management's discussion & analysis
9. looking forward to 2006
A discussion of the outlook for 2006 and TELUS’ 2006 financial and operational targets, including key assumptions and financing plans
The following discussion is qualified in its entirety by the Forward-looking statements at the beginning of Management’s discussion and analysis, and Section 10. Risks and risk management.
9.1 General outlook
In 2005, the telecommunications market displayed general trends similar to recent years. The wireless sector continued to drive growth and equity values, while the wireline sector remained soft with some recovery in data revenues. Canadian telecommunications operators continued to follow strategies focused on core operations and maintenance of cash flow, including efficiency measures and the integration of past consolidating acquisitions.
The Canadian telecom industry, including wireline and wireless, generated estimated revenues of approximately $35.5 billion in 2005, with Bell Canada and its affiliated regional telecommunications companies representing about 48% of the total. As the second largest full-service telecommunications provider in Canada, TELUS generated $8.1 billion in 2005, or about 23% of the total.
Revenue growth in the Canadian telecom market in 2005 was approximately 3%, similar to that experienced in 2004 and roughly in line with overall gross domestic product (GDP) growth. Wireless continued to be the growth engine for the sector with wireless revenues growing approximately 16% over 2004. Offsetting wireless growth was continued general industry weakness in wireline voice with declining long distance and legacy data revenues, partially offset by growth in enhanced data services. With a focus over the past five years on wireless, data and IP, TELUS outpaced the industry average in 2005 with 7% consolidated revenue growth. Similar growth rates for both TELUS and the industry are expected in 2006.
The competitive environment in 2006 is likely to be influenced by past industry consolidations. In May, Rogers Communications acquired Call-Net and gained access to Call-Net’s residential and small business customer base and CLEC (competitive local exchange carrier) network, potential operational synergies and cost savings, as well as access to significant tax losses. Combined with the acquisition of Microcell in 2004, this enhanced Rogers’ national competitive position across a number of business and consumer segments. Transactions completed in 2004 – including Manitoba Telecom Services’ acquisition of Allstream, primarily a national long distance and legacy data provider, and BCE’s acquisition of the assets of 360networks – continue to have some impact on the competitive telecom landscape.
With margins and growth rates in legacy voice and data services trending downward, ILECs (incumbent local exchange carriers) are continuing to focus on enhanced operating efficiencies. Indeed, most of the major ILECs have signaled their intent to invest in restructuring wireline operations to improve efficiencies in 2006. At TELUS, this has been an ongoing priority for four years.
New service offerings are expected to play an important role in shaping the competitive landscape in 2006. In February 2005, Shaw Communications launched VoIP-based local telephony service in Calgary, and subsequently expanded it to other major centres in Alberta, B.C. and Manitoba. Other cable-TV operators, including Videotron, Cogeco and Rogers, have all launched comparable services in Eastern Canada during 2005. Bell Canada responded with a VoIP offer.
Capital markets and investors are expected to watch closely how operators are going to protect revenues and margins, and fend off competitive threats with new and existing services as well as efficiency enhancements. At the same time, they will be looking for growth in wireless and data to generate continued operating earnings and cash flow growth.
Wireless
The wireless industry continues to experience robust growth with year-over-year industry revenue and EBITDA growth of approximately 16% and 22%, respectively. Capital expenditure levels have generally stabilized as carriers leveraged previous investments and took a disciplined approach to third generation (3G) network upgrades, resulting in substantial industry cash flow improvement.
Wireless penetration in Canada increased to approximately 52% of the population in 2005. Approximately 1.8 million new subscribers were added in Canada during 2005, representing a penetration gain of approximately five percentage points, a third consecutive year of accelerated subscriber growth. There remains considerable growth potential for the Canadian industry as subscriber growth is expected to continue at a healthy pace towards penetration rates seen in other developed countries such as the U.S. (currently estimated at more than 70%).
Industry revenues from wireless data have been growing exponentially in recent years, and are expected to continue to gain traction with both the higher penetration of existing data services (such as text messaging, picture messaging, gaming, ringtones and Canada-U.S./international data roaming) and the introduction of new services (such as mobile TV, video messaging, java games and music on demand).
