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Vodafone Group (NASDAQ:VOD)

F3Q13 Earnings Call

February 7, 2013 3:30 am ET

Executives

Andy Halford – Chief Financial Officer

Vittorio Colao – Chief Executive

Stephen Pusey – Chief Technology Officer

Philipp Humm – Chief Executive Officer, Northern and Central Europe

Nick Read – Chief Executive Officer, Africa, Middle East and Asia Pacific Region

Analysts

Simon Weeden – Citigroup

Akhil Dattani – JP Morgan

Justin Funnel – Credit Suisse

Nick Lyall – UBS

James Britton – Nomura

Robin Bienenstock – Sanford C. Bernstein

Andrew Beale – Arete Research

Nick Brown – Espirito Santo

Paul Marsch – Berenberg Bank

Jerry Dellis – Jefferies

James Ratzer – New Street Research

Nick Delfas – Morgan Stanley

Lawrence Sugarman – Liberum Capital

Ottavio Adorisio – Societe Generale Securities

Stephen Howard – HSBC Bank

Guy Peddy

David Wright – Deutsche Bank

Andy Halford

Good morning. It is Andy here. Good morning, welcome to Vodafone’s interim management statement call. I am joined by Vittorio and a number of our colleagues here.

I will take you through the financial highlights for the quarter, before handing over to Vittorio to update you on strategic developments, and comment on the outlook before we move onto Q&A.

So let me start on slide three, the highlights of the quarter. Group service revenue declined on an organic basis by 2.6% or by 0.4%, excluding MTRs. This growth is lower than the previous quarter, firstly due to 1.6 percentage points decline in Northern and Central Europe compared to the previous quarter driven in part by MTR cuts in Germany, and secondly a decline of 1.4 percentage points, compared to the previous quarter in our AMAP region, driven primarily by a slowdown in South Africa.

Data grew by 12.8% across the group, driven by increase in smartphone penetration, which is now at 33% in Europe, up from 25% this time last year. Growth in emerging markets continued to be healthy with Turkey, India and Vodacom partially offsetting the macro and regulatory pressures in Europe. Vodafone Red is now being launched in five markets to strong customer demand with 2.2 million customers as of the end of January.

In Verizon Wireless, service revenue grew by 8.7% during the quarter, and we received a GBP2.4 billion dividend of which we are returning GBP1.5 billion to our shareholders via a share buyback program, which commenced in December. Net debt fell to GBP23.3 billion, mainly as a result of the Verizon Wireless dividend. Following our performance for the quarter, we confirm our full-year adjusted operating profit and free cash flow guidance.

So on to slide four. Here you can see our performance by region for the quarter. Europe remains very challenging, and in particular we saw a deterioration of trends in Northern and Central Europe, which I will explore in more detail shortly. In AMAP, growth of 2.7% increases to 4.1% when the MTR impact is excluded. Momentum in AMAP continues to come from growth in customers, improving data penetration, and stabilizing prices, particularly in India.

For the group overall, the regulatory impact represented a 2.2 percentage point headwind to growth in the quarter, compared to 1.7% and 2.0% in Q1 and Q2 respectively. The growth in data and wholesale continues, although messaging and voice collectively contributed a quarter-on-quarter service revenue decline of 0.9 percentage points.

Capex for the quarter was GBP1.5 billion, and free cash flow was GBP1.2 billion. On slide five you can see that the impacts of currency movements and M&A effectively neutralized each other during the quarter. Data continues to grow at around 13%, now contributing 16.2% to the group’s total service revenue. Although voice pricing remains under pressure, voice usage was up 10.6% this quarter, consistent with the growth over the past few quarters.

Whilst messaging volumes continuing to increase overall, revenues were down 7.9%. Looking ahead, the visibility between messaging, voice and data revenue allocation will become somewhat distorted as price plans increasingly include unlimited voice, and therefore the revenue allocation per bundle changes. Roaming, voice and data revenues were adversely impacted by 12% and 6% respectively due to the decline in tourism in most of our European markets.

Turning to the next slide, let us take a closer look at each of our main markets in detail. Starting with Germany, against the backdrop of increased competition and a new MTR cut, German service revenues declined 0.2%, or an increase of 0.5%, excluding MTRs. Data growth of 11% continues to be supported by increasing smartphone penetration, up 11 percentage points year-on-year to 32%. We continue to execute well in enterprise with service revenues up 2.4%.

We continue to refine our approach to A&R spend, which has mitigated the weaker top line. Onto LTE, we now have over 400,000 customers, including an additional 135,000 LTE mobile customers, growing strongly in the quarter, supported by the launch of new LTE enabled handsets. LTE population coverage in Germany now stands at approximately 53%.

UK growth declined for the quarter by 5.2%, primarily driven by a further decline in consumer confidence, and weaker consumer contract performance, and further pressure on the consumer prepaid customer base, which has declined 6.5% year-on-year though we gained a quarter of a million postpaid customers in the quarter. Data growth of 6% is driven by continued increase in smartphone penetration, and in mobile Internet usage.

Netherlands, service revenue for the quarter declined 3.5% driven by challenging economic and market conditions, especially within the no-frills space. Data growth of 23% is partly mitigating a decline in messaging revenues. Looking ahead, we are launching our Red tariffs in March, and we continue to get our network LTE ready following the spectrum auction in December.

Turkey continues to perform strongly with continuing growth across all segments. The customer base has grown 5% year-on-year, with ARPU growth of 10% in a stable pricing environment. Turkey now has 19% smartphone penetration, which is driving strong growth in data revenue. Turkey’s enterprise business grew 41%.

Moving to southern Europe, Italy, the ongoing macro conditions in Italy, coupled with strong price competition and large MTR cuts, all contributed to a decline in service revenue of 13.8%, or 9.3% excluding MTRs. Whilst voice and messaging service revenues have stabilized quarter-on-quarter, and outgoing usage increased by 8% and 3% respectively, mobile only service revenue declined 14.6%, and fixed revenues declined 8.1%.

Spend optimization in the enterprise unit has been a key focus, following a steeper decline in enterprise service revenue of 10.5% in the quarter. We continue to have great success in Italy with the Vodafone One Net proposition, which grew strongly at 39%. Data revenue has slowed to 2%, but mobile Internet growth remained strong, and the data attachment rate is now at 57%.

Moving to Spain, where the macroeconomic environment remains very tough, and converged offers and MVNOs continue to gain traction. Service revenue fell 11.3%, or 9.6%, excluding MTRs. Against this tough backdrop we have introduced our new Red tariffs with the option to add a DSL service to a mobile tariff. Data revenue growth remained strong at 18% with smartphone penetration of 47%, up 11 percentage points in the last year. We have recently announced a significant restructuring in Spain.

Moving to our AMAP region on slide eight, India grew at 9% in the quarter, a slight slowdown from the previous quarter, driven by new regulations being implemented into the market, including a new rule requiring all operators to verify all new customers, which has resulted in a lower rate of customer acquisitions in the quarter.

APRU continues to grow as voice prices stabilize and data penetration increases. We see early signs of 3G data is beginning to gain traction. Vodacom’s service revenue growth slowed to 1.9% with growth of 23% coming from the International businesses, and healthy customer growth right across the group. South Africa service revenue for the quarter declined 1.8%, primarily driven by a less aggressive summer promotion this year, increased competition, and our decision to withdraw from the prepaid calling card market. Stabilization in data pricing in South Africa assisted strong data growth of 17% with smartphone penetration growing strongly.

