Good morning, everyone, thank you for joining us for our fourth annual summit. Thank you all for the support you've given us as a firm. Some of you who saw our last session with Disney heard Michael say the same thing, all of us, on behalf of the whole firm, we can't thank you enough for the support that you've given us, and it's hard to believe that we're now in our fourth year doing this. Thank you for those of you who are joining us by webcast this morning. I'm really delighted to have Matt Ellis joining us this morning. Matt, congratulations again on your new role.
Thank you.
Obviously, one of the themes that we're going to talk about a lot throughout this conference, and I know the topic, just judging by the question I get, everybody wants to talk about M&A. I'm going to talk about that with you a little bit, but I want to start with the most recent transaction, Straight Path, and wonder if you could just tell us what was it that was so compelling about Straight Path? There was a sort of sense of urgency about getting Straight Path. What was so compelling about it, and what do you plan to do with it?
Yeah. Good morning, Craig, and great to be here. Before I start, I think we have our safe harbor slide, which I need to reference if we can put that up, please. We'll get that up here in a second. I'll make reference. Obviously, we'll make forward-looking statements this morning, and there's obviously risk associated with that. The full statement is on our website. With that said.
There.
There we go. There it is in all its glory. With that said, to get to your question, as you think about Straight Path, I'd suggest you think about it in terms of the overall ecosystem of building out 5G and really the journey we've been on for the last two, three years now. When we first started on this, we felt that there was some great use cases around 5G, and there was a lot of talk, "Well, the standards aren't going to be there until 2022, 2023." We said, "Well, we think if we put our muscle behind that it doesn't need to be that long." We've partnered with other carriers around the globe, specifically in South Korea and Japan.
We've partnered with some of the network manufacturers such as Samsung and Nokia and Ericsson, and you've seen us really make a lot of progress there. We've tested the technology first in lab, and then last year, we took it out of the lab into the field, and now this year, obviously, we're doing the pre-commercial scale trials that we're just kicking off now. What you see us doing is really building out what we need to launch 5G as we go forward, and obviously, one part of that is spectrum. We have some 5G, the millimeter wave spectrum through the XO transaction. That got us 28 GHz spectrum in significant parts of the country, but not all of the country. When you look at the Straight Path asset, they bring more of that 28 and also nationwide coverage at the 39 gig level.
It was really a case of adding another asset that we're going to need to build out 5G and be able to deploy it as quickly as we want to. There will be other 5G spectrum that comes available through FCC auctions, but that's probably a couple of years away. We felt like taking the uncertainty off the table of having to wait to participate in the auction. We now know what we have, and it puts us in a position we can deploy the 5G solutions as soon as they're available.
Is it fair that, I presume the answer to this is yes, but that your engineering tests have been sufficiently positive to say, look, this is actually going to work for issues like rain and trees and leaves and that sort of thing, that you're confident that there's a real business case for deploying this spectrum?
That was part of the taking it out of the lab last year and doing some of the field trials. We demonstrated that it works. We demonstrated that you can deal with some of those issues and how you do the beamforming as you operate in these much more high-frequency bands, which is different than in our traditional spectrum. We proved that you can solve those initial challenges that people saw. To the point we said, we're going to now test it on a larger scale, which is what we're in the process of launching right now. We're doing that in 11 different cities, which have different topographies so we get comfortable with how that you use this spectrum and make it work, and then we'll deliver the business cases coming out of that. Those trials are just starting.
Too soon to tell you how they're going. I'm the most eager person to know. We should have answers out of that as we get later into the year, and then we'll talk more about specific use cases. Obviously, we think the fixed wireless broadband will be the first use case. After that, we'll get into mobility use cases as well.
I'm going to come back a little bit to fixed wireless broadband later, I want to start with the core business.
Okay.
In wireless, it's fair to say the first quarter, not just for you, but really for the industry as a whole, was a very challenging quarter. With slow growth in phones, also ARPU's down, and I think it was the industry's first ever year-over-year service revenue decline after 17 years of growth. Competitive intensity, I would argue, is probably the highest we ever saw in the first quarter. What's the argument that it gets better, first for the industry as a whole and then for you specifically?
Yeah. I would say, look, I'll talk about where we are. We feel good about where we are today in the industry. You got the combination of the best network and the largest base of customers. What you saw us do in the first quarter was launching Unlimited, because we'd reached the point where customers were having to make a choice. Other carriers had decided to launch Unlimited. It was leading our customers to make the choice between, do I want that feature function where I don't have to worry about how much data I'm using anymore, or do I want to be on the best network? What we did was we launched Unlimited. Customers didn't have to make that trade-off anymore. We immediately saw a benefit in the results.
As I think we said on the earnings call, I fully expect that we will be phone net add positive during the second quarter. We're certainly seeing a turnaround in the business since we launched that. The other key component around this is when we made that change, it wasn't a price reduction. There's certainly customers optimizing and taking advantage of it. We also have customers stepping up to it. Overall, we think that this will not be a negative to ARPU by going on Unlimited. It was really just getting on that same level playing field from a functionality standpoint and going from there. We like where we're positioned today. We're still premium priced. We launched it in a disciplined fashion. It's at a premium to where the market is because we have the premium network. We like where we're performing today.
Have you seen any sign that the competitive intensity that made first quarter soft for you and everyone, have you seen any real signs that that's abating in any way? What should we be looking for? You said phone net add positive. What else do you look for to say the business is starting to turn?
Yeah. Look, from the competitive environment standpoint, it's certainly been a competitive industry, not just in the past year or so. At various times over the last 20 years. I think if you look where we are today, it shows that we compete effectively even in that type of environment. We'll see how the industry plays out the rest of the year and if it gets more aggressive or less aggressive as different devices come out. We'll wait and see. Let's talk about service revenue for a second as an answer to your question. First quarter, we saw the negative 6.1% year-over-year. We said we expect second quarter to be in a similar type of range. We said we expect the back half of the year to show improvement in that trend.
If I break that apart a minute and maybe explain why we have that confidence, you'll see that improve. If you look at the different components in service revenue, one of them is the line access fee. If you go back to August of 2015 when we launched the price plan, when we introduced small, medium, large, extra-large sizes, that was when we said we're not going to be fairly even on customer choice between the subsidy model and device payment model. We're really going to go more to device payment. When a customer went to device payment, you go from that $40 line access fee to the $20. Now, you're correcting the revenue elsewhere in equipment revenue, as you know. From looking at service revenue, you've got that trade-down.
When we get into the third quarter of this year, we have the 2-year lapping of that, really getting behind that. The headwind in the line access component of service revenue will be less when we get to the back half of the year. The overage component. Again, in the third quarter a year ago, we added features to our plan with Safety Mode and Carryover Data that started to allow customers to manage their overage more so than they could in the past. Obviously, that's a significant feature of unlimited as well, that you get there. We've seen significant migration of the base to both the plan we launched last summer with those features and now certainly with unlimited. We'll start to lap the anniversary of that as we get into the third quarter as well.
The headwinds in both the line access and the overage will start to reduce as we get into the back half of the year. The other thing that we're seeing is we're seeing customers in the base step up to get to unlimited. Whereas previously they'd say, "I'm not sure I want to pay an extra $20 a month to get an extra 4 GB of data." They say, "Well, I pay an extra $20 a month and I get unlimited." We're seeing more step-ups that way. When you add those things together, the reductions of those headwinds that we see line of sight to beginning in the third quarter, we're confident the service revenue trajectory gets better in the back half of the year.
We tend to do an accounting adjustment for.
Right
ARPU and service revenue. I suspect you internally do the same so that you can get a sort of apples-to-apples view. I don't know whether you do it the same way we do. Do you think, adjusted for the downdraft that comes from transitioning customers to EIP, do you actually get to positive ARPU growth in the back half of the year?
I think we certainly see the ARPU situation improving. The exact timing of that getting to growth, we'll see whether that comes in the back half of the year or whether that gets to sometime further out in the future. That depends a little bit on how things play out. To your point, that's why we also look at service revenue plus installment payments. Because what I'm really interested in-
Yeah
irrespective of how I've bifurcated the bill out and all the mess we've made with this, you get to what's the total amount I'm billing the customer monthly. Again, in the first quarter, even though service revenue was down 6.1% year-over-year, the billings, the service plus installment billings, were up on a year-over-year basis. That's another reason why we feel good about the business.
Okay, good. Let's talk about your network now, because you talked about going to unlimited and the big controversy I think that I hear from investors is whether the network is ready to handle the kind of load that you're seeing. I guess the first place is at just at a 30,000-foot view, how's the network holding up as unlimited data usage ramps up? I think the argument was you probably only saw, because it came late in the quarter and people had to opt in, you probably only saw just the front edge of the increase in volumes that you're going to see over the rest of the year.
Yeah. Look, the network's performing great, and it's performing as we expected when we decided to launch unlimited. We started thinking about unlimited last year. Weren't convinced we were going to do it, but obviously as it was in the marketplace, we asked ourselves, is it something that we can do if we want? Obviously the core brand promise that we make consumers is about the quality of the network experience. We said very early as we started to think about unlimited, well, if we're going to go there, we're not going to jeopardize that brand promise. We're only going to go there if we're convinced that the network performance can continue to lead. The network team was confident in that. They spent a lot of time on the back end of last year convincing the rest of us that that was the case.
When we decided in the first quarter where we saw the competitiveness in the marketplace and we were seeing customers were really looking for that functionality, we'd reached a point where we felt network was there. Look, if I break down network, and I understand where the question comes from, we think about network in terms of coverage and capacity. We completed, really, the build-out of coverage of the LTE network really about three years ago now. Since then, we've been adding capacity. There's different ways you add capacity. We think about adding capacity with spectrum, we add capacity with the network architecture, and then we add capacity through densification. From a spectrum standpoint, we continue to deploy more spectrum to our LTE network. Today we're running just over 50% of our spectrum assets are supporting the LTE network.
There's significant amounts of spectrum we still have to deploy against the current network, whether that be the AWS-3 spectrum, which is starting to go into service this year, whether that be refarming PCS and 850 MHz spectrum that supports the 3G and voice networks. As we get customers migrate off those, we refarm that spectrum over to the LTE network. As I think about heading into 2018, we're going to get access to unlicensed spectrum, too. We are continuing to add spectrum assets to the network. You get to the network architecture, and whether that be some of the features in LTE Advanced or whether that be what we're doing with CRAN and those type of technologies, we are more efficiently deploying the spectrum today than we were five, six years ago when we launched the LTE network.
Every piece of spectrum we have is doing more now and capable of doing more, and we see further opportunities to have gains just through the architecture. You get to densification. We're doing exactly what we said we'd do. Remember we came out of the AWS-3 auction and there were some cities that we didn't win, and we chose not to go. We said there's a price at which it makes more sense to add capacity through densification versus just spectrum. We've done what we said we were going to do by densifying the network, and you've seen the network performance in that time period since then continues to lead the industry. Densification very much works. There's still a lot for us to do with densification. A couple of other plus points about densification. One, it pre-positions the network for 5G.
By putting the small cells in, putting that dark fiber in, you're creating some of that backbone that you're going to need for that next-generation network. Secondly, it's more efficient to densify than just to add capacity through spectrum. For example, here in New York, it's certainly a market where we've had to add capacity. If I'm going to do that through spectrum, I go buy a piece of spectrum that covers, yes, it covers Manhattan, it covers the five boroughs, but it covers areas outside that, too. I may not need additional capacity throughout that geography. When I do it through densification, I pinpoint specific locations, like maybe right here, and I'm able to add capacity here without adding capacity where I don't need it, which is obviously that's efficient.
We're very comfortable with the network performance on Unlimited, and we're seeing what we thought we'd see when we decided to go all in.
One of the arguments that I think everybody here will be familiar with is notwithstanding all the things you said about the ways that you add capacity, there's still a broad perception that you are spectrum-constrained, and that particularly relative, if you take metrics like MHz pop per subscriber.
