In his book One Up On Wall Street, Peter Lynch said that it took him twenty years to realize , “whether a stock costs $50 a share or $1 a share, if it goes to zero you still lose everything.” Investors looking at Frontier Communications (FTR) would be wise to heed his warning. With the shares trading around $0.55 per share, investors may be thinking of trying to catch this falling knife. Unfortunately, this blade is sharp and attempting to grab this perceived bargain could leave shareholders seeing red.
No questions please
It’s not uncommon for famous people who are embarrassed by an event to say, “no questions please.” Normally companies use their earnings conference call to answer questions and help analysts and investors understand their competitive position. However, Frontier’s management eliminated the question and answer session on the last two earnings calls. It’s not surprising that executives don’t want to answer questions as the numbers speak loudly enough. The company has been losing customers for years and there is little reason to believe this trend will be broken any time soon.
Frontier and its peer CenturyLink are battling a secular decline in traditional video subscribers. The streaming future of television is here and cutting the cord seems destined to become a national pastime. During 2019, the major TV-pay providers in the U.S. lost at least 4.6 million subscribers, representing a more than 60% increase over the prior year. Though this challenge is obvious, the affect on Frontier and CenturyLink is dramatically different.
In Frontier’s case, the company’s consumer business represents just over 51% of total revenue. On the other hand, CenturyLink’s generates less than 25% of its revenue from the consumer business. Given the significance of the consumer business, the fact that Frontier is losing subscribers in broadband, DISH Network, and non-DISH video, is particularly alarming. It would be one thing if Frontier had an off quarter or two, but for the last two years each of its consumer businesses has declined sequentially.
Frontier Communications Broadband Subscribers graph
(Source: Frontier Quarterly Earnings 2017 – 2019, author’s graph)
Frontier Communications video subscribers
(Source: Frontier Quarterly Earnings 2017 – 2019, author’s graph)
When half of your business declines each quarter and management doesn’t want to answer questions, it’s a serious red flag. Inside of these numbers, Frontier’s broadband challenges suggest weakness where CenturyLink reports strength. Both companies reported a decline in broadband subscribers, yet CenturyLink’s broadband revenue increased by 2.3% year over year, whereas Frontier’s revenue declined by 3.4%.
Theoretically as video moves toward streaming, there should be an increase in demand for broadband connectivity. If Frontier cannot grow a business that benefits from an economic tailwind, investors shouldn’t stick around to see how this plays out.
Which do you believe? Words or numbers?
When we get right down to it, numbers speak louder than comments from management. When Frontier decided to suspend its dividend, it made a convincing argument for the benefits to the balance sheet. At the time, CEO Dan McCarthy said , “The suspension will make available an additional $250 million annually to accelerate debt reduction.” As of September 2017, Frontier’s leverage ratio was 4.39:1.
Roughly a year later, McCarthy’s comments seemed designed to reassure shareholders that the company was on the right path. He said , “I am very pleased that fourth quarter results reflect our improving execution as well as initial benefits from our transformation program.” Based on these comments, investors were being asked to believe that Frontier’s business was improving. However, the company’s leverage ratio rose from the prior year to 4.72:1.
In Frontier’s most recent earnings, management reassured investors that it remains committed to reducing debt. Unfortunately, the company’s leverage ratio once again increased to a new high of 4.81:1. To put Frontier’s balance sheet issues into perspective, not only is the company’s leverage ratio getting worse, but the level of net long-term debt to total assets has risen as well.
From the end of 2017, to the beginning of 2019, Frontier’s net long-term debt to total assets ratio consistently hovered around 0.70. Due to the company taking a $5.4 billion write-down of its goodwill assets, by June of this year the ratio had risen to 0.94. In the last quarter, Frontier quietly wrote off another $276 million in goodwill, causing the net debt to total assets ratio to rise again.
By point of comparison, CenturyLink retired nearly $2 billion in net debt over the last year. While Frontier’s net debt nearly equals each dollar of total assets, CenturyLink’s ratio sits at a far more comfortable 0.5. The bottom line is Frontier suspended the dividend ostensibly to improve its balance sheet, unfortunately the company’s business has declined while the balance sheet has deteriorated just as quickly.
Double or nothing
Frontier’s decision to sell its operations in Washington, Oregon, Idaho, and Montana for $1.35 billion could provide investors a template for its overall valuation. If we divide the four states by the sale price, we get $337.5 million in cash per state. Assuming this sale is completed, Frontier will still be doing business in 25 states. If the remainder of the states have a similar value of $337.5 million each, this would suggest Frontier’s remaining value is $8.44 billion.
The bad news for investors is even if Frontier used all its sale proceeds to retire debt, it will still be sitting on $15.2 billion in net long-term debt. Given the assumptions we’ve worked with so far, the net value of Frontier would be a negative $6.76 billion. On the other hand, even if the 25 remaining states are worth double the value of the 4 being sold, the company’s value after net debt would be $1.68 billion. Given that the stock’s total market cap is right around $61 million, this would represent quite a premium to the current value. When the choice is between a huge negative value or a pie in the sky option, I prefer to side with the more realistic possibility.
The bottom line for Frontier investors is bleak. The company is consistently losing customers from its largest revenue business. Writing down goodwill reduces total assets. In the meantime, the marketplace value for the company’s 4 states that are being sold suggests the remaining value of Frontier could be a significantly negative number. Unless the remaining operations are worth nearly twice the value per state of the proposed sale, holding out hope for a recovery in the stock seems like trying to grab the blade of a perpetually falling knife.
