Array Digital Infrastructure, Inc. (AD) Earnings Call Transcript & Summary

I'm Phil Cusick, and I cover the comms services and equipments -- comms services and infrastructure space here at JPMorgan. I'm joined today with Ted Carlson, who's President and CEO of TDS Telecom as well as Chairman and Founder of U.S. Cellular. We're joined by Doug Chambers, CFO of U.S. Cellular, and Vicki Villacrez, CFO of TDS. Everyone, thanks very much for joining us.

Ted, given these unprecedented times, can you talk about what U.S. Cellular and TDS are doing to address this for customers and some of the longer term structural changes you expect to happen across your business?

Well, I think that -- Phil, it's good to see you, and thank you for inviting us to the JPMorgan conference. We're working to make sure our customers are well taken care of, and that starts with a great network. We have planned our networks for about a 6-month service margin at both U.S. Cellular and TDS Telecom. And so we were able to absorb the increase in traffic that we saw in both businesses. And Doug could comment on that. I think the U.S. Cellular traffic was up about 15%, and at Telecom, it was up about 25% just from the crisis. So the networks are performing well, and we're continuing to invest in those. And you probably have noticed our CapEx for this year, very large by U.S. Cellular and TDS Telecom standards, but that's a sign that we really want to give our customers the best that it's possible to give them, whether that's 5G, or increased speeds and capacity in U.S. Cellular's case or access to VoLTE, or over at Telecom, building out as much fiber as we can, both with inside of our existing LEC networks and also into new territories outside of those existing LEC networks that are areas of opportunity. So it starts with the network, but customer service is also important. And so 2 months ago, the U.S. Cellular folks who worked in the call centers, 80% of them went home and they've been working from home, very effectively taking care of our customers, giving that great experience that U.S. Cellular has always been noted for. At TDS Telecom, we signed up for an application where our service techs can now instruct the customer who doesn't want the tech to come inside the house to do virtually a self-install of the equipment, let's say it's in the basement or wherever it is in the rec room, and guide them through that on a video application on a smartphone. So it's things like that, that we're doing for the customers. And of course, we've signed up for the Keep America Connected Pledge. We signed up for the first pledge, both companies did, and both of them signed up for the extension. And in addition to that, each company added some additional features, which I think we ought to have Doug and Vicki talk about, to give our customers some extra protection, those who need it.

Doug, do you want to follow up there?

Sure. So with respect to additional things we voluntarily did in addition to the pledge, we waived overage fees through July 31. So that started in mid-March and we're doing that for a period of time. Also, like Ted mentioned, our network traffic since the onset of the pandemic, we've experienced about a 15% increase in data traffic. And that's been more spread out throughout the day as opposed to concentrated in the peak periods, also in more suburban parts of the network, less focused on city centers, if you will. And so given that our network has handled it quite well, we haven't had to make any adjustments to capacity investments or other investments on our network as a result of the pandemic.

Okay. Vicki?

Yes. And likewise, in addition to extending our pledge to the FCC through June 30, we've also offered a broadband for the first 30 days into the pandemic. We offered a broadband product promotion that gave broadband 60 days free to low-income families, families with children and college-aged students. And we saw an initial surge of real uptake of that product during that first 30 days. Also, our immediate response was to prepare for the shift to more Internet use from the home. And as Ted alluded, we saw significant increase in our network traffic. Just to give you a statistic, the average usage per customer across our wireline and cable networks increased 24%. And that was from the time before the pandemic started.

Okay. Those customers who are coming in on the free service, are they taking other things and actually paying for them? Or these are mostly free customers who are going to go away when that free ends?

So we had about 20 -- almost 2,700 new customers taking the free promotion, and about 30% of those customers also signed up for voice -- hardwired voice services. And so these are customers in areas that really valued the voice service. And their work from home, their school at home demanded that they have these services in place. And we are putting in action items to work with these customers, as the 60 days -- as they roll off the 60 days, to stay with us as paying customers going forward.

Okay. At the same time, we've been -- you've been dealing with this pandemic, we've seen Sprint and T-Mobile finally come together. Ted, you've been asked repeatedly if you see Sprint or T-Mobile entering your markets, and it's never seemed to have much of an impact. With the new T-Mobile having an abundance of spectrum, what have you done to prepare for them to come into your territories?

