Lumen Technologies, Inc. (NYSE:LUMN) Goldman Sachs 2022 Communacopia + Technology Conference September 15, 2022 1:45 PM ET
Company Participants
Chris Stansbury – EVP & CFO
Conference Call Participants
Brett Feldman – Goldman Sachs
Brett Feldman
Well, it’s my pleasure to welcome to our Communacopia + Technology Conference. A new participant, Chris Stansbury, new — recently new Chief Financial Officer of Lumen Technologies. Chris, thanks so much for being with us.
Chris Stansbury
Great to be here. Thanks.
Brett Feldman
Let me do a mic check. Is this thing coming through okay back there? All right. So we saw the news earlier this week that Jeff Storey is going to be retiring after a very distinguished career, and that Kate Johnson will be stepping in as the new CEO in November. And just as a very small pre-ample, Jeff was a long tenured speaker at Communacopia, and we always had a great conversation. So it was a bit bittersweet for me. But please pass along my congratulations to him on this great time in his life.
Question-and-Answer Session
Q – Brett Feldman
My question for you is, do you have a sense for what Kate’s priority is going to be for Lumen?
Chris Stansbury
Yes. I mean, first of all, let me thanks for the kind words on Jeff. Jeff, I’ve only worked with him a short time. He’s great to work with. He and I had a very open dialogue about what, ultimately, was going to be his transition when I joined. And when you look at where he’s positioned Lumen, I think we are really in a much better place to succeed. We’ve focused down the organization with the trend what not so that the consumer space is more focused and focused on growth products. And the same is true in the business segment when you look at our growth portfolio.
So when you think about Kate coming in and you look at Kate’s background — hockey fan, all right? Think about Wayne Gretzky saying, you don’t go where the puck is, you skate where the puck is going. And that’s really, I think, the skill set that Kate brings, which is the way Lumen will monetize what is a very strong network, a network that people would kill to have.
It’s about the service layer and how we bring services that logically should reside on that network that consumers need and want. And so there’s been a lot of work that’s been done on that, that as I said, Jeff has positioned us for. But I think Kate will only take us further in that regard. So I’ve talked to Kate, but I think that’s really where her focus will be, and we’ll learn more as she gets onboarded.
Brett Feldman
Well, as I mentioned, you’re recently new to Lumen. You’ve been with the company for, I guess, a little over five months now. Can you share your thoughts on what you’ve observed so far and how that’s shaping your outlook for the company and really your more immediate priorities?
Chris Stansbury
Yes. I mean, I came to Lumen because I believed in the growth mission that Lumen was on. And I’ve been part — my previous role of an organization that was in a slow to no growth environment, and then was able to transition to more of a growth mindset and the performance followed. And that opportunity, it definitely exists at Lumen.
And when you look at what Lumen is today and the portfolio that exists today, I think you’ve got a group of dedicated people. It’s an interesting mix because you’ve got a lot of the legacy telecom kind of knowledge that’s critical, particularly for longer-lived products and assets.
But you’ve also got a group of people that have developed a lot of cutting-edge solutions for today’s needs, whether that’s Edge or SASE, as examples. And so when I got into Lumen and then we started to unpack that, I saw a real opportunity to improve investor messaging but also, frankly, improve the way that we were driving performance internally.
So when we last quarter started to disclose more around what was in the enterprise bucket. I guess something to back up is, in the Q1 earnings, we disclosed a lot more around the consumer business, right, and what was going on with Quantum Fiber. And then in the second quarter, it was really about more disclosure around the business segment. And the product life cycle approach that we laid out wasn’t just an external messaging thing, it was increased focus internally on how we’re going to manage, how we’re going to allocate resources, how we’re going to hold people accountable. And so the company has done some shifts in terms of org structure, so there’s dedicated people now managing each of those product portfolios.
And in that, we think there will be longer-term value. So we’ll make smarter resource allocation decisions will drive better EBITDA as products get further along in their life cycle and the people that are focused on growth are going to be incented to drive that growth.
So more to come, and I think we’ll continue to give more disclosure as appropriate so that the investor community can get better insights into what we’re doing. But I’m excited. I really think good things are going to come in the next few years.
