5 Things Frontier Communications' Management Wants You to Know

By Markets Fool.com

Source: Frontier.

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Frontier Communications is not in the business of delivering big surprises. In its most recent quarterly report, the mostly rural telecom unloaded both sales and earnings in line with analyst estimates.

That doesn't mean that Frontier investors already know everything there is to know about the company. Even a well-understood business in a mature sector will have unexpected wrinkles in its business model. One way to tease these revelations out is to pay attention to the management team's quarterly earnings calls.

On that note, here are the five most interesting details you'll find in Frontier's third-quarter earnings call.

Welcome to Connecticut!
Frontier closed a buyout of AT&T's landline operations in Connecticut just before announcing its third-quarter results. Hence, the earnings discussion turned to additional Connecticut details, early and often.

First, Frontier CFO John Jureller explained how the deal unlocked large cost-saving synergies from Day One:

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Frontier CFO John Jureller. Source: Frontier.

We are extremely pleased that the day one Connecticut net cost synergies of $150 million that we have achieved were substantially ahead of our expectations. These synergies are due to replacing the higher allocated cost for AT&T's provision of various support services to the Connecticut operations with our lower expense structure.

To be clear, these savings are not generated from reducing headcount in Connecticut. In fact, we're committed to bringing new jobs to the state. We are confident that we will be able to exceed the overall $200 million cost synergies target and ahead of our initial three-year timetable.

In other words, Frontier's business model is far leaner than AT&T's. Frontier can back these claims up with solid numbers, too.

For the comparable quarter, AT&T reported an 8.8% operating margin in its wireline segment. By comparison, Frontier's operating margin was 19.6%. This company is nothing but wireline services. Against this background, it makes perfect sense that AT&T's Connecticut assets would garner lower operating expenses under Frontier's aegis -- and that's without invoking the traditional buyout efficiency ghost of headcount reductions.

On the ROADM again ...
Then, Chief Operating Officer Dan McCarthy filled us in on plans to upgrade the networking infrastructure in the new Connecticut market:

The network in Connecticut is in good shape. Our plans include upgrades to the existing fiber transport systems to ROADM Architecture in all markets. We have already begun to pursue a low cost approach to extend the U-Verse footprint in our Connecticut markets. These areas represent low hanging fruit in terms of deployment costs and are [a] great opportunity to take market share while meeting our commitments on broadband deployment to Connecticut state regulators.

The ROADM conversion that McCarthy brought up is a modernization of the long-range backhaul infrastructure. It lets existing fiber lines stay in place, but replaces the equipment connecting to the fiber lines with new signaling and signal reader machinery. Under ROADM systems, the traffic capacity is multiplied many times over by using multiple wavelengths of light. The speed-boosted fiber traffic can also be rerouted and reconfigured on the fly with software changes.

This important upgrade helps Frontier improve its fiber-based core network, both in Connecticut and elsewhere. The modern infrastructure allows for centralized management, quicker and cheaper network reconfigurations, and a better platform for high-speed customer services. Killing a whole flock of birds with one stone, ROADM networks also help Frontier meet the broadband expansion requirements that drove the deal through regulatory approvals.

It's all about the broadband
The ROADM discussion dovetails neatly with Frontier's broadband services. This category is the largest driver of organic growth, not just for Frontier but also for telecoms in general these days. And the company can boast strong results in this crucial operation.

Frontier CEO Maggie Wilderotter. Source: Frontier.

"This quarter, we achieved our seventh consecutive quarter of strong broadband net adds with 21,900 in the quarter and 87,000 year-to-date," said Frontier CEO Maggie Wilderotter. "Frontier increased broadband market share in 81% of our local markets through the first nine months of 2014."

In most cases, that means stealing customers from the local cable companies in Frontier's service areas. Very few markets would have more than one cable service and one telecom to choose from when selecting a broadband Internet service.

