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

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Good afternoon, everyone. I'm Eric Luebchow, Senior Analyst at Wells Fargo, and thanks for joining us today at our TMT Summit. Really pleased today to be joined by Maxine Moreau, who is the President of Lumen's Mass Markets division. So Maxine, thanks so much for joining us today.

Thank you for having me.

So Maxine, obviously, you're the President of one of the more interesting segments of Lumen today. So perhaps you could just give us a little background of your role and your responsibility at the firm.

Sure. So Mass Markets is made up of our consumer and small business customers. Last year, we generated about $5.9 billion in revenue. We operate under 2 separate brands: our new go-to-market fiber brand is Quantum Fiber, I'll talk about that a good bit today; and then the CenturyLink brand that everyone is familiar with that we've operated for many years and will continue to operate for our nonfiber assets. But our future growth is going to come from Quantum Fiber as we expand our fiber footprint. At the end of third quarter, we had about 2.7 million fiber-enabled locations.

That's great. And obviously, the big news recently was the strategic divestiture to Apollo of your ILEC property. So maybe you can talk about just what the what the rationale was for selling some of your ILEC properties and reinvesting in consumer fiber. What made now a particularly attractive time?

Sure. So we announced our agreement with Apollo back in August. That transaction will divest about 20 states of our ILEC operations. And those 20 states, think of them as more rural in nature. The 16 states that we are retaining will be much more urban, suburban. And we're really pleased with the valuation we received from Apollo on those assets. And we expect to close the transaction still in the second half of 2022. And then just most recently, which is the exciting part is, in November, we announced our mass market fiber expansion plan, where we are targeting about 12 million locations across our remaining 16-state footprint after we closed the Apollo transaction. And we also announced, as part of that, our plan to accelerate the pace in which we're building to about 1 million locations next year compared to about 400,000 we've been building in the last recent years, and then exiting the year at a run rate that would bring us closer to 1.5 million to 2 million a year.

Great. Yes, that was an interesting announcement on your last earnings call. And I think you still have about 21 million homes across the remaining footprint. And I know you've mentioned before that about 70% or 15 million are in suburban or urban areas, but you identified 12 million as the near-term addressable market. So maybe you can talk about, is 12 million the ultimate goal? Do you think that, depending on your success, you could go further than that to bridge that gap between the 12 million you've identified and the total footprint you have today?

So we've done a thorough review, part of it through the Apollo transaction and then looking at the states that we wanted to retain. And after a lot of analysis, we do feel like that 12 million number is sort of the right target for today that would bring us attractive returns. There are several things that can impact that: construction costs, future demand, population growth, population density, the competitive dynamics. There could be upside to the 12 million target. I think Neel mentioned that on the last earnings call, over time, as technology and cost evolve. And I mean we'll continue to look at the remaining footprint, the other 30% that have much lower density, and leverage opportunities that come before us to bring fiber to those areas economically through various state and federal programs.

Got it. That's helpful. Maybe you can talk about just strategically what's changed at Lumen and why you decided that you had a slightly more of a microtargeting approach to fiber before. It seems like now you're taking a much broader approach to building out larger chunks of your footprint. Did anything change? Is it directly tied to the ILEC divestiture, where you had the capital you needed to do that? Is there something more attractive about the current competitive environment, just anything that has led you to this decision?

