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

All right. Welcome back to the afternoon of the second day of our 30th Communacopia. I'm Brett Feldman, Goldman's U.S. telecom, cable and media analyst. And it's my great pleasure to welcome back to the conference this year, Jeff Storey, the CEO of Lumen Technologies. Jeff, thanks so much for being with us.

Thank you, Brett. I look forward to this conference every year. I look forward to next year being in person.

That's the plan. Well, listen, usually, we jump into Q&A, but I think you actually had a few things you wanted to say, just to get the ball rolling. So I will turn it over to you.

Yes. I just thought I would recap. We had a very busy quarter in the second quarter, and I think it's exciting times for us. So I thought I'd recap the quarter. We announced 2 transactions, the sale of our LatAm business to Stonepeak for $2.7 billion, roughly a 9x multiple. The sale of 20 of our ILEC states to Apollo for $7.5 billion, a 5.5x multiple. I won't go into the details here, but I think the valuations go a long way to reinforce what we've been saying about the sum of the parts of Lumen and why we think we're undervalued. We believe in the business, and we continue investing in growth, growth in our enterprise business through investments in edge cloud, managed technology services, adaptive network and connected security services. We've also been investing our time and energy and money and growth through the partnerships and alliances that we've established. We've been investing in growth in our consumer and small business customers through Quantum Fiber. As a reminder, Quantum Fibers are fiber-based mass market business that we've already launched in many of the 16 states will retain after the sale to Apollo. With around 2.5 million homes passed within our existing fiber footprint, we have good reason for our confidence. Penetration rates, ARPU, churn, NPS give us confidence across the board with our mass market business. And with around 15 million urban/suburban units in our retained markets, we think there's a lot of opportunity for growth. We continue investing in EBITDA and revenue growth through our ongoing transformation. As you look at our EBITDA and customer satisfaction results over the past several years, I think we've done a great job of transforming the business, and we continue to do so. Many of our transformation efforts culminated in the launch of the Lumen platform. And the Lumen platform is really a new way of interfacing with and delivering services to our customers. We still have a lot of work ahead of us, but I'm pleased with what we've accomplished in transforming Lumen over the past couple of years. On the second quarter call, we also announced a $1 billion share repurchase plan. As I said a couple of minutes ago, we believe our shares are undervalued and thought that was an appropriate action for the company. We certainly continue to invest in growth. But I think we've also been clear that the dividend is an important part of our capital allocation strategy and a very effective way to return shareholder -- return value to shareholders. And lastly, through a mix of pay downs and refinancings, we reduced our indebtedness and our annual cash interest expense substantially. Looking forward, we're comfortable allowing the time line to achieve the target leverage to extend as we work through this investment cycle. So we're sticking -- we still believe the target that we established a couple of years ago is correct, but we are willing to let that extend as we invest in our growth. As I said at the outset, these are exciting times for Lumen. And Brett, I look forward to the discussion today.

All right. Well, listen, that was a great overview, a great way to get started. We have a lot to dig into. And I actually want to start with one of the big growth opportunities that you said you see emerging for the business, which is edge compute. In order to pursue this opportunity, you've announced partnerships with IBM, VMware, SAP and Zoom. Why do you believe that Lumen is well positioned for this opportunity? What are the key ways that your network is differentiated to provide edge solutions? And ultimately, why are these leading tech and IT companies partnering with Lumen?

Well, first of all, I agree with you. We do see it as a big opportunity and largely because the Lumen network is differentiated, and that's also why the -- these IT companies are wanting to partner with us. They recognize and we believe that, first of all, we have one of the world's best fiber networks. I know you'll be shocked to hear me say that. We have one of the world's best fiber networks. But it's also one the most connected networks. If you look at our peering relationships, if you look at the number of data centers we're in, the number of cloud service providers, the number of enterprise locations that we serve directly with our fiber network. And we are one of the most interconnected, most connected networks anywhere. If you look at our edge facilities by combining our physical footprint with our fiber footprint, I said earlier in the year that we were going to have 95% of the U.S. enterprises within 5 milliseconds of delay by the end of the year. We're at 97% today. So we've accomplished all of that. That's another strategic advantage that we have, being very close to the customers, being very close to where our customers' data is created or analyzed or acted on really helps our edge business. And so I think if you look at the partners that we've established, that's what they see. That's the value they see in the relationship with Lumen is that we really do have a competitive advantage in the edge space.

Is there any way you can frame how big the opportunity is? Or maybe a better way of asking it, when should investors expect that edge revenues become a notable contributor to the top line?

