Telefónica, S.A.
Q2 2021 Earnings Call Transcript

Published: 1 Aug 2021

[Adrian Cincinnati:]

Good morning and welcome to Telefonica's Conference Call to discuss January to June 2021 results. I’m Adrian Cincinnati from investor relations. Before proceeding, let me mention that the financial information contained in this document has been prepared under International Financial Reporting Standards as adopted by the European Union. These financial information is unaudited. This conference call and webcast including the Q&A session, may contain forward-looking statements and information relating to the Telefonica Group. These statements may include financial or operating forecasts and estimates or statements regarding plans, objectives and expectations regarding different matters.

[Jose Maria Alvarez-Pallete:]

Thank you, Adrian. Good morning, and welcome to Telefonica's second quarter results conference call. With me today are Angel Vila, Laura Abasolo, Eduardo Navarro and Lutz Schuler, CEO of Virgin Media O2 JV. As usual, we will first walk you through the slides, and then we will be happy to take any questions you may have. The second quarter was crucial for Telefonica. We reached an inflection point in the transition to sustainable profitable growth with organic revenue up and year-on-year trends accelerating for the fourth consecutive quarter. We posted our best-ever net income after booking capital gains from the sale of Telxius Towers and the creation of the Virgin Media O2 U.K. JV. Moreover, these capital gains have translated into a more efficient capital structure. And finally, they help us reduce net financial debt by 30% year-on-year. In parallel, our more efficient capital structure was reflected with our net debt denominated in LATAM coverage is increasing to 30% versus 21% as of March. On the strategic front, we continued progressing on our objective with key transactions closing in June and July. In the U.K., one of our core markets, our position was reinforced as we created the national connectivity champion. Additionally, we continue to modulate the exposure to Hispam. The InfraCo in Chile has been completed, and we announced a new fiber vehicle in Colombia with KKR. Telefonica Tech has reinforced its capabilities in the cloud space with the acquisition of Cancom UK. and Altostratus, while accelerating year-on-year growth trends. With regards to Telefonica Infra, FiBrasil started operations in July after regulatory approvals were granted, all of this with digitalization gaining even more relevance and supporting our operating model and facilitating economic and social recovery. Finally, ESG remains an important part of our strategy.

[Angel Vila:]

Thank you, Jose Maria. On slide five, we will review the performance of our Spanish operation, which is turning around its revenues and showing annual growth for the first time since late 2019. The market rationalization that we have been promoting since Q4 2020 is bearing fruit. Following a somewhat muted commercial activity over the last quarters, all accesses showed a month-on-month recovery throughout the quarter with positive net adds in fixed broadband in June. The early ending of the football season had a negative impact on conversion ARPU.

[Laura Abasolo:]

Thank you, Angel. Let's move to slide 12. During the quarter, we continue to modulate our exposure to the Hispam region. However, accelerating growth and for the first time in 15 quarters, we posted year-on-year revenue and OIBDA growth simultaneously in reported terms in Hispam America. On the commercial side, accesses increased year-on-year for all main products. In contract, all main markets posted positive net additions while in FTTH net additions accelerating, driving a record performance for the company in Q2. In the fixed business, the new fiber vehicle announced in Colombia, together with InfraCo in Chile is a clear example of our strategy to lower capital intensity, crystallize asset value while accelerating expansion plans. On slide 13, we show how net debt has come down by EUR nine billion or 26% since December 2020, thanks to the sale of Telxius Towers and the VMed O2 U.K. JV, coupled with a strong EUR910 million free cash flow generation. Net financial debt stood at EUR23.2 billion as of June or 26.2% post estimated distribution of proceeds to Telxius minorities. Including post-closing events, net debt could be reduced to EUR25.8 billion. Net debt-to-OIBDA ratio went down to 2.57 times, that is 0.2 times below '20 ratio. Our liquidity cash amounts to EUR26.9 billion, and our average debt life has increased to 13.7 years, placing us in a very comfortable position as we have covered maturities beyond 2024. Telefonica maintains a proactive and innovative approach to financing in 2021, raising EUR5.3 billion in total, including financing and the German fiber JV and the first green bond at Virgin Media O2 JV. We are evolving our financing strategy with increased weight of debt in LATAM currencies as shown by the long-term financing rates in local currencies by our subsidiaries in Chile and Colombia. To note, Coltel signed two sustainable linked bilateral loans, being the first Telefonica Hispam company to sign sustainability-linked bilateral loans. The effective cost of interest payment over the last 12 months stood at 2.69% as of June 2021, due to debt reduction in debt-denominated European currencies and its cost. I will now hand back to Jose Maria to recap.

