Mobily is still ahead in identifying growth opportunities at the earliest and investing wisely in the domestic market. While investment in NGN (next generation network) at home and expanding overseas operations will boost long-term prospects for Saudi Telecom Co. (STC), the latter carries the risk of high non-operating losses due to currency fluctuations, which was evident in Q3. However, STC is now modestly valued with a decent dividend yield of 6.0 percent. On the other hand, it is still risky to invest in Zain prior to restructuring despite the recent dive in the stock.
STC's international business is rising, however it's vulnerable to currency fluctuations, which was evident in Q3, making it difficult to predict results. However, according to Al-Rajhi Capital, the long-term growth is still intact and the weak Q3 results have been already reflected on the share price (-8 percent post results), making the stock attractive at current levels.
Mobily is the leader in mobile broadband with 42 percent market share and likely to continue generating double-digit growth for at least two years. Though margins have slipped, robust revenue growth will continue to drive profitability. Al-Rajhi Capital estimates a full year dividend of SR3 which implies 6 percent yield for 2011.
Although below expectations, Zain's operating performance was satisfactory. However, high financial costs continued to result in net losses; accumulated losses expected to reach 69 percent of the paid up capital by end of the year. Zain's fortune depends on the outcome of the restructuring, which is likely to go through in Q1, 2012. Post restructuring, accumulated losses to come down by 80 percent and net debt to decline 40 percent, thus making financials look much better.
Al-Rajhi Capital continues to rate Mobily as Overweight with a revised target price of SR70; offering 39 percent upside; The bank also retains Overweight rating on STC with a cut in our target price to SR40. It remains Neutral on Zain and cut target price to SR6 as it is still risky prior to financial restructuring.
Accurate data for the size of the Saudi Broadband market is very difficult to obtain. The Communication and Information Technology Commission (CITC), the Saudi telecom regulator, publishes figures on the size of the telecom and Internet markets in a rather confusing manner. According to the recent H1, 2011 report, the total broadband (fixed and mobile) subscriptions at the end of H1, stood roughly at 13 million (11 million for mobile and 2.02 million for fixed line).
The number of subscriptions at the end of 2010 were 4.4 million (including around 1.46 million fixed (DSL) broadband). These figures certainly suggest that the mobile broadband market growth is still intact.
Al-Rajhi Capital said in its report, the third operator Zain seems to be far behind its rivals, largely due to the financial uncertainties surrounding the company and slowness in introducing competitive offers to the market. Mobily has around 2.3 million mobile broadband customers, while STC has 1.9 million, and Zain around 2, 00,000 broadband accounts. These figures totaled at 4.4 million at the end of Q3, a 42 percent growth from 3.1 million accounts in 2010. Thus, it is clear that mobile broadband is growing substantially faster than fixed line broadband (10 percent y-o-y growth).
With CITC reporting a mobile penetration rate of 195 percent, it is expected the competition among operators will continue to intensify. Going ahead, service providers will need to increase their marketing expenses and lower tariffs in a bid to maintain revenue growth. Recently, these companies have shifted their focus on smart phones and tablet sales which rely on various online applications and require constant internet connectivity, the report said.
Saudi Arabia is the largest country in the Gulf region with an estimated population of 27 million. Growing at the rate of 2 percent annually, the country benefits from its young and fast growing population - 30 percent of the population is below 15, and 46 percent in the range of 15-39 indicating that retail consumption of the country will be high. This combined with a 20 percent of the total population being foreign guest workers helps ensure that money is being spent on telecoms services, are some of the factors positive for the Saudi telecom sector.
The lifestyle of Saudis has been constantly changing with the young population actively joining the work force and desire to follow a modern lifestyle. Looking specifically at the telecom sector, the markets have been flooded with exciting innovations like tablets and smart phones, which have opened a completely new segment for the industry. From introducing various offers with a motive of selling sims, the companies have now concentrated more on selling smartphones and tablets to gain market share. The report said young school and college goers actively purchasing these tablets and smartphones, which has become a part of their lifestyle. This segment is fast growing and under-penetrated and hence it offers a significant growth opportunity for all telecom companies as customers will continue to buy these items, trying to flow with the trend.
The market pie will continue to grow on the back of favorable demographics, though at a slower pace. It is expected that all companies will increase their market share but the breakdown is likely to change. Assuming the restructuring goes through, Zain, being the third operator, will probably gain more market share than other operators, mainly at the expense of STC as Mobily is more focused on domestic market. Zain has been clearly targeting users below 15 years old; this is reflected in its TV ads and campaigns. This marketing strategy is expected to payoff considering that 30 percent of population are below 15 years old.
The report said voice market is clearly moving toward maturity at a fast pace with penetration rate reaching 200 percent; operators have started lowering voice call charges in order to increase the minutes of usage (MOU). This will further push down ARPU levels from SR83 in 2011 to SR75 in 2014. The Al-Rajhi Capital report said STC has the highest ARPU of around SR96-100 due to dominance in the postpaid segment while Mobily is far behind at SR65 below Zain's which carries an ARPU of SR77. However, it is worth mentioning here that Saudi mobile pricing is relatively high by the standards of developing markets. For example, ARPU in China is only around $10 and in Malaysia $13 while in India it is close to $2-4. On the other hand, ARPU in various Gulf countries like UAE, Kuwait and Qatar stands at $30-55, which is substantially higher than that in Saudi Arabia. High ARPU in GCC countries reflects high GDP per capita and purchasing power parity in the region.
As competition grows, margin level of the all operators is set to fall due to a gradual decline in RPM (revenue per minute). The overall RPM has declined by 17 percent from 2009 and the effect has been seen on the margins of all three operators. The report said EBITDA margin estimate for STC has declined by 60 bps to 37.3 percent for 2011 and 40 bps to 36.9 percent for 2012 on the back of higher advertising costs and falling call charges. For Mobily, the margins will fall gradually in 2012 as the company will concentrate on maintaining its double digit growth, but the fall should not be as steep as evident in 2011. Mobily to end 2011 with a gross margin of 51.9 percent, a 300 bps decline over last year.
Zain, on the other hand, has been constantly improving its margins due to better control on interconnection charges and operating costs. Zain's gross margin to remain close to current level of 50 percent. Zain's EBITDA margins to strengthen from current levels (13 percent in 2011) on account of increased sales leading to economies of scale and falling SG&A costs as a proportion of sales which currently stands high at 37 percent of sales.
Al-Rajhi Capital maintained its Overweight rating on Mobily and STC as well as Neutral rating on Zain KSA. We have cut our target price for all three companies under our coverage to factor in the increasing competition and maturing voice market leading to falling call rates. Zain, despite doing well as a No. 3 operator, still presents a dull case due to its failure in addressing its huge debt and interest costs. With losses now close to 70 percent of the capital, capital restructuring becomes a top priority for Zain. Hence the bank maintains its Neutral rating on the stock. STC now trades at a 2012 PE of 8.4x and offers a dividend yield of 6 percent. Mobily, on the other hand, trades at 6.5x and offers similar dividend yield of 6 percent, which makes it one of the cheapest investment option available in the market.
