Telefónica - Earnings Call - Q1 2011

Transcript

Speaker 7

Good afternoon, ladies and gentlemen, and welcome to Telefónica's conference call to discuss January-March 2011 results. I am María García-Legaz Ponce, Head of Investor Relations. Before proceeding, let me mention that this document contains financial information that has been prepared under International Financial Reporting Standards. This financial information is annotated. This presentation may contain announcements that constitute forward-looking statements, which are not guarantees of future performance and involve risk and uncertainties, and that certain results may differ materially from those in the forward-looking statements as a result of various factors. We invite you to read the complete disclaimer included in the first page of the presentation, which you will find on our website.

Speaker 3

Good afternoon, ladies and gentlemen, and thank you for attending Telefónica's first quarter results conference call. Today, I have with me Julio Linares, our Chief Operating Officer, Guillermo Ansaldo, Head of Telefónica España, José María Álvarez-Pallete López, Head of Telefónica Latinoamérica, Matthew Key, Head of Telefónica Europe, and Miguel Escrig Meliá, our Chief Financial Officer. During the Q&A session, you will have the opportunity to ask questions directly to any of them. Q1 results prove a solid start to 2011, with a performance that is totally in line with our expectations and therefore affirms our full-year guidance. Our high diversification continues to drive our results, boosting top-line growth and sustaining our best-in-class profitability. The exposure to Latin America, and especially to Brazil, drives our superior growth profile, already accounting for 45% of our sales in OIBDA.

On the other hand, a ripe data offer to fully monetize the ramp-up in data adoption has led to a 19% year-on-year organic growth in mobile data revenue. As we explained at the beginning of the year, 2011 marks a change in our commercial strategy, with an increased focus on value instead of changing volume. In parallel, we continue strengthening our networks and platforms to meet customers' demand. Please turn now to slide number 3 to quickly review the first quarter of 2011 major financial metrics. Reported year-on-year growth rates are positively impacted by changes in consolidation, mainly the full consolidation of Vivo and Forex. Nevertheless, performance in organic terms remains solid. Revenue grew steadily by over 10% in nominal terms and 1.4% year-on-year in organic terms. OIBDA reached close to €5.6 billion, up 9% in reported terms, with a slight organic decrease.

As a result, we continue to post a robust OIBDA margin at 36.1%, showing a limited erosion year-on-year. Operating cash flow exceeded the €4 billion mark in the quarter, with a 4.9% year-on-year decline in organic terms impacted by a different pace of CapEx execution versus a year ago. Net income reached €1.6 billion, declining 1.9% year-on-year despite the strong growth in OIBDA. This is explained by several factors. D&A increased year-on-year, mainly driven by the full consolidation of Vivo and the recognition of €86 million in the quarter due to the amortization of Vivo's purchase price allocation. Please notice that total PPA increased 13% year-on-year. In organic terms, D&A was pretty flat. Profit from associates also drove net income down, mainly as a result of PT's deconsolidation from the second half of 2010 and the lower contribution from China Unicom year-on-year.

On top of these impacts, profit attributable to minority interests dragged €110 million from net profit in this quarter, mainly due to the change of consolidation of IVO and the very strong performance of its earnings. As a result, earnings per share reached €0.36, or 1.5% down year-on-year. Excluding the impact from the purchase price allocation, EPS would stand at €0.41, 0.2% up versus the first quarter of 2010. On slide number 5, we detail our value-oriented customer base and revenue growth drivers, stressing the benefits of our broad diversification. Growth in the first three months of the year was underpinned by the continued expansion of our mobile base, on the back of strong growth in the contract segment, which accounted for close to 60% of net adds in the quarter and already represents one-third of our base.

By regions, Telefónica Latinoamérica continues to be our key growth engine, which, combined with the solid performance posted by Telefónica Europe, outpaced the decline in Telefónica España. By services, we continue to evolve our revenue mix, increasing our exposure to the fastest-growing businesses. Mobile services, including fixed and mobile and services beyond connectivity, already account for 25% of our sales, with a strong growth from these services offsetting the lower contribution from traditional voice services. I'd also like to highlight the very positive performance of organic revenue growth, excluding MTR cuts, which would stand at 2.4%. Smartphone demand and data usage continue posting a strong momentum, especially in Europe. Total mobile broadband penetration has reached 12% of our total mobile base, or up two percentage points versus December, with significantly higher figures for both Telefónica Europe and Telefónica España.

The increased customer base and our data tariffs with tiered pricing launched across markets have led to a remarkable 19% year-on-year organic growth in data revenues, in line with the growth recorded in the previous quarter, driven by the 36% increase in non-peer-to-peer SMS revenues. On the hot topic about SMS cannibalization, it is true that there is a growing adoption of messaging applications among our customers, but thanks to the right tariff plans, we are being able to monetize new usage patterns, and therefore, we are strongly growing our total data revenues. Let me stress that peer-to-peer SMS revenues are growing 5% year-on-year in organic terms. What is key for us and for the industry as a whole is that we are generating more revenues.

The split by concepts really depends on the type of bundles and revenue allocation criteria that each player applies, and therefore, on the different commercial policies of each company. Turning to slide number 7, Telefónica continued to post a very healthy OIBDA margin in the first quarter, despite increased efforts to boost contract and smartphone penetration, which drove commercial costs up and higher network costs. This performance highlights the benefits of further cost-savings initiatives. Our scale and efficiency gains derive from our integrated management model, with tangible savings from global projects. By region, I'd like to mention the good margin at Telefónica Europe, and the pretty flattish year-on-year performance at Telefónica Latinoamérica, which partially offset the margin erosions suffered in Spain.

