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Magyar Telekom Group Interim management report – First nine months 2011 results

Signs of revenue pressures easing with growth in underlying EBITDA margin; guidance for full-year confirmed

Budapest, November 10, 2011 00:00

Magyar Telekom (Reuters: MTEL.BU and Bloomberg: MTELEKOM HB), the leading Hungarian telecommunications service provider,  today reported its consolidated financial results for the first nine months of 2011, in accordance with International Financial Reporting Standards (IFRS).

Highlights:

  • Revenues were down 3.2%, from HUF 452.6 bn to HUF 438.2 bn in the first nine months of 2011 compared with the same period in 2010. This was mainly due to lower fixed and mobile voice revenues in all three countries of operations (Hungary, Macedonia and Montenegro). These declines were partly offset by growth in SI/IT, TV and mobile internet revenues. Appreciation of the Hungarian forint also had a slightly negative translational effect on revenue contribution from the two international subsidiaries.
  • EBITDA declined by 20.1%, from HUF 186.9 bn to HUF 149.4 bn , with an EBITDA margin of 34.1% . Underlying EBITDA, excluding investigation-related costs and provisions, severance expenses and the special telecom tax, was down by 2.0% to HUF 187.3 bn. The underlying EBITDA margin was 42.7% in the first nine months of 2011 compared to 42.2% in the same period of 2010. The higher underlying EBITDA margin reflects the strong cost-cutting measures undertaken in employee-related and other operating expenditure. In addition to this, Q1 2011 results were also supported by a HUF 1.4 bn gain on real estate sales in Hungary.
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Details of special influences, telecom tax
and EBITDA performance (HUF bn)
Q3 2010 9M 2010 Q3 2011 9M 2011
Investigation-related costs and provisions 0.7 2.0 5.7 16.7
Severance expenses 0.6 2.1 0.4 2.1
Telecom tax 0 0 6.3 19.0
Total Special Influence 1.3 4.1 12.4 37.9
Reported EBITDA 67.4 186.9 51.6 149.4
Underlying EBITDA 68.7 191.1 64.0 187.3
  • Magyar Telekom has been subjected to a special telecom tax charged on the company’s annual revenues, retrospectively from January 1, 2010. As this was only introduced in Q4 2010, the impact of the tax was only seen in the Q4 results of both the Group and its segments in 2010 . However, the reported EBITDA of the Hungarian segments (Telekom Hungary and T-Systems Hungary) now i ncludes the special telecom tax for both 9M 2010 and 9M 2011 to allow for a more accurate comparison of the year-on-year performance of these segments. 9M 2010 Group numbers however, were not restated, (in line with IFRS rules), thereby making the Group’s year-on-year performance less comparable.
  • On June 24, 2011 the Board of Directors of Magyar Telekom approved an agreement in principle with the staff of the U.S. Securities and Exchange Commission (the “SEC”) to settle its investigation relating to the Company. In light of this agreement in principle with the SEC and the ongoing negotiations with the Department of Justice (the “DOJ”), the Company recognized in Q2 2011 a provision of HUF 11.5 bn (USD 62.4 million) in connection with these investigations: of which HUF 1.1 bn related to interest expense and was accounted for within the net financial results , with the rest accounted for within Other operating expenses in the Telekom Hungary segment. The Company continues to engage in discussions with the DOJ regarding the possibility of resolving the DOJ’s investigation of the Company through a negotiated settlement. In light of this, an additional HUF 8.2bn provision was created in Q3 2011, of which HUF 2.7 bn of foreign currency losses on the created provisions were accounted for within the net financial results .
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Details of investigation expenses (HUF bn) Q3 2010 9M 2010 Q3 2011 9M 2011
Legal Costs 0.7 2.0 0.2 0.9
Provisions within Other operating expenses     5.5 15.8
Provisions within Net financial results     2.7 3.8
Total provision     8.2 19.6
  • Profit attributable to owners of the parent company ( net income) decreased by 42.2% from HUF 56.9 bn to HUF 32.9 bn. This decline was driven by the fall in reported EBITDA and only partly offset by lower income tax. Income tax expense decreased by 37.1% in 9M 2011 compared with 9M 2010 due to a combination of a lower profit before tax and a one-time charge of HUF 5.2bn in Q2 2010 due to an adverse change in Macedonian tax law.
  • Net cash generated from operating activities decreased by HUF 14.0 bn to HUF 134.2 bn. The decline is mainly due to the telecom tax for the first half of the year being paid in July (tax for the second half will be paid in October), whereas last year, telecom tax for the whole year was paid in just one installment, in December 2010. Operating cash flow was also negatively impacted by lower underlying EBITDA, partly offset by lower paid income taxes and reduced interest payments due to lower average interest rates on our debt.
  • Investment in tangible and intangible assets (CAPEX) decreased by HUF 10.4 bn to HUF 43.9 bn in the first nine months of 2011 compared to the same period in 2010. Telekom Hungary accounted for HUF 35.7 bn of total CAPEX while HUF 2.0 bn is related to T-Systems Hungary. In Macedonia and Montenegro, CAPEX was HUF 4.3 bn and HUF 1.9 bn, respectively.
  • Free cash flow (operating cash flow and investing cash flow adjusted for proceeds from / payments for other financial assets) decreased by HUF 4.0 bn in the first nine months of 2011 from HUF 89.7 bn to HUF 85.7 bn. While operating cash flow was HUF 14.0 bn lower year-on-year, this was largely offset by lower CAPEX and higher proceeds from our real estate sales.
  • Net debt decreased from HUF 278.5 bn at the end of September 2010 to HUF 272.4 bn by the end of September 2011. The net debt ratio (net debt to total capital) was 31.9% at the end of September 2011.


