Sprint's (S) Management Presents at Bank of America Merrill Lynch Leveraged Finance Conference (Transcript)

| About: Sprint Corporation (S)

Sprint Corp. (NYSE:S)

Bank of America Merrill Lynch Leveraged Finance Conference

November 30, 2016 09:30 ET

Executives

Tarek Robbiati - CFO

Analysts

Ana Goshko - Bank of America Merrill Lynch

Ana Goshko

[Call starts abruptly]

Leveraged Finance Conference. Again, I'm Ana Goshko, I cover High-Yield Telecom and Technology and we're thrilled this morning to have Sprint with us. And from Sprint we have Tarek Robbiati, the Company's Chief Financial Officer. So -- because this is a pretty well-known story to most of you; we're going to do a full Q&A Session this morning, so I'll start up with a list of questions and then we'll be also be happy to open it up to the audience.

So Tarek, thank you very much for being with us.

Tarek Robbiati

Thank you, Ana, for having me.

Ana Goshko

Great. Before we launch into the questions, any opening comments for our investor audience this morning?

Tarek Robbiati

No, but I'm delighted to be here just like last year, last year was a very fruitful event for me. It was one of the first events, so I'm pretty fond of this event and coming back and interacting with you every year.

Ana Goshko

Okay, great. So we'll all train [ph] and do it. So let's start with subscriber trends and specifically postpaid trends. So we're in the thick of the holiday shopping season, just came out of the post-Thanksgiving weekend, can you provide us any update on either porting trends or anecdotally, what Sprint saw on their stores or in their channels, in October and November, and specifically as we entered the holiday gift and shopping season?

Tarek Robbiati

Yes, I mean this is traditionally a very active period with Black Friday and also Cyber Monday, it's almost like a preparation for the Christmas season. It was very intense for the industry, overall, a lot of marketing activity. So far we feel good about what happened for us during that period of time and it's in line with our expectations for the quarter.

Ana Goshko

Okay. And then, you know, obviously it's a very competitive world, this market and the U.S. and now that we're in this shopping season, how is Sprint trying to differentiate itself in the market?

Tarek Robbiati

So -- you know, the differentiation occurs overtime. As you've noticed, our message from a marketing standpoint has been evolving and will continue to evolve. Since Marcelo joined, about now -- two years almost, and our Central message first has been on price but even that has changed when we introduced the full market rally [ph] campaign or it was known as the full market rally [ph] campaign, I switched to Sprint. And the message is really, evolving because a lot of things are happening at Sprint. Our network is improving dramatically, very, very quickly and we got to a point where demonstrably our network is within a whisker from the competition, it's not the number one network yet but we are away. And so the message evolved to 'why pay more', 'why pay a 50% premium for 1% difference'. This started to resonate really well with our customers.

And also we are pretty pleased with the progress from a brand recognition standpoint because there has been a number of awards that have come our way, well known to you in the audience, JD Edwards Awards that we've received are very encouraging for our marketing and for our company. And moving forward, the emphasis on price will shift a little bit and will continue to evolve and we will emphasize different aspects of differentiated offering as we build a cracking network for the future.

Ana Goshko

Okay. And -- you know, as you seek to improve net ads, as you highlighted, price can drive gross ads but you also really want to make your customers stickier in other ways. So other than price, what do you believe has been working for Sprint to make the customers stickier and to reduce the churn?

Tarek Robbiati

So churn, as you know is usually there are three reasons why people leave you; one, and the most important one is the network. If network doesn't perform, 50% of the -- in 50% of the cases, that's the number one reason that customers sight for leaving you. The second reason is price and that's for about 30%, 35% of the reasons why customers churn. And then the third one is service. So our emphasis is really to ensure that we continue to retain and attract customers and minimize our churn. So we've done great deal of good progress, all the way upto the second quarter ended September. We continue to see further upside on churn, but there is always a seasonal factor, the third fiscal year quarter, this calendar year fourth quarter is a traditionally high churn quarter because you have many market decisions, given the marketing activity around Black Friday and Christmas.

