Vodafone 1H Earnings Call Transcript

123jump.com Staff
22 Nov, 2008
New York City

Vodafone the UK telecom operator net income declined 35% to

Vodafone Group Plc ((VOD))
Half Year 2008 Results Presentation Transcript
November 11, 2008 9:30 a.m. GMT

Executives

Vittorio Colao -- Chief Executive Officer
Andy Halford -- Chief Financial Officer
Steve Pusey, Chief Technology Officer

Analysts

Laura Janssens -- UBS
Robin Bienenstock -- Sanford Bernstein
Paul Howard -- Cazenove
Alan Burkitt-Gray -- Global Telecoms Business
Robert Grindle -- Deutsche Bank
Will Draper -- Execution
Darren Ward -- Liberum Capital
Terry Sinclair -- Citigroup
Justin Funnell -- Credit Suisse
Nick Delfas -- Morgan Stanley
Andrew Beale -- Arete Research
Graham Ruck -- Merrill Lynch
Michael Armitage -- Blue Oar
Mark James -- Collins Stewart
James Hutton-Mills -- Toscafund
Petri Allas -- Redburn Partners
Stephen Howard -- HSBC
Christopher Nicholson -- Oraca

Operator

Welcome to the Vodafone Group Plc half year results presentation, which took place at 9:30 am on the 11th of November 2008. The following presentation is being made only to and only directed at persons to whom presentations may lawfully be made. You may not disseminate any recording of this call in whole or in part to any member of the public or to any person to whom the communication may not lawfully be made. Any information in this communication relating to the price of which relevant informations have been bought or sold in the past or the yield in such investments cannot be relied upon as a guide to the future performance of such investments. These presentations do not constitute any offering of securities or otherwise constitute an invitation or inducements to any person to underwrite, subscribe for or other acquire securities in any company within the group. The presentations contain forward-looking statements which are subject to risks and uncertainties because they relate to future events. These forward-looking statements include without limitation statements in relations to the group’s projected financial results up to 2009 and 2010 financial years. Some of the factors which may cause actual results to differ from these forward-looking statements can be found by referring to the information contained under the heading ‘Under information forward-looking statements’ in the half year financial reports for the six months ending the 30th of September 2008 and principal risk factors and uncertainties in our annual report for the year ended the 31st of March 2008. The half year reports and annual reports can be found in our website www.vodafone.com. The presentations also contains certain non- GAAP financial information. The group’s management believes these measures provide valuable additional information in understanding the performance of the group or the group’s businesses because they provide measures used by the group to assess performance. However, this additional information presented is not uniformly defined by all companies including those in the group’s industry. Accordingly they may not be comparable to similarly titled measures and disclosures by other companies. Additionally, although these measures are important in the management of the business they should not be gauged in isolation or its replacements for or alternatives to but rather as complementary to the comparable GAAP measures such as revenue and other items reported in the consolidated financial statements.

Vittorio Colao -- Chief Executive, Vodafone Group plc

Good morning and welcome to the presentation of Vodafone’s results for the six-month period ended September 30th 2008 and thank you very much for attending my first webcast with the financial community as Chief Executive of Vodafone. Thank you. Let me go through the agenda for the morning. I will start first with the highlights of the results and summarize our revised guidance ranges for the current financial year. Then I will pass to Andy, who will present detailed financial results. Finally, I will get back and I will give you first an overview of our operations in Europe and in emerging markets, and then a detailed account of the strategy review exercise that we have conducted in the last two or three months.

I really look forward to your comments and your questions, and I just would like to remind you that, at 11 o’clock, we’ll observe the two-minute silence for Armistice Day. So let me begin with the summary of results. Revenues, EBITDA, operating profit, free cash flow, EPS, all have experienced double-digit growth in the first half, albeit thanks to foreign exchange benefits. On an organic basis, group revenue has increased by 0.9 percentage points and 2.6 on a pro forma basis, including India. EBITDA has declined about 3% and operating profit about 1% on an organic basis. Group cash flow generation remains strong and has increased 16% to £3.1 billion, benefiting from foreign exchange, improved tax settlements and lower interest charges. EPS increased by 17.1%, of which around 14.5% was due to the foreign exchange benefits.

The Board has reviewed the present dividend policy in the light of recent forex volatility, the impact of acquired intangibles and the current economic environment, and we have concluded that it would provide more certainty to shareholders if the Board adopted a progressive dividend policy instead of the 60% of earnings formula. Essentially, this is a policy through which dividends will rise smoothly over time, and the interim dividends will rise by 3.2%. By now, most of you have probably read and analyzed our statements. So I really would like to start by giving you my condensed view of the status of our operations and our performance across Vodafone in the first half. First, I would say that, despite revenue trends that have been softer than expected in Europe, we have a good position and we have again demonstrated the ability to generate good cash flow, essentially through cost optimization, through more sharing of our platforms and through good purchasing.

In terms of market performance, I look at our performance as good in three out of five of the large markets where we operate, stabilizing in Spain and weaker than expected in the UK. We have taken all the actions, as I will describe later in the day, but it will take some time to see the benefits go through. In Turkey, the turnaround has not yet materialized and we are putting a lot of effort now on fixing what I would call the basics, which basically is network, distribution and commercial offerings to our customers. We have impaired Turkey’s value, largely but not exclusively due to changes in the discount rate, and we will cover this again later. And finally, in the kind of broad overview points, data and emerging markets continue to be engines for growth, offsetting voice pricing pressures. So, in order to deliver our cash flow guidance that I will illustrate in a few seconds, in the second half it will be essential to have very strong focus on execution in all our markets and, of course, an ability to manage external pressures through very good cash management.

Now, updated guidance for the current financial year, revenue will be between £38.8 billion and £39.7 billion. Operating profit will be between £11 billion and £11.5 billion. CapEx range is revised downward to between £5.2 billion and £5.7 billion, and the free cash flow range increases to between £5.2 to £5.7 billion. The decrease in revenue guidance reflects the more challenging market conditions, in particular in the UK and in Spain. The lower revenues result in lower operating profit, but we have reduced the impact by cost reduction and direct cost saving and the increase in free cash flow guidance reflects lower CapEx, better tax and the group focus on free cash flow generation that we are enforcing. I will now pass to Andy for his financial review. Andy?

