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Edited Transcript of RTKM.MZ earnings conference call or presentation 2-Aug-19 12:00pm GMT

Q2 2019 Rostelekom PAO Earnings Call

Moscow Aug 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Rostelekom PAO earnings conference call or presentation Friday, August 2, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ekaterina N. Ustinova

Public Joint Stock Company Rostelecom - Head of IR

* Mikhail Eduardovich Oseevskiy

Public Joint Stock Company Rostelecom - Chairman of the Management Board, CEO, President & Director

* Sergey Nikolaevich Anokhin

Public Joint Stock Company Rostelecom - CFO, Senior VP & Member of Management Board

* Vladimir Sergey Kirienko

Public Joint Stock Company Rostelecom - First VP & Member of Management Board

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Conference Call Participants

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* Alexander Vengranovich

Renaissance Capital, Research Division - Analyst

* Anna Kurbatova

Joint Stock Company Alfa-Bank, Research Division - Senior Analyst

* Herve Drouet

HSBC, Research Division - Head of EEMEA Telecoms, Media and Technologies Equity Research

* Ivan Kim

* Maria Sukhanova

BCS Financial Group, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen. Welcome to the conference call to discuss the Operational and Financial Results of Rostelecom for the second quarter and the first 6 months of 2019. Today at the call, we have our CEO and President Mikhail Oseevskiy; First Vice President, Vladimir Kirienko; and Senior Vice President and CFO, Sergey Anokhin.

As usual, I would like to remind you that some statements by the management may in effect be forward-looking statements. We do not recommend to unduly rely on such statements and to take into account that the actual performance may differ from such statements and projections.

With that, we're happy to begin our presentation. I'm handing over to Mikhail Oseevskiy.

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Mikhail Eduardovich Oseevskiy, Public Joint Stock Company Rostelecom - Chairman of the Management Board, CEO, President & Director [2]

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Good afternoon, colleagues and friends. I would like to say that certainly the quarter in review has been the best for our team. We have demonstrated very strong and solid results that are the consequence of the systematic efforts of transforming our company into a digital service provider. This enabled us to post indeed very strong results for the first 6 months as well. We are very optimistic about the second half of 2019 and even today, even up to date, we have made considerable efforts to secure the margins of our business profitability, the revenue growth rates, the increase of digital and content services share. We are actively diversifying our product portfolio. We are going -- reaching out into new areas. We are building new partnerships. We have a high degree of readiness on our Tele2 transaction.

And now I would like to ask my colleagues to discuss this in more detail.

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Vladimir Sergey Kirienko, Public Joint Stock Company Rostelecom - First VP & Member of Management Board [3]

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[Vladimir Kirienko speaking] Good afternoon, colleagues. In the second quarter, indeed, we have demonstrated very strong results. The main drivers of the development of digital business, the revenue from digital and content services have been up 11%, and the driver here is the VAS and Cloud, where revenue growth was almost 20%. A similar performance and an increase by almost 1/4 is in VPN, mostly by large corporate and government customers.

In terms of our segment performance, we have demonstrated positive performance across the board, with B2G being the leader and with an increase of 7% year-on-year.

Let's move to the next page. Here, as you can see, we continue ramping up our digital business. And in the quarter in review, the revenue was over 57%. So our revenue mix is progressing as planned. The fixed telephony is going down, it's now already under 20% and quite expectedly, our digital services grow.

Let me now discuss our main success drivers underpinning this performance. In terms of new B2C services, we are now targeting the various areas of life of individual. And it's important for us to launch new areas and new products.

