Omantel. Dealing with Liberalization. key data

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1 omantel Dealing with Liberalization December 09, 2010 key data Fair Value per Share (OMR) Closing Price (OMR) * week High / Low (OMR) / YTD / 12-month Return -4.55% / -4.25% Trailing P/E 9.0 Market Cap (OMR Millions) 929 Shares Outstanding (Millions) 750 Free Float 30% Reuters / Bloomberg Code OTL.OM / OTEL OM *As of December 6, Sources: Bloomberg, Zawya, and NBK Capital key metrics 2009A 2010F 2011F 2012F EPS (OMR) EPS Growth 6% -23% -10% -9% P/E Dividend Yield 8.1% 7.3% 6.6% 6.6% Adj.EV/ EBITDA Revenue (OMR Millions) Revenue Growth 0% -1% -2% -2% Adj.EBITDA (OMR Millions) Adj.EBITDA Growth -4% -6% -4% -2% Adj.EBITDA Margin 56% 53% 53% 52% Sources: Company financial statements and NBK Capital forecasts (OMR Millions) 4Q2009A 3Q2010A 4Q2010F 1Q2011F Revenue Adj.EBITDA Source: NBK Capital Rebased Performance Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Omantel Sources: MSCI, Reuters, and NBK Capital Analysts Diala Hoteit T E. diala.hoteit@nbkcapital.com MSCI Oman Alok Nawani T E.alok.nawani@nbkcapital.com Highlights 12-Month Fair Value: OMR Recommendation: Accumulate- Risk Level**: 4 Reason for Report: 9M2010 Update We believe that the different sub-segments of the telecom market in Oman are at a unique stage in their competitive evolution: 1) The mobile market is awash with a number of competitors, and 2) the fixed-line market is now a duopoly, while its sub-set, the fixed-broadband market, is being considered for further liberalization. With the mobile penetration rate reaching 125% at the end of September 2010, we believe that the Omani mobile market is approaching maturity and hence expect slower growth. We forecast the number of mobile subscribers will grow at a compounded annual growth rate (CAGR) of 9% between 2009 and 2014 and the penetration rate will reach 146% in Omantel lost its monopoly over the fixed-line sector and international gateway in 2Q2010. With limited guidance from Omantel and Nawras on the expected performance of the fixed-line market in the coming years, we believe that the total number of fixed-lines will witness another decrease during 2010 due to the fixed-to-mobile substitution. However, Nawras s entry should stimulate the market starting in Omantel s 9M2010 revenues grew by 4% year-over-year (YoY) to OMR 316 million. We note that the majority of this growth is a function of the consolidation of revenues from WTL starting July However, during 3Q2010, WTL s revenues declined by 27% YoY to OMR 6.2 million. According to Omantel s press release, WTL has been facing major challenges that affected the company s growth and profits. The 9M2010 adjusted EBITDA declined by 7% YoY to OMR 170 million, representing an adjusted EBITDA margin of 54%. We expect total revenue and adjusted EBITDA to decline at a CAGR of 1% and 3%, respectively, between 2009 and Omantel s cash-dividend recommendation track record should act as a positive catalyst for the stock. This represented a payout ratio of 60% for 2009 and a dividend yield of 8.1%. We expect management will maintain a similar level of dividend distribution over the coming years. The stock is currently trading on an expected 2010 dividend yield of 7.3%. We have reduced our fair value estimate for the share price from OMR to OMR However, it still represents an upside potential of 17% versus the current market price of OMR 1.239; hence, our recommendation is Accumulate. ** Please refer to page 8 for recommendations and risk ratings. nbkcapital. com

