UNCERTAINTY SURROUNDS THE SECTOR

Transcription

1 KSA TELECOM SECTOR UNCERTAINTY SURROUNDS THE SECTOR We remain Overweight on STC and Neutral on Zain, while downgrading Mobily to Neutral. We are cautious on the sector due to 1) uncertainty on Mobily s outlook, 2) Zain vs. Mobily lawsuit, 3) impact of changing interconnection charges and 4) MVNOs (Virgin Mobile and Lebara) beginning operations. However, we believe STC is the best pick in the sector due to the strong fundamentals and positive dividend outlook. We expect earnings for the sector to increase 12% YoY in 2015E, to SR15.5bn. Remain OW on STC, Neutral on Zain; Downgrade Mobily to Neutral: We downgrade Mobily to Neutral with a PT of SR52.0 of the back off the ongoing concerns regarding its financials as well as growth expectation. We maintain our OW rating for STC with a PT of SR82.6, supported by strong fundamentals. We remain Neutral on Zain with a PT of SR7.5. We believe Zain s outlook concerns are fairly reflected in the stock price. Recent events at Mobily lead to cautious outlook: Although Mobily stock price declined 48.9% since September due to the recent restatements and accounting issues, we remain cautious on the company s outlook. We have reduced our net income estimates for 2015E by 42.7% to SR3.92bn. Net income is expected to grow 9% in 2015E with a CAGR growth of 3.8% going forward. Based on bear case scenario analysis, write-off and slower than expected growth could reduce the PT to SR37.3 while the PT could increase to SR58.9 if Mobily managed to return to pre-crisis profitability. Mobily vs. Zain lawsuit negatively impacts the sector: We believe the outcome of Mobily vs. Zain lawsuit is critical for the sector given its impact on the outlook of both companies. If Zain wins the case, Mobily will write-off SR1.1bn, adding more pressure on its uncertain outlook. While if Mobily wins the case, Zain will be obligated to pay SR2.2bn and therefore have its breakeven point revised even further. Although we expect long procedures, the outcome will negatively impact the overall sector outlook either way MVNOs entry to impact MNOs: We believe competition in the sector will increase, as Virgin Mobile and Lebara commence operations. Mobily and STC are expected to benefit from MVNOs in the form of higher revenue from unused infrastructure, however, Zain is at a disadvantage as it will be competing with four players. Sector earnings to grow 12% YoY in 2015E: We expect the sector earnings to grow 12% YoY in 2015E to SR15.5bn, mainly driven by a 6.5% growth at STC. With concerns surrounding other operators, STC remains our top pick due to positive earnings outlook and higher dividend potential. The sector is currently trading at 2015E P/E of 10.8x in-line with peers average. Saudi Telecom companies Valuation matrix P/E EV/ P/BV DY ROE ROA PT MCap Stock perf (%) (x) EBITDA (x) (%) (%) (%) Rating (SR) $mn Dec YTD STC OW , Mobily N ,775 (1.2) (44.4) Zain KSA N 7.5 1,961 (14.4) (26.9) NM (14.3) (2.8) Iyad Ghulam i.ghulam@ncbc.com Source: NCBC Research, All prices as of 25 December 2014 N: Neutral, UW: Underweight, OW: Overweight, NC: Not Covered Please refer to the last page for important disclaimer

2 KSA TELECOM SECTOR Analysis of Mobily concerns Overview on the latest developments at Mobily Mobily s accounting issues impacted investors and lenders confidence Mobily reported an unexpected poor set of 3Q14 results and restated the 2013 and 2014 financial statements. The revision was mainly due to an error in revenue recognition. This was combined with higher bad debt provisions, higher opex and depreciation costs which led to a restatement of around SR1,080mn. On a restated basis, revenues declined by 14.8% YoY. The main issues highlighted by the auditors include revenue recognition concern on loyalty programs and capital lease related to fiber optics. Moreover, the significant increase in account receivables from SR5.7bn to SR10.2bn during the last four years is also a concern. In 3Q14, Mobily reported provisions of SR471mn related to impairments of inventory and goodwill. Restatements and the further potential write-offs could trigger more problems going forward. Mobily has always been an attractive dividend paying company. However, considering the recent events which could involve further provisions, the sustainability of the current dividend policy is questionable as it could trigger loans covenants. It could also restrict the company s ability to raise more debt. Mobily s has a total debt of SR15.3bn with a 2015E debt to equity ratio of 0.44x. Mobily vs. Zain legal issues overshadow the sector Mobily recently initiated arbitration proceedings against Zain in regards to a network infrastructure agreement signed on May 6, Mobily claims that an amount of SR2.2bn in exchange for services provided must be paid by Zain. Mobily had to make a SR1.1bn provision due to the delay in receiving the amount. The Company has requested arbitration proceedings in accordance with the Service Agreement as Zain have not paid the amount. Zain claims that the amount owed to Mobily is fully paid except for SR13mn remains outstanding. Moreover, the company states that the claims made by Mobily are against CITC regulations. We expect the trial to be lengthy putting more negativity on the sector. Sensitivity analysis on Mobily and Zain We believe the current issues surrounding the sector reduce the clarity to forecast its outlook. We have performed a sensitivity analysis on Mobily and Zain, assuming different scenarios regarding 1) growth, 2) write-offs and 3) outcome of the arbitration proceedings. We believe this gives a better clarity on earnings and Price Targets for both companies. Three scenario analysis on Mobily Base Case: Revenue to grow 7.3% YoY in 2015E and normalize thereafter at a CAGR of 3.2% Net margin to rise from 18.1% in 2015E to 18.5% in 2019E Going forward, no additional write-offs assumed Bull Case: Mobily achieves a high revenue growth of 7.3% + 8% going forward from 2014 levels Margin expansion on decline in cost of services by 2% 2

