Telefónica - Earnings Call - Q2 2011

Transcript

Speaker 5

Good afternoon, ladies and gentlemen, and welcome to Telefónica's conference call to discuss January-June 2011 results. I'm María García-Legaz, 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 unedited. 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. We encourage you to review our publicly available disclosure documents filed with the relevant securities market regulators.

If you don't have a copy of the relevant press release and these slides, please contact Telefónica's Investor Relations team in Madrid by dialing the following telephone number: 34 91 482 8700. Now, let me turn the call over to our Chief Estate Officer, Mr. Santiago Valbuena, who will be leading this conference call.

Speaker 7

Thank you, María, and good afternoon, ladies and gentlemen, and thank you for attending Telefónica's 2011 first half results conference call. Today, I have here with me Julio Linares, our Chief Operating Officer; Guillermo Ansaldo, Head of Telefónica España; José María Álvarez-Pallette, Head of Telefónica Latinoamérica; Matthew Key, Head of Telefónica Europe; and Miguel Escrig, our Chief Financial Officer. During the Q&A session, you will have the opportunity to ask questions directly to any of them. Telefónica has released today a set of strong earnings despite economic challenges and headwinds from regulation. First half business trends are consistent with 2011 targets, and therefore, we confirm our full-year guidance. We have also had strong top-line growth driven by the robust performance at Telefónica Latinoamérica, excluding Mexico, and solid mobile data growth.

We continued to deliver benchmark profitability, expanding margins quarter on quarter, and limiting OIBDA year-on-year decline in Spain to levels similar to those of the first quarter. Latinoamérica already accounts for over 45% of consolidated figures from revenue to operating cash flow, driven by the stellar performance of Brazil, and that shows the benefits of our high diversification. I would also like to highlight the significant progress made in several areas since our last call in May. This proves that Telefónica has strong execution skills. We have reached the new social agreement with the unions in Spain. We are announcing higher than anticipated integration synergies in Brazil, and we have launched our partnership program, which proves scale is a differential and valuable asset. All these initiatives will have a positive impact in cash generation. Finally, the administrators state that we fully reaffirm our dividend commitments.

With our key financials, and starting with a summary on the P&L, please go to slide three. Reported year-on-year growth rates were positively impacted by the full consolidation of Vivo since October 2010. Revenue increased 6.3% year-on-year in nominal terms to almost €31 billion and grew by close to 1% purely organic. Six months OIBDA topped €11 billion, up close to 4% in reported terms and declining around 2% in organic terms. Profitability remained robust, with OIBDA margin up sequentially to 36.6% in the first half and limited year-on-year erosion. As a proxy to cash flow generation, operating cash flow ended at close to €7.5 billion, which is equivalent to a 6% organic decline compared to 2010 first half figure.

Our first half net income exceeded the €3 billion mark, with second quarter profit negatively impacted by Telco's revision of the value of its stake in Telecom Italia, which reduced net income by €353 million. Please notice that this is a non-cash item. In addition, cumulative D&A grew at double digits, driven by the full consolidation of EVO and the amortization of EVO's purchase price allocation, leading to a 9% year-on-year increase in total PPAs. Profit attributable to minority interests continued to drive net profit as a result of the change of consolidation of EVO and higher earnings from this company. All things considered, EPS stood at €0.70, but stripping off the impact from purchase price allocation and the revision of the value of Telco's stake in Telecom Italia, EPS would have reached €0.88.

Slide number five shows the results from our value over volume commercial strategy, being mobile contract and mobile data our key focus areas. Our total access base grew 6% year-on-year to 295 million, with superior growth in the mobile contract segment, which already represents more than 30% of our mobile customer base. Contract net adds were strong across regions, accounting for 47% of mobile net adds in the first half and over 100% at Telefónica España and Telefónica Europe. At the same time, demand for smartphones and other data devices continued to be strong, driving up mobile broadband penetration across all markets. By region, mobile broadband penetration reached 28% in Europe and 23% in Spain, although still a low figure for Latin America shows a huge opportunity going forward.

The rapid expansion of mobile broadband and our tiered data rates launched across all markets led to an outstanding 19% year-on-year organic increase in mobile data revenues, with a ramp-up in growth in the second quarter in most markets. Mobile data revenue already accounts for 30% of mobile service revenue, up four percentage points versus the first half of 2010, with a contribution ranging from roughly 25% in Spain and Latin America to 41% in Europe. The fact that non-P2P SMS data revenues account for the majority of data sales in each region and continue posting very solid growth rates, along with the right pricing schemes, including bundles, limited cannibalization risk from new services and applications. Please notice that P2P SMS revenues continue to grow. Slide number seven, we detail Telefónica's evolution of revenue mix.

Telefónica Latinoamérica emerges another quarter as a key contributor to growth, accounting together with Telefónica Europe for over two-thirds of consolidated sales, offsetting headwinds in Spain. Broadband and services beyond connectivity already account for 26% of revenues, compensating the lower contribution from access and voice sales. Let me now turn to slide number eight to talk about our business's profitability. Despite the commercial drive to boost smartphone and contract penetration, along with increased network costs on higher traffic volumes and impact from inflation in some countries, operating profitability remains solid thanks to higher efficiency derived from our scale, scope, and global initiatives. OpEx year-on-year growth rates slowed down for the second consecutive quarter, reflecting continued focus on efficiency improvements. As a result, consolidated OIBDA margins stood at 36.6% in the first half, a limited erosion year-on-year, but expanded 50 basis points quarter on quarter.

