Koninklijke KPN N.V. (KPN) Earnings Call Transcript & Summary

Great. Let's get started. It's my pleasure to welcome KPN management to Communacopia, CEO, Joost Farwerck; and CFO, Chris Figee. And thank you so much for joining us today, guys.

Hello. Nice to join you.

Thanks. Perfect. [Operator Instructions] But I'd love to kick off with the impact of COVID at KPN with the 2Q results, I think your commentary and also the financials sort of spoke for themselves in terms of the resilience of revenue and EBITDA, but you did caution about some potential downside risks to guidance that could emerge or develop through the year. If the macroeconomic impact in the Netherlands was to worsen. So I'd love to just get your thoughts. Firstly, sort of what are the key areas that we should be considering here? And then secondly, as part of that is, what have you actually seen as we've gone through the summer months and the lockdown started to ease and the activities coming back?

Yes. So thank you. When COVID started, first of all, we realized how important we are as a broadband supplier in the Netherlands. And when it comes to connectivity in general, we are the largest workspace provider in the Netherlands. We're the largest Office 365 reseller in the Netherlands. And we also, of course, are large in consumer market, and we saw this workspace moving into households. And we did quite well. So first, we saw COVID not really against us. We are super relevant for the society, and everyone is grateful how much we keep up our networks, and it's okay. So we were positive on the results, Q1, Q2, when it comes to the COVID effect. We were a bit cautious on the rest of the year when it comes to economic downturn and payment behavior of our customers. Today, I would say, we're less cautious. We're more positive because we see that our government is supporting enterprise, big time in the Netherlands. They even made the promise to continue that until next year, and they recently communicated that they will keep on doing that until mid of next year. So that is supporting our Dutch economy. They -- our government now has the slogan that we will invest ourselves out of this crisis. So all in all, we see limited risk on payments behavior of our customer base in the Netherlands today. So that is the good part. Yes. What we also learned is that we can -- that we notice inefficiencies in our company, yes, being more clear on the table today. I mean, all people moved home. We closed our shops. We sent our field engineers home. We put them back in the field in a different way of working, of course. We opened up our shops, but still 10,000 people are working from home. We scale up to 25% to offices, but we will probably stay around the level of 50%. So we also see that we can be far more productive with less people against less cost in the future as well as we do today. So that's interesting as well.

That's great. That was -- my second question actually was China sort of tied this into the change in behavior that might be permanent from COVID. And it basically sounds like you're saying that as you see this impact from COVID, it enhances your ability to digitalize the company. And you've already have this EUR 350 million cost-cutting framework out to 2021. So I'd love to sort of bring those themes together and get some more color on how we should think about the near-term momentum on cost cutting and whether there's perhaps upside risk to the EUR 350 million and then also thinking beyond that.

Yes. So as long as we are in the middle of migrating our B2B stack to the new world, cost cutting is super important for us. It's always important. We're good at that, and we're in the middle of digitizing the whole company. We have this program running, and we are ahead of plans. So end of the year, we probably have to do EUR 50 million next year, and then we reached the level of EUR 350 million. So it does make sense when we keep on running the program like this to do an upgrade somewhere in the near future. I think COVID did not change mankinds, to be honest, the Second World War didn't either. So it is more than I currently -- that I face the inefficiencies in our company that already exists for a very long time. And that we want to cash in. So what we did is that we have a crisis team in place. We have another team to introduce the new insights into the cost-cutting program for the coming 4 years as well. And we will benefit from that for sure. Of course, we have to discuss it with our works council, and they don't like to change that much. But in general, yes, we can optimize a lot by working from home on the level of 50% average will be different per department. We cut on loss from traveling costs, on lease costs we're going to do a lot, and we will benefit from that. So in our program, we do change a lot. We migrate our customers. We're going to switch off copper in the coming years. We're going to switch off all legacy systems like SDH, et cetera. But I think the way we run our business as a company, that's also very interesting for us to add in this program. So I'm pretty convinced that our cost-cutting program for next year probably is going to be upgraded, and then we're going to add 3 more years to the program.