2 VALUATION We have lowered our 12-month fair value estimate for Omantel s share price to OMR Due to further market liberalization, the telecom market in Oman is witnessing growing competition between operators that is affecting the companies performance. We reviewed our forecast, taking into consideration the 9M2010 performance in Oman and Pakistan. Given that our fair value is 17% higher than the last closing price, our recommendation for Omantel is Accumulate. THE STORY IN OMAN The telecom market in Oman is witnessing new changes affecting the market dynamic. Five mobile resellers entered the market, which led to increased competition and put more pressure on prices. In addition, Nawras acquired the second fixed-line license and an international gateway. We believe that the different sub-segments of the telecommunications industry are at a unique stage in their competitive evolution. The mobile market is awash with a number of competitors. The fixed-line market is now a duopoly, while its sub-set, the fixed-broadband market, is being considered for further liberalization. Hence, given the scale of the Omani market, it has now become increasingly important for operators to develop their niche markets and thereby try to capitalize on their respective competitive advantages. For a detailed review of the Omani telecommunications market, please refer to our report Nawras Initiation of Coverage Broadband: A New Revenue Driver (dated December 9, 2010). However, specific to Omantel we find the following to be the key recent developments. Fixed-line Market Evolves into a Duopoly Omantel lost its monopoly over the fixed-line segment as Nawras acquired the second fixed-line license. Nawras s fixed-line business is largely focused on providing fixed-broadband services. Hence, to tackle the new competition, Omantel offered new promotions on corporate ADSL connections (offering a waiver on installation fees, hardware charges, and subscription fees for a limited period) and fixed-line voice services (via unlimited bundle offers for on-net fixed-to-fixed usage). Liberalization of the International Gateway Historically, Omantel has been the only operator to have an international gateway in Oman. However, after the second fixed-line license was awarded to Nawras, starting May 2010, it also received its own international gateway. We believe this development has already led to increased competitive pressures on Omantel s wholesale business and will continue to be a key competitive feature in the Omani market. Furthermore, we note that the Telecommunications Regulatory Authority (TRA) has disclosed its intentions to potentially issue a new class I license for an international gateway in the future. The Retail International Calls Market under Pressure Omantel and Nawras have been facing significant pressure on their retail international calls revenues via the usage of illegal Voice over Internet Protocol (VoIP) services in Oman. While the TRA has been making constant attempts to clamp down on illegal VoIP service providers, these services remain a cause for concern for licensed operators. Omantel is currently in the process of introducing attractively priced international-calls related products to protect the company s revenue market share of the international calls segment and compete with Nawras s recent launch of a VoIP product. New Submarine Cable Agreements In May 2010, Omantel signed an agreement with Gulf Bridge International (GBI), whereby the operator will provide the GBI submarine cable system a landing station in Oman. The cable system is expected to provide Omantel with enhanced global and regional connectivity, thereby enhancing the capacity and resilience of Omantel s network. nbkcapital. com 2

3 Mobile Market Overview For a more detailed review of the Omani telecommunications market, please refer to our report Nawras Initiation of Coverage Broadband: A New Revenue Driver (dated December 9, 2010). With the entry of five mobile resellers, the mobile market witnessed high growth in the number of mobile subscribers. We estimate that the penetration rate, based on the number of active subscribers, reached 125% at the end of September 2010 compared to 106% at the end of September 2009, with the number of active mobile subscribers having grown by 22% over the same period. Omantel s market share declined marginally from 47% in 2009 to 46% as of September The acquisition of net additional subscribers trend is correlated to the company s sales promotion. While in 2009 Omantel captured 21% of the new subscriber additions, during 9M2010 the operator s performance was much stronger with a capture rate of 39% despite the growing number of mobile resellers and subsequent increase in competition. Omantel s blended average