Partner Communications Company Ltd (PTNR) 2013 Q3 法說會逐字稿

Thank you, and thank you to all our listeners for joining us on this conference call to discuss Partner Communications' third-quarter results for 2013. With me on the call today is Haim Romano, Partner's CEO; and Ziv Leitman, our CFO. Haim Romano will open the call by presenting the quarterly results and recent developments, naturally focusing on the network sharing agreements with Hot Mobile. Ziv Leitman will then provide a more detailed explanation of our quarterly financial and operational results; and, finally, we'll move on to the Q&As.

Before we begin, I would like to draw your attention to the fact that all statements in this conference call may be forward-looking statements within the meaning of section 27A of the US Securities Act of 1933, as amended; section 21E of the US Securities Exchange Act of 1934, as amended; and the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995.

Regarding such forward-looking statements, you should be aware that Partner's actual results might vary materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are contained in Partner's press release dated November 19, 2013; as well as Partner's prior filings with the US Securities and Exchange Commission, on the Forms 20-F, F-1, and 6-K; as well as the F-3 shelf registration statements, all of which are readily available.

Please note the information in this conference call related to projections or other forward-looking statements is subject to previous Safe Harbor statements as of the date of this call. For your information, this call is being broadcast simultaneously over the Internet and can be accessed through our website at orange.co.il.

I will now turn the call over to Partner's CEO, Haim Romano. Haim?

Hello, everyone, and welcome to our third-quarter 2013 results conference call. 10 days ago, we have signed a network sharing agreement with Hot Mobile. We are proud to be the first company in Israel to sign such an agreement, and believe it's great news for all of us. This agreement will enable us to get a significant CapEx and OpEx saving, and, of course, a huge effect on our EBITDA. Acceleration on the LTE rollout, improvement coverage and network quality, increase network capacity and significant environmental benefit.

Turning to the results of the third quarter, I am encouraged by the initial signs of improvement in our results. We see that 29,000 net adds that we have this quarter, on top of our case of our base and higher ARPU, are clear signs that the Company strategy is working. Having said that, the competition is still fierce, and the competitors still offer aggressive and discriminating offers.

We also continue to invest in our network. This quarter, we invested NIS116 million in capital expenditure in our network and IT. Partner network is now the most advanced network and the best for our customers. And, of course, we are LTE ready. This was the key reasons behind the agreement with Hot Mobile.

At the same time, we continue to generate strong free cash flow and continue to reduce our debt. Net debt has reduced by NIS3.2 billion, and net debt to EBITDA is below 3. Our commitment is to continue to create value for the benefit of our customers, employees, and stakeholders.

Now, I would like to turn the call to our CFO, Mr. Ziv Leitman. Ziv, please.

Thank you, Haim. As Haim mentioned, we are beginning to see early indication of stabilization in the operating environment. This translated into an increasing cellular ARPU by NIS1 in the third quarter, mainly reflecting a slight moderation in price erosion of cellular services, together with seasonal effects. In addition, the cellular churn rate for the third quarter of 2013 declined for the third consecutive quarter, and the postpaid subscriber base grew by 24,000 subscribers. This is the first time the postpaid subscriber base has grown significantly versus the previous quarter since the beginning of 2011.

Service revenues for the cellular segment were NIS738 million in the third quarter, an increase of 2% from the second quarter; again, mainly explained by slight moderation in price erosion of cellular services and seasonal effects.

Equipment revenues in the third quarter of 2013 were NIS167 million, decreasing by 7% or NIS13 million from the previous quarter. However, we still managed to improve the gross profit from equipment sales by NIS1 million, despite the reduction in revenues.

For the fixed line segment, service revenue totaled NIS267 million, a decrease of 4% from the second quarter, mainly reflecting the continued pressure on prices for the fixed line services. The ISP subscriber base slightly increased in the third quarter, for the first time in two years.

On the expenses side, the Company continued to adjust its cost structure and to implement operational efficiency measures. In the third quarter, these measures led to a decrease in operating expenses, excluding cost of equipment sold and depreciation expenses of NIS4 million, compared to the last quarter. And the number of employees on an FTE basis at the end of the third quarter was 4153 compared with 4377 employees at the end of the second quarter.

EBITDA increased by NIS4 million, largely a result of increasing cellular service revenues and the reduction in operating expenses, which are partially offset by the decrease in fixed line service revenues.