Regarding our full-year guidance, on slide number nine, we do reiterate the outlook announced in February. In the second half, we expect Telefónica Latinoamérica to continue delivering a robust performance, capitalizing the synergies potential in Brazil, and despite the negative impact from the unexpected change in regulation in Mexico. In Telefónica España, we're not expecting a further deterioration in OIBDA year-on-year change on the back of sustained growth in mobile data, further cost savings, and the sale of non-core assets, as we announced in our last investor conference. In Telefónica Europe, we expect a steady performance in the second half of the year. Let me now walk you through the operating and financial performance of the three regions, starting with Telefónica España.

Despite challenging conditions shaped by weak consumer confidence and strong price competition, OIBDA in the second quarter showed a similar year-on-year performance as in the previous quarter, as we further deployed cost-cutting initiatives with all our OpEx items except labor cost, showing a decline. We maintain our commercial strategy, prioritizing value over volume, and we increased the commercial resources devoted to customer loyalty, driving lower churn rates sequentially across all our services. As a result, and despite the sustained loss of high margin revenues, OIBDA margin increased sequentially more than one percentage point to over 45% in the second quarter. We continue to expand the coverage and capacity of our fixed and mobile broadband networks as reflected in the higher CapEx year-on-year. On slide 11, we provide additional color on the mobile business, where commercial activity was focused on expanding mobile broadband penetration and fostering data usage.

Mobile service revenue declined 8.1% year-on-year in the second quarter, or 6.1% excluding mobile termination rate cuts. Voice revenues continue to be impacted by volatile usage trends and intense price competition, as reflected in voice ARPU, though price erosion slightly eased in the quarter. On the other hand, data revenues were strong, up 13% in the quarter, and showed a ramp-up in year-on-year growth rates on the back of the over 26% increase in non-P2P SMS revenues. The fact that these revenues already account for 73% of our total data revenues implies that SMS cannibalization risk from new applications is relatively low. Let me stress that SMS revenues have recorded a similar performance as in previous quarters, with double-digit growth declines mainly explained by the current economic weakness.

On the wireline business, usage optimization and the lower access base weigh down on voice revenues, while fixed broadband revenues remain pressured by the ARPU decline in a broadly stable customer base. However, it is important to notice that price competition in the quarter was more rational, as most of our competitors have transferred to their customers the ULL price increase. We maintained our value-oriented strategy with more selective promotions on broadband, leading to a slowdown in the ARPU year-on-year decline. On top of that, churn improved quarter on quarter. At the same time, IT revenues continue to grow nicely by 15% in the month through June on the back of our differential capabilities to target the corporate segment. Let's now move on to slide number 13.

Despite market skepticism about our ability to further reduce costs in a very difficult environment, we have reached a three-year-long social agreement with the unions in less than two months since we started negotiations. This agreement will reinforce significantly our flexibility to manage our cost base, leading to further efficiency gains. On top of the new collective agreement that links for the first time salaries to OIBDA targets of the company rather than exclusively to CPI, the social agreement includes a new workforce redundancy plan in the wireline business already approved by the labor authorities, involving up to 6,500 employees until 2013. The resulting cost per employee is estimated at €415,000 in net present value terms, including the unemployment benefits, which were covered by the Social Security in previous plans.

Regarding the financial impacts, we can tell you that at the P&L level, we will account for a provision representing the net present value of payments to employees joining the plan until they reach their retirement age. The provision will be booked as non-recurring personnel expense in the second half of the year for an amount of roughly €2.7 billion. As benefits, we will save personnel and G&A expenses with positive impact in net income starting in 2012. In cash terms, yearly payments to pre-retirees are offset by the benefits related to lower personnel and G&A expenses, and therefore, the plan is cash flow positive since year one. Overall, we estimate the plan will generate around €1.4 billion of excess cash for the group. In terms of leverage, our committed payments will gradually increase in the coming three years as employees join the plan.

Moving on to slide number 14, we start the review of our Latin American operations. In the second quarter, we had a strong commercial momentum with sequential increases in net adds across all services. On top of volume, it is remarkable the increased quality of the customer base with a growing weight of contract and smartphones in mobile and bundles in wirelines. Top-line growth remains strong at similar levels as in the first quarter, despite a weaker performance in Mexico. Excluding Mexico, revenue growth will ramp up from the previous quarter to 7% year-on-year. This solid performance was reached without jeopardizing our robust profitability, posting an OIBDA growth pretty much in line with sales expansion if we exclude Mexico. Organic OIBDA margin declined by just 0.5% each month year-on-year to 37% in the first half.

Please notice that growth rates are negatively affected in 2011 by a lower contribution from regional projects compared to 2010, as our priority this year is to deliver on the projects already in place rather than launch new ones. The next slide shows the solid data and broadband revenue performance driving robust growth both in mobile and wide line. Increased mobile broadband penetration on top of the healthy expansion of voice sales boosted outgoing mobile service revenue up 12.3% year-on-year in organic terms. The differential profile of our mobile customer base is reflected in the year-on-year growth in RPUs. Wide line revenues ramped up in the quarter on the back of a growing contribution of internet and pay-TV revenues. As of today, new services like data in mobile and internet and pay-TV services in wide line already account for roughly 25% of each business sales.

