1&1 AG (1U1) Earnings Call Transcript & Summary

[Interpreted] Good morning, ladies and gentlemen, I'm happy to welcome you on behalf of the Chairman and CEO Mr. Dommermuth and Mr. Huhn. The Board, in the context of this telephone conference, will present you the results of the first half of the business year '22 and then give you the forecast for the second half of the year. And after the presentation, the Board will be available to answer your questions. Thank you, and I'll hand over the stage to Mr. Dommermuth.

[Interpreted] Thank you, Mr. Keil. Thank you, ladies and gentlemen, to join us here to our half year conference. Mr. Huhn and I split up our parts. I give you the corporate development 2022, the first half of the year. And inform you of where we are with the buildup of the mobile network so far. And then Mr. Huhn will present the financial figures for the first half and give you the forecast for the second half of the year. I would like to start with the corporate development in the first semester. Many of you have seen this chart before that shows where we are active. We have 2 areas, broadband connections, DSL and FTTH and mobile contracts. In the broadband connections, we are the largest alternative DSL provider in Germany. We offer VDSL, FTTH complete packages, including voice and IPTV from our sister, 1&1 Versatel, and the last mile is provided by Deutsche Telekom or the local city carriers. We have a very good net quality. We regularly win the connect's landline test or we are on the second space. And you see the placings in the last years, always taking turns with Deutsche Telekom. In the mobile sector, we have 11.3 million mobile service contracts. We are a mobile virtual network operator. We have a broad market coverage with different brands, most of all, 1&1 AG, but also co-brands, GMX and WEB.DE, our sister companies. And we have a number of discount brands from our corporation, Drillisch. Our customers are highly satisfied. This is a logo from Focus Money together with ServiceValue, a survey where they looked at how customers recommend brands, and our 1&1 made 1st place in that survey. You may say it's easy to say, easy to do because there's not so many telecommunications companies. That's not quite true because over 1,300 companies took part of different industry. And if you look at all of them, 1,355 altogether, 1&1 took second place. The first place was taken by our sister, GMX. So I think there's no better way to do this. We have a high quota of recommendation. Our brand is very popular. We are currently working on the 5G network. I'll come back to that later. We will stay an MVNO until that network with our services from Telefonica and Vodafone. Our customer contracts were increased by 120,000 to 15.55 million contracts in the first half of the year, 4.71 (sic) [ 4.17 ] of these are broadband lines. That means a drop of 70,000 contracts. In the mobile Internet range, we have 11.3 million contracts, which is a growth of 19,000 contracts. And I think it's important to mention that, in this year, we have the so-called TKG effect, the amendment. Since '21, we have a new Telecommunications Act in place. And this allows customers to cancel their contracts more quickly as soon as they have a lift of the minimum contract time, which is usually 24 months. Before, customers had a notice of 3 months to the end of the contract year. Today, they can cancel the contract on a monthly basis. And this is why we differentiate the number of cancellations we have operative and how many came about because they are premature, so to say, so that we can compare the years. And here, we see the TKG effect, the earlier effectiveness of the cancellations has hit us with 60,000 in the broadband lines, and the mobile network with 110,000. Apart from that, I think the performance is quite beautiful. The 10,000 broadband contracts are, of course, 10,000 too many. However, about a year ago, we lost 30,000. So we see an improvement in the situation in mobile Internet. With the 300,000 contracts that we have operative, we see a beautiful growth. The TKG effect will fade away over the course of the year. But in the first semester, as you see here, it kicked us with 170,000 contracts where the effectiveness of the cancellation was earlier than in the year before. If we look at the revenue, we were able to increase that by 1.1%. That is because of the other revenues, for example, smartphone sales with a contract maturity of 24 months in our contract, but they will be paid back over that course of time. That is volatile, depending on the devices of the producers and how aggressive we price them, but there's little margin on that. The