Gaining market share against cable in the vast majority of Frontier's markets is impressive, because it's mostly done with aging DSL services. Fiber may be the future, but fiber-to-the-home services are currently only available to less than 10% of Frontier's households -- and that's in the very small handful of markets that have access to Frontier fiber at all. More on this in a minute.

Room for improvement
In fact, Frontier is fighting an uphill battle in many markets. The company is gaining ground, but still lags far behind the cable-based Internet service leaders.

"We believe we have substantial room to increase our residential broadband market share, since current share is less than 25% in our 27 states excluding Connecticut. Driving broadband share higher remains our number one priority, and represents a significant revenue opportunity for Frontier," McCarthy said. "Network speed capabilities continued to improve with 55% of households capable of 20 megabits or more, 75% capable of 12 megabits and 84% capable of six megabits."

Right. Traditional DSL services get slower and less reliable the further away from the local service station your house sits. The situation improves a bit with fiber-to-the-node networks, where a high-speed fiber connection gets split into DSL streams much closer to your premises, but even that is a long way behind the premium speeds of direct fiber services.

To place the bandwidth figures into perspective, a high-definition Netflix stream uses a little less than 4 megabits per second. Watching two HD movies at once is impossible on a six-megabit DSL line, and a single instance of the new 4K video standard is more than the 12 megabit service can handle.

Cable services don't have to battle the distance limitations of telecom-grade DSL, and can often offer faster services to most consumers. Upgrading DSL customers to truly modern fiber services would turn the tables, giving Frontier a leg up on most of its cable-guy rivals.

For that reason, I'll be keeping a close eye on how the fiber (and particularly the more efficient ROADM version) rollouts progress over the coming couple of years. The faster Frontier manages to blanket its coverage area in high-speed fiber services, the better.

All fiber, all the time
Finally, McCarthy updated investors on how its first few all-fiber developments are working out:

Frontier COO Dan McCarthy. Source: Frontier.

In October, Maggie announced the launch of gigabit and 500 megabit capabilities in Durham, North Carolina. Durham is an attractive market where we can leverage our previous network investments to facilitate the ultra-high speed products without adversely impacting our capital expenditure trends.

Following completion of these investments, we will be able to offer an expanded product suite from basic speed to one-gigabit services. And we'll expand our current fiber-to-the-home footprint, which is already a healthy 10% of homes passed as of the end of Q3. Durham joins Beaverton, Oregon where we are also offering gigabit service.

Keep in mind that nearly 85% of our customers take only the data basic speed tier today even though 75% of our footprint is capable of choosing the higher speed service. This remains a tremendous opportunity to offer additional speed and capacities as customers' broadband needs change.

Let's break down the math, shall we?

Frontier has introduced fiber-to-the-home services in just two markets so far, leaving the vast majority of its network on lower-speed levels. Outdated DSL services must handle the last mile, even where fiber-to-the-premises lines connect the neighborhood to Frontier's backbone.

In Durham and Beaverton, Frontier has pulled fiber past 10% of the available households. Again, 90% of these markets can still gain a big speed upgrade.

And in Frontier's experience, customers tend to choose slower speeds even when they do have faster services available.

Add these three limits together, and you'll see that Frontier could upgrade nearly all of its current customers to higher-speed services than what they use today. The ROADM fiber project will help with this, and then it comes down to sales execution. Given the rich operating margins at Frontier, the company seems to have room for lower end-user pricing as well.

So if Frontier is willing to sacrifice some of its margins, it could gain a lot of ground against its cable-based broadband rivals. Again, the company is already increasing its market share in most cases, but cable still dominates by a factor of 3-to-1.

Will Wilderotter and Jureller take Frontier in that direction? I don't know, but I would like to see them try. Launch fiber services in more markets, pair them with attractive pricing, and see how it works out.

I'm sleeping with one eye open, looking for signs of this strategy. It could be a winner.

The article 5 Things Frontier Communications' Management Wants You to Know originally appeared on Fool.com.

Anders Bylund owns shares of Netflix. The Motley Fool recommends and owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.