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Portugal Telecom (NYSE:PT)

Q3 2012 Earnings Call

November 8, 2012 11:00 AM ET

Executives

Zeinal Bava – CEO

Luis Pacheco de Melo – CFO

Analysts

Jonathan Dann – Barclays Capital

Paul Marsch – Berenberg Bank

Robin Bienenstock – Sanford Bernstein

Jonathan Dann – Barclays Capital

Ivon Leal – BBVA

James McKenzie – Fidentiis

Nuno Matias – Espirito Santo

Operator

Greetings and welcome to the Portugal Telecom 2012 first nine months training update. (Operator Instructions). Representing Portugal Telecom today we have Zeinal Bava, CEO and Luis Pacheco de Melo, CFO. I will now turn the conference over to Bava. Please go ahead.

Zeinal Bava

Okay. Thank you very much. Good afternoon ladies and gentlemen. Thank you very much for being on this call on behalf of my team and I. This is our trading update, it's not a complete release of financial statements because it takes to the consolidation of our Brazilian assets namely Oi and Contax. And therefore in all figures that we have presented here, we have not included any information on our Brazilian assets which we will be announcing the results later in this month. A complete set therefore of consolidated financial statements of Portugal Telecom for the first nine months of the year will be disclosed on the 30th November of 2012.

In the nine months of 2012, our operating revenues amounted to EUR2321, EBITDA stood at 994 million. Our margin reached 42.8% and in particularly by the very strong margin performance of the Portuguese Telecom businesses, which posted a margin of 44.9%.

Revenues in our Portuguese business stood at 682 million in the third quarter 2012. At the decline of 6.7% year-on-year. Having said that if you exclude the regulation effect, revenues in the Portuguese Telecom businesses would have declined by 5.4% year-on-year. In the third quarter of this year which compares with 5.5% in the second quarter of 2012 meaning that it was pretty stable performance not withstanding an adverse macro-environment.

With regard to CapEx, the CapEx in the nine months amounted to 449 million, it's about 20% of slightly less than 20% of all revenues. While CapEx of our Portuguese businesses is stood at about 370 million down by 7.5% year-over-year reflecting as we have said in the past the fact that most of the modernization investments in our company are pretty much done.

EBITDA minus CapEx reached 545 million. Our operating cash flow was about 416 million and free cash flow stood at EUR178 million. Our net debt end of 2012 adjusted for tax effect in relation to the transfer of the regulated pension plans of the Portuguese state amounted to 4.591 which was a reduction of 110 million compared to the second quarter of this year. So as we have indicated in the past we remain committed to have financial flexibility and to continue to reduce our leverage going forward.

Our cost of debt as my CFO. Will explain to you in a lot more detail still very attractive stems at about 4.2% whereas the cost of gross debt is about 4.4%, our liquidity position remains very strong as we are fully financed until July 2016. Let me now take you through in a lot more detail on the business and give you that training update before I hand you over to my CFO.

In the first nine months of this year our wireline customers increased 6.3%, our mobile customers increased 9.4% particularly in mobile I would like to emphasize that we continue to show very strong performance in postpaid, postpaid customers were up 5.2% and I also would like to highlight that we are making significant progress in the youth segment and in our own calculations we believe that in the last six to nine months we have been able to recoup between 2 and 3 parentage points of market share especially in the 15 to 24 years segment of the market.

Our total customers therefore in Portugal reached at the end of the nine months 12.393 million that’s an increase of 2.7% which against the current backdrop I would say that it's encouraging performance going forward. Thinking about the revenue growth and talking a little bit about each segment, if you take the residential segment what you find is that we have done extremely well, Weather One is talking about TV, broadband or even PSTN liners.

Our TV customers under the (inaudible) brand increased 22.5%. Most importantly in broadband we saw growth of 13.1% and no doubt you will have seen in the presentations that we put out even in PSTN lines in the third quarter we saw an increase of 11,000. This is probably the best performance we have hosted in PSTN in the last three years and it basically just supports the view that we have presented to you in the past that the transformation, the intellectual transformation that we have done and the transformation that we have also done in the business model of our residential segment is beginning to give the kind of results that we had expected.

ARPU was up 2.8% and most importantly 87% of our customers in the residential segment are on flat fees, which means that we have much, much superior predictability in the segment than we have ever had before. Top line was up 4.1%, some analyst might say that slightly worse than 5.1% that we posted in the second quarter but as you can imagine 4.1% compares very favorably with our peer group companies in Europe and I suspect that it will also I would also compare very favorably with our direct competitors in the Triple Play market here in Portugal.

