Shenandoah Telecommunications Company (SHEN) Earnings Call Transcript & Summary

Hi. Good morning, everybody. Welcome to the second day of the UBS Global TMT Conference. I'm Batya Levi with the telecom, cable, media and communications infrastructure team in research. Our next presenter is Shenandoah Telecom. We have Jim Volk, Chief Financial Officer, on video with us; and Dave Heimbach, Chief Operating Officer, is going to be dialing in. Thank you for joining us, Jim.

Good morning, Batya, and thank you for hosting. We're happy to be here.

I just wanted to start with maybe a quick overview of the strategic focus of the company as we head into next year. What are your main priorities as we look into '21?

Yes. '21 is going to be a very transformative year for Shentel. We are in the process of selling our Wireless business to T-Mobile, as we've been a Sprint affiliate for about 20 years now. As part of that agreement, there was a purchase option if Sprint merged with a competitor, which certainly T-Mobile qualifies for, that they would have an option to purchase the business from us through an appraisal process. And T-Mobile exercised that option in late August. And the appraisal process is about to start, and we expect the 3 appraisers to have a valuation towards the end of January and for closing to occur in the second quarter.

Okay. Can you remind us what that -- I think you already booked it in your discontinued operations, what that asset includes in terms of maybe the spectrum that you own, the towers? Do they -- I believe they stay with the company.

The towers stay with the company. We have -- so Shentel is a diversified, yes, telecommunications company. About 2/3 of our revenues today come from Wireless as a Sprint affiliate. We do not own any spectrum. We -- part of our affiliate agreement with Sprint is we're allowed to use their spectrum in addition to using their brands, access to their back office and several other benefits that we get from the affiliate agreement. But we do own 220 macro towers and another 8 small cells that we lease to our Wireless business. Those towers and small cells will stay with us, and T-Mobile will eventually become the customer at the end of the transaction. In addition to that, we also have our growing Broadband business. We're generating a little bit over $200 million of annual revenue today. It's mainly an incumbent cable business, but we recently, in the past year, started building out Fiber to the Home in a product we called Glo Fiber. And just in October, we launched a fixed wireless broadband under the product name, Beam. That we're targeting underserved communities in Virginia, West Virginia, Mid-Atlantic markets.

Great. I would like to dig into all of those segments. Maybe going back to the sort of the current environment. We've seen COVID impact different parts of the business in different ways. Can you just give us an overview of what has been the impact across your businesses now? And how the -- how have the trends been over the last 9 months going into '21?

Yes. So on the Broadband business, it's actually been a tailwind for us. Demand has been stronger, not only for Internet service, but for higher bandwidth internet services. We've had 2 record quarters in the second and third quarter doing about 6,000 broadband net adds for us. We're also seeing customers slowing. The churn rate has slowed on the video product. Customers are staying at home and working at home and have maintained the video product more than what they have been doing in the past. So we've actually had 2 quarters of essentially flat video subscribers, which has been a change. It's probably been 4 or 5 years since we had positive net adds on the video side. We're also seeing a decline in bad debt. This is a central service, and customers are paying us very promptly. We've had very little bad debt over the COVID period. I would say on the Broadband business, the only area where it's been a little bit of a headwind has been on our commercial fiber business, where we're selling to other carriers and to enterprises in the Mid-Atlantic area. Little slower on the sales side there. I would say, more over the last 3 or 4 months, but we're hopeful that will turn around shortly in the beginning of 2021.

Got it. And maybe on the broadband side, do you believe that this was maybe a pull-through effect as maybe you benefited from wireless-only customers moving on to broadband and they're asking for higher speeds? Could those -- is there more room to go on the broadband side?

In our markets, I think, absolutely. We were 37% penetrated as of the end of 2017. We've been growing that steadily over the last couple of years as we implemented DOCSIS 3.1, and we now have a gigabyte service to all the homes, 99% of the homes in our service area. We also introduced a new rate card, which was -- created a better value play. You get more bandwidth for similar prices from what we were offering before. And we made some improvements to our operational areas, both the call center and our field task. The combination of all of that has been -- we've grown penetration from 37% to 40% at the end of 2019, and we're already up to 47% as we ended the third quarter.

