Bigger tends to be better when it comes to cable and internet providers, at least for their bottom lines. Image source: Getty Images.
Frontier Communications (NASDAQ: FTR) just about doubled in size in April, when it completed its $10.54 billion acquisition of wireline properties, formerly owned by Verizon (NYSE: VZ).
The deal gave the small-time cable and internet player 3.3 million voice connections, 2.1 million broadband customers, and 1.2 million FiOS video subscribers across parts of California, Texas, and Florida. It was an acquisition that took Frontier from being a small-time player to putting the company firmly in the mid-tier of pay TV and internet providers.
That's an important changebecause it gives the company a broader user base to spread research and development across. CEO Daniel J. McCarthy laid out why he made the deal in a press release when it closed.
"This is a transformative acquisition for Frontier that delivers first-rate assets and important new opportunities given our dramatically expanded scale," he 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."
Buying the Verizon territories sort of put Frontier in the game, but if it hopes to compete with the industry giants it sells service against in all of its territories, it needs to get bigger.
What's next for Frontier?
Getting bigger through making a major acquisition was a big move for the company, but it's still very small compared with the companies it must compete with. Frontier has about 1.3 million cable customers, according to the most recent number from Leichtman Research Group. That puts it ahead of only Mediacom, which has 842,000 customers, and Cable One, which has 338,000.
There are also another 4.3 million or so pay-television customers belonging to other private companies. If Frontier wants to compete with big boys such as Comcast, Charter Communications, and AT&T, which have 22.3 million, 17.3 million, and about 25 million subscribers, respectively, it simply needs to get bigger.
That's not going to happen through marketing or by offering better prices than its rivals, which is Frontier's normal tactic in its markets. It's hard to know exactly how many new users the company will add (or lose) each quarter with its new properties, because it suspended marketing during the transition period, but recent quarters show slight attrition of its overall user base.
Even if Frontier can turn that into slight growth, there's no way the company can add users using its current tactics in any meaningful numbers. That means it won't get bigger, and while it can now spread expenses across more users, it has a long way to go before it can be as efficient as its rivals.
For McCarthy's company to truly complete, it needs to grow, and that means merging, acquiring, or otherwise adding more customers.
Growing is working
During his company's Q2 earnings call, which Seeking Alpha transcribed, McCarthy pointed out that buying the Verizon territories has paid off in terms of more efficient operations.
"I am particularly pleased to announce that following the successful cutover of the newly acquired assets, we achieved annualized integration cost synergies of $1 billion in the second quarter," he said. "This is a substantial outperformance relative to our original day one target of $525 million. We have also raised our total synergy target to $1.25 billion, which is considerably above our prior $700 million target."
Those are very good numbers, and they show the company knows how to operate efficiently with a larger customer base. It's simple logic. A small cable company with 500,000 subscribers needs a billing and a customer service department. As that company grows to 1 million, 2 million, even 10 million customers, it still needs those things, but it doesn't have to expand them on a one-for-one basis.
With cable and internet, in some ways the bigger you get, the more efficient of a company can be. In addition, a larger company can spend less per user on research and development while still spending more overall.
With the Verizon deal, Frontier went from 3.17 million residential customers to 5.24. That's a big increase, but what's most impressive is that the emerging player took its average monthly revenue per user for $64.43 in June 2015 to $83.20 in June 2016. That's more revenue with less expense, which going forward is the recipe the company needs to not just be profitable, but to also sever its debt while perhaps making more deals.
Buying other companies isn't an easy play for Frontier, given that it's taken on billions in debt to complete the Verizon deal. That said, McCarthy needs to find ways to get bigger, or else his company won't be able to compete. That means merging with, buying, or even making joint-operating deals with some of the smaller players left in the space.
That's not a simple road to travel, but it may be possible, given that most of the players left on the board are likely not big enough (aside from perhaps privately held Cox) to attract much interest from the big boys. Frontier has grown and shown that it can manage that growth into being more efficient. Now it needs to keep marching forward to be anything more than an easily defeated nuisance.
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Daniel Kline has no position in any stocks mentioned. He caught a Squirtle in his living room. The Motley Fool owns shares of and recommends Cable One 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.