[Jose Maria Alvarez-Pallete:]

Thank you, Laura. To recap, first, In the second quarter, we completed two significant steps in our long-term sustainable growth strategy, the completion of the Virgin Media O2 JV in the U.K. and the sale of Telxius Towers to American Towers. Second, our top line performance returned to growth, while net income reached an all-time record level and -- with free cash flow excluding spectrum, growing by more than 30% year-on-year. Third, we continue to prioritize growth when it comes to CapEx allocation with almost 50% devoted to NGNs. Fourth, we posted a significant net debt reduction as much as 30% down year-on-year or EUR11 billion, mainly due to capital gains on the strategic transactions, which improved the capital structure of the group. Finally, we are upgrading our full year guidance to a stable -- from stable -- to stable to a slight growth at both the revenue and OIBDA level. CapEx -wise, we feel extremely comfortable by reiterating our up to 15% CapEx to sales target. Thank you very much for listening. We are now ready to take your questions.

[Operator:]

And your first question today comes from the line of David Wright from Bank of America.

[David Wright:]

Hello guys. Thank you very much for the call this morning and a lot to digest. I guess the most significant announcement is the decision to move the U.K. business from cable to fiber. I see the price upgrades you've given the GBP100 per premise versus the GBP60 DOCSIS. So can you just give us some more on your thinking? Is it the offload disadvantage ultimately that has driven the decision to choose fiber over cable? That is a very, very interesting development. I would very much welcome your thoughts. And just secondly, on to Spain. I appreciate, I think, Angel, you guided toward better ARPU dynamics in the second half. And you mentioned some dilutive effect in the Q2 number from football. If you could just expand on that the moving parts, please? That would be very useful.

[Angel Vila:]

Thank you David, this is Angel. I will start with response to the U.K. question, and then I will pass to Lutz. Today, we have announced that VM O2 has the intention to upgrade the fixed network to full fiber to the premise by 2028. This will imply covering with fiber an additional 14.3 million cable premises because we already have 1.2 million, which are covered with fiber through lightning. We, from Telefonica have been clear supporters of fiber networks, all across our footprint. We already enjoy the largest fiber footprint in Europe by far. And we have been extremely supportive of the proposal of the JV. Lutz, I pass it on to you, and then I'll take it back on the Spanish question.

[Lutz Schuler:]

Yes, Good morning David. So we have in U.K., a very unique situation. We have a deep fiber fully ducted network. And that brings us in the position that we can upgrade our network to fiber to the premise at very low cost. And this is referring to the GBP100. Now we have the comparison with DOCSIS 4.0, right? So we have, based on DOCSIS 3.1, today already 1.1-gig speed available. We can upgrade DOCSIS 3.1 to above 2-gig per second. And then after that, we have taken the decision not to go for DOCSIS 4.0, but instead to go for fiber to the premise. This is clearly an offensive move because we see a lot of business opportunity coming with it. Think about the wholesale market in U.K., think about the B2B market and also better competitive position in the consumer market. Yes. Back to you, Angel.

[Angel Vila:]

Thanks, Lutz. I'm going to the Spanish question and the moving parts. You were asking about if I am right, the second quarter ARPU evolution and what would be the outlook for the second half of the year, no? We have experienced an ARPU decrease in the second quarter. And the main drivers of that evolution are the following

[David Wright:]

And Angel, if I could just follow up, I guess the football downgrades, that should be annual though that happens every year, does it not. And you mentioned the tough comp on pricing. I assume it's difficult now to envisage price increases with the current competitive pressures. And the obvious question is maybe the margin doors need to step down now. Is that correct with the digital services running a lower profitability? Thank you.