So I wouldn't say our strategy has changed. I'd say it's evolved. If you think back to 2017, late 2017, when CenturyLink acquired Level 3, at that time, Level 3 had no consumer business. Both companies had pretty low -- relatively low market share in small business. So naturally, the company was primarily focused on enterprise. With that said, we said we would consider strategic alternatives for all of our assets. We've done that. At the same time, we continue to focus on improving our own operations. And Mass Markets brings a lot of cash flow to Lumen. We don't believe in low-calorie revenue. We don't think it adds value. One example of that was where we discontinued our operations of our linear video product, our product we offered as Prism. And to your point, we were microtargeting our fiber investments in areas that generated the highest returns at a pace that we were comfortable with for the company, looking at our capital and our capital allocation strategy. And then along the way, we created our vision of the Quantum Fiber platform. This was pre-COVID. COVID has just reinforced the need for quality fiber broadband service in homes and small businesses. And our all-digital experience has really resonated with customers. Our -- so we look at our fiber investment performance. We look at our Quantum Fiber platform that we've built. We combine that with our proven ability to execute and take share. And so now we feel like it's the time to accelerate and drive that profitable growth within Lumen. The Apollo deal just allows us to streamline our portfolio and narrow our focus to this more targeted 16-state footprint. Like you said, 70% of that remaining footprint is in urban-suburban clusters. These clusters have the density that makes sense to go deeper with fiber. We're initially targeting the 12 million I spoke about. And lastly, we're going to move to a market-level approach because we think it's a necessity as we pivot from this microtargeting to this deep fiber strategy.

Interesting. Maybe you could talk about the go-to-market strategy as you both build the homes and then you try to fill them. I mean, obviously, we understand that fiber is, in many ways, the best technology there is for residential broadband. How are you planning to differentiate the brand versus presumably a lot of the cable competitors that are in the footprints in which you're going to build today? And maybe any details on the go-to-market strategy would be helpful.

So we were talking about it before the call started, all of us were, the importance of fiber. But first, I can't emphasize enough, we're enabling a platform, a platform that's 100% digital end to end, and we've been very intentional about that. It includes the entire customer life cycle, from learning about our services, ordering the services, billing the services, it's a prepaid subscription-based model, all the way through ongoing support. And it not only serves customers the way they want to be served but also allows us to drive down our operating costs. It reduces the need for customers to ever need to call us. We're also expanding our local market-level leadership and resources, which will ultimately be responsible for driving that growth at the local level. They'll be responsible for driving the fiber expansion plans, for driving the local sales and marketing, the customer experience and the full market P&L. And with our targeted focus in this urban and suburban market area, we can tailor our go-to-market approach based on the trends in that market, the competition, the buying behaviors, the -- all other factors to position us for success. And with our digital platform, 100% digital platform, our local market focus in this differentiated Quantum Fiber customer experience, we know we can win. I saw a quote from a customer just this week, they said, this is quote, "Everything about my Quantum experience has been frictionless and the speeds are fantastic." So we believe we're set in a really good position to take market share and grow our fiber base.

Interesting. And do you have anything you can share on the 16-state footprint in terms of cable overlap or any type of competitive response that you would expect as you start to build out this footprint with fiber? I presume that the large cable cos are your primary competitors, but I'm just wondering if there's anything you can share on that front.

So you probably know, you just said it, we have a near-ubiquitous cable overlap in these target markets but feel like our localized go-to-market approach gives us a strong competitive advantage. Like you said, we know that symmetrical fiber broadband with low latency offers a superior performance to other technologies. And where we've invested, we've grown our customer base, we've taken share, and we win.

Yes. That's totally fair. Perhaps on the build cadence, you mentioned that 1 million homes next year, and you'll hopefully hit a run rate that's 1.5 million to 2 million eventually. Maybe you could talk about internally what you have to do in terms -- in order to hit that build target. Materials, labor, supply chain, are there any bottlenecks that might impair your ability to ramp up to that degree?

Well, there's lots of moving parts there. We are shifting our focus to this market-based approach. We're mobilizing our workforce and kind of all the key resources. We're working with local municipalities on permitting and zoning. And we're working collectively with our suppliers to ensure the entire supply chain understands what our future needs are, and they're ready to support us. We've got a high degree of confidence that we've got a clear line of sight to build to the numbers that Jeff shared in November. But we're going to continue our disciplined approach to these investments. And if we feel it's prudent, we'll change our pace. But we have a -- we're a large company with a long rich history and experience of building high-quality network assets. And so I feel like we're really positioned well for our future.

