Lumen Technologies, Inc. (NYSE:LUMN) Raymond James TMT and Consumer Conference Call December 4, 2023 2:15 PM ET
Company Participants
Chris Stansbury – Chief Financial Officer
Conference Call Participants
Frank Louthan – Raymond James
Frank Louthan
My name is Frank Louthan. I’m the senior wireline analyst here at Raymond James. We’re very pleased to have Lumen back here with us at the conference. We’ve got Chris Stansbury, Chief Financial Officer.
Question-and-Answer Session
Q – Frank Louthan
And so, Chris, why don’t we just kind of jump into some questions here. Your first Analyst Day in June, maybe catch us up on kind of what’s happened since then, what’s changed, and how that strategize is playing out so far?
Chris Stansbury
Yeah. I mean, the turnaround is well underway. We continue to build the processes and the improvements internally to deal with what is legacy declines in telecom. And as we get into next year, we’ll share a lot more detail around that. But we’re seeing significant improvement in seller productivity in large enterprise. For example, we continue to see improvement in the onboarding of new logos in mid-markets. And as a result of all of that activity, migration, obviously, around legacy to new products, we expect the market will see a meaningful improvement in the rate of deceleration by mid-year next year.
At the same time, there’s a lot going on on the innovation side. And that’s the part that we’re really excited about for our future when you think about where the market is going from a GenAI standpoint, and we were on the panel earlier today, but there’s just an explosion of data that’s happening right now and the need for flexible networking is here and now and that’s what we’re here to do. And I think it’s going to be very disruptive to telecom.
Frank Louthan
All right. Great. So, you’ve had a lot of change with management in the last 12 months. To what extent is that process complete? And how should we think about the leadership team and where it is right now?
Chris Stansbury
Yeah. We’ve had a lot of turnover at the executive level. And what you’ll see across the board, sales, customer service, marketing, HR, is just an influx of people from technology. And it’s really what we’re here to drive. You’ll continue to see that kind of disruption as we go forward. So, in the New Year, we’ll be naming a new Head of Product. And I think that’ll be a big announcement just in terms of the skill set that’s coming into Lumen.
And I think what’s really interesting is, look, we’re in the middle of a turnaround. The stock today is at $1.50. And I think a lot of people tend to be negative in those kind of situations. But I can tell you that from a broader talent standpoint, there’s been a significant boost in people that want to be part of what we’re doing because they see where we’re going.
We’ve won accolades from U.S. News & World Report. And there’s this really interesting group, the American Opportunity Index, which is part of the Schultz Foundation and the Burning Glass Foundation at Harvard. And they look at social media, and they look at employee movement and employee opportunity. And we were ranked Number 12 overall of 396 companies. There’s no company input. And Number 1 in communications and telecoms.
So, talent is going to be what gets us out of this, and it’s a big part of our story, and we’re excited about it.
Frank Louthan
All right, great. So, walk us through some of the cost savings initiatives that you’ve got in place with that? That’s always a big part of a turnaround on the front-end. And how should we see this affecting margins in the business over the next 12 months?
Chris Stansbury
Yeah. So, we’ve said that from a run rate standpoint, the second half of ’23 should be about peak OpEx. We’ve obviously added incremental cost to the business as we’re rewiring things and getting the business turned around. As we go forward, there will be significant cost savings opportunities. I mean, today, it’s really a wasteland of a lot of acquisition, IT costs and whatnot. I think 13 order entry systems, 36 GLs, but by the end of next year, we will be largely through ServiceNow adoption, a new SAP instance that gets us to one GL. So, there’s significant opportunities down the road for cost efficiency just with the base we have, never mind the business shifting itself to more, I would say, software and digital deployment of network, which will have additional savings.
We have taken a $300 million cost action that will give us a full year benefit next year. And that’s really, I would say, driven around stopping activities that may have been important in the past, but are less important as we go forward, as we shift from legacy to new. And it’s allowed us to capture some of the dis-synergies from the asset dispositions we’ve done over the last few years.
Frank Louthan
All right, great. So, as if a turnaround wasn’t enough, also turning around the balance sheet and working on that. A couple of things with that that I’ve gotten a lot of questions from investors, and maybe for the us, equity analysts in the room, give us a little debt refi 101 here. Talk to us about the importance of getting the revolver and the first lien done and where all that fits and how you’re getting — you’re working on this strategize to get the whole balance sheet put together?
