SAUDI TELECOM COMPANY

Transcription

1 SAUDI TELECOM COMPANY Moving to Broadband November 30, 2011 key data Fair Value per Share (SAR) Closing Price (SAR) * week High / Low (SAR) / YTD / 12-month Return -22.1% / -17.2% Trailing P/E 8.65 Market Cap (SAR Millions) 66,400 Shares Outstanding (Millions) 2,000 Free Float 16.40% Reuters / Bloomberg 7010.SE / STC AB *As of November 29, Sources: Zawya and NBK Capital key metrics 2010A 2011F 2012F 2013F EPS (SAR) EPS Growth -13% -18% -1% 2% P/E Dividend Yield 9% 6% 8% 8% EV/EBITDA Revenue (SAR Millions) 51,787 55,161 57,354 59,281 Revenue Growth 2% 7% 4% 3% EBITDA (SAR Millions) 19,621 20,169 20,663 21,034 EBITDA Growth -5% 3% 2% 2% EBITDA Margin 38% 37% 36% 35% Sources: Company s financial statements and NBK Capital QUARTERLY forecasts (SAR Millions) 4Q2010A 3Q2011A 4Q2011F 1Q2012F Revenue 13,444 14,015 14,190 13,597 EBITDA 5,240 5,198 5,071 4,932 Sources: Company s financial statements and NBK Capital Rebased Performance Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Sources: Reuters and NBK Capital Analysts STC Diala Hoteit T E. diala.hoteit@nbkcapital.com TASI Alok Nawani T E. alok.nawani@nbkcapital.com Highlights 12-Month Fair Value: SAR 42 Recommendation: Buy - Risk Level**: 3 Reason for Report: Re-Initiation of Coverage Re-initiating coverage. As of 1Q2011, Saudi Telecom Company (STC) started to provide a breakdown of the group revenue by operation, which we considered a good first step toward better disclosure. Therefore, we are re-initiating coverage on STC. We arrived at a 12-month fair value for STC of SAR 42 per share by using two valuation methods: a discounted cash flow (DCF) based on a sum of the parts (SOTP) and a peer comparison based on P/E and EV/EBITDA multiples. Our fair value offers an upside potential of 27% compared to the last closing price, our recommendation is Buy. STC is a well-diversified telecom operator. The company is present in 10 countries, with mobile, fixed-line, and Internet operations. Despite STC s broad geographical diversification, Saudi Arabia, generating around 67% of group revenues (9M2011), remains an extremely critical market. STC s international operations generate around 33% of group revenues, with the most notable contribution coming from Turkey. In addition, STC also maintains exposure to India, Indonesia, Malaysia, Kuwait, and Bahrain. Broadband is the new path. With voice market saturation, aggressive competition, and low blended voice average revenue per user (ARPU), STC s new strategy, across all the company s markets, is to focus on the broadband market to be able to drive growth. 9M2011 financial performance. During 9M2011, STC s revenues grew by 7% YoY, driven by healthy growth across all operations. However, operations in Saudi Arabia and those under Oger Telecom (which together accounted for 88% of group revenues) were the key drivers for group-level revenue growth, delivering 4% and 6% growth, respectively. EBITDA delivered 5% YoY growth. However, the EBITDA margin witnessed a slight contraction, which we believe is a result of strong competition in the home market. In addition, net income witnessed a sharp 25% YoY decline owing to foreign exchange losses of SAR 1 billion. Outlook. Due to strong competition in all the markets where STC operates, we believe the group revenue will grow at a compound annual growth rate (CAGR) of 3% between FY2011 and FY2016. We expect the international operation to contribute around 34% of total revenue in FY2011 and to reach 38% by FY2016. We expect EBITDA to grow at a CAGR of 2% between FY2011 and FY2016. This will lead to the EBITDA margin contracting from 36.6% in FY2011 to 34.7% in FY2016. **Please refer to page 24 for recommendations and risk ratings. nbkcapital. com

2 contents EXECUTIVE SUMMARY... 3 VALUATION... 4 SOTP DCF Valuation... 4 Sensitivity Analysis... 5 Peer Group Comparison... 5 POSITIVE CATALYST & KEY RISKS... 7 INVESTMENT RATIONALE... 8 UNDERSTANDING STC... 9 FINANCIAL PERFORMANCE REVIEW AND OUTLOOK TELECOM MARKET OVERVIEW AND OUTLOOK Saudi Arabian Mobile Market Saudi Arabian Fixed-line Market Saudi Arabian Broadband Market Turkish Mobile Market Turkish Fixed-line Market Turkish Internet Market Malaysian Mobile Market Kuwaiti Mobile Market Bahraini Mobile Market Indonesian Mobile Market Indian Mobile Market STC MAJOR SUBSIDIARIES Binariang Viva Kuwait Oger Telecom Viva Bahrain FINANCIAL STATEMENT... 23

