Saudi Arabia Telecom - Fransi Capitalcampaign.fransicapital.com.sa/pdf/SFC_Telecom_STC_Mobily...Mobily played out; STC unfolding We initiate coverage on the Saudi telecom sector with

Refer to important terms or use, disclaimers and disclosures on back page. Saudi Fransi Capital

Saudi Arabia – Telecom Telecom | Equity Research | 12 February 2013

Mobily played out; STC unfolding

We initiate coverage on the Saudi telecom sector with an optimistic outlook. The Kingdom‘s

telcos have been investing in network upgrades and are, in our opinion, well-placed to tap

emerging broadband and data services opportunities. We see Saudi Telecom Company

(7010/STC AB), which is ahead in the capex cycle, offering a free cash flow yield nearly twice

that of Etihad Etisalat (Mobily) (7020/EEC AB), which is currently making considerable capital

investments. We find STC‘s valuation most attractive, the risk perception around the shares to

be overdone and the recent weakness in the shares as a lucrative entry point. Mobily, a pure

play on the Saudi market, has recorded strong earnings growth and ROE well above peer

average, however, shares had a phenomenal run and we see them as almost fairly valued at

current levels.

BUY STC with TP of SAR 51.1/share, HOLD Mobily: With STC regaining the

domestic market initiative backed by an upgraded fixed broadband infrastructure

capable of bringing interactive entertainment and high-speed data to every Saudi

home and business, much of its capex spend behind coupled with some international

operations turning EBITDA positive – STC is undoubtedly our top-pick. We start STC

with BUY recommendation and Target Price (TP) of SAR 51.1 per share – implying an

upside of 28%. Our initiation on Mobily is with HOLD recommendation and TP of SAR

80.6 per share, suggesting a moderate upside of 8%. With an EV/EBITDA 2013 of

4.6x 2013, STC is at a 17% discount to the Middle East and Africa (MEA) peers, while

at 6.9x, Mobily is trading at a premium of 24% to MEA peers.

Increasing broadband penetration and data revenue to drive top line: We expect

STC to deliver a top-line CAGR of 3.9% versus Mobily‘s 5.4% for the period 2012-17e.

Broadband services is the main driver to revenue growth, with segment penetration

(as a % of household) forecast to reach 60% in 2017 compared to an estimated 45%

in 2012. Favorable demography (high percentage of a tech–savvy, young population,

~57% under 30y), rising number of internet users, low levels of broadband penetration,

increasing smartphone adoption in the Kingdom coupled with a potentially large

appetite for data intensive entertainment solutions and a push towards e-government

would primarily drive demand in the broadband market. Unlike voice services (where

mobile services substituted fixed line), the emerging trend of data service adoption

through Wi-Fi networks (vis-à-vis cellular network) is gaining traction across several

developed markets.

EBITDA margins to expand; earnings outlook positive: We forecast broadband to

drive growth for Saudi telcos, with STC expected to leverage on its dominant market

position in the fixed line/FTTH operations (fiber ~10x Mobily), push into mobile

broadband and pricing power while international market growth prospects convert into

EBITDA contribution. Leadership position in mobile broadband space, management

track record and superior ROE‘s are positives for Mobily. We expect EBITDA margins

for both entities to expand ~120-250 bps to ~38-39% levels. Earnings are projected to

grow at an average 4-7% yoy over the next five years.

International markets offer long-term growth prospects for STC: International

markets offer long-term growth opportunities and earnings diversification. However, in

view of the ongoing political risks across the Middle East region and recent one-off

hits, investors are likely to attach a discount to diversified telcos like STC. We believe

the Saudi market is relatively well-insulated from various regional risks and domestic

focused Mobily offer a better perceived risk profile vis-à-vis STC. However, we see

that the attractive growth prospects of STC‘s international operations, including Kuwait

(top line up ~127% during 2011–2012) and Bahrain (up ~170% over the same period),

have been overshadowed. Nevertheless, with an estimated ~77% of EBITDA coming

from Saudi Arabia, the 33% discount on EV/EBITDA 2013 on STC relative to Mobily is,

in our opinion, excessive and should narrow in the coming year.

Rating Summary

Company Rating Price Target

Price Upside

Saudi Telecom (STC)

BUY 39.9 51.1 28.0%

Etihad Etisalat

(Mobily)

HOLD 74.8 80.6 7.8%

Zain KSA NC* - -

Prices as of February 11, 2013; * Not covered

Valuation Summary 2013e

Company P/E EV/

EBITDA

Dividend yield

Cash flow

yield

Saudi Telecom (STC)

9.0 4.6 5.0% 12.8%

Etihad Etisalat

(Mobily)

9.0 6.9 6.2% 7.3%

Sources: Company, Saudi Fransi Capital analysis

Telecom stock movement vs TASI

Source: Bloomberg

Sector Coverage

Roy Cherry

[email protected]

+966- 1-2826844

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mailto:[email protected]


Saudi Fransi Capital Page 2

STC: Key Forecast

Revenue and EBITDA margin (2012-2017e)

EPS vs Net income margin (2012-2017e)

Capex vs Capex-Sales (2012-2017e)

Sources: Company reports, Saudi Fransi Capital analysis

Note: Forecast based on existing accounting methodology, EBITDA and net income margins exclude one-off‘s.

Mobily: Key Forecast

Revenue and EBITDA margin (2012-2017e)

EPS vs Net income margin (2012-2017e)

Capex vs Capex-Sales (2012-2017e)


Note: 2012 EPS adjusted for 770mn shares

59.4 60.7 62.765.5

68.571.8

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Summary financials and ratios – STC and Mobily

STC (in SARmn) 2008 2009 2010 2011 2012 2013e 2014e

Revenue 47,469 50,780 51,787 55,662 59,372 60,722 62,659

EBITDA 21,743 20,612 19,621 20,025 20,945 22,191 23,132

Net Profit 11,038 10,863 9,436 7,729 7,351 8,875 9,135

Earnings per share, SAR 5.5 5.4 4.7 3.9 3.7 4.4 4.6

Dividend per share, SAR 3.8 3.0 3.0 2.0 2.0 2.0 2.5

Total Assets 99,762 109,587 110,781 111,402 117,912 127,512 133,970

Total Debt 36,321 36,109 33,697 33,598 34,823 37,526 38,360

Total Equity 42,562 50,833 53,464 54,082 58,969 64,543 69,467

Key Ratio and Valuation

EBITDA margin (%)* 45.8% 40.6% 37.9% 36.0% 35.3% 36.5% 36.9%

Capex/ Sales 34.3% 30.8% 21.9% 14.1% 14.8% 16.0% 15.0%

ROAA (%) 13.3% 10.7% 9.1% 7.1% 7.0% 7.8% 7.5%

ROAE(%) 30.5% 28.0% 23.1% 17.2% 16.3% 17.8% 16.9%

Cash flow yield (%) 6.1% 0.4% 12.3% 10.8% 4.2% 12.8% 14.1%

P/Earnings 6.6 7.2 7.3 10.3 10.9 9.0 8.7

P/Book 2.2 2.1 1.9 1.7 1.6 1.4 1.3

EV/ EBITDA 5.5 5.2 5.7 5.6 5.2 4.6 4.2

P/Sales 2.3 1.7 1.6 1.4 1.3 1.3 1.3

Mobily (in SARmn) 2008 2009 2010 2011 2012 2013e 2014e

Revenue 10,795 13,058 16,013 20,052 23,642 25,553 26,461

EBITDA 3,794 4,837 6,165 7,454 8,591 9,267 9,660

Net Profit 2,092 3,014 4,211 5,083 6,018 6,406 6,797

Earnings per share, SAR 2.7 3.9 5.5 6.6 7.8 8.3 8.8

Dividend per share , SAR 0.7 1.1 1.8 3.0 3.9 4.6 4.9

Total Assets 27,192 30,926 33,430 37,501 38,623 42,617 46,468

Total Debt 9,790 8,595 7,972 7,073 8,258 9,039 9,468

Total Equity 9,754 12,243 15,580 18,388 20,906 23,769 26,808

Key Ratio and Valuation

EBITDA margin (%) 35.1% 37.0% 38.5% 37.2% 36.3% 36.3% 36.5%

Capex/ Sales 27.4% 25.2% 20.5% 18.5% 20.6% 17.5% 16.0%

ROAA (%) 8.9% 10.4% 13.1% 14.3% 15.8% 15.8% 15.3%

ROAE(%) 26.7% 27.4% 30.3% 29.9% 30.6% 28.7% 26.9%

Cash flow yield (%) 1.0% 1.7% 3.8% 5.2% 3.8% 7.3% 8.6%

P/Earnings 27.5 19.1 13.7 11.3 9.6 9.0 8.5

P/Book 5.9 4.7 3.7 3.1 2.8 2.4 2.1

EV/ EBITDA 17.4 13.5 10.4 8.4 7.5 6.9 6.5

P/Sales 5.3 4.4 3.6 2.9 2.4 2.3 2.2

Sources: Bloomberg, Company reports, Saudi Fransi Capital analysis

Note: Per share data for Mobily based on 770mn shares;

* Excluding One-off charges

Historical multiples based on closing prices as of February 11, 2013



TABLE OF CONTENTS

Mobily played out; STC unfolding ..................................................................................................................................... 1

Summary financials and ratios – STC and Mobily ........................................................................................................... 3

Investment Thesis ............................................................................................................................................................... 6

Mobily mostly played-out, STC still unfolding.................................................................................................................................................. 6

Saudi Arabian Telecom Market ........................................................................................................................................ 13

Mobile revenue accounts for 80% of Saudi market ...................................................................................................................................... 13

Saturated mobile penetration in Saudi Arabia with three operators, STC leading ........................................................................................ 13

Similar prices for mobile services leave little to differentiate on pricing front ................................................................................................ 15

Competitive pricing for iPhones; most players attracting customers through “free” offers ............................................................................ 16

STC’s dominance in fixed line to continue .................................................................................................................................................... 17

Broadband opportunity untapped; attractive growth prospects for data services ......................................................................................... 19

STC’s superior pricing power for high-speed FTTH services ....................................................................................................................... 21

Internet usage in Saudi Arabia has substantial room for growth .................................................................................................................. 22

Trend reversal of fixed-mobile substitution could unfold in data service; STC at a competitive advantage ................................................. 25

Intensifying competition; STC enjoys pricing power in FTTH ....................................................................................................................... 26

Margins under pressure; high ARPU data services to drive EBITDA ........................................................................................................... 26

High bad debt provision for STC, potential to improve exists ....................................................................................................................... 27

Potential value creation opportunity through network sharing for both STC and Mobily .............................................................................. 27

STC ahead in capex cycle; opportunity to drive asset returns higher ........................................................................................................... 28

Moderate regulatory risks & stable royalty fees ............................................................................................................................................ 28

Regulatory cost pressure easing, room for margin expansion as data revenue mix increase ...................................................................... 29

Strong balance sheet position; capital return prospects are high ................................................................................................................. 30

STC: Investment Highlights ............................................................................................................................................. 31

Investment Thesis ............................................................................................................................................................. 33

STC’s background: Leader among GCC telecoms ....................................................................................................................................... 33

Well established network infrastructure; competitive advantage in fixed broadband .................................................................................... 34

International markets offer long-term growth for STC, but investor concerns exist ...................................................................................... 36

Change in reporting method starting 1Q 2013 .............................................................................................................................................. 40

New international opportunities for STC – Morocco, Algeria and Libya ........................................................................................................ 40

Margin outlook positive ................................................................................................................................................................................. 41

Improving core operating environment to drive earnings .............................................................................................................................. 41

Legacy PSTN a drag on STC’s returns ......................................................................................................................................................... 43

Capex program mostly behind for STC ......................................................................................................................................................... 44

Strong balance sheet to support dividends ................................................................................................................................................... 44

Our forecast vs. consensus ........................................................................................................................................................................... 45

4Q 2012 results: One-off charges impact bottom line ................................................................................................................................... 45

In a worst case scenario, STC could take upto 32% knock on earnings ...................................................................................................... 45

Valuation ............................................................................................................................................................................ 46



We arrive at a fair value of SAR 51.1 per share for STC .............................................................................................................................. 46

Mobily: Investment Highlights ......................................................................................................................................... 53

Investment Thesis ............................................................................................................................................................. 55

Mobily establishing itself as market leader from being market challenger .................................................................................................... 55

Solid mobile infrastructure; but behind in fixed broadband ........................................................................................................................... 55

Data services the key margin driver, EBITDA outlook positive ..................................................................................................................... 56

Earnings outlook is positive ........................................................................................................................................................................... 57

Management track record and superior ROE are positives for Mobily ......................................................................................................... 58

Mobily to continue its ambitious capex program ........................................................................................................................................... 59

Mobily is a key asset for Etisalat; a case for future stake increase exists ................................................................................................... 60

Mobily expected to continue with the shareholder-friendly policy ................................................................................................................. 60

Our forecast vs. consensus ........................................................................................................................................................................... 60

4Q 2012 results: Continuous business momentum ...................................................................................................................................... 61

Valuation ............................................................................................................................................................................ 62

We arrive at a fair value of SAR 80.6 per share for Mobily ........................................................................................................................... 62

Appendix: Telecom sector ............................................................................................................................................... 68

Appendix: Saudi Telecom Company ............................................................................................................................... 70

Appendix: Etihad Etisalat Company (Mobily) ................................................................................................................ 71

Recommendation Framework .......................................................................................................................................... 72

Research & Advisory Department ................................................................................................................................... 73

Disclaimer .......................................................................................................................................................................... 74



Mobily mostly played-out, STC still unfolding

While Etihad Etisalat (Mobily) has outperformed the Tadawul All-Share Index (TASI), Saudi Telecom Company (STC)

has been an obvious long-term under-performer. STC‘s underperformance was initially warranted based on concerns

about: 1) growing domestic competition, 2) under-performing acquisitions, 3) burden of fixed line network, 4)

perceived lack of agility and innovation compared to newcomers, and 5) exposure to regional countries facing

instability.

STC underperforms market; Mobily a clear outperformer (2007 to February 11, 2013)

Sources: Bloomberg, Saudi Fransi Capital analysis

Today STC has absorbed the initial ‗shock‘ to its business, regrouped and is, in our view, back on the offensive on

multiple fronts. In our opinion, STC is regaining the domestic market initiative backed by an upgraded fixed

broadband infrastructure capable of bringing interactive entertainment and high-speed data to every Saudi home and

business coupled with international operations delivering growth and starting to turn EBITDA positive – STC is

undoubtedly our top-pick.

In short, we believe the stock is at a turning point and initiate our coverage with a BUY recommendation and a target

price (TP) of SAR 51.1 – implying an upside of 28% to the last of SAR 39.9 per share. In contrast, we believe Mobily

is almost fairly valued at current price levels and start our coverage of the stock with a HOLD recommendation and a

TP of SAR 80.6, suggesting a moderate upside of 8% to the most recent closing price of SAR 74.8 per share.

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TASI STC Mobily

Investment Thesis

Mixed performance by Saudi telcos; Mobily outperforms on strong fundamentals



While Mobily, is a more purist play, continuing to command a sector premium, we believe the regained traction at

STC will shrink the gap in 2013. We see the recent weakness in STC‘s shares, on the back of the one-off expenses

recorded in 4Q 2012, as an attractive entry point. STC is down ~8% YTD, compared to a rise of around 8% for

Mobily.

STC is our top pick

Company Rating Investment merits Investment risks

Saudi Telecom Company

(STC AB)

BUY

Well established infrastructure to support broadband demand

Pricing power in high-speed broadband services

Attracting customers through bundled service offerings

International growth avenues; diversified income streams

Attractive dividend yield

Legacy PSTN network to drag company’s ROE

Near-term risks attached with international operations – Bahrain/Kuwait and India

Declining market share in mobile services

Recent management changes pose near term risks

Etihad Etisalat/ Mobile

(EEC AB)

HOLD

Industry leading ROE’s

Market leadership in Mobile broadband

A priced asset for Etisalat’s regional growth ambition

Attractive dividend yield

Faster migration of broadband data into fixed networks

Source: Saudi Fransi Capital analysis

Both STC and Mobily are trading at a P/E of 9.0x on 2013 earnings in line with GCC peers, but at a discount of 10%

to their counterparts in the Middle East and Africa (MEA). On EV/ EBITDA basis, STC is trading at 4.6x on 2013

EBITDA, a 17% discount to MEA and 1% discount to GCC peers, while Mobily trades at a 24% premium to MEA

peers and 48% premium to GCC peers.

Current valuation under prices improving growth/risk profile of telcos

Saudi Telecom Index valuation trend

(Past P/E and P/B based on historical prices/ forward

multiples based on current prices)

Saudi Telecom Index valuation trend

(Past EV/EBITDA and EV/ Sales based on historical prices

/ forward multiples based on current prices)

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International diversification prospects overshadowed by ongoing tension in the region; a drag on STC’s valuation




Potential to drive asset returns higher; capex cycle is mostly behind especially for STC

The declining capex-to-sales ratio augurs well for the sector‘s asset return. We expect STC‘s capex-to-sales to

moderate further to 13% during the forecast period, while Mobily is expected to maintain an average 16% capex-to-

sales for the next five years. Mobile network coverage is well in place for both STC and Mobily (>95% in Saudi

Arabia) and services such as ADSL, FTTH and 3G/4G are being made network ready. With the international

operations of STC gaining traction and FTTH services taking off in Saudi Arabia, STC is thus expected to see its

capex-to-sales decline from a peak 15% expected in 2013 to 13% by 2017. In comparison, mature global players

have capex-to-sales ratios of around 10-13% - implying our assumption is on the conservative side. However, for

STC, the legacy PSTN network is expected to remain a drag on returns, which explains the gap in ROE/ROA

between Mobily and STC. This would continue to be a structural gap between the telcos, with Mobily warranting a

sector premium.

ROE/ROA of Saudi telcos vs. MEA peers

Return on Equity (%) (LFY)*

*LFY: Last Fiscal Year

Return on Assets (%) (LFY)


STC

Mobily

Etisalat

Du

Batelco

Omantel

Zain Kuwait

Qtel Jordan Telecom

Turkcell

Vodacom

MTN

Maroc Telecom

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Etisalat

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Turkcell

Vodacom

MTN

Maroc Telecom

MEA - Median



STC offers ~2x higher free cash flow yield than Mobily

Although Mobily enjoys a superior ROE, STC‘s attractive free cash flow yield (~2x that of Mobily) is a positive in our

view. As a percentage of free cash flows, we believe that Mobily would re-invest 80–90% in the business as it

commences network upgrade/fiber rollout; for STC, however, we see this proportion being relatively lower with most

of its FTTH expansion completed.

STC generates ~2x higher free cash flows than Mobily

STC – free cash flows (SAR bn)

STC – Capex as a % of free cash flows (%)

Mobily – free cash flows (SAR bn)

Mobily – Capex as a % of free cash flows (%)

Sources: Saudi Fransi Capital analysis

STC 2013e free cash flows offer a yield of 12.8% compared with Mobily‘s 7.3%. Therefore, at current prices, we

would prefer buying STC‘s cash flows to Mobily‘s.

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STC’s attractive free cash flow yield

Free cash flow yield – STC (%) 2013e-17e

Free cash flow yield – Mobily (%) 2013e-17e


Higher risk premium for regionally diversified STC to remain a near-term stock overhang

Despite prospects of earnings diversification and growth opportunity in international operations, the ongoing regional

tension is likely to remain an investor concern on STC for the near term. STC is relatively less exposed (than GCC

peers) to the various Middle East countries currently undergoing political tension (Egypt, Syria, Libya, Yemen and Iraq).

However, uncertainty in Bahrain and to a much lesser extent Kuwait poses a risk for STC‘s Viva operations in the GCC

region. In our view, the Saudi market is relatively well insulated from regional tension and Mobily offers a better risk

profile than STC. One-off charges (totaling SAR 1.2bn) during 4Q 2012 have renewed investor concerns over STC‘s

international operations.

Growth at home – Key market forecasts

We expect Saudi telcos to deliver healthy earnings growth over the next five years (average growth of 5.1% to 8.5%

during the forecast period to 2017), led by attractive growth prospects in the domestic market. Expected increase in

broadband penetration in the Kingdom and a better mix of high ARPU data services with growing post-paid customer

base should support EBITDA margins. Penetration of high ARPU data services is expected to arrest the downtrend in

EBITDA margins; our margin projection is in the range of 36-39% over the forecast period. Both STC and Mobily are

operating at margins below the MEA average.

