Telefonica, S.A. (NYSE:TEF)
Q2 2014 Earnings Conference Call
July 31, 2014 8:00 AM ET
Executives
Pablo Eguirón – Head, IR
Ángel Vilá – CFO and Corporate Development Officer
Analysts
Georgios Ierodiaconou – Citi
Giovanni Montalti – UBS
Akhil Dattani – JP Morgan
Paul Marsch – Berenberg Bank
Justin Funnell – Credit Suisse
Luis Prota – Morgan Stanley
Fabián Lares – JB Capital Markets
David Wright – Bank of America
Jean-Francois Paren – Credit Agricole
Jerry Dellis – Jefferies
Nick Brown – Goldman Sachs
Keval Khiroya – Deutsche Bank
Operator
Good day, ladies and gentlemen. Thank you for standing by and welcome to Telefonica’s January to June 2014 Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a reminder, today’s conference is being recorded.
I would now like to turn the call over to Mr. Pablo Eguirón, Head of Investor Relations. Please go ahead, sir.
Pablo Eguirón
Good afternoon, and welcome to Telefonica’s conference call to discuss January-June 2014 results. I’m Pablo Eguirón, Head of Investor Relations.
And before proceeding, let me mention that this document contains financial information that has been prepared under International Financial Reporting Standards. This financial information is valid [ph]. This presentation may contain announcements that constitute forward-looking statements, which are not guarantees of future performance and involve risk and uncertainties. Certain results may differ materially from those in the forward-looking statements as a result of various factors. We invite you to read the complete disclaimer included in the first page of the presentation, which you will find in our website.
We encourage you to review our publicly available disclosure documents filed with the relevant securities market regulators. If you don’t have a copy of the relevant press releases and the slides, contact Telefonica’s Investor Relations team in Madrid by dialing the following telephone number, 3(491)-482-8700.
Now, let me turn the call over to our Chief Financial and Corporate Development Officer, Mr. Ángel Vilá, who will be leading this conference call.
Ángel Vilá
Thank you, Pablo. Good afternoon, and welcome to Telefonica’s first half 2014 results conference call. Today with me is Jose Maria Alvarez-Pallete, Chief Operating Officer. So during the Q&A session, you will have the opportunity to address to us any questions you may have.
Telefonica has released today a strong set of results based on the execution of the management priorities established for the year. First, the quarter evidenced a pickup in commercial activity with remarkable momentum in net add, especially Pay TV, mobile contract, smartphones and fiber. We are working on expanding customer value by reducing churn and improving ARPU.
Second, top line grew year-on-year for the fifth consecutive quarter boosted by Telefonica’s Hispanoamerica growing at double-digit and mobile data ongoing expansion.
Third, OIBDA was stable year-on-year. Financing increased their force in commercial expenses with cost savings from efficiencies. As such, OIBDA margins posted a limited decline year-on-year in organic terms both in the semester and in the quarter.
Fourth, spending for network differentiation continues to accelerate. If financial flexibility was sustained benefiting from a strong free cash flow of EUR1.7 billion in the six months to June while net debt stood at EUR43 million after the sale of Ireland closed in July.
Fifth, EPS posted an outstanding sequential improvement, EUR2.26 per share in Q2.
And finally, let me remark that these results are fully aligned with our expectations and therefore our guidance and dividend policy are confirmed.
Let me now start with a summary of key financials on Slide 3.
Reported first half evolution was impacted by negative FX and the deconsolidation of Telefonica Czech Republic. Although in Q2, both impacts slowed down slightly. The first factor, FX, is at 7.9 percentage points in the semester and 10 percentage points in the second quarter to revenue and OIBDA variation. But at the same time, reduced the payments in euros of CapEx, interest, taxes and minorities; therefore, the FX impact on OIBDA is virtually neutralized at free cash flow level.
In organic terms, second quarter revenues posted a consistent performance versus the first quarter, growing 1.3% year-on-year to reach EUR25 billion in the first half, while OIBDA topped [ph] EUR8.1 billion and remained flat. OIBDA margins stood at 32.3%, 50 basis points lower than in the first six months of 2013.
