IHS Global Insight Perspective | |
Significance | Verizon Communications has sold 4.8 million more access lines, mainly rural, in a deal that will help it to focus on high-growth services. |
Implications | Frontier Communications will triple in size and may improve the focus and investment prospects in these regions. |
Outlook | Verizon is able to realise a declining asset to reduce debt load and release shareholder value. Although larger, the deal appears to be more favourably structured than the controversial disposal of assets to FairPoint and may improve investment in these regions. |
Verizon Communications has announced that Frontier Telecom is to acquire assets from Verizon including switched and special access lines, internet service and long-distance voice accounts, and fibre-to-the-premises (FTTP) assets deployed by Verizon in 41 local franchises and the state of Indiana, which pass approximately 600,000 homes and small businesses. Frontier will continue to provide video services in these areas after the completion of the merger. This amounts to 4.8 million local access lines in 14 states, 2.2 million long-distance customers, and 1.0 million broadband subscribers—including 110,000 FiOS internet customers and 69,000 FiOS TV customers—while 11,000 of Verizon's 237,000 employees, primarily from the local phone business, will be transitioned over to Frontier, which currently employs around 5,800 staff.
The states covered include Arizona, Idaho, Illinois, Indiana, Michigan, Nevada, North Carolina, Ohio, Oregon, South Carolina, Washington, West Virginia, and Wisconsin. In addition, the transaction will include a small number of Verizon's exchanges in California, including those bordering Arizona, Nevada, and Oregon. Verizon ended the first quarter with around 35.2 million access lines in 25 states including Connecticut, Delaware, Florida, Maryland, Massachusetts, New Jersey, New York, Pennsylvania, Rhode Island, Texas, and Virginia; the District of Columbia; plus most of California, which are not covered by the transaction. This will leave Verizon with around 30 million access lines. The deal does not include any assets of Verizon Wireless, Verizon Business (former MCI Inc.), Federal Network Systems LLC, Verizon Network Integration Corp., Verizon Global Networks Inc., or Verizon Federal Inc.
When the deal concludes—which is expected to take around 12 months—Frontier will become the fifth-largest incumbent local exchange carrier with 7.0 million access lines, 1.6 million broadband connections, and 16,000 employees in 27 states; pro-forma revenues of more than US$6.5 billion; earnings before interest, tax, depreciation, and amortisation (EBITDA) of US$3.1 billion; and free cash flow of US$1.4 billion. Synergies of US$500 million a year are expected from merging network, IT infrastructure, and corporate administration functions while leveraging will decrease to 2.6 time pro-forma EBITDA
Frontier Communications Q1 Financial Performance | |||
Revenues (US$ mil.) | Q1 2008 | Q1 2009 | Change Y/Y |
Local | 217 | 201 | -7.5% |
Data and Internet | 146 | 156 | 7.2% |
Access Services | 108 | 90 | -16.5% |
Long Distance | 46 | 41 | -10.9% |
Directory | 29 | 28 | -3.2% |
Other | 23 | 21 | -7.3% |
Total | 569 | 538 | -5.5% |
Operating Income | 164 | 140 | -15.1% |
Net Income | 46 | 40 | -13.0% |
Frontier Communications Q1 Operating Performance | |||
Q1 2008 | Q1 2009 | Change Y/Y | |
Residential Access Lines | 1,553 | 1,427 | -8.1% |
Business Access Lines | 833 | 790 | -5.2% |
Broadband | 543 | 600 | 10.5% |
Video (DISH) | 101 | 146 | 44.0% |
Total Service Subscriptions | 3,031 | 2,963 | -2.2% |
Deal Structure
The deal will see the acquired operations spun off into a new entity that will then be merged with Frontier in a deal with a total value of around US$8.6 billion. Verizon shareholders will receive US$5.3 billion in Frontier common stock (subject to adjustments) at a rate of 1.0 share for every 4.2 held in Verizon, giving them ownership of around 68% in the new company. Verizon will receive around US$3.3 billion through a combination of cash, debt securities, and assumption of debt but have no stake in the resultant company. This spin-off and merger structure will qualify as a tax-free transaction, apart from cash paid in lieu of fractional shares.
Outlook and Implications
This deal dwarfs the controversial sale of 1.5 million lines in three states to FairPoint, which only operated around 250,000, that closed a year earlier and took debts of around US$1.5 billion off Verizon's books—as well as a reported US$600-million tax write-off (see United States: 1 April 2008: Verizon-Fairpoint Deal Closes). That deal was bedevilled by regulatory difficulties, where the local regulators essentially demanded a lower price and concessions to ensure and enable FairPoint's investment in the local network infrastructure. IHS Global Insight recalls this had led Verizon's chief executive officer (CEO), Ivan Seidenberg, to suggest that similar transactions would not be pursued for some time, although that seems to have now elapsed (see United States: 21 April 2008: Fairpoint Outlines Deployment Plans, United States: 18 January 2008: Fairpoint Taps Occam Networks for Broadband Network Upgrade, United States: 30 October 2008: FairPoint Taps Nortel for 3.65GHz WiMAX Solution, and United States: 4 December 2008: FairPoint to Test IP TV over Fibre). FairPoint also struggled to integrate Verizon systems, and Maggie Wilderotter, Frontier Communications chairman and chief executive officer, highlights that "We have a track record of successfully integrating new operations and know that a seamless transition benefits customers and employees" (see United States: 5 March 2009: FairPoint Struggles with Verizon Systems—Report and United States: 6 March 2009: Fairpoint Sees Revenues Drop 11.3% Y/Y). It is possible to realise value from rural networks and this deal is notable as, in a neat trick thanks to the share element of the deal, it will actually reduce leveraging—the relative debt load comparative to earnings—which should remove worries that the emergent company will not be able to finance investments.
Verizon is realising these declining assets (due to wireline attrition) to focus on advanced IP deployments offering high growth from new services such as converged voice video, super high-speed internet, and wireless—having seen losses to basic DSL as well as ongoing voice line attrition in the past year (see United States: 28 April 2009: Verizon's Q1 Revenues Up 12% Y/Y on Strong Wireless Subscriber Growth, United States: 17 June 2008: Verizon to Offer Triple-Play without Landline Voice, United States: 12 January 2009: Verizon Completes Alltel Acquisition, and United States: 2 September 2008: Verizon Promotion Offers Free DSL for Six Months). For Verizon it will release value to shareholders, reduce debts, and allow the company to focus on the core metropolitan markets where more advanced FTTP infrastructure deployments (FiOS) are being implemented. Seidenberg, chairman and CEO of Verizon, noted that "This transaction is part of our multi-year effort to transform our growth profile and asset base to focus on wireless, broadband, and global IP."
One of the more interesting aspects of the deal is that it does include some FiOS deployments. Associated Press reports Wilderotter as noting that "Getting these FiOS markets is going to be terrific for Frontier because it allows us to understand video delivery….From there, we can decide whether we want to deploy FiOS or FiOS-like services in other markets." These may have been more marginal markets or a sweetener on top of the disposal of the largely rural, ageing copper network to Frontier, which is the main objective of these local access line sell-offs. Funds have been made available for broadband deployment in these sorts of markets, which Frontier may be more willing and able to tap (see United States: 13 February 2009: Broadband Tax Credits Dropped from Stimulus Package in U.S.).