Broadband and data services to drive revenue growth

We project single-digit yoy revenue growth for STC and for Mobily over the next five years. Increasing broadband

penetration is expected to drive the top line. The broadband opportunity in the Kingdom is currently untapped. A young,

tech-savvy population and growing internet user base bode well for data services. With broadband penetration as low

as 5.7% of population, the Kingdom offers significant long-term potential, compared to a GCC average of 9%. While

Mobily is expected to lead the mobile broadband market, we expect STC to benefit from a trend of increasing data

traffic through fixed line networks. Mobile broadband is witnessing a competitive pricing environment, but we see STC

commanding higher pricing power for home broadband services through its FTTH network and ability to offer bundled

services including, in addition to broadband, IP TV and landline.

Mobily to attain 40% market share in mobile by 2017; STC to dominate fixed lines

We expect Mobily to garner 40% market share (of subscribers) by 2017, inching closer to market leader STC, while

Zain KSA is forecasted to capture 15% of the total market. While ongoing challenges at ZAIN KSA are expected to

12.8%

14.1%15.1%

16.0%

18.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

2013E 2014E 2015E 2016E 2017E

7.3%

8.6%9.5%

10.2%11.0%

0%

2%

4%

6%

8%

10%

12%

14%

2013E 2014E 2015E 2016E 2017E

Favorable environment for adoption of high ARPU data services

Favorable environment for adoption of high ARPU data services



translate into near-term gains for both STC and Mobily, we have conservatively projected some growth in Zain KSA‘s

long-term market share. We expect STC to continue leading the fixed line market with 90% share.

Telecom penetration levels

Target market penetration* estimate (%) 2017e


*Fixed line/ Fixed broadband penetration as a % of households

STC is expected to gain mobile market share and lose some of its advantage in fixed broadband market to Mobily.

Market share forecast

Fixed line target market share estimate (%) 2017e

Mobile market share estimate (%) 2017e

Fixed broadband target market share estimate (%) 2017e

Mobile broadband market share estimate (%) 2017e


67%

45%

186%

43%

70%60%

210%

70%

0%

50%

100%

150%

200%

250%

Fixed Line Fixed Broadband Mobile Mobile Broadband

2012e 2017e

97%90%

3%10%

0%

20%

40%

60%

80%

100%

120%

2012e 2017e 2012e 2017e

STC Others

47%

45%

39%40%

34%

36%

38%

40%

42%

44%

46%

48%

2012e 2017e 2012e 2017e

STC Mobily

95%90%

5%10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2012e 2017e 2012e 2017e

STC Mobily

23%

35%

73%

55%

0%

10%

20%

30%

40%

50%

60%

70%

80%

2012e 2017e 2012e 2017e

STC Mobily



Key investment risks

Downside risks

Aggressive price-based competition could impact telcos’ profitability: We see high degree of competition in

the telecom sector, especially in the mobile and broadband markets, with Zain KSA fast establishing its market

presence. New MVNO licenses could see higher levels of competition for customer acquisition and aggressive

pricing strategies could negatively impact profitability of operators.

Political tension in the region could drive equity risk premium higher for telecom: We fail to see investors

attaching a premium for international market opportunities of Saudi telcos considering the ongoing political

tension in various Middle East/African nations. Although Saudi Arabia is well insulated from these risks and STC

operations are less exposed (than peers) to crisis-hit regions, investors could attribute a higher risk to regional

exposure. Also, poor track record of Zain and Etisalat is expected to remain a concern over the prospects of

international strategies by GCC telcos. However, at this stage, we do not foresee any risk to STC‘s operations in

Turkey due to Syria‘s ongoing crisis and Turkey‘s response to the same (missile deployment at the border).

Risks attached to technology changes: The telecom market is characterized by rapid technology changes,

and adoption of new market technologies could impede operator returns. STC had to scale back its WiMax

operations due to emergence of alternate technologies. Data traffic could increasingly turn to fixed Wi-Fi from

cellular network. Such trends could significantly change operator profitability and impact asset turnover in the

sector.

Moderate regulatory risks, renewed investor concern for regional telcos: Besides, new MVNO license

considerations at CITC, there could be potential new telecom licenses issued in the Kingdom – however, this

seems unlikely at the moment. In event such a development would materialize, it would be detrimental to the

prospects of existing players and could significantly alter the competitive landscape and impact sector profitability

and our forecasts. The recent regulatory action in the UAE (royalty fee structure changes for Etisalat/ Du)

renewed investors concerns over regulatory risks for regional telcos, however, our understanding is that no such

plans are in the making in Saudi Arabia.

Escalation of Euro area crisis could lead to a market sell-off: While the telecom sector in Saudi Arabia is well

insulated from the Euro area crisis, renewed concerns in Europe could trigger a return of risk aversion and lead

to a market sell-off, thereby impacting overall stock market performance, including that of the telecom sector.

Upside risks

Continued challenges at Zain KSA could be positive for both STC and Mobily: We see Zain KSA‘s

corporate restructuring as a near-term challenge that the management is attempting to sort out. However, any

further delay in restructuring could benefit both STC and Mobily. The resulting decrease in the level of

competition within the sector could bring about positive changes to risk/ growth profile and drive STC/ Mobily‘s

valuation higher.

Higher uptake of new broadband services, more sustainable ARPU’s: Higher than expected up take of new

broadband services in the Kingdom could sustain ARPU‘s higher for both STC and Mobily.

Reduction in Government charges, especially Mobile services could provide further upside: While we do

not expect any changes in the royalty fee structure, we note that CITC had earlier reduced the fixed line royalties

from (15% to 10%) post introduction of new licenses. Mobile services are charged at 15% currently and any

reduction of the same could drive margins and hence valuation positively.

Increased disclosure, especially on STC’s international operations, could help reduce perceived

investment risks attached into the sector: Investor have limited insight into STC‘s international operations and



are therefore attaching a risk premium to the business, something we could see decline significantly in case of

increased disclosure.

Mobile revenue accounts for 80% of Saudi market

Revenues from domestic telecom services (comprising mobile/GSM, fixed and data) rose at a CAGR of 13.2% to SAR

65.7bn during 2005–11. The total sector revenue, including international operations, increased at a CAGR of 17.7% to

SAR 83.9bn during the same period.

Dominance of mobile; STC commands ~55% revenue share

Revenue market share (2008 – 2017e)

Segment-wise trends in sector revenue (in SAR bn)

(Total excluding international revenue)

Sources: CITC, Saudi Fransi Capital analysis

Revenues from mobile services have increased at a CAGR of 13% since 2005 and account for 80% of the Saudi

telecom market. Amongst all operators, STC was the most negatively impacted initially, having lost considerable

subscriber share. Nonetheless, STC commands a lead over Mobily in terms of revenue share (an estimated 55% in

Saudi Arabia in 2012).

Saturated mobile penetration in Saudi Arabia with three operators, STC leading

Mobile services have been the key driver of the Saudi telecom sector. Mobile penetration increased to 191% in 2011

from 61% in 2005, reflecting a mature market. Currently, the Saudi penetration rate exceeds that in the rest of GCC,

baring the UAE. Emergence of new players such as Etihad Etisalat (Mobily) and Zain KSA ended STC‘s monopoly.

However, STC continues to lead the market with ~47% subscriber share. We forecast this share to decline to 45% over

the next five years due to increased competition. Mobily has acquired 39% market share in its seven years of

operations; we forecast its share to stabilize at 40% by 2017. The third operator Zain KSA was fast establishing its

market presence, but has more recently been facing financial and growth challenges, Zain KSA is likely to hold 15%

share over the next five years. We estimate penetration to rise to 210% and mobile subscriber base to 66.5mn by 2017.

0%

20%

40%

60%

80%

100%

Mobily Zain KSA STC- Saudi Arabia

25.2 28.5 33.2 38.0 39.0 45.1

52.4 9.0

9.8 9.3

11.2 13.5

15.5 13.3

9.5 14.5

16.6 18.2

0

15

30

45

60

75

90

2005 2006 2007 2008 2009 2010 2011

Mobile Fixed & Data International

34.2

65.7

61.6

52.5

49.2

42.538.4

Saudi Arabian Telecom Market

Mobile services – key driver of telecom

Saturated mobile market in Saudi Arabia



Mobily and Zain KSA expanded market presence

Mobile penetration Saudi Arabia vs. MEA/ BRIC (2011)

Market share by subscribers – Mobile (2005–17e)

Sources: ITU, IMF, CITC, Saudi Fransi Capital analysis

Led by rapid penetration of mobile services, the share of new prepaid connections in the total subscriber base

increased to nearly 88% in 2011 from 67% in 2005. However, with saturation of penetration levels, operators are

focusing on improving the post-paid customer mix. Furthermore, CITC‘s stricter regulation on SIM card registration

brought down the number of prepaid subscribers to 45.4mn in 3Q 2012 from 47.1mn in 2011. Accordingly, we expect

prepaid to account for 85% of the total subscribers by 2017. On the other hand, the share of postpaid subscribers is

expected to improve moderately to 15% by 2017.

Postpaid subscribers to increase; STC and Mobily benefit from weakness at Zain KSA

Prepaid/Postpaid mix – Mobile (2005–17e)

YoY revenue growth (2009–4Q 2012)


Increasing accessibility due to better affordability intensified competition and rapidly expanded the mobile segment.

Consequently, ARPUs declined to less than SAR 80 per month in 2012 (estimated) from ~SAR 150 per month in 2005.

We expect the mobile ARPU‘s to decline further amid the prevailing competition, segment maturity and possible

inclusion of MVNOs in the coming years. We estimate ARPU in the mobile segment to decline 1–4% annually during

our forecast period.

124%

180%

74%

73%

191%

130%

135%

218%

150%

156%

104%

99%

114%

120%116%

0% 40% 80% 120% 160% 200% 240%

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

Jordan

Tunisia

83%

69%61%

53% 48% 47% 47% 47% 45%

17%

31%39%

41%41%

37% 39% 39% 40%

6%12% 16% 14% 14% 15%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2006 2007 2008 2009 2010 2011 2012e2017e

STC Mobily Zain KSA

33%23%

17% 15% 14% 12% 12% 13% 15%

67%77%

83% 85% 86% 88% 88% 87% 85%

0%

20%

40%

60%

80%

100%

2005

2006

2007

2008

2009

2010

2011

2012e

2017e

Post-Paid (%) Pre-Paid (%)

21% 23%25%

12% 11%

33%

17%13%

3%

-4%

-15%

1%

7%

2%6%

17%

8% 9%

2%

-20%

-10%

0%

10%

20%

30%

40%

2009 2010 2011 Mar 12 Jun 12 Sep 12Dec 12

Mobily Zain KSA STC- Saudi Arabia



Mobile subscriber additions at the cost of declining ARPU levels

Mobile subscribers vs. ARPU (2005–17e)

Mobile ARPU – STC/ Mobily (2011–17e) in SAR per month


Given STC‘s better postpaid subscriber mix (postpaid mix of 20–30% is high compared with the regional benchmark of

10–15%), we continue to assign it a mobile ARPU premium of 4–7% over Mobily for the near term. However, over the

long term, we expect STC‘s ARPU to be in line with Mobily as it protects mobile market share by lowering tariffs.

Meanwhile, Mobily would increasingly chase postpaid customers, which is expected to support ARPU. Thus, we expect

faster contraction in mobile ARPU for STC over the forecast period (~4% annual) than Mobily (~1% annually).

Similar prices for mobile services leave little to differentiate on pricing front

With focus increasingly shifting toward the broadband space, there is little differentiation on the pricing front among

players providing traditional mobile services (Voice/SMS). Analysis of basic plans (STC - Sawa, Mobily – 7ala and Zain

KSA Hala) indicates that prepaid pricing is mostly comparable between players, while there are differences in postpaid

offerings. For instance, all players charge prepaid customers with 55 halalas per minute for voice calls and 25 halalas

for SMS. For postpaid customers, Zain KSA (Mazaya Light plan) and STC (Jawal Easy) offer voice calls at 25/35

halalas respectively, while Mobily (Khatty) offers the same for 45 halalas.

Competitive pricing for mobile services

Mobile - Prepaid pricing – Basic offers

Voice call: in halalas per minute; SMS: in halalas per message

Mobile - Postpaid pricing – Basic plans

Voice call: in halalas per minute; SMS: in halalas per

message


14.1

19.7

28.4

36.0

44.8

51.653.7 53.5

66.9

50

60

70

80

90

100

110

120

130

140

150

0

10

20

30

40

50

60

70

80

2005 2007 2009 2011 2017e

AR

PU

(S

AR

pe

r m

on

th)

Su

bscrib

ers

(m

n)

20

30

40

50

60

70

80

90

2011 2012e 2013e 2014e 2015e 2016e 2017e

STC - Mobile ARPU Mobily - Mobile ARPU

25

55

25

30

55

25

20

55

25

0

10

20

30

40

50

60

Fee (SAR) Voice Call SMS

STC - Sawa Mobily - 7ala Zain KSA - Hala

20

35

25

20

45

25

20

25 25

0

10

20

30

40

50

Fee (SAR) Voice Call SMS

STC -Jawal Easy Mobily - Khatty Zain KSA - Mazaya Light

Subscriber additions at the cost of ARPU contraction



We note players are competing through ―free benefits‖ plans to make free calls/SMS, with STC‘s pricing being more

attractive. For instance, STC charges SAR 99 for monthly free benefits compared to SAR 140 by Mobily and Zain KSA.

Overall, we find Zain KSA playing the pricing game, while STC is drawing customers through ―free benefits‖ offers. Zain

KSA remains the most aggressive offering attractive pricing plans.

STC’s attractive pricing of “free benefits plan”

Free benefits plans - Charge by validity (in SAR)

Free benefits include unlimited free calls (within network) and free SMS


Competitive pricing for iPhones; most players attracting customers through “free” offers

Besides competitive pricing for Voice/SMS, telcos are offering attractive pricing plans for smartphones. iPhone offerings

are competitively priced in the Kingdom, with Zain KSA triggering a competition by recently slashing prices by 15–35%

across variants. However, most players are pushing the product free of cost to monetize through high APRU postpaid

connections. For instance, STC offers entry level 8GB iPhone free to customers who sign up for 12 months at SAR 249

per month, and most iPhone variants (except 64GB) free for a 18-month period. Zain offers iPhone 4 (8GB) for just

SAR 45 in its SAR 150 per month plan, while it offers iPhone free of cost in the SAR 450 per month plan(Mazaya Elite).

Mobily‘s offer of 8/16 GB free with SAR 349 per month plan appears the least attractive. STC also offers iPhone 5

(16Gb) free of cost for customers who sign-up for 18 months. Overall, we note that while Zain KSA has attractively

priced iPhone products, STC‘s ―free‖ offerings are drawing relatively more customer sign ups.

Zain KSA aggressively pricing “iPhone offerings”

iPhone product pricing (in 000‘ SAR)

Starting plans for free iPhone offers (in SAR per month)

* Zain has attractively priced the iPhone 4 (8 GB) at just SAR 45


7 10 10

29

45 45

99

140 140

0

20

40

60

80

100

120

140

160

STC - Sawa Mobily - 7ala Zain KSA - Hala

1 day 1 Week 1 Month

1.6

2.5

2.9

3.2

2.32.5

2.9

3.2

1.5

2.22.4

2.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4 - 8GB 4S - 16GB 4S - 32GB 4S - 64GB

STC Mobily Zain

249

349

150

249

349

450

249

NA

450

0

100

200

300

400

500

STC Mobily Zain*

4 - 8GB 4S - 16GB 4S - 32GB



Introduction of mobile number portability (MNP) has also increased the level of competition in the Kingdom. Although

operators are focusing on converting a share of prepaid to post-paid mix to reduce subscriber churn, we expect service

quality to determine operator switching than competitive pricing. In our view, STC has a slightly better edge over Mobily

due to its better network coverage and bundled services offerings that may inhibit operator switching. In addition, STC

can draw operational experience from Turkey (through Oger Telecom), where MNP was introduced few years back.

Quality of Service – All players meet CITC benchmarks

Service quality 2011

Voice quality standards (score) 2011


Operators are also cashing in on the high traffic during the Hajj season (Islamic pilgrimage) in the Kingdom. STC

launched two types of SAWA Haj SIM cards for the Haj season. STC also provided IP based Virtual Private Network

(IPVPN) connectivity to all railway stations. Mobily too is investing for Hajj traffic adding 150 new towers at Makkah and

Mashair. In addition, Mobily provided free internet access to pilgrims via WiFi in select regions. Mobily also tied up with

Bahrain Air for distribution of free pre-paid SIMs for travelers. Overall, we find STC at a relative competitive advantage

over Mobily due to its operating presence in Muslim populated countries such as Malaysia / Indonesia, who are

frequent travelers for Hajj season.

Note that the Hajj season which in recent years has been commencing in the fourth quarter and will continue to do so

for the next couple of years has some impact on earnings seasonality. Typically, the quarter accounted for an average

27% of total annual revenue in 2011 and 2012. Due to differences between the lunar and solar year/calendar the

starting date for the pilgrimage will be 10-11 days earlier each year. The Hajj is expected to move into the third quarter

(both commencements and finalization) starting 2015.

STC’s dominance in fixed line to continue

The Kingdom had 4.7mn fixed line subscribers in 3Q 2012 (please see Appendix A for subscriber data across fixed,

mobile and broadband services). An estimated 72% (3.4mn) are connected to households, with the balance 28%

(1.4mn) attributed to businesses.

Most notably, fixed line subscriptions are turning the tide and delivering growth again. Total subscribers picked up to

4.7mn, supported by growth in both segments, after an initial stagnation around the 4-4.2mn level during 2007-2010.

We believe, this offers further indication of STC‘s renewed push which has been enhanced by better offers and

bundling services and thus bringing supposedly dying assets/capabilities back to life as part of a comprehensive

customer experience. STC currently holds an estimated 97% market share of fixed lines.

0.41%0.61%

1.0%

0.0%

1.0% 1.0%

<2% <2%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Unsuccessful Call rate Call drop rate

STC Mobily Zain KSA CITC Standards

3.73.7

4.0

>3.5

3.2

3.3

3.4

3.5

3.6

3.7

3.8

3.9

4.0

4.1

STC Mobily Zain KSA CITC Standards

Fixed line market in Saudi Arabia relatively less competitive; STC to dominate the segment



STC loses share to competition; room for growth in fixed lines

Fixed line penetration Saudi Arabia vs. MEA/ BRIC (2011)

Market share trends in fixed line segment (2005–17e)

Sources: CITC, Company reports, Saudi Fransi Capital analysis

Nevertheless, faster adoption of mobile services in the Kingdom suppressed the subscriber base for fixed lines, which

grew at a CAGR of just 3.9% since 2005 vis-à-vis 25% for mobile. In line with regional trends of fixed to mobile

substitution, we forecast a moderate increase in fixed line penetration. STC is expected to continue to lead with 90%

market share until 2017, while new operators such as Etihad Atheeb (―Go‖ brand) is expected to capture the rest.

We forecast the number of residential lines in Saudi Arabia to increase at a CAGR of 5.5% during 2011–17 and reach

4.1mn toward the end of our projection period. In addition to growth in the consumer market, the enterprise/corporate

sector offers key opportunities for Saudi telcos. We expect STC to sustain its competitive advantage in this segment.

The company accounts for the majority of the Kingdom‘s backbone infrastructure capacity (please see Appendix B for

STC‘s infrastructure details of STC); in fact, even competitors rely on this capacity. We expect the number of business

lines to increase at a CAGR of 9.3% to 2.2mn between 2011 and 2017.

Unlike the mobile segment, fixed line is less competitive. However, faster penetration of mobile services (subsititution

effect) has dented ARPU in the fixed line segment. We estimate ARPU in residential fixed line to have declined to less

than SAR 125 per month in 2012 from ~SAR 210 per month in 2005. We expect ARPU in the residential sector to

continue falling due to competition from mobile offerings. STC, which dominates the fixed line market in the Kingdom, is

now offering bundled services (broadband) to fixed line subscribers to arrest the fall in ARPU. Through its ‗Jood‘

packages, STC offers high-speed internet services along with unlimited fixed local/national calls and attractive

discounts on calls to international numbers.

Unlike residential fixed line, business line yields relatively better ARPU (estimated at ~1.5x), stemming from higher

minute usage/ data. We estimate ARPU in business fixed line to have declined to less than SAR 190 per month in 2012

from ~SAR 315 per month in 2005. During our forecast horizon, we expect ARPU in fixed line to decline 1–4% annually

for both residential and business lines.