The federal platform we have launched recently, RTK Key, which reinvents the approach to the surrounding area of residential homes. And the main -- or the first offering here was the smart intercom and smart video surveillance and we'll expand further into smart metering, the bar gate smart key, et cetera. All of this helps us to growth blended ARPU by over 6% in the quarter in review. Also in that quarter, we launched the full scale conversions offering in Moscow and some other regions. And by the end of the year, we are planning to roll out the fully new FMC offering to our customers. And we believe this is part of a comprehensive product line development. And our Wink platform will soon celebrate its first anniversary, and now over 2 million customers have installed this Wink app and soon we will migrate our users from TV boxes to other formats. And another important step was that we were able to sell quite a number of video surveillance cameras and increasing our growth rates there several folds.

Now in B2G, as I explained, our revenue grew by 7% due to the implementation of Smart City and data centers as well as other services. We are seeing a lot of demand on behalf of the business and the governments for virtual IT infrastructure. The revenue from virtual data center increased by 42%. This was driven on the back of improved reliability and quality of service as well as increasing bandwidth between virtual machines to 10 gigabit per second. This is the best performance in the market currently.

Rostelecom also commissioned the first stage of Udomlya data center, with a significant number of rack spaces. And today, Udomlya is the largest center in terms of rack space. In corporates, we are applying an ecosystem approach. And our objective is to become the entry point for any solution in the products that we offer. And this demonstrates a strong -- great results. In information security we have almost doubled our revenue in reporting period. And we launched a Solar MSS, the management security service provider, revamped system of cybersecurity provider. It covers over 9 integrated services providing development services to our customer as well as secure channels. We reaffirmed our position as a leader in this area. There are some very strong results in other areas. We were able to double our corporate TV sales. We had a 40% growth in video surveillance for corporate customers.

I would also like to note our success in O2O, our operator for operator segments. We were able to increase the profitability in that segment, even though the segment itself is quite stable. We were able to grow by 6.5% versus the 6 months last year largely due to development of infrastructure services and providing additional services to our customers such as operators.

In the second quarter, we also continued growing our O2O business. And today, we have in service over 140,000 kilometers of optic fiber at 1.5x growth. And the number of base stations serviced by us exceeded 60,000, also almost double growth there. We believe that the important area here is the development of transnational data transfer. And today, the sales of our channels and capacity in terms of Europe-Asia transit and other areas increased by some 500 gigabits, and we intend to continue expanding our capacity there.

In conclusion, I would like to say that we really believe that we see second quarter's performance as a very strong one, and that is fully in line with our strategy until 2022. And this sets a very important foundation for the future. We will continue developing our digital services to cater to the needs of all of our customers across the board.

That's it from me. I will now like to pass the floor to Sergey Anokhin, our CFO.

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Sergey Nikolaevich Anokhin, Public Joint Stock Company Rostelecom - CFO, Senior VP & Member of Management Board [4]

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Hello, everybody. Regarding our financial performance. In the second quarter and in the first 6 months, we demonstrated very solid performance on the financial side, which was the outcome of the successful implementation of our strategy by the company and also partly by seasonality and some one-off events, if you were to compare year-on-year performance. This is also something that we have to consider as we discuss the projections and potential guidance for 2019.

Okay. So OIBDA was RUB 27 billion and growth was almost 13% year-on-year, that's for quarterly performance. And 6 months performance, OIBDA was over RUB 50 billion. Within that, there's a contribution by various factors, as Vladimir mentioned. We have seen very strong performance of -- the increase over the previous period was over RUB 5 billion. We are seeing growth in personnel cost, that is driven by the development of our digital competence, by the development of the relevant areas of our business. And we also start offering certain services through an outsourced model so as to increase the service level.

I would also like to note that at about this time last year, we were one of the sponsors in the World Football Cup. And those costs were not there. This year, this also drove the very strong performance in the first 6 months this year.

I would also like to note some strong receipts under the Bridging the Digital Divide program this year compared to last year. And there were some improvements in the network development costs and some of the services were, in fact, in-sourced and are now provided by internal resources.

And also last year, we had some developments in provisioning last year.

Now in terms of net income, the growth numbers are a bit different. But for the 6 months, we saw a very strong growth of 43% and totaling almost RUB 10 billion. The drivers here are further improvement of our financial performance and of Tele2 as our subsidiary and equity investments.

