The impact of the economic crisis on the Spanish telecommunication sector: main challenges and opportunities

1. The impact of the economic crisis on the Spanish telecommunication sector: main challenges and opportunities ENTER-NEREC Javier Borrachero, CFA Madrid +34 91 789 8872 javier.borrachero@spain.ing.com June 2009

2. The impact of the crisis on the sector Resilient but not immune • Investors have been debating for a while about the sector defensive characteristics • Initialy investors expected a limited exposure to the economic cycle • Low level of discretionary consumption (3% of households budget) • Solid numbers reported up until 4Q08: solid free caash flow generation, resilient top-line, cost cutting initiatives • 2008 guidance met • No sign of financial distress (with a few exceptions) • Sector relative outperformance in 2008 • But the sector has showed it is not inmune • Telecoms is a late-cycle: economic weakness has emerged later on the cycle • Growth areas have not materialise as expected in a weak economic environment • Intense competition, price deflation and tough regulation remain in place • Several operators have cut 2009 guidance • Sector has underperformed in the last 6 months

3. Consumer staple or discretionary? Technological waves have boosted telecom spend • Little evidence of how telcos fare in a downturn: most value added products not tested before • Certainly in previous crisis pre-committed spend such as telecom services, housing and food (partly obliged and partly discretionary) tend to resist better • Telecom services have captured a growing share of customers wallet over 3 successive waves of technology • Fixed-line take off in the 70s • Mobile take off • Internet take off • Consumers have received more value for money compared to other necessities • According to surveys, household intend to preserve telecom services if having to reduce their overall spend

4. Areas most at risk during a downturn • Consolidation of telecom spending • Mobile more exposed than fixed, particularly pre-paid • Easier to trade-down and optimise traffic and tariffs • High impact on some VAS: roaming, ringtones, wallpapers, voice substitution (fixed or messaging) • Slow down in the take up of new services that require handset upgrades • Significant impact on the low end users (i.e. immigrants) • Internet and fixed telephony are more stable with non variable monthly subscriptions • Line disconnection limited to home foreclosures (USA) or company closures (Spain) • Some migration from fixed to mobile broadband • Slow down in triple play growth • Enterprise. Lower consumption, company insolvencies • IT-related services shows mixed results: overall market contraction but telecoms have gained market share from a low starting point

5. Cashflow sustainability Telecoms seek cash flow protection • Under the new scenario, telecom managements want to preserve cash flow, continue to de-leverage and maintain DPS • Adjusted EqFCF for the sector decreased from 2005 to 2007 but stabilised in 2008 • Capex discipline (and absence of M&A activity) are essential for cash flow preservation and financial soundness • Most incumbents have guided to lower 2009 capex figures European telecoms operators - Adjusted equity free cash flow* (€bn) * Adj EqFCF for stocks covered, excluding non-recurring items and spectrum purchases, constant currency

6. Capex discipline Fibre investment might be the wild card • As the correlation of telecom expenditure and private consumption becomes more evident, telecom companies also become more capex-conscious • Volume fall amid price deflation • Cost rigidity becomes an issue • Capex is the lever to pull • Capex prioritization • Spectrum costs and next generation network investments • However, companies have some room to manoeuvre • TEF says 2008 capex is peak, 75% of capex is transformation and growth, only 25% maintenance • FTE says 35%-50% of capex is for growth projects • PT says in previous crisis domestic capex was cut to 8% of sales Capex guidance TEF: capex 2008 €8.4bn, 2009 <€7.5bn (excluding spectrum auctions). Close to 50% in Latam Telecom Italia (domestic): 2008 €3.5bn (15.2% capex/sales), 2009 €3.3bn, 2010 €13.0-13.5% capex/sales. FTE: 2008 12.8% capex/sales, guidance 2009 12%-13% but has indicated it may go below 12% if market deteriorates. FTTH budget already delayed

7. Mobile spectrum costs Investment needed in 2009-10F • Companies might be more interested in gaining additional mobile spectrum than in fibre investment • Mobile broadband growth is outpacing fixed broadband • Mobile spectrum is a scarce resource and a more clear competitive edge • Spectrum auctions in Western Europe could cost the industry €16.7bn by end 2010 Spectrum costs are a downside risk for the telecoms sector as these costs are not fully reflected in consensus and management estimates See report Mobile spectrum auctions, published 16 Oct 2008

8. Fibre at its infancy in Europe • Fibre economic model not yet proved • No clear killer application • Unpredictable economic turnaround • Lack of competing infrastructures due to funding issues (cable) • Higher cost of funding, limited access to new credit • Lack of total regulatory clarity surrounding fibre roll-out industry • Access to third parties, regulatory holidays, wholesale offers, ducts, network sharing, in-house wiring • Network or functional separation remains an issue for incumbents • Some recent measures taken by regulators could favour incumbents fibre roll-out: • Geographical segmentation (Portugal, UK) • NGN towards infrastructure-based model (NL, Spain, Germany) • Competitors’ ADSL assets risk being stranded • Regulated returns: increases in ULL and wholesale prices (BT, TI) • Incipient fibre roll-out • France is the most advance due to the existence of three strong players and political/regulatory support. However, all three existing players have scaled back fibre capex • Most other operators are deploying VDSL or have not yet started with fibre commercial offers • In some countries capex is backed by public funding (Sweden, Australia, Italy, Portugal, Germany, UK)

9. The Spanish situation: low visibility • The economic situation is hitting Spain more than the rest of Europe • Telecom expenditure is more linked to private consumption (employment) than to other GDP components • Higher level of company destruction (particulary SoHo, SME) • Real Estate crash affecting new lines growth (and second home disconnections) • Competition becoming more intense • Lower economic visibility than in the rest of Europe • 1Q09 numbers severely hit by the slowdown • TEF Spain 1Q09 rev -6% adjusted, sector mobile -7.2% • 1Q08 sequential decline in pay-TV subs (Digital+ -34K, Imageneo -7.6K, ONO -23K) • Limited room for further headcount reduction? • Improvements in the regulatory framework but unexpected new threats looming ahead • CMT has already laid out key regulatory aspects • New tax on sales to fund private TV (0.9% on sales, circa €200m) on top of other levies (USO, spectrum costs) • No commercial offer yet • TEF: limited offer, no mass-market launch (Trio Futura, 30MB, HD-TV, DVR) • Orange: trials in Barcelona • Jazztel: no official plan yet • ONO: large capex cut to reduce leverage

10. The Spanish situation: a gloomy conclusion? • Jean Marc Vignolles CEO Orange España (Cinco Dias, 1 junio 2009) “De momento los numeros no salen. No estamos en una situacion que nos permita tomar una decision de despliegue masivo en redes de fibra…para nosotros el proyecto prioritario y mas ambicioso es el que tenemos en movil con Vodafone para el uso comun de redes 3G. De momento la fibra no es el tema numero uno en comparticion”