22.1%

31.0%

2.7%

21.2%

16.4%

17.3%

15.8%

34.0%

24.5%

9.3%

10.8%

8.5%

11.1%

7.4%11.4%

0% 10% 20% 30% 40%

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

Jordan

Tunisia

100% 100% 100% 100% 100% 99% 99%97%

90%

1% 1% 2%3%

10%

84%

86%

88%

90%

92%

94%

96%

98%

100%

2005 2006 2007 2008 2009 2010 2011 2012e2017eSTC Others



Fixed line subscriber growth picking up, sharp decline in ARPU levels

Residential fixed line subscribers (2005–17e)

Business line subscribers vs. ARPU (2005–17e)


The wider economic development in Saudi Arabia, is translating into establishment of new economic cities, and

favorable investment climate is driving new business establishments, thereby creating robust demand for connectivity.

Development initiatives in the ICT sector by the government also bode well for enterprise sector demand. The

increasing number of new establishments in the Kingdom is a positive for the segment growth prospects. STC has long

enjoyed competitive advantage over peers due to its long-standing relationship with large corporations.

The favorable investment climate for new enterprises in the Kingdom and demand from SMEs are expected to drive

uptake in the business lines. While the global economy has been in turmoil, Saudi GDP growth has run between 5.1-

7.1% over the past three years and it is projected to expand by 4.2% in 2013 according to IMF. Meanwhile, bank

lending continues to expand at a rate of 17% (3Q 2012) - providing further indication of the growth underway and

prospects for expansion in business line uptake.

STC‘s current focus is on medium and large-sized businesses, while SME is considered an attractive growth market,

going forward. The company has more than 55 corporate sales outlets in the Kingdom and has won several prestigious

smart city projects such as KEC, ITCC, KAFD, and Olaya Towers & Knowledge City.

However, new players – Zain KSA, Etihad Atheeb and Mobily – are increasingly capitalizing on enterprise market

opportunities in Saudi Arabia. Despite challenges, Zain KSA could make inroads into the enterprise segment

(specifically targeting global players having presence in the Kingdom) through its strategic partnership with Vodafone.

According to Mobily, the size of the ICT market for enterprise segment in Saudi Arabia is estimated to reach SAR 29bn

by 2015.

Broadband opportunity untapped; attractive growth prospects for data services

The Saudi mobile market is saturated with a penetration of 191% in 2011, higher than the GCC average. Furthermore,

increasing competition from new players is clouding growth prospects. However, we expect opportunities in broadband

and data to drive Saudi telcos. Broadband penetration in the Kingdom is currently low at 6% of the population and

below the GCC average. Increasing internet users, favorable demographics (high percentage of tech-savvy young

population, ~57% are below 30 years), and rising smartphone uptake in the Kingdom would drive the broadband

market. Internet users in the Kingdom increased to 15.2mn in 3Q 2012 from just 3mn in 2005, reflecting an average

annual growth rate of 27%.

2.8 2.9 2.9 3.0 3.0 3.13.3

3.5

4.1

80

100

120

140

160

180

200

220

240

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

2005 2007 2009 2011 2017e

AR

PU

(S

AR

pe

r m

on

th)

Re

sid

en

tia

l lin

es (

mn

)

Residential lines ARPU (RHS)

0.91.0 1.1 1.1

1.21.0

1.31.4

2.2

80

110

140

170

200

230

260

290

320

350

0

0.5

1

1.5

2

2.5

2005 2007 2009 2011 2017e

AR

PU

(S

AR

pe

r m

on

th)

Bu

sin

ess lin

es (

mn

)

Business lines ARPU (RHS)



Mobily a clear leader in mobile broadband; STC closing in

Mobile broadband – Subscribers vs. ARPU

Mobile broadband – Mrket share (%)


We forecast the mobile broadband subscribers to reach 22.3mn towards the end of our projection period, implying a

CAGR of 11.9% for the period 2011-2017. We expect Mobily to lose out its initial advantage in the mobile broadband

space to STC/ competition and expect, STC to make market share gains (to 35% by 2017) as against an estimated

23% in 2012 while Mobily is expected to retain its leadership position with 55% share of the market in 2017.

For the fixed broadband market we forecast subscribers to reach 3.5mn towards the end of our projection period,

implying a CAGR of 10.5% for the period 2011-2017. STC dominates the fixed broadband segment and is expected to

retain 90% of the market share during the forecast period. However, competition from Mobily is expected to remain

high given its plans for an aggressive fixed broadband strategy, posing a long-term threat to STC‘s dominance in this

segment.

STC to dominate the fixed broadband market

Fixed broadband – Subscribers vs. ARPU

Fixed broadband – Market share (%)


We estimate ARPU in broadband to have declined to less than SAR 100 per month in 2012 from ~SAR 180 per month

in 2007. We expect a moderate 1–4% decline annually in ARPU during the forecast period. In terms of pricing in mobile

broadband, STC and Mobily are comparable; however, the former commands a 18–25% premium on home broadband.

We do not expect Zain‘s aggressive pricing to remain sustainable in the mobile broadband segment.

1.42.7

11.312.4

14.2

16.2

18.1

20.2

22.3

50

60

70

80

90

100

110

120

130

140

150

0

5

10

15

20

25

2009 2011 2013e 2015e 2017e

AR

PU

(S

AR

pe

r m

on

th)

Mo

bile

Bro

ad

ba

nd S

ub

src

ibe

r (

mn

)

Subscribers ARPU (RHS)

16% 13%20% 23% 25% 28% 30% 33% 35%

83% 85%77% 73% 69% 66% 62% 59% 55%

1% 2% 3% 4% 5% 7% 8% 9% 10%

0%

20%

40%

60%

80%

100%

2009 2011 2013e 2015e 2017eSTC Mobily Zain KSA

1.4

1.72.0

2.32.6

2.83.0

3.33.5

50

60

70

80

90

100

110

120

130

140

150

160

0

1

2

3

4

2009 2011 2013e 2015e 2017e

AR

PU

(S

AR

pe

r m

on

th)

Fix

ed

Bro

ad

ba

nd S

ub

scrib

ers

(m

n)

Subscribers ARPU (RHS)

100% 98% 96% 95% 94% 93% 92% 91% 90%

0% 2% 4% 5% 6% 7% 8% 9% 10%

0%

20%

40%

60%

80%

100%

2009 2011 2013e 2015e 2017eSTC Mobily



Competitive pricing for broadband, but STC holds substantial advantage in fixed

Mobile broadband plans – SAR per month

Home broadband plans – SAR per month


STC’s superior pricing power for high-speed FTTH services

STC enjoys superior pricing power for FTTH services, which offers speeds up to 200 Mbps, significantly higher than

its peers. The company priced high-speed offerings at ~2-3x that of the current 2/4 Mb offerings of competitors. We

consider this sustainable in the near term, as competitor Mobily is behind STC in terms of cable reach in the kingdom

(FTTH coverage ~1/10 that of STC) and expect STC to enjoy the first mover advantage in the near term. However,

we expect a significant fall in FTTH broadband pricing over the long term.

STC’s superior pricing power for high-speed FTTH offerings

STC‘s FTTH pricing for various speeds (in SAR per month)


99

199

350

100

200

350

40

100

280

0

50

100

150

200

250

300

350

400

1GB/ 2GB 5 GB Unlimited

STC - QUICKnet Mobily - Connect Zain KSA - Speed 4G

249

199

NA

199

169149

199

175149

0

50

100

150

200

250

300

2/4 MBps 1MBps 512Kbps

STC - Jood Mobily - Broadband @ home Etihad Atheeb - Go

249296

346

799

0

100

200

300

400

500

600

700

800

900

4 Mbps 20 Mbps 40 Mbps 200 Mbps

Average pricing of competitors

Zain KSA competes on pricing in mobile broadband; STC commands pricing power in high-speed broadband



Internet usage in Saudi Arabia has substantial room for growth

Benchmarked with the MEA region, we believe internet usage in Saudi Arabia is low, indicating the growth momentum

would continue in the near term. Also keep in mind that in the absence of entertainment options like cinema, we believe

the significance of broadband as an entertainment gateway is potentially much higher than less conservative markets.

Similarly, access to computers in the Kingdom leaves room for growth and government initiatives toward overall

Information Communication and Technology (ICT) development bode well for the sector.

Room for further penetration of computers/internet users in Saudi Arabia

Internet users Saudi Arabia vs. MEA/BRIC (2011)

Computer access Saudi Arabia vs. MEA/BRIC (2011)


According to Communications and Information Technology Commission (CITC), there were 11.7mn mobile broadband

subscribers in 3Q 2012 compared with just 1.4mn at the end of 2009. The Kingdom‘s mobile broadband penetration

reached 41% at the end of 3Q 2012, and is comparable with that of the developed world. While the traditional voice

market is on the decline, broadband opportunities through ADSL and FTTH services offer growth opportunities in the

fixed line market. Fixed line technologies offer superior speeds compared to Mobile broadband. (See Appendix C for

more details of technologies in Fixed/ Mobile). STC has a comprehensive strategy of bundling content and applications

into its high-speed network infrastructure and is positioning itself through triple play offers as a one-stop shop for

communication and entertainment. Through Interactive TV services (InVision), STC is successfully playing up the

entertainment appeal, which is strong in Saudi Arabia. The company also owns 71% stake in Dubai based Intigral, now

a leading regional provider of content services and digital media – serving several regional operators. Besides

distributing content, Intigral‘s main competitive advantage is its proprietary methods of content management – allowing

content to be tailored and facilitate user censoring. For example, InVision users will get a heads-up if an upcoming

scene could be unsuitable by Saudi norms, through the movie or tv show turning into slow-motion seconds before –

thus allowing the user to skip if they desire.

45.0%

49.0%

10.1%

38.3%

47.5%

86.2%

74.2%

70.0%

77.0%

68.0%

35.6%

14.0%

51.0%

34.9%39.1%

0% 20% 40% 60% 80% 100%

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

Jordan

Tunisia

45.4%

55.0%

6.1%

35.4%

57.3%

87.0%

69.0%

76.0%

87.0%

58.0%

20.0%

34.2%

51.4%

19.1%

0% 20% 40% 60% 80% 100%

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Algeria

Morocco

Jordan

Tunisia

Increasing internet users and tech-savvy, young population in Saudi Arabia – positives for broadband uptake



Low broadband penetration levels in the Kingdom; rising trend of net users positive

Broadband penetration Saudi Arabia vs MEA/ BRIC (2011)

Trend in internet users (2005-3Q 2012)


With increasing internet users, social network usage in the Kingdom has grown. The number of users on Twitter and

Facebook in the Kingdom is growing across all age and social groups. According to CITC, there were an estimated

4.8mn users of Facebook in Saudi Arabia at the end of 2011, a penetration rate of 16.8% and 35.3% of total internet

users.

High per capita GDP and young population – positives for sector

% population under 30 years

Per capita GDP 2011 (USD)

Sources: UN, IMF, Saudi Fransi Capital analysis

Alongside growing internet users, Smartphone penetration in the Kingdom is picking up. Industry sources cite one in

every two handsets sold in the Kingdom is a smartphone. According to Informa Telecoms and Media, Saudi Arabia had

a smartphone penetration rate of 17.1% in 2011, which is expected to reach 44.8% by 2015. Besides, driving demand

for data services, higher smartphone penetration is expected to increase overall mobile penetration rate due to the

presence of some dual-SIM models and many Saudis carrying more than one handset. Industry surveys point toward

high adoption of smartphones, tablets and laptops in the Kingdom, well ahead of many developed markets.

8.6%

12.2%

1.1%

11.6%

5.7%

9.2%

1.3%

16.1%

16.2%

1.7%

2.3%

2.8%

1.8%

3.2%5.1%

0% 4% 8% 12% 16% 20%

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

Jordan

Tunisia

3.0

4.8

7.6

9.310.3

11.4

13.6

15.2

5%

15%

25%

35%

45%

55%

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

2005 2006 2007 2008 2009 2010 2011 3Q 2012

Internet Users % of Population (RHS)

50.9%

37.1%

57.9%

43.2%

57.0%

44.8%

54.4%

49.6%

49.5%

62.9%

48.9%

47.8%

47.0%

54.7%44.0%

30% 40% 50% 60% 70%

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

Jordan

Tunisia

2,493

12,993

1,514

5,417

21,196

98,144

43,723

63,626

22,918

23,572

2,932

5,503

3,084

4,6184,317

0 20,000 40,000 60,000 80,000100,000

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

Jordan

Tunisia



High penetration of tablets & smartphones in KSA; data traffic to multiply by 2016

Tablet/Smartphone/Laptop usage

Data traffic forecast (MB per month) by type of device

Sources: Cisco, Google survey(2012), Saudi Fransi Capital analysis

The high penetration of data-centric devices in the Kingdom is expected to drive data traffic multi-fold. According to

Cisco, globally the average monthly data traffic of smartphones is forecasted to surge 17 times (from 150Mb per month

per device in 2011 to average 2.6Gb per month by 2016). Data usage levels in laptops/notebooks would continue to

remain the highest and multiply by 3.3x between 2011 and 2016 (from 1.5Gb per month per device in 2011 to average

6.9Gb per month by 2016).

While the demand environment for broadband services in the Kingdom is well in place, the access route toward the

same is likely to determine operators‘ success over the long term. STC is aggressively rolling out both mobile

broadband and fixed line networks for offering broadband services, while Mobily is riding on the fast adoption of mobile

broadband services in the Kingdom. According to Cisco, global data traffic is carried predominantly through fixed

network, but mobile is expected to increase its share to 17% by 2016 from 5% in 2011. Driven by rising smartphone

penetration and net users, the consumer space is forecasted to account for 77% of data traffic compared with 51% in

2011.

Fixed networks dominate global data traffic; Consumer segment to surge

Data Traffic forecast by type of network 2011 & 2016e

Data Traffic forecast by segment 2011 & 2016e

Sources: Cisco, Saudi Fransi Capital analysis

STC accounted for an estimated 90% of the total daily Internet and data traffic, which exceeded 1,600Tb in Saudi

Arabia, in 2011. Moreover, the company‘s superior and upgraded fixed broadband network, which now extends to

nearly 300,000 km in the Kingdom (compared to an estimated 30,000 km for Mobily), is a further testament to its strong

position in the high-growth data segment.

63%

68%

5%

30%

50%

49%

60%

61%

26%

28%

38%

44%

16%

24%

6%

7%

7%

0% 20% 40% 60% 80%

Saudi Arabia

UAE

Egypt

Italy

France

Spain

Tablet Smartphone Laptop/ Notebook 0 2,000 4,000 6,000 8,000

Non smartphone device

Smartphone

Portable gaming console

Tablet

Laptop/ Netbook

2016e

2011~25x

~17x

~8.2x

~3.3x

In MB per month per device

95%83%

5%17%

0%

20%

40%

60%

80%

100%

2011 2016eFixed Mobile

51%

77%

49%

23%

0%

20%

40%

60%

80%

100%

2011 2016eConsumer Business

Smartphones and tablets are well penetrated in the Kingdom; data traffic set to surge

Globally, fixed networks carry higher data traffic than mobile; consumer segment to outpace business demand in data usage



Trend reversal of fixed-mobile substitution could unfold in data service; STC at a competitive advantage

Unlike voice services (where mobile services substituted fixed lines), emerging technology trend of data service

adoption through Wi-Fi networks (vs. using a cellular network) is gaining traction across many developed markets. We

expect data market adoption trends in Saudi Arabia to be characterized by regional/global trends. According to Cisco,

data traffic volumes in the MEA region were mostly through fixed lines, accounting for 95% in 2011 and expected to

reach 83% by 2016, reflecting a CAGR of 53%, while mobile data traffic is expected to outpace fixed traffic with a

CAGR of 103%, during the same period, from a much lower base.

Tablet users prefer WiFi/WLAN; Smartphone users prefer mobile networks

Data access mode – Tablet/ Notebook

Data access mode – Smartphones

Sources: Google survey (2012), Saudi Fransi Capital analysis

The evolving trend of mobile traffic getting offloaded through fixed networks offers significant long-term prospects for

fixed line operators such as STC. The drivers of mobile-fixed transition include bandwidth constraints for mobile in high-

density population areas, spectrum constraints limiting scalability of services, and relatively poor indoor connectivity of

mobile broadband. Fixed broadband connectivity, thus, offers a better technology option to address the growing

demand for data services in the long term.

According to a Google survey, in Saudi Arabia, WiFi/WLAN is the preferred data access route among tablet users, while

mobile is being mostly used for smartphones. Thus, STC would potentially look to monetize its fixed network

investments by tapping Wi-Fi opportunities. STC is successfully adding customers through service bundling (triple-play

offerings) and is thus placing data-heavy entertainment services into its high-speed fixed broadband network. More than

300,000 km of fiber-optic cable are already operational in the Kingdom and STC‘s FTTH services, branded as VERVE,

offer broadband speeds up to 1 GBps – far greater than any other competitor. In addition to attractive service offerings,

STC attracts customers through integrated services and billing across fixed line and broadband services. Besides

opportunities in the residential market, an anticipated shift toward e-government/e-health in Saudi Arabia is likely to

benefit Saudi telcos, primarily STC.

75%79%

42%

64%

83%

62%55%

38%

48%

16%23% 20%

0%

20%

40%

60%

80%

100%

Saudi Arabia

UAE Russia Italy France Spain

WiFi/ WLAN @ home UMTS/3G/4G/LTE

60% 57%

4%

41%45%

53%

65%69%

97%

48%

77%

63%

0%

20%

40%

60%

80%

100%

Saudi Arabia

UAE Egypt Italy France Spain

WiFi/ WLAN @ home UMTS/3G/4G/LTE

Wi-Fi access gains prominence in Saudi Arabia; STC may monetize fixed network investments



Intensifying competition; STC enjoys pricing power in FTTH

Broadband and data being the next leg of growth for telecom, operators are increasingly chasing the market across

segments. STC dominance in fixed broadband is being challenged by Mobily. Through its acquisition of Bayanat Al

Oula, Mobily is targeting the demand for high-speed Internet by offering service through its 3.5G network. Fixed line

broadband competition in the Fiber-to-home market is also expected to intensify with new players deploying competing

networks and have strong support from GCC incumbents—Batelco and Etisalat. However, STC is expected to retain its

competitive advantage of attracting customers through bundled service offerings. In addition, we see the recent

slowdown in Zain KSA (sales down on YoY basis) benefitting both STC and Mobily.

While overall revenue growth for the sector is showing moderate signs of improvement, we belive ARPUs would be

supported by:

a) Expected pick up in postpaid customer mix: Operators are focusing on prepaid to postpaid conversion. For

instance, STC continued to push for prepaid to postpaid migration in 2009 by offering 2G ―SAWA‖ customers

an upgrade option to a 3G postpaid plan for no additional fees while retaining the number. In fact, we see

postpaid subscribers increasing at a faster pace than prepaid, indicating that operators are successfully

migrating the user base.

b) Challenges at Zain KSA offer near-term advantage for both STC and Mobily: Aggressive pricing by Zain KSA

may not be a sustainable business strategy for the company currently. Zain has priced its mobile broadband

offerings (Speed 4G) at a discount to STC/Mobily rates.

c) Uptake in data services to support ARPUs: Current pricing plans for mobile broadband are ~1.5–2x the

estimated sector ARPU. We estimate fixed line ARPUs to deteriorate at a much slower pace than mobile

ARPUs. While the traditional voice market is on a decline, broadband opportunities through ADSL and FTTH

services offer scope for growth in the fixed line market. In fact, we see STC enjoying pricing power through its

bundled services and ability to offer a one-stop shop for communication, business and gradually also

entertainment The ongoing gradual shift to e-government and e-health services coupled with existing links to

government provide further strength to the story.

Margins under pressure; high ARPU data services to drive EBITDA

Amid growth opportunities, the high degree of competition amongst telcos in Saudi Arabia is impacting operator

margins. EBITDA margins have contracted to low 30s from high 40s over the past 5–6 years. While the entry of new

players pushed mobile penetration higher, sector profitability was impacted by a) downward pressure on ARPUs

resulting from competitive pricing and b) higher sales and marketing costs – subscriber acquisition costs. However,

telcos have focused on cost cutting measures to partly offset the negative impact on margins by reducing General and

Administration expenses.

