Telefónica O2 Germany third quarter operating review

In the first nine months Telefonica O2 Germany’s mobile customer base grew by 1.5 million (31.8% higher than the same period last year), taking the total customer base to 14.0 million (+14.9% vs. September 2007). Mobile net additions were strong in the quarter (402,405) on O2 Genion and Inklusivepakete tariffs and partners brands. The Tchibo Mobile brand added 26,241 customers in the third quarter, while the Fonic brand added 163,585 customers, to end September with a base of 580,021. Partner channels, including HanseNet, Tchibo and Fonic, had a strong quarter and recorded 179,776 mobile net additions, totalling 680,807 net additions for the first nine months of the year.

A total of 146,623 net contract customers were added in the quarter, 35.5% lower than the third quarter of 2007 driven by disconnections of customers due to the alignment of active customer definitions on partner brands with O2 (with no impact in revenues), and a focus on quality customer growth. The mix of higher value customers in gross adds on O2 branded Genion and “Inklusivpakete” tariffs increased to around 80% from approximately 60% in the first quarter. In the first nine months 644,523 contract customers were added (+25.8% year-on-year) to take the base to 6.9 million (+14.8% year-on-year). Contract customers made up 49.2% of the total mobile base at the end of September, stable versus September 2007. A total of 255,782 net prepay customers were added during the third quarter, leading to a net gain of 862,250 customers in the first nine months (+36.6% year-on-year) to give a prepay base of 7.1 million customers at the end of September (+14.9% year-on-year), reflecting balanced growth between prepay and contract.

Churn was higher by 0.5 percentage points year-on-year in the quarter at 2.0%, mainly driven by partner’s contract disconnections mentioned previously, with prepay churn broadly stable at 1.9% but improving quarter on quarter. In the first nine months of 2008 churn rate increased 0.3 p.p. year on year to 1.8%.

MoU grew by 4.2% year-on-year in the third quarter to reach 141 minutes in the first nine months (+8.8% year-on-year), driven mainly by flat rate promotions on prepay.

Total ARPU in the quarter was 16.8% lower than the same quarter last year, mainly as a result of the acceleration in migrations from legacy to new tariffs such as Genion and Inklusivpakete, which offer significantly better value to the customer. At the end of September, 85% of expected migrations had been completed, with the program ahead of schedule and expected to be completed during the fourth quarter. One-off tariff promotions launched during the second quarter and lower roaming out activity also impacted in the quarter, leaving a total ARPU in the first nine months of 17.5 euros (-15.4% year-on-year). Contract ARPU for the nine months (-15.8% year-on-year) reflected the dilution from lower spending partner customers (who have a low acquisition cost), while prepay ARPU declined 11.5% year-on-year.

Data ARPU was 6.7% lower than the third quarter last year due to the shift from SMS to voice usage with the introduction of better value tariffs and flat rate voice promotions. For the nine months data ARPU was 4.8 euros (-5.4% year-on-year). Non-SMS revenues grew at 23.0% year on- year in the first nine months, driven by mobile Internet “Surfsticks” and web browsing packs, while SMS volumes grew 12.6% year-on-year, up to September.

O2 DSL acquired 32,681 customers during the third quarter to add 123,366 customers in the first nine months of the year, reaching a total customer base of 198,070. Telefonica Deutschland reported 1.2 million ULL lines in total at the end of September (472,910 lines in September 2007).

Revenue growth in the third quarter was 0.7% year-on-year, reflecting seasonality impacts in ULL growth during the summer, and the ARPU trends mentioned previously impacting mobile service revenues. For the year to date revenues totalled 2,664 million euros, growth of 2.0% year-on-year.

Mobile service revenue for the third quarter was down 2.8% compared to the same period last year, due to the ongoing optimising behaviour of customers, ongoing migration process of customers to better value tariffs, one off promotions and lower roaming-in revenues, which were partially offset by growth in the customer base (+14.9%). For the first nine months mobile service revenues totalled 2,139 million euros, down 1.7% year-on-year.

Revenues from wholesale fixed broadband customers increased 38.9% year-on-year in the third quarter to reach 310 million euros in the first nine months (+42.8% year-on-year).

Operating income before depreciation and amortization (OIBDA) for the third quarter declined by 2.4% year-on-year (though increased 7.6% quarter on quarter), reflecting increased acquisition and retention activity on contract and the change in tariff mix on gross adds, partly offset by lower staff and administrative costs. OIBDA for the first nine months totalled 533 million euros, growth of 16.9% year-on-year; while on a like for like basis3 OIBDA declined by 3.5%. OIBDA margin in the third quarter was 21.0%, an increase of 1.5 percentage points over the first half 2008, and sequentially improving (19.0% in the first quarter, 19.9% in the second quarter) resulting in a margin for the first nine months of 20.0% (21.1% in the first nine months of 2007 on a like for like basis).

CapEx amounted to 619 million euros for the first nine months with operating cash flow (OIBDA-CapEx) amounting to -86 million euros, mainly as a result of the acceleration of the wireless network rollout, which is in line with Telefonica O2 Germany’s network investment plans.