Yeah
That sort of thing. Say more about how you think about spectrum. It used to be you would say, "I want to make sure I have spectrum to plan ahead 12-18 months." Is that timeframe still appropriate, and how confident are you that you do have the spectrum assets that you need?
Yeah. We still plan ahead. That 12 to 18-month window is still the right one. We forecast where we see demand going, and we see where we have capacity, then you obviously see where that equation looks like it's going to break, and then you architect a solution. That solution's going to differ by geography. In the old days, it used to be, I'll just put up another macro cell site, and I have to have the spectrum there to make that work. Now it's a question of, okay, how am I going to use small cells, and there's different types of small cell solutions. What's the right solution for the geography where you're going to need to add capacity 12 to 18 months out?
We showed a video at the sell-side event last week that's available on the website where we showed three different geographies and how you're densifying in different ways in those different geographies because of the specifics of each location. The team continues to do that 12 to 18 months out. That's what they've been doing. The things the engineers are deploying in the field today are things we started planning for in the first half of 2016. The things that we're planning today is for activity we'll actually deploy in 2018, and that continues to be the case. Spectrum's one way that we can add that capacity, but it's not the only way.
As I say, it's really about looking where we think we see we need additional capacity 12 to 18 months out, then we find the right solution, and that is often as much around densification as it is around, "I need more spectrum in that particular location.
The densification story has been a somewhat slower one for almost everyone than I think we would've anticipated a couple of years ago, whether it's zoning, whether it's the cost of roof rentals and street furniture rentals, and that sort of thing. Can you talk about the pace? You said you're planning 12 to 18 months in advance for getting that done, but how long does it take to scale a small cell network in a given location?
Well, you touched on some of the points that are there. Certainly the zoning and permitting and so on takes time, which is why we plan that far in advance, so that we can get it done. I think we know how to do that. We've been doing it for a long time, and we've shown that we can get there. You don't just go into some densified city and say, "Okay, it's done densifying." There's layers to that. You go and do initial densification, and you come back and you densify further and so on. It's continuous how we do that in different geographies, because you're adding the capacity that you're going to need some far out in the future, 18-24 months out, but I'm not necessarily trying to put the capacity I'm going to need 10 years out.
That would be a little inefficient to deploy it that fast. The reason why we do it that way is just the timing to get the permits, to work with the local authorities to get there. I think we know how to do that now, and I think we've demonstrated that. That's why we've added the amount of densification we have in numerous cities across the country, and you see it in the network results.
Is it fair to say that's becoming a more and more important part of your capital budget?
The densification piece?
Yeah.
Yeah. I think when you look at the capital budget, overall the number stays fairly consistent, but what's in there evolves significantly over time. If you think, you go back a number of years, obviously it was around 3G and then it shifted to 5G and then it shifted to 4G, and even within 4G it's moved from initially it was about coverage, to now it's moved to capacity, and within capacity, there's a fair amount of that, the densification. As I said earlier, we're thinking about it not just deploying densification for 4G, but how, as you put that densification in, we're pre-positioning for a 5G deployment as well. We make that asset deployment as efficient as possible.
Bottom line, I guess, for me and for a lot of your investors is the core Verizon strategy of network advantage in wireless still possible? Is there still room for network advantage to be a differentiator? Do you still own that position?
Absolutely. I think that shows up in the numbers we saw in the second half of the first quarter after we took away the functionality difference, unlimited versus not unlimited. You saw the numbers we had in the second half, and that's with a price premium against where some of the other guys are. It shows that consumers understand the value of the network. They're willing to pay that premium to get on the Verizon network experience, and we fully expect to continue that. As I think about not just in 4G LTE, but as we get to 5G, we're confident that we are leading the way there. We're going to deploy that first and continue that history of that network leadership.
Let's talk about 5G for a second. You mentioned the trials that you're already doing and that it may be too early to report anything back.
Right
on what you're seeing. Let's take fixed wireless broadband for a second. What's your intuition about the geographies where it's going to make sense? Does it make sense only in extremely dense markets? Does it make sense only in the suburban rings around dense markets? Where does the business case play out for fixed wireless?
Yeah. I think what it ultimately depends on is how far you can propagate that signal, right? That's really why we're doing the trials to get comfortable with how far. That really says how far out in that dense urban to suburban ring and so on, it makes sense to go. We'll have more sense later in the year on the size of that particular opportunity. We certainly think it's significant. We certainly think it's a meaningful business case, we look forward to getting to the end of the trials and being able to be a little more specific about that. We don't believe at this point it's just a dense urban opportunity. We think it moves a little more broader than that.
Like in the case of building a wireline network, is it I'm guessing advantaged in places where there's aerial infrastructure relative to buried infrastructure, presumably, it's easier in places where there's telephone poles or street furniture than in places where there's not, or just street furniture, which I guess has become a euphemism for.
Right
streetlights.
Right. Yeah. As you think about it, really what I may take you back on this one is what we're doing in Boston, which is about the value of a fiber network across multiple usage and architecting that network to provide multiple uses, whether it's connecting cell sites, whether that's a 4G cell site or becoming a 5G cell site, whether it's providing a residential solution, as we are in the Boston build with the Fios product, whether it's connecting small businesses or enterprise businesses, going into the tall buildings in the center of the city and connecting those up for enterprise solutions. Even, as we move forward here, how do you connect up all these smart city solutions, the kiosks that are out there, that you see a number of cities now, just walked past one on the way here this morning.
Then the smart lighting solutions and traffic cameras and the like. So it's a case of putting that fiber in that's going to support those multiple uses, including the 5G business case. If you think about that fiber going out and using the street architecture, and as you say, aerial plants, easier than obviously when you have to go dig the ground. It's the combination of those things, and I think we've also learned how you go, even when you have to put the fiber below ground, we know how to go do that as efficiently as possible.
Lowell has talked about the architecture that you're using in Boston. Nick and I, some of you may have seen, just published a pretty extensive report on the 5G architecture, our small cells part two piece, that suggests it's a pretty expensive proposition to start doing 1,700-strand sheaths in lots of different geographies. Is it a fair expectation, you said before that the mix within your capital budget changes over time, but is it reasonable to assume that as you start to build extensive 5G, that it's going to have to take just plain more capital spending, that it's a more capital-intensive business than what we've seen so far?
Yeah, I wouldn't necessarily say that's the case. We're going to have to see. We'll get through the trials, and we'll determine the size of the opportunity as we discuss, and then we'll decide how quickly we decide to deploy against that. I'd say more to come there, but I'm not sure that I'd say that that's not a foregone conclusion by any means.
I'm going to wrap up on wireless with just one last question, and that is, your margins in wireless have consistently been the envy of everyone in the industry. That's both a blessing and a curse, right? There are some who would argue that we've seen peak margins, they'll never be sustainably that good. There's others that would say, no, you've actually got, as the upgrade rates stay low, and you keep taking costs out of the business. How do you think about those two things, and how do you think about the margin trajectory of the wireless business as you look out?
Yeah, I like that question. I think we've got it for a number of years now, and we keep getting asked it because we keep reducing the margins, right? Look, it's about continuing to improve the efficiency of the business. We don't always talk about it probably as much as we should do, but there's a number of ways that you see us continue to improve the cost side of the wireless business. It starts with network, and as we deploy the network more efficiently this year than we did last year and the year before that, the cost per bit comes down, and we're constantly doing that. That's been something at each generation of the wireless industry, you've seen us do that.
The first year of any of the generations is the most expensive cost per bit, and then it continues to come down from that, and we can see a continued line of sight with the LTE network to continue to bring down that cost per bit for the remainder of this year, next year, and going forward. The network piece, we think, continues to get more efficient. Then as you think about other parts of the cost structure from a distribution standpoint, we think there's still opportunity to reduce the cost of the distribution side by making distribution more of a digital-first activity. There's opportunities there to continue to reduce the cost there. On the customer care side, we continue to work and understand what's causing customers have to call and take away those reasons that's causing them to call.
If there are things they need to do, how can they do that in a self-serve fashion? With the app we launched last year, there's a number of things that a customer used to have to make a call, they can now do on their own time and just take care of themselves.
Is it fair to say that a customer who's on an unlimited plan has a lot fewer reasons to call?
There's obviously less things they have to call about, so that helps the cost side of the equation. There's a number of levers there to continue to drive the cost side, whether it's network, distribution, care, other things, too. That's an every year activity for us. It's not just a one-off program.
It used to be in these interviews, we would say, now let's turn to the wireline business. In some ways, the wireline business isn't really a separate business anymore. A lot of what you've been talking about is really the integration of wireless and wireline. Let me step back for a second, because you've divested a lot of your wireline assets to Frontier in a couple of sequential transactions. On the other hand, you seem to be increasing your dependence on wires. Can you talk about that trade-off of, on the one hand, coveting wires, whether from someone else or building more, and on the other hand, divesting some of what you already have?
I'd start off by saying that we still very much do have two segments, how we think about go to market. We go to market with wireless products and services, and we go to market with wireline products and services. That's not fundamentally changing. What you're seeing change a little bit more is the network, the provisions there. Historically, we've talked about the wireline network and the wireless network. As you said, that's where you're seeing more convergence. Because the wireless network, the reach of fiber into the wireless network, or wires in general, is a lot more than it used to be as you move from a macro cell site network to one with more small cells in.
What's important to the products and services we offer, whether that's a wireline or a wireless to a wire and wireless customer, is the quality of that fiber asset in the underlying network architecture. Certainly, we've talked a little bit about Boston and how we're building the network there, and you should think of that as a blueprint for how we're building fiber in other locations as well. You mentioned we've divested some assets. Obviously, the last one was the three geographies that we divested to Frontier last year. What we really did is we took those properties that still had a large amount of copper in them. We divested those, and we took the proceeds and used that to buy the XO asset, which gave us fiber metro rings in 45 of the top markets around the country.
We are certainly committed to the wireline asset. It's the foundation of the networks, both to provision wireline and wireless. In addition to obviously buying assets like XO, you see the agreements recently with Corning and Prysmian to spend $1.3 billion over the next 3 years buying fiber. We're committed to the wireline business because it's really the backbone of all of the network services that we're offering.
One of the alarming numbers to me that I saw in anybody's first quarter report was the rate of decline in AT&T's wireline business, in their commercial wireline business. Yours was much more of a constant trajectory, that it's not an easy business.
Yeah.
They had a very steep acceleration in the rate of decline in commercial wireline. What are you seeing, or is that a canary in a coal mine for that industry and that segment as a whole is getting more challenging?
No, I think we're seeing the continuation of the trends you've seen in our results for the past few years now. We've done a couple of things in that space. First of all, at the start of this year, we talked about we've broken up those customer segments. We used to have what we call consumer mass business, then enterprise. Within that, you had within consumer mass business, it was always consumer was the primary focus. Within enterprise, certainly the larger customers were the focus. What we did, we brought the mass business out of the consumer piece. We brought the more medium-sized business out of the enterprise and formed that new customer group. They're very much focused on the SMB space, including state and local government and education institutions.
Now that you've got a group that's very focused on that category, we're developing product offerings where you may bundle the voice and data needs of those type of customers in a product that fits for them. We're optimistic that that will help us to offset some of the secular declines just from legacy voice and data from copper-based services. When you get to the enterprise space, yes, you've got some of those secular declines that we've seen now for a few years. I think we've been the first to deploy some of the SD-WAN product in that space and seeing great take rates from customers. We've got those product offerings out there, some network virtualization offerings out there that are really allowing us to grow those businesses that offset some of the secular decline.
We're confident that the revenue trajectory we've been on will still be in that low single-digit negative number where we've been. We see the things we're doing in terms of new products and services providing enough of an offset to the decline in the legacy that we don't see any significant downward trend that you discussed.