In Australia performance remains weak. A large restructure of the cost base took place in November, which included a 35% headcount reduction. Investments in improving network quality remains a priority. Acquisition APRU improved this quarter following a change in commission terms, which encouraged sales staff to target high-value customers, and we have increased our focus on customer value management. The single RAN program is now complete, which will enable us to deploy LTE in due course.

And finally Egypt, which was stable quarter-on-quarter at 3.1% growth. However, looking ahead the political unrest and economic uncertainty may have a slightly negative impact on consumer spend and visitor numbers for the country. Data growth remains very strong at 25%, with data penetration now at 16%.

Turning to the US, Verizon Wireless had another strong quarter with service revenue up 8.7% year-on-year and overall ARPU rising [6.6%]. This was driven by a record number of postpaid net adds in the period of 2.1 million. An increasing proportion of postpaid sales were smart phones, representing 87% in the quarter. In total, Share Everything plans now represent 23% of Verizon Wireless’ retail postpaid base.

Customer adoption of 4G LTE also continues to gain momentum. 4G LTE is now currently available to nearly 90% of the US population. Almost 50% of the total data traffic is now on 4G LTE, and in January Verizon Wireless announced the sale of certain 100 MHz spectrum licenses for $2.1 billion.

Now onto slide 10 for the group’s free cash flow and our balance sheet position. We generated GBP1.2 billion of free cash flow during the quarter, which was slightly lower than the prior year, due principally to the foreign exchange movements. Excluding M&A and foreign exchange movements, free cash flow was up 2.7%. Net debt fell during the quarter to GBP23.3 billion, boosted by the GBP2.4 billion Verizon Wireless dividend received in the quarter. Only GBP0.1 billion of the related GBP1.5 billion buyback have been executed by the quarter end.

The TelstraClear acquisition was completed in November. The 0.2 billion Spectrum payment related to the Ireland, Romania and India auctions and the fourth quarter will include payments for the Netherlands auction and if successful, the UK and Czech auctions.

Finally we have today confirmed our guidance range for the year, which includes adjusted operating profit to be at the upper end of the GBP11.1 billion to GBP11.9 billion range, and free cash flow to be at the lower half of the GBP5.3 billion to GBP5.3 billion range.

We expect group EBITDA margin to decline at a slower rate this year than last, supported by our cost efficiency programs and improving margins in India and South Africa. Looking ahead to Q4, I would remind you about the reversal of the leap year benefit, and the increase of the MTR drag, which combined will create an incremental quarter-on-quarter reduction of around 1.5 percentage points on top line growth.

With that I will hand over to Vittorio to take you through the remaining slides.

Vittorio Colao

Thanks Andy. So first I would go on page 11. I would like to give you here a brief update on our key areas of strategic and commercial focus. First, clearly positive news on data, bundlings, market penetration and our new pricing plan, Vodafone Red. Data traffic across our network continues to grow rapidly. It is over 50% year-on-year. Smartphone data traffic is more than doubling with mobile broadband dongle traffic instead continuing to decline.

We continue to push smartphone penetration, which has actually accelerated in recent quarters. Over half of our contract customers in Europe are now using a smart phone, and their data usage is increasing to around 30% year-on-year on a per customer basis. Financially, we are managing this transition well with now nearly half of our European mobile service revenue coming from bundles. This is the right-hand part of the chart, coming from bundles, up 8 percentage points versus the third quarter of last year.

And finally, and perhaps more importantly, Vodafone Red that I talk about at the media presentation, today we have launched the Vodafone Red in five markets, and we have as of the end of January about 2.2 million contract customers across Europe. The initial customer feedback here has been very positive with clearly higher NetPromoter scores. To give you an example, in Italy you had 10 points higher improvement just for the right customers.

The revenue trends are encouraging with the balance of down traders versus up traders being a little better than what we anticipated, and any slight ARPU dilution being more than offset by volume gains, with our share of gross adds being now up 20% in Germany just to give you an example. Now, Vodafone Red is not just a consumer story. Over 25% of our gross adds so far have been in enterprise, and we will be addressing the prepaid market with a Red-like approach in the coming month as we introduce a range of enhancements to the proposition and take it to many more of our markets. I will talk more about Red at the full-year results.

Turning page, network, in terms of future proofing our network we have made good progress. We have now rolled out single RAN technology to 48% of our European footprint. This is up 20 percentage points year-on-year. The proportion of our backhaul traffic, which is high-capacity and also very good, over 50% of our estate now covered.

On key utilization metrics, we continue to remain comfortable. We have peak utilization at only 7% across our network today. This has consistently been the case despite the data usage increase that I talked about. Downlink speed across our European HSPA footprint have also improved considerably as we continue to make good progress on supporting higher speed data, to deliver an excellent experience to our customers. We now have 97% of our footprint on 14.4 Mb per second, and 36% at 43.2.

As a result of this ongoing investments, our customers are now enjoying an increasingly good experience on HSPA+, and where we have it on LTE. On LTE we have made good progress. In terms of commercial launches, we now have LTE offerings in 6 countries, and we are preparing for LTE in further five months.

We already secured the majority of the spectrum required to meet coverage and capacity needs over the last three years. We have invested nearly GBP4 billion in spectrum in eight countries, and have existing spectrum in further 10 markets that can also be used for LTE. The majority of this spectrum has been forward purchase for an average of 15, 20 years, and despite this we have been able to maintain a strong balance sheet position as Andy has described.

Finally with the continued investment we have made in the network, we are well positioned for the rapid deployment of LTE in this country at a relatively low incremental costs given the investment we made in single RAN and backhaul capacity.

We will move to page 13, enterprise, in enterprise our new organizational structure is in place allowing us to better address our customer needs to leverage our scales and geographic footprint, and to fully realize the growth opportunity from offering converged services to enterprise customers.

A few words on Cable & Wireless, in November we announced that integration of Cable & Wireless Worldwide will be accelerated given the better-than-expected state of the business, and the stronger demand experienced from combined products and services. The integration of the senior management teams is now complete. Our program to stabilize Cable & Wireless operational performance is also yielding positive early results, with the volume of high impact customer service issues decreasing by one third since August.

Our key for synergies network program to connect our base stations to Cable & Wireless network has commenced, and the rationalization of the combined Vodafone Cable & Wireless enterprise product set is underway. In the quarter itself, we continued to see strong demand with Vodafone global enterprise increasing the total number of connections it has to 5.7 million. This is a 12% increase year-on-year. In machine to machine, we won a big new contract with Caterpillar, and further extended our connect to drive plan with BMW to further 58 countries.

This takes the total number of connections that we have in these areas to 9.7 million, 42% increase year-on-year. And finally in One Net, the unified service product, the number of users has increased by 33.4% to 2.4 million. A qualitative comment on enterprise contract, both the value and the duration of the contracts that we win is also increasing. It is normal because businesses are looking for delivering more transformational changes to their own operations, and as a result they use Vodafone to drive down their cost.

The next slide is on convergence, here there is debate surrounding convergence, specifically in the consumer space. It has intensified over the recent month. As a result, let me spend few minutes reviewing the latest developments in this area, and re-emphasizing our approach to convergence.

In Europe, it is clear that operators in some countries are accelerating their convergence strategy. This is most evident in Spain and in Portugal, where incumbents have launched quad-play offers. Also cable MVNOs are active in this space throughout Europe. So customers’ appetite for convergence product is being successfully stimulated. This was, I would say, already established in enterprise and it is now becoming more visible in the consumer market, partially also because of the need to optimize household spend throughout Europe.