3 KSA TELECOM SECTOR Arbitration results go in favor of Mobily No additional write-offs against its receivables Bear Case: Revenue growth remains flat after declining 7.6% in 2014E Margins decline on increase in cost of services Arbitration results go against Mobily Mobily writes-off SR1.1bn Mobily faces additional write-offs of SR2.1bn related to high account receivables Exhibit 1: Impact on Mobily s PT and Net Income SR mn unless specified Scenarios Bear Base Bull 2015 net profit 1,613 3,916 4, net profit 1,702 4,012 4, Net margin 8.1% 18.1% 20.0% Net Income CAGR ( ) (31.2%) 5.7% 15.5% PT (SR) Source: NCBC research Three scenario analysis on Zain Base Case: Revenue to grow 10.1% YoY in 2015E and normalize thereafter at a CAGR of 4.6% Net losses to decline by 45% in 2015E, with the company achieving breakeven by 2020E Bull Case: Arbitration results go in favor of Zain Zain benefits from decline in Interconnection charges Bear Case: Arbitration results go against Zain Zain pays SR2.2bn Exhibit 2: Impact on Zain s PT and Net Income SR mn unless specified Scenarios Bear Base Bull 2015 net profit (1,277) (727) (267) 2016 net profit (1,015) (464) Net Profit (836) (280) Net Profit PT (SR) Source: NCBC research 3

4 KSA TELECOM SECTOR Outlook summary High dividend yields no longer a key attraction in the sector We highlighted in our previous report that the frequent and high dividend yields being the key strengths of the sector. However, we believe the recent set of incidents in the Saudi telecom sector could have an impact on the dividend paying ability of the companies involved. Given Mobily s failure to pay dividends for 3Q14 and the lack of further clarity, we reduce Mobily s dividends expectation in 2015E to SR2/share with a dividend yield and payout ratio of 4.2% and 39% respectively. The potential of not paying dividends at all remains an option. On the other hand, STC have already increased its dividends to SR4/share with a dividend yield of 5.7% and a payout ratio of 65% in 2015E. Further dividends growth could be constrained if the company explores M&A opportunities in the MENA region. Top-line pressures expected as the sector approaches maturity We expect total revenue of the three stocks under coverage to rise by 4.7% YoY in 2015E and expand at a CAGR of 3.3% thereafter. This compares to a CAGR of 9.4% between While growth in data remains the key sector driver, voice is approaching maturity given the expected increase in penetration from 169% in 2014 to 180.7% in 2018E along with ARPU pressure. We believe the operators will seek to grow through improving operational efficiencies and implementing cost optimization programs. We expect earnings of the covered stocks to increase 12.0% in 2015E, with a CAGR of 4.8% thereafter. Exhibit 3: Total mobile subscribers (mn) and Penetration rate % Q14 2Q E 2015E 2016E 2017E 2018E 190% 185% 180% 175% 170% 165% 160% 155% 150% Mobile Subscribers (mn) Penetration (RHS) Source: CITC 2Q14 report, NCBC Research The increase in mobile subscribers signals an end to SIM cancellations According to the latest CITC data, the total number of mobile subscribers in Saudi increased for the first time in two years, to 51mn in 2Q14. This implies a penetration level of 169.3%. CITC regulations and restricted free international roaming had resulted in a decline in mobile subscriptions from a peak of 53.7mn in 2011 to 49.8mn in 1Q14 (with penetration rates dropping from 188% to 165.1%). However, as stated in our previous update, we believe the effect of these one-offs has ended and we expect the mobile subscriber count to grow at a CAGR of 2.9% for the period E, with penetration levels stabilizing at 180.7% by 2018E. 4

