Telefónica Deutschland Holding AG (OTCPK:TELDF) Q2 2020 Earnings Conference Call July 29, 2020 4:00 AM ET

Company Participants

Christian Kern – Investor Relations

Markus Haas – Chief Executive Officer

Markus Rolle – Chief Financial Officer

Conference Call Participants

Jakob Bluestone – Crédit Suisse

Keval Khiroya – Deutsche Bank

Mathieu Robilliard – Barclays

Joshua Mills – Exane

Ulrich Rathe – Jefferies

Georgios Ierodiaconou – Citi

Christian Fangmann – HSBC

Polo Tang – UBS

Wolfgang Specht – Bankhaus Lampe

Frederic Boulan – Bank of America

James Ratzer – New Street Research

Christian Kern

Good morning, everyone, and thank you for joining us today. On behalf of the management team, it is my pleasure to welcome you to Telefónica Deutschland first half preliminary results call.

Before proceeding with the management presentation, we would like to inform you that the financial information contained in this document has been prepared under international financial reporting standards. As usual, this presentation may contain announcements that constitute forward-looking statements, which are not guarantees for future business performance and involve risks as well as uncertainties. Also, certain results may materially differ from those in these forward-looking statements due to a number of factors. We invite you to read the detailed disclaimer as included on the first slide of this presentation. Using the provided QR code, you can also download today’s presentation in the IR section of our company web page.

Here with me today are Telefónica Deutschland’s CEO, Markus Haas; and CFO, Markus Rolle, who will take you through our Q2 results presentation, followed by a management Q&A session.

Markus, over to you now.

Markus Haas

Good morning, ladies and gentlemen. Thank you for joining us today for Telefónica Deutschland’s Q2 2020 Preliminary Results Call. My CFO colleague, Markus Rolle, and I are delighted to welcome you and look forward to discussing our results with you, just a few days after Telefónica Deutschland celebrated its 25th anniversary.

In 1995, the predecessor company, Viag Interkom, became Germany’s fourth mobile network operator. To date, Telefónica Deutschland has successfully consolidated the German market and connects with more than 42 million people with mobile services and more than 2 million with fixed access, and not to forget the steadily growing number of machines.

With the accelerating digitalization also in the back of COVID-19, we will continue to make an even bigger impact on all areas of people’s life and work. Our foundation remains strong. Our network proved resilient, coping well with COVID-19, driven by traffic increases. The 4G rollout made steady progress in half year 1, despite some temporary disruptions to the LTE supply chain in the tough COVID-19 environment. Overall, we are on track to achieve our full year 2020 coverage target. At the same time, we are preparing for a ramp-up of 5G. Also, we have significantly brought forward our ambitious ESG target to be climate-neutral by no later than 2030.

Now let me share with you some key facts about our first half business performance. I’m delighted to say that our core business is intact despite COVID-19 and are the operational business trends. We are seeing encouraging signs of a recovery post easing of lockdown restrictions. However, the business has not been completely immune to COVID-19 impacts. In particular, worldwide travel restrictions compromising roaming patterns, lockdown measures resulted in muted prepaid dynamics due to WiFi offloading at home and the mandatory mid-March to end April closure of our two shops led to somewhat weaker trading.

On this background, we are proud to announce today a robust set of operational and financial results for the first half of the year. We won 347,000 net additions, supported by online channels as shops were closed for a few weeks. The annualized churn on the O2 brand has become down to historic low of 14.3%, reflecting predominantly the steady improvement of network quality and service. Obviously, also our own brand postpaid ARPU has been impacted by the COVID-19-related reduction of roaming revenues. However, excluding roaming, own brand postpaid ARPU was stable and has already resumed its growth path in June, as Markus Rolle will show in more detail.

Overall, half year 1 financials reflect COVID-19 impacts and other non-recurring special factors. Revenue was up 2% year-over-year with sustained healthy growth of handset and fixed revenues, while MSR faced tougher year-on-year comps after the achieved MSR turnaround a year ago. OIBDA was down 1.9% year-over-year, mainly reflecting the flow-through from the revenue mix, including higher supply costs, mainly from handsets as well as the just mentioned COVID-19 impacts and other non-recurring special factors. Excluding COVID-19 and all non-recurring impacts, operationally year-over-year growth trends are intact with revenue and OIBDA up 3.8% and 2.4%, respectively.

On Slide number 4, let’s take a closer look at the encouraging signs of operational recovery on the back of phased easing of lockdown restrictions. Three observations: first, a gradual recovery of trading performance and prepaid dynamics started with the phased removal of lockdown measures, for example, shop reopenings already in late April and increased mobility; second, towards the end of the second quarter, gross adds and prepaid data top-up bookings are back to pre-COVID-19 levels; and third, at the same time, churn stayed at slightly lower levels than pre-COVID supported by our sustained retention focus and improved network quality. So hence, we are delighted to highlight that trading momentum has swiftly recovered. Roaming revenues are already showing early signs of a recovery, especially inbound roaming is picking up. We expect this recovery to gain further momentum with the continued easing of worldwide travel restrictions. Overall, we see Telefónica Deutschland in a robust position with encouraging signs of operational recovery, managing well the impacts of the pandemic. Let me also mention that we continue to support our employees, customer and the wider society through a variety of COVID-19 initiatives.