Definitely. That's helpful, Maxine. So perhaps on the question of build cost, on your last earnings call, you mentioned you expected build costs to be less than $1,000 per home pass. So I just wanted to dig into that a little bit. We've seen a pretty wide range of build costs across your peers that can range anywhere from $400 to several thousand dollars, depending on household density and a variety of other factors, whether that's aerial or buried fiber. So maybe you can talk about your average build costs, is there a wide range depending on the geographies you're building out? And is there anything else you can share on your confidence in those numbers?

Sure. So with our market-based approach, as we go deeper and as we enable more fiber, we're going to look at these at a full market level, so looking at an entire market. And if you look at where we built today through our microtargeting, our cost to build was much less than the $1,000 because we primarily leveraged aerial plant in those builds. Going forward, what you're going to see, as we go deeper and deeper in the market, is our mix is going to shift. So we're going to have more in-ground, more buried construction. But with our scale and our density, and I talked about our density in those 12 million locations in the remaining footprint, we feel really good about our assumption of being able to build at a cost of less than $1,000 per location on average when you look across the entire build for our market.

Got it. That's helpful. And maybe you could talk about are there additional adjacency -- growth adjacencies with SMB or enterprise as you're overlaying a lot of fiber in your market, that you can improve the growth rates in those businesses in addition to the residential opportunity?

So when you think about where we're building and suburban -- dense urban and suburban areas at a much larger scale, of course, those builds are going to be close proximity to some of our existing enterprise base. And the deeper we go with more fiber coverage in each area, it's going to give us more opportunity to bring more on-net connectivity while extending our Lumen platform to more potential enterprise customers. So yes, there are some synergies as we go deeper and deeper in these markets.

Great. And on the question of the build costs, just going back to that, obviously, the less than $1,000, maybe you can talk about targeted returns that you hope to generate based on the success of the platform, the penetration rates you think you can achieve. I think you've talked about 40% penetration over time, but any insight into those metrics and some of the moving pieces would be helpful for us.

I'll start with the penetration part. So we are comfortable that we can reach a penetration of 40% or above. We've seen this in some areas that we've invested in already with fiber. We have some capabilities in certain areas where we have instant activation, where you go into your apartment complex or your home and you bring up your computer or your service and you can purchase it immediately without calling anyone, without rolling a truck. And in those cases, we've seen the 40% penetration much sooner in the process, much quicker. But it varies market to market, depending on the competitive landscape. Again, with our all-digital Quantum Fiber experience, we're seeing really high NPS, and we believe that our service is superior, and we're continuing to evolve our service and adding capabilities, things that allow us to grow our subscribers, grow our ARPU over time. We're evolving our in-home, in-building strategy that allows more of that instant activation after the first install. And then later this month, we'll be rolling out the next generation of optics, which is XGS-PON, which will allow multi-gig services. From a return, we haven't externally said what our target return metrics are. But as we plan to go deeper with our fiber footprint, we expect to do that at returns that are nicely above our current cost of capital.

Sure. That's fair. And is there any general time line to think about how long it would take you to get to 40% penetration once you pass the home? Will it take 2 years, 3 years, 4 years? I understand it probably depends on the exact geography. But any kind of general time line to think about for us?

We have not shared that. It definitely varies geography by geography and type of construction, if it's a single-family home development where we have exclusive marketing rights or we're the sole provider versus where the homes haven't even been built yet but we passed them with fiber. So it varies from market to market. And it can be in a very short period of time or over a period of 3 years.

Yes. And part of this, of course, is you're going to overbuild customers that are on more legacy technologies like DSL. Is that an easier sales process when you're overbuilding an existing customer and upgrading them, obviously, probably ARPU-accretive? Or do you find that it sometimes can be more difficult for customers on legacy technologies that don't want to pay a higher price, they don't necessarily need the faster speeds of fiber?

