Cogeco Communications Inc
TSX:CCA
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Cogeco Communications Inc
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Good day, and welcome to the Cogeco Inc. and Cogeco Communications Inc. Third Quarter 2018 Earnings Conference Call. Today's conference is being recorded.At this time, I would like to turn the conference over to Mr. Patrice Ouimet, Senior Vice President and Chief Financial Officer of Cogeco Inc. and Cogeco Communications Inc. Please go ahead, Mr. Ouimet.
Thank you. Good morning, everybody, and welcome to our third quarter conference call. So joining me today are: Louis Audet; René Guimond; Andrée Pinard; Pierre Maheux; and Philippe Bonin.So before we begin this call, I'd like to remind listeners that the call is subject to forward-looking statements, which can be found in our press release.And I will now turn the call over to Louis Audet.
Thank you, Patrice, and good morning, ladies and gentlemen, and thank you for joining us to discuss the results of Cogeco Communications Inc. and Cogeco Inc.'s third quarter results ended May 31.Our success at Atlantic Broadband has been the prime engine of our growth this quarter. Let us begin with a discussion of Cogeco Communications. Revenue is up 15% in constant currency, reached $637.1 million and EBITDA is up 15.2% in constant currency to reach $287.3 million, generating an industry-leading 45.1% margin.The quarterly dividend was reconfirmed at $0.475 per share, a 10% increase over the same period last year.Let us now discuss the individual components of Cogeco Communications, starting with Cogeco Connexion. Our third quarter revenue at Cogeco Connexion has been flat and EBITDA has declined year-over-year by 1.7%. Excluding a nonrecurring gain disclosed in the third quarter of last year, revenue would have been up 0.7% and EBITDA would have declined 0.5%. Two simultaneous events have influenced this outcome. First, we have implemented a new customer management system, which replaces 22 legacy systems during the quarter. During the transition, we have purposefully slowed down sales and marketing activities and despite that we had seen an impact on service levels on our -- in our customer care centers, which, as you know, are otherwise normally performing at the top of the industry. This has caused modest customer losses as part of the transition. This new customer management system will improve the quality of the customer experience, while increasing the organizational -- the organization's overall efficiency. Second, our promotional expenditures were excessive as we discussed at the last quarter. We are now back to normal. So this is now behind us.We expect annual revenue and EBITDA growth to be in the low-single digits. We had been accumulating reasonably priced spectrum in Canada at auction and in a private transaction as we seek out options to offer wireless services in our footprint in a profitable way respecting our financial needs. I will comment on this in more detail towards the end of this presentation.For the time being, let us turn now to Atlantic Broadband. The integration of MetroCast and the acquisition of MetroCast is now virtually complete and highly successful. As a result, Atlantic Broadband's operating margin has grown from 41% to 44.8% over the -- over last year. And the conversion to the ABB brand took place in May and the introduction of TiVo and higher-speed Internet packages are taking place as we speak. Our expansion plan in Florida is progressing as anticipated.At Cogeco Peer 1, we consider the situation to now be stable with revenue and EBITDA being similar in constant currency to last year's third quarter and this year's first half. We are committed to seeking our share of this growing market and serving our customers well.Let us now take a brief look at Cogeco Inc. Advertising markets are sluggish, but we're able to minimize its influence to restrict cost controls, and we are maintaining our solid ratings, particularly in the Montréal market. The CRTC will be hearing our application to acquire 10 radio stations from Radio-Nord in regional markets of Québec on September 6. And once they have published their decisions, we expect to close in the ensuing weeks.Let us now talk about wireless in Canada. I'd like to take a few moments to answer the questions that we've been receiving from investors about our potential entry into the wireless sector, which we have been fielding in the last few weeks. Let me begin with a brief -- a very brief historical introduction. We did not attempt to get involved in the wireless sector a number of years ago when spectrum was first put up for auction. The reason is that we felt; first, that the roaming and access conditions were not conducive to a successful entry; and, second that we did not have the financial stamina to be successful. The financial failure of those new entrants that did not operate wireline networks in major cities to back them up have unequivocally demonstrated that we made the right choice at that time. This does not mean that we consider the wireless sector to be unattractive from a business standpoint, quite the contrary. But simply that we thought the right conditions were not there for us to be successful at that point in time. Today, we remain interested in offering wireless services to complement our service offerings to customers within our traditional cable footprint and grow our share of our