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

All right. Good afternoon, everybody. Thank you for joining us. I'm Eric Luebchow, senior analyst on the Wells Fargo Communications Infrastructure and Telecom Services team. Thank you for joining us. We're very pleased to have Chris Stansbury, the CFO of Lumen. Thank you for joining us, Chris.

Yes. Great to be here today.

So maybe we could start off kind of at a high level. I think one of the critical components to your story is kind of the progression to revenue growth in the next few years. And maybe you could, at a high level, kind of give us some of the building blocks from the kind of mid-single-digit declines that we have in the base today to get back that glide path to growing revenues by 2028 or 2029.

Yes. I mean the transformation is well underway. It's working. And if you look at where we sit today, just this past quarter, in the third quarter, we announced that half of our revenue stream is coming from the items that are actually growing and the other half is from items in decline. So we're already from a portfolio standpoint in a very advantaged position versus our competition. And that's why you see our rates of decline at roughly half of what you see in the industry. If you play that forward, if you quite simply just take the industry rates of growth and decline by product and then you layer in the revenue impact from the PCF deals that we sold, the $10 billion of deals as well as $500 million to $600 million in digital revenue, you get to growth on the business segment by the end of '28. So roughly $0.5 billion in each of those 2 buckets, the PCF and the digital. So they're not crazy assumptions at all. Obviously, we'll work hard to go faster, but we feel really good about where we sit.

Yes. And if you think about the relative growth rates or declines in your business, like how should we expect legacy? Is that going to be declining at a faster rate than grow in the near future? Or do you think you'll kind of be able to eclipse that over the next couple of years when we think about the relative...?

I think it will continue to decline at rates that are a little faster than grow for the next year or 2. It really depends on how fast the digital adoption comes, and it is coming our way. I mean we're seeing incredible rates of adoption, albeit on a small base for our Network-as-a-Service offerings growing at 30% quarter-on-quarter consistently now. So it's just a matter of time, but you will definitely see the rate of decline improve as we move through that window. And we'll continue to give visibility around the components of that as well as the adoption rates around the digital product portfolio growth. But you will continue to see the growth items each quarter become a bigger and bigger percentage of the business as we go forward. So that's all positive.

In the Network as a Service growth category, from someone who comes from a more traditional telecom background, it's probably relatively misunderstood. And I'm sure you guys will help us along the way to understand it better. But maybe you could just talk about that platform. I think you have north of 1,500 customers today. You could talk about what makes that particularly unique to other players you're competing with in the telecom ecosystem that are primarily really just focused on the connectivity layer.

Yes. I'm going to hover here for a couple of minutes and walk people through it. If you look through enterprise telecom over history, its Achilles heel has been that it's not scalable, period. So every single provider when they provided a new service to a customer required a level of infrastructure to support that. If you want Ethernet, if you want VPN, if you want Internet on demand, it literally was truck rolls and boxes and things getting plugged into other things. It's very static. It's slow moving. And as a result, it stifled innovation. It also generated a lot of cash, which led to dividends, which led to declining rates of sales, which led to borrowing to pay the dividend, and we've seen that story repeat itself multiple times. Network as a Service for the first time, brings scalability to enterprise telecom. Quite simply, it is one infrastructure layer, one port at a customer location that can carry thousands of services on it. Those services are delivered digitally. The customer can self-provision those services. There are no truck rolls or far fewer truck rolls. And so it's infinitely scalable. That's why it's so important. And we're the only ones investing in that infrastructure broadly. But that isn't just about consuming services at that location. It's also about the ability in a world where data is proliferating, both in its magnitude, but also in terms of where it sits as data centers to support cloud to support AI are chasing cooler temperatures, power, water. So the ability to access digitally all your data in all the places and move it through very high capacity, low latency pipes is absolutely critical. It's table stakes for AI, and that's why we're doing it. And the crazy thing is no one else is. So we feel really good about where we sit.

And as we think about kind of the PxQ math to get to the revenue run rates that you've talked about, how should we think about that? Is there kind of a base connectivity layer price that you'll charge? And then as they take more and more services, you can obviously drive up kind of your average revenue per user? Or how should we think about kind of the interplay of the PxQ?

