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Consolidated Communications Holdings, Inc. (NASDAQ:CNSL)

Citi 2014 Global Internet, Media and Telecommunications Conference

January 07, 2014 06:00 PM ET

Executives

Steven L. Childers - Senior Vice President and Chief Financial Officer

Analysts

Unidentified Analyst

…pleasure and thanks to those in the room, for your interest in Consolidated and those listening to the webcast. So just as we are go into the New Year it would be a great time to catch up on a review of 2013 and some of your strategic and operating priorities for 2014.

Steven L. Childers

Sure, I appreciate the chance to address all those that follow our story and for those that are new to it, we operate in five states. We are a broadband service provider build on four major acquisitions that started with the divestiture of the Illinois assets from the McLeod bankruptcy back in 2002.

Looking just at 2013 we’re very excited about a fairly exceptional year. We delivered consistently strong operational and financial results. We’re on target with respect for the integration timelines we set out with the most recent acquisition that we closed in 2012. We’re in actually the second phase of that where we’ll complete the billing integration and with all of our acquisitions we consolidate the operations support systems first, organize functionally which we did in the case of the SureWest, Kansas and California operations and expect to see continued benefits of that deal, both from a cost synergy perspective and a revenue synergy perspective.

And I might add also just before Christmas we completed a successful refinancing of our term debt that will yield cash interest savings of roughly around $5 million per year. And it pushes out our ‘17 and ‘18 maturity towers into 2020. And added with that we upsized our revolver capacity from $50 million to $75 million and extended the term on the revolver as well to December 2018.

So with that as background we feel really well positioned for 2014.

Unidentified Analyst

Excellent, can you provide an update on -- you touched on the SureWest integration process, how that’s progressed, you’ve noted that that you are about nine months ahead of the synergy realization timeframe and how should investors get comfortable or perhaps some incremental synergy realization.

Steven L. Childers

I think the way to look at that is that historically we’ve been solid integrators with all the major deals that we’ve added to our portfolio and this is no different. We will complete the billing system integration in late third quarter of this year and the first step of that is the user interface, which is converting the first quarter and the platform conversion than late -- at the back end in the late third quarter and our integration team follows the same playbook that we’ve done from other deals.

And if you look at the synergy percentages, those have ranged from 15% to 19% of operating expense of the target and the $25 million we will exceed that. In this case we are confident of that by at least 10% and so this year while I can’t put a specific number on it, with the billing system integration we know that some enhancements will lead to more better productivity and we’ll have certainly cost savings benefits but that we view as upside.

Unidentified Analyst

And given the size of that deal relative to your legacy business, can you elaborate on some of your -- perhaps the best practices or some of the qualitative things that you’ve learned from the SureWest plant and the management process that was there?

Steven L. Childers

Well we leverage the strength of every deal that we’ve done and we use those as opportunities to improve our operation and support systems. And just to give you an example SureWest had a very robust front-end on their customer support system. And we are using that and leveraging that in our billing system conversion.

So taking that, building that interface, the efficiencies that come with it, building for that interface to help us present to the service rep who is dealing with the prospective customer what’s the available bandwidth is for that customer. And so it's more of a decision support tool in recommending different options and the IP nature of our network allows that tool to real time give us capabilities of where the customer’s geographic interest is in establishing service.

That’s just one example. We’ve also benefited just by nature of larger scale from purchasing power, content acquisition we have more diversity there and certainly the expansion of two strong markets, specifically the Sacramento market with the legacy WINFirst acquisition that SureWest had done in 2003, had a lot of untapped commercial and business-to-business opportunity for us. We are going to leverage that asset with our sales and marketing experience and the consolidated history and those will provide for some revenue opportunities for us that growth market brings to the table.

Unidentified Analyst

And how does Consolidated view the current M&A landscape and whether there are any attractive fiber optics or other network elements that Consolidated would like to add to its portfolio to be more competitive over time.

Steven L. Childers

While we don’t view ourselves as the biggest player in the M&A space, we do think that we are competitive in all the markets that we serve and so with our organic operating strength and the natural deal flow that we continue to be a part of we are going to continue to be prudent buyers.

We are going to continue to look at opportunities where we can take those strengths from our operating experience and produce and extract some value. So like what I think would be different than the ILEC focus we’ve had in the past in telecom, historic telecom company is we’re more apt to be interested in fiber assets, more likely to look at cable properties than we would have looked at historically.

We know the consumer business very well. We know the business, our commercial focus very well. And we know the wholesale and carrier side very well and we know how to leverage common assets across those three areas of customer focus and manage sales channels and marketing strategies for each of those three.