So we do expect a little bit of a bump but that's perfectly in-line with our expectations and as we continue to evolve our product offering and our marketing, we are also enhancing the way we retain customers and upgrade them. So there has been a lot of emphasis, tremendous emphasis on digital capabilities at Sprint and everything we've done on our websites; I will invite you all to go and check our website, whether you look at them from our mobile phone or whether you look at them from a computer, you will see they have changed quite dramatically. And our app on the various application stores that you see has been rated very highly, and this is -- we have very good feedback from customers around service, right, and the service that we sort to provide is becoming more and more acknowledged at something that is a shift from the past and we are becoming a company that is easy to be doing business with.

Ana Goshko

Okay. There has been a see [ph] change in the industry over the last couple of years. So it was -- the movement from a traditional subsidized plans for consumers and to installment in the leasing. And you know, Sprint has in my view -- the lead interview in leasing phones to customers. So based on Sprint's experience to-date, I wanted to get your assessment of the pros and the cons of phone leasing, is churn lower for your leased customer base and how much is -- what is Sprint's commitment to continuing the program?

Tarek Robbiati

So leasing is a business that plays up overtime. You've got -- it's too early to call whether it has yielded material benefits on churn, you got to run through a cycle of about 24 month. But that cycle is -- we start to have good visibility about it and what stage they clear is that the fact that you are leasing a phone gives the opportunity to Sprint to have another engagement opportunity with customers at the end of the term. So that's a great, we're very happy to capitalize on. Are we committed to leasing in the long run? You know, we're flexible, we think that it's -- there is still a fair bit of opportunity there, let's see how our portfolio plays out in performance terms. There is a lot of different aspects that play into during the leasing portfolio. Surfaces to show you our flexibility -- we surfaces to say that we've stopped leasing Android phones back in early September 2016 and the reason why that is, it's because those phones don't hold their residual value well enough. And not good enough to register what we have in mind. So we stopped leasing Android phones and this goes into heart of why do leasing? Should leasing -- there is the central reason why companies embark on a leasing journey; it's because they see value in the second-hand market of a particular asset. And they have insight on what that second-hand value will look like. And so far so good, we monitor this very, very closely. I do that personally and it's looking quite positive for us.

Ana Goshko

Okay. And moving on just to overall service revenue trends; so Sprint has experience of decline in postpaid service revenue for numerous years and there has been numerous factor [ph]. So one, there was the period of subscriber loss, there was the move to the unsubsidized plans which we just touched on, and then there is this price competition. So two of these factors are becoming less of a headwinds as the companies returned to postpaid phone growth and you now have a majority of the base on an unsubsidized plan which really just leaves the question of ARPU and price competition. So most centrally, do you believe that Sprint can return to postpaid service revenue growth? And if so, what needs to happen?

Tarek Robbiati

Yes, so of course service revenue growth is very, very important to us and we will return to service revenue growth, it's a matter of quarters and not years. We still have to complete the transition away from subsidized plan to financed plans. Now 67% of our base is on financed plans, we still have according to our internal estimate, some 20%, 25% to go; not everything can be financed, there will always be an element of subsidized plans for certain customer groups. But that trend has to play out and that will continue to create a mix shift between services revenue and operating revenue as we know. But when you look at the total of our service revenue plus revenue from [indiscernible] and leasing, year-over-year I think that you would observe a 4% growth, we grew from $5.6 billion to $5.8 billion period-over-period. So the total revenue is growing, I'm not so much worried about the service revenue trend as it stands today because of this shift, and also we know that our marketing message is evolving, we have -- we know what's -- what we are selling and how we are loading on various price points and we are pretty pleased with the progress that we're seeing on that.

Ana Goshko

Okay. As Sprint had a lot of success with the 50% off promotions versus the competitors, but most of those are -- have been two year plan. So how you're going to handle the aspiration of those two year plans as prices potentially increase or should increase for customers that is -- likely a turn event. So what's the strategy with approaching that?

Tarek Robbiati

So we did telegraph very quickly and constantly to customers that this is a time limited promotion and after time period is over, we can expect a price increase. We're not concerned about -- how can I say, a real shock or a price shock as a result of the promotion ending. We have a number of plans that we can put customers on that are higher ARPU price point but there still are very competitive relative to whatever else exists in the marketplace. And so it's a matter for us of really managing that transition of customers from where they stand today on the promotional plans on to the plans that we have. And this goes back to what we were saying a moment ago around how do you upgrade customers and what capabilities do you deploy to enable an easy upgrade to the new plan, and the digital capabilities that we've deployed are very, very good step moving forward.