On Slide number 5. Telefónica Deutschland summarizes the robust performance in half year 1 2020. Our operation and core business trends are intact while not immune to the prevailing COVID-19 environment. We achieved the expected robust business development in half year 1 despite the government-imposed lockdown measures, including worldwide travel restrictions. Since the beginning of the pandemic, the management team has continuously been monitoring and analyzing the development of the COVID-19-related restrictions and the phasing impact on the company’s full year 2020 CapEx deployment. In this context, Telefónica confirms its financial outlook for fiscal year 2020 for revenue and OIBDA, while anticipating CapEx to sales ratio to be below the initially envisaged 17% to 18%.

Let’s move to Slide 6 for a quick recap of our recently announced infrastructure deal with Telxius, which is the largest MNO-led rooftop transaction being executed in Europe. The deal and the future cooperation of Telxius has a strategic importance and comes with significant benefits of our business. Three key levers: first, driving value crystallization selling around 10,000 rooftop sites and up to 80 towers crystallizes value by monetizing the currently attractive valuations for constructional network infrastructure, and thus maximizing shareholder value. Second, enhancing financial flexibility. The transaction further enhances our financial flexibility and continues to strengthen our financial profile while we can focus on our core business activities. We continue using the mobile size as anchor tenant while having secured long-term access to strategically important locations for 5G rollout.

And third, improving CapEx flexibility. As anticipated in our investment for growth program, this transaction significantly increases our CapEx flexibility. As part of the expanded cooperation, Telxius has committed to construct additionally 2,400 build-to-suit sites over the next four years. The bulk of these sites contributes of Telefónica Deutschland’s obligation under the white-spot sharing deal with the German government and the German MNOs. We will execute the spin-off and transfer of sites in two tranches. Around 60% of sites will be transferred by August and the remaining approximately 40% in mid-2021. While the €1.5 billion proceeds will be auctioned – accounted for in-line with the two-step execution process, we have agreed upon three installments for the purchase price. two payments aligned with the transfer schedule of sites and a final 15% payment in 2025. With regards to the use of proceeds, we evaluate various options and anticipate to provide an update to the market within the next few months.

On Slide number 7. Focus on the foundation of Telefónica Deutschland’s success and a core element of future business growth, our network. The network has been resilient, coping well with major changes in traffic volumes since the beginning of the lockdown. We saw a strong increase in fixed and mobile voice volumes as well as higher fixed data traffic while mobile data traffic trends remained broadly unchanged. Despite the challenging COVID-19 environment and some related temporary supply chain disruptions for LTE elements, our LTE rollout has made steady progress in half year 1. In the most populated federal state of North Rhine-

Westphalia, we have already achieved a coverage target of 97% and even provide 100% household coverage in the city states Berlin, Hamburg and Bremen. I’m also delighted to confirm that our efforts to speed up our LTE rollout following the easing of the COVID-19 restrictions have been successful. We have now installed 40% of our full year coverage target equal to more than 3,000 new LTE elements and thus achieved the first milestone of the German regulator within the grounded grace period, avoiding any potential fine.

Of course, we are not resting and keep our weekly run rates high. Only recently, we achieved a new record of turning on a new site every 10 minutes. Substantial improvement of NPS are only one tangible evidence of the steady coverage and quality enhancements of our network. Overall, we are fully on track to achieve our coverage target of installing additional 7,600 LTE elements by the year-end 2020.

As we continue with the LTE rollout, we are also deploying smart metering for electricity to our sites to further increase the CO2 efficiency of the O2 network. As we speak, almost 7,500 of our sites are already equipped with smart meters, and we target to have all of our sites covered by the end of next year. With smart metering, we are taking a further step towards achieving our goal of being climate-neutral by no later than 2030. At the same time, we are preparing the ramp-up of the 5G rollout in Germany in the top five cities by the end of 2020. We have recently selected Ericsson as the sole supplier for our 5G core network. With Ericsson, we have chosen a European technology for the most security-sensitive area of our network. Over time and in line with the usual renewal cycles, we will phase out Chinese technology from the existing core networks. For the 5G radio access network, we continue to build upon our proven multi-vendor strategy with Nokia and Huawei. The contracts with both vendors include compensation clauses if either of them fails to pass the high security certifications in Germany, which Parliament is expected to finalize after the summer break 2020. It’s our ambition to supply Germany’s largest 30 cities with a total of 16 million inhabitants by the end of 2022.