Yes. It's -- the PxQ is exactly the way to think about it. We're going to give some more information on that at Investor Day because we're learning on the fly. We're learning a lot right now. But think about PxQ really being broken down into a number of subsets because there's DC to prem connectivity. There's DC to DC. There's DC to cloud. There's prem to cloud, right? There's all those different combinations. And depending on how you want to access that data and move it around, the PxQ will be slightly different for each of those. But we do think about at its most basic level, the number of ports per customer and the number of services per port and the price per port. We're still looking at that initial port. Do we charge for that port? Or do we just put that port in that location because then we're going to force adoption a lot faster and people start consuming services faster. So still TBD, but more to come at Investor Day.

And as you think about pricing that, when we think about the history of telecom, pricing compression was just a way of life forever, right? Obviously, you're building a platform that's different that none of your peers necessarily can or plan to replicate at least based on what they've said. So does that give you maybe a little bit more stickiness in the pricing you think you can achieve just given the fact your peers are not even trying to adopt something similar?

Yes, I mean look, if you think about the PCF deals, what is our durable competitive advantage? It is the network. It's that conduit that was put in the ground 25 years ago that has remained empty because of the advances in photonics. At that time, we were pulling under 100 strands of fiber through each conduit. Today, we're pulling as much as 1,728 and it's faster. So there's a lot of scalability there. And for anybody who wanted to compete with us, they'd have to replicate that. It doesn't exist. No one has the pipes. And by the way, if it did exist, there'd be a lot more noise about other people winning a lot of the $10 billion that we've won. There is no more definitive proof that we have an advantage than the fact that we have won $10 billion of PCF deals. There is more to come and others have not. But when you think about the digitization, it's so important. There's a -- I think it was Microsoft that actually had a really great clarifying metric that they're very focused on right now. And it's referred to as time to first token. And that is the time it takes for data to be consumable in AI. And all of the economics are driven around how do you shorten that time. And the reason that's important is today, a GPU cluster costs about $2,000 an hour to run. And in order to earn a return on those clusters, you have to keep them fed and spinning as fast as they will spin. If you are using legacy telecom that say is a 10-gig connection, it would take 222 hours, almost $450,000 of GPU time to move a petabyte of data. If you're using a 400-gig connection, it's 6 hours. So the services that we're bringing are giving customers in the power of their hands the ability to move their data from anywhere to anywhere digitally on demand and shorten that time to token time frame. So the value we bring now isn't about, hey, I can sell you a cheap wave to the procurement department. We're talking to C-suite executives because they're rewriting their business models. based off of our ability to improve their total value of ownership.

And maybe related to that, Chris, we were talking about this a little bit before our discussion here, but there's been a lot of fear in the market, particularly the last couple of weeks around an AI bubble forming and inflated valuations in the sector. There have been parallels that have been drawn to the current AI craze with the telecom bubble that crashed over 20 years ago. So maybe you could kind of give your perspective on where we're at in terms of that -- the AI infrastructure build-out and how it may be a little bit different than what we experienced 20 years ago and how you're positioned relative to your peers?

I'd say 3 things. Point number one, 20 years ago when the Internet was developed, there wasn't a use case. It was just a thing. And the financing that drove that was a lot of private funding and highly leveraged companies. Today, the checks that are being written are by very extremely well capitalized, the best capitalized institutions in the world. And so this is just cash off their balance sheet. There's not a lot of financial risk in that. AI is real, okay? That would be the second point. And I don't know, we don't know, none of us know who's going to win or lose. But what is absolutely a truth is that as a country, we have to stay in the lead on AI or we will fall behind. This is the great way to narrow the gap between nations, and we have to stay in front. and enterprise has to stay in front, and they're leaning into it hard now because they know it's the next wave of productivity. The third, last and most important point as it relates to Lumen is unlike those chasing data centers or GPUs, we're in the networking business. We are the only ones who are building a network ecosystem to support AI and multi-cloud. The network is not getting overbuilt. The big investments we're making in the network are prepaid by our customers. There is no financial risk. And so what I know with confidence, what we know with confidence is that while we don't know who the winners and losers will be, we know that the winners will be riding on our network.