Yes, fantastic. That's really helpful color. And perhaps shifting a bit more to the different divisions and also trying to get some update on the competitive landscape. We start with consumer. I mean, firstly, it'd be great to get your comments on how we see the competitive landscape today because the market was pretty competitive despite consolidation in mobile, a little bit less competitive in fixed. And now we've got this shift in mobile towards unlimited and a big push by all the players towards convergence. So thinking about all of those things, how do you see the competitive landscape in consumer?

Well, the good thing is that we saw some consolidation in the markets in the past. So that's how we ended up with VodafoneZiggo on one side, us on the other side, and then T-Mobile also positioning itself as a converged player. The most important thing on T-Mobile is that they really build up an important high ARPU consumer base mobile. This is how they make their money. So they have an important bank book to protect on the mobile side. And that's what is no longer making them a challenger on the mobile side. On the broadband, they're combining that with mobile. They are more aggressive when it comes to our propositions and VodafoneZiggo, so they're cheaper. And that's what you currently see in the market because we have an inflow on our network of roughly 15,000 to 20,000 new active connectivities per quarter, which is mainly T-Mobile. And therefore, it's so important. We think it's important for us to improve the quality of our service and stop the decline of the base in retail. We're not against an inflow on the wholesale side, but we, of course, look at the plant of what's coming in. We try to motivate T-Mobile to go after cable customers and not ours, and we try to, yes, incentify that in the way we make the wholesale deals. So for us, it's important, I guess, that we stop all this rotation in the Dutch market. And the only challenge we really face is that T-Mobile is claiming that they need to grow 7% in broadband markets. That is, of course, a story they created. They're probably going to prepare for an IPO or a sale or a party sale or -- yes. So then you always need a story on growth. And we're not against that. Our fiber case, our broadband case is including wholesale. We activate 52% of the households in the Netherlands on the total. But we also drew a line in the sand when it comes to our retail market share. So that is important for us as well. So it's a balancing act of what we face, wholesale, retail together. And yes, it's all about the good wholesale deals we make to increase the value on our network.

Yes. Yes, great. I mean a couple of things to follow up there. I think perhaps starting with the comments you made on fixed broadband and the need for T-Mobile to take some share. One of the things that you're facing in the broadband market is the migration of the Telfort customers, which you've already done in mobile. Could you give us an update there, and how we should think about potentially that being slightly different to how you did it in mobile?

Well, in mobile, we have a pretty good BSS system and -- which is far more flexible than what we used to run. So we were able to migrate the whole base in a decent way in a couple of weekends to KPN without impacting the service for our customers. So that is done quite well. Broadband is always more difficult. I've done a couple of migrations, Tiscali to Telfort, et cetera. Well, in the old days, you had to send out field engineers, swap hardware. So that is a pretty challenge to do such a thing. That's why we only decided to migrate Telfort because of we have this whole new OSS system built, which is a complete new IT stack, and we run our broadband base in a completely different way, far more flexible than we used to do. So we migrate the Telfort base in phases. It's built up in different layers. Just as we serve wholesale customers, we internally also serve our own serve costs. So from a broadband standpoint, everything has been migrated to KPN's OSS. And the next phase is that we will migrate all the addresses of our customers as well without touching hardware or anything. And that's new. That is a new way of migrating broadband. We did a couple of thousands last week. And so we do 1,000 customers, and then we check how things are going. Everything went well, but we're still waiting and checking to see what the impact for our customers was. And if we can see that something been wrong or whatever, we will do a couple of thousands more, and then we will do batches of 10,000. And at the end, we give the go, and then they will go in batches like 50,000. And then we have everything under control. So we scale up, and when we think it's not good that things are not going in the right way, then we will delay the program. So it's really different from what I've seen in the past or what I've seen other telcos that do. We really want to do it smoothly without impacting the service for our customers. It's a quality improvement for our customers.

Yes. That's really helpful. And perhaps, maybe this is the wrong way to think about it going forward. But historically, we've seen probably more steady inflation-type price rises in fixed. So I was just wondering how you think about the medium- to longer-term ability to take price, I guess, in fixed, but also as you think about your converged offers like KPN Hussel?

