WELL-POSITIONED PLAYER IN EGYPT

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1 CURRENT PRICE EGP FAIR VALUE EGP RECOMMENDATION BUY TABLE OF CONTENTS Investment Rationale 2 Global Industry Outlook 5 Egypt Fundamentals 7 Egypt Telecom Sector 8 Company Overview 14 Financial Analysis 15 Capital Structure 17 SWOT Analysis 18 Valuation 19 Pro Forma Financials 21 Appendix 23 WELL-POSITIONED PLAYER IN BROADBAND PENETRATION BELOW 5% IN PRESENTS GROWTH POTENTIAL We expect broadband to be one of the main growth drivers for Mobinil, as is the case for most operators in the MENA region. With less than 5% of the population currently having broadband access, the takeoff of this technology is expected to enhance the operator s revenues. Mobinil is expected to finalize its acquisition of asset LinkDotNet by July, which would help it gain a lot of ground in the broadband market. 1Q 2010 FINANCIALS SHOW STABILIZATION IN REVENUES Operating revenues reached EGP 2,546 million for the first quarter of 2010, a 2% rise from EGP 2,490 million in the same quarter of The telecom sector in Egypt is reaching a stabilization stage in mobile voice usage, and this is evident in revenue growth trends. The price war in the second half of 2009 among the three existing operators (Mobinil, Vodafone Egypt, and Etisalat Misr) continued to have an effect in the first quarter; apparent in the weakening ARPUs. The effect of the price war will continue in the second quarter of 2010 with the prolongation of competitive promotions on international rates. SUCCESS OF BOND ISSUANCE DEMONSTRATES CONFIDENCE IN MOBINIL Mobinil secured a debt facility through a bond issuance worth EGP 1.5 billion in an offer that closed in January The bonds were issued through a private placement. Part of the proceeds will be used to pay for the 3G license. The success of the bond issuance indicates confidence in Mobinil s solid operations and the company s ability to strengthen its liquidity position to pursue expansion plans. WHITE FLAG PREVAILS... OT AND FT REACH AGREEMENT OVER MOBINIL In April 2010, Orascom Telecom (OT) and France Telecom (FT) settled their disputes on the ownership structure over Mobinil, after battling in several courts for over a year. FT will be paying OT USD 300 million as a control premium for Mobinil. OT maintained its stake in the Egyptian Company for Mobile Services (ECMS), whose brand name is Mobinil. WE INITIATE COVERAGE WITH A TARGET PRICE OF EGP Using the top-down approach, we foresee potential in Egypt for telecom operators, especially in the broadband segment. While we anticipate growth in all three mobile operators, stemming largely from the development of broadband services, we see Mobinil as the best-positioned operator as it was the first to expand networks to 3G, an initiator of value-added services, and is expected to have a strong presence in data services through its imminent acquisition of LinkDotNet, a data service provider. STOCK DATA COMPANY COVERAGE Louna Merhi Equity Analyst Louna.Merhi@asib.com Youssef Nizam, CFA Head of Equity Research Youssef.Nizam@asib.com Market Cap (EGP) 17,556,000,000 Number of Shares 100,000,000 Free Float 29% Av. Monthly Liquidity (EGP) 73,159, week High (EGP) week Low (EGP) Trailing PE 8.91 PE 10 E 9.61 PB 5.58 Mobinil Stock Performance Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Year E 2011E 2012E 2013E 2014E Revenues (EGP million) 10,807 11,171 11,081 11,226 11,546 11,882 Net Income (EGP million) 2,038 1,827 1,867 1,905 2,133 2,274 EPS (EGP) (EGP)

2 INVESTMENT RATIONALE GDP growth in Egypt is expected to be above MENA and global averages On a macroeconomic level, it is expected that Egypt will witness yearly GDP growth of more than 5% from 2010 till This is higher than the GDP growth rate of the world economy and of the Middle East and North Africa (MENA) region. Chart 1: Egypt GDP Growth 8% 6% 4% 2% 0% -2% E 2011 E 2012 E 2013 E 2014 E Egypt Middle East and North Africa World Source: International Monetary Fund (IMF) Leader in the mobile voice market Mobinil continues to be the market leader in Egypt with a share of 41.1% of the mobile voice market as of the first quarter of We expect Mobinil to retain its leadership over the next four years. However, in data services we expect Telecom Egypt (TE) to continue its dominance through its subsidiary TE data. Telecom Egypt had 676,000 ADSL subscribers as of Q1 2010, with a market share of 61.1%. Table 1: Key figures for Mobinil on a Quarterly Basis 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 Subscribers (million) Penetration Rate 58.7% 64.7% 69.8% 76.4% 79.5% Market Share 45.6% 44.4% 43.6% 42.0% 41.1% ARPU (EGP) EBITDA (EGP million) 1,156 1,318 1,268 1,322 1,021 Sources: Company press releases, Audi Capital estimates Shift in mobile market parameters in Egypt characterized by stagnating revenues due to low ARPUs resulting from the price war Mobile voice revenues stagnate because of lower ARPUs, despite of room for subscriber growth Market parameters in Egypt have changed since the second half of 2009, due to operators competing with aggressive offers. In the third quarter of 2009, Etisalat Misr was the first to launch a promotion where its subscribers can call on-net and off-net subscribers at EGP 0.19 per minute. In November 2009, Mobinil followed suit by offering prepaid subscribers the lowest on-net rate of EGP 0.08 per minute. Vodafone Egypt also proposed a flat rate of EGP Mobinil management stated that the telecom sector in Egypt is reaching a stage of stabilization, as seen in the 2% revenue growth y-o-y for 1Q We believe that mobile voice revenues have indeed reached a stabilization stage. However, the mobile penetration level of 76% as of the end of 2009 is still low compared to other countries in the Middle East. We estimate that penetration levels will exceed 100% by Despite a large addressable market in the future, weakening ARPUs could offset significant growth in subscriber numbers, leading to low single-digit revenue growth over the next few years. 2