5 KSA TELECOM SECTOR Exhibit 4: Wireless broadband subscriber and Penetration rate % Q14 2Q E 2015E 2016E 2017E 2018E 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Wireless broadband subscribers (mn) Penetration (RHS) Source: CITC 2Q14 report, NCBC Research Revision in interconnection charges could re-shape the sector CITC recently announced its plans to reconsider interconnection charges between the telecom operators in the Kingdom. The current charges for mobile at SR0.25/min are considerably higher than the global average of SR0.08/min. As mentioned in our previous sector update, we believe these charges play a significant role in determining the profitability of the sector. We believe STC and Mobily benefit the most from the current interconnection charges due to their large market share. Zain, on the other hand, has the lowest market share and is required to pay a high off-network minute charge of SR0.25. This forms the bulk of Zain s expenses (54.3% of cost of services). Based on our assumption of a decline in charges to SR0.08, we believe Zain s cost of service will drop by SR558mn, thereby enabling it to achieve break-even faster than expected (2017E). We also expect STC and Mobily to be negatively impacted with their revenues declining by SR321mn and SR236mn, respectively. Overall, we believe any revision in charges to have a significant positive impact on Zain, thereby improving the outlook of the company. However, if changing interconnection charges was followed by a reduction of end-user minutes prices, the picture will be different. We believe the sector profitability will be negatively impacted, putting further pressure on stock prices. Virgin Mobile and Lebara launch operations as first Saudi MVNOs Virgin mobile, in partnership with STC (STC owns 10%), was the first MVNO to launch its services in Saudi. The company targets the youth and expatriate segment. Under this partnership, Virgin Mobile will have access to STC s network and infrastructure. Jawraa Lebara has also started its operations targeting the expat community in the kingdom. The company had initially planned to launch its service in March 2014 but issues related to interconnection charges led to subsequent delays. Axiom Telecom is the third MVNO expected to enter the Saudi telecom space with a partnership with Zain. However, no progress has been announced recently. 5

6 KSA TELECOM SECTOR In the past five years, the global MVNO markets grew rapidly. Virgin Mobile has successfully managed to grow in the UK with over 4mn customers, gaining more than 8% market share in its five years of operations. This was supported by its strategy to target the young customer base, a model the company plans to replicate in Saudi. We believe the entry of MVNOs will benefit end users due to availability of a wide range of competitive and innovative services. However, it will increase competition for existing players in an already saturated market. While partnership with MVNOs could lead to an additional source of revenue that helps support revenues, the risk of strong competition remains with a potential margin contraction. Telecom sector the worst performer on sector-specific concerns Mobily and Zain declined 48.9% and 39.8%, respectively since the highest point recorded by the TASI in September We believe these declines were due to the recent weakness in oil prices, but more importantly the recent events at both companies. The concerns surrounding the two stocks and the decline in oil prices negatively impacted the price of STC, which declined 7.2% from its high of SR75.8. The Telecom index declined 33.7% since Sep-2014 and is down 21.5% YTD. This compares to a decline of 21.5% for the TASI, which is up 2.5% YTD. The sector is trading at 2015E P/E multiple of 10.8, in-line with peers average. Exhibit 5: 3-month return of covered stocks, sector and TASI STC TASI Sector Zain Mobily -6% -22% -34% -40% -49% Source: Tadawul 6

7 KSA TELECOM SECTOR Recent company events Zain proposes restructuring program through capital reduction Zain proposed a capital restructuring program which will reduce the capital by SR4.9bn and the number of shares by 496.3mn shares i.e. 45.9% of total capital. We believe this is purely an accounting measure. It aims to prevent Zain from falling into CMA s radar with respect to new regulations implemented in July 2014, regarding companies with accumulated losses of over 50% of their paid up capital. This is the second time Zain involves in a capital restructuring program. In July 2012, Zain reduced its capital by SR9.1bn or 65.7% of capital. Since then, Zain reported significant losses as a result of higher D&A charges and other financial costs. Consequently, the company s accumulated losses surged. STC international investments at risk of FX losses Other than its operations in Bahrain and Kuwait, STC has international operations in Turkey, Malaysia and South Africa. Given the recent strength in the US$, currencies in these countries have depreciated 7.9%, 6.6% and 10.5% YTD, respectively. We believe STC s exposure to these countries could result in short-term margin pressures on account of FX volatility, thereby impacting its bottom-line. Historically, STC has faced currency pressure, with losses from FX for 2013 coming-in at SR5mn in 2013 vs. SR153mn in

8 KSA TELECOM SECTOR Changes to estimates In the table below, we have highlighted the changes to our 2014E and 2015E numbers and price targets since our last update on the sector in September Exhibit 6: Changes to estimates In SR mn, unless otherwise stated Old 2014E New 2014E % Chg % Gr Old 2015E New 2015E Saudi Telecom Co. Revenue 46,513 45,846 (1.4) ,003 47,121 (1.8) 2.8 Gross profit 28,003 28, ,951 29, EBITDA 18,850 19, ,446 19, Adjusted EBIT 11,978 12, ,332 12, Adjusted net profit 11,440 11, ,252 12, Price target SR (2.7) Mobily Revenue 26,115 20,208 (22.6) (7.6) 27,756 21,674 (21.9) 7.3 Gross profit 13,606 10,952 (19.5) (7.6) 14,427 11,719 (18.8) 7.0 EBITDA 9,541 6,770 (29.0) (16.5) 10,078 7,396 (26.6) 9.2 EBIT 6,637 3,610 (45.6) (35.7) 6,911 3,921 (43.3) 8.6 Net profit 6,547 3,592 (45.1) (35.8) 6,834 3,916 (42.7) 9.0 Price target SR (50.4) Zain KSA Revenue 6,263 6, (3.9) 6,884 6, Gross Profit 3,218 3, ,788 3,678 (2.9) 13.3 EBITDA 1,194 1,076 (9.8) ,723 1,564 (9.2) 45.3 EBIT (498) (557) NA NA (32) (140) NA Adjusted net profit (1,272) (1,318) NA NA (621) (727) 17.0 NA Price target SR (29.3) % Chg % Gr 8