Ana Goshko

Okay. So will you be individually reaching out to customers? So -- I mean actually Sprint customer -- you're very good about telling me when my son is blowing through his daddy cap [ph], so thanks for that. But I think…

Tarek Robbiati

Yes, great on immediate plans by the way. And we have also family plans as well, and surely we can find a solution for that.

Ana Goshko

Great.

Tarek Robbiati

Sorry.

Ana Goshko

No, it's good. He actually -- he needs on that one, he doesn't need unlimited planks [ph] so he'd never do his homework. So -- but to the question of how you're going to manage the customer base through the expiration of the 50% promotions. Is this going to be really a case-by-case, I mean, an opportunity [ph] emailing and reaching out to customers and showing them their options?

Tarek Robbiati

All right, no doubt that you have to communicate with customers, and we do that constantly. I mean this is a necessity in our business, whether there was a promotion or not, you have to keep the dialogue going. And it's really, really, really important because customers tend to forget what goes on and then if they are surprised, they are very unforgiving. And it's not in our interest to surprise customers, so we'll continue to communicate with customers in different way. Sometimes we reach out to those customers, sometimes we put in a hand, a tool for them to reach out to us or a combination of both but we feel good about the means that we deploy to ensure that we minimize churn when those promotions expire.

Ana Goshko

Okay. So wanted to touch on prepaid. So Sprint has been losing a lot of prepaid customers, I mean, at a pretty notable pace. So I think the reported numbers are going to start to look better because going forward the Company announced it's going to remove a block of inactive devices from the base [ph], so hopefully, the pace of loss at least improves; but can you summarize what the issues have been in the prepaid business and what the strategy is on the plans going forward?

Tarek Robbiati

So the prepaid industry here is incredibly competitive, right, and so you know I would encourage everyone to not judge the performance of a prepaid player by just looking at subscriber numbers because to a large extent, the number is meaningless, what you really have to look at is revenue growth and profitability in that particular segment. So the best data point I can give you around that is -- the best-in-class player in the industry has a 4% monthly churn. So when you're at that level of churn, while roughly 0.5% -- half of the base of that particular player has washed out in the space of one year, so you really don't look at just customers, and I think they are very irrational offers right now are there and that is something to be taken into account.

So what are we going to do about this is that we will really look at being very selective around the type of customers we acquire. They are customers we take advantage of the fact that they can get a free phone to constantly switch and it doesn't bother them to lose their mobile number, that's not the type of customer we would want to acquire. So we'll be a lot more segmented in our approach to marketing to prepaid customers and lot more selective, also on credit quality and so on. Work has started, we are going to purge [ph] the base as we have pointed out a little bit. And there is a series of measures that we'll play out overtime, there is no easy fix when you have very high industry churn on prepaid. We will also have to rethink a number of aspects of the business, particularly the distribution side to improve the experience of our customers in that.

Ana Goshko

Okay. I want to move on the cost side, so I think with your entry to the company has coincided with a $2 billion cost cut plan. We wanted an update on where you are in completing that program? And then I think you know, the question really always is, as -- under the CFO you come into the Company, you find places where you need to cut cost but are you identifying places where you need to reinvest?

Tarek Robbiati

So that's a great question. I think you know, one of the reasons I was attracted to Sprint is I saw a player of a pretty large scale because when you have a player that has $32 billion of revenue, it's not a small company. And I did see an opportunity to liberate that top line and we break the cost structure to drive bottom line benefits. We're on our way, this is a never ending, never ending program, right, so we are on-track to deliver $2 billion of run rate -- exit run rate cost reductions from '16 to '17, we already showed and demonstrated to the market that we delivered $1.1 billion of hard cost stake out [ph] in the first six months of the year, so we're very pleased with that and this is a little bit like a fitness test, right. You cannot really -- you should never get to be complacent around your cost in any company. So we'll continue to drive cost out in fiscal year '17 and beyond.

