Frontier Communications Corp (NASDAQ:FTR) is a company in dire straits, and nobody seems sure whether it will come together again. FTR stock has lost nearly 72% in the year-to-date, and 80% over the past 12 months at a time when the S&P 500 index has climbed 9.8% and 13.7% over the timeframes.
The company made a gutsy move when it took on a mass of debt to buy fixed-line networks and related assets from Verizon Communications Inc. (NYSE:VZ) in Texas, California and Florida for $10.5 billion.
But that move has taken a turn for the worse, even as customers continue leaving in droves. Meanwhile, FTR has done a poor job of integrating Verizon’s FiOS operations with its own.
Now Frontier is staring at a mountain of debt to the tune of $17 billion, and the juicy dividend has been repeatedly slashed, the last 62% cut coming in May. FTR was also recently forced to reverse-split its stock 1-for-15 in a bid to shore up a stock which, at a 34-year low of $1.06, was in danger of becoming a penny stock.
Is FTR Stock Fool’s Gold?
To be fair, there’s a silver lining to that almighty stock crash. At 15%, FTR stock now sports a dividend yield that can make many REIT stocks green with envy. But is the rich dividend even sustainable or is the stock little more than fool’s gold? Some investors believed that the reverse stock split would put a floor on the battered shares.
Yet, FTR stock has tumbled nearly 8% since the split about a week ago.
History has taught us that companies that survive near-death experiences have the ability to make bold contrarian investors great returns when everyone else has given up on them. Think companies like Advanced Micro Devices, Inc. (NASDAQ:AMD), Micron Technology, Inc. (NASDAQ:MU), Apple Inc. (NASDAQ:AAPL) and General Motors Company (NYSE:GM). Any chance FTR will join this camp, given how badly everybody has bailed on it?
FTR stock has three buy, 11 hold and zero sell recommendations on the Street. It’s clear that Wall Street believes that this company can somehow make a comeback.
But first, we need to understand the genesis of the company’s woes.
Frontier Communications: High Churn
When Frontier bought the Verizon assets, it effectively acquired 3.3 million voice connections, 1.2 million FiOS video subscribers and 2.1 million broadband connections. The deal gave the company considerable economies of scale, and the company’s management has been able to squeeze an impressive $1.25 billion in annualized cost synergies by the end of Q1 2017 due to improved operational efficiency.
FTR has also been seeing good growth in its FiOS customer base, with the last quarter marking the third consecutive quarter of FiOS gross adds. FiOS (Fiber Optic Service) is the company’s signature bundled service consisting of internet access, telephone and television.
But that’s perhaps where the good news ends.
Frontier has been bleeding customers like crazy. Consumer churn for the voice and broadband segments has remained high and shows no signs of slowing down. The company reported a loss of 155,000 residential customers and another 15,000 business customers during Q1 2017. That was actually a significant sequential increase compared to Q4 2016 when the company lost 144,000 residential and another 14,000 business customers. At this rate, it won’t be long before the company shrinks to its former size.
With high churn also comes deteriorating cash flows, and with less cash to spend the dividend is frequently among the first victims to go out the window. Even though the May dividend cut was notable due to its sheer magnitude, the company has been shrinking the dividend since 2010 when it perked up to $1 per share annually compared to the current level of $0.16 per share. The yield topped up at 35% in May compared to the current 12.6%.
But nothing about this company scares off investors like its debt burden. At a leverage ratio of 4.39x, you will be hard-pressed to find a more leveraged company in this sector. The company has targeted a 3.5x ratio by 2021, which is still too high by all measures (ideally debt-to-equity should remain below 0.5).
Even more worrying is the fact that the company is not spending nearly enough cash on capex to improve its infrastructure and stem the churn. The only saving grace here is that the company could take on more debt to upgrade its infrastructure.
FTR has a credit agreement that requires it to maintain a leverage ratio not exceeding 5.25x till March 2018. The ceiling will then fall 25 basis points in the subsequent years till 2020. The near-term maturity schedule looks manageable — $363 million in 2017 and $733 million in 2018.
Despite its colossal debt, FTR can borrow up to around $3 billion before it breaches the debt ceiling. That kind of cash could help the company do some pretty extensive upgrades which, hopefully, will persuade its customers to stick around.
Investing in FTR Stock
Whether the company will be willing to take that gamble remains to be seen. If you are a bold contrarian investor willing to bet on FTR stock, buying Frontier Communications 11.25% Mandatory Convertible Preferred Shares, Series A (Frontier Communications Corp (NASDAQ:FTRPR)) looks like the safer bet.
Although FTRPR shares are more expensive than FTR stock and it also closely tracks FTR performance (meaning you are not inured from poor performance), it currently yields a handsome 45.3% and has a higher call on cash than the common stock. However, FTRPR is junior to the company’s debt, meaning if push comes to shove and the company scraps the entire dividend, then you are out of luck. Companies though only stop paying preferred dividends as a last resort so that does not seem very likely.
FTRPR looks like a safer bet; FTR stock not so much.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.