TIM Participacoes SA (NYSE:TSU) Q4 2015 Earnings Conference Call February 5, 2016 8:00 AM ET
Rogerio Tostes - Investor Relations Officer
Rodrigo Abreu - Chief Executive Officer
Pietro Labriola - Chief Operating Officer
Richard Devlin - UBS
Daniel Federle - Credit Suisse
Michel Morin - Morgan Stanley
Eric Guo - Gabelli Asset
Vera Rossi - Goldman Sachs
Jonathan Dann - RBC
Walter Piecyk - BTIG
Good morning, ladies and gentlemen and welcome to TIM Participacoes Fourth Quarter and Full Year 2015 Results Conference Call. We would like to inform you that this event is being recorded and all participants will be in a listen-only mode during the company’s presentation. There will be a replay for this call on the website. After TIM Participacoes remarks are completed, there will be a question-and-answer session for participants. At that time, further instructions will be given.
Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act 1996. Forward-looking statements are based on the beliefs and assumptions of TIM Participacoes’ management. They involve risks, uncertainties and assumptions, because they are related to future events and therefore depend on circumstances that may or may not occur in the future. Investors should understand that internal and external factors could also affect the future results of TIM Participacoes. [Operator Instructions]
Now, I will turn the conference over to the IRO, Mr. Rogerio Tostes. Please, Mr. Tostes, you may proceed.
Hello, everyone. Good morning and welcome to our results conference call. In this quarter, we are changing our dynamics for the conference call and try to optimize your time and also promote more space to interact with our top management. In that regard, our CEO, Mr. Rodrigo Abreu will present a brief overview on our release, on our results released last night and then we will move to Q&A session with the participation of our other top management. I would like to remind that the participants can make questions or ask through the Internet and also in the mobile webcast platform and also the IR app.
Now, I turn the floor to Mr. Rodrigo Abreu. Rodrigo, please.
Thank you, Rogerio. Good morning, everybody. Welcome to our call. And as mentioned, this is the call for the fourth quarter 2015, but mainly covering also the full year results 2015 given obviously all of the factors that occurred last year. And as Rogerio mentioned, I will not attain myself to all of the last level of details in each of the slides and rather try to present a comprehensive view of the most important information in each and at the end of the presentation, we will have a little bit more time for Q&A and we can discuss the details of the participation of the other participants of the management team.
So, let’s start and start from Page 2. And the first message without the question refers to the tough scenario faced in 2016 and how we have faced what we are calling this perfect storm of adverse conditions in the country and in the sector. Obviously, it’s not necessary to emphasize the tough macro situation, everybody knows about it, but it’s important at the same time to highlight what happened during the year which was a market deterioration with the progressive worsening of the situation in pretty much all of the key macro metrics that ended up impacting the sector.
But I would like to highlight even more what is it that the company did to react to the challenges. In all other crisis situations, there is a set of conventional actions such as cutting investment programs and doing dramatic cross-cutting and trying not to disrupt the existing offers to protect the revenue base. And our approach certainly was one of adopting very quick reaction measures on the short-term, but also without losing sight of the mid long-term goals. And as such, we are able to maintain what we call the appropriate infrastructure investments for data and for the future. And on the short-term, we did a complete change of the portfolio for all segments moving towards a new business model in particular on the prepaid market with the introduction of the off-net network, off-net calling.
Finally, obviously we had a keen attention to the structural yet selected efficiency programs to defend financial results in face of a tough short-term environment for revenues. And what were the results of this approach? On Page 3, we can start highlighting that it was indeed a challenging year from the standpoint of revenue and EBITDA results, but the efficiency actions we mentioned have protected that the operating margin of the company and we can see this by the sharp difference between the downsides on revenue, which ended up getting close to BRL900 million lower than the previous year and the EBITDA, which had a moderate impact compared to last year of just BRL100 million. This was the effect of several cost reduction measures and operating more efficiently in general. And in this way, we could execute the infrastructure investments planned for the year with a focus on 4G and it was possible to see the concrete results of those investments as we have achieved at the end of the year, the undisputed 4G coverage leadership.
Also the third front of action, as mentioned, was a complete renew of our portfolio of plans and offers for all segments, continuing to reposition teams as we had started a while ago. In order to do that, we eliminated the difference between off-net and on-net calls as I mentioned and created also more attractive data voice package bundles repositioning us to capture clients of higher value and thus defending our competitive position on the prepaid segment. Many people talked about our dependency from the community effect, given our large prepaid base and what we did effectively eliminates this dependency on the plan going forward.
What were the impacts of all of those changes, both in the company strategy as well as in the country and the sector scenario on the customer base and we can see this on the next page on Page 4 that those big changes actually has an impact on the behavior of the customer base. And it’s important to understand this, not only on the numbers, but what to expect from now on in terms of customer base behavior.
The first highlight on the customer base is that the overall customer base had a reduction for the first time both for the overall market as well as for team. In particular due to the reduction of the prepaid base with a search for greater efficiency and profitability by the part of all players and in our case, even with this large number of prepaid disconnections, we maintained the leadership on the prepaid share in addition to regaining the number two share on postpaid human, both in terms of our net adds as well as in the total share of what we call the postpaid human or those postpaid subscribers, excluding M2M and modems.
With this, with a new portfolio, we also started to position a change in the way we analyze our base with emphasis on our bundled packages and recurring payments instead of just looking at the pay as you go events that were highlighted in the past. And also, it’s interesting to see that all of those changes in the second half have allowed us to regain a growth in the so-called base of first SIM and those refer to all of the changes we did not only with the launch of the new portfolio at the end of the year, but also to several adjustments in offer that we started doing by June, July last year.
Obviously, it’s still too early to have a complete view of the results of the new portfolio, but on Page 5, we can have some first take on the new offers. The changes to the portfolio in the second half were many as I mentioned and I also like to mention the Liberty Top, the increase of the data allowance to 50 megabytes per day on the prepaid and the change of speeds with the launch of the new portfolio by the last days of October. As natural, a change of this order of magnitude takes some time to produce all of the expected results, but despite just the three full months after the launch, it’s possible already to make some comments on the initial results of the new plans.
