Telefónica, S.A.
Q3 2021 Earnings Call Transcript

Published: 4 Nov 2021

[Adrián Zunzunegui:]

Thank you. Good morning, and welcome to Telefónica's conference call to discuss January-September 2021 results. I'm Adrián Zunzunegui 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. This financial information is unaudited. This conference call and webcast, including the Q&A session, may contain forward-looking statements and information relating to the Telefónica Group. These statements may include financial or operating forecasts and estimates or statements regarding plans, objectives and expectations regarding different matters. All forward-looking statements involve risks and uncertainties, including risks related to the effect of the COVID-19 pandemic, that could cause the final developments and results to materially differ from those expressed or implied by such statements. 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 release and the slides, please contact Telefónica's Investor Relations team in Madrid or London. Now let me turn the call over to our Chief Operating Officer, Mr. Ángel Vila.

[Angel Vila:]

Thank you, Adrián. Good morning, and welcome to Telefónica's third quarter results conference call. With me today are

[Laura Abasolo:]

Thank you, Ángel. Moving to Hispam on Slide 11. We can see how our renewal strategy is gaining traction. We continued transforming our operation to FTTH after connecting 669,000 new accesses in the first 9 months of the year. Additionally, new fiber vehicles in Chile and Colombia will further accelerate FTTH deployment. In mobile, accesses rose 9%, with all 5 main countries posting growth for the fourth straight quarter. This focus on high-value accesses, together with a maximization of operational efficiencies from the new operating model and digitization, drove an improved year-on-year trend in both service revenue and OIBDA for the fourth consecutive quarter. It is also worth highlighting that revenue and OIBDA posted positive growth on both reported and organic basis. Finally, we continued to lower capital employed in the region. And CapEx to sales was reduced to 9% in the first 9 months of the year. Turning to Slide 12. Net financial debt stood at €22 billion as of September or at €25 billion post estimated distribution of proceeds to Telxius minorities. Including post-closing events, net debt would be reduced to €25.6 billion, a reduction of €9.6 billion since December 2020, mainly due to inorganic deals, such as the sale of Telxius and the VMO2 U.K. JV, coupled with a resilient free cash flow generation of €1.5 billion. Net debt to OIBDA ratio went down to 2.49x, 0.3x below the fiscal year '20 ratio. We maintained a healthy liquidity cushion of €22.6 billion, thanks to some liability management exercises and repayment of short- and medium-term bank debt. As a result, our average debt life has increased to 13.85 years and the maturities are covered beyond 2024. Telefónica financing activity amounts to 4 -- sorry, to €5.4 billion year-to-date, including the financing of JVs, such as VMO2 and the fiber vehicles, UGG and FiBrasil. We maintain an increased focus on ESG financing and continue to increase debt in LatAm currencies, most recently in Uruguay. Effective cost of interest payments over the last 12 months stood at 3.27% as of September 2021. Telefónica Group, with the vast majority of its debt at fixed interest rates and denominated in euros, is in a solid position to face any future rise in interest rates in the G7 countries. I will now hand back to Angel to recap.

[Angel Vila:]

Thank you, Laura. To wrap up on Slide 13, our strategic focus remained on sustainable and profitable growth through ongoing portfolio simplification, further deleverage, execution of transactions to crystallize value, development of fiber vehicles and tech units and continued digitization with high-quality, secure and greener networks. Top line growth accelerates within a quarter in which FX was -- has not been a drag with both revenues and OIBDA showing organic growth for the second consecutive quarter. Smart capital allocation is reflected in 45% of CapEx being devoted to next-generation networks while acquiring spectrum so far this year at significantly lower than benchmark prices both in Spain and in the U.K. The integration of our JV with Virgin Media is progressing at pace, returning to top line growth in Q3 while continuing to invest for the future. It's also worth highlighting the strengthening of our balance sheet and capital structure. And finally, we are confirming our 2021 outlook and dividend. Thank you very much for listening. And we are now ready to take your questions.

[Operator:]

Your first question comes from the line of David Wright from Bank of America.