[Angel Vila:]

Well, regarding the football end of season, you would have to compare with 2019, similar effect because in 2020, the competition were halted. So we didn't have that impact one year ago, which we are experiencing now. Regarding price increases, we are seeing price increases from competitors. Vodafone and Euskaltel are increasing prices now in July. Orange has announced price increases in August. So that happens in the market. And regarding margin, yes, what we have seen is, in this quarter, since we have been reactivating some of the commercial activity, but we still do not have full recovery of roaming, which is at levels -- the second quarter roaming is at levels, depending on the geographies between 1/3 and 40% of what would be the normal roaming levels compared, for instance, to Q2 2019. So we still have -- we're suffering the impact of roaming still not reactivating. We also have a reactivation of handset sales, which come with lower margins and IT. That has put pressure on our margin. But for the second half, we will be not far from the 40% levels because we see and we expect some further roaming reactivation, which is margin accretive, the proved ARPU that I was talking at the beginning of your question. And we will continue having efficiencies in commercial costs. So for the second half, you should see, and we are expecting margin recovery, at least one percentage point higher than what we saw in Q2, and we should be not far from the 40% levels.

[Operator:]

Your next question comes from the line of Georgios Ierodiaconou, Citi.

[Georgios Ierodiaconou:]

Yes, thank you for taking my questions. I actually have two kind of follow-ups to the previous questions asked by David. The first one around the decision to go for fiber. You mentioned the opportunity on the wholesale market. I'm just curious what was preventing doing some kind of agreement with cable on wholesale? Is it the demand on the other side? Or is it logistically allow users to do that with fiber? And if I could perhaps ask a question whether that also makes it easier for you to find partners to fund the upgrade to fiber? Whether that's something you may be considering in parallel to what you already announced? And then my second question is Spain, and thank you for going through the moving parts. I think it's quite clear. Some of the things are happening under your control. But if you could also comment, you mentioned that the price increases announced by your competitors. If I'm not mistaken, in Spain they notify the customers will be earlier. How much of the benefit was already in the June numbers you have shown on slide five? And how much of it do you think across to the third quarter? So should we expect that you move into positive territory now that your competitors have done more for more?

[Angel Vila:]

Thank you, Georgios, the first question, I pass it to Lutz, please.

[Lutz Schuler:]

Hi Georgios, so I mean when you think about the wholesale market, it's very simple, right? More short and midterm, we can offer a possible wholesale partner, the faster speed onto our cable network, right? Today, one gig. In the near future, 2.2 gig. And then, right, for the longer term, we have all the speed possible available higher than 10-gig up and download. So this simply puts us in a very strong future-proofed position in potential negotiations. And I think the partner approach is completely independent from that, right? So we haven't announced any acceleration on lightning. So obviously, we are pursuing possibilities there. But I think the announcement today to upgrade on to fiber is simply taken into account the unique position in U.K., right? At very low cost, you get to a fully fledged fiber network. And that, in the long term, puts us in a very strong position. Back to you, Angel.

[Angel Vila:]

Thanks, Lutz. And regarding the second question on Spain. I think we have to envelope everything that's happening into a more rational market. We have been working in driving rationality in the market by cooling down. This has had a benefit in terms of our churn. Also fostering quality has improved our NPS. And the market is behaving more rationally. And what we have seen is that the promotions have gone to half of what they used to be. Even the early summer promotions, the different players are having, for instance, for second residences, are softer with more rational behavior. This more for more that we are seeing from our competitors are a sign of rationality. All operators have shown forces to stop irregular practices for acquiring subscribers. The regulator has been promoting a spectrum auction with conditions, which are pro investment. And we have seen rational behavior in that auction as well. So we think that there are evident signs of rationalization from most players in the market. And this is leading to these dynamics that I was describing before with respect to outlook for ARPU and also in the commercial traction that we are seeing within the quarter. I don't know if that responds your underlying question on that.

