Lumen Technologies, Inc. (NYSE:LUMN) New Street Research and BCG Fiber-to-the-Future Conference March 22, 2024 12:10 PM ET
Company Participants
Chris Stansbury - Executive Vice President and Chief Financial Officer
Conference Call Participants
Jonathan Chaplin - New Street Research
Jonathan Chaplin
Good afternoon, everybody. I'm delighted to introduce our next speaker, Chris Stansbury, CFO of Lumen. Chris, last time we did meetings together, you were relatively new in the seat. Kate had been announced, but she hadn't joined yet. The conversations were difficult. A tremendous amount has changed in the course of the last year and a half.
Perhaps the most important of which or most significant of which is the TSA that you managed to pull off and closed this morning, because it makes everything else we're going to speak about today possible, freeze up the team to focus on the business with a clear runway to 2029. So congratulations for getting that done, and thanks for joining us today.
Chris Stansbury
Yes. Thanks very much. And, it's great to be with everybody, and that's -- that was a great way to say it. When you look at our capital structure, all the way back to when we were paying a dividend. Right? We were, just before Kate joined, we were paying a $1.1 billion dividend a year, and we had $20 billion of outstanding debt, $10 billion of which was due in 2027, and $12 billion to $13 billion do really between now and then.
So, as we were executing the turnaround, which we're making great progress on, ultimately, the debt had the potential to be a limiting factor, just given where the credit markets were. So, the execution of the TSA is a major milestone for us. There's no way to understate it because it clears the path, it gives us the financing we need, and it frankly puts a lot more confidence in the marketplace that we've now got time to do it.
So we're pleased, we're excited and, the fact that that the broader market, and it was the broader market we were negotiating with supported this in a very tough credit environment. I think that's a big vote of confidence.
Question-and-Answer Session
Q - Jonathan Chaplin
Yes. It is. It's, fantastic that you've managed to pull it off. So before the TSA, Chris, you did a big reset in June, where you projected a return to growth in revenue and EBITDA in '25 with EBITDA accelerating to sort of 9% two years later. And you sort of, in the interim, had challenges before executing the TSA where some customers were concerned about liquidity.
And it sort of you've where '24 guidance has come in has been a little bit below the original plan, I think largely as a result of that. As we think about the rest of the plan, how should we sort of adjust the forecast that you put out there in June for the challenges up to the TSA and now that you've got the TSA done?
Chris Stansbury
Yes. It's a good question. And to your point, I'll just give you a little bit of color on that.
If the customer concerns ran the full gamut, right? So, smaller, less financially sophisticated customers, were concerned about, our longevity. The bigger customers, they're making multimillion dollar decisions weren't concerned about the longevity. They were concerned about, our focus, right?
And with the debt overhang combined with the credit markets and the formation of the group ultimately take us down a path of distraction where delivery against what they need from us would be challenged. So that's really what the overhang was, and we saw it impact sale rates in the back half of last year, and we talked about that as a reason for the lower guidance as we came into this year. A few comments around that.
First, we still expect, EBITDA to hit its inflection point next year. Initially, the thinking was earlier in the year. It's probably later in the year, and then revenue would follow that by a few quarters.
What we're going to do in the second half of this year is give, an update on that, with a lot more clarity. And the reason it's going to take a few more months to get that done is we've got both Satish Lakshmanan, who came to us from AWS, who's their Head of AI, who's the Head of Product now, and Dave Ward, who has deep technology experience including NaaS, he was previously the CEO of PacketFabric. They're, really finalizing the clarity around the go forward product portfolio and how that's going to go to market and how that builds.
And what we intend to bring the market is deep visibility inside of enterprise. Here's the legacy business and how it's declining and how we expect that to play out. Here's what's on the truck today and how those rates of sales are improving, and here's the innovation that ultimately comes in behind that. And that's how we get to that point of inflection, because I think the faster we share that, the more confidence the market will have, about the turnover. So that will give you that a little bit down the road here.
