Vodafone Group Plc (VOD)
Half Yearly 2008 Earnings Call Transcript
July 22nd 2008 9:00 a.m. GMT

Executives

Arun Sarin – Chief Executive
Andy Halford -- Chief Financial Officer
Vittorio Colao -- Deputy Chief Executive
Paul Donovan -- Chief Executive, Vodafone EMAPA

Analysts

Robert Grindle -- Deutsche Bank
Simon Weedon -- Goldman Sachs
Will Draper – Execution Charitable Trust
Mark James -- Collins Stewart
Justin Funnell -- Credit Suisse
John Karidis – MFG
Ottavio Adorisio -- Société Générale
Nick Delfas -- Morgan Stanley
Paul Howard -- Cazenove
Jerry Dellis – JP Morgan
Terry Sinclair -- Citigroup
Guy Peddy -- Macquarie
Andrew Beale -- Arete Research
Dean Tenerelli -- T. Rowe Price
Darren Ward -- Liberum Capital
Christian Kern -- Lehman Brothers
Graham Ruck -- Merrill Lynch

Arun Sarin -- Chief Executive

Good morning and thank you for joining us. I’m here with Andy Halford and we’ll be giving you our perspective on the first quarter and the progress we’re making in the business. Vittorio Colao and Paul Donovan are here with us and they’ll join us for the Q&A. Overall, this was a more challenging quarter. In our European results, we clearly saw a weaker economic environment in Spain but strong data revenue growth trends continue. In EMAPA, growth remains strong in India, at about 50%, and whilst we continue to execute our turnaround in Turkey, growth has slowed here as expected. So let me first turn to the numbers, beginning with the Group picture. Overall, Group revenues grew to £9.8 billion, up 19.1% on last year, including a significant uplift from the movement in the euro/sterling exchange rate. On a pro forma basis, including India and with constant currency, growth was 3.7%.

In Europe, where our markets remain competitive, total revenue was up 15.5%, with 13.5% benefit from the euro movement, and 2.2% from DSL acquisitions. Revenue declined by 0.2% on an organic basis, with our strategy to drive increased usage offset by ongoing price reductions. Once again, we experienced strong organic growth in data, with revenues up 26%. In EMAPA, we continue to deliver good top-line growth. Total revenue increased by 30.5%, reflecting in particular the acquisition of Vodafone Essar. On an organic basis, total revenue growth in EMAPA of 9.2% was still driven substantially by customer growth and includes Turkey for the first time. Our customer franchise continues to strengthen. We now have over 269 million mobile customers on a proportionate basis and over 234 million customers on a statutory basis. Net additions were 9.1 million in the quarter. We posted 1.3 million net adds in Europe and 7.8 million in EMAPA, including 5.1 million in India.

Let me now take you through some of the important trends that we saw in the first quarter. In Germany, organic service revenue declined by 1.9%, with customers continuing to adopt better value price plans and ongoing pressures on SMS and incoming revenues. Usage growth remains robust, with outgoing call volumes up 19%. Data growth remains strong at 25%, with good and strong trends in PC connectivity, both in enterprise and consumer. Vodafone Germany is also proving to be a strong reseller of Arcor DSL, with 104,000 adds in the quarter. In Italy, organic service revenue growth was 0.6%. Whilst the Bersani decree is no longer impacting the growth rate, we’ve had a tougher comparative quarter due to new voice and messaging tariffs that benefited the first quarter last year. The business retains a strong focus on contract and business customers, data revenue increased by over 40%, again, with strong PC connectivity growth and an increased contribution from mobile internet, service revenue declined by 2.5% in Spain, on an organic basis. Competition has been intensifying for some time, with rising penetration and new players. The Spanish economy has also weakened significantly and we had a strong quarter last year, which makes for a tougher comparison. These factors led to a decline in voice revenue, with slowing customer growth and an acceleration in the rate of ARPU decline. Messaging revenue also fell, largely reflecting the timing of promotions. Data revenue growth slowed due to the absence of the 100-day 100-car promotion this year and the introduction of price caps.

