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Telefonos de Mexico, S.A.B. de C.V. (NYSE:TMX)

Q3 2007 Earnings Call

October 23, 2007 10:00 pm ET

Executives

Rui Echavarra - IR Officer

Adolfo Cerezo - CFO

Analysts

Andrew Campbell - Credit Suisse

Vera Rossi - Morgan Stanley

Miguel Garcia - Deutsche Bank

Patrick Grenham - Citigroup

StanleyMartinez - Legal and General Investments

Rizwan Ali - Deutsche Bank

Henry Cobbe - Nevsky Capital

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2007 Telefonos de Mexico Earnings Call. My name is Alicia, and I'll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this conference is being recorded for replay purposes.

I would now like to introduce Mr. Rui Echavarra, Investor Relations Officer, and Mr. Adolfo Cerezo, Chief Financial Officer. Mr. Echavarra, you may begin.

Rui Echavarra

Thank you. Good morning, and thank you for joining us on this conference call to discuss our third quarter results. As is our practice, our prepared remarks are supported by slides on our website. If you have not logged in, please click on www.TELMEX.com/investors.

We will begin with our forward-looking statements. During the course of this conference call and it’s question-and-answer session, we may make statements that constitute projections, expectations, beliefs and similar forward-looking statements. TELMEX's actual results could differ materially from results anticipated or projected in any such forward-looking statements.

Additional detailed information concerning important factors that could affect the company's performance is readily available in TELMEX's Form 20-F and other filings with the Securities and Exchange Commission. These documents are available on both the SEC's and TELMEX's website.

Now, I will turn the call over to our CFO, Adolfo Cerezo.

Adolfo Cerezo

Thank you, Rui. Good morning, everyone. At the end of the third quarter TELMEX had 18.157 million lines in service. That represents 21% of Mexico's telecommunications market of fixed, mobile and voice services including those also by the cable companies. 9.8 million of our lines are in areas where there is competition. Our cable companies have market presence. Those 9.8 million lines represent 46% of the fixed voice services market in Mexico. The remaining 8.3 million TELMEX lines which account for 39% of the fixed voice services market are in areas where our competitors do not choose to operate.

In this quarter, these customers generated revenues of 5.8 billion Pesos and an operating loss of 708 million Pesos. We have recognized that these areas, that do not attract competitors, are different from other market segments. Even so, TELMEX respects these customers, as part of our commitment to serving all of Mexico.

Therefore, to work effectively with the particular characteristics of these market segments, we have created the non-served communities by competition business unit, which will operate and report independently within TELMEX with the objective of meeting their needs in an efficient manner.

We continue to make computers available for sales in our TELMEX stores. We offer financing for up to three years and customers can choose their loan plans, starting at monthly payments of 183 Pesos without Value Added Tax. Additionally, customers who sign up for our internet service receive a 20% discount on their computer payments.

These efforts contribute to growth in broadband services, recognizing that low computer penetration in the country is one of the main obstacles to growth in that market. These plans are a major reason that we have sold more than 240,000 computers in our TELMEX stores throughout this year.

In the third quarter, we added 296,000 broadband Infinitum ADSL accounts in Mexico, bringing the total to approximately 2.7 million services. Of the total of 3.1 million internet users, 85% are broadband Infinitum users. In Mexico now, close to 13% of homes have access to broadband services. There is still a lot of room for growth in that market. But our efforts to expand broadband usage are having a positive impact. The pace of broadband growth in Mexico is among the highest of all countries that are members of the OECD, according to it's Communication Outlook 2007 Report.

In the quarter, we launched a new service package that we are calling Todo México sin límites or all Mexico without limits. For a fixed monthly fee of 869 Pesos without value added tax, customers get fixed line rent, unlimited local calls and domestic long distance minutes, as well as access to an Infinitum account and digital services. The new package continues our emphasis on matching service we choose with customer preferences. Packages also give us more predictable revenue strength. So this is another win-win situation in how TELMEX works with customers.

Here is another example. Nine years ago, Mexico had 2200 Local Service Areas, that number has dropped to 397. Each Local Service Area now averages 5000 square kilometers where more than 260,000 inhabitants are served. Those statistics compare favorably with Local Service Area figures in other countries.

Even so, we are taking a novel step to improve the Local Service Areas arrangement for our customers. On the [our new] program announced this month, customers can take advantage of our domestic long distance price per minute of 0.50 Mexican cents, in 174 neighboring cities. This initiative reduces the long distance cost for our customers approximately 58% in these cities.

We have been following the progress of the Convergence program in Mexico. In these conversations we [get investments], so let me bring you up to date. The bases for the convergence of networks and related requirements was established on the October 3, 2006 Acuerdo de Convergencia or Convergence Agreement, as part of achieving interconnection and interoperability of networks.

