Shenandoah Telecommunications Company (SHEN) Earnings Call Transcript & Summary

Good afternoon. We're going to get started with our next session. Disclosures are available at the registration desk. For those joining us via the webcast, I'm Mike Rollins, covering the communications services and infrastructure categories for Citi Research. So for our first of 2 sessions during our time slot today, I'd like to welcome back Jim Volk, SVP and CFO of Shentel. Thanks for joining us today.

Mike, great to see you again. Thanks for the invite.

Thanks. So we have microphones set up around the room. So if you have a question, please push the button. When it goes on, we'll get your question worked in. So Jim, maybe you can just share your strategic and operating priorities for the coming year.

Sure. 2020 is likely to be one of the more transformative years for Shentel in a long time strategically. With the Sprint-T-Mobile merger, for those of you who don't know, we're an affiliate of Sprint PCS. That merger is a catalyst. It will likely create a couple of different strategic options for us, whether it's to end up selling the business to T-Mobile, if the merger goes through, possibly reaffiliating with T-Mobile and acquiring some of their legacy network and subscribers. Or if the deal doesn't go through, I think there may be some optionality with Sprint in increasing our footprint and growing our business through expansion of Sprint as an independent company. In addition to that, I've been spending a fair amount of my time just trying to understand the rest of the business. I've been with Shentel about 6 months now. And we have some very valuable cable and fiber assets and businesses and towers that are somewhat unknown, and we're trying to find -- they're all very valuable, we're trying to scale up that part of the business as well. That would be the ideal scenario that we're able to scale up the wireless and the cable fiber side of the business at the same time.

Great. So you mentioned the importance of the Sprint-T-Mobile merger for you. Do you have a prediction on the outcome?

I would say it's a coin toss from my perspective. I'm not a legal expert, but we've been -- obviously, we have a vested interest so we've been following what's going on with the state AG lawsuit. But from what I can see, it looks like it's a toss-up.

And just from your experience, to the options, maybe you can walk us through just how that process would work if the deal does go through.

Yes. So in our Sprint affiliate agreement, we have a language that addresses a potential merger by Sprint with a competitor. Certainly, T-Mobile would qualify as a competitor. And T-Mobile would come to bat first. They have a call option to buy our PCS wireless business for 90% of the appraised enterprise value. There's a time clock associated with that. And there is an appraisal process associated with that, that we would hire an appraiser, they would hire an appraiser and the 2 appraisers would hire a third. And this would get resolved somewhere between 30 and 120, 150 days after the merger would get closed. If...

When you say -- sorry, go ahead.

If they decline that option, we would have an option to purchase the legacy T-Mobile network and subscribers at a formula in the affiliate agreement, which is essentially 75% of the enterprise value per subscriber of the T-Mobile customers and network before the deal would have closed. We think those economics are very attractive, and we would be very interested in doing the second option.

So they make the decision first, whether to call with the appraisal process. And then once they do that, is there any other discretion that you have other than picking an appraiser? Or does it just run its course?

It just runs its course. But yes, they have the call option first. The ball is in their court first to do that. Now despite what I just said is contractually outlined, we could always negotiate outside of that. And that's always a possibility. And if we come to a favorable deal on either option, that might be the preferred way to go for both sides. But if we don't feel like we're getting to what we think is a fair deal, we think the provisions in the agreement are good and would be very favorable for our shareholders.

And if -- I guess, then maybe taking a step back and just thinking operationally, what do you see in the marketplace right now in terms of the competitive landscape, promotional environment?

It's been a healthy landscape in the markets that we compete. We have about 7 million licensed POPs in the Central Pennsylvania, Virginia, West Virginia markets. Kind of outside of D.C., west of D.C. in Richmond. We've recently acquired a couple of adjacent markets from Sprint over in 2017 and 2018. The first market, Parkersburg, West Virginia, we just recently completed the investment in the build-out to get this thin network with kind of low penetration rates built to our standards. Our -- and in our operating strategy is we want to have the best network in our markets, and we'll invest heavily to make sure that we have the latest and greatest technology, and that we have the best coverage. And then we try to follow that with distribution. And it's a very simple strategy, but it's worked many times over for the past 20 years as part of our affiliate agreement. So we recently completed that -- those first 2 steps of that strategy in the second quarter. We completed the build-out of Parkersburg to our standards. We've added distribution. And Mike, we've had -- we just announced today, we just had the second consecutive record quarter of gross adds and net adds that we've had historically in our 20 years of being in the wireless business. So we're starting to see some of the dividends from our recent investments.

