Frontier Communications

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 2/5

Frontier Communications is a telecommunications company providing broadband, voice, video, and data services across the United States, currently undergoing a strategic shift towards fiber optics while facing declining legacy operations.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Frontier Communications (FYBR) operates primarily in the telecommunications industry, offering a range of services including:

  • Fiber Broadband: This is the company’s primary growth driver, offering high-speed internet access to residential and business customers. Frontier is rapidly expanding its fiber optic network to capture a larger market share.
  • Copper Broadband: Legacy broadband services offered via copper networks, which are experiencing declining subscriptions due to technological shifts and competition.
  • Voice Services: This traditional segment provides voice communication solutions. It also faces challenges from technological changes that are pushing customers toward digital communication methods.
  • Data and Internet Services: These services include various products such as data networking and enterprise level internet access solutions. It is also one of the growth areas for the company, given the increasing need for digital services.
  • Video Services: These services include traditional and now streaming tv content for customers. Frontier is trying to bring them into their broadband services to provide additional value to customers.

Geographic Segmentation

Frontier serves residential and business customers across 25 states in the United States. The company primarily focuses on markets with significant broadband opportunities.

  • Shift to Fiber Optics: The telecommunications industry is undergoing a major shift from traditional copper networks to faster fiber optic networks due to higher demand from customers.
  • Growing Broadband Demand: The demand for high-speed internet access, essential for modern applications like streaming and remote work, is consistently rising.
  • Increased Competition: The telecom industry is highly competitive, and companies are constantly battling for market share. These competitors include cable companies offering similar services as well as wireless and fixed wireless services, particularly from companies like T-Mobile and Verizon.
  • Regulatory Landscape: The industry is subject to extensive federal, state, and local regulations, which can significantly affect operations and capital expenditures. This results in high barriers for entry and can help companies with existing regulations.

Competitive Landscape

  • Incumbent Telecos: Many other established telecommunications companies such as Lumen Technologies (CenturyLink) and AT&T offer similar services and represent significant competition for Frontier.
  • Cable Operators: The growing overlap in services offered by cable operators, such as Xfinity, make them a direct competitor to Frontier in local markets.
  • Wireless Providers: New entrants in the wireless sector with options for fixed-wireless access are disrupting the market, specifically for those companies that offer only copper services.
  • Regional Providers: In many parts of the U.S., smaller local companies with good regional dominance can outcompete larger companies due to local relationships and lower overheads.

What Makes Frontier Different

  • Aggressive Fiber Deployment: The company is investing heavily in expanding its fiber optic network, which is not a strategy undertaken by all competitors. They hope that by transitioning to the modern communications infrastructure, the company will be able to have a competitive advantage in the markets they serve.
  • Transformation to Digital Services: The company is shifting its focus away from legacy services to emphasize high-speed data and internet services, placing themselves in the heart of the digital economy and capturing the increasing need for these services.
  • Strategic Partnerships: Frontier has partnered with various organizations for initiatives such as the Affordable Connectivity Program (ACP), which brings a focus to providing service to customers in underserved areas and increase their share of the overall market.

Financials In-Depth

  • Revenues: Frontier has two primary reporting segments, Consumer and Business. In recent financial reports, Consumer saw a revenue of $657 million for the three months ended December 31st 2023 while Business generated revenues of $799 million. Revenue for the nine months ended on the same date were $1.8 billion and 2.29 billion, respectively. In both segments, fiber revenue is increasing while legacy copper revenues are decreasing.

While business revenues are slightly higher than consumer revenues, both are decreasing year on year. The company seems to be unable to stop its legacy declines. Fiber growth is somewhat able to offset this but not by much. Also note that for the full year 2022, revenue was $2.69 Billion for consumer and $3.34 Billion for business. This shows a continuing trend of reduced revenues.

  • Gross Margins: Gross profit margins are very low, averaging 42 percent for the nine months ended September 30th, 2024. The company reports separate revenue from wholesale and resale customers.

A 42 percent margin is not very good, as it means there is significant variable cost associated with every new sale. This indicates that the company has very little pricing power and are competing on costs in various markets.

  • Operating Expenses: Operating expenses have been steadily decreasing for the company over the years. As of September 30th 2024, operating expenses totalled at $1.4 billion for the three months, and 4.3 billion for the nine months ended, respectively. Restructuring costs were the largest factors in the expenses, which is a good sign that they are removing redundancy.

Decreasing operating expenses, if sustainable, indicates that the company can become more efficient and profitable. The issue of rising operating expenses can mean that operating issues would persist and make profitability tough.