So the latter is not the issue. They always want a faster speed. No matter what speeds they're on, they always want a faster speed. So our penetration curve actually is better when we are overbuilding our legacy copper plant to fiber. In a new greenfield area, we do that as well. Those numbers are in addition to these numbers. But where new housing starts occur in new subdivisions, new multidwelling units, we see a slower ramp, mainly because -- and there's not a lot of homes necessarily built on these properties day 1. Whereas when you overbuild your existing plant, you've got an embedded base of customers you can target and a footprint that is available with homes on it or businesses on it day 1. So we see a quicker ramp.

Yes, and that makes sense. And I mean, of the 12 million homes you're targeting, are those mostly just overbuilding your existing footprint? Or are there some potential greenfield new development-type opportunities outside of the core ILEC footprint that you'd be targeting as well?

That 12 million is overbuild.

Okay. And do you see -- I mean, do you think there might be adjacent geographies that could be interesting for you to enter? Or is it just too early to say?

I would say it's too early to say outside of our footprint, although we have built outside of our footprint before on a small scale. But new subdivisions and new households, we do that today, and we will continue to do that where it makes good financial sense.

Sure. And one question we get a lot, Maxine is around the threat of 5G or fixed wireless to consumer broadband. And presumably, obviously, we know fiber has better speeds, lower latency, better upstream capabilities. But I mean, do you see that as a potential threat in some of your geographies, where T-Mobile or Verizon or one of the other fixed wireless offerings does makes it harder for you to get to your targeted penetration rates?

So in the near term, I think those technologies do provide a threat to our lower-speed customer base, especially where we're not intending to overbuild with high-speed fiber broadband. But over the long term, fiber is going to prevail. And you saw our plan. Over the next few years, 70% of our footprint, we believe, is ideal for fiber. And we're targeting to have that enabled at 70% over the next few years. So over the long term, fiber is the key winner.

No, understood that. Another topic that's been very topical recently is on the infrastructure bill, which, I believe, provisioned over $40 billion for building out new network and a variety of other funding for affordability programs. So maybe you could give us your initial thoughts on the infrastructure bill. I know it's still early days, but could that potentially be a catalyst for you to go beyond and build out some of the potentially more rural footprints or expensive cost-to-build footprint that you have, something that you might consider in the future?

So I'll start with the 12 million build target does not contemplate any subsidy from the new infrastructure bill. So there is potential upside to the 12 million number. We're excited. We think the bill is a great opportunity to bring our symmetrical Quantum Fiber service to unserved or underserved locations across our footprint, across all the remaining 16 states. The size of the subsidy right now is unknown within each state. It's going to vary. It's going to largely be determined by the program rules that will be established by the states and the federal funding administrators. But we've been -- we heavily participated in CAF, and we will look at this program. There's actually multiple legs of this program, as you know. We'll look at each and every one of them. We've been working with the states on the development and the refinement of the grant programs that have been in place for several years and are being modified somewhat. And we'll continue to have a strong presence in those discussions as well at the federal level. But yes, we're excited, and we believe that this will give us an opportunity to bring quality fiber services to more of our footprint and more of our customers.

Interesting. And I also understand there are a variety of, not federal, but state-level stimulus programs in place as well that potentially could also be additive to your footprint as well if you choose to build in those locales.

That's right. And we do that today on a smaller scale to what has been communicated at the federal level. But yes, we participate in those today, and we'll continue to do so with our local market focus.

That's great. We touched on this a little earlier, Maxine, but I wanted to go back to it. It's on the supply chain. One of your biggest competitors mentioned that there were some supply chain constraints this year on, I believe, just some small components of fiber optic cable. They slowed down their pace of building a little bit. Maybe you could talk about how you manage your vendors in terms of prepurchasing inventory, precontracting, how you deal with the labor impact of it. You mostly outsourced to third-party vendors. Just I know that's a very all-encompassing question, but just if you could give us a little more color on how you're managing supply chain. And it sounds like you're pretty comfortable with your build targets, but it's been such a big topic of conversation recently. I just wanted to get your latest thoughts.