Andy Halford -- Chief Financial Officer, Vodafone Group Plc

Right, thank you very much Vittorio, and I will just do a quick overview of the key financials, a couple of comments on liquidity, and add a little bit of detail on to the outlook position. So, first of all, key numbers: £19.9 billion of revenues and £5.8 billion of adjusted operating profits. Top right-hand chart here, you can see the walk. So 17.1% headline increase in the revenues and, if you go across, you can see that 12.5% of that was made up of the FX benefit, particularly the euro, 3.7% of it was the contribution particularly from the India and Tele2 acquisitions, and the underlying organic growth was 11.1%. If you actually put India into the equation for both six-month periods then, on a pro forma basis, the growth was 2.6% for the two half years. The EBITDA margin was 3.2 percentage points down across the group, in line with our expectations, and I’ll talk to that in a little bit.

On the adjusted operating profit, the bottom right-hand chart here, the headline was an increase of 10.5% in the adjusted operating profit for the group. 12 percentage points of that came from the foreign exchange. The acquisitions did not have a huge impact on the operating profit, and the underlying was a 1% decline in profit between the two periods. Now, as Vittorio has mentioned, we have decided to take an impairment charge against the carrying value of the asset in Turkey, £1.7 billion. The largest part of that is because the long-term market interest rates have risen over the period since the end of March, and that, when we apply it in the discount calculation, has resulted in about two thirds of that value reduction. The other one third is to do with the operational performance and outlook for the business that Vittorio will talk to in a minute. The adjusted earnings per share, 7.52p per share, an increase of 17.1%, obviously fuelled significantly by foreign exchange.

So, let’s start with the revenues in Europe. So the key numbers in Europe, the revenues were up by 14.3%. 13% of that came from the foreign exchange, particularly the euro. We averaged a rate of 1.26 for the first half of this year, which was 14% down from the equivalent period last year. The impact of the Tele2 acquisitions was about two percentage points of growth and, if you strip those out, the underlying was a 1.1% decline in the revenues in Europe. Now, if you look at it another way, the regulated incoming revenues themselves caused about 1.3 percentage points of reduction in revenues between the two periods. So all the rest of our products, particularly the data products, the growth there very strong, 23% increase in data revenues covered the reduction in the revenues on the out going voice and on the roaming. The chart on the top right is then, looking at sequential quarters and comparing the growth rates with the equivalent quarters in the previous year. We talked in July about a 0.2 percentage reduction in the first quarter revenues. The equivalent number for the second quarter was 1.3%. The 1.3% had a stable impact from Spain and about half the 1.3 came from the performance in the UK business. Interestingly, if you look at that rate of revenue change by customer segment, the consumer segment revenues were sort of flat to very slightly down; the business customers that we’ve got, our revenues were up about 3%, and actually our large business, international business, accounts within that were up like 8%, so a very strong performance on the business front.

Moving then onto the revenues in EMAPA, headline growth there 25.7%, significant growth still. 9% of that came from foreign exchange, 7.7% of it came from the acquisition in India, leaving an underlying organic growth of 8.8%. That was very much driven by the increase in the customer base and also by a very, very strong performance in data, with data revenues in EMAPA up by 56%. Again, on a pro forma basis, so putting India into both periods in full, the growth rate was 14.4%. The chart on the right, again the quarterly changes there, you can see that the rate of increase slowed slightly in the last quarter, primarily due to reductions in the growth rate in India and in Turkey, with the other businesses basically continuing to grow as they were previously.

Now, onto the EBITDA, on the left-hand side, for Europe, the EBITDA grew by £0.4 billion to £5.2 billion for the period, a significant impact from foreign exchange here, with 0.7, which more than covered the slight reduction in the revenues on voice etc that I talked about a second ago. We invested slightly more in customers, which I’ll talk to on the next slide. Operating expenses remained exactly stable year-on-year and, importantly, we did invest a bit more into the fixed and DSL space. That did not have a significant impact upon the EBITDA but, on the top of the chart, you can see the margin movement in Europe, which moved down by two percentage points overall, of which 0.8% was because of the mix of the lower-margin DSL businesses. In EMAPA, on the right-hand side, the growth in the EBITDA there was £0.3 billion, increased to 1.7. The increase was split fairly evenly between the ongoing businesses and India and foreign exchange. The overall margin decreased by 1.7 percentage points to 31.5%, and that was predominantly the margin change in India that Vittorio will talk about later. The rest of the businesses in EMAPA were actually pretty stable on their margin.

European costs, we have split these out into two parts. The left-hand side are the sort of customer-facing costs, and the right-hand side are the technology, network, IT and support costs. So just on the left-hand side, the yellow are the purchase costs of equipment and the commissions that we pay to third parties, and you can see those rows very, very slightly year-on-year about a 1% increase in unit volumes, about a 1% increase in unit price. Volume has been kept down to only the 1% level, partly because of the push to SIM-only. The top part of that chart in blue are the costs of our customer care centers, our sales and distribution and our marketing, and those have been kept exactly flat year-on-year, as have all of the costs on the right-hand side, the network, the IT and the support costs. So all those cost areas kept absolutely stable year-on-year, and I think you should look at this in the context of voice volumes that have gone up about 9% and data volumes which have very nearly doubled during the period, so adjusted operating profit up £0.6 billion to £5.8 billion.

If I go across the chart here, a slightly lower EBITDA contribution, higher in EMAPA, slightly lower in Europe, depreciation and amortization costs basically stable year-on-year, a strong contribution from associates, Verizon Wireless in particular, which I’ll come onto on the next slide, and then, moving across, again a big foreign exchange benefit, primarily from the euro, albeit, in the second half, we’ll get some further benefit from the dollar if it stays at its current rate.

So, Verizon Wireless published their numbers a few days ago, another period of very, very strong performance. Top left-hand chart here is the revenues, $12.7 billion in the quarter, now running at an annualized rate of over $50 billion a year. The top right-hand side, you can see the share of the net contract additions of the big four players in the market, 63%. Bearing in mind they have about a 30% market share, it is basically punching at about double their normal weight. The EBITDA margin has been stable during the period. Hence the overall EBITDA has gone up and in terms of contribution to the profits of Vodafone, 20% on an organic basis, 25% on a reported basis, these now account for 25.5% of our adjusted operating profit, compared with 22.5% a year ago. And on the bottom right, you can see the EBITDA less CapEx, a sort of proxy for cash flow, which is now comfortably running at over $1 billion per month. The Alltel acquisition has now received regulatory clearance and the expectation is that that deal should close somewhere around the end of 2008.

