Bezeq The Israel Telecommunication Corp. Ltd (BEZQ) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to Bezeq's First Quarter 2021 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded and broadcasted over the web. At this time, I would like to turn the call over to Mr. Naftali Sternlicht, Investor Relations Manager of Bezeq. Mr. Sternlicht, please go ahead.

Thank you, operator. Welcome, everyone, and thank you for joining us on the call today. With us from Bezeq Group's senior management team, we have Mr. Gil Sharon, Bezeq's Chairman; Mr. Dudu Mizrahi, Bezeq's Fixed Line CEO; Mr. Ran Guron, CEO of Pelephone, Bezeq International and yes; and Mr. Tobi Fischbein, Bezeq Group's CFO. Before we start, I would like to draw your attention to the safe harbor statement on Slide #2, which also applies to any statement made during today's call. The speaker's comments will generally follow the slide presentation, which is available under the Slides tab on the webcast link and may also be downloaded from Bezeq's IR website. You can go through the presentation by clicking on the arrows on the left or right-hand side. Let me now turn the call over to our Chairman, Mr. Gil Sharon for prepared remarks. Tobi will then continue the presentation on group financial highlights, followed by Dudu discussing Bezeq's fixed line results. Ran will pick up with results of our subsidiaries, after which management will be available to answer questions.

Thank you, Naftali. Let's start on Slide 3. The strategic vision of the Bezeq Group has always been to be the leader of the Israeli telecommunication market, providing a full range of products and services for the residential and the business market. Towards that vision, we're focusing our management attention and resources on the following: one, accelerating the deployment of fiber optics in the residential sector as well as continuing to strengthen the business sector in Bezeq fixed line; two, continue streamlining and cost reduction in key subsidiaries, companies and improve free cash flow; three, we're implementing the restructuring in yes and Bezeq International, which will create 2 growth-oriented companies: one, focused on the growing IT sector; and the other focused on the residential market. Lastly, Pelephone will focus on marketing 5G as a growth engine to increase revenues and ARPU. All of these initiatives are focused on building infrastructure and growth engines for the future. Turning to Slide 4. We continue to push forward our strategy while delivering results. On the financial side, adjusted EBITDA was up slightly year-over-year. Free cash flow amounted to ILS 323 million, allowing us to continue to reduce the group's net financial debt. At Bezeq fixed line, we grew revenues for the fourth consecutive quarter while continuing to improve in key operating metrics. At the subsidiary companies, Pelephone continued to grow its postpaid subscriber base. yes improved its free cash flow and increased IP subscribers. Our streamlining efforts also led to a decrease in operating expenses. However, revenues were down year-over-year due to the effect of COVID-19 on mobile roaming. We are pleased to report that the material weakness in internal controls over financial reporting in Bezeq International was removed this quarter. The group's strong financial results and accelerated deployment of fiber and 5G infrastructures are laying a solid foundation for our future growth. The Board of Directors approved a plan for structural change in the subsidiaries, that will include the merger of Bezeq International into yes as well as spin-off of ICT business division to a new separate company. This decision was driven by convergence in activities in the sectors, commercial and regulatory changes in respective markets of both subsidiaries, as well as our intent to strengthen their operations through the sale of triple play bundles and deepen the synergies and efficiencies of the subsidiary companies to generate value for all shareholders. Let me now turn the call over to Tobi to talk about the financial results. Tobi brings extensive experience in financial and capital markets as well as in-depth familiarity with Bezeq. Welcome back, Tobi. We look forward to achieving great results together.

