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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

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EEMEA

telecoms

March 2017

Equities // Telecoms / EEM

EA

EEMEA telecoms5G: Threats or Opportunities?

EQUITIESTELECOMS / EEMEAMarch 2017

By: Hervé Drouet, Ziyad Joosub and Eric Chang

5G will be evolutionary rather than revolutionary, but the impact will be significant for EEMEA telcos, bringing new challenges and opportunities

Long term, diversified operators might be advantaged but the benefit will hinge mostly on regulation, substitution and competitive risks

Short term, the drivers are likely to remain dividend, currency impact and data monetisation/affordability

1

EQUITIES ● TELECOMS / EEMEA

16 March 2017

Executive Summary 2

Short-term drivers in 2017: Affordability,

FX and dividend 2

Long-term driver: 5G: threat or

opportunities for 2020 4

Winners and losers 7

Changes to our target prices and

summary tables 9

Affordability and telecom

spending dynamic in EEMEA 10

The costs of mobile data ‘access’

across EEMEA 10

Handset affordability drives

smartphone penetration 10

Level of data pricing correlated to mobile

spend as a percentage of GDP 13

Macro and economic momentum also

has an impact on elasticity and

competition intensity 15

Conclusion 16

Currency swings still impact

telcos 18

Selective currency swing still to

impact telcos 18

Dividend sustainability and trends 25

5G: threat or opportunity? 28

5G is round the corner – even in EEMEA 28

5G will need handling with care by

EEMEA telcos 29

EEMEA telcos will need to overcome

challenges to monetise 5G 30

5G may introduce new risks 34

5G can nevertheless offer significant

opportunities in some areas 36

Potential winners and losers 42

Short-term drivers 42

Long-term driver: 5G 44

Conclusion 46

Companies section 48

Etisalat (ETISALAT UH) 49

Global Telecom Holding (GTHE EY) 54

Magyar Telekom (MTELEKOM HB) 59

Megafon (MFON RX) 63

Mobile Telesystems (MTSS RX) 67

Mobily (EEC AB) 71

MTN Group (MTN SJ) 76

O2 CZ (TELEC CP) 82

Ooredoo (ORDS QD) 86

Orange Polska (OPL PW) 92

Rostelecom (RTKM RM) 96

Saudi Telecom Co (STC AB) 100

Telkom Group (TKG SJ) 106

Turk Telekom (TTKOM TI) 111

Turkcell (TCELL TI) 115

VimpelCom (VIP US) 119

Viva Kuwait (VIVA KK) 124

Vodacom Group (VOD SJ) 129

Vodafone Qatar (VFQS QD) 136

Zain Group (ZAIN KK) 140

Zain KSA (ZAINKSA AB) 146

Disclosure appendix 153

Disclaimer 156

Contents


16 March 2017

2

5G is just round the corner with commercial launch likely to have

started in some EEMEA emerging markets by 2020, bringing

opportunities (higher speed, better latency, fixed wireless radio

access), challenges (densification of network, regulation, software

skills) and risks (use of unlicensed spectrum, network slicing,

OTT). We look at which operators will be at a natural advantage.

Short term, we would expect investors to concentrate on dividend

trend, data monetisation, affordability and currency impact.

Short-term drivers in 2017: Affordability, FX and dividend

Are micro drivers more relevant than macro in 2017?

Over the past few years, cyclical and macro considerations have been the prevalent drivers of

EEMEA telecom sector performance but this macro correlation seems to have declined

significantly in recent months. We now see a new scenario unfolding in which emerging market

macro and currency volatility have stabilised and secular and fundamental telecoms drivers

demand greater consideration.

In his multi-asset research report (A game-changer for equities: Diversification is back,

16 February 2017), HSBC’s strategist Daniel Grosvenor highlights the sharp declines in equity-

market correlations since Donald Trump's US presidential election win which surprised the

markets. At the sector level, correlations between long and short duration names have turned

negative for the first time since the 2008 financial crisis, while emerging markets are again

moving independently from developed, with greater variation between countries within these

blocs. The market, previously highly macro-driven, is likely to be much more responsive to micro

themes. This increased fragmentation of equity markets suggests greater scope for

diversification and greater opportunities to outperform, making country and sector calls

increasingly important.

Affordability and data monetisation, regulatory and currency impact, dividend outlook

In our previous thematics report (When the going gets tough, 6 April 2016), we showed that

ROIC for EEMEA operators was under pressure from challenging macros and currency woes.

Regulatory and tax risks have increased and data monetisation is becoming crucial. We also

discussed how macro factors are exerting pressure on operators to become more rational and

to protect margins through leaner business models. In order to limit ROIC erosion companies

are increasingly optimising capital expenditure. If the regulator allows, a more collaborative

approach (consolidation, network sharing) would also help preserve ROIC. Sale and lease back

of tower businesses in an attempt to bring cash upfront and help strengthen balance sheet has

been temporarily thwarted by FX movements where debt has largely been in hard currency.

Executive Summary

3


16 March 2017

With EM macros and currency starting to stabilise and potentially even strengthening in some

cases, we think the key short-term drivers to consider in EEMEA telcos are:

Data monetisation and affordability

Currency impact

Regulation trends

OpFCF and Dividend outlook

On data monetisation and affordability, we look at current affordability a local level and whether

there is room for catch up. The idea is to look at how the telecoms sector and telecoms prices are

affordable for local users. Is pricing stretched versus average consumer spending or is it cheap?

Is consumer telecom spending sensitive to or correlated with the state of the economy?

Our analysis shows that even adjusted for the economy, smartphone penetration in South Africa

and Africa lags EEMEA. The lag in South Africa could be explained, in our view, by a lower

urbanisation rate and less spread of wealth across the population (gini index). As smart phone

prices gradually fall, penetration should catch up with the sector average. Smartphone

penetration is driven more by low end affordability (as GDP per capita PPP adjusted, or as a

percentage of disposable income) and should continue to improve as emerging market

currencies stabilise and cheaper Asia-produced smartphones flow into EEMEA markets.

Compared with their per capita wealth levels, we think South Africa, Africa and Russia have the

most room to grow smartphone penetration.

Mobile data pricing (adjusted to GDP PPP) varies considerably in EEMEA with the cheapest in

Russia and Poland and the most expensive in Algeria, Nigeria and South Africa. Data pricing in

Turkey, Czech Republic and Hungary looks well balanced. Aggressive competition keeps data

pricing low in Poland while aggressive independent retailers in Russia keep churn high and

tariffs low. We believe a switch to monobrand retailers could be a catalyst for enhanced data

monetisation in Russia while we think it might take consolidation in Poland to see more rational

pricing competition.

Mobile spending appears quite resilient during a macro recession but high elasticity is generally

seen in countries where there is rational competition or market repair through consolidation.

This is the case for Turkey, Czech Republic (rational competition) and Pakistan (consolidation).

With most EEMEA countries seeing GDP growth, a rational competitive environment or a

consolidating market could unlock elasticity for countries such as Russia or Poland.

Countries with stable and rational competition, like Turkey, are well placed to monetise data further.

On currency, we look at which operators are more exposed to currency movements and which

are most likely to benefit or not. The overall impact of currency is the highest for companies most

exposed to countries whose currencies are under pressure, and which are most exposed through

their capex and debt. This is the case Turk Telekom, MTN and to a lesser extent, Russian telcos.

With most GCC currencies pegged to the USD, GCC domestic telcos are by default the least

impacted by currency exposure to USD. For the other operators the least sensitive to low gearing

and local currency financing rather than hard currency is O2CZ.

On regulation, we look at regulatory change happening in the region and in particular the

impact of the removal of European international mobile roaming (we estimate a c2% impact on

average revenues for the CE3 telcos).


16 March 2017

4

Dividend trends and sustainability remain key criteria for EEMEA Telecom investors in the

short term. We analyse the dividend outlook for EEMEA telecoms based on the attractiveness

of dividend yields and the ability to maintain the dividend. Companies offering high dividends

and high dividend yield spreads over the 10-year sovereign yield with improving trends score

highest in our model. To determine the sustainability of dividends, we look at the FCF yield and

current leverage ratio (net debt/EBITDA). By analysing the FCF-dividend yield spread, we can

gauge a company’s ability to pay dividends without affecting gearing.

Companies with lower dividend yield vs FCF yield and leverage ratios are considered less at

risk of cutting existing dividends. Zain Group, O2CZ, Magyar, Etisalat score well from that

perspective, while Zain KSA and Etihad Etisalat score much less well. Companies set to

improve their dividend the most in the next two years are VimpelCom and the Turkish telcos

(ie Turkcell, Turk Telekom) – assuming TRY and RUB stability.

MTS and Megafon offer high dividend yields, albeit room to increase these further is limited due

to most surplus cash flow already being returned shareholders. Significant changes in company

fundamentals would be needed to improve dividends, such as a shift from independent retailers

towards monobrand shops.

Long-term driver: 5G: threat or opportunities for 2020

HSBC’s European telecoms team recently published a detailed report on 5G and its impact on

the European telecom sector in FT5G – What the telecoms sector need is a new acronym

(16 January 2017). In this report, we analyse the impact of 5G on EEMEA telecom operators.

5G could come sooner than you think

We believe the technological lag between EEMEA and developed markets is shrinking and that

5G roll-out may come to EEMEA markets sooner than investors expect. Turkey and Russia are

due some pre-commercial launches and some city coverage in H2 2018, with full commercial

launch nationwide in 2020 in both countries. 5G is not only about linking machine to machine

devices, but bringing higher speed, better latency and better spectrum efficiencies. In fact, 5G

could come relatively quickly to EEMEA emerging markets for the following reasons:

A shorter technological and investment cycle for EEMEA telcos: technology is becoming

cheaper, sooner, thanks to key telecoms equipment manufacturers in emerging Asia

(particularly China) such as Huawei;

A potential wireless capacity crunch driven by a sharp increase in data services while

capacity will start to become inadequate in some countries. This effect could be amplified

by the lack of home fibre broadband in emerging markets where the main means of data

access is via smartphones (smartphone penetration is above 50% in most EEMEA

countries). 5G will provide substantial improvements in speed, latency and capacity – if we

consider the additional spectrum to be delivered;

The benefit of 5G Fixed Radio Access (FRA), enabling efficient and fast fixed wireless

broadband access to smaller cities and rural urban areas where current broadband

provisioning is poor in emerging markets;

The evolutionary technology upgrade path of 5G, enabling relatively fast adoption by

EEMEA telcos operators. Network operators do not always need all of the capacity on day

one but are more likely to adopt a phased approach.

5


16 March 2017

5G will bring threats and opportunities

From a sector perspective:

1. 5G is unlikely to directly boost sector revenue but it could impact business models via base

station densification. The technology would increasingly move towards the software layer,

an area in which not all telcos have strong skills or expertise. 5G could also promote Fixed

Radio Access (FRA), however, which could be an interesting technology with which to

provide broadband in some emerging markets, especially for mid-size towns in rural areas.

2. Converged players have the advantage in backhaul and cross-selling, which could have

significant implications for EEMEA telcos, where diversified operators could have an

advantage over pure mobile where they are present.

3. With potential new high frequencies allocated which might be unlicensed, 5G could

introduce new risks to the telcos sector in terms of new entrants taking customers away.

The process of attributing new frequencies by the regulators could also have a significant

impact on future sector profitability.

In EEMEA, some applications could be monetised due to a lack of alternatives, but this would

require telcos to acquire a great deal of software development skills and sufficient knowledge of

the requirements of individual industries to be able to devise solutions for them. Overall, we

think monetisation for operators in EEMEA will still come mostly from increased connectivity

needs and data usage.

