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MarketScreener Homepage  >  Equities  >  OTC Bulletin Board - Other OTC  >  Frontier Communications Corporation    FTRCQ

FRONTIER COMMUNICATIONS CORPORATION

(FTRCQ)
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Frontier Communications : Fitch Rates Frontier's $1.65 Billion DIP Facility/Notes 'BB+'; Assigns Expected Ratings

09/29/2020 | 05:20am EST

Fitch Ratings has assigned a 'BB+' new issue rating to Frontier Communications Corp. (Frontier, NYSE: FTR) $1.65 billion of senior secured Debtor-in-Possession (DIP) financing in the form of a DIP-to-exit term loan and/or notes.

The initial form will be as DIP facility/notes to be funded while the company is in bankruptcy. While in bankruptcy, the loan/notes will have a super priority administrative claim. Once Frontier emerges from bankruptcy, the DIP loan/notes will convert to first lien senior secured term loan and notes that will be pari passu with the company's reinstated first lien senior secured debt and first lien revolver. The DIP rating is assigned only with respect to the facility as it exists during the pendency of the bankruptcy. The post-emergence exit facility will have a distinct rating predicated on the reorganized debtors' new capital structure and with typical notching off of the Issuer Default Rating (IDR).

Under Fitch's criteria, DIP instrument ratings are point in time and accordingly, this issue rating will be withdrawn within one business day.

Criteria Variation: In the analysis of the Frontier DIP, we have considered both loan and bond components as being akin to a loan for the various considerations described in the criteria because the bonds and the loans components will share the same collateral, have identical provisions and the distinction in debt form (loan vs bond) does not impact the relative risk. The variation did not lead to a category level rating change.

Fitch has also assigned a 'BB-(EXP)' Long-Term IDR to Frontier and its subsidiaries with a Stable Outlook. In addition, Fitch has assigned expected instrument ratings based on the capital structure outlined in 'Liquidity and Debt Structure'. Frontier's and Frontier Southwest's senior secured debt have been assigned a 'BB+(EXP)'/'RR1' ratings. The senior unsecured debt of Frontier North, Frontier California and Frontier West Virginia has been assigned a 'BB(EXP)'/'RR2' rating. The senior unsecured debt of Frontier Florida has been assigned a 'B+(EXP)'/'RR5' rating. Fitch expects to assign the ratings following Frontier's emergence in early 2021. The expected ratings will be reviewed for material changes prior to Fitch assigning final ratings. Material changes may include changes in the company's capital structure at emergence, any material deviations from current assumptions, as well as Fitch's issuance of updated criteria or criteria exposure draft. Expected ratings, like any other rating, can be raised, lowered, placed on Rating Watch or withdrawn.

KEY RATING DRIVERS

DIP Key Rating Drivers:

Collateral Value to DIP Loan/Notes: The overcollateralization of the DIP facility/notes is the most important rating driver and carries significant weight in the issue rating. Although substantially all value is pledged to the DIP lenders, the majority of the actual collateral is limited to equity interest in certain subsidiaries. The enterprise valuation underlying the confirmed plan of reorganization equals $11.25 billion of which approximately $10.8 billion is included in the DIP collateral package. Fitch forecasted EBITDA for 2020 and 2021 is $2.38 billion and $2.04 billion, respectively (net of CAF II funding), reflecting a bankruptcy multiple of approximately 5x. The multiple is supported by peer trading multiples and purchase multiples in sector M&A transactions. Structurally senior debt at the subsidiary level as well as the equally ranking DIP revolving facility eat into the DIP term loan collateral cushion. Incurrence of incremental term loan debt and/or additional subsidiary level debt could further reduce collateral coverage.

Facility Structural Attributes: Structural features of the DIP agreement are another key rating driver. Certain structural features of the DIP facility/notes terms were considered to be protective of lenders, including its priming first lien, super-priority administrative ranking and the inclusion of subsidiary guarantees. However, lender control over the bankruptcy process is limited due to the absence of maintenance financial covenants and case milestones. The limitation of collateral to equity interests in subsidiaries is less protective and can give rise to additional structurally senior or structurally pari debt.

