Sprint's (S) Management Presents at Deutsche Bank's 24th Annual Leveraged Finance Conference (Transcript)

| About: Sprint Corporation (S)

Sprint Corporation (NYSE:S)

Deutsche Bank’s 24th Annual Leveraged Finance Conference Call

September 28, 2016 2:20 p.m. ET

Executives

Tarek Robbiati - CFO

Analysts

Unidentified Company Representative

Thanks everyone. Thanks for coming to the presentation slot. Actually it will be just more like a Q&A session for Sprint. With me here on -- at the table today is the company's Chief Financial Officer, Tarek Robbiati and I want to thank all of you guys again for coming and hanging in there for day two. I know it is a grind, lots of presentations you sat through, so we appreciate everyone's attendance. And thanks very much to Sprint for making the effort to coming out and spending some time with us.

So I thought maybe a good way to start was if you could talk a little bit about the release you had about recently on the iPhone 7 where you talked about the numbers being well in excess of some of the subscriber trends that you saw around the 6. And I think an interesting question that has come up was; one, how much of that is the internal upgrades versus new growth opportunities, and how much of it is being driven by just the difference in subscriber behavior about the way people used to sort of go and upgrade handsets before we had things like leasing and EIP and some of the other things that may actually facilitate more activity than there was under the subsidy model.

Tarek Robbiati

I think you can hear me from here. Thank you for asking the question. I think it's a combination of factors that have come into the play so far with respect to the iPhone 7. Remember, we did drive the behavior of customers by launching programs such as iPhone Forever. And these programs are designed to achieve several purposes, but the first one is to make sure that customers stay with us as they consider the next generation of the phone. And this has been done in very close collaboration with Apple, and we're pretty happy with this. So no doubt that you see a number of customers that a year ago subscribed to iPhone Forever wanting to upgrade to the next iPhone model. So that is part of the equation. But our orders -- preorders ahead of the launch were strong as we mentioned in our press release. And right now, I think the overarching question is whether these orders are going to be back ordered for a long period of time. There is an element of the orders that is backordered because it's a matter of supply and demand, and but so far so good. We see that the situation evolves, and over time these orders will be fulfilled during the course of the rest of the month which is pretty much over and October. So we feel good about what's going on with the iPhone 7.

Unidentified Company Representative

And then as we talk a little bit more about the sub base, one of the questions that has come up on the past few calls has been around prepaid, churn’s been up a bit over the past year. You've lost some customers in each quarter, some of it’s competitive dynamics, some of it is intentional in terms of where you focused prepaid across your various platforms. Can you talk a little bit more about what you think the value proposition is for Sprint in prepaid and what you need to do to kind of stabilize the sub results in that area?

Tarek Robbiati

Yes certainly. So remember where we started from a couple of years ago when Marcelo started as a new CEO of Sprint. Sprint in 2014 was a different company, or today we’re a different company than we were back then. We were facing a situation where we had a very high churn in our postpaid business and we did everything we could to rein to churn in through a number of measures, including the introduction of leasing but also improving our network performance and so on and so forth. So it may be fair to say that we didn't dedicate as much attention to prepaid as we would like. But it was a matter of focusing and stopping the time the bleeding in 2014 around the postpaid business that represents 70% of what we do. But we now recognize that two things -- we recognize and we always knew it that prepaid is an incredibly important business for us. It's incredibly important and everything we miss on prepaid dilutes the growth that we see in postpaid, so we absolutely have to address that.

And second, we also recognize that prepaid is not that different from postpaid, it's really all around the way customers pay us, and the way their credit truly functions and what the credit risk underlying the prepaid customers is. So we feel that our brands, whether it's Boost, whether it’s Virgin, are valuable and we feel that we have to rejuvenate the brands and dedicate as much focus on prepaid and we have done for the past 24 months on postpaid. We have put in place a new management, we have great opportunities that we see in the prepaid business. And we have to rein in churn which is to date higher than we would like it to be.