[David Wright:]

And if I might just add, a very poignant message given by your CEO, writing about Jesús Romero, which I think is very much appreciated by all of the analyst community who knew him well. So thank you very much for that, and of course, our deepest sympathies. Just going back to the print itself, you have mentioned both in the presentation and in the report that Q3 domestic EBITDA was impacted by higher energy costs, but that you don't expect these to continue. So I wondered if you could just expand on that. That would seem counterintuitive to perhaps what is happening right now. So just some detail on that, please, and how we could expect that domestic margin to evolve.

[Angel Vila:]

Thank you, David. And first of all, thank you for your comment on Jesús Romero. He was a very much appreciated colleague, a very smart person, and not only very smart but very good personally and a great colleague and friend. All of us are going to miss him very deeply. So going to your question, so on Spain, on OIBDA and related to energy. The third quarter OIBDA had a decline of 8.9% year-on-year, dragged mainly by two factors. The first one is the energy price doubling, which explains close to 3 percentage points of this 8.9% decline. And the other factor is a tougher comparison base, as we had already anticipated in previous calls, on content costs year-on-year due to the one-time impact we had in this third quarter of 2020 on sports and other content rebates. Revenue improvement, on the other hand, is not totally reflected in OIBDA margin as the growth drivers of revenues at IT and handsets that yield a lower margin. And in addition, roaming did not fully recover for this quarter, which is, as you know, a high-margin contributor. So we can say that OIBDA is impacted by some of short-term impacts and a tough comparison base in content that will not be there in the coming quarters. We expect the energy impact to affect potentially a few quarters ahead but to fade away at some point early next year. And roaming will depend on the COVID situation but is still not fully recovering yet. In any case, if one were to exclude the effect of the higher energy costs and the content base effects, the year-on-year organic EBITDA trend in Q3 would have clearly improved versus the second quarter. So regarding margin, margin in Q3 stays at 38%, stable versus Q2. If we were to exclude the energy price inflation, margin would have exceeded 39% as we had been communicating and as it was expected. Faced with this situation, especially on the energy inflation front, you should expect us to activate even further efficiencies in our Spanish operation to try to mitigate as much that impact. And then of course, if one looks at the capital intensity of our Spanish business, I would like to highlight the operating cash flow margin, which stands in the 9 months at 27.7%, which continues to be a benchmark figure. And if it were adjusted by energy costs, that, at some point, its impact will fade away, would be even higher than that.

[Operator:]

Our next question comes from the line of Fernando Cordero from Banco Santander.

[Fernando Cordero:]

Also as a follow-up on the Spanish operation, and particularly considering the recent developments on the fiber-to-the-home assets, in that sense, I would like to discuss a little bit the impact of the recent regulatory update on your wholesale fiber offer. And in that sense, what could be the impact of this new framework in your portion of revenues and potentially considering the recent press reports on your ownership of the fiber network and the value of that network? And secondly, also as part of this regulatory update, there has been an acceleration of the process of the copper network switch-off. And I would like to understand on which is then -- or which is the current progress on savings materialization of the switch-off of the copper network.

[Angel Vila:]