Looking at net adds we added 37,000 customers in Pay TV if you take into account the work that we are also doing and own the SMEs side of the business, total number of Pay TV customers of Portugal Telecom increased by 41,000.

PSTN as I mentioned did extremely well with slots 11,000 and broadband we also had a very strong quarter. Also like to highlight that when you think about the customer mix, today about 63% of our customers are double play and triple play, the revenue generating units for unique customer have also increased 8.6% which means that we are selling not just more premium services including video on demand than we ever had before. This is of course underpinning the ARPU performance that I just mentioned earlier, ARPU was up as I said 2.8% in the last 12 months.

Turning over little bit to fiber, fiber continues to do very well in our market. As you know we have 1.6 million homes which are the best homes in Portugal in terms of household income, covered with FTTH, 60% of the net adds of Portugal Telecom in the third quarter were fiber customers.

Fiber customers not only generate a slightly higher ARPU but have the lowest strength in old office that we have in our residential segment and as a result the customer lifetime value continues to be very attractive notwithstanding the upfront investments we have to make to acquire those customers.

Turning now to the personal segment, personal revenues were impacted by MTRs. MTRs in our market were down 64%, this is one of the biggest declines in MTRs that we have witnessed in Europe. Interconnection revenues were down 32.8% in the third quarter alone, 26.5% in the first nine months of the year. So yes personal revenues have been impacted significantly by the glide path that our regulator approved which has been one of the most acute that we have seen in Europe but I would say the good news is that we now have termination rates or we will have termination rates end of the year of 1.27 which will be among the lowest in Europe and I suspect that there is very little to fall from where we will be at the end of the year.

With regard to the impact of the current macro-environment in the consumption. Certainly it is having an impact, having said that we believe that the bigger impact that we have seen especially in the last two to three months in our market has been some irrational behavior on the part of our competitors namely Vodafone in the youth segment. Personal revenues were down 11.2%. We were very encouraged by the July and August performance in terms of recharges. September was particularly difficult and I would say that that had something to do with austerity measures but again I repeat a lot to do with the fact that we have seen irrational competitive behavior particularly from Vodafone.

In the slides that we have included in our presentation. We have shown to you how recharges, our monthly recharges are behaving. The conditions remain very volatile the trends are very difficult to predict. Having said that recharges are a lead indicator in terms of performance and the good news is we are seeing or we saw much better recharges in October than we saw in the month of September and as you know that is a lead indicator and it will translate in revenue performance in the next few months, if people use those recharges to actually do minutes of usage and to consume mobile data. One of the biggest focuses we have had in our company is to invest in the migration of fee to postpaid customers and also to promote data usage because we believe that it not only drives ARPU but it also reduces churn.

Our flat key customers in the personal segment currently stands at about 22%, if you were to look at just wireless overall probably it stands at somewhere between 40% and 50% and this is important because it's significantly improves the predictability of revenues in the personal segment or in the mobile segment if you want as well.

Flat fees continues to increase and we continue to also see significant progress in terms of data usage, data usage revenues today already account for roughly 32% – 33% of our revenues in the personal segment and we believe that we can do a lot better in the future as we continue to push smartphone penetration in the market.

Subscriber acquisition cost are reflecting the effort that we have been making to promote smartphone usage. As you know smartphones have average prices which are higher than feature phone or non-smartphones. So not only notwithstanding the fact that we are selling less handsets, the handset sales and subsidies are picking up a bit simply because we are trying to push smartphones in our customer base because we believe that this is the avenue that we have to promote data usage and continue to if you like reduce churn which is very important in terms of customer lifetime value driver.

In terms of enterprises in the past we have talked to you about the lumpiness of some of the contracts. We told you also that we would improve the performance of the corporate segment and SME segment as months went by and as we install some of these very large contracts that we won in the course of the last six to 12 months. If you look at the total contract value in our business it has picked up significantly in the last nine months and therefore going forward we believe that this is one segment that we will continue to do better. Not only because we have growth in the scope of services we offer not only because we are investing heavily in cloud but also because when you think about SMEs we continue to make very good progress. In broadband, in TV and also in mobile. If you take broadband, broadband subscribers who are up 6.5%, if you take TV, TV subscribers were up 29.6% if you take mobile, mobile subscribers were up also 7.1%.