Yes. So in general, on broadband, we increase our tariffs every year. So on a yearly basis, we improve our ARPU around EUR 1.50 or something like that. So also, this quarter, we see better ARPU than a year ago. The challenge was really on mobile. And on the -- that's for 2 reasons. We always give the discounts on the mobile side in convergence. But also because of the whole competition around mobile over the last years in the Netherlands. Now I just explained how this market is now more to a stable environment. So we're doing okay on mobile consumer with an ARPU around 17 for 6 quarters in a row. Important to keep it there. Of course, we have roaming issues due to COVID. But besides that, we are running at ARPU in a much better way than we did. And we all introduced unlimited in the market, which is priced around EUR 30. So -- and the inflow is very strong around that. So if everything works out well and the other 2 don't make strange mistakes or start aggressive promotions or whatever, then we could create value in the mobile segment in the Netherlands. All of us, to be honest.

When it comes to fixed, I mean, we've increased our prices with inflation in VodafoneZiggo the same, actually they did more than we did. And there's nuanced differences. But frankly speaking, pricing between KPN and Vodafone for all our customer package is relatively close. T-Mobile, of course, is a cheaper offer. But they also increased prices this year. And thereby narrowing, they've got rely their own definition of what inflation compensation is. And so I think their price increase is a bit larger than ours. So I think there is a price gap. But all of us, all 3 large players do follow inflation every year. This historically fall inflation and increased prices. So it feels that the whole -- everything is gradually shifting up.

So yes, again, that's really helpful. So that sounds like a slightly more positive message. And as you highlighted, you potentially got this accretion from the move to unlimited, given your postpaid ARPUs only 17. Yes, I think, look, that really covers off consumer. So perhaps one of the tougher areas has been B2B. And I'd love to maybe just take this in 2 parts because clearly, COVID impacts B2B quite a lot in the telco space. So perhaps if we could talk about the migration of the customers and the structural shift in B2B first and how that's progressing. And then perhaps I'll come back and ask a bit more on COVID specifically.

Yes. I think the way we look at B2B and how we look at the business on a weekly basis, really split up in 3 subsegments. And that's also important. What we discussed with our new Board that we should realize that we are mainly consumer, SoHo SME company. 75% of our margin comes from consumer business and wholesale. And household is, at the end, the consumer business on our network as well. So 25% of our margin is B2B, and half of that is seen SME. So that's why we focus -- we prioritize on SME. And in the migration plan, we now got -- I think, at the end of this quarter, we go over 85% of the migrations. And migrations means that customers are in KPN ONE, which is the new environment, just as Hussel is in the consumer business. And the whole theory is that after we migrated that base, we stabilized. And that -- so that's the plan. And logically, that will happen next year. In LE, we're not as far as in SME, but also 75% we've done. And there, we are looking at 2 things. How can we speed up these migrations? And by the way, are we doing these migrations smart enough. So it's always good to challenge around plans, to be honest. Corporate is about a lot of revenues but less margins. And then -- so besides -- if it wasn't for COVID, I think we would have shown an improvement in the trend in B2B. I'm sure of that. And it is, for us, super important to finalize the migration to SME and show the inflection there and then do the same trick on LE. And then we cover like 95% of KPN's or more EBITDA. And currently, we are really challenging our teams on the migration plans because there's always a lot of work there, and sometimes just stopping things for a period of time is helpful as well. If you look at our new installed base on KPN ONE for SME, then for me, the interesting challenge is, okay, could we have come there in a more efficient way than how we did it over the last 3 years to challenge our migrations in LE. So in general, our strategy works. And it's important for us because all this cost cutting for the main part, this appears into, yes, the loss of EBITDA in B2B. And that's why we can only show like small single-digit EBITDA growth. We inflect there, and we can really benefit from all these cost cuttings. So that's important for our company as well. So yes, we're challenging them.

Yes. And then perhaps picking up on the COVID impact. I think from other telcos, there's lots of things being cited like the delay of larger scale IT projects, potential acceleration of the rationalization of PSTN lines. I mean are you seeing these sort of impacts? And if so, to what sort of magnitude?