Let's now review the brilliant performance of our businesses in Brazil. In the second quarter, we reinforced our leading position in the market with increased net ads quarter on quarter in all services. Especially remarkable are the results achieved in mobile, where we continue to increase market share in the contract segment, now at 36%, leading RPU to grow year-on-year as we leverage our leadership in the mobile broadband space. RPU growth and customer expansion led mobile service revenues up 15% year-on-year in the first half, with growth accelerating again in the quarter. Wide line revenue growth also ramped up in Q2, mainly due to a better performance of new businesses and the full consolidation of TVA. As a result, total organic revenue growth in Brazil posted the eighth consecutive quarter acceleration.

More importantly, this robust performance was achieved while profitability improved, as shown by the two percentage points margin expansion in the first half and the solid 13% increase in OIBDA. Let me now spend a few minutes in updating you on our synergy program in Brazil. Only three quarters after closing the deal, there are clear evidences that synergies are flowing faster than expected and that benefits will be larger than originally anticipated. As a result, we are increasing the total net present value of operating synergies by 16% through a range of €2.7 to €3.1 billion, 60% of them derived from OpEx savings and the remaining 40% equally split between higher revenues and lower CapEx. On top of these, we maintain our targets of €1 billion through €1.5 billion from financial and fiscal synergies.

The results just explained show that the fixed and mobile businesses combined are better and stronger, and the performance will improve as we partially reinvest integration benefits to further reinforce our position in a market with significant growth potential. In 2011, operating synergies will have a positive impact in operating cash flow of over €120 million, rising in coming years to a €400 million run rate from 2014. We feel very comfortable with these targets as our execution skills are delivering tangible results. In slide 18, we provide more color on the initiatives supporting these goals. Let me rapidly summarize them.

In terms of the offer, business integration is allowing us to be more competitive in the corporate and SME segment and to improve our reach, as we will leverage our wireless national footprint to offer fixed services outside São Paulo, where we expect to launch an integrated offer in the second half of the year. In platforms and efficiency, initiatives such as rationalization, unification, aggregation, and optimization from core networks to data centers or customer care-related activities are leading to material savings. In terms of new services, we are leveraging the global scale of Telefónica to further innovate and expand customer spending. To sum up, our businesses in Brazil have posted a stellar performance, clearly outperforming fears, and we are in a process that may be the start of a virtuous and self-powered circle, as some of the synergies are reinvested into the business to continue strengthening our market leadership.

Turning now to slide number 19, I will explain the recent developments in Mexico. The good news is that operating KPIs are improving quarter on quarter with increased volumes of gross ads, good traction of our mobile broadband offer, and a drastic change in outgoing traffic trends. These improvements are not yet reflected in financial metrics, but give us comfort on the initiatives launched to turn the business around. The bad news is that the major change in the regulatory framework with significant cuts in termination rates, which in the short term are having and will have a painful impact on our business, as you can see on the slide. Please notice that these impacts are maximum impacts, as they do not include any elasticity effect.

On the other hand, this drastic change could erode in the mid to long term some competitive advantages of the dominant player, improving our market positioning. In our view, the regulatory review is incomplete, and therefore, we expect the regulatory framework to continue evolving to tackle different positions in the market with different regulatory rules. To finish off with Latin America, just two comments. The southern region performance remains very robust, while in Venezuela, we have made remarkable progress in our commercial proposition, allowing us to post strong top-line growth and very solid margins. Let's now turn to slide number 21 to talk about Telefónica Europe. Telefónica Europe continued the execution of its value over volume strategy, delivering a good financial performance despite challenging environments and severe regulations.

Past growth in mobile broadband penetration, together with successful tiered data pricing, led to solid mobile data revenue growth of 12% year-on-year, leveraging outstanding 32% non-P2P SMS sales. Smartphone penetration will further increase in the second half of the year, leveraging on sub-hundred euro handset availability. OIBDA increased over 3% organically in the first half, as increased investment in acquiring and retaining the best value customers and negative impact from regulation were offset by efficiencies from business restructuring and additional scale from network platforms sharing. As a result, OIBDA margin slightly expanded to 27% up to June. The group also continued to actively invest in new business areas such as financial services and O2 media, which are now beginning to have a noticeable impact, mainly on increased customer satisfaction. Telefónica UK, as slide 22 shows, continued building a profitable mobile broadband ecosystem.

Strong demand for smartphones from new and existing customers drove penetration up to 35%, with 55% of contract smartphone users in the consumer segment already based on tiered data plans. To highlight is the fact that most of these customers are taking the upper tier range of the tariffs, limiting the cannibalization risk from IP voice and messaging apps. As a result, customer spend was broadly stable over the previous quarter. Six months revenue continued to be fueled by non-P2P SMS data that were up 32% year-on-year in the first half. In Q2, sales performance was sharply impacted by mobile termination rate cuts from April by four percentage points and by the progressive change in the company's commercial relationship model with some distributors until the second quarter of 2010. Please notice this effect will not affect year-on-year comparisons in the second half of the year.