Before turning to the regions, let me stress that the first quarter results are in line with our full-year outlook, and as we anticipated last February, growth rates will accelerate in coming quarters as the guidance is back and loaded. Let's now move to our operations in Spain, where trading conditions continue to be tough, with a strong price-oriented competition and no recovery in voice usage patterns. In this context, our strategy has focused on value, with limited commercial activity in this quarter. However, it is relevant to highlight that negative revenue trends seem to be easing, though we need additional quarters to confirm this trend. In the first quarter, we posted sequential improvements in revenue across businesses, mainly driven by better data growth. Costs remain virtually frozen, with personnel expenses being the only item rising year-on-year due to the impact of 2010 CPI.

As we announced, we are working to have a more flexible labor framework, and we have just had the kickoff meeting negotiations with the unions. Non-labor costs continue to decline, despite the negative effects in commercial costs of the increasing weight of smartphones on our sales. Our permanent focus on efficiency does not mean that we give up future growth. We are investing to continue enhancing our quality gap versus peers, expanding mobile broadband capacity and coverage, and progressively rolling out fiber and VDSL. In the coming quarters, you should expect some slowdown on CapEx growth because of a different execution path versus 2010. Slide 10 adds more color to the performance by business. In wireless, MSR continue under strong pressure, though there is a mild sequential improvement driven by outgoing mobile service revenue on the back of the double-digit growth in data revenues.

Regarding RPUs, there are two different realities. On the one hand, the continued fixed-price competition in voice is leading to lower prices, but no elasticity driving voice RPU down. On the other hand, data RPUs are starting to gain momentum on strong mobile broadband revenues. In the wireline business, a similar reading: voice is not recovering, and broadband continues to be strongly affected by competition. Nevertheless, we have recorded a good performance in data and IT revenues in both areas in which, to be competitive, you have to rely on differentiated quality infrastructure. All in all, we do not see big changes in competitive dynamics in Spain, but we continue to rely on our differential capabilities to defend our value leadership.

Moving to slide number 11, to review our Latin American operations, you can see that in the first quarter, we grew our customer base by 8% year-on-year on the back of double-digit growth across different services, with the exception of fixed taxes, which remains stable. This is a remarkable performance in the region and shows that the strong growth of some of our services is not cannibalizing others. Let me also stress that 20% of our mobile customers have a contract, and 44% of the net adds recorded in the quarter were also contract. Regarding financial metrics, I'd like to highlight the strong acceleration in growth in Brazil, which has become Latin America's main growth engine. On top of that, we continue to deliver a consistent performance in the southern region.

On the other hand, the weakness in Mexico and the lower contribution from regional projects have negatively impacted our results. If we were to exclude these initiatives in both years, organic growth would ramp up from 2010 year-end. We have been able to deliver top-line growth, maintaining our solid profitability in contrast with market trends, reaching this quarter an OIBDA margin of 36.2%. Moving to the next slide, let's look at revenue breakdown by business. Wireless already accounts for almost two-thirds of our revenues and keeps growing at double digits. The fixed business, although at a lower pace, also posted an outstanding 3% organic growth year-on-year. Outgoing mobile service revenue recorded a very good 13% year-on-year organic increase, driven by the combination of an expanding customer base and RPUs, with mobile data being clearly the key growth engine. The positive performance in outgoing voice contribution also should be mentioned.

Fixed revenues accelerated their growth pace in the first quarter, thanks to the increased penetration of broadband and pay-TV services. This led to a ramp-up in these revenue streams to double-digit growth rates. Please turn now to slide 13 to review our outstanding performance in Brazil. Two quarters after we increased our stake in Vivo, it is evident the improvement in the operating and financial performance of the company, which has been accompanied by better results from our wireline business. We continue to lead the wireless market, where we are further increasing our contract market share, leveraging a best-in-class data network. Telesp, despite weather factors affecting its commercial activity in the first quarter, has continued to accelerate its transformation, and therefore, fixed broadband revenues. Nevertheless, it is worth highlighting our enhanced commercial TV offer, with positive net adds for the second consecutive quarter.

Q1 total revenue growth in organic terms almost doubled the growth rate posted in 2010, while for the first time in the last five quarters, we are expanding our margins in Brazil on a year-on-year basis. All this despite the fact that synergies generation year-to-date has been limited. As a consequence, first-quarter organic OIBDA growth reached 12%, and consolidated OIBDA margins stood at 36%. Clearly, our Brazilian operations are outperforming market peers, as mobile service revenue is showing. To finish with Latin American operations in slide 14, let me just make two comments. In Mexico, operating trends remain similar to the previous quarter. We continue recording a strong performance in the contract segment, while the weak results in prepaid drove down revenues and OIBDA. There are some initial signs of improvement in commercial activity.

Gross ads grew 17% year-on-year, and traffic is growing sequentially for the second quarter in a row. We need more time to see a recovery of the business here. In the southern region, our operations posted solid top-line growth, showing an acceleration in the first quarter, with some OIBDA margin expansion on the back of higher margins in Chile and Peru. In summary, very good in Latin America, benefiting again from our diversification and where Brazil continues to post stellar performance. Let's now turn to slide number 15, where we show that Telefónica Europe delivered strong financial performance in the first quarter of 2011, as it continued to implement its value-over-volume strategy, especially focusing on mobile broadband, while also driving growth from new business areas. Mobile broadband penetration continued to accelerate, reaching 27% of the total mobile base at the end of March 2011.

This, coupled with improving quality mix, led to a total organic revenue up 4%, excluding MTR cuts, with non-peer-to-peer SMS revenue contributing close to 3 percentage points. OIBDA rose 6% year-on-year in organic terms due to profitable data growth and continued efficiencies across the business. As a result, OIBDA margin increased 1 percentage point on March 2010 in organic terms, exceeding 26%. From a network deployment perspective, we are progressing well on our investment program, thus helping solid cash flow generation. Telefónica UK, as slide 16 shows, consciously took the decision not to chase volumes this quarter, but to continue generating value from the best quality customer base in a competitive market, particularly at the lower value end. Despite lower upgrades, contract churn remains stable at a market-leading 1.1%, further proving that Telefónica has the right foot in the UK market.