3 Broadband penetration below 5% presents a growth opportunity Value-added services are a revenue growth driver, especially in the broadband segment Promotions and price cuts are unsustainable, as EBITDA margins have been severely pressured Debt issuance enhances company s liquidity to pursue expansion Dividend payment-in-parts attractive to investors Mobile broadband constitutes less than 2% of revenues for It is therefore a future growth driver. We expect that broadband revenue growth for 2010 will be in the double digits. Mobinil has launched mobile broadband offers in 2009 and should continue to do so in With a current broadband penetration of below 5%, the underpenetrated and underserved Egyptian market should provide the operator with ample opportunity for growth. Mobinil is offering mobile broadband at 7.2 Mbps. Offering at speeds of 14 Mbps will boost demand for broadband and thus increase penetration levels. Mobinil launched mobile broadband in February The operator offered a mobile broadband unlimited tariff for EGP 20 per month as of December Also, Mobinil launched prepaid blackberry services in November Mobinil is continuing to differentiate itself by offering competitive and innovative value-added services to subscribers. At a stage where mobile revenue growth is expected to be relatively flat, a focus on value-added services is prudent as it is a driver of revenue growth. If these new services will be demanded more than expected, then revenues will grow more than the figures in our forecasts. We have assumed the rate of uptake of value-added services by subscribers to be average in our forecasts. While we believe broadband and value-added services to be growth drivers for Mobinil, we have conservatively assumed that the high growth from broadband revenues would be offset from the decline in mobile revenues. This would lead to a 5-year CAGR of 1.9% in revenues till Ongoing promotional offers and price cuts by the operators competing in Egypt have hurt EBITDA margins. During the second half of 2009, Etisalat Misr started offering a EGP 1.99 per minute flat rate to any destination in the world. Two weeks into the promotion, Vodafone launched the same offer. Mobinil then proposed a 15% discount on international calls. In the first quarter of 2010, Mobinil matched the terms of the promotion by Etisalat and Vodafone. As a result, its EBITDA margins have declined significantly in the first quarter of The price war continued to have an effect in 2010, as ARPUs declined in the first quarter of The deterioration in margins is due to unsustainable promotions and offers being introduced to the market. Table 2: Financial Indicators of Mobinil EGP Million 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 Revenues 2,490 2,725 2,793 2,799 2,546 EBITDA 1,156 1,318 1,268 1,322 1,021 EBITDA Margin 46.4% 48.4% 45.4% 47.2% 40.1% Source: Company Press Releases Mobinil secured a debt facility through a bond issuance worth EGP 1.5 billion in an offer that closed on January 24, The bonds were issued through a private placement. Part of the proceeds will be used to pay for the 3G license. Mobinil is not the first operator in the Middle East to adopt such a funding strategy. Qatar Telecom pioneered debt funding in June 2009 by issuing bonds worth USD 1.5 billion, which were oversubscribed more than 8.5 times. Mobinil s bond issue was also oversubscribed. This indicates confidence in Mobinil s solid operations and its ability to increase liquidity for expansion, which is expected to improve cash flows over the medium and long term. Mobinil provided a 2009 dividend per share (DPS) of EGP 9.5. This implies a dividend yield of 5.41%. Mobinil has a flexible dividend policy which was demonstrated in 2009 when the dividend payout was reduced to enhance cash flow generation and to provide payments for a 3G license and for the completion its acquisition of LinkDotNet. Mobinil has two more payments for its 3G license, totaling EGP 1.85 billion, that are expected to be paid by year-end. According to Mobinil s CEO, Mobinil will finalize the LinkDotNet deal by July. Over the past six years, Mobinil has been paying dividends in installments throughout the year. Most investors prefer dividends to be paid in 3

4 this fashion rather than on an annual basis, as it allows them to realize returns gradually instead of receiving a lump sum at the end of the year. We expect the DPS to pick up after Mobinil completes installment payments for its 3G license. We estimate 2010 DPS to be slightly lower than 2009, at EGP 8, as there will be 3G payments in Table 3: Mobinil Dividends per Share (DPS) E DPS (EGP) The bottom line is: We like the company s focus on value-added services such as mobile banking, its aggressive entry on broadband promotions, and the upgrading its networks to 3G. Declining ARPUs, coupled with the introduction of broadband offers and value-added services, will ensure that revenues will be relatively stable going forward. We like Egypt s GDP growth of 5% in 2010, which is expected to be higher than the Middle Eastern average according to the International Monetary Fund. As growth in telecom services is correlated to GDP growth in the country, we see this as positive for Mobinil. Penetration levels of 76.4% for mobile and below 5% for broadband as of end of 2009 indicate that there is still potential for growth in subscriber numbers compared to neighboring countries. Mobinil is the market share leader in the mobile market in Egypt and we expect it to remain in this position for the next four years. We issue a Buy recommendation with a target price of EGP , implying a 31.1% upside potential. 4

