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Disclaimer & Disclosures
This report must be read with the disclosures and the analyst certifications in
the Disclosure appendix, and with the Disclaimer, which forms part of it.
Issuer of report: HSBC Bank Middle East Ltd
View HSBC Global Research at:
https://www.research.hsbc.com
Low oil prices create much uncertainty
Investor focus likely to shift to cash flows and dividend
sustainability, away from growth
We downgrade Etisalat (to Hold) and Mobily (to Reduce)
and initiate on Viva Kuwait at Reduce
GCC telecom operators are not immune to low oil price
While HSBC forecasts a significant recovery in Brent to USD60/bbl in 2016, investors
are wondering about the impact of a sustained low oil price on Gulf telecoms
operators. In this environment, we prefer companies that operate in a rational
competitive and regulatory environment and have the following characteristics:
superior spectrum and network; offer of bundled services (fixed, mobile, data and
media content); a rigorous approach to costs.
Choosing the right stocks in this environment
Investor focus will inevitably shift to cash flows and dividend sustainability. The Gulf
telecom operators’ key attractions are their relative defensiveness and ability to pay a
sustained dividend which is USD-pegged. When looking at these companies, we
think investors should focus on: the macro environment; regulatory and competitive
risks exposure; dividend sustainability as well as valuation.
We have ranked the stocks in our coverage accordingly. We prefer STC and Zain to
Mobily and Vodafone Qatar because the former rank strongly on our scorecard.
We maintain our Buy rating on Zain and STC. On the basis of valuation, Vodafone
Qatar remains a Reduce and Ooredoo a Hold. Etisalat rose 62% in 2015 and we
downgrade it to Hold from Buy with a new target price of AED15. Etisalat’s dividend
yield (which is de facto USD-denominated) in excess of 5% lends support to its share
price. We initiate coverage of Viva Kuwait at Reduce, with a KWD0.77 target price.
In this report, Eric Chang assumes primary coverage of Etisalat, Mobily, Ooredoo, STC,
Vodafone Qatar and Zain.
11 January 2016
Eric Chang* Analyst
HSBC Bank Middle East Ltd.
+971 4 423 6554
Herve Drouet*
Analyst
HSBC Bank plc
+44 20 7991 6827
Nikhil Mishra*
EEMEA Telecoms Associate
Bangalore
* Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations
GCC Telecoms EQUITIES TELECOM
MENA
HSBC’s MENA telecoms coverage universe, ratings and target price changes
Stock Ticker Country Currency Price TP Upside/Downside Previous TP New rating Previous rating
Etisalat ETISALAT UH UAE AED 16.40 15.00 -8.5% 16.25 Hold Buy Mobily EEC AB KSA SAR 26.96 14.75 -45.3% 41.00 Reduce Hold Ooredoo ORDS QD Qatar QAR 75.80 74.00 -2.4% 101.00 Hold Hold STC STC AB KSA SAR 66.57 81.50 22.4% 77.00 Buy Buy Viva Kuwait VIVA KW Kuwait KWD 0.99 0.77 -22.2% N/A Reduce N/A Vodafone Qatar VFQS QD Qatar QAR 12.31 9.00 -26.9% 14.50 Reduce Reduce Zain ZAIN KW Kuwait KWD 0.35 0.48 37.1% 0.71 Buy Buy
Source: HSBC estimates, Thomson Reuters, price as at close of 06 January 2016
Low oil price environment calls for selectivity
EQUITIES TELECOM
11 January 2016
2
Executive summary 3
STC and Zain our preferred names 3
GCC telecoms are defensive, but
one should be selective 3
How do GCC telecom companies
rank? 4
Conclusion 6
Valuation 6
Is GCC telecom really defensive? 9
Why macro matters 9
What are the impacts of a slowing
economy on GCC telecoms
operators? 10
How can telecom operators mitigate
headwinds? 13
Conclusion 13
Regulation and competition 15
Competitive environment in GCC 15
Regulatory environment in GCC 16
Where is valuation relative to
dividend sustainability? 19
Valuation 19
Dividend sustainability 20
How do GCC telecom companies
rank? 21
Choosing 7 key relevant drivers 21
Ranking the companies 22
Company section 27
Etisalat (ETISALAT UH) 28
Mobily (EEC AB) 34
Ooredoo (ORDS QD) 39
Saudi Telecom Company (STC AB) 45
Viva Kuwait (VIVA KW) 51
Vodafone Qatar (VFQS QD) 58
Zain (ZAIN KK) 62
Disclosure appendix 68
Disclaimer 71
Contents
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11 January 2016
STC and Zain our preferred names
In this report we analyse each operator’s positioning in terms of seven key criteria and conclude
that Saudi Telecom Company (STC) and Zain are better positioned than their peers. We
therefore reiterate our positive stance on these two stocks.
STC’s leadership in Saudi Arabia constitutes, in our view, a key competitive advantage. It has
the greater share of post-paid mobile customers (i.e. the high-value segment) and a near
monopoly on fixed line services. As such, the incumbent remains a net beneficiary of data
growth. Market leadership is sustaining its high profitability and strong free cash flow generation.
We note that STC’s unleveraged balance sheet (SAR20.2bn net cash position as at Q3 2015)
gives it the means to invest in network capacity and spectrum indiscriminately. Its cash pile can
be put to use for acquisitions or dividend increase. We think there is scope for STC to pay
dividends in excess of our current estimates. In November, the company announced a dividend
policy which commits to a minimum quarterly dividend of SAR1 per share.
Our Buy rating on Zain remains a valuation call. The current share price effectively ascribes nil
value to operations outside of Kuwait and Saudi Arabia. We deem this particularly harsh. Zain’s
high dividend yield (11.4% in 2015e and 14.3% in 2016e) should provide some support. Zain
trades significantly below the GCC and EEMEA sector average. On 2016e EV/EBITDA
multiples, Zain currently trades 2.4x while the GCC and EEMEA trades on 8.1x and 5.8x
respectively. It trades on a 2016e PE of 5.8x, a significant discount to the GCC (10.0x) and
EEMEA (10.4x) averages. We do highlight however that Zain has the greatest exposure to
macro country risk.
GCC telecoms are defensive, but one should be selective
In 2016, we believe the growth outlook for Gulf Cooperation Council (GCC) telecom operators
will be relatively limited due to the macro environment in the Gulf as well as low oil prices.
Telecom companies are perceived to be relatively defensive but our analysis shows that they
will not be immune to a deteriorating macro environment. Investors’ focus will likely shift towards
value, returns and cash generation, away from growth.
With this in mind, we believe investors should look at: the macro environment; the regulatory
and competitive risks exposure; dividend sustainability and valuation.
Executive summary
We rank our GCC telecom coverage according to 7 key criteria
We think investors should focus on: exposure to regulatory and
competitive risks; dividend sustainability and valuation
We prefer STC and Zain (both rated Buy) to Mobily (downgraded to
Reduce from Hold) and Vodafone Qatar (Reduce)
EQUITIES TELECOM
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4
We look at seven key criteria that best represent these factors:
Domestic macro and the potential impact from a sustained low-oil price environment:
As we highlight in the first section of this report, the impact on telecom operators could be
felt through subscriber growth, margins and increased taxation. Our MENA Economics team
rate the economies of Kuwait, Qatar, Morocco and UAE more resilient to the oil price shock.
(see CEEMEA Economics Quarterly: Further to fall, 7 October 2015). As such, we think
operators with an exposure to Qatar, Morocco and UAE could be potentially less exposed
from a macro perspective.
Diversification and ability to mitigate the impact of a low oil price environment: We
believe exposure to non-oil producing countries as well as network quality and bundled
services could mitigate the impact of a low oil price environment. Operators such as
Ooredoo and Zain should benefit from diversification relative to pure domestic mobile
players such as Mobily and Vodafone Qatar.
Government ownership and the regulatory environment outlook: A significant
government stake should provide some comfort in a challenging economic environment. We
think companies would be potentially shielded from regulatory pressure if their dividends are
a source of state receipts and the government is a significant shareholder. In this respect,
STC, Ooredoo and Etisalat would be advantaged relative to Vodafone Qatar or Mobily.
Competitive positioning and ability to remain in a rational price and cost disciplined
environment: We think the regulatory regime in the GCC will remain relatively benign over
the medium term. All of the challengers (to the incumbent) have built a sustainable
subscriber share. We do not expect any regulator to favour one operator over another to
address any potential market imbalance. We think they will instead let competitive forces
run their course. Nonetheless, operators like Mobily continue to face tremendous
challenges and still need to rebuild ROIC and trust with stakeholders.
Balance sheet strength: in order to accommodate any significant macro shock, we would
prefer operators with a strong balance sheet. The latter is supportive of dividend
sustainability. STC and Etisalat have the strongest balance sheets while leverage ratios of
Mobily and Vodafone Qatar need to be monitored.
Cash-flow generation: We believe this should be the most scrutinised criteria in 2016 with
dividend yield. Cash-flow generation looks strongest for STC, Etisalat and Zain. Conversely,
Mobily and Vodafone Qatar have the weakest cash generation.
Valuation: Quality and defensive stocks like STC and Etisalat have seen their price
performing well during 2015. Although multiples have expanded, valuation remains
relatively attractive for STC. Zain appears the most attractive on most valuation criteria but
we highlight its greatest exposure to higher macro country risk. Vodafone Qatar looks the
most expensive on valuation grounds.
How do GCC telecom companies rank?
We rate companies according to the parameters discussed above. Each criterion carries a score
ranging from 1 to 5. A 5 denotes the most favourable outcome while 1 denotes the lowest, least
favourable outcome. We assign an equal weighting to each factor.
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GCC telecom scorecard
Diversi- Government Market Balance Cash Macro fication ownership position sheet flow Valuation Total
STC 3 1 5 5 5 5 4 28 Etisalat 4 3 5 4 4 4 2 26 Zain 4 3 2 4 3 3 5 24 Ooredoo 3 4 5 3 3 3 2 23 Viva Kuwait 4 1 2 3 2 1 3 16 Vodafone Qatar 4 1 2 2 2 1 1 13 Mobily 3 1 2 3 1 1 1 12
Source: HSBC estimates
STC is the only integrated telecoms operator in Saudi Arabia. As the incumbent, it has
successfully defended its market leadership in fixed and mobile services. Its
competitiveness is reflected in the profitability of the domestic operations. High returns
generate solid cash flows which, in turn, strengthen the balance sheet. This becomes a
virtuous circle as STC can reinvest to support network infrastructure, enter new markets
and increase dividends. The Saudi government is the majority shareholder with an 83.7%
stake. Theoretically, this should reduce the likelihood of detrimental regulatory initiatives.
We think the state would prefer greater dividends than increasing taxation. Given that Saudi
Arabia represents 88% of STC’s 2015e revenues, STC does not rank well on
'Diversification' and 'Domestic macro' criteria. Following its re-rating during H2 2015, STC’s
trades at modestly attractive multiples.
Etisalat has the most consistent ratings amongst our coverage. Its strong share price
performance (+62% in 2015) precludes it from achieving a top ranking. Etisalat has been
diversifying away from its domestic market (which is still resilient) into non-oil dependant
economies. Whilst the UAE represents 55% of 2015e group revenues, Morocco already
contributes 12%. We note that the UAE federal government is Etisalat’s core shareholder.
This affords the incumbent a solid credit rating. In addition, we highlight that Maroc Telecom
(in which Etisalat has a 48% stake) is 30% owned by the Moroccan government.
Zain’s share price dropped 34% in 2015. The steady de-rating has been fuelled by
continued political instability in Iraq, concerns over political stability in Sudan and the
protracted turnaround at Zain KSA. The current price suggests that only Kuwait and Zain
KSA have an intrinsic value. This is not justified in our view.
We acknowledge Ooredoo’s competitive advantage in Qatar. It remains profitable and the
dominant operator in mobile and fixed services. We like the support of the Qatari government
(a 52% shareholder) and the resilience of the economy. Nevertheless, in the current macro
environment, that competitive advantage is offset by its international operations. That
portfolio is concentrated in energy-focused economies (Algeria, Iraq, Kuwait and Oman).
Although Indonesia has high growth potential, the economy is largely commodities-based. In
these markets, Ooredoo is still focused on growth which limits the scope for cash flow
generation and de-levering. Overall, the outlook on dividends remains stable.
After overcoming accounting issues, Mobily is a turnaround story. This explains why it rates
poorly on financial criteria. Mobily does not offer any diversification as it is a focused play on
oil-dependent Saudi Arabia.
Kuwait was an attractive market characterised by high ARPUs and margins. Launched in
2008, Viva Kuwait broke the Zain-Ooredoo duopoly and intensified competition. All three
operators have similar market shares. As it focused on growth, Viva’s cash flow generation
and balance sheet are not attractive. Its returns do not justify its valuation especially when
profits are adjusted for subscriber acquisition costs. Most in the industry expenses such
costs but Viva capitalises them and amortises them over the contract tenor.
EQUITIES TELECOM
11 January 2016
6
Vodafone Qatar was formed with the purpose to operate in Qatar. Its parent (Vodafone
Group owns 23%) is perhaps a limiting factor on any international ambition. We recognise
the difficulty in competing: i) against the incumbent and ii) in a small market. Profitability and
cash generation are within reach but valuation remains stretched. The company trades on
24.9x 2016e EBITDA when the GCC sector trades on 8.1x and the EEMEA sector on 5.8x.
Conclusion
HSBC Oil & Gas Research oil price forecasts assume a significant increase in Brent oil price to
USD60/bbl in 2016 and USD70/bbl in 2017 from the current prices. Given the uncertainties
related to the path of oil prices and the policy measures, any price change would probably not
be immediate but gradual. In the event oil prices remain low for an extended period, we believe
some companies would be more immune to negative impact of low oil prices than others.
Based on the macro factors discussed earlier, we highlight the attraction of Etisalat and
Ooredoo in the event of sustained low oil prices.
Etisalat generates 70% of revenues from the UAE and Maroc Telecom (which has
operations in Morocco and West Africa).
Ooredoo generates half its revenues from Qatar, Kuwait and Indonesia. Iraq, Algeria and
Oman represent 35% of revenues.
Concurrently, should the oil price remain weak over the long term or decline further, Mobily,
STC, and Zain could be more at risk because of their geographic concentration.
Mobily is a Saudi pure-play. As a member of the Etisalat Group, it has limited scope for
geographical diversification outside its domestic market.
STC generates 90% of its revenue from its domestic market. Viva Kuwait (and the market
itself) is too small to offer any diversification benefits.
The benefit of Zain’s core domestic market (Kuwait) is diluted by its presence in Iraq, Sudan
and South Sudan. All three countries have macro and security challenges. In addition, Iraq
is Zain’s largest revenue and profit contributor.
Valuation
We summarise our ratings and views for each company under coverage. Within this report we
are making changes to our estimates and Target Prices.
Ooredoo and Etisalat most
defensive in a sustained low
oil price environment
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11 January 2016
Summary of change in estimates
__________ New ___________ __________ Old __________ ______ Change________ 2015e 2016e 2017e 2015e 2016e 2017e 2015e 2016e 2017e
Etisalat (AED m) Revenue 52,505.6 55,710.8 57,772.8 56,239.0 57,795.7 59,494.7 -6.6% -3.6% -2.9% EBITDA 26,662.9 26,685.4 27,313.1 28,387.5 28,964.6 29,687.4 -6.1% -7.9% -8.0% Margin % 50.8% 47.9% 47.3% 50.5% 50.1% 49.9% 0.3% -2.2% -2.6% Net profit (reported) 7,790.9 8,590.6 9,142.1 9,926.5 9,830.9 9,938.8 -21.5% -12.6% -8.0% Mobily (SAR m) Revenue 13,374 13,590 14,514 15,354 16,310 17,357 -13% -17% -16% EBITDA 1,866 3,835 4,886 4,606 6,181 6,709 -59% -38% -27% Margin % 14.0% 28.2% 33.7% 30.0% 37.9% 38.7% -16% -10% -5% Net profit (reported) -2,106 -733 323 624 2,115 2,643 nm nm -88% Ooredoo (QAR m) Revenue 32,321 33,487 35,289 32,781 34,275 35,913 -1.4% -2.3% -1.7% EBITDA 13,319 13,646 14,142 12,515 13,190 13,927 6.4% 3.5% 1.5% Margin % 41.1% 40.8% 40.1% 38.2% 38.5% 38.8% 3.0% 2.3% 1.3% Net profit (reported) 2,145 2,400 2,621 1,834 1,871 2,206 17.0% 28.3% 18.8% STC (SAR m) Revenue 49,616 51,959 52,670 46,240 48,051 49,835 7.3% 8.1% 5.7% EBITDA 19,606 19,854 20,127 19,421 20,181 20,931 1.0% -1.6% -3.8% Margin % 39.5% 38.2% 38.2% 42.0% 42.0% 42.0% -2.5% -3.8% -3.8% Net profit (reported) 10,020 11,579 11,724 11,441 12,140 12,809 -12.4% -4.6% -8.5% Zain (KWD m) Revenue 1,109 1,110 1,174 1,205 1,279 1,353 -8% -13% -13% EBITDA 488 487 518 504 536 568 -3% -9% -9% Margin % 206 236 275 248 284 320 -17% -17% -17% Net profit (reported) _________ New __________ __________ Old __________ ______ Change________
2016e 2017e 2018e 2016e 2017e 2018e 2016e 2017e 2018e Vodafone Qatar (QAR m) Revenue 2,246 2,437 2,710 2,569 2,936 3,276 -12.6% -17.0% -17.3% EBITDA 482 572 690 655 837 1,032 -26.4% -31.7% -33.1% Margin % 21.5% 23.5% 25.5% 25.5% 28.5% 31.5% -4ppt -5ppt -6ppt Net profit (reported) -356 -261 -150 -182 10 204 nm nm nm
Source: HSBC estimates
Buy
Zain. We acknowledge the headwinds in nearly all its markets. But the current price
suggests that only Kuwait and Zain KSA have intrinsic value. The company is trading at
14% 2016e dividend yield. This could be interpreted as an indication of the markets
discounting an imminent dividend cut. The consensus and HSBC forecast a KWD 0.04
dividend for 2015. We think the absolute amount is achievable given its reasonable
leverage ratio (Net debt/EBITDA 2016e of 0.9x, Net debt/Equity 2016e of 25.9%). A cut
would risk the ire of retail investors (who remain the main drivers of GCC stock markets)
and may accelerate a de-rating. We have adjusted the target price to KWD0.48 (from
KWD0.71) as we move from a DCF-based sum-of-the parts to one that is multiples-based.
This implies 37% upside and we rate Zain Buy.
STC is the dominant player in Saudi Arabia and is leveraging that position to increase cash
returns. We like the steady cash flow generation and un-geared balance sheet. Absent any
significant M&A ambition, we think STC has the scope to increase dividends. We increase
our target price to SAR81.50 from SAR77 mainly due to a lower WACC. As this implies 22%
upside, we rate STC Buy.
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Hold
We downgrade Etisalat from Buy to Hold. Domestic operations continue their solid
performance. We turn more cautious on Etisalat’s international markets. The stock has
sharply re-rated. It was up 62% in 2015 and has risen 34% since the 22 June 2015
announcement on foreign ownership of UAE stocks. We deem the company fairly-valued
and downgrade our rating to a Hold. Etisalat’s dividend yield (which is de facto USD-
denominated) in excess of 5% lends support to its share price. We have reduced the target
price to AED15 (vs AED16.25) due to lower valuation of Maroc Telecom and Mobily.
Ooredoo. The solid outlook on its profitable domestic business is diluted by headwinds in
key international markets. We cut our target price to QAR74 from QAR101 as we lower the
valuation of Ooredoo’s operations in Oman, Iraq, Algeria, Tunisia. That is driven by a
combination of lower estimates as well as a move (from a DCF) to a Target EV/EBITDA
valuation. Our target price is 2% below the last close and we rate the stock Hold.
