Source: Seeking Alpha
Vodafone Group (NASDAQ:VOD)
Q1 2015 Earnings Conference Call
July 25, 2014 4:30 a.m. ET
Vittorio Colao – Chief Executive
Nick Read – Chief Financial Officer
Steve Pusey – Chief Technology Officer
Philipp Humm – Regional CEO Europe
Akhil Dattani – JPMorgan
Tim Boddy – Goldman Sachs
Nick Delfas – Redburn Partners
Justin Funnell – Credit Suisse
James Ratzer – New Street Research
David Wright – Bank of America
James Britton – Nomura
Simon Weeden – Citigroup
Robert Grindle – Deutsche Bank
Andrew Beale – Arete Research
Jerry Dellis – Jefferies
Lawrence Sugarman – UBS
Adam Rumley – HSBC
Paul Marsch – Berenberg Bank
Ottavio Adorisio – Societe Generale
John Karidis – Oriel Securities
Welcome to the Vodafone Group analyst and investor conference call. Your host today is Vittorio Colao, CEO of the Vodafone Group. Please go ahead, Mr Colao.
Vittorio Colao – Chief Executive
Good morning everybody. Welcome to our interim management statement for the first quarter of ’14-’15. I will take you through the highlights and update you on our strategic and commercial developments and our views on the current regulatory environment, then Nick will update you on our financial performance and take you through the trends in our six key markets. He will also provide some country by country detail on the progress of Spring. We’ll then close and move to Q&A for which Nick and I will be joined by Philipp and Steve who are here with us.
So I will start with Slide 4: highlights for the quarter. Group organic service revenue was down 4.2% compared to 4% in the previous quarter, excluding mobile termination rates, was 2.9% in Q1. We continue to see strong growth in our emerging markets driven by continued customer growth and data usage.
Growth in AMAP was 4.7% or 6.2% excluding MTRs. This growth rate was, as expected, slightly down on the previous period due to the lapping of prior year prices rise in India and the impact of MTRs in South Africa.
In Europe, conditions remained challenging due to continued competitive and regulatory pressure. As a result, service revenue fell 7.9% year-on-year. However we are beginning to see encouraging signs of stabilization quarter on quarter due to our commercial actions on Red and 4G and investment in the network. Our actions are attracting a higher quality of customers. We now have 6.7 million customers with 4G and 14 million with Red. Our 4G and Red plans to continue to drive strong data usage. Data traffic growth accelerated to 73% year on year across the group and 53% in Europe.
Project Spring. Our Project Spring program is gaining speed. Our European 4G coverage increased that to 52%. This is up 20 percentage points since September. Our network performance is also improving. In the last nine months, we have reduced dropped calls in Europe by 1.2 million per day. In this quarter, we have made further progress also in our unified communications strategy across Europe.
Integration of Kabel Deutschland has begun and is on track. We have announced fiber alliances in Ireland and in Portugal this week, and just this week, we had also two further steps – the completion of the acquisition of Ono and the revised agreement with Orange to build fiber and give them access to 1 million homes from Ono.
Finally, we have made some smaller moves on the M&A front, including the planned purchase of Cobra, a leading machine to machine provider to enhance our capabilities in this space and we sold our business in Fiji.
Free cash outflow was £0.6 billion in the quarter. This is £1.5 billion lower than the last year due to the phasing of CapEx spend associated with Spring. Net debt at the end of the quarter was £14.1 billion.
So Nick will be talking later about the performance of each of the main countries in more detail. I would like now to give you an overview of the broader
Chart on page 5 shows revenue service growth, excluding termination rates with AMAP countries in blue and Europe countries in red. As you can see, AMAP is strong and growing with service revenue up 6.2 points. Our high quality network and customer service continues to attract customers with the base up 10% in the year driving usage.
The number of data users increased by 31% to over 100 million and data traffic more than doubled. Also, not on this slide, I also want to talk or check – say a word about M-Pesa. M-Pesa remains a key success story for us. The base is now 18 million, up 1 million in the quarter.
This slide also shows that revenue continues to decline 6.6 in Europe. However we are seeing some mobile ARPU stabilization, and we are also delivering better churn rates in consumer contract around 1 percentage point better year on year. What this slide does not show is that we are seeing quarter on quarter stabilization in absolute revenue in a number of key markets in Europe such as Italy and Germany.
