General rules

The Polish telecommunications market is subject to sector regulation established at EU level and transposed to national legislation. It is supervised by the National Regulatory Authority - the Office of Electronic Communications (UKE). As a general rule the telecom market is divided into separate markets of wholesale and retail services (so-called “relevant markets”). UKE analyses the level of competition within each of these markets and, based on this analysis, decides on the necessary level of regulations. As a former incumbent operator on the fixed services market, Orange Polska is designated an entity with significant market power and is subject to regulations in certain market segments. As such, this regulatory regime has significant impact on some of the services we provide. On the mobile market, regulations are equal for Orange Polska and other big market players. Our activities are also subject to supervision by the Office of Competition and Consumer Protection (UOKiK).

Core regulations

We consider the following regulations to be the most important for our business at the moment:

• Regulation of wholesale broadband services (so-called BSA) and physical access to last mile infrastructure (LLU) belonging to Orange Polska, including ducts, is mandatory in all areas of the country under cost orientation obligations and non-discrimination requirements, and covers both fibre and copper lines. BSA to Orange Polska fibre and copper infrastructure is not mandatory in the 76 municipalities which are deregulated. In the rest of the country, Orange Polska is obliged to provide BSA based on non-discriminatory conditions and prices based on costs (verified by Margin Squeeze/Price Squeeze tests).
• Regulation of call termination services in fixed network – Orange Polska is not the only operator subject to this regulation but its regulation is the most restrictive in terms of termination rate and wholesale access conditions. Additionally, the fixed termination rates applied to Orange Polska and other operators are asymmetrical.
• Regulation of retail and wholesale access markets for fixed telephony, including wholesale line rental (WLR) – Orange Polska is the only operator which is regulated in terms of retail and wholesale access fees (call services are already deregulated). These regulations can limit price flexibility in retail offer creation.
• European regulations regarding roaming prices in the European Union – Since 15 June 2017 retail prices for roaming services are equal to domestic retail prices. Operators are protected against abusive use of roaming through the “fair use” policy. As roaming price regulations have a negative impact on both revenue and profitability, Orange Polska applied to UKE for the right to use surcharge mechanisms for customers who abuse Roam Like at Home rules.

Obviously as a business entity we must also comply with administrative decisions and general law and regulations. Recently the legal environment has been changing dynamically. Further amendments to telecom rules are pending both at European and national level.

Recent trends in regulatory environment

The regulatory regime over the past few years has been evolving toward a policy of balanced intervention. This is mainly related to changes in the structure of the overall telecom market in Poland and a much higher degree of competition in particular segments (e.g. emergence of cable operators as important players in retail fixed broadband).

For example, UKE is currently working on solutions that will guarantee symmetrical access to cable and building infrastructure. Regulatory obligations are expected to be imposed not only on telecommunication operators but also on CATV operators, especially the largest ones.

At the same time UKE more often supports regulatory policy that favours an investment environment, moving from ex-ante regulations to ex-post verification, if a competitive environment already exists. We expect the next major development in the regulatory framework to be a change in Fixed Termination Rate (FTR) calculation. UKE is working on a new FTR costing model in line with the European Commission’s recommendation. When it is implemented, it will have a material negative impact on Orange Polska’s revenue.

Changes in the Polish economy, such as GDP growth, inflation, unemployment, disposable income, interest rates or foreign exchange rates, can influence our ability to create value. Whilst these areas are outside of our direct control, we can use our hedging strategies to mitigate the potential adverse impact of market movements. Poland’s economic situation improved in 2017 and according to economic forecasts solid growth should be maintained in the years ahead.

GDP growth

In 2017, the Polish economy grew at a considerably faster pace than in 2016. Real GDP grew by 4.6%. The positive economic conditions resulted mainly from growth in private consumption supported by rebound in investments and exports. These growth engines will face difficult challenges in subsequent years, mainly due to labour shortages and wage pressure. In 2017, household consumption expenditure remained under strong inflationary pressure, but was stimulated by falling unemployment, growing wages, ‘500+’ welfare programme and low interest rates. Poland’s economic outlook depends also on the condition of other European economies and the economic climate in global markets. According to Bloomberg’s consensus forecast, Poland’s GDP is expected to grow 3.6% both in 2018 and in 2019.