9 KSA TELECOM SECTOR Summary of changes to estimates STC Changes in the P/E based peer valuation have led to a 3.1% reduction in our PT. We have revised downwards our revenue estimates slightly by % for 2015E-16E on the back of lower-than-expected revenue growth in 3Q14. This has slightly reduced our PT by 0.4% Mobily We have revised down our revenue estimates by 22-23% for E as well as declined our estimates along all the profit lines by 19-43% for the same period, on the back of the significantly poor 3Q14 results which saw restatements in the top-line as well as higher opex leading to margin pressure. We have also reduced our EBIT-Net margin estimates by bps for E. These changes in the fundamentals led to a decline in our PT by 50.2%. We have reduced the premium over peers to -5% from 10% taking into account the recent concerns. Changes in the P/E based peer valuation have led to a 2.1% reduction in our PT. Zain We have revised downwards our revenue estimate by around 4% for 2014E while keeping it flat for E, mainly due to slowdown in the Telecom sector due to increasing competition. We have reduced the premium over peers to 20% from 50% given the issues surrounding the stock. Changes in the P/B based peer valuation have led to a 6.3% reduction in our PT. 9

10 TELECOM SAUDI TELECOM COMPANY COMPANY UPDATE Defensive name, top pick in the sector We remain Overweight on STC with a PT of SR82.6. We expect STC s net income to grow 6.5% in 2015E of the back off improved revenues and lower costs. Growth through potential expansion opportunities in MENA remains key driver. The performance of international subsidiaries and higher dividends are key catalysts. The stock currently trades at a 2015E P/E of 11.4x, compared to peers average of 9.2x which we believe is justified given the strong fundamentals and attractive dividend yield of 5.7%. STC revenues marginally impacted by lower interconnection charges: CITC is planning to reduce interconnection charges. The current interconnection charge placed by CITC is SR0.25/min. This compares to a global average of SR0.08/min. Provided that STC has the biggest market share in Saudi, we believe STC is the biggest beneficiary of interconnection charges. Therefore, we expect the reduction to reduce STC s revenues by approximately 0.4% or SR321mn, if charges decline to SR0.08/min. Expansion within the MENA region; potential catalyst: STC has SR20.5bn in cash and ST investments on its balance sheet. We believe the potential use of this cash reserve is a key determinant for STC s outlook. Based on the management feedback, we believe STC is looking for expansion opportunities both locally and within the MENA region. With revenues from international operations increasing 66.7% YoY in 3Q14 and the maturity of the Saudi market, we believe expansion will be a key catalyst for growth going forward. Best dividend yield in the sector: In-line with our expectations, STC increased its quarterly dividend to SR1.0/share, taking its DPS to SR3.5 for 2014E. Mobily s recent issues which restricted its ability to pay dividends, which in turn increased the attractiveness of STC as a key dividend name in the sector. We expect a DPS and dividend yield of SR4.0 and 5.7% in 2015E, increasing to SR5.0/share and 7.1% in 2016E, respectively. Remain Overweight on STC with PT of SR82.6: We maintain our Overweight rating on STC with a PT of SR82.6. This is mainly driven by strong fundamentals and attractive dividend outlook. However, the performance of controlled subsidiaries, strong domestic competition, and FX exposure are the key risks. The stock currently trades at 2015E P/E of 11.4x, a premium to peers average of 24%, which we believe is justified. Summary Financials SR mn 2013A 2014E 2015E 2016E 2017E CAGR (%) Revenues 45,605 45,846 47,121 48,795 50, Gross profit 27,413 28,351 29,055 30,104 31, EBITDA 18,471 19,445 19,763 20,445 21, EBITDA margin (%) Adjusted net income 11,001 11,594 12,348 12,782 13, Adj. net margin (%) EPS (SR) DPS (SR) Source: Company, NCBC Research estimates OVERWEIGHT Target price (SR) 82.6 Current price (SR) 70.4 STOCK DETAILS M52-week range H/L (SR) 76/54 Market cap ($mn) 37,586 Shares outstanding (mn) 2,000 Listed on exchanges TADAWUL Price perform (%) 1M 3M 12M Absolute 6.2 (4.2) 28.5 Rel. to market Avg daily turnover (mn) SR US$ 3M M Reuters code Bloomberg code VALUATION MULTIPLES 7010.SE STC AB 13A 14E 15E Reported P/E (x) Adjusted P/E (x) P/B (x) EV/EBITDA (x) Div Yield (%) SHARE PRICE PERFORMANCE Dec-13 Jun-14 Dec-14 Source: Bloomberg STC Tadawul (RHS) Iyad Ghulam i.ghulam@ncbc.com Please refer to the last page for important disclaimer

