2023-12-05 13:18:02 ET
Lumen Technologies, Inc. (LUMN)
UBS Global TMT Conference Call
December 05, 2023, 11:15 AM ET
Company Participants
Chris Stansbury - Executive Vice President and Chief Financial Officer
Conference Call Participants
Batya Levi - UBS
Presentation
Batya Levi
Great. We'll get started now. Thanks everyone for joining us. I'm Batya Levi with the Communications team at UBS. And our next speaker is Chris Stansbury, EVP and CFO at Lumen. Thank you so much for joining us.
Chris Stansbury
It's great to be here.
Question-and-Answer Session
Q - Batya Levi
Great. So, just given the time of the year, we -- I wanted to start off with, what you're mainly focused on as we head into '24?
Chris Stansbury
Yeah. I mean, the fourth quarter is obviously well underway. We're very focused on finishing the year strongly. But really, the pivot is now to next year. We're in the middle of a transformation. If I think about it kind of in terms of renovating a house, over the last year, we've done all the ugly stuff that you can't see, right, replumbing it, rewiring it, building new motions for how we retain customers and migrate customers to new things, focusing on innovation, focusing on execution. And so, '24 is really where that hard work starts to show up in the results. And so, we're very focused on making sure that deep into the organization, all of our objectives are aligned around that, and that people have the tools they need to succeed next year. So that's the focus right now.
Batya Levi
And a lot of news or attention is going towards the TSA. So, maybe if you could just give us an update on where we are? What are the next steps as you complete the process?
Chris Stansbury
Sure. And, oh, I forgot to say up front.
Batya Levi
Right.
Chris Stansbury
I might add the forward-looking statement thing. So, you can check out all of our language around that on the Lumen IR website.
But -- so the TSA, obviously, that's something that we came to an agreement with the group on about a month ago. We're in the middle of that. We're very focused on bringing that to closure. The portion of that that the focus is on today is really around getting the banking group, the revolving banking group lined up behind it, and that's where we are right now.
Batya Levi
Okay. Maybe just dig into that a little bit. And there was a little bit of confusion around it. If you can help us kind of understand what drove it? Why now? And as we get out of it, maybe sort of some goalpost that we should think about in terms of where -- like how much incremental interest expense is this going to need and...
Chris Stansbury
Yeah. So, there has been a lot of noise around it. Not surprising, it's a huge transaction, particularly in a tough credit environment. We were in the motion of refinancing our capital structure really focused on two things. One, making sure we can continue to invest in the turnaround. And two, dealing with a challenging maturity structure where half of our debt of a fairly highly-levered company was due in one year, in 2027.
And so, there was overhang on the customer side, saying, "Hey, wait a minute, this thing looms. Even if you guys execute the turnaround, is there risk?" Because our customers -- our enterprise customers, they're making multi-year, multimillion dollar decisions, and they want to know that we're going to be around to provide that service.
So, we were in a motion to address that. Our capital structure for a lot of legacy reasons is complex, a group formed as we address that, and we view that as an opportunity to meet our financial needs, but also deal with those issues in a bigger bite rather than a bunch of smaller bites. And that's really what the TSA got us to.
There was -- candidly, there was an alleged technical default. We don't believe there was. And the real answer is it doesn't matter who's right, because what matters is the noise in the marketplace is not our friend, and that just casts further doubt into customers' minds. And so that's why we embrace the process and why we are where we are today.
It is a more expensive deal. So, if you think back, Batya, to our Investor Day, we did say that we would refinance debt at the time of maturity and we expected to be paying much higher coupon and that's what those assumptions were. This pulls that forward. So, it all obviously move around by year, but it's about a $200 million to $300 million solve that we've got to do. And the way we're going to do that is we're not going to expand our consumer builds. We'll stay at the pace we're at right now, which is a healthy 0.5 million enablements a year. I think the rest of the space is largely adjusted given cost of capital. So, I don't think we're out of line with that, but that's how we fund that gap.
Batya Levi
Got it. And is it true -- I mean, my understanding is that group that sort of on the other side, you did not have any control over that group.
