Portugal Telecom, SGPS (NYSE:PT)
Q2 2011 Earnings Call
August 31, 2011 11:00 AM ET
Zeinal Bava – CEO
Luis Pacheco de Melo – CFO
Georgios Ierodiaconou – Citi Group
Soomit Datta – New Street Research
Greetings and welcome to the Portugal Telecom 2011 First-Half Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Zeinal Bava, CEO of Portugal Telecom. Thank you sir, you may begin.
Okay, thank you very much. Good afternoon, ladies and gentlemen. Zeinal Bava from Portugal Telecom. I’m here with my CFO, Luis Pacheco de Melo and our financial team including our IR Director, Nuno Vieira.
We following the Vivo transaction on the 27th of September 2010, Portugal Telecom has adjusted its 2010 financial statements in order to recognize Vivo as a discontinued operation, and following the acquisition on the 28th of March of 2011 of a 25.3% stake in Oi and a 14.1% stake in Contax, PT’s statements of financial position and our proportionally consolidated the assets and liabilities of these stakes as at 31st March, 2011 and income statement as from 1st of April 2011.
So this second quarter, we are already proportionately consolidating the investments that we have made in both these companies.
In the first half of 2011, our consolidated operating revenues amounted to Euro 2,669 million, while EBITDA reached Euro 1,000 million. Our consolidated EBITDA margin stood at about 37.5%. Net income reached Euro 228 million, and basic earnings per share stood at roughly $0.26 in the first half of 2011.
Our CapEx in the first half as well amounted to 418 million, that’s equivalent to roughly 15.7% of revenues. And in Portugal that’s primarily directed to investments in new technologies, future proof technologies, namely FTTH network and the pay- TV service, as well as the swap of the 2G equipment that we’re doing in order to prepare ourselves to launch 4G as and when.
In the first half of 2011, our EBITDA minus CapEx reached Euro 582 million and the EBITDA minus CapEx of Portuguese businesses amounted to roughly Euro 409 million, which was an increase of 7.4% year-on-year.
Our operating cash flow was roughly Euro 525 million, while excluding the consolidation of Oi and Contax, it amounted to roughly 451 million on the back of improving revenues and EBITDA trends in Portugal, and of course downward pressure on CapEx following the completion of the network modernization program and tight management of working capital in Portugal.
Our free cash flow excluding the cash out-flow related to the acquisition of the investment in Oi and Contax stood at roughly Euro 317 million in the first half, that compares with 22 million in the first half of last year. And therefore a significant improvement.
As at 30th June, excluding the proportional consolidation of Oi and Contax, net debt adjusted for the receivable of 2 billion from Telefónica, which is still pending and the transfer of our regulated pension plans to the Portuguese state, our net debt therefore amounted to Euro 4.269 billion. And this is of course after the payment of about Euro 1.1 billion in dividend in the 3rd of June of 2011.
Our cost of net debt remains very competitive. If you exclude the interest on certain cash deposits that we had preparing ourselves for the Oi investments, our net debt, our cost of debt stands at roughly 3.5%.
The liquidity position of Portugal Telecom continues to be very robust. Our balance sheet is very well-financed, all maturities and commitments are fully financed until the end of 2013. And as my CFO will explain to you later, with the roll if we – with the roll up of certain banking facilities that we have, it is possible that the financing requirements of Portugal Telecom will be fully financed not until the end of 2013, but until the end of 2015, but I will let Luis explain that to you in more detail.
Let me now just perhaps take you through some of the operational highlights of Portugal Telecom. And perhaps some of the key messages I would like to leave with you in this call and considering that we’ve already provided you with a trading update is that, mail continues to drive solid performance of retail accesses in Portugal.
The retail accesses were up about 6.6%. We continue to do also fairly well in terms of broadband. Broadband customers were up 11.5% year-on-year and pay-TV customers were up about 31% year-on-year. So with regard to the fixed line drivers thinking about the residential market, all of our services continue to do fairly well, notwithstanding the fact that we are facing adverse market conditions.
TMN is the market leader, customers were up about 0.9% and 27.3% of our revenues are already coming from data. When one looks at the mix of revenues of Portugal Telecom, thinking about the resilience of our top line performance, it is worth highlighting that between the fixed and mobile in Portugal, non-voice revenues already account for almost half of service revenues in the first half of 2011.
To be more precise, it’s roughly 46% and we would expect this 46% to continue to grow in the future as we actually take advantage of the opportunities of the digital world on the back of the significant investments that we have made in new technologies at Portugal Telecom.
So in the first half of this year, what we see in Portugal are clearly improving revenue trends, significant cost reduction and tight CapEx control. In fact we continue to believe that the modernization program of Portugal Telecom is coming to an end and in the future we will not only see the benefit of that in terms of top line performance and market share gains, but also in terms of cash flow generation.