Reduce
We downgrade Mobily to Reduce from Hold. The Etisalat-affiliate faces numerous
challenges. Mobily need to address the lack of investor confidence and present a clear
turnaround strategy. The mobile operator is facing greater competition (from STC and a
resurgent Zain KSA) as well as an increasingly stressed economic outlook. We cut our
target price to SAR14.75 as we have significantly reduced our estimates. We have lowered
2015-2018 revenues estimates by an average of 15%. For the same period, we have cut
EBITDA estimates by an average of 41%.
We initiate Viva Kuwait at Reduce with a target price of KWD0.77. The latest entrant
has been a formidable competitor by disrupting the Zain-Ooredoo duopoly. Since
commercial launch, Viva’s subscriber base has grown at a 50% CAGR. We expect
subscriber growth to slow down to 2% CAGR 2015-8e. We also ARPU growth to slow down
to 4.8% CAGR 2015-8e from 9.1% in 2014 and 9.7% in 2015e. Parent company STC has
submitted a tender offer of KWD1/share to buy out the 74% minority shareholders. Absent
any takeover rules or investor protection in Kuwait, STC is under no obligation to increase
its offer. The shares are up by 7.6% since the announcement on 18 November 2015 and
appear fully valued. We initiate at Reduce.
We rate Vodafone Qatar Reduce and cut our target price to QAR9 from QAR14.50 due
to lower estimates. We recognise the difficulty in competing against the incumbent in a
small market. Six years after commercial launch, Vodafone Qatar has not posted a net
profit, such is the challenge of operating in a small market. Yet, markets rate the company
highly. We do not think Vodafone’s ROIC or dividend yield justifies such premium. The
stock looks expensive in our view, trading at 24.9x 2016e EBITDA while the GCC sector
trades at 8.1x and the EEMEA sector is valued at 5.8x.
HSBC’s MENA telecoms coverage universe, ratings and target price changes
Stock Ticker Country Currency Price TP Upside/Downside
Previous TP New rating Previous rating
Etisalat ETISALAT UH UAE AED 16.40 15.00 -8.5% 16.25 Hold Buy Mobily EEC AB KSA SAR 26.96 14.75 -45.3% 41.00 Reduce Hold Ooredoo ORDS QD Qatar QAR 75.80 74.00 -2.4% 101.00 Hold Hold STC STC AB KSA SAR 66.57 81.50 22.4% 77.00 Buy Buy Viva Kuwait VIVA KW Kuwait KWD 0.99 0.77 -22.2% N/A Reduce N/A Vodafone Qatar VFQS QD Qatar QAR 12.31 9.00 -26.9% 14.50 Reduce Reduce Zain ZAIN KW Kuwait KWD 0.35 0.48 37.1% 0.71 Buy Buy
Source: HSBC estimates, Thomson Reuters, price as at close of 06 January 2016
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Why macro matters
Not all companies are equal. Even within the GCC telecom universe, each company will be
affected differently by reduced economic activity. This is largely due to their geographical
exposure. In a low oil price environment, fiscal and external accounts of GCC countries
deteriorate at a fast pace. This affects budget shortfalls, public finances and overall growth.
Some countries are more exposed than others and the degree of vulnerability varies
considerably from state to state. Our economists expect all of the oil exporters to face stiffening
headwinds and weakening economic prospects, but for the very wealthiest of the region, there
is still a great deal of room for manoeuvre.
Measuring wealth as a function of oil income per capita and saved wealth, three economies,
Kuwait, Qatar and the UAE, standout. In Kuwait, for example, public spending increased much
more modestly than elsewhere in the region and its oil income – measured in USD/head – is
very high. As a result, the state has a breakeven oil price estimated by the IMF at under
USD50/b, with estimated gross foreign assets over 490% of GDP and debt of less than 25% of
GDP. In the UAE, foreign assets estimated by the Sovereign Wealth Fund Institute at close to
USD1.2trn equate to USD125,000 per national and could fund some 9 years of public spending
if oil earnings fell to zero.
For the other three GCC states – Bahrain, Oman and Saudi Arabia – prospects are much more
difficult. Modelling the draw on sovereign assets and the pace of debt gain is difficult given the
uncertainties that hang over oil earnings, spending trends, trend non-oil growth and inflation. If
oil runs at its current rate USD50/bbl, however, with no cuts in spending and assuming a 50:50
debt and equity funding mix, our economists estimate government savings at SAMA to be
exhausted by 2020 and debt would have risen to as much as 60% of GDP (see CEEMEA
Economics Quarterly: Further to fall, 7 October 2015).
HSBC economists believe that Kuwait, Morocco, Qatar and UAE are the countries best placed
(within MENA) to manage the slump in oil receipts. They believe that deficits in Qatar should be
modest, based on an oil price of cUSD60/bbl and are unlikely to prompt material fiscal
tightening. In Morocco, economic growth has maintained momentum, running at 4.3% in Q2 15
Is GCC telecom really
defensive?
Low oil prices have negative fiscal implications of varying degree
across the MENA region
The impact on telecom operators may be felt through subscriber
growth, margins and increased taxation
On the basis of macro factors, we prefer Etisalat to Mobily, STC
and Zain
Our economists believe
Kuwait, Morocco, Qatar and
UAE are more resilient than
Bahrain, Egypt, Oman and
Saudi Arabia
EQUITIES TELECOM
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10
– almost 2ppts above its 2014 average. The UAE is slowing, not stalling. Its balance sheet is
exceptionally strong, with gross foreign assets estimated at USD700bn-1trn (more than 200% of
GDP) suggesting that the economy can weather the sharp fall in oil receipts.
Conversely, they believe that the following countries are more vulnerable: Bahrain, Egypt,
Oman and Saudi Arabia. They forecast an increase in Bahrain’s 2015 budget deficit to 13% of
GDP. Parliament has agreed to pass some fiscal consolidation measures in response to the
rising budget shortfalls: a controversial removal of subsidies on meat products, fees for sewage
services. In Egypt, our economists are concerned by the pace of economic reform and currency
controls. Oman is one of the most exposed Gulf countries to the oil price: its economy and state
budget are heavily reliant on hydrocarbon revenues. In addition, the modest wealth cushion is
insufficient to weather a prolonged low oil price environment. Lastly, in Saudi Arabia, our
economists forecast a c45% drop in oil receipts compared to that of the previous three years –
the biggest terms of trade shock in a generation.
The table below shows the market presence of each operator under our coverage.
GCC telecom operators’ presence in MENA (% 9m 2015 revenues)
ORDS ZAIN ETISALAT STC EEC VFQS
Algeria 13% Bahrain 5% N/M Egypt 8% Iraq 15% 33% Kuwait 7% 29% N/M Morocco N/A 24% Oman 8% Qatar 24% 100% Saudi Arabia N/A N/A 90% 100% Tunisia 6% UAE 56%
Source: Company data
What are the impacts of a slowing economy on GCC telecoms operators?
Low oil prices are adversely affecting the economies of the MENA region. Although relatively
defensive given their high dividend yield and cash flows, telecom companies may not be fully
immune to an adverse economic environment. With oil prices extending their low levels, we
believe that telecom operators could face challenges on various fronts.
Subscriber growth
Excluding Saudi Arabia, expatriates from a majority of each GCC country’s population. As such,
foreigners also constitute a large share of telecom operators’ subscriber base. As economic
activity slows down in the GCC, we could see lower inflow of foreigners (especially blue-collar
workers) and potentially an outward migration of the foreign population. Either scenario would
negatively impact the subscriber base. In that respect, STC and Mobily (EEC) are less at risk of
foreign subscribers decline than other GCC operators due to their large exposure to the Saudi
market, where foreigners only represent 31% of total population.
Foreign population (2013)
Foreign Total population (as % total) population (m)
Saudi Arabia 31.4% 28.85 UAE 83.8% 9.34 Kuwait 60.2% 3.37 Qatar 73.8% 2.17
Source: United Nations
Telecom companies are not
immune to adverse macro
Subscriber growth most
sensitive to countries with
highest blue-collar expats
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11 January 2016
ARPU and margins
In some countries, there are signs of lower consumer spending. By extension, there will be
repercussions on telecom services. This could put downward pressure on ARPUs. As the
significant part of an operator’s operating costs is fixed, lower ARPUs would drive down margins.
During the financial crisis, the experience in Qatar and the UAE suggests that ARPU declines
were driven by competitive forces rather than operators chasing a dwindling subscriber base.
UAE mobile ARPU (AED) Qatar mobile ARPU (QAR)
Source: Company data Source: Company data
Operators with high post-paid market shares would be least affected by lower consumer spend
because post-paid customers are less price-sensitive. Post-paid subscribers are generally high-
value customers and would capture a greater proportion of the country’s Nationals. In that
respect, we highlight Etisalat, Ooredoo, STC and Zain who should be less exposed than their
GCC peers.
Royalties and taxation are no panacea for fiscal woes
Governments that are overly dependent on hydrocarbon revenues are seeking to diversify their
income source. Raising telecom royalties could be one avenue.
We believe that an increase in telecom royalties would not make a big difference for
governments. In 2014, telecom services generated USD9.6bn of revenues in the UAE and
USD16.8bn in Saudi Arabia. Royalty rates are based on a combination of revenues and profits.
Admittedly, an increase in royalties would not make a big difference in a government’s
revenues: for example, in 2014 Etisalat paid USD1.4bn in royalties, compared to UAE
government receipts of USD150bn.
Nevertheless telecom companies operating in lower public deficit countries with large financial
reserves and which already have relatively high telecom royalty regimes are less at risk than
those operating in high public deficit countries with low financial reserve and which have
currently low telecom royalty regime.
The table below highlights the various telecom royalty rates (whenever publicly disclosed) within
the various countries in which the GCC operators have a presence. We think the governments
of Saudi Arabia, UAE, Kuwait and Qatar are less likely to seek an increase in telecom royalties.
Their foreign reserves provide a cushion to withstand the oil price shock. For the last 12 months,
Oman has considered increasing royalty fees to 12% of revenues (7% currently).
0
50
100
150
200
250
Q108
Q308
Q109
Q309
Q110
Q310
Q111
Q311
Q112
Q312
Q113
Q313
Q114
Q314
Q115
Etisalat Du
0
50
100
150
200
Q109
Q309
Q110
Q310
Q111
Q311
Q112
Q312
Q113
Q313
Q114
Q314
Q115
Ooredoo Vodafone
Pre-paid more impacted than
post-paid
There is lower risk of increased
telecoms taxation in countries
which have lower public deficit
and large reserves
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12
Telecom royalty regimes in the GCC
Fee on Fee on Public Foreign Comments Revenue Profit deficit Reserves (% GDP) ($ bn)
Saudi Arabia mobile 15% Nil -14.9 622.1 fixed 10% Nil data 7% Nil Iraq N/A N/A -12.9 29.6 Egypt N/A N/A -11.8 15.6 Bahrain N/A N/A -11.7 4.8 Oman 7% 12% -10.1 14.0 Algeria N/A N/A -7.1 135.0 UAE 15% 35% -2.1 74.2 Etisalat and du pay different levels of royalty
rates which are a function of their revenues and profits. Etisalat pays 15 % royalty fee on its UAE regulated revenues and 35 % of profit after deduction of the royalty fee on the UAE revenues. In respect of profits from international operations, the 35 % royalty is reduced by the amount paid in foreign taxes.
Morocco N/A N/A -2.5 19.8 Qatar Nil 12.5% -2.1 45.6 Company provides for a 12.5% industry fee on
profits generated from the Group’s operations in Qatar
Kuwait Nil Nil 0.2 24.2 There are no royalty fees in Kuwait. Listed companies pay 1% of profit to the Kuwait Foundation for the Advancement of Science, another 1% of profit for Zakat and 2.5% for the National Labor Support Tax
Source: Company data
We would argue that higher royalties could actually result in lower dividends for governments.
Higher royalties would detract from profits and therefore dividends. We note that all telecom
operators have some form of government ownership.
Government share of dividends in 2014 (USDm)
Source: Company data
Although royalty increases are unlikely to figure as a negative factor for telecom operators, we
find it useful to rate operators according to their market exposure to countries with weak fiscal
positions. The chart below shows the benefits of having sizeable operations in the UAE,
Morocco, Qatar and Kuwait. Based on the criteria, we highlight Etisalat and Ooredoo as the key
beneficiaries on account of their geographical portfolio. The UAE and Qatar have enough
reserves and consequential sovereign wealth to withstand economic shocks.
- 200 400 600 800 1,000 1,200 1,400
STC
Etisalat
Ooredoo
Zain
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11 January 2016
Fiscal balance (% GDP)
Source: HSBC estimates
How can telecom operators mitigate headwinds?
There are different ways operators could try to mitigate the negative impact of a weak
macro backdrop.
Increase/promote usage. One obvious way is to push subscribers to increase voice and
data usage. To sustain usage growth, operators will need a superior network (as measured
by historical capex spend) and spectrum allocation. In Saudi Arabia, we highlight STC and
Mobily as key beneficiaries. Both operators have invested significantly in their networks. In
the UAE, Etisalat benefits from being the incumbent but du has made great strides in
improving network coverage and gaining subscriber market share. In Kuwait, Zain leads
over Ooredoo and Viva in terms of network quality and subscribers. In Qatar, Ooredoo is
the dominant player.
Revenue stream diversification. Bundling different services together (mobile, voice, data,
media content) ensures that subscribers are less likely to leave and promotes subscriber
stickiness. As the telecom market matures, bundling mobile and fixed line services helps
operators generate cost synergies, retain subscribers and deliver superior voice and data
coverage and capacity. In difficult times, we believe operators should gradually focus on
convergence services. We would therefore favour integrated operators over pure-plays.
STC, Ooredoo and Etisalat have the upper hand in their respective domestic markets.
Maintaining pricing discipline. Putting a stop to tariffs erosion is the key to maintain and
improve margins. In Saudi Arabia, STC’s strong balance sheet will help it weather
aggressive pricing from Mobily or Zain KSA. In the UAE, we have noticed that Etisalat is
aligning itself to Du’s marketing strategy. In Kuwait, third-entrant Viva has disrupted the
market and has overtaken Ooredoo.
Conclusion
HSBC Oil & Gas Research oil price forecasts assume a significant increase in Brent oil price to
USD60/bbl in 2016 and USD70/bbl in 2017 from the current price. Given the uncertainties
related to the path of oil prices and the policy measures, any change in oil price would probably
not be immediate but gradual. In the event oil prices remain low for an extended period, we
believe some companies would be more immune to negative impact of low oil prices.
-25
-20
-15
-10
-5
0
5
10
15
20
25
SaudiArabia
Iraq Egypt Bahrain Oman Algeria UAE Morocco Qatar Kuwait
2015f 2016f
Network quality and
convergence services could
mitigate impact
Pricing and cost discipline
is key
Ooredoo and Etisalat most
defensive in a sustained low
oil price environment
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14
In a scenario of sustained oil-price weakness and based on our economists’ forecasts (where
Kuwait, Qatar and UAE would be the least affected economies), we highlight Etisalat and
Ooredoo because:
Etisalat generates 70% of revenues from the UAE and Maroc Telecom (which has
operations in Morocco and West Africa).
Ooredoo generates half its revenues from Qatar, Kuwait and Indonesia. Algeria, Iraq, Oman
and Tunisia represent 41% of revenues.
Conversely, most negatively exposed stocks would be Mobily, STC, and Zain because of their
geographic concentration to countries whose fiscal position and GDP growth would be most
affected by continued oil-price weakness.
Mobily is a Saudi pure-play. As a member of Etisalat Group, it has limited scope for
geographical diversification outside its domestic market.
STC generates 90% of its revenue from its domestic market. Viva Kuwait (and the market
itself) is too small to offer any diversification benefits.
The benefit of Zain’s core domestic market (Kuwait) is diluted by its presence in Iraq, Sudan
and South Sudan. All three countries have macro and security challenges. In addition, Iraq
is Zain’s largest revenue and profit contributor.
Macro ranking
Ranking Comment
Etisalat ++++ The UAE represents just over half of group revenues. Maroc Telecom with operations spanning Morocco and West Africa) represent a quarter of Etisalat revenues
Vodafone Qatar ++++ Vodafone is a domestic play. Zain ++++ Kuwait represents 30% of revenue while politically- sensitive countries (Iraq, Sudan, South Sudan
and Bahrain) represent half. Ooredoo +++ Qatar and Indonesia represent nearly half of revenues Politically-sensitive countries (Algeria, Iraq,
Oman, Tunisia) represent 41% of Ooredoo revenues STC +++ Saudi Arabia represents 90% of revenues. Viva Bahrain and Kuwait are unlikely to contribute
significantly due to the size of their respective markets. Turk Telekom is accounted as an associate and hence its impact is limited.
Mobily +++ Mobily is a domestic play.
Source: HSBC
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11 January 2016
In a slowing growth environment, the ability to maintain both margins and cash-flow generation
is becoming more critical. Operators in a low-competitive environment with limited regulatory
pressure are better positioned.
We think the regulatory regime in the GCC will remain relatively benign. All of the challengers
(to the incumbent) have built a sustainable subscriber share. We do not expect any regulator to
favour one operator over another to address any potential market imbalances. We think they will
instead let competitive forces run its course.
Competitive environment in GCC
We do not foresee any new entrants on a two-year horizon
On a two-year horizon, we view it highly unlikely that any GCC government will make any new
telecom licences available.
MENA telecom market review
Algeria Given the current macro, we think it is unlikely that there would be a license for a 4th mobile operator. Bahrain The market is already saturated with 3 operators Egypt Telecom Egypt has won the universal license which will allow it to offer mobile services. Given the current macro,
we think it is unlikely that there would be a license for a 5th mobile operator. Iraq The government is tendering a 4th mobile license Kuwait There are already three operators. Its small population make it unlikely there would be a fourth entrant. Morocco The country could technically accommodate a 4th entrant. We think the State’s 30% stake in Maroc Telecom
should prevent any brash decision. Qatar No talks of a third entrant. Saudi Arabia As the largest country of the Gulf, Saudi Arabia could accommodate a fourth operator. But we think Zain KSA’s
experience thus far would act as a deterrent. UAE We think government ownership in both operators would mitigate any risk of a thirds entrant
Source: HSBC
MVNO: muted impact
Thus far in the Gulf, Saudi Arabia and Oman are the only markets that have accommodated
mobile virtual network operators (MVNOs). There are no publicly available data which would
suggest any negative impact. MVNOs in both countries target the price-sensitive segment of the
market (i.e. blue collar expats and youths).
Intensity of competition on pricing versus more rationale competition
Kuwait is arguably the most competitive telecoms market in the Gulf. The entry of Viva in
December 2008 has been disruptive to Zain and Ooredoo who were operating a profitable
Regulation and competition
Regulatory framework should remain relatively benign. Number
portability and termination rate cuts had minor impacts
We do not foresee any new entrants over the next two years
Kuwait telcos potentially under more competitive pressure from
Ooredoo while Oman is exposed to disruptive MTR in future
No new entrants expected.
Competitive price should
remain rational
EQUITIES TELECOM
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16
duopoly. In Q1 this year, Viva overtook Ooredoo in terms of subscriber numbers. That prompted
Ooredoo to respond with equally aggressive promotions.
In Saudi Arabia, the smallest operator Zain KSA has opted to focus on improving profitability
instead of increasing market share. Despite the emergence of MVNOs and Mobily’s difficulties,
we are reassured that Zain KSA has shied away from increasing its market share.
Regulatory environment in GCC
We foresee a benign regulatory environment in 2016. We do not anticipate any mobile
termination rate (MTR) cuts. Royalty regimes should remain unchanged (except for Du whose
royalty will increase as communicated by the UAE Ministry of Finance 3 years ago)
Trends in Mobile Termination Rates (MTRs)
The chart below highlights MTRs across GCC countries.
