So I think we can kind of just kick it off, I guess. Dave, again, congrats on the Sprint transaction. What's going right? What's going wrong?
Well, fair enough. Well, first of all, I'd like to thank you for hosting me today.
Thank you for being here.
Thanks, BofA. Thank the investors for taking the time to meet with us. Well, you just paid us a compliment in the beginning, saying it's a shiny new asset. Oftentimes, one of the alleged issues with the Sprint network is its age, and you know, like some things, old does not necessarily mean bad. In the case of the Sprint network, we've been very happy with the quality of the assets that we acquired. We in fact did an appraisal on the physical assets, that's the 485 buildings, as well as the 19,000 route miles of intercity fiber, 1,200 route miles of metropolitan fiber, that came in at approximately $1 billion. We paid $1 for that asset, so I think we did well.
I think, what's going right, we definitely are happy with the asset. We're happy with the people that we acquired. What is not going as well as we would like, getting data transferred over from T-Mobile onto our systems has been a slower process, in part because of some of the cybersecurity concerns that T-Mobile has had because of some of its breaches. I think a second area of concern for us is the fact that the demand for our services actually turned out to be stronger than we anticipated, which is great, but our ability to provision is not where we want it to be. Just to remind investors, you know, we are taking an asset that is effectively a fiber asset that was originally built for long-distance voice.
It was the nation's first transcontinental fiber optic network, built in the late 1980s at a cost of about $20 billion, to terminate at fortified tandem switch offices. That network has really not been actively utilized for nearly 20 years. We are clearing out those switch facilities and repurposing the physical network to sell optical transport services or wavelengths. In order to do that, we need to connect those tandem locations up to our metro networks, and we need to reconfigure those so we can sell services in 800 carrier-neutral centers across the U.S. Sprint was running provisioning at about 35 facilities, with a 60-day provisioning window, and we do provision at about another 210 facilities, with more like a 120-day provisioning window. The ultimate goal is to be able to provision in 17 days or less.
So we have a lot of work to do. The good news is, more than we expected. The bad news is, we're not filling that demand as quickly as we'd like.
So let's move on to the things that are going right. So one of the things I think that when we look backwards at your track record in M&A, and this is actually, I think, a slide that you put up in the very early phases of the Sprint transaction announcement, maybe even at Ana's conference in Boca. And it was a slide that showed how people from the company when you bought it, and how many people were left inside the organization when you were done integrating it. And this transaction seems to be a bit of an anomaly because you keep waxing poetic about how great the people are and how long their tenure has been, and it seems like you might be a little soft on us.
Can you tell us a little bit about what's going on with the opportunity to create synergy through headcount reduction?
Yeah. So there's a lot of areas to create synergy. Headcount reduction is one of those areas. Again, just to remind investors, this business, at peak, had 70,000 employees. When we started working with the business, there were 1,800 still in the business. Between the time we began negotiations with T-Mobile and signed a deal, we staffed for the business, the headcount was reduced to 1,320. Between signing and closing, the headcount was further reduced from 1,320 to 952. At closing, we anticipate probably about another 150 employees leaving the company, as a result. I also think composition of the employees is going to change. Prior to the acquisition, Sprint was 950 employees, and only 51 that-...
Potentially were in sales, and I put that qualifier in because none of those 51 had an actual quota. None of them had actually sold new customers for nearly 15 years, and they were customer relationship managers. They had existing relationships that they managed. There were 1,496 customers that these individuals farmed, but we didn't go out and hunt for new business. Compare that to Cogent, to the acquisition, we were 1,100 employees, 950 had direct quota responsibility, another 200 in sales support roles, so 750, and only 350 in operations. So some of the things we've done, some of those sales people have left the organization that came from Sprint. Some have been reassigned to operational roles, and we've actually continued to hire sales people.
We today have over 650 quota-bearing reps, and that's still not enough out of a total employee population of about 2,000 employees. So our goal is to continue to create value out of the network and operations teams at Sprint, to grow the sales organization, and all of the individuals will have quota and responsibility. You know, a criticism of Cogent has been a transactional sales model. We typically churn about 5.2% of our sales force a month. I don't see that materially changing. We have a quota. It's black and white, the ramp, and at the end of that ramp, they either make their numbers or it's just not the right role for them. We have not softened our criteria.
Just on, yeah, maybe on the topic or generally, you know, one of the, you know, the way we kind of model the company is hiring, training up quota-bearing sales reps, productivity for rep. You know, during the pandemic, obviously, that was a struggle. In the aftermath of the pandemic, people still had kind of cushion, and there wasn't really a huge amount of enthusiasm for work. What does the funnel look like for you for inbound sales trainings, converting to quota-bearing, and then how are you working on productivity at the margin?
I think if you ask employees, they've had an appetite for work, but not an appetite to go to the office and work.
I actually disagree with that. I tend to think if you stayed at home, you probably were not as productive. So during the pandemic, we kept hiring at pre-pandemic levels, but our sales force turnover, because of the strict discipline around productivity, actually increased from 5.2% a month to 8.7% at peak. We were back down last quarter to 5.4%, so pretty much back to pre-pandemic levels in terms of turnover. Our model is to continue to hire people and grow the sales force on an aggregate basis of somewhere around 7% per year, number of quota-bearing reps. We have a very formalized training program. It lasts a month. There's two more months of a ramp, and then you're expected to be selling. Now, sales is a process, and in any process, you need to go through the steps.
The most important step here is building the funnel, and that means having enough legitimate opportunities to work. Our sales force that is successful have adequate funnels. Those who fail don't do the activities. And you know, to be successful at Cogent means to do high-volume, outbound selling. We expect a new rep to do 100 cold calls a day. Now, the majority of those cold calls don't result in a sale ever, and many of them result in delayed sales. What we have seen over the past six months is a gradual improvement in sales cycles shortening. So our corporate growth rate actually has continued to improve and is positive.
So to remind investors, prior to the pandemic, our corporate business, where we're selling directly to end users, was growing at 11% year-over-year, and it had that average growth rate for 15 consecutive years, with only two negative quarters during the great financial crisis. Pandemic hit, and the growth rate went from positive 11 to -9%. Today, we're back to a 1% growth rate year-over-year in that business and improving. The second part of Cogent's organic business was its NetCentric business. It had averaged 9% growth prior to the pandemic.... going into the pandemic, it was actually growing below trend line at 3%. Pandemic hit, and we actually had the best growth rate in our corporate history. Our growth rate shot up organically to 26% year-over-year.