In those specific markets we have been able to launch competitive quad-play offerings, even if we are currently unable to compete on the product base – on the fiber based product. So I highlighted in our half-year results, we are confident that the – let me call it fiber antitrust regulation will provide some protection for new incumbent operators, albeit effective enforcement will vary by country, and we will therefore not count only on regulators in this space.

So as a result, our strategy, I confirm today, is to provide unified comms services using a country by country approach. And here we will do it by doing different things. First of all of course accelerating the successful enterprise unified comms strategy, the One Net example that I already described. Second, negotiating wholesale access to NGN and access infrastructure with regulatory protections, where we feel this is solid. In the slide we put BT in the UK as an example.

Third and are considering fiber deployment, possibly we have co-investment, but also alone. Here the examples would be Portugal, where I have authorized our operation to increase our FTTH deployment. We cover today 200,000, about 200,000 homes and we have between 30,000 and 40,000 IPTV customers. Here we are out to increase our presence directly owned with fiber-to-the-home in the main urban areas, or in Italy in a different way through the Metroweb agreement.

And finally and/or we can also add value when it is value creating acquisition of assets, Cable & Wireless, so tests are clear that Andy has referred to is the fourth thing. Now, of course, a combination of these strategies also at market level is and will be possible. So overall the objective is to provide unified services in every market where there is demand.

Moving to page 15, during the quarter we continued to make good progress also on driving efficiency and standardization across the group in implementing cost saving initiatives in order to deliver the stated GBP300 billion organic Opex reduction target by the end of next year. These initiatives include firstly the reduction of network Opex. We have began our UK active sharing with Telfonica, and we will start using 18,500 sites by 2015.

In Ireland we have entered into passive sharing agreement with Hutch, and we are targeting 2000 sites by 2015. Second, we are working on the IT front, software and application efficiencies, we continue to centralize software procurement and we stop supporting legacy applications, both of which have clear opportunities for savings.

Thirdly, our Shared Service Program has been accelerated. Today, 7400 employees have been migrated, driving process efficiencies and clearly labor costs arbitrage. And finally we are on track to deliver our 10% reduction in support cost.

Finally on the last page, the outlook for 2013, across most of Europe I expect macro, regulatory and competitive headwinds to continue. As I highlighted earlier, also convergence in enterprise and increasingly in consumer is gaining more traction. And we also expect on the positive, healthier competition between ecosystems as the likes of Blackberry and Nokia mount their comebacks, and Windows phone gains in popularity.

LTE will become even next year increasingly more important as new handsets and commercial offerings enter into the market, and the tablet adoption is set to reach the mass market with all the new models being presented.

So against this backdrop, what actions are we taking to mitigate the headwinds and to support the current and future growth opportunities of the business. Firstly, as I said and I want to reiterate again, we have successfully launched Vodafone Red and we expect the roll-out of this program to continue and be enhanced in our other markets during 2013.

Secondly we continue to invest in the network to ensure that we are ready to support the rapid increase in data, and the roll-out of new technology.

Thirdly, we look to both strengthen our position in convergence and manage our mobile operating systems relationships more profitably, and finally we continue to focus on driving cost down across the group and we are on target to deliver our GBP300 billion organic cost reduction target in Europe by ’13, ’14.

Thank you for your listening. Now, Andy and I will be very happy to take your questions. Operator, back to you.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question is from the line of Simon Weeden at Citigroup. Please go ahead with your question. Your line is now open.

Simon Weeden – Citigroup

Thank you very much. I have got a couple of questions. One is, I wondered if you wouldn’t mind elaborating a bit on a comment Andy made early on on the transition to the unlimited voice plan, we will have a visibility impact on the messaging and voice, I just wondered if you could spell out a bit more on what – you know, it looks like if you go from 100% postpaid, not on unlimited plans, will be something more like 50%, or 60%, or should we – are we going to see kind of a slowdown in data revenue as a result of that for example? And the second question was just on Germany, where I think if I’m connecting up the right comments, you were talking about quite a big improvement in share of gross additions on postpaid resulting from Red, and maybe I have the wrong country, but at the same time we saw a negative net add quarter in any case, but perhaps if you can just expand a little bit on the competitive dynamic in Germany, and what is happening. Thank you.

Vittorio Colao

Yes, Simon, let me take the first one and then I will leave Andy to probably clarify the second one. First of all, you are really basically burning my speech in Barcelona, the Mobile World Congress. But I will give you nonetheless the answer, I really think that we through Red we are addressing a big secular change in communications.

Customers are very happy to have unlimited voice and unlimited SMS, and this addresses in a drastic way the whole over the top discussion. So it is a strategic move. We have customers who are super happy with this, and it is also a very good thing because it brings back into our hands a service that otherwise could have been split between us and the over the tops.

Clearly there will be, especially now in the initial phases some dilution effects because the first ones who take it are of course the ones especially in the UK and Italy where we are receiving higher bills. But then this is the beginning of a program, you can look at the US as a good example where the ARPU is under – as mentioned, keeps going up, where you can enrich your offers, and when you can basically build on the trend of the future, which is data really, and increase the entertainment and productivity usages.

So I think it is a broader thing than just the introduction of a very successful pricing plan. I think it is the industry or I hope the industry, but for sure Vodafone’s answer to the move to all IP networks and you know, ubiquitous unlimited communication. Andy, but this is my speech in Barcelona. So please don’t repeat it.

Andy Halford

Simon, just on your first question, we will try to do the simple version of this, clearly when people are just paying for a bundle trying to decide how much of that is for the voice part, how much is for messaging, how much for data is a little bit arbitrary. The rules say we needed to look at how much one would pay separately for those individual components if one were buying them separately, and sort of allocate on that basis.

The concept of buying separately is becoming much more difficult as unlimited becomes much more proliferated both on messaging and now on voice, and hence getting separate points of references is not becoming the easiest thing in the world. So we’re actually giving some thought just to how we might look at revenues going forward and see whether there is a more informative way of looking at them, but it will have a slightly depressive effect on messaging, and hence move slightly more into the other spaces as we go forward.

Simon Weeden – Citigroup

Germany?

Andy Halford

Sorry, Germany, your question was what, on the net add side of it?

Simon Weeden – Citigroup

Net and gross add balance seemed to be receiving different directional comments.

Vittorio Colao

Yes, let me pass the microphone to Philipp Humm, who is among the people who are in the room. Philipp.

Philipp Humm

Yes, hi Simon. Simon, our share of or let us say the share of Red plan of our overall gross adds increased, and so it is now up to 67% in the segments where we launched Red, which is basically consumer postpaid at this point in time. So the comment was not meant to say that overall our gross adds went up because of that. But it is really the share.

We continue to focus on high-value customers and we’re not trying to eat up the market in Germany from a SAC point of view.

Simon Weeden – Citigroup

Got it. Thank you very much.

Operator

Our next question is from the line of Akhil Dattani of JP Morgan. Please go ahead with your question. Your line is now open.

Akhil Dattani – JP Morgan

Yes, hi, good morning. Just a couple of questions please. Firstly on restructuring, and you mentioned that you have taken initiatives in a couple of markets like Spain and Australia, so I just wondered if you could help us understand what the quantum of restructuring charge could be this year, and maybe if there is anything we should think about into the subsequent year as well. And then secondly, on KPN, we have seen an interesting announcement or development in that market from KPN in terms of their equity raising. And the comment from them has been that they have been more commercially aggressive already into Q4. So I just wondered if you could help us understand whether and either the German or Dutch market you are seeing any sort of changing competitive behavior from them, and whether that leads to any change in dynamic as part of your concerns, thanks a lot.