Right. And who do you mainly compete with in broadband in those areas?

We're competing generally against DSL. And we have very limited competition. So I would say, 96% of the markets, we're competing with DSL. And actually, 8% of the markets, we are both the telephone company and the cable company. So we're essentially competing against ourselves. There's no competition. Only 4% of the markets that we have kind of another fiber provider that we're competing against. And those companies are generally -- Frontier's about 1/3; Verizon is about 1/3; and then CenturyLink is the rest.

Right. And in this environment, are you seeing maybe competition putting in a little bit more resources behind their speeds, availabilities and maybe just sort of like increasing that competitive intensity?

We have not seen it in our markets. I think the DSL in our markets, these are all Frontier, Verizon, CenturyLink are all bigger companies, and it at least appears to us that they're deploying their capital in probably the bigger markets that they compete in, and we haven't seen any changes in their service offerings, which are generally 25 meg or less. So with our ability to offer up to 1 gig and kind of our sweet spot, I would say, would be 150 megs service. We're -- I think we're gaining market share there as customers with the work at home and stay at home mandates are asking for more and more bandwidth.

Got it. When with pretty much the entire footprint, getting a gig speed, can you talk a little bit about maybe what percent of your base is at that higher speed or what the new sales have been in terms of taking the higher speed? And also what the ARPU uplift is when you transition a customer to the higher speed?

Yes. Batya, at the end of 2018, only about 17% of our customers had a bandwidth speed of 25 meg or greater. Since we made the improvements to the network and offering the higher speeds, and again, changing up our rate card to create a better value proposition, 74% of those -- of our customers now have 25 meg or higher. And like I said, the sweet spot seems to be more focused on the 150 meg plan, which creates a competitive moat between us and our DSL competitors who really can't offer anything close to that. As part of our strategy, we weren't looking for big bandwidth ARPU increases. We've really been feeling we've been underpenetrated, and we were focusing on subscriber growth. And as I mentioned earlier, we've seen -- we've had a nice tailwind and a nice segue here over the last couple of years in driving growth while maintaining flat -- flattish ARPU.

Got it. And you did mention that video trends had been more stable than before. And that's something that we've been seeing across the board. Why do you think that is? And do you -- are you seeing any changes maybe as we are going through the -- sort of towards the end of the year? And what would you expect the video trends to be starting next year?

Yes. I think the video trends are really driven by folks who are staying at home more and the convenience of linear TV is more paramount than perhaps in the past. Having said that, I don't think this is a permanent shift. I think this is probably a temporary shift that we're happy to take advantage of. But I would expect, as the vaccine gets out and people start moving about more freely, I would expect the churn will probably start to increase. So at least that's what our internal plan [indiscernible]

Right. Okay. And how do you approach video pricing? Do you pretty much pass along the programming cost increases? Are you taking a more agnostic view on if the customer takes video from you or not?

Yes. We are a broadband-centric business. Our focus is on the broadband product and growing that. We do offer video. We think that's part of the package that a lot of our households and families value, and we do expect to make a profit there. But at this stage of the game, we are just passing along the increases. We're not necessarily increasing our profit margins, probably, but we are passing along the increases to kind of stay afloat. And the programming cost and the retrans costs are continuing to go well.

Right. Right. And on the -- as you look at broadband -- broadband-only customer base or maybe overall, your cable and wireline properties together, as broadband becomes a larger part of the business, where do you think margins could go to?

