Qwest Corp Q2 FY2021 Earnings Call

Greetings and welcome to Lumen Technologies Second Quarter 2021 Earnings Conference Call. As a reminder, this conference is being recorded, Tuesday, August 3, 2021. It is now my pleasure to turn the conference over to Mike McCormack, Senior Vice President, Investor Relations. Please go ahead, sir.

Thank you, Franz. Good afternoon, everyone, and thank you for joining us for the Lumen Technologies Second Quarter 2021 Earnings Call. Joining on the call today are Jeff Storey, President and Chief Executive Officer; and Neel Dev, Executive Vice President and Chief Financial Officer. Before we begin, I need to call your attention to our safe harbor statement on Slide 2 of our 2Q 2021 presentation, which notes that this conference call may include forward-looking statements subject to certain risks and uncertainties. All forward-looking statements should be considered in conjunction with the cautionary statements on Slide 2 and the risk factors in our SEC filings. We will be referring to certain non-GAAP financial measures reconciled to the most comparable GAAP measures that can be found in our earnings press release. In addition, certain metrics discussed today exclude costs for special items as detailed in our earnings material, all of which can be found in the Investor Relations section of the Lumen website. With that, I'll turn the call over to Jeff.

Good afternoon, everyone, and thank you for joining today's call. It's an exciting day for Lumen, and we have a lot to cover. I'll begin today's call with our recently announced transactions, including the just announced sale of a portion of our legacy local exchange business to Apollo. I'll then ask Neel to review a few second quarter highlights as well as provide a preliminary view of the expected effects of these transactions on Lumen's financial profile. And of course, we'll reserve time for your questions at the end of the call. So let's jump in. Last week, we announced the sale of our Latin American assets to Stonepeak at a value of $2.7 billion, representing an approximately 9x multiple of the Latin American business' 2020 estimated adjusted EBITDA. There are more details about this transaction in the release materials, but the simplest way to think about LATAM is that we will transfer ownership of substantially all our LATAM-based customers and assets to Stonepeak, and are entering into a services agreement with Stonepeak to continue to serve the needs of our enterprise customers based outside the region. Subject to customary regulatory approvals, we expect this transaction to close in the first half of 2022. I'm also pleased to share that we have agreed to sell our legacy local exchange business in 20 states to Apollo for $7.5 billion, representing a multiple of approximately 5.5x our 2020 estimated adjusted EBITDA. In short, with this transaction, we are transferring to Apollo all our legacy local exchange assets in 20 states, along with the consumer, small/medium business, state and local government, education and wholesale customers served by those assets. Lumen will retain ownership of our non-local exchange fiber assets in those 20 states, including our long-haul fiber and the enterprise CLEC assets. Lumen will also retain our legacy local exchange assets in another 16 states. In the transferred markets, the service needs of Lumen's enterprise and government customers will be met under a network services agreement to be entered into with Apollo. Subject to customary regulatory approvals, we expect this transaction to close in the second half of 2022. I'm very pleased with the valuations we were able to achieve for these 2 sets of assets. On the whole, our retained markets have significantly higher fiber penetration, population density, enterprise demand and overall growth opportunity than the transferred assets. We have spoken about the sum of the parts analysis of Lumen and I believe multiples of 5.5x for these 20 states and 9x for LATAM should shine a bright light on the relative value of our retained business. Don't get me wrong, the 20 states we're selling to Apollo are good markets with quality assets, talented employees and excellent customers. As we looked at these states, though, we knew that we were unlikely to prioritize investments in these markets ahead of our other opportunities in the Enterprise and Quantum Fiber. After closing of this transaction, approximately 70% of our remaining mass-market footprint is well suited for Quantum Fiber investment. This transaction will allow the transferred assets to get the higher level of investment we know they can sustain, and we are committed to partnering with Apollo to help them realize their vision for these markets. As I mentioned on our Analyst Day back in April, we have worked very hard over the past 3 years to transform our company, both financially and operationally. We’re committed to driving growth over the Lumen platform and continue to transform the business. These transactions are fully aligned with that strategy and we believe will drive future growth as we meet the needs of the fourth industrial revolution, for enterprises and consumers alike. Undertaking these transactions allows us to simplify our business, deliver differentiated products to a higher percentage of our customer base and target our capital investments to drive higher growth and more attractive long-term returns on both the Lumen platform and through our Quantum Fiber investment. Of course, the transactions create pressure as well. While the sale of the consumer assets is expected to have a positive effect on our product mix day 1 after close and an improved growth profile going forward, the high levels of cash flow these