What about in the consumer business? What's the future of Fios for you?
Yeah, no, Fios is a great business. I think you see in this quarter, we've added some things around the gigabit connection.
Has that had real traction?
We're seeing some traction, certainly. What you've got is, and it continues to be because of the symmetrical upload and download speeds. We believe it's a superior product to other products that are out there. When we put the right offering out there around it, we see it resonate in the marketplace. It continues to be important. Look, broadband is going to be very important to the home connection going forward. More so today than it was yesterday, and more so tomorrow than it is today. Customers continue to connect more devices in their home to their broadband network. Having that broadband network that can handle all those connections on it is incredibly important, and we think the Fios network gives consumers the best broadband network to handle all of that.
I take it that is still a business that you see as strategically core.
I think offering broadband in-home solutions is still strategically core.
In sort of Fortress Northeast, as I've always called it.
Yeah, at this point in time, certainly in the Northeast is where we've got that footprint. We think that continues to be a very important product.
I guess the same question I asked about on the wireless side, wireline margins have actually been one of the untold stories. You've actually had a nice turn in-
Yeah
wireline margins. How much more runway is there for wireline margins? Lapping the Frontier transaction, have we now seen most of what we're going to get?
Yeah. We said we would take out the stranded costs with the Frontier transaction. The team's worked well there. You're also getting to the point this year where you kind of lap some of the benefits coming out of the labor contract last year. We've said, and certainly first quarter came in at a little north of 22%. We'll see fluctuations in the margin throughout the year, as we typically do in wireline. For the year as a whole, we certainly think it'll be better than a year ago, be in the below 20% range. We'll continue taking cost out as we go forward. I think the wireline team, because of some of those secular declines that we talked about, have been out there for a while. The team really knows how to continue to attack the cost side of the equation.
You see that, and that's why you see the results in the margins you do. We think, as I say, it'll be in the low 20s, and we'll see what we can do next year on top of that.
I guess the one last thing we haven't talked about yet within the portfolio is AOL and Yahoo. Is that big enough to move the needle as a growth driver?
Yeah, absolutely. Just the day we close, when you take the two businesses, even without any integration benefit, it's a $7 billion business on an annualized run rate. That's not small by any means. As you heard Tim talk about last week, his goal is to get by 2020 up to around $10 billion or so. That business has the ability to move the needle. We think there's tremendous advantage of bringing the Yahoo, the eyeballs they have, the content platforms they have, merge that with the AOL content, and then you've got the ad tech platform underneath it. The challenge today with the current business is just not having as many eyeballs there as we need to drive the growth there.
When you bring that volume of eyeballs that Yahoo has, you start building out these super channels that we talked about around news and sports and finance and tech and lifestyle and so on, there's a tremendous opportunity to build a very good platform. Tim likes to talk about building the brands that consumers love and building platforms that companies love. That's the challenge that the team's working on. They've got a great integration plan. They're ready to go, we look forward to closing and getting on with it.
We were joking about "Game of Thrones" before, there's certainly a sense pervading this summit that there's this sort of pendency of a huge wave of M&A coming. Your strategy's been pretty different, certainly than AT&T's, but than a lot of peers and a lot of what people expected, in that you've done a series of what, by contrast, are relatively small deals. Now with Straight Path, but previously with Yahoo and then going back to AOL. Nothing like the kind of giant deals that some people have speculated about. Before we talk about that piece of it, when I look across the portfolio, can you get this business back to consolidated GDP-like growth without big acquisitions?
Absolutely. Look, you start with service revenue in wireless. Obviously, that's the biggest part of the business today, and just moving that piece. We talked about some of the headwinds that are in the service revenue piece right now that we have line of sight to, as we get to the second half of the year, start to dissipate. Excited about that. Certainly, with the change in the customer acquisition metrics, pre and post unlimited, makes us feel good about the impact on service revenue and wireless. As we said, we expect service revenue trends to improve in the second half of the year and get back to year-over-year numbers during the course of 2018. That will be a significant move from what you've seen over the past year or so.
Wireline, we talked about, we think a lot of the trends there are you're going to see what we've been seeing. Then the growth from the new businesses. We certainly think the combination of AOL Yahoo will not be a $7 billion business. It will grow significantly from there. Then even Telematics, with the acquisitions we did last year, that's now a business that's at about a $1 billion annual run rate from a revenue standpoint with significant growth ahead of it. You add all those things up, we certainly see that there is a path to revenue growth as you go forward here, as you just kind of work through those headwinds over the course of the next few months and quarters, and you get back to just the businesses we now own and closing Yahoo and being where we need to be.
Let's talk about the topic everybody wants to talk about. We've made jokes about whether it's the dating game or Tinder or all those kinds of all the different combinations that everybody wants to make for everybody else.
Everybody is playing billionaire matchmaker here. You've been matched to wireline assets, the cable operators. To be fair, you as a company didn't go out of your way to dispel the idea that you might be interested in buying cable. You've also been speculated as a buyer of big spectrum assets. You've been speculated as a buyer of content companies. Talk about each of those things, if you will, and just how you think about the strategic sufficiency of the portfolio-
Right
What each of those things might bring.
Let me maybe take it to a high level first and talk about how we think about M&A in general. You start with, you have the strategy of what it is you're trying to do with the business, how you're going to grow the business going forward. Then the question becomes, does M&A provide an opportunity to accelerate the execution of that strategy and do it in a manner that generates additional shareholder value versus just organically building and executing that strategy?
That seems like that's distinct from, say, we're not talking about M&A as diversification, we're talking about it in service of our existing assets. Is that fair to say that's the guiding principle?
I would think that we always have to articulate how M&A fits with the existing strategy of the business.
Okay.
When you apply those two screens of does it accelerate the execution of the strategy and can you do it in a fashion that creates shareholder value, a large number of opportunities don't survive going through those two screens. You've seen the things we've done, and it's been different to what some other folks have done. Certainly as we think about network assets and fiber assets, we've talked a bunch over the past few months about why we think fiber's important, the fact that there's a lot of fiber that's out there, but it's not really the fiber that we're looking for to execute our strategy and how we want to build a network, and this kind of this converged fiber network that we've spoken about.
If there's an asset out there that allows us to accelerate the deployment of that in a way that creates shareholder value, we certainly would look at that. As you heard Lowell say in the TV interview he did a couple of weeks ago, we haven't seen anyone that's got the network architecture that we're looking for. Certainly by the agreements that we talked about with Corning and so on, that we've shown that we're certainly comfortable just organically adding to that network capacity to get where we want to go. I think that same type of thinking applies across other spaces, too.
Spectrum and content, same concepts?
Well, spectrum, so as it relates to LTE, as I think about spectrum, you say, okay, I know I need to continue to add capacity to my LTE network. We talked a lot about that earlier. I can do that by adding spectrum. We've said all along that spectrum at the right price is certainly something that we would have a conversation about. We buy spectrum in the secondary market all the time. We did a number of transactions last year and continue to do so. Spectrum at the right price is certainly something we do. We have other opportunities to densify the network and get where we need to. When you move to 5G, we said we don't have the spectrum that we need.
We're not sure that we want to wait for an auction and the certainty around timing of that, and you don't know how an auction's going to play out. We said let's go ahead and go get that spectrum, and certainly we've done that through both XO and now Straight Path so that we can execute our 5G strategy on the timeline we want to and not have to wait for the asset to be available. Then as you think about content, look, the content industry is changing. We've all talked a lot about some of the pressure in linear TV. Just because there's that pressure there doesn't mean consumers are consuming less content. They're just doing it in very different ways.
Certainly that as we bring AOL and Yahoo together under the Oath brand, we think that will be a significant platform at which consumers come and consume content. Some of that content we own. We own some today, AOL has, with things like HuffPost and TechCrunch and so on. Certainly Yahoo has a good amount of its own content. We're also confident that with the ad tech platform, we can participate in the monetization of that through digital rights and not having to own all the content that comes through there as well. Look, we're constantly looking at how the content evolving as the way people consume it's evolving and we'll see the best way for us to participate there.
We're happy getting digital rights as we do today and using that as the way that we can then monetize it through the ad tech platform.
I want to wrap up with a question about the balance sheet. There was just the 8-K that came out, what, a week or so ago about the S&P-
Yeah
change in targets. Is there anything you can add about the trajectory of your leverage ratios and your targets?
Yeah. Really, all that was really about was the trajectory hasn't changed. As we said in the release, we remain committed to a strong balance sheet with improving credit metrics. I don't see a change in the trajectory. The reason why we issued that 8-K was, of course, S&P sort of changed their view of the industry and therefore their requirement to get to that higher credit metric moved and that was one we saw. We're not sure our trajectory was online with that new number, so we felt it was the right thing to do to communicate to our investors. The way we're managing the balance sheet hasn't changed as a result of them changing that metric.
I continue to expect that I'll see the same improvement in their credit metrics that I would have done if they'd left that threshold in the place they previously had it.
We're just about out of time. I want to leave it for you to, as you look out at the audience, you've got an awful lot of either shareholders or potential shareholders here. What do you think that they might not understand or should understand better about Verizon, and make the case for why, at this valuation, they ought to own Verizon?
Look, I see tremendous opportunities across our business as we go forward. That's on many levels. It starts with the portfolio of network assets we have that allow us to be the network leader today, but also as we get into next generations of technology. We have the best LTE network. We have great fiber assets, and we are leading the way as we go to 5G, undeniably so. When I think about that, network is the foundation of the strategy and allows us to do things at a faster pace than I think a lot of the other folks that we compete with.
When you have those network functions both now and as we think looking forward, and you combine that with the base of customers we have, the products and services that we have the opportunity to develop and enrich people's lives in this connected world that we live in, we have the opportunity to do things at a scale that I don't think anyone else has. That's a tremendous opportunity. Then you add in what we're doing with some of the new businesses. We got into those businesses, we got comfortable with them, and then we decided, okay, now's the time to add scale. We've certainly done that. We talk about what we're doing with Oath and what we're doing in Telematics and those businesses coming together.
There's a number of opportunities for us to lead going forward and to generate significant shareholder value. I look forward to being back here, and we can talk about the progress that we've made, and I'm very confident that we're going to deliver across that portfolio.
Matt, I look forward to that as well, and I thank you for coming this year, and I thank all of you for joining us.
Thank you.
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Thank you all for joining us for the summit and for those of you on the webcast, thank you for joining us as well. It is my absolute pleasure to introduce John Stephens, who's going to be talking about AT&T in their first visit to our summit. John, I'm really delighted to have you here today.
Thanks, Alex. We appreciate it.
Hey, good morning, everyone.
Good morning.
Oops. Yeah, these chairs are almost too comfortable, we'll do our best to stay awake. John, I'll let you give your safe harbor in just a second with your first answer. Let me just kick it off, because you guys certainly have a lot going on in your business. Maybe the place to start is with your vertical integration strategy, with the big deal that is pending. Take us back to the genesis of the vertical integration strategy and just talk about how you plan to leverage the combination of assets of now distribution, DirecTV, and ultimately, the content from Time Warner.
Sure. Craig, thanks for having us here. Thanks for everyone in the room. Today's conversation will include forward-looking statements that are subject to risks and uncertainties. You can find further information on our website or in our SEC filings. I think that'll satisfy all our legal disclosure requirements. Secondly, I usually do this at the end, but I want to do this right from the start. It's one message. If no other message you get from me today, one message you walk away from today is, a couple 200,000 people a year are either killed or seriously injured from distracted driving car accidents. As a company who provides cellular service to millions and millions of the customers, we really don't want any revenue from people who are using our devices while they're driving. You can cost a life. You can ruin a life.
