Sprint Corporation (S) Management presents at Bank of America Merrill Lynch Leveraged Finance Conference (Transcript)

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About: Sprint Corporation (S)
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Sprint Corporation (NYSE:S) Bank of America Merrill Lynch Leveraged Finance Conference December 5, 2018 8:50 AM ET

Executives

Andrew Davies - Chief Financial Officer

Analysts

Ana Goshko - Bank of America Merrill Lynch

Operator

Ana Goshko

Great. Welcome everyone to the Bank of America Merrill Lynch Leveraged Finance Conference. And I'm Ana Goshko, I cover Telecom and Technology from the high-yield research side, and we're thrilled to have Sprint with us today. We have Andrew Davies, the CFO; and Jud Henry, the Head of Investor Relations. So without further ado, Andrew, thank you so much for being with us.

Andrew Davies

It is pleasure. Thanks for inviting us.

Ana Goshko

Any opening comments or would you just like to jump right into it.

Andrew Davies

No, let's jump right into it.

Ana Goshko

Okay. Andrew you've been with Sprint I mean five six months now. So we'd appreciate hearing if you have any initial notable impressions of the company, anything that's been unexpected.

Andrew Davies

Yes. I guess I think the first thing to say it was as I was kind of doing my research and reacquainting myself with US wireless before actually getting into the role. It was notable kind of the transformation of Sprint had been through over the last several years, and fixing the balance sheet and in particular all the work on cost taking out $6 billion of cost over a four year time period. And at least $1 billion of cost reduction over that in each of those years. So I was very positively inclined just because I'm seeing kind of the change, the transformation that they've been through.

I think when I arrived what the main thing that was notable to me was just the levels of energy and passion and resiliency that you still had within the employee base, which is a positive surprise to be excited. But I kind of half expected that to find somewhat jaded workforce right can all of the work, all of that intense sledding that had gone over the past few years. But that kind of frankly wasn't the case.

Ana Goshko

Okay. I apologize. I did want to start out just if you would remind the audience and for those maybe aren't aware you have, I don't want to date you but you have quite substantial experience in telecom and wireless. So maybe kind of hit the highlights of some of your more recent experience here and tactics for you because I think it does give a view to kind of insights that you bring into the business.

Andrew Davies

Yes. Thank you for that. So it's somewhat ironic actually to, for me to be somewhat pigeon-holed if you like. And I'm not-- that's not a criticism because as a finance person I kind of generally think, and this partly comes from my spending time with GE earlier on in my career. I kind of believe that a well-grounded finance person that can think well and communicate well should be portable across most industries actually. So it's kind of strange that I've ended up in one particular industry for quite such a long time. But, basically, I've been in wireless now for over a decade and a half started off in the UK as CFO of over an MVNO on both the Vodafone and O2 networks called Singlepoint which is owned by guy called John Caudwell.

We sold that business to Vodafone, fall of 2003. So I then spent almost exactly ten years within Vodafone, number two kind of finance person in Vodafone Japan, sold Vodafone Japan to South Bank. CFO in Turkey, CFO for Vodafone, India, CFO Verizon Wireless for the last three plus years that Vodafone held its 45% interest in what was the JV at the time. Then CFO at VimpleCom which is now VEON in Amsterdam and then now CFO of Sprint.

So, obviously, yes, a mix of very different geographies there. I've seen very kind of high-tech device centric wireless markets like the US, Japan. I've seen really basic cash based low technology markets, Turkey, India to an extent and some of the stands as well. And I've done everything in the end of the CFO umbrella from being a very strategically and operationally focused CFO, focusing very much on the front end of the business. Such as I am now more or -- most the time I am with Verizon Wireless, but also more traditional corporate finance and back office kind of focused CFO roles.

Ana Goshko

Okay, great. So I think a theme for a lot of the questions that we have about Sprint and you coming in is that you are in kind of a unique position because you joined the company after the company had already agreed to a transformative merger. So and this really runs through it, I think a lot of the operational and strategic questions that we're going to touch on to what degree are there constructive changes that you would like to make and to what degree do you feel that you need to sort of hold back because sort of what's the point if you were going to end up a combined company with T-Mobile in next nine months say.

