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

[ A round table session ], we are streaming, but we invite you guys to ask questions if you like. And just there will be a guy with a mic moving around as needed.

So I guess, Paul, just maybe kick it off with the big question. Uniti's a REIT, you don't have a choice whether you pay a dividend or not. And yet, the stock trades with an 11% dividend yield because no one is convinced that you're actually going to pay the dividend. Can you square that circle for me?

Yes. Well, first of all, Dave good to be here. Glad to be back, like being in New York, we were just talking about. My daughter is in school here. So...

In Williams.

No. Fordham. Good excuse to get to see my daughter as well. So glad to be here. Yes. So we've got a lot of questions about REIT status. And is it really worth it to be a read? And what about the dividend? And does the dividend that we have to pay in order to maintain our REIT status, does that make sense for Uniti. And so a lot -- had a lot of those questions, particularly in this environment where everyone is focused on cash flow and liquidity and the macro environment. And so a couple of quarters ago, we thought it would make sense for investors given those questions to really lay out our viewpoint and the case for maintaining our REIT status. And we think it's pretty clear. We think it's very clear right now that the REIT status has real value for Uniti and for our shareholders. And we're not married to any particular tax structure for the long term. I mean it's something we're going to continue to evaluate and make sure it makes the most sense. But we feel strongly that the REIT structure makes the most sense for our investors. Now the large piece of that is because of the tax advantages we get as a REIT. A significant portion of our revenue is triple net cash flow from our master leases with Windstream and a few others. And it's highly high-margin revenue, highly profitable that -- those kinds of cash flows, and so shielding those from taxes over the long term, we think creates significant value. There's certain pieces of it like the new rules around deduction for interest expense for a C-Corp, that's limited to 30% of EBITDA. So there's a cap on that and a higher interest rate environment. As a REIT, we're actually able to deduct all of our interest expense. And so that creates a situation for us along with some other pieces to the puzzle of that analysis. That creates a situation where if we were to switch to a C-Corp, our projections for our taxable income over the next several years we'd be shifting a lot of that dividend just to the Federal government. And so when it's a choice between paying the Federal government and paying shareholders, we think shareholders like for us to pay them. So there's also other advantages that we think comes from being a REIT that are strategic, a little bit harder to quantify. But in terms of strategic transactions, some of the tax advantages that we can get in terms of our ability to transfer assets to potential buyers of assets, with a step-up is enhanced as a REIT. And so we find significant value there. So once we kind of -- we laid out that, I think that resonated well with shareholders. But then the next question is, okay, well, you've also told us that you expect at the current dividend level to be over distributing -- distributing above the REIT minimum by about $100 million to $150 million between now and the end of 2025. Is that the right thing to do for the business? To date, our Board has elected to continue to maintain the dividend at its current level. But it's something we're continuing to evaluate given our other capital allocation priorities. And I think that could change its flexibility that we have as a business to do that. But to date, the Board has elected to continue to maintain the current redividend and there's some trade-offs there between, we are about 2 years away from free cash being free cash flow positive. So there's really a short window for us in terms of the period where we've got to fund the dividend outside of free cash flow. And that path to free cash flow, we can talk about that a little bit, but that path to free cash flow is mostly baked in the cake because it's mechanically a part of the Windstream settlement and how those settlement payments roll off and how the GCI investment commitments step down over time and GCI revenue steps up over time. And so a lot of that is just mechanical. It's already baked in the cake. It's not dependent on us raising our level of performance or I mean we got to continue to execute our core business for sure. But a lot of that is just already baked into the cake. So there's a limited period of time here between now and have -- being free cash flow positive, including the dividend at its current level. And so the Board is weighing the trade-offs between lowering that down and bringing some of that $100 million to $150 million of excess into liquidity and into the business versus the stability of that dividend and the signaling of that dividend -- lowering that dividend in terms of our confidence in the business going forward. So we're weighing all those things. We continue to weigh all those things. But to date, we're -- we've been committed to maintaining the dividend at its current level.

So if we kind of take that out and say, on an annualized basis, if you did bring down the dividend, how much could it come down to the minimum distribution?

