AT&T Inc. (NYSE:T) Morgan Stanley European Technology, Media & Telecom Conference 2022 November 17, 2022 6:20 AM ET
Company Participants
Pascal Desroches – Senior Executive Vice President, Chief Financial Officer
Conference Call Participants
Simon Flannery – Morgan Stanley
Simon Flannery
All right. Good afternoon, everybody. I’m delighted to have Pascal Desroches joining us from AT&T. Welcome to Barcelona.
Pascal Desroches
Thank you for having me, Simon. Good afternoon, everyone.
Simon Flannery
So, before we get started, please note more research disclosures on morganstanley.com/researchdisclosures. I believe you have a safe harbor as well.
Pascal Desroches
Yeah, I think you should refer to our website. Some of the statements we’re about to say are forward looking, and therefore, subject to uncertainty. You can go to our website for more details.
Simon Flannery
Great. So it’s been a busy year for AT&T. For those of you in the audience who are not as familiar perhaps with the story, perhaps just take us through what happened, where we are and the priorities as you go into 2023?
Pascal Desroches
Yeah. Look, again, it’s such a pleasure to be here. This is my first trip outside of the US since the pandemic. So it’s really nice to be here and tell you a little bit about the AT&T story.
AT&T has had a change in management probably that goes back now to around two-and-a-half years. I was new as the CFO. And the CEO, John Stankey, although he had been with the company for years, he’s now the CEO getting to make all the decisions. So you have a company that had a number of different businesses that were about to hit an investment cycle. You had very high debt levels. You had a much higher dividend, absolute level of dividend nearly twice what the current dividend is.
All those things created an untenable situation. And what we did is we systematically got the company to focus much more on its core business, connectivity. We separated Direct TV. We separated Warner Media. We have deleveraged significantly since two years ago. And at the same time we’re doing that, we’re investing significantly in both the media business and our connectivity businesses because they, understanding we had work to do on the balance sheet, but time was of the essence to reignite growth of AT&T.
And where we are, we have two key areas of focus right now. We’re a pure play connectivity company, we’re focused on fiber, which we believe is the fixed technology that will be required by any consumer who can have it if you fast forward 5 to 10 years. And given the long lead time for the investment cycle, it’s critical that we act now in urgency to make sure that we are able to participate in the very favorable sectoral dynamics.
Then, we also invested significantly in spectrum. And over the last two years, we’ve invested nearly $37 billion in spectrum. And the last two years, we’ve also stepped up our competitiveness in terms of customer offers.
All those things leave us a point where our wireless business, which is roughly 70% of the company, is growing revenues, ARPU and growing EBITDA. And we expect that to continue as we look forward. The secular dynamics underlying wireless remain very favorable.
Fiber, we grew fiber revenues nearly 30% last quarter. And as we’re rolling out fiber, we were able to penetrate. Customers want it. It’s a better technology than cable offers. And it’s at a discount to the cable offerings. So, better technology at more attractive price points and ARPU there is also growing.
So, no, look, needless to say, really proud of the work we’ve done the last two years. As I look forward, there’s more work to do, in particular. We need to do more in hitting the middle of the P&L and driving operating leverage across our businesses. And we’re committed to doing so. And I think you see from the new management team, we are very focused in acting with purpose.
Simon Flannery
Right. So great overview. So one of the big overarching themes at the conference or backdrops has been the macro question. You had noted extended payment terms in Q2. It seems like that stabilized in Q3. But just update us on what you’re seeing from the consumer and on the enterprise side.
Pascal Desroches
Let’s start with the consumer. Overall, the consumer in the US remains pretty resilient. And customer demand remains pretty healthy. And it’s one that, coming into this year, we expected growth in wireless to moderate some. Well, no. Nine months in, we’re really happy with the pace of business. And it’s really healthy.
With that said, during the two years of the pandemic, what we saw is incredibly low delinquencies, low churn, and the ability to collect really quickly as consumers were sitting with government stimulus checks. As some of those forms have been used up, what we’re seeing is a normalization of the collection cycle back to pre-pandemic levels. And that’s part of what we saw and that’s part of what we announced earlier this year.