This was 44% of our revenue is growing at 26% a year. Great result. It was a result of a rapid transition from linear television to streaming. That growth rate has moderated some, but is still low double digits, around 10%, 11%. We anticipate that NetCentric growth rate to remain above trend line for the foreseeable future. The pull forward in streaming that occurred in the U.S. is now occurring in the rest of the world on a delayed basis. Our NetCentric business is continuing to outperform historic trends, and our corporate business is improving, but at a slow pace. The acquired enterprise business that came with Sprint, the second asset that we bought, was a business that was burning nearly $1 million a day.
So when we consummated the transaction, there was $560 million of run rate, -$300 million of EBITDA, and thirty million of CapEx, and -$330 million of cash flow on a $560 million business. The way to fix that is jettison gross margin negative products. We have done that to rightsize the sales force, and most importantly, optimize the network. We believe we will stabilize that business at between $440 million and $450 million in revenue, and we'll get it to be a 20% positive margin business by applying a disciplined strategy around products, selling four basic products: Internet access, VPN services, colocation, and optical transport services.
But the real upside and growth driver going forward will be the ability to take the Sprint network and sell optical transport services. We think we will be able to grow that from its current annualized run rate at closing of $8 million a year to a $700 million run rate within 7 years, fairly linearly. Yeah, we will report transparently to investors, number of wavelengths, amount of revenue. We are seeing more demand than we expected, but as I said, the installations are longer. We should even this out and should be able to hit a $100 million run rate within roughly, you know, 14, 15 months of closing, $80 million in the first year.
That was the answer to the hiring question?
Well, it was a lot of answers. Why we do need to continue to hire salespeople, and we don't need to hire more operations people.
And so, is the hiring of salespeople really a conversion of the Sprint bodies from what they're doing today into salespeople, or replacing those bodies with new blood that's salespeople-centric?
There have been... Of the 51 people that came in the sales with a sales title from Sprint, the majority of them are no longer in sales at Cogent. Some have left the company, some have been converted to operational roles. So there are probably about 20, low 20s number that are still here that I think are embracing our sales model, but most of our sales growth is coming from hiring new candidates from the outside.
Okay, so the other thing that you said was working with the merger was the asset a t the same time, you said that the connection from the 45 nodes back to your metro network was the choke point to enabling wavelength sales, among other things, and that that was going far more slowly than expected. Can you elaborate a little bit on what the choke point is?
So I'm not sure it's going slower than what we expected. What is frustrating is the demand has been better than we expected, so we have more wavelength orders that we cannot fulfill.
That's kind of a unique experience. Normally, we're out creating demand and chasing customers. We're actually getting orders that we have to tell customers are on a delayed install. So to convert the Sprint network into a wavelength sellable network, four things have to happen. The first you had mentioned is the physical connection of the Sprint backbone to a metro footprint. We're probably about 70% of the way through that. We expect to get all of those connections done probably by the middle of first quarter of next year. The second thing that has to happen is our metro networks need to be optimized for wavelength sales. So today, we have roughly about 1,150 physical rings around the world, sitting on about 20,000-mile route miles of metro fiber.
In the U.S., each of these rings has a mix of multi-tenant office buildings and data centers. To optimize for wavelength delivery, we need to segregate those two types of buildings onto separate rings. This is a span by span effort that's underway. We, I think, have, I think as of yesterday, there were 136 of those U.S. rings in process of being optimized. We will get all of that done between now and the end of next year. The third thing that has to happen is we need to put transponder shelves in all of the carrier-neutral data centers that we are connecting. That allows us to then provision a wavelength by just plugging in a transponder at each end.
I know one of our competitors, in response to our provisioning goals, gave a statement at a conference saying they're going to have instantaneously provisionable waves. Well, the only way you can do that is pre-provision everything. You still need to go plug in something. If you've got it pre-plugged in, you're going to be very capital inefficient and not optimize your network. So the goal is to create the base structure that is quickly then upgraded on a as-demand needed basis. The final thing we need to be able to do is optimize these routes for where the wavelengths are regened and where they are dropped. And to do that, there are really two different architectures. They're not unique, you know, one or the other in each market, and you have to work on a case-by-case basis.
But all four of these efforts are being simultaneously done, and again, we're going to report every quarter a wavelength-enabled, wavelength provisioning times. Because of the high contribution margins, and this being the primary reason for doing the transaction, it's what we are going to be measured on.
You know, this linear ramp from kind of $2 million revenues run rate in the second quarter, you know, would suggest that we're going to, you know, be ramping. I remember the math, but it's like, you know, you'd have to kind of go 2, 4, 6, 8, 10 kind of progression. You know, are some of the provisioning delays that you're seeing impeding that result? Are some of those- is that linearity contingent on these issues being addressed? Or is your linearity assuming the current plan of addressing all these issues, and so therefore, we're not impeding the rate of growth in wavelengths right now?
It's much more the latter. So on the good news side, the number of wavelength orders that we've received is greater than we anticipated this time, so we have a bigger pool. On the bad news side, we are slower on provisioning than we would like to be, but we are where we expected to be. So if we are successful in bringing down the provisioning times and demand remains as robust as it is, we will actually exceed our goals much more quickly than what we have outlined. What I am not comfortable in representing to investors is how durable that excess demand is, and it is a little hard to tell, is this because there's a new entrant in the market and people are frustrated with the current suppliers?
Is it because we really do have unique routes that are better, and that's why people are coming to us? Or is it because there are new applications that are driving incremental demand? So what I'm trying to do is be maybe a little more conservative on the demand side, because that's a little bit outside of our control. And where I'm comfortable we'll meet our objectives is on the supply side and having the ability to have 800 facilities with two-week provisioning windows.
By when?
By the end of 2024.
Right. So let's talk... Are we talking about twice as much wavelength orders, 10% more wavelengths orders, an order of magnitude more wavelength orders than you expected? Like, what are we talking about here?