So I mean you can shift it around a little bit from year-to-year, but call it, $50 million a year that on average between now and sort of 23, 24, 25 somewhere in that neighborhood that it could come down is our projection.

And so when you think about the idea that if you did lower it and then if the yield reflected a conviction that you had done what had to be done, but there was no wiggle room to do more, is the -- do you believe that maybe the yield would then kind of revert back to more of a normal 6% to 7%? And so it would actually be kind of net neutral to the stock, but then it would be positive from a liquidity standpoint is what's the bull case scenario or the best -- the most compelling reason not to lower the dividend?

Yes. Well, I think -- I mean, if you look at statistically dividend cuts, or destructive of equity -- I mean there's a negative reaction pretty much across the board.

I'm familiar.

Yes, with dividend cut. So I think I know it's a debate -- something we talk to investors a lot and there are differing opinions upon our investors. I mean I don't think we are necessarily a yield-driven stock. If you look at our investor base, it's not a ton of income-type investors, traditional REIT type investors that have invested in Uniti historically. I think you can debate whether or not the market is expecting a dividend cut. We have definitely investors that have different opinions on that for sure. So I can't tell you I know for sure what the dividend -- what the yield would settle on. But we do think there would be a negative reaction in the market likely to a dividend cut for sure.

Well, so then -- but if we get then to the point in time where you're free cash flow positive and all these other things in the post 2025 time, you have to just simply raise the dividend again, correct?

Yes. So here's another piece of it, Dave, is that you don't see REITs generally, and it's not something that we think would be the best idea to really peg our dividend to something like REIT taxable income, even though the minimum distribution requirement is absolutely pegged to taxable income. You don't see really REITs pegging their dividend policy to taxable income. Taxable income can move around a lot. It's things like bonus depreciation elections and moving dividends from 1 year to the next. It can bounce around and yo-yo around a lot. So I think we want to be careful about pegging our dividend to something that's going to move around a bit. But if you did reduce it down for a period of time, we would -- our projections over time would be that, that would taxable income would begin to grow as the settlements roll off, as we continue to grow the business, interest rates also have an effect on taxable income for sure. So depending on where interest rates went that could have an effect on that. So I would expect that over time, taxable income is going to come back up and the dividend would have to come back up with it.

Yes, go ahead.

So just hypothetically, if you were to cut the dividend, what would you spend that money on?

Well, you would have -- you would want a compelling case for what you spent that money on, right? So either deleveraging, either investing in the business. I think those are things that are positive reasons potentially for cutting the dividend. We're free cash flow as we've talked about, we're in a free cash flow negative position for the next couple of years. So cutting the dividend would help with liquidity and meeting all our capital allocation obligations for sure. And would likely not go to deleveraging in any meaningful way in the interim, just given it's not -- it wouldn't be a large size if you're talking about $50 million a year. It wouldn't make a large dent in that. So I mean, I think if we brought in -- if we cut the dividend, we will be using it to make sure we can maintain the current level of investment in the business. And satisfied our obligations with investing in the GCI program and that sort of uses.

Okay. Well, you're not constrained right now on just regular investment in the business. I mean I guess I was wondering, would you rather spend it on delevering, potentially taking debt out below par, be accretive, or is there sort of like something on the M&A front that would be a better return on capital to investors rather than just paying out the dividend that obviously, the market doesn't seem to be giving you credit for?

Yes. I think those are -- those could be good uses of funds from that. But it would have to go within our needs for our current capital allocation and those priorities as well.

So I mean, so just kind of like maybe you could -- you kind of touched a little bit on this, the cadence of getting to free cash flow positive from where we are today, you've targeted by the end of 2025, right? And so there's some moving parts. There's the settlement payments at $100 million for the Windstream bankruptcy settlement on an annual basis. I think that those end in 2025...

In mid-2025 yes.

So that piece is $100 million that drops out. Then there's the GCI program, and that's topping out, I think, at $200 million and...

This year, we're expecting it to be about $250 million, and that really tops it out. The annual levels step down over time next year is $225 million is the cap and then it steps the year after that. It steps to $175 million and then eventually down to $125 million. Windstream has the ability to roll over unused portions from previous years. But if they use the full $250 million this year, there's virtually nothing left to roll over. So it would kind of step down to those annual caps.

