Lumen Technologies, Inc. (LUMN) Earnings Call Transcript & Summary

Disclosures are available at the registration desk. And for those of you joining us via the webcast, I'm Mike Rollins covering the communication services and infrastructure categories here at Citi Research. And I'd like to welcome back to the conference, Jeff Storey, CEO of CenturyLink. Jeff, thank you so much for joining us today.

Thank you, Mike. I appreciate the chance to be here.

So it's become tradition as we start our discussion today and being that we're in a new year, so early in it, if you give us your strategic and your operating priorities for the coming year.

We continue to transform the products and services we're selling, the way we operate our business. And so we're really focused on -- from a strategic perspective, really focused on making sure that we deliver to the market the products and services and capabilities that customers need, recognizing that telecommunications is always changing, and for example, compute resources are moving more to the edge. So we continue to invest in making sure that we have edge technology available. We look at our network and today have something north of 90% of American businesses within 5 milliseconds of our network. How do we continue to expand that footprint? How do we make that even shorter time periods? Because we think that's going to matter more and more in the future than it does today. We also strategically want to continue to invest in our network back in the mid-summer. We talked about overbuilding our long-haul network with ultra-low latency fiber that gives us capabilities and the ability to operate networks at more efficiency and greater capacities. And we continue to invest in making sure that we're expanding the footprint. So the core strategic asset that we have is our fiber network. And the IP layers that sit on top of that and all of other transport services like MPLS or SD-WAN or any of those capabilities that sit on top of it. And so from a strategic perspective, we are really focused on how do we provide the products and services that our customers need in a very digital way and efficient way. And how do we make it easy for our employees to do their jobs and leverage the fiber footprint that we have.

Great. Yes, and then just thinking about you describing some of the capabilities and the reach of your network, can you touch on, as a communication service provider, what products or geographies do you see the company having a unique advantage?

It's wherever our fiber is. That's where our competitive advantage is. And if you look throughout the U.S., we have certainly very rich long-haul networks with many conduits available so that we can expand -- continue to expand the network for years to come without having to build new trenches and dig new trenches. If you look on the -- in the U.S., we have very dense metro fiber networks and continue to expand that. If you look the first quarter, I think we added about 4,500 new buildings, second quarter about 5,000, third quarter about 5,000. So we're adding 4,500 to 5,000 new buildings every quarter. That gives us a competitive advantage to continue to take fiber directly to the customer. We have rich networks in LATAM. We have rich networks in EMEA. We partner more in Asia than we do build and operate our own networks. But we have great partners in -- throughout Asia Pacific and have really good business relationships with other carriers there.

As you try to put it into context the significance of adding 4,500 to 5,000 buildings a quarter, what's the total addressable buildings right now or roughly that we should be thinking about in terms of what's in the base?

We have about 150,000 buildings on-net today. I don't know what the ultimate target is. It's north of 200,000. So I don't have a specific number for that, but there's plenty of opportunity. And we look at buildings from a couple of different perspectives. We rarely build it and hope they will come. That's just not a great strategy, especially when you have already 150,000 buildings in place. And when you sell as much as we do, we know where we pay off-net expenses. And that's one of the first filters that we look at, where are we paying other carriers to deliver our services to customers. And we target those buildings because we can convert that, save the expense, provide a better experience when we're 100% on-net with the customer. That's a better experience for the customer, gives us better control of the network itself in how do we guarantee redundancy and survivability for the customer. And then we also have the benefit of looking at all of the incoming requests for new services. And so we target -- we have plenty of opportunity to continue to expand the building footprint. Have to do a really good job of once we add the building, converting the off-net expense to on-net and continuing to sell to all the new customers in the building, which gives us -- if you look at legacy CenturyLink footprint, we've got a great small and medium business within the legacy footprint. Level 3 never focused on those customers. And so we have a lot of buildings outside of the legacy CenturyLink footprint, where we've got great small and medium business customers that we haven't really ever penetrated. So how do we go to those buildings? How do we offer products and services to all of the customers? Not just the GAM customers, not just the large enterprise, but all of the customers located in that building.