MTR in the GCC
Source: Company, Regulatory Authority
Mobile termination rates in the GCC are significantly higher than in Emerging Europe. We notice
that the UAE, Oman and Saudi Arabia have MTRs at the higher end of the spectrum and
therefor are more at risk to be cut in the future. This currently favours the incumbents (which
have leading market shares) but this advantage should gradually be eroded as MTRs are being
reduced. MTR cut could be disruptive if the smallest operator used an MTR cut has an
opportunity to increase market share and launch a price war (for example in the form of lower
voice/data usage unit cost). So far it has not been the case in Saudi Arabia, where the smallest
operator Zain KSA has focused on improving margin rather than market share. In Oman and
UAE, this could potentially be more disruptive although in UAE we are still in a duopoly and
therefore market share gain would be relatively limited. In Qatar, the regulator has reduced
MTRs earlier this year and has set further reduction for the next two years. MTR will decline by
a further 15% by 2017. Saudi Arabia cut mobile rates by 40% earlier this year.
Mobile number portability
Mobile number portability (MNP) is a relatively recent development in GCC. So far, we are not aware
of any mobile operators publicly stating it as a major contributing factor to subscriber gains.
$0.0000 $0.0100 $0.0200 $0.0300 $0.0400 $0.0500 $0.0600 $0.0700
South Africa
Bahrain
Morocco
EE average
Kuwait
Nigeria
Qatar
Saudi Arabia
Oman
UAE
We expect a stable regulatory
environment in 2016 and no
significant MTR cuts
17
EQUITIES TELECOM
11 January 2016
Introduction of mobile number portability in the GCC
Introduced in
Bahrain Q3 2011 Kuwait Q2 2013 Oman Q3 2006 Qatar Q1 2013 Saudi Arabia 2006 UAE Q4 2013
Source: HSBC
The charts below show the incumbents in the UAE and Qatar have maintained their market
shares, despite the recent introduction of MNP.
UAE mobile subscriber share Qatar mobile subscriber share
Source: Company data Source: Company data
Investors should keep an eye on spectrum costs
Spectrum auctions and prices in the Gulf are not publicly disclosed. Whereas all Gulf countries
have switched to 4G networks, only Omani operators have publicly disclosed information on
price paid for spectrum. The table below is the result of a search from a variety of sources.
We notice a disparity in the MHz cost per population. Such a disparity appears to stem from the
country’s level of wealth. The price paid by GCC operators exceed even the cUSD0.8/MHz/pop
paid by Orange Polska (OPL PW, PLN6.4, Reduce, TP PLN6.2) at the latest 4G spectrum
auction. In CE3 Telecoms: dividend at risk for Orange Polska due to high spectrum price
published on 7 September 2015, we look at the excess price paid by Orange Polska relative to
the European average of cUSD 0.57/MHz/Pop.
Past spectrum auctions
Operator Cost Spectrum Population MHz cost per pop
(USD m) (MHz) (m) (USD)
Mobily 2G 3,227 20 29.0 5.6 Mobily 3G 1,967 10 29.0 6.8 Zain KSA 6,109 60 29.0 3.5 Vodafone Qatar 2,120 100 2.0 10.6 Mobinil - 2G 305 15 80.0 0.3 Mobinil 3G 640 20 80.0 0.4 Etisalat MISR 2,900 40 80.0 0.9 Asiacell- Iraq 1,250 145 31.0 0.3 Zain Jordan- 4G 200 20 6.5 1.5 Zain Jordan- 3G 71 10 6.5 1.1 Ooredoo Oman - 4G 25 30 4.2 0.2
Source: Company data
0%
20%
40%
60%
80%
100%
Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15
Etisalat Du
0%
20%
40%
60%
80%
100%
Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15
Ooredoo Vodafone
Spectrum costs have
historically been expensive
but have recently declined
EQUITIES TELECOM
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18
Change in royalty fees and taxation
We argued previously that we do not expect any major change in royalty regimes for the Gulf-
based telecom companies.
In the UAE, the royalty regime extends to the current year. The UAE ministry of finance will disclose
the rules for the 2017-2020 period by year-end. We do not expect any negative surprises. A less
stringent treatment of Etisalat’s foreign profits would be a positive for the stock. In the current
framework, Etisalat pays royalties to the UAE government on profits from overseas (which
themselves are subject to local taxation). Removing this form of double-taxation would allow Etisalat
to increase dividends in excess of our current estimates.
Removing royalties on
Etisalat’s foreign operations
would allow it to increase
dividends in excess of our
current estimates
19
EQUITIES TELECOM
11 January 2016
Valuation
Zain remains very attractive on valuation. The stock trades on 2.4x 2016e EV/EBITDA, a
70% discount to the GCC average. On a 2016e P/E basis, the discount is 42%. The current
share price ascribes nil value to the operations outside of Kuwait and Saudi Arabia. This
seems unjustified, particularly taking into consideration the 2016e dividend yield of 14.3%.
STC remains attractive at current prices. Its dominance of the Saudi telecoms market underpins
the cash flow and unlevered balance sheet. This bodes well for any potential dividend increase.
Where is valuation relative to
dividend sustainability?
In a lower growth environment, investor focus is going to turn
toward cash flow generation and dividend sustainability
Based on our forecasts, we think historical dividend levels look
sustainable at Etisalat, Ooredoo, STC and Zain
We highlight Etisalat and STC as the two companies with potential
dividend upside
Peer comparison table
Company Ticker Rating Ccy Last Target __ EV/EBITDA___ _____ P/E_______ __ FCF yield ____ ___ Div. yield ___ ____ ROIC ______ price price 2016e 2017e 2016e 2017e 2016e 2017e 2016e 2017e 2016e 2017e
Etisalat ETEL.AD Hold AED 16.40 15.00 5.2 5.0 16.6 15.6 11.2% 11.5% 5.2% 5.5% 31.4% 30.2% Mobily 7020.SE Reduce SAR 26.96 14.75 10.1 7.9 0.0 64.2 -9.3% 2.5% 0.0% 0.8% 2.3% 5.3% Ooredoo ORDS.QA Hold QAR 75.80 74.00 4.4 4.1 10.1 9.3 11.3% 12.2% 5.6% 5.9% 9.4% 9.7% STC 7010.SE Buy SAR 66.57 81.50 6.5 6.3 11.5 11.4 8.3% 9.8% 6.4% 6.8% 20.5% 20.5% Viva Kuwait VIVA.KW Reduce KWD 0.99 0.77 3.3 3.0 5.7 6.6 5.1% 9.6% 0.0% 0.0% 41.6% 30.2% Vodafone Qatar1 VFQS.QA Reduce QAR 12.31 9.00 24.9 21.0 0.0 0.0 -0.3% 0.6% 1.7% 1.7% 3.0% 4.4% Zain Group ZAIN.KW Buy KWD 0.35 0.48 2.4 2.1 5.8 5.0 38.1% 42.6% 14.3% 17.1% 16.5% 18.5% GCC 8.1 7.1 10.02 9.62 9.2% 12.7% 4.7% 5.4% 17.8% 17.0% Magyar Telekom MTEL.BU Hold HUF 409.00 420.00 4.7 4.4 12.9 10.9 12.6% 14.5% 3.7% 3.7% 4.0% 4.6% Megafon MFON.MM Hold RUB 862 875 4.9 4.7 0.0 0.0 10.6% 8.8% 0.0% 0.0% 20.9% 18.9% Mobile Telesystems MBT.N Buy RUB 5.76 9.00 3.9 3.5 0.0 0.0 14.2% 17.1% 0.0% 0.0% 19.0% 21.1% Orange Polska OPL.WA Reduce PLN 6.40 6.20 4.2 4.0 48.1 36.6 15.8% 15.6% 3.9% 3.9% 1.8% 1.9% Rostelecom ROSYY.PK Hold USD 7.34 8.50 2.9 2.7 0.0 0.0 17.5% 18.3% 0.0% 0.0% 7.9% 8.5% Turkcell TCELL.IS Hold TRY 9.84 11.30 4.6 4.4 8.7 8.4 5.8% 8.4% 5.3% 5.9% 9.2% 9.0% Turk Telekom TTKOM.IS Hold TRY 5.30 5.60 4.5 4.2 8.3 7.2 8.5% 10.8% 10.9% 12.7% 9.8% 10.1% VimpelCom Ltd VIP.OQ Buy USD 3.26 6.40 2.8 2.7 5.3 5.1 4.4% 9.4% 6.9% 7.3% 14.7% 14.4% EE 4.1 3.8 10.4 8.5 11.2% 12.9% 3.8% 4.2% 10.9% 11.0% MTN Group MTNJ.J Buy ZAR 132.79 216.00 3.7 3.3 7.6 6.7 11.4% 13.5% 8.1% 9.1% 23.3% 25.3% Telkom SA TKGJ.J Reduce ZAR 60.66 45.00 2.9 2.6 10.6 9.9 9.2% 10.9% 5.2% 5.5% 14.3% 14.9% Vodacom Group VODJ.J Buy ZAR 151.05 157.00 8.4 7.5 15.3 13.4 4.8% 5.6% 5.9% 6.7% 41.2% 43.9% Africa 5.0 4.4 11.2 10.0 8.5% 10.0% 6.4% 7.1% 26.3% 28.0% EEMEA average 5.8 5.2 10.4 9.1 10.0% 12.3% 4.6% 5.1% 16.2% 16.2%
Source: HSBC estimates and Factset, price as on 06 Jan 2016 1 Vodafone Qatar has 31 March year-end. Data for 2016e and 2017e relate to its Fiscal 2016 and Fiscal 2017 respectively 2 P/E have been adjusted to exclude Mobily and Vodafone Qatar
EQUITIES TELECOM
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20
Ooredoo. Focus on international growth limits the potential for cash flow generation and
dividend increase. We think a discount to Etisalat and STC is justified given the headwinds.
Ooredoo’s international markets will bear a combination of risks: competitive, geopolitical and
currency depreciation.
Etisalat performed strongly since the announcement on foreign ownership. Since 22 June
2015, Etisalat has soared 34%. We fail to see any further catalysts in 2016 and think
Etisalat is fairly valued at current levels.
Mobily is a turnaround story although investor confidence remains low. High EV/EBITDA
multiples are a reflection of depressed earnings..
Viva Kuwait is fairly valued. The risk/reward equation looks unfavourable as we model
slowing growth and muted margin expansion.
Vodafone Qatar looks expensive in our view, trading at 24.9x 2016e EBITDA while the
GCC sector trades at 8.1x and the EEMEA sector is valued at 5.8x. We recognize the
difficulty in competing against the incumbent in a small market. Six years after commercial
launch, Vodafone Qatar has yet to post a net profit. Such is the challenge of operating in a
small market. Yet, market rate the company highly. We do not think Vodafone’s ROIC or
dividend yield justifies such premium.
Dividend sustainability
In the run-up to Q4 results, investors will focus on the dividend potential. Here we assess which
company’s dividend is potentially at risk.
STC. The company has recently clarified its dividend policy (minimum of SAR1/ share per
quarter). We like its steady cash flow generation and un-geared balance sheet. Absent any
significant M&A ambition, we think STC has the scope to increase dividends.
Etisalat. We think there is upside risk especially if 48%-owned Maroc Telecom can
turnaround the performance of its African assets.
Mobily. The company needs to turn itself around. In our forecasts, we do not expect any
dividends before 2017 thus limiting its attractiveness to yield-chasing investors.
Ooredoo. There are too many headwinds. It is investing in Burma (a greenfield). It is
fighting off intense competition in Algeria, Tunisia and Kuwait. Thus limiting the likelihood of
any dividend increase.
Vodafone Qatar has not generated a net profit since its establishment. Yet, the Qatari
mobile operator has started paying a dividend since FY2014. It bases its dividend payment
on net profit excluding license amortization. We forecast a stable DPS of QAR 0.21 in the
period leading to FY 2018. We think that level of dividends is achievable given its current
gearing level (FY2016e Net debt / EBITDA of 3.8x and FY2016e Net debt/Equity of 36.6%).
Zain. Management has been guiding on an 80-90% pay-out ratio. Given its languishing
share price, we doubt management would cut nominal dividends in 2015.
Dividend sustainability
Company Currency DPS DPS FCF Net debt Net debt/EBITDA 2015e 2016e 2016e 2016e 2016e
Etisalat AED 0.80 0.85 15,068 5,671 0.2 Mobily SAR 0.00 0.00 -1,929 18,017 4.7 Ooredoo QAR 4.00 4.25 3,943 25,719 1.9 STC SAR 4.00 4.25 10,466 4,113 0.2 Viva Kuwait KWD 0.00 0.00 25 17 0.1 Vodafone Qatar QAR 0.21 0.21 -29 1,844 3.8 Zain KWD 0.04 0.05 260 462 0.9
Source: HSBC estimates
21
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Choosing 7 key relevant drivers
In 2016, we believe the growth outlook for GCC telecom operators will be relatively limited due to the
macro environment in the Gulf as well as low oil prices. Telecom companies are perceived to be
relatively defensive but our analysis shows that they will not be immune to a deterioration of the
macro environment. From growth, investors’ focus will likely to shift towards value, returns and cash
generation. As such, we think investors should look at: the macro environment; the regulatory and
competitive risks exposure; dividend sustainability and valuation.
We have selected 7 key criteria that correspond to the above. These are:
Domestic macro and potential impact of a sustainable low oil price environment: As
we highlighted in the first part of this report, the impact on telecom operators could be felt
through subscriber growth, margins and increased taxation. Operator with an exposure to
Qatar, Morocco and UAE could be potentially less exposed from a macro perspective than
those more exposed to Saudi or Algeria.
Diversification and ability to mitigate the impact of a low oil price environment: We
believe exposure to non-oil producing countries as well as network quality and convergence
services could mitigate impact for companies. Operators such as Ooredoo and Zain should
benefit from diversification relative to pure domestic mobile players such as Mobily and
Vodafone Qatar.
Government ownership and the regulatory environment outlook: A significant
government stake should provide some comfort. In a challenging economy, the regulatory
regime and the dividend payment of companies with a relatively significant state stake
would potentially be more protected. STC, Ooredoo and Etisalat would compare favourably
against Vodafone Qatar or Mobily.
Competitive positioning and ability to remain in a rational price and cost disciplined
environment: We think the regulatory regime in the GCC will remain relatively benign. All
of the challengers (to the incumbent) have built a sustainable subscriber share. We do not
expect any regulator to favour one operator over another to address any potential market
imbalances. We think they will instead let competitive forces run its course. However
operator like Mobily are still facing tremendous challenges. It still needs to rebuild ROIC and
trust with stakeholders.
How do GCC telecom
companies rank?
We ranked GCC telecom companies on 7 key criteria
The most important drivers are: regulatory and competitive risks
exposure; dividend sustainability and valuation
We prefer STC and Zain over Mobily and Vodafone Qatar
EQUITIES TELECOM
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22
Balance sheet strength: in order to accommodate any significant macro shock, we would
favour operators with a strong balance sheet. The latter is supportive of dividend
sustainability. STC and Etisalat have the strongest balance sheets while leverage ratios of
Mobily and Vodafone Qatar need to be monitored.
Cash-flow generation: We believe it would be the most scrutinised criteria in 2016 with
dividend yield. Cash-flow generation look strongest for STC, Etisalat and Zain. Conversely,
Mobily and Vodafone Qatar have the weakest cash generation
Valuation: Quality and defensive stocks like STC and Etisalat have seen their price
performing well during 2015. Although multiples have expanded, valuation remains relatively
attractive for STC. Zain appears the most attractive on most valuation criteria but we wish to
highlight its greatest exposure to higher macro country risk. Valuation at Mobily start to look
attractive, but lack of visibility on the resolution of the major issues it face, still make it
unappealing for investors. Vodafone Qatar looks the most expensive on valuation grounds.
Ranking the companies
We rate companies according to the parameters discussed above. Each criterion carries a
score ranging from 1 to 5. A 5 denotes the most favourable outcome while 1 denotes the lowest,
least favourable outcome. We assign an equal weighting to each factor.
GCC telecom scorecard
Diversi- Government Market Balance Cash Macro fication ownership position sheet flow Valuation Total
STC 3 1 5 5 5 5 4 28 Etisalat 4 3 5 4 4 4 2 26 Zain 4 3 2 4 3 3 5 24 Ooredoo 3 4 5 3 3 3 2 23 Viva Kuwait 4 1 2 3 2 1 3 16 Vodafone Qatar 4 1 2 2 2 1 1 13 Mobily 3 1 2 3 1 1 1 12
Source: HSBC estimates
Saudi Telecom Company (STC)
STC is the only integrated telecoms operator in the Kingdom. As the incumbent, it has
successfully defended its market leadership in fixed and mobile services. Its competitiveness is
reflected in the profitability of the domestic operations. High returns generate solid cash flows
which, in turn, strengthen the balance sheet. This becomes a virtuous circle as STC can
reinvest to support network infrastructure, enter new markets and increase dividends.
The Saudi government is the majority shareholder (through the Public Investment Fund) with a
60% stake. Theoretically, this should reduce the likelihood of detrimental regulatory initiatives.
We think the state would prefer greater dividends than increasing taxation.
Saudi Arabia represents 88% of STC’s 2015e revenues. The company does not fare well in
'Diversification' and 'Domestic macro' terms. Given its re-rating, STC’s trades at modestly
attractive multiples.
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STC’s scorecard
Source: HSBC estimates
Etisalat
Etisalat has the most consistent ratings amongst our coverage. Its strong share price
performance precludes it from achieving a top rank. We wish to highlight Etisalat’s has been
diversifying away from its domestic market (which is still resilient) into non-oil dependant
economies. Whilst the UAE represents 55% of 2015e group revenues, Morocco already
contributes 12%. We note that the UAE federal government is Etisalat’s core shareholder. This
affords the incumbent a solid credit rating. In addition, we highlight that Maroc Telecom (Etisalat
has a 48% stake) counts the Moroccan government as 30% shareholder.
Etisalat’s scorecard
Source: HSBC estimates
Zain
Zain’s share price dropped 34% in 2015. The steady de-rating has been fuelled by continued
political instability in Iraq, concerns over political stability in Sudan and the protracted
turnaround at Zain KSA. The current price suggests that only Kuwait and Zain KSA have an
intrinsic value. We deem this harsh and unjustified.
Domestic macro
Diversification
Gov't ownership
CompetitivenessBalance sheet
Cash flow
Valuation
Domestic macro
Diversification
Gov't ownership
CompetitivenessBalance sheet
Cash flow
Valuation
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Zain’s scorecard
Source: HSBC estimates
Ooredoo
We acknowledge Ooredoo’s undeniable competitive advantage in Qatar. It remains profitable
and the dominant operator in mobile and fixed services. We like the support of the Qatari
government (a 52% shareholder) and the resilience of the economy.
Nevertheless, in the current macro environment, that competitive advantage is offset by its
international operations. That portfolio is concentrated in energy-focused economies (Algeria,
Iraq, Kuwait and Oman). Although Indonesia has high growth potential, the economy is largely
commodities-based. In these markets, Ooredoo is still focused on growth which limits the scope
for cash flow generation and de-levering. Overall, the outlook on dividends remains stable.
Ooredoo’s scorecard
Source: HSBC estimates
Viva Kuwait
Kuwait was an attractive market characterised by high ARPUs and margins. Launched in 2008,
Viva Kuwait broke the Zain-Ooredoo duopoly and intensified competition. All three operators
have similar market share. As it focused on growth, Viva’s cash flow generation and balance
sheet are not attractive. Its returns do not justify its premium valuation, especially so when we
Macro
Diversification
Gov't ownership
CompetitivenessBalance sheet
Cash flow
Valuation
Macro
Diversification
Gov't ownership
CompetitivenessBalance sheet
Cash flow
Valuation
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11 January 2016
adjust profits with subscriber acquisition costs. Most in the industry expenses such costs but
Viva capitalises them and amortises them over the contract tenor.