Well, that takes us to really our whole philosophy of how we run the company. And again, it starts with the network. So we're building out 5G, just the way they are, using 600 megahertz, except that I think that they're building it out with 4G and 5G on the same spectrum, whereas we have clean spectrum that we're able to dedicate to 5G. We've also been active in the millimeter wave auctions. We've assembled a nice batch of spectrum there that should allow us to provide very high speeds in certain areas with high traffic. We don't have mid-band spectrum, they do. So that's a gap in our spectrum position. But there are auctions coming up both this year and next year that may allow us to fill in that, but I can't really talk more specifically about that given the closeness of those auctions.

Of course. Yes, sticking with...

We really -- let me just -- one more comment on that one. We really haven't seen that much of either one of them in terms of increases in market share in our territories. T-Mobile, at least anecdotally, from what I've heard, has made most of their gains by focusing on a few large cities where they have really increased their share. And that's been pretty consistent, I believe, for them since their founding as a company in the United States. So I don't anticipate that, that focus will change over the next 3 to 5 years.

I think that's fair. You've done a good job of maintaining low churn in the base, but churn in your peers has fallen farther. And I've been surprised that yours hasn't come down faster given the high-quality network that you have. Do you think that's a mix issue as you compete mostly in consumer? Or do you have quite a bit of business as well?

Well, we don't have a lot of large enterprise, which would probably have the lowest churn. And we're under-indexed in the small business, which again has lower churn. And of course, you have to remember that we're -- well, you do know that we're a regional carrier. So there is a certain amount of movement from people from one part of the country to another, and that churn is unavoidable in our case. But our churn has improved with the pandemic. I think people are nervous about doing anything with something that works well and not going to something that might not work well. And I think that while I don't want to get out on a limb here, I think you'll see that churn go down even further in the second quarter.

Okay. Ken discussed cable MVNOs is focused on low end customers that don't provide particularly attractive economics for U.S. Cellular. Does that seem like that's where they're going to stay? Is at the low end over time? Or do you think that they move up? And is it right? Do you sort of ignore that low end portion of the customer base? Or does it make sense to have some kind of save offer to hold on to those people over time?

Well, the arrangement they have was -- in the case of Charter and Comcast with Verizon and Altice with Sprint and now T-Mobile, we don't know the details of that. They've never been made public. But it's rumored that they make their most money on -- when the customer is a low user. And so -- otherwise, why wouldn't they go for the high users now, right? But who knows what that arrangement could be renegotiated to be sometime in the future. However, does Verizon really want to have its highest usage customers go off brand, away from its own brand? I'm not so sure.

Okay. Okay.

And to your point, we can't neglect the low end of the market. We do have save offers for some of those folks. And if it gets to be a bigger portion of the industry, which it may well be, right? Because there is a growth trend there, we're going to be doing more about that.

Okay. I mean it's fair to say that your postpaid ARPU has grown nicely over the last few years. How sustainable are the underlying drivers of that revenue growth?

Well, let me ask Doug to take that one because he's into more of the details on what are the drivers of the ARPU growth.

Doug?

Yes. Some of the key drivers that are causing the increases now are, we're experiencing a higher proportion of handsets in our portfolio relative to connected devices. That's 1 key driver. We're increasing our device protection revenue over time. And then last year, regulatory fee revenue to recover regulatory cost has increased. So those 3 things are really, particularly in Q1 of 2020, what drove the increase in ARPU. And those things have some staying power. We're going to obviously continue to drive device protection penetration as far as we can. And I think that you'll see that those things continuing for a period of time. Recognize we do have some headwinds with the pandemic. Specifically, we talked about -- earlier about waiving overage fees as well as late fees and restore from suspend fees related to the pledge. That will have an impact. In addition, and we've talked about this, we're experiencing a higher proportion of connected devices being added relative to handsets post pandemic, our hot spots and routers and the like. Those too -- that's a good thing. We're happy to add connected devices. But just recognize it's slightly down with ARPU. These will typically carry a slightly lower ARPU than a handset. So some good things happening with -- there's been an increase in ARPU over the past several quarters and more, but some COVID-19 headwinds as well.

Okay. Okay. Ted, you referenced 5G and spectrum a few minutes ago. You put a lot of money already into millimeter wave, and it sounds like you're excited to put more into mid-band over time. What's the most exciting part about 5G in terms of incremental revenue for you and your territories?

