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

All right. Well, welcome back, everyone, to our next keynote session here on day 3 of Communacopia. I'm Brett Feldman, the firm's U.S. telecom infrastructure analyst. It is my pleasure to welcome back to this year's conference in virtual format, Kenny Gunderman, the President and CEO of Uniti Group. Kenny, thanks for being with us.

Brett, thanks for having us, and good morning.

All right. Well, I mean, let's just jump right into it. Obviously, you recently reached a settlement agreement with your largest tenant Windstream. And that should go into effect as they imminently emerge from their bankruptcy. And so the question we have now is, what are your key strategic and operating priorities through remainder of this year and more importantly, as you look ahead into 2021 and hopefully, a post pandemic world?

Yes. So we're very excited about the settlement with Windstream and more excited about having it actually close and Windstream emerge. And I think you hit on it, it's imminent. So priority #1 is doing what we need to do to facilitate that closing and facilitate their emergence. We're very pleased with what that means for our business, essentially pro forma for that deal. We'll have 120,000 route miles of fiber, which really puts us on par with some of the biggest independent fiber providers in the country like Zayo with 130,000 in Crown Castle with 80,000 to 85,000. So gives us a lot of fiber, tremendously supercharges the amount that we have to lease up, increases our portfolio by 90%. It also really, we think, substantially future proofs our business because there's an investment program as part of the settlement, where we're going to be building fiber to the home and fiber which we're immediately leasing to Windstream. But ultimately, it's future-proofing our network at renewal 10 years from now. So we're very excited about that. And ultimately, Windstream will be a much healthier customer, which has been a drag on our story for the past couple of years. So that part will be addressed materially. So #1 is just executing on that. #2, with all this new fiber and with a lot of the fiber we've been building over the past several years, we're really going to be focused on leasing up the network. So we're pivoting from a construction/build mode to more of a lease-up mode, which will not only drive more cash flow into the business through less CapEx, but will drive improved margins in our business. And just -- we'll start to see some of the scale benefits of the investments that we've been making. And again, we're very excited about the lease-up potential that's coming with the settlement fiber in addition to the fiber that we've been building. And in many cases, those opportunities are intertwined because we've effectively gotten out really a national network of fiber. And we've been demonstrating that success over the past several quarters, and we've started to show investors some of that lease-up success. So we're very excited about that. We'll be very focused on that. And then thirdly -- and by the way, that's not at the expense of doing additional anchor builds, but will be a lot more selective at those opportunities. And then thirdly, we're going to be reengaging with the strategic market, the M&A market. We've always stayed connected there through the bankruptcy before, but we've been a lot more cautious. But the opportunity set is -- continues to be tremendous for us there, not only in terms of big strategic deals, but also just opportunities to continue growing our real estate portfolio through OpCo deals and certainly through lease-up deals of the network. So looking forward to that, we've got a full plate for the rest of this year, but really excited to have a clean sheet of paper going into 2021, and a much cleaner and more attractive story for our investors in the new year.

All right. Let's dig into some of that then, and we'll start with your fiber business, which currently represents about 30% of your consolidated revenue. On your second quarter call, you highlighted strong installation activity in that business. I think you had indicated there was about a 40% increase from the prior quarter. Can you help us understand what's driving that strength in your fiber segment? Can you, if at all possible, try to unpack the extent to which is related to things that are unique to COVID versus something you see as a bit more structural and durable?