Financial expenses in the third quarter decreased from the previous quarter by NIS18 million, mainly due to foreign exchange gains, which were partially offset by an increase in CPI linkage expenses as a result of higher inflation rates. Together with the increase in EBITDA, the decrease in financial expenses led to net profit rising by NIS80 million to a total of NIS38 million for the quarter.

Free cash flow before interest payments for the third quarter was NIS273 million. The Company has so far generated NIS763 million in free cash flow over the first nine months of 2013. Cash flow continues to be supported by changes in working capital, which, this quarter, decreased by NIS143 million mainly due to the decreasing trade receivables and inventory.

At the same time, the Company continued to invest in its network and IT infrastructure. CapEx investments have totaled NIS368 million since the beginning of the year, a level broadly unchanged from last year. We also continued to lower the net debt, which already was reduced by approximately NIS0.9 billion over the last 12 months.

I will now be happy to open the call to questions. Moderator, please begin the Q&A.

(Operator Instructions). David Kaplan, Barclays.

Three questions I have. Two of them are on regulation, recent announcements by the Ministry of Communications, and also your network share agreement. And then the second one is just on subscriber acquisition costs, how you see those going forward.

But I'll start with the other two first. There was a letter sent out by the Ministry of Communications about differential pricing for new and old customers. It seemed as though they were claiming that that was illegal. I assume you guys have seen that letter.

What do you make of that letter? Or what do you think that is going -- what is the impact that is going to have on pricing in the market, especially for some of the newer operators? I guess we'll start with that one.

Thank you for your question, David. Firstly, we are the only company that does not discriminate between new customers and old customers. We thought it's one of our main principles and advantages, that we support our base and we don't give any advantage to new customers. I think that this will make the market more rational, because giving those benefits to new customers led the market to the revolving door that we all see for the last 24 or 20 months. I think it will bring the market to the kind of a new behavior, that if you can't offer something to new customers without affecting your base, you wouldn't do it. So any new offer that you are offering to a customer, you should offer to your base. And then even for the newcomers, it's something that I'm not sure that they will jump to do. So I think it will make them think twice before offering aggressive offers to the market.

For example, the three months free offering by one of the players should be offered to their base as well. So I think it will make a big difference between what's going on in the last 20 months. And the question is if the MOC will enforce it. Letter and declaration is one thing; enforcing it is another thing. So we should make -- wait and see. And now the MOC is intending to force this regulation. It's in the license for the companies, as you know, if you read the letter. So we expect that the MOC will enforce it.

All right, well, since you touched on licenses, let's touch on network sharing agreements for a second. I know you guys signed a deal with Hot, and it's still subject to approval by both the Ministry of Communications, although he seems to have made comments leaning towards approving it. But also the Antitrust Commissioner -- if we are not mistaken the way we read the license agreement that Hot Mobile has -- that they are required to build out the network, and I don't see how they are going to be doing that with a network sharing agreement.

Do you see this agreement getting approved? And if it does get approved, again what is the impact that's going to have on the overall market, the two other networks that are already built out there -- either them sharing, or sharing with one of the other operators, and how do you see that playing out?

And then I guess that also will lead to the third question, which would be more for Ziv.

I think that it's interesting what's going on all over the world. It's obvious that we should go to that direction. You can see, even in much bigger countries, more than three networks. And you know, the issue of rolling out network and Israel, we know it very well. It's almost impossible to erect new sites in the middle of cities. It's more than costly; it's not possible because of municipalities and the environment issues. So, I can't see Hot and Golan rolling out real network during the three or five years as their license obligate them to do that.

I think this agreement is good for all of the players in the market. It's good for the customers because it will reduce fares in the marketplace. If Hot would save money, and not rolling out their network by themselves and counting on us, they will be able to offer better prices. For us, of course, it's a lot of savings; savings and improving the EBITDA. So we can be -- we can compete, as well. And of course, I believe that the market will be beneficial out of the LTE rollout and enhancing the technology, and other [reset] that will come out of it.

So I think that the Ministry of Communication has already declared its support over this issue. We haven't heard the antitrust, but I can't see why the antitrust should object it. Because, at the end of the day, it won't affect the competition in the country. As fast as they will be able to present a good network, without drawing in the higher cost, the faster we can be a good competitor. So, I can't see why the antitrust issue should be a relevant one. I hope that we will be able to convince them.

