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

Well, good morning. This session is for Citi clients only, and disclosures are available at the back of the room next to the AV desk. Welcome back to Citi's 2024 Global TMT Conference. I'm Mike Rollins with Citi Research, and we're pleased to welcome Michelle Brukwicki, Senior Vice President of Finance and CFO of TDS Telecom. Michelle, thank you so much for joining us.

Thank you very much for having us. We're very happy to be here.

Great. And we may get into some survey questions during our time together. So if you'd like to participate in those, you can scan the QR codes with your phone, it'll bring up the selections. We're going to ask questions live today in the room to get your perspective on some interesting topics. And then these results are anonymous, and we don't track anyone. So please feel free to participate at your leisure. So with that out of the way, I have one other additional item I'd like to share. We are going to keep today's discussion with Michelle to TDS Telecom since I'm not able to discuss or ask about any of the recent corporate announcements by the company. So thanks for your understanding in advance.

So Michelle, with all those housekeeping items out of the way, if you could share with us your strategic and operating priorities as you look out over the next few years for the TDS Telecom business.

Yes. So at TDS Telecom, we've got a lot of really great and exciting things going on for -- well, we're in the middle of what we call it a transformation, a transformation into being a fiber-based company. Our vision is to be a fiber-based company to serve our customers extremely well, be easy to do business with. And we started on this journey in earnest a couple of years ago. And we are in the middle of it, and this is what's going to take us into the next several years as we keep going down this path. And when I say we're transforming ourselves into a fiber-based company, TDS Telecom was built up through a series of ILEC acquisitions, copper-based facilities. We got into cable about a decade ago. And we have been -- we see that fiber is the winning technology out there. We believe it's the winning technology out there. And so we started with upgrading ourselves, our copper facilities to fiber, probably about 10, 12 years ago, and we've been doing that consistently over that time period. And then really where our growth is coming from is that we took that model of building fiber networks, running fiber networks, and we took it outside of our existing geographies, and we're now embarking on new territories, going into communities is the fiber overbuilder in about 100 new communities, mainly in the Pacific Northwest and in Wisconsin. And so we have worked for the last couple of years to get those communities to some stage of initially launching, getting the fiber built to a point where we can initially launch and start serving some customers. And these are going to be multiyear builds, and so that's what's going to take us into the next few years, that's an exciting expansion growth story. And like I said, we are not forgetting about our legacy markets. We continue to upgrade ourselves to fiber in our legacy markets. And with the government program, the enhanced A-CAM program, which we're going to be participating in, in almost all of our states with many, many addresses, that's going to get fiber even deeper into our legacy copper-based network. So we're very excited about where this journey is going to take us and where we'll end up after all of this investment.

It gives us a lot to dive into, maybe just one question. Fiber has been around a long time. What changed that catalyzed both the further build out of fiber within the footprint as well as the pursuits of edge out? What changed in the model, the investment cycle, capital allocation that enabled and catalyze TDS Telecom to make this pivot?

