AT&T Inc. (T) Earnings Call Transcript
December 7, 2021
Earnings Call Speaker Segments
Welcome everyone to the next session of the 2021 Barclays Global TMT Conference. I'm Kannan Venkateshwar, telecom, cable and media analyst here at Barclays. I'm delighted to have with me today Pascal Desroches, Chief Financial Officer at AT&T. Pascal, welcome to the conference. Great to have you here.
It's a pleasure to be here, Kannan. Thank you for having me. And for those tuning in, happy holidays.
And before we get into the Q&A, I guess maybe we should get the safe harbor out of the way?
Absolutely. Just as a reminder, some of the -- our discussion today contains forward-looking information that are subject to risks and uncertainties, and results may different materially. So refer to our Investor Relations website or SEC filings for more details.
Great. So Pascal, I mean one of the interesting things is you've had a record year of growth in unit growth on postpaid phones. But for the most part, investors have struck it off. And even in a day like today when the market is up, it looks like telecom stocks are still down in a strong [ tape ]. And part of this specific to AT&T is of course, the one of [ media ] deal technicals, but it feels like there's also a significant amount of skepticism on the quality of growth that the operators are seeing this year. And there's, of course, concern that margins will come under pressure, given the promotions and the [indiscernible] step up in the coming quarters. How would you counter this narrative? And what should we look to as we go into next year, in terms of improvement in the underlying trend lines?
Kannan, even before we go to that, maybe let me just try to go through, at a very high level, what we are trying to do as a company. When John took over as CEO, now it's -- he has 5 quarters of reported results under his belt. In that time, at the beginning he identified, I want to do 3 things. I want to grow customer relationships in 3 areas: wireless, fiber and HBO Max. I want to -- we want to operate more efficiently and effectively. And we want to be disciplined in our capital allocation, including strengthening our balance sheet and delevering. And I'd say immodestly we are doing well on all those counts. So first, let's talk on wireless. We have added nearly 4 million subscribers the last 5 quarters. That's more than the last decade. Fiber, we've added over 1 million subscribers, and HBO Max nearly 14 million. And you sit back and you say, okay, the wireless business is under siege. Last quarter not only did we have a significant growth in subscribers, but we grew profit margins. We grew EBITDA, and we expect that growth to accelerate as we go into Q4. So we're growing revenues, subscribers and profits. And yet there is lots of handwringing about whether or not this is sustainable. And we'll get to that in a second. Fiber, we couldn't be more pleased with how we have stepped up our build, and we think the opportunity before us is significant. We hit some supply chain disruptions during the summer. We're on pace to deliver 2.5 million incremental homes by the end of this year. And in HBO Max, we've launched in Latin America and the U.S. And as we look forward, we're really optimistic based on those results, with Europe and other parts of the globe coming in the future. So all in all operationally, we're doing very well. And importantly, we have put ourselves in a position where we have really gained flexibility to appropriately invest in each of these opportunities with the WarnerMedia transaction, the DIRECTV transaction, which strengthened the balance sheet significantly. We've had $55 billion of monetizations closed or announced. So you sit there and you say, we have more ability to invest stronger balance sheet, less pressure from leverage, and a resized dividend that is appropriate given the characteristics of the company going forward. I think, as I said immodestly, I think we've really delivered on everything we've said. So turning specifically to wireless, our job is to run the company in a way that is sustainable. And the offers that we have out there as well as our execution in providing value to customers has gone a long way towards strengthening the performance of our wireless business. Oftentimes, people look at and say, "Okay, it's the offers that are not sustainable. That's what's driving all this growth." But I think what is important is there are a lot of things we are doing incredibly well that people have not taken notice. First, when Jeff McElfresh took over a little less than 2 years ago, he identified several things, including how do we go to market differently? How do we empower the teams on the front line to go after customers in a way that's prudent? Also, how do we more -- in a more disciplined way, look at our segmentation and target relationships in underserved segments? For example, FirstNet, we saw an opportunity to serve a segment of the U.S. population that was underserved by us. And we went after it. We provided a good product and service, and that's been a big source of our growth. We also started to bundle content. That helped. And then finally the promotions came in. So it's a lot of things. And all of that is at a time where our customer service is getting better, and the network is performing well. It's all those things that are really driving this, and that's why we believe it's sustainable.
Okay. And I guess when we think about the bigger picture across the industry, the industry as a whole is adding about 9 million subs this year, versus on average of about 6 million in prior years. And so that's part of the skepticism, I guess, that investors have. And some of this could be macro because of the COVID -- because of things like EBB or the government support programs, which could have caused some kind of a pull forward. But this would also imply that next year could be one of the slowest years for the telecom industry in a long time. So when you think about this setup, how would you counter that? I mean does next year look like a normal year, which is about 6 million-odd kind of a subscriber base for the industry as a whole on postpaid phones? Or are we talking about a reset in some form and then picking up from there in '23? How should we think about the framework?