Yes, I think we'll just have to wait and see. They and the Ministry of Communications have both surprised us in the past.

Ziv, just can you talk a little bit about the cost -- the impact on cost, from a potential of the network sharing agreement, as we think towards next year, and we think towards the 4G spectrum auction and the rollout of that network, the LTE network?

As it was described in the PR in the first period, we are going to enjoy from national roaming revenues, so you'll see no effect on the OpEx. While in the second period, once the NSA will go into effect, there will be a mechanism of OpEx sharing. And the mechanism is such that half of the OpEx, the total OpEx of Hot partner and the JV out of the OpEx, will be divided 50-50. And half of the OpEx will be divided according to traffic. This is the basic idea. (multiple speakers)

That's on the OpEx side. But what about on the CapEx, for an LTE network?

And regarding the CapEx, it's 50-50. So, any new CapEx will be divided 50-50 by us and by Hot.

Okay. I will -- that's it for me, thanks.

Alex Balakhnin, Goldman Sachs.

I have -- the first question is on the potential for the operating expenses reduction. And we have been seeing that the management of reduction is diminishing. So you now have recorded cuts less and less, of course, than you used to do before. And I was just wondering, as a business, have you caught all the excessive costs now, and the expense base is how you would like it to be -- to look like? Or you see further potential for the cost-cutting?

And probably to add a different angle to this question, in case of the resumption of the revenue growth -- and I think we are really close to that -- do you think that you will be able to maintain the cost level like the [date shift lateral]? Or with the revenue growth, you will have to probably allow some cost items to rise. So if you could walk us through this, it would be helpful.

First, we have plans to reduce costs more than we did this year. And there is a way to go. And we are looking for other areas that we can reduce costs, and we didn't finish our efficiencies plan by all means.

Ziv, if you want to elaborate on that?

Hi, Alex, but we cannot expect to see in the future the same savings as were in the past. Regarding headcount, you can see that in the last quarter, the number of FTEs -- the number of employees on an FTE basis -- were reduced by 224. Out of the total OpEx, if you take the average cost per employee based on our latest 20-F and multiply by the number of employees, so you will get roughly to the number of -- so the total cost of headcount is about 25% of our expenses. And big chunk of our expenses are beyond our control.

It's like interconnect, which is according to regulation; rent, which is a long-term contract. But we are looking for all kinds of ways to keep the efficiency process. We are moving more and more toward the digital model. Now, as part of the new retail division, we think we can be more efficient in terms of cost/benefit and so on. So in order to sum up, we can expect more savings, but it's not in the rate, as it was in the past.

Just let me add on that -- that what we, I think, successfully did -- that we managed to reduce our cost and positions without hurting our service. On the contrary, while our last surveys indicate that our service level is getting better, and we find a way to be more efficient without affecting our service and our competitive position as the best service provider in Israel in the telecommunications industry.

Second, we are trying to reduce costs in all the areas; for example, rent and rates, saving in electricity, and many other issues that we are touching all the time, and we believe that there is still a potential of cost reduction ahead of us.

Might I just follow up here, and ask -- in the situation your revenues start picking up and grow, do you think that you might have caught some of the cost items successively, so you would prefer to reveal the cost base; or you don't, and there is a change, things like that?

Increasing the revenue should not increase the cost base of the Company.

And might I just follow up on the previous question, on this economics of Hot Mobile sharing agreement? And you described this in the press release, that half of the costs up to 2017 are shared and the other half is shared as a portion of traffic. But on this last half, can it be a situation that a partner carriers over 50% expenses if the traffic is disproportionately in direction of partner, or it is also sort of an even cost-sharing for the second half?

If I understand right, you ask about the second half of the OpEx regarding the agreement, right?

Yes, yes.

Okay. If there will be no traffic at all at Hot, it means that Hot does not exist, if I understand right the question. So there is a minimum limit on traffic that they have to be obligated to. So there is a limited fee that they have to pay, and on top of it is according to traffic.

But does this participation in the first half -- so, basically, they carry 25% of the JV costs and -- like from the very beginning, which is the minimum fee. And for example, if they -- like if they their market share is sort of yours in traffic, then probably they just share 25% on the cost management (multiple speakers).