Viva Kuwait’s scorecard
Source: HSBC estimates
Vodafone Qatar
Vodafone Qatar was formed with the purpose to operate in Qatar. Its parent (Vodafone Group
owns 23%) is perhaps a limiting factor on any international ambition. We recognise the difficulty
in competing i) against the incumbent and ii) in a small market. Profitability and cash generation
are within reach but valuation remains stretched. The company trades on 24.9x 2016e EBITDA
when the MENA sector trades on 8.1x and the EEMEA sector on 5.8x.
Vodafone Qatar’s scorecard
Source: HSBC estimates
Mobily
After overcoming accounting issues, Mobily is a turnaround story. This explains why it rates
poorly on financial criteria. Mobily does not offer any diversification as it is a focused play on oil-
dependent Saudi Arabia.
Macro
Diversification
Gov't ownership
CompetitivenessBalance sheet
Cash flow
Valuation
Macro
Diversification
Gov't ownership
CompetitivenessBalance sheet
Cash flow
Valuation
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Mobily’s scorecard
Source: HSBC estimates
Domestic macro
Diversification
Gov't ownership
CompetitivenessBalance sheet
Cash flow
Valuation
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Company section
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28
Investment case
Etisalat’s key attraction is strong cash generation in the UAE and Morocco. In both markets, it is
the incumbent with advantageous market positions (as evidenced by EBITDA margins in excess
of 50%). That cash can then either be reinvested into growth markets or paid out as dividends.
Moreover, as we highlight in this report, it operates in economies that should be able to weather
falling oil price receipts better than others.
Etisalat’s UAE operations have performed strongly so far this year. In Q3 alone, subscribers grew
7% while revenues increased 6%. More importantly, EBITDA margins have improved by 100bp
during the year (200bp on a sequential basis). Mobile and broadband have been the main growth
drivers. Recently, residential fixed services have opened to competition through the
implementation of fibre network sharing. Although this should ultimately result in increased
competition in fixed services, we doubt that in the medium term Etisalat will lose significant
market share. The current initiative excludes broadband for corporates and cable television
services, which means that either operator is not able to offer competing high-value triple-play
packages (voice, internet and cable television). Whilst Du is able to offer residential services in
Abu Dhabi, Etisalat will now have access to freehold areas of Dubai where Du had de facto
monopoly. We don’t believe there will be competition on pricing per se. We have compared both
operators’ current fixed services package. We discern Du’s trying to compete on value rather
than going head-to-head with Etisalat on pricing. This is positive for both as it preserves margins.
Results from international operations have been lacklustre. Maroc Telecom has been impacted
by competition. Q3 results showed early signs of improvement as the Moroccan incumbent
operator resumed with growth in its domestic market. In Pakistan, PTCL has been impacted by
lower international incoming traffic as well as stiff price competition in the mobile segment.
Egypt has been doing well (on a local currency basis) owing to strong performance in data and
the post-paid segment. This performance is not reflected in Etisalat’s consolidated accounts due
the depreciation of the Egyptian pound. Lastly, Mobily (its 27.5%-owned associate in Saudi
Arabia) is going through a turnaround phase. Its losses have impacted Etisalat’s profits.
The stock price has re-rated significantly last year, up 62% in 2015 and up 34% since the
announcement of foreign ownership rules and subsequent inclusion the in MSCI EM Index. It
now trades at 5.2x 2016e EBITDA (EEMEA average: 5.8x) and 16.6x 2016 earnings (EEMEA
average 10.4x). We believe the share price is fairly-valued and fail to see any catalyst for
outperformance. We downgrade our rating to Hold on valuation grounds.
Etisalat (ETISALAT UH)
Strong domestic performance offset by weakness at international
operations
The stock was up 62% in 2015 and valuation looks fair
We cut our target price to AED15 (from AED16.25) and downgrade
our rating to Hold from Buy
Attractive margin and cash-
flow in UAE and Morocco
Improvement in Morocco.
Pakistan set to improve due
to consolidation
FOL and inclusion in in MSCI
EM Index are the drivers of
share price performance
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Etisalat share price performance
Since Performance
In 2015 +61.8% FOL announcement (22 June 2015) +34.2% FOL implementation (15 September 2015) +11.0%
Source: Thomson Reuters DataStream
Company profile
In 1976, Etisalat started as the incumbent telecom operator in the UAE. It has since been a
trailblazer in the Middle East through a series of “firsts” in the region.
A timeline of success
Year Event
1982 1st mobile network 1994 1st GSM services 1995 1st internet service provider 1999 1st to launch ADSL broadband services 2003 1st 3G network 2010 1st 4G LTE network
Source: Company data
Etisalat began its international diversification through a series of acquisitions and greenfield
projects. Today, it is an integrated telecoms operator focused on the Middle East, Africa and
South Asia. It has built a portfolio of assets primarily focused on MENA (KSA, UAE, Egypt,
Morocco) and Africa (Benin, Burkina Faso, the Central African Republic, Gabon, the Ivory
Coast, Mali, Mauritania, Nigeria, Niger, Togo, Sudan). It also owns operations in South Asia
(Afghanistan, Pakistan, Sri Lanka). The UAE still represents half of group revenues and EBITDA
while Maroc Telecom represents the bulk of the balance.
Etisalat at a glance
Unit Stake Business segment Comment
Middle East UAE 100% Fixed, Mobile Greenfield KSA 27% Mobile Greenfield Egypt 66% Mobile Greenfield Africa Maroc Telecom 48% Fixed, Mobile Acquisition. Presence in Morocco, Benin, Burkina Faso, the Central African
Republic, Gabon, the Ivory Coast, Mali, Mauritania, Nigeria, Niger, Togo Nigeria 40% Mobile Greenfield. Joint-venture with Mubadala Sudan 90% Fixed Acquisition South Asia Afghanistan 100% Mobile Greenfield Pakistan 23% Fixed, Mobile Acquisition Sri Lanka 100% Mobile Acquisition
Source: Company data
Estimate changes
We incorporate the most recent quarterly trends in our model and review some of our
assumptions to reflect greater challenges outside its core UAE market. We have cut our
revenue estimates for Etisalat’s international operations. Egypt and Maroc Telecom face a
challenging competitive environment as well as currency depreciation. We think Pakistan’s
performance may improve due to the pending market consolidation but for the moment we
factor a strong dollar.
Owing to operating leverage, we have also cut our margin estimates. Our EPS estimates are
down by 14% on an average due i) to lower margins and ii) losses from its Saudi associate Mobily
Diversified assets in UAE,
KSA, Egypt, Pakistan,
Morocco, and Africa
Limited impact from “Mobily”
issues in KSA with 27% stake
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Etisalat: changes to our estimates
__________ New ___________ __________ Old __________ ______ Change________ AEDm 2015e 2016e 2017e 2015e 2016e 2017e 2015e 2016e 2017e
Revenue 52,505.6 55,710.8 57,772.8 56,239.0 57,795.7 59,494.7 -6.6% -3.6% -2.9% EBITDA 26,662.9 26,685.4 27,313.1 28,387.5 28,964.6 29,687.4 -6.1% -7.9% -8.0% Margin % 50.8% 47.9% 47.3% 50.5% 50.1% 49.9% 0.3% -2.2% -2.6% Net profit (reported) 7,790.9 8,590.6 9,142.1 9,926.5 9,830.9 9,938.8 -21.5% -12.6% -8.0%
Source: HSBC estimates
Valuation and risks
Valuation
We continue to value Etisalat on sum-of-the-parts. We believe that this methodology is the most
appropriate for a company with wide array of assets and varying degrees of minority leakage.
We continue to base our SOTP on 2016 estimates and make the following revisions:
1. We continue to value Maroc Telecom at 6x EBITDA which yields a value of AED6,511m,
down from AED7,431m previously. In our view, dominance of the Moroccan market
warrants that multiple. We previously erroneously assumed that Etisalat owned 53% of
Maroc Telecom. We adjust our valuation to reflect Etisalat’s effective stake of 48.4%.
Etisalat owns 91.3% of Etisalat Investment North Africa. The latter owns 100% of Société
de Participation dans les Télécommunications which holds a 53% stake in Maroc Telecom.
2. Account for a lower valuation of Mobily, which we bring in at our target price of SAR14.75,
down from SAR41 (see the chapter on Mobily for greater detail);
3. We continue to value the UAE operations on 6x 2016e EBITDA in light of its sustained solid
performance throughout the year. We deem this reasonable relative to STC’s 2016e
EV/EBITDA multiple of 6.5x. For the other units valued on EV/EBITDA multiples we assign
a discount to regional peers primarily due to their lower profitability.
As a result of these revisions our fair value target price for Etisalat falls to AED15 from AED16.25.
As this implies 8.5% downside, we downgrade the stock to Hold from Buy. Etisalat’s dividend yield
(which is de facto USD-denominated) in excess of 5% lends support to its share price.
Etisalat SOTP
AEDm EBITDA EV % EV % Method 2016e /EBITDA stake of EV
UAE 15,782.7 6.0x 100.0% 94,696.1 75.6% Multiple Maroc Telecom 6,511.1 6.0x 48.4% 18,910.2 15.1% Multiple Egypt 2,588.1 5.5x 66.0% 9,394.9 7.5% Multiple Pakistan 1,492.0 2.4x 23.4% 830.4 0.7% Market value Asia 311.5 3.0x 100.0% 934.4 0.7% Multiple Subsidiaries 124,766.0 Mobily 3,754.1 7.7x 27.0% 3,002.1 2.3% Target price Nigeria EMTS 1,688.7 5.0x 40.0% 3,377.4 2.7% Multiple Associates 6,379.6 Other interests 313.3 0.2% EV 131,458.8 Debt -23,351.5 Cash 17,269.8 Adjustment for minority's share in debt 3,805 Equity value 129,181.6 Issued shares (m) 8,696.8 Target price (AED) 15.0 Current share price (6 Jan 2016) 16.4 Upside/downside -8.5%
Source: HSBC estimates
We downgrade Etisalat on
valuation after a good share
price performance
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Risks
The key downside risks to our rating include:
Adverse regulatory developments in the UAE and Morocco. These two countries represent
70% of group revenues in 2015e. Taxation on telecoms services is a convenient way for
governments to raise income. In general, governments may be tempted to increase the
taxation rate at times when oil receipts are under pressure.
Unfavourable political developments in the markets in which Etisalat operates.
In the UAE, Du could intensify competition on the fixed line segment. Whilst the regulator is
planning to widen the scope of fixed network sharing to include cable television services, a
timeline is uncertain. Being able to offer triple-play (bundled voice, internet and cable
services) would allow Du to effectively compete with Etisalat.
We acknowledge the potential for Etisalat to overpay for its M&A ambitions. But we are
comforted by the discipline exercised on its acquisition of Maroc Telecom.
We also highlight the potential for earnings swings due to FX volatility. Nearly half its
revenues are generated in non-dollar pegged currencies.
Key upside risks include:
Formal dividend policy. The UAE stock market is essentially driven by retail investors who view
dividends as very important. Currently, Etisalat pays dividends on a half-yearly basis with a
stable increase. We think a move to a quarterly dividend would be positively received.
Any further easing of foreign ownership for the company. As a reminder, FOL is set at 20%
but foreigners cannot exert any voting rights.
Positive impact of FX changes on Etisalat's earnings as half its revenues are non-dollar pegged.
Etisalat KPIs
2015e 2016e 2017e 2018e
UAE mobile ARPU (AED) 114.7 116.0 117.6 119.4 Revenue growth 7.7% 6.1% 3.7% 4.8% EBITDA margins 50.8% 47.9% 47.3% 46.5%
Source: HSBC estimates
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Etisalat in a nutshell
The UAE government is a key shareholder The UAE remains the key revenue driver (2015e) 2013-14 growth driven by the acquisition of
Maroc Telecom
Source: Bloomberg Source: HSBC estimates Source: HSBC estimates
A cash generative company (AEDm) Attractive dollar-denominated yield Solid balance sheet with acquisition firepower
Source: HSBC estimates Source: HSBC estimates Source: HSBC estimates
60%
40%
Emirates Investment Authority Free-float
55%26%
19%
UAE IAM Other
0%
5%
10%
15%
20%
25%
30%
2013 2014 2015e 2016e 2017e 2018e
Revenue
EBITDA
44%
46%
48%
50%
52%
0
5,000
10,000
15,000
20,000
25,000
30,000
2013 2014 2015e 2016e 2017e 2018e
EBITDA Margin
0.0%
5.0%
10.0%
15.0%
2013 2014 2015e 2016e 2017e 2018e
FCF Dividend
-0.6x
-0.4x
-0.2x
0.0x
0.2x
0.4x
-15,000
-10,000
-5,000
0
5,000
10,000
2013 2014 2015e 2016e 2017e 2018e
Net debt (cash)
Net debt/EBITDA
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Financials & valuation: Etisalat Hold Financial statements
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Profit & loss summary (AEDm)
Revenue 48,767 52,506 55,711 57,773
EBITDA 23,365 26,663 26,685 27,313
Depreciation & amortisation -7,337 -7,499 -7,361 -7,685
Operating profit/EBIT 16,028 19,164 19,324 19,628
Net interest 1,248 -246 -268 -246
PBT 11,007 10,946 13,221 13,865
HSBC PBT 11,482 11,505 13,221 13,865
Taxation -1,154 -1,297 -992 -1,040
Net profit 8,892 7,791 8,591 9,146
HSBC net profit 9,367 8,350 8,591 9,146
Cash flow summary (AEDm)
Cash flow from operations 29,920 18,837 25,897 26,754
Capex -8,911 -7,635 -9,569 -10,019
Cash flow from investment -25,758 -7,855 -9,569 -10,019
Dividends -6,924 -3,512 -7,392 -7,827
Change in net debt 13,284 4,169 -2,208 -2,018
FCF equity 21,103 9,659 15,068 15,449
Balance sheet summary (AEDm)
Intangible fixed assets 34,785 31,460 30,369 29,474
Tangible fixed assets 45,973 44,851 48,150 51,379
Current assets 38,762 36,901 39,554 41,941
Cash & others 18,543 15,472 17,680 19,698
Total assets 129,585 122,750 127,612 132,332
Operating liabilities 44,415 37,635 37,292 37,101
Gross debt 22,253 23,352 23,352 23,352
Net debt 3,711 7,880 5,671 3,653
Shareholders' funds 42,276 42,976 44,175 45,493
Invested capital 56,562 60,105 63,102 65,995
Ratio, growth and per share analysis
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Y-o-y % change
Revenue 25.5 7.7 6.1 3.7
EBITDA 23.6 14.1 0.1 2.4
Operating profit 12.5 19.6 0.8 1.6
PBT 31.0 -0.6 20.8 4.9
HSBC EPS 9.5 -19.0 2.9 6.5
Ratios (%)
Revenue/IC (x) 1.1 0.9 0.9 0.9
ROIC 37.5 31.7 31.4 30.2
ROE 22.6 19.6 19.7 20.4
ROA 10.1 8.2 10.1 10.2
EBITDA margin 47.9 50.8 47.9 47.3
Operating profit margin 32.9 36.5 34.7 34.0
EBITDA/net interest (x) 108.5 99.6 111.1
Net debt/equity 6.1 13.2 8.8 5.3
Net debt/EBITDA (x) 0.2 0.3 0.2 0.1
CF from operations/net debt 806.3 239.1 456.6 732.3
Per share data (AED)
EPS Rep (diluted) 1.12 0.90 0.99 1.05
HSBC EPS (diluted) 1.18 0.96 0.99 1.05
DPS 0.70 0.80 0.85 0.90
Book value 5.35 4.94 5.08 5.23
Valuation data
Year to 12/2014a 12/2015e 12/2016e 12/2017e
EV/sales 2.8 2.7 2.5 2.4
EV/EBITDA 5.9 5.3 5.2 5.0
EV/IC 2.4 2.4 2.2 2.1
PE* 13.8 17.1 16.6 15.6
PB 3.1 3.3 3.2 3.1
FCF yield (%) 15.9 7.2 11.2 11.5
Dividend yield (%) 4.3 4.9 5.2 5.5
* Based on HSBC EPS (diluted)
Issuer information
Share price (AED) 16.40 Free float 40%
Target price (AED) 15.00 Sector Diversified Telecoms
Reuters (Equity) ETEL.AD Country United Arab Emirates
Bloomberg (Equity) ETISALAT UH Analyst Eric Chang
Market cap (USDm) 38,830 Contact +971 4 423 6554
Price relative
Source: HSBC
Note: Priced at close of 06 Jan 2016
5.00
7.00
9.00
11.00
13.00
15.00
17.00
19.00
21.00
5.00
7.00
9.00
11.00
13.00
15.00
17.00
19.00
21.00
2014 2015 2016 2017Etisalat Rel to DUBAI FINANCIAL MARKET INDEX
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Investment case
At the end of 2014, Mobily had to significantly restate its 2013 and 2014 accounts on the back
of accounting errors. As a result of these errors, the CEO and CFO stepped down and were
replaced in July 2015. A thorough review of the accounting standards led to further significant
restatements of the past 2 years’ accounts. Stakeholders would likely want evidence of a clean
set of accounts as well as the implementation of a robust corporate governance framework. The
new management is undoubtedly formulating a turnaround strategy. Such business plan will
need to be sustainable. To regain investors’ trust, we believe the company will need to show
that it is able to manage its business on cash returns metrics.
Banks. The company technically breached its loan covenant as a result of the significant
restatements. On 29 December, following a year of negotiations, Mobily announced that a
majority of its lenders agreed to waive the covenant breach. (Reuters: Saudi Mobily agrees
with majority of lenders to waive breach). Starting in Q4 2015, we have assumed an
increase in debt funding costs to 5% (from 2%).
Investors would benefit from improved investor relations with emphasis on transparency,
consistency and “pro-activeness”. The disclosure of simple operating metrics (segmental
disclosure, subscribers numbers by segment, ARPU by segment etc.) would be a start.
Company profile
Mobily is a mobile operator focused in Saudi Arabia. It was established in 2004, shortly after the
Etisalat-led consortium won a GSM and 3G license (for SAR13bn).
The company had auspicious beginnings. Within a year from inception, the company listed on
the Saudi Exchange and built a 3G network with 79% population coverage at launch. From the
outset, Mobily decided that network investments as well as clever marketing would be key to its
commercial success. 1m subscribers joined Mobily within 90 days of launch. By the end of
2006, the start-up achieved a 30% subscriber share, a threshold it has defended since. Despite
the launch of Zain KSA (the third entrant) in 2008, Mobily’s market share has not strayed below
the high 30s.
Commercial success led to a series of financial milestones. Mobily was EBITDA-positive in
Q4 2005. It was profitable by Q1 2006 and started generated cash-flow in Q3 2006.
Mobily (EEC AB)
Enormous challenges remain
Rebuilding ROIC and trust with stakeholders is an imperative
We downgrade to Reduce from Hold with a TP of SAR14.75
from SAR41
Still facing legal, operational
and financial challenges
A key Saudi mobile
operator…
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From its experience in the UAE, Etisalat knew data’s potential: the UAE was the first country in
the Middle East to roll-out a 3G network. Accordingly, Mobily built a network based on 3G
specifications. In 2008, it rolled out a 3.5G network, a first in Saudi Arabia, which attracted
broadband internet subscribers. It also built a fiber optic network and acquired Bayanat al-Oula
for its data services license.
In 2012, as growth in mobile voice services slowed, Mobily shifted its focus towards the
Information and Communication Technologies (ICT) segment. It began directly challenging the
incumbent STC on the Enterprise client segment.
