What Frontier Communications Needs To Soar in 2014

Frontier Communications (FTR) did reasonably well in 2013, lagging somewhat behind the market but still posting a solid total return of more than 20%. Yet with it and peers Windstream (WINMQ) and CenturyLink (LUMN -1.14%) struggling to find the growth in high-margin areas like enterprise telecom and residential broadband that they need, Frontier needs to hope that it can find growth from sources like its recent deal with AT&T (T 0.98%).

Source: Frontier Communications.

Frontier's high dividend yield is a big draw for the stock, but it also scares potential investors because of its apparent fragility. With Frontier having had to cut its dividend twice already, the prospect of a third cut sits badly with shareholders who don't want to suffer any further losses. Yet if the key to success is customer retention, Frontier will face another big test as it integrates the Connecticut customers it acquired from AT&T. Let's take a closer look at Frontier Communications and its prospects for 2014.

Stats on Frontier Communications

Source: Yahoo Finance.

What's next for Frontier Communications in 2014?
As you can see above, Frontier Communications doesn't inspire much confidence among analysts, who believe that Frontier has already achieved all of its stock's potential upside. By contrast, both Windstream and CenturyLink have target prices that are 10% or more above their current share prices, suggesting much more for share-price gains in 2014.

The watershed moment for Frontier in the recent past was its transaction with AT&T. Under the deal, Frontier agreed to acquire AT&T's wireline business and fiber network in the state of Connecticut, paying $2 billion in cash. For a debt-ridden company like Frontier, using so much cash to acquire more assets might seem like doubling-down on a losing bet, but Frontier expects the deal to have a positive impact on its adjusted free cash flow within the first year after it closes. Moreover, it sees the deal improving its free-cash-flow ratio, arguably making its dividend more sustainable in the long run.

The real question for Frontier will come when it has to go into the credit market to raise money by selling debt. By the second or third quarter of 2014, interest rates might well have risen again, costing Frontier more in interest expense to sell bonds. Moreover, Frontier already carries a junk bond rating, and further debt already led Fitch Ratings to downgrade its rating further, potentially making it even harder for Frontier to get financing at attractive rates.

The other issue Frontier needs to pay attention to is whether it can compete in the enterprise segment. Last week, the company introduced new Ethernet offerings for retail and wholesale customers, offering traffic prioritization services that allow customers to define their own mission-critical applications and provide quality-of-service capability to improve network efficiency. Moreover, with plans to offer virtual private-line service to allow customers to direct data bandwidth between two fixed points, Frontier hopes to cater to the increased need among enterprises for data analytics and other real-time application needs. CenturyLink has done a good job of focusing on businesses; both Frontier and Windstream need to work harder to have equal success in the key segment.

For Frontier to have a stronger 2014, it needs to make good on the Connecticut AT&T acquisition while also doing a better job of integrating and holding onto its customer base in other areas. Otherwise, the slow erosion in its customer base will eventually put Frontier in a position where it can't sustain its business at the levels investors expect.

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