5 In our initiation of coverage on Mobinil, we address selective issues of the outlook for the telecom industry in developing countries, as these will have implications for the future of Mobinil and for its competitive environment. GLOBAL INDUSTRY OUTLOOK Telecommunications are a necessary utility. While the need for mobile phones continues to grow, the magnitude of growth has been slowing as the industry is relatively mature and heading towards consolidation. Driving forces for the telecom industry are changing to adapt to the dynamic environment. With voice usage revenues for mobile operators reaching a cap level, operators are looking to enhance bottom-line profits by other means. COSTS OF SERVICES IN DEVELOPING COUNTRIES ON A SLIPPERY SLOPE While prices of telecom services are declining globally, they are still relatively expensive in developing countries compared to developed countries. As seen in the chart below, there is a wide disparity between developing and developed countries, with the former paying more for telecom services. The Information Communication Technology (ICT) Price Basket examines three telecom services (fixed line, mobile, and fixed broadband services) in 161 economies. Chart 2 : ICT Price Basket of Developed and Developing Countries Developing Countries Developed Countries Source: International Telecommunication Union ICT Price Basket 2008 ICT Price Basket 2009 Prices of telecom services in developing countries are to converge to prices in developed countries We expect prices of telecom services in developing countries to decline significantly over the coming years, slowly converging to the level of developed countries. Telecom prices in developed countries are also anticipated to decline, but only slightly. TODAY: BROADBAND PRICING DECREASES ARE INSUFFICIENT TO TRIGGER HIGH DEMAND IN DEVELOPING COUNTRIES All prices for telecom services have decreased, with broadband prices dropping the most in However, the most expensive service among the three telecom services (mobile, fixed line, and broadband) is the fixed broadband. For example, according to the International Telecommunication Union (ITU), ARPUs in Africa for fixed broadband and mobile services are relatively expensive. This high pricing for fixed broadband is reflected in the low penetration levels of around 1% of population in Africa for 2009 compared to a 39% 2009 mobile penetration rate. 5

6 Broadband to be a key driver of revenue growth in the Middle East Broadband prices should decrease significantly over the coming years. We expect that when prices are lowered, demand for broadband will rise exponentially in the Middle East. CONVERGENCE TO CONTINUE IN 2010 The trend towards convergence is expected to continue in Consumers have responded positively and exhibited high demand for multifunctional mobile phones. The success of the Blackberry and ipod products, which are oversold, is exemplary of the receptiveness for and use of multifunctional devices. Bundling services is another form of convergence, and is becoming a popular trend in the Middle East. For example, in April 2010, Telecom Egypt bid for a triple play license to supply cable, voice and internet services to residential compounds. CONSOLIDATION Consolidation is in the air for regional operators in the Middle East Egypt to follow the trend: lower prices, more subscribers for broadband and mobile services With the exception of some countries such as North Korea, the industry is generally heading towards consolidation. This is apparent in the recent wave of acquisitions, the latest of which is the Zain-Bharti deal. Zain Group sold its African unit to Bhartil Airtel for USD 10.7 billion in March 2010, excluding its Moroccan and Sudanese operations. We believe that the Bharti-Zain deal has opened the eyes of regional operators to the benefits of consolidation. This deal was one of the biggest telecom deals in the region; we expect it to be contagious, leading several regional telecom giants to follow an M&A strategy. IMPLICATIONS FOR Egypt s low broadband penetration rate will increase as prices go down and the lower-income population bracket will become part of the addressable market. However, if broadband ARPUs remain at their current high levels, growth in broadband revenues for operators will not be as strong as anticipated. As broadband ARPUs in Egypt start to converge to the ARPUs of developed countries, demand will increase strongly. We believe there to be a remarkable potential in internet services in Egypt given the low penetration levels. Bundled services to become more popular in Egypt Moreover, the bundling of services and convergence of products are expected to become more common in Egypt. In the next few years, the slope of the demand curve for internet services will become much steeper than it is today. 6

7 IAN MACROECONOMICS FAVORABLE FOR OPERATORS Young population implies high future demand for mobile services Large population with steady growth ICT sector contributes materially to Egypt s real GDP Egypt has attractive market demographics as 33% of the population is less than 15 years of age. Since young people tend to be more technologically inclined, and the addressable market will swell as more children come of age, this signifies a robust future demand for telecom services. Egypt has an estimated population of 76.7 million. Population growth is anticipated to be increasing at a steady rate of 2.0% over the next four years. The contribution of the ICT sector to real GDP is 3.6% as of the first nine months of This relatively strong contribution is expected to grow in correlation with GDP. The Egyptian GDP is estimated to increase by 5% in Egypt s GDP growth is higher than global GDP growth and will continue to be higher. Chart 3: Real GDP Growth 8% 6% 4.7% 5.0% 5.5% 5.7% 5.9% 6.2% 4% 2% 4.2% 4.4% 4.5% 4.5% 4.6% 0% -2% -0.6% -4% E 2011E 2012E 2013E 2014E World GDP Egypt GDP Source: International Monetary Fund Chart 4: GDP Growth and GDP per Capita of Selected Countries in the Middle East Region (2009) USD 80,000 60,000 40,000 20, % 10% 5% 0% -5% Iraq Egypt Jordan KSA Oman Bahrain Kuwait UAE Qatar GDP per Capita GDP Growth Source: IMF Relatively high GDP growth From a regional perspective, Egypt has stronger GDP growth than selected neighboring countries, with the exception of Qatar and Lebanon. This translates into stronger growth in consumer spending on telecom services compared to some of the other countries in the Middle East. 7