So there's -- so we'll get -- by the fourth quarter of 2024, we're run rating at about $100 million benefit from reduced settlements probably run rating a $75 million improvement from lower GCI investments with an eye towards that stepping down yet again. So it's $175 million. And what then -- then there's two other pieces, right? There's the organic CapEx, which has been a lot of development for, I guess, anchor builds for customers, which theoretically will step down through time as those businesses ramp up. So can you just remind us the amount of CapEx step down that you need from the organic business and the amount of organic growth from the business to fill the hole that gets us to fourth quarter free cash flow positive?

Yes. And there's one other piece from the Windstream that Kenny mentioned, which is the rent from GCI payment. So as we make more -- there's an 8% yield on that. So as we make more of those investments -- there's a 1-year delay between when the investment is made and when the cash payments from Windstream start. So those ramp up, so that shrinks the gap a bit more. Our expectations and our projections in terms of that path to free cash flow is really kind of continuing the operational trajection for the rest of the trajectory for the rest of the business, just kind of where it is today. We're talking about mid-single-digit growth for the Uniti Fiber business. Capital intensity coming down but not because we're lowering the nominal level of CapEx at Uniti Fiber, but because we're continuing to grow that business. So we expect a CapEx at Uniti Fiber to stay about where it is today. So in that $110 million, $120 million on a net basis CapEx. So continuing to invest in the Uniti Fiber network at the same level we are today growing the top line, that capital intensity comes down. We were at 50-plus percent capital intensity at Uniti Fiber a couple of years ago. Now it's down to about in the 40% range. And we would expect that to kind of continue to come down towards 35%, maybe even a little below that over the next few years. But most of that is from growing top line, not from reducing the nominal level of CapEx.

So when you say that the steady state level of growth for the Fiber business is 3%, have you been realizing 3% year-over-year revenue growth in the fiber business recently?

So on our recurring revenues, we have. So recurring revenues have been growing in the mid-single digits level year-over-year, where we've had some variability really has been in our onetime revenues. So this year, so onetime revenues can be more lumpy. So the last -- from last year to this year, we went from about $25 million in ETL payments from the Sprint consolidation as they're decommissioning towers down to $15 million of ETL payments from that consolidation.

ETL stands for Early Termination Liability.

Liability. Yes. Some people say ETF, early termination fee, but ETL is another way to say it. So -- and then onetime equipment sales and onetime installation. Some of that has moved around a little bit. We've also embedded in that monthly recurring growth has been some headwinds in the wireless business in terms of Sprint consolidation again and some return activity with wireless carriers. Although we've announced a couple of major returns of wireless -- our wireless backhaul portfolios with 2 major providers about 2/3 of our tower base that we've now returned between the 2 deals at about the same monthly recurring level out to 2030. So a lot of the wireless reterm activity is now behind us because we've done some master reterms to push those deals way out into the future. But there have been some headwinds in terms of the Sprint consolidation and some of those reterms that have provided some headwinds. But even with that, we've been growing the recurring base of revenues year-over-year in that mid-single digit space. So we want to continue to do that. Continue to deliver that growth, and we can do that with the same level of CapEx that we have that we're putting into that business today.

So we kind of hear from different fiber services providers. Everybody's kind of got their special sauce. But the [ cogens ] of the world talk about the slower-than-expected return to work and so they've been kind of peaking out between 0% and 1% growth in post-pandemic world versus what they used to be like growing at 10%. The lumens of the world are kind of struggling to kind of get to growth along any vector, but their argument is they need to retool the sales force. And frankly, the decision-making processes from their target customer base haven't really reaccelerated. The function of maybe related to Dave's comments about return to work, just we don't know what we're engineering to optimize for. So hearing a fiber services company like yourself target 3% growth excluding the termination fees and whatnot. How does Uniti feel comfortable making that as a base case expectation?