OIBDA performance remains strong, driven by a muted commercial activity and ongoing cost efficiencies. The steep quarter-on-quarter slowdown was mainly due to different mobile termination rate cuts timing in the UK market, explaining close to eight percentage points of the deceleration. Let's now review our operations in Germany, where we continue to enjoy a strong commercial momentum in mobile. The good traction of tariffs like O2 Blue and fast adoption of smartphones, strongly supported by the MyHyundai distribution model, led to close to 460,000 contract data up to June, accounting for two-thirds of the total, driven by the strong traction in the consumer and business segments. The company is already showing tangible benefits in customer loyalty, as reflected in contract churn declining trend.

Non-P2P SMS revenue continued to post solid growth at 65% year-on-year in Q2, accelerating sequentially and leading to a quarter-on-quarter ramp-up in MSR growth to over 7% ex-mobile termination rates. OIBDA rose close to 2% and the margin remained flat-ish at 23% in the first half, as we reinvested in the benefits from restructuring and business integration to foster commercial activity. We also launched LTE in several rural areas in Germany, with a limited impact in CapEx, as both sites are located within the current 2G 900 megahertz grid. Turning to slide 24, I'd like to mention that we maintained net interest expense pretty stable year-on-year. They stayed below €1.2 billion in the first half, despite the fact that the average total debt increased 17%. The debt increase has led our leverage ratio, total net debt plus commitments over OIBDA, slightly above the upper part of our target range.

The excess debt over 2.5 times would have been offset if working capital consumption had been within the target range communicated in our investor conference. We are working to beat our goal of working capital consumption in 2011. I want also to highlight our solid liquidity position, with close to €8 billion of unused committed credit lines as of June 2011, most of them long-term, on top of €2 billion for the pending payment to PT for a bracelet sale. To sum up, we have posted a solid set of numbers amid difficult trading conditions, including severe mobile termination rate cuts. Revenue trends continue to be strong, while profitability was stable to improving quarter on quarter. Our unique footprint in Latin America is boosting growth. We are leading the mobile broadband opportunity, monetizing it through tiered data rates.

We continue to prove our strong execution skills with significant progress in key strategic areas in two months. Finally, I'd like to reiterate our confidence to deliver on our commitments. We are well on track to meet 2011 guidance, and despite operating challenges, free cash flow generation will be ahead of our initial estimates by year-end, as we leverage on capital discipline and further initiatives to improve working capital. No doubt, we will meet our dividend targets for the next years. Thank you very much, and we now stand ready to take your questions.

Speaker 9

The first question comes from Tim Boddy from Goldman Sachs Group. Please go ahead with your question.

Speaker 3

Yeah, thanks. I had a clarification and a question. The clarification was just around what you were saying about guidance. You said last quarter that you expected growth to accelerate through the year. That statement hasn't been repeated, so it'd just be helpful to understand how you see this sort of sequential momentum. Also, when you mention asset sales in Spain as preventing any further duration in the EBITDA growth year-on-year, can you try and quantify that? That would be really helpful. The question really had is around the UK market, where again, I didn't understand the comments around the change in distribution model. I was surprised to see the very sharp slowdown in traffic growth. If you could comment on those factors and the causes, that would be helpful.

Speaker 0

This is Julio Linares. Let me take your first question. We are expecting a better performance around the year, but our results are being weighed down by a few operations like Spain, where recovery is getting longer than we expected, and Mexico, where we have the impact of mobile termination rate cuts. Because of that, and because the turnaround is being slower than we expected, now we don't think that we can talk anymore about expecting to be a year with a back-end loaded in our results. We do confirm our guidance both on revenues and OIBDA margins. We confirm that our expected growth will be up to 2% on revenues, and we are expecting a limited erosion of our OIBDA margin.

Speaker 8

Thank you. Just to pick up your two points on the UK. First up, we made a change in quarter two, 2010, where with distribution channels we moved from sort of a revenue share model to a more traditional SAC model, which would have boosted Q2 2010 revenue and therefore obviously reduced the year-on-year growth Q2 2011. On the traffic growth point in the UK, Q2 voice was down 8%, traffic SMS up 18%. If behind your question, do we see any significant impact from OTT products? No, we don't. Interestingly, customer spend deterioration didn't accelerate, it was about minus 3% in Q1, about minus 3% in Q2 of customer spend. The good news is that the subscriptions, which are becoming more and more important of our overall revenue, remain stable.

The fact that customer spend went down was largely driven by out-of-bundle minutes, which was driven by the voice reducing, but no overall significant impact from OTT products.

Speaker 9

Great. Thanks. The next question comes from Fabian Lares from JB Capital Markets. Please go ahead with your question.

Speaker 1

Hi, good afternoon. I would like to address the first question to Mr. Linares regarding the slowdown in Spain. Perhaps Mr. Ansaldo can also step in. Do you see that this is more of a secular shift happening on the market on pricing, both in mobile and in fixed-line broadband? If that's the case, is your strategy of value over volume truly rightly directed? Basically, we are heading more towards a price-driven model in the market. Does the headcount reduction specifically give you that flexibility to become more competitive in the future? That would be my first question. The second question is regarding the Atento IPO that was canceled. I would like to know whether you still have plans to float it again anytime this year. I know that the market situation is poor.

If not, could you give some visibility whether that would even be a priority anymore or not? We'll show you maybe considering that in our cash flow estimates. Thank you.