I would say at four months into the transaction, we probably have a backlog that's over double where we anticipated it being at this point. But again, I don't want to get people too excited. I can't confirm that that's all demand just because Cogent's so great, or it's just people frustrated with their current suppliers.
I mean, it's not unusual, you know, for anyone who kind of jumps into a new market with a new product, that there's 10% of the market hates who their provider is. And, you know, if that's, there's a... I don't know, multi-year contract cycle that exists, two, three. I mean, so right away, 3% of the, of the $2 billion wavelengths market might be interested in being at your doorstep, asking.
That's exactly right.
Let me out of this existing relationship with this guy I hate." So who is it? You-- when you described the pool of demand for wavelengths, you kind of said there was three big buckets. There's the hyperscalers, there's the, for lack of a better term, the ISPs, the telecom-
The regional ISPs.
And then, you know, kind of large enterprises y ou know, that might include maybe some of the large streamers and those sorts of guys.
Organizations like Bank of America.
Bank of America. So who—where is the demand coming from? Is it pretty much just Ethernet everywhere, or is it one camp seems to be the driver at the margin?
I would say two of the three are driving the bulk of that demand. That being the content generators, primarily hyperscalers, but also some CDN operators. So companies, hosting companies that are pushing applications or content out. The second large group are the regional ISPs pulling down traffic and connecting their islands of demand. The enterprise market is the smallest of the three, and that's what we've continued to see. And there's actually a fourth pool that we were not anticipating in closure, which is a new group of buyers of service. And I almost hate to use this term because it's so promotional, but it really is the correct one, which is AI-related. Companies that are not traditional hyperscalers, but are looking to do large amounts of computation at multiple sites. So the Internet remains the cheapest, most reliable, and most ubiquitous way to move information.
There is a significant market for people willing to pay a premium for dedicated transport services for three reasons: security, deterministic, meaning you know exactly how long it's gonna take from point A to point B, and third, the ability to move very chunky or large amounts of data. The Internet does very well with packetized data and small file transfers. If you're trying to replicate the entire content of a 1-million-square-foot data center between two locations, doing it over the Internet, it's very painful. Doing it with wavelengths is a much better way to do it. That's why the hyperscalers are the most robust set of demand, but there are some industrial companies that are more focused on AI now and have placed orders for wavelengths.
So, you know, now that we're kind of... I know we're still early days, but it's healthy. Now we've got maybe at least a data set to work with of orders that are coming in. So you described to me, you know, a marketplace for wavelengths that looks like $800-$900 a wave a month for a 10 gig.
That's correct.
About $2,500 a month for a 100 gig, and that there is a nascent market for 400 gigs, which we might think is around $5,000.
That's correct.
So though, if those are market prices, where is Cogent coming into the market? Where are those orders booked at relative to those price points?
Again, off of a small base, but last quarter, our ARPUs were $18.99, so it was a mix of 10s and 100s, no 400s. And it is very route specific. There are cases where we will discount. We will discount in response to specific orders, but a little different than we did in entry to the transit market. We don't feel it's necessary to go to the market with a categorical 50% discount to market. You know, I think when customers buy in bulk, they're expecting a discount. When customers buy for longer term. We had one international carrier who insisted on a 5-year term for wavelengths. Well, we gave a 15% discount for locking up that revenue for 5 years.
What would be the normal term, two?
2 to 3. 3 would obviously be the most common, but this particular carrier actually wanted it for 5 years and actually wants to prepay on install. It's just the way their accounting allows them to treat it as a prepay, and, you know, you never say no to taking payments upfront.
So, you know, and so just in that, again, and maybe you can give us a little bit more historical context, given the work you've done, but in the past, we've talked about how the NetCentric business, you know, that's a kind of... It's on this perpetual price decline curve. I think maybe 10% decline, maybe more, depending. But, you know, if we kind of take those $800-$900, $2,500, $5,000 price points, at what rate are those price points likely falling, offset by what rate is, you know-
Demand-
Change? Yeah.
So I started this process with maybe a bit of a pessimistic view. I had read a number of third-party studies, did some channel checks on our own, and I did not believe that the total addressable market for wavelengths was growing. It was about a $2 billion market, and it was flat.... I think as I saw this fourth bucket of demand enter the market, I became more comfortable with the industry studies that have indicated the market's going to grow in dollar value at about 7% a year. As I think about price declines, they have averaged in the 15%-20% per year, so slightly lower than the rate of price declines for transit, which has averaged 23% a year. But the issue with wavelengths is it is so route specific.
There are some routes that actually go up in price, particularly if the route has low latency characteristics or is particularly unique. So one of the advantages to the Sprint asset is that 90% of the routes are truly unique to Sprint.
$19 ARPU.
Go.
The $19 ARPU, what do you think that is discount to market, roughly? You said, you said previously when you did that, it was a 50% discount in, in wavelengths. What do you, what do you, where do you think your, your pricing relative to market?
So on the discounting, it's an iterative process with sales. We have built an automated tool that takes two endpoints. You plug it into our CRM, it actually produces the KMZ map, showing the exact route with 1-meter accuracy, and produces a price. Customers naturally don't usually take the first price, and there's a negotiation around that. Typically, if we need to discount off of that list more than about 10%, we are looking for some competitive offer. Show us an invoice of what you're paying today, show us a competitive offer, and we will guarantee to beat it. We have not seen many of those. We think that our market pricing was established realistically against the current market prices.
Thank you. Okay, got it. So all good on the wavelength front then. Market potential, you know, flat to potentially growing, pricing coming down, but mix improving. You've come to market with pricing that people aren't pushing back on. Backlog is twice what you thought it would be. You know, current course and speed, we can still hit all the targets we've put out d espite the fact that we would love to be provisioning faster if we could. And, you know, the next 15 months will be kind of pretty much the meat of getting to the point where you can do what you would really like to be doing at a national and a global level.
Correct.
Anyway, presumably, no one in the competitive landscape would be looking to price their back book differently. But is your presence in the market, do you detect affecting anyone's position in the front book as they go to the market?