The challenge for us in this segment is to continue to improve the value proposition to our customers so that we can mitigate if you like short term pressure that we have in terms of prices. As we have indicated to you in the past, Portugal Telecom has no wish to compete on prices. Having said that we will always want to have the best value offer in our market and if we do have to compete on prices to protect our market share we will do so. It is not our preference, we prefer to differentiate based on innovation and we prefer to differentiate based on the value proposition that we give to our customers and we would like to differentiate going forward by promoting much, much higher data usage.

If you look at the non-voice revenue contribution of Portugal Telecom it continues to show sustainable growth. Our non-voice revenues in Portugal currently stand at 51.4% that’s a pickup of 5.1 percentage points in just one year. If you look across residential, personal or enterprise segment in all of these segments we continue to make significant progress in terms of promoting non-voice usage, higher penetration of flat fees which increases if you like the predictability for your business and the relevance of the services that we offer to our customers.

It is Portugal Telecom’s view that in the Portuguese market notwithstanding the current environment we still have scope to continue to increase not only our market share of subs but also our market share of revenues.

A quick run on our if you like African and rest of the world businesses. Starting overall what you saw across the board, we did very well in customers, we did very well in revenues proportional revenues were up 23.4%, nine months if you just look at the third quarter revenues were up 25.4%. With regard to EBITDA if you look at the nine months our EBITDA was up 22.9%. If you look at the third quarter our EBITDA was up 30%.

We are very proud with the performance that all our businesses in Africa and rest of the world are able to post notwithstanding the fact that each one of them has a different set of challenges. Starting with MTC with the kind of penetration that we already have in Namibia, the clear focus is promoting elasticity in terms of voice usage but also data usage.

Significant progress is being made in the roll out of 4G in Namibia and we believe that the 4G investment that we are making will allow us to gain substantial market share in broadband independent and agnostic of the fact that it is fixed or mobile.

Revenues in Namibia were up 14% in the first nine months of the year and EBITDA was up 7.8%. CV Telecom notwithstanding the fact that we have a very hostile regulatory environment, revenues are pretty much flat in the first nine months of the year and EBITDA it's flattish. We believe there is significant room for us to improve specifically if one is thinking about TV penetration in Cabo Verde and also mobile especially data.

In terms of (inaudible) it's a slow market but encouraging performances across the board. Third quarter revenues were up 36%, EBITDA was up 29%. In terms of Timor Telecom revenues were up 24.4%, EBITDA was up 33%.

We will have more competition in Timor next year. Our concession agreement has been renegotiated, having said that we believe that we have built a structural competitive advantage in that market not only by securing the best coverage but also by securing the best distribution network in terms of telecoms in Timor engaging more than 3000 to 4000 local individuals that work with us as agents.

In terms of Angola again very robust performance not just in terms of revenues EBITDA but also customer growth. In Macau CTM the growth is being underpinned not just by sales of equipment but also data usage, smartphone penetration continues to be very high and will be encouraged especially by the EBITDA growth of 13.7%.

Let me now hand you over to my CFO and then I will do a very quick wrap up and then of course we will be delighted to take any questions that you may have. Thank you.

Luis Pacheco de Melo

Thank you. Good afternoon ladies and gentlemen. After our CEOs comprehensive and our operation. Let me focus on the main financial highlights for the quarter. As our CEO mentioned this trading (inaudible) is not the complete release of the financial statements, it excludes the proportional consolidation of our Brazilian asset. On the revenues excluding the contribution of Brazil revenues were down by 5.4% with a strong performance of our full consolidated international assets.

In the third quarter revenues in Portugal were down by 6.7% as a result of basically the adverse economic situation but also as a result of the regulatory context. Excluding the fact of the regulation and also including the roaming and regulation impacts on wholesale, revenues in Portugal would decline by 5.4% which is much better from the second quarter of this year.

Within Portugal residential continued to pose a very solid growth with 4.1% as a result of a strong RGU performance and also as a result of the ARPU increase. On personal segment revenues were down 11.2% reflecting the decline the interconnection, revenues but also of course economic conditions and also the competitive environment in our market.

However having said that however, the monthly recharges in October has improved vis-à-vis what we have seen in the third quarter.

Enterprises revenues continue to show some improvement throughout the quarter as our CEO mentioned also as a result of the lagging of some of these big contracts that we have won over the course of the last six to nine months. On the wholesale another revenues which declined 11.6% basically reflect lower traffic revenues and the decline on the public pay phones and also on the 32% decline in our directories business which as you know we only have financial investment.

Nevertheless it is an improved trend from the second quarter. Going to EBITDA and OpEx in the third quarter EBITDA was down 7.1% to 328 million equivalent to 42.6% margin. EBITDA performance in Portugal was partially compensated by the strong EBITDA performance on our fully consolidated international assets excluding of course on these comment.