8 IAN SECTOR OUTLOOK Today, the Egyptian telecom sector is considered as one of the most liberalized in the Middle East. With three mobile players in the market, the telecom sector is highly competitive. Telecom Egypt was the incumbent telecom company when Mobinil was established in 1998 as the first competing mobile operator. In 2006, a third mobile license was awarded to Etisalat Misr for USD 3.1 billion. Etisalat entered at a time when penetration rates in Egypt were still below the average of peer countries. Market entry was more difficult in other countries in the region. In Saudi Arabia, for example, Zain KSA acquired the third mobile license for USD 6.1 billion in 2008, but Zain s entry at a time when the mobile penetration rate was above the 100% mark made it difficult for Zain to become profitable in a short period and since the market was relatively saturated Zain was unable to attain a large market share. Chart 5: Egyptian Subscribers (million) by Operator and Mobile Penetration rates % % % % % 80% 70% 60% 50% 40% 30% 20% 10% 0% E Mobinil Vodafone Egypt Etisalat Misr Mobile Penetration rates (%) Sources: Operators press releases, Ministry of Communications and Information Technology, Audi Capital Estimates Chart 6: GDP per Capita versus Mobile Penetration Rate (2009) USD 70,000 60,000 50,000 40,000 30,000 20,000 10, % 150% 100% 50% 0% Iraq Egypt Jordan KSA Oman Bahrain Kuwait UAE Qatar GDP per Capita Penetration Rate Sources: Business Monitor International, International Monetary Fund, regulators, Audi Capital estimates Fixed line penetration rates have remained relatively stable, with a slight deceleration over the last three years, a period during which mobile penetration has been expanding exponentially. This was expected due to the fixed-to-mobile substitution trend taking its toll and the fierce price wars that occurred in the second half of 2009 between the three mobile operators. In the fourth quarter of 8

9 2009, mobile ARPUs declined to around USD 6.5. There continued to be a drop in the first quarter of 2010 to USD 5.6. As ARPUs continue decreasing as per our expectations, the lower-income households will come into the addressable market as a result of lower pricing on voice services and value-added services. The Egyptian mobile market is highly concentrated with prepaid subscribers constituting around 90% of the total subscriber base. The low proportion of postpaid subscribers is one reason for low ARPUs. Demand for data services has been on the increase for the last few years. Total broadband revenues in Egypt are estimated to have been about 5% of total revenues for mobile operators in It is expected that they will constitute 10% of total revenues in 2011, as prices for these services become more competitive. From a regional perspective, offers for mobile services in Egypt are among the most competitive. Operators have been competing on a price-basis, placing pressure on their EBITDA margins. However, mobile broadband and mobile banking have not yet been introduced in Egypt. Therefore, we see growth potential in the Egyptian market from data services, value-added services such as mobile banking, and improving efficiency measures which provide economies of scale. Figure 1: Overview of the Egyptian Telecom Sector Mobinil was established in May. It paid $320 million for the license. Six months later, VFE launched operations, paying $512 for the second license. Telecom Egypt acquired its first stake of 8.6% in VFE. VFE acquired 3G license for $591 million in March Etisalat Misr started operations in May 2007, paying $3.1 billion for the third license. Mobinil launched 3G services. Intense price war between the three mobile operators E Total mobile subscribers (millions): 0.1¹ Mobile Penetration: 0.1% 7.8% 40.6% 54.8% 76.4% 93.0% ¹ Figure as of June E 12% 11% 51% 44% 42% 46% 39% 50% 5% Mobinil Market Share Vodafone Egypt Market Share Etisalat Misr Market Share Sources: ITU, operators websites, Audi Capital Estimates 9

10 COMPETITIVE FORCES OF THE MOBILE INDUSTRY IN Figure 2: Porter s Five Forces for Providing Telecom Services in Egypt Threat of Substitutes - Possible threats to Mobinil's services could be software applications that allow users to make voice calls over the internet, such as Skype, affecting voice revenues for Mobinil. - Another threat to Mobinil would be landlines, although fixed line penetration rates have been decreasing due to the fixedto-mobile substitution effect. Buyer Power High Bargaining Power of Buyers - There are two other mobile operators and negligible switching costs through mobile number portability. - There is no buyer concentration as there are millions of users. Price increases would affect usage levels. Threat of Substitutes Low Competitive Rivalry High Entry Barriers Very High Bargaining Power of Suppliers - Telecom infrastructure equipment can be purchased from numerous suppliers. - Quality among suppliers differs. -Large selections of handset brands, meaning low concentration of suppliers. Competitive Rivalry - Competition between operators is on a price basis as seen in the price war in Operators try to offer various value-added services to differentiate themselves. Supplier Power Low - Moderate Threat of New Entrants - New entrants have to pay for an expensive license through a bidding process authorized by the government. - Large capital requirements are needed to build infrastructure. -High mobile penetration rate in Egypt. SHEDDING LIGHT ON MOBINIL S ENVIRONMENT The mobile industry is reaching a mature stage, with entry barriers, the threat of substitutes, and the bargaining power of suppliers all being in favor of Mobinil. We believe that in this maturing market, Mobinil should focus on differentiating itself. The operator should also take efficiency-improving measures and retain subscribers by continually offering new value-added services. 10