So if the asset is a strong solid network, whether its hybrid fiber coax, preferably fiber rich or even an operating legacy or a local exchange company, I think we would consider all three of those as potential options.

Unidentified Analyst

Recently AT&T divested some assets in Connecticut to Frontier, [inaudible] assets and given it wasn’t that contiguous with the rest of their plans, is there an opportunity within your portfolio that you consider as non-core, would be better to expand upon your contiguous footprint and maybe rationalize the non-contiguous, given that you operate across those five states?

Steven L. Childers

Well, it wouldn’t be those five states you’d pick if you are starting from scratch. I realize when you look at them on a map but if you consider our acquisition screening process it starts with a solid base of asset and an environment where community focus can be leveraged as a marketing tool and create sales opportunities.

All those markets and states that we’re in fit that model. And we take our functional organization approach, our experience in making sense out of technology for our customers and leverage that. So I think the key -- so to answer your question would we be divesting of any states, no. We’re not interested in doing that. We like the diversity of the markets we have and think it fits well in our portfolio.

Would we look at other states? I think we would. But it will have to be a significant enough beachhead or of size that warranted turning it into a hub, a work center hub for us and while we would rationalize the back office and executive overhead functions we continue to keep an employment presence in all the markets that we serve even though we organize functionally and build economies of scale for our call centers where appropriate, we do keep our work center focused and stay involved in the areas we serve.

So a sizeable business of $60 million, $70 million, $100 million in revenue we would look at [a stake in other states] [ph]. Otherwise smaller fiber assets we would probably be more apt to be interested in something contiguous versus [distant] [ph].

Unidentified Analyst

Can you talk about the network infrastructure and essentially the breakdown of the plant by access technology, you have copper, or coax, fiber, or the percentages therein, of [inaudible] and the speed capabilities and cost to your plant on average?

Steven L. Childers

Well that’s kind of a multi-segment question. So let me start first with different technologies as disparate as it may seem we become, in our acquisition interest, as I just mentioned, a lot less singular focused and that’s really based on the fact that most things have directionally ended up IP-oriented. And so with consumer triple-play being more and more IP-based, whether it’s voice, video or Internet access, commercial enterprise as the second customer route being metro Ethernet oriented and then the carrier being more native ease in that oriented for wireless backhaul or university or large institutional type customers that we serve.

The real fundamental common theme is that the network assets be robust and in good condition. So whether it’s preferably fiber and so any fiber asset as long as it can be leveraged across at least two of those customer groups will be of interest to us. And our experience with that technology has allowed us to see how we maximize bandwidth to consumers or to businesses even it’s over copper and I’ll give you an example. 80% of our base is accessible with our video product and with 20 megabits or better speed. 60%, we can get 50 megabits to and it’s not a long [path] [ph] or a huge hurdle to get 100 meg or even a gig to someone in our suburban markets who might have that requirement.

So is there more a limiting factor in the hybrid fiber coax area? Yes, from a shared bandwidth perspective there is, but we’re getting in front of that curve. We are very good at traffic management, very good at capacity measurements and we’re taking that experience, applying it to that network and pushing it more and more towards 100% digital. So I would say you would see a continued growth as customer demand grows in our deployment of capacity augmentation but we’ve been successful in staying in front of that curve for our entire history.

Unidentified Analyst

And what you’ve seen as the sweet spot for broadband demand from a customer perspective and if you could you explore some of the drivers of future data demand. So we’ve seen over-the-top video adoption but there is ultrahigh-def television, is there other things out there that you can see the usage curve increase more?

Steven L. Childers

I think the sweet spot is if you are talking in terms of consumption, the sweet spot continues to move. We saw back in 2009 or ’10 with the Netflix all you could eat product launch which they backed a little bit away from, a huge increase in bandwidth consumption in October-November timeframe and every holiday season we see an increase in the IP-enabled devices across our footprint because we can actually, we have visibility to how many devices are hanging off any one particular modem in a home or business.

And yet the average utilization in a home is roughly 3.5 megabit and peaks to around 6 meg in some of the more highly utilized congested areas from a density perspective. And so it’s been easy, reasonable I should say, for us to stay in front of the use curve and one of the ways that we manage that is watching the demand closely and staying in the two-thirds or 56% utilization max before we augment capacity.

Secondly we continue to cache content close to our customers and so frequently visited sites we automatically store and refresh as close to the neighborhood node or the area switch or big iron host which, that serves this data community.

