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

All right. Well, good morning, and welcome to 2022 Nareit, everybody. Thank you for coming to join us. My name is David Barden. I'm the communications infrastructure analyst for Bank of America based here in New York. And I'm super pleased, once again, to have the honor to welcome Kenny Gunderman, CEO and Chair of Uniti Group. And I've done this a number of years in a row, Kenny. And we always start off with kind of a blend, tell us about Uniti question. But I thought what I wanted to do this time was going to start off with a little bit more nuanced version of this. The communications infrastructure group has become a big part of the REIT world. And the thing that the REIT community, I think, likes and also is concerned about is it has a technology-like exposure. And for me, what I think is interesting about communications infrastructure in the REIT world is that the kinds of things that REIT investors worry about, the decentralization of work -- remote work, remote learning, online sports betting, telehealth, all these things that work to substitute for traditional real estate live in the communications infrastructure world. And there's data center REITs, there's tower REITs, but in the fiber world, there's really only you, now that DigitalBridge essentially is going to become C-Corp next year.

So I guess what I wanted to start out with a little bit was talk about Uniti's situation in the digital infrastructure, comm infrastructure world?

Yes, great question, David. And thanks for doing this, as always, and thanks to Nareit for having us. Yes, great question. We -- so we own 130,000 route miles of fiber around the country, and we believe that fiber is the critical ingredient to all broadband traffic today and certainly will be in the future. There's really not a technology that's being developed to replace fiber. There are things on the edge, like satellite and fixed wireless and mobile broadband and fiber-to-the-home, that we consider to be on-ramps. Those are just on-ramps and technology that drive traffic onto our network. And so to your question about technology, there's not a lot of technology risk at Uniti. So 90%-plus of our traffic is wholesale, which means it's very passively managed revenue. So our customers are buying contracts for 10, 15, 20 years. We're locking in that very steady revenue stream, generally with 1%, 2% escalators, very tower-like economics. And then from their our margins are pretty high. Our CapEx is low because it's passively managed revenue. And so the technology risk of customers driving traffic onto our network is really owned by the customer, not Uniti. So passively managed and network all over the country, very valuable, 50-year lived assets. And we think the trends -- the secular trends are all favorable to our business, meaning that things like telehealth, things like working from home, things like remote learning, those are all things that drive traffic onto our network. And so whether you're here today using your iPhone, or you're working from home using fiber-to-the-home, or whether you're traveling using mobile broadband, those are all things that eventually backhauled onto a fiber network. And so we are agnostic as to which of those edge technologies win. We're agnostic as to whether or not ILECs be it the cable guys, be it the satellite guys, be it the mobile broadband guys, we don't really care because they're all customers of ours, and they're all driving traffic onto our network.

So Kenny, the digital infrastructure world has been a very hot one. We've seen a ton of deals, American Tower buying CoreSite, DigitalBridge buying Switch, and as recently as, I think, December of last year, just 6 months ago, there were reports that there were companies interested in buying Uniti and maybe recombining it with one of your big tenants, Windstream, and then reparsing the assets out. Could you talk about where Uniti sits today in terms of being an organic growth company versus being a company that's maybe shopping itself and looking for it out?

We're not shopping ourselves, but there are companies interested in buying either all of Uniti or parts of Uniti. And the -- that's not news necessarily. We've always talked about the...

I'm going to pretend it's news.