And so that gets us to the next question, which is something I think investors are just trying to get their arms around, which is how you size the addressable market for your business and wholesale segments if you kind of combine it sort of the ex-consumer piece. How do you define that? How do you think about where your market share is? As you mentioned, low in some areas. And sort of how to think that plays out over a multiyear period of time?

Yes. So it gets very complicated very quickly. If you look at our dark fiber business, just to kind of start at the lowest level of the stack, I think that I can't define what the overall addressable market is because customers continue to want more and more dark fiber. I try not to worry about what our share is. I try and win every bit of business we ought to win and make sure that we do it at a profitable point. I don't ever give the guidance that we're going to win all the business. That's a really good way to make sure you're the absolute lowest cost provider. I don't -- I want to create value for the assets that we have. So we look at the dark fiber business and believe that we're the best in it. There's nobody out there that we think is better at providing dark fiber, more successful at doing it. We've heard some of our competitors talk about they're not winning any big deals, and I know exactly why they're not. Because we win our share of the dark fiber business. There's lots of competition. There are a lot of competitors with assets, but I think that we're really good at delivering those capabilities and customers choose us as a result. If you look at MPLS, that's a totally different business, further up the stack. We don't view MPLS as a stand-alone business anymore. We view it in the context of MPLS/SD-WAN. We think those 2 things go together. For about the last 1.5 years, I've been saying in conferences like this -- you probably asked me last year, is SD-WAN going to eat into your MPLS business? And for the last 1.5 years, I've said they're complementary to each other. And I absolutely think that the market is bearing that out and what we've seen with our customers. There are places where we used to sell MPLS services, where MPLS was not the best solution. But there was not an SD-WAN. And so -- are there some places where we've converted from MPLS to SD-WAN? Of course. But there are some places that we wouldn't sell anything because MPLS was not the best solution. And now we have the opportunity to sell SD-WAN to those locations. And so we view them in the context of each other and that recognize that -- and in the context of waves and private lines and other services that there are different interconnection technologies, different networking technologies that make sense for different applications in different locations. And so MPLS and SD-WAN, we look at together. We think that they're great businesses. I always think our market share should be higher, but -- and I think that we should be selling faster and more of them, but we're very pleased with it. Things like security, we're relatively low in the overall addressable market. Now we've been very specific about what we will do and what we won't do. We're not trying to go in and sell a whole bunch of hardware to companies to help them secure with hardware. We do it from time to time, but that's not the primary focus. Protecting our customers with DDoS, protecting them with threat intelligence and giving them insights in WAF and all these other capabilities are where we're really focused on providing those. But I think we have -- there's a lot of upside from our addressable market. And frankly, I look at every part of our business, whether it starts with dark fiber or security application that sits on top of things and think we have a lot of opportunity to grow and a lot of opportunity to go out and be more successful than we are. There's -- it's a competitive market. Every single one of our products you can buy from multiple competitors. And our value comes in that we just do things better.

So taking that to the next step. So you've got this pace of building growth that you're doing more on a success basis as opposed to speculative. You're refocusing your sales teams on where you're underpenetrated or have low share or have presence but maybe not -- didn't have as much focus on different organizations that have come together to be what CenturyLink is today. You're very competitive in some markets like dark fiber, adding new products. So what's the other side of the equation that's been holding back the totality of revenue performance in -- we could think about it in innings or what percent we're kind of through, but where are we in this continuum of dealing this other side of the headwinds when investors look at the totality of the revenue performance for the company?

Yes. And I start -- when I look at our revenue, I break it down much more granularly than just the overall single revenue number.

And I'm excluding consumer from this part of the conversation, of course.

