sfc telecom ar

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

Saudi ArabiaTelecom Telecom | Equity Research | 12 February 2013

Mobily played out; STC unfolding

We initiate coverage on the Saudi telecom sector with an optimistic outlook. The Kingdoms

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

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

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

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

investments. We find STCs valuation most attractive, therisk perception around the shares to

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

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

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

current levels.

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

domestic market initiative backed by an upgraded fixed broadband infrastructure

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

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

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

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

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

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

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

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

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

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

Broadband services is the main driver to revenue growth, with segment penetration(as a % of household) forecast to reach 60% in 2017 compared to an estimated 45%

in 2012. Favorable demography (high percentage of a techsavvy, young population,

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

increasing smartphone adoption in the Kingdom coupled with a potentially large

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

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

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

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

developed markets.

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

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

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

broadband and pricing power while international market growth prospects convert intoEBITDA contribution. Leadership position in mobile broadband space, management

track record and superior ROEs are positives for Mobily. We expect EBITDA margins

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

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

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

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

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

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

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

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

that the attractive growth prospects of STCs international operations, including Kuwait

(top line up ~127% during 20112012) and Bahrain (up ~170% over the same period),

have been overshadowed. Nevertheless, with an estimated ~77% of EBITDA comingfrom Saudi Arabia, the 33% discount on EV/EBITDA 2013 on STC relative to Mobily is,

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

Rating Summary

Company Rating PriceTarget

PriceUpside

SaudiTelecom(STC)

BUY 39.9 51.1 28.0%

EtihadEtisalat

(Mobily)

HOLD 74.8 80.6 7.8%

Zain KSA NC* - -

Prices as of February 11, 2013; * Not covered

Valuation Summary 2013e

Company P/EEV/

EBITDA

Dividend

yield

Cash

flowyield

SaudiTelecom(STC)

9.0 4.6 5.0% 12.8%

EtihadEtisalat

(Mobily)

9.0 6.9 6.2% 7.3%

Sources: Company, Saudi Fransi Capital analysis

Telecom stock movement vs TASI

Source:Bloomberg

Sector Coverage

Roy Cherry

[email protected]

+966- 1-2826844

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TASI STC EEC
mailto:[email protected]:[email protected]:[email protected]


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Saudi Fransi CapitalPage 3

Summary financials and ratiosSTC and Mobily

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

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

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

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

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

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

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

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

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

Key Ratio and ValuationEBITDA margin (%)* 45.8% 40.6% 37.9% 36.0% 35.3% 36.5% 36.9%

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

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

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

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

P/Earnings 6.6 7.2 7.3 10.3 10.9 9.0 8.7

P/Book 2.2 2.1 1.9 1.7 1.6 1.4 1.3

EV/ EBITDA 5.5 5.2 5.7 5.6 5.2 4.6 4.2

P/Sales 2.3 1.7 1.6 1.4 1.3 1.3 1.3

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

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

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

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

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

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

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

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

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

Key Ratio and Valuation

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

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

ROAA (%) 8.9% 10.4% 13.1% 14.3% 15.8% 15.8% 15.3%ROAE(%) 26.7% 27.4% 30.3% 29.9% 30.6% 28.7% 26.9%

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

P/Earnings 27.5 19.1 13.7 11.3 9.6 9.0 8.5

P/Book 5.9 4.7 3.7 3.1 2.8 2.4 2.1

EV/ EBITDA 17.4 13.5 10.4 8.4 7.5 6.9 6.5

P/Sales 5.3 4.4 3.6 2.9 2.4 2.3 2.2

Sources:Bloomberg, Company reports, Saudi Fransi Capital analysis

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

* Excluding One-off charges

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


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TABLE OF CONTENTSMobily played out; STC unfolding ..................................................................................................................................... 1

Summary financials and ratiosSTC and Mobily ........................................................................................................... 3

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

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

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

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

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

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

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

STCs dominance in fixed line to continue .................................................................................................................................................... 17

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

STCs superior pricing power for high-speed FTTH services ....................................................................................................................... 21

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

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

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

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

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

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

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

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

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

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

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

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

STCs background: Leader among GCC telecoms ....................................................................................................................................... 33

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

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

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

New international opportunities for STCMorocco, Algeria and Libya ........................................................................................................ 40

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

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

Legacy PSTN a drag on STCs returns ......................................................................................................................................................... 43

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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Mobily mostly played-out, STC still unfolding

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

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

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

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

instability.

