With the wide adoption of technologies like voice communications over the internet and high-speed broadband connections, telecommunication providers CenturyLink (CTL +9.23%) and Frontier Communications (FTR +0.00%) are both facing the secular decline of their legacy businesses.
As a result, both companies are developing fiber assets to adapt to their markets. And during this transition, they must also deal with a significant debt load. Yet despite their similarities, CenturyLink seems to be a much safer investment than Frontier Communications.
CenturyLink is slowly improving
Given the secular decline of its legacy voice and low-speed broadband businesses, CenturyLink's third-quarter revenue dropped to $5.6 billion, down 3.6% year over year. The company's fiber business isn't large enough yet to reverse the downward trend of its top line.
But since management has divested less profitable activities like selling low-margin equipment, CenturyLink's profitability is improving. The company's third-quarter adjusted EBITDA margin expanded to 40.3% compared to 39.3% one year ago. The year-over-year revenue growth in its international and enterprise segments limited the decline of its adjusted EBITDA from $2.29 billion last year to $2.26 billion. In addition, with a capital program in the range of $3.5 billion to $3.8 billion this year, management expects significant full-year free cash flow of $3.1 billion to $3.4 billion.
CenturyLink's net debt of $33.7 billion remains important, but it's diminishing thanks to the company's strong free cash flow. And with stable EBITDA, the net debt-to-adjusted-EBITDA ratio dropped from 4.1 one year ago to 3.7 while the company paid $1.4 billion in dividends. After a cut, the dividend, which seems to be safe, now represents an annual cash outflow of $1.1 billion.
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Frontier Communications has some extra issues
Frontier Communications is facing the same challenges as CenturyLink. Frontier Communications' legacy voice business is dragging down the company's performance, and management is trying to grow revenue with high-speed offerings based on its fiber network. But Frontier Communications' results aren't on par with CenturyLink's.
Last quarter, Frontier Communications' revenue dropped to $2 billion, down 6.1% year over year. The revenue slump is due to the decrease in the number of customers across all its businesses. And even though fiber should support growth, the company posted its sixth consecutive decline in fiber-based broadband customers.
Also, in contrast with CenturyLink, Frontier Communications' operating costs as a percentage of revenue increased year over year. As a result, the company's adjusted EBITDA margin dropped from 41.3% to 40.3%.
Management claimed trailing-12-month (TTM) operating free cash flow was $563 million. But that operating free cash flow doesn't take into account $179 million of payments and reorganization costs, which means Frontier Communications' TTM free cash flow actually fell below $400 million.
As a result of modest free cash flow and declining EBITDA, the company's net debt-to-adjusted-EBITDA ratio increased from 4.78 one year ago to 4.81 at the end of last quarter.
Given these difficulties, Frontier Communications' finance committee is evaluating strategic alternatives that could have a negative impact for shareholders -- recapitalization or refinancing under unfavorable conditions -- and management didn't even take analysts' questions during the last two earnings calls.
CenturyLink is a better buy but it's still risky
The market values CenturyLink at a slightly higher valuation compared to Frontier Communications. For instance, CenturyLink's enterprise value-to-sales and enterprise value-to-EBITDA ratios of 2.3 and 5.7, respectively, exceed Frontier Communications' ratios of 2.1 and 5.1. But CenturyLink's capital structure is much safer given its lower debt load. Besides, CenturyLink's strong free cash flow allows the company to reduce its debt and pay a dividend.
Thus, despite its slightly higher valuation, CenturyLink is clearly a better buy than Frontier Communications. But prudent investors should keep in mind CenturyLink remains a risky tech stock because of its high debt load during a transition that hasn't translated into revenue growth yet.