Lastly, net debt stood at EUR43.8 billion at the end of June, EUR6 billion lower than last year’s figure.
On Slide 4, I would like to stress that commercial activity ramped up showing very strong volumes. This way, total net add exceeded EUR2.6 million, growing 40% quarter-on-quarter and posting a better trend in most categories, but especially in high value services such as mobile contract, Pay TV and fiber.
We continue to focus on value and growth levers, as I just said, increasing customer loyalty on the back of customer differential propositions. This strategy translated into a sequential improvement of churn levels across the board.
Slide 5 shows the remarkable growth of future key drivers, highlighting Pay TV momentum up 32% year-on-year. Connected fiber accesses double year-on-year and LTE coverage in Europe reached almost 50% of the population. Smartphone traction continues and penetration expanded 8 percentage points year-on-year to 32%. As such, the strong investments in customer expansion enable to improve customer satisfaction and differentiation, setting the stage for further sustainable growth.
Best in class portfolio diversification by geographies and services underpinned organic revenue growth as shown in Slide #6. In first half of 2014, Telefonica’s Hispanoamerica and Telefonica Brazil remained as key growth areas, more than offsetting the wholesales by some of our European businesses.
Let me also highlight mobile data revenues which accelerated revenue growth in Q2 to 9.2% year-on-year and increased the weight of our mobile service revenues to 40% which is 3 percentage points up year-on-year.
Revenue flow coupled with good progress on cost-efficiencies allowed the cumulative for EBITDA to remain flat year-on-year organically. Margin declined 50 basis points year-on-year in the first six months and 60 basis points in the second quarter, reflecting higher customer investments linked to capture future growth.
In Slide #7, free cash flow generation was robust in the six months to June, reaching EUR1.7 billion or exceeding EUR1.8 billion before spectrum payments. I would like to highlight the 14.7% year-on-year growth in free cash flow, levered on improvements in most categories of free cash flow metrics.
Despite adverse FX effects, CapEx increased on assets sold.
Let me remind you that the first half of the year is traditionally impacted by seasonal effects. Therefore, free cash flow should record a better performance in the second half.
We continue to invest strongly to improve quality and capacity and foster growth, as shown on Slide 8. On network, we keep on accelerating use of broadband deployments in order to meet steady increases. 4G is increasingly available for customers in key markets.
With recent new launch in [indiscernible] on fiber, we have doubled the size of the network, having impact [ph] more than 10 million premises. We are exploiting technology to provide the best data experience, combined with multiple initiatives which are leveraged on our scaling. One example is the global management of roaming traffic already in place in our major markets.
IT is helping businesses transformation according to common principles, such as standardization, modernization, reutilization and automatization. We give you some examples. We launched more business support projects across Telefonica’s Hispanoamerica and we are strengthening our digital capabilities for marketing and self-care.
Finally, efforts on simplification and consolidation continue. With more than 6% of physical servers review, over 160 applications decommissioned, three additional data centers closed and sustained progress progression on virtualization.
Turning to Slide #9, let me go through the main progresses achieved in the digital arena. In the B2B area, solid year-on-year growth rates are shown in different services. Machine to Machine is growing by more than 50% on solid access trends and key deals signed in the first half. Cloud revenue was up 20%. And information security surpassed 40% increase. With relevant agreements reached this quarter such as the one with Etisalat.
Regarding the consumer segment, video stood as one of the key drivers. With revenues accelerating above 15% year-on-year, as we continue to focus on reinforcing our position with exclusive content acquisition.
The global device management is driving the smartphone adoption with special focus on LTE as the total volume of LTE increased eightfold year-on-year.
Finally in financial services I would like to highlight the launch of Yaap Shopping in Spain allowing customers some stores to be connected to discount offers and loyalty program.
Let me now update you on the progress of our business in Spain, which is showing signs of recovery driven by an intense commercial performance.
Our new quadruple play offer leveraged on our superior TV and fiber is a game changer in the Spanish marketplace as shown by outstanding Q2 net adds pushed by higher growth adds and especially by churn reduction across services.