Post-Petition Liquidity and Cash Flow: The $1.650 billion DIP facility/notes are being used entirely to refinance outstanding first lien bonds and provides no additional liquidity. However, Fitch anticipates the core business to produce modestly positive FCF on a go forward basis (Fitch estimates around $500 million in 2021, declining to $250 million to $300 million in 2022 when CAF II funding expires and prior to any replacement funding). Furthermore, Frontier has robust cash reserves as a result of several asset sales executed during the pendency of the bankruptcy.

Prospects and Restructuring Scope: The DIP-to-Exit facility/notes executed post-confirmation is unique and alleviates a substantial amount of risk typically associated with the bankruptcy process. Fitch anticipates the company will emerge as a going-concern and continue to operate. Although a somewhat lengthy regulatory approval process will likely delay emergence until early 2021, the confirmation of the plan signals the conclusion of the debtor/creditor negotiation phase and emergence is expected to occur in due course. Upon emergence, Frontier will have a significantly improved balance sheet and financial profile with debt reduced by approximately $11 billion+ and interest expense reduced by $1 billion.

Expected Rating Key Rating Drivers:

Low Leverage upon Emergence: The 'BB-(EXP)' IDR and Stable Outlook is supported by relatively low leverage for the IDR and relatively low leverage compared with other telecom operators in Fitch's U.S. telecom universe. Fitch expects gross leverage of 2.8x at YE 2021 (net leverage of 2.4x). In the absence of additional rural broadband support, leverage, both gross and net, could rise approximately 0.4x to 0.5x. Additionally, a much improved FCF position will result with a reduction in interest expense of more than $1 billion annually. Fitch believes the company will have the opportunity to increase investments in key strategic areas including fiber to the home, and greater fiber investment to support enterprise and wholesale services, including fiber to the tower. The rating is constrained by the near-term expected decline in legacy revenues and the need to continue to take costs out of the business.

Managing Impact of Coronavirus: Fitch believes the risk of the pandemic on the operational performance of the telecom sector is low relative to other sectors. Enterprise revenues have some pressure with businesses temporarily closed (with the effect on small businesses more pronounced), but this has been mitigated by increased use in communication services to conduct business as travel is down materially and remote working continues. Stability in consumer revenues has been supported by demand for broadband, not only for work at home, but remote learning and increased consumption of entertainment services such as video and gaming.

Capital Allocation: Frontier is expected to emerge from bankruptcy in early 2021. The current holders of senior unsecured debt will become the new owners of the company as a result of the restructuring support agreement. The company's capital allocation policy remains uncertain while the company is in bankruptcy with respect to more aggressive investment plans and an articulated capital structure. Fitch believes the company and parties to the restructuring support agreement are targeting a net leverage ratio of less than three times based upon the anticipated level of debt at emergence.

Challenging Operating Environment: Frontier's rating incorporates a challenging operating environment for wireline operators. Fitch expects Frontier's revenue trends to continue to be negative in the next couple of years on an organic basis. The expiration of CAF II funding in 2022 will also have an impact on the company. Fitch expects this latter effect to be mitigated by the next generation of broadband support through the Rural Digital Opportunity Fund, although Fitch's assumptions exclude potential funding from this program. Additionally, the de-emphasis of products such as video will impact revenues but have a far lower impact on EBITDA margins given programming cost offsets.

FCF and Debt: Fitch is estimating FCF will be around $500 million in 2021, when it is expected to emerge from bankruptcy. FCF could decline to around $250 million to $300 million in 2022 upon the expiration of CAF II funding. The effect on FCF due to the expiration of CAF II funding could be mitigated by additional broadband funding support. Following the emergence from bankruptcy, Frontier will have a much more tenable capital structure.

