Philippine Long Distance Telephone Company's (PHI) CEO Manny Pangilinan on Q2 2016 Results - Earnings Call Transcript

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Philippine Long Distance Telephone Company (NYSE:PHI)

Q2 2016 Earnings Conference Call

August 02, 2016 03:00 AM ET

Executives

Melissa Vergel De Dios - Head of Investor Relations

Manny Pangilinan - Chairman and CEO

Anabelle Lim Chua - CFO

Ariel Fermin - EVP, Head of Consumer Business

Eric Alberto - EV Head of Enterprise Business

Rafael Bejar - VP

Ray Espinosa - Head of Regulatory Affairs and Policy

Joachim Horn - Chief Technology and Information Advisor

Analysts

Gopa Kumar - Nomura

Arthur Pineda - Citi

Varun Ahuja - Credit Suisse

Oot Karesh Narotta - JPMorgan

Operator

Good afternoon and welcome to the PLDT conference call. This conference call is being recorded and the details are indicated in the conference call invitation posted in the Investor Relations section of the PLDT website.

At this point, I would like to turn you over to Melissa V. Vergel De Dios, Head of Investor Relations, for the introductions. Please go ahead, thank you.

Melissa Vergel De Dios

Good afternoon, and thank you for joining us today to discuss the company's financial and operating results for the first half of 2016. As mentioned in the conference call invitation, a copy of today's presentation is posted on our website. For those who have not been able to do so, you may download the presentation from www.pldt.com under the Investor Relations section. A podcast of this briefing will be available from our website after the call.

For today's presentation, we have on stage members of the PLDT Group management team, namely, Mr. Manny Pangilinan, Chairman and President/CEO; Ms. Anabelle Lim Chua, Chief Finance Officer; Mr. Ariel Fermin, Head of our Consumer Business; Mr. Eric Alberto, Head of our Enterprise Business; Attorney Ray Espinosa, Head of our Regulatory Group. At this point, let me turn the floor over to Mr. Manny Pangilinan for the presentation.

Manny Pangilinan

Good afternoon to everyone. Thank you for joining us for today's first half presentation. Since we have a rather long agenda, I'd like to start the proceedings right away and turn over the microphone to Anabelle.

Anabelle Lim Chua

Good afternoon, everyone. Let me start with a quick overview of the financial results for the first half of 2016. Our service revenues for the period of six months came in at 80.6 billion or 75.8 billion or 75.8 billion net of interconnect which is stable year on year. Total revenues including non-service revenues were also stable or flattish versus last year.

If we take out the effect of the ILD and NLD revenues from our total service revenues, these were actually up 2% at 72.1 billion or a 1.2 billion increase year on year. Fixed line segment led the growth at a 9% increase year on year, equivalent to 2.4 billion increment, which offset the wireless decline of 3% equivalent to 1.7 billion.

EBITDA for the period came in at 30.8 billion, which is 13% down year on year and an EBITDA margin of 38%. We will provide more details on the revenues and the EBITDA in the following slides.

Core income for the first six months of the year was at 17.7 billion or 6% year on year decline. The core income in the first half included 7.4billion gained from our asset sales, in particular the divestment of our 25% in Beacon Electric.

On a reported net income basis, the number was further adjusted for the additional asset impairment that we booked with respect to our investment in Rocket Internet. That's equivalent to 5.4 billion that was booked as of June 30 to mark down the investment to the closing share price of EUR17.47 for Rocket. At this point I'll turn the presentation over to Ariel, Eric and Mr. Bejar before we come back with the details of the financials.

Ariel Fermin

Good afternoon, everyone. I'd like to show you a sheet that essentially tells the story that a data upsurge in the consumer group for PLDT and Smart really fuels the digital pivot. It manifests here that PLDT and Smart are, when you look at it, at different stages of this journey of this pivot. It's shown in no better way than the percentage of data for the total business where in the PLDT fixed-line business data was accounting for almost 60% of the revenue. In mobile it's about a fourth. So particularly for the fixed-line business as you can see on the screen, there are a lot of digital services that already run on broadband in the scheme.

Have been said that, the total Consumer Group for first half of 2016 posted a 1% increase in revenue versus same period last year. That would be about PHP0.5 billion. PLDT home was having double digit growth and mobile, would be having a decline at this stage.

Now, what you will see on screen would be the following points: really just data upsurge for both home and mobile in this case. For mobile, our growth rates for 2016 first half are twice as much than the same period of 2015 [indiscernible] in terms of absolute revenue. For home, because of the aggressive rollout that we're doing particularly in fiber, the data revenue is three times as much as 2015.

With that kind of growth you'd see all the things that we're doing right now with fixed and mobile, because the commitment to the community is that we now have an opportunity to offer converged services, particularly in the areas of connectivity, entertainment, home monitoring, or we call it peace of mind, and convergence in this case.

For connectivity, we have here, it is a [anchored] in FIBR, and of course Telpad which is at the center of a connected home. For entertainment, we've been doing this for years already, IPTV again with another, convergence with another member of the group that's with Cignal, and [S Sport] with the TVolution sticks and the boxes that we sell.

Home monitoring systems are done with FamCam together with mobile, because obviously you want to check what's happening at home, because you're always in mobile. The last piece would be convergence where there's QuadPlay, where you have landline, broadband, mobile phones and of course IPTV in this case.

We've launched shared data plans here in this year. It's getting good traction. Just very recently we launched wearable’s. You can see that little figure on screen. Those are watches with what they call pedometer functionalities. They really, it tells the parents where the kids are. That's the kind of approach that we're using as we humanize technology in this case.

So all in all, the Smart Home, or the converged services that you see on screen, account for almost 1 billion of revenue. It's growing by a solid 37% at this point. So we will continue driving this agenda, growing data for both fixed and mobile, and with that growth comes a compounded growth as well on the digital services, etc. on broadband. That's it for the consumer group of PLDT at this point. Thank you.

Eric Alberto

Thank you. Good afternoon, everyone. I'd like to touch on the enterprise group performance for the Group. We are delighted to report that the enterprise group posted 11% increase over same period last year, the first half, growing our business to 15.8 billion, which is an over 1.6 billion incremental revenue from the same period first half last year.

