Frontier Communications (NASDAQ:FTR) is one of the largest telecoms you've never heard of. It's the largest phone and cable TV service in rural America, and a generous dividend payer. From an investor's point of view, Frontier has plenty of headroom for dividend growth and a proven appetite for game-changing acquisitions. The stock has gained 71% over the last year, assuming dividends were reinvested along the way.
But it's not all wine and roses for Frontier investors. Here are three primary reasons why Frontier's stock might fall in the foreseeable future.
Big buyouts don't automatically fix every problem
Have you seen Frontier's revenues over the last five years? First, the company more than doubled in size by picking up 4.8 million landline accounts from Verizon Wireless (NYSE:VZ). But the huge revenue boost came with a slow leak. Frontier's trailing sales have declined 15% since the Verizon-powered peak in 2011:
Phone services brought in $2.4 billion in sales in 2011, alongside $1.8 billion of broadband service revenue. By 2013, broadband sales had increased by about $100,000 while the larger voice division shrank by $450,000. In short, Frontier's growth in next-generation services is not keeping up with the rate of deflation in legacy revenue.
Management doesn't see this trend ending anytime soon.
"We will likely face further reductions in voice customers, switched access minutes of use, long distance revenues and federal and state subsidy revenues," Frontier stated in its latest overview of business-related risk factors. "The factors referred to above, among others, are likely to cause our local network service, switched network access, long distance and subsidy revenues to continue to decline, and these factors may cause our cash generated by operations to decrease."
Frontier is a popular choice for dividend investors, thanks to its generous 6.1% yield. However, this is no ironclad Dividend Aristocrat, looking back at countless years of relentless payout increases.
In fact, Frontier has reduced its dividend twice in the last five years. These cuts were necessary to close the Verizon deal, but the circumstances don't reduce the sting of lower quarterly payouts. The company hasn't made up for this cardinal sin by offering increases afterward, either:
Frontier's free cash flow is on the rise nowadays, and the reduced payouts leave lots of headroom for reupping the dividend again. However, the company is also knee-deep in another billion-dollar asset buyout that might delay dividend increases for several more years.
The pending acquisition of about 1.5 million AT&T (NYSE:T) voice, video, and broadband customers in Connecticut has hit some resistance in regulatory proceedings. Frontier is still moving forward as if the deal will close, which brings us straight to the third anchor around the company's neck:
Tons of debt
Frontier is sitting on a $7.9 billion long-term debt load, balanced against $800 million in cash equivalents. This type of debt-heavy balance sheet is nothing new in the telecom industry, where every inch of success and subscriber acquisition depends on large amounts of infrastructure investments.
Keep in mind that the all-cash AT&T transaction would add at least $1.6 billion of fresh debt on top of the current amount. Frontier has already carved out the financing for this, in the form of senior debt notes.
Frontier's balance sheet is already shaky, even by the standards of the asset-and-debt-heavy telecom industry. The ongoing buyout binge isn't helping unless Frontier can unlock game-changing value from its big deals.
The Verizon deal boosted cash flow, but will take decades to pay for itself. This proposed AT&T agreement is smaller and lighter, but still expensive. Since this balance sheet can hardly afford to take on more debt, Frontier investors might be better served if Connecticut's regulators rebuff the AT&T contract.