Yes. So if you split consumer out and we look at each of our business segments, I'd give you kind of the -- my view of the Wholesale. And you can go back to the Level 3 days, look at any time that we spoke before, and you asked me about Wholesale. I would have said it will be flat to slightly down. Let's still say that. Our Wholesale business will be flat to down. That's just the white nature of the Wholesale and it continues -- industry consolidation continues to follow that trend. It's very predictable. And it's very manageable. And so it's not a surprise to us. We're really good at managing the Wholesale business and working on the profitability of it. At the same time that when we go out and renegotiate with a big wholesale customer, they're all big providers to us, and we don't do them unilaterally. We do them bilaterally. And so sometimes we take revenue hits that actually have pretty substantial EBITDA growth coming from them. And so the Wholesale business is going to be flat to slightly down. I don't -- I focus on how do we manage it profitably. And we're really good at it, and it's very predictable. If you look at the high end international and GAM, we had, in GAM, some headwinds from customers that we've talked about a lot in the past. Most of those are behind us. But by the nature of those customers, they're highly competitive. Their -- the price points are low, they tend to be our largest -- some of them are our largest customers. We've got to do a better job of continuing to penetrate the GAM customers because there are a number of customers in that group that don't buy anything from us. And they're big global customers, we've got to go make sure that we sell them and we earn our way into their business. And they probably all buy something, but not anything substantial. And so we've got to continue to grow that. We think there's good opportunity. Our international business is strong, have headwinds from FX and other things from time to time. You have tailwinds sometimes from FX. Right now, we're in a headwind period. But the underlying growth of the business excluding FX is pretty good. So we're focused on making sure that for our international and GAM customers, we're meeting their needs and growing their business. If you look at the next segment, which is Enterprise, which also includes our federal government, we do a great job with the federal government. We're very pleased with that business. We've got a great team focused on them. We have great capabilities. And we work really hard to continue to grow that business and are pleased with it. Also within that is our Enterprise group. That's a big name, but it's kind of our mid-Enterprise customers up until you bump into the GAM customers. So it's a little bit imprecise in the naming of it. But we believe that is the core of what we have to grow. And if you look at the third quarter, the third quarter revenue was stronger than the second quarter. We've said for both GAM and Enterprise that the second half of the year will be better than the first half of the year. We don't really give revenue guidance, but we give color from time to time, and that's what we said on the third quarter. I think we started saying it on the second quarter call, but then also said it again on the third quarter call. And so we are very focused on getting that to grow. On the small and medium business, that one has some headwinds that the others don't have. I mean they all have headwinds of legacy private line or customers moving to IP services. But on the small and medium business, the headwinds are a little more around voice. And some of the small business customers moving off voice and going to entirely cellular. So there's some of those types of things, making sure that we have good products that help us win there. And they start to -- at the really small end, they start to look more like the consumer-type customers. So it's about having fiber close to them. It's about having broadband capabilities, maybe layering in some security capabilities on top of that to bring a set of services that help them. There's some philosophy that you only sell pipes and you don't sell any other services. And my answer is you only sell what the customer wants to buy. And in some cases, that's pipes. And in other cases, it's DDoS protection wrapped on top of that or firewall protection wrapped on top of that. And we focus on how do we go after the small and medium business customers and sell them the products and services that they need to be successful in their business. The opportunity for us, again, and I mentioned this, is that we've done really well in the legacy CenturyLink footprint. And we've never really focused on it as much outside of the legacy CenturyLink footprint. And we have tens of thousands of buildings with those customers in them, and we need to do a better job going out and putting our products and services in front of them. But I do believe that there's great opportunity for that. Our success inside our footprint indicates that we'll be successful outside our footprint, especially knowing that it will all be fiber-based.

No. It sounds like it's more complicated than just advertising on the website to go do that. So would this be a place of incremental investment that may be needed and have some kind of payoff period in the future?

Well, it's part of our investment in adding new buildings. It's part of that, building up the infrastructure in a building. You do a little more upfront if you're going after those small and medium business customers so that you can have rapid turn up. And so there's a little bit of investment in there. It's not outside of what we've been doing, but there's a little bit -- and from a people perspective, there's an investment in making sure that you have a digital environment where customers can buy services from you without having to interact. But if they want to interact with a human, we want to have those capabilities too. So that's not about augmentation. That's about repurposing. We have a lot of outbound call centers and inbound call centers and how do we make them focused on that customer set outside of our footprint? How do we do a better job of focusing them? How do we do a better job of making it easier for them to do their job, the call center reps, so they can be more effective in selling the products and services? And so there is some investment associated with it. It's not outside the bounds of what we've been doing. There is repurposing and more effectiveness that we have to drive, but it's not really out of the bounds of what we've been focusing on either.

