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

All right. Good afternoon, everybody, and let me add my welcome to our TMT conference. So nice to have everybody back in person here. Before we get started, please note Morgan Stanley -- we can find disclosures on www.morganstanley.com/researchdisclosures or contact your salesperson. My great pleasure to welcome back Ted Carlson, President and CEO of TDS. Ted, thank you for joining us today. We appreciate it.

Thank you, Simon. It's great to be here. My first conference post-COVID.

I think for a lot of us as well, it's just nice to make reacquaintance with people and catch up on a couple of years.

So let's kick off. You had your earnings recently, and you put out a 2022 guidance. You've been very busy the last few quarters in the spectrum auctions, 5G, fiber. So we've got a lot to talk about in the next few minutes. But perhaps you could sort of talk through the priorities for 2022 for both the wireless and wireline businesses. And what are the key elements behind the guidance?

Okay. So I think to the guidance, when you look at the guidance for U.S. Cellular, what you see is an assumption that the current heavy promotional activity in the industry will continue through this year. We were [Technical Difficulty] by our growth in postpaid customers last year, and we want to stabilize our market share in the postpaid business. And with heavy promotional environment for existing customers by AT&T and now responded to by Verizon and T-Mobile, U.S. Cellular is going to have to do something more than what we did in 2021 to stabilize our share. And LT talked about that something more being kind of a mass promotion beginning in the second quarter, but then following that, a very focused promotion based on our understanding of our individual customers to help them upgrade their handsets to 5G. We only have about 30% of our customers that today have 5G handsets in their hands. So that's one of the priorities, but that's just one of them for next year. In terms of some of the areas where we have some positive momentum going on, at U.S. Cellular, the business and government area, we brought someone in who had run all of Sprint's business and government about just almost 1.5 years ago now. And she's done a really great job in terms of putting the infrastructure in that part of our business where we dramatically underindex what our share should be. Our share should be about double of what it is. So there's a lot of room to grow. And there, what we've done is to put the systems in that will make it easy and likable for people to want to put meaningfully sized accounts with U.S. Cellular. We frankly hadn't done our work prior to LT joining us of getting the systems in place that people with large business accounts want to have. But that's -- it's going well, and I think you're going to see some growth coming from that in 2022 and later years because there's a lot of room to grow there. In the area of prepaid, we've done quite a bit of work there in 2021. And I think that we gained prepaid customers in 2021, and we anticipate our goal is to gain prepaid customers again in 2022. Again, we dramatically underindex what our share should be in prepaid. There's a lot of room to grow there. And in that case, what we've done is to do a lot of work with what we call customer life cycle management, where in the past, we never touched the customer once they went on as a prepaid customer. But now we touch them regularly. We've innovated in the sense that we now give them a certain grace period, a number of days after the formal expiration of their 30-day cycle, to re-up with us. And that's helped a lot, but there are things like that, that have made us -- are making our prepaid business better. So that's a growth area for 2022. In the area of towers, I mean, one of the really bright spots from 2021 was the -- what you saw in the fourth quarter, 9% increase quarter-over-quarter from the prior year in our tower revenues. And as LT said on the call, most of that, probably 80% plus of the incremental revenues flows through in the way of cash flow. So we're looking at the tower business as a business today, it -- we've considered it to be strategic. But what we're beginning to realize is that the tower business is an actual business and that we can grow the tower business by attracting other tenants onto our towers. Now I think we're at 1.48 tenants per tower, and that includes ourselves. The big tower companies are about 2.0x. So they're ahead of us. But they're not so far ahead of us that it's impossible to think that we could catch up someday, particularly when you think that we're one of the tenants, right? And we're not going to churn off of our own tower business, right? So that gives us an advantage in terms of growing our tower business, the annual growth rate. So that business is growing nicely, and we're really putting the shillelagh to that, so to speak. We've reduced the cycle times. We've told people that we're open for business. We have a nice modestly sized deal that we mentioned. I think that -- we signed with DISH. We'd love to do more with them, do more with the big 3 carriers. We're open to doing as much as we can to grow that because it's a very attractive business. From, as you know, return on capital, the tower companies far exceed the wireless industry's return on capital.

And you've got plenty of room for additional tenants on those towers?

Oh, yes. Right. We do.

Yes, yes. Good. And then on the TDS Telecom side...