Well, I think the impact of COVID on the business market, first and foremost is roaming, right? The international global business travel outside of Europe, that's quite good margin business. So it's -- our clients traveling to the U.S. or global people traveling to the Netherlands. So that business travel is impacting roaming, and the business market where the roaming effect really resides mostly. Other negatives are lower IoT revenues, lower hotspot stores revenues, hotspots in the trains. Well, now we don't take the train anymore, so that hotspot revenues are less so that's kind of where it is. And finally, we've seen some delay in IT projects, [indiscernible] these late IT projects. And fourthly, where I can't really quantify, but I presume it's there that there is a structural secular decline in fixed line -- fixed voice lines. I would think that, that has accelerated somewhat because of COVID. If you are an SME entrepreneur, all your staff's at home. You need to cut costs. Well, if these guys on the mobile phone, you might just take out these fixed lines. So on those 4 areas, we see revenue -- service revenue and thereby margin pressure on the business market. There's still growth in security. There's still growth in other areas. We're still doing well on workspaces. So we sell more workspace positions. But ultimately, roaming is quite a high-margin business that you can't really compensate. So I think our B2B market has -- it definitely is challenged in terms of complexity, in terms of the self-inflicted revenue loss due to migrations, but it's not planned and as we wanted to be, but that's kind of exacerbated or amplified by COVID on those 4 areas.

Perfect. That's really helpful. And perhaps just the last segment to cover off before we move onto the network in fiber with wholesale. I mean you touched on it already in terms of being quite a happy wholesaler to T-Mobile in fix. But could you just give us your view on how we should think about the wholesale business. I mean overall, really, I realize it's made up of fixed wholesale and then also MVNO contracts on the mobile side. But just generally, given we don't think cable regulation is coming back, should we think of wholesale as a nice and profitable growth driver for KPN as an aggregate?

As a matter of fact, it does. I mean growth, of course, relative. We're not -- I mean our wholesale business is showing growth in number of subscriber lines, number of postpaid clients in MVNO business and therefore, growth in EBIT or EBITDA. So the wholesale business is actually already growing about 10%, but a couple of percentage points a year growth is reasonable for the wholesale business and is driven by improving underlying days and drivers. As I said, lines I mean, I think we're now -- we close over 1 million lines in wholesale and broadband. Our postpaid client base is increasing, prepaid decreasing, but postpaid increasing. Actually, of course, COVID impacts the group, but the COVID negative on our MVNO is less. So we saw our MVNO somehow had a client base that still made lots of calls or try to travel to roaming locations. So yes, it's fair to assume that the wholesale is a very nice profit contributor. It actually also shows some growth. We don't see that changing anytime soon. And we've kept an open wholesale business even if no longer regulator, we actually haven't even materially changed our catalog. So the product services prices have actually effectively been the same pre and post the deregulation court case.

Yes. And moving on to the network. And I think one thing that's always in focus with telcos and investors, but particularly KPN because you've been so clear on the 3-year plan to '21. And people are thinking about '21, but trying to think beyond that. When we think about your fiber-to-the-home rollout, it's gathering pace and your targets, particularly this year and in 2021, are very clear. I mean could you talk us through that ramp up? And also, Chris, perhaps how the CapEx mix today, so the EUR 1.1 billion, how that changes? And then the third part of the question is, how should we think about fiber beyond 2021 and also tying that into CapEx?

Yes. So to start with what we currently are doing is scaling up the fiber rollout in the Netherlands in an efficient way. We've done it in the past. So we know how to do it. We've stopped that. We've upgraded our copper network on VDSL. So fiber to the cabinet we rolled out for 90% in the Netherlands. Yes. Last year, we did like 100,000 fiber-to-the-home connections in the Netherlands. This year, we go above 300,000. And that means that next year, we will move to a level that is not stretched to the supermax, but we think is the best level. And that's more or less what this year, the whole market in the Netherlands does consolidate it. So we lock in all that production capacity. And by doing that, I think we make good deals with the contractors for long-term guarantees we give them. And we're innovating together with these contractors, the way we roll out fiber, to simplify the rollout, to speed up the rollout and to be more efficient in the areas we're building. And we will probably not go above that level. It's good to build a machinery and to keep it for a while on that level, and that is far enough. So it doesn't make any sense to stop after coming year. Well, until now, from a CapEx point of view, we're decreasing CapEx on all kind of buckets and moving that more to the fiber side. And of course, together, we are working now on the plan for the coming years on what to do.

