Market Overview

Telefónica's Net Profit Increases 28.9% and Reaches 1,600 Million Euros in the First Half of the Year

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  • The Company upgrades guidance and reiterates the
    dividend
    announcement for 2017.
  • The second quarter of 2017 shows a general
    acceleration in growth
    in main financials and operational terms.
  • Revenues reached €12,960m in the quarter
    (+1.9% vs. 2Q16, +3.1% in organic terms), thanks to improved trends in
    all segments. Both service revenues and terminal sales accelerated
    year-on-year organic growth (+2.9% and +5.2%, respectively).
  • OIBDA amounted to €4.158m in April-June
    (+6.1% vs. 2Q16, +7.2% organic vs. 1.3% in the first quarter). The
    OIBDA margin stood at 32.1% and recorded a year-on-year expansion of
    +1.3 pp (+1.2 pp organic).
  • Free cash flow reached €1,620m in the January-June period, double than
    in the same period a year earlier.
  • Net profit for the quarter was €821m (18.4% vs. 2Q16) and net profit
    per share stood at €0.15 (+16.3%).
  • Debt totaled €48,487m in June, with a year-on-year reduction of
    €3,706m, or a €4,981m reduction including the sale of Telxius. Net
    debt was €279M lower than at the end of March.

José María Álvarez-Pallete, Executive Chairman of Telefónica:

"During the second quarter of the year we have accelerated organic
growth through the execution of our structural quality-based strategy,
which was reflected in the strong competitive positioning in our main
markets. Moreover, we continued to make progress in our transformation
towards becoming a platform Company, with CapEx devoted to UBB networks,
underpinning E2E digitalization and cognitive intelligence, with a
differential value proposition for customers. All this, with a stronger
balance sheet, after doubling Free Cash Flow in the last twelve months
and reducing net debt by 5 billion euros, when considering the sale of
the stake in Telxius.

The strength and better business trends in the first half of the
year, as well as being well-positioned to continue capturing sustainable
growth in the coming quarters, allow us to upgrade our guidance for
2017".

Financial results _ January-June 2017:

Telefónica today announced its results for the first half of the year, a
period characterized by growth across the board and by good progress in
the transformation process of the company and in the reduction of the
group's financial debt. The second quarter of the year shows the
acceleration of this growth, in both financial and operational metrics.

The Company upgrades guidance and reiterates the dividend announced
for 2017
.

  • Revenue guidance upgraded to growth >1.5%
    (vs. stable previously), despite the negative impact from regulation
    (approximately 1.2 p.p.).
  • OIBDA margin guidance (y-o-y expansion up
    to 1 p.p.) and CapEx/Sales excluding
    spectrum (around 16%) reiterated.

Growth across the board

The Company remained focused on increasing the weight of higher-value
service so quality of the Telefónica Group's customer base continued
improving, as reflected by average revenue per customer increase (+3.1%
y-o-y in organic terms) and churn reduction (-0.2 p.p. vs. the first
quarter). Total accesses stood at 346.2m at June and showed y-o-y growth
in LTE (1.6x y-o-y); in mobile contract accesses (+5% y-o-y); in
smartphones (+19%), achieving a 61% penetration. FTTx and cable
customers (10m) grew 19% vs. June 2016 and accounted for 47% of the
total fixed broadband accesses, reaching a coverage of 41.2m premises
passed (+14% y-o-y). Pay TV accesses improved sequentially and returned
to post positive net additions in the quarter (+56k) for the first time
since the second quarter of 2016.

In the second quarter, revenues (€12,960m) increased 1.9% y-o-y
and accelerated growth to 3.1% in organic terms thanks to improved
trends across the board. Also, growth accelerated in service revenues
(+2.9% y-o-y organic) and handset sales (+5.2%). Mobile data revenues
continued to be a key growth driver and improved their pace of growth in
the second quarter to 17.8% y-o-y in organic terms, increasing their
weight over mobile service revenues by 6 p.p. to 60%. Revenues reached
€26,091m in the first half (+3.4% y-o-y; +2.3% y-o-y organic).

Operating expenses (€9,048m in April-June; -0.2% y-o-y) grew 1.2%
y-o-y in organic terms due to higher network and system costs and
increased personnel expenses.

Operating income before depreciation and amortisation (OIBDA)
totalled €4,158m in the second quarter, growing 6.1% vs. April-June 2016
(+7.2% y-o-y organic), while OIBDA margin stood at 32.1% in the second
quarter, reflecting a y-o-y expansion of +1.3 p.p. reported (+1.2 p.p.
organic). OIBDA totalled €8,179m in the first half of the year (+5.5%
y-o-y; +4.3% organic) and the margin reached 31.3% (+0.6 p.p. reported;
+0.6 p.p. organic).

As a result, net profit in the quarter (€821m) increased 18.4%
y-o-y. In January-June, it reached €1,600m (+28.9% y-o-y). Basic
earnings per share stood at €0.15 in the second quarter (+16.3%) and
reached €0.29 (+30.3%) in January-June.