And there's also been some skepticism in the market around the large hyperscalers building data centers, but a new wave of AI model developers, neocloud, GPU as a service, companies that have to take on more leverage are not necessarily that profitable today, driving a lot of the demand. I mean are they companies that you do business with today as well? And do you have kind of different terms and conditions when you do business with them versus a much more established hyperscaler?

It's really interesting because when we started the announcements around the PCF sales 18 months ago, things like neocloud weren't even in the decision set. We couldn't have predicted that at the time. Are they customers -- potential customers today? Absolutely. Every contract looks a little different, but broadly speaking, they behave the same. So I think that's what the mode would be. But we've actually said recently, we said on the last earnings call, we're not going to try to predict how big that TAM is anymore because we don't know, right? We wouldn't have predicted this a few years ago. We're at $10 billion. More is coming. We're involved in a number of conversations right now. But the demand is there.

And of that $10 billion of PCF, how much do you attribute that to more AI training in more remote locations versus kind of the next wave that Kate talks about that we hear about a lot, kind of inferencing more edge use cases that are going to require more metro fiber, locations that are closer to the end consumers. I know that's going to take place over a number of years, but where are we in that evolution?

It's a really good question. Really, over the last year or so, we've seen it shift quite a bit. You still have a lot of training going on, and the training will continue. I was at a at a conference recently and some of the AI experts were saying that over the next 3 years, AI is going to become 10,000x more capable than it is today. And so that will continue to evolve. But companies are definitely leaning into it. You've seen our discussion around Palantir and what we're doing. So we're definitely starting to see more inference now. And that's where our tools become so critical because it's about self-provisioned access to the network. I mean we had an announcement yesterday, and it was really exciting. It's with a smaller company, but it's with Meter. And it's really the first example when we talk about ecosystem partners where tech providers are coming to us to build APIs into our network because it makes their product better. It's kind of a synonymous relationship. They're a LAN company. We have WAN. So today, digitally, you can provision your networking needs that allow you to move stuff to the edge, right, in a digital way. You're going to see a lot more of those announcements. And I think that is evidence of the fact that everybody is preparing for enterprise needing to, in a very flexible way, access those AI algorithms.

Interesting. As we look at the mix of the $10 billion today, maybe you could talk about where you're at in kind of the CapEx cycle to build out the rest of the infrastructure. I know there's kind of a combination of existing conduit and some new routes that are part of this deal. Has a lot of the capital spend so far really just been pulling through conduit, overpull work? Or there are a lot of new route builds as well that we should expect over the next year?

Most of it is actually existing conduit. So the CapEx is really about 2 things. It's about blowing fiber through those empty conduit, and it's about building the ILAs, the in-line amplifiers, the sites that -- where the fiber comes out of the ground for the signal to be repowered and sent on its way. So we're well on that path. We're meeting all the milestones with our various customers. In some cases, in some of the contracts, we're getting incentive payments because we're ahead of schedule and on or below budget. So that's all very good. At Investor Day, we will separate out the PCF cash flows from the non-PCF cash flows. And what I can tell you is that even when you separate out the PCF cash flows, the business actually self-sustains over the next 5 years, right? So that is because the revenue trajectory is getting better. It's also because post the debt restructuring we did not yet 2 years ago now, once we close that sale to AT&T of the fiber-to-the-home business, our interest expense will be cut in half. So we'll be going from $1.4 billion down to $700 million. So the balance sheet is becoming a real point of strength, and it gives us a lot of options strategically. But -- so we will give you more of that. But what I can say for now is that with all the CapEx that is PCF driven with all the cash flows that are PCF driven, ex PCF, this business is self-sustaining.

And you've also laid out plans to materially expand your metro and long-haul fiber assets as well that I don't believe is really related to PCF, right? That's really just the core business. So maybe you could kind of outline the CapEx that's being spent in the core business, not related to the hyperscalers.