To-date, TELMEX has signed 16 interconnection agreements, with different cable companies. We also have carried out investments and modifications in our telecommunications network in a timely manner to meet the requirements.

On the other hand, the objectives established by the Federal Government regarding Competition, Convergence and Coverage are desirable for the rapid development of telecommunications, and will surely increase investments and penetration of telecommunications services. That will bring broader service offering and improving prices for consumers in Mexico. The achievement of these objectives will reduce the significant lag in offering integrated services, coverage and penetration of data and video in Mexico. The news release that we issued yesterday afternoon provides details of TELMEX performance in the third quarter.

We just spent most of our time this morning on how the telephone market in Mexico is changing and in our operations in Latin America. As I described earlier TELMEX is a company that understands each market and makes the necessary adjustments to succeed, and those markets change. Our growth drivers now are data, mostly service packages and international operations.

At the same time we are successfully managing our business in the maturing market in Mexico, all the while maintaining our commitment to advance our country's telecommunications infrastructure. The many challenging dynamics of the business were evident in the third quarter results. I will discuss our operations in Latin American [multi-trade] in a moment. But let met start with another view of our business in Mexico with particular emphasis on broadband.

The keys to market leadership are our network capabilities and the value our services provide to customers, particularly in the residential and small business market segments. Customers are attracted to multi-service packages. Customers like their value and we benefit from the predictable and recurring revenue stream.

At the end of September, we had customers participating in more than 3 million telecommunications packages. That is 21% more than a year ago. The revenues generated by packages have increased 42% from the year earlier level.

As I mentioned, our Infinitum broadband offer continues to be a major attraction for customers. They have participated in the survey directly or signing up for a package that includes both ADSL and our voice services. At the same time, as we have increased demand for that service, we have adjusted prices to reflect market conditions.

In April, we reduced broadband prices, which was one of the reasons why internet revenues went up only 3.5% in the third quarter, compared with the year earlier. In the corporate data market DSL line equivalency increased 17%, bringing the total to 2.6 million Pesos. Our revenues increased a little over 2%.

Local traffic and domestic long distance declined 6% and almost 1% respectively, from a year ago. Although international long distance traffic gained from last year's level. Even when we see year-over-year declines in usage, it is important to mention that our products and services, which generate fixed monthly revenues, continue to increase.

We have a very substantial customer base using our telecom platform, becoming acquainted with TELMEX commitment to excellent service as we [spawn] into new service offerings.

Moreover, our telecom platform supported a strong increase in interconnection traffic, which gained almost 16% over the year earlier period to 11.7 billion minutes that is an indication of the multiplying effect TELMEX has in the Mexican telecom industry.

The third quarter turned in an operating margin of 36.9% in Mexico and an EBITDA margin of 50.3%. Although the numbers are important, the key points to draw from the statistics are that, our market is evolving rapidly. TELMEX understands the changes and we manage our business to make the most of market realities.

Now, I will give you an overview of our operations in Latin America. Then I'll review the consolidated resources and we'll open the call to your questions.

Our Latin operations as a whole performed very well. Revenues were up 11%, and EBITDA totaled the equivalent of US$329 million. More important, our customer base has grown substantially. Having said that then I will focus my remarks on Brazil and Colombia. In Brazil, we continue [to work up] Embratel from a long distance company to an integrated telecommunications company. The Telefonos is achieving the signed results. Long distance represented 54% of total revenues in the quarter just ended, compared with 65% to the year's ago.

Embratel also is focused on consolidating each position in the corporate data business, and expanding its local service offering in the mass market, with initiatives produced increases of almost 30% in line equivalents and 31% in lines in service in the third quarter. Libre our local service brand in Brazil has more than 1 million lines in service, an increase of almost 34% compared with last year.

Additionally, on September 30, the company provided Net Fone triple play services through Net Services to 469,000 customers. This initiative led by the growth in lines in service translated to a 6% increase in revenues compared with a year ago. Local service revenues increased 37% offsetting a 1.5% decline in domestic long distance revenues.

We have enhanced our management team in Brazil, which is evident in the approach to costs as well as significant year-over-year improvement immediately on operating margin.

As a matter of fact, Brazil is contributing 27% of consolidated revenues and almost 17% to consolidated EBITDA. Costs and expenses declined almost 21% largely, because the '06 quarter included a non recurring facts related charge. Without that charge, costs were essentially flat compared with a year ago. More efficient use of resources offset higher personnel and telephone handset expenses necessary for growing the local service market.

