Hurdles Seen at Verizon, Frontier Rural Line Transaction

The deal requires approval by the Justice Department, FCC, 10 of the 16 states and local franchise license transfer authorities, said Stifel Nicolaus in a note Wednesday. Getting an okay from federal authorities shouldn’t be tough, “given that it actually is a deconsolidation move by Verizon,” the analyst firm said. However, it’s likely the FCC will impose conditions on the deal, considering the Democratic commissioners dissented from the FCC order approving Verizon’s spinoff to FairPoint Communications, it said. State regulators may have concerns, but it’s unlikely they will block the deal, it said. More likely, some states “will use their leverage to demand and extract concessions on broadband build-out, service quality, jobs, and possibly related financing issues.”

Opposition to the deal may come from Verizon competitors, said an attorney representing competitive local exchange carriers. The networks being divested are likely used for wholesale, so the change could affect CLECs, cable companies and others, the lawyer said. As with any spinoff, there’s a risk that the wholesale business will suffer under the new owner, the source said. Regulators in an all- Democratic Washington are likely to be wary of the risk of stranding significant parts of the country’s wireline infrastructure, said Bernstein Research analyst Craig Moffett.

Meanwhile, the divestment won’t affect Verizon’s current aspirations for unbundling forbearance, a Verizon spokesman said. “None of the areas covered by the Frontier transactions are in the six [metropolitan statistical areas] we sought relief for previously,” he said. After on Tuesday withdrawing petitions to the FCC for forbearance in Rhode Island and Virginia Beach, Va. (CD May 13 p6), Verizon currently has no pending forbearance requests at the FCC. However, a court decision is pending on an appeal of the FCC’s 2007 denial of the carrier’s earlier six-market petition.

Frontier doesn’t expect any regulatory and transaction hurdles, Chief Operating Officer Dan McCarthy said in an interview. Verizon CEO Ivan Seidenberg agreed, saying on a conference call Wednesday that he expects the deal to close in a year. As Frontier seeks regulatory approval in nine to 12 months, the combination of different types of debt instruments it will use enables the company to raise the capital very easily in a still-tight credit market, McCarthy said. Frontier will have to raise some $3.3 billion to complete the deal, which was structured as a tax-free spin- off merger. Verizon shareholders would own about 68 percent of Frontier after the deal closes, Verizon CFO John Killian said.

No integration hurdle is expected, McCarthy said. The vast majority of the properties in the transaction won’t do billing conversion because the companies will build identical billing systems from day one, he said. Only West Virginia will have a billing conversion, he said. The transaction sees 11 common states, including 672,000 lines from Frontier and 3.8 million Verizon lines, McCarthy said. “We know those states very well and we will look for opportunities to integrate Frontier’s operations with Verizon,” he said, emphasizing he doesn’t expect any problems impacting either side of the equation.

CWA and IBW have “serious concerns” about the deal, they said. The deal leaves Frontier saddled with debt that will lessen the potential amount available for investment in high- speed broadband deployment, they said. Frontier is seeking broadband stimulus money and state funding for broadband deployment, McCarthy said. Similar tax-free transactions by Verizon, especially those involving the Reverse Morris Trust tax provisions, haven’t worked out well, especially for consumers in New England now served by FairPoint, unions said. The unions are reviewing the deal and will bring concerns to management at both companies, they said. Some 11,000 Verizon employees will move to Frontier and the companies expect no union issues, Frontier CEO Maggie Wilderotter said.

The deal would leave Verizon more heavily tilted toward wireless, Moffett said. It should allow Verizon to focus on growth drivers of consumer wireless and fiber broadband and TV in more densely populated markets, said Standard & Poor’s analyst Todd Rosenbluth. The deal could also benefit Dish Network, said Wachovia Securities analyst Marci Ryvicker. Dish has a distribution partnership with Frontier and the additional lines could lead to additional subscribers, he said. Verizon CEO Seidenberg cited the deal as part of Verizon’s strategy to transform its growth profile and asset base to focus on wireless, broadband and global IP.

With the deal, Frontier will be the largest rural-only service provider, with more than seven million access lines, 8.6 million voice and broadband connections and 16,000 employees in 27 states, Wilderotter said. The demographic and density of 14 Verizon states are “pretty much a rural profile,” Frontier’s sweet spot, McCarthy said, citing a similar customer base. The transaction includes Verizon’s switched and special access lines in the affected areas and its Internet service and long-distance voice accounts. Also included are fiber-to-the-premises assets deployed by Verizon in 41 local franchises and the state of Indiana, which pass roughly 600,000 homes and small businesses. Frontier will continue to offer video services in the areas after the completion of the merger.

Frontier posted a Q1 net income of $36.3 million, versus $45.6 million in the previous year due to a decline in access lines and reduction in switched access and subsidy revenue, the company said Wednesday. It added about 20,100 net high-speed Internet customers and 26,100 video customers. The company reiterated that it expects capital expenditures to range from $250 million to $270 million.

The operations Frontier will acquire include all of Verizon’s local wireline operating territories in Arizona, Idaho, Illinois, Indiana, Michigan, Nevada, North Carolina, Ohio, Oregon, South Carolina, Washington, West Virginia and Wisconsin. In addition, the transaction will include a small number of Verizon’s exchanges in California, including those bordering Arizona, Nevada and Oregon. As of year-end 2008, these operations served approximately 4.8 million local access lines; 2.2 million long-distance customers; 1 million high-speed data customers, including about 110,000 FiOS Internet customers; and 69,000 FiOS TV customers.

The regulatory approval process could drag out longer than a year “due to the number of approvals needed and the type of conditions potentially sought by the FCC and the states, said Medley Global Advisors in a note late Wednesday. The analyst firm expects state commissions “to pay close attention to some of the merger conditions assigned to the VZ/FRP transaction two years ago as they may be used as a guidepost for how to address some of the problems that have come up since the deal closed,” it said.