Andy Halford

Let me take, Akhil take the first one, so the restructuring, we have said next year we will take 300 million out of the run rate of the Opex, there clearly will be costs associated with doing that. At the moment I will be thinking we would be looking at getting a payback of about a year on that. So to put it the other way around probably a charge of around 300 million at the end of the year, but then getting that pay back within a 12-month period.

Vittorio Colao

Yes, Vittorio here, on the KPN question, I agree with you that the definition of their announcement was interesting yesterday. To be honest I read their words more as a statement of intention for the future rather than a description of the past. We have seen some I would say, yes, there is a little bit more activity on the b2b front from KPN. I think in the Netherlands we are still doing well, and in Germany it is not KPN who has the biggest part of our focus and attention on mind. But of course I read more of the prospective implications of their statement rather than finding a huge amount in the past quarter.

Akhil Dattani – JP Morgan

Fine. Thank you.

Operator

Our next question is from the line of Justin Funnel of Credit Suisse. Please go ahead with your question. Your line is now open.

Justin Funnel – Credit Suisse

Yes, hi. Just on tiering, obviously the move to Red has started, and it is probably early days. Just wondering about your early thoughts on tiering, on data tiering, I think when you first moved into these sorts of price structures two or three years ago, it was quite a disappointing up tick of higher tiers, and not many customers buying a bigger tier every year. I'm just wondering if you're starting to see a better trend, more customers buying a bigger data bundle in the last 12 months. Secondly what your thoughts are about as you evolve these plans, going to more of a share – shared data, share everything structure, which seems to be driving very good growth at Verizon Wireless. Do you think there's the same opportunity in Europe? Are there, for example, a lot of tablets that are yet to be attached to the mobile network where you could get some upside?

Vittorio Colao

Yes, Justin, thank you for the question. It is always the – let me say we have evolved our thinking on tiering, mostly as a consequence of learning, lessons learnt in the US, and also the role of over the top players in Europe. So we still believe that and we have evidence that as I said in my speech that customers are using data more and more in Europe. I think individual level is going up, and that is good because it means that there is more of a trend towards the American if not the Korean levels.

And so I do believe that over the future as Andy also said, we will be looking at ARPU more and more as the real indication of the value delivered to the customer, and the customers will start thinking 1 Gig, 2 Gig, 3 Gig, whatever is my level I will buy whatever package is there.

The approaches we have taken for Red is for the time being more to make sure that when the customer get out of the shop, they don’t have to immediately upgrade. So they feel worry free for a while, and then volume increase will basically push them into whatever price bucket is the right one.

So if you feel a tiering approach is on the data component and it is more generous than what we started with. If you remember we started with 300, 500, we are more kind of around 500 I Gig recommended package. On the evolution, as I said, Red is not a pricing plan, is a strategic perspective.

So we will expand it. We will extend it in several directions. For sure prepaid will be covered, and we will be covering in smart ways, which by the way required quite a bit of IT expertise, which is good. I will not comment specifically whether it will be exactly the same as in the US or with different variations. You have to keep in mind that US is a market that has been used to family purchasing and family discounts for many, many years.

And in Europe instead we have prepaid, which is the classic enter products for the younger part of the family. So there might be differences, but the philosophy is the same.

Justin Funnel – Credit Suisse

Thanks very much.

Operator

Our next question is from the line of Nick Lyall at UBS. Please go ahead. Your line is now open.

Nick Lyall – UBS

Hello, good morning. It was a question on Spain please, on the subscriber losses in the churn, I wondered, is it possible to explain how much you think is due to the previous subsidy cuts, and how much is due to a lack of fixed, or at least a lack of fixed presence, and if it is a problem on fixed, what do you think the problem is, is it brand, or is it regulation and network, and where would it fit on slide 14 please. And second, is it possible to ask just on Verizon, just a blunt question please. In principle, are you considering any changes to the Verizon shareholding, if it gave you more flexibility to buy back shares, cover the dividend faster, or to buy fixed in Europe? Thanks.

Vittorio Colao

Yes, the first question is real longer. It requires a real long answer and the second will be much shorter. First of all on Spain, you need to – as I said there has been an impact of converged offers in the market. We have responded with Vodafone Red, inclusive of DSL. I have to be honest we have less strength than Telefonica in that space, and we have less credibility than Telefonica in that space.

So we have a good early answer, but I think all the operators, not just Vodafone have clearly seen a decrease in the segment of the converged offers due to the Fusion offer. In this segment of instead of the pure mobile connections, or let me say for those customers who still buy pure mobile, we’re doing very well in Spain in the high-end with Red, and we’re losing in the mid to end to let me say MVNO low frills type of like I think most of the market.

So you can say that the Spanish market is really becoming like three things, there is a high-end mobile, there is a converged, and there is a low end, low-cost. The economic conditions of the market and the economy unfortunately clearly give different weights to the different offers. We’re not able, as I said today, to replicate the fiber based offer of Telefonica. I think it is unfortunate and it is wrong from a regulatory point, but we also will fight it, but we will not just rely on regulatory protection because otherwise we could become very old from that.

On the Verizon question, first of all we are pleased with the performance of Verizon, which keeps being a terrific asset, and a terrific asset whose benefits are clear, accruing now also to the Vodafone shareholders. The board regularly looks at the situation. When I say regular it means really regularly, and of course, we keep discussing with Verizon the future of the partnership, how to optimize it, whether it should continue or not. When we have news, I’m sure we will update, but for the time being that is where we are.

Nick Lyall – UBS

Thanks very much.

Operator

Our next question is from the line of James Britton at Nomura. Please go ahead with your question. Your line is now open.

James Britton – Nomura

Thanks very much. I had two questions please. Could you possibly update us at this stage on the board’s thinking on the forward dividend policy, is consolidating cash flows a relevant measure for dividends given the contribution of Verizon Wireless to your bottom line that is the first question. And then secondly, on the accounting changes that you reference, can you just explain the reasons behind the 400 million cash flow adjustment from the accounting changes on March 12, is this actually linked to the 4G license payment in Italy, or is this GBP400 million number a good guide for the potential adjustment going forward?

Vittorio Colao

Yes, let me just take them in order. Obviously we are not giving guidance now on future dividend commitments. That is a decision that the board will take sort of in a short period of time. The current 7% expires in May as you know. What I would say is the board are going to look at this holistically, and obviously this will not surprise you we will look at the cash flows from our control businesses, the dividends, the spectrum payments, the dividend commitment out, et cetera in forming a view. The board are very clear that the ordinary dividend is the primary form of remuneration to shareholders, and that many of those shareholders are very keen that we would be maintaining that as we go forwards, and I think at this point in time, I will sort of leave it at that, and obviously when the board deliberates on that we will let you know what happens.

Your second question on the change of accounting, we are also to publish more pro forma intimation on this, but on the cash side of it, the change is actually not to do with spectrum payments or anything like that. It is just that on Italy we will move to essentially a cash received basis as it is in our share of the dividends that are paid out in the business rather than just doing it on the proportionate cash flows generated. So it is the extent that the dividend pays out all the cash, it will not make much difference to the extent there is a difference in the dividend the cash generated, then it will cause a slight difference.

It is the way the reporting requirements are changing, absolutely nothing substantively is changing our ability to get cash out of the business at all. And I think that is the key point to be aware of that.