Moving to my final slide. I would like to reiterate our five key strategic priorities for the “new 20s” which have one common goal, delivering attractive shareholder returns. First, we are investing into the development of our business model to accelerate the company’s growth profile. Second, we will be leveraging smart investments into the LTE expansion of our mobile network to further improve service quality and achieve our coverage targets at the same time. We have already achieved the first milestone, and our efforts are bearing fruit as evidenced by substantial improvements in the NPS. Third, in fixed, we will leverage our wholesale access to VDSL and cable, which will enhance our bundling capabilities. We are making good progress in preparing the required IT interfaces to launch an O2-branded cable product towards the end of the year 2020. A technology-agnostic approach will enable us to bundle mobile and fixed as well as mobile and mobile and thus support further churn reduction. Fourth, we have started our 5G investments and are building a strong basis for fixed mobile substitution, which we expect to be a future driver of revenue and profitability. And last, also the identified B2B opportunity remains intact despite the currently challenging COVID-19 environment and particularly for SMEs and SoHos. Overall, our successful execution of these five strategic priorities ensures that we will be able to offer our shareholders an attractive remuneration not only today but also in the foreseeable future.

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Markus, now over to you for the detailed discussion of our Q2 results.

Markus Rolle

Thank you, Markus, and also a very warm welcome from my side. I hope that you and your families are keeping safe and healthy in very special times that we have. Let me take you through our Q2 2020 operational and financial performance in more detail. Let’s go through the numbers before we kick off the Q&A.

On Slide 10, you see that our operational trends are intact despite COVID-19. Our revenue stood at €1,790 million, which is an increase of 0.3% year-over-year despite the sharp drop in roaming contribution, as Markus has mentioned before. We saw sustained handset and fixed revenue growth and tougher comps for MSR. Our operational revenue trends remained intact with a plus of 3.8% year-over-year, excluding approximately €60 million of combined COVID-19 impacts and other non-recurring special factors. COVID-19 impact accounted for the lion’s share of these combined special factors, roughly 2/3 at revenue level and somewhat less at OIBDA level.

MSR fell minus 3.3% year-over-year to €1,275 million, including the vast majority of the mentioned, approximately €60 million of special factors, mainly due to the lockdown-related impacts, such as weaker trading momentum, lower demand for prepaid services and a meaningful drop in roaming. We also saw a gradual recovery of trading performance and prepaid dynamics, which started with the phased removal of the lockdown measures, while roaming is expected to recover gradually with easing travel restrictions. Excluding combined special factors, operational MSR trends improved by plus 1.3% year-over-year in Q2 2020 on tougher year-over-year comps due to the MSR turnaround in Q2 2019.

Handset revenue growth accelerated to 14.4% year-over-year and totaled to €322 million. This is driven on the continued strong demand for high-value handset supported by the online channels during the lockdown phase. Fixed line revenue continued its growth path, posting plus 4.3% year-over-year growth to €193 million. This was supported by the retail customer base growth on the back of strong VDSL demand. Our fixed retail revenue maintained its upward trend and registered plus 6.6% year-over-year growth, reflecting the year-over-year higher customer base, driven by the strong VDSL demand.

On Slide 11, we show the gradual trading recovery and also early signs of ARPU rebound post the lockdown phase. Mobile postpaid showed 150,000 net additions. This is reflecting the gradual recovery of the trading momentum post the lockdown as evidenced by the latest trend in June with sustained customer demand for the well-performing O2 Free portfolio. Our partner’s performance remained solid. O2 postpaid churn improved by 0.1 percentage point year-over-year and continued to be at even lower levels of 1.1%. This is mainly driven by our retention focus, supported by our sustained network quality improvement and also some tailwinds from COVID-19-related lower churn entries at the end of the second quarter.

ARPU trends are giving evidence of the lockdown-related headwinds on roaming, trading and the demand for prepaid packages due to WiFi offloading at home as well as further regulatory effects. In combinations, these are offsetting factors for the ARPU-accretive effects from the O2 Free portfolio and the new value-added services. Our own brand postpaid ARPU was down minus 2.3% year-over-year. Excluding the COVID-19-related loss of roaming revenues, own brand postpaid ARPU was broadly stable year-over-year and already resumed its growth path in June with an up of 0.7% year-over-year.

Fixed broadband came in with 13,000 of net adds, and the customer base is now accounting to 2.2 million. This is driven by the continued strong demand for our VDSL business, which showed an up of 41,000. The fixed broadband ARPU showed also continued growth here now with 1.7% year-over-year to €23.80. This is again reflecting the growing portion of the VDSL customers. The partner contribution continued its broadly stable trend with regards to gross adds, which is at 59%, and also MSR as a percentage of postpaid of around 27%.

On the next slide, you find our OIBDA of €552 million, which is down minus 5.1% year-over-year. This is reflecting the revenue flow-through, including the strong growth of lower-margin handset revenues and higher supply costs as well as approximately €40 million of combined COVID-19 and other non-recurrent special factors. And additionally, costs, for example, with regards to legal proceedings and the implementation of the temporary VAT reduction. Nonetheless, our OIBDA margin stood at 30.9%. Excluding combined special factors, our operational OIBDA trends remained intact, posting a growth of 2.3% year-over-year growth. And our operational OIBDA margin is at 32.1%.