On the proportional basis our other international assets posted a solid 30% increase in EBITDA in the third quarter. In Portugal EBITDA was down 8.8% to 301 million equivalent to 44.1% EBITDA margin.

Service revenues minus direct cost in Portugal were down by 50 million approximately in the third quarter while EBITDA was around 29 million as a result of course of lower OpEx on the remaining OpEx items. In the third quarter our OpEx excluding D&A declined by 5%, wages and salaries were down by 3.1%, direct costs were down by 3.9% reflecting the MTR decline and also lower directory business cost as revenues also declined significantly in the quarter. In the third quarter and notwithstanding the continued Cosmo (ph) growth in Pay TV programming cost remained flat vis-à-vis last year which represents a 18.5% decline on the per customer basis.

The commercial cost were down 6.8%, reflecting lower commission and lower marketing which more than compensate the growth on cost of goods sold.

If we were to exclude the cost of goods sold then commercial cost were down 16.7% in the quarter. This performance on the commercial cost was achieved against the backdrop of slower churn as now our CEO mentioned before as mentioned before which is driven by the role out of the new technology namely the FFTH the 4G and also the increased bundle services namely the Triple Play.

As our operating expenses it is almost 6%, also explained by lower maintenance and repairs following the roll out of the FTTH and also lower support services as explained on the following slides and also the slightly higher provisions in the quarter.

Going forward we continue, we will continue to implement additional structural cost initiatives which continue to translate into significant cost savings as we discussed in our technology and innovation conference last week.

On the cost initiatives, on the customer care side they continue reduction in our care space is also underpinned by the roll out of the new technologies. We have seen lower churn coming down, we have seen churn coming down, but this new networks are also robust are more robust than the copper 2G and the 2G, 3G networks and the result of that you see better quality of services and therefore lower customer care cost overall. On the IT spending we have introduced structural cost initiatives which will have an impact on the discontinuation of almost 50% of our IT applications which then should imply lower licensing cost, lower service cost and also lower cost with teams associated with IT spending.

On the operation side the robustness of this new network also are translating into lower levels of strict rules and all the levels of field operation costs as we also highlighted in our conference last week the invocation and technology conference.

On the CapEx side excluding Brazil, CapEx in the quarter declined by 9.5% year-over-year and in Portugal it declined by 11.7%. For 2012 and despite the full rollout of the 4G network and also the investments in our data center we are forecasting the total CapEx in Portugal should increase by approximately 100 million vis-à-vis is what we saw last year, the full year of 2011.

On the cash flow front excluding Brazil operating cash flow increased by 11% in the quarter to 287 million benefiting from a strong focus on profit stability and also from a normal working capital investment in the quarter.

With results of free cash flow it stood at 122 million in the quarter which includes also dividends received from oil and the other international assets. On the financing side we have been successful in the recent debt placements and debt issuance and we continue to improve our financial flexibility.

In 2012 upto now PT have issued and renewed debt amounting to 2.3 billion. The extension of the commercial paper program of 200 million, the extension of the credit facility that now stands at 800 million, the issuance of the 400 million retail bond placed last July and the issuance of the international euro bond 750 million already now in October.

This is cost of (inaudible) now stands at 4.2% net debt, on the gross debt stands at 4.4%. The average maturity of our debt after the bond issues is now six years.

Net debt excluding (inaudible) compact decreased by 110 million in the quarter and now amounts to 4.6 billion. The decline of 110 million is mainly due to the free cash flow generated in the quarter which then was slightly penalized by the dividends paid by our fully controlled subsidiaries to the minority shareholders.

PT after these issuances, PT is now fully funded until July 2016. Let me now hand over to our CEO, for his final comments and remarks with regards to his announcement.

Zeinal Bava

Okay, thank you Luis. Very quickly. So you sum up. With regard to the Portuguese business, what I would say that the we would expect trends to continue to improve in the corporate segment. As we said in the past, there was some lumpiness but I would say that with the broadening of the scope of services that we’re offering and also the increased efficiency at which we are beginning to install our new business customers, we believe that those trends are likely to improve.

With regard to the residential, we remain very confident that we have the best triple play offer in the market. We are leaders at the moment in terms of triple play. We believe we can further increase our leadership in the future by differentiating our services on the back of more local content, on the back of more interactive services and the fact that we have fiber. In the case of the personal segment, we would expect performance to remain volatile, although recharge in October up here encouraging compared to at least September and we will remain a very competitive as I've said in the past because we believe that we are not going to lose and we think the right strategy is not to lose market share.

