Optimum Communications, Inc. (OPTU) Earnings Call Transcript & Summary

Good morning. Thanks for joining us. I'm Phil Cusick, and I cover the comm services and infrastructure space here at JPMorgan. I'm glad to welcome Dexter Goei, CEO of Altice USA. Dexter, thanks for joining us.

Thanks, Phil. Nice to see you.

Nice to see you. Given these unprecedented times, maybe let's start off with an update on what you've seen in the last few weeks for customers and how your employees are doing.

So we -- as you saw in our first quarter, we had very strong results, both on customer net adds and on broadband, with a little bit of a continuation on the trend on video, as we saw in the fourth quarter, for the first time over at Altice USA. So the trends are very similar going into April and year-to-date. A little bit of a geographic shift in so far as our Suddenlink properties locked down a little bit later than the Northeast. And as such, the volume on gross adds kind of just shifted 2, 3 weeks relative to the East, where we saw a big surge of traffic and activity in March, and that's basically what happened or very much similar trends in our selling properties in April. So the activity levels are very strong. It's been, let's call it, all the way until mid-April very, very much gross add driven, just very strong performance across the board. I would say in the last 2, 3 weeks, we are seeing the benefits of also reduced churn, right? So that is helping continually very strong trends in our business year-to-date. In terms of workforce, we are up and running. Clearly, we have field services that are an essential service for installs and service visits. We have obviously a very strong protocol on worker safety and also customer safety. So there's a whole host of things that we precheck ahead of a service call. Most of -- almost all of our call center people are working from home. The entire corporate staff is working from home. It's really essential network-related people that are in our headquarters, in our network and our NOC; and then secondly, just the field service people. So we're doing pretty much what we can do as best we can while at the same time helping to service our clients and being responsive as much as possible given the surge of traffic and demand for the products.

Okay. I think you said recently the most of your improved broadband performance has been in DSL markets rather than against FiOS. Do you think the shift of people being at home has permanently changed the penetration opportunity against DSL?

I do. I absolutely do. If you typically look at our Optimum footprint, let's put aside Suddenlink, we are quickly seeing a lot more activity usually on the competitive footprint with FiOS. Our performance in the first quarter and year-to-date has not changed whether or not FiOS is installing or not. It's been pretty steady relative to that, just a very highly penetrated area. But where we've seen a large uptick in the activity levels has been in our noncompetitive areas or competitive areas relative to DSL. And clearly, we've seen a lot of activity there where we're seeing never corders and DSL guys coming on board across our footprint. And that has been a little bit surprising but not -- intellectually not surprising at all given the activity levels from home, given children at home. And I absolutely believe that the opportunity for us to increase our penetration levels in those areas has increased significantly.

Is the credit quality or the demographics of those customers coming in, whether they're DSL or never corders? Are they significantly different than average?

I mean historically, we've always said to ourselves they are the lesser attractive demographics of our area. I don't think we have the full statistics across our footprint to understand whether the medium household incomes, particularly in the Optimum footprint, are significantly different in certain areas than others. But that has clearly not been an issue here in the last 2 months since we've been down in lockdown for us to be driving a lot more increased activity in those areas. And similarly, I guess, on the Suddenlink footprint, the gross add number has been very strong. And so as we start piecing through that data through the rest of the second quarter, we'll give you some more in the end of second quarter as to where we think that's coming from.

Okay. And you grew broadband ARPU nicely in the first quarter. Obviously, there are some accounting issues there. But after a pretty healthy price increase, you're going to see, I think, even bigger growth this quarter. I can't believe I'm saying this, but is the strength in broadband an indication that even with a pretty healthy price increase here, you're still underpricing this product?