Now, moving onto financing costs, on the bottom here, financing costs of £743 million, a reduction year-on-year of £150 million. Some of that was to do with the items at the bottom of this table, so the put accounting for the India option, and also to do with foreign exchange. If you therefore focus on the adjusted financing costs line in the middle, you can see a reduction there of about £40 million year-on-year, at £483 million. A number of moving parts in here, higher euro interest rates, lower US interest rates, a slight change in the mix of our overall profile of debt towards dollar denominations, and some mark-to-market gains during the first half of the year. We’d expect the second-half financing costs to be a little bit higher because we would not anticipate the same mark-to-market gains in the second half, and also we received the dividend from China in the first half of the year. Worthwhile noting, I think, that around 70% of our interest costs are fixed going forwards for about an 18-month period.

Now, on taxation, we have achieved an effective tax rate of 26.5%, slightly better than we had been expecting for the period, and a significant 3.5 percentage points better than the effective tax rate we had in the half year a year ago, primarily due to two reasons. Firstly, some countries have reduced tax rates during the period, most notably Italy and Germany and secondly, we have made further ongoing improvements to our own internal capital structure, which have also given us an advantage. So the 26.5% rate directionally, we think that that should be good for the rest of this year and, actually, we think that should now be sustainable as we go forward on a medium-term basis. Now, as ever, a brief update on the tax disputes that we have on the go at the moment and the answer is not a lot of change on any of them at this point in time. The CFC case is now hopefully in the second-highest level of court hearing. We remain very comfortable and confident with our position on that but still expect it to take some time to resolve. The Indian court case, we are awaiting judgment on the sort of first round of that, probably over the coming weeks or days and then, in terms of the other sundry settlements, we are continuing to work our way through those; a slightly lower level of settlement in the first half of the year, a little bit more settlement in the second half, but roughly about 0.5 billion a year that we are settling those.

So, adjusted earnings per share up 17.1%, 2.8% of that underlying performance, some of that obviously bolstered by the benefits on the financing costs and the interest, 14.5% of it from foreign exchange, and a very small element from the share buyback, which obviously only impacted one small part of the half year. So we’ll get a slightly bigger impact from that in the second half of the year, but overall an underlying increase in the earnings per share of 2.8%. Free cash flow, Vittorio mentioned this earlier on, we have been giving this a big focus during the period. 3.1 billion of free cash flow, before spectrum costs, which is an increase of 16% compared with the previous year, so slightly more operational free cash flow generation from the core European businesses. In the EMAPA region, we invested about £300 million more into CapEx in India, but basically self-funded that. The dividends were lower in this first half of the year because of the dividend flow from SFR, which is as expected, but nonetheless that was a reduction. Interest costs, a slight benefit that I referred to a minute ago. And then tax, we have got a significant cash flow benefit from that, which gives us the closing £3.1 billion number and the overall free cash flow per share, pre spectrum costs, about 5.85p per share, up 16.4% year-on-year.

Capital expenditure, so Europe on the left, EMAPA on the right, headline level, the capital intensity, capital spend as a proportion of revenues, basically constant year-on-year. In Europe, it was 8.4% in both periods. In absolute pound terms, that was an increase of £0.1 billion. That was in part FX. It was in part the DSL and Tele2 investments and, in part, putting in an ERP system, or starting to put an ERP system into the Group. On the right-hand side, for EMAPA, again the capital intensity percentage there was basically the same as it was a year ago. The actual spend was about £0.3 billion higher, and that was all targeted at the Indian market, where we have been investing in the new Spacetel circles and we have got a six-month cost in here for this year whereas, a year ago, it was a five-month cost on the capital for India. So India is the whole of the reason for the increase in EMAPA.

Net debt: £27.7 billion at the end of September, £2.6 billion of which was the put option in India, so underlying debt at £25 billion. A number of moving parts in here, M&A was a net outflow of about £800 million, being primarily Arcor and Ghana. There are a couple of line items in here for Qatar, where we have an in and an outflow, but the net is an outflow of about £50 million, as we expected. We did almost all of the £1 billion of share repurchases by the end of September, so we have the outflows from that and then we have a foreign exchange movement of about £1 billion, representing primarily the movement on the dollar. So, overall, comfortable with the debt position and very comfortable with our low single ‘A’ credit rating, especially in the present environment.

Let me just talk briefly on the issue of liquidity, which I know has been a very real topic, more generally. Top right-hand chart here shows the maturity of the various debt instruments that we have got out. Key messages are that in no year do we go above £3 billion and on average we have got about a seven-year life. On the left-hand side, you can see the snapshot at the end of September, just over £1 billion of cash at that point in time. Commercial paper, about £2.3 billion and, indeed, we have been accessing the commercial paper markets, even over the last few weeks, and have issued several hundred million dollars’ worth of commercial paper during that period.

The bond side, we have £2.5 billion of bonds that will mature in May 2009 and we will probably access the markets at a point in time. The markets, clearly, at the moment, are fairly tight, but it is possible to do, the pricing may be higher, and we will look over the period between now and May to make sure that we have that funded or, in the event that we do not do that, we have got $9 billion of committed, un-drawn bank facilities spread across a large range of banks and institutions, which have got a life of three to four years. So I think, in overall terms, our liquidity position is fine and we continue to have a strong balance sheet position.

Now, on the outlook, Vittorio just painted the high-level picture. Here, just to give a couple of points more detail on this, we have taken the revenue guidance down slightly, but all of the other metrics, basically, are the same or, on the cash flow, slightly higher. Some of that is operational reduction and some of it is FX improvement, but overall I’d just observe that, whilst the revenue is a little bit weaker, overall we’re turning that into slightly more cash than originally envisaged. So, just to walk through the key numbers here, we have taken the revenues down by £1 billion, primarily because of Spain and the UK and India. We have, within that, got some reduction in the number of devices and handsets that we are selling as part of our deliberate commercial strategy. So that is an element of it and essentially, on the revenue line, sort of mid point of range, we’re anticipating a similar rate of organic change in revenues to that that we experienced in the second quarter.

