Frontier Communications (FTR) has dazzled income investors with its big dividend yield. Yet with the battering its shares have taken over the past two years, Frontier has left those who bought into the stock for its dividend feeling shellshocked and uncertain of its future prospects.
Looking forward, Frontier's success depends on stabilizing its customer base and making the transition from old-technology obsolescent landline offerings to higher-margin services. That's the thesis of my premium report on Frontier Communications. In this excerpt from the report, I examine the risks that the company faces.
1. Frontier may not make the most of its Verizon acquisition.
One big risk that Frontier faces is that it won't be able to benefit from its former Verizon (VZ 0.90%) customers as much as it thought when it made its deal. A similar deal involving FairPoint Communications (NASDAQ: FRP) provides a worst-case scenario. In March 2008, FairPoint bought customer territories in northern New England from Verizon. After facing a host of problems in getting customers onto its own network architecture, FairPoint had trouble selling those new customers higher-value products and eventually had to declare bankruptcy. Although the terms of the Frontier deal are much different, the similarity is that Verizon presumably had reason to get rid of landline customers in both cases -- and if it thought they'd be profitable, Verizon might well have held onto them.
2. A possible future bond downgrade could increase borrowing costs.
Also, in January, Standard & Poor's revised its outlook on Frontier's debt from stable to negative. Although the rating agency didn't immediately change Frontier's BB junk bond rating, it opened the door to future downgrades, pointing to declining revenue and earnings trends stemming from competition and from customers moving to wireless phone service. That has already shown up in Frontier's borrowing costs, as the company has offered large premiums to redeem bonds paying around 8% that mature in the next two to three years, replacing them with 9.25% bonds that mature in 2021.
3. Litigation could distract Frontier from more important strategic initiatives.
Finally, late last year, a set of Frontier customers filed a class action against the company, alleging that it imposed surcharges that violated the Internet Tax Freedom Act. With some of the alleged fees making no sense -- for instance, charging Internet customers phone-related fees like 911 and Universal Service charges -- there's a possibility that Frontier has inflated its reported revenue, as well as exposing itself to possible punitive damage awards. Frontier didn't specifically list the lawsuit among legal proceedings in its 2011 annual report, which arguably implies that the company doesn't believe the plaintiffs have a high chance of winning.
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That was just a part of the Motley Fool's premium research report on Frontier Communications. Frontier rivals Windstream (WINMQ) and CenturyLink (LUMN -0.76%) certainly share some of these risks as they try to integrate their own recent acquisitions and find way to add to growth, and with all three companies having substantial amounts of debt on their books, Frontier isn't alone in having to do its best to maintain a favorable credit rating in order to keep its access to the credit markets.