3 Executive Summary STC is a well-diversified telecom operator. STC s international operations generate around 33% of the group revenue, with the most notable contribution coming from Turkey (we estimate the Turkish contribution is around 18%) whereby Turk Telekom maintains an effective monopoly in the fixed-line market, while Avea is the third mobile operator. In addition, STC also has exposure to India, Indonesia, and Malaysia, which are high-growth markets. The company is present in one of the largest telecom markets (in terms of number of subscribers) in the Middle East and North Africa (MENA) region. Despite the operator s broad geographical diversification, Saudi Arabia remains an extremely critical market for STC, generating around 67% of group revenues driven by STC s 40% market share of a total mobile market of 49 million subscribers. STC was established in 1998 as the sole telecommunications services provider in Saudi Arabia (subsequently had an initial public offering [IPO] in 2002). The government of Saudi Arabia is the majority stakeholder in STC with 16.4% of the company s shares listed on the Tadawul. In 2007, STC started its acquisition spree and is now a multi-national telecommunications operator with mobile operations in eight countries and fixed-line operations in three countries. Broadband is the new path. With voice market saturation, aggressive competition and relatively low blended voice ARPU, STC s new strategy, across all markets, is to focus on the broadband market to drive growth. The key positive catalysts for the stock are the following: a) Potential tower sharing between Saudi Arabian telecom operators. We believe the companies might enter into an agreement to merge their tower assets during 2012, which should result in significant CAPEX and OPEX savings. Operators may also potentially sell off a stake in the merged entity to a strategic investor, which could result in capital gains. b) Potential decrease of telecom taxes in Turkey (special tax stands at 25%; in addition to the 18% value added tax), which is curbing growth. We expect that any reduction in taxes will help companies attract more subscribers and hence improve growth. As for key risks, STC is affected by a) Currency fluctuation risk in various operations. During 3Q2011, STC had around SAR 780 million in currency losses, around 26% of the company s 3Q2011 operating income. b) Aggressive competition leading to pressure on margins in Saudi Arabia. According to STC s management, the company s strategy in Saudi Arabia is to preserve its leading market share even if it comes at the expense of margin. c) Expansion at high prices. The company is aiming to have around 50% of its total revenues from international operations in two years. d) Limited disclosure. STC started to disclose its revenue by operation only in 1Q2011. The company did not provide an EBITDA breakdown until now. We value STC at SAR 42 per share. From a valuation standpoint, using a combination of valuation methods, a DCF based on a SOTP and a peer comparison based on P/E and EV/EBITDA multiples, we believe that the 12-month fair value for the stock is SAR 42. This represents a 27% upside potential from the last closing price; hence, our recommendation is Buy. nbkcapital. com 3

4 Valuation We value STC using a combination of SOTP and peer comparison based on P/E and EV/EBITDA multiples The purpose of this valuation exercise is to use fundamental analysis to arrive at a fair value estimate for STC s share price. To arrive at this fair value, we used a combination of two valuation methods: DCF based on SOTP and a peer comparison based on P/E and EV/EBITDA multiples. However, this does not represent a guarantee that this value is achievable within our time frame, as a wide range of variables and market dynamics can ultimately affect the market price of an asset. Each investor must use his or her favorite mix of fundamental research, technical analysis, and market intelligence to arrive at an investment decision that matches his or her objectives and tolerance for risk. We arrived at a fair value for STC of SAR 42 per share by allocating a greater weight (80%) to the SOTP DCF valuation, a methodology that examines the fundamentals of the company to determine its future cash-generating ability. This fair value is 27% above STC s last price; hence, our recommendation is Buy. Figure 1 Fair Value per Share Valuation Method Value Weight Our 12-month fair value for STC is SAR 42 Discounted cash flow - SOTP SAR 44 80% Peer comparison SAR 32 20% Weighted average fair value SAR % Source: NBK Capital SOTP DCF Valuation To value STC using SOTP DCF, we separately forecasted through to 2016 the financial results for STC s main consolidated operations. Accordingly, each operation received an individual valuation that incorporated the operation s specific market dynamics. From the forecasted financial statements, we extracted free cash flows that were used in our valuation of each operation. We discounted the cash flows to the end of November 2012 (12 months from now) to obtain an estimate of the value of each of STC s operations. We assigned a separate risk rating for each operation, which resulted in each having its own unique cost of equity. In addition, we assigned different debt and equity weightings for each operation depending on our outlook for the capital structure of each operation moving forward. Our SOTP DCF model resulted in a fair value of SAR 44 for STC s share price. The per-share valuation of each operation helps shed light on the source of the value. In Figure 2, we can see that, in terms of value, Saudi Arabia remains the single most important country for STC, accounting for 86% of its enterprise value (EV); while Turkey is responsible for 8% of STC s EV. nbkcapital. com 4

5 Figure 2 Sum-of-the-Parts Valuation Saudi Arabia Turkey Malaysia Others Net Debt plus Minority Total Saudi Arabia and Turkey together represent 94% of STC s total EV DCF Value (SAR Millions) 96,643 50,040 34,989 2,424 (23,909) 160,186 Effective Ownership 100% 19.06% 17.50% Value (SAR Millions) 96,643 9,546 6, (23,909) 88,968 % of EV 86% 8% 5% 1% Per Share (SAR) (12) 44 Source: NBK Capital Sensitivity Analysis We performed a sensitivity analysis (Figure 3) on two important inputs in our SOTP DCF valuation model: the cost of equity and the perpetual growth rate used in computing the terminal value. Figure 3 Sensitivity Analysis Growth Increments Cost of Equity Increments -1.00% -0.50% Base case +0.50% +1.00% -1.00% SAR 45 SAR 43 SAR 41 SAR 39 SAR % SAR 47 SAR 45 SAR 43 SAR 41 SAR 39 Base case SAR 49 SAR 47 SAR 44 SAR 42 SAR % SAR 52 SAR 49 SAR 47 SAR 44 SAR 42 +1% SAR 55 SAR 52 SAR 49 SAR 47 SAR 44 Source: NBK Capital Peer Group Comparison We compared STC to other telecom operators with considerable operations outside the operators home countries (Figure 4). We obtained the consensus forward P/E estimates for each peer group member. The simple average P/E for the sample, excluding the highest and lowest values, was 9.1x. STC, in contrast, currently trades at a lower P/E of 8.7x, based on our 2012 forecast EPS. We also valued STC relative to the EV/2012EBITDA for the same sample. The simple average EV/2012EBITDA for the sample, excluding the highest and lowest values, was 4x. STC, in contrast, currently trades at an EV/2012EBITDA of 4.3x, based on our 2012 forecast EBITDA and net debt levels. Using a simple average of the two multiples, and excluding outliers among the companies in the sample, we estimate the value of STC share at SAR 32. This implies that STC is currently slightly overvalued, considering STC s current market price of SAR nbkcapital. com 5