On the second half.

Alex, let's take a simple example. Let's assume that their traffic is 25%. So they will participate. Their total participation will be 37%, and we will be bearing 63%.

So they participate in these costs disproportionately, like disproportionately greater for as long as their revenue, or their traffic share as well?

Yes.

Yes. On the OpEx only. CapEx is 50-50. It's a mechanism that's part of it. It's fixed, and part of it is variable, according to the traffic. This was the logic behind this model.

Yes, I see it. Thanks.

Michael Klahr, Citibank.

My question is about the Hot agreements. Haim, I think you made a comment in your remarks that there is potential for Hot to pass that on to customers in the form of lower prices. And my question is, aren't you worried that if you've -- you're able to take costs out of the business in terms of CapEx or OpEx, that on a longer-term view you've actually taken out any different network differential which you may have had previously? There is a risk that those any savings you make are passed on to customers in the form of lower prices over the longer-term.

First, I want to go to my comment before that we see that this agreement will help not just us: the Ministry of Communication, with the stress that we have of four generation frequencies; and of course, there are environmental issues that I mentioned before.

Regarding to our competitive advantage, I think the competitive advantage is not just because of size here and there. The core network and the products are still under our control, of course. And we are not afraid from losing our competitive advantage in that respect; because, technology-wise, we will still be ahead of others because of our engineering, and our radio engineers and our systems, and products of course.

Regarding the fares, today they are paying to what we read, more than NIS200 million per year. As it doesn't stop them for representing very, very low price to the market. So, you expect them to be more rational, but they didn't do that. And I think that tomorrow, when they will get our network and get the license fee, and they will be able to compete on the right way, we believe that the market will be more rational. But I don't think that this will encourage them or stop them. (multiple speakers)

Okay. And can you explain the points about your -- can you give us some color in terms of -- do you think you still can maintain the network advantage versus them? What does that actually consist of? What's the -- I'm guessing that this is most of the -- when you talk about the non-core networks, we're talking about most of the CapEx spend.

Non-core network is the sites themselves; if you talk about the passive sides, not the radio included. If you're talking about the active, it's the radio; it's the RBS and the antenna is included, but not the core network -- the transmission included, but not the core network. The differentiation should be over the network with enhancing the abilities of our core network and optimization of the network. Every one of the companies will do the optimization for himself. The coverage is not an issue today in Israel. It's not an advantage of coverage. In the early days, coverage was an issue. Today, coverage is not an issue. So we don't think we're going to lose any of our competitive advantage with this joint venture.

On the other end, if you see the competition today, except of our ourselves and Pelephone, nobody is talking about quality of network, or speed of network, and such items like that. Everybody is talking about price and campaigns and products. (multiple speakers) And, obviously, they are not -- you see that they are Hot. And Hot is running on telephone and having their own network, but they are not talking about their network and not enhancing their advantage in that respect. So, it's more than just using the same sites or the same antennas.

So I have got you right: you are giving up coverage, but you're maintaining the quality?

Right.

Okay. All right, thanks. And my other question on the pricing side is, if I look at offers in the market, I can see -- I mean, to me, it looks as if the market is currently as competitive as it's ever been, in terms of in-store pricing. I think perhaps you stand out as one company, which is -- your pricing, or your 1 gigabyte unlimited effort has gone up very slightly, but only something like NIS3 over the last six months. So, what makes you more confident that the pricing is going to improve in the coming six months?

It's a very good question. First, there is the news from -- of today, that the MOC sent a letter that the discrimination between new customers and all customers should not be presented anymore.

Am I right at that letter is now -- looking at the letter, is it not about number portability customers versus new numbers?

No, no. It's a discrimination between old customers and a new customers. And this is mainly what is driving the prices down. Because you offer a new customers better price than your customers. So your customers are leaving, and then you have to do some campaigns to get the customers from other companies to compensate yourself, and vice versa.

So I think that if they would stop those campaigns running, and this revolving door, you will see that the prices are stable faster than we can. Because Golan is offering zero, and we have to compete with zero. So we offer lower price. And then customers are coming from Pelephone and Cellcom and they are offering lower price to new customers, and they go on. So I think that if they would stop the campaigns, calling other companies' customers to come to join them -- and rather than losing customers, it will be beneficial for all of them.