11 SAUDI TELECOM COMPANY Financials Exhibit 7: Income Statement In SR million, unless otherwise stated Revenues 44,745 45,605 45,846 47,121 48,795 50,323 % change Cost of services (19,483) (18,191) (17,495) (18,066) (18,692) (19,246) Gross profit 25,262 27,413 28,351 29,055 30,104 31,077 Gross margin (%) Operating expenses (15,516) (16,425) (15,886) (16,162) (16,863) (17,452) EBITDA 16,273 18,471 19,445 19,763 20,445 21,147 EBITDA margin (%) Dep. & Amortization (6,337) (6,378) (6,980) (6,870) (7,204) (7,521) EBIT 9,746 10,989 12,465 12,892 13,241 13,625 EBIT margin (%) Financing costs (678) (143) (153) (139) (126) (111) Other inc./expenses, net 313 1, Pre-tax profit 7,378 10,448 12,868 13,461 13,935 14,427 Tax (Zakat) (215) (230) (799) (633) (656) (679) Reported net income 7,276 9,897 11,594 12,348 12,782 13,234 Adjusted net income 7,467 11,001 11,594 12,348 12,782 13,234 % change Net margin (%) EPS (SR) Exhibit 8: Balance Sheet In SR million, unless otherwise stated Cash & cash equivalent 1, ,036 10,328 13,268 16,812 Other current assets 11,148 10,831 11,613 11,801 12,326 12,829 Total current assets 21,432 32,161 32,768 37,248 40,714 44,761 Net fixed assets 39,873 38,402 39,086 39,702 40,232 40,422 Intangible assets, net 5,054 4,608 3,778 3,318 2,857 2,396 Investments 13,394 9,592 9,592 9,592 9,592 9,592 Other assets 1, ,021 Total non-current assets 61,073 55,199 59,039 59,234 59,349 59,119 Total assets 82,505 87,360 91,807 96, , ,880 Short-term loans 1,411 1,561 1,964 1,868 1,704 1,540 Other current liabilities 15,376 14,016 14,660 14,647 14,940 14,952 Total current liabilities 16,787 19,650 16,624 16,516 16,644 16,492 Long-term loan 9,953 6,976 6,160 5,539 4,991 4,358 Other liabilities 4,580 4,570 5,186 5,762 6,483 7,337 Total non-current liabilities 14,533 11,547 13,346 13,301 13,474 13,695 Total liabilities 31,320 31,197 29,969 29,816 30,118 30,187 Share capital 20,000 20,000 20,000 20,000 20,000 20,000 Reserves & surplus 21,944 26,889 31,935 36,283 39,065 42,299 Shareholders' funds 51,337 56,230 60,868 65,216 67,998 71,232 Total equity & liabilities 82,505 87,360 91,807 96, , ,880 11

12 SAUDI TELECOM COMPANY Exhibit 9: Cash Flow Statement In SR million, unless otherwise stated Cash flow from op. (a) 15,723 19,636 22,969 19,218 20,042 20,651 Cash flow from inv.(b) (12,802) (15,662) (4,882) (6,689) (6,885) (6,825) NOPLAT 9,462 10,746 11,692 12,286 12,618 12,984 WC 2,370 (1,043) (137) (200) (232) (491) CAPEX (6,142) (7,711) (6,835) (7,025) (7,274) (7,250) Depreciation 6,337 6,378 6,980 6,870 7,204 7,521 Free cash flow 12,027 8,370 11,700 11,931 12,316 12,764 Cash flow from fin.(c) (4,989) (4,427) (8,938) (8,237) (10,216) (10,283) Net chg. in cash (a+b+c) (2,068) (454) 9,150 4,292 2,940 3,544 Cash at start of the year 3,683 1, ,036 10,328 13,268 Cash at end of the year 1, ,036 10,328 13,268 16,812 Exhibit 10: Key Ratios Per share, unless otherwise stated EPS FCF per share Div per share Book value per share Valuation ratios (x) P/E P/FCF P/BV EV/sales EV/EBITDA Div yield (%) Profitability ratios (%) Gross margins Operating margin EBITDA margins Net profit margins ROE ROA Liquidity ratios Current ratio Quick Ratio Operating ratios (days) Inventory Receivables outstanding Payables outstanding Operating cycle Cash cycle