6 Figure 4 Forward P/E and EV/2012EBITDA Multiples Comparison Company Price* (Local Currency) Market Data Market Cap (USD Millions) EV / 2012 EBITDA 2012 Forecast EPS P/E The average EV/2012EBITDA for the sample, excluding outliers, stands at 4x MTN Group Ltd 13, , , Telefonica Czech Republic , Telecom Italia SpA , Etisalat , Qtel , Orascom Telecom , ,635 Weighted average Simple average Simple average excluding outliers Median *Prices as of last close. Sources: Reuters Knowledge and NBK Capital nbkcapital. com 6

7 Positive Catalyst & Key risks Positive Catalyst Potential tower sharing in Saudi Arabia. We believe that telecom operators in Saudi Arabia might enter into an agreement to merge their tower assets during 2012, which could result in sizeable OPEX and CAPEX savings. The operators may potentially sell off a stake in the merged entity to a strategic investor, which could result in capital gains for the operators and hence be a potential catalyst for STC. Decreased telecom taxes in Turkey. Telecom taxes in Turkey are very high, curbing potential growth in the market. We expect that a reduction in taxes will help companies attract more subscribers and hence improve growth. Key Risks Currency fluctuation. During 3Q2011, STC had around SAR 780 million in currency losses, around 26% of the company s 3Q2011 operating income (currency losses are due to losses at the Oger Telecom level as a result of the Turkish Lira and the South African Rand exchange rate fluctuation against the USD). Aggressive competition leading to pressure on margins in Saudi Arabia. According to STC s management, the company s strategy in Saudi Arabia is to preserve market share even if it comes at the expense of margin. Lately, STC has provided its subscribers with counteroffers to preserve its position in the market. Hence, if there is aggressive competition in the operator s home market, STC s margin will be under tremendous pressure. Expansion at high prices. STC is planning for further diversification. The company is aiming for around 50% of its total revenues to come from international operations within two years. Limited company disclosure. STC started to disclose its revenue by operation only in 1Q2011. However, the company did not provide us with an EBITDA breakdown until now. nbkcapital. com 7

8 Investment Rationale Present in one of the largest telecom market in the MENA region (in terms of number of subscribers). Despite the operator s broad geographical diversification, Saudi Arabia remains an extremely critical market for STC, generating around 67% of group revenues (9M2011). Although competition has been severe in the mobile segment, STC has maintained its leadership position and has been vigilant in terms of maintaining its focus on the high-value market via the introduction of new data technologies (most recently, long-term evolution [LTE]). Furthermore, the operator maintains an effective monopoly in the fixed-line market and is at a distinct advantage due to the vast fixed-line network presence and strong demand for broadband services. A well-diversified telecom operator. STC s international operations generate around 33% of group revenues (9M2011), with the most notable contribution coming from Turkey (we estimate the Turkish contribution is around 18% of group revenues) whereby Turk Telekom maintains an effective monopoly in the fixed-line market, while Avea offers exposure to the Turkish mobile market as the third operator by market share. Turkey is characterized by its fast-growing market with a young population that gives STC exposure to stable cash flow generation as well as operating growth. In addition, STC also maintains exposure to India, Indonesia, and Malaysia, which are high-growth markets. Broadband is the new path. With voice market saturation, aggressive competition, and low blended voice ARPU, STC s new strategy, across all the company s markets, is to focus on the broadband market to drive growth (data ARPU is very high compared to voice ARPU). In Saudi Arabia, STC introduced LTE technology to improve the capacity and speed of data transmission. In other markets, STC is also working on upgrading its broadband network to capture the expected growth from the data segment. For example, Indonesia is currently home to the second largest user base for Facebook. Synergies. Given STC s size and geographical expanse, the operator stands to benefit significantly via group synergies (infrastructure, marketing, procurement, and collaboration on knowledge sharing). For example, STC via its wide exposure and high demand for infrastructure was able to build a price book with vendors and get discounts across all its operations. The group also has cross-market products for Hajj and roaming. Strong balance sheet. STC has good cash and cash equivalents accounts on its balance sheet amounting to SAR 8.4 billion as of September 2011 (SAR 4.2 per share). The company has a moderate leverage level with a debt-to-equity ratio of around 0.68x (versus a MENA telecoms average of 0.78x). nbkcapital. com 8

9 Understanding STC STC was established in 1998 as the sole telecommunications services provider in Saudi Arabia (subsequently had its IPO in 2002). The government of Saudi Arabia is the majority stakeholder in the operator with 16.4% of the company s shares listed on the Tadawul. In 2007, STC started its acquisition spree and is now a multi-national telecommunications operator with mobile operations in eight countries and fixed-line operations in three countries. Figure 5 highlights STC s key acquisitions and ownership structure. Figure 5 STC Ownership Structure and Expansion Footprint Public Pension, Gen. 6.6% Org. for Insurance, 7.0% Period September 2007 Acquisitions STC acquires 25% stake in Binariang STC has been rapidly expanding since 2007 Public Float, 16.4% September 2007 December 2007 April 2008 STC acquires 51% stake in Axis STC acquires the third mobile license in Kuwait STC acquires 35% stake in Oger Telecom Saudi Govt., 70.0% January 2009 June 2009 STC acquires the third mobile license in Bahrain STC establishes Intigral (GDMH) May 2011 STC increases stake in Axis to 80.1% Source: Company data Home market still the largest revenue driver Despite STC s large geographical presence, the company still generates around 67% of its total revenue (9M2011) from its home market, which is characterized as being the largest fixed-line and mobile market in the GCC (STC is the leader in the fixed-line and mobile markets). The exposure to Oger Telecom contributes to around 21% of the group s revenues as the operator allowed STC to have access to the Turkish fixed-line and mobile markets (in terms of market share, Turk Telekom is the leader in the fixed-line market and the third mobile operator), in addition to the South African mobile market. The Malaysian investment holding company Binariang generates 7% of STC s revenues via the company s exposure to Malaysia (in terms of market share, Maxis is the leading mobile operator) and India. The remaining operations in Kuwait, Bahrain, and Indonesia each generate 2% or less of total revenues. nbkcapital. com 9

