Cogeco Cable Management Discusses Q3 2013 Results - Earnings Call Transcript

Jul.11.13 | About: Cogeco Communications (CGEAF)

Cogeco Cable (OTC:CGEAF) Q3 2013 Earnings Call July 11, 2013 11:00 AM ET

Executives

Pierre Gagné - Chief Financial Officer and Senior Vice President

Louis V. Audet - Chief Executive Officer, President, Non-Independent Director, Member of Strategic Opportunities Committee, Chief Executive Officer of Cogeco Inc and President of Cogeco Inc

Analysts

Gregory W. MacDonald - Macquarie Research

Maher Yaghi - Desjardins Securities Inc., Research Division

Jeffrey Fan - Scotiabank Global Banking and Markets, Research Division

Drew McReynolds - RBC Capital Markets, LLC, Research Division

Glen Campbell - BofA Merrill Lynch, Research Division

Dvaipayan Ghose - Canaccord Genuity, Research Division

Vince Valentini - TD Securities Equity Research

Operator

Good day and welcome to the COGECO Inc. and Cogeco Cable Inc. Q3 2013 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Pierre Gagné. Please go ahead, sir.

Pierre Gagné

Thank you very much. Good morning, everybody. I have with me in this room, Louis Audet, our President and CEO.

Louis V. Audet

Good morning.

Pierre Gagné

René Guimond, Vice President, Public Affairs and Communication; Andree Pinard, Vice President and Treasurer; and Alex Tessier, Vice President, Corporate Development.

Before we begin, listeners are reminded that this call is subject to the forward-looking statements which can be found in the press release issued yesterday and this morning, July 10 and 11, 2013, by COGECO Inc. and Cogeco Cable Inc.

Now we'll turn it to Louis for further comments before we begin the Q&A session. Louis?

Louis V. Audet

Thank you, Pierre, and good morning, ladies and gentlemen. Welcome to this review of our third quarter, and thank you for taking the time to join us this morning.

We're pleased to report good financial results both at Cogeco Cable and COGECO Inc. for the third quarter. As you can see, the initiatives that we put in place during the first half of the year are now bearing fruit in the form of enhanced revised guidance for fiscal 2013, as well as very attractive guidance for 2014. Let us first talk about Cogeco Cable.

We were delighted to see, earlier in the month of June, the appreciation ratings published by J.D. Power and Associates about TV and Internet services in the Eastern region of Canada, where Cogeco Cable ranks as the second best Internet provider in the Internet region -- in the Eastern region. And of course, we also had very good ratings for our Television service.

So turning now to the financials. As of May 31, we had 7 months of operating results for Atlantic Broadband and 4 months for PEER 1. As you can see, the performance is strong both in Canadian cable, U.S. cable and Enterprise services, in all 3 sectors.

Cable Canada [ph] and Atlantic Broadband are strong free cash flow generators at this point, and continue to be so. As we had previously announced, the Enterprise sector will be free cash flow breakeven on an EBITDA basis in fiscal 2014, barring any unforeseen opportunity, which could change that, but it's somewhat unlikely. You will have noticed that we've taken advantage of every possible opportunity to reduce our interim interest rate expenditure and lengthen our maturities, acting upon the low interest rates that prevailed in the April to June interval. Also, you will have noted that for the first 9 months, excluding discontinued operations that were sold last year, the profit from continuing operations rose 24.3%.

Turning now to COGECO Inc. The media situation has improved during the third quarter for our radio and outdoor activities and we feel confident about our guidance for the rest of the year.

A few words now about fiscal 2014. We are publishing attractive fiscal 2014 guidance with substantial sales, EBITDA profit and free cash flow growth, which is built on our debt reduction and acquisition integration focus, which we discussed at our last meeting.

That concludes my introductory comments, and I'll turn it back over to Pierre.

Pierre Gagné

Thank you, Louis. So we'll ask the operator, Tracy, to set up the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Greg MacDonald with Macquarie Securities.