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

Sources:Bloomberg, Saudi Fransi Capital analysis

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

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

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

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

undoubtedly our top-pick.

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

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

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

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

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TASI STC Mobily

Investment Thesis

Mixed performance by

Saudi telcos; Mobily

outperforms on strong

fundamentals


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

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

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

Mobily.

STC is our top pick

Company Rat ing Investment mer i ts Investment r isks

SaudiTelecomCompany

(STC AB)BUY

Well established infrastructure tosupport broadband demand

Pricing power in high-speedbroadband services

Attracting customers throughbundled service offerings

International growth avenues;diversified income streams

Attractive dividend yield

Legacy PSTN network todrag companysROE

Near-term risks attachedwith internationaloperationsBahrain/Kuwait and India

Declining market share

in mobile services Recent management

changes pose near termrisks

EtihadEtisalat/Mobile

(EEC AB)

HOLD

Industry leading ROEs

Market leadership in Mobilebroadband

A priced asset for Etisalats regionalgrowth ambition

Attractive dividend yield

Faster migration ofbroadband data intofixed networks

Source:Saudi Fransi Capital analysis

Both STC and Mobily are trading at a P/E of 9.0x on 2013 earnings in line with GCC peers, but at a discount of 10%to their counterparts in the Middle East and Africa (MEA). On EV/ EBITDA basis, STC is trading at 4.6x on 2013

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

peers and 48% premium to GCC peers.

Current valuation under prices improving growth/risk profile of telcos

Saudi Telecom Index valuation trend

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

multiples based on current prices)

Saudi Telecom Index valuation trend

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

/ forward multiples based on current prices)

18.0

14.9

10.9

12.313.1

10.9 9.9

2.2 2.2 1.8 1.9 2.1 1.9 1.7

0

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15

20

2009 2010 2011 2012 Current 2013e 2014ePrice/Earnings (x)Price/Book Value (x)Linear (Price/Earnings (x))Linear (Price/Book Value (x))

3.12.8

2.1 2.2 2.3 2.2 2.1

9.4

8.2

6.27.0 7.1

6.46.0

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2009 2010 2011 2012 Current 2013e 2014eEV/SalesEV/EBITDALinear (EV/Sales)Linear (EV/EBITDA)

International diversification

prospects overshadowed by

ongoing tension in the

region; a drag on STCs

valuation


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

The declining capex-to-sales ratio augurs well for the sectors asset return. We expect STCs capex -to-sales to

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

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

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

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

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

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

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

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

sector premium.

ROE/ROA of Saudi telcos vs. MEA peers

Return on Equity (%) (LFY)*

*LFY: Last Fiscal Year

Return on Assets (%) (LFY)