10 Figure 6 STC s Major Subsidiaries and Revenue Drivers STC (Saudi Arabia) 67% of Revenues Mobile and Fixed-line 26% 25% 100% 35% 51% Viva Kuwait Binariang Viva Bahrain Oger Telecom Intigral STC maintains exposure to eight mobile and three 2% of Revenues Mobile 7% of Revenues 1% of Revenues 21% of Revenues 1% of Revenues Mobile Content provider fixed-line operations 100% 99% 75% Maxis Comm. OTAS 3C 14.9% 74% 70% 55% 100% 80.1% Axis (Indonesia) Aircel (India) Maxis (Malaysia) Turk Telekom (Turkey) Cell C (South Africa) 1% of Revenues Mobile Mobile Mobile & Fixed L. Fixed-line Mobile Full Consolidation Proportionate Consolidation 81% Avea (Turkey) Mobile Note: Revenue contributions are for the 9M2011 period. Sources: Company data and NBK Capital STC is the largest revenue-generating operator among our sample of major listed MENA telecom players. The company s revenue reached around USD 13.8 billion in FY2010 followed by Etisalat with USD 8.7 billion in revenue. In terms of the EBITDA margin, however, STC, with 38% (FY2010), stands below the MENA telecom average of 42%. These metrics illustrate that STC is one of the largest telecom operators in the region. Furthermore, with nearly USD 8.3 billion in debt (3Q2011), STC has the second highest debt level among major listed MENA telecom players. However, the operator s debt-to-equity ratio at 0.68x is lower than the MENA telecoms average of 0.78x. The operator maintains a net debt position of USD 6 billion, representing a net debt-to-equity ratio of 0.50x (in line with the MENA telecoms average of 0.52x). STC s debt profile in conjunction with the company s scale of operations goes to show tremendous balance sheet strength. Figure 7 STC s Operations vs. Other MENA Telecoms 16,000 70% 14, ,000 60% 12, STC is the largest revenue generator with a strong balance sheet 12,000 10,000 8,000 6,000 50% 10,000 40% 8,000 30% 6,000 20% ,000 10% 4, ,000 0% 2, % FY2010 Revenue (USD Millions) FY2010 EBITDA Margin Last Reported Total Debt (USD Millions) D/E Sources: Companies data and NBK Capital STC is the second largest player (right after Etisalat) among the listed MENA telecom players in terms of market capitalization at USD 17.7 billion (as of November 29, 2011), while being the third most liquid stock in the MENA telecoms universe, making the company a critical component to major benchmark indices. nbkcapital. com 10

11 Figure 8 MENA Telecoms Market Caps and Traded Values 24,000 21,000 18,000 STC is the second largest player in terms of market cap with good stock liquidity 15,000 12,000 9,000 6,000 3,000 0 Market Cap (USDm) Average Daily Traded Value YTD (USD'000 per day) Note: As per last closing prices on November 29, Sources: Exchange data and NBK Capital nbkcapital. com 11

12 Financial Performance Review and Outlook During 9M2011, STC s revenues grew by 7% YoY, driven by healthy growth across most operations. However, operations in Saudi Arabia and those under Oger Telecom (which together accounted for 88% of the group s revenues) were the key drivers for group-level revenue growth, delivering 4% and 6% growth, respectively. Other key highlights include Viva Kuwait and Viva Bahrain delivering 56% and 167% YoY revenue growth, respectively. Overall, revenue growth trickled down to the EBITDA level, growing 5% YoY. However, the EBITDA margin witnessed slight contraction to 36.9% from 37.5% in 9M2010, which we believe is a result of strong competition in STC s home market. However, net income witnessed a sharp decline (25%) owing to foreign exchange losses of around SAR 1 billion. Our forecasts imply a dividend yield of 6% for FY2011 In terms of dividends, as STC is planning to expand further, the company has reduced its quarterly dividend per share payout to SAR 0.50 per share from SAR 0.75 per share in FY2010; as a result, we saw the payout ratio decline to 56% during 9M2011 (from 63% in 9M2010). Hence, for FY2011 we are expecting a payout ratio of 52%, which implies a dividend yield of 6%. Going forward, we expect that STC will close the year with a 7% increase in revenue YoY, implying 4Q2011 revenue of SAR 14.2 billion (growth of 6% YoY). We are expecting the current international operations to contribute around 34% of total revenue in FY2011 and to reach 38% in FY2016. Due to strong competition in all the markets where STC operates, we believe the group revenue will grow at a CAGR of 3% between FY2011 and FY2016. We expect EBITDA to grow by 3% YoY in FY2011 and at a CAGR of 2% between FY2011 and FY2016. This will lead to an EBITDA margin of 36.6% in FY2011 and 34.7% in FY2016. STC has been investing in enhancing the company s broadband network across its operations. CAPEX as percentage of sales was around 19% as of FY2010, and we are expecting it to reach around 18% in FY2011. Figure 9 Financial Performance Review and Outlook (SAR Millions) 9M2010 9M2011 % Ch FY2010 FY2011F % Ch FY2012F CAGR (2011F- 2016F) We forecast long-term revenue and EBITDA CAGRs of 3% and 2% between FY2011 and FY2016, respectively Revenue 38,343 40,971 7% 51,787 55,161 7% 57,354 3% EBITDA 14,381 15,098 5% 19,621 20,169 3% 20,663 2% EBITDA Margin 38% 37% 38% 37% 36% Net Profit 7,151 5,392-25% 9,436 7,703-18% 7,645 2% EPS % % % DPS % % % Payout Ratio 63% 56% 64% 52% 65% CAPEX na na na 10,001 9,938-1% 10,751 2% CAPEX as % of Sales na na 19% 18% 19% Total Debt 30,624 31,163 2% 30,188 30,720 2% 32,907 6% Debt-to-Equity Ratio Sources: Company financial statements and NBK Capital nbkcapital. com 12