Thank you, Fernando. There have been some developments recently in the broadband fiber market revision. The main one has been setting the new competitive zone, which means a nonregulated zone, now to cover 696 towns and cities in Spain. Formerly, it was just 66. This represents now 70% of the Spanish population. And formerly, it was half of that, 35% of the Spanish population. This deregulation will be applied after a transitional period of 6 months now. And this leads -- we have not only the regulated area wholesale business, but we also have reached commercial agreements with several of the players in the Spanish market. This leads to continue to have a substantial line of revenues and strength in our wholesale and others revenue line in the Spanish P&L, which is growing at 8.9% in the third quarter. And here, we are -- in spite of still not having a full recovery of roaming, we're having a strong impact, both from the fiber wholesale through NEBA and other modalities but also from MVNOs. We have, as you know, a very well developed fiber network in Spain. Now it's covering close to 85% of all the premises in the country. We have developed one of the largest fiber networks across the European market. This network for us is a strategic asset. It's probably not reflected in our valuation but gives us optionality in the future. It's such a well-developed network that probably the greenfield opportunity is less so than one -- or is less relevant than what you can see in other fiber because we are developing in other markets, such as Germany. And the commercial wholesale agreements, as I was saying before, are already in place, which enable already a very good wholesale monetization of this fiber network. There is a strong interest in the market for this type of assets. We have a very valuable asset that gives us full optionality and flexibility to assess future options. I would like to stress that any option we may pursue in the future will consider always the strategic relevance of this asset for the Telefónica Group. Then regarding the copper switch-off, we continue to progress consistently across the Spanish footprint. We have been -- we plan to decommission the copper network by 2025. We have closed 1,015 central offices since 2015 and up to September of this year. And we have increased in the past every year to close as many central offices as -- to reach this target in 2025. This target, to shut down 100% of copper central offices, would imply real estate capital gains. It will be possible on the back of the new broadband market regulations, as you were saying, reducing the time to shut down with unbundled local loop players in those central offices, that has been reduced this time from 5 years' to 2 years' notice. So this will help us accelerate. And we will, of course, be achieving the one-off benefits of selling the real estate, selling the copper, the OpEx efficiencies because of the fiber network is much more efficient than the copper and also CapEx efficiencies in this process.

[Operator:]

Next question comes from the line of Jakob Bluestone from Credit Suisse. Your next question comes from the line of Carl Murdock-Smith from Berenberg.

[Carl Murdock-Smith:]

Just I'd like to ask a question, please, on LaLiga and just ask you to kind of expand on your approach towards that auction, your expectations with regards to inflation or deflation and more broadly, your thoughts on the potential for content ownership fragmentation going forwards.

[Angel Vila:]

Thank you for your question. The conditions for the tender of LaLiga were published yesterday evening. And at the moment, we are evaluating the procedure and the different possibilities. There is some time ahead because the tender is opened for applications until the 13th of December. So the envelopes will be submitted on the 13th of December. What we see is that it’s in line with the LaLiga’s intentions that had been speculated or published in different media. So there are several options to package the matches and even the length of those rights. The packages can be the whole 10 matches of the – of every weekend, can also be split by packages of 5 and 5 matches or 7 and 3 matches of every weekend. And they open also the possibility of some bidder potentially acquiring specific weekends and whole matches. And the period for the rights is between 3, 4 and 5 years. We are interested in this differential content. It’s a content which is relevant for us to maintain and improve our commercial ratios, such as ARPU and churn, which are quite differential to any of our competitors. But of course, these rights have to be acquired in a cost-effective way. So we apply a very strict cost analysis based on profitability as we have done every time in the past. We will aim for deflation in this content. We achieved slight deflation in the previous cycle of LaLiga. We achieved double-digit inflation in the current rights of the Champions League. But of course, it’s early to say how the whole setting will apply. This is not the first time that LaLiga auction comes with several lots. We have lived in the past with situations in which we own part of the rights, we acquired from other players other part of the rights. In the process, also in the last 3 years, we have been integrating in our platform some over-the-top players, among them, some sports-oriented over-the-top players. So we are analyzing in detail and developing strategic approaches for the various outcomes that could come of the different lots of this auction. It’s something again that will develop later in the fourth quarter, bids to be submitted on 13th of December. And then the process will go on. We’ll keep the market updated as we have more news on this.

[Operator:]

Our next question comes from the line of Nawar Cristini from Morgan Stanley.

[Nawar Cristini:]

I have two questions, please

[Laura Abasolo:]