And when you look at the opportunities, is there a way to just measure, given the -- what you're describing as just repeated success in the way you've invested in taking share. If you look at the under-penetration in the markets that you purchased and the improvements, is there some back of the envelope math that you guys keep in mind like we should be X percent greater in subscribers because the company has completed its investments? Forgetting the time frame for a moment, do you think about it in those terms?

Yes, it's a real simple way of thinking about it. Like the markets that we just bought were about 500,000 POPs. It was about 5% penetrated when we purchased them. Our investment thesis is we want to get those markets to be similar penetrated as what we're seeing in our legacy businesses, which would be in the 20% range. And time-wise, once the network has been upgraded and distribution has been added, that's a 3- to 5-year process in our view. So we think it's going to be a nice tailwind for the next several years. And we're just kind of starting that process in the second expansion area, what we call the Richmond Sliver, which is about 1 million additional POPs. We're still in the construction phase in upgrading that network. But that will be some additional tailwind that we would expect probably starting more in '21 than this year.

Okay. And when you just think about the pricing environment, what have you been seeing on that front in terms of just what's taking to get these subscribers?

We tend to leverage the Sprint national plans. And Sprint has been fairly aggressive here the past 18, 24 months in trying to keep the gross add engine working. So we're generally following their lead with that. And again, I think in terms of what is making a buying decision. We need to have a value play for our customers to bring them into the store. But ultimately, we think network reputation kind of rules and having enough points of distribution to adequately cover where people live. And we think we know that better since we live and breathe in these markets. And that's the winning formula. So it's not just price. It's really network and getting the distribution in place.

And you mentioned the opportunity to scale and grow your fiber presence and your broadband presence. Can you talk a little bit more about what you have today and what would be the options to try to accelerate the scale for those assets?

Sure. On the cable fiber side of the house, we have cable franchises that pay us about 200,000 homes in Virginia and West Virginia. We're about 40% penetrated on broadband side. And we think that's actually an opportunity. We think the national guys, the Comcast and the Charters are in the 50% range and higher. We think we can achieve that as well. We've recently completed the DOCSIS 3.1 upgrade, so we can offer 1 Gig of data to all of our customer homes if they so desire. And in addition to that, we implemented a new rate card over the past year that is kind of encouraging customers to -- it's a better value play for the customer and it's encouraging step up. For a few extra dollars, they get a lot more bandwidth. And we see bandwidth speeds selected by our customers double in the past year during that process. In addition to that, we've recently announced a Fiber to the Home edge-out strategy. We're planning to -- we've announced it in 6 markets in Virginia. We're generally going to be competing against a local telco who does not have a fiber or a coax cable network. It's basically a copper network that we'd been competing at in DSL 10 meg or less for the most part. And that cable company -- and majority of those markets, it's a national cable company that may be placing more of their investments elsewhere in the country versus in these Tier 2, Tier 3 markets. We think it's a great opportunity to grow our cable franchise and our cable business to be in a duopoly. And we're looking to cover about 60,000 new homes at a cost of about $1,000 or less. And we think this business in 5 years could -- we can get 28% penetration, which would translate to about a $50 million annual revenue business with 50%, 60% EBITDA margins would be a pretty good investment for us. And we think there's more opportunities outside beyond these 6 markets, but we want to kind of trial it with them and see how we make out and learn from our variances.

So having both the experience on the wireless side and the fiber side, how do you think about 5G, fixed wireless broadband and the role that could play in an overbuild or expansion strategy relative to just building fiber?

