RSI10 Etihad Etisalat Company EEC AB: Saudi Arabia Rating Target price NEUTRAL SAR53.0 (5% downside) Current price Share information Market cap (SAR/US$) SAR56.0 (23 November) 43.17bn / 11.51bn 52-week range 55.79-98.04 Daily avg volume (US$) Shares outstanding mn 770.0mn Free float (est) 61% Performance 1M 3M 12M Absolute -34.1% -36.8% -35.2% Relative to index -26.6% -24.4% -48.0% Major Shareholder: Emirates Telecoms Corp. 27.4% Gen. Organisation for Social Insce. 11.8% Valuation 12/14E 12/15E 12/16E 12/17E P/E (x) 13.1 11.5 12.3 12.2 P/B (x) 1.9 1.8 1.8 1.8 EV/EBITDA (x) 8.5 7.7 7.8 7.7 Dividend Yield 6.2% 6.2% 7.1% 7.8% Performance 101.00 91.00 81.00 71.00 61.00 51.00 Price Close Relative to TADAWUL FF (RHS) 70 30-10 11/13 02/14 05/14 08/14 Source: Bloomberg, Company data, Al Rajhi Capital 113 99 85 71 57 43 Etihad Etisalat (7020.SE) Adjusting to a new normal Pritish K. Devassy, CFA Senior Research Analyst Tel +966 11 2119370, devassyp@alrajhi-capital.com Mobily reported a 71% y-o-y decline in its Q3 2014 net profit, way below the 3% y-o-y consensus growth expectation. More importantly, the company s past financials were restated and the stock plummeted ~40% following the announcement. The restatements have not only lowered its income and valuation levels to a new normal, but have also tarnished its image as a bluechip company. Many questions on accounting practices and the dwindling business have come under the spotlight following the results. Based on the various valuation methods, we have arrived at a valuation range of SAR45-56 per share for the stock. Our new target price of SAR53 per share (downside 5%) is based on an average of our DCF and relative valuation (based on PE & EV/EBITDA) methods. We continue to remain Neutral on the stock. Revisions announced by Mobily: The restatements effectively mean that the company has revised down 23% of its aggregate revenues (SAR4.1bn) and 10% of the earnings it reported over the last few quarters, on a cumulative basis. Any timing issue of revenue recognition should not have any material impact over the long-term. However, a closer look at the company s restated financials also reveals its dwindling core business and raises questions about its past accounting policies, unexplained accounts receivable and other revenues. Focus on cash flows: Given the accounting changes, we focus mainly on the cash flows, as we have done in the past for Mobily. Since dividends are the key attraction to hold the stock, it is imperative to focus more on cash flows. While the operating cash flows can be reasonably estimated, it remains to be seen whether the company will change its capex plans. A new normal for the company: Following the reclassifications, the company now will have a new normal for its net profits, which is around half of the previous normal. The net profit growth will be driven by the FTTH(Fiber to the home) business in the coming quarters, while core profits will struggle to see growth. There is an upside risk if the company is able to sell more-than-expected FTTH capacity and continues to use lease accounting for bulk sales to its distributors. Nevertheless, this will impact the company s future revenue stream due to the upfront recognition of revenues, and will make it even more challenging to achieve sustainable growth in a saturating market. Valuation: Based on our valuation methodology, we have arrived at a target price of SAR53 per share based on an average of DCF and relative valuations. This implies a downside of 5%, and accordingly, we have a Neutral rating on the stock, and advise caution due to stock price sensitivity to the ongoing investigations and related news flow. We forecast a DPS of SAR3.5 for 2014e and 2015e as well, although the visibility is low at the moment. Note: Please refer to page 9 to understand the potential risk factors. Period End (SAR) 12/13A 12/14E 12/15E 12/16E 12/17E Revenue (mn) 25,191 17,274 17,837 17,604 17,760 Revenue Growth 6.8% -31.4% 3.3% -1.3% 0.9% Gross profit margin 51.4% 61.0% 62.0% 62.0% 62.0% EBITDA margin 36.5% 38.2% 41.0% 40.5% 40.5% Net profit margin 26.5% 19.1% 21.1% 19.9% 19.9% EPS 8.67 4.28 4.88 4.55 4.59 EPS Growth 10.9% -50.6% 14.0% -6.8% 0.9% ROE 29.8% 14.1% 16.0% 14.5% 14.4% ROCE 19.7% 9.1% 10.0% 9.2% 9.3% Capex/Sales 15.4% 41.1% 28.0% 20.0% 18.0% Disclosures Please refer to the important disclosures at the back of this report. Powered by EFA Platform 1