Yes. Well, it was back, like I said, about a decade ago, 10 to 12 years ago was when we really started seriously upgrading our copper network to fiber. And it was at that time that, well, as everybody knows, data usage just keeps increasing. And so our network was needing enhancements and upgrades, and for a certain amount of time that was being done just with copper. And at some point, we said, you know what, if we're going to make any further investments in this network, let's make it be fiber. And that's when we started doing it in certain areas. And in a few communities, mainly it was in Tennessee is where we really started to say, let's just overbuild ourselves completely with fiber and see how that goes. And customer demand was very high, was very successful, and we said this needs to be the direction we go in the future. Any network investments now into our legacy ILEC markets, it's going to be fiber. So that's what changed. It was many, many years ago. And as we were building fiber in our ILEC markets and getting very comfortable with running fiber networks, it really became a competency of ours in terms of knowing how to build, having partners who work with us to do those construction projects and then how to operate it. And we've learned that running a fiber network is the most efficient network to run, and so it is a lower cost network over time versus copper. And so as we develop that competency and really became firm believers that fiber was the technology to take us into the future, at the same time, we got into -- well, that was the pivot in the legacy market. We were also looking for growth opportunities. And we did a whole evaluation of where to go next, and we landed on cable. The cable also similar business model to what we were already doing. It's a little different technology, but you're serving customers running a network. And so we decided to grow by doing a couple of cable acquisitions. And we did for us, a couple of sizable cable acquisitions in 2013, 2014. And we would have kept going on cable acquisitions. But at that time, the multiples really started increasing. And TDS Telecom and TDS in general, it's very financially disciplined company. So we were not going to keep doing acquisitions just at any cost. And so the acquisition pipeline slowed down for us after the couple larger ones that we did. We said, well, if this acquisition strategy isn't going to continue in a big way, what else could there be? And we said, well, we've been organically building fiber in our existing networks in our existing markets. What if we took that competency and that know-how and went into new markets and went in as overbuilder and organically started growing. Did a lot of -- you can imagine with TDS, we did a lot of analysis on this and got ourselves comfortable that this was a really viable path forward, and we started slow. We started this in 2017 with one market right outside of our home base in Madison, Wisconsin, and did that overbuild into that community and got great results, customer take rates. It was very successful. So we said, let's take that a little bit further, went to more communities around Madison, Wisconsin area. Same results, and then we started branching out further, a little further into Wisconsin. And then eventually, we went out to Coeur d'Alene, Idaho was our first Pacific Northwest market. And so we took that growth strategy, test and learn, test and learn and got bigger over 2017, '18, '19, '20. And after we really kind of prove this out in a number of different markets, that's when we started to really build the funnel and go bigger over the last couple of years.

And remind us, sorry, of the size of each of these. So you've got the homegrown telecom footprint of x, cable y, edge out and then how fiber is going to get infused into all of this.

So we can slice and dice our service addresses in a couple of different ways. One is by technology. So we have just over 1.7 million service addresses across our serving territories. And if you break those down into what technology we're using, about half is fiber today. And about 1/4 of it is still copper and about 1/4 of it is DOCSIS or DOCSIS 3.1. The other way that you can look at our service addresses that 1.7 million is by market type. And that's what I've been talking about the different types of markets. So our ILEC markets, our legacy copper markets, our cable markets and then our new expansion markets. So of the 1.7 million service addresses, about 800,000 of them are the ILEC markets. And like I said, we've been putting fiber into those markets for a long time now. EA-CAM will take fiber even further into those markets. The ILEC is about 44% fibered up today, and then that will just keep growing, especially with EA-CAM over the next few years. So in terms of a path forward for our ILEC markets, having that governmental program to help us get fiber even deeper into rural America, where it would be uneconomical to do it on our own, that's going to be a really nice path forward for those ILEC markets. So that's about half of our service addresses. Then we have about 500,000 of the 1.7 million in our cable markets. So primarily DOCSIS 3.1, and that can offer gig speeds today. But even in our cable markets, we've been putting fiber. We've overbuilt ourselves in a couple of small pockets and any new greenfield builds, new neighborhoods, we build those with fiber. So we're about 17% fiber in our cable addresses. We will never probably overbuild all of our cable addresses with fiber. But any new addresses, any growth, we certainly will, and we will do cable selectively as potentially competitive response to other actions. Then we have the expansion markets. Those are the new markets. The brand new markets for us were the fiber overbuilder, about 400,000 addresses today in those markets. Those are 100% fiber, and they will continue to only be fiber as we keep building those out. We're about 1.7 million service addresses today. The publicly stated goal that we've put out is about we're going to get to about 2.2 million within the next few years. That actually will just keep growing. At some point, we'll update our longer-term goals as we get a little bit more clarity about EA-CAM and where that's going to take us. But it will be at least 2.2 million service addresses with a really large percentage of those being fiber, certainly almost all of them able to offer [ Gig ] or faster to our customers.

