Shenandoah Telecommunications Company (SHEN) Earnings Call Transcript & Summary

Good afternoon, everybody, and thanks for joining for our next discussion, which hopefully is going to be with Jim Butman, CEO of TDS, although he's missing at this point in time; and Ed McKay, COO of Shentel, delighted to have them both back at the conference. I think the perspectives we get from speaking to Jim and Ed are always just super insightful in helping us shape how we think about the industry because they both got the benefit of operating across a very diverse infrastructure, cable assets, fixed wireless assets, fiber assets, copper assets. And so can sort of compare and contrast the benefits and challenges in those different assets in a way that nobody else can. Thanks so much for joining us today. We really appreciate it.

Great pleasure to be here, appreciate you up too.

Yes, no worries. And sort of to kick things off, we were sort of speaking before the session started about the 2 transactions that you're about to close. You're selling towers, you're buying fiber assets. I'd love to just kick off with your perspective of what that says about sort of relative values for infrastructure assets. I guess, simplistically, and self-servingly, it suggests that this is a good time to sell tower assets, maybe they're decently valued or at least you've got a good value for yours. And it's a good time to buy fiber assets, maybe holistically, they're undervalued. Yes, what's your sort of perspective on what we should read from these transactions into the values for these 2 different asset classes generally?

When we sold our wireless business to T-Mobile back in 2021, our tower assets were no longer core assets. We've always said we would consider selling them if we had an opportunity to redeploy that capital. And we felt that with the acquisition of Horizon Telecom in Ohio, this was a great time to explore the sale of those assets, and we were very pleased with the multiple we received significantly higher than the publicly traded comps. So we felt like it was a good use of those -- of the sale and the proceeds to help fund not only our Horizon acquisition, but to help provide growth capital for our fiber broadband expansion.

And that obviously makes a ton of sense. Can we sort of extrapolate from the Horizon transaction on the Glo Fiber in the sort of prioritization of capital for broadband assets that broadband assets are sort of undervalued more broadly? Or do you think it's very specific to the asset that you bought?

We certainly believe in our case, the broadband assets are undervalued, particularly a company like us that is very quickly primarily becoming a fiber-to-the-home provider. This past year, our Glo fiber markets reached more passings than our incumbent cable markets. So we're excited about this fiber-first growth strategy and even accelerating our growth further.

Jim, thanks for joining us. I'm glad we found you. Really appreciate you having on today.

They've had me in a virtual room somewhere I was lost.

Lost in virtual space.

Yes. Thank you. Good to see. I see it once a year. We keep talking about getting together, but we don't.

If we need to do that, good to see you as well.

Awesome. So Jim, you ended 2003 with 1.7 million total locations, of which $800,000 were fiber. You beat guidance, you're slowing the build a bit in 2024. I think largely because of the interest rate environment. But when I look at the trends in the fiber business, they just -- they look awesome. You're growing ARPU at 5%, revenue at 6%, EBITDA at 20%. I wouldn't have thought that the rise in interest rates on their own would sort of warrant pulling back in the business just given what you're able to deliver on the other side.

Yes. Well, Jonathan, thank you for having me, first of all you can [ say that ]. And so look, -- we -- I'm glad you recognize we have more opportunities than we can fund basically is what it is, a bit is what I would say. But I want to explain it. So over the last 2 years, we've spent over $1 billion in capital, right, building out networks really focused on our out-of-territory markets. A lot of our ILEC now is the best economic areas we've fibered up. We've got DOCSIS 3.1 in cable. We build all new fiber -- new subdivisions with fiber. So a big part of our build, the front-end part of it we've spent. However, the pullback is in our ILEC and cable and we are continuing -- continue to build at the pace, roughly the pace in our out-of-territory okay? So I want you to understand in the mix, all right? The other thing we're doing in 2024 is we are doing all the engineering for what is a significant A-CAM build, okay? So really, this is the year we're doing a lot of engineering for the ILEC. And next year, that capital will come in. So we want to keep the fiber out-of-territory markets going, all right? The other thing that we're doing is, obviously, we've got to be responsible with our leverage ratio, stay within our prudent guidelines of what we want for leverage ratios. Can I -- the other thing is the market likes what we're doing. We've been spending a lot of -- we've got negative free cash flow. We spent a lot of money over the last 5 years. And now we want to show an aggregate and the market likes it, is we want to show the great revenue growth and the trajectory of that revenue growth and the improved OCF. So the time is kind of right. And you're right, though, the interest rate environment isn't pretty, right? And so I would say in the short run, all of this timing, we feel like it's a little bit of a puzzle that as we do all the engineering and we get into the next years. Hopefully, the interest rate environment will be better, better for Wendy, and we'll have other sources of funding as how we were hopeful that we will find other sources of funding when the market gets better.

