Ticker: FTR
Sector: Technology
Industry:
Telecommunications
Recommendation: Wait
Data
Price: 7.48
52-wk high: 8.50
52-wk low: 6.13
Based on my research, my recommendation for our current
holding of Frontier Communications is a:
Market Cap: 2.33 Billion
Avg. Trading Volume:
5.48M
Wait
Frontier offers a unique investment opportunity with its significant
EPS (2009): 0.38
dividend and upcoming acquisition. While they will be cutting the
P/E: 19.57
dividend assuming the Verizon deal goes through, it will still yield
over 10%. Further, the Verizon deal will make Frontier the largest
Dividend Yield: 13.37%
ROA: 1.79%
rural provider of telecommunication services in the United States.
However, many legal barriers must be overcome before this deal
happens and due to the large stock trade that will occur with Verizon
ROE: 28.00%
investors, the price of an FTR share will be in question. Further,
Profit Margin: 5.82%
besides acquisition, there isn’t a significant amount of growth in the
Operating Margin: 28.62%
industry forcing me to use 3% growth rates for the valuation.
I recommend to Wait until the end of semester to decide on this
stock. By that time we can see what has happened with Verizon and
the next dividend isn’t for a couple of months. Frontier has a good
model and good niche but a lot could go wrong.
Report by Taylor Fox
4.4.10
Company Background
Frontier Communications Corporation (Frontier), formerly Citizens Communications Company,
is a communications company providing services to rural areas and small and medium-sized
towns and cities. The Company provides communications services to residential and business
customers in its markets. It offers a variety of voice, data, Internet, and television services that
are available as bundled or packaged solutions and for some products, a la carte. They offer
local and long-distance telephone service, Internet access, wireless Internet access, digital
phone, DISH satellite TV and more. As of December 31, 2009, the Company operated as an
incumbent local exchange carrier (ILEC) in 24 states. They provide service to approximately 3.0
million access lines and High-Speed Internet subscribers. The Company’s business is with both
residential and business customers. Its services include access services; local services; long
distance services; data and Internet services; directory services; television services, and
wireless services. Frontier Communications is the highest yielding stock in the S&P 500
with an amazing 13.7% dividend yield. The telecom stock is in the midst of acquiring assets
from Verizon (VZ: 29.7989 -0.37%) in an $8.6 billion deal.
Map Showing States currently being served by Frontier Communications.
Verizon Deal:
Overview
Frontier announced in May 2009 its plans to acquire Verizon's local wireline operations serving
residential and small-business customers in predominantly rural areas and small to mediumsized towns and cities in 14 states. Frontier announced that New Communications Holdings Inc.
("Spinco"), a subsidiary of Verizon Communications Inc. ("Verizon") formed for the purposes of
holding defined assets and liabilities of the local exchange business and related landline
activities of Verizon in 14 states, has priced $3.2 billion aggregate principal amount of Senior
Notes. The gross proceeds of the offering will be deposited into an escrow account. Spinco
intends to use the net proceeds from the offering to fund the special cash payment by Spinco to
Verizon, in connection with the spin-off of Spinco to Verizon's shareholders and the subsequent
merger of Spinco with and into Frontier.
Potential Troubles:

Less than three years after Verizon’s sale of its New England landlines to FairPoint
Communications, FairPoint has filed for bankruptcy. Now, workers face cutbacks and job
losses and customers complain about deteriorating service and the lack of high-speed
broadband and other new technologies. Hawaiian Telecom also filed for bankruptcy after
Verizon used the same tax loophole to dump its landlines in Hawaii. A Verizon landline
sale has often been laden with poor business results.

Illinois Judge rejects the merger in their state. According to Tapia, evidence presented in
the case in front of the Illinois Commerce Commission did not support the sale because
the transaction would leave Frontier too laden with debt to be able to properly manage
the lines and other infrastructure.

Frontier’s ability to provide adequate, reliable, efficient, safe and least-cost public utility
service will also be diminished by the proposed re-organization.

All stock deal so Verizon stockholders may dump the stock because they don’t know
anything about it.

Jobs bill provision may pose hurdle for Verizon-Frontier landline deal. A provision in a
federal jobs bill that outlaws a tax loophole used in Verizon's bid to sell its telephone
landlines to FrontierCommunications Corp. in West Virginia and 13 other states could
derail the sale. The U.S. House passed legislation that includes a ban on a tax shelter -known as a Reverse Morris Trust -- that Verizon and other companies have used to spin
off operations tax-free. Verizon plans to use the Reverse Morris Trust as part of its $8.6
billion deal with Frontier.The Communications Workers of America said the elimination of
the tax-free provision, which now goes to the U.S. Senate, could be the "death-knell" for
Verizon's plans to sell 617,000 wire lines in West Virginia to Frontier."The Reverse
Morris Trust was designed by Wall Street for Wall Street, not West Virginians," said Ron
Collins, a union vice president. "We're happy Congress shares our view that the Reverse
Morris Trust is a tax break for corporations, not a job-creating tool. Without this tax
loophole, I don't believe Verizon would be so eager to sell to Frontier."
Debt from Deal
The Senior Notes consist of $500 million aggregate principal amount of Senior Notes due 2015
(the "2015 Notes"), $1.1 billion aggregate principal amount of Senior Notes due 2017 (the "2017
Notes"), $1.1 billion aggregate principal amount of Senior Notes due 2020 (the "2020 Notes")
and $500 million aggregate principal amount of Senior Notes due 2022 (the "2022 Notes", and
together with the 2015 Notes, the 2017 Notes and the 2020 Notes, the "Notes"). They expect
the credit rating on the debt to be BB.
Good News from the Deal

Upon completion of the transaction, Frontier will be the largest pure rural
communications provider and the nation’s fifth largest incumbent local exchange carrier
(ILEC) with more than 7 million access lines, 8.6 million voice and broadband
connections and 16,000 employees in 27 states.

