Uniti Group Inc. (UNIT) Earnings Call Transcript & Summary

Another good morning and disclosures are still available at the registration desk. For those of you joining us via the webcast, I'm Mike Rollins, covering the communication services and infrastructure categories at Citi Research. And I'd like to welcome back to the conference the team from Uniti, Chief Financial Officer and Treasurer, Mark Wallace; and Bill DiTullio, Vice President of Investor Relations. Thank you both for joining us today.

Thank you, Michael.

Thanks, Mike.

Well, just to kick us off, if you could share with us your key strategic and operating priorities for 2020.

Sure. Let me start with -- just to let everybody know, we did post a presentation on our website this morning. So I would ask you to -- encourage you to read that, refer to that and -- as well as the forward-looking statements included in that presentation. And in terms of our priorities, they're pretty consistent with what we have articulated previously, certainly, during the last quarter, a lot of our focus now, and #1 is focusing on the Windstream-related issues that we have and the ongoing mediation process. So that will continue to be our #1 priority until there's a resolution there. We've also had a big emphasis on continuing during that process, during the Windstream bankruptcy process, continuing to have very solid operating performance across all of our business units. So Uniti Leasing, Uniti Fiber as well as Uniti Towers. And then third, I'd say that we're also focused on -- turning a lot of our focus now to leasing up our existing portfolio. As you know, we've had, particularly at Uniti Fiber, we've had a lot of large dark fiber and small cell projects that had either -- were either completed in the fourth quarter or will be completed early in this year. So we're turning our attention to leasing up those assets and then also, otherwise, trying to optimize our portfolio during this time. And by optimizing, generally, that means trying to recycle some capital in this market at pretty attractive valuations. You've seen us do that with the Latin America Tower portfolio, our ground lease portfolio. We also sold our Midwest operations as part of the Bluebird transaction that we did earlier this year. And that will continue to be a lot of our focus as well, trying to optimize the existing assets that we currently have. So it's probably easier to talk about priorities to just go business unit by business unit and go through those. So let me stop there, and I'll let Bill kind of walk through the individual business units.

Yes. Thanks, Mark. So yes, starting with Uniti Fiber. As Mark mentioned, our primary strategy there is going to be leasing-up the dark fiber and small cell projects that will be completed by the end of 2019 or we expect to be completed by early 2020. So we're primarily going to be focused on leasing up those large dark fiber and small cell projects, there's 14 in total, primarily through nonwireless opportunities, so selling to enterprise, wholesale, E-Rate -- to the E-Rate program to schools, those government types of opportunities. So if you looked at our bookings activity over the last couple of quarters, you've noticed that majority of those bookings activities has been with new nonwireless opportunities, and we expect that trend to continue. So when you look at these incremental opportunities, these all have attractive incremental yields that will drive those anchor yields that we target of 5% to 7% on those initial anchor builds, and we've seen that play out to fruition so far. We expect those 5% to 7% initial cash yields to go up into the low teens through this incremental lease-up that will have margin profiles of anywhere between 70% to 90% margins. So that would really be our focus on 2020, is driving that additional lease-up in those markets. As Mark mentioned too, we are also focused on deemphasizing some of our noncore assets. So you've seen it talked about winding down Talk America, our CLEC business. We expect that to be fully wound down, I think, by the end of April of this year. And then we've seen some of the other businesses that we've talked about deemphasizing. So we have a construction business where we build fiber, primarily, for DOTs. We don't have use of that fiber. So again, low-margin business. And then we also have these one-off equipment sales. So it's not to say we're not going to continue to sell equipment where equipment has value as part of a strategic bundle, strategic services to customers, it has a part there. But this one-off, again, it's unpredictable, low-margin types of business. So we've made an effort to start to deemphasize some of that. And then, again, these businesses that we're deemphasizing, a lot of them were acquired when we did our prior acquisitions through PEG and then through the spin-off through Windstream. I think another focus of ours at fiber is lowering our capital intensity. So if you look at our capital intensity today, it's around 50% as a percentage of Uniti Fiber's revenues. And that's really a function of continuing to build out these dark fiber small cell projects that I talked about. But as those start to end by the end of earlier this year, and as we approach the end of 2020, we expect our capital intensity to come down to the mid-30% range. And that's not to say that we're not going to continue to do greenfield builds, we will. We're just not probably going to do 14 at a time, we'll do a handful. That bolsters the cadence better on those. But also, it's a function of leveraging the existing network that we've built with the lease-up, which requires substantially less CapEx than the anchor builds themselves. That's why we feel we can get to that mid-30% range by the end of this year. So turning to leasing. Again, our primary focus there will be leveraging the existing assets that we've acquired over the last couple of years and start to lease-up those assets, too. So if you recall, back in 2018, we acquired fiber from TPx. CableSouth, we acquired the fiber assets from CenturyLink and then we entered into an opco/propco transaction with Macquarie/Bluebird. So on some of those assets, we have the rights to lease those assets to third parties. So I think that will continue to be a focus of ours. And then we will continue to pursue other sale leaseback and opco transactions, but the timing and the size of those will be dependent on where our cost of capital is at that point in any given time. And then turning over to Towers. I'd say the focus there is to continue to build out Towers in the U.S. As Mark mentioned, you saw us recycle some of our capital there at attractive valuations, selling off the LATAM portfolio in the ground lease business, but we continue to build towers in the U.S. So for 2019, we still expect to build around 240 towers. And then going forward, our goal is to build between 200 to 300 towers per year. Primarily, we're building towers today for AT&T. And so we -- that's the level of comfort. We feel comfortable building that level of towers given the capital intensity of that business as well. So I think building out towers and then also start to lease them up, very similar economics to the fiber business. So 5% to 7% initial anchor yield and then driving through second tenant, driving those in incremental yields up to the teens. So we do have MLAs in place with 3 of the 4 major wireless carriers today. So I would expect in 2020, we'd expect to see us ramp up some of that leasing activity as well there.

