Sprint (S) 45th Annual UBS Global Media and Communications Brokers Conference (Transcript)

Sprint Corporation (S) 45th Annual UBS Global Media and Communications Brokers Conference Call December 5, 2017 10:15 AM ET

Executives

Tarek Robbiati - CFO

Analysts

John Hodulik - UBS

John Hodulik

I'm John Hodulik, the media and telecom analyst here at UBS, and I am very pleased to announce that our next speaker is Tarek Robbiati, the CFO of Sprint. Tarek, thanks for being here.

Tarek Robbiati

Good morning, John. Thanks for having us.

John Hodulik

So we have got about 48 minutes for some Q&A and again I have the iPad here which if you have any questions, you can download the app. Please feel free to send them my way and I will filter them into the Q&A. Tarek, you guys had an eventful 2017, maybe not as eventful as it could have been, but as you look out into 2018, can you talk about the priorities for Sprint?

Tarek Robbiati

Yes. 2017, which is not over by the way, was eventful. It was packed with action and it was a good year, very good year. So, we are very excited about the future, particularly because now we can concentrate on executing our plan. We feel very good about this and the focus is really around execution with three dimensions in mind. Number one, network rollout, it's all about rolling out our network, we'll talk more about that. Number two, customer experience, we will address other non-network related customer experience issues that we see in the business. Number three, we will expand distribution in our footprint. We started doing that in fiscal year 2017 across all three, but we will turbo-charge and accelerate all of that in fiscal year 2018.

John Hodulik

Got you. Before we dig at each one of those, maybe we should first sort of put the T-Mobile deal to bed. Sounds like you got close but couldn't get it over the goal line. Can you give us sort of general summary on what happened and maybe why it didn't happen?

Tarek Robbiati

So I mean it was a very exciting seven, eight months. We had extensive due diligence on both sides. We were dancing. It was really exciting. We exchanged a kiss on the cheek. And then our parents saw that and sent us back to our rooms. Jokes aside, look, it was – pretty much it boiled down a core decision that Masa made. It's a bold decision. Remember there is a regulatory uncertainty backdrop around the combination between us and T-Mobile, and when you took that and the prospect of losing control, Masa looked at our plan, felt very comfortable about our plan. He said, look, move on, go and execute. This is what the focus of management should be. And we are very glad to have him because he is always incredibly creative and helping us accelerate what we want to do.

John Hodulik

So, I guess at this point, I mean I know the talks are off for now and the deal is dead at this point. Do you foresee a chance to potentially revisit that in the future, or should we really move on?

Tarek Robbiati

No, I think it's important that we all move on. It was very positive experience despite the fact that we did not get to a point of the finishing line where the deal is announced. I particularly enjoyed meeting my counterparts in the T-Mobile team. We have a huge respect for them, of what they have accomplished. We feel that there was a huge amount of synergies available to us. We could have created a very different player in the U.S., bringing real competition to the duopoly at the top. All of that was wonderful, but let's not forget the regulatory uncertainty was pretty high. We found that it was something that would have created a lot of disruption on Sprint. We never intended to get into a deal that would be risky for the Company, for its shareholders, for its employees. On balance, it's a right decision. Let's move on. If it would be revisited down the track, it's not going to be immediate, but this is more something that our Chairman will have to deal with and we will see how that goes.

John Hodulik

Now I know it's in a completely different field, but the DOJ's aggressiveness on the AT&T-Twix deal, did that give you, as you sort of look back, make you think, wow, we may have dodged a bullet there and we did the right thing by stepping back?

Tarek Robbiati

Yes. I mean certainly when you look at, and it's not just across the telecom industry, I think even if you look at the pharmaceutical industry, there were a couple of deals that were turned down by the government. It is certainly something that we are mindful of. That's why let's move on, let's execute. We have got a lot to do at Sprint in fiscal year 2018 and beyond. There are exciting times ahead of us and it's better that we focus on this and see how we are going to be growing our business moving forward.

John Hodulik

Got you. Now subsequent to the end of the deal talks, you had a couple of announcements. One was higher CapEx spending. Could you talk about the sort of decision behind that and maybe how the incremental capital will be spent?

Tarek Robbiati

So I'll explain to you our decision on CapEx, which is a decision that we already made before the transaction with T-Mobile came to effect. In fact, as a management team it would have been really, really a negative if we had embarked on an M&A transaction without investing in the network, because of that regulatory uncertainty. So, you can imagine us going into a transaction deciding not to invest in the network for whatever cash reason or synergy protection reasons that you can come up with, that would have been a really bad decision.

