Telefónica, S.A. (TEF) Earnings Call Transcript & Summary

Good morning, everyone. Good afternoon, everyone, in Europe. It's a pleasure to welcome back Telefonica management to Communacopia. Today, we have Chairman and CEO, Jose Maria Alvarez-Pallete; and Chief Financial and Control Officer, Laura Abasolo. Welcome back, and thanks again for coming.

Our pleasure. Thanks for having us.

Great. Just as a quick reminder for those in the audience, there is the ability to register questions online, which I can try and weave into the Q&A. And also potentially get to at the end if we have time. But firstly, I'd love just to pass over to you for a short introduction.

Well, thank you. The first message I would like to send is that as a sector, and namely us as a company, we think we have been having a very resilient performance during the COVID situation. It has, of course, impacted us in different levels, but we have been having a very, very strong operational focus during the pandemic, namely in our 4 core markets. And thanks to that, have been able to deliver year-on-year growth in both the second quarter and the first half of the year in operating cash flow and operating cash flow margin. We have been having a significant commercial improvement throughout the quarter, in particular during the month of June, and especially in the high end value accesses layer of the market, we have been able to do that with a decline in churn. It is true that churn was kind of frozen during the pandemic, but when markets were reopened and the stores were reopened, very good performance in terms of churn. And therefore, we have -- all of this has resulted in an increased customer lifetime value. We have been able to do that because of our infrastructure, the infrastructure that we have been building. Another important message out of the pandemic is that digitalization has accelerated. In our case, online sales have been up to 39%, which is 11 percentage point more than a year ago. And digital channels are up 17% versus the first quarter. Strong free cash flow generation, almost EUR 1 billion free cash flow -- free cash flow in the second quarter. That should accelerate during the second part of the year and a significant liquidity position. So in spite of COVID affecting us in terms of weaker revenues in some leisures like roaming or others or handset sales, pretty strong or pretty resilient performance. That has allowed us to confirm our dividend. It is true that we have been giving up guidance as we have it structured before. But we have been guiding towards or indicating towards the amount CapEx outlook maintained at slightly negative to flat at the end of this year. And basically, we have reiterated the long-term guidance of 2022 organic revenue growth and an expansion of 2 percentage points of OIBDA minus CapEx. In terms of strategy execution, we have been basically sticking to the 5 messages that we gave back in November last year, our core markets, trying to strengthen our position in our core markets, and that explains the transaction that was announced in the U.K. with Liberty Global that also explains why we are trying to improve our position in Brazil through this potential with the offer that we have done for OI mobile assets jointly with America Movil S.A.B. and again, pretty strong performance, operationally speaking, in the 4 core market with OIBDA minus CapEx, basically growing almost 2% year-on-year. We are trying to reduce our exposure to Latin America. We have not been able to perform an inorganic transaction, but we have been assigning more debt in local currency to Latin America in order to try to reduce the volatility of the euro return generated in the region. And you should expect from us to keep going into that direction, both in terms of leverage of data assignment, but also in terms of inorganic moves. In the meantime, we are improving our organic performance in the region. And in organic terms, OIBDA minus CapEx have increased 10% in local currency in Latin America. In Telefonica Tech, we keep evolving. We have been working very hard in the segregation of the assets. The spinning off of our assets, people and products and services. And cybersecurity is almost complete. Cloud, we are significantly advanced. So we have started to report pro forma revenues, and you should expect from us to keep reporting the overall financial estimates of that unit as we work in order to put that in value. In terms of Telefonica Infra, we have been transferring 10,000 towers from Germany, Telefonica Germany into Telxius, in a complex transaction. And now Telxius is 1 of the largest towers companies in Europe. And we have been building optionality through fiber projects, both in Brazil and in Germany. And then finally, in terms of operating model, we committed with the market that we will be expanding 2 percentage point of our operating cash flow margin going forward. We have significantly improved that during the first half of this year. So we have now proof points that we are heading to the right direction. So overall, our resilient performance during the crisis, we reaffirm other strategic pillars. And it is something, we are going to try to accelerate execution in the second half of the year. I propose to stop there and give ground for Q&A.