Chris Stansbury
Yeah. So, the debt structure at Lumen has been challenging. I mean, candidly, we were a company that was very focused on paying a dividend until about a year ago. And that’s what drove a lot of the activities inside of the company, a lot of the behaviors. And over the last year, a year ago, we cut the dividend, eliminated it completely, so that we could drive heavy investment in our turnaround and in innovation. And we’re in a space where our competition is not investing in the space, and we’ve got a great product that has been released to the market, and more will come. So that’s where we felt the investment needed to be. We’ve disposed of assets that no longer were strategic, Latin America, EMEA, it’s very North American focused now.
But if I look at the debt structure, roughly half of our debt is due in 2027, and that is a legacy of the past, and it’s a real challenge. I mean, a lot of your peers were basically saying to us, “Look, we don’t know if you can turn it around or not, but if you can, is it going to be in time because of this big debt wall that’s out there?” And so, that’s a real thing, and that’s what we’re focused on dealing with. The result of all of that is that a group was formed around largely one of the debt structures. There’s a complex debt structure underneath that holds a lot of the collateral. And we reached agreement with that group a little over a month ago for how we can go forward, push out a lot of those maturities, and we’re in the middle of working through that. Getting the banks on board from a revolving debt standpoint is a critical piece of that, and those conversations are ongoing.
Frank Louthan
So, what is the strategize if not all the debt holders sign on? I mean, what percentage of the balance sheet refinancing do you — would you consider a success and will get you to be able to have the breathing room going into 2027?
Chris Stansbury
Well, I mean, first and foremost, the focus is closing the TSA. And we believe there’s a pathway to doing that. That said, we obviously have a strategize B and C, and that’s what we’re working on before the group was formed. But that’s not really where the focus is. As I said, we really do believe that we can work our way through that. The roughly half of the debt that’s due in 2017, I would say, is harder to refinance debt. The other half is highly secured, so less of a concern.
Frank Louthan
Okay, great. So, as part of that, one of your big initiatives is Quantum Fiber, where you’re up — going through and effectively upgrading a lot of your copper network in the LEC to fiber. But as part of the debt refinancing program, you’re now just going to kind of flatline that with — but this year, you mentioned there’s some other projects you’re looking on to invest. Back at the Analyst Day, this was one of the bigger things you were going to invest in. So, what’s kind of changed? And what is it about those other projects that have maybe better returns that you mentioned?
Chris Stansbury
Yeah. I think there’s a couple of things. I mean, first of all, if you look at Lumen’s footprint today, 20% of it is a consumer business, right? We’re really not a LEC. And that’s a business that’s got great returns, but it’s a different investor profile, right? It’s a heavy investment upfront for a 30-, 40-year return as customers pay into that fiber.
But if you look across that segment, what’s happened in the last six months is, with the cost of capital just skyrocketing, you’ve seen all of the fiber builders in that space slow down their rate of increased deployment. And that’s effectively all we’re doing. We’re holding at current levels.
But when you look at the 80% of the business that is enterprise, that’s a shorter time to pay back. It’s a much higher return. You’ve obviously got to push on innovation, but with some of the announcements that are now public around network as a service and ExaSwitch, edge compute, just to name a few, there’s much greater returns for our shareholders there, and that’s where the primary focus is going to be going forward.
So, I think if you were to wind the clock forward, the consumer space is a space that is screaming for consolidation, we won’t be the consolidator.
Frank Louthan
Yeah. Okay. So with that, going back a little about a year ago, you paused this build on — the build on Quantum. What have you learned since then as you’ve kind of restarted it, even though that maybe at a slower pace? What did you learn from that? And what — how should we think about that build and the returns you’ll get and the different puts and takes on that business?
Chris Stansbury
So, the reason we paused last year was we were metriced, I think, on the wrong variables. And we had concerns, so we readjusted. And the two metrics were cost per enablement and number of enablements, rather than something more return-focused, right? Make sure you’re building fiber in places where people value it. And so that’s what we did.
We do have a market-based approach. And I would say that the 500,000 enablements, plus that we’ll have this year, are high quality. I think you’ll see a faster map — a faster build to our enablement target of 40%. Now, even on the builds, frankly, that we did that we were less enamored with, the reality is I don’t think our penetration looks all that different than the competitive set, but I think there’s an opportunity there for more. Now, as I — that’s construction.