Thank you for your question. Starting from Hispam and the good performance against initial expectations, I would tell you that since we took the decision to run Hispam in a different way, we've been approaching the region in a very disruptive model. And therefore, we have achieved great fruits of the new management model. It has not surprised us because it's been based on a very thorough execution, covering many and pulling many levers. First of all, the management approach is completely different. We have gone through a regional model in which we not only serve best practice, but we run many important projects for the whole region with a team which is -- with people in Madrid but with people in every country in Hispam. So that not only allow us to be more efficient, it has also driven a lot of agility. And we are already reaping good savings of that new regional model that will be at the run rate by 2022. Also, we modulated exposure through CapEx reduction, but that doesn't mean we will jeopardize growth. And in fact, you are seeing we are having record net adds as we are going through a lean and more variable CapEx or investment model. Another focus, and I'm probably asking both parts of the question similarly as I'm going through the priorities and actions we are taking, was high-value customers. So we have put all the focus on FTTH. We have put the focus in contract. And we have put the focus on giving the better service possible to our clients. And NPS has improved. And in the places where we were still running not so well versus competitor, we have improved substantially, so not only absolute, also relative NPS have improved a lot. Another thing was Hispam not dragging management focus, not dragging financial resources, being self-sustained. And for that, we have allocated much more debt. The ratios, the net to OIBDA ratios in Hispam are similar to the group levels or even higher. You have seen a lot of financing activity in Chile, Colombia, Uruguay. The most recent, Peru already had leverage that was raised prior to this year. So that has also made Hispam much more -- less volatile to FX movements and at the same time, very autonomous from a financial point of view. Finally, I would say that we still have a lot of optionality but not only in the inorganic front, as we have proven with the sale of Costa Rica already approved, with the fiber costs, both Chile and Costa Rica were approved this quarter. And they have posted nice capital gains and also net debt reduction. We also signed the El Salvador disposal. And with that, all Central American assets have been divested. And we will also get, as we said, a regulatory approval for Colombia. So those two will continue helping both in the net debt reduction. But there's a lot of optionality in the organic front. And we definitely have improved business plans from 2019. And we will continue executing thoroughly versus those very stronger now business plans. And also, a final comment, on the bid that you commented. Also, that bid was evenly distributed. But part of that had to do also with Argentina. And I think that Argentina shows how we manage in inflationary environments. So our capacity to raise prices but also to manage every OpEx and CapEx line is really remarkable. And in the case of Argentina, it's not only the OpEx and CapEx management, it's also, and this comment applies for the entire Hispam and also for the remainder of Telefónica, how advanced we are in digitization. So we have reduced the weight of the most inflation-related OpEx, and we -- as we have a much more digitized business model to attempt -- to serve our customers for operations and so on, we are more resilient. And I think Argentina is a good proof of that when you look at the performance despite inflation being around 50%.

[Angel Vila:]

Regarding your second question, we have seen recently infrastructure fund investments in the fiber space in Spain. First conclusion of this, it proves the very high valuation of the infrastructure assets in our country. Again, not necessarily our asset is being valued. But as you said, it also anticipates new potential competitors in this segment. We believe that the risk is under control. As much of our wholesale business is protected by long-term agreements, we also have a fully developed network, which is available today for any wholesale counterparty compared to the potential growth plans of these fiber core challengers, which have a very limited footprint. We compete with differential assets. We have long-time expertise in the wholesale market. And if anything, one could see that part of the expansion plans of some of these fiber core challengers are not only organic but also inorganic, thinking of consolidation of small fiber core players, which brings the topic of potential consolidation in the Spanish market in this small infrastructure space. But also, one has to reflect about the Spanish market, which – and it’s – the sustainability of its current structure. We believe that players are showing low or insufficient return on capital employed ratios except Telefónica, except ourselves. And this is not sustainable in the long term. And this could lead to further consolidation in the market. Of course, we would be supportive. We would welcome market consolidation and market repair that would foster further next-generation investments and benefits for the customers.

[Operator:]

And our next question comes from the line of Jakob Bluestone from Credit Suisse.

[Jakob Bluestone:]

Apologies for the technical issues earlier, I'm not sure what happened. I had two fairly quick questions on Spain. Firstly, just -- I mean, you've obviously referenced the increase in energy prices. But I'd be interested in just any comments on sort of broader pricing inflation you're seeing. Specifically, do you see risks that your labor costs might have to rise as a result of rising inflation? So that's the first question. The second question, you mentioned earlier the optionality around your fiber in Spain. I was wondering if you could maybe be a little bit more specific, given there's been some recent press coverage about a potential minority stake sale in your Spanish fiber network. Could you maybe just sort of share with us what do you think are the pros and cons of such a move? And what would be your red lines?

