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BCE Inc. (NYSE:BCE)

Morgan Stanley Technology, Media & Telecom Conference

February 27, 2013 4:55 pm ET

Executives

Siim A. Vanaselja - Chief Financial Officer, Executive Vice President, Chief Financial Officer of Bell Canada and Executive Vice President of Bell Canada

Analysts

Simon Flannery - Morgan Stanley, Research Division

Simon Flannery - Morgan Stanley, Research Division

Okay. Good afternoon, everybody. My great pleasure to welcome again to our conference, Siim Vanaselja, CFO of BCE. Before we get started, please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures here in the Morgan Stanley public website at www.morganstanley.com/researchdisclosures, or at the registration desk.

Question-and-Answer Session

Simon Flannery - Morgan Stanley, Research Division

So Siim, BCE had an analyst meeting a couple of weeks ago, laid out a pretty constructive vision for 2013. You raised your dividend again. Perhaps you just -- review for us here your key priorities for the year and so what you're really focused on.

Siim A. Vanaselja

Sure, thanks, Simon. And thank you for the opportunity to be here today. Our priorities for 2013 are really aligned with the overall strategic priorities of the company. So starting with Wireless, it's really about trying to maintain the strong momentum that we've seen in our Wireless business over the last few years now, just continuing to be able to take attractive market share of net post-paid adds to continue growing ARPU and to take churn down. We're approaching the 700 megahertz spectrum auctions in the fourth quarter. We hope to be successful there. Irrespective, we're going to be continuing to build out LTE in urban areas through 2013. And hopefully, as we get into 2014 to be building out in rural areas as well. So I think we couldn't be more pleased with how well our Wireless business is going and in the prospects for growth, growth that we have going forward. On the Wireline side, similarly, I think 2013 is a really important point of progress in the business on the residential side. We've made significant investment in fiber TV and in our IPTV footprint coverage. By the end of 2013, we would expect to have IPTV built out to 4.3 million households, that is close to 7 million households in our territory. We're seeing a good takeup rate of about 85% of our Fibe TV customers taking all 3 products. So the ability to bundle and penetrate into that residential customer base and build on some of the early success that we saw in 2012, while benefiting from some of the price increases that we've put through in the residential market in the beginning of 2013, and seeing some of the customers that were on significant promotional discounts in 2012 coming off of those -- off of those discounts. So that's important. And then on the media side, it's really continuing to benefit from the attractive -- the specialty rates that we've -- agreements that we've put in place with other BDUs and seeing some escalation in those rates in 2013 and beyond. Hopefully, seeing some resumption of confidence in the advertising market, and hopefully getting approval to move forward with the closing of the Astral transaction. And beyond that, it's about cutting costs. We have, as we indicated in our Investor Day, we have a target of $170 million of cost reduction that we're going to execute on in 2013. That's going to help drive what we think is pretty solid growth in free cash flow in the range of 5% to 9%, and that's the underlying foundation for our dividend growth markets, the dividend growth strategy in the capital markets.

Simon Flannery - Morgan Stanley, Research Division

Great. Well, maybe we'll just touch on Astral first. I think the CRTCs, if you check, there's some hearings in the spring. Just talk us through the timeline as you see it and how confident are you and what's different this time versus last fall when obviously, there were some oppositions here?

Siim A. Vanaselja

Yes. Well, first, I should just correct you. There is no date that is currently set for an Astral hearing with the CRTC. As everybody knows, our original application with the CRTC was rejected in the latter part of 2012. We refiled the new application with the CRTC. We hope that with the remedies included in that new application and with the benefit spending program that we've outlined in there that, that will satisfy both the CRTC and the Competition Bureau. But it's really in their hands at this point to make that application public to set a date for a hearing and to decide on the fate of the transaction. Our agreement with Astral has an outside closing date for regulatory purposes of July 31, and that's potentially where we stand today. So we're hoping that we'll hear from the CRTC in making our application public and setting a date for the hearing.

Simon Flannery - Morgan Stanley, Research Division

Okay. And talking of waiting on Ottawa, what's the latest on getting the rules for the 700 megahertz? And there's just been some talk that it might slip into 2014.

Siim A. Vanaselja

Yes. There has been some talk about that. Simon, I don't think I'm in a better position to try to speculate on when those rules are going to come out, but I'm hopeful that we'll see them shortly.