If you don't do it for yourselves, if you don't do it for your families, if you don't do it for your neighbors, do it for my grandchildren. We really don't need anyone to be distracted while they're driving. Please, it can wait. It definitely can wait. With that said, with regard to our fully integrated strategy, let's take a step back and make sure, first of all, we're a fully integrated network carrier. Whether it's our wireless, and extensive wireless holdings, and extensive wireless capabilities, whether it's an extensive fiber footprint, whether it's an extensive traditional wireline network, whether it's our satellite distribution, we are the integrated carrier, so we have the capability to deliver services to customers anywhere they live and work, anywhere they want.
With that, we found that premium content was critical to that. Both not only content, but premium content was critical to the success of that. That is what customers really wanted. The Time Warner transaction clearly has significant content, but the more important thing, it's of the highest quality. The ability to do that and take that and incorporate it and, if you will, converge it with our various delivery and capability services is phenomenal. From that perspective, that's where it came from. It started with this network integration and has moved on to now what the customers want, what are they focused on. They want this ability to have this content anywhere they live and work, anywhere they want to use it.
With regard to that, it's also, quite frankly, from a financial perspective, just a really very attractive transaction in the sense of the diversity of the revenue, the revenue growth perspectives, the cash flow growth perspectives. If you will, the payout ratio improvements. Quite frankly, the diversity of revenue from a regulatory perspective, even though the regulatory environment has certainly significantly improved over the last six months, Time Warner and its content revenues are much less regulated than our traditional business. The CapEx intensity characteristics are very positive for our business. From all those aspects of it was a very attractive transaction. Quite frankly, the leadership at Time Warner is, at least on our part, very well-respected, great talent.
Jeff Bewkes, my counterpart, however, all do a great job and are great to work with and have great teams. That's another critical aspect of why this thing works for us.
Can you preview some of the things that you can do uniquely with the vertical integration strategy? You've already done a lot with bundling DirecTV with wireless and what have you. Can you just give us a sort of sneak peek at some of the things that, the ideas that keep you excited at night when you think, "Wow, I can't wait until we get this and here's what we can do?
Sure. Craig, you touched on one, but six million customers already are bundling our wireless and our video products. That goes to not only a really great experience, but quite frankly, our smartphone churn in the first quarter was 0.9. It was dramatic, really great. You can see the actual financial results in our business from doing that. If you look at our recent Unlimited Choice, Unlimited Plus products, you can see where Unlimited Plus, we're adding to it the ability to have DTV or DTV Now at a real value rate, a $25 coupon, the ability to put HBO on that. It's early in these offerings, what we've seen so far is a really great response from our customers. We're really pleased with them. Those are some of the things.
If you go deeper, though, and you say, I've got this company who's got 25 million distribution points on video, 15 million-plus distribution points on broadband, maybe 100 million distribution points on wireless when you talk about tablets and phones. You got this tremendous amount of data. We take that data and say, "Hey, Warner Studios, this is what people are actually watching. This is what they're engaging in. This is what they want to look at. Can you take this information and help you in the production side of how you choose movies and what projects you want to do?" Hey, Turner and TBS, and Cartoon Network, and Adult Swim, and here is what viewers are actually looking at. On your digital properties, this is what they're looking at on the cell phones, and can you take this information and really learn more about your business?
We all went through the election cycle, and quite frankly, the pollsters, I think all of us would agree, were inaccurate. We all witnessed what happened with Brexit, and the EU leaving that, and I think all of us would agree that most of the pollsters had it wrong. That same kind of data is what the content industry uses today. What we'll offer is detailed, real viewing information, real usage information that can be used, first and foremost, in simply the production, in the decision-making, in the internal workings. Secondly, it's going to be that same information can be used for advertising services, marketing services, by advertising companies saying, "What are customers really watching? What do they really cling to?" We can use it there, and of course, you can use it in this combined company to be more effective with your advertising.
Those are really great opportunities across the board. I will tell you, the ability to have really high-quality talent on the video side, to then take videos and curate them and modify them for use on the wireless screen, for use on the phone screen, for the use on the tablet. Having people who do this with great skill and talent is a huge opportunity so that we can curate, we can develop, we can get customer-focused delivery of video products that we probably aren't nearly as qualified to do on our own and would be much more difficult to do on our own.
Now, I want to talk about Time Warner just as a business for a second, separate from the synergy opportunities. The cable nets business is a business that faces some real secular challenges, and that's still a big part of what you're buying. Talk about the way you see the cable nets business and sort of within the mix of assets. They've got studio-
Sure
movie studio, television studio, HBO.
Warner, great studio, wins awards, Emmys, Oscars, year in and year out, have a great, if you will, business relationship with talent and the ability to retain talent and produce talent. From that standpoint, really great opportunity. We might be able to provide them support from administrative sides or from technical sides, but great talent in and of themselves, great reputation. What really adds to that is a phenomenal library. When you think of this distribution of wireless, 100 million points, if you think of the distribution of broadband, if you think of distribution on video, and suddenly you have now this tremendous high, some would say it's the best library out there. Certainly one of the best, but many people would tell you it's the best library of content out there.
The ability to use that throughout the business and to coordinate gives a whole new meaning to this merger. When you look at Turner, and you think about four of their stations are in the top 50, really closer to the top 40, and three of them are in the top 20 of rated stations out there. As the bundle changes, as we go from 300 channels to something other than that, 85%, almost 90% of their revenues are in those top 40 channels. It gives the finance team a very good feeling about the reliability. When you think of the quality of their products that they have and the shows that they have, the sports contracts they have, feel really good about that.
The ability then to, once again, curate that, use it differently, deliver it over a tablet, deliver it over a phone, the curation gives us a lot of excitement. Using a coordinated effort on a digital delivery service. Instead of DIRECTV NOW being a platform we're developing and CNN Digital and so on and so forth, all being separately done, the ability to take our resources and say, "Let's just come out and come out with the best digital platform for all our properties." That cost-saving item and that quality and that speed to delivery is really important.
You go to HBO and you think of just a really the player in the industry that's got the best capabilities to deliver on over-the-top video on demand, pay quality, and the ability, as we've done, we've done studies where in many cases it's more attractive to put HBO on your phone than it is to give you a free phone. Many of our customers value the HBO more than they value a free piece of equipment. Those kinds of things are where we see the activities. As I say, it's a tremendously high-quality product and company and great results. It also will fit very well, mesh with what we have, our capabilities and skills together.
Let's talk about DirecTV for a second. That's another business where the pay TV category as a whole suffered a very challenging quarter with real acceleration in cord cutting. You've talked about that as you clearly went into DirecTV with an expectation that that was going to happen. Can you talk about the trajectory of cord cutting and how you think about that business and going forward?
Sure. You're right in the sense that we expected the pay TV business on the linear side to come down, then there'd be other opportunities on over-the-top and other delivery mechanisms. I can tell you from July of 2015 through the end of last year, our satellite performance was better than we had expected in our kind of modeling and our forethought. In the first quarter, we gave some of that back. When you look at the first quarter for us, there was a lot of involuntary churn. We had been aggressive in last year and had sought after some customers that we previously hadn't sought after with some packages and some offerings. Quite frankly, we went too far and about half the churn we had, or just under half the customer losses we had were involuntary in the quarter.
That was a business decision we made to go after them. It was a business decision we made to adjust the numbers in the first quarter. That's just what happened. With regard to that, though, if you will, more or less, we're in line on the customer count base on the satellite side with where we expected to be. We are continuing to work on DIRECTV NOW. We're continuing to work on our other over-the-top, whether it's AT&T media partnership, whether it's the other things we've got going to develop that opportunity to sell to those 20 million households that don't have a paid TV subscription. The ability to have the content relationships today through the DIRECTV subscriber base, through the U-verse subscriber base, gives us a footing to go put those kind of products together.
Before we talk about DIRECTV NOW and that transition, how do we think about the trajectory of the traditional satellite business going forward?
I think it's the same as we had when we bought it, that we think we can hold or maybe improve market share, but in a business that the overall linear TV will be coming down. We think it's got a slower trajectory than many do, but we do think it'll be coming down.
Fair enough. Now let's talk about DIRECTV NOW . Has that met your expectations? How should investors think about and measure success for DIRECTV NOW ?
Yeah, no, it has met our expectations. Actually, it was phenomenal results in December. The promotions we put with the Fire Stick and the Apple TV were overwhelmingly positive. Great. After we did that, we said, "Okay, now that we've got that big customer base built, let's go test the system. Let's go test the platform. Let's focus our efforts in that first quarter on really improving the platform, making sure we get all the technical kinks out, making sure the customers get the best quality experience." That's what we did. We weren't focused on putting a lot more sales on. We wanted to see how the promotions reacted from a churn perspective. We continued to add customers throughout the quarter, so that's a great thing. Our next step is to add, as you may have heard, we've announced we've added 14 Fox affiliates.
Local stations are now going to be added to the package. We're adding some more premium content. We're looking to do things like features like a cloud DVR and those kinds of things. Those are the things we're going to be working on now, and we'll be ready, we expect to release in the second half of the year. For an overall success base, we feel good about where we're at. Craig, if you're asking me, do we have a targeted specific number of subscribers that I'm ready to announce? No, I don't. Quite frankly, I don't mean to be flippant about that, but it's really very directly, we're going to go through a merger with Time Warner, who's got some pretty good products and brands, things like HBO, and some pretty good digital offerings.
We're going to need to go through that process and make sure we figure out which is the best ones to take. The development of DTV Now is really important in the sense of having the opportunity to go into those 20 million households who don't have a paid TV. The people who don't want to maybe have an alternative delivery system. They want to get it wirelessly as opposed to a dish, or they may not have cable where they're at. They have the fiber connections. It's really important to have that and have that platform, we feel good about the progress we've made.
Why the choice not to disclose subscribers for DIRECTV NOW in the first quarter?
Pretty simply, we've got 145 million wireless customers, 25 million TV customers, and 16 million broadband customers, and we serve everybody in the Fortune 1000. These numbers aren't material, we don't want to get into a situation where we want to manage the business with a focus on the quality of the product as opposed to saying, "No, we were up 3,000 this month and down 1,000 next month." We want to focus everybody on what's the best thing for the product and the offering.
One last question before we turn away from DIRECTV NOW . How do I think about the customer lifetime value of DIRECTV NOW subscribers? You've got enviably high margins in DIRECTV.
That's both a blessing and a curse, right?
Right.
Those customers are extraordinarily high-value customers. Is there any way to replace that with DIRECTV NOW customers, or do you have to look to the value of what they bring in wireless churn to keep that value?
Yeah. We're not looking at DTV NOW as a replacement for DirecTV. We're looking for DTV NOW as a way to give customers a service that they wouldn't otherwise have, whether it be when I'm traveling and being able to watch TV easily and very conveniently on my tablet, or whether it's one of my children who don't have a full subscription because they're not interested in, for example, sports. My daughters and my son-in-law just don't have an interest in sports, they prefer DTV NOW. It makes it very easy for them. They can take it where they want. They really like it. It's touching those that we wouldn't otherwise touch. It's a product offering. That's the point on it.
If you then can bundle it with wireless, whether it's what we're doing today with our traditional postpaid product, if we can then get it in a bundle with prepaid You can get other products added on. Bundling it with Cricket, for example. We can touch a market that we underserved today. If you will get that relationship built with them when they become a more traditional homeowner, a more traditional buyer of our services, we already have the relationship, we already have the commonality with our products and services. That's a great offering. We're doing this very, very successfully with Cricket. We started that over three years ago when we got into the prepaid business in a different way. It was a much different view for us.
We are extremely pleased with how it has performed, and we think it's a great sign that looking to touch those customer base that we wouldn't normally touch, that we wouldn't normally address, is certainly a worthy endeavor. That's what DTV NOW provides us that opportunity to do. As well as a guy like me who likes having that convenience of having the icon on my tablet, turning it on, and being able to watch it wherever I am, whether I'm waiting for a plane, or in between meetings, or in my hotel room when I'm traveling.