A couple of thoughts on that, Kannan. I mean we sit here handwringing because the industry is performing better than it ever has before. How ironic is that? Yes. And you look for -- yes, do we believe over time that you will get back to the industry growing in line with population? Yes, that is long term what's happening. But right now, the consumer is very healthy, and we are seeing continued really good demand. And in that environment, we are growing. We are taking more than our fair share. At some point, does it get back to normal? Yes, we're not assuming it stays this way forever. But right now, there is no indication that things are slowing down or that we're hitting a wall. So all in all, like the consumer is very healthy. And I see no evidence of this is a pull forward from next year, based on the market dynamics that are happening and that we're seeing over the course of the last several weeks. Look, what we're doing, we believe, is good economics. It's good business that we would sign up for every day of the week because we think we're able to grow profitably. And also, we're not interested in devaluing our very valuable service here. And we think over time, that will prove out through our continuing to grow both top line and bottom line in this business better.
And as you look at next year, I guess one of the tailwinds for the industry as a whole is the new infrastructure bill. And we'll talk about the investment side of it in a bit. But when we think about the consumer side of it, there is obviously a $14 billion subsidy program for consumers. And based on the EBB program it looks like consumers want to use this more for wireless than for wireline. So [ nonpaid channel ] has been unusually low over the course of this year. So do you foresee that being potentially a continued tailwind or a structural tailwind long term?
Absolutely. I think EBB has helped. But for us as you know, Kannan, we don't take EBB dollars for our postpaid plans. They only apply to our prepaid plans. And the amount of subsidy money is going to increase when you look at this. Right now, we're going to go to people being qualified for this at twice the poverty level in the U.S. So many more consumers will be eligible for this. And that's what gives us optimism, and we haven't factored any of this into the guidance we gave. So we think that there are structural tailwinds that should help. And just overall when you look at what the pandemic has taught us in the importance of connectivity, I think you have an increased incidence of people having more than one device. We also have families probably [ aging ] down in terms of when kids get their first phone. All those things are helping. And yes it will, at some point, abate and go back to more normal. But there's nothing to suggest that even in a normal environment, this is not a great industry to be in.
So I guess just thinking through that a little bit, the churn environment looks like you might be in an unusually low churn environment for some time because of these government programs. And then like you mentioned, the EBB program applies -- or the way you guys have implemented it, maybe it qualifies more for prepaid than for postpaid. But as you go into next year and beyond, given the size of the program, is it fair to say that you might expand the eligibility of these programs to include more postpaid subs? And also, could you give us some sense? I know on the postpaid side, the impact isn't probably that big. But on the prepaid side, how big of a tailwind has this been so far?
We haven't disclosed how big of a tailwind that it's been, and so I'm not at liberty to discuss that here. As we go forward, look, we'll evaluate the plan and the requirements in its totality and make a call as to whether or not it makes sense to expand it to postpaid. And as I said, there's not just one thing that has helped our growth. It's a variety of things. And that's why we are really confident that as you move forward, this is something that is sustainable and it's really good business for us.
Got it. And on the ARPU side, I think you've talked about stable ARPUs in '22 previously. Could you help us understand the puts and takes to get there? Handset AMR is probably a drag, but upgrades and churns could potentially offset some of this. But what are the puts and takes in ARPU as we head into next year?
Here is the way I think about it. We're in a period the last 2 years where we haven't seen the same level of international roaming as we had pre-pandemic. We're less than 50% of pre-pandemic levels. So that's one of the factors to keep in mind. Two, our limited elite plan, which is our most our highest plan, that is our fastest-growing plan and only 20% of subscribers take that plan. So we think there is a lot of opportunity, a lot of headroom to grow that top plan. And so you look at international roaming plus upgrades to higher tier plans, we think that ARPU stabilizes in 2022. Stabilized ARPU, continued growth in subscribers and transformation is how we look at the business as you move forward to the next several years. And then remember, our ARPU is at the highest end in the industry as well.
Yes. Got it. And then when we think about 5G as an opportunity in terms of monetization, I mean it's obviously a big shift from a technology or a network structure perspective. But the shift towards 5G has started off with you and your peers having to give away free phones to drive adoption. And the adoption has been faster than the 4G cycle because of that; but it also feels like for the first time, the networks have evolved faster than application needs to some extent. So given the backdrop, I mean how do you generate returns on 5G investments higher than the cost of capital? Is this more of a pricing upside, a margin upside? Is it more of a cost opportunity? How should we think about it longer term?