Margin trend less favorable; competition impacts margins

EBITDA margin trend for Saudi Telcos (2007–4Q 2012)

Gross margin trend for Saudi telcos (2007– 4Q 2012)


46%

41%

36%35%

34% 35% 35%

33%

30%

25%

30%

35%

40%

45%

50%

2007 2008 2009 2010 2011 Mar 12

Jun 12

Sep 12

Dec 12

STC Mobily Industry

60%61%

59%

56%

54%55% 55%

54%53%

40%

45%

50%

55%

60%

65%

2007 2008 2009 2010 2011 Mar 12

Jun 12

Sep 12

Dec 12

STC Mobily Industry

EBITDA margins under pressure; falling ARPUs and increasing acquisition costs impact margins



High acquisition costs; telcos focus on cutting overhead costs

Selling and marketing as a % of revenue (2007–4Q 2012)

General and Admin. as a % of revenue (2007–4Q 2012)


We expect increased adoption of data services to drive EBTIDA margins. The reasonably affluent characteristic of the

population (high per capita income) makes Saudi Arabia a market that could adopt high ARPU value-added services

such as online gaming, video streaming and other data heavy applications.

High bad debt provision for STC, potential to improve exists

STC incurred SAR 1.6bn as bad debt provision in 2012, significantly higher than SAR 236mn incurred at Mobily. As a

percentage of sales STC incurred a cost of 2.7% as a result of high bad debt provision in 2012 compared to just

1.0% in Mobily. While this reflects Mobily‘s superior management of receivables, we see this as an area STC could

potentially improve going forward. However, we note that receivable days at STC is significantly lower at STC (~60

days) compared to Mobily (~90 days) in 2012. Mobily is thus offering extended credit days to ensure a more

profitable operation than STC.

STC incurs bad-debt costs ~ 6-7x that of Mobily, room for improvement

Bad debt provisions as % of sales: STC vs Mobily

Receivable DSO‘s: STC vs Mobily


Potential value creation opportunity through network sharing for both STC and Mobily

Amid high competition impacting profitability, we see asset sharing opportunity for both STC and Mobily potentially

driving cost synergies. In fact, STC currently offer mobile site sharing services, allowing competitors to put their base

station antennas on STC towers. STC's network consists of around 5,000 base stations covering around 97% of the

population. In addition, industry sources cite potential capex savings for new installations through tower sharing, a

positive for cash flows. Competitor Mobily has already initiated development in network sharing. The company recently

6%7%

14%14%

13% 13%12%

14%13%

0%

2%

4%

6%

8%

10%

12%

14%

16%

2007 2008 2009 2010 2011 Mar 12

Jun 12

Sep 12

Dec 12

STC Mobily Industry

8%

13%

8%7% 7% 8%

8%

7%7%

0%

2%

4%

6%

8%

10%

12%

14%

16%

2007 2008 2009 2010 2011 Mar 12

Jun 12

Sep 12

Dec 12

STC Mobily Industry

1.5%

1.9%

3.0% 3.1%

2.4%2.7%

3.0%

1.1%0.9% 0.8% 0.9% 1.0%

0%

1%

2%

3%

4%

5%

2007 2008 2009 2010 2011 2012

STC Mobily

5362

82

61 57 6163

105

153

131

115

91

0

30

60

90

120

150

180

2007 2008 2009 2010 2011 2012

STC Mobily

Tower sharing opportunity could reduce operating expenses by 12–15% – a potential margin driver.



announced infrastructure sharing with Atheeb Telecom in the fixed broadband segment. Synergistic opportunities thus

exist for Saudi telcos through potential sharing of each other‘s assets to tap the broadband market opportunity, an

arrangement that could gather prominence in the near future. However, we highlight that there is no decision yet on

this topic and note that a key driver for tower sharing globally has been funding requirements (through selling towers to

third party). STC and Mobily do not have the same urge for new funds. In addition, we sense that there is a degree of

uncertainty surrounding the comparative gains from this.

STC ahead in capex cycle; opportunity to drive asset returns higher

In order to tap the emerging opportunities in data and broadband services in the Kingdom, Saudi telcos are

aggressively investing in building a network infrastructure to support these services. Mobile network coverage is well in

place for both STC and Mobily (>95% in Saudi Arabia). Services such as ADSL, FTTH and 3G/4G is been made

network ready. STC launched commercial 4G Long Term Evolution (LTE) mobile broadband networks in 2H 2011 and

has presence in over 38 cities. STC aims to achieve 4G mobile broadband network coverage of 95% of the population

by 2014. Similarly, Mobily‘s 4G LTE network, operated by subsidiary Bayanat Al-Oula, has coverage in 31 cities and is

targeted to cover 85% of the Saudi population. STC is also fast rolling out its fiber-based internet services in the

Kingdom. The sector‘s capex-to-sales ratio is on decline (24% in 2007 to ~16% in 4Q 2012). We expect ROA for both

STC and Mobily to be driven by these investments. Thus, capex is mostly lower for STC, with the potential to improve

asset turnover. Ex-acquisitions, STC‘s capex-to-sales declined from 17% in 2007 and is expected to reach 13% by

2017, while for Mobily, capex-to-sales is estimated to be relatively higher at ~18% over the next three years and

thereafter decrease to 16% by 2017. In comparison, mature global players are typically sustaining a capex/sales ratio

of 10-13% - our figures on Saudi operators are more conservative.

Capex cycle mostly behind; network deployed for value-added services

STC‘s Capex-to-sales ( ex-acquisitions) (2007– 2017e)

Mobily‘s Capex-to-sales (ex- acquisitions) (2007–2017e)


Moderate regulatory risks & stable royalty fees

Post the introduction of Zain KSA, the third mobile operator, we believe the regulatory environment has moderated

significantly. While CITC is pursuing an overall developmental goal for the telecom sector, we see limited risks ahead

for the sector. The CITC is working on introducing MVNO licenses, and recently requested proposals from interested

parties – with a deadline set for May 4th 2013.

In a scenario of new MVNO licenses, we expect entry of well-established regional operators into Saudi Arabia. For

instance, players such as Du (UAE) have already expressed interest in exploring the MVNO opportunity in the

Kingdom. Q-tel amongst other telcos, which was outbid by Zain KSA for the third mobile license, could look to

participate in the MVNO opportunity. Considering that MVNO typically chases the low ARPU/untapped customer

segments, we see Zain KSA at a larger risk than STC/Mobily. Furthermore, considering the ongoing challenges at Zain

KSA, the new entrants are likely to target its customer base. European experience of MVNO‘s indicate that a potential 5

-10% share, could be captured by the new players. STC is expected to be at a competitive advantage over Mobily, as it

17%

12% 12%

10%

14%15%

16%15%

15%14%

13%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2007 2009 2011 2013E 2015E 2017E

24%

27%

25%

21%

18%

21%

17%16%16%16%16%

0%

5%

10%

15%

20%

25%

30%

2007 2009 2011 2013E 2015E 2017E

Decreasing capex-to-sales ratio – a positive; network coverage well in place across technologies



could draw operational and managerial expertise from Oger Telecom (35% stake) which runs a successful MVNO in

South Africa – Virgin Mobile through its holdings in Cell C. Also, MVNO could present STC with a wholesale business

opportunity, allowing it to sell excess bandwidth to new players.

Overall, we see moderate regulatory risks to the sector, which are overshadowed by strong market and growth

fundamentals underpinned by growing demand for data services and we find STC at a relative competitive advantage

over its peers. We also highlight, that Saudi Arabian regulatory environment has typically enjoyed a more balanced and

structured approach than some GCC markets. Moreover, unlike some key markets in the region Saudi Arabia already

satisfies the WTO‘s requirement of three mobile operators.

Regulatory cost pressure easing, room for margin expansion as data revenue mix increase

Royalties/ Government charges are regulated by CITC for telecom operators in the Kingdom. Besides, license fee

and fee for usage of frequency spectrum, Saudi based operators are required to pay commercial service provisioning

fee to the regulator. CITC has a fee structure of 15% of net revenue (revenue less interconnection costs) for mobile

services, 10% of net revenue for landline services and 8% of net revenue for data services. While we do not expect

any changes to the fee structure in our forecast period, there exists room for moderating the same, especially in the

mobile services.

Royalty fee charges for telecom services in Saudi Arabia

Service Type As a % of net revenue (revenue less interconnection costs)

Mobile services 15%

Landline services 10%

Data services 8%

Sources: CITC, company reports, Saudi Fransi Capital analysis

In fact for both STC and Mobily, the government charges (as % of sales) is witnessing a declining trend indicating

lower regulatory costs as a result of increasing mix of data revenue, where royalty fee is relatively lower. For STC

government charges (% of sales) have declined from 14% (in 2007) to 9.4% in 2012 while for Mobily it declined from

12.4% (in 2007) to 5.7% (in 2012).

Regulatory costs (as a % of sales) on a decline, a positive for margins

STC‘s government charges ( % of sales) (2007– 2012)

Mobily‘s government charges ( % of sales) (2007– 2012)


Government charges include : Royalty, license and frequency usage charges

Revenue include handset sales and others

14.0%

11.7%11.2% 11.1% 11.3%

9.4%

0%

2%

4%

6%

8%

10%

12%

14%

16%

2007 2008 2009 2010 2011 2012

12.4% 12.6%

9.6%8.7%

7.8%

5.7%

0%

2%

4%

6%

8%

10%

12%

14%

2007 2008 2009 2010 2011 2012

Room for margin expansion exist through lower government charges as data revenue mix increases



Strong balance sheet position; capital return prospects are high

While new international opportunities exist for Saudi telcos, in light of the ongoing regional tension, any investments

are likely to be highly selective. In fact, any international investments are likely to emanate from STC – as we believe

other operators are restricted from expanding beyond Saudi, by their main stakeholders and license restrictions.

Following the global financial crisis and the Arab spring, companies focused on consolidating existing operations (STC

recently increased its stake in Axis, Indonesia to 80% from 51% earlier). The declining net debt/EBITDA in the sector

is, overall, a positive, in our view. The net debt-to-EBITDA has declined to 0.5x in 4Q 2012 from a high 2.8x for Mobily

in 2007, while for STC the ratio came down to 0.6x in 4Q 2012 from 1.2x historically. There could be a likely capital

return phase in the near term than chasing new growth avenues. We, thus, expect STC to balance out growth/returning

cash to shareholders. Furthermore, the current dividend yields are attractive for both STC and Mobily, though

moderately below peers in GCC/ MEA.

Saudi telcos are well capitalized

Net Debt – EBITDA ratio ( 2007-4Q2012)

STC / Mobily dividend yield (%) vs GCC/ MEA peers


1.0

2.0 2.1

1.8 1.6 1.6

1.5

1.2

0.7

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2007 2008 2009 2010 2011 Mar 12

Jun 12

Sep 12

Dec 12

STC Mobily Industry

5.1

6.2

6.2

5.6

9.6

7.0

7.4

2.6

6.9

5.1

4.8

7.7

6.2

0 2 4 6 8 10 12

STC

Mobily

Etisalat

Du

Batelco

Omantel

Zain Kuwait

Qtel

Jordan Telecom

Vodacom

MTN

Maroc Telecom

MEA - Median

SAUDI TELECOM COMPANY Telecom | Equity Research | 12 February 2013


STC: Investment Highlights

We initiate coverage on Saudi Telecom Company (7010/ STC AB) with a BUY rating and a TP of

SAR 51.1, implying an upside of 28% to the last close of SAR 39.9 per share. At 4.6x EV/EBITDA

ratio on 2013 estimates, STC is trading in line with GCC peers but at a 17% discount to MEA

comparables. While one-off charge in 4Q 2012 (in its International operations) and the recent

management changes are of concern, we see a misplaced risk perception on the counter not

crediting the attractive long-term growth prospects both in Saudi Arabia and international markets.

We forecast EPS 2013 of SAR 4.4, 8.5% higher YoY (ex-one off items). Assuming maintained

DPS, the implied dividend yield is 5.0%. However, we see upside potential on dividends as cash

continues to pile up.

We believe the company is well placed to benefit from the emerging trend of

mobile-fixed convergence in broadband services: STC dominates the Kingdom‘s

fixed line market (~90% share). The company has aggressively rolled out its high-speed

fixed line network across the Kingdom (300,000 km, ~10x Mobily) and enjoys a

competitive advantage over peers. STC is well placed to exploit the emerging

opportunity of broadband access via tablets/smartphones through both fixed lines (Wi-

Fi) and mobile. We expect STC‘s revenue to grow at a low single-digit average of 3.9%

YoY during 2012–17. We forecast 2013e top-line of SAR 60.7bn, 2.3% higher YoY.

65% from Saudi Arabia and 35% from international operations.

Pricing power in broadband; attractive opportunity in service bundling: STC

enjoys pricing power in high-speed broadband services through its Jood and VERVE

brand, an FTTH service with download speed up to 1000Mbps. While we are cautious

about competitor GO fast rolling out its services, we expect STC to maintain its

competitive advantage through bundled service offerings (InVision) and superior fixed

broadband speed, which is successfully adding new customers. STC added 100,000

new customers into its fiber optic network (home and business) in 4Q 2012, an increase

of more than 1000% over 4Q 2011. The company also achieved a 15% growth in

subscribers for the bundled services in 4Q 2012.

International diversification a long-term positive; currently overshadowed by

regional tension: Besides acquisition-led international presence (Oger and Maxis),

STC has made successful inroads into the saturated Kuwaiti and Bahraini markets

(capturing an estimated mobile share of 20% and 35%, respectively in 2011) through

green field operations, which is noteworthy. Yet we would like to stress that despite the

ongoing protests in Bahrain, Viva Bahrain saw revenues spike by some 166% and Viva

Kuwait 127% during the two years of 2011-2012 compared to 2010 and have turned

EBITDA positive. All in we forecast, a 5.6% yoy growth in STC‘s EBITDA in 2013 to

reach SAR 22.2bn. CAGR for our forecast period is 5.3%. We expect EBITDA margins

of 36.5% in 2013e, 127bps higher yoy.

Legacy PSTN networks to remain a drag on ROE; penetration of data services to

drive asset returns: The traditional PSTN network (14% of revenue) remains a

structural drag on the company‘s return profile (ROA of -0.8% in 2012 versus 6.4% for

the company). Consequently, we forecast STC‘s ROE to range in the high teens until

2017 driven by a high mix of data services, which are expected to account for nearly

26% of total revenue by 2014 compared to 23% in 2012. Near-term catalysts for the

stock include traction in FTTH services and potential value unlocking in tower assets.

Rating Summary

STC BUY

TARGET PRICE (SAR) 51.1

Upside/(Downside) 28.0%

Stock Details

Current Price* SAR 39.9

Market Capitalization SAR Mn 80,000

Shares Outstanding Mn 2000

52-Week High SAR 46.5

52-Week Low SAR 35.8

Price Change (YTD) % -7.6

EPS 2013e SAR 4.4

Beta (1 Year Adj.) 0.68

Ticker (Reuters/ Bloomberg)

7010.SE STC AB

* Price as of February 11, 2013

Key Shareholders

Public Investment Fund 70.0%

Public Pension Agency 6.6%

General Organization for Social Insurance

7.0%

Publicly Held 16.4%

Source: Zawya

Price Multiples

Current 2013e

P/E(x) 10.9 9.0

EV/ EBITDA (x) 5.2 4.6

Dividend Yield (%) 5.0 5.0


STC vs. TASI

Source: Tadawul

Sector Coverage

Roy Cherry

[email protected]

+966-1-2826844

0.00.20.40.60.81.01.21.41.6

STC TASI




FINANCIALS & RATIOS

Key Financials (in SAR mn) 2008 2009 2010 2011 2012 2013E 2014E

Revenue 47,469 50,780 51,787 55,662 59,372 60,722 62,659

EBITDA 21,743 20,612 19,621 20,025 20,945 22,191 23,132

EBIT 12,042 12,130 10,977 8,488 9,281 10,387 10,699

Net Profit 11,038 10,863 9,436 7,729 7,351 8,875 9,135

Balance Sheet (in SARmn)

Current Assets 18,946 22,663 18,704 21,967 28,783 38,570 46,128

Property Plant and Equipment 44,382 52,737 55,127 55,085 56,005 56,972 56,957

Net intangible assets 31,695 29,222 31,837 29,318 28,162 26,843 25,585

Total Assets 99,762 109,587 110,781 111,402 117,912 127,512 133,970

Total Debt 36,321 36,109 33,697 33,598 34,823 37,526 38,360

Total Equity 42,562 50,833 53,464 54,082 58,969 64,543 69,467

Total Liabilities 99,762 109,587 110,781 111,402 117,912 127,512 133,970

Cash Flow Statement

Net cash provided by operating activities 21,149 15,956 21,185 16,488 12,106 23,682 23,749

Cash flows from Investing Activities (35,468) (13,542) (13,175) (8,264) (9,301) (9,321) (8,996)

Cash flows from Financing Activities 14,763 (2,765) (9,669) (7,686) (4,278) (4,006) (6,869)

Key Ratio 2008 2009 2010 2011 2012 2013E 2014E

Gross margin (%) 62.4% 61.0% 58.6% 56.3% 56.6% 57.2% 57.6%

EBITDA margin (%) 45.8% 40.6% 37.9% 36.0% 35.3% 36.5% 36.9%

Revenue growth (%) 37.8% 7.0% 2.0% 7.5% 6.7% 2.3% 3.2%

Growth in EBITDA (%) 30.1% -5.2% -4.8% 2.1% 4.6% 5.9% 4.2%

Growth in earnings (%) -8.2% -1.6% -13.1% -18.1% -4.9% 20.7% 2.9%

Debt/ Equity (x) 0.8 0.7 0.7 0.6 0.6 0.6 0.6

Capex/ Sales 34.3% 30.8% 21.9% 14.1% 14.8% 16.0% 15.0%

ROAA (%) 13.3% 10.7% 9.1% 7.1% 7.0% 7.8% 7.5%

ROAE(%) 30.5% 28.0% 23.1% 17.2% 16.3% 17.8% 16.9%

Cash flow yield (%) 6.1% 0.4% 12.3% 10.8% 4.2% 12.8% 14.1%

Per Share Ratios 2008 2009 2010 2011 2012 2013E 2014E

Earnings per share 5.5 5.4 4.7 3.9 3.7 4.4 4.6

Dividend per share 3.8 3.0 3.0 2.0 2.0 2.0 2.5

Valuation Ratios 2008 2009 2010 2011 2012 2013E 2014E

P/Earnings 6.6 7.2 7.3 10.3 10.9 9.0 8.7

P/Book 2.2 2.1 1.9 1.7 1.6 1.4 1.3

EV/ EBITDA 5.5 5.2 5.7 5.6 5.2 4.6 4.2

P/Sales 2.3 1.7 1.6 1.4 1.3 1.3 1.3





STC’s background: Leader among GCC telecoms

Established in 1998, Saudi Telecom Company is the incumbent telecom operator in Saudi Arabia, offering services

across fixed, mobile, data and internet to both consumer and enterprise users. STC, which enjoyed monopoly in

Saudi Arabia until 2004, is now competing in the domestic market with new players that are backed by other leading

GCC operators such as Etisalat (Mobily), Zain (Zain KSA) in mobile and Batelco (Atheeb Telecom) in fixed lines.

STC has successfully diversified its business into other regional and international markets such as Turkey (Oger

Telecom), Kuwait and Bahrain (Viva operations) in the MEA region and Malaysia, Indonesia (Maxis) and India in Asia

(please see the company‘s timeline in Appendix A). STC is the largest telecom operator based out of GCC with a

customer base of ~160mn across 10 countries in MEA and Asia. STC‘s interests in various operations are detailed

below.

STC – Company structure


Investment Thesis

STC is a leader among GCC telecoms; presence in more than 10 countries and has ~160mn customer base.



Well established network infrastructure; competitive advantage in fixed broadband

We have a positive outlook on STC considering the expected domestic market growth led by data segment demand

and its diversified and growing international business.

In our opinion, well-established telecom networks are a key competitive advantage for STC, which holds infrastructure

assets across fixed, mobile and data operations in both domestic and international markets. The company also

provides backbone infrastructure capacity for IP-based services to other operators. In addition, the company is now

positioned in the Saudi market as the only one-stop communication/entertainment shop. Besides a comparable mobile

offering, it has a dominant presence in fixed line that it is gradually being able to reposition and bring back to life as

value added in its bundled offers. The roll-out of IP-TV and FTTH internet with speeds reaching up to 200 Mb/sec is

also another first on this scale in the Kingdom.