And there are different degrees of complexity in taking cost out. Now I think we are at a point where we have to fundamentally transform Sprint and it doesn't mean that we were not doing it before but here we have to attack the way we work, and attacking the way we work means you have to fundamentally change capabilities, process and people to be able to do things better and more efficiently and so on and so forth. So to answer your question, are there areas where there is a need for reinvestment; probably, but would that create a OpEx spike? No, is the answer. One area I can think about is our distribution, it's incredibly complex and I would say Marcelo is dissatisfied with the level of sophistication of our distribution or lack of, rather.

And I think it's right, I think we need to really boost up our distribution and in doing so, that doesn't mean you're going to spend more because there is a mixed effect between expensive distribution channels versus cheaper distribution channels and by the way, it's incredible but the cheaper distribution channels are the most productive distribution channel. So it's a worthwhile investment that we would make in that field because it would drive higher levels of productivity if we were to invest in a greater number of company-owned stores which are the cheapest and the most productive channels that we have.

Ana Goshko

Okay. And I'm going to move on to the CapEx and network strategy. So there is a view that Sprint spend materially under-spending in network CapEx. I know you've got [indiscernible] investors and others all the time, but with current and fiscal year guidance of under $3 billion, and also the decision not to enter the broadcast spectrum auction for low band, those of you that really what's been driving those two decisions, it's been capital constraint. So just wanted to give you another platform to explain the rational for both of those decisions.

Tarek Robbiati

I love the question, it's really -- look, the heart of a wireless company, the heart of the value that exist in a wireless company is around this question. And there is a natural trade-off with how much CapEx you deploy versus the spectrum holdings you have. And so when you look at it this way, and you put it in the overall context of the industry, when you see wireless traffic doubling every 18 months, you would imagine that we would need to invest tons and tons of money in CapEx to keep up with the demand but the real trick and this is where we are different. So when you have so much spectrum available, you really don't need to spend that much money on equipment, you can deploy a lot more capacity by putting more spectrum on air. And it's a lot more efficient from all sorts of angles, cost and time to market, just to name a few.

So right now all the carriers in the U.S. cover 300 million pox [ph], right. So really the investments that are needed are less around coverage and a lot more around capacity, and that's where when you have a pretty enormous spectrum holding like we do. We have more spectrum per subscriber than any other carrier in the U.S. and possibly we're amongst the very top in the world. So when you have that much spectrum, you can't deploy it to a great capacity advantage moving forward. This is where the value of the company is and that's why we'll talk about that hopefully with spectrum lease.

And do we materially underinvest relative to what -- relative to the past, yes, but the past is not really reflective of where we are today. The past was the point in time where Sprint had to invest to cater to three different network platforms; an IDN network platform, a WiMAX network platform and a CDMA network platform. We move with network vision towards one platform that was EVDO focused, not LTE focused; and this took all the way upto I'd say July '13, July '14. And when you look at that then you have to invest in three different platforms, of course you're going to be spending a lot of money. Is that a judicial spend? Probably not.

So now that we moved on to a LTE based platform and we tuned our platform to be a single one that aggregates spectrum across 800 -- 1900 and 2500 megahertz, we can -- we have an incredible level of flexibility to provide coverage and capacity to our customers wherever they are; and that is a new capital intensity point which hasn't been experienced. So there is a need for everyone to reset and we'll probably have to do a better job ourselves at explaining to the market why we believe we have a capital intensity advantage to other players. But for those of you who follow the industry well enough, the answer -- it goes back to the point I was making before which is it's all about spectrum, it's all about spectrum.

Which takes me to the second part of your question which is why didn't we participate in the 600 megahertz auction? We did not participate in the 600 megahertz auction, not because we were not -- we didn't have the money at that time or we were under-resourced. It is simply -- it's a spectrum that is the spectrum of the past. The world is moving towards high capacity wireless data networks, and in that world the best and most efficient spectrum that is needed to cater for that -- that demand where you have the traffic doubling every 18 months is mid-band spectrum, it's the spectrum that we have, the 2500 [ph] spectrum that we have, it's not a [indiscernible] spectrum. It used to be the WiMAX spectrum; we repurposed it entirely to just deliver an outstanding LTE experience.

So now we do three carrier aggregation, three times 20 megahertz, a three carrier aggregation on 2.5 which delivers incredible experience to customers moving forward. So why invest in 600 megahertz of spectrum if that spectrum doesn't really cater for the future? And also it's a spectrum that you cannot deploy for four years and it doesn't have an ecosystem in support that is as widespread as the 2.5 ecosystem which is the largest ecosystem in the world.