Jonathan Chaplin
Yes. That'd be fantastic context. I think it'll help a lot. Leaving aside the sort of the product piece, which is still, coming into focus with new leadership. When I look at the CapEx piece of guidance, the '24 guidance didn't change much from the original plan. Should we think of the '25 through '27 CapEx plan still being mostly the same?
Chris Stansbury
Again, at this point, I don't think that's a bad assumption. The key variables will be if we see any opportunities to expand an offering. But at this point, I'm not signaling that we see that or we don't see that. That's where I want to give, Satish and Dave some time. Because the whole goal here is to drive it as fast as we can.
And then the other thing that is out there is, there's a lot of chatter, there's a huge amount of demand for increased networking capacity by hyperscalers large enterprise, and it's really driven by AI. You can't understate the demands for infrastructure that exist, and our infrastructure is the preferred infrastructure. We've got the largest network of 400 gig ways. We've got conduit in the ground that's valuable.
And when you combine that with the service offering that's coming, because not just the capacity, it's how can I use it flexibly, quickly, how can I turn it up, turn it down, how can I keep it secure? We're the only company that owns a network that's able to also offer that service off, the services that make the consumption easier.
So, there could be some CapEx that comes with that, as that demand comes in, but there would also be incremental, revenue, EBITDA, and cash flow. We don't guide big deals as it relates to conduit and dark fiber, because we don't know what they're going to hit, and they're big and chunky. But to the extent that any of that, comes our way, we'll certainly keep people updated.
Jonathan Chaplin
And, looking at the '24 guide, it looks like the overall number is pretty close to what it was in the original plan. The mix between business and consumer has shifted a little bit. Consumer is down, business is up. Where within business is that incremental investment going? Is that, the sort of conduit in dark fiber that you were just speaking about?
Chris Stansbury
So, there's a few things. So, first of all, in consumer, we're holding at 0.5 million build. We're initially going to go up. The reality is with inflation, those the cost per build has gone up, and you see that across, the fiber of the home sector. So, the consumer CapEx didn't come down as much as you would have expected going from 750,000 to 500,000 enablements. So that's part of it.
But on the on the enterprise side, I would say the biggest single thing, it's not necessarily a lot of incremental capacity at this point. It's more, what we announced a year ago where we're investing heavily on fixing the inside of Lumen so that we can bring a better customer experience.
And just by way of example, a little bit of data we can we can share, ServiceNow has been attempted to be installed many times at limited. And it failed because there was never an effort to fix the process before they automated it. And, we're taking a very disciplined approach. I sat in a review yesterday with our ops team, where they're going through product by product and fixing the process before we automate it.
And so an example is DIA circuits where it used to take us between 50 and 60 days to deliver. We would miss the customer delivery day 3 or 4 times. We'd often requote because we got that wrong. We didn't have a good sense of where our inventory was. The team has completely rewired that process. It's now down to a little over 20 days.
If it's a NaaS circuit, it's minutes. And our very first delivery through ServiceNow, which was not a NaaS enablement was about 5 days. So the investments that we're making to bring that kind of an experience across all of our products is really, I would say, what the incremental CapEx is in the near-term.
Jonathan Chaplin
Chris, back at the Analyst Day, in June, Kate spoke to a total business telecom revenue pie in the U.S. growing from I think it was a $115 billion to a $135 billion over the next few years. Network-as-a-Service sort of in a separate piece showing growth of 20% CAGR, which did a great job of laying out Lumen's right to win in those segments.
I guess that where we struggle a little bit is when we look at the revenue for all the big telcos in enterprise that we can track. In aggregate, it's declining. And so how do I bridge between the sort of growth trajectory from a $115 billion to $135 billion?
And what we see for Verizon and AT&T and you guys and the other pieces that we can count, who's capturing the piece in the middle? Is that you competing increasingly against the cloud platforms for telecom services?
