Cincinnati Bell's CEO Presents at Morgan Stanley Technology, Media & Telecom Conference (Transcript)

Feb.28.13 | About: Cincinnati Bell (CBB)

Cincinnati Bell, Inc. (NYSE:CBB)

Morgan Stanley Technology, Media & Telecom Conference Call

February 28, 2013, 01:50 pm ET

Executives

Ted Torbeck - President & CEO

Kurt Freyberger - CFO

Analysts

Simon Flannery - Morgan Stanley

Simon Flannery - Morgan Stanley

Okay. Good morning everybody. Thanks for your time. It’s my great pleasure to introduce Cincinnati Bell management. Here we have on my left, Ted Torbeck who is newly appointed as Chief Executive Officer, congratulations and Kurt Freyberger, the CFO of Cincinnati Bell. Busy time for you, just completed the CyrusOne IPO, yesterday you reported your earnings and gave guidance for this year.

So before we just get into please note that all important disclosures including personal holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at www.morganstanley.com\researchdisclosures or at the registration desk.

So Ted, perhaps you can just talk about your vision for the company in the post CyrusOne era and the priorities for 2013.

Ted Torbeck

Well, thanks Simon and thanks for having us today. I appreciate it. We are pretty excited about our future. If you look at it, there is really three main areas that we are focused on. One is we got a very strong wireline business that still generates a lot of cash flow. Two is, we are investing in fiber and I see this as the path to growth for our company. So we are going to put a lot of effort, a lot of initiative and lot of money in building out fiber, both on the consumer end of business side. And then three, we still own 69% stake in CyrusOne, the datacenter company we just IPO-ed and that is really our path to get the debt down to the appropriate levels and we are real excited about their future, not only just a great management team, but also a great list of customers that will grow with them as well as future opportunities as well. So those three areas Simon, I think are extremely exciting for our company.

Simon Flannery - Morgan Stanley

Okay. Well, let's kick if off with the wireline business if we could. As part of your guidance, you announced a heavy commitment to Fioptics continue to add fiber business and consumers, can you just provide a little bit more color about what you are trying to achieve this year and how maybe Kurt can just talk about free cash flow and the balance sheet and how you balance those; in the last few years, datacenters have taken priority in terms of your CapEx hierarchy and now you obviously have some more ability to diverge or to direct it to the wireline?

Ted Torbeck

Well, last three or four years we've invested roughly $40 million to $50 million in fiber. We've got a good presence in both the consumer and the business side. We have about 3,600 buildings that are lit with fiber; on the business side. This year we're going to try to do another couple hundred, which will put us far ahead of our next competitor.

On the consumer side, we have about 25.6% of the city covered and we have about 205,000 homes passed. We've been extremely successful. We’ve had about 28% penetration rate. When we’ve had that customer for at least 24 months, we've been able to take that penetration rate up to 35%. It's a very profitable business for us. The returns are what we are seeing is somewhere in the 20% neighborhood. So we're extremely bullish about our fiber product.

Our customers -- the positive thing is we're getting, for the first time, we started Super Bowl Sunday. We actually had a commercial on local network. It's the first time, we did our mass marketing and the demand we're getting from that is just incredible. So the demand is really out there on the consumer side and the business side. And you know we're just trying to fill that with additional investments to meet that demand. Kurt?

Kurt Freyberger

That’s right. I think when we think about our balance sheet, is with the CyrusOne investment if you apply that to current value today against the debt, we're already to place where 2.9 times or only 2.9 times our 2013 EBITDA. So we've talked in the past about a two or three times leverage ratio. It's kind of what our goal is. We're there. We’ve already, because of the successful IPO, we've already been able to kind of get to a point where we believe we're comfortable in that zone of being an appropriately levered telco; that combines, overtime we’ll monetize that CyrusOne asset. The cash flow from the fibre investments we’re making are going to kick-in, and you are going to end up with free cash flow of significant amounts, down the road a couple of years, where can start talking about some significant things we can do that shareholder certainly thinks that we can do.

Simon Flannery - Morgan Stanley

So this year is negative free cash, but do you think you can get the positive free cash done in 2014 or something?

Kurt Freyberger

We will in positive in free cash flow in 2014.