Contract smartphone handset sales were 82% of sales and upgrades in the quarter, increasing the penetration over total addressable base to 33%. This, together with encouraging trends in the adoption of tiered data tariffs from new and existing customers, led to a solid 10% year-on-year data revenue growth, which fully offset voice revenue performance, driving total revenue growth of 5%. OIBDA margin increased 2 percentage points to 27%, mainly as a result of the lower trading activity we found this quarter, but also due to our consistent approach to maximize customer lifetime value. Although CapEx evolution in the first quarter does not signal trends, let me highlight here the tangible benefits we are having from spectrum reforming in the 900 megahertz band, with limited additional investments. Let's now turn to slide number 17 to review our operations in Germany.

In the first quarter of the year, the company posted solid commercial activity. Contract net adds were strong and accounted for 67% of total net adds in the quarter, backed by the successful adoption of mobile broadband and further improvements in churn. Mobile broadband penetration continued to rise to 22%. These results show the benefits from the investment in spectrum and the company's focus on value. In parallel, the prepaid segment recorded solid growth from the partner channels. We have finalized the integration of Hansenet, resulting in further cross-selling opportunities ahead of us. The good commercial performance is reflected in the financials. Total mobile revenues, excluding MTRs, ramped up to 12%, driven by the robust stable evolution of data revenues, which already represent 39% of mobile service revenue. The strength in non-peer-to-peer SMS revenues continued, with growth accelerating to 32% year-on-year.

Also note that handset sales rose strongly due to the myHANDI model, which actually decouples handset subsidies from service revenues. OIBDA margin remains stable year-on-year, despite the commercial focus on contract, thanks to the company's efforts and efficiency, with the restructuring program commenced in 2010 expected to generate further benefits from the second quarter. Turning to slide 18, I would like to highlight that we have reduced net financial debt back to €1.4 billion from December 2010, which has allowed an improvement on the leverage ratio of 0.08 points to 2.42 times OIBDA, including commitments as of the end of March. The decrease in financial debt is explained mainly by retained free cash flow, bigger interest payments versus accrual interest, the FX translation of non-euro debt, and positive mark-to-market on cash flow hedges with no impact on the P&L.

Financial expenses add up to €579 million with the marginal FX P&L. Taking into account the total average debt in the period of €55.6 billion, the effective cost has been 4.23%. In the coming quarters, we expect an increase on the effective cost, driven mainly by outstanding forward starting swaps for fixed rates in the long term and our expected increase of short-term rates. It's also to highlight the fact that we have restored Telefónica's average net debt life over six years, after a temporary deviation in line with our commitments. This was achieved thanks to our balance financing activity year-to-date in the bond and the bank markets, with the latest refinancing of €4 billion on the Vivo acquisition facility initially maturing in 2013. To recap, Telefónica has started 2011 delivering a solid performance as we capitalize on our execution skills and diversification.

Speaker 6

The first question comes from Tim Boddy from Goldman Sachs. Please go ahead, Tim.

Speaker 5

Yes, thanks for the question. I wanted to ask a couple of questions on Latin America. First of all, in Mexico, I was wondering if you could add more color on the challenges you're facing in Mexico and to the turnaround plan you have in place. That would be very helpful, I guess, particularly in the prepaid market that the pressures felt. Secondly, in the UK, just a question around, obviously, we saw a slowdown in growth this quarter as you optimized value, and the margin obviously is very strong. How do you see your strategy going forward? Is it sustainable to continue on this value path? Thank you.

Speaker 1

Thanks for the question. On Mexico, during the first quarter, we still have poor performance, basically because we are still facing the same issue that we had at the end of the previous quarter. You know that in the second quarter of 2010 and the third quarter of 2010, we have eliminated some promotions, free days of traffic, and micro-recharges, betting on a more rational behavior from the market. In fact, it didn't happen. Therefore, we have been reinstalling all those promotions, micro-recharges, and being back on the market. We went back with several traffic promotions, and we made a significant and consistent move, and this has created tension in commercial expenses that are partly explaining the poor performance of OIBDA in this first quarter, as we have not seen yet revenues flowing through the P&L.

It started to happen at the end of March, and we have some good signs in April, but it's still too soon to say. We have as well developed a significant effort in deploying our 3G network in Mexico, once we have the spectrum that we needed. We aim to have a similar cover of our main competitor in 3G by the end of this year, on the most significant part of the Mexican market. That has been creating some tension as well in expenses during the first quarter of 2011. We think that this will mitigate one of the most significant disadvantages that we have in the Mexican market, which is coverage. We have slowed down our migration effort from prepaid to postpaid. We have a more clear picture of the soundness of our database.

We have restarted that migration process at the end of March and in April, and we are expecting to have some result. As a summary, the turnaround is taking longer than estimated. We have some initial positive signs, like a good level of commercial activity. Gross ads were at 60% year-on-year. Outgoing MOU is down 19% year-on-year in the quarter, but during the month of March, it was 31% higher than during the month of February. We have been able to sustain our market share in spite of all those difficulties, and the customers are already reaching 8% of the total customer base. In summary, we acknowledge that we have a weak performance in this third quarter.

We have been accelerating some decisions, both commercially and in network deployment, and we expect those decisions to have a significant hit in the coming quarters that should help us to accelerate the turnaround.

Speaker 5

Hi, Tim. It's Matthew here. Let me pick up your question. From a strategy perspective, we believe we've got the right strategy in the UK, and we would never chase value when we don't think it's there. The reality is the market in the UK, the high street, has been very quiet over the first quarter. No real change in that trend coming into the second quarter. We do see a very high level of competition, where some tariffs that are being sold by some of our competitors, we certainly wouldn't want to do because we think they'd be value destroying. From an OIBDA growth perspective, what you certainly shouldn't be doing is building in the sort of the 14% year-on-year growth through into the second quarter. Let me give you just a bit of color on that.