Yes. The broadband margins today are in the low 40%. The EBITDA margins are below 40% range. I would say as video continues to decline and broadband becomes a bigger piece of the pie, our incremental broadband margins on gross margin basis are close to 85%. So the margins still should start working up towards the 50% range. And in addition to that, we are offering 2 new products. As I mentioned earlier, we -- our Fiber to the Home product we launched a year ago, our fixed wireless product we just launched in October. Both of these products are using the same integrated fiber coaxial cable networks that were -- the spiderweb is pushing out. And we're able to leverage our back office and our existing fiber quite a bit to do that. So that's -- those businesses will come in at a higher incremental gross margin than if we are starting this business in a new [ environment by ourselves. ] So yes, we do expect our EBITDA margins probably to grow from the low 40% up into the 50% range over the next 4 or 5 years.

Got it. And again, let's talk a little bit about your Fiber to the Home business. Can you maybe just go over what the overall base is in terms of how many homes would make sense to build to? And how do you make that decision? And maybe -- I think you launched it about a year ago. So what has been the sort of the first early learnings from that launch?

Yes. I think my colleague, Dave Heimbach, has joined. So Dave, if you are in and can speak, maybe I'll let you take this one.

I can speak. The question is can you hear me?

Yes, we can hear you fine.

Jim, you're doing such a great job. I hate to interrupt you. Good morning, Batya. Yes, on the Glo Fiber strategy, we -- in our region, we've started with a TAM of roughly 2 million households across an 11-state region that we view as having adjacency and where we can gain operating leverage and scale, based on our experience as a Sprint affiliate and operating over the last 20 years across a much wider swath of geography than our incumbent cable markets or even our commercial fiber network. And we have down-selected, so to speak, through our filters based on population growth and economic factors and competitive factors to roughly 0.5 million to 0.75 million target households. And at the most recent quarter, we have shared with you all that we have franchise-approved a little less than 120,000. So our market development activities continue to soldier on as we head into next year. Our pace of construction, we expect to roughly double as we head into next year, targeting to build a little less than 50,000 passings next year. And the way we think about that business in terms of -- we're targeting mid- to high teens and overall about a 20% internal rate of return with that business. That means that we are disciplined on those passings that we target. We generally try and target $1,000 per pass or less with that business. Our primary competition is Comcast. All of these markets we have launched thus far are non-Fios, Verizon. So really, whereas we were 1 of 4 or even 1 of 5 competitors in the cellular market, where we competed with the big 3 in addition to U.S. cellular, we think that being 1 of 2 broadband competitors in the home, where we're competing with the superior product as well as the superior value proposition versus Comcast, where there is no other viable choice in the market for folks, is a pretty compelling opportunity.

Right. That's great. And I believe you've attached about -- you've reached about 15% -- in the teens penetration in the first cohort of homes that you've launched with fiber. How has that been versus your expectation? And where do you think the overall penetration could go to?

Our target penetration is the high 30% range on a terminal basis. We have some neighborhoods that are already a little over 30% from our first cohort of neighborhoods that we built. And those are in the market of Harrisonburg, Virginia. So our expectations, particularly with the tailwind that COVID brought, have been exceeded thus far in terms of our -- what we underwrote our business case for these investments in 2020. So we're pretty bullish on our prospects thus far.

Got it. Great. And since you -- when you entered the market, do you see any changes from a competitive perspective? How are they responding?

Not really much change in the competitive landscape from our experience thus far, Batya.

Okay. And I believe you've kind of suggested that you're taking a more sort of stable approach to pricing and not necessarily adding -- increasing prices on this high-end product. Why is that? And maybe I might have not understood it right.

Yes. With our Glo Fiber strategy, we're taking a Southwest transparency type approach to the market. So we're not doing anything too gimmicky with introductory rates. Price is what is as advertised, there's no hidden fees or surcharges or those kinds of things. And we just think that with how the consumer has been trained all these years by the cable industry, mind you, we're an incumbent cable provider as well, so understand that we understand this better than most. We are trying to go to market with just an altogether different value proposition. The price value equation that we believe we are offering from a local or regional provider in addition to product superiority, not product parity, with symmetrical speeds and low latency is sufficient to not have to go into any kind of discounting.

Got it. And in terms of how you pick the next sort of markets to launch or to build first, are they all new agile properties for you? Or are there also some cable properties that would make sense or maybe wireline properties that would make sense to push fiber closer and closer, which could potentially lower the cost.