Quite the contrary, we want to continue to make progress in the youth segment and we also would like to improve if you like the value proposition by investing more and more in convergence. So those of you that attended our technology day, remember the differences between bundling and convergence and we believe that with the investments that we have made in IT and with the fact that we have symmetrical technologies in fixed and mobile with FTTH in one hand and LT on the other which pretty much end of the year will cover more than 90% of all parts, we should be able to give people the best convergence offer ever and I believe that this will be probably an avenue that we will look to proceed but always reiterating the fact that we wish to compete on differentiation and on value proposition as opposed to price because we would like to generate value for our shareholders.

Costs of supplying in our company, goes without saying, you’ve seen us reduce costs again and again and again. This quarter we brought cost down another 5%. We believe that one has to take into account the fact your addressable cost base of this company has been declining. There are certain costs that we can do very little about. These are direct costs of the businesses that we do but in everything that is addressable, we will continue to maintain high level of discipline and as Luis mentioned to you, a few examples and as we mentioned in our tech day, we will continue to leverage technology, better IT system to structurally reduce cost in our company and continue to underpin the kinds of margins that we are posting which stand at about 44% right now.

Our African businesses continue to do pretty well. Our rest of the world businesses continue to do pretty well and as you know, they are all cash positive and they also pay dividends.

With regard to CapEx, in our domestic markets, 550 million is our guidance. We see no reason why we should not be able to do exactly the 550 million or thereabout and therefore we believe that as most of the modernization CapEx is done, that is a number that you should continue to work on as a guidance or as a formal guidance from Portugal Telecom.

Financial flexibility has improved a lot. In our company, we've done a number of debt issues which have gone extremely well, our bonds are all trading or at least the short term maturities, they are all trading at par or above par. That seems to indicate also the confidence that bond holders have in a way that we manage our balance sheet. But last but not the last, we remain also comfortable with the dividend of $0.325 and we also remain very confident about our ability to continue on a debt commitment that we have made to shareholders.

So without further delay, let me now answer any questions you may have and once again on behalf of my team and I, thank you very much for being on this call. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Paul Marsch with Berenberg Bank. Please go ahead.

Paul Marsch – Berenberg Bank

I have a couple of questions. On content costs, in Q4 I think you’re launching several new TP channels. Do you think those direct costs can continue to fall into Q4 with those channels being launched and into 2012? That's the first question. Second question, on enterprise looking into Q4 in 2013, do you expect the improvement. Are you talking there about a slower pace of decline year-over-year or could that revenue stream possibly even stabilize with those new contracts and customers beginning to come on the stream and for the corporate contracts, so those are the kind of contracts that come with up front margin pressure with the profitability of lower the beginning and increases through the life of the contract or would they have a more even profitability profile? Thanks.

Zeinal Bava

With regards to content costs, if you bear in mind that our Pay-TV customers have increased 22.9%. I would highlight the content costs year-to-date up about 2%. So you can see the kind of efficiency that we have been able to gain by surpassing the 800,000 – 850,000 mark that I referred to you a number of times when we were launching our Pay-TV service.

So against that backdrop, the investments that we are making in some of these new channels will continue to be marginal because we believe we still have room to grow, our Pay-TV customer base. In our Technology Day, we showed you the segmentation of the market and there are at least 2 million customers out there that have Pay-TV and that are not customers of mail. And therefore we believe that the investments that we’re making in some of this local investment not only will be a driver of penetration and our market share but also we believe will help us reduce churn to even in a lower levels or lower record levels than what we have currently.

With regards to the corporate customers I would say that initial challenge is to make it less negative than it has been. Our revenues have been declining 8%, 8 something percent in corporate. We would like to do certainly much, much better than that. Its early days to give you for example a clear view of what the potential of the cloud is or what the potential of for example consolidation of data centers or virtualization of platforms may mean for us next year.

We are investing as you know significant amounts of especially management time and expertise of our company in developing those services. I hope that when we announce the full year results in March, April next year, we should be able to give you more flavor, but I would say that today, we feel a lot more confident about our ability to reverse some of these declines that we've had in the corporate segment because some of these very large projects that we won a few quarters ago, we have been able to improve or we have been able to bring it on stream. With regards to the corporate segment, what I would say is the following and I would say the same with regards to the FTTH customers that they have in their mails service which is you have a divorce between economic impacts and financial impacts.