Listen, I think we continue to have a great upside in upselling our tiers. 2/3 of our broadband subscribers today are doing 200 megabits or less. You are -- as you mentioned to me right before this call, you've upgraded to -- from -- I'm assuming 200 megabits to 400 megabits. And if you had the ability to go to 1 gig, you probably have - - would have gone 1 gig. And so that road map that we are seeing, we're seeing a lot of activity. They're in the tens of thousands. They're not in the hundreds of thousands. The opportunity for us is 2.8 million of our subscribers today are taking 200 megabits or less. And as we see this type of activity, the change in dynamics in terms of being at home, whether it's for school reasons or for work reasons, and the fact that we're upgrading fully, obviously, on a 1-gig basis on coax, but we're upgrading the entire Optimum footprint to fiber-to-the-home, we have a product road map that is extremely lengthy in terms of speed capacities. And as we think about all of the different elements here, what really is striking is that the Optimum footprint arguably in terms of a non-accounting basis ARPU is significantly lower than Suddenlinks', right? So because of the activity with FiOS and other competitors, we have a lower-entry ARPU on broadband, which, as we deliver superior products and a superior road map going forward, we think we're going to be able to push those ARPUs nicely, particularly since the income levels here -- the average income levels here are 20% higher than the rest of the U.S. So it really gives us a lot of comfort that, let's call it, the non-accounting, high single-digits, low double-digits broadband growth in revenue and ARPU will continue for the time to come.

Okay. And we heard from a couple of our big telecom carriers just yesterday about how with 5G, they're going to start targeting more home broadband customers. And it sounds like almost on a neighborhood-to-neighborhood or house-to-house basis where they have excess capacity for T-Mobile. Does that change how you think about that dynamic over the next few years as at least that alternative to cable that right now is just DSL starts to improve?

Listen, I think we've had this discussion for the last couple of years around 5G, the limitations in the performance and the pricing limitations relative to fixed and any type of metrics, whether it's a per-gig cost or whatnot. And we were supposed to have fixed-line substitution in 5G already today. I don't know whether you've seen any of it or heard any of the anecdotal stories around it, but we're big believers here. We understand the technology extremely well. Our sister companies have deployed full 5G in Europe, so we understand those. And we understand its limitations, right? And we think it's a much more complementary experience to your fixed-line experience than anything that somebody, on a rate-for-rate basis, whatever, trade in really a wireless connection relative to a fixed-line connection. So I'm not saying that it's not a concern of ours, but if you look at our footprint in the West, 3.5 million homes passed in very rural areas, I think those will be areas where any semblance of a 5G competition will be difficult to make economically work. And then secondly, in the tri-state area, you do have ourselves. You do have FiOS here. And you do have a lot of contention and line-of-sight issues here that it makes it, let's call it, just more difficult to compete economically in our areas. So we're probably, at least from a structural standpoint, if the technology worked, and that's a big if, and when it works, and that's a big when, we are probably one of those areas where we're somewhat structurally protected for a while.

Okay. And you said recently that you plan to overbuild FiOS with fiber within the next 2 years. How should we think about the pace of fiber deployment beyond that?

Yes. So we -- year-end last year, we were at 700,000 homes ready for service. We are about to launch our double-play product here in the next -- hopefully next quarter in there. And we were on pace to doing a nice acceleration here in 2020 until we ran into what we're dealing with right now, where we've effectively had to shut down most of our construction there. So I suspect we're going to end the year more like 1 million homes passed, maybe a little bit more in terms of ready for service. But we clearly then will accelerate in 2021 and 2022. I don't want to call it yet. We're not obviously in budget 2021, but we will be doing efforts to try and double that next year and get to 3 million homes by the end of 2022. And that will cover our entire FiOS footprint, plus we'll be targeting some of the wealthier areas of the Hamptons, Fairfield County, some parts Westchester County, those types of areas. And then the question for us is going to be the rollout of the last 2 million homes. Today, I have a desire to do that. I've actually -- we've actually seen what can happen in our non-FiOS zones relative to the interest levels for better service at a performance and the ability to pay and pay up. So it will always be much more efficient from an NPV standpoint in terms of our OpEx savings and our CapEx savings to do out the entire 5 million homes. But that's just a point in time today. Let's have that discussion continuously over the next couple of years as we finish off our FiOS overbuild.

Okay. And maybe talk about what trends you're seeing in video. There's been a discussion as to whether we'll see accelerating cord-cutting. We think that may happen later in the year as the economy gets worse and maybe some of these subsidies come through. But right now, we've been hearing that cord-cutting has actually been pretty reasonable from carriers. What do you see both in terms of the churn side and then attach as customers are taking the broadband?