Great. Let's try to get our audience here involved in our discussion. So we're going to put up a question about the forward path of investment. And what is the best path for TDS Telecom to create value? Sustain the current multiyear investment strategy into fiber, slow the pace of the fiber footprint expansion and just accelerate the path to positive annual free cash flow generation, or accelerate fiber deployments, including with BEAD, which can then accelerate revenue growth and future profit potential? So we'll see what our audience thinks of that.

Yes, that would be great.

And just as we're going through kind of the opportunity set, one of the things that was kind of interesting is you had some adjustments this year to guidance.

Yes.

So can you talk us through in terms of the operating performance, what's going well, maybe what hasn't gone to plan?

Yes. So I'll start with 2023, something that went well. So we -- if anybody is tracking us and tracking our capital spending, we had very big capital years in 2022 and 2023 in order to get those about 100 new markets to some point of it being initially launched. So a lot of capital spend and a lot of service address delivery. Last year in 2023, we exceeded our service address delivery. We were shooting for about 200,000. We ended up about 217,000 marketable fiber addresses we added last year. So that's a plus. That was an overperformance last year. Now this year, we have slowed our capital spending a bit. We can't keep at the pace that we were going in the last couple of years. We're slowing this down a little bit. And now that we've got our markets initially launched, and we will make sure that we're pacing our capital to stay within leverage targets that we've set for ourselves and to try to be able to fund as much of our growth as we can with our own profitability, our own adjusted EBITDA. And so this year, you're seeing a lower capital, and we're focusing on selling into those addresses that we have been launching over the last year or so. I will say the broadband net adds are coming in slower than we had expected, and there's a few reasons for that. It's not just in our expansion markets, it's in our legacy markets as well. In our expansion markets, we realized that in a few of our areas, we needed more door-to-door staffing people. That's a good news story because we can fix that we're on, and we've got that all rolling forward. There's also -- some of the addresses that we were planning on getting this year are coming in a little bit slower than expected. We're running into some permitting delays in some of our markets. That's a common thing that anybody who builds fiber knows you're going to run into certain delays from your municipalities with the permitting. Sometimes you run into delays on your locates, things like that. So we are running into a little bit of that this year. Again, that's a good news thing because it's a timing thing, and that's easily able to be worked through. But the service addresses are delayed a little bit. So those things do impact when our expansion broadband net adds hit our books. In our legacy markets, in our cable and our ILEC, we are experiencing more competitive threats in those markets, especially on the cable side with either the ILEC upgrading to fiber or fiber overbuilders creeping in. And so that is impacting our net adds in our cable markets. So we've got responses to those two. Again, like we're not going to just go and overbuild ourselves with fiber everywhere as a competitive response. Sometimes that might make sense in cable, but not always. And so there -- that's where you look then for like retention offers, maybe some marketing campaigns, speed upgrades, things like that in order to compete and defend your market share in those markets. So that's an area that I would say we are -- we're not hitting as fast as we had originally planned. One other area that this year, we're seeing a little bit more than others is video connections that they're not in terms of gross adds, customers aren't taking video at the same rate that they were taking it maybe even a year ago. So this has really been in just the last few quarters for us that we're noticing this. Still, a substantial number of our customers who sign up for broadband also want a video product from us. So it still is a big enough percentage of our customers that it makes it worth offering video for us, but it's just slower. And so the broadband net adds and the video net adds are the couple of things that made us change guidance in the second quarter. We lowered our revenue guidance a bit. But on the other side of where are we overperforming, I would say, in terms of profitability, we're significantly overperforming. In our expansion markets, we are finding that we're operating those networks even more efficiently than we had assumed in our business cases, and so that's adding to our profitability. And our entire organization is really, really motivated to be as efficient as we possibly can. I mean, we are really watching our hiring. We're watching our T&E. We're streamlining processes because everybody is very motivated to know that the more we can generate adjusted EBITDA, that's going to help fund our capital investments for the growth, and everybody is very aligned on that. So we actually raised our adjusted EBITDA guidance in second quarter, and that's definitely an area that for the last few quarters we've been overperforming on.