Well, on the TDS Telecom side, the guidance that we showed, showed that there was some decline in EBITDA coming in 2022, but all of that decline, as Vicki Villacrez indicated, is due to starting up new fiber markets that are out of our traditional LEC territory. And we think this is one of the best business opportunities that I've seen in my career, and I've had a long career in this business, the fibering up of America. America is only about 30% fibered, and that other 70% is many tens of millions of homes that need to be fibered. And while the larger companies are going to be getting to some of those homes, and they've said they are going to, they're really focused on the very large metro areas. So our focus is on midsized markets, areas that have maybe 20,000 homes to 100,000 homes or service addresses potential, and there are lots of those around the United States. Now 10 years ago, if I'm here and I'm talking with you, we know I'm not going to probably be saying there's still lots of those. So this is the time to take those markets and develop them before the big companies get around to them. I mean the first fiber usually wins. There's not much incentive to build a second fiber in a market. So this is the time for us to capture that opportunity. We look at that as a 10% to 14% return, after-tax return opportunity on our investments. And our most recent funding where we did this preferred stock offering that you all helped us with was at 6%. So there's a significant spread that we think we can make for our investors by pursuing this fiber opportunity as fast as we can go.

And you can be quite surgical with where you go?

We can be very surgical, but we have a limit because we're -- I mean every company in America has a limit when it comes to fibering up America. But we have a limit. I mean our balance sheet is not perfectly extensible. But we're -- we have set a goal, and we mentioned this on the call of growing our total service addresses passed from 1.4 million today to 2.1 million over the next 5 years. And that's -- it's a big expansion. It's a 50%. And that's an opportunity that just hasn't been here for us in the past. I mean we -- in the past, we have bought cable companies, but that's an acquisition. These are greenfields and...

And in some ways, the last 2 years has really crystallized the demand side of that project...

In terms of the market receptivity?

COVID just driving up broadband demand...

Oh, yes, right. It's been clear now that people are going to need to not just do entertainment from home. They're going to need to work from home, and they're going to want to work from home. I mean in our own company, we've -- well, in our corporate part of our company, we've set a minimum of 2 days a week back in the office, but then the other 3 days, depending on the department, on the boss can be 3 days working from home. And you need great broadband, and fiber is better than anything else. It's more dependable. I mean to give you an idea, I was looking at our stats, and our rate of call-outs on our fiber network is 0.7% per month. On our cable network now, which we've spent a lot of money to improve, it's 1% a month. In our traditional telecom network, which we've also spent a lot of money to improve, it's 1.5% a month. So fiber just is a better experience for people.

That's a great overview. Maybe we come back to the wireless business. You talked about the focus on holding share in wireless, and there's a big debate about how fast the industry is going to grow. But we have seen good ARPU and ARPA growth across the industry, including at U.S. Cellular. So what's your perspective of your ability -- obviously, inflation is running well above where industry growth is. So your ability to continue to push people onto higher plans and have some continued growth in the service revenue through ARPU growth.

Well, we've seen people be receptive to upgrading their devices and going onto a higher price plan. I think people's income levels are in the -- let's say, the 3% range. I mean their income levels are not growing 7%, so that's going to squeeze people. But I think that there's still plenty of room to grow in terms of upgrading people from the -- if you want to call it, the non-all-you-can-eat plan to an all-you-can-eat plan and then to a higher quality, in other words, higher data rate, unlimited plan. There's still a lot of room in our company to do that. So I think we guided to low single digits in terms of that growth rate. And I think that the industry could do that. I mean I think we can't grow faster than the industry in the postpaid handset world because I mean that's the most competitive part of the industry. I think that we'll do well to hold our own in that part of the industry. But if the industry decides that it's going to continue upgrading people to better quality, I mean we'll be able to do the same. We've acquired a lot of spectrum in the last 1.5 years, starting with -- or the last 2 years, starting with millimeter wave and C-band and DoD band. So I mean we'll be able to keep pace with upgrading the quality of the experience, but the pricing really is in the hands of the larger companies, not in our hands. We have to live within that model.

Sure. It seems like they're also focused on growing the top line as well. So...

I think so. I think so. Although T-Mobile is still -- quite frankly, I mean, it's still a price leader for new acquisitions. And AT&T, over the past year, has been a price leader in terms of leading the industry down in terms of the level of promotional. So if those 2 companies continue to do what they've done, then the industry may continue to be a low single-digit growth industry. I mean it all depends on the behavior of the largest 3 players.

You talked about the spectrum purchases. You've talked about your 5G buildout plans. You talked about the handset, the device upgrades. What's the -- what does 5G mean for U.S. Cellular in terms of the business opportunity?