Solid investment commitment and deployment of infrastructure

The transformation process of the Company continued its progress in the
quarter, as evidenced by the high investment commitment of the group and
the deployment of infrastructure in the different geographies. In this
way, Telefónica registers at June 30, 41.2 m premises passed with FTTx
and cable (+14% y-o-y) and an LTE coverage of 68% (89% in Europe). CapEx
in the first half (€3,507m) was focused on 4G and fibre optic network
expansion, and the simplification and digitalisation of processes and
systems, and its y-o-y performance (-4.0% reported; -5.7% organic)
reflected integration synergies, consolidation and network optimisation
("big data"). Operating cash flow (OIBDA-CapEx) reached €4,672m
in January-June and grew at double digit rates (+13.9% y-o-y in reported
terms; +13.0% organic), reflecting business performance and lower CapEx
intensity. Y-o-y growth accelerated sequentially in the second quarter
8.6 p.p. up to 17.5% in organic terms (+16.0% reported).

In addition, Telefónica continues to advance its deleveraging strategy.
Net debt stood at 48,487 million euros at the end of June and
experienced a reduction of 3,706 million euros y-o-y, or a 4,981
million euros reduction considering the closing of the sale of Telxius
.
In the quarter, debt reduction is of 279 million euros compared to
March, thanks to free cash flow generation (€1,021m) and the lower value
in euros of the net debt in foreign currencies (€648m). In January-June
2017, free cash flow totalled €1,620m, doubling y-o-y, despite
the seasonality associated with working capital.

During the first half of 2017, Telefónica's financing activity
amounted to approximately €6,884m equivalent and continue focused on
strengthening the liquidity position, and refinancing and extending debt
maturities (in an environment of very low rates). Therefore, as of the
end of June, the Group maintained a comfortable liquidity position,
covering debt maturities for around the next 2 years. The average debt
life stood at 7.82 years.

Definitions: Organic
Growth: Assumes constant exchange rates from 2016, excludes the impact
of hyperinflationary adjustments in Venezuela in both years and
considers a constant perimeter of consolidation. In OIBDA and OI terms,
excludes write-downs, capital gains/losses from the sale of companies,
sale of towers, restructuring costs and material non-recurring impacts.
CapEx also excludes investment in spectrum. Underlying Growth: Reported
figures excluding the impact of write-downs, capital gains/losses from
the sale of companies, tower sales, restructuring costs and material
non-recurring impacts, as well as depreciation and amortisation charges
from purchase price allocation processes.

Separately, given the absence of official exchange rates representative
of the economic situation in Venezuela, the Company has considered the
need to estimate a synthetic exchange rate that matches the progression
of inflation to reflect the economic and financial position of the
Group's subsidiaries in Venezuela in a more accurate way. This rate has
been fixed at 3,547 VEF/USD at the end of June 2017, affecting the
January-June 2017 results reported by the Company. This new exchange
rate reversed the positive contribution of exchange rates in the first
quarter, which became negative in the second quarter, detracting 0.8
p.p. and 1.3 p.p. to the y-o-y growth of revenues and OIBDA
respectively. Excluding Venezuela, the contribution would have been
positive (+1.5 p.p. in revenues and +1.8 p.p. in OIBDA in the quarter)
on the back of the appreciation of most Latin American currencies vs.
the euro, particularly the Brazilian real.

Results by geographies:
(y-o-y changes in organic terms)

Telefonica España. In the second quarter of 2017 T. Espana's
results showed a sequential improvement in revenue performance. This
evolution was driven by higher commercial activity, with churn reduction
in virtually all services, which reflects the sustainability of the
Company's value strategy. Quarterly service revenues improved their
year-on-year performance compared with the previous quarter and
decreased by 0.8%; this growth would have been positive (+0.2%) if the
impact of the lower revenues from wholesale TV rights of "La Liga" were
excluded; an impact that will be neutralised from August.

Revenues in the second quarter reached to €3,160m (Q2: -1.9%
year-on-year; Q1: -2.6%) and improved compared with the previous quarter
(+0.6 p.p.), thanks to the better service revenue performance (Q2:
-0.8%; Q1:-1.5%; +0.8 percentage points compared with the first quarter)
and despite a higher decline in handset sales (-31.8%, -1.9 p.p.). Total
revenues (€6,226m) and service revenues (€6,062m) in the semester
declined 2.3% and 1.1% respectively.

OIBDA in April-June rose to €1,282m, which is 1.5% less than the same
period a year ago (Q2:-2.4%), driving a sequential improvement of 0.9
percentage points explained by the better revenue performance and cost
containment. The OIBDA margin stood at 40.6% (+0.8 p.p. q-o-q, +0.2 p.p.
y-o-y). In the first half of the year, OIBDA stood at €2,425m with a
1.9% year-on-year reduction. CapEx in the semester rose to €704m (-20.6%
y-o-y) and operating cash flow grew soundly to €1,720m (+8.0% y-o-y).

Telefonica Deutschland. In a dynamic market increasingly focused
on larger data buckets, Telefónica Deutschland maintained solid momentum
in the second quarter, leveraging on "O2 Free" and the 15 year
anniversary promotions of the O2 brand.