11 THREE CAKES AND A HOT OVEN It can be something of a challenge to make a great cake. In Egypt, there are three operators in the process of making a cake, each one different from the other. The oven symbolizes the Egyptian telecom environment, which inevitably affects each of the operators. THE REGULAR ONE Telecom Egypt was the only operator before the entry of Mobinil and Etisalat. It is currently the sole fixed line provider in Egypt. There is a general consensus that companies in which governments have a controlling stake tend to be slightly disadvantaged in terms of marketing abilities and customer-oriented services. Telecom Egypt has been increasing its data services and generates a positively growing free cash flow. However, its fixed line subscribers have been decreasing due to the fixed-to-mobile substitution trend. It has a 45% ownership in Vodafone Egypt, the country s second mobile operator, which has been contributing to growth in its bottom line and subscribers. Telecom Egypt s future growth drivers are its strong presence and market share leadership in data services offerings, such as broadband. We categorize it as the regular one since it is growing steadily, with sustainable positive free cash flows, and a focus on data services. THE ONE WITH RASPBERRY FILLING Mobinil has been providing value-added services and strong promotions to its subscribers revenues grew by 8%, EBITDA by 9%, and earnings by 3%. Revenues have decelerated because of its aggressive promotions and lower tariffs. Strong mobile competition has led to Mobinil s ARPU diminishing significantly to EGP 32 as of the first quarter of 2010, an 18% decline y-o-y. Mobinil will be employing a high capex strategy for 2010 to complete its 3G network. We categorize it as the one with raspberry filling as we perceive it to be successfully adopting a differentiation strategy, and is a leader in new services. It was the first to announce the launching of its 3G network and has intentions to start mobile banking in the near future. THE ONE WITH ELABORATE ICING The third telecom operator, Etisalat Misr, launched its services in It had a market share of 12% as of the end of The icing on this cake is the only thing that is holding it together as it is covering the holes of the cake. These holes are the result of circumstances beyond the control of Etisalat Misr. Being the third market entrant, it paid dearly for the license, and fell victim to the aggressive nature of competition in the Egyptian mobile business. Price-slashing was the motto in the Egyptian mobile industry throughout WHAT WE LIKE Mobinil seems to be the most satisfying choice for us, as it has distinguished itself among operators as a customer-service company, with notable growth over the last few years. It has established a 3G network and continues to work on upgrading and maintaining its networks. We see continued growth in all operators from broadband services as the penetration rate is estimated at below 5% of population in Egypt. We consider Mobinil to be the best-positioned operator in Egypt since it was the first to expand networks to 3G, is an initiator of value-added services, and is expected to have a strong presence in the broadband segment. 11

12 PRICE WAR: OPERATOR RIVALRY LEADS TO FIERCE COMPETITION Figure 3: Prepaid Line Promotions Q3 09 Etisalat Misr launched Cross-net tariff plan for EGP 0.19 Nov Mobinil launched on-net rate for EGP Vodafone then offered a flat rate of EGP 0.19 Dec Etisalat presented a flat rate of EGP 1.99 per minute on all international calls. - Vodafone offered same promotion after two weeks During the first half of 2009, telecom operators enjoyed high growth in revenues coupled with reasonable promotions. Market parameters changed in the second half of 2009, when operators started to compete with aggressive offers. In the third quarter of 2009, Etisalat Misr was the first to launch its Ahlan Kol El Nas (Everybody Welcome) promotion, in which its prepaid subscribers can call at a flat rate EGP 0.19 per minute. In November 2009, Mobinil followed suit with its Khat El Masry (The Egyptian Line) campaign, offering prepaid subscribers the lowest on-net rate of EGP 0.08 per minute. Vodafone countered this move with its Kol El Masrayeen (All of the Egyptians) promotion, offering a flat rate of EGP Etisalat subsequently re-launched its Ahlan Kol El Nas with an additional 90 free minutes of talk time for each user. For postpaid customers, Etisalat initiated an unlimited line offer. Similar offers were then launched by Mobinil and Vodafone. In December 2009, operators presented subscribers with discounted international rates. Etisalat Misr offered an EGP 1.99 per minute flat rate to any destination in the world. After two weeks, Vodafone introduced an identical offer. Mobinil then proposed a 15% discount on international calls. In the first quarter of 2010, Mobinil matched the terms of the promotions of Etisalat and Vodafone, and the promotion continued in the second quarter of The heated competition started taking its toll in the second half of 2009 and is expected to continue throughout We expect ARPUs to deteriorate significantly, reaching USD 5 in the second quarter of 2010 (down 11% from the previous quarter) as competition between operators remains intense. While we see an increase in usage levels for voice services in Egypt, declining ARPUs will keep revenues from growing in the high double digits. We believe growth will come mostly from improving operating efficiency, data services, bundling services, and consolidation. 12

13 ARPUs expected to continue weakening Mobinil had 26.1 million subscribers by the end of the first quarter, a significant increase of 23% q-o-q. The surge in subscribers was due to the price war in the second half of 2009, which lowered ARPUs but also resulted in the addition of a new lower-income subscriber segment to the addressable market. Operating revenues reached EGP 2,546 million for the first quarter of 2010, a 2% rise from the first quarter of Average blended ARPU declined to EGP 32 in Q from EGP 39 in Q The competitive price reductions in the second half of 2009, including the Khat El Masry promotion, caused a drop in ARPUs from EGP 40 in the second quarter of 2009 to EGP 37 in the fourth quarter of Our estimates indicate that Vodafone Egypt s ARPUs decreased much more than Mobinil s. This shows that Mobinil has a greater ability to sustain rock-bottom prices than its rivals. Vodafone Egypt (VFE) reported a 30% rise y-o-y in customers as of Q and a 1% rise in revenues for the same period. We believe there has been a larger decrease for VFE in ARPU levels y-o-y. The price war in the second half of 2009 among the three existing operators (Mobinil, Vodafone Egypt, and Etisalat Misr) continued to have an effect in the first quarter, evident in further weakening ARPUs. INTERCONNECT ISSUE RESOLVED IN FAVOR OF MOBINIL On June 7, 2010, Mobinil won the court case as the Administrative Court ruled in favor of the old interconnection rates. The old interconnection rates comprise of a fixed rate between Telecom Egypt and the mobile operators. The rate between the mobile operators is also fixed under the old interconnect agreement at EGP 0.115/minute. On the National Telecommunications Regulatory Authority announced that it will appeal the court s recent decision announced two days ago. The rates were changed in an unsymmetrical way under the new interconnect policy. Rates for an operator terminating on Mobinil, Vodafone Egypt, Etisalat Misr, and Telecom Egypt (TE) were EGP 0.085/minute, EGP 0.1/minute, EGP 0.11/minute, and EGP 0.065/minute, respectively. The second change in interconnect rates were the terminating rates from TE to Mobinil at EGP 0.113/minute, and from Mobinil to TE at EGP 0.065/minute. The problem arised two years ago between fixed line operator Telecom Egypt (TE) and mobile operators Mobinil and Vodafone Egypt (VFE). TE said that the fixed-to-mobile interconnect rates were making it less competitive. As a result, in September 2008, the regulator announced that the rates should be lowered. Mobinil filed a lawsuit protesting this decision as it considers the unequal rates among operators to be unfair. The company continued to record interconnect revenue and costs based on the old rates. In January 2010, TE filed a claim, requesting Mobinil to pay USD 364 million for remaining interconnect costs. Mobinil management stated that it will not pay unless the relevant authorities say it must. We continue to use the old interconnect rates in our forecasts as Mobinil continues to apply the old rates. NOTE Mobile termination rate is the revenue operator A receives when a subscriber from operator B calls a subscriber using Operator A s network. Operator A will charge Operator B a fee for terminating the call on its network. 13