  • Profitability: The company has had a continued period of losses. The net loss attributable to shareholders was $32 million in the three months ended September 30th, 2024, and $707 million for the nine months. There was a large asset impairment, of 102 million in the income statement.

Given that the company is consistently losing money, the viability of the business becomes questionable unless major improvements are made. These losses indicate major problems and challenges ahead.

  • Leverage: The company is highly leveraged. As of December 31st 2023, their long-term debt stood at approximately 15 billion, while their total equity was 10.5 billion. This high debt load might make capital structure changes more difficult.

High leverage could lead to possible bankruptcy in a high interest rate environment. This is one of the most concerning factors about the company and will continue to cause problems for years to come.

  • Cash Flow: As of December 31st 2023, their cash stood at $1.3 Billion. They have a reasonably adequate cash reserve but the high liabilities are more concerning.

Moat Rating

Given the above analysis, FYBR is assigned a moat rating of 2 out of 5. Here’s the justification:

  • Positive factors: The company has a wide customer base and is in a relatively regulated industry with high barriers to entry. Its aggressive fiber deployment should create a moat if they are able to capture enough market share.
  • Negative factors: Competition, primarily by the cable and wireless companies, is intense in all of the markets it operates. Further, it is facing rapid erosion of legacy copper services, decreasing their total revenue as a result of it, which negatively impacts the overall performance of the business. Finally, they have a low ROIC, indicating that they are not capitalizing their assets well.

Understandability Rating

The business is rated a 4 out of 5 for understandability. Here’s why:

  • The basic business model is easy to understand (providing telecommunication services).
  • However, the different aspects of the business, its segments, its operational capabilities are all incredibly complicated and hard to understand. Also, the company’s complex accounting practices and constant changes in its financials makes understanding the business much harder than for simpler businesses.
  • Understanding their future outlook and performance requires a detailed understanding of the financial statements.

Balance Sheet Health Rating

FYBR’s balance sheet health is rated 2 out of 5 based on the following factors:

  • High debt levels: Their long-term debt is approximately 1.5x of its equity, a risky proportion that could lead to possible bankruptcy in the future.
  • Consistent losses: Due to the company being unable to generate positive earnings, they have continually decreased their equity and are using up cash reserves to run operations.
  • Low free cash flow: Despite all of their operations, the company is unable to generate cash that exceeds its operations expenditures, making it reliant on raising new debt/equity. This makes the company more susceptible to bankruptcy.

Risks that could harm the moat and business resilience

  • Technological Disruption: Fast advancements in technology, especially in wireless and satellite services, could render its services obsolete or less valuable, leading to a reduction in its profits and a shrinking market share.
  • Intense Competition: Competition from other telecom providers and wireless providers can lead to price wars, lower margins, and customer churn as consumers switch providers.
  • Regulatory Changes: Changes to regulatory policies or unfavorable rulings can increase operating costs or negatively impact the company’s future prospects. The biggest risk to the company right now is that of the US government’s Affordable Connectivity Program (ACP), in which the company provides internet services to those in underserved areas with subsidy from the government, but may be discontinued in the future. This is because approximately 46% of their consumer customers are using services through this program, and losing them may materially damage the business.
  • High Debt Load: The company’s high debt levels makes it more susceptible to financial instability if revenue or earnings do not meet forecasts, and could potentially trigger default.
  • Inability to Manage Costs: The company still needs to cut costs and improve its financials to be more profitable and sustainable. The past losses reflect how ineffective they were in keeping costs down.
  • Economic Downturn: A reduction in the overall health of the U.S. economy may reduce the company’s spending on new fiber and other infrastructure projects, making it less able to acquire new customers.

Recent Concerns / Controversies and Problems

  • The company has been consistently losing money, which has significantly affected the stock and created investor uncertainty.
  • The company has continued to lose customers in its legacy copper operations and although they are doing their best to transition to fiber, it is not enough to offset this.
  • The company is highly leveraged, making its operations more risky.
  • In their earnings call, the company has stated that they are worried about a potential drop in government funding for the Affordable Connectivity Program (ACP), which may materially impact their business. This is the most concerning factor right now.

While the company’s focus on fiber deployment and shift towards digital services is promising, the company has a long way to go to prove its viability and profitability. The high debt levels, consistent losses, and risks of operating in a rapidly changing environment makes this a risky investment for the time being. They are taking steps to control costs and improve profitability, but the challenges remain high.