Chris Stansbury
None. I mean, I think that's a really important point, and thanks for bringing it up. We had no control over who was in the group. We had no control over who was in the steering company, a subset of that group. It's the steering group that we negotiated with. It was a very tough negotiation. We did build in, on our side, basket capacity, as well as covenant flexibility to deal with other portions of the capital structure not included in the TSA. We can't talk about that now because of non-solicit rules. So, as soon as the TSA closes, we can start to address the other portions of the structure.
Batya Levi
Okay. Do you expect it to close soon or could this drag on further?
Chris Stansbury
The TSA expires December 31st. So, the focus is on getting it closed before the end of the year.
Batya Levi
Okay. And would that give you enough time just to continue to focus on their operations and you'll have enough funding and/or are you sort of be -- will you be more opportunistic with other forms of funding? And maybe how do you think about the ABS opportunity?
Chris Stansbury
Yeah. So, certainly ABS is an opportunity. It's something that we're looking. Right now, obviously, the focus is the TSA, and that's consuming most of our time right now. But we're doing the work that you need to do to enable securitization-type deal to happen down the road. So that work is happening.
Look, I think it's an interesting conversation, because I've only been in telecom now for a little over a year-and-a-half. Kate has been here for a little over a year. And it's a space where, particularly in the enterprise space, there has not been innovation. It's been dumb pipes, and that's it. And there's this accepted view that everything moves down into the right, and therefore, the best way to manage the business, I jokingly say, is to die last, right?
And so, there's that the balance sheet management side of returns, which usually ends up in some kind of a restructuring, that's not the opportunity for us. We have significant, proprietary technology that has started to enter the market. We've talked about it, NaaS, ExaSwitch, edge fabric, and the conversation with customers around that is significant.
And so, the fact that we're focusing on migrating customers from legacy to new and bringing new very disruptive innovation to the market, the fiber is important, but if you stop with the fiber as the story, you're going to lose. It's about the service layer on top of that. And we think that the bigger opportunity is on EBITDA growth, then on debt -- simply debt reduction, we got to do both.
Batya Levi
I do want to touch on that a little bit more. And you're right, on the enterprise side, the telecom companies are generally known as the connectivity provider and maybe just the dumb pipe. And the value creation goes to others, the tech side, the software side. How do you change that narrative? And how should we -- what should we track to see that you're actually gaining share there?
Chris Stansbury
That's also a very good question. I think a big wake up call for us was the third quarter earnings call. We knew that the bulk of the questions were going to be around the debt deal, fair. What was shocking is that the only business questions were around fiber-to-the-home, which is 20% of our business. And so, we've got work to do. We owe you and the broader investment community the right set of metrics around, I would say, three things, right?
If you think about how we manage the enterprise space, it's secure the base, and think about that as customer migration from legacy old products to new. So, don't ignore those customers that are on really profitable, cash-rich legacy products, actively engage in a conversation on migrating them to the new thing, because customer lifetime value is a real thing.
The second basket of activity is really around driving executional excellence. So, the work we're doing in mid-markets on adding new logos, the work we're doing in large enterprise on adding sellers and better metrics around that to add net new. There's a set of metrics around that that we can share.
And then, the third is the innovation, where I think we can give a better pathway to the disruptive nature of that technology and the share-taking that we see in that opportunity.
And so, as we get into next year, we'll give more metrics around that. So hopefully, the broader investment community can model more closely to what we're expecting.
Batya Levi
Like you said, Kate has been on the CEO role just over a year, you're a little bit longer. But as you look at that transformation phase, what inning are we in? Do you still need to invest or spend time to put the pieces together? Or you -- or is that mostly done and now it's kind of going after that?
Chris Stansbury
It's -- I would say, we're fourth inning. There's still investment to come. I mean, we can't forget there's a lot of EBITDA that's in this business today. And one of the reasons why we're having debt conversations is because we're committed to spending all of it on driving the transformation and getting to a better place as fast as we can. So, there's still innovation to come. We will continue to innovate around NaaS and ExaSwitch and security, but a lot has also been done.
So, what you're going to start to see is the impact of the activities over the last year, start to reduce the rate of decline, and do that in a more meaningful way. If you look at our enterprise space kind of adjusted for acquisitions and whatnot, I think we're competitively in a very good place today, but there's more improvement to come and you'll start to see that in the second half of this year.