14 COMPANY OVERVIEW In 1998, the Egyptian Company for Mobile Services (ECMS) was Egypt s first mobile operator. Mobinil, the brand name of the company, provides telecom and internet services. It is listed on the Cairo and Alexandria Stock Exchanges. Since July 2008, Orascom Telecom has been one of Mobinil s majority stakeholders along with France Telecom (FT). In April 2010, Orascom Telecom agreed to a new shareholding structure that included capping its direct ownership in ECMS at 20%. The company ended the year 2009 with 25.4 million subscribers, a 26% rise from 20.1 million in Mobinil is the leading GSM operator in Egypt, with a dominant market share of 42% as of the end of The overall mobile penetration rate was 76.4% at the end of Mobinil acquired a 3G license in 2007 and announced the launch of 3G networks in September The other two wireless operators have also acquired 3G licenses. The broadband market in Egypt has potential as the penetration rate was below 5% as of the end of Egypt is characterized by low incomes and a low internet user penetration rate of 14.5% as of Prices need to decline in order for a demand for broadband services to develop. Figure 4: Ownership Structure of Egyptian Company for Mobile Services (ECMS) France Telecom 71.25% 28.25% Orascom Telecom Free Float 29% Mobinil 51% ECMS 20% STRATEGY Since the market is reaching a stabilization stage, mobile revenues should stabilize and grow approximately in line with the country s GDP at a rate of around 5%. Mobinil will be focusing on broadband services, as this market is underpenetrated, and value-added services for differentiation. 14

15 AT LAST OT-FT SETTLEMENT ON MOBINIL In April 2010, Orascom Telecom (OT) and France Telecom (FT) settled their disputes on the ownership structure over Mobinil, after having battling in several courts for over a year. The terms of agreement are as follows: FT will be paying OT USD 300 million as a control premium for Mobinil, OT s direct stake in ECMS will be no more than 20%, FT is to be involved in the day-to-day management activities of Mobinil as it will have a controlling stake, OT will have voting rights in material decisions, although FT has the majority control and voting rights for ordinary decisions concerning Mobinil, and OT gets put option rights to sell all its Mobinil interests to FT at a price between EGP and EGP per share. OT will be using the equity method for reporting Mobinil s financial figures, a change from the consolidation method used previously, and FT will be applying the consolidation method of accounting. FINANCIAL ANALYSIS 1Q 2010 AT A GLANCE Operating revenues reached EGP 2,546 million for the first quarter of 2010, a 2% rise from EGP 2,490 million in the same quarter of Average blended ARPU declined to EGP 32 in Q from EGP 39 in Q The price war in the second half of 2009 among the three existing operators (Mobinil, Vodafone Egypt, and Etisalat Misr) continued to have its effect in the first quarter, evident in weakening ARPUs. Table 4: Mobinil ARPUs over the Past Five Quarters (EGP) 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 Blended Monthly ARPU Excluding Visitor's Roaming Prepaid Monthly ARPU Postpaid Monthly ARPU Source: Company Press releases EBITDA stood at EGP 1,021 million at the end of the first quarter, a 12% plunge from EGP 1,156 million the previous year. EBITDA margins are on a downward trend. EBITDA margin for the first quarter of 2010 was 40.1% compared to 46.4% in Q1 2009, a decrease of 630 basis points. Mobinil closed the quarter with million subscribers, a 23.3% increase y-o-y from million for the same period last year. Consolidated net income was EGP 357 million this quarter, a 2.4% fall from EGP 366 million in the same quarter last year. 15

16 EBITDA margins are expected to improve in the second half of 2010 based on our expectations that Mobinil will be improving operating efficiency and focusing more on offering new services to subscribers rather than on competing with other operators on pricing, as it did in the price war that occurred in the second half of Chart 7: Quarterly Revenue vs. EBITDA margins (EGP million) % 46.4% 40.1% 60% 40% Q 07 1Q 08 1Q 09 20% 0% Earnings EBITDA Margins Sources: Company press releases, Audi Capital estimates A GLIMPSE OF 2009 Mobinil s total operating revenues for 2009 went up by 7.9% to EGP 10,807 million from EGP 10,015 million in This rise is associated with an increase in mobile subscribers and higher demand for data services. Subscriber additions for the year were 5.25 million in 2009 compared to net additions of 5 million in The price war resulted in lower-than-expected ARPUs of EGP 37 for the fourth quarter of 2009 compared to EGP 44 for the same period in Reported EBITDA was EGP 5,122 million, a 9.4% advance from EGP 4,681 million in the previous year. EBITDA margins improved by 66 basis points and reached 47.4% in This improvement was due to higher revenues having a cascading effect down to the EBITDA level. Selling, general, and administrative expenses grew 2% y-o-y, reaching EGP 1,722 million. Depreciation and amortization grew by 14.9% y-o-y to EGP 1,907 million, owing to increasing capital expenditure for expanding and upgrading networks. Net operating profit increased by 4.2% to EGP 3,214 million. Interest expense accelerated by 23.4%, and reached EGP 724 million. Mobinil reported positive net foreign currencies exchange differences in 2009 of EGP 38 million compared to a loss of EGP 55 million recognized in Chart 8: Yearly Revenue vs. EBITDA margins (EGP million) 2,500 2, % 46.7% 47.4% 46.6% 49.2% 60% 1,500 40% 1, ,824 1,970 2,038 1,827 1, E 2011 E 20% 0% Earnings EBITDA Margins Sources: Company press releases, Audi Capital estimates Net Profit for the year went up by 3.5%, from EGP 1,970 million to EGP 2,038 million. EPS for the 12 months in 2009 was EGP compared to EGP in

