Telephone and Data Systems, Inc. (TDS) Earnings Call Transcript

Good afternoon, and welcome to day 4 of the Morgan Stanley TMT Conference 2021. I'm Simon Flannery. I cover telecom services and communications infrastructure. And it's my great pleasure to welcome the teams from U.S. Cellular and TDS Telecom. Welcome all.

Thank you.

Thanks, Simon. Thank you.

Before we get started, let me just note that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative.

So LT, if we could start with you, 2021, how do you see the priorities? You've obviously been in the seat now for several months. You see a lot of opportunities to take the business forward. So talk us through the guide for '21 and what you're most focused on.

Yes. Thanks, Simon, and good afternoon, everyone. Thank you for having us. It's a pleasure to be with you. So I think about 2021, I think about our priorities. I have to start with a bit of a strange one, which is we have to really focus on keeping our employees and our customers safe and healthy. And ordinarily, that would be a given. But I think both the pandemic, and then I think really, unfortunately, some of the actions that certain states are taking around no mask mandates make that a little bit more difficult. And so it's something that we have to pay a lot of attention to, spend a lot of time with our associates and spend time educating our customers. And so that's -- health and safety is job one for us. If I focus a little bit on these broader strategic priorities of the business, we have a long-term objective to practically double our return on capital in the coming 3 or 4 years. And if I think about -- you mentioned I joined about 8 months ago. If I think about why I joined in the situation of the business in which I joined, we have a subscriber base that has had just sort of very, very slight gradual erosion over time. Team's done a really nice job with ARPU, and so revenue has been somewhat stable. We've also done a nice job with some OpEx efficiencies. And so you've seen some operating cash flow expansion. But at the end of the day, you can't cut your way to growth. And so if I think about how we're going to get to that return on capital expansion, I do think we have continued opportunities in OpEx efficiencies. I think we have continued opportunities in CapEx efficiencies. You see that with our guidance of this year. But this year is really about growth. And it's about driving growth in total subscribers, so trying to pivot the business from losing market share to at least being flat on market share, if not growing market share in certain categories. Some ARPU expansion -- expectations on the postpaid side. And you put those 2 things together, and we want to be exiting this year, having pivoted the business towards growth. And seeing that in a sustainable fashion to drive that return on capital expansion over time.

Great. And maybe, Jim, we could do the same for TDS Telecom 2021 priorities?

Yes. Thank you, Simon. Much like LT, safety of our employees is job one, and we're not out of this yet. We're hopeful, but we're always preparing for the unexpected [ cellular wins ]. But let's focus on the business. So in line with our strategic objectives, there's really 3 focus areas, right? Grow revenue, and that has to do with all of our investments in broadband; increase the operational effectiveness of the company, meaning we operate lean, we've got to operate lean. And then third, we have a keen focus on a constant improvement on improving the customer experience. So let me just give you a little bit on each of those. In terms of growing revenue, job one this year is to deliver 155,000 new fiber addresses. As a result of that, we're investing heavily in the coming year and for future years, $450 million of capital. Over 90% of that $450 million in capital is focused on broadband investments. So we're driving deep penetrations. Our goal this year is to get 60% penetration on our overall cable operations. Some markets are better. And then in the core ILEC market, we're driving for a 47% share, all right? And if you look at where the growth is coming, we're still fighting some of the CLEC declines in some of the legacy parts of the business. But the out-of-territory will grow by a little over $30 million, and cable still is going to grow revenues by $11 million. Overall, we'll grow by about $25 million, but we're just hitting that part where we're going to start to see nice growth in the years ahead. So the second piece is increasing operational effectiveness. We're constantly focusing on reducing activity, truck rolls, calls to call centers. We've got an aggressive supply chain management organization, which we're now adding a logistics team. They're driving great cost savings, especially like LT with the big capital budget, we're driving reductions in OpEx and CapEx. We're establishing a construction light team that will help us in terms of efficiencies. And then we're on a plan here to make big movement on -- we're moving to a strategic a strategic stack on our IT systems. And we have significant focus on that, which will help take costs out of the business in future years. The last thing is we've got a team constantly improving customer experience. First and foremost, you got to have the best products. Our products in our markets, especially our fiber markets, they have the fastest speeds, the most -- the best capacity, symmetrical, given all the tailwinds that we have with COVID. And then we have our TDS TV+ product, which we're levering and we're seeing really nice growth in that product and in conversions. And then lastly, COVID helped us, but we're making nice improvement on self-serve options and customers want it. So thank you.