The two key drivers in the first quarter are firstly upgrades, as Santiago said. They're 24% lower year-on-year, which clearly gives us a benefit in the quarter from an OIBDA perspective. Three things driving that: it's the benefit of the 24-month contract that we started doing about 18 months ago, which we said we would get the benefit with prolonged customer life. It's a little bit about the economic environment, people not wanting to commit to a new two-year contract. Thirdly, I think there's been a lack of sort of clear differentiation from a handset driver perspective in the market. The last thing that I should mention is termination rates. In the UK, in quarter one, we got a one-off benefit of about £12 million. The way the termination rates work in the UK is you have to hit a blended rate over the termination rate period.

Our competitors in the market actually over-indexed on their revenue last year, so effectively had to reduce their rates in quarter one, which gave us a cost of sales upside. In addition, in quarter two, we clearly had to make an MTR cut on the 1st of April, which all hit us by a similar amount in quarter two.

Speaker 6

Thank you very much. The next question comes from Georgios Iridioconou from Citigroup. Please go ahead with your question.

Speaker 4

Yes, good afternoon. I have two questions, please. The first one is regarding the four-year guidance you gave in Madrid for 2% to 4% OIBDA growth. Looking at the first two years, you did less than 1%. This year, best-case scenario is around 2%, probably lower. That means you will need 5% to 6% at least next year in order to get to the bottom end of that guidance. Is it still valid? If that's the case, can you give us some color on what's going to drive the OIBDA acceleration next year? My second question is on the domestic mobile strategy. When France Telecom reported the results, they reported higher commercial expenses, and they signal that's something that could continue. I believe during the investor day, you signaled the potential to reduce subscriber acquisition costs.

Do you think that will be possible if Orange and maybe some of the other competitors remain aggressive on subsidies? Thank you.

Speaker 0

This is Julio Linares. Regarding your first question, I have to refer to the updated guidance that we provided in London in our last investors' conference. As you know, there, we refer to OIBDA margin, and we talk about upper 30s with a limited erosion. That's the reference for our OIBDA margin guidance today.

Speaker 2

Hi, Georgios. This is Guillermo Ansaldo, taking up the second question regarding the domestic mobile market. Yes, in London, I mentioned that our strategy is to, along the next three years, gradually move from the commercial expenditure in mobile from pure acquisition more to retention. That's a gradual movement. It depends, obviously, on the different moments of the market, and it's also segmented across different types of client customers, clusters, sorry. We are starting to do so. Obviously, we have to keep an eye on the market and be very pragmatic. We are already doing that, trying to protect the customers that have the largest customer life value, in order to produce the better value for the company.

Speaker 7

Next question, please.

Speaker 6

The next question comes from Paul Marsh from Joh. Berenberg. Please go ahead with your question.

Speaker 5

Yeah, hi. I've got two questions. Firstly, on SMS trends. In Spain, SMS ARPU seems to have fallen significantly from last year's level of about €1.80 per calendar month to €1.60 in the first quarter. Now, looking back at last year's first quarter, there was a similar fall in the first quarter from the €2 level. I'm just wondering what the reason is for that reduction that seems to happen each first quarter. Last year, it was then stable through the rest of the year. Following on from that, there's a clear reversal of SMS ARPU in the UK and also in Germany, with SMS reversing from year-over-year growth in Q4 to year-over-year declines in Q1.

I'm just wondering if you can maybe cast some light on that, given some of the concerns that have been raised by other operators that smartphones and instant messaging are cannibalizing SMS traffic and revenues.

Speaker 2

This is Guillermo taking up. Let me see if I understand the question regarding SMS. Obviously, SMS overall revenues are up, is following because of the overall macroeconomic conditions and some trends based on the different activity and different substitutes. However, when you take into account SMS and premium SMS, the premium SMS, which puts some noise in the series quarter on quarter, was affected by the level of activity of contests that we have on the market and also in changes in regulation last year. That's placing some noise. The trend is similar this quarter to the other one, as you mentioned before. There's no particular thing that happens one quarter. It varies from quarter to quarter, depending on changes in regulation, which happened more than one year ago. That makes some noise in the comparison and some trends in the market. It's basically the same path.

There's no news there.

Speaker 5

Hi, Paul. It's Matthew here. Let me pick up your SMS point. Let me talk about the UK because I know there were some questions around certainly the level of activity. Your underlying question in terms of are we seeing a shift to IP messaging? Absolutely not. We're not. Clearly, in the UK market, things like BlackBerry Messenger, WhatsApp, and Facebook, etc., have been around for a while. Our SMS per customer year on year is actually up 16%. I think what you might be looking at is the ARPUs on SMS. Recognizing quarter one, we had a voluntary reduction in termination rates on SMS. Across all the networks, we took the termination rate down from £0.03 to £0.02. No OIBDA impact. It's actually offsetting cost of sales because people get the benefit on the other side.

That may be what you're looking at, but we're certainly seeing no shift in customer behavior to IP-type messaging.

Speaker 3

That's great. Thank you.

Speaker 0

This is Julio Linares. Just to give you some more information at the group level, our SMS revenues are growing on a year-on-year comparison basis, 5%. Our mobile data ARPU is increasing on a year-on-year basis, 9.3%. Because of that, our mobile data revenues are growing at almost 19%. That's the result that we see today. As you see, quite positive. Regarding the future, we believe that we will be able to keep good growth based on our current strategy, basically through our tiered data pricing and bundling strategy.

Speaker 3

Thank you.

Speaker 7

Next question.

Speaker 6

The next question comes from David Antony Wright from Deutsche Bank AG. Please go ahead with your question.