13 TELECOM MOBILY RATING CHANGE Recent events lead to outlook uncertainty We downgrade Mobily to Neutral with a PT of SR52.0. The major accounting incident which was followed by dividend cuts and CMA investigations have shocked the market and impacted investors and lenders sentiment. Moreover, Mobily will be facing additional challenges which include increasing competition, change in interconnection charges and sector maturity. Although Mobily is currently trading at a 2015E P/E of 9.3x, we remain cautious on the company as overall risks outweigh any potential upside. Weak growth expectations in 2015E: The poor 3Q14 results due to revenue recognition error led to a restatement of SR1.1bn. We believe this raises concerns of further write-offs which negatively impacted investor s confidence. We expect 2015E revenues to rise 7.3% YoY and to increase at a CAGR of 3.2% thereafter, leading to a net income CAGR of 3.8%. Mobily is expected to report a net income of SR3.9bn in 2015E. As the market is maturing, we believe Mobily will be facing difficulty returning to pre-crisis profitability levels. High accounts receivable of SR9bn signal a concern: Since it started selling its promotional capital lease plans, Mobily s total receivables grew significantly from SR5.7bn in 2010 to SR10.2bn. We believe this was due to aggressive revenue recognition methods. The company has taken a total provision of SR471mn for 9M14 with further potential write-offs. We believe this could impact the profitability of the company significantly. Arbitration issue with Zain to potentially impact outlook: We believe the recent lawsuit with Zain over the payment of SR2.2bn will have a significant impact on Mobily s outlook. If Mobily lose, we expect its PT to decline by 28% to SR37.3. Please refer the sensitivity analysis for more details. Unclear dividend outlook: We believe the recent issues will impact Mobily s dividend payout. Mobily did not pay any dividend in 3Q14. We believe the company will pay a DPS of SR2.0 in 2015E, reflecting a dividend yield of 4.2% and vs. our previous estimate of SR5.0 and 5.5%, respectively. Downgrade to Neutral on weak outlook: We downgrade Mobily to Neutral due to the recent issues surrounding the company as well as the uncertain outlook. The stock is currently trading at a 2015E P/E of 9.3x, a discount of 2.1% to peers which we believe is justified. Summary Financials SR mn 2013A 2014E 2015E 2016E 2017E CAGR (%) Revenues 21,866 20,208 21,674 22,254 23, Gross profit 11,850 10,952 11,719 12,009 12, EBITDA 8,112 6,770 7,396 7,738 8, EBITDA margin (%) Net income 5,598 3,592 3,916 4,012 4,198 (6.9) Net margin (%) EPS (SR) (6.9) DPS (SR) (15.0) Source: Company, NCBC Research estimates Please refer to the last page for important disclaimer NEUTRAL Target price (SR) 52.0 Current price (SR) 47.5 STOCK DETAILS M52-week range H/L (SR) 98/39 Market cap ($mn) 9,775 Shares outstanding (mn) 770 Listed on exchanges TADAWUL Price perform (%) 1M 3M 12M Absolute (8.0) (47.0) (43.9) Rel. to market (4.3) (29.0) (47.1) Avg daily turnover (mn) SR US$ 3M M Reuters code Bloomberg code VALUATION MULTIPLES 7020.SE EEC AB 13A 14E 15E P/E (x) P/B (x) EV/EBITDA (x) Div Yield (%) SHARE PRICE PERFORMANCE ,000 10,800 9,600 8,400 7, ,000 Dec-13 Jun-14 Dec-14 Mobily Source: Bloomberg Tadawul (RHS) Iyad Ghulam i.ghulam@ncbc.com

14 MOBILY Financials Exhibit 11: Income Statement In SR million, unless otherwise stated Revenues 23,585 21,866 20,208 21,674 22,254 23,039 % change 17.6 (7.3) (7.6) Cost of services (11,608) (10,016) (9,256) (9,954) (10,244) (10,625) Gross profit 11,977 11,850 10,952 11,719 12,009 12,414 Gross margin (%) Operating expenses (3,443) (3,738) (4,182) (4,323) (4,272) (4,284) EBITDA 8,534 8,112 6,770 7,396 7,738 8,130 EBITDA margin (%) Dep. & Amortization (2,399) (2,502) (3,160) (3,475) (3,744) (3,985) EBIT 6,135 5,610 3,610 3,921 3,994 4,144 EBIT margin (%) Interest charges, net (169) (191) (248) (247) (241) (218) Other income Pre-tax profit 6,088 5,677 3,684 4,012 4,108 4,298 Tax (Zakat) (70) (78) (91) (96) (96) (100) Net income 6,018 5,598 3,592 3,916 4,012 4,198 % change 18.4 (7.0) (35.8) Net margin (%) EPS* (SR) , *Based on 770mn shares Exhibit 12: Balance Sheet In SR million, unless otherwise stated Cash & cash equivalents 1,302 1,570 3,575 2,031 1,595 1,233 Short-term investments Other current assets 8,798 13,764 13,647 14,472 14,597 14,832 Total current assets 10,100 15,334 17,221 16,503 16,192 16,065 Net fixed assets 17,255 20,733 24,670 27,244 29,250 30,273 License fees 9,412 8,913 8,282 7,651 7,020 6,390 Goodwill 1,530 1,530 1,530 1,530 1,530 1,530 Total non-current assets 28,197 31,181 34,488 36,431 37,806 38,198 Total assets 38,296 46,515 51,709 52,934 53,998 54,263 Short-term loans Cr. portion of long-term loans ,433 1,371 1,071 1,071 Other current liabilities 8,995 11,642 13,371 12,574 12,141 11,200 Total current liabilities 9,748 12,424 14,805 13,945 13,212 12,271 Long-term loan 7,506 9,970 11,124 10,836 10,532 9,461 Other liabilities Total non-current liabilities 7,643 10,128 11,272 10,981 10,690 9,624 Total liabilities 17,391 22,552 26,077 24,926 23,903 21,895 Share capital 7,000 7,700 7,700 7,700 7,700 7,700 Reserves & surplus 13,906 16,263 17,931 20,307 22,394 24,667 Shareholders' funds 20,906 23,963 25,631 28,007 30,094 32,367 Total equity & liabilities 38,296 46,515 51,709 52,934 53,998 54,263 14