As you know, we take upfront costs when we gain some of these customers but as they are loyal customers and they have lower churn, they stay with us pretty long time. So with regards to the corporate customers, we are seeing more pressure and we have been seeing pressure from the market to give upfront discounts for longer term contracts as you know exist in the market. we have a pretty significantly especially in the large corporate segment and therefore we continue to believe that those contracts are very attractive contracts for us and they give a scale and then allow us to if you like reducing the tuition list because allow us to getting to new services where in the past we have not been able to compete in. so I would say that corporate less negative, corporate probably an opportunity that can be driven on the back of clouds, maybe March, April, I'll give you a new update and on content costs, we’re quite happy with the progress we've made so far.

Operator

Our next question comes from Robin Bienenstock with Sanford Bernstein. Please state your question.

Robin Bienenstock – Sanford Bernstein

I am just wondering you’ve talked a little bit about total telecom offers converging wireline and wireless and I am wondering, what you can do to avoid that creating incremental pricing pressure from Vodafone or anybody like that and how can you make those offers more attractive. And then secondly if you can just tell me whether you’re comfortable with your current level of leverage and whether you think you are in the right place or whether you think it would be more comfortable with a little bit less or more? Thanks.

Zeinal Bava

Let me take the second question first. You saw that we have brought our debt down by 110 million already and you’ve heard Luis also explain to you that we have maturities which are I would say very comfortable. So whilst we will continue to work to increase our financial flexibility, right now we’re very comfortable with how our balance sheet is looking and if we can continue to deleverage, we will continue to do so. Having said that, we believe there are certain investments that we need to do because they are attractive, they generate the kind of value that we believe we should pursue, therefore as a result of those investments, so we will take them.

But I would say that at the moment, with the kind of maturity we have and the costs that we have, we’re fairly happy and if we can, we will continue to deleverage. With regards to the convergence, we can offer as I mentioned a seamless experience fixed and mobile because we can offer you at home between 100 megabits per second and 400 megabits per second and we can offer 90% of the Portuguese population by year end with LTE with 100 to 150 megabits per second. So we can provide a unique agnostic, if you like, experience to our customers in terms of access and also services but if voice to data is relevant and we believe that we will be unique in this market when we do so.

The reason we have not yet launched it is because we believe that we need to have all our IT systems in place so that we can actually deliver an experience that is seamless as opposed to bundles which you see in the sector happening elsewhere in Europe. So I think we will have a unique value proposition. As you know, convergence, there’s a lot to be said. There aren't that many examples of success in our sector.

We believe it’s the right way to go about it because if you think about the personal segment and mobility, yes, it will be very important but yes, we also need to be able to derive a premium for that mobile and the way right now the competition is behaving, it is very difficult to justify that mobility premium and we hope that we can do that on the back of convergence and on the back of giving you the TV experience that you have at home also on the move anywhere at very attractive prices. Thank you.

Operator

Our next question comes from Jonathan Dann with Barclays Capital. Please state your question.

Jonathan Dann – Barclays Capital

It was two questions historically provided an update on your level of comfort with consensus. Can you just remind me would we still expect CapEx in 2013 to sort of reduce and a while back when we had separate fixed and mobile EBITDA, there was the ambition to have stable EBITDA probably I guess by now. I know you don't have to disclose it now, but have we hit the point where legacy fixed line EBITDA would have been stable in most of the pressure is NCRs, price pressuring mobile or is the economy or if different factors happens?

Zeinal Bava

With regards to CapEx, the consensus is about 550 million for 2012. As I said earlier, we are comfortable with that kind of CapEx level. If you look at what we have announced in the third quarter, I would say that is more or less where CapEx should be. As we also indicated in our Technology Day, we will continue to monetize our company but most of it is pretty much done so the focus will be mainly IT and on IT as we also said in our Technology Day, the biggest investment we need to make is in the CRM in mobile and then ultimately we have an investment to do in the billing system which frankly we don't think we will be doing in 2013. So I would expect that our CapEx for 2013 will be lower than the 550 off 2012.

So it will be lower than the 550 of 2012. So the CapEx will come down compared to this year and we believe that it is also worth highlighting that one-third of our CapEx is customer driven CapEx and that customer driven CapEx is what we like to say good CapEx because it’s a CapEx that we incur and on the other side we have a customer that is actually subscribing a service from Portugal Telecom. So next year, yes, certainly less than 550. We will be probably below 500, I think very likely that we will be below 500 next year.

