AT&T Inc. (T) Earnings Call Transcript & Summary

All right. Good afternoon, everybody. I'm delighted to have Pascal Desroches joining us from AT&T. Welcome to Barcelona.

Thank you for having me, Simon. Good afternoon, everyone.

So before we get started, please note Morgan Stanley -- research disclosures on morganstanley.com/researchdisclosures. I believe you have a safe harbor as well as, Pascal.

Yes. I think you should refer to our website, some of the statements we're about to say are forward-looking and, therefore, subject to uncertainty and go to our website for more details.

Great. So it's been a busy year for AT&T. For those of you who in the audience who are not as familiar perhaps with the story, perhaps just take us through what happened, where we are and the priorities as you go into '23.

Yes. Look, again, it's such a pleasure to be here. This is my first trip outside of the U.S. since the pandemic. So it's really nice to be here and tell you a little bit about the AT&T story, I mean, AT&T has had a change in management, probably that goes back now to around 2.5 years. The situation -- I was new as the CFO and the CEO, John Stankey, although he had been with the company for years. He was -- he's now the CEO getting to make all the decisions. So you have a company that had a number of different businesses that we're about to hit an investment cycle. You had very high debt levels. You had a much higher dividend, absolute level of dividend or nearly twice what the current dividend is. All those things created an untenable situation. And what we did is, we systematically would -- got the company focused much more on its core business connectivity. We separated DIRECTV. We separated Warner Media. We have delevered significantly since 2 years ago. And at the same time, we were doing that, we were investing significantly in both the media business and our connectivity businesses because understanding we had work to do on the balance sheet, but time was us in the essence to reignite growth at AT&T. And where we are -- we have 2 key areas of focus right now. We're a pure-play connectivity company. We're focused on fiber, which we believe is the fixed technology that will be required by any consumer who can have it. If you fast forward 5 to 10 years. And given the long lead time for the investment cycle, it's critical that we act now urgency to make sure that we are able to participate in the very favorable secular dynamics. Then we also invested significantly in Spectrum, and over the last 2 years, we've invested nearly $37 billion in Spectrum. And we -- in the last 2 years, we've also stepped up our competitiveness in terms of customer offers. All those things leave us at a point where our wireless business, which is roughly 70% of the company is growing revenues, ARPU and growing EBITDA. And we expect that to continue as we look forward. The secular dynamics on the mainline wireless remain very favorable. Fiber. We grew fiber revenues nearly 30% last quarter. And as we're rolling out fiber, we're able to penetrate. Customers want it. It's at -- it's a better technology than cable offers, and it's at a discount to the cable offering. So better technology at more attractive price points and ARPU there is also growing. So all in all, look, needless to say, I'm really proud of the work we've done in the last 2 years. As I look forward, there's more work to do in particular -- we need to do more in hitting the middle of the P&L and driving operating leverage across our businesses. And look, we're committed to doing so. And I think you see from the new management team, we are very focused and acting with purpose.

Great. Great overview. So one of the big overarching themes at the conference or backdrops has been the macro question. You had noted extended payment terms in Q2. It seems like that's stabilized in Q3, but just update us on what you're seeing from the consumer and on the enterprise side.

Yes. So look, overall, let's start with the consumer. Overall, the consumer in the U.S. remains pretty resilient and customer demand remains pretty healthy. And it's one that coming into this year, we expected growth in wireless to moderate some. And all in all, 9 months in, we're really happy with the pace of business, and it's really healthy. With that said, during the 2 years of the pandemic, what we saw is incredibly low delinquencies, low churn and the ability to collect really quickly as consumers were sitting with government stimulus checks as some of those farms have been used up, which we're seeing is a normalization of the collection cycle back to pre-pandemic levels. And that's part of what we saw, and that's part of what we announced earlier this year. We're also seeing an uptick in delinquencies back to actually -- it's slightly worse than pre-pandemic levels. All in my mind, signs of nothing alarming, but at the same time, something we have to keep a close eye on as we look out the next several years -- the next several quarters because it's only a matter of time when inflation persists at the rates it's been, it's only a matter of time before the consumer begins to really feel the effects of that. We saw the Fed report that in the U.S., we had the highest jump in credit card debt since 2007. So that tells me the consumers starting to feel a pitch and that these higher interest rate levels, credit card debt will be very expensive to maintain. So all those things caused me to be somewhat cautious. But look, candidly, when I think about where we are as an industry and as a company, the last thing the consumer is going to turn off is their wireless relationship. I mean, you needed to live, you needed to work. And it's one that I don't -- I think we are as resilient as any, say, economic challenges.