And so that served to help us manage our Internet [train] [ph] capacity demand, but in particular I think the demand is going to be based on additional high-def devices you mentioned very high def TVs, 4K I think is out currently and there may be 5K because the CES is coming on I don’t know. But a lot of that utilizes time-shifted content which is more of a download than a streaming high-def experience. And while that will evolve and demand for bandwidth will still grow I think we are well equipped with the tools to stay in front of that and to anticipate our customers’ needs and make sure we have product offering that meet those needs.

Unidentified Analyst

How much of the demand or the usage on your network is downstream versus upstream and is there any potential way to further segment your customer offering with tiered bandwidth to protect against the threat of over-the-top adoption.

Steven L. Childers

Well, it’s -- let me answer the first part of that. The downstream versus upstream continues to be roughly of 8 or 10 to 1 difference. If you see an average of 4.5 meg down then you are seeing half of -- obviously 4.5 gig down and you are seeing half a gig up or 4.5 meg down, half a meg up. And so that seems to be a natural tendency right now and there’s few exceptions where someone is producing some content on a local basis in a school library or medical services situation but that’s pretty much the rule of thumb. And we haven’t seen that change dramatically over the last couple of years.

I would say though the way that we deal with the tearing situation, have historically done it is by continuing to allow unlimited usage but throttle the speed for end users. So unlike a shared environment with cable modems every subscriber of ours can be controlled at whatever the subscription rate is. And so they can continuously use that and peg it out at three meg but if they only have a three meg product then that’s the speed that they are going to get. And that’s been our way of controlling the demand but also it’s been a way of informing our marketing organization on upsell opportunities because we can then take those customers that have the three pegs and upgrade them to 10, 20 or 50 meg.

Unidentified Analyst

And just one question then about Google and their investments in parts of Kansas City what level of overlap is there with their SureWest plant and what type of competitive reaction has there been in the marketplace from some of their price fee offerings and their pricing?

Steven L. Childers

We have -- we get this question often and there is the least overlapping customer we have. And yet like any other competitor we watch them and we have interest in them and we take them seriously but despite having very little overlap with them, it gets a lot of attention. There is roughly 2,500 homes where there is overlap. We’ve probably seen a couple of 100 transition in some cases to Google and back to us.

It’s a very self installed oriented experience and so it takes a fairly tech savvy person. And we are consultative sales process in terms of our strategy and like I mentioned earlier we make sense out of technology for our customer. So our retention tool and competitive advantage and differentiator has been our service relationship with our customers, our single point of contact for issue resolution and that continues to work well for us.

Unidentified Analyst

And following the SureWest acquisition you’ve got much more exposure to IPTV across your network plant. How do you balance the rising programming costs in competition with the large scale cable companies?

Steven L. Childers

We buy roughly 75% of our programming from the MTTC through a co-op relationship and we’re passing more of those cost increases through now than we ever have to our subscribers. But at the same time we’ve been able to deal with the challenging increase in programming cost because our retention continuous to improve and our trend continues to go even lower than the industry leading averages we maintained.

So we feel while the programming costs are still way too much of a percentage of the revenue that we can keep our margins fairly flat and share more of that burden with our end user than we have in the past.

Unidentified Analyst

We’ve seen IPTV penetration like broadband penetration to a degree across your footprint. What are the obstacles there to accelerating growth are there any short-term impediments and what’s your target for penetration over the next couple of years with that product?

Steven L. Childers

Yeah I don’t see there any really structural impediments and it’s interesting because to me it’s fairly logical that IPTV penetrations will be less than broadband and we started with IPTV or a broadcast video product back in the mid-2000, 2004, 2005 timeframe although we were experimenting with it early 2003 and we started with Internet broadband deployment in the 1999-2000. So it’s got a lead there. It’s a more diversely used product, broadband Internet. It’s a little closer to just the utility than entertainment -- broadcast video.

So I would see penetration of Internet or broadband being in mid 40s as a reasonable target and we’re there in some of the legacy neighborhoods where they’ve been less competitive because of our robustness in terms of the product offering in our network assets. On a TV side we think that mid-30% penetration is where we would stabilize.

In fact some of our earlier markets are in the low 40s. In terms of penetration that’s where we own the development from the point it was opened up and we’re at an even entry level with any other competitor where we’ve over built we’ve had some of our earlier markets from the 2005 timeframe in the mid 30% range and some of our latter market are still in the single-digits. So the way we look at it is continued upside opportunity for our consumer business in those areas where we haven’t exceeded the 30% threshold.

Unidentified Analyst

Recently we’ve seen more efforts from the wireless industry, Sprint and [Dish] are driving their fixed wireless network. You see any perceived threat from LTE as a threat to the fixed home product.