Unidentified Company Representative

And you mentioned postpaid there and the improvements that you’ve made. I wanted to talk a little bit about postpaid, the post-paid base. When you look at the significant turnaround you've had in postpaid phones or even postpaid in general, because even you faced some headwinds from some tablets that kind of rolled off at earlier points during the year. A lot of it's being driven by improvements in churn, and we're going to talk a little bit about the network in a bit. But can you talk a little bit about how much more you see in terms of being able to continue to drive churn down and capture more of your gross adds into net adds?

Tarek Robbiati

Yeah, so on churn, we finished the first quarter on the handset churn better than what the Street expected. We posted a churn level at the end of the first quarter of 1.39%. You probably know that, but we do feel that this isn't good enough. I think there is further upside from churn. This will be coming more evident as we continue to improve all the reasons for customers to stay with us. So a number of things have gone into the thinking of how we can reduce churn. The first is the network. We've improved our network quite dramatically with the rollout of 2.5 spectrum. Right now, we have rolled it in to the extent that it covers 70% of 300 million POP that we cover. We still have further upside from improving the experience and the performance of the network either by way of coverage or by way of actual speed.

And second, we have also worked a lot at improving the perception that people had around our network and that had to do with the marketing campaign that we've launched back in June-July with Paul Marcarelli which has become our spokesman as he officially defected from another carrier. And so we're very pleased with that campaign, because what it actually pointed out is that there isn't much of a difference between network performance today. We don't profess to have yet the best network but we do feel that our network is good and certainly does not justify a very large premium that the competitive providers are actually charging, so the message has shifted and rather than saying best network, we shifted the messaging to say why pay more. And this started to resonate with consumers in the United States and we're pretty happy about that.

So as the perception of the network improves and the actual performance of the network improves and this is really visible through all the awards that we've been winning from various parties, whether you look at Nielsen or whether you look at J.D. Powers or whether you look at Good Metrics, they all concur in saying that the Sprint network has improved. And so as the network improves and our marketing message resonates more with customers, this brings in more customers through the front door and the customers who are with us benefit from the improved performance as well. So churn will have to come down. We expect it to come down from the 1.39% that we've witnessed in the first quarter, we see further upside from there. Where that will take us is yet to be seen but I feel there is further upside there for the quarters and years to come.

Unidentified Company Representative

So that's a good segue to talk about the network a little bit, because you’ve obviously spent a lot of time on it. You mentioned you had roughly 70% coverage of 2.5. If we were to look at the churn performance on a market by market basis, is it really that clear that when you go in and you sort of overlay the 2.5 in the macro environment, you start to see the radical changes in network performance and you can almost mirror that to the changes in churn?

Tarek Robbiati

There is a very strong correlation between our network performance and the churn. There is no doubt people churn you first and foremost because of the network, 50% of the reasons why customer churn are network related. 30% to 35% are price related and 15% to 20% are service related. So we are competitive on price with unlimited offers, so that is really good. The network is improving and the service we continuously improve. So customers don't really know whether they are in 2.5. They don't really care. What they really want to see is a right customer experience and it's true that yes, if you roll out 2.5 and you are able to deliver a carrier aggregation capability, then the customer experience on our network becomes really good. And that's what the customer sees. And as we roll out more of different capabilities in the network, 2.5 spectrum carrier aggregation, beamforming, and when we densify our network, all of that is conducive to improving the customer experience and making sure that customers stay with us.

Unidentified Company Representative

So can we talk a little bit about carrier aggregation for a second? That's been mentioned by T-Mobile earlier today, Verizon has talked about it. To the best of my understanding a lot of what you're doing is intra-band carrier agg with 2.5, and the messages that we're starting to hear from some of the other carriers is a lot about inter-band and you do have some other bands, you've got some low band 800 from the Nextel transaction, you've got some other PCS. How far away are we from seeing you guys do a lot more on the inter-band carrier aggregation and how big of a difference is that going to be able to make to be able to use some lower band spectrum to get around some of the propagation issues with the 2.5?