The trend of fixed-mobile substitution in Saudi Arabia impacted STC the most. Nonetheless, the company remains the

market leader with an estimated share of 47% in mobile services and dominates the fixed line segment with its 97%

share. STC‘s high mix of postpaid customers (~20–30% versus regional benchmark of 10–15%) is a key positive. Until

2014, we expect the company to retain 46% market share in mobile operations as well as its leadership position in fixed

line (with 90% share).

Demand for broadband in the Kingdom has been mostly mobile based (in terms of subscribers, while traffic volumes

are predominantly over fixed lines), but we see an emerging global trend of mobile-fixed convergence in accessing the

Internet. STC is positioning itself through fiber roll-outs across Saudi Arabia (300,000 km of fiber, 10x Mobily/Bayanat).

Furthermore, STC is aggressively rolling out the fiber network to provide high-speed internet services (speed up to 200

Mb/sec) and aims to cover more than 1.5mn homes by 2014. Its fixed broadband subscribers grew 19% in 4Q 2012

compared to 4Q 2011.

We expect the company to make inroads in the mobile broadband segment, which is currently dominated by Mobily.

STC launched commercial 4G Long Term Evolution (LTE) mobile broadband networks in 2H 2011 and has presence in

over 38 cities. The company aims to achieve 4G mobile broadband network coverage of 95% of the population by

2014.

We forecast STC‘s revenues to reach SAR 60.7bn in FY 2013 and increase to SAR 62.7bn by 2014, (ex-accounting

change). Segment-wise, while mobile services remain the major revenue source, we see an increasing trend of data

contribution to the company‘s business mix. Data segment is expected to account for 31% of total business compared

to 23% in 2012.

Increasing contribution from Data segment

Revenue Breakup – Segment (in SAR bn)

Revenue Breakup – Segment (%)


Note: Based on current accounting method

32.6 34.1 34.2 37.9 38.0 37.6 38.3 39.3 40.2 41.2

9.1 9.3 10.28.3 8.4 8.8 8.8 9.0 9.1 9.25.7

7.2 7.19.4

13.4 14.6 16.4 18.3 20.422.7

0

15

30

45

60

75

GSM PSTN Data Others

69% 67% 66% 68% 64% 62% 61% 60% 58% 57%

19% 18% 20% 15%14% 15% 14% 14% 13% 13%

12% 14% 14% 17%23% 24% 26% 28% 30% 31%

-20%

0%

20%

40%

60%

80%

100%

GSM PSTN Data Others

Infrastructure assets across fixed, mobile and data applications in both Saudi and international markets



We forecast STC‘s mobile subscribers in Saudi Arabia to reach 25.9mn in 2013 and increase to 27mn by 2014, while

mobile ARPU are expected fall 4% annually to SAR 69 per month by 2014. In the fixed line segment, we expect a total

5.2mn lines in 2014 (Home + Residential), while blended ARPU are conservatively estimated to contract to SAR 138

per month by 2014.

Steady growth in mobile and fixed lines market

Mobile segment - Subscribers vs ARPU (2010-2017e)

Fixed lines - Subscribers vs ARPU (2010-2017e)


In the broadband market, we expect STC to make market share gains. Mobile broadband subscribers for STC are

forecast to reach 3.6mn in 2013 and increase to 4.5mn by 2014. In the fixed broadband segment, we expect STC to

continue its dominance with an estimated 2.6mn subscribers in 2014, while ARPU‘s are expected fall 4% annually to

SAR 88 per month by 2014.

Broadband market – STC is well placed for growth, especially fixed broadband

Mobile broadband - Subscribers vs ARPU (2010-2017e)

Fixed broadband - Subscribers vs ARPU (2010-2017e)


Besides growth prospects within the Kingdom, we expect company‘s International markets to increase their contribution

to 40% by 2017 compared to 32% in 2012 (based on the current accounting method). In 2012, STC delivered a 40%

yoy growth revenue in its controlled subsidiaries (Viva Bahrain, Viva Kuwait and PT Axis - Indonesia) and added new

subscribers across post-paid, pre-paid and wireless broadband services.

24.2 25.1 24.925.9

27.0 28.029.1

30.1

50

60

70

80

90

100

110

120

130

140

150

0

5

10

15

20

25

30

35

AR

PU

(S

AR

pe

r m

on

th)

Su

bscrib

ers

(m

n)

STC Subscribers ARPU (RHS)

4.14.5

4.85.0

5.2 5.3 5.55.7

60

90

120

150

180

210

240

0

1

2

3

4

5

6

7

AR

PU

(S

AR

pe

r m

on

th)

Su

bscrib

ers

(mn

)STC Subscribers ARPU (RHS)

0.3

2.32.8

3.6

4.5

5.5

6.6

7.8

50

60

70

80

90

100

110

120

130

140

150

0

1

2

3

4

5

6

7

8

9

AR

PU

(S

AR

pe

r m

on

th)

Su

bscrib

ers

(m

n)

STC Subscribers ARPU (RHS)

1.71.9

2.22.4

2.62.8

3.03.2

50

60

70

80

90

100

110

120

130

140

150

0

0.5

1

1.5

2

2.5

3

3.5

AR

PU

(S

AR

pe

r m

on

th)

Fix

ed

bro

ad

ba

nd (

mn

)

STC Subcribers ARPU (RHS)



Increasing contribution of international revenues

Revenue Breakup – Geography (in SAR bn)

Revenue Breakup – Geography (%)


Note: Based on current accounting method

Due to increasing competition in the domestic telecom market, the company ventured internationally, chasing both

growth and business diversification. International operations contributed around 32% to STC‘s top line in 2012. The

company executed a strategy of adding a mix of both existing and green field operations. While stake purchase in Oger

(35%) and Maxis (65%) was into existing operations, STC won third mobile licenses in Kuwait (26% stake) and Bahrain

(100%) to commence green field operations.

International markets offer long-term growth for STC, but investor concerns exist

In anticipation of growing domestic competition, STC forayed into international markets as early as 2005 through its

stake purchases in Oger Telcom and Maxis in Southeast Asia. This was soon followed by regional expansions.

While GCC telecom companies had mixed fortunes with their expansions, barring Etisalat‘s successful venture in Saudi

Arabia (Mobily) and Q-tel operations in Oman and Kuwait, expansion by regional players has met significant

challenges. Zain had to exit Africa due to excessive leverage, while Etisalat could take impairment charges in PTCL

(Pakistan) and has recently announced stake sale in XL Asiata, Indonesia. Similar to other GCC telcos, STC leveraged

its balance sheet to chase international growth prospects for stakes in Maxis and Oger and licenses in Kuwait and

Bahrain.

What was a bumpy ride initially, has more recently begun to bring rewards to STC as some of these businesses start

gaining considerable traction and turn EBITDA positive (Bahrain & Kuwait). We also understand that both the Indian

and Indonesian operations are heading in the same direction in the next two years. Consequently, we see attractive

growth prospects for STC‘s international operations (which represented ~32% of total revenue in 2012) – Oger, Maxis,

Kuwait and Bahrain. However, these are currently under looked by investors due to the ongoing tension in the region,

limited disclosure and consequently ability to assess and value. We highlight that unlike its GCC peers, STC is

relatively less exposed to regions that are undergoing a political crisis. However, we note investor concerns exist for

STC‘s Viva operations in Bahrain and to a much lesser degree Kuwait. Yet we would like to stress that despite the

ongoing protests in Bahrain, Viva Bahrain saw revenues spike by some 155% and Viva Kuwait 121% during the two

years of 2011-2012 compared to 2010 and have turned EBITDA positive. With regards to increased disclosure, we

understand that efforts are being undertaken to facilitate a more accurate understanding of the international business

at STC.

35.3 38.1 40.4 40.6 41.0 41.9 42.7 43.6

11.111.2

10.4 10.6 10.9 11.5 12.2 13.0

3.83.9

4.2 4.4 4.64.8

5.15.3

0

10

20

30

40

50

60

70

80

2010 2011 2012 2013E 2014E 2015E 2016E 2017E

Saudi Arabia STC Bahrain (Viva)

Gulf Digital Media Holding Kuwait Telecom (Viva)

Oger Telecom PT Axis

68% 68% 68% 67% 66% 64% 62% 61%

22% 20% 18% 17% 17% 18% 18% 18%

7% 7% 7% 7% 7% 7% 7% 7%

0%

20%

40%

60%

80%

100%

2010 2011 2012 2013E 2014E 2015E 2016E 2017ESaudi Arabia STC Bahrain (Viva)Gulf Digital Media Holding Kuwait Telecom (Viva)Oger Telecom PT Axis

Despite near-term concerns in Viva operations, STC’s international growth prospects remain attractive



STC relatively less exposed to conflict regions than GCC peers, but risks exist

STC has minimal exposure to Jordan through Cyberia (Oger Telecom)


However, STC has a minority shareholder status in most of its international operations, providing an opportunity to

further raise its stake in select regions. It is no secret that STC remains highly interested in upping its stake in Oger

Telecom and the dialog is likely ongoing. Such a move, would boost international contribution and present additional

growth prospects for the company. We note that STC has the first right of refusal on Oger.

Overall STC group has more than 123mn subscribers in its international network with a target population of 1.6bn and

average penetration of 127%. STC‘s international revenues are generated, in order of contribution, from the following

subsidiaries – Oger Telecom (~18% of revenue, Turkey and South Africa), Binariang Holdings (~7% of revenue,

Malaysia and India), Viva operations (~5% of revenue, Kuwait and Bahrain) and PT Axis (~2% of revenue, Indonesia).

International market presence for STC

Market Summary Pop. (mn) Penetration (%) Operator Subscribers (mn) Market share

Turkey

Fixed 74.7 81% Turk Telekom 15.0 99%

Mobile 74.7 87% Avea 12.8 20%

South Africa 50.6 127% Cell C 12.8 20%

Malaysia 28.6 128% Maxis 13.0 35%

Indonesia 241.0 98% PT Axis 14.2 6%

Bahrain 1.1 150% Viva Bahrain 0.6 35%

Kuwait 3.7 135% Viva Kuwait 1.0 20%

India 1,206.9 74% Aircel 53.6 6%

STC Group 1,606.6 127%

123.0


Oger Telecom (35% stake) forms 18% of revenue

In 2007, STC purchased 35% stake in Oger Telecom for USD 2.6bn. Oger holds telecom assets in Turkey (55% of

Turk Telekom) and South Africa (75% of Cell C, South Africa‘s third largest mobile operator). In addition, the company

provides ISP services in Saudi Arabia, Lebanon and Jordan through Cyberia. Turk Telecom, through its 81.1% holding

in Avea, has diversified operations beyond traditional fixed line services (a market which is on the decline in Turkey).

Avea is the third largest mobile operator in Turkey with about 20% market share in 2011.

Company Algeria Egypt Sudan Bahrain Jordan Iraq Palestine Tunisia Yemen Pakistan Countries

STC Y 1

Batelco Y Y Y 3

Etisalat Y Y Y 3

Qtel Y Y Y Y 4

Zain Y Y Y Y 4

Presence in Turkey and South Africa through stake in Oger; making inroads in Mobile segment



Leadership in fixed line/broadband; Avea holds ~20% share in mobile

Turkey Market Summary/Forecast (%)

Turkey 2008A 2009A 2010A 2011A 2012E 2013E 2014E

Population (mn) 71.1 72.1 73.0 74.7 74.9 75.8 76.7

Fixed Line Subscribers (mn) 17.5 16.5 16.2 15.2 14.9 14.7 14.6

Penetration Levels (%) 98% 91% 88% 81% 79% 77% 75%

ARPU (TRY) 23.9 21.1 22.2 21.9 22.2 21.1 20.9

Turk Telecom Subscribers (mn) 17.5 16.6 16.0 15.0 13.6 13.3 12.9

Turk Telcom Market Share (%) 100% 100% 99% 99% 91% 90% 89%

Broadband Subscribers (mn) 5.7 6.5 7.1 7.6 8.8 10.2 11.6


ARPU (TRY) 26.2 31.1 32.7 36.3 37.4 36.9 36.8

Turk Telecom Subscribers (mn) 5.7 6.2 6.6 6.8 7.0 8.1 9.2

Turk Telecom Market Share (%) 99% 96% 93% 90% 79% 79% 80%

Mobile Subscribers (mn) 65.8 62.8 61.8 65.3 67.7 70.7 73.8


ARPU (TRY) 14.6 18.0 19.2 20.5 22.4 21.3 21.1

Avea Subscribers (mn) 12.2 11.8 11.6 12.8 13.5 14.4 15.3

Avea Market Share (%) 19% 19% 19% 20% 20% 20% 21%

Sources: IMF, ITU, company reports, Saudi Fransi Capital analysis

Cell C has made steady inroads into a market dominated by telco majors such as MTN and Vodacom (a subsidiary of

UK-based Vodafone Group). The company holds around 20% market share in South Africa, offering services to

~12.8mn subscribers in 2011. In addition, Cell C runs a successful MVNO, Virgin Mobile, in the country through its 50%

holding in the company. MVNO trends are gaining traction in GCC markets, and STC would look to leverage its

expertise of MVNO operations through Oger Telecom.

Cell C fast establishing presence in South Africa

South Africa Market Summary/Forecast (%)

South Africa - Cell C 2008A 2009A 2010A 2011A 2012E 2013E 2014E

Population (mn) 48.9 49.5 50.0 50.6 51.2 51.8 52.4



ARPU (USD) 18.0 18.0 18.0 18.0 17.9 17.7 17.6

Cell C Subscribers (mn) 3.6 5.6 8.1 12.8 13.5 14.9 16.3

Cell C Market Share (%) 8% 12% 16% 20% 20% 21% 22%




Binariang (25% stake) contributes 7% to revenue

STC entered the Asia-Pacific market through a USD3.0bn deal for 25% minority stake in Binariang, which owned 100%

interest in Maxis Telecom (Maxis) at that time. Following Maxis‘ IPO, Binariang‘s stake came down to 65%. Maxis have

presence in Malaysia, Indonesia and India.

Malaysia – a growth market for STC

Malaysian Market Summary/Forecast (%)

Malaysia - Maxis 2008A 2009A 2010A 2011A 2012E 2013E 2014E

Population (mn) 27.5 27.9 28.3 28.6 29.0 29.5 30.0



ARPU (MYR) 56.0 56.0 50.0 52.0 49.9 45.1 44.2

Maxis Subscribers (mn) 9.8 10.7 12.0 13.0 13.5 14.0 14.6

Maxis Market Share (%) 35% 35% 35% 35% 36% 36% 36%


Viva operations contribute ~5% to revenue; Kuwait (26% stake) and Bahrain (100%)

Through successful bids for third mobile licenses, STC entered the Kuwaiti and Bahraini markets in 2008 with its Viva

brand. Despite being well-penetrated mobile markets and dominated by regional majors such as Zain and Qtel (Kuwait)

and Batelco (Bahrain), Viva captured an estimated 20% share in Kuwait and 35% in Bahrain in 2011.

STC successfully penetrates GCC markets through Viva brand

Kuwaiti Market Summary/Forecast (%)

Kuwait - Viva 2008A 2009A 2010A 2011A 2012E 2013E 2014E

Population (mn) 3.4 3.5 3.6 3.7 3.8 3.9 4.0



ARPU (USD) 69.0 55.0 52.0 33.0 32.7 31.9 31.7

Viva Subscribers (mn) 0.1 0.4 0.7 1.0 1.3 1.4 1.5

Viva Market Share (%) 4% 13% 18% 20% 25% 26% 27%

Bahraini Market Summary/Forecast (%)

Bahrain - Viva 2008A 2009A 2010A 2011A 2012E 2013E 2014E

Population (mn) 0.8 1.0 1.1 1.1 1.2 1.2 1.2



ARPU (USD) - - 14.0 31.0 32.7 31.9 31.7

Viva Subscribers (mn) - - 0.5 0.6 0.6 0.7 0.8

Viva Market Share (%) 0% 0% 30% 35% 36% 37% 38%


Viva Bahrain saw revenues spike by some 166% and Viva Kuwait 127% during the two years of 2010-2012 and have

turned EBITDA positive.

Viva brand well established in Kuwait and Bahrain

Increasing presence in Malaysia and Indonesia; high Muslim population provides synergies during Hajj



PT Axis (80.1% stake) accounts for less than 2% of revenue

Besides its presence in Asia through Binariang, STC made direct investments in the region and holds 80.1% stake in

PT Axis, an Indonesian mobile operator. PT Axis holds an estimated 5% market share in Indonesia, but offers

synergies to STC‘s operations in the form of the country‘s large Muslim population base (~230mn plus) that travels

regularly to Saudi Arabia for the Hajj. In addition, STC is looking at potential value unlocking in tower assets through a

USD200mn deal.

Small presence, but synergistic market for STC

Indonesian Market Summary/Forecast (%)

Indonesia - PT Axis 2008A 2009A 2010A 2011A 2012E 2013E 2014E

Population (mn) 231.0 234.3 237.6 241.0 244.5 248.0 251.5



ARPU (USD) - 4.0 4.0 4.0 4.0 4.0 4.0

PT Axis Subscribers (mn) - 3.3 9.5 14.2 16.6 19.2 22.0

PT Axis Market Share (%) 0% 2% 5% 6% 7% 7% 8%


Change in reporting method starting 1Q 2013

STC is adopting a new accounting policy effective January 2013. Currently, STC treats joint-venture projects using the

proportionate consolidation method according to IAS 31. Following the introduction of the International Accounting

Standards Board‘s IFRS 11 in place of IAS 31, STC would change its accounting method from proportionate

consolidation to the equity method. Oger Telecom (35%) and Binariang Holdings (25%) would be the major assets

impacting the accounting change. While revenue accounting will change, we highlight that there will be no impact at

Net income level. We will update our numbers once the new standard is fully adopted. For now, we have included a

pro-forma estimate of the company‘s financials (both Pre-equity method and Post-equity method). (See following table).

Pro forma estimates - STC

In SARmn Pre-Equity

2012 Post-Equity

2012 Pre-Equity

2013e Post-Equity

2013e

Revenue 59,372 44,745 60,722 45,771

Net Income 7,350 7,350 8,875 8,875

Total Assets 117,912 82,557 127,512 89,278

Total Liabilities 58,943 31,314 62,969 33,453


New international opportunities for STC – Morocco, Algeria and Libya

Amid regional tension, there exist new opportunities, especially for STC. French group Vivendi announced plans to

offload its 53% stake in Maroc Telecom. Oman, Libya and Lebanon are considering new telecom licenses and Algeria

could potentially see the much delayed privatization of its incumbent Algerie Telecom. Considering the current low risk

appetite for the Middle East region among international investors, GCC-based telcos could well participate in these

opportunities with lesser risks of overpaying for assets. Outbidding for regional licenses and operator stakes has

negatively impacted operator returns in the past (including Zain KSA), and a similar scenario is less likely to be

repeated in the current geopolitical environment.

Strong balance sheet position of Saudi telcos; could be frontrunner in upcoming license/ stake opportunities.



Maroc Telecom: All major regional telcos – Qtel, Etisalat and MTN South Africa – could be serious competitors for this

stake. However, we highlight that STC has not indicated a recent interest in this stake. The company had showed

interest to enter into Meditel (Morocco‘s second-biggest player) back in 2009. The Maroc Telecom stake is estimated to

be worth USD 7.1bn (~SAR 26bn1).

Margin outlook positive

STC‘s EBITDA margins contracted significantly following its international foray amid competitive pressure in the

domestic market. We expect the company‘s ARPU to contact 3–4% over our forecast period (through to 2017e).

However, increasing contribution from data services, expected pricing power in FTTH and bundled services (InVision

and IP TV) coupled with improving returns for the international business should translate into higher EBITDA margins

for the company. STC‘s subscribers in bundled services increased 15% yoy during 4Q 2012. We expect margins to

recover to the 38% level by 2017.

Positive EBITDA outlook

EBITDA outlook 2008-14e (in SAR bn)

(excluding one-off‘s)

EBITDA margin outlook 2008-14e (%)


Improving core operating environment to drive earnings

Improving operating environment and a positive margin outlook are expected to translate into earnings growth of 19%

for STC in 2013. We forecast that the company‘s net income in 2013 would be SAR 8.8bn. This translates into an EPS

of SAR 4.4 (a conservative estimate, 2% below consensus). Foreign currency fluctuations have negatively impacted

earnings in the past, and we advise caution considering STC‘s increasing exposure to international markets. However,

we expect net income margins to expand to 15-16% levels over the long term (forecast period through 2017e). In fact,

excluding one-off items (Foreign exchange/ impairment charges)

1 Estimated value for 53% stake in Maroc Telecom as on December 26, 2012, based on South Korea based KT Corp‘s

bid.