STC

Mobily

Etisalat

Du

Batelco

Omantel

ZainKuwait

Qtel JordanTelecom

Turkcell

Vodacom

MTN

MarocTelecom

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7 9 11 13 15

Price-Book2013e

Price- Earnings 2013e

Size of bubble indicates market cap

STC Mobily

Etisalat

Du

Batelco

Omantel

ZainKuwait

Qtel

JordanTelecom

Turkcell

Vodacom

MTN

MarocTelecom

25

30

35

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55

60

3 4 5 6 7 8 9

EBITDAMargin(%)2011

EV / EBITDA 2013e

Size of bubble indicates market cap

16.3

30.6

22.8

19.4

11.8

23.4

12.1

14.322.1

11.5

60.7

24.9

44.2

22.1

0 10 20 30 40 50 60

STC

Mobily

Etisalat

Du

Batelco

Omantel

Zain Kuwait

QtelJordan Telecom

Turkcell

Vodacom

MTN

Maroc Telecom

MEA - Median

7.0

15.8

7.9

8.9

8.9

16.0

8.1

2.6

13.6

7.3

22.7

12.3

17.0

8.9

0 5 10 15 20 25

STC

Mobily

Etisalat

Du

Batelco

Omantel

Zain Kuwait

Qtel

Jordan Telecom

Turkcell

Vodacom

MTN

Maroc Telecom

MEA - Median


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

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

view. As a percentage of free cash flows, we believe that Mobily would re-invest 8090% in the business as it

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

of its FTTH expansion completed.

STC generates ~2x higher free cash flows than Mobily

STCfree cash flows (SAR bn) STCCapex as a % of free cash flows (%)

Mobilyfree cash flows (SAR bn)MobilyCapex as a % of free cash flows (%)

Sources:Saudi Fransi Capital analysis

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

would prefer buying STCscash flows to Mobilys.

10.2

11.312.0

12.8

14.4

0

4

8

12

16

2013E 2014E 2015E 2016E 2017E

95.2%

83.4%

79.1% 75.0%64.9%

0%

20%

40%

60%

80%

100%

120%

2013E 2014E 2015E 2016E 2017E

4.2

5.05.5

5.96.3

0

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2

3

4

5

6

7

2013E 2014E 2015E 2016E 2017E

105.7%

85.2%81.8% 79.9% 78.1%

0%

20%

40%

60%

80%

100%

120%

2013E 2014E 2015E 2016E 2017E


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STCs attractive free cash flow yieldFree cash flow yieldSTC (%) 2013e-17e Free cash flow yieldMobily (%) 2013e-17e


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

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

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

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

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

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

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

international operations.

Growth at homeKey market forecasts

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

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

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

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

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

operating at margins below the MEA average.

Broadband and data services to drive revenue growth

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

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

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

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

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

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

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

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

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

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

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

12.8%

14.1%15.1%

16.0%

18.0%

0%2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

2013E 2014E 2015E 2016E 2017E

7.3%

8.6%9.5%

10.2%11.0%

0%

2%

4%

6%

8%

10%

12%

14%

2013E 2014E 2015E 2016E 2017E

Favorable environment for

adoption of high ARPU

data services

Favorable environment for

adoption of high ARPU

data services


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

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

Telecom penetration levels

Target market penetration* estimate (%) 2017e


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

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

Market share forecast

Fixed line target market share estimate (%) 2017e

Mobile market share estimate (%) 2017e

Fixed broadband target market share estimate (%) 2017e

Mobile broadband market share estimate (%) 2017e


67%

45%

186%

43%

70%60%

210%

70%

0%

50%

100%

150%

200%

250%

Fixed Line Fixed Broadband Mobile Mobile Broadband

2012e 2017e

97%90%

3%10%

0%

20%

40%

60%

80%

100%

120%

2012e 2017e 2012e 2017e

STC Others

47%

45%

39%40%

34%

36%

38%

40%

42%

44%

46%

48%

2012e 2017e 2012e 2017e

STC Mobily

95% 90%

5%10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2012e 2017e 2012e 2017e

STC Mobily

23%

35%

73%

55%

0%

10%

20%

30%

40%

50%

60%

70%

80%

2012e 2017e 2012e 2017eSTC Mobily


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Key investment risks

Downside risks

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

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

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

pricing strategies could negatively impact profitability of operators.

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

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

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

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

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

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

Turkey due to Syrias ongoing crisis and Turkeys response to the same (missile deployment at the border).

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

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

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

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

sector.