markets generate will be free cash flow dilutive in the near term, even at these strong valuations. Even so, we are confident that these transactions are right for our business over the long term and will improve the growth profile of our company. Neel will cover some of the operational financial impacts but let me take a moment to speak to the implications of these transactions on our capital allocation strategy. First, we absolutely expect to accelerate the pace of our growth investments in Quantum Fiber. By retaining the 16 states we have, fiber-based consumer and mass market services remain a huge opportunity for us and we have built a differentiated offering with Quantum Fiber, enabling an all-digital customer experience that uniquely positions us among mass-market broadband providers. As Neel will discuss, our Quantum Fiber results are bearing this out as we saw another quarter of net adds for our fiber and higher-speed offerings continuing results from previous quarters. The jury isn't out on this one. When we invest in consumer fiber, we take share and we drive profitable growth. As I mentioned, upon closing the Apollo transaction, approximately 70% of our remaining mass market footprint will be the sort of urban and suburban markets that are best addressable with Quantum Fiber solutions. We are developing an accelerated build plan, and we'll share those details as they're finalized. What we can tell you today is that while we remain strategic and disciplined in our approach, we expect to build faster and with more scale in the markets that we prioritize for Quantum Fiber investment. We also believe we have a unique opportunity to grow our Enterprise business by leveraging our expansive fiber network to provide essential transport services and further penetrating our on-net buildings, utilizing our edge computing network to move critical workloads closer to the source of data and the use of data and expanding the capabilities of the Lumen platform and enabling greater digital consumption of our services for all of our customers. I'm the first to acknowledge that we're not yet seeing the pace of growth that we expect from these initiatives, but we remain confident in the opportunity and are streamlining our focus and further investing to drive that growth. Second, I expect we will manage our balance sheet to remain more or less leverage-neutral over the next few years as we accelerate investment into our growth initiatives. Longer term, I believe the previously articulated leverage range is the right one for our business. But I'm prepared to allow the timeline to achieve that range to extend as we work through this investment cycle. Further, beyond fully investing in the growth of our business, we're mindful of being opportunistic in considering share repurchases. We are not choosing share repurchases over funding growth. Even as we scale the Quantum Fiber build and the Lumen platform investments, we expect to have excess capacity to consider opportunistic share repurchases if we can do so at multiples that will be accretive to long-term share value. To that end, we've also announced today approval by our Board of a $1 billion buyback program. Lastly, the dividend. We have long stated that we believe return of cash in the form of a dividend is an appropriate capital allocation vehicle in a business like ours. However, with these transactions, the profile of our business is changing and will change rapidly going forward as we lean into investing for growth and continuing to rationalize the portfolio. I do realize that will put pressure on our dividend after we close these transactions and the further we get into our investment program. But as of now, we are not faced with that trade-off decision, and we'll continue to balance the return of cash to shareholders through dividends and buybacks while we accelerate our investment in Enterprise and Quantum Fiber growth. Let me provide a small bit of color on my views on the second quarter results. While we worked hard to get these transactions announced, we remain very focused on driving performance in those areas that we believe provide the best opportunity for growing revenue and strong returns. That said, our second quarter revenue trends were sluggish. We've talked about the slow sales in the fourth quarter and the beginning of the first quarter as a result of COVID and delayed decision-making. Since then, we've seen good sales growth sequentially and believe our growth initiatives across the Lumen platform will help us improve our revenue trends as we move forward. Before I turn the call over to Neel, let me offer a few points in summary. We're excited about the two transactions we've announced. We're pleased with the valuations that have also done these transactions to drive investment and operational focus within the remaining business, sticking to the strategy we discussed since launching Lumen and Quantum Fiber last fall. At 5.5x on the ILEC business and 9x adjusted EBITDA on the LATAM business, we believe the valuations highlight and support our view of the sum of the parts for the remaining business. While we already operate one of the world's most extensive and powerful fiber infrastructures, we will continue to invest in growth via the Lumen platform, cloud edge initiatives and to accelerate deployment of Quantum Fiber. We believe the recently announced transactions were executed at excellent valuations and are aligned to our strategy of streamlining our business to those markets on which we are best able to profitably invest in growth. With that, I'll turn the call over to Neel to provide a few more details on the quarter and some of the expected effects from the announced transactions.