21.720.6

19.6 20.020.9

22.123.0

0

5

10

15

20

25

2008 2009 2010 2011 2012 2013E 2014E

45.8%

40.6%

37.9%

36.0% 35.3%36.5% 36.9%

25%

30%

35%

40%

45%

50%

2008 2009 2010 2011 2012 2013E 2014E

Data services reverse downtrend in EBITDA margin



Positive outlook on earnings front

EPS outlook 2008-14e (in SAR)

Net income margin forecast 2008-14e (%)


Excluding one-off’s

Net Income outlook 2008-14e (in SAR bn)

Net income margin forecast 2008-14e (%)


5.5 5.4

4.7

3.93.7

4.4 4.5

0

1

2

3

4

5

6

2008 2009 2010 2011 2012 2013E 2014E

23.3%

21.4%

18.2%

13.9%12.4%

14.5% 14.5%

0%

5%

10%

15%

20%

25%

2008 2009 2010 2011 2012 2013E 2014E

12.9

10.3

8.18.7

8.28.9 9.1

0

2

4

6

8

10

12

14

2008 2009 2010 2011 2012 2013E 2014E

27.1%

20.4%

15.7% 15.7%13.8% 14.6% 14.6%

0%

5%

10%

15%

20%

25%

30%

2008 2009 2010 2011 2012 2013E 2014E



Legacy PSTN a drag on STC’s returns

STC‘s legacy PSTN operations remain a drag on ROA. These operations contribute 14% to revenue, but are loss-

making with an ROA of -0.8% in 2012 versus 6.4% for the company. Nonetheless, we forecast STC‘s ROE to range in

the high teens until 2017 driven by a high mix of data services (ROA of 49.2% in 2012). Revenues from data services

are expected to account for nearly 30% of the total by 2017 compared with 17% in 2011.

PSTN network a drag on ROA’s; Rising share of Data to drive ROE’s

Segment wise ROA (%)

RoE Outlook 2008-14e(%)


22.6%

-1.3%

39.2%

10.4%8.7%

-0.8%

49.2%

6.4%

-10%

0%

10%

20%

30%

40%

50%

60%

GSM PSTN Data Total

2009 2010 2011 2012

30.5%

28.0%

23.1%

17.2% 16.3%17.8% 17.3%

0%

5%

10%

15%

20%

25%

30%

35%

2008 2009 2010 2011 2012 2013E 2014E

Strong balance sheet; potential to scout new market opportunities, especially Morocco



Capex program mostly behind for STC

STC has introduced 4G Long Term Evolution (LTE) mobile broadband services in over 38 cities and is targeting to

cover 95% of the population by 2014. Given the completion of a majority of network rollouts (fiber network in the

Kingdom), we expect the capex-sales ratio to be at 15-16% levels till 2014. This ratio is projected to decrease to 13%

over the long term.

Capex program to continue until 2014

Capex outlook 2008-14e (in SAR bn)

Capex-Sales 2008-14e (%)


With majority of STC‘s capex program behind, we expect STC to generate free cash flows of SAR10-14bn annually in

our forecast period. At current prices, STC offers a superior free cash flow yield of 12.8% on 2013 estimates.

Attractive free cash flow yield for STC

Free cash flow outlook 2013-17e (in SAR bn)

Free cash flow yield 2013-17e (%)


Strong balance sheet to support dividends

STC has a strong balance sheet with SAR 5.1bn in cash as of 4Q 2012 and SAR 8.7bn in Short term investments. The

company offers an attractive dividend yield of 4.8% at the current market price. At a DPS of SAR 2.0 per share, the

payout ratio of 45% for 2013e is currently lower than the average of 62% during 2008–10. Although neither the

management nor the Board of Directors have hinted at an increase, given the absence of new acquisitions or stake

increases, we believe that an increase in payout is bound to happen sooner or later. Cash has been piling up, and net

cash per share stood at SAR 6.9 at the end of 4Q 2012, a YoY increase of 53%.

16.315.6

11.4

7.88.8

9.7 9.4

0

2

4

6

8

10

12

14

16

18

2008 2009 2010 2011 2012 2013E 2014E

34.3%

30.8%

21.9%

14.1% 14.8%16.0%

15.0%

10%

15%

20%

25%

30%

35%

40%

2008 2009 2010 2011 2012 2013E 2014E

10.2

11.312.0

12.8

14.4

0

4

8

12

16

2013E 2014E 2015E 2016E 2017E

12.8%14.1%

15.1%16.0%

18.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

2013E 2014E 2015E 2016E 2017E



Our forecast vs. consensus

Our forecasts are conservative compared to Bloomberg consensus estimates. For 2013, we forecast revenue of

SAR60.7bn, 3.2% lower to consensus while our earnings forecast is 2.0% lower. However, we see STC sustaining

higher EBITDA margins (than consensus) going forward reflecting our view of a higher business mix from data

services.

Conservative forecast compared to consensus

Forecast 2013e 2014e

Saudi

Fransi Capital

Consensus Difference

(%)

Saudi Fransi

Capital Consensus

Difference (%)

Revenue (SAR mn) 60,722 62,700 -3.2% 62,659 65,322 -4.1%

EBITDA ( SAR mn) 22,191 22,518 -1.5% 23,132 23,386 -1.1%

EBITDA margin (%) 36.5% 35.9% 63bps 36.9% 35.8% 112bps

EPS (SAR per share) 4.4 4.5 -2.0% 4.6 5.3 -14.3%

*Consensus forecast as of February 11, 2013


4Q 2012 results: One-off charges impact bottom line

STC‘s earnings surprisingly declined 80% in 4Q 2012. The company reported one-time non-recurring, non-cash

charges of SAR 1.2bn in its International operations. The bottom line was impacted by the SAR 641mn charge related

to the revaluation of investments fair value in Cell C (South Africa) and Aircel (India). In addition, STC shared a one-off

charge of SAR 544mn in Binariang Holdings which led to a deferred tax charge for its investments in Aircel, India.

However, excluding these charges, the company‘s net income grew 10.2% YoY in 2012.

Results snapshot 4Q and FY2012

In SAR mn 4Q 2011 4Q 2012 Difference

(%) 2011 2012

Difference (%)

Revenue 15,249 14,993 -1.7% 55,662 59,372 6.7%

Gross profit 7,935 8,144 2.6% 31,328 33,597 7.2%

Operating income 2,814 1,900 -32.5% 11,171 11,252 0.7%

EBITDA 5,021 4,307 -14.2% 20,025 20,305 1.4%

Net income 2,278 468 -79.5% 7,729 7,350 -4.9%


In a worst case scenario, STC could take upto 32% knock on earnings

Considering the uncertainty over one-off charges in STC‘s international operations, we look at potential scenario‘s to

assess the impairment risks attached to some of its key international assets – Binariang, Oger and PT Axis. Our

analysis indicates a potential 32% knock on 2013 earnings at a worse case scenario (100% impairment of the goodwill

recorded for these investments). On a per share basis this translates to SAR 1.4 per share negative impact for STC.

Scenario: Impact on earnings resulting from one-off impairment charges

Goodwill Impairment Charge (%)

Binariang

Holdings

Oger Telecom

PT Axis Total Impact

On 2013 Earnings

Per Share Impact (SAR)

100% -19.8% -7.2% -4.6% -31.5% 1.40

80% -15.8% -5.7% -3.7% -25.2% 1.12

60% -11.9% -4.3% -2.7% -18.9% 0.84

40% -7.9% -2.9% -1.8% -12.6% 0.56

20% -4.0% -1.4% -0.9% -6.3% 0.28




We arrive at a fair value of SAR 51.1 per share for STC

We have valued STC using the Weighted Average approach. The methods used include Discounted Cash Flow (DCF)

Sum-of-the-parts and relative valuation. We assigned higher weight to DCF approach, and arrived at a target price of

SAR 51.1 per share for STC, indicating a 28% upside from current levels.

Valuation summary of STC

Fair Value Weights

DCF Valuation SAR 58.8 40.0%

EV/EBITDA SAR 47.6 20.0%

Fair P/E Multiple SAR 44.1 20.0%

Sum-of-the-parts (SOTP) SAR 45.9 20.0%

Weighted Average Fair Value SAR 51.1

Upside/(Downside) from current market price % 28.0%


Valuation - Scenario Analysis

Fair Value estimate at different scenario‘s

Base Case Mobile penetration rate in Saudi Arabia

expected to reach 210% by 2017e

STC to retain 45% market share in mobile

and 90% in fixed line and fixed

broadband

Price-based competition to dent ARPU by

4% yoy

Capex-sale to moderate to 13% over the

long term

Bull Case Mobile penetration rate in Saudi Arabia to

reach 230% by 2017e

STC to increase market share in mobile

to 48% and retain 90% in fixed line and

fixed broadband

Operators to focus more on service

differentiation beyond price-based

competition; ARPU down 1% yoy

Capex-sale to moderate to 12% over the

long term

Initiating coverage with a BUY rating

Overall, we find STC shares attractive at current levels;

upside potential of 28%

STC shares offer a good margin of safety; limited

downside

Bear Case Little room for increase in mobile

penetration rate in Saudi Arabia; to touch

195% by 2017e

STC unable to maintain market position in

mobile and fixed line services ( down to

40%/ 85% respectively)

Aggressive price-based competition to

significantly hurt ARPU; down 5% yoy

Evolving technological changes push

STC to continue at higher capex levels

Sources: Bloomberg; Saudi Fransi Capital analysis

30

35

40

45

50

55

60

65

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13

SAR 46.7

SAR 59.3

SAR 50.8

Fair Value

Bull Case Base Case Bear Case

Valuation

Mispricing of STC’s stock; a buying opportunity



Discounted Cash Flow (DCF)

Our DCF model is based on a five-year explicit forecast period until 2017. We arrived at a WACC of 11.1% for STC,

slightly higher than what we used for Mobily. In terms of terminal growth, we applied a 2.5% terminal growth rate to

estimate the terminal value. With this terminal growth rate being in line with what we used for Mobily, we believe it to be

on the conservative side specifically given STC‘s presence in several potentially high growth international markets. Our

DCF approach yields a fair value of SAR 58.8/share.

STC: Discounted cash flow valuation summary

In SAR mn 2013e 2014e 2015e 2016e 2017e

EBIT * (1-t) 11,189 11,502 12,158 12,881 13,692

Add: Depreciation and Amortization 10,069 10,671 11,254 11,847 12,450

Less: Minority interests (699) (727) (756) (786) (817)

Changes in Working capital (642) (781) (1,142) (1,548) (1,615)

Capital expenditure (9,716) (9,399) (9,501) (9,597) (9,333)

Free Cash flow to Equity 10,201 11,267 12,014 12,798 14,376

Present Value of the free cash flow 9,305 9,263 8,902 8,544 8,651

Terminal Value

174,378

PV of future cash flows 44,666

PV of terminal value 104,936

Total Enterprise Value 149,601

Add: Cash & Equivalents 13,792

Less: Debt 34,823

Less: Minority Interest 7,575

Less: Other liabilities 3,449

Equity Value 117,547

Number of shares (mn) 2,000

Fair value per share SAR 58.8

Upside/(Downside) % 47.3%


Fair Price-Earnings (P/E) multiple approach

We use a Fair P/E multiple approach using the formula (RoE-g)/(RoE*(Ke-g)), which in our view best captures the

risk/return and growth prospects of the company. We arrive at a Fair P/E multiple of 10x for STC, a 1% discount to

MEA 2013 median P/E multiple based on a ROE assumption of 15.9%, growth of 2.5% and a discount rate of 11%. Our

Fair value estimate using P/E approach is SAR 44.1 per share derived by applying a 10x P/E multiple to 2013 earnings

forecast of SAR 4.4 per share.



Relative valuation

For STC‘s market approach–based relative valuation, we used EV/EBITDA multiples, which we believe is the most

suited for valuing STC. We selected a peer group of telcos operating within the GCC region and operators based

outside of the GCC but with operations in the MENA region (MTN, Vodacom, and Maroc Telecom). Our comparative

valuation is summarized in the following table. We expect STC‘s multiples to trade in line with the median valuation

multiples of its peer group.

Relative Valuation

Market

Cap (USD mn)

Price/Earnings (x) EV/ EBITDA (x)

Company 2012e 2013e 2014e 2012e 2013e 2014e

Saudi Telecom 21,282 10.7 9.0 8.7 5.1 4.6 4.2

Etihad Etisalat 15,349 7.6 9.0 8.5 6.1 6.9 6.5

Etisalat 20,944 10.1 9.9 9.6 4.3 4.1 4.0

Du 4,493 9.9 9.5 9.5 4.1 3.6 3.3

Batelco 1,589 7.8 8.3 6.9 5.1 4.9 4.5

Omantel 2,770 8.9 8.5 8.3 4.8 4.7 4.6

Zain Kuwait 12,215 11.6 11.6 10.8 6.7 6.7 6.5

Qtel 10,153 11.4 9.0 8.4 4.6 4.4 4.2

Jordan Telecom 1,887 14.5 13.4 12.7 6.7 6.5 6.3

Turkcell 14,000 12.3 11.3 10.6 6.8 6.2 5.6

Vodacom 19,460 16.2 13.9 13.1 8.1 7.4 6.9

MTN 37,619 15.1 13.3 12.1 5.8 5.6 5.2

Maroc Telecom 10,961 12.7 12.5 12.7 6.5 6.6 6.6

Median Multiple for Saudi Arabia (Ex- Zain KSA)

9.1 9.0 8.6 5.6 5.8 5.3

Median Multiple for GCC 10.0 9.0 8.6 4.9 4.7 4.4

Median Multiple for MEA 11.4 9.9 9.6 5.8 5.6 5.2


Note: Relative valuation based on closing prices as of February 11, 2013

EV/EBITDA approach: We apply MEA peer EV/EBITDA to reflect the company‘s risk/return and growth prospects. This

however is conservative as STC offers international growth opportunity, especially in fast growing Asia region, while it

remains less exposed (relatively) to conflict regions in the Middle East. Our Fair value estimate using EV/EBITDA

approach is SAR 47.6 per share derived by applying a 5.6x EV/EBITDA to 2013 EBITDA forecast of SAR 22.2bn and

deducting net debt, minority interests and liabilities of SAR 32.1bn.



Sum-Of-The-Parts (SOTP)

We have also valued STC on a sum-of-the-parts (SOTP) basis. We considered each operation and arrived at an

EV/EBITDA-based approach value for individual assets. We applied EV/EBITDA multiples for each region into the

forecasted EBITDA (for unlisted entities – Cell C, Viva operations in Kuwait and Bahrain, Axis, Aircel and other assets

of STC) and on consensus estimates (for listed entities – Maxis and Turk Telecom). We arrived at an SOTP value of

SAR 45.9 per share for STC.

STC: Sum of the Parts Value

Entity

Effective interest (%)

of STC shareholder

Type EV/

EBITDA multiple

EBITDA 2013e

Curr-ency

Enterprise Value

(in SAR mn)

Share to

group (%)

STC - Saudi Arabia 100%

5.6 17,268 SAR 96,330 77.8%

Oger Telecom

Turk Telecom 19% Listed 5.6 5,308 TRY 11,930 9.6%

Cell C 26% Unlisted 6.5 227 USD 1,444 1.2%

Viva

Kuwait 26% Unlisted 4.7 137 USD 626 0.5%

Bahrain 100% Unlisted 4.7 69 USD 1,204 1.0%

Binariang

Maxis 16% Listed 7.6 4,526 MY 6,730 5.4%

Aircel 19% Unlisted 7.6 198 USD 1,046 0.8%

Axis Indonesia 84% Unlisted 7.6 139 USD 3,311 2.7%

Other Assets Unlisted 4.7 247 SAR 1,154 0.9%

Total

123,775 100%

Enterprise Value 123,775

Add: Cash 13,792

Less: Debt 34,823

Less: Minority Interests

7,575

Less: Other liabilities 3,449

Equity Value 91,721

Number of shares (mn)

2,000



Exchange rates used USD:SAR: 3.75 ; Turkish Lira TRY:SAR: 2.11; Malaysian Ringgit MYR:SAR:1.20




FINANCIALS – INCOME STATEMENT

Income Statement (in SAR mn) 2008 2009 2010 2011 2012 2013E 2014E

Revenue from services 47,469 50,780 51,787 55,662 59,372 60,722 62,659

Cost of services (17,837) (19,779) (21,464) (24,334) (25,775) (25,983) (26,578)

Gross Profit 29,633 31,001 30,323 31,328 33,597 34,739 36,080

Gross profit margin (%) 62.4% 61.0% 58.6% 56.3% 56.6% 57.2% 57.6%

Selling & marketing expenses (2,128) (6,866) (7,083) (7,424) (8,489) (8,290) (8,554)

General & administrative expenses (5,762) (3,522) (3,619) (3,879) (4,162) (4,258) (4,394)

Depreciation & amortization (6,408) (7,799) (8,642) (8,854) (9,053) (10,069) (10,671)

Impairment provisions - - - - (641) - -

Total Operating Expenses (14,297) (18,187) (19,344) (20,157) (22,345) (22,616) (23,619)

Operating Income 15,335 12,814 10,978 11,171 11,252 12,122 12,461

EBITDA ( Ex-One Off) 21,743 20,612 19,621 20,025 20,945 22,191 23,132

EBITDA margin (%) (Ex-One off) 45.8% 40.6% 37.9% 36.0% 35.3% 36.5% 36.9%

Cost of early retirement program (675) (811) (606) (414) (313) (319) (325)

Finance costs (1,432) (1,385) (1,781) (2,238) (2,503) (2,548) (2,599)

Commissions and interest 624 362 309 450 366 450 459

Other Income (1,809) 1,151 2,076 (481) 478 682 703

Other income and expenses, net (3,293) (683) (1) (2,683) (1,971) (1,736) (1,762)

Income before Zakat 12,042 12,130 10,977 8,488 9,281 10,387 10,699

Zakat (376) ( 335) (118) (118) (247) (286) (294)

Provision for tax (457) ( 642) (820) (479) (1,011) (527) (543)

Net Income 11,210 11,154 10,039 7,891 8,023 9,574 9,862

Non-controlling interests (172) (290) (602) (163) (672) (699) (727)

Net Income for the year 11,038 10,863 9,436 7,729 7,351 8,875 9,135

Basic EPS on net income 5.5 5.4 4.7 3.9 3.7 4.4 4.6

DPS 3.8 3.0 3.0 2.0 2.0 2.0 2.5

No: of shares 2,000 2,000 2,000 2,000 2,000 2,000 2,000




FINANCIALS - BALANCE SHEET

Balance sheet (in SAR mn) 2008 2009 2010 2011 2012 2013E 2014E

Cash and cash equivalents 8,061 7,710 6,051 6,589 5,115 13,936 21,819

Short term investments - - 385 2,446 8,677 8,677 8,677

Accounts receivable, net 8,120 11,461 8,707 8,755 9,890 10,624 10,128

Prepayment and other current assets 2,765 3,492 3,561 4,177 5,101 5,333 5,503

Total Current Assets 18,946 22,663 18,704 21,967 28,783 38,570 46,128

Investments in equity & others 2,452 2,533 2,540 2,682 2,732 2,786 2,842

Property, plant and equipment, net 44,382 52,737 55,127 55,085 56,005 56,972 56,957

Intangible assets, net 31,695 29,222 31,837 29,318 28,162 26,843 25,585

Other non-current assets 2,287 2,433 2,572 2,349 2,230 2,341 2,458

Total Non Current Assets 80,816 86,924 92,077 89,435 89,128 88,942 87,842

Total Assets 99,762 109,587 110,781 111,402 117,912 127,512 133,970

LIABILITIES & EQUITY

Accounts payable 6,649 7,657 7,036 5,190 6,569 6,868 7,087

Other credit balances - current 4,335 4,819 3,509 3,667 3,987 4,149 4,315

Accrued expenses 5,762 6,205 6,058 8,576 7,785 8,139 8,412

Deferred revenues - current portion 2,248 2,081 1,568 1,858 2,185 2,229 2,273

Murabahas and loans - current portion 3,905 8,579 8,447 5,972 4,712 5,100 5,202

Total Current liabilities 22,899 29,341 26,618 25,263 25,237 26,485 27,289

Murabaha and loans - non current portion

28,081 22,711 21,741 23,960 26,124 28,277 28,843

Provisions for end of service benefits 2,738 2,844 2,995 3,062 3,449 3,733 3,808

Other payables - non current portion 3,482 3,859 5,962 5,035 4,133 4,474 4,563

Total Non Current Liabilities 34,301 29,414 30,698 32,056 33,706 36,484 37,214

Share capital 20,000 20,000 20,000 20,000 20,000 20,000 20,000

Statutory reserve 8,233 9,299 10,000 10,000 10,000 10,000 10,000

Retained earnings 9,783 13,552 16,287 19,516 22,866 27,742 31,940

Other reserves - - (1,269) (1,133) (671) (671) (671)

Financial statements' translation differences

(378) (816) (22) (1,474) (801) (801) (801)

Total Shareholders' equity 37,638 42,035 44,996 46,908 51,394 56,269 60,467

Non-controlling interests 4,924 8,798 8,468 7,174 7,575 8,274 9,000

Total liabilities and equity 99,762 109,587 110,781 111,402 117,912 127,512 133,970




FINANCIALS – CASH FLOW

Cash flow statement (in SAR mn) 2008 2009 2010 2011 2012 2013E 2014E


Net cash flows from investing activities (35,468) (13,542) (13,175) (8,264) (9,301) (9,321) (8,996)

Net cash generated from financing activities

14,763 (2,765) (9,669) (7,686) (4,278) (4,006) (6,869)

Net increase/ decrease in cash and cash equivalents

443 (351) (1,659) 538 (1,473) 10,356 7,883

Cash & cash equivalents at the beginning of the period

7,618 8,061 7,710 6,051 6,589 5,115 13,936

Cash & cash equivalents at the end of the period

8,061 7,710 6,051 6,589 5,115 13,936 21,819


Refer to important terms or use, disclaimers and disclosures on back page. Saudi Fransi Capital

ETIHAD ETISALAT COMPANY Telecom | Equity Research | 12 February 2013

Mobily: Investment Highlights

We initiate coverage on Mobily (7020/ EEC AB) with a HOLD rating and a TP of SAR 80.6,

implying an upside of 7.8% to the last close of SAR 74.8 per share. At 6.9x EV/EBITDA on 2013

estimates, Mobily is trading at a premium to GCC and MEA peers. Mobily has created strong

market presence in Saudi Arabia, and it is poised to benefit from the growing demand for

broadband in the Kingdom. It has aggressively rolled out mobile networks across Saudi Arabia

and is gaining on market leader STC. We forecast EPS 2013 of SAR 8.3, an earnings growth of

6.4% YoY. Assuming maintained DPS (at SAR 1.15 per share), the implied dividend yield of

6.2% makes the counter attractive to hold.