With regard to the EBITDA of fixed mobile, yes we are not giving that kind of information because we also think it doesn’t make sense to think about it that way but you very rightly pointed out, most of the pressure that we are seeing is particularly on the mobile side of our business. 64% drop in mobile termination rates has a huge impact in EBITDA. Of course austerity measures have had an impact as well but I will repeat what I said earlier, I would add maybe a third aspect which is worth keeping at the back of your mind and its irrational behavior on the part of some competitors which frankly against this backdrop, will force us to reconsider CapEx plans because we need to generate returns for attractive for our shareholders. Thank you.

Operator

Our next question comes from Ivon Leal with BBVA. Please state your question.

Ivon Leal – BBVA

Couple of questions, first one on, I don't know if you could tell us how are you pricing or you plan to price your LT products, as what you’re having today and you wish you’d expect some kind of impact on 2013 mobile revenues. And the second one, I don't know if you could share with us what is the amount of your yearly subsidy costs and if you have to consider to reduce that our eliminate that going forward?

Zeinal Bava

With regard to mobile prices, frankly I would say that portions having most of the impacts in terms of the average revenue per user. I am leaving to one side interconnection revenues which were down substantially and that is something which is exogenous to our business but if you think about just customer revenues a lot of that impact has to do with the fact that there is a back book of customers that are migrating tariff plans. When you look at our average revenue, revenue per minute is coming down because usage continues to increase. Our minutes of usage were up about 6-7% and that has to do with the fact that people are getting more for the same or for less money than before.

With regards to subsidization, couple of things, first, we subsidize mainly smartphones. We subsidize mainly when people are migrating from pre to postpaid because we believe that postpaid value proposition is an attractive one both for our customers and for ourselves. Postpaid customers not only use more mobile phones, but they also do a lot more data usage. So more data usage and as you can imagine churn is a very important driver of the customer lifetime value in our business.

With regard to subscriber acquisition, and the tension costs, what I will say that when you look at across the board, Portugal Telecom, what you find is that we are significantly reducing our subscriber acquisition and tension costs. Subsidies are low in our market especially if you take the low end of the markets. The low end of the market in most cases doesn’t have subsidies. Subscriber acquisition and retention costs in our company were up about 5.5% but allow me to pull your attention to the fact that they stand at about 28.7 euros. Now this includes if you like subsidies, it includes marketing costs and it includes also commissions.

And if you take into account the fact that the handset prices that are selling now are higher than if you like feature phones or very basic phones that we used to do two to three years, it’s been a significant reduction already. So we’re quite happy with the current business model that we have. We have no intention of changing it and when you look at other markets, what you see is that this is the kind of model that would seem to make customers more loyal to your brand and to your company for longer periods. So ultimately lower churn and this is what we think is important that we continue to reduce in our business. Thank you.

Operator

Our next question comes from (inaudible) with Macquarie. Please state your question.

Unidentified Analyst

Just a quick question please on the competitive intensity. You talked about a rational behavior in the youth segment but can you just describe what's going on competitive wise in some of the other segments such as the business and the more adult areas. And secondly, looking back over the course of September, you mentioned the recharge rates were low in that. Have you tried to identify or can you work out why for example September was poor, October was better. Is there anything you’ve been able to glean from that evidence just to see what the consumer is thinking? Thank you.

Zeinal Bava

September was the month when a number of the initiatives in the new budget were being discussed in the market and as you can imagine, against that backdrop, business confidence levels and consumer confidence levels tend to have a direct impact. So once some of the details of the measures were made public and some of the details become more familiar to people, as you can imagine people started going back to what is their normal course of business. So I would say that October, we’re back to normal course of business and as a result, if you like the recharges have clearly been impacted by that.

Again, I will also highlight that on the back of what we saw in September, we've also been doing more heavy promotion to promote usage especially of minutes and also internet and therefore that also has to do with the fact that we've had to do some more heavy promotions to get the usage also increasing because we believe that there is still significant room for us to increase usage and if you like ARPU in our market, because as we showed to you in the past and we shared with some of you, today when you think telecom services cant select in 1.5% of the household income in Portugal. Whereas if you look at the top five preferences of services in any household in Portugal you will find that telecoms is one of the top five.

So we account for 20% of the preferences on average whilst we only command 1.2 to 1.5% of the household budget. So I believe that the efforts that Portugal Telecom has been making to broaden the services that we offer, not just of the residential segment, convergence on the other hand but also if you like corporate segment will end up increasing our share of wallet in the future.