Brett Feldman
I want to follow up and talk about sort of the new reporting format that you alluded to and how it’s not just a reporting format, but it’s a reflection of a genuine change in terms of how you’re operating the company. The new segments are nurture, grow and harvest. Are these actual distinct segments? Or are they different processes? So can you maybe give us some practical examples of how your team manages these products and whether you have the same people working on multiple?
Chris Stansbury
It depends on function. So sales force will sell all of them, okay? But — but the way we approach sales compensation as we progress will change. You’re going to get as a salesperson, you’re going to get paid more for grow and then less as we move through nurture and harvest.
The teams that are focused on the harvest bucket in particular, their goal is to drive NPV and maximize the NPV of those products as they get to end of life. And it’s not an easy job. I mean, it’s — if you think about it, you could have two markets that look very similar. And if I pick on legacy voice for a second, you might have one of those markets where there’s still enough density of usage that going in and doing a huge cost optimization is not the best play.
The best play in that situation may very well be price optimization. And how do we take price where we can. In a similar market where there’s a lot less usage, the play may very well be trying to move that consumer to another product like VoIP and, frankly, turning off that service and stop paying utilities, stop paying maintenance.
It gets tricky because, obviously, things like TDM support multiple end products. But that’s the muscle tissue that we need to develop. And frankly, nurture not to compete with the nurture bucket, but products will continue to move into harvest over time, right? They’ll go from growth to nurture, to harvest. And so that capability, that mindset of managing products as they get closer to end of life, is a skill set that we need to continue to focus on, and I think we’ll only provide upside with that extra focus.
Brett Feldman
Aren’t the sales people all going to work on the grow? I mean, how do you make sure that they feel like they can be rewarded by working across the suite of products?
Chris Stansbury
I mean, I guess in short, is that if you sell grow, you’re going to get paid more than 100%, and that’s the incentive, right? So it’s a very clear incentive. I think the other thing that’s really important is that the way we allocate resources will change.
So rather than everybody feeling pressure to grow and with that pressure requesting resources, whether it’s in the form of OpEx or CapEx. It’s now much more clear as to which lane you’re in. And in the harvest bucket, it doesn’t mean we’d never spend any CapEx, but it’s going to be CapEx where the returns are guaranteed, where the returns are very immediate. Let’s say, some kind of a cost play.
But beyond that, we’re not investing in it. In the case of nurture, think of things like VPN and ethernet, yes, we’re still supporting those things. We’re still selling those things. There will still be some CapEx that’s spent there, but it’s really the growth bucket where you’re going to get more of those resources. And so I think the choice making that goes around managing all of this gets a lot cleaner with the shift.
Brett Feldman
It sounds like the vision for how you want Lumen to operate is pretty well defined and clear. Where are you in terms of actually reorienting the organization to be managed this way day to day? What do you have to do to get there, if you’re not there yet?
Chris Stansbury
I would say we’ve largely done it. We put in a leader for the harvest bucket because that was the piece that really didn’t have the focus. Nurture and grow have a lot of support and have had a lot of support as I arrived at Lumen. So it’s really the harvest bucket that needed the most attention, and we’ve already reorganized people around that. And as I said on things like sales comp, that comes as we as we roll into next year.
So we’re in the middle of designing next year’s compensation program, and that will be part of that. And then next year, we’ll also introduce for people that are on more of a bonus management, whatnot, they will be bonus differently. The grow teams focus on growth, the harvest team focus on cash generation and long-term NPV of those businesses.
Brett Feldman
All right. I want to get in talking about the business a little bit. But before we do, you’re a very big company. You have substantial exposure, business customers, large to small, you also touch a lot of consumers. And so you do have a vantage point on the economy right now. How are inflationary and macro headwinds impacting your customers and your business? And how much might that vary depending on which end market you’re looking at?
Chris Stansbury
Yes. I would say — we’re not seeing the demand for what we sell slowing, right? And frankly, we’re not seeing decisions taking longer to be made. The decisions are being made, things have to go through more approval layers, right? There may be more signatures required. Just look inside of Lumen, there’s things that I’m having to approve today that I wasn’t asking to approve when I joined. So I think that’s normal. The thing that I think is important to remember is through COVID, particularly in large enterprise, did not spend a lot of time on data centers, right?