The M&A column here, not particularly significant, but have added in various contributions from Ghana and Poland and the Neuf Cegetel deal that SFR have done and then, on the foreign exchange, lots and lots of moving parts on this. We are now assuming that, for the second half of the year, the average exchange rate on the euro will be 1.26, and we’re assuming that, for the same period, the average dollar rate will be 1.67. So both of those numbers a bit lower than we had when we gave the original guidance at the 1.30 euro and 1.96 dollar rates. CapEx, we have reined in. We have reduced the amount of CapEx, even though we’re spending a bit more in India, and we have been very focused upon our interest and tax costs and hence, overall, why we have managed to nudge up the overall free cash flow guidance by 0.1 for the year as a whole.

So, in summary, strong headline numbers with a significant benefit from foreign exchange and the geographic dispersion of our assets. Data growth very, very strong across the group still and our push into the business and the enterprise segment is also bearing fruit. Cash flow has been a huge area of focus, as has making sure we have got the appropriate liquidity, and also driving the tax rates further down. So, with that, I will now hand back to Vittorio.

Vittorio Colao

Thank you, Andy. I will now run through the performance of our larger operations and then present the conclusions of the strategy review. It will be slightly longer than usual but I am confident that we’ll have enough time for a good Q&A session. So, let me start with some overall comments about Europe. Europe remains a story of cash generation. In the first half, we have generated £3.6 billion, up from last year. Capital intensity 8.4%, which is lower than our yearly targets of 10%. Organic service revenue growth, if you take out or, actually, you equalize the impact of Easter on the number of working days, has been at minus 1% in Q1 and Q2. EBITDA margins down, as expected, a couple of points, and 40% of this decline being linked to DSL. So these are the broad numbers about Europe.

Let me start by diving into the UK. Now, in UK, we have experienced a tough first half. Revenues, as the chart indicates on the left side, have declined organically 1.7 percentage points after adjusting for the VAT credit of last year. We have got a good performance in contract additions but we have been hit by churn in the high-value customer segment. Roaming revenue has been weak, mainly due to the regulation. So the impact on price, but also due to the fact that we have seen reduced business travel and in general, these three things have resulted in lower service revenues. Now, we also have some good news in the UK. Data revenue continues to grow at 30%. We have today more than half a million Data Cards in the UK, and this is a good reflection, I think, of our pricing strategy on data and our good quality of network. EBITDA margins, I’m moving to the right hand of the chart, have declined on the underlying business 2.3 percentage points and this is linked to mainly three things, the fact that we had to renew contracts, 18-month contracts that had been established in 2006 as a part of the move to the 18-month period, higher advertising spending to support our commercial efforts and network costs to support the data story and then there is the one-off VAT 0.8 that you see in the chart. So market conditions have been highly competitive in the UK and I have to say we have not moved fast enough, as we have done in the previous year. You might remember we were growing at 6, 7, 8% for two or three quarters and we have a bit slowed down.

We have taken actions already. We have improved our consumer contract offers. We have increased the emphasis on SIM-only. We have improved the conditions for top-up. In enterprise, we are pricing more aggressively in the UK, and our pricing policy for enterprise today is not to lose customers, profitable customers, on pricing grounds and, as you might have seen outside of the room, we are now focusing on our device ranges. We have the BlackBerry Storm, the exclusive BlackBerry Storm, exclusive to Vodafone and Verizon, and many other devices in all the segments of the range, and of course the UK team has been working on cost, in particular on technology and G&A costs.

So, as a summary, I’m still convinced that the UK remains structurally a challenging market and, therefore, Vodafone has to be more commercially agile in the market, leaner on cost, and especially if consumer confidence worsens in the country. Spain, what has happened in Spain? When we announced the first quarter KPIs, there have been a lot of questions about the steep change in our growth between quarter four and quarter one. So I think I should devote some seconds to going through what has happened. In Spain, we have grown for 16 quarters more than the market, and we have done it focusing on what I would call the mobile-only segments of the market. So, essentially, SoHos, migrant workers, what locally is called Autonomos, we had tariffs for Autonomos and these are segments which are also, due to the way the Spanish economy is structured, these are also generating a lot of international calls. So when the slowdown has hit the market, clearly these segments have been hit more. You might remember that, in those days, in July, we said one third, one third, one third: one third is the economy, one third is the promotion and one third is competition. So now, today, I can be a bit more precise about exactly what has happened. Precisely, the timing of the promotional activity has caused a 3.1 percentage point decline. The stronger competition, including the loss of Yoigo, has weighted 2.5 points, and the migrant worker segment has weighted 2.1 points and we call this the impact of the economy. So these are today’s, if you want, facts and the analytics. My simple conclusion is we have underperformed in the market. So, what actions have we taken after this? First of all, let me say that the actions that we’ve been taking are working, and the rate of decline in the market is stabilizing and, actually, it’s slightly less in quarter two than quarter one, minus 2.2 versus minus 2.5.

We’re doing well in contracts and also in data revenues. Despite the fact that the number is not particularly good, this really is two different things. Data connectivity keeps going well and, on the other hand, we are seeing a decline in infotainment and the impact of some price caps that we have put in the market to protect, actually, high data users, to avoid the so-called ‘bill shock’. Prepaid, which is the segment where migrant workers tend to be concentrated, is down 11% year-on-year, but the quarterly trend is flat. So while we see still a lowering of international calling from the immigrant customers, we are not seeing neither large decreases in contract numbers nor a worsening trend.

Moving to EBITDA on the right, excluding the impact of Tele2 and DSL and the Universal Service Obligation charge that is now levied in Spain, the margin fell 1.8 percentage points, due to increased A&R spend, again in the contract space, where we have been doing well. So, in Spain, after the sharp decline, we have acted quickly. We have increased immediately, as soon as we saw the decline, on-net promotions. We have improved the Vitamina pricing in Spain. We have pushed SIM-only products. We have included or introduced zonal pricing and we have launched DSL and especially this Vodafone DSL, which is a Vodafone router integrating HSDPA and DSL, which we think is particularly well-taken in the Italian market and, therefore, we are bringing it everywhere. In summary, we have acted in Spain. We have taken the necessary steps to address the pressures but it will take time to recover, and so we expect Spain to continue to be challenging over the next few quarters.