In the second quarter, revenues reached €1,771m and improved their y-o-y
trend to -3.4% (-4.1% to €3,542m in the first half). OIBDA reached €461m
and its y-o-y growth rate accelerated to 3.8% in the quarter (€861m in
January-June; +2.7% y-o-y) as incremental synergies of €40m offset the
negative effect from regulation as well as continued investments into
the positioning of the O2 brand. OIBDA margin was 26.1% and expanded 1.9
p.p. y-o-y.

In the first half of 2017 CapEx totalled €435m (+1.3% y-o-y),
benefitting from incremental synergy related savings of €20m while
Telefónica Deutschland pushed ahead with network integration and further
rollout of the LTE network. Operating cash flow (OIBDA-CapEx) totalled
€426m in January-June 2017; up 4% y-o-y.

Telefonica UK. Telefónica UK delivered a robust financial
performance in a competitive market, demonstrating the success of its
customer-led, mobile-first strategy, with yet another quarter of revenue
and OIBDA growth built on its market-leading customer loyalty.

Revenues continued to grow this quarter, up 2.6% y-o-y to €1,607m (+2.3%
in the first half, €3,208m), building on the 2.1% growth seen in the
first quarter, on better trends in both mobile service and other
revenues. The robust revenue and expenses performance resulted in OIBDA
growing by 3.9% y-o-y to €433m in April-June (vs. +0.6% in the first
quarter; €849m, +2.2% in January-June), while OIBDA margin stood at
27.0% in the quarter, up 0.3 p.p. y-o-y, and was flat y-o-y in the six
months to June (26.5%).

CapEx amounted to €434m in January-June, up 15.4% y-o-y, as Telefónica
UK continued to invest in the rollout of LTE. Thus, operating cash flow
(OIBDA-CapEx) decreased by 8.7% y-o-y to reach €415m in the first half.

Telefonica Brasil. In the second quarter of 2017, Telefónica
Brasil continued to show an acceleration in revenue growth that, coupled
with a reduction in operating expenses for the sixth consecutive
quarter, allowed to maintain solid growth in OIBDA and operating cash
flow, in a context of expanding margins. This performance was achieved
in spite of the regulatory impacts (-45.6% in mobile interconnection
rates, -17.7% in fixed-mobile retail, -35.3% in fixed local and -50.9%
in fixed inter-urban, since 25 February 2017).

Revenues in the second quarter (€3,028m) grew 1.8% y-o-y (+1.7% in the
half year) despite the regulatory effects (impact of -1.8 p.p. in y-o-y
change for the second quarter; -2.0 p.p. for January-June) and lower
handset sales (-0.4 p.p. in y-o-y change for the quarter and for the
half year). Thus, OIBDA totalled €1,034m in the second quarter (+7.0%
y-o-y; +7.2% in the half year) and OIBDA margin stood at 34.1% in the
quarter and at 34.5% in the first six months (+1.7 p.p. and +1.8 p.p.
y-o-y respectively).

CapEx for January-June 2017 (€915m; -3.6% y-o-y) was primarily allocated
to the expansion of the 4G and fibre networks. As a result, operating
cash flow (OIBDA-CapEx) amounted to €1,223m in the first half (+17.0%
compared to January-June 2016). In the first half of the year, synergies
due to the purchase of GVT had a positive impact in operating cash flow
of €286m (€833m in the last two years).

Telefonica Hispanoamérica. In the second quarter of the year,
Telefónica Hispanoamérica recorded strong year-on-year growth in
revenue, OIBDA and operating cash flow both in organic and reported
terms, despite the change in the Venezuelan exchange rate to a synthetic
conversion rate of 3.547 bolivars fuertes per US dollar.

Revenues in the second quarter (€3,134m) were up 15.5% y-o-y (+12.3% in
January-June), posting robust acceleration (+9.2% in the first quarter),
with a positive contribution from mobile service revenues (+18.2% y-o-y;
+10.6% y-o-y in January-March) and fixed (+5.7%; +4.1% y-o-y in the
first quarter). In reported terms, revenues increased by 5.9% (+6.7% in
January-June). OIBDA reached €892m in the quarter and accelerated its
y-o-y growth up to 20.9% (+6.2% in the first quarter; +13.5% in the
first half) with the notable positive contributions from Argentina,
Mexico and Colombia. In reported terms, OIBDA increased 6.9% (+5.7% in
the first six months of the year to €1,796m). Thus, OIBDA margin stood
at 28.5% for the six-month period (+1.3 p.p. y-o-y) and 28.0% in the
half year (+0.3 p.p. y-o-y).

CapEx amounted to €923m in January-June, decreasing by 6.2% y-o-y, and
was mainly aimed at improving the network, with the deployment of 4G and
fibre optic networks, as well as the simplification and digitalisation
of processes and systems. Thus, operating cash flow (OIBDA-CapEx)
amounted to €873m in the first six months with a year-on-year growth of
43.2% (+28.2% in the reported terms).

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