So, in all cases, investing in the network was the right strategy. And Marcelo had flagged that back, if I'm not mistaken, at one of your competitors' conferences back in September, and we were right in the middle of M&A discussions back then. So, nothing has changed. Nothing has changed and we are now having to continue on the path of investing in our network, and let me elaborate on where the money is going to go.

So there are different components in our network rollouts that we will invest in. First and foremost, we have to tri-band a lot of our towers. Tri-banding means putting all the bands that we have at our disposal on every tower that we have, 800, 1900, 2500. We have not rolled out 2500 in full across our footprint. We've rolled it out roughly covering 70% of the pops, 50% approximately of all the towers that we have. We know that when we deploy 2.5G, the experience that our customer witness is much, much better than when they don't. So that is number one, the focus on network deployment.

The second is, we are going to add a few new towers because our network footprint is probably in need of an expansion in some specific neighborhoods where we feel we are a little bit short. So we are going to roll out new towers, a few thousand towers, to get back in line with neighborhood expansion.

Three, and this is key to Sprint, I don't think any other player will do it to the same extent that we will, we are going to be aggressively rolling out as part of the tower upgrades and neighborhood expansions, Massive MIMO, and that helps really drive spectrum efficiency to the next level and increase our capacity by a factor of 10x. Effectively we will put in new radio systems that will involve 64 transmission element and 64 receive elements. When you look at that, what it's capable of doing and using spectrum, it takes the spectrum efficiency to the next level. We will be augmenting our capacity by a very large factor of 10x, like I said a second ago. So, that's the third leg, is Massive MIMO.

The fourth leg is, everything we have spoken about around small cell densification, and that is including by itself a combination of mini-macros which are built in right of way, air strands, and also Magic Boxes, and when you take all of that into account, plus a few other things that are relatively for smaller scale, we will be spending $5 billion to $6 billion next year in deploying our network. You could expect that probably for a couple of years we would be at around that level, but then we will come back down from that level to a more sustainable CapEx-to-sales ratio and a $4 billion to $5 billion of CapEx spend per year.

John Hodulik

Got you. So maybe a little bit more on some of those aspects. So the small cells, I don't think you guys say specifically how many you have, but can you give us a sense of how much of the investment is going to go into that small cell area and maybe some general sense for how many small cells do you expect to have when you start to see that CapEx go back to normalized levels?

Tarek Robbiati

So, we have spent in fiscal year 2016 and 2017 a lot of time securing several thousand permits for small cells, and we feel very good about that. Also, as part of this strategy, as you know we have signed an agreement with Altice, which is a very unique agreement we spent a lot of time working on that we are very happy with. And in that agreement we gain access to their infrastructure, they gain access to our infrastructure. It's an unconventional MVNO deal, but it allows us to really leverage two things.

Number one, their backhaul, we have unfettered access to the backhaul at rates that we feel are very competitive. This helps in the deployment of small cells. It's a critical path, a critical ingredient that we all need to deploy small cell. And number two, we agreed with them the ability to deploy our radios in what we call over-the-air cable or air strands, and that should help a lot in their footprint, and we feel very good about that.

The good news about Altice is that we know the company, we are like-minded, and we don't have to really rely on permits to be able to deploy the infrastructure. We are going to be piggybacking on each other infrastructures, which is great news for us. It's a very, very creative deal and what's underpinning it is they get also a discount on the air-time for them to launch a mobile service, but the discount schedule is predicated on performance hurdles [indiscernible], so the rollout of our network capabilities in their infrastructure.

John Hodulik

So maybe on the towers on the macro side, are these targeted more for areas outside your footprint or are they more rural areas or are we looking for sort of building out in the existing networks?

Tarek Robbiati

Mostly it's for what we call the neighborhood expansion. It's very much around addressing the fact that urbanization shifts and by and large we need to strengthen our presence in our footprint. And that is because you don't rollout a network without looking at specific markets where you can really gain share. So, the network will be accompanied with a deepening of our distribution capabilities, our marketing efforts in those specific markets where we intend to put those new towers to play. Over time, yes, we will go into more into the rural side of the U.S., but so far I think the majority of the neighborhood expansion is on the fringe of our footprint.

John Hodulik

Got you. And then how should we think about the distribution expansion, and maybe put some timing on it and if you can give us some numbers around points of distribution, that would be great?