Andrew Davies

Yes. You are right. I mean it is almost a unique kind of challenge which is partly --part of what attracted me, right. Yes, so I'm generally kind of pretty radically thinking and CFO like transformation and very focused on change. But part of the challenge both for me as an individual but more so in my role as a CFO is to bring extreme rigor and discipline in terms of the choices that we make and the prioritization that we put into initiatives. So we have there's a bunch of stuff that I would love to get into as a CFO that I've consciously stopped doing. And literally as in I'm not even articulated my thoughts to into much detail internally within the business.

So for example, we have back office architecture and processes which are probably a decade behind the times, right. I'd love to get into those and fix them and but I can't because that's a two or three year program. So we've been very focused on just, we need to make sure that the things that we put in place-- we're either confident that they're going to survive the merger and integration process, and that they have bring value to the merged company, or they are things where we are going to get a cash payback by the end of this fiscal year.

Ana Goshko

Okay, great. So with that let's jump into the more nitty-gritty on Sprint separation. So I think one of the biggest hurdles that Sprint faces right now particularly with regard to the ability to grow the customer base is really postpaid phone churn. So Sprint has attributed their current peak in postpaid churn largely due to expiration of promotional offers. But where are these customers going? We are not in what I would say the most price competitive kind of stage of the wireless market in the US right now. As customers roll off of their promotions are they leaving for better deals or are they leaving for better network?

Andrew Davies

Yes. I think there's many different little dynamics going on within churn, right. So let me just kind of take a step back and then discuss them a little more holistically. So we saw an elevation of churn from Q1 of our fiscal year Q2. So the end of the September quarter. I'm not, as did all operators right and that's largely driven by seasonality because you got the big iconic device launches at the end of the quarter. We did to your point see an elevation of churn year-on-year right for that last quarter. And the sequential increase that we saw was greater than we would typically see in that quarter. And that is caused by as you described it people rolling off promotions.

So I mean what we've done there is to level set is historically the network wasn't as competitive as it could have been both in terms of coverage and speeds et cetera. So we had a lean more heavily into promotions both on the acquisition side and the retention side. We consciously -- now that we've started a fixed network, we will come on to that in more detail later. Now that we've kind of started to fix the network, we then consciously step back from being quite so aggressive on promotions, which led to a big pricing change that you saw middle of July where we still offer profound away the best value in the market at the given price points.

What we also did is we had customers that had promotional offers when they reacquired them 12-18 months ago, which had now expired and historically we'd been a little reticent about stepping them up after their promotional period. Company took position even before I arrived frankly kind of first calendar quarter of this year to be a little bolder and step up people more closer towards their upgrade. And obviously you have a-- you put a test group in place and you kind of monitor churn characteristics after the step up period.

And what we see is ,yes, you do get a bit of elevation of churn within that cohort but the 25% at least our pool improvement that you get from that cohort more than offsets the churn impact. So that's what you saw a bit in Q2 where we I think sequentially the churn increase by roughly 18 bps compared to Q1 and almost double what it was the prior year. Now we are going to see an elevation of churn again this current quarter. So Q3 of fiscal year, again that's largely driven by the seasonality right, a big selling season, everybody's churn steps up in this quarter.

And then it's going to step down from next quarter onwards. Now what will impact things going forward is more, we're fixing a network. We've got improved speeds, improved coverage et cetera and we see in areas where we've deployed our next-gen network initiatives that the customers scoring in terms of reception network are improving. And that should start to benefit too going forward. So kind of that said kind of a more holistic view of what's going on with churn. And in terms of where they go into and I'm not going to be overly specific, but the data that we see internally would suggest that customers that are leaving are probably leaving right now related to their prior experience on Sprint's network. But also, I'm not going to overly disagree but I'm not sure that I would describe the competitive environment as benign ways as you may have--as you did necessarily.

Yes. I think certainly when you look at service pricing, there have been no major changes apart from ours for some time. However, and I guess the thing that I noticed most when I came back into the US wireless industry after a four plus year gap was how much more aggressive all of the operators were on device promotions generally. And what we've seen is that device and promotional activity was marginally higher in this most recent iconic device launch period I understand but then it had been in the prior year. And you certainly see little elevation in terms of promotional activity around the Black Friday and Cyber Monday time period as well.