Sure, so if you look at our CapEx spend today and exclude the fiber-to-the-home business, we're spending about $3 billion. You should also exclude $1 billion from that because it's paid for upfront in the big builds, right? So there's really $2 billion of CapEx that we finance. $400 million to $500 million of that a year for the next few years is really going into maintenance. There's a lot of sins of the past that we're fixing generators that haven't been replaced in 30 years, things like that, a lot of tech debt. But the balance is either funding equipment, the old way of selling that we will still do as we're transitioning as we sell deals to customers, but it also includes a few hundred million a year to do things like these metro expansions and rapid routes. That's all about increasing the capacity for things like DC to DC, DC to prem, DC to cloud, prem to cloud. The connectivity, think of it as a mesh, a fabric mesh where digitally, the customer will be able to go from anywhere to anywhere on demand in minutes. That's what that's building out. And again, no one else is building it. So that's why we feel very good that we're not impacted by a bubble.

What about some of the other products that are within your grow bucket that you don't necessarily strip out every quarter, thinking like wavelengths. We've talked a lot about that with one of your competitors or IP. Like what are kind of the growth trends there? We've heard about wavelengths, for instance, is growing pretty substantially, maybe 5% to 10% a year at an industry level. I think you're the largest provider in the industry. So I assume that's been a nice growth area for you. Maybe we could just kind of dive into some of those products.

Yes. Waves, definitely, we're growing pretty much with market. And we're seeing a transformation, right? There's 1 gig waves that are pretty soon going to be in decline because people are moving up the stack, right? They're moving 100, 400. And let's remember, the fiber that we're putting in the ground right now in the next 18 months is going to go to 80 and 1.6T as that equipment comes along. So the speeds and the capacities are just going to continue to rise. So we definitely see demand in waves. We see demands for security. We had an announcement with Microsoft today about that we can talk about. We see dark fiber, so non-PCF, smaller dark fiber deals with customers, a lot around connectivity, security, edge, compute. So.

Interesting. You had an announcement a month or 2 ago about how you're actually -- your provisioning times in waves have actually come down quite a bit. I know that was potentially a criticism from some customers that it took so long.

It absolutely is.

And it seems like you've kind of maybe fixed one of the pain points. Does that help drive incremental conversations activity with them?

Too early to say. I can tell you, though, that the response from customers has been fantastic because our ability to stand up waves as these rapid routes, these waves-ready routes are put into place. And we're doing clusters of 16 cities at a time. The first 16 are done, and we're well on our way on the second 16. You'll see us continue to do that as we move our way around the country. But the time to deliver is reduced substantially and customers have been very pleased.

And the mass market sale or the Quantum Fiber sale to AT&T sounds like that's going to come very soon in the first part of next year. Maybe you could just talk about some of the cash -- free cash flow accretion you're going to get from that sale. And then as we think about what you retain, really your kind of DSL and copper base, presumably, AT&T is going to try to overbuild that in a quicker fashion. I assume you will probably enable them to do that given the structure of the deal. Does that potentially give you the opportunity to take some cost out of the fiber network? We have heard about some of the large wireless companies or fiber companies decommissioning copper and taking out maintenance CapEx.

Yes. Really a few things. So really excited about that deal and excited about the construct of the deal. We, to your point, are selling only the fiber assets. And frankly, we're selling really from the edge of the neighborhood into the neighborhood. We kept those main lines because they're critical to our enterprise strategy. And so the structure of the deal really worked well for us. We'll use the proceeds from that sale, the after-tax proceeds as well as some cash on the balance sheet. And we will entirely shortly after closing, wipe out $4.8 billion of super priority debt, which is what we put in when we did the debt restructuring not quite 2 years ago. That will bring down our total debt from a little over $18 billion to just a little over $13 billion, bring our total leverage down to 3.7, 3.8. It will go down from there. And oh, by the way, over the course of the last year, we've significantly restructured the rest of the stack. So it's a much more smooth normal maturity curve. The team has done a phenomenal job. So that's what we'll use the cash for. As it relates to the consumer business, there will be some overbuild, but I want to be really clear. The bulk of our footprint, we pass 17 million, 18 million homes. I think we've got a little over 1 million voice customers and about 1.4 million DSL customers. Most of those sit in very rural areas where I don't think they're building fiber. The opportunity though is -- and we're in conversations is I think there's a real opportunity between the 2 companies for us to use potentially AT&T's fixed wireless product. And to your point, when we think about areas where there's less penetration, the cost savings associated with turning that off, it could be substantial. So we have to get the economics right, but we will manage that business for cash. And I think it will be a long wind down because it does sit in those rural areas. We're probably talking 7-plus years. But there is a great cost takeout opportunity. Quite frankly, I think there's a copper mining opportunity, and that isn't even on our radar screens as it relates to kind of financial outlook at this point.