New devices such as BlackBerry devices, PDAs and new high-speed EVDO network cards are expected to drive continued growth in the business segment. Data growth is expected to help offset voice revenue pressures or lower monthly revenues from new lower usage customers.
Both of TELUS’ major national wireless competitors are pursuing wireless resale, or MVNO (mobile virtual network operator), partnership opportunities. In March 2005, Virgin Mobile launched prepaid consumer wireless service in several of Canada’s largest cities. Virgin Mobile Canada, a joint venture between Virgin Mobile and Bell Mobility, uses Bell’s network for the provisioning of wireless resale services. Virgin’s strategy focuses on offering prepaid products and services at discounted prices to the youth segment. Other MVNO wireless resale agreements have been announced including one by a well-known food retailer. Though the MVNO market share is currently small in Canada, this activity can create enhanced awareness and broaden distribution in certain wireless market segments.
While wireless industry operating fundamentals remain healthy in Canada, dynamic competition is expected to continue in 2006. There is likely to be continued focus on the price-sensitive prepaid market and pricing pressures may arise from other new MVNO entrants. Additionally, both of TELUS’ major competitors have continued to promote discount brands in the marketplace.
The wireless sector continues to pursue an industry-wide approach toward implementing wireless local number portability (WLNP) on an expedited timeframe by March 2007, as mandated by the federal government and Canadian Radio-television and Telecommunications Commission (CRTC) in 2005. WLNP may increase competitive intensity in the wireless industry, due to the removal of a key barrier to switching from one carrier to another.
Wireline
In contrast to the robust predictions for the wireless sector, expectations for the more mature wireline segment are modest.
Consumer residential access line growth is expected to continue to be impacted by the migration to wireless service, decreases in second lines, and substitution to cable telephony and other VoIP services. The market for long distance is also expected to continue declining, as VoIP providers promote aggressively priced voice packages to entice customers to switch providers.
In past years, non-facilities-based VoIP service providers (such as Vonage, Skype and Primus) had modest success with local telephony, although concerns remained over reliability and safety issues due to provision over public Internet versus the more reliable, circuit-switched telephony. However, Canadian cable-TV companies with their own facilities and distribution channels are expected to be more formidable competitors. It is estimated that the four cable companies captured more than 300,000 local telephony subscribers in 2005.
Competition for the residential customer is expected to increasingly focus on the best integrated offerings of voice, Internet, TV/video and wireless that deliver reliability, enhanced functionality and convenience along with good customer service. In November 2005, TELUS commercially launched TELUS TV in Edmonton and Calgary, with plans to launch in other urban centres of British Columbia and Alberta. TELUS’ goal is to achieve competitive differentiation compared to its cable competitor by being able to offer a larger quadruple-play range of services – wireline local and long distance, wireless, high-speed Internet and TV. The roll-out of video entertainment services gives TELUS the opportunity to grow wallet share with retail customers, while enhancing customer loyalty and retention due to customers using multiple services.
The business market continued to show signs of growth as evidenced by data revenue growth in 2005. While voice and legacy data services are expected to continue declining, growth in enhanced data service revenues is expected to at least partially offset the trend, as the adoption of data services increases, and as small and medium-sized business and enterprise customers look to upgrade legacy networks and equipment. The business market segment is increasingly adopting IP and managed services as a means of achieving operational efficiencies and improving revenue generation.
Telecom providers are expected to continue migrating voice and data traffic to a single IP-based platform over the next several years, providing combined IP voice, data and video solutions. It is expected that the resulting cost efficiencies will, at least in part, compensate for margin pressure anticipated from the transition from legacy to enhanced IP-based services. There will likely be an increasing effort to look at the end-to-end delivery chain and to fundamentally redesign the processes and systems associated with each element (ordering, provisioning, fulfillment, assurance, customer care, billing and collections) to improve productivity.
In May 2005, the CRTC ruled that VoIP services are to be regulated for incumbent telecommunications providers only, with the extension of all local exchange tariff obligations to all ILEC local VoIP offerings in-territory. A joint appeal made in July 2005 by TELUS, Bell Canada and other ILECs to the Federal Cabinet to reverse the CRTC’s VoIP decision is pending.