Tarek Robbiati

So we can do both. The good news about Sprint is that we can do intra-band and inter-band carrier aggregation. We choose to do by and large intra-band because we're building a high capacity network for the future. And really our network strategy is fairly obvious and it's every operator’s network strategy is relative as to the position they start with. So some operators do inter-band carrier aggregation because they don't have enough band size in the one band where they could do intra-band carrier aggregation. So when you look at spectrum efficiency for the new world -- the new world of high data capacity, spectrum efficiency is proven to be better when you use high frequency spectrum than low frequency spectrum. This is physics. It's undeniable and that's the truth.

So the ability that an operator has to put in and deploy a lot of spectrum on air within a single band is going to improve the customer experience if that band is really at the higher end of the spectrum ranges. So band sizes in this world, our industry matter. Remember and it's an unstoppable trend, data traffic on wireless network doubles every 18 months. You can choose to have the wind blow in your face or rather have this wind blow in my back because this trend is unstoppable, we've seen it in Asia. We've seen it -- I've seen it personally in Australia. In Japan, it’s the same story, we see it with our parent company SoftBank and we're seeing it here in the U.S. So when networks are deployed, they have to be deployed strategically to build for capacity in a world where data consumption doubles every 18 months. And what's behind it is the consumption of video and that I presume you all know but it's a very very strong trend. And that world of high data capacity on air can only be realized by densifying networks and putting high frequency spectrum on air and deploying more high frequency spectrum for every customer than any other operator can do. And this is our strategy. So that's why we feel very strongly about our spectrum position overall.

And when you fast forward the picture towards the world of 5G. What is 5G? 5G is a combination of different things, one of which is carrier aggregation, we already do that. The other one is beamforming which is the ability to direct the signal specifically where the consumption is taking place through a specific device at a specific location, we do that. Massive MIMO is something that we are working on like every other carrier in the industry is working on. And then you have to have milli-electric [ph] wave spectrum that is talked about by everybody in the industry. And in our mind, 2.5G is going to be to 5G what 800 is to the 4G world. And so when you think about it in those terms, building a high capacity network has to start by putting as much high frequency spectrum on air as you possibly can.

Unidentified Company Representative

Licensed. Licensed high frequency spectrum, like your 2.5 you're saying?

Tarek Robbiati

That's right. But then also you know millimeter-wave spectrum as it comes available. So the debate between intra-band and inter-band is a bit false in my mind. You really have to look at it and say, if I'm an operator and I have a certain spectrum position I'm going to leverage all the spectrum I have to be able to deliver to the customer the best customer experience and more spectrum generically is better than less and band size matters in this world of high data consumption which is rising exponentially every 18 months.

Unidentified Company Representative

And was that part of the rationale behind why -- among other reasons why you were not participating in the current auction which was obviously low band focused? It sounds like the future is going to be the core of the network will be 2.5 and things like millimeter and maybe even centimeter wave technologies will wind up being the offload the backhaul, a lot of the sort of congestion avoidance features?

Tarek Robbiati

Yeah, and thank you for asking this. I mean, you know, a year ago when I joined there was a speculation that we did not go for putting our names for the 600 megahertz auction because we didn't have the liquidity to do it. And that is not at all why we made the decision. It wasn't about liquidity, it's about network strategy. And in the world of 5G, you need to have high frequency spectrum. Why bid for low frequency spectrum? We have plenty of it at 800 and 1900 and that's enough. And the new world will be also involving lower frequency spectrum for propagation basically for voice, really important to still have access to 800 spectrum and 1900 spectrum. But we don't want to be buying just for the spectrum. We are building a network for the future. And we have plenty of that spectrum that we can harness and we intend to do so.

Unidentified Company Representative

So how much of the 2.5 are you using in your sort of most congested heaviest subscriber usage market? How much of that do you actually have deployed at this point?