Speaker 6

Hi, this is Guillermo Ansaldo. We take the questions regarding Spain. The first part of your first question regarding the slowdown in Spain is both in fixed and mobile. When you compare the second quarter with the first quarter, it's an acceleration of the decline. It's both pricing and consumption. Maybe in mobile, we see the combination of both, of pricing and consumption. In the fixed, maybe the more recent news is that despite the acceleration in consumption as the slower growth in the fixed broadband market, we see some more rational behavior on the pricing side as the different competitors are adjusting their tariffs to the new ULL prices. We will continue with our value over volume strategy. We will continue focusing on quality of service and commercial efficiency. Obviously, we see opportunities to attract and protect customers with high value. We'll go for it.

The proof of that is that we continue focusing on contract and postpaid in mobile. Obviously, for example, what we are doing in data in mobile. Also in IT in the corporates. Also on that side, we changed our organization to have in the commercial side a geographical closer approach to our customers. We can have direct decision-making processes on the commercial side on the field. That will help us to be more precise in targeting customers or situations which we believe that we can create more value. Obviously, the headcount reduction will, in the next three years, this year and the next three years, will improve our profitability. That will give us flexibility to reinforce our strategy and to be more effective on the market.

Speaker 2

Fabian, this is Santiago on Atento. If you read again the communication that we produced, the word we used, and we used it carefully, was we suspend the IPO process. It has not been canceled. We continue to think that it is the right thing to do with Atento. The reasons why we couldn't complete it are related to the weak stage of the markets. If the markets, as we expect, should improve, we would look at it heavily again. The current plan continues to wait for market conditions to improve. If that is the case, we will take it again at the public markets.

Speaker 1

Okay, thank you.

Speaker 5

Next question, please.

Speaker 9

The next question comes from Jesús Romero from BofA Securities. Please go ahead with your question.

Speaker 4

Thank you. I have two questions. The first one on the UK. I don't know if Matthew, you could explain the contract output dropped quite a bit in the quarter. I don't know if you can give us a bit more detail on what drove that and perhaps talk about the outlook for the second part of the year in the UK. The second question on the net debt/OIBDA of 2.56. If I looked at the second part of the year, you have €3.5 billion of dividend commitments and a spectrum auction in Spain, €2.7 billion restructuring charge, and potentially FX adjustment to your Venezuela cash position. What can you tell us about net debt/OIBDA or what you think will be for the end of the year? Do you think you'll be under the 2.5 range? Thank you.

Speaker 8

Jesús, let me pick up your point on, I think it was contract ARPU rather than blended ARPU, was it?

Speaker 4

That's right.

Speaker 8

Yeah. If you look at contract ARPU, you can look at it from two angles, really. One which is a sort of customer usage profile and one was a spend profile. Clearly, the main thing that drove the ARPU reduction was the mobile termination rate cut. Overall, we've been probably heavier impacted by the mobile termination rate cut than the other operators. From a total revenue perspective, it's probably reduced our revenue by about 4.6% in the quarter, which will continue through the rest of the year. I just think we've got a higher element of prepaid subs than the other operators. On postpaid ARPU, when you look into what's happening, voice is coming down, SMS is coming down, but data is going up quite significantly.

The good news on data is we are getting a higher data ARPU per user across the total base, but also the customers that are taking a data bolt-on are increasing their spend as well. That's not just a UK phenomenon. That is a cross-Europe phenomenon as well, which I think is good news. The other way of looking at it is between subscriptions and out-of-bundle. As I said earlier on, subscriptions actually are broadly flat. We're holding our subscriptions level, effectively the access fee, at a level which is really important for future tariffing from a product bundling perspective. The element that is going down is the out-of-bundle, and that's largely because of the minutes reduction that I answered to Tim's question earlier on.

Speaker 0

I chose taking your question on the leverage ratio. We really expect at year-end to be below the 2.50. So complying with our commitment, there are several factors that make us confident on achieving that goal. On the first hand, we have a capital generation which is going to accelerate across the year, especially due to working capital management. If you see, we have been paying this quarter or this semester a high amount of CapEx and well beyond what has been accrued. This is not going to happen in the second half of the year, rather the opposite. Also, some of the payments we have in the second half, such as the spectrum in Spain, can be split into tranches. Roughly 50% of that will be paid later in 2012.

Regarding the impact of the new provision from DERE, taking into account that they are non-cash and that we are going to recognize as debt, really, which we owe to creditors. The portion that is going to be signed with employees, which will become actual creditors of the company this year, and that could be a little bit above one-third of the total provision. On top of that, as you know, our guidance on the leverage reduces that amount by the tax savings associated to these commitments, which is a difference in comparison with the normal debt, which has not a tax shield on the principal. That's it.

Speaker 4

Thank you.

Speaker 5

Next question, please.

Speaker 9

The next question comes from Georgios Iera Diaconu from Citi. Please go ahead with your question.

Speaker 1

Yes, good afternoon. Perhaps if I could extend the previous question one year forward. As you add more employees and therefore you recognize more commitments, obviously, it will benefit EBITDA, but that takes longer. If you do exceed your target of 2.5 times, is it something you have to be firmly within by year-end, or is it something you wish to be around that level in the next two or three years? Therefore, even if temporarily you move beyond that, it wouldn't necessarily change the way you do things. Could you please clarify again regarding the tax impact, whether this year and next year the provisions you'll take will benefit the tax? My second question is again regarding the agreement and the part where you've changed the way salaries are linked to EBITDA targets rather than the CPI.

