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

Good afternoon, everybody. Welcome to the Lumen fireside chat at the Goldman Sachs Communacopia and Technology Conference. My name is Mike Ng, and I cover Lumen and media cable telecom here at Goldman. And I have the privilege of introducing Chris Stansbury, who is the President and CFO at Lumen. First and foremost, thank you so much for being here this afternoon.

It's great to be here.

So Chris, you've had a very busy year with the sale of fiber-to-the-home assets to AT&T, the Alkira acquisition. Now that those deals have closed and you've hit your leverage target, maybe you can talk a little bit about what execution looks like from here and what the strategic priorities are for the company?

Yes. The future for us is very clear, and that is a complete digitizing of the networking experience. And when you think about our portfolio today, we've already got a significant growth company inside of Lumen. That's over half of our revenue. Last quarter, it grew 14%. We separately have a legacy stream of revenue, and that's sole purpose is to generate cash while we pivot this transformation. And that's something that we'll continue to do on that side. But as we go forward, Alkira, combined with what Lumen's footprint is today and our ability to provide direct cloud access, when you combine that direct cloud access and our NaaS capabilities to get you from premise to the cloud, we now have what we would refer to as an East-West capability, which is really the ability in a very network and cloud agnostic way, move data from anywhere to anywhere on demand. And so as enterprise moves to inference, the network is the bottleneck. It's not energy, it's not GPUs, it's the network. And we've just created the unlock to make all of that work in a much more efficient way, but also a lower cost of ownership way. So we think it's the right solution at the right time, and that's the focus.

Great. You talked about the strategic revenue within Lumen over 50% of business revenue today. I believe strategic revenue includes PCF, private connectivity fabric, digital and other growth revenue. To set the stage, maybe you could just talk about what's in strategic revenue? What key products are?

Sure. So the historical base of strategic revenue is really connectivity solutions. So you're going to have fiber waves, IP, security will be in there as well. That's the bulk of what's in there. What we're really seeing in terms of growth today is significant growth in on-demand waves, which is not a surprise. When we talk about PCF and those big pipes, those are really of interest to a very few customers. The capacity is enormous. It's largely hyperscale focused. And even with existing conduit and existing routes where we can deploy relatively quickly, it's still years, right, until that capacity is fully online. When you get into other customers that are big customers, big users, neocloud, as an example, waves is really the solution because it's ready and it's ready now. We've invested significantly in the network and our ability to provide 400 gig waves on demand, we had revenue grow, I think it was 11% last quarter, but sales actually grew 35%. So connectivity is still the underlying piece that's driving the strategic revenue.

That's super interesting. I mean why don't we talk a little bit more about waves, private, dedicated bandwidth, SLA reliability, why are neoclouds asking for waves? Where else is the demand coming from? And what does the competitive landscape look like?

Yes. So if we think about what's happened in the connectivity environment over the last few years, there was this burst at the beginning, which was really PCF driven, which was hyperscale demand for training of their LLMs. It was for internal consumption. They need massive pipes to deal with the training aspect of AI. As we move into inference, the next largest customers who are part of that ecosystem is the neoclouds, right? And immediately on the heels of that is enterprise. And that's where you start to move into the waves environment because it gives you that connectivity that you need right now. And our ability to sell that is bolstered by the fact that our waves product today on a NaaS circuit is digitally available. You can self-provision and you can be up and running in a very short period of time rather than waiting for trucks to drive around. So it's the combination of what we have today as a capability and what's being deployed through network as a service that makes this a very compelling offer for enterprise and the neos.

Super interesting. Maybe we can talk a little bit about PCF. Lumen has one of the largest fiber networks in the world. Obviously, some direct exposure to support distributed AI training in the case of PCF. Maybe you can just talk a little bit about PCF, the growth in that business, potential opportunities you see for more PCF orders in addition to all the success that you've had with that product to date.

Yes. So let's talk about just the broader network footprint for a minute because where there is not a return today is new builds. New routes that require new conduits have really low single-digit returns on investment. And we've been very clear that we're not interested in doing that. We don't need to do it. And we don't need to do it because we've got -- by 2030, we estimate 58 million miles of fiber in the ground. At the same time that we're providing a digital access layer to consume it, and with Alkira, a product that allows enterprise to orchestrate across anybody's fiber. So to invest hundreds of millions of dollars in new routes is just not where we're going to focus. PCF is different. PCF is existing roads. It's conduit that was put in the ground 25 years ago. It was put in the ground at a time where they thought they'd get about a dozen strands through each 2-inch PVC. And today, we're pulling over 1,700 through each 200 -- through each 2-inch PVC. So the reality is, is that we've got excess capacity. And PCF really solves 3 things for us. The first is it allows us to monetize a dormant asset and at great margins and great returns that has in turn allowed us to delever. The second thing is that it has created proximity with the hyperscalers, which is why we have direct cloud on-ramp access in our facilities. Gone are the days where you have to slow down your signal and pay interconnect fees to get access to the cloud. You can get 400 gig access through Lumen's network without having to go through an interconnect logic. And without the infrastructure that you need at every point of interconnect, you don't need hundreds of firewalls and load balancers and all the equipment that has to be managed. So you can simplify all of that. The third thing that PCF brought us is as we're pulling fiber for the hyperscalers, we have pulled fiber and continue to pull fiber for our enterprise customers. We've talked about rapid routes. We've talked about metro rings. Our ability to deliver a 35% sales growth on waves is because we've made those investments and we've got capacity that is ready to sell today. So when we look at our CapEx guidance, which we talked about at Investor Day back in February, that's inclusive of all those investments. So PCF is a great opportunity to unlock that value in those 3 ways. There will be more. We're in multiple conversations today. But whatever is incremental to what's already been sold is not part of our algorithm or our guidance from Investor Day. It's upside, and we'll use those cash proceeds to continue to delever.