Speaker 5

Yeah, hello, guys. It's David here. A couple of questions. First of all, you saw very strong growth in the data and IT revenues in Spain, and I think that offset a lot of the pressure in traditional. I'm just wondering to what extent we should expect that to continue, certainly this quarter, but at that kind of run rate throughout the year, is that valid? Secondly, I guess a question for Matthew. You chose to step away from the high street in the UK because of a perception of lower activity and a little more competition. Can you just give us an update on sort of what you're seeing so far in Q2? Is the consumer still standing back? Are you guys still standing back? Thanks.

Speaker 2

Hi, David. This is Guillermo. Yes, fixed data, as I understand, they're talking about fixed data. It has some very healthy growth during the first quarter. You have to take into account that this is the fixed business. Part of that activity is linked to sales to mobile operators and our own mobile operators. The net is positive, but it's not as impressive, this number. That is a good trend that is affected by that intercompany activity. In IT, it's an activity that has a positive growth, but as it is booked as projects and there's a lot of volatility quarter over quarter. We see a positive pipeline, a very healthy pipeline in IT. You have to take into account that some quarters are higher than others because of the way projects are finished and accepted and booked.

Speaker 5

Yeah, hi, David. As far as the UK high street is concerned, nothing significantly different, I don't think, in our experience in terms of Q2 versus Q1 to date. I don't think we stepped away completely from the high street. We stepped away from where we didn't see there was value. Where we think we can drive value, we are still there. Just to reiterate my point on upgrades, significantly lower upgrades. I'd be worried if I saw our churn increasing, but our postpaid churn is still market-leading, as you can see, at 1.1%. Upgrades probably will kick up a little bit at the end of quarter two, as we start to unwind from the first 24-month contracts that we wrote two years ago. The short answer is no significant change in Q2 trends.

Speaker 6

Okay, very clear. Thanks, guys.

Speaker 7

Next question, please.

Speaker 6

The next question comes from Justin Funnell from Credit Suisse. Please go ahead with your question.

Speaker 4

Thank you. Happy to hear that. Three questions, please. In the UK business, again, there's quite a bit of.

Speaker 7

Justin, sorry, we can't hear you well. Can you repeat your question, please?

Speaker 4

Yeah, I'll shout it a bit. In the UK business, there's quite a few call volumes. Volumes fell about 10% sequentially. I just wondered if Matthew could talk about that. Is that all the economy, or is that some cannibalization of voice by data? Secondly, can you discuss a bit more smartphone uptake in Latam outside your Brazil business? We're starting to enjoy some mass-market adoption of smartphones in the wider Latam region. Thank you.

Speaker 5

Hi, Justin. Let me pick up your first point. I think the question was around call volumes, and I guess particularly minutes of use. The first thing is just be careful not just to look at prepaid, look at a consolidated number, because there is still a trend in the market of high-end prepaid customers moving to postpaid. Having said that, when you look at the combined number, yes, our minutes of use, quarter one on quarter one, per customer down about 9%. I think, as I said to Paul's question, the flip side of that is our SMS per customer, quarter one on quarter one, is up 16%. The other thing I would say is we are seeing some postpaid optimization of bundle usage and the level of minutes outside bundle, and in fact, the level of text outside bundle reducing a little bit in quarter one.

If you strip out the minutes of use and strip out the MTRs and look at customer spend, no significant difference variance in the trend, certainly even from Q4 to Q1. Both sort of minus 2.5%, minus 2.8%, very little movement on that. In summary, minutes of use per customer, yes, it's down. SMS more than offsetting it at the moment. There is optimization, but customer spend trends not significantly changing.

Speaker 1

Taking your question on the smartphones in Latin America, yes, we have seen an acceleration at take-up in the number and in the activity in the market. In fact, in terms of smartphone growth, we have probably more than 120% increase year-on-year. We have basically reached a level of in the neighborhood of 5% smartphone over total volume of total customer. In fact, we are seeing a significant activity and a significant increase in activity as the prices of the smartphones are heading down. We are already approaching a level close to $100, which is where we really think the market is going to be accelerating even more. If you judge upon the impact of all this effort, jointly with Telefónica in the region, we have been increasing our total broadband accesses in the region by more than 83% year-on-year. That is driving up data revenue.

Data revenue is posting a very solid 32% year-on-year growth. We think this is a very sound trend. As the prices of smartphones should be heading down, this trend should accelerate. On top of that, trying to link this question with the previous one on non-SMS revenues, 52% of data revenues are coming from non-SMS related. Very solid trends accelerating, and volume should be very relevant in the next quarters.

Speaker 4

Thank you.

Speaker 7

Next question, please.

Speaker 6

The next question comes from Guy Petty from Macquarie. Please go ahead with your question.

Speaker 4

Yeah, good afternoon, Tim. Just a quick question on Spain. In the presentation, Santiago, you mentioned that Spanish trends seem to be stabilizing, but you'd like to see a few more quarters before you've got any confirmation of trend. What are you actually looking for to see a more positive environment going forward? What are the sort of key things you're going to be measuring? Thank you.

Speaker 7

Just a bit, sir. You want to go first? No, you?

Speaker 2

Hi, again. This is Guillermo. I would take yes. As Santiago mentioned, we see a better performance in the top line in this quarter compared to the last one in several business lines and the overall numbers. Looking at consumer trends and the overall dynamics of the market, we believe we need to confirm these trends in the following quarters. Remember, for example, that the third quarter last year was better than the fourth one. The fourth one was weaker. This is a spectrum. It looks like we are in a situation where quarter by quarter and also month by month, we have some volatility. There is a moody consumer trend depending on the month, on the news that they have, or overall, there are some changes in consumption patterns. As you know, there is a very intense competitive dynamic in the market.

We need to wait, in our opinion, another quarter to have a clear trends going forward.

Speaker 7

Next question, please.

Speaker 6

The next question comes from Ioan Leal from BBVA. Please ask your question.

