Telefónica Reports a 65.6% Rise in Net Profit to 8,835 Million Euros at the End of September

Telefónica, S.A. (NYSE:TEF) (LSE:TDE)

• Solid performance: The acceleration in Group revenue growth was consolidated in the first nine months of the year (+6% vs. +5.4% in the first half), thanks to the improvement seen in all regions. Consolidated revenues totalled 44,280 million euros between January and September
• Significant diversification: 67% of Telefónica Group revenues now derive from outside Spain. Latin America, with a reported revenue growth of 10.7% in the first nine months of the year, already accounts for 42% of total revenues. The UK and Germany continued to drive revenue growth in Europe (+11.8% yoy)
• Commercial effort: Despite the strong competition existing in all markets, Telefónica captured 4.1 million new customers between July and September, reaching close to 282 million accesses (+4.9% year-on-year). On the back of intensive sales activity, net customer adds in the first nine months of the year multiply by 1.7 those in 2009, while gross adds grew more than 15%
• High value businesses are growing at a healthy pace: At the end of September, Telefónica already has more mobile broadband customers (19 million or +73.4%yoy) than fixed broadband customers (16.7 million or +26.5% yoy)
• Efficiency: Consolidated OIBDA was 20,368 million euros, an increase of 22.5% in the first nine months of the year (+65.3% in the third quarter)
• Investment to keep growing: Telefónica has invested 7,241 million euros so far this year. This amount includes 1,379M€ and 1,010M€ for spectrum acquisition in Germany and Mexico, respectively. 76% of the remaining CAPEX has been allocated to business transformation and growth projects. Telefónica maintains its strong cash generation capacity (OIBDA-CapEx) with 13,127 million euros in January-September 2010

In line with expectations and as a result of the strong sales effort rolled out during the year, results in the first nine months of 2010 reflect the continuation of the positive growth trend marked by the Company.

Therefore, consolidated revenues reported by Telefónica between January and September attest to a sound performance and acceleration in the pace of growth due to the improved performance in all regions and the positive effects of diversification. 67% of Group revenues now derive from outside Spain. Furthermore, in the third quarter, results from OIBDA downwards were positively impacted, among other factors, by the value unlocked at Vivo following the acquisition of the 50% stake in Brasilcel held by Portugal Telecom

In sum, Telefónica reported net profit growth of 65.6% in the first nine months of 2010 allowing the Company to again reiterate its financial targets for the year and through to 2012, including shareholder remuneration through increasing dividends. Telefónica has committed to paying a dividend of 1.40 euros/share in 2010 and a minimum dividend of 1.75 euros/share in 2012.

282 million customers

The solid revenue performance reflects the sharp increase in commercial activity registered by the Group's operators across all their markets, with the total number of accesses rising to 281.8 million, which represents organic growth of 7.1% versus the end of September 2009 (reported growth of 4.9%). By region, of particular note are the expansion of the customer base at Telefónica Latinoamérica (+9.4% year-on-year) and Telefónica Europe (+5.8% year-on-year organic; +13.8% reported).

The increased commercial drive resulted in year-on-year growth in gross additions of 15.3% during the first nine months of 2010. At the same time, customer loyalty programmes and the commitment to improve quality have kept the churn rate stable year-on-year at 2.3% during the first nine months of the year. As a result, the Company registered net additions over the nine-month period through to September of 17.4 million accesses (13.5 million in organic terms; 1.7 times the net additions recorded in the same period of 2009), having captured 4.1 million new accesses in the third quarter.

Mobile accesses at the Telefónica Group stood at 214.9 million at the end of September, a year-on-year organic growth of 9.2% (+4.4% reported). Organic net additions since the beginning of the year reached 12.7 million accesses (+3.9 million accesses in the third quarter).