Churn reduction of the new conversion offer allowed us to reach 1.2 million TV customers and 0.9 million fiber accesses in June paving the way to build the leading platform for content delivery at home. We have also repositioned 0.7 million Fusion customers in the quarter which implies resetting the 12-month commitment with the service.
While in the mobile business, improved portability trends, net contract mobile net adds to turn positive for the first time since Q2 2011.
Fusion is not only helping to gain commercial momentum and extend the lifetime of our customers by dramatically reducing churn, but it is also enhancing the value of the base by accelerating the take up of high value services as reflected by that close to 80% of new customers are opting for high packages in Q2.
This commercial performance is leveraged on a strong network differentiation. And we keep investing to large discount. We have already passed 7 million premises after increasing by 1.3 million, the premises covered in just one quarter.
Spain’s financial performance is shown on Slide 11, the progress in recent quarters, which allows us to think that revenues have already reached the bottom. This improvement has been driven by lower reprising impact and progressive stabilization of the customer base.
So the improved commercial performance that we are already noticing should lead revenues to gradually improve year-on-year trends and to grow again in the coming quarters. In terms of profitability, OIBDA margin declined in the quarter reflected the strong commercial effort devoted to anticipate revenue recovery by capturing the value we see in a market that is finally showing a clear macro turnaround.]
Please turn to Slide 12 for a review of our operation in U.K. From a trading standpoint, commercial momentum picked up in the second quarter and as part of this, our contract churn improved to record 1% extending the market leading loyalty.
O2 Refresh continues to be a successful proposition together with the prerogative upgrade of high value customers to LTE, resulting a contract segment increase of mid single-digit.
Top line returned to growth in the second quarter despite the negative contribution of Refresh following its anniversary in April 14 and the disposal of six business assets. The sequential improvement of revenue trends is the result of non-SMS data revenue acceleration to almost 20% year-on-year.
Lastly, improving business dynamics translated into a stable OIBDA and margin in Q2 when excluding non-recurrent effect.
In Germany, commercial dynamics reflect the strong direction of new propositions with both gross adds and contract churn improving their trend. As a result, contract net adds more than doubled the average of the last four quarters. Additionally, we continue to focus on LTE deployment reaching a coverage of 52% at the end of June.
LTE consolidated as the main driver of mobile data monetization in a very competitive market with 86% of handsets sold in Q2 versus 40% a year earlier. In this context, mobile service revenue showed a better year-on-year trend in the second quarter, down only by 2.5% when excluding MTRs on lower ARPU dilution.
Q2 OIBDA margin was 2.7 percentage points lower year-on-year following the increased commercial investment enhanced trading momentum.
Finally, I would like to remind that we have overcome an important milestone in the acquisition of E-Plus with the easy conditional approval on July 2nd.
In Brazil, turning to Slide 14, our leadership position in network quality and brand perception gave a strong performance in the most valuable segments of the mobile business. As such, for four quarters in a row, we captured more than 60% of the contract net additions, while smartphone penetration almost doubled year-on-year to 32%. As a result, we have expanded our contract market share by 3.4 percentage points year-on-year to 41.3%.
In the fixed business, the execution of our turnaround strategy continues on track, with second quarter net adds of fixed services accelerating. On top of that, fiber optic spans out after connecting 37,000 households on accelerated fiber deployment that already reached 2.9 million premises passed. This operational performance resulted in an improved revenue and OIBDA trend as Slide #15 shows.
Service revenue growth accelerated year-on-year despite the increased negative regulatory effect this quarter. As such, service revenue would be growing about 6% when regulation is excluded. Also excluding regulatory impacts, mobile service revenue ramped up to 11% in Q2 year-on-year on strong mobile data growth which grew once again 40% year-on-year.
Fixed revenue slightly accelerated on lower working days due to the Football World Cup. At the same time, OIBDA reverted the trend of last quarter’s growing 4% year-on-year in Q2 on revenue improvement and on a strict cost discipline, offsetting higher commercial costs incurred to keep improving our market position.
Turning to Slide #16, in Telefonica Hispanoamerica, we kept posting a strong revenue and OIBDA growth. As such, excluding regulation, second quarter revenues grew by 13% year-on-year or 12% when excluding Venezuela, with a solid performance across the board.