We will also give -- I think, in addition to just what's going on inside of enterprise from a product standpoint, we're going to give you much better visibility around large enterprise, mid-markets, public sector, wholesale. We'll give you all the pieces. So -- because they're behaving in different ways in terms of their point of inflection back to growth, but we'll give you the insights around that as we go forward.
Batya Levi
Going back to the Analyst Day, you laid out some operational goals for each segments. You maintained generally your free cash flow targets. But that, I guess, the adjustment is maybe higher interest [indiscernible] with lower CapEx. But on the operational side, what are some of the changes that you're seeing right now?
Chris Stansbury
So, there's -- again, it's a company that was very focused on paying a dividend. There wasn't a lot of internal investment. 13 order entry systems, 36 GLs, all that's getting cleaned up this year. So, the customer experience is improving. Our visibility into our own performance is improving. And when you layer that with a lot of the work that we're doing internally around AI, we're one of the early launch partners on Copilot. There's an enormous amount of productivity that's getting unlocked and will continue to get unlocked as we move through the year. So, as we get to the end of '24 and into '25, '26, I think we'll be on a pathway to some significant cost reduction and efficiency as we go forward.
Batya Levi
Okay. Maybe digging in a little bit with the enterprise segment and stepping back, can you talk about what you were seeing from a macro environment and sort of competition, maybe some pricing trends?
Chris Stansbury
I would say nothing has changed yet, although early signs are that next year will be better than the past couple of years have been as inflation starts to moderate. And we're certainly hearing from customers and, just more broadly, industry analysts that there's need for investment, right? There hasn't been as much over the last couple of years. So, I think that's good, particularly when combined with what we're seeing in terms of things like seller productivity and the things I mentioned earlier around migrating customers and driving better net new performance with new customers.
So, I think that sets itself up well, but the part that we're most excited about is the disruptive innovation. And if you think about what's happening in enterprise today, customers are working in hybrid environments, right? There's on-prem. There's private cloud. There's public cloud. Within those cloud environments, there's multi-cloud. And what's happening right now, it's not just something that's projected to happen, it's just an explosion in the amount of data.
The learning algorithms of GenAI are consuming enormous quantities of data. You talk to the data center providers, third-party data center providers, you talk to the hyperscalers, they're all scrambling to build data centers to meet that need. And the biggest constraint they face is power. So, they're getting further and further away from the point of consumption and latency now becomes an issue. So, when you look at the innovation we're bringing, we're dealing with that.
So, we're digitizing the network. What does that mean? That means that you can consume the network the way you want to consume it when you want to consume it. So, NaaS is port-to-port connectivity that you light up through your computer and you light up that connectivity in minutes, not weeks or, worst case, months, depending on customer experience.
That's also a gateway to things like ExaSwitch, where -- okay, what is ExaSwitch? It's a thing and people are confused by it understandably, it's an optical switch. It reroutes an optical signal from one place to another. And what's happening is you get into these much bigger data load environments that are more fragmented is the need to move massive quantities of data instantaneously, in some cases, between two different hybrid or -- sorry two different hyperscale environments.
And so, ExaSwitch does that. It allows you to move the equivalent of 1 million or so 4K videos in an instant from A to B. And so, the ability to do that is something that we have IP around. As we talk to customers -- we were in New York talking to the financial services sector a few weeks ago. What we're getting asked is not why. We're getting asked how quickly can I get that, because it's solving a number of immediate problems that can't be solved with just doing more direct connections of laying more fiber.
And so, the fiber is critical. We've got 6 million miles of 400-gig waves in the ground. There's another 6 million coming. It's important. But if you stop the conversation at fiber, now you're talking about down into the right, it's commodity, it's not interesting. It's about that service layer.
The third leg is really edge fabric. So, companies today pay a lot of egress fees to get access to their own data. And in a world where we're driven by apps and apps need data, you're doing all that development work, you can do that in an edge of network, zero latency environment that's already built, it's available through Lumen and can be accessed through NaaS and then you wrap security around it.
So that's really the future. That's the disruption factor that we think we can bring. It's really a tech focus. And the talent that's coming into Lumen today is astonishing in terms of the people that want in. We'll make an announcement late this year, early next year about our new Head of Product, I think it'll shock the industry in terms of the kind of talent that's coming into the company.
Batya Levi
But there is a perception that as these services are rolled out, they are -- they have deflationary pricing. So, how -- will the volumes make up for the difference that you expect that pool of revenue to continue to grow?
