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Telecom Argentina S.A. (NYSE:TEO)

Q3 2013 Earnings Conference Call

October 31, 2013 11:00 AM ET

Executives

Pedro Insussarry – Director-Finance and Head-Market Relations

Stefano de Angelis – Chief Executive Officer

Adrián Calaza – Chief Financial Officer

Analysts

San Dhillon – Barclays Capital Securities Ltd.

Michel Morin – Morgan Stanley & Co. LLC

Rodrigo Villanueva Bravo – Merrill Lynch

Operator

Good day everyone, and welcome to the Telecom Argentina Third Quarter 2013 Earnings Conference Call. Today’s call is being recorded. Participating on today’s call, we have Stefano de Angelis, Chief Executive Officer of Telecom Argentina; Adrian Calaza, Chief Financial Officer; Guillermo Rivaben, Director of Mobile Business Unit; Solange Barthe Dennin, Manager of Investor Relations Division.

And now I would like to turn the call over Pedro Insussarry, Head of Finance. Please go ahead.

Pedro Insussarry

Okay, thank you Ann. As Ann just mentioned, the purpose of this call is to share with you the consolidated results of Telecom Argentina Group that correspond to the nine-months period of 2013 ended on September 30.

We would like to remind you that for all those that have not received our press release or presentation, they can call our Investor Relations office to request such documents or download them from the Investor Relations section of our website at www.telecom.com.ar/investors. Additionally, this conference call is being broadcasted through the webcast feature available in subsection and can also be replayed through this same channel.

Before we continue with the conference call, I would like to go over some Safe Harbor information and other details of the call, as we usually do in our quarterly conference calls. I would like to clarify that during the conference call and Q&A session, we may produce certain forward-looking statements about Telecom’s future performance, plans, strategies and targets. Such statements are subject to uncertainties that could cause Telecom’s actual results and operations to differ materially.

Such uncertainties include, but are not limited to the effects of public emergency law and complementary regulations, the effects of ongoing industry and economic regulation, possible changes in demand for Telecom products and services, and the effect of marginal factors such as changes in general markets or economic conditions in legislation or in regulations.

Our press release dated October 30, 2013, a copy of which is being included in the Form 6-K report to be furnished to the SEC, describes certain factors that may affect any forward-looking statements that we may produce during this session. Furthermore, we urge the audience of this conference call to read the disclaimer clause contained in Slide 1 of the presentation.

The agenda for today’s conference call as seen in Slide 2 is to go over the general market overview, followed by the discussion of the business highlights, a review of our financial figures and finally, we will end the call with a Q&A session that we normally do to the financial community

Having gone through these procedural matters, I’ll now go over a brief macro overview as an introduction to the general operating environment.

Please refer to Slide 3 of the presentation where we included some snapshots on the current Argentine macroeconomic environment. Levels of economic growth showed some signs of recovery, but at lower pace than that evidenced in recent quarters led by an upturn in the agricultural and construction sectors.

During this quarter, industrial construction was impacted by a reduction in car maker exports, but other sectors such as non-metallic mineral products continued to sustain growth trends. Commodity prices showed some adjustments, but the industrial production and public construction pushed the commercial activity up.

In the third quarter of 2013, real wages decreased, while private consumption remained stable, thanks to the income tax reduction, the expansion in public social expenditures and the increase in consumer lending. Moreover a slightly more positive consumer confidence was perceived during the quarter when compared to that registered 12 months ago.

On the external front, like I mentioned, despite increases in agricultural exports, rise in energy imports continue to effect the trade balance. The official exchange rate accelerated at deprecation pace, while continuity slightly improved external competitiveness.

Finally, tax collection postponed revenues up, however public expenditures continue to grow at the higher pace, deteriorating physical balance. Moreover, the assistance on the Central Bank to service debt and from the public pension fund system continued during the period.

Having gone through these significant reduction of the macro context in which we operate, let me pass the call to our CEO, Stefano de Angelis will go over the business highlights.

Stefano de Angelis

Thank you Pedro. Good morning to everyone. Please refer to Slide five, where we show the business highlights for the nine months period of the year. On the Mobile business, we continue to lead in the market in terms of revenue share, while we have optimized our commercial cost structure.

In terms of resources, we have focused our efforts in service quality improvement, strengthening 3G and the other access capacity. It is also worth mentioning that 3G penetration reached 41% of our customer base, while we had a remarkable performance in smartphone sellouts that reached 65% of total devices sold.

Regarding the fixed business, again note that we continued with the FTTx deployment to enrich our value proposition. It is remarkable that 19% broadband ARPU increased in the third quarter and the positive trend in quarterly net add both in fixed lines and broadband access through a significant improvement in provisioning of services.

When it comes to our financials, we continue with our fixed cost control behavior to mitigate the impact of the higher labor related costs and higher taxes. The share buyback program launched in May 2013 continues steady for thus adding value to shareholders.