Gregory W. MacDonald - Macquarie Research

Wanted to zero in a little bit on the 2014 guidance because the guidance itself, as you know, doesn't get broken down into the segments. So as I look at it, your biggest ability to move the needle has always been Canadian cable. I've been tracking something like a 3% revenue growth opportunity there, and I'm assuming, because of both the subscriber maturity and competitive environment, I'm not assuming anything greater than that for next year. Could you comment on the outlook for Canadian cable and, in particular, pricing power potential in terms of what might be built into guidance for 2014?

Louis V. Audet

Well, the outlook for Canadian cable remains good. It's -- as you know it's a very competitive market, but it's one in which players are focused towards turning good shareholder returns. So that -- that's always a good thing. But it's still intensely competitive. It's maturing somewhat. But we continue to see great potential. We continue to think that these services, and the Internet Service in particular, is highly desirable and subject to further rate increases. As you know, we are not price setters. We are rather price takers or price followers. But it's clear that the Internet Service has a very good dynamic. So I think, all in all, we are reasonably confident about the prospects for next year. Now having said that, I'll turn it over to Pierre, who I'm sure would want to comment on some of the numbers you alluded to.

Pierre Gagné

So, I mean, using as a proxy the 3%, as you've indicated, is not unreasonable.

Gregory W. MacDonald - Macquarie Research

Okay. And that's based on assumptions for price increases as per previous years and current trends on subs, right? You're not assuming anything outside of normal trends?

Pierre Gagné

That's right.

Gregory W. MacDonald - Macquarie Research

Okay. And then, a second question if I could. The PEER 1 business is new for a lot of people covering the stock, and we saw 4 months of those results, so it's in for the full quarter. And, at least from my perspective, you came in pretty close on the Enterprise side of the business. Is there anything from a growth perspective there that we should be -- we should know about that we might not now? For example, has anything changed on the potential for higher occupancy? Is there anything changing on the revenue front, for example, on revenue per racks [ph] or metrics such as that, that you can update us on? Just for the -- just to throw it out, I've got something in the $190 million range on revenue for that PEER 1 asset and $63 million in EBITDA, and I don't want to get into specifics, but is it your sense that The street might be a little bit low in 2014 on the PEER 1 asset, and that might be a description or an explanation of the delta? Because that 2014 guidance delta is pretty big relative to consensus.

Louis V. Audet

Okay. So Pierre will answer to your numbers. All I can say is what we are seeing is a continuation of the good growth pattern that PEER 1 has enjoyed in the past, along with a few operating synergies resulting from more efficient use of capital from the combination of CDS and PEER 1. So -- but there are no extraneous assumptions about rates charged or anything other. It's just the continuation of the growth of the business, but taking advantage of the fact that we now have a pool of assets that's twice the size and that there's some cities where you don't have to build.

Gregory W. MacDonald - Macquarie Research

Yes.

Pierre Gagné

To -- look, I mean now you're starting to peel the onion, so we'll get into detail which was not the objective as was we put guidance. Because then we'll start to explain each of these segment and it will become like trying to zero in on one issue over the other where we should look at the consolidated numbers. But look, I think -- and I think you're referring to maybe some of the competitors that have decided to reduce pricing and so on, so forth. The point is that the pricing so far appears to be firm. We haven't seen or heard any changes from what we're offering at this date. The growth on the PEER 1 front is carrying on. We think that the margin will move a little bit higher because of the occupancy rate. I mean, that's as best. I wouldn't want to go as specifically what PEER 1 is using and what CDS is using because then, we're getting into more than segmented information. But my point is that the growth that should -- that this sector will have over next year is what we could see double-digit growth on the revenue and the EBITDA line. We're still seeing that on a combined basis, CDS, PEER 1, and this is what we're -- where we think we could achieve for next year and the assumption behind these numbers are for that.

Gregory W. MacDonald - Macquarie Research

Okay. So just to get back to the original message. You're seeing growth in all segments, Canadian cable, U.S. cable and the enterprise segment, and we shouldn't draw any conclusions about the 2014 guidance that one of these divisions is outsized relative to the other?

Louis V. Audet

Exactly. Yes, that's right.