Thank you, Jeff, and good afternoon, everyone. I want to leave ample time for your questions on our announced transactions so I will briefly review our second quarter results. Let me begin with our financial highlights in our earnings presentation. For the second quarter 2021, we delivered solid adjusted EBITDA and expanded margins year-over-year. Cash flow remains very robust, providing the opportunity to ramp investment in our key growth areas in the second half of the year. However, given our spending in the first half, we are reducing our CapEx guidance to be in the range of $3.2 billion to $3.5 billion. And accordingly, we are adjusting our free cash flow expectation to $3.1 billion to $3.3 billion for the full year 2021. As Jeff mentioned, our Board has approved a $1 billion share buyback program over 2 years, with which we will be opportunistically buying back shares. Turning to second quarter revenue by sales channel. Total revenue in the second quarter declined 5.2% on a year-over-year basis to $4.924 billion. Normalizing for the sale of our correctional facility business in the third quarter of 2020, our revenue would have declined 4.9%. It is important to remember that year-over-year metrics were meaningfully affected by the surge in demand for voice collaboration and conferencing in the second quarter of last year, making comparisons less relevant. From a sequential perspective, total revenue declined by 2.1%, primarily driven by lower sales in the last couple of quarters. Moving to business segment. In the second quarter, total business revenue declined 2% sequentially and 5.2% on a year-over-year basis to $3.522 billion. Normalizing for the sale of the correctional facility business, the decline was 4.9%. Within our business segment, IGAM revenue declined 0.9% sequentially and 2.6% on a year-over-year basis. The year-over-year decline was primarily driven by higher usage in the prior year period related to COVID. Within IGAM, compute and application, IP and data and fiber infrastructure services were flat sequentially driven by improvement in sales and installs. Large enterprise declined 0.6% sequentially and 4.3% on a year-over-year basis. Compute and application services and fiber and infrastructure services both grew sequentially. Mid-market enterprise declined 4.7% sequentially and 9.7% on a year-over-year basis. Sequential performance was impacted by strong nonrecurring revenues we highlighted last quarter. This sales channel was also impacted by the previously noted sale of the correctional facility business. Wholesale declined 2.6% sequentially and 5.5% on a year-over-year basis. As a reminder, the first quarter of this year benefited from carrier settlements. Our overall business segment revenue performance continued to be impacted by delayed decision-making by enterprise customers in the current environment. While year-over-year comparisons this quarter were affected by the pandemic-related surge in voice services last year, we are seeing stabilization in sequential trends. Moving to business segment revenues by product categories. Compute and application services for the enterprise channels grew sequentially and was flat year-over-year. We expect compute and application services, which includes cloud edge and our newer Lumen platform offerings, to provide additional growth with increased market traction. IP and data services for enterprise channels declined both sequentially and year-over-year as increased demand for IP and work-from-home solutions were offset by continued delayed decision-making for enterprise hybrid network deployments. Fiber infrastructure services for enterprise channels grew year-over-year. Sequential performance was impacted by strength in nonrecurring revenues for equipment and professional services in our mid-market channel last quarter. Voice and other services in the wholesale channel continue to be managed for cash, with legacy voice declines in line with our expectations, but year-over-year comparisons were impacted by higher COVID-related usage in the year-ago quarter that I just mentioned. As with the first quarter, market conditions in the second quarter remained challenging. As Jeff mentioned, we are not pleased with our revenue performance year-to-date, and have a solid plan to improve our revenue trajectory as the economy reopens and our new initiatives take hold. Turning to mass markets, second quarter 2021 revenue declined 2.2% sequentially. During the quarter, we added 31,000 Quantum Fiber customers, reaching a total of 746,000. Our mass markets fiber broadband revenue grew 30% year-over-year this quarter. Fiber-based broadband revenue now represents 17% of mass market's broadband revenues compared to 13% in the year-ago quarter. Turning to adjusted EBITDA. For the second quarter of 2021, adjusted EBITDA was $2.109 billion compared to $2.135 billion in the year-ago quarter. We expanded adjusted EBITDA margins during the quarter, growing 170 basis points year-over-year to 42.8%. As we continue to direct incremental operating expense investments towards key growth areas of the company, we were able to more than offset those investments with our ongoing focus on operational transformation savings. Capital expenditures for the second quarter of 2021 were $646 million. As we have mentioned, a significant portion of our capital is success-based. With the lengthening sales cycles, we were able to calibrate our capital spending to the current environment. As previously mentioned, we have adjusted our CapEx expectations lower for the full year, with an expectation that the second half spending will be higher than the first half as we start to ramp our mass market investments, and business decision-making accelerates. In the second quarter of 2021, the company generated free cash flow of $1.044 billion, and we have adjusted our full year 2021 guidance for free cash flow as a result of lower capital spending year-to-date. During the second quarter, we continued to make progress on our deleveraging initiatives by reducing net debt by more than $700 million. We issued $1 billion of lower coupon debt during the second quarter to refinance more than $1.2 billion of debt. On a year-over-year basis, we have reduced net debt by $2.3 billion. Moving to the financial outlook for 2021. Other than the previously mentioned capital expenditures and resulting free cash flow changes, all other guidance metrics remain unchanged. We remain confident in our adjusted EBITDA target of $8.4 billion to $8.6 billion. Moving on to our announced transactions, both today with Apollo for part of our ILEC footprint and last week with Stonepeak for our LATAM business, I would like to provide you with some high-level financial impacts that should help inform your modeling as you look past the expected closings in 2022. With respect to the LATAM divestiture, we estimate our 2020 revenue related to the transaction at approximately $800 million; estimated adjusted EBITDA, a little over $300 million and capital expenditures of about $200 million. The estimated adjusted EBITDA includes costs to operate the business on a stand-alone basis and also elimination of non-cash revenues and resulting EBITDA consistent with the proposed sale. These impacts predominantly affect our IGAM channel. In terms of the ILEC transaction, we estimate our 2020 revenue related to the divested assets at approximately $2.5 billion; estimated adjusted EBITDA of $1.4 billion; and CapEx of about $400 million, excluding CAF. Similar to LATAM, these estimates include revenue and costs to operate the business on a stand-alone basis. As far as revenue associated with this transaction, about 70% of the revenue is mass markets, and the remainder roughly split between wholesale and enterprise channels. In terms of the product mix, about 50% of the revenue is for voice and other product categories, and the remainder are largely mass market broadband revenues. As with any carve-out, we do expect some dissynergies, but we are also confident that we can address those with our focus on cost transformation initiatives. Upon the closing of both transactions, Lumen's NOLs will be substantially utilized, and we will become a cash taxpayer. As Jeff mentioned, we will manage our debt profile to ensure that the transactions are leverage-neutral. And our long-term target leverage of 2.75 to 3.25 net debt to adjusted EBITDA remains unchanged. In summary, we have made significant progress this quarter in optimizing our business with a clear focus on positioning Lumen to capitalize on the growth opportunities. We expect business segment trends to improve, driven by our Lumen platform initiatives as enterprise decision-making accelerates. And we are very excited about the investment and growth opportunity in our mass markets fiber business. With that, we'll open it up for your questions.