Could you give us an idea of what the impact could be to numbers? Is it possible to tell us, for instance, how much it would have reduced OpEx had it been implemented so far this year? Thank you.

Speaker 0

Okay. Our leverage commitment is a commitment to be respected. Certainly, at year-end, it's not for the medium term. Although there may be temporary deviations, such as we have had this semester, we have to work to correct them. As I told before, we feel confident that we will do in the near future. Regarding the implications on tax of the commitments, we will recognize this next quarter, €2.7 billion of charge. This will have an impact on accrued tax, not on cash taxes. The cash tax savings will appear when we pay, and we will start making payments next year. We will save there 30% in taxes of every yearly payment.

Speaker 1

Thank you.

Speaker 6

Georgiu, this is Guillermo. Regarding the agreement with the unions for Telefónica España, first clarification, this is only for the fixed business, which has the majority of the employees, as you know. In the past, the salary increases were linked to CPI. That was clear. Now, what we have is a scale that, depending on the achievement of our targets in this specific company, the salary increase will move from 1% in any case to the floor or to CPI as a ceiling and an additional non-consolidated amount if we go through, for example, 103%, 105% of achievements. The impact on the accounts depends on how the business goes. If we hit our targets, there was no comparable impact because we will give CPI in any case.

If we are under our targets in this company, we will have an increase which is lower than the one we have been given in the past. This gives us more alignment of our expenses with our OIBDA. If we are having a great year, overachieving targets, it will be similar. If we are under, we are gaining flexibility in terms of the increase. This is an increase that goes forever. Basically, it's a more variable, if you want to call it, the structure.

Speaker 1

Thank you.

Speaker 5

Next question, please.

Speaker 9

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

Speaker 4

Yes, hello. Wanted to confirm, you just mentioned that in 2011, the provision from the social plan should be around one-third of the total provision. Wondering whether that means that one-third of the employees are supposed to sign up for the plan this year, whether you can give us any light on whether this is going to be in the last part of the year or any savings should be accrued this year or is pretty much going to come next year. This is the first question. The second question is on your EBITDA guidance of margin having limited erosion relative to last year. In the first half, you are putting a tick in that box. Last year, it was this first half, it's been 36%. It was a 1% compression. For the full year, the reference you gave is 38% in 2010.

I'm wondering whether if you stay around 36% for the second half, and this is a two percentage points compression, this is still considered as a limited erosion. Thank you.

Speaker 0

Luis, this is Miguel. Taking your question, your first question, let me stress, we are going to book the full accounting provision in the third quarter, roughly €2.7 billion. From the leverage ratio point of view, we have always been avoiding double counting. This means that we are not including in the OIBDA this provision, but rather we are adding up to our debt, the equivalent debt commitments. We will have just debt equivalent commitments when we have actual creditors. This means that we will recognize the amount of debt corresponding to people actually signing this year. We estimate that this could exceed one-third of the total base we are targeting. That's it.

Speaker 6

This is Guillermo, just to complement Miguel's comments regarding savings. Since we are going to start the program in September this year, the impact on OIBDA will be very limited. Almost all the majority of the impact will be in 2012 and in 2013 and forward.

Speaker 0

This is Julio Linares. Regarding your question on OIBDA margin erosion, yeah, 36% will be the maximum limited margin erosion.

Speaker 8

That is perfect. Thank you.

Speaker 9

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

Speaker 8

I was wondering, could you give some comments on? Hello?

Speaker 5

Torsten, we cannot hear you well.

Speaker 1

Okay, one second. Let me try differently.

Speaker 8

Is it now better?

Speaker 5

Let me see if you can repeat your question, please.

Speaker 8

Hello, can you hear me better now?

Speaker 5

Yes, much better. Thank you.

Speaker 8

Yeah, we're still having lines problems. Two questions, please. On Spain, we've seen revenue slow down year on year, but that's also a tough comp period. Can you give us some idea on the outlook going forward? You've seen competitors reducing prices. The consumer is still impacted. How do you see Spain will develop in the second half from a competitive and revenue-generating environment? The other one is back to the UK and the impact of the change in distribution agreement. Can you give us some idea how much of the non-MTR slowdown we can put towards the distribution agreements, or i.e., one-off, and how much is the consumer trying to get its spending in order? Thank you.

Speaker 6

This is Guillermo. Regarding the outlook for the rest of the year, what we are seeing is now, for example, in July, is a similar trend as we've seen in the second quarter. That means consumption contraction and obviously price competition more intense in the mobile recently, as I mentioned before. We don't see a major change in the near future. Maybe by the end of the year, we can see some signs. To be honest, July looks similar to the second quarter, and there's a lot of volatility. We expect a similar scenario. We have several initiatives on the cost side to balance on the OIBDA side. That's why we're saying that we see no further duration on the OIBDA year-over-year change now. There's a decrease, but not more than we see up to now.

Speaker 8

Torsten, hi, just to pick up your question on the UK. I've got a mental model where I reconcile between Q1 growth and Q2 growth. If Q1 was +4%, take out 4.5% for mobile termination rates. If Q2 is -4%, you've got another three percentage points to go, which is roughly, very roughly split, one-third the accounting classification point, one-third lower base growth, and one-third customer spending. That's the broad split. As we've said, the third from the accounting classification distribution element doesn't continue. Base growth, we will have some more momentum in the second half. We probably won't recover to the levels we were at last year. The spending is very much a consumer confidence question, I think, for the UK.