The absence of the tax related charge contributed to our semi EBITDA from slightly negative cash flow in the '06 period to positive cash flow of 575 million Reais in this year's third quarter, reducing our margin of 26.4%. Operating income was 294 million Reais with 13.5% margin.

In Columbia, our efforts in the data business have been focused on the corporate and SME segments. The story is similar to Brazil, in that the number of line equivalents has increased 67%, which have made a strong push in Columbia to acquire and integrate the cable TV companies, so that we are in a good position to offer triple play in a meaningful way.

On October 10, we completed an acquisition of Cablecentro and Satelcaribe, adding them to our existing properties from Superview, TV Cable and Cable Pacifico. TELMEX entities now passed more than a 2.5 million homes. The data market and cable TV emphasis almost tripled revenues in Columbia year-over-year. However, cost and expenses increased as we move to integrate cable TV companies and added personnel to sell to the small and medium sized business markets. The EBITDA strength was encouraging, totaling 20.8 billion Columbian Pesos and producing 16.3% margin.

Now, I will summarize TELMEX consolidated results, consolidated revenues increased, 2.1% from a year ago totaling 48 billion Pesos. Three factors were primarily responsible for the improvement. One, internet access revenues increased almost 9%. Two, interconnection revenues rose 16% mainly due to domestic and international long distance calling party base and three, other revenues primarily reflecting the [contribution] of TELMEX stores and Yellow Pages gained 34%.

Our relentless cost control efforts, along with the absence of the non-recurring charge in the '06 period related to Brazil, ICMS tax enabled us to reduce cost 3.3% entering third quarter. Operating income increased 18% with a margin of 21.4% and EBITDA increased 11% with a margin of 42.5%.

Net income reached 9.3 billion Pesos, 38% more than in the third quarter of last year. First, you can see that TELMEX achieved a strong border line performance in the third quarter. It is especially a significant accomplishment given that our markets are highly competitive and are undergoing accelerated regulatory and technological change. Our [super set] comps form the core principles that have always guided our business. We focus on the customer. We make sure our telecom platform supports a mixed marketable technological advanced, so that we can also heed to the consumer at attractive prices and at the right time for the market. We manage our financial resources wisely to take advantage of growth opportunities. In short, we operate TELMEX to build value for both customers and shareholders. Thank you for your interest in TELMEX and now we will take your questions. Alicia.

Question-and-Answer Session

Operator

(Operator Instructions). And the first question comes from the line of Andrew Campbell with Credit Suisse. Please proceed.

Andrew Campbell - Credit Suisse

Yes, good morning. My question is about the very strong growth that you saw in Brazil, particularly with local lines, and I understand the Net Fone growth is part of the triple play at net, but I wanted to ask about the other local line growth that you are experiencing. And could you give us a little more color on what products you are selling? Is this the leeway product that was from Libre? Are these really corporate lines of which you are connecting more customers, and with actual fixed infrastructure, but where is the rest of this line growth coming from if it's not related to Net Fone?

Adolfo Cerezo

Okay, Andy. Let me start with the end of your questions. Yes, in terms of the local market, it's a combination and the Libre brand, you're right it came from [Besca] as probably you'll remember. We decided a year ago to reshape the whole business for local services. Once we had our (inaudible) technology, we decided to accelerate this, and that's the reason. Because we have more than 1 million uses of e-service, probably the people remember in the beginning that we used to keep the handsets for free. We decided to stop that practice and now, in fact, we are selling the handsets, and the business is growing.

In addition to that, we have the corporate, the corporate business, which basically brings you to the $1.2 million figure and that's a [prepaid] line. The prepaid line revenues are also taking account in the revenue-lining in Brazil. So those are growing very fast, and Libre is growing at a pace of 34%, in terms of revenue generating units. On the prepaid line, it's growing at a pace of 30%, so those are good indicators of how this business grows. The rest of the business is the internet business and the data business and that continues to grow as well. It's been complimented with the Star One business and the satellite business which last year were not so good. This year the performance has been better, and because when we compare the use, it looks better.

Andrew Campbell - Credit Suisse

Okay. I understand, just as a follow-up to the Libre product, so do you believe that will continue to be an important source of growth, the idea that's still going to be one of the core local service offerings that you have here?

Adolfo Cerezo

I think so, based on the trend that we have seen. Based on how the Brazilian market looks, I think so we should rely on growth based on the Libre activity.

Andrew Campbell - Credit Suisse

Okay. Thanks. It was helpful.

Adolfo Cerezo

Welcome.

Operator

The next question comes from the line of Vera Rossi with Morgan Stanley. Please proceed.

Vera Rossi - Morgan Stanley

Thank you. In terms of EBITDA margins in Brazil, where do you expect your margins to be in the next two years? Today you are in the mid 20s, what levels do you think it could increase from the current levels? Thank you.