With this transition, the company pursued lofty financial targets and aggressive accounting
policies. The strategy unravelled and the accounting problems were disclosed in Q3 2014. The
problem was revenue recognition related to: i) one of its promotional programs as well as ii) to
non-readiness of FTTH (Fibre-To-The-Home) ports related to a lease contract signed with one
of its approved distributors. The restatements were significant. Cumulatively, SAR 3.8bn of
profits was restated from the 2013 and 2014 financials. Market reaction was unequivocal and
Mobily’s share price has collapsed by two-thirds. Mobily KPI
2015e 2016e 2017e 2018e
ARPU (SAR) 55.5 57.4 58.9 60.5 Revenue growth -4.4% 1.6% 6.8% 5.7% EBITDA margins 14.0% 28.2% 33.7% 35.0%
Source: HSBC estimates
Estimate changes
Although new management has not presented its strategy for the company, we think it would
make sense to implement a leaner cost structure and rationalise capex. This is the basis of our
estimates in 2015-2016. The company has been reporting very weak numbers due to numerous
one-offs. As reported figures become cleaner (a lower recurrence of “one-offs”) and the base
becomes more favourable, we expect Mobily to show an improvement in financial metrics. We
expect revenues to grow by 1.6% in 2016 and by a healthier 6.8% in 2017. We see EBITDA
margins improving to 34% in 2017e from 14% in 2015e.
Moreover, we do not expect dividends to resume before 2017. The company’s most pressing
matter is to meet loan covenants and increase liquidity.
We have significantly reduced our estimates. Due to weak performance in past quarters, we
have taken a less sanguine view of the company. We have cut revenues in our forecast period
by 15% on average as we model a slower rate of subscriber growth. Mobily has posted
4 consecutive quarters of losses. Whereas previously we expected a rapid turnaround, we now
take a cautious approach. We model a return to profitability in 2017.
Mobily: change in estimates
___________ New ___________ ___________Old ____________ _______ Change% _________ SARm 2015e 2016e 2017e 2015e 2016e 2017e 2015e 2016e 2017e
Revenue 13,374 13,590 14,514 15,354 16,310 17,357 -13% -17% -16% EBITDA 1,866 3,835 4,886 4,606 6,181 6,709 -59% -38% -27% Margin % 14.0% 28.2% 33.7% 30.0% 37.9% 38.7% -16% -10% -5% Net profit (reported) -2,106 -733 323 624 2,115 2,643 nm nm -88%
Source: HSBC estimates
… that diversified into the
fixed and ICT segments as
the market matured
No dividend or return to
profitability before 2017
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Valuation and risks
With accounting irregularities behind them and new management in place, we view Mobily as a
restructuring story. Given its operations are predominantly Saudi based, we continue to believe
that DCF is the most appropriate method of valuing the company.
We have used a DCF model and removed the 20% discount factor because our forecasts are
now very conservative. The fair value is based on an 8.1% WACC (9.2% previously) which we
have derived from a 7.8% cost of equity, pre-tax cost of debt and a greater target debt-to-asset
ratio of 60% (30% previously) to reflect lower cash generation.
A lower WACC is not enough to offset the value destruction stemming from the recent
accounting restatements and as a result our target price falls to SAR14.75 from SAR41. This
implies 45% downside and we downgrade the stock to Reduce from Hold.
Risks
Key upside risks include
Successful partnership with banks regarding loan covenants re-negotiation and refinancing
Mobily gaining market share (from STC) on the ICT (Information and Communications
Technology) segment
Greater mobile broadband usage could be a catalyst for ARPU increases
Improved disclosures and corporate governance initiatives could increase investor confidence
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Mobily in a nutshell
Etisalat should remain supportive… … of Mobily’s turnaround plan (SARm) We expect growth to return in 2016
Source: Bloomberg Source: HSBC estimates Source: HSBC estimates
But covenants renegotiation is key (SARm) No point chasing EEC for yield Capital discipline is crucial
Source: HSBC estimates Source: HSBC estimates Source: HSBC estimates
27%
12%61%
Etisalat Hassana Free-float
0%
10%
20%
30%
40%
50%
0
2,000
4,000
6,000
8,000
10,000
12,000
2013 2014 2015e 2016e 2017e 2018e
EBITDA Margin
-100%
-50%
0%
50%
100%
150%
2013 2014 2015e 2016e 2017e 2018e
Revenue EBITDA
0.0x
2.0x
4.0x
6.0x
8.0x
10.0x
0
5,000
10,000
15,000
20,000
2013 2014 2015e 2016e 2017e 2018e
Net debt (cash) Net debt/EBITDA
0%
5%
10%
15%
20%
25%
2013 2014 2015e 2016e 2017e 2018e
FCF Dividend
-10%
0%
10%
20%
30%
40%
2013 2014 2015e 2016e 2017e 2018e
ROIC CapEx / Revenues
EQUITIES TELECOM
11 January 2016
38
Financials & valuation: Etihad Etisalat(Mobily) Reduce Financial statements
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Profit & loss summary (SARm)
Revenue 13,995 13,374 13,590 14,514
EBITDA 2,779 1,866 3,835 4,886
Depreciation & amortisation -3,554 -3,484 -3,628 -3,652
Operating profit/EBIT -776 -1,618 206 1,234
Net interest -185 -341 -939 -903
PBT -961 -1,959 -733 331
HSBC PBT 0 0 0 0
Taxation -150 -147 0 -8
Net profit -1,111 -2,106 -733 323
HSBC net profit -1,048 -2,106 -733 323
Cash flow summary (SARm)
Cash flow from operations 8,786 384 2,366 4,794
Capex -4,393 -2,718 -3,356 -3,361
Cash flow from investment -4,407 -2,725 -3,356 -3,361
Dividends -2,888 0 0 -162
Change in net debt 1,903 2,159 1,929 -361
FCF equity 4,058 -2,822 -1,929 522
Balance sheet summary (SARm)
Intangible fixed assets 10,045 9,486 8,965 8,446
Tangible fixed assets 24,073 23,793 24,041 24,269
Current assets 12,314 7,153 8,347 9,482
Cash & others 3,064 2,009 1,244 2,398
Total assets 46,456 40,450 41,372 42,215
Operating liabilities 12,997 7,437 7,928 7,816
Gross debt 16,993 18,097 19,261 20,055
Net debt 13,929 16,088 18,017 17,657
Shareholders' funds 17,351 14,914 14,181 14,343
Invested capital 30,371 30,985 32,181 31,982
Ratio, growth and per share analysis
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Y-o-y % change
Revenue -22.7 -4.4 1.6 6.8
EBITDA -62.8 -32.8 105.5 27.4
Operating profit -116.5 499.0
PBT -120.1
HSBC EPS -122.3
Ratios (%)
Revenue/IC (x) 0.4 0.4 0.4 0.5
ROIC -0.5 -3.9 2.3 5.3
ROE -5.2 -13.1 -5.0 2.3
ROA -1.7 -3.7 0.5 2.9
EBITDA margin 19.9 14.0 28.2 33.7
Operating profit margin -5.5 -12.1 1.5 8.5
EBITDA/net interest (x) 15.0 5.5 4.1 5.4
Net debt/equity 80.3 107.9 127.0 123.1
Net debt/EBITDA (x) 5.0 8.6 4.7 3.6
CF from operations/net debt 63.1 2.4 13.1 27.2
Per share data (SAR)
EPS Rep (diluted) -1.44 -2.73 -0.95 0.42
HSBC EPS (diluted) -1.36 -2.73 -0.95 0.42
DPS 2.50 0.00 0.00 0.21
Book value 22.53 19.37 18.42 18.63
Valuation data
Year to 12/2014a 12/2015e 12/2016e 12/2017e
EV/sales 2.5 2.8 2.9 2.6
EV/EBITDA 12.5 19.7 10.1 7.9
EV/IC 1.1 1.2 1.2 1.2
PE* 64.2
PB 1.2 1.4 1.5 1.4
FCF yield (%) 19.6 -13.6 -9.3 2.5
Dividend yield (%) 9.3 0.0 0.0 0.8
* Based on HSBC EPS (diluted)
Issuer information
Share price (SAR) 26.96 Free float 61%
Target price (SAR) 14.75 Sector Wireless Telecoms
Reuters (Equity) 7020.SE Country Saudi Arabia
Bloomberg (Equity) EEC AB Analyst Eric Chang
Market cap (USDm) 5,974 Contact +971 4 423 6554
Price relative
Source: HSBC
Note: Priced at close of 06 Jan 2016
12.00
32.00
52.00
72.00
92.00
12.00
32.00
52.00
72.00
92.00
2014 2015 2016 2017Etihad Etisalat(Mobily) Rel to TADAWUL ALL SHARE INDEX
39
EQUITIES TELECOM
11 January 2016
Investment case
The Qatari market remains highly attractive due to high wealth, fast population growth and
strong economic activity. The football World Cup in 2022 and Qatar National Vision 2030 are
key catalysts for the national economy. Ooredoo remains in a good position to benefit from the
future data growth. That in itself is not sufficient to mitigate headwinds.
In Algeria, Global Telecom (GLTD LI, USD 1.28, Buy, TP USD2.20) resolved its dispute
with the local government by agreeing to a fine and selling a majority stake in djezzy
(Global Telecom retains a 49% stake and operational control). As a result, djezzy is
competing on equal footing. The depreciation of the DZD compounds the problem.
Indosat has operated a net turnaround. Nevertheless, the IDR weakness dilutes its impact
on Ooredoo’s profits.
In Kuwait, Viva (a STC subsidiary) has been a market disruptor. Through aggressive
marketing, it has built a 30% market share mainly at Ooredoo’s expense.
In Myanmar, we see the long-term value of Ooredoo’s 3G strategy but are left wanting for
more. On many metrics, Ooredoo is lagging Telenor (which focused on a 2G network).
Telenor (TEL NO) has been EBITDA positive within 3 quarters of commercial launch. Its
subscribers and revenues are double that of Ooredoo.
Given that the company’s risk-reward profile remains balanced, we continue to rate Ooredoo Hold.
Company profile
Ooredoo is a mobile operator focused on MENA and South-East Asia. In the MENA region,
Ooredoo operates in Qatar, Algeria, Iraq, Kuwait, Tunisia, Oman and Palestine. In Asia,
Ooredoo is present in Indonesia, Myanmar and the Maldives. In addition, Ooredoo has
investments in Pakistan, Singapore, Laos and Cambodia.
Ooredoo KPI
2015e 2016e 2017e 2018e
Qatar mobile ARPU (QAR) 128.9 129.2 131.0 132.9 Revenue growth -2.7% 3.6% 5.4% 4.8% EBITDA margin 41.2% 40.8% 40.1% 39.7%
Source: HSBC
Ooredoo (ORDS QD)
Qatar remains an attractive and profitable market
International operations face significant headwinds. Execution risks
warrant a cautious approach
We maintain our Hold rating but cut our TP to QAR74 from QAR101
Very successful in Qatar and
Algeria less so in Kuwait and
Myanmar
Competition set to fight back
in Algeria
The most diversified GCC
telco but also the most
impacted by FX volatility
EQUITIES TELECOM
11 January 2016
40
Ooredoo Group (ORDS QD) is the holding company for the Qatari operations as well as listed
entities in Kuwait, Oman, Indonesia and Iraq.
In Qatar, Ooredoo offers mobile and fixed services. Its monopoly ended when Vodafone
Qatar started operations in 2009. Currently, we estimate Ooredoo’s market share at c68%.
The entry of Vodafone Qatar resulted in strong pricing competition and a sharp ARPU
decline. Mobile broadband provides an attractive opportunity. We expect data usage to
continue increasing at a high rate. Smartphone penetration is high in Qatar so 4G services
will gain traction. In the fixed line segment, Ooredoo has a dominant position although
Vodafone Qatar is gradually investing in fiber.
Ooredoo Kuwait (OOREDOO KK, KWD 1.06, Not Rated). Ooredoo acquired a controlling
stake in 2007 and increased its ownership to 92.1% in 2012. This entity includes its
namesake operation as well as mobile subsidiaries in Algeria, Tunisia, Palestine and
Maldives. The unit remains listed on the Kuwaiti exchange despite its limited free-float.
Ooredoo Oman (ORDS OM, OMR 0.708, Not Rated) is a mobile operator focused on Oman
and is listed on the Muscat Securities Exchange in 2011. The group owns a 55% stake.
Indosat (ISAT IJ, IDR5,375, Hold, TP IDR4,500). Ooredoo initiated its investment in the
Indonesian mobile operator in 2008. In the following year, Ooredoo obtained control by
increasing its stake to 65%.
Asiacell (TASC IQ, IQD 7.10, Not Rated). Ooredoo own 64% of the Iraqi mobile operator. It
is second to Zain in this market. 3G services were launched earlier this year.
Estimate changes
We have reduced our revenue estimates due to headwinds in key international markets.
Currency fluctuations have been a major driver of lacklustre results in the last quarters.
Indonesia, Algeria and Tunisia, particularly, have been severely hit by FX fluctuations. Their
results were weaker in QAR (relative to the local currency). Moreover, Iraq is affected by the
lack of security, implementation of VAT and pricing competition among the operators. Tunisia is
also facing challenging macro environment.
The group has maintained good cost discipline. EBITDA margins improved by 300bp y-o-y in
Q3 as profitability in Qatar, Indonesia, Kuwait, Algeria and Myanmar improved. Reflecting on
margins improvement, we have raised our margins expectations. We have also adjusted our
depreciation estimates upwards as it continues its investment cycle. Overall, we have lifted our
net profit expectations by 20% on average over the 2015-17e period.
Ooredoo: change in estimates
___________ New ___________ ___________Old ____________ ________ Change __________ QARm 2015e 2016e 2017e 2015e 2016e 2017e 2015e 2016e 2017e
Revenue 32,321 33,487 35,289 32,781 34,275 35,913 -1.4% -2.3% -1.7% EBITDA 13,319 13,646 14,142 12,515 13,190 13,927 6.4% 3.5% 1.5% EBITDA margin 41.1% 40.8% 40.1% 38.2% 38.5% 38.8% 3.0% 2.3% 1.3% Net profit 2,145 2,400 2,621 1,834 1,871 2,206 17.0% 28.3% 18.8%
Source: HSBC estimates
Valuation and risks
Because of its many operations across different geographies and a greater proportion of
minorities in its portfolio, we move to value Ooredoo on a multiples-driven sum-of-the-parts
basis, in line with Etisalat, rather than using a 50:50 mix of DCF and multiples-based sum-of-
the-parts as we did previously.
Earning extremely volatile
due to FX
41
EQUITIES TELECOM
11 January 2016
Ooredoo is a conglomerate with assets spanning the MENA region and extending to South-East
Asia. Some of the more significant operations (in terms of profitability and value) are listed in
their respective countries’ exchange (Ooredoo Kuwait, Ooredoo Oman, Indosat, Asiacell). We
highlight that Ooredoo Group has varying degrees of ownership in this assets. A DCF at group-
level would not fully capture the minority leakage.
In our sum-of-the-parts, we have revised the valuations we ascribe to each asset. We make the
following assumptions:
We believe Ooredoo’s market leadership, profitability and cash generation in Qatar
warrants a valuation of 6x 2016e EBITDA.
We assign a lower 2016e EV/EBITDA multiple in Algeria, Kuwait, Oman, Palestine and Tunisia
given that Ooredoo is not the dominant operator in these markets. We value Oman and Kuwait
on a 4.5x 2016e EBITDA while Algeria and Tunisia are valued on 4x 2016e EBITDA.
For Ooredoo’s operations in Iraq, Burma and the Maldives we assign a multiple of 3x 2016e
EBITDA. This low multiple reflects: geopolitical instability in Iraq; Greenfield operations in
Burma and limited growth prospects in Maldives.
We bring in Indosat (ISAT IJ, IDR5,300, Hold) at HSBC’s target price of IDR4,500. This is
based on a DCF using a COE of 12.7% (a risk-free rate of 8.3%, a 5.0% risk premium and a
beta of 0.88) and a terminal growth rate of 3%. Upside risk could come if interconnect rate
cuts in 2016 provide an avenue to take revenue market share from market leader
Telkomsel (Not Listed) while downside risk could ensue from irrational industry competition
stemming from the move to take share.
Due to lower estimates in Oman, Iraq, Algeria and Tunisia, and changes to our valuation
methodology, the valuations of operations in these four regions are significantly lower.
Consequently we have reduced our target price from QAR101 to QAR74. This implies 2%
downside and we rate the stock Hold.
Ooredoo SOTP
QARm EBITDA EV % EV % Method 2016e /EBITDA stake of EV
Qatar 4,357.0 6.0x 100.0% 26,141.8 54.5% Multiple Oman 1,394.4 4.5x 55.0% 3,451.0 7.2% Multiple Iraq 1,791.2 3.0x 64.1% 3,444.4 7.2% Multiple Indosat 3,283.6 65.0% 4,160.2 8.7% Target price Burma 88.9 3.0x 100.0% 266.7 0.6% Multiple Kuwait 623.0 4.5x 92.1% 2,582.0 5.4% Multiple Algeria 1,563.0 4.0x 73.7% 4,606.5 9.6% Multiple Tunisia 804.2 4.0x 84.1% 2,705.2 5.6% Multiple Maldives 131.0 3.0x 92.1% 362.0 0.8% Multiple Subsidiaries 47, 719.9 Palestine 64.2 4.0x 44.6% 114.6 0.2% Multiple Associates 114.6 EV 47,834.5 Debt 30,420.8 Cash -4,702.2 Adjustment for minority's share in debt -1,514 Net debt 24,205 Equity value 23,629.9 Issued shares (m) 320.3 FV (QAR) 74.0 Current share price (6 Jan 2016) 75.8 Upside/downside -2.4%
Source: HSBC estimates
EQUITIES TELECOM
11 January 2016
42
Risks
Key upside risks include
Favourable FX movements. Algeria, Tunisia, Iraq, Indonesia represent 56% of 2015e revenues
Maintaining market share in Qatar especially in (the high-value) post-paid segment
Positive geopolitical developments particularly in Iraq and Tunisia
Key downside risks include
Security worsening in Iraq and Tunisia
Further negative FX movements
Governments looking to telecom companies for increased income contribution through
higher royalties, taxes and spectrum charges
Unanticipated changes to the competitive landscape. In Qatar, the government the Qatari
the Qatari government could emulate Kuwait — a country of similar size — and invite bids
for a 3rd mobile license. We not that this scenario has not been publicly discussed and the
likelihood is remote.