Tarek Robbiati

So, up to end of June we had about 1,100 Company-owned retail stores. We started an aggressive distribution program that involved around reusing the footprint of the RadioShack stores that we acquired. So, some of those RadioShack stores were converted into Sprint stores. That was done very, very quickly. In the space of a few weeks we opened up an additional 360 stores.

In addition to the RadioShack stores, we also took ownership of those stores that we had built with the help of [indiscernible]. So, you add another 100 some stores with that. On top of that, we've also built our own stores and we are on track to build couple of hundred stores there. So, in the space of I'd say two to three quarters, we added 600 to 700 stores to our distribution network.

And we continue to explore different distribution models, right. So, one of the debates that we are having is, do we continue to push our own footprint or do we leverage some of our partner dealers? It's a combination of both that we need to tackle because the world is becoming more and more about digital distribution and one has to be mindful of the fact that having a lot of capital in brick-and-mortar may not be over the long term the right thing to do. So we are attacking distribution across our own footprint, distribution partner's footprint and digital, and that's the story for fiscal year 2018 as well.

John Hodulik

Got you. And one of the other things you talked about as far as initiatives is improving the customer experience. Can you give us a little bit more detail on those initiatives?

Tarek Robbiati

So, we have now come to understanding really what drives churn. And so, I have to make a little detour to answer your question. We have built a very extensive analytical model that gives us a real strong correlation of a churn score with the network quality. So, that is something that we know nationwide and we are able to pinpoint to reasons that are network related that create churn for our customers.

But not every bit of churn is network related. So, we are now turning our attention to other experiential issues, which is billing, care, et cetera, that may lead to dissatisfaction amongst our customers and we are attacking those.

And then of course we feel that price remains a key focus. We will continue to be the price leader. People also churn because of prices but that is not our case. We feel good about that. So, all hands on deck to attack network related churn and other customer experience related issues that our customers face.

John Hodulik

So, it seems like you are knocking down each one of these issues, network, customer care, even broader distributional help with churn. When do you think that we expect to see some real improvement and do you think as you look over again this sort of call it two to three-year timeframe, can you get to a point where churn metrics are similar to what we are seeing with the rest of the industry?

Tarek Robbiati

Yes, so for this quarter, which is a quarter that is I would say characterized by promotions, you can expect a 15 bps increase in churn sequentially from the prior quarter. By the way, this is better than the prior year period where sequentially we experienced a 20 bps increase, if my memory does help me. So, over time, churn will come down.

What is now very interesting with that analytical tool that we just discussed is that we know that customers who experience the right level of network experience generate churn that is well below the 1.3% mark, right. We intend to go below that mark over time.

And so, the answer to churn is a local answer. You got to go in every market, figure out what the root cause is and address that, and this is why our network efforts will be bearing fruit because we know where we will have to rollout the network to address the churn issue.

John Hodulik

Got you. [Indiscernible] about the competitive environment. You said obviously the fourth quarter is generally the most competitive of the year where you have generally a lot of promotions [indiscernible] handsets, around the holidays. What are you seeing in the market today? Sprint I would say appears to be changing its tune a little bit in terms of how they talk about price. You guys have the ' Cut Your Bill in Half' and even the free service month or free service for a year. It sounds like the tone has changed a little bit coming out of the last call you guys held.

Tarek Robbiati

We remain the price leader. We intend to remain the price leader, and because we will have a capacity advantage that allow us to do that. So, there is no change to the long-term view. Probably to your point, there is a change in emphasis. We have raised prices the past few weeks…

John Hodulik

And you signalled that that may happen again.

Tarek Robbiati

Yes, we did also signal that that may happen again. And we feel good about this. We don't think we need to be ultra-aggressive to be able to grow our business. And specifically around the competitive dynamics of this quarter, while it is characterized by intense promotional activities around Black Friday and Christmas and so on, it is actually a little bit more rational than the prior years, and that is across the board. Part of it is also related to supply of iPhone Xs, which is in high demand and in short supply. So, you don't see – we haven't seen so far extravagant aggressive promotional activity across the sector.

John Hodulik

So, there are sort of some cross-currents there. At the same time that you guys are the price leader, you have postpaid handset ARPU that appears to be the highest of the big four. At the same time you're talking about being less price aggressive. Should we expect that, we talked about churn conversion, should we also expect the ARPU to converge or maybe even dip below what we are seeing for the other three major players?

Tarek Robbiati

It's a great question. So our ARPU now is still higher than T-Mobile. We still face a little bit of pressure in the short term as customers move away from non-device finance plans to device finance plans, but over time we would expect ARPU to reach an inflection point.

