TELEcOM SEcTOR IN SaUDI aRaBIa: caLLING FOR … SEcTOR IN SaUDI aRaBIa: caLLING FOR GROWTH ......

FOOTNOTES

1

Kingdom of Saudi arabia

equity research

July 1, 2009

STOck DaTa

TELEcOM SEcTOR IN SaUDI aRaBIa: caLLING FOR GROWTHrELaTiVELY dEfEnSiVE on THE doWnSidE WHiLE STiLL EnJoYing a SHarE in THE uPSidE

telecoms have demonstrated less sensitivity to market risk relative to companies in other sectors during market downturns and tend to benefit from the improved market sentiment and fundamentals during recoveries. this is due to their superior dividend yields, solid balance sheets, and high earnings visibility. using the top-down approach, we have initiated coverage on saudi telecoms. the Kingdom’s strong fundamentals of a high growth population with 38% of the inhabitants below the age of 15 and a broadband penetration rate under 5% are favorable characteristics for telecom companies.

STC: furTHEr oVErSEaS EXPanSion aS domESTiC marKET SHarE LESSEnS

the company’s expansion plans in 2007 and onward have made its earnings less dependent on domestic competition, but more susceptible to country and currency risk, especially from turk telekom and south africa’s cell c. Foreign currency exposure has been improving against the dollar in the second quarter of 2009.

mobiLY: THE groWTH STorY

Mobily’s growth story is reflected in its price target of sar 53.44. the company’s growth drivers are its focus on broadband and quality services. Furthermore, the company’s saudi-only operations, sheltered from foreign currency risk, make this stock our favorite pick in the saudi telecom sector.

Zain Saudi arabia: STarT-uP WiTH a STrong nEEd for finanCing

We cannot deny that Zain Ksa’s entry into the saudi telecom sector has triggered profound chang-es. its savvy advertising and aggressive promotions compelled other operators to follow suit by offering discounted international rates. however, we believe that the company’s aggressive capital expenditures to build its own network and its entrance at a time when the mobile penetration rate is already above 100% will make it difficult for Zain’s free cash flow to reach the break-even point within the next two years.

FOOTNOTES

equity research

current price

Fair price

recoMMendation accUMULaTE

current price

Fair price

recoMMendation BUY

current price

Fair price

recoMMendation HOLD

FOOTNOTES

equity researchequity research

Global industry outlook 2

Global telecom sector performance 6

telecom sector in saudi arabia 7 companies in perspective 12

saudi telecom company 18Company Overview 19Investment Rationale 21Financial Analysis 24Pro Forma Financials 26Valuation 28

etihad etisalat (Mobily) 30Company Overview 31Investment Rationale 32Financial Analysis 35Pro Forma Financials 37Valuation 39

Zain saudi arabia 41Company Overview 42Investment Rationale 43Financial Analysis 45Pro Forma Financials 46Valuation 47

appendix 48

sector coverageLouna merhiEquity [email protected]

Youssef nizam, CfaHead of Equity [email protected]

TaBLE OF cONTENTS

regulated by cMa - License no. 06017-37

1July 1, 2009

SaUDI TELEcOM SEcTOR stc MoBiLy Zain

saudi telecom company Mobily Zain Ksa

Market cap (sar) 103,000,000,000 24,570,000,000 16,450,000,000

Market cap (usd) 27,470,203,000 6,552,843,570 4,387,231,450

number of shares 2,000,000,000 700,000,000 1,400,000,000

Free Float (est.) 16% 58% 45%

average Monthly Liquidity (sar) 1,450,551,178 841,375,717 4,618,287,862

52-week high (sar) 70.00 42.24 24.75

52-week Low (sar) 33.80 22.50 10.15

pe 09 e 9.26 9.44 na

pB 2.75 2.53 1.50

SaR 51.50 SaR 35.10 SaR 11.75

SaR 63.95 SaR 53.44 SaR 11.69

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SaUDI TELEcOM SEcTOR teLecoM

GLOBaL INDUSTRY OUTLOOkit’s a brave new world for the global telecom industry, with the evolution of key success drivers in the market. the relatively mature level of voice usage has compelled industry leaders to expand their horizons and tackle new growth opportunities. the market has been moving towards exploit-ing data-driven services, a relatively new growth segment.

the diagram below illustrates the driving factors shaping the telecom industry today.

figure 1: Factors affecting the telecom industry

THE GLOBaL STORY OF TELEcOM NOW

despite the hardships anticipated for 2009, the industry may have reached a historical inflection point, moving towards a data-based rather than a voice-based service future. telecom industry leaders are experiencing reduced revenue growth in mature and overcrowded markets, pressure to lower prices, and slower subscriber growth. a change in the dynamics of the industry is being witnessed. to stimulate growth, the global industry is relying increasingly on data services, conver-gence, overseas expansion, and consolidation.

Telecom Industry

Want more speed, value-added services

Customers

Regulations Introducing new competitors, lower prices

Competition New players in the market, substitutes

Technology Evolving technology to meet customer desires

Macro- Economics

Slower GDP growth, slower growth prospects

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1 broadbandBroadband expansion is accelerating due to cheaper services and improvements in infrastructure. For example, Vodafone Group, one of the world’s leading mobile telecom companies, has derived 8.2% of its revenues from data services for the quarter ending March 31, 2009. the company is tap-ping into emerging markets that are i) underpenetrated in terms of users relative to population and ii) still new in introducing internet services on mobile phones.

Chart 1: World Broadband subscribers (millions)

Source: International Telecommunication Union (ITU)

Chart 2: Vodafone data revenues (GBp millions)

Source: Bloomberg

1 Convergencetelecom players are on the way to converging services through the bundling of video, voice, and data or other services (offering triple play services). Bundling services, such as broadband and media services with wireless voice services, will enable telecom providers to offer competitive rates. the notion of convergence in the telecom industry has led to wireless players diversifying away from mobile-only services. British telecom, the oldest telecommunication company in the world, has re-cently started providing converged services. this was after the telecoms regulator recommended the company to offer triple play services comprising of phone, broadband, and television services. this deregulation will stimulate competition between telecom providers as they compete for more attractive packages to offer customers.

0

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400

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2004

2005

2006

2007

2008

CAGR = 31.4%

104 158

216 284

350 406

727 1,109 1,438

2,186

3,046

2.7% 3.8%

4.6%

6.2% 7.4%

0

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2,000

3,000

03/0

5

03/0

6

03/0

7

03/0

8

03/0

9

Data Revenues Percent of Total Revenues

CAGR = 43.1%

FOOTNOTES

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July 1, 2009


1 foreign Expansionindustry leaders are expanding their footprint in emerging markets with high growth potential in order to boost revenue growth. For example, telefonica Group is one of the leading integrated telecom providers worldwide offering communications, information, and entertainment solutions to over 252 million customers today. it has been extending its services overseas, mainly in Latin america and eastern european countries.

Chart 3: revenue contribution from selected regions for telefonica Group

Source: Company Data

1 Consolidationthe industry is heading towards consolidation, leaving two or three large telecom operators in each country. this will lead to companies acquiring a larger market share and customer base, lower churn rates, improved profitability, and greater efficiency. in december 2006, at&t’s acquisition of Bell south company was approved. at&t’s first quarter earnings for 2007 increased to usd 2.8 million from usd 1.4 million year-on-year (y-o-y), a 100% increase. the company’s churn rate was reduced by 18.75% compared to the previous year. in addition, the merger implied a fusion of wireless fixed and satellite services that can be offered in a bundled package. in north america, the wireless indus-try in 2007 was characterized by acquisitions of smaller regional carriers by major carriers.

Table 1: selected at&t financials with the consolidation of Bell south company

Sources: Company Data, Forbes

USD million Q1 07 Q1 06 Percent change

Net Income 2,848 2,229 27.77%

Total Revenues 28,969 20,927 38.43%

Operating Income 4,664 3,437 35.70%

EBIT Margin (%) 16.10% 16.42% -1.97%

Wireless Revenues 9,070 3,600 151.94%

*We have adjusted the table above to show the synergies of the companies by consolidating their financials in the first quarter of 2006 and in order for the figures to be comparable year-on-year.

37.0%

24.0%

34.0%

26.0%

0%

10%

20%

30%

40%

Latin America Europe

2008 2007 2006

35.0%

27.0%

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FROM SaLaD BOWL TO MELTING POT

in the future, mobile phone capabilities will entail countless applications to support mobile bank-ing, investing and payments, advertising, and medical care among other applications. telecom providers will continue to partner with application providers, reaching a point where mobiles will become an infinite-function utility.

SaME INDUSTRY DRIVERS IN THE Gcc, BUT aT THE BEGINNING OF THE STORY

telecom in the Gulf region is on the threshold of a broadband boom, although it is currently still in the stage of sector liberalization. telecom egypt is the sole fixed line provider in egypt, and qatar telecom is currently the only telecom operator in qatar. But new operators are emerging. Vodafone qatar, the winner of the second mobile license, is expected to commence operations in 2009. saudi arabia issued 3 new fixed line licenses and is studying the possibility of a fourth mobile license. over the next few years, the Gcc markets will become crowded with players and growth margins will deteriorate. Gcc operators will be looking for the same growth opportunities that global telecom leaders are exploiting today. regional operators will follow the leaders’ strategies, which include focusing more on data services, offering triple play services (which saudi telecom company has already done), consolidating with other providers (horizontal or vertical consolidation) to enhance revenues and operating efficiency.

Mobiles will become an infinite function utility

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GLOBaL TELEcOM SEcTOR PERFORMaNcE: NOT ENTIRELY BULLET PROOF

MYTH #1: Telecoms are outperforming the market

despite the defensiveness of telecom, the sector is not entirely immune to market downturns. on a year-to-date basis, the dow Jones index showed a 1.9% decline, while the dow Jones telecom index showed a 10.3% increase in value. on the other hand, the Bloomberg World index increased by 10.3%, whereas the Bloomberg World telecom index dropped by 0.9%.

Table 2: General indices vs. telecom indices performance

Source: Bloomberg¹

MYTH #2: Dividend yields in the telecom sector are not as high as in other sectors

in the united states, the 12-month dividend yield (weighted according to market capitalization) of the dow Jones index and the dow Jones telecom index was 3.4% and 3.9%, respectively. in general, telecom indices show a higher dividend yield than general indices.

Table 3: dividend yield of General indices vs. telecom indices

Country General Equity Indices Dividend Yield (%) Telecom Equity Indices Dividend Yield (%)

World Bloomberg World Index 3.1 Bloomberg World Telecom Index 4.4

USA Dow Jones Index 3.4 Dow Jones Telecom Index 3.9

KSA Tadawul Index 3.3 Tadawul Telecom Index 3.6

Source: Bloomberg2

MYTH #3: Telecom companies have higher debt positions and lower liquidity positions than companies in other sectors

as of June 16, 2009, the top 20 companies (by market capitalization) in the Bloomberg World tele-com index had a value-weighted debt-to-eBitda ratio of 1.3, while the top 20 in the Bloomberg World index had a debt-to-eBitda ratio of 2.2. telecoms showed a net debt-to-eBitda ratio of 0.58 compared to 1.0 for the Bloomberg World index, reflecting a lower degree of financial leverage.