We are seeing higher interest expense versus last year. And there was also a negative impact from higher DD&A, depreciation and amortization. That is because of our PPE has grown and also because last year, there was a positive effect from the review of the useful life of a number of assets. And that drove down in the past periods the DD&A, which it didn't do this year.

In terms of our CapEx, it is on track. It progresses as planned. Within the 6 months to date, excluding government programs, our CapEx has been some RUB 28 billion. That's higher than the same period last year, but in line with the guidance that we have provided. So the growth over the past period is by RUB 1.3 billion. That in particular is driven by the ramping up of some of the programs to which we are a part here. And also it was a contribution by higher, as I mentioned, receipts for the BDD, Bridging the Digital Divide, project. Now our CapEx growth, excluding government programs, was 17.6%.

Talking about free cash flow and net debt. As I discussed in the first quarter performance here, we have completed our providing connectivity to hospitals, which improved our performance this year and cumulative total for 6 months, the cash flow was RUB 3.2 billion in this period versus a more negative number last year. Once again, last year, we were waiting for receipts of payments related to video surveillance for presidential elections. So basically we have a seasonal picture here.

We also had an improvement in our working capital because we have received a payment, as I mentioned, for providing connectivity to hospitals. There were some changes in accounts receivables in B2C. So all of that helps improve the working capital structure.

Higher receipts in the second quarter helps us reduce the net debt versus the same period last year. And net debt-to-EBITDA was 1.9x. The debt structure remains stable and mostly consists of a longer-term debt.

Let me remind you that in early second quarter, we placed bonds for RUB 15 billion at 8.45%. Whereas, as our weighted average interest rate is some 7.86%. So we believe those were on quite good terms for that particular bond placement.

In terms of our guidance, until the end of this year, given the strong performance for the first 6 months across our business units and also given the fact that there will be perhaps fewer positive one-offs in the second half of the year, so we have revised upwards our revenue guidance by 3% growth versus 2018. The fact that we are cautious in our updated guidance is because we are watching how the tax legislation evolves. There may be some additional outlays for us in that respect, and that is why we're also conservative about our OIBDA. So we remain on the conservative side in terms of revising our guidance.

In terms of cash CapEx, the guidance there is RUB 65 billion to RUB 70 billion in that range.

Okay. Thank you.

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Ekaterina N. Ustinova, Public Joint Stock Company Rostelecom - Head of IR [5]

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[And Ekaterina Ustinova says that] We are now happy to start the Q&A session. (Operator Instructions)

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ivan Kim, Xtellus Capital.

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Ivan Kim, [2]

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I have, I guess, 3 questions. First, why the acceleration of growth in your VPN revenue. I can see your explanation in your press release that it's driven by higher demands by B2G customers. But even versus the first quarter, that's quite a significant acceleration. So what's your take on that? I would like to have your comments, if you have any.

Then I may have missed your discussion as to why you should expect some more conservative EBITDA in the second half of the year. You mentioned some facts. So fetch us -- can you please explain once again given the high growth of EBITDA in the first 6 months the overall guidance for 2019 remains quite conservative. And my third question is about the free cash flow, more of a general nature. Should we expect the increase of the free cash flow for 2019 compared to 2018.

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Vladimir Sergey Kirienko, Public Joint Stock Company Rostelecom - First VP & Member of Management Board [3]

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[Vladimir Kirienko handles the first question.] In terms of the explosive growth of VPN, the explanation is very simple. Our corporate customers evolve in terms of the consumption of their services. So first, they mostly consume broadband. Now as they mature, they would migrate to more sophisticated services. So that could be seen as an evolution. Because within the VPN contracts, we have had some that have started as broadband. So that's a customer evolution, if you will. That's beneficial for us because it increases our profitability and in general, increases customer loyalty.