We’re also seeing an uptick in delinquencies back to – actually, it’s slightly worse than pre pandemic levels. All, in my mind, signs of nothing alarming, but at the same time, something we have to keep a close eye on as we look out the next several quarters because it’s only a matter of time. When inflation persists at the rates it’s been, it’s only a matter of time before the consumer begins to really feel the effects of it.
We all saw the Fed report that, in the US, we had the highest jump in credit card debt since 2007. So, that tells me the consumer is starting to feel a pinch. And these higher interest rate levels, credit card debt will be very expensive to maintain. So, all those things cause me to be somewhat cautious.
But, candidly, when I think about where we are as an industry and as a company, the last thing the consumer is going to turn off is their wireless relationship. You need it to live, you need it to work, and it’s one that I think we are as resilient as any to economic challenges.
Simon Flannery
Great. And on the enterprise side?
Pascal Desroches
On the enterprise side, look, my expectation is, over time, enterprise will probably be more exposed than consumer. But with that said, right now, enterprise has been going through a secular decline on the wireline side on the wireline side, which is the majority of that business, and that has continued.
I wouldn’t say that decline has accelerated because of economic conditions. So it has continued at the same rate that we last reported. But when I think about – companies are faced with real economic challenges, they may all of a sudden decide, you know what, this legacy phone line is probably not a priority for me and let me accelerate the decline. But so far, we haven’t seen any of that.
Simon Flannery
Right. You touched on inflation there. So just can you talk through your exposure to energy prices, to salary above normal, and how you’re addressing that with your productivity initiatives?
Pascal Desroches
Sure, thing. Look, like all companies, we have been impacted by inflation. Since late last year, our CEO started to talk about inflation and the concerns that it would linger. And we’ve seen it in labor. We’ve seen it in energy. We’ve seen it in materials. We’ve seen it in shipping, with transportation costs. All those things did hit us. We had planned for a healthy level of inflation in our plans this year. But relative to those initial expectations, we have been exposed to the tune of over an incremental billion dollars above those in our planning assumptions.
And what we had done to offset that is that, earlier this year, we did some targeted price increases in some of our older plants where we haven’t engaged with consumers recently. And as a result of those targeted price increases, the goal was to help upsell those consumers to our higher price plans. Let’s engage with them. Let’s upsell to our higher price plan. And it has worked out slightly better than we were anticipating. And it has been an accretive move for us.
We’re also continuing to really drive savings through our cost transformation program. The way to think about that is we are trying to drive efficiencies across our distribution channels. Over the last two years, we have shuttered many of our owned and operated retail outlets. We are using digital technology more and more to help drive customer acquisition and customer self-service and upgrading your phone. And we are in the very early innings of that. I think the opportunities there are very attractive.
When I think back to the start of the pandemic, we had to build new muscles that we haven’t had historically. We’ve gotten much better at using our digital channels, to service customers, we’ve gotten much better in using digital technology and customer self-service in dispatching fiber and minimizing the number of fiber truck rolls that we have to do. All those things, we’ve had to build the muscle because of the pandemic. They will benefit us for years to come.
Simon Flannery
Great. Yeah, it’s amazing how the wireless industry is still so dependent on the retail store experience. But I guess, over time, we’ll gradually evolve.
So let’s dig deeper on wireless, if we could, Pascal. You hinted at it in your opening comments. But it’s been a series of strong KPI results over the last few quarters here, better than expected, and often leading or close to the lead in the industry. And that’s quite a contrast from a couple of years ago where AT&T really hadn’t been growing wireless subscribers. So, what’s driving this? And is it sustainable?
Pascal Desroches
Here’s the way I would break it down. First, at the industry level, we’ve seen elevated industry growth in a variety of factors. Small business formation – small business gets started, they’re not going to get a wireline line, they’ll give their employees wireless. The chances are the employee already had a wireless connection. They’re not going to change their number because everyone they know has it. So, all of a sudden, you have people with two phones, you have families getting phones for kids at younger ages, you have seniors for years didn’t think they needed phones all of a sudden – during the pandemic, you want to see your grandchildren, you’re going to probably learn to use an iPhone. So all those things are helping increase the industry growth.