And the maintenance capital you spend on the copper network is a couple of hundred million dollars a year. Is that right? Something like that?

Yes, that's right. Just keeping things turned on, yes.

Yes. Yes. Got you. Okay. So obviously, there's some opportunity there. Okay. Great. And maybe we could just talk about broader cost transformation. I know you're in the midst of a broader cost transformation effort. I think ERP Phase 1 is the latest major initiative you're on, but I'm sure there's a lot more that lies ahead. And a lot of this within your guide to grow EBITDA in '26 and thereafter. So maybe you could talk about the main cost areas you're focused on today. Maybe any preview of what we should expect over time?

If you really think about the sector we're in and the landscape, the only way that scale -- go back to where I started the conversation, the only way that scale existed in enterprise telecom over the last number of decades is buying other companies. But when that happens, none of us, I mean, Lumen, I mean the other big guys, none of us ever consolidated the IT stack. So it is a dog's breakfast of tech debt. It's ugly. And the path to freedom isn't trying to consolidate all that. The path to freedom is selling all the new stuff that is replacing the old stuff on a clean new set of IT infrastructure and then turning off those old systems as those products retire. So a big, big piece of that modernization and simplification is really around addressing the tech debt. And so there's 2 paths, and we're running them in parallel. One is the big investments that take years to get in place, ERPs, right, the ServiceNows of the world, those kinds of things. The other path, though, and I can't emphasize how much it's helping us, is the use of AI with companies like Palantir, where they can come in and their algorithms will find connectivity and data across multiple systems, that actually move us forward much faster. We don't have to wait for those systems to retire. Case in point, when you're running whatever it is, 16 different order entry systems, you end up with customer disputes, invoice disputes. We're now, after a 5-week test resolving half of those through Palantir's tools. So as we go forward, there's going to be a lot more of that. We're going to get more efficient, and that's what's driving the $1 billion of exit run rate by the end of '27.

And there's been some big announcements from some of the telcos as well about headcount reductions and people are always focused on the future of AI and what that will mean for the labor force. So as you look at your headcount today and think about the kind of productivity unlock you can get by enabling them with more AI tools, whether that's software stack, whether that's building new routes, like is there a lot more of that to come that's beyond the $1 billion?

I think we're -- as a society in a place where that's inevitable. And I think what our job is, as leaders is to make sure that we're preparing people for the future, right? I think the more that people can be exposed to AI and how it can change their lives, and yes, there will ultimately end up being reductions, those are skill sets you can take to your next role, right? And so -- but I think that is a reality, right? It's a reality that a lot of us face. I don't know how much of the other announcements across the sector are driven by AI versus just broader cuts. We're focused on doing things the right way and making sure that everything is focused on the customer and that as we improve that customer journey and we can drive efficiencies, that's where that comes from.

And maybe just touching back on the revenue equation again. I know we talked about some of the products. But as we think about the customer end users, so the large enterprise versus mid-market versus public sector, how you kind of expect those to trend over the next handful of years until we get back to this kind of revenue stability and revenue growth?

Yes. I mean there's opportunities across the stack. We're very strong in public sector. We'll continue to be strong in public sector. Wholesale has been a decliner for the last few years because, again, we sell to our peers, they sell to us. Everybody is pulling back on copper circuits. So that's been impacting that. But as we move into the future, and we're doing more digital, I think there's wholesale opportunities. And in mid-markets and large enterprise, different scale. I think Network as a Service is big in both of those. But you think about mid-markets and the ability to deliver services digitally to customers, what a great way to reach that audience. In large enterprise, it's that and the end is extremely disruptive stuff like direct cloud on-ramps where very large users of data that need to feed those GPU clusters don't want to have to go through, for lack of a better example, county roads to get to the cloud, paying toll charges all along the way when they can get on the auto bond by connecting to the cloud directly through Lumen's network. And those are direct cloud on-ramps, 400-gig connectivity that is coming now. That is very disruptive to the space.

