Telefónica O2 UK

First half operating review

In the first six months of the year, Telefónica O2 UK maintained its leadership position in the market through best-in-class contract churn and customer satisfaction indicators. The Company  recently came away with the most prestigious award of “Best Network Operator” at the 2009 Mobile Awards for the second year in a row.

The Company’s total mobile customer base at the end of June 2009 reached 20.7 million lines (excluding Tesco Mobile), representing a 6.6% year-on-year growth. Net mobile additions in the first half of 2009 reached 394,021, with 252,268 net additions in the second quarter. The contract segment continued to record a strong performance in the second quarter of 2009, adding 312,673 contract customers (+73.3% year-on-year), totalling 598,940 net additions in the first half (+41.8% year-on-year). Contract customers made up 43.6% of the total base at the end of June 2009 (40.6% in June 2008). This positive evolution was mainly due to churn containment, the ongoing prepay to contract migration process and continued commercial activity around “Simplicity” and high-end devices.

The UK prepay market continued to be very tough in the first half of the year, with the Company focusing on retaining value customers within this segment with propositions such as “Top Up Surprises”. As a result, 204,920 net disconnections were registered in the first half of the year (60,405 net disconnections in the second quarter).

Churn in the contract segment sustained its solid evolution at 1.2%, both for the second quarter and first half of the year, showing a year-on year reduction in both periods (0.1 percentage points in the quarter and 0.2 percentage points in the first half). Total churn for the quarter was 2.6% (+0.3 percentage points, year-on-year), while for the first half was 2.7% (+0.1 percentage points, year-on-year).

In terms of usage, traffic carried in the first half of 2009 grew 16.2% year-on-year to 26,102 million minutes (+15.0% in the second quarter). Prepay customers increased usage on propositions such as “Unlimited”, while contract customers continued optimising their voice bundle utilisation.

Voice ARPU showed a year-on-year decline of 6.6% in local currency, reaching 15.8 euros in the first half of the year (-6.9% year-on-year in local currency in the second quarter), due to the continued uptake of customer propositions, such as “Simplicity” (with reduced acquisition costs), as well as the optimising behaviour of customers when using voice bundles. In addition, outgoing roaming activity in the first half was impacted by less travelling in the current economic environment.

Data ARPU rose 1.7% year-on-year in local currency in the first half of 2009, reaching 9.0 euros (+1.9% in the second quarter in local currency), reflecting the continued increase of customers accessing the Internet through mobile connections, partially offset by a decline in SMS ARPU due to the optimising behaviour of customers and the voluntary reduction of mobile termination rates.

As a result, Telefónica O2 UK’s total ARPU for the first half of the year showed a 3.8% year-on- year decline in local currency to 24.7 euros, with a year-on-year decrease of 3.9% in local currency in the second quarter.

Telefónica O2 UK’s DSL broadband service added 116,016 lines in the first half of 2009 (52,398 in the second quarter), leaving the total fixed broadband customer base at 456,882 lines at the end of June (2.4 times higher than in June, 2008).

Revenues for the first half of 2009 were 3,194 million euros, a solid increase of 5.5% year-on-year in local currency (+4.1% year-on-year in local currency in the second quarter). Mobile service revenues in the first half of 2009 were 2,926 million euros, a 5.0% year-on-year growth in local currency (+4.7% in the second quarter), with an increasing contribution from data revenues (+8.7% year-on-year in local currency in the first half of the year and +9.0% in the second quarter). Non P2P-SMS data revenues registered strong growth of 51.3% year-on-year in local currency in the first half, with a noteworthy ramp up in the growth rates posted in the second quarter (+60.3% year-on-year in local currency vs. +42.2%, up to March). Revenue growth from handset sales continued its downward trend in the second quarter (change in phasing of prepay handset shipments and more commercial activity around SIM-only).

Operating income before depreciation and amortization (OIBDA) totalled 798 million euros in the first half of 2009, a 4.5% year-on-year growth in local currency (+2.4% year-on-year in local currency in the second quarter), leveraging on optimisation of customer retention costs (market leading churn and increased proportion of SIM-only customers), compensating increased commercial activity in the contract segment. Continued operational efficiencies in non-commercial costs, as well as improved contribution from the DSL business also helped to sustain margins. OIBDA margin for the first half was 25.0%, broadly flat year-on-year (-0.2 percentage points), while for the second quarter was down 0.5 percentage points to 25.8%, mainly due to the above mentioned increased activity in the contract segment.

Operating cash flow (OIBDA-CapEx) for the first half was very strong, totalling 539 million euros, an increase of 19.8% year-on-year in local currency, reflecting the positive OIBDA performance and CapEx reduction of 17.5% year-on-year in local currency.