Ana Goshko

Okay. So the other side of the coin the subscriber growth is obviously the growth side attracting that had the new customers. What is the hook now? I mean what attracts a new customer to Sprint or what's the strategy for that? And then as part of that do you believe that the publicity over the merger has impacted negatively actually store traffic and consumers perception are concerned that in terms of coming to Sprint?

Andrew Davies

Yes. I think the hook as you put it goes back to the foundational elements of our strategy, which is the best unlimited price plan and the network built for unlimited. So we still offer the best pricing at a given --for a given product set and a given service set. And we've now --we're now significantly improving the network, right, we got faster download speed, we got better coverage and again we get into that later on. So in terms of the customer proposition, it's actually --it's probably now more compelling than it ever has been right. I mean best value for money and now we're getting much, much closer towards network parity towards this-- towards the second part of your question.

Yes, I think we do see a fractional kind of slowdown in foot traffic and door swings into --

Ana Goshko

And you attribute to potentially some concern or confusion over what the merger means?

Andrew Davies

Yes.

Ana Goshko

Okay.

Andrew Davies

But, again, we've still got a share of growth signs in the market which far outweighs our average market churn when look at the total customer base. So we're still over indexing on share of gross signs relative to what you'd expect.

Ana Goshko

Okay. And looking at prepaid so prepaid generally has been within the industry a soft spot, there's been some slowing growth there. I think the company has highlighted that. I've done a lot of work on the Boost brand. So the Boost brand has been strong, but one of the initiatives within Sprint in recent times has been to proactively migrate prepaid customers to postpaid, but within the prepaid brands and particularly within boost brand. So wanted to understand --

Andrew Davies

What was going on there? Yes.

Ana Goshko

What's going on? The strategy, how that benefits you?

Andrew Davies

Yes. So let's just level set on kind of Boost first of all. So as you alluded to making really solid progress within the Boost brand generally 200,000 net adds this last quarter before we talk about the migration activity. I think seven consecutive quarters now of net adds in Boost. We've got nine successive quarters of year of churn improvement and that all goes back to the work that we did a couple of years ago improving distribution and on how we went to market with that Boost brand.

So very, very happy with how that Boost brand is delivering performance for us. So what we're doing in terms of the migrations is and unless it is all to do with the gradual convergence of prepaid and postpaid over time anyway in the fact that the economic conditions have kind of helped everybody at. So we've looked at our prepaid customers and said, look, there's a number of those customers which would benefit from a postpaid like proposition. So we don't have enough history and enough data on them to actually run full credit verification processes, but what we do is we look at tenure and we look at the frequency and the amounts with which they recharge and top-up et cetera.

And if customers fit certain criteria within that we then contact them proactively and offer them the ability to step into some of our device financing propositions. The thought process for us is that that kind of creates more stickiness with that customer maybe gets them to elevate their ARPU a little bit as well. So when they take that offer of the device financing that then to us makes them look like more of postpaid customer than a prepaid customer. So we migrate them or transfer them from prepaid to postpaid. But they're still within the Boost perimeter, right. So they still sit on the Boost billing architecture et cetera.

Ana Goshko

Okay, got it. And that does entail device financing. So there is an upfront cash outlay that Sprint incurs but obviously you calculated that the NPV to Sprint with a reduced churn over time is positive.

Andrew Davies

Absolutely, absolutely. Yes and we're not stepping these people up into iPhone 10 S5 12 gigabyte devices, right. I mean these are getting --these customers are still getting some 6s and 7s. So the upfront cost for us is actually not massively different than if they took a subscribed prepaid device.

Ana Goshko

Right. And then you recycle handset so held from postpaid into the prepaid sector, is that --

Andrew Davies

Well, we --it's not as binary as that. I mean we recycle handsets period. So we've got a lot of devices every single month that come back to us via reverse logistics that result the kind of the leasing program that we have on postpaid. So when we --when those devices come back, we grade them; we recondition them, if possible and sell them as certified pre-owned or sometimes we'll just choose to dispose of them by auction. And make a margin in doing so.

Ana Goshko

Okay. I think you touched on this already, but if we move on to network spending. So, again, I feel that there's a real balancing act because as part of the merger there is a plan to integrate the networks and it's going to take three years, the companies have said it's going to cost $10 billion with regard to integration costs. The same time Sprint's got still run its business and improve its network. How do you balance to make sure that the network spending that's happening now is not kind of stranded or wasted capital once the merger is completed?