Well, not for nothing, but isn't it interesting that we've been talking for now getting close to half the session, and we've been talking all about entertainment and media types of businesses, instead of wireless and wireline. It's a glimpse of the future, maybe, of the new AT&T and how much your portfolio has changed.
Generally, it is a glimpse of that. Generally, a finance guy with my background is not one people talk about content in Hollywood. It is a surprise.
Well, let's turn to the wireless business for a second.
Sure.
The first quarter was a challenging quarter for the industry. What are you seeing in the second quarter so far in terms of competitive intensity? Is it any more measured than it was in the first quarter?
Sure. First of all, the unlimited offers, and specifically the change in process by one of our competitors to go to unlimited changed things in the first quarter. When Verizon did that, we took a breath and said, "Okay, what are we going to do?" We took a methodical approach. We didn't immediately respond. Because of that, there was some disruption in our customer counts. Since we've come back with our Unlimited Choice, Unlimited Plus plans, and quite frankly, it happened then, but even since we've added HBO to our Unlimited Plus offering, we've had really great customer counts, kind of really turn to a very good situation. We feel good about that. One thing I want to point to, though, is we had record EBITDA margins in our wireless business in the first quarter of right under 42%.
We have a lot of noise about this, but the team is really performing on a generation of value basis. Secondly, if you look, we had some really good performance on our smartphone postpaid churn of 0.9. We had good performance on our prepaid. Yes, there was a lot of noise. Yes, there was some competitive pressure. I want to step back and make sure the team that runs that business did a really great job for us and had a good financial quarter. Next step is this. If everybody in the industry wants to go to a competition level that's based on capacity, because if you go to unlimited, you're then competing on capacity.
If you want to go to capacity, we didn't start this, we weren't the first movers here, but my goodness, we are by far, without question, best positioned to compete in that. 60 MHz of spectrum that we're now not only are putting in, have the ability to put into service to dramatically improve or dramatically expand our capacity, but we also have a check from the federal government on a co-pay arrangement to pay for most of it. $6.5 billion through our FirstNet contract. We have a FirstNet contract that gives us this 2 by 10 700 MHz very high-quality low-band spectrum that they negotiated with us, and we negotiated with them that we can use this for our commercial customers. We can use this for our day-to-day needs. Now, granted, they can use our overall network for FirstNet customers.
They got $100 billion worth of assets and $60 billion worth of spectrum to use for FirstNet. We get to use the 700 spectrum, and that capacity for our day-to-day customers. If you think about that, if you want to move to a capabilities or a competitive environment that's based on capacity, we feel very good about our position. We are like no other.
This is something that we can do today, that we're doing today, whether it's this deep fiber footprint we've had from our legacy companies, or the expansion that we did with VIP, or the extensive fiber we're putting in to satisfy some of our commitments with the DTV transaction, whether it's four-way carrier aggregation and four-way MIMO and the 500 meg speeds we got in Austin on our LTE network last quarter in our test there, whether it's AirGig and the new technology and the patents we have around delivering broadband to the home, whether it's the testing we did with the 28 GHz in Austin to provide a 1 gig millimeter-wave service, or whether it's the leadership we're providing on the 5G standards. We are like no one else.
There's a lot of stories out there that nobody's got the capacity, capabilities, and quite frankly, the progress already today, and in the near term, dramatic additional progress. We feel very good about that. We didn't start down this road, but if that's where it's going to take us, we will be in very good shape, and completely different than anybody else you'll hear at this conference.
Let me ask you a question that I just asked your counterpart at Verizon in the last session is, do you believe in network advantage as a wireless strategy anymore? There's certainly a sense from a lot of investors that the age of network differentiation is behind us, and that's sort of a bleak future for wireless. I'm guessing you would disagree, but is there a path for AT&T to really assert network advantage, and keep network from being a commodity?
Yes. First and foremost, it's what we talked about at the very start, the converged product set and the ability to deliver video and curated-
The core to that is what content, not just the network itself.
It ties together. Secondly, it's this ability that as content grows dramatically, networks can get full. Networks can get constrained, and whether it's through whatever means, people can get quality that can erode or not be as high. We are not that company. In fact, we're on a road to even improve what we're already providing. The second piece for us, though, is if you do this as our network team has laid out, if you do this at the same time you're doing network function virtualization or converting it to a software-defined network, you can do this and it'll lower the ongoing operating costs. Dramatically lower the per megabit cost to deliver the service. You get higher quality at a really efficient price. We believe that is critical to the financial competitive advantage we'll have, for ourselves, for our shareholders, for our customers.
The ability to sustain that is provided by that. It's a multi-step process that the team's going through. It's just that the FirstNet contract provide us 2 by 10, 20 megahertz nationwide spectrum, and a $6.5 billion copay to really jumpstart us in this process.
Bottom line, as we look out for the wireless business, when do you see revenue stabilization in that business?
We'll see it as network capacity in other people's networks start to fill. We'll see it as we get the build-out of the FirstNet, so we have this capability to sell FirstNet services, but also smart cities, but a nationwide platform of Internet of Things. We're seeing it today, and we'll see more of it in our Mexico wireless business. It's a real distinction for us because we've got 100 million customer capabilities just south of the U.S. that is growing revenues, growing very fast in constant currency and growing in USD, but growing dramatically fast in constant currency, adding 3 million customers last year. We'll get it from there. For us, we'll see it from all of those aspects. As I say, this balance that we're going through, and we're continuing to add prepaid customers at a real strong clip.
That has a benefit for today, but quite frankly, it has a benefit in future years as those customers may change and migrate up to bigger plans.
Let's talk about network densification and particularly the path to 5G for a minute.
You looked at Straight Path, decided not to chase it. You've got your FiberTower spectrum and you have some spectrum, but how confident are you in the millimeter wave business as a business plan? Have you seen enough yet to give you some confidence that there's a real return on investment there for building out the density that's going to be required at those spectrum bands?
Let me say it this way, we're extremely confident in our overall wireless network strategy. For us, it's a comprehensive strategy. It doesn't just rely on millimeter wave working or not working. It's comprehensive. It's the deep spectrum position we have. It's the deep fiber. We have more fiber out there than I think anybody based on our legacy businesses, based on what we're doing with fiber to the prem, based on the number of businesses passed. It's based on all of it. The millimeter wave is an important piece to it. Our FiberTower holdings, opportunity for FiberTower holdings because we don't have FCC approval yet. We do think we're going to get a meaningful footprint out of that, at a very attractive price, that will allow us to build out in the 39 GHz space. You guys can look at the filings.
They have somewhere under license, somewhere in the just under 400 MHz nationwide. We'll work through. They've got some challenges that we'll work through with the FCC, we're encouraged that we'll get a meaningful footprint to build off of. Our strategy doesn't just rely on that. We can get fiber to the home with AirGig. We can get, excuse me, broadband to the home with AirGig. We can get broadband to the home with fiber. We can get broadband to the home with fixed wireless local loop. When you think about most of the non-urban areas of the country and you think of the low-band spectrum we're going to have in service, there's going to be a tremendous mobile broadband speed capabilities that you can get from that process. We're optimistic about millimeter wave helping. I think its small cells backhaul will be very good.
I think getting 5G, not necessarily millimeter wave, 5G into the core network will be very, very helpful. We will see how millimeter wave as a broadband replacement to the home works out. We're interested in it because we've got so much local footprint that we can leverage off of that millimeter wave to the home and offload it onto our own network, making owners' economics really sensible. The challenge for others is if you don't own that network, you're going to have to pay freight to somebody on that, and that's what causes it. We'd love for it to work for us because we're in the best economic position, it's not our only game. The network team's done a great job of having multiple choices in this ongoing trip or ongoing path to continuing to have the best quality, highest speed, deepest network.
You mentioned the wireline business and the synergy between wireless and wireline, which I think has really reignited investors' imaginations in the last year or two as people have come to view them as much more complementary than I think a couple of years back.
I appreciate you saying that because we've stuck by our wireline business, and people have had differing opinions on that. That integrated carrier model, which has led to the converged content and distribution model, is something that we believed in for years. This is that, and I say, I point that out, there's some long-term consistency and reliability to our strategy and our story. We actually follow through on a long number of years on a consistent pattern, a consistent thought, and we're proud of that, and it's working for us.
One of the businesses there, U-verse broadband-
Sure
was actually one of the highlights of the quarter. You did a-
IP broadband did very well.
You did real well in IP broadband. Talk about that for a second.
A couple of things. One, we put a lot of fiber out there, and that's helped. Secondly, we're getting through the DSL legacy business. If you look at the numbers, it's 6%, 5% of the total broadband is in that DSL. The rest of it's in the IP broadband.
Is that a growth business again? Is that a growth business?
Once again, on a long-term basis, absolutely. On a quarter-by-quarter basis, I got to tell you, the second quarter's traditionally a seasonal business.
Yeah
that's challenged for that quarter. Yes, it's going to be a growth business for a lot of reasons. One of the better ones is that we continue to maximize our utilization of the fiber we have out there, and we're adding to it. We'll have 6 million fiber to the prem by the end of the year. We'll have 12.5 by the middle of 2019. Quite frankly, the 12.5 is a commitment number that we've made to the FCC. Quite frankly, because of the way the counting works, we'll probably have closer to 13 million or 14 million fiber to the prem locations by 2020 or so. It'll just be the way the numbers work. That's a really great opportunity.
What kind of return are you seeing on that? I know that that was part of a commitment that you made in order to get the DirecTV deal done, have you found that to be sort of an attractive investment in its own right that says, "I'd be happily doing this anyway"?
On the standalone basis, it's meeting our investment projections, it's meeting our ROIC standards. The exciting part about it, though, that's a longer-term payout as most network assets are, network investments are, it's good, solid returns. The exciting part about it is what it's doing to churn when you bundle it with wireless, when you bundle it with video, when it gives us that capability, when it eliminates our position as a one-product offering to the home. Because now with the video offering, whether it's a U-verse or whether it's satellite or a DIRECTV NOW, now I have the broadband to go with it. That bundling, as I mentioned earlier, our quad play products are seeing some pretty significant, very, very measurable reductions in churn. We're making progress on that. Most significant of the inwards on the broadband in particular are bundled.
Broadband standalone, good product. We're getting the returns that we expected. The real value is the ability to bundle it with other things.
We talked about IP broadband as one of the strong points. One of the softer spots in the quarter was on the commercial wireline business, where those declines accelerated meaningfully. Can you talk about what was the source of that softness?
Two pieces of it. One is the Strategic Services continue to grow. They grew at about 8% level. We saw continued slow business fixed investment. I think most of you saw the GDP growth rate's a 0.7 in the first quarter, we tend to trail some of the response on GDP growth. Our Strategic Services did really well in an environment where there was slow growth, but we saw some grooming and we saw a lot of voice choices that were made by our customers to say, "Okay, we've been running dual systems with regard to VoIP or with regard to wireless, or reconfiguring our operations. We've run a lot of backup systems from our legacy products, we've gone to strategic, now we're going to groom those off." We did see that's correct.
We've adjusted our marketing plans and our sales teams and set up a group of folks who are going to specifically address those issues. What I would suggest to you is that we're certainly hopeful and expect that revenue losses will change. The key here for us is to get the business fixed investment going again in the economy, that'll drive that strategic service growth. We would hope to get it back to where it was just one year or two years ago in the 12%-15% range. We're almost to the tipping point. We're at 40% of that revenue stream is in Strategic Services . We can get that over to the tipping point where it's the majority of it and have those kinds of growth rates at 8% and 10% there, you can see where that's a very vibrant business.
You've talked about SD-WAN for a long time, mostly as a cost savings opportunity as an operator.
It's a double-edged sword, I suppose, in that your customers can look at it as a price saving opportunity.
Right.
Can you talk about what your thoughts are about SD-WAN? Is that a net positive? Is it a net negative? When does it start to show up in your commercial wireline numbers?