Simon Flannery - Morgan Stanley, Research Division

So let's turn to the Wireless business, if we can. And I think one of the things that, you know Rogers was here earlier, and then we can just talk about the growth potential of the Canadian market overall, and that you have this penetration, some 20 points lower than the U.S. And I think the question I get a lot is why and what's different about Canada? And can you close that gap, which would imply that you're going to have robust industry growth for another 3, 5 years?

Simon Flannery - Morgan Stanley, Research Division

Yes. Well, I think that there's good growth opportunity in the Canadian wireless industry for a number of years to come. Certainly, penetration rates have an opportunity to increase. The penetration rate of higher value smartphone customers, which in the case of Bell Canada today, stands at about 65% of our postpaid base, certainly has opportunity to grow. And ultimately, I think 100% of the customer base is going to be on smartphones. There's unique opportunities, I think, within the industry -- that Bell has an opportunity to go after. We've traditionally had a lower market share of wireless customers in Western Canada, Western Canada being a higher ARPU market. So we've been building Bell-branded stores, sourced branded stores in Western Canada and seeing signs of success and picking up market share there. With the relationship that we have on the Wireline side with our business customers, I also think that there's an opportunity to pick up market share in the business side of Wireless. And then of course, for a whole bunch of historic reasons, when you look at Bell's Wireless business relative to the other incumbent operators, we've had lower ARPU, we've had higher churn, lower smartphone penetration. And as you've seen through the course of 2012, we've been really narrowing that gap in which some of the measures that I talked about, I think there's an opportunity in 2013 to narrow that gap further. What we're really excited about in wireless as well is the opportunity for Mobile TV where, clearly, we're the leaders in Canada, and we see great potential for that part of the market to continue growing. And then, of course, there's machine-to-machine and mobile commerce, all of which we're focused on establishing Bell as the leading market player. So all to say, nothing but good opportunities for ongoing growth in Wireless.

Simon Flannery - Morgan Stanley, Research Division

So maybe if you could just elaborate on the Mobile TV. I think you've said you might have as many as 1 million subscribers exiting '13. It's something that we're really not familiar with in the U.S., and I think some operators here would react with horror at the thought of allowing people to stream television for fairly $5 a month, something like that.

Siim A. Vanaselja

So it's really an add-on to your basic mobile plan, where for $5 a month, I think you get about 10 hours of viewing. And so it's access to a full lineup of televisions -- of television programming. Consistent with that strategy, and Kevin Crull, the President of Bell Media, talked about this at our Investor Day. We'll also be launching TV Everywhere in our markets in 2013. That is an authenticated TV service that would have live television programming, catch-up programming of television series, and a fairly robust and deep library of both movies and TV series. And this is a product that you'll be able to watch on really any screen at any time. So whether it's a television screen, Internet screen, tablet or a smartphone device, it'll be available to Bell customers, and there's also an opportunity to bring that product to other distributors and access their customer base with it as well.

Simon Flannery - Morgan Stanley, Research Division

And from the network side of things, you're able to handle the sort of traffic loads that's putting on your network?

Siim A. Vanaselja

Yes. I mean, we've, as you've seen, we've increased our capital intensity level that's been directed towards broadband investments and -- both on the Wireline and Wireless side, that we've been spending significantly to keep pace in the overall backbone network.

Simon Flannery - Morgan Stanley, Research Division

Good. The last couple of years that you've been here, we've focused a lot on wireless competition. And clearly, TELUS and Rogers aren't showing anywhere, I mean, it's robust competition. But at the low end, you get the sense that there's been some of the challenges that haven't hit some of the growth metrics that they'd hope to, and there's been some management changes. Do you sense a kind of a coming consolidation there or some more rationalization of space?

Siim A. Vanaselja

Well, the answer is I don't know. And I think it's really up to the market, the right place to determine the success of competitors. What I do know is that in Canada, I think, as an industry, we're fortunate to have 3 strong incumbent competitors with significant balance sheets, and we've all been making very substantial capital investments. And I think in Canada, we've created the strongest wireless infrastructure and advanced infrastructure of pretty much any -- in any country around. And as you say, we have a number of new entrants, their focus has been on the lower end of the market. They've had a significant impact on pricing at that lower end of the market. And we'll see where they go in terms of consolidation or I think, as I say, it's up to -- it's really up to the marketplace to determine who's going to be successful.