customers' telecommunication spending.Fortunately, two new trends have emerged which can help us enter the business on financially attractive terms. First, there is a growing frustration in the public with regards to the price of wireless services in Canada. This is being echoed at the government and regulatory levels. Thus, it is likely that a more favorable regulatory environment will come to be. Second, new technologies have emerged, which play directly to the strengths of deep fiber networks such as the ones operated by Cogeco Connexion throughout its Canadian footprint.The case in point is the emerging 5G technology. This technology relies on smaller cells, which are located closer to the user and can generally be mounted on cable facilities, and they can easily be set by existing fiber-dense networks at little or no additional feeder cost. Thus, at this point in time, the opportunity exists to start with a blank sheet of paper and leapfrog existing legacy network topology and build directly using the technologies of the future. Hence, Cogeco Communications may conceivably participate in the benefits of existing wireless services such as voice, data and Internet as well as inexpensively explore emerging low-latency services such as the Internet of Things, driverless cars, Internet cities, intelligent cities and the like.In pursuit of this objective, we think that the model that is most likely achievable, while satisfying our profitability requirements will be a hybrid model. It will consist of segments relying on the MVNO model whether negotiated or imposed as well as some segments where we may be a facilities-based operator. That is why we've started devoting relatively small amounts of capital towards accumulating spectrum, which we may use in such a hybrid MVNO model or offer out in a partnership arrangement. The value of the spectrum is supported by a vibrant market.As we contemplate our potential entry into the wireless space, we have established the following capital allocation priorities at Cogeco Communications. Capital will first be allocated to the acquisition of cable networks in the United States, which has proven to be highly rewarding financially. Second, capital will be deployed to continue to maintain and enhance our existing cable networks and potential extensions thereof towards 1-gigabit per second Internet services and other more evolved services as the market requires. Our third priority will be our entry into wireless services in Canada. We intend to manage these priorities in such a way that our debt-to-EBITDA ratio remains well below 4x with a long-term stable objective of around 3x. This means that the amount of capital potentially devoted to wireless -- to the wireless entry will, out of necessity, be eminently reasonable. To achieve a financially successful entry and conserve capital, a new business model will have to be developed and that is what we're working on. And as stated previously, it'll be a hybrid model in all likelihood. This means that we intend to continue to accumulate low-cost spectrum where it is usable by us and makes sense.With regards to the upcoming 600-megahertz auction, about which we've been receiving numerous questions, we will evaluate the opportunity of participating, and we will only consider doing so through a partnership whether with a current operator or otherwise. This statement confirms that we are aiming to enter the wireless space on a limited basis on the condition that it is a profitable business and investing prudently within our priorities and financial means in our existing territories. I would hope that this statement of our intentions will help shareholders better understand our low-risk approach to wireless.In conclusion, for fiscal 2018, our January 10 guidance remains unchanged. We are releasing today our preliminary financial guidance for fiscal 2019. It calls for revenue growth in the 6% to 8% range on a constant currency basis relative to fiscal 2018; EBITDA growth in the 8% to 10% range; and stable CapEx intensity in the 20% to 21% range. Free cash flow growth that will result is in the 18% to 25% range. Our CapEx budget includes investments to be able to offer gigabit speed in approximately 60% of our Cogeco Connexion footprint and 85% of our Atlantic Broadband footprint by August 31, 2019. In addition, we're planning to invest about $30 million in building an additional pod in our Kirkland data center to meet existing customer needs. As you can see, with the focus on sound operation, fiscal 2019 looks very promising.That concludes the opening statement, and we're now prepared to answer your questions.
[Operator Instructions] Your first question comes from the line of Jeff Fan from Scotiabank.
Got a couple here. First just on the operations with respect to the CRM system and the upgrade. Wondering if you can help us just quantify any cost that you incurred in Q3 related to that implementation and whether that continues into the fourth quarter? And also on the subscriber activations, the impact that it had in the quarter. Are we back to normal subscriber activation levels now into Q4? And then I've got a question on wireless, probably just -- thank you for all the details and color. But maybe just a broad strategic question, further we -- do you just think wireless for you is an offensive tactic? Or is it just more of a defensive tactic to protect your customer base? And -- hope we can get some color there.