Simon Flannery - Morgan Stanley

Okay. Let’s talk about the CyrusOne stake; talk about your interaction with CyrusOne now that they are a separate public company and the lock-up expires in January. How does the board, management think about monetizing that, is that a multi-year process, it's obviously is more of a portfolio obviously to some extent?

Ted Torbeck

Well, looking at CyrusOne today, although it's roughly $1 billion of value to us, we still think it's under valued and we also think over next 12 to 24 months you are going to see tremendous growth in that business, so the valuation will only go up from there. So what we look at is, we look at a lot of different things, we look at how they are operating, how they are future looks, we look at our company as well, and how we are doing to the returns that we are putting forth and at that appropriate time we will make the right decision for the shareholders on when monetize it, how much the monetize it and you also can’t do too much of time you bring it hurt could CyrusOne as well. So we are taking all these things in consideration. Actually it's a good problem to have, because we think like I said we think it's under valued and if we think as it grows in value it just adds more to us.

Simon Flannery - Morgan Stanley

Okay. So I think your comments on Fioptic and some of take rates are consistent with what we have been hearing from some of the other Telco’s here this week. What speeds do you think (inaudible) was talking about gigabits, that comes to city and so forth; what speeds do you think are necessary to be competitive; is it 20 megabits, or is it 50 or is it a 100 and what are you sort of engineering to and perhaps the other thing then so how do you deal with the content cost, are you still able to make a return on the video sides?

Ted Torbeck

Those are two good questions. First of all, the speeds that we deal in, we deploy fiber two ways, we take the fiber to the node of a neighborhood and then use our copper for the less mile to the home and into the home. We also will take fiber all the way to the home, when we take it all the way to the home we’re getting about 100 mgs. When we take it to the node and use the existing copper to the home, we run any where from 40 to 50 mgs. So it’s very comparable Time Warner has from a cable perspective.

Simon Flannery - Morgan Stanley

Data products 40 to 50 of the total bandwidth including TV?

Ted Torbeck

Total bandwidth is 40 to 50, so it’s very comparable with the cable and in that regard but when we go to home with fiber it’s significantly better product, so right now I think…..

Simon Flannery - Morgan Stanley

I think about 10% of your homes; is that right?

Ted Torbeck

Yeah, about 10%.

Simon Flannery - Morgan Stanley

Okay, and on the content cost?

Ted Torbeck

On the programming costs?

Simon Flannery - Morgan Stanley

Yes.

Ted Torbeck

On the programming cost, we have been very successful compared to all the price; it is a challenge each time we deal with this, but we are going to continue to push price and push that price onto the consumer in the business that they use.

Simon Flannery - Morgan Stanley

And in terms of the fiber build, you talk about doubling your footprint to 70% or so; is that for sort of the economic limit right now and how long is that going to take you?

Ted Torbeck

I really give a range 60% to 70% because the way we are managing this is we are really tight on the return and making sure that we are getting every dollar return for what we are investing in. So as we go further to 50% and 55%, we are going to see we are in areas that it’s going to be difficult to meet the returns that we have because of the cost to install it or the cost to build it out. So I still think it’s probably somewhere in that 60% to 70% range. But again, we manage it extremely tight and if it doesn't meet the returns we are not going to build it out.

Simon Flannery - Morgan Stanley

And you grow up to 10% a year or so or something under.

Ted Torbeck

This year we are going to spend on the consumer side about $75 million, that's up from $50 million last year, and we will get about another 10% covered. So we will have if $70 million is a number we end up having we'll be half way there at the end of this year.

Simon Flannery - Morgan Stanley

One of the things that the company has been pretty successful at is sustaining wireline margins. We've seen a lot of cases you know there's a real problem in that you are losing revenues from high margin products particularly on the voice side legacy products and adding lower margin products but you've been able to with productivity improvements and now there's pretty much you know negate some of those trends, how do you see your ability to sustain that going forward?

Ted Torbeck

I still think there are legs as far as productivity. I see that we are in the infant stage in things like Lean and using tools like Six Sigma to continue to get more efficient. Where we primarily put the focus on is where we have a lot of people and where there is a lot of labor mainly on the installs, the technicians, the call centers, all these areas I think there's big room for improvement.