Yeah. We're starting to see it now. We're starting to see SD-WAN providers want to talk to us about doing deals together with us. You're right, on an embedded base, there's some risk. Quite frankly, that risk on some of the legacy services might be there anyway. From our perspective, protecting that base by not looking to the future. As opposed to looking to the future, we're going to always look to the future. We have made some investments in SD-WAN. We're looking forward to making it part of our product offering, understanding that giving customers better quality service internally leads to them buying more products and services from you.
It may not change the total revenue picture, it does change the stickiness and the quality of service, and then using it as a tool for new business outside of our existing footprint.
Okay. Got it. I'm going to zoom out a little bit now to some bigger picture issues. One of the themes that everybody wants to talk about at this conference is M&A.
You're involved in a big transaction, so in some ways
We're going to be careful
more of an observer. If I look at the wireless business, do you think consolidation is possible in wireless, horizontal consolidation is possible in wireless? You guys have some experience of the regulatory process there. Is it possible, and what would that do to industry dynamics if you got it?
Certainly, it's possible. We'll see, but certainly, it's possible. I'm not suggesting any likeliness one way or the other. If you think about what we do and what's happening today, we've talked a lot about millimeter wave, we talked about fiber, we're talking about 5G. These networks take an extensive amount of investment. From that perspective, when you have a high capital intensity type business, it makes sense to have a rational number of rational competitors. That would be good for the market, that would be good for customers, the quality of service and capabilities, as well as good for our investors. There's some logic there. Certainly, it's a new FCC. I would leave it to people who know more about how they might think about it.
It's not the FCC, I think we'd all agree, that we had dealt with for most of the past four or five years or the last eight years. It would be interesting to see how they might view it. Third, some of the players are facing financial challenges, that is one reasonable process to evaluate in this situation.
I know with a huge transaction like Time Warner on your plate, it's hard to, as a CFO, to even imagine what comes next. We already hear people talking about, well, what about the synergies that could come from the satellite business with Dish Network or more content? How do you think about the different options that come after Time Warner?
The first thing is probably paying down some debt. That's the thing that comes first. We're going to have a great, tremendous cash generation machine when we combine these assets. Let me get that out first. That'll be our focus. If you look at things like what comes next, well, quite frankly, we need to get through the FiberTower and work through, in a very respectful manner, the FCC to get approval for that. We'll look to that auction that's going to be coming up probably, hopefully, by the end of 2018, but certainly early in-.
The millimeter wave auction.
Yeah. They've got 1,400 megahertz of spectrum they're auctioning off. I would assume that anybody who buys Straight Path wouldn't be interested in buying any more, or may be limited. That participation in that, it'll give us an easy path to finish that off. You'll think of things like that. It's a very easy, doable process.
You mean with respect to balance sheet planning?
Yeah. You think about that. You do think about any ways to do cost savings. You think about, do I have to own all the real estate I own? This is focused on AT&T real estate, as well as Time Warner real estate, just that normal course. We look through your portfolio and look to evaluate what things fit and what don't and so forth. That's an ongoing process. With regard to cost-sharing activities that make sense, certainly, those are reasonable questions for people to ask.
Cost share, in this case, with Dish Network, for example, where you might be able to do some cost sharing with Dish Network.
That's a very reasonable question to ask, and we'll wait till we get our Time Warner transaction through the process to go into speculation on any specific items. I understand the issue. Back in 2000, when SBC had a less than national footprint, and BellSouth had a less than national footprint, and we brought those two companies together and operated a great wireless company called Cingular. We've looked to those things in those ways in the past. I'm not suggesting this is anything like that. I'm just saying right now, we're going to stay focused on the Time Warner transaction and make sure we focus on that.
If I pull all this together, and I think about the portfolio of assets you've got, which really has transformed quite a lot over the last-
Yep
the last few years, at least if I include Time Warner as-
Sure
in that bundle. I'm looking here. I have my AT&T pen here. How do we think
Can you show that logo to the crowd, please?
How do we think about the portfolio growth story for a second and the path to GDP? Right now, you've got a very large wireless business, but that business is facing some pressure and is still a negative revenue growth business. I've got a wireline business that's quite large but is still a negative revenue growth business. DirecTV or the entertainment segment in general is about at the waterline. How do I think about the trajectory back to growth for AT&T and the GDP growth target?
Got you. Let me start off, the simplest order for me is you look at Latin America and Mexico, you look at what we've been doing. I mentioned it earlier, but Mexico's been a really great growth engine for customer counts. Constant currency revenue growth is significant. We're getting through that investment phase. We've got 85 million POPs built, we're in effective markets where we have distribution and marketing and a great network. We're ready to grow that business, there's real opportunities there, we're doing it today. We've changed that game down there for those properties. Latin America is doing well, generating cash. It's operating in a tough economic and political environment, but it's doing really well. Those are first ones, particularly Mexico, real good growth opportunity.
Secondly, on mobility, as we get the FirstNet built out, the Internet of Things, the connected devices that continue to play in this space of prepaid, quite frankly, the capabilities that will come from having Time Warner's skill set from curation of video and other things and those abilities, especially with this tremendously deep network, we feel very good about that. On the broadband side, as you pointed out, the IP broadband, the expansion of the fiber, the ability, it's growing today. It grew in the quarter. That continued opportunity growth. Strategic Services , growth at 8%. We'd hope to get that up higher, that growth at 8% on 40% of our wireline revenues . If we're talking about the legacy services, we're going to continue to face some of that challenge. It'll be there.
We're not suggesting it's going to stop, we're going to have to get through that process, convert as many of those voice customers to wireless, convert as many of those voice customers to VoIP, get those DSLs up to IP broadband, and so forth. We're going through the change in our life process, so to speak. Then you go over to our next business, and you look at Time Warner, and you think, wow, they grew revenues, I think, last quarter 6%, and did a tremendous job with profitability. When you bring those two businesses together, that content and that distribution data, and you think about the opportunities to grow revenue or profitability from the data and knowledge about choosing products or projects in Warner Bros. Studios and how you advertise and the ARPUs you get from our CPMs you get from Turner or for Turner.
All of that's a tremendous opportunity. That's how I think about it. Let's be straightforward. We have some legacy services that we'll continue to pay attention and try to manage very effectively, they are legacy services. We're looking forward, though, with everything else to those next generations software-defined products and services. I think we're doing a pretty good job of being very pragmatic while also looking forward.
A little nearer in for 2017, talk about the puts and takes of your 2017 EPS guide.
Yeah. You think about it, the investment cycle last year in Mexico was about $1 billion. The simplest put, our guidance is in the mid-single-digits EPS growth. If you think about cutting that in half as an example, as an illustration, that's $500 million or $0.05 a share on our business. That's 2% growth just by the change in the trends there. Not suggesting that's the only thing. I'm just suggesting that that is what's there. Second, if you look at what we've been doing, the big iron costs are what we call ATNO, our network operations and our technology group, is year-over-year reducing costs in real dollars. From software-defined networks, from network function virtualization, from automation, digitization.
I can give you examples of payment arrangements and credit arrangement programs through my credit collection where we used to do 20% of those automated and 80% manual. Now it's flipped. Millions of calls going away or millions of opportunities to automate things. All of those things you've seen us continue to maintain margins in a challenged economic environment. That's going to continue. As a factoid, 34%, at the end of the year, of our network functions were virtualized. We'll be to 55% by the end of this year. Think about what cost savings that brings, and the savings of the prior work you've done start paying for this investment. Last year we were paying for the investment to get up to 34%. Now that 34% is fully generating huge amounts of savings and it's a self-funder of things going forward.
We have those kinds of things throughout our business. Our big iron team, as my boss likes to call them, is doing a really great job.
We're just about out of time. I want to leave it with just an opportunity for you with current and potential investors in the room. What should they be thinking differently about AT&T, and how do you make the case for why they should own AT&T at this valuation?
Yeah. We're that next generation company. Our strategy is as sound as any strategy out there and as forward looking. We have the assets assembled. We have the customer base that's uncomparable, and with the Time Warner, we'll have all the assets. Not just the distribution, but the content that we have an ability to take this collection of assets and dramatically grow the profitability of this business. The indicators are all there, if you will. The network quality, the network savings, the FirstNet transaction, and the content costs, the advertising capabilities, the growth in Mexico. All of the indicators are there. It's a very exciting opportunity for us and we're looking forward to getting going and get after it.
John, I can't thank you enough for being here today. It's been a pleasure and I look forward to seeing you back here next year.
Thank you Craig. Thank you everyone.
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Four times. It's terrific to have you back. I was just reflecting, when we had our first summit and you sat in that exact same chair, your stock was at $143 a share. Comcast was about three months into the regulatory approval to acquire Time Warner Cable. It's fair to say a lot has happened.
All's well that ends well.
I want to start with what you've learned in the consolidation process of Time Warner Cable and Bright House now. You're almost exactly a year in. What's gone well and what's taken longer or been more costly than you expected?
Well, the name of our deal was Safari, I guess we found Livingstone along the way. It was long and arduous, getting it done obviously took an odd path. Fundamentally, I approached the acquisition with the notion that the cable infrastructure was a superior infrastructure and that properly managed and properly capitalized, it could stand up superior products and services relative to its competitors and win in the marketplace and had a great growth path in front of it. If you actually increase the penetration on a fixed asset, the economics of that are fantastic. That opportunity requires a lot of work, actually, though, to make that happen and to transform a company so that it is capable of using its assets.
The cable industry was slow to respond to the satellite, all digital threat, and had its spectrum clogged with analog signals and had the capacity to take up its data speeds more rapidly than it did. Has the capacity to be a better service provider and has the capacity to use voice and other product security, other services to improve the attributes of the communications connectivity, such that it could drive itself deeper into the marketplace and really wasn't doing that. In order to do that, there's a lot of work, especially in an acquisition, and especially in an acquisition the size of the one we did, which was significantly bigger than us. It's working the way I expected it to work, and the timelines are working as I expected it to work, and we're achieving the results as I expected.
Now, there are issues with recreating a company and combining three companies that require spending money, spending capital, spending operating dollars, and then getting the results of those and having those flow through the financial statements. Right now we're in the putting it together stage. We've actually rolled out all of the pricing and packaging. We're getting the response out of the marketplace that we expected. Once you get the marketing response and the subscription response you expect, the economics flow, and you can predict them quite easily.
You've always thought about the business and I can remember all the lessons you've taught me over the years about measuring a business by the subscribers you don't have yet and maximizing the revenue per home passed rather than subscriber.
That's right.
Are you licking your chops as you look at the new territories and think about all of that greenfield or white space or whatever the right analogy is that you see?
Yeah. Actually, if you think about our cable company, one way to look at it, if you could move space and time, it's 50 million homes passed with those 26 million customers and 24 million non-customers. In front of the 24 million non-customers, if you could put them all together and you'd have a fully capitalized infrastructure in front of 24 million potential passings, would you rather have that or would you rather have the 26 million existing customers and the ARPU changes you could make out of that? I want both. We have both.
Yeah.
When I think about the business, gee, we've got this free cable company built in front of 24 million non-subscribers.
We'll talk about that in a second. A little more prosaically, if I think about the 3-year synergy targets that you've outlined for the deal of about $1 billion, can you give any more color on how quickly you realize that? Have you discovered anything new about how long the runway is? Is that still the right number?
Well, we've said that we would get to about $700 million of run rate this year, in the middle of this year, $1 billion in 3 years. When we say synergy, we mean costs as a result of the transaction that come out of the business, as opposed to all of the operating synergies that are in our business model, which are still there as well. There's a general margin improvement that comes from the way we operate the business and intend to operate the business going forward. None of those kind of margin improvements are in our synergy numbers. I can tell you how we're going to get all those if you want to hear. We're on track for the publicly disclosed synergies related to the transaction.