Speaker 5

Hello. Good afternoon, everybody. A couple of questions on Latin America. The first thing, José María, I don't know if you could explain us what is happening to MTRs in Mexico. I think there has been a recent ruling which actually will drive the implementation of Cofetel's decision to decrease MTRs by 60% between América Móvil and the smaller operators in the market. I don't know how this is going to affect your MTRs and how it's eventually going to affect in the long-term América Móvil competitive position in the market. That's the first one. The second one, I don't know if you could update us on the Telefónica Vivo integration synergies.

Speaker 1

Okay. Thanks, Ioan. On the new interconnection rules in Mexico, the Mexican Supreme Court decided on May 3rd that whether the new interconnection rules are cleared through the legal process between the different players, the new rules, the new prices should be applied, which is, in fact, quite surprising. These new charges represent a radical change of the rules of the game in Mexico in terms of interconnection. Current interconnection prices, in order to give you an idea, are in the range of $0.95, $0.85 Mexican pesos, which is a similar level to most European countries, in spite of a very different penetration level. The Mexican regulator decided a nominal decrease to $0.39 of a peso, which is a 60% decrease.

On top of that, they decided to change the tariffication from a rounding basis to a minute to a per second basis, which, in fact, represents a further decrease because of the length of the calls. This Supreme Court decision forces all players to apply this change in spite of the different legal processes initiated by both Telmex and ourselves. As you know, we are a net interconnection revenue company. We have more interconnection revenues than OIBDA than expenses. Our main counterparty is Telmex. We have an agreement in place with Telmex at the initial prices of $0.95 to $0.85. Therefore, everything is going to be dependent on what is going to be the reaction of Telmex to this new ruling. In the short run, such a drastic decrease would have a significant impact on everybody, I would guess, in the country, who is a net recipient of interconnection revenues.

It is tough to quantify right now what is going to be the impact because of the preexisting agreements and because of the different interests of the different parties involved. In the long run, I think that even though this decrease is too drastic and too fast, it would set up a new competitive environment where on-net prices are going to be more affordable for the new entrants, for the ones that have a lower market share, including ourselves. In the long run, we think this is going to be positive from a competitive standpoint. In the short run, it's going to be tough to identify because, again, the drop is too drastic and too fast. Taking the Telmex and Vivo question, we were trying to advance to you in London after two quarters in a row of being very involved in both units together.

We are very positive on the synergies that we are able to achieve. Once the legal process has been completed and the new organization chart has been announced and communicated, we are really accelerating our plans. During the first quarter of 2011, we have already accomplished significant insights, and that's why we reaffirm that the €2.3 billion to €2.7 billion synergies net present value range that we shared with you, that we announced at the time of the transaction, we think this is a minimum range. The synergies identify around three main pillars in terms of the offer, the joint offer. The first one is a very intensive joint offer in the corporate segment that we are already ready to go and that we are already sharing with our customers.

We are already analyzing a fixed wireless for inside and outside São Paulo that should help us to accelerate growth in revenues and to be more efficient in terms of deployment of the more traditional products, such as voice. In terms of platform and efficiency, the intercompany, you know that we have this long-distance code, the 15, that was shared among Vivo and Telesp, with zero margin for Telesp. Now we can be much more efficient because we are as well eliminating intercompany indirect taxation. In network and joint network planning in transmission, again, we are taking advantage of all units inside and outside São Paulo. Data center, we are advancing, and we are working very intensively in doing the brand convergence towards Vivo, generating more synergies in terms of commercial expenses and distribution.

We are extending the contract that we have with Open Telefónica in the remainder part of Latin America to Vivo, and that's why we have been gaining some significant success in terms of ringback tones, co-branded cards, and financial services. I'm trying to quantify a little bit all those efforts. In order to give you an idea, we have had 27,000 more contracts with small and medium companies. We have been able to generate more than R$100 million in the first quarter of this year from savings in network and transmission, R$10 million in terms of hardware maintenance and IT suppliers, more than R$70 million in new products and services, and just expanding the ringback tones in three weeks in Vivo, we have been able to reach 1.2 million new customers, new services. All in all, very optimistic, and that's why we have been accelerating the reorganization effort in Brazil.

Speaker 7

Next question, please.

Speaker 6

The next question comes from Will Milner from Arad Research. Please go ahead with your question.

Speaker 5

Thanks very much. Just one question on Spain firstly. The retail broadband revenue trend, obviously, pretty disappointing, going back 10%. Clearly, I guess you're still suffering from competitors offering discounts on DSL to their mobile customers. I guess the question is, if those offers don't change, if they continue to be in place in the market, what will you change in your commercial approach to address the backbook issue? I think you did put a similar offer in place during the quarter. I'm just wondering if there's any positive signs from that that would arrest the decline in that trend. A second question, just picking up on Matthew's earlier point that he made. What is the percentage of revenues in the UK that come from out-of-bundle minutes usage and out-of-bundle SMS usage? Perhaps also that if you have those figures for Spain as well, that would be quite useful. Thanks.

Speaker 2

Yes, Will. This is Guillermo. Regarding your question in retail broadband, yes, of course, there is, as in previous quarters, very aggressive competition in the fixed broadband market with aggressive promotion and offers. However, on the other side, last April 7th, the increase in the unbundling of the local loop price has been enforced. We have started seeing some moves in the competition that are either increasing some charges or slowing down some of the promotions. It's too early to see a trend, but we are starting to see some logical reaction to adjust their P&L. This is not a changing trend, but it's something that is new in the market, and we need to keep an eye on that. We are more selective on promotions.

We have done fewer promotions in the first quarter than in previous quarters because we want to understand in a better way and more deeply where we are creating value and where we are not. We have been more selective. On the other side, we need to see if this increase in the wholesale prices changes the shape of the dynamics.

