Kenneth Meyers - Chief Financial Officer
Steven Campbell - Chief Financial Officer, U.S. Cellular
Telephone and Data Systems, Inc. (TDS) Morgan Stanley Technology, Media & Telecom Conference February 27, 2013 12:45 PM ET
Good afternoon, everybody. We're delighted to have TDS and U.S. Cellular here today. Ken Meyers, CFO of TDS; and Steve Campbell, CFO of U.S. Cellular, welcome. Thank you for braving the blizzards of the Midwest to get here for this. Please note that all important disclosures, including personal holding disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at www.morganstanley.com/researchdisclosures or at the registration desk.
So Ken, maybe we can start, you just reported earnings yesterday, and you put out some guidance for 2013, you gave us some more color on the Sprint transaction and the impact on your financials, you changed some disclosures, including the LA partnership and so forth. So perhaps you just give us just a sort of overview of the key takeaways from '12 and outlook for 2013.
I like the way that you kind of have been trained and you've got to make your full disclosure statement before you start. Well my IR Department, right in the front, this is a virtual world, so consider this the virtual Safe Harbor warning that I'm putting up to you. So you can find that on our website also. What a world we live in?
Yesterday, we announced earnings for last year and talked about our priorities for this year. TDS has both got a wired operation and cellular, so I'm going to let Steve talk about some of the priorities at Cellular. But the parent company, I'd say the big themes are, last year we spent money investing in IPTV and rolling it out to 10 markets, and this is the year that we have to market and sell that and expect to see some benefits of that, one.
Two, over the last two years, we've been investing in HMS, hosted and managed service type companies in that same business, and again, all those are expected to come to fruition this year. And the other quite frankly new one, yesterday was announced the acquisition of a cable company Baja Cable. We see that as just using a different technology to do the same things that we do on the telephone side, and that is deliver high-quality broadband voice and video to customers in midsize and smaller towns.
And so we get to leverage all the capabilities that we have, whether it'd be running networks, providing customer service, residential marketing, but doing it to a different group. In doing that acquisition, it's been interesting some of the reaction. And the biggest one was this is the company that had just recently upgraded a lot of its assets and hasn't yet done the marketing. So penetration is low and as a result, when we look at, we build our own models to value it.
But when the Street looks at it, they like to go over the metrics and say, well, how does this compare to the last year, and if you look at it in a revenue metric three times, people say, it looks a little rich. You look at it in a homes pass basis under $1,300 looks pretty attractive, and they're quite frankly two sides of the same coin.
I mean because the penetration is low. The revenue opportunity we think is pretty high and so on a revenue multiple it looks high, but in terms of our own models, and we don't buy an either one of those metrics, but rather we look, we model out, when we think we'll do the business. We're pretty excited about what we think we can do to leverage the investments we already have in that area. So those are probably the big highlights I'd call it on the wired side. You want to talk a little bit.
I think important initiatives are strategic objectives for U.S. Cellular in 2013. I think I had mentioned four. And the first is closing the divestiture transaction with Sprint. So you may recall that in November we announced that we'd be divesting of our Chicago and St. Louis and a couple of other smaller markets to Sprint. And so there is work ongoing related to the transaction, clearing the regulatory fuller hurdle as well as completing transition services agreements.
So we'll be providing transition services for a period of up to two years to Sprint related to both our customer base in our network operations, so those agreements are under negotiation now. And then I mentioned regulatory approvals, and what we believe now is that we should get clearance within the next 60 days or so from the FCC.
But it won't be part of the Sprint Softbank.
No. In fact, the informal discussions that we've had with people in the commission indicate that our transaction, we'll get approval and it won't get caught up in the swirl around Sprint and Softbank. So we're pleased to hear that and so we're pretty confident that we'll get those approvals say in the next 60 days, and then we could proceed closing as soon as possible after that, which means that I think we're well on track to what we've said about a close by midyear.
I think the second important thing to call out for this coming year is related to that, which is monetizing other related assets in the divestiture market. So as part of the transaction, we're retaining ownership of the 565 towers that we have in those markets and so the company will be looking at alternatives to monetize value there. It might include an aggressive program to continuing ownership and aggressively leasing up those towers, but potentially a divestment as well.
And also there is spectrum in those markets that it's unused in those operations and it was not part of the transaction with Sprint. There is some additional PCS, but also AWS spectrum in the market, and the company will be looking at alternatives to monetize that spectrum over the next several months.