Christopher Mattheisen, Chairman and CEO commented: “The third quarter results highlight several positive trends in the fixed line, mobile and IT businesses. In the fixed line segment, we have seen the benefits of our flat rate Hoppá package, introduced at the start of this year, coming through with fixed line churn reduced to 6% at the end of September compared to 9% one year ago. Our increased promotion of bundled packages as well as the energy offers also contributed positively to the results. In the residential mobile segment, we have continued to increase our voice market share and saw a sharp increase in the number of mobile broadband subscriptions. The  proportion of sales now made up by smartphones has reached almost 70% in the postpaid segment and while we expect this to contribute positively to revenue as customers increase data usage, we have however, seen a corresponding rise in our subsidy costs.  In the SI/IT segment, we were able to reverse some of the negative revenue trends seen in previous quarters thanks to some infrastructure projects at KFKI in the corporate segment. Trends in the public sector remain weak, and we have seen no positive uplift in IT spending. Despite the challenging economic climate, we have been able to slow third quarter revenue deterioration to 1.7% (the average decline for the first 6 months of the year was 3.9%). However, we have been unable to prevent a fall in underlying EBITDA due to a change in the revenue mix (increased contribution of lower margin SI/IT revenues) and the increased level of handset subsidies. Despite this fall, underlying EBITDA margins for the quarter remained at a healthy level of around 42%.

For the full year, we remain cautious due to the deteriorating economic indicators, while the competitive environment is also expected to strengthen as we approach the year end. We welcome the introduction of the new iPhone 4S and several tablets in our stores, although of course we expect there to be a corresponding rise in the level of handset subsidies for the fourth quarter. Despite this, we have maintained our guidance for revenue decline of 3-5%, a 4% decline in underlying EBITDA and CAPEX reduction of approximately 5% for 2011.”

 

Q3 2011 results analysis

Group

  • Revenues declined by 1.7% in Q3 2011 compared to the same quarter in 2010. Retail voice revenues decreased across all markets, reflecting the unfavorable economic environment and intensifying mobile competition in Macedonia. Wholesale mobile revenue declined as Hungarian mobile termination rates were cut from December 2010. TV and mobile broadband revenues and higher SI/IT revenues partly offset these declines.
  • Reported EBITDA was down by 23.5% in the third quarter of 2011, while underlying EBITDA declined by 6.9%. This underlying EBITDA decline was driven by a higher proportion of lower margin SI/IT revenues and increased subsidies on smartphones and tablet sales. The underlying EBITDA margin also decreased from 44.4% in Q3 2010 to 42.0% in Q3 2011.


Telekom Hungary Segment

Revenues before inter-segment elimination fell by 2.6% to HUF 106.3 bn, EBITDA was down 20.0% to HUF 33.4 bn and EBITDA margin was 31.4% in the third quarter of 2011. Excluding special influences, which mainly includes the special telecom tax and the investigation-related costs and provisions, underlying EBITDA was down by 7.5% to HUF 44.7 bn in the third quarter of 2011 compared to the third quarter of 2010. The underlying EBITDA margin declined from 44.3% to 42.1% driven by the reduction in high-margin voice revenues coupled with increased handset subsidies.