With respect to Africa and Asia, our focus continues to be on commercial activity across all our assets which is fueling top line growth, proportional revenues adjusted for the Kwanza, the evaluation of the Kwanza was up about 17.7% year-on-year. We also have as you know clear leadership positions in all of our markets, furthermore all our assets are fully financed and cash flow positive.
With regard to Brazil, mobile gross ads at Oi maintain very strong pace, posting the best performance in the past three years in the second quarter. No doubt, you heard the conference call of Oi and clearly this was a good quarter in terms of mobile gross ads. Having said that, mobile net ads reflect a decision of the company to focus on healthy and profitable customers and of course clean up of database.
Fixed broadband customers grew 7.8% year-on-year, although, we continue to believe that we can do much, much better than this and the growth opportunity in terms of broadband in Brazil is pretty significant. But the good news is that the service already covers roughly 4,600 municipalities and therefore positions Oi uniquely to take advantage of the future growth of broadband in Brazil in the future.
While fixed lines declined 6.5%, we continue to believe that pay-TV will allow us to transform that part of the business very similar to I think what we have been able to do also in Portugal. Although, from a small base, but pay-TV customers grew 26% benefiting from an increased coverage of the service in that market.
With regards to the PT’s balance sheet, I’ve taken you through the cost of net debt, but allow me also to reinforce the message with regard to our pension fund. Our pension plans have been transferred to space and therefore from a qualitative standpoint and thinking about value at risk at Portugal Telecom that has improved significantly with that decision to actually transfer those funds to the states. So if you’re thinking about the credit quality of Portugal Telecom, I would say that there is clearly a very positive point to bear in mind considering also the volatile market conditions that we’re all facing.
Let me now focus on the second quarter highlights and to get to some additional details in terms of our performance. Our total customers, our wireline retail accesses as I said grew 6.6%. Probably you are now more interested in what’s going on in July and August. And what I can say is that, we’ve had and we continue to see very good demand for services in the month of July and August.
In fact, July and August tend to be and September tend to be better months for us due to seasonality and I would say that we are very confident that this year mail will go above a million subs by the end of the year. As you know, we launched a service with 5,000 customers in April 2008, we’ve indicated to the market that we would reach critical mass with roughly 800 to 815,000 subs.
We have gone well beyond that. We finished the second half of the – second quarter of this year with 919,000 pay-TV customers. We are confident that by the end of the year, we will be above a million subs and therefore working towards leadership of pay-TV in Portugal and naturally this confidence that we have in terms of the growth in our pay-TV service in Portugal will also underpin our performance in terms of broadband and also wireline retail accesses.
With regards to Oi, we – as we said we had a good quarter in terms of gross adds in terms of mobile and Oi has at the end of the first half had 65.9 million customers. So when you aggregate that with other customers that we have in our businesses at PT, our total number of customers is 88.3 million. And in my view, that provides us with the scale that’s required to remain very competitive when talking to our suppliers and ensuring that we have access to technology and not only in a timely fashion, but also at very competitive prices.
In terms of wireline and TMN, retail revenue growth in wireline has consolidated, so roughly between the first quarter of 2010 and now second quarter 2011, we continue to see retail revenue growth of circa 1%. And in the second quarter, you also saw a reversal in the EBITDA trends of fixed line with EBITDA growing actually 1.1% and margin stabilizing at above 40%. We remain confident that we can continue to revert the trend of EBITDA going forward and whilst we’ve indicated that it was our ambition to reverse those trends this year that we’ve actually done better than expected in the second quarter.
So the focus continues to be ensure that we have the right discipline in this company to continue to surprise on the upside in terms of EBITDA performance and if possible in the next few quarters further consolidate this trend.
In terms of TMN, in terms of billing revenues, you now that have realized that our billing revenues are showing improvement quarter-after-quarter. Third quarter 2010 billing revenues were down 8.4%. In the fourth quarter, so minus 10%. In the first quarter we saw minus 9.7%, in the second quarter minus 8.2%.
So clearly stabilizing trend and notwithstanding the top line pressure that we’re seeing for a number of reasons also because MTR have been coming down, margins remain at a healthy 47%.
With regard to resilience of our top line, 55.4% of our revenues in fixed line are now non-voice revenues. At TMN, data contribution is 27.3%, in aggregate that’s about 46%. So therefore it’s actually in this environment with some of you very concerned about the impact of the economy in terms of consumption and so on and so forth, my belief and our belief here is that the fact that we have been able to transform our business means that probably we’ll be able to withstand that pressure better than other peer group companies that have not done what we have done in terms of transforming not just our business model, but also our network.
Following the consolidation of Oi, thinking about diverse geographical diversification today, Portugal Telecom has 59% of its revenues and 51% of its EBITDA derived from international assets. That is a significant achievement considering that in 2008 international revenues represented about 30%, 35% of our top line.
We’ve – we now stand at 59% and the fact that we are present in Portugal, Brazil and Africa allows us to say that from diversification standpoint probably our risk profile and our ability to withstand future challenges in terms of economic outlook in Portugal are better than average.