I’d like now to turn to progress against several key initiatives, Spring, 4G and unified communications in that order. So Slide 6, we have made a good progress on our Project Spring program and in overall terms we are around A quarter of the way through the program.
Within the 6000 new 4G base stations, 4700 were in Europe in the period. Therefore our European 4G coverage increased to 52% as I mentioned a while ago, compared to 46% last quarter and 32% when we started the program. So we are well on our way to our 91% target by March 2016.
In India, where we aim to have 95% 3G outdoor coverage in targeted urban areas over the next three years, we have taken the 3G coverage on this footprint to 89% with around 2300 sites added in the quarter. In South Africa, we added around 470 4G sites and 290 3G sites in the last three months only. 75% of our sites in South Africa are now connected to high-capacity backhaul and we expect to complete our radio access network renewal program in the next quarter.
We continue to build a more robust network with more single RAN and high-capacity backhaul. Today in Europe, 72% of our sites have high-capacity backhaul and 22% have fiber. Single RAN is in 68% of our sites and finally in terms of fiber to the home we have increased these by 1 million household passed since last September.
So we are now on Slide 7: 4G. We have put together a number of charts here showing clear evidence of good progress. Starting from the top left, we have increased our 4G customer base – the red bars – to around 7 million as I said earlier. These are active customers with both 4G device and a 4G plan. The opportunity to upsell is clear as 7 million out of 15 million who have a device do not have a 4G plan yet.
You will see within the trend that the proportion of those who have a device that also have a plan is increasing as well to 49% compared to 36% in Q3 last year.
Moving to top right, we are delivering a better network experience. As I said our 4G network now covers 52% of the population. We are supporting the 4G rollout with the targeted local communications strategy focusing on network benefits and differentiation rather than price.
Bottom left, we see that the trend to use more data continues. Data usage in Europe is not just growing, it is also accelerating with growth of 42% last quarter and 53% in this quarter. This growth is evident in all of our main markets in Europe. This traffic is driven by more smartphones where penetration of the base increased 7 percentage points now at 47% in Europe. As half of the base still don’t have a smartphone, there is clearly a lot of growth left.
Now there is also more usage for smartphone as it is now 530 MB in Europe, this is up 100 MB on the level of just six months ago. Also 4G usage is still around twice the level of 3G in some countries where we have attractive content such as UK, the ratio becomes three times. As a result of this strong demand 4G now accounts to 19% of data traffic on our European network, up one percentage point on Q4. This is why we’re pushing content combined with 4G.
We have now launched content in eighth markets, seven in Europe. We aim for the most relevant partners in each market. During the quarter we added a full content bundle of music and theme in Spain from Canal+ and Napster as a part of the Red tariff plan. In Italy we launched music and video services with Infinity and Spotify and in UK we launched Netflix on the July 1 for Red customers, adding this to the existing content choices that you are aware of, of Spotify and Sky Sports. We aim to add more content this in more markets over the coming weeks and months.
So further add [ph] on the strategy unified communications, this is page 8. This is an area where we have made significant progress during the quarter. Taking the right hand side of the slide first, we continue with the momentum on fixed broadband net adds with some 119,000 across the group of which 170,000 were in Europe. This represents the third consecutive quarter of strong growth. We now have 9.4 million fixed broadband users, including 2.3 from KDG.
Our total customer base increases to around 11 million after the acquisition of Ono. Vodafone today is one of the largest providers of fixed broadband services in Europe. Fixed now represents 23% of service revenues and 24% of enterprise revenue. Fixed revenue continues to be under pressure due to price competition in many markets but we are seeing overall revenue growth.
Now looking at the progress in deploying the services in the various markets. In Germany, the integration of KDG is now underway creating a fully integrated operator covering 12 million homes of 29% of the population. And in addition, we have also the attractive wholesale offer from DT which covers 40% of the population. In May, we commenced the cross-selling of services around 600 Vodafone stores and 200 KDG stores under a giant Zuhause brand.
Italy. In Italy, our self-built fiber rollout is progressing and we expect to reach our 6.4 million target by 2016 and this components a wholesale deal with incumbent which has an addressable base of 2.2 million. The recent Ono acquisition will allow us to establish a strong platform in Spain as that asset already covers 41% of the householders. And as mentioned, we have agreed to new terms with Orange to target 2 million homes in total while providing Orange with a wholesale access to 1 million home passed by Ono.