To sum up why we like telecomsthe telecom sector presents an attractive investment opportunity due to its relatively defensive nature, solid dividends, strong balance sheets, and earnings visibility.

FOOTNOTES¹performance as of June 16, 2009, 4:38 pM 2Figures as of June 16, 2009, 4:38 pM

Country General Equity Indices YTD MTD WTD Telecom Equity Indices YTD MTD WTD YTD MTD WTD

WorldBloomberg World Index 10.3 0.3 -2.2

Bloomberg World Telecom Index -0.9 0.5 -1.6 -11.2 0.2 0.7

USA Dow Jones Index -1.9 1.3 -2.1 Dow Jones Telecom Index 10.3 1.9 -1.7 12.2 0.6 0.4

EMEAMSCI Emerging Markets Index 27.8 -1.5 -2.8 MSCI EMEA Telecom Index 19.1 1.7 -0.6 -8.7 3.2 2.2

KSA Tadawul Index 26.2 2.9 2.0 Tadawul Telecom Index 14.2 1.3 1.7 -12.0 -1.6 -0.3

Relative Telecom Performance

% % %

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TELEcOM SEcTOR IN SaUDI aRaBIaFrom the peak of the global financial crisis in august 31, 2008 till June 16, 2009 the performance of the saudi telecom index was better than other key sectors in saudi arabia, such as banking, petro-chemicals, and building and construction. Moreover, the telecom index performed above average relative to the 31% decline of the tadawul all-share index. among the telecom sector, Mobily was the outperformer with a drop of only 4%.

Table 4: performance of sectors and Benchmark in saudi arabia

Source: Bloomberg

Table 5: performance of telecom companies in saudi arabia

Performance as of 31/08/08 till 16/06/09 31/08/07 till 16/06/09Mobily -4% -37%Saudi Telecom Company -15% -24%Zain Saudi Arabia -44% -38%

Source: Bloomberg¹

SaY GOODBYE TO SOLOS

saudi telecom company (stc) was the only mobile operator in 2004. at the time, the mobile pen-etration rate was 40% and there were only 9.2 million subscribers. the monopoly was broken with the entry of etihad etisalat (Mobily) in 2005. the liberalization of the saudi arabian mobile market caused the penetration rate to soar to 109% in 2007, implying a 6-year caGr of 50% for subscriber growth. in the second half of 2008, Zain, a third mobile rival, entered the local market. the impact of Zain’s entry still remains uncertain in terms of how much of the company’s growth will be due to new subscribers and how much will be from capturing existing subscribers.

FOOTNOTES ¹Zain saudi arabia’s performance is from the date of its ipo (March 23, 2008) instead of august 31, 2007.

Performance as of 31/08/08 till 16/06/09 31/08/07 till 16/06/09

Tadawul Hotel Index 0% -15%

Tadawul Retail Index -6% -24%

Tadawul Energy Index -10% -14%

Tadawul Agriculture Index -14% -19%

Tadawul Media Index -16% -47%

Tadawul Transportation Index -18% -14%

Tadawul Insurance Index -20% -58%

Tadawul Telecom Index -20% -36%

Tadawul Real Estate Index -26% -30%

Tadawul Industrial Index -27% -18%

Tadawul Banking Index -28% -26%

Tadawul Cement Index -29% -33%

Tadawul Petrochemical Index -42% -21%

Tadawul Building Index -46% -24%

Tadawul All Share Index -31% -26%

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July 1, 2009


similarly, fixed line operations in saudi arabia will be transformed from solo to multi-player and stc will face competition in the fixed line segment as well. the communication and information tech-nology commissions (citc) has issued 3 new fixed licenses. competition will stimulate demand for this relatively underpenetrated market.

the liberalization of the telecom sector in saudi arabia has led to key changes, such as breaking the 100% mobile penetration mark, de-monopolizing the fixed line segment by approving 3 new fixed line licenses, and the launching of aggressively competitive promotions launched by all three mobile players.

SaUDI TELEcOM SEcTOR OUTLOOk

the industry is currently in the phase of expansion with new players entering the market. Licenses in saudi arabia are still being issued and a study for a fourth mobile license is ongoing according to a statement by dr. abdulrahman al-Jafary, the governor of citc, in February 2009.

the global industry outlook leads us to derive a potential outlook for the saudi sector. the global trend towards consolidation of fixed and wireless providers allows fixed providers to guard their subscriber bases due to the fixed-to-mobile substitution trend. also, the offering of triple play ser-vices to customers through the convergence of mobile and fixed telecom operators is likely in the future. We expect etihad etisalat and Zain saudi arabia to acquire, converge, or to merge with one of the three coming fixed line operators over the long term.

We estimate that data revenues in saudi arabia will show a 4-year caGr of 15% by 2012. We expect that when prices are lowered, demand for broadband will rise, and so will its revenue contribution. figure 2: overview of the saudi telecom sector

Mobile Penetration:

Total mobile subscribers (millions):

40% 61% 82% 109% 128% 139%12% 23%

2.5 9.2 14.1 19.7 28.4 34.0 38.05

100%

22000011

64%

36%

22000077

56% 38%

6%

22000088

84%

16%

2005

STC Mobily Zain

1998 2001 2004 2005 2006 2007 2008 2009E2002

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Sources: CITC, Companies Data, Audi Saudi Arabia Estimates

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DOUBLE S (SOLID aND STaBLE) MacROEcONOMIc INDIcaTORS

saudi arabia has a relatively robust economy which can support sustained growth in demand for mobile services. according to the iMF, the Kingdom’s population is expected to grow at a steady rate of 2.5% annually in the coming years. also, the country’s demographics are favorable. 38% of the population is below the age of 15, allowing for a higher expected addressable market in the future.

Chart 4: age structure of the saudi population

Source: Saudi Arabian Monetary Agency (SAMA)

in 2008, saudi arabia’s real Gdp growth was higher than the average global Gdp growth. saudi ara-bia’s real Gdp growth was 4.6% in 2008 and is projected at 2.9% in 2010, while global growth was estimated at 3.2% and 1.9% for 2008 and 2010, respectively. despite a reduction in iMF estimates, Gdp growth in Ksa is expected to continue to exceed global Gdp growth. it is worth to note that saudi arabia’s nominal Gdp per capita was usd 19,345 (sar 72,448) for 2008.

Chart 5: real Gdp Growth

Source: International Monetary Fund (IMF)

in 2007, expatriates accounted for 4.9 million out of a total population of 24.3 million, a 20.16% share. it is expected that the number of expatriates will continue to rise due to labor needed to work on six new planned economic cities in the Kingdom and saudi arabia’s announcement of an expansionary budget of sar 475 billion for 2009.

Demographics

Age breakdown

2007

0-14 38.20%

15-64 59.40%

65+ 2.40%

Total 100.00%

2%

0-14 15-64 65+

60%

38%

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KSA GDP World GDP

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BROaDBaND TO EXPERIENcE EXPONENTIaL GROWTH

the broadband penetration rate of 4.1% in saudi arabia in 2008 is quite low relative to other coun-tries. a barrier to the spread of broadband usage is high prices. however, when prices will fall due to greater competition, penetration rates will rise exponentially, leading to improved broadband revenues for all providers. With the issuance of 3 new fixed licenses in saudi arabia, broadband us-age should witness double digit growth.

We believe that with 3 additional providers of broadband coming to the country, the penetration rate will easily reach 20% and possibly even more. as to when this will happen, this will depend on when the new fixed line providers will launch their ipos. atheeb telecom already went through with its ipo and has started commercial operations in June. in the context of current market conditions, we expect the other 2 fixed providers to delay their offering. in order to capture broadband growth, the companies should lower prices in order to gain large subscriber additions before new entrants arrive.

all countries in the Gcc are relatively underpenetrated with Bahrain and qatar having the highest broadband penetration rates of 12.14% and 12.08% as of the end of 2008, respectively.

Chart 6: Broadband penetration rates (2008)

Source: ITU

Chart 7: World Broadband subscribers (millions)

Source: ITU

0%

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THE MaRkET SHaRE SPLIT

The pie gets bigger in absolute terms but the size of each slice remains to be determined

We expect subscriber numbers to grow by a 3-year caGr of 7.0% to reach 46.5 million by 2012. this growth is stimulated by a youthful population, high population growth, a larger addressable market due to higher penetration rates, stronger competition that will lower prices and thereby stimulate subscriber growth, and an increased demand for data services.

as the number of slices increase, the pie will get even bigger

as the number of players increases, competition between them will fuel growth. competition will cause players to create more attractive packages and promotions for their customers. this can be achieved through decreasing tariffs or providing value-added services. if prices decrease, and we expect they will, a new lower-income customer segment will come into the addressable market. the burden will be on the operators as their arpus decrease from lower pricing on voice services and value-added services.

The question is not whose slice is bigger but who will be able to maintain or grab a big-ger slice than their existing one

Whether or not saudi telecom will continue to have the biggest mobile market share is irrelevant to its capability to generate higher organic revenue growth. the company’s mobile market share is expected to stay dominant, but to drop to 50% by 2012.

We believe that Mobily will demonstrate its resilience by preserving its market share. it will have more subscribers and higher revenue with the expansion of the addressable market.

even with Zain saudi arabia accessing the market and adding the most in subscriber market share, we believe it is still not enough for it to breakeven by 2012, due to the high costs of license amortiza-tion, rising depreciation from aggressive capital expenditures, management fees, and royalty fees expensed yearly.

Chart 8: Market share 2008

Sources: CITC, Audi Saudi Arabia Estimates

38%

56%

6%

CAGR = 7%

Market Share 2008 Market Share 2012E

Mobily STC Zain KSA

15%

35%

50%

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Chart 9: Mobile revenues


Chart 10: Forecasted saudi active Mobile subscribers (millions)


cOMPaNIES IN PERSPEcTIVE

TRaNSPaRENcY ISSUES NEED TO BE aDDRESSED

transparency in the saudi telecom sector is below industry norms. penetration rates are not dis-closed in financial statements by operators. the citc (communications and information technology commissions) has indicated a mobile penetration rate of 116% for 2007. We believe that the 2007 penetration rate has surpassed the 100% mark, but is lower than 116% due to an overstated sub-scriber count from the operators. our estimates indicate a 128% mobile penetration rate for saudi arabia in 2008.

in order to calculate actual penetration rates, the active subscriber count must be used. citc declared that all three operators report subscribers active within the last three months, not clarifying whether ‘active’ subscribers include those that only receive incoming calls. saudi telecom announced 19 mil-lion active subscribers for 2008. Mobily has recorded a total subscriber base, including inactive sub-scribers, of 14.8 million customers. Zain saudi arabia has announced 2 million active subscribers for the year 2008.

despite penetration rates being overstated, we believe that the saudi market is highly penetrated and has potential for further expansion. the saudi penetration rate is slightly below average and the Kingdom remains underpenetrated relative to its Gcc peers and other comparable countries.

8 11 18 21

25 30 34 37 41 44 46 47

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CAGR = 27.3%

CAGR = 6.3%

14.4 15.3 15.8 16.3

20.1 21.5 22.4 23.3

3.4 4.5 5.7 7.0

0 10 20 30 40 50

2009E 2010E 2011E 2012E

Mobily STC Zain KSA

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Chart 11: Gdp per capita versus Mobile penetration rate (2008)

Sources: IMF, ITU, Audi Saudi Arabia estimates

Moreover, discrepancies arise concerning the calculation of arpu (average revenue per user). ar-pus are not stated in the companies’ financial statements, nor is there a clear standard for calculat-ing arpu. there are no agreed-upon international standards for calculating arpu. however, stating arpus in financial statements is a recommended international standard.