Please turn to Slide 6 to commence on the mobile business performance. Our value proposition fostered growth in postpaid and prepaid segments with 550,000 net adds in the third quarter versus 193 in the second quarter of 2013.

As of September, our customer base totaled $19.9 million with a 5% year-on-year expansion supported by postpaid growth while maintaining our market position in terms of subscribers.

Meanwhile, monthly ARPU rate is 70.4 pesos, an increase of 21% when compared to the third quarter of 2012. We highlight the increase in non-voice ARPU of 34%, that is third quarter 2012 that was boosted by the expansion in value added services penetration and usage.

Moreover, we momentarily launched new data, SMS and Voice Bundle to increase usage and penetration while defending traditional service revenues. In addition, the 3G customer base continue to grow reaching approximately 8.1 million in the third quarter, representing 41% of our subscriber base. We then highlight the growing trends of the mobile unit monthly Internet users that reached 6.3 million customers in the quarter.

In Slide 7 we showed that service revenue grew 23% in the nine-month period of the year, supported by the increasing in data and Internet services that particularly in this quarter rose by 31% and 58% year-on-year respectively. Thanks to this expansion, value added services revenue participation is the highest in the region reaching 58% of revenues in the nine months.

This outstanding revenue performance was achieved despite limited pricing actions, especially in the nominal postpaid existing plans; this performance has helped us to sustain our service revenue leadership while optimizing our commercial costs. Quarterly SAC & SRC costs reached 12.5% of service revenues, reducing 370 basis points from 16.2% a year ago. This was achieved thanks to a subsidy reduction notwithstanding the significant improvement on their handset mix, offer and sales.

Please turn to Slide 8 for a snapshot of the Paraguayan operation. Our customer base in Paraguay reached 2.4 million, increasing by 6% year-on-year. While postpaid customer rose by 17% year-on-year, improving the customer base niche and showing a solid market performance. This was achieved by leveraging our leadership in this mobile internet market while expanding 4G LTE services, supported by the continuous network expansion in terms of coverage and capacity.

In the nine-month period of 2013, revenues in pesos rose by 34% year-on-year while value-added services revenue represent 54% of service revenues explained by higher Internet service revenues. Finally, operating income before D&A in Paraguay increased by 28% year-on-year.

Slide 9 shows the evolution of mobile revenues that grew in the nine-month period by 27% year-on-year to 14.7 billion pesos. Revenues coming from mobile Internet services and data such as content and SMS were the main drivers of growth, increasing by 58% and 31% respectively.

Retail voice and wholesale services were both up by 9%, while handset sales increased by 50% due to the improved mix and the effects of the reduction in subsidies. As mentioned before, the Paraguayan operation posted a 34% growth in Argentinean pesos.

Please refer to Slide 10 as we move to the evolution of our fixed business. The fixed broadband subscriber base regained momentum with 35,000 net adds in the third quarter of 2013 from firming the positive trend while the ARPU grows by 19% year-on-year to 126 pesos with a slight reduction in churn. Furthermore, the XPD [ph] chief net for deployment continues to offer higher speed so as to enrich the value proposition and improve the customer experience perception.

Slide 11 shows the evolution of our fixed voice lines that reached 4.1 million. We have continued with positive net adds in the quarter, thanks to a significant improvement in the service provisioning process and we were able to report a monthly ARBU of 53 pesos per month, an increase of 9% year-on-year. This performance was achieved thanks to the high penetration of our bundled offers. Moving over, the corporate ICT and Data Center services delivered revenue growth with a robust revenue performance of 30% growth year-on-year.

We can see in Slide 12 that during the nine months of the year, fixed business revenues expanded by 16% year-on-year and totaled 5.1 billion pesos, representing 26% of consolidated revenues. The expansion was mainly due to the growth of our residential Internet services, where revenues increased by 27% year-on-year or 385 million pesos, followed by data revenues that contributed with a 30% growth or 158 million pesos revenue increase.

Despite retail and wholesale voice services, our caps with frozen tariff in nine months 2013, we were able to increase revenues coming from these services by 7% and 6% year-on-year respectively. Nowadays about one-third of our revenues in the fixed business are price regulated.

Slide 13 shows the evolution of our consolidated capital expenditures. We have invested 2.9 billion pesos in the nine months 2013 that represents 15% of revenues confirming the positive trend in CapEx, but with a significant allocation to network quality upgrade.

It’s worth mentioning the growth in the quarterly CapEx that increased by 59% in third quarter 2013. Moreover, we can also refer to that FTTx rollout deployment to improve commercial offer and user experience. In addition, controlled level of handsets have destabilized in tangible assets.