You may be aware that we also announced a couple of weeks ago a joint fiber deployment plans in Ireland and in Portugal we have a great a reciprocal deal with incumbent [covering 900,000 homes from December ‘14, 450,000 each. This further accelerated our build programs and so in Portugal now we are targeting 2 million homes passed compared to the original target of 1.5 million with Spring.
With all these agreements and our self-built programs we are now creating, as we declared in our strategy, a strong position across Europe. Looking at the left-hand side, which shows our coverage today, we already have NGN access to potentially around 40 million homes in Europe. Going forward our self-built plans will increase the number of homes passed by further 5 million over the next couple of years.
And then on Slide 9, my views on the regulatory environment in Europe. As I said that six months ago, the situation is improving or did [ph] not as much as it would be possible and in my view desirable. Consolidation is indeed happening as we see in Germany and in Ireland. I would say that the remedies imposed on non-infrastructure-based operators are a little bit inconsistent with the need to invest in coverage and services in Europe. But consolidation is anyhow a good thing.
Roaming regulation will need to be detailed. For Vodafone, this is less and less of an issue, as we succeed with our take your home tariff abroad option. We have today 15 — more than 15 million users of this service and we just extended it beyond Europe to a number of countries, including very importantly the US, India, Australia and New Zealand.
So my priorities for the year continue in the regulatory area, continue to be implementation of harmonized spectrum rules, net neutrality regulation and then roaming and the connected continent implementation.
In summary, again regulations in Europe is moving in the right direction. It could be a little bit more decisive in supporting our sector’s recovery.
Nick, I would turn to you for other details.
Nick Read – Chief Financial Officer
Thank you, Vittorio. Good morning everybody. I will start on Slide 11 by giving you an overview of the group performance. But before getting into the detail, I’d like to point out that the slide includes Italy at a 100% for all periods, which is a statutory basis moving forward.
I’d also like to add that we’ve included Cable & Wireless in Q1 of this year but not restated Q4 in the organic growth rate. If we were to restate Q4 to include Cable & Wireless, the group service revenue growth add would be down 4.1% and Europe down 8.4%.
Group service revenue in the quarter was £9.4 billion which was down 4.2% year on year. If you remove the mobile termination rate impact, it was down 2.9% which is stable on Q4 performance.
In Europe, service revenue declined by 7.9% reflecting continued competitive and regulatory pressures. However we are seeing evidence of commercial execution in a number of markets, particularly in terms of stabilizing ARPU and improving in churn rates for consumer contracts. The momentum in mobile contract and fixed customer additions in the second half of last year has continued into Q1.
AMAP continues to grow strongly at 4.7% driven by good customer growth and strong data usage with active data customers up 31%. The pace of growth slowed as expected due to lapping of price increases in India and the 50% MTR cuts in South Africa.
Turning to revenue by service. Mobile in-bundle revenue increased 4.7%. This growth was driven by our Vodafone Red plans which are now used by 14.3 million customers, up 2.3 million in the quarter. We now have 61% of European mobile revenue in-bundle, a rise of 5 percentage points year on year.
Enterprise service revenue fell 2.9% which reflects ongoing ARPU pressure in domestic segments. However Vodafone global enterprise revenue increased by approximately 2%, machine to machine up 31%. These two areas represent around a quarter of enterprise revenue.
Fixed service revenue increased 0.1% following a 1.8% decline in Q4, reflecting the strong broadband net adds in the second half of last year and continued growth in Q1. Other service revenue continues to be impacted by the conclusion of several MVNO deals.
CapEx was £1.9 billion in the quarter which is around 850 million, ahead of last year’s spend due to accelerated network deployment as part of project Spring. This takes the ratio of CapEx to sales to 18% compared to 11% a year ago.
We had a free cash outflow of 0.6 billion in the quarter compared to a 0.9 billion inflow last year. The movement mainly reflects the significant increase in CapEx in the quarter along with the start of the project Spring CapEx ramp-up in Q4 last year, which affected working capital this quarter.
Net debt at the end of the quarter was 14.1 billion, an increase of 400 million from March. I know that some of you include the $5 billion worth of Verizon loan notes in your net debt calculation. So on this basis net debt would be £11 billion. Net debt will be 5.7 billion higher after the Ono transaction completes at the end of this month.
Before I move on to the country detail, it is worth adding that our view on the EBITDA outlook remains unchanged. We expect the organic decline excluding KDG and Ono in half one of this year would be quite sharp, reflecting the year-on-year revenue performance, Project Spring OpEx and the continued higher commercial costs as seen in half 2 last year. However in half 2 this year, we will be lapping the increase in commercial spend and should be seeing an improving revenue trend helping to drive a smaller decline in organic EBITDA year-on-year.