Simon Flannery - Morgan Stanley, Research Division

You talked about some of the drivers of your margins. Your ARPUs are rising, your churn is falling. One of the big other elements is subsidies. And obviously, as you drive your smartphone penetration, there's heavy subsidy coming with that. Is this something where you think that you're going to be able to make some progress either through competition from the different ecosystems or just from writing the cost curve down of LTE devices. George had commented favorably on the Blackberry launch. And you're one of the first carriers to carry that, so any color around how that fits?

Siim A. Vanaselja

Yes. I think between Apple and RIM and Android devices, and now Windows 8 devices, the ecosystem is certainly broadening, and I think that bodes well for subsidies over the longer term if that can sustain itself. I mentioned that our smartphone penetration is at about 65%, and we would obviously be looking to grow that. And one of the key factors where we have to get the balance right is that, as we continue to grow that smartphone penetration, what the right level of subsidization is versus the credit quality of the customers and the type of ARPU that we can bring in on those customers, all with a view of trying to maximize the return and lifetime value of those customers.

Simon Flannery - Morgan Stanley, Research Division

Great. So let's turn to the Wireline business. You've made a lot of progress on your Fibe and IPTV product this year and you've talked about the buildout. Can you help us with the economics? How are you seeing that in terms of your ability to ultimately improve your Wireline margins or stabilize and improve them and reduce churn and so forth -- drive ARPU.

Siim A. Vanaselja

Well, I think it's pretty simple. If you want to be in the Wireline business, you need to buildout fiber. If you want to be in the residential Wireline business, you need IPTV, because the future and today, is all about bundling on the residential side. Bell has been fortunate in that we've been able to sustain Wireline margins at about 37%, 38%. And we've sustained them at that level for the last 5 years. And I think we're confident with sort of the mixed changes that are taking place in the Wireline business, where the basic voice component that is declining is becoming less in terms of the overall total. IPTV is adding to growth and revenue, adding to EBITDA. 85% of our IPTV customers are also taking Home phone and fiber Internet from us. So the ARPU, the churn, the lifetime value of those customers all are significant contributors to maintaining that margin.

Simon Flannery - Morgan Stanley, Research Division

Do you have any early, say, market -- some of the first markets you'd go into sort of some penetration levels. Can you give us a sense? Because you're adding so many homes passed each quarter that it's hard to get a cohort of kind of people who've been -- had it for 18 months or whatever...

Siim A. Vanaselja

Yes. Well, it's still early days. And it's interesting, because market-to-market, the success in penetration can vary quite a bit, depending on just the competitive dynamics and in each market, and that's the good learning experience for us as we move forward. As George Cope mentioned at our Investor Day, our objective, and if we can achieve it, is really to get to a 50% market share in our residential Wireline markets. And the real question is over what period can you do that? And that is going to vary market by market. And I think you have some precedence in terms of Bell Aliant, a subsidiary company of ours that launched their IPTV service before us and in the U.S., AT&T and Verizon, where there's -- the markets that are well over 25% penetration.

Simon Flannery - Morgan Stanley, Research Division

And I think one of the advantages that Canadian operators have is programming costs. It doesn't seem like we just have time or cable talk about 10% growth per subscriber this year. You have a lower cost growth rate, but you also have a natural hedge cost. Can you talk about that?

Siim A. Vanaselja

We do, and that's part of the defensive part of the strategy behind our acquisition of CTV, the creation of our media segment and hopefully, the ability to close on the Astral transaction that programming has been, I think, for all operators, probably the fastest-growing cost. And with our media segment today, we're paying close to 40% or 50% of those programming costs to ourselves. And it also gives us -- gives us an asset that we can better negotiate programming costs with other vertically integrated operators in Canada.

Simon Flannery - Morgan Stanley, Research Division

If we turn to the enterprise side of the business, I think, you know, just as in the U.S., it's been a struggle for the incumbent operators. Can you talk a little bit about the trends there, the macro trends, the competitive trends that you're seeing in any kind of, of the things that might start to, again, as in consumer, where there's some legacy assets become smaller and the growth to your assets start to...

Siim A. Vanaselja

Yes. Well, our business, I think, consistent with what we're seeing across North America, has been a pretty challenging market on the enterprise side. We've certainly seen it stabilize, but we're not seeing any significant additions, any significant new infrastructure spending programs on the telecom side. That's typically economic-related. And I think Bell Canada is well-positioned in the enterprise markets to really seize growth when those spending caps are turned back on within the enterprise segment. One of the things that we're quite excited about is our acquisition of Q9 in the data center space. And the commercial agreement that we've entered into between Bell and Q9, Bell will be able to leverage that Q9 relationship and become the preferred connectivity supplier for Q9 customers and hopefully have the ability to not just provide connectivity, but to upsell some of our managed service dilutions to that customer base as well. And we see that as being an attractive opportunity to pursue growth, not just in the enterprise market but in the SMB market as well.