margin comes from the service revenue. Here, we increased that by 2.6%. As I just said, we lost some DSL customers. And this loss of customers led to the broadband business to have a minus of 0.9% (sic) [ 4.9% ]. And for the mobile business, this means a growth of 4.7%. So the service turnover in mobile services has increased by 4.7%. Looking at the EBITDA. We look at 2 different segments. One is the Access segment, that's our traditional segment that we have always been doing. And in this segment, we were able to increase the EBITDA by 9.5% to EUR 384.3 million. And in the mobile networks, we are also increasing it. We have start-up cost of EUR 16.1 million earlier in the year to further buildup of the network. That was a bit more than the year before. And the excess 9.5% nicely show that we are well able to make the contract profitable that we have and keep and develop customers that we have developed. Now we can move on to the mobile network of 1&1. We've started a first friendly user test and the focus is on the first test here. We are right at the beginning. However, I would like to show you some results of that test already. The first thing is the question on the latency times, how quick do the servers respond. And in the test, we have latency times of 3 milliseconds. If we have applications in our far edge computing centers, here, you see a multiplayer game, Minecraft. And here, we got 3 milliseconds of latency times. That is close to what is physically possible. Parallel to that, we looked at the bandwidth. Here, we have bandwidth a bit above 1 gigabyte. And you probably going to say others have done that as well, but you have to see what frequencies you have available. And compared to Telefonica, Vodafone or Telekom, we have quite low frequency bands. And despite that, we allow for gigabit bandwidth. That was an important goal for us because I think in marketing later on, that is a speed we'll have to deliver and that we cannot stay behind and not worked in the friendly user test as well. It's also important to look at the stability, are we able to keep our net so stable that the data transfer and telephone calls work consistently. And here, we are doing quite well as well. Within 24 hours, we could download over 8 terabytes to the customers. So that is all quite nicely looking of what we have theoretically planned at one point when we decided to take that OpenRAN architecture. It's proven now that this work in Karlsruhe, Mainz and Frankfurt. And quite clearly, we have to develop this, scale it up, build it up. But what we can say, as of now, the technology works quite well so far and fully fulfills our expectations. Moving on to the next steps. In the next quarter, we are going to see an extension of the Internet connections. We are looking at 36 additional peerings. In the first quarter, we want to offer the first product, Fixed Wireless Access. That's what we have tested. And for that, we're going to have 140 regional edge data centers and 24 decentralized edge data centers and 2 core data centers. And next year, we will look at the connection of the network with all the telephone networks. First, for Telekom, we're going to start with national networks first and, in the second quarter, we're going to connect to international telecom networks. And that's also going to see the start of national roaming. As a test phase with Telefonica, we agreed that in the third quarter, we're going to provide national roaming and commission it. We want to start testing it in the second quarter. And in the third quarter, together with the availability of national roaming, we want to start on the federal level. That's the point when we can offer mobile products. The Fixed Wireless Access is not mobile without national roaming. The customers who leave their cell, we'll not be able to provide it anymore. That is why it's very important for us to get national roaming and get it in time as well so that in quarter 3, we can start with that. And at the same time, we're going to start with the sales of our MVNO products, discontinue these and then we're going to start to migrate the existing customers. It's 11 million. And we took a time span of 2 years to migrate these customers to our network. That's quite a number of steps that we are facing, but I'm confident that we will be able to manage. We are proceeding quite well. Of course, there is a day or 2 where you think, "Well, it could have gone better." But in general, we are proceeding well, and I'm optimistic that next year, in August, we will be able to commission the network. Thank you for your attention so far. And now I'd like to hand over to Mr. Huhn for the financial figures.