Let me now turn to the individual key countries in order of size. Moving on to page 12, Vittorio has already taken you through the high level picture on Spring. We gave a commitment to provide details of our progress in each of our main markets and this is the first time the KPIs are included. I will limit my comments on Spring progress on each market, as I think the data speaks for itself. Bottom line, deployment progresses at pace.
Turning to Germany, service revenue declined 4.9%, which is a 1 percentage improvement on Q4. This reflects a stabilization of contract ARPU quarter-on-quarter, which can be seen in the bottom right table. We continue to see growth in the contract customer base, albeit slightly down on the strong performance in the second half of last year. The reported number you will see is broadly flat, but this was due to a non-revenue impact in base clean-up of 61,000. So the underlying growth was 65,000.
In the consumer prepaid and enterprise segments, we continue to see significant pressure from price competition creating continued downward pressure on ARPU. However our operational performance continues to improve on many fronts. We now have 3.4 million customers using our Vodafone Red plans, up 2 million over the year, and 1.5 million 4G customers demonstrating an improvement in the quality of our customer base.
We made significant further improvements to our voice and data networks to close the gap to our main competitor. We added nearly 500 4G sites to increase 4G coverage to 70% and 1500 2G and 3G site were modernized with new equipment and single RAN technology. As a result dropped call rates improved by 19% year-on-year. We expect to close the performance gap further over the coming months.
KDG, which reports in a couple of weeks, pre-released some keen figures today which show continued growth. Revenue grew 5.8% compared to Q4 plus 3%, and net broadband additions of around 83,000 was similar to the prior quarter.
As you know we commenced the integration program in April and we’re on track with our plans. We commenced cross selling as of May and this is taking place in 600 Vodafone stores which is about half and 200 KD stores which is about 90% of the footprint.
Finally, we have strengthened the management team through the integration of KDG with the appointment of Andreas and Manuel in the Vodafone Finance Director and fixed director roles respectively.
Turning to the U.K. on slide 13, here the basis of reporting has changed, as the U.K. now includes the U.K specific operations of cable and wireless in the organic calculations for the first time. This had a 2.6 percentage point impact on growth in Q1. We have restated growth for prior periods to help you understand the trends. On this basis service revenue was down 3.2% compared to 4% in Q4.
Taking the mobile business first, mobile service revenue declined by 0.6% compared to a decline of 3.8% in Q4. The improved trend reflects the combination of a 2 percentage point benefit from the MTR unwind and a 1 percentage point underlying improvement in our commercial performance.
The overall consumer mobile business returned to growth in the quarter led by a 3.8% increase in consumer contract revenue with continued good traction of 4G bundled with content and packages which is helping stabilize ARPU. The rollout of 4G services continued achieving 40% population coverage and hitting the 1 million customer mark last week. We continue to enhance our content offering adding Netflix from the 1st of July.
Although not on this slide, we did see a slowdown in contract net adds which mainly reflected the ongoing decline in the handset market in favour of SIM only and some evidence of postponed purchases ahead of the iPhone 6 release later this year. In addition we continue to see revenue declines in enterprise and consumer prepaid due to competitive price pressure. In the fixed based service revenue declined 10% due to price pressure and a cut in fixed termination rates. Excluding this latter point the underlying fixed service revenue fell 7.4%.
The integration of Cable & Wireless continues to proceed in line with their overall business plan as we drive the network and business integration. We are also encouraged by a fixed sales pipeline. We are making good progress on new store openings reaching 15 by the end of the quarter, also the 150 target. And as you can see on the right hand side of the page, we have focussed on the expansion of our 4G coverage and within London our dropped call rate improved to 0.86% from 0.97% in Q4. However clearly we have more to do.
Moving to Italy on page 14, the market remains extremely competitive as we continue to suffer from the low level of prices following last summers’ price war with a number of operators still discounting the headline prices to attract new customers. As a result our consumer ARPU and customer base trends remain under pressure. However there were headline price increases by most players over February-March and we have also put through some further increases in June. However the two smaller operators remain aggressive. These higher prices have helped deliver a 2 percentage point improvement in revenue trends quarter-on-quarter.