Chris Stansbury
I don't -- so I think deflationary pricing is just more and more faster fiber. Again, if that's where the story stops, that's a deflationary story, that's commodity. The service layer, customers are willing to pay for access to ExaSwitch where we have IP protection. Speed is important, so access through NaaS, that's important. So, I think what we're going to see, again, just like we saw when third-party data centers came into existence, it's what we saw when data center providers moved to cloud and as-a-service, not just on-prem, we're going to end up with a hybrid environment. You're going to end up with banks needing point-to-point connectivity between San Francisco and New York, but they're also going to need some of these other things that allow them to pulse up, pulse down. And I think in that, not only is there value they're willing to pay for it, it's a share-taking opportunity.
Batya Levi
Right. And as you go through these opportunities, you're partnering with potential providers as well. Maybe you were the anchor provider. How does the profitability of that partnership look for you?
Chris Stansbury
Still to be solved. So, what I don't want to do is tell you that we've got it all figured out, because we don't. I think the technology is figured out, but how that's priced, how that's priced in a broader ecosystem, all those things are things that we're working on right now.
Batya Levi
Okay. So, when you look at near-term enterprise trends, they've been pretty stable, actually, on a sequential basis. Can we expect that to continue? Are there any sort of drivers you would...
Chris Stansbury
Again, I think -- and it's hard to call how much is market versus how much is just us doing a better job of execution. But what we do have a line of sight to when we get deeper into the data is we should see, as I said, improvements in our trends in the second half of next year. I think the rate of deceleration will continue to improve and be more noticeable at that point.
Batya Levi
In large enterprise, it's been delayed, but we're starting to pick up more and more wireless companies kind of talking about private 5G opportunities. Are you seeing that as a new competitor coming in?
Chris Stansbury
I haven't seen a lot of it. There's certainly on-campus situations where customers require that. In that case, we partner with others who provide that. We don't have any desire to be in that space, nor do we think it's really where our core competency is. I mean, our core competency is that service layer that sits on top of what is a very fast network today and that's where our focus is.
Batya Levi
Got it. On the -- maybe just one more on the sales funnel for enterprise. Is there any change? Is there a little bit more delays in decision making?
Chris Stansbury
I'd say it's the same. So, it has slowed. What we are seeing in our funnel is the funnel starting to grow as seller productivity rises. So, for example, in large enterprise, we've added many, many new salespeople over the course of the last year. Some of those are replacing salespeople who have left and that's okay, because we're pivoting to more of a technology sale than a telecom sale, and it's a different skill set. But we're seeing seller productivity rise every month. We're measuring that very closely. And then, in mid-markets, that's a combination of both direct and indirect. Our indirect partner network has grown significantly, and again, we're measuring great progress there. So, I think we'll continue to see improvements as we move into next year.
Batya Levi
And maybe moving to the mid-markets, you mentioned that you added more logos, but when you just simply look at the revenue trends, it still continue to decline mid-single digit.
Chris Stansbury
We will -- I mean, I do not want to confuse anyone. We will continue to see revenue declines until '25, because we're trying to turn around an ocean liner that has been really in fairly mid- to high-single-digit decline for the last number of years. Our rate of decline when you adjust for divestitures is probably in the 4% to 5% range, which I think is better than the broader competitive set. But that will improve, that rate of decline will improve as we get into the back half of the year, which should show the market line of sight to our point of inflection in '25.
Batya Levi
But specifically for the mid-markets group, do you see more competition from cable or maybe...
Chris Stansbury
No. If anything, if I were to break it apart between large enterprise, mid-markets, public sector, public sector is much longer lead times between sale and revenue, big, big deals. We've won a number of large deals recently and that will visibly hit revenue in the second half of next year.
I'd say the next in line in terms of being close to that point of inflection is actually mid-markets. The team has done a phenomenal job. There is a huge share-taking opportunity there because we neglected it. We were very focused on a direct selling motion. It doesn't work in that space. And so, we built a lot more muscle through the partner ecosystem and that's starting to show results.
And then, I'd say just because the magnitude of what we had to do in terms of new sellers and churn in sellers, large enterprise probably lags that. But that's kind of a sequence, I think, you'll see in terms of as things start to pivot, and that's why I want to give you the visibility.