Political risk in Iraq and
currencies risk in Algeria,
Tunisia, Indonesia
43
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Ooredoo in a nutshell
Government support is unequivocal The most diversified operator in the GCC (2015e
revenue split) Leverage is sustainable (QARm)
Source: Thomson Reuters Source: HSBC estimates Source: HSBC estimates
FCF would support higher dividends But Ooredoo remains committed to investing for the long-term
Source: HSBC estimates Source: HSBC estimates
64%
36%State of Qatar
Free-float
24%
22%
15%
15%
19%
5%
Qatar
Indonesia
Iraq
Other GCC
North Africa
Other 0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
0
5,000
10,000
15,000
20,000
25,000
30,000
2013 2014 2015e 2016e 2017e 2018e
Net debt (cash) Net debt/EBITDA
0%
5%
10%
15%
20%
25%
2013 2014 2015e 2016e 2017e 2018eFCF Dividend
0%
5%
10%
15%
20%
25%
30%
2013 2014 2015e 2016e 2017e 2018e
ROIC CapEx / Revenues
EQUITIES TELECOM
11 January 2016
44
Financials & valuation: Ooredoo Hold Financial statements
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Profit & loss summary (QARm)
Revenue 33,207 32,321 33,487 35,289
EBITDA 12,859 13,319 13,646 14,142
Depreciation & amortisation -7,626 -7,902 -8,007 -8,041
Operating profit/EBIT 5,232 5,417 5,639 6,101
Net interest -2,032 -2,027 -1,976 -2,035
PBT 3,520 3,233 3,694 4,098
HSBC PBT 3,379 3,429 3,694 4,098
Taxation -992 -695 -794 -881
Net profit 2,134 2,145 2,400 2,621
HSBC net profit 1,993 2,340 2,400 2,621
Cash flow summary (QARm)
Cash flow from operations 11,181 10,071 10,978 11,297
Capex -8,391 -7,253 -6,936 -6,959
Cash flow from investment -9,594 -8,721 -8,124 -6,959
Dividends -1,946 -2,281 -2,281 -2,361
Change in net debt 352 931 -572 -1,976
FCF equity 1,578 3,301 3,943 4,251
Balance sheet summary (QARm)
Intangible fixed assets 33,691 34,610 35,106 35,592
Tangible fixed assets 33,691 34,610 35,106 35,592
Current assets 25,687 15,794 12,986 15,178
Cash & others 17,437 7,650 4,702 6,678
Total assets 98,166 90,141 88,357 91,554
Operating liabilities 19,483 18,038 17,360 16,728
Gross debt 42,797 33,941 30,421 30,421
Net debt 25,359 26,291 25,719 23,742
Shareholders' funds 23,488 24,352 25,391 26,571
Invested capital 56,148 59,326 61,136 62,956
Ratio, growth and per share analysis
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Y-o-y % change
Revenue -1.9 -2.7 3.6 5.4
EBITDA -11.6 3.6 2.5 3.6
Operating profit -23.9 3.5 4.1 8.2
PBT -16.8 -8.1 14.3 10.9
HSBC EPS -38.8 17.4 2.6 9.2
Ratios (%)
Revenue/IC (x) 0.6 0.6 0.6 0.6
ROIC 8.5 9.6 9.4 9.7
ROE 8.2 9.8 9.7 10.1
ROA 4.3 4.7 5.1 5.4
EBITDA margin 38.7 41.2 40.8 40.1
Operating profit margin 15.8 16.8 16.8 17.3
EBITDA/net interest (x) 6.3 6.6 6.9 6.9
Net debt/equity 83.2 82.9 77.3 67.8
Net debt/EBITDA (x) 2.0 2.0 1.9 1.7
CF from operations/net debt 44.1 38.3 42.7 47.6
Per share data (QAR)
EPS Rep (diluted) 6.66 6.70 7.49 8.18
HSBC EPS (diluted) 6.22 7.31 7.49 8.18
DPS 4.00 4.00 4.25 4.50
Book value 73.33 76.02 79.27 82.95
Valuation data
Year to 12/2014a 12/2015e 12/2016e 12/2017e
EV/sales 1.8 1.9 1.8 1.7
EV/EBITDA 4.7 4.6 4.4 4.1
EV/IC 1.1 1.0 1.0 0.9
PE* 12.2 10.4 10.1 9.3
PB 1.0 1.0 1.0 0.9
FCF yield (%) 4.5 9.5 11.3 12.2
Dividend yield (%) 5.3 5.3 5.6 5.9
* Based on HSBC EPS (diluted)
Issuer information
Share price (QAR) 75.80 Free float 36%
Target price (QAR) 74.00 Sector Wireless Telecoms
Reuters (Equity) ORDS.QA Country Qatar
Bloomberg (Equity) ORDS QD Analyst Eric Chang
Market cap (USDm) 6,667 Contact +971 4 423 6554
Price relative
Source: HSBC
Note: Priced at close of 06 Jan 2016
47.00
67.00
87.00
107.00
127.00
147.00
167.00
47.00
67.00
87.00
107.00
127.00
147.00
167.00
2014 2015 2016 2017Ooredoo Rel to DSM 20 INDEX
45
EQUITIES TELECOM
11 January 2016
Investment case
In Saudi Arabia, mobile broadband has been the driver of growth. The significant increase in
data usage force operators to invest in network capacity as well as find ways to ease the burden
on mobile networks (e.g. offloading mobile data to Wi-Fi). We believe: i) operators will require
additional spectrum and ii) a strong fixed line network would complement the mobile network by
easing the capacity burden and improving quality of service.
STC’s leadership in Saudi Arabia constitutes, in our view, a key competitive advantage. It has
the greater share of post-paid mobile customers (i.e. the high-value segment) and a near
monopoly on fixed line services. As such, the incumbent remains a net beneficiary of data
growth. Market leadership is sustaining its high profitability and strong free cash flow
generation. We note that STC’s unleveraged balance sheet (SAR20.2bn net cash position as at
Q3 2015) gives it the means to invest in network capacity and spectrum indiscriminately. Its
cash pile can be put to use for acquisitions or dividend increase. We think there is scope for
STC to pay dividends in excess of our current estimates. In November, the company announced
a dividend policy which commits to a minimum quarterly dividend of SAR1 per share. Our
revised target price is SAR81.5 and implies 22% upside. We rate the stock Buy.
Company profile
Saudi Telecom Company (STC) is the incumbent telecom operator in Saudi Arabia where it
remains the only integrated telecom company. Liberalisation of the Saudi telecoms market
operated in stages. In 2004, the CITC awarded the second mobile license to Mobily. The fixed-
line market was liberalised in 2007 with the award of three new fixed-line licences.
Despite the competitive pressure from market liberalisation, STC was late in seeking international
diversification. STC deployed capital by acquiring minority stakes to mixed results. Currently, the
company is limiting its expansion ambitions to the Middle East. Its subsidiaries in Kuwait and
Bahrain have performed remarkably well despite being the third entrant in small markets.
Saudi Telecom Company
(STC AB)
Dominant player in the Saudi mobile and fixed market with an
increasing advantage on capacity and network…
Generates strong cash-flows and increases the potential for
dividend hikes
We increase our target price to SAR81.5 from SAR77 and rate the
stock Buy
Well positioned in both
mobile and fixed with an
increasing advantage on
capacity and network
Strong cash flow and dividend
Leading integrated operator
in KSA
EQUITIES TELECOM
11 January 2016
46
The rationalisation of STC’s international operations has resulted in a positive impact on both its
financials and investor sentiment. In terms of revenue contribution, Saudi Arabia represent 90%
of group while Kuwait and Bahrain contribute the balance. Domestic operations remain the key
driver as the size of the Kuwaiti and Bahraini markets limits the upside potential.
STC KPIs
2015e 2016e 2017e 2018e
Saudi mobile ARPU (SAR) 87.7 91.4 94.1 96.2 Revenue growth 7.6% 4.7% 1.4% 3.0% EBITDA margin 39.5% 38.2% 38.2% 37.8%
Source: HSBC
Estimate changes
We have increased our revenue estimates as we factor in: i) greater mobile subscriber market
share to reflect STC’s recent gains and ii) higher ARPU resulting from increased data usage.
This is slightly offset by lower margins as we foresee cost pressures mainly related to marketing
and promotions as a consequence of increased competition in the mobile segment. The 40%
decrease in termination rate announced in February 2015 has levelled the playing field for Zain
KSA. Moreover, macro-economic weakness resulting from low oil prices could negatively impact
the performance of the company.
In November, the company announced a dividend policy which commits to a minimum quarterly
dividend of SAR1 per share. We factor in a gradual improvement in STC’s dividend pay-out. We
expect a SAR4 dividend for 2015e and then forecast a SAR0.25 yearly increase. Given the
strong cash generation and solid balance sheet (SAR20.2bn net cash position as at Q3 2015),
we think there is scope for STC to pay dividends in excess of our current estimates.
STC: change in estimates
___________ New ___________ ___________Old ____________ ________ Change __________ SAR m 2015e 2016e 2017e 2015e 2016e 2017e 2015e 2016e 2017e
Revenues 49,616 51,959 52,670 46,240 48,051 49,835 7.3% 8.1% 5.7% EBITDA 19,606 19,854 20,127 19,421 20,181 20,931 1.0% -1.6% -3.8% Margin 39.5% 38.2% 38.2% 42.0% 42.0% 42.0% -2.5% -3.8% -3.8% Net profit (reported) 10,020 11,579 11,724 11,441 12,140 12,809 -12.4% -4.6% -8.5%
Source: HSBC estimates
Valuation and risks
STC is essentially a Saudi pure-play with some peripheral international operations (mobile
operators Viva Kuwait and Viva Bahrain). Saudi Arabia represents nearly 90% of 2015e group
revenues and 85% of 2015e EBITDA.
We value STC on the average of a sum-of-parts and DCF valuation. We have lifted our fair
value target price to SAR81.50 (SAR77 earlier) mainly due to a lower WACC. On either method,
Saudi Arabia is the clear value-driver.
Summary valuation
Fair Weighted SAR/share Weight value TP
DCF 50% 91.58 45.79 SOTP 50% 71.56 35.78 Target Price 81.57
Source: HSBC estimates
A large incumbent which can
benefit from further
restructuring
Saudi Arabia is the clear
driver of the valuation
47
EQUITIES TELECOM
11 January 2016
We base the DCF on a WACC of 7.5% (vs 9.7%) and a 2% long-term growth rate. We make the
following assumptions for the WACC calculation:
Risk-free rate of 3.5%
A lower 4.5% equity-risk premium (8% previously) to reflect our Strategy Team’s current
view on Saudi Arabia.
A target debt-to-asset ratio of 30% (28% previously)
In our sum-of-the-parts, we have revised the valuations we ascribe to each asset. We make the
following assumptions:
We believe STC’s market leadership, profitability and cash generation in Saudi Arabia
warrants a multiple of 6x 2016e EBITDA,
We think a 4x 2016e EV/EBITDA multiple for Viva Bahrain is reasonable given that STC is
the 3rd
entrant in a small market.
We bring in Turk Telecom (TTKOM IT, TRY5.30, Hold, TP TRY5.60) at HSBC’s target price
of TRY5.60. This is based on a DCF using a COE of 15% (a risk-free rate of 9.5%, a 5.5%
risk premium and a beta of 1) and a terminal growth rate of 3%. Downside risks include:
increased competition, a more aggressive-than-expected decline in data pricing, a
sustained weakening economic outlook. Upside risks include: faster-than-expected margin
improvement, TRY appreciation relative to USD.
We value Maxis (MAXIS MK, MYR6.67, Reduce) at HSBC’s target price of MYR5.40. This
is based on a dividend-discount model using a COE of 6.8% (a risk-free rate of 4%, a 3.5%
risk premium and a beta of 0.8) and a terminal growth rate of 1%. Key upside risks include
better-than-expected recovery in the wireless market share coupled with stronger pricing
power, higher-than expected margins, lower-than-expected capex and a higher-than-
expected pay-out.
We bring in Viva Kuwait at our target price (see company section on Viva Kuwait). This is
based on a DCF using a risk-free rate of 3.5%, 4.5% equity risk premium and beta of 1. We
use a terminal growth rate of 2.5% and long-term EBITDA margin of 37%. STC: SOTP
EBITDA EV % EV % Method SARm 2016e /EBITDA stake of EV
Saudi Arabia 17,747.7 6.0x 100.0% 106,486.1 88.2% Multiple Viva Kuwait 2,125.2 2.2x 26.0% 1,237.0 1.0% Target price Viva Bahrain 602.6 4.0x 100.0% 2,410.6 2.0% Multiple Subsidiaries 110,133.7 Turk Telecom 19.3% 4,784.2 4.0% Target price Maxis 16.2% 5,751.4 4.8% Target price Associates 10,535.6 EV 120,669.2 Debt 6,634.5 Cash -28,924.5 Adjustment for minority's share in debt
-167
Net debt -22,457 Equity value 143,126.0 Issued shares (m) 2,000.0 FV (SAR) 71.56
Source: HSBC estimates
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48
Risks
Key downside risks include
An extended period of low oil prices would have deeper impacts on the Saudi economy and
telecom spending
Higher competition in the mobile segment (from Zain KSA and MVNOs) and in the ICT
segment (Mobily)
A further cut in termination rates in Saudi Arabia would impact revenues and margins as
STC is the leading operator in the country.
Given its net significant net cash position, STC may indulge in dilutive M&A activity. We believe
the possibility is lower as the company seemed to have learnt from its past experience.
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STC in a nutshell
STC is a government-owned entity Revenue split (2015e) We forecast growth rates to normalize
Source: Thomson Reuters Source: HSBC estimates Source: HSBC estimates
… and margins to taper off (SARm) While cash keeps piling up… (SARm) Sustained by strong returns
Source: HSBC estimates Source: HSBC estimates Source: HSBC estimates
70%
14%
16%
PIF
GRE
Free-float
89%
7% 4%
KSA Kuwait Other
0%
5%
10%
15%
2013 2014 2015e 2016e 2017e 2018e
Revenue
EBITDA
36%
37%
38%
39%
40%
41%
42%
17,000
18,000
19,000
20,000
21,000
2013 2014 2015e 2016e 2017e 2018e
EBITDA Margin
-2.0x
-1.5x
-1.0x
-0.5x
0.0x
-30,000
-25,000
-20,000
-15,000
-10,000
-5,000
0
2013 2014 2015e 2016e 2017e 2018e
Net debt (cash) Net debt/EBITDA
0%
5%
10%
15%
20%
25%
30%
2013 2014 2015e 2016e 2017e 2018e
ROIC CapEx / Revenues
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Financials & valuation: Saudi Telecom Company Buy Financial statements
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Profit & loss summary (SARm)
Revenue 46,108 49,616 51,959 52,670
EBITDA 18,980 19,606 19,854 20,127
Depreciation & amortisation -7,429 -7,332 -7,132 -7,091
Operating profit/EBIT 11,551 12,274 12,722 13,035
Net interest 93 192 160 -32
PBT 12,221 11,087 12,900 12,804
HSBC PBT 11,010 11,385 12,231 12,140
Taxation -776 -575 -669 -664
Net profit 11,008 10,020 11,579 11,724
HSBC net profit 10,573 10,893 11,579 11,724
Cash flow summary (SARm)
Cash flow from operations 18,546 20,548 17,775 20,189
Capex -6,711 -8,440 -6,800 -7,195
Cash flow from investment -9,212 -14,813 -6,800 -7,195
Dividends -6,500 -8,000 -8,000 -9,250
Change in net debt -3,245 2,371 -2,590 -3,377
FCF equity 11,153 11,724 10,466 12,298
Balance sheet summary (SARm)
Intangible fixed assets 4,448 4,647 3,891 3,300
Tangible fixed assets 38,298 38,973 39,398 40,093
Current assets 38,238 40,914 42,037 45,332
Cash & others 5,467 1,332 2,522 4,499
Total assets 90,573 92,111 92,920 96,119
Operating liabilities 19,388 21,702 19,681 21,140
Gross debt 9,799 8,034 6,634 5,234
Net debt 4,332 6,703 4,113 735
Shareholders' funds 60,471 60,964 64,543 67,267
Invested capital 56,129 61,501 63,123 63,086
Ratio, growth and per share analysis
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Y-o-y % change
Revenue 1.1 7.6 4.7 1.4
EBITDA 2.8 3.3 1.3 1.4
Operating profit 5.1 6.3 3.7 2.5
PBT 17.0 -9.3 16.3 -0.7
HSBC EPS -0.7 3.0 6.3 1.3
Ratios (%)
Revenue/IC (x) 0.9 0.8 0.8 0.8
ROIC 22.7 21.5 20.5 20.5
ROE 18.1 17.9 18.5 17.8
ROA 13.0 11.7 13.4 12.9
EBITDA margin 41.2 39.5 38.2 38.2
Operating profit margin 25.1 24.7 24.5 24.7
EBITDA/net interest (x) 638.1
Net debt/equity 7.1 10.7 6.2 1.1
Net debt/EBITDA (x) 0.2 0.3 0.2 0.0
CF from operations/net debt 428.1 306.5 432.2 2745.2
Per share data (SAR)
EPS Rep (diluted) 5.50 5.01 5.79 5.86
HSBC EPS (diluted) 5.29 5.45 5.79 5.86
DPS 3.50 4.00 4.25 4.50
Book value 30.24 30.48 32.27 33.63
Valuation data
Year to 12/2014a 12/2015e 12/2016e 12/2017e
EV/sales 2.8 2.7 2.5 2.4
EV/EBITDA 6.7 6.7 6.5 6.3
EV/IC 2.3 2.2 2.1 2.0
PE* 12.6 12.2 11.5 11.4
PB 2.2 2.2 2.1 2.0
FCF yield (%) 9.0 9.3 8.3 9.8
Dividend yield (%) 5.3 6.0 6.4 6.8
* Based on HSBC EPS (diluted)
Issuer information
Share price (SAR) 66.57 Free float 16%
Target price (SAR) 81.50 Sector Diversified Telecoms
Reuters (Equity) 7010.SE Country Saudi Arabia
Bloomberg (Equity) STC AB Analyst Eric Chang
Market cap (USDm) 35,467 Contact +971 4 423 6554
Price relative
Source: HSBC
Note: Priced at close of 06 Jan 2016
51.00
56.00
61.00
66.00
71.00
76.00
81.00
86.00
91.00
51.00
56.00
61.00
66.00
71.00
76.00
81.00
86.00
91.00
2014 2015 2016 2017Saudi Telecom Company Rel to TADAWUL ALL SHARE INDEX
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Investment case
On 18 November, STC submitted a proposal to the Kuwaiti regulator to acquire the remaining
74% of Viva Kuwait it doesn’t own without disclosing a price. Viva’s share price is up 7.6% since
the announcement, but this includes a 10% fall since 14 December (see next). The Capital
Market Authority recently gave its approval (subject to undisclosed conditions). On Monday
14 December, STC disclosed it will offer KWD1/share to buy-out minority investors and as we
mentioned above, the stock has come down 10% since then which suggests the market may
have been disappointed with the level of the offer.
We highlight that, in Kuwait like in the rest of the Gulf, there is no regulatory framework that
cover minority investors’ rights or take-overs. As such, STC is under no obligation to increase its
offer. For reference, we point out that the 2008 IPO was priced at KWD0.105/share.
Shareholders who bought the IPO would have seen a 10-fold return on their investment.
We initiate with a Reduce rating on Viva as we do not see further upside in the stock. After 31%
revenue growth in 2014, we expect growth rates to decelerate (+14% in 2015e, + 6% in 2016e).
In our forecast period (2015-18e), we model 5.5% revenue CAGR and EBITDA CAGR of 6.8%.
Strong subscriber growth momentum led to sharp increases in revenues (+31% y-o-y in 2014)
and EBITDA margins (a 11ppt improvement). However, if we adjust 2014 EBITDA for subscriber
acquisition costs, margins would actually be in the region of around 26% instead of 47%.
Viva: adjusted P&L
KWDm 2013 2014 2015e 2016e 2017e
Revenues 182.4 239.0 272.4 289.6 297.0 Subscriber acquisition costs -48.7 -51.0 -66.2 -51.6 -49.6 % revenues 26.7% 21.3% 24.3% 17.8% 16.7% EBITDA (reported) 65.6 112.6 125.2 155.9 152.4 margin 36.0% 47.1% 46.0% 53.8% 51.3% EBITDA (adjusted) 16.9 61.6 59.1 104.3 102.8 margin 9.3% 25.8% 21.7% 36.0% 34.6%
Source: Company data, HSBC estimates
Viva Kuwait (VIVA KW)
After the initial high growth phase, subscriber and ARPU growth
should slow down as the market matures
Regulatory framework in Kuwait limits the likelihood of STC
increasing its bid for Viva minorities beyond KWD1/share
Valuation looks rich; we initiate with a Reduce rating and a TP
of KWD0.77
Viva is likely to suffer from
Ooredoo more aggressive
offer and therefore lower
growth outlook
EQUITIES TELECOM
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Company profile
In 2007, the government of Kuwait established the Kuwait Telecommunications Company to
launch the 3rd
mobile operator in the country. STC bid and won a 26% stake in this operator for
KWD 248.7m (USD931.4m). Commercial operations were launched in Q4 2008 under the brand
name ‘Viva’.
As the latest entrant, Viva disrupted the Zain/Ooredoo duopoly in Kuwait and initiated a phase
of heightened market competition. In a very short period of time, Viva has carved itself nearly
one-third of the mobile subscriber market.