Chris Stansbury
Yes. It's a great question. And I think it really does put into context what we're doing here. So, if you look at, let's talk about the competitive environment first. Our two major competitors who named, have been very public in saying their next best investment is not on the enterprise side. It's really, it's a fight for the consumer. It's around wireless fiber to the home to some extent. And that's where their investment dollars are going.
Legacy telecom is a real thing. And when you look at their results, and we talked about this on Q4 earnings, they're down 8% to 10%. In the same quarter, we were down 3.5%. So we're already making the pivot. We're already relying less on legacy and investing in the future, and that's why we're performing better, but still not where we need to be.
Now as we go forward, what's happened? There's really three things that are driving, the need to digitize telecom, and that's the explosion of hybrid environments. It's multi cloud, so I don't just have a relationship with one hyperscaler.
I mean, it's probably multiples. I've also got private cloud, and I've got enormous amounts of data that's exploding every year, and I need to move it around, and I need to move it around flexibly. Today, there are companies that try to provide those services. None of them also own the network.
So, NaaS is a good example where there are NaaS providers out there, but when you dig into their underlying results, they're struggling, and they're struggling because they have to go buy network from us and from others. And so it's an impossible thing to scale.
Our ability to deliver NaaS, frankly, at a much deeper layer in the network. It's far more powerful, far more flexible for the user, is really unparalleled. So it's two-fold. It's a shift from those who have tried, but can't. But I would also say it's a better way. So you've heard Kate talk about the cloudification telecom. Think of it that way.
Data centers all used to be sitting inside of large enterprise, and then hyperscalers said, there's a better way, not for all of your workloads, but for a significant portion and it's called cloud. And there's efficiency in that, there's speed in that, there's security in that, that that you can't bring to yourself. That's exactly what we're going to do to the network. And so it's not about necessarily increasing total spend on telecom. It's a shift. And we think we take a lot of share when that happens.
Jonathan Chaplin
And so I guess, if I sort of dumb it down into analyst speak, it's we've really got to, like, look at it. We've got really got to look at the segment, the revenue pie more thoughtfully. It's not like the overall revenues are going to grow at a faster rate, or that AT&T and Verizon are going to decline at a faster rate. You're just shifting your mix within that stack and that's what allows you to go from declining to growing, I guess.
Chris Stansbury
Broadly speaking, yes. And the way we do it is by bringing new services that are easier to consume. Basically, everything becomes digital. You can light up the service, you can move data, you can keep it very secure because of our Black Lotus Labs property. And that's something that no one else is doing in the space.
Jonathan Chaplin
By the way, I heard a stunning stat yesterday from one of our speakers pertaining to really the old legacy business, at Lumen, which is they're starting to see forward purchases for long haul circuits from cloud providers, who are worried that with the growth and demand they're seeing from AI in particular, that there's not going to be enough infrastructure in the ground to satisfy demand, in 3 or 4 years' time.
And so they're locking in capacity now, which I think has fascinating implications for long haul networks and sort of telco infrastructure in general. We haven't heard about an environment that would drive stabilized pricing or drive pricing up in that piece of the network for a long time?
Chris Stansbury
Yes. It's a good place to sit right now. The reality is of this, Satish, made a comment to me the other day from his experience at AWS. And, the rough approximation that that they used was that 90% of the world's data was created in the last two years.
And so that that really speaks to just how rapidly this is scaling. And when you look at the fact that that data centers, and there's a lot of talk about those, their biggest issue is power. That's the constraint. So they're getting further and further away from the point of consumption.
So you have data needs exploding. You have data getting further and further away from where it needs to be, and latency in today's world becomes a real problem. So the ability to sit on the most modern network, move data very flexibly, really at your fingertips and very quickly and securely, that's the big unlock.
And we're the only ones that are really investing in that space, and that's why we think our moment is now. And the environment is right for it and our service offering satisfies a need. It's critical.
Jonathan Chaplin
Chris, you said, recently that you get a much faster return on CapEx invested in the enterprise business, than you do on CapEx invested in the consumer business. The returns on the consumer business or consumer CapEx is sort of very visible to us and that we can see, you invest in homes passed. We see the incremental revenue.