If I think about the historical paradigm for this industry, what I recall going back in time is 2 principles: urban subsidizes rural, business subsidizes consumer, i.e., for the same type of service, the business customer historically pay more than a consumer. Level 3 is a new entrant or an insurgent. Other businesses that you own as insurgents didn't necessarily have that pricing paradigm to deal with. But CenturyLink kind of grew up, of course, as an ILEC. Is that an issue in the CenturyLink business, where it's still working through these historical paradigms of -- on the business side where prices might have been higher because of the way the industry established itself and it's still kind of working through this -- maybe a flattening of what value is across what we call a gigabit or a minute of voice or IP voice?

Yes. Well, we don't look at how do we subsidize one business from another. Each business has to stand on its own. And if you're going to win in the market, you can't embed subsidies on this product set because you're not going to win. It's a competitive market. You're not going to win if you embed subsidies. So we tried very diligently to make sure that each market, each customer segment, each product stands on its own and doesn't require subsidy from any other part. I think that -- I can't tell you what happened in the '80s, but in the 2000s, this is the notion that consumer was subsidized by business, probably just not right. I don't think it was really that big of a subsidy. Rural tends to be subsidized because there are rural inefficiencies associated with operating rural networks, but I don't think that they were built in subsidies from business to consumer. The market would bear a certain rate, and so that's what was charged. I think that today, each product, each service, each segment has to stand on its own.

And speaking of that, one of the things that you've been doing is actively churning unprofitable products and businesses. Where are you in that process and continuum? Yes.

Yes. So I'm going to -- I'll break it down a little bit too. If you look at the -- some of the unprofitable contracts that either company had, we're largely through that. There might be one that pops up here and there, but we're largely through that. If you look at the unprofitable circuits that may occur, made sense when we installed it this way, but then we've got rate increases from some wholesale provider underneath it. Now maybe that circuits underwater. That's not as big a number as the other category. But we're probably halfway through that. I don't really know the exact number. It's not a huge drain on the business. But it's still something that we're pretty focused on. If you look at unprofitable products like Prism, and I'll use the Prism one as a specific example, I think that beginning of '18, we had something like 200,000 Prism customers and I think we're around 70 -- 50,000 to 75,000 now of those customers. It's gone from hundreds of millions of dollars of revenue to $30 million, $40 million worth of revenue. It's going to be a long slow decline from here. So that's -- it's not behind us, certainly not from a year-over-year comparison perspective. It's not behind us, but it's becoming a smaller part of the business. Then there are other things that we still sell that are -- we don't sell them, but we still support that are unprofitable and you just have to drag customers kicking and screaming away from them, things like ATM services. That was a great technology in 1995, and I wish every ATM customer would just go away. And I don't mean automated teller machines. I wish ATM customers would just go away, but we still support some of those types of things. That's just the nature of the business we're in. And it's part of what we have always had to operate in.

We do have mics around the room, so if there are questions, just raise your hand and we'll get to you. Consumer business. Where are you in the process of this strategic review? And are there any new insights that you've learned along this process that I think began, what, back last spring?