So in the fourth quarter and the first quarter of this year, the acceleration that we've seen on a like-for-like basis for ourselves has really been driven by lower attachment rates. So the attachment rates, as you may know, in the Optimum footprint have typically been around 60% in terms of gross adds, and that number has fallen down to 43%, 45%, right? So that delta is what's driving the supermajority bulk of our acceleration in video losses. That's not a bad thing for us from an economic standpoint. And if we're going to see a deterioration in our videos, we'd much rather it be on the gross adds side given that's an economically challenging client for 2 to 3 years, particularly on a free cash flow basis. And so the economics are good. And actually, it gives us comfort that we're not seeing an acceleration in cord-cutting, which I don't -- our peers are saying on that. But we're not seeing that here, particularly in the Optimum footprint. So as we shift into April, we've seen a marked -- a significant change in the slowdown of disconnects there. And so the numbers are tracking closer to what we've seen before Q4 of last year than it was at Q1 this year. So it'd be interesting to see how that continues to evolve, but May, at least as of today, is looking pretty good. So we -- our perspective here, just intellectually, is that as people are on lockdown, TV usage and the desire to have a bundle continues to be a high priority when people are at home. So does that foreshadow a Q3 or Q4, as we come out of lockdown, switch in people? I can't call it. You would arguably expect to see something like that given the economic challenges that we're running into. But from what we see today, we forecasted a deterioration in our subscriber numbers in Q3 and Q4 just to see what it would look like based on economic challenges, and we still feel very comfortable as to where our performance is going to be for the year.

Let me ask you about that attach rate. Was there a change in how you talk to the customer when they call in looking for service that was somewhat related to that lower attach rate? Did you push wireless harder or try to upsell on broadband with more that time than pushing them on to video?

No. Not at all. I mean as you know, a large part of our activity is e-commerce driven today. So we're at about 40% of our subscribers are e-commerce driven, and then another 40% typically are doing inbound calls and then the rest is door-to-door and retail. We're not approaching it. Clearly, the e-commerce activity is directed by the consumer, and those tend to be very much lower attachment rates on the video product. And it's really the inbound, so -- where we've seen good consistency from -- of -- from bundle. But as people aren't moving, as we continue to grow our e-commerce, that's where you're seeing the lower attachment rates coming through on e-commerce attachment, right? So -- which makes a lot of sense, right? People have the choice. They're going specifically to broadband. There's no real desire for the video product. They're not getting talked to by a third party and making the choices, and it's a lot easier.

And so as we shift more and more toward, I imagine, an e-commerce channel, more sophisticated customers, who are more comfortable doing business on the Internet, that lower attach probably continues?

I think that's right. I think that's right. Obviously, today, when there's no sports on, when you think about the bundle, it's very much driven by news and sports. People are watching, obviously, a lot of news today. Our ratings, both on Cheddar and on News 12, are through the roof. But with no sports on board, no one is really looking to attach themselves today on a gross add basis, which is interesting. So the activity that we're seeing in April and in May is really about reduction in churn of video. So where we were seeing a reduction in attachment rates, which was the trend in Q4 and Q1, what we're seeing here in better performance is a reduction in churn on the video product, which totally makes sense.

Yes. Yes. Some of the comments from John Stankey this morning and from other speakers yesterday, it's clear that more and more content is going to be sold on a sort of a VOD or over-the-top basis than has been in the past. And over time, that probably starts to include sports as well. You've talked before about the risk of that catalyzing the video downshift. Can I ask, how do you frame your conversation with programmers today? And as you think about writing new contracts over the next few years, how do you protect yourself from maybe a deteriorating content and exclusivity on the linear side for the next few years?

Well, I think to decouple that question on our conversations with programmers today, it's all about having a lot more options on the menu, including the contract, right, which is, to the extent that, that platform does not have an OTT service today, to make sure that we are able to get that at the same time as anyone else there so that we're not precluded from having them; and secondly, for those that we know are out there either actively preparing it or about to launch, we're in active economic discussions on how to be a partner with them, right? So there's an expected launch, as you know, very soon. And the gentleman you referenced in your question is about to launch. And so we're in active discussions, and it's been very productive to be a good partner there with them. And so we think it's all good news. No matter what, it's all good news, which is consumers want options to pick and pay what they want to do. For us, the degradation of our gross margin continues as you're flowing through 3- to 5-year contracts. And so the only meaningful savings that we could see in our business on a direct cost basis is as we start renewing and trying to change that dynamic in terms of affiliate fees going the wrong way for us. And I think we're there. I think we are in that stage of our lives where our partnerships and our discussions with programmers are very much more realistic in terms of what we see, what they see and how to help them and help us transition into a much more consumer-friendly situation where people are watching and paying for the stuff that they want to watch.