Received approval from all other states.

The transaction is subject to approval by Frontier shareholders and the satisfaction of
customary closing conditions and regulatory approvals, including the Federal
Communications Commission and nine state public service commissions. The
transaction is expected to be completed in the next 6 months.

Estimates of synergies from the acquisition are in the $500 million range and an
example of 2008 statistics with the merger is shown below.

The FairPoint bankruptcy after the acquisition of Verizon assets is an obvious
concern. However, Frontier has a track record of good synergy transactions. In the
past few years, 3 companies have been acquired by Frontier and all deals realized
better than expected synergy.
Below is a map outlining the current territories served by Frontier along with the additional
area that would be acquired.
4th Quarter Results
Revenue for the quarter declined 4.8% year-over-year to $521 million. Local services revenue
declined 8% year over year to $188.6 million, while data and Internet services revenue
increased 4% to $160 million. Switched access service revenues declined 6% year over year to
$90.9 million, while revenues from long-distance services fell 3% from the year-ago quarter to
$41.4 million.
Frontier added approximately 14,600 high-speed Internet customers in the quarter, and ended
2009 with 635,947 (up 10% year over year) total high-speed Internet customers. As a result of
low customer acquisition costs and declining capital expenses, broadband remains more
profitable than the company’s traditional local and long-distance services. The company added
8,400 video customers in the quarter, bringing the total number of customers to 172,961 (up
44% year-over-year).
For full year 2009, revenue fell 5% year-over-year to $2.12 billion
This is obviously a very capital intensive business so there is a lot of depreciation. At over half a
billion dollars, they are able to have a strong cash flow even thought net income isn’t that
strong.
5 Year Performance Chart:
Competition
Overall, the market is pretty saturated but Frontier has carved out a nice niche. Companies like
Verizon are trying to shed this type of business due to the lack of growth, but this also means
less competition in the field. Looking at the metrics below, FTR’s superior dividend yield
obviously jumps out at you. We will discuss it later in the report. Looking at the Current and
Long Term Debt to Equity Ratios, it is obvious all of their liabilities are long term. They have the
strongest current ratio amongst the competition and one of the highest debt to equity ratios.
However, in a business where acquisitions can be needed to grow, debt is necessary to
enhance the business. None of the return on assets are very strong in this industry and I would
imagine the ROE is high due to the amount of leverage. The Profit Margin for FTR is also well
below the completion possibly raising a red flag to operating efficiencies.
Just as red flags were being raised about efficiency, observe the following graph.
One Year Performance Versus Competition
The Dividend!
Frontier Communications is the highest yielding stock in the S&P 500 at over 13.5%.
A $1 dividend on a $7 stock is significant but it will be cut to 75 cents after the Verizon deal
closes. They expect to generate $1.95 in cash flow per share and about $1.1 to $1.2 in free
cash flow per share. They don’t have any significant debt maturing until 2011, $1.2 billion. The
CEO forecast in an interview a free cash flow of $1.7 billion the first year after the close of the
Verizon deal and with only 740 million shares outstanding, that is less than a 50% payout ratio.
If the Dividend were to drop today to the .75 cents, the yield would drop from 13.6% to 10%.
Other Considerations
Analysts
Mean Target:
7.65
Median Target:
7.25
High Target:
10.00
Low Target:
6.25
No. of Brokers:
10
A Majority of the Analyst recommendations for the past year were to “hold.”
Insider Trading and Share Repurchase


No Share repurchases in 2009 but in 2007 and 2008 the repurchased 17,000,000
shares each year.
Besides being given stock through options, all directors and insiders have been selling
shares. Not exactly enough to make them rich, but selling nonetheless.
Interest Rate Considerations

With the economic reports indication there may be a rise in interest rates looming, a
highly leveraged business like this one exposes itself to a lot of interest rate risk.
However, 94% of FTR’s debt is fixed rate debt.
Valuation:
I chose to use the Two-Stage Discounted Free Cash Flow Valuation Model.
For the growth rates, I simply took the average return on assets of 3% during the last year (2008
to 2009) and applied it into perpetuity.
To determine the Discount rate:




I used a beta of .88
Risk free rate of 3.7 which is the current 10 year treasury rate.
Further I used a market return rate of 9%
This yields 8.364%. Taking this number into consideration with buffets 10% standard, I
chose to use 9% to discount the future cash flows.
The rest of the numbers were taken directly of the 2009 financial statements ending 12/31/09.
Using this model, I calculated Frontier Communications has an intrinsic value of $5.33,
significantly lower than the current market value. I feel watching the Verizon deal as it transpires
and reconvening after more is known would be a wise play with this stock.
Valuation:
Income Statement
Balance Sheet
Statement of Cash Flows
Sources
Finace.google.com
Finance.yahoo.com
http://www.zacks.com/stock/news/30936/Frontier+Meets+but+Profits+Slide
http://online.wsj.com/article/BT-CO-20100309-715891.html?mod=WSJ_Deals_LEFTLatestHeadlines
http://www.businesswire.com/portal/site/home/permalink/?ndmViewId=news_view&newsId=2010032
4006447&newsLang=en
http://wallstnation.com/5Dividend-Stocks-03102010
http://phx.corporate-ir.net/phoenix.zhtml?c=66508&p=irol-newsArticle&ID=1406773&highlight=
http://www.tradingmarkets.com/news/stock-alert/ftr_jobs-bill-provision-may-pose-hurdle-for-verizonfrontier-landline-deal-876584.html