Great. And on the enterprise side?

On the enterprise side, look, my expectation is over time, enterprise will probably be more exposed than consumer. But with that said, right now, enterprise has been going through a secular decline.

On the wireline side?

On the wireline side, which is the majority of that business. And that has continued. I wouldn't say the decline has accelerated because of economic conditions. So it has continued at the same rate that we last reported. But when I think about companies are faced with real economic challenges, they may all of a sudden decide you know what this legacy phone line is probably not a priority for me or let me accelerate the decline. But so far, we haven't seen any of that.

Great. You touched on inflation there. So just can you talk through your exposure to energy prices to salary above normal? And how you're addressing that with your productivity initiatives?

Sure thing. Look, like all companies, we have been impacted by inflation. Since late last year, our CEO started to talk about inflation and the concerns that it will linger. And we've seen it in labor. We've seen it in energy. We've seen it in materials. We've seen it in shipping transportation costs. All those things did hit us. We had planned for a healthy level of inflation in our plans this year. But relative to those initial expectations over -- we have been exposed to the tune of over an increment of $1 billion above those that are planning assumptions. And what we had done to offset that is earlier this year, we did some targeted price increases to -- in some of our older plants where we haven't engaged with consumers recently. And as a result of those targeted price increases, the goal was to help upsell those consumers to our higher-priced brands. Let's engage with them. Let's upsell to our higher price plan. And it has worked out casually slightly better than we were anticipated, and it has been an accretive move for us. We're also continuing to really drive savings through our cost transformation program. The way to think about that is we are driving to drive efficiencies across our distribution channels. Over the last 2 years, we have shuttered many of our owned and operated retail outlets we are using digital technology more and more to help drive customer acquisition and customer self-service and upgrading your phone. And we are in the very early innings of that. I think the opportunities there are very attractive. When I think back to the start of the pandemic, we had to build new muscles that we haven't had historically. We've gotten much better at using our digital channels to service customers. We've gotten much better in using digital technology and customer self-service in dispatching fiber and minimizing the number of fiber truck rolls that we have to do. All those things, we've had to build the muscle because of the pandemic, they will benefit us for years to come.

Great. Yes, it's amazing how the wireless industry is still so dependent on the retail store experience.

Yes.

But I guess, over time, we'll gradually evolve. So let's dig deeper on wireless, if we could, Pascal. You hinted at it in your opening comments, but it's been a series of strong KPI results over the last few quarters here, better than expected and often leading or close to the lead in the industry. And that's quite a contrast from a couple of years ago where AT&T really hadn't been growing by subscribers. So what's driving this? And is it sustainable?

Yes. Here's the way I would break it down. First of all, at the industry level, we've seen elevated industry growth in a variety of factors, small business formation small business gets started. They're not going to get a wireline line. They'll get a wire -- they'll give their employees wireless. The chances are the employee already had a wireless connection. They're not going to change that number because everyone they know has it. So all of a sudden, you have people with 2 phones. You have families getting phones for kids at younger ages. You have seniors for years didn't think they needed phones, all of a sudden or during the pandemic you want to see your grand children, you're going to probably learn to use an iPhone. So all those things are helping increase the industry growth. And then what we've also done, we -- for years when we were spending on -- we had to spend on media, DIRECTV and others, we probably weren't putting the right level of resources after against our wireless business. And in 2019, '20, we stepped up our investments and to match those peers. And the way we did it was a little bit different than our competitors instead of simply providing offers to our new customers, we wanted to make sure we kept our existing customers because our churn was higher historically than others. And what that did is we offered the same exact promo to existing and new customers. It lowered our churn. In fact, it's a much more efficient way to acquire a subscriber is to keep them. So it's -- we did that. We also reorganized the way we went to market, giving more decentralized authority to different geographic regions. Additionally, this is really important. One of the benefits that AT&T has is it has great enterprise relationships. And we have done a much better job the last 2.5 years of leveraging those relationships to drive additional wireless customers. We built our FirstNet network, and that has also been a source of new customers. So we're doing a lot of things right. And we are now able to compete on a level playing field. And I will put my team up against anyone once they have the right resources.

Great. So there is a lot of concern about the competitive environment. We have the cable companies. We have DISH. I mean how do you see the competitive environment now and going forward? And how does that play into industry pricing or food trends, et cetera.