Viva has carved itself nearly one-third of the mobile
subscriber market
Mobile subscriber shares in Kuwait
Source: Company data
Viva was officially listed on the Kuwait Stock Exchange in in late 2014. The IPO process was
initiated in 2008, raising KWD25m (USD93m) for a 50% stake. On 18 November, STC
submitted a voluntary tender offer to Kuwait’s Capital Markets Authority (the regulator) for an
approval to buy-out the 74% it did not own in Viva. On 13 December, the regulator gave its
approval subject to unspecified conditions. The following day, STC announced it will bid
KWD1/share for minorities. We note that the government is currently a 24% shareholder in Viva
and has not indicated whether it plans to maintain this stake or reduce it.
The Kuwaiti market is very attractive for mobile operators: a fixed network run as a monopoly by
the Ministry of Communication; high income levels and relative ease of network deployment
given the country’s size.
As a duopoly, Zain and Ooredoo enjoyed high levels of ARPU (Zain had ARPU of around KWD20 in
2007). This in turn allowed the accelerated introduction of 3G and 4G services. Given the favourable
mobile market dynamics, Kuwait now boasts one of the highest 4G penetrations in the world.
Since its commercial operations in 2008, Viva quickly gained subscriber market share from the
two other operators. The STC’s subsidiary overtook Ooredoo as the second largest player in
2013. Competition has been fierce and is reflected through ARPUs. Zain’s ARPU fall from around
KWD20 in 2007 to around KWD11 in 2014. But Viva has actually seen its ARPU levels
increasing and as a result its revenues outpaced its subscriber growth in 2014 and in 2015 YTD.
0%
10%
20%
30%
40%
50%
60%
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
Jun-10
Sep-10
Dec-10
Mar-11
Jun-11
Sep-11
Dec-11
Mar-12
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
Jun-15
Sep-15
Zain Ooredoo Viva
A rare example of a
successful late entrant
53
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11 January 2016
Valuation and risks
The stock currently trades at 3.3x 2016e EV/EBITDA (reported) and 5x EBITDA adjusted which
compares to an EEMEA average of 5.8x. The difference between the adjusted and reported
multiple is due to Viva’s accounting treatment of subscriber acquisition costs. The company
capitalises the cost and then amortise it over the subscriber’s contract tenor. In the table below,
we calculate an adjusted EBITDA and net profit by expensing these costs.
Headline valuation
(period-ending) 2016e 2017e 2018e
EV/EBITDA (reported) 3.3 3.0 2.8 EV/EBITDA adj. 5.0 4.6 4.2
Source: HSBC
Viva remains a start-up company. As such a multiples-based valuation would be punitive. We
opt instead for a DCF valuation which will capture its long-term potential. Our target price of
KWD 0.770 is based on a WACC of 7.5%. We have calculated Viva’s cost of capital using
HSBC’s GEM strategy’s following parameters: risk-free rate of 3.5%; 4.5% market risk premium.
Given its short trading history (listing in December 2014), we use a beta of 1. We use a 2.5%
terminal growth rate and a long-term EBITDA margin of 37%.
Our target price is KWD0.77 and implies 22% downside. We initiate with a Reduce rating.
Risks
Key upside risks include
Further market share gains particularly on the lucrative post-paid segment
ARPU improvement could yield better-than-expected margin increase
STC increasing its bid beyond KWD1/share
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Viva in a nutshell
STC-backed Viva’s… Exponential growth is normalizing rapidly Profitability normalizing (KWDm)
Source: Bloomberg Source: HSBC estimates Source: HSBC estimates
and forecast cash generation starting in 2015 Which helps with deleveraging Normalizing CapEx will not translate into higher returns
Source: HSBC estimates Source: HSBC estimates Source: HSBC estimates
26%
6%
18%
50%
STC KIA Other gov't entities Free-float-50%
0%
50%
100%
150%
200%
2013 2014 2015e 2016e 2017e 2018e
Revenue EBITDA
0%
10%
20%
30%
40%
50%
60%
0
50
100
150
200
2013 2014 2015e 2016e 2017e 2018e
EBITDA Margin
-15%
-10%
-5%
0%
5%
10%
15%
2013 2014 2015e 2016e 2017e 2018e
FCF Dividend
-1.0x
-0.5x
0.0x
0.5x
1.0x
-100
-50
0
50
100
2013 2014 2015e 2016e 2017e 2018e
Net debt (cash) Net debt/EBITDA
0%
20%
40%
60%
80%
2013 2014 2015e 2016e 2017e 2018e
ROIC CapEx / Revenues
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11 January 2016
Viva's P&L
(KWD m) 2013 2014 2015e 2016e 2017e 2018e
Revenues 182.4 239.0 272.4 289.6 297.0 308.0 change 32.7% 31.0% 14.0% 6.3% 2.5% 3.7% SG&A -116.8 -126.4 -147.1 -133.8 -144.6 -155.4 EBITDA 65.6 112.6 125.2 155.9 152.4 152.6 EBITDA margin 36.0% 47.1% 46.0% 53.8% 51.3% 49.5% Subscriber acquisition costs -48.7 -51.0 -66.2 -51.6 -49.6 -50.8 EBITDA adjusted 16.9 61.6 59.1 104.3 102.8 101.8 EBITDA adj. margin 9.3% 25.8% 21.7% 36.0% 34.6% 33.1% Depreciation -21.3 -22.4 -26.8 -31.5 -36.1 -39.5 Amortisation -18.2 -45.3 -47.1 -32.0 -37.6 -43.6 EBIT 26.1 44.9 51.4 92.3 78.7 69.4 EBIT margin 14.3% 18.8% 18.9% 31.9% 26.5% 22.5% Interest income 0.0 0.0 0.1 0.1 0.0 0.1 Interest expense -1.4 -2.2 -2.8 -2.4 -0.5 -0.5 Net interest -1.4 -2.2 -2.7 -2.3 -0.4 -0.4 Exceptional items -0.2 -1.8 -0.9 0.0 0.0 0.0 PBT (reported) 24.5 40.9 47.7 90.0 78.3 69.0 PBT (clean) 24.7 42.7 48.6 90.0 78.3 69.0 Zakat -0.3 -0.5 -0.5 -0.9 -0.8 -0.7 KFAS 0.0 0.0 -0.5 -0.9 -0.9 -0.8 NLST 0.0 -0.1 -1.4 -2.3 -2.0 -1.7 Tax -0.3 -0.5 -2.4 -4.1 -3.6 -3.2 Net profit (reported) 24.3 40.4 45.3 86.0 74.7 65.9 Net profit (clean) 24.4 42.2 46.2 86.0 74.7 65.9 # shares (m) 499.4 499.4 499.4 499.4 499.4 499.4 EPS (reported) 0.05 0.08 0.09 0.17 0.15 0.13 EPS (clean) 0.05 0.08 0.09 0.17 0.15 0.13 DPS 0.00 0.00 0.00 0.00 0.00 0.00
Source: Company data, HSBC estimates
EQUITIES TELECOM
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Viva's Cash Flow Statement
(KWD m) 2013 2014 2015e 2016e 2017e 2018e
Net profit 24.3 40.4 45.3 86.0 74.7 65.9 Depreciation 21.3 22.4 26.8 31.5 36.1 39.5 Amortization 18.2 45.3 47.1 32.0 37.6 43.6 EOSB -0.7 -0.9 -0.1 0.3 0.1 0.1 Change in inventories -2.7 -0.8 -7.3 -6.3 -0.3 -1.0 Change in trade receivables -2.8 -8.6 -2.3 -5.3 0.1 -1.1 Change in other receivables 1.4 -0.2 -1.3 -4.3 -0.6 -0.7 Change in trade payables -18.4 -10.0 -4.7 1.1 0.2 0.3 Change in other payables 15.1 -16.0 11.1 -8.9 -0.9 1.0 Change in working capital -7.5 -35.7 -4.6 -23.6 -1.5 -1.5 Operating CF 55.6 71.4 114.5 126.2 147.0 147.7 Fixed assets -69.4 -17.1 -37.4 -49.2 -49.7 -51.0 Intangible assets -48.7 -51.0 -66.3 -51.6 -49.6 -50.8 CapEx -118.0 -68.1 -103.7 -100.8 -99.3 -101.8 Investing CF -118.0 -68.1 -103.7 -100.8 -99.3 -101.8 Equity issuance 0.0 0.0 0.0 0.0 0.0 0.0 Debt issuance 36.5 32.3 1.0 0.0 25.0 0.0 Debt repayment -5.8 -8.8 -13.4 -21.8 -21.8 -21.8 Dividends 0.0 0.0 0.0 0.0 0.0 0.0 Financing CF 30.7 23.5 -12.5 -21.8 3.2 -21.8 Other 28.6 -1.8 -18.4 Change in cash -3.1 25.0 -20.1 3.6 50.8 24.1
Source: Company data, HSBC estimates
Viva's Balance Sheet
(KWD m) 2013 2014 2015e 2016e 2017e 2018e
Fixed assets 119.0 113.1 123.5 141.2 154.9 166.4 License 0.1 0.1 0.1 0.1 0.1 0.1 Subscriber acquisition costs 30.4 36.2 55.7 75.2 87.2 94.4 Intangible assets 30.6 36.3 55.8 75.3 87.3 94.4 Other non-current assets 0.7 0.7 0.6 0.6 0.6 0.6 Fixed assets 150.3 150.1 179.9 217.2 242.8 261.4 Inventories 4.9 5.8 13.1 19.4 19.6 20.6 Trade receivables 12.3 20.9 23.2 28.5 28.4 29.5 Other receivables 4.8 5.0 6.3 10.6 11.2 11.9 Cash 6.7 32.3 31.1 34.7 85.5 109.6 Current assets 28.7 63.9 73.7 93.2 144.8 171.6 Total Assets 179.0 214.0 253.6 310.3 387.5 433.0 Share capital 49.9 49.9 49.9 49.9 49.9 49.9 Statutory reserves 0.0 0.0 0.0 0.0 7.5 14.1 Retained earnings -40.4 0.0 45.3 131.3 198.5 257.8 Equity 9.6 49.9 95.3 181.3 255.9 321.8 Debt 65.7 85.5 73.1 51.2 54.4 32.6 Employee EOSB 1.7 2.6 3.0 3.3 3.4 3.5 Accruals & provisions 60.0 45.8 56.8 46.1 45.3 45.5 Trade payables 21.6 11.6 6.9 8.0 8.2 8.5 Other payables 12.0 15.2 14.9 16.4 16.3 16.9 Due to related parties 8.4 3.4 3.7 4.1 4.1 4.2 Other Liabilities 103.7 78.5 85.3 77.8 77.2 78.6 Total Equity & Liabilities 179.0 214.0 253.6 310.3 387.5 433.0
Source: Company data, HSBC estimates
57
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Financials & valuation: VIVA KUWAIT Reduce Financial statements
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Profit & loss summary (KWDm)
Revenue 239 272 290 297
EBITDA 113 125 156 152
Depreciation & amortisation -68 -74 -64 -74
Operating profit/EBIT 45 51 92 79
Net interest -2 -3 -2 0
PBT 41 48 90 78
HSBC PBT 43 49 90 78
Taxation -1 -2 -4 -4
Net profit 40 45 86 75
HSBC net profit 42 46 86 75
Cash flow summary (KWDm)
Cash flow from operations 77 121 132 151
Capex -68 -104 -101 -99
Cash flow from investment -68 -104 -101 -99
Dividends 0 0 0 0
Change in net debt -6 -11 -25 -48
FCF equity 6 12 25 48
Balance sheet summary (KWDm)
Intangible fixed assets 36 56 75 87
Tangible fixed assets 113 124 141 155
Current assets 64 74 93 145
Cash & others 32 31 35 86
Total assets 214 254 310 388
Operating liabilities 78 85 78 77
Gross debt 86 73 51 54
Net debt 53 42 17 -31
Shareholders' funds 50 95 181 256
Invested capital 103 137 197 224
Ratio, growth and per share analysis
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Y-o-y % change
Revenue 31.0 14.0 6.3 2.5
EBITDA 71.6 11.3 24.4 -2.2
Operating profit 72.2 14.3 79.7 -14.7
PBT 66.7 16.8 88.6 -13.1
HSBC EPS 72.9 9.5 86.1 -13.2
Ratios (%)
Revenue/IC (x) 2.8 2.3 1.7 1.4
ROIC 45.4 25.7 41.6 30.2
ROE 141.8 63.6 62.2 34.2
ROA 21.7 20.5 31.3 21.5
EBITDA margin 47.1 46.0 53.8 51.3
Operating profit margin 18.8 18.9 31.9 26.5
EBITDA/net interest (x) 50.9 45.8 69.2 354.9
Net debt/equity 106.6 44.1 9.1 -12.2
Net debt/EBITDA (x) 0.5 0.3 0.1 -0.2
CF from operations/net debt 144.3 287.4 800.0
Per share data (KWD)
EPS Rep (diluted) 0.08 0.09 0.17 0.15
HSBC EPS (diluted) 0.08 0.09 0.17 0.15
DPS 0.00 0.00 0.00 0.00
Book value 0.10 0.19 0.36 0.51
Valuation data
Year to 12/2014a 12/2015e 12/2016e 12/2017e
EV/sales 2.3 2.0 1.8 1.6
EV/EBITDA 4.9 4.3 3.3 3.0
EV/IC 5.3 3.9 2.6 2.1
PE* 11.7 10.7 5.7 6.6
PB 9.9 5.2 2.7 1.9
FCF yield (%) 1.2 2.4 5.1 9.6
Dividend yield (%) 0.0 0.0 0.0 0.0
* Based on HSBC EPS (diluted)
Issuer information
Share price (KWD) 0.99 Free float 50%
Target price (KWD) 0.77 Sector Diversified Telecoms
Reuters (Equity) VIVA.KW Country Kuwait
Bloomberg (Equity) VIVA KK Analyst Eric Chang
Market cap (USDm) 1,623 Contact +971 4 423 6554
Price relative
Source: HSBC
Note: Priced at close of 06 Jan 2016
0.39
0.59
0.79
0.99
1.19
0.39
0.59
0.79
0.99
1.19
2014 2015 2016 2017VIVA KUWAIT Rel to KUWAIT SE PRICE INDEX
EQUITIES TELECOM
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58
Investment case
The macro-economic fundamentals of the domestic market are strong: high income levels, fast
population growth and strong economic activity related to football World Cup 2022 and Qatar
National Vision 2030. But these positives are negated by company specific factors. Vodafone Qatar
has witnessed strong pricing pressure from Ooredoo thus impacting revenue and profitability.
Vodafone Qatar remains at a competitive disadvantage relative to Ooredoo which has a robust fixed
line network. We have a Reduce rating on the stock owing to its unjustified valuation.
Company profile
In December 2007, Vodafone and the Qatar Foundation consortium won the Qatar’s second mobile
licence. Vodafone Qatar was established shortly after. During the summer of 2009, the company
concurrently launched commercial operations and a listing on the Qatar Exchange. In 2010, it won a
fixed license. The company launched commercial services for fixed broadband in 2012.
Despite market share gains, profitability and cash generation have remained below Vodafone’s
initial plans as Ooredoo defended its positions. As of Q3 2015 (calendar). Vodafone had a
market share of 32%. 4G services were launched last year. Vodafone has been re-directed its
focus on the post-paid segment, Ooredoo’s stronghold.
Estimate changes
Vodafone Qatar is impacted by the Ooredoo-initiated price competition. Since Q2 2014,
Ooredoo’s ARPU has decreased 7.3% and its market share has increased by 160bp. During
that same period, Vodafone Qatar’s ARPU has decreased by 15.3%. We assume that Vodafone
Qatar’s ARPU will be under pressure for the next three years and forecast ARPU to further
decline by 11%. We reflect that in our revenue and margins outlook. On average, we have cut
EBITDA projections by 30% for the period to FY2018e. The company should nevertheless be
able to maintain current dividend payment (QA 0.21) but without scope for an increase.
For FY2016, we have moderated our subscriber and ARPU expectations and thus reduce our
revenue forecast to QAR2.25bn. Our revenue estimates are at the lower end of company
guidance (QAR2.2-2.4bn). We have equally trimmed our EBITDA margin forecast (21.5%) to a
shade lower than management’s target of 23.5%. In our view, Vodafone Qatar needs to
Vodafone Qatar (VFQS QD)
Competition with Ooredoo is rational
Profitability is within sight but valuation looks stretched
We cut our target price to QAR9 from QAR14.5 and rate the
stock Reduce
At a competitive
disadvantage relative to
Ooredoo which has a robust
fixed line network
A late mobile entrant battling
an incumbent with
entrenched market positions
in Qatar
Profitability and ROIC below
initial plan
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increase marketing spend to challenge Ooredoo’s market leadership. We think that an
exceptional second half is unlikely to offset H1 results.
Vodafone Qatar: change in estimates
__________ New ___________ ___________Old ____________ _______ Change% _________ QARm, 31 Mar year-end 2016e 2017e 2018e 2016e 2017e 2018e 2016e 2017e 2018e
Revenue 2,246 2,437 2,710 2,569 2,936 3,276 -12.6% -17.0% -17.3% EBITDA 482 572 690 655 837 1,032 -26.4% -31.7% -33.1% % margin 21.5% 23.5% 25.5% 25.5% 28.5% 31.5% -4ppt -5ppt -6ppt Net profit -356 -261 -150 -182 10 204 nm nm nm
Source: HSBC estimates
Valuation and risks
Six years after commercial launch, Vodafone Qatar has not posted a net profit, such is the
challenge of operating a small market. Yet, markets rate the company highly. We do not think
Vodafone’s ROIC or dividend yield justify such premium. The stock looks expensive in our view,
trading at 25x FY2016e EBITDA. For comparison purposes, the GCC trades at 8.1x while the
EEMEA sector is valued at 5.8x. Valuation table
Company ____ EV/EBITDA _____ _____FCF yield _____ _____ Div. yield ______ ______ ROIC _______ 2016e 2017e 2016e 2017e 2016e 2017e 2016e 2017e
Vodafone Qatar1 24.9 21.0 -0.3% 0.6% 1.7% 1.7% 3.0% 4.4% GCC 8.1 7.1 9.2% 12.7% 4.7% 5.4% 17.8% 17.0% EE 4.1 3.8 11.2% 12.9% 3.8% 4.2% 10.9% 11.0% EEMEA average 5.8 5.2 10.0% 12.3% 4.6% 5.1% 16.2% 16.2%
Source: HSBC estimates, priced at 6 January 2016 1 Vodafone Qatar has a 31 March year-end
Given that Vodafone Qatar is in a similar development stage as Viva, we continue to value it on
a DCF. We have reduced our target price to QAR9 (from QAR14.50) mainly on the back of
lower estimates. We use a WACC of 9.4% (vs 10.5% previously) based on a 10.6% cost of
equity compared to 12% previously. The cost of equity is now based on our strategy team’s
assumption for Qatar: risk-free rate of 3.5%, equity risk premium of 5% (whereas previously we
used a conservative 8.5%) and beta of 1.4.
Our target price implies 27% downside and we rate the stock Reduce.