I think on the mobility play, in our PCS division, we're selectively starting to build some small cells now for our 5G rollout. But in general, I'm a big believer that the cable fiber plans will always provide a faster data speed than what you're going to get on the wireless experience. Even though 5G is going to enhance that. DOCSIS 3.1, we can now go up to 1 gig, and wireless will not be able to handle that. So from that aspect, we don't view that as a threat. But the one benefit of being in the multiple segments that we're in, in a small geographical area is when we put fiber into the ground, we can get a return on that investment from several of our businesses. Like I've mentioned, the Fiber to the Home project. We're going to be building metro fiber in 6 Tier 2 towns. Those investments, we think we can get a great return just on the core investment on the Fiber to the Home residential play. But those -- that same fiber is going to be available for small cells that we could offer to a Verizon or to an AT&T or T-Mobile down the road as well. So we're able to utilize these investments and get multiple returns for the different parts of the business that we're in. And then lastly, we've also decided to purchase 2.5 gigahertz spectrum covering about 1 million POPs for about 3,000 homes. And this is more of a fixed wireless play. We're planning to use the spectrum as a fixed wireless play on the edges of our cable and fiber networks, where it's uneconomical for us to build cable and fiber further out. But offer a more competitive offering than what customers are getting today, which is generally a 10 meg or less product from a satellite or a WISP provider. With leveraging the spectrum, the 2.5 gigahertz, the propagation will take us out about 1 mile to -- 1.5 miles to 2 miles out. We think we can penetrate about 30% of that market. And again, in 5 years, we believe this could be a $50 million revenue business with just getting about 1/3 of the market share there.

And on the video side, where you offer cable service, where are you in the process of either kind of holding on to the bundle the way it is or trying to get more to a broadband-only model and just let customers bring their own content?

Yes, Mike, we're focused on growing broadband. We're about 40% penetrated on broadband today and we think we can grow that into the 50%, and that's going to be our growth engine. We continue to offer a competitive video product. And we -- our gross margins on that video product are about 30% today. So we're making money on it. But we're certainly not leading with that. So we're more happy just to bring on new broadband customers. If they want to bring their own video service on top of that, that's fine with us. It's actually the gross margin as a broadband customer is about 85%. So it's a more profitable customer for us if they're only buying broadband. But we're also -- understand certain segments of the market, certain households are going to want the triple play and want the linear video package, and we want to be able to offer that as well.

And speaking of just the cable model, as other cable companies have offered a wireless product, have you seen any impact in your wireless region?

Are we seeing cable in our wireless region? Yes. So we see Comcast in several of our Virginia markets, and we see Altice in a few of our West Virginia markets. Altice is -- I think they just launched their product, I believe, in September, October. So I haven't really seen any material results from them to date. And even on the Comcast side, they've been doing this for about 2 years. We -- Comcast is reselling essentially the Verizon network. So when we look at our port-in, port-outs, and by the way, we're port-in favorable across the board on -- over the last several quarters. But when we see ports come in from Verizon, we can't tell if they're a Comcast port-in or if they're a Verizon port-in. So it all looks the same to us. Our analytics guys have kind of estimated that they think Comcast's presence in the market has maybe added 5 basis points of churn. So relatively minor is what we're expecting so far.

Just in our final couple of minutes, anything else that you want to highlight that's underappreciated by the market for your company?

I would say one of the top things, we're talking about deploying our free cash flow in new products, Fiber to the Home and fixed wireless, but we're also generating a free amount of free cash flow already. We're -- for those of you who don't know us that well, we're generating about $600 million of revenue, but over $100 million of free cash flow in 2018, and we expect a similar amount in 2019. And that really gives us -- and that's assuming about 20% of revenues are being reinvested back through CapEx in the different parts of the business. So that still gives us a lot of optionality to do tuck-in acquisitions, to return value to shareholders, whether it's through a dividend or a share repurchase program, which we recently announced in October an 80 million share repurchase program. So we're in a enviable position that we can invest aggressively organically, and we can also return money to the shareholders. And lastly, my cost of capital is less than 8% today. The cost of debt is about 3.5%. I'm only about 2.5x levered. So if there was a more transformative acquisition out there. We have plenty of dry powder that we can go ahead and raise capital to fund that if the right deal came across.

How far up would you be willing to take net debt leverage for the right transaction?

Yes, we're at 2.5x today. Could we go another turn? I think we certainly could. Could we go more than that? Historically, Shentel has not been a highly levered company. So I think we would look at how, if we went up higher than that, how quickly would it come back down to more normalized levels. So yes, we're certainly willing to do more than what we have on the balance sheet today.

Great. Thanks so much.