Our first question is from Phil Cusick with JPMorgan.

I have a lot of questions today. My first one is if you could provide some insight into the revenue and EBITDA figures from the U.S. business, specifically regarding the locations that have been kept and sold. What have you learned from this, and what has been the growth trajectory for each of these segments?

So Phil, we've shared a map illustrating the ILEC asset sales transaction, which highlights the states involved in the sale. However, we are only selling the ILEC operations in those states, while retaining the CLEC and IXC networks. This transaction affects around 20 states and includes not just our mass markets revenue but also ILEC access revenue for wholesale and enterprise, amounting to roughly $2.5 billion in revenue and $1.4 billion in EBITDA. Regarding the growth profile you mentioned, 50% of that revenue comes from voice and other services, which are seeing a decline similar to the overall mass market portfolio. In terms of fiber revenues, less than 10% is from that declining area since it primarily covers rural regions. Additionally, about 60% of our CAF II subsidy and units are within the footprint we're selling. Nevertheless, broadband revenues in these states have remained relatively stable due to the current competitive landscape, but we anticipate changes in the future. That provides a high-level overview of the mix and footprint.

And if I can, one more. It sounds like buybacks at this point are more of an option or consideration than a plan. Can you just expand on what opportunistic means and how that fits into the leverage plan?

Yes, I'll start, and I'll let Neel add to that. Our Board has authorized $1 billion worth of buybacks. And what that means for us is if we see good opportunity to buy the stock at prices that we think are undervalued, then we'll do so. And you've heard us talk a lot about some of the parts. And we think that our business in this transaction shows that the sum of the parts is pretty strong and pretty good.

Yes. And in terms of your question, Phil, on leverage. Like Jeff mentioned, we expect to be largely leverage-neutral. And as we look forward, the key thing to highlight there is that we're going through an investment cycle. So we do plan to scale up our investment in the remaining 16 states. We've proven out our model with the micro-targeting approach. And as Jeff highlighted, we're moving more from a micro-targeting to really scale up our investment with a market-based approach. And so as we go through this investment cycle, simple way to think about it is we're directing more of our operating cash flow towards investment versus paying down debt. But we haven't changed our long term.