So the market is dominated by Lumen and Zayo, Lumen being by far and away the largest. They have appeared to be going in a different direction, focusing more on managed enterprise services, both in their public statement, but probably the most important place to see that is in their sales comp plans. So they actually compensate salespeople more for selling those services than they do selling wavelengths. Salespeople are very Pavlovian. They follow the incentives, and for that reason, we think we have a good chance of capturing a very large market share quickly from someone who is not particularly focused on this market. And I'm going to play back the tape 15 years ago, when we were a relatively nascent player in the transit market, and at that time, Level 3 was the dominant transit player.
They kind of said: "Well, transit's not an important product to us. Cogent's not really a credible player." We have gone from a couple percent market share to now 25% of that market, surpassing Lumen on third-party research for number of routes, amount of traffic carried, number of connections, size of connections. By all of those objective measures, we have been, you know, the dominant player in transit. Their response had been to hold pricing, not be ultra-aggressive, and to incent customers to buy other products. I, I don't want to be complacent, but it appears that's what they're doing with wavelengths as well. In the case of Zayo, there's a different issue. Zayo...
We are a customer of Zayo, as well as a supplier to them of IP, and we've got a great relationship, but they struggle to have accurate records of their inventory, having done 49 acquisitions, and securing either wavelengths or dark fiber from them is challenging. And again, I just encourage people not to talk to us as a single customer, but talk to other customers in the market. Now, I know they're working on correcting those inventory problems, but there's still some work to be done.
So just to understand the market better and your two key competitors. So this, it sounds like there was a change in Lumen's behavior. Is that coinciding with the change in management there? And I'm just wondering why the change in Lumen and the defocus? And then secondly, on Zayo, you know, they brought Steve Smith in a couple of years ago. So is it under the kind of new change in management there, do you think they're becoming a stronger competitor?
So two very different questions, Ana. So, first of all, I think the desire to sell higher-level managed services already was started under Jeff Storey's administration and probably accelerated by Kate Johnson when she came in. So there's a greater emphasis, but it was something that was already in the works. Secondly, we were not in the wavelength business, so it was kind of something that was orthogonal to what we were paying attention to. But it does seem that both the composition of the sales force and the compensation of the sales force is incenting them to focus on enterprise accounts and somewhat harvest the existing wavelength business. So I can't predict the future, but it appears they're going in a different direction. In the case of Zayo, I think it is different.
Zayo was not nearly as dominant in the wavelength business, and a large part of its wavelength business was focused on a very niche market, low latency. It's actually a market that we are not focused on for high-speed trading. That seems to be the bulk of where they have been focused. They have a problem that's probably more severe than Lumen. Lumen was a series of acquisitions, but not 49 acquisitions. And as a customer of Zayo, I know we are often frustrated in buying dark fiber from them, and they can't deliver it because they don't know where it is. Now, they've hired third parties to come in and help them fix their inventory management system. They're putting in new software to do that. I think Steve's a great leader.
I just think it's a very large task that he has in front of him, and it's not clear to me that the institutional knowledge and the data even exist to reconstruct their inventory. One of the huge advantages to Sprint was the fact there were no acquisitions. It was all organically built. They actually spent too much money maintaining records and data. They over-engineered things. They disregarded profitability. That's an issue we're trying to address, but it actually left us with a very good sense of where the network assets are.
So we just spent 40 minutes talking about 1% of the business.
Let's talk about the other 99%.
We have zero minutes left. I think we did hit some of the, some of the run rates. You want to say, just very quickly, anything that we need to know about corporate or NetCentric that's gonna surprise us in the third quarter?
You know, I think the corporate business is going to continue to slowly improve, but do not expect it to rebound to pre-pandemic levels over the next several quarters. I think the NetCentric business will continue to outperform long-term expectations and will continue to perform above the run rates that we have had to date. We're seeing good growth in traffic, good growth in demand. Feel pretty good. And on the enterprise side, which is an acquired customer base, you know, I think the three takeaways are, one, you know, we're taking away products that customers have been used to, that are gross margin negative, and they're not happy, but they understand it. Two, I think those customers are more durable than we even thought they would be because the cost of shifting to another provider is so large.
And third, and this has been a little surprising to us, the lack of other global enterprise alternatives. So Lumen used to have a global network. It's now retreated to North America. AT&T and Verizon had global facilities-based networks have pulled back. Orange Business Services, BT, T-Systems, all had global facilities networks and now pulled back to their home market. That actually has left Cogent in this unique position of being the only global facilities-based network. Now, we have that network to sell transit, but because that network exists, we're also able to layer on MPLS and VPLS services, and I think that will help us more than we expected in the enterprise space.
Okay, great. We'll leave it there. Thank you, Dave, for joining us. We appreciate it. Thank you, everybody.
Hey, thank you, everyone.
Next up in this room will be Uniti.
Uh-oh!
and, our run time of the session, we are streaming, but we invite you guys to ask questions if you'd like, and just there will be a guy with a mic moving around as needed. So I guess, Paul, just maybe kick it off with, you know, the big question. You know, Uniti is a REIT. You don't have a choice whether you pay a dividend or not.
And yet, the stock trades with an 11% dividend yield, because no one's convinced that you're actually gonna pay the dividend. Can you square that circle for me?
Yeah. Well, first of all, Dave, good to be here.
Good.
Glad to be, glad to be back. Like being in New York. We were just talking about my daughter's in school here, so,
Oh, NYU?
No, at Fordham.
Oh, okay. Great.
So, good excuse to get to see my daughter as well. So glad to be here. Yeah, so we've gotten a lot of questions about REIT status, and you know, is it really worth it to be a REIT, and what about the dividend, and does the dividend we have to pay in order to maintain our REIT status make sense for Uniti? And so we had a lot of those questions, particularly in this environment where everyone is focused on cash flow and liquidity, and the macro environment. And so a couple of quarters ago, we thought it would make sense for investors, given those questions, to really lay out our viewpoint and the case for maintaining our REIT status.
We think it's pretty clear. We think it's very clear right now that the REIT status has real value for Uniti and for our shareholders. You know, we're not married to any particular tax structure for the long term. I mean, it's something we are gonna continue to evaluate and make sure it makes the most sense, but we feel strongly that the REIT structure makes the most sense for our investors. Now, the large piece of that is because of the tax advantages we get as a REIT. A significant portion of our revenue is triple-net cash flow from our master leases with Windstream and a few others.