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Sergey Nikolaevich Anokhin, Public Joint Stock Company Rostelecom - CFO, Senior VP & Member of Management Board [4]

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[Sergey Anokhin is handling your second and third question].

So let me now comment about the cautious guidance, regarding the second half of the year. We say that we expect that the guidance is over 3%. Now in terms of tax and this is something that we have seen even early in the year, that was some higher taxation for movable property. And we are now watching the discussion with the tax authorities in terms of the interpretation of the various groups of assets that may become additionally taxable. So that is an area of uncertainty for us, and that is what drives the somewhat conservative guidance because of that.

Let me remind you that, last year, our third quarter was fairly strong. And we understand that looking at the second half of the year, this year versus last year, we were able to put under our belt a lot of projects and contracts in the first 6 months of the year. So that may -- might translate into lower performance, if you will, in the second half of the year.

And also, in terms of cost, I did explain to you that there were some costs the last year that are there not there this year. They were very specific and they were specifically related to the first 6 months of the year, not the second 6 months of the year. And a lot of that was related to the providing the video surveillance for the presidential election. So this factor -- so we had an improvement in the first 6 months this year versus last year but wouldn't have a commensurate effect in the second 6 months of the year.

In terms of the free cash flow versus last year, even though we have seen better performance versus last year, but still these are not some very high amounts at this point in time, so we prefer to have a more cautious approach and to celebrate later, so to say, as we achieve the actual results.

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Operator [5]

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And it is from Alexander Vengranovich, Renaissance Capital.

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Alexander Vengranovich, Renaissance Capital, Research Division - Analyst [6]

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I also have a couple of questions. Following up on the previous ones in fact. In terms of cash flow, we have seen that this year, there has been a change in the trend. In the past couple of years, your first 6 months was quite weak. Now this year we

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and you will continue to get more government receipts in the second half of the year.

My second question is because you have such strong cash flow performance in the first 6 months, have you been thinking potentially about the changing the timing of interim dividends? Now if previously you paid them at around winter, then would you probably want to pay them in autumn? Because by that time, you would already have the cash flow enabling you to do that.

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Sergey Nikolaevich Anokhin, Public Joint Stock Company Rostelecom - CFO, Senior VP & Member of Management Board [7]

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[Sergey Anokhin is handling your question.]

Now in terms of quarterly performing seasonality, we would say that this particular instance is a one-off in connectivity for hospitals, that particular project. The payments under that project is the main driver behind that. So we wouldn't want to confirm that there will be a new trend in the seasonality of payments from the government because the budget cycle is still the same. So we would still expect to receive most payments closer to the end of the year. And I guess that also partly answers your second question that this particular instance was more of a one-off and the underlying performance of our cash flow would remain largely the same. So we believe that our current practice and timing of interim dividend payments is optimal in terms of how we accumulate our cash to do that.

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Operator [8]

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(Operator Instructions) The next question comes from Maria Sukhanova, BCS.

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Maria Sukhanova, BCS Financial Group, Research Division - Research Analyst [9]

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I have 3 questions. First is, again, about working capital. This -- the fact that you were able to receive some receivables under the government contract, was that related to services provided last year or this year?

My second question is about the Aurora system on Huawei handsets or telephone equipment. And there have been some discussion of this recently, so I'd like to get some more clarity about that. And my third question is that you have mentioned that the Tele2 transaction should have an impact on dividends, but commerce and newspaper did mention that there might be some equity share related to that transaction. So now in terms of your dividend policy, is it minimum 5% -- RUB 5 per share or is it related to the cash flow value?

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Sergey Nikolaevich Anokhin, Public Joint Stock Company Rostelecom - CFO, Senior VP & Member of Management Board [10]

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[Sergey Anokhin is taking your questions.]