Chart 12: selected country Mobile arpus (2008)

Sources: Regulators, Audi Saudi Arabia estimates

LIcENSE FEES, ROYaLTY FEES aND MaNaGEMENT FEES cONSTITUTE THE BULk OF EXPENSES

Mobily paid usd 3.45 billion for a 25-year license, while Zain Ksa bought the third mobile license for usd 6.1 billion. the saudi government imposes a royalty fee on all telecom companies. there are talks about reducing royalty fees, but no decision has been taken yet. the impact of reducing royalty fees would be particularly high for Mobily and Zain saudi arabia since the entirety of their revenues are subject to royalty fees, unlike stc’s revenues which are diversified due to overseas ex-pansion. We estimate that 79% of stc’s total revenues are from local operations and will be subject to saudi royalty fees in 2008. in addition to royalty fees, the subsidiaries of Zain and etisalat also pay management fees.

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GDP per Capita Penetration Rate

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HaJJ EFFEcT ON PROFITaBILITY

it is estimated that around 3 million subscribers visit saudi arabia during the hajj pilgrimage¹ sea-son, which is reflected in the seasonality of Mobily’s fourth quarter earnings. Mobily recorded its highest quarterly earnings during the fourth quarter, and we suppose this seasonal peak to stem mainly from the increase in visitor roaming revenues. stc revenues do not exhibit such seasonality. in fact, over the last 3 years, fourth quarter earnings have been worse than the previous 2 quarters.

Chart 13: Mobily quarterly earnings Chart 14: stc quarterly earnings

Source: Bloomberg Source: Bloomberg

TO OWN OR NOT TO OWN INFRaSTRUcTURE

in its first two years of operation, Mobily leased transmission capacity from stc’s backbone net-works. in the meantime, Mobily has completed building its own capacity infrastructure to support itself. Zain, being new to the market, is leasing transmission capacity from both Mobily and stc. this will generate an additional stream of revenue for Mobily and stc depending on Zain’s usage capac-ity. We have not included this revenue stream in our financials for Mobily and stc since it is early to quantify its significance. We expect that Zain will build its own infrastructure in the future when its usage capacity rises to a point where it would be cheaper to build than rent.

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Fee Type

Mobile Royalty

Fixed

Management

10% of �xed voice revenue, plus 1% of revenue for operating license

15% of mobile revenue in year 1, 10% in year 2, and 5% in year 3, plus 1% of revenue for operating license

Comments

For Mobily: SAR 37.5 million (USD 10 million) per yearFor Zain KSA: 4% of revenues for year 1 and 2, dropping to 2% in year 5 plus 0.7% of annual revenues for brand royalties to Zain Group

Table 6: saudi arabia royalty Fees and parent company Management Fees

Source: Communication and Information Technology Commissions (CITC)

(sar millions) (sar billions)

3.40 3.41

0

0.5

1

1.5

2

2.5

3

3.5

4

3.20

2.79 2.72

3.10 3.14 3.06 3.03

3.84

3.01

1.16

2.49

Jun-

06

Sep-

06

Dec

-06

Mar

-07

Jun-

07

Sep-

07

Dec

-07

Mar

-08

Jun-

08

Sep-

08

Dec

-08

Mar

-09

37

116

217

330

251 304 311

514

326

448

539

778

480

0

100

200

300

400

500

600

700

800

Mar

-06

Jun-

06

Sep-

06

Dec

-06

Mar

-07

Jun-

07

Sep-

07

Dec

-07

Mar

-08

Jun-

08

Sep-

08

Dec

-08

Mar

-09

FOOTNOTES¹ hajj pilgrimage is an obligation that must be carried out at least once in the lifetime of every Muslim who can afford to do so.

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PROMOTIONS BY OPERaTORS

competition in the saudi telecom industry has been escalating with the entry of a third mobile player. at high penetration rates, players are pursuing lower pricing strategies to retain customers and attract new ones. the mobile number portability feature allows subscribers to switch operators without losing their original mobile number. therefore, with low switching costs, customers have a higher bargaining power and more flexibility in choosing a telecom operator that is most appealing to them in terms of pricing. this signifies a highly competitive landscape for the telecom industry. after Zain’s launching of two aggressive pricing promotions, the remaining two operators offered attractive promotions for its customers in order to be on the same level of competition.

figure 3: the commencement of mobile promotions in saudi arabia

in august 2008, Zain launched two promotions called the “one network” and the “one month on you, one month on us” package. the “one network” coverage allows businessmen traveling with-in the Middle eastern and african region to talk at discounted rates. the “one month on you, one month on us” is a lifetime promotion whereby subscribers pay their phone bills every other month. in october, Mobily offered discounted international rates in 56 countries and stc followed suit in november.

caPITaL STRUcTURE

saudi telecom was debt-free until 2007, when it began expanding overseas. the debt-to-capital ratio of 43% is still at a conservative level and we expect leverage to decline to 39% for 2009. We believe its net debt-to-eBitda ratio will be reduced to less than 1.1 in 2009.

Mobily has improved its capital structure from 69% of leverage in 2005 to 50% in 2008. We expect Mobily to obtain financing in the second half of 2009 for upgrading and maintaining its network. its net debt-to-eBitda ratio should be below 2.0 for 2009.

Zain Ksa reported debt of sar 11.9 billion for the year ended 2008. it has a debt-to-equity capital target structure of 50-50. We believe Zain will need substantial financing for the coming years and will increase its leverage from 50% to over 60% in 2009.

stc has the most conservative capital structure. although Zain was leveraged at about the same percentage as Mobily at the end of 2008, we expect it to obtain additional debt financing to imple-ment its own infrastructure. its other option for financing would be to seek a rights issue, making its debt-to-total-capital ratio more attractive. Zain’s relatively high leverage position is to be expected for a start-up telecom company. We believe an optimal debt-to-equity ratio to be 50-50.

Oct 2008

Aug 2008

Aug 2008

Nov 2008

Zain introduced the 'One Network' coverage

Zain introduced 'one month on you, one month on us'

Mobily introduced an international roaming agreement with 56 countries

STC launched a roaming alliance with 158 countries

Sources: Companies’ data

Chart 15: Leverage position of stc (sar billions)

Sources: Company financials, Audi Saudi Arabia Estimates

Chart 16: Leverage position of Mobily (sar billions)


Chart 17: Leverage position of Zain (sar billions)


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July 1, 2009


13.58 31.99 30.18 0% 0%

27.4%

42.9% 39.3%

0 5

10 15 20 25 30 35

2005 2006 2007 2008 2009E

Debt Debt/Total Capital

8.95 9.44 8.92 9.79 12.41

69.3% 67.6% 60.1% 50.1%

51.6%

0 2 4 6 8

10 12 14

2005 2006 2007 2008 2009E


11.86 15.24 16.61

50.3% 59.7%

64.3%

0

4

8

12

16

20

2008 2009E 2010E


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July 1, 2009


Chart 18: net debt to eBitda


-0.2 0.4

1.2 1.0 0.9

4.4

2.8 2.2 1.9

1.4

-3

0

3

6

2006

2007

2008

2009

E

2010

E

STC Mobily

current price SaR 51.50 Fair price SaR 63.95

recoMMendation accUMULaTE

STOck DaTa

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July 1, 2009

SaUDI TELEcOM SEcTOR

SaUDI TELEcOM cOMPaNY – reinVentinG its corporate identity

WE iniTiaTE an aCCumuLaTE rECommEndaTion WiTH a TargET PriCE of Sar 63.95

currency fluctuations from subsidiaries in turkey and south africa have been improving in the sec-ond quarter of 2009. a significant portion of stc’s income is exposed to FX risk, as 21% of its reve-nues come from overseas subsidiaries. With foreign currencies picking up, we advise an accumulate recommendation on stc with a target price of sar 63.95, and a 24.17% upside potential.

offEring onE of THE HigHEST diVidEnd YiELdS in THE rEgion

stc currently offers a dividend yield of 7.28%. the distribution of quarterly dividends to investors is characteristic of the company. although dividends have been cut to sar 0.75 for the last two quar-ters, they still remain relatively high. its dividend yield makes this stock attractive to investors.

onLY inTEgraTEd oPEraTor

saudi telecom is the only integrated operator in saudi arabia to offer triple play services. it will be able to offer better pricing on land lines in the future.

domESTiC groWTH To SLoW WiTH nEW ComPETiTion in mobiLE and fiXEd SEgmEnTS

With the introduction of competition in the fixed line business in saudi arabia and increased com-petition in the mobile market, stc’s profitability will be impaired in both business segments. For saudi fixed line operations, we expect a 4-year caGr of 3% for revenues by 2013. We estimate rev-enues from mobile operations to grow by a 4-year caGr of 1% by 2013.

inTErnaTionaL EXPanSion: good or bad?

it is uncertain whether stc’s overseas acquisitions have realized significant returns. in our opinion, stc’s expansion in overcrowded markets such as india may not yield significant returns. While ex-pansion has bolstered the company’s revenues, it may take 3 years to realize bottom-line profits from overseas expansions which require significant capital expenditures. entering mature markets and pumping capital into these expansionary ventures could have a double loss effect since a satu-rated market will not provide substantial returns and capital expenditures will add to losses in a mature market.

Market cap (sar) 103,000,000,000

Market cap (usd) 27,470,203,000

Free Float 16.00%

av. Monthly Liquidity (sar) 1,450,551,178

52-week high (sar) 70.00

52-week Low (sar) 33.80

pB 2.75

trailing pe 9.81

pe 09 (e) 9.26

(sar million) 2008 2009 e 2010 e 2011 e 2012 e 2013 e

net income 11,038 11,118 11,897 12,104 12,234 13,433

eps (sar) 5.52 5.56 5.95 6.05 6.12 6.72

dps (sar) 3.75 3.75 4.00 4.50 5.00 5.50

stc

90

70

50

30

Dec

-07

Mar

-08

Jun-

08

Sep-

08

Dec

-08

Mar

-09

Jun-

09

Incumbent operator witnesses market share decline

Expansion projects started in 2007

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July 1, 2009


cOMPaNY OVERVIEW

PROFILE

saudi telecom (stc) was established as a Ksa joint stock company on april 2, 1998. it is listed on the tadawul stock exchange. stc provides a range of telecommunication services including mobile, fixed line local and international telecom services.

stc was the only operator in saudi arabia until the monopoly was broken by mobile operator etihad etisalat in 2005. in 2008, stc still dominated the subscriber market with a share of 56%. neverthe-less, it has witnessed a decline in market share due to greater competition with the entrance of Zain saudi arabia. With three new fixed licenses released, stc will face competition in its fixed line services for the first time.

in september 2007, the company began expanding on an international scale by acquiring 25% of Malaysian-based Maxis Group. Maxis Group manages mobile operations in Malaysia, india, and in-donesia. stc also has a 35% stake in oger telecom. By 2008, it had acquired 26% of Kuwait teleco-company, a new mobile operator in Kuwait. in January 2009, the company acquired Bahrain’s third mobile license for usd 230 million.

figure 4: saudi telecom company’s international operations

Source: Company data

Chart 19: stc ownership structure

Source: Tadawul

the saudi telecom company is mostly a state-owned entity in which the government holds a con-trolling stake. the chairman of the company is dr. Muhammad bin sulaiman al-Jasser.