Data monetisation has become more critical, with operators gradually expanding their offers and

integrated operators gradually benefiting from customers shifting to bundles and convergence

services. Smartphone penetration in the EEMEA region has lagged developed regions because

of currency headwinds and affordability, but penetration should gradually catch up as currency

stabilises. 5G FRA could be also an attractive proposition for fixed wireless broadband where

there is no fixed-line last-mile connection.

There are risks. The 5G shift towards greater importance of the software control layer could be

taken up more by the tech giants to the detriment of telcos’ data monetisation. Google’s Project

Fi and Facebook’s project ARIES could be threats – even for EEMEA telcos operators if they do

not rapidly enhance their software capabilities and engage more aggressively with digital

services. With 5G, Wifi and Mobile networks are used simultaneously; thus unlicensed

frequencies could also threaten telcos’ ability to monetise data.

Who is at a natural advantage?

Diversified operators could benefit through bundles versus pure mobile competitors as they are

likely to see a cost advantage. With simultaneous use of 5G with Wifi, the value of a fixed asset

is likely to increase for pure mobile operators. EEMEA telecoms operators might be able to

monetise and/or improve margin in countries where:

Access to spectrum is cheap and channelled to existing operators instead of disruptors or

new entrants (eg Russia, GCC)

Licenses and frequencies are tech-neutral (eg most EEMEA countries)

Net neutrality is not required and zero rating pricing of content is accepted by the regulators

(Russia, GCC)

Disruptive new entrants or technology (eg Google’s Project Fi) is limited for security

reasons (eg Russia, GCC)

There are opportunities for broadband in rural mid-size cities through 5G Fixed Radio

Access where there is a lack of fixed alternatives (Cable, Fibre, xDSL) (eg some regions in

Russia, Turkey, SSA, South Africa)

Competition is limited to three players with no small players (ie that can create danger of

layering) (eg Turkey, GCC, South Africa).


16 March 2017

6

We believe countries and regions such as Russia, GCC and South Africa can provide a relatively

good environment via which to monetise 5G opportunities while limiting potential disruptive risks.

EEMEA telcos operators more likely to succeed are those with:

diversified fixed and mobile operations (where 5G fuses with Wifi, wireless automatic

offload) that compete with pure mobile operators;

the ability to invest and which have deep pockets (densification of cells)

superior tech-neutral spectrum

strong innovation skill sets in service layers, and

strong software skills sets

Based on our scorecard analysis, companies that are naturally well placed are those that have:

The most room to monetise 5G: Operators scoring highly in this category have a high

potential for data and connectivity growth, strong opportunities in 5G Fixed Radio Access,

good levels of investment to meet demand and are ready for bundles. Integrated operators

(ie those with fixed and mobile operations) with access to premium content also have an

advantage if they compete versus pure mobile operators.

Low level of services substitutes or rational competition. Companies that operate in

markets where consolidation is taking place tend to score highly. Competition generally

becomes more rational post-consolidation as the number of players and substitutes

diminishes. Conversely, operators in markets with potential new entrants score worst as

smaller players tend to be the most irrational or aggressive on tariffs, so as to gain market

share and reach critical mass. With 5G, small players may introduce the risk of a significant

discount through layering. Markets with two or three players generally rank more highly than

those with four or five. Security concerns (telecoms are perceived as strategic assets) could

be an inhibiting factor for deep pocket international new entrants.

Accommodating regulation on 5G. A regulatory environment with few constraints

generally enables operators to access spectrum at more advantageous prices (eg through

beauty contests instead of auctions). Tech-neutral licenses are also advantageous as

existing spectrum could be used for 5G. Not having net neutrality could also be an

advantage for existing telcos, helping monetise data traffic through prioritisation. Zero

pricing data content could benefit operators that provide content. Finally, companies

operating in countries with a more lenient regulator tend to score highly.

A business model that is adequate for 5G dynamics. Companies with superior networks

and spectrum, strong innovation and software skills (digital agenda) and which are

diversified rank highly, as do those with adequate strategies to limit cannibalisation of voice

by data through data-tiered packages, convergence services and strong brand positioning.

In more mature markets, we like to see site-sharing and a more cooperative approach

among players – as long as it is a passive network element. We view business models that

relinquish control of the company’s own active network as unfavourable, as we see this as a

risk at times of new technology roll-out cycles such as 5G.

Overall Russian telcos (MTS, Megafon, VIP), Turkcell and MTN score well. In MENA, Ooredoo

and Saudi Telecom have the highest scores in their regional group.

7


16 March 2017

Winners and losers

Short-term drivers in 2017: Currency, data monetisation, dividend trend

In the very short term, key share price drivers for EEMEA telcos are:

Data monetisation and affordability, as data becomes the most significant growth engine

Currency impact, as there is much more dislocation between countries, and exposure

sensitivity varies significantly among EEMEA telcos

OpFCF and dividend outlook, as investors still mostly tend to perceive telcos as a dividend

yield play.

We rank operators in quintiles to get a net short-term criteria score, then overlay our thematic

scoring with our valuation matrix. We look at the upside implied by our fair value target prices,

2018e multiples (EV/EBITDA, EV/OPFCF, PE) and dividend yield spread. The higher the score,

the cheaper a stock looks. We summarise our analysis with the bubble chart below. The

companies in the top right-hand quadrant rank the highest on both short-term criteria and

valuation, with those in the bottom left-hand quadrant ranking lowest.

Short-term thematic score vs valuation relative

Source: HSBC

On both valuation and short-term drivers, Zain Group ranks well in GCC, with VIP, Magyar

Telekom in EEMEA. In South Africa, the scoring does not highlight any significant difference

between operators. The picture partly reflects the negative view HSBC’s FX strategists have on

most EEMEA currencies versus USD. This has a greater negative effect on operators with

higher sensitivity to currency movements due to their hard currency debt levels or a high portion

of capex paid in USD (eg Russian telcos, Turk Telekom, MTN). Should the RUB, Naira and TRY

appreciate, those companies would score significantly higher.

Long-term driver: 5G impact

The potential long-term impact is more fundamental for the operators, in our view. We have

updated our traditional thematic scoring methodology to include the potential opportunities and

threats 5G brings to EEMEA telecoms. We rank operators in quintiles to get a net thematic long-

term 5G score based on data monetisation ability, competitive threats and risks faced, 5G

regulation, and each company’s model. A high long-term net thematic score indicates a

company is well placed for 5G and a high net valuation score indicates the stock looks cheap

relative to peers. On both valuation and 5G drivers, Turkcell and the Russian telecoms score

well, and STC in MENA. MTN scores relatively well overall in South Africa. Those that rank

Mobily

Etisalat

GTH

MagyarMFON

MTS

MTN

O2 CZ

ORDS

OPL

RTKM

STC

Telkom SA

TTKOM

TCELL

VIP

Viva

Vodacom

Vod Qatar

Zain

Zain KSA

1

2

3

4

5

6

1 2 3 4 5

Val

uat

ion

Rel

ativ

e

Short term thematic Relative

Key :Buy =Hold =

Reduce =(size = mkt cap)


16 March 2017

8

poorly include Zain KSA, Vodafone Qatar. Despite being diversified, CE3 telcos only rank in the

medium range due to heavy competition from cable, high OTT penetration, which could become

a greater risk with 5G, and a much less supportive regulatory environment with a potentially

high spectrum cost.

Net long-term thematic score vs net valuation score

Source: HSBC

The table below summarises our overall analysis. Those more likely to benefit from 5G are

operators that rank well on our key criteria for the short term drivers related to affordability,

currency impact, dividend trend; and on more long-term key criteria related to 5G (eg data

monetisation, competitive threats and risks, 5G regulation, having a company model that is able

to cope with 5G dynamics and its coming challenges).

Stock ranking based on scorecard

High ranked Low ranked

ST score Magyar Telekom, O2Cz , ZAIN, TCELL, Etisalat ZAINKSA, VIVA, VFQS 5G positioning score MTS, MFON, TCELL, MTN, VIP VIVA, VFQS, OPL Valuation Score (high=Cheap) ZAIN, GTH, TTKOM, TCELL, VIP, MFON, RTKM VFQS, VOD, O2Cz

Source: HSBC

Taking into consideration both the thematic and valuation scores, we highlight our Buy-rated

companies: Turkcell, VimpelCom and MTN look strong on long-term factors, while Magyar

Telekom and Turkcell look strong on short-term metrics.

Mobily

Etisalat

GTH

MagyarMFON

MTS

MTN

O2 CZ

ORDSOPL

RTKMSTC

Telkom SA

TTKOM

TCELL

VIP

Viva

Vodacom

Vod Qatar

Zain

Zain KSA

1 2 3 4 5

Val

uat

ion

Rel

ativ

e

Thematic Relative

Key :Buy =Hold =


9


16 March 2017

Changes to our target prices and summary tables

Rating and target price changes in this report

Company Currency Old TP New TP Old Rating New Rating Reason

Ooredoo QAR 78 91 Reduce Reduce Change in estimates GTH EGP 8.7 8.0 Hold Hold Change in estimates VimpelCom Rostelecom Vodacom

USD RUB ZAR

5.4 88

172

5.2 84

160

Buy Hold Hold

Buy Hold Hold

Change in estimates Change in estimates Change in estimates

Source: HSBC estimates

Rating and target price summary table

___________________ Buy ____________________ ___________________ Hold ___________________ _________________ Reduce __________________ Company Curr TP Price Company Curr TP Price Company Curr TP Price

Mobily (Etihad Etisalat) SAR 27.20 21.65 MTS RUB 250 270 Etisalat AED 14.9 17.85 MTN ZAR 141.5 122.9 STC SAR 71 65.75 Zain KSA SAR 7.1 8.75 Turkcell TRY 14.2 12.2 Vodacom ZAR 160 149 Ooredoo QAR 91 99 VimpelCom Ltd USD 5.20 3.98 GTH EGP 8.0 7.0 Viva Kuwait KWD 0.74 0.82 Magyar T. HUF 580 500 O2 CZ CZK 270 272 Vodafone Qatar QAR 8.1 9.04 Megafon RUB 700 628.7 OPL PLN 5.0 4.67 Zain Group KWD 0.49 0.48 RTKM RUB 84.0 76.5 Telkom SA ZAR 77 69.8 Turk Telekom TRY 6.0 5.7

Source: HSBC estimates, priced as of 8 March 2017

Valuation Summary Table

Company Currency Ticker Rating CMP TP Up(down)side EV/EBITDA EV/OP FCF PE

Etisalat AED ETEL.AD Reduce 17.85 14.90 -16.5% 5.7 9.0 18.9 Global Telecom USD GTHE.CA Hold 7.0 8.0 14.3% 2.9 4.8 9.5 Magyar Telekom HUF MTEL.BU Buy 500 580 16.0% 4.7 8.7 14.6 Megafon RUB MFON.MM Buy 628.7 700 11.3% 4.4 9.0 11.3 Mobile Telesystems RUB MTSS.MM Hold 270 250 -7.4% 4.4 8.1 9.3