Both our portfolios on the large enterprise, large local and multinational portfolios as well as the small and medium enterprise portfolios have grown double digit, the large corporate portfolio growing at 10% and the small and medium enterprise group growing at 13%.

All our product, service and solutions lines with the exception of fixed voice, which is flat, have grown double digit. These are fixed data. Even our wireless voice and wireless data and solutions components are double digit growth. Certainly a very important component of the enterprise business proposition is in ICT and enterprise solutioning, double digit growth, as well as our foray into the international market through data global connectivity for enterprises, again double digit growth.

We have a very rich and robust year-to-date pipeline across our fixed and wireless as well as our ICT solutioning. This is pipelines. We are five months out worth of target revenues in the pipeline as we speak today with about 300 million in monthly recurring charge in the pipeline and 1.2 billion one time charges for our recorded opportunities as I speak today.

We still have, it's August, we still have a good five months in building that pipeline towards year end and we have level of confidence that the growth momentum in the enterprise space shall continue.

True to our mission to enable enterprises with the right ICT and digital tools, we ourselves have enabled ourselves with the digital tools by which to effectively run our business. We have actively taken in the salesforce.com platform that allows us real time enterprise sales tracking through the salesforce.com solution. That allows us to do consolidated revenue monitoring and automated monitoring through single customer view, a granular and detailed relationship management and accounts management platform that allows us to have visibility on our relationship to the customers in as far as fixed, wireless, ICT and digital solution requirements that they have.

As part of our digital mission to be the leading ICT and technology provider in this country, we have key initiatives to ensure we have continued growth strong growth in this particular sector. We're doing it in threefold. First, we are trying to lead the mind shaping of our enterprise, customer constituencies, by way of digital events that allow us to highlight and articulate the value proposition of business solutions as it enables business to do, to be more competitive and to be better at their core business.

Some of you might have followed our Philippine ICT Leadership Summit in partnership with leading ICT research firm, IDC, through digital now last June. We have this very successful, on its third running in the SME space the Tech Island.

We have also complemented our 130 strong relationship manager human resource facing off the large corporate and multinational portfolio by actually complementing them with 40 new warm bodies who are enterprise digital sales and solutions architects. These architects are, they supplement our relationship managers in articulating the value proposition of leveraging digital platforms on SMACS, social engagement, M2M telemetry, big data analytics, the cloud and security solutions, and how these solutions actually enable the enterprises to do their business better.

Last but not least, on the SME front, we have undertaken and we continue to undertake a Sugod-Suyod program, which is really in Tagalog a street-to-street business-to-business establishment coverage. We have identified 13 regional areas outside of Metro Manila where SMEs, which we deem and our records how they call research indicator , SME growth is going to be most robust and they put across the appropriate type of coverage and resource to really blanket and cover the opportunities in these markets.

Last but not least, the building blocks of a digital future for this country is really into the data centers, which actually host all the data elements that allow for SMACS to happen: social media, internet of things, big data analytics, the cloud, as I mentioned, and of course security solutions. We are delighted to report that last week we have finally completed our Makati VITRO data center, the biggest, most massive, the most secured data center in the Philippines today with a rack capacity of 3,600. This has been certified by NTT, the world's leading data center operator with their Nexcenter certification of quality and security making this facility a financial grade data center, meaning to say even the largest banks, this is trustworthy for the larger banks to entrust their data elements to us that we host them. A month and a half from now we will soon open our eighth datacenter in VITRO Clark, which is another 1,500 capacity inside the Clark development ecozone.

Before the year ends, we will open a small [indiscernible] datacenter facility in Davao and groundbreaking our data center in Cebu. By end of this year we are looking at raising our leadership capacity in the datacenter space along with the ancillary digital solutions that datacenter operations carry to 8,300 racks. By the end of 2017, we're really looking at that nice round number of 10,000 rack capacity which puts us really in leadership position as far as the building block datacenter is concerned, and thirdly, paves the way for our, really meeting our aspiration to be the preferred digital enabler for all business in this country. That ends my presentation. Thank you.

Rafael Bejar

Thank you, Eric. Good afternoon. As you may recall, Voyager Innovations is the end-to-end innovations factory of the PLDT Group. Activities range from R&D to incubation, acceleration, operation of businesses and spinoffs. I'll highlight to you now several businesses that have gained traction over time. These may not reach the scale of Eric’s and Ariel’s businesses, but we hope to do that one day. These are mostly in the FINTQ and the mobile payment space. So I’ll start with FINTQ. Pera Agad is our digital micro-credit business. It’s a lending platform that grants loans, anywhere from PHP2,000 to PHP10,000 using credit scoring algorithms. We are in partnership with a third party, so we don't take the credit risk.

We just launched last June 2016 and should go commercial by start of September. Good results so far, 30% response rate meaning 30% of those who are invited through SMS to avail of the loan apply for the loan. And of those, 50% were granted the loans. The loans have a maximum tenor of 24 weeks and are weekly amortized. So we’re happy with the take-up and we hope that it’s going to be an excellent product for emerging markets where micro-credit is a basic need. The second product is Mobile Loansaver. This is our partnership with the Landbank. The core product here is lending, but it comes with insurance and other savings as options. So for this platform, we have since launch granted more than PHP10 billion of loans. For this year we have granted so far PHP4 billion. It’s now open to subscribers, so this is a telco-agnostic platform.

Some interesting insights here is 75% of borrowers come from the provinces and 47% do their borrowing outside of office hours. That started at 0%, it’s now 47%. Note that our lending platforms are not really disruptive kinds of lending activities. In the first world, FINTQ is mostly P2P, so granting loans outside the banking system. In our case, we are enabling the banks. We don’t take the credit risk. We’re enabling the banks to perform their activities on a digital platform. The third part of this, Lendr. Consistent with that strategy, Lendr is a marketplace. It’s a digital marketplace for consumer loans, meaning salary loans, auto loans, home loans and other kinds of loans. They have signed 35 banks to participate in this marketplace of which two are now on board, one for auto loans and another for pension loans.

