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Edited Transcript of BEZQ.TA earnings conference call or presentation 30-Mar-17 1:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Bezeq Israeli Telecommunication Corp Ltd Earnings Call

Jerusalem May 10, 2017 (Thomson StreetEvents) -- Edited Transcript of Bezeq Israeli Telecommunication Corp Ltd earnings conference call or presentation Thursday, March 30, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Allon Raveh

Bezeq The Israel Telecommunication Corporation Limited - CFO

* Naftali Sternlicht

Bezeq The Israel Telecommunication Corporation Limited - Ir Manager

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Conference Call Participants

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* Chris Grundberg

UBS Investment Bank, Research Division - Head of Research for South Africa, Executive Director and Analyst

* Michael Klahr

Citigroup Inc, Research Division - Director

* Tavy Rosner

Barclays PLC, Research Division - Equity Analyst

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Presentation

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Naftali Sternlicht, Bezeq The Israel Telecommunication Corporation Limited - Ir Manager [1]

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Welcome, everyone, and thank you for joining us on the call today. With us from Bezeq Group's senior management team, we have Mr. Shaul Elovitch, Bezeq Chairman; and Mr. Allon Raveh, Chief Financial Officer of the Bezeq Group.

Before we begin today's discussion, I will start with a brief safe harbor statement. Today's conference call and webcast contain general data and information as well as forward-looking statements about the Bezeq Group. Although Bezeq believes its expectations are based on reasonable assumptions, these statements are subject to numerous risks and uncertainties and should not be regarded as a representation that anticipated events will occur or that expected objectives will be achieved. Today's conference call and webcast contain partial information from the public reports of Bezeq under the Israeli Securities Law for which the Hebrew reports can be accessed at the Israeli Securities Authority's website.

The call and webcast are not a substitute for review of the detailed reports of Bezeq. Today's conference call and webcast also do not constitute an offer or invitation to purchase or subscribe for any securities. And nothing contained herein shall form the basis of or be relied upon in connection with any contract or commitment whatsoever.

Let me now turn the call over to Allon to provide some highlights from the Group-wide 2016 fourth quarter financial results.

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [2]

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Okay. Well, thank you, Naftali, and hi, everybody. I hope you can hear me better. In 2016, our operating results reflect the Group's ability to successfully navigate the rapidly-changing domestic telecom market. Intense competition in the cellular market, growing impact of the wholesale market reform and growing competition in the television market continue to shape the industry's landscape. In response, we have set long-term visions in shaping the digital future of Israel. And we are confident that the Bezeq Group companies are prepared to meet the challenges head-on and continue to lead the quality of service -- in quality of service and enumeration.

In 2016, we invested over ILS 1.4 billion, over 14% of our revenues, in expanding and upgrading our telecom infrastructure. This year, we launched the first smart business and smart city service offerings in Israel and expanded our smart home solutions for Bezeq customers. In the cellular market, we created growth drivers, including our unique Pelephone cyber service, big data solutions and IoT starter kits for start companies. In addition, we remain at the forefront of the global television industry. Just this month, we were the first in Israel to launch 4K broadcasting.

The Israeli market enjoys a favorable economic mix of high-economic growth, low inflation and low unemployment. Bezeq is uniquely positioned to benefit from Israeli telecom market, which is growing at a pace of more than 3% per annum, with an average population growth of 2% a year. We believe that this healthy economic environment, which is at the top of all developed markets globally, will continue to drive Bezeq's results going forward. Our solid cash flow and healthy balance sheet enable us to maintain ongoing technological investment while consistently distributing dividends to our shareholders as well reflected in 2016 annual results.

Now let me provide you with some financial highlights. Group revenues in 2016 totaled ILS 10.08 billion compared to ILS 9.99 billion in 2015, an increase of 1%. The increase was due to the consolidation of yes, beginning in the second quarter of 2016, which was part -- sorry, and deferred -- second -- first quarter of '15, which was partly offset by decreasing revenues across Group segments and primarily at Pelephone.

The Group's profitability was impacted by the following items in 2016 and in 2015. Capital gains on real estate in 2016 were lower than '15. And as a result, other operating income in '15 was ILS 25 million, while there was no operating income recorded in 2016. Financing expenses in 2015, including -- included a cancellation of the provision for accumulated interest on taxes owed for prior years relating to the financial income from yes, further to an agreement with the tax authority in the net amount of ILS 76 million.