Mobily (Etihad Etisalat) SAR 7020.SE Buy 21.65 27.20 25.6% 7.6 53.8 182.0 MTN Group ZAR MTNJ.J Buy 122.87 141.5 15.2% 6.3 11.8 16.8 O2 CZ CZK SPTT.PR Hold 272 270 -0.7% 8.3 9.4 16.4 Ooredoo QAR ORDS.QA Reduce 99 91 -8.1% 5.0 10.1 14.4 Orange Polska PLN OPL.WA Hold 4.67 5 7.1% 4.5 14.9 -34.2 Rostelecom RUB RTKM.MM Hold 76.5 84 10.0% 2.8 7.6 14.1 Saudi Telecom Company SAR 7010.SE Hold 65.75 71 8.0% 5.9 13.2 14.9 Telkom SA ZAR TKHJ.J Hold 69.8 77 10.3% 2.8 7.7 10.4 Turk Telekom TRY TTKOM.IS Hold 5.7 6 5.3% 4.5 8.9 10.3 Turkcell TRY TCELL.IS Buy 12.18 14.2 16.6% 5.4 13.9 12.0 VimpelCom Ltd USD VIP.OQ Buy 3.98 5.2 30.7% 3.2 5.2 4.4 Viva Kuwait KWD VIVA.KW Reduce 0.82 0.74 -9.8% 3.0 13.2 10.1 Vodacom Group ZAR VODJ.J Hold 149 160 7.0% 7.2 11.5 14.4 Vodafone Qatar QAR VFQS.QA Reduce 9.04 8.1 -10.4% 13.7 33.3 -42.0 Zain Group KWD ZAIN.KW Hold 0.48 0.49 2.1% 3.7 5.4 7.2 Zain KSA SAR 7030.SE Reduce 8.75 7.1 -18.9% 9.9 99.2 -7.8 Median 4.7 9.4 11.3

Source: HSBC, prices are as of 8 March, FY17e for multiples


16 March 2017

10

The costs of mobile data ‘access’ across EEMEA

We look at wealth, affordability and consumer spending dynamics across EEMEA to establish

which markets hold the most upside and downside risks in terms of (1) smartphone penetration and

affordability, (2) mobile data pricing and (3) consumer ability to increase spend on mobile data.

Handset affordability drives smartphone penetration

Smartphone penetration varies across the EEMEA region. Penetration rates vary from

70%+ in GCC, to below 40% in Sub-Saharan Africa (South Africa, Nigeria). Handset adoption

remains a key enabler for effective data monetisation in conjunction with absolute data pricing.

South Africa and Africa may be characterised by lower smartphone adoption levels due to the

prevalence of dual-sim usage in these markets; Russia exhibits similar levels. Therefore, we

believe South Africa is currently still lagging the EEMEA telcos sector, due, possibly, to a lower

urbanisation rate and greater wealth disparity (as measured by the gini index). As handset

prices decrease, we expect smartphone penetration in these countries to converge to the

regional sector average.

Relative pricing of smartphones varies considerably across markets. Differences in duties,

taxes, VAT, wealth and cost of living dynamics are likely to explain the variance across

smartphone pricing in EEMEA markets.

Affordability and telecom

spending dynamic in EEMEA

Smartphone penetration is correlated to the affordability of the

cheapest smartphone relative to disposable income: Africa has room

to catch up

EEMEA mobile spend accounts for low single digits of disposable

income. For greater share of customer wallet, operators must ramp up

monetisation of data connectivity and develop faster digital services

Data pricing is cheapest in Russia, rational competition could allow

prices increase. Sensitivity to macro is highest in Turkey, Pakistan

and Czech Republic

In EEMEA, South Africa is the

laggard in terms of

smartphone penetration

Retail pricing difference in

high end smartphones is not

explained by affordability due

to absence of subsidies

11


16 March 2017

USD price of iPhone 7 (LHS) versus GDP per capita PPP-adj (RHS)

Source: Company data, Worldbank, Numbeo, GDP PPP for FY15 taken from World bank

PPP-adjusted GDP per capita or monthly disposable income differences do not explain

the variance in pricing. We have not observed any relationship between GDP per capita and

handset pricing. Therefore handset pricing appears not to follow a subsidisation model to cater

for lower-income markets.

USD price of iPhone 7 (lhs) versus average monthly disposable income (rhs)

Source: Company data, Worldbank, Numbeo

Smartphone penetration driven by wealth dynamics. Based on monthly disposable income,

the UAE, Saudi Arabia and Qatar are the markets with the lowest wealth barrier to smartphone

adoption. Algeria and Turkey have the highest barriers from an affordability perspective.

Smartphone penetration

more driven by low end

smartphone affordability

Lowest wealth barrier in

GCC, highest in Algeria

Most affordable smartphone as % of GDP per capita (lhs) versus smartphone penetration (rhs)


0.7%1.3% 1.6%

3.2% 3.6% 3.9% 4.0%

5.8%6.8%

9.8%

0%

20%

40%

60%

80%

100%

0%

5%

10%

15%

Saudi

Arabia

Russia South

Africa

UAE Qatar Hungary Czech

Republic

Poland Turkey Algeria

Price of most affordable smartphone as % of monthly PPP-adj GDP per capita LHS



16 March 2017

12

In the EEMEA region, Turkey and Poland have the highest smartphone penetration

relative to GDP per capita dynamics. Algeria and Poland are characterised by high retail

handset prices, partially offset in Poland by moderate subsidies from telcos operators and in

Turkey, by a more aggressive marketing campaign to push data services, helped by consumer

financing services put in place by operators such as Turkcell.

Smartphone penetration in South Africa, Russia and Saudi has the most room to grow

based on GDP per capita wealth levels. Saudi, Russia and South Africa wealth dynamics are

likely to be overstated when using GDP per capita metrics given their respective commodity-

driven wealth.

Price of most affordable smartphones

Source: Company data FY16, Worldbank, Numbeo

Monthly disposable income (after tax and finance costs) is a more appropriate metric

with which to gauge smartphone affordability across the region. This data is provided by

Numbeo and also takes into account cost of living criteria.

Using monthly disposable income yields a more accurate comparison. On a monthly

disposable income basis, results are more in line with reality, in our view, but correlation

between disposable income and smartphone penetration is evident.

Turkey and Hungary appear to have disproportionately higher smartphone penetration

relative to monthly income dynamics, while UAE, Saudi and Qatar have significant room to grow

smartphone penetration, based on monthly income levels.

The more affordable the smartphone versus disposable income (LHS), the higher the penetration (RHS)


2% 2%7%

9% 11%14% 14% 15%

29%

40%

0%

20%

40%

60%

80%

100%

0%

10%

20%

30%

40%

50%

UAE Qatar SouthAfrica

CzechRepublic

Poland Russia Turkey Hungary Nigeria Algeria

Price of most affordable as % of monthly disposable income


Turkey and Poland have the

highest smartphone

penetration relative to GDP

per capita PPP adjusted

The more affordable a

smartphone is versus

disposable income, the

higher the penetration

13


16 March 2017

Smartphone penetration in South Africa is overstated (dual-SIMs are prevalent) while

monthly income levels explain the high penetration rate in Nigeria

In South Africa, the pre-paid segment represents 80% of the subscriber base and is

characterised by customers holding multiple SIMs (which we believe to be at c1.67x). If we

adjust for that factor, smartphone penetration per capita is closer to 55%. We therefore see

scope for growth as the market is not as penetrated as headline figures suggest.

Nigeria appears highly over-penetrated given monthly income levels. This is a function of cheap

handsets as well as the lack of alternative communication/entertainment/connectivity options

(other than mobile).

In general, markets that are heavily skewed towards prepaid subscribers tend to have higher

multiple SIMs. This is the case in most markets in Africa and to a certain extent Russia.

Level of data pricing correlated to mobile spend as a percentage of GDP

Mobile data pricing varies considerably across EEMEA. Nigeria, Poland and Russia are

characterised by the lowest spend levels whilst the UAE, Algeria and South Africa are the most

expensive markets.

Average price per GB of data (USD)

Source: Ofcom

Mobile data pricing as a percentage of GDP. Nigeria, South Africa and Algeria appear the

most expensive on this basis, whilst Qatar, Russia and Poland are cheapest.

The cheapest mobile data

pricing is in Poland and

Russia; the most expensive

is in Algeria and UAE

Average mobile data (per GB) price as a percentage of monthly GDP PPP adj (basis points)

Source: Ofcom


16 March 2017

14

Mobile data pricing as a percentage of monthly disposable income. Nigeria, Czech

Republic and South Africa are the most expensive on this basis, while Qatar, Russia and

Poland are the cheapest.

Average mobile data (per GB) price as a percentage of monthly disposable income (basis points)

Source: Ofcom

Mobile data spend as a percentage of GDP per capita (PPP) versus ARPU as a

percentage of GDP (PPP). On this metric, the more expensive the mobile data, the greater the

proportion of mobile telecom spend in PPP-adjusted GDP per capita. South Africa, Hungary and

the UAE exhibit higher mobile ARPUs relative to GDP per capita levels. Russia, Poland appear

to have structurally low ARPUs relative to GDP per capita levels.

Comparing data pricing, wealth and total mobile spend dynamics for EEMEA operators

Source: Ofcom

Russia, Turkey and Czech

Republic have lower mobile

ARPU as a percentage of

monthly GDP per capita

15


16 March 2017

Mobile data spend as a percentage of monthly disposable income, versus ARPU as a

percentage of monthly disposable income. We think some of the disparity can be explained by

multiple SIM card usage, which can understate the real ARPU by unique subscriber. This would be

the case for markets with a relatively high prepaid level (eg Africa, Russia). In reality, we believe

mobile spending in Nigeria is closer to c2% of disposable income and c1.5% in Russia. We note

with interest that mobile telecom spend (as a percentage of monthly disposable income) is relatively

uniform across the EEMEA region. We find that mobile data pricing has no bearing on monthly

mobile spend. There is scope for this ratio to improve. The key for mobile operators is to monetise

data services but also introduce digital services and content.

Comparing data pricing, income and total mobile spend dynamics for EEMEA operators

Source: Ofcom

Macro and economic momentum also has an impact on elasticity and competition intensity

We look now at how ARPU has been impacted by GDP per capita in the past three years. The

impact varies across operators, with some markets showing a completely negative correlation to

economic conditions (Middle East, Turkey and Czech) whilst others show a very strong

correlation (Ukraine, South Africa, Russia and Poland). The countries with the highest

correlation to macro factors have recently been in recession, such as Ukraine, Nigeria and

Russia or, in South Africa’s case, have higher mobile service pricing. This shows that mobile

spending has been somewhat resilient to macro economic downside, in that it is a way of

providing cheap entertainment as well as communications. In steep economic downturns

however, or in a high pricing environment, mobile service revenue growth is highly correlated to

macro factors.

Turkey, Pakistan and Czech Republic have shown the lowest correlation to macro conditions –

whether positive or negative. These countries have seen a more rational competitive

environment through less aggressive competition (eg Turkey, Czech Republic) or consolidation

and market repair (Pakistan).

Mobile ARPU constant

across countries at 1-2% of

disposable income

There is more room to

monetise data and digital

services

Mobile spending is resilient

unless there is a steep macro

downturn or mobile services

are priced at a premium

The lowest correlation is in

countries where there is

rational competition or

consolidation


16 March 2017

16

Conclusion

Even adjusted for the economy, smartphone penetration in South Africa and Africa lags EEMEA.

South Africa lagging the EEMEA telcos sector might be explained by its lower urbanisation rate and

lesser spread of wealth within the population (gini index). As smart phone prices gradually decrease,

penetration should catching up with the sector average, driven as it is by low end smartphone

affordability (as GDP per capita PPP adjusted, or as a percentage of disposable income), and we

expect this to continue to improve as emerging market currencies stabilise and cheaper Asian

smartphones flow into EEMEA markets. Compared with their per capita wealth levels, South Africa,

Africa and Russia have the most room to grow smartphone penetration in our view.