Batya Levi
Right. Okay. So, the last 10 minutes, and now we're shifting to Quantum Fiber. You expect the pace to continue. It seems like it's a dilemma. There is stranded costs kind of building the fiber, but once you build it, you can see some nice penetration and growth of that segment as well. So, how do you think about the opportunity?
Chris Stansbury
It's a good business. It's just a different business. And I think the way enterprise, telecommunications and the service layer is valued is very different than the way fiber-to-the-home is valued. And the payback cycles are different, and the margins are different. So, our view is that the fiber-to-the-home business is important. Our view is that the fiber-to-the-home segment needs further consolidation. And we're very clear in saying we're not going to be the consolidator.
If -- our best next investment dollar is in the enterprise space, and quite frankly, I think the build pace we're adding consumer again is consistent with what others in the space are doing. And said another way, if additional capital rained down from the sky right now, I don't think I'd put it into fiber-in-the-home. I think we'd use that to pay down debt because of where debt is trading today.
So, those are the trade-offs. And I think that consolidation point, when does that happen? Who knows. Obviously, it's a tough environment from a capital standpoint and cost of capital. So, we'll have to see how that plays out. But we'll continue to look at it market by market. And you could see us -- I think there's ways for us to do a better job of monetizing that asset. We might sell a market. We might look for a partner in a market. We might look to wholesale some of that. So, there's a lot of different levers we can pull to drive additional value today, but longer term and strategically, our belief is these two things don't belong together.
Batya Levi
Right. And is that view different for your fiber versus non-fiber?
Chris Stansbury
No, I think it's -- I would call it more kind of consumer versus enterprise. I would draw the lines there.
Batya Levi
And SME goes with -- SMB goes with the consumer business?
Chris Stansbury
We'd have to -- there's a line in there. At some level, yes, but the reality is there's obviously access to more of that mid-market customer that is important, where there's last-mile connectivity, but those things are all negotiable, as you look at those kinds of transactions.
Batya Levi
Right. In the near term, until we sort of get a change in the business model, I think you had assumed that the mass market would start to stabilize from '25 beyond, but with a faster fiber build.
Chris Stansbury
Correct.
Batya Levi
And now that the build is slower, should we expect that stability is also pushed away?
Chris Stansbury
Yeah, that's going to get pushed out a little further on the revenue side. But again, our focus right now is on return. So, I think there's other things perhaps we can do between investment and EBITDA. And those are the things we're looking at right now.
Batya Levi
Are you seeing any change in the competitive environment with fixed wireless maybe coming in a little bit faster?
Chris Stansbury
Fixed wireless is certainly a competitor in more of the older copper markets. Fixed wireless, I don't think plays as well in the large major metros where we're focused on fiber builds, and quite frankly, where a lot of the fixed wireless providers are focused on fiber builds. So -- but it is more of an issue in those copper markets. Now for us, we're starting in a pretty poor position. We have 10% market penetration where we have copper. So it's, I think, less of an issue than maybe others are facing.
Batya Levi
How quickly should we expect you to think about strategic options for this segment?
Chris Stansbury
We're thinking about them right now, and we have been. I think the issue is it's not us saying, "Ah, we want to hang on. We want to wait." It's what's the right point for us to extract value, because that's critical. We're not fire-saling anything. And I think that will be determined by the broader market, cost of capital, and other external factors.
Batya Levi
Got it. And in the meantime, for example, BEAD opportunity is going to come in, which is -- which could fund some of these investments. Are you interested in tapping that?
Chris Stansbury
It's a possibility, but we're not counting on it in any of our projections. I think those programs are valuable. We're big believers in closing the digital divide, but the way those programs work is there's very often no return in it. And so, we're going to be cautious about where we participate and where we don't.
Batya Levi
Okay. On the cost-cutting side, I think you laid out $300 million opportunity. When do we get to that run rate? And then, how do you think about it?
Chris Stansbury
So, the $300 million will be a full-year impact for next year. Those actions have taken place, and it'll benefit us next year. The reason we did that was really two-fold. We know that with all the debt noise, there's been a lot of customer overhang. My team, Kate, me, we're spending a lot of time on the phone with customers who are making multi-year, multimillion dollar decisions and they want to know we're going to be around. And inevitably when we have the conversations, business moves forward.