[Georgios Ierodiaconou:]

Yes. If I could ask a follow-up on the fiber question. I'm just curious to understand, you mentioned that finding a financial partner is independent radically from the decision today. I just wanted to understand two things. Firstly, whether financial partner is more lean toward project lightning itself? Or whether it could include some of the existing infrastructure? And is it fair for me to assume that it makes sense for you to announce wholesale deals before you find a financial partner because, obviously, that way the price is better? So should we basically expect the wholesale just to compress? Thank you

[Angel Vila:]

Lutz, to you. Thank you.

[Lutz Schuler:]

I would say everything is possible. And also every order is possible, is the simple answer, right? We have different plans. We are in different conversations. Let's see, right? It's too early to tell. Sorry to be not more concrete, but we're actually in the middle of it. Thank you. Back to you, Angel.

[Georgios Ierodiaconou:]

Thank you.

[Angel Vila:]

Thank you. Next question please.

[Operator:]

Thank you. Your next question comes from the line of Jakob Bluestone from Credit Suisse.

[Jakob Bluestone:]

Hi, good morning. Thanks for taking my question. I've got one question, please, on Spain. You referenced Spanish EBITDA, which sort of fell fairly similarly to what we saw during Q1. And I was just wondering if you could comment specifically around the outlook for EBITDA in Spain? When do you think the rate of growth might improve? You obviously mentioned that ARPU growth or consumer ARPU -- conversion ARPU growth should improve in the second half. But I think that only makes up about sort of 1/3 of your service revenues and there's other stuff in there as well. So could you maybe comment specifically on what is the outlook for EBITDA in Spain? Do you think the growth rate will improve in the coming quarters?

[Angel Vila:]

Thank you Jakob, the trend of OIBDA in Q2 improved versus Q1 slightly, but improved, thanks to improved service revenues, and despite a worse year-on-year comparison versus what was a very typical Q2 in 2020 because in the second quarter of last year, we had very low commercial and production costs and some nonrecurring factors. So it improved its trend, but the comparison was tough versus one year -- one quarter, one year ago, that was very atypical. This improvement was lower than the revenues improvement because of the lower margin of some of the revenue growth levers, namely handset sales and IT. And as I was saying before, the reactivation of roaming. We believe that from Q3 onwards, the football seasonality will revert, improving the ARPU and therefore, flowing into profitability and also recovery of roaming, which may add, in our estimates, around one percentage point to margin. And this would, of course, improve the trends for the second half. One thing that I would like to note is that on the third quarter, there will be a difficult year-on-year comparison related to content costs because one year ago, we got some rebates from content suppliers to us because of the nonhappening of certain sports events. And this helped the OIBDA of the third quarter 2020, and that is not a recurring factor in 2021. So all in all, we believe that the margin is going to be -- going back to close to 40%. The year-on-year comparison in the second half will improve. But in the third quarter, we'll be adversely affected by these nonrecurrent content rebates we had one year ago.

[Operator:]

Your next question comes from the line of Keval Khiroya from Deutsche Bank.

[Keval Khiroya:]

Thank you. I've got two questions, please. So firstly, can you update us on where you stand on the potential of further inorganic options in LATAM? And do you think it will now be easier to strike potential deals now that hopefully most of the COVID drags are behind us? And then secondly, following on from the previous questions on Spanish OpEx. You will obviously have this continued mix shift toward more digital services. And as you look beyond 2021, do you think any areas where you can actually accelerate the level of cost reduction to then help the overall impact on the margins beyond this year? Thank you.