First of all, all of the new plans had a significant increase in gross additions when compared to the run-rate pre-launch. In addition to the increase in gross additions, they all also presented an ARPU increase when compared to the existing base in all of the segments. Obviously, it’s important to mention that we are still in a period of stabilization of the offer and there are migrations between planned fluctuations in the numbers of the customer base, but we expect when we hit cruise speed, a positive effect on the customer base, on ARPU, and obviously in the results generated by the new offers as far as revenue growth.
The new offer also brought to us more quality to our customer acquisition and we can see this by the mobile number portability results, which after a long and historical series of negative results, where we lost more customers with number portability than gained customers from other operators, we turned positive immediately after the portfolio launch in November and have remained positive ever since against all of the other operators. It’s in addition to that, it’s also important to highlight that the expected impact in terms of costs of the new offer given that it presents off-net minutes, which end up increasing our interconnection costs are within expected not only in the overall off-net number of minutes that we have to pay as interconnection costs, but also in the relation of the total traffic incoming, outgoing. Obviously, the new offer also has an interesting take on data by bringing data to be a more integral part of all of the bundles that we offer.
And on the next page, we can see that beyond the new offers data continues to follow its path towards becoming the company’s largest share of revenues. It’s worth highlighting the great competitive position in 4G and in 3G share in defense given that they both represent already the vast majority of the customer base and it’s also important to highlight the return to growth of the data user penetration on the total active base in all segments, starting with the offer adjustments that I mentioned starting on the second half of last year.
With this, data revenues continues to grow at a fast pace. We also had an increasing percentage of the data revenues over total revenues and they were still in particular by the innovative revenues, which excluded of SMS have grown almost 40% year-after-year. Now SMS, which has declined in the last two years, represents less than 5% of the total revenues allowing the innovative revenues to resume a path of substantial growth.
Talking about data, obviously the competitive positioning in data is paramount of the future success and thus the emphasis on the infrastructure, which had a year of great results as we can see on Page 7. As mentioned at the beginning, we reached the coverage leadership in 4G both in population served as well as number of cities and this was possible because of the focus of the infrastructure investments and the use of the re-farming of the 1.8 gigahertz frequency, which allowed us to have a significant increase in the number of 4G sites, well ahead of competitors during 2015.
Interesting to note is that out of the 4G sites, we have the vast majority of them connected with fiber and talking about fiber, fiber continued to receive important investments with sizable growth of the installed base during the year allowing us to support the increase in data traffic growth, but not only 4G infrastructure grew and also on 3G, we added another 500 plus cities to the network reaching what we call a competitive 3G coverage. It’s important to highlight that all of this was done despite the FX headwinds and our team managed to expand the infrastructure above targets maintaining the same CapEx plan as originally devised.
In terms of quality, the good performance of the infrastructure keeps getting reflected also in the continued improvement of all of our quality metrics as can be seen on Page 8 and we continued to reach higher levels of speed and quality of connection as well as maintaining 100% of the states in the country within the range of Anatel’s main quality metrics. We also continued to be the least complain operator in consumer protection agencies in 2015.
Talking about the fixed business on Page 9, following the turnaround initiated in 2014, the fixed business presented excellent results in 2015, both in residential as well as in corporate services with a total revenue growth of close to 15% in the year. In residential, on the broadband side, the Live TIM customer base almost doubled, while increasing ARPU substantially as well more than 10% compared to 2014. In the corporate segment, sales were 25% higher than in 2014 and helped to make the whole fixed segment grow. And finally, it’s also interesting to notice that the improvement on the fixed voice services. They also deserve mention as they returned to growth with a marked increase of the share in the residential voice market despite the market drop.
In terms of impact on revenues on Page 10, we can see that the changing revenue patterns continued during the year with a reduction in incoming and obviously the incoming also will be a less impactful to the total revenues as we move forward as can be seen by the reduction of the MTR impact on overall revenues, which were at approximately 8% in the fourth quarter, but also it’s interesting to highlight during the year, the stability of our customer generated revenues. And in addition to that, when we look at total revenues, it’s important to notice that the total revenues declined, because of a marked decline in handset sales following a change in our strategy to focus handsets on value customers with smaller volumes. It’s always good to remember that the handset revenues in our case are EBITDA neutral and thus its reduction does not bring any significant impact to margins. As already mentioned, data follows its growth path and should overtake voice revenues by sometime around 2016 and this is the way we see a continuation of the revenue patterns that started a while ago. Obviously, to protect the financial results in terms of the short-term revenue challenges, we continue to invest heavily on efficiency.
And on Page 11, we can see that the focus on the structural efficiency program continues bringing significant results in 2015. The total OpEx continued to decline in the last quarter and in the year closing 2015 at minus 7% with efficiency across the board in virtually all areas. It’s also important to notice that when we look at costs, naturally there are elements that would make costs increase as the network expands and also with the impact of inflation. In our case, those cost increases were more than compensated by the efficiency initiatives of which close to BRL350 million are recurring efficiencies, helping us to stay on track with a BRL1 billion plan announced during the second quarter of 2015.
Going to margin on Page 12, all of the actions helped us expand our EBITDA margin in 2015 to 31% of total revenues or 36% of service revenues, an all-time high for the company. Helping that, the percentage of data on revenues and a reduction of the MTR inputs contributed to the margin increase. The balance sheet also continues to be extremely solid with a very low net debt to EBITDA ratio and our financial flexibility was preserved also by the process of selling our towers, which contributed to a cash position and the increase in overall net profits during 2015 despite the lower recurring results in a period of investments and revenue transition. To support our investment program, the company will propose to distribute the minimum level of dividends to the next shareholders assembly at 25% of the adjusted net profit.