Tarek Robbiati

So like I said a moment ago, 70% of our 300 POP is covered by 2.5. So there is further room for improvement there. And I think we'll put eventually all our spectrum holdings on air over time of course as we see fit, really important we do so. Remember also that what starts to matter more is the downlink portion of the spectrum as opposed to the uplink portion of the spectrum. Because unless you are an avid peer to peer user you don't lose very much the uplink components of your spectrum. So it's really interesting to see the ratios between usage of uplink versus downlink. The ratio is tilting in favor of downlink because of the change that we see in usage pattern around video. And therefore it's really important to have a band size that is large enough to cater for that trend. And we're pretty happy with right now seeing that trend develop.

Unidentified Company Representative

And maybe just to take a one more step further on the network side, small cell has been a big point of debate in the market, you guys came out and talked about roughly $3 billion type CapEx strategy which sounds like it's primarily focused around small cell deployment. Can you just talk a little bit about where you are in the process with small cell? I think you’ve talked about an RFP that's been out there and working through the various municipality and other regulatory approvals you need. How far away are we from seeing and hearing something more material on how far along small cell is?

Tarek Robbiati

Yes. So the word that we will all hear about in the industry for the next several years is densification. And why is this? It's because again you go back to basics, which is building a high capacity network requires high frequency spectrum, that high frequency spectrum carries a lot of traffic but does not travel very far. Therefore you need to densify your network. And what we embarked on is our densification optimization program which is there to supplement the capacity that we have built through Network Vision with towers. So we are building around towers to add capacity with small cell sites. That process that you're referring to requires submission of permits to the various municipalities where we deploy our network and every municipality is different. Every municipality has its process and the permitting is taking the time it takes in every jurisdiction, and so far so good. We see good progress with the permits and we are getting permits back in the amount that we were expecting. But as you want to see the network being deployed, I have to tell you we're not deploying the network one small cell site at the time because that it wouldn’t be really effective. We need to receive a critical mass of permits in every municipality to start to deploy the network by cluster and that is a program that will unfold over several quarters from now on. So we are pleased with the progress, we will approach a point in time where it would be visible in specific municipalities and we will certainly showcase this in due course.

Unidentified Company Representative

And I guess there was a lot of debate around the CapEx guidance you provided. I think some of the skeptics were saying that in essence you were sort of starving the network of needed CapEx and I think you guys have tried talking about why your CapEx spend is different and where it's going to be focused. Can you just remind us on sort of the core thesis behind the CapEx spend and its sustainability given what you want to achieve with the network?

Tarek Robbiati

So I didn’t mean to ignore that, that was part of your prior question too. Thanks for reminding me about it. So remember our starting point. We spent and historically Sprint has had the highest CapEx to sales ratio of the industry. With Network Vision we spent a fair bit of money modernizing our tower infrastructure. And so we are still benefiting from that historic investment and this is really a positive walking into fiscal year ‘16 and that's why our CapEx in part was lower in the first quarter of fiscal year ‘16.

The second part is the fact that the permitting process had to take place and so we knew that we had to kickstart the permitting process and so far so good on that front. The third aspect of it is that our densification optimization program like I said a moment ago intends to build infrastructure around the towers. The cost of those cell sites, small cell site is a fraction of the cost of the towers. So it depends on how many cell sites you need to build in every geography but a cell site is on average costing 20% the cost of a tower. So you need to spend less per small cite as you roll out some of them. So the spend is more scattered over time because of the permitting and the unit dollars that you spend are lower and the two effects combined explain why we guided the market towards the 3 billion mark for this fiscal year. We said less than 3 billion. So let’s not forget the words less than when we talk about this. But so far we're happy with how it's progressing and the network never ever stops from morphing. It's a important consideration to be had. We don't build networks statically and the reason why you don't do that statically is because the customer usage pattern evolves and customer travel to different neighborhoods as urbanization takes place.

And we have also the fourth leg of our strategy. We have the ability to truly understand the usage of a specific phone with big data and deploying our network in a surgical manner where we see that usage evolving. So it will take a bit of time to densify our network but we believe this is the right thing to do strategically for the long run.