Once again, the focus on higher-value customers has been reflected in a significant increase in contract net additions, which accounted for 64% of total organic net additions in the quarter (34% in the same quarter last year), and for 58% of the accumulated nine-month figure (42% in January-September 2009). This has left a total of 66.8 million contract customers (+15.9% year-on-year in organic terms), which represents 31% of the Group’s total mobile accesses (+3 percentage points year-on-year organic). Meanwhile, the strong take-up of smartphones and dongles together with the launching of new and more segmented price schemes is enabling the Group to increase its number of mobile broadband accesses to more than 19 million by the end of September 2010 (+73.4% year-on-year), a figure that represents a penetration over the total mobile access base of 9%.

Retail fixed broadband accesses reached a total of 16.7 million, with organic net additions of 1.1 million accesses since the beginning of the year (3.2 million reported). This represents an organic year-on-year increase of 10.7% (+26.5% reported), a significant acceleration versus the growth rate recorded at the end of June (+9.2%), driven by the improvement in quarterly net additions in Latin America and the growing activity in Germany (net additions were 3.6 times greater than in the previous quarter) and Spain (net additions rose 24.4% quarter-on-quarter). The number of pay-TV accesses stood at 2.7 million at the end of September, a 7% increase in organic terms on September 2009 (+9.8% reported).

Bundles of voice, broadband and television services remains key to Group strategy and churn control. In Spain, 90% of retail fixed broadband accesses are bundled as part of either a dual or triple service package, while in Latin America the figure is 57%.

Fixed telephony accesses totalled 41.5 million and continued to post a better year-on-year organic performance like in previous quarters.

Sustained revenue growth

On the back of the increased commercial activity, revenues rose to 44,280 million euros in the first nine months of 2010, thereby consolidating the acceleration in growth observed since the beginning of the year. As a result, revenue growth stood at 6.0% year-on-year in the first nine months of the year and at 7.3% year-on-year in the quarter. The Company continues to further increase revenue diversification, and Telefónica España now accounts for just 32% of Group revenues, with 67% coming from Telefónica Latinoamérica (42%) and Telefónica Europe (25%).

Revenue growth also accelerated in organic terms, to 2.5% year-on-year in the first nine months of the year compared with 2.0% during the first half. Stripping out regulatory impacts, organic growth in revenues would be 3.7% versus the first nine months of 2009.

It is worth highlighting the sustained pace of year-on-year revenue growth at Telefónica Latinoamérica and Telefónica Europe, which accounted for 2.7 and 0.9 percentage points of the organic growth in consolidated revenues respectively, and offset the lower contribution from Telefónica España.

Consolidated operating expenses amounted to 28,635 million euros in the first nine months of the year, 6.1% more than in the same period of 2009 in organic terms. Supply costs rose 4.4% year-on-year to September, reaching 12,696 million euros and personnel expenses amounted to 5,965 million euros in the first nine months, which represented organic growth of 14.4% year-on-year (+19.2% in reported terms). It is important to bear in mind that the 2010 figure includes restructuring costs, mainly relating to Telefónica Europe (202 million euros in Germany in the third quarter). The average number of employees over the first nine months was 264,668.

Global initiatives to drive efficiency

At the same time, as part of the Telefónica Group's strategy to launch global projects, it is important to highlight the positive impact of centralising processes, which over the first nine months of 2010 amounted to 161 million euros in terms of revenues and 153 million euros in OIBDA.

Gains on sales of fixed assets in the first nine months of 2010 totalled 3,944 million, and were mainly the result of the positive impact of the revaluation of our previously held stake in Vivo at its fair value at the date of acquisition of the 50% in Brasilcel owned by Portugal Telecom (3,797 million euros in the third quarter) on the one hand, and of the disposal of Manx Telecom at the end of June on the other (the latter led to a capital gain of 61 million euros).

This left nine-month OIBDA at 20,368 million euros, up 22.5% year-on-year, after recording a 65.3% rise in the third quarter due to the significant gains on sales of fixed assets mentioned above. Reported OIBDA margin reached 46.0% for the January-September period (+6.2 percentage points year-on-year).

In organic terms, OIBDA declined 2.3% year-on-year in the first nine months of 2010, in line with the first-half performance and negatively impacted by the lower OIBDA at Telefónica España and by restructuring costs registered in Germany during the third quarter (202 million euros). Stripping out the latter impact, the OIBDA trend since the beginning of the year is in line with the Company's internal forecasts, which pointed to a gradual acceleration of OIBDA over the course of the year.