James Britton – Nomura

And can I ask if that GBP400 million is a good guide for the adjustment as of next year?

Vittorio Colao

It all depends on the dividend payments. So, you know, year by year it could change a little bit, but as I said we will do an update shortly on that, but substantively we absolutely can influence and control the cash dividends out of that business as much as we ever could in the past. And that really is – there is no change, this is just purely a reporting issue.

James Britton – Nomura

Thanks.

Operator

Our next question is from the line of Robin Bienenstock of Sanford Bernstein. Please go ahead with your question. Sir, your line is now open.

Robin Bienenstock – Sanford C. Bernstein

Yes, thanks very much. I have two questions if I may. The first is you said that Red isn’t a pricing plan, it is a strategic perspective, but I guess I would like to know whether you think that it is a strategic perspective rather than market structure that is going to make European revenue growth catch up with American revenue growth. My second question is more of a high-level question, which is just some of the largest telecom groups in the world are getting bigger, you have seen (inaudible), and Softbank, and now AT&T talking about getting bigger, so I’m wondering whether you think that scale is going to be more or less important in 2 to 5 years time? Thanks very much.

Vittorio Colao

Yes, the first question Robin, the world is not white or black or either or, the world is also made of end to end and other things. So there is two angles here. It is not that the strategic perspective takes away the validity of the industry structure, nor vice versa. What we are facing is a big change of network and technology. We are going to kind of flatter networks, IP, all the things that we now over the top layers. The pricing and the strategic approach to this is very important, and is very important to define the role or the relationship between the operator and the customers in the future. That is why I said Red is not just a pricing plan, it is more, because it is enabling customers to do what they want, and setting them up to use more and more our services like it is the case in the US.

So in that sense, of course, it is very important. It is not an either or if you ask me, an industry structure helps, of course, an industry structure helps and is very important, so you need to work on both. And therefore to your point also the industry structure is very important in Europe, and the way operators invest and treat the investment, and the requirement on return on investment and the price are linked in this sense.

So it is not an either or, they are both very important. On the scale thing, again, scale is important. Scale in the relationship with suppliers is important. We see it on a daily basis with continuing requests from our partner markets to be included in our purchasing agreements, and not totally enthusiastic response from our suppliers, which clearly indicates that there is an advantage in scale.

Same thing with Verizon, where we keep having cases where either one of the two partners finds out that you can save money or get more out of suppliers. So scale has importance, and will have importance. Of course, again it is not an either or, it also needs to be very focused on local market conditions because if a local market you are not taking into consideration, what a maybe smaller player does from a competitive point of view you might find yourself with the savings on the cost side, but not the customer loyalty.

So it is not black and white. You need to do both.

Operator

Does that answer your question?

Robin Bienenstock – Sanford C. Bernstein

Thanks very much.

Operator

We now go onto Andrew Beale of Arete Research. Please go ahead. Your line is now open.

Andrew Beale – Arete Research

Good morning. I just wonder if you can talk a little bit about what Red tariffs do to absolute EBITDA per subscriber sort of now and in the future. And I guess I’m thinking that you are getting a little bit higher fixed APRU, a bit less variable APRU, perhaps a little bit more SAC, and payments in the short-term. But longer term you are obviously taking away the added bundle decline. So I’m just wondering what sort of breakeven profile you see on those tariffs?

Vittorio Colao

You basically gave my answer, thank you Andrew. You missed one small thing, in the short term we can have – one measure is ARPU dilution, but also EBITDA dilution. In the short term in markets where termination rates are still a factor, we might get also a little bit dilution because those customers are liberated, and they make more cross net calls, and this might imply that we get on those segments a little bit of imbalance, timing versus termination rates paid. Now I always say it is bad in the short term is good, because the more people say, ‘oh, I call you because, you know, with my Vodafone Red tariff I don’t pay.’ The more you convince the other that maybe also the others should go on the Vodafone Red thing.

And with mobile termination rates today, unfortunately becoming less and less relevant from a P&L point of view, eventually it is not a very – short-term could be bad but it is not a wrong strategy. So everything else you said is right. I mean more fixed commitment, lower churn, in the short and you can have some SAC because they get better phones. Red is also, and again this is another piece of my Barcelona speech, it is also a different way of presenting our service to customers, a big discussion about subsidies, non-subsidies, the Spanish model and so on.

At the end of the day the way we are now changing the sales processes, you first pick your price plan, then you add your phone, and you can choose A, B, and C. It made sense because we have now A, B, and C, and we not only have AA, or A and it starts with A. So it is more than just the things that you said, but it is essentially the things that you said.

Andrew Beale – Arete Research

Okay, can I just ask you a little bit about the cost, I mean the cost saving programs you have indicated that you will increase the restructuring charges, but you haven’t changed the cost of guidance, is that just because it is not a material increase in the restructuring charges, or is it that this is something for next year, next year’s guidance?

Vittorio Colao

Well, Andrew, what we have said is that the Opex for next year, excluding restructuring charges, we are expecting to get the ongoing down by 300 million. What I said earlier is roughly there will be a charge of 300 this year in order to execute that, but by inference it is a sort of 12 month or thereabouts cash payback.

Andrew Beale – Arete Research

So the charges are not increasing versus what you had said at the full year?

Vittorio Colao

No, I mean, I don’t think we put a full year number on it previously.

Andrew Beale – Arete Research

Okay. Thank you.

Operator

Our next question is from the line of Nick Brown at Espirito Santo. Please go ahead. Sir, your line is now open.

Nick Brown – Espirito Santo

Thanks. Two questions please. Firstly if I can follow up on Germany, KPN has indicated it is going to be more aggressive this year in fighting for market share in the consumer segment. Given some of your other competitors not responding in kind, will you be happy to accept a certain level of market share loss to preserve margins, secondly the weakness in the UK, it looks to do with more than just macro weakness, and I think you said prices are coming down from a relatively high level, with the mobile spectrum auction industry indicating it is going to be aggressive in 4G pricing, how do you think you can stabilize service revenue declines here?

Vittorio Colao

Yes, why don’t I take the last one, which is more strategic on 4G, and I will let Philipp Humm take the Germany KPN thing, and the UK one. I really will like to keep it at high-level. First 4G, we are still in some markets paying for the spectrum, or not even have the spectrum. I think it is a premium service. I share the everything everywhere stated position in Italy, in Germany. In Portugal we have a premium on 4G, and I think it will be healthy for the return on the capital that we have or will commit to put and position 4G at a premium.

Of course you must deliver the service, or the service must be a better service in which I do believe. So I am more for there must be at least initially a better return on 4G customers, who by the way seem to be willing to pay it now. Other players might have different policies, I mean it is good for their shareholders. We will see. Same comment a little bit on Germany, we are not – sorry, it is a main market. We are not willing to give up value customers or customers who have long-term value with us.

We are very, very keen to have a strong market position. I said Red is part of it. It will be extended. It will be improved, but I am – here we are really focused also on the value that these markets have to create and the capital amount that you put on those markets. Having said that for the details of the answers I think Philipp is more appropriate to give an answer.

Philipp Humm

Yes, maybe just to address both questions in Germany and the UK, in both cases we are really focusing on maintaining and improving our market share, continuing to focus on Red and on high-value customers. Network improvement all the things which really enhance our brand. We are not really interested in eating up in any way the markets, but we will obviously have to observe what the competitors are doing in the respective market and then decide on our answer accordingly.

