This was published on July 8, 2015, and updated on March 14, 2016.
Telecom company Frontier Communications (NASDAQ:FTR) has been attractive to dividend investors for years, with yields that consistently rank among the highest in the stock market. Yet Frontier has had a much harder time keeping its share price up, as concerns about its ability to hang onto the customers it goes to such great pains and expense to acquire have weighed on investor sentiment.
Even as the company raised its dividend 5% earlier this year for the first time since two massive dividend cuts several years ago, Frontier Communications still faces the challenge of making its acquisition strategy pay off in the long run, and investors have responded to that challenge by bidding the stock down by almost a quarter in the first half of the year. Let's look more closely at how Frontier Communications has done in 2015 and what is next for the telecom specialist.
Optimism gives way to fear at Frontier
Frontier actually started out 2015 on several positive notes, pushing the stock up as much as 30% in February. A combination of factors led to that initial surge, including solid financial results and news of another big acquisition. In its fourth-quarter results, Frontier reported adding more than 420,000 broadband customers as well as 191,000 net new subscribers to its video service, as the company cashed in on its newly acquired assets in Connecticut to boost its overall reach.
In part as a result of that acquisition and its positive effect on cash flow, Frontier raised its dividend by 5% to $0.105 per share. That is a far cry from the $0.25 per share it paid quarterly as recently as 2010, but it nevertheless got Frontier moving in the right direction once again.
Even more important for the bullish argument was the February announcement that Frontier would make a massive purchase of Verizon (NYSE:VZ) assets in California, Florida, and Texas. In the deal, Frontier agreed to pay $10.5 billion for wireline assets in the three key states, giving Verizon some much-needed cash in the wake of its full takeover of its Verizon Wireless unit and the billions it has spent in auctions to acquire more spectrum assets.
For Frontier, though, the deal means getting more exposure in markets with substantial growth potential. Moreover, many Verizon customers in those areas already take advantage of the FiOS fiber-based Internet service, giving Frontier a greater chance at retaining and building higher-margin business rather than dealing with those with less technologically sophisticated telecom services like landlines and slow Internet.
By May, though, much of the shareholder enthusiasm about Frontier had subsided. The first-quarter financial report fell short on key measures including revenue and net income, with adjusted earnings coming in at just half what investors had wanted to see. Frontier continued to build up its customer counts on the broadband side, but a drop in consumer lines offset some of the monthly revenue gains that the telecom specialist managed to produce during the quarter. A lack of solid guidance with respect to the pending Verizon acquisition also created uncertainty about exactly what the deal could mean for the long term.
Can Frontier bounce back?
Despite the poor performance, Frontier unquestionably has a huge opportunity right in front of it. The Verizon acquisition will give Frontier access to a large number of prospective new customers, including 3.7 million voice customers and 2.2 million broadband subscribers. And 1.2 million of those customers have Verizon FiOS service. With Verizon already having spent billions building out the FiOS network in those areas, Frontier is paying for a ready-made opportunity to offer high-speed Internet to a customer base that is hungry for greater broadband speed.
If Frontier is successful in converting on its Verizon asset purchase, then the ramifications for dividend investors could be impressive. Frontier believes that the deal could be 35% accretive to its free cash flow even in the first year after the transaction closes, and because Frontier bases its dividend payout in large part on its free cash flow, that could mean further dividend increases once the Verizon acquisition is complete. With the expectation for a 13-percentage-point improvement in its dividend payout ratio, Frontier investors will not see the stock return to its glory years of the past right away, but it looks like the company is making a substantial move toward getting back some of its lost luster.
In the end, though, Frontier cannot simply buy its way to success. It also has to make sure it offers the customers it gets from acquisitions the service they need and want. If former Verizon subscribers simply jump ship and defect to other carriers following the acquisition, then the decline in the share price so far in 2015 will turn out to have been entirely justified. Indeed, as the stock's relatively flat performance between mid-2015 and early 2016 shows, investors are largely waiting to see whether Frontier Communications can execute well on the merger when it happens.
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