Steven L. Childers

I think for those who’ve followed our history we hedge our bets with wireless relationship on both sides of that equation. And so while LTE may for the very low end customer be a good solution it’s going to be low speed, lower speed than what you can get from a fiber node or even a bonded copper option that we provide. And I think it will be three, five years before that gets a lot of traction as networks are built out and the wireless industry gets their hands around whether they are going to continue to charge for usage or allow unlimited and choke the speed.

But as that grows with our wholesale and carrier customer focus one of those three groups I mentioned earlier we’re going to continue to connect sites, we’re going to continue to use that fiber to the tower as a way to enter business or commercial opportunities and build out the end use and consumers where it makes sense.

So I think it is a competitive threat on the very low end of the broadband market but it’s also an opportunity for us.

Unidentified Analyst

And given the speed capabilities of your plants, can you update us on the types of service offerings that you are selling to business customers, now you’re experiencing the pressure from cable increasingly trying to get into that product?

Steven L. Childers

The fiber-based inventories in that product that we offer starts as small as 1 meg or 1.5, is a historical bandwidth number but many customers are looking at a 10 meg product these days and we have customers on as high as 100 meg service and a few very large customers in some more urban markets that are aggregating 100 meg service agreements with us for datacenter and multi locations, hubbing of their own network so we are essentially a carrier provider for them.

So it really depends on the applications, it depends on the customer, it depends on whether there is single location and how data intensive their usage is. But it all starts with a metro Ethernet foundation and we are there on those other services as the needs appropriate.

Unidentified Analyst

Can you try and size how much of your revenue is created from that business customer today?

Steven L. Childers

The way, we don’t break it out by customer group but the way to think about it would be that 80% of our revenue is broadband or potentially broadband or commercial oriented. So we’ve continued to migrate the business both through acquisitions and our organic focus to a broadband business if you will.

Within that 80% you probably have half of that consumer oriented, may be a little bit less than half around 35% and then the rest of that -- may be 40% of that and then the rest of that if you will that’s commercial or carrier oriented and that includes access relationships that are fiber interconnections because of our partnership. So across Texas for example 2,500 miles transport network and the support we provide there for wireless companies in connecting not only to their towers but the mid source.

Unidentified Analyst

Can you provide some details or specifics around wireless backhaul initiatives and the size of the opportunity within your footprint?

Steven L. Childers

Sure, our footprint with respect to wireless backhaul is larger than our legacy or local change territory if you will. And probably historically while some might have anticipated that’s where your biggest opportunity was and for some of our colleagues in the industry that may be true but our network expands because of the legacy CLEC businesses that we acquired as well as the fiber transport networks that support our multiple state. It provides an opportunity for good solid growth that we’ve got 785 sites currently under contract.

About 180 of those are still in the pipeline and our last quarter with 60 new sites was one of our largest quarters yet and I keep thinking that’s going to trend down and we haven’t seen the end of that opportunity yet from what our wholesale and carrier fleet tells us. So we still think there is upside in that number.

Unidentified Analyst

You mentioned earlier that you hedge your bets on the wireless side. Maybe can you describe your relationship with Verizon Wireless partnership and how that relationship between the performance of Verizon at the Verizon level compared with the degree of cash flow that comes out of that entity?

Steven L. Childers

We are a minority partner in wireless partnerships with Verizon that came from our acquisitions, mainly Texas and Pennsylvania. And essentially in the case of Texas we have 24% of the assets and Verizon been careful to maintain 51% so they can control it. But the benefit for us even though we only have a minority interest in Pennsylvania in that metro partnership, I think we’ve got 2% or 3%. But the benefit for us has been they are good properties, they produced a good cash flow this past year, last LTM of third quarter was in the $33.7 million run rate range.

We’ve seen historically a 10% to 12% growth in that dividend and we’re on the right side of the dividend policy with Verizon in light of the things they emphasize on whether its wireless expansion or the Vodafone transaction they did, to get dividend to the parent, they have the dividend our pro rata portion of that, most of the LTE investment it’s not all of it’s behind them for the markets that -- in which we’re a partner.

And so we expect some continued cash flow growth beyond the roughly $34 million that we’re seeing coming out of 2013.

Unidentified Analyst

Should we think of that as comparable to your historical rates going forward is that a fair assessment?

Steven L. Childers

I think that’s a fair assessment, if not maybe even a little stronger.

Unidentified Analyst

And currently there is bit of elevated capital intensiveness in the businesses -- your investment in the SureWest plant, where should we expect that to level out overtime once those fiber investments begin to slow?