We've always talked about the strategic value of our assets. So we have, again, a 130,000-route mile fiber network. We think we're the second largest independent fiber operator in the country. And in terms of the digital infrastructure space, fiber is a very valuable shared infrastructure asset that has a tried and true bid in the private market. Anywhere 15 to 20x cash flow is what buyers are paying, maybe in some cases, even more than that. And that's been the case for the past 4, 5, 6 years. And so a very valuable platform, very interesting time in the space, where there's a lot of new capital trying to get into the space or trying to enlarge their position in the space. So having that platform obviously attracts interest. In addition to that, you mentioned our -- one of our large tenants, Windstream is a residential broadband provider. Their business today is very heavily focused on building fiber-to-the-home. So again, fiber and fiber-to-the-home. Fiber-to-the-home is a trend that the industry is really getting behind in a way that it hasn't ever before. I mean, they were -- Verizon started building fiber-to-the-home many, many years ago, but then there was a pause, and now we're back to building fiber-to-the-home because the economics are working today in a way that they haven't in the past. And so a lot of capital is coming into that space. You've seen large funds, like Apollo, buy businesses from Lumen. Searchlight has bought assets from Frontier. They've invested in Consolidated. Macquarie bought Cincinnati Bell, took them private. So again, there's a bid out there in the private market among infrastructure funds for those types of assets. And the network that we own and we lease to Windstream is a critical part of their business. We've always talked about it being a mission-critical part of their business. And so no surprise. There is interest in that sort of part of our business as well. So we obviously, as fiduciaries, are willing buyers and willing sellers, if valuations are right. And for those of you who know us, we have built businesses like a ground lease business and we eventually sold it. We built a tower business, both in Latin America and in the U.S., and we eventually sold those businesses because -- not because they weren't good fits with our business, but because there were opportunities to sell those companies or businesses at premium valuations. And so locking in that value, realizing that value for our shareholders is something that we did. And we're willing to do that again at the appropriate valuations. But with all of that said, we're not shopping the company. We're not running a process. We're focused on running the business day to day and really taking advantage of those secular trends that I talked about. And when you look at the core business, and it's always a point of great frustration for me that most people don't look at the core business today. It's really all about the stuff swirling around us. But the core business is performing very, very well. Margins are improving. EBITDA and AFFO growth are in the 5% to 10% range top line revenue. If you look at true year-over-year, it's in the 4% to 5% range. Capital intensity is coming down. And so we're leasing up our network. We're adding appropriate greenfield builds, anchor builds where it makes sense, and we're expanding that national network in a way that I think, historically, fiber companies that have traded publicly have not been able to do. So we're demonstrating economics that we think are appropriate for a REIT that really show good, solid cash flow over a long period time, and we're taking advantage of those secular trends. So that's our day-to-day focus. And when the phone rings, we answer it, and we're going to continue to do that. And we think we've proven to be both smart buyers and sellers, but also importantly, we're executing on the business.

So I want to ask one question that kind of bridges us from the swirl to the core business conversation, which is to the word you used probably 10x in that kind of answer to the last question, valuation. I think the REIT community is used to looking at AFFO and NAV and cap rates. And you guys have kind of 2 businesses, right? There's the fiber business. There's the sale leaseback business. How should investors think about? You said 15 to 20x on the fiber side. I assume you meant EBITDA instead of cash flow. But could you kind of walk us through how you think about how investors should value Uniti? And then kind of we'll talk about what's going on with the core business.

Yes. So over the past number of quarters, we have been talking about a framework on how to value us because we know we're somewhat unique. And in order to help people see how we look at it, we show our non-Windstream business, our core fiber business valued at 15 to 20x EBITDA. You're right, David. Again, that's a tried and true multiple proven in the private market. And then we looked at our Windstream MLA. So independent of all of our other sale-leaseback business, just looking at our Windstream MLA, we've talked about valuing that at around 10x EBITDA. And we've given a bunch of different data points. You can look at cap rates. You can look at how our appraiser valued the business back in 2020 when we recut our MLA with them. We think that's roughly an appropriate valuation as a starting point. And I think that the -- at the end of the day, when you look at how the market is valuing our piece parts, it's hard to say because I think that there isn't a lot of focus on our core business. There's a lot of focus on the swirl. And so as a result, we believe there's a conglomerate discount applied to our stock related largely to the MLA that we have with Windstream, which is, obviously, our largest customer. So we've tried to focus people on the piece parts. We haven't been successful at that with the public market. But I would say with the private market, I think we've made a lot of progress in that regard. So at the end of the day, roughly 10x cash flow -- sorry, multiple on the MLA is probably valued in the public market by 6 or 7x, and therein lies the disconnect.