[Laura Abasolo:]

Thank you, Keval, for your question. Going to Hispam, our aim in Hispam is not to do deals. It is to modulate our exposure as we focus on profitability, efficiencies and extracting more value from our assets. Having said so, I think we find a nice formula with the fiber costs, which are allowing to accelerate growth, which are allowing to capture that fixed broadband growth in those countries. And at the same time, we are monetizing the brownfield and the contract. And both the FibreCo in Chile, the FibreCo in Colombia and the very soon expected approval of Costa Rica are going to contribute to net debt reduction of EUR one billion in 2021. But that's not the ultimate goal, as I said. And we are modulating and improving return on capital in different fronts. One of us is taking care of the operations. And I think we have, as commented, delivered very strong results. Revenue and OIBDA improved by 9.5% and 0.3% organically. And in terms of commercial KPIs, we had very, very solid. New contract accesses are over EUR1.1 million in the first half of the year. Fiber is growing very well, booming with almost 0.5 new connections, and that's being fueled by a new operating model. A new operational model, much more neutralized, which is going to bring very nice savings and at the same time, it's giving us a lot of agility. We are already operating as such, and the FibreCo in Colombia was being run by a true regional team, doing it in a very short period of time, as you have seen since we closed the FibreCo in Chile. And we are also going to work on that line in the case of Peru. As you have seen also in the debt explanation, we are reducing the equity exposure substantially. We have net debt in Chile, Peru and Colombia very much aligned to the group ratio, around three times. And we've been active throughout the first half year. We've been issuing in Chile. We are having issuing in Colombia. We are preparing back financing in Uruguay, that is going to take net debt in Uruguay to almost two times OIBDA. And we are doing this with very asset light. So no capital or very low capital is being devoted to the region. We are not detracting neither management focus from the group nor financial resources, and Hispam is becoming an optionality and a potential for value creation as it's been the case already through the financials and through the three inorganic deals that I commented. And as COVID headwinds remove, I think that's going to be even better.

[Jose Maria Alvarez-Pallete:]

If I may add, Keval. This is the first quarter in the last 15 quarters that Hispam grows in euros in reported terms and also in OIBDA. So I think that also the operational performance of the Hispam unit is helping us to allocate in a different manner our capital structure. So please note that there is a turnaround in euro reported terms in both revenues and OIBDA.

[Angel Vila:]

And regarding your question on direction of travel of OpEx. Not only looking at the rest of the year, but going forward toward next year, the main buckets of costs of Spanish operation would be personnel cost, content cost, then we have cost of goods supply, costs related to IT, commercial cost and other expenses. So the direction of travel of these different elements, when one looks not for the next quarter, next second quarter, but getting into the years to come. Personnel cost, as you have seen, we are continually working for efficiencies with respect to personnel cost. The second bucket, content costs. We are going to start seeing new cycles of sports where we have acquired or we plan to acquire content with deflation. So for instance, from September this year, the new UFA Champions League kicks in where we achieved a 16% reduction in the cost in the last auction. And of course, La Liga will be one year after, and the auction still has to take place, but our aim is to go for deflation. These two lines should go in the direction of being more efficient cost wise. On supply costs or cost of goods sold for either our IT activity or the handsets, which are implicit in our new Fusion portfolio, this will be aligned with the evolution of those revenue lines because those are directly linked to the cost of sale. Commercial costs, in general, should keep the same way as they have now. And other expenses like net worth savings, efficiencies from legacy switch of bad debt and so on, these are going -- we expect to continue to decline as has been the case up to now at a significant rate. So this should be the direction of travel of our cost function in the Spanish operation.

[Operator:]

Your next question comes from the line of Nick Delfas from Redburn.

[Nick Delfas:]

Yes, thanks very much. Question for Lutz, really. Of GBP100 upgrades figures quite eye-catching, obviously, for those of us who live in the U.K., calling a plumber tends to cost that much. Have you really tested that in a wide range of situations to understand whether that's the real cost? And then what's your cost to connect on top of that?

[Angel Vila:]

Lutz, to you again.

[Lutz Schuler:]

Yes. And so yes, we have done pilots already. As we speak, we are doing a bigger pilot with 50,000 premises. So the technical team is very confident to meet that number. As I said before, right, it's -- the reason for that is that we have already in our network deep fiber everywhere, and then we have really proper ducts. So it's -- what we have found so far and what we have all documented is that the GBP100 are achievable. This compares to GBP60 what we have tested, if we would call, for DOCSIS 4.0, right? So it's not that DOCSIS is debt in general, right? It's simply a great situation for the U.K. You had a second question on cable, right? I forgot that. What was that, again?