Ana Goshko

Okay. Couple of follow-ups on that but you know I want to move onto a free cash flow questions and some of the cap [ph] and give the audience an opportunity. So we have time -- I might circle back but moving onto the free cash flow, the cash flow or free cash flow question; so you know, a major component of Sprint's recent negative free cash flow has been the move to unsubsidized phone plans which we touched on. So in reality, many customers walk out of the store with an expensive phone, little to no money down, and Sprint has a working capital hit. You've been addressing this in part through receivable sales and a less handset securitization vehicles, when does the free cash flow drag from the phone installment sales? When do you get your base to a point where you're kind of -- are in and out normal -- in a normalized in terms of those cash flows?

Tarek Robbiati

Yes, so the working capital drag is also functional of how fast you grow, right. So the more you grow, the more you have the need to address the working capital drag. So we embarked on MLS back a year ago to make sure that we optimized the cash advance from the structure. And MLS was very effective structure for that purpose because we were getting cash not only on the receivable but also on the residual value of the leased assets; and the cash advance that we had with MLS were north of 80%, 84% to be precise. So it's very efficient as a mechanism to neutralize the working capital drag.

Having said so, and I think we flagged it to the market -- when you optimize on cash advance and because you have a residual value component which is not funded by debt investors but by equity investors, the natural consequence of it is that the cost of capital of the structure is higher than other debt-only based structures. So we flagged it was mid-single digit rates, it was at the time back to in November '15, much better than the higher alternative. So very pleased with that then but now it's time to look at things slightly differently, now it's time to look at things that are more in tune with what happens in the securitization markets and we did flag this back a year ago, we did say that the MLS structure will have to evolve and we're going to let that evolve.

And overtime as we generate more and more receivables from customers, we will securitize those receivables. As we do already with the banking market, we will securitize those receivables in termed [ph] markets as well.

Ana Goshko

Okay. So had given all that do you feel that Sprint is now in a position to potentially generate positive free cash flow in FY17? And really the bigger question is what has to happen for Sprint to be able to generate free cash flow on a sustained basis?

Tarek Robbiati

Yes, so many different points in your question. We have to continue to address the working capital drag to get to the point of sustained positive free cash flow. It's too early to tell you where we will be in fiscal year '17 on a adjusted free cash flow basis; we still have to run through our budget. Yes, this year our CapEx was a little bit low compared to where we see the norm to be, and that is normal because it had to do with the timing of permits we did to identification program. We will find more CapEx next year than this year, and as a result of that then we will have to find ways to offset that CapEx increase to still continue to be hopefully on a positive adjusted free cash flow result. But it's too early to say because we're working through this and there is an element of how hard we're going to go with our -- how aggressive are we going to be with our network deployment plan, we're still going through this and we will let you know. But the crux of the matter if you want to be sustaining adjusted free cash flow positive, you got to drive more OpEx out, you're going to be efficient with your CapEx and neutralize your working capital drag and we are attacking those three things in parallel.

Ana Goshko

Okay. I want to touch on your capital structure strategy and really through the next steps that you might be considering. So instead of raising money in the high yield markets, Sprint just have other really asset based sources, right, so we talked about the MLS handset securitizations, we did secured lending against network equipment and most recently you did secure securitized lending against the spectrum. So had the bonds have -- have performed very well this last year, so theoretically the -- our cost of raising debt in a high yield market is a lot more attractive, obviously than it was this time last year or at the beginning of 2016. So what are the next steps? Are you thinking of moving back to more traditional approach in the capital structure, potentially looking at the leverage loan market or actually just re-entering the high yield market?

Tarek Robbiati

I really love the question because this is really the heart of what the CFO does. So, remember where we were a year ago? A year ago we were almost written-off by everybody.

Ana Goshko

Not me.

Tarek Robbiati

Not you, thank you. But I had just started with Sprint on early September '15, we got to double downgrade from Moody's -- I didn't take this personally but I felt it was a welcome gift, it was actually quite nice. And then you know the high yield industry started to turn south, you remember this all the way upto December and January, February '16 because the oil prices were unstable and there was a lot of uncertainty back then. So -- and we've learned from that period, and what we've learned at Sprint is that we have to diversify our sources of funding. And so we raised money on the back of assets that we had and we started with handsets and we did network leaseco. And then we left deliberately the spectrum leaseco, the best for the last.