In addition, there were tax expenses in 2015, and that included a tax income of ILS 29 million due to the cancellation of a tax provision as per the agreement with the tax authority. Furthermore, financing expenses in 2016 included an increase in a provision in the amount of ILS 55 million for contingent consideration to Eurocom, in connection with the acquisition of Eurocom's stake in yes.

In the fourth quarter of 2016, there was also ILS 79 million tax expense and -- or a total of ILS 143 million for the full year 2016. And that was due to the decrease in the general corporate tax rate in Israel, initially from 26.5% to 24% and then onwards -- sorry, from 26.5% to 25%; and then during the year, from 25% to 24% in 2017; and then on -- 23% in 2018 onwards. This reduction reduced the Group's deferred tax assets.

In terms of EBITDA, our Group-wide EBITDA in 2016 was ILS 4.06 billion compared to ILS 4.25 billion in 2015. EBITDA margin for the Group was 40.3% versus 42.6% last year. Adjusted EBITDA was down ILS 100 million or 2.4% year-on-year.

The Group's net profit in 2016 was ILS 1.24 billion compared to ILS 1.72 billion in 2015. As I mentioned before, most of the reduction in our net profit was due to lower capital gains; one-off financing and tax income items in 2015; I'm referring to income recorded in 2015; and one-off financing expenses recorded in 2016.

The Group's cash flow from operating activities in 2016 was ILS 3.3 billion compared to ILS 3.74 billion in 2015. The decrease compared to last year was primarily due to changes in working capital, which were partly offset by the consolidation of yes from the second quarter of 2015. Free cash flow in 2016 was ILS 2.25 billion.

Let me now turn to some KPIs for the quarter. In the Fixed Line broadband Internet sector, our client base continued to grow and reached a record-high of 1.558 billion lines, with broadband market share increasing to 69% compared to 68% at the end of last year. This was driven mainly due to the wholesale market, which continued to growth and increased by some 30,000 new subscribers in the fourth quarter of 2016. Internet ARPU modestly decreased to ILS 90. The number of telephone subscribers was 2.119 billion, a decrease of 18,000 lines in the last quarter of 2016. And average revenue per line was ILS 56, a decrease of ILS 2, primarily due to seasonality in the last quarter of 2016.

In the model segment, the number of Pelephone subscribers grew 54,000 in the fourth quarter of 2016 and reached 2.4 million subscribers. During 2016, Pelephone recruited 250,000 new subscribers, making Pelephone the leading recruiter of subscribers in the Israeli cellular market. Pelephone's ARPU was ILS 62 in the fourth quarter of 2016, which is a decrease of ILS 6 from the last quarter, primarily influenced by increased competition in the market as well as seasonality and the impact of the new government contract, which was signed in 2016.

In the multichannel TV market, yes lost 3,700 subscribers in the fourth quarter of 2016 and had 614,000 subscribers at the end of '16. yes ARPU increased by ILS 4 to ILS 237, primarily due to seasonality factor, such as sale of content. And in general, yes has maintained its strategy of protecting its ARPU and its reputation as a high-quality product at the cost of a certain loss of profit during the quarter.

As part of our commitment to returning value to our shareholders, the Board of Directors recommended a distribution of 100% of the net profit of the company for the second half of 2016 as a cash dividend to the shareholders. An amount of ILS 578 million or approximately ILS 0.21 per share will be distributed. The semiannual dividend, which is subject to shareholder approval, would be payable on May 29 this year, with an ex-dividend date of May 16.

Let me now turn for -- to our forward-looking financial metrics. First of all, looking at the year 2016, I'm happy to conclude that after adjusting for one-off items, such as early retirement provision and reductions in corporate taxes, we successfully met our revised guidance for 2016 in all parameters: EBITDA, net profit and free cash flow.

The Group's full year 2017 financial outlook projects are as follows: net profit, approximately ILS 1.4 billion; EBITDA of approximately ILS 4 billion; and free cash flow of approximately ILS 2 billion. This guidance does not include the effect, insofar as there are any, of a provision for early retirement of employees and of signing any collective labor agreements, the realization of the company's right in the real estate property called Sakia, which was valued at ILS 460 million, the cancellation of the Group's corporate or structural separation, including any potential effects from the merger with yes. It does include, however, the expected positive impact of the early implementation of IFRS 15 on our results as you can see in our financial statements.