[Angel Vila:]

Thank you, Jakob. As for inflation, our base scenario is for inflation to peak in the near term. But of course, we are taking steps to fight the risk of a scenario of a longer-term inflationary environment. We are paying very close attention to energy costs, wages and others, such as chip shortages. For the time being, the main impact that we’re seeing is higher energy prices. And we are trying to manage these inflationary pressures by different ways. On one side, on the revenue, we are trying – or we are working to improve our growth profile through capital allocation into growing businesses. And this is partially reflected in our digital B2C and B2B new businesses. Inflation adjustment, which is possible in U.K., Brazil and Hispam, where there are inflation-linked tariffs, is not the case in Spain, although we have been still been able to promote more-for-more moves in the market. We also have pass-through mechanisms in most of our wholesale contracts. So we have on the revenue side some mechanisms. On the OpEx level, we will continue to implement and accelerate efficiency measures, fostering digitalization, as Laura was saying. And I should say that we have an OpEx structure that somehow hedges us from this. On one hand, the content costs, we are working in deflation in sports content. We achieved that in previous auctions of Champions, Formula One, other contents. And as I said before, in this LaLiga auction, we’re going to aim for a certain degree of deflation. In network costs, we have the energy costs that amount to around 3% of our OpEx base. And here, we are taking steps to be more efficient in energy consumption and also in the contract for supplying that energy. The employee costs, given all the efforts that we have done in the past for being more efficient in personnel and more productive in our operation, the weight of employee cost is a significantly lower weight over total revenues than the average in the sector. And here, this is protecting us. And finally, on CapEx, our first natural hedge is the significantly lower than average capital intensity because of the investments we have been already doing in our operation in Spain. So we are not immune, but we have been taking and we’ll continue to take measures to offset inflation-related impacts. And we believe that, as we have shown in the past, we have lived in perimeter inflationary situations in many instances. We have proven in the past our ability to adjust our cost base. Then regarding the fiber, I’m afraid I cannot be more specific. We have again a very well developed fiber company. It’s very well invested, still has some growth opportunity. But the greenfield opportunity is not that large. We are also taking benefit of the European recovery funds through the program, UNICO, in order to continue expanding the network into different areas. It’s a very effective capital deployment model while helping to improve the connectivity in the country. And it’s a very attractive asset. We know that there is interest. We are seeing valuations given by the market to this type of infrastructure. And this gives us flexibility to assess future options, that, in any case, we take into account the strategic nature of the asset for us.

[Operator:]

Our last question comes from the line of Keval Khiroya from Deutsche Bank.

[Keval Khiroya:]

I've got a question on Spain, please. You've highlighted the strong domestic free cash flow margin partly reflecting the lower CapEx of some of the growing revenue streams. So anything you can say on how we should think about how the domestic free cash flow margin should evolve over the next year or 2? Would your goal be to maintain it close to the current 27%?

[Angel Vila:]

Well, we – as you know, we don’t guide on specific operations. And we will be issuing the group guidance for 2022 and forward with our full year results. But what we see is the momentum on our revenue line is sustained. So we believe that, as we said before, the ARPU in the second half of the year will be higher than in the first half. And we continue to develop new digital products in B2C. The traction in B2B is quite strong in the recovery from COVID. Also, the wholesale line is strong, so momentum on the revenue line is strong. We will continue to work on efficiencies to maintain the OIBDA margin in the levels of very high 30s, where we are trading right now. And CapEx would remain focused on deployment of next-generation networks, not so much fiber anymore. Yes, we will continue to be deploying 5G. We already have coverage with non-stand-alone 5G, higher than 80% now in Spain. But moving into 2022 and into 2023, that will develop further. But in any case, we continue to have the priority to have operational cash flow in Spain to be the benchmark in the industry in Europe. That is an absolute priority for us.

[Operator:]

At this time, no further questions will be taken.

[Angel Vila:]

Thank you very much. We hope we have been able to respond to the questions that you may have on us. Please feel free to reach our Investor Relations department for any further questions that you may have. Thank you.