Mobily leads fast-growing mobile broadband market in Saudi Arabia: Mobily

currently holds an estimated 40% share in Saudi Arabia‘s mobile market in terms of

subscribers; additionally, it is the leader in the mobile broadband market with more

than 8.7mn subscribers (estimated ~70% market share). Apart from tapping the mobile

broadband opportunity, Mobily is positioning itself as a provider of fixed broadband

services through the purchase of Bayanat. This would enable the company to compete

more effectively with STC‘s bundled service offerings. Revenues from the fiber optic

and 4G networks grew more than 70% YoY. Overall, we expect Mobily‘s revenue to

grow at a CAGR of 5.4% during 2012–17. We forecast 2013e top-line of SAR25.6bn,

8.1% higher YoY.

Increasing contribution from data services; EBITDA outlook positive: Mobily is

capitalizing on the rising broadband penetration trend in the Kingdom. High ARPU

data services accounted for 30% of the company‘s revenues in 4Q 2012 which is

expected to reach 34% by 2014. Increasing contribution from data services and

anticipated pricing power through 4G services could translate into higher EBITDA

margins for Mobily. We expect a 7.9% yoy growth in Mobily‘s EBITDA in 2013 to reach

SAR 9.3bn. CAGR for our forecast period is 6.7%.

Management’s track record and superior ROE warrant sector premium: Mobily

operates at an industry leading ROE (~30% in 2011), second only to Maroc/Vodacom

from among the leading Middle East and Africa (MEA) telcos. Considering the

greenfield operations of the company (unlike the ―incumbent‖ advantage enjoyed by

Maroc/Vodacom), the management‘s track record of delivering profitable growth at

high ROE‘s is notable. Mobily warrants a premium to its peers, in our view. We

forecast Mobily‘s ROE to average 25.4% in our forecast period till 2017.

Shares fully priced with limited upside potential: While the ongoing business

momentum is a positive for Mobily, we see Mobily‘s shares fully priced at current

levels. Mobily is rewarding its shareholders through a bonus issue (1:10), which was

recently approved by the board. Mobily also announced a dividend of SAR 1.15 per

share in 4Q 2012, taking its total dividend distribution in 2012 to SAR 2.99bn. Mobily‘s

shares have outperformed TASI owing to the former‘s ongoing business momentum

and are expected to command a premium valuation.

Rating Summary

MOBILY HOLD

TARGET PRICE (SAR) 80.6

Upside/(Downside) 7.8%

Stock Details

Current Price* SAR 74.8

Market Capitalization SAR Mn 57, 580

Shares Outstanding Mn 770

52-Week High SAR 75.5

52-Week Low SAR 53.0

Price Change (YTD) % 8.2

EPS (2013e) SAR 8.3

Beta (1 Year Adj.) 0.80

Reuters Code / Bloomberg Symbol

7020.SE EEC AB

*Price as of February 11, 2013

Key Shareholders

Etisalat 27.5%

GOSI 11.4%

Other Saudi Investors and Public 61.1%

Sources: Company reports, Zawya

Price Multiples

Current 2013e

P/E(x) 9.6 9.0

EV/EBIDTA (x) 7.5 6.9

Dividend Yield (%) 5.2 6.2


Mobily vs. TASI

Source: Tadawul

Sector Coverage

Roy Cherry

[email protected]

+966-1-2826844

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Page 54 Saudi Fransi Capital

ETIHAD ETISALAT Telecom | Equity Research | 12 February 2013

FINANCIALS & RATIOS

Key Financials ( in SAR mn) 2008 2009 2010 2011 2012 2013E 2014E

Revenue 10,795 13,058 16,013 20,052 23,642 25,553 26,461

EBITDA 3,794 4,837 6,165 7,454 8,591 9,267 9,660

EBIT 2,099 3,045 4,279 5,138 6,088 6,497 6,893

Net Profit 2,092 3,014 4,211 5,083 6,018 6,406 6,797

Balance Sheet (in SAR mn)

Current Assets 6,621 8,577 9,415 9,893 10,427 12,608 14,868

Property Plant and Equipment 8,117 10,370 12,457 16,412 17,255 19,646 21,818

Net intangible assets 10,923 10,450 10,028 9,665 9,412 8,833 8,252

Total Assets 27,192 30,926 33,430 37,501 38,623 42,617 46,468

Total Debt 9,790 8,595 7,972 7,073 8,258 9,039 9,468

Total Equity 9,754 12,243 15,580 18,388 20,906 23,769 26,808

Total Liabilities 27,192 30,926 33,430 37,501 38,623 42,617 46,468

Cash Flow Statement


Cash flows from Investing Activities (5,571) (2,889) (3,227) (3,408) (5,086) (4,465) (4,234)

Cash flows from Financing Activities 2,586 (1,687) (1,516) (3,237) (2,338) (2,761) (3,329)

Key Ratio 2008 2009 2010 2011 2012 2013E 2014E

Gross margin (%) 55.8% 57.8% 54.9% 51.5% 50.9% 50.9% 51.1%

EBITDA margin (%) 35.1% 37.0% 38.5% 37.2% 36.3% 36.3% 36.5%

Revenue growth (%) 27.9% 21.0% 22.6% 25.2% 17.9% 8.1% 3.6%

Growth in EBITDA (%) 28.7% 27.5% 27.5% 20.9% 15.2% 7.9% 4.2%

Growth in earnings (%) 51.6% 44.1% 39.7% 20.7% 18.4% 6.4% 6.1%

Debt/ Equity (x) 1.0 0.7 0.5 0.4 0.4 0.4 0.4

Capex/ Sales 27.4% 25.2% 20.5% 18.5% 20.6% 17.5% 16.0%

ROAA (%) 8.9% 10.4% 13.1% 14.3% 15.8% 15.8% 15.3%

ROAE(%) 26.7% 27.4% 30.3% 29.9% 30.6% 28.7% 26.9%

Cash Flow Yield (%) 1.0% 1.7% 3.8% 5.2% 3.8% 7.3% 8.6%

Per Share Ratios

Earnings per share 2.7 3.9 5.5 6.6 7.8 8.3 8.8

Dividend per share 0.7 1.1 1.8 3.0 3.9 4.6 4.9

Valuation Ratios

P/Earnings 27.5 19.1 13.7 11.3 9.6 9.0 8.5

P/Book 5.9 4.7 3.7 3.1 2.8 2.4 2.1

EV/ EBITDA 17.4 13.5 10.4 8.4 7.5 6.9 6.5

P/Sales 5.3 4.4 3.6 2.9 2.4 2.3 2.2






Mobily establishing itself as market leader from being market challenger

Etihad Etisalat Company (Mobily) was established in 2004 in the monopolistic Saudi Telecom market, and it launched

commercial services in May 2005. Backed by the UAE-based Etisalat, which paid USD 3.5bn for the mobile licenses

(2G and 3G) in 2004, Mobily currently has a mobile subscriber base of over 11.1mn.

It holds an estimated 40% share of the mobile market and nearly 77% share in the mobile broadband space. Mobily

has been in the forefront of introducing new technologies in the Kingdom; it recently became the first operator to

launch TDD-LTE (4G) services in the Middle East and North Africa region through its subsidiary Bayanat Al Oula.

We forecast Mobily‘s revenue to reach SAR 25.6bn in 2013 and increase to SAR 26.1bn by 2014, a growth of 8.1%

yoy. We expect company‘s data revenues to increase their contribution to SAR 8.3bn or ~31% by 2014 compared to

SAR 6.5bn or ~27% in 2012 while the contribution from Mobile / Others (which include product distribution /

Smartphones) is expected to decline to 69% by 2014 from 73% in 2012.

Increasing contribution from data services for Mobily

Revenue trend – Mobily (2008-14e) in SARbn

Mobily revenue mix (2008 -14e)


Solid mobile infrastructure; but behind in fixed broadband

We expect Mobily to continue its leadership position in the mobile broadband market; additionally, Mobily is

positioning itself in the fixed broadband market through key acquisitions. The SAR 2.9bn acquisition of Bayanat Al

Oula, a regional WiMax broadband player, in 2010 was a step in this direction. Mobily thus introduced broadband

services, branded as broadband@home, to compete with STC in the household market. Similarly, through the SAR

80mn acquisition of Zajil, a local internet service provider Mobily strengthened its presence in Saudi Arabia‘s

broadband market. However, we highlight that Mobily (30,000 km of fiber) is significantly behind STC (300,000km of

fiber) in the fixed broadband space.

Mobily has more than 8.7mn mobile broadband subscribers and an estimated ~77% market share in Saudi Arabia in

2011. Although STC is expected to make inroads into the mobile broadband space, we see Mobily continuing its

leadership position in Saudi Arabia. The company has completed the deployment of its 4G LTE network across the

Kingdom, and it is poised to compete with STC. Mobily intends to cover more than 32 cities and 85% of the

population in Saudi Arabia under its 4G network.

Furthermore, the favorable broadband penetration trends in the Kingdom are advantageous for Mobily. The company

is increasingly shifting its business mix toward high-ARPU data services. From accounting for only 9% of the

company‘s total income in 2008, data revenues are expected to reach 33% by 2017. In fact during 4Q 2012, Mobily‘s

data revenue grew 41% year over year with data traffic volumes of 750 Tb per day as against 163 Tb in 2011. We

expect Mobily‘s market share in mobile broadband to reach ~71% by 2014 and 65% by 2017.

1.0 1.8 2.94.4

6.5 7.7 8.39.8

11.2

13.1

15.6

17.117.8 18.1

0

5

10

15

20

25

30

2008 2009 2010 2011 2012e 2013e 2014e

Broadband / Data Mobile/ Others

10.8

25.623.6

20.0

16.0

13.1

26.5

9% 14% 18% 22%27% 30% 31%

91% 86% 82% 78%73% 70% 69%

0%

20%

40%

60%

80%

100%

2008 2009 2010 2011 2012e 2013e 2014e

Broadband / Data Mobile/ Others

Investment Thesis

Mobily is increasingly tilting its business mix towards high-ARPU data services, a positive for margins

Mobily is the second-largest telco in the Kingdom

The strategic Bayanat Al Oula acquisition offers Mobily entry into the mobile-fixed data convergence market



Mobile and broadband segment forecast

Mobile segment – Subscribers vs ARPU (2010-2017e)

Mobile broadband - Subscribers vs ARPU (2010-2017e)


We forecast Mobily‘s mobile subscribers in Saudi Arabia to reach 22.1mn in 2013 and increase to 23.2mn by 2014,

while mobile ARPU is expected to contract marginally by 1% annually to SAR 67 per month by 2014. In the broadband

market, we expect Mobily to lose some of its market share, mostly to STC and Zain KSA. Mobile broadband

subscribers for Mobily are forecast to reach 10.4mn in 2013 and increase to 12.5mn by 2014, while ARPU is expected

fall 1% annually to SAR 60 per month by 2014. For the fixed broadband segment, we expect the company to make

steady inroads as it completes its FTTH roll-out over the next five years. We forecast Mobily to have a 10% share of

the market by 2017 with an estimated 0.3-0.5mn subscribers by 2017.

Data services the key margin driver, EBITDA outlook positive

While we see Mobily‘s ARPU contract 1% over our forecast period, increasing contribution from data services and the

expected pricing power through 4G services should translate into higher EBITDA margins for the company. Mobily is

expected to benefit from fiber-optic and 4G data service revenues, which increased by more than 70% in 4Q 2012. The

company invested in the advanced 4G network through Bayanat; this network covers more than 4,500 sites across the

Kingdom. In addition, it is rapidly establishing its presence in the Enterprise segment, the revenues of which grew 71%

yoy in 4Q 2012. Overall, we expect long term operational gearing, data business growth, impact of lower government

royalties (8% versus 15% for mobile) to boost EBITDA margins by 200–220 bps over our forecast period (2017e).

Positive EBITDA outlook

EBITDA Margin Outlook 2008-14e (in SAR bn)

EBITDA Margin Outlook 2008-14e (%)


19.0

21.0 21.022.1

23.224.4

25.626.8

50

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60

65

70

75

80

0

5

10

15

20

25

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2010 2011 2012e 2013e 2014e 2015e 2016e 2017e

AR

PU

(S

AR

pe

r m

on

th)

Su

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ers

(m

n)

Mobily Subscribers ARPU (RHS)

19.0

21.0 21.022.1

23.224.4

25.626.8

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55

60

65

70

75

80

0

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15

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2010 2011 2012e 2013e 2014e 2015e 2016e 2017e

AR

PU

(S

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Mobily Subscribers ARPU (RHS)

3.8

4.8

6.2

7.5

8.69.3

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4

6

8

10

12

2008 2009 2010 2011 2012 2013E 2014E

35.1%

37.0%

38.5%

37.2%36.3% 36.3% 36.5%

25%

27%

29%

31%

33%

35%

37%

39%

41%

2008 2009 2010 2011 2012 2013E 2014E

Mobily expected to sustain EBITDA margin levels in the high 30’s over our forecast period.



Earnings outlook is positive

We expect Mobily‘s earnings to grow 6.4% in 2013 and forecast its 2013 net income to touch SAR 6.4bn. This

translates into an EPS of SAR 8.3 (on 770mn shares outstanding). The net profit margin is expected to remain around

the ~25% level during the forecast period (2017e).

Earnings outlook positive

Earnings per share* outlook 2008-14e (in SAR)

*EPS adjusted for 770mn shares

Net Income margin 2008-14e (%)


2.7

3.9

5.5

6.6

7.88.3

8.8

2

4

6

8

10

2008 2009 2010 2011 2012 2013E 2014E

19.4%

23.1%

26.3%25.4% 25.5% 25.1% 25.7%

0%

5%

10%

15%

20%

25%

30%

2008 2009 2010 2011 2012 2013E 2014E



Management track record and superior ROE are positives for Mobily

In 2011, Mobily extended its management agreement with Etisalat (UAE) for five years. This irons out any

management-related concerns, unlike the case with STC. The company management has also laid down a stretched

T-Strategy framework that focuses on growth, efficiency, and differentiation (GED). (See Appendices A & B for details

of Executive Management/Corporate Strategy)

Mobily operates at a superior 30%+ RoE (MEA average of 22%), which in our view is a key positive for this name. Its

policy of quarterly dividend distribution as against half-yearly is also a positive for the stock. We forecast Mobily ROE to

average 25.1% in our forecast period (2017e).

Mobily’s return profile is industry-leading; ROE outlook positive

Mobily vs select MEA peers - ROE 2011 (%)

Mobily- ROE Outlook (%)


STC

Mobily

Etisalat

Du

Batelco

Omantel

Zain Kuwait

Qtel

Jordan Telecom

Turkcell

Vodacom

MTN

Maroc Telecom

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60

70

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RO

E (%

) 2

01

1

ROA (%) 2011


26.7%

27.4%

30.3%29.9%

30.6%

28.7%

26.9%

24%

25%

26%

27%

28%

29%

30%

31%

2008 2009 2010 2011 2012 2013E 2014E

Mobily enjoys industry-leading ROE; management track record is a positive



Mobily to continue its ambitious capex program

According to management, the company plans to invest around SAR 22.0bn in network infrastructure development

over the next five years. Mobily recently awarded contracts worth SAR 963mn (USD 256mn) to Huawei and Ericsson

for upgrading its 3G and 4G networks. Besides investing in the mobile broadband space, Mobily aims to strengthen its

fiber optic network to cover 500,000 residential units by 2013. In light of the capex program, the company‘s capex-

sales ratio is expected to remain ~16% in our forecast period.

Aggressive Capex plan at Mobily

Capex outlook 2008-14e (in SAR bn)

Capex-Sales 2008-14e (%)


Mobily‘s high capex program is expected to dent free cash flows for the near term. We forecast Mobily to generate

SAR4-6bn annually in our forecast period. Mobily offers a free cash flow yield of 7.3% on 2013 estimates.

Capex plans to dent free cash flows in the near term

Free cash flow outlook 2013-17e (in SAR bn)

Free cash flow yield 2013-17e (%)


3.03.3 3.2

3.7

4.94.5

4.2

0

1

2

3

4

5

6

2008 2009 2010 2011 2012 2013E 2014E

27.4%

25.2%

19.8%

18.5%

20.6%

17.5%

16.0%

15%

17%

19%

21%

23%

25%

27%

29%

2008 2009 2010 2011 2012 2013E 2014E

4.2

5.05.5

5.96.3

0

1

2

3

4

5

6

7

2013E 2014E 2015E 2016E 2017E

7.3%

8.6%9.5%

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0%

2%

4%

6%

8%

10%

12%

14%

2013E 2014E 2015E 2016E 2017E



Mobily is a key asset for Etisalat; a case for future stake increase exists

With the growth outlook for Mobily being positive, we look at the business case for Etisalat to consider increasing its

stake in Mobily beyond 27.5%. We expect the following factors as being favorable from Etisalat‘s perspective:

a) Mobily is a high-ROE operation in a low–risk, high-growth market;

b) High degree of competition in the domestic market UAE – Du has successfully penetrated the market – is pushing

the company to chase growth outside the UAE;

c) Etisalat‘s other international operations are at high risk in the current geopolitical climate, for example Egypt

(Etisalat Misr), Pakistan (PTCL) and Sudan

Mobily expected to continue with the shareholder-friendly policy

The recent Board approval for a bonus share (1:10) indicates management‘s focus on rewarding shareholders. Despite

the resultant increase in its capital base (770mn shares), we expect the company to raise the payout ratio (55% over

the forecast period). Mobily‘s shares offer an attractive dividend yield of 6.4% at the current market price. The company

is paying a dividend of SAR 1.15 per share each quarter and is expected to increase its full year dividend to SAR 5.0

per share in 2013. This translates into a post-bonus payout ratio of 55%. Mobily has a strong balance sheet with SAR

5.1bn in cash as of 4Q 2012 and SAR 8.7bn in Short term investments.