Asset Sale: Frontier sold its operations in Washington, Oregon, Idaho and Montana (the Northwest operations) to WaveDivision Capital, LLC (WDC) for $1.352 billion in cash, subject to closing adjustments. This cash combined with existing cash will be used to settle claims in the bankruptcy process. Fitch estimated the transaction multiple was approximately 5.3x based on 2019 estimated EBITDA (Fitch-calculated EBITDA is before restructuring and other charges and a goodwill impairment) for the operations.

Secured Debt Notching: Frontier parent secured debt is notched up two levels from the IDR. The secured debt benefits from certain guarantees and equity pledges. The first mortgage bonds of Frontier Southwest are also notched up two levels from the IDR given the security provided by a first lien on substantially all of its assets. For rated entities with IDRs of 'BB-' or above, Fitch does not perform a bespoke analysis of recovery upon default for each issuance. Instead, Fitch uses notching guidance whereby an issuer's secured debt can be notched by up to tow rating levels.

Unsecured Debt Notching: For corporate entities rated 'BB-' and above, the rating assigned to an issuer's senior unsecured debt instrument assumes an average recovery available to these creditors in the event of bankruptcy. When average recovery prospects are present, IDRs and unsecured debt instrument ratings are equal, with no notching. For subsidiary unsecured debt, Fitch notes the structural seniority to Frontier parent debt and the rating is notched up one level to 'BB(EXP)'/'RR2'. At any rating level where the bespoke approach is not used, analysts can denote contractual or structural subordination that is detrimental to the unsecured debt by rating it lower than the IDR; additionally, a bespoke style analysis determining below average recoveries could also lead to a rating lower than the IDR. The 'B+(EXP)'/'RR5' Recovery Rating assigned to Frontier Florida's unsecured debt reflects Frontier Florida as a guarantor of Frontier's secured credit facility.

Parent-Subsidiary Relationship: Fitch linked the IDRs of Frontier and its operating subsidiaries based on their strong operational ties.

Frontier has an ESG Relevance Score of 4 for Management Strategy due to operational challenges following the close of the Verizon transaction that resulted in elevated subscriber churn and weaker than expected revenue, which had a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

DERIVATION SUMMARY

Frontier has a higher exposure to the more volatile residential market compared with CenturyLink, Inc. (BB/Stable), one of its wireline peers, and to some extent, Windstream Services, LLC (not rated by Fitch). Incumbent wireline operators within the residential market face wireless substitution and competition from cable operators, including Comcast Corp. (A-/Stable) and Charter Communications Inc. (Fitch rates Charter's indirect subsidiary, CCO Holdings, LLC BB+/Stable.) Cheaper alternative offerings, such as voice over internet protocol and over-the-top (OTT) video services provide additional challenges. Incumbent wireline operators had modest success with bundling broadband and satellite video service offerings in response to these threats.

Fitch expects the company to emerge from bankruptcy with lower leverage than its higher rated peers CenturyLink and Charter.

Frontier needs to improve its competitive position in the enterprise market. In this market, Frontier is smaller than AT&T Inc. (A-/Stable), Verizon Communications Inc. (A-/Stable) and CenturyLink. All three companies have an advantage with national or multinational companies given their extensive footprints in the U.S. and abroad. Frontier also has a slightly smaller enterprise business than its wireline peer Windstream.

Compared with Frontier, AT&T and Verizon, have wireless offerings that provide more service diversification. Frontier's gross leverage is expected to be slightly higher than AT&T and Verizon follow its emergence from bankruptcy.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

--The maximum DIP size is $1.65 billion as split between the term loan and notes.

The final DIP order and DIP documentation is generally consistent with the terms provided in the term sheet and DIP motion.

Revenues decline just above 10% in 2020, largely reflecting the sale of the Pacific Northwest properties on May 1, 2020. Revenue declines at a slightly lower rate in 2021 and 2022, due to the partial year of the NW assets in 2020, and the loss of CAF II revenues, respectively.