Yes. So Mike, if you split up our fiber into -- CapEx in fiber and nonfiber buckets, even nonfiber piece clearly is declining over time. And we'll communicate and disclose more on that in due course, but you will see that we are able to reduce CapEx over time and not have an internally increase in CapEx cost. So in nonfiber portion of it is declining. And the fiber part is increasing, that's a deliberate and dedicated management decision. And there, we heavily weigh, of course, the return that fiber makes. And it's a bit of a delicate balance on what you communicate on fiber return because you don't want to antagonize the regulator with having too high returns on fiber. So it's a very -- so what -- I mean my strategy is to give all the ingredients, the elements like penetration, ARPU, churn, so that's pretty simple for somebody outside the world to redo in a basic excel model, what the ROI on fiber is. It's safely north of 10%, where penetration is actually the biggest driver of that IRR or because it's a long-term sort of cash flows. But with the current penetration levels, we are north of 10%. And if you push that penetration higher, actually becomes more attractive. So we believe that investing in fiber is a value-creating strategy. It's the right way to deploy capital. And we're, to some extent, constrained -- not even as much by our balance sheet, constrained by how much construction capacity is there in the market because you don't want to raise the prices by just keep on adding new construction workers to your team. We're locking in our capacity for the coming years. And as Joost said, we've got a machine that fits out 400,000 to 500,000 homes and produce the returns that we're talking about. It would be a way to do the 20 for 1 year and stop it thereafter.

And I think it's important that we explain the case well to ourselves and the markets. 50% of the sales we do in broadband is now coming in from fiber, while we only have 1/3 of footprint in the Netherlands. ARPU is higher, and churn is lower. Quality is better. So the business case is really working. It's not a plan for the future. We built a business case in 2008, and it was a combination of wholesale and retail. And currently, we're moving exactly on that level, and there's no reason to think that we're not going to improve that business case in the coming years. There's no reason that at the end we will be dominantly present in fiber areas because it's the clear best infrastructure. So it is not a plan for the future. It is what we currently see in 1/3 of the Netherlands, how good that fiber case is working. So that's why we're super positive on it.

Yes. Perhaps, I mean one thing that caused perhaps a disproportionate sort of -- disproportionate amount of questions that the last quarter was your small acquisition of an over-builder. Setting that aside because it was a very small deal. More broadly, what do you see today as the overbuild landscape in the Netherlands? And if you're ramping up and essentially taking a lot of the build capacity, does that pressure over-builders? Or is it easy to cooperate with over-builders? How do you think about essentially partnering or buying over builders versus your organic build with your 10% plus IRR?

Well, first of all, we don't have overlap of fiber in the Netherlands, like in other countries, that's all we avoided. That's us dominantly covering end of this year, 2.8 million households and delta by EQT currently has a footprint of 400,000. They rolled out mainly in the rural areas, it's all KPN management. So they knew we wouldn't go there, that's for us not a priority region. And then there are other initiatives in the Netherlands. But yes, rolling out fiber is one thing, running a telecom network is the second. So usually, they come to us and they ask us, can you activate the network, connect it to KPN? And how -- yes, could you, by the way, run it for us? And then we usually say, we will do that, but we want a call option, and we want to make a good deal on mid-term. So the thing we bought, what was it last quarter, we knew it was coming because we would never have made an OEM deal with these guys if we wouldn't be able to buy it. So -- and we -- and the way we look at things is that we compare it to our own rollout plans. And we look at the opportunity, and we make a decent decision on it. It's very small. And it is adding value to our base. We do it. But these are all pretty small initiatives between 1,000 and 5,000, 10,000 households max.

Perfect. That's really clear. And actually, one topical question I've just seen on my screen from the audience is there's a question saying, look, there's very big bids for infrastructure companies the last mile fiber assets, which KPN has a lot of. Would KPN sort of do the opposite and ever considered becoming capital-light and doing a sale and leaseback of the fiber assets if the valuation was high enough to free up capital. I mean just a sort of theoretical question.