Got it. And so this is -- it sounds like -- well, I guess the question is the threshold for your return threshold for making investments in fiber gone up as a function of the rate environment? Or you're pulling back a little bit more just to stay within the constraints of your leverage targets. It's more about sort of access to capital than it is about the hurdle rate going up?

It's actually both is what I would say. And so we just want to be -- the great news is we got a big part of the build. We've got a lot of service addresses like I was saying, -- we've now got a lot of service addresses, and we've been making a nice pace on penetrations. But now this is the year to keep telling the team. The previous years have been fiber service addresses, fiber service addresses. Now it's customer surface addresses. We want to demonstrate. I think it's going to -- I believe we're going to show a really nice story this year after a lot of upfront capital. They're now going to see an aggregate, people are going to start to see the fruits of the significant capital investment. But you're right, I mean, we are bullish on this. I mean our -- so when you look at our IRRs, I know I told you a year ago that we target 11% in most of our IRRs between 11% and 15%. Those have held up. I mean, we are just really pleased if anything, I mean, we're hitting the penetrations that we've targeted. And we're actually finding the cost of operating these systems, the new markets are lower. So we're still being conservative. We're holding to our penetration rates. We're beating them in many cases on the front end, but we're also realistic about long-run competition. And so we're feeling really good.

And Jim, have you explored the ABS market as a cheaper source of debt for helping to fund these -- the investment in fiber assets?

Yes, Jonathan, we have. In fact, I always say we explore everything, right? We don't [indiscernible] have a rock. We don't over turn. So for us, we've been able to fund with debt and low-cost preferred. We got low-cost preferred at 6.5%. So when you think about that rate, and we don't have to secure our assets or -- and we don't have to secure customer contracts. We've got the cost of capital or the low cost of debt for the plan that we've got right now. So we feel pretty good with our plan and what we need to fund it.

Makes sense. And so one of the templates that we've seen crop up recently, and there's a lot more sort of talk about it, I think, amongst ILEC in particular, is taking assets, moving them off balance sheet into a JV, bringing in a financial partner funding off balance sheet. Is this -- could that be a way for you to reaccelerate the pace of investment while at the same time showing investors the returns on the piece that you've already built?

Yes. As I said, we have gone down this path. We've looked at it. We've actually engaged a process to do it. And this was a couple of years ago when we were trying to sort out everything and that's when we ultimately landed on the lower cost preferred instead of we have full control. We didn't have to give up some of the opportunity. So we have looked at it, and I will always say, I think it's something that we will look at in the future, too, because we do have more [ opportune ] than we can fund. So I think it is an opportunity. We've looked at it. But for the size of our plan right now, we feel okay.

Okay. And when I look at where you're spending fiber, I mean, I think you articulated it right at the beginning, which is the spend is going primarily into new builds, not so much into upgrading the old -- the ILEC infrastructure. Why are the returns in new builds better than in the existing footprint? Jim, I would have thought because you've got pre-existing infrastructure, it would be cheaper to upgrade that than it would be to do brand-new builds.

It is. You're right. And what I would tell you is we've done the most economical builds, the best returns, right, in the areas that make most sense. So we've gotten to a lot of the really attractive, we call it in-territory fiber deeper. We've done those. The other side, though, Jonathan, is we are really focused on transforming the company. And to transform the company, we need revenue growth. So I'm not saying we're not protecting the core market, but we've done the best. We now have A-CAM to do the very rural areas. So we're going to -- we feel really good about the plan but to really transform the company, I think I heard Ed saying this, what I'm really proud of over the last, whatever, 10 years because we started this by buying cable operations. If you look at our 1.7 million service addresses, we've now are bigger in cable in our out-of-territory fiber than we are in what was on the origins of traditional telephone operation. We've got 1.7 million service addresses and 800 are now in the core business of the ILEC. So -- and you've got to have growth, right? Because the challenge with just over building yourself is you're pretty preserving growth, still a good IRR, but you don't get the growth.

Got it. And then, Ed, switching over to you, you're accelerating your build in 2024. I think you're still targeting an incremental 350,000 fiber locations?

Yes, we are. So last year, we constructed almost 90,000 new fiber passings finished the year with about 450,000 total broadband passings. 230,000 of those are fiber. So we're now a fiber dominant company. I think for 2024, we're targeting over 100,000 additional fiber passing. So we're accelerating that build. So really over the next 3 years, the goal is to reach over 600,000 homes and businesses with fiber, and that will include new markets in Ohio that are part of our Horizon acquisition that we discussed.