Perfect. Thank you very much. And I'd love to pick up on pretty much all of those topics, actually. And perhaps just starting with the impact of COVID, which you highlighted was quite material in the second quarter. Could you give us an indication of how some of the temporary COVID impacts might be starting to come back in the second half and things like the trends on roaming, but also sports in Spain?

Sure. First, let me try to summarize how we have reacted as a group to COVID. The first thing when the confinement was declared in the different countries, we immediately act on the offer. And therefore, we put more content in most of the places, we increased data allowances. So we put more value so the customers could feel that we care about them. In terms of home projects, we immediately started remote working. The 95% of more than 120,000 people were working from home that has never been done before in the history of Telefonica, and it worked. We now -- we have the tools in place to have all the processes to make it efficient. So we have been able to preserve the activity of the company because of our employees have been working from home. In terms of suppliers, we try to protect the weakest part of the supply chain by extending -- by shortening payment terms to our suppliers. And therefore, also to try to contribute to our customers -- to SMEs customers in order to improve their working capital. In terms of society, we created a fund in which we have been buying medical equipment in the different countries. And in terms of our shareholders, we have been preserving our dividend. The impact of COVID on us in the first half of this year has been pretty significant, I would say. EUR 730 million in revenues in the second quarter and almost EUR 340 million of OIBDA. So it has not been that we are immune, but we have been pretty resilient. We have been able through OpEx contention. OpEx has been down 4.9%, and CapEx has been down 23%. And therefore, that's why we have been able to preserve at the group level, operating cash flow with basically a stable performance of minus 0.7%. So we think that immediately after the lockdown was lifted, we saw a significant pickup in mobility. We opened our stores and we have a different performance in the different countries. So I will try to summarize the different -- the 4 core markets, so to say. In the case of Spain, June and July were robust. August was weaker because we have not been having roaming revenues coming from tourists because in order to give you an idea, visitors from the U.K. or from Italy are down 80% to 90%, so significant impact in roaming. And -- but the reality is that we have been stronger on B2C because the football season has been extended. And therefore, the period of time, the seasonality of time in which churn increased because there is no football for 2 months, has been reduced to 15 days. So better trends in terms of commercial activity and net adds because of churn -- of lower churn. And also in terms of second line, the residential markets, so Spain is evolving according to the guidance that Ãngel Vila, our Chief Operating Officer, shared with you at the time of our second quarter results. So heading towards the second half of the year that should be stronger, both in KPIs and in financial terms at the first half of the year. In terms of Germany, GDP is recovering much in Germany, is stronger than in Spain, and we feel that, and we feel that in commercial activity, in all layers. I mean, in prepaid, in postpaid and also in the wholesale segment in Germany that you know is very, very important. So Germany heading towards a stronger, I would say, performance compared with previous quarters. In the case of the U.K., different elements. I mean, in terms of roaming, similar impact to the case of Spain in terms of handset revenues as well. Those are important features. But also in the case of the U.K., the SMIP this is the Internet of Things, a big contract that we have of gas meter, water meters installment in the U.K. is taking time to retake the traction that we had before. So it's improving, but it's going to be taking a little bit more of time to have the run rate that we used to have in terms of growth going forward. So commercially speaking, strong, but not as strong as Germany. In the case of Brazil, I would say a strong recovery, strong recovery in prepaid, which is important. Nice recovery in terms of postpaid. I mean -- and strong recovery in terms of fiber adds. According to expectations in terms of DTH disconnections and the wireline -- voice wirelines evolution. So overall, to make a long story short, in the case of our 4 core markets, we are a little bit above our own expectations when we were running our simulation for the second half of the year. So it should be a quarter according to our expectation or a little bit above. I'm waiting for the fourth quarter to see how it looks like by overall, according to expectation or slightly above.

