According to the FCC, 19 million Americans still have no access to high-speed Internet services, three-quarters of whom live in rural areas. While the FFC's majority views that as abject failure -- progress for universality isn't being completed in a "reasonable and timely fashion" -- the minority notes that between 2003 and 2009, high-speed broadband was brought to 95% of the population.
Back in 2010 when the agency first decided broadband access was moving too slow (the FCC reviews the issue each year), the FCC expanded the scope of its power to impose "net neutrality," or the government's regulation of the Internet. Telecoms like Verizon (NYSE: VZ ) and AT&T (NYSE: T ) have challenged the rules in court and many analysts believe the regulations will go down to defeat.
The majority, though, uses faulty logic in saying we'll never get to universal access unless the FCC steps in. For one, it ignores that between the last report and the current one, 7 million more Americans gained access. Worse, it doesn't include access gained via mobile broadband because it can't find reliable data so it just assumes no one gets it that way (even though the report notes 99.4% of the population is covered by 3G services or better).
Regardless of how one views the situation, whether the telecom industry is falling short of its ability or has achieved remarkable success in a short amount of time, the FCC's report shows rural telecom operators still have a big market they can exploit.
Scarcity of opportunity
The industry's biggest player is CenturyLink (NYSE: CTL ) with a $26 billion market cap, though it's a much more diversified business, followed in a distant second place by Windstream (NYSE: WIN ) at $6 billion and Frontier Communications (NYSE: FTR ) at less than $5 billion. CenturyLink has been a consistent performer with its stock rising 37% over the past year, but its two rivals trade well below their prior-year levels: Windstream is down 8%, and Frontier has lost a quarter of its value. Both, though, have bounced off their absolute low points.
As much as they're all dedicated to expanding their rural services, it remains essential for them to grow beyond that. CenturyLink, for example, bought data storage company Savvis last year for $2.5 billion, while Windstream acquired PAETEC for $891 million to build out its fiber network and cloud computing capabilities to service enterprise-level customers. The acquisition added $389 million to its revenue, now accounting for 25% of the total.
More, more, more!
Windstream, in particular, has pursued a growth-by-acquisition strategy that has the ratings agencies worried its debt levels will pressure performance if they run into headwinds. Moody's has cautioned it has only a "narrow margin of safety."
It has other issues in addition to a heavily leveraged balance sheet. Total revenue dropped 1.5% last quarter and wholesale revenue plunged 12% after it discontinued some products, causing GAAP earnings to drop to $0.09 per share from $0.19 a year ago. Frontier also suffered falling revenue, both sequentially and year over year as it suffered an 8% loss in residential customers and a 9% drop in business customers.
Standard & Poor's sees Frontier's business challenged on several fronts, particularly from wireless carriers and cable operators. But, like Windstream and CenturyLink, it has agreements with DISH Network and DIRECTV. That gave it 13,300 net additions on the satellite customer front, but it lost 7,000 FiOS customers.
All three telecoms trade at nosebleed valuations, with CenturyLink at 50 times earnings, Frontier at 47, and Windstream at 36, and each also offers enterprise values trading at rich multiples to the free cash flow they generate. Their dividends are also seemingly attractive, with Windstream and Frontier yielding 9.8% and 8.6%, respectively, but their debt-laden financials mean caution is needed. Windstream has payout ratio of 256% and Frontier offers one up of 523%. which suggests these dividends might not be sustainable.
Disconnected from reality
These telecoms have enjoyed a nice bounce in their stocks, but I have trouble recommending them as an investment still. Their risk profiles seem elevated, and I think CenturyLink would be the better choice here because of its diversity and breadth of services. But let me know in the comments box below if you disagree that Windstream or Frontier Communications will be hanging up on growth.
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