Why Frontier Communications Corporation Shareholders Have Something to Worry About

6/7/17

By Daniel B. Kline, MotleyFool

Frontier Communications (NASDAQ:FTR) made a $10.54 billion bet on growth, and so far, it has not paid off.

The company bought Verizon's (NYSE:VZ) wireline business in California, Texas, and Florida (CTF). That gave Frontier approximately 3.3 million voice connections, 2.1 million broadband connections, and 1.2 million FiOS video subscribers, according to a press release. At the time the deal closed in April 2016, CEO Daniel McCarthy was excited and believed he had set his company up to succeed in the long term.

"This is a transformative acquisition for Frontier that delivers first-rate assets and important new opportunities given our dramatically expanded scale," he said. "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."

The Verizon deal did make the company bigger and it did create an economy of scale. What McCarthy did not count on is that in all four quarters since the CTF purchase closed, Frontier has lost some of the customers it paid $10.54 billion for.

A remote contol is pointed at a television.

FRONTIER HAS SEEN ITS SUBSCRIBER COUNTS MOVE STEADILY IN THE WRONG DIRECTION. IMAGE SOURCE: GETTY IMAGES.

What is happening?

When Frontier reported its Q2 2016 results McCarthy explained that it had lost customers partly due to the switchover from Verizon and partly due to the suspension of marketing activities. That tune continued in Q3, before the CEO introduced a new excuse in Q4.

At the end of 2016, when Frontier reported the loss of 144,000 more residential customers as well as 14,000 business customers, McCarthy had a new excuse. He blamed the drop on Frontier getting rid of former Verizon customers who had not paid their bills.

"This process is almost complete, and we expect to return to a normalized trend by the start of the second quarter," he said in the Q4 earnings release. "I am pleased that underlying CTF customer trends improved in Q4 and continue to improve in Q1."

That did not happen. In Q1 Frontier lost 155,000 residential customers and 18,000 business customers. Those are bigger losses than the previous quarter, and despite the company and its CEO continually saying the trend will reverse, there is little reason to believe it will.

What's next for Frontier?

The company needs to show it can stop customers from leaving and attract new ones. McCarthy has done a very good job managing expenses and squeezing operational efficiency out of his newly larger company. Still, even though he has delivered $1.25 billion in annualized cost synergies at the end of Q1, you can't cut your way to success.

If Frontier keeps losing around 160,000 subscribers each quarter some of those cost savings gained from being bigger will start to disappear. That's a very realistic scenario because while McCarthy delivers credible excuses for the drops, he has not shown he knows how to stop them.

Frontier may well be falling victim to the cord cutting impacting most of its competitors. It also appears to have lost momentum as an alternative to the established players in cable, likely because so many new options have popped up in recent months.

Those may not be solvable problems. Frontier may well be a tire with a slow leak where at first it does not seem so bad, but eventually the problem leads to a blow out.

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