We now go to PayMaya. PayMaya is the mobile payments product of Voyager. Our accounts on our mobile wallet have doubled since the start of the year. So we’re tracking more than 1.5 million accounts by the end of the year at least. We are the number one financial app in the Philippines on Google Play Store. We are the only prepaid card that works with Uber. On the business side, meaning on the business side of the card business, we are also a processor at a gateway and an acquirer in the online space. So we have the three largest online merchants with us; a fourth is also coming. For our domestic remittance product, we just relaunched the brand and we're tracking towards a $2.5 billion throughput for 2016.

On Freenet, Freenet is the new name of SafeZone. SafeZone, if you recall, is the platform that allows consumers to access sites online free of data charges. So we now have 70 enterprises that participate in this platform, so their customers go to their sites free of data charge. They pay us in terms of bandwidth. This was the same platform that we used to air President Duterte's inaugural speech as well as the FIFA qualifying tournament free of charge to the Filipino audience. This was the number one trending app in App Store in the Philippines at that time.

The last one is digital commerce. Under digital commerce you have TackThis and Tackatack. TackThis is our on boarding site for SMEs. There are 1 million SMEs in the Philippines as Eric has discussed. Of this only less than 1% are online. So we provide an easy experience for SMEs to participate online. Tackatack is the marketplace where we put all of this on boarded merchants into a big marketplace. That ends my presentation.

Anabelle Lim Chua

Thank you, Ariel, Eric and Doy, Let me now run you through with some details of our financials for the first half.

Turning to slide 6, our total revenues, as I indicated earlier, declined by 1% to 80.6 billion. Actually, data grew by 5.5 billion or 23% year on year and now account for 36% of our total revenues. The growth in data was spurred by a 55% increase in mobile internet, a 22% increase in corporate data, a 16% increase in fixed broadband and a 12% increase in wireless broadband.

Offsetting the increase in data was 4.3 billion or 9% decline in SMS and voice that put together the data and the SMS voice revenues was actually 2% increase year on year. However, we do have the residual effect of a declining ILD and NLD which accounted for 1.7 billion decline during the period.

Now when you look at our revenues by way of business units, as earlier reported by Ariel, Eric and Doy, our consumer business actually accounts for about two thirds of our total revenues with a 1% increase year on year. The home segment within the consumer business grew by 9% year-on-year. Enterprise is driving at a 10% increase year on year and is close to 20% of our overall business. International and carrier business as expected has been on a decline. The Voyager numbers here reflect the deconsolidation of PayMaya during this period and are not actually comparable year on year.

Turning to the revenues broken by fixed line versus wireless, you’ll see that the fixed-line business remains firmly on the growth path posting revenues of PHP30.9 billion or 7% year on year. Data accounts now for 59% of the total revenues for the fixed-line business and was up 12% year-on-year.

Turning to the wireless business, the revenues amounted to PHP52.7 billion, or 5% less compared to a year ago, largely due to the decline in SMS and voice revenue. However, the data segment within the wireless business rose 29% to PHP14.1 billion and share now of the overall wireless business is at 27%. When you decompose the growth in the consumer and the enterprise businesses, the similar story that data is really the driver for the growth. For the enterprise business, data broadband revenue increases underpin the growth in the enterprise revenues with fixed-line data and mobile internet combined accounting for PHP1.7 billion or practically the 10% growth in enterprise.

It’s a little different story in the consumer side. While we see growth in data amounting PHP4.1 billion, there are declines, however, in the voice and SMS revenues as the behavior and usage shifts from data away from SMS and voice. In terms of revenue mix, the enterprise business, you’ll see that similar to the fixed-line business about 59% or close to 60% of the revenues are now accounted for by data in broadband. In the consumer side, it’s at 38% with voice/SMS still accounting for 60% or the larger part of the revenues of the consumer side.

Now turning to the next page, after showing you the revenue performance where we came in at about PHP600 million, there are, however, in terms of the EBITDA numbers, higher subsidies and higher provisions that impacted our EBITDA for the period offset by an improvement in our cash OpEx by PHP1.5 billion. So we saw subsidies rose by PHP2.5 billion during the period as we continued to drive the growth in data and smartphone adoption. Provisions, on the other hand, were up in part because of a review [indiscernible] of the migration of our Sun postpaid account from a previous billing system to a new billing system which is similar to the Smart billing system.

And as a result of that migration, we had to book about PHP1.7 billion of extra provisions for the period relating really to prior years. That represented PHP1.4 of provisions against receivables and about PHP300 million provisions against inventory. There is another PHP 1.4 billion increase in provisions as a result of our review of the collection efficiency and the quality of our accounts relating principally to the wireless postpaid business. EBITDA came in at 30.8 and EBITDA margin stood at 38% during this period.

Now, from a core income and reported income perspective, the decline in EBITDA, PHP4.8 billion, was offset by the asset sales that we book resulting in a gain of PHP7.4 billion from the Beacon sell-down. There were similar gains from Meralco sell-down previous years of about PHP3.2 billion, so that’s a net increase in the gain from the asset sales. Now, aside from this, we do have to recognize that as we sell down our position in Meralco that our equity earnings in Meralco will be in a decline mode. So effectively after this sell down, our effective interest in Meralco will be down to 8.7%. So that will come through in terms of lower equity and earning in the future periods.

Financing costs and depreciation expense during the period were also higher because of our CapEx spending and the need to fund additional CapEx. From a reported income perspective, as indicted earlier, there is an additional asset impairment with respect to the Rocket position equivalent to 5.4 billion to reflect the share price of Rocket at the end of June. There's been a bit of improvement in the share price of Rocket since this, but we are booking this base in the June 30 prices.

Turning to the CapEx slide, I guess the analysts are aware that we have indicated that from the original 43 billion CapEx guidance for the year we had communicated an $100 million additional CapEx, a result of the move to utilize the frequencies acquired from San Miguel. So effectively our updated guidance for CapEx is at 48 billion, 20 billion of which was already incurred at the half year.

There are lots of activities on the network side to improve our service and our customer experience coupled with dealing with the fact that increasingly we are seeing a shift towards heavier data usage.

So we are in the last part of the integration of the Sun network into Smart covering Cebu and Metro Manila. We are undergoing a spectrum reforming program where we are reallocating some of our spectrum, particularly 900 towards 3G and 864 4G. We have to put in additional transport and fiber optic capacity to deal with the heavier traffic, and we continue to optimize the network for better performance. So there are a lot of activities to try to improve both the coverage and the capacity of our network.