[Interpreted] Well, thank you very much, Mr. Dommermuth. I'd like to start with Slide 15, the earnings for the first half of the year 2022. Dommermuth already spoke about the revenues. The cost of sales increased only slightly in the first half of this year compared to the first half of the last year to EUR 1.317 billion. The gross profits from turnover went from EUR 616 million to EUR 634 million. What's important is the out-of-period revenue that we generated in 2021. If you eliminate those and compare the adjusted results, we are at EUR 577 million compared to the EUR 634 million of the first half of 2022, and that would be a growth of 10%. The distribution costs due to higher expenses for marketing of EUR 235 million increased to EUR 248 million. Administrative costs increased slightly from EUR 59 million to EUR 60.2 million. This includes the expenses for 5G, which increased by EUR 1.2 million. If you eliminate those, then the administrative costs actually decreased slightly compared to last year. What significantly increased are the other operating income and expenses from EUR 8.7 million to EUR 11 million. From debt collection costs, we have a position of depreciation impairments on receivables and contract assets, which increased from EUR 34 million to EUR 49.2 million. This increase of EUR 14.8 million results, on the one hand, from higher income from a reminder in debt collection fees and also the effect of the TKG, the Telecommunications Act. There is a higher blocking limit, which means that we disconnect our customers later. That leads to higher cumulative debt that has a total effect of EUR 5.4 million and has an impact on revenues, of course, and another EUR 5 million results from higher return rates and higher debt collection rates. During the pandemic, we saw that the debt collection was much better or payments by customers was better than prior to corona, but we're slipping back to the same level we were pre-corona. So in the first half of the year, we saw an increase compared to last year. The financial result in the first half of the year was at minus EUR 3.2 million. EUR 3.2 million resulting from investments in white spots. We have committed to EUR 50 million worth of investments. By contrast, we don't need to pay the frequency charges for 12 years. So without this, we would have a balanced financial result. Profit before taxes was EUR 284.5 million. Last year, it was EUR 296.1 million. That includes, of course, the EUR 39.4 million in out-of-period revenue. If you eliminate that, we're at EUR 257.7 million compared to the EUR 284.5 million, which is a growth of 10%. Tax expense decreased slightly from EUR 88.9 million to EUR 85.6 million. The consolidated result was EUR 199 million compared to EUR 207.2 million last year. Let's now move on to the balance sheet. The balance sheet sum increased by EUR 344.5 million to EUR 7.063 billion. The short-term liabilities increased to EUR 7.063 billion. EUR 45 million, a result from the increase of the active write-offs; another EUR 30 million, a result from higher demands from reserves. Long-term assets increased due to the fact of contingent down payments. On the liabilities, the short-term liabilities increased by EUR 166 million due to liabilities against consolidated companies and liabilities from services. Long-term liabilities slightly decreased and equity increased by EUR 199 million in the course of the first half of the year. On the next slide, you can see the development of the cash flow in the first half of the year. Net inflow of funds from operating activities was EUR 238 million composed of EUR 273.2 million cash flow from operating activities, minus EUR 1 million from change contract assets and contract liabilities. What had a positive effect with the EUR 171.9 million were changes in receivables from and liabilities to related companies, EUR 31.1 million positive effect came from an increase in income tax, a negative impact with EUR 61.6 million was the change in trade or other receivables and trade and other payables, further negative impacts at EUR 157.1 million were change in accrued expenses and that is the down payments with the contracts with 1&1 Versatel and Deutsche Telekom. The change of inventories had a negative impact of EUR 18.3 million. Cash flow from investment activities was at EUR 220 million, EUR 51.3 million resulting from CapEx and EUR 169 million from investment of free cash. Cash flow from financing activities was slightly above last year at EUR 16.1 million. EUR 7.2 million were repayment of lease liabilities and EUR 8.8 million resulting from dividend payments. The free cash flow was at EUR 186.8 million after EUR 177 million last year. On the next slide, we have shown the bridge for the first half year from EBITDA to free cash flow. You can see the EUR 368.2 million EBITDA in the first half of the year of 2022 against the negative effect of accrued expenses of EUR 157.1 million. Then also minus EUR 37.8 million were due to trade and other payables and other liabilities. A positive effect then, EUR 171.9 million, from liabilities against related companies. The balance from other working capital had a negative impact of EUR 44.7 million. And taxes was minus EUR 62.4 million; CapEx, minus EUR 51.3 million. So we arrive at a free cash flow of EUR 186.8 million. Now let's move on to the forecast for the business year of 2022. We confirm the forecast so far with a service revenue of about EUR 3.2 billion after EUR 3.1 billion last year. The EBITDA, we expect to be at previous year's level, at EUR 672 million. What's important here is that the forecast includes EUR 70 million of cost for building the mobile network. This was at EUR 38 million last year. We expect for this year, 450,000 new contracts. The operating growth with contracts we expect to be 650,000 contracts compared to 600,000 last year minus the 200,000 contracts shift to the recent Telecommunications Act amendment. CapEx, we still expect EUR 400 million for this year after EUR 37 million last year. The CapEx increase is mainly due to our investments into the mobile network for antennas, computers and software. Maybe one more point before we start with the Q&A. Mr. Dommermuth had mentioned already the buildup of the mobile network. We would like to give more detail on this in Q4. Now I'd like to hand back to the operator for the Q&A session.