If you think about subscription growth, there’s really internally been an issue because we were selling both CenturyLink Fiber and Quantum Fiber, two different IT systems, two different sets of inventory. Again, back to a lot of legacy IT. The team did a great job collapsing those things. We’re now only selling one brand. It’s one IT stack, and that is Quantum. And so, what we’re doing right now is building scale on the marketing engine side.
And again, with cost to capital, where it is right now, the worst thing we can do is have dormant fiber in the ground for long. And so, really the marketing engine now has a chance to catch up to the construction engine, and that’s what we’re focused on.
Frank Louthan
Yeah. So, what has been the competitive reaction as you go out into the marketplace? What are the others in there doing when you show up? What is the reaction from the fixed wireless players?
Chris Stansbury
Yeah. So, fixed wireless isn’t really a competitor in the major metros where we’re focused. Fixed wireless is a competitor, and I think if you look across the industry where people are more copper-based, that’s a bigger threat. They’re lower speeds, lower amounts of data usage. We’re certainly seeing that in our copper footprint. And so — but again, we’re starting with 10% penetration-ish. So, not a significant hurdle for us. But in the major metros, not an issue. Again, we’ll be a share taker in those metros. We’re Number 1 or Number 2 with fiber. And cable, I think, in particular, has done a very good job of taking share for many, many years as the business wasn’t invested in. So, this is more opportunity than risk for us.
Frank Louthan
Yeah. Okay. So, one of the things always kind of put out to investors and advantage that an incumbent has is you got a lot of ways to win. It’s not just selling to getting X percent of the homes passed. So, to what extent is your fiber build helping you with your wholesale business, with small business, enterprise, and so forth as you’re densifying the network?
Chris Stansbury
I mean, it definitely gives us more of an opportunity there. But again, I would say, in terms of our focus, it’s really the enterprise side, because the consumer business is only 20%. And there is an element of reaching that business customer that the fiber gives us, but by far the bigger economic opportunity for us is on the large enterprise, mid-market, public sector side, where our heavy investment in things appreciate NAS and ExaSwitch have taken place.
Frank Louthan
Yeah. Okay. With those bigger investments that we saw in the video and you mentioned earlier when we had this lunch discussion on generative AI and Microsoft Copilot and so forth, for those that kind of weren’t there, talk to us about that opportunity, either both internally, and that was a big part of the discussion at lunch, how enterprises are using this internally for cost savings and optimization, and then externally as a revenue opportunity?
Chris Stansbury
Yeah. So, if you think about where we are today in the enterprise side, right, legacy telecom, you’ve got things appreciate VPN and voice that are in refuse. We’re focused very heavily on how we migrate those customers to newer forms of telecom. And I did not come from the telecom landscape, and I’ve said many times, one of the things that always staggered me about telecom, kind of one of those unwritten rules was, is that once you got a customer on a legacy service, never talk to the customer again because they might turn something off. We’re taking exactly the opposite approach, being very proactive about how we advance them to newer services. But if you think about that — that’s really kind of stabilizing the base.
If you think about innovating, GenAI is here and it’s here right now and it’s consuming enormous amounts of data. And it’s made more complex by the fact that large enterprise today is doing all their compute needs in hybrid cloud environments. What does that mean? That means on-prem, public cloud, private cloud, edge, and multi-cloud. And so, what does that mean? That means they’re using more than just one third-party cloud provider. Their own private clouds could be in multiple locations, or on-prem could be in multi-locations. So, it’s a very complex web that exists today.
And what matters in all of that, as data is exploding, is speed and access. So, if you think about legacy telecom, the most innovative that anybody has gotten is, “Hey, we’ve got this new faster fiber.” Okay, that’s a commodity. And we built 6 million miles of 400-gig waves, there’s another 6 million going in the ground now. And that’s important foundationally to us, but it’s not about the fiber, okay? If you stop there, it’s a commodity. It continues to be a race to the bottom.
What it’s about is it’s really about our ability to make that data easy to consume through digitization. So, think about today when you’re a customer for at home or when you’re a large enterprise, it requires truck rolls to get connectivity between A and B. Well, what about a world where just appreciate public cloud, you’ll log onto your computer and you can get port to port connectivity in minutes, if not seconds, from any place to any place, that’s NAS. That’s what’s been launched. And a lot of our network is NAS enabled, more of it will continue to be NAS enabled.