Thank you, Gil. I'm very pleased to be back at Bezeq and join its strong and experienced management team and committed employees just at the beginning of such an exciting and challenging phase of unprecedented infrastructure deployment. I'm excited to get to work and look forward to meeting with investors. Let's turn to Slide 6. The group's strong financial results continue to validate the strength of the group operation, a diversification of sources of revenue and the ability to streamline expense. Revenues in the first quarter of 2021 totaled ILS 2.22 million compared to ILS 2.19 million in 2020, an increase of 1.6%. The increase in Bezeq's fixed line revenues was partially offset by a decrease in revenues of the subsidiary company. Meanwhile, group wide operating expenses increased year-over-year, mainly due to an increase in expenses in Bezeq International, which was partially offset by a decrease in expenses in yes. Group wide salary remained stable at ILS 480 million. Decrease in salary expenses of subsidiary companies was offset by increases in Bezeq online and Bezeq fixed line. Turning to Slide 7. Adjusted EBITDA in the first quarter totaled ILS 918 million compared to ILS 907 million in 2020, an increase of 1.2%. Group-wide adjusted net profit in the first quarter totaled ILS 299 million compared to ILS 325 million in 2020, a decrease of 8%. The decrease was mainly due to an increase in depreciation and financing expenses which benefited in Q1 of last year from financing income in respect of employee benefit as a result of the increase in market yields at the outbreak of the COVID-19 pandemic in March 2020 as compared to financing expenses in the current quarter. CapEx in the first quarter of this year totaled ILS 458 million compared to ILS 338 million in 2020, an increase of 36%. The increase was due to investments in Bezeq's fixed line, primarily related to the launch of the fiber deployment project. Free cash flow in the first quarter totaled ILS 323 million compared to ILS 436 million in 2020, a decrease of 26%. The decrease in free cash flow was due to an increase in tax payments in Bezeq fixed lines and changes in working capital in Pelephone, which was partially offset by an increase in proceeds on the sale of real estate in the current quarter. On Slide 8, we have broken down subscribers and average revenue per user ARPU by different business segments. Let me point out the subscribers in cellular, retail broadband and TV segment moved up during the quarter, with Pelephone posting the highest sequential growth since Q3 of 2019, while retail broadband ARPU grew to ILS 103 compared to ILS 98 in the first quarter of 2020. Turning to Slide 9. We are adapting operations to evolving market conditions and continue to improve our debt profile. Particular note this past quarter is the year-on-year decrease of ILS 887 million in net debt as well as the decrease in net debt-to-EBITDA leverage ratio from 2.3 in the first quarter of 2020 to 2.0 in the first quarter this year. It is worth reminding that over the past few weeks, both domestic rating agencies affirmed our credit ratings with stable outlook, with Midroog removing the negative credit rating. Lastly, on Slide 10, for the 2021 outlook, we continue to forecast group-wide adjusted net profit of ILS 1 billion, adjusted EBITDA of ILS 3.5 billion and CapEx of ILS 1.7 billion. Now Dudu will share with you highlights based on fixed line operations. Dudu?

Thanks, Tobi. We finished another strong quarter with the growth in revenues and in most operating and financial metrics. We achieved strong financial results with revenues growing 3.5% year-over-year and adjusted EBITDA, up 3.7% year-over-year. In addition, continued robust sales of equipment led to increased retail broadband ARPU, as we grew the number of retail broadband lines for the fourth consecutive quarter. The first quarter saw the start of a revolution in the Israeli telecom market as Bezeq rolled out its fiber optic projects at unprecedented speed and intensity. Turning to Slide 13. As of now, Bezeq's fiber optic network already reaches 480,000 Israeli households, an unprecedented rollout phase in the world. On the map, you can see the widespread deployment in the whole country. We expect to reach about 1 million households by the end of the year. And yesterday, we announced that we will reach about 80% of Israeli households within the next several years. On Slide 14, as we continue to upgrade Internet speed, key metrics of our broadband services are showing results. Revenues from broadband services grew 0.7% year-over-year despite a decrease in wholesale rates. The number of retail broadband lines grew for the fourth consecutive quarter, while retail ARPU grew both quarter-over-quarter and year-over-year. Our Internet is the only product in Israeli telecommunication market with growing ARPU, where we are constantly adding new services and products for our customers. On Slide 15, our full WiFi strategy, which focused on improving the broadband experience at home continues to prove itself, and our revenues continue to grow at high rates. At the end of the first quarter, 579,000 customers were using advanced BE router with 277,000 customers benefiting from WiFi enhancers. The numbers continue to go up in both cases. On Slide 16, our telephony offering continues to see increase in traffic during the quarter, with outgoing minutes up 9% year-over-year and incoming minutes up 15% year-over-year. As a result, telephony ARPL increased year-over-year. In addition, there was a moderate decrease of only 9,000 access lines compared to an average quarterly decrease of 20,000 lines in 2020. Turning to the next slide. We saw revenue growth across our other segments as well. Quarterly revenues for transmission and data segments were up 9.8% year-over-year due to an increase in revenues from transmission services for ISPs and businesses customers. Quarterly revenues for the cloud and digital segment were up 13.8% year-over-year due to an increase in virtual exchange and cloud services for businesses. Quarter revenue -- quarterly revenues of the other segment were up 7.8% year-over-year due to an increase in revenues from the sale of cellular handsets. Turning to Slide 18. Salary expenses were impacted by the recognition of stock-based compensation of ILS 5 million in the first quarter. Operating expenses were impacted by an increase in subcontractor expenses. On the next slide, adjusted EBITDA in the first quarter totaled ILS 671 million compared to ILS 647 million in the prior year quarter, an increase of 3.7%. Adjusted net profit in the quarter totaled ILS 290 million, mostly in line with the same quarter last year. In summary, we continue to grow broadband Internet revenue, which is driven by an increase in subscriber and ARPU. Sales of BE Router and WiFi enhancers have seen tremendous success. The launch of nationwide deployment of fiber will drive continued growth. We are at the start of an exciting and challenging time as we get ready to launch innovative services and products, which will revolutionize Internet capabilities in every household in Israel. With that, I'll now turn the call to Ran to talk about Bezeq subsidiaries.