Yes. So we don't generally provide forecasts on trends in the market. I think there are a lot of research analysts that can provide some of that insight. I've -- I was speaking with somebody recently, somebody I consider a very sophisticated computing professional and a CEO of a big company. And their view was that edge can be as big as cloud. Now whether it's as big as cloud or not, it's a big opportunity, and we have a strategic advantage in the way that we deliver services. So I remain confident -- very confident in the market opportunity and expect to see growth with increased market traction.

All right. Well, sticking with the enterprise theme, the Verizon and AT&T are your largest competitors in the enterprise market. And they're touting their 5G networks is positioning them to deliver an emerging suite of services as businesses incorporate 5G into their operations and our core products and services. Does Lumen need 5G capabilities to meet large enterprises' connectivity and edge compute needs over the next decade?

Yes and no. We don't need to go out and buy billions of dollars' worth of spectrum and build out infrastructure throughout the U.S. or broader. But 5G access is an important thing. And it's the last 100 feet of our business that we need to worry most about with 5G. So if you look, we announced a partnership with T-Mobile to provide 5G edge solutions to our enterprise customers. We believe campus networking with 5G is a real opportunity for us. But we also believe that when we can -- when fiber competes against wireless, fiber wins. 5G, 4G, I don't care. When you have fiber competing against wireless, fiber wins. The last 100 feet, very important to have a campus area capability for 5G because there is mobility within the campus. But as soon as that data, that traffic wants to leave the campus, it needs to leave on fiber. And so we think there's a great opportunity to continue to partner with companies like T-Mobile to deliver 5G services where it makes sense for us in IoT applications and other things, but also really coupling it with the fiber infrastructure that communications really wants to ride on.

Could you elaborate a little bit on the T-Mobile partnership? How did that come together? And what made it a win-win? What are you additive from their standpoint? And how are they additive from your standpoint?

Well, it comes down to use cases. First of all, we've got a great relationship with T-Mobile and have had for a long time. They're an important provider to us. We're, I believe, an important provider to them. So we've got a great relationship down through the organizations and how we work together. But it comes down to use cases. And what use cases do they need to partner with Lumen on and for providing to their customers? And what use cases can we partner with them on providing to our customers? And so we'll continue to look at that. And I mentioned campus area networking. I mentioned IoT. Those are some of the use cases that we think are really, really attractive for the joint Lumen-T-Mobile partnership.

All right. We can move on a little bit. Like all large-scale telcos, you continue to have high revenue exposure to legacy services that are in structural decline. How are you offsetting legacy declines in your business?

Yes. So one, it's kind of a couple of different things. First of all, we're trying to slow the declines, provide the best service possible. You've seen us transform our business, improve our customer experience, and move to digital model, launch our Lumen platform, [ visual ] interaction model with our Lumen platform and make sure that we're serving our customers' needs with the legacy products and services, create -- don't create a reason for people to turn off, so provide a great experience, and we're continuing to do that. We also -- though we're investing in growth, if you look at our edge capabilities, our security services, orchestration, our managed technology services, dynamic connections, which is really a network as a service capability, we've been leaning heavily into enterprise customers growth to make sure that we are providing the capabilities in the way that they want to consume them going forward. We're also focused on Quantum Fiber. I mentioned that we've been ramping Quantum Fiber builds and more details are probably forthcoming in earnings calls and other things. But we're very pleased with the success that we've seen. We have 2.5 million homes within our fiber footprint. Our penetration rates are going up, our ARPU is strong, customer satisfaction and NPS scores. We've built a digital interaction model over the last couple of years for our Quantum Fiber customers that we think is second to none. And we will continue to -- as we build more fiber into locations, we'll bring that suite of capabilities to our customers more broadly.

Yes. We've seen several releases seen several releases about Black Lotus Labs work to identify and address cyber security vulnerabilities. It seems like this is becoming a regular set of headlines across a range of sectors. Can you spend a few moments on what those capabilities do for you and how you're leveraging them?

Yes. So we operate one of the world's most deeply peered and interconnected network. So we see a lot of traffic. We see good traffic. We see bad traffic. We see a lot of what goes on in the Internet. We have capabilities that our clients love like stopping DDoS attacks. Our hyper DDoS products allow our customers to use -- to stop DDoS attacks in a matter of minutes and more and more ransomware DDoS type of attacks. And so we're -- we have capabilities that our customers love. We also have some of the world's best security experts. And we spend our time looking for bad guys, that are out there operating networks. And that's what Black Lotus Labs does. When you pair the security expertise that we have with the robust network capabilities that we have, our customers enjoy a superior level of protection. And that's what's important to them is securing and protecting their data is a key part of our mission.