17 CAPITAL STRUCTURE Chart 9: Debt Structure (EGP million) 10,000 8, % 135.4% 182.4% 192.9% 250% 200% 6,000 4, % 2, ,550 4,980 5,739 7, Q E 100% 50% Debt Debt/Total Capital Sources: Company Press Releases, Audi Capital estimates Mobinil improved its leverage position during 2009 by reducing its debt by 10.3%, from EGP 5,550 million in 2008 to EGP 4,980 million in In the first quarter of 2010, debt levels increased due to the issuance of bonds worth EGP 1.5 billion. The issue closed oversubscribed, demonstrating investor confidence in Mobinil and positive market sentiment. Current debt-to-total-capital levels are relatively high at 182% as of the first quarter of 2010, but are expected as the company is financing its capital expenditures for the completion of its 3G network rollout and the acquisition of LinkDotNet from Orascom Telecom. The LinkDotNet deal is valued at EGP 650 million. We anticipate that levels of debt will decrease slightly over the coming years, as EGP 1.85 billion for the 3G network is expected to be fully paid by year-end, which will reduce the need to finance capital expenditures. The optimal debt to total capital level for the company is estimated at 80%. We believe that the operator could opt for a rights issue if further financing is needed in order to avoid a further increase in its leverage level. 17

18 SWOT ANALYSIS STRENGTHS 1 Mobile market leader. 1 First operator to announce the launch of 3G networks in September Initiator of value-added services. 1 Ability to access the capital markets even in tight market conditions. 1 Broadband penetration in Egypt below 5% as of Mobile penetration in Egypt at 76.4% as of WEAKNESSES 1 Heavy concentration of prepaid subscribers compared to postpaid subscribers. 1 Low average household income could lead to lower than anticipated demand for the 3G network. 1 Mobile revenues are stabilizing, with a 3.4% growth in 2010 revenues expected for the Egyptian mobile sector. 1 High capex spending could put pressure on dividends. 1 Telecom Egypt is the broadband market leader. OPPORTUNITIES 1 Demand for 3G services, enabling subscribers to have faster services to upload and download data. 1 Higher demand for broadband achieved by lowering prices is a catalyst for revenue growth. 1 Demand for value-added services, such as mobile banking. THREATS 1 Unfavorable policy decisions by the regulator with respect to interconnect fees as well as other possible unfavorable regulatory decisions. 1 Stronger than expected price competition in

19 VALUATION FREE CASH FLOW TO THE FIRM Using the Free Cash Flow to the Firm (FCFF) model, we have estimated the intrinsic value of Mobinil derived from the forecasted financials below. The assumptions of the FCFF were based on a fiveyear forecast period and a WACC of 9.7%. The fair value obtained from this model is EGP , indicating a 31.13% upside potential over the current price of EGP When looking at Mobinil in 2014, we have assumed that much of the anticipated growth from data services would be recognized, reflecting the move of the company into the saturation stage, leaving limited growth opportunities other than organic growth. Going forward, a growth rate of 1.25% in the FCFF model has been assumed. Table 5: Forecasted Free Cash Flows (EGP million) 2010 E 2011 E 2012 E 2013 E 2014 E Net Income 1,827 1,867 1,905 2,133 2,274 Change in Working Capital 1, Non-Cash Charges 2,238 2,430 2,500 2,539 2,583 Capex 2,819 2,438 2,357 2,425 2,495 Interest Expense Free Cash Flow to the Firm 691 2,490 2,657 2,788 2,859 Present Value of Free Cash Flow to the Firm 629 2,069 2,012 1,924 1,799 Present Value of Terminal Value 21,531 Intrinsic Value of the Firm 29,965 Net Debt 2010 E 7,119 Intrinsic Value of Equity 22,845 WACC 9.7% Terminal Growth Rate 1.25% Shares Outstanding (million) 100 NAV (EGP) Source: Audi Capital estimates EV/EBITDA VALUATION Using the EV/EBITDA valuation model, we have arrived at an intrinsic value for Mobinil. We chose a sample of peer operators in the region and took the average of EV/EBITDA for the current and 2009 levels. Since 2009, Mobinil has been trading at a discount to the peer sample when looked at from an EV/EBITDA multiple. We have then taken the average of the two averages and arrived at a multiple of 6.05 for the industry. As such, and following a conservative approach, we have applied a discount of 10% to compute our fair value for Mobinil of EGP