[Nick Delfas:]

Yes. Well, that gets you past the home, so what's going to be the cost to...

[Lutz Schuler:]

Yes, be connected. So I think we haven't disclosed that yet. I've seen that you made an estimate, right, already. You're not so wrong with that estimate. So because obviously, we have to test that again, we have to pull fiber then entirely into the home and the customer obviously needs a new CPE. The good thing is that we can do this entirely demand-driven. What do I mean with that, right? If a customer gets on to DOCSIS 3.1 today, right, the customer can get up to 2.2-gig speed, yes, and fiber then kicks in for higher speed. So therefore, right, we get to our fiber network at very low cost very quickly. And then the migration cost, right, are simply linked to a customer jumping on to higher speeds than 2.2-gig. And this obviously also can come with additional revenue. So therefore, I think to call out costs independent of top line is not appropriate at the moment.

[Nick Delfas:]

So you'd have a connection fee of maybe GBP300 plus for an incremental, maybe, if someone wants it.

[Lutz Schuler:]

Maybe not connections fee. It can be also, right? I mean you've seen the new wholesale regime in U.K. And you see that simply, it seems that the first time in the country if we are able to monetize higher speeds. And so I think right, today, the average speed of the Virgin Media customers, 200 MB, this is 2.5 times faster than the average of the country. So we talk about now a business model that kicks in for an average speed above 2.2-gig, yes. So I think either the monthly subscription will be higher, combination of installation costs and monthly will be higher whatever. I think, right, it's early days. Stay tuned.

[Nick Delfas:]

So sorry, you have a large connection fee, but you're going to have to pay for that for the incremental ARPU from a customer wanting 10-gig versus 1-gig?

[Lutz Schuler:]

Exactly, right? I mean we can choose what we are going to do between installation cost and connection costs.

[Nick Delfas:]

Okay. Thanks very much.

[Lutz Schuler:]

Okay.

[Jose Maria Alvarez-Pallete:]

Thanks Nick. We have time for one last question, please.

[Operator:]

Thank you. Your final question comes from the line of Carl Murdock-Smith from Berenberg.

[Carl Murdock-Smith:]

Hi. Thank you for the question, I just wanted to ask a slightly longer-dated question. I recognize it's more of a Board decision than necessarily for you. But just beyond this year, what are your thoughts regarding the voluntary scrip option? You obviously seem quite confident in terms of the future. You seem to think that your shares are cheap. So why are you happy to continue to see the share price? Will the share counts continue to increase? And now that the net debt is much reduced following the M&A, should we be thinking that the voluntary scrip option won't continue in future years?

[Jose Maria Alvarez-Pallete:]

Well, thanks for your question. As you know, what we have tried is to provide flexibility to our remuneration policy, especially in uncertain times this year because of the COVID outcome and also because of several spectrum auctions that we had on top of the table that now two of them are cleared. In terms of the acceptance of our shareholders to this proposal, 71% came for shares in the last and therefore, they were somehow protected by the dilution. And we are trying to devote any excess free cash flow that we have in order to try to mitigate the dilution impact of the scrip option. We have canceled 1.5% of what treasury stock in the last shareholders' meeting. And today, we are proposing an additional cancellation of 0.7%. So I guess that the answer is that for the time being, we will provide this flexibility. That we have that committed for this tranche -- this coming tranche in December of the 2021 dividend. And the second tranche will be approved by the next shareholders' meeting, and we will update you there. We don't have a specific proposal to share. For the time being, we really appreciate this flexibility that allow us to keep investing into growth CapEx. But yes, you're right, we are approaching the time in which the debt levels are much more sustainable and in which the underlying EPS is back to better trends. So we will be reassessing the position in the next year-end results.

[Operator:]

At this time, no further questions will be taken.

[Adrian Cincinnati:]

Thank you very much for your participation, and we certainly hope that we have provided some useful insights for you. Should you still have further questions, we kindly ask you to contact our Investor Relationship department. Good morning, and thank you all.