And what we’ve also done, for years, when we were spending on – we had to spend on media, Direct TV and others, we probably weren’t putting the right level of resources after – against our wireless business. And in 2019/2020, we stepped up our investments to match those of peers.
And the way we did it was a little bit different than our competitors. Instead of simply providing offers to new customers, we wanted to make sure we kept our existing customers because our churn was higher historically than others.
And what that did is we offered the same exact promo to existing and new customers. It lowered our churn. It’s a much more efficient way to acquire subscriber is to keep them. We did that. We also reorganized the way we went to market, giving more decentralized authority to different geographic regions.
Additionally, this is really important, one of the benefits that AT&T has is it has great enterprise relationships. And we have done a much better job the last two-and-a-half years of leveraging those relationships to drive additional wireless customers. We built our FirstNet network. And that has also been a source of new customers. So we’re doing a lot of things right. And we are now able to compete on a level playing field. And I will put my team up against anyone and once they have the right resources.
Simon Flannery
Great. So, there is a lot of concern about the competitive environment. We have the cable companies, we have Dish, how do you see the competitive environment now and going forward? And how does that play into industry pricing ARPU trends, et cetera?
Pascal Desroches
Let me try and break this down by the different – I’m going to hit first cable, which is – cable right now has been gaining share. My belief is they’ve been gaining share because one of my competitors has made a conscious decision to say, okay, I’m going to probably take better economics at the sacrifice of smaller share.
And so, what has happened is where the share losses have happened in the telcos has been the biggest competitor, and as a result – but it’s getting 80% of the profits back through the MVNO agreement.
So, you look at that, that was a trade they consciously made. Right now, cable doesn’t have a wireless network, as we all know. Are they going to go out and build a wireless network? Pretty expensive. They also have a big upgrade in the last mile that needs to happen. Are they going to prioritize building a wireless network over doing that upgrade? There’s also massive amount of infrastructure money trying to tap into the cable profit pool.
When I start to think about all those elements, like, is it possible that they come in? Maybe. But is it likely? Probably not. And then, you look at – you mentioned this, we have a really good MVNO agreement with them. It’s attractive for us. And we think we have the capacity to deliver it without impacting our network. And whether they will build the network, we’ll see, but it takes time. It takes enormous resources. And we’ll see.
And these T-Mo and Verizon, the industry construct is healthy. Do I see the participants denigrating profits through a massive pricing war? I don’t see it. When you look at the behavior, everybody’s behaving quite rationally.
Simon Flannery
Great. So you talked to the outside about the focus on 5G? Can you update us on the deployment of 5G? And how do you monetize 5G?
Pascal Desroches
We started this year with a deployment plan that started after our major competitors. And what we’ve done is we said we were going to cover a population of 70 million by the end of this year. We are now over 100 million pops covered. And we expect to end the year at above 130 million. So we are deploying…
Simon Flannery
It’s with C-band and 345.
Pascal Desroches
This is our mid-band spectrum. And we are deploying faster than we thought. And it’s really – I think the team has done an exceptional job of driving in the build process. And the quality of the spectrum is better than we thought in terms of its propagation. And so, we’re able to do it faster. And hopefully, over time, it will be more economical. That’s the point. So, all those things are positive. And we expect to – we haven’t provided updated guidance. The last guidance we provided was to get to 200 million pops by the end of 2023.
Simon Flannery
Okay, but you’re ahead of that plan.
Pascal Desroches
We are ahead of where we thought we would be at this point.
Simon Flannery
And monetization?