Our next question is from the line of Eric Luebchow with Wells Fargo.

You mentioned that the dividend might be under pressure during this investment cycle. Could you discuss what the payout ratio looks like on a pro forma basis, what your comfort level is for the next couple of years, and how you will decide whether to maintain the dividend or possibly reduce it to fund more investments?

So Eric, I think Jeff summarized it well. We've just closed the transaction and plan to increase our investment. I want to share a few broader observations regarding the factors we are considering. First, the company's capitalization will look very different by the time we close the transaction and shortly thereafter. We are reducing debt and intend to buy back shares, which is an important factor to keep in mind. Jeff also mentioned that we continue to optimize the portfolio, so we will be active in that area. Regarding additional growth capital, it's a question of timing and scaling. We aim to increase our efforts responsibly to avoid stranded capital and ensure we are driving penetration where we invest. There are various factors we are evaluating, so I can't provide a specific payout number at this time. However, as we scale, as Jeff highlighted, it will put pressure on the payout ratio. While we are not at that point yet, it's something we wanted to emphasize. Furthermore, the pressure will come from investing in areas where we've demonstrated good returns, which will ultimately benefit shareholders.

And the only thing that I'll add is that we have the benefit of a strong balance sheet and we continue to invest in growth, and also, return cash to shareholders through dividend and share buybacks. And so we view that as a strength for us and will be part of our balanced approach to capital allocation moving forward.

And just maybe one more on the fiber expansion in consumer fiber. You have 2.4 million fiber-enabled homes today. I know you've said in the past, you still think you're underpenetrated. I mean how meaningful do you think that business can become? I mean where are you seeing opportunities where returns or penetration levels you can get are attractive. Maybe you could just expand a little bit on where you plan to take that business in the next few years.

Sure. We'll provide more details in the upcoming quarters regarding our plans. We've reviewed this business and, as Neel noted, we've been effectively executing our micro-targeting strategy, resulting in successful growth in our market penetration. We see significant opportunities ahead. In the 16 states we retain, there are about 20 million homes passed, with 70% of them located in urban or suburban areas, which amounts to around 15 million homes. We believe these represent excellent opportunities for fiber investment. Therefore, we aim to accelerate our plans and scale our efforts, as our experience over the past couple of years shows that we've done a commendable job investing in fiber and expanding where we operate.

Our next question is from Simon Flannery with Morgan Stanley.

Great. On the CIO and the enterprise spending, I think last quarter, you talked about expecting a resumption or an increase in delayed decision-making improving in the second half. Is that still your expectation? Have you sort of seen a pickup in activity here? Or when do you think that's going to really become more meaningful in terms of accelerated bookings? And then coming back to the deal flow, help us with timing here because you actually took your CapEx guidance down even though you're highlighting higher CapEx. Is the CapEx contingent on closing these deals? Or will you start that more aggressively in the near term. And sort of the same with the buyback, is that tied to the deal close? So could you start that imminently?

I will address all three of your questions. Neel, feel free to add anything if I miss something or if my answer is incomplete. Regarding enterprise spending, we noticed a slowdown in the fourth quarter and early in the first quarter, but we have seen sequential improvement since then. That’s accurate. Sales are improving sequentially, but the Delta variant is influencing how our customers are returning to work, and we are also adjusting to these challenges. We are confident that sales cycles will improve and that we will meet our sales expectations, although there are still several factors that could hinder this progress. As for capital expenditures, they are more closely related to your first question than to deal flow. When sales cycles and purchasing cycles slow down, we tend to spend less capital. Our capital spending is closely tied to our growth. Therefore, we haven't invested as much in the first couple of quarters as anticipated. We do expect this to change, as we anticipate higher capital utilization in the second half of the year due to increased sales and revenue growth across the business. Finally, regarding buybacks, they are not contingent on closing any deals. Our Board has approved $1 billion in repurchases, and this decision is based on market evaluation and taking advantage of the right timing.

And when does the Quantum acceleration start? Is that kind of early next year? Or could that happen this year?

Yes. That's what I was going to add, Simon. I think the underrun that Jeff highlighted is really related to the current environment and the enterprise business, and that's what we manage on a success-based basis. But we haven't slowed down on Quantum, and we are looking to accelerate that second half of this year and going into next year. And that's not contingent on the deal. But with these things, it takes a while because there is this actual physical deployment, so permitting, et cetera, but we're scaling up.