Mobile data pricing (adjusted to GDP PPP) varies considerably in EEMEA with the cheapest in

Russia and Poland and the most expensive in Algeria, Nigeria and South Africa. Data pricing in

Turkey, Czech Republic and Hungary looks well balanced.

Aggressive competition keeps data pricing low in Poland while aggressive independent retailers

in Russia have prevented tariffs from adjusting for inflation. We believe a switch to monobrand

retailers could catalyse enhanced data monetisation in Russia while consolidation in Poland

might be required to see more rational pricing competition.

Mobile spending appears quite resilient during a macro recession but high elasticity is generally

in countries where there is rational competition or market repair through consolidation. This is

the case for Turkey and Czech Republic (rational competition) and Pakistan (consolidation).

With most EEMEA countries seeing GDP growth, being in a rational competitive environment or

consolidating market could unlock elasticity for countries such as Russia or Poland.

Countries like Turkey, with stable and rational competition, are well placed to further monetise data.

Mobile spend correlation to GDP

___________ GDP per capita (USD) _____________ ______ ARPU (USD) / GDP per capita (USD) _______ Country Operator 2014 2015 2016 3 year CAGR 2014 2015 2016 3 year CAGR Correlation

Algeria ORDS 5 459 4 175 4 129 -13.0% 1.6% 1.9% 1.9% 9.2% -1.00 Qatar ORDS 93 990 68 940 60 733 -19.6% 0.4% 0.6% 0.7% 22.9% -1.00 Kuwait ORDS 40 689 27 756 26 146 -19.8% 0.6% 0.8% 0.9% 22.8% -1.00 Saudi Arabia STC 24 499 20 583 19 922 -9.8% 1.0% 1.4% 1.5% 24.9% -0.99 UAE Etisalat 43 213 38 650 38 050 -6.2% 0.9% 1.0% 0.9% 4.5% -0.98 Kuwait VIVA 40 689 27 756 26 146 -19.8% 0.9% 1.3% 1.5% 29.1% -0.98 Qatar VFQS 93 990 68 940 60 733 -19.6% 0.4% 0.5% 0.6% 17.7% -0.98 Kuwait ZAIN 40 689 27 756 26 146 -19.8% 1.2% 1.4% 1.4% 6.4% -0.98 Saudi Arabia EEC 24 499 20 583 19 922 -9.8% 0.7% 1.0% 1.2% 30.1% -0.94 Turkey TTKOM 11 102 11 245 11 522 1.9% 1.1% 0.9% 0.9% -10.8% -0.90 Czech republic O2 17 001 17 636 18 454 4.2% 1.0% 0.8% 0.8% -11.1% -0.88 Saudi Arabia ZAINKSA 24 499 20 583 19 922 -9.8% 0.8% 0.8% 0.8% 3.9% -0.88 Turkey TKCEL Turkey 11 102 11 245 11 522 1.9% 1.1% 1.0% 0.9% -8.9% -0.87 Pakistan GTH 1 312 1 428 1 289 -0.9% 1.9% 1.8% 2.1% 5.1% -0.79 Pakistan PTCL 1 312 1 428 1 289 -0.9% 2.7% 2.0% 2.1% -11.5% -0.53 Algeria GTH 5 459 4 175 4 129 -13.0% 1.7% 1.7% 1.5% -6.8% 0.58 Russia MFON 14 160 9 243 8 838 -21.0% 0.7% 0.6% 0.6% -9.4% 0.87 Poland OPL 14 332 12 492 12 309 -7.3% 0.8% 0.8% 0.7% -8.4% 0.89 Russia MTS Russia 14 160 9 243 8 838 -21.0% 0.7% 0.7% 0.6% -7.1% 0.90 Nigeria MTN 3 268 2 763 2 260 -16.8% 2.5% 2.2% 2.2% -6.6% 0.91 Russia VIP Russia 14 160 9 243 8 838 -21.0% 0.7% 0.7% 0.6% -6.6% 0.92 South Africa VODSJ 6 503 5 727 5 018 -12.2% 2.1% 1.9% 1.8% -7.2% 0.92 Ukraine TKCEL Ukraine 3 095 2 125 2 052 -18.6% 0.8% 0.7% 0.7% -7.4% 0.98 Ukraine VIP Ukraine 3 095 2 125 2 052 -18.6% 1.2% 1.0% 1.0% -6.2% 0.99 South Africa MTN 6 503 5 727 5 018 -12.2% 1.6% 1.6% 1.5% -4.4% 1.00 Ukraine MTS Ukraine 3 095 2 125 2 052 -18.6% 1.3% 1.0% 1.0% -12.7% 1.00

Source: HSBC, World bank, IMF

17


16 March 2017

The countries with the highest correlation to macro conditions have been recently in recession,

such as Ukraine, Nigeria and Russia or, in South Africa’s case, have higher mobile service

pricing. Turkey, Pakistan and Czech Republic have shown the lowest correlation to macro

conditions – whether positive or negative. These countries have seen a more rational

competitive environment through less aggressive competition (eg Turkey, Czech Republic) or

consolidation and market repair (Pakistan).

The countries with the highest mobile spend as a percentage of GDP are Nigeria, Pakistan,

Algeria, South Africa and Saudi Arabia. We believe the high level of mobile spend in Nigeria,

Pakistan and Algeria can be explained by low wealth dynamics; in South Africa it is driven by

higher pricing and gini-coefficient, while in Saudi Arabia is driven by a high propensity to

consume mobile services. Poland, Russia and Qatar have scope to increase mobile spending

more than other countries across EEMEA.

EEMEA biggest spenders on mobile services

________________ GDP per capita (USD) ________________ __ ARPU (USD) / GDP per capita (USD) ___ Country Operator 2014 2015 2016 3 year CAGR 2014 2015 2016

Nigeria MTN 3 268 2 763 2 260 -16.8% 2.5% 2.2% 2.2% Pakistan PTCL 1 312 1 428 1 289 -0.9% 2.7% 2.0% 2.1% Pakistan GTH 1 312 1 428 1 289 -0.9% 1.9% 1.8% 2.1% Algeria ORDS 5 459 4 175 4 129 -13.0% 1.6% 1.9% 1.9% South Africa VODSJ 6 503 5 727 5 018 -12.2% 2.1% 1.9% 1.8% Saudi Arabia STC 24 499 20 583 19 922 -9.8% 1.0% 1.4% 1.5% Algeria GTH 5 459 4 175 4 129 -13.0% 1.7% 1.7% 1.5% South Africa MTN 6 503 5 727 5 018 -12.2% 1.6% 1.6% 1.5% Kuwait VIVA 40 689 27 756 26 146 -19.8% 0.9% 1.3% 1.5% Kuwait ZAIN 40 689 27 756 26 146 -19.8% 1.2% 1.4% 1.4% Saudi Arabia EEC 24 499 20 583 19 922 -9.8% 0.7% 1.0% 1.2% Hungary MAGYAR 14 007 12 240 11 903 -7.8% 1.3% 1.2% 1.2% Ukraine VIP Ukraine 3 095 2 125 2 052 -18.6% 1.2% 1.0% 1.0% Ukraine MTS Ukraine 3 095 2 125 2 052 -18.6% 1.3% 1.0% 1.0% UAE Etisalat 43 213 38 650 38 050 -6.2% 0.9% 1.0% 0.9% Turkey TKCEL Turkey 11 102 11 245 11 522 1.9% 1.1% 1.0% 0.9% Kuwait ORDS 40 689 27 756 26 146 -19.8% 0.6% 0.8% 0.9% Turkey TTKOM 11 102 11 245 11 522 1.9% 1.1% 0.9% 0.9% Saudi Arabia ZAINKSA 24 499 20 583 19 922 -9.8% 0.8% 0.8% 0.8% Czech republic O2 17 001 17 636 18 454 4.2% 1.0% 0.8% 0.8% Ukraine TKCEL Ukraine 3 095 2 125 2 052 -18.6% 0.8% 0.7% 0.7% Poland OPL 14 332 12 492 12 309 -7.3% 0.8% 0.8% 0.7% Qatar ORDS 93 990 68 940 60 733 -19.6% 0.4% 0.6% 0.7% Russia MTS Russia 14 160 9 243 8 838 -21.0% 0.7% 0.7% 0.6% Russia VIP Russia 14 160 9 243 8 838 -21.0% 0.7% 0.7% 0.6% Russia MFON 14 160 9 243 8 838 -21.0% 0.7% 0.6% 0.6% Qatar VFQS 93 990 68 940 60 733 -19.6% 0.4% 0.5% 0.6%

Source: HSBC


16 March 2017

18

Selective currency swing still to impact telcos

In our previous thematic report (EEMEA telcos: when the going gets tough, 6 April 2016), we

highlighted that secular and fundamental drivers would gain prominence when emerging market

macro and currency volatility stabilised, and the EEMEA telecoms valuation gap relative to

European peers would narrow. Since then, emerging markets currencies and macro conditions

have somewhat stabilised. The valuation gap has reduced albeit this is mostly attributable to de-

rating of the European companies. There is a positive aspect to the historical pressure EEMEA

telecom operators have had to contend with, in that it has pushed them gradually to react more

rationally to economic factors. They have sought to protect margins through leaner business

models and have found ways to limit ROIC erosion by optimising costs and – to a certain extent

– capex. A more collaborative approach (consolidation, network sharing) can also help stem

ROIC declines – if the regulator allows it. Tower assets spin-offs could also bring cash up-front

and crystallise higher valuations.

However currency movements have widely diverged within the region. During 2016, RUB has

sharply appreciated against USD while TRY has been under significant pressure.

HSBC End of the Year Exchange rate estimates for EEMEA currencies

2016 2017e Change

RUB 61.2 65.0 -6% TRY 3.5 4.0 -12% ZAR 13.7 14.0 -2% CZK 27.0 26.2 3% PLN 4.4 4.6 -4% HUF 309.0 310.0 0%

Source: HSBC FX Strategist forecasts

Currency swings still impact

telcos

Operators with the highest debt in hard currency, gearing and capex

are the most sensitive to currency swings

Sensitivity should decline as currencies stabilise and capex falls due

to network sharing

Turk Telekom is the most sensitive, STC the least

Headwinds in currency and

macro have pushed EEMEA

telcos towards a more

collaborative approach

EEMEA currency are now

diverging significantly

between countries

19


16 March 2017

EEMEA currencies vs USD over FY15, FY16 and FY17e

Source: Company data, HSBC estimates

We have likened telecom operators to importers because a proportion of their capex, debt and

costs is denominated in hard currency. That has translated into a significant divergence in FCF

and thus EEMEA telcos’ total return performance.

The EEMEA telecoms sector is feels a negative impacted from local currency devaluation

versus hard currency (USD, EUR). Many EM operators could be partly seen as importers

through capex, some raw materials and international traffic. Part of their capex is in hard

currency, as is part of the operating cost (indirectly from energy costs, for example, or directly

from potential subsidies on handsets). This would directly impact cash flow in local currency.

The capital structure also impacts their equity valuation in local currency as a part of their debt

is often in hard currencies, while most of their operations generate local currency cash flow

(only international roaming revenues are USD-driven).