Pascal Desroches
Monetization. There’s a lot of talk about 5G right now. And I do believe, over time, there will be fabulous use cases for 5G. When you think about the network splicing capabilities, things like autonomous driving where you need very low latency, there are going to be great use cases. They’re not here now. That’s probably why you haven’t heard us talk about them as much as perhaps others have. They’re not here now. They’re probably not going to be meaningful to us as a company or even as an industry until probably, I’d say, 2025, you’ll start to see more evidence of it in 2024, as everyone has rolled out their 5G core, you have developers starting to develop on it and develop new products and services. But until then, it’s really not going to be that meaningful to the overall businesses. So, are we excited about it? Absolutely. But is it meaningful today?
Simon Flannery
And you’ve taken a very different approach on fixed wireless to your two major competitors. You do use it in rural markets. But how does your view of that differ?
When you think about our business, the lead times are long and they’re expensive. And you do it because you want to create a sustainable – you know you’re going to create a sustainable business model that provides returns for years to come. And so, we feel really good about our investment in 5G and fiber.
Fixed wireless, when you look at customer acquisition costs, how much does it cost to acquire that customer? How much does it cost to maintain that customer and expand the capacity of your network to serve that customer?
Look, consumers think it is sufficient in terms of quality. If you look at the price point at which it’s offered, our conclusion is it’s really not where we want to spend our time and effort. Instead, it could make sense in places where fiber is going to come in a few years, it could serve as a catch product to our legacy copper. It could make sense in certain rural areas, it could make sense in certain enterprise temporary construction zone. It’s like that. But it’s not one way we think it’s – we want to prioritize our scarce capital and going after.
Simon Flannery
Well, let’s pivot to the consumer wireline and the fiber side. And if I can start with this convergence question, we used to talk about triple play for a long time. But now, it’s looks like the survey work that we did with Ben and team recently showed that the wireless plus broadband bundle is now overtaking the video plus broadband bundle. So how do you think about the importance of that model?
Pascal Desroches
Apologize in advance, going to talk our own book. We are the only the only company that is a scaled principal in both. We are the largest fiber provider. And when we think 5, 10 years from now, I just don’t see consumers accepting anything other than fiber. We’re building it as fast as we can, while at the same time deleveraging. And also, I think the power that 5G will bring will make wireless relationships even more valuable. And we are able to provide both with our owners economics.
And when we offer both, we see an uplift in our wireless penetration, a meaningful uplift. One of the things that we realize is this, when we bring fiber to a consumer, they love it. And it’s much easier to sell them on, hey, we also have a great wireless service. So having that and the perception that fiber brings from a quality and consumer affinity is just extraordinary. So, it’s a play we really believe in. And I think we would generally earn a lot more. And the returns are much more attractive if you have both customers. And it’s one we can offer as principals.
Simon Flannery
So talk about the results of your deployment so far and the projections. You want to get to 30 million homes by 2025. There’s been a lot of talk about challenges some folks are facing with permitting, supply chain, labor availability, how’s your build going and how is the penetration working out?
Pascal Desroches
Our build is going really well. And so far, what we said publicly is, by 2025, we expect to get to 30 million plus homes. Roughly 25 million plus consumer, 5 million business. We are at the end of the third quarter, 18.5 million consumer, 3 million business. And where we build fiber, we are penetrating very well. We’re penetrating probably twice the level that we have historically.
The long pole in the tent is really getting fiber to a location. Why we penetrated faster than historical levels, I think consumers now are getting much more sophisticated about the benefits of fiber. For years, cable was good enough. It was easy to differentiate, given the products available. Now with everyone working part time, at least some of the time from home, the benefits of fiber are coming through and through and it’s delivered at a more attractive price point. So, we are really happy with the deployment and how it’s going, and we’re committed to continuing to deploy. And as I said earlier, our ARPUs are higher than we thought. Our ARPUs grew 7% last quarter. And the intake ARPU is higher than the average ARPU that we posted.
One of the gating factors is how quickly can we roll it out. What’s important to us is making sure, while we’re rolling it out, we continue to delever our balance sheet, to give us more operating flexibility long term.