As final comment, even in the face of what we call the perfect storm scenario in 2015, we believe that our strong fundamentals and the focus on the long-term helps to reduce the impact and we have good indicators to show in multiple fronts as highlighted throughout the presentation. In 2016, we will maintain our focus on developing the business further based on the three pillars of the infrastructure evolution, the stabilization and success of the new portfolio and the actions of our efficiency plans. On February 16, we will announce our 2016 to 2018 industrial plan update and a joint event with Telecom Italia in London.
In summary, focus on the structural mid long-term actions and intense works on short-term actions and a confidence both in our vision and in our capacity to execute. So, that’s the initial introduction. Thank you for being with us and let’s go straight to the Q&A session.
[Operator Instructions] The first question comes from Richard Devlin, UBS.
Hi, good morning everyone. Thanks for taking the question. Just a question firstly on data ARPU growth which looks like it decelerated sequentially in Q4, just wondering if you can give us some detail for that? You obviously got some macro pressure, but would also assume that you continue to benefit from the voice and text substitution trends or maybe if there is a lower data ARPU profile with the new plans. So anything to sort of help us understand the data ARPU growth in Q4 that would be really helpful? And then secondly, just a quick question, given that the sharp increases in energy prices, I am just wondering if you can give us what percentage of your total operating expense is represented by energy costs. Any help on those questions would be terrific. Thank you. Thank you all.
Okay, thank you Richard. Well, talking about data ARPU, we continue to observe a growth in data ARPU even though slightly smaller than the growth in the past and this is in line with the data revenue. I would like to call your attention to three things here very shortly. The first one, you mentioned Brazil, which is obviously the impact of a tougher macro in the fourth quarter and this without the question produced the impacts of a slightly less aggressive growth in all fronts, including data, even though the growth continues to be significant, both as far as revenues and as far as ARPU. The second one is that we also see a change in the speed of the penetration of the data users as far as our percentage of our total base and we see this percentage increasing back again at the end of the year after all of the changes that we did. So, when you increase the percentage of data users, it’s natural that it takes some time for the revenue to accelerate again and we expect that this will help us again sustain the results on the increase in data revenues both ARPU as well as revenues and in particular with the impact of the higher ARPUs of the new plan as far as all of the offers go. In this case, it’s also interesting to highlight that the new plans have bundles more than anything. And so every time more it’s going to be important to highlight the ARPU of the overall consumption not necessarily of each individual service as I have mentioned, but obviously we still expect data to continue growing at a healthy pace.
And the last comment on the first question is that obviously in the fourth quarter 2014, we had a very tough comps, because we had a very strong fourth quarter in 2014 and so the comps actually don’t help a lot when you are reading all of the numbers, but we continue to forecast a substantial growth in the data ARPU and this should continue as we stabilize the base with the new portfolio as well.
As far as the energy prices, obviously we know that energy prices have an impact on the OpEx and they went up by a significant amount last year, but the overall impact of energy alone is relatively small in the range of the low single-digits, but I would like to highlight what is it that we are doing to compensate for that and this has to do with a few actions – structural actions on the infrastructure side. The first one is on technological innovation. So, every time more we are resorting to a more efficient energy approaches in our sales, in our base stations, in particular with introduction of models such as what we call our Biosite, which has reduced energy consumption and with the usage of small cells, which likewise have a reduced energy consumption.
The second one is a structural agreement in terms of increasing the amount of sharing that we do. So, our rent sharing agreement, which were expanded last year with the inclusion of Vivo on the 4G and with the signature of several rent sharing agreements also on 3G helped us to reduce the impact of the energy cost significantly. Obviously, there is two factors helping increase cost in terms of energy. One, our prices, the other one is quantity and we do have to remember that we continued to grow our network at a substantial pace and we will continue doing this, this year. So, that’s why it’s important to face this impact. We are pretty much focusing on all of the actions we can possibly take to reduce the impact on the network elements, which will grow on average more than 25% from one year to the next both from last year to 2015 and from 2015 to 2016.
Okay. Thanks very much, Rodrigo. Understood. Very much appreciated with that color. Thank you.
Thank you, Richard.
The next question comes from Daniel Federle, Credit Suisse.
Okay, thank you very much. Good morning, everybody. My first question is related to, TIM is not a concession in Brazil, but I would like to see if you see any opportunity for TIM from the new fixed line model that is expected to be approved probably this year. And my second question is that consider that eventually all the other players who launch also on-net and off-net flat fees plans, which is the main competitive advantage of TIM today?
Thank you, Daniel. Good morning and straight to your two questions. The first one as you mentioned we are not a concession. And fortunately, we are not subject to many of the limitations that are inherent to this model today after the market has evolved to a market more based on frequencies and fiber and data rather than copper and voice, but obviously, we do see the changes in concession as positive for the whole industry, because we need to help the industry with the capacity to invest with a capacity to produce results. And obviously, it’s not healthy to have a regulation that doesn’t allow for that.
As far as specific opportunities for us, I would say that more than just looking at what will be possible in the future it’s interesting to look at what’s possible today and obviously, it’s still a very small number. But one of the things we did was we tried to accelerate our sales on the fixed voice environment, because we know that the concessionaries have some exposure to what we call voice-only customers and legacy voice-only customers, where the fixed voice has a relatively high price and can be attacked as far as voice on the fixed mobile substitution front. So, we started doing that. We see some space to regain share there. And we have done exactly that both with our TIM fixed product, but as well as just with sheer voice.
As far as the second question on the on-net, off-net competitiveness versus competitors, obviously there are several things to consider. The first one is in terms of who moves first and who is able to position better. We have seen this in the past Daniel and this is not the first time that TIM changed the dynamics in the market with a new business model in terms of the offer and it’s super important to highlight that every time we did this correctly, we ended up obtaining a much superior positioning in terms of recognition of the customers as far as the convenience and the attractiveness of the offer. Two examples for you, the first one was on the per call, obviously everybody copied the per call model after a while, but that theme started to be associated with the main operator that offered accessible attractive per call charges, because we were the first one to do with. And so we got associated with that.