On Slide 13, you find the evolution of our free cash flow and net debt year-to-date development. The company generated a free cash flow of €316 million in half year 1. CapEx totaled to €475 million, with a CapEx over sales ratio of 13.1%, reflecting the more back-end loaded annual deployment also due to COVID-19 while being on track to achieve the full year 2020 coverage targets. Free cash flow dynamics reflect some seasonal working capital effects. Working capital movements and adjustments were negative in the amount of minus €264 million. This seasonal development was mainly driven by the prepayments for incidental lease cost, low-value and short-term leases in connection with leased lines and mobile site rental and other prepayments, minus €10 million; the reduction of CapEx payables, minus €73 million; the decrease in restructuring provisions, minus €11 million; and other working capital movements in the amount of minus €170 million, including silent factoring transactions for handset receivables in the gross amount of €393 million, which were outweighed by other working capital movements, including a reduction in trade and other payables and deferred income, primarily prepaid vouchers, as well as an increase in inventory. Lease payments primarily for leased lines and antenna sites amounted to €336 million. As a result, free cash flow after lease stood at minus €21 million for the reporting period compared to minus €5 million in the prior year.

Our consolidated net financial debt of €4,438 million as of 30th of June 2020, implies a leverage ratio of 1.9 times, mainly reflecting the full year 2019 dividend payment of €506 million in May. The leverage remained well below the company’s self-defined target ratio of at or below 2.5 times. That leaves us comfortable leverage headroom with regards to the company’s BBB rating by Fitch.

Let me sum up the key takeaways with my final slides. Our business dynamics are intact. We are confirming the full year outlook and midterm guidance for revenue and OIBDA, while anticipating CapEx over sales to be below the initially envisaged 17% to 18% range. The management team is continuously monitoring and analyzing the COVID-19 developments. Revenue performance in Q2 confirmed the operational trends with strong handsets and fixed revenue contribution, while MSR reflects the lower roaming contribution. OIBDA includes special factors, while our operational trends are intact. Free cash flow after lease dynamics show the normal usual seasonality development. Net debt is slightly up post the dividend payment with a leverage in line with our target. Finally, a solid balance sheet, our strong liquidity position and our ability to generate free cash flow support total shareholder returns.

With this, I would like to hand back to the operator and start the Q&A.

Question-and-Answer Session


[Operator Instructions] The first question is from Jakob Bluestone with Crédit Suisse. Please go ahead.

Jakob Bluestone

I had a couple of questions, please. Firstly, I’m struggling a little bit with the math for sort of getting to the EBITDA guidance for the full year of flat to slightly growing EBITDA. In the first half, you did minus 2%. So to sort of get to the bottom end of that range, you’d have to do about 2% growth in the second half, which is kind of what your ex COVID run rate is. But presumably, there’s still some roaming drag, particularly around Q3 and the summer months. So it just seems to me that the guidance seems to sort of imply no COVID effect at all in the second half. And I think you also mentioned the comps become a little bit tougher. So if you can maybe just sort of help us through the math of how do you get to the guidance for the full year, that would be quite useful.

And then just secondly, if you can maybe share your thoughts on your latest thinking around potential buyback particularly in light of the tower transaction, what’s your current thinking that would be very useful.

Markus Haas

Jakob, on your first question, I think the operational trends on OIBDA with 2.3% growth year-over-year in the first half year, Q1 and Q2, plus the washout of the non-recurring effect from Q2 into the second half year, brings us there. So we are fully committed to deliver the OIBDA guidance that we have given and reconfirmed today.

Markus Rolle

And let me follow-up your second question with regards to buyback, Jakob. We have always indicated that we are not in a rush for that decision. So we will decide on the second half year of what we do with the proceeds, and we’ll also announce that. And of course, all options remain open, amongst others, also the buyback option.


The next question is from Keval Khiroya with Deutsche Bank. Please go ahead.

Keval Khiroya

Two questions, please. So firstly, just going back to the EBITDA trends for the full year. Obviously, you’ve highlighted quite clearly where hopefully some of the COVID drag should start to turn off. Just from an OpEx perspective, obviously, some other operators have highlighted the potential for more structural costs to come out, and these happen during the course of the year. As we look to the second half, do you see any more scope for those savings to come through?

And then secondly, just in terms of roaming exposure. If we just look at the baseline EBITDA exposure for roaming in Q3, is it similar to Q2? I know, obviously, non-EU roaming and inbound is potentially quite profitable, but presumably for outbound roaming within Europe, you are still net payers of that?

Markus Rolle

Let me take your first question. Of course, I can confirm that the company always searches for structural cost improvements, and we will also do so in the second half year. Let’s not forget that we have already done a lot of initiatives already in the past with regards to the merger-related activities that we have done. But we have also clearly announced that all the times that we see further improvements, especially from the digitization of services, et cetera, which we will, of course, also pursue in the second half year. And of course, we are also expecting benefits from that one going forward.