They were entirely focused on how do we get people what they need to work remotely how can we secure that as much as possible. So that’s where the spending went. And the data center got neglected. And so companies have a real need, especially in today’s world to make sure that they are keeping pace with things like security as an example. So that’s a real trend, a real tailwind.
I’d say another tailwind is, it’s no surprise, I think the estimate is that 80% of data is going to be stored off-premise by the time we get to 2025. A lot of companies want to maximize that opportunity, but not all data can be in a public cloud where data latency is an issue.
And increasingly, as we see smart factory, we see smart retail, we see increased use of Meta — I mean, I had a conversation with someone yesterday where a company that I can’t name, is actually looking at creating a digital twin of their factories so that they can use Meta to manage factories remotely. You can’t have data latency to do that effectively. That’s where Edge comes into play. 97% of business is covered by what we built within 5 milliseconds. So I think the demand for complex solutions that link together on-prem, off-prem public cloud, off-prem edge, remote work, where SD-WAN and SASE may come into play, and making all of that work together is really our opportunity. So again, no real slowdown in what we’re seeing on the sales side at this point.
Brett Feldman
Well, that was going to be my next question. You’ve had improved revenue performance across, I think, all your business channels in the second quarter, maybe at a slightly more granular level, what’s driving that?
Chris Stansbury
Well, some of it really is — and we don’t disclose this today, it’s something that I think we can look at. But again, in the business segment, it takes time for sales to convert to revenue, right? Large complex deals can deal with hundreds of thousands of sites that have to be turned on. And so some of what you’re seeing and really a lot of what you see is not revenue activity that’s because of something we did this quarter. It relates to activities that took place in previous quarters. And so, looking at that working process, that sales backlog, that continues to grow. That’s a good thing. That’s future revenue that we can realize.
I think the other — so that’s a large enterprise and public sector. I think the other big opportunity is obviously mid-markets. And Jeff has not been shy in talking about that. And arguably, I think Lumen was behind and did a great job at standing up a digital marketplace where the user experience is very solid. And more and more product is on that website every day. So in the last few weeks, we’ve got SASE on there, Fiber+ is on there. DDoS is on there. Today, we announced DIA.
The user experience has simplified its self-service — and it also happens to be very efficient, right, from an OpEx standpoint. So I think for that market, making those products more available without somebody having to come in person to visit is absolutely critical. And we’re, I think, really making some inroads there, and that showed up in results.
Brett Feldman
Is that going to require significant incremental investment on the OpEx side?
Chris Stansbury
No. I mean if you think about the marketplace itself, it’s built. So that that’s done. There’s obviously work that goes on every day to get more product on there. But I would not say that, that’s an incremental spend kind of situation that’s part of the motion right now.
And the other thing you’ll see from us as we go forward is you’ll see connectivity of that marketplace to other platforms that can help generate even more traffic. So I think we’re definitely moving in the right direction. And by the way, back to the question on Kate, I’m sure that will be another focus area. She’s obviously got a lot of experience in the digital arena, and I think that can only help us there.
Brett Feldman
One of the things — well, we hear — we’ve heard heard over time is when you have more sales, we see a bit more CapEx. And the idea is — but don’t worry about it, it’s success-based CapEx, right? We won revenue, now we’re spending capital. But it seems that one of the investment features of Lumen should be that there is so much fiber in capital that has already been deployed in the business.
And so a question we get is, are we going to be getting to a point where not only you have a revved up sales engine, but you can do it in a more capital efficient way because you’re increasingly leverage over what you’ve already deployed. Where do you think the company is in that investment cycle?
Chris Stansbury
It’s a good question in terms of where we are in that cycle. But most certainly, if you think about, again, the product buckets but the growth bucket is less capital intensive than what the harvest bucket was years ago. So look, there will continue to be demand to invest in infrastructure for large customers that want connectivity between A and B and they want it to be dedicated.
That is what it is. And the key there is we don’t spend that money until we know we have a contract that’s got great returns associated with it. But to your point, as we move to more and more of a complex and software-driven environment, I think the opportunity is less CapEx as a percentage of revenue than we have historically had. But we’re — I would say that’s still a ways out. It really is going to be dependent on how and how fast the growth bucket grows.