Yes. Late spring probably is when it began. We're -- I said back then it'd be a long, complex process, and we wouldn't give any updates until we're done. I'm still going to stick with that. But I'll tell you what we're looking at. And it's how do -- first and foremost, how do we operate the business more effectively and more efficiently and better than anybody else and are there ways, things that we should be doing about the consumer business that make us more effective. And so for example, I mean, the strategic review started with the decision to not sell Prism TV. The strategic review started with the decision not to continue to augment with bonding and vectoring of copper plant, but move more towards fiber investment. So there are things that we have been learning and implementing as we go through it. And then ultimately, is there somebody that could operate the business better than we can? And can we get better value for our shareholders by spending it, by selling it, by partnering, by doing something different than it is? We're along that process. We're still working on it. We've looked at every different scenario along that continuum. We haven't made a decision on which ones they are. I know which one we control the most and that is operate it better. And so we are implementing those things as we identify them. And I also know that it's a great business for us. It really is. And if you look at comps in the market, there are other companies that have recently sold -- that sold which is arguably our worst business, the consumer business is arguably our worst business, at higher multiples than all of CenturyLink trades at. And we've got great fiber business. We've got great data services business, Internet backbone, MPLS, edge computing. All of those should be at higher multiples. And so I do think that there's some confusion in the market about what it is and that people should be looking at some of these other external valuations and apply it a little bit to CenturyLink. But again, we believe in the business. We think we can continue to execute on it. And if it makes sense for us to just continue to implement the things that we're finding, then that's what we'll do. We haven't come to an answer yet, but we're getting pretty -- getting closer.

Are you referring to the Cincinnati Bell announcement?

I don't want to name any particular ones, but there have been a couple of transactions recently that have 5, 6 EBITDA multiples, that type of thing.

And when you look at the investment opportunities for fiber, I think often, people ask about the return on capital, what that might look like. How much for CenturyLink? Is it a return on capital decision versus a terminal value decision?

Both go into it, but I think it's more a return on capital. There's some terminal value that's associated with it. But that's around the edges. If you got 2 projects, then it's about return on capital if you're trying to evaluate them. Sometimes we will do builds with other parties because there's some terminal value associated with the asset -- future value, not terminal value but future value. We might not need it today, but we believe that it's going to be worthwhile later. That around the edges might not be based as much on return on capital. But most of our decisions are based on return on capital.

And you spoke earlier about how the very low end of small business or small end of small business is similar to consumer, and proximity of fiber is important in those purchasing decisions. Have you came to some conclusions about, in the long term, however you want to define it, what percent of the consumer footprint needs to get upgraded to fiber at some point in the future?

Yes. We look at that through our microtargeting efforts. And I won't go into the parameters that we use, but we look at where do we think that it makes the most sense for us to build fiber. We prioritize around that as fiber pushes deeper and deeper and naturally makes other areas more profitable because you have less build to get fiber. And so we look at all of our lines of business, whether it's consumer, helping 5G carriers, our enterprise business. We look at pushing fiber deeper and deeper. And the more we do that, the more it makes different parts of the consumer business more advantageous. And so we'll continue to do that. In the microtargeting, we have a lot of opportunities still ahead of us to execute on that.

Can you describe the current capital allocation strategy for CenturyLink and whether or not you're satisfied with where it currently sits?

So we made a decision as a Board and as a company, early in 2019 to change our capital allocation strategy. And we had kind of 3 guiding principles that we were looking at. Number one, how do we invest in our EBITDA growth, revenue growth but also EBITDA growth. And we looked at our needs and said, we want to invest more capital there. So we took an apportionment and said we're going to invest that in the growth of CenturyLink. Number two, we looked at our debt load. And we said we want to get to -- over the course of 3 years or so, we want to get to 2.75 to 3.25. At the beginning of 2019, there's a lot of concern about interest rates. We had a lot of debt. We thought it was more prudent to reduce debt. And so we made a decision to get to that 2.75 to 3.25 over the course of 3 years. If you look over the course of 2019, we made tremendous progress, reduced our interest expense pretty substantially, but also reduced our overall indebtedness, and we'll continue to follow that plan. And in round numbers, that's a couple of billion dollars a year. And then we also wanted to continue to return capital to our shareholders. So we're still paying something north of $1 billion in dividend payments to shareholders, and we think that's the appropriate capital allocation policy. We're 1 year into our 3-year plan associated with it. At the end of the 3 years, when we get our net debt to adjusted EBITDA ratio down to where we want it, we'll obviously look at it again and see where we are. But we're projecting that would be in like a 30% payout ratio, something like that, and we think that's entirely manageable and not a concern. And so we're 1 year into the 3-year plan, and we're pleased with the progress we made on it.