Well, we haven't done the fundamental research on that ourselves. But we have seen research from credible sources, people like Ericsson and Nokia, where they surveyed customers around the world and in North America to see people's willingness to pay more for a higher speed, lower latency experience. And people in North America, if I remember the stats right, are willing to pay about 15% more. Now 15%, that's a big deal in this industry. I mean you know that. I know that. It all depends on industry leadership, the people who set the prices, who set the standards for what those packages will look like. I mean we're a price taker. U.S. Cellular is. So it depends on the industry leaders as to whether that willingness to pay can be captured.

So it's mostly a consumer data device and people paying a premium for that for faster speeds?

Well, that's the first element, the enhanced, what we call eMBB, enhanced mobile broadband. It got faster speeds, lower latency. I mean it opens up things that people have some challenge doing today. Things like AR, VR, gaming on your cell phone with a great gaming experience that compares to your home computer. It's things like that on the consumer side. But there is another element to it, which is the business side. And we're under-indexed there. And we think that there's room there in the IoT area. We've been doing fairly well with that in the last several years. And we think there's some room there. But in terms of the broad size of the increase of what's there, I would say it's a consumer play on the eMBB, and then there's a fixed wireless play. And as you know, Verizon is very much on that page. And I have great respect for Verizon and their strategic planning. They've been very much ahead of the industry in terms of planning. And so I think that, that will have some legs. Now question is, where will it have legs, right? If there's a cable company already providing high-quality fixed broadband service, and then there's a LEC that provides poor quality DSL, a new entrant coming in there will do 2 things. It will provide something better than that DSL and it will provide an alternative to the cable company. And as you know, the cable companies don't have the best reputation for customer satisfaction. They have relatively low Net Promoter Scores. So simply by being a new entrant that treats its customers well, there should be a meaningful share that can be gained by a fixed wireless operator.

So let's dig into that. And it brings into the discussion some of the things Vicki's side has been doing. As you think about fixed wireless broadband for consumers, what's the economics of using wireless versus building fiber, like TDS has pretty successfully? How do you think about the trade-offs there?

Well, I think the trade-off -- I think you have to have a certain density in either case. I think the density that you can get to with a fixed wireless offering is a lower density than you can get to, let's say, with a new fiber build to make your business case.

Okay. And then...

You can extend your systems out further if you choose to. I mean if you were strictly a wired operator, you could choose to extend those systems using fixed wireless access in the lower density areas. Now in our case, each company is run on its own. So we don't keep them from competing with each other. So that's okay if they compete. So U.S. Cellular would pick areas that are dense and then some that are less dense. TDS Telecom probably wouldn't at this point choose to go into fixed wireless access because it has plenty of opportunities to build fiber outside of its existing footprint that are high density.

Okay. And so the millimeter wave spectrum that you bought at U.S. Cellular, is that primarily for fixed wireless access? Is that the idea?

No, no. Well, we'll see. Okay? It's optionality on the fixed wireless access. Again, I have great respect for Verizon. I think they've made a big play in it. I think there will be something there. But it's not the primary play. The primary play is to satisfy our customers for enhanced mobile broadband, higher speeds and lower latency, and to reduce the cost of producing a bit.

Okay. Okay. Vicki, maybe you can dig in now into the -- what you've seen lately in terms of the fiber build out? Can you just remind people what you've done so far and how you think about the next layer of that?

Thank you, Phil. If you saw our first quarter results and our start to the year, we were really pleased. We had a strong start. We reported a 4% top line growth with a 2% organic growth. And that is driven by our cable acquisition that we closed at the end of last year and it's also that growth is a direct result from our fiber investments that we've been making. Our fiber strategy is two-pronged. It's really a focus on overbuilding within our current ILEC footprint as well as expanding into new markets and new territories. And when you think of our fiber program, you're really -- we're really doing 2 things. One, we're increasing the number of service addresses that are served with fiber to the premise. And two, at the same time, we're expanding our total footprint. And so at the end of the first quarter, 32% of our wireline service addresses are now served by fiber, and this is up from 27% a year ago. So our investments, you can see the progress our investments are making. And this is the underpinning of our revenue growth that we're showing in the wireline footprint. The wireline footprint itself also grew 5% year-over-year. So we're expanding our -- at the number of service addresses that we serve. Over the year, if everything goes as planned and the pandemic doesn't slow down our construction too significantly, we're hoping to move this metric up to near 40% by the end of the year.