Services revenues inflection is probably something we can point to fiscal year 2018, towards the end of fiscal year 2018, which is really important, and then you will see ARPU turning the corner as we move with our new network and new services that we can charge for at a higher price.

That's what I would say on ARPU. I think you could also look into what we are doing on the prepaid front. We feel very, very encouraged with some of the trends that we are seeing on prepaid. We have cleaned up remarkably well over the past two to three quarters our prepaid business. It's starting to really turn the corner very, very well. I'm very positive about that and the management there has done a fantastic job.

John Hodulik

Got you. I think one of the bigger surprises coming out of the third quarter or the calendar year third quarter was how great you guys did in gross add share. You pointed the strength in prepaid, but on the gross add side I think it's the highest gross add share you've had in a long, long time, 22% by our numbers. And that includes the first real quarter where I think we've seen the cable guys come in. So what's driving people into the Sprint stores and do you think that you can maintain or even grow that share of gross adds on the postpaid handset side?

Tarek Robbiati

So, [indiscernible] share of gross adds is 20% to 22%, is the highest it's been for several quarters. We think we can maintain a level of 20%. But right now the focus is with distribution expansion, and as we continue to be the price leader, it's to drive productivity across all our channels. And as you can see with convergence on stores, the reason why we have converted them is that of course stores that we operate directly have higher productivity than those stores that we don't, and we will continue to drive a different retail experience to get the productivity uplift that we are seeking.

John Hodulik

With the new distribution, and if the efficiency continues with that or moves with that, I mean any chance to move that higher than the 22% you saw?

Tarek Robbiati

Yes, it's gradual. We are going to go deeper in markets where we feel we have the network up to scratch. This is a combination that you have to execute on. We will go deeper in some markets with deeper distribution in fiscal year 2018 as we continue to rollout our network. This is a gradual process that will unfold over the next couple of years.

John Hodulik

Got you. Maybe if we could turn to I think sort of the top line drivers, maybe talk a little about cost-cutting, you've cut $2 billion in costs in fiscal year 2016, I think about $1.3 billion in 2017, how much left is there to go and maybe what are the areas that you guys are targeting?

Tarek Robbiati

So, for fiscal year 2017 we said we would be delivering $1.3 billion to $1.5 billion net cost reductions. At the half year turn we have delivered $750 million. But when you look at the fact that we are investing $800 million to $1 billion on top of the $1.3 billion cost reductions in this year, we are in excess of $2 billion. So we feel good about this. Moving forward we will probably have to rebalance cost cuts with reinvestments. Let's not forget that in nine quarters we have cut $5 billion of costs. That is not an easy thing to do. There are very few companies who have achieved that level of cost reduction over that timeframe, which make us very proud. So, I think that now is the time to rebalance that cost-cutting effort with reinvestments to grow the business moving forward.

John Hodulik

So, as we look maybe outside [indiscernible], if you look at the fiscal year 2018, cost cutting has become a lesser priority and these other three things that you mentioned really take center-stage?

Tarek Robbiati

Yes, because the way now to think about cost-cutting is more, if I can use an analogy, it's a fitness test, right. You got to keep fit, you got to keep removing the fat that you have in the system that inevitably develops over time, and we are going to continue to do that. Our focus for fiscal year 2018 will be around pushing digitization which gives us real great benefit in terms of care cost reductions and also look at other aspects of our business IT to drive customer experience benefits, as we talked about a moment ago. But again, now we are in different phase, it's more about staying fit than to take a lot of fat that we had before.

John Hodulik

So, if I sort of put it all together, you've been able to push wireless margins to around 40% or so adjusting for the impact of leasing. Is this sort of a steady-state level that we should expect here or – because you've got some puts and takes, the digitalization and the customer care improvements should help, but you're making some investments and is this a good level going forward?

Tarek Robbiati

Our wireless margins are 50% before the adjustments you mentioned, but internally we do adjust for [at least] [ph] depreciation. This takes you to the 40% mark. We feel we can go a little bit higher than that, but that's a good level, and as we grow the top line and this starts to fuel operating free cash flow, which gives us a headroom to invest in the network, so we feel that this level of margin is sustainable for the future.

So, I think it's really important that we keep the discipline in the business. If you don't keep the discipline in the business, you're going to slip back into a territory that is unhealthy for Sprint. We got to keep the discipline. That's why I think about it like running a marathon and keeping fit.