It's highly high margin revenue, you know, highly profitable, those kinds of cash flows, and so shielding those from taxes over the long term, we think creates significant value. You know, there's certain pieces of it, like the new rules around deduction for interest expense. You know, for a C Corp, that's limited to 30% of EBITDA. So, you know, there's a cap on that in a higher interest rate environment. As a REIT, we're actually able to deduct all of our interest expense, and so that creates a situation for us, along with some other pieces to the puzzle of that analysis.
That creates a situation where if we were to switch to a C Corp, our projections for our taxable income over the next several years, you know, we'd be shifting a lot of that dividend just to the federal government. And so when it's a choice between paying the federal government and paying shareholders, we think shareholders like to like for us to pay them. So there's also other advantages that we think comes from being a REIT in terms that are strategic, a little bit harder to quantify. But you know, in terms of strategic transactions, some of the tax advantages that we can get in terms of our ability to transfer assets to potential buyers of assets with a step-up is enhanced as a REIT, and so we find significant value there.
So once we kinda we laid out that, I think that resonated well with shareholders. But then the next question is: Okay, well, You've also told us that you expect that the current dividend level to be over-distributing, or distributing above the REIT minimum by about $100 million-$150 million between now and the end of 2025. Is that the right thing to do for the business? To date, our board has elected to continue to maintain the dividend at its current level. But it's something we're continuing to evaluate, given, you know, our other capital allocation priorities. And I think, you know, that could change. It's flexibility that we have as a business to do that. But to date, the board has elected to continue to maintain the current REIT dividend, and there's some trade-offs there between.
You know, we are about two years away from being free cash flow positive. So there's a really short window for us in terms of the period where we've got to fund the dividend, you know, outside of free cash flow. And that path to free cash flow, we can talk about that a little bit, but that path to free cash flow is mostly baked in the cake because it's mechanically a part of the Windstream settlement and how those settlement payments roll off, and how the GCI investment commitments step down over time, and GCI revenue steps up over time. And so a lot of that is just mechanical. It's already baked in the cake.
It's not dependent on us, you know, raising our level of performance or. I mean, we've got to continue to execute our core business, for sure, but a lot of that is just already baked into the cake. So there's a limited period of time here between now and having to be free cash flow positive, including the dividend at its current level. And so, you know, the board is weighing the trade-offs between lowering that down and bringing some of that, you know, that $100-$150 million of excess into liquidity and into the business. You know, versus the stability of that dividend and, you know, the signaling of lowering that dividend in terms of our confidence in the business going forward.
So we're weighing all those things. We continue to weigh all those things, but to date, we've been committed to maintaining the dividend at its current level.
So if we kind of take that out and say, on an annualized basis, if you did bring down the dividend, how much could it come down to the minimum distribution?
So, I mean, you can shift it around a little bit from year to year, but, you know, you'd call it $50 million, you know, a year that on average, between now and, you know, so 2023, 2024, 2025 s omewhere in that neighborhood, that it could come down, is our projection.
And so when you think about the idea that if you did lower it, and then if the yield, you know, reflected a conviction that you had done what had to be done, but there was no wiggle room to do more, do you believe that maybe the yield would then kind of revert back to more of a normal 6%-7%? And, you know, so it would actually be kind of net neutral to the stock, but then it would be positive from a liquidity standpoint. What's the bull case scenario or the best the most compelling reason not to lower the dividend?
Yeah. Well, I think, I mean, if you look at, you know, statistically, dividend cuts are destructive of equity value. I mean, there's a negative reaction, you know, pretty much across the board-
I'm familiar.
Yeah, with dividend cuts. So I think, you know... I don't know, it's a debate, something we talk to investors a lot, and there are differing opinions among our investors. I mean, I don't think we are necessarily a yield-driven stock. You know, if you look at our investor base, there's not, it's not a ton of income-type investors, traditional REIT-type investors that have been invested in Uniti, historically. I think you can debate whether or not the market is expecting a dividend cut. We have definitely investors that have different opinions on that, for sure. So, I can't tell you. I know for sure what the yield would settle on, but we do think there would be a negative reaction in the market likely to a dividend cut, for sure.
Well, so then, but if we get then to the point in time where you're free cash flow positive and all these other things in the post-2025 time, you would have to just simply raise the dividend again, correct?
Yeah. So, and here's another piece of it, Dave, is that I... You don't see REITs generally, and it's not something that we, we think would be the, the best idea to really peg our dividend to something like REIT taxable income, even though the minimum distribution requirement is absolutely pegged to...
Taxable income
Taxable income. You don't see really, REITs, pegging their dividend policy to taxable income. Taxable income can move around a lot.
Right.
It's, you know, things like bonus depreciation elections and moving dividends from one year to the next.
$0.50 per share.
It can bounce around and yo-yo around a lot. So, you know, I think we wanna be careful about, you know, pegging our dividend to something that's going to move around a bit. But if you did reduce it down for a period of time, our projections over time would be that that would... That the taxable income would begin to grow as those settlements roll off, as, you know, we continue to grow the business. You know, interest rates also have an effect on taxable income for sure. So depending on where interest rates went, that could have an effect on that.
But I would expect that over time, taxable income is going to come back up, and that the dividend would have to come back up with it. Yeah.
Yeah.
Yeah.
Yeah, go ahead.
Oh.
Sorry.
It's okay, Nathan. So just hypothetically i f you were to cut the dividend, what would you spend that money on?
Well, you know, you would want a compelling case for what you spent that money on, right? So, you know, either de-leveraging or investing in the business. I think those are things that are positive reasons, potentially for cutting the dividend. You know, as we've talked about, we're in a free cash flow negative position for the next couple of years. So cutting the dividend would help with liquidity and meeting all our capital allocation obligations, for sure. And would likely not go to de-leveraging in any meaningful way in the interim, just given, you know, it wouldn't be a large size.
If you're talking about $50 million a year, it wouldn't make a large dent in that. So, I mean, I think if we cut the dividend, we would be using it, you know, to make sure we can maintain the current level of investment in the business and satisfied our obligations with investing in the GCI program and that sort of uses.
Okay.
Yeah.