In December 2005, the CRTC announced the extension of the current price cap regime by one year to mid-2007. Although the ILECs have advocated changes to the price cap regime to allow more flexibility, the current CRTC price cap framework established in 2002, as well as other recent decisions, continue to support the CRTC’s facilities-based competition framework. Carriers are also awaiting a CRTC decision in 2006 on local forbearance signaling how long, and under what conditions, ILECs can obtain increased freedom and flexibility to compete with cable-TV and other providers of local services.
Within the CRTC’s facilities-based competition framework, TELUS’ strategic focus on delivering national business services in data and IP, and its more than 40% exposure to the fast-growing Canadian wireless market, positions the company to generate above-average consolidated growth in 2006 and beyond.
9.2 Financial and operating targets for 2006
The following targets for 2006 were announced to the public on December 16, 2005. The Company has a practice of reaffirming or adjusting annual guidance on a quarterly basis.
For the wireline segment, 2006 EBITDA is expected to be flat to a decline of $50 million, resulting from increased restructuring costs partially offset by continued operating efficiencies. Wireline revenue growth in the non-incumbent territory in Central Canada is expected to increase in the range of $18 million to $68 million in 2006, while targeting another strong increase in EBITDA.
For the wireless segment, 2006 EBITDA is expected to increase by $260 million to $310 million as a result of a 14 to 17% increase in revenues, continued economies of scale, cost containment and continued strong growth in wireless subscribers.
The 22 to 33% growth rate for earnings per share is being generated not only by higher operating profitability, but also by lower financing costs as a consequence of reduced debt levels. The significant growth in earnings per share is despite expectations for higher restructuring costs in 2006. In addition, the 2005 earnings included 18 cents of positive impacts from the settlement of prior year tax matters, which are not projected to reoccur in 2006 to the same magnitude.
Key assumptions and sensitivities for 2006 targets
For 2006 target purposes, a number of assumptions were made including:
- Economic growth consistent with recent provincial and national estimates by the Conference Board of Canada that were available in 2005, including gross domestic product growth of 3.1% in Canada
- Increased wireline competition in both business and consumer markets
- A wireless industry market penetration gain similar to the approximately five percentage point gain in 2005
- Approximately $100 million of restructuring and workforce reduction expenses ($53.9 million in 2005)
- Effective tax rate of approximately 35%
- No prospective significant acquisitions or divestitures are reflected
- No change in foreign ownership rules
- Maintenance or improvement of investment grade credit ratings.
Earnings per share, cash balances, net debt and common equity may be affected by the potential purchases of up to 24 million TELUS shares under the Normal Course Issuer Bid that was accepted by the Toronto Stock Exchange and commenced December 20, 2005. There is no assurance that these assumptions or the 2006 financial and operating targets and projections will turn out to be accurate.
9.3 Financing plan for 2006
TELUS has no significant amount of debt maturing in 2006. TELUS’ financing plan is to use free cash flow generated by its business operations in 2006 to: (i) repurchase TELUS Common Shares and Non-Voting Shares under the Normal Course Issuer Bid; (ii) pay dividends; and (iii) retain cash-on-hand for corporate purposes. The Company expects to increase and reduce the balance of proceeds from securitized receivables and use bank facilities, as needed, to meet any other cash requirements.
TELUS also expects to maintain its current position of fully hedging its foreign exchange exposure for indebtedness and generally expects to maintain a minimum of $1 billion in unutilized liquidity. At the end of 2005, almost all of TELUS’ total debt was borrowed on a fixed-rate basis.
TELUS may also consider refinancing all or a portion of its Notes due June 1, 2007 in advance of the regularly scheduled maturity date. These U.S. dollar denominated liabilities were fully hedged into Canadian dollar liabilities at the time of issue and TELUS may also terminate or restructure these swap arrangements prior to maturity. Potential sources for the refinancing of these Notes may include retained cash from operations as well as public long-term debt and short-term debt such as commercial paper. For the related risk discussion, see Section 10.7 Financing and debt requirements.