And maybe in the last few minutes here, we can touch on the balance sheet. We -- you alluded to it a little bit earlier, but you've reduced your annual cash interest expense by over $230 million, I believe, year-to-date. This obviously doesn't include the cash proceeds you'll get from the AT&T transaction early next year. So it seems like you're in a very good place. I guess -- and if you look at your maturity stack, you really don't have much at all until 2029. So -- but you alluded to on your call that there are still things you're looking at. So maybe you could just talk about what's kind of next on the agenda now that you've delevered so substantially.

It's been an extremely complex balance sheet. And I don't think that does any investor any favors, whether you're a credit investor or you're an equity investor. And so you will continue to see us simplify the structure, both in terms of number of reported entities so that we more closely align the way we run the business to the investors in those entities. But you're also going to see us simplify the structure. I mean we have 4 layers right now, right? You've got the super priority. You have first lien, you have second lien, you have unsecured. We can simplify that, too. Super priority obviously goes away. So we'll continue to do things in line with that in principle. And my goal is that our balance sheet is boring. I want to be boring. And I want to be the most boring guy at the credit conference, not the one that gets chased around the hallways.

Yes. No, that would be quite a transformation from many years ago. And I guess longer term, as we think about you returning to revenue growth, continuing to improve profitability, and you've talked about declining capital intensity, right? And how do you think about returning capital to shareholders? I mean it's a little bit premature to get into that today, but just a long.

Yes. No, we've talked a little bit about it. I mean, look, the #1 goal is to make sure that we are funding what we need to fund to execute the turnaround, and we're doing that. And that could be organic, which is where it's focused today, potentially. And again, I'm not signaling anything, nothing on the table today. It could be inorganic if the right thing comes along. The second thing is to bring leverage down a little more, so we've got some extra gun powder. And then after that, I think you're looking at share repurchases to the extent that there's excess cash flow because I think the stock remains well undervalued. We've seen obviously some nice valuation uptick. Obviously, the markets pulled back on the AI trade. Again, I think fears of a bubble that don't really exist for us. But I think that's where we go next.

And you've obviously pruned the portfolio significantly with mass markets, with some of the international assets being sold. I mean, do you sit here today, you think most of the kind of noncore asset sales are behind you? Or are there still some things on the margin that you can?

I think there's still some things on the margin. I mean, certainly, there's a copper mining opportunity, right? And there's a few other little things in there. Our real estate footprint will shrink over time. So we'll constantly be in the mode of getting rid of those things. Are they material to our outlook? No. But it's just good hygiene and a lot of costs tied in those assets, and it's a way to manage that.

Yes. Fair enough. And as we think about kind of longer term, where do you think kind of the right leverage level is for Lumen based on your current investment?

I haven't said it, but probably low 3s, somewhere in there. We'll give more guidance at Investor Day and more certainty. Look, there's 2 ways we get there, right? We get there by paying down debt. We also get there by inflecting EBITDA next year and growing from there. And one thing that we haven't talked about as we close is the ecosystem layer. And I think in our transformation, that may very well be the most important thing. And that's where I mentioned earlier, tech partners are building APIs into our network and pulling our network through with their products because it makes their time to revenue faster. It makes their customer experience faster. The number of tech companies that have shown up and have started to build APIs into the network, it's staggering. We talked about Meter yesterday, the Microsoft announcement today where they're taking our Black Lotus Labs threat intelligence and building it into Sentinel. We talked about Commvault on earnings and automated backup and recovery, Zscaler, it's coming. So I think a big piece of how we delever the company is actually by growing the numerator, and we're super excited about that.

Well, great. That's a great place to end. Thank you, Chris, for joining us today.

Thanks a lot.