20 Table 6: EV/EBITDA Valuation EV/EBITDA Current 2009 Average Mobinil Saudi Telecom Company Mobily Zain Group Qatar Telecom Orascom Telecom Maroc Telecom Etisalat Wataniya Telecom Telecom Egypt Average Discounted Average 5.50 Sources: Bloomberg, Audi Capital estimates Table 7: Deriving Fair Value for Mobinil EV/EBITDA EBITDA 2010 (EGP Million) 5,210 Enterprise Value (EGP Million) 28,648 Net Debt Q (EGP Million) 5,449 Minority Interest Q (EGP Million) -1 Market Capitalization (EGP Million) 23,200 Shares Outstanding (million) 100 NAV (EGP) per share Sources: Company financials, Audi Capital estimates FAIR VALUE Combining the FCFF Valuation and the EV/EBITDA Valuation, we arrive at a fair value of EGP We allocate 50% of the valuation weight to the FCFF Valuation and 50% to the EV/EBITDA Valuation. Table 8: Valuation Combination Methodology Fair Value (SAR) Valuation Weight Weighted Fair Value FCFF Valuation % EGP EV/EBITDA Valuation % Source: Audi Capital estimates 20

21 PRO FORMA FINANCIALS Table 9: Consolidated Balance Sheet (EGP million) E 2011 E 2012 E 2013 E 2014 E Fixed Assets (net) 8,911 9,894 10,224 10,403 10,611 10,845 Assets Under Construction License Fees (net) 2,956 4,484 4,162 3,840 3,518 3,196 Investments Available for Sale Rent Deposits Total Long Term Assets 12,770 15,171 15,181 15,040 14,928 14,842 Inventory Accounts Receivable Other Debit Balances Prepaid Expenses Cash at Banks and on Hand Total Current Assets 1,869 1,752 1,775 1,757 1,937 1,925 Total Assets 14,640 16,923 16,956 16,797 16,864 16,768 Provisions Banks Facilities Short Term Loans 407 2,650 2,650 2,500 2,400 2,000 Creditors 2,521 1,911 1,896 1,921 1,975 2,033 Other Credit Balances 1,116 1,153 1,144 1,159 1,192 1,227 Accrued Expenses & Other Payables 993 1,378 1,306 1,331 1,369 1,408 Total Current Liabilities 6,000 7,383 7,286 7,200 7,226 6,958 Excess of Current Liabilities over Current Assets -4,131-5,630-5,511-5,443-5,289-5,033 Net Investments 8,639 9,541 9,669 9,597 9,639 9,810 Paid Up Capital 1,000 1,000 1,000 1,000 1,000 1,000 Treasury Shares Reserve (Gains from Treasury Shares) Legal Reserve Equity Settled Share Based payments Retained Earnings 2,438 2,576 3,544 4,199 4,932 5,706 Total Equity Attributable to Equity Holders of the Company 3,680 3,818 4,785 5,441 6,174 6,947 Minority Interest Total Equity 3,679 3,817 4,784 5,439 6,172 6,945 Long Term Creditors - Licenses Fees Long Term Payable Long Term Loans 4,013 3,371 2,832 2,379 1,998 1,679 Bonds - 1,342 1, Deferred Tax Liabilities Total Long Term Liabilities 4,961 5,724 4,885 4,158 3,468 2,865 Total Equity & Long Term Liabilities 8,639 9,541 9,669 9,597 9,639 9,810 Source: Mobinil, Company financials, Audi Capital estimates 21

22 Table 10: Consolidated Income Statement (EGP million) E 2011 E 2012 E 2013 E 2014 E Operating Revenue 10,807 11,171 11,081 11,226 11,546 11,882 Cost of Services -2,039-2,150-2,039-2,077-2,136-2,198 Other Operating Costs -1,776-1,874-1,776-1,809-1,861-1,915 Selling, General, and Administrative Expenses -1,722-1,787-1,662-1,740-1,732-1,782 Estimated EBITDA 5,270 5,360 5,604 5,600 5,817 5,986 Estimated EBITDA Margins 48.8% 48.0% 50.6% 49.9% 50.4% 50.4% Reported EBITDA 5,122 5,210 5,447 5,443 5,654 5,819 Reported EBITDA Margins 47.40% 46.64% 49.15% 48.49% 48.97% 48.97% Depreciation & Amortization -1,907-2,238-2,430-2,500-2,539-2,583 Remuneration, Allowances, and Salaries of Board Members Impairment Losses of Accounts Receivable Net Provisions Total Operating Costs -7,592-8,215-8,072-8,294-8,439-8,655 Net Operating Profit (EBIT) 3,214 2,956 3,009 2,932 3,107 3,227 Impairment Losses of Investment Interest Income Other Income Interest Expense Capital Loss Net Foreign Currencies Exchange Differences Net Profit for the Year before Income Tax 2,573 2,298 2,349 2,396 2,683 2,860 Current Tax Deferred Tax Income Tax Net Profit for the Year 2,038 1,827 1,867 1,905 2,133 2,274 Equity Holders of the Company 2,038 1,827 1,867 1,905 2,133 2,274 Minority Interest ,038 1,827 1,867 1,905 2,133 2,274 Earnings Per Share (EGP) Dividends Per Share (EGP) Source: Mobinil, Company financials, Audi Capital estimates 22

23 APPENDIX: FORECASTED SUBSCRIBERS, MARKET SHARE, PENETRATION RATES, AND ARPUS Chart 10: Mobinil Subscibers (million) and Market Share % % 41% 40% 40% E 2011 E 2012 E 40% 0% Mobinil Subscribers Mobinil Market Share Source: Company press releases, Audi Capital Estimates Chart 11: Egypt Mobile Penetration Rates 120% 103.0% 110.0% 100% 93.0% 80% 76.4% 60% E 2011 E 2012 E Source: Operator s website, Audi Capital Estimates Chart 12: Mobinil ARPU Forecasts (EGP) E 2011 E 2012 E Source: Company press releases, Audi Capital Estimates 23