Okay. And how do you think about return on capital on those builds? What do you need in terms of penetration to get a good return?

Right. So that varies by every market that we're looking at. As you know, we've announced a number of new markets that we are expanding our fiber services into. Clusters of markets within the state of Wisconsin and also in the Pacific Northwest, really attractive cluster of markets that have a really nice growth rate. They have weaker competition, as Ted had said, where you have a LEC that has not been investing into their network over a significant period of time and is unable really to provide the services, the broadband services that customers demand today. So market selection is really key. Picking the right market is really key to the success of our strategy. And so what we do is we build a DCF, a very detailed DCF model, top-down all the way through to make sure that we can execute a plan that's going to deliver above our weighted average cost of capital. And if they don't -- if the economics don't work out, we either adjust our build plans neighborhood by neighborhood or we go and we select another market. And so we exercised this discipline. Just like we did with acquisitions, we exercised the same discipline over both copper overbuilds as well as greenfield builds.

Can you give us an idea of what that penetration might look like? Understanding that every market is different and it's different expense, what would need might be?

Sure. Yes, sure. So a lot of our models that started out early on where we were targeting roughly a 30% take rate, a 30% penetration for broadband, and we're finding on that we're on the upside of that number. So -- and that number was around an average that we've been seeing in our copper markets where we had done some overbuilding. What we're excited about is that our first trial market, which was in Sun Prairie, Wisconsin, within the first year of build, we were up to a 50% penetration. And so that really has encouraged us to expand the strategy. And so we're looking -- that's just I think -- I think that's evidence of the pent-up demand that you see in these markets that we're selecting. And I would say that video is also an important piece of that. So with the 50% broadband penetration, we are also achieving roughly a 25% video penetration. This is what we saw in our trial market.

And in a world where many video providers are getting out of that business or deemphasizing it at least, you're building new markets and building into it. Do you think that video is an important part of getting that broadband customer?

Yes. Video is very important to us. It's an important part of our bundle strategy and it's important to our customers. The target market that we're focusing on value these services and this is what's been driving our growth. We reported a high single-digit growth for video connections in our wireline in the first quarter of about 9%, as we're both expanding the rollout of IPTV across our ILEC markets and also that is an offering in our new out-of-territory markets. And on average, we're seeing about 40% of our broadband customers in our fiber markets take an IPTV product. So video is important to those customers and they value that. And I think with the pandemic, on the backside of this, I think services in the home are only going to be underscored. They've become -- they're essential services and they'll be even more valued coming out of the backside of this pandemic.

Sorry. I cut you off.

Well, I was just going to also say that we've also just rolled out our new TDS TV+ product in 2 cable markets. This is a far superior feature-rich product and we're very excited about this rollout, and we think that our customers will respond well to this.

Okay. Doug, Vicki went through some of the math on -- a very high level math on the DCF that TDS does before building a new fiber market. Can you help us think about what the math is around buying new spectrum, whether it's millimeter wave or mid-band? And how you expect to get a return on that at U.S. Cellular level?

It's not as -- so as you know, the spectrum auctions, you have a onetime opportunity to acquire that spectrum, right? In the way we look at our business, we need the layer cake of spectrum in order to be competitive from a 5G standpoint. We need the low band, we largely have that. We need the millimeter wave and the high band, and we've acquired over the last year most of what we need there. And then we need the mid-band, which, as Ted indicated earlier, that's the part we currently lack. And so -- the 5G use cases, they're not all defined as far as where the monetization lies in consumer mobility, fixed wireless access, private networks, IoT, et cetera. We believe they're there. And we also know that if we fail to acquire that spectrum and fail to roll out 5G to our current base of customers, we will cease to have a competitive business. So we know we are going to keep up. We need to acquire that spectrum in order to have the network experience that we aspire to and that our customers deserve. And so we're doing that, and we're quite bullish about the future of the wireless industry in 5G. But right now, it doesn't lend itself to a DCF or a quantitative analysis of monetization because there's not complete clarity on all the different monetization opportunities.

Okay. Okay. And Ted, to that spectrum point, and I know that you're limited on what you can say about different bands. But as we think about paying for that spectrum, the mid-band that's coming up this year, do you think about what's the best way to do it? Is it tapping the revolver and borrowing money in a low-rate environment? Do you look at a couple of the strategic assets that you have in terms of towers or the Verizon partnership?