The momentum in the enterprise segment remains positive. We continue growth in customers to 25,000 and a 7 percentage point improvement in churn compared to last year. Fixed line revenue grew 1.5%, as the broadband customer base increased by further 25,000 to 1.8 million. We now offer fibre services through wholesale agreements in 55 cities and we are progressing well on our own fibre build, remaining on track to pass 6.4 million homes over the next two years.
Moving to India on page 15, service revenue increased 10.3%, driven by continued customer growth, higher data usage and improved voice pricing. However the pace of growth slowed compared to Q4, which was expected and reflected the lapping of last year’s voice price increases. Mobile customers increased by 3.3 million during the quarter, giving a closing customer base of 170 million. Data usage grew 102% during the quarter, split 3G growing 185%, 2G growing 67%, primarily driven by 28% increase in active data users and a 46% increase in data usage per customer. We now have 57 million data customers including 10 million 3G customers, with over 29 million smartphone users, representing a 17% penetration of the total customer base. Data now accounts for 11% of service revenue compared to 7% a year ago.
Turning to India’s Spring program, we’ve deployed nearly 2000 new 3G sites. We remain optimistic about 3G in India as we continue to expand the network and leverage the benefits of 3G roaming which was permitted earlier this year. In addition we are well on the way to open 150 Vodafone branded large format stores focussed in the urban areas to provide a higher level of service to small businesses and consumers.
We continue to expand our M-Pesa service in India, where we now have 66,000 sales agents nationwide and 1.5 million registered users, of which around 300,000 are active. While the timing is still being confirmed, it’s worth noting that we anticipate another spectrum auction later this fiscal year.
Moving to page 16, Vodacom’s organic service revenue was flat in Q1. In South Africa, organic service revenue decreased by 2%. This was driven by 50% cuts in MTRs which led to a 4 percentage point negative impact on growth. In addition price competition in the prepaid segment in South Africa has intensified significantly with effective prices down 25% year-on-year in Q1. However we have responded well with targeted promotions, regional offers and dynamic discounting based on successful much more for more design principles. We also continue to deliver strong in data revenues of 18.5%, driven by the penetration of smartphones and tablets which increased 19% to 8 million devices and the expansion of air coverage with 4G to 58% population coverage and 3G to 96%.
Vodacom’s mobile operations outside South Africa delivered service revenue growth of 8.4%, mainly driven by customer growth. This was down from around 15% in Q4 due to pricing pressure mainly in Tanzania and the DRC. M-Pesa continued to perform well across all of Vodacom’s international operations with over 4.8 million customers actively using the service. In Tanzania alone the service now accounts for 21% of revenue and around half its customers use it.
Last but not least, Spain on page 17. This is a market where the triple pressures of economic weakness, MTR cuts and significant price discounts for converged services have combined to reduce service revenues by 15.3% year-on-year. Although not on this slide, the revenue trend in mobile deteriorated with service revenue falling by 17.6% versus 14.4% in the prior quarter. As we responded to competitive pricing and the mobile only market shifted towards SIM only and mid tier handsets.
However many areas of our commercial performance continue to improve. We delivered a 3.7 percentage point reduction in contract churn and we have seen continued take-up of Vodafone Red and 4G with 1.5 million and 1 million customers respectively. In contrast to mobile, our fixed business continues to show strong momentum with revenue growth remaining positive at 7.3% year-over-year, as we added 48,000 new customers during the quarter. At the end of June we had 0.6 million homes covered by our joint fibre network and as of last week this was 0.8 million. The completion of the Ono transaction will significantly strengthen our competitive position in the market with cross selling due to start from Q3. On our report in early August, at this stage performance is in line with our business plan.
Looking out to Q2, headline revenue growth will benefit from a 4.5 percentage point improvement from the MTR unwind, and on that I will now hand back to Vittorio to summarize.
Vittorio Colao – Chief Executive
Thank you, I’m on the last page, so key points, performance in Europe stabilizing quarter-on-quarter in several markets. Strong customer growth and data take-up in emerging market continues. We are pleased with the progress on unified communication strategy. Progressing NGN plans in Germany; that is Spain, Ireland, Portugal, as I mentioned earlier. KDG and cable and wireless integration on track. Ono just completed, so we’ll start integration now. Project Spring really at good speed, about 25% completed thanks to the work done in the previous years on modernisation and therefore enabling the network for this new wave of investment. We maintain a strong balance sheet as Nick has indicated and we confirm the outlook for ’14-’15. I think I will now take your questions, asking Philipp Humm who runs Europe and Steve Pusey who runs technology to join us.