Great. And if we can turn for a moment to the first priority you described with -- which is resolving the situation with Windstream. Can you just give us an update of where you are in the process? And anything that you can share in terms of your latest viewpoints on the situation?

Yes. So as you probably know, the mediation process is governed by confidentiality, so there's very little that I can say about that. What I will say is that while I think everybody read in some of the cleansing disclosures that the mediation process was technically suspended, I will say that there continues to be a lot of conversation going on among all parties that are involved in Windstream bankruptcy process. And we're still working towards and hope to be working towards a negotiated resolution. But that mediation process, there's still a lot of conversations going on, and there's very little I can actually say about the process other than that is ongoing. There's a trial date that is set for early March. And today -- there's a couple of other omnibus hearings are scheduled between now and that date, and then there's a few other relevant dates. But other than that, there's really not a lot that I can say, yes. In terms of -- I think a lot of people have looked at the cleansing disclosures and the proposal that we set forth in the term sheet that was included therein. I think that's a reasonable framework for how we think about what a resolution might look like from our standpoint. We've always said that we wanted to try to achieve something that was mutually beneficial. I think that's a reasonable framework to kind of indicate how we think about the structure of a mutually beneficial resolution.

Can you describe -- I think there is an indication, either at a conference, maybe it was on your conference call, I can't remember which the venue was, that mediation could restart, or there might be ongoing conversations between parties that happen that it could officially restart, has it officially restarted?

I would say, technically, no. But there still continues to be a lot of conversations, and it can restart. It really is just a matter of the mediation judge, Judge Chapman, actually just deeming it to have been restarted. But again, as I've said at -- have said previously at other conferences, there continues to be a lot of dialogue between all parties in it. And so there continues to be progress being made.

Do you expect to have some kind of resolution, whatever it is, in 2020?

I wouldn't want to really kind of project out exactly the timing of the resolution or what the resolution will look like. I mean we've -- we really need to keep most of our comments here because of the confidentiality that governs the mediation process, not really get into making projections about things at this point.

And if I could, on just more of a broader topic that is influenced by this. How do you think about net debt leverage in the future? In the past, when we spoke, you made some comments about directionally where you might want to see that over time. So based on everything that you've now learned and where you want to take the asset mix, the investment profile, what is appropriate net debt leverage for this company over time?