And it’s just – on that, I think we’re trying to serve both. I think when you look at AT&T, being the largest fiber provider, we have preferred access to supplies, to resources to build, and we know how to work through the permitting issues very well. So, I think we have a core competency that is going to serve us well for years to come.
Simon Flannery
And what’s the latest on exploring partnerships or joint ventures to help accelerate or expand that footprint?
Pascal Desroches
For those who are not, there were rumors about us exploring a joint venture. And I’m not going to comment on that specifically. But where could potentially some sort of partnership make sense. It would be, one, a financial partner that brings capital, but we are able to bring our expertise and scale and our supply contracts to an area we probably wouldn’t get to otherwise during the next few years,
Simon Flannery
And this maybe would [indiscernible] or something like that.
Pascal Desroches
Yes. And then three, can we bundle our wireless relationships? All those things, you’d have to conclude that all those things work and the returns are attractive? And if things lined up, of course, we would look at it.
Simon Flannery
Great. You touched on business wireline. I think you’ve said that you do expect some of these secular trends to abate over time. Can you update us on what’s your latest thinking is there?
Pascal Desroches
Our business is wireline. As I mentioned at the outset, the vast majority of our revenues are in legacy communication services. That’s declining, and that will continue. As we are deploying fiber, we are targeting – going after small and mid-sized markets more aggressively. Candidly, we have probably not done as good of a job as we should do in tackling that market. And now, with our fiber deployment, with more resources, that’s a market we think we can compete very effectively and then take share over time.
I also think 5G over time will be a real growth vector on the enterprise side, even more so than the consumer side. But that’s a few years away. So in the meantime, what you will see is growth in fiber being more than offset by legacy declines in communication services, but we’re also hitting the cost basis of that business very hard. We’re rationalizing products. We’re using more indirect distribution streams to drive more efficiency in customer acquisition. So we’re doing all the right things, but it will be a few years of a transition to that business. But I feel really good about the future. You will get to a point where fiber revenue growth and 5G services will create an overall revenue growth.
Simon Flannery
But what happens in consumer wireline?
Pascal Desroches
Absolutely. And we are a few years away from that, though.
Simon Flannery
Direct TV, you’ve deconsolidated, but you still have a large equity ownership in it. So it’s hard for us to see the performance. Maybe you can just share, how is it performing versus your expectations and your confidence level in the cash flows that you are expecting from there?
Pascal Desroches
Overall, look, here’s what I would say. The business is performing much better than we thought. You think back to two-and-a-half years ago, almost immediately, the first question AT&T would get on earnings calls, Direct TV is declining more, what are you going to do about it. And we did something about it. We put it in the right capital structure, we partnered with TPG. And the leadership team there, led by Bill Morrow, has done an outstanding job in optimizing that business. They’ve taken a lot of costs out, there’s a lot of profits and cash coming out of that business. And, candidly, the cash is better than we anticipated at the time we did the transaction. The transaction has worked. We did it for the right reason. It is working out really well for us, but team’s done even a better job than we expect them to do in managing that business.
As you look forward, what do I think will happen? Of course, the cash flows are going to decline, but they’re still going to be very meaningful. They’re going to be very meaningful. And we’re at a point in the distribution waterfall that the vast majority of the cash is going to come to us. Other than tax distributions to TPG, the cash comes to us because of the way that we constructed the distribution waterfall. So, all in all, it’s an asset that I think we have optimized. We put in a very good place.
Simon Flannery
Great. And what’s your interest in strategic options for that unit?
Pascal Desroches
No surprise. If there is a way to create value beyond what we think we’re going to get, you would obviously look at it. But right now, we put the business in a place where we’re only going to do something if it creates incremental value. There’s no burning need to do anything.
Simon Flannery
Right. Let’s turn to the balance sheet and capital allocation if we can. You talked about deleveraging a couple of times, both what you’ve done with the various divestitures and prospectively as well. So, there’s a lot of talk about rising interest rates here. I think you’re actually talking about your interest bill falling next year. So, perhaps just take us through your balance sheet as it’s now structured in terms of duration, fixed floating and the interest expense.