I want to go ahead here and go back to something that you touched on with your opening remarks, which are the 2 key strategic transactions that you recently announced. And just to recap, you're going to be selling your ILEC business in 20 states to Apollo Global. That's a $7.5 billion deal. And you also announced the sale of your LatAm business with Stonepeak for a $2.7 billion deal. You touched on already some of the growth opportunities. But I think that the follow-up question would be, can we just talk a little more deeply how is it that these transactions actually position Lumen to be better able to pursue some of those growth opportunities that you see?

Yes. I mean, first of all, they allow us to continue to simplify our business and focus our business. If you look at the sale to Apollo Global, we will sell 20 states, but we'll retain 16. In those 16 states, we will increase our focus. We will make sure that the digital experience that we've developed that we can deliver that to our customers within those states very effectively, and we'll continue to extend our footprint within those markets. The same thing is true with the LatAm sale. We will focus more intently on the U.S. and Europe and make sure that we continue to meet the needs of our global customers. We -- one of the things that we've proven with our Asia Pacific approach is we don't have to own every part of the network. And so we expect to have a tremendously a strong relationship with Stonepeak and the LatAm business post the sale. And so we'll continue to serve our Latin American needs from the U.S. We'll continue to serve our Latin American needs from EMEA. And that it really allows us to focus and pay attention and invest in the growth opportunities we see here domestically.

Has there been any notable developments since you announced the transactions?

No, not really. I mean we have a lot of hard work to be done. We have to continue to work with Apollo and Stonepeak to make sure that we hand over a company -- companies to them that are what they were trying to acquire. So we'll continue to do that. We've got great relationships with both. This is not the first time we talked to them and worked with them. So we have great relationships. And we'll continue to make sure that we deliver anything. We do expect that the lifetime transaction will close somewhere in the first half of 2022, and the ILEC transaction will close somewhere in the second half of 2022.

All right. Last question on this. So as you think about sort of the pro forma composition of Lumen as those deals are completed, would you be looking for any further asset repositioning? Or are you reasonably comfortable that what the company is going to look like is going to be what you need to execute against these growth opportunities?

Well, we've been -- I've always been very candid in saying that we're open to smart things. Sometimes I've had to say, no, I really mean it. We really are open to either acquiring or divesting companies that don't make sense for us from a core strategic standpoint. So we continue to be open to that. Now there are some capabilities that I'd like for us to acquire in our business. There are probably some non-core assets that we still have that if we could -- if we had the right deal, we would divest of them. And so we are open-minded. And I really mean that we are open minded that we do look at that, that's not just CEO speak. That's a real conviction that our job is to return shareholder value. And that if we have assets that somebody else can do more with than we can, we should sell them. If they're non-core assets to what we're doing, we should be open-minded to that. And we've historically been an acquisitive company. So if there's something out there that fills a gap or product gap or capability gap that we have, we'd certainly be open to doing that as well.

All right. Let's talk a little bit about your large enterprise and your IGAM businesses. You acknowledge that your second quarter results are somewhat sluggish reflecting elongated sales cycles and some delayed decision-making into late 2020 and earlier this year as your business customers just grappled with the uncertainty of COVID. But you also noted that your sales activity had improved. The delta variant has obviously impacted decision-making, and we've seen some disruption in supply chains. You put all that together, can you just give us an update on the large enterprise demand environment? What does the sales funnel look like? And are large enterprises finally moving ahead with some of these projects?

Yes. So I'll just basically repeat what I said in the second quarter call. We'll talk about the third quarter results during our third quarter call. But you're absolutely right, we have seen elongated sales cycles. We saw at the end of the year, the very first couple of months of 2021 with massive COVID spikes, we did see continued delay. I talked about on the second quarter call that we're seeing sales pick up and that we're seeing some of the closing of deals that we hadn't seen. So that is absolutely true. We are still -- I still think longer than pre-COVID on sales cycles, but they are improving. We did see a pickup sequentially each month over the second quarter. We'll continue to focus on how do we drive those continued improvement. And so yes, that is true, although -- and revenue results were lower than we wanted, but we do expect to see sequential improvement over time. And we're watching this closely for the impact of delta variant and other variants that may come along. But we are starting to see our customers make decisions, and that's an important thing. The sales cycles may have been longer during parts of 2020 and in parts -- early parts of 2021, they weren't making a decision. We are starting to see them make decisions as they really figure out how they're going to operate in a post-COVID environment.