Yes. Well, I think we're delivering that today, and we continue to see strong demand from our customers. So you take, for instance, our enterprise business, we're growing those revenues double digit year-over-year, this year over last year and last year over the previous year. Wireless bookings are down, and we projected wireless bookings going into this year to be down significantly from 2022. We had about a 50% expectation for a decrease of about 50% in those wireless bookings. But we're -- we've been filling that gap with other wholesale demand on our national network and our metro networks. And I think one of the things from our perspective that allows us to do that, is that like -- so take our enterprise business, for instance, it's a very targeted set of products and services, very mission-critical, fiber infrastructure, products, dark fiber, high-capacity transport, DIA, Dedicated Internet Access and we're very targeted in the markets that we're providing those services and very targeted to the even the customers that we're targeting for that. We're targeting customers that are fiber passes where we've got the ability to bring our own fiber into those businesses. And we think that gives us a competitive advantage in terms of our ability to serve those customers' needs. And our penetration rate of the enterprise customers that our fiber passes today is low to mid-single-digit penetration rates of the customers that we pass. So there's a lot of headroom for additional growth there, and we're finding a lot of success in targeting those businesses along our fiber. And as we build fiber to new enterprises, we're passing additional enterprises and expanding the addressable market that we can serve there. So that's a form that's been working well for us. We've increased the size of that enterprise sales force from 25 to 30 a couple of years ago to 40 to 45 reps today. And so we think we've got a lot of headroom to continue to deliver that kind of growth and deliver those kind of bookings. And our bookings are at space have kept pace even this year with decision cycles maybe getting a longer -- a little bit longer with decisions with customers being a little bit more cautious. We've been able to continue to book enterprise revenue at about the same level that we booked at last year. And so -- and one of the things that we're seeing even with -- and we are seeing some longer decision cycles, especially in wholesale, the wholesale markets, but what we're seeing is our funnel level, our demand level has never been stronger in terms of the number of -- the volume of deals that we've got coming through, the number of quotes that we're putting out. And so we're seeing real demand there. So we're confident that, that demand is going to continue to materialize. Even if it materializes a little slower, we're confident it's going to continue to materialize.

Can you go back just real quick when you said that you -- obviously, the majority of your business is wholesale that kind of, I think, is an anchor tenant for some of the outlook for growth, maybe not so dependent on that the network planning, but you just mentioned wholesale being a little slower even. If the wireless guys are kind of retreating a little bit as an incremental driver of demand, who is backfilling that demand that makes you comfortable?

Yes. So we're getting demand from other wholesale carriers from the hyperscalers that's coming in to backfill a lot of that -- a lot of that demand that the wireless players are maybe leaving a void there.

Okay. And so then the way you guys have described the fiber business in the past, it's -- I think it's something like an anchor tenant build with 6%, 7% type of yield. And then once you've kind of got the asset in the ground, then you can kind of co-locate on it, bring incremental business and those returns can be mid-teens or even better. So I guess, my understanding, you kind of mentioned that you're going to continue at the current cadence of investment, which presumably means that it's kind of a continued cadence of anchor builds and revenue growth is going to be a combination of what comes from those 6%, 7% yields than those higher yields. And that mix increasingly shifts towards the higher yield in colocation revenues, margins should be creeping up. Is that -- is that something directionally we can expect in kind of the '24 '25 and beyond horizon? Or should -- is there a reason because we need more salespeople, we need these other things going on. We're going to have to reinvest some of that incremental return back in the business?

Yes. No. I think from an investment level, I think we -- what we're seeing in terms of lease-up is really superior returns in terms of what we're getting from our markets. So 50% plus yields on average is what we're getting the lease up in our market. So that's really stellar returns, and we're going to -- we want to continue to do that. And like I said before, we've got the headroom to continue to do that in our markets given our penetration rates there. So we're going to continue to make those investments. And the shift has largely been made in terms of our business in terms of shifting from those anchor builds that we were doing 2 or 3, 4 or 5 years ago to more of the lease up now. So I think you're going to continue to see the same sort of mix that what we're doing today kind of as we go into the next couple of years. But as we stack that revenue one, it is accretive from a margin perspective. So we -- our margins are up, have been from an EBITDA perspective, kind of the high 30s to 40% margin. We've increased to in recent quarters. And I would expect that to continue to creep up a bit as we continue to add them more accretive lease-up type revenue that's really high margin on to the network.

