When you're looking for key emerging trends, it's always a
smart idea to scrutinize the bi-monthly short-seller data.
When the short interest is rising among many stocks in any
particular industry or sector, it should really get your
attention. It's a possible sign that the entire group is bound
for trouble ahead.
When I looked at the short interest data for the end of
August, I noted that short sellers were going after
on concerns that competition from new areas may threaten the
wireless industry's cartel pricing.
Fresh short interest data for mid-September has just been
released, and the shorts are really digging in, going after
as well. And these three firms are now among the 20 most heavily
shorted stocks on the New York Stock Exchange. That's quite a
concentration of interest in what has historically been a very
Rising Short Interest (millions of shares)
It pays to track events in this industry, as nearly 250
million shares are being held by short sellers, which indicates
broad interest among major short-selling hedge funds.
Yet it's another, more vulnerable telecom firm that has also
popped up on short sellers' radars. And compared with the big
three wireless service providers, this stock has a lot more
A Lonely Frontier
Sprint, Verizon and AT&T carry considerable amounts of debt,
but they also have robust cash flow to support it.
Frontier Communications (
can't say the same. As I'll explain in a moment, the company's
acquisitions spree has left it no stronger, and the coming tax
load may soon bite hard.
That explains why short sellers are going after Frontier at a
furious pace. Fully 221 million shares are held short,
representing 22% of the float and a stunning 26 days' worth of
trading volume. It's the third most heavily shorted stock on the
Sirius XM (Nasdaq: SIRI)
Intel (Nasdaq: INTC)
||Flickr/Wayne's Eye View
Frontier has been providing local and
long-distance phone service for more than 80 years. It's
a slowly dying business, which has caused many operators
to sell out, and Frontier has been a willing buyer,
acquiring landline service contracts across the
The Changing Telecom Landscape
Frontier has been providing local and long-distance phone service
for more than 80 years. It's a slowly dying business, which has
caused many operators to sell out, and Frontier has been a
willing buyer, acquiring landline service contracts across the
company. Frontier has also been trying to make a push into the
business telecom market, which can offer higher revenue
Frontier's buying spree has pushed revenues up 150% since 2009
(to $5 billion in 2012). In that time, long-term debt has risen
from $5 billion to $8 billion. The more than $600 million in
annual interest expenses are onerous enough, but within three to
four years, a big chunk of the debt will be coming due.
Maintaining the current dividend of $0.40 a share, which has
already been shrinking in recent years, seems increasingly
reckless. Frontier currently has $560 million in cash, which
might seem like a lot, but the company will need that cash to
repay more than $4 billion in bonds coming due before 2017.
That's why the dividend -- which is currently a hefty 9% --
seems so foolish. Management should be preserving every last
penny to keep the balance sheet strong enough to handle those
coming debt burdens.
Moreover, management is hoping and praying that interest rates
never rise. The company mistakenly issued debt with variable
interest rates (with an average loan carrying LIBOR (London
interbank offered rate), plus 2.75 additional percentage points).
If both the U.S. and European economies start to strengthen in
2014, LIBOR is bound to rise a few percentage points. That means
Frontier's interest expenses would climb yet higher, sapping the
cash the company will need to pay off those bonds.
Indeed, that's the angle that short sellers are likely
targeting. Frontier believes it will simply keep rolling over its
debt as similar rates. It looks like a workable business model at
the moment, as cash flow exceeds interest expenses.
But higher interest expenses would first lead to an
elimination of that dividend. Then the broader business model
would eventually be crippled, as the company's falling interest
coverage (from higher interest expenses) leads lenders to balk
and refuse to help the company roll over its debts.
Risks to Consider:
As an upside risk, Frontier could pursue asset sales to
lighten the debt load, though the company would likely receive
less for those assets than what it paid over the past several
Action to Take -->
Frontier has seen its margins on EBITDA (earnings before
interest, taxes, depreciation and amortization) and net profit
fall by roughly 7 percentage points over the past five years.
Severe ongoing industry pricing pressure will likely push margins
even lower in coming years. That's not what the company's lenders
want to see. Don't look for this stock to suddenly collapse in
coming weeks and months. But it's hard to see how this company
can survive over the long haul, and patient short sellers likely
see this as a "terminal" short.
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