15 MOBILY Exhibit 13: Cash Flow Statement In SR million, unless otherwise stated Cash flow from op. (a) 6,173 5,535 8,838 6,011 7,452 7,230 Cash flow from inv.(b) (4,076) (3,951) (6,467) (5,418) (5,118) (4,377) NOPLAT 6,065 5,533 3,520 3,828 3,901 4,048 WC (3,549) (2,320) 1,847 (1,623) (558) (1,176) CAPEX (2,762) (5,424) (6,467) (5,418) (5,118) (4,377) Depreciation 2,399 2,502 3,160 3,475 3,744 3,985 Free cash flow 2, , ,968 2,479 Cash flow from fin.(c) (2,484) (1,315) (367) (2,137) (2,769) (3,215) Net chg. in cash (a+b+c) (387) 268 2,004 (1,544) (436) (362) Cash at start of the year 1,690 1,302 1,570 3,575 2,031 1,595 Cash at end of the year 1,302 1,570 3,575 2,031 1,595 1,233 Exhibit 14: Key Ratios Per share, unless otherwise stated EPS FCF per share Div per share Book value per share Valuation ratios (x) P/E P/FCF P/BV EV/sales EV/EBITDA Div yield (%) Profitability ratios (%) Gross margins Operating margin EBITDA margins Net profit margins ROE ROA Liquidity ratios Current ratio Quick Ratio Operating ratios (days) Inventory Receivables outstanding Payables outstanding Operating cycle Cash cycle (66) (92) (185) (124) (102) (62) 15

16 TELECOM ZAIN KSA COMPANY UPDATE Lower interconnection charges, a key catalyst We remain Neutral on Zain with a revised PT of SR7.5. We expect the company to continue to grow faster than the sector. However, this is not expected to fully translate at the bottom-line level. The implementation of the new connection charges will be a key catalyst for Zain as it will enable the company to reach break-even faster than expected. However, increasing competition with the operation of the two MVNOs is a concern as Zain has not yet signed any MVNO agreement. Revision in interconnection charges a key catalyst: We believe Zain will be a key beneficiary of the revision in interconnection charges proposed by CITC. Zain has the lowest market share among the three Telecom players and is required to pay a high off-network minute charge of SR0.25, which represents around 54.3% of Zain s cost of services. A decline in charges to SR0.08 will result in Zain s COGS declining by SR558mn, thereby enabling the company to achieve a faster-than-expected breakeven. Zain s arbitration issue with Mobily under scrutiny: Mobily recently initiated arbitration proceedings against Zain over the non-payment of SR2.2bn for services rendered under a Service Agreement. Zain claims that it has paid the required amount except for SR13mn. If Zain loses the case, it will further constrain the company s financials. This could also impact investors and lenders confidence in the company. Two restructures in two years: Zain proposed its second capital restructuring program which will reduce the capital by SR4.9bn and number of shares by mn shares. We believe this is aimed at avoiding CMA s radar with respect to new regulations implemented in July 2014, regarding companies with accumulated losses of over 50% of their paid up capital. Remain neutral with PT of SR7.5: We maintain our Neutral rating on Zain with PT of SR7.5. We have reduced our estimates to reflect the short-term concerns surrounding Zain which include the recent weak results and the impact of breaking the covenant with lenders. The reduction in interconnection charges and news about its MVNO partner will be a key catalyst while additional competition from MVNOs remains a key risk. NEUTRAL Target price (SR) 7.5 Current price (SR) 6.8 STOCK DETAILS M52-week range H/L (SR) 11.4/5.8 Market cap ($ mn) 1,961 Shares outstanding (mn) 1,080 Listed on exchanges TADAWUL Price perform (%) 1M 3M 12M Absolute (23.4) (35.1) (25.7) Rel. to market (19.8) (17.0) (28.8) Avg daily turnover (mn) SR US$ 3M M Reuters code 7030.SE Bloomberg code ZAINKSA AB VALUATION MULTIPLES 13A 14E 15E P/E (x) NM NM NM P/B (x) EV/EBITDA (x) Div Yield (%) SHARE PRICE PERFORMANCE 12 12, , , , , ,000 Dec-13 Jun-14 Dec-14 Zain Tadawul (RHS) Summary Financials 2013A 2014E 2015E 2016E 2017E CAGR (%) Revenues 6,523 6,268 6,902 7,345 7, Gross profit 3,135 3,247 3,678 4,028 4, EBITDA 890 1,076 1,564 1,851 2, EBITDA margin (%) Net income (1,651) (1,318) (727) (464) (280) NM Net margin (%) (25.3) (21.0) (10.5) (6.3) (3.6) EPS (SR) (1.53) (1.22) (0.67) (0.43) (0.26) NM DPS (SR) Source: Company, NCBC Research estimates Source: Bloomberg Iyad Ghulam i.ghulam@ncbc.com Please refer to the last page for important disclaimer