Adolfo Cerezo

Brazil is currently moving in the region of 26% for the EBITDA margin. The cumulative figures…Also we are close to 26, in the quarter it was 26.4%, and for the nine months it was 25.8%. It is hard to predict how it will look in two years, but I can tell you that based on the company performance, I don't have any doubt that we should see a positive trend in the EBITDA margin and the rational is simple.

The customer base continues to grow and the company is taking care of operating costs. We know that an important portion of all costs in Embratel depends on interconnection costs. They are going down, and they have been used to in a rightly way.

As long as we can push for new services like the Net Fone, in this case, that will add to the margin.

Vera Rossi - Morgan Stanley

Do you expect margins to go above 30% at some point?

Adolfo Cerezo

I am not alluding to playing with a crystal ball, so I would rather say I would like to see, but it will depend on a number of things.

Vera Rossi - Morgan Stanley

And what things should we be paying attention to, aside from the interconnection rates?

Adolfo Cerezo

It always has to do with rates in Brazil, yes. That's one of the cases, but it also has to do with Embratel's ability to consolidate, to integrate these services, and to expand in the mass market. That's a challenge that Brazil has.

Vera Rossi - Morgan Stanley

Okay, I have one question about Mexico. Can you talk -- give us an update about the IPTV that you expected to launch now in the third or four quarter, and whether or not you already launched IPTV in Mexico?

Adolfo Cerezo

There are some dates that we have to comply with before launching IPTV in Mexico. Let me take the opportunity to comment again, based on your question. June of this year, June 12, this year, they say, our telecommunication commission COFETEL issued in the official gazette. They are the solution that establishes the rule to implement the portability of geographical and non-geographical numbers by portability. Because there are three present conditions that TELMEX has to comply with in order to provide IPTV solutions or services such as that. Portability is one of them; and interconnection and interoperability are the other two. These portability resolutions established technical and operative specifications, but finally this publication of a portability resolution appeared in September.

And then we have to wait for the publication of these resolutions, and the process began on September 20. Based on that, the process, if fair, should end in November this year but we've been waiting for additional information. We are still waiting for the technical and operative specifications, which are supposed to be published in November. In that case, on that we'll take portability to begin next year. So, what I can tell you, our next slide is TELMEX has invested, what its needed for complying with the portability requirements that a figure close to US$60 million.

We are ready and we are waiting for that. In the mean time, we have been discussing different issues, one of them is decent rules, these portability rules are not so clear. In our point of view are absurd for TELMEX. We do not agree in generating incentives for no payment of the past due balances on the current rules, because they are not clear. They could mean that, once a customer has decided to move from one telecom operator to another and taking his or her number and the rules are [variant] to you, in order to take off the balance date. But, as I say, that's taking a lot of time. We are still waiting for the technical and operative specifications. So, but on line you have to wait until next year to see TELMEX providing IPTV services.

Vera Rossi - Morgan Stanley

Okay. Just I need to see if understood correctly. You won't be able to offer IPTV until number portability is in place, is that correct? Or until the rules?

Adolfo Cerezo

That's correct.

Vera Rossi - Morgan Stanley

Okay. It's not until the rules are clear?

Adolfo Cerezo

That's correct.

Vera Rossi - Morgan Stanley

It's until it's in place so till one customer from one of your competitors can move to your network or vice versa?

Adolfo Cerezo

That's correct. I mean assuming -- our assumptions is that which I've already complied with other two conditions to reduce, we have signing a connection agreement on interoperability I means it's over.

Vera Rossi - Morgan Stanley

The other two items, interconnection and interoperability have read the result or not yet?

Adolfo Cerezo

Yes, we have read the result in our view.

Vera Rossi - Morgan Stanley

In your view, but in terms of the regulator view?

Adolfo Cerezo

Ask them.

Vera Rossi - Morgan Stanley

Okay. Thanks.

Adolfo Cerezo

You are welcome Vera.

Operator

The next question comes from the line of Miguel Garcia with Deutsche Bank. Please proceed.

Miguel Garcia - Deutsche Bank

Hi. Thank you, I wanted to focus on the other revenue line in Mexico, it grew 22% from last year when you also have Yellow Pages sales and PC sales. Could you give us a quick breakdown on this revenue and what's generating this fast growth? Also in terms of the Colombian operations they have been reporting high volatility in margins probably due to the consolidation of the cable operations, do you think it's reasonable to expect in the longer term margins of in the mid 30% I mean based on all their cable operations in the region?

Adolfo Cerezo

Good day Miguel, other revenues in TELMEX mainly two components which I mean they do define the behavior of these lines. The TELMEX stores, we have been in the process of remodeling our TELMEX stores since a year ago. We continue modernizing them, and attracting customers. They use not to visit our stores.