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

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

seems unlikely at the moment. In event such a development would materialize, it would be detrimental to theprospects of existing players and could significantly alter the competitive landscape and impact sector profitability

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

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

plans are in the making in Saudi Arabia.

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

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

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

Upside risks

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

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

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

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

valuation higher.

Higher uptake of new broadband services, more sustainable ARPUs: Higher than expected up take of new

broadband services in the Kingdom could sustain ARPUs higher for both STC and Mobily.

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

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

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

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

Increased disclosure, especially on STCs international operations, could help reduce perceived

investment risks attached into the sector: Investor have limited insight into STCs international operations and


13/74



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

increased disclosure.

Mobile revenue accounts for 80% of Saudi market

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

65.7bn during 200511. The total sector revenue, including international operations, increased at a CAGR of 17.7% to

SAR 83.9bn during the same period.

Dominance of mobile; STC commands ~55% revenue share

Revenue market share (20082017e) Segment-wise trends in sector revenue (in SAR bn)

(Total excluding international revenue)

Sources:CITC, Saudi Fransi Capital analysis

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

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

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

Saudi Arabia in 2012).

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

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

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

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

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

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

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

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

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

0%

20%

40%

60%

80%

100%

Mobily Zain KSA STC- Saudi Arabia

25.2 28.5 33.2

38.0 39.045.1

52.49.0

9.89.3

11.2 13.5

15.513.3

9.514.5

16.618.2

0

15

30

45

60

75

90

2005 2006 2007 2008 2009 2010 2011

Mobile Fixed & Data International

34.2

65.7

61.6

52.549.2

42.538.4

Saudi Arabian Telecom Market

Mobile services key driver

of telecom

Saturated mobile market in

Saudi Arabia


14/74



Mobily and Zain KSA expanded market presenceMobile penetration Saudi Arabia vs. MEA/ BRIC (2011) Market share by subscribersMobile (200517e)

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

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

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

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

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

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

expected to improve moderately to 15% by 2017.

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

Prepaid/Postpaid mixMobile (200517e) YoY revenue growth (20094Q 2012)

Sources:Company reports, Saudi Fransi Capital analysis

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

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

We expect the mobile ARPUs to decline further amid the prevailing competition, segment maturity and possible

inclusion of MVNOs in the coming years. We estimate ARPU in the mobile segment to decline 14% annually during

our forecast period.

124%

180%

74%

73%

191%

130%

135%

218%

150%

156%

104%

99%

114%

120%116%

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

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

Jordan

Tunisia

83%

69%61%

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

17%

31%39%

41%41%

37% 39% 39% 40%

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

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2006 2007 2008 2009 2010 2011 2012e2017e

STC Mobily Zain KSA

33%23%

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

67%77%

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

0%

20%

40%

60%

80%

100%

2

005

2

006

2

007

2

008

2

009

2

010

2

011

20

12e

20

17e

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

21% 23%25%

12% 11%

33%

17%13%

3%

-4%

-15%

1%

7%

2%6%

17%

8% 9%

2%

-20%

-10%

0%

10%

20%

30%

40%

2009 2010 2011 Mar 12Jun 12Sep 12Dec 12

Mobily Zain KSA STC- Saudi Arabia


15/74



Mobile subscriber additions at the cost of declining ARPU levelsMobile subscribers vs. ARPU (200517e) Mobile ARPUSTC/ Mobily (201117e) in SAR per month

Sources: CITC, Saudi Fransi Capital analysis

Given STCsbetter postpaid subscriber mix (postpaid mix of 2030% is high compared with the regional benchmark of

1015%), we continue to assign it a mobile ARPU premium of 47% over Mobily for the near term. However, over the

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

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

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

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

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

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

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

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

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

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

Competitive pricing for mobile services

Mobile - Prepaid pricingBasic offers

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

Mobile - Postpaid pricingBasic plans

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

message


14.1

19.7

28.4

36.0

44.8

51.653.7 53.5

66.9

50

60

70

80

90

100

110

120

130

140

150

0

10

20

30

40

50

60

70

80

2005 2007 2009 2011 2017e

ARPU(SARpermonth)