With regard to CapEx, most of our CapEx has been invested in the modernization of our network. I’ll mention that in more detail in a minute. But clearly, our CapEx from a qualitative standpoint also has the advantage in that about a third is client-related, which means that if demand is lower than expected, then you certainly see the upside of that in lower CapEx and therefore higher cash flow.
With regard to our net debt-to-EBITDA ratios, again we’ve seen a significant improvement post the Vivo transaction. And today, we are very confident that our cash flow – our cash flow and our balance sheet structure allows us to ensure that we continue to keep on investment grade rating and from that standpoint, you will maintain very close dialog with the rating agencies to ensure that they have the same level of comfort that we have.
And therefore and that they understand our resolve and our commitment to continue to ensure that we remain very disciplined not just in terms of cost, but also in terms of cash flow to continue to deliver on all the promises that we have made generally speaking to the market.
Couple of few more things I would like to highlight. One of them is to do with the revenue decline in the fixed line. Our fixed line decline actually appears slightly exaggerated in the way that the numbers are presented in the first half and this is because we have as you know one extraordinary project which was a school project providing connectivity to all the schools in Portugal, which involved a lot of installation work and equipment sales.
And as you know, we also consolidate a directories business, which is reflecting secular trends with top line declines of over 25%, 30%. If you adjust for these two, I would say extraordinary events in terms of top line in our fixed line business, our top line in the fixed line business is only declining 2.8% in the first half of this year.
Residential operating revenues are actually up about 6.3% in the first half, SMEs and SOHOs are down 6.9%, albeit, that we continue to believe that with the restructuring we’ve done in SMEs and SOHOs, we should be able to improve those trends as we continue to – are allowed new services such as Smart, Cloud, and so on and so forth.
With regard to – with regard therefore to the growth in wireline domestic revenues, I would say that we compare favorably in the context of the sector. In the first quarter, our top line was down 4.8% adjusting for directories and the school project in the second quarter, there was a clear improvement in the trend and the revenues were down only 1.1%.
But I can say with regard to the months of July and August is that, as I mentioned earlier, things are going better than expected and we continue to see good demand for sales, especially in the residential segment and when actually plays about mobile in prepaid as well.
In terms of EBITDA performance of the fixed line, we saw declines in OpEx of about 9.3%. We continue to believe that the cost reduction in our company is sustainable. Having said that, every now and then there will be some extraordinary cost items that we will have to deal with namely in terms of maintenance and repairs due to for example in the summer when we have significant fires and so on and so forth.
But, leaving to one side some of these one-off effect. The trend is in the direction that we think it’s healthy and the 9.3% decline in OpEx that you saw in the first half just goes to show how committed we are to adjusting our cost structure in order to live up to the consensus out there, which we’ve indicated to you we are very comfortable with. So therefore the wireline EBITDA reversal in the trend in my view is something that we will continue to work towards maintaining in the future.
In terms of mobile, in Portugal improving trends as ‘tribal plan’ drag effect is reaching an end and upside from the take-up of our simply e-plan is also gaining momentum. As we know these e-plans provide a bundle of voice SMS and data and in our view provides the best value proposition in the market and its attracting not just sort of normal customers with normal tariff plans, but also some of the customers that we have in the tribal plan that will like to buy bundles of voice and data as opposed to data on a stand-alone basis.
So we continue to see good pick up of our e-plan and we think that we should be able to have more than 500,000 people on this plan before the end of the third quarter of this year. So we think with ARPU enhancement that we’ve seen from this plan, this will no doubt underpin an improvement in the top line performance especially in the prepaid market in Portugal.
Also in TMN, we continue to deliver on cost-cutting, margins well above 40% circa 47% and again OpEx we think that can continue to come down in TMN. And I would say that July, August, September will continue to be months when we will continue also to reduce those costs and we think there is potential to continue to do that for at least most of this year.
With regard to our network and investments in IT, we have reached critical mass in terms of pay-TV, the Fibre rollout will be completed when we reach 1.6 million homes. We will not be investing beyond 1.6 million homes unless regulation changes.
And therefore at 1.6 million homes our Fibre rollout plan will be completed and we continue to see network and IT investments as accelerate as off the transformation of our business model and also cost-cutting. So the cost-cutting efforts will probably come is structural and by structural I mean that we will continue to invest in marketing and in sales because we see an incredible opportunity on the back of the investments we have made in technology to gain share not just in the residential segment, but also in the corporate and SME segments as well.
Triple play the growth opportunity for us and profitability is improving as a result of double-digit declining – declining programming cost per customer. The programming costs were down 19% and therefore it is important as we continue to work towards achieving that objective of having more than 1 million mail subscribers by the end of or before the end of the year.
With regard to cost reduction again, just to label the point about how structural this is, we’ve integrated all our stores under a single brand. And obviously, you’re beginning to see the benefits of that in terms of revenue generating unit sales ratio. So we’re selling more per store and we are selling more fixed line products in old mobile stores and vice versa.