[Interpreted] [Operator Instructions] We start with Martin Hammerschmidt, Citi Bank.

[Interpreted] Yes, I have 2 questions. One is concerning the drop of customers, the 170,000 in the first half of the year due to TKG, with a minus of 200,000 for the overall year. It sounds a bit optimistic. How can you help us to understand what is going to change in the second half of the year to see that improvement so that we shouldn't take that 400,000 minus. And last year, the Telefonica, we heard that there's going to be price increases during the course of the year. And if other players will do the same, would you follow these steps, get the more for more price increasement? And if not, why not?

[Interpreted] Yes, please let me start with the TKG effect. You're quite right, if we look at the 170,000 in the first quarter and then the forecast that we gave initially and that we have renewed today with 200,000 for the second half, then it looks as if it's a bit asymmetric. And actually, we do expect the second half to see less of TKG effects. Whether we will really end up with 200,000, I can't say. But the net growth of 400,000 will be delivered. That's fixed goal, and we do assume that that's going to work. You ask for the price increases that Telefonica did with more for more. Difficult to comment because I don't know what's going to happen when, what dimensions that's going to have, whether that's O2 or blue or whether it's in the service provider business with MobiCom Digital or whatever, that is difficult to comment. At this point, we usually follow the market for our navigation. And if we see opportunity to implement higher prices, we will take opportunity of that. We have no concrete plan at the moment, but we are observing the market conditions. And of course, we have to see how the inflation is going to develop over the next months.

[Interpreted] And if I may come back to Mr. Huhn's statement of the second quarter, the CMD, could you just give us a little flavor of what is to expect, what the goals are?

[Interpreted] Well, we are going to give more information on the architecture and the partner landscape and the operations model that we have established to build up that network in order to give a better overview of the technologies, the architecture and how we're going to cooperate with the partners, what financials are concerned. We will give an overview of invest and cash that we plan for the next coming years. And of course, we are going to look at the KPIs that may be of relevance for the 1&1 mobile network and give an overview of what that will mean for the next years and how that will affect P&L.

We can now take our next question from Yemi Falana, Goldman Sachs.

This is Yemi from Goldman. Two questions from me. Firstly, on network rollout, maybe a multipart question. Clearly, you've reaffirmed the EUR 400 million CapEx guide for this year. But some of your European peers have seen rising investment costs as they roll out network. And DISH CEO, Charlie Ergen, has been flagging that their network build-out in the U.S. is going over budget to some extent. So as you get deeper into that network build-out process, are you seeing higher cost prices relative to when you initially made your plans? That's the first part. Secondly, do you continue to expect to pay for that entire rollout out of organic free cash flow? And maybe finally, on the network rollout side, beyond your existing agreements with telcos, could you provide some color on how actively you plan on leveraging the various telcos that now exist in the German market? And then maybe if I can sneak one more in just on the margin profile because one aspect of the network rollout rationale was ultimately to achieve higher margins as a network owner. Do you still expect rising margins from the end of '23 onwards as you begin that customer migration period? That would be great to know.

[Interpreted] With respect to the first question, as far as our assumptions for the business case are concerned, CapEx and OpEx, we are still on the level that we had expected before. We have had a large number of contracts that exclude the inflation risk that we have made agreements on the price increasement for the next year. So this EUR 400 million that we have given us guidance for this year have increased due to these effects, but they are moving framework of what we have calculated in the initial case. With respect to the funding, the plan is that over the next years, we will look at the financial needs for the investments and the buildup of the network to fund that from our cash flow and the credit or the positive that we have at the moment. And if we have clearance on the low-band frequencies and the funding needs resulting from that, we will decide on how to get up and fund ourselves medium and long term. As far as the margins are concerned, we are expecting levels of EBIT margins that are going to have a strain because we will take the investments in the network, which is not under full capacity at the beginning. Our expectation, however, is that if we have built up the 50% and the customers are migrated and we generate the traffic coverage that we have calculated, that we'll have an EBIT margin situation, which is quite comparable to today's margin.