By region, Telefónica Latinoamérica is the Group's main driver at the OIBDA level, with organic growth of 4.8% versus September 2009, recording an improved performance versus the first half (+3.9% to June). Telefónica España, meanwhile, continues to reduce its contribution to Group OIBDA to 40% for the first nine months (excluding the positive impact from the revaluation of our previously held stake in Vivo at its fair value at the date of acquisition of the 50% in Brasilcel owned by Portugal Telecom), impacted by current adverse economic conditions and the higher commercial activity.

As a result, operating income (OI) for the January-September period totalled 13,624 million euros, 36.8% up on the same period of 2009 in reported terms (+0.1% organic growth).

Nine-month profits from associates reached 68 million euros, for a year-on-year growth rate of 43.6%, which is due mainly to the improved results from the Company’s stake in Telco S.p.A. Net Financial Results up to September 2010 amounted to 1,974 million euros (-13.2% year-on-year), including 191 million euros expense is due to the transfer of the difference in market value of our stake in BBVA, from equity to financial results.

Intense activity on the financial markets

At the end of September, net financial debt amounts to 54,504 million euros. The ratio of net debt + commitments to OIBDA reached 2.4x at the end of September, reflecting the impact of the acquisition and consolidation of the additional 50% in Brasilcel as of September 30.

During the first nine months of 2010, the financing activity of the Telefónica Group, excluding short term Commercial Paper Programmes activity, rose to 14,625 million equivalent euros considering foreign exchange rates at the end of September, with the main objective of financing in advanced 2011 debt at the holding level and finance the acquisition of 50% of Brasilcel. It is worth mentioning the syndicate facility for a value 8,000 million euros signed in July, 5,000 million of those maturing in 2013 to finance the Brasilcel deal, and 3,000 million maturing in 2015 to pay back banking debt maturing in 2011. At the end of September 2010, bonds and debentures represented 61%, on the consolidated financial debt breakdown, while debt with financial institutions reached a 39% weight.

Corporate income taxes for the first nine months stood at 2,730 million euros, and included 321 million euros of fiscal effects relating to the positive impact from the revaluation of our previously held stake in Vivo at its fair value at the date of acquisition of the 50% in Brasilcel owned by Portugal Telecom.

Losses attributable to minority interests reduced the net income figure by 153 million euros during the nine-month period through to September 2010.

The result of all the above was a consolidated net income for January-September 2010 of 8,835 million, 65.6% higher year-on-year. The main drivers behind this performance were: i) the positive net impact from the revaluation of our previously held stake in Vivo at its fair value at the date of the acquisition of the 50% in Brasilcel owned by Portugal Telecom (3,476 million euros); and, ii) the negative effects of the restructuring costs in Germany during the third quarter (202 million euros) and the transfer of the difference in market value of our stake in BBVA, from equity to financial results (191 million euros). Basic earnings per share stood at 1.95 euros (+66.6% year-on-year).

Capital Expenditure (CapEx), excluding spectrum acquisitions, stood at 4,851 million euros for the first nine months, rising 5.9% on the same period of 2009 in organic terms (+11.1% in reported terms). The Company continues to focus its investments on growth and transformation projects (76% of total investment, excluding spectrum acquisitions), fostering the development of broadband services (both fixed and wireless). It should be highlighted that in May Telefónica O2 Germany invested 1,379 million euros in additional spectrum. Similarly, and more recently, Telefónica Móviles Mexico has also acquired more spectrum and renewed licences, recording spectrum investments of 1,010 million euros in the first nine months of the year. As a result, CapEx through to September, including investment in spectrum, reached 7,241 million euros. Operating cash flow (OIBDA –CapEx) for January-September 2010 reached 13,127 million euros (+7.1%). The increases in cash flow at both Telefónica Latinoamérica (organic growth of 3.2%) and at Telefónica Europe (+14.0% in comparable terms) are to be highlighted.