13 Telecom Market Overview and Outlook Saudi Arabian Mobile Market Saudi Arabia had the most impressive mobile subscriber growth in the GCC, as the mobile subscriber base grew at a CAGR of 27% between 2007 and 2010 (versus the GCC ex-saudi Arabia average of 20% and a peer group average of 5%). STC is the incumbent mobile operator in the country where the company s monopoly ended with the commercial launch of Mobily s services in 2005, followed by Zain Saudi Arabia in We believe a mix of factors such as the liberalization of the mobile market, the young and growing population, the affluent economy, the Hajj and Umrah seasons, and the growing commercial and retail demand for data have been the key drivers behind the market s growth. Figure 10 Saudi Arabian Mobile Market Review M2011 Market Subscriber Base (Millions) Market growth 40% 29% 26% 24% 9% Peer group average growth 6% 3% 4% 7% 4% STC is losing market share to the competition Market Share STC 61% 52% 45% 42% 40% Others 39% 48% 55% 58% 60% Average Blended ARPU (USD) Saudi Arabia Peer group average Sources: Company data and NBK Capital Clearly, strong competition has been the primary cause of the decline in STC s estimated market share to around 40% in September In the beginning, Mobily focused on low-value subscribers; however, as soon as its network was as competitive as STC s, Mobily changed strategy to target the high-value segment via a focus on data services. Thus, Mobily is currently the second largest mobile operator with an estimated market share of around 39%. We estimate that Zain Saudi Arabia, on the other hand, has been able to secure a market share of around 20% since the company s commercial launch in Despite losing market share, STC has maintained its market leadership, as well as a positive trajectory in subscriber growth with a CAGR of 16% between 2005 and 2010 (we estimate the number of STC s mobile subscribers grew by 4% during 9M2011). With a maturing voice market and increased mobile broadband competition, we believe that STC mobile subscribers will now grow at a CAGR of 4% between 2011 and 2016 and the operator s market share will reach 38% in Operators focus on mobile broadband data We estimate that the mobile average blended ARPU in Saudi Arabia declined at a CAGR of 14% between 2007 and 2010 versus 4% for the peer group, a direct result of the aggressive competition among mobile operators (with constant revisions in tariffs and offers), and due to the strong pace of subscriber growth in the market. However, mobile operators have been increasingly focusing their efforts on capitalizing on the high demand for mobile broadband services to control ARPU deterioration, and as a result have been benefitting tremendously. For instance, STC witnessed 151% YoY growth in mobile broadband revenues during 3Q2011 while our estimate indicates more than 40% YoY growth for Mobily, largely due to the growth of the company s 3G services. In addition, all three operators have now announced the commercial launch of their LTE services, which in our view should further support the market s ARPU levels going forward. nbkcapital. com 13

14 We estimate STC s 9M2011 average blended ARPU at USD 29 (down 7% YoY) stands significantly higher than Mobily s at USD 21 and Zain Saudi Arabia s USD 16. This large differential can be attributed to STC s high-value focus over the years (postpaid subscribers represent an estimated 21% of STC s subscriber base). Going forward, we believe that for STC the data contribution will support blended ARPU, which we are forecasting to reach around USD 26 in Tower-sharing could be a major OPEX/CAPEX saver In addition, we expect STC to conclude a tower-sharing agreement with Mobily during 2012, whereby the two operators will form a separate company that will own their respective tower assets. We believe this development could result in sizeable OPEX and CAPEX savings. Figure 11 Saudi Arabian Mobile Market Outlook M F 2012F 2013F 2014F 2015F 2016F Total Subscribers (Millions) Growth 24% 9% 13% 7% 5% 4% 3% 3% STC is expected to maintain its market leadership Market Share STC 42% 40% 40% 39% 39% 39% 38% 38% Others 58% 60% 60% 61% 61% 61% 62% 62% STC Blended ARPU (USD) Sources: Company data and NBK Capital Saudi Arabian Fixed-line Market STC maintains an effective monopoly in the fixed-line segment Saudi Arabia the largest fixed-line market in the GCC The Saudi Arabian fixed-line market currently has two active fixed-line operators, STC and Etihad Atheeb (15% owned by Batelco; operating under the brand name Go). However, given the small scale of Etihad Atheeb s operations we believe that STC still maintains an effective monopoly in the fixed-line market. Saudi Arabia has the largest fixed-voice subscriber base in the GCC at around 4.3 million at the end of 2010 (accounting for an estimated 60% of total fixed-lines in the GCC), followed by 1.48 million in the UAE. Fixed-to-mobile substitution is a prevalent theme in the region, and the increase in broadband subscriptions has limited the need for more than one fixed-line for dial-up Internet browsing. Accordingly, many countries have witnessed declining and even negative growth rates in the recent past. Fixed-line subscribers in Saudi Arabia grew at a CAGR of 2.5% between 2006 and 2010 (versus a GCC-ex Saudi Arabia average of 3.6%). Going forward, however, we expect the trend of fixed-to-mobile substitution and the growth of broadband subscriptions to continue; hence, we forecast fixed-lines to grow at a CAGR of 2% between 2011 and Saudi Arabian Broadband Market With increased demand for broadband services, the operators in Saudi Arabia are upgrading their networks to be able to capture the potential growth from this segment. According to the telecom regulator in Saudi Arabia, the number of broadband subscribers reached 4.4 million at the end of 2010, implying a CAGR of 123% between 2005 and Fixed wireless and mobile broadband contribute to around 65% of that figure, while DSL subscriptions make up the rest. Turkish Mobile Market Turkey has three mobile operators: a) Turkcell, the leading mobile operator with a 53% market share (September 2011) and a publicly listed company; b) Vodafone Turkey, the second-largest mobile operator with a 28% market share; and c) Avea (Turk Telekom owns around 81% of the company, and the remaining stake is held by Isbank) with a market share of 19%. nbkcapital. com 14