So -- and just to short circuit all that, I mean, it kind of -- you put that math together, it puts the value somewhere in the probably mid-20s versus where it trades at 11% today. So your argument is that there's a lot of hidden value here that people can look at. And the underpinnings of that hidden value are obviously the core business. About 80-ish percent of what your business is, is that sale leaseback business. And there's really kind of two parts to that. There's the Windstream lease, which is the anchor tenant. And then there's kind of all the other stuff that you do. So I guess those 2 questions would be, number one, the Windstream relationship has evolved in a way that seems to be pretty healthy for Uniti. So let's start with that. What is the status of that relationship right now?

Yes. So the day-to-day working relationship is very good. When we recut the MLA with Windstream back in 2020, we agreed on an investment program to basically future-proof our network. And a big part of that was that Uniti would commit capital as part of that program up to $250 million a year to invest, to build fiber-to-the-home, overbuilding the copper in the network. And we're getting paid an 8% anchor rate, which is, frankly, in our view, an above-market anchor rate compared to the anchor yields that we're getting from some of our wireless carriers. So that's a critically important part of the relationship, day-to-day working together to build fiber-to-the-home to both future-proof our network, taking it from roughly 20% fiber to hopefully well over 50% in the next 10 years. So that's a big part of it. We also own the national CLEC network, which is a fiber network. We leased a portion of that to Windstream. We used to lease that exclusively to Windstream, but an important part of the recut of the deal in 2020 was giving ourselves the ability to actually use that network ourselves and turn it into a true shared infrastructure asset. And so day-to-day, we are actually executing on that. So when you look at our businesses, Uniti Leasing is really that the business where we're leasing up that network ourselves, and that business is growing at 10%, 15%, 20% a year. And so we are super happy with that, excited about it. I think the growth potential is terrific. Those opportunities come in at 80%, 90% margins. Again, very passively managed revenue. In most cases, they come in with virtually no CapEx or very little CapEx, if you need to spend a little to complete network segments, but for the most part, very little CapEx. And that network is probably 20% utilized today. And so there's a tremendous amount of excess capacity in that network that we look forward to using over the next 5, 10 years.

The -- so the other part of the sale leaseback business implies -- it's actually more of a buy leaseback from your perspective. And buying assets is dependent on your cost of capital. And as you mentioned, maybe the 8% yield that you got on Windstream is a premium to deals that you could do maybe in the fair market valuation situation. So as we live in a world where rates are rising, the cost of capital is growing, is the sale leaseback market growing because sellers are getting more anxious to sell? Or is it getting tighter because the cost and the hurdle rate for you to make these purchases goes up?

Yes. It's -- and when we talk about sale-leasebacks, we consider dark fiber IRUs to be very analogous to that. And for those of you who aren't telecom experts, dark fiber IRUs have been done in the industry for many, many years, and it's really just selling access to a network, very passive access over a 10- or 20-year period. And the decisions that customers make on buying a dark fiber IRU versus building our own network or doing a sale-leaseback with us are much more than just about cost of capital, it tends to be network planning related. Do -- how much capacity do they need? Are they transitioning their business to more of a network infrastructure business versus a managed services business or a cloud-based business? So a lot of things factor into it, but clearly, cost of capital is important. And in a lot of cases, a sale-leaseback or an IRU gives a customer the ability to use that capital in other ways. And so when they think about their cost of capital, it also is an opportunity cost. I mean, what am I going to get by using that capital to go do something else? And so that gets factored in. So it's not just about what Uniti, what's your cost of capital and customer A or customer B, what's your cost of capital. But with all that said, in a rising rate environment, that obviously puts the cost of capital back into focus more so than in a normal environment. And I would say it's really less about our cost of capital in the vacuum or our customers in a vacuum. It's really just that relative cost of capital, what's ours relative to theirs, and number one. And number two, what's -- the volatility in cost of capital is a problem. And if you know what your cost of capital is, over a steady longer-term period of time, even if it's elevated, you can plan around it. So in these choppy markets, volatility is higher and that relative cost of capital is a little bit more unknown. So all of that to say, yes, it makes it harder to do sale-leasebacks or even IRUs in a choppy market. But I don't think -- we don't think this is a sustained period of volatility. We think it's going to level out. And when it does, we think we'll get past that bit of choppiness.