The third thing that I'd like to mention is a key goal for U.S. Cellular this year will be to continue and push along our deployment of LTE technology in our network. As you know, we've been investing in that upgrade since some time in 2011. By the end of 2012 we had progressed to a point where we covered roughly about 60% of our customer base, I think 61% is more precise. And by the end of 2013, we expect to cover about 87% or 88% of our customer base. So again, very important program for us, substantial investments in 4G portion of network again this year.
And then the fourth big area focus for us would be growing our customer base. We had a net loss in postpaid customers this past year, and so turning that around and having positive growth in subs in 2013 is a key area of focus. Of course, there is two parts to that. There is gross ad, so new acquisitions of customer and churn. And I think we've been doing a pretty good job on the gross ad side actually, last year gross ads, like using the fourth quarter as an example, up about 4.5% year-over-year.
So in the context of this very competitive marketplace, where we're happy to see the gross ad grow. Churn has been an issue for us. We've had elevated churn over the last several quarters, and so that will be an area of focus for us this coming year. Taking a number of steps in that area, including better analytics, deeper analytics and understanding churn events and actually identifying customers that are likely to churn, and then targeting them with specific offers, either something related to their plan or a particular device and so forth. So again, really looking to drive churn down this coming year, so that we can have a positive growth on some of these.
Thank you. I think starting with you Ken, and then broadband, I think you've obviously made a number of growth acquisitions over time, but this is a little bit different. I understand what you're saying in terms of you're selling the same products just over a different architecture.
Do you see the ability to kind of have some synergies? You talked about raising the penetration, but on the cost side, I don't whether that's programming aggregation or just learning some things from them or vice versa where you help run your operations better. I don't know if you've quantified anything at this point? And you're going to have some significant cash resources at TDS, but particularly out of U.S. Cellular is there something where we may see more investments?
Yes, we think there are synergy opportunities in terms of what we're buying and our current operations. In fact, we've actually spent a good amount of time looking at the cable business itself and the cable model, and how it could leverage what we're doing today. The company that we're buying actually was private equity owned, they had a management team that probably doesn't stay with us, and use many of the resources we have internally.
Now the second level management all stays, right, but in terms of the top management, that's one of the first day we drove the top. But they use customer service that's what we've got there. The network operations and that kind of activity, it doesn't do much on the purchasing content, purchasing too small of a step, but we think that future acquisition in the area could leverage that.
We will continue to look at them. It's been an active period recently in world cable, but that's not like there is a long list of companies that are out for sale at any one point in time. We like it and at the right price we're interested. But like on the wireless side, earlier on there are lot of deals you'll see, but there aren't necessarily a lot of deals that you decide with your mix of assets or strategy or whatever.
So we like that. We also like what we've seen in the HMS area and really targeting at the midsize businesses. We are interested in the Morgan Stanley business and Chase's business, the big data center business, but really looking at the types of business we have in our footprint today in terms of midsize there's 200 desktops to 2000 is what we define that as. And we're looking at building kind of end-to-end solution, whether they are looking for co-location, whether looking for managed services, whether they are looking for disaster recovery, and you may get in with one sale, but frankly using equipment sales now as an entry point and then over time sell your services.
Steve, on the asset sales in the rest of the spectrum and the tariffs, I hear that the transaction is going to close soon. Are those assets going to be availed maybe the spectrum already, but the towers are going to be available to be sold this year or do you need to get through the transition period? It sounds like you're still trying to reside exactly what you'll do with them, perhaps you could give us a little bit of color what's the tendency there and are these prime location?
I think probably a different answer depending on whether you're talking about towers or spectrum and in terms of how fast you can move there. But I think generally the way I think about that is, job one, is to get the transaction closed. And again we were hoping that that will happen mid year. We will have a period of time that we're providing transition services to Sprint it could be for a period of up to two years.
And certainly the towers will be used in providing those services, but I don't believe that the requirement to do that would preclude a sale of the assets, because those are assets that are being detained by U.S. Cellular and in any case they aren't part of the sales. So I can't give you precise timing other than to say, we've already begun to think about that and we want to move along at a pace that makes sense.
If I think about these towers, is it 1 or 1.5 tenants, if Sprint isn't going to use them, then they're really kind of empty. Is that fair or is there a lot of to different tenants?
There are tenants on many of the towers and Sprint may in fact want to use some of them. I mean they've actually indicated that there is a fair number of them that they may want to co-located on post-closing. But I think 1.5 to 2 tenants on average is probably reasonable to think about this portfolio.
And then you mentioned a point, it was sort of growing the base and you talked about churn. I gathered from what you're saying that this is primarily voluntary churn, this is not a bad debt issue anything like that. And given the time of it sort of points directly to the iPhone perhaps, so as being perhaps the source of that. Is that your sense of what's going on here or is it nationwide LTE networks and T-Mobile's going to get an iPhone maybe next month and going to rollout LTE. Have you made any progress? How it changed your thinking here about this sort of the economics or the attractiveness of offering that.