Perfect. That's really helpful in terms of running through the markets. And I'd love to just come back to Spain. There's a lot of focus as ever in Spain on the current competitive situation. It sounds like what you're saying is that you're pretty happy with the performance in the mid and the high end segments. But I'd love to get a bit more color on that and also addressing how you see low end competition in Spain as well.

Sure. Before COVID in Spain, we were heading towards revenue stabilization. It took us a while to head towards that because of the structure of the market and the intensity of promotions and discounts on the market. COVID has altered that because of these roaming effects and others that we have shared. So in the case of Spain, Spain is roughly 50-something, 56%, 58% B2C. Roughly 20-something B2B and 19% wholesale. In the case of B2C, high end of the market, basically, it's a 2 player scenario, Orange and ourselves. Intensity, commercially speaking, is a more rational market overall. We have some tactical promotion as we speak now in the month of September because there is the over-the-top that used to have the football rights is no longer having them. And therefore, there is roughly 80,000, 90,000 customers that are available for being converted, so to say. So it's a fight between Orange and ourselves. But it's very tactical and very centered around this group of customers. So churn on the high end is relatively low, and value is being preserved as we speak. And this is this tactical fight for this segment of customers. In the mid end, mid-end for us accounts for part of our Fusion tariffs with Movistar brand and also Orange, but also the MasMovil, the Euskaltel and the Vodafone brand, the Vodafone brand. On that regard, intensity is high, but we see some signs of rationality. And that's because of 2 major facts. The first 1 is the tender offer on MasMovil. According to the numbers of the simulation we have been running, the returns that are going to be required for this new capital structure means that there is less room for doing aggressive promotions because of the wholesale retail pricing. And something similar happens with Euskaltel. So we think that at the mid-end rationality or aggressiveness should be mitigated going forward. I mean at the low end, very, very active, very intensive. I mean, with different brands, [Louis,] in the case of Vodafone, Amena, Jazztel itself and Digi, I mean, a lot of -- so the low end, very, very dynamic, very, very competitive. And we don't see any signs on that regard going forward. A lot of rumors around potential consolidation derived from some of the transactions that are being under place, but no facts, so to say. I think that if consolidation was to be proposed, it would be welcome. And whatever we can do to facilitate that in terms of wholesale agreement, long-term wholesale agreements at rational pricing, we'll try to be supportive if that was to be the case. But for the time being, those are just rumors, not facts.

No, great. That was actually my next question with consolidation. And perhaps I could just ask on top of that because that's a really clear view from your perspective. Do you see a change in stance from the European Commission potentially following the legal case in the U.K. around the O2 merger potentially to help validation team?