  • While fixed voice revenues have continued to decline due to migration towards IP-based solutions, attractive bundled offers and the Hoppá packages, the rate of fixed revenue decline has slowed down to 3.6% in Q3 2011. Fixed line churn was reduced to 6.3% by September 2011 from 8.6% a year ago. The decline in fixed line internet revenues narrowed to 2.0%, while growth in TV revenues remained strong at 8.9%. The total number of TV customers exceeded 773,000 by the end of September, with strong migration from cable TV to the IPTV service.
  • Mobile revenues decreased by 2.0% to HUF 60.7 bn in the third quarter of 2011. A slight increase in the customer base, higher mobile usage and a steady increase in the proportion of post-paid customers could not fully offset the unfavorable impact of lower effective tariff levels. As such, retail voice revenues were down by 1.8%. T-Mobile, however, managed to further increase its market share to 45.3% amongst active customers. Voice wholesale revenues were hit by a 16% cut in mobile termination fees, effective from December 2010 while non-voice revenues grew by 5.2% as a result of a 57.9% increase in mobile broadband subscriptions that supported the growth in mobile internet revenues. Driven by an increasing ratio of higher priced smartphone sales, equipment and activation revenues grew by 10.5%.


T-Systems Hungary Segment

Revenues before inter-segment elimination were up 16.1% to HUF 30.8 bn. EBITDA was up 62.9% to HUF 4.3 bn in the third quarter of 2011 and the EBITDA margin was 13.8%. Excluding special influences, which mainly includes the special telecom tax, underlying EBITDA increased by 35.7% to HUF 5.3 bn. The underlying EBITDA margin of 17.3%, up from 14.8% in the third quarter of 2010, reflected efforts to improve efficiency in light of the drop in high-margin voice revenues while last year’s results were also negatively impacted by the Governmental measures announced in August 2010.

  • Fixed line revenues were down 4.9% to HUF 7.4 bn driven by lower usage and continued erosion of our customer base, principally caused by mobile substitution, coupled with significant price pressure. Voice retail revenues declined by 11.1%.
  • Mobile revenues were up 14.4% to HUF 8.4 bn, driven by the increase in other mobile revenues compared to last year’s level which was significantly cut due to the Governmental measures announced in August 2010. Voice revenues on the other hand were down by 7.4%, as declining average tariff levels and lower levels of usage could not be offset by the increase in our customer base.
  • SI/IT revenues were up 31.5% to HUF 15.0 bn in the third quarter of 2011. While the restrictive measures imposed by the government are still blocking any new public IT deals, Q3 2011 revenues have benefitted from the contribution of some big infrastructure projects in the corporate segment.


Macedonia

In Macedonia, revenues decreased by 12.4% to HUF 18.2 bn in the third quarter of 2011 compared to the same period in 2010, with EBITDA down 13.4%. The appreciation of the Hungarian forint had a negative effect on revenue contribution (on average, the Hungarian forint strengthened by 3.9% against the Macedonian denar in the third quarter of 2011 compared with 2010). The EBITDA decline is due to the intense competition within the mobile market, resulting in significant pricing pressure and increasing level of handset subsidies; both these factors could not be offset by a fall in other operating expenses.

  • Fixed line revenues were down 9.4%. The strong decline in voice retail revenues was coupled with lower internet and data revenues. Growing demand for double and triple play packages resulted in growth in TV revenues.
  • Mobile revenues declined by 14.6% due to the fiercely competitive environment in Macedonia. The competition driven tariff reductions put pressure on ARPU which was down by 8.1% despite higher usage. Nevertheless, T-Mobile Macedonia remained the clear market leader with a 50.3% market share. Despite the increase in mobile internet usage and the higher number of SMS messages sent, non-voice revenues also declined due to promotions offering free and discounted SMS messages.


Montenegro

Revenues of the Montenegrin subsidiary were down by 4.7% to HUF 9.1 bn in the third quarter of 2011, however the decline was mainly caused by unfavorable FX changes (on average, the Hungarian forint strengthened by 3.9% against the euro in the third quarter of 2011 compared to the same quarter in 2010). EBITDA declined by 11.3% to HUF 3.7 bn and the EBITDA margin deteriorated from 43.1% to 40.1% mostly due to higher handset subsidies, higher marketing and maintenance costs.

  • Fixed line revenues were down 6.7% in the third quarter of 2011. The decrease in retail voice revenues was due to increased mobile substitution and discounts offered in flat-rate packages. The voice wholesale revenue decline was due to a significant migration of international traffic towards Serbia where it is now transited by competitors. However, both Internet and TV revenues increased, driven by a strong focus on bundled services.
  • Mobile revenues were down 3.4% due to the unfavorable FX changes. In local currency, mobile revenues were flat as the growth of retail and non-voice revenues were offset by lower wholesale revenues driven by a 15% cut in interconnection tariffs from April 2011.