Speaker 9

The next question comes from Mathieu Robillard from BNP Paribas Exane. Please go ahead with your question.

Speaker 1

Yes, good afternoon. Thank you very much. First, a question on Brazil. Very strong revenue growth on mobile and fixed. Now, part of that is washed out through the intercompany elimination. I wanted to see if it was possible to get a little bit of clarity as to what kind of revenues are disappearing, where do they come from, essentially. Is it essentially corporate? Is it retail? I mean, residential? The second question has to do with the working capital. You highlight that typically in H2, you tend to recover some of the working capital investment that you do in H1. In fact, that's what happened in the last few years. The only question was, in 2010, you actually had a very positive working capital impact of $2.6 or $2.7 billion, which helped, obviously.

I was wondering, therefore, if we should expect in 2011 a real recovery in working capital as we typically are, because maybe some of the things that were passed in 2010, and I'm thinking about, for example, Brazilian spectrum or Mexican spectrum, those things will actually not revert in 2011. Thank you.

Speaker 0

Taking your question on Brazil and the revenue growth, the consolidated revenue growth, and the impact of interrelation between both companies, wireline and wireless, I can tell you that you have the effect on the elimination part of our disclosure. You can have an idea there of what's the impact of traffic interrelated between both businesses that has significantly increased due to the promotion of domestic long-distance products through the mobile. Now that we are in control of both businesses, we have become more aggressive, commercially speaking, and therefore, we have been able to be more present on the market and be more competitive, namely against Team Brazil.

In order to give you an idea of how the underlying trends in revenue are going in the different businesses, both wireline and wireless, excluding that effect, let me tell you that the line losses, the traditional line losses, have been further limited in this second quarter. Remember that in the first quarter, we have heavy rains. We are losing 1.2% of our lines, but the second quarter has been much better than the first one. Therefore, 70% of our lines are bundled. Broadband is growing. On the wireline side, it's growing more than 17%. TV is growing 45%. It is true that it includes the TVA customers, but excluding that effect, it will be growing in the neighborhood of 10%. On the side of Vivo, the underlying growth of service revenue is growing 14%, almost 15%. Data ARPU is already 22% of total. Data revenue is growing 42%.

Non-SMS data revenue is growing 42.5%. The data ARPU itself is growing almost 22%. Total customer base is growing 14%. All underlying metrics, even excluding the effect of this interconnection, tariff charges are very, very strong. We can be more detailed in further explanation. If you want to have a specific idea of the underlying trends, you have on the elimination part of our statements the interrelation between both companies.

Speaker 2

Hello, Matthew. This is Miguel. It is true that this year we are not going to have some extraordinary items improving the working capital, which are mainly related to year-end provisions in 2010, which had not any cash payment that year. This is not what I understand managing the working capital. We have started this year a program, as we communicated in our investor day, to improve the working capital, working with suppliers in the CapEx area and also standardizing throughout the group the payment terms in OpEx and improving the collection. We feel pretty confident that this is going to yield fruits. It's starting to do it right now and will accelerate in the second half of the year. Also, the CapEx trend is quite clear. We will still have one extraordinary effect, as I have mentioned before, due to the delayed payment of the Spanish spectrum auction.

All in all, we expect to beat the target we communicated in our investor day of 2% to 5% consumption in working capital over operating cash flow. We are confident in being better than that.

Speaker 1

Thank you very much.

Speaker 5

Next question, please.

Speaker 9

The next question comes from Yvonne Leal from BBVA. Please go ahead with your question.

Speaker 4

Good afternoon, everybody. A couple of questions. The first one in Mexico. It would be very helpful if you could give us further detail on the new tariffs that you've launched in July and how that compares with the American mobile tariffs. Do you have any kind of internal targets in terms of the timing to stabilize EBITDA in Mexico? That's about Mexico. The second one in Spain. I don't know if you could update us on the fiber and VDCL rollout and how that is affecting your share of NetApps in those regions where you're rolling out the new network.

Speaker 0

Good afternoon, Yvonne. María García-Legaz Ponce is speaking. In Mexico, in terms of the tariffs that we have launched pretty recently, it's the reaction of the new interconnection of the new mobile termination rate scenario in Mexico. We have launched a tariff that includes all destinations, including all networks, in order to try to take advantage of this reduction in the entry barrier to the, namely to the Telcel community. The competitor has reacted immediately, but I think that this is one of the potential positive effects of the interconnection reduction, and we want to foster that as soon as possible. Having said that, we are in open conversations with the regulator because we think that this drop has been too severe and too immediate. Therefore, we have conversations because we disagree on some of the calculations they have used in order to reach this level of mobile termination rates.

I think that those conversations are open, and we think that the competitive environment in Mexico is still, from a regulatory standpoint, not closed. In terms of the situation in Mexico, it's a weak quarter from a financial standpoint, very weak quarter because of the year-on-year comparison with revenues down 30% and OIBDA dropping 30%. It is true that because of the deterioration from a financial standpoint, it started in the third and most importantly in the fourth quarter of the previous year, the year-on-year comparison is going to be better because at the end of the day, the underlying operating metrics are getting better. We are intensifying our CapEx deployment, namely in 3G. We are basically doubling the amount of our base stations in the country. Data revenue is growing 11% versus, namely, almost flat in the first quarter. Non-SMS data revenue is growing, is almost tripling.