The higher CapEx thus translate to higher net debt numbers and we're seeing increase in the net debt number to a level of about $2.7 billion for June, or equivalent to 1.96 net debt to EBITDA. There will be further increases as we work to the incremental CapEx for the balance of the year.

The San Miguel transaction in the first instance, for the first 50% payment that we've made, has been really funded by the proceeds generated from the sell down of the Beacon. So that has been neutral in terms of the impact and the net debt for the first half. But there is still a balance of the other 50% for the San Miguel consideration that will have to be paid in December and another 25% next year.

We continue to manage our debt exposures, trying to manage the currency exposure down to about 9% now in terms of the total unhedged. We benefited from the low interest environment in that our average interest cost is running about 4.4% for the total debt portfolio.

Maturities are higher next year given we have a 2017 bond that comes due in the first quarter. We expect to refinance most of this in the peso market. We have arranged the requisite funding specially to refinance the bond that is coming due.

The next slide is really an update on the acquisition of the San Miguel transaction. I'll turn over to Attorney Espinosa to give an update.

Ray Espinosa

As you are aware, PLDT and Globe each acquired 50% of the telephone businesses of SMC for a total consideration of PHP70 billion. Half of that has been paid. That’s around PHP26.5 billion. The highlight of this transaction is the telco companies of SMC actually have access to around 365 megahertz of spectrum in various rated frequency bands. Of that, both PLDT and Globe returned to the government, to the NTC, 85 megahertz of spectrum and retained 280 megahertz in different bands split equally between the two companies each covered by a co-use arrangement approved by the NTC. The NTC is the sole regulatory body that approves all use arrangements over frequencies.

The transaction was closed on May 30, 2016 after we had considered the transaction as having been deemed approved pursuant to the transitory circulars of the Philippine Competition Commission. The review of this transaction prior to closing has been compliant with the transitory circulars of the PCC, was done by the company’s in-house lawyers as well as external counsels of the respective parties. On July 8, 2016, each of the parties to the transaction were called to a meeting by the PCC. We were asked to explain to the PCC our respective positions on the transaction, which we did. The PCC consistently across the three meetings took the view that the transaction was not deemed approved under the transitory circulars and that the transaction would be subject to a phase one review by the PCC. On the basis of this position taken by the PCC, PLDT decided to bring the case before the Court of Appeals.

We filed a petition for Certiorari and Prohibition with an urgent application for the issuance of a Temporary Restraining Order and/or a Writ of Preliminary Injunction against the PCC in order to protect the deemed approved status of our transaction and to avoid confusion as to the implementation of the transaction. Similarly, on the same day but in the afternoon, Globe filed essentially a similar petition before the Court of Appeals. With respect to our PLDT petition, the 12th Division of the Court of Appeals issued an order requiring the Office of the Solicitor General as the statutory legal counsel of the PCC to file comment within 10 days, which is an non-extendable period. Upon receipt of that comment, PLDT is given five days, again a non-extendable period, within which to reply, after which the court will decide whether it would hear the case and oral argument or just consider the prayer as being deemed submitted for decision.

So we are still waiting for the pleading of the Solicitor General’s office. Based on the check I made this morning we have not received any copy of the comments filed by the OSG. So as far as the transaction is concerned, we are pursuing a business-as-usual policy. We are implementing that transaction. PLDT is basically integrating the frequencies into its network parallel plan. Our network group has completed a three year network parallel plan which was submitted last week to the NTC in fulfillment of one of the conditions of the co-use agreement.

This calls for the integration of all of the frequencies who are pursuant of the transaction and which are the subject of the specific co-use arrangement approved by the NTC. As of the end of the first half, we have already so far fired up eight cell sites on the 700 megahertz frequency. The target is to rollout 300 cell sites on this frequency by year end. We have also so far switched on additional facilities in 2,221 cell sites using the SMC's 1800 megahertz spectrum.

So as far as we're concerned, the frequencies are being used consistent with the condition of the NTC, and right now the benefits of these frequencies are now being enjoyed by the public in those areas where the frequencies are being used. There is demonstrable improvement in speed and quality of it there. Thank you.

Rafael Bejar

Beacon or customer management? Maybe just a brief word on the disposal of the indirect interest in Meralco shares. As you know, last May 31, we managed to sell 50% of our equity interest in Beacon which owns, Beacon in turn owns 25% of Meralco. That was sold to Metro Pacific for a total consideration of PHP26.2 billion.

The transaction closed May 30. Of the 26.2 billion consideration, 17 billion was paid by Metro Pacific to PLDT, so that amount of 17 billion was used by PLDT to defray 50% of our portion of the purchase consideration of the San Miguel Telco. So approximately 13 billion of the 17 billion was used by PLDT to pay for the 50% interest, 50% down payment or the 50% interest in the San Miguel Telco.

We are now in discussion with one or two investors in respect of the balance of our interests in Beacon or as Anabelle mentioned, 8.7% attributable equity in terms of Meralco, most likely for a similar price as the sale to Metro Pacific, except that now Beacon owns 56% of Global Business Power. So it is likely that the total consideration for the balance, so the 50% will be slightly higher than the 26.2 billion. We estimate that the total consideration could be as much as PHP29 billion. But we don't expect closing to occur until early next year.

The balance of the 9.2 billion owing to PLDT by Metro Pacific is payable over four years at a rate of approximately PHP2 billion starting 2017 onwards until 2020.

Now in respect of capital management, really dividends, the Board has decided on recommendation of management to cut the dividend payout from 75% last year to 60% this year in light of two things. As you know, the elevated CapEx especially for 2016 being now around PHP48 billion and at the same time we anticipate the decline EBITDA for the year, we’ll get into that when we give the guidance numbers. So the interim dividend for share is being paid at PHP0.049 per share payable on September 1 to shareholders and that represents 60% of the payout here.