Well, I think the 2 big opportunities are the core business opportunities, and the first of those is providing an enhanced mobile broadband experience. Reducing the latency when people are calling up a new website; increasing the speeds, I mean that's part of the new website experience. When they move from one website to another, how fast does it load? And is it a happy experience or is it not? So I think that it's customer satisfaction. I think our growth rates in terms of data usage on the network without a whole lot of 5G usage yet are still running 30%. So I think that 5G offers the prospect with an even better experience of continuing those 30%, 40% growth rates, which means that the wireless industry becomes more and more fundamental to everything we do every day. I mean we have a supercomputer in our pocket. Everyone of us does that has a smartphone, and it's just going to get better and better. The videos are going to get better and better. The smartphones now, I think, are dominating the gaming experience for people as opposed to stand-alone gaming consoles. And that will keep getting better and better, the smartphone experience there. So that's the kind of enhanced mobile broadband piece of it. On the flip side, without 5G spectrum and without building out the 5G spectrum, you can't really keep pace on a cost-effective basis using 4G with the number of bits that you need to carry. You've got to reduce the cost per bit in 5G. And in particular, millimeter wave; and in particular, massive MIMO deployed on mid-band are critical to bringing down the cost per bit so that every player that wants to be a player in the industry can keep up with the growth rate of data and be able to make it happen on a cost-effective basis. So those are the 2 big things. I mean I think there's an opportunity on the Internet of Things. I mean as you -- as I mentioned, we're building up our B2B business, and the Internet of Things is going to go better because of 5G capabilities than the 4G capabilities. And there are all these things about connected cars and cars communicating with each other and avoiding accidents. But that's a little bit down the road. I mean I think the core businesses are the 2 big things that I talked about.

And then the fixed wireless as well.

Well, the fixed wireless is potentially a large business opportunity, I think, perhaps more so for us than, let's say, the more urban carriers. Our company tilts toward the more rural, small town, midsized town areas where there are not both cable companies and fibered-up LECs operating in those towns in many of the places that we serve. Maybe there's only a cable company or maybe there's a very poor-quality cable company, and there's only a DSL, copper DSL, or maybe there's not even a cable company because it's beyond the reach of the cable company in rural America. And I think that our ability using the mid-band spectrum, both the DoD spectrum and the C-band spectrum, is to basically replicate our current cell site configuration. The signals will travel about as far as they do currently and provide higher speeds for people in those rural areas. And if we can get a millimeter wave signal to them through our towers, and we've been able to send a signal 7 kilometers at 1 gigabit per second, line of sight admittedly, but 7 kilometers, if we can get a millimeter wave signal to them and a mid-band signal to them, we can offer them, let's say, kind of a guaranteed 300 megabit per second experience, which is far better than what they would get with their current DSL. So that's the best circumstance where there's no cable and there's no fiber. But even where there's cable and where there's no fiber, having an alternative to the cable company is something that people dearly want. And I think we could probably get a 25%, 30% market share using our over-the-air technology if we're just going up against the cable company. Now if there's both cable and fiber, then I think the share, in my guess, is -- based on my experience, but which may not be -- is not perfect vision, is maybe 10%, 15%, at most 20% share for the fixed wireless access. But I think again, to my point, we -- because we tilt more rural, there are more of our customers who are beyond the reach of the cable company, more of our customers who have only a cable company, no fibering. I think we have a real opportunity here to build a fixed wireless access business using the spectrum that we've obtained. And as LT pointed out, the Investment in Infrastructure and Jobs Act, IIJA, looks to bring about $8 billion of those $42.5 billion -- look like they will be directed toward the areas that are under our footprint. Now we're going to have to compete with fiber for those dollars, and we're certainly not going to get all the dollars. But even if we got, what, 12% of those dollars, it's $1 billion, right? So it's an opportunity. But we got to compete for it. We've got to convince the states that it's not just about bringing fiber where maybe cable is today. It's also about bringing a high-speed Internet experience beyond where cable is today.

Yes. That's somewhere in 2023, I presume, of your sense of time...

I think that probably the -- realistically, the first you're going to see real dollars flow from that would be 2023 because the maps are not done yet, as I understand it, and there's a challenge period for the maps. And challenges can be nasty or -- I shouldn't use that word. I should use, they could cause delays, right? So you're probably looking at next year. And the states still have to develop their procedures, right, because they're going to -- supposedly, you're going to have a lot of flexibility for each state to have its own procedures, even though there's a general set of procedures coming out from NTIA.

Yes. Continuing on that sort of fiber dynamic, perhaps for people who aren't following it as closely, just talk a little bit about the sort of success you're having in some of these edge-out markets, what you've been seeing that gives you the confidence that you can take the penetration up to the 40%, 50% levels over time.

