (as of March 31) had only $331 million in cash equivalents versus over $4.8 billion in debt; the future looks very cloudy. However, since the Verizon deal will triple Frontier's size, previous measures of cash flow to dividends will soon prove outdated; even the balance sheet will get a shake-up. Moving forward, any unexpected costs integrating Verizon's services could be enough to cause either a temporary reduction or suspension of the dividend. In the wake of the Verizon deal, Frontier already cut the dividend from $1 to $0.75 per share.

Hold

  • A Verizon disaster? The areas that Verizon sold to Frontier are in deep need of additional investment. While the lack of modern features, such as broadband Internet, in many of these markets presents opportunities for Frontier, it may also stretch Frontier's ability to pay its current dividend if that added investment balloons in cost or new subscribers are below expectations. It's never easy swallowing assets that triple a company's size. However, it's even harder when those assets have been neglected and a new company inherits disenfranchised customers.

Final call
The history of smaller telecom players acquiring assets from Verizon isn't exactly pretty. Given the complexity and risk of acquiring assets of this size, Frontier's dividend shouldn't be considered "stable" in the coming years. If you're an investor looking for more stability, Verizon or AT&T (NYSE: T  ) have a better shot of continuing their high yields. At this point, I have to advise investors to take a "hold" stance on Frontier.

Have any better telecom stocks or high-dividend paying stocks? Leave a comment in the box below!

Eric Bleeker owns shares of no companies listed above. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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  • Report this Comment On July 17, 2010, at 9:17 AM, woo131 wrote:

    As one of the unfortunates, living in "rural America", only 8 miles from a large Pennsylvania city (but as our beloved Governor has quoted, "Pennsylvania has two large northern cities; everything in between is Alabama."), I positively detest Frontier. I now have satellite TV, Verizon cell phone, and Verizon internet access, and am seriously considering dropping my land-line. Most of my neighbors have cable (a competing company).

  • Report this Comment On July 19, 2010, at 7:06 PM, Veritas1010 wrote:

    I too live in rural America (a.k.a. what I call "The Forgotten America" and yes I have traveled extensively in the past in rural PA so I understand the unfortunate and ill-expressed characterization - politicians, UGH! Vote them all out! ), however our telephone company is a co-op and run so well I only wish I could invest in it. However, having said this let me ask why you and your neighbors have such disdain for this company? I have no exposure to it this company meaning to say I have not been a customer nor do I know anyone who is. I guess I am trying to get you (or others) to elaborate here, specifically - what have they done (or not done). Appreciate any light you could shed here!

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