15 The high tax environment is a negative for the overall market The mobile market has been witnessing aggressive competition while mobile operators have to deal with a relatively high mobile tax environment. The special tax implemented on mobile voice services since 1999 stands at 25% in addition to the 18% value-added tax. The telecommunications authority in Turkey called on the Ministry of Finance to reduce the special taxes in March 2010, but we have yet to see any reductions in mobile voice tax rates. Mobile subscribers grew at a CAGR of 18% between 2004 and 2008; however, due to the introduction of mobile number portability (MNP) in November 2008, multiple SIM card usage has dropped. Accordingly, mobile subscribers declined by 5% and 2% during 2009 and 2010, respectively. Figure 12 Turkish Mobile Market Review M2011 Market Subscriber Base (Millions) Market growth 19% 7% -5% -2% 5% Peer group average growth 18% 15% 8% 7% 5% MNP weighed on market growth in 2009 and 2010 Market Share Avea 16% 19% 19% 19% 19% Others 84% 81% 81% 81% 81% Average Blended ARPU (USD) Turkey Peer group average Sources: Company data and NBK Capital During April 2009, the Turkish regulator reduced the mobile termination rates in Turkey by approximately 30%. Subsequently, mobile operators started introducing unlimited flat-rate plans (with the same tariffs for on-net and off-net calls), which further intensified competition and resulted in a 12% YoY decline in blended ARPU during In April 2010, the telecom regulator further reduced the mobile termination rate by 52%. However, blended mobile ARPU in Turkey grew by 11% during the year, due to the increased focus on postpaid subscribers (postpaid subscribers grew by 7% YoY) and mobile broadband. Despite this recovery, Turkey s blended ARPU (USD 12 in 9M2011) still remains 20% lower than the peer group average, which, in our view, is attributable to the high tax rate environment and strong competition in the mobile market. Avea s market share has remained relatively stable over the recent past at around 19%. However, the operator s 9M2011 blended ARPU grew by 12% YoY to USD 14. We believe this growth is attributable to the operator s fairly strong high-value focus as well as growth in prepaid usage. Avea s postpaid subscribers (44% of total subscribers) grew by 20% YoY at the end of September 2011, and the operator now has the second highest market share (25%) in the postpaid segment. Avea has been channeling its efforts to stimulate data usage via new offers and infrastructure investments, as well as maintaining a focus on customer retention. However, given the operator s track record, we maintain Avea s market share at around 20% throughout our forecast horizon. nbkcapital. com 15

16 Figure 13 Turkish Mobile Market Outlook M F 2012F 2013F 2014F 2015F 2016F Avea s market share is expected to remain at around 20% Total Subscribers (Millions) Growth -2% 5% 6% 5% 2% 2% 2% 2% Market Share Avea 19% 19% 19% 20% 20% 20% 20% 20% Others 81% 81% 81% 80% 80% 80% 80% 80% Avea Blended ARPU (USD) Sources: Company data and NBK Capital Turkish Fixed-line Market Turk Telekom largely dominates the Turkish fixed-voice market. The company has a fixed-line concession agreement valid until However, since liberalization efforts were made in January 2004, the market now has a variety of fixed telephone service (FTS) providers (88 at the end of 2009) providing local calls, long distance, and international direct dial services. Although the introduction of FTS providers in the PSTN market has resulted in increased competition (FTS providers managed to capture 4% share of the PSTN traffic and a 10% PSTN revenue share at the end of 2009), we believe that the more dominant threat to the PSTN segment (and hence Turk Telekom) is from the fixed-to-mobile substitution effect. As evidence, we note that Turk Telekom s PSTN subscribers declined at a CAGR of 4% between 2007 and Figure 14 Turkish PSTN Market Snapshot Market Subscriber Base (Millions) Market growth -3% -4% -5% -3% Peer group 5% 5% -1% 0% Fixed-to-mobile substitution leads to constant declines in the market s subscriber base Revenue Market Share Turk Telekom 94% 92% 90% na FTS providers 6% 8% 10% na Traffic Market Share Turk Telekom 97% 97% 96% na FTS providers 3% 3% 4% na Blended ARPL (USD) Turk Telekom Sources: Company data, IMF, ITU, Information and Communications Technologies Authority Turkey, and NBK Capital The key regulations in the fixed-line market include the following: Special Communications Tax The special communications tax on fixed voice services stands at 15%. Number Allocations and Fixed Number Portability As part of the liberalization process, number allocation and fixed number portability were introduced in However, reportedly there have been difficulties with successfully implementing fixed number portability. Despite the declining trend in Turk Telekom s fixed-line subscribers, average revenue per line (ARPL) also witnessed a decline at a CAGR of 3% between 2007 and However, to combat the declines in subscriber base and erosion of ARPL, during 2010 Turk Telekom focused on retaining customers by introducing bundled minute offers, reduced international calls, and special mobile call tariffs. As a result, the rate of subscriber decline slowed during 2010 to 3% (versus 5% in 2009), ARPL declined at a slower pace of 3% (versus 8% for 2009), and minutes nbkcapital. com 16