So, that's been the trigger for selling the amount of computers that we have sold this year 240,000 computers and that's one good reason because you have seen growth on DSL. Yellow Pages is another important driver. So, those are the two main issues that define growth, what I can tell you is that, what we have seen is that, we continue observing growth in TELMEX stores line, so that's a good indicator for our business.

Then Columbia, Columbia at this time, we are in the process of integrating the different cable companies that we have acquired. That's an interesting challenge. It's an interesting challenge because of our different companies and different kind of organizations. And the idea is that we have to continue the business, and we have to continue providing services to our customers in Columbia. And in the mean time, to upgrade the network, what I can tell you is that, at this time in Columbia, it's bi-directional in these network, it's 17%.

We have to spend a lot for increasing, excuse me, it's only one third of the network, its bi-directional network. So, we have to spend for upgrading the network and for evolving it into a bi-directional way. As I said, we are passing more than 2.5 million homes. We should be close to 3 million homes at the end of this year and I think it will grow larger in '08. So, that means CapEx for Colombia next year.

And that also brings some operating and maintenance cost but that's part of the business. We know that we are contemplating that, this is not a model as reducing the number of heads in this business or adding more users. It's not as simple as such. So, it will take time but on line. Sure, we should see an increasing margins not as fast as I would like to see then not in '08 because the year will take most of our efforts in concluding these consolidation process and accelerating offering for triple-play and dual-play in Colombia. I should advise to wait until '09 to see margins going out dramatically.

Miguel Garcia - Deutsche Bank

Okay. Thank you. Now if I may, based on the fact that sales of PC and Yellow Pages are in all revenues, something that might be only a short-term, do you think that you can maintain margins in Mexico above the 50% that you reported this quarter or we should expect based on the migration to wireless and voice over IP a slow erosion in the future?

Adolfo Cerezo

This year, we experienced erosion in our margins and that's because the calling party pays revenues, they are known as good to us, as rest of our revenues, so margins are lower so as long as, we had an important in flue coming from calling party pays revenue that affected all margins this year. And as we reached 50% figure in the quarter, the cumulative figure was 49.5%, the second quarter we were below 50% in line and we continue with our efforts for controlling and reducing operating cost. So, what I can tell you is, as long as we can have a positive growth in revenues, growth is always positive. As long as we have growth in our revenues, and as long as we continuing to controlling our expenses. I cannot say that 50 will be reached, but will be close to that in fees.

Miguel Garcia - Deutsche Bank

Okay. Thank you.

Adolfo Cerezo

You are welcome.

Operator

The next question comes from the line of Patrick Grenham with Citi. Please proceed.

Patrick Grenham - Citigroup

Good morning. Could you just talk a little bit about first of all the clean up of the base? And secondly, how are you going to deploy capital between the core competitive part of the business and the connect part of the business? How are you going to see that in Mexico, they are both Mexican question?

And then on the Brazilian business, you mentioned that the growth in West Brazil, you do have line growth that's apart from growth that's happening through net. How do you see that going in the future do you think what percentage of Embratel's local service growth will be on its own path? And what percentage do you think will be through that?

Adolfo Cerezo

Okay. Let's start with the Brazilian side. Net has been growing faster, that's because the new service that we've introduced jointly probably you'll remember that a year ago, in October, we had 139,000 Net Fone users in Brazil. So 139,000, and now we are talking about 470,000 users. So, that business grows really fast and another opportunity that we have is that we found that delivery business in Brazil and that it was not well attended, we could operate it in a better way and as I explained earlier, the decision was made in order to stop it in the way, it was implemented.

We have to reshape the technical platform, to introduce a new one, and to market it in a more aggressive and different way. We are using call center, we added people that's because I explained it, and that's when we deal with expenses side in Brazil. We said okay, take in, take out the tax impact you will see that cost are basically flat. On the way to explain that is because we added personally for marketing efforts and we added charges coming from handsets that were sold.

So, this is a new door that has been opened in the case of Embratel. Now, if the mass market that is saying that it has potential to grow. There is no way, again to saying that we could sustain the current trend. But again, what I can't say is that yes, we are putting our efforts to keep these trend of growth and that's an interesting market. And that compliments the portfolio of services that Embratel has or that's adding revenues and it has positive impact at the EBITDA level. So, we will continue pushing for that. At the same time that net services will continue pushing for Net Fone. Those are different markets. That's in [Western] Brazil. Brazil has enormous room for growth. We are dealing with different markets [why] should they overlap in some cases. But at this point there are different strategies, different market strategies, we have different kind of users and in both cases they are growing.

