Zain KSA restructuring ensures fresh start

Vol mn RSI10 Zain KSA ZAINKSA AB: Saudi Arabia US$5.41bn 48.3% US$142.1mn Market cap Free float Avg. daily volume Target price 15.90 9.68% over current Consensus price 16.10 11.0% over current Current price 14.50 as at 8/7/2012 Research Department Mazhar Khan, Equity Research Analyst 9661 211 9248, khanm@alrajhi-capital.com Underweight Neutral Overweight Neutral Key themes We expect mobile services to continue to outperform fixed-line services in Saudi Arabia over the next few years, driven by mobile data. Zain has been heavily reliant on low income groups to generate revenues. Implications Zain has been performing decently as a number three operator in the Kingdom by tapping growth in voice and data services. The problem for Zain is its high debt burden, which reduces the share of enterprise value attributable to equity shareholders. Performance 24 19 14 9 70 30 150-10 100 50 Earnings Period End (SAR) 12/12E 12/13E 12/14E 12/15E Revenue (mn) 7,230 8,018 8,881 9,718 Revenue Growth 7.9% 10.9% 10.8% 9.4% EBITDA (mn) 1,153 1,559 1,963 2,284 EBITDA Growth 28.3% 35.1% 25.9% 16.4% EPS 1.11-0.63-0.20-0.11 EPS Growth -18.9% -43.7% -68.6% Valuation 14 12 10 8 6 4 2 0 Price Close MAV10 MAV50 Relative to SASEIDX (RHS) 07/11 10/11 01/12 04/12 EV/Sales (x) 01/10 01/11 01/12 01/13 166 155 144 132 121 110 99 87 76 Zain KSA restructuring ensures fresh start Zain has made significant progress by getting the restructuring plan approved from its shareholders, and is now planning a rights issue. This will involve converting SAR2.5bn of debt into equity and raising SAR3.5bn from the market; thus paying to its immediate debt holders. We estimate a 31% decline in company s debt, leading to a substantial savings in financial costs after the restructuring program is implemented. In our view, the restructuring process will ensure a smooth transition for the company from its mixed performance over the past couple of years. Considering this positive development, we have lowered the overall risk estimate for the company and raise our target price to SAR15.9, and upgrade Zain to Neutral. Restructuring will positively impact bottom-line: Zain s restructuring plan involves two parts: first, cancelling 65.7% of the issued shares and second, reducing its share capital from around SAR14.0bn to SAR4.8bn. After successfully completing this plan, the company will now have a rights issue to increase its share capital from approximately SAR4.8bn to SAR10.8bn. We believe the restructuring activity will wipe out 31% of debt from Zain s books and will enable the company to save around 35% on financial costs, which will in turn result in a significant improvement in its bottom-line. Capex plan looks interesting: Out of the rights issue proceeds, 20% will be utilized in improving and upgrading network; mainly on HSPA and LTE. This is a positive development since the company had been suffering from lack of capex, which was hampering growth. Capex fell to only 10% of sales in 2011 from a decent 16% during 2010. Compare to Zain, Mobily had an aggressive Capex allocation of 25%, while STC allocated 13% of sales to Capex in 2011. A few concerns still persist: Zain s restructuring plan is likely to succeed, and set to make the company financially stronger than it is now. Although, the restructuring plan should reduce Zain s net debt by 31% to SAR10.8bn, debt level will still be 1.5x our estimate of 2012 sales of SAR7.2bn. Similarly, the net debt will still represent 40% of enterprise value of SAR26.2bn. We believe Zain needs to reduce its net debt to a level roughly equal to this year s sales or to 25% of enterprise value, which implies cutting net debt to about SAR7bn. Further, Zain should put efforts to improve its brand