1 Reason to Sell Frontier Stock (and 2 to Buy)

By Daniel B. KlineMarketsFool.com

Frontier Communications (NASDAQ: FTR) has made a huge bet on its future, and so far, the early returns are not good when it comes to subscriber counts, but they're more positive in other areas.

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The company spent $10.54 billion to buy Verizon Communications, Inc.'s (NYSE: VZ) wireline operations in California, Texas, and Florida (CTF). At the time of the deal, Frontier's CEO Daniel J. McCarthy called the move "transformative" and said in a press release that the acquisition "delivers first-rate assets and important new opportunities given our dramatically expanded scale."

That's not an understatement since the purchase more or less doubled the size of McCarthy's company.The acquired businesses include approximately 3.3 million voice connections, 2.1 million broadband connections, and 1.2 million FiOS video subscribers (along with 9,000 or so employees). How Frontier integrates those properties, and whether it can not only keep the subscribers it paid for, will ultimately decide whether the deal made sense for shareholders.

Frontier has gotten bigger, but maybe not big enough. Image source: Getty Images.

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Subscribers are leaving

Frontier's Q3 earnings report, the second since it acquired the Verizon CTF properties, showed a bad trend when it comes to subscribers. The company has not only lost video customers, which has been an industrywide problem, it also saw its broadband subscriber count fall as well.

The cable, internet, and phone company closed Q2 with 5.22 million total customers. That number dropped to 5.07 million in Q3 with the company losing about 90,000 video subscribers and just under 100,000 broadband users. Frontier also saw its business user base drop, and overall churn inched up to 2.08% from 1.91% in the previous quarter.

These numbers don't guarantee that the Verizon deal won't result in steady subscriber gains, but it does show that Frontier will have to fight just to hold onto these users. For the CTF deal to make sense, the company needs to show that it can become a bigger player. Two straight quarters of declining numbers at best show that doing that will be harder than expected.

The synergies are working

Aside from subscriber growth, part of the logic behind buying the CTF properties was that the combination would let the company save money. In theory, that's because the old Frontier was paying too much for certain things because it did not have a big enough user base to spread the costs across. That has proven to be true, and the savings are coming in bigger than expected, which the company explained in its Q3 earnings release:

At some point, saving money won't cover up losing subscriber revenue, but it does buy a longer runway. McCarthy has shown that he can manage his company well, and that makes it less dire that the initial user count numbers have gone in the wrong direction. Ultimately, cost-savings are not a reason to buy or hold this stock, but they are a strong reason to own shares if you believe McCarthy can turn around his subscriber problem.

Frontier is an acquisition target

Now that Frontier has over 5 million customers, it has become one of the few remaining prizes left in the cable/broadband space. The company would be an attractive acquisition target for the same reason it bought the Verizon properties. Any rival buying Frontier would add very little expense in taking over its business.

Subscriber growth (even adding 5 million customers) might require adding some customer service and back-end people, but once those departments exist, the added cost for growth is minimal. Frontier would provide any player in the cable space an immediate increase in subscriber revenue without greatly increasing incremental costs.

Any acquisition of Frontier would likely come with a big premium for shareholders. For example, Time Warner Cable stockholders received a 40% premium when their company was bought by Charter Communications,and Cablevision shareholders got a 22% premium over where that stock was trading when it was bought by Altice.

Is Frontier a buy?

As a stand-alone company, Frontier is likely to continue to lose subscribers. The cable and internet provider remains a small fish competing against well-heeled competitors that can match its offers -- or even undercut them.

That said, McCarthy's strong fiscal management has made it so Frontier can slowly bleed users while, at least for a while, continuing to show decent financial results. That should buy the CEO time to either somehow turn things around or, more likely, find his company a home with a much bigger rival at a solid premium for shareholders.

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Daniel Kline has no position in any stocks mentioned. He was once a Frontier customer but moved. The Motley Fool recommends 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.