We’re maintaining our traditional look-back approach so early part of next year when the results in terms of profitability and cash are determined by for the entirety of 2016 then we would determine whether there is an opportunity to enhance the dividends for the entire year. Now in respect of guidance numbers for the year 2016, as I indicated we guided core EBITDA at around PHP70 billion in the earlier part of this year but in light of the events that have happened in the first half and as we speak we believe that the more appropriate number for EBITDA this year would be in the PHP64 billion, PHP65 billion range. CapEx, as Anabelle indicated, will be around PHP48 billion. We maintain a core income of PHP30 billion for the entire year with the reported PHP17.7 billion for the first half so we have got about PHP12 billion to PHP13 billion to go for the balance here.

Payout is now at 60% for the reasons I’ve already indicated, the look-back approach when the full year is finished. Finishes the presentation.

Melissa Vergel De Dios

All right. We’re now ready to take your questions, we’ll take questions first from the conference facility before we take questions from the floor. Operator.

Question-and-Answer Session

Operator

Thank you. The floor is now open for your questions. [Operator Instructions]. Our first question comes from Gopa Kumar. Your line is now open.

Gopa Kumar

Hi. Thank you for the opportunity. This is Gopa from Nomura Singapore. A few questions. First is your wireless revenue is down as voice and SMS continue to decline. So how long do you expect this to continue before data offsets this then we see some growth in the, or growth or even stability in the overall wireless revenues. That’s one. Secondly, you’ve added subscribers in this quarter which is good but I also see that the subsidies, expenses et cetera are continuing to go up. Going forward, would you have to spend more on subsidies if you have to sustain or improve the subscriber additions?

Third question is given your CapEx plans and then your focus more on network side and data growth potential, etc. do you think that the 60% dividend payout is a sustainable level or could we see you are revising it lower? You mentioned that you are open to selling the stake, remaining stake in the Beacon. If that happens will the proceeds be used to maintain dividends or would you prefer to lower your debt levels? Thank you.

Ariel Fermin

Thank you for your questions. I will respond to the first two. Now as far as wireless revenues are concerned it all starts with the revenue mix that were shared earlier for mobile. Specifically were starting to get one fourth, only one fourth of our revenue was in data. We'll probably close the year around one-third of our revenue is in data. What you have here is a situation where even if, as shown earlier at least for the consumer group, even if we were growing data by PHP3.4 billion already to the tune of 38% growth, when you have a situation where both calling and texting was declining more than the PHP3.8 billion gain then you would have a negative net effect in this case.

For perspective, calling and texting were declining by an average of 15% the first half of the year whereas last year it was at least from a calling standpoint it was a single digit decline. In fact it was four times as much in terms of a declining trend for this category.

So when, what do we see happening? As we've experienced in the fixed line business in PLDT it's a critical, it's imperative for us to have data account for half our revenue. And at the rate we're going, say, growing data by 30%, 35% we'll probably achieve that end of next year or the perhaps the middle of 2018. That's the perspective that we have. Only then will we have a more well, more equilibrium in our revenue mix, we’re [indiscernible] economics for [indiscernible] that's point number one.

On the second point would be on subsidies there was a, it's a subsidy from that subject matter. It is a necessary tool for growth that we've seen in the postpaid business growth that we've had quarter on quarter, we I think posted some 12% growth, 50,000 more net gains. The goal there is really to get good paying subscribers, good quality subscribers.

Up to when will that last? I think at this point we've gotten the subscribers that we want and the key really here is to retain them, is to retain those subscribers so that there is recurring income from our end. Yes, so that's for the first two questions.

Melissa Vergel De Dios

What do we do with the proceeds from the Beacon, the remaining Beacon sale, pay down debt or dividends?

Rafael Bejar

I think the intention is to of the, assuming that we are able to generate a purchase consideration of approximately 29 billion in the first half of next year that there's a balance due to San Miguel in respect of the 13 billion more that is outstanding payable to them actually in December and in May of next year as to about PHP6.5 billion or PHP6.6 billion which according to them is about PHP13.2 billion. We intend to use the proceeds of the balance of the Beacon shares to defray the entire purchase consideration being around 26 billion to San Miguel. So we will fund the purchase of the San Miguel Telco as it's entirely with internal cash resources. The intention is not to use any debt in respect of that acquisition.

Now the balance of the 29 billion, remember there's still 29 billion to be raised from the balance shares, another 9 billion owed by Metro Pacific to PLDT but payable PHP2 billion each year, a little over PHP2 billion each year. So about PHP38 billion, PHP38.2 billion to be a bit more precise is due starting 2017 up to 2020, the bulk of which will come in the first half of next year. So the PHP13 billion of the PHP29 billion will be used to pay for San Miguel completely and then the balance of PHP26 billion is intended to be used to reduce debt.

Gopa Kumar

Thank you. I just have two follow-up questions. First is you mentioned your focus on higher quality subscribers. My question was f you have to retain the subscribers or possibly improve your market share, would you have to spend more on the subsidy level or do you think the current levels you should be able to sustain it. Secondly, sorry on the dividends, can we assume that given your network plans 60% payout is something that can be sustained? Thank you.

Rafael Bejar

Thank you for the question. Under subsidies you see that the first half is a bit elevated versus first half last year but in the second half of the year it will be reduced so that it will be no more than the total year last year. So we felt that that was the best strategy to retain the subscribers.

Gopa Kumar

Okay.

Melissa Vergel De Dios

[indiscernible]

Rafael Bejar

I think in respect of the dividend policy it’s clearly the intention to keep it at that level for the foreseeable future but the thing is that what we need is really overall financial discipline in respect of the debt levels that are prudent for us moving forward because if you are seeing our EBITDA hovering at PHP65 billion to PHP70 billion we really have to ensure that the capital budget, the CapEx budget moving forward is as well disciplined and determined very well because on top of the CapEx if we assume between PHP40 billion to PHP45 billion moving forward and the if your EBITDA is about PHP65 billion, PHP70 billion, the rest of the EBITDA we’d have to spend on interest expense, taxation and dividends.

So the space is rather tight but we intend to fully stay within that discipline of the EBITDA. We really have to manage our affairs particularly our financial affairs and cash flows very tightly moving forward. We don’t want to see that net debt to EBITDA exceeding 2 times by the end of 2017. There will be periods we may exceed it for a while but we certainly want to keep to the financial discipline of net debt to EBITDA being sub 2.

Gopa Kumar

Thank you this is very clear. Thank you so much.

Operator

Our next question comes from Arthur Pineda. Your line is now open.