Operator

Our next question comes from Maher Yaghi with Desjardins Securities.

Maher Yaghi - Desjardins Securities Inc., Research Division

I wanted to ask you if -- I noticed that you did not provide any PSU number forecast for next year. Is it because you're still wanting to see the full seasonality of ABB, and that's why you're not giving that?

Louis V. Audet

Well, I think we're -- on the cable side, we're entering a more mature state. And you can see that the rhythm of additions of customers is slowing down for all actors in the industry, regardless of where they're coming from. So I think it's increasingly going to be about customer retention, about quality of service and about rational use of assets and pricing. So I think that, that metric has now a diminished importance, and we're -- hence, we're focusing more on financial results.

Maher Yaghi - Desjardins Securities Inc., Research Division

Okay. And in terms of business mix on the cable side, can you talk a little bit about the margin profile? How do you see the margin profile shifting as the mix changes? Can you maybe provide separately that kind of visibility on the U.S. and the Canadian side?

Louis V. Audet

Well, as you could see in the Q3, the EBITDA margin on the U.S. cable has essentially remained the same as the Q2, where it was our first quarter. And we were of the view that the margin should remain about the same for a foreseeable period. Now with respect to the Canadian cable assets, we are of the view that the margin will remain about the same as well. In the PEER 1/CDS group, because now PEER 1 has a lower EBITDA margin as compared to CDS, the mix of these 2 assets, what you saw in Q3 should be a base that we will start to grow the margin from. So -- and that's the way it should go.

Maher Yaghi - Desjardins Securities Inc., Research Division

That's good visibility. And last question on ABB business. I mean, there's a lot of small regional players around the areas that you have in the U.S. And as you mentioned in the past, this was supposed to be your launching pad for additional growth areas. Can you maybe talk a little bit about the dynamics in the cable business in areas where you are, and what should we expect in the next year? Could we see some additional small tuck-ins to grow your business down there?

Louis V. Audet

Well, there are a number of operators, as we mentioned. And yes, you may see some small tuck-ins come along during the year, and that's always a little difficult to predict because it depends when people are ready to sell. But, by and large, I don't think any of these will make a meaningful difference on what we are presenting today for 2014, nor for 2000 -- I'm sorry, 2013, nor for 2014 because whatever they are, they would, in principle, be sufficiently small as to not modify our trajectory towards debt reduction.

Maher Yaghi - Desjardins Securities Inc., Research Division

Right. So they should be self-funded acquisitions?

Louis V. Audet

That's the idea, yes.

Operator

Our next question comes from Jeff Fan with Scotia Capital markets.

Jeffrey Fan - Scotiabank Global Banking and Markets, Research Division

Maybe expand that last question a little bit more. There's been a lot more conversations around cable consolidation in general, both in Europe as well as in the U.S. And the thinking there is really a along scale and to protect against rising programming cost. Louis, maybe we can get your thoughts there in terms of how if or if not whether that kind of thinking applies to you, whether there -- you see any benefits in -- or need in terms of protecting against programming cost increase in the future, or any other reasons for further consolidation?

Louis V. Audet

Yes. Well, of course, as a consolidator, we very much like the idea of future cable system purchases within the general guidelines we've set for a reduction of debt levels within our company. So, of course, we're very enthusiastic about consolidation. Now that being said, the imperative is more about growth than it is, in our opinion, about defending something. As you know, our programming purchases in the United States are done mainly through the National Cable Television Cooperative, which is a group of cable companies that represent 11 million customers. So that's yielding competitive programming rates, which suit us just fine in the United States. And I also wish to remind you that margin levels, whether in Canada or the U.S., are not correlated to company stock. They are correlated, as they have been now for decades, to other factors, factors such as people's determinations to generate higher margins. So I think that's the best answer I can give you.

Jeffrey Fan - Scotiabank Global Banking and Markets, Research Division

Okay. Great. And just a couple of follow-ups. On the U.S. margins, you guys said that you would be flat. I guess the thinking, going into the U.S. right now, is -- for your business, is that there should be some improvement in the subscriber growth driven by more HD content. You recently signed a TiVo deal, which should help improve the interface of the service, et cetera. And with the growth in digital, wondering what kind of assumption you've built into your programming cost increase in the U.S. for next year, and how that sort of -- what offsets there are to keep margins relatively flat going into next year?