Sure. So to begin with the implementation of our new customer management system at Cogeco Connexion, this is something that's been in the works at Cogeco Connexion for a long time. And we finally came to a point in time where we could afford doing it. And, hence, we have undertaken it and it is replacing about 22 other systems that had been bolted on to our infrastructure with the passage of time. So it is a great simplifier of our processes as well as an enhancer of our marketing abilities and a reducer of our operating expenses over the longer term. And some of these savings are actually included in our fiscal 2019 guidance. So overall, this is a highly desirable project. As you could expect with such a major transition, there are bumps in the road. There are bumps along the way. They are normal. They must be expected. This is not said to minimize the pains of -- that some customers have suffered. I recognize that this has occurred for a number of customers and we are really sorry that they've had to endure that, but this is for the better of this company and its shareholders over the long term as well as for its customers because services in the longer term will cost less and that's in the interest of all customers. Now most of the impact was felt in the month of May. Slightly meaningfully decreasing into June with still some impact going on now with an expectation that things should be resolved by the end of this month. Customer losses or a lack of acquisitions -- for the most part, has come from the fact that we have to slow down our marketing activities because otherwise the call centers would have been even worse off than they have been and we know they have been swamped with calls, people were getting new invoices they weren't used to, some people regrettably the system didn't recognize and these are all things that we have corrected and continue to correct. So that would be my answer with regards to your question as it concerns our transition to a new customer management system. With regards to wireless, well, you know our philosophy, Jeff. Our philosophy is we like to eat our cake and still have it. That's our philosophy. It always applies. So what we're trying to do here with wireless is we would like to build a profitable business and along the way that profitable business will also be defensive. So it's both of the above. And it's keeping with our philosophy to get the best possible results from our initiatives and to invest intellectual capital first to make sure that we develop the wise solutions.
And maybe just a quick one on capital allocation. Would you consider swapping your ICT business if that opportunity came up for -- to free up capital for your wireless investment?
Well, that's an interesting question from a theoretical point of view when you look at a sheet of paper. And that's -- I think that it's a fair question, when you look at it from that viewpoint. We currently are working on this business, and we want to serve our customers well and want to treat our employees well. So your question is, at this stage, is more theoretical than anything else. And so I guess, we are content right now with seeking our fair share of the market.
Your next question comes from the line of Drew McReynolds from RBC.
I just -- Patrice or Louis, on the fiscal 2019 guidance, in terms of your internal growth assumptions by segment, can you just provide a little additional granularity on what you expect there? And on the CapEx, presumably there is very little, if any in there for wireless outside of spectrum. And then I'll have an additional question after that.
Okay, great. So as you saw, the guidance includes the full impact of MetroCast. So we had it basically for 8 months in 2018 and 12 months in 2019. And we've disclosed what it is organically as well. So organically for revenue is 2% to 4% and EBITDA is 3% to 5%. And to be clear, this is in constant dollars, right, the same FX. So in terms of business units, as we usually provide some color, but not exact numbers. For Cogeco Connexion, we're planning to see revenues increasing in the low-single-digit range and that would be true for EBITDA as well. For ABB, similar to last year, in terms of what we were planning for the year is a mid-single digit, so for both revenue and EBITDA. And for Cogeco Peer 1, it would be in the low single digit for both revenue and EBITDA. And -- yes, and for CapEx, to your question. So the CapEx, we're expecting some increase that's related to the construction of the new pod in Kirkland because also, we have a bigger platform now that we've bought MetroCast. So there's some increase there. If you were to use constant dollars, that's about $35 million increase in CapEx year-over-year and it does not include construction, or I would say, first of all, spectrum license acquisitions, that's excluded from our definition of capital investments. And it does not include any significant number or a number related to wireless construction.
Just a follow-up, switching gears. On the competitive environment, obviously, always competitive, wondering, this quarter or in the current quarter, we're seeing generally some aggressive tactical marketing by BCE and Rogers, particularly in Ontario. Just comment on any spillover impact or implications for Cogeco more interested in kind of relative to what you've seen in the past?
Sure. Well, I would categorize competition as continuing to be vigorous. And that's all I could say really.
[Operator Instructions] Your next question comes from the line of Vince Valentini from TD Securities.
Echo my thanks for the color on the wireless strategy, Louis. Question number one is on the guidance and the tax assumption in there. I'm not sure how you get to it. First of all, clarify, I think, I read that -- you're saying that the cash tax rate in 2019 will be 19%. I'm not sure how you get there. Do you not still have tax shelters plus the benefits of tax reform in the U.S. so that ABB's cash taxes should be effectively 0? So to get to consolidated of 19% you'd have to have a very high tax rate in Canada, so if you can help me understand that'd be great. And the second question is, the $30 million you are going to spend on a third pod in -- at the Kirkland data center, is there some regional reason why you have to have capacity in that location? Because -- correct me if I'm wrong, but you have excess capacity across your network of data centers and there's been some trouble filling that up at reasonable prices, so could it not be possible to just shift business around and use capacity you already have rather than spending $30 million on new capacity?
I'll start with the second question, which is an excellent one. This is an investment related to additional revenue that was included in the contract when we signed it 2 years ago. So this is for an existing customer, the identity of which we are not allowed to disclose. And as part of the contract, there was a spike in revenue and there was a spike in investment to support that. So that's, we're just honoring our contract here.
Can I just clarify that? Is any of that incremental revenue showing up in your 2019 guidance? Or do you just spend the money in '19?
Oh, yes. It is in the fourth quarter -- starts in the fourth quarter.