Unidentified Company Representative

And as we sort of think about what the future of the network will be, 5G is certainly a part of that, and I think there's been a lot of talk about things like the Internet of Things and other connectivity that is going to exist. How is the small cell network being sort of designed to kind of take advantage of the future next layer of connectivity over and above the average 300 and some odd million cell phones that there are that are out there and connected right now?

Tarek Robbiati

So the world of Internet of Things is a world where in simple terms everything is always on, right? And that's pretty much the best -- the simplest way I can summarize it for you. And if you think about that world, then you have four core metrics that will start to matter to different degrees, some already matter. So dropped calls is a first metric and that matters a lot. No one likes to have a dropped call, we're doing fine already on this one where we've overtaken AT&T for a couple of quarters in a row now in terms of dropped call performance according to Good Metrics, so that's good.

The second metric that truly matters is time on LTE and this is an expression of all how broad your coverage is, and this metric matters quite a lot. So you need in the IoT world to have a lot of time on LTE because this is where you get the best experience. The third metric that truly matters is the speed of the connection because everything needs to be always connected and that is a measure that we can track off. And the fourth one is the network availability and how quickly you can establish a data session, because if everything gets connected all the time whether it's a car or a fridge or a mobile phone, you really need to get the network session established almost in a snappy fashion very very quickly. So this new world requires a network to be incredibly dense and having a lot of capacity to very quickly establish the session and maintaining that session of communication as you see it. So we are getting ready for IoT. There's a lot of work that we're doing also with our parent SoftBank for this. And it's an integral part of our plan.

Unidentified Company Representative

So let's pivot here a little bit and talk about the balance sheet capital structure and liquidity. You guys made a lot of progress this year on that front. I think you surprised some in the market with your creativity in terms of what you've been able to get done. First, let's just talk about MLS. MLS is essentially your way of sort of taking the handset piece of the business and sort of moving it off and kind of focusing Sprint on the services side. Are you still confident in sort of the three to four tranches as per year, the kind of 3 billion to 4 billion annually and do you think that changes at all around things like iconic device launches where you might see more faster more rapid uptick of devices around periods like this?

Tarek Robbiati

Well, thanks for saying that. I would much rather talk about finance and talk about the network [indiscernible] so let’s talk about finance now. So MLS was a very important part of our strategy and I joined Sprint a year ago, this time last year we were downgraded by Moody’s. I had just started in my new role and I thought this was a wonderful welcome sign for me. And – but the rationale behind that was – is fairly simple and straightforward and. It was right at the time, it was you, Sprint, have maturities falling, you have liquidity that isn't sufficient in their view to cover those maturities, you have to tap into the high yield market, the high yield market is getting closed for you and therefore we downgrade you. And that logic held but there's one thing that was missing from it was we do have assets. And we do have assets and we can raise money against those assets. That's where MLS came in and we wanted to prove that point that we could raise money particularly to cater to the increasing working capital drag that smartphones trigger for every telco operator.

So we started raising money with MLS back in November and we did another tranche back in April. So we did two tranches, we raised about $1.3 billion of cash in each, we received a cash advance of about 1.1 billion, there is a deferred consideration we will receive in the end as you know. And this has helped neutralizing the working capital drag that we have on handsets. The incredible thing about our industry is that until the advent of smartphones the capital intensity of our industry was driven more by the network than by the mobile phone devices themselves. So this has shifted and this has shifted since ’07, ’08 with the launch of the iPhone and other smartphones. And so we spend about $10 billion on devices each year and you know call it 5 billion on the network each year on average. So then when you look at the network spend it lasts us a longer period of time than the handset spend. So for every dollar that we spend on the network we have to spend about $8 on handsets, right? That’s the capital intensity and how it has shifted dramatically.