But you're not constrained right now on just regular investment in the business. I mean, I guess I was wondering, would you rather spend it on delevering, potentially, you know, taking debt out below par, that'd be accretive? Or, you know, is there sort of like something on the M&A front that would be a better return on capital than-
I think those-
investors, rather than-
Yeah
just paying out the dividend that obviously the market doesn't seem to be giving you credit for?
Yeah, I think those could be good uses of funds from that. But we'd have to go, you know, within our needs for our current capital allocation and those priorities as well, so yeah.
I mean, just kind of, like, maybe you could—you kind of touched a little bit on this, the cadence of getting to free cash flow positive from where we are today, you've targeted by the end of 2025, right? And so there's some moving parts. There's the settlement payments at $100 million for the Windstream bankruptcy settlement on an annual basis. I think that those end in 2025.
Mid 2025, yeah.
So that piece is $100 million that drops out. Then there's the GCI program and that's topping out, I think, at 200 and-
Two. this year, we're expecting it to be about $250 and that'll really top it out. The annual levels step down over time. Next year is $225, the cap, and then it steps to the year after that. It steps to $175, and then eventually down to $125. Windstream has the ability to roll over unused portions from previous years, but if they use the full $250 this year, there's virtually nothing left to roll over. So it would kind of step down to those annual caps. Yeah.
So we'll get by the fourth quarter of 2024, we're run- rating at about a $100 million benefit from reduced settlements. Probably run- rating at a $75 million improvement from lower GCI investments, with an eye towards that stepping down yet again.
Yeah. Yeah.
So that's 175. And what then-- then there's two other pieces, right? There's the organic CapEx which has been, you know, a lot of development for, I guess, anchor builds for customers, which, you know, theoretically will step down through time as those businesses ramp up. So can you just remind us the amount of CapEx step down that you need from the organic business and the amount of organic growth from the business to fill the hole that gets us to fourth quarter free cash flow positive?
Yeah, it's, and there's one other piece from the Windstream that we didn't mention which is the rent from GCI payments. So as we make more investments, there's an 8% yield on that. So as we make more of those investments, there's a one-year delay between the investment—when the investment is made and when the cash from payments from Windstream start. So those ramp up, so that shrinks the gap a bit more.
Our expectations and our projections in terms of that path of free cash flow is really kind of continuing the operational trajectory for the rest of the business, just kind of at where it is today. You're talking about mid-single-digit growth for the Uniti Fiber business, a capital intensity coming down, but not because we're lowering the nominal level of CapEx at Uniti Fiber, but because we're continuing to grow that business. So we expect CapEx at Uniti Fiber to stay about where it is today.
So in that $110-$120 million on a net basis, CapEx. So continuing to invest in the Uniti Fiber network as it... at the same level we are today, growing the top line, that capital intensity comes down. You know, we were at 50%+ capital intensity at Uniti Fiber a couple of years ago. Now, it's down to about in the 40% range, and we would expect that to kind of continue to come down towards 35%, maybe even a little below that, over the next few years. But most of that's from growing the top line, not from reducing the nominal level of CapEx.
Yeah. So when you say that the steady-state level of growth for the fiber business is 3%, have you been realizing 3% year-over-year revenue growth in the fiber business recently?
So in on our recurring revenues, we have. So recurring revenues have been growing in the mid-single digits level year over year. Where we've had some variability really has been in our one-time revenues. So this year, so, and one-time revenues can be more lumpy. So the one, last—from last year to this year, we went from about $25 million in ETL payments from the Sprint consolidation as they're decommissioning towers, down to $15 million of ETL payments from you know from that consolidation.
ETL stands for Early Termination-
Liability.
Ah.
Liability. Yep. Yep. Some people say ETL, Early Termination Liability.
Yeah.
But ETL is just another way to say it. So, and then one-time equipment sales and one-time installation, you know, some of that has moved around a little bit. We've also embedded in that monthly recurring growth, you know, some headwinds in the wireless business in terms of the Sprint consolidation, again, and some reterm activity with wireless carriers. Although, we've announced a couple of major reterms of our wireless backhaul portfolios with two major providers, about two-thirds of our tower base that we've now retermed, at between the two deals at about the same monthly recurring level out to 2030.
So a lot of the wireless reterm activity is now behind us because we've done some master reterms to push those, you know, those deals way out into the future. But there have been some headwinds in terms of the Sprint consolidation and some of those reterms that have provided some headwinds. But even with that, we've been growing the recurring base of revenues year-over-year in that mid-single digits base. So we want to continue to do that, continue to deliver that growth, and we can do that with the same level of CapEx that we have that we're putting into that business today.
So we've, you know, we kinda hear from different fiber services providers. Everybody's kind of got their special sauce. But, you know, the Cogents of the world talk about the slower-than-expected return to work. And so they've been kinda eking out, you know, between 0%-1% growth in a post-pandemic world versus what they used to be, like, growing at 10%. You know, the Lumens of the world, you know, are kind of struggling to kind of get to growth along any vector. But, you know, their argument is, you know, they need to retool the sales force. And frankly, the decision-making processes from their target customer base haven't really re-accelerated as a function of every maybe related to Dave's comments about return to work, just we don't know what we're engineering to optimize for.
So, you know, hearing a fiber services company like yourself target 3% growth, you know, in excluding the termination fees and the whatnot, how does Uniti feel comfortable making that as a base case expectation?
Yeah. Well, I think we're delivering that today, and we continue to see strong demand from our customers. So you take, for instance, our enterprise business. We're growing those revenues double-digit year-over-year, this year over last year and last year over the previous year. Wireless bookings are down, and we projected wireless bookings going into this year to be down significantly from 2022. We had about a 50% expectation for a decrease of about 50% in those wireless bookings. But we've been filling that gap with other wholesale demand on our national network and our metro networks.
And I think one of the things from our perspective that allows us to do that is that—like, so take our enterprise business, for instance. It's a very targeted set of products and services, very, you know, mission-critical fiber infrastructure products, dark fiber, high-capacity transport, DIA, dedicated internet access. And we're very targeted in the markets that we're providing those services and very targeted to the, even the customers that we're targeting for that. We're targeting customers that our fiber passes, where we've got the ability to bring our own fiber into those businesses. And we think that gives us a competitive advantage in terms of our ability to serve those customers' needs.