-40%

-30%

-20%

-10%

0%

10%

20%

30%

RUB UAH PLN CZK HUF TRY DZD PKR MAD KWD QAR SAR AED NRA ZAR

2015 2016 2017e

Telecoms are like importers

A significant part of their

capex and debt is in hard

currency (EUR, USD)

Capex exposure and Sensitivity for EEMEA Telecoms

Companies capex/ebidta % of capex in HCY Capex exposure to FX FX YoY in 2017 FX effect on Capex FX sensitivity score

MTS 45% 55% 25% -6% -1.5% 2 VIP 38% 55% 21% -6% -1.2% 2 MFON 51% 55% 28% -6% -1.6% 2 RTKM 56% 55% 31% -6% -1.8% 2 OPL 58% 28% 16% -4% -0.7% 2 O2 CZ 21% 21% 4% 3% 0.1% 5 MAGYAR 46% 67% 31% 0% -0.1% 3 TTKOM 49% 50% 25% -12% -2.9% 1 TCELL 61% 50% 31% -12% -3.6% 1 GTH 40% 50% 20% 0% 0.0% 4 ORDS 51% 33% 17% 0% 0.0% 4 VFQS 59% 100% 59% 0% 0.0% 4 ETISALAT 37% 46% 17% 0% 0.0% 3 ZAIN 31% 21% 7% 8% 0.5% 5 ZAINKSA 74% 100% 74% 0% 0.1% 4 STC 55% 100% 55% 0% 0.1% 4 EEC 86% 100% 86% 0% 0.1% 5 VIVA 77% 100% 77% 8% 6.1% 5 MTN 46% 50% 23% -2% -0.4% 3 VODSJ 37% 45% 16% -2% -0.3% 3 TKG 64% 40% 26% -2% -0.5% 3



16 March 2017

20

Sensitivity of capex to currency

For each operator, we analyse capex relative to EBITDA and the proportion of capex in hard

currency to determine the capex impact on cash flow. We then assess the capex exposure.

Although capex is still relatively significant in EM versus DM, the ratio has come down

significantly from five years ago as markets have matured. The proportion of hard currency

capex has also fallen significantly. The most sensitive operators are those with high capex

spending and a high proportion of capex spend in hard currency. GCC companies are the least

sensitive due to their USD peg, with the most sensitive (by decreasing order) being Turk

Telekom, Turkcell, the Russian operators and MTN.

Capital expenditure in hard currency (%)

Source: HSBC estimates, Based on FY16

Capex/EBITDA over FY16 and FY17e


Move from capex-heavy to asset-light likely to continue

As ROIC remain under pressure, the key question is to what extent EEMEA operators should

adapt their models and reduce their asset bases. The diagram below shows the various options

related to network sharing. It can begin with site sharing and even involve the disposal of active

network equipment.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

MTS OPL O2 CZ MAGYAR TTKOM ORDS VFQS ETISALAT ZAIN VODSJ

0%

20%

40%

60%

80%

100%

120%

140%

16 17e

Most sensitive Turkish

telcos, least sensitive GCC

telcos

The optimum level of network

asset ownership depends on

market maturity, regulation

and competition

21


16 March 2017

From Asset heavy to Asset light

Source: HSBC

Historically, the length of regulatory cycles seems twice that of technological cycles

Source: HSBC

We argue the optimum level of assets depends on a variety of factors. What is the market

position of the operator (ie is it dominant)? How mature/developed is the market? How stringent

is the regulation? And how long can a market sustain irrational competition?

In mature markets with heavy regulation and stable competition, an operator would likely pursue

a more extensive asset-light model. However, we believe the logic/rationale would stop at the

spin-off of the active network. We remain sceptical of operators (like O2 CZ) which spin-off the

entire network (i.e. inclusive of the active electronic components). This heightens the risks of

losing control on the next technology roll-out (for example, 5G expected after 2020). Turk

Telekom has, for example, signalled it will be actively pursuing sites and capex sharing with

competitors and would even consider some active equipment sharing.

Tower assets – sales and lease back valuation getting more difficult to monetise

We believe the monetisation of tower assets is gradually becoming more challenging. Valuation

of TowerCos have somewhat de-rated since H2 2016. Some IPOs have also been postponed:

Telefonica/Telxius and Turkcell/Global Tower are notable cases. However, we believe

opportunities remain in Pakistan, Bangladesh and potentially Russia. VimpelCom, with

operations in the three countries, would be a beneficiary. Turkcell is still considering listing its

Tower business in 2017. The willingness of Turk Telekom to pursue capex sharing and

colocation may help boost the tenancy ratio. Our previous analysis shows towers becomes

profitable when the tenancy ratio exceeds 1.4x.

Site sharing Spectrum sharing

Active network sharing

Passive network spin off

Active network spin off

- Heavy capex

- High control

- Higher margins

- Asset light/Low Capex

- Low control

- Lower margins

Spectrums sharing

Active Network sharing

Passive Network spin off

Active Network spin off

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Cap

exLo

wer

H

ighe

r

Europe

US

c2000 c2012-13 c2025? c2040??

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Reg

ulat

ion

Ligh

ter

Hea

vier

Europe trying to regain early 2000s technology leadership – lightening regulation to stimulate capex…

Tougher regulation may cost US its capex lead – sowing seeds of future lightening of regulation…

Technological cycle: eg 3G Technological cycle: eg 4G Technological cycle

Regulatory cycle: peak to trough to peak, or trough to peak to trough Regulatory cycle

Turkish and Russian

companies may be tempted

to further share capex and

even active network

Turkcell seeking to IPO tower

business, VimpelCom to sale

and lease back towers in

Russia, Pakistan and

Bangladesh.


16 March 2017

22

Currency impact on debt could remain significant

Local currency depreciation would negatively impact equity valuations (in local currency) of

telecoms operators that have significant amounts of debt in hard currency and/or significant

international assets.

In the table below, we have identified each company’s exposure on their capital structure to

potential currency movements. The equity value would in theory be proportionally impacted by

the combination of their gearing and portion of debt in hard currency, assuming the enterprise

value in local currency stays the same. Reported net profit would also be impacted by FX losses

and so would dividends, assuming the dividend policy is based on a payout ratio of reported

net earnings.

Turk Telekom and VimpelCom are the most exposed while GCC companies are the least.

Equity value is impacted by a

combination of gearing and

proportion of debt in hard

currency

Debt exposure and sensitivity for EEMEA Telecoms

Companies net debt/market cap % gross debt in HCY Net Debt exposure to FX FX YoY in 2017 FX effect on Net Debt FX sensitivity on Debt

MTS 44% 27% 12% -6% -0.701% 2 VIP 108% 73% 79% -6% -4.592% 1 MFON 52% 23% 12% -6% -0.695% 2 RTKM 89% 0% 0% -6% 0.000% 4 OPL 115% 0% 0% -4% 0.000% 4 O2 CZ 4% 0% 0% 3% 0.000% 4 MAGYAR 77% 0% 0% 0% 0.000% 4 TTKOM 42% 82% 35% -12% -4.074% 1 TCELL 14% 75% 11% -12% -1.257% 2 GTH 114% 0% 0% 0.000% 4 ORDS 74% 78% 58% 0% 0.022% 5 VFQS 10% 100% 10% 0% 0.004% 4 ETISALAT 0% 70% 0% 0% 0.000% 3 ZAIN 30% 98% 30% 8% 2.332% 5 ZAINKSA 263% 100% 263% 0% 0.407% 5 STC -14% 100% -14% 0% -0.022% 2 EEC 86% 100% 86% 0% 0.133% 5 VIVA 0% 100% 0% 8% -0.001% 3 MTN 21% 45% 10% -2% -0.185% 2 VODSJ 11% 5% 1% -2% -0.011% 3 TKG 9% 4% 0% -2% -0.007% 3

Source: HSBCe

23


16 March 2017

Proportion of debt in hard currency (%)

Source: Company data, Based on FY16

Net debt/Market cap over FY16 and FY17e

Source: company data, HSBC estimates

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

OP

L

O2 C

Z

MA

GY

AR

MF

ON

MT

S

ETISA

LAT

VIP

TCELL

OR

DS

TTK

OM

ZAIN

VFQ

S

ZAIN

KS

A

STC

EE

C

VIV

A

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

16 17e


16 March 2017

24

FX Sensitivity

FX Sensitivity on Capex FX Sensitivity on Debt Overall FX sensitivity

MTS 2 2 2 VIP 2 1 2 MFON 2 2 2 RTKM 2 4 3 OPL 2 4 3 O2 CZ 5 4 5 MAGYAR 3 4 4 TTKOM 1 1 1 TCELL 1 2 2 GTH 4 4 4 ORDS 4 5 5 VFQS 4 4 4 ETISALAT 3 3 3 ZAIN 5 5 5 ZAINKSA 4 5 5 STC 4 2 3 EEC 5 5 5 VIVA 5 3 4 MTN 3 2 3 VODSJ 3 3 3 TKG 3 3 3

Source: HSBC estimates, Rounded up to the nearest integer

We calculate overall FX sensitivity by considering FX sensitivity on capital expenditure and debt.

More limited impact of currency swing on opex

Currency swings have some bearing on the cost structure of EEMEA operators, including

international interconnect costs. However, operators also receive international interconnect

revenue in hard currency. The net impact will depend on whether the operator is a net exporter

of international voice minutes and data traffic or an importer. Countries popular with tourists

(Turkey, CE3) are generally importers of minutes and would be the least impacted by

interconnect costs but would benefit from increased revenues. However, as EU roaming fees

are removed this summer, the CE3 telecom companies are likely to see a greater impact on

EBITDA mobile margins in 2017. MTN also has significant hard currency exposure in its

Nigerian subsidiary: we estimate c33% of opex is in USD and relates to tower leasing

agreements and managed service contracts. The company has guided that for every 10%

weakening of the Naira, 2% of EBITDA is lost. We expect this level of dilution to moderate over

the medium term as tower lease contracts are renegotiated into Naira.

Overall currency impact

The overall impact of currency movements is highest for those companies most exposed to

countries whose currencies are under pressure, and which are most sensitive on their capex and

debt. This is the case for Turkish companies (Turk Telekom), MTN and to a lesser extent Russian

operators. GCC domestic operators are by default the least impacted as their currencies are in

some way pegged to the USD. O2CZ stands out because its low gearing and local currency

financing blunts the impact of currency swings.

Removal of European

roaming will negatively

impact CE3 telcos margin

Turkish telcos most sensitive

to FX, GCC telcos the least

25


16 March 2017

EEMEA Telecom investors still regard dividend outlook as a key criterion. In this section, we

look at each company’s dividend ‘attractiveness’ and sustainability.

We measure attractiveness by looking at the dividend yield and its spread over the 10-year

sovereign bond yield. Companies with high dividends and high dividend yield spreads over their

respective country 10-year sovereign yield with improving trends rank highest on our scorecard.

To gauge the sustainability of dividends, we look at the FCF yield and current leverage ratio (as

measured by net debt/EBITDA). The FCF-dividend yield spread serves to measure a company’s

ability to pay dividends without impacting gearing. The companies with lower dividend yield vs

FCF yield and leverage ratios are considered less likely to cut dividends.

Dividend outlook score


Dividend sustainability and

trends

Dividend outlook score is based on the attractiveness of dividend

yield and the company’s ability to increase it

Sustainability of dividends is driven by a low capital expenditure

requirement and strong balance sheet

Zain, O2 CZ and Etisalat screen well based on dividend outlook

Improving sustainable

dividend remains key for

EEMEA telcos


16 March 2017

26

We take into consideration the dividend estimates for the next two years (2017e and 2018e) to

determine the score on each parameter. We assign higher scores for companies with better

dividend yields, higher dividend-sovereign spreads, better FCF yields and lower leverage. We also

assign higher scores for companies with increasing trend of paying higher dividends. A higher

overall score implies better dividend outlook.