Yes. COVID has had a relatively small negative effect on our business, and I would say the positive effect has outweighed the negative. On the negative side, to remind folks, and of course, Brett, you know this, but really less than 5% of our revenue, 5% -- less than 5% of our total revenue is related to enterprise -- enterprise services. And that segment of the industry is the one that's been most heavily affected by COVID and, in particular, small businesses. And when you look at small businesses, that's an even smaller percentage of our revenue. It's something like less than 2%. So as a result, just by that alone, you're not going to see a huge effect on our business. We're just a predominantly wholesale-centric business, and that's going to continue to be the case. Even though we're leasing up our networks more to enterprise customers over time, we're still going to be predominantly enterprise. So as a result, where we have seen effects of COVID, some of the negative effects, we've seen delays on installations. I think at one point, that peaked out at something like 50,000 of MRR a month. That's now down to less than 10,000 of MRR per month in terms of that delay. But again, that's a timing issue. It's not a churn issue. We haven't seen any churn related to COVID. So we've seen some delays on installs. And we've seen some softness on enterprise bookings, simply because our sales folks are not able to get out and make physical calls and they're not able to get out and win new logos at the same pace that they were prior to COVID. But again, I view that also as a timing issue. Once things start to normalize, I think that'll get back to a regular pace. But really, on the demand side, we've seen just a tremendous, what I'd say, tremendous increase in activity among our wireless customers, carriers, and how much of that is related to COVID versus just normal network planning on their part is hard to say. But I do think at least some of it is related to COVID as their residential networks, their wireless networks, I think, are getting -- are seeing an increase in demand. And we've certainly seen an increase in demand from some of the more virtual-centric providers like health care providers, virtual medical visits, certainly schools are planning more heavily for virtual learning. And so some of those types of demand elements, I think, are outweighing some of the negatives that we're seeing on COVID. So that's a long-winded way of saying that a lot of the positive effects that we're seeing in our business are not related to COVID. They're more related to the fact that I think we're moving from a build and an anchor-centric business more to a lease-up-centric business, and we're now starting to see the fruits of some of those investments that we've made over the past several years.

So a key question we get is, does improving demand for your fiber infrastructure convert into improving returns? In other words, how do you feel about the pricing opportunity and the ability to execute against this funnel and to get returns you find to be attractive?

Yes, I think that's a great question. And I think the answer is yes. I mean, yes, we've always been pretty transparent going back several years about the unit economics of our business. And we've always talked about the anchor awards, the anchor builds being in the 5% to 7% to 10% cash flow yield range. And then the second, the third, the fourth tenant or the lease-up drives those margins or cash flow yields into the 10%-plus range, the double-digit range. And that's exactly what we're seeing. So when we're out building an anchor network, whether it be a small cell or a dark fiber to the tower or a lit fiber to the tower, we're seeing those cash flow yields in the 5%, 6%, 7% range. And now, what we're seeing, and we're starting to show investors transparently is as we're leasing up these networks, we're seeing those cash flow yields on those lease-ups at 40% plus yields, which is obviously driving the blended yield well above 10%. And over the past several years, and we've demonstrated this with the 15 or so large anchor builds that we've talked about publicly, we've really tripled the amount of MRR on those networks on average, which in effect is similar to saying we've added 3 new tenants to those networks. Obviously, that -- those -- that MRR is comprised of enterprise and additional wireless customers and schools, et cetera. So it's not literally just 3 new tenants, but it's the equivalent of 3 new tenants. And when you consider that all of that is being brought on the network at 40% plus yields then the blended yields you can imagine are well plus -- well above 10%. So we are seeing those economics. It gives us confidence in the model. It gives us confidence to pursue additional anchor yields -- or sorry, anchor builds, but selectively, as we're really trying to monetize the existing network that we have.

Yes. You noted that you're increasingly focused on leasing up the infrastructure you've been deploying or acquiring for the last couple of years. And from an incremental return standpoint that makes a ton of sense. At the same time, as a result of the new agreement that you have struck with Windstream, which as you pointed out, in many ways, helps future-proof your business. I think a lot of investors would expect that your cost of capital would start to improve, and we're already in an incredibly low interest rate environment. So in theory, that backdrop would suggest you should be deploying even more capital. So how do you balance that? How do you think about the attractiveness of ramping the returns and the cash generation on your existing assets as well as trying to meet some of the demand in the market by deploying new capital?