So that's one thing. So I do believe we will be able to maintain a high level of margin. I don't know if we will be able to keep it at 46% but I do believe we still have room to drive a lot of productivity.

One of the things that we are going to do this year we have an IT services and hardware sales business. We are going to combination that with CBT which is our Cincinnati Bell business. We are going to make it one organization. So we will get, we will realize somewhere between $4 million and $5 million of cost savings there this year.

The other thing that I still think that there's opportunity is in sourcing and we've brought consultants and they help us to get out some of the costs that we haven't got into before. So I still think we've got legs to get productivity.

Simon Flannery - Morgan Stanley

So we can talk about the enterprise side for a minute. First, what's your assessment of the sort of demand environment and the macro trend spending, and then how do you stack up with Time Warner Cable was here yesterday very excited about the opportunity in the SMB space moving up market, what are you seeing there and do you have the ability to regain market share or to drive that growth in that business obviously datacenters have been a big plan in that space that sort of separate now?

Ted Torbeck

Well, our CBTS unit historically, they are the ones who have got us in the datacenters and they got, our first customer and datacenters was GE. So and the reason that relationship developed was through our, it was our managed and professional services and it grew over time.

I think company especially on the enterprise front, especially company like GE believe me I know I worked there for 20 years. They are always looking and pushing the envelope for new and greater things, and I think we probably have somewhere close to 400 people on our payroll that work for GE, work in GE everyday and so I think there is always going to be opportunities to look for, if you can bring solutions to them, they are going to be open to listen to see if he can deliver.

So what I look at is three things in this integration with CBT and CBTS. One is the cost savings I mentioned, it’s about $5 million. We also have the CBTS side has done a great job of doing end-to-end solutions for enterprise. We can take these solutions now go down market on it.

Our focus is going to be right in the major area. We think we have anywhere from 250 million to 400 million opportunity in sales there and that's you know, as businesses look and they get more and more data, you are going to have issues that you didn't have before like data management, like data backup, data storage. These are all things and services we can provide that we were providing before.

So I think this is a big area of opportunity for us. It’s where we are really going to focus and its leverage things that we do for the enterprise customers and put them in the major market. I think when you start going down further than that in, you got a really, who you are really competing against is the IT teams that are in these businesses because they don't want to let go that responsibility.

So as you go further down there you know, the challenges can you make money at it. And we do believe we can in the major but we are going to have keep focus in theirs as well down market. The other point, the third point is just as important with this combination

Of CBT and CBTS is that we are developing a group of people that are really focused on what's the next five-year product. And these are guys that have developed a lot of the products that we use for enterprise today like VDC, we have cloud offerings, we develop cloud offerings for the SMB group.

So this is a very highly energised group of technical people and they are looking at developing solutions five years down the road. And this would be applicable to not only the really the enterprise but also SMB and the major markets. So those three things with the combination of CBT and CBTS I think are really going to keep us growing not only now, but in the future.

Simon Flannery - Morgan Stanley

And the macro, any sense of the how (inaudible) macro environment is?

Ted Torbeck

In Cincinnati?

Simon Flannery - Morgan Stanley

Yeah

Ted Torbeck

I think it's very positive, what we see is the enterprise customers are really pushing to outsource more and more of this type of work and I think we are well positioned it's a way for them to get cost and they want to invest in other things other than in some of the areas that we are investing in and we can provide the expertise and I think we are the very good, Cincinnati marketplace is the unemployment rate is better than national. So business is good in Cincinnati.

Simon Flannery - Morgan Stanley

Not that we haven't heard too much of that so that’s good to hear. Now let’s turn to wireless if we could, it was tough fourth quarter for lot of these smaller wireless carriers, you gave some cautious guidance on EBITDA for 2013, how are you considering your alternatives, you got a lot of got a lot of valuable spectrum and you have the customers and you got an LTE decision to make here, you don't have the iPhone, its something that's been questioned for several years now, you got through your biggest strategic kind of action strike us but this is been excellent you talked about maybe a process on the call, so perhaps just help us think through your full process there…

Ted Torbeck

Without a doubt being a local Telco competing AT&T and Verizon everyday it's extremely difficult. However, we do have a good network within our local community. We have a lot of brand royalty within our community, but I look at those three things that we are looking at, one is do we invest in LTE, if we do invest its going to have to meet the hurdles that we have already set with the investment with fiber and those are pretty tough hurdles ahead. So we are not going to invest if we can't hit those hurdles, we currently running a pilot on LTE and we are going to continue to review that.