In Germany, our position is good. In the second quarter, service revenue decline 1.8%, a similar level to the past two quarters. Contract revenue is broadly stable, thanks to this family of SuperFlat offers that I will cover later. Data growth keeps being good and the only segment where we have declined is prepay, a 12% decline, due to the strong competition that we have from discounts, and notably from Aldi. EBITDA margin in Germany is up 0.6 percentage points, thanks to the reduction in A&R. Now, this reduction in A&R is really linked to two things. We’re pushing more SIM-only and we’re subsidizing less prepaid. Arcor is now the number two player in the DSL market, and although I have to say competition remains intense and the rate of market growth is declining and we expect to decline due to the fact that penetration has increased.

So, looking ahead, what will we do in Germany? We will continue to drive in the contract space with SuperFlat concept. We have just launched, as a response to the pressure that we have in the prepaid segment, we have launched a new aggressive CallYa 5/15 prepay tariff, which is really aimed at regaining ground in the prepay market against the Aldis of this world, and of course we continue to integrate Arcor, where we see cost benefits in the networks and the services part. So, in general, we expect German trends to improve later this year, and I would say that, while we have to be cautious in the current climate, so far we have seen limited measurable impact from the economic weakness.

Italy, Italy is another positive story. Our revenue is up 8% in Italy; seven of this is really linked to the Tele2 acquisition. So organic service revenue is up about 1%, 0.9%, to be precise, and here we have different trends. First of all, strength in contract, we have pushed contract and business. Growth of revenue is 15%. Growth of customer base is 34%. We have shifted away from a volume orientation in prepay to a value orientation and we have a very, very strong data growth. 37% is, at this point, the highest in our mature European market, clearly driven by a very strong drive of PC connectivity. Interestingly enough, you might remember that Italy was the first market where we have started going on television with consumer propositions in data, and this is proving to be the right thing to do. Finally, we have now in the market a Tele2 DSL offer and a Vodafone DSL offer and, between the combined, we have 650,000 DSL customers in the country.

EBITDA margins in Italy have declined 4.5 percentage points, mainly due to the Tele2 acquisition, and the remaining 0.8% is really A&R, again linked to the driving Contract. So Vodafone Italy continues to execute well. We expect further good performance going forward, even though, as for Germany, we have to be cautious, given the GDP forecast for the country that we have all read. Now, moving to emerging markets, broad comments about emerging markets, emerging markets again, we are displaying robust growth. This is a growth driven by customer additions, and so penetration mainly. Emerging markets is cash-generative, despite the fact that we are investing big amounts in network to support the expansion.

Updates since April, we have got the license in Qatar. We have completed the acquisition in Ghana. We have increased our stake in Polkomtel and last week, we announced the purchase of the controlling stake in Vodacom. There are two operations that I think is worth focusing a bit of attention, India and Turkey. So I will go first through India. Now, India is a great market, strong fundamentals for voice, great opportunity for data, which clearly is the next big thing in all the emerging markets, and the thing which is to me very important is penetration is still only 27% as of end of September. In the first half, our revenue growth has slowed to 41%, essentially due to tariff reductions that have taken place in the market in the first quarter. These tariff reductions have got a higher effect on the second quarter, with growth at 36%, and we have maintained competitiveness. We now have, in the markets where we operate in the historic or 16 circles, 21% market share and, on a nationwide basis, we have a 17% market share. A bit of explanation on the EBITDA evolution in the market: on the right-hand side, you see a 5.6 percentage point decline.

Here, there are three things that explain this decline. The first is the outsourcing of IT to IBM. This is the classic Opex versus CapEx trade-off. Overall, we saved money but, on the P&L, the impact is 1.3 points. The second is the expansion in the seven new circles, where we were not before, the so-called ‘Spacetel circles’, which clearly, in the beginning, has cost but doesn’t have revenues, and this is 1.4 points and then the remaining 2.9 points are exactly the impact of the price reductions, net of the savings that clearly come from the increased scale. We have invested £600 million in CapEx in the first half and we expect to invest for the full year over £1 billion. We are permitting an accelerated base station rollout, 2,000 base stations per month, which we think is very important, given the competitive context. Indus Towers, which is the tower company, has started operations in July and shortly the shareholders, the partners, will contribute the assets to the company. So, in essence, our focus in India remains growth, penetration in existing and in the new circles. The opportunity in India, I am convinced, remains very large and it is particularly attractive for players like Vodafone, players who have the scale to support competitive pricing to our customers. We therefore expect absolute level of revenue growth to remain strong, despite the pricing pressures.

The other country that was worth a bit of diving is Turkey. As I said at the outset, Turkey’s performance has been disappointing. In the second quarter, our service revenues, left hand of the chart, have declined 2.1 points year-on-year on an organic basis, and this comes after 3.7 in the previous quarter. I could quite frankly mention several external factors that have determined this performance. I could mention the timing of Ramadan, which was not fortunate, the termination rate cuts, the change in GDP forecast, but I don’t want to hide behind these factors. The performance in Turkey, our performance in Turkey, has not been where it should be.

We have added two million customers in the quarters but, due to the fact that, one year ago, we had weaker controls in our indirect distribution, we have got a big churn and we are actually negative on net adds. It is taking longer to fix the network and also to have a solid distribution platform for a country of 70 million people. So, in this context, our EBITDA margin actually slightly improved to 19.6%, even after very high taxes that are a characteristic of the market, but clearly profitability is not the issue for us in Turkey. Our priority is now in Turkey to invest, to improve the perception of the network and to improve our distribution, so that we can deliver more services and better services to the Turkish customers.