Sure. So let me try to answer it this way. It -- I'd say, if we get to a resolution with Windstream that's similar to the cleansing proposal and cleansing term sheet that was included in that document that we had put forth, I'd say that I would expect us directionally to want to reduce leverage from where it is today. So I would expect us to reduce leverage, we would look to increase our credit ratings as well. And we would also look in that instance also continue our M&A strategy and continue the M&A strategy to further our diversification strategy that has kind of been on pause during this process. So I would say the -- kind of the contingencies there, the large contingencies, obviously, would be, when do we get to a resolution, as you mentioned earlier, what does that resolution look like? And then also, it depends somewhat in terms of what -- how does our business evolve. And we have 3 business units now, both the Towers business, Uniti Fiber business and the Uniti Leasing business. As we go forward into 2020 and finish our planning cycle and the Windstream situation plays out, then we'll obviously need to decide based on our M&A pipeline where we want to deploy capital and how much we want to deploy into each one of those business units. They clearly have different levels of capital intensity. As Bill articulated, Uniti Fiber capital intensity will come down this year relative to where it's been as those projects are completed. At the same time, the Uniti Leasing business, we've continued to see deploying capital into that business. I think we'll continue to deploy substantial amounts of capital into that business, and it has a very different financial profile. It's a long-term leases, generally, with -- most of our lease rates have been in the 9%-plus range. There's a lot of different ways you can build in different growth factors above and beyond just the escalator into those transactions. I think there's a large opportunity set there. And it's generally -- it's next to 100% EBITDA margin business. It doesn't consume a lot of CapEx. And the CapEx, it generally consumes with the Bluebird transaction, it's growth capital, to continue to invest, and it really doesn't require any working capital from our standpoint. So it's a different business model, and we really like re-leasing business. And as far as I know it's proprietary, I don't know anybody else is actually doing that model as well.

And if there's questions, just please push your microphone and the light will go on, and we'll get you involved in the conversation. I'm thinking back to that term sheet. And if we just take your side of the column, the Uniti proposal. I talked about funding some tenant improvement capital. How do you look at that CapEx? Is that like an annual ongoing investment that Uniti would just make out of cash flow from operations, or is that something where you would want to prefund that somehow and kind of just process that differently than what typically would happen in these recurring investments that you're describing, whether it's in Leasing or Fiber or Towers?

Right. So just for everybody who doesn't know. So what Mike is describing is, so in the term sheet that was in the cleansing materials that we had filed, we had part of our proposal, and a large part of it was to -- was what was referred to in there, as I remember, it was TCI, tenant capital improvement. So essentially, what it was, what we had put forth in proposal to where we would invest the capital to build, overbuild Windstream's existing networks and their markets, but we would invest and build new fiber networks in those markets. And then that network, that new -- the new network would be leased to Windstream. Now the reason we put it forward and the reason we think that's a good framework for our mutually beneficial transaction here is the fact that it allows us to continue to invest in our fiber network. It improves our network over time. It's new fiber going into projects that we would underwrite along with Windstream. And then for Windstream, they need to continue to invest and have expanded fiber network, so they would have access to that and exclusive access through a leasing arrangement. And that would help -- we would expect that would help their business trajectory. I would also help -- over time, it would help their credit profile as well. And so I think it would help them along with whatever leverage in credit ratings they target coming out of bankruptcy, I think it makes them a healthier tenant. It has us investing in new fiber networks that are good for our business and exactly core to our business. And then the other part of it that we try to consider as well is we wanted to make sure that whatever we put forward, we would have to like -- in all likelihood, we would expect to go to the capital markets, whether those be public or private, in order to raise capital to invest in those -- in that -- those fiber builds. And when we did that, we want to make sure that we have an attractive investment thesis for investors to provide capital to us. And so we try to think of those things. You'll see some of that reflected in the economics, some of that is also reflected in some of the terms of the lease as well. And so that was what the -- that was our proposal. So to your point, I do think that if we did reach an agreement that was similar to what we had suggested in that proposal, that we would go to the capital markets, either public or private, in order to raise the capital to fund those investments. Alternatively, we also, as I mentioned earlier, we have had several events where we've recycled capital from existing assets and that's a possibility as well.