So how do you think about what that consumer-friendly situation could look like? We've been talking about a la carte for more than 10 years. Is that the -- are we talking about the beginnings of some kind of a la carte structure?

I think -- listen, I think that the -- once you have sports, local RSN sports that transition to some type of an online OTT platform optionality, that will be the big change for everyone, right? And as you look at the economics of the RSNs today, they kept you to drive decent per-subscriber affiliate fee growth, but the subscriber base is deteriorating at a faster pace, right? So the net-net of it is most of the RSNs are going into negative growth territory and distributors like ourselves, as we renew, are just not going to deal with much higher affiliate fees. And so this is where we're going to see, I think, over the next couple of years a real transition here on the consummation of sports. And if you consume sports a bit differently, I do think that radio consumers on MVPDs or vMVPDs may change the way they consume their video product as well.

Could that ideally result in some slowdown in the departure rate of pure linear video and improvement in margins over time? Are we just -- am I ahead of myself?

Listen, I think so. I mean, at the end of the day, people do want a video product. Maybe the fat bundle is very much a product that is for higher-income, family-oriented, probably higher-age-group demographics. And we have a lot of those, particularly in the Optimum footprint. 30% of our subscribers have been with us for over 10 years, and 50% have been with us for over 5 years, right, so -- on the video product. Those are very good subscribers for us. I don't anticipate, and we haven't seen it yet, a strong acceleration in churn rates from those subscribers. But I think the flip side to it is consumers who do want some type of video package want it skinny and want choice. And if they can get both of those, then it may slow down what we see. And obviously, I think we're big admirers of what Comcast has done on the Flex side because we think it's a good product and giving optionality to clients to also have an OTT product on top of it. So that's really the path. I think the Flex path is really where consumers are headed, and it may be a combination of a skinny bundle plus 2 or 3 OTT providers is going to replace what we see today in terms of fatter bundles.

Okay. Going to advertising. You mentioned a few minutes ago that News 12 and Cheddar ratings are really strong. You talked on the conference call about 2Q advertising being down maybe 30%. Could ratings start to improve that? Or is there just not enough demand to keep volume -- not enough demand, right?

Actually, if we look at -- you don't see this data, but if you look at our numbers on News 12, the News 12 numbers are doing actually quite well. Obviously, on a CPM basis, their rates have come down because local advertisers and regional advertisers don't have as much money, but the ratings are simply up. So bang for your buck. If you're an advertiser today and you're paying money, you probably want to come to News 12 because you're getting a really, really good return on what you're doing. That's not the same on Cheddar, which is really more of a national platform. Even though ratings are up significantly, you're not seeing national advertisers, a lot of the branded content advertising that we do on Cheddar. People are holding off until they see a real opening from a national standpoint or a lot more volume and reopenings before starting to advertise again. I will tell you that in the last week or so, we are feeling better about advertising. I don't know whether that feeling will continue, but we've run our downside 1 and downside 2 cases, and we're tracking very closely to the downside 1 case, which is very comforting that we're going to go through a difficult Q2. And assuming that there is much more volume in terms of reopenings as we go into Q3, we expect to see a lot of activity. We are already starting to see some decent presidential activity already. We took in a very big order last week on presidential. And so -- and people -- and it's interesting, and you can just guess who is out there advertising early. It's just interesting that we're going to -- we're already seeing that -- those dollars flow through and -- which bodes well for, let's call it, a status quo relative to 2018 political year and potentially better. It just depends on, obviously, all the political dynamics of that. But we feel good about our ability to deliver good political. It's really about our local advertising and when is that going to come back in any significant strength.

So I assume that the political was more on the Cheddar national side than the News 12 side?

It's both. It's a little bit across multiple platforms, right? So...

Okay. And then following up there, local advertising is going to come back, I imagine, when small businesses come back. So what are you seeing in the last few weeks as some parts in the country reopen but your sort of core in the Northeast remains pretty locked down?