Finally, it’s worth mentioning that we continue to carry out our CapEx plan. However, we have encountered certain delays in execution due to exogenous factors such as delays in the municipal authorization process.

Slide 14 describes some of the items of the action plan that we have defined for our network CapEx plan and some of the goals we have achieved in this respect. The access networks, we are implementing the integration to six sector sites while significantly increasing the intervention in conventional and unconventional sites. We are in the process of the 2G to 3G spectrum for reforming and we have significantly increased the penetration of more spectrum efficient 3G devices and we have significantly expanded the number of cabinets with FTTC technology.

All these actions are trying to achieve a significant improvement in the levels of network performance thus reaching a better quality of service and customer experience.

Now, I will pass the call to Adrian Calaza, who will go over our financial performance. Thank you.

Adrián Calaza

Thank you. The business performance that Stefano had described was reflected in our financials, posting growth both in terms of revenues and profits that outperformed the markets.

Please turn to Slide 16, where we show the evolution of consolidated revenues and operating income before depreciation and amortization. In the nine months of 2013, consolidated revenues reached 19.8 billion pesos with a 24% year-on-year growth, particularly fostered by the growth of the third quarter 2013 of 26% year-on-year due mainly to significant increases in content and internet services as we commented before.

It is important to underline that revenues coming from regulated tariffs, services accounts for just 9% of total revenues, due not only to the growth of mobile and broadband businesses, but also because we continue to be affected by basic frozen tariffs that are frozen since 2001. Operating income before depreciation and amortization, totaled 5.6 billion pesos in the nine months period of the year, representing 28% of revenues and growing but 18% year-on-year.

It’s worth note noting that in the third quarter we maintained the solid growth of 22% registered in the second quarter of this year, even with high cost pressure, coming from labor related costs, after mid year union bargains. Thanks not only to the significant revenue growth, but also to strict control policy and to optimization of commercial costs.

In Slide 17, we can see the evolution of our operating income before depreciation and amortization and the most relevant components that affected its evolution. With consolidated revenues growing by 24% year-on-year, some cost expanded above this level.

For example, the increasing direct taxes on revenues strongly impacted our margin in 18 basis points growing 34% year-on-year mainly due to increased municipal levies and charges and higher provincial turnover taxes.

As mentioned direct labor costs grew by 27% year-on-year after the new bargaining agreements that also impacted our margin. Additionally, value-added service cost expanded at a strong pace but in this case related to the significant expansion of content services, that delivered a strong growth in total revenues, although with a lower marginal contribution that other value-added services.

On the other hand, and thanks to an efficient cost approach, marketing and sales costs, fees for services, maintenance and materials and other costs grew at lower pace compared with revenues helping us to partially mitigate the impact of cost inflation in other items.

Moreover, in Slide 18, we can see the composition and the marginal analysis of our cost structure. In the nine months of 2013, direct labor cost represented 21% of our total operating costs or 15.1% of revenues. Related to this we have reached agreements with the unions involving an annual increase in salaries of approximately 26%. That was granted in two installments starting in the first quarter of 2013 with 15.5% rise.

It is remarkable that during third quarter, marketing and sales costs have remained at the same level in comparison with the nine months of 2012, despite a significant increase in revenues. This was a result of significantly lower level of handset subsidy and actions undertaken to maintain cost under control.

Finally, as we just mentioned cost related to value-added services almost double its participation to growth in penetration, end usage of services led again with operating incomes contribution.

Please turn to Slide 19, you can see that the performance of our operating income that reach 3.3 billion pesos with a 16% in the nine month of 2013 growth, and a significant growth of 31% in the quarter. The operating income performance together with a positive financial results allowed us to both the net income attributable to Telecom Argentina up close to 2.3 billion pesos growing back 23% year-on-year, mitigate the impact of FX losses due to the exposure in accounts payable. We have executed positive hedging actions that contributed to increase in financial results.

Regarding our financial position in Slide 20, you can see that the Telecom Argentina Group continues to report a healthy operating free cash flow generation that reached 3.0 billion pesos in the nine-month period of the year, equivalent to 15% of our revenues allowing us to reach a net cash position of approximately 5.7 billion pesos.

It is important to add the line that with this financial structure and accurate reductions with hedging insurance, the Company exposure to FX risk is extremely low.

It is also worth mentioning that at September 2013, we have repurchased 10.8 million peso shares, 1.1% of our capital, bring out approximately 310 million pesos of the 1.2 billion pesos reserve created for the share buyback program launched in last May.

So having concluded with the presentation, and with the final remarks, we are more than pleased to answer any questions you may have. Thank you very much.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from San Dhillon from Barclays.

San Dhillon – Barclays Capital Securities Ltd.

Hello, two questions, if I may. Could you explain how much higher the average ARPU of postpaid subscribers relative to the prepaid subscriber in Argentina? And secondly, what is the make up of the average broadband customer or what speed is most popular and are people taking unlimited capacities for instance? Thank you.