Our forecast vs. consensus

Our forecasts for Mobily are broadly in line with the Bloomberg consensus estimates. For 2013, we forecast revenue of

SAR 25.6bn and EPS of SAR 8.3, in line with consensus. However, we expect a lower EBITDA margins (than

consensus) going forward reflecting our more conservative view on the pace of margin improvement and increasing

competition in the mobile broadband space (Mobily expected to lose market share).

Broadly in line with consensus

Forecast 2013e 2014e

Saudi

Fransi Capital

Consensus Difference

(%)

Saudi Fransi

Capital Consensus

Difference (%)

Revenue (SAR mn) 25,553 25,608 -0.2% 26,461 27,333 -3.2%

EBITDA ( SAR mn) 9,267 9,411 -1.5% 9,660 10,042 -3.8%

EBITDA margin (%) 36.3% 36.8% -48bps 36.5% 36.7% -23bps

EPS (SAR per share)

8.3 8.4 -0.5% 8.8 8.9 -0.3%

*Consensus forecast as of February 11, 2013


Etisalat could look to expand its participation in Saudi Arabia beyond its current 27.5% interest.



4Q 2012 results: Continuous business momentum

Mobily continued to witness strong business momentum and reported a solid set of numbers for 4Q 2012. Leveraging

on Hajj season activities, the company‘s top line grew 16.7% yoy to SAR 6.8bn, while EBITDA increased 10.3%. Data

revenue (up 40%) continued its double-digit trajectory and accounted for 30% of total revenue in 4Q 2012. Earnings

were up 10.7% yoy for the quarter to reach SAR 1.7bn.

Results snapshot 4Q and FY2012

In SAR mn 4Q 2011 4Q 2012 Difference

(%) 2011 2012

Difference (%)

Revenue 5,802 6,772 16.7% 20,052 23,642 17.9%

Gross profit 3,087 3,479 12.7% 10,326 12,034 16.5%

Operating Income 1,754 1,902 8.4% 5,305 6,192 16.7%

EBITDA 2,305 2,541 10.3% 7,454 8,591 15.3%

Net Income 1,697 1,878 10.7% 5,083 6,018 18.4%




We arrive at a fair value of SAR 80.6 per share for Mobily

We valued Mobily using the Weighted Average approach. The methods used include discounted cash flow, Fair P/E

and EV/ EBITDA multiple. We assigned higher weight to DCF approach, and arrived at a fair value a fair value of

SAR 80.6 per share for Mobily, indicating a 7.8% upside from current levels.

Valuation summary of Mobily

Fair Value Weights

DCF Valuation 79.2 40%

EV/ EBITDA 71.4 30%

P/E Multiple 91.8 30%

Weighted Average Fair Value 80.6

Upside/(Downside) from current market price % 7.8%


Valuation - Scenario Analysis

Fair Value estimate at different scenario‘s

Base

Case

Mobile penetration rate in Saudi Arabia

expected to reach 210% by 2017e.

Mobily to retain 40% market share in

mobile services and 65% share in mobile

broadband.

Price-based competition to affect ARPU,

expected to decline of 1% yoy.

Capex-sales to moderate to 16% over the

long term.

Bull

Case

Mobile penetration rate in Saudi Arabia

expected to reach 230% by 2017e.

Mobily to emerge market leader in Mobile

service with 45% market share; to hold

70% market share in mobile broadband.

Operators to focus more on service

differentiation beyond price-based

competition; ARPU expected to decline of

remain flat yoy.

Capex-sales to moderate to 14% over the

long term.

Overall, we find Mobily shares to be almost fully priced

at current levels; 7.8% upside potential seen.

We would wait and observe Mobily’s progress in

penetrating Saudi Arabia’s fixed broadband market.

Initiating coverage with a HOLD rating

Bear

Case

Penetration rates in Saudi Arabia expected

to reach only 195% by 2017e.

Mobily is unable to maintain market

position and loses out to competition –

STC and Zain KSA.

Aggressive price-based competition to

deteriorate ARPUs considerably; decline of

2% yoy.

Cost overruns in Fiber rollout to increase

capex; deployment of emerging

technological changes.

Sources: Bloomberg; Saudi Fransi Capital analysis

40

50

60

70

80

90

100

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13

SAR 71.0

SAR 92.4

SAR 80.6

Fair Value

Bull Case Base Case Bear Case

Valuation

Mobily looks fully priced at current levels, limited upside seen.



Discounted Cash Flow (DCF)

Our DCF model is based on a five-year explicit forecast period until 2017. We arrived at a WACC of 10.7% for Mobily,

slightly lower than what we used for STC. In terms of terminal growth, we applied a 2.5% terminal growth rate to

estimate the terminal value. Our DCF approach yields a fair value of SAR 79.2/share.

Mobily: Discounted cash flow valuation summary

In SAR mn 2013e 2014e 2015e 2016e 2017e

EBIT * (1-t) 6,550 6,950 7,388 7,718 8,038

Add: Depreciation and Amortization 2,653 2,643 3,015 3,368 3,740

Changes in Working capital (514) (389) (469) (506) (543)

Capital expenditure (4,465) (4,234) (4,468) (4,698) (4,926)

Free Cash flow to Equity 4,224 4,970 5,465 5,882 6,309

Present Value of the free cash flow 3,862 4,105 4,079 3,965 3,843

Terminal Value

79,113

PV of future cash flows 19,854

PV of terminal value 48,190

Total Enterprise Value 68,045

Add: Cash 1,302

Less: Debt 8,258

Less: Other liabilities 137

Equity Value 60,951

Number of shares (mn) 770






Fair Price-Earnings (P/E) multiple approach

We use a Fair P/E multiple approach using the formula (RoE-g)/((RoE*(Ke-g)), which in our view best captures the

risk/return and growth prospects of the company. We arrive at a Fair P/E multiple of 11x for Mobily, a moderate

premium to MEA 2013 median P/E multiple (reflecting the company‘s superior ROE) based on a ROE assumption of

25.4%, growth of 2.5% and a discount rate of 10.7%. Our Fair value estimate using P/E approach is SAR 91.8 per

share derived by applying 11x P/E multiple to 2013 earnings forecast of SAR 8.3 per share.

Relative valuation

For Mobily‘s market approach–based relative valuation, we used the EV/EBITDA multiple, which we believe are the

most-suited for valuing Mobily. We selected a peer group of telcos operating within the GCC region as well as those

based outside of the GCC but with operations in the MEA region (MTN, Vodacom, Maroc Telecom). Our comparative

valuation is summarized in the following table. We expect Mobily to continue commanding a premium over GCC peers

and trade in line with the median valuation multiples of its MEA peer group.

Relative Valuation

Market

Cap Price/Earnings (x) EV/ EBITDA (x)

Company (USD) 2012e 2013e 2014e 2012e 2013e 2014e

Saudi Telecom 21,282 10.7 9.0 8.7 5.1 4.6 4.2

Etihad Etisalat 15,349 7.6 9.0 8.5 6.1 6.9 6.5

Etisalat 20,944 10.1 9.9 9.6 4.3 4.1 4.0

Du 4,493 9.9 9.5 9.5 4.1 3.6 3.3

Batelco 1,589 7.8 8.3 6.9 5.1 4.9 4.5

Omantel 2,770 8.9 8.5 8.3 4.8 4.7 4.6

Zain Kuwait 12,215 11.6 11.6 10.8 6.7 6.7 6.5

Qtel 10,153 11.4 9.0 8.4 4.6 4.4 4.2

Jordan Telecom 1,887 14.5 13.4 12.7 6.7 6.5 6.3

Turkcell 14,000 12.3 11.3 10.6 6.8 6.2 5.6

Vodacom 19,460 16.2 13.9 13.1 8.1 7.4 6.9

MTN 37,619 15.1 13.3 12.1 5.8 5.6 5.2

Maroc Telecom 10,961 12.7 12.5 12.7 6.5 6.6 6.6

Median Multiple for Saudi Arabia (Ex- Zain KSA)

9.1 9.0 8.6 5.6 5.8 5.3

Median Multiple for GCC 10.0 9.0 8.6 4.9 4.7 4.4

Median Multiple for MEA 11.4 9.9 9.6 5.8 5.6 5.2

Sources: Bloomberg, Saudi Fransi Capital Analysis

Note: Relative valuation based on closing prices as of February 11, 2013

EV/ EBITDA approach: We apply a 20% premium to MEA peers‘ EV/EBITDA to reflect the company‘s risk/return and

growth prospects of Mobily and our applied EV/ EBITDA multiple of 6.7x. We justify this premium with the fact that

Mobily offers a significantly above average ROE. Our Fair value estimate using the EV/EBITDA approach is SAR 71.4

per share; this was arrived at by applying a 6.7x EV/EBITDA to the 2013 EBITDA forecast of SAR 9.3bn and deducting

net debt and liabilities of SAR 7.1bn.



Income Statement (in SAR mn) 2008 2009 2010 2011 2012 2013E 2014E

Revenues 10,795 13,058 16,013 20,052 23,642 25,553 26,461

Cost of Services and sales (4,768) (5,512) (7,230) (9,726) (11,608) (12,547) (12,928)

Gross Profit 6,026 7,547 8,783 10,326 12,034 13,006 13,533

Gross margin (%) 55.8% 57.8% 54.9% 51.5% 50.9% 50.9% 51.1%

Selling & Marketing Expenses (815) (1,093) (1,059) (1,173) (1,397) (1,518) (1,572)

General & Administrative Expenses (1,417) (1,617) (1,559) (1,699) (2,046) (2,221) (2,300)

Depreciation & Amortization (1,299) (1,629) (1,810) (2,149) (2,399) (2,653) (2,643)

Total Operating Expenses (3,531) (4,339) (4,429) (5,021) (5,842) (6,392) (6,515)

Operating Income 2,495 3,208 4,355 5,305 6,192 6,614 7,018

EBITDA 3,794 4,837 6,165 7,454 8,591 9,267 9,660

EBITDA margin (%) 35.1% 37.0% 38.5% 37.2% 36.3% 36.3% 36.5%

Finance expenses (437) (204) (146) (213) (169) (183) (192)

Other Income 41 41 70 46 65 66 67

Income before Zakat 2,099 3,045 4,279 5,138 6,088 6,497 6,893

Zakat (7) (31) (67) (54) (70) (91) (96)

Net Income 2,092 3,014 4,211 5,083 6,018 6,406 6,797

Basic EPS (SAR) 2.7 3.9 5.5 6.6 7.8 8.3 8.8

DPS (SAR) 0.7 1.1 1.8 3.0 3.9 4.6 4.9

No: of shares 770 770 770 770 770 770 770



FINANCIALS – INCOME STATEMENT



Balance sheet (in SAR mn) 2008 2009 2010 2011 2012 2013E 2014E

Cash and cash equivalents 1,264 933 1,661 1,690 1,302 2,715 4,483

Short Term Investments 1,050 600 450 - - - -

Accounts Receivable, net 3,098 5,481 5,748 6,323 5,904 6,445 6,815

Due from Related Parties, net 38 69 23 11 6 6 6

Inventories, net 108 132 297 470 721 772 800

Prepaid Expenses & Other assets 1,063 1,361 1,237 1,399 2,493 2,669 2,764

Total Current Assets 6,621 8,577 9,415 9,893 10,427 12,608 14,868

Property, plant and equipment, net 8,117 10,370 12,457 16,412 17,255 19,646 21,818

Licenses, Acquisition fees, net 10,923 10,450 10,028 9,665 9,412 8,833 8,252

Goodwill 1,530 1,530 1,530 1,530 1,530 1,530 1,530

Total Non Current Assets 20,570 22,349 24,015 27,607 28,197 30,009 31,600

Total Assets 27,192 30,926 33,430 37,501 38,623 42,617 46,468

Short-term loans 1,862 371 599 1,201 - - -

Current portion of long term debt 1,286 1,777 1,843 4,895 753 915 938

Accounts Payable 4,367 6,167 6,225 7,808 5,580 5,639 5,872

Due to related parties 78 211 281 194 132 138 143

Accrued expenses and other liabilities 3,155 3,663 3,307 3,949 3,609 3,865 4,002

Total Current liabilities 10,749 12,189 12,256 18,047 10,075 10,556 10,955

Long term loans 6,642 6,448 5,529 977 7,506 8,124 8,530

Provisions for end of service benefits 46 47 66 89 137 167 175

Total Non Current Liabilities 6,688 6,495 5,595 1,066 7,643 8,291 8,705

Authorized, issued and outstanding share capital

7,000 7,000 7,000 7,000 7,000 7,700 7,700

Statutory reserve 347 649 1,070 1,578 2,180 2,820 3,500

Retained earnings 2,407 4,595 7,510 9,810 11,726 13,249 15,608

Total Shareholders’ equity 9,754 12,243 15,580 18,388 20,906 23,769 26,808

Total liabilities and equity 27,192 30,926 33,430 37,501 38,623 42,617 46,468


FINANCIALS - BALANCE SHEET



Cash flow statement (in SAR mn) 2008 2009 2010 2011 2012 2013E 2014E


Net cash flows from investing activities (5,571) (2,889) (3,227) (3,408) (5,086) (4,465) (4,234)

Net cash generated from financing activities

2,586 (1,687) (1,516) (3,237) (2,338) (2,761) (3,329)

Net increase/ decrease in cash and cash equivalents

561 (331) 728 28 (387) 1,606 1,769

Cash & cash equivalents at the beginning of the period

703 1,264 933 1,661 1,690 1,302 2,715

Cash & cash equivalents at the end of the period

1,264 933 1,661 1,690 1,302 2,715 4,483


FINANCIALS – CASH FLOW STATEMENT



Appendix A – Telecom sector snapshot

Key parameters 2007 2008 2009 2010 2011 2012e 2017e

Mobile subscribers (mn) 28.4 36.0 44.8 51.6 53.7 53.5 66.9

Mobile penetration (%) 114% 140% 168% 187% 191% 192% 210%

Fixed line subscribers (mn) 4.0 4.1 4.2 4.1 4.6 4.9 6.4

Fixed line penetration* (%) 65% 65% 63% 63% 66% 67% 70%

Fixed broadband subscribers (mn)

0.6 1.0 1.4 1.7 2.0 2.3 3.5

Fixed Broadband penetration* (%)

14% 23% 30% 35% 39% 45% 60%

Market share – Mobile (%)

STC 61% 53% 48% 47% 47% 46% 40%

Mobily 39% 41% 41% 37% 39% 40% 45%

Zain KSA 0% 6% 12% 16% 14% 14% 15%

Mobile broadband subscribers (mn)

0.1 0.3 1.4 2.7 11.3 12.4 22.3

Mobile Broadband penetration (%)

0.3% 1.3% 5.4% 9.8% 40.3% 43.0% 70.0%

* as a % of households

Sources: CITC, ITU, Saudi Fransi Capital analysis

Appendix B – Telecom Infrastructure STC/ Mobily

STC

Technology Generation Platform Frequency Launch

2G GSM 900 1996

2.5G GSM 900 2004

2.5G GSM 900 2005

3G W-CDMA 2100 2006

3.5G W-CDMA 2100 2006

3.5G W-CDMA 2100 2009

3.5G W-CDMA 2100 2009

4G LTE - 2011


Mobily

Year Technology introduced by Mobily

Aug-2006 UMTS

May-2007 UMTS/ HSDPA

Dec-2008 HSDPA Trial

Mar-2009 HSPA Launch

Feb-2009 HSPA+ Trial

Apr-2009 LTE Trial

Dec-2009 HSPA+ Launch

Sep-2012 TDD LTE Launch


Appendix: Telecom sector



Appendix C –Fixed/ Mobile Technologies

Fixed Network Download Speed Mobile Network Download Speed

Technology Technology

ADSL 1 Mbps GPRS 80 Kbps

ADSL+ 24 Mbps EDGE 384 Kbps

VDSL 52 Mbps UMTS 2 Mbps

FTTH I00 Mbps LTE 30 Mbps

FTTx GPON I0 Gbps IMT Advanced I Gbps

Sources: Telefonica, Saudi Fransi Capital analysis



Appendix: Saudi Telecom Company

Appendix A: Executive Management

Executive Title

Eng. Abdulaziz A. Alsugair Chairman of The Board

Dr. Khaled Abdulaziz Al Ghoneim Chief Executive Officer (CEO) of STC Group

Jameel Bin Abdullah Al Molhem* CEO of STC Saudi Arabia*

Krishnan Ravi Kumar Group Chief Financial Officer (CFO)

Dr. Fahad Hussain Mushyat Vice President (VP) of Strategy Affairs

Eng. Mohammad Bin Nasser Al Jasser VP of Enterprise Services

Eng. Ibrahim Bin Abdulrahman Al Omar VP of Personal Services

Eng. Mazid Bin Nasser Al Harbi VP of Home Services

Ameen Bin Fahed Al Shiddi VP of Finance

Dr. Mahmoud Abdulkarim Al Khatib VP of Regulatory Affairs

Dr. Homoud Mohammed Al Kusayer VP of Wholesale

Eng. Bandar Mohammad Al Gafari VP of Network Sector

Eng. Omar Abdullah Al Nomany VP of Information Technology


* CEO of STC Saudi Arabia Jameel Bin Abdullah Al Molhem resigned recently

Appendix B: Timeline – STC

Year Development

1998 Established in Saudi Arabia

2002 Goes public via IPO

2003 DSL services launched in Saudi Arabia

2005 Introduces 3/3.5G services

2007 Purchases stake in Maxis Communications

2007 Wins third mobile license in Kuwait

2008 Acquires 35% stake in Oger Telecom

2008 Launches operations in Indonesia – PT Axis

2009 Wins third mobile license in Bahrain

2010 Launches IP TV and triple play services in Saudi Arabia

2011 Increases stake in Indonesia to 80.1%




Appendix: Etihad Etisalat Company (Mobily)

Appendix A: Executive Management

Executive Title

Abdulaziz Saleh Al Saghyir Chairman

Khaled Omar Alkaf Chief Executive Officer and Managing Director

Abdulaziz Al Tamami Chief Operating Officer

Thamer Al Hosani Chief Financial Officer

Abdulrahman Ghaleb Chief Contracts and Administrative Officer

Marwan Al Ahmadi Chief Business Officer

Hamed Al Kharji Chief HR Officer

Ahmed Al Hashimi Chief Marketing Officer (Acting)

Mohammed Saad Beseiso Chief Sales & Customer Relations Officer

Medhat S Amer Chief Information Officer

Mohammed Basafi Chief Technical Officer (Fixed and Broadband Network)

Nasser Al Nasser Chief Technical Officer (Mobile Radio Network)

Taher Bin Ammar Bin Taher Al Dabbagh Senior Vice President, Partnership Strategy and Development

Fadi G Kawar Senior Vice President, Finance Strategy

Dr Fahed Moussa Al Zahrani Senior Vice President, Human Resources

Sami Nashwan Senior Vice President, Consumer Marketing

Nader Nuwayhid Vice President, Investor Relations and Corporate Governance


Appendix B: GED strategy framework - Mobily

Strategic Frame Development Action

Growth (G)

Mobily plans to tap the broadband market opportunity in the Kingdom and focus on developing international wholesale. Mobily seeks to leverage on its existing base of both consumer and corporate businesses.

Efficiency (E)

Optimizing Capex/Opex through network outsourcing and infrastructure sharing and aims to realize synergies by process optimization.

Differentiation (D)

Differentiation aspect revolves around a focus on improving customer experience, drive innovation, service standardization across product offerings and focus on developing skilled staff.

Sources: Investor Presentation December 2012, Mobily, Saudi Fransi Capital analysis


Recommendation Framework Telecom | Equity Research | 12 February 2013

BUY: The analyst recommends a BUY when our fair value estimate is at least 10% higher than the current share price.

HOLD: The analyst recommends a HOLD when our fair value estimate ranges within ±10% of the current share price.

SELL: The analyst recommends a SELL when our fair value estimate is lower by more than 10% from the current

share price.

Recommendation Framework


Research & Advisory Department Telecom | Equity Research | 12 February 2013

Head of Research & Advisory

Roy Cherry

[email protected]

+966-1-2826844

Saudi Fransi Capital

Call centre

800-124-3232

Website: www.sfc.sa

Research & Advisory Department



Disclaimer Telecom | Equity Research | 12 February 2013

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