If holding onto the customers it gained in buying Verizon's (NYSE:VZ) wireline systems in California, Texas, and Florida (CTF) determines whether Frontier's (NASDAQ:FTR) $10.54 billion deal was a good investment or not, then so far, it has not been.
There were some positive signs in the company's Q3 earnings report, especially when it comes to savings realized from nearly doubling in size. However, dropping subscriber numbers are a cause for concern, even if CEO Dan McCarthy downplayed the importance in his remarks in the Q3 earnings release:
I am pleased that we achieved third quarter adjusted EBITDA of $1 billion. We are reaffirming our adjusted EBITDA guidance for the 4th quarter and outlook for 2017. We are on course to improve our revenue performance, principally by returning to normal customer trends in the CTF market over the coming quarters.
That's the outlook you would expect the CEO to have, and it's possible the Q3 subscriber drops are merely a remaining hangover from the switch from Verizon. It's also possible that Frontier has gotten bigger, but not big enough for long-term viability in the pay television and internet spaces.
How many customers left Frontier?
Frontier reported a net loss attributable to common shareholders of $134 million, or a loss of $0.12 per share. Revenue fell from $2.6 billion in Q2 to $2.52 billion in Q3 with drops in both the CTF properties and the company's legacy business.
The company explained this in the earning release, noting "a slower than expected recovery of FiOSgross additions," in the CTF properties. On the positive side, average revenue per user (ARPU) remained close to the big jump it took in Q2, the first quarter after the Verizon deal. ARPU came in at $82.34, down only slightly from $83.20 in Q2.
The problem is that while ARPU has gone up dramatically since the CTF customers were added, the number of customers has shrunk. Frontier's overall subscriber base dropped from 5,228,000 in Q2 to 5,073,000 in Q3. Drops were shown in business customers, video subscribers, and even broadband users, an area where most of its competitors have been posting big gains.
What happens next?
McCarthy believes the drops this quarter are merely a speed bump on the way to success. The company said in the earnings release that it "anticipates improved customer additions in the fourth quarter."
And, while the subscriber numbers were troubling, Frontier has made gains in other areas. The company has raised its cost-synergy target from the $1.25 billion it outlined in the Q2 earnings release and call to $1.4 billion. "Yet-to-be attained cost synergies of $400 million are anticipated to be achieved by mid-year 2019, including $250 million anticipated to be achieved by mid-year 2017," the company wrote.
You can't cut your way to success
Saving money was always going to be a benefit of the Verizon deal, but at some point, Frontier needs to go back to adding customers -- or at least not losing them. The company has been relentless in driving home its message that everything is on track, and it once again laid out its long-term goals in the Q3 release:
Frontier's priorities continue to be driving strong free cash flow and continuing a disciplined capital allocation policy. Frontier is committed to maintaining an attractive dividend, preserving its industry-leading dividend payout ratio, and reducing leverage.
That sounds nice, and McCarthy has proven to be a very capable manager of the various financial metrics, but at some point, that's not going to be enough. Cost-cutting and relentlessly managing the bottom line, while paying shareholders for their patience, are solid strategies.
In the long run, though, Frontier needs more customers. So far, even though it's early in the game, it has not shown it can do that. That's not necessarily enough to scare investors away, but it should be at least a cause for concern if it does not turn around in Q4.
Daniel Kline has no position in any stocks mentioned. He did not eat any Halloween candy (despite wanting to). The Motley Fool recommends Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.