So maybe shift gears a little bit...

And I'm talking about Uniti Fiber and things, right now on the consolidated basis, margins are much higher.

And that's what I was just going to shift gears to the largest part of your business.

Right.

So the sale leaseback part of the business, obviously dominated by the Windstream lease. How is the relationship with Windstream these days?

No, we're -- on an operating level, we're operating very closely with Windstream, and that's going really well. We have to coordinated on a number of things on really almost a daily basis, right? So those things are GCI. We're having to work with each other. They -- we underwrite those deals. They present the business cases in terms of the markets that they want to invest in, which we approve. And then as those expenses come in, we're working closely with them to work through all those expenses and determine what's eligible for reimbursement under the GCI program and making those reimbursements. So that requires a lot of coordination. And then we now have the ability and a core piece of our business strategy going forward is leasing fibers and even lighting fibers and providing wavelength services on the reversion fibers that we got back from Windstream as part of the settlement in 2020. So we now have the ability to...

That's at least about 3% growth.

To lease up 2.2 million strands have reverted back to us in 2020, and we built business group about that. And that's where some of that demand that I was talking about to fill the wireless voices coming from as we ramp up that business. But those fibers -- there's still a triple net lease, right, and Windstream is still maintaining those fibers. And so we have to coordinate together as we look to serve our customers on the non-Windstream customers on those fibers to make sure that they're being maintained and we can fix any problems that arise on the fiber portion of the network expediently. So that requires coordination on a regular basis, Windstream. And all that's going, I would say, going well. For sure, there's been public dialogue that hopefully, it's quieted down a little bit, maybe, maybe not, but there's been public dialogue and it seems like that our two companies are a long way apart on some larger, more strategic things. And there are some definitely some differences of opinion there. But I think overall, the relationship works well for the day-to-day operations aspects of what we've got to do to both be successful in running our businesses.

So I only -- these days, it is good to see Tony and crew once a year down in Boca [indiscernible] conference. So I don't know really the inner workings. I know you guys share a lot of their financials. But with respect to where your GCI dollars are going, is it into backhaul fiber? Is it into fiber-to-the-home? Like what are the assets that you're getting for your dollars right now?

So in large part, GCI is targeted at overbuilding the kinetic copper network with fiber. And we think that's critical for the value of that network going forward. To Windstream and then conversely to us as well as the owner of that -- those assets and leasing those to the operator of those assets. So we think that investment in the fiber-to-the-home business and overbuilding the copper network with fiber is the right strategy and a critical strategy for that business. So those dollars are largely going into that. GCI is not available for extension into new markets. It's not available for maintenance. It's available for really the improvement of the existing network, which is, like I said, largely copper overbuild.

So I've had a -- this is a complex question, I guess. But it's something, for instance, we've been talking about a lot with the Canadians in particular. Telus, for instance, who's overbuilt 80% of their copper network in fiber. AT&T has talked about their very strong fiber initiative and the implications that has for copper is that we're decommissioning copper. And is there any of the copper that Windstream has that's part of the Uniti portfolio? Or is it just fiber?

So Windstream, I mean, the network that Uniti owns that we leased to Windstream is both copper and fiber, right? So as copper gets overbuilt with fiber, then that copper could be decommissioned, could continue to stay in use. It's only about 40% to 50% of the copper network will be overbuilt with fiber per the GCI program, the run rate that we're going and the commitment that we've made to do that. So that would get us to close to 50% of the network being overbuilt. So there'll still be a substantial amount of copper in that network. And you don't need a 100% fiber network to deliver higher bandwidth and better speeds. You've got to get fiber to the key nodes. You've got to get it closer to neighborhoods, but don't necessarily have to have a fiber drop at every home to drive higher bandwidth services to customers. But there will still be a fair amount of copper in that network even after the GCI investment that remains.