Subscribers(mn)

20

30

40

50

60

70

80

90

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

STC - Mobile ARPU Mobily - Mobile ARPU

25

55

25

30

55

25

20

55

25

0

10

20

30

40

50

60

Fee (SAR) Voice Call SMS

STC - S awa Mobily - 7ala Zain KSA - H ala

20

35

25

20

45

25

20

25 25

0

10

20

30

40

50

Fee (SAR) Voice Call SMS

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

Subscriber additions at the

cost of ARPU contraction


16/74



We note players are competing through free benefits plans to make free calls/SMS, with STCs pricing being more

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

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

KSA remains the most aggressive offering attractive pricing plans.

STCs attractive pricing of free benefits plan

Free benefits plans - Charge by validity (in SAR)

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


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

Besides competitive pricing for Voice/SMS, telcos are offering attractive pricing plans for smartphones. iPhone offeringsare competitively priced in the Kingdom, with Zain KSA triggering a competition by recently slashing prices by 1535%

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

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

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

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

Mobilys offer of 8/16 GB free with SAR 349 per month plan appea rs the least attractive. STC also offers iPhone 5

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

priced iPhone products, STCs free offerings are drawing relatively more customer sign ups.

Zain KSA aggressively pricing iPhone offerings

iPhone product pricing (in 000 SAR) Starting plans for free iPhone offers (in SAR per month)

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


7 10 10

29

45 45

99

140 140

0

20

40

60

80

100

120

140

160

STC - Sawa Mobily - 7ala Zain KSA - Hala

1 day 1 Week 1 Month

1.6

2.5

2.9

3.2

2.32.5

2.9

3.2

1.5

2.22.4

2.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

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

STC Mobily Zain

249

349

150

249

349

450

249

NA

450

0

100

200

300

400

500

STC Mobily Zain*

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


17/74



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

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

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

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

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

Quality of ServiceAll players meet CITC benchmarks

Service quality 2011

Voice quality standards (score) 2011

Sources:CITC, Saudi Fransi Capital analysis

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

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

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

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

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

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

frequent travelers for Hajj season.

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

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

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

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

(both commencements and finalization) starting 2015.

STCs dominance in fixed line to continue

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

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

(1.4mn) attributed to businesses.

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

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

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

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

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

0.41%0.61%

1.0%

0.0%

1.0% 1.0%


18/74


19/74



Fixed line subscriber growth picking up, sharp decline in ARPU levelsResidential fixed line subscribers (200517e) Business line subscribers vs. ARPU (200517e)

Sources:CITC, Company reports, Saudi Fransi Capital analysis

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

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

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

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

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

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

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

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

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

prospects for expansion in business line uptake.

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

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

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

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

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

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

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

by 2015.

Broadband opportunity untapped; attractive growth prospects for data services

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

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

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

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

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

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

annual growth rate of 27%.

2.8 2.9 2.93.0 3.0 3.1

3.33.5

4.1

80

100

120

140

160

180

200

220

240

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

2005 2007 2009 2011 2017e

ARPU

(SARpermonth)

Residentiallines(mn)

Residential lines ARPU (RHS)

0.91.0 1.1

1.11.2

1.0

1.31.4

2.2

80

110

140

170

200

230

260

290

320

350

0

0.5

1

1.5

2

2.5

2005 2007 2009 2011 2017e

ARPU

(SARpermonth)

Businesslines(mn)

Business lines ARPU (RHS)


20/74



Mobily a clear leader in mobile broadband; STC closing inMobile broadband Subscribers vs. ARPU Mobile broadbandMrket share (%)


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

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

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

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

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

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

retain 90% of the market share during the forecast period. However, competition from Mobily is expected to remainhigh given its plans for an aggressive fixed broadband strategy, posing a long-term threat to STC s dominance in this

segment.