Maxis

BinariangNTS (Indonesia) KTC (Kuwait)

Turk Telekom

Oger Telecom

Cell C (S. Africa)

Maxis (Malaysia)

Aircel (India)

Cyberia

Avea (Turkey)

STC Bahrain

51% 25% 26% 35% 25%

44%

100%

100% 74%

75% 95%

81%

Saudi Telecom Co.

55%

*cyberia operates in Ksa, Lebanon, and Jordan as an internet service provider (isp).**stc won the license for Bahrain’s third mobile telecom company, which is expected to start operations by 2010.

70%

7%

7%

16%

KSA Public Investment Fund

KSA Public Pension Fund

General Organization for Social Insurance

Free Float

FOOTNOTES

stc

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July 1, 2009


STRaTEGY

the company has evolved from a local to a regional player since 2007. the company aims to main-tain its leadership position in the local telecom sector despite new competition in the market from wireless and wired line services.

its coverage expanded from one country to ten countries within 2 years. oger telecom alone pro-vides stc exposure to four countries (turkey, Lebanon, Jordan, and south africa).

PROFILE OF kEY aSSETS1 Saudi fixed LineFrom 1998 until 2008, stc monopolized the saudi wired line voice operations. its total revenues from fixed line operations (voice and data services) should trend upwards with stronger demand for data services. We estimate that dsL subscribers have reached 4.12 million households as of the end of 2008.

the introduction of 3 new fixed line licenses, won by atheeb telecom (owned by Bahrain telecom co), optical communications (owned by Verizon of the usa), and Mutakamilah (owned by pccW of hong Kong) will negatively affect stc’s wired line revenues starting 2009 and should drive up fixed line penetration rates.

1 Saudi mobileWith the competition slashing their prices, arpus are expected to decline to sar 104 by 2012. We estimate that arpu reached sar 118 by the end of 2008. Market share will have to be split among 3 operators. We expect stc’s market share to be 52% by 2010. We project it to be down to 50% by 2012, reaching 23.3 million subscribers and reflecting a 4-year caGr of 5.9% for subscriber growth. saudi telecom will thus continue to have the dominant share of the mobile market. the saudi mo-bile market penetration level is below the levels observed for 2007 in qatar and Bahrain which are 136% and 166%, respectively.

1 Turk Telekom/aveasaudi telecom owns 35% of oger telecom, which has a 55% stake in turk telekom. turk telekom, a fixed line operator, is consolidated in oger telecom’s financials. turk telecom owns 81% of avea, turkey’s third mobile operator. since no geographical revenue breakdown is provided in stc’s finan-cials, we estimate turk telekom’s fixed line revenues to constitute 7.35% of total 2008 revenues. We project this share to decline gradually (assuming no further drop in the turkish Lira) to 6.8% of total revenues in 2013. our estimates indicate that turk telekom ended the year 2008 with 17.5 million subscribers. the number of turk telekom’s subscribers from wired line voice services is expected to be below 16.5 million by 2012. this is due to the fixed-to-mobile substitution trend. We estimate that turk telekom had 7.59 million adsL subscribers as of the end of 2008 and will have over 15.0 million by 2013.

We estimate avea’s revenues to make up 2.34% of stc’s 2008 revenues and 2.5% of 2013 revenues. avea’s subscribers are expected to number over 16.0 million by 2013 compared to 12.4 million in 2008.

Expanded footprint from 1 to 10 countries within 2 years

Fixed line competition to enter the market in the second half of 2009

stc

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July 1, 2009


1 maxis (malaysia)stc owns 25% of Maxis through Binariang holding. according to 2008 estimates, Maxis’ Malaysian-based subsidiary contributes 5% to total stc revenue, a figure which we expect to remain relatively steady until 2013. Binariang holding also has subsidiaries in india and other countries, but we be-lieve the Maxis subsidiary in Malaysia to be the main contributor to Binariang holding revenues. therefore, we use the Maxis subsidiary in Malaysia as a proxy to value Binariang’s contribution to the Group.

1 other assetsstc’s 26%-owned Kuwait telecom communications began operations in the second half of 2008. its start-up nature makes its contribution to the total valuation of the company’s on-going operations minimal at this stage and it is therefore not included in our valuation, which focuses on core assets.

Table 7: selected operations for stc

Sources: Company Data, Audi Saudi Arabia Estimates

INVESTMENT RaTIONaLE1 stc’s forward pe is estimated to be lower than comparable companies in the region. stc’s for-ward pe is 9.26x compared to a 9.67x weighted average pe of regional telecom companies.

1 stc has a dividend yield of 7.28%. Moreover, stc distributes dividends every quarter. the board of directors recommended a dividend per share of sar 0.75 for the first quarter of 2009, a more conservative distribution than last year’s first quarter dividend of sar 1.0. We have factored into our forecasts a more conservative dividend policy going forward. nevertheless, the dividend per share remains high.

1 according to our estimates, stc captures the highest mobile market share of 56% for 2008. stc continues to be the dominant provider of fixed line voice services in saudi arabia, with new competition introduced in June 2009.

1 Before 2007, stc had no leverage on its balance sheet, but that has changed with its foreign expansion drive. total debt reached sar 31.99 billion in 2008, with a net debt/eBitda ratio of 1.18. We expect the net debt/eBitda ratio to fall below 1.1 for 2009.

Trading at a favorable PE

One of the highest dividend yields for telecom companies in the region

Expect net debt/EBITDA to fall below 1.1

Saudi Arabia Saudi Telecom Co. 100.0% 56.0% 3 18.5 54.0% 2008

Malaysia Maxis Malaysia 25.0% 41.0% 3 10.2 5.0% 2008

India Aircell 18.5% 4.5% 11 9.5 1.8% 2008

Kuwait Kuwait Telecom Co. 26.0% 4.0% 3 0.4 N/A 2008

Turkey Avea 16.0% 19.0% 3 12.4 2.3% 2008

South Africa Cell C 11.0% 10.0% 3 5.1 0.5% 2008

Bahrain STC Bahrain 25% - 3 - - 2009

Subscribers(Millions) As of

Contribution to RevenueCountry Name Ownership

No. ofOperators

Mobile Market Share

stc

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equity research

July 1, 2009


Recently entered Kuwait and will soon enter Bahrain

STC is the leader in fixed broadband in KSA

Deployment of NGN could be a growth driver for STC

Ongoing promotional offers to compete with operators

expected to hurt margins

Emerging markets less attractive due to overcrowding

We expect a positive earnings surprise in the second quarter

of 2009

1 stc has diversified its revenue streams through its geographical expansion. 21% of revenues from 2008 are generated from foreign operations.

1 the company has entered the Kuwaiti market, which had a relatively high arpu of usd 55-60 and a penetration rate of 88% for 2008. Viva Kuwait had 400,000 subscribers as of the end of 2008. stc benefits doubly from interregional tourism. on average, around 1 million visitors a year come from Kuwait to saudi arabia.

1 stc also won Bahrain’s third mobile license in 2009. it is estimated that 1 million visitors come from Bahrain to saudi arabia and 8 million saudi nationals travel to Bahrain on a yearly basis. stc’s interconnection charges should be reduced as frequent flyers to Kuwait and Bahrain would have an incentive to switch mobile operators. eBitda margins are expected to improve from 42.8% in 2008 to 44.8% in 2013.

1 the company’s dsL services in saudi arabia have been utilized by more than one million cus-tomers. around 4.1 million households are currently subscribed to stc’s dsL services. the majority of subscribers are using fixed broadband, while 50,000 are wireless customers. in 2008, the fixed broadband market was split, with 1.0 million for stc and 250,000 for Mobily. although stc is the leader in fixed broadband in the Kingdom, Mobily is the leader in wireless broadband.

1 stc representatives indicated that next Generation networks (nGn) will contribute to future company growth. next Generation network is a telecommunications network that has the capacity to handle multiple types of traffic including voice, data, and multimedia. We have not integrated this in our analysis since it is too early to value its effective contribution.

1 stc continues to provide promotional offers. it has initiated a new offer for mobile customers where every minute after three minutes have passed will be cut to 50 halalas per minute for all out-going (local and international) calls. the offer began on March 21, 2009 and lasted for one month. For example, calling any of the Gcc countries will cost sar 1.3 per minute for the first three minutes and then 50 halalas for each following minute.

1 While operators believe that emerging countries with low penetration rates are attractive, de-clining arpus in overcrowded emerging countries result in lower-than-expected revenues. For ex-ample, with 11 mobile operators in india, market share will have to be split among all players. opera-tors may have to compete through lower pricing.

1 the turkish Lira depreciated against the us dollar by 7.7% between the last quarter of 2008 and the first quarter of 2009 and stayed at about the same level ytd (from June 16, 2009). the south african rand has appreciated by 19.0% ytd (from June 16, 2009), improving cell c’s revenue contri-bution compared to the first quarter. We expect revenues from turk telekom and cell c to be higher in the second quarter of 2009 than the previous quarter, assuming all else constant. however, the uncertain direction of foreign currency exposure makes the company’s earnings more volatile than those of Mobily and Zain, that do not have overseas operations.

The bottom line is:

We issue an accumulate recommendation on the company based on its low pe relative to peers, its attractive dividend yield, the recent improvement in foreign currency exposure, and its foreign acquisitions which should generate bottom-line profits in the long run.

stc

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July 1, 2009


SWOT aNaLYSIS

1 high dividend yield

1 dominant mobile market share

1 dominant fixed broadband market share

1 Fully integrated telecom company offering mobile, fixed line, and data services and only Ksa operator offering triple play services

1 saudi government owns high ownership stake

1 Modest net debt/eBitda ratio of 1.18 (compared to 2.25 for Mobily)

1 Wholesale revenue from Zain Ksa and etihad atheeb

1 Wireless broadband market share is dominated by Mobily

1 Losing mobile market share from increased competition

1 earnings volatility from emerging country currency exposure

1 constantly looking for overseas expansion

1 Kuwait’s third mobile operator, with a relatively high apru of usd 55-60

1 Won Bahrain’s third mobile license

1 rising demand for data services in the broadband segment

1 Larger addressable market due to lower pricing resulting from competition

1 continuing to provide value-added services

1 intense competition in mobile market

1 issuance of 3 new fixed licenses is expected to decrease arpus and reduce fixed market share

1 currency fluctuations in turkey and south africa

1 Mobile number portability

STRENGTHS

WEakNESSES

OPPORTUNITIES

THREaTS

stc

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equity research

July 1, 2009


FINaNcIaL aNaLYSIS

FIRST QUaRTER OF 2009:

1 revenues for the first quarter were sar 12,143 million, a 1% decrease q-o-q and 27% increase y-o-y. this can be attributed largely to growth in mobile revenues of 3.5% q-o-q from sar 7,926 to sar 8,203 million.