Markus Haas

On roaming, we see more or less three elements. As I mentioned, inbound roaming is coming back. We also saw strong signs of recovery in June, so in the last month of the second quarter. And also, Germany is an attractive place to make holiday for many other European in these days. So this is clearly a positive development. And rest of Europe, as said, is more neutral for us. And rest of world is an uncertainty. But let’s also highlight our exposure on rest of world is significantly lower with a significantly lower B2B customer base. We are a consumer-centric business, and rest of world is mainly B2B travel. So from that perspective, we also do not have the crystal ball. But as we see, we see clearly highlights of recovery there, and we now need to watch out, as Markus Rolle said, on a weekly basis how things are going. But overall, these three elements are key, and there’s a different exposure by different operators to these three factors.


The next question is from Mathieu Robilliard with Barclays. Please go ahead.

Mathieu Robilliard

If I could come back to roaming. I just wanted to clarify. I think you had said in the past that you were a net payer of roaming throughout the year. So whilst obviously in Q1 and Q2, lower roaming has had a negative impact. Is it fair to understand that in Q3 where typically a lot of Germans travel outside of Germany, the fact that there’s less travel means that the EBITDA impact from lower earnings could actually be a positive? And that’s partly what supports your confidence in reaching the guidance? So that would be the first question.

And second, is there any update you can give us in terms of the discussion you’re having with Drillisch on the MNO remedies, but also in terms of the timing of the arbitration processes?

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Markus Rolle

Mathieu, I can confirm that we are a net payer in roaming on a wholesale basis. So that’s completely right. And as Markus was mentioning, due to the fact that Germany is seen as a very safe travel destination currently due to the low COVID-19 infections that we have, we are seeing here positive trends from people traveling to Germany also for the holidays and, of course, also people working here in agriculture and other areas going forward. So that is what I can confirm on that one. And we need to see now how that easing of travel restrictions will also affect the rest of world trading that we see with regards to roaming, how many people will go to new countries, where, of course, we are not making that high portion that – of revenue that Markus was mentioning due to the low B2B exposure that we are having. But of course, we need to see how these trends develop in the next quarters.

Markus Haas

And your second question, Mathieu. There – the price review arbitration proceedings are ongoing. They continue under the normal course of the rules that the parties have given to this arbitration. And in parallel, we continue to negotiate the national roaming agreement with United Internet and Drillisch.

Mathieu Robilliard

And one last point. Is there any time line? Because obviously, you mentioned some deadlines in the past, which, I guess, weren’t that formal. But I mean, is there a formal stop to that process at some point?

Markus Haas

Yes, not the formal top stop. It’s also clear that negotiations can’t run endlessly, as we said. I think that’s also the expectation by the involved authorities. So from our perspective, we do everything. We made an attractive offer, put it on the table, and let’s see how this now finalizes. There is not – and there was a nine-month indication time line for negotiation, and we are over that nine-month indication time line. I think these are the facts that we know today. And from that perspective, we clearly believe that these negotiations will not run endlessly. So – and both parties put effort into that. I think this is what we can say.


The next question is from Joshua Mills with Exane. Please go ahead.

Joshua Mills

Two questions from me. One on the COVID impact and one on Huawei. On the COVID impact, could you give us a bit more detail on how the €38 million revenue headwind you saw in Q2 breaks down between roaming effects and then also prepaid? And on the prepaid point, there’s a useful slide, Slide 4, which shows the top-ups recovering. Is that number of top-ups? Or is it a kind of useful financial metric which will give us an indication of how prepaid revenues develop through the year?

And then secondly, on Huawei, I’d just be interested to get your views on not just how the political situations evolved, but also what your technical team is saying with regards to the sustainability of using Huawei in the radio access network? Are there any concerns on your side that given the restrictions placed on the business and access to U.S. technology, there’s a vendor risk here rather than just a political one on a three-to five-year view?

Markus Rolle

Josh, let me take the first question on the COVID impact. With regards to the mentioned effect, of course, roaming is the biggest contributor because there was nearly no travel during the lockdown period, which eased already, and that is also why we described it before, we see already back-end improving trend. With regards to prepaid, the second major driver, we can declare today that we have full recovery. And indeed, you see the number of top-ups in that graph. However, it also gives you an indication of the value of top-ups, because the value mix usually doesn’t change. So we gave you that indicator in order to show you also that the revenue trends of recovery are going the same lines that you see here. And here we are back on precrisis level. And the driver for that is that people optimized on the short term because they were staying at home, use their WiFi at home. And once they were allowed to go out again and go into the streets again, they reassumed or recapped on their prepaid bundles again, and they are using that back to the normal levels that we have seen prior to the crisis.