image by clearly outlining its strategies. Continued management reshuffle has also affected the company s overall brand image. In our opinion, the restructuring plan will definitely play a big part in bringing the company back on track. Conclusion: The key change to our estimates is likely to be lower interest costs. We estimate that the restructuring plan will cut Zain s annual net interest charges by around SAR350mn and raise its net profit. The plan should help assure Zain s long-run viability and will lower the financial risks to a fair extent. Thus, we have increased our target price to SAR15.9, which is equal to our fair value per share estimated by long-run discounted economic profit valuation. We raise our rating to Neutral and we believe that successful execution of the restructuring plan could be a key driver of Zain s financial recovery. Disclosures Please refer to the important disclosures at the back of this report. Powered by Enhanced Datasystems EFA Platform 1

Corporate summary Share information Valuation Zain KSA is the third largest telecom operator in Saudi Arabia, with a market value of US$5.41bn. The company launched its services in Q3 2008. By our estimate, Zain enjoys a 13-14% market share in mobile accounts, although its revenue share is lower at 9-10%. Zain has no presence in the fixed-line market. Zain KSA is an affiliate of the Zain Group of Kuwait. Zain Kuwait is an emerging telecom player operating in various markets in the Middle East and Africa. Market cap (SAR/US$) 20.30bn / 5.41bn 52-week range 10.54-23.09 Daily avg volume (US$) 142.1mn Shares outstanding 1,400mn Free float (est) 48.3% Performance: 1M 3M 12M Absolute -17% -28.5% 6.1% Relative to index -19.9% -17.3% 2.4% Major Shareholder: Mobile munications Co. (Kuwait) 25% Faden Trading and Contracting 6.8% Source: Bloomberg, Al Rajhi Capital Period End 12/12E 12/13E 12/14E 12/15E Revenue (SARmn) 7,230 8,018 8,881 9,718 EBITDA (SARmn) 1,153 1,559 1,963 2,284 Net Profit (SARmn) (1,383) (678) (213) 118 EPS (SAR) 1.11-0.63-0.20-0.11 DPS (SAR) - - - - EPS Growth -18.9% -43.7% -68.6% na EV/EBITDA (x) 24.7 15.6 12.1 9.8 P/E (x) na na na 133.0 P/B (x) 1.7 1.9 1.9 1.9 Dividend Yield 0.0% 0.0% 0.0% 0.0% Zain KSA: Outlook improves Restructuring plan involves capital reduction, followed by a rights issue Zain has finally secured approval from its shareholders to go ahead with restructuring and has launched its rights issue in the market. Rights issue is priced at SAR10 and will be available for a period of seven days. After the rights issue, Zain s paid up capital will reach SAR10.8bn. Below is the table showing the reduction and rights issue calculation for Zain. Figure 1 Zain: no. of shares (mn) Current shares 1,400.0 Share reduction -919.9 Interim new share base 480.1 Rights issue and debt-for-equity swap (new shares) 600.0 Final new share base 1,080.1 Figure 2 Zain: share capital (SAR mn) Current share capital 14,000 Capital reduction -9,199 Interim new share capital 4,801 Rights issue and debt-for-equity swap (new capital) 6,000 Final new share capital 10,801 Around SAR2.5bn of debt to be converted to equity Referring to the prospectus released by Zain, we infer that out of the SAR6.0bn rights issue, SAR2.5bn of capital increase would be utilized to convert the debt into equity, while SAR2.1bn will be repaid to its debt holders. Around SAR1.15bn will be utilized for capital expenditure. We think that the minority shareholders will subscribe to the issue, as it has been launched at a fair discount to the implied market price post capital reduction; i.e., SAR10 as compared to SAR15.65 (based on share price SAR7.8). The company should not have any issues raising SAR3.0bn as the issue has been fully underwritten. We believe that Zain s