I'll come back to some of that operating leverage and those margin opportunities in a minute. Usually, I start the conversation with you about the broadband business, but I want to start on the video side this time. There's been a really market acceleration in the rate of cord-cutting. You've always expressed some skepticism about how wide the appeal of virtual MVPDs would be. Have you changed your view at all as you've seen programmers increasingly sort of arm all of these virtual MVPDs with more and more better content at what are pretty aggressively low retail prices, at least? We don't know the wholesale prices, but the retail prices are awfully low.
Well, look, the question gets asked a lot of different ways. People talk about skinny bundles, people talk about over-the-top, and they're really different concepts. One is will programming companies allow themselves to be packaged in smaller packages that result in less penetration? That's a hard decision to make if you have a highly penetrated business. I don't think you see a lot of that really happening in the over-the-top space. Will there be rich, fat, over-the-top products maybe sold with no margins, or sold with no margins at least for promotional purposes, which cable is already sold that way.
Right.
I think, yes, there'll be competitive pressure there. When you look back over the last 5 years, I was looking at the numbers, the whole MVPD marketplace has shed about 3 million customers over 5 years now. I saw some people talking about Disney ESPN losing 11 million customers over that period of time. If you look at during that same period, the over-the-top providers through the end of 2016, 1.5 million customers.
Yeah
You could argue that a little bit either way. If you look at telco's effect on cable, I do think that there'll be some chipping around the margins, and I do think there's, on the margin, less MVPD customers, which I think is a cost-driven issue. I do think there are other issues in it besides just cost. Used to be when a young guy would go off to college, if he would live off campus, he would subscribe to cable to get ESPN. Now he gets it over-the-top from his parents' account. A lot of loss on the margin is really about lack of security and the inability of content companies who are becoming distributing companies from controlling where their product goes.
If you look at the whole pie, yes, people want to save money because it's too expensive, and there's some downgrading within the category, but the vast majority of people are still subscribing to a video package, and an MVPD or a package of that.
This lack of security concept, you've made some headlines at our conference over the past few years by talking about that. The numbers that you just laid out for ESPN, for example, of their loss significantly larger than the loss for MVPDs in general.
Right.
The translation to virtual MVPD is quite a bit smaller than the loss for MVPD.
Correct.
Is that gap, in your mind, a piracy issue? Is that gap?
Yes. Piracy changes the elasticity of demand a lot, particularly to the person who's stealing it or taking it. It changes the overall value proposition, but so does price increases, and you've had both. You have people managing their packages down to basic only, broadcast only, and that's the biggest phenomenon.
Yeah.
some cable companies have let that happen in the way they market their product, too.
stepping off of that presumably is easier than stepping off of the entire bundle.
Right.
Let's put your hat on now as a negotiator when a programmer comes into the room. How does the conversation we just had about the way the programmers have responded to the various threats in their business and with the rise of virtual MVPDs and OTT, how does that change the way you negotiate with your programming partners?
Well, I've actually seen a lot of change of heart in programmers recently in terms of their desire to rekindle an affiliation as opposed to just a transactional relationship. There's a lot we can do for them in terms of advertising platforms and making their business more successful by helping them sell more high-quality, higher CPM products and improve the video experience. There's a lot we can do. A lot of people are concerned about their general position and don't want to be disaggregated from the bundle. They have a problem with growth, and they have a problem with rates, they have a problem with advertising. Even with all their problems, though, it doesn't mean they should rip themselves apart and become 20% penetrated product. They're looking to find new ways to create new customer experiences that are good for customers.
They're looking at us and seeing what we have, and seeking ways to work with us that are somewhat new.
Do you think it changes the long-term trajectory of That cost item for you has been growing at high single digits for two decades?
Yeah
or at least a decade.
Long time.
As you look out in aggregate with the content community, what do you see for that cost trajectory?
Well, I think it's marginally going to change to our benefit, but not much. I think the general trend is the more likely scenario.
Okay.
I think on the edges, there's a lot of pressure on the price for the content companies.
Okay.
They've gotten to the point where they're not realizing the value of the price because it's translating into marginal sub-loss.
Right. As I think about the Q side of P times Q for a second, the quantity, I don't want to look too far out and just focus on virtual MVPDs and the OTT stuff. What about your legacy competitor, Satellite? What have you seen with respect to the competitive dynamics of you and the Satellite business?
Well, look, I think that's our biggest opportunity in terms of market shift. I think we have a superior platform to Satellite. We can create customer relationships as a result of the better products that we stand up, the interactive products, and the nature of television viewing going forward, and the advertising products that we can stand up. That combined with high-speed data and other products that we can sell to make the total value of the customer relationship better. I expect to grow our business. I expect to grow video, and I expect to grow data, and I expect to grow voice.
Grow video in subscribers, not just in-
Correct
dollars.
Both. I expect to grow video in subscribers, and I expect to grow expanded video even faster than basic video.
Oh, interesting. actually tiering up customers-
Yes
instead of tiering them down.
Yes. Which has been our history, by the way. Our tendency is to sell rich products in a bundle and make the whole value of the bundle competitive. Compelling, is a better word. Your video, your data, and your voice, and soon to be your mobile, will all be combined in a way that you're better off. People want everything.
When you think about your broadband business, and you're naturally selling broadband to bundled customers. As customers cut the cord, there's a pricing opportunity in readjusting the total value of the relationship to sort of preserve economics. How do you think about the price value equation of broadband?
Of a broadband-only customer?
Yeah.
It's interesting. I want my broadband-only customers to be video, to be everything. I want to give them as much of a reason to be my customer as possible. Again, back to giving them as much value as I can give them and still be profitable. A couple of 25%-30% of our broadband-only customers are satellite customers.
Is it really that low? I would've thought it was higher.
Yeah. It used to be half.
Yes
We've been growing that category fairly rapidly.
Yes. They would seem like a pretty obvious target.
They are. All satellite-only customers, of all the cohorts we market to, they're the most responsive. I mean, data-only.
Yes.
Sorry. Data-only customers are the most responsive customer base we have to marketing.
Interesting.
Why is that?
For marketing of video.
Yeah. If I send a video promotion out, send it to non-subs, send it to any cohort you want.
Do you know which of those are satellite customers and which of those are.
Yes
internet video customers?
Pretty much. We have fairly good data on it.
Tell me more about this responsiveness to marketing. Is it different in the satellite customers? Are the satellite customers just ready for a different answer? Is it the customers who don't have any MVPD are ready to be marketed a better video solution, or what is it?
Particularly the customers that have no MVPD, they're the most responsive.
Interesting
to buying MVPD services. If you think about cable, and you think about churn, and you think about seasonality, and you think about lifestyle changes, people coming in and out of the household, college kids returning, all of the things that happen in life that cause subscription levels to change, and there are a lot of them. They're less volatile in the data-only space. The volatility in video still remains. It's higher.
Yes.
You have people coming in and out of the category of video, but they stay data only while they're coming in and out based on this. I lived in Maine for a while, and in the summer in Maine, everyone went to camp. Camp could be a lean-to, or it could be a house. You'd leave your winter house and just be outdoors for the three weeks of summer, and people would turn off their cable, and they still do. People turn off their cable for parts of the year.
They turn off their video.
Yeah.
You're saying less so their broadband.
Less so the broadband, right. You have that volatility. The video volatility has always existed in the business. That's why it is. What it means is that the broadband business is a highly stable business.
Now, more prosaically for a second, the softness that we saw in the Time Warner legacy footprint in video and in broadband still grew, but not at quite the same rate. Can you talk about that a little bit? How close are we to the end of that? That's largely, as I understand it, the legacy of the Time Warner Cable promotional pricing just before the deal closed.
Yeah. Look, Time Warner wanted to make a video number, there were data packages that were discounted that cost less if you took video than if you didn't. A lot of those are churning out. A lot of them were basic only. On the margin, in the last year, I think they were selling 40% of their connects as basic only, meaning.
You're not losing much when you lose one of those customers.
No. We're actually transforming them through a marketing strat. We don't take our existing customer base and say, "You have to change. You can keep your package, whatever it is." What we do, though, is start marketing a high-value product package, the triple play that we offer, the Spectrum-branded package, and people move into it. It takes time to move them into it, and they move in at their own pace, and the value of that package is relative to what they were getting before. The other thing that's going on in the Time Warner business, which is actually physically and financially the biggest single piece of our P&L now, is that there were 90,000 different promotional offers, and many of them were deeply discounted. They were also piled on top of each other.
How did I not get one of those, by the way?
You had to call in. It was a Turkish bazaar. You'd call in, bargain, you'd come up with, they would invent a package. There's a lot of that out there. They're also exploding packages, meaning at the end of the term, they go back to full price.
Generate lots of calls to customer service.
They generate a lot of calls and big rate increases. We, up until recently, were unable to see that or intervene in that prior to it happening. That was one of the downsides of lack of visibility into the billing systems and how all of those-
How close are we to the end of working through all of the kind of morass?
We've already turned a corner in terms of unit growth, and we are selling more on a year-over-year basis than we were.
The second quarter's always seasonally weak, but-
It is, but in terms of.
seasonality aside
day by day, year-over-year, we're better.
Yeah. Okay
already. Now, it's going to.
That's within the Time Warner footprint, or just the whole company?
Yes, in Time Warner.
Within Time Warner, okay.
the whole company.
Got it. There's a lot of runway left in Time Warner for raising speeds.
There is.
Last quarter, it was 43% are at 60 megabits per second and higher. How quickly do you get that ramped, that you get people onto speeds that are really differentiated?
Pretty quickly. I think if you look at where we first did new product and pricing in Time Warner, like Los Angeles, the first market, 34% of the customer base is already on the new pricing and packaging.
Okay.
About half the country right now has an offer in front of them of 100 megabits in the standard package, and about half is at 60. I think that'll get closer to the majority being 100 as we move through time. We held some back as we cleared broadband space, spectrum. Our package is rich everywhere we offer the product now. It's just really a question of marketing our way through the legacy customer base, and we do that in a deliberate way, and we do it in a voluntary way, meaning the customer has to buy our service. We don't force upgrade them.
Is there a point at which fast enough is fast enough? I mean, is there any sign of speed exhaustion in your customer base?
Speed exhaustion? Well, maybe there should be, but there isn't. We have a pathway to get to 10 gig symmetrical.
Yeah. Talk about that. Talk about DOCSIS 3.1 and what you see coming.
Yeah. We have some 3.1 DOCSIS deployed already experimentally. Most of our network infrastructure, all of the big metal in the network is 3.1 already. The modems are going to price pretty much like existing modems, sub $50 kind of modem pricing. It could be rapidly deployed. The question is, so what? Is a gig better than 100 in a practical way? It isn't today, unless you're a business or you have some unusual use pattern, but it will be. I'm convinced that the data usage trends that we've seen for a decade will continue, that we will ultimately stand up virtual reality products that are extremely bandwidth intensive. I think our infrastructure is suited to do that better than any infrastructure there is.
I think if you think about what that world would look like, millimeter wave technology or small cell technology or Wi-Fi technology, which is also capable of multi-gig speeds on a roadmap. It's an in-home product or an in-office product where massive speeds and latency can be delivered into creating whole new products and whole new ways of living that are hard to explain, but I'm convinced is the reality of our digital future.
I'm guessing, and your infrastructure is better positioned for that.
I think it is.
It does tee up an obvious question, which is, historically, you've always driven volumes more than price. Your preference has always been, I'd rather maximize penetration.
I like it all.
Think about the.
The question is, what's the best?
The sequence is,
How do you get the most?
Yeah. Talk about that a little bit. What's your current thinking about price and volume as the two levers in your business?