1 saudi telecom company reported quarterly earnings of sar 2,488 million in the first quarter of 2009 compared to sar 1,166 million in the fourth quarter of 2008 and sar 3,029 million in the first quarter last year, a 113% increase q-o-q and an 18% decline y-o-y. eBitda margins increased to 46.2% from 36.9% in the fourth quarter of 2008. however, we maintain our eBitda margin ex-pectation at a modest level as we believe that the eBitda margin will be lower in the quarters to come. in the past, stc’s first quarter eBitda margins have generally been higher than the other three quarters.

Chart 20: quarterly earnings (sar millions) vs. eBitda Margins

Source: Company financials

1 Fourth quarter earnings comprised a FX loss of sar 2 billion, while first quarter FX losses amount-ed to sar 695 million. excluding Foreign exchange losses, first quarter earnings remained approxi-mately the same as fourth quarter earnings. First quarter earnings would be almost 5% higher y-o-y after adjusting for foreign exchange losses.

3,029 3,840 3,012 1,166 2,488

51.2% 48.4% 47.9%

36.9% 46.2%

0%

10%

20%

30%

40%

50%

60%

0 500

1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500

1Q 0

8

2Q 0

8

3Q 0

8

4Q 0

8

1Q 0

9 Earnings EBITDA margins

stc

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equity research

July 1, 2009


Revenue growth driven by mobile and data revenues

Higher advertising costs for start- up operations and protection

of domestic market share

2008 aT a GLIMPSE:

1 the company’s revenues soared by 37.8% y-o-y from sar 34,458 million to sar 47,469 million, driven mainly by a boost in GsM revenues reaching sar 32,644 million and growth in data revenues of sar 5,690 million, constituting 12.0% of total revenues. according to our estimates, the mobile penetration rate rose from 109% in 2007 to 128% in 2008.

1 total operating expenses grew by 53.7% from 2007 mainly as a result of a 195% increase in selling, general and administrative expenses. this was mostly due to foreign acquisitions of start-up businesses incurring high advertising costs and intensive advertising and marketing campaigns initiated with the entrance of Zain saudi arabia to protect market share. We expect selling, general, and administrative expenses to be 15% of revenue for 2009, lower than 2008’s 15.2%. this is above historical percentages, but explained by the entry of a third mobile player into the saudi market in 2008 and etihad atheeb telecom launching operations in the second half of 2009.

1 eBitda margins deteriorated from 48.5% to 42.8% in 2008. We believe there is a strong correla-tion between eBitda margins and earnings. With the exception of 2006, higher eBitda margins translated into higher probability.

1 profitability took a hit in 2008 due to foreign exchange fluctuations in turkey and Bangladesh and lower eBitda margins attributable to promotional offers launched at discounted rates to com-pete with mobile players. earnings decreased by 8.2%, from sar 12,022 million to sar 11,038 million.

Chart 21: yearly earnings (sar millions) vs. eBitda Margins

Sources: Company financials, Audi Saudi Arabia estimates

stc

12,447 12,799 12,022 11,038 11,118

52.9% 50.9% 48.5% 42.8% 42.3%

0%

10%

20%

30%

40%

50%

60%

10,000

10,500

11,000

11,500

12,000

12,500

13,000

2005

2006

2007

2008

2009

E

Earnings EBITDA Margins

PRO FORMa FINaNcIaLSTable 8: consolidated Balance sheet


2006 2007 2008 2009 E 2010 E 2011 E 2012 E 2013 E

(unconsolidated)

Cash and Cash Equivalents 2,909 7,618 8,061 10,712 9,174 7,784 8,628 9,909

5,599 - - - 3,000 3,000 3,000 3,000

3,939 4,973 8,120 8,278 8,508 8,656 8,749 8,896

915 1,386 2,765 2,819 2,897 2,948 2,979 3,029

13,362 13,977 18,946 21,809 23,579 22,388 23,356 24,834

30,128 34,369 44,382 46,754 49,614 51,346 52,238 52,221

732 13,856 31,695 30,903 30,130 29,377 28,642 27,926

1,140 2,404 2,452 2,427 2,403 2,427 2,476 2,501

759 4,205 2,287 2,409 2,557 2,646 2,692 2,691

32,759 54,834 80,816 82,493 84,703 85,796 86,048 85,339

46,121 68,811 99,762 104,302 108,282 108,184 109,404 110,173

1,960 3,082 6,649 6,870 6,962 7,083 7,159 7,073

2,420 6,217 4,335 5,682 5,758 5,859 5,921 5,850

3,749 5,587 5,762 5,937 6,016 6,121 6,187 6,113

1,394 1,773 2,249 2,288 2,352 2,393 2,419 2,459

- 560 3,905 2,930 3,060 2,148 2,781 2,111

Total Current Liabilities 9,523 17,219 22,900 23,707 24,149 23,603 24,467 23,607

624 - - - - - - -

- 13,019 28,081 27,252 25,343 21,285 18,065 15,587

1,820 1,932 2,738 3,152 3,195 3,250 3,285 3,246

- 748 3,482 3,597 3,646 3,709 3,749 3,704

Total Non Current Liabilities 2,444 15,700 34,301 34,002 32,184 28,245 25,100 22,537

11,967 32,919 57,201 57,708 56,332 51,848 49,566 46,144

20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000

5,818 7,020 8,233 9,345 10,534 11,745 12,968 14,312

8,339 8,659 9,783 12,289 16,108 19,191 21,412 23,725

- 197 -379 - - - - -

-3 - - - - - - -

34,154 35,876 37,637 41,634 46,643 50,936 54,380 58,036

- 16 4,924 4,960 5,307 5,400 5,458 5,992

34,154 35,892 42,561 46,594 51,950 56,336 59,838 64,029

Financial Statements' Translation Di�erences

Unrealized Loss on Other Investments

Total Common Shareholders' Equity

Minority Interest

Accrued Expenses

Current Portion of Deferred Revenues

Current Portion of Long Term Borrowings

Deferred Revenues

Total Shareholders' Equity

(SAR million)

Equity Method and Investments

Other Non Current Assets

Total Current Assets

Prepayments and Other Current Assets

Short Term Investments

Intangible Assets (net)

Retained Earnings

Other Payables

Borrowings

Employees' End of Service Bene�ts

Total Liabilities

Contributed Capital

Statutory Reserve

Other Payables

Property, Plant, & Equipment (net)

Accounts Receivable (net)

Total Assets

Total Non Current Assets

Accounts Payable

Total Liabilities and Equity 46,121 68,811 99,762 104,302 108,282 108,184 109,404 110,173

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equity research

July 1, 2009

SaUDI TELEcOM SEcTOR stc

27


equity research

July 1, 2009


Table 9: consolidated income statement


2006 2007 2008 2009 E 2010 E 2011 E 2012 E 2013 E

(unconsolidated)

26,392 27,087 27,370 27,223 27,308

1,150 1,243 1,305 1,340 1,299

2,542 2,517 2,501 2,506 2,689

3,008 3,085 3,429 3,589 3,912

22,631 25,165 32,119 33,093 33,931 34,606 34,658 35,207

11,751 12,226 12,372 12,918 13,266

3,548 3,579 3,625 3,569 3,531

9,763 9,293 15,350 15,299 15,805 15,997 16,487 16,797

32,394 34,458 47,469 48,392 49,737 50,602 51,145 52,004

4,446 4,825 5,542 5,650 5,807 5,908 5,971 6,072

3,810 4,427 6,131 6,291 6,217 6,072 5,882 5,980

4,284 4,275 6,164 6,284 6,459 6,571 6,641 6,753

1,932 2,442 7,194 7,259 7,212 7,084 6,905 6,761

1,438 1,773 2,127 2,420 2,487 3,036 3,580 3,120

3,836 4,098 6,407 6,775 6,963 7,084 7,160 7,021

19,746 21,840 33,565 34,678 35,144 35,756 36,139 35,706

16,484 16,716 20,311 20,489 21,556 21,931 22,166 23,318

12,648 12,618 13,904 13,714 14,592 14,846 15,006 16,298

500 548 675 735 755 768 777 790

-994 -376 1,186 869 893 908 918 933

343 427 833 820 862 877 887 933

12,799 12,019 11,210 11,291 12,082 12,293 12,424 13,642

- -2 172 173 185 189 191 209

12,799 12,021 11,038 11,118 11,897 12,104 12,234 13,433

6.40 6.01 5.52 5.56 5.95 6.05 6.12 6.72

5.75 5.00 3.75 3.75 4.00 4.50 5.00 5.50

EPS (SAR)

DPS (SAR)

Early Retirement Programme

Interest and Other Expenses

Zakat and Taxes

Minority Interest

Avea

Maxis - Malaysia

Other

Wired Line Revenues

Total Wireless Revenues

(SAR million)

Wireless Revenues

Saudi Wireless

Total Revenues

Government Expense

Interconnection Expense

Employee Expense

Saudi Fixed

Turk Telekom

Total Wired Lined Revenues

Selling, General and Administrative Fees

Operating Expenses

Earnings

Common Earnings

Maintenance

Depreciation and Amortization

EBITDA

EBIT

the geographical distribution of revenues is not disclosed in historical financialstatements and are audi saudi arabia estimates.

stc

FOOTNOTES

VaLUaTION

DIVIDEND DIScOUNT MODEL

using the dividend discount model, we have arrived at an intrinsic value of sar 66.49 for stc.

the assumptions of the model were based on a 5-year forecast period, with a risk-free rate of 2.78%, a beta of 0.838, and a market risk premium of 8.7%; a required return on equity of 10.07% was de-rived. We assumed a perpetual growth rate of 3%.

Table 10: dividend discount Model

Source: Audi Saudi Arabia Estimates

PEER VaLUaTION

using the peer-weighted average forward pe of 9.67, a fair value of sar 53.77 was derived for stc based on our 2009 eps estimate of sar 5.56.

Table 11: peer Valuation sample

Sources: Audi Saudi Arabia Estimates, Bloomberg (Prices as of June 30, 2009)

2009 E 2010 E 2011 E 2012 E 2013 E

Net Income (SAR million) 11,118 11,897 12,104 12,234 13,433

Number of Shares Outstanding (million) 2,000

Earnings per Share (SAR) 5.56 5.95 6.05 6.12 6.72

Dividends per Share (SAR) 3.75 4.00 4.50 5.00 5.50

Present Value of Dividends per Share (SAR) 3.41 3.30 3.37 3.41 3.40

Present Value of Terminal Value (SAR) 49.59

Cost of Equity 10.07%

Terminal Growth Rate 3.00%

Fair Value (SAR) 66.49

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SaUDI TELEcOM SEcTOR stc

Company Name Country PE Forward PE PB

Saudi Telecom Co. Saudi Arabia 9.81 9.26 2.75Etihad Etisalat (Mobily) Saudi Arabia 9.39 9.44 2.53Qatar Telecom Qatar 7.56 8.12 1.89MTC Zain Kuwait 12.54 11.13 2.37Wataniya Telecom Kuwait 10.55 10.25 2.33Orascom Telecom Egypt 16.26 15.48 4.43Emirates Tele. Co. (Etisalat) UAE 8.35 7.93 2.32

Arithmetic Average 10.64 10.23 2.66Weighted Average 10.27 9.67 2.57

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FaIR VaLUE

combining the ddM Valuation and the peer Valuation, we arrive at a fair value of sar 63.95. We al-locate 80% of the valuation weight to the ddM methodology and 20% to the peer Valuation.