The second piece of it is really what we would call zero gravity. So again, ease of data movement. We launched a product called ExaSwitch. It’s a physical device. It’s a switch that is mirrors. We have IP on the use of that in telecom. No one else can use it. And that allows you to advance the equivalent of a million 4K videos in an instant. So, in today’s world, moving stuff from AWS to Microsoft to Google, there’s a lot of that transport and the hyperscalers all wanted this technology for that reason. And so, as you’re in this more complex environment, the ability to advance those huge workloads is critical.
The next big thing you need is ubiquity and proximity. What does that mean? That means that as we go forward in time, more and more of this data consumption, you heard it on the AI panel, is getting pushed advance and advance away from the point of consumption. Because what’s the number one constraint? Power, right? These data centers will pull down the grids of major metros. So, they’re getting advance and advance away where they can find the power. They need high speed in between, but they also need flexibility.
Our edge compute fabric, what does that allow? It allows you to, again, through NAS, access public cloud, and you can do all of your compute, your app development live in a zero-latency environment. It’s already built and there’s huge cost savings associated with it because you’re not paying a whole lot of egress fees to get to that data.
So, when you look at all those things in combination and then say, “All right, I’m going to wrap security around that where we have proprietary products,” that’s the future. And that’s how customers want to handle their telecom. And more and more of those customers as we’re sitting within the financial services sector is a big one, is not asking us why, they’re asking us how fast they can get it, because they need it now. It huge opportunity.
Frank Louthan
So, is this net new revenue with NAS and ExaSwitch, or is this just an evolution of products that customers were paying for before that they’re just going to advance traffic? And then kind of the follow-up, what keeps competitors from being able to offer something similar?
Chris Stansbury
So, a few things. It’s definitely net new. There will also be cannibalization as it relates to our existing business, but we will be a share taker in this because we’re the only ones that are innovating in the space. Again, another unwritten govern of telecom, cannibalization is bad. Guess what? Our consumer fiber business is a great job where we never cannibalized ourselves and now we have 10% market penetration. Cannibalization is good if you’re innovating and you’re pushing forward because then you’ll take share and that’s where our focus is.
Now, can others do it? I guess with the right level of investment. But if you look at the other major players in the space, they are either strictly commodity providers or they would fall into what I would call more legacy telecom, where their primary focus is on wireless cell use, and they’re not investing in the space. So, we’ve got a great opportunity as a result.
Frank Louthan
Okay, great.
Chris Stansbury
And by the way, ExaSwitch is IP, as I said. That’s only ours to use, no one else has that.
Frank Louthan
Okay, great. Got a couple more questions, and we can take some questions from the audience if someone have some. So, I’ve got my sort of finance geeky question that I only get to ask every few years when interest rates change, but talk to us about how should we think about pension expense and how interest rates are affecting you guys in that regard and going forward?
Chris Stansbury
So, we — when we’ve done the divestitures over the last few years, particularly the 20-state ILEC sale last year to Brightspeed, that eliminated a significant pension liability. We still do have, obviously, a lot of pension, but we have some funding needs in the coming years. That was all contemplated in Investor Day. So, not significant, manageable, and we’ve done a very good job of keeping pace with that as we go forward. So, not a major concern at this point.
Frank Louthan
Okay. Do we have any questions from the audience? Nope? All right, great. So, one of the things you recently announced a project in — with California, the state of California. Walk us through how that works? California generally — I generally don’t see my companies rushing to do business with California, and especially a middle-mile type project. Walk us through how that came about and that type of opportunity for you guys?
Chris Stansbury
Sure. So, our network is conduit based. What does that mean? That means literally we’ve got boring old conduit laid all over the country and it allows you to pull fiber, exchange fiber very efficiently. You don’t have to dig up earth to lay new fiber. You can literally pull old and shoot new through. And as that fiber has gotten better and better over time and capacity has increased, we have in some cases some excess conduit. This was a great example where that situation existed and California is really trying to drive ubiquity on the ability to access the internet. And we’re big believers in that, that we’ve got to close the digital divide. It’s good for everyone. And so, it was a unique opportunity for us to help them overcome that problem through the power of our network. And it’s a long-term relationship, and we’ll relish revenue from that for many years.