Maybe just at a higher level, can you just give us a bit more insight into what the conversations are like with your IGAM and large enterprise customers? Where are they in their IT transformations? What are the most pressing problems that they're trying to solve, not this quarter, but just sort of as the next sort of big thing they have to get through? And then what gives you confidence you're positioned to meet those needs?

Yes. So these customers are definitely, as you alluded, are transforming their businesses. And this is the customer segment, the large enterprise IGAM customers, GAM customers that had the longest relationship with Lumen, that have a long relationship with Lumen. They know us well. They know our capabilities. They know that our capabilities are necessary for their transformation. And where we see them going is toward a digital -- all-digital experience, where they buy and sell -- buy and consume our capabilities through digital interfaces through their applications, talking to our applications, not somebody picking up the phone and calling and ordering capacity, that actually digitally interfacing with us. And as -- they recognize what we've done with the Lumen platform and appreciate the capabilities that, that brings to them. So I think we're a great provider to these customers, but we can always do better. And we are focused on making sure that our Lumen platform continues to meet the needs as they change, as they automate and as they move to an all-digital experience within their businesses.

I want to spend a little bit more time talking about the mid-market enterprise business. About 15% of your revenues come from serving small and midsized businesses. And that segment has faced some particularly intense headwinds as we've moved through this pandemic. What's the backdrop for services in that segment right now? Because it seems like you have some cross currency. It felt like we had a reopening tailwind. We've had some disruption from delta. Where [ does that leave you right now ] in terms of that customer segment?

Yes. You're right. These segments have been particularly hard hit by the economic effects of the pandemic, and we see -- we see that in our business with them, supporting them. There are pockets of demand within mid-market, but there continues to be uncertainty. And we'll continue to work with those customers. because we believe we have great solutions to their challenges, but we need them to rebound. And you're also right, it's kind of been bumpy in the rebound, but it's moving up and to the right. And we'll continue to watch it closely. We'll continue to deliver strong value propositions to those customers with our fiber-based connectivity and other services. And we'll stay focused on them, but they have been hard hit.

You said that you do see this mid-market enterprise segment as a growth opportunity over the long term, what's the path to getting there and to really being better positioned to grow with this customer base, particularly when you look at how focus some of the cable companies have been in that segment and successful in that segment?

Yes. And we've got good competitors out there, and that always makes us a better company. If I start -- I won't go through the litany of reasons why I think our solutions are better than others. But the symmetrical nature of our connectivity for enterprise customers and business customers is naturally an advantage. We are leveraging things like our edge network even for the mid-market customers. Some of them will want to use our edge network directly, but others will use software-as-a-service providers like SAP. Our relationship with SAP allows us to deliver, for SAP, their capabilities to those mid-market customers, helping them grow their businesses and sustain their businesses. And so as we bring on more and more software-as-a-service providers over the edge network, we think that will help those companies. And then finally, we have 180,000 buildings on net, and there's a lot of opportunity for us to grow in those buildings with very capable products where we can bring not just connectivity but security and orchestration and managed technology services. Many customers need help, making these transitions through technology. And that's one of the strengths that we have as a company, and we'll continue to deliver those to our customers.

All right. Moving on to the consumer segment. Following the Apollo transaction, your ILEC footprint will include 21 million customer locations, of which 2.4 million are currently passed by your fiber network. I think you said that about 15 million of the homes in these retained markets could potentially be attractive to upgrade to fiber because those are generally in the urban or suburban portions of that footprint. What outlook should investors have for your consumer business following the Apollo transaction? And do you believe it can eventually return to growth?

Well, absolutely, our objective is to grow. And we do think that the consumer mass market business and I'm lumping in the small business customers into their, I think that they want the capabilities that we have and that when we deliver them over fiber and as we've proved over the last X number of quarters. I mean it's not been 1 or 2 quarters, it's been 10, 11, 12 quarters as we've proven over that period, when we offer a high-speed all-digital experience customers buy, customers move toward us. And so we'll continue to do that. We absolutely do believe that we can, by selling the 20 states that are not as core to us that we can invest more heavily, more concentrated efforts within the 16 states that we're retaining. And so we'll -- we absolutely will continue to invest in fiber. We expect to grow where we invest. And frankly, we have where we invest, we grow.

Have you experienced any supply chain issues? We've been hearing elements of that from different companies throughout the conference.