Simon Flannery - Morgan Stanley, Research Division

One of the highlights of the BCE story over the last few years has been dividend growth. And in fact, it seems likely that 3 major Canadians have a little war of dividend growth going on, which is very good for the shareholders since it certainly has helped the stock price. You changed your dividend policy to sort of focus on it more on a pre-cash flow payout. And you also have an executive compensation which is, in part, tied to your dividend strategy. So can you just talk about the importance of the dividend and the dividend growth model and how that's tied into the compensation?

Siim A. Vanaselja

Sure. Well, first, we have a very clear, transparent capital market model which is based off of dividend growth. And the payout ratio of 65% to 75% of free cash flow, as Simon said. Today, we're just slightly below the midpoint of that free cash flow payout. Our guidance for 2013 on free cash flow is growth of 5% to 9%. And what we've seen over the past few years in the company is just the incredibly powerful base of free cash flow that Bell has the reliability of that free cash flow foundation and the ability to grow it. And we've increased our capital intensity through the course to 2012 above our originally planned level. And we had the flexibility to do that because of the strength of our cash flow. And we've upped our capital intensity guidance for 2013 to 16% to 17%, and we have the ability to do that and still generate 5% to 7% growth in free cash flow. So that's the foundation for the dividend. In terms of management's compensation plan, it's pretty simple and very well aligned with our common shareholders. So our long-term incentive plan involves restricted share units, performance-based share units that, that's based on our ability to grow free cash flow in line with our dividend growth objectives.

Simon Flannery - Morgan Stanley, Research Division

Great. We have got some time for questions from the audience.

Unknown Analyst

I read some comments that the 4 or the few prepaid carriers that are out there in Canada, the CRTC left the door open for a foreign takeover of those smaller carriers. If you could just maybe clarify if that's the case? And if that did happen, what would have changed in the Canadian landscape? There's some potentially large foreign operators that might be interested in entering the safe markets.

Siim A. Vanaselja

Yes. So foreign ownership growth in Canada were relaxed to allow foreign ownership of telecom operators who have less than a 10% market share. So that would set the new wireless entrants into that category. And as you look at WIND Mobile or Globalive, with recent changes in their shareholdings there now, I think 100% owned by VimpelCom. So there's nothing precluding any of those operators from being completely foreign-owned

Simon Flannery - Morgan Stanley, Research Division

So you've talked about the capital spending. A little bit more -- maybe you could just drill down into some of the big buckets, relative focus on Wireline, Wireless and LTE versus 3G.

Siim A. Vanaselja

So as I said, capital -- our capital intensity guidance is that 16% to 17% of revenues for 2013. The vast majority, 80% to 85% of that, I believe 85% of that capital is spent on our strategic priorities and principally on broadband. So on the Wireless side, continuing to build out LTE in urban markets. And on the Wireline side, we currently have built out IPTV to 3.3 million homes. And by the end of 2014 -- 2013, we should have that built out to 4.3 million homes. And beyond that, there's a whole bunch of strategic priorities in terms of improving the effectiveness and the efficiency of our call centers and field service operations, our billing platforms. We've come a long way, I think, in terms of the cuts overall, the customer experience. And there's a lot of capital dollars that have gone into that and will continue to go into customer service.

Simon Flannery - Morgan Stanley, Research Division

And just to be clear, if and when Astral does close, that's going to be cash flow accretive. So it'll likely take the CapEx intensity down and then will be EPS accretive?

Siim A. Vanaselja

Yes. So just to be clear for everyone, the financial guidance that we outlined at our Investor Day is for Bell and BCE on a stand-alone basis, excluding Astral. And if and when the Astral transaction is approved and closes, we would intend to refresh our guidance at that point in time. As you say, Astro would be an attractive transaction in terms of accretion to EPS and free cash flow. And in that regard, it's well aligned with the capital market strategy of the company.

Simon Flannery - Morgan Stanley, Research Division

Great. Well, Siim, we appreciate your time. Thanks for taking the trip our way.

Siim A. Vanaselja

Thank you, Simon. Thank you, everyone.

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