Brett Feldman
I want to talk about an area where you’ve had some decent sales traction if we look back really over the last several quarters, which is public sector. You’ve announced a couple of very large wins, which are probably up on your website. What’s been working there? And how do you think about the potential to maybe do even better, particularly as you repoint the organization?
Chris Stansbury
Yes. I think it comes down to the, frankly, the service offering, right? So these contracts are large contracts that other players have held. They come to the point where the contract expires and they can re-up with the provider that they’re working with today or they can look for other options.
And Lumen has done very well in that space because of the offering that we bring. Again, complexity is a great thing for Lumen because if we can solve USDA’s problems as they’re trying to connect 4,000 locations and make sure that all of that is secure, that creates a stickiness, that creates margin. Those engagements are very attractive to us. So I think it really is driven by the fact that our offering is so strong. We’ve made the investments in areas where our competition has not, and that gives us the edge.
Brett Feldman
You alluded to mid-market earlier, feels like that’s an area that, for a long time, has underperformed relative to the potential that Lumen has seen there. The cable companies have just absolutely dominated that segment. If you think about the breadth of your fiber network, the scope of your sales force. What’s it going to take to be able to get your fair share in the mid-market?
Chris Stansbury
Some of it definitely is the digital experience that I talked about. I think also it’s about expanding beyond our own sales force and using other people’s sales forces, right? So back to kind of channel partners. And that’s something that’s got renewed energy inside of Lumen.
I actually spoke to a channel partner conference that we had a few weeks ago. And I think that’s a real opportunity that we can tap into, and we’re definitely focused on driving today. So that’s something that I think in recent history hasn’t had as much focus. So both of those things, digital being turned on and using more channel partners to reach that market, are underway. And I think we’ll do well.
Brett Feldman
Any other investment or maybe tuck-in acquisitions or something else you think might need just to be more capable there?
Chris Stansbury
I don’t know that we need. I would say, though, that we’re definitely open to acquisitions that make sense. So if we see a gap in the product portfolio and it can be more easily filled by buying rather than building, then that’s something that we’re definitely open-minded in terms of doing. And again, I’m excited to have Kate join and get her perspective on where she thinks some of those opportunities could arise.
Brett Feldman
You mentioned edge compute earlier and you gave some examples of these conversations that are happening, but it still sounds kind of like conversations. And so I guess I’d be interested in hearing your state of the fairs in terms of when do you think this could become a real revenue opportunity.
And I’ll throw my follow-up question at you. We always hear edge compute, in many cases, talked about in context of and how it’s sort of an extension of mobile infrastructure. That’s not really the approach that you’re taking. What gives you confidence that you can be a major player in edge compute for enterprises if you’re not also bringing in the mobile element of how Edge factors in?
Chris Stansbury
So in a situation where the customer does want the mobile factor, we obviously have a relationship with T-Mobile, and we can leverage that. But when you think about edge compute, I’m going to steal one of Jeff’s line, which is data wants to find fiber as fast as they can, right?
And a lot of the edge use cases and frankly, where Edge makes the most sense is where latency is an issue. So that 5 millisecond factor that I talked about, that’s really the tolerance level for customers that are running smart retail, smart factory floor, they can’t have latency more than that.
And so the edge product, I think frankly, can’t be touched as it relates to that kind of latency and, frankly, reliability, particularly when you think about edge sitting in networks that we have today, where we’ve got the ring around the city, and there’s a failsafe for if the data can’t go in one direction, it can go the other direction.
So — the fact that we can provide that, we can provide it in a secure way, you can buy it by the drink, you can buy a dedicated edge tower that’s yours that sits on one of our facilities where there’s backup utilities, there’s back up cooling, all the things that you need, it’s a very robust product.
So now that said, we’re early innings. But with data transitioning more and more off-prem, and with things like labor challenges and more people looking to use automation in the retail and in the factory environment, I think we’ll see growth there pretty quickly.
Brett Feldman
Well, let’s start to talk about your fiber business for a little bit. Can you give us an update right now on the Quantum Fiber build, in particular, are you still on track to build to 1 million homes this year?
Chris Stansbury
That is absolutely the push. I would tell you that our product is performing very well, right? The NPS scores are very strong. We’re seeing the penetration levels continue to grow each quarter. So we’ve talked openly and shared data on the 2020 cohort. I think after 12 months, we were 22%. After 18 months, we were at, I think, 27%, 28%. We’re over 30% now, and we’ll continue to give color on that. 40% plus is the goal. So very, very pleased with that. But I’ll also be really open and transparent in saying, it’s hard work. I mean our operations team probably gets far more attention from Jeff and me than they’d like because the — doing this is not easy.