A second one, much more recent in this, is the introduction of the zero-rating on specific services, which are now changing, but when we did that with WhatsApp after a while, this was copied, but TIM still got recognized as being the primary provider if you want to have this type of service even after all of the competitors have changed. So, there is a lot going about credibility on the offers as far as transparency and innovation and TIM has been traditionally long known as an innovator as one that operated – that can produce innovation and also for the transparency of our offers. We don’t want things, which are hard to understand, which are full of gimmicks and that’s exactly the purpose of the new off-net offers. So, we have first mover advantage. We also want to establish ourselves as a very convenient choice for concentrating traffic. And so we believe that indeed even if everybody ends up copying, there is an advantage of moving first.
When we look at the current competitive scenario, we can see that one of the players already did it. They copied us. We don’t see a lot of impact so far especially because it was a partial copy copying just some elements of our offer. The market leader did not copy and so as a different positioning and we believe it’s going to still take a while and then we have players that have not made up their mind in terms of what they want to do. So, we can see that there is a space for a clear position and we are taking it. We are occupying it. The second thing is that obviously the differentiation comes not only with the offer and the positioning, but also on what is it that you are able to offer. And now one of the things we have invested tremendously and have highlighted tremendously in the recent months is our infrastructure investments, in particular on 4G. And on 4G, we end the year with the largest 4G coverage and this is a significant differential for anybody that wants to select the new plan given all of the market reshuffle in terms of offers from now on. So we do have 200 more cities than the second player. We do have more population coverage. We are using the 1.8 frequency to be able to offer better 4G indoor coverage in the areas in which we cover. And as such, this we will be used as a differentiator going forward even knowing that in the mid to long-term normally the infrastructure of all the key players that have the capacity to invest end up converting to similar level.
So we do have some short-term advantages. We are exploring some of the long-term advantages such as the positioning the image. And also we have a speed of reaction, which honestly every time we need to do something even if it’s both, we will end up doing it and positioning ourselves for the future. We don’t have the dependency of the community model anymore. This was a big concern. Everybody pointed out that the community model was a weak spot that had to be addressed. We initially addressed it with the data offers. Now we are addressing it with the inclusion of the off-net. And so it is, in fact a game of positioning.
Thank you very much.
The next question comes from Michel Morin, Morgan Stanley.
Yes. Good morning, so a couple of things Rodrigo, first on the handset sales, it looks like your cost of goods sold was very, very low. So I just wanted to understand a little bit better, what is behind that, it’s we calculate $5 per gross add, I mean I know it’s not perhaps the most relevant metric, but it’s very, very different from what we have seen in the past, so I was wondering if there was some reversal of prior position, perhaps some written down inventory that you sold at a significant profit. So if you can explain what happened there. And then secondly, something similar with respect to FISTEL, there were some significant disconnections of prepaid subscribers in the fourth quarter and it’s not clear to me how during the year perhaps you are provisioning for FISTEL and whether or not in the fourth quarter, you have to reverse the provision and again may be that is a little bit of a one-time adjustments in the fourth quarter. So, if you can walk us through those two things just to better understand how we need to think about this going forward? Thank you.
Thank you, Michel and good morning. So on the handset, let me call your attention that in terms of handsets, given the dynamics of how handsets come in, go out are a page for accounted for, it’s important to have a look on the handsets always with the full year results in mind. And when we look at the full year results, you see that the full year results point out to something that we have always mentioned, which is that the handsets are relatively neutral in terms of EBITDA. We had handset sales in 2015 of BRL1.8 billion versus a product margin of minus BRL28 million, meaning that what we are talking about is just logistics costs here and there as to run the business and so it’s a substantially EBITDA neutral operation.
In the fourth quarter, the numbers you see, they refer exactly to how we ended up accounting for costs and ins and outs in logistics and movements of the handsets. So it should not be interpreted as a one-off event, it’s just an organic representation of the operation of handsets. During the year that ended up having a slightly more positive impact on Q4, but it’s important to look at the full year numbers for the handsets and you see that we are exactly where we expect it to be. In terms of FISTEL, two things, the first is that it’s relatively complex and not everybody understands that actually, it’s a very convoluted process to understand how fixed sale credits are paid for, accounted for and can be used. Starting with the differentiation between the installation FISTEL versus the maintenance FISTEL, so we have obviously 13 versus the 26, 13 for the maintenance, 26 for the installation. And they produce results, which have to be accounted for regarding your customer base, both in terms of net adds on a monthly basis or as far as the total base on an annual basis.
Obviously, when you add subscribers and then you start to reduce the subscribers, you have an interesting effect, which is you have paid for FISTEL users in terms of the activation fee, which in the end, if your overall base will go down, we will not be there next year. So producing an effect which obviously, if you clean up your base, if you have lower users, in the next year, you are going to pay less maintenance FISTEL. But at the same time because you ended up paying for an increase for net adds or increasing base FISTEL, when you have positive net add, the moment you have negative net add, you start to accumulate what we call credit of the usage of FISTEL and those credits can be used in two ways. One, if you can request that those credits be accounted for and then you pay BRL26, but you are going to be able to recover 50% of those credits if you just give up the credits to activate future users or you can maintain those credits, unused credits to use for new activations in case you go back to having positive net adds.
And so it’s a very, very complex process. But the ultimate effect of that as far as your question about one-off in fourth quarter versus what can happen going forward, I would say that in the fourth quarter because we have reduced the base with a larger number than usual, we did have a partial impact that could be considered as an effect in Q4, but we maintained a significant amount of credits as well for future usage and so in the future, we are going to have a base that will pay less FISTEL and some credits for you to use going forward. Obviously, we are not opening up all of those numbers because of a competitive strategy. But the most important effect of that Michel, the core of your question, I believe is that the savings in FISTEL due to the reduction of the customer base becomes organic from now on, because we have to account for the averages of activation in customer base and they become organic. It’s not a one-off that should be considered as the saving just in Q4.
Great. Thank you very much Rodrigo.
You are welcome.
The next question comes from Eric Guo, Gabelli Asset.
Hi guys, how is it going?