So we have also seen some impact of labor and material shortages, but we've been able to mitigate most of those through our planning and internal alignment -- We've got a great supply chain group, a great supply chain ecosystem that we've developed over many, many years. We have diversification, not only in our equipment, but in our fiber, in our labor. And we have mitigation plans that we're comfortable with that will allow us to deal with any of these near-term challenges. Of course, we'll continue to monitor things very closely, but we feel very well positioned to execute the plan that Jeff communicated. And yes, it's placing orders much well in advance of what we've historically done. It's working with our suppliers and making sure that they're clear and they have a good understanding of where we're going and at what scale we're going to, and so that they're ready to meet our needs. But it's something that requires everyday focus.

No, understood. And just wondering if you have any insight at all -- obviously, the properties you're divesting to Apollo, were those just -- as you looked at those as a potential opportunity to overbuild, were those just too expensive? Was there any reason that you thought you could just get better economics selling them versus doing an overbuild in those markets as well?

So I would say it allowed us to focus. There are markets that would have been lower in our priority list to invest in. So the fact that Apollo has plans to build -- overbuild in those markets, and I obviously can't share with you what their exact plans are, but it's a win-win. It's a win for the customers. It's a win for Apollo. And it's a win for Lumen because we received a really attractive return on those assets, for assets that, like I said, would have been lower in our priority list to invest in. And now we get to focus on those larger markets that provide a better return quicker at a much higher scale.

Yes. And obviously, it helps your business mix as well because you're divesting a whole lot of kind of legacy voice revenues, correct, that you will not have to manage the secular declines in those products as well.

That's right.

Okay. That's great. No, that's all really helpful, Maxine. So just 1 or 2 more for me before we finish up. I know we touched on this a little bit, but perhaps you could talk about your SMB footprint today. I think this is primarily a residential build. But are you going to be passing a lot of small and medium businesses that might be accretive to the growth profile of the company? Is that something that also might be something we should look at in terms of your ability to penetrate, not just residences, but also small and medium business?

Yes. So when I talk about the 12 million number, that is not just homes. That is locations. So that's homes and small businesses that would fit under the purview of Mass Markets. And so that is already contemplated in our numbers. And what I would say is that, historically, I've said it before, our market share has been relatively low in that space. So yes, we believe that there's great upside. As we apply our mass market techniques, our mass market go-to-market, the digital approach that we've used for consumer for several years to our small business customers, we're seeing the pace of those customers moving to our fiber broadband services much stronger than it has been historically. So yes, we believe there's upside there as well as we partner with our enterprise organization. And as we do these builds, we look at the area holistically. We're not just saying, okay, we're just going to build to these subdivisions, and we're going to forget about these small businesses or we're going to forget about these enterprise buildings. We're looking at it holistically. But the lion's share of the number, when you just look at pure numbers, is from residential customers.

Got it. That makes sense. And do you think you have the internal resources, the salespeople in place today to really attack this opportunity? Is that something that you're looking to scale up in conjunction with building out a lot of new homes? Or are there any other things you need to scale up internally in order to be able to -- not just from a building perspective but to sell to the footprint?

We're absolutely increasing our sales distribution. We're increasing it both internally with our own sellers and increasing with our partner channels. And then, of course, the digital platform, any customer anywhere could purchase it online without ever talking to a person. So our Quantum Fiber platform can be ordered 100% digitally. But absolutely, we are beefing up our field sales, field sales leadership across these major markets.

Well, we're out of time now. So Maxine, thanks for walking us through a pretty exciting area of Lumen and something we'll be following closely from our seats. So thanks for joining us today.

Thank you, Eric. I hope you can tell, we're excited as well.

Absolutely. Appreciate it.