Frontier Communications Parent Stock: Strong Demand Visibility (NASDAQ:FYBR)

Pratchaya Investment summary My recommendation for Frontier Communications Parent, Inc. (NASDAQ:FYBR) is a buy rating. The growing need for faster broadband connections drives up demand for fiber connections, and this plays well into what FYBR is offering to consumers today. With little to no competitors in the region it covers, the demand visibility for FYBR is clear, as can be seen from its historical fiber penetration rate. Business Overview FYBR is the largest pure-play fiber internet service provider in the US. As of 1Q24, FYBR has a total of 2.97 million broadband customers, split between 2.7 million consumer customers and 240 thousand business customers. The infrastructure that FYBR uses includes both fiber and copper, with fiber being the main revenue driver (55% as of 1Q24). FYBR Demand for data necessitates fiber connectivity It is a known fact that household bandwidth needs are increasing, driven by the increasing demand for streaming content, the usage of latency-sensitive applications (video calls, for instance), and the Internet of Things. To illustrate this impact, global internet speeds have risen rapidly over the past few years, from ~25Mbps in 2020 to ~47Mbps in 2023, and access to the internet has grown every single year over the past two decades. Consequently, the total consumption of data has also risen. I do not see a future where the world will consume less data moving forward, and as such, the demand for gigabit-capable broadband technologies should continue to go up from here. To facilitate such connectivity, I believe fiber connection is the most optimal choice, relative to copper, DSL, and cable. The biggest advantage of fiber connections in today’s world is their ability to deliver symmetrical (both down and upload) low-latency connectivity. This was not super important in the past because consumers had little need for strong upload speeds (most use the internet to watch videos). That is not the case anymore today; the growing adoption of video calls, live streaming, mobile connectivity (uploading work documents), etc. necessitates very strong upload speeds. Little competition in areas covered Redfox Capital Ideas Therefore, I am a strong believer that more consumers will adopt fiber connections when they are offered the opportunity to do so. Note that FYBR is not pioneering a new form of infrastructure with its fiber plans, so the adoption curve should not vary widely from its historical adoption rate. According to management, FYBR has historically seen base-line penetration (passings acquired from Verizon in 2016) move towards >40% over time, consistently. This also means that FYBR has a strong visibility to growth whenever they lay out new fiber passings. And in those base markets, we’ve grown penetration from about 40% just over three years ago up to now our milestone of 45% in our mature markets. 1Q24 earnings transcript Redfox Capital Ideas As of the past few quarters, FYBR average new fiber passings per quarter are 330 thousand, or ~1.2 million a year, and because new fiber passings are higher than customer adds, this has resulted in total fiber penetration declining. But this is a good thing. Given the predictable demand precedent from the base fiber passing, it suggests that there is still plenty of room for growth. The pushback is that consumers may adopt other service providers fiber plans. There is certainly a scenario of that, but the good news is that a large majority (86%) of FYBR’s current footprint has one or fewer competitors, which means FYBR predominantly operates as a monopoly, or duopoly. In areas where FYBR is the monopoly, the growth runway is clear as there is no competition. As for the duopolistic areas, the growth profile is also attractive. Firstly, there will be very little price competition as both parties are likely to be rational and grow together given the strong secular tailwind. Secondly, due to the capital-intensive nature of residential broadband deployments and sticky customer base (FYBR had 1.2% consumer fiber churn in 1Q24), there are little to no reasons to incentivize a third player to penetrate the market. Now why are we doing that, of course, in-part to make sure that we preserve the very attractive market structure that we operate in, where across our footprint, in 86% of our footprint, we have one or fewer gigabit capable competitors and market structure is one of the most attractive things about the fiber market in the US and relatively unique in my experience relative to other markets around the world. 1Q24 earnings transcript Attractive unit economics masked by voice and video segment FYBR strategy is to focus on fiber and deprioritize its voice and video segments, which I think is the right strategic move as those two segments are either in secular decline or face strong competition. Collectively, these two segments represent 28% of total revenue and are declining at a low-teens percentage annually, which translates to low-to-mid-single-digit growth headwind at the topline. FYBR Over time, FYBR should see topline acceleration due to two reasons. Firstly, the above two segments will become a smaller mix; hence, the growth impact is smaller. Secondly, FYBR fiber connections have a higher average revenue per user [ARPU] than their copper connections. As of 1Q24, the difference is around 16% (consumer fiber ARPU: $65 vs. copper ARPU: $56), so FYBR should see a positive mix shift impact from this as fiber connections become the larger mix (driven by the secular tailwinds I mentioned ahead). Thirdly, because of the value proposition that FYBR brings to consumers and the duopoly or monopoly operating environment, FYBR should be able to continue raising prices (2.5% CAGR over the past 5 years). Valuation FYBR Redfox Capital Ideas I model FYBR using a forward EBITDA approach, and using my assumptions, I believe FYBR is worth $33. The growth outlook is pretty visible, in my opinion. So long as FYBR continues to execute like it has done over the past few quarters, growth should accelerate, as I have discussed above. As the topline grows, the EBITDA margin should grow accordingly, in line with management guidance for FY24. To sense-check management guidance, 1Q24 adj EBITDA already grew at 5.4%, so it should not be hard for FYBR to grow at that range moving forward. The driver of higher EBITDA growth anchors on margin expansion, for which I am taking a conservative approach as management intends to continue investing in more fiber passes, which requires reinvestments. Other listed fiber players (T-Mobile, Altice USA, Verizon Communications, Charter Communications, Comcast Corp., and Dish Network) are all trading in the same range as FYBR at 6 to 8x forward EBITDA at an average expected EBITDA growth of low-to-mid-single-digit percentage range. As I expect FYBR to grow EBITDA at mid-single-digits, I believe it deserves to trade at the high end of the valuation range. Risk FYBR’s strategy of focusing on standalone fiber-based broadband may not appeal to certain potential customers relative to cable operators’ connectivity bundles. If management decides to step up investment in expanding its fiber network, it may cause near-term profitability to plummet as it would see a step up in operating costs and CAPEX. Lastly, FYBR has a pretty high leverage ratio of 4.5x LTM EBITDA. If demand fails to materialize as expected, it may impact FYBR’s ability to pay down debt. Conclusion My view for FYBR is a buy rating. The base assumption I have is that the growing need for faster internet speeds will drive more fiber connection adoption. Given that there is limited competition in most regions that FYBR covers, it enjoys a clear runway for growth. The higher ARPU of fiber connections, price increases, and diminishing mix of declining segments should drive revenue acceleration and margin expansion.

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