It is difficult to split precisely the reduction in growth from the prior quarter, but we estimate around two thirds from the economic and competitive factors and one third from a tougher comparison. Unemployment is rising, particularly in the migrant worker segment, where we’ve been a strong performer. GDP growth is also slowing and we’ve seen rapid tariff optimization, which is easier in the Spanish contract market, given lower monthly commitments. Whilst this has been a tough quarter for Spain, there are a number of initiatives underway to reinvigorate growth, and we should not forget how strong growth has been over a prolonged period. UK remains one of our most competitive markets, with service revenue growth of 2.1%. Voice pricing pressures remain high, combined with slightly lower usage growth. Messaging growth slowed, as we are a year on from the refresh of our text bundles. The data story remains positive, with an increase in revenue growth, back above 30%, with 85,000 PC-connectivity adds in the quarter, including strong take-up in our USB modems. While the competitive environment is clearly continuing to impact the UK business, we do feel there are signs of the current economic weakness, although it is hard to split the two effects.

Now let’s turn to EMAPA and to India and Turkey in particular. In India, we have continued to execute well. Total pro forma revenue growth in the first quarter was 52%, with a year-on-year customer growth of 60%. Monthly net adds in the quarter improved to a record 1.7 million, ahead of the launch of our Spacetel circles, which will occur later this year. During July, we exceeded the 50 million customer mark. We continue to execute on our plans in Turkey, but the competitive, political and economic environment is very challenging. Service revenue growth in the quarter was 3.7% and was hit by a large cut in termination rates. Adjusted for this growth, growth was nearer 11%. The next key step is to complete our ongoing overhaul of the network to enable us to compete more effectively in the market, and this will be done by the end of the year. In the US, Verizon Wireless has posted another strong quarter, with net adds of 1.5 million, resulting in over 10% growth in customer base since last year. Verizon will report its June quarter on July 28th. Other highlights of our EMAPA performance include continued strong organic service revenue growth of 18% in Egypt, 15% from Vodacom in South Africa, and 8% in Romania.

Before I turn to guidance, let me briefly tell you about the progress in our strategy. In terms of cost reduction, our major cost programs around IT outsourcing, network supply chain, data centers are all established and delivering savings. Cost remains an important focus for the management team and, from the beginning of this financial year, we have stared to implement a wide range of further initiatives to streamline our business processes and drive costs out of the business. For example, in IT, we are consolidating software licensing, maintenance agreements, data storage. We are rationalizing our property and our advertising production costs, as well as centralizing our roaming activities. These are just some of the long list of ongoing initiatives in light of the current environment. Some of these, of course, will be accelerated to drive earlier savings. In addition, we’re even more focused on commercial cost discipline, particularly acquisition and retention costs, advertising and publicity.

Next, let’s look at total communications, which is now 15% of our revenues. Data revenue for the Group has continued to be strong, with a 29% organic growth. Growth is coming primarily from PC connectivity, not only through strong business performance, but increasingly from consumers as USB modems become more widespread. Across the Group, we now have 29.9 million 3G devices, including 3.1 million 3G Connect Cards, mostly in Europe, and double last year. We now have around 3.5 million handheld business devices, up 115% on last year. Fixed line revenues increased to over £600 million. We now have over 3.7 million fixed broadband customers in 13 markets across the Group, with 2.8 million in Germany, up 26% on last year. Finally, there have been a number of portfolio changes in the quarter. We’ve strengthened our fixed broadband position in Germany by buying out the minorities in Arcor. We’ve been awarded the second mobile license in Qatar and expect to launch services by the end of the financial year and most recently, we agreed to take control of Ghana Telecom, a leading player in that market.

Let me conclude by looking at our guidance. This has clearly been a more challenging quarter for the Group, particularly in Spain. Overall, our pro forma growth rate in the quarter, at 3.7%, was somewhat below the growth rates implied by our guidance range for the year and although it is too early to see a clear pattern emerging, we are beginning to see a greater impact from the current economic environment than previously envisaged. There are also early signs of delays in handset replacement, with lower-than-expected equipment revenue, which is good for our profitability. We have already been seeing an increase in our SIM-only activity, and this is a trend we will encourage. As a result of these recent trends, we now see revenue around the bottom end of our outlook range. As I have said, we remain focused on driving costs out of the business, and the current operating environment will see us even more focused.

