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On Sep 26, we maintained our Neutral recommendation on Frontier Communications Corporation (FTR - Analyst Report) following mixed financial results for the second quarter of 2013. While the company’s bottom line was in line with the Zacks Consensus Estimate, the top line missed the same.

Why Retained?

Frontier focuses on generating additional revenues through customer retention and market share gains, new product deployments, broadband expansion as well as improved sales and marketing initiatives. We believe that the company is on track to achieve its growth goal and expects continued focus on cost control and efficient practices to improve margins. We also believe that the company’s efforts to streamline work force, restructure operational processes and eliminate redundancies for further cost containment will bode well for earnings growth in 2013.

The company is ramping up its broadband Internet speeds by utilizing DSLAM architecture along with ADSL2+ and VDSL2 technology. As a result, the company targets providing 20 Mbps service to 52% of its subscriber base by the end of 2013 and 60% of customers by 2013. In addition, the 6 Mbps service is expected to increase 80% by 2013. To expand further into the broadband market, the company is utilizing the Connect America Fund (CAF) proceeds. Under CAF, Frontier is entitled to a $300 million funding support for broadband deployment in rural areas. The company already received funds worth $71.9 million under CAF Phase I interim support.

These funds would benefit approximately 92,876 households in which Frontier is required to provide broadband services within Jul 2015. In addition, the prerequisites for the grant include expansion of broadband availability to at least 85% of the households under its coverage with minimum speeds of 3 Mbps by year-end 2013 and 4 Mbps by year-end 2015. In Aug 2013, the company also applied for $71.5 million under CAF grants, which will help it in adding more locations under its broadband coverage.

However, Frontier remains significantly challenged by the fragile economic condition in its service territories and competes with the loss of legacy fixed telephony business to wireless and other competitive offerings. Approximately 65% of Frontier’s access lines are exposed to cable voice service offerings. The persistent decline in access lines continues to tighten local service revenue, which accounts for most of Frontier’s overall revenue. The growing presence of Time Warner Cable’s (TWC - Analyst Report) Voice over Internet Protocol offerings in Rochester (Frontier’s largest non-rural market representing 25% of its total access lines) further impedes its addressable market.

Further, the company is struggling to cope with the effects of customer loss and rising costs. During the second quarter, Frontier lost 19,200 customers, of whom 16,300 were residential and 2,900 were business subscribers. The company’s local and long distance service revenues dropped during the quarter as more users migrated from the traditional landline service. Delays on part of clients to make deal-related decisions due to unstable economic conditions affected the commercial revenue figure. For 2013, the company is expected to see higher operating expenses related to increase in benefit costs, sales expense and costs associated with product launches.

In addition, pension expenses including post-retirement benefit expense would range between $100 million and $110 million in 2013. Cash tax expense is estimated in the range of $125–$150 million. We believe that these cost headwinds will weigh on the near-term financial performance of the company.

Frontier, which operates with other carriers like CenturyLink, Inc. (CTL - Analyst Report) and United States Cellular Corporation (USM - Analyst Report)  has a Zacks Rank #3 (Hold).

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