This week, Durig Capital takes a look at a company that provides communications services for consumers and businesses across the U.S. Frontier Communications has spent most of 2018 making progress on its transformation initiatives that are designed to reduce costs, increase profitability and improve the balance sheet. The company recently released its fourth quarter and full year results for 2018. The company is showing progress on its initiatives.
- Total fourth quarter revenue of $2.12 billion, stable sequentially.
- Adjusted EBITDA for the fourth quarter of $895 million, a sequential increase over third quarter.
- Fourth quarter operating free cash flow of $358 million.
- Full year operating free cash flow of $620 million.
- Interest coverage for fourth quarter of 2.2x.
Frontier Communications’ April 2022 bonds are currently trading at a significant discount, giving them an outstanding yield-to-maturity of about 23%. These bonds provide investors with an excellent opportunity for diversification into the essential service of internet connection. Considering Frontier’s solid free cash flow and excellent interest coverage, these 2022 bonds make an ideal addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, which historically, has done well in a rising interest rate environment, shown below.
Fourth Quarter and Full Year Results
Frontier Communications posted solid results for its fourth quarter 2018 as well as its full-year 2018. The company has spent all of 2018 implementing a Transformation Program to ultimately make the company more competitive in the marketplace. Some of the highlights from its fourth quarter and full year results include:
- Fourth quarter net cash from operating activities totaled $603 million, with full year net cash from operating expenses registering $1,812 million.
- Fourth quarter operating free cash flow was $358 million, with full year operating free cash flow registering $620 million.
- Average revenue per customer (ARPC) for fourth quarter was $86.05, an increase both sequentially and relative to the fourth quarter 2017.
- In the fourth quarter, Frontier either retired or purchased (on the open market) a total of $487 million in debt.
- Adjusted EBITDA for the fourth quarter was $895 million, as compared to $878 million in the third quarter 2018, a sequential increase of 2% over the previous quarter.
- Frontier has posted impressive LTM (last twelve months) free cash flow for all four quarters of 2018.
Through the company’s transformation initiatives, Frontier is targeting a $500 million EDITDA benefit by the end of 2020. Daniel McCarthy, Frontier President and CEO alluded to these efforts in the company’s most recent earnings release. “We continued to expand the scope of initiatives underway in our transformation program in the fourth quarter, and multiple teams are now scaling a range of solutions that were developed through the transformation initiatives. I look forward to continued progress and expansion of the program over the course of 2019 and 2020 as we advance toward our targeted $500 million EBITDA benefit.”
Frontier’s latest investor presentation illustrates the company’s solid 2018.
(Source: Frontier Communications Investor Update, Fourth Quarter 2018)
About the Issuer
Frontier Communications Corporation (NASDAQ: FTR) is a leader in providing communications services to urban, suburban, and rural communities in 29 states. Frontier offers a variety of services to residential customers over its fiber-optic and copper networks, including video, high-speed internet, advanced voice, and Frontier Secure® digital protection solutions. Frontier Business offers communications solutions to small, medium, and enterprise businesses.
Internet Access: An Essential Service for Consumers and Businesses
In today’s modern society, access to the internet via broadband or cable is essential. Internet access has touched nearly every aspect of life. It has allowed many individuals to work remotely to earn their living. It gives access to seemingly unlimited amounts of information. It allows us to shop for everything from clothing to food and everything in between from the comforts of our home. It gives students access to research and online teaching. It brings entertainment into our homes. In fact, at the end of 2016, the nation of Canada declared broadband internet is a basic telecommunications service. Demand for access to the internet, and access with greater capabilities and greater speeds, will only continue to grow. Companies like Frontier will be essential to meeting these demands.
In fact, in light of the continuing declines in voice and cable usage, and with more things moving online via the internet, Frontier has recently been focused heavily on enhancing its internet offerings. In October 2018, it rolled out its gigabit service (downloads for customers of 1 gigabit per second) to customers in its FiOS and Vantage Fiber markets. It also recently unveiled its Frontier Simply Wi-Fi Secure service to small and medium sized businesses. This service provides small to mid-sized businesses with a secure, fully-managed wireless network and also offers real-time analytics on the customers and guests who connect to it. One of the indicators that traditional cable TV service is in decline is the growing number of people utilizing streaming services to watch television.
Recent Bond Issuance Transaction
Within the last week, Frontier announced that it intends to offer $1.650 billion aggregate principal of first lien secured notes due 2027 in a private transaction. The company intends to use proceeds to refinance two terms loans into senior secured debt. This refinancing will take $1.65 billion in debt that is currently due in 2021 and move it to 2027. This transaction gives Frontier time to continue to pay down its debt and look for options for its debt that matures in 2022.
Interest Coverage and Liquidity
Interest coverage is an important metric for investors / bondholders because it is an indication of the company’s ability to cover interest payments for its existing debt. For its most recent quarter (Q4 2018), Frontier Communications had operating income (without the effects of non-cash depreciation and impairment charges) of $860 million, and interest expense of $388 million, resulting in an interest coverage of 2.2x.
In terms of liquidity, as of December 31, 2018, Frontier had cash and cash equivalents totaling $354 million. In addition, the company has $575 million available on its credit revolver, resulting in total liquidity of $929 million.
The risk for bondholders is whether Frontier can continue to make progress on its transformation initiatives, increasing revenues and profitability, while reducing debt. The company has stabilized its revenues over the past four quarters and has made a shrewd move refinancing its 2021 debt in order to buy time and allow its initiatives to take hold. The company is generating healthy free cash flow which should help with the company’s goal to reduce debt and improve its balance sheet. Based on Frontier’s recent wins, it appears that the about 23% yield-to-maturity on these April 2022 bonds outweighs the risks identified.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Internet access has become a needed service in our modern day society. It has brought unprecedented convenience and access to the world around us. Frontier Communications has built itself on providing access to this and other services within its suite of products and services. The company appears to have stabilized its revenues in 2018 and appears to be on the cusp of expanding its revenues and profitability through its transformation initiatives. With the recent refinancing of its 2021 debt, the company has positioned itself to address its additional debt coming due in 2022. Its April 2022 debt, couponed at 8.750%, is currently trading at a significant discount, resulting in an impressive yield-to-maturity of about 23%. Given Frontier’s admirable progress on its initiatives, the excellent yield-to-maturity on its 2022 bonds makes them an ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.
Issuer: Frontier Communications Corp.
Ratings: Caa1 / CCC+
Yield to Maturity: ~ 23%
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About Durig Capital
Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services.
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Disclosure: Durig Capital and certain clients may hold positions in FTR’s April 2022 bonds.
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