I think you made a lot of points in that question, but first is, yes, the churn issue is primarily a voluntary churn issue. So when you look at period-to-period changes and the increase in churn it has been about voluntary churn. And as I'm sure you'll appreciate there are lot of reasons why customers leave us, but certainly the iPhone is a factor there. Our research tells us that there is a good chunk of that churn that is iPhone related. The thing that's interesting about that is that those customers that tell us that they're leaving for the iPhone is fully 85% of them tell us that they're still very satisfied with U.S. Cellular Service.
So it's an important factor. And I think we're going to continue to look at the economics of getting that device. I think we've said that it could be done under what we consider to be reasonable season fees that it would be a good device to have in the portfolio. In the meantime, we think we have a great portfolio devices and we're very pleased about the fact that we've been able to enter some of the iconic devices like Galaxy SIII and the Galaxy Note at the same time as other carriers. So we feel like we have probably got the most robust, assessed device portfolio we've had in a long time and certainly the iPhone would be a nice addition, but I think I'd say ongoing analysis, I think still an open question for us.
For us I think one of the things we've talked about in the past is when we looked at this question in the past, we were just stating our transition from a primarily CDMA EVDO network to LTE. And at that point in time, there wasn't any LTE iPhone on the roadmap. That was one that was being talked about, right. And for us, it's important to quite frankly stop investing in the EVDO network as soon as possible, and to put all of your investment wouldn't have the long-term pay off, right.
So that's changed, both in the terms of what's available from a handset side but it's also you will see the change in our CapEx guidance. I mean last year, CapEx at U.S. Cellular was $835 million in guidance, for this year it was $600 million. And we're spending about the same amount of money in LTE each year with our wave two, now going to wave three. The big part of that difference is the fact that we've moved along so well with the migration of our customers to LTE that we hope we've kept the growth, and so that was a big issue couple of years ago when we looked at this.
That's a great point and I think to Ken's point when you look at our fourth quarter results and subsidy on equipment was an improvement factor in our results for the quarter. But we've made great progress in moving customers from 3G to the 4G devices. That's certainly a big component increase year-on-year, both more smartphones, the higher penetration. We moved our overall base from 30% to 40% in smartphones. And the sale of 4G devices was an important part of that and as Ken said that reflected in our guidance for CapEx, where while we'll have a similar and pretty large amount of expenditure for 4G, where we've been able to cut back substantially on any continuing investment at 3G.
I guess one of the keys to making successful transition to LTE is roaming. Have you been able to make any progress there? Obviously, you're going to have several other LTE networks up and running, who maybe more willing to partner with you. Is that something where we could see some more progress this year?
I think we could see more progress this year. We don't have meaningful progress to report today as far as 4G roaming agreement. I think it's fair to say that our key roaming partners and some of that aren't big roaming partners today have certainly indicated a willingness and intent to work with us. But we've still got some issues to overcome in terms of band class and handsets that that will actually work across the various bands made for roaming.
But clearly an indication and willingness from all of our roaming partners to work with us when we're in a position to have those handsets and I think we expect that ecosystem is going to evolve and that before too much longer we'll be in a position to make some progress in terms of actual commercial agreement.
I think we're also encouraged by the outcome of the litigation related to the FCC's mandatory roaming rule. That rule have been issued some time back and then was contested in the courts. I think with Verizon in the lead on that but the courts have upheld the FCC's jurisdiction to issue that rule, and so we feel like having a mandatory roaming requirement will help us both in working with the OEM's in getting the devices, but then also with our roaming partners in terms of commercial.
So Ken we had Century Link here yesterday. Cincinnati Bell reported this morning. And I think those are very common theme with TDS which was investing for growth and the desire to get that wireline business to a sustainable growth topline. And like you, I think we've heard a lot of investing in data centers investing in IPTV and so forth. So how do you balance kind of the desire to sustain margins and yet invest for the future? There is always that, do I harvest and take cash out or de-lever a pay buyback stock versus we're running this thing for years to come, and yet not go too far that way to where you start burning a lot of cash?
That's where the management and the board spend all their time. It's a little bit of a double-edged sword. We've got great assets and capabilities in these businesses and we can harvest them. And we all know what that looks like. And it works fine for a year or two, and you can cut costs for a while. But you can't cut them completely forever. And so all of a sudden you hit a wall there all. So we can do that but we also said with all those capabilities we have and those customer relations and other things can we leverage that.