And our penetration rate of the enterprise customers that our fiber passes today is low, kind of low to mid-single-digit penetration rates of the customers that we pass. So there's a lot of headroom for additional growth there, and we're finding a lot of success in targeting those businesses along our fiber. And as we build fiber to new enterprises, we're passing additional enterprises and expanding the addressable market that we can serve there. So that's a formula that's been working well for us. We've increased the size of that enterprise sales force from 25-30 a couple of years ago, to 40-45 reps today. And so, you know, we think we've got a lot of headroom to continue to deliver that kind of growth and deliver those kind of bookings.
Our bookings in that space have kept pace, even this year, with decision cycles maybe getting longer, a little bit longer with decisions, you know, with customers being a little bit more cautious. We've been able to continue to book enterprise revenue at about the same level that we booked it last year. So, one of the things that we're seeing, even with and we are seeing some longer decision cycles, especially in wholesale, the wholesale markets. But what we're seeing is our funnel level, our demand level has never been stronger in terms of the number of the volume of deals that we've got coming through, the number of quotes that we're putting out.
And so, we're seeing real demand there, and so we're confident that demand is gonna continue to materialize. Even if it materializes a little slower, we're confident it's gonna continue to materialize.
Can you go back just real quick? When you said that you're, you know, obviously, the majority of your business is wholesale. That kind of, I think, is an anchor tenant for some of the outlook for growth. Maybe not so dependent on, you know, that, the network planning, but you just mentioned wholesale being a little slower even. If the wireless guys are kind of retreating a little bit as an incremental driver of demand who's backfilling that demand that makes you comfortable?
Yeah. So we're getting demand from other wholesale carriers, from the hyperscalers, that's coming in to backfill a lot of that demand that the wireless players are maybe leaving a void there.
Okay. And so then, you know, the way you guys have described the fiber business in the past, it's y ou know, I think it's something like an anchor tenant build is a 6-7% type of yield. And then once you've kind of got the asset in the ground, then you can kind of co-locate on it bring incremental business.
And those returns can be mid-teens, you know, or even better. So I guess, my understanding, you kind of mentioned that you're gonna continue at the current cadence of investment, which presumably means that it's kind of a continued cadence of anchor builds, and revenue growth is gonna be a combination of what comes from those 6%-7% yields and those higher yields. And as that mix increasingly shifts towards the higher yielding colocation revenues, margins should be creeping up. Is that something directionally we can expect in kind of the 2024, 2025, and beyond horizon? Or is there a reason, because we need more salespeople, we need these other things going on, we're gonna have to reinvest some of that incremental return back in the business?
Yeah, no, I think from an investment level, I think we... You know, what we're seeing from, in terms of lease- up is really superior returns in terms of what we're getting from our markets. So 50%+ yields on average is what we're getting in the lease- up in our market. So that's really, really stellar returns, and we're gonna, you know, we wanna continue to do that, and like I said before, we've got the headroom to continue to do that in our markets, given our penetration rates there. So we're gonna continue to make those investments.
The shift has largely been made in terms of our business, in terms of shifting from those anchor builds that we were doing 2 or 3, 4 or 5 years ago, to more of the lease- up now. So I think you're gonna continue to see the same sort of mix that we're doing today, and as we go into the next couple of years. But as we stack that revenue on, it is accretive from a margin perspective. So, you know, our margins are up, you know, have been from an EBITDA perspective, kind of the high 30s to 40, 40% margin.
We've increased to in recent quarters, and I would expect that to continue to creep up a bit as we continue to add that more accretive lease-up type revenue that's really high margin on to the network.
Maybe shift gears a little bit-
I'm talking about Uniti Fiber i n this case, right? Not on a consolidated basis, margins are much higher.
Right.
Yeah.
That's why I was just gonna shift gears to the largest part of your business.
Right. Right.
So the sale leaseback part of the business, obviously dominated by the Windstream lease. How is the relationship with Windstream these days?
No, we're operating very, very closely with Windstream, and that's going, that's going really well. We have to coordinate it on a number of things, you know, really almost a daily basis, right? So those things are GCI. We're having to work with each other. You know, we underwrite those deals. They present the business cases in terms of the markets that they want to invest in, which we approve, and then as those expenses come in, we're working closely with them to work through all those expenses and determine what's eligible for reimbursement under the GCI program and making those reimbursements. So that requires a lot of coordination.
And then, you know, we now have the ability, and a core piece of our business strategy going forward is leasing fibers, and even lighting fibers and providing wavelength services on the reversion fibers that we got back from Windstream, and as a part of the settlement in 2020. So we now have the ability to-
That's a piece of that 3% growth that we were talking about.
To lease the 2.2 million strands that reverted back to us in 2020, and we've built a business group about it. That's where some of that demand that I was talking about to fill the wireless void is coming from as we ramp up that business. But, those fibers are—there's still a triple net lease, right? And Windstream is still maintaining those fibers, and so, you know, we have to coordinate together as we look to serve our customers on the non-Windstream customers on those fibers to make sure that, you know, they're being maintained, and we can, you know, we can fix any problems that arise on, you know, on the fiber portion of the network, expediently. So that requires coordination on a regular basis with Windstream.
And all that's going, I would say, going well. For sure, there's been public dialogue that you know, hopefully it's quieted down a little bit, maybe, maybe not.
Well, but there's been public dialogue, and there's, you know, it seems like that our two companies are a long way apart on some larger, more strategic things. And there are definitely some differences of opinion there. But I think overall, the relationship works well for the day-to-day operations aspects of what we've got to do to both be successful in running our businesses.
So I only these days only ever get to see Tony and crew once a year down in Boca at his high yield conference. I don't know really the inner workings. I know you guys share a lot of their financials b ut with respect to where your GCI dollars are going, is it into backhaul fiber? Is it into fiber-to-the-home ? Like, what are the assets that you're getting for your dollars right now?
Yeah. So in large part, GCI is targeted at overbuilding the Kinetic copper network with fiber. And we think that's critical for the value of that network going forward to Windstream and, you know, then conversely, to us as well, as the owner of that, those assets and leasing those to the operator of those assets. So we think that investment in the fiber-to-the-home business and overbuilding the copper network with fiber is the right strategy and a critical strategy for that business. So those dollars are largely going into that. GCI is not available for extension into new markets. It's not available for maintenance. It's available for really the improvement of the existing network, which is, like I said, largely copper overbuild.
