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When the rural telecom operator first announced that it was paying $8.5 billion to Verizon (NYSE: VZ ) to take over Big Red's wireline operations in 14 states, the plan seemed a bit bonkers. Economies of scale are one thing, but nearly tripling in size overnight while almost doubling the company's debt load and diluting its stock something fierce simply couldn't be a good idea. After all, Verizon was selling these assets for a reason. It's difficult and expensive to run a mostly small-town network of voice and data communications. Why would Frontier do a better job at it than Verizon?
As it turns out, Frontier knows how to do a lot of things right where Verizon was doing it wrong. According to CEO Maggie Wilderotter, "Verizon has not been doing much in those markets from an advertising or engagement perspective over the last several years." By contrast, Frontier is stepping hard on the marketing pedal and reversing some consumer-phobic policies of the old owner. For example, Verizon wouldn't sell lower-priced DSL service in territories also covered by its fiber-optic FiOS service, but Frontier will. If you wanted TV service in those areas before, FiOS TV was the only choice -- now, Frontier is happy to market a choice between FiOS and DIRECTV (Nasdaq: DTV ) .
"In our vernacular, what we care about is keeping the customer, getting the customer to take more products and services from us and making sure the customer is happy with the choice points," Wilderotter said. It's all about customer choice. I hear echoes of the policy that made Google (Nasdaq: GOOG ) great: "Focus on the user and all else will follow." Whole Foods Market follows a similar path in retailing. You may have noticed that Apple CEO Steve Jobs values user-friendly design above all else. It might sound like a stretch to put crusty old telecom Frontier in that kind of context, but I think that's the right way to think about its assets, including the hefty tack-on properties it just bought from Verizon.
While the impending Qwest (NYSE: Q ) and CenturyLink (NYSE: CTL ) tie-up might be more of a merger of equals, they'd be wise to closely watch Frontier's progress. The relative success of Frontier's early integration seems to be a good indicator the two companies will be able to squeeze out synergies that were waved in front of shareholders when the deal was announced.
Comparing sales and earnings year-over-year or even quarter-over-quarter is sort of pointless right now, because the Verizon transaction messes up every calculation. From the financial results, I'd focus on this tidbit: free cash flow increased from $120.3 million a year ago to $339.1 million this time around, easily fueling Frontier's 8.3% dividend yield. Management is "very committed to maintain your $0.75 annual dividend," and the cash flows will support that policy -- especially once Frontier completes the overhaul of Verizon's strange policies and starts reaping the rewards of those changes.
If you know of a better-looking dividend play than Frontier today, you're a better income hunter than me. Feel free to share your exploits in the comments below.