Frontier should rip a page from the Gigapower playbook – analyst

New Street Research has long argued that Frontier Communications should separate its "Wave 3" footprint into a joint venture with a financial backer that would effectively mimic Gigapower, the AT&T-Blackrock joint venture. Now the firm is putting some numbers behind that idea, suggesting that such a move would help Frontier, among other benefits, accelerate its generation of free cash flow.

Wave 3 refers to about 5 million locations in Frontier's footprint that are not attractive to build fiber to without some sort of financial assistance. (Wave 1 and Wave 2 represent the 10 million locations that are part of Frontier's current fiber network upgrade program.)

Frontier previously said its analysis showed that perhaps 1 million to 2 million locations in the Wave 3 footprint are candidates for fiber upgrades without subsidies, but it has acknowledged that partnerships and joint ventures might be suitable for the rest of that part of its footprint. It's not yet clear if the $42.45 billion Broadband Equity Access and Deployment (BEAD) program might open up some opportunities for Wave 3 upgrades. Frontier has also securitized a portion of its network assets to help fund its current 10 million-location fiber build, but has not expressed any plans to execute a similar agreement for the Wave 3 footprint.

Related:Frontier sparks 'formal and comprehensive review process'

Frontier has yet to commit to a path for the Wave 3 footprint. The company is currently undergoing a broader review of its business that is exploring potential partnerships, JVs, divestitures and merger scenarios. Frontier has not yet announced the outcome of that review.

But several analysts believe Wave 3 is a prime target for partnerships or JVs. In addition to New Street, analysts at MoffettNathanson and TD Cowen have shared that view.

New Street Research analyst Jonathan Chaplin believes the financial approach of the AT&T-Blackrock Gigapower joint venture presents a model that could be applied to Wave 3. Gigapower is focused on initially building fiber networks to about 1.5 million locations that fall outside of AT&T's existing wireline footprint, and is also expecting to participate in the BEAD program.

Notably, Gigapower will use an open access model that enables multiple outside parties to sell services on its fiber network, with AT&T on board as the first tenant. New Street's JV idea for Frontier's Wave 3 build is a bit different in that it assumes a hybrid retail/network company that would look "similar to a wireless MVNO." While Frontier would assume responsibility for customer acquisition and customer care, the JV would be a "network company" that's responsible for building and operating the network.

Related:Fiber focus helps Frontier return to 'sustainable growth'

A 'pure-play' fiber JV

"To keep things simple in this iteration, we treat the JV as a pure-play fiber JV the same as Gigapower and Lumos," a fiber-focused joint venture involving T-Mobile and EQT, Chaplin explained.

Forging a JV focused on 3 million locations in the Wave 3 footprint stands to "generate strong returns" for Frontier and a partner, and the result "will be far more material for Frontier than Gigapower is for AT&T," Chaplin noted.

New Street's model assumes that Frontier captures 100% of the retail value of the retail business and 50% of the network business piece of a Wave 3 JV. In turn, the model values Frontier's stake in the combined businesses at $2.8 billion, or $11 per share, on a suggested value for fiber assets of at least $3,800 per location. New Street's model also pins a $12.5 billion future value on the 3 million locations within the Wave 3 footprint.

Meanwhile, the financial partner's stake could be worth about $4.4 billion on an $800 million investment, suggesting an internal rate of return of 12% over ten years, Chaplin noted in the report. "We suspect they will capture most of this value in less than ten years, and the return will be higher," he explained.

Related:Frontier turns a big corner as revenues rise in Q1

As noted earlier, the analyst also believes this approach could accelerate Frontier's ability to generate free cash flow (FCF).

"Frontier investors are clamoring for FCF," Chaplin explained. "If Frontier funds the Wave 3 opportunity themselves, they may not see FCF until the end of the decade. The easiest way to capture the Wave 3 opportunity, while providing a path to FCF in the next two years, would be moving the investment off balance sheet and into a JV (structural separation)."

Frontier urged to move on Wave 3

He also believes Frontier would be smart to move forward in the Wave 3 markets sooner than later, believing that overbuilders backed by private equity might step in to invest in those areas and "erode [Frontier's] opportunity."

(Source: New Street Research)

New Street's model for Wave 3 estimates build costs of $5 billion over a period of six years, with 2.2 million locations self-funded and 800,000 BEAD-funded locations. That's paired with an assumption that Frontier will eventually achieve 53% penetration in the JV markets.

Assuming the JV gets underway in 2025, New Street sees it reaching 1.59 million subs by 2034, with a high of 248,000 subscriber adds in 2030.