Table 12: combination of Valuation Methodologies


stc

Fair Value (SAR) Valuation Weight Weighted Fair Value

66.49 80%53.77 20%

SAR 63.95

Methodology

DDM ValuationPeer Valuation

Market cap (sar) 24,570,000,000

Market cap (usd) 6,552,843,570

Free Float 58.00%

av. Monthly Liquidity (sar) 841,375,717



pB 2.53

trailing pe 9.39

pe 09 (e) 9.44


net income 2,092 2,604 2,922 3,287 3,364 3,645

eps (sar) 4.00 3.72 4.17 4.70 4.81 5.21

dps (sar) 0.75 1.00 1.25 1.34 1.70 2.03

current price SaR 35.10

Fair price SaR 53.44

recoMMendation BUY

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SaUDI TELEcOM SEcTOR MoBiLy

ETIHaD ETISaLaT (MOBILY) – WeLL prepared For the coMinG rise

WE iniTiaTE a buY rECommEndaTion WiTH a TargET PriCE of Sar 53.44

By 2006, two years after the start of operations, the company reported positive earnings. For 2009, we predict that Mobily will realize earnings of sar 2,604 million, generating a positive free cash flow of sar 2,052 million, and stable dividend growth of 33.33%. Mobily’s saudi-only operations, aggres-sive entry into data services and continuous launching of new value-added services make it a top telecom stock pick in the region.

mobiLY rECEiVEd Sar 4.6 biLLion in bidS for rigHTS iSSuE

the company’s rights issue was oversubscribed more than 2 times. the sar 2 billion rights issue sup-ports the company’s liquidity position. according to Mobily, the proceeds will be used to continue the expansion of its infrastructure.

gaining ground in THE broadband marKET

Mobily has completed the acquisition of 96% of Zajil international telecommunications for sar 80 million. it previously purchased 99.9% of Bayanat al oula, another saudi data service provider. Broadband revenues constituted 10% of Mobily’s revenues in the fourth quarter of 2008, a signifi-cant contribution. With a broadband penetration rate of 4.1% in saudi arabia for 2008, the data services segment is expected to continue growing.

oPEraTionS groWing in a domESTiC framE

Mobily eliminates foreign exchange risk by having operations solely in saudi arabia. the country’s strong fundamentals of a high growth population and a high percentage of expatriates are favor-able characteristics for telecom companies. it is in the best interest of Mobily to remain local, in our opinion, since regional telecom players’ decisions to go international have usually led to higher leveraging and lower than expected profitability from overseas operations.

STOck DaTa

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cOMPaNY OVERVIEW

PROFILE

etihad etisalat (Mobily) launched operations as saudi arabia’s second GsM mobile operator, break-ing saudi telecom’s mobile monopoly. Mobily was established by uae-based emirates telecommu-nications corporation (etisalat).

Mobily acquired the second mobile license in saudi arabia in 2005 for sar 13 billion. Mobily launched its services in May 2005, ending the year with 2.3 million subscribers, constituting 16% of the saudi mobile market. By the end of 2008, we estimate that the company reached a 38% mar-ket share, with 13.02 million active subscribers. the company was the first to introduce Blackberry services and the iphone in saudi arabia. it was also the first mobile saudi operator to introduce value-added services such as MMs (picture messaging), location-based services (LBs), international roaming for prepaid subscribers, Gprs/Gprs edGe roaming, and other services. Mobily was the first saudi wireless operator to launch in-flight calls abroad, through aero Mobile, a specialized aviation mobile operator. it also initiated the first video mail service in Ksa and pioneered the launch of 3.5G services in Ksa in June 2006.

Chart 22: Mobily ownership structure

Source: Tadawul

in april 2008, Mobily’s founders floated an additional 20% for the public, in compliance with the royal decree mandating a 20% increase in the company’s equity in its third year of operations. on september 15, 2008, the 40% rights issue was successfully completed, increasing the company’s capital from sar 5 billion to sar 7 billion.

STRaTEGY

Mobily is successfully reaching its long term vision: to transform from a pure mobile operator to a multi-functional telecom operator in saudi arabia. in 2008, Mobily acquired 99.9% of Bayanat al oula and 96% of Zajil international telecom, two data service providers in Ksa. Bayanat has a WiMaX license. For the fiscal year 2009, we estimate that data services revenues will amount to 10-12% of total revenues.

Mobily is optimizing the cost of existing operations through its acquisition of a 66.6% stake in the saudi national Fiber network (snFn) which replaces the use of stc’s international gateway net-work. the proceeds of the sar 2 billion capital raise are used for upgrading, funding, or rolling out networks.

27%

11%

4%

58%

Etisalat

General Organization for Social Insurance

Other

Free Float

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First to offer many value-added services in the Saudi telecom market

Mobily successfully completed the SAR 2 billion capital increase

Acquired two data services operators in less than a year

Cost containment measures through establishment of an

independent stand-alone network

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Mobily takes the lead in wireless broadband market

Saudi-only focus is a key investment point

Fiber network will meet customers’ demands

DPS of SAR 0.75 for 2008

Strong provider of value-added services

INVESTMENT RaTIONaLE1 the company’s focus on broadband, 3.5G services, and other value added services distinguish it from other telecom operators. With a broadband penetration rate below 5% in the Kingdom, there are growth opportunities that Mobily is exploiting through its recent acquisitions of Bayanat al-ou-la and Zajil. Mobily had 300,000 high speed packet access (hspa) wireless broadband subscribers, while stc has 50,000 subscribers as of the end of 2008. hspa-based broadband allows subscribers to access the internet simply by plugging the device into the usB port. this eliminates the need for customers to wait for the initial setup and delivery of services as is required for fixed-line broadband.

1 although we do not see financing as being an issue for Mobily given the historical growth in its earnings, successful completion of the rights issue ensures that funding is available to pursue expansions.

1 Mobily’s saudi-only focus is a key investment point. having operations only in saudi arabia removes foreign exchange and political risk. We have seen several companies suffer from unfavor-able foreign exchange movements, such as qatar telecom from the indonesian rupee depreciation against the dollar and orascom telecom from the pakistan rupee depreciation against the dollar. therefore, Mobily’s saudi-only focus makes its earnings less volatile compared to regional players such as qatar telecom and stc.

1 Mobily has its own backbone infrastructure thanks to its stake in the saudi national Fiber net-work (snFn). snFn is a 12,500 km fiber optic network covering all of saudi arabia. the Kingdom’s largest network, with a cost of sar 1 billion, is expected to be completed in 2009. Benefits from this project include lower transmission costs, since Mobily will no longer lease line capacity from stc. Mobily will also be able to offer faster and better quality of data and voice services, especially to business entities. Leasing capacity to other telecom operators will generate additional revenue. Zain has an exclusive agreement to lease capacity from Mobily. also, three new fixed licenses have been issued to Batelco, pccW, and Verizon. We believe that these players will initially start by leas-ing capacity from either stc or Mobily. etihad atheeb, owned by Batelco, has already agreed with Mobily that it will be renting capacity from its networks.

1 in addition, Mobily has an active investment stake of 33.3% in an e-cable project. this project is expected to be completed by the end of June 2009 and will facilitate internet and voice traffic be-tween asia and europe through the Middle east. the cable extends to the uae, saudi arabia, egypt, and european countries.

1 a dividend per share of sar 0.75 has been distributed for 2008, a 50% increase from last year’s sar 0.50. this is a positive signal for investors, since the company continues to invest in network roll-outs and upgrades while at the same time giving out dividends, and all this with merely three years of operations. While Mobily’s dps is lower than stc’s sar 3.75, the infant company argument justifies the disparity.

1 Mobily launched the iphone 3G on February 22, 2009. it is the exclusive provider of this service in the Kingdom. according to Zawya, 25,000 customers ordered the iphone within hours of the launch. this illustrates how, despite the high mobile penetration rate, Mobily is increasing its subscriber base through value-added services.

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1 Mobily’s high capital expenditures for infrastructure purposes will affect free cash flows but improve eBitda margins. in the long-run this will stimulate free cash flow generation as costs are optimized. We believe that investing in telecom assets today will be to the advantage of the com-pany. Mobily is the first operator in the Kingdom to provide broadband internet services through 3.75G networks by using the high speed uplink access (hsupa). Mobily has put aside sar 1 billion for the project.

1 the company’s net debt/eBitda ratio for 2008 is 2.25, lower than the 2007 ratio of 2.79. 2009’s net debt/eBitda ratio should be lower, between 1.7 and 2.0. this will be due to the anticipated im-provement in eBitda and positive cash generation.

The bottom line is:

Mobily’s entrance into the saudi telecom sector when the penetration rate stood at a mere 61% gave it a big advantage for capturing a solid piece of the market share. to retain its market share, Mobily continues to provide value-added services (such as the recent iphone launching), expand its broadband services and lead in wireless broadband services (although it ranks second in broadband over-all). Most importantly, its earnings are less volatile due to its operations being purely domestic. We issue a Buy recommendation on Mobily.

Capex to increase cash flow generation in the long run

Lower net debt/EBITDA expected for 2009

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SWOT aNaLYSIS

1 diversifying revenue streams through focusing on value-added services and data services

1 saudi-only operations avoid currency and country risks

1 quickly responded to Zain’s one network services by establishing roaming agreements with almost 100 operators in 56 countries

1 successful capital increase

1 Fiber network targeting business entities

1 indirectly supported by the uae government through etisalat

1 Wholesale revenue from Zain Ksa and etihad atheeb

1 dominant wireless broadband share

1 90% of customers are prepaid subscribers, signaling lower arpus and high sensitivity to pricing

1 Fixed broadband market share is dominated by saudi telecom and stc is ranked first in broadband overall




1 convergence with a fixed line provider in the future in order to enable competitive pricing for customers

1 intense competition in mobile market

1 new entrants in fixed line operations (affects broadband revenues)


STRENGTHS

WEakNESSES

OPPORTUNITIES

THREaTS

MoBiLy

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FINaNcIaL aNaLYSIS


First quarter revenues were sar 2,810 million up 22% y-o-y from sar 2,308 million. We did not compare it to the preceding quarter, since the fourth quarter for Mobily exhibits seasonality across previous periods and is therefore not a suitable basis for comparison.

the company’s first quarter earnings were sar 480 million, a 47% increase y-o-y from sar 326 mil-lion. this is due to higher subscriber growth, improved eBitda margins (from 31.5% in 1q 08 to 32.3% in 1q 09), and continuing growth in broadband.

Chart 23: quarterly earnings (sar millions) vs. eBitda Margins

Source: Company financials

the chairman of Mobily announced that the first quarter of 2009 ended with 15 million subscribers primarily on account of Mobily’s exclusivity rights to the iphone launched in February 2009, and increased demand for data services. We estimate that the company ended the quarter with 13.5 million active subscribers.

a GLIMPSE OF 2008:

1 Mobily reported revenues of sar 10,795 million, a 27.9% boost from the previous year’s sar 8,440 million. data revenues contributed 10% of revenues for the fourth quarter. We expect data revenues to constitute 11% and 15% of revenues in 2009 and 2010, respectively.