Nick Brown – Espirito Santo

Thank you.

Operator

Our next question is from the line of Paul Marsch at Berenberg Bank. Please go ahead with your question. Your line is now open.

Paul Marsch – Berenberg Bank

Thank you very much. I have two questions. Do you think that Q4 could be the low point for the trend on organic service revenues for the group? I mean it feels like service revenue momentum in India could possibly improve, South Africa judging from the call yesterday, it sounds like some of the calling card abuse factors fade that you might get some improvement there. So I’m just wondering if we should be looking at Q4 as the sort of low point in the declining trend. And then specifically on Spain, and the fiber wholesale challenge, is the problem in Spain for you that you can’t make a margin on the Viva tariff that Telefonica has introduced, or is it actually the access to the physical infrastructure that is the problem. And when will you be launching your challenge to the regulator in Spain?

Vittorio Colao

Yes, let me take the second question. Then maybe Nick can give – Nick Read can give some directional answers on South Africa and India. I doubt that we give quarter-by-quarter guidance on the next quarter and which one is the low point or things like that. But you know maybe there is a value still in commenting on how India and South Africa are going.

On Spain the issue is not the physical access, it is the pricing level, and it is the operating conditions around it. VULA type of access is something that can look good on paper, and be horrible operationally, or can be great operationally, but leave you zero margin and therefore there is zero incentive to do it.

As I said, we are challenging it. So we’re already active locally and once we have exhausted the local process, we will go to Brussels and Brussels I’m pretty sure will have a much higher sensitivity to this than the local authorities. Having said that that is not going to be our only alternative because, of course, I don’t want to have grey hair when the solutions are found. And therefore we will also work on alternatives.

Nick, not with quarterly, detailed guidance by quarter answer, but overall India and South Africa comments.

Nick Read

Yes, what I would say is that yes, I think from a South Africa perspective, if you exclude the effect of the leap year, you may start to see some marginal improvement into Q4 over Q3. Specifically talking about India, we have suffered a hit from the consumer protection regulation and new subscriber verification rules, which will continue to dampen in the fourth quarter on top of the leap year. So I think it will be more into next fiscal year you will start to see the improvement.

Paul Marsch – Berenberg Bank

Can I ask a follow on?

Vittorio Colao

Sure.

Paul Marsch – Berenberg Bank

I just want to – by listening to the call yesterday from Vodacom and M-Pesa, you seem to be accounting for about almost 20% of Vodacom’s international growth, it was 4 percentage points of the 22% International growth from international. Management is saying that it is 40% EBITDA margins right. Why shouldn’t I be getting quite excited about reading across from that to your launch of M-Pesa in India?

Vittorio Colao

Well, first of all if you get to be very excited about our launch of M-Pesa in India, I mean feel free. I do believe it is a great thing. Honestly the power and the opportunity coming from mobile money transfers in emerging markets is absolutely evident, and the positive cases of not just Kenya now, but Kenya, Tanzania, and the launch that we are making in other markets actually are there.

In terms of detailed economics, I’m not sure how the math works. Nick, you want to comment on that. It seems that we cannot extrapolate African conditions into India.

Nick Read

No, exactly. The operating model and business model varies by country depending on the regulatory conditions.

Vittorio Colao

And the regulations in India are different and we have bank partner there, and you know, you cannot take the money out. There is many other differences, but please keep your excitement on the concept and the customer acceptance because I agree it is great. I think the economics will be again country by country refined.

Paul Marsch – Berenberg Bank

Thank you.

Operator

Our next question is from the line of Jerry Dellis at Jefferies. Please go ahead with your question. Your line is now open.

Jerry Dellis – Jefferies

Yes, good morning. Thank you for taking my questions, two please. Vittorio, I just appreciate your comments on the recent statements from Hutch UK management that don’t intend to price 4G as a premium. They have already set I think quite an aggressive price point of about GBP36 increase in the '80s, may be GBP30 ex that for what effectively is unlimited voice and data with a heavily subsidized device, given you’re your contract APRU today is about GBP32. I just wondered how you think you will be able to push that up going forward, and then the second point is really just to do with termination rates, especially we're rapidly approaching quite trivial levels of MTRs across Europe. We're seeing what has happened when that occurred in France and more recently in Italy, just thinking about how you think you will sort of preserve your sort of scale as you are sort of on net benefit begin to erode in more markets going forward. Thank you.

Vittorio Colao

Yes, I think the second is, Jerry, an easy answer. It is exactly why I said the Red is a change. We played with Red ahead of or at least in most of the cases ahead of competition. We, as I said, I want customers to be happy, to be worry free, and we are replacing gently and gradually the concept of I'm staying with Vodafone because I have a great network and an unmet advantage with, I stay with Vodafone because I have a great network and a great pricing plan worry free, I can call everybody.

Of course it requires more investment I mean, all the things that I talked about for probably the last year, you know, great shops, great experience, better customer care everything else that supports a new positioning vis-à-vis the customers. So you're right and that's why we are doing what we're doing. On Hutch, listen you know, everybody does what they want. We will play it in the market. We will see. We have plans on how to improve, increase, enhance customer advantage on Red. Eventually we would always be competitive and if the UK market will be less profitable than others, I mean, by the way it is already less profitable than others, be it we cannot comment on you know, on other people’s strategies. Philipp is there anything more that you can add?

Philipp Humm

You know, it is maybe just a comment, we continue to focus on our quality attributes and if you would take our Red plans again, we have for GBP37 unlimited voice and text and 1Gb including a device. Assessing we are from that point of view already competitive, we were always able to sustain a price premium as a quality brand and we will do whatever is needed to continue to enhance the quality of our brands so we can continue to sustain a price premium.

Operator

Our next question comes from the line of James Ratzer at New Street Research. Please go ahead with your question. Your line is now open.

James Ratzer – New Street Research

Yes, thank you. Two questions, the first one, just following on from the last on the UK business, you say in a statement you have seen lower out of bundle usage, and you also say you've seen positive uptake of Vodafone Red. I mean, are those two statements directly linked to each other. I'm just wondering if you could therefore say what percentage of your base in the UK now take Vodafone Red. And what does that mean more revenues in the UK could be at risk of that trend. And the second question just to go back to another you raised earlier on your stake in Verizon Wireless, do you and the board think that your value of the Verizon Wireless stake is fairly reflected in the current share price, and the fact that you're buying back stocks make me believe that you think it is not fairly reflected. And what do you think is the best way to get it potentially fairly reflected in the price, and there has been more commentary from Verizon about doing a deal. I mean do you think some form of compromise deal is a best way to unlock that value gap. Thank you.

Vittorio Colao

First of all, on the UK it's a combination, it is not only that but it is a combinations. For sure we have less, the moment when you have more Red customers, by definition you have less out of bundle because you know, out of unlimited, there's nothing. So mathematically you can hire out a bundle and there is a little bit of optimization and lower segments, I would say attitudes to optimization to saving and all these things, and honestly how much is one, how much is the other is difficult to say.

I can tell you that and again this is a little bit ahead of what we wanted to do today. That Red is today just a bit less than 10% of our customer base penetration, higher in consumer contract, lower in business, and therefore it will continue going up. My intention is to have Red representing at the end of the next financial year, a pretty relevant part, not the majority of course, but a pretty relevant part of our revenues. As I said we have it now as an enterprise, not everywhere.

