Frontier Communications (NASDAQ:FTR) has seen its plan to become a bigger player in the pay television and internet space hit a major roadblock.
The company completed its $10.54 billion purchase of Verizon's (NYSE: VZ) wireline business in California, Texas, and Florida (CTF) in April. That deal gave it approximately 3.3 million voice connections, 2.1 million broadband connections, and 1.2 million FiOS video subscribers. Essentially, that was enough to turn a regional player into a national company.
Unfortunately, since the Verizon purchase closed, not much has gone right for Frontier, at least when it comes to holding onto the subscribers it paid billions for. The numbers have not been huge, but instead of being able to leverage its new size to add customers, the company has seen its user counts in all categories move in the wrong direction.
What Frontier has done right is use its new size to achieve cost savings. Getting bigger has created significant synergies for the company, which was part of the reason for buying the Verizon properties in the first place. Going forward, there are really only two metrics for investors in the internet, cable, and phone service business to watch: its subscriber counts and whether it meets its savings targets.
Customers are leaving
When the CTF deal closed in April, Frontier cut off all marketing efforts so it could concentrate on the technical and behind-the-scenes work needed to move millions of subscribers to its system. That caution, and the problems caused by the cutover explained why second-quarter numbers were down. That period, which started on April 1, the day the sale completed, was easy to write off.
The company's Q3 numbers did not improve, though. In fact, they were down in all categories. Frontier saw its overall residential customer base go from 5.22 million at the end of Q2 to 5.07 million when Q3 closed. In addition, business subscribers dropped from 528,000 to 516,000 during the same period. The company also lost 99,000 broadband customers and 92,000 video users.
CEO Daniel McCarthy addressed the loss of subscribers during the Q3 earnings call, which was transcribed by Seeking Alpha (registration required). He noted that CTF subscriber trends improved sequentially in the third quarter, "although it is not yet at the rate we are targeting."
Cost-savings are key
While Frontier has seen its subscriber numbers go in the wrong direction since the Verizon deal closed, it has outperformed when it comes to cost-savings created by synergies from the purchase. In its Q3 earnings release, the company raised its annualized cost synergy target to $1.4 billion, up from the $1.25 billion target outlined in the second-quarter earnings report. "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," wrote the company.
The two numbers are linked
At some point, if people keep leaving, Frontier will have lost enough subscribers that it will no longer have the same level of cost efficiency. McCarthy made it clear during the earnings call that he was addressing the defections by reorganizing the company in what he called a "customer-focused" structure. The CEO made it clear that he expected things to turn around.
"Although our net subscriber performance affected Q3 revenues in CTF, we remain disciplined in our base management processes and did not experience revenue or margin erosion as customers migrated from promotional pricing to normal price points," he said. "...As we ramp marketing and adjust our offers, we expect continued improvements in net subscriber performance in the fourth quarter."
For shareholders, it's a pretty simple formula. The company has to stabilize its user base in order to actually achieve the cost savings that made the Verizon deal a good investment. So far, McCarthy has been able to manage around the falling numbers, but at some point, that won't be possible. If Frontier hopes to make its $10.54 billion bet pay off, it needs to hold onto -- and even add -- customers.