Let's see our survey results reveal.

Yes.

So the results. 25% sustain the current multiyear investment strategy into fiber, 75% accelerate fiber deployments, including with BEAD to accelerate revenue growth and future profit potential. So within that, given the answer from our audience, as you think about that opportunity, you mentioned going from 1.7 million homes to 2.2 million homes, is there a business plan somewhere laying around that could be significantly more expensive? And what could be the catalyst that may unlock that for TDS Telecom?

Yes. We are always looking at how big this could be. And we've had different size programs. The one that we're talking about, that's the one that we're executing on right now. But -- so there's a couple of ways that, that could be bigger. One, the areas that we've chosen to go into for our expansion markets. We did a lot of diligence on those markets, and we chose areas of high growth. And so we go into an area and there's usually like a -- it's a cluster of markets. Maybe you have kind of a core market that you start with and then there's other surrounding communities, and their high-growth areas. And so these markets that we're going into should be able to continue showing growth for us for many, many years to come as you do edge outs of those and you just benefit from the natural growth of the communities. So there are organic growth opportunities. We do have those slated out in like a 10-year plan. We give you one year guidance. But our team is looking out over multiple years and see the growth potential there, and that's on the organic side. There might also be at some point in a few years, we think that there could be inorganic growth opportunities as well. We've talked about this fiber deployment being a land grab. And that's why we were so focused in 2022 and 2023 on getting our flags planted in the communities that we had chosen because the economics of this is such that we're going into communities that already have a cable provider, so that's a strong, high-quality broadband provider. And we're going into areas where the LEC has generally not upgraded itself with fiber. So we can come in, and we're like the second high-speed broadband provider competing mainly with cable. And those are the types of areas that we chose to go into. Now once you go in as an overbuilder, if another company wants to come in as an overbuilder, the economics just don't work as well. And so that's why -- and things have generally operated pretty rationally in the marketplace on that. And once an overbuilder comes in, it doesn't always make sense for the LEC to upgrade to fiber. They've already lost some market share, and it's hard to get that back. We know that from experience because we're a LEC provider in certain geographies. And so we have real-life experience and see how that plays out when we're on the other side of it. So in terms of being able to be organic and go into new communities, as communities get gobbled up and flags get planted, it's not going to make sense to keep going and adding new communities to our funnel if others have already started fibering them up. So the organic growth path will probably slow down here pretty soon in the next few years. But at that point, perhaps there will be acquisition opportunities that we would definitely want to be ready for because we are a long-term operator. We build the networks. We're a long-term operator. We want to own the customers. We want to serve the customers. But we realize not everybody who's investing in fiber maybe has that same objective and same strategy. So there may be builders, network owners who want to get out and turn it over to a long-term operator.

Great. I'm going to queue up our second survey question, which I think is going to be the question du jour today at the conference around convergence. So -- especially in light of today's news. So should TDS Telecom offer converged bundle services and the choices for our streamers are: yes, mobile and video bundles provide for higher penetration and profits; yes, but only for mobile services; and no, just stay a pure-play broadband access provider and leave the rest to someone else. So we'll see what our group here thinks of that. But before we get to that, when you look at the multiyear model, it sounds like where you've seen kind of the shaving of performance was more on the cable side for some of the things that you're doing as the insurgent with fiber. But when you look at that fiber model and you look at that 10-year model that you've built, when you do the sensitivity, what's the minimum penetration and the minimum ARPU that TDS wants to achieve to feel like they can get a healthy return on capital, and it's a worthwhile project? Like what are those cutoff points that you look at in the business model?