Hi, there, good morning Eric.
Hi. So I just wanted to see if you guys can provide some additional color on how much of the network in interconnection decline was driven by the MTR reduction and just how you guys look at – going into 2016, how you guys look at the positive impact of the MTR decline on interconnection costs and potentially offset by increase of network traffic associated with the new offerings?
Thank you, Eric. So just a few comments and then we can give you just some color in terms of our numbers. In terms of comments, first you are correct, there are two effects. Actually there are three effects of the interconnection costs going forward and you mentioned two of those. The first one is regarding the reduction of the interconnection cost because of the MTR decline. And this has been going on for a while and the numbers were important, were obviously very significant as far as 2015 numbers. And they will continue being significant in 2016. So when we look at an MTR cost reduction of 37%, this has a corresponding impact on lowering our interconnection costs in cruise mode. And this will continue to occur, so as an important part of the efficiency initiatives and efficiency savings, even though this one is generated by our regulatory measure, not by our direct action, is the reduction of the interconnection cost. Let’s say, you are completely right, this will go on.
The second one is the off-net impact and we expected a level of increase in the off-net traffic, but with two observations. The first one is that we expected this to be compensated partially by an increase in the incoming traffic as well. So when we increase the incoming traffic, we end up minimizing a little bit of the increase of the new off-net offers. And as such, we had created the business plan where the two effects end up not being completely compensated, but end up fitting the bill as far as how many more customers and how much more ARPU we can generate with the new offer. And this is completely under control. So moving forward, this impact given that at the moment zero, the heavy users tend to adopt it and so with the higher percentage of off-net minutes, moving forward we believe that there is an initial impact which we are seeing now and this will tend to get reduced. But there is a third impact as well as far as interconnection costs, which have to do with the way we ended up presenting our offers and how the competition reacts, because if competition reacts, obviously there will be a change in the incoming with a trend for us to receive more incoming traffic. So it’s not just dependent on what we are doing, but it’s depending on the competitive environment. So overall, we continued to see that the balance of the incoming versus off-net outgoing costs we will continue to be positive overall, meaning that we will have less costs of interconnection given what we are seeing right now.
Okay, that was helpful. Thank you. And just quick – just another quick question, so the timing of [indiscernible] efficiency plan, is it okay to assume that you guys are going to kind of hit another 30%, 35% in 2016 or is it going to be more back end loaded in 2017?
No, you are right. You are correct in assuming that we expect to hit yet another 30%, 35% on those efficiencies during 2016. Obviously, we have several types of efficiencies as I mentioned. Some of them are one-off and so they apply just to the year as we do something extraordinary. Some of them and those are the most important ones are recurring efficiencies, especially when we change processes or when we introduce the usage of our own infrastructure does reduce the costs or when we optimize some efficiencies in terms of outsourcing, it seems like that and they become recurring impact. The recurring impact, those that we control is what we expect we will be able to achieve another 30% to 35% during 2016. Obviously, in addition to that, there is all the volume associated cost impact that can go down. For instance, as far as costs of the interconnection that we just mentioned. It’s important to mention, when we look at the overall number that the initiatives that we have when we look at ‘16, they tend to be in the same range of BRL300 million to BRL400 million recurring costs savings when compared to what we were doing the year before. But it’s also important to mention something and we tried to illustrate that when we talked about the costs and the efficiency on Page 11, which is the following.
You have to remember that when we look at costs, there is impact to grow costs in two particular areas. One is on the infrastructure because of volumes, because of quantity, we are growing our network close to 25% year-over-year as far as number of sites or number of elements in the network. And obviously those carry energy costs, those carry site leasing costs, those carry maintenance costs and as such they should bring a cost increase overall in terms of OpEx. The second one is inflation. Obviously, inflation continues to be a factor even though we expect a smaller number of inflation for 2016. It weighs heavily on personnel costs, it weighs on pretty much all of the third party services that depend heavily on our labor and as such we do have an impact on inflation. What we are doing with our cost efficiencies is to offset those results so that we can have a balanced financial result. So you have costs going up on one side and you have costs going down on the other side. And obviously we mentioned the interconnection effect of costs and we mentioned also the network effect of costs, but we are looking at that in pretty much all of the area. We are looking at how to restructure our commissions, how to look at internal processes, how to improve outsourcing, how to look at real estate costs and just to give you an idea in a few months, we should relocate to a new headquarters reducing significantly the recurring monthly costs in terms of real estate and things like that. We have approached a zero base budget process from last year to this year as far as creating our budget. We continued to our work on the zero base budget in pretty much all of the areas. And given all of the numbers that we have so far as far as budgets, we believe we are on track as you mentioned to be exactly in line with the plan that we announced last year.
Okay, great. Thank you, guys. That was very helpful.
Thank you, Eric.
[Operator Instructions] Our next question comes from Vera Rossi, Goldman Sachs.
Thank you. Could you talk about how TSU and Oi are sharing the 4G network and with the re-farming of your 1,800 megahertz, if you continued to plan to share network with Oi? Thank you.
Hi Vera, good morning. Thank you for the question. And well, first let’s understand what we are doing on the 4G rent sharing. We continue to have the 4G rent sharing agreement with Oi. And this has been very successful one. No operating issues with a significant positive impact as far as reducing OpEx of our rent, but it’s important to highlight one thing, which is that the rent sharing agreement is exclusively for the 2.5 frequency. We are not doing any rent sharing as far as 1.8 gigahertz is concerned. And this is important, why, because in the case of the 1.8 gigahertz, all of the 1.8 gigahertz re-farming investments and results are exclusive to TIM. So, we are activating 1.8 on our own sites and this allows us a short-term competitive advantage. It’s not being shared with any other operator.