Markus Haas

Josh, on your second question, top line. I think it’s clearly our duty to manage the uncertainty and protect our business and our shareholders. So on core, we have taken a clear decision on 5G core, we’ll go with Ericsson. And on all radio-related activities, as I mentioned in the presentation, we are fully protected on reimbursement, and we now need to wait for the final outcome of the decision. From a technological point of view, coming back to your question, I think the quality standards and the quality – the technical quality being delivered, that delivered does not raise concerns in our technical departments. So with all vendors we have, we have no technological concerns. But clearly, we need to manage the uncertainty, and this is what we have done. So I think we are protected, and we now need to see how the final decisions will go.


The next question is from Ulrich Rathe with Jefferies.

Ulrich Rathe

So I would ask my two questions on, first of all, the special items outside of COVID-19. I understand there is a settlement in there. Could you just describe whatever you can talk about with regards to this other stuff that’s not directly COVID related?

My second question is on the fixed line trends. The ADSL loss was a bit higher than in prior quarter. And the VDSL was a bit higher – well, the intake was also a bit higher, but not very much. So it sounds a bit as if the ADSL-VDSL conversion is actually weakening a little bit at the moment. Is this an effect of competition? Or is it just phasing? Or do you have any comments on that dynamics on the fixed side?

Markus Haas

Thanks for your question. The special factor was a move back. I think we did some smaller settlements with partners. Clearly, they are confidential. But overall, it’s non-recurring. I think that’s the key factor on that. And then so far, we do not expect any effect on the year-end or in Q3 or Q4, non-recurring, smaller settlements and nothing to worry about.

Markus Rolle

Ulrich, let me take your second question with regards to fixed line trends. Here, I can only confirm that the underlying trends are completely intact. Of course, you see also some effects from the COVID-19 lockdown phase of our shops, also on the DSL development. We see a continuous trend of ADSL into VDSL migrations. We see continuous demand also for our VDSL product, upgrading to higher speeds. And that is also, by the way, reflected in the positive trend of ARPU development that we see. So overall, we are very pleased with the VDSL and with the fixed line development in general.


The next question is from Georgios Ierodiaconou with Citi. Please go ahead.

Georgios Ierodiaconou

I have two, please. The first one is around the partner trading and revenues. You used to have a slide updating us on the mix of gross adds and also the MSR contribution. I appreciate, Markus, you’ve already made some comments on this. But it will be great if you can confirm that the trends are roughly unchanged. And also actually on the MSR side, if you could give us an indication of whether the percentage has stayed at 28% or whether the retail business suffered a bit more because of the roaming impact.

And then my second question is just a follow-up on some of the previous ones around the EBITDA phasing. I appreciate that if you deliver the organic performance of H1, you should be in line to reach the bottom end of your guidance. But obviously, that would imply that roaming recovers almost fully which that will be unlikely in the third quarter. So is it possible to perhaps give us any indications of what are the other perhaps cost savings or revenue items that you expect to go your way to mitigate for any shortfalls in roaming year-on-year?

Markus Rolle

Georgios, so yes, we have taken out the slide because there was not so much to say because of the stable trends that we see there. But I can confirm that these trends are very stable. So there’s nothing to hide. Our partner contribution share of postpaid gross adds was at 59%. So similar to previous quarter where it was at 61% or the quarter before at 60%.

And with regards to the MSR contribution, we see roughly 27% share over postpaid MSR, which is roughly 1 percentage point lower than the previous quarter. But this is, of course, driven by the before-discussed special factors. So also here, the underlying trends are pretty much in line with our expectations.

Markus Haas

On your second question, that’s fully confident to meet the OIBDA guidance. And from that perspective, we clearly also have our efficiency program still in place to underpin the guidance that we have given. So we do not fully bet on roaming on that side to be just clear. So also in the second half, we clearly expect the flow-through of some of our efficiency measures and programs that are in place in Telefónica Deutschland.


The next question is from Christian Fangmann with HSBC. Please go ahead.

Christian Fangmann

I have two questions. The first is on working capital. It looks like you had a very high working capital outflow in the second quarter. Obviously, also lower top-ups, which is typically positive for you guys, which you didn’t really have in terms of demand in the second quarter. But what can we expect in the rest of the year? I mean, basically, you have, call it, roughly flat free cash flow this year, so sort of 0 free cash flow. Can you help us understand the phasing for the second half a bit better?

And the second one is on the CapEx outlook. It looks like you’re now expecting it to be below the initial 17% to 18% CapEx ratio. So what’s driving this? And how much lower do you expect it to be in the end? To give a rough indication would help.

Markus Rolle

Christian, with regard to working capital, I can tell you that we are pretty much in line also with previous year’s performance following the usual seasonality patterns here that we see, and we are expecting to build up also similar to previous years, the changes here. So from an overall perspective, we are in line with our expectations for the first half year. We always have a very back-end loaded cash flow profile, and that also applies for this year.

