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

Before we begin, disclosures are available at the registration desk. For those of you I haven't met, I'm Mike Rollins and I cover communication services and infrastructure for Citi. We're pleased to welcome Kate Johnson, CEO of Lumen. Kate, it's great to see you. Thank you so much for being here.

Thanks. It's always great to be with you.

I think back -- it was our January conference 2023, I think where we first met, you'd just come to Lumen.

I was there for a hot second, yes.

And since then, it's been extremely busy for Lumen. Over the more recent period, the team and you have discussed creating a new industry category. Can you unpack that for us?

Sure. So coincidentally, I started in November of '22 and on November 7, specifically, and ChatGPT 3 was the first publicly available instance of AI that we could all download to our phones, and that launched on November 22 of that same month. And I think when we talked in January, we were just starting to hypothesize this notion of really pivoting the network in support of enterprise data consumption growth, right? And I think we're there. We have created a platform for enterprise networking for AI. And I think while none of us could see it quite clearly, so clearly in November of '22, what we have now is people, data and applications are dispersed geographically. They sit in buildings. They have applications and data sitting in clouds and data centers and at the edge, then you add billions of AI agents, billions of them, and each one of these agents is generating and consuming huge quantities of data. And that data resides kind of everywhere and needs to be shipped everywhere. And the new problem that we are solving for customers is they have the need to ship data from anywhere to anywhere in real time to fulfill their AI ambitions. And in order to do that, you need three things. You need a massive physical network, you need a programmable network, so a digital platform sitting on top of that, and the cool thing about ours is, is it's agnostic to whose fiber is underneath. So we can leverage our great network but also other people's. And then you needed a connected ecosystem because what you're connected to really matters. It's not just the buildings, the edge points, the clouds and the data centers, but also you need to be connected to other technology companies. And we've got all three working together, and it's given us a growth engine.

Digging to this a lot deeper. When I think about -- just to start off, for background, when I think about Lumen's core competency in business and wholesale, I think a lot about Level 3 and what that brought to the table for your company. And I think about it, as you mentioned, like some combination of business locations and data centers and there's a variety of products used to connect all of this together, right? It used to be called like Frame ATM, Internet transit and MPLS. Now it's lit fiber waves, dark fiber. So the question is, as you look today, the Lumen of today, the Lumen of tomorrow, like what you're selling to customers? Is it a different menu? Is it different pricing models? Like what should we take in terms of like what you're actually selling into these customers?

It's -- everything is changing. So the classic way of connecting and transporting is becoming digital and on demand. So I want the ability to fire up the circuit and and pick my bandwidth and pick my security levels and things like that, but I also want to orchestrate it. So it's all of connectivity and transport just like the past couple of decades, but it's this new set of capabilities, which is unique to us as a carrier, which is the orchestration layer, which says I need to be able to manage policy, I need to be able to control the data flow. I want to pick where it goes and when it goes there and to set all of the attributes of how big it is, how secure it is, how fast it is along the way. And what that enables us to do is go -- we used to sell physical circuits, how many you want to buy, we worked with procurement. They set a price and bandwidth limit and said not to exceed X and Y. And now we're really selling outcomes. If you think about hospitals need, for example, real-time diagnostics across their systems. Banks need real-time fraud detection services across their branches. Retail companies need real-time inventory management across all of their warehouses to get the right product in the hands of the right customer at the right time. You can't do any of that without AI, and you can't support AI without a programmable network. So we finally have a seat at the table with the CIO and the CTO to have a conversation about delivering business outcomes, which is very different than where we've been in the past.

And so when you mentioned the orchestration layer, is that what you really mean by a programmable network?

Sure. Programmable, really, it's defined by a couple of things. Number one, can I see it through a single pane of glass? Can I see it...

On your screen?

On your computer screen can I look at the network and see the whole thing? Where is the circuit? What are all the qualities of it? What bandwidth is it? How is it performing? What security services do I have on it, et cetera? Can I see it on a computer screen and can I manage provision and support it without actually having to physically go do intervention, okay?

And so how disruptive is this in terms of a shift? And where do you see the marketplace relative to where you're going?