Steven L. Childers

Well, if you look historically SureWest for example was in the 20% plus of revenue in terms of their capital investment. We’ve historically been in the 10% to 12%, highest 13% and right now we are in the 16%, 17% range. I don’t know that we’ll get quickly back down to the 10% to 12% range but it’s very possible. We’ll spend less capital and we predicted synergies in the capital investment strategy and we’ll realize that without giving specific guidance we’ll realize that in 2014. We did realize it in ’13.

And so I think the way to think about it would be continued capital reduction and reasonable continued investment in success-based opportunities and we think there is room in that because these were well funded, well supported assets. So we’re not starting with a retooling of a whole bunch of new technology.

Unidentified Analyst

On your financial leverage net debt-to-EBITDA has been in the low to mid four times range for period of time can you update us on what is your target financial leverage range and can you expect to achieve that leverage?

Steven L. Childers

I can’t give you specific timeline but I can say that we would like to be go forth and organically feel very comfortable that’s much more over the next couple of years. But we also look with the conclusion of the integration process with SureWest and our interest in continuing to be acquisitive, we look at acquisition opportunity as an opportunity to improve the balance sheet. We won’t do a deal unless it meets our criteria and so we’re not in a hurry to do something just for balance sheet reasons but that will certainly be a factor in any deal we look at.

Unidentified Analyst

Would be willing to raise leverage in the short-term to facilitate a deal?

Steven L. Childers

Most likely not. It has to be really strong, I can never say never but it has to be something that was so compelling that the market would see the logic without a lot of description but most likely not.

Unidentified Analyst

Any questions from the audience?

Question-and-Answer Session

Unidentified Analyst

Yeah, can you comment on access line declines and I think the most recent quarter you were down about 4%. Do you see going forward, do you see that’s speeding up, slowing down in light of everything else that’s going on I think someone mentioned LTE and fixed line wirelesses out there, speed is a factor. So can you comment on that?

Steven L. Childers

Yes historically, again that 4% would be an annualized run rate versus specific quarter number. We’ve been ahead of our peers or at least fairly solid if not the best of the bunch but our focus has really produced that result of lower access line loss with our bundles and a portion of that has actually been self-inflicted because we do transition some customers to an IP-based voice product where the features of the unified messaging platform for our business customers for example better meet their need.

But yet even with that and I would have said I expect this to be higher in 2013 even with that our marketing team tells me that they are fairly comfortable that we’ll stay in the four, five range and that even more of that going forward will be cannibalization of our own. So the revenue opportunity if not neutral will be an upside as we add more features and services to that. But I think if it grows beyond 4% and remember it’s on a smaller base of course because the law of averages obviously, if it grows from a percentage perspective I think it will be a result of self-inflicted cannibalization to our VOIP product.

But I don’t expect to see the fixed wireless, with the saturation of wireless phones everywhere, I don’t expect to see that to have a huge impact.

Unidentified Analyst

Earlier you made a comment about some of your customers switching to Google VOIP and then switching back what would cause the customer to switched back from Google fiber?

Steven L. Childers

In our experience and this is only what the customers angrily have said to us in the feedback we’ve gotten as I have done my rides with technicians and been in the field what we’ve heard is it’s more effort to use the service. When there is issue it’s harder to solve the problem. And so one comment this is anecdotal was if it’s free, it’s only good if it works. And yet we know that they will get those bugs worked out. We know they are very viable strong service provider in the areas that are their core focus.

So we don’t take for granted those I mean any time you are new into a market there is going to be some challenges. But we also know strategically that our service focus and complicated approach to selling services to customers continues to work well for us and we think that will continue to work well in Kansas city.

Unidentified Analyst

May be one last question will be on the SureWest acquisition is mostly behind you. How would you rate Consolidated’s ability grow revenue on a go-forward basis?

Steven L. Childers

Organically we feel we’re close to that. Let me answer the question this way. We feel good about our ability to grow revenue. The headwinds that we face are like any other of our colleagues in the industry, it’s the regulatory pressure and what happens with the universal service funding. We are very active in all those fronts. So we can hopefully predict it as well as anyone, but the ability to grow revenue if all those things stay equal we feel good about.

Access line loss we’ve offset for years now, keeping revenue relatively flat if not eking out little bit of growth. I think the real uncertainty that we face and it will short lived is when the SEC implement phase 2 of the CAP and universal service shift from traditional voice to broadband and then we’ll take a short term hit on that and also very confident in our ability to outgrow subsequent changes because there are typically access line relays.

Unidentified Analyst

That’s great. Thanks very much for your time.

Steven L. Childers

Thank you very much. Good afternoon and thanks for your support and attention with Consolidated.

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