revenue per user (ARPU) stood at USD 32 during 9M2010, 8% lower than the blended ARPU of USD 34 in We believe this decline is attributable to the healthy subscriber growth exhibited by the operator during 9M2010. To a large extent, this decline in blended ARPU has been negated by the 9% increase in Omantel s post-paid subscriber base during 9M2010 to 232 thousand (representing 11% of Omantel s mobile subscriber base). In contrast, Nawras s blended ARPU stood at USD 25.5 during 9M2010 (1% lower than Nawras s ARPU of USD 26 in 2009). Fixed-line Market Overview The Omani fixed-line subscriber base has been witnessing declines since 2006 due to the fixed-to-mobile substitution effect. Furthermore, the growth in ADSL has been dampened by the significant takeoff of mobile broadband services. According to the TRA report published in June 2010, during 2009, on average, fixed lines decreased by a monthly rate of 2,203 lines. Omantel s fixed-line subscriber base stood at 252 thousand at the end of September 2010 versus five thousand subscribers for Nawras. Nawras is primarily focusing on expanding broadband services by offering aggressively priced and differentiated services. We believe Nawras s specialized focus on the broadband segment and the expected subsequent increase in competitive activity within the broadband segment will be a vital growth catalyst for the Omani fixed-line market. Omantel s 9M2010 average revenue per line (ARPL) stood at USD 38.6, 2% higher than the 2009 ARPL of USD This marginal increase is primarily related to the decline in Omantel s subscriber base. FINANCIAL PERFORMANCE Omantel s 9M2010 revenues grew by 4% YoY to OMR 316 million. We note that the majority of this growth is a function of the consolidation of revenues from WTL starting July Domestic revenues declined by 1% YoY and represented 92% of total revenues. International revenues from WTL stood at OMR 24 million and represented 8% of Omantel s 9M2010 revenues. During 3Q2010, revenues from WTL declined by 27% YoY to OMR 6.2 million. According to Omantel s press release, WTL has been facing major challenges that affected the company s growth and profits. Mainly, price wars have impacted margins, and the global financial crisis affected borrowing costs and impacted the PKR/USD exchange rate. Thus, during the AGM on March 27, 2010, Omantel s shareholders asked the board of directors to develop a strategy for WTL. Hence, the board has assigned consultancy firms to evaluate the company s operations and recommend steps required to improve its performance. Per the consultants recommendation, Omantel s board has announced nbkcapital. com 3

4 its intention to attain shareholder approval for providing USD 70 million in funding to WTL (via a third-party bank guarantee as well as the issuance of a convertible loan). The proceeds are expected to be utilized by WTL to finance its future capital expenditures and re-finance its liabilities. Figure 1 Omantel 9M2010 Results Third-Quarter Results Nine-Month Results (OM R millions) 3Q2010 3Q2009 % Ch 9M2010 9M2009 % Ch Margins are under presssure Revenue % % Adj. EBITDA % % Adj. EBITDA margin (%) 52% 56% 54% 60% Net Profit % % Source: Company financial statements and NBK Capital From a segmental standpoint, during 9M2010, the fixed-line segment was the best performing with 9% YoY revenue growth to OMR 77 million (representing 24% of total revenues). Mobile revenues grew by 4% YoY to OMR 174 million (representing 55% of group revenues). Finally, wholesale revenues faced a 2% YoY decline to OMR 65 million (while representing 21% of total revenues). However, if we look at the performance of this segment in 3Q2010, we notice a revenue decline of 30% YoY; this decline is primarily due to Nawras s launch of the international gateway in May According to management, the decline of international gateway revenues had an impact amounting to OMR 8 million during 9M2010, and management is expecting a further impact of between OMR 2 and 3 million during 4Q2010. Figure 2 Omantel s 9M2010 Revenue Mix by Segment Nine-Month Results (OM R millions) 9M2010 9M2009 % Ch As % of Total Wholesale revenues are rationalized by