Andrew Davies

Yes, look, I mean it's probably not as much of a balancing act or as much as a dilemma as you might think, right from the upside looking in --

Ana Goshko

And let me -- are you rationing spending right now on the network?

Andrew Davies

No.

Ana Goshko

No, okay.

Andrew Davies

That's firm no. So the integration costs, you mentioned that $10 billion. I mean a lot of that is not --is actually just to pay off for long- term cell site leases that either T-mobile or Sprint would have, right. It's now actually related to dismantling of network equipment per se. So we're not spending quite a bit more money on the network than we did this time last year, right. So we spent well nearly $1.4 billion in this last quarter which is basically double year-on-year. We spent $2.4 billion year-to-date through September. And we now we've guided we change the guidance a little bit too somewhere between $5 billion and $5.5 billion on a full year basis.

So we are rolling out the network. We are fulfilling kind of on the network, the next-gen network initiatives that we've discussed. We just put in the third part of, one part of the strategy. So what is that involved? So it's rolling out 2.5 gigs across the majority of the cell site by the end of this year. We're already at 70% compared to 50% last year. We are densifying the network. So we've now got more than 20,000 small cells in place compared to maybe 2,000 a year ago of. And a lot of those are kind air strands which we'll talk about later I have no doubt. And then there's the rollout of massive MIMO. So all of these things are going to be foundational for the merged company assuming we get the merger approved.

So we don't see that there's much risk that any of the capital that we're currently deploying this year is going to end up being stranded. Because the most company will need 2.5 gigs for the spectrum fully deployed. It's going to need massive MIMO. So it's going to need the densification of the small cells, by small cells.

Ana Goshko

Okay. Because this is a debt conference and you've got a lot of your capital structure in the room right now. The whole lot of your capital structure in the room. So let's touch on this. So when you came to Sprint and you got a good look at the free cash flow profile which this year is still negative. And how the guidance for the year well recently improved is still negative $500 million to negative $1 billion and among the four national carriers Sprint certainly has a highest leverage. What did you think and what's your comfort level running this business with this free cash flow profile and this capital structure?

Andrew Davies

Good question. What do I think? Well, I was very pleased with what I saw actually. In the sense that I'd been in far, far more difficult capital structure and cash flow situations quite frankly. And you look back what the Treasury team and Michelle as CFO has done prior to me arriving. And they had done a really good job in putting in place a pretty robust capital structure and liquidity profile. I know kind of historically Sprint had been very dependent on a high yield market which then couple years ago became very difficult. So they put in place some quite innovative and complex structures, spectrum financing, securitization of leasing and IB receivables et cetera.

But in terms of the capital structure, I was very pleased because it was one less thing that I had to focus on and the certainly in the short and medium term as the CFO because it was -- we'd already kind of fixed what needed to be fixed before me --my arrival. And we've got a very, very strong liquidity profile over $9 billion of cash on the balance sheet at the end of the last quarter, which meant that we had certainly a structure that was fit for purpose this side of the merger. Now, obviously, we've done a little bit of work since then because one part of my role right is to be every so often is to kind of look at the downside scenarios and prepare for those downside scenarios and engage in at times some relatively conservative risk management.

So we've recently improved the liquidity again by expanding the term loan B by just over a billion dollars and more importantly in many regards from my respect putting in place this amendment to the term loan B documentation which then allows us to potentially significantly up size the spectrum notes if the merger didn't get approved, and if we had to pay for standalone life.

Ana Goshko

Okay. So you've superseded my question. So reading into that, the amendment which would allow you to under the credit facility issue more spectrum secured notes is really like an insurance policy that you put in place proactively.

Andrew Davies

Yes. I mean I view as an insurance policy and that's the way that I kind of laid out for the Board when I needed to get approval from the Board to do this last series of financing transactions.

Ana Goshko

Okay. On the free cash flow side, the company has -- is effectively guiding to an improvement so and has said it believes it can achieve breakeven free cash flow. So from going from a burn of about $500 million to $1 billion to breakeven in FY2019. What's the driver of that?