With regard to the Field Force, our monthly cost per revenue generating unit is also coming down. So whilst cost on an absolute level might actually be going up a bit, but per unit is actually coming down, customer care costs are also coming down as we move more of our customer interaction on line and simplified processes.
The investments we made in fiber are also reducing the number of costs to the call center and also are contributing towards a significant reduction, not just in terms of churn rate, but also in terms of the number of technicians that we actually have to send to the homes of our customers to actually resolve any complaints that customers may have.
With regards to CapEx. Our CapEx as I’ve mentioned before to you, 30% are investments in technologies, 30% are customer related and about 40% is maintenance and repairs. With the end of our modernization program, as you can imagine in the future I would say 2012 and beyond, the likelihood of downward pressure on CapEx is pretty significant. But if customer CapEx remains high, that should be good news because it means that we are selling more and you will see the benefit of that in terms of the top line.
With regard to LTE, we expect the spectrum options to happen in the fourth quarter of this year. As we have indicated that we are interested in buying more spectrum and we are interested in moving ahead with LTE, it’s actually because we see significant synergies and advantages by having LTE in mobile and fiber in terms of the fixed line. In fact, some of those synergies actually coming through because 85% of our mobile stations are already connected with fiber. But we expect the option of inspection to happen in the fourth quarter. We are looking forward to seeing the exact terms and conditions to actually understand how we will position vis-a-vis LTE, but I think it is expected that soon the terms and conditions will be made available and I think as and when that happens, our IR director will no doubt come back to you with some additional information.
With regard to CapEx as in mentioned, we will see downward pressure and this is against industry trends when you expect naturally where you expect financially CapEx to go up because a lot of our peer group companies have not made the modernization in the essence that Portugal Telecom has made.
With regard to Oi, the wireline business is reflecting secular trends, mobile gross adds did well. Having said that, as you know, there is – we’ve just recently hired a new CEO for Oi and against that backdrop and the telecoms committee, if you like engineering and network committee, we put together. Portugal Telecom controlling shareholders. The board of Oi is working very closely with the management team to actually put forward a turnaround plan for that company and therefore, we continue to believe that Oi has a unique franchise and has substantial growth opportunity in that market, be it in mobile, be it in pay-TV or broadband for that matter. And right now, the focus that we have is in ensuring that the simplification of the corporate structure is completed on time.
We indicated to you in the past that we would like to see the simplification of the corporate structure completed by the end of the fourth quarter of this year. The board of Oi have approved the incorporation of the various companies. We are preparing the filing for the SEC. And as and when that filing has been approved, we will then summon a shareholders’ meeting and that shareholders meeting will finally approve the transaction.
So we continue to believe that it is possible to get this transaction done by the end of the year. It is absolutely critical for the turnaround of Oi that we move ahead with a simplification of the corporate structure. It is a simplification of the corporate structure which will allow the management of Oi to have their right conditions to implement what is required to operationally turnaround the company naturally with the full support of all shareholders and of course from a technological stand point with the support of Portugal Telecom.
Other international operations are showing, I would say pretty good growth and therefore from my end I’ll just say that we think the second quarter was actually better than we had expected in Portugal. In Brazil clearly, there is work to be done in terms of transforming our business model, but clearly the recent approval by the Senate of which will allow companies to move to pay-TV and transform the business model provides a unique opportunity for us in terms of the future.
And with regards to our balance sheet structure, we are very confident that we have what it takes to continue to deliver an obligation is not just with equity, holders are also bondholders. And last but not the least, I will just that for July and August, we continue to see, I would say trends very similar to what we saw in the second quarter, which means that we continue to feel very comfortable with the consensus that’s out there on our company, which as you know, with regard to EBITDA for wireline is Euro 735 million, and in terms of mobile is Euro 560 million. So with regard to the consensus that’s out there, I would like to reinforce the message that, we are confident about our ability to deliver on that.
So Luis, please I’ll hand over now to our CFO. Thank you.
Luis Pacheco de Melo
Okay, thank you. Now good afternoon ladies and gentlemen. I’ll be very quick. Just a few minutes on the low EBITDA figures, net debt, cash flow and then I’ll turn out for Q&A. On the EBITDA as Zeinal mentioned, it increased by 73.5% and it’s basically due to the consolidation of Oi. If we exclude the consolidation of Oi, then EBITDA would have decreased by 5.5%. And it’s basically due to the revenue performance at TMN, so revenue pressure on TMN, and despite almost 12% decline in operating cost in TMN.
As already mentioned, EBITDA on the wireline grew by 1.1% consistently improving trend. Consolidated EBITDA margin stood at 35.7% in the quarter and 40.2% if we exclude Oi. On depreciation and amortization, it increased – it almost doubled, and that’s due to Oi 13 Portugal, it increased by 11.2% and is basically due to the wireline pay-TV business that was responsible for 14 million out of the 20 million increases.