On the 4G rent sharing agreement, there is yet another important fact to mention which is that in addition to Oi, at the end of last year, we also signed an agreement to include Vivo in the rent sharing agreement. This was already approved both by Anatel and by [indiscernible] and so for the next wave of smaller cities, we will have a rent sharing agreement with the three players us, Oi and Vivo. And as far as the 1.8, we will continue implementing 1.8. There is still a fair amount of 1.8 sites to be re-farmed because if you remember what we do with the 1.8 is that we use existing 2G 1.8 sites and simply replace some line cards on the radio, so there is no need to change the base station. There is no need to add the new base station. There is no need to change the antennas or the radios. And so by doing this, it’s a very, very CapEx efficient process of adding 4G coverage. And so we will continue to do that. We believe because we do have a substantial amount of our 1.8 frequencies that can be used for re-farming, we have a short-term advantage that we are using to the fullest.
Okay. And a follow-up question, when you look at your expansion in 4G in your current coverage, do you plan to have most of your 4G coverage in 1.8 gigahertz or in the other frequency that you are sharing with the other companies?
Well, let’s remember that in terms of coverage, it’s important to understand that 4G coverage is a combination of different frequencies. On the 2.5, there is a minimum mandatory coverage and this minimum mandatory coverage obviously is complied with, but in addition to the minimum mandatory coverage, the 2.5 is an interesting frequency for capacity, because it has high capacity. So if you have a large number of sites such as in the major metro areas, we do have a significant number of sites. And this is possible because of the rent sharing. So, we have more sites in 4G 2.5 than pretty much everybody else because it’s good for capacity. In addition to that, when we look at the 1.8, the 1.8 is better for indoor coverage. So depending on the regions, obviously the 1.8 will be extensively used to provide better quality coverage in addition to the capacity and we can do that with the 1.8 in pretty much the entire country.
In addition to that, it’s interesting to note is that there will be areas where there is no obligation yet in implementing 2.5 that we can offer the 1.8 and have 1.8 coverage only and this will be an even better competitive differentiator, because there is no obligation of 2.5. As we have the 1.8, we can do the re-farming and does have some sites in just 1.8. And finally, we know that in a few years starting this year, but then being completed by 2018, we are going to have also the 700s to be able to cover the entire country with the 4G. So in the end, we are going to have the three frequencies used to have optimal 4G coverage and starting already this year and I mean in the first half already, we will start offering carrier aggregation to increase the speeds of 4G. So, as we do have 10 megahertz on the 4G, 2.5, we will use carrier aggregation between 2.5 and 1.8 and thus we will substantially be able to increase the speeds of our 4G service in particular for high-end users who have the top-end models of 4G handsets, but remembering that because carrier aggregation has been developed over the last several years, it will be every time more a common feature on even mid-tier 4G handsets. So, we plan to use that to the fullest as well.
Okay, thank you.
Our next question comes from Jonathan Dann, RBC.
Hi, there. I have got two questions. One is just looking at the prepaid base, can you remind us what the inactivity policy is and give us some sort of sense of how many customers are sort of very inactive. Is it 5 million, 10 million people who are not using their phone in sort of 80, 90 days? And then secondly, I think you have mentioned sort of perhaps not re-launching the brand, but perhaps some kind of re-launch toward a more data-centric brand or accelerating the brand. Can you give us some idea of what the plans are to basically accelerate the data strategy?
Absolutely, Jonathan. Good morning. So, as far as the first question, let’s remember that the fact of what is the percentage of active users on the base, there is only one official parameter for that and this is Anatel’s parameter of having to comply with at least 90 days before the last top up, so you are able to disconnect a customer. And this is the only parameter that has to be obeyed. Obviously, every operator will have variations here and there of those parameters and it’s a competitive information that every carrier is keeping to itself of how to manage those numbers. And in the past, we can say that there was a lot more flexibility in those numbers, why? Because having a large community was paramount because of the community effect. What we did was effectively break the cycle and because of breaking the cycle, not only we are able to be more strict in being much, much closer to this parameter, but also to do that at no expense to our strategy because now as most of our plans already have the off-net, we are not dependent on having a large customer base on the prepaid.
We also have to say that the consolidation of the SIM cards both because of the macro and because of the usage of messaging has accelerated in the past, what we call the silent base. And thus, it was possible to do this much, much stronger process of base cleanup at the end of the year. When we look at the current base numbers, I can say that our current base numbers are very, very close to what we consider an active customer base. And thus what we said in Slide 4 is that we have a much better representation of our customer base right now, even though given the process of the consolidation of SIM cards, we are to see how much more this will accelerate for the entire market as far as reducing the number of prepaid users, but I believe that throughout that I heard what we were saying for a while now, we have been saying this pretty much since the beginning of the year, we expected that at some point the prepaid base would be reduced significantly and this is exactly what happened.
So right now, I believe we are very comfortable with the way we are handling this. We are managing our view of the customer base and so we can reaccelerate the penetration of data. We can reaccelerate the consumption specially based on bundles and this goes to the second question Jonathan on the repositioning. Obviously, there is several ways to reposition the brand. And the first and foremost thing we had to do and that’s why so much emphasis on what we did on infrastructure last year was to really make sure we had a very competitive data infrastructure and that’s exactly what we have been doing. That’s why we have increased the CapEx, that’s why we have invested so much in achieving 4G leadership. And as I mentioned, that’s why we also invested this year still significant amount of CapEx on 3G. So, we talked a lot about 4G, but on 3G, we added 500 plus CDs in 3G coverage. So, we believe we have a very competitive data network and data infrastructure today and this is important for the repositioning.
On the second part, obviously the key thing is to reposition the brand in terms of quality, but also as far as how attractive and how convenient our network and our offers are for what we call the higher value users. With prepaid being consolidated, we are going to see a phenomenon of even on the prepaid, prepaid users having higher value in some cases because of the recurring offers, because of the consolidation of the spending. And as such, we have tried to make our data plus voice bundles to look attractive for pretty much the three segments with a complete restructuring of the portfolio. So, you will see that not only we added the off-net and that was a very important feature of adding the off-net on the prepaid and increasing the number of minutes on post and Controle, but also we increased and rationalized the number of megabytes in each of the plans and now have very attractive bundled offers. Obviously as far as data, in addition to pushing for the data quality, which we have been doing, we are also doing a number of actions on the value-added services as far as positioning interesting offers for the value-added services, so we can regain, resume the growth in VAS as well.