Thanks, Dudu. 2 years into the Alpha projects, we are pleased to report that there has very significant success. We saved ILS 230 million in 2020 compared to 2018 by appointing 1 unified management team to streamline operation. We reduced senior management positions by 45% and reduced employee headcount by 1,300 over the last 2 years. We -- as we also lowered operating expenses through joint procurement for all 3 companies and savings in the real estate. Going forward, we are planning to move for more savings in investments and costs of support through switch to one CRM system; joint sales and service packages; continued streamlining in operating expenses; as well as further development of the ICT operations. We ended a strong quarter, and we can already see the pathway out of the COVID-19 period. As you can see on Slide 23, we saw continued growth in Pelephone and yes subscribers. At yes, we are continuing to grow the number of subscribers and already 29% of the customer base is using IP services, along with a significant improvement in free cash flow. Pelephone continues to deploy its 5G network with significant growth in 5G subscribers. At Bezeq International, with the launch of the FIBER+ network and growth in business and data operations, we are seeing stable revenues, increase in free cash flow and growth in the company's commercial services. During the first quarter of 2021, we progressed full steam ahead with the Alpha 2 program to develop synergies between the companies. The goal of the Alpha 2 program entails a merger of Bezeq International into yes, spinning-off of the ICT business division of Bezeq International into a separate company and continued streamlining. We have already approached the Ministry of Communication, and we will be starting negotiation with the labor unions next month. The continuation and extension of the Alpha project will allow us to provide customers with a significant value experience to offer triple cost-effective packages based on approval from the anti-trust authority to yes and to increase competition in the Israeli telecom market. Technologically, project Alpha continues to march forward on to next-generation offering in 5G mobile, Internet over fiber optics and IP broadcasting across the subsidiaries as well as execute our structural and organization transition. Turning to Slide 26 through 28. Let's briefly look at some key financial metrics for the subsidiary companies. We continued to lower salary expenses during the quarter. Since 2018, salary expenses decreased by 23%. Revenue went -- revenues went down slightly year-over-year for the quarter. Expenses were relatively stable during the quarter with a moderate increase due to ongoing impairment in Bezeq International assets. Adjusted EBITDA decreased year-over-year due to the pandemic impact on roaming revenues which was partially offset by improved results in yes and Pelephone through the quick adaptation of expenditures to lower revenues. Adjusted net profit was down year-over-year for the quarter. Turning to Slide 29 and 30. In Pelephone for the next generation of cellular in Israel, we are looking to provide our customers with diverse handsets, record speed private broadband and wide coverage 5G services. Leveraging new and improved services continue to grow number of postpaid subscribers for the fifth consecutive year. Adjusted EBITDA was up year-over-year. A slight decrease in revenues was primarily due to the decline in roaming revenues as a result of the impact of the pandemic, which was mostly offset by an increase in revenues from incoming costs and increasing equipment sales due to the launch of a new iPhone model. Turning to Slide 31 and 32, during the quarter, Bezeq International launched FIBER+ network. Revenues were down slightly year-over-year due to the decrease in revenues from Internet services and international calls, partially offset by an increase in sales of business communication services. Moving to Slide 33 and 34. At yes, subscriber growth where customers continue to migrate to IP. The success of IP migration continues to manifest itself to improve cash flow. I will now turn the call back to Tobi.