1 operating expenses increased by 28.4%, from sar 2,745 million to sar 3,525 million due to rising selling, administrative, and general expenses. advertising expenses were higher than during previous periods because of Zain entering the market in 2008. eBitda margins will improve in 2009, since Mobily will no longer use stc’s international gateway, but the saudi national Fiber network (snFn).

1 eBitda margins rose to 35.1% in 2008 compared to 34.9% in 2007.

1 Mobily earnings increased from sar 1,380 million to sar 2,092 million, a 51.6% rise due to ac-celerated subscriber growth, an increase in minutes of usage from competitive promotions, data revenues growth, and the development of a proprietary network.

1Q 09 revenues up 22%

Data revenues should be 11% of revenues in 2009 and 15% in 2010

326 448 539 778 480

31.5% 33.4% 34.3% 40.0%

32.3%

0%

10%

20%

30%

40%

0

200

400

600

800

1Q 0

8

2Q 0

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Chart 24: annual earnings (sar millions) vs. eBitda Margins

Source: Company financials, Audi Saudi Arabia estimates

MoBiLy

-1,167

700 1,380 2,092 2,604

-38.9%

34.3% 34.9% 35.1% 35.9%

-50%

-30%

-10%

10%

30%

-3,000

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-1,000

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PRO FORMa FINaNcIaLSTable 13: consolidated Balance sheet

Sources: Company Financials, Audi Saudi Arabia Estimates

MoBiLy

(SAR million) 2006 2007 2008 2009 E 2010 E 2011 E 2012 E 2013 E

(unconsolidated) (unconsolidated)

Cash and Cash Equivalents 548 703 1,263 3,794 3,383 1,727 3,721 1,176

Short Term Investments - - 1,050 2,000 1,500 1,750 2,000 2,250

Accounts Receivable (net) 734 1,460 3,098 3,484 3,788 4,017 4,141 4,354

Due from Related Parties 5 71 39 40 42 43 42 43

Inventory 38 69 108 115 125 131 133 140

Prepaid Expenses and Other Assets 717 810 1,063 1,116 1,172 1,231 1,292 1,357

Total Current Assets 2,042 3,113 6,621 10,549 10,009 8,897 11,329 9,320

Property, Plant, & Equipment (net) 3,848 5,479 8,117 9,908 11,466 12,711 14,104 15,922

License Acquisitions Fees (net) 11,800 11,287 10,923 10,410 9,896 9,383 8,869 8,356

Goodwill - - 1,530 1,500 1,500 1,500 1,500 1,500

Investment in Unconsolidated Subsidiary - 2 - - - - - -

Total Non Current Assets 15,648 16,768 20,570 21,817 22,862 23,594 24,473 25,777

Total Assets 17,690 19,881 27,191 32,367 32,872 32,491 35,802 35,097

Short Term Loans 7,840 - 1,862 889 889 445 222 111

Current Portion of Long Term Loan - 1,011 1,286 2,371 2,899 3,047 3,551 730

Accounts Payable 2,526 3,142 4,365 4,910 5,337 5,594 5,699 5,992

Due to Related Parties 179 111 78 81 84 85 84 87

Accrued Expenses and Other Liabilities 998 1,765 3,157 3,261 3,393 3,451 3,417 3,510

Total Current Liabilities 11,543 6,029 10,748 11,511 12,602 12,621 12,974 10,430

Long Term Loans - 7,912 6,642 9,147 6,248 3,202 3,651 2,922

Provision for Employees' Indemnities 13 26 46 51 56 61 67 74

Shareholder Loan 1,600 - - - - - - -

Total Non Current Liabilities 1,613 7,938 6,688 9,198 6,304 3,263 3,718 2,996

Total Liabilities 13,156 13,967 17,436 20,709 18,906 15,884 16,692 13,426

Contributed Capital 5,000 5,000 7,000 7,000 7,000 7,000 7,000 7,000

Statutory Reserve - 138 347 607 900 1,228 1,565 1,929

Retained Earnings -467 775 2,407 4,051 6,066 8,379 10,545 12,742

Total Shareholders' Equity 4,533 5,913 9,754 11,658 13,966 16,607 19,110 21,671

Total Liabilities and Shareholders' Equity 17,690 19,881 27,191 32,367 32,872 32,491 35,802 35,097

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Table 14: consolidated income statement


(SAR million) 2006 2007 2008 2009 E 2010 E 2011 E 2012 E 2013 E

(unconsolidated) (unconsolidated)

Total Revenues 5,840 8,440 10,795 12,488 13,575 14,395 14,840 15,604

Cost of Sales 2,680 3,779 4,774 5,370 5,837 6,118 6,233 6,554

Gross Pro�t 3,160 4,662 6,021 7,118 7,738 8,277 8,607 9,051

Selling and Marketing Expenses 365 641 816 944 1,026 1,088 1,122 1,180

General and Administrative Expenses 670 1,073 1,411 1,686 1,805 1,885 1,915 2,013

Other Operating Expenses 124 - - - - - - -

EBITDA 2,001 2,948 3,794 4,488 4,907 5,304 5,571 5,858

Depreciation and Amortization 845 1,031 1,298 1,347 1,535 1,716 1,941 1,973

Operating Income 1,156 1,917 2,496 3,141 3,372 3,587 3,630 3,885

Interest Expense 479 556 438 520 429 274 239 208

Other Income 23 43 41 50 54 58 59 62

Earnings before Tax 700 1,404 2,099 2,671 2,997 3,371 3,450 3,739

Zakat - 24 7 67 75 84 86 93

Net Income 700 1,380 2,092 2,604 2,922 3,287 3,364 3,645

EPS (SAR) 2.64 4.00 3.72 4.17 4.70 4.81 5.21

DPS (SAR) 0.50 0.75 1.00 1.25 1.34 1.70 2.03

MoBiLy

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VaLUaTION

FREE caSH FLOW MODEL

using the discounted cash Flow model, we have estimated the intrinsic value of Mobily derived from the forecasted financials below. the assumptions of the dcF were based on a 5-year forecast period, with a Wacc of 8.14% and a long term growth rate of 3%. the fair value obtained from this model is sar 53.44, indicating a 52.25% upside potential over the current price of sar 35.10.

Table 15: Forecasted Free cash Flows


MoBiLy

(SAR million) 2009 E 2010 E 2011 E 2012 E 2013 E

Net Income 2,604 2,922 3,287 3,364 3,645

Change in Working Capital -203 -193 -21 117 -103

Non-Cash Charges 1,347 1,535 1,716 1,941 1,973

Capex 2,622 2,579 2,447 2,820 3,277

Interest Expense 520 429 274 239 208

Free Cash Flow to the Firm 2,052 2,499 2,851 2,608 2,653

Present Value of Free Cash Flow to the Firm 1,898 2,137 2,254 1,907 1,794

Present Value of Terminal Value 35,946

Intrinsic Value of the Firm 45,936

Net Debt 8,527

Intrinsic Value of Equity 37,409

WACC 8.14%


Shares Outstanding (million) 700

NAV (SAR) 53.44

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SaUDI TELEcOM SEcTOR MoBiLy

PEER VaLUaTION

using the peer-weighted average forward pe of 9.67, a fair value of sar 35.97 was derived for Mobily based on our 2009 earnings per share (eps) estimate of sar 3.72.

Because Mobily is the only purely local player in the sample, the pes are not comparable and the tar-get price derived from peer valuation is unreliable. therefore, we do not factor it into our valuation and rely exclusively on the discounted cash flow model to arrive at our target price of sar 53.44.

Table 16: peer Valuation

Sources: Audi Saudi Arabia Estimates, Bloomberg (Prices as of June 30, 2009)

Company Name Country PE Forward PE PB

Saudi Telecom Co. Saudi Arabia 9.81 9.26 2.75Etihad Etisalat (Mobily) Saudi Arabia 9.39 9.44 2.53Qatar Telecom Qatar 7.56 8.12 1.89MTC Zain Kuwait 12.54 11.13 2.37Wataniya Telecom Kuwait 10.55 10.25 2.33Orascom Telecom Egypt 16.26 15.48 4.43Emirates Tele. Co. (Etisalat) UAE 8.35 7.93 2.32

Arithmetic Average 10.64 10.23 2.66Weighted Average 10.27 9.67 2.57

Market cap (sar) 16,450,000,000

Market cap (usd) 4,387,231,450

Free Float 45.00%

av. Monthly Liquidity (sar) 4,618,287,862



pB 1.50

trailing pe na

pe 09 (e) na


net income (2,278) (1,416) (1,091) (715) (359) (24)

eps (sar) (1.33) (1.01) (0.78) (0.51) (0.26) (0.02)

dps (sar) 0.00 0.00 0.00 0.00 0.00 0.00

STOck DaTa

current price SaR 11.75Fair price SaR 11.69

recoMMendation HOLD

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SaUDI TELEcOM SEcTOR Zain Ksa

ZaIN SaUDI aRaBIa – rouGh Way to Go

WE iniTiaTE a HoLd rECommEndaTion WiTH a TargET PriCE of Sar 11.69

We believe that Zain will not report positive earnings before 2012 because of high operating ex-penses during the company’s start-up phase, high recurring amortization expenses from the usd 6.1 billion license fee, cost of renting network capacity from stc and Mobily, and price slashing due to intense competition. Zain reported a 7% market share for 2008. We expect it to reach17% by 2015.

Zain KSa rEPorTEd 2 miLLion SubSCribErS for 2008

the company reported 2 million active subscribers for the year ended 2008. according to our esti-mates, Zain will capture 9% of the market in its second year of operations and reach 15% in 2012 with 7.0 million subscribers, a 3-year caGr of 27.2%. We believe that there still remains an unaddressed segment of subscribers from the low income bracket. We expect penetration rates to increase even further in 2010 and Zain saudi arabia to contribute to the expansion of the addressable market.

Zain KSa EXPECTS To brEaKEVEn in 2010?

Zain’s former ceo, dr. Marwan al ahmadi, predicted eBitda would reach the breakeven point in 2010. he also expressed confidence that the company will have its own independent infrastructure in 3 years, 2 years earlier than expected. We believe that aggressive capital expenditure initiatives, along with an overpriced license (leading to a high annual amortization expense) will make it dif-ficult to achieve profitability within two years. Mobily’s earnings turned positive in 2006, its second operating year. however, Mobily’s amortization expense was less and the mobile penetration rate was only 61% in 2005, providing much greater room for growth.

WE rEmain buLLiSH on THE abiLiTY To finanCE and rEfinanCE

We believe there is a good chance for Zain Ksa to obtain debt financing and refinancing to fund its aggressive capital expenditures which are necessary given that it is still in its initial phase of development. under current market conditions, the highly visible nature of telecoms earnings is a significant positive factor that banks take into account when studying the loan repayment capabil-ity of a company. Borrowing is tempting at currently low rates.

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cOMPaNY OVERVIEW

PROFILE

Zain saudi arabia is the third mobile provider offering 2G and 3G mobile services to be introduced in the Kingdom. Zain Ksa started operations in the third quarter of 2008. it is a subsidiary of Zain Kuwait, which submitted the highest bid of usd 6.1 billion for the 25-year GsM license in saudi arabia in March 2007. the company’s ipo began in February 2008. it offered 50% of its shares on the saudi stock exchange to raise usd 1.87 billion. the company is targeting an optimal structure of a 50-50 debt-to-equity ratio.