Zain Group, O2 CZ and Magyar Telekom rank highest due to high dividend yield spread, good

free cash-flow generation and reasonable leverage.

Russian telecoms offer high dividend yield but sovereign bond yields cap the spread. A steady

decline in sovereign Russian yield will increase the spread and improve the overall valuation scoring.

Zain Group ranks highest on strong dividend yield, spread over sovereign yield, robust free

cash-flow yield and an increasing dividends trend.

O2 CZ ranks highly on its high spread over sovereign yield and increasing trend of dividends.

Etisalat ranks high on dividend outlook mainly driven by high spread over sovereign bond yield.

We are most optimistic about the dividend outlook for Magyar Telekom. We believe Magyar

Telekom has room to increase dividends. Its dividend policy is based on a net debt/total capital

ratio cap of 40%, which we expect to decline further over the next year. We forecast dividends

increasing to HUF30 per share in FY17 (compared to HUF25 per share in FY16).

Zain KSA and Mobily’s poor rankings are mainly driven by their leveraged balance sheets, and

poor dividend and FCF yields.

For South African telecoms MTN has the most scope for absolute dividend transformation on a

medium-term view, while short term is likely to see muted dividend growth performance from MTN;

once capex-intensity normalisation commences in FY18e and FX dilution is in the base we expect

a multi-year earnings and dividend growth profile to play-out at MTN. We expect MTN to

progressively delever as FCF margin expansion cycle commence in conjunction with steep capex

reductions off a high base. Vodacom is also likely to exhibit strong acceleration (high single digits)

in FY18e (March year end) as the impact on earnings of one-off BEE charges and FX translation

losses cease (Vodacom has a fixed dividend pay-out of 90% of HEPS). Telkom SA is likely to

High score for high dividend

yields and spread over

sovereign, high FCF yield,

and lower leverage

Dividend trend and Dividend policy for EEMEA Telecoms

__________ Div Yield ____________ _____ FCF Yield _______ Company 15a 16a/e 17e 15a 16a/e One offs Dividend Policy

Mobily 0.0% 0.0% 0.0% 9.8% (20.2%) Etisalat 4.5% 4.8% 5.1% 11.2% 10.9% GTH 0.0% 0.0% 0.0% (0.7%) 17.1% Magyar 3.0% 5.0% 6.0% 7.4% 11.1% Net Debt/Total Capital under 40% MFON 8.6% 12.2% 12.2% 8.7% 6.5% MTS 7.1% 9.3% 9.3% 8.3% 9.4% Potential fine related to Uzbekistan Minimum RUB20 per share MTN 10.5% 5.6% 6.2% 29.3% 14.1% ZAR7 unless there is some unforeseen

deterioration in key markets O2 CZ 5.8% 6.2% 6.0% 6.3% 7.3% 90-110% of Net Profit Ooredoo 2.8% 2.8% 3.0% 6.6% 9.3% OPL 5.3% 5.3% 5.3% 17.8% 14.2% EU Fine around EUR127m RTKM 7.6% 7.6% 7.6% 9.1% 9.2% Lower of 75% of FCF or RUB45bn over FY16-18 STC 6.1% 6.1% 6.5% 9.4% 6.9% Minimum SAR1 per quarter valid until Q3 2018 Telkom SA 3.9% 5.2% 5.8% 8.1% 8.8% 60% of headline earnings TTKOM 4.2% 0.0% 6.0% 11.2% 6.4% 92% of Net Profit Turkcell 0.0% 0.0% 4.1% 6.8% 5.1% At least 50% of Net Profit VIP 0.9% 0.9% 2.4% (17.3%) 6.3% Progressive Dividend Policy Viva 0.0% 1.2% 1.2% 0.7% 5.6% Vodacom 5.3% 5.8% 6.4% 4.1% 4.7% At least 90% of headline earnings Vod Qatar 0.6% 0.0% 1.7% 0.6% 0.8% Zain 6.3% 7.4% 8.4% 12.1% 14.1% 70-80% of EPS Zain KSA 0.0% 0.0% 0.0% 9.9% 35.7%


Higher score overall for Zain

group, O2 CZ, Magyar,

Etisalat

Zain KSA and Mobily still low

on dividend score with high

leverage

27


16 March 2017

exhibit pedestrian dividend growth in the medium term, with growth dynamics for Enterprise/IT

impacted by public sector budget cuts in South Africa. While scope for margin expansion is limited,

with higher finance costs and D&A we forecast low-single digit earnings and dividend growth for

Telkom SA (established a fixed pay-out of 60% of HEPS).

Despite a strong growth outlook (in terms of revenue and EBITDA), we estimate Turkcell’s FCF

yield is under pressure from 4.5G-related expenditure (capital expenditure needed for network

rollout and the remaining instalment on the license). However, we believe the dividend outlook

remains positive. We expect the shareholder dispute to be resolved this year and assume

regular dividends related to the current fiscal period will be paid. We remain conservative and

do not factor any extraordinary dividends related to the cumulative unpaid dividends from the

past two years. This may represent an upside risk to our score for Turkcell.

Turk Telekom’s dividend outlook score is mainly driven by increasing dividends. 2016 dividends

were impacted by TRY volatility last year. We assume the TRY/USD stabilises over the next few

quarters, with negligible forex loss in FY18e. This will have a positive y-o-y impact on net profit;

thus we forecast an increase in dividends as pay-out is linked directly to net profit.

Russian telecoms operators present high dividend yields but have limited scope for

improvement. The upside risk is concomitant to a significant shift in fundamentals and concerns

specifically the independent retail distribution network (eg split of Euroset). The dividend yield

spread is capped by still-high Russian sovereign yield and by much of the free cash-flow

already being returned to the dividend. Investors are nevertheless being paid to wait for a

potential shift in fundamentals.

VimpelCom’s fast growing cash flow offers one of the most attractive dividend positive trend.

Breakdown of Dividend outlook score

Company Dividend yield

score

Spread over sovereign

yield score FCF yield

score Leverage scre Dividend trend

score Total score Total score

Rebased to 5

Mobily 1.2 2.3 1.2 0.4 2.4 7.5 1 Etisalat 3.6 4.3 2.9 3.6 3.0 17.4 5 Global Telecom 1.2 0.8 4.8 2.1 2.4 11.3 2 Magyar Telekom 2.4 3.6 4.4 1.6 5.0 17.0 5 Megafon 4.8 3.4 2.5 0.9 2.4 14.0 3 MTS 4.4 2.6 3.2 1.8 2.4 14.4 4 MTN Group 3.1 1.8 3.6 2.2 3.4 14.1 3 O2 CZ 3.8 4.5 2.5 3.4 2.8 17.0 5 Ooredoo 2.3 3.9 3.9 1.4 4.2 15.7 4 Orange Polska 2.2 3.2 2.8 0.6 2.4 11.2 3 Rostelecom 4.0 1.7 3.4 1.2 2.4 12.7 3 STC 3.4 4.1 1.3 4.2 3.2 16.2 4 Telkom SA 2.7 1.3 2.0 4.0 2.6 12.6 3 Turk Telekom 4.0 1.9 3.9 2.3 4.6 16.7 4 Turkcell 1.9 1.0 2.0 3.2 4.0 12.1 3 VimpelCom Ltd 2.8 3.6 4.3 0.9 4.8 16.4 4 Viva Kuwait 1.4 2.9 1.1 3.8 2.4 11.6 2 Vodacom Group 2.9 1.6 1.8 2.8 3.8 12.9 3 Vodafone Qatar 1.7 3.4 0.9 2.7 3.6 12.3 2 Zain Group 4.4 4.8 4.5 2.9 4.4 21.0 5 Zain KSA 1.2 2.3 1.8 0.2 2.4 7.9 1

Source: HSBC estimates, Higher score implies better outlook for the company

Turkish telcos have one of

the highest dividend trends

as currency stabilises and

the shareholder dispute at

TCELL is resolved

Russian telecoms offer high

dividend yield but limited

room for improvement

VimpelCom offers strong

improvement of dividend

outlook


16 March 2017

28

HSBC’s European telcoms team recently published a report on 5G and its impact on the

European telecom sector in FT5G: What the telecoms sector need is a new acronym. Here,

we analyse the impact of 5G on EEMEA telecom operators.

5G is round the corner – even in EEMEA

Characteristics of emerging EEMEA markets

The emerging markets presents significant specific characteristics relative to developed

markets. They have a majority low-ARPU multi-SIM subscriber base, which combines low

density rural areas and rapidly expanding urban environments. In some African countries, the

power grid is unreliable at best and mobile towers require back-up diesel generators. In

addition, given geographical size and population spread, wired networks are not prevalent so

the provision of telecom services is heavily reliant on mobile networks. Lastly, regulatory

frameworks vary significantly within the EEMEA region as regulatory bodies take different views

on net neutrality; tech neutrality and competitive dynamics within domestic markets.

5G is coming to EEMEA sooner than you think

5G is expected to be launched commercially in developed market around 2020. The question is

when it will be implemented in most EEMEA markets. New technologies roll out on average

every ten years in mobile (1G, 2G, 3G, 4G, and now 5G) with an average five-year lag between

devoloped markets’ roll out and emerging markets. Using GDP/PPP/capita figures and

assuming a 10% per year decline in telecom equipment prices, it takes on average five years

after rollout in DMs for it to be affordable in EMs.

Popular wisdom would see emerging markets rolling out 5G at a late stage, well after developed

markets but we beg to differ. 5G is not only about linking machine-machine devices. In fact, we

believe 5G could come relatively quickly in the EEMEA region for the following reasons:

5G: threat or opportunity?

A 5G roll-out from 2020 will have significant implications with

opportunities (FRA, data usage, connectivity) and risks (unlicensed

spectrum, layering, OTT WIFI)

We rank companies highly that are i) tech neutral, ii) spectrum rich,

iii) operate in markets with low probability of new entrants. Network

densification will advantage diversified/converged operators relative

to pure mobile

Russian telcos, Turkcell and MTN score highly. CE3 telcos, despite

their diversified network, are penalised by regulation and competition.

In MENA, STC scores relatively highly

Emerging markets have

strong characteristics with

subscale wireline networks

Technological lag between

EEMEA and developed

markets is shrinking

29


16 March 2017

A shorter technological and investment cycle for EEMEA telcos: technology is becoming

cheaper, sooner, thanks to key telecoms equipment manufacturers in emerging Asia

(particularly China) such as Huawei;

A potential wireless capacity crunch driven by a sharp increase in data services while

capacity will start to become inadequate in some countries. This effect could be amplified

by the lack of home fibre broadband in emerging markets where the main means of data

access is via smartphones (smartphone penetration is above 50% in most EEMEA

countries). 5G will provide substantial improvements in speed, latency and capacity – if we

consider the additional spectrum to be delivered;

The benefit of 5G Fixed Radio Access (FRA), enabling efficient and fast fixed wireless

broadband access to smaller cities in rural urban areas where current broadband

provisioning is poor in emerging markets;

The evolutionary technology upgrade path of 5G, enabling relatively fast adoption by

EEMEA telcos operators. Network operators do not always need all of the capacity on day

one but are more likely to adopt a phased approach.

Although 5G technology is not yet officially standardised, emerging market telecoms operators

have expressed significant interest.

The Turkish government has signalled its intention to be one of the first countries globally to use

5G. In January 2017, Ericsson said it had completed the first “5G” technology trial in Turkey,

achieving transmission speeds in excess of 22 gigabits per second and paving the way for

commercial 5G deployment in 2020.