On PRB’s, they decreased in the second quarter to 14.3 from 17.8 last year, and it’s basically due to the transfer of most of the pension fund assets into the Portuguese state. With regard to the net income, net income decreased by $66 million in the quarter to 98 million, and this reflected basically, we – in 2010, we had net income from discontinued operations basically Vivo of 61.4 million in the second quarter last year. The 61.4 million included more or less 32 million, resulting from the foreign-exchange translations and that we had accumulated until then.
In addition to that, last year we booked 48 million tax gain due to the restructuring at – in Africatel as you might recall. And this year we also added D&A, which was higher than last year as I already mentioned.
On the positive side, of course now we have the contribution of Oi and we had also decreased on the net interest expenses and it’s basically because of the Oi disposal and all the cash that we had until we invested in Oi and we paid an extraordinary dividend.
With regards to CapEx, it almost doubled in the quarter and that is basically due to Oi. If you exclude Oi, it increased by 15.3% and it’s basically a seasonal effect in this quarter as for the accumulation – the year-to-date figure is still below last year’s figure by almost 6%.
On the cash flow front. Cash flow from operations increased by 32%, also basically due to Oi or if we exclude Oi it decreased by 14% and that is basically due to TMN’s revenue performance. As I explained that on the year-to-date, our cash flow more than doubled from that of last year.
On the free cash flow in the quarter including Oi, it was negative by 136 million. If we exclude Oi it was positive by 31 million. The negative impact in the quarter was basically due to the acquisition of Allus by Oi. And we also had some payments, legal payments and deposits for certain legal actions in Oi.
On the financing side, net debts if we include the receivable of 2 billion from Telefonica, consolidated net debt stood at 6.6 billion. It is worth highlighting this 6.6 billion include 2.4 billion, which is a translation of Oi’s net debt into our balance sheet. And the figure also includes 900 million, which is payments that we still have to pay to the State due to the pension fund transfer last year.
I know that some of you had some questions regarding the Euro 2.4 billion, those coming from Oi, out of this Euro 2.4 billion, 1.8 came directly from Oi, 600 million came from the Contax – and the moving companies that stand in between us and Oi. The increase in net debt from the end of last year basically reflect the $3.7 billion that we invested in Oi and the 1.1 billion ordinary and extraordinary dividend that we paid last May.
From the same period last year, the increase was 1.5 billion, which is lower than the 2.4 billion that we just consolidate from Oi and also the effect of the pension fund transaction. On the net debt to EBITDA now on the consolidated basis, it stands at 2.6 times, which is a significant decline from 3.6 times of last year, and that is due to the legal transaction of course that this 3.6 on a like-for-like basis if we have included the pension fund transaction would have meant four times last year and now it’s 2.6 times.
The average cost of debt declined from 4.6% to 3.4%. The average maturity now stand at around six years, excluding an Oi of course, and the total cash available plus undrawn facilities stand at 5.4 billion, of course the 5.4 include the 2 billion from Telefonica. And then I’ve mentioned before, if we just assume that in 2014, we are able to roll out of the club deal that we just signed then all our commitments will be financed not until the end of 2013, but the end of 2015.
With regards to the pension funds, the unfunded post retirement benefits obligation stood at 29 million at the end of June. Then in addition to that, and we have the liabilities of the salaries to pre-retirement and suspended out employees, which amounted to $860 million. So overall, we have around $890 million unfunded pension and obligations and salaries to pre-retire and suspended employees that after-tax is around $670 million. In addition to that in Brazil, we have right now $55 million of unfunded pension obligation.
So let me now hand it over to Zeinal for a final remark.
Okay, thank you, Luis. So just a quick summary. We continue to believe that the performance of the residential segment at Portugal Telecom in Portugal will continue to underpin our top line performance.
In terms of the wireline, we need to remain very I’d say discipline in terms of cost, which we intend to do in order to consolidate the EBITDA performance in the wireline that we have posted in the first half of this year, which as you know has been pretty much flat compared to the same period of last year.
TMN in terms of mobile, we continue to believe that on the back of all the work that we’re doing around the e-plans and of course the better comparisons of second half this year versus second half last year in terms of tribal plan will allow us to show a better performance in terms of prepaid.
Having said that, we remain exposed especially in the postpaid segment, so thinking more mainly about the corporate segment and SMEs and SOHOs to the customers becoming a lot more rational in the way that they utilize the services. And therefore in order for us to continue to deliver the EBITDA performance in line with the consensus again at TMN, we will need to monitor cost pretty costly and also work on the basis that there will be rational behavior on the part of our competitors, but also in terms of regulation when it comes to mobile termination rates, which in Portugal as you know are already about 20% below the European average and at present are about $3.05.
In Africa and Asia, we continue to believe that there will be customer and top line growth and these companies will continue to generate good cash flow and repatriate capital, which will underpin cash flow performance on a consolidated basis at Portugal Telecom.