Louis V. Audet

Well, the premise of this -- one of the premises of this transaction was our plan and ability to sell more Internet, more phone and more digital services into the existing customer base, and perhaps with the help of TiVo, bring in some additional new customers. So that's the premise and it's the premise that carries through in the 2014 guidance.

Jeffrey Fan - Scotiabank Global Banking and Markets, Research Division

So should we -- we should expect to see some PSU improvement in terms of adds for 2014?

Louis V. Audet

We would, yes.

Operator

Our next question comes from Drew McReynolds with RBC Capital Markets.

Drew McReynolds - RBC Capital Markets, LLC, Research Division

Just, I guess, a couple of follow-ups for me. Just first, Louis or Pierre, on the PSU growth in 2014, I know you don't want to provide guidance and I think your explanation's pretty clear. Just wondering, certainly, if you're still kind of targeting something that's positive, as opposed to flat or modestly negative. And then the second question, just in terms of the appetite for further acquisitions, I believe in the past, you've mentioned that you'd want to see your leverage kind of below 3.5x net debt-to-EBITDA or lower before you'd kind of consider anything of size. Just wondering with your very good free cash flow guidance, whether that has changed at all.

Pierre Gagné

Okay. So with respect to the PSU -- look, we prefer not to provide guidance because I think it's -- well, we're driving like the rest of the industry in terms of the financial numbers and not the number of PSUs. And I think that we will just leave it as that. With respect to the leverage, what we've said we would do to the market over the next couple of years is we would reduce leverage. We've said that there may be some tuck-in acquisition, as Louis mentioned, and that's what we want to do. So it's the best we could say at this stage of the game.

Drew McReynolds - RBC Capital Markets, LLC, Research Division

Okay. Pierre, and if -- just one kind of follow-up. Just with respect to Atlantic Broadband. Just wondering in your -- the areas that you operate in, with respect to a pickup in U.S. housing activity, just wondering if there's any kind of meaningful impact that you're seeing in those geographies with respect to new homes.

Pierre Gagné

Yes, you would see a definite pick up in Florida, Maryland, Delaware and South Carolina, and perhaps less so in Pennsylvania.

Drew McReynolds - RBC Capital Markets, LLC, Research Division

Okay. And do you expect that to have a meaningful impact, Louis, or just a nice tailwind to have at your back for now?

Louis V. Audet

I think, at this stage in our guidance, it's treated as nice tailwind.

Operator

Our next question comes from Glen Campbell with Bank of America Merrill Lynch.

Glen Campbell - BofA Merrill Lynch, Research Division

A couple of questions on the U.S. cable business. Could you give us a sense for the year-over-year growth rates in revenue and subscribers for the business from May to May?

Pierre Gagné

It's because they've never had the same quarter. Look, I would give you a -- oh, I hate to -- Glenn, I'll ask to take it off record because they have a calendar -- if you want, year end. It's -- and I don't think I would have it like that. But I could tell you directionally, it would be like roughly mid-single-digit in revenue and EBITDA line.

Glen Campbell - BofA Merrill Lynch, Research Division

Okay. And how about on the subscriber side?

Pierre Gagné

I'm sorry?

Glen Campbell - BofA Merrill Lynch, Research Division

And on the subscriber side?

Pierre Gagné

I'm sorry, I don't have it with me. I can't help you on that one.

Glen Campbell - BofA Merrill Lynch, Research Division

And rate increases in the U.S.? Could you give us a sense of the timing? I mean, I'm assuming it varies a bit by system, but the main ones?

Louis V. Audet

We have implemented rate increases that are in line with the rest of the industry. And our -- as people approach end of promotions, of course, there's an adjustment after the first year, the second year and the third year. So that kicks in as well.