In Russia, MTS is working with Nokia and Ericsson on developing a 5G test network in time for

the 2018 football world cup. MegaFon is planning a similar exercise with Huawei. In February

2017 Rostelecom signed a strategic partnership agreement with Gazprom Neft on the industrial

internet of things (IIoT) development. The key goal of the agreement is to establish long-term

and effective cooperation between the two companies to form new business models, as well as

to develop and implement innovative IT technologies.

We expect GCC countries to be among the first globally to commercialise 5G services due to

their oil wealth and populations with high disposable income. In the UAE, Etisalat had 5G in late

2016. Both UAE operators aim to launch 5G services in time for the Expo 2020 in Dubai.

Similarly in Qatar, Ooredoo held 5G trials with vendors Huawei and Nokia and in January STC

announced it achieved data transmission speed of 70Gbps.

We doubt the industry can agree completely on a new standard this year and produce the

relevant equipment in scale before the next decade. However, because of the increasingly

modular nature of mobile technology, platforms can continue to benefit from ongoing

incremental technological improvements long before ‘official’ 5G infrastructures are completely

unveiled’ and start to be implemented with a later version of 4G LTE.

5G will need handling with care by EEMEA telcos

In our European Telecoms team’s recent global telecom thematic FT5G: What the telecoms sector

need is a new acronym, three key outcomes for the global telecoms sector are highlighted.

1. 5G is unlikely to directly boost revenues but it may disrupt business models due to the

required base station densification. In addition, the technology will increasingly focus on the

software layer, a skillset which is not always associated with telecom operators. On the other

hand, 5G could also help establish Fixed Radio Access (FRA) as a broadband access

technology. FRA may be particularly useful in emerging markets, mid-size towns in rural areas.

5G already been tested in

some Emerging markets with

a possible roll out from 2020

5G standard still not

completely defined

5G could introduce new risks

but also new opportunities


16 March 2017

30

2. Converged players have the advantage on backhaul and cross-selling. In the EEMEA

region, this has significant implications: diversified operators could be advantaged relative

to pure mobile operators.

3. The process of attribution of new frequencies could have a significant impact on the

sector’s profit outlook. 5G will require the allocation of new high frequencies spectrum,

some of which might be unlicensed. This could introduce new risk to the telecoms sector.

EEMEA telcos will need to overcome challenges to monetise 5G

We are sceptical about the 5G Internet of Things (IoT) revenue proposition

Expectations for 5G are unrealistic, in our view. Equipment manufacturers are claiming

exponential improvements in coverage, latency, capacity and speed. We are somewhat

cautious about 5G’s vaunted coverage and capacity capabilities, while we acknowledge latency

and speed could significantly improve.

5G promises substantial improvements along four dimensions

Source: HSBC

If we look at the demand side of the equation, Gartner predicts there will be more than twenty

billion connected objects (the Internet of Things, IoT) by 2020. IDC predicts each individual will

own five devices within the next year.

We explain in detail why we are sceptical about the 5G revenue proposition later in the report.

4G LTE networks are capable of serving many applications often cited as necessary for IoT

usage. 4G technology incorporates a pair of standards that address machine-machine

communications: LTE-Machine (LTE-M) and narrowband IoT (NB-IoT). Both standards have

already been deployed. We also note LoRa and Sigfox are complementary initiatives. These

standards operate in the 868MHz band and at low speeds (a few kbps) but with much lower

energy consumption than 4G standards. We fail to understand in what aspect 5G might be truly

ground-breaking. By adding further standards, 5G might merely further fragment the situation.

As wireless technology becomes increasingly modular and flexible, technical progress will be

evolutionary rather than revolutionary. Unlike previous technologies, we think technical

enhancement will be incremental and less of a step change. We view 5G more as an optimiser

5G improves Latency and

Speed; much less so

Coverage and Capacity

4G LTE can currently handle

IoT communications

5G more an evolutionary than

revolutionary

31


16 March 2017

in the sense that will it enable networks to manage applications more efficiently. Each

application requires very different features from the network. 5G should be able to handle

“heterogeneous demand”. Some applications (e-health is one example) will require high

reliability but modest latency and bandwidth. Others may demand extremely low bandwidth and

can potentially fit around more demanding services (many IoT sensors). But it is unclear

whether 5G delivers new applications for which there is real demand (i.e. for which consumers

are willing to pay).

So far, monetisation of machine-machine communication (which was originally discussed in

conjunction with 3G) has been very slow and revenues have been insignificant, representing

only 1% of Vodafone group revenues, for example. In the EEMEA region, the short-term

potential for machine-machine communication appears even smaller. Firstly, there is a smaller

installed base of machines and sensors. Secondly, we think relatively cheaper labour cost and

lower affordability will negate the demand in the short term within emerging markets.

Most applications do not require double-digit Mbps. In mobility applications, customers are

likely viewing one screen at a time. In the instances where separate ‘screens’ are available (for

example a Virtual Reality (VR) headset), the customer’s focus will be on one display area at a time.

Specifically in a mobility context, there are also likely clear limits as to what resolution is required.

The vast majority of videos are watched on a smartphone or tablet. A single-digit mbps bandwidth is

sufficient to watch a video at the highest video resolution adapted to these devices’ screen size. In

the same fashion, most IoT applications would not require high speeds. We think it is unlikely these

applications would impose an extraordinary burden on networks. For most, the capacity

requirements will be limited, often in the order of a few kbps.

There are nevertheless some revenue opportunities for 5G in EEMEA

On the other hand, 5G may further enable a complete range of applications, even in emerging

markets, from monitoring to control, automation of industrial process in manufacturing or

resource extraction, mobile banking, mobile health, or mobile education. These services might

be still in their infancy (m-banking is already significant in some African countries) but could

have a promising future due to the lack of alternatives. 5G combined with some relevant

applications delivery could offer new services that are in demand but are currently not fulfilled,

bringing a technological leap at a relatively affordable cost in a significant number of emerging

market countries.

But monetising those services would require telecom companies to have a great deal of skills in

software development and sufficient knowledge of the requirements of individual industries to

be able to devise solutions for them. The difficulties for operators in monetising purely data

connections is the lack of strong tangible differentiation between them on just connectivity.

Operators who are investing further in their software development skills and moving towards

digital applications will be at a greater advantage (eg 02CZ, MTS, Megafon, VimpelCom,

Turkcell). Network operators are de facto not immediately qualified in the software domain, as

demonstrated by the rise of OTT apps. Operators have continued to provide the underlying

connectivity, but have – for understandable reasons – failed to keep up with the degree and

pace of innovation that is possible in the software domain.

Overall, we believe monetisation for EEMEA operators would still mostly originate from the

increased need for connectivity and data usage. Data monetisation has become more critical.

Operators have gradually expanded their offers. Integrated operators are gradually benefiting

from the consumer shift to bundles and convergence services. Smartphone penetration in the

region lags the developed world because of currency headwinds but should gradually catch up

when currency stabilises.

So far, operators have found

it difficult to monetise

machine-machine

communications

Most IoT applications do not

require high speed or high

capacity

Some applications could be

monetised thanks to lack of

substitutes in emerging

markets

Telcos are generally not good

in software and innovations,

but would need to develop

those skills very quickly

Data monetisation still to

come from increased

connectivity and data usage


16 March 2017

32

Within the EEMEA region, Cisco, the networking equipment manufacturer, forecasts a 60%

2015-20 CAGR in mobile data traffic (based on Cisco’s VNI Mobile Forecast Highlights, 2015-

2020). Companies that can monetise this data growth and improve (or at least minimise dilution

of) ROIC rank better on our scorecard. We therefore look for operators with access to affordable

spectrum auction.

EEMEA region to see strong jump in data traffic

Mobile data traffic generated by an average smartphone to rise significantly

Source: Cisco, HSBC Source: Cisco, HSBC

We believe 5G can provide significant revenue opportunities in emerging market mid-size cities

in rural areas where fixed broadband or other alternatives are unavailable. 5G would be an

economical and efficient way of provisioning Fixed Radio Access for fixed broadband services

through beamed firming technologies. Countries with relatively high numbers of rural mid-size

cities with very limited fixed broadband network infrastructure (e.g Turkey, Poland, Russia,

African countries) should benefit.

In our 2012 report CEEMEA telecoms, voice versus data: price it right, we highlighted that

network neutrality would also be a key element that may help monetisation of data access

potentially through data prioritisation. Current networks tend to throw all applications together

instead of prioritising those that are time-sensitive. This tendency is aggravated by the impact of

restrictive net neutrality regulation. A 5G network may be able to stratify its service further into

different classes tailored to the precise needs of each application. In turn, this may enable the

mobile industry to actively remediate large problems such as network congestion or capacity

crunch. In our view, operators in countries where net neutrality is not enforced are more likely to be

able to monetise versus their return. Whereas net neutrality is an ingrained concept in CE3

countries, South Africa and to an extent Turkey, its interpretation is more fluid in Russia, the Middle

East and some African countries.

5G will accelerate the process of base station densification

Our previous thematic reports have consistently highlighted how improvements in mobile

technologies appear to be subject to diminishing returns. The transition from 2G to 3G provided

for very substantial gains in spectral efficiency (i.e., the amount of data that can be

accommodated in a given Hertz of radio frequency), but the shift to 4G afforded much more

modest gains. Succinctly, we are already close to the physical limit (defined as the “Shannon

limit”) of spectral efficiency. As such, capacity increase can only be achieved through high

frequency spectrum. The limiting factor of this spectrum is their shorter range. Therefore,

operators would need more base stations to increase capacity.

71%

54% 53% 52% 50%45% 42%

0%

20%

40%

60%

80%

ME

A

Asi

aPac

Glo

bal

CE

E

LatA

m

W E

urop

e

N A

mer

ica

Mobile data traffic 2015-20 CAGR

929

4406

0

1000

2000

3000

4000

5000

2015 2020

Mobile data traffic per month generated by asmartphone (MB)

37% CAGR

5G FRA could provide fixed

wireless broadband more

cheaply if fixed broadband

was non existent

Operators in countries where

net neutrality is not enforced

are more likely to be able to

monetise versus their return

5G High frequencies short

range and the Shannon limit

will lead to network

densification

33


16 March 2017

This only leaves a handful of levers to improve bandwidth:

MIMO (multiple-input multiple-output antennae)

Additional spectrum

Small cells

Potentially, enhancements to prioritisation via network slicing/network virtualisation

Off-load traffic to alternatives, e.g., WiFi

The “Shannon Limit” will confine 5G to modest spectral efficiency gains

Source: HSBC

Base stations with small cells cover a smaller area (than a macrocell). The main benefit is

increased bandwidth: available radio frequencies are shared between fewer users and as a result

more spectrum can be allocated to each user. However, small cells sites have limitations that

are not automatically a desirable outcome. In practice they tend to interfere with macrocells,

thus eroding their efficiencies and capacity. A poorly placed small cell may only penetrate into

buildings beyond the first floors. In addition, each small cell would require power and backhaul.

We note securing additional sites could be problematic in certain locations.

The existing process of network densification will be intensified with 5G

Source: HSBC

1

2

3

4

5

6

0

-15 -10 -5 0 5 10 15 20

Typical loaded mobile

network (outdoors)

Inaccessible

Region

Lower interference environments e.g. isolated hotspots,

femtocells

Shannon limit

Shannon limit with 3dB offset

OFDMA

CDMA (HSPA)

Required SNR (dB)

Ach

ieva

ble

rat

e (b

ps/

Hz)

1

2

3

4

5

6

0

-15 -10 -5 0 5 10 15 20

Typical loaded mobile

network (outdoors)

Inaccessible

Region

Lower interference environments e.g. isolated hotspots,

femtocells

Shannon limit

Shannon limit with 3dB offset

OFDMA

CDMA (HSPA)

Required SNR (dB)

Ach

ieva

ble

rat

e (b

ps/

Hz)

4 miles4 miles

1 mile


16 March 2017

34

With the expected densification of cells, operators that have a strong balance sheet, good ability to

invest and a dense network will have a natural advantage. We also highlight the competitive edge

diversified operators have over pure mobile operators due to their greater backhaul capacities.