STC to dominate the fixed broadband market

Fixed broadband Subscribers vs. ARPU Fixed broadbandMarket share (%)


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

in 2007. We expect a moderate 14% decline annually in ARPU during the forecast period. In terms of pricing in mobile

broadband, STC and Mobily are comparable; however, the former commands a 1825% premium on home broadband.We do not expect Zains aggressive pricing to remain sustainable in the mobile broadband segment.

1.42.7

11.312.4

14.2

16.2

18.1

20.2

22.3

50

60

70

80

90

100

110

120

130

140

150

0

5

10

15

20

25

2009 2011 2013e 2015e 2017e

ARPU(SARpermonth)

MobileBroadbandSubsrciber(mn)

Subscribers ARPU (RHS)

16% 13%20% 23% 25%

28% 30% 33%35%

83% 85%77% 73% 69% 66%

62% 59% 55%

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

0%

20%

40%

60%

80%

100%

2009 2011 2013e 2015e 2017eSTC Mobily Zain KSA

1.4

1.72.0

2.32.6

2.83.0

3.33.5

50

60

70

8090

100

110

120

130

140

150

160

0

1

2

3

4

2009 2011 2013e 2015e 2017e

ARPU

(SARpermonth)

FixedBroad

bandSubscribers(mn)

Subscribers ARPU (RHS)

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

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

0%

20%

40%

60%

80%

100%

2009 2011 2013e 2015e 2017eSTC Mobily


21/74



Competitive pricing for broadband, but STC holds substantial advantage in fixedMobile broadband plansSAR per month Home broadband plansSAR per month

Sources: Company, Saudi Fransi Capital analysis

STCs superior pricing power for high-speed FTTH services

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

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

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

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

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

STCs superior pricing power for high-speed FTTH offerings

STCsFTTH pricing for various speeds (in SAR per month)


99

199

350

100

200

350

40

100

280

0

50

100

150

200

250

300

350

400

1GB/ 2GB 5 GB Unlimited

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

249

199

NA

199

169149

199

175149

0

50

100

150

200

250

300

2/4 MBps 1MBps 512Kbps

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

249296

346

799

0

100

200

300

400

500

600

700

800

900

4 Mbps 20 Mbps 40 Mbps 200 Mbps

Average pricing of competitors

Zain KSA competes on

pricing in mobile

broadband; STC commands

pricing power in high-speed

broadband


22/74



Internet usage in Saudi Arabia has substantial room for growth

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

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

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

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

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

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

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

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

According to Communications and Information Technology Commission (CITC), there were 11.7mn mobile broadbandsubscribers in 3Q 2012 compared with just 1.4mn at the end of 2009. The Kingdoms mobile broadband penetration

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

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

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

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

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

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

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

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

distributing content, Intigrals main competitive advantage is its proprietary methods of content management allowing

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

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

thus allowing the user to skip if they desire.

45.0%

49.0%

10.1%

38.3%

47.5%

86.2%

74.2%

70.0%

77.0%68.0%

35.6%

14.0%

51.0%

34.9%39.1%

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

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

BahrainOman

Egypt

Algeria

Morocco

Jordan

Tunisia

45.4%

55.0%

6.1%

35.4%

57.3%

87.0%

69.0%

76.0%

87.0%

58.0%

20.0%

34.2%

51.4%

19.1%

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

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Algeria

Morocco

Jordan

Tunisia

Increasing internet usersand tech-savvy, young

population in Saudi Arabia

positives for broadband

uptake


23/74



Low broadband penetration levels in the Kingdom; rising trend of net users positiveBroadband penetration Saudi Arabia vs MEA/ BRIC (2011) Trend in internet users (2005-3Q 2012)

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

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

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

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

users.