Andrew Davies

Well, there's not one single driver, but it's again it's all real kind of solid operational things. Right. So there's no financial engineering in there. So, first of all, like we haven't talked about it so much but this last quarter we returned to wireless service revenue growth year-on-year. We expect that level of wireless service revenue growth to continue for the foreseeable future.

Ana Goshko

And that's driven really by the ARPU.

Andrew Davies

It's driven by the ARPU by kind of how we've rethought the commercial equation as I refer to earlier and the balancing of gross adds churn upgrades, ARPU, promotional offers et cetera. But, yes, so we return to wireless service revenue growth. Now we don't expect that level of growth to expand materially, but we do think that the level of growth that we've now got is sustainable. So once you get through a few quarters of that, all of a sudden you start to generate year-on-year wireless revenue, service revenue on a full year basis. So there's a revenue growth story. We didn't talk about it earlier but even though we've made significant cost reductions in the past, we still think there's room to grow to get more cost reductions more in the digital-- digitally enabled space.

Whether it's through the use of improved analytics to improve decision making or just the deployment of artificial intelligence automation et cetera to speed up and simplify and therefore reduce the cost of all of our major processes. So that will lead to obviously-- those two things will lead to EBITDA accretion which is kind of the main thing that drives cash flow. But also we are working on the various working capital initiatives. I mean one of the things that I'm focused the team on much more this year is driving working capital improvements. So whether that's in just good old-fashioned renegotiating of vendor payment terms or putting in place supply chain bank financing to help vendors.

Again working with vendors to improve the logistics processes around both device supply chain and network equipment of supply chain and basically almost leaving no stone unturned in terms of all of the asset side of the balance sheet. So there's a many different buttons and levers that we can push and pull that will result in us having the path towards at least cash flow breakeven.

Ana Goshko

Okay. And as the CFO, so I think of a lot of spending decisions have to come to you to get a sign-off. Does the state of the balance sheet; the leverage, the free cash flow profile, does that constrain the company from any desired spending or investment areas promotionally, network wise, investment wise?

Andrew Davies

No. It doesn't. We -- I really don't feel that my decision-making is constrained at all by any balance sheet or liquidity considerations. Yes, the constraint that we put in place in which I'm probably the biggest proponent of is what we discussed earlier which is, hey, I want to make sure that if we are going to spend money-- we're either going to get the bang for the buck this year or I know I'm safe investing in this area because it's been to survive the merger. And we --I'm sure that we're going to get long-term value creation out of it.

Ana Goshko

Okay. While I've still a few minutes I'm curious I wanted to ask you on your as a newcomer of fresh pair of eyes coming into the US wireless industry, what's your view on cables role? I guess Comcast in particular is the most active and I think you've got some background. We've learned from Comcast MVNO relationship with Verizon Wireless, but are they having an impact within the industry and do you believe on an MVNO basis that they really can ultimately ever become kind of serious players in wireless?

Andrew Davies

It's probably a little too early to conclude on the latter part of your question. I think its early days, right. So they've got maybe on a quarterly basis now a few percentage points share of gross adds. So mathematically it is obviously an impact there. We don't see much impact when we look at our porting characteristics right. But, yes, there's clearly an impact but given what I said earlier about the competitiveness of the marketplace just within, if you will, the legacy wireless operators. You don't really know this the cable operators right now being more aggressive than anyone else.

I mean it'll be interesting to see in a few years time if they develop scale. If they then become much more aggressive, but yes I would imagine I mean and this is certainly what I would be doing if I was in their situation. The people that you acquire in the first instance, you do so almost completely under the radar because you're just reaching out in a very isolated discreet manner and proactively to your existing cable customer base. And then you ring fence the promotion. So it's actually, it's not really visible to the marketplace generally what you're doing so.

Ana Goshko

Okay, great. So we didn't touch really on the merger regulatory aspects. We had a session yesterday. We had Andy Lipman here, and he gave us some his views and we had a good discussion on the prospects for the regulatory approval there. And we understand that's Marcelo Claure's job, and you're the man here kind of taking care of business well. Marcelo is out working on the regulatory approvals. So you think, and thank you very much. We wish you the best of luck in the next couple of months. So some big decisions to come out of DC on the merger and hoping for the best. And, Andrew, thank you so much for being with us.

Andrew Davies

Thank you. Appreciate it.

Question-and-Answer Session

Operator

[Operator Instructions]

End of Q&A