Speaker 5

Hi, Will. It's Matthew. On your out-of-bundle question, I think, yeah, as I said, customers certainly optimizing and managing very carefully around their out-of-bundle percentage. You will have seen recently, we just increased our per-minute and per-text rates out-of-bundle. The actual number out-of-bundle is single-digit on both numbers. Both are less than 10% on both out-of-bundle voice and out-of-bundle.

Speaker 3

I guess on actual ARPU, what's the %?

Speaker 5

Do you know what, Will? I don't know. Let us take it offline and come back to you.

Speaker 3

Okay, thanks a lot.

Speaker 6

The next question comes from Luis Prota from Morgan Stanley. Please go ahead with your question.

Speaker 1

Yes, hello. I have two questions. The first one is on Spain. Sorry to come back to the issue of the out-of-bundle and these things, but in your mobile data tariffs, your structure looks very similar to that of KPN. This is based on add-ons rather than data-centric bundles. The question is whether you are seeing in Spain any similar trends to those that KPN have mentioned, declining out-of-bundle traffic in Spain, voice cannibalization of data. You've mentioned that you are not seeing this in the UK. Any light on what's happening in Spain and whether you are planning to move to more data-centric bundles would be useful as your peers are already in that kind of tariff. The second question is regarding your debt position. I'm hearing some comments from credit rating agencies kind of suggesting that your rating might be at risk if you don't cut debt substantially.

I would appreciate your thoughts on this and whether you have any other assets on top of ATENTO that could be for sale. Thank you.

Speaker 2

Hi, Luis. This is Guillermo. Obviously, we are tracking cannibalization impacts. As in the past, we were tracking fixed to mobile and broadband cannibalization, and we have positive news. We are starting to track more closely cannibalization of services like SMS and data. So far, our data indicates that on revenues, there is a positive net impact, meaning that what we estimated could be a decrease in SMS is more than compensated by the revenues that we are generating in data. For example, this quarter, we have a 7.6% increase year over year in data API. It is something that we know we have to keep an eye on, and we have to track that very frequently. As in fixed to mobile, so far, we've seen also a positive net impact on our numbers.

Speaker 0

Okay, Luis. This is Miguel. Taking your question about our rating, I think that we have made good progress in this quarter just by reducing substantially our leverage ratio just in a quarter. It is true that we have been helped by FX, but also we have been paying down both principal and accrued interest with the capital we have been generating. We think that we are in line towards the requirements made especially by S&P, but this will take some time until we achieve our targets at year-end.

Speaker 7

Next question, please.

Speaker 6

The next question comes from Torsten Achtmann from JPMorgan Chase & Co. Please go ahead with your question.

Speaker 5

Good afternoon. Could you update on your progress on cost cutting in Spain? You already indicated at the presentation that you're negotiating the CPI. Can you say how far you are? Also, on the headcount reduction, have you started negotiations there? Secondly, on Argentina, the service revenue growth seemed to have slowed down from 25% last quarter to 14% this quarter. Any specific reason for that, or could you give some more clarity around it? Thank you.

Speaker 2

Hi, Torsten. This is Guillermo. Regarding the question in Spain and cost-cutting measures in Human Resources, for the non-union program that we started in the last quarter of last year, that program is going on smoothly and is hitting its targets. Regarding the unionized efforts, after the company union elections in Telefónica España last March, the new bargaining committee was created April 27, I believe. The first meeting of this committee was held on the 11th, two days ago, in which it was discussed about the different issues previously mentioned in the Investor Day in London. The negotiations will accelerate and take place in the next few weeks, and we'll keep you posted. So far, we are moving according to the calendar, but there's no news to report.

Speaker 1

Good afternoon, Torsten. Taking your question on Argentina, in fact, in the previous year, we accounted for a very big contract that we have with the government to distribute PCs jointly with our connection, and that has somehow altered the comparison. Overall, in the first quarter in Argentina, we have a very strong quarter. Revenues in the country were up 16%, 15.8% compared with 12.9% a year ago, which is the most comparable figure. And OIBDA is up in the country 11% compared with 10.7% a year ago, again, the most comparable figure. Both units are doing very well. Our wireline business is growing 16% revenues versus 11% a year ago and 12% OIBDA versus roughly 3% a year ago. The wireless business is growing very nicely, 16% revenue growth and roughly 11% OIBDA growth, with trends being sound and very focused on value.

In fact, in Argentina, we think that we have a very strong quarter, both financially and commercially. If you were to exclude this contract that we had last year, the trends are even better than the previous year.

Speaker 7

Next question, please.

Speaker 6

The next question comes from James Edmund Ratzer from New Street Research LLP.

Speaker 5

Yes, good afternoon. I had two questions, please. The first one was regarding your performance in Brazil. Clearly, a very strong quarter, and it looks like a lot of the acceleration in growth at Vivo has been driven by your change in strategy on DLB calling and using the 15 code. I was wondering if you could just talk us through a little bit more what your plans are with regard to this. Are you planning to cut prices more aggressively? To what extent do you see volumes can further grow and help accelerate revenue growth in Brazil? I mean, clearly, it's been a boost for Tim. Do you see a similar performance ahead for yourself? The second question was regarding your Spanish broadband business. I'm still struggling a little bit with the revenue outlook on broadband.

You're saying you're not competing for, or it's harder to compete for new net adds at the moment, which I understand. At the same time, we're seeing RPUs on your existing customers actually come down at an accelerating rate. I mean, is this a customer spinning down and bill optimizing on the fixed line as well? If it is, could you say how much further you think this has to run from current RPU levels? Thank you.

Speaker 1

Hi, there. Taking your question on Brazil, Brazil as a whole posted a very strong quarter. Both units performed pretty well, Telesp and Vivo. Telesp has been affected at the level of OIBDA by heavy rains and the effort that we have been doing to preserve quality and not to increase customer insatisfaction. In fact, we are one of the very few industries or companies, if not the only one, that has been stepping out of the crisis even stronger. Revenue growth in Telesp has been positive for the third quarter in a row. I would suggest to focus on Telesp because in spite of the fact that we have been incurring more costs in order to preserve quality, I think that quality is going to pay back in the short run.