John Hodulik

Got you. And then how should we think about cash flow trends over the next couple of years, say fiscal year 2018 and 2019, with all the CapEx, this sort of outsized CapEx, over the next couple of years?

Tarek Robbiati

So, if you look at our operating cash flow, we generated $3.2 billion in the first half. The whole of last year we generated $4.2 billion. This year from a CapEx standpoint we are targeting $3.5 billion to $4 billion of CapEx, which is $2 billion more than the prior year, right. So, we have the headroom to invest more. Next year it's going to be a similar story. Probably next year we'll dip into a slight negative free cash flow because $5 billion to $6 billion of CapEx is quite a big number. This isn't to sustain – this isn't I would say the average normalized level of CapEx spend. It's above it. So, this will be coming down over the upcoming years.

We have the ability to stretch ourselves a little bit and it's for good cause. It's really critical for Sprint that we put our spectrum to use for once and for all, as my boss Marcelo said, and we're going to do so. This year we feel pretty good about cash. We'll be positive adjusted free cash flow. We have a very clear financing strategy to contiguously cycle out of expensive debt into cheaper debt. This quarter alone we paid down about $2 billion of expensive debt between Network LeaseCo and also a legacy Clearwire notes that were costing us 14.75% points. So, we have the ability to fund our network expansion cycle out of expensive debt into cheaper debt and reduce our cost of capital over time.

John Hodulik

So from a free cash flow standpoint, you said fiscal year 2018, fiscal year 2019 also sort of around breakeven?

Tarek Robbiati

Around breakeven for both. We are equipping ourselves from a financing standpoint to be able to manage the impact that CapEx investment will have around cash.

John Hodulik

Got you. And then in terms of generating or sources of capital, the spectrum lease financing was a very – seemingly very efficient way to raise capital. You have more under this program. Any sort of plans to tap that and then [indiscernible] do more lease financing on the spectrum side beyond the existing program?

Tarek Robbiati

Yes, so the original program of Spectrum LeaseCo, as you point out correctly, was a larger program than what we have raised. It was $7 billion. We have raised last year around October $3.5 billion out of the $7 billion. We will go to market in the upcoming month for the second tranche of Spectrum LeaseCo.

If you look also into our secure revolver facilities, we have a carve-out to be able to execute a second program of spectrum financing, which is going to be about the same size. So, that is going to be a really major source of financing, of cheap financing because of secured and investment-grade financing that we are tapping to.

And also to take into account the working capital needs that we have finance devices, similarly we are going to extend our device financing away from the banking market more into terms market with standard ABS securitization deals. We will be in the market in fiscal year 2018 with those.

John Hodulik

Got you. And maybe wrapping up, Tarek, we started off with some of the strategic stuff, maybe we could finish with the strategic stuff, there is obviously a lot of talk about combining wireline and wireless and obviously SoftBank is involved in a number of sort of new initiatives and potentially large longer-term investments, gives us a couple of aspects to it. How do you see Sprint or do you see Sprint as a standalone company five years from now, is there any sort of obvious places where these assets fit, both within what SoftBank is doing or in other areas of the broader telecommunications infrastructure? And then how important is it I would say both either to Sprint or SoftBank for Sprint to remain a sort of public listed company?

Tarek Robbiati

[Indiscernible] question. If you really step into Masa's shoes, he has now with the Vision Fund a lot of capital that he is putting to use in the TMT space. There are numerous investments that complement Sprint. Think about ARM for IoT and what we are going to do there. Think about OneWeb for satellite connectivity, which is going to be ubiquitous within probably three-four years with a number of LEOs sent over orbit. All of that makes us at the epicenter of Masa's vision. And this is the reason why he was uncomfortable ceding control. So we are back to that point.

He really wants to demonstrate what can be done when you put all of these assets together and you start to manage them to create synergies for the newer variety that is unfolding, which is an enormous, enormous opportunity, and different types of communication using satellites.

So, it will be a lively period for us as well in that context. We are constantly having discussions with SoftBank group. We work very closely with SoftBank. Marcelo right now is in Japan. I spoke to him a couple of days ago. We exchange e-mails. Every 24 hours we have new ideas coming out. So it's always exciting.

With respect to your last bit as to whether or not it's important for us to stay listed or becoming private, there are pros and cons and this has been a debate that has come and faded and come back all the time. It's a question that is more to be directed to Masa and SoftBank. Either way, we are happy where we are as a management team.

John Hodulik

Great. Tarek, thanks for your time today.

Tarek Robbiati

Thank you.

Question-and-Answer Session

[No Q&A session]