So you created the plan kind of weaving or leaning into the consumer review, which sounds like you've learned a lot. We'll wait for the answers. But could the answers of that consumer review, because you didn't know that in advance, ultimately affect maybe what that 3-year plan looks like and then could then, in turn, affect the way capital allocation looks like sooner than what was established in a 3-year plan?

Certainly. I mean we would -- if you look at debt, if we were to do something with the consumer business, then that's going to affect what the debt is on the -- both on the consumer business or the [ RemainCo ]. So certainly, there's some recursive nature and iterative nature between those things. But it's still too early to predict what that looks like and as soon as you do something and then what happens to this, and playing what-if games are sometimes fun but not very productive in public.

And one other thing that you mentioned, those things that you ruled out over the course of the consumer process, for example, you mentioned some of the things that you did in product, in Prism and different things, have you ruled out consumer as kind of a separable segment versus ILEC or have come to any conclusions on that front?

No. We haven't come to the conclusions, but it's a worthy observation that sometimes might not be consumer, it might be ILEC, it might be this, it might be that. And that's part of the review.

Do you have a question?

Curious to get your thoughts on M&A, whether it's small tuck-ins or potentially bigger acquisitions, and if so, if there's any particular areas that will be interesting for CenturyLink.

If there's any what?

Any particular areas or types of companies that will be interesting for M&A?

Yes. So we've -- both previous companies and CenturyLink today were acquisitive companies, and it's part of our strategy to be acquisitive companies. We bought mid last year a company called Streamroot, which helps our CDN business, gives us capabilities for delivering content over meshed networks more efficiently, more effectively for customers. And so there are certainly capabilities that we will go after. They tend to be around our products and services that we're trying to launch, managed services, edge computing, dynamic connections, cloud solutions. Those are all products and services that we're really focused on growing. And so those tend to be the areas where you might look toward M&A. Don't have anything in particular in mind, but we are a growth company, and we want to be a growth company focused on those products and services. And so if there are capabilities out there that we can acquire and bring to market faster than doing them ourselves, then we'd certainly look at that. But we are -- continue to be an acquisitive company. Streamroot, we bought with cash. So they're not great, big acquisitions likely, but we'll see -- look at it from that lens.

You also mentioned the focus on investing in EBITDA growth. And one of the things that you've been doing consistently is efficiency gains, cost cutting. Where are you in the process of cost cutting momentum? And do you see new opportunities to sort of refresh or enlarge the quantum of opportunity that sits in front of you?

Yes. So I've said this so many times. People probably get tired of hearing it. But it's absolutely -- my philosophy is not about cost cutting. My philosophy is about providing a great customer experience. And I know where we're not because that's where we're spending our cost to augment the customer experience that we're not providing. And so I look at cost as a way to provide a better experience. And I don't see any insight of how to provide a better experience for the customer. And so we've been really good. We gave synergy targets for the merger synergies. We met them much faster than we predicted we would. We gave targets at the beginning of the year that we saw another $800 million to $1 billion of transformation synergies. It's not linear, and you're obviously going to do the easy things first. So I wouldn't look at the path that we've been on, and the first couple of quarters of success don't necessarily predict the next couple of quarters. But I -- but those things are driven by milestones and driven by efforts to improve the customer experience. And I still see lots of opportunities to do that. We haven't gauged them. When we looked at the $800 million to $1 billion, we targeted specific figures. We know the names of them. We know the scope of them, and we know how to address them. And that's when we go public with what those things are. But even after we finish the things that we've got, I still see opportunities for us to do a better job in our customer experience and to drive more efficiency. Customers know when they're not being efficient. And they're usually the one that has to pay the price for it and a bad experience. And so we'll -- I still see lots of opportunities. We are focused on making sure we capture the ones that we prioritized upfront, but then we'll continue to focus beyond that.

Jeff, thank you for your time today.

Thank you and thank you all for the interest in CenturyLink.

Thanks.