And the thing that MOC did a good job, not for the rest of the customers; for the companies, as well. Because they stopped this irrational behavior of giving just the good offers to new customers from other customers, and discriminate your base. So this revolving door. maybe it will stop. And I think that for us, it's great news. The question is if the MOC will enforce it. That is the big question. And we'll do everything we can to be sure that this will be enforced by the MOC.

And Michael, if you have the letter from the Minister of Communication, in section 4, it is written specifically that any discrimination between new customers and installed base is not allowed, in terms of prices and any other benefit. It's not just in terms of prices -- and any other benefits; it stated very, very clearly.

You know what happened? When Golan started and Hot started, they started with NIS99 and NIS89. Then, the big guys reacted, reducing price for the new customers. And then we started the win-back policy. And they forced the new guys to reduce prices because they have to recruit the customers to spend for their license. So enforcing the MOC policy, this is the name of the game today. And as I said before, we will like to see how the MOC is enforcing it.

Okay. But that's a very new development, and people have been talking about high prices for the last three or four months. Is there anything that's tied from that, or is that the main driver of higher prices?

I think that all of the companies, their plans are for limited time. It's discount for limited time, and this time will come. And when in the market, you won't see any other new campaigns, so they will stay with a new price after the increasing. So today they are jumping from company to company, because they have better offers. But, tomorrow, when they want to present better offers because they don't want to offer it to their customers, you won't see customers running after -- every day after the new offer. So the churn rate will definitely go down. (multiple speakers).

But the companies such as Golan and Hot, who have very small installed bases anyway, much less impacted than Pelephone and Cellcom.

No. It's not like that. Because you know Golan is recruiting today, every month recruiting something like 20,000 new subscribers paying zero income, and losing 8000 subscribers paying some income. So, for him, it's a losing situation. I think this is the reason that the newcomers complain to the Ministry of Communication about this discrimination. Because for him, it will be better to recruit customers, not in zero income, in NIS89; and not to do those campaigns that, in the end of the day, will bring the revolving door again. But it's still to be seen.

Right. It's not reflected in the market yet.

No, no, no.

It's not the forecast for the fourth quarter.

Michael, actually there are still campaigns and we (multiple speakers)

No. I see them there. I see them -- NIS49 at Pelephone for the first three months or four months.

But they are not offering that to their customers. And this is -- and, again, I'm saying it for the fourth time. I think now the Board is in the MOC field, enforcing them to work due to their license or not. This will make the rationality of the market, and right way to do with your customers.

And my next question is on costs. If I look at non-cash costs, I think I see that it has kind of stabilized over the last three quarters. They took a leg down in the first quarter by about a bit more than NIS20 million, but have remained around those levels, or slightly lower in Q2 and Q3. And just wanting to understand, coming back to -- the last caller was asking about the potential for another leg down in cost savings. Just want to be able to understand what kind of magnitude you're talking about.

If you're talking regarding depreciation and amortization --

No. Away from -- I'm talking about cash costs, away from depreciation and amortizations.

Regarding the cash cost, as I said before, this quarter it was NIS696 million compared to NIS700 million in the previous quarter. It's a saving of NIS4 million. But NIS4 million -- this is the net savings. Imagine by the number of employees that were reduced, that the headcount cost was reduced by more than NIS4 million.

From the other end, we have other costs that might -- went up. And you should take into consideration it's part of the cost, let's say, they are linked to the CPI, like rent. Some of them are according to regulation. Some of them, it's long-term contract. But as I said before, we are keeping our efficiency program, and we will see more savings in the future.

Okay, thanks. And just lastly, on wholesale and on fixed, when do you expect to get more clarity on wholesale pricing? Do you expect it to be this year, or early next year, or six months from now?

I believe it's going to be this year, according to what I understand from the MOC. It should be before the end of this year, but you never know. I hope it's going to be soon, and they are going to be the right numbers.

Okay. Thank you very much.

(Operator Instructions). There are no further questions at this time.

Before I ask Mr. Romano to go ahead with his closing statements, I would like to remind participants that a replay of this call is scheduled to begin in two hours. In the US, please call 1-888-326-9310. In Israel, please call 03-925-5904. And internationally, please call 972-3-925-5904.

Mr. Romano, would you like to make your concluding statement?

I would just like to thank you for joining our conference call for the third quarter. And, as we say, everyone [OMJ].