Patrick Grenham - Citigroup

And is (inaudible) is really a business. Is that a business product now or is that a residential product or how are you separating them?

Adolfo Cerezo

It is a business, it is a business.

Patrick Grenham - Citigroup

It's only a business product now.

Adolfo Cerezo

Yes it is.

Patrick Grenham - Citigroup

Okay. And on the Mexican business, you are separating at the CONAT. How are you separating the CapEx there?

Adolfo Cerezo

The CapEx and the CONAT case it's basically maintenance CapEx. At the beginning that's what we have decided to allocate, but we wanted to support this business. We are talking about a lot of lines and the idea is to support them. I don't want to give you a wrong figure, because I don't have it. What I can tell you is the way in which we allocated CapEx for CONAT, is based on all the maintenance CapEx needed, it's been allocated in CONAT.

Patrick Grenham - Citigroup

Alright, what percentage of your Mexican CapEx would be in that business do you think?

Adolfo Cerezo

Let me guess in general maintenance business in Mexico it goes for 45% at the total CapEx. Total CapEx in Mexico is in the region of US$1.1 billion, so I'll take 45% of that. And then go 50:50, which I mean maintenance business it does not distinguish between good or not as good lines. They required the same kind of maintenance business.

Patrick Grenham - Citigroup

So, we are talking about US$250 million or so?

Adolfo Cerezo

Yes, sir.

Patrick Grenham - Citigroup

Okay, great. Thank you.

Adolfo Cerezo

You welcome, Patrick.

Operator

The next question comes from the line [Stanley Martinez] with Legal and General Investments. Please proceed.

Stanley Martinez - Legal and General Investments

Thank you. Good morning Adolfo and good morning Rui. I've a question, a follow-up on the Columbian operations. I realized it's early in your budgeting cycle for next year, but do you have any preliminary estimate for the Columbian CapEx, for the integration of the cable properties with you're using operations in Columbia. And also on interconnection, it looked like sequentially you had a lower interconnection cost than I had expected and some lower sequential growth in interconnection minutes of use growth. Should we be anticipating a lower incremental impact from national calling party pays in the future quarters? And then I just have one brief question on the tax rate, it was lower than I'd expected this quarter, and I am wondering whether TELMEX is applying some NOLs from Brazil and what impact that might have on consolidated effective taxes at the group level going forward? Thanks.

Adolfo Cerezo

Okay Stanley. Let me start with the Columbian CapEx. Growth across the years, this year its US$200 million that's the estimated Columbian CapEx, that includes of course CapEx for the cable company. Next year in the region of US$300 million mainly focused on, as I had explained before upgrading the network, taking it to a bidirectional way, and also expanding the network. And then your question is on lower interconnection cost. Was that question part of a Columbia market or?

Stanley Martinez - Legal and General Investments

No I'm sorry is it in Mexico where we saw that you just had lower sequential growth in interconnection minutes at least relative to Q1 and Q2 and wondering whether we should be anticipating as you move further away from the implementation of national caller party pays whether that affects in terms of sequential interconnection minutes of use growth is going to start to flatten out.

Adolfo Cerezo

Okay. This is the way on how the market reacts. Calling party pays for long distance purposes, I mean domestic and international it was introduced in November last year. And so the economists are -- all these people behind desks that they only love to see papers and books, they assume that elasticity is the only variable that works in this market. Okay, at the beginning, yes, that's the case. But then the market is alive so the market wants to have realized and the market is only cost [bars]. There are players, I mean operators, so each one will take the best alternative that satisfies their purposes.

In other way, the customers will look for the less expensive alternative. But also that applies for telecom operators. So what we are seeing is that we balance this year as we have had growth in minutes, but at the same time, mobile line operators and other telecos they are taking advantage of that and they are looking for heavy users on promoting different alternatives. But more important is the market itself which is digesting these changes and what you are seeing is the trend for that.

Internal the rates, for the calling party pays system they will be reduced in the years ahead, it's been announced. So for example the local calling party pays rate. This year is 1.85 Pesos. It's been split 1.34 Pesos they go to the mobile company and 0.51 Pesos go to the fixed line operator TELMEX in our case. This rate will go down to 1.72 Pesos next year, 1.60 Pesos in '09 and 1.51 Pesos in 2010 year.

The tax rate, this year we've been dealing with a figure which I would advice to see between 34% and 35% that's now in our estimation the range for the TELMEX effective rate this year.

Stanley Martinez - Legal and General Investments

And as you continue to -- is there a potential though as your earnings at Embratel and some of the other [non-ILEC] operations grow as a proportion of group operating earnings for that tax rate to come down because you will be applying net operating losses at each of the individual countries against their income in those countries. Could that potentially bring that rate down into the low 30s perhaps?

