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Telecom Argentina S.A. (NYSE:TEO)

Q2 2011 Earnings Call

August 2, 2011 11:00 am ET

Executives

Pedro Insussarry - Head, Finance

Franco Bertone - CEO

Adrián Calaza - CFO

Solange Barthe Dennin - Manager, IR

Analysts

Ricardo Cavanagh - Itaú BBA

Miguel Garcia - Deutsche Bank

Michel Morin - Morgan Stanley

Alex Garcia - Citi

Operator

Good day, everyone, and welcome to the Telecom Argentina, TEO, second quarter 2011 earnings conference call. Participating on our call today, we have Mr. Franco Bertone, Chief Executive Officer of Telecom Argentina; Mr. Adrián Calaza, Chief Financial Officer; Mr. Pedro Insussarry, Head of Finance; and Mrs. Solange Barthe Dennin, Manager of Investor Relations.

At this time, I'll turn the call over to Mr. Pedro Insussarry.

Pedro Insussarry

Good morning to everybody. On behalf of Telecom Argentina I would like to thank you for participating in this conference call. As mentioned by John our moderator, the purpose of this call is to share with you the consolidated results of Telecom Argentina and correspond to the first half of the current fiscal year 2011 ended on June 30, 2011.

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

Before we continue with the conference call, I would like to go over some Safe Harbor information and other details of the call. We 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 regulation, the effects of ongoing industry and economic regulation, possible changes in demand for Telecom products and services, and the effects of marginal factors such as changes in general market or economic conditions, in legislation, or in regulation.

Our press release dated August 1st, 2011, a copy of which is being included in 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.

As usual in our quarterly conference calls, the agenda for today as seen in Slide 2 is, first to go over general market overview, then we'll go over some business highlights, and after that we'll go over some specifics of the evolution of our financial figures. And we'll end the call with a traditional Q&A session.

I'll go over a brief macro overview as an introduction to the general operating environment. In Slide 3, we include some snapshots of the Argentina macroeconomic environment. You can note that the macro conditions are giving support to the growth of our business. During the second quarter, the Argentina economy continued growing, based in booming private consumption, yielded by high commodity prices.

The industrial production performed very well, mainly in the segments of non-durable goods and the supply for construction. On the other side, the energy sector was the main ballast in a context of high demand and supply restrains. It is worth noting that in the second half of 2011, we will have a presidential election, where private consumption and investment tend to go down.

As already mentioned, consumption remained strong promoted by low interest rates and extensive installments plans for the purchase of durable goods. Moreover, despite high inflation, consumer confidence reaches a four-year record high level, although it was stable through the recent months. Probably one of the reasons for the booming consumption is that wages are growing in a similar way to inflation, and in some cases even faster, fostering consumption.

On the fiscal front, fiscal balance remains stable, fuelled by the economic recovery, although public spending continues at record high levels, and it could suffer further increases due to additional expenditures related to the upcoming presidential elections. The trade balance was affected by growing imports and somewhat slow export growth. Capital outflows have increased in the second quarter of 2011, and will probably remain high during the election period.

In this challenging macroeconomic context for Argentina, our company continues to deliver growth, both in terms of its business and operations. And we will highlight them during this conference call. And having gone through this introduction let me pass the call to Franco Bertone, who will go over with the business highlights. Franco?

Franco Bertone

Thank you, Pedro, and good morning to everyone. Second quarter 2011 posted a fairly solid performance in all lines of businesses. We led the mobile market with highest growth of net cash and subscribed lines, and we had a healthy growth in the fixed segments too.

As highlighted in Slide 5, please turn to Slide 5. We were leaders in the mobile net adds, while improving our mix of addition and recording record-fast revenues that currently are at high as 46% of service revenues. Our Paraguayan operation as well performed well in a consolidated environment.

Our position as an integrated ICT provider is getting stronger and new product launches boost the fixed broadband business. Consequently internet and data revenues rose 28% year-on-year and the overall fixed business revenue posted a consistent 16% year-on-year growth in the third semester of 2011. Because of strong operating performance, our free cash flow exceeded the equivalent of P$500 million in the last 12 months. And net income rose 41%, reaching at P$1.2 billion in the first half of this year.

Let me now address some of the phase around mobile operation that are detailed in Slide 6 of the presentation. In the Argentine mobile market we posted another strong quarter result with a 16% year-on-year ARPU increase and 13% customer based growth, posting over P$0.5 million in net adds in the second quarter. We have also continued gain in market share with 230 basis point increase that is taking us to 33.2% market share in the mobile industry.

This represent a market share of net adds in excess of 75% over the last 12 months. This was accomplished, promoting all inclusive plans that increased overall mobile usage as well as ARPU, while enabling effective customer console (inaudible).