We're concerned about the conversations that don't come our way, right, where people make a decision without talking to us. And so, we took the cost action to hedge against any EBITDA risk associated with that noise, very hard to quantify. So, I don't think we view that as a way to bump up EBITDA next year. I think we look at it as an insurance policy against some of our initial thoughts, and obviously we haven't given guidance yet. So that's really how we think about it.
The second reason we did it is frankly there were activities going on inside the business that we were trying to stop. They were more legacy focused. There was really no value in continuing them, and they were continuing. And so, the only way to stop them was to eliminate them. And it was a way for us to also drive additional focus on where we're going and where we've been.
Batya Levi
All right. One sort of still remaining question is that you laid out some financial targets back in June, and there's been some developments. But you also pulled forward the tax, NOL, $900 million. But that doesn't necessarily show up in the numbers. So, what is the near term -- where are we going to see the near-term pressure in terms of the financial model?
Chris Stansbury
So, the pull-forward on the NOLs gives us a benefit. We'll get it -- we'll take a bit of it this year. It's going to pay our estimated taxes in Q4, $200 million, and the remaining $700 million will come in early next year. So, I think the way you'll see it play out in the model is from a free cash flow standpoint, we won't see a lot of pressure next year, even with the cost of the debt transaction. The adjustment that we made by not increasing the build on consumer is really kind of an average impact over the next four years. But I think '24 free cash flows is actually going to be probably a little better because of that.
Batya Levi
Right. Okay. And maybe on the CapEx side, the reduction is mostly coming from the fiber side.
Chris Stansbury
All of it is, yeah.
Batya Levi
All of it. And enterprise, how should we think about the trends for enterprise capital intensity? Is that sort of -- is there a lag in terms of trying to drive that revenue growth?
Chris Stansbury
No, I'd say that today, while we're definitely investing in, we talked at the beginning of this year about the need to invest in things like ServiceNow and the SAP to clean up the IT environment that we have. And that's certainly part of the base this year and next, and we'll be done with those. Today, we're still in an environment where a big, big piece of the enterprise CapEx is success-based. We do a deal with USPS, there's CapEx that goes with that. As we go forward, I think we'll be in that environment for the next couple of years, but as the digital transformation and disruption takes place, I think we'll see less capital intensity as a percentage of revenue as we move to more of a software-defined kind of model. So, yet to be quantified, but I think directionally, that's where we move as time goes on.
Batya Levi
Is that like three-plus years out?
Chris Stansbury
I think by the time we get to scale, that's probably about right. Again, we've got to give you better visibility into what we think that scaling ramp looks like around digital innovation, that's part of what we're working on trying to quantify so we can give it to you for next year.
Batya Levi
Okay. Maybe just kind of like putting it all together, as we -- you'll give us proper guidance sort of beginning of the year, but as we think about the moving parts in EBITDA decline kind of trending towards '24, what -- should we expect to see similar trends continue until you start to see the benefits of the cost cutting?
Chris Stansbury
I think you'll continue to see an improvement in the rate of decline, particularly once we get to the second half, you should see a pathway to us getting to the point of inflection on revenue growth. And then, as we get into '25 and '26, in addition to the revenue benefits, you'll see some additional productivity coming out of the system as we've cleaned up some of those IT environments, we've improved the customer experience with process improvement and then backed up by ServiceNow. So, you'll see both. You'll see the benefit to EBITDA from the revenue and you should also see it from continued productivity improvements.
Batya Levi
And in terms of the leverage, I guess, should we expect you'd like to keep it sort of...
Chris Stansbury
Yeah, I don't think leverage gets higher than where it is right now. I mean, maybe a tick. It's not going to be much. And then leverage should come down. But again, our focus on managing the leverage is not taking the easy way out, right? The focus on leverage is about driving EBITDA higher. It's not about driving debt lower. And we think that is the bigger near-term opportunity and that's why we're focused on it. That's why Kate bought stock, that's why I bought stock. We see it out there and we're excited about it.
Batya Levi
Okay. Great. I think that's all we have time for. Thank you so much.
Chris Stansbury
Thanks, Batya.
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Lumen Technologies, Inc. (LUMN) UBS Global TMT Conference (Transcript)