See, let me try and break this down by the different first hit, first cable, which is, cable right now has been gaining share. My belief is they've been gaining share because one of our competitors has made a conscious decision to say, okay, I'm going to probably take better economics at the sacrifice of smaller share. And so what has happened is where the share losses have happened in the telcos has been the biggest competitor and as a result, but it's getting 80% of the profits back through the MVNO agreement. So you look at that, that was a trade they consciously made right now, cable doesn't have a wireless network, as we all know. Are they going to go out and build a wireless network, pretty expensive. They also have a big upgrade in the last mile that needs to happen. Are they going to prioritize building a wireless network overdoing that upgrade. There's also a massive amount of infrastructure money trying to tap into the cable profit pool. When I start to think about all those elements, like is it possible that they come in, maybe, but is it likely? Probably not. And then you look at -- you mentioned this -- we have a really good MVNO agreement with them. It's attractive for us, and we think we have the capacity to deliver it without impacting our network. And whether they will build the network, we'll see. But it takes time, it takes enormous resources, and we'll see -- and these TiMo and Verizon, and it's -- the industry construct is healthy. Do I see the participants to integrating profits through a massive pricing war. I don't see it. It's -- when you look at the behavior, everybody's behaving quite rationally.

Great. So you talked at the outset about the focus on 5G. Can you update us on the deployment of 5G? And how do you monetize 5G?

We started this year with a deployment plan that started after our major competitors. And what we've done is we said we were going to cover a population of $70 million by the end of this year. We are now over 100 million POPs covered, and we expect to end the year at above 130. So we are deploying.

Through C-band and 3.45 in it?

This is on mid-band Spectrum. We are deploying faster than we thought, which really, I think the team has done an exceptional job of driving in the build process and the quality of the Spectrum is better than we thought in terms of its propagation. And so we're able to do it faster. And hopefully, over time, it will be more economic of that deployment. So all those things are positive, and we expect to -- we haven't provided updated guidance. The last guidance we provided was to get to 200 million POPs by the end of 2023.

Okay. But you're ahead of that plan.

We are ahead of where we thought we would be at this point.

And monetization?

Monetization. Look, there's a lot of talk about 5G right now. And I do believe over time, there will be fabulous use cases for 5G. When you think about the network slicing capabilities, things like autonomous driving where you need very low latency, you're going to -- there are going to be great use cases. They're not here now. That's probably why you haven't heard us talk about them as much as perhaps others have. They're not here now. They're probably not going to be meaningful to us as a company or even as an industry on -- so probably, I'd say, 2025, you'll start to see more evidence of it in 2024 as everyone has rolled out their 5G core. You have developers starting to develop on it and develop new products and services. But until then, it's really not going to be that meaningful to the overall businesses. So look, are we excited about it? Absolutely. But is it meaningful today? No.

And you've taken a very different approach on fixed wireless to your 2 major competitors? I mean you do use it in rural markets, but how does your view of that differ?

When you think about our business, the lead times are long and you are long and they're expensive. And you do it because you want to create a sustained -- you know you're going to create a sustainable business model that provides returns for years to come. And so we feel really good about our investment in 5G and fiber. Fixed wireless, when you look at customer acquisition cost, how much does it cost to acquire that customer? How much does it cost to maintain that customer and expand the capacity of your network to serve that customer. What consumers think it is sufficient in terms of quality. If you look at the price point at which it's offered, our conclusion is it's really not where we want to spend our time and effort. Instead, it could make sense in places where fiber is going to come in a few years. It could serve as a catch product to our legacy copper. It could make sense in certain rural areas. It could make sense in certain enterprise temporary construction so on things like that. But it's not one where we think it's -- we want to prioritize our scarce capital going after.

Great. Well, let's pivot to the consumer wireline and the fiber side. And if I can start with this convergence question. We used to talk about triple play for a long time, but now it looks like the survey work that we did with Ben and team recently showed that the wireless plus broadband bundle is now overtaking the video plus broadband bundles. So how do you think about the importance of that model?

Yes. I apologize if Ben's going to talk our own book. We are the only company that is a scale principle in both. We are the largest fiber provider. And when we think 5, 10 years from now, I just don't see consumers accepting anything other than fiber. We're building it as fast as we can. While at the same time, deleveraging. And also, I think the power that 5G will bring will make wireless relationships even more valuable, and we are able to provide both with our owner's economics. And when we offer both, we see an uplift in our wireless penetration, a meaningful uplift. I mean you -- one of the things that we realized is this when we bring fiber to a consumer, they love it, and it's much easier to sell them on, "Hey, we also have a great wireless service. So having that and the perception that fiber brings from a quality and consumer affinity is just extraordinary. So it's a play we really believe in. And I think we generally earn a lot more and the returns are much more attractive if you have both customers, right? It's one we can offer as principles.