Well, let me try to answer in a separate bucket, so to say. I will try to focus first on the U.K. approval process. And then an overall answer to the, I would say, mood -- Europe towards consolidation or potential regulatory changes. In the case of the JV very, very aligned with Liberty and trying to have the approval process in an expedited manner. Not clear for us if this is going to be decided in the European Union or in the U.K. because Brexit is in the middle. So if it is the European Union, that's good news because that means that it's in Phase I without significant remedies. But we are working with -- in parallel with both the European Commission and with the CMA because it's not clear for us who is going to be the decision maker. We think all the merits of the transaction means that under the theory of harm analysis, there is no impact on the vertical businesses in terms of the MVNO market or the mobile -- or the wireline broadband market. But neither horizontally. So I think that it has all the merits to be approved in an expedited manner, whatever that's decided in the U.K. or in the European Union. In the meantime, we have been working very intensively on -- through clean teams to solidify the synergy that we have been sharing with the market. This GBP 6.3 billion of synergies in the different chapters. And now we have much more comfort through these clean teams that those are executable and realistic synergies. The third pillar on that thing is the -- there were 2 conditions present, 1 of them being the regulatory approval. The other 1 was the financing of the transaction. We executed the financing of the transaction last week, did 3 different tranches in 3 different currencies. So very successful financing effort. So the transaction is just now subject to regulatory approval. And then finally, the management team has been discussed as we speak with Liberty. So very advanced in order to be prepared for whenever. Having said that, we think it should be approved in an expedited manner and without significant remedies, either in the U.K. or in the European Commission. Now in overall -- because we think it's an easy transaction to approve. It's fixed to mobile, no vertical or horizontal integration in different markets, so no concentration. So it's an easy one. I think it should be an easy one. Overall mood on consolidation in Europe, if the pandemic has proven something is that networks are essential. The only country in Europe in which the video signal has not been degraded was Spain because we have the fiber network. So ultra-broadband network are essential going forward. And 5G is going to be an essential part of the recovery program all around Europe, namely in Spain, but all around Europe. And that means that this pandemic has been accelerating some digital changes that were supposed to occur in the next 3 to 5 years. Cloud adoption, video streaming, education, remote working, so every single thing that we were scheduling or projecting to happen in 3 years' time is happening now. And some of those effects are here to stay. I mean the cloud effect or the education or the remote working, some of them are going to be preserved over time. And that cannot happen without strong networks. And that means that in most of the countries, I would say, in all of the countries competition authorities and telecommunications constituencies are starting to realize that the networks have become obsolete. The definition of relevant market is no longer valid. I'm no longer just competing with Vodafone or with Orange or with MasMovil or with Digi here in Spain. I am competing with WhatsApp for voice, I'm competing with Netflix for video. But they are not even recognized in terms of relevant definition of market shares. So this is changing. A proof point of that is that last week in Spain, WhatsApp and Facebook have been declared telecommunication operators for the purpose of telecom tax. So the definition of the relevant market is going to change, and that's going to be altering the concentration parameters going forward. So I do think this is a game changer. I don't know how much time this is going to take, but I think it is reversal.

That's really interesting. And it actually brings me just about to my last question on Spain, which was often, I think for investors looking at the Spanish market, the fiber to the home landscape is often seen as quite complex, partly because you have some overbuild, but often because you've got lots of different wholesale agreements between the different parties. So could you just update us on how you see this evolving and also how you think about the impact on Telefonica when you think about your wholesale business in Spain and/or maintaining or even growing your own network utilization?

Sure. I think that a very important message upfront is that the wholesale market on fiber is radically different from the wholesale market of traditional copper or mixed network, so to say. Why am I saying that? In the case of Spain, the price at which you unbundle a copper line is a theoretical cost calculated by the regulator and is around EUR 9. The [Neva,] the access to our fiber network is EUR 70. That doesn't mean that we cannot sell below EUR 70. It means that whoever requires [neva] from us needs to be at must -- at EUR 70. And because of those are brand-new networks, there is an incentive not to overbuild. Because if you have a dynamic bilateral commercial agreement and focus market, means that you reach agreement with third parties. Initially it was Vodafone with Orange and then, we jumped on board on that. And now you have 4 different players that are exchanging coverage of deployments with others. That means that for us, in the case of Telefonica, namely, it is accretive because the more we shift 1 copper wholesale access for 1 fiber wholesale access is accretive in terms of revenues. And for the first time in our history, we have more customers with fiber wholesale access than with copper. And that's why wholesale revenues are starting to grow. So it increases or accelerates the return of your recently deployed fiber network and it creates a market in which the regulator has no incentive to play because you have a very active and dynamic commercial market. So I think that in the case of Spain, the overbuilt, is mostly numerical because some of the accesses that Orange says they have or Vodafone, they say they have or MasMovil say they have are indirect access to us. And vice versa is like myself in Germany, I have access -- indirect access to Deutsche Telekom network or to Vodafone cable network. So I think that it doesn't need to be derived from an overlap of networks because then you have a same cost and you are not incentivated to realize the value of that network. In the case of Spain, it's a very dynamic fiber wholesale market with a cap put by the regulator, but with enough commercial flexibility for you to build on your tariffs. So I think -- and that's why wholesale has become a source of growth for our revenues in Spain. And remember that wholesale is 19% of our revenues in Spain.