Stefano de Angelis

No, [indiscernible]. It sounds your question about the ARPU. Our postpaid ARPU is around 135 pesos, and our prepaid customer based ARPU is 40 pesos. That’s the relationship between both the ARPUs.

San Dhillon – Barclays Capital Securities Ltd.

But great and the question…

Stefano de Angelis

Regarded the most popular we did fixed broadband, you were asking, right?

San Dhillon – Barclays Capital Securities Ltd.

Yes, that’s correct.

Stefano de Angelis

Yes, today the more popular is 6 megabyte ultra, highest penetration in the sale of the new plan.

San Dhillon – Barclays Capital Securities Ltd.

Okay, great. Thank you, guys.

Stefano de Angelis

You are welcome.

Operator

(Operator Instructions) We’ll go next to Michel Morin from Morgan Stanley.

Michel Morin – Morgan Stanley & Co. LLC

Hi, every one. I was just wondering if you can comment on your ability to raise prices in mobile. We know that your fixed line tariffs in the regulated area has been frozen for many years now. But in mobile what kind of government pressure are you seeing to not reach prices and what price increases have you been able to put through this year. Thank you.

Stefano de Angelis

Correct there wasn’t been a wire line business just to inline that with price that is free these day and monthly seeing up the broadband obviously and that in the mobile this year as I would in the speech, we received political pressure regarding the nominal price increase of the existing postpaid plans.

Right, as you know that the prepaid nominal tariffs are very different from the real tariff that they would estimate. So we were able to manage all the promotion regarding the prepaid and some of the postpaid plans. We were able to act as we can in the plans for postpaid for the new gross adds.

Why we were honestly facing these limitations in order to increase the price of the existing plans. What does its mean, it’s mean that we are in this moment discussing a lot of change in the regulation. So we were asked to with the new regulation especially the quality regulation that we are expecting for November will finalize and publish in order to add an arena where we can discuss with the government looking at figures and facts not only at quality as base in the perception of the single user. And you note that the perception of the single user in the mobile arena may change strongly.

So starting from November, we expect for the mobile to have a more rational approach regarding tariff where we can discuss pricing and quality on the same stage. We finalized that we were working and this is remarkable in the ARPU expansion of the mobile strongly and the up selling of the postpaid plans of the existing customer base. And this helps us to increase the ARPU in a significant way.

Michel Morin – Morgan Stanley & Co. LLC

Great, thank you very much.

Operator

We’ll take our next question from Rodrigo Villanueva from Merrill Lynch.

Rodrigo Villanueva Bravo – Merrill Lynch

Hi good morning. A couple of questions, the first one is related to interconnection costs. We saw significant decline on a quarter-on-quarter basis of 27% this quarter. I was wondering if you could share with us what is behind this improvement and also if it is reasonable to assume a similar level going forward? That would be my first question.

Stefano de Angelis

Regarding the interconnection cost in this quarter we have finalized a new – I don’t think the agreement with Moviles [ph] there. You know that we have roaming agreement in Argentina. I had mentioned on roaming agreements regarding the north and southern region for us. Obviously the cost is basically driven by the needed coverage that we have in the southern regions.

As we’ll – meaning parts of the second quarter we were accounting the whole contract that that’s a very – this was time in 2004. So the pricing of voice and SMS was basically in the market because of the impact of the inflection, while the data was, just to give you an example, it was in 5 pesos per megabyte.

We were able to re-discuss this agreement.

So passing from the third quarter we are normalized interconnection cost just to answer to your question, this is something that we have to expect these trends in the next quarter, the answer is yes, because now we have finalized these agreement, but these agreement we will loose the interconnection roaming costs for the next quarters.

Rodrigo Villanueva Bravo – Merrill Lynch

Okay, thank you very much. And my next question is regarding dividend distribution. I was wondering if there is any update regarding the possibility to distribute cash to shareholders through dividends in 2015?

Stefano de Angelis

I confirm in the second quarter conference call I told that we were acting in order to bring to the we have a reserve of 1 billion pesos and we have the ability to approve the dividend distribution in the Board of Directors and our impression is confirmed to bring the decision to pay the dividend by the year end, meaning the year end of 2013.

Rodrigo Villanueva Bravo – Merrill Lynch

Okay, okay. Thank you very much.

Stefano de Angelis

You are welcome.

Operator

And with no further questions in the queue, I’d like to turn the call back over to management for any additional or closing remarks.

Pedro Insussarry

Okay, thank you everybody for participating in our call. And excuse us for the delay in starting the call, we have a problem with the supplier taking the international connectivity. Thank you very much and thank you, [indiscernible].

Stefano de Angelis

Thank you.

Operator

This does conclude today’s conference. We thank you for your participation.

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