Look, it's a very fair observation in terms of where we are in the evolution cycle. I think we are ready for 5G adoption, but the use cases and new product set is not evolved to a level that it will. And every -- if you look back to every evolution of new instance of connectivity, there's always productization that develops. And there is no reason to believe that this won't happen here. And we think that, that will allow us to introduce in many instances, differentiated pricing. And what is important is this: we have locked up customers that we know are good customers for a -- on long-term contracts. So when those products are indeed available, we can introduce them and provide differentiated pricing models where it makes sense.
Got it. All right, so I guess from a pricing perspective, we should think about it still being an evolution as applications evolve, right?
Absolutely.
Okay. And when it comes to fiber, I mean which is the other big topic of conversation in terms of your strategic plans, this is not the first time you guys are going through the cycle of fiber investments. It's been going on for a while. But thus far, your growth in fiber has barely offset the legacy copper declines. And so I mean that's I think part of the reason why folks are a bit more skeptical. But when you think about the next phase of deployment, why does it look different from your perspective? And can the infrastructure bill accelerate your build-out plans in any way?
Look, it is a fair commentary that we -- what's different this time? And I would say if you look back, there were periods the last 5 years where we weren't deploying fiber at the pace that we should have. The one thing that we are confident of where we have the product available in a market, we take share and while we're able to generate really attractive returns. If you look back, there were periods where we didn't invest, we didn't grow our footprint, and that hurt us. That's not going to happen. We've committed to get -- adding 2.5 million homes this year. And we're on track to do that, and we're going to accelerate that from here. So the real difference is we're going to continue building out our footprint. As we build out our footprint, we expect to generate really attractive returns. That should generate net subscriber acceleration revenue growth. And in terms of overall profitability, look, like most instances when you're going through a transition, there is a period where legacy revenues are falling faster than increases. We hit the crossover point earlier this year, and we now are at a point where both revenues and profits are growing the consumer wireline business. And as we look out next year and beyond, we expect that to accelerate. So all in all, we feel really good about where we are. We know the commitment by this management team and the Board. And there's nothing to suggest that we're going to stop because this is a great business, and we're really good at.
So you just talked about revenue and profitability accelerating this business next year and beyond. From a cadence perspective, does that mean that sequentially, we continue to see an acceleration in net adds as well? And is it reasonable to say that when you look out, say, a longer time period, say, 3 to 5 years, your penetration rates could look more cable-like, which is about 50% kind of a number? Is that a fair number to look at?
Yes, we are -- first, yes, you should start to see as new homes hit the market and become available, we are going to hold ourselves accountable for -- having increased subscriber net adds. And in terms of penetration, I think whatever we are in a market, we generate very attractive returns. And getting to a net penetration approaching 50% is the right ballpark to be in. And I feel really good. The thing to also keep in mind is when you have that penetration, it provides other opportunities to bundle our wireless services. So also allowing us to take share in wireless beyond what would be natural, because we're able to, between both products, offer a compelling value proposition to consumers.
Got it. And then I guess shifting gears to the business side a little bit, when you look at the outlook for revenues, strategic services are essentially offsetting some of the legacy services. How does -- how do you balance the portfolio with respect to profitability? How does EBITDA in this segment progress over the medium term? And then is this more of a cost opportunity? Or are there other revenue opportunities that you guys are also addressing?
Yes, a couple of thoughts. First, if you look at where we are in the evolution of this business, connectivity and enterprise connectivity is fundamentally changing. There are many services that we used to provide that are not being provided by the hyperscalers and at a scale that we're not in. And we're actually proactively getting out of these businesses because they weren't good businesses for us. So there is a rationalization of low-margin products that's happening. And going the other way is we are increasing our core connectivity revenues. So the thing that makes AT&T unique is that we can provide the underlying connectivity that enterprises need. And whether we are partnering with a hyperscaler and providing a solution for a company, underlying it is the connectivity, which can only be delivered through great fiber and spectrum. And so having a combination of the 2, we think, sets us up well. So over the next few years, what you should see happening is '22, we should hit an inflection point going into '23. And so by the end of '23, we should see growth in overall revenues for the enterprise business, principally garnered from going to providing connectivity to small and mid- businesses, in addition to providing the vital connectivity for large organizations, but with some of the product sets and solutions different than they are today. And again, once you reach that inflection point on revenues, profits should follow as well.
Got it. And there are some new opportunities on the business side with respect to things like private networks. And we've started seeing the hyperscalers like Amazon dabbling in that space more recently. And you, of course, have your own cloud tie-up. So when we think about the opportunity here, it looks like there are some new markets that should open up with 5G. But at the same time, you also have potentially new competitors. So when you look at growth in this segment, is this more a function of your core connectivity business? Or will these newer revenue streams start contributing anytime soon?