So this concludes my review. And let me remind you that after this call, we'll be holding also an analyst conference at our headquarters in Tel Aviv. You are, of course, invited if you are in Israel. This concludes our remarks, and we can now start the question -- the Q&A session. So over to you, operator. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Tavy Rosner of Barclays.

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Tavy Rosner, Barclays PLC, Research Division - Equity Analyst [2]

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First off, on the guidance. You pointed to ILS 4 billion EBITDA, ILS 1.4 billion net income, similar numbers to what you delivered this year on an underlying basis. Can you get -- run us through the main operating assumptions for each segments? Where you see the main EBITDA net margin contributor into 2017?

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [3]

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Tavy, thanks for the question. We -- as you know, we don't provide a detailed breakdown of the assumptions behind these guidance figures. And also, that's -- one of the reasons is because we are one of the only -- we're actually the only company in the Israeli telecom market that's actually providing guidance for next year. But also because sometimes, there are things that offset each other and it's difficult to start breaking down these numbers into different parts. We do go through a very thorough process internally and with the different companies in the Group to get their view on what's happening in the market, what are the changes for next year. And that is all reflected at the bottom line in the guidance that we provide. I think, in general, the trends that you saw, just -- and that's just the general comment in advance -- but to address your question is, I think that the general trend that we saw in 2016, we feel that the market will continue to experience them also in 2017. So the weakness in -- or decreased competition in the cellular market, in the TV market, are all reflected in these figures. And there's also the competition in the Fixed Line market, which, at the end of the day, is affecting the company's result. And you see the development in the wholesale market, which is continuing to grow. All of that is reflected, at the end of the day, in our guidance for next year. Having said that, we don't expect any big changes, any new -- material new issues at the moment in the year 2017.

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Tavy Rosner, Barclays PLC, Research Division - Equity Analyst [4]

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Okay. That's helpful. And in the press release that you guys issued, management talks about the need for lifting of structural separation. Can you give us a sense of where you see things standing now? And what kind of major KPIs we should be looking for in the coming months?

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [5]

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Yes. As you know, even longer than me, we -- all of you on the line -- and this is an issue that the company is aiming at and working very hard at achieving. We believe that this should have been implemented long ago. After the wholesale market reform was implemented, there were about 9 months during this period it was supposed to be implemented. And this has passed quite some time ago already. But we know that the recent developments were that the Ministry of Communications issued a letter to us saying that they are going to go ahead with the process, with the removal of the structural separation -- sorry, with the removal of the corporate separation. We saw that this is going to be a very quick process. At the end of the day, they decided to put it on hold for a while until they get some feedback from the state controller. We're still waiting for this feedback, feedback on the Ministry of Communications. Just to make this clear, not feedback on Bezeq in any way, as far as we know, at least. And we know that the state controller is working on the report. We don't know exactly when they're going to issue it or what's going to be written in it. Our assumption -- it was supposed to be 3 months, by the way, from the end of December. So it was supposed to be now, more or less. But we haven't seen it yet. So we're waiting. And then after we see this report and after the Ministry of Communications sees the report, I assume that we'll probably see some developments then. There's probably some delay because it was supposed to be now. So I think we should expect it anytime soon. Whether it's a few days or a few weeks, it's difficult for me to say.

Did I answer your question, Tavy?

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Tavy Rosner, Barclays PLC, Research Division - Equity Analyst [6]

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Yes. Thanks, Allon.

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Operator [7]

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The next question is from Michael Klahr of Citibank.

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Michael Klahr, Citigroup Inc, Research Division - Director [8]

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Allon, I want to follow up on the previous question about guidance. When I clean up the numbers by this year and next for some of the one-times you've mentioned, I get ILS 300 million left in EBITDA next year versus this year. So first, I just wanted to ask -- I take out real estate gains and also early retirements and the impact from the tax -- sorry, from the IFRS change. So I just wanted to ask, are my numbers correct, firstly? And secondly, I know you said you don't want to talk about individual segments or to give too much detail, but that's quite a significant drop. I just wanted to understand if you could tell us anything about why you expect that kind of year-on-year drop in underlying profitability.