17 of use (MoU) grew by 1%. In the first nine months of 2011, Turk Telekom s subscribers continued to decline (by 3%); however, the introduction of an inflation adjustment to bundle packages (in 1Q2011) contributed to 2% YoY growth in ARPL. Furthermore, due to the introduction of bundled packages, the fixed/recurring revenue contribution (vis-à-vis usage-based variable revenue contribution) to the PSTN revenues now stands at 67%, which lends a certain degree of stability to the PSTN revenue stream. Going forward, we believe that the fixed-to-mobile substitution is going to continue; however, the uptake of naked DSL services should cushion the decline in revenue going forward. Figure 15 Turkish PSTN Market Outlook M F 2012F 2013F 2014F 2015F 2016F Subscriber base growth will remain under pressure Total Subscribers (Millions) Growth -3% -3% -4% -5% -1% -1% -1% 0% Turk Telekom ARPL (USD) Sources: Company data and NBK Capital Turkish Internet Market Internet services in Turkey are available via ADSL, mobile broadband, cable Internet, Integrated Services Digital Network (ISDN), and satellite services. However, ADSL services has the highest market share among these technologies (approximately 92% in 2009), with the ADSL subscriber base registering a 35% CAGR between 2005 and 2010 which demonstrates the increasing demand for Internet services in the country. Turk Telekom is the major supplier of wholesale ADSL services in Turkey, with a retail subsidiary (TTNET) controlling the majority of the retail market. Since the launch of 3G services in 2009, mobile broadband has grown substantially in the country and is positioned as the prime challenger to ADSL growth and hence to Turk Telekom s fixed broadband business. However, in our view the superior capacity advantage offered by ADSL continues to drive ADSL growth. In addition, we feel that efforts such as reductions in the special communications tax (on fixed-line Internet services from 15% to 5% as of March 2009) have further accelerated growth in the ADSL market. More recently, in 2Q2011 the introduction of naked DSL (DSL connection, without the PSTN line) has also helped support Turk Telekom s ADSL subscriber growth. Turk Telekom s fixed-broadband ARPL declined until 2008 due to rampant subscriber growth. However, with the easing of subscriber growth, the trend reversed in 2009 with the fixed-broadband ARPL registering healthy growth thereafter (fixed-broadband ARPL registered 10%, 8%, and 13% growth in 2009, 2010, and 9M2011, respectively). We believe the increased bandwidth offerings by Turk Telekom have also helped prop up fixed-broadband ARPL levels. Furthermore, inflation adjustments (of 8% to 10%) made by Turk Telekom to some of its unlimited packages (December 2010) have also lent support to fixed-broadband ARPL levels. Going forward, given the limited alternatives for broadband services, Turk Telekom will still have full control and pricing power over the ASDL segment. Thus, we believe that this segment will continue on its growth path. nbkcapital. com 17

18 Figure 16 Turk Telekom s ADSL Outlook M F 2012F 2013F 2014F 2015F 2016F Broadband services will grow based on increased bandwidth offerings and strong demand Total Subscribers (Millions) Growth 7% 3% 4% 4% 4% 4% 2% 3% Turk Telekom ARPL (USD) Sources: Company data and NBK Capital Malaysian Mobile Market Maxis is currently the leading mobile operator in Malaysia, while also maintaining an international gateway and fixed-line operations. However, the mobile segment generates the majority of Maxis s revenues (96% in 1H2011). Owing to strong demand, the Malaysian mobile subscriber base grew at a CAGR of 14% between 2007 and Figure 17 Malaysian Mobile Market versus Peer Group H2011 Mobile subscribers grew at a CAGR of 14% between 2007 and 2010 Market Subscriber Base (Millions) Market growth 20% 17% 12% 14% 0% Peer group average growth 17% 22% 12% 8% 6% Market Share Maxis 42% 41% 40% 40% 37% Others 58% 59% 60% 60% 63% Average Blended ARPU (USD) Malaysia Peer group average Sources: Company data and NBK Capital Although Maxis maintains the highest market share of 37% (in a four-player market), recently the company has been facing intense tariff competition in the low-value segment (prepaid and low-value postpaid users) via bundled package offerings by its main competitors Celcom and Digi with market shares of 34% and 27%, respectively. Thus, Maxis was able to capture only 12% of the subscriber net additions during 1H2011 (after adjusting for Maxis s new subscriber definition), versus 39% in We believe the operator is currently maintaining its focus on the high-value data segment and is not aggressively chasing subscriber additions. As evidence, we note that the operator suffered from only a 4% YoY decline in its 1H2011 blended ARPU versus declines of 8% and 7% for Celcom and Digi, respectively. Given the ongoing price war in the low-value segment, we believe Maxis is well placed as it maintains not only the highest market share in the postpaid segment (44%) but also the highest concentration of postpaid subscribers (25% of its subscriber base) versus its competitors. In line with STC s strategy of focusing on broadband, we believe that Maxis is well positioned to capture the growth of this segment. nbkcapital. com 18