High per capita GDP and young populationpositives for sector

% population under 30 years Per capita GDP 2011 (USD)

Sources:UN, IMF, Saudi Fransi Capital analysis

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

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

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

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

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

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

8.6%

12.2%

1.1%

11.6%

5.7%

9.2%

1.3%

16.1%

16.2%

1.7%

2.3%

2.8%

1.8%

3.2%5.1%

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

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

Jordan

Tunisia

3.0

4.8

7.6

9.310.3

11.4

13.6

15.2

5%

15%

25%

35%

45%

55%

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

2005 2006 2007 2008 2009 2010 2011 3Q2012

Internet Users % of Population (RHS)

50.9%

37.1%

57.9%

43.2%

57.0%

44.8%

54.4%

49.6%

49.5%

62.9%

48.9%

47.8%

47.0%

54.7%44.0%

30% 40% 50% 60% 70%

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

JordanTunisia

2,493

12,993

1,514

5,417

21,196

98,144

43,723

63,626

22,918

23,572

2,932

5,503

3,084

4,6184,317

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

Brazil

Russia

India

China

Saudi Arabia

Qatar

Kuwait

UAE

Bahrain

Oman

Egypt

Algeria

Morocco

JordanTunisia


24/74



High penetration of tablets & smartphones in KSA; data traffic to multiply by 2016Tablet/Smartphone/Laptop usage Data traffic forecast (MB per month) by type of device

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

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

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

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

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

6.9Gb per month by 2016).

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

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

broadband and fixed line networks for offering broadband services, while Mobily is riding on the fast adoption of mobilebroadband services in the Kingdom. According to Cisco, global data traffic is carried predominantly through fixed

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

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

2011.

Fixed networks dominate global data traffic; Consumer segment to surge

Data Traffic forecast by type of network 2011 & 2016e Data Traffic forecast by segment 2011 & 2016e

Sources:Cisco, Saudi Fransi Capital analysis

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

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

nearly 300,000 km in the Kingdom (compared to an estimated 30,000 km for Mobily), is a further testament to its strongposition in the high-growth data segment.

63%

68%

5%

30%

50%

49%

60%

61%

26%

28%

38%

44%

16%

24%

6%

7%

7%

0% 20% 40% 60% 80%

Saudi Arabia

UAE

Egypt

Italy

France

Spain

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

Non smartphone device

Smartphone

Portable gaming console

Tablet

Laptop/ Netbook

2016e

2011~25x

~17x

~8.2x

~3.3x

In MB per month per device

95%83%

5%17%

0%

20%

40%

60%

80%

100%

2011 2016eFixed Mobile

51%

77%

49%

23%

0%

20%

40%

60%

80%

100%

2011 2016eConsumer Business

Smartphones and tablets are

well penetrated in the

Kingdom; data traffic set to

surge

Globally, fixed networks carry

higher data traffic than

mobile; consumer segment to

outpace business demand in

data usage


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

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

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

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

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

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

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

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

Data access modeTablet/ Notebook Data access modeSmartphones

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

The evolving trend of mobile traffic getting offloaded through fixed networks offers significant long-term prospects forfixed line operators such as STC. The drivers of mobile-fixed transition include bandwidth constraints for mobile in high-

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

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

demand for data services in the long term.

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

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

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

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

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

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

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

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

benefit Saudi telcos, primarily STC.

75%79%

42%

64%

83%

62%55%

38%

48%

16%23% 20%

0%

20%

40%

60%

80%

100%

SaudiArabia

UAE Russia Italy France Spain

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

60% 57%

4%

41%45%

53%

65%69%

97%

48%

77%

63%

0%

20%

40%

60%

80%

100%

SaudiArabia

UAE Egypt Italy France Spain

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

Wi-Fi access gains prominence

in Saudi Arabia; STC may

monetize fixed network

investments


26/74


27/74



High acquisition costs; telcos focus on cutting overhead costsSelling and marketing as a % of revenue (20074Q 2012) General and Admin. as a % of revenue (20074Q 2012)


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

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

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

High bad debt provision for STC, potential to improve exists

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

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

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

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

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

profitable operation than STC.