Yes. And how have higher rates impacted the opportunity for you?

They really haven't slowed down our build pace at all. In fact, we've increased the number of targeted homes, and we're building fiber to and we -- and I've mentioned, we did recently announce the sale of our tower business. So we're using that to fund not only the Horizon acquisition, but also our continuing broadband growth. So we feel like we're in a good position from a capital perspective.

And from a cost to build perspective, I think last time we spoke, you were in the $1,000 to $1,400 range. Is that still the cost to pass?

We're still in that range. We did see a 5% to 10% increase in both our labor and material costs late 2022, early 2023. But since then, costs have remained fairly stable. We launched Glo fiber in 2019, first 3 years of construction. We were in the lower half of that $1,000, $1,400 range in 2023. We were in the upper half of the range. We expect to be in that upper half in 2024 as well.

Got it. And in your sort of long-term planning, it seems that you're underwriting target penetration of around 38% in your fiber markets, which is a little bit lower than I would have expected. Most of your fiber peers are sort of targeting 40% to 45%. What's the difference in your markets? Is it all demographics?

Well, I would say historically, Shentel has a little bit a little more conservative on our projections than some of our peers in the industry. I think demographics may play a role. Some of our markets may not be as strong as some of our peers. We do focus on smaller Tier 3, Tier 4 markets in rural areas. I think another difference is, unlike some of our larger peers, Glo fiber builds are 100% greenfield builds into new markets. So we're not overbuilding our existing service area. So I think that's a factor there. But from a competitive standpoint, we're targeting areas where there's only one broadband competitor. We avoid areas where the LEC is deployed fiber. We avoid areas where there's another fiber overbuilders. So I'd say, on average, our markets are probably a little less competitive than some of our larger peers.

Yes. And your ARPU, it is higher than your larger peers. To what extent does that hamper penetration, do you think? What's the sort of the trade-off between the 2?

So our ARPU for our Glo Fiber markets is in the mid-$70 range. We were actually able to grow ARPU by about 4% in 2023. We've been very successful at the mid and high end of the market. Almost half of our customers choose speeds of 1 gig or higher. We think we have a premium fiber product. So we're focused more on maximizing the overall revenue and margins as opposed to maximizing subscriber numbers.

Interesting. And so when I look at the stats on cable versus fiber, it's really interesting. You've got higher ARPU on cable, but also higher churn, lower ARPU on fiber lower churn. Is there a relationship between the churn and the ARPU do you think?

Well, maybe some -- our cable markets, they're typically smaller, less competitive. Our ARPU there was about $83 -- churn was about 1.65% last year. Compare that to Glow Fiber, $76 ARPU and 1% churn. So churn is definitely lower in our fiber markets. I think the price value proposition is better with Glo Fiber than it is with cable. We've got a lot more capacity on those fiber networks. We're able to offer much higher speeds because of that. We've had very strong Net Promoter Scores in our Glo Fiber markets over 60. So we're doing well there. In cable, we still have decent Net Promoter Scores, but definitely not near what they are in Glo Fiber. I think another factor is that the demographics in our cable markets typically aren't as good as the demographics in our Glo Fiber market. So there is more involuntary churn in those markets. But over time, I would expect the ARPUs to diverge, probably a slight increase in our Glo Fiber markets. And I would expect the ARPU in our cable markets to come down somewhat as we see some additional competition.

Got it. Jim, you mentioned at the beginning that you've accepted enhanced A-CAM funds. I think it's 270,000 locations with those locations that would have been eligible for BEAT? And are you effectively choosing enhanced A-CAM over a BEAT as a funding source?

Yes. I think I said even last year, I don't know that, that was our preferred. That's what we wanted. I mean, we work very closely with industry coalitions, and we are very involved in helping architect the EA-CAM program. And so what we like about the EA-CAM program compared to BEAT is it's an ongoing revenue stream all the way to 2038. So it doesn't -- it not only pays for the build, but you get ongoing revenue streams or maintaining the networks. And so that's what we like about that program. The other part of it is by choosing A-CAM, these are not eligible for BEAT. So we kind of have certainty with kind of what it looks like from a competitive market standpoint. So yes, we're feeling good about the EA-CAM program. However, it's a big commitment in terms of a build.

Yes. And are you doing those A-CAM markets with fiber?

Mostly fiber. I mean we're going to -- right now, we're going through all the engineering. We're going to be smart about the builds. But I have to tell you, in the long run, I think they'll become fiber. But there will be -- there'll be areas where it makes sense, where we can use short copper loops. I mean we get to the 120, and we're providing good service, we'll do it. We're not going to throw just money because it's fiber, but it will -- the vast majority will be fiber.