In Brazil, we have significant operational turnarounds ahead of us. The good news is that, the relationship between partners is very good. We have a new CEO, we have a management team that is very commitment to deliver on results as well. And the simplification process which is ongoing is absolutely critical for us to implement the turnaround that is required. And in my view in a market, which continues to – in our view remain extremely attractive in terms of future potential world not just in terms of mobile, but also in terms of broadband and pay-TV.
With regard to Oi again, we expect Oi to pay dividends and those dividends will underpin our cash flow. The dividend policy at Oi, we expect that we should be able to address what should be the dividend policy at Oi once we have the simplification process of the corporate structure completed. And as indicated by Oi’s CFO, probably first quarter next year, we should be able to come back to the market with more news in that regard.
With regard to our balance sheet, it’s well funded, if we roll out half of the club deal we have no funding requirements before 2016. So until the end of 2015 our funding requirements will be completed. We think that this should give the rating agencies on one hand, but also our investors and one hold is on the other hand, the confidence that Portugal Telecom will continue to honor all of its obligations despite the fact that of course we are facing adverse economic conditions in Portugal. But it is worth highlighting that more than 50% of Portugal business, Portugal Telecom’s business is now then outside Portugal.
Thank you very much for being on this call. My team and I are of course very happy to answer any questions you may have. Operator, we’re happy to take any questions now. Thank you.
Thank you. (Operator Instructions) Thank you. Our first question is from Georgios Ierodiaconou with Citi Group. Please proceed with your question.
Georgios Ierodiaconou – Citi Group
Yes, good afternoon. I’d like to ask two questions please. The first one is, your some comments around trading conditions in July and August, particularly along the fixed line business. Could you give us some color on mobile, the prepaid recharges, perhaps some color on mobile broadband whether performance there is as good as you would have expected it. And my second question is around Oi, I think you commented towards the end about a dividend policy early next year, since we’re getting the simplification probably in the next couple of months, is the returns that you may be able to allow, announce a top up dividend for this year or is that unlikely?
Okay, thank you. With regard to mobile, I would say that the performance of prepaid in so far this quarter has responded very well to a number of promotions that we have done out there, which seem to support the view that there is some elasticity of demand.
So I would say that with regard to recharges on the prepaid, perhaps I would say the reaction to the promotions we’ve done has been good and we’re quite happy with what we have seen on the prepaid. In terms of broadband the trends are very similar to the first half. In terms of post-paid mobile is where we are seeing significant pressure in terms of downward pressure, because especially corporate customers are becoming extremely rationale in the way that they use certain services, not just voice but also data, especially what we call extra platform.
So corporate customers used to allow employees to use additional minutes on top of whatever was contracted.
Some of these are actually being to some extent limited in terms of usage and of course, that is having an impact. So that’s the one post prepaid and postpaid in line with in terms of broadband. And I would say that with regard to regulation of course, they remind that termination rates did come down in August to $3.05. So that will continue to be a slight drag in terms of top line performance at TMN.
With regard to Oi, as I said, once the simplification process has been completed, the company should be able as the CFO of Oi has already indicated publicly that the company should be able to address the issue of the dividend policy. So I’m not necessarily committing to you that we would come out with a dividend policy statement, but I would say that we will have the right conditions to address what should be the sustainable dividend policy for Oi going forward. At this stage, I wouldn’t like to comment a lot more other than this, because we are in the process of filing with the SEC and we need to get the corporate restructuring out of the way, and we consider that that is absolutely critical, if we are going to be successful in implementing or in executing the operational turnaround of the company.
The good news is that, the committees have down a very solid and a very professional work. Those exchange ratios have now been approved by the board, have been made public. And therefore, we think that, that should pay the way for us now to do the last mile, which is to do the SEC filing and then call the shareholders meeting, and go ahead and simplify the corporate structure, which is – has been an hindrance, not just in terms of us being able to execute operationally, but also from the analysis of the capital markets as well. Thank you.
Georgios Ierodiaconou – Citi Group
(Operator Instructions). Our next question is from (inaudible) with Espirito Santo Investment Bank. Please proceed with your question.
Hi, good afternoon. I have two questions if I may. One is on the wireline segment, (inaudible) if I remember correct, you had mentioned that EBIT infraction would come at what stages of this year or even in 2012 and we are never to reach that in first half. And it is seasonal that you would reach out to grow this year on the wireline segment. And on Brazil, regarding the regulation on more termination rates, can you give us an update on what’s going on there? Thank you.
With regard to – thank you. With regard to the wireline performance, we’d indicated that sometime this year we would be able to reverse the trend with at some stage said that we hope that one quarter we can post a positive EBITDA.
And first quarter this year, our EBITDA was only down 0.2% and in the second quarter it was actually up 1.1%. Now that has been achieved on the back of significant cost-cutting and discipline at our company, not just wages and salaries but across the board.
