Is Verizon’s Acquisition Of Frontier A Good Idea?

Wireless behemoth Verizon (NYSE:VZ) announced early Thursday morning that it would be acquiring Frontier Communications – the largest pure-play fiber internet provider in the U.S. – in an all-cash transaction valued at $20 billion. This would be one of Verizon’s biggest acquisitions in recent years. So why exactly does Verizon want to buy Frontier?

Verizon’s wireless business has been slowing down as 5G adoption begins to saturate and gains seen through Covid-19 have been easing off. Moreover, the wireless market is getting more competitive, with T-Mobile taking a lion’s share of new subscribers thanks to its much-improved network. Cable TV companies like Comcast are also offering wireless services at more affordable prices by leveraging Verizon’s network.  In 2023, wireless services revenues expanded by just about 3%. This is forcing Verizon to focus on other areas to drive its cash flows.

The broadband market looks attractive, given the surge in demand for high-speed data services post-Covid for various applications including ultra-high-definition video streaming, gaming, and remote working and learning. Verizon’s broadband business has been faring well with total broadband net additions exceeding 375,000 for the last eight quarters straight. However, expanding coverage further is a time-consuming and pricey affair. This makes buying out existing broadband providers a more favorable alternative. Frontier, with its roughly 2.2 million fiber subscribers will extend Verizon’s network reach to 25 million premises over 30 states. Frontier is also in the process of upgrading its legacy copper-based network to fiber optic-based cables. Frontier could help Verizon scale up its broadband footprint quickly.

There could be considerable scope for Verizon to drive synergies as well. Frontier filed for Chapter 11 bankruptcy in 2020 due to its weak financial position and high debt, and the company has been focusing on managing costs and improving operations in recent years. Integrating with Verizon could help improve cost efficiencies via increased scale, distribution, and network integration. Verizon is projecting at least $500 million in annual run-rate cost synergies from the deal within three years from closing. We think there could be scope for some revenue synergies as well given that Verizon could cross-sell its wireless services to Frontier’s broadband customers. Verizon also expects the transaction to be accretive to its revenue and adjusted EBITDA growth rates upon closing.

Stepping back, VZ stock has performed worse than the broader market in each of the last 3 years. Returns for the stock were -8% in 2021, -20% in 2022, and 3% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is less volatile. And it has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment around rate cuts and multiple wars, could VZ face a similar situation as it did in each of the last three years and underperform the S&P over the next 12 months – or will it see a recovery?

We remain marginally positive on Verizon stock, with a $44 price estimate which is about 7% ahead of the current market price. The stock trades at just about 9x consensus 2024 earnings, which is reasonable in our view. Verizon also has a thick forward dividend yield of over 6%. See our analysis on Verizon Valuation: Expensive or Cheap for more details on Verizon’s valuation and how it compares to peers.

[1] Returns as of 9/5/2024
[2] Cumulative total returns since the end of 2016

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