So talk about the results of your deployment so far and the projections you want to get to 30 million homes by 2025. There's been a lot of talk about challenges some facing with permitting, supply chain, labor availability. How is your build going? And how is the penetration working out?

Our build is going really well. And so far, what we said publicly is by -- apologies, by 2025, we expect to get to 30 million-plus homes, roughly $25 million plus consumer $5 million business. We are at the end of the third quarter, $18.5 million consumer, $3 million business. And where we build fiber, we are penetrating very well. In fact, we're penetrating hardly twice the level that we have historically. And it's one -- the long pole in the tent is really getting fiber to a location. Why are we penetrating faster than historical levels. I think consumers now are getting much more sophisticated about the benefits of fiber for years, cable was good enough. There was -- it wasn't easy to differentiate given the products available. Now with everyone working part time, at least some of the time from home, the benefits of fiber are coming through and it's delivered at a more attractive price point. So we are really happy with the deployment and how it's going, and we're committed to continuing to deploy. And as I said earlier, our ARPUs are higher than we thought. I mean, our ARPUs grew 7% last quarter. And the intake ARPU is higher than the average ARPU that we posted. So it's one -- look, the gating factor is how quickly can we roll it out. And it's one -- what's important to us is making sure while we're rolling it out, we continue to maintain -- to delever our balance sheet to give us more operating flexibility long term. And it's just one that I think we're trying to serve both. I think when you look at AT&T, we are being the largest fiber provider, we have preferred access to supplies to resources to build. And even we know how to work through the permitting issues very well. So all in all, like I think we have a core competency that is going to serve us well for years to come.

And what's the latest on exploring partnerships or joint ventures to help accelerate or expand that footprint.

I -- for those who are not aware, there were rumors about us exploring a joint venture. And I'm not going to comment on that specifically. But where could potentially some sort of partnership makes sense, it would be, one, a financial partner that allows, where that brings capital, but we are able to bring our expertise and scale and our supply contracts, two, an area we probably wouldn't get to otherwise during the next few years.

And this maybe would be money or something like that.

Yes. And then three, can we bundle our wireless relationships? All those things, you'd have to conclude that all those things work and the returns are attractive. And if things lined up, of course, we would look at it.

Great. Great. You touched on business wireline. I mean I think you've said that you do expect some of these secular trends to abate over time. Can you update us on what your latest thinking is there?

Here is a business wireline. As I mentioned at the outset, the vast majority of our revenues are in legacy communication services, that's declining, and that will continue. We are -- as we are deploying fiber, we are targeting going after small and midsized market more aggressively. Candidly, we have probably not done as good of a job as we should do in tackling that market. And now with our fiber deployment with more resources, that's a market we think we can compete very effectively and take share over time. I also think 5G over time will be a real growth vector on the enterprise side, even more so than the consumer side, but that's a few years away. So in the meantime, what you will see is growth in fiber being offset by -- being more than offset by legacy declines in communication services, but we're also hitting the cost basis of that business very hard. We're rationalizing products. We're using more indirect distribution streams to drive more efficiency in customer acquisition. So we're doing all the right things, but it will be a few years of a transition of that business. But I feel really good about the future. You will get to a point where fiber revenue growth and 5G services will create a overall revenue and growth.

That which happened in consumer wireline?

Absolutely.

Yes.

And we are a few years away from that, though.

Yes. Good. DIRECTV, you've deconsolidated, but you still have a large equity ownership in it. So it's hard for us to see the performance. Maybe you can just share with how is it performing versus your expectations? And your confidence level in the cash flows that you are expecting from there?

Overall, look, yes I would say the business is performing much better than we thought. You think back to 2.5 years ago, almost immediately, the first question, AT&T would get on earnings calls, DIRECTV is declining more, what are you going to do about it? And we did something about it. We put it in the right capital structure. We partnered with TPG and the leadership team there led by Bill Morrow has done an outstanding job in optimizing that business. They've taken a lot of costs out. There's a lot of profits, the cash coming out of that business. And candidly, the cash is better than we anticipated at the time we did the transaction. The transaction has worked -- we did it for the right reason. It is working out really well for us. But the team has done even a better job than we expect them to do in managing that business. As you look forward, what do I think will happen? Of course, the cash flows are going to decline, but they're still going to be very meaningful. They're going to be very meaningful. And we're at a point in the distribution waterfall that the vast majority of the cash is going to come to us other than tax distributions to TPG, the cash comes to us because of the way that we constructed the waterfall -- the distribution waterfall. So all in all, it's an asset that I think we have optimized we've put in a very good place.