So it's incredibly disruptive on a bunch of different fronts. So the first thing is it's disruptive from a business model perspective. So let's talk about old telco, point-to-point static bill every month, take a couple of months to deploy a circuit, set it up, and you're good to go for a long, long, long, time. You're not going to give much innovation, right, but you're going to have this static route that's there for you if you need it. That's not where we are now. We're saying that AI requires data to be moved from anywhere to anywhere in real time, which is non-deterministic. So you can't actually build a physical network with the legacy business model to support your AI ambitions today because you wouldn't be able to afford it. You'd need to put a link into every single building and every single cloud and every single data center. What we're selling is on demand and consumption based. We're selling an option to consume these services on our platform, and that's incredibly disruptive from a business model perspective. But we're also doing a lot of technical innovation that's disruptive to existing business models. I'll give you two examples. One is colos where -- MeetMe rooms where traditional enterprise connected through these colocation facilities and carrier neutral facilities into the cloud, tens of billions of dollars of fees to get that connection. When we built out PCF for the hyperscalers, we also worked with them to start to conceive of a brand-new architecture for cloud connectivity. And our cloud on-ramps bypass these colocation facilities and go directly into the cloud. So it bypasses that fee, it's more secure, it's higher capacity and it's more cost effective. That's one. About another example of network innovation to disrupt the marketplace. As people, data and applications geographically dispersed, you have this proliferation of these colos as well as firewalls, right? Every time you have a person that needs to access your network somewhere, you have to segment that part of the network and make sure that you have local policy to protect that person's data and also to protect the company from the motions of bad actors as well as whatever that person is consuming on the network. When people keep dispersing you've got more and more proliferation or sprawl of these firewalls and it all need to be managed locally from a policy perspective, right? We now have a platform that allows us to manage policy centrally with a single cloud service rather than locally across hundreds or sometimes thousands of different firewalls. One service centrally cloud provisioned versus hundreds or thousands of physical interventions locally is a huge economic shift. We saved tens of millions of dollars of hardware for our customers, and we can deploy things instantly which is obviously sort of the way of the world these days. So it's not just the business model disruption, but it's also technically we continue to innovate. I've got a bunch more examples, but I'll leave it there.

No, this is great. So just the centralizing security, essentially is what you're describing. So through software, you're able to centralize the security for multiple business locations, customer access points. And so you're delivering the same quality, reliability, security.

I would say -- I would argue better.

But from an easier point.

It's more efficient, it's faster and it's more secure. And Mike, I never understood when I was working for Microsoft leading their U.S. business, I could never understand why network wasn't cloudified. Compute storage were cloudified. We could do all these things with compute storage, but never with networking, I couldn't understand it. And then when I got into the industry really telco had ceded innovation to all of the tech companies outside of the network, and Lumen is bringing all of that innovation back into the network.

As I think about what you're describing, it feels to me like the reason maybe network has been tougher is because there's such a physical aspect to it, right, where cloud compute, you can locate it in different places and get similar...

I don't know. With digital twin technology we can instantaneously create a digital network. So that's why I never really got it because have you seen chips, like they're physical too, right? Storage, compute, physical. But in our minds, all digital. You can actually go find that hardware somewhere. So the fact that there's a physical network, yes, it's geographically dispersed and it happens to be in the ground, which has its own set of challenges, et cetera, sometimes it's aerial. But for the most part, digitizing the network was logical, and it's absolutely essential for AI. We cannot achieve our AI ambitions in this country at a global level without a digitized network.

So when you think of the Lumen value proposition to customers and then ultimately to shareholders, like how do you rank the importance of your physical network versus your software and the technology that you're using to now in the future deliver network? And maybe there's a element of this that's people and resource, like how do you think about what your greatest most valuable assets are?

Back in the day, before this -- we started disrupting the industry, it was just a physical game. You always wanted to win the build, you always wanted to have the physical infrastructure. Since we've created a programmable network, we are now agnostic to the underlying fiber itself and to any cloud or provider. So you can run our services across that, which is great -- across anybody's fiber, which is great because there's this notion of diversification. Customers want to have multiple routes to get to the same thing, and they tend to do that through separate carriers. We can do that for them quite easily. But what's more is we can orchestrate and make AI work on anybody's network. So back to your question, it used to just be table stakes, I got to have the fiber to win the service business. That's no longer the case. Lumen can operate globally now, which expands our TAM massively, but probably more importantly, we do have the world's biggest and best network. Those are my -- that's my opinion. And I think that it compounds our value in North America for sure, because I could build on ramps, because I partnered with the cloud companies to build multi-cloud gateway, so I can ship data from into any cloud and in between clouds really, really well. And so that's how we think about it moving forward is that sometimes, I want to have the physical link. And I want to have the physical link because I can embed incredible technical capabilities into it to do things that others can't. But since I've been with the company, when I started, we were 12 million fiber miles strong. And by the end of 2031, we will be 58 million fiber miles strong, so almost quintuple what it was. And that's to serve the hyperscalers, but also we've reserved a very large percent of that network for our enterprise business, which is growing now that AI is helping companies transform.