Thank you. Maybe we can come back to you at cellular. One of the things that we've been focused on is life after COVID. And Jim, you hinted at it there a minute ago. LT, I think, a challenge for the industry recently, depending on what side you're on, is smaller switcher pools. And part of it has been stores being closed and so forth. So how do you see that evolving? Is this lower churn something that may be sustained as we go from 4 big to 3 big players? Or do you see this reopening driving, that there's just this pent-up demand and we could see more competition and more switching but just delayed 3 to 6 quarters? And then to sum up Jim's comments, how are you thinking about your store footprint and your store size and some of the ways you go-to-market post pandemic?

So it's interesting when I was listening to Jim talk just now, Simon, I imagine you're probably fairly familiar with it right now, but there probably aren't a whole lot of industries that are talking about the tailwinds that COVID prevent, right? And in our case, it is somewhat the case, right? I mean, I think there's been -- there's been some benefits to the industry. I'm very proud of how we've responded. One of the things that you've seen, you mentioned it, is the lower switching pool. I wouldn't call that a tailwind, but lower churn, certainly is. And so I really think there's 2 drivers of that lower churn. I think the first you mentioned it is quite simply less traffic in stores. Certainly, we saw it with COVID. February is very slow with all the weather events around the country. So from a retail store traffic, we're down about 30% in February of this month. I expect March to be better. It wasn't quite as bad in January, which brings me back to weather having some impact. But I also -- as we come out of COVID, I expect that there will be a little bit of pent-up demand in terms of people who have been waiting to make a switch, who have been waiting to come into a store and go get it done. I do think that digital will continue to play a much larger component for the industry, for us and our business. But at the end of the day, most customers do still prefer, when you're making a switching decision, to come into a store. And I do think that that's been depressed by the pandemic. I think on the flip side, though, is that our industry has done a very good job over the last couple of years, and I would argue, particularly during the pandemic and improving the experience we provide to customers. Both from a connectivity perspective, I think we've -- as an industry, I'm very proud of what U.S. Cellular has done, I think. From a network connectivity perspective, we recently won a J.D. Power award. We're providing a great network experience. I think we're trying to couple that with a great customer experience. And you're seeing that across the industry. And so you see general perceptions of the industry have improved substantively over time. I think that will contribute to lower churn that will last, and it will last past the pandemic. How much of the lower churn that we're seeing right now can I apply to one versus the other? So how much do I apply to COVID versus general industry sentiment or satisfaction with your current carrier, I don't know. I think we'll find out probably in the summer and in the fall. So it's a long way of saying, I do think that the switching pool will expand throughout the rest of the year. But I also think that some of what we're seeing from a lower churn perspective is here to stay. And so I don't think we're going to go back to the days of particularly high churn. And if I may, I do think that just because you touched on it. I mean, I think that there are a couple of learnings from the pandemic that are here to stay for the industry. I mean, I think that the general satisfaction that people have had with their wireless service at a time when, at least for us, we've seen demand on our network go up 50% year-over-year. And I -- that was last year, and I contrast that when we had plans pre-pandemic for that to increase about 25%, right? So we saw double the amount of increase in our network than we expected. We were able to serve it, I think, very well. We had a great customer experience. And I do think that, that satisfaction with wireless is going to increase. I think the digital -- the movement to digital is here to stay. I think in the past, wireless carriers might have gotten away with saying, well, it's a complicated transaction, and we don't really need to invest in the digital experience. Those days are gone. You have to have a compelling digital experience if you're going to succeed. I do think what's going to be interesting coming out of COVID is that the importance of connectivity has been reinforced. And so I do expect to see substantive government investment in terms of infrastructure, particularly in terms of broadband. And I expect that will provide some tailwinds for our industry as well.