And obviously, Windstream is spending its own capital in addition to your capital. But to the extent that the combination of the dollars you're giving them, especially the dollars you're giving them, to the extent that that's being used to overbuild copper, Windstream is paying you two rents, right? They're paying you within the $650 million, they're paying you rent on the copper that was part of the original lease deal. And then when you put fiber on top of that copper you charge them another 8%, so they're paying you rent twice, how do you see that working itself out when we get to the lease conversation at the end of the day.

Yes. So that's not the way you would value and look at the network from an appraisal perspective, which is how more than likely we're going to come to valuing that network. The appraisal process we'll accept the value and sets the value of the network by the -- they look at a number of things, including the income approach, a replacement value approach. And so what you're looking at and what you're quantifying is the value of that network to Windstream in terms of the income that it can produce and Windstream, it may have copper and it may have fiber, but it's not charging homes for copper and fiber, right? Those things are driving towards a singular income. And the replacement value as we invest more and more fiber into that network. The replacement value of that network goes up as well. So it's -- I don't think you can look at it that way in terms of their leasing a copper line and now there's a fiber line on top of the copper lines that we're charging them twice. We're charging them for the value of that network and running and operating their business.

It's your favorite topic, Dave, but it's on the lead sheath cable. So under like the older legacy assets that are part of the assets under the lease. Under the terms of this triple net lease. If there was a requirement or just voluntarily, you wanted to replace that lead with fiber lead sheathing with fiber assets. Is that Uniti's responsibility? Or is that Windstream's responsibility? And then to the degree that they're seems like all the carriers are saying that they're working with the EPA. Are you guys having those conversations? Or is Windstream having those conversations?

Yes. So under the triple net provisions of the lease, an environmental remediation is a responsibility of Windstream as the tenant on the network. So technically, by the letter of the lease, is their responsibility for remediation. But obviously, any expense that Windstream is taking on is important for us as well because it affects the health of their business. So it's definitely something where we would look to work with them on that in terms of assessing it, in terms of thinking about how we would remediate anything that would need to be remediated. But technically, under the triple net lease remediation of environmental issues would fall to them under the lease.

So the -- maybe with the wrapping up, we've got a few minutes, I think Kenny, as your standard bearer, your CEO has made this -- made an argument that when you kind of look at Uniti stock, it just doesn't -- the stock price doesn't make sense. Because to my point earlier about the dividend, you have to pay the dividend and you cannot get rid of the dividend, you could lower the dividend, but it would still be there and then we'd have to go back up even if you did lower it. And so he's expressed a view that maybe if the market isn't going to organically reward Uniti for the value you guys believe you've created, inorganic ways would be the way to go forward. Now obviously, interest rates have moved dramatically and the world looks different from a financial standpoint. Is inorganic something that's still on the table in the current rate environment? Or do we have to wait for a rate environment to change before people's weighted average cost of capital become land in a place that makes doing these kinds of deals attractive?

Yes. I think deals can still get done now. I think we've -- I think there's a bit more stability in terms of interest rates are still high. That still figures into the math of how valuation works and prices people are willing to pay and the cash flow that assets can generate. So obviously, that figures into prices and deal multiples and that sort of thing for sure. But I think deals can get done, but it's definitely, it's definitely harder to do deals in this market. So I certainly don't want to suggest that it's not. It's more difficult. It's more difficult to get financing as we get deals financed, but it's not impossible. So I think deals can get done. I think there's still strong interest in quality assets. And we've mentioned recently that we're -- we're continuing to have conversations and continuing to think about M&A. And we think there are opportunities there. But it is harder for sure.

And I think the last point worth mentioning is so I think late last year, earlier this year, you guys have basically cleaned up the balance sheet from a maturity standpoint. So yes, you're operating at a free cash flow deficit but you can manage that. And you've got really until probably 2027 before something needs to be addressed. And so you've created a runway here where there's a lot of time to pick your spots along that strategic path, if that's where you choose to go. Is that fair?

Yes. No, I think that's very fair.

Okay. Well, then I just wrapped it up. Thank you very much, guys. Thanks, Paul, for being here. Bill. Thank you everybody for coming. Appreciate it. Thank you.

Thank you, Dave.

Thanks, everybody.