Chart 25: Zain Ksa ownership structure

Source: Tadawul

STRaTEGY

the company’s former ceo dr. Marwan al ahmadi said that the company will have its own net-work infrastructure and that eBitda will breakeven by 2010. additionally, the company stated that it plans to have a long term market share of approximately 20% within 5 years.

Zain Ksa has been aggressively advertising its promotions such as ‘one network’ coverage and ‘Weekend X 2’ package, giving the company a competitive edge over the other telecom companies. it was Zain Ksa’s ‘one network’ coverage promotion that prompted other mobile providers to follow suit by offering discounted international rates in order to retain their customers.

25% 45%

7%

7% 5% 11% MTC Zain Kuwait

Saudi Plastic Factory

Faden Trading Contracting Est.

General Retirement Est.

Other

Free Float

Zain Ksa

High annual amortization cost of license

Cons: third market entrant, intense competition

Price-competitive or value-added-services-competitive?

We think it’s a little bit of both

Zain is targeting business entities

Net debt-to-equity ratio to rise to 2 in 2012

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INVESTMENT RaTIONaLE1 Zain saudi arabia’s mobile license was purchased for a steep usd 6.1 billion (sar 22.9 billion), whereas the second Ksa mobile license, granted to Mobily, had a usd 3.45 billion (sar 13 billion) price tag. in our estimates, the expensive license, as well as the startup costs and interconnection fees, will keep the company’s free cash flow far from breaking even until 2012.

1 We think Zain faces three inevitable obstacles on its way to success. Firstly, the track record of third market entrants for mobile providers in the eMea region has shown that long term market share does not usually exceed 20%. secondly, Zain’s competitive environment obliges it to either reduce prices in order to capture market share or to provide value-added services. thirdly, Zain Ksa is entering a market with a penetration rate of above 100%.

1 if Zain is to be able to compete with stc and Mobily in a market approaching saturation, then it should be price-competitive. however, this would come at the expense of more time for its earnings to reach the breakeven level.

1 Zain’s lower prices will be reflected in lower arpus. in order to increase its revenues, Zain should focus on non-voice services, an area where stc and Mobily are trying to gain ground.

1 Zain’s competitive promotions such as ‘one network’ coverage appeals to all expatriates, except those from asian countries or businessmen traveling to countries outside the Middle east and afri-ca. Zain’s ‘one month on us, one month on you’ promotion is limited to the first 500,000 subscribers, a number Zain now exceeds by more than 1.5 million. the promotion will retain existing subscribers, but not attract additional ones. We do not deny the attractiveness of the promotions yet wish to highlight their limits.

1 in March 2009, the company released an offer called the ‘Zain Business package’ targeting busi-ness entities. this package offers a discounted tariff to all numbers of the same organization. Before the Business offer, the company announced the launch of its “Weekend X 2” offer for all customers starting January 31, 2009. during weekends, Zain subscribers will receive as a bonus double the amount spent during the weekdays.

1 the total amount of Zain’s debt was sar 11.86 billion for 2008, with a net debt to equity ratio of 0.96. in addition to the capital raised, there is a strong need for financing to fund capital expendi-tures for infrastructure. in our forecasts, we therefore expect future capital to be provided through shareholders and debt. the recent interest rate cuts and injections of funds into the banking sector indicate that it may now be easier for saudi companies to obtain financing from local banks. We expect Zain’s level of debt to increase, and the net debt-to-equity ratio rise to 2 in 2012.

The bottom line is:

Being a third market entrant, paying a high licensing fee, facing intense competition, entering at a penetration rate above 100%, and an estimated free cash flow breakeven point in 2012 were the main factors for our issuing a hold recommendation on the company.

Zain Ksa

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SWOT aNaLYSIS

1 savvy advertising and marketing campaigns

1 Brand name recognition

1 offering value-added services and competitive international rates

1 indirectly supported by the Kuwait investment authority through Zain Group

1 high license cost

1 no dividends in the near term

1 Free cash flow to reach breakeven level in 2012

1 Massive capex to be incurred

1 high net debt/equity level at 0.96

1 Low borrowing rates under current conditions

1 convergence with a fixed line provider in the future in order to enable competitive pricing for customers




1 intense competition in mobile and data services

1 entered when mobile penetration rate was above 100%

1 third market entrant


1 refinancing needed

STRENGTHS

WEakNESSES

OPPORTUNITIES

THREaTS

Zain Ksa

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FINaNcIaL aNaLYSIS


the first quarterly revenues that Zain saudi arabia reported were at a level of sar 581 million, with a gross profit of sar 146 million. operating losses were sar 656 million and net losses amounted to sar 765 million. the losses are due to the recent start of operations, high depreciation and amor-tization expenses, and selling, general, and administrative expenses a start-up telecom company would normally incur.

We estimate that the number of subscribers reached 2.4 million for the first quarter of 2009.

2008 aT a GLIMPSE:

the company’s revenues came in at sar 505 million for the year 2008. the company officially started operating in august 2008. Gross profits amounted to sar 16.5 million and operating losses were sar 1,700 million for the year 2008. the company recorded revenues for 4 months and expenses for 18 months, reporting a net earnings loss of sar 2,278 million.

Zain Ksa

PRO FORMa FINaNcIaLSTable 17: Balance sheet


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SaUDI TELEcOM SEcTOR Zain Ksa

(SAR million) 2008 2009 E 2010 E 2011 E 2012 E 2013 E 2014 E

Cash and Cash Equivalents 583 319 305 889 625 484 550

Accounts Receivable (net) 318 665 876 1,006 1,104 1,126 1,204

Prepaid Expenses and Others 221 332 436 543 650 730 800

Inventory 60 58 72 91 109 123 133

Total Current Assets 1,182 1,373 1,690 2,530 2,489 2,462 2,686

Property, Plant, & Equipment (net) 2,409 4,219 5,756 6,934 7,764 8,546 9,087

Intangibles (net) 23,075 22,159 21,242 20,326 19,409 18,493 17,577

Other Assets 0 440 484 528 533 559 615

Total Non Current Assets 25,484 26,817 27,483 27,788 27,706 27,598 27,280

Total Assets 26,666 28,191 29,172 30,318 30,195 30,061 29,967

Accounts Payable 414 955 1,200 1,512 1,810 2,030 2,199

Vendor Financing 534 900 900 1,200 1,400 2,000 2,500

Murabaha Facility 9,164 5,785 1,173 4,000 2,000 3,000 4,000

Short Term Loans 0 2,500 2,500 3,000 3,000 3,000 3,000

Current Portion of Shareholder Loan 315 1,006 1,256 837 500 250 0

Current Portion of Long Term Debt 0 0 1,326 1,362 2,034 2,103 2,175

Other Current Liabilities 2,664 1,685 2,140 2,689 3,218 3,611 3,922

Total Current Liabilities 13,091 12,831 10,495 14,599 13,962 15,994 17,796

Shareholder Loans 1,849 2,843 1,587 750 0 0 0

Long Term Debt 0 2,207 7,871 6,464 8,088 5,945 3,834

Employees' End of Year Indenmity 4 4 4 5 5 6 6

Total Non Current Liabilities 1,853 5,054 9,462 7,219 8,093 5,951 3,840

Total Liabilities 14,944 17,885 19,957 21,819 22,054 21,945 21,636

Contributed Capital 14,000 14,000 14,000 14,000 14,000 14,000 14,000

Retained Earnings -2,278 -3,694 -4,785 -5,501 -5,860 -5,884 -5,670

Total Shareholders' Equity 11,722 10,306 9,215 8,499 8,140 8,116 8,330

Total Liabilities and Shareholders' Equity 26,666 28,191 29,172 30,318 30,195 30,061 29,967

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Table 18: income statement


VaLUaTION

FREE caSH FLOW MODEL

a small variation in market share, arpu, or discount rate can lead to a significant change in the target price. We estimate that the figures and target price are fairly presented. subjective estimates play a major role in valuing a company in its early phase of operations.

using the discounted cash Flow model, we have estimated the intrinsic value of Zain derived from forecasted financials below. the assumptions of the dcF were based on a 6-year forecast period, with a Wacc of 6.92%. the model uses a long term growth rate of 3%. the fair value obtained from this model is sar 11.69, implying a 0.51% downside potential from the current price of sar 11.75.

Table 19: Forecasted Free cash Flows


Zain Ksa

(SAR million) 2008 2009 E 2010 E 2011E 2012 E 2013 E 2014 E

Revenues 505 2,558 3,368 4,193 5,019 5,631 6,173

Cost of Sales 489 1,126 1,415 1,782 2,133 2,393 2,593

Gross Pro�t 16 1,433 1,954 2,411 2,886 3,238 3,580

Selling and Marketing Expenses 1,021 1,151 1,179 1,258 1,129 1,126 1,235

General and Administrative Expenses 260 358 455 545 627 676 710

EBITDA -1,265 -77 320 608 1,129 1,436 1,636

Depreciation and Amortization 435 1,107 1,179 1,239 1,287 1,335 1,375

EBIT -1,699 -1,183 -859 -631 -157 101 261

Interest 226 301 304 160 281 209 134

Other Income 65 68 72 75 79 83 87

Earnings for the Period -1,859 -1,416 -1,091 -715 -359 -24 215

Pre-operating Expenses 418 - - - - - -

Net income -2,278 -1,416 -1,091 -715 -359 -24 215

EPS (SAR) -1.33 -1.01 -0.78 -0.51 -0.26 -0.02 0.15

DPS (SAR) 0.00 0.00 0.00 0.00 0.00 0.00 0.00

(SAR million) 2009 E 2010 E 2011E 2012 E 2013 E 2014 EEBITDA -77 320 608 1,129 1,436 1,636

Change in Working Capital -954 -370 -604 -604 -499 -323

Capex 2,000 1,800 1,500 1,200 1,200 1,000

Free Cash Flow to the Firm -1,122 -1,110 -288 534 734 959

Present Value of Free Cash Flow to the Firm -1,050 -971 -236 408 526 642

Present Value of Terminal Value 28,320

Intrinsic Value of the Firm 27,639

Net Debt 11,279

Intrinsic Value of Equity 16,360

WACC 6.92%


Shares Outstanding (million) 1,400

NAV (SAR) 11.69

UAE Government

Etisalat Qatar Telecom Wataniya Kuwait Telecom STC

Mobily

60%

27%

0.80% 51% 21% 24% 26%

70%

25%

25%

Saudi Government

Kuwait Investment Authority

Zain Kuwait

Zain KSA

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aPPENDIX: OWNERSHIP STRUcTURE OF REGIONaL TELEcOM PLaYERS

Sources: Companies’ financials

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FaIR VaLUE DEFINITION

REcOMMENDaTION GUIDE

aDDRESS

DIScLaIMER

it is an unbiased estimate of the 12-month potential market price of the stock

BUY: upside potential in share price is more than 30%

accUMULaTE: upside potential in share price is between 10 and 30%

HOLD: upside or downside potential in share price less than 10%

REDUcE: downside potential in share price is between 10 and 30%

SELL: downside potential in share price is more than 30%

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downside -30% -10% +10% +30% upside

SELL REDUcE HOLD accUMULaTE BUY

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