We can estimate the incremental EBITDA that comes through with that. Much harder for us to see it in business where the overall revenues aren't growing at the moment. Can you unpack, the, like, how we should be thinking about returns on capital in business?
Chris Stansbury
Yes. And that's exactly why I want to give the visibility in the second half of the year. What has completely, kind of clouded the ability to see that? One, enterprise is, is more complex, it's not a P times Q model and consumer is. But it's really the decline of a legacy business. Right?
So you have this cash rich portion of the business that requires little investment, basically maintenance spend, but it's in rapid decline. And think really when I talk about our nomenclature, it's grow nurture harvest. It's really that harvest bucket, which is declining double digits, and it's basically voice in private line. And that's just going away.
When you wait that into the business results and you say, well, business is declining, so how can you be earning a return? The things that are driving the return are really the grow bucket. And it's capital that's going into new installs with customers.
My goal is by giving you the pieces, you'll be able to see that more clearly because the EBITDA growth is coming from, those growth products we have today as well as the innovation portfolio that follows, as well as any kind of big dark fiber infrastructure deals we do. That'll become more visible once we break apart the pieces for you. But that's really, I think, what's clouded things.
Jonathan Chaplin
So that'll be really helpful. Is it right to think that the harvest piece doesn't, there's no CapEx to support that or very little CapEx to support that?
Chris Stansbury
Yes. Maintenance CapEx.
Jonathan Chaplin
And then the most of the CapEx, I guess, is going to support the growth segment. But as I look at the like the incremental revenue in that segment, at the moment, it's growing at, like, roughly at a $180 million a year. Like, how do I put that together with the component of CapEx that's going into business?
Chris Stansbury
Sure. So, the best example I could give you at this point until we break things out further, in the Q4 results, we broke out, the channel within North American enterprise. So we gave you large enterprise, mid markets, public sector, wholesale.
And, public sector, we said would be the first to return to growth, and that's because we've won a lot of really big contracts that we've made announcements around really over the last 18 months or so. They take a long time to get them installed. They're big complex deals.
Those are 10, sometimes more than 10-year contracts. They have CapEx associated with it. So think about it as an NPV of an upfront CapEx investment, but a very long return cycle associated with it. So that's definitely a big piece of the CapEx. And again, enterprise is consuming quite a bit of CapEx for us to fix the customer experiences I discussed here.
Jonathan Chaplin
Yes. That's another piece that really clouds the there's a sort of the transformation CapEx, separate from CapEx that's driving revenues. And so that clouds the picture as well. As I think about the, so, you're investing CapEx and enterprise against 10-year contracts, and you get a good return on that.
The return profiling mass markets is different, but I'm wondering, potentially not worse in aggregate. So you're building a 40 to 50-year asset. Takes you much longer to get to free cash flow breakeven on that investment. But you've got a lot more certainty around the investment just because the end market is so much more stable, you've got one competitor in most of those markets.
How do you think about sort of capital allocation decisions in the context of it? It's a quick return with a lot less confidence in the longevity of the cash flows beyond the initial contract versus a slow return with years and years of visibility?
Chris Stansbury
Yes. So a couple of things.
First of all, these are two great businesses, right? They just, to your point, have very different return profiles. There's a much greater upfront investment on consumer into your point, a longer payback period, but it goes well into the future. Here's how we look at it though. From a competitive landscape, there is going to be a lot of competition around fiber to the home. There's no question about that.
In the enterprise space, as I said earlier, there's not a lot of competition for the kind of offerings that we can bring. So our ability, with that next investment dollar to drive significant disruption and differentiation is much higher in the enterprise space. And that's where we see the greater return.
Now in the consumer space, again, a great business that because of the long payback cycles, that is a sector that's screaming for consolidation. And our belief is that consolidation will happen, and our view is we will not be the consolidator. We have a great asset. We're going to continue to invest in it.