Two is, we are looking at possibly selling the business and we had discussions with people, you are absolutely right, its been talked about for a couple of years now and its still be in discussion and then the third is the way that you can partner with someone and those discussions are happening as well, so I like the…

Simon Flannery - Morgan Stanley

So (inaudible) another type structure?

Ted Torbeck

Yeah, something similar to that, where we do the sales and marketing, so there are discussions and it is something that we have to address and we are working to do that.

Simon Flannery - Morgan Stanley

Okay, we are hearing a lot more on Europe on convergence but I would say that in the US there really hasn't been plot play as just sort of mythical creature but you probably have more integration than some, let's talk about, if you let's say where to sell it, do you think its crucial that you do have a wireless product to bundle with you?

Ted Torbeck

I don't think it’s crucial. The way we see it and we try this a lot is try to how do we bundle wireless with our wireline business, the consumer really considers it two different decisions and its been difficult to bundle wireless with the wireline product and clearly business does, they look at it as two different. So as far as hurting us is, we are going to have to debundle some because we have had some success there, not a lot but we have had some, but its not going to be a big issue in my mind.

Simon Flannery - Morgan Stanley

Your turn spiked quite a bit in Q4 and we had iPhone launches before but it seemed to be particularly noticeable this year and we've seen some prepaid carriers had a very tough quarter. Is there something going on here or is this the mobile share, family share type plans that…

Ted Torbeck

There's three things, I definitely think the family share plan will have an impact so you can use multiple devices. Two I definitely think that the LTE combined with the iPhone was, that's the third iPhone, those three things definitely would hurt us. They ran very, Verizon and AT&T ran very strong holiday promotional events in this past holiday season and it did impact us. The churn has gone back to normal levels in February.

Simon Flannery - Morgan Stanley

We heard about Verizon and AT&T earlier in the week talking about optimism on wireless margins, you know clearly you are in a slightly different place but I think when you look at T-Mobile bringing out LTE and bringing on iPhone, and you look at Softbank coming into Sprint, I think some people view this as being likely a very challenging year. Is that's what's behind the EBITDA guidance or is it more just the loss of scale that is being sort of happening in the last couple of quarters here.

Ted Torbeck

Yeah, its more of a loss of scale than anything else, we lost 19,000 subscribers just in the fourth quarter alone last year. So we've done a good job of taking cost out, we've done a good job of managing as tight as we can, but at some point the amount of subscribers we've lost, we've lost 13% of our subscribers last year. So that's what's catching up to us.

Simon Flannery - Morgan Stanley

Any thoughts on how the competitive environment may change this year, do you think its going to be dramatically different.

Ted Torbeck

Simon I think we've got a plan on it being just as competitive if not even more competitive than it’s been. So I think it gets tougher not easier. But with that said, we have a local company, we have a network that is still strong, we still have 400,000 subscriber, 250,000 are on postpaid and a 150,000 on prepaid. So we still have a strong business and we can't lose sight of that.

Simon Flannery - Morgan Stanley

Kurt coming back to you, you started off by saying the leverage on the pro forma basis is up three times now. If you normalize CapEx, if you, you've got high margins, you've got a lot of NOLs, there should be a lot of cash coming out over time. I think investors have been hoping perhaps for dividend or buyback and so forth if you are investing in other wireline companies with sort of second [chances] just typically a decent dividend or buyback. How do you think about when is the right time to consider some of those actions given you can sort of say that the conditions are in place today and yet some of the things you haven't sold the CyrusOne stake yet, you still got the investment to make.

Kurt Freyberger

Yeah I think it really, it comes back to a lot of what Ted has said. The opportunities we see in front of us with fiber are very real and very high return, high profitability types of opportunities and we think time is of the essence. We have customers screaming for this pilot products, both consumer and business. And so we think now is the time to strike in terms of making those investments in fiber. Fiber [swing] similarly, I think, has opportunity in front of it, and so while we look at the potential for appreciation in both of these business lines, we think we need to have a further monetization of CyrusOne and sometime to invest in fiber. We think the combination of the two is going to be very, very impactful. We're going to see significant free cash flows overtime. When we get to that time that we’ve accomplished those things, we will have significant free cash flow that we can do some very shareholder friendly transaction with.