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

Bad debt provisions as % of sales: STC vs Mobily Receivable DSOs: STC vs Mobily


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

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

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

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

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

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

6%7%

14%14%

13% 13%12%

14%13%

0%

2%

4%

6%

8%

10%

12%

14%

16%

2007 2008 2009 2010 2011 Mar12

Jun12

Sep12

Dec12

STC Mobily Industry

8%

13%

8%7% 7% 8%

8%

7%7%

0%

2%

4%

6%

8%

10%

12%

14%

16%

2007 2008 2009 2010 2011 Mar12

Jun12

Sep12

Dec12

STC Mobily Industry

1.5%

1.9%

3.0% 3.1%

2.4%2.7%

3.0%

1.1%0.9% 0.8% 0.9%

1.0%

0%

1%

2%

3%

4%

5%

2007 2008 2009 2010 2011 2012

STC Mobily

5362

82

61 57 6163

105

153

131

115

91

0

30

60

90

120

150

180

2007 2008 2009 2010 2011 2012

STC Mobily

Tower sharing opportunity

could reduce operating

expenses by 1215% apotential margin driver.


28/74



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

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

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

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

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

uncertainty surrounding the comparative gains from this.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

STCs Capex-to-sales ( ex-acquisitions) (20072017e) Mobilys Capex-to-sales (ex- acquisitions) (20072017e)


Moderate regulatory risks & stable royalty fees

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

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

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

partieswith a deadline set for May 4th2013.

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

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

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

participate in the MVNO opportunity. Considering that MVNO typically chases the low ARPU/untapped customersegments, we see Zain KSA at a larger risk than STC/Mobily. Furthermore, considering the ongoing challenges at Zain

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

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

17%

12%12%

10%

14%15%

16%15%

15%14%

13%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2007 2009 2011 2013E 2015E 2017E

24%

27%25%

21%

18%

21%

17%16%16%16%16%

0%

5%

10%

15%

20%

25%

30%

2007 2009 2011 2013E 2015E 2017E

Decreasing capex-to-sales

ratio a positive; network

coverage well in place across

technologies


29/74



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

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

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

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

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

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

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

satisfies the WTOs requirement of three mobile operators.

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

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

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

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

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

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

mobile services.

Royalty fee charges for telecom services in Saudi Arabia

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

Mobile services 15%

Landline services 10%

Data services 8%

Sources:CITC, company reports, Saudi Fransi Capital analysis

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

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

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

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

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

STCs government charges ( % of sales) (20072012) Mobilys government charges ( % of sales) (20072012)


Government charges include : Royalty, license and frequency usage charges

Revenue include handset sales and others

14.0%

11.7%11.2% 11.1% 11.3%

9.4%

0%

2%

4%

6%

8%

10%

12%

14%

16%

2007 2008 2009 2010 2011 2012

12.4% 12.6%

9.6%8.7%

7.8%

5.7%

0%

2%

4%

6%

8%

10%

12%

14%

2007 2008 2009 2010 2011 2012

Room for margin expansion

exist through lower

government charges as data

revenue mix increases


30/74



Strong balance sheet position; capital return prospects are high

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

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

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

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

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

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

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

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

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

moderately below peers in GCC/ MEA.

Saudi telcos are well capitalized

Net DebtEBITDA ratio ( 2007-4Q2012) STC / Mobily dividend yield (%) vs GCC/ MEA peers


1.0

2.0 2.1

1.81.6 1.6

1.5

1.2

0.7

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2007 2008 2009 2010 2011 Mar12

Jun12

Sep12

Dec12

STC Mobily Industry

5.1

6.2

6.2

5.6

9.6

7.0

7.4

2.6

6.9

5.1

4.8

7.7

6.2

0 2 4 6 8 10 12

sfc telecom ar

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