Sure. We do push fiber further into our wireline and cable properties where it's applicable and where there's a good return profile. And generally speaking, any new greenfield deployment, our preference is to do with fiber as opposed to coax or certainly as opposed to copper. But the vast majority of the construction efforts on the fiber front for us over the next several years are going to be in greenfield markets, much as we've done thus far.

Got it. Okay. And the next cohort that's going to come in, are you -- what kind of capital intensity do you expect in those markets to reach those homes? Is it still in that $1,000 per home kind of cost?

It is. That's right.

Okay.

Yes. So yes, roughly speaking, we expect to, like I said, roughly double the pace of construction next year. So in terms of capital allocation, the capital allocation to Glo Fiber next year will be roughly double what it was this year. But we're still targeting the same KPIs from a cost per pass perspective.

Got it. And then that $1,000 cost per home, is that -- is it all-in in terms of cost to connect as well? Or is it just a whole -- like it's cost to pass, and then there is a little bit more depending on the success base portion of it?

Yes. That's exactly right. The cost to connect the subscriber is in the $600 to $700 range, and then we've got a roughly $250 of cost per gross add on the sales and marketing customer acquisition front. So on a cash basis, it's about roughly double the cost to pass to connect the customer with about 2/3 of that capitalized.

Got it. Okay. Maybe if we move to the Beam business. Can you talk a little bit about what the overall opportunity is with fixed wireless? And maybe if we can start off with the assets that you own, you leverage in order to build up on this product?

Sure. So as you pointed out earlier in the call, we have been opportunistic in acquiring the band spectrum assets over the last couple of years. We picked up some 2.5 from the speculator, and we picked up 3.5 in the CBRS auction. And between those 2 footprints, we have ample opportunity to target what we are referring to as uncabled households. So if you are familiar with this part of the country, it gets urban to rural very quickly. And the economics associated with wireline-based deployments, whether it's fiber or it's coaxial cable, start to become far less compelling when you get into lower density areas. So this strategy is designed to target areas where either there is no cable today or no fiber today, and there is unlikely to be cable or fiber in the future, given the economics of wireline-based delivery and deployment. And so we are deploying a 5G-ready LTE standard wireless network on a Nokia-based platform that will deliver at launch. We are in market now 100 meg download speeds to the consumer, those speeds will increase over time as the technology further develops, particularly on the CPE side. And the value proposition there really is we're competing with folks who generally are buying low-speed DSL or satellite internet service for their home dwelling. And these are the same folks designing and constructing this network -- has designed and constructed our cellular network as a Sprint affiliate with over 2,000 base stations. So we'll have about 25 towers online by the end of this year, and we're still firming up the plans for next year. But similar to the Glo Fiber strategy, this is an opportunity to complement both our incumbent cable networks as well as our Glo Fiber markets, leverage our Tower portfolio, leverage our wireless expertise and really use this technology in the last mile. The vast majority of these cell sites are going to be fiber-fed. It will be a combination of macro sites as well as small cells that target the less densely populated areas of our footprint. And really, it's just part of our strategy to be an integrated broadband provider, leveraging a mix of heterogeneous technologies here based on levels of density and competition.

Right. We -- the RDOF results came out yesterday. I know you're in a quiet period, but definitely more fixed wireless companies showed up in terms of those winnings, and I think surprised the incumbents from that sense. Can you talk a little bit about, at least in your coverage right now as is, what could be the overall opportunity in terms of home reach4r with this product. And maybe sort of the same question as you think about fiber, what are the economics in terms of cost per home pass? And you did mention CPE, are you seeing some reduction in the CPE cost?