Bearing in mind also that we continue to invest in terms of share of mind, so we’re not cutting back. On marketing expenses, nor are we cutting back on commissions as we have indicated in the past that we are not going to lose market share on the back of price. We will be the most competitive operator in this market. Although, we continue to believe that the market should be rational, because this is a capital-intensive sector and with long payback. But if we have to respond to more aggressive competitive behavior in the market, we will do so.
Although, again I would say, we would not recommend that. But I would say that market share gains for us are being underpinned by investments that we have made in new technologies. What’s highlighting here that the cost-cutting is being achieved because we’ve done business process reengineering. The investments for example, we’ve made in fiber has reduced the maintenance and repairs in certain parts of our network significantly. Decline faults have come down a lot, client calls with regard to faults have also reduced.
Recently for example, we have made available in all the TV screens of customers that have the mail service. They invoice, their fixed line invoice so that they can actually check themselves their invoices on the TV screens. And therefore, on line if they want to interact with us or resolve some of their queries and therefore, as you can imagine all of this is not just allowing us to improve the quality of service that we provide for our customers, but also at the same time to reduce costs.
With regard to programming costs that was a – that’s a big item now in our P&L. We are seeing benefits from the fact that we have gone above 85,000 subs. We finished the first half with 919 customers – 919,000 customers, and we hope and we expect this year to go above a million subs. And we think that that is certainly doable, and we hope that before year-end, we should be able to achieve that target. And that as you can imagine, we’ll underpin performance in terms of broadband, but also in terms of line disconnections.
And therefore, as we have said in the past, the reversal of the trend have to be underpinned not just by significant cost-cutting, which is what we are doing, but also good top line performance. So on the residential, we think that if we are able to maintain the performance that we have seen so far, we feel very confident that EBITDA performance will also come through.
With regard to mobile, of course the ability for us to reduce cost is not the same, because mobile companies as you know have always been much more tightly managed than fixed line companies in the past. Having said that, we continue to show more than 10% decline in OpEx in mobile. But I would say that at this stage critical for us in terms of mobile is to ensure that we continue to improve the trend in terms of billing revenues and in that regard, it was good to see that second quarter was better than first quarter and of course, first quarter was better than fourth quarter last year. So I think that there’s work here to be done.
Clearly, people are responding to bonuses that we are giving them on certain promotions that we do, et cetera, and this is what we need to continue to do. But I would say that the performance in terms of EBITDA in mobile will be much – will be grossly impacted by the top line decline that you are seeing because our ability to mitigate that by cost cutting is to some extent limited.
Having said that, there are synergies between fixed and mobile, which we are taking advantage of, and we will continue to take advantage of the fact that we are an integrated telco, will allow us to improve our value proposition to customers in the future even as we launch LTE. It is what’s highlighting that in those markets where operators don’t have fiber, LTE may represent a threat and a possible – additional cannibalization of fixed by mobile. In our market, I think that LTEs together with fiber investments that we have made will allow us to actually move the goalpost away from Telecoms into ICT and therefore increasing significantly the addressable market in terms of revenues for Portugal Telecom. That’s why we are confident that the restructuring we’ve done of our SME offers will result enough improving our performance in SMEs.
I think that is clearly a segment where I think we can still improve performance and I think that improvement in performance will have to be achieved on the back of investments and technology we’ve done, which have allowed us to launch recently our cloud offer, which I encourage you to check online it’s called smart cloud PT.
PT and you will see that in that Smart cloud offer that we have available we are providing SMEs and so in Portugal with a unique value proposition together with our international part as Microsoft and Cisco, but I would say that whereas in wireline we hope and we’re working towards stabilizing the EBITDA performance for the next few quarters. In the case of wireless the improvement in EBITDA performance will depend very much on improvements in terms of topline as well. Thank you.
Our next question comes from (inaudible). Please proceed with your questions.
Hello, good afternoon everybody. Just to come back I think you did not give an opinion on what has happened to the MTR in Brazil, I mean the decision has been delayed I think for some months already (inaudible) the regulator is reconsidering the initial preposition of my 10% decrease for this year. I don’t know if you could with us your thoughts on that. And maybe also the second question is whether you could give us idea of what you expect in terms of CapEx for the options the end of the year, spectrum options and maybe also for the (inaudible) technology?
Okay, in terms of MTRs what I would say, I wouldn’t like to comment specifically for obvious reasons, we would like to continue to work our views on MTRs directly with regulators both in Brazil and in Portugal, but what I would say with regard to Brazil is that it is absolutely critical that one achieves the right balance between fixed and mobile in order to ensure the long-term sustainability of the business model of fixed line in Brazil in reference in pay-TV will be pretty significant, the fixed mobile cannibalization in Brazil has been pretty significant as well in the last few quarters. So I think it is important that the conditions are created so that operators invest in future proof technologies in order to underpin the development of the Telecom sector in Brazil.