So we still see the outlook for the adjusted operating profit, CapEx and, therefore, free cash flow unchanged. This illustrates the resilience that I’ve discussed previously and demonstrates the benefits of Vodafone’s strategy and the diversity of its assets and products. I will now hand you over to Andy, who will take you through the quarter in greater detail. Andy?

Andy Halford -- Chief Financial Officer

Thank you, Arun, and good morning, everyone. In a moment, I will talk in more detail about the revenue trends across the Group, but first I want to say a few words about our outlook statement. In May, at the time of our full-year results, and in the subsequent road show, we were able to brief you on the basis of the first six weeks trading of the quarter. However, in June, there was a slowdown in our trading performance, notably in Spain, which, as you would expect, we have been monitoring closely since then. I would stress we are reiterating the other elements of our guidance, notably operating profit and free cash flow. Now let me talk about the revenue trends in more detail. I will comment further on guidance at the end. As Arun has already said, the Group’s first quarter organic and pro forma growth is lower than the final quarter of last year. On an organic basis, total revenue grew 1.7% in the quarter, a sequential fall from 3.6%. Pro forma growth, in turn, has reduced from 6.1% to 3.7%, with Spain accounting for around half of this slowdown.

So, let me provide some more color on the drivers of this, starting with the Europe region. Total revenue in Europe reduced very slightly by 0.2% year-on-year on an organic basis, with an increase in customer base, voice usage and strong data growth offset by pricing pressures and the continuing impact of termination rate reductions. This represents a slowdown from 1.5% growth in the previous quarter. Within this, organic service revenue in Spain slowed sequentially from growth of 5.2% in the fourth quarter to a 2.5% decline in the first quarter. However, if we strip out Spain, organic service revenue in the rest of Europe combined only declined from 1.1% to 0.4%. Although there is some overlap between the dynamics of Spain and other markets, we do not see a direct read-across to the rest of Europe, given two important factors. In recent years, we have performed very strongly in the Spanish migrant worker sector, which has been dominated by Spain’s large construction sector. As a result of the events in Spain, we believe we have been impacted disproportionately by this strong market position. Secondly, a prevailing post pay pricing structure with a higher out of bundle component than we see in many other markets.

As I said, in Europe excluding Spain, service revenue rose 0.4% on an organic basis, compared to 1.1% last quarter, with the UK accounting for over half of the sequential slowdown. This is a robust performance, with the marginally slower growth primarily a function of strong take-up of specific messaging tariffs in the UK and Italy in the comparable period, and some signs of economic weakness in the UK. Breaking down this organic service revenue into the main constituent parts, I will start with voice revenue. Voice revenue was 3.5% lower year-on-year, broadly in line with the 3.0% decline in the previous quarter. Within this, outgoing voice revenue was 2.3% lower, in line with the previous quarter. Outgoing voice volumes grew 15%, offsetting effective price declines of a similar level. This usage growth was driven primarily by Italy and Germany, reflecting the take-up of large-contract voice bundles and prepaid usage initiatives.

Incoming voice revenue in Europe declined by 5.7%, a similar rate to the previous quarter, as 5% minute growth was more than offset by the impact of mandated termination rate cuts of around 11% in effective rate per minute. Messaging revenue grew at 2.9% on an organic basis, somewhat lower than the 7.5% in the previous quarter. This slowdown was most significant in Italy and the UK, where strong take-up of the Infinity tariff in Italy and SMS bundles in the UK boosted the comparative period. Data revenue in Europe increased by 31%, with strong growth continuing across our main markets and sustaining the level of growth seen last quarter. Including Spain, data revenue reached £552 million in Europe in the quarter. Increased penetration of 3G and business devices continued to be the main drivers of European data growth. In aggregate, data cards and handheld business devices reached 5.3 million, up 83% on last year. 3G devices have now reached 24% of our European customer base.