Yes. There's certainly going to be some supply chain issues, nothing that we aren't managing. We're a big customer for many of our suppliers. And so we've been working closely with them but we're definitely having to work closely. I've sent 2 e-mails in the last 2 weeks to CEOs of major suppliers saying, we don't see -- we don't have a problem yet. But if we don't stay on top of it, we're going to have a problem, please prioritize the Lumen needs appropriately. And so there are going to be issues. We continue to focus on them. I'm not pointing to anything today that slows down our growth or anything like that, but we are definitely seeing some beginnings of challenges in the supply chain. So we'll stay focused on it.

Historically, Lumen has been a big participant in broadband subsidy programs. However, the CAF II program is coming to an end at the end of this year, and you expect much lower subsidy revenues as we move on beyond that. The infrastructure bill that's been passed by the Senate includes $65 billion for broadband. Under what conditions would subsidy or stimulus programs enable you to increase the availability of high-quality broadband at an affordable price with economics that justify Lumen making that investment?

Yes. So I'm going to -- a little bit of a punt on this question. You tell me what the broadband bill looks like, and I'll tell you how it's going to affect Lumen. We'll have to wait and see what actually comes out of Congress and what -- and then what kind of the guidelines are around that. I'll just say that we have demonstrated an ability to efficiently invest in the network. And we support the idea of incentives for broadband to help us build into more areas. And so we'll work with the government to understand and to influence how those monies can be used to build out better broadband infrastructure.

And I know you don't want to say too much right now, but one of the things I was thinking about was you've identified 15 million homes that you think make economic sense, you got to figure that out. [indiscernible] 6 million you retained footprint that you as of now it doesn't feel like it's going to have the economic returns to justify the investment. Is it safe to assume that depending on how the subsidy program ultimately unfolds, that may be the element of your business that is more meaningfully impacted by it?

That piece of the business is obviously the greater opportunity to use broadband funds to support. But the fact that we've said there are 15 million homes that are urban or suburban does not imply that there are only 15 million homes that we should invest in or that we should invest in all 15 million of those. We think that, that's a great opportunity. We think there's plenty of market opportunities that's out there. Some of it will be in the 6 million homes that you referenced. Most of it, the majority of it will be in the 15 million to the extent that there are opportunities for us to invest with Government assistance to drive better broadband throughout our footprint, we'll do that.

Got it. You substantially completed your cost transformation plan and signaled that OpEx savings are probably going to slow down a bit from here. And discussed earlier, you're obviously looking to boost investment in your growth initiatives. Going forward, what outlook should investors have for OpEx trends and margins? And in what ways do you see opportunities to capture further cost savings to offset your growth investments?

So we did achieve our 3-year $800 million to $1 billion cost transformation initiatives that we discussed about a year ahead of schedule, which means that we still see lots of opportunities ahead for us to continue to transform the business. And I don't intend to slow down in any way. Now Brett, you've heard me say this many times at Communacopia that cost savings are really a byproduct for me. What we're after when we invest in transformation is a better experience for our customers, a simpler environment for our employees, both of those -- when you do those correctly, you provide a lower -- you do it at a lower cost. And so our cost transformation is really more about our digital transformation, our customer experience transformation and then the byproduct, a good outcome that comes along with it is cost transformation. And so the good news is that we think that there are still opportunities to continue to improve our customer experience, continue to simplify the products and services that we sell and continue to simplify the way that we sell them.

So how do you think about Lumen's path to EBITDA growth if cost transformation is slowing versus the historical pace? Does this inevitably require the company to be on a path to top line growth?

Yes. And we don't give the EBITDA guidance beyond the current year, but we will have to continue EBITDA growth through a combination of cost improvement and revenue growth. I mean it's pretty straightforward. Those are the 2 biggest levers that we have.

Well, I've got time for one last question here, and it goes back to something you touched on in your opening remarks, which is that you believe that cost -- capital return should be a part of your ongoing capital allocation. You made note of the $1 billion buyback program that the Board has authorized. I got to ask, can you give us an update how much of that program have you taken advantage of so far?

No, I can't. Not surprising to you, but I appreciate the question. We'll update you more as we get closer to our third quarter earnings call. But I've been very clear. We think our company is undervalued. We think -- we said we would be opportunistic in the way that we buy back shares. And we believe that's a fair way to return value to shareholders. And so we -- our Board did authorize that, and we'll update you closer to the third quarter call.

All right. I had to ask. Well, Jeff, thanks so much for being here virtually, and we certainly hope we see you in-person next year.

Thank you very much, Brett, and I appreciate everybody's attendance and participation in this. So thank you.