The next question is from Batya Levi with UBS.

With all the pieces on the financials that you helped us with, I think dividend payout would look more close to 70%, 75% without really leaning into CapEx. So can you please provide a bit more color why you would like to maintain the dividend at these levels now and not maybe accelerate the buyback beyond what you have announced? And just a couple of follow-ups. On the taxes, would the NOL cover most of the taxes? Or will there be some leakage? And if you can also talk about how much has subsidies these assets that you're selling we're receiving?

So Batya, regarding the dividend, I would direct you to Jeff's comments. Essentially, if we consider the timing of the deals, the LATAM sale is set for the first half of next year, while the ILEC asset sale is expected in the second half. We anticipate that the ILEC asset sale will take around 12 months, but it could take longer. There is some uncertainty, particularly related to the timing of all the necessary approvals. As I mentioned, there are many variables to consider between now and then, such as our company's future capitalization and growth capital. Therefore, we believe it's a bit early to make any declarations. This is an issue that Jeff and the Board will approach thoughtfully. However, we recognize the calculations you're making are similar to what others will consider, and there will be some trade-offs between growth capital and how we allocate resources to that versus the dividend. But this is not something we need to resolve today. As for your question about the NOL, there are many variables to take into account. One factor is the taxable income from our core business depending on the deal timing. Then, there are tax regulations that will apply when we finalize the deal, which adds another variable. However, we know that considering our NOL balance, these assets have a low tax basis, so we will be utilizing our entire NOL. By the time we reach the closing of the deals, we will incur some cash taxes on top of that and will become a cash taxpayer afterward.

Our next question is from Brett Feldman with Goldman Sachs.

You previously conducted a strategic review of the consumer business a few years ago and chose not to proceed. One of the questions you might receive is what has changed since then. Was it simply identifying the right partner, or were there other factors that enabled you to move forward? Additionally, it appears you've completed a significant review of your asset portfolio, as indicated by the transactions you've announced. Is that process still ongoing, or do you believe these transactions will result in the asset base you desire? On a more operational note, there have been numerous questions during this call regarding your strategy for increasing investment in fiber for mass markets. However, what about the business sector? If you have surplus capital, are there opportunities to further develop the business market?

Sure. In terms of what's changed, I want to address all your questions. However, there hasn't been any change. A few years ago, I mentioned our open-minded approach and the desire to make smart decisions that benefit our shareholders with good returns on our investments and divestitures. We've been collaborating with Apollo and recognized them as the right partner at the right time. They plan to invest substantially in these markets to facilitate growth, creating a strong business for them. We will collaborate closely, as they will be a significant provider while we serve our Lumen customers across 20 states related to the ILEC assets they'll manage. We've committed to being smart and open-minded; we now have these two transactions as evidence of that effort. Regarding whether this approach is ongoing, absolutely. We will always aim to be smart and open-minded about our assets to maximize shareholder value. We will keep looking toward potential acquisitions and divestitures that align with our evolving business. This connects to your question about fostering growth on the business side. We've discussed our Lumen platform as a growth booster for the Enterprise sector. We've focused on edge cloud and edge computing capabilities for our customers, alongside partnerships with companies like Zoom, VMware, and IBM, allowing us to integrate their capabilities into our offerings. These efforts and others will enhance growth from our enterprise customers, as well as improve our effectiveness in penetrating buildings and lighting new properties, all of which are integral parts of our business operations.

Our next question is from Frank Louthan with Raymond James.

When you look out at the ILEC operation that you're retaining, what do you think you can build to those customers per home passed? And it looks like you've got a little over 10% of the addressable locations with fiber. What's the overall broadband penetration? And what percentage of those homes ultimately do you think you can target to build fiber?

So, I'll let Neel answer the second question about how many homes and all of that. And I'm not 100% sure I have the first question right, Frank, but I'm going to answer the question as I heard it, which is what do I think we can build to those customers. I think we can build a great product set that we can deliver in a digitally consumed way. If you look at our fiber-based Quantum Fiber new customer experience, I think our NPS is like positive 74, which I would put up against anybody, anywhere. And so, I think that what we're building for them is a great product, is a highly secure, robust product that can be consumed digitally and through very ease of use for our customers, so we'll continue to deliver that. And then, Neel?

