Are The Short Sellers Right About This Telecom?


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 Sprint ( S ) and AT&T ( T ) 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 Verizon ( VZ ) 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 stable industry.

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 potential downside.

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 ( FTR ) 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 Nasdaq (behind Sirius XM (Nasdaq: SIRI) and 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 company.

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 streams.

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 years. 

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. 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.

This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks: FTR , S , T , VZ



More from StreetAuthority:

Related Videos




Most Active by Volume

  • $16.94 ▼ 0.53%
  • $8.20 ▼ 7.13%
  • $3.68 ▼ 1.34%
  • $18.32 ▼ 3.93%
  • $4.92 ▲ 1.44%
  • $30.04 ▼ 1.69%
  • $7.13 ▼ 14.30%
  • $5.61 ▼ 4.10%
As of 7/6/2015, 04:15 PM

Find a Credit Card

Select a credit card product by:
Select an offer:
Data Provided by