I can also confirm that from COVID-19, we have so far no material impact on working capital movements. We see a very low portion of customers taking the moratorium so that they pay later from the government. And we also see that our suppliers are paying their bill as we have planned it. So from an overall perspective, we are expecting also a very solid second quarter.

Markus Haas

On CapEx, we wanted to give full transparency that there are smaller shifts between the quarters, and it could also end up that some of the equipment will be delivered more in January than in December. So I think this shift are now reflected with the announcement of this morning, we would not expect significant amounts below the 17%. So it was just giving transparency in these days. Supply chains are overall under control but there are some smaller shifts. And this flexibility we need, this is why we gave the transparency.


The next question is from Polo Tang with UBS. Please go ahead.

Polo Tang

I just have two questions. The first question is just about service revenues and the trajectory. So is Q2 the trough? Or should we expect things to get worse, just given the fact that you have tougher comps, I think, in particular, from roaming in revenues where you had a boost in Q3 last year? And can you also maybe talk about how you see the headwinds and tailwinds in terms of service revenues developing over the coming quarters? And then how much of a recovery in roaming are you assuming to get to your full year guidance? So that’s just really the first question around service revenues.

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And second question is really just a bigger picture question about the competitive landscape. Can you talk to me what you’re seeing in terms of both mobile and also fixed broadband?

Christian Kern

Polo, can you repeat your question? The second question, please. That wasn’t clear to us.

Polo Tang

Yes, sure. The second question was really just a bigger picture comment around what you’re seeing in terms of the competitive landscape. So specifically, what you’re seeing in both the mobile market, but also the broadband market?

Christian Kern

Okay. That’s very clear. Markus, do you want to take?

Markus Rolle

I will take the first question with regards to service revenue. Of course, we are seeing now the expected peak of the COVID-19 impacts in the second quarter, driven by the factor, of course, that there was nearly a full slowdown of roaming due to the travel restrictions, which only eased at the end of the quarter. And secondly, also, of course, because of the lockdowns within Germany, which eased by the end of April so there was already two months of recovery happening. And as we have mentioned before, here for the national ones, we are already back to normality, whereas in roaming, we see positive trends but they will be monitored in the course of the next weeks and months, as Markus was mentioning before.

So overall, we see that development. And of course, we do not see the one-off that we have seen in Q2. We do not foresee any further one-offs for the third and for the fourth quarter.

And from an underlying perspective, I think basically nothing has changed versus the previous calls that we had. We see a continuous good momentum of our retail brands. Our O2 portfolio remains very attractive for our customers. We still get better inflow values than average customer base. And also on the churn side, after improving significantly from a numbers perspective, reporting an all-time low of churn here in the second quarter, we are also expecting that the former headwinds that we had from private pricing offers due to network quality and service are easing out over the time. So from that perspective, the underlying trends remain intact.

Markus Haas

Polo, on your second question, let’s start from the consumer. I think overall, the macro shows us that consumer spend power is more or less at pre-COVID levels. So that’s important for us. We also have seen higher hardware sales during the crisis. So overall, the macro impact on Germany is quite low, especially on consumer. So consumer spend level is still high. That’s good. Secondly, also unemployment is 0.5 million more, but the recovery is going to start. So overall, very, very stable trends, and this is important for us that we see on the mobile side, especially also strong demand with a little dip in mobile data usage in the second quarter due to WiFi, but it’s completely back. So after the lockdown, the mobile usage trends are in the trends that we’ve seen before. And that clearly drives more demand for higher data bundles for unlimited tariffs. So – and so far, the ARPU up. The upsell part of our portfolio, as also Markus just mentioned, is fully on track. So it’s still a dynamic market, but it’s fully rationale on the mobile side.

On the fixed side, we also clearly see increased demand for higher bandwidth. Clearly, we have seen over the first half year some proportional activities with speed dumping. So that extremely high bandwidth, up to 1 gigabit per second are sold at €40 levels, et cetera. So from that perspective, this is a watch out for the whole market from our perspective, but we clearly see that both markets are intact, and we clearly also saw a slow. And Germany is here follower country slowly – slow growth on converged offers. It is increasing, but very – on very low levels compared to other European markets.


The next question is from Wolfgang Specht with Bankhaus Lampe. Please go ahead.

Wolfgang Specht

One question from my side. Following the transaction on the tower side, can we expect any changes in leasing payments going forward? Can you give us some insight here?

And then again, on the fixed network side, which is small but not neglectable for you. We saw solid trends on additions of customers and also on sales. Can you give us an idea how the margins and thus the OIBDA is developing here?

Markus Rolle

Yes, of course. Wolfgang, let me take the first question with regards to the tower side and if we expect lease changes. Yes, of course, we are expecting that. We will, of course, also give you clarity once the transaction is finalized, and we will then include that also into the guidance for next year accordingly. So of course, there are some changes that we have to take into account, and we will make that very clear once we have finalized the transaction.