So how are we addressing it? First, we have established a technology roadmap and we have a program which will, in six months, bring the network up to the level where Vodafone expects it to be and the customers expect it to be. Second, we have a number of initiatives to ensure that we bring to the country the right commercial offers for the right customers and third, we are working on both direct and indirect distributions to deepen and make it stronger. There’s number portability coming, 3G auctions coming. It is important that we get these three building blocks, the network, the distribution and the commercial offering, right in place. This will take time. This will take time but Turkey is and remains a very attractive market, 70 million people, very young population, all the elements for positive growth are there. So my conclusion on Turkey is that, in Turkey we know what we have to do. We have done the right things and we are confident that we will get it right. I am at the end of my kind of operational review. Let me summarize in simple words what our operational imperatives are. I would say our operational imperatives are fairly straightforward. Improve our market position in Spain and UK. Complete the turnaround in Turkey and continue to perform well in Germany, in Italy, in India and, of course, also in all the other markets. In order to do this, we have commercial plans in place. Where we need, we have technology plans and I have to say we have also strengthened the management of these operations, first of all by focusing the regions on a smaller number of countries and by rotating leadership skills to suit the diverse needs of the market and I think that, shortly, we will also announce the appointment of a Turkish CEO to strengthen the local team.

So, now I have to run through the revised strategy. Before getting to the strategy, I would like to spend a few seconds to share with you my personal perception of our telecommunication industry. Seen from my perspective, which is the perspective of somebody who comes from the personal mobile angle of the industry. I would say that, in the context of turbulent times, we should not forget that we operate in an industry which continues to be able to generate strong and consistent cash flow, basically on delivering very compelling services that serve a fundamental human need. This, to me, is the crucial point. Now, somebody believes that voice is increasingly mature in developed markets, but there is the data opportunity. The data opportunity, rate of revenue growth, is strong in mature markets and will be strong in emerging markets, and I truly and strongly believe that, as we all can see, if we walk into a shop or if we walk into a train, that ubiquitous connectivity is basically a one-way road. Once you start using it, you just cannot give it up and for sure, and I’m very confident, nobody will give it up just for saving the cost of a couple of drinks in a month and this is what I really strongly believe. It’s a one-way road and the cost and the benefit of this ubiquitous connectivity compared to the costs are incredibly compelling.

Moreover, in the emerging economies, mobile connectivity will be the main or, in some cases, the only way to access the Internet and to have a communication platform for work and for personal living and even if growth does not show up maybe for periods, due to general conditions, the mobile side of the industry has flexibility in managing the cost base. If you take CapEx, perhaps half of CapEx are pure maintenance or kind of fixed CapEx, and the remaining parts are driven by volumes or by development and if you look at Opex, and I will elaborate further in my presentation, if you look at Opex 35% are truly fixed. So we individually have levers and, collectively, if you let me use a kind of simpler expression, we have some taps, collective and as an industry that we can open or close, depending on development and depending on the economic phase. I do believe that we operate in an attractive industry and I do believe that this is an industry with economies of scale serving essential services with flexibility on the cost base.

So where does Vodafone stand in this industry? I think Vodafone has some very distinctive attributes, which put us at centre stage in this industry. Quickly going through them, we have demonstrated that we have a strong cash flow performance. We have a diverse portfolio of assets in mature and emerging markets, and most of the places we are either number one or number two. We have been pioneers in the data world, both at the network end, 3G, HSDPA, and at the service end, with all the initiatives that we have done. We have a strong brand in the consumer space but this strong brand is becoming stronger and stronger and more credible also in the enterprise and business space and finally, we have demonstrated that we have advantages of scales on infrastructure and on purchasing.

So my view of the industry, balancing the right and the left-hand side of this slide, is that this is an attractive industry which provides essential services in a very, very kind of compelling way and serving in a compelling way a very basic human need and Vodafone, on the other hand, is very well-positioned because, on all the key elements of this industry, we have demonstrated that we have some strength. So we can make a good investment case, if we execute efficiently. So execution will be a word that you will hear from now on quite a bit of time. The new strategy had to reflect these things, had to reflect the new economic environment, our strength and what we believe is the future of our sector. So the starting point for our strategy was the May ’06 strategy. The May ’06 strategy has served us well, and I don’t need to go in great detail into all things. We were starting from high prices and low volumes; we have reduced price by 17%, increased volume by 21%. We have declared cost targets which we have delivered, the flat Opex or the 10% capital target, which somebody said was unachievable in those days, but eventually we are at 8.4%, as I said. We have increased our emerging market exposure through the exciting, I would call it exciting, addition of India and the promising addition recently of Vodacom, and we have moved into total communication, having today a business which, on an annualized basis, is worth £2.8 billion in mobile data and having DSL capabilities everywhere.

We have sold £3 billion of non-core assets. We have grown dividends, made sizeable capital returns to shareholders and in the process, we have retained the single ‘A’ rating, which, in these days, seems to me fairly relevant. So, how has the environment changed in this period? Now, the environment clearly has changed. The evident thing is that prospects for economic growth have changed. There have been issues with inflation rising in emerging markets, maybe a bit less now, but still there with energy concerns, especially where we depend on diesel or where people depend on basic food for a large part of their spending. Competition remains, I would say, strong. Double-digit price declines are kind of expected and the norm and these offset growth in usage. We have discussed with many of you the concept of elasticity and how much price declines can be balanced by volumes. The concept has proven difficult: difficult to measure, and also difficult to demonstrate. There’s more converged offerings and, when I say ‘converged offerings’, I don’t just say fixed mobile offerings but also platforms like the iPhone or Android, which give multi-platform access to the same services and resellers and discounts have a bigger role in the industry.

And, finally, regulation keeps having an important role, not just in defining the mobile space but also defining the way we interact in the DSL broadband space with large incumbents. So we had to review the strategy to reflect the new market conditions and to reflect what we thought was the right thing for Vodafone. Our November ’08 strategy can be illustrated in a fairly simple way with one target and four pillars. The one target is really focusing the whole of Vodafone on driving free cash flow generation and a stronger execution focus.

In order to do this, we must drive four things, first, strong operational performance, both at a revenue level and at cost level. Second, pursue the existing, the already existing today growth opportunities that we see in our communication space, mobile data, enterprise and broadband. Third, we need to deliver appropriate returns from our existing emerging market assets as a priority, and look at expansion opportunities, if and when they arise, cautiously and selectively and finally, we need to reward our shareholders and be disciplined on how we use their money.