Restatements and Reclassifications We first try to evaluate the key announcements made by Mobily regarding its financial statements, which are: a) reclassifications relating to changes in accounting policy and b) the restatements because of the revenue timing issues. At this stage, we would like to emphasize that the below analysis is made based on our reading of the announcements and our understanding of the relevant accounting standards. There are many questions that remain to be answered and we will revisit our views and estimates, if the company provides more clarity at a later stage. Figure 1 Restatement effect on Revenue 1H13 3Q13 1Q14 2Q14 Old 11,565,452 6,444,936 6,237,265 5,989,688 New 9,609,803 4,883,455 5,094,213 3,778,975 Change (1,955,649) (1,561,481) (1,143,052) (2,210,713) % change -17% -24% -18% -37%. Units in 000 SAR Figure 2 Restatement effect on Net Profit 1H13 3Q13 1Q14 2Q14 Old 2,950,680 1,686,604 1,399,626 1,311,895 New 2,993,827 1,631,937 1,612,043 412,443 Change 43,147 (54,667) 212,417 (899,452) % change 1% -3% 15% -69%. Units in 000 SAR Reclassifications: As per the company, the reclassifications resulted from presenting revenues from the sale of bundled handsets and SIM Cards net of the related costs. As per our understanding, Mobily has changed the way it used to recognize bundled handset sales. The company now recognizes only the net revenue from the sale of bundled handsets instead of reporting revenues and costs separately. This change has resulted in a 19% cumulative write-down of its revenues. This reclassification is immaterial at the operating profit level given there were no net gains from sales; however, the previous method was inflating the revenue line. As a result of this, the net operating margin has been positively impacted. Restatements: As per the company, the restatements were, as a result of an error in the timing of revenue recognition resulting from a promotional program. The company has also adjusted its revenue and net income from the leasing fiber optic communication network due to lack of readiness for use in full by the end-user of the service. In simple words, as per our understanding, the company recognized revenues earlier than it should ideally have accounted for. Mobily had reported SAR 1.2bn revenue from the sale of capacity (FTTH) to its distributor during 1H14, which now has been restated to only SAR72mn in Q2 2014 and SAR103mn in Q3 2014 based on the readiness of the ports at the customer end. Although there is not enough clarity, we have tried to analyze these restatements as below: On customer loyalty program: The Q3 2014 financial statements briefly touched upon the company s accounting policy for its customer loyalty program. As per our understanding, the customer loyalty program (Neqaty) restatements did not affect the financials as much as the restatements due to the FTTH revisions. For every riyal of Mobily s services paid for by the subscriber, 1 point gets credited. If a subscriber accumulates as much as 750 points, the same can be exchanged for free credit for Mobily s services or at other approved partners. This in our view explains the restatement related to the customer loyalty program as the company is supposed to defer revenues equivalent to the value of points credited to the customer. Disclosures Please refer to the important disclosures at the back of this report. 2
Starting this quarter Mobily has started providing accounting treatment of its loyalty program in the notes to the financial statements. According to the same, loyalty award credits are identified as a separate component of sale and are accounted as a liability in the balance sheet, which in our view was not done in the past resulting in the restatement. On FTTH Business: The company had recognized SAR1.2bn revenue in 2Q 2014 related to a lease contract signed with a distributor as part of its FTTH business. The contract was classified as a capital lease contract by the company. Subsequently, Mobily s internal committee reviews revealed that the FTTH ports as per the contract are not ready at the customer end, and hence, the entire revenue recognition related to the contract during 2Q was not proper. Accordingly, the company restated the revenue related to this contract for Q2 from SAR 1,232mn to SAR 72mn and booked another SAR 103mn during the third quarter based on the readiness of the contracted ports. The company did not reveal whether the review was part of their regular activities or due to any other reason. This accounting treatment and restatement raises two questions as far as we are concerned. The first one relates to the treatment of accounts receivable related to the lease contracts as the company started recognizing long-term accounts receivables (SAR 2.2bn) only from the third quarter. If the long-term accounts receivable are related to these lease contracts, we are unable to understand why the same was treated differently during the second quarter and prior periods. The second