The EBITDA margin is expected to decline to the high 30% range in 2020 and 2021 from the low 40% range in 2019. The loss of CAF II funding further lowers EBTIDA margins in 2022. Pressure in 2022 could be partly offset by future rural broadband subsidies.

Capital spending reflects company plans of approximately $1.3 billion in 2020. Thereafter, capital intensity ranges from 16%-18%.

Cash taxes are nominal in 2020-2023.

The maximum DIP size is $1.65 billion as split between the term loan and notes.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Gross leverage, defined as total debt with equity credit/operating EBITDA, expected to be sustained at or below 3.0x, with FFO leverage of 3.0x, while consistently generating positive FCF margins in the mid-single-digits;

Greater certainty around the company's capital allocation given the new shareholder base upon emergence;

Successful execution on cost reduction plans;

Consistent gains in revenues from anticipated investments in fiber and broadband product areas;

Demonstrating stable EBITDA and FCF growth.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A weakening of operating results, including deteriorating EBITDA margins and an inability to stabilize revenue erosion in key product areas or offset EBITDA pressure through cost reductions;

Discretionary management decisions, including but not limited to execution of M&A activity that increases gross leverage beyond 4.5x, with FFO leverage of 4.5x, in the absence of a credible deleveraging plan.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Frontier has a substantial amount of liquidity at the current point in time with more than $2 billion of cash. At emergence, the company expects to have $150 million of cash and an undrawn $625 million credit facility. First lien debt is expected to be $3.344 billion, second lien debt is expected to total $1.6 billion, and subsidiary debt is expected to total $856 million. Parent takeback debt is expected to be $750 million, and whether or not it is secured or unsecured will be determined at emergence. Fitch expects to provide a final rating on the takeback debt at that time.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Frontier has an ESG Relevance Score of 4 for Management Strategy due to operational challenges following the close of the Verizon transaction that resulted in elevated subscriber churn and weaker than expected revenue, which had a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

RATING ACTIONS

ENTITY/DEBT	RATING	RECOVERY	PRIOR
Frontier North Inc.	LT IDR	BB-(EXP) 	Expected Rating		WD

senior unsecured

LT	BB(EXP) 	Expected Rating	RR2	
Frontier Florida LLC	LT IDR	BB-(EXP) 	Expected Rating		WD

senior unsecured

LT	B+(EXP) 	Expected Rating	RR5	
Frontier California, Inc.	LT IDR	BB-(EXP) 	Expected Rating		WD

senior unsecured

LT	BB(EXP) 	Expected Rating	RR2	
Frontier Communications Corporation	LT IDR	BB-(EXP) 	Expected Rating		WD

senior secured

LT	BB+(EXP) 	Expected Rating	RR1	

super senior

LT	BB+ 	New Rating		
Frontier Southwest Inc.	LT IDR	BB-(EXP) 	Expected Rating		WD

senior secured

LT	BB+(EXP) 	Expected Rating	RR1	
Frontier West Virginia Inc.	LT IDR	BB-(EXP) 	Expected Rating		WD

senior unsecured

LT	BB(EXP) 	Expected Rating	RR2	

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

(C) 2020 Electronic News Publishing, source ENP Newswire

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Financials (USD)
Sales 2020 7 156 M - -
Net income 2020 - - -
Net Debt 2020 7 053 M - -
P/E ratio 2020 -0,32x
Yield 2020 -
Capitalization 10,7 M 10,7 M -
EV / Sales 2020 0,99x
EV / Sales 2021 1,13x
Nbr of Employees 16 302
Free-Float 97,8%
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Bernard L. Han President, Chief Executive Officer & Director
Pamela D. A. Reeve Chairman
Kenneth W. Arndt Chief Operating Officer & Executive VP
Sheldon Bruha Chief Financial Officer, Treasurer & Executive VP
Steve Gable Chief Technology Officer & Executive VP
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