And speaking of which, there's been -- going back in time, there were press reports about maybe some of the things that you may be considering on some smaller or larger capital recycling opportunities. Can you frame for us just what might be low-hanging fruit or opportunities for you to recycle further capital within the company? Maybe size it a little bit?

Yes. Some of the opportunities that we have, it's hard to kind of articulate them prior to having something we announced. Sometimes, in many cases, they're actually opportunistic. As I've indicated, we have discussions with strategics as well as financial buyers, other infrastructure funds, other private sources of capital, private investors. And so many of these opportunities grow out of those conversations. And so in some cases, they're planned or they are transactions that we plan. And in some cases, they are opportunistic, meaning that they -- somebody else brings the idea to us, and we continue to have those. I guess one of the things I didn't mention is the other thing that we have on our priority list as well that we don't talk about quite as much and had it during the Windstream bankruptcy is we can -- even though we haven't been executing on large-scale M&A like we had previously, is we continue to keep our M&A pipeline active. So certainly, there continues to be a lot of opportunities for us in the M&A pipeline. As you know, most of our transactions have always been proprietary transactions. We still have those and continue to work those, so that to the extent that we get to a resolution, we can continue to diversify our portfolio as we had previously.

And just for the -- because of the complicated nature of a bankruptcy process as well as the litigation that you're involved with. So you have the trial date you mentioned. You mentioned that you're still talking, parties are still talking. Are there any other procedural or legal issues that you're dealing with as part of the Windstream bankruptcy that would either be an opportunity for Uniti to kind of get through this in a way that you like? Or are there risks where there's these other things going on that investors should just pay attention to because no one may know how they're going to work out?

So I mean it's hard to really, I'd say, probably answer that question and cover everything. There's a lot going on in both the bankruptcy process, litigation process, there's a lot of motions being made in the court, motions, stipulations. So it's kind of hard to cover all that here in the short time period. I would encourage everybody in that score just to read the court documents and the filings, a lot of the court proceedings are actually available in audio, so you can listen to them, if you so desire and read the transcript. So I'd encourage you to do that.

Any other questions before we move on back to some of the business units? So moving back to the business units. On the Tower side, how has colocate -- I know it's an emerging part of your business, but how is colocation been going? You mentioned the 3 or 4 MLA agreements that you have and at what kind of pace are you able to lease-up additional tenants on the towers?

Yes, Mike. So yes, we have MLAs in place with 3 of the 4 major wireless carriers today. And I would expect -- we're still in the very early innings of leasing that up, so if you look at our tenancy ratio today and you exclude some of the nontraditional towers that we acquired when we did the Hunt and acquired some towers from Windstream when we did that transaction, our tenancy ratio today is about 1.1x. So we're still -- with most of our towers, just have the anchor tenant on there. When you look at our lease-up potential, I would expect, in 2020, it's -- we'll probably have more on this when we give our 2020 guidance for next year, we report our fourth quarter earnings. But I would expect the lease-up to start to ramp this year. We did see a little bit of lease-up in 2019. I think it was about $400,000 in annualized MRR. I would expect to increase it from there going forward in 2020 and beyond. But it does take time to lease up these towers. And it's not like every tower we built for AT&T today is going to have a second tenant on it. So we look at it from a portfolio approach. So when we go to look to build towers, right, not only we're looking at just from a feasibility, engineering standpoint, but we're also looking at, when we're building these towers, what is the lease-up potential. So there may be some towers that we're building that will only have one tenant, but we want to make sure that we are leasing up and if those towers to reach -- to get to that mid -- low to mid-teens yield over the next couple of years when we have fully leased up those towers to what we believe the full lease-up potential is.

And you described some of the fiber assets that you now have in your marketing, and you bought these -- some of these assets from other companies. What do you find Uniti is able to do with these assets that maybe the old owners maybe didn't do as well or didn't do it all to drive incremental leasing on your portfolio?