Thanks, Ran. Let me remind you that we will be holding a virtual analyst conference in Hebrew for the local market after this call. This concludes our prepared remarks. Operator, let's begin the Q&A session.

[Operator Instructions] The first question is from Tavy Rosner of Barclays.

First, I wanted to talk a little bit about fiber deployment. You guys reiterated guidance for CapEx at ILS 1.7 billion. I'm just wondering, given the pace of deployment, do you think that looking ahead, it's sustainable? Like, is it enough to support the rollout? And I guess as a follow-up, perhaps related to this, we saw an increase in operating expense at Bezeq fixed, and you guys pointed to increase expense as subcontractors. Is it related to the fiber rollout?

Well, Tavy, we've said at the beginning of the year that we expect to reach about 1 million households by the end of the year. And the CapEx guidance we gave supports that deployment. And regarding your second question, part of it relates to the fiberoptic project and other parts relates to other segments and services.

Understood. And I guess as a follow-up to the CapEx question is really a question about dividends. It's something that investors frequently ask us about timing of resumption. Last quarter, you guys mentioned you were exploring it or had hired a consultant to look into it. I guess when we see you guys generating positive free cash flows, I'm wondering what's the thought process beyond the timing of resumption?

Tavy, this is Gil. Yes, we started looking at dividends, and we will continue to examine the issue later this year, looking carefully on all aspects, including lowering our debt and retaining our credit ratings and as well as total return to shareholders.

Okay. And perhaps one last for me. On 5G, it seems that, unless I'm mistaken, most of the carriers are offering it for the same price as 4G. So is there an opportunity to offer more for more? Or we already lost that battle and just 5G is taken for granted?

Tavy, this is Ran. This, in fact, it works differently. All operators in Israel are offering more for more, meaning 5G costs more than 4G. In Pelephone, we have a significant amount of customers, and the takeout is really surprising and good. We didn't publish the numbers, but we are really satisfied with the pace. So it's going quite well, I would say.

The next question is from Ondrej Cabejšek of UBS.

I wanted to follow-up on the fiber side of things. So I was wondering from your perspective now that you're clearly launching the service on a reasonable scale, your competitors are clearly doing everything they can to lock in the former wholesale customers to their retail side. I mean, how bad do you think the wholesale trends get before the retail pickup starts compensating for it? Is it kind of if we look at where your peers are in terms of home-pass, you will clearly be surpassing that pretty soon and within a couple of months. Do you think that we're seeing the worst kind of second quarter, third quarter? And then is that the retail pickup will take over in that sense? And related to that, how -- or where are we in terms of the ISP infrastructure separation, which I presume, from your perspective, will help a lot in turning the revenue trends around as you start to collect the ISP fee and you get a much more direct relationship with the customer. That would be my first question, please.

This is Dudu. Regarding your first question, the negative trends we see on wholesale is, of course, coming from the fact that Cellcom and Partner are taking customers from wholesaling Bezeq network to their own fiber optic networks. And of course, part of it is offset by the growth in our retail customers, and we expect to see further increase in retail customers as the fiber rollout continues, and we start more aggressively adding more and more retail customers to the network. Another thing is that the Bezeq subsidiaries are expected to start offering fiber services on a wholesale basis, which we also -- we expect that to have a positive effect on the wholesale numbers. Trying now to see whether it will be fully mitigated or not, is still early, but these are the main trends in the market. Regarding the second question about the ISP, the hearing process is already done. The political situation in Israel now prevents the minister to take the decision or makes it more difficult for him to take the decision. They are looking into the legal aspects of that, whether they can take the decision right now or whether they should wait to the new government. Either way, we think there's a good chance that in the following weeks, we will see -- we'll have the decision. Bear in mind that the process will be roughly 9-month process until we will be able to fully offer a unified broadband service.