Pascal Desroches
I will give our treasury team enormous credit for the work they’ve done the last several years in really helping us foresee what was likely going to be on the horizon? What we have done in addition to delevering – we’ve delevered substantially – but we still have, call it, $131 billion of net debt on our books as of the end of the third quarter. That debt has an average maturity of 17 years, 95% of it is fixed. And the way the maturity towers have been constructed, we have the ability through free cash flows after dividends to pay that down. And so, while clearly, like anyone else, we have some exposure to refinancing risk, it’s not at all significant. 95% of it fixed at 4% rate of interest, pretty darn good. And having that sort of cost of capital is a real strategic benefit for us at this point.
Simon Flannery
Great. And your target remains 2.5 times.
Pascal Desroches
It is. In my mind, I think we never want to get the company back to the place it was a couple of years ago. In order to do so, we think it’s really important to be solid triple B, such that we have the access we need to the market. And we’re able to get reasonable cost of borrowing. And that is a real benefit and a real source of competitive advantage. And we don’t want to give that up. So we are committed to getting down to 2.5 times. At the time, when we do get to 2.5 times, we’ll consider. Do we do buybacks? Do we raise the dividend? Do we invest more in areas like fiber? Or do we continue to delever in an interest rate environment that is really high and where we may get differentiated terms between BBB and BBB+. Maybe we continue to delever, but no decision to be made until we get to that 2.5 times.
Simon Flannery
The capital spending, you’re obviously going through some pretty big projects right now. Can you just help us understand the near term and medium term outlook for CapEx, including, I guess, Q4?
Pascal Desroches
Yeah. Let’s start with this year, we guided to $24 billion through the end of the third quarter. We went at $19.5 billion. So we reiterated our guide of $24 billion in the third quarter. So what that’s telling you is we’re going to spend around $4.5 billion. That compares to $6.8 billion in the third quarter.
So one of the questions I’m often asked is, how are you comfortable you’re going to be able to hit the $14 billion. If you take third quarter free cash flows of $3.8 billion, you add on to that an incremental 2 plus billion dollars through lower CapEx. That’s why I feel comfortable what we’re going to be able to deliver.
As we look out, what we said is, we expect next year to spend comparable to what we’re spending this year. And both 2022 and 2023 are elevated because of our C band deployment. And the amount that we’re investing in our transformation efforts, upgrading the underlying technical infrastructure of the company. So once we get beyond 2022 and 2023, CapEx should moderate down to around a $20 billion average.
Simon Flannery
And it still includes a lot of fiber builds, right?
Pascal Desroches
It still includes a lot of fiber build. And indeed, it also allows us to continue to delever. If you think about where we are, I’ve said free cash flows are going to grow next year relative to this year. And as we see the declines in CapEx, that should provide further operating leverage in free cash flow in the out years because they’re allowing us to continue to delever.
Simon Flannery
Great. And just following up on that, 2023 cash flow, I know you’re going to give us more detail in January, but just go through the piece parts that makes you confident in that. If the CapEx is flat, obviously, interest helps a little bit, but what are the other moving parts that gives you confidence in growth?
Pascal Desroches
So here is the way, look, I simply put. We’re going to grow this business and we’re spending at the levels that we expect to grow the business. Why do we expect to grow? Our wireless subscriber base is much higher than we started the year and much higher than we expected to end 2022. That pace is at higher ARPUs. There are transformation savings coming in from the work that we’ve been doing. That will be a growth driver. We have things like 5G costs that we incurred this year, we’re not going to incur next year. So all those things give us confidence we’re going to grow EBITDA and relatively flat CapEx, lower interest, improved working capital, being offset by higher taxes and lower DTV distributions. That’s the way to think about our cash flows. And we’ll give a lot more detail when we record our fourth quarter results in a few weeks.
Simon Flannery
Great. Well, Pascal, unfortunately, we’re out of time. Thank you so much for your time today.
Pascal Desroches
Thank you. Thank you for inviting me. Thank you.
Question-and-Answer Session
Q –
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