Adolfo Cerezo

Perhaps, but you have to go in detail for each country. Let me give you the example of Brazil. It doesn't matter if you have losses coming from previous years. In Brazil, there are strategic rules you have to have first a taxable basis to apply it and second you cannot use more than 30% of the taxable basis to take advantage of previous losses. So it will take time, it's not as easy as it looks and then we have to analyze the other country, but yes in generally in theory once we can take advantage of these previous year losses and that could benefit our effective tax rate in the future.

Stanley Martinez - Legal and General Investments

I'll look forward to it. Well thank you very much for your time Adolfo.

Adolfo Cerezo

You are welcome Stanley.

Operator

The next question comes from the line of Rizwan Ali with Deutsche Bank. Please proceed.

Rizwan Ali - Deutsche Bank

Good morning. My question was related to your margins in Mexico. As you launch IPTV services, we've seen in Chile, CDCs margin go down quite a bit. So, should we expect something similar in Mexico's growth for you? And the second question is this split between have CONAT and other lines that you have. Was it is a regulatory requirement and at some point are you going to argue with COFETEL to give you different tariff structures for where you have competition, where you don't have competition?

Adolfo Cerezo

Okay, Rizwan. IPTV, let's say, that it's not a rule of some but always when we are launching in service and as long as we cannot reach the critical mass number. Yes, we will be expecting margins in general. I'm not an expert in this business but I've been in this business for quite a long time. So, what I can tell you is that, as long as in this business we can see figures in the regions of the 100,000 then we could start thinking about not being too far from breakeven. Once we have figures in the region of mediums then the business begins and that's when we can add to the bottom line.

If we isolate the business the TV business, this thing has happened in Brazil, I mean margins were not as good at the beginning and they are improving. We're expecting to see this same in Columbia and that should be the case in Mexico also. So yes in the short-term that could affect, it will depend on our ability to grow the business and to reach a reasonable in order to compensate this margin effect. But hard to estimate at this time, I prefer not to give any figure. The CONAT strategy, the CONAT strategy calls for a first -- the commitment that we have in Mexico to provide service to every Mexican.

Second that we have invested a substantial amount of money in fixed assets I mean we are not looking for someone to lease this facility or to block in some area and try to pay for marginal cost. This is a business in which we are committed and [we have decided to invest a lot]. So but at the same time we decided that it was worth to pay attention to the business and not to disturb, not to forget that we have got so much in this business and thinking about different rates, no I don't think so. I mean that's something that we don't have in mind at this time, but we assure you that this is a sensitive business even though we have a lot of lines. Its 8.3 million lines, we are making only less than 6 billion Pesos from revenues and now we are loosing the operating level. So, the message of this is, this is a sensitive business and it's also part of Mexico.

I mean, it's a way in which are maturing markets and that's because they use the word maturing. This is not a mature market, this is a market that can be treated to with the same rules that we're applied in the matured markets and incidentally most of them are [afraid]. This is a market that needs to grow. This is a market in which at this time the idea is not to fight for a piece of the cake, but to increase the size of the cake. Also I mean we have to refocus then and that's because we decided to create this business unit to pay attention to these customers that the next CONAT will have.

Rizwan Ali - Deutsche Bank

Thank you.

Adolfo Cerezo

You are welcome Rizwan

Operator

The next question comes from the line of Henry Cobbe with Nevsky Capital. Please proceed

Henry Cobbe - Nevsky Capital

Hi there, thanks so much for the call. Just a couple of questions, the first is on your affiliate income is that mostly from (inaudible)? The second question is just on the fight of the buyback fund. You still have a large buyback fund even after the buyback you have done in third quarter? Do you aim to exhaust this by the time of the next meeting in April? Certainly, just could you summarize the CapEx budget for this year and next year, perhaps by region? And lastly just on IPTV whether -- how much of the plan would involve rolling out fiber, the fiber network or will it only exist in kind of copper?

Adolfo Cerezo

Okay, Henry. Let me look through my figures. Let me start with the last one we will go for the resultant, the IPTV project. The IPTV project -- the driver usually -- the amount of megabits that you have to provide to users in order to give only channels that are expected on that kind of the quality that also we expect into receive and based on that our plan goes for basically fiber-to-the-node in some cases. When it makes sense from the economic point of view with the [big] fiber-to-the-home but those are just a few cases but if we are doing a fiber-to-the-node project. So in order to decrease substantially the distance for the corporate line and to be sure that we can provide all the megabits needed for our offer and it's too early to say something more than and I will prefer not to comment on specifics on how these networks -- on how the concept of these network looks but it's a fiber-to-the-node.