Yes. Well, we're seeing -- and I think that maybe Vicki Villacrez, who was our CFO at Telecom, and now she's gotten promoted to be our TDS-level CFO and will be taking over that spot in May -- the end of May, I think she talked about that in a 3-year period, we see the penetration -- and Jane, correct me if I'm wrong. I think the penetration is looking at about 35%, which is about a 40% market share on average in 3 -- over the course of 3 years once a market is launched. And then it can go over the longer term up to about a 45% penetration, which would be a superior market share to cable in those markets. Now that's on average. It's not going to be the case in every single market, but that's on average. And that's supported by the markets that we've already launched. So fiber just is a better solution than cable. And I think that that's been shown not just in the U.S. but in Canada. I mean it just does -- it gives a better experience. And it's symmetrical, right? I mean it's -- and a lot of people need more symmetry when they're working from home.

And any updates on the supply chain or input cost inflation? Any...

Well, the supply chain has been a challenge for us in terms of our fiber electronics and -- well, and the fiber. So we are -- instead of ordering, I think, 3 to 6 months ahead, I think we're now ordering like 1.5 years ahead. So it's made a big change. And we've had to take some deliveries on equipment 6 months earlier or maybe even a year earlier than we would have taken those deliveries traditionally. But the fiber program is such an important part of our growth objective and such a wonderful opportunity from the standpoint of rate of return that we just can't afford to stock out. So we suffer a little bit, but our cost of short-term financing is low. So if we have to pay another 1% or 2% because we're a year early in getting our inventories, that's okay.

And anything on sort of the availability of construction labor or the cost of construction?

What we've seen is that contractors are willing to take less risk because they have a lot more opportunity. And so we've had to adjust the way we work with them to a modest degree to help them out more than what we had to a couple of years ago because they got more bargaining power.

So more upfront payments [ on things ]...

Yes, right. They got more jobs they can go to. But I mean why not? I mean there are partners, right? And we don't want a contractor just to come in and work with us on one job and then go off and never see him again or her again. We want a contractor that's going to do one job and do others and bid for more and so that we don't have 100 contractors that we have to manage.

Sure. And then they get more demand from the infrastructure bill next year and so forth. So...

Oh, yes. Well, that's looming, right? So this is the time to get them into the fold, so to speak, before they get distracted by that, right?

You talked about the benefits of fiber, and it's -- I'm sure it's going to be a big thing this week. But how do you -- how does that inform your cable upgrade, plant upgrade path?

Well, what we're doing in cable is we are -- every new subdivision is being built with fiber. And we haven't made a final decision yet, but the leaning right now, Simon, is that we would adopt the fiber technology that we have in the fiber out-of-territory markets rather than go with DOCSIS 4.0. That's a leaning. It's not a final decision at this point.

Okay. And is there any time frame for that?

For the decision? Jane, I haven't heard a time frame yet. So...

Okay. If we sort of pull back to the kind of corporate level, TDS has an attractive dividend yield. You've got a track record of long-term dividend growth. But the valuation is at a discount to some of the peers. You've got some assets like the LA Partnership, which you may not be getting full credit for. You've got 2 listed securities. So how do you think about the stock price and value realization for the company over the medium to long term?

Well, I think that in the near term, I think that we have been perceived as a company that isn't generating free cash flow. And much of the market tends to value companies based on free cash flow. So I think that as long as the market continues to value companies based on free cash flow, and we're not generating free cash flow, in fact, we're spending more than what we take in, it's going to be a challenge, right, for a good segment of the market to want to invest seriously in us. On the other hand, we're investing in terms of the ratio to cash flow. That ratio is the most aggressive over on our telecom side of the world. And it's there where I mentioned we had this wonderful rate of return compared to our cost of funding. And when you look at the longer-term picture and you look at the amount of money that's pouring into private equity and into infrastructure funds to do the same kind of thing that we're doing, which is building fiber out-of-territory, over-builder, right, we are an over-builder. You've got to believe that those folks who are investing in private equity and in the infrastructure funds understand that that's an opportunity. Now that maybe is a different kind of investor than the public stock market, right? Because when you invest in private equity, you normally are tying up your money for 8 years, okay, or for 6 to 8 years, maybe 10 years now. So it's a different investor group. But I think the strategy that we're on in telecom is the same strategy that is being deployed by the private equity folks. And those are -- there are a lot of smart people in private equity. So I'm not worried about the strategy. But in terms of how the public stock market perceives it, unless we can get enough people who think like private equity investing in us, right, it could be a challenge for us.

So taking the long view.

Yes.

Great. Well, Ted, unfortunately, we're out of time. Thank you so much for joining us here today.

Thank you, Simon. This is great. Great to see you in 3 dimensions and everyone else.

Absolutely. I hope we are going to be back here in a year and keep doing it so that...

Yes, I'd love it. Thank you.

Thank you.