And so we had to look at it and that we think that the HMS area and cable are ways of sustaining that. At the same time, we also look at the different things that we've done historically and we have over the last five years now I think we've brought in almost $900 million of stock between the two companies. So it's a balanced approach. It's not doing all of one or doing all of the other but we'll continue to kind of serve many masters which is what a public company does.
And to that end, you've got I don't know if dilemma is the right word, but you will generate some cash from the Sprint transaction, there maybe more cash coming in from towers or spectrum sales, but it's sitting at U.S. Cellular, as a TDS shareholder how does one get access to that cash or is might U.S. Cellular be more aggressive in buybacks or there are acquisitions that could they could make or other strategic, I know you've been looking at a lot of corporate actions. You've consolidated the share classes and so forth, but what is sort of next on the agenda there?
The cash currently is building at Cellular and the transaction that Steve talked about could add to that? And that's the board level decision at U.S. Cellular and what we said was that to have a position on that before the cash was there, before the sale is closed wasn't how we were going to do business. But we have been working with the board.
So that as we get to closure, we are hopeful that we'll have a position on use of cash, but that's going to be at the Cellular level, because that's where the cash is. And you've named all the choices, right. You can buyback more shares. You can do a special dividend. You can start a recurring dividend, you can look at acquisitions. That is undecided at this point, more to come on that. And then once that decision is made then we can deal whatever the secondary effects that are.
And how do you feel about the value reorganization at the holding company level? Is that something what you think there is anything one can do?
So we've spent a lot of time looking at what are the options, what can you do. Mathematically, it's the case where, if you look at what Cellular is valued at and say that's all you are buying when you buy TDS, right. Then everything else is for free. Well, for free, whatever our choice is break the two up. I don't know that telecom is big enough by itself.
So that doesn't work, buy it in for cash and suddenly the cash that we're talking about isn't there to do other things with, buy it in that equity, look at the difference in the two equity prices. What we concluded in the past as we looked at it is it's nice to have. It's not a critical, if it destroys value at the TDS level by causing big delusion by doing it, where is the logic behind that. So it's a nice to have at the right price, but it doesn't stop us from running the business.
You got plan for couple of questions.
The LA partnership, you just talked about, you were sort of I think highlighted the value there a little bit more with the move. Was there anything more than that? Is that just about making sure the people are aware of the quality asset and is that something where you're looking or would ever consider divestiture?
So for years we've had a portfolio of investments in other wireless systems. LA is clearly the biggest, but there is also an ownership interest in the Oklahoma City market that AT&T runs. There is a few different ones in there. And these are extraordinarily valuable assets. They generate substantial earnings for the company, and they unlike oil and gas partnerships, these things distribute their cash. There is no management fees off the top, and so you see that cash coming through the cash flow statement every year.
And it is such a meaningful number for company our size that when we talk about operating cash flow or EBITDA, or whatever number we're using, we're drawing the arbitrary line just above that, and we're ignoring it. And so really just to highlight the value, we decided we're going to start a little bit further down the line income before taxes and talk to a more inclusive measure of the total earnings power of the company.
One of the highlights in the quarter was the prepaid number. You continue to have some good momentum with your Wal-Mart brand case. Can you just talk a little bit about, prepaid often is you have a new product in your promotion and it has a very strong kind of launch period, and then it sort of settles down. What inning are we in, in terms of that, and maybe just so for people who aren't just familiar, just to explain that kind of that product?
So what Simon is referring to is that in May of 2012 we launched a new prepaid service as part of our prepaid service. We call it U Prepaid, and it's actually a phone in the box-type prepaid offering that we're offering through Wal-Mart, and were currently in about 450 Wal-Mart stores in our footprints for that product. And I think that given that we launched the product eight or nine months ago, I think we're still in the early phases although we expect to get into more of a steady state here pretty soon.
I think when we think about our prepaid business, the thing we like about is that we think our research is telling us that probably 85% or so of this is actually incremental business. It's not prepaid moving from U.S. Cellular company or branded agent stores, but it truly is incremental business for us and profitable business for us. So we're pretty excited about it. In fact, we're actually able to leverage that to with a postpaid offering in Wal-Mart in over 400 stores in the October timeframe. And that's still in the very early stages, but we're encouraged by that.
What ARPU is it generating?
Comparable to what we have in the overall, either postpaid or prepaid. But again it's more about being in places where customers want to shop. So again, we're really happy that it isn't just cannibalizing our own business. It really is incremental distribution and incremental revenue. That's in part why we're so excited about it.
Unidentified Company Representative
Well, unfortunately we're out of time and Steve, we appreciate you time. Thank you.
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