question relates to the appropriateness of treating these contracts as capital leases given that the core network is normally considered as part of the company s core assets. The company had stated the following (highlights given by us) in its 2Q results announcement, which we find very interesting given the restatements in the third quarter. The company put in its strategy to accelerate the pace of spreading broadband services that carry high profit margins, by not relying totally on traditional methods in selling and providing these services, which will have a positive impact on the future revenues and profits of the company, especially with the growing demand for broadband services that have created new investment opportunities. The company has innovated new products that are sold in wholesale, featuring recurring revenues that fall under the medium-term contracts, while the long-term contracts do not carry recurring revenues, given the importance of accelerating the return on investment (Payback Period), and drawing the attention to the risks of wholesale sales contracts and capital leases. The company has prepared a mitigation plan to limit these risks. Mobily had already set a bad precedent in Q2, when it had to reverse the entire revenue related to Atheeb deal it had recognized in Q1 following the cancellation of the deal. The market regulator has also announced a probe following Mobily s results announcement. Mobily s parent company, Etisalat earlier released a statement assuring confidence about Mobily that its recovery plan is well underway. This comes following rumors of strained relations between the companies. Earlier on October 23, Mobily had announced the appointment of the Group CFO of its parent company Etisalat as its Deputy CEO. On 23 rd November, Mobily s board of directors announced suspension of the company s CEO till the Audit committee submitted the final detailed report on the restatements and related events. The responsibilities have been temporarily assigned to the Deputy CEO. In our view, serious steps are necessary to regenerate investor interest in the company. This is a significant decision especially considering the fact that Mr. Khalid was the CEO from July 2005 and was responsible for making Mobily one of the leading listed companies in Saudi Arabia. Following the suspension, Etisalat in a statement called for an independent investigation to identify the exact reasons behind the restatements. Disclosures Please refer to the important disclosures at the back of this report. 3
Our view: Focus on cash flows Focus on cash flows: Given the low growth prospects for the telecom sector, Mobily s attractiveness as an investment opportunity primarily comes from its dividend yield. We had stressed the importance of evaluating cash flows in our previous report and had moderate growth forecasts as well. However, the restatements have effectively lowered the base and given the moderate growth expectations, ability to pay dividends and thereby its FCF becomes more important from a valuation perspective. This is also prudent considering the financial restatements, as the earlier reported financial statements except the cash flow provided a distorted view. We expect the company to witness a consistent decline in its usage revenues, offset by contributions from its FTTH business till mid-2016, and a gradual growth in the ICT business thereafter. We expect the overall operating cash flow to be around SAR6.5bn in 2014e. The upside risk of higher revenues comes from the higher-than-expected FTTH Wholesale contract revenues in the future. The company s capex/sales ratio has seen variations over the past few years, from 20% in 2012 to 15% in 2013 to an expected 40% in 2014. An increase of SAR2bn in 2014 was attributed to the construction of the new headquarter in Riyadh. We expect the capex to remain at elevated levels in 2015 as the construction of the new headquarter has not been completed yet. Unlike a typical mature industry where the capex requirements taper to a minimum, the telecom industry suffers from higher capex requirements even during a mature phase owing to a) technology up-gradations and b) increase in capacity to meet the bandwidth requirements for users with no proportional increase in revenues. For 2014, we expect a capex of SAR7.1bn. Assuming no increase in debt and no major changes in working capital requirements, the company will be in a position to pay a dividend of SAR3.5 per share (lower than the Q2 2014 annualized dividend per share of SAR5). We think this is reasonable as the company has been maintaining cash at 3% of the consolidated assets in the past and has met other working capital needs by raising additional