That's very clear for the most part. Could I just make one clarification just on the spectrum frequency point? I think you mentioned that the plan is to fund via organic free cash flow, but dependent on some factors around potential spectrum, you'd have to reconsider the funding arrangements. Could you maybe clarify what you meant there?

[Interpreted] We can't comment on that at this point. That is a bit of speculation, and we cannot do this at this point of time to give a figure for the value.

We'll now take our next question from Joshua Mills of BNP Paribas.

I have 2, please. So it wasn't quite clear from the translation, but I think you were talking about the fact that bad debt provisions have increased this quarter. Could you just clarify whether that's the case? And also what's driving it? It'd be very interested to know whether you're seeing any impact on the brand mix, maybe people shifting towards the lower end of your tariff range as a result of the macro backdrop. So any commentary you can give there would be great. And then secondly, coming back to the net add number, it sounds like you're very committed to hitting the guidance. But if I look at the mobile and broadband trends for the first half and even adjust for that 170,000 that you attribute to the German telco law, it does look like the run rate in mobile is lower than in the past. And then in fixed line, you're continuing to lose subscribers. So is there a brand or tariff reset that you're anticipating, which could help to reaccelerate those subscriber growth trends? Or are you pinning all of the hope on the fact that once the regulatory effects wash out, you'll have much better underlying growth? It'd be of great interest hearing that.

[Interpreted] With respect to the first question, as far as the drop in credit is concerned, the effects from these are not a shift to the contracts between the different brands. The major reason for this is an increase of the dropout quota in the post-corona phase. During corona, the dropout curves have declined, with all brands of the default quarter at the level of prior corona at the moment. And the other effect is due to the TKG regulations. I have pointed out that the limit value is increased. It was at EUR 75 before, and it is over EUR 100 now. This is how the nonpaid amounts increased before we can block customers and hand that over to en caso offices. So that hasn't got to do with more discount contracts now compared to premium brands. The same applies for the TKG effects, the 170,000 that we had in effect in the first half of the year. This effect is mainly in the first half of the year because not all customers had 12 months' maturity, but maybe 6 straight months only. And then they could have left the company, so that effect is stronger in the first half of the year than it will be in the second. And as Mr. Dommermuth had said for the second half we expect a lower effect of about 30,000 contracts and the split out in the brand world corresponds to what we had seen or expected in the beginning of the year.

Okay. Great. I mean, maybe to ask it another way, we've seen your broadband net add trends get progressively worse for several quarters now. I know that the message that you give is we're happy to see -- we're relaxed that we're seeing some of these customers leave their lower value. We're waiting for new wholesale contracts and better terms to upsell people to faster speeds. Could you just give us a time line on when we might be able to expect to see that broadband net add number stabilize? Or should we assume that the negative 30,000, 40,000, 50,000 run rate each quarter will continue in the second half as well?

[Interpreted] As we have explained before in our discussions also over the last few months, that the extension of FTTH coverage, particularly by Deutsche Telekom, we see that the new momentum will build up in the market there, thus, much higher opportunities in marketing. Now how fast this can be leveraged this potential? It's difficult to say at this point. Of course, we started marketing this, but at the same time, the areas where we can market are only emerging at this stage. So we believe that we will have to wait for developments over the next year to see how coverage expands and what sales opportunities result from this. So stabilization and improvement is something that we expect for next year. We can see it in the operating figures of this year. In the first half of the year, we had the minus 10,000 mentioned by Mr. Dommermuth for the first half year. Before that, we had minus 30,000. So we believe that next year, through the fiber optic changes, we will see positive trends going forward.

We can now take our next question from Polo Tang of UBS.