I want to get back to that opportunity in a moment. But before we do, maybe just taking a step back and as you think about this transformation, if you can give us an update on the multiyear journey to return the company to positive financial growth, revenue, EBITDA, free cash flow?

We're right on schedule. So we promised stabilizing free cash flow. Check, got that under control. The second thing is we promised EBITDA growth in '26. Check, on target for this year, which we're super excited about. And then third, the third step of that was returning to revenue growth. And what we've committed to and we see a path to do so is to return to positive revenue growth in the business segment in 2028, on target.

So coming to the PCF opportunity in the hyperscaler opportunity, market is very focused on this. How important or future deals? I think you were at $13 billion contract value. So how important are these future deals? And do you have an update on where you are or where that's going?

First things, how important are the deals to our future. We have zero PCF business based into our long-range plans. We don't forecast it. It's very lumpy, and what that speaks to is how strong our strategic revenue growth is, right? We don't need the PCF deals to transform our business anymore. But we did at the time that we did it -- did those deals, the first $13 billion we really needed that cash injection. And it helped us transform financially. We were able to recapitalize. We completely transformed our cap structure. We simplified from three filers down to one in combination with selling fiber-to-the-home to AT&T. Really turned the balance sheet in totality from a liability to a very strong asset. So we're not there anymore. We don't need the PCF deals in order to fund future growth, and the real opportunity for the company, the one that delivers higher margin, higher quality revenue is the digital platform piece of it. So when we think about doing more of these deals, they've got to meet certain criteria, and it's basically builds are not really something that we're signing up to do. We will do over pulls of our existing conduit because we can hit margin metrics that are accretive, and we're pretty committed to delivering a mix shift to digital that delivers margin accretion to our shareholders in addition to revenue growth.

Is there an element of this? You mentioned earlier that one of the things that you're doing is you create these PCF or have created these PCF deals, you're creating this connectivity you're reserving extra capacity, whether it's to sell the enterprises, whether it's to connect to these clouds directly, so you've got control. So is there a magnetic effect that having more of these customers, so it's beyond just like a return on capital of this specific deal, but there's this evolution of you just want to have all the strategic customers that could be winners in the future because that's going to pull through all this enterprise and the ecosystem?

Once they plug into the fabric, they're in the fabric and they have access to all of the capabilities. But when I talked about the financial transformation that the PCF allowed us to do, that's also where the source of all of our innovation came from. We launched NAS. We codeveloped on-ramps with all of the hyperscalers. We built multi-cloud gateway. We garnered enough extra cash on hand to go buy an orchestration platform called Alkira. All those capabilities came from that initial tranche, and now that we have all of the biggest companies in the world plugged into the network, we're continuing to innovate with them and to work with them to say how can you take advantage of our network to grow your business, and that's the magic. I say I came from Microsoft. Any company or a customer that could help us accelerate cloud consumption was one that we wanted to be a part of the ecosystem. And it's the same as Lumen builds this platform, we know that the way to ingratiate ourselves with those cloud companies is to accelerate consumption of their platforms. And we do that because we have bigger pipes, they're more intelligent, they're more secure and they drive acceleration.

So you mentioned with the enhanced financial flexibility, you went out, you bought Alkira. We were talking about some of the orchestration cases earlier. What did this acquisition do to turbocharge what you're offering to customers? And what's the value that they're going to see now from having this added capability?

So think about it this way. We bought an orchestration platform that allows us to move data from anywhere to anywhere, cloud core, data centers, edge, buildings, it gave us access to two things, $47 billion of TAM, right, because companies need the ability to move their data from anywhere to anywhere. And it gave us access internationally because it's carrier and cloud agnostic. So there are so many different use cases. It's almost impossible to -- can you tell them excited, by the way, it's impossible to go through them all. But think about extra net direct connection between technology companies happens all day long. We can do this with our private network and the orchestration capability. Moving data from cloud to cloud, we do that exceptionally well. And again, firewall and colo sprawl, it allows us to deliver centralized cloud services that eliminates the need for local policy setting and local intervention, so it's a brand-new set of capabilities. It's capabilities that are sitting with the CIO, the business decision maker, the CTO, we are now out of procurement. We don't sell physical links anymore. We sell business outcomes. Huge transformation for us, huge transformation for our customers and something that's going to take time for us to build the muscle and for them to see us in that way.

So maybe just to double-click on that just for another moment, so you're changing who you're engaging with in the organization, how far are customers along in this journey? So what percent of the customer interactions have now moved to that level versus that's where the puck is still going?