The Biggest Risk Facing Frontier Communications

By Markets Fool.com

Frontier (NASDAQ: FTR) spent $10.54 billion to buy Verizon's (NYSE: VZ) wireline operations in California, Texas, and Florida.

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The move gave the small company 3.3 million more voice connections, added 2.1 million broadband customers, and 1.2 million FiOS video subscribers. It was a bold bet to become big enough to compete in a market that has become dominated by giants, and CEO Daniel McCarthy was confident on the day the deal closed that it would be a difference maker for his company.

"This is a transformative acquisition for Frontier that delivers first-rate assets and important new opportunities given our dramatically expanded scale," McCarthy said. "It significantly expands our presence in three high-growth, high-density states, and improves our revenue mix by increasing the percentage of our revenues coming from segments with the most promising growth potential."

That's all true, but even spending $10.54 billion only made Frontier a small player instead of a tiny one. That may not be enough to stop the company from getting crushed by its bigger rivals.

Frontier has gotten bigger, but that may not be enough. Image source: Mike Mozart, Flickr.

What is Frontier's play?

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Frontier has always been about price and value since in all its markets it competes with at least one more-established incumbent. The biggest problem facing the insurgent cable and internet providers is that all carriers face pressure to lower prices by offering skinny bundles.

The major cable carriers, including Comcast (NASDAQ: CMCSA) and Charter Communications (NASDAQ: CHTR), have begun testing cheaper cable packages tied to consumers needing broadband services. These offers keep (or in some cases connect) customers tethered to traditional cable, albeit at a cheaper price.

Big cable has to do this because it's not competing with smaller cable carriers offering better teaser pricing. The industry now competes with alternative streaming services like Netflix, Hulu, and more. That could leave Frontier squeezed out of the picture with bigger cable companies matching or beating its pricing while streaming services offer a tantalizingly cheaper option.

What can Frontier do?

Every cable company wants to straddle the line between offering its current full-price service and having cheaper "skinny" channel lineups to keep people from cutting the cord. If Frontier seeks to compete simply by copying its rivals, then it is doomed to fail.

Skinny bundles will be carefully negotiated with the content owners. It's likely that a small player like Frontier won't have the muscle to negotiate deals as good as Comcast and Charter can make. Because of that, it won't be able to win customers by going cheaper.

What it can do is offer even more choices. If possible, to be something truly different, Frontier should go fully a la carte -- let people get only the channels they want. That's likely to be an expensive proposition for consumers who want more than a few channels, but it's a seductive offer that could earn more money for the small cable provider.

Individual channels will cost more per channel than each would as part of a bundle. A would-be cord-cutter may opt for an a la carte package with TBS, Cooking Channel, and a couple of other things. That customer will also buy broadband and, going forward, he or she may add channels, pushing Frontier's margin over where it would have been for a traditional bundled package.

Go big or whither away

This is not an easy path for Frontier. Channel owners do no want skinny bundles, let alone a la carte choices. In the current market, a company can use its popular stations to force cable providers to include less-watched channels in their bundles generating lucrative carriage fees.

A skinny bundle or a la carte would end that practice. That's clearly where the industry is headed, but it's going to go there with big cable and big content delaying things as long as possible.

For Frontier to succeed in the long-term, it needs to mark out its own territory Like DISH Network did by being first to the streaming-skinny-bundle party with Sling TV. Nearly every, if not every, pay television provider will follow, but no other will receive the marketing bump from being first.

Frontier has an opportunity here to be something different as what it is now becomes less relevant as bigger companies encroach on its marketing space. If it does not change, the company runs a major risk of being pushed aside by the big boys.

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Daniel Kline has no position in any stocks mentioned. He likes having every cable channel -- even the ones he never watches. The Motley Fool owns shares of and recommends Netflix and Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.