With regard to irrational behavior in the youth segment, basically you will no doubt be familiar that recently a number of promotions have been launched by our direct competitors in this market, that if you like have reduced the prices of tariff plans by an addition 4 euros for example and that has a significant impact, whilst these are promotions that will last only until the end of January, they have a direct impact in ARPU. We believe that the way for us to live up to what our changing consumer trends in the market is not by lowering ARPU.

We believe that people at the moment already enjoy in Portugal among the lowest prices in mobile in Europe. If you look at our (inaudible) Telecom in mobile, currently stands at about 8.4 euros. So that's one of the lowest in Europe already. What we believe we need to do is take customers up the ladder in terms of getting them to use more data, to get them to use if you like their mobile phones, to do more things and to make it more important in their lives. This is why Portugal Telecom in its Tech Day showed a number of innovations that we have in the pipeline in order for us to live up to our (inaudible) means to them and it will improve the lives of the people. So therefore, our strategy is clearly aimed at making services that we offer to customers more relevant and we believe that by pushing aggressively some of these innovations we will achieve that and we believe that the industry should take a cue from this in the sense that we should be giving people more for the same price because prices in Portugal are already low enough.

But I'll repeat what I said earlier in my quote. We will be the most price competitive in this market because do not wish to lose market share in Portugal in any of our segments. We don't think that that's the way the industry should approach this. We believe we are a capital intensive industry. Our paybacks are getting longer and therefore as a result we prefer to compete based on differentiation and innovation because we would like to continue to invest and surprise our customers with more innovations in the future. Thank you.

Operator

Thank you. Our next question comes from James McKenzie with Fidentiis.

James McKenzie – Fidentiis

Just one quick question, in your press release you talk about a free cash flow which I presume is the domestic business plus dividends of 178 million in the first nine months of the year. How do I square that with a debt that has increased in the domestic business by 750 million euros? I would have expected the debt would have been more or less flat on that sort of basis.

Luis Pacheco

(Inaudible) is the dividends of Portugal Telecom based. But you have to also bear in mind, normally all the other items are in terms of interest and also taxes and PRBs but basically interest and that is are eagerly waited on the first half of the year. so the increase in net debts on the domestic side in our case is base is basically due to the dividends that we paid and during the course of the year and the higher weight of these interest paid on the first half of the year. And just coming back in to your question, what we increased in terms of net debt, 2 million and so probably (inaudible) and myself can go through your numbers and see where your 750 million is coming from.

James McKenzie – Fidentiis

And would you have an estimate of debt for year end? Do you expect a significant reduction in debt in the fourth quarter?

Zeinal Bava

Basically what we've seen in previous years is fairly that in the last quarter, the main components of debt reduction is normally working capital investment which is normally negative. But we should expect for this year is that we have these investment or realizing working capital probably around 100 million in this quarter.

James McKenzie – Fidentiis

Is the domestic working capital going to be significantly negative for the year, i.e. is there going to be a working capital absorptions here in Portugal.

Zeinal Bava

Up until now we have invested in the domestic business 150 million more or less give it back with 100 reduction which should be at the end of the year end at around 50.

Operator

Our final question comes from Nuno Matias with Espirito Santo. Please state your question.

Nuno Matias – Espirito Santo

Two questions just. One, do you have any exception on when you might begin your buyback or is this something only for next year? And secondly, regarding also cash flow generation. Do you still have any expectations regarding the dividends coming from Mongolia? Is it something for Q4 that we should expect?

Zeinal Bava

With regard to the buyback, as we indicated in our announcement of dividends that we would be looking to execute that over the next two years depending on market conditions and financial flexibility. So at this stage, I would say that our main focus is to ensure that we continue to honor the commitment that we've made on dividends that we’re very confident that we’ll be able to do which is the $0.325 that we have committed to.

And with regard to the buyback we have, if you like the necessary mandates both from our board and from our shareholders meeting to execute that as and when we think it’s appropriate. So we will always keep that option and as we've indicated that, it’s something that we wish to pursue over the next three year period. Thank you.

Operator

I'll turn the conference back to management for closing remarks.

Zeinal Bava

Thank you very much for being on this call and there are some questions debt that (inaudible) is more than happy to answer offline. So, please feel free to call him and once again on behalf of my team and I, thank you for being on this call and I also would very much like to thank every analyst and sales people, investors that came to our Technology Day and I also would like to say that you will find some of those materials also in our IR site. So please feel free to download them and if we can be helpful with any further information that could be of interest to you on the back of those presentations, then please feel free to call us at any time. For those of you that we’ll meet in Morgan Stanley, I hope to see you next week, if not, thank you very much and best wishes. Bye, bye.

Operator

This concludes this conference.

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