Yes, it's a great question, Brett, and something we think about constantly. And in fact, we're very actively thinking about it as we speak because we're -- the amount of -- as I was mentioning, the amount of demand that we're seeing is it's at a fever pitch, including from our wireless customers. And so we're actively evaluating RFPs that comprise almost 60 of our existing markets. And some of those are lease-ups of existing networks, but some of them are new builds both in existing markets and new markets, which obviously represent more capital and represent those lower-yielding opportunities versus the 40%-plus opportunities. So, and I think -- so it's important to point that out because there's no lack of demand in our industry. There's no lack of opportunity in our industry. There's no lack of opportunity to drive bookings and therefore, growth and -- but the result of all that is just higher capital intensity. So from our perspective, we want to continue having a steady diet of those anchor builds because you need those in order to have lease-up potential and you need to keep feeding those into the system, and those will require capital. But as we've talked about where we want to be from a steady state point of view and maybe more directly answering your question, we do kind of want to be in that 20% to 25% to 30% capital intensity range on a revenue basis. And that's going to be driven by capital required to lease up networks in addition to a handful of anchor builds. And we just think that's a good comfortable place to be for a more mature fiber business, and we're starting to get into that range of being a more mature fiber business. I think to offset that capital, however, it's important to point out that when we talk about lease-up on our national network, which is really a lot of the fiber that we're getting in this Windstream settlement plus fiber we've acquired in the past, both from CenturyLink and TPx and some of the other OpCo deals that we've done, those -- that lease-up is extremely capital -- I'm sorry, extremely cash accretive. In many cases, we're selling IRUs that are bringing in cash, a heavy amount of cash upfront and locking in very predictable cash returns over the next 10 or 20 years from O&M and -- or maybe even from dark fiber leases. And so that part of our business, I think, is underappreciated in terms of one that helps fund our overall business and helps fund the capital that's coming into Uniti Fiber.

All right. So as the business sort of moves into a more sustained period of lower capital intensity relative to where you had been historically, how should we also think about the EBITDA profile of your fiber business? I believe you generated an EBITDA margin or you're expecting to generate EBITDA margin this year in the range of around 38%. If we look at much more scaled telco providers that provide that connectivity over predominantly their own infrastructure, you can sometimes see margins north of 50%, north of 60%. How do you think about the structural long-term margin profile of your fiber assets as they mature?

Yes. I think you're right, Brett, that, that margin is low relative to where it should be, and I think you're going to see that margin go up over time, and it's going to go up. And I don't know if we've given a number publicly. So I won't comment on that simply because I don't know. But I do know that when I look at our longer-term plan, both next year and beyond, we're certainly expecting those margins to improve. And it's an improvement related to the lease-up partly, because you're rather than focusing on 5%, 6%, 7% yielding anchor builds, you're focusing on those 40% plus yields that are -- and frankly, those -- when I talk about cash flow yields, those translate to 80%, 90% EBITDA margin deals when you're talking about lease-up. So that mix of the business is going to drive those yields higher. But then you also -- we also are starting to see the benefit of some of the investments that we've made in the business, not just from a CapEx perspective, but if you recall, over the past couple of years, we've added people, including salespeople and technicians and service delivery people out into our markets. I think it was last year. We talked about adding a good number of folks there. And so you're going to start to see the scale benefits of those people that we added over the past couple of years. And then thirdly, we've made some divestitures in cases like the Macquarie Bluebird deal and others, where we've sold actively managed revenue and we've replaced it with passively managed revenue in the form of OpCo-PropCos, which just require less margin. And so there's an opportunity for us to reduce costs out of our business, not only in terms of people, but in terms of systems and in terms of some of the investments that we've made in other regions of the country that we're going to be able to pull back on. So when you put all those 3 things together, it's definitely going to lead to margin enhancement over time.

That's a great summary. If we go back to something you said earlier, you talked about how there's no shortage of opportunity in your sector. And from listening in on a couple of other telecom infrastructure sessions, it seems like there's also no shortage of capital looking to invest in this industry. And sometimes, that can result in a challenging competitive backdrop. And so one of the questions we've been getting is, are you seeing any new or emerging providers in the fiber space that are willing to do deals under economic constructs that you wouldn't consider? And if so, is that any way impacting your ability to lease-up your existing assets? Or is the presence that you've established in some of the second and third tier markets making you a little bit immune to that dynamic?