Let me start with question one. The performance of the second quarter is largely driven by payments related to last year's contract. And the long waiting period, if you will, in terms of the payments, was driven by a change in procedures by our large customers. And there were some inspections that had to be carried out, that took time. And once it has been completed, all the payments has been carried out. But clearly this performance is partly driven by our organic results, by our strong results. In terms of Aurora, there were some proposals made at the government level and at the level of Rostelecom versus Huawei. Now those proposals and ideas they're being studied by the parties. So there's nothing to be mentioned here at this point. In terms of our dividend policy, I would like to confirm that the structuring of the Tele2 transaction is one thing, but we would like to stick to the principles that underlie our dividend policy. And that's 75% of the free cash flow, et cetera.

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Operator [11]

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The next question is from Anna Kurbatova, Alfa-Bank.

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Anna Kurbatova, Joint Stock Company Alfa-Bank, Research Division - Senior Analyst [12]

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My first question is about the process of the sale of Central Telegraph space or the real estate. So when could that sale happen. And as it happens how will it reflect in your financial statements and could it have a positive effect on your OIBDA for 2019? And my second question is more of a strategic nature. Because we understand, even now that the capital structure will change following the Tele2 merger, I would like to ask a question about the longer-term status about the preferential shares. They are at an even small proportion of equity even now, and it will further decrease. So I was wondering is there any, if not discussion, but may be some objective to change the equity structure in relation to the preferred shares, say in the mid- to longer term. So how comfortable the current structure is for you at the moment. So do you see the preferential, the sort of preferred shares as a potential for optimization, if you will.

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Mikhail Eduardovich Oseevskiy, Public Joint Stock Company Rostelecom - Chairman of the Management Board, CEO, President & Director [13]

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[Mikhail Oseevskiy is handling your question.]

In terms of the sale of the real estate, the area or the space held by our subsidiary in Central Telegraph have been put up for an auction at Sberbank site, the auction should happen in September. We are seeing potential interest, so let's wait and see how it goes. If the auction is successful, we'll get the results, which will be the difference between the sale price and the booked price. And again, we'll get our pro rata share of that difference. And similar to last year, we will expect to get that money through dividend payments. In terms of preferred shares, at this point in time, this is not among our priorities.

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Operator [14]

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We currently have no further questions in Russian. We will now move to questions in English.

We will now take a question from Herve Drouet from HSBC.

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Herve Drouet, HSBC, Research Division - Head of EEMEA Telecoms, Media and Technologies Equity Research [15]

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Couple of questions as well. Firstly, on the CapEx, could you give a bit more detail on the breakdown of where currently you spend. Is it more in the digital initiatives you are providing, or is it more within the networks? Second thing is regarding the growth you experienced in Cloud and VPN. Do you have any views and should we -- do you see a change of inflection in term of growths in that regard? And do you think that there is room for even accelerating growth in those 2 segments?

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Mikhail Eduardovich Oseevskiy, Public Joint Stock Company Rostelecom - Chairman of the Management Board, CEO, President & Director [16]

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In terms of our CapEx priorities, that is fully in line with our strategy objectives. That's Mikhail Oseevskiy, the CEO, handling your question. We believe it is important to develop our base infrastructure, if you will, the telephone infrastructure, the connectivity infrastructure. And we develop the backbone and we continue tapping international markets as Vladimir has been explaining. We are doing a lot of new construction and at the same time providing comprehensive range of services in each apartment or community or neighborhood. At the same time, each year our focus is shifting each sequence year to the products that's become the new growth drivers such as data centers, investments in software, investments in IT security and all of that is reflected in our CapEx structure.

Sergey, if there are no further questions.

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Sergey Nikolaevich Anokhin, Public Joint Stock Company Rostelecom - CFO, Senior VP & Member of Management Board [17]

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[Sergey] The operator confirms that there are no further questions, so the company thanks. Thank you for being with us, and goodbye.

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Operator [18]

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Ladies and gentlemen, this completes the conference call. You may now disconnect.

[Statements in English on this transcript were

Spoken by an interpreter present on the live call.]