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3 Reasons Frontier Communications Stock Could Fall

By Daniel B. Kline - May 21, 2016 at 11:54AM

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The cable, broadband, and phone company has completed a major purchase that expands its footprint, but the move comes with some big risks.

Frontier Communications (FTR) recently completed the biggest transaction in company history.

The cable, broadband, and phone company purchased Verizon's (VZ 0.00%) wireline operations in California, Texas and Florida for $10.54 billion. The deal, which closed April 1, more than doubled the size of the company, giving Frontier approximately 3.3 million voice connections, 2.1 million broadband connections, and 1.2 million FiOS video subscribers.

It's a huge move for the company, and one that comes with considerable risk. CEO Daniel McCarthy, as you might expect, anticipates big things from this purchase.

This is a transformative acquisition for Frontier that delivers first-rate assets and important new opportunities given our dramatically expanded scale. It significantly expands our presence in three high-growth, high-density states, and improves our revenue mix by increasing the percentage of our revenues coming from segments with the most promising growth potential.

Everything the CEO said is true, but that doesn't mean Frontier will have smooth sailing ahead. It does have a significant opportunity to succeed, but it could just as easily fall flat on its face, either due to its own actions, or due to industry conditions in general.

Image source: Frontier.

Frontier could botch the transition

McCarthy admitted during the company's Q1 earnings call, which was transcribed by S&P Capital IQ that things did not go flawlessly.

"As with any transfer of this scale and complexity, there were some issues at the outset, but these affected less than 1% of our customers in total and much less than that at any point in time," he said, acknowledging that the need to train employees "...delayed the rate of reaching a normal business cadence, and as a result, we were slower in responding to customers and restoring service. This disappointed some customers and resulted in some negative publicity in the market."

Some problems were to be expected given the size of switch-over, but media reports in the former Verizon territories suggest that not all issues have been resolved, and some customers have been without service for extended periods. There is likely to be a certain amount of understanding and good will because it's a new company taking over, but that will evaporate quickly if the issues are not resolved.

It does not take many disgruntled customers to create a media storm, and that could lead to former Verizon customers leaving and new subscribers being harder to obtain.

The market for pay-television could shrink

So far, the loss of pay-TV customers to cord-cutting has proven more of a trickle than a flood, with the entire industry only losing about 385,000 subscribers in 2015, and actually gaining 10,000 in Q1 2016, according to information from Leichtman Research Group. But just because cord-cutting has not caught on does not mean it won't.

Frontier stock is exposed to the risks of a shift in consumer behavior, if people start ditching full-service cable for streaming options or even skinny bundles. With the streaming leaders constantly adding to their content lineups, and a number of companies planning skinny bundles or new streaming services, it remains possible that a major shift in the pay-television market could still occur.

A big competitor could eat Frontier's lunch

Frontier, despite the Verizon deal, remains a relatively small fish in a big sea. This expansion will help it spread out its research and development costs, but it does not give the company the resources of some of its potential broadband rivals.

Because of that, Frontier could take a hit if, for example, Alphabet's Google expands its fiber service into any of its markets. In fact, the telecoms industry in general faces the risk that the search giant, or any of the other potential players in the space, finds a viable, alternative way to deliver broadband. That might mean blimps, drones, or technology not-yet widely known, but that type of product -- while probably not imminent -- could undermine telecoms, and therefore Frontier's, business model and its stock price.

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