Yes. So it's a little bit of both. I mean in markets where we have existing network, it's not affecting our ability to lease up at all, or I haven't seen it, haven't felt it. I don't think that's really an issue. So where we've got network -- and we as you know, Brett, we operate in Tier 2, 3-ish markets, in some cases, even smaller. And so the competitive dynamic there is just a lot -- there's just a lot less competition. And where we do see competition, it may be a local ILEC or a local -- relatively local cable provider or maybe a very large national provider where the market just isn't a priority for them. And so it's a really great competitive dynamic for us, and that's why we focus on those markets. So from a lease-up perspective, I see less of an issue there. Where I think it comes into play is if there's a big greenfield build or a new opportunity in a new market that's in our footprint that would otherwise be in our zone of opportunity, then it's more of a heads up competition versus what could be a new provider. And in some cases, I'm hearing names of companies I've never heard of before. And it's really, in some cases, not even an established company. It may just be a management team that's got -- maybe got some infrastructure money behind them. And in those cases, we do hear anecdotally of providers or potential providers may be chasing deals that look uneconomical to us. And so back to our discussion earlier about the demand, that's a scenario where there's a tremendous amount of demand, we could go and win an award like that. But is it -- and it shows up as nice growth, and it shows up as a nice bookings hit. But then down the road -- 2, 3, 4 years down the road, you have to pay for that uneconomical deal, and it's just not worth it from a profitability point of view. So there is some of that going on in the industry. I think some of that's just natural, and you see it generally. But I think at this moment in time, we're probably seeing more of it than we normally do. With all of that said, I don't -- in some cases, I think we often forget that our customers, especially the wireless providers are aware of that. And in some of our markets, we know we're competing against a new provider and they're willing to take on really uneconomical deals, but the customer, the wireless provider looks at that and says, hey, do we really want to get in bed with a new provider here who's willing to do this uneconomical deal and then 2, 3, 4 years from now, this provider is -- gets themselves into economic distress and it creates an issue for the customer. So I think there's an element of rational thinking on the customer's part that sometimes trumps the irrational thinking on some of our competitors. And we try to have that dialogue openly with our customers. In some cases, it works, and other cases, not. It's just part of the balance that we deal with day-to-day.

I want to stick with the wireless theme right now and talk a little bit about small cells. You've already done a good number of small cell deployments throughout your footprint. I was hoping you can maybe give us your insight into what the demand backdrop looks like for small cells, whether you think that, that could be accelerated by some of the spectrum options that are coming up? And then maybe just more broadly, how do you think about the positioning of your infrastructure to support small cells in second, third, and in some cases, smaller markets versus the large metros?

Yes. We like small cells very much, but we like them as a part of our business, not an exclusive business on their own. And what I mean by that is we view small cells as more of an anchor build. It gives us an opportunity to go in and build a network for a carrier, again, generally in that 5%, 6%, 7% yielding range gives us a lot of additional fiber to lease up once you've built the network for the anchor customer, and you've got -- you've locked in a 10 or 20-year deal with the anchor customer. And then from there, we're not -- we don't underwrite models for small cells that are reliant upon the second small cell tenant or the third small cell tenant. We underwrite models that are reliant upon lease-up from enterprise, lease-up from E-Rate, lease-up from other wholesale, lease-up from fiber to the tower, lease-up from additional small cells where the opportunity presents itself. But we pursue a full range of lease-up on those networks, and we think that's necessary to drive optimal economics as opposed to only focusing on second and third small cell tenants. I say that because in our markets, the Tier 2 markets, small cells have not been nearly as prevalent yet as you're seeing in the Tier 1 markets. And we expected that, and it's just -- it's really a priority perspective from the wireless carriers. They focused first on those markets where they needed the densification and where they had the highest traffic volumes. And obviously, that's the NFL cities. But we've also said that we expect small cells to come eventually. And we've seen that. And as you pointed out, we have a 2,000, 3,000 portfolio of small cells. And when you look at the opportunity and what we're seeing in some of these RFPs that we're looking at now, there is a growing demand for small cells in our markets. And in some cases, in some markets where we've built fiber to the tower, the amount of small cells that are being demanded from these RFPs, it's 7, 8, 9x the number of macro towers to small cells. I mean it's a huge opportunity. And I think for us, we've got the network in place in a lot of these markets. And as I was pointing out earlier, and virtually any fiber company will tell you, if you have a network in a market already and a carrier wants to deploy small cells or even macro towers, fiber to macro towers, you've got a great opportunity to win that business because speed to market and obviously, a lower cost basis give you a huge advantage. So when that demand comes for small cells, which is building, we're going to be well positioned for it when it does.