We're going to continue to build fiber enablements and grow subscription. But we're also going to look for ways to monetize it. Maybe there's ways to wholesale some of that fiber. Maybe we do some joint venture type relationships where we can get a bigger bang for the buck for the capital that's going in the ground.
But the ultimate objective there is to continue to build value in that asset and when the time is right, right rate now, if there's not a lot going on, obviously, with the capital markets the way they are, then, that'll be a very attractive asset for somebody, and then we can double down on the enterprise.
Jonathan Chaplin
So I think AT&T has put out an a really interesting template for a structure where the investment in fiber, in the mass market doesn't have to happen on your balance sheet, but you retain some of the upside in a tax efficient structure. Would you think of doing something similar, putting a bunch of mass markets into a JV with a financial partner who can then fund the investment in fiber?
Chris Stansbury
That's a possibility. It's a real option. What we're doing right now, and it's probably going to take us a couple more months to get through the work. Because we don't think there is a play right now for a one big transaction to consolidate the space, we're looking at it market by market, more specifically state by state and saying, alright. Is it a situation where, we look at JV?
Is it a situation where we look at potentially wholesaling some of the fiber? Do we sell a market if we can get great value for it, right? So all of those scenarios are on the table and we're looking in at each one of them, again, market by market.
Jonathan Chaplin
If I think of your footprint in, like, really big blocks, like the old Qwest footprint in six big cities, in the mountain region and west. Is there not maybe an opportunity to put all of those into a new structure similar to the bright speed transaction, but where you retain a stake in it?
Chris Stansbury
Again, it's a possibility and we're looking at all those things.
Jonathan Chaplin
And one of the other interesting themes sort of that's cropped up in the last few months is T-Mobile taking an active role and actually funding fiber deployments. As you think about sort of different partners with somebody, Tier 1 wireless carrier be a natural partner for helping build out the mass market fiber opportunity?
Chris Stansbury
Absolutely. I mean, again, when you think about the strategic focus, those carriers are in a battle for the consumer. Our enterprise business is focused in different areas. Logically, they could very well be a suitor or a partner in those kinds of relationships. And so we continue to explore all those options. There's lots of work to do. I'd say there's always a level of dialogue and conversation, but it's too early yet to call what we think we're going to do market by market.
Jonathan Chaplin
And then unfortunately, I have a sort of a bunch more questions on this. I guess, we'll continue the conversation at your Analyst Day later in the year. But before we jump off, just going back to the TSA. You've bought yourself time until 2029. That's a lot of time to get a lot done. Is your, is the view that by the time you get to where you'll have to be refinancing the 2029 maturities?
Leverage will have organically come down, and the business will be growing at a rate that the balance sheet from that point on will be financeable. Or do you have to engage in transactions around the mass markets business between now and 2029, to be in a sustainable balance sheet position?
Chris Stansbury
Yes. The capital structure is not dependent on anything we do with mass markets. So I think that decision is mutually exclusive. Your question is the right question, and let me answer it this way. Kate and I and then Board had a lot of conversation around. What's the best way to drive returns and what's the best way to improve leverage.
And we strongly felt that driving the numerator, EBITDA was a much faster path to long-term success than just simply managing the denominator. So the whole plan with the TSA when we were approached by the group was which was largely a Level 3 group. We said, yes, we'd love to engage, but we got to tackle the whole structure so that we can execute.
And so, yes, we believe the business, with the innovation, with the lead we already have, will pivot well in advance of any refinances we have to do. Now I would add that to the extent that there's large infrastructure type deals that are not in guidance because we don't know when they come, that to the extent that there's any incremental cash there, we'll continue to work on the capital structure.
So, it's not pencils down. There's, I think, a lot of improvement we can continue to drive in the shape of our maturity curve, and that'll be a focus as we see opportunities for it.
Jonathan Chaplin
Chris, this has been a great discussion. I really appreciate the insights. Thank you very much for joining us today.
Chris Stansbury
Yes. Thanks, Jonathan. Look forward to talking to you again.
Jonathan Chaplin
Cool.