Yes. So when you look at the assets we acquired. So our first acquisition was PEG bandwidth back in 2016. They had network in the Northeast, Midwest and the Southeast. And then our follow-on transaction after that was Tower Cloud, and they primarily had fiber in the Southeast, and they were building one of the dark fiber projects they were undertaking in Florida at that time. And then you look at 2017, then when we acquired Hunt and Southern Light, Southern Light was the biggest acquisition to date in fiber. And Hunt was primarily located in Louisiana, and their specialty was in E-Rate selling to schools and then Southern Light had a very nice fiber network in the Southeast that basically spanned from almost East Texas all the way to Northern Florida. So when you put all that together, what we've now created or what we now have is a very large, dense owned-fiber network in the Southeast, and that has been our primary focus of development of new projects as far as lease-up. And to take it a step further, we primarily operate in Tier 2 and Tier 3 markets within the Southeast. So we're not competing in the Tier 1, the NFL-type cities. We're focusing more on rural, suburban types. So some of these markets have been underserved. When you look at the competitive nature of these markets, most time you're dealing maybe with the local regional fiber provider and the ILEC that's there. So now with the scale that we've created and been able to add these networks and become more fully integrated. We believe we have a scalable network in the Southeast, where we can leverage that network and continue to add on lease-up, and we can bring in competitive products into those areas at competitive prices. And we feel that we will at least earn our market share or more in those markets.

I think just to add on to what Bill said, I think the other thing that he alluded to is that now Uniti Fiber now has -- offers the full suite of services, whether it be fiber backhaul, small cell, E-Rate. We serve military installations. We also had an enterprise business, wholesale business. So each one of those companies that we previously acquired did not have a full suite of services. So what we've done is we really have built a platform company that does have a full suite of services. To Bill's point, that's a regional operator concentrated in the Southeast and then really focus on the Tier 1 and Tier 2 markets. And just to kind of elaborate also, that's in contrast to Uniti Leasing. These are really 2 distinct businesses, both fiber focused. But Uniti Leasing is totally different. It's more of a -- whereas Uniti Fiber has design, construction, operation capabilities across the full suite of products and is regionally focused, Uniti Leasing is really a passive business where we own the asset, but we lease it, somebody else operates the assets. It's not regionally concentrated, it can be a nationwide footprint. And so they're really totally different businesses that we operate. And like I said, I think when you're re-leasing, it's -- as far as we know, it's a totally proprietary business. It's not being offered by anyone else.

Right. If you were to measure what you paid for the assets and then you look at the capital that you've added in in the numerator, you look where now the EBITDA has gotten to, have you been able to compress the acquisition multiple from the initial purchase to where we are today?

Yes. So those businesses has -- let me try to answer your question this way. Those businesses have performed very well relative to our expectations. And part of that is, you probably know, the integration of those businesses has been -- has gone very well. We've exceeded all of our cost savings and other synergy opportunities that we had early identified, pretty much all of that now is behind us. There's still a little bit left to do on off-net, on-net savings that we'll still be able to realize going into 2020. But otherwise, the integration has gone well. I think our customer service has gone well. We've continued to invest in the infrastructure of the business itself, whether it'd be adding additional people. We've also invested in the underlying systems for both sale support and deployment. So I think the businesses, the investment thesis that we had, has turned out very well. I think we've had good execution from our teams.

And when you think of just what you've done with the triple net leases, the Uniti Leasing business, one of the interesting things that came out of the tax reform was this idea that at some point, interest deductibility may have a limit to it. Has that opened the door, specifically, to more conversations about sale-leasebacks and leasing on your platform because it's a way to turn leverage and an interest expense into a leasing expense and improve the tax efficiency for companies that want to have higher kind of philosophical leverage to themselves?

Right. So I can't point you to any transaction. I would say that was really a key reason why we did the transaction or is really important to our counterparty. You're exactly right though, that rent isn't subject to the limit as opposed to the interest deductibility allowance. So that can be useful in the future, and it may be useful in the future. We have had conversations with counterparties about it as we've entered into transactions, but I wouldn't really say at this point, I can't really identify any transaction that probably wouldn't have been otherwise done because of that factor. But it is something that people do consider.

And as you had investor conversations over the last few months, what do you feel is the most underappreciated part of the Uniti story?