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [9]

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Okay. Thanks for the question, Michael. I think, first of all, we all know that the cellular market is still suffering, and we are seeing ARPUs continuing to drop across the sector. We saw it. I haven't seen actually partners' result published today, but we saw the Cellcom's report and Pelephone's report. So we're all aware of the fact that the current trends in the market are lower in terms of pricing from the ARPU that the companies have on their -- in their financial statement. So that's one driver.

Secondly, there's a certain level of uncertainty in different parts of the telecom market, such as the TV market with a partner talking about launching their product. Recently, you saw Hot announcing that they're going to launch some OTT service as well. That's one example. There's some other examples about the telephony resell reform. So there are a few things that create a certain level of uncertainty. And when you write down your forecast, your guidance, I think the last thing you want to do is disappoint the investors. So we have to be a bit cautious on the numbers that we publish. I'm not saying that the numbers are incorrect. But that's our best estimate. I'm just saying that we need to take into account the level of uncertainty. And at the end of the day, if the market -- if our assumptions are going to be proven wrong and the market is going to be better than we anticipated, then we will see a revision in the guidance later during this year. I'm not saying it's going to happen. I'm just saying that that's also something that could happen.

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Michael Klahr, Citigroup Inc, Research Division - Director [10]

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Okay. That's fair. Am I right in saying that your numbers are kind of conservative given our uncertainty and low and that there is room? Or can they kind of represent a quite kind of weak scenario? Is that fair?

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [11]

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I -- yes, I tend to agree with the statement that the numbers are conservative in the sense that we were careful in making these calculations. And I think there is potential for better results during the year, but we'll have to wait and see.

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Michael Klahr, Citigroup Inc, Research Division - Director [12]

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Okay. And my second question is about the provision for -- the increased provision to Eurocom. Can you remind us what the -- what that part of the transaction, the performance-based part is based on? What metric? And is there potential for further increase of provisions there?

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [13]

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Yes. The provision reflects the part that is due for payment based on yes or DPS's performance during the post-acquisition period; i.e. 2015, '16 and '17. So the provision -- or the amounts that would be due under this part of the payment, in total, can reach up to ILS 170 million plus interest. The way that's provision...

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Michael Klahr, Citigroup Inc, Research Division - Director [14]

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How much...

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [15]

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Sorry? So the maximum amount under this part of the contract is ILS 170 million. At the moment, the provision in our financial statement is at an amount of ILS 84 million. So if we have to pay the full amount, we may have to pay additional -- on top of that, the difference between ILS 84 million and ILS 170 million plus interest, and the interest depends on when we pay. So it can be ILS 175 million, it can be ILS 180 million or it can be more than that if it takes more time. It depends on the timing. Now having said that, we have already paid 2 down payments of the ILS 57 million plus interest each during 2016 and during 2017. So the additional amount that would actually be due for payment is the difference between the ILS 170 million and the amount that we already paid. I hope I clarified it. If not, we can take it offline.

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Michael Klahr, Citigroup Inc, Research Division - Director [16]

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No. That's okay. And what's the performance metric? Is it EBITDA? Is it free cash flow? Or is it...

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [17]

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Free cash flow.

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Michael Klahr, Citigroup Inc, Research Division - Director [18]

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It's free cash flow. And what explain the increase in yes free cash flow in the quarter? It was quite -- it was a big increase here I think, both quarter-on-quarter and year-on-year. What was that?

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [19]

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So free cash flow is -- well, free cash flow is affected or was improved due to; one, improved efficiency and efficiency measures that the company has taken; two, is the lower of number of subscribers, which basically means that the company basically buys less boxes because when a subscriber leaves the company, he returns the box and then the company can reuse it, so it means less subscribers; and three, there are also some temporary working capital changes as well.

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Michael Klahr, Citigroup Inc, Research Division - Director [20]

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Okay. And the working capital changes, were they reversed? And should we see those reverse in '17? Is that one time? Or it's a...

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [21]

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You'll have to wait -- we'll have to wait and see.

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Operator [22]

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(Operator Instructions) The next question is a follow-up from Tavy Rosner.

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Tavy Rosner, Barclays PLC, Research Division - Equity Analyst [23]

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Just a quick follow-up on the mobile. I just wanted to ask if you're feeling any difference in the pricing environment following the acquisition of Golan by Electra.