debt. Mobily has the capacity to raise further debt given its low leverage ratios. However, as we have already indicated, this is not sustainable given Mobily s situation as its top-line and bottom-line growth are expected to slowly decline, while capex will remain high. In the case of STC, the company is more attractive as its associates are undervalued. STC continues to see its domestic revenues declining. STC is also trimming costs, which have led to an increase in dividends, as we have discussed in our previous report. Mobily accounts for interconnection revenues and costs separately as compared to STC, which reports the same on a net basis. This possibly explains the high accounts receivable/prepaid expenses and equally high accounts payable/accrued expenses in the past for Mobily and not so much for STC. Other observations Some of our other observations arising from the revised financials are: a) Accounts receivable: Mobily reported a SAR3bn increase in its accounts receivable during the first nine months of 2013, and registered around SAR4.7bn increase in current assets, which is 26% of the sales reported over the same period. Even after adjusting for the reclassification and restatement, the total current assets increased by SAR4.2bn, which is still 23% of its sales. The company s operating cash flow/ebitda average of 89% witnessed during the 2009-2011 period fell to 60% in 2013 due to a sharp increase in current assets. The company has also accounted for long-term receivables of SAR2.1bn as a new line item in Q3 2014, which was not the case earlier. Disclosures Please refer to the important disclosures at the back of this report. 4
In our view, this represents the non-current revenue portion of the lease contracts/bulk sales, for which the company had recognized the entire revenue during the contract term at the beginning itself. Looking at the sharp increase in accounts receivables Mobily might face an increase in provisions related to accounts receivables. b) Other revenues : The company s reported other revenues, which accounted for around 30% of its revenues during FY2013. This segment pushed up Mobily s top-line growth to 7% in 2013, where as its core usage revenues declined by 7%. Based on the restated financial statements, the company also reported that its 9M 2013 revenues for bundled handsets stood at SAR3.5bn, which when applied for the year proportionally comes in at SAR4.7-5bn. This implies unexplained other revenue of around SAR3bn for 2013. c) Decline in core revenues: The 7% decline in usage revenues in 2013 as well as the trend of bundled handset sales in the restated periods indicates the slacking position of the company. Q2 2014 saw a quarterly decline of 5% in bundled handset sales, while Q1 2014 witnessed a 6% decline from Q3 2013. While this could have been impacted by the launch of iphone at the end of Q3, the overall bundled handset levels are clearly declining. As for its FTTH business, the company had reached 530,000 homes of fiber optic household connections in Q1 2014. In Q2, Mobily reported that it reached 850,000 homes. However, despite the increase of 320,000 new connections, the overall revenues declined on a q-o-q basis. Figure 3 Operating cash flows/ebitda for Mobily over the years Figure 4 Declining core and increasing other revenues (SARbn) 100% 90% 80% 93% 88% 89% 90% 82% 18 16 14 69% 65% 80% 70% 60% 70% 60% 50% 40% 30% 20% 60% 12 10 8 6 4 2 14% 25% 18% 9% 41% -7% 50% 40% 30% 20% 10% 0% -10% 10% 0% 2008 2009 2010 2011 2012 2013 0 2009 2010 2011 2012 2013 Usage Others Usage y-o-y Others y-o-y -20% Disclosures Please refer to the important disclosures at the back of this report. 5
PE EV/EBITDA Div yield DCF Current Al Rajhi TP Etihad Etisalat Company The new normal for earnings The adjustments to its past statements have reduced earnings visibility for the company making forecasting difficult. Based on the declining usage revenues due to the saturation in the market and assuming the FTTH project to contribute revenues evenly over the next two years, we have revised forecasts for Mobily to a new normal. The company before its restatements had an average quarterly net income of SAR1.6bn. Following the restatements, the new average net income for the first three quarters, even after adding back provisions in Q3, comes to around SAR900mn. So even if the company posts earnings of SAR1.6bn, which is highly improbable for its fourth quarter, the current year earnings would be much below our previous expectations. We expect a new normal of ~SAR3.5bn as net profit for Mobily, which is around half of our previous estimates. The valuation range arrived at through various methods is as follows: Based on PE: Until the stock prices plummeted, Mobily was trading at a two-year average forward earnings multiple of 9.4x. Assuming the company will continue to trade at its historical PE of 9.4x, the fair price comes to SAR45.9 based on our 2015 net profit estimate of SAR3.8bn. We do not expect the PE to go much below the current levels given Mobily was already trading at a good discount to the average TASI PE. Based on EV/EBITDA: The company trades at an EV/EBITDA of 7.4x, around 30% above the CEEMEA average, which is mainly due to a difference in royalty calculation. Mobily reports lower EBITDA as the company account royalty charges (~SAR1.1bn) above EBITDA, while its CEEMEA peers report the same below the EBITDA line. If Mobily continues to trade at its historical EV/EBITDA levels, the fair price comes to SAR52.3 per share based on our 2015 EBITDA estimate of SAR7.3bn. Based on dividend yields: The company s last paid dividend per share was SAR1.25 per share in Q2 2014. Mobily had a progressive dividend policy of increasing pay-outs and dividends. The increasing dividends were not sustainable, as we mentioned in our previous report, since Mobily was not generating enough free cash flows to meet its dividend payout and was depending on borrowing. Based on our dividend estimate of SAR3.5 per share for 2014, Mobily s fair value comes to SAR55.6 per share, assuming it maintains its historical dividend yield of 6.3%. Since Mobily is more viewed as a dividend stock, this probably explains the current trading price of around SAR56. Nevertheless, a lower than estimated dividend going forward will also be a major risk to the stock. Figure 5 Valuation estimates as provided by various methodologies 60 53.5 55.6 56.1 56.0 53.0 50 45.9 40 30 20 10 0 Disclosures Please refer to the important disclosures at the back of this report. 6
Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Etihad Etisalat Company Figure 6 Historic PE multiples Figure 7 Historic EV/EBITDA multiples 12 11 10 9 8 7 6 10 9 8 7 6 5 4 3 2 1 0 Disclosures Please refer to the important disclosures at the back of this report. 7
Our valuation and estimates Valuation: We continue to value the company using a mix of DCF and relative valuation methods. Based on our PE and EV/EBITDA estimates, we have arrived at a valuation of SAR45.9 and SAR53.5 per share respectively. Based on our DCF valuation, the fair value per share comes at SAR56 per share. Based on our methodology, we have taken the average of DCF and relative valuation methods and arrived at a target price of SAR53 per share for the stock. For the relative valuation, we have given equal weightage to PE and EV/EBITDA multiples. New estimates: As per Mobily s Q2 quarterly earnings report, the company innovated new products that are sold in wholesale, featuring recurring revenues which fall under the medium-term contracts, while the long-term contracts do not carry recurring revenues and had drawn the attention to the risks of wholesale sales contracts and capital leases. This clearly shows the non-repetitive nature of the long-term contracts that the company has signed with the distributors and bulk buyers. Assuming two years for the completion of the current FTTH lease (that which was reversed); we have forecasted the contribution per quarter to be around SAR150m, which is more than what it has realized in Q2 and Q3 of 2014. In any case, based on the analysis below, the potential for future connections is limited. There are 4.7m households in Saudi Arabia (3m Saudi and 1.7m non-saudi) as per the latest census data. Assuming a 75% maximum penetration for Saudi households (similar to developed markets) and 50% for non-saudi households, the total potential broadband connections is 3.1mn. At the end of 2014, STC plans to reach 1.5mn households, while Mobily plans to connect 1.2mn households by 2014 (total of 2.7mn), leaving limited potential from newer fiber optic connection/leases. This is also reflected in the CITC data on total fixed-line broadband connections. The total wireline broadband connections have slowed from 9% in 2013 to 6% annualized by Q2 2014. However, when more housing units come online, revenue might pick up gradually. Figure 8 Fixed Wireless and Wireline Broadband connections in Saudi Arabia 2008 2009 2010 2011 2012 2013 Q2 2014 Total lines (mn) 1.04 1.44 1.74 1.95 2.54 2.92 3.18 growth 38% 21% 12% 30% 15% 9% Fixed Wireless 0.04 0.1 0.2 0.3 0.6 0.8 1 growth 150% 100% 50% 100% 33% 25% ADSL 1 1.34 1.54 1.65 1.822 1.862 1.812 growth 34% 15% 7% 10% 2% -3% FTTx/Leasing 0.118 0.258 0.368 growth 119% 43% Total wireline broadband 1.94 2.12 2.18 growth 9% 3% As for other estimates, we have forecasted Mobily s voice revenues and mobile data