Taking the specific question on Vivo, in fact, Vivo posted a very solid set of results, and I focus on the levers that we anticipated in London that were announced by Vivo Conference Hall. In fact, we keep focus on value. We are not fighting just the number of customers, and that's why we have been lagging behind our other competitors in terms of the prepaid market share in this quarter. In fact, we have increased significantly our market share in contract in these last 12 months. We already have a 35.5% market share in contract in Brazil, which is roughly 5 percentage points above our average market share. More than 40% of the net adds in the quarter have been based in contract. Therefore, we are pretty focused on gaining the bulk of the value of the Brazilian market.

Traffic is up 13% year-on-year, with on-net traffic growing much more than that. MOU and ARPM are practically stagnant with a very slight decrease. Service revenue is growing in the neighborhood of 15%. We have seen a great acceleration in recharges. We proved that our commercial offer is attractive and a very consistent growth in data revenues with a 21% increase. This proves that we have the best brand, that we have the best network, and that we are leaders in quality. Those are the levers upon which we are aiming to build on. That explains as well the difference in margins because we are pretty focusing on getting the value of the market and the growth of the market, what really matters. By the way, data revenue has been increasing 47%.

Very, very strong performance in a very strong and dynamic market, and we are very enthusiastic about the future.

Speaker 5

Could I ask specifically on the D&A opportunity? I mean, to what extent do you think that has further growth ahead? Thank you.

Speaker 1

Yes. In fact, the DLD, the domestic long-distance code that were co-used by Vivo and Telesp, was owned by Telesp and used as well by Vivo with a 0% margin with Telesp. All the different billings between the two companies were quite inefficient in terms of indirect taxation and, on top of that, as well in terms of bundling products. Now that the restructuring process is over, and it's over just from three weeks ago, we are going to be able to compete with our closest competitors in the region in a much more efficient manner in the domestic long-distance market with less inefficiency as a whole. Therefore, we think that we could be more present in this market with more attractive prices for our customers. Still, not flowing through the P&L as the restructuring was not over yet.

Speaker 2

James, this is Guillermo. Regarding your questions about free broadband, two things. First, regarding the ARPU variations, there is a direct impact of the promotions, but not only the promotions that you put in place this quarter, but the promotions that were put in place in the past. For example, last year, in the first quarter, we had a lot of activity on our side on promotions, the 12-month promotions, meaning that a customer will sign up for €19.90 per month of fixed broadband for 12 months, and then the price will go after 12 months, we go up to €40. What happens at the end of any promotion in any company in any situation is that a percentage of customers remains with the service provider with increased price, and some other customers churn.

What we have seen in the past, that's why one of the things we are looking more carefully in terms of value, is that the percentage of customers that after the promotion churn is higher. The value of the promotion is more questionable than in the past. That's why we decelerate a little bit in the last months in terms of putting new promotion in place, because the postmortem numbers are different because the crisis is shaping, obviously changing the customer behavior of our customers. Many of that impacts on our number because we have a lot of promotions that were expiring in the first quarter, and we were not adding new promotion in higher volume to our base.

Looking into the future, besides the fact that the increase on the UL that I mentioned before, remember that we are accelerating and deploying the upgrades in copper that we started last year. This means that, for example, the people that were up to 1 megabit for the same price go to up to 6 megabits, and the people that were in 6, we are moving them to 10. We're trying to, for the same price, give them more value and trying to sustain a lower churn. I hope that helped you to understand a little bit of the dynamics of this quarter, where, again, lower promotion this quarter and a lot of promotions one year ago with a behavior that was not as good as expected as in the past.

I think the same is happening in the rest of the market because we are starting to see some minor movements in the competition of trying to improve a little bit the conditions on their side, not on the customer side, because I get that they are also questioning the economics of the promotions.

Speaker 5

Okay, thank you.

Speaker 7

We have time for the last question.

Speaker 6

The final question comes from Javier Borrachero from Kepler Capital Markets. Please go ahead with your question.

Speaker 5

Yes, good afternoon. I have a question on Germany. One, in terms of the EBITDA margins, on slide 17, you mentioned this progress in restructuring that may deliver more efficiencies in Q2. Maybe if you can comment on to what extent we can really see EBITDA margin expansion coming from this restructuring or maybe the pressure from commercial costs may keep them more subdued. Also, maybe if you can comment a bit more on the Hansenet, the cross-selling opportunities with Hansenet, and whether you could expect maybe some top-line acceleration in coming quarters in Germany. Thank you. Hi, Javier. It's Matthew. Let me pick up your point. Yes, in Santiago's presentation, he spoke about OIBDA margins. The reason the declared number has gone down is because clearly we're now consolidating Hansenet, and it's not quite like for like versus last year in the first quarter.

Once you strip Hansenet out, it's broadly flat. The restructuring benefits will start to come through in Q2. They'll ramp up during the year, and by the end of the year, they'll get to about 3% of margin. The other key dynamic you should see in the margin is certainly around MyHandy and the increasing proportion of MyHandy, which clearly impacts service revenue as well. From a combination of Hansenet, until we were one statutory company, German law didn't allow us to cross-sell products. Now we are one statutory company, we.

Speaker 7

It is a major focus for us in Germany to exploit certainly the O2 base from a DSL perspective and the Hansenet base from a mobile perspective. We are hoping to see some results of that during the second half of the year.

Speaker 3

There are no more questions.

Speaker 6

Okay, with this intervention by Matthew, I'd like to thank you for having attended this first quarter with us from Telefónica. I wish you the best and a very nice weekend. We'll be holding the next conference call at the end of July.