And so I guess this is kind of a bridge then to kind of the other part of the Uniti core business. But one of the key themes, I think, in a rising rate environment is this notion of pricing power. And obviously, your existing longer-term contracts, there's limited pricing power. But I guess maybe this goes to your answer around new contracts. Once people can kind of plan around where the cost of capital sits, your cost of capital moves, their opportunity cost of capital moves, you can likely pass that through into new contracts. But when we get into the fiber services business, there's a little bit more velocity in terms of contract turnover. And I was wondering if you could kind of talk a little bit about how you see the pricing power between incremental sale-leaseback and then new fiber contracts as you kind of move forward?

Yes. So first of all, our monthly churn is 0.2%, 0.3%. So very, very low, and that's a terrific part of our business that we try to accentuate. So again, that's a result of these 10-, 20-year contracts. And generally, when people buy dark fiber or they're on your network, they don't tend to move off because it becomes an integral part of the -- of their network and their network planning. But yes, with that said, when renewal comes about -- especially our larger customers tend to look for discounts. They tend to look for -- hey, I want to stay on your network. I want to buy more capacity, but I need a discount. And so as a result of that, we make bake those -- tend to bake those discounts into our initial pricing of the deal. And so we've always talked about getting 5%, 7%, 8% initial yields with our anchor customers. And then from there, the second, third and so on tenants tend to drive those cash flow yields well above 10%. So right now, when you look at the key anchor builds that we've done over the past several years, all of those are tracking at around 20% all-in cash flow yields. And again, that's all inclusive of any sort of pricing discounts that might happen. So with that said, you then have to get into specific products and specific customers about where the pricing power lies and what the trends are. I would tell you, and if you ask any telecom guy, they'll tell you that -- or women, the pricing pressure around dark fiber has generally been relatively flat in the past 10, 15 years. People generally pay around $1,000 per fiber mile, and that continues to be the case. And so that's a key part of our business. When we talk about 90% of our business being wholesale, wholesale is dark fiber. And so there's not a lot of pricing pressure in that particular area of our business. And when it comes to enterprise, which is a relatively small part of our business, but it's a part that's growing at 10%, 15% a year, yes, pricing pressure there because those are contracts that are generally 3-, 5-, 7-year contracts. So a lot smaller part of our business, but shorter contracts and higher churn. So if you just look at that part of our business, it's around 0.8%, 0.9% monthly churn. And so as a result, when those contracts are renewing, there's pressure. But holistically, we just don't see a lot of it. And even in this environment, where the cost of labor is going up and the products or the cost of equipment, the cost of all the raw material that go into building fiber and building conduits, those are all rising. But so far, we've been able to sort of subsume those into our pricing to customers. I hate to say we're passing those along to customers, but for the most part, we are. And so we haven't really seen much pressure from that.

So if we think about the sale-leaseback business, there's kind of the wind piece, there's the non-wind piece. If we think about the fiber services business, there's the wholesale piece and there's the retail piece, and the wholesale piece is the big part. And -- starting, and I think it was probably fourth quarter 2020, we started to see a big step up in your wholesale business and your monthly recurring revenues, which run probably 800,000 to 1 million a month per quarter. About 2/3 of that is the wholesale side. And a lot -- presumably a big chunk of that was related to the Windstream settlement. You got access to a lot of their network and have been able to profit from that. So the year-over-year has been really strong as of the first quarter of 2022, but roughly flat kind of from 4Q to 1Q. So which of these 2 trends is more powerful, kind of the quarterly stable trend in wholesale or the significant step up year-over-year in wholesale?