And the shift that you had in the journey was first I'm showing up liquidity and maximizing cash advances to now really draconically [ph] lowering cost of debt and cost of capital. So when you look at spectrum leaseco, we priced $3.5 billion bonds at a 3.36% coupon. We literally substituted the 6% notes that are falling due now in December '16 which we are repaying, plus the 14 and 3.25 notes from Clearwire, it's about 300 million of them which we've repaid plus the nine and 125% notes that are due in March '17 with the 3.36% coupon. I mean this says the Company $174 million of net interest expense, right. And liquidity is off -- the liquidity issues are in my mind well addressed, the best data point I can give you, I'm pretty proud of it, is when you look at our five-year CDS curve. We were -- last year in January, the CDS five-year insurance was costing 19 points but now we are roughly at high four [ph], right, so it's an incredible change in a very small period of time.

So now that you look at the journey moving from maximizing cash advance to lowering cost of debt, this is all designed as part of a strategy that is deliberate to diversify sources of funding, that's what we're going to do. In the future to answer the last part of your question, will we continue to tap the high yield markets, yes. But for me to tap the high yield market at 12% as it was in January '16 or to tap it today which is at the much lower level is a very different story. So for us to get back into high yield we need to continue to drive cost of debt down.

Ana Goshko

Okay. So a tactical question and I've been actually very eager to ask you. So on that and recently completed spectrum securitization; you know, Sprint took only $3.5 billion of a possible $7 billion program. And you took all five-year tranche which has relatively [ph] amortization before it matures and you did not issue any of the initially planned 10-year tranche which would have provided more runway on the maturity profile. So you know, what am I supposed to read into or what are we supposed to read into your decision to really -- only take some of the money that was potentially available to you and to really focus on the -- on a shorter dated security rather than kind of terming it out?

Tarek Robbiati

Again, it's a deliberate choice to drive down cost of debt and it was really, really designed for that purpose because there was a view that Sprint can only raise money in high single digit and double digit rates. So I went deliberately down the path to minimize cost of debt to set a new benchmark for fund raising. And also as part of the logic and the whole process, we did not need to raise the total size of the program which was $7 billion; we need also to be mindful of the cost of carrier. So we all go back to the market and do the second part of the program, another $3.5 billion in due course, we flag that as we were [indiscernible] with investors and we said that repeatedly. And we'll get there eventually; I don't think it's something that we will do too far from now.

Ana Goshko

Okay, great. We really only have about a minute left. So as I will agree with the time we talk in terms of my questions but is there a question from the audience? No braining [ph] questions? Okay, so I'm going to end with the big question, with a new Presidential administration, Republican and Mr. Trump; you know, what would Sprint like to see out of a new Presidential administration with regard to communication policy?

Tarek Robbiati

So I mean it's too early to tell what President-Elect Trump will do. I mean he still has to install his team and take-off. So we're watching this very closely but we will be happy to work with the new administration of course, particularly on a couple of areas which are important to us. There is a talk about streamlining the sites acquisition process; it's very interesting to us as we deploy a very dense network. We look forward to this, and then we'll see what happens with other aspects of the policy, it's way, way too early to speculate. And we'll just watch and see what the policy will be.

Ana Goshko

Okay. And with regard to DOJ and FCC policies to wireless consolidation, if the regulatory environment was conducive to large scale mergers, particularly in wireless, does Sprint have the propensity to pursue or be involved in large scale M&A?

Tarek Robbiati

I don't look at it like this. I don't wait for a change in the administration to do -- to think about M&A. M&A is not something you speculate on, it's -- in our view, it's a right you earn to do. And the best way for us to earn that right is to deliver on our plan, deliver on the fundamentals, improve our equity value and that's what we're focused on. We'll see whether there will be policy changes and we'll accommodate larger M&A transactions but right now we're focused on driving the plan.

Ana Goshko

Okay, great. Well, Tarek, thank you so much for being with us and best of luck to you and to Sprint for 2017.

Tarek Robbiati

Thank you, Ana. Thank you.

Question-and-Answer Session

End of Q&A

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