And when I say VAS, I exclude data connectivity have decelerated a little bit during last year, while we were doing a reshuffling of the portfolio, but we expect this to accelerate as well again. And as such is a comprehensive movement, is a mix of how you present the offers of the value of the bundles, of the quality of your network, of how you position yourself and obviously how you communicate. We are going through a period of significant change in our communication. We are being more emphatic on the quality of our network, on our positioning as a value player and we will continue doing that during the year, Jonathan.
Okay, excellent. Can I ask a follow-on? The charts on Page 5 of port-in, has that trend continued in January?
Yes. Well, obviously it’s still too early to tell about January, because not all of the official numbers are out, but our trend of port-in on mobile number portability has continued ever since the launch of the new portfolio. So, we have been having a very consistent positive performance since the launch of the portfolio. And the same holds true for the rate at which we have increased our gross additions. So, obviously as I mentioned on the presentation, it’s very early, but we are relatively happy with how the first offers were received as far as the attractiveness, as far as the commercial traction and in particular as far as the quality of the port-ins.
Still on Page 5, if you take a look at the numbers, there is one number which I didn’t highlight, but it maybe worth highlighting which is what is the percentage of the gross additions that comes with the port-in. And when we look at that, in January last year, this percentage was just 9%. So, of all of the growth sites we had, only 9% came out with the number portability on the postpaid granted. When we look at what happened in December, this number shot up to 20%. So, it’s more than doubling the percentage of gross adds that come with number portability and this is a very good indicator of the quality of the acquisition as well. So, because right now, obviously it’s always a great thing to have a high number of gross adds, which is even more important than that to have a quality of those gross adds both in terms of the ARPU as well as in terms of a customer that comes with the intention of selecting you as the preferred operator. And going forward, we still have to wait a little bit for the stabilization between all of the migrations between plans to be able to get into what we call cruise mode with all of the positive impact from the new offer. There is still a lot to happen in the first six months of the year.
Thank you very much.
Our next question comes from Walter Piecyk, BTIG.
Hey, Rodrigo. How are you doing? Just wanted to talk about ARPU, just in general, I mean, it looks like the declines are starting to moderate for a number of different reasons. I know that someone talked about deceleration of data in overall. And when you think about – first can you update us on the mix of phones that are LTE in the quarter or at the end of the year, how do you expect that trend, how the ARPU is different for those phones, for those smartphones versus your regular smartphones? And then just with the overall, I know it sounds like seven or eight questions, but it’s basically just talking about ARPU, how the MTR, which should have impacted in Q1 versus this kind of shift that’s going on to LTE smartphones? Thanks.
Hi, good morning, Walter. Thanks for the questions. Starting with the ARPU, indeed the ARPUs are trending a little bit better and this is due to several factors actually not but just the one single explanation for that. The first one is obviously the increase in the quality of the user base. When we start to be more selective, when we start to fix a number for our criteria of disconnection that ends up leaving with us just the better clients, when we start reviewing our policies of the quality in terms of acquisition, this all tends to improve the ARPU a little bit. The second thing goes towards the new portfolio and obviously, it’s still again too early, the numbers are still relatively small. And when we look at what goes on with the new portfolio, the one thing to highlight is that if you compare all of the offers on the new portfolio with the offers on the old portfolio, the three segments have higher ARPUs. So, on the prepaid, our new portfolio has a base offer of BRL7 recurring per week. When you add the recurring effect, the BRL7 and then there is a second offer of BRL10, which is very popular, it’s higher ARPU than in the past.
When we look at the Controle, the base offer on the Controle is a base offer of BRL50 versus the base offer of the BRL32 in the previous offer. And so it’s a significant ARPU uplift as well on the new plan and so both in the prepaid as well as in the Controle, we have double-digit increase in the ARPU outgoing of the new offers compared to the base. Obviously, it takes a while for this effect to fully materialize, because the new offer is still penetrating the base as we move forward. On the postpaid, the new offers also have a higher ARPU on average given the combination of all the three main plans on the new offer on the postpaid 99, 139 and 169, but it’s a smaller ARPU uplift given that’s the main reason for the changes in the postpaid portfolio, the pure postpaid portfolio is not necessarily just to increase ARPU, but it’s to become more attractive and to increase the customer base on postpaid going forward. So, obviously all of the other factors of migrations up and down accounted for. So, we do see an ARPU uplift in all three on new components of our three segments of our portfolio. So, this is the second one.
But Rodrigo, when you at look at Q4, the uplift was a little bit more this year, but you always tend to have this Q1 sequential decline obviously because of the MTR cuts. If some of these uplift factors that you are citing plus the mix of LTE, is it going to help to mitigate some of the typical 6%, 7% sequential decline that we typically see in Q1?
Yes, obviously, when I was talking about all of the ARPU comparisons, I was talking about outgoing ARPU, generated ARPU, not considering the MTR. So, the MTRs are right. The MTRs produce some impact on the total ARPU especially with the minus 40% cuts, but we have to remember that every year this decline, which you correctly point out in the first quarter occurs because of the reduction of the MTR is going to have a smaller impact as compared to the previous year because of the reduction of the MTR as a percentage of revenues. And so, as a percentage of revenue….
But you are seeing a better sequential uplift, you already are seeing a better sequential uplift [indiscernible] factors you talked about?
Absolutely, it will most likely be a more positive sequential uplift in terms of ARPU, with all of the considerations that we are going to have the MTR declines. On the second question, on the LTE handsets what we are seeing right now, obviously the uplift in terms of penetration on the base is occurring very, very rapidly. I would say that out of our sales today, we already account with virtually 100% of the new sales as LTE. We have removed the old phones from our portfolio, so we don’t have any phones which are not LTE in our portfolio going forward. Eventually, there maybe smaller quantities of stock, which are still 3G, but those will very, very rapidly go away. And so 100% of our new sales will be LTE as far as portfolio goes.