Yes, definitely, the significant step up. I think part of the reason quarter-over-quarter looked flat is because 2021 had some business in it that we divested. So if you normalize out for that, that growth is there. And yes, I think the 800,000 to 1 million of additional MRR bookings per quarter is the new norm for us. And if you go back to 2020, when we got access to the broader network and you add 6, 9, 12 months to that time period, that's when those -- that step up really happened. And that's really the sales cycle. On wholesale, it's generally a 6-, 9-, 12-month sales cycle because you're dealing with larger customers. You're dealing with a larger sale. It's more complex. And so that's kind of -- with logical thinking when you consider -- when we got access to the network. So we're very excited about that trend. I say all the time that we don't have a demand problem in our business. We have plenty of demand. For us, it's really a question of profitable demand. We want to make sure that we're bringing on customers and opportunities that we know will generate 10%-plus yields over a period of time and also allow us to continue to bring our capital intensity down. And so that's why we focus on EBITDA and AFFO growth as opposed to top line growth. I think in our industry, in fiber, in particular, companies in the past have gotten themselves in trouble by chasing the top line because if you're -- all you're doing is adding anchor customers at 5% or 6% yields and driving the top line, you tend not to be profitable. So with all that said, bookings are a great leading indicator for us, but what's more important is what are those yields that are getting spit out after they're installed and after there's a period of time of lease up.

We only got a couple of minutes left, but I wanted to ask 2 kind of big questions. One is a lot of the topics that we're going to be talking about the next few days here at Nareit 2022 is going to be the U.S. staring down the barrel of a potential recession as the Fed tries to cool the economy. And we've had this kind of question around the pandemic and its impact on decision-making around businesses. At Bank of America, we're still trying to figure out what our go-to-work strategy is going to be. Probably we won't know it until the end of the year. So from a retail perspective, how is Uniti positioned to kind of weather what is going to happen next in the macro scenario?

I think we're positioned very well. The pandemic -- the height of the pandemic is a good leading indicator of how your business performed during that period of time is a good leading indicator for a recession or another downturn in the economy, and we performed very well. In fact, we had virtually no negative impact from the pandemic because we don't care if someone is working in an office building in downtown Manhattan or if they're working at home in Little Rock, Arkansas because at the end of the day, they're still driving the same amount of bandwidth. They're still driving the same amount of traffic that is getting backhauled onto a fiber network. And we saw that during the pandemic. People were buying more access and more capacity because they were lighting up new workstations or they were participating in more telehealth or more e-learning. And so I think it just speaks to the mission-critical nature of our network. It speaks to the long-term contracts that tend to go -- get you through a period of 6 or 9 or 12 months of a downturn in the economy. If you're buying a 10-year contract, you started it before the downturn and it prices out well past it. But with all that said, I think where the impact we will likely see is that on the enterprise side of our business, there's probably going to be some speed bump. And again, that's 5% or 10% of our business. And with respect to enterprise customers, what they're going to do during any downturn, we don't know for sure, but I think it will essentially be a relatively small -- there essentially be a relatively small impact to our business.

Perfect. And then that leaves us enough time to talk about the thing that a lot of people are going to care about, which is the dividend. You have a covenant exists that has limited your ability to revisit your dividend policy. You've kind of -- you got a threshold of potentially of getting to that -- meeting that covenant. What is the go-forward plan from a capital allocation standpoint? Is it invest more in sale-leaseback? Is it invest more in the fiber business? Or is it invest more in returning cash to shareholders?

Yes. So I think sometime this year, next year, we'll clear that covenant, and the Board will have the opportunity to assess raising the dividend, which we're in a position to do. We've got strong liquidity. The balance sheet is in a really strong place. But the Board also has the ability to invest more in the organic business. As I said, we don't have a demand problem. So it's all a question of how much capital do you want to spend to grow the business, and we've got great opportunities to do that. Personally, that's my preference. But when it comes to that decision, it's the Board's decision. We also have a tried and true M&A acquisition business, bolt-on acquisition business that has performed very well over the years, and that's a good use of capital for the Board to consider. So when the time comes, they'll have a good list of alternatives. I think we're in a rising rate environment. Our yield is elevated to 5.5%, 6%. That makes raising the dividend less interesting. So that will also weigh in when the time comes for that decision.

I'll just say you're raising it.

Yes. Don't say that.

So that's our time. So thank you all for joining us. I really appreciate Kenny for letting me be part of this presentation. Thank you so much. I'm assuming you have a fully packed day. And thank you all for joining us, and enjoy the rest of your conference. I appreciate it. Thank you.

Thank you. Thank you, David.