Our value proposition together with customer retention offer resulted in the significant churn reducing in the postpaid segment. I think as a new way to use mobile data usage, we successfully launched mass market internet plans taking advantage of the increased penetration of data enabled handsets.

Slide number 7 shows third semester value-added service revenue growing 60% year-on-year, reaching a record level of 46% of service revenue. This was achieved mainly thanks to our market leadership, especially in the smartphone segment, which helped to boost non-SMS revenues to record high levels. We accelerated handset upgrade, targeting customer retention and ARPU stimulation, but still reducing subsidy for handset sold.

In order to continue growing data services and reaching higher data usage from all of our customer base, we are pursuing mobile internet massification through convenient packaging offers such as the unlimited internet offers of P$1 per day.

Slide number 8 shows how mobile revenues grew to P$6.1 billion this quarter, posting a 35% increase or P$1.556 million when compared to the first half of 2010. Value-added services played the greatest part in revenue expansion with a P$876 million increase, but is a 60% growth year-on-year. Prepaid traffic voice and monthly fees revenues were up 15%, mobile interconnection revenue 9% and handset sales over 50%.

Our Paraguayan operation posted a 59% year-on-year increase reporting in Argentine pesos. Revenue actually increased almost 30% and (inaudible) if you look at currency revaluation compared to the Argentina pesos.

Please move to Slide number 9 to comment about the wireless business. The broadband subscriber base grew in line with competition. We continue addressing the market with innovative ideas such as bundled mobile and fixed internet broadband offerings or ADSL Turbo, where customers can boost the speed in their broadband connection at selected hours of the day at their convenience or preference. In general, the broadband maintained sustained ARPU growth and churn reductions, while the estimated market share along the top three players continued stable at 35%.

Slide number 10 shows voice landline in service that kept growing more than annual 1% rate, and the average monthly bill is at 7% when compared to last year to nearly P$46 per month. The continued migration to slab plans and local and long-distance calls delivered an overall increase in price per minute despite operating with frozen tariffs.

The evolution of wireline revenue as shown in Slide 11, third party revenues totaled P$2.6 billion, a 15% increase or P$343 million compared to last year. Broadband and data services are key to our revenue growth and they increased 31% year-on-year respectively. Meanwhile, fixed telephony business posted a 9% growth for voice-managed services and a 7% increase in monthly fees. Revenues coming from interconnections were up 12% year-on-year.

Slide 12, shows our third semester CapEx, totaling P$752 million that is 9% of consolidated revenue with a 13% year-on-year increase. CapEx deployment is targeted in mobile and fixed network capacity and quality in order to support provision of new services and improve their performance. In addition, we are investing in mobile technology that can be upgraded and software configured and will provide us with additional scalability and flexibility to the mobile network management.

Finally, I'll remind you that the Argentine government announced a spectrum auction for the 19850 MHz band in December of this year. I have gone through the business highlights, and I'll pass the call to Adrián who will go over the financials of the business.

Adrián Calaza

Thank you, Franco. The business highlights just mentioned by Bertone have reflected into significant results in terms of revenues and profitability. Please refer to Slide 13, where we can see the evolution of revenues and operating profit before depreciation and amortization.

In the first half of 2011, consolidated revenues reached P$8.6 billion, growing by 28% when compared to the first half of 2010. We can also see that prices of regulated revenues currently account for 12% of total revenues, mainly because of the relative better performance of the fixed broadband and mobile business in recent years, but also due to frozen tariffs both the basic and fixed tariff.

Our operating profit before depreciation and amortization grew 25%, totaling P$2.7 million for the first half of 2011, with a slight reduction of the margin from 32% in the first half of last year to 31% in this first half.

For further detail, please refer to Slide 14, where we can see the breakdown of our consolidated cost structure. Some few remarks about our cost structure that we would like to highlight. We continued our marketing and selling efforts in preparation to number portability, as well as permanent profits in cost efficiencies to mediate the impact of inflation together with CapEx deployment intended to reduce ITX and network maintenance cost.

This has reflected in the evolution of our cost, as a percentage of revenues, where marketing and sales expense represented 23.4%, increasing from 21.1% in the first half of last year. Labor cost reached 12.7%, while interconnection cost represented 8.4% of consolidated revenues from 10.1% in the same period of last year. And other costs with a flat reduction, down to 15.3%.

As seen in Slide 16, operating profit rose at 28% year-on-year growth, reaching almost P$2 billion thus maintaining our operating profit margin at the same level from last year of 23%. Thanks to this expansion and profited financial results with which in the first half of 2011, our total net income of P$1.2 billion, equivalent to a growth of 41% when compared to the same period of last year, when we had negative financial results.