Well, Phil, we have a very strong balance sheet, a lot of access to capital. And some of the areas that probably would be high on the priority list would be the EIP receivables financing. We've done only a portion of what's possible there. We've understood that there is vendor financing available that's backed by the governments of the countries that -- where the vendors are located that we haven't tapped, but the larger companies have. There's term loan from our banks, and those are on good terms, relatively modest interest rates. And then, of course, the revolvers are there as well. So I think that -- and then the credit markets we think will be open to us in some form between now and the time of those auctions if we participate in them. We've done a fair amount of retail debt over the years, long-dated debt, which has provided a very stable balance sheet for us. And those markets appear to be recovering. They're not open now, but they do appear to be recovering. So I wanted to put those out there because I think we should have Doug comment on our -- the way we look at the towers.

Doug?

Yes. That hasn't -- it has not changed. I mean we're consistently, just said, and we continue to maintain that our towers, our strategic asset for our business, particularly as we build out 5G into our network modernization. They do generate about $70 million per year in co-location revenues currently, and so a nice chunk of our profitability. And as I think Ted mentioned, they are down the hierarchy of financing alternatives to the extent that we need to source financing from areas other than the traditional methods that Ted enumerated. We would consider doing some sort of tower monetization as a financing vehicle to invest back in our business, not as a way to raise proceeds for a share buyback or a dividend, but as a alternative for traditional financing if necessary.

Okay. It's funny, Ted, I think I've been listening to people ask you about selling your towers for almost 20 years. And I think every time the subject has come up, they were more expensive than the last time we had talked about them. So is your view that this is just an asset that doesn't make sense to sell in general? Or is there a price in your mind where you just have to take the money and run?

Well, I would say this about it, that the tower business, I think, it's a very long-lived asset. And we like long-lived assets. It's a business where you have the advantage over your customers that go on the tower, because once they go on the tower, it's very hard for them to move. So we benefit from that when we lease space on the towers to others. That $70 million is -- Doug can comment on what its growth rate is, but I think it's mid- to high single digits growth rate, that $70 million. And that's a very nice thing to have in the portfolio. Whereas if you sold the towers, what you do is you put yourself in the position of that person who has to decide whether they're going to get off the tower in order to avoid the next rent increase. It's a tough position to put yourself into. And I don't think we should go there unless we have to. The other thing about selling the towers is you have to pay tax on selling the tower. So there is a wedge. I mean it's spread out over many years, but nevertheless, there is a wedge that uncle gets to take if you sell your towers. So that's not a good thing.

Last question. I want to ask because each company bought stock in the first quarter. What was it about those prices, and they were very low, that made the stock especially compelling to drive that buyback? And is there a point at which you, yourself, Ted, might be interested in buying stock in the companies?

Well, let me comment in sequence to your questions. First of all, the big one -- the bigger one was U.S. Cellular purchasing its stock back. We need to maintain a tax consolidation with U.S. Cellular. In order to do that, we have to own over 80% of it. If we allow employee incentive plans to continue rolling on, which they will, each year without buying any stock back, we would break through that 80% level and lose the tax consolidation. Once you lose it, you can't get it back for 5 years, if I remember the rules. So that's something a place we don't want to go. So we do have to buy stock back at U.S. Cellular to offset that. Now the question is, when do you buy it back? Well, you try to buy it back when it's relatively inexpensive compared to what it's been trading for in the past. And it was relatively inexpensive when we bought it back this year. So we went into the market and bought some back, knowing that that's something we have to do. Now in the case of TDS, that was opportunistic. The TDS stock price was so low that it didn't make any sense. And even though we have to conserve our funding at TDS for the out-of-territory fiber builds and for more cable acquisitions, there's a point where you reach where the price is so low, it makes sense to buy some back, some, not so much that you destroy your ability to grow telecom, but some. Now your third question about my buying stock. I get stock every year from the company in the form of an incentive plan. I've never sold any, at least for the last, I don't know, 10, 12 years, I haven't sold any stock. I give some stock to charities and I give some stock to family members, but I haven't sold any. So I keep accumulating it. So I don't need to buy more stock.

Got it. I think that's -- they're telling us to wrap it up. Thank you very much for your time, everyone, and have a great day. Thanks, everyone, for joining. Bye, Ted.

Thank you, Phil. Have a great day.

Thank you.

Thank you.