I will start describing the first element of driving the operational performance, which is value enhancement. As I said, the May ’06 strategy had revenue stimulation as a key pillar, which really was about driving voice usage through price reduction. However, price-per-minute falls continue to erode margins and they’re not compensated by enough elasticity and this is clearly indicated in the left hand of the graph, which correlates outgoing price and outgoing usage. We also need to address the remorseless rise in customer investments. That has been the main driver of margin erosion in the recent years. This, of course, will always be influenced by market factors, but it’s critical that we get smarter and more focused on our investment and our subsidies. We have to optimize the value of relationships. This means, moving away from per-minute pricing and having lower prices as a result of loading our offers with more value, minutes, or megabytes or whatever is going to be the measure, extending such offers across the communities, family members or company employees, allocating better our commercial investment and rewarding longer relationships for the customers. One other way we call it, we call it much more for more, more people in the family, more services, you get much more.

From a price perspective, this means that Vodafone wants to be always price-competitive in the high end and in the medium end of the customers, and we should not be afraid of lowering our prices, as long as we achieve three things. We load our infrastructures more. We balance our commercial cost and we improve the lifetime and, therefore, the scope of our relationship with the customers. We have the network capacity to do this and this is consistent with any industry where scale does matter. So you probably will say ‘fine, good theory, how does it work in practice?’ Or ‘does it work in practice, by the way?’ And let me give you a German example, where, in Germany, we have developed the SuperFlat concept that I illustrated in the beginning. This is a head of household-type of tariff, where, as I said, you add built-ons, more services or more family members, and you get better conditions. As the graph shows with the blue bars, we’re getting more revenues for more usage, and much more compared to the existing entry tariffs. Now, what the graph does not show is the commercial investment which is related to that, which of course is commercially sensitive, but I can tell you it is much better for us as well. So this is a tariff which is better for the customers but is also better for Vodafone, and you can expect to see more, not exactly this in every market but more of this philosophy around.

Now, moving to the second element of operational success, we need to work on cost. Let me start with a bit of a description, since there has been some speculation on our ability to work on cost, a small description of our cost base. If you take the £27.4 billion of cash costs that we had last year, putting together Opex and CapEx, reading horizontally the weight is 30% direct cost, which mainly is interconnect, 34% customer-related, including A&R, 17% technology, IT, G&A, operations, and 19% CapEx. If you look instead vertically, what drives these costs, you will see that a quarter of these costs are generically usage or volume-driven. 41% are market-related and 35% are fixed. Now, let me cover first the market-related. I already said the market-related costs are or have been responsible for the margin erosion of our industry recently. As I said, we have to acknowledge that market conditions and being competitive clearly influence a large part of our decisions to have commercial cost, but we also have to acknowledge that it is too easy to accept that this is outside our control and we become passive in this area. So value enhancement as I described before is an essential part to addressing these costs and remaining competitive at the same time.

Let’s now move to the fixed costs. So, what is strictly under our control? Now, here are some cost programs that we have in the company. As you can see, these cover all areas: technology, logistics, everything, general administration and support functions. The concept here is to really drive down costs and achieve regional scale, with a goal to save £1 billion by year 10/11 relative to the 07 or 08 number, and use these savings to offset some of the inflationary pressures that we have in our business, to fund some of the growth opportunities, and of course to offset the revenue pressure. Now, the overall effect on our cost structure of the initiatives would be the following.

In Europe, we really want to ensure that operating costs remain broadly stable from last year to 10/11 and many of the programs will also have an impact on CapEx. The 10% CapEx that we had in the past is confirmed. As I said before, 5% is basically maintenance, about 20% to 25% is volume-related and a part of it is expansion. We think that we can maintain that target and by the way, if you look at Germany last year, which is a place where we have a big presence and converged operations, if you put together Arcor and Vodafone, we already last year were at 10%, so we think it’s doable. A different approach for emerging markets, now, here, the opportunity for growth is there. So here the target is not to reduce costs or to keep costs flat; the target is to have cost growth lower than revenue growth and, of course, we have to put more CapEx, Andy has shown before 21% of revenues, but we don’t see any reason why, long-term, these markets, when they mature, should not trend towards the 10% number. So this is our approach on cost. I now want to address the growth opportunities. Now, the growth opportunities have been really and strongly prioritized, based on where we think Vodafone has advantages, and we do think, as I said before, that our advantages are in network scale, in brand and in customer base and customer assets.

First, mobile data, now, mobile data, we already have delivered. We have £2.8 billion annualized revenues, best-in-class products and networks. I believe that there is a great opportunity in Europe. In Europe, we have doubled from 4% to 8% the data subscriptions in our base in one year. If you look at the left-hand side of the graph, you see penetration of Mobile PC connectivity devices, plus 84%. If you look at handheld business devices, plus 96%, what does this mean? This means that more and more people walk around with data-enabled devices in their pockets or wherever they keep them, and more and more people, as much as it happened with voice and with text, six, seven, eight years ago, are getting accustomed more and more to use these devices. I really think that this is an important opportunity for us.

How will we drive this opportunity? I would say, first of all, focusing on devices. It’s important that we have the best. We’re working on Netbooks. In these days, in the UK, I think the Dell Netbook is selling 2,000 per week. We’re working on USB keys or dongles, we’re working on phones, and clearly there’s a huge work of segmentation and development that will take place. We have demonstrated. UK is an example, Italy is another one that we can be creative and aggressive with pricing schemes, and we have to do it because the more you get into deeper and deeper segments of the society, the more you need to segment your pricing and we have reorganized our competencies and our efforts in the IP services space, both in consumer and in business, through Vodafone Business Services and Vodafone Internet Services, which are our two units who are in charge of developing IP-based services for our customers, linking our billing, our CRM, our databases into the customer experience.

Second opportunity, enterprise, in enterprise, this is another area where we have done well. We have a £7 billion business here. We took a disproportionate share of mobile data growth and this demonstrates, I think, the credibility of the Vodafone brand in this space. The pies on this chart represent an estimate of the £175 billion market that Enterprise have, where you see the green part is the mobile part. It’s relatively small part. Now here, on the left hand, we have done pretty well in the corporate segment. We established in 2006 Vodafone Global Enterprise. Now it’s growing still 8%, very strong position in large multinationals, and with a deepening cooperation with Verizon, which is adding a lot of value here. What is the next step is working on SMEs and sorry, first of all, of course, the first step is, to continue to work well on multinationals and continue to leverage on that, but the second thing is to now extend our services into SoHos and SMEs and this is what Vodafone Business Services is about. It’s a local operation, so we will operate locally. We will leverage on our business divisions that we have created in all the markets where we operate, and we will clearly leverage on our assets, strong sales force, trusted brand, and share services and products, especially in the IP space, where this is today possible.