Great. And maybe, Jim, you sort of touched on it. But it was pretty prescient to be leaning into fiber to the home when COVID broke. Has the demand for broadband and what you've seen there -- has the financial equation changed now as a result of the increased demand and the higher tiers that folks are taking? Are you looking at this differently?

Well, the good news is we planned for it. I mean, we didn't plan for COVID, but we've been planning to ever-increasing appetite for broadband. Last year was amazing. Right about this time, we were all thrown back on our heels on what's going to happen to the business. There was just a lot of concern. Well, the irony as we finished the year, we [ meet ] our revenue targets and we underspent. So it was it actually -- there were some really nice tailwinds. What it really did amplify is the connectivity in the home and how important it is. So it's having fiber, having symmetrical speeds, having really great WiFi experiences. I mean, everybody should count how many connected devices they've got in their home. Now I asked my son in Chicago, how many connected devices does he have and he's married and he has no children, he's got 46 connected devices. And I thought that's insane, and I counted for just my wife and I, we got 25. It's just -- it's amazing to me what's going on. Now let me tell you what we are seeing. We offer -- we can offer 50% of our customers can get gig service. And the usage on -- so about 20% on the margin are taking our gig product. And we're not -- we're still what we call, not discounting it highly. Some people are discounting it more than we are. We're kind of being intelligent about that. The other thing is the average usage on our home networks is over 450 gig. We've got 14% are taking terabit in the home. So all that said, we're riding some really nice tailwinds with our fiber investments and all the investments we're making in it. And a couple of things that I would add that, similar to LTE, what's happened is it's reinforced the importance of digital and self serve. It actually accelerated our self-serve options because necessity was the mother of invention. And the last thing that I think is here to change or stay for the change is look what's happening here. Our T&E expenses were way down. I think some of that is here to stay. Our real estate footprint, we're re-rationalizing our footprint. We've got 2,300 of our 3,000 employees working remotely still today. So things will come back, but I think there were learnings in necessities that caused us to really reinvent ourselves.

Yes. Maybe, Doug, if I could go to you. LT was talking about return on capital, and that obviously puts a focus on CapEx. So how are you thinking about managing the balance sheet and capital allocation and working capital? What are the opportunities there?

Yes. I mean, we feel like from a liquidity standpoint, we're in really good shape right now. And from a CapEx standpoint, you can see from our guidance, that we're down $100 million year-over-year. And we've got a cost program in place for -- we're going on the fifth year now. It's largely been OpEx focused, and it's yielded great results. And during 2021, we're continuing to keep our footing in the gas with respect to that OpEx program, but we're also really focused on capital efficiency and implementing a zero-based budgeting program in our network area and really trying to make gains on the capital efficiency side. So to improve return on capital, we have to pull all the lever's revenue. And to manage cost, we have to manage capital really well. And so we're focused on all those areas. And from a financing perspective, you've seen what we've done in 2020. And again, from a liquidity standpoint, we're in a good place to fund all our CapEx and spectrum needs.

Great. And Peter, a similar question for you. What's the -- how do you see the capital allocation driving the -- both the investment in the business, but managing leverage and cash flow and working capital?

Well, you know us from -- you've been covering us for a long time, so you know we're financially conservative. So we don't want to let our leverage levels get too high. You saw us do -- we were in the market with a transaction last week to sell some preferred stocks so that we could raise some money and not have to go against our leverage levels. We get equity credit from the rating agencies for that type of transaction. But we are in a capital investment cycle in both businesses. And I think you've heard both from LT and Jim about what good things are going on. We're spending a lot of money on both sides of the business for a very good reason. And we've determined that if there's a good business case or something, we will raise the capital that we need to get it done. And I think we've proven that in the last year. And we had to get a little bit creative earlier, again, last week, doing rating agency friendly capital. But we have an abundance. We have a real gift looking at us with this, both -- at both businesses, these are historic onetime opportunities to grow our businesses, both on -- for LT on the 5G side, with all the different use cases that might be available for us there over time. And then on the fiber side, what Jim was talking about, these are things that are not going to be there forever. So we have to aggressively invest in them. But as Doug says, doing it in a smart and efficient a way as we possibly can.