Arthur Pineda

Hi, thanks for the opportunity, just three question from me please. Firstly, on the mobile business, you’ve mentioned that call and text have dropped and this is driving the acceleration in terms of the decline in mobile revenues. But aren’t these common pressures to everyone in the industry, why are we seeing such a divergence in trajectory that’s actually worsening quarter on quarter? The second question I had is with regard to regulation. Can you discuss your views on the PCC’s decision to review the deal? What happens if the deal is not approved? Do you have any recourse in the payment you made to San Miguel, can you recycle the CapEx as well? The third question I had is with regard to the provisions that were booked in the second quarter. You've mentioned that this was due to the harmonization of the digital billing platform, does this mean we should see some reductions on this line in the subsequent quarters then now that it's been fully provided for? Thank you.

Ariel Fermin

On the first question, yes it's true. Every operator has experienced what we're experiencing, they're continuously experiencing what we're experiencing that we got to be managing our tail. Just for perspective now calling and texting for us that is the equity that we have for Smart. We've really been known for that kind of service, a really superb service in that category.

The challenge for us is a [reskin], to reskin our model so that people, our subscribers understand that from calling and texting they start using data. For them to start using data and that's why we go to Smartphone adoption which we did in quarter one. That's why we go into a massive roll out of LTE, capable base stations and all that.

This is the journey that we are taking. As I've said we started the year at one fourth for revenues worth of data, probably end of year it's a third, probably next year it will be 40%, 45%, so and so forth. It can only get better at this point. With data growth, you will see that the digital services running on data would come into play as we've seen in the fixe line business where not so long ago data was not even, what, 30%; now it's 60%.

And as I've shared earlier, all this smart home services that you can imagine from monitoring systems to connectivity, to energy management at some point, bundled services, so on and so forth come into play. It's a matter of time and so the North Star's clear, it's really between now and accomplishing that North Star. We've got to manage it in a way that's so disciplined so that we teach our subscribers to, aside from being very good in calling and texting, we're also very good at data.

Ray Espinosa

On the PCC matter, the question that you raised is actually this one process of a very complex case. As you're aware, we have a case before the Court of Appeals questioning effectively whether the PCC can still review the transaction given the terms of its transitory circular.

For your question that assumes that the Court of Appeals in that particular case will decide against us. If the Court of Appeal says that the PCC can still review the transaction we have the option of either appealing that decision further to the Supreme Court or just allowing the review to take its course.

If we obviously bring it to the Supreme Court, then the, that eventuality will take a longer time to come to bear. But if we agree to have the transaction reviewed by the PCC and the PCC comes to a decision that it will not uphold the transaction and will deem it void, we still have a recourse to appeal that decision that the transaction is void and not approved back to the Court of Appeals. That will be the progression.

Now to your question, if in the final analysis the decision of the Court is that the transaction is indeed void as determined by the PCC, then the voidness of the deal goes back to the inception. Therefore, the parties, the buyers, have a right to recover whatever has been paid to SMC. It will require a complete unwinding of the transaction which means a return of the shares that we had acquired over these companies back to San Miguel. San Miguel would have to return to us the payments that we have made so far.

That eventuality obviously produces many complications because we are already implementing the transaction. We are rolling out the frequencies. We are integrating the frequencies into our networks. As the frequencies are fired up and used to serve the public, the public benefits from this frequency. It’s a very complex matter already at that stage. How eventually the government will approach it we still don’t know. It may in fact end up in a situation where we need to huddle with the government and see what is the best, the next best alternative or situation where this gravitates into a full-blown case. So it’s very difficult to speculate at this time, we have to just take it one step at a time and see how our case goes.

Anabelle Lim Chua

On your last question, Arthur, also you see from our full year guidance in respect to EBITDA of PHP64 billion that there is an implied increase in the second half EBITDA compared to first half, which does mean that some of the provisions as discussed earlier should not be repeated in the second half because they were one-time catch-up positions.

Unidentified Company Representative

If I may add to what [indiscernible] said, I think then the subsidies in the second half is likely to be more contained to us than the first half. I think we exceeded the subsidies for the first half to the tune of PHP2.5 billion compared to the subsidy level realized in the first half of 2015. So the intention is to keep the subsidy level for the second half this year flattish to slightly up compared to what it was in the second half of 2015. So that will contribute partly to the anticipated increase in EBITDA for the second half of this year.

Arthur Pineda

Understood, thank you.

Operator

Our next question comes from Varun Ahuja. Your line is now open.

Varun Ahuja

Thanks for the opportunity. I’ve got a few questions. Number one I just wanted to check with you on the subsidies part that you mentioned. Do you think when you reduce your subsidies will it have an impact on service revenue as you’ve been mentioning that you’ve been subsidizing to get service revenue. In case you go, loosen your scheme on subsidy do you think service revenue will get impacted. I also want to check that how much does it on prepaid handset subsidy that you've been doing. How much of those customers that you are subsiding handset are still on the network over the last six months? What have you seen on those prepaid handset subsidies part?

Number two. I just wanted to check with you on the bookkeeping question on the service revenue for wireless I noticed there is some declassification between data and SMS revenue. So I just wanted to check why SMS revenues have over the past reduced and you’ve increased your data revenue. Any specific reason why would you do that? Then I want to check on the, your hunt for the new CEO. I remember having a discussion that you’re looking for a new CEO. What is happening on that front? Those are the few questions that I have right now. Thank you.

Ariel Fermin

On the first question on subsidy rate, yes, it does bring the service revenue up and particularly the data partner service revenue. A case in point would be the PHP3.8 billion increase in data this year versus a shade below PHP2 billion last year, so hence I mentioned twice as much growth, point number one.

Now when you look at subsidy, there is the prepaid and the postpaid fees of that one. In the prepaid fees I hope you remember what we did with Smartphone 888, $18 smart phones quarter one. That was a bomb because it resulted to 60% of our subscribers of those smart phones actually using data. Prior to that they weren't using data. This is really part of the market development objective that we had set ourselves to do.

By the way, after 60% of them using data because you were giving them calling its premium model, just a limited amount of data, 40% of them actually bought more so that is the kind of evolution that we're seeing. It is to our advantage that we do that because the penetration of smart phones in our subscriber base wasn't that high yet. Point number one.