Third opportunity, fixed broadband, now fixed broadband in several markets fixed broadband is becoming an increasingly important part of our communication customer proposition, particularly for enterprise and for high-value customers. We believe that we can generate incremental value by selling broadband into our mobile customers and also by attracting new customers through the shops, as it is happening these days in Germany, where, as I said, we are now the second provider in the country. We have network, we have distribution and we have scale to work on DSL. In some countries, we have decided to own DSL broadband assets but we are technology-agnostic. Our choice is and will always be to invest based on three criteria, basically, geodensity, local geodensity, local pricing level, and local regulation. So we will pursue this opportunity where this makes sense financially and where we have the right assets. Our approach to broadband here is and will be a market-by-market approach. Now, turning to emerging markets, I already said that we will be shifting our focus from expanding to prioritizing execution in emerging markets. Why do I think that this is appropriate? And this chart illustrates why and the easy answer here is because we are in the right places. Because we are in India and India is an incredible growth opportunity, because, through Vodacom and other subsidiaries, we are in the Middle East and Africa. We are exposed to China through China Mobile. We are exposed to the US through Verizon Wireless. We are not in Latin America but, basically, this chart says Vodafone is where it should be.

If you think about the seven Spacetel circles of India, we call them circles which is sort of a funny name but we’re talking about 300 million people. So Vodafone is adding coverage of 300 million people. The GDP clearly and the GDP per capita is different than a mature market, but this is the scale of development in India. Therefore, my primary focus in emerging markets will be to ensure that we execute on our business well and in order to do this, you notice we have reorganized, as I said, our EMAPA operation into smaller regions, with greater focus on fewer markets each. Growth in this market, as I said, will remain strong but we have the mobile data opportunity. If you look at Vodacom, what Vodacom in South Africa, has achieved by becoming the first provider of broadband across all technologies through a mobile platform, this gives you an idea of the potential and the important thing, the important success factor here, will be the ability to bring lower-cost devices to these markets.

When I go to India, when I go to Kenya, when I go to South Africa, the one thing that they ask is, of course, penetration and coverage, because that’s essential, but the next thing is ‘When are you going to bring me a low-cost data-enabled device?’ So we are convinced that this is going to be an important thing, executing and, as a priority, executing in these markets. Talking about expansion, we have criteria to screen the opportunities. These are the classic criteria you would think of and, of course, we have M&A financial criteria that are in place to look at specific opportunities. We have identified only a small number of large markets of significant size and these could be explored in the future selectively and cautiously. In the markets where we are not present and where we don’t want to put equity, we have the partner-market operation, which is, we think, a very effective way of bringing our services to a market and giving to our customer’s access at good condition to that market, without committing equity and the MTS deal, which is a huge deal that we announced two weeks ago, is I think the best example of that. So, in summary, our approach to emerging markets is to focus first on execution and then cautiously and selectively on expansion. The fourth element of our strategy is capital discipline. We will be about cash flow generation. One question, which is logical is, what are you going to do with the cash?

Now, first, of course, is profitable investment in our existing business. This means supporting our businesses. This means going after the three growth opportunities that I have illustrated and, of course, there’s the spectrum, where our position is that, while we are comfortable with the spectrum allocation that we have, we might, on a country-by-country basis, look at specific opportunities. The second priority is to clearly enhance returns to our shareholders, primarily by the way of dividends, and then you have M&A. First, I would like to say that, within existing markets, I see consolidation as a positive for the industry, and I would support in-market consolidation, active or passive, as a concept. The synergies that we are looking or we are seeing in the Alltel case, we think Verizon are clearly indicating that in-market consolidation creates value for shareholders. There are also other examples that we are seeing and, in our own world, even integrating Arcor and Vodafone is creating synergies, so our position on consolidation is that we support.

Emerging markets, I covered before, and this leaves with portfolio management and now, on portfolio management, we review every controlled asset in the Vodafone portfolio, and the check is, does the asset return the local cost of capital and is the asset worth more to somebody else? And if the answer to these questions requires it, we have to take and we will take the appropriate actions.

We also have a few non-controlled assets. Verizon Wireless is the first, still delivering double-digit revenue growth in the process of completing, as I said, a major value-creating acquisition, Alltel. We recently have deepened the cooperation with Verizon Wireless in areas like technology, devices, with the Storm that you can try outside, and on global accounts. The Board reviews Verizon Wireless regularly and we remain open-minded as to how to maximize the value to our shareholders, taking into account the complex and tax-efficient structure that we have. So we are today convinced that our current position is the best for Vodafone. We have a good partnership and a strong operational cooperation with SFR as well, supported by a good shareholder agreement and, most importantly, by a very aligned strategy and finally, we have an important investment in China Mobile. Now, China Mobile, I don’t need to tell you, is the number one player in a growing market, enjoying large-scale advantage, and here again we have a good partnership. Very important, the cooperation on the LTE development, but more recent and, I think, very promising, we are extending the cooperation to services through the joint venture that we have with China Mobile and Softbank. Our investment provides exposure to a leading player in a fast-growing market.

So, in conclusion, the Board continues to review our positions in these companies regularly. In summary, if I had to say what I would like you to take away from today, I would like you to kind of have a clear idea of what my management and myself will spend our time on and what are our priorities and our priorities are put here in a chart. We will work on strengthening our businesses everywhere and, of course, most importantly, where we under perform, focusing our management on value and making sure that we implement the £1 billion cost program. We will work hard to improve contribution from data, enterprise and develop broadband, as part of the changing profile of Vodafone.

Focus on delivery in emerging markets and look at expansion cautiously and selectively and of course maintain clear priorities for surplus capital. Our ambition is to confirm or sustain the free cash flow generation in the £5 to £6 billion range, which it has been for last year and is the guidance for this year and I would like to ask you to let me conclude with my personal ambition, the personal ambition of Vittorio Colao. My ambition is to lead Vodafone in an industry that I do believe is still attractive and to fully exploit, dur