Glen Campbell - BofA Merrill Lynch, Research Division

Okay. So for the U.S. systems though, I mean, we got the timing for the Canadian ones. Could you give us the timing over the past 12 months for the U.S. rate hikes?

Pierre Gagné

I'm sorry, what you -- the timing?

Glen Campbell - BofA Merrill Lynch, Research Division

Yes.

Louis V. Audet

It was the -- I think it's February, March.

Glen Campbell - BofA Merrill Lynch, Research Division

February, March. Okay, that's great. And then one last one. I mean, in Canada, you've made a very conscious decision to tighten your credit policies to get a better class of customer, and that seems to be -- there's a couple of objectives there, less credit losses, obviously, and less promotion hoppers as you call them. And then, now that the policy has been in place for several quarters, could you give us your sort of thoughts on how it's working, whether it's contributing to margins, whether you're seeing churn drop, whether there's an opportunity to fine tune in favor of subscriber growth?

Louis V. Audet

Okay. Well, I think this policy has been beneficial to this company and its shareholders. It has reduced the amount of unproductive traffic immensely. And hence, there are -- there is fewer wasted effort of people coming in and not paying, and then going out, and our having to send trucks to connect them and disconnect them. And our people having to run around to ask -- to phone them and see if they're going to pay. So yes, it's having a very positive impact on this company and you can see it in the increasing margin numbers.

Operator

Our next question comes from Dvai Ghose with Canaccord Genuity.

Dvaipayan Ghose - Canaccord Genuity, Research Division

I just wanted to go back to this PSU question. I understand yourself and your peers no longer really look at PSUs because it's not growing. But do you really think you can sustain revenue and EBITDA growth and cash flow growth without any PSU growth, especially if they are in terminal or be in gradual decline?

Pierre Gagné

It's a good question. The way it's shaping up both in Canada and in the U.S., is that we continue to be able to add new Internet and phone, and we continue to be able to raise rate on a reasonable level. And we continue to sell to businesses. And the business sector is one that's growing in the 20% plus range on both sides of the border, and that's a very important source of revenue for us and one where we have still -- there's still a lot of runway on that, on that opportunity. So the combination of these 3 factors is what supports the growth rates that we are guiding to today.

Dvaipayan Ghose - Canaccord Genuity, Research Division

That's a very fair point. Obviously, you've diversified against consumer-only risk. On the price increases though, you said sensible price increases or something of the like. Is there any concern about regulatory scrutiny? Obviously, your friends in the wireless industry seemed to have got a lot of regulatory scrutiny. A study came out recently, which said that Canada has amongst the highest Internet rates in the world on the high-end, not on the low-end and so on. Is there any concern that regulators may start looking at your pricing?

Louis V. Audet

That's a little hard to believe because you have a fully functioning competitive market. No one is giving anyone a break in this market, I can assure you. We have strong competitors. We have -- we even have strong resellers in this marketplace, which hardly exists in the wireless space. But in the wire line space, they are reselling -- are selling cheaper than us. So it's a fully functioning competitive market, so it's hard to see why there would be a regulatory intervention.

Dvaipayan Ghose - Canaccord Genuity, Research Division

Well, that's fair. And then my last question, if I could look at the debt deleveraging in a slightly different manner. So you're at a peak of 3.8x after your 2 large acquisitions. Given your guidance, without a massive dividend increase, you'll be at nearer 3x, I think, by the end of '14, around 3.1x, 3.2x. Is the balance sheet powder being kept dry for future acquisitions or in lieu of, would you consider more meaningful dividends and share buybacks over the next 12 to 18 months as you perhaps go to 3x or even under?

Louis V. Audet

Philosophically, our company is -- has been, and of course, it's always the purview of the Board of Directors, but historically, we are not very favorable to share repurchases. We are favorable to dividend increases and, of course, debt reimbursements. So you can -- I think you can count on a continuation of those policies for the near future. Now in terms of acquisitions, I think you are now way ahead of us. It's not about keeping powder dry for this or for that right now. It's basically about putting our nose down and getting those operations to perform as well as they can, integrating them in the most intelligent manner possible and reimbursing debt. So we're not -- it's not about dry powder at this stage at all.