We've been growing at 5%, 6% customer relationship, with a couple of points of rate in there. Some of it's step-up rate. Most of it's step-up rate where people buy into promotions and then they increase their rates in an agreed-upon rate plan as part of the promotional pricing. You can get 8% kind of revenue growth out of that. In a world where you're improving the quality of your service and increasing the life of your customers by increasing their satisfaction, which is related to rate, you extend life. That reduces transactions per dollar of revenue, which reduces cost per dollar of revenue. You get a larger EBITDA growth in percentage terms than your revenue growth with a highly satisfied customer base.
There's an art in there, deciding what the right price step-ups ought to be and what the product valuation is from a consumer experience perspective, and how that translates into word of mouth and market share growth. I can't tell you that I know the theory behind it, I don't know where all the points are, you feel your way around in there. I've got a model that works pretty well for creating value.
It's fair to say you still think there's an awful lot of penetration ramp left inside there?
Yeah, I do. I think we're at 50% share on data, and about 50% share on MVPD. Yeah, I think there's a lot of ramp. I think the high-speed data business can grow as a category still.
It's about 77% penetrated or something nationally.
I think that gets up in the low 90s.
One business where you still got happily reasonably low penetration is your commercial services business.
Yes
where you still have a lot of runway in front of you.
Yeah, under 10% there. There's probably $20 billion. Well, look, I break that into two categories, enterprise and SMB.
SMB, you're probably what, 20% share?
Probably, yeah. I'm not sure exactly, but in that range.
Your growth decelerated a bit, in the Time Warner side at least. Is that a function of?
Revenue growth
repricing?
Yeah.
That you stepped down prices.
Yes
Accelerated unit, because we don't get to see the unit numbers.
Yeah. I guess you don't.
that clearly.
Although I thought we.
Well, you have units for the traditional measures, but particularly as you get into the enterprise, how big a ticket somebody is getting is hard to see.
I agree. It's hard to look at. It's even hard to look at internally.
Yeah
They're all odd products.
Yeah.
We have two strategies that are related, when we look at SMB, we think, "Gee, this business looks a lot like residential." You can standardize it. You can go for volume. You can get all the economies of volume scale if you put the business in the right model. We repriced the business, we are generating significantly more unit growth. That unit growth will translate into market share, it will translate into higher revenue growth than we had prior to the price reduction market share strategy change. It just takes some time.
How long is that transition period?
Well, we did it at Charter previously.
As I recall, it was a couple of quarters. It was actually quite fast.
It's a year. I don't look at it in quarter terms.
Yeah
it is what it is.
As I recall, it went quite quickly and there's some pressure on pricing and then there's a re-acceleration out of that.
There was pricing, yeah. What happens is your incremental units are coming in at a lower rate, right? Your revenue growth slows, but they pile up, and they stay longer, and you get more of them.
Yeah.
You have a bigger number.
Is there a law of large numbers, though?
You can run out of footprint.
Well, no, your growth rate right now is $1 billion a year of new growth in commercial or getting close to it.
Yeah.
Is it hard to extract an extra $1 billion out of a segment like that every year? That's a big number.
Yeah. Those are big markets, and the answer is yes.
Yes, it's hard, or yes, you're getting that much out.
It's hard, but we can do it.
Yeah.
The enterprise space, just big business in our footprint's $20 billion, and we've got less than a $2 billion business. There's a lot of upside.
Do you get a different competitive response as you just get to that size, and the telcos start to feel the pain more viscerally?
We'll see, but yeah, it's a responsive market. We can stand up much greater speeds in more places than most legacy phone companies, and particularly more than legacy phone customers are paying for and getting in their existing product set. It's difficult to take that copper product and just knock the price down, because even knocking the price down doesn't improve the speed experience and all of that. I think we have a better physical asset in most locations where we compete.
I probably could've started this conversation with wireless, and some would say I probably should've since I started AT&T with the video business. Talk about, you said 2018 for your wireless launch for the MVNO. Does your agreement with Comcast change the timing of that at all?
No. Our agreement with them on the MVNO is to explore opportunities together. We have the same MVNO. We're the same company. We're proceeding to launch in 2018 regardless of our relationship with them. There are opportunities for us to do the same things and for us to learn what they've already learned and to make them efficient and to make us efficient. We've agreed to explore what those opportunities might be. Things like buying handsets and things like using provisioning systems and billing interface systems, software systems that are common, so that you'd have interoperability in certain cases, using Wi-Fi together, using our Wi-Fi platforms in ways that would enhance the value of our product. We didn't agree to do any of that. We agreed to explore that.
Okay. They bought spectrum in the auction, and it seems like their model is going to be a coverage canopy layer for when you're in your car on the highway or what have you, and then a real capacity layer that you and they will have in a similar model of probably Wi-Fi. Maybe it evolves to a millimeter wave or something eventually out of home.
Right.
Is that the right way to think about it? How does the fact that you don't have that coverage layer, and that you didn't get capacity in the spectrum in the auction, how does that change the way you think about the economics of that business?
First, you should talk to them about why they bought the 600 MHz spectrum and where that is. I actually don't even know. Would I have bid on it? I was in a very difficult situation with the deal pending. I couldn't bid on it if I wanted to. A couple of times I tried to talk Tom Wheeler into being easier on me if I would bid on it to but that was to no avail. The MVNO is a 4G MVNO and with follow on technology, so it can be whatever future products there are. With regard to owners' economics and owning a cellular network or component pieces of it, there may be opportunities to do that. One, you can think of the Wi-Fi network as a wireless network already. In our company, we have 200 million devices connected to our network today.
We are a wireless company. In fact, almost all of the bits that we send are sent wirelessly. 75% of the bits that go to T-Mobile's phones or Sprint's phones or AT&T's phones, or Verizon's phones come through a Wi-Fi network, not through a cellular network. If you think about bit utilization and future bit growth, it's sedentary kind of bit utilization. It's movies and video and maybe 4K in the future. That requires a small cell architecture, which we already have in the home. We can take that architecture up and take the speeds up dramatically. So do you need boomer frequencies like 600 MHz? You do if you're in the mobile business and if you're a mobile wireless operator. To me, there's a different-
As opposed to a stationary wireless.
Correct. Most of the bits today are stationary wireless.
Is that a viable long-term segmentation or does a customer, even if they're stationary 90% of the time, that 10% of the time is still going to be really important?
It's important. Hence an MVNO, hence why we want to have a mobile product. The question is, how much owner's economics do you need? How much of the total network experience is mobile? How much of that should you own or not own?
I've always characterized it as ultimately the end game of the MVNO is that it starts to look more and more like an in-region roaming agreement and less like a traditional MVNO, in that you're not outsourcing the whole customer experience. You're outsourcing what is effectively mid-band spectrum at that point.
It's one way of thinking about it, yes. It's an MVNO, most of the relationship won't be there.
Okay. You will own the customer relationship and the billing systems and all that sort of thing.
That's right.
in-house. The wireless carriers are all talking about network densification as item number 1 strategically.
Right.
What role do you think you play in that? Do you think you are an arms dealer of infrastructure to support all those cells, or are you a competitor to those players as they densify? How do you think about that?
Generally, I think of myself as a competitor, a long-run competitor.
Okay.
We're already pretty dense. We're dense and what we don't have is the wide.
Is your HFC architecture, I guess, is a different way to put it. Is your HFC architecture the right architecture for small cells? If you view the wireless operators as competitors, does that suggest that ultimately that's a network you're building for yourself?
Well, our network is for ourself and our customers, and that's the way we look at our network. It's our primary asset and it's our primary differentiator. We're in a competitive world, and people can stand up other kinds of architectures to compete with us and do the same things as us, but it's expensive and maybe not as good, I hope. I look at myself as a long-run competitor and trying to make strategic moves for the long run so that I can end up with the customers. I think that our network itself is a small cell network already. The question of whether you want to use small cells for mobile is, to me, the question. You could also use them for fixed broadband.
Yeah
replacement, I guess. Although I think that's a very expensive.
Obviously not something that's interesting to you because you already have it.
I have it already, yeah.
Yeah.
You could think about some of that for wireless drops. There are technical circumstances where small cell fixed point-to-point wireless would work for us.
Okay.
In enterprise, for instance, getting to buildings, accessing physical locations where there's no connectivity. Generally, we have connectivity. We have a high capacity pipe all the way into that radio in the house, which we can enhance. We have a pathway to get to 10 gig symmetrical. We don't need wireless drops. Do you need small cells for mobility? Even when you think about mobility as a business, and you think about 5G or you think about products that might exist in a high capacity, low latency world, like some virtual reality product, is that a mobile product? Would you build a small cell mobile network outside so that people could ride around in their cars in virtual reality?
Will 4G be a mobile platform for that part of your life that you need a pretty high capacity mobile platform, but not where you go for.
Well, I do certainly think.
certain kinds of experience.
the 5G network, there's a real question about what do you use it for and what is the business case.
Yeah. I don't know the answers to those questions, but I think our architecture lends itself to answering those questions better than any other architecture.
Well, that, it brings me to the popular "Game of Thrones" game that everybody is playing at this conference for the next two days. M&A, everybody wants to think about every combination. John Malone pointedly talked about how cool it would be to see wireless and cable combined.
John likes M&A.
Talk about the logic of a combination of preexisting assets, so an existing cable operator with an existing wireless operator. Do you see the logic behind that?
Yes, I don't know that it's necessary. I think all the things I just said about how you can use an MVNO and what a 4G network is and how that's combined with the kinds of capacities we already have makes it feasible not to have one. At the right price and the right owner's economics, would it pay to have your own network? Maybe. I don't think it's a foregone conclusion that you have to.
You want to expand at all on the right price and the right economics?
No, I'm not going to go try to sell market price.
John has also talked favorably about the combination of content and distribution. That's something that's always been near and dear to him.
Yes.
Do you see the value of vertical integration into content?
There are some advantages to having it, I guess, but there are disadvantages, too, and scale, the natural scale issues in the content business. If you think about AT&T buying Time Warner, are they going to turn Turner into an AT&T-exclusive product or HBO? Probably not, because the value of those businesses would be three-quarters less than they are and what they're paying for it, right?
Yeah.
You need a national business, which means you have to have relationships with distribution, and you have to run it as a programming business. It's hard to run it for your own internal purposes. I see that as a fundamental issue with owning content. I think NBC went to Comcast at a very good price, and it's a very good asset, and they'll do well with it because of what they paid for it.
That's different than saying there's compelling vertical synergies. It's just that was a good asset that they bought at a good price.
Yeah. I think that's right.
Okay.
They may argue that differently, but I, that's what I think.
Lastly, horizontal consolidation. Do you think there's any more room for horizontal consolidation in the cable industry, or have we come to the bigger-
There isn't that much left, I love the cable assets and think they're good. I think that there are platform economics by integrating. If they were available, they would be interesting to me.
As a place to wrap up, given all of that, how do you think about your long-term balance sheet and capital deployment? Where are your priorities?
Well, that hasn't really changed. If we can invest in the business, we will. If we can find M&A that's accretive, we will. If we can't do any of that, we can buy back our stock. We bought a couple billion dollars back in the last couple quarters. The company's set up from a balance sheet perspective quite well. I expect it to grow and increase EBITDA, I expect capital intensity to come down.
How low?
Huh?
How low?
Lower. It's high now because of the integration and duplicate costs, but it comes down. You saw what was coming down at Legacy Charter. You saw what Legacy Cablevision did. It comes down and should come down. It comes down for a lot of re-- And technology's bringing it down. EBITDA goes up, capital intensity comes down. Interest costs, we've got a really nice fixed interest portfolio, with equal towers out for a long period of time. We're very liquid from an EBITDA to interest rate. I think we've got a $3 billion interest rate budget in a six, with. If you take capital, if we ever had any kind of liquidity issues, we have huge capital budgets that can be managed.
We've got a very secure debt structure, and we have the ability to throw enormous free cash flow in the future. I think that's a good business.
I think there's a lot of people in the room that would agree with you. Tom, thank you very much for joining us.
You bet.
I look forward to having you back for our fifth next year.
All right. Thank you.