We will have it everywhere in enterprise. We will have it prepaid and eventually also the question on how much is Red will be difficult to answer because it will be basically the new pricing frame work for Vodafone. On the Verizon thing, we keep discussing. It is difficult for me to say whether the value is fairly reflected because I should know exactly how much is attributed to Verizon, how much is attributed to us depending on which one you set first, the other one is probably undervalued. But difficult to say which one of the two is less appreciated. Of course, the board keeps looking at how to make sure that the true value of our assets, all of our assets not just the Verizon one, is reflected in the stock price.

Operator

Our next question is from the line of Nick Delfas at Morgan Stanley. Please go ahead with your question. Your line is now open.

Nick Delfas – Morgan Stanley

Yes, thanks very much. First of all you said you will not count only on regulators to solve the conversions problem. I guess this could either mean wholesale agreements with cable companies or M&A. If it doesn't mean M&A can you issue some kind of commitment not to issue new shares at the PLC level. Obviously, the rating on your shares is low compared to most things you might want to buy, and secondly you're starting to have a real LTE base in Germany. How do those customers look in terms of usage per month and how do you think that will change the competitive environment, and do you think that could actually reduce the need to worry about conversions.

Vittorio Colao

Thank you Nick for your questions. This gives me also the opportunity to offer Steve Pusey the opportunity to make some comments about usage of LTE customers in Germany and how it has looked like. On the – we're not just relying on the regulators point. I mean, I can take the easy example of Portugal. I do believe that the Portuguese authorities should, I'm sure that there is appropriate wholesale of fiber but at the end of the day as I said we just reopened the works for extending our fiber coverage in Portugal.

We will do more Lisbon, more Porto and more in the other cities, and we will invest our own capital, not even co-invested probably. So we clearly will have dual strategies in most places. Clearly M&A as in the case of Telestra or Cable & Wireless is on the cart, and you know, it is pure speculation to discuss you know, things that are not in front of us. So not even getting close to the funding question that you're raising, but as I said we keep all possible alternatives open. On LTE, Steve, do you have anything?

Stephen Pusey

Yes, good morning Nick. Quick answers for you, of the – as you heard earlier the base one could consider in two parts the fixed mobile substitution base, and the pure mobile base in terms of traffic utilization. On the fixed base, we are seeing traffic levels of about 13 Gb to 3.5 Gb per month reflecting you know, quite healthy fixed usage, and that looks like sort of normal. We are all moving towards suburb and DSL base one would find in most countries.

So it is certainly acting as a substitution there as one goes into the cities, and much larger usage requirements and entertainment requirements. I don't think it could act as a sole substitution for a converged offer. Mobile usage itself is slightly up on the general 3G. So that's healthy reflecting you know, probably slightly faster modems, but it is not spectacularly different on today's traffic levels that we see from very aggressive 3G users in the cities, et cetera.

Nick Delfas – Morgan Stanley

Great. Thanks very much.

Operator

Our next question is from the line of Lawrence Sugarman of Liberum Capital. Please go ahead. Your line is now open.

Lawrence Sugarman – Liberum Capital

Good morning. Just a couple of questions on India following up on questions asked before. It seems there has been some news on pricing, and in a more positive direction, I just wondered what your views on those were and whether you think this is the start of a more positive trend, and secondly there's a lot of discussions around the pricing of spectrum, and it doesn’t look like parties have reached a sensible agreement at this stage. Do you think that that is likely to happen in the near term or would it be something that continues to be a problem in terms of investment going forward.

Vittorio Colao

Nick, you want to take the questions?

Nick Read

Yes, so in terms of pricing, yes pretty much this year it is stabilized I think. We are increasingly seeing signs of price hardening in the marketplace with sort of a lot of promotional minutes being removed from the marketplace. So I think you will see that as a trend through quarter four into next fiscal year in addition obviously to the data growth, and probably towards the later end of next year in terms of again average base size growing again post the news subscriber verifications rules.

In terms of spectrum, we have a spectrum auction on the slate for March. I think we have been totally consistent for the past year in say a number of the circles both in the November auction which for all intents and purposes failed, and this auction are overpriced relative to international standards. So I think we have to see what the demand is in this particular auction.

Lawrence Sugarman – Liberum Capital

Thank you.

Operator

Our next question is from the line of Ottavio Adorisio of Societe Generale. Please go ahead with your question. Your line is now open.

Ottavio Adorisio – Societe Generale Securities

Hi, good morning gentlemen. I have a couple of questions. The first is on free cash flow, basically we don't have a cash flow statement. So it is difficult to reconcile new adjustments to get to a 2.7% increase net of Forex or M&A. Looking at the fact that most of the cash flow is euro-denominated, and being the euro is down only 6%, I basically get only GBP90 million impact negative. Because you have the negative impact, the year-on-year is GBP270 million. I was wondering if M&A, basically – and if the impact, this GBP170 million, it's all due to Cable & Wireless? The second is a bit more strategic, and it's about the Red tariffs. Now there's been a lot of talk during this conference about the Red tariffs and what it can do to the competitive environment. Now let's say that Red tariff will be up and it will be successful in gaining market share. And my question is that would it stop competitors offering the same and trigger competitive downwards re-pricing, with the final outcome being more value being transferred out of the industry towards consumers? And the third is just a clarification; it's not a question. I heard Andy mentioning towards his speech that due to drags from macro and MTRs, in the next quarter we could have 150-basis-point deterioration of year-on-year growth from ante revenues. Now I don't know if this is correct or not. Could you please clarify? Thanks.

Vittorio Colao

Why don't I take the Red answer and then I leave the others to Andy. The – again Ottavio, I have to go back to my answer to Robin. Life is not either or. You have to do certain things and but of course other things also have to be right. The point you raise is applicable to everything. What makes it impossible for competitors to be below you whatever you do is always true. So yes, of course, we can go over to Red tariffs. Everybody could get into the kind of American model and everybody can eventually rise to the bottom.

It can happen. But at least what you have been doing here you're taking away all the intermediation risk from the over the top. You make the customers happy and more loyal and more grateful for what they get, and you get the customer’s focus on data and data usage, which is the future of our industry, and not metered SMS and maintenance usage, which was not. So as I said in my earlier answer it is never only one thing that makes you win.

It's about how you run retail. It is about the network, it is about the services that you add. It's about the cooperation with other parties. We have not discussed in this call but we know you're doing a lot of cooperation with WiFi providers, the London Underground, and now will be enabled through Virgin. We do a lot of co-operations with content and media owners. Here in the UK we announced the telegraph, but we have similar things everywhere else. It is never a single thing that makes you, you know, unbeatable because by definition there is not a single thing that cannot be copied. We have to take a broader view and the industry structure point that Robin raised before is also right on free cash flow and --

Andy Halford

I mean, the free cash flow is about 250 lower in absolute terms, and so about a third of that is M&A and two-thirds is FX. The FX is not limited to the euro. It is also the rupee, which was slightly higher than the euro rate of change, and South Africa, and the Rand there also. In terms of the other question, the leap year and MTR quarter-on-quarter effect in aggregate, yes, about 1.4 percentage points of additional drag compared with the third quarter.

Ottavio Adorisio – Societe Generale Securities

Thanks.

Operator

Our next question is from the line of Stephen Howard of HSBC. Please go ahead with your question. Your line is now open.