And so when you look at this you say we have to put in a structure that neutralizes that working capital drag and that's what we have accomplished with MLS. That said the structure is quite unique and creative because it combines credit risk with asset risk. And we got cash against the value of the assets that we were putting in the structure, that structure will evolve. It's always been our intention to have that structure evolved towards being closer to the securitization markets. We've seen some of our competitors tapping into the securitization market, we feel this is a great idea. We actually were on the bandwagon. And we will evolve our MLS structures to tap into the securitization market. So overall we will continue to deploy asset backed financing to fund Sprint and there are other plans that we have in field.

Unidentified Company Representative

Can we talk a little bit, to the extent, you can about Spectrum LeaseCo? After you did MLS you did some other stuff, you did a Network LeaseCo which was really ran equipment yet you got an unsecured bridge in place that kind of bridges you to something like Spectrum LeaseCo. What do we know enough now about Spectrum LeaseCo to kind of put a framework around what the expectation should be of folks around, kind of how you think about the sizing of that, how much spectrum you would think would be available? Is it going to be a nationwide block, put some sort of framework around if possible?

Tarek Robbiati

Yes. So MLS was first and you know we did Network LeaseCo back in April as well, we built also further liquidity by securing a bridge from our banks which helps us in the short term. It was important and it's important to understand the sequence here. We really needed liquidity upfront to take care of our working capital drag. I wanted back in March-April to address the 2016 maturities that fall due to – March ’17 maturities that fall due and I wanted to do that early on because we were very much under pressure by the markets to address this issue. And we knew and we always said back then that between Network LeaseCo and Spectrum LeaseCo we would do somewhere around $3 billion to $5 billion of asset backed financing. We did a Network LeaseCo and that you know and we also flagged that in doing Spectrum LeaseCo we would be putting small quantity of spectrum in a structure and raise money against it. And in the sequence I wanted to do Spectrum LeaseCo later on because the most expensive dollar you raise is the first dollar. As the performance of the company improved and we had a great first quarter and our performance continues to improve, our cost of capital starts to drop. And spectrum is really critical to the value of Sprint. We want to make sure that we have the right structure with Spectrum LeaseCo and we're on track to raise money with Spectrum LeaseCo before the end of the calendar year hopefully.

Unidentified Company Representative

And could you just again – with just a couple minutes remaining -- talk around your priorities for the balance sheet and the capital structure? I think you previously said that you intended to repay rather than refinance the maturities coming due within the current guidance period. As we look a little bit further out, obviously your cost to capital in the high yield market has come down a lot in the current calendar year. How do you think about the other levers now that you have available whether it's the secured market, the junior guarantee market or the straight unsecured market?

Tarek Robbiati

So we take things one step at a time and. But the broad theme that I want you to all walk away with is that we do not want to be dependent on any single particular form of financing to finance Sprint. It's important for us that we have a diversified financing strategy. And so we will use different types of source of financing whether it's high yield, whether it's asset backed lending or others that I'm not mentioning but -- to continue to finance our operations. And that's really important because now that we have shored up liquidity we're paying more attention at lowering our cost of capital and lowering our cost of debt. We pay every year around $2.3 billion of interest expense. It's a very high number and it stands in the way from us becoming pretax positive. You know, it's not talked a lot about in our – by the analysts who follow us but we do have a fair bit of operating losses on our balance sheet that we would like to monetize and realize the value for. We have $19.2 billion of notes at the end of the first quarter. So it's really important that we monetize this and the way to monetize this is over time reduce our cost of debt and that will take time because you know that, we have to repay those maturities as they fall due. Some of them are non-callable, the majority are non-callable. It's really important that we have sufficient liquidity to repay them and it's a gradual process that we are embarking on incremental over the next several quarters to reduce our cost of debt. But take away from me that the important thing is to diversify our source of financing and we will meet our obligations as they fall due.

Unidentified Company Representative

Great. Well, Tarek, with that we are just about out of time. But we thank you very much for coming.

Tarek Robbiati

Thank you for having me. Thank you very much.

Question-and-Answer Session

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