17 ZAIN KSA Financials Exhibit 15: Income Statement In SR million, unless otherwise stated Revenues 6,171 6,523 6,268 6,902 7,345 7,683 % change (7.9) 5.7 (3.9) Cost of services (3,311) (3,388) (3,021) (3,224) (3,317) (3,399) Gross profit 2,860 3,135 3,247 3,678 4,028 4,284 Gross margin (%) Operating expenses (1,981) (2,244) (2,170) (2,114) (2,177) (2,169) EBITDA ,076 1,564 1,851 2,115 EBITDA margin (%) Dep. & Amortization (1,810) (1,840) (1,6330 (1,704) (1,763) (1,821) EBIT (932) (949) (557) (140) EBIT margin (%) (15.1) (14.6) (8.9) (2.0) Financing costs (823) (723) (771) (600) (570) (598) Other inc./expenses, net Pre-tax profit (1,749) (1,651) (1,318) (727) (464) (280) Tax (Zakat) Net income (1,749) (1,651) (1,318) (727) (464) (280) % change (9.1) (5.6) (20.2) (44.9) (36.2) (39.6) Net margin (%) (28.4) (25.3) (21.0) (10.5) (6.3) (3.6) EPS (SR) (1.62) (1.53) (1.22) (0.67) (0.43) (0.26) Exhibit 16: Balance Sheet In SR million, unless otherwise stated Cash & cash equivalents 2,385 1,293 1,760 2,314 3,089 4,619 Other current assets 1,995 2,022 2,135 2,159 2,271 2,395 Total current assets 4,380 3,315 3,895 4,472 5,360 7,014 Net fixed assets 4,285 4,293 4,476 5,372 6,141 6,322 Other assets - license fees 19,226 18,276 17,327 16,377 15,428 14,479 Other assets other licenses Total non-current assets 23,636 22,927 22,083 22,033 21,856 21,094 Total assets 28,016 26,242 25,978 26,505 27,216 28,108 Short-term loans Other current liabilities 3,980 3,626 3,176 3,425 3,538 3,675 Total current liabilities 15,401 3,826 3,366 3,615 3,728 4,968 Adv. from shareholder non-cr. portion 2,563 3,034 3,433 3,585 3,737 3,889 Long-term loan 0 8,631 8,990 9,365 9,755 8,891 Other liabilities Total non-current liabilities 4,164 15,657 17,171 18,177 19,239 19,171 Total liabilities 19,564 19,483 20,537 21,792 22,967 24,139 Share capital 10,801 10,801 10,801 10,801 10,801 10,801 Reserves & surplus (2,349) (4,001) (5,319) (6,046) (6,510) (6,790) Shareholders' funds 8,452 6,759 5,440 4,713 4,249 3,969 Total equity & liabilities 28,016 26,242 25,978 26,505 27,216 28,108 17

18 ZAIN KSA Exhibit 17: Cash Flow Statement In SR million, unless otherwise stated Cash flow from op. (a) (1,150) ,796 1,884 2,158 Cash flow from inv.(b) (562) (803) (846) (1,654) (1,586) (1,058) NOPLAT (932) (949) (557) (140) WC (2,100) (376) (536) CAPEX (1,055) (860) (826) (1,600) (1,519) (974) Depreciation 1,810 1,840 1,633 1,704 1,763 1,821 Free cash flow (2,276) (345) (286) ,151 Cash flow from fin.(c) 3,316 (517) Net chg. in cash (a+b+c) 1,605 (1,092) ,530 Cash at start of the year 780 2,385 1,293 1,760 2,314 3,089 Cash at end of the year 2,385 1,293 1,760 2,314 3,089 4,619 Exhibit 18: Key Ratios Per share, unless otherwise stated EPS (1.6) (1.5) (1.2) (0.7) (0.4) (0.3) FCF per share (1.7) (0.3) (0.3) Div per share Book value per share Valuation ratios (x) P/E (4.2) (4.4) (5.6) (10.1) (15.8) (26.2) P/FCF (3.9) (21.3) (25.7) P/BV EV/sales EV/EBITDA Div yield (%) Profitability ratios (%) Gross margins Operating margin (15.1) (14.6) (8.9) (2.0) EBITDA margins Net profit margins (28.4) (25.3) (21.0) (10.5) (6.3) (3.6) ROE (27.5) (21.7) (21.6) (14.3) (10.4) (6.8) ROA (6.4) (6.1) (5.0) (2.8) (1.7) (1.0) Liquidity ratios Current ratio Quick Ratio Operating ratios (days) Inventory Receivables outstanding Payables outstanding Operating cycle Cash cycle

19 KSA TELECOM SECTOR Kindly send all mailing list requests to NCBC Research website Brokerage website Corporate website NCBC Investment Ratings OVERWEIGHT: NEUTRAL: UNDERWEIGHT: PRICE TARGET: Other Definitions Target price represents expected returns in excess of 15% in the next 12 months Target price represents expected returns between -10% and +15% in the next 12 months Target price represents a fall in share price exceeding 10% in the next 12 months Analysts set share price targets for individual companies based on a 12 month horizon. These share price targets are subject to a range of company specific and market risks. Target prices are based on a methodology chosen by the analyst as the best predictor of the share price over the 12 month horizon NR: Not Rated. The investment rating has been suspended temporarily. 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