Mobile broadband net adds is growing 180%. The total customer base is growing almost 13% and contract customers 21%. The traffic is growing 4.7% for the first time in the last three quarters. On-net traffic growing 7%. MOU has a limited decline. In summary, we see some turnaround in the operational metrics that should start to be reflected from here till year-end.

Speaker 6

This is Guillermo regarding your questions about fiber. What you can infer from the CMT data is that the fiber numbers, as quantitative, are very limited. It's less than, in our case, less than 2% of our total broadband plant. We are focusing in this stage on improving the processes, the quality of installation, the customer experience, and also the commercial side, how to sell these services in the places where we have footprint. This is very early stages. We are learning and perhaps no material impact at all on our overall numbers.

Speaker 5

Next question, please.

Speaker 9

The next question comes from John Keith from Sanford Bernstein. Please go ahead with your question.

Speaker 8

Thank you. Good afternoon. Two questions, please. Firstly, if you have to choose the year-end between three of your stated targets, that is paying the full dividend, keeping debt to OIBDA under 2.5 times, and paying the dividend out of organic cash flow rather than debt, how would you prioritize among those? The second question is, how would you rate the probability of a significantly worse mobile termination rate cut in Brazil occurring? Thank you.

Speaker 2

Hi, John. This is Santiago. When we get to the year-end, I am convinced 100% that we will have been able to show that the commitments that we set for ourselves are fully doable. I would not engage in a hypothetical discussion as to what comes first because all three are realizable. We are going to meet all three. When we produce those numbers, we think we accommodated a sufficient cushion, a sufficient degree of leeway so that we are comfortably going to meet our growth, our margins, and our dividend commitments without any further strain.

Speaker 0

the question of mobile termination rates in Brazil, no news on that front yet. The conversation or the rumors or the noise that we are hearing from the market is that it's going into the direction of a progressive cut or glide path scenario rather than a drastic initial cut. No further news so far.

Speaker 8

Thank you.

Speaker 5

Next question, please.

Speaker 9

The next question comes from Jonathan Dunn from Barclays Capital. Please go ahead with your question.

Speaker 4

Oh, hi. Thank you. Could you do two things, please? Could you clarify the dividend language around the 2013 and onward dividends? Could you just sort of let us know what sort of magnitude of cash flow are you expecting to repatriate from Latin America annually?

Speaker 2

Hi, Jonathan. This is Santiago. On the dividend language, let me be again specific. What we have said is that we are going to pay a full dividend in cash out of the results to be generated in 2012 of €1.75 per share. Starting 2013, that is to be paid in late 2013 and early 2014, as the calendar goes, we left the window open not to change the amount, but to be open, that is optional, towards the content of that payment. We could, at that time, ask around and see whether a buyback would be more interesting as a partial commitment, as we have done in the past, than a full cash. No decision has been done. We don't have any strong preference for either.

We will have enough time from now until the end of 2012 to ask around and see what the investor community feels, if there is a majority feeling.

Speaker 4

Would you roll out a script dividend?

Speaker 2

When the time comes, we will get there. What we have said is that at these low valuation levels, it would not make much sense from our perspective to increase the share count. It will not be used. A script dividend in the sense of issuing new shares is not something that is in our arsenal yet.

Speaker 0

Hello, Jonathan. This is Miguel. Regarding repatriation from Latam, year to date, we have repatriated close to €1.4 billion, and we plan to more than double that in the full year.

Speaker 8

Thank you very much.

Speaker 5

We have time for the last question.

Speaker 9

The final question comes from Stanley Martinez from Legal & General Investments. Please go ahead with your question.

Speaker 4

Oh, good afternoon to you, María and Santiago, and thank you for taking my call. I just have two questions today. Both concern Telefónica's leverage target and evolution therein, following into Jesús and Georgio's questions. Miguel, I did not see a reiteration of Telefónica's 2.0 to 2.5 times leverage target in the slides or in the detailed reports text. Is that because the social agreement, which is NPV positive in the long term, and it has the slightly leveraging effect, was not included in previous guidance? Is that fully offset by the additional tax synergies in Brazil, which was also not included? If not, is the leveraging now a longer-term ambition, perhaps for 2013 or beyond? Is Telefónica's new central tendency around 2.5 times gearing and, if so, increasing rather than stable to declining gross debt?

Speaker 0

Our leverage targets have been set in a way that we are going to be able to comply whatever we do, and we consider any movement we do with its impact in the leverage. Really, the recent provisions in Spain are going to increase, obviously, our commitments. As I have told you, this could be around one-third of what we have been commenting. This will be offset by cash flow generation because we have not just the ambition of generating cash flow to pay the dividend, but to have some leeway for other purposes, including this debt cancellation. Obviously, in the equation and when looking forward, we take into account everything, and we take into account the tax savings in Brazil, as we take the tax savings in Spain or in other countries, or the cash flow generation from the business.

We will continue moving towards the medium part of the range in the coming years.

Speaker 2

Okay, ladies and gentlemen, with this, we come to the end of this conference call. We thank you for having spent the time to listen to us. For those of you who still haven't enjoyed the summer break, probably well deserved, please take it. We will be back with the Q3 numbers sometime in mid-November. Thanks very much and have a good day.