The second one is that on the customer base, we already have 12% of the customer base with the LTE handsets and this is increasing rapidly. Obviously, it’s significantly different as far as the three segments. On the postpaid, it ranges already close to 25% to 30%. On the Controle, it ranges between 10% and 16%. And on the prepaid, it’s approaching the 10% between 7% and 10% of the customer base. So, the numbers are very significant and they are advancing very rapidly. And as far as ARPU differences, there is an ARPU difference in particular because of the bold differences and the extra bundle data consumption or the higher packages and the numbers that we have highlighted in the past continues to hold through. On average, a 4G user is consuming almost three times as much data than a 3G user. So right now, the goals are in the range of 400 to 450 megabytes for a typical 3G user and goes up to 1.1 to 1.2 gig on a 4G user. And this has a direct correspondence on the overall ARPU of the users.
So, LTE is 12% in the base today? If most of the phones, smartphones that you are selling now, so obviously that percentage is going to go up and you have every one of the those LTE users that’s using three times as much data or there are some people that are buying an LTE phone, but not necessarily using….
On average, obviously we are talking about the averages, right. So on average, it’s three times as much. Obviously, you have a higher concentration of the pure postpaid and the high end users, but on average, the 4G numbers are consistent regardless of the segment.
I mean, with those, I just don’t understand with those metrics, 12%, 100% of sales, three times you are metering the data, like how is ARPU not going up in 2016 or 2017, I get the MTR cut, but if you just put those numbers together, I am not sure how you don’t see growth in ARPU in 2016?
No, but remember that we did not talk about ARPU numbers in ‘16 yet. What we were talking about was all of the behavior of ARPU in 2016. Obviously, when we look at what’s going to happen in the future, we do expect ARPUs to go up, obviously accounting for the impacts of incoming. How much up will they go will obviously depend on the behavior of the economy and the trends of consumption of revenue. Let me remember that on the LTE, when I said three times as much 4G than 3G, I am referring to the goal to the bytes of usage, not directly on the ARPU, because obviously if you have higher plans, higher plans have higher ARPUs, but not in a direct relation of three to one. So if you just – to give you an example, if you look at our postpaid plans on the new portfolio, we have the new portfolio with a 2 gigabytes, 4 gigabytes, and 6 gigabytes of data and the ARPUs are 99, 136 and 169. So you have reducing prices per volume as you go up, but higher ARPU is not in the same proportion of the consumption, right. So Pietro can also add a comment, Pietro is our COO. I guess you have the chance to meet him in the past.
Walter, if I can elaborate more on your question related to the ARPU, it’s important to explain in a better way our strategy, also to understand where we can look for ARPU uplift and where we can find differently. First of all, when you image the Brazilian market as a too cheap market, two SIM market, where everybody use two SIM, the first part that we are attacking is prepaid, because from the consolidation of the SIM, because people today have two SIM, you can have increase of ARPU and in the meantime, you can drive also the process of the data transmission, because keep in mind that usually just one of two SIM can surf on data, this is the first thing. Second, Controle is the offer that is performing better today, also compared to the market, it has a good price point, but the ARPU uplift is driven by the increase of data. So if you look at all the offer starting from the 55 until to the 70, the increase of the ARPU of the customer is driven by the increase of consumption of data. Our challenge today is not only to discuss about data ARPU increase, but ARPU stabilization with regard to uplift, because we are selling bundle. And to keep the value, we put the off-net because it’s not the risk that this industry in Brazil care on, should be that the only on-net strategy could review the real ARPU.
And then reaching the volume of data, then you move to the postpaid. Keep in mind that however the main challenge is on the prepaid area where every day, you have to fight with the customers to fight and as I said, we have to fight on the share of wallet of the customer between different products and inside the telco industry, we have to fight each other, having two SIM to be the SIM that allows the customer to be recharged. For this reason, perhaps we didn’t like the recurring model. With the recurring model, it means that every week we take from the customer wallet several reals. We don’t leave to the customer the possibility to choose week-by-week if they can use with that or with other. And this is based on for which as Rodrigo highlighted in the Chart 4, you can see a new way to look at the portfolio with offer base on a consumption model, where again, every day you fight with the other operator with the SIM to take the customer expenditure. With the recurring model that should allow to do generate this uplift. I don’t know if it is better now.
Yes. And just to be sure, because we talked about all of the ARPU behavior that occurred in 2015. On 2016, we certainly expect an outgoing ARPU – significant outgoing ARPU increase.
Alright. Thank you, Rodrigo.
You are welcome.
Our next question comes from Michel Morin, Morgan Stanley.
Thanks for taking the follow-up. I just wanted to follow-up a little bit more on the portability chart on your – I think Slide 5, did you say Rodrigo that you were positive against every other competitor, did I hear that correctly?
Hi Michel, that’s absolutely correct. We were tracking this obviously on a total basis, but then against other operators as well. And on the other operators and this is a chart that talks about postpaid portability. So on the postpaid portability, which is the vast majority of the portability, we are positive against all of them.
The data is right now is to share this, would you actually be willing to share some portability ratios, just to get…?
Yes, we can provide this information on the one-to-one absolutely. I believe though, many of those numbers are public.
Thank you, ladies and gentlemen. Without any more questions, I am returning to Rodrigo Abreu for his final remarks. Mr. Rodrigo, please proceed.
So thank you all again for participating in our call. As I have already emphasized, it is indeed a challenging period, but we are confident in our capacity to execute. So we will count on the great team that TIM has and we hold firm on our plan, our vision and our execution. Thank you for being with us in the call. And I hope to talk to you all in the next call regarding the results of the first quarter 2016. Thank you all. Have a great day.
Thus, we conclude the conference call result of TIM Participacoes. Your lines can now be disconnected. For further information and details of the company, please access our website www.tim.com.br/ir and take the opportunity to download TIM IR App available for Android and iOS platforms. You can also follow at tim_ir on Twitter. Thank you.
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