Operator

[Operator Instructions] Our next question comes from Vince Valentini with TD Newcrest.

Vince Valentini - TD Securities Equity Research

A couple of questions. First, just to follow up on that last one, on the dividend. Given that you are in the mode of not thinking about big acquisitions and just integrating what you have, I'm just trying to correlate your recent dividend increases with the free cash flow strength you've seen. So in your 2014 guidance, obviously, you're using your numbers for 2013 and 2014, there's a 55% increase in free cash flow. Should we expect that to translate into somewhat meaningful dividend growth over the next 12 months?

Louis V. Audet

I -- you should expect -- well, again, it's the Board's prerogative, but you could normally expect dividend increases. Now as you have seen with our company in the past, our board members like to see the performance before they make a decision on the dividend. And I think you can expect that, that will be their behavior going forward. So yes, we should see dividend increases but you will also see debt reimbursement, and you will see a Board that will like to distribute what it has already witnessed, as opposed to act on projections. So I think that's what you should expect to see.

Vince Valentini - TD Securities Equity Research

Okay, that's fair. Two other ones. One, just a small one on the U.S. subscribers. You talked about some seasonality and some snowbirds having an impact on these third quarter results. Is it fair to say Q4, you wouldn't see any change in that, but in fiscal Q1, you would hope to see a bounce back as those snowbirds come back south?

Pierre Gagné

Yes, that's what we should expect to see based -- and basically, when you look at the decline in the basic subs -- if my memory serves me well, it's about 70% or 65% of the decline in the basic sub came from the Miami cluster so -- because of them leaving so.

Vince Valentini - TD Securities Equity Research

Okay, good. And just to try another question, just to add on that. Have you considered changing your marketing or pricing strategies in some way trying to convince those people to just leave the service connected when they go home and get some sort of discount if they're not actually using it for 6 months?

Louis V. Audet

There already are plans of that nature in place. So I think what you are witnessing today is it's buffered from what it could be, if these plans weren't in place.

Vince Valentini - TD Securities Equity Research

Okay, good. And last one -- obviously, you may have limited comment on this, but I want to ask anyway. Given all this talk about Verizon potentially looking at Canada, seems like you -- your company is very well-positioned as, potentially, a strategic partner if they need regional partners who have both fiber assets that they can use for backhaul, as well as bundling capability that they may want to leverage in some sort of marketing alliance. Seems like it could be a win-win to add wireless as an MVNO product from a reasonable -- reasonably scaled and credible new supplier. Could you give any thoughts to how this wireless world unfolding could help you in the future, and whether you've entertained any thoughts of may be partnering with somebody, if there is a viable fourth carrier?

Louis V. Audet

Well, I think our philosophical orientation hasn't changed at this stage yet, which is not to say it will never change because it's always difficult to predict the future. But at this stage of the game for us, there is, in all likelihood, no motivation to introduce a cellular phone product. But there is motivation and we are continuing to deploy WiFi hotspots across our franchises at a somewhat faster pace than what we announced in the past. Perhaps not as fast as one of our cable brethren who have a very aggressive plan in place, so we're not on that track. But we're certainly on the track of increasing the number of WiFi hotspots in place. Now of course, we remain open, particularly in cities like Montréal and Toronto but also across all our franchises, happy to provide backhaul to cellular providers whoever they may be. And if it's Verizon, then it will be Verizon. Right now, we're doing business with all the others. So sure, that's a great opportunity and one where we are able to act quickly to please our customers.

Operator

Thank you. And there are no further questions at this time. Please continue.

Pierre Gagné

Okay. Well, thank you, everybody for attending this call. The plan right now is to have our next conference call on October 31 to provide our year-end results. So I want to thank everybody for attending the call. Wishing everybody a great summer. And of course, Andree Pinard and I are always available to answer your questions. Thank you again for attending the call.

Louis V. Audet

Thank you, bye.

Operator

Ladies and gentlemen, this concludes the conference call for today. We thank you for your participation. You may now disconnect your line, and have a great day.

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