Investigations into certain consultancy contracts

As previously disclosed, the Company’s Audit Committee conducted an internal investigation regarding certain contracts relating to the activities of the Company and/or its affiliates in Montenegro and Macedonia that totaled more than EUR 31 million. In particular, the internal investigation examined whether the Company and/or its Montenegrin and Macedonian affiliates had made payments prohibited by U.S. laws or regulations, including the U.S. Foreign Corrupt Practices Act (the “FCPA”). The Company has previously disclosed the results of the internal investigation. For further information regarding the internal investigation, see the Company’s annual report for the year ended December 31, 2010.  

The United States Department of Justice (the “DOJ”), the United States Securities and Exchange Commission (the “SEC”) and the Ministry of Interior of the Republic of Macedonia commenced investigations into certain of the activities that were the subject of the internal investigation. Further, in relation to certain activities that were the subject of the internal investigation, the Hungarian Central Investigating Chief Prosecutor’s Office has commenced a criminal investigation into alleged corruption with the intention of violating obligations in international relations and other alleged criminal offenses. In addition, the Montenegrin Supreme State Prosecutor is also investigating the activities of the Company’s Montenegrin subsidiary that were the subject of the internal investigation and has requested information from the Company’s Montenegrin subsidiary in relation to the relevant contracts. These governmental investigations are continuing, and the Company continues to cooperate with these investigations. 

On June 24, 2011, Magyar Telekom announced that its Board of Directors had approved an agreement in principle with the staff of the SEC to resolve the SEC’s investigation relating to the Company through a settlement. Pursuant to the agreement in principle, the Company, without admitting or denying the allegations against it, would consent to a U.S. court order permanently enjoining it from any future FCPA violations and pay disgorgement and a conditional civil penalty. The agreement in principle reflects the SEC staff’s consideration of the Company’s self-reporting, remediation and cooperation with the SEC’s investigation. The agreement in principle is not a final settlement of the SEC’s investigation. While the Company’s Board of Directors has approved the terms of a final settlement, the final settlement remains subject to approval by the SEC and a U.S. District Court.  

The Company continues to engage in discussions with the DOJ regarding the possibility of resolving the DOJ’s investigation of the Company through a negotiated settlement. The Company may be unable to reach a negotiated settlement with the DOJ. Any resolution of the DOJ investigation could result in criminal sanctions, including monetary penalties, which could have a material effect on the Company’s financial position, results of operations or cash flows, as well as require additional changes to its business practices and compliance program. The Company cannot predict whether or when a resolution of the DOJ investigation will occur, or the terms, conditions, or other parameters of any such resolution. 

In light of the ongoing negotiations with the DOJ, the Company has increased the amount of the provision recognized in connection with these investigations to HUF 19.6 bn (USD 90.8 million) in the third quarter of 2011. However, the amount of any payment obligation upon final settlement or other resolution of these investigations may differ from the amount of the provision. 

In addition to the provision, Magyar Telekom incurred HUF 0.9 bn expenses relating to the investigations in the first three quarters of 2011, which are included in other operating expenses of the Telekom Hungary segment.

 


About Magyar Telekom

Magyar Telekom is Hungary's principal provider of telecom services. It provides a full range of telecommunications and infocommunications (ICT) services including fixed line and mobile telephony, data transmission and non-voice as well as IT and systems integration services. The Hungarian business activities of Magyar Telekom are managed by two segments: Telekom Hungary (the home-related services brand T-Home and the mobile communications brand T-Mobile) and T-Systems Hungary (T-Systems brand). Magyar Telekom is the majority owner of Makedonski Telekom, the leading fixed line and mobile operator in Macedonia and it holds a majority stake in Crnogorski Telekom, the leading telecommunications operator in Montenegro. Magyar Telekom's majority shareholder (59.21%) is MagyarCom Holding GmbH, fully owned by Deutsche Telekom AG.

This investor news contains forward-looking statements. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are based on current plans, estimates and projections, and therefore should not have undue reliance placed upon them. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events.

Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors are described in, among other things, our Annual Report on Form 20-F for the year ended December 31, 2010 filed with the U.S. Securities and Exchange Commission.

In addition to figures prepared in accordance with IFRS, Magyar Telekom also presents non-GAAP financial performance measures, including, among others, EBITDA, EBITDA margin, underlying EBITDA, underlying EBITDA margin and net debt. These non-GAAP measures should be considered in addition to, but not as a substitute for, the information prepared in accordance with IFRS. Non-GAAP financial performance measures are not subject to IFRS or any other generally accepted accounting principles. Other companies may define these terms in different ways. For further information relevant to the interpretation of these terms, please refer to the chapter “Reconciliation of pro forma figures”, which is posted on Magyar Telekom’s Investor Relations webpage at www.telekom.hu/investor_relations.