We continue to believe that the broadband penetration in Brazil can be increased significantly in the future. We also believe that pay-TV penetration in Brazil can also increase significantly and this is substantiated by a number of analysts and also a number of – that do write reports on it. And I’m sure, we own an agreement that the increased penetration of broadband mobile, pay-TV will also improve. I would say, the economic conditions and the wealth of the people in those markets where you have seen these penetrations actually increase.
So we are committed to investing and ensuring that Oi is remained very, very competitive and operate that is well-provisioned to take advantage of all these growth opportunities. But it is important that, when one is thinking about taxes and one is thinking about regulation that, it is taken into account the fact that the fixed line companies in Brazil do have significant challenges around universal service obligations, simply also because the fact that the country has continental dimensions.
And therefore, I am very hopeful that taking into account the fact that increasing broadband penetration is a priority in that market. Also bearing in mind the bandwidth requirements that, that market will see on the back of Olympics and the World Cup that the regulator and the government will put in place policies that incentive us to invest.
So with regard to regulation in Brazil and Telecom’s policy in Brazil, I remain very hopeful that, that market will find the right balance, essentially to encourage the necessary investment for us to grow and use Telecoms actually to contribute towards the development of that country and of that economy.
With regard to CapEx, we’ve indicated that in Portugal, we will be spending this year about the same as we spent last year, which is circa Euro 657 million. And as I’ve said earlier in my presentation, 40% of our CapEx is maintenance, 30% of our CapEx is modernization of the network and 30% is client related CapEx. With regard to client related CapEx, equipment prices are coming down. We ourselves are innovating how we connect our customers.
Take for example fiber, with this analog overlay that we have done, we have reduced the number of set-top boxes in the homes of the customers from two on average to 1. That is saving us the cost of one set-top box per households are reducing, if you like the customer related CapEx, also equipment prices are coming down. And therefore, what we think is that, our ability to manage our cash flow is better or much, much better than average, because the modernization of our network will be completed by the end of this year.
If you like beyond this year, most of our investments are going to be channeled towards customers, customers buying all service and also IT transformation that we still need to do in some areas. But – and so, if I would say that the scope for us to continue to – you put it to this way, there will be downward pressure on our CapEx beyond 2011. And therefore we think that the cash flow of Portugal Telecom will be underpinned not only by the dividend that we expect to get from all the investments that we have, but also by the fact that our CapEx will see downward pressures as we reach completion of our modernization program.
We praise to have high customer related CapEx, why because that means that customers are buying our service. And therefore, if you see high customer-related CapEx that should be good news in terms of top line.
And therefore that will support our view that in order for us to do well in the future in the sector we need to grow our top line and that’s why our focus is in ensuring that we have the primitives, the traditional understanding of what are the primitives of our business to continue to grow away just from telecoms and clearly into ICT taking advantage of the opportunities that the digital world offers to us. Thank you.
Thank you. And our last question comes from Soomit Datta with New Street Research. Please proceed with your question.
Soomit Datta – New Street Research
Yeah, hi there. Just a question please on the consolidation of Oi. When I look at the numbers you put into the revenue numbers in EBITDA you took onto your P&L, they seem to be slightly higher than if I just take 25.6% of Oi’s reported numbers and then make the correct currency adjustments. So I just wondered I presume that’s because as other revenues at play more part and maybe further up the chain. I just wanted to check out understood that correctly. And if so, I just wondered is there any way we can understand how those other revenues are going to develop going forward, please?
Luis Pacheco de Melo
Okay. Let’s see, the big difference then, if you look at what we have reported, if you look at what they have reported and convert into Euros, I think on the revenue line the difference is around 40 million. The 40 million is basically the different way of accounting between Brazil and Portugal Telecom.
For example and two-thirds of that is relates to this, is basically penalties that are imposed on clients. We book as revenues and they book as minus cost, okay. And then rentals of non-strategic equipment are also booked as revenues on our side and they are booked as minus costs at Oi. So the basic difference comes from that, and there is no revenues in the intermediary companies that accounts for that difference. Then if you look at – and therefore these plus revenues that we have are plus costs as well, and therefore on the EBITDA level basically, the effect of these inflated revenues are basically zero.
Soomit Datta – New Street Research
As a quick follow up, I thought the EBITDA level was slightly higher as well?
Luis Pacheco de Melo
Okay. On the EBITDA, the difference as you make this calculation is around 6 million. And this is just because there was a financial gain that we spoke in the second quarter, already that was actually referred to the first quarter and we just restated that. And so, going forward, you shouldn’t see any differences between us and them or any difference between….
Soomit Datta – New Street Research
Okay. That’s very clear. Thank you.
Luis Pacheco de Melo
Okay. Thank you.
Okay. Thank you very much for being on the call. My team and I of course as usual always available to answer any questions you may have. My IR Director, Nuno Prego, is of course available after this conference call to answer any further queries you may have. And again, I appreciate you being on the call and I look forward to speaking to you in November when we announce our third quarter results. Thank you very much. Good afternoon. Bye, bye.
Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
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