Markus Haas

On the fixed side, as you rightly said, we do not own an own fixed access network. So and so far, the wholesale conditions we get on the market on this product is key for us for profitability. We are constantly monitoring and also negotiating new terms with the extension of the contingent model on VDSL with Deutsche Telekom. And clearly, this is essential in order to drive profitability on the fixed side. We have done the turnaround on physicals and also on revenue. So it’s a profitable business for us. But clearly, we also need with or without the help of the regulator, clearly, continue to negotiate future-proof models with our suppliers.


The next question is from Frederic Boulan with Bank of America. Please go ahead.

Frederic Boulan

Two questions, please. The first is on Huawei. So just a follow-up on the previous question. I think you said today, you’d be comfortable with the technology provided, which is fair enough. But I think the question was more considering the ban from the DoT on semiconductors. Don’t you think there is a vendor risk down the line? And any concern about the ability of Huawei to deliver 5G kit on the three-to five-year view?

And then secondly, on free cash flow, if you could help us after the negative H1, any idea of expectations for the full year? And then Telxius looking at the scope of the deal and the 2,400 new sites you’re going to lease to Telxius, is it fair to assume about €120 million lower free cash flow impact as a result? I mean, can you help us navigate those impacts?

Markus Haas

Fred, on your first question, as I said, this is important to get clarity this year. Because in case we need a 5G swap or whatever, we could do it with a third vendor very quickly. So from that perspective, we need clarity on the certification by the end of the year by the government in order to foresee if there’s impact. So far, we feel well protected and – but we need clarity soon.

Markus Rolle

Fred, let me take your second question with regards to free cash flow development. I think I mentioned it already before, we are following the normal seasonality. We have a very back-end loaded cash profile also. You have seen that also in our comparison to prior year, which is on prior year level. So there is no major changes with those previous years expected.

With regards to the 2,400 sites that you were mentioning, I cannot yet give you a detailed answer to that one. However, I want to conceptually explain: first of all, these sites will come over time. So they will not come at day 1. They will come at a later stage in four years, they will be spreaded over four years. And of course, we have to also take into account that also in a normal situation, there would have been lease obligations. It’s now just that Telxius offers us build-to-suit sites that we can easily use. So that is the difference between the two concepts. But of course, also, the other one would imply lease payments that we would have to take into account.


The final question is from James Ratzer with New Street Research. Please go ahead.

James Ratzer

Had two questions, please. So the first one is just going back to the topic around national roaming discussions with 1&1 Drillisch. I mean, are you able to give us any more color on why they are taking the amount of time they are? I mean, is there some structural difference around the pricing in the contract? Or are we down to discussing some of the finer points at the moment? And are you able to give this update you talked about with cash returns before there’s been any resolution on the national roaming agreement?

And then the second question was regarding the mobile service revenue trends going into the second half. Just to confirm, Markus, what you said. I mean, you were expecting the underlying trends to remain intact. So I think – I mean, you were at 1.3% growth this quarter, if we strip out the COVID and MVNO settlements. Is that, therefore, we should be expecting around 1.3% growth for the second half in underlying MSR?

Markus Haas

James, thanks for your question. On national roaming, I think from our perspective, the MBA has been extended for five years. So we made an offer and it’s finally Drillisch’s decision to decide when they want to sign. So we are not in a hurry on this, but we are fulfilling all our duties to come to a conclusion as quickly as possible. So from that perspective, as I said, we’re in the middle of the negotiations. And I think there’s nothing to add. I think once the deal will be signed, I’m sure it will be immediately announced by both parties. So let’s give the time for it. The rollout obligations are not so stringent that sit on the first MNO. So from that perspective, let’s see how long we will continue to negotiate.

Markus Rolle

And James, with regards to the MSR performance, you have seen that we have a very stable and solid positive development in terms of operational MSR performance. And this is what we have worked for very hard, and we have done that in order to sustain also the growth for the future. We have a guidance out there, guiding for minimum 5% of revenue increase over the next year. And of course, the MSR is also a driver to sustain that growth. There might be always some fluctuations around the quarters. That is also usual, that depends on previous year and the comps that you have, et cetera, but the underlying trends are intact. I can confirm that, yes.

James Ratzer

And then so just to confirm, are you able to give the announcement around cash and what you [indiscernible] that if the national roaming agreement hasn’t been signed?

Markus Rolle

Well, that’s two independent topics. We are currently monitoring, of course, all the impacts that are around us, and we will update in the second half year on that one. And we have also clearly mentioned before, first of all, we have already now the prolongation from the Bitstream contract that we have, which gives us certainty for the next couple of years. And that is why the national roaming discussions do not directly impact those discussions.

Christian Kern

Great. Thank you, everyone, for participating in the call. We really appreciate the constructive and good questions you had. We hope you understand even better now why we are confirming our full year 2020 guidance now that you have additional color around those topics. And if there are any further questions, the IR department is at your disposal to answer those. Thank you so much, and have a good day. Take care.


Ladies and gentlemen, thank you for joining. The conference is now over. You may disconnect your telephones. Thank you.