ARPU to decline. The company s operating margins will increase in the future as the handset business is a near zero-margin business. However, this will not change its absolute level of profits. If the company signs more wholesale revenue contracts than expected, there is a possibility of a further increase in margins as these contracts deliver high margins. This could be because the company has already been capitalizing expenses for its fiber optic infrastructure and is only accounting for revenues and direct costs while recognizing the same. Without that, the operating margins could drop over the long-term given the increase in exposure to the lowmargin ICT business. While the company had estimated a 25% margin for the ICT business, our understanding from the European markets convinces us that the margin would be much lower. We apply an additional risk premium of 0.5% while calculating cost of equity for Mobily to account for the increased risk perception on the company post the restatements. Disclosures Please refer to the important disclosures at the back of this report. 8
Overall, we highlight our new estimates as follows in the table below: Figure 9 Summary 2014 2015 2016 2017 Revenue 17,273,523 17,836,540 17,603,508 17,760,157 EBITDA 6,603,105 7,312,981 7,129,421 7,192,864 EBITDA margin 38.2% 41.0% 40.5% 40.5% Net profit 3,298,546 3,758,994 3,504,271 3,534,434 DPS 3.50 3.50 4.00 4.36 Cash flow from ops 6,514,129 7,108,908 6,923,926 6,986,333 Cash flow from investment (8,272,654) (4,994,231) (3,520,702) (3,196,828) Cash flow from financing 1,530,291 (2,695,000) (2,695,199) (3,083,758) Upside/Risks to our estimates a) There is upside potential to our forecasts and target price a. in the event of a reduced timeline for completion of its FTTH leasing b. if the company is able to recover all the long-term accounts receivable c. in the event of higher contribution from the ICT business d. if the company continues to borrow to pay higher dividends (short-term upside only, not sustainable) e. if there are more than expected FTTH contract businesses signed in the future, leading to substantial additional revenues f. if the company decides to do a stock split as it has the capacity to do so g. if the company outlines a clear strategy for future growth b) The main downside risks are related to: a. decrease in dividends due to i. if capex increases given that the construction of headquarter building is not over ii. require to pay creditors earlier than estimated iii. reduced ability to increase debt or refinance existing debt iv. further increase in receivables b. higher-than-expected provisions and write-offs c. further restatements/reclassifications during Q4 as the current changes relate to the first nine months of 2013 and first half of 2014 d. adverse outcome from the ongoing regulatory investigations Q4 might provide more clarity We believe that Mobily s Q4 results could provide more clarity on its sustainable revenue/earnings levels. Other key areas to watch out for in Q4 results are trends in usage revenues, accounts receivable (current and long-term) & capex, accounting treatment of lease contracts and any further changes in accounting standards. The company s Q4 result announcement will be a reflection of the company s intentions, and seriousness to resolve the current issues and regain investor confidence. Disclosures Please refer to the important disclosures at the back of this report. 9
Nov-00 Mar-01 Jul-01 Nov-01 Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13 Mar-14 Etihad Etisalat Company Where is the sector headed? Increased challenges, muted expectations: The broader telecom sector is facing increased challenges not just in Saudi Arabia, but also across the globe; with most telecom companies struggling for growth. The sector touched its peak during the last decade with the internet boom benefitting the telecom space, as reflected in the premium PE multiples seen in the below chart. Telecom companies currently not only lack growth, but also face a unique situation of higher capex requirements in their mature phase unlike most other sectors. Generally when sectors mature, the capex levels decrease as most of the capital expenses would be related to maintenance costs in the absence of expansions. However, for the telecom industry, the capex is high even in the mature phase because of a) technology upgradations (from 2G to 3G to 4G etc) b) more investment toward enhancing capacity for the data-hungry users, especially in Figure 10 Historical MSCI World Telecom PE multiples 30 25 20 15 10 5 0, Bloomberg urban areas given the bandwidth constraints all of this with no proportionate increase in revenues. Data users are keener in Saudi