So 1Q '22 kind of the earliest that you would say if it passes next week, then that would be when you're ready to roll out the unified service?

Yes. That's the earliest, as it seems now.

And second question, if I may. You've -- as a Board or the company as a Board has decided to integrate or merge rather yes and international. Is there any chance that the 2 combined, along with some efficiencies could have a net income positive enough to warrant a second look at the type of assets coming back to the balance sheet somehow?

It's Gil, and I'll also let Tobi. Let me first answer it strategically. The split of the ICT and the merger of the residential portion of the business of Bezeq International into yes. I'll start with the merger itself. First of all, the reasons for the merger are two. One is that the regulation, as you know, is ending the ISP as a stand-alone business. And the second and most important is that the market and the consumer, the market is a combined market of triple play. So we need to change our way of doing business on go-to-market and install a united product of bundle of triple play, and this will be better done as one united company, of course, through the improved sales on one hand and the efficiencies. On the other hand, it will improve bottom line. To what extent exactly, we do not know yet, but we are on the spreadsheets right now. So Tobi, if you like to say anything more?

I just would reaffirm that it's still early. And every quarter, we need to make those assessments also in relation to the external experts that make the appraisals on yes and on Bezeq International. And then we will do this also on the merge entity once to know how it looks like. So it's a bit too early as we plan these 2 companies to integrate later on towards the end of the year.

The next question is from Jerry Dellis of Jefferies.

I have 2 questions, please. Firstly, in terms of the Pelephone ARPU outlook. You talked about 5G driving a return to growth. I'd be interested to understand, please, the sort of shape of ARPU recovery that you expect. And whether at this early stage, you're already seeing positive signs in the market, perhaps as some of the peripheral players are struggling. Is that producing any positive developments in market pricing before we get to 5G? And then the second thing has to do with triple play. We read different articles, which suggest that the Ministry of Communications is objecting to the marketing of triple play services by Bezeq International and yes. I just would be interested in your perspectives on those articles, please.

Okay. So this is Ran. I'll start with the second question because this might be confusing, but the Ministry of Communications does not object to a triple play offer between the subsidiaries. In fact, it was just approved by the Anti-Trust, which allow us to offer this kind of offers. So what you may have read or may have heard is the Ministry of Communications not approving a triple play offer between Bezeq fixed line and the subsidiaries, but this has been the situation ever since. So our optimistic lookout for a triple play offer, being a significant part of the group growth. Maintenance and the merger of Bezeq International Residential division in 2 years will help us bring or improve our go-to-market in this way. So this is the second question. First question is about Pelephone ARPU. We see 3 drivers, 3 trends that drive ARPU forward. First of all, is roaming services. Roaming is supposed to come back. We are now at 30% roaming comparing to 2019 which means there is a lot to go back, a lot to recover. The recovery of roaming services will help a lot. Second, take-up of 5G packages will help as well. And this is all based on a market that is relatively stable in the last year or 2 years. And this was not the situation in the past. So if you take a stable market and 2 drivers, we can be kind of optimistic. I will not refer to prices because we never do, but it looks promising, I would say.

Could I just ask a quick follow-up question on something else? The merger of Bezeq International and yes by the Ministry of Communications. Do you have visibility as to when the decision be forthcoming on that, please?

We submitted our request to the Ministry of Communication. The process should take a few months, but we expect the request to be approved during 2021. So -- but it's not for us to decide. So we wait for the decision.

[Operator Instructions] There are no further questions at this time. I would like to remind participants that a replay is scheduled to begin in a period of 3 hours on the company's website at www.bezeq.co.il. Mr. Fischbein, would you like to make your concluding statement?

Thank you. I would like to thank you all for taking the time to join us today. Should you have any follow-up questions, please feel free to contact our Investor Relations department. Management looks forward to speaking to you on the second quarter 2021 earnings call. Thank you.

Thank you. This concludes Bezeq's First Quarter 2021 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.