Mm-hmm. So I've got a... This is a complex question, I guess. But it's something, for instance, we've been talking about a lot with the Canadians in particular. Telus, for instance, who's overbuilt 80% of their copper network with fiber. AT&T has talked about, you know, their very strong fiber initiative and, and the implications it has for copper, is that, you know, that we're decommissioning copper. And is there any of the copper that Windstream has that's part of the Uniti portfolio, or is it just fiber?
So Windstream, I mean, the network that Uniti owns that we lease to Windstream is both copper and fiber, right? So as copper gets overbuilt with fiber, then that copper, you know, could be decommissioned, could, you know, continue to stay in use. It's only about 40%-50% of the copper network will be overbuilt with fiber per the GCI program.
At, you know, the run rate that we're going and the commitment that we've made to do that s o that would get us to close to 50% of that network being overbuilt. So there'll still be a substantial amount of copper in that network. And you don't need a 100% fiber network to deliver higher bandwidth and better speed. You gotta get fiber to the key nodes. You've got to get it closer to neighborhoods but don't necessarily have to have a fiber drop at every home you know, to drive higher bandwidth services to customers. But there'll still be a fair amount of copper in that network, even after the GCI investment that remains.
Obviously, Windstream is spending its own capital in addition to your capital. But to the extent that the combination of the dollars you're giving them, especially the dollars you're giving them, to the extent that that's being used to overbuild copper, Windstream's paying you two rents, right? They're paying you within the $650, they're paying you rent on the copper that was part of the original lease deal. And then when you put fiber on top of that copper, you charge them another 8%, so they're paying you rent twice. How do you see that working itself out when we get to the lease conversation at the end of the day?
Yeah. So that's not the way, that's not the way you would value and look at that network from an appraisal perspective, which is how, you know, more than likely we're gonna come to valuing that network. The appraisal process looks at the value and sets the value of the network by the, you know, the, you know. They look at a number of things, including the, you know, the income approach, a replacement value approach. And so what you're looking at and what you're quantifying is the value of that network to Windstream in terms of the income that it can produce, and that, you know, you know, Windstream, it may have copper, and it may have fiber, but it's not charging homes for copper and fiber, right?
Correct.
They're, you know, those things are driving towards, you know, a singular income. And the replacement value, as we invest more and more fiber into that network, the replacement value of that network goes up as well. So it's I don't think you can look at it that way in terms of, you know, they're leasing a copper line, and now there's a fiber line on top of the copper line, so we're we're charging them twice. We're charging them for the value of that network and running and operating their business.
Yeah. Oh, Ana wants to know? Okay.
Oh, it's your favorite topic, Dave, but it's on the lead sheath cable. So under, like, the older legacy assets that are part of the assets under the lease. Under the terms of this triple net lease, if there was a requirement or just voluntarily you wanted to replace that lead with fiber, you know, lead sheathing with fiber assets, is that Uniti's responsibility or is that Windstream's responsibility? And then to the degree that seems like all the carriers are saying that they're working with the EPA. Are you guys having those conversations, or is Windstream having those conversations?
Yeah. So, under the triple net provisions of the lease, environmental remediation is a responsibility of Windstream as the tenant on the network. So technically, by the letter of the lease, it's their responsibility for remediation. But obviously, you know, any expense that Windstream is taking on is important for us as well because it affects the health of their business. So it's definitely something where, you know, we would look to work with them, you know, on that in terms of assessing it, in terms of, you know, thinking about how we would remediate anything that would need to be remediated. But technically, under the triple net lease, remediation of environmental issues would fall to them under the lease. Yeah.
Okay. So maybe with the wrapping up, we've got a few minutes. I think, you know, Kenny, you know, as your standard bearer, as your CEO, has, you know, made this, made an argument that when you kind of look at Uniti stock it just doesn't, the stock price doesn't make sense. Because you know, to my point earlier about the dividend, you have to pay the dividend, and you can't get rid of the dividend. You could lower the dividend, but it would still be there.
Right.
And then it would have to go back up, even if you did lower it.
Yep.
And so, you know, he's expressed a view that maybe if the market isn't gonna organically reward Uniti for the value you guys believe you've created, inorganic ways would be the way to forward.
Yep, yep.
Now, obviously, interest rates have moved dramatically, and, you know, the world looks different from a financial standpoint. Is inorganic something that's still on the table in the current rate environment, or do we have to wait for a rate environment to change before, you know, people's weighted average costs of capital become... land in a place that makes doing these kinds of deals attractive?
Yeah. I think deals can still get done now. I think there's a bit more stability in terms of, I mean, interest rates are still high. That still figures into the math of how a valuation works and, and, you know, prices people are willing to pay and the cash flow that assets can generate. So obviously, that figures into prices and, and deal multiples and that sort of thing, for sure. But I think deals can get done. But it's definitely harder to do deals in this market. So I certainly don't wanna suggest that it's not. It's more difficult. It's more difficult to get financing and get deals financed, but it's not impossible.
So I think, I think deals can get done. I think there's still strong interest in quality assets. And you know, we've mentioned recently that you know, we're continuing to have conversations and continuing to think about M&A. And we think you know, there are opportunities there, but it is harder, for sure.
You know, I think the last point worth mentioning is, so you know, I think late last year, early this year, you guys have basically, you know, cleaned up the balance sheet from a maturity standpoint.
Yep.
You know, yes, you're operating at a free cash flow deficit, but you can manage that.
Yep.
You've got really until probably 2027 before, you know, something needs to be addressed.
Right.
And so you've, you've created a runway here where there's a lot of time to pick your spots, as you know, along that strategic path, if that's where you choose to go.
Yep.
Is that fair?
Yeah. No, I think that's, that's very fair. Yeah.
Okay. Well, then, I just wrapped it up for us. Thank you very much, guys. Thanks, Paul, for being here.
Yeah.
Bill, thank you, Ron, for coming. Appreciate it.
Thank you.
Thank you.
Thank you, Dave. Yeah, thanks, everybody.