Inflation

Average annual CPI reached 2.0% in 2017, which was below the inflation target (2.5%). Throughout the year there was a rise in prices in all main segments of goods and services except clothing and footwear, with food prices growing the most. Despite growing inflationary pressure, throughout the year the Monetary Policy Council kept the reference interest rate at the record low of 1.5% (set in March 2015), upholding an opinion that the current stable economic growth limited the risk of inflation remaining below the target in the medium term.

Compared with other branches of the economy, the telecommunications sector reported declining profitability in 2017, which was a result of a decrease in effective prices accompanied by significant capital expenditures required to upgrade obsolete infrastructure in line with the growing expectations of customers and ensure service availability in the areas of coverage gaps.

Unemployment and labour costs

The labour market has been positively affected by the general macroeconomic climate, which was reflected in an increase in employment and a decrease in unemployment to 6.7% (-1.6 pp. year-on-year) at the end of 2017. At the same time, an increase in wages in the enterprise sector was reported. Between January and December 2017, these wages were up 5.9% in nominal terms. A further decline in unemployment may be expected in 2018. However, as it will be approaching the natural rate of 5%, the existing problems with labour shortage and growing labour costs due to wage pressure may intensify. This in turn may negatively affect the mood in some parts of the enterprise sector and constitute a barrier to economic growth by limiting investments.

Interest rates

2017 did not bring any changes in the Central Bank’s policy, and interest rates remained stable at a historically low level. The Monetary Policy Council is expected to keep interest rates unchanged in 2018, while taking steps to prepare the market for increases in 2019. However, a potential increase in interest rates should not have any major influence on the debt service costs of the Group, as it maintains a high hedging ratio.

Foreign exchange rates

Foreign exchange rate fluctuations affect Orange Polska’s liabilities denominated in foreign currencies and settlements with foreign operators. However, this influence is greatly contained by a portfolio of hedging instruments held by Orange Polska. In 2017, Polish zloty gained 4.9% against the Euro and 19.7% against the US dollar. The Polish currency fluctuations were caused by both internal and external factors. The funds buying T-bonds and recognising our country’s good economic perspectives returned to Poland. Low volatility worked well for the local currency. Any potential depreciation of Polish zloty should not have in medium term major influence on Orange Polska’s liabilities denominated in foreign currencies or settlements with foreign operators owing to a high hedging ratio.

The Polish telecom market is characterised by high levels of competition and relative fragmentation. It is mainly driven by mobile services and a high degree of fixed-to-mobile substitution in both voice and broadband. These factors have had a critical impact on the overall performance of the market in the past. Taking into account the favourable economic situation in Poland, the very low prices of telecom services and more equal market shares among major players, we believe there are grounds to expect market participants to focus increasingly on value generation. This would create a more benign market situation going forward.

Polish telecom market – still declining but the trend is improving

According to our estimates, between 2012 and 2017 the total value of the telecom market was declining at a pace of around 1-2% per year. However, the trend has been gradually improving through this period which may suggest more stability going forward. The key factors that have influenced market performance in recent years include:

• The very high level of price competition in mobile services, exacerbated by several price wars in both B2C and B2B segments. The key disruptor was Play, a latecomer to the market, which by the end of 2012 was taking advantage of MTR asymmetry and pursued an aggressive strategy to gain market share.
• The structural decline of fixed voice services which was influenced mainly by 1/ very fast proliferation of affordable mobile services, 2/ partial regulation of this segment, 3/ unfavourable demographic trends.
• Weak fixed broadband infrastructure, especially outside of big cities, which in combination with the rapid development of mobile services and strategies of mobile-only market players resulted in partial fixed-to-mobile substitution. Penetration of mobile broadband positioned as home internet access is much higher in Poland versus the EU average.
• Pay-TV market being negatively affected by development of strong free digital terrestrial television.

These trends have had a greater effect on Orange Polska than on the overall market, and this has been reflected in falling revenue.