Stephen Howard – HSBC Bank

Thanks very much. I had a couple of questions on the regulatory environment. Firstly, what do you think the implications would be if any of the incumbents are demanding the ECU was to decide that it wasn't any longer necessary to subject markets fix that if the market for terminating segments of least lines to ex-ante regulation. What I am really interested here is can you still cope on the backhaul side of things, and on the topic of convergence, obviously one of the options it has been discussed today is negotiating wholesale access to fiber. I recall Vittorio at the ETNO conference in Brussels last year you threw down the golden words to the incumbents challenging them to deliver on equivalence. What I would like to know is are you more or less confident than you were back then for the regulations are actually going to be enforced, and certainly those comments on Spain suggest you're no more confident. Thanks.

Vittorio Colao

Yes Stephen. I know you're a very acute observer of what's happening on an incredibly important area, which is where business crosses regulation. On the first point, market fix, we have again different situations in different markets, which is why we always have a self build component of it, which today Steve is…

Andy Halford

81% self build today.

Vittorio Colao

Yes, which is pretty, pretty relevant, which means that we of course take advantage of good conditions where good conditions are there but we cannot 100% rely on good conditions. To be honest Cable & Wireless as you know, was part of the story that are organic investments that we are making in South Africa, in India, of course there's the TelstraClear thing in New Zealand. So every market has its own mix of I rely on good commercial deals, but of course, we also need an alternative you know, which we have to build ourself.

Conference in Spain I don't know, I mean I cannot comments on specific situations. There are regulators and incumbents who are there in different positions before Christmas. We made it very clear in a very formal way our position to all of the incumbents in Europe. We've got very, very different answers. To be honest there are some with whom I'm pretty confident we have reached a good agreement and others that I'm less confident. But again these are open negotiation discussions.

I don't think it will be fair to them to put in the public you know the good and the bad. So that's more or less my answer. I see that some things are changing but again we're not just relying on the protection from rules.

Operator

Our next question is from the line of Guy Peddy at (inaudible). Please go ahead with your question. Your line is now open.

Guy Peddy

Thank you. Good morning all. Just a couple of things Vittorio, do you think you actually have the tools to compete, for example, in markets of Spain and Germany, which seem to be where the competitors are sort of upping the ante currently, because you told earlier about competitive headwinds and headwinds would tend to suggest you don't have the tools to compete. On a secondary point both this week both KPN and Swisscom signaled as you're trying to grow revenues in a new data environment it is a lot more expensive delivering legacy revenues, i.e., margins are only going down in the future. It that something that you're seeing as well especially with, for example, the Red transition that basically is going to be significantly margin dilutive going forward. Thank you.

Vittorio Colao

Yes, I think Guy, we have two different things here. When I talked about headwinds, the headwinds are really more the economy, and our expectation for the conditions in not all but most of the European countries next year. When you talk about tools to compete I am confident that I will have everywhere the tools to compete, Germany more confident than Spain, but just because you know, regulatory and incumbents’ behaviors are different but you know, I will have them in Spain as well.

As I said I mean take Portugal which in theory seems more kind of a closed environment. I told you, you know, we're going to invest tens and tens of millions and you know, we're going to have them or maybe something will change. So – but physically we are in an RFP/RFQ process and we are selecting our new wave of partners and vendors for fiber and that type of technology.

So I will have the tools to compete. The headwinds you know, that is not a lot I can do on the European economy. On margins, I believe that the comments from KPN are probably of a different nature than the comments from Swisscom. I can talk about Swisscom because we talk a lot to them, they are a partner market, and we were there by coincidence a month ago.

Clearly they have a point in saying that old, new cloud-based and let me say, unified services, I don't call them conversion because it is the network that converge them but the services are unified, tend to have lower percentage margins but we need to look at the absolute margins. If these are additive, and we can drive revenue from services, it is good.

It is a little bit like our VGE profitability where some customers have a lower percentage profitability but we serve them in 80 markets and we have services on top of basic connectivity. Therefore it is a good thing. Directionally I tend to agree with the Swisscom comments. I do not know about KPN because again they seem coming from a different motivation or reason I would say, which is why we have to go into the services that are really worth.

Guy Peddy

All right, thank you.

Operator

Our next question is from the line of David Wright at Deutsche Bank. Please go ahead with your question. Your line is now open.

David Wright – Deutsche Bank

Yes thanks guys for taking the call. I know you've got question, I know you've got a lot today. It is probably following up a little from Guy to be honest. So it seems to me that from a convergence perspective you are somewhat reactive at the moment, for instance, Spain, Portugal. Obviously, the Red tariff is still very much a mobile only proposition. So it is not the case, are you reactive to convergence and not proactive, and is that because proactively could possibly mean low returns, and that obviously feed back to maybe the message you gave to Guy, is the converged service something that threatens your returns and that's why you will only be reactive to it. Thank you.

Vittorio Colao

Yes, very interesting question because I understand the psychology of it. Let me say first of all in Portugal today, in Portugal we are ready physically connected through an agreement with Sonae. About 200,000 homes we have about 30,000, 40,000 IPTV customers, which means that we already started way back I think three years ago kind of the convergence, the unified service thing. We had put the basis for that. We have not pushed because A. the regulation was different or at least the framework was supposed to be different, and quite frankly there was no market pool. So we put the basis.

We have experience. We didn't push because there was not a market pool as I said in my speech, the more this is stimulated and of course it has to be stimulated by the guys who are bigger in this domain, the more there would be demand and we will go there. In Germany, we have probably 200,000 or something little bit less than 200,000 IPTV customers, we have a network, we have offers.

Again if the market shows more interest, more demand, more appeal for that we are there. And the same applies to Spain, and the same applies to Italy. So we have been providing services for the last five years in all of those markets. The degree of intensity of investment is just a function of market demand. A small correction, it is not true that Red does not offer mobile – fixed, it is through that. It does not offer fixed everywhere but for example in Spain it does, and in Portugal it will very shortly. So I do think, I think we are, it shows that we are reactive, in the sense that we react when we see that there starts to be demand in the market. We are not reactive out of fear. We are reacting because we need to put our money where the best return is and so far the best return was on broadband and data and HSPA.

David Wright – Deutsche Bank

So just essentially that suggests that the best return is with the mobile side, so implicitly convergent services --

Vittorio Colao

I don't know because you know you need to, it depends on price levels. Again the price level at which these services can be set could be a low discount, there was a note that was written by somebody this week. I can’t remember who said well it could turn out just to be big discounting at the end of the day, or it could turn out to be the American model again, where people pay more and more for the cable connections, for their video-on-demand services, for their cloud repositories, and enterprises pay more because they basically rely on security, rely on hub hosting, and all these things.

Again you can see two scenarios. One is a pure discounting scenario. One is a, you know, enrichment and improvement scenario. It is normal that this is driven by incumbents. I'm saying I don't feel ashamed or anything in saying fine, if BT and Telefonica push the market in that direction and there is customer acceptance, I hope it will be an enrichment story and not a discounting story.

David Wright – Deutsche Bank

It's very interesting. Thank you.

Operator

Our next question – currently there are no further questions in the queue. So gentlemen, may I please pass back to you for any closing comments.

Vittorio Colao

Yes, thank you. I mean I think we debated almost everything. Let me just summarize the I would say three key messages from our point of view. One, Vodafone 2015 continues to be good performance, albeit a bit slowing in emerging markets, and data, which is the key strategic thing. We keep seeing headwinds in the economy, especially in Europe, and for that we continue to work on our cost and efficiency reduction programs, and third takeaway, we are actively working on providing unified services in all the markets where demand will be there with a variety of solutions depending on the local conditions. Thank you very much for your attention today, and I look forward to meeting you in person. Thank you, operator.

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