Risks
Key upside risks include
A resilient Qatar economy driving telecom spend
Increased market share in mobile (especially the post-paid segment) and fixed services
Better-than-expected ARPU improvement would be a fillip to revenue
Valuation still too rich in our
view
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Vodafone Qatar in a nutshell
Core shareholders provide technical and political support
Historical growth rates not sustainable Profitability remains subdued (QARm)
Source: Bloomberg Source: HSBC estimates Source: HSBC estimates
As CapEx eats into returns… … and delays deleveraging … thus limiting yields
Source: HSBC estimates Source: HSBC estimates Source: HSBC estimates
22%
23%
55%
Qatar Foundation Vodafone Free-float
-50%
0%
50%
100%
150%
2013 2014 2015e 2016e 2017e 2018e
Revenue EBITDA
0%
5%
10%
15%
20%
25%
30%
0
200
400
600
800
2013 2014 2015e 2016e 2017e 2018e
EBITDA Margin
0%
5%
10%
15%
20%
25%
2013 2014 2015e 2016e 2017e 2018e
ROIC CapEx / Revenues
0.0x
1.0x
2.0x
3.0x
4.0x
0
200
400
600
800
1,000
1,200
2013 2014 2015e 2016e 2017e 2018e
Net debt (cash) Net debt/EBITDA
-1%
0%
1%
2%
3%
2013 2014 2015e 2016e 2017e 2018eFCF Dividend
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Financials & valuation: Vodafone Qatar Reduce Financial statements
Year to 03/2015a 03/2016e 03/2017e 03/2018e
Profit & loss summary (QARm)
Revenue 2,307 2,246 2,437 2,710
EBITDA 567 482 572 690
Depreciation & amortisation -752 -801 -808 -813
Operating profit/EBIT -186 -319 -236 -123
Net interest -18 -19 -25 -28
PBT -216 -356 -261 -150
HSBC PBT -216 -356 -261 -150
Taxation 0 0 0 0
Net profit -216 -356 -261 -150
HSBC net profit -216 -356 -261 -150
Cash flow summary (QARm)
Cash flow from operations 637 344 449 561
Capex -404 -391 -390 -379
Cash flow from investment -404 -391 -390 -379
Dividends -178 -178 -178 -178
Change in net debt 54 117 40 -77
FCF equity 228 -29 59 181
Balance sheet summary (QARm)
Intangible fixed assets 5,709 5,187 4,666 4,145
Tangible fixed assets 1,343 1,455 1,558 1,645
Current assets 151 -73 -192 -188
Cash & others 151 -73 -192 -188
Total assets 7,444 6,803 6,287 5,885
Operating liabilities 0 0 0 0
Gross debt 1,878 1,770 1,692 1,619
Net debt 1,727 1,844 1,884 1,807
Shareholders' funds 5,566 5,033 4,595 4,267
Invested capital 7,052 6,642 6,224 5,790
Ratio, growth and per share analysis
Year to 03/2015a 03/2016e 03/2017e 03/2018e
Y-o-y % change
Revenue 16.4 -2.6 8.5 11.2
EBITDA 14.2 -14.9 18.6 20.7
Operating profit
PBT
HSBC EPS
Ratios (%)
Revenue/IC (x) 0.3 0.3 0.4 0.5
ROIC 4.6 3.0 4.4 6.6
ROE -3.8 -6.7 -5.4 -3.4
ROA -2.6 -4.7 -3.6 -2.0
EBITDA margin 24.6 21.5 23.5 25.5
Operating profit margin -8.1 -14.2 -9.7 -4.5
EBITDA/net interest (x) 30.7 25.4 23.3 25.1
Net debt/equity 31.0 36.6 41.0 42.3
Net debt/EBITDA (x) 3.0 3.8 3.3 2.6
CF from operations/net debt 36.9 18.7 23.8 31.0
Per share data (QAR)
EPS Rep (diluted) -0.26 -0.42 -0.31 -0.18
HSBC EPS (diluted) -0.26 -0.42 -0.31 -0.18
DPS 0.21 0.21 0.21 0.21
Book value 6.58 5.95 5.44 5.05
Valuation data
Year to 03/2015a 03/2016e 03/2017e 03/2018e
EV/sales 5.2 5.3 4.9 4.4
EV/EBITDA 21.0 24.9 21.0 17.3
EV/IC 1.7 1.8 1.9 2.1
PE*
PB 1.9 2.1 2.3 2.4
FCF yield (%) 2.2 -0.3 0.6 1.8
Dividend yield (%) 1.7 1.7 1.7 1.7
* Based on HSBC EPS (diluted)
Issuer information
Share price (QAR) 12.31 Free float 55%
Target price (QAR) 9.00 Sector Wireless Telecoms
Reuters (Equity) VFQS.QA Country Qatar
Bloomberg (Equity) VFQS QD Analyst Eric Chang
Market cap (USDm) 2,857 Contact +971 4 423 6554
Price relative
Source: HSBC
Note: Priced at close of 06 Jan 2016
8.90
10.90
12.90
14.90
16.90
18.90
20.90
22.90
8.90
10.90
12.90
14.90
16.90
18.90
20.90
22.90
2014 2015 2016 2017Vodafone Qatar Rel to DSM 20 INDEX
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Investment case
For the past 12 months, the stock has been volatile on the back of continued political instability
in Iraq and a protracted turnaround at Zain KSA.
In Iraq, political uncertainty creates significant headwinds and the current share price suggests the
market attributes no value to this asset. In July, Zain Iraq fulfilled its regulatory requirement by listing
on the local stock exchange. Over time, this should provide greater over the value of this unit.
In Saudi Arabia, Zain KSA’s network quality lags the competition due to previous
underinvestment. We would argue it can only compete on pricing. In the past year, Zain KSA
has been stepping up capex and the results are clear. Subscribers have been growing.
Profitability has improved. Moreover, as the smallest player, it should be a beneficiary of the
termination rates cut.
Our Buy case remains a valuation call. The current share price effectively ascribes no value to
operations outside of Kuwait and Saudi Arabia. We think this is unjustified. Zain’s high dividend
yield (11.5% in 2016e) should provide some support. We also note that the stock trades
significantly below the GCC and EEMEA sector averages. Zain currently trades on 2016e
EV/EBITDA of 2.4x when the GCC and the EEMEA are valued at 8.1x and 5.8x respectively. On
2016e PE, Zain trades at 5.8x against a GCC average of 10.0x and a EEMEA average of 10.4x.
Company profile
Established in 1983, Zain is Kuwait’s first mobile operator and has been the undisputed leader
since. Zain also operates subsidiaries in seven countries (Iraq, Bahrain, Jordan, Sudan, South
Sudan and Lebanon where it operates under a management contract on behalf of the
government). In many of these countries, Zain is the leading mobile operator with the highest-
share of post-paid subscriber as well as quality spectrum. In addition, Zain has a 15.5% stake in
Moroccan mobile operator inwi as well as a 37% stake in Zain KSA.
The Kuwaiti mobile market opened to competition in 2000 when a second mobile license was
awarded. In the following decade, Zain embarked on a frenetic path to international
diversification through acquisitions as well as Greenfield operations. 2005 was a milestone.
That year, Zain paid USD3.36bn to acquire Celtel International, a Sub-Sahara African mobile
operator with a presence in 13 countries. A mere five years later, Zain sold its African portfolio
to Bharti Airtel (BHARTI IN, INR322, Buy, TP INR450) for USD9bn.
Zain (ZAIN KK)
Political instability in and uncertainty drive headwinds
Current share price suggest only Kuwait and Saudi Arabia have
intrinsic value …
… and ascribes no value to the rest. We rate Zain Buy with a
target price of KWD0.48, from KWD0.71
Political uncertainty had
weighted down sentiment…
But should be offset by very
attractive dividend yield and
valuation
Undisputed leading mobile
operator in Kuwait with
diversified operation in MENA
Good track-record as an
asset trader with Celtel
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In its current form, Zain’s main markets are Kuwait, Iraq, and Sudan.
As a result of having three operators in a country of 4m inhabitants, Kuwait is a highly
competitive market. It is characterized by high ARPUs and a 200% penetration rate. Zain is
the market leader with 37% share although the other two operators have 30%+ market
shares. This has led to a decrease in ARPU. The company has a strong 4G network with
100% coverage.
Zain has been providing mobile services in Iraq since December 2003. It is the market
leader with a 43% share of subscriber. It mainly operates a 2G network with 98% population
coverage. 3G services were only introduced earlier this year. As a result, data usage is still
very low (its revenue contribution is in single digits).
Sudan. In February 2006, Zain acquired the remaining 61% stake in Mobitel and rebranded
its operations as Zain in September 2007. The company has a market share of 41% with
89% population coverage. Data usage is still low with data revenues representing only 9%
of total revenues. Overall ARPU is low at around USD5.
Estimate changes
Zain will continue to face headwinds in its key markets. In Kuwait, competition has intensified
since Viva’s commercial launch. In Iraq, geo-political instability and VAT add to the pressure of
high competition. Nevertheless, the company has delivered on margin improvements. EBITDA
in Q3’15 remained stable despite a 7% revenues decline (in USD terms). That implicitly
suggests a c.300bp margin improvement on a y-o-y basis.
Given the headwinds mentioned above, we have trimmed our revenue estimates by an average
of 11% for the 2015-17 period. The impact on EBITDA, however, is only about 4% on average
for 2015-17 as we forecast 200bp margins improvement thanks to cost control.
Zain: change in estimates
____________ New _____________ ____________ Old _____________ __________ Change ____________ 2015e 2016e 2017e 2015e 2016e 2017e 2015e 2016e 2017e
Revenue 1,109 1,110 1,174 1,205 1,279 1,353 -8% -13% -13% EBITDA 488 487 518 504 536 568 -3% -9% -9% Net profit 206 236 275 248 284 320 -17% -17% -17%
Source: HSBC estimates
Valuation and risks
The current price suggests that only Kuwait and Zain KSA have an intrinsic value. We deem this
harsh. As argued previously, we value companies which have a portfolio of assets on a
multiples-based sum-of-the-parts. In this report we move from a DCF-based sum-of-the-parts to
a multiples-based one to value Zain, in line with peers. Whilst a DCF provides a long-term
fundamental view, we think investors would prefer a valuation that reflects market sentiment.
For each asset, we assign a target multiple that is a function of its market positioning,
profitability and political risks.
We value Kuwaiti operations at 5x 2016e EBITDA. We believe Zain’s market leadership,
profitability and cash generation in Kuwait warrants a multiple that is higher than the one we
assign to other operations.
We assign a lower 2016e EV/EBITDA multiple (4x) in Jordan and Bahrain given that Zain is
not the dominant operator in either country.
Operations in Iraq, Sudan and South Sudan are valued at 3x 2016e EBITDA. This low
multiple reflects these countries’ geopolitical instability
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64
Zain has a management contract in Lebanon where it operates a mobile operator on behalf
of the Government.
We have reduced our target price from KWD 0.71 to KWD 0.48, a reflection of our switch from a
DCF-based valuation. We have significantly reduced the valuation of Zain’s operations in
Kuwait, Iraq and Saudi Arabia. Our revised target price implies 37% upside and we rate the
stock Buy.
Zain: sum of the parts valuation
EBITDA EV % EV % Method KWDm 2016e /EBITDA stake of EV
Kuwait 174.6 5.0x 100.0% 873.2 37.7% Multiple Iraq 125.3 3.0x 76.0% 285.7 12.3% Multiple Sudan 91.5 3.0x 100.0% 274.4 11.8% Multiple South Sudan 7.4 3.0x 100.0% 22.2 1.0% Multiple Jordan 54.0 4.0x 96.5% 208.6 9.0% Multiple Bahrain 21.6 4.0x 54.8% 47.4 2.0% Multiple Lebanon 9.9 1.0x 100.0% 9.9 0.4% Multiple Subsidiaries 1,721.4 Zain KSA 161.8 3.0x 37.0% 179.8 7.8% Multiple Associates 179.8 Other assets 417.0 18.0% EV 2,318.2 Net debt -462.5 Equity value 1,855.8 Issued shares (m) 3,901.3 FV (KDW) 0.48 Current share price (6 Jan 2016) 0.35 Upside/downside 37.1%
Source: HSBC estimates
Risks
Key downside risks include:
The main risk remains geopolitical instability in Iraq and to some extent Sudan and
South Sudan.
We would also highlight the potential for dividend cuts. Over the past quarters,
management has been guiding to a pay-out ratio (80-90%) instead of an absolute amount.
We expect a dividend of KWD0.04 in 2015 and 2016 which is equivalent to 76% of net
income. A dividend cut would put pressure on the stock and would be a downside risk.
Negative FX movements in some of its markets impacting the group’s financial performance
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Zain in a nutshell
Government is a passive investor 2015e revenue split Kuwait and Iraq have been a drag on growth
Source: Bloomberg Source: HSBC estimates Source: HSBC estimates
… and profitability Capital discipline ensures… … sustainable leverage
Source: HSBC estimates Source: HSBC estimates Source: HSBC estimates
25%
15%50%
10%
KIA Al-Khair Free-float Treasury shares
31%
33%
36%Kuwait
Iraq
Other
-10%
-5%
0%
5%
10%
2013 2014 2015e 2016e 2017e 2018e
Revenue EBITDA
40%
41%
42%
43%
44%
45%
440
460
480
500
520
540
560
580
2013 2014 2015e 2016e 2017e 2018e
EBITDA margin
0%
10%
20%
30%
40%
2013 2014 2015e 2016e 2017e 2018e
ROIC CapEx / Revenues
0.0x
0.2x
0.4x
0.6x
0.8x
1.0x
1.2x
0
100
200
300
400
500
600
2013 2014 2015e 2016e 2017e 2018e
Net debt (cash) Net debt/EBITDA
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66
Financials & valuation: Zain Group Buy Financial statements
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Profit & loss summary (KWDm)
Revenue 1,213 1,109 1,110 1,174
EBITDA 517 488 487 518
Depreciation & amortisation -172 -166 -170 -171
Operating profit/EBIT 346 321 317 347
Net interest -8 -12 -16 -11
PBT 245 258 291 336
HSBC PBT 293 284 291 336
Taxation -31 -34 -35 -40
Net profit 194 206 236 275
HSBC net profit 231 232 236 275
Cash flow summary (KWDm)
Cash flow from operations 480 451 438 472
Capex -172 -195 -176 -165
Cash flow from investment -318 -349 -176 -165
Dividends -195 -156 -156 -195
Change in net debt 88 123 -106 -107
FCF equity 307 247 260 302
Balance sheet summary (KWDm)
Intangible fixed assets 1,095 1,191 1,191 1,191
Tangible fixed assets 853 974 980 974
Current assets 721 818 924 1,040
Cash & others 344 377 483 590
Total assets 3,277 3,603 3,705 3,815
Operating liabilities 656 894 935 984
Gross debt 788 945 945 945
Net debt 445 568 462 355
Shareholders' funds 1,625 1,531 1,571 1,612
Invested capital 1,669 1,710 1,676 1,631
Ratio, growth and per share analysis
Year to 12/2014a 12/2015e 12/2016e 12/2017e
Y-o-y % change
Revenue -2.2 -8.6 0.1 5.8
EBITDA -3.8 -5.7 -0.1 6.4
Operating profit 0.7 -7.0 -1.2 9.4
PBT -9.4 5.2 13.0 15.3
HSBC EPS -0.8 0.7 1.5 16.7
Ratios (%)
Revenue/IC (x) 0.8 0.7 0.7 0.7
ROIC 18.3 16.8 16.5 18.5
ROE 14.2 14.7 15.2 17.3
ROA 7.4 7.2 7.7 8.6
EBITDA margin 42.7 44.0 43.9 44.1
Operating profit margin 28.5 29.0 28.6 29.6
EBITDA/net interest (x) 68.2 41.1 31.2 45.4
Net debt/equity 24.8 33.0 25.9 19.3
Net debt/EBITDA (x) 0.9 1.2 0.9 0.7
CF from operations/net debt 107.9 79.4 94.7 132.8
Per share data (KWD)
EPS Rep (diluted) 0.05 0.05 0.06 0.07
HSBC EPS (diluted) 0.06 0.06 0.06 0.07
DPS 0.04 0.04 0.05 0.06
Book value 0.42 0.39 0.40 0.41
Valuation data
Year to 12/2014a 12/2015e 12/2016e 12/2017e
EV/sales 0.9 1.1 1.0 0.9
EV/EBITDA 2.2 2.5 2.4 2.1
EV/IC 0.7 0.7 0.7 0.7
PE* 5.9 5.9 5.8 5.0
PB 0.8 0.9 0.9 0.8
FCF yield (%) 44.6 37.5 38.1 42.6
Dividend yield (%) 11.4 11.4 14.3 17.1
* Based on HSBC EPS (diluted)
Issuer information
Share price (KWD) 0.35 Free float 50%
Target price (KWD) 0.48 Sector Wireless Telecoms
Reuters (Equity) ZAIN.KW Country Kuwait
Bloomberg (Equity) ZAIN KK Analyst Eric Chang
Market cap (USDm) 4,972 Contact +971 4 423 6554
Price relative
Source: HSBC
Note: Priced at close of 06 Jan 2016
0.29
0.39
0.49
0.59
0.69
0.29
0.39
0.49
0.59
0.69
2014 2015 2016 2017Zain Group Rel to KUWAIT SE PRICE INDEX
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Notes
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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Eric Chang Chang and Herve Drouet
Important disclosures
Equities: Stock ratings and basis for financial analysis
HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's
existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons
when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different
securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and
therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should
carefully read the entire research report and not infer its contents from the rating because research reports contain more
complete information concerning the analysts' views and the basis for the rating.
From 23rd March 2015 HSBC has assigned ratings on the following basis:
The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12
months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will
be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a
Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is
between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more
than 20% below the current share price, the stock will be classified as a Reduce.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage,
change in target price or estimates).
Upside/Downside is the percentage difference between the target price and the share price.
Prior to this date, HSBC’s rating structure was applied on the following basis:
For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate,
regional market established by our strategy team. The target price for a stock represented the value the analyst expected the
stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as
Overweight, the potential return, which equals the percentage difference between the current share price and the target price,
including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the
succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight,
the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or
10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral.
*A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12
months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However,
stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the
past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating,
however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
69
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Rating distribution for long-term investment opportunities
As of 10 January 2016, the distribution of all ratings published is as follows:
Buy 46% (30% of these provided with Investment Banking Services)
Hold 40% (29% of these provided with Investment Banking Services)
Sell 14% (17% of these provided with Investment Banking Services)
For the purposes of the distribution above the following mapping structure is used during the transition from the previous to
current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current
model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis
for financial analysis” above.
Information regarding company share price performance and history of HSBC ratings and target prices in respect of long-term
investment opportunities for the companies that are the subject of this report is available from www.hsbcnet.com/research.
HSBC & Analyst disclosures
Disclosure checklist
Company Ticker Recent price Price Date Disclosure
ETIHAD ETISALAT (MOBILY) 7020.SE 25.73 08-Jan-2016 1, 5, 7
ETISALAT ETEL.AD 16.05 08-Jan-2016 1, 5, 7
INDOSAT ISAT.JK 5300.00 08-Jan-2016 1, 5, 6
MAXIS MXSC.KL 6.65 08-Jan-2016 6, 7
OOREDOO ORDS.QA 74.80 08-Jan-2016 5, 6, 7
SAUDI TELECOM COMPANY 7010.SE 64.68 08-Jan-2016 2, 6, 7
TURK TELEKOMUNIKASYON
AS
TTKOM.IS 5.16 08-Jan-2016 2, 5, 6, 7
Source: HSBC
1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months.
2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3
months.
3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this
company.
4 As of 31 December 2015 HSBC beneficially owned 1% or more of a class of common equity securities of this company.
5 As of 30 November 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of investment banking services.
6 As of 30 November 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of non-investment banking securities-related services.
7 As of 30 November 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of non-securities services.
8 A covering analyst/s has received compensation from this company in the past 12 months.
9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as
detailed below.
10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this
company, as detailed below.
11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in
securities in respect of this company
HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of
companies covered in HSBC Research on a principal or agency basis.
EQUITIES TELECOM
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70
Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment
banking revenues.
Whether, or in what time frame, an update of this analysis will be published is not determined in advance.
Economic sanctions imposed by the EU and OFAC prohibit transacting or dealing in new debt or equity of Russian SSI entities.
This report does not constitute advice in relation to any securities issued by Russian SSI entities on or after July 16 2014 and as
such, this report should not be construed as an inducement to transact in any sanctioned securities.
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1 This report is dated as at 11 January 2016.
2 All market data included in this report are dated as at close 06 January 2016, unless otherwise indicated in the report.
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TELECOM COMPANY
71
EQUITIES TELECOM
11 January 2016
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MICA (P) 041/01/2015
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Global
Analyst, Global Sector Head Stephen Howard +44 20 7991 6820 [email protected]
Europe
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Global Telecoms, Media & Technology Research Team