And on the cash tax. So in 2018 what we provided in guidance was 24%, so that's going down to the 19%. But your question is probably why 19%. Looking at Canada, that's about 26%, and we're not in a cash tax position in the U.S., so you're right. So -- and absolute tax is complicated. There's many elements in there, but I would say the main element that increases, if you were just to take a pro rata of our overall business and single out Canada only, I would say there's reversals for tax purposes of -- or I would say, a different level of depreciation for tax purposes of fixed assets over time. So it's a lower tax shield from this than we had in the past. So if you compare our accounting depreciation versus our tax depreciation, the accounting is higher and the tax is lower, which means that we -- the rate otherwise would have been lower than this 19%. So hopefully that's clear. I'm happy to explain, talk more to that. But that explains why it's at 19% and not at a lower number.
So Patrice, is there some sort of timing issue in terms of elevated cash taxes in Canada in '19 that maybe go away in 2020? And if so, is that an amount you can quantify at all?
No. I think, it's -- these things don't move much year to year because these tax depreciations get taken over many years. But you do see that we're decreasing the cash tax to -- from 24% to 19%, which has to do also with the profitability coming from MetroCast where we're not in a cash position in U.S. But I would say going forward, you should probably expect something that would be similar.
[Operator Instructions] Your next question comes from the line of Maher Yaghi from Desjardins Capital Markets.
Louis, sorry, I wanted to ask you, do you agree that having 2,500 and 2,300 megahertz spectrum is enough or not enough to have a model that you described or it's a hybrid model where we have an MVNO, but also have a facility-based operations in place. I'm trying to assess maybe just your view on what the 5G topology means in terms of what the kind of spectrum you need to have it in place?
Well, to be honest, Maher, I think you're well ahead of the parade here. And I commend you for that. But we're still in the early stages where you can't just sit still, you have to start accumulating some of the assets, which we think will be useful to what we want to do, acquire them in a market where they have value, if ever you have to backtrack and slowly build your business case. So it's way too early. So is it enough or is it not enough? I guess, it's not enough. But then, again, is it the only thing in the mix far from it? What does it mean? It means exactly what I said earlier in the opening statement. We will not spend much capital, but we will slowly using the best of our abilities and using brainpower, try to come to something that works for shareholders and for customers that is reasonable, that's within our means. It's all I can say, really, at this stage. You're trying to get into the precise nature of components. I think that's way too early for us.
The only reason I'm asking, Louis, is because there is -- as you said, there's a spectrum auction coming up in the very I would say short-term for those communication companies that. And so from my understanding of the 5G network, you need to have small, long and short in terms of spectrum management abilities. So the question is not 4 or 5 years in the future more or like 1 year in the future, and that's why I asked it.
Yes. Well, I think, Maher, what I can say is the statements I have just made is straightforward. It encompasses all the answers to the questions you've just asked. And rather than paraphrase it and step outside of the sandbox, I would encourage you to relisten or read the statement I made. It contains all of the known answers to your question.
Okay. And my second question, I just wanted to ask you on your hybrid model. Are the 2 components of that hybrid model mutually exclusive or inclusive, i.e., if you can secure an MVNO type model, will you still have a facility-based operation or vice versa?
I think, you have to look at it in a more, how shall I say, flexible way. If you want to enter into a partnership, you have to have something to offer. So the way we look at it is, we can -- there are some things that we can offer. There are some things other parties can offer. But you can't arrive empty-handed and whatever emerges is tailored to the markets you serve.
Okay. That's fair. Sorry, and my last question on your expectations for fiscal year '19. Patrice, you mentioned some of the assumptions underlying revenue growth. Can you maybe just help us with the subscriber metrics or some of the -- how your views are on subscribers for Canada and the U.S. in terms of PSUs?
Sure. Well, I think that we don't provide guidance on the PSUs but generally, what happens in Canada is we have some losses in video and phone, and we gain on the Internet. I would not expect anything different in the coming year. And that includes both residential and business. And the business segment is the one that's growing faster. And in the U.S., typically, we lose a bit of video and grow phone and Internet. I would say, with MetroCast now, one of thesis there in buying it was expecting a lot of growth. And so far, it's going well. Actually, a bit beyond our expectations, where by introducing a new platform on the video, which is a TiVo and pushing bundles, we actually think in that region we can grow video. So you take all this together, the video should be better performing than in the past, which was a slight decrease and continued growth in phone and Internet.
[Operator Instructions] There are no further questions at this time. I turn the call back over to the presenters.
Okay. Well, thank you, everyone. We look forward to disclosing our fourth quarter results in late October. And feel free to call us in the interim if you have any questions. Thanks to all.
Thank you, have a great summer. Bye.
This concludes today's conference call. You may now disconnect.