Got it. That makes sense. Yes, I was wondering sort of when I looked at the 120 requirement for A-CAM, if it was sort of putting money into upgrading copper, I'd wonder about whether that would be sort of a good long-term investment. But if it's mostly fiber, it's sort of a moot point.

Yes, right.

And what are your plans for the copper locations that you'll be left with after you've sort of upgraded everything to fiber that makes sense?

Well, we'll always have the tricky part in -- or the dilemma in ILEC the traditional telephone areas is, while much of it, even given markets will be fiber, you'll still always have some copper that you didn't get to. So generally, you're going to be running both networks, okay? We do have one network that we've converted totally to fiber, and we're decommissioning it -- sorry about that. We're doing that now. But we're pretty hopeful that by the time we get done and we get out there in 2028, 2029, our ILEC should be pretty fortified.

Yes. And in that market that you're decommissioning it, can you give us a sense of what the difference in sort of operating cost and maintenance CapEx per location is between fiber-only market and copper?

Yes. So I can give you a few facts here. What we find in a fiber market, and all fiber market because we obviously got out-of-territory that's all fiber and then we've got copper. And what we tend to find is our trouble index is reduced by 25%. So 25% -- and I want to talk about this a little bit because that's somewhat -- I think that the data is still early because your trouble index in fiber markets when you're doing new installs, you're going to have more miss fires. You're going to have some of that. So when you get to a steady state, that trouble index is going to be even lower. The thing that's really impressive, though, is the fact that our dispatches in our fiber markets are 50% lower, right? So that means you're not rolling a truck because what happens is the tools that our technicians and our help desk have remotely can do so much more with fiber to eliminate all those truck rolls. So we're -- we don't have the full cost metrics yet because we want to have time to have mature fiber, all fiber markets and compared to all copper, but we're really encouraged with the cost curves here.

Ed, do you have any specifics on sort of cost comparisons between fiber and copper?

I don't have that.

I want to make sure I'm hearing you say though, in what area, copper versus fiber, what?

So I was actually flipping the question over to Ed, but so I sort of -- Jim, for you, I'm interested in sort of 2 scenarios. You got new build fiber, and I wonder how that compares to copper. But like what would be super interesting actually would be in the markets where you've made the -- you've decommissioned the copper entirely and now you're fiber-only like what happened to the cost structure in those markets. But yes, I think your answer was it's like fiber economics are still early, and you don't want to prejudge it too much.

That's right. Like we're -- we've got good analytics on this, but it's still worth to give you to draw specifics -- definitely, the trend lines are great, but we don't have a good enough salt period for that to compare.

Yes.

I don't have any specific data on copper, but I will say with fiber compared to HFC, we're seeing about a 50% savings in our operating cost, manufacturing maintenance repairs and power. So it does make a big difference.

50% savings just on those 3 categories or in the -- on total costs?

Correct. That would be in the operating cost on those 3 categories. But we also have less maintenance CapEx as well. With the fiber networks, we have plenty of excess capacity day 1. So we're not having to spend additional dollars on capacity as customers use more data, for example.

And Ed, is there a sort of a cost per location that we can think of for fiber locations and what it would be for HFC locations, so we can understand what those like 3 categories amount to in savings overall.

At least in our networks, and again, they're fairly rural, but it translates to between $30 and $40 annually per household passed as far as savings.

Interesting. And then on the subsidized locations front, I think you guys are doing 30,000 locations subsidized. Are those all state-funded builds?

Correct. They're all state-funded builds. They were through the American Rescue Plan Act funds. We're still targeting roughly 30,000. Right now, we've been awarded $85 million in government grants so far. That's to about 25,000 passings. And we're expecting those grants to cover more than half of the total build costs for those projects.

Got it. And then is BEAT an area of interest for you beyond those locations? Is there a decent opportunity within surrounding your markets for -- to go after BEAT as well?

We're not as excited about the BEAT program. With the state ramps with the ARPU funds, there were fewer strings attached than what we expect to see with BEAT. So we're going to be hesitant to be a big player in BEAT, if there are mandates on labor rates, mandates on pricing, and we're also worried about some of the owned-risk reporting requirements. So we're watching to see what happens. But with what we've heard so far, we likely will not be a big player in BEAT.

Got it. I guess the same -- I mean, that's part of what's driving your decision as well, Jim.

That's correct.

Yes. It's the strings, got it. Gentlemen, we've run out of time, unfortunately. I only got halfway through my questions. So we'll have to pick this up again sometime soon. But really appreciate both of your perspectives today. This has been very valuable.

Thank you, Jonathan.

Thank you, Jonathan.