Yes, I believe Jeff mentioned this earlier. If you examine the footprint we maintained, approximately 15 million out of the 21 million homes are in urban and suburban areas. We consider most of these to be addressable. We are conducting further work in this area and will provide more details in upcoming quarters. We believe that a significant portion of this is indeed addressable. Regarding our cost structure, while I won’t disclose a specific figure, I can say that we maintain a very competitive cost structure compared to other public companies we've observed. As for our penetration rates in the regions where we've been operational for some time, we see penetration levels of around 40% to 50% for fiber service to homes. Additionally, we are experiencing very high EBITDA margins, as we are making substantial investments in self-service capabilities, focusing not only on installations for new customers but also on enhancing how we support our existing customers.

Okay. I apologize. My first question was really more on the cost per home passed. I probably didn't phrase it very well. Any insight there on what you think you can build in those states that you're keeping?

Yes. While I won't provide a specific figure, I can share that we believe we have a solid cost advantage based on the states we're focusing on. When considering all of our business areas, including state and local government, federal government, enterprise customers, small and medium businesses, and consumers, we think we can develop our infrastructure at an appealing price point, and we will keep our focus on achieving that.

And Frank, we do have a separate slide deck on the website, which can help you get to a sort of an enablement percentage. If you look at that slide, we can follow up as well.

Our next question is from David Barden with Bank of America.

I have two questions, mainly about the Apollo deal. When you break down the segments, you have direct costs, historical segment EBITDA, and then a lot of corporately allocated overhead costs. Is the methodology for calculating the EBITDA numbers for the divested properties influenced by the NSA you discussed with both counterparties, Neel? Do you anticipate that they will fully reimburse you for the allocations to these entities, making you net neutral? How is the NSA finalized? My second question is for Jeff. You mentioned cash flow dilution. When I tally the numbers, the Latin American segment shows a negative $100 million in EBITDA after CapEx, and the ILEC shows $1.1 billion, totaling $1.2 billion. After factoring in taxes as a full taxpayer, that could be around a negative $800 million. Then being a full cash taxpayer might add another $700 million, bringing it to about $1.5 billion. Losing CAF II accounts for roughly another $100 million, reaching a total of roughly $1.6 billion. On the debt side, with $10 billion in cash at 5% interest, after taxes, that would save around $350 million, so it appears to be negative about $1.25 billion on a pro forma basis. Are there additional factors we should consider, Neel, as we model what 2023 will look like for Lumen under these conditions?

Yes. On your first question, I would say it's EBITDA on a stand-alone basis. So, it's really a direct cost to run the business. And then there's the NSA MSA netting out of that. So, at a high level, our 2020 EBITDA, like I mentioned, was $1.4 billion, that will be the impact to Lumen going forward. So that's the simple way of thinking about it. And in terms of the math that you're doing. Yes, those are the numbers that we provided. Obviously, like I mentioned a couple of times before, you have to make some assumptions in terms of the capitalization of the company going forward. And keep in mind, there's also CapEx for CAF II that's going to fall off. So, over the last 3 years or so, we've been averaging $300 million or so. So that will fall off as well. Now we're ramping up other investments, but that's another data point to keep in mind.

Our next question is from Nick Del Deo with MoffettNathanson.

First, a quick question for Neel. Do the revenue EBITDA and CapEx metrics you mentioned for the divested ILEC assets include or exclude CAF II? You indicated they were for 2020, so I'm curious if those are expected to decrease further in 2021.

Yes, those figures are from 2020 and exclude CAF II. The CAF II subsidy will be behind us by the time the deal closes.

Those are solid numbers that are not expected to decline. Regarding the buyback plan, is it wise to repurchase stock considering your leverage, which is nearly 4x if you account for CAF II, the company's growth prospects, potential cash flow impact from the deal, and upcoming cash taxes? Historically, you've managed the business and even Level 3 in a rather conservative financial manner, and it seems like there's a shift in philosophy happening.

I don't know if it's a philosophical change. We look at how do we return the best value to shareholders. And we believe that dividend is an important part of that. We believe growth is certainly an important part of that. But we also believe that there are times when it's appropriate to use a repurchase program. And our Board has decided that now is an appropriate time for us to authorize one. And then we will continue to look at the market. We'll look at our other opportunities to invest, and we'll make those decisions opportunistically.

Yes. The only thing I would add to what Jeff just said is that the key word is opportunistic. If we believe our equity is undervalued, then that represents an opportunistic investment from our perspective.

Our next question is from Ana Goshko with Bank of America.