I'd say the opportunity set that we have in some of the -- particularly the, I'd say, Unity Leasing business and Uniti Fiber business over time is probably not really maybe well appreciated by all investors. So as I said, I think the Uniti Leasing business is something that we really started from scratch. And so I think you'll see more and more us deploying capital into that business. I think the opco/propco transaction that we did with Macquarie serves as a -- will serve as a good template for us to do additional transactions similar to that in the future. And then I think also -- on the Uniti Fiber business, I think, again, we've deployed a lot of capital into new builds over the last few years since we acquired these businesses. And I think people probably underappreciate that -- now that we're going to be soon through that investment phase, we can start realizing the benefits of those investments by leasing it up. And as I said, that's what we're focused on. So I think both of those, I think people probably haven't understood the Uniti Leasing business as well, or have focused on a lot more since the Macquarie transaction. And probably really haven't seen us focusing on the investment cycle at Uniti Fiber but not yet, it'll completely -- the lease-up of those assets, which we'll start to see this year.

And do you view both of those businesses as -- when you think of the future operations of Uniti and the range of scenarios that could emerge, do you view both Leasing and Fiber as critical and strategic to your future?

Yes. I think that Uniti long term wants to be long-term holders of communication infrastructure asset. What form, what structure, those things may evolve over time, just as it has now with Uniti Leasing versus Uniti Fiber, but we want to be long-term holders of communication infrastructure assets, primarily fiber.

And you've dabbled in LATAM for a few years, Mexico. Are you committed to being more of a domestic infrastructure company, or do you have global aspirations over time?

I think right now, we're focused on U.S. So focused on domestic at this point. Someday, that may change. But right now, our focus is the U.S.

And as you look at the capital investment side, one of the hard things, I think, for investors has been trying to contemplate fiber AFFO because you have a portion of the CapEx that's like truly maintenance. But then there is a portion of the CapEx that's for churn replacement because fiber churn is different than tower churn, for example. Can you frame what the annual revenue churn in total is for the fiber business and how you contemplate that capital to kind of keep that totality of fiber revenue flat in any given year?

Yes. So if you look at our churn, you look at the third quarter, our churn was about 1%, and we expect churn to be at similar level for the fourth quarter. So that would put churn for the full year at that 0.9% -- put the churn to 0.9% to 1%. So when we look at those churn levels, if -- the way we think about it, Mike, is this -- is that maintenance CapEx is about 2% to 3% of Uniti Fiber's revenues. We view the churn replacement CapEx as being a couple of percentage points on top of that, so it's not very material. Most of the CapEx that we're spending today in fiber is for the success-based CapEx for these dark fiber and small cell projects for 2019. We expect net success-based CapEx of about $150 million, which put us at that close to a little bit below 50% capital intensity. And again, that will come down over the course of 2020 and eventually trend towards the mid-30% range. And going forward, I think given the level of lease-up and level of greenfield projects that we'll probably pursue, being in that 30% to 35% capital-intensity range is probably the right way to think about it over the medium to long term.

So to -- so if you're doing 0.9% to 1% per month, so like 11% to 12% annual churn?

That's right. Yes.

And so to replace that 11% to 12%, it's the 2% to 3% maintenance and just a couple of points.

Percentage points, yes. Because again we're going to be leveraging the existing network. And when you add on another customer, new customer, placed a customer who was off, there may be some additional CapEx, but it will be materially lower than what it would be to build a new greenfield build.

Great. So as we're pushing through from the beginning of the year onward over the next 12 months, is there anything else that you'd like investors to keep in mind?

I don't think so. I think we've kind of done a good job of covering what our priorities are right now. Obviously, we're still going through our -- haven't quite finished up our planning cycle for 2020. We'll get that done, and then we'll have additional guidance to give you on our next earnings call. But I think we've covered the key priorities for now.

And one last thing on liquidity. Is there anything from a liquidity perspective that investors should just be following things that you may want to do in the early part of the year?

Well, I think I indicated earlier that if we're able to come to a resolution with Windstream that's similar to our cleansing disclosure that we had, then I would expect us to be in the capital markets after that, partly deploying some of the capital that we would need for the TCI commitments I mentioned earlier. But probably also once we -- to also continue our diversification strategy as well. As I mentioned earlier, we'll continue to keep our M&A pipeline fresh. And so I'd expect we'd have some things to do on that front as well.

Thank you for your time today.

Yes. Thank you.

Thanks, Mike.