And I’d say that anybody that is in the market of building out fiber networks would probably tell you the same thing. So it is a grind every day, but we feel good about the enablements that we’re driving, and we’re going to continue to grow those.
Brett Feldman
It’d be interesting to hearing your thoughts on the conviction you have that this is the right time to accelerate fiber investment. If we just think about things that are going on, fixed wireless has sort of emerged, I think, in a more significant way, taking a lot of share. Cable companies have gone ex growth, but now they’re talking about moving to DOCSIS 4.0 more aggressively to try to close that gap. And then just less moves right now, so fewer shots on goal. How are you thinking about your positioning as you ramp that capital?
Chris Stansbury
Yes. I mean, I think the big picture here is I don’t think we’ve ever seen a scenario where the customer has decided that they need less data consumption, right? If you think about everything that we do every day, we consume more and more and more. So the network that we’re building is as future-proof as you can build a network today.
And that was evidenced by the 8 gig product that we announced at the time that we — right around the time that we had Q2 earnings. Not because we think 8 gig is a big opportunity right now, it was a statement. This isn’t on a lab bench where one day we think we can get a little more. It’s a symmetrical product up and down and nobody can touch it.
So — that’s where the world is going. We’re focusing on large metros. We’re not going to take this into smaller less-dense markets. And when you think about things like fixed wireless again, I think it has its place. But that place really is more remote areas where it’s very unlikely that fiber will ever be laid, right? Certainly not in the near term just because of the economics. And I think it has its role. It doesn’t work as well in large dense areas where there’s not line of sight to a tower and fiber to just point, they don’t want to find fiber, right?
So on the cable side, DOCSIS, yes, did it, that will improve the cable offering. It doesn’t come anywhere close to the symmetrical nature of the product that we’re delivering. So we feel good about it, and I think that’s why we’re getting the penetration that we’re getting.
Brett Feldman
And how are you thinking about the long-term potential of the business? In other words, what do you think is the right target for penetration? How do you think about the profitability and margin profile of this business at scale?
Chris Stansbury
Yes. It’s — that’s still evolving, right? So we’ve talked about 10 million to 12 million in enablement. We’ve talked about 40% plus penetration. The enablements that you can reach is really dictated by the penetration levels you can achieve and the ARPU that you can achieve. So we’re still learning as we go. If we can drive beyond the 40%, then that opens up doors for additional enablements that we can do.
So we’re still learning as we go on that. But again, there’s nothing that we’ve seen yet that is falling short of the metrics that we need to hit for this to be successful.
So when you think about those roughly 10 million to 12 million in enablements, at 40% plus penetration in roughly a $65 ARPU, we do really well. And so we feel good about that.
Brett Feldman
And what gives you confidence in that ARPU — rough ARPU estimate just knowing what’s going on in the market?
Chris Stansbury
The — I mean, that has held firm. We’re not getting pushback. So when we’re in market and quite frankly, not doing a lot of marketing. So it’s — if you think about some of the earlier marketing we did, it was a lot of door hangers. And we’re getting — on that 2020 vintage, we’re getting the penetration at that $65 ARPU without a big push. So those are all really positive signs to us and I think there’s only upside from there.
Brett Feldman
It’s obviously very capital intensive to do this. The government has recognized that the Infrastructure Bill has substantial money available for grants since there’s other programs as well. Can you give us an update on how Lumen is positioned for that?
Chris Stansbury
Yes. I mean, I guess that’s a good example of nothing in life is free, right? So there’s obviously auctions around that. And look, if it makes sense for us to use those funds and to reach areas that we otherwise wouldn’t get to, great. But we’re not going to chase something to try to hit a revenue target that doesn’t make economic sense for our shareholders.
So we’re part of those processes. It’s not a quick process. But again, we have limits in terms of how low will go, so to speak. And if we get it, great. If we don’t get it, that’s fine.