On the financial side in Slide 17, we can see our free cash flow generation in the last 12 months of P$2.2 billion. This allowed us to reach a net cash position of P$1.2 billion, as of June 30, that represented an increase of P$910 million in the last 12 months. It is worth to mention that in April, Telecom Argentina paid its annual cash dividend of P$915 million. To conclude, we would like to go over with you how we are progressing with our business targets in accordance to our 2011 guidance disclosed on February 25.

As you can see in Slide 18, our revenue performance has been faster than what we have projected, basically due to a better performance in our customer base and higher ARPU, both in the mobile and fixed broadband businesses. In line with the better performance in terms of revenues, operating profit before depreciation and amortization has grown faster than what was expected. But it is important to note that cost in the second half of the year are relatively higher, mainly due to inflationary impact in our cost structure and a higher level of commercial activity.

Finally, the roll out of CapEx in the first half of the year, is typically slower than in the later part, mainly due to seasonality, the procurement process and logistical matters. In this trend we project that we will be meeting the guidance disclosed to the market.

Having concluded with the presentation, we would like to mention that all these financial data presented are in local currency. Remember that the Telecom Argentina Group will be adopting IFRS since January 2012. So having concluded with the presentation, we are more than pleased to answer any question you may have. Thank you very much.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Ricardo Cavanagh with Itaú BBA.

Ricardo Cavanagh - Itaú BBA

I have two questions. The first one is on the net adds you are showing 75% share that has been rising, well basically in the past quarter and compared to the last year that was very strong as well. What are the main factors that you achieved such a strong performance relative to the rest of the market, and if you think that this large percentage share of net adds is likely to prevail? And the second one is, you mentioned a growing component within value-added services of non-SMS, if you could provide details on the percentage that non-SMS are representing within total value-added service revenues?

Franco Bertone

In relation to your remark about the net adds, market share we had is certainly strong 75%. It's the third time we hit the percentage as high as this. We don't expect that to be maintained in future guidance for sure, but it certainly represents that we are in a strong recovery past from the past few years, in which we have been certainly affected by the restriction that the company had as a consequence of the defaulter effect.

All that is behind our shoulders and we started a strong recovery, both in market share and revenue share, and we definitely made some important and definite steps over the last few quarters. We believe that this kind of growth and this kind of positioning is a stronger element, both of the strengths and security facing the possibility period that will start some time early in 2012.

As far as the value-added services' percentage of service revenues, certainly SMS (inaudible), it's around 80% of the TOU sold there, being indicative that there is a progressive solution of the percentage as SMS services in absolute terms are growing at a lower pace than the overall value-added service revenues. And growth rates of new innovative value-added services is about twice as much as the total one, so that I think is a fair indication I can provide to you about the dynamic source of that revenue trend.

Operator

We'll turn our next question from Miguel Garcia with Deutsche Bank.

Miguel Garcia - Deutsche Bank

My question is regarding the regulatory environment and how are the conversations regarding the possibility of offering video services should be playing? And also, are there telecom operators maybe smaller ones that are already authorized to do so?

Franco Bertone

Yes, regulation in that respect depends on the nature of the main license each operator is varied upon, and there is a non-symmetry in the market between cable service operators that do have access to providing telephony services to their customer base. And operators like ourselves that are telecom operators that cannot provide video services to our customer base, and the same condition as the cable operator can. That does not mean in definite terms that telecom operators cannot provide video services.

And as a matter of fact there is an element of interpretation of the Paraguayan regulation that gives certain options that are getting more and more interesting from commercially and marketing purposes as video technology do progress. As a matter of fact, one of our competitive has already launched video streaming services. It's an option that we have in front of us and that we have been preparing network and system for and maybe (inaudible) future as well.

Miguel Garcia - Deutsche Bank

Did you have any date or estimate of when you could start doing something like that?

Franco Bertone

We're getting very, very ready.

Operator

We'll turn now to Michel Morin with Morgan Stanley.

Michel Morin - Morgan Stanley

I was wondering if you can talk about the progress regarding salary negotiations for the second half of this year. If I' am not mistaking you're probably in that process right now. And secondly in terms of the mobile market share are you noticing whether not any of your competitors are perhaps disconnecting customers more aggressively? Or in another words, do you feel that you're also gaining share of gross additions, in addition to net additions. And are you gaining share of revenue in the mobile segment?

Franco Bertone

As far as the negotiation with union employment base, they have been already concluded. They will take place from July 1st, as salary. And on annualize based 12 month's period there are 31% end-to-end salary growth. The 31% will be applied in two installments. Last year were three, so there was a positive target in July and another one in November and third one in 2011. So this year it will be one in July 2011 and the complete 31% will be first quarter next year. So that's how the salary negotiation ended up.

As far as your observation about how we account for our customer base and disconnection and net adds, et cetera, and revenue, we do have a pretty consistent policy in that respect. Our criterion is pretty tight and conservative. I would say that the best proof of it is that our revenue share is increasing faster than our market share.