competition Fixed % 24% Mobile % 55% Wholesale % 21% Sources: Company financial statements and NBK Capital The 9M2010 adjusted EBITDA declined by 7% YoY to OMR 170 million, representing an adjusted EBITDA margin of 54% (versus 60% in 9M2009). Operating expenses during 9M2010 grew by 18% YoY, while the consolidation of WTL has also pressured the group s EBITDA performance. The 9M2010 net profit declined by 21% YoY to OMR 84 million. The deeper decline versus EBITDA relates to an 18% YoY increase in depreciation and amortization costs, finance costs coming in at OMR 1.4 million (versus interest income of OMR 2.2 million in 9M2009), and a one-off insurance claim settlement of OMR 3.6 million realized during 9M2009. Omantel s net debt position at the end of September 2010 stood at OMR 26 million (54% lower than OMR 56 million at the end of 2009), representing a net debt-to-equity ratio of 0.06x (versus 0.13x at the end of 2009). Capital expenditure (CAPEX) during 9M2010 declined by 36% YoY to OMR 43.5 million, and represented 14% of sales (versus 22% in 9M2009). The majority of the CAPEX relating to the expansion of the 3G network took place during nbkcapital. com 4

5 OUTLOOK Below is a summary of the most important changes we have made to our forecasts due to the ongoing competition and the company s performance during the last nine months: Mobile Market Forecast As we mentioned in our report Nawras Initiation of Coverage Broadband: A New Revenue Driver (dated December 9, 2010), with two integrated telecom operators and five mobile resellers, the mobile market in Oman is witnessing aggressive competition that pushed the number of mobile subscribers to grow swiftly in the last few years. We believe that the number of active mobile subscribers will still see double-digit growth during 2010 and 2011 (19% and 12%, respectively) and then revert to moderate growth. We estimate that the total number of active mobile subscribers will grow at a CAGR of 9% between 2009 and 2014 rather than our previously estimated 5% based on the current performance of the market. We believe that Omantel will be as active as the company was during the first nine months of 2010 with regard to the acquisition of new subscribers and therefore be able to protect its market share. Hence, we are forecasting the company s market share will drop to 43% by 2014 from 46% at the end of September We decreased the blended ARPU over our forecast period, at a faster rate, to reflect the levels reached during the 9M2010. We are expecting the ARPU to reach USD 24 during Figure 3 Mobile Market in Oman Key Market Metrics 2009a 9M2010a 2010f 2011f 2012f 2013f 2014f Resellers will claim their stake of the market Total Mobile Subs. (Thousands) * 3,176 3,694 3,771 4,239 4,532 4,740 4,924 Growth 23% 16% 19% 12% 7% 5% 4% Market Share: Omantel 47% 46% 46% 44% 43% 43% 43% Others 53% 54% 54% 56% 57% 57% 57% Omantel's Blended ARPU (USD)* *based on estimated active subscribers. Sources: Informa database and NBK Capital Fixed-line Market Forecast Omantel lost its monopoly over the fixed-line sector and international gateway during the second quarter of With limited guidance from Omantel and Nawras on the expected performance of the fixed-line market in the coming years, we believe that the total number of fixed-lines will witness another drop during 2010 (declining by 3% over the year) due to the fixed-to-mobile substitution. However, Nawras s entry into the game will push the sector positively, and we believe that starting in 2011 we will see positive growth in the number of fixed-lines led by Nawras. We expect that Omantel s market share will drop to 75% in As for Omantel s blended ARPL, we expect it will be under constant pressure; thus, we forecast the blended ARPL will decline from USD 39 in 9M2010 to USD 28 in nbkcapital. com 5