Brett Feldman
Earlier, you expressed your view on why you believe the consumer is ultimately going to want to get the better product. And I’m not necessarily disagreeing with you. I could contrast that, though, with what we heard earlier this week, I’ll point to the Charter session. Tom Rutledge pointed out that their network serves about 55% of the homes that are actually in their footprint, so about 55% of the customers in their region or households in their region by their broadband. But by their estimate, they’re only getting 26% money the homes in their footprint spend on connectivity. And they say that’s why it’s so important for us to bring in this mobile product. We’re giving them a better overall deal. And so it’s not just the broadband connection and the quality of that connection, but it’s the aggregate savings.
So first of all, I’m curious how you think about that. And if you do believe that there is merit to that, how could Lumen pull more products and services into its bundle?
Chris Stansbury
Yes. I mean, again, those are things that we will always look at and consider. But our belief is, look, we’re getting the penetration levels we’re getting in those markets in that environment today. Our belief is that, that’s a — that may be attractive to consumers save. It’s a pretty short road in terms of how it can play. The reality is our cable competitors, their economic models are under threat by fiber.
And so for them to respond with bundles makes a ton of sense. I get it. But I don’t think that’s ultimately going to win the day over the long run. And so we’re quite happy to drive to that 40% level that we’ve talked about. But in time, I think the consumer is frankly going to have no choice. We actually we’re in a one-on-one last week with an investor, and they were talking about what happened in their household when COVID hit. And their cable product worked great when they were the only user in the house. And then all of a sudden, their spouse was at home. Three kids were trying to do school work, and it just couldn’t keep up. And so in the middle of COVID, he was scrambling to get fiber to deal with the loads that exist. So look, I think we’re closer to the finish line than the starting line in terms of the connectivity piece really mattering. More and more devices in the home are connected. And so look, if it’s a short-term issue, fine, I don’t think this is a long-term strategy that wins the day.
Brett Feldman
All right. So I can’t have a conversation with the CFO of Lumen without talking about capital allocation. I think I set a record for going this long…
Chris Stansbury
I appreciate it. We got to talk about strategy for 32 minutes. So that’s good.
Brett Feldman
And you know the gist of it. There’s a lot of data among investors about the leverage profile the dividend policy that the company has relative to the recent trajectory in EBITDA. And obviously, the business mix is in the midst of evolving right now. And so I guess I just want to hear your thoughts on the inputs, the process, how you think about the right parameters for all those things as you’re giving feedback to the Board on what you think the capital allocation choices should be going forward.
Chris Stansbury
Absolutely. And I think the first thing is that — look, we understand the math the analysts are using buy side, sell side. And I’m not going to push back on that. There’s also things that we’re looking at that I can’t talk about, right, that are inputs to that decision, and just the broader capital allocation decision on where and how we spend and deploy capital.
From a Board standpoint, this is top of mind. We talk about it at every meeting. I’ve been in two Board meetings so far have also been in a couple of other non-board meetings with Board members, and it’s a discussion in every one of them. So there is the understanding that we need to provide greater clarity as time goes forward.
My ideal, just sitting in the seat that I sit in, would be we’ve got a little more work to do on just strategically the numbers, if you will, and how that plays out in the coming years. And ideally, what I’d really like to share is not a conversation on capital allocation, but the bigger picture, which is here’s the strategy, here’s where we’re going, here’s where revenue pivots, here’s where EBITDA pivots, here’s the investments that are required to support that, and here’s the capital allocation decisions that we’re making to fund all of that.
So we need a little more time to explore a couple of other options. And then I think we’ll clarify where we go from here.
Brett Feldman
Putting aside the level, and I’m not asking you to give us a preliminary recommendation, but does the dividend make sense under all these scenarios?
Chris Stansbury
I don’t want to say yes or no to that, quite frankly, because I don’t know. I do think the dividend is very important, right, to our investors today and that’s a very clear input to the decision that gets made. But the key criteria that the board is using that Jeff and, I’m sure, Kate will use and I’m using is — the goal is to drive long-term returns for the shareholders and what’s the best way to do that.
So at this point, I don’t want to commit, but I will — at the same time, I’m saying that, I also want to say we understand how important the dividend is and that’s a very clear input to the decisions as we go forward.
Brett Feldman
All right. Well, Chris, this was a great discussion. Thanks so much for being here.
Chris Stansbury
Yes, thank you.
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