Simon Flannery - Morgan Stanley

Okay, so that sounds like it sort of late ‘14, ‘15 kind of timeframe. Is that fair?

Kurt Freyberger

I think, a lot of it depends on the monetization of CyrusOne and we've not set a timeline for that. We will continue to monitor it. We will, as Ted mentioned, look at their results versus ours and needs that we have and overtime, you will definitely see us to monetize that investment down. We've not set a timeline.

Simon Flannery - Morgan Stanley

And in the meantime they are paying you a dividend on this?

Kurt Freyberger

Yeah, their dividend run rate is about 28 million a year. This year we will get three quarters worth about 21 million.

Simon Flannery - Morgan Stanley

We got time for some questions from the audience.

Question-and-Answer Session

Unidentified Analyst

Given the return profile you’ve outlined for the fiber business, why do you think it is that on, when you reported your results, your stock traded off so much given all the positive opportunities, it seems like people feel that that increase in CapEx is really wasted money and potentially it should be distributed to shareholders today as evidenced by the negative equity value creation in response to the increase of CapEx.

Kurt Freyberger

Well I think there is a couple of things that drove the decline in the price, one is wireless and the fact it's a first time we show that we are going to have a fairly significant decline in EBITDA so that was certainly one. Two, is the amount of free cash flow we talked about although we didn’t give a number we get back into it and we did say we are going to be negative. So I think that was another point. And then third was, the fact that we are investing at a time when we are paying dividend. I think the all of those three things together we are collective of why we had a pretty good substantial decline.

I can tell you that I am very bullish on our future and that we have an asset that is growing and will continue grow that we can take our debt down, and two we got a fibre business, then I think in 2014, you will see that on the other revenue side we are going to hit the point where it's actually growing and we will have a point 2014 where you are going to see EBITDA growth in the wireline business. So I am bullish on the return, I am bullish on fibre and the opportunities that provide us.

Ted Torbeck

I think we are investing in fibre, we are investing in our product that should come with some high multiples and I don’t think we are yet getting credit for that. I think we have to perform and execute and I think that valuation will come.

Unidentified Analyst

Yeah, I was just wondering, how CyrusOne decided to take on, I think it was 525 million of debt to pay your dividend. It seems relatively under levered compared to the peers and so what are the prospects of you getting some miniaturization from debt finance dividends versus selling your equity stake overtime?

Kurt Freyberger

Yeah, on CyrusOne, we try to set that and we are favorably so that the IPO to be very successful and we also want to retain as much equity stake as we could, because again Ted mention we are very bullish on CyrusOne can do overtime. So we set it up with a very appropriate towards low ends of leverage had a very successful IPO. We expect with things from that investment overtime and we think that’s going to end up and result in those having a very low leverage ratio as we monetize our equity position, but we actually did set up to maintain as much equity position as we could in that investment.

Unidentified Analyst

(Question Inaudible)

Kurt Freyberger

CyrusOne it’s not my control to company anymore, but CyrusOne in my view has lot of growth opportunities in front of it to the extent that takes on additional financing it will likely be for additional opportunities.

Simon Flannery - Morgan Stanley

So I think AT&T was here on Tuesday and they were talking about assets sales looking at various real estate and other towers, I think you’ve sold your towers already, but looking at other part are there things there that obviously not on the scale of CyrusOne, but other thing is that you can look at to monetize and offsetting that are the capabilities or might you do some tuck in M&A or other things to enhance your product portfolio on the enterprise side or?

Kurt Freyberger

Clearly on the sale side Simon is the wireless business. I don't, I'm not, I can't think of anything else that we have other than maybe some buildings that we can sell. And on the M&A front we are going to put 100% focus on 2013 on Cincinnati and laying fiber and getting into buildings and getting businesses and consumers and then at the same time focus on the $250 million to $400 million opportunity in the major market that we think we can go after. So M&A at this point in time is something we are not considering at this point.

Simon Flannery - Morgan Stanley

Great, unfortunately we are out of time. Ted and Kurt we appreciate your time today for taking the trip out here. Thank you.

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