Arabia than most other regions across the world given the lack of entertainment options. Saudi Arabia operates at the higher end of the spectrum for its data transmission, which has lower data capacity/bandwidth than the lower end of the spectrum (900 MHz range). All this is despite the fact that Saudi Arabia and its Gulf peers have seen much lesser competition than its Western counterparts due to the relatively favorable regulatory environment as the government owns substantial stakes in telecom operators. Although the contribution of these firms (relative to oil) to the government s coffers will not matter much, the telecom sector will continue to be regulated favorably given the importance of security and e-commerce initiatives. In Saudi Arabia, telecommunication companies constitute 10% of the total market capitalization of the listed companies. This is much higher as compared to the weights of telecom service companies based in the US or in the Eurozone, where their total market cap is less than 5% of their respective indices. What is the way out? The sector s declining voice revenues will have to stabilize before we can see a strong positive contribution from the data revenues to push forward the telecom companies overall growth. In fact, after years of weak performance, there has been some renewed interest in the telecom sector in some developed countries, because a) data usage has started picking up and b) pricing is improving because of consolidation in a highly competitive market. However, this is ruled out for the local market as there are only three serious players in the market. Saudi Arabia, like its GCC peers, has call rates that are among the highest in the world, leaving no scope for further increase. If anything, they can only fall Disclosures Please refer to the important disclosures at the back of this report. 10
given that the termination charges for the mobile companies have not been changed for more than four years now. Globally, most regulators lower the termination charges paving the way for price declines and competition. Venturing into international markets for growth has also not turned out to be successful because of the intense competition in the markets. STC also entered the international markets only to exit at a later stage due to struggling operations. The international expansion phase saw the company s dividends per quarter shrink from a stable 0.75 per share to SAR0.5 per share. Currently for Q3, STC s DPS was at SAR1 per share. In most western countries, innovations have been happening in the fixed-line space with the quad play services, HDTV and interactive TV services, etc. This business requires heavy investments because of the costly process of laying infrastructure. This is an area where STC enjoys a competitive edge over the other two players given that it owns majority of the capacity. Broader implications: Over the past many years, given the brand image Mobily has built in the Kingdom, the stock had become an attractive option for both institutions and retail investors. True to its image, Mobily was the mobile data pioneer in Saudi Arabia and the Gulf region over 2009-12, growing aggressively and offering investor attractive returns. Unfortunately, the company is no more the same as it was a few years back. As discussed earlier, the attraction to hold the stock is mainly for its dividends. The restatements have not only dented investor confidence as a blue-chip company, but could possibly put pressure on the other TASI-listed companies, to enhance disclosure practices. None of the telecom companies currently provide operational numbers even as basic as the number of subscribers for various services on a consistent basis. Globally, telecom companies are known for their detailed reporting standards with companies such as Vodafone, which has presence in around 30 countries, providing operational details to the extent of total minutes spoken on phone for most of its regions. Even within the region, some telecom companies clearly have much better disclosures. Disclosures Please refer to the important disclosures at the back of this report. 11