6 Figure 4 Fixed-line Market in Oman Key Market Metrics 2009a 9M2010a 2010f 2011f 2012f 2013f 2014f Living with liberalization Total Fixed-lines (Thousands) Growth -8% -4% -3% 6% 4% 4% 4% Market Share: Omantel 100% 98% 96% 86% 83% 79% 75% Others 0% 2% 4% 14% 17% 21% 25% Omantel's Blended ARPL (USD) Sources: Company data and NBK Capital Financial Forecast: Due to WTL s performance during 9M2010, we have revised the company s contribution to total revenue downward. We prefer to see material enhancement in WTL s performance before making the company a major value driver for Omantel Group. Accordingly, we have lowered WTL s contribution to total revenue in 2014 to 6% versus our previously expected 18%. Based on the current market dynamics, we believe that domestic revenue will decline at a CAGR of 2% between 2009 and Group adjusted EBITDA will also be affected by the relatively poor performance of WTL and the increased competition in Oman. We now forecast adjusted EBITDA to decline by 3% in the coming five years and the adjusted EBITDA margin to decline from 54% in 9M2010 to 51% in Figure 5 New 2010 Forecast Compared with Previous Forecasts (OMR millions) 2009 Actual F 2010 New Forecast Versus Old New 2009 Actual Old 2010 F Adjusting for competition and treading cautiously with WTL Revenue % -6% Adj.EBITDA % -6% Adj.EBITDA Margin 56% 53% 53% Net Profit % -5% Source: NBK Capital nbkcapital. com 6

7 FINANCIAL STATEMENTS Balance Sheet (OM R Tho usands ) Historical Forecast Fiscal Year Ends December ASSETS Cash and Short-Term Investments 81,828 32,042 10,200 33,265 76, , , ,065 Total Receivables, Net 53,505 62,957 63,240 61,757 60,790 60,040 59,411 59,132 Total Inventory 3,210 5,796 4,830 4,708 4,582 4,369 4,322 4,367 Prepaid Expenses 7,543 10,442 8,050 7,847 7,637 7,281 7,203 7,279 Other Current Assets, Total 62,977 74,440 74,440 74,440 74,440 74,440 74,440 74,440 Total Current Assets 209, , , , , , , ,284 Property/Plant/Equipment, Total - Net 287, , , , , , , ,304 Intangibles, Net 31,229 38,421 41,169 36,951 32,734 28,517 24,299 20,082 Long-Term Investments 62,723 72,450 73,175 73,906 74,645 75,392 76,146 76,907 Other-Long Term Assets TOTAL ASSETS 590, , , , , , , ,194 LIABILITIES & EQUITY Accounts Payable 5,813 9,803 8,050 7,847 7,637 7,281 7,203 7,279 Accrued Expenses 21,230 28,830 20,400 19,922 19,610 19,368 19,165 19,075 Current Port. of LT Debt/Capital Leases 19,997 53,444 19,850 15, Other Current Liabilities 106, , , , , , , ,583 Total Current Liabilities 153, , , , , , , ,937 Long-Term Debt 58,918 35,000 33,076 20,000 30,000 30,000 30,000 30,000 Deferred Income Tax 764 3,463 3,636 3,818 4,009 4,209 4,420 4,641 Minority Interest 1,088 18,240 19,152 20,110 21,115 22,171 23,279 24,443 Other Liabilities, Total 3,178 10,461 10,461 10,461 10,461 10,461 10,461 10,461 Total Liabilities 217, , , , , , , ,482 Total Equity 372, , , , , , , ,712 TOTAL LIABILITIES AND EQUITY 590, , , , , , , ,194 Income Statement (OM R Tho usands ) Historical Forecast Fiscal Year Ends December Total Revenue 411, , , , , , , ,499 Cost of Revenue 30,923 35,372 40,252 39,237 38,183 36,406 36,015 36,393 Gross Profit 380, , , , , , , ,106 Selling/General/Admin. Expenses 76,702 86,930 79,226 78,890 78,831 79,407 79,726 79,733 Depreciation/Amortization 54,771 68,569 76,309 81,262 85,872 90,154 94,398 98,906 Other Operating Expenses 62,266 59,166 71,427 70,921 70,987 70,886 70,910 70,959 Operating Income 186, , , , , , ,250 95,508 Interest Income (Exp), Net Non-Operating (2,209) 1,315 (4,241) (2,642) (1,955) (1,800) (1,800) (1,800) Other, Net (44,891) (20,942) (26,334) (25,842) (25,556) (25,319) (25,095) (24,992) Net Income before Taxes 139, , ,212 99,638 90,808 83,381 75,355 68,716 Provision for Income Taxes 20,488 17,400 13,225 11,957 10,897 10,006 9,043 8,246 Net Income After Taxes 119, ,233 96,987 87,682 79,911 73,375 66,312 60,470 Minority Interest (632) (80) (82) (83) (85) (87) (88) (90) Net Income 118, ,153 96,905 87,598 79,826 73,289 66,224 60,380 Cash Flow (OM R T ho us ands ) Historical Forecast Fiscal Year Ends December Cash from Operating Activities 196, , , , , , , ,140 Cash from Investing Activities (209,055) (150,122) (106,949) (90,760) (85,831) (81,145) (80,442) (83,974) Cash from Financing Activities (12,341) (95,952) (113,349) (87,001) (67,252) (62,051) (56,966) (53,460) Net Change in Cash (24,555) (49,786) (21,842) 23,065 43,705 51,261 54,128 52,706 Sources: Company financials and NBK Capital nbkcapital. com 7

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