Yes. Well, the thing is that we are -- we make our money on our assets. And selling off these assets is one way, but then it's -- then you are more or less selling off the heart of KPN. So what we think is that we have a very healthy balance sheet. What we currently do is bringing in a lot of value, running a fiber co more separately, is probably a good idea. Selling up the fibers, yes, that's not really the best way to create the max value, we think. It is important to understand how the case works. It is important to report on all the numbers we do on fiber, probably separated more from what we do on copper. But it in our current strategy, it is more or less the fiber co we're building and the simplified serve co we're digitizing, and that will be the future-proof KPN, and that's the value of KPN.

So that's super clear. I mean just really 2 questions to finish. Firstly is on free cash flow. Over the years, KPN has had quite a few moving parts below operating cash flow, things like restructuring, more recently, working capital mix changes. And Chris, I know you've already come in and introduced a lot more disclosure here, which has been really helpful. But how do you foresee the working capital outflows in 2021 progressing related to fiber? And perhaps similar, how would you lead us to think about restructuring charges on a similar time period?

Sure. On the latter, restructuring charges, are gradually declining over time. We had a future restructuring behind us. I think in this very year, in 2020, there'll be bit more backload than front-loaded simply because in the first half, during the lockdown, we held back on restructuring in close cooperation with the unions and the works council. So there will be some uplift in restructuring charges in the second half, although not massive, but it's kind of how the balance in the year. And in the coming years, I can see them continuing, but probably not at the same level as we used to have. And when it comes to working capital, I hope the disclosure helps you guys a lot. I mean rolling -- increasing the fiber rollout due to the payment scheme that one has, the delta in fiber drives actually your working capital consumption because you have to prepay your field services construction partners. So working capital is a bit of a drag on free cash flow this year. And we've taken a whole range of initiatives in a working capital program to limit that to being able to counter a lot of it. So when I look at my numbers, I see underlying a drag on working capital, headline mitigated by all series of working capital measures and optimizations. So therefore -- that actually ends up with some negative, but a reasonable number. I would say the drag from working capital decline in the coming years should probably receipt. So because the delta -- the step-up in number of homes become less. We make sure w move to 500,000, and then we're going to step up around 500.000. And it's the delta in number of homes that drives actually in the long run your working capital consumption. So I'd expect next year, working capital might still be a small drag, but too much smaller than that is today.

Perfect. We're nearly out of time. So I just wanted to come to how you think about shareholder returns. I mean if we think about KPN over the last 5 years, leverage has come down a lot. And in recent years, you've had a number of disposals. So how should we think about your target leverage for the company given everything you've highlighted, really, which is high levels, you're well invested. And then secondly, how should we think about any leverage ambitions tying into shareholder returns policies? I think the dividend is very clear, but incrementally, I think we've been getting 1 or 2 questions about whether you consider a buyback again, and that's something that KPN, as a company, has done in the past.

Sure. When you -- it starts with our balance sheet, right? We've got a healthy balance sheet with a fair dose of cash on our balance sheet. Good flexibility in our funding program. We've got a CP program out there. We issued a bond last week. And leverage is around 2.3x net debt to EBITDA with an internal positive guidance of up to 2.5. And I think that -- I have no issue going to 2.5 if we have the right application, that would still keep us safe within the investment-grade rating band. And within the average of where the European telco landscape is in terms of leverage. So I think today, we're just probably at or slightly below the average. So we've got room to maneuver. Our question is how to balance buying back shares and investing in fiber? And what makes the best returns? Can you do both? Are we at or one or the other? Is it end one and end the other? So some it's actually on our mind, but we -- it's important to do that in a comprehensive way. This's not a rash decision to just buy back shares just for the heck of it. If you do it, it needs to be be something like a program, a framework at which one can decide. So it is on our mind because we are aware of where our share price is. We are aware of our investment plan. And it's in the coming period for us to tie all of that together, but luckily, we can do it without a position of strength with sufficient balance sheet flexibility.

Perfect. That's a great place to finish, and it just leaves me to thank you, both, very much for your attendance. I have really enjoyed the session.

Thank you. Thanks very much.

Thanks.

Bye-bye.