This was mainly due to:

• The need to adjust to high price competition in mobile to defend market shares in both B2C and B2B segments.
• Very significant exposure to fixed voice, as an incumbent operator.
• Underperforming the overall market in fixed broadband due to regulations and weak infrastructure in big cities, resulting in the loss of market share to cable operators.
• No significant exposure to pay-TV market.

Expected future market trends

We expect the following key trends to drive the market in the years ahead:

• It is arguable that we should expect a more benign situation on the mobile market going forward. Unlimited all-net voice tariffs have become a market standard and the price of services has fallen to one of the lowest levels in the EU. In addition the market shares of the four main players have more or less equalised. Over the past 12 months, operators have revised their tariff plans to encourage customers to migrate to higher price points in return for more attractive features (e.g. music or TV content). This suggests to us that the market is increasingly focused on a “more for more” approach and value generation. This is certainly the case for Orange Polska. However, the market is still very competitive, as are smartphone prices, and recovery so far has been rather slow. Operators increasingly compete for household incomes by offering very favourable rates for incremental services.
• Data consumption should experience a further surge, spurred by the proliferation of mobile devices and very fast growth of data per customer. We foresee that data consumption will continue to grow at the current pace at least for the next few years while the smartphone revolution continues in Poland.
• Significant investments in high-speed broadband infrastructure will continue, from Orange Polska but also other market players as well the government POPC programme. Better infrastructure combined with growing data needs will drive the migration towards high-speed internet. Taking into account the economics of fibre network rollout as well as all network investment plans announced publicly so far (including Orange Polska and governmental POPC programme), we estimate that in the mid-term the number of households within reach of the fibre network in Poland may exceed 7 million, compared to around 4.1 million at the end of 2017.
• Convergence is increasingly recognised as the household business-winning formula. This is evidenced by the success of our Orange Love offer, the pending acquisition of Netia by Cyfrowy Polsat Group, and T-Mobile’s intention to buy wholesale access to our fibre network.
• Fixed voice will further decline, but as time goes on this has less and less impact on the overall market performance.
• The pay-TV market should remain relatively stable. Poland still has very strong linear TV. Of course OTT content is growing fast, but it should remain an add-on to linear TV, rather than a significant substitution factor.
• We expect the gradual adoption of eSIMs on the market, starting with wearables, but we see limited impact on the smartphone market by 2020.
• The trend towards digitalisation plays an increasingly important role in all spheres of people’s lives, and mobile services are no exception. The widespread adoption of digital solutions such as app-only services, mobile shopping experience or customer care via an in-app chat or bots, will create a totally new level of operator- -customer interaction.

On the other hand, we will be under further pressure from negative trends in legacy services and old technologies in fixed broadband. More details on our strategy are presented in the strategy section

Orange Polska: a key market player in all market segments

The Polish telecom market is fragmented, both in mobile and fixed segments. So far, consolidation is rather slow and for the most part only taking place in fixed; however, the market seems to be trending towards mobile-fixed combinations. Over the past five years the most notable transaction was the acquisition of the mobile operators Polkomtel by media group Cyfrowy Polsat in 2013. This created a media-telecom group focused mainly on bundling pay-TV and mobile services.

In December 2017 Cyfrowy Polsat announced the acquisition of Netia, the largest alternative fixed operator. This transaction is also pending approval from the Office for Competition and Consumer Protection. According to Cyfrowy Polsat, acquisition of Netia allows Cyfrowy Polsat, among others, to gain access to complementary broadband technology and to enter the new market of large Polish cities. If finalised, the transaction may bring increased competition in the convergence area. However we can also expect that increased marketing of convergence by a larger number of players will greatly increase its appeal as a market category, boosting demand for this service category.

In the fourth quarter of 2016, UPC (the number one cable operator) announced the acquisition of Multimedia Polska (the number three operator). This was supposed to be a major in-market consolidation transaction in the cable industry. However, in March 2018 UPC withdrew its application for this acquisition from the Office for Competition and Consumer Protection. In the opinion of that body, the merger of these cable networks might have created a player with a dominant position in 11 local markets for broadband internet and pay-TV. According to the media, acceptance of the transaction by the regulator was most likely conditional on UPC’s withdrawal from other assets on these markets, and this would force modification of the conditions for the acquisition of Multimedia. UPC’s owner did not manage to reach an agreement with the sellers as to the terms of the transaction which would take into consideration these new conditions.