Income Statement (SARmn) 12/13A 12/14E 12/15E 12/16E 12/17E Revenue 25,191 17,274 17,837 17,604 17,760 Cost of Goods Sold (12,243) (6,731) (6,778) (6,689) (6,749) Gross Profit 12,948 10,543 11,059 10,914 11,011 Government Charges S.G. & A. Costs (3,758) (3,941) (3,746) (3,785) (3,818) Operating EBIT 6,688 3,382 3,825 3,568 3,596 Cash Operating Costs (16,001) (10,671) (10,524) (10,474) (10,567) EBITDA 9,190 6,602 7,313 7,129 7,193 Depreciation and Amortisation (2,502) (3,220) (3,488) (3,561) (3,597) Operating Profit 6,688 3,382 3,825 3,568 3,596 Net financing income/(costs) (191) (250) (323) (323) (323) Forex and Related Gains Provisions - - - - - Other Income 257 342 353 348 352 Other Expenses Net Profit Before Taxes 6,755 3,474 3,855 3,594 3,625 Taxes (78) (176) (96) (90) (91) Minority Interests - - - - - Net profit available to shareholders 6,677 3,299 3,759 3,504 3,534 Dividends (3,696) (2,695) (2,695) (3,084) (3,358) Transfer to Capital Reserve - - - - - 12/13A 12/14E 12/15E 12/16E 12/17E Adjusted Shares Out (mn) 770.0 770.0 770.0 770.0 770.0 CFPS (SAR) 11.92 8.47 9.41 9.18 9.26 EPS (SAR) 8.67 4.28 4.88 4.55 4.59 DPS (SAR) 4.800 3.500 3.500 4.005 4.361 Growth 12/13A 12/14E 12/15E 12/16E 12/17E Revenue Growth 6.8% -31.4% 3.3% -1.3% 0.9% Gross Profit Growth 8.1% -18.6% 4.9% -1.3% 0.9% EBITDA Growth 7.7% -28.2% 10.8% -2.5% 0.9% Operating Profit Growth 9.0% -49.4% 13.1% -6.7% 0.8% Net Profit Growth 10.9% -50.6% 14.0% -6.8% 0.9% EPS Growth 10.9% -50.6% 14.0% -6.8% 0.9% Margins 12/13A 12/14E 12/15E 12/16E 12/17E Gross profit margin 51.4% 61.0% 62.0% 62.0% 62.0% EBITDA margin 36.5% 38.2% 41.0% 40.5% 40.5% Operating Margin 26.6% 19.6% 21.4% 20.3% 20.2% Pretax profit margin 26.8% 20.1% 21.6% 20.4% 20.4% Net profit margin 26.5% 19.1% 21.1% 19.9% 19.9% Other Ratios 12/13A 12/14E 12/15E 12/16E 12/17E ROCE 19.7% 9.1% 10.0% 9.2% 9.3% ROIC 23.7% 9.7% 10.4% 9.3% 9.4% ROE 29.8% 14.1% 16.0% 14.5% 14.4% Effective Tax Rate 1.2% 5.1% 2.5% 2.5% 2.5% Capex/Sales 15.4% 41.1% 28.0% 20.0% 18.0% Dividend Payout Ratio 55.4% 81.7% 71.7% 88.0% 95.0% Valuation Measures 12/13A 12/14E 12/15E 12/16E 12/17E P/E (x) 6.5 13.1 11.5 12.3 12.2 P/CF (x) 4.7 6.6 6.0 6.1 6.1 P/B (x) 1.8 1.9 1.8 1.8 1.8 EV/Sales (x) 2.1 3.2 3.2 3.2 3.1 EV/EBITDA (x) 5.7 8.5 7.7 7.8 7.7 EV/EBIT (x) 7.8 16.6 14.8 15.7 15.4 EV/IC (x) 1.6 1.6 1.5 1.5 1.5 Dividend Yield 8.6% 6.2% 6.2% 7.1% 7.8% Disclosures Please refer to the important disclosures at the back of this report. 12
Balance Sheet (SARmn) 12/13A 12/14E 12/15E 12/16E 12/17E Cash and Cash Equivalents 1,570 2,442 1,862 2,570 3,276 Current Receivables 8,654 6,960 7,029 7,099 7,169 Inventories 915 842 817 792 768 Other current assets 4,228 4,794 4,889 4,985 5,084 Total Current Assets 15,334 14,977 14,535 15,385 16,236 Fixed Assets 20,733 23,835 25,922 26,461 26,642 Investments 6 5 5 4 4 Goodwill 1,530 1,530 1,530 1,530 1,530 Other Intangible Assets 8,913 8,425 7,845 7,265 6,685 Total Other Assets - 2,161 2,161 2,161 2,161 Total Non-current Assets 31,181 35,957 37,463 37,422 37,022 Total Assets 46,515 50,934 51,998 52,807 53,258 Short Term Debt 782 1,082 1,082 1,082 1,082 Trade Payables 11,529 11,627 11,627 11,627 11,627 Dividends Payable Other Current Liabilities 112 111 111 111 111 Total Current Liabilities 12,424 12,820 12,820 12,820 12,820 Long-Term Debt 9,970 14,267 14,267 14,267 14,267 Other LT Payables - - - - - Provisions 158 953 953 1,342 1,616 Total Non-current Liabilities 10,128 15,220 15,220 15,609 15,883 Minority interests - 2 2 2 2 Paid-up share capital Total Reserves 23,963 22,893 23,957 24,377 24,554 Total Shareholders' Equity 23,963 22,893 23,957 24,377 24,554 Total Equity 23,963 22,894 23,958 24,379 24,555 Total Liabilities & Shareholders' Equity 46,515 50,934 51,998 52,807 53,258 Ratios 12/13A 12/14E 12/15E 12/16E 12/17E Net Debt (SARmn) 9,182 12,907 13,488 12,780 12,074 Net Debt/EBITDA (x) 1.00 1.95 1.84 1.79 1.68 Net Debt to Equity 38.3% 56.4% 56.3% 52.4% 49.2% EBITDA Interest Cover (x) 48.2 26.4 22.7 22.1 22.3 BVPS (SAR) 31.12 29.73 31.11 31.66 31.89 Cashflow Statement (SARmn) 12/13A 12/14E 12/15E 12/16E 12/17E Net Income before Tax & Minority Interest 6,755 3,474 3,855 3,594 3,625 Depreciation & Amortisation 2,502 3,220 3,488 3,561 3,597 Decrease in Working Capital (4,190) 1,324 (138) (142) (145) Other Operating Cashflow 546 (1,505) (96) (90) (91) Cashflow from Operations 5,613 6,514 7,108 6,923 6,986 Capital Expenditure (3,871) (7,097) (4,994) (3,521) (3,197) New Investments (6) (1,176) - - - Others (75) 0 - - - Cashflow from investing activities (3,951) (8,273) (4,994) (3,521) (3,197) Net Operating Cashflow 1,662 (1,759) 2,114 3,403 3,789 Dividends paid to ordinary shareholders (3,619) (2,888) (2,695) (2,695) (3,084) Proceeds from issue of shares - - - - - Effects of Exchange Rates on Cash - - - - - Other Financing Cashflow (189) (168) - - - Cashflow from financing activities (1,315) 1,530 (2,695) (2,695) (3,084) Total cash generated 347 (229) (581) 708 705 Cash at beginning of period 1,302 1,570 2,442 1,862 2,570 Implied cash at end of year 1,649 1,342 1,861 2,569 3,275 Ratios 12/13A 12/14E 12/15E 12/16E 12/17E Capex/Sales 15.4% 41.1% 28.0% 20.0% 18.0% Disclosures Please refer to the important disclosures at the back of this report. 13
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