Then on the postpaid piece, as I've mentioned, it is about retention particularly in the second half of year. We've gotten the people we had wanted to get and plan to retain them with good service and good care.

Melissa Vergel De Dios

CEO. A new CEO. [indiscernible].

Manny Pangilinan

Well, I don't know. I, there's no specific timetable. I think it's fair to say that all of us have our nose fixed to the grindstone as we speak. There are a number of issues that are attendant to operating the business.

Just to give you the scale of what we're facing, to an earlier question posed to us, you just have to remember if you take a 30,000 feet view of the PLDT Group revealing our service revenues net of interconnect is in the area of 150 billion. About half of that belongs to the legacy revenues, texting, voice, and toll traffic, international and national long distance, 15 billion on toll traffic, international and national and 60 billion are on voice and texting.

That, those three service streams, service revenues streams were and continue to be a strength of PLDT. But as well they represent a major weakness because the whole world is moving to data. We know that; you know that. But the size of our issue is dissimilar to any other Telco in this country. Not only do we have to replace the revenue like for like, legacy to data, but you know that the margins on the new business on data are lower than margin of the old. The margins on international long distance is up to 90% so it's difficult to replace that kind of business with the new business especially when your CapEx as well is elevated in order to build a robust data network as we are building now both on fixed and on the wireless.

If you take a certain proportion, a certain ratio of data revenues to legacy revenues, let's say, about twice on the wireless side to be able to maintain the level of productivity or profitability as you saw in the previous years.

So that’s what we’re dealing with so when you ask for a timetable as to when we can finally see the light of day, the answer is we really don’t know, I think we have some notion, we have some schedule of when we think we’ll see that light of day but at the end of the day that's a tough call to make. We do know that we have to get through it and the proven fact is that in respect of home and enterprise where the concentration of data revenues to total revenues are already above 50%, in the case of enterprise business up 60%. What has happened? Revenues are up which you want to see, subscribers are up, EBITDA levels are up and EBITDA margins are up.

So there’s no reason why we cannot push the wireless business to that same situation but it will take time. It won’t happen tomorrow, it won’t happen in the second half of this year. But I tell you we’re striving mightily to push wireless to that position without too much sacrifice of the cash position, the debt position and the profit quality of PLDT. So we’re in this tough period where people are unhappy. I’m sure when we cut the dividends you guys are not too happy but our debtors and our creditors and the ratings agencies must be quite happy. So that’s where we are, that’s the broad challenge that faces this Group and to think it’s always been how do you get this guy to sell some more with the margin of texting and international long distance.

Varun Ahuja

Yes, thanks for the detail. And a quick check on the reclassification if you can tell any reasons why SMS revenue have been reclassified as more cellular and mobile internet that will be helpful. I just wanted to check, can you quantify the amount of one-time provision that has been there in this quarter so that won’t be occurring the next quarter. I can remember you talking about PHP2 billion so that will be hopeful.

And lastly, I just wanted to understand on domestic voice, I understand international voice is on a decline but if you look at other countries, India and Indonesia, domestic voice is still at least growing at some decent rate, not declining as fast as you are seeing in The Philippines given it’s is still a developing country. So I wanted to understand what is happening on domestic voice, why the declining so strongly. That’s it. Thank you.

Unidentified Company Representative

I’ll reply to the third question why domestic voice is not in the same pattern as Indonesia. The domestic voice business actually earned revenues also from the cross interconnect among carriers and the telcos. Given the fact that there are alternative ways by which people do communicate now, it’s true the bucket pricing on wireless which are aggressively priced, add to that the disruption being created by OTT platforms on typically Viber line what have you. I guess all of you have that app in your smartphones that actually created the rapid disruption in the domestic voice.

So we’re managing that long tail. There is indeed a certain segment of the market that actually have, it's not a different shape nor mined voice with a legacy thereby which people can get but certainly across the wider market the business of domestic voice obviously by your own experience in this room has been gravely disrupted. On the other two, I think there was a question on SMS which I didn't quite understand, my other colleagues could answer that.

Melissa Vergel De Dios

Varun, we'll take the question on the re-class of mobile internet offline, we'll just get you the detail on that one. Then you had a question on provision. Could you repeat your question please?

Varun Ahuja

What were one time kind of provision this quarter? If I understood you said around 1.7 related to prior year that also 300 million also. I just wanted to see quantification of one time provision that you have done during the quarter which will not occur in the second half or any future?

Anabelle Lim Chua

They were result of the migration of our postpaid base on billing system, partly receivables, partly on inventory. 1.4 billion of receivable, 300 million of inventory. So that will not repeat in the second half.

Varun Ahuja

So 1.7 billion?

Anabelle Lim Chua

That's correct.

Varun Ahuja

Total, okay. Thank you.

Melissa Vergel De Dios

There are no more questions from the conference facility. We'll open the floor up here for questions. There is a microphone in the aisles. Last chance. Oh, there is a question.

Unidentified Analyst

My question relates to the fact that as you improve the revenue mix, as you try to build up the data broadband for the consumer and the enterprise it seems that the EBITDA suffers, the pipeline suffers. You've been very effective in the enterprise side of the business even though the low margin data is growing, the top line has been growing up 10%. Is there a strategy that you are employing so that you can have some more effective in the consumer where it seems it's more challenging than in the consumer where your share of the data is only 38% compared to revenues compared to the 60% share of your data revenues to enterprise?

Also relating to your subscribers, you continue to lose subscribers in the prepaid and postpaid about 400,000 from year end to 64,000 [64 million] 100,000 lower than 64 million as of June. Is this just a question of competition now? But you're already putting some efforts, budget for the subscription subscriber’s subsidy, already there it's there. Is there a strategy here to arrest this slide in subscribers base. Thank you.

Manny Pangilinan

Just to address your question on the profitability part of it. It's an extension of what I said earlier, whilst the legacy revenues are in total something in the other of 75 billion, I didn't mean to suggest that that voice revenues or SMS were going to totally disappear at some point in time. I think there will be some steady state and don't ask me at what level where international traffic, national long distance, voice and texting will hit at that steady state.