Michel Morin - Morgan Stanley

And then if I can just come back on the salary increase. Are you prepared to share with us what the increase was that the portion of the 31% that went through July 1st?

Franco Bertone

Yes, 31% (inaudible) will be applied from July 1st and the balance from this quarter next year.

Operator

(Operator Instructions) We'll go now to (Clara Tiroga) with Raymond James.

Unidentified Analyst

I have a couple of questions. First, if you can give us any guidance of CapEx for the auction of additional spectrum. If not, we can assume that the company has really reserved in that front from this investment? And then we can expect that the impair will be around 75% during 2012? Secondly, with some compression of margins during the quarter, if you see a further compression during the second half of the year, and given the number mobile portability has been postponed. So you believe that this could benefit 2011 numbers?

Adrián Calaza

For your first question, we don't know how much it would cost us, the additional spectrum, given it's public based. So with a base price that is difficult to know how it will finish. So, yes, we'll do write a reserved money for this auctioning. So next year, we expect to pay the dividends in line with free cash flow generation, as we already several times.

So in order to beat that, we have additional spectrum auctions. We will have to reserve money. If not, we will try to increase our bidder rating. As a mater of fact, what we already said in different opportunities, we will not try to conserve money, if we don't need it. We will try to pay dividends to all our cash flow generation.

Franco Bertone

As far as your second question, maybe I'll take that about the margin for the second half. Yes, we expect to have higher impression in our margin in the second semester compared to the figures we just tabled with you. The fact that number portability may delay a little longer, because of process reason, we'll not release at all pressure on margin on the second semester, because the cost associated with the implementation of portability are incurred beforehand and the additional revenues if any will occur after.

So the effect of delaying a few months, so that as of today, we don't expect to happen, but just in case it was the case, we don't expect that to reduce at the cost of self-preparation So yes, we do have concern about salary, and we mentioned during the financial presentation that we expect lower margin in the second half than we had in the first.

Operator

We'll take our next question from Alex Garcia with Citi.

Alex Garcia - Citi

Still on the guidance, when we tried to do the math it's kind of like just basically subtracting what you guys have reached on the first half of this year versus your guidance. The drop in margin this is material. So I just wanted to touch points here such based on, basically if you guys are being conservative on the guidance or you guy's don't want to talk about any tariff fee raise throughout second quarter? But I mean when we do the math, the drop in margins on second half is a bit material. So I just wanted to make sure if you guys are being conservative or, and you should expect this guidance to be revised and/or to be beaten easily, especially on the EBITDA? That is my question. Thank you.

Franco Bertone

I would say, if had to mention a few factor of what we detected in doing the math, I would comment on the fact that this figure was stable over nine months ago, before we had visibility of the actual 2010, that are earlier being strongly above our end-market expectation as well and are stretched for a three-year period in which growth rate in revenues and margins are growing less and less as we progress into the three years period. So when they compare sum of the first six months, our three-year period also benefit of this different scale factor.

I will also say the same thing that the second half of this year is significantly affected by the preparation work of portability that is up to the usual and traditional margin pressure that we experience in the second half of the year, after July 1st. And not only employees pay rates increased, I just provided before the scale of this increase that certainly today the majority of the unionized pay scale in the country is attacking. And therefore, not only human resource cost, but also third parties cost, as far as they are based on personal cost also increases. So that typical of our yearly calendar and is effecting the second half. On top of that we have the portability factor, and on top of that as I said, we have a third semester over three-year period in a prospect of declining growth rates and therefore is effecting your project.

Alex Garcia - Citi

And then, just 31%, 32% in the first half versus a sort of indication of margin of 26% in the second half is a big drop. So I was worried, should we be worried or should we be more expecting 26%? That's being exaggerated, doesn't it for the second half?

Franco Bertone

Maybe the comment is more appropriate to what you're saying is that, having achieved what we did achieve in the third semester, we are definitely confident our yearly target will be met and patched.

Alex Garcia - Citi

And just one another question if I may, have you guys have done any exercise or what should we expect was to yield starts to publish IFRS numbers. I mean we do can compare the Teleco Italia numbers in the presentation and guidance versus the Argentine GAAP. But just to refresh, what sort of changes should we expect once you guys start to publish IFRS numbers?

Franco Bertone

Yes, we understand your question and request. I mean there is a full discloser of it in our press release that was published today just to help you to cross-verify figures. And our Argentinean euro-converted IFRS figures would be releasing today at the Group level. But please refer to the press release we published today.

Operator

Thank you. And there are no further questions at this time.

Pedro Insussarry

Yes, alright. Just wanted to thank all of you for being in our conference call today. Please contact as your convenience if you wish to do so. And thank you to John for assisting us during the call. Thank you so much.

Operator

This does conclude of teleconference. You may disconnect your lines at any time. And have a wonderful day.

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