5 Risks That This Telecom Needs to Worry About

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If you’re a potential investor in telecommunications company Frontier Communications (NASDAQ: FTR) you may find the allure of a 10% dividend yield drawing you in. However, if you look at the risk section of the company’s form 10-K you will find five risks that may give you pause in your consideration for investment.

Market shift away from landline service

The very first risk listed in Frontier’s risk section states:

“We will likely face further reductions in voice customers, switched access minutes of use, long distance revenues and federal and state subsidy revenues, which could adversely affect us.”

Frontier’s focus lies in bringing landlines and broadband to rural areas, while in the rest of the market and even in some rural areas, customers continue to switch from landline to total cell phone usage. Frontier’s loss in landline customers amounted to 7% in 2012, resulting in a 4% decline in its revenue. Frontier’s net income declined steadily since 2010. A loss in customer base of this magnitude would represent a horror to any potential business owner such as you.

Intense wireless competition

Another interesting risk they noted:

“We face intense competition, which could adversely affect us.”

Interestingly, telecommunications company Verizon (NYSE: VZ) sold a huge chunk of its wireline business in 2010 to Frontier so that Verizon can focus on its wireless business. Now, Verizon expands revenue and profitability by conquering Frontier’s and others' landline marketplace with wireless market expansion.

In 2012, Verizon’s overall revenue increased 4%. An 8% revenue increase in Verizon’s wireless segment contributed to the overall increase in revenue. Wireless revenue comprised 66% of 2012 revenue. Conversely, revenue in Verizon’s wireline segment declined 2% in 2012 on top of a 1% decline in 2011, giving indication of a downtrend in landlines.

Another powerful competitor, AT&T (NYSE: T) derives 52% of its revenue from wireless as well, meaning this company also continues to siphon landline business from the likes of Frontier, Verizon and from itself. AT&T’s voice business as a percentage of overall revenue declined from 23% in 2010 to 18% in 2012.

AT&T’s overall revenue increased 0.6% in 2012. AT&T’s wireless revenue increased 6% in 2012, while its landline revenue decreased 1% in 2012 on top of a 3% decline in 2011.

These two telecommunications companies (Verizon and AT&T) represent a relatively better place to park your money in this industry due to their participation in the growing wireless segment.

The choking weed of debt

Interest payments on debt choke out profitability of any entity, corporate and individual. For Frontier:

“Substantial debt and debt service obligations may adversely affect us.”

In 2012, Frontier’s long-term debt comprised an astounding 203% of stockholder’s equity. Its operating income of $987 million exceeded its interest obligations by only 1.43 times. The general rule of thumb for margin of safety stands at five times interest expense. As you can see, interest expense adversely affects Frontier.

Disappearing dividends

Frontier also reports:

“We cannot assure that we will be able to continue paying dividends.”

Frontier slashed its dividend for the past three years straight to shore up its balance sheet. This gives indication that Frontier’s frothy dividend yield of 10% may not last. 

Goodwill is badwill for the investor

Frontier compiled a great deal of goodwill:

“We have a significant amount of goodwill and other intangible assets on our balance sheet. If our goodwill or other intangible assets become impaired, we may be required to record a non-cash charge to earnings and reduce our stockholders’ equity.”

The amount paid for a company in excess of its book value equates to goodwill, which gets recorded as an asset on the acquirer’s balance sheet. If the acquisition performs poorly then goodwill gets written down. In 2012, Frontier’s goodwill line item registered at $6.3 billion or roughly 154% of stockholder’s equity.

Given the declining state of Frontier’s landline assets, some of which originates from Verizon, the chance of a significant write-down in goodwill exists. If that happens then net income will nosedive and consequently leave a sour taste in the mouth of Mr. Market, who will bid Frontier’s shares south.

Conclusion

The declining nature of Frontier’s landline business will invariably lead to a continued decline in profitability, dividends, and overall financial state. The world continually adopts the wireless phone as the main form of communication. On the whole, your money will be served better elsewhere.

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