Frank Louthan
So, are you mostly just contributing the conduit, or are you then blowing fiber through it as well or…
Chris Stansbury
It’s multi-tiered, yeah. It’s not just one element.
Frank Louthan
Yeah. So that level 3 conduit from — that Mike and I recall from many, many years ago coming back. Anybody have any questions in the audience? No? All right. So, one of the — on the regulatory side, the FCC has a couple initiatives in the sector going on. Another — yet another iteration of Title II and then the digital discrimination rulemaking. What are your thoughts on these? And how it impacts your business? Any potential risks? Or how are you thinking about how it impacts you guys?
Chris Stansbury
I mean, again, when you think about where the focus is and where we’re going, I mean, we see a lot of the world’s internet traffic because of our pairing relationships. We’re big believers in non-discrimination and access to the network. I know there is going to be — this is not going to be quick legislation. There’s going to be a lot of arm wrestling, and I’m sure legal debates and whatnot. So, it’s still really early, but no, we don’t see a risk to our business.
Frank Louthan
Okay, great. Well, maybe step back to the generative AI question and Copilot and so forth. You guys are early on with that. Talk to us about how you’re using that. And then, I’m very interested in the potential revenue opportunity down the road for things appreciate this. How do you — and you mentioned the amount of traffic and so forth, and we talk about that a lot with the data centers. Someone’s got to get the data in and out of the data center and therein lies the networking opportunity. Tell us how you think you fit in with those things?
Chris Stansbury
Yeah. I mean, GenAI is here. It’s real. It’s not just a buzz term. I mean, I recall a few years ago, people talked about the internet of things. Then people kind of wondered what that was. It sounded cool, right? This is real. And we hear from some of our customers that the amount of data consumption that exists right now for those large learning models is already competing with the amount of cloud volume on everything else. It’s staggering.
So, the landscape of compute is changing right now. That’s why when you connect all the pieces together and you look at third party data center providers, hyperscalers, they’re all scrambling to add more capacity. And as I said, more capacity, but advance away from the point of consumption. So, speed and zero latency are absolutely critical. And when you look at what we would call our proprietary gift, which is that underlying network of conduit and high-speed fiber and waves and the development and build we’ve done around that and continue to do, it’s really how you monetize it. And so for us, that opportunity combined with the innovation that we’re bringing to market on how to consume the network.
So think about consuming the network your way. There will always be a level of point-to-point connectivity that’s required and sold, and that’s part of large enterprise. But that is not the end of the story. There’s also the need to pulse up, pulse down. There’s the need to do app development. The world runs on apps, right? Business applications, personal applications, what do apps need? They need data, they need zero latency. And so, the edge compute environment we have, fits right into that.
So, I think where we’re positioned and the innovation that we’ve already brought and the innovation that continues to come really put us at the forefront to be able to capitalize on that. But the here and now reality of a legacy business that has elements that are declining and elements that are growing is something that we’ve also been focused on. And again, I think you’ll really start to see a lot of improvement in that as we get into mid-year next year. So, both things are going on, and it’s exciting. That’s why I’m confident we’re going to turn it around.
Frank Louthan
All right, great. Okay. Maybe finish up with one last question I kind of get from investors with kind of the slowdown in Quantum, are you concerned that that attracts folks coming in to overbuild you? And what do you — how does that position you long term? If you achieve a point, you can kind of reaccelerate that?
Chris Stansbury
Yeah. I mean, obviously, that’s always a concern. But I guess the big answer is no, because, again, cost of capital is a real thing. And we’ve seen things slow down across the industry. That said, look it, as I said, we’re not going to be the consolidator, but I think they’ll be market by market opportunities. I don’t think there’s one big answer in terms of how consumer gets managed over time. One market could be a sale, another market could be partnership. I think things appreciate wholesale could be an opportunity in some cases.
So, I think there’s a way to unlock the value of that network that exists today while we continue to build it out. But no, I’m not overly concerned about overbuilders coming in and making a big play at this point.
Frank Louthan
All right, great. All right, Chris, thank you very much for being here. Really appreciate it.
Chris Stansbury
Yeah. Thanks, Frank.
Frank Louthan
And thanks, everybody.