19 Figure 18 Malaysian Mobile Market Outlook H F 2012F 2013F 2014F 2015F 2016F Maxis is expected to maintain its market leadership Total Subscribers (Millions) Growth 14% 0% 6% 8% 6% 5% 4% 4% Market Share Maxis 40% 37% 37% 36% 35% 34% 34% 34% Others 60% 63% 63% 64% 65% 66% 66% 66% Maxis Blended ARPU (USD) Sources: Company data and NBK Capital Kuwaiti Mobile Market Before 2008, the Kuwaiti mobile market was a cozy duopoly. However, a consortium led by STC was awarded the third mobile license, which was branded as Viva Kuwait and launched its services in September Thereafter, Kuwait witnessed a revival of competition in the mobile market, which led to strong growth in the number of mobile subscribers. Figure 19 Kuwaiti Mobile Market versus Peer Group M2011 Market Subscriber Base (Millions) Market growth 9% 17% 25% 11% 4% Peer group average growth 9% 7% 4% 4% 2% Competition spurs market growth Market Share Viva Kuwait na 5% 16% 18% 20% Others 100% 95% 84% 82% 80% Average Blended ARPU (USD) Kuwait* Peer group average *2007 and 2008 ARPUs exclude Viva Kuwait. Sources: Companies data and NBK Capital The key highlight during 2009 was Viva s rampant subscriber acquisition (we estimate that the operator captured 63% of subscriber net additions during the year), which resulted in increasing Viva s market share to an estimated 16% by the end of However, since then the new entrant effect has lost steam, and competition has revived from Wataniya Telecom and Zain. Thus, we estimate Viva s market share increased to only 20% by the end of September 2011, with Viva retaining the number three position in a market led by Zain with a 41% market share, closely followed by Wataniya Telecom with a 39% market share. Although the Kuwaiti blended mobile ARPUs have always remained at a premium to their peer group, with the entry of a third operator, these premiums have been declining rapidly. We estimate Viva Kuwait s 9M2011 blended ARPU at USD 29 (up 16% YoY), significantly lower compared to Zain and Wataniya Telecom at USD 53 and USD 38, respectively. We believe this differential is largely a function of a higher percentage of high-value subscriber concentration for Zain and Wataniya Telecom vis-à-vis Viva Kuwait. From a regulatory standpoint, the Ministry of Communication (MOC) in Kuwait is looking to implement per-second billing in the Kuwaiti mobile market, and started a dialogue with Kuwaiti mobile operators in September Furthermore, the MOC also issued a notice concerning the implementation of mobile number portability (MNP). Although we believe these developments will make Kuwait s mobile market more competitive, we have yet to see any imminent deadlines nbkcapital. com 19

20 issued for implementing these measures. Recently, the MOC issued a new decree (July 26, 2011) whereby all three mobile operators would now pay monthly fees of KD 0.500/SIM for all active lines as well as inactive lines in inventory. Before this decree, mobile operators paid fees only on postpaid subscribers. We believe that the establishment of an independent telecommunications regulator for the Kuwaiti market will also be conducive to the future health and evolution of the mobile market. Going forward, we believe that the total number of mobile subscribers in Kuwait will grow at a CAGR of 5% between 2011 and 2016 with Viva s market share increasing to 24% by Figure 20 Kuwaiti Mobile Market Outlook M F 2012F 2013F 2014F 2015F 2016F Total Subscribers (Millions) Growth 11% 13% 16% 7% 5% 5% 4% 4% Viva Kuwait will gradually expand its market share Market Share Viva Kuwait 18% 20% 21% 22% 23% 23% 24% 24% Others 82% 80% 79% 78% 77% 77% 76% 76% Viva Kuwait Blended ARPU (USD) Sources: Company data and NBK Capital Bahraini Mobile Market Bahrain s telecommunications market has historically been one of the most competitive in the region. The active role of the regulator and the small size of the country have helped telecom operators introduce the latest technologies to the market and have contributed to the market s unique evolution. In addition, Bahrain is a known tourist destination for Saudi nationals, which makes STC s investment in Bahrain a strategic move. With Viva Bahrain s commercial launch in March 2010, the levels of competitive activity and the market s technological innovation have increased, which has further spurred the growth of the Bahraini mobile market. As evidence, the number of Bahraini mobile subscribers grew at a CAGR of 12% between 2007 and 2010, versus a peer group average of 5%. Since Viva Bahrain s commercial launch, the operator has been offering highly competitive products such as free on-net calls and broadband connectivity, as well as extremely cheap international tariffs. As a result, the operator has been able to grow its subscriber base aggressively and secured an estimated market share of 33% by the end of September 2011 (overtaking Zain Bahrain in 2Q2011). This growth is impressive within just seven quarters of operations. However, because of this aggressive growth and promotional activities, Viva Bahrain s 9M2011 blended ARPU declined by 2% YoY to USD 40. Indonesian Mobile Market Indonesia, the fourth most populous nation in the world, has nine mobile operators. Due to the strong demand and a high degree of tariff competition, tremendous growth in mobile subscribers was witnessed at a CAGR of 34% between 2007 and 2010 (versus a peer group average of 22%). Axis, following its commercial launch in early 2008, has become the fifth largest mobile operator in the country, with a market share of 4% at the end of September We note, however, that the top three operators in the country maintain a combined market share of 86%. We believe this fact in conjunction with heavy tariff competition (with strong participation from the leading players), limits the potential for rapid market share growth for new market entrants. Furthermore, nbkcapital. com 20

21 we believe that STC s investment in Indonesia is also a strategic move, as Axis is well positioned to capture roaming revenues from the large number of Indonesian tourists visiting Saudi Arabia for Hajj and Umrah. Indian Mobile Market Owing to strong demand for mobile services in India and aggressive competition among 15 mobile operators, the market saw a 49% CAGR in the overall subscriber base between 2007 and 2010 (versus a peer group average of 32%). Although Aircel is the seventh largest operator in the country (operates in all of the 23 circles in India), with nearly 60 million subscribers and a 7% market share at the end of September 2011, we believe Aircel is still positioned for healthy growth given the strong demand for mobile and Internet services in India. nbkcapital. com 21