Right. And just to clarify, so the CapEx associated with PCF is not for digging new routes, it's for the fiber that goes into the pipe?

That's exactly right. And so of our roughly $3 billion of CapEx that we've guided for the year, about $1 billion is for PCF. And it's not capital intensive because it's paid for before we pay to the suppliers. So there's about $2 billion that is supporting the ongoing base Lumen business and $1 billion that's going into PCF.

Great. And then before we move on from PCF, I was just wondering if you could talk a little bit about the financial contributions that you expect from PCF in terms of revenue? Maybe talk about the cash margins and that sort of thing. You guys have had a tremendous amount of success, right, with Microsoft, GCP, AWS, Meta, Anthropic, I believe, as well. So just talk about what the cash margins looks like.

Yes. So what we said is that the cash contribution is roughly 30%, roughly our EBITDA margins. So EBITDA less CapEx gets you to roughly 30%. And we gave guidance, I can't recite it off the top of my head, but we gave guidance at Investor Day that talked about how the revenue would ultimately come into play because what happens is we recognize the revenue as route segments get delivered, and it gets recognized over the balance of that contract. The cash, we gave guidance on because the cash, 90% of the contract value, the cash is received in the first 3 years, and that's to support the rental fee for the conduit as well as to support all the CapEx. 10% is earned in a year to run the network. And so the Investor Day materials gave an idea of how the revenue would flow, how that CapEx would flow and what the free cash flow look like.

Great. One of the things that you mentioned on last quarter's earnings call that I thought was interesting was just your work around satellite backhaul. And obviously, satellite has been more of a topic of focus recently. And I think Lumen provides satellite backhaul for many enterprises. Are the number of ground stations increasing? Are you seeing that in your satellite backhaul demand? Is it meaningful enough to show up in the P&L? Like how do you think about it?

So it is an area of growth. And I think, clearly, as we see more players in that space, providing network connectivity, we'll continue to see growth there. I think the bigger point is we're at a point in our transformation where enterprise, whether it be a satellite provider or whether it be a multinational bank, people are moving enormous quantities of data today. It's getting more and more dispersed because every piece of data has a home, right? It's sitting on a storage array somewhere. And the issue is there are so many somewheres today that it's getting impossible to manage in the way that networking has traditionally managed it. The way networking has traditionally managed it is, "Oh, you need a pipe between A and B, okay, I'll build it for you. Oh, you need another one, okay, I'll build another one." There are too many to build. The issue is the complexity and the static nature of those deployments today. So when you combine a network footprint that is extensive, but then you provide an orchestration layer that literally lets you provision, manage security, manage segmentation, give you visibility into the network, provide security and do that, frankly, on a global scale. There's a number of enterprises where that's going to be attractive. And so satellite is just one of them.

Great. I wanted to ask about Starlink as a potential threat, if I could. Starlink has ambitions to build a very large enterprise business, whether that's providing connectivity to enterprises or whether that be for broadband or for backhaul. Do you see that as something that is competitively differentiated relative to what Lumen currently offers?

I see it as complementary because the reality is that there will be endpoints where the most logical way to connect is satellite, right? It's not going to make sense to bring fiber to every location. The reality though is that, that data that flows up to a satellite and back down to Planet Earth is going to need to find fiber as fast as it can. So it's another point of consumption that ultimately ends up on fiber. And again, what it does is it feeds into the complexity, which is enterprise is going to have more and more data that continues to be dispersed further and further away. We don't know where all those endpoints are today. And what we thought was going to be an endpoint last month is not an end point this month because there's a new regulation that says we're not going to allow data centers in our neighborhood. And so that uncertainty and that complexity is exactly what we're able to solve today. So complexity is good. Complexity brings margin.

Great. If we shift gears a little bit, I wanted to ask about digital revenue. Lumen has guidance for $800 million to $900 million in digital revenue by 2030. First, could you just talk about what's in digital revenue? And then what are the primary drivers of that growth through that digital revenue?

So, digital is really taking what is traditional services, traditional connectivity and digitizing it, meaning that you can buy it, provision it, deploy it without a truck having to roll to your location. And so as we -- what we've provided some level of insight to are adoption metrics for Network as a Service, number of customers, number of ports. We're ahead of our own internal desires. A lot of those ports haven't been installed yet because the customer is not ready. They bought it, but they've got to do some work on their end. As soon as those ports are installed, they give us the ability to then sell every other service digitally through software at incremental margin that is starting at 80% and fast approaching 100% because it's digitally delivered. The marginal cost to provide that is effectively 0. So that's the goal is to digitize the entire network so that all services can be provided digitally. And interestingly, and we've talked about this and there'll be more to come, but in earnings, Kate talked about the fact that some legacy services, I should say, traditionally delivered services that fall into our strategic bucket, direct Internet access. There are a number of ports in our system today that Alkira and their technology effectively makes a digital port. It allows us to deliver more than the service that, that port was installed for. And so the important point is it allows us to scale. So that piece was not in our guidance. We're doing some work on that and we'll communicate more with the market. But ultimately, to the extent that we can digitize those circuits, it allows us to then scale and sell N+1 services beyond that. And so that's another way that we can drive growth.