This evolution is underpinned by the growing uptick of non-SMS mobile data posting an increase of 41.5% year-on-year in Q2 along with the higher penetration of fixed broadband and new services above 18% this quarter.
At the same time, let me remark that this revenue performance is steadily flowing into OIBDA offsetting higher commercial and network expenses. All countries in the region with exception of Uruguay are growing OIBDA year-on-year which keeps accelerating and growing double-digit even after excluding Venezuela.
On a per country review, let’s move to Slide #17. In Colombia, solid revenue and OIBDA year-on-year growth remained in Q2 underpinned by structural changes implemented by the regulator one year ago.
In Argentina, revenue and OIBDA were both growing above 20% versus Q2 ‘13. With year-on-year erosion in profitability reflecting currency depreciation and inflation driven costs.
In Chile, revenue and OIBDA performance have been highly impacted by the new regulatory framework for mobile and fix termination rates. Nevertheless, let me highlight the strong year-on-year increase in OIBDA margin on better commercial comps and despite strong trading in most valuable segments.
To continue with Latin America overview on page 18, in Peru, revenue and OIBDA reached double-digit growth fix regulation, and the low Smartphone penetration provides a huge opportunity onward to an already strong mobile data growth.
Mexico posted once again this quarter an accelerated trend on mobile service revenue, increasing by almost 8% year-on-year, while profitability improved despite strong trading momentum. Let me also highlight, the new regulatory framework will be effective from mid August, providing additional growth opportunities in a more dynamic and competitive telecom sector.
In Venezuela and Central America, revenue was severely impacted by lower handset sales. But mobile sale revenue kept increasing at a strong rate of about 30% year-on-year. Especially not worthy is the leading non-SMS growth in the region on a right monetization strategy.
Let me now move to the financial side on slide 19. Net debt has been reduced to the absolute level of EUR43 billion. The balance between free cash flow and dividends have allowed divestment proceeds for EUR3.1 billion to fully flowing to lower debt [ph].
Despite stable OIBDA in organic terms, lower reported OIBDA due to LatAm currency depreciation on divestments, has pushed up the leverage ratio in the year. To offset this effect, we are putting together measures to reduce leverage. Among others the voluntary skip dividend in November, the recent mandatory exchange on voluntary shares or the expected mandatory convertible link to the Plaza deletion [ph].
Slide 20, shows the ongoing diversification in our funding process while keeping a high liquidity caution. In the last quarter we raised EUR1.25 billion through a mid year bond [ph] yielding 2.24%. We have launched private placement bonds for EUR0.7 billion [ph] with three years of average maturity and 67 basis points as average spread to repay more expensive debt with similar maturity. And we have also being granted bonk [ph] loans at similar spread.
We keep a liquidity caution of EUR22.2 billion. Even after the E-Plus acquisition, an early debt repayment for EUR2.2 billion, we will still keep outstanding liquidity levels while controlling financial cost.
Effective interest cost to stay similar to our previous quarter in the middle of the target range. Despite the increase on average cost of debt driven by the reduction of debt held mainly in Euros and Corticorona [ph] with lower cost on average. And second, by keeping ahead in [ph] strategy in LatAm currencies with higher cost.
To conclude, let me highlight that we have made further progress in our transformation strategy. First, we are accelerating commercial momentum with increased customer appetite for value and quality, translating into lower turn levels.
Second, commercial action and investments led to positive organic growth for the last five quarters with improved trends quarter on quarter in Brazil, UK and Germany, while outstanding commercial trading in Spain anticipates revenue recovery in next quarters.
Third, level [ph] OIBDA performance year-on-year, organic and healthy margin of 32.3% in the first half – sorry, third, level [ph] OIBDA performance year-on-year, organic and healthy margin of 32.3% in the first half. The year-on-year erosion resulted from higher net debts in Q2 and focused investments to expand 4G coverage and fiber.
And finally, in the first half of the year, we posted a strong cash generation while our financial flexibility sustain.
Thank you very much for your attention. And now we are ready to take your questions.
Question-and-Answer Session
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