In the aggregate, is it 20 billion, 30 billion, 40 billion we have no idea but we do know that it will be declining I think this year, next year perhaps until 2018. Is the decrement going to be on a smaller delta basis? I would like to think so, we hope so that the decrement so that the task of replacing it becomes less difficult in the coming years.

Now the challenge is that as you replace the revenue of the legacy what you’re replacing it with is sometimes lower margin partly because that’s the nature of the business and it’s a very competitive market out there. You asked us about subsidies, Globe is pushing out subsidies as well. There’s got to be some competitive pressure on us to have our own subsidy in respect of our own business. So the margins are lower so there’s one thing you can do, only one or both things, either you, the revenue you replace it with is higher than what you’ve lost or you reshape your OpEx level, your OpEx model at a lower state. To us that’s what we did in fixed many years ago.

We had a massive restructuring of the personnel headcount at fixed. That’s why when we were able to replace the legacy revenues on fixed which are harder still when international accounting rates were about $1 per minute and they’re down to about, what is it $0.10, $0.12. So that hit the fixed line business massively. So you could see the fortunes of the fixed line were pretty bad at that time so there was a digital [indiscernible] initiated, I think the early part of the last decade. And then a massive reshaping of personnel and OpEx. So you have to do both. Now that has got to be done as well on the wireless side because I think it will take us a number of years before we can replace at the ratio of one for one.

At the same time you have to address the OpEx. You can see that the OpEx levels were cut in the first half to the tune of PHP1.5 billion, I think we have some ways to go for the second half this year and some more ways to go in 2017/2018. We have to ensure that the OpEx level we’re seeing now has got to be refashioned in a way that suits the data model of the future. We cannot operate this business, this data business on the basis of a legacy OpEx, it’s as simple as that. At the same time the revenues they take a bit of time before we can replace it, more than one to one.

Unidentified Analyst

Further just to the…

Manny Pangilinan

We could speak concepts, we know that, everybody knows that so the trick has always been how do you execute in a way that does it. The easier bit is to cut your OpEx, painful for people but you need to do it. The tricky bit now is revenues. So your point about sub numbers, revenue numbers, yes, agreed, the question is how you execute and frankly we can’t say much about that because people are listening in on this conversation.

Melissa Vergel De Dios

Before Ariel answers, we have to have our Chairman move to his next commitment but we can continue with the Q&A.

Manny Pangilinan

You mean I’m talking too much.

Melissa Vergel De Dios

No.

Ariel Fermin

To the extent I can share to respond to your question that’s a nice question. So I mentioned reskinning this model earlier, it’s really about reshaping the box economics so that we earn decent money from every revenue that we get.

To the extent I can share, the three things, the three levers that we're working on that point would be number one ARPU, ARPU. When you get a sub what you want is to increase the basket size per subscriber that you get. With our move to faster data, LTE in particular, what we know is that for people who are on LTE they consume more data therefore modernization happens, that's point number one.

Number two. And we did mention being a little more efficient in the middle as we did in PLDT years ago. Number three would be yield. When you have, we have to, we're having a discussion on our legacy services, the yield part of that legacy services. It's a given that those legacy services, traffic wise will go down but it's about yield. Are you getting the most, are you maximizing the most aisles of traffic that you're seeing in the network. Those are the three things that I feel I can share to respond to your question.

Unidentified Analyst

Just a comment, it seems to me that it becomes increasingly harder for PLDT to replace the legacy revenues with your low margin data revenues given the reduction in the subscribers. It becomes a little harder.

Unidentified Company Representative

Indeed that's the challenge if you look at the business model from purely on a pure Telco orientation point of view. That's besides the mission and the challenge that we have on hand in the Group that these are digital pivots to transform ourselves not to be a Telco but to be a technology provider both in the enterprise and in the consumer market.

If you look at access to access, the access to deliver voice and SMS businesses on its impact of CapEx to network is certainly different from the type of margins that you can get from a data play where are consumers, whether consumer or wireless or business. I don't know the high bandwidth requirements like video and high definition video that.

The challenge for us, that's why we have to go into from a Telco technology company which is what we're trying to do without going into details is to put overlaid services over that, Triple-play, Quad-play in generic terms for consumer and certainly and the preferred provider and trusted expert solutions for the enterprise space, that is our mission.

Unidentified Company Representative

Increased usage for ..

Unidentified Company Representative

And yes we have, and obviously we have the dependency of habit, of usage, trusted customer experience and inverse business in our favor.

Unidentified Analyst

Thank you, sir.

Unidentified Company Representative

Thank you very much.

Melissa Vergel De Dios

Any more questions from the floor? One last question from the conference facility.

Operator

Thank you. Our next question comes from [Oot Karesh Narotta]. Your line is now open.

Oot Karesh Narotta

Yes, hi, everyone. Thanks for taking my question. This is Karesh from JP Morgan. Just a couple of questions, one on the commitment to NPC on the network deployment and the core usature agreement. Is there a commitment to deploy LTE and 4G spectrum irrespective of the smart phone penetrations and in respective of the usage that you guys are estimating in that region?

Secondly, this question on the tax rate. What is the effective tax rate do you see going ahead for the next two years? Thank you.

Joachim Horn

Okay this is Joachim Horn, I'm the Chief Technology Advisor. This is a chicken and egg problem, it has always been the phone or the network. The history has shown that without a network people will not be motivated to buy the phone supporting the standard so you have to roll ahead.

But having said that, as we go more rural we would look to a much more cost-efficient way to roll out by making use of the low band spectrum. That is the benefit of the SMC deal that all of a sudden we have a spectrum which will actually enable the much more cost-efficient, far reaching rollout into the rural areas, which would not have been possible without that spectrum at hand. But the answer is we need to go first with the spectrum rollout and then acquire the customers accordingly.

Anabelle Lim Chua

On the tax rate, typically our effective tax rate would be around 27%, 28% but last year and potentially this year there are some deferred tax assets that we may be able to utilize which would allow us to bring down our effective tax rate to lower than that in the second half.

Oot Karesh Narotta

That’s very clear. Thank you.

Melissa Vergel De Dios

There are no questions in the conference facility, one last chance for the questions on the floor. If there are none we can end the conference call. Operator?

Operator

Thank you and that concludes today’s conference. Thank you for your participation. You may disconnect your line in your own time.

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