restructuring plan is likely to succeed and make the company financially stronger than it is currently. After the restructuring, the company should be able to concentrate on strengthening its network and expanding its domestic reach. Figure 3 Zain's Rights issue: use of proceeds SAR mn Conversion of debt into equity 2,546 Payment of Murabaha 750.0 Capex 1,150.0 Payment of current liabilities 1,434 Issue expenses 120.0 Total 6,000.0 20% of rights issue proceeds will be utilized for capex Out of the rights issue, around 42% will be utilized in converting debt into equity, while 36% of the issue proceeds will be paid to debt holders. One major allocation that should excited shareholders is a 20% allocation of rights issue for capex plan and developing network. The rest 2% will be allotted for issue related expenses. Disclosures Please refer to the important disclosures at the back of this report. 2

ZAIN KSA: Beyond restructuring Fundamentally an improved company We tweaked our model with present forecasts to observe any noticeable changes happening to Zain s financials and fair value. We estimate that the capital reduction will bring down accumulated losses by 60% and similarly, net debt should fall by 31%, while the cash position will grow by 170% supported by cash proceeds earned through the rights issue. Interest costs should come down by 30% causing a decline in net losses. It is worthy to analyze a few gearing multiples, which are improve after the restructuring. Gearing ratios will definitely improve after the capital restructuring. Overall, the company s financial position will certainly get better. Figure 4 Zain: estimated changes in net debt (SAR mn) Net debt at end Q1 2012 15,335 Reduction from debt-for-equity swap -2,546 Reduction from rights issue -2,184 Final net debt 10,605 Figure 5 Zain: gearing ratios 2011 2012E Net debt/sales (x) 2.3 1.5 Net debt/ebitda (x) 16.9 7.9 Net debt/equity (%) 354% 102% Net debt as % of enterprise value 43% 40% Disclosures Please refer to the important disclosures at the back of this report. 3

Income Statement (SARmn) 12/11A 12/12E 12/13E 12/14E 12/15E Revenue 6,699 7,230 8,018 8,881 9,718 Cost of Goods Sold (3,499) (3,905) (4,134) (4,520) (5,005) Gross Profit 3,200 3,325 3,884 4,361 4,713 Government Charges S.G. & A. Costs (2,301) (2,172) (2,325) (2,398) (2,429) Operating EBIT (811) (555) (82) 337 644 Cash Operating Costs (5,800) (6,077) (6,459) (6,918) (7,434) EBITDA 899 1,153 1,559 1,963 2,284 Depreciation and Amortisation (1,710) (1,708) (1,640) (1,626) (1,640) Operating Profit (811) (555) (82) 337 644 Net financing income/(costs) (1,114) (827) (597) (550) (526) Forex and Related Gains - - - - - Provisions - - - - - Other Income - - - - - Other Expenses - - - - - Net Profit Before Taxes (1,925) (1,383) (678) (213) 118 Taxes - - - - - Minority Interests - - - - - Net profit available to shareholders (1,925) (1,383) (678) (213) 118 Dividends - - - - - Transfer to Capital Reserve - - - - - 12/11A 12/12E 12/13E 12/14E 12/15E Adjusted Shares Out (mn) 1,400 1,080 1,080 1,080 1,080 CFPS (SAR) (0.153) 0.263 0.891 1.308 1.627 EPS (SAR) (1.375) (1.115) (0.628) (0.197) 0.109 DPS (SAR) 0 0 0 0 0 We expect a respectable EBITDA growth over 2012-14 The EBITDA margin should swing up sharply in the next two years, though the growth will be capped by marketing expenses Growth 12/11A 12/12E 12/13E 12/14E 12/15E Revenue Growth 12.9% 7.9% 10.9% 10.8% 9.4% Gross Profit Growth 26.5% 3.9% 16.8% 12.3% 8.1% EBITDA Growth 171.9% 28.3% 35.1% 25.9% 16.4% Operating Profit Growth -30.3% -31.6% -85.3% 91.2% Net Profit Growth -18.4% -28.2% -50.9% -68.6% EPS Growth -18.4% -18.9% -43.7% -68.6% Margins 12/11A 12/12E 12/13E 12/14E 12/15E Gross profit margin 47.8% 46.0% 48.4% 49.1% 48.5% EBITDA margin 13.4% 16.0% 