So two questions. So first, I just wanted to clarify the planned use of proceeds, and then I had a second question on leverage. So the total sale price is $10.2 billion, $1.4 billion of that is assumed debt. I think people are assuming that's that EMBARQ fund due in 36. If you can just confirm that. But then that leaves $8.8 billion of cash proceeds, assuming that's all shielded from taxes. Is that all going to debt paydown? Or is that still TBD? Is some of that potentially earmarked for the fiber investment and/or potentially other share buyback.

So Ana, the $1.4 billion is the EMBARQ notes. And then if you think about leverage, our objective is to stay leverage-neutral. So if I look at kind of our leverage this quarter, based on LTM, we're roughly around 3.5x. If you adjust for CAF, we're probably 3.7x. So even with the deals and our investments, we expect to stay roughly in that ZIP code as we go through the investment cycle. So that's the objective.

Okay. So then you could dial up or dial down the amount of debt that you'll repay because your target really is to maintain kind of neutral leverage at this point. Is that fair?

Yes, that's right.

Your leverage target has been set at 2.75x to 3.25x. However, this target was based on a business model heavily influenced by ILEC assets, which, according to your own analysis, hold a lower value. As you transition toward a higher-valued business, should you reconsider that leverage target? Given the nature of the debt-to-value ratio, you might find it feasible to support and sustain a higher leverage level.

Yes, that's a good question, and that is why we are comfortable maintaining our leverage-neutral position over the next few years as we navigate the investment cycle. To your point, if you examine the ILEC assets we are selling, you could argue that this business would have much lower leverage without an investment commitment or profile. Thus, we could have made a case for paying down significantly less debt with that transaction. However, we are choosing to stay where we are and are comfortable with that as we progress through the investment cycle.

Have you discussed any of this with the rating agencies yet? They might consider this in their ratings, potentially viewing it as neutral to higher leverage. Do you think the rating will be favorable with the separation of the ILEC assets?

Yes. We just closed the transaction today. We have had some discussions with them, and we will ensure that we continue those conversations.

And with that, our last question is from James Ratcliffe with Evercore ISI.

Just following up on the topic of deleveraging to ensure I understand your perspective. The transaction should clearly lead to deleveraging. Based on the numbers you've shared, you're losing $1.7 billion in EBITDA while reducing net debt by around $10 billion. Are you suggesting that the investments will significantly boost ongoing EBITDA or that free cash flow might turn negative? I'm trying to grasp how this isn't viewed as a deleveraging transaction. Additionally, do you have any insights on potential legislation regarding digital discrimination and its impact on your ability to efficiently deploy fiber within the remaining outlet footprint?

I’ll take the first part of your question, and Jeff can address the second part. Our leverage-neutral comment is straightforward, so don’t read too much into it. We’re not providing forward-looking guidance on EBITDA or cash flow. What we mean is that as we go through the investment cycle, we’ll aim to maintain a leverage-neutral net debt to EBITDA ratio after the deal closes. This is based on factors such as the organic performance of the business and deal proceeds. Currently, we are at 3.5 times; when adjusting for CAF, we’re at 3.7 times. Going forward, we expect to manage to a similar range as we navigate the investment cycle.

Regarding digital discrimination, I can say that while I represent Lumen, Apollo is also investing in 20 states to enhance fiber access and broadband services in those regions. Lumen is pursuing similar initiatives by investing in fiber and aiming to increase broadband penetration for our customers with high-speed services. This aligns with our investment strategy and our commitment to benefiting the communities we serve. We will collaborate with government entities to participate in programs addressing the digital divide. In our remaining areas, about 70% are urban or suburban, which presents a significant opportunity, especially with a high percentage of multiple dwelling units. This enables us to reach a broad customer base with broadband services. Thank you for your questions, and I appreciate your participation in this call on short notice. We are excited about the two transactions announced, as they are transforming our company profile. Our focus on investment and rationalizing our portfolio at 5.5x for the ILEC business and adjusted EBITDA for the LATAM business demonstrates our belief in the value of our remaining operations. We are satisfied with these valuations, which also drive investment and operational concentration in the business. With a strong balance sheet, we continue to foster growth and provide cash returns to shareholders through dividends and share buybacks. I am very pleased with the transformation we have accomplished over the last few years and look forward to the growth opportunities ahead. Thank you once again for joining this call, and we greatly appreciate it. Operator, that concludes the call.

Thank you. We would like to thank everyone for your participation and for using Lumen Technologies' service today. This does conclude the conference call. We ask that you please disconnect your lines. Have a great day, everyone.