Yes. Look, here is the way we think about it on the enterprise side, right? Amazon did introduce a private network service where the spectrum is CBRS. So the real question becomes is that going to be good enough for major enterprises that really depend on great reliability? We don't believe so. If they want to provide better connectivity, they're going to need to work with us and other spectrum holders; and also fiber, making sure that you have fiber in critical locations to ensure the reliability of performance. So I think that's why we feel really good. Whether we are partnering with a hyperscaler or doing it ourselves, at its core, it's the need for connectivity that is going to be the critical success factor. And we have it in both fiber and spectrum.
Got it. I think we just have about 3 minutes left. And so I just wanted to touch on the transaction, on the balance sheet a little bit. On the transaction side for WarnerMedia, the Discovery S-4 seemed to imply a $4.5 billion less cash amount coming to AT&T versus the $30 billion that was initially anticipated. Could you just help us understand the framework for the deal? So should we think of it as $38.5 billion right now instead of $43 billion? And what exactly changed?
Really this is something I think it's a lot to do about something that's pretty common sense that's just really not that big a deal. Like most deals, we agreed on a certain working capital framework. So -- and one of the items is if we've securitized cash receivables that will go with the transaction, we've received the cash already. And therefore, it would only make sense that, that has to be taken out of the $43 billion proceeds. But net-net, we're still getting $43 billion by advancing through securitization, we've already gotten that cash. So the balance is just -- we're just truing up a working capital item. So at the end of the day, it is a $43 billion cash component, plus 71% of the new company shares to our shareholders. So that's really the deal. It hasn't changed, and this is just a working capital true-up mechanism. So wherever the securitization balance is, it will be taken out of the $43 billion.
Got it. And then in terms of the deal structure, you have the choice of either a split or a spin. And when we think about it, the split obviously results in a significant implicit buyback of your stock. And given where the stock is trading at, I mean we'll see where it is in 6 months. But assuming where the stocks are trading today and assuming the tax structure of the deal doesn't get impacted, it would seem like that's the most obvious way to go in terms of deal structure. Any reason to think otherwise? And I have one follow-up maybe you can address along with that, which is if you were to do a split-off, it also shrinks your share count, and it would have given you an opportunity to manage your dividends a lot more efficiently. But I think the $8 billion to $9 billion number is locked in irrespective of the share count. So why not use that as an opportunity potentially to manage your balance sheet a lot more efficiently?
A couple of things. We do think this is a unique opportunity to deliver great value to our shareholders. And what we are looking at, we think both are great ways to do -- both a split and a spin are great mechanisms for delivering value. And we're not going to make the decision until we get closer to the time of the separation to ensure that we have complete information, including the relative share prices of the 2 entities. And look, in terms of the dividend, what we've said is 40% to 43% of roughly $20 billion of free cash flow. So when you look at that relative to the free cash flow, so let's say at 40%, you're at 8 billion. And so free cash flows after dividend is 10 to 12 billion -- 10 billion plus. And so you sit there and say, that can go a long way towards allowing us to continue to strengthen the balance sheet and give us lots of flexibility to potentially look at other ways to deliver value over time to our shareholders. So we feel good about where we're at. And we think the choices before us are both really attractive. And we're going to use all the information that we can to make that choice.
Got it. And one last question on this, on the free cash flow side is the $20 billion free cash flow guidance. The conversion ratio for that, I think, is higher than what the industry has managed prior to 2020 in the normal course of business. And of course, this comes in the middle of a CapEx cycle. How much of this is on account of new opportunities, either on the cost side or things like the DISH deal that got consummated on the wholesale side? And could there be upside because of the scale of the DISH deal, at least near term? So could you parse this out a little bit for us to understand how you get there?
A couple of things to keep in mind. Just look at if you look Discovery, the WarnerMedia Discovery S-4, WarnerMedia's cash contributions to the consolidated company this year have not been that significant. So if you start with that and through -- look at the cash we have generated through 3 quarters of the year. So that's fact one. That's -- then you couple on top of that, we expect this business to grow over the next several years, including things like the DISH deal should help because that's very high margin dollars. DIRECTV, we've said that the cash we receive from DIRECTV is going to be part of our free cash flow. And so when you look at that, that company is still going to generate a meaningful amount of free cash flows. And as an owner of 70% of the residual interest, we expect to get more than our fair share of that. So all those things gives us confidence that we should be able to be in that $20 billion zone.
Okay. That's great, Pascal. We've run out of time. Obviously, there's always a lot to discuss with AT&T.
Absolutely.
But thanks for spending time with us today.
Thank you for having me, and happy holidays to everyone tuning in.
Thank you.
Take care.
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