Yes. So the targeted passings for our Beam product are, as we disclosed on our last quarterly calls, 425,000. Now our network is going to cover a lot more than that candidly. But we're not going to be targeting necessarily customers that live in areas that would be covered by Comcast, for instance. And so that number really represents the quantum of target households within our spectrum footprint, where we believe that folks, generally speaking, only have access to a 25-megabit speed or less product offered from somebody else. In terms of the cost per passing, this is a much more capital-efficient technology, which is why it makes more sense in lower-density applications. So we're targeting roughly $350 per passing on a fixed wireless basis, and the cost to connect to subscriber is in the $400 to $500 range. So again, just overall, Batya, it's a much more capital-efficient technology to deploy.

Right. Got it. And you're mostly using the spectrum bands that you laid out to that 503.5, and the equipment goes on the towers? Or do you need to support it with some small cells as well?

We'll be doing a mix of macro cells and small cells, and then we mount an outdoor CPE at or near the rooftop, the roof line of the customer's home.

Got it. Okay. Great. That's very helpful. And in terms of maybe pricing this product, how do you approach the strategy there?

Yes. Our pricing is going to start at $60 a month for a 25 meg tier and go up from there. Again, this is another opportunity from a price value equation for us where we don't see the need to engage in significant or substantial discounting or any kind of gimmicks with introductory periods. This is a case where folks, generally speaking, don't have a lot of choice. And so we think that offering a fair price for what the carrier-grade service that we're delivering is, where we can get a fair return on our capital, is the strategy we're going to undertake here.

Got it. Okay. Great. Maybe we move on to the balance sheet side and capital allocation. With -- maybe if you could talk a little bit about what your priorities of capital allocation would be, and assuming the wireless sale proceeds will also sort of come in towards the end of the second quarter, yes, how would you think about the priorities with that cash?

Yes. Batya, generally, we're -- first of all, we'll have to pay some taxes related to the sale. We don't know exactly what they are yet until we know what the sale price is. So -- but taxes will be at the top of the line. And our credit facility requires -- it has a mandatory repayment option if we sell wireless. So we'll be paying down about $700 million of debt. And then after that, we'd like to be acquisitive if -- and we've been doing some small tuck-in acquisitions, but we'd be looking more for transformative broadband deals if they're there. If they're in sight, we will probably hold some capital back for that. But if we don't have anything particular in sight, we're not going to sit on the cash. We'll likely return cash value to the shareholders, possibly through a special dividend, possibly through a share repurchase program. We're still working through the general parameters of what that would look like with our Board of Directors in the coming months here. So we don't have a firm plan yet, but there are the things likely that we're planning.

Got it. I guess the tax is obviously going to depend on the end result. But have you disclosed what your cost basis is?

We have not.

Okay. Got it. And maybe in terms of a lot of different projects in the works in terms of Fiber to the Home and Beam and potentially getting some RDOF winnings as well, how do you think about the capital intensity of the business going forward or maybe sort of breaking it out in terms of the allocation for fiber or fixed wireless or supporting the existing cable infrastructure? How should we think about CapEx longer term?

Yes. We're going to be -- as Dave just talked about, we're going to be in an investment cycle here for the next 4, 5 years on our Glo Fiber and our Beam product rollouts. So we're just in the early innings of both of them. With wireless -- with the divestiture of wireless in the first half of next year, that will be negative free cash flow for probably rest of '21, '22. Probably -- my plans suggest that we'll turn cash flow positive in probably 2024 as we continue to invest in these new markets and as we talked about great returns on investments of 20% to 30% on the different products. So as I think about capital structure post-wireless, we're looking for something that will create the flexibility to allow us to make these investments. We're going to have a lot of cash coming in the door in the first half of the year. We'll have to figure out how much of that we will return to shareholders, how much of that will be behind for potential acquisitions and to make sure that we have enough -- that we're fully funded on our business plan. So there's a lot of flexibility there on how we kind of come up with the capital structure. Again, another work in progress that we're looking at some different options of how to do that in the most prudent way.

Got it. And can you talk a little bit about the thought process of increasing the dividend recently as you head into sort of like this incremental investment cycle and potential free cash flow dilution?