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [24]

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Well, I don't think that, at the moment, we're seeing any major difference. I think that it's more a matter of atmosphere in the market. All these talks about the fact that Golan was the driver of flow -- pricing in the market and that now it's going to be more rational and some of the statements that were made by Gil Sharon, who was part of the acquisition -- the acquiring group. I think it created maybe an atmosphere of things coming down a little bit, but we haven't seen prices in the market go up. Actually, Golan itself is still very aggressive in its offering. It was also -- it also undertook to keep offering plans at ILS 30 or below that, even after the acquisition for a period of at least 2 years. And we've seen Hot Mobile keep its ILS 49 all-inclusive offering, so -- and other companies keeping their sub-brands at very low prices. So if you look at the ARPU of the company, let's say, which is on average maybe about ILS 60, and you look at the plans in the market of anything between ILS 20 up to all-included at ILS 50, it's difficult to see how this recovery is going to happen in the near future. But -- and we haven't even seen Exxon yet enter the market. So it's difficult, I think, for us to see how this market -- with the current market dynamics and 6 operators, what's going to be the driver for the prices going up, at least in the near future.

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Operator [25]

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The next question is from Chris Grundberg of UBS.

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Chris Grundberg, UBS Investment Bank, Research Division - Head of Research for South Africa, Executive Director and Analyst [26]

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Yes. Just a quick one, I guess. I wonder if you could flesh out a little bit of the point you made on the TV competition. And I guess, just anything you can add in terms of the -- your competitive response would be very interesting clearly that this -- the lower-cost offerings in the market seems to be taking some share. I just wonder if you can flesh out how you see that playing out over the course of this year.

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [27]

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Okay. Chris, thanks for the question. I think we're all seeing the market here. And the market here is -- the market dynamics are that -- still as it used to be over the past years. There are 2 main companies, Hot and yes, which are offering multi-TV plus VOD solutions. And I think that yes is trying to keep itself, and I think successfully, as the prime product, the top-quality product. And, therefore, it's not offering the same solution that currently Cellcom TV is offering. I think there's a room -- there's definitely a room for Cellcom TV with its slim product, with its low-cost solution. But in a market with households that, in a way -- usually in Israel, there -- these are big families, 5, 6 people, sometimes it can be 6 or 7 with kids, with teenagers, with adults. People want to have a variety of choices. Also TV, I think in Israel, is a very significant element in the entertainment activities of household and the family. So there are people who are willing to take this low -- I wouldn't say low quality, but let's say, low-end product that includes only a few linear channels and a VOD library. And I think that by getting 10,000 subscribers -- 10,000 or 12,000 subscribers every quarter, that more or less reflects the attractiveness of this solution. So after almost 2 years, there are 110,000 subscribers for Cellcom TV. We haven't seen -- while there are more than, of course, more than 1 billion subscribers in multichannel TV products market.

So looking forward, I think that you saw -- I don't know if you saw that Hot yesterday announced that it's also going to offer a slim product. yes will also consider this during the year and may do something similar. But that's a completely different product from getting the -- this diversified product with 4k channels, with a variety of TV and content that you can't get on any of these other low-cost platforms.

So just to summarize. There's the major or the mainstream market, which is looking for the high -- higher-quality product. And there's, I think at the moment, what look -- what seems to be a more niche market for people who are willing to take the lower-quality product, and I think these things can live together. At the end of the day, one important thing to make -- one important point to make is that we all need to earn money. And I think that you need to bear in mind that with 100,000 subscribers, and even with 200,000 subscribers, you can't earn money if you charge people ILS 100 or ILS 150 for a TV. So there will have to be an increase -- a significant increase, I believe, in the pricing of this product over time if they want to make money. And, of course, if they want to expand their product to a wider product, they will have to invest much more and buy much more content; i.e. increase their prices significantly. And I think the difference with the yes and the Hot product is going to be narrower over time.

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Operator [28]

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There are no further questions at this time. I would like to remind participants that a replay is scheduled to begin in a period of 3 hours on the company's website at www.bezeq.co.il.

Mr. Raveh, would you like to make a concluding statement?

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Allon Raveh, Bezeq The Israel Telecommunication Corporation Limited - CFO [29]

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Yes. Thank you very much, everybody, for your questions. I hope I addressed them all. Thank you for taking the time to join us today. If you have any further questions, please feel free to contact Naftali and our Investor Relations Department or myself as well. I'm available. And we look forward to speaking to you during 2017. The next quarter earnings call is coming very, very soon. Thank you very much.