Yes. I mean so officially, churn rates are holding steady. And in the first quarter particularly, we didn't see any need to take large accruals on bad debt. We took what we thought was reflective of the activity we're seeing. Obviously, days receivables here are extending, and you're seeing pressure, obviously, on disconnects, whether or not they're actually going to disconnect or not. But the aging, let's call it, of our receivables is extending. Typically, we have a -- let's call it, a success rate in getting someone who's close to disconnect coming back at about 93%, 94%. That's more like tracking at the 80% to 85% today, right? And so there is a delay. I think the delay is clearly extended by 30 to 45 days here, right, in terms of trying to really see whether the client is going to come back. Now if the client reopens, he's coming back. If the client does not reopen, obviously he's not coming back. And that's where I think it's a little bit too early to tell. Business owners today are obviously holding on to cash and acting accordingly relative to their suppliers. And I think it's just too early to tell to see whether we're going to see a wholesale closing of a lot of small businesses here in the Northeast. I will tell you it is a Northeast issue, as you flagged. It's been an Optimum issue, not a Suddenlink issue. Suddenlink gross add sales continued through the lockdown at a decent pace. It's really the gross add sales on the Optimum footprint that has fallen 40% to 50% during the pandemic. But it started to come back as we are hearing semblances of a reopening here. And the question really is going to be on the bad debt side. We're not there yet to call it, but it is obviously something that's on -- that's at the top of the radar screen.

Okay. Can you help us scale? I think you talked on the conference call that revenue could still be stable in the SMB side. Can you help us scale what the impact of that business could be?

Well, listen, we've been running again our downside 1 and downside 2 scenarios. The SMBs' revenues in 2019 were slightly over $1 billion, $1.050 billion. And so from what we see today, we see a $50 million risk in our revenues type thing. But $50 million risk relative to -- not last year but relative to our budget this year was growing, right? So our growth rate in SMBs is kind of mid-single digits. So if we're growing at $50 million, $30 million to $50 million in budget, and we're all $50 million, we'll miss budget then by $20 million, right?

Right.

So we should not be down year-over-year. We should be flat to slightly up on the SMB business.

That would be a pretty good outcome given where...

That will be a very good outcome, exactly.

All right. Copy that.

That'd be a very good outcome for us.

Yes. Okay.

And so that's where we're -- we're tracking in that area today with a big, obviously, disconnect expectation in Q3. Q2 -- end of Q1 and Q2 is really a sales-driven reduction in revenues for the year. And then the whole question will be what is the impact in Q3 on bad debt and disconnects, right?

Okay. Okay. Finishing up there, and we're about out of time, but that drives a lot of questions around where your leverage level will end the year. Now you -- last year, you ended the year a little bit above your 5 turns target. Does that make you feel like you need to be at or below 5 turns this year? Or is that sort of 5-point-something range kind of good enough as you think about the leverage and buyback base?

Listen, we -- we're neither here nor there relative to 5 versus 5.1, right? That's not going to change our risk profile. I think what we've committed to, to our bondholders and our debt holders and everyone on that side of the capital structure is that we're going to maintain that 4.5 to 5x range. Obviously, with interest rates where they are and where our stock price is today, 5x sounds a lot better than 4.5x just purely on a mathematical equation. We reiterated our guidance on the first quarter earnings that we're going to do $1.7 billion of buyback and maintain a 5x last 2 quarters annualized leverage, and we feel good about that. Obviously, the questions that came after that were how do you expect to grow EBITDA 4% to 5% in the second half. We can go through each one of our businesses, but we feel very good about our ability to do that. So revenues are going to grow. Our EBITDA, we had a little bit of a sideways EBITDA in the first quarter of this year on a relative basis just because, you have to remember, we had a sideways fourth quarter last year, and that has an immediate impact on the sequential quarter thereafter. But if I told you what my numbers look like on EBITDA in April, we are coming out of impact from Q4 2019 nicely. We are on track on our EBITDA budget. We don't expect that to hold given what's going to happen to advertising going forward. But year-to-date, relative to our budget, which we put together in November and December of last year, we're on track. So that gives us a lot of comfort that even though we may see and we expect to see some sideways movements in revenues, that our ability to operate our business more efficiently given the environment, being able to make quicker decisions relative to our cost structure going forward on a permanent basis has allowed us to feel good about our ability to deliver that 4% to 5% EBITDA growth in the second half, which will allow us to deliver the $1.7 billion and 5x. So we -- for everything we see today, we feel good about being able to hit those.

That's a good place to stop. Dexter, thanks very much for joining us, and thanks, everybody, for being on the line. I hope to see you soon and stay safe.

Thank you, Phil. Take care.

Thanks, buddy. See you later.