Great. And what's your interest in strategic options for that unit?

Look, no surprise. If there is a way to create value beyond what we think we're going to get, we would obviously look at it. But right now, we put the business in a place where we're only going to do something if it creates incremental value. There's no burning need to do anything.

Great. Let's turn to the balance sheet and capital allocation, if we can. You talked about deleveraging a couple of times, both what you've done with the various divestitures and prospectively as well. So there's a lot of talk about rising interest rates here. I think you're actually talking about your interest bill falling next year. So perhaps just take us through your balance sheet as it's now structured in terms of duration, fixed floating and the interest expense.

Sure. I will give our treasury team enormous credit for the work they've done the last several years and really helping us foresee what was likely going to be on the horizon. What we have done in addition to delevering, we do ever substantially, but we still have, call it, $131 billion of net debt on our books as of the end of the third quarter. That debt has an average maturity of 17 years. 95% of it is fixed -- and we -- the way the maturity towers have been constructed, we have the ability through free cash flows after dividends to pay that down. And so while clearly, like anyone else, we have some exposure to refinancing risk, it's not at all significant. I mean 95% of it fixed at 4% rate of interest, pretty darn good. And having that sort of cost of capital is a real strategic benefit for us at this point.

Great. And your target remains 2.5?

Yes, it is. Look, here in my mind, I think we never want to get the company back to the place it was a couple of years ago. And in order to do so, we think it's really important to be solid BBB such that we have preferred, we have the access we need to the market. And we're able to get reasonable cost of borrowing. That is a real benefit and a real source of competitive advantage. And we don't want to give that up. So we are committed to getting down to 2.5x. At the time when we do get to 2.5x, we'll consider do we do buybacks, do we raise the dividend, do we invest more in areas like fiber or do we continue to delever in an interest rate environment that is really high, it -- and where we may get differentiated terms between BBB and BBB+ maybe we continue to delever, but no decision to be made until we get to that 2.5x.

Okay. Great. The capital spending, you're obviously going through some pretty big projects right now. Can you just help us understand the near-term and medium-term outlook for CapEx, including, I guess, Q4?

Yes. Let's start with this year. We guided to $24 billion. Through the end of the third quarter, we were at about $19.5 billion. So we still -- we reiterated our guide of $24 billion in the third quarter. So what that should tell you is we're going to spend around $4.5 billion. That compares to $6.8 billion in the third quarter. So one of the questions on an open axis, are how are you comfortable you're going to be able to hit your $14 billion. If you take third quarter free cash flows of $3.8 billion, you add on to that an incremental $2-plus billion through lower CapEx, that's how why I feel comfortable we're going to be able to deliver. As we look out, what we've said is we expect next year to spend comparable to what we're spending this year. And both '22 and '23 are elevated because of our C-band deployment. And the amount that we're investing in our transformation efforts, upgrading the underlying technical infrastructure of the company. So once we get beyond '22 and '23, CapEx should moderate down to around the $20 billion range.

And that still help -- it still includes a lot of fiber build, right?

It still includes a lot of fiber build and it also allows us to continue to delever. If you think about where we are, I've said free cash flows are going to grow next year relative to this year. And as we see the declines in CapEx that should provide further operating leverage in free cash flow in the out years, allowing us to continue to delever.

Great. Well, just following up on that, the '23 in cash flow. I know you're going to give us more detail in January, but just go through the piece parts that makes you confident in that if the CapEx is flat. Obviously, interest helps a little bit. But what are the other moving parts that gives you confidence in growth?

Yes. So here is the way -- look, simply put, we're going to grow this business, and we're spending at the levels that we -- if we expect to grow the business. Why do we expect to grow? Our wireless subscriber base is much higher than we started the year and much higher than we expected to end 2022. That base is at higher ARPUs there are transformation savings coming in from the work that we've been doing, that will be a growth driver. We have things like 5G costs that we incurred this year we're not going to incur next year. So all those things give us comfort, we're going to grow EBITDA and relatively flat CapEx, lower interest, improved working capital being offset by higher taxes and lower DTV distributions. That's the way to think about our cash flows, and we'll give a lot more detail when we report our fourth quarter results in a few weeks.

Great. Well, Pascal, unfortunately, we're out of time. Thank you so much for your time today.

Thank you. Thank you for inviting me. Thank you.