The CapEx let me -- in CapEx this year, Mexico US$1.1 billion all of the Net, Brazil US$650 million, Columbia US$200 million and Argentina [US$60] million, Peru US$30 million, Chile US$80 million, and that's the total. Next year, the ballpark estimation that we have at this time, Mexico US$1.1 billion, Brazil is US$700 million, Columbia US$300 million, Argentina US$60 million and we have to consider Ecuador next year. We acquired a small company in Ecuador and we have to grow this company and so we are expecting to spend -- to invest US$70 million. Peru, Peru also we acquired a couple of cable companies the small ones, so Peru will take a US$100 million next year. Chile, Chile also because, we acquired a DTH company, we should expect to invest a US$100 million in Chile next year.

Henry Cobbe - Nevsky Capital

The Ecuador number was how much?

Adolfo Cerezo

Ecuador 70.

Henry Cobbe - Nevsky Capital

And the affiliate income?

Adolfo Cerezo

The income from Net in special terms, while in dollar terms, which is maybe this year is in the region of US$25 million, US$27 million that's the participation in Net that we are reflecting in our consolidated figures in the quarter.

Henry Cobbe - Nevsky Capital

And is that included in the equity and results of affiliate's line?

Adolfo Cerezo

Yes and in the balance and then that it goes to…

Henry Cobbe - Nevsky Capital

And what are the other companies in the affiliate line. Just because it seems that -- in third quarter you had 285 million Pesos of affiliate income and a net 41% of -- 38% of the net was 45 million Pesos so, you are just going to work out with the other 240 million Pesos?

Adolfo Cerezo

I think we have to go in detail to break it down. We don't have it at this time. So we'll look for you and we'll provide that later just cant' review it if you don't mind.

Henry Cobbe - Nevsky Capital

Okay. Also you will have to segregate the breakdown of the interconnection revenues a step between [calling party pays] and fixed line interconnection I think you usually set the data after the quarter results?

Adolfo Cerezo

Let me look for that.

Henry Cobbe - Nevsky Capital

And there is between local and long distance and international CPP?

Adolfo Cerezo

Interconnection it's a 5.6 figure.

Henry Cobbe - Nevsky Capital

Yes.

Adolfo Cerezo

Okay. Telecom operators to mobile operators 567, and the balancing goes to calling party pays [different penalties] local and long distance.

Henry Cobbe - Nevsky Capital

407 was long distance and 167 was mobile? And what was the spilt of the calling party pays in terms of local DLD and ILD?

Adolfo Cerezo

3.5 for local, 3.5 billion for local, 1 billion for domestic long distance and the rest goes for international long distance.

Henry Cobbe - Nevsky Capital

Okay

Adolfo Cerezo

And finally the buyback, the buyback here we still have room for the buyback, based on the current strength that we have. We have been buying the TELMEX shares at a pace of 4 million TELMEX shares. TELMEX shares not ADRs per day all this time, that gives us enough room to reach April next year and I don't have a good idea at this time what the TELMEX Board will decide on the buyback but as long as we have good idea and that should happen in the end of March. We will announce that of course.

Henry Cobbe - Nevsky Capital

But I mean typically you draw down the buyback funds by the time of AGM. But at the moment the buyback funds still seem such a long way to go before even at 4 million shares a day. You are not going to draw it down by April so, would you be aiming to get it down to I mean to the 10 billion level by April?

Adolfo Cerezo

The buyback reflects our thoughts on TELMEX shares. But the buyback also is being used like an internal variable that we can control. As long as we don't have better alternative to put the cash that TELMEX generates, we go for the buyback. Of course, that has an implicit point, which in my view it's obvious for all of you, as long as we continue buying out our shares because we are convinced that there is intrinsic value in our shift. If we don't think so, I have studied several times and we'll repeat it, this is not a charity business, that's because we separated the TELMEX foundation. So, if we continue buying our share back because we know that there is value. We know that we have to look for other alternatives and once we've found one of them, we can reallocate some of these phones and to go for [summer procedures] or to go for upgrading or expanding the telecom platform in several countries at the same time and then we'll continue buying shares back, it could affect the level that the message is there, we are confident in our company and that we are confident in the fundamentals these company has, that's been reflected in the buyback activity.

Henry Cobbe - Nevsky Capital

Okay.

Adolfo Cerezo

Okay. You're welcome. And probably we have specious for one additional question. Operator?

Operator

At this time, we have no additional questions in the queue, sir.

Adolfo Cerezo

Okay. Great. So, we appreciate all your time. Have a good day. Thank you very much.

Operator

Ladies and gentleman, thank you for today's conference. This now concludes the presentation and you may now disconnect. Good day.

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Source: Telefonos Q3 2007 Earnings Call Transcript
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