19.4% 22.1% 23.5% Operating Margin -12.1% -7.7% -1.0% 3.8% 6.6% Pretax profit margin -28.7% -19.1% -8.5% -2.4% 1.2% Net profit margin -28.7% -19.1% -8.5% -2.4% 1.2% Other Ratios 12/11A 12/12E 12/13E 12/14E 12/15E ROCE -7.2% -4.3% -0.7% 2.8% 5.6% ROIC -3.9% -2.8% -0.5% 2.0% 4.0% ROE -36.9% -20.9% -7.9% -2.6% 1.4% Effective Tax Rate 0.0% 0.0% 0.0% 0.0% 0.0% Capex/Sales 10.6% 8.0% 9.0% 8.0% 7.5% Dividend Payout Ratio 0.0% 0.0% 0.0% 0.0% 0.0% Zain is not cheap on EV/sales measure, which is the one of the simplest valuation measures for a loss-making company Valuation Measures 12/11A 12/12E 12/13E 12/14E 12/15E P/E (x) na na na na 133.0 P/CF (x) na 55.2 16.3 11.1 8.9 P/B (x) 4.7 1.7 1.9 1.9 1.9 EV/Sales (x) 5.3 3.9 3.0 2.7 2.3 EV/EBITDA (x) 39.5 24.7 15.6 12.1 9.8 EV/EBIT (x) na na na 70.8 34.6 EV/IC (x) 1.8 1.4 1.4 1.5 1.5 Dividend Yield 0.0% 0.0% 0.0% 0.0% 0.0% Disclosures Please refer to the important disclosures at the back of this report. 4

Balance Sheet (SARmn) 12/11A 12/12E 12/13E 12/14E 12/15E Cash and Cash Equivalents 780 1,743 2,075 2,172 3,011 Current Receivables 1,007 783 862 959 972 Inventories 44 86 129 142 165 Other current assets 602 764 764 764 764 Total Current Assets 2,432 3,376 3,831 4,036 4,911 Fixed Assets 4,059 4,031 4,120 4,213 4,310 Investments - - - - - Goodwill - - - - - Other Intangible Assets 20,253 19,253 18,245 17,237 16,229 Total Other Assets - - - - - Total Non-current Assets 24,312 23,284 22,365 21,449 20,538 Total Assets 26,744 26,660 26,196 25,486 25,449 Short Term Debt 9,748 7,553 7,453 7,053 7,053 Trade Payables 5,691 5,680 5,994 5,897 6,443 Dividends Payable - - - - - Other Current Liabilities 72 55 55 55 55 Total Current Liabilities 15,511 13,287 13,501 13,004 13,550 Long-Term Debt 6,242 3,299 3,299 3,299 2,599 Other LT Payables 675 664 664 664 664 Provisions 23 453 453 453 453 Total Non-current Liabilities 6,940 4,417 4,417 4,417 3,717 Minority interests - - - - - Paid-up share capital 14,000 10,801 10,801 10,801 10,801 Total Reserves (9,707) (1,845) (2,523) (2,736) (2,619) Total Shareholders' Equity 4,293 8,956 8,278 8,065 8,182 Total Equity 4,293 8,956 8,278 8,065 8,182 Total Liabilities & Shareholders' Equity 26,744 26,660 26,196 25,486 25,449 Net debt for 2012e will now stand at a decent 1.2x sales Capex/sales ratio is falling due to shrinking cash balances and high accumulated losses Ratios 12/11A 12/12E 12/13E 12/14E 12/15E Net Debt (SARmn) 15,209 9,109 8,677 8,181 6,642 Net Debt/EBITDA (x) 16.92 7.90 5.57 4.17 2.91 Net Debt to Equity 354.3% 101.7% 104.8% 101.4% 81.2% EBITDA Interest Cover (x) 0.8 1.4 2.6 3.6 4.3 BVPS (SAR) 3.07 8.29 7.66 7.47 7.58 Cashflow Statement (SARmn) 12/11A 12/12E 12/13E 12/14E 12/15E Net Income before Tax & Minority Interest (1,925) (1,383) (678) (213) 118 Depreciation & Amortisation 1,710 1,708 1,640 1,626 1,640 Decrease in Working Capital 43 395 192 (206) 510 Other Operating Cashflow 85 9 - (0) - Cashflow from Operations (88) 730 1,154 1,207 2,268 Capital Expenditure (711) (577) (722) (710) (729) New Investments - - - - - Others (9) - - - - Cashflow from investing activities (720) (577) (722) (710) (729) Net Operating Cashflow (807) 153 432 496 1,539 Dividends paid to ordinary shareholders - - - - - Proceeds from issue of shares - 3,000 - - - Effects of Exchange Rates on Cash - - - - - Other Financing Cashflow - (2,184) - - - Cashflow from financing activities 885 810 (100) (400) (700) Total cash generated 78 963 332 96 839 Cash at beginning of period 702 780 1,743 2,075 2,172 Implied cash at end of year 780 1,743 2,075 2,172 3,011 Ratios 12/11A 12/12E 12/13E 12/14E 12/15E Capex/Sales 10.6% 8.0% 9.0% 8.0% 7.5% Disclosures Please refer to the important disclosures at the back of this report. 5

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