Orange Polska is the largest player present in all segments of the market, the value leader in the mobile market, as well as the volume and value leader in fixed broadband and fixed voice.

Note: market view as of March 2018

The standard of living and the employment rate in Poland have moved significantly closer to the EU average, but there are still a number of difficulties. Despite considerable successes, Poland’s rate of employment at 69.5% is still lower than the EU average.

The rate of unemployment has continued to fall, reaching 6.9% in January 2018. However, Poland is still facing the problems of rapid ageing of its population and high emigration. The unfavourable demographic trends are already reflected in a decline in the working-age population. The percentage of elderly people in the entire population is expected to grow from 20.9% in 2010 to 58% in 2050, according to the European Commission’s Country Report Poland 2016.

Much progress has recently been made in addressing inequality and poverty. The number of individuals affected by poverty or social exclusion has steadily decreased since 2008.

Digital exclusion is one of the factors leading to social exclusion. Internet access is nowadays not only a convenience, but often a precondition of full participation in social, cultural and professional life. According to the Central Statistical Office (in Polish Główny Urząd Statystyczny - GUS), 81.9% of Polish households had access to the internet (and 78% had a broadband connection) in 2017.

According to the report “Information society in Poland in 2017”, the key barrier to broader internet use is lack of motivation (67.6%) as well as lack of the relevant skills (54.2%). Financial barriers are indicated as the reason for lack of internet access by about 18.7% of households, while lack of technical opportunities at the place of residence is cited by just 0.7%. We can thus surmise that hard barriers (financial or infrastructure-related) have decreased in importance.

The use of the internet and modern technologies varies with social and demographic factors, especially age and education. The internet is used by a great majority of young people and very few seniors. Internet use is also correlated to wealth and size of town, though the role of these factors has been declining.

The average monthly disposable income per capita amounted to PLN 1,598 in 2017 (Central Statistical Office data), which is an increase of PLN 123 versus 2016. It corresponds to approximately 70% of the average for all EU member states and 66% of the average for the Eurozone. The Central Statistical Office stressed the importance of the ‘Family 500+’ programme in its report. On average, this benefit accounted for 16.8% of household disposable income per capita in 2016. In addition, there is a disparity in income depending on urban/rural residence and the industrialisation of the region.

A major issue for the growth of our business is a generational change, which affects both the customer market and the labour market. Each generation has different values and needs and a different attitude towards new technologies. Baby Boomers (1943–1964) have a very distanced attitude to new technologies. They cope very well without modern solutions, which they accept out of necessity rather than choice. For Generation X (1965–1979), the emergence of new technologies was a landmark experience, and they became a means to improve effectiveness and increase productivity. Members of Generation Y (1980–1996) do not remember working without the Internet or mobile phones. For them, new technologies are obvious and natural. For Generation Z (1997–2003), the online world is as tangible as the real one; 97% of them use the internet, 92% use social media and 80% use electronic banking services.

Environmental

Orange Polska is sensitive to global challenges related to the natural environment and natural resources. As a provider of telecommunication services we can significantly contribute to reducing the negative impact of business on the environment, so we incorporate initiatives to raise environmental awareness and respect for the environment into our business activities. Within our environmental protection policy we ensure compliance of our operations with the law and other regulations regarding ecology.

We promote environmentally friendly solutions, which help to reduce greenhouse gas emissions through offering services that can replace traditional communications or written documents. Thanks to tele- and video-conferences, electronic document flow, online shopping, e-services, e-invoices and comprehensive ICT systems for business and administration, we make environmental protection part of everyday life. Thanks to monthly sending of electronic invoices to 5 million of our clients, we saved almost 750 tonnes of paper in 2017 and saved 17,000 trees (34 hectares of forest), and we used 55 tonnes less paper and 4 million fewer envelopes than in 2016. Our business activities influence the natural environment through generation of industrial waste such as electronic and electrical equipment, batteries and storage cells, cables and telegraph poles. The disposal of these items is closely controlled.