Yes. We've historically had an annual dividend, and it's generally been kind of a function of our earnings in our cash flow. And this was one of the strongest years we've had in several, and the Board decided to increase the dividend accordingly up to $0.34 a share from $0.29 a year ago. So as we think about the dividend going forward, I would guide you that we plan to maintain the annual dividend. Exactly where that lies is again a decision that we're discussing with our Board of Directors as we think of capital allocation. Our stock generally has not traded off of the dividend. The dividend yield today is like less than 1%, so -- the dividend yield. So it has not been a dividend paying stock. But having said that, it's something lot of our shareholders come to expect. It's something we're planning to keep in place post-wireless.

Got it. And in terms of the balance sheet, what's your comparable leverage target? And when do you think you will get there? I guess, after the...

Yes. I mean, today, we're about 2.25 net leverage. I would guide you, the new capital structure as we think a year or 2 out as we keep making investments, I don't think we'll go much above that. I think that will be kind of the level that we end up within the next, call it, 3 to 5 years.

Got it. And then in terms of...

Now in terms of transformative acquisition, and we have to go to the debt markets, we can certainly go up higher. As you're, I'm sure, very aware, a lot of broadband companies are levered at 4, 5, 6x. But if there was something transformative that need a lot of sense and created some scale and some benefits, we could certainly go up to 3 and maybe beyond 3 as long as there was a clear path to driving the leverage back down over time.

Got it. And what about potential other asset sales, for example, the Tower business? Most of the carriers, we've seen them getting out of it. Now you're becoming more of a sort of like -- you could actually treat it as a more independent -- it could be the more independent tower operator of those assets now. But how do you think about it? And especially now that the multiples have gone up so much, would it make sense to sell them? Or does it make sense to -- or do you need to own them?

Yes. First of all, I would say the towers are not strategic to us, especially with wireless now being sold. But having said that, they're extremely valuable. They provide a very constant growing cash flow with very high creditworthy customers on the other end. We are on our towers today, but the tenant ratio is about 1.8 to 1. So generally, for every tower we're on, 1 of the other big 3 is also on same tower. So there's a revenue stream and a cash flow stream coming from that. If I needed -- again, as I think a transformative M&A, if I needed some additional capital versus going to the equity markets, I would probably sell the towers first and finance the acquisition partially through a tower sale. But I'm going to have more than enough capital through wireless sale next year and a new capital structure, that I don't think there's any pressing need to sell the towers in the near future.

Got it. Okay. Maybe one last question, tying it all together in terms of -- the appraisal process is ahead of us. The relationship could also evolve in terms of you providing the fiber backhaul maybe to T-Mobile. Is there -- like how would you position the company within the M&A landscape? I know you've mentioned that you would like to be acquisitive and buy. But could we see the other way as well, where you have a lot of fiber, it makes sense to get scale and benefit from scales. So could you see it also on the other side, where maybe it's not just the wireless assets, but the overall company would make sense for someone else?

Yes. Batya, we will always look to maximize shareholder value. So if there was something on that side of the house, it was something I'm sure our Board and our CEO and Dave and I would all look at. Having said that, we -- when we look at our 5-year plan and we see the growth opportunity in front of us with the new products and what we think this business can grow into, neither of the new products are generating any EBITDA today. In fact, it's negative EBITDA today. So as those products grow, we think we're going to generate a lot of value for our shareholders. For somebody to come in and try to make it all for -- it's going to -- I struggle how they're going to be at a value those business is in the same way that we see them. And now that we're into rolling them out a year plus now with Glo and growing 2 or 3 months into the Beam, but we're seeing promising signs early on. It's something that we're going to have to decide how to rationalize the different [indiscernible] Because we believe in our plan. We think we have a great strategic plan, a great position in the marketplace to grow the business long-term. And that's always been the focus of Shentel for 100-plus years now, is to reinvest back in the business and grow long term. And we think we have a great plan in front of us. But having said that, we'll always do what's right for the shareholders.

Okay. Awesome. I think that's a great place to end. Thank you both for joining our conference. Hope to see you in person next year.

Yes, absolutely. Thank you, Batya.

Thank you.

Thank you.