5G may introduce new risks

5G Network virtualisation may introduce new risks

5G will accelerate the current trend of shifting network functions away from specialised

hardware kits into software running on servers. Features that once required specific hardware

may instead be carried out by software running on standard servers. The ‘network slicing’

functionality in 5G specifically gives operators the flexibility to slice their network into different

strata to provide services to different categories of customer. In the long term, and as 5G

matures, this could enable tech giants such as Google to increasingly take control of the

software layer and out-manoeuvre telcos on monetising data connectivity (think how WhatsApp

cannibalised SMS revenues).

We can already picture a virtual network that would run on top of the network infrastructure.

The virtual network would be controlled by a software layer, an area where traditional telecoms

operators might find themselves rapidly out-innovated. There is therefore a risk of the sector

being further disrupted by OTT and internet companies.

We highlight the potential threat from Project Fi, a Google MVNO in the US. The key feature is

that connectivity is assured by WiFi and cellular networks. For the purpose of this venture,

Google leases cellular capacity from traditional network operators. The service switches

seamlessly between WiFi and cellular networks according to signal strength and speed. Google

has a pre-eminent position thanks to its Android operating system which has the potential to give it

much greater reach than any individual telecom operators.

We reiterate that software has historically not been telecom operators’ core competency; thus

those with strong software skills are more likely to resist the onslaught of tech companies.

Use of Unlicensed spectrum could bring new players and more fragmentation

5G spectrum plans

Range Band Description

<1GHZ 470-694MHz ITU aims to identify bands for 5G usage 600MHz US plans for 5G usage 700MHz EC plans for 5G usage 1-6GHz 3.3-3.8GHz Likely band for initial 5G services globally 3.85GHz FCC has already signed off plans for 5G usage 4.8-4.99GHz Being explored by several countries for 5G usage >6Ghz 6-24GHz 24Ghz EC plans for 5G usage 28Ghz FCC has already signed off plans for 5G usage; Japan and Korea examining etc Many more higher bands are being explored

Source: GSMA 5G Public Policy Position, November 2016

5G brings WiFi with Mobile to create the heterogeneous network (hetnet)

The 5G standard is designed to integrate a variety of alternative approaches in a concept

referred to as heterogeneous networks (and so the ‘hetnet’). It offers the prospect of greater

integration of WiFi into wireless. For example, a smartphone could simultaneously use the

wireless network and WiFi. This could help significantly through offload and especially in areas

where there is data congestion during peak hours. As a result, improved end-user experience is

a positive outcome.

Diversified Operators with

good ability to invest will be

at an advantage

5G shift towards software

control layer could help tech

giants limit telcos data

monetisation

Google Project Fi will first

seek to connect via WiFi, and

if that is unavailable, will go

through MVNOs

Core software competencies

for telcos needed to keep

internet companies at bay

With 5G, WiFi and Mobile

network are used

simultaneously

35


16 March 2017

Operators with a fixed broadband and mobile network infrastructure would be at a more natural

advantage and we believe WiFi offload will remain a powerful tool. While it is already a widely

used option today, 5G offers the prospect of improved integration into cellular platforms.

Carrier aggregation technology is already a feature of 4G networks, but the technology has so

far focused on enabling customers to access multiple bands of licensed spectrum – all owned

by the relevant network operator. The next step is to permit subscribers to use the available

bandwidth in unlicensed spectrum (i.e., WiFi) in addition to cellular. There has been

considerable progress made on getting WiFi/unlicensed capacity to work seamlessly with

cellular/licensed networks. We would therefore anticipate seeing the importance of unlicensed

spectrum made available to customers continuing to increase. There are larger blocks of

spectrum available at higher frequencies. Some of this (spare) spectrum will likely be allocated

on an unlicensed basis. However the unlicensed spectrums are short range and would

somewhat limit cannibalisation.

On a final note, one of the problems with unlicensed spectrum is that operators cannot control

the availability of the associated frequencies (since they do not own them). Furthermore,

although additional unlicensed spectrum is being added at 5GHz, its poor propagation

characteristics will make its availability highly variable on the top of the crowded nature of

2.4GHz WiFi spectrum. The most likely scenario is one where the ‘base’ connection would use

licensed spectrum (which the operator controls) while the unlicensed spectrum would be utilised

when and where available to boost data throughput.

Proposed 5G spectrum above 6GHZ

Source: World Radiocommunications Conference 2015

Within EEMEA emerging markets, operators with greater spectrum in the low bands should be

advantaged as the service will be provided deeper in the buildings through a larger cell.

Divesified telcos would

benefit from WiFi offload

Unlicensed frequencies could

be a threat for telcos data

monetisation

EEMEA telcos with higher

bandwidth spectrum in low

bands will be at an advantage


16 March 2017

36

Spectrum holdings

Company 800

MHz 900 MHz 1800 MHz 2100 MHz 2600 MHz Total

spectrum Mobile subs

(m)

Total spectrum Hz/Mobile

subs

O2 CZ 20 22.8 30 39.6 40 152.4 5 31.0 Vodafone Qatar 0 11 20 15 0 46 1.5 31.0 Magyar Telekom 20 0 50 30 60 160 5 29.2 Viva 0 10.2 14.6 15 0 39.8 2.4 16.6 Zain 0 13.8 14.2 15 0 43 2.9 14.8 Ooredoo 0 11 20 15 0 46 3.1 14.8 Turk Telekom 20 20 70 30 35 175 17 10.3 Etisalat 0 24.6 40 15 0 79.6 9.7 8.2 Orange Polska 20 13.6 19.2 29.6 30 112.4 16 7.2 Turkcell 20 24.8 59.6 70 60 234.4 34 6.9 Megafon 15 40.4 88.8 30 80 254.2 74 3.4 VIP 15 30.8 87.2 30 20 183 59 3.1 MTN 0 22 24 30 0 76 29 2.6 MTS 15 28.8 83.6 30 20 177.4 77 2.3 Vodacom 0 22 24 30 0 76 34 2.2

Source: Company data

Our preference is for countries where:

Access to spectrum is cheap and channelled to existing operators instead of disruptors or

new entrants (this is generally the case for Russia and GCC countries).

Licenses and frequencies are technology-neutral. Attributed spectrum can be used in the

future for 5G. This is generally the case for Russia and Turkey.

Potential entry of disruptive new entrants (Google Fi) or technology (VoIP, messaging apps)

is limited. This could be for strategic reasons (Russia) or national security (GCC).

Competition is balanced, generally where limited to three players with no small players

(danger of layering and heavy discount).

5G can nevertheless offer significant opportunities in some areas

5G may also accelerate take-up of fixed broadband as IT (and ICT) increasingly move

from a desktop/centralised architecture to a webtop/ centralised cloud architecture

HSBC recently used a new acronym: FT5G = Fibre-to-5G (FT5G: What the telecoms sector

need is a new acronym). FT refers to the fact data packets tend to begin their journey in the

core network on fibre. 5G refers to fact that they tend to end their journey on wireless: cellular or

(more often) WiFi. Inbetween there lies a series of intermediary technologies: FTTP, G.fast,

DOCSIS3.1, etc.

5G introduces a new architecture within networks with a direct link to the cloud. In addition to

providing wireless connection (IoT = Internet of Things), 5G is likely to accelerate the shift from

desktop to webtop. In the latter ‘domain’, most applications and documents are centralised in

the cloud and desktop computers are increasingly used as terminals. We wrote on this

transformational shift in Cloud burst (October 2011). One of our conclusions was that it

decreases the Total Cost of Ownership of PCs and their application, which could have a

significant impact on affordability and potentially push for further adoption in emerging markets.

A significant outcome of this transition will likely be increasing data consumption and

connectivity, in particular in Emerging markets.

We prefer countries that

allocate cheap spectrum to

existing operators rather than

to new entrants

5G is likely to accelerate the

shift from desktop to

WebTop, which in turn will

increase the need for data

consumption and

connectivity in EEMEA

37


16 March 2017

Full circle: cloud involves return to centralised processing

The cloud provides a more efficient way of doing processing

Source: HSBC Source: HSBC

5G may open a significant opportunities in fixed radio access (FRA) for emerging markets

As discussed previously, WiFi would remain a best-efforts service. It lacks scalability and cannot

substitute for mobile. However, 5G might be a substitute for fixed-line connections with FRA in

certain contexts. There could be an interesting development for FRA in EEMEA markets as a

substitute for satellite broadband (like in Nigeria), providing cheaper backhaul capabilities in

rural areas and fixed wireless broadband services in rural urban areas (some parts of Russia,

Turkey, North Africa and Africa) where no fixed line infrastructure really exists. FRA could play a

key role in areas where the balance of population density, the value of the available market and

the practicability of deployment are right.

5G use: FRA and IoT

Source: HSBC

What is FRA?

Proposed FRA solutions work over mmWave frequencies exploiting beam-forming techniques.

One drawback of such high frequencies is their limited range, perhaps 100-200 metres as a

base-case and up to 500 metres when working with line-of-sight.

5G FRA could open opportunities in Emerging EMEA

We believe FRA could be an interesting technology to provide fixed broadband with line of sight

into medium cities or villages where there are currently no alternatives (such as cable, fibre, or

even VDSL or G fast). We see an application in regions and countries such as Africa, North

Africa or in rural areas in Russia, Turkey and even Poland.

In the US, Verizon and AT&T have publicly disclosed their plans for 5G, placing particular

emphasis on its capabilities in a fixed-line context. One solution being trialled by AT&T involves

using millimetre wave to send a multi-Gbps signal from one central building (which is connected

directly by fibre) to its neighbours via rooftop-mounted antennae. Each individual apartment in

the block served by this wireless signal is then connected to the building’s existing (copper)

wiring. It was trialling a point-to-point millimetre wave wireless technology coupled with in-

building wiring to provide 100Mbps bandwidths to individual households.

Dis

trib

ute

d C

en

tra

lise

d

<1980s:

mainframe

1990s-2000s:

client/server

Future: the

cloud

Processing on desktops Processing in the cloud

Interesting development and

monetisation opportunities of

5G FRA in EEMEA

5G FRA would provide cheap

backhaul and fixed wireless

broadband in rural urban

areas


16 March 2017

38

We believe 5G FRA could be an economical way of providing fixed broadband in areas where it

is unavailable. G fast would probably be a better solution economically if a fixed line connection

existed. We believe 5G FRA could be a solid alternative to satellite broadband delivery with 5G

FRA bringing a much better latency and higher capacity to the end user, at perhaps a lower cost.

Facebook has signalled its interest in wireless solutions, with two development projects

underway: Terragraph and Project ARIES (Antenna Radio Integration for Efficiency in

Spectrum). Project ARIES involves base stations with 96 antennae capable of supporting 24

simultaneous communications streams. It uses massive MIMO (i.e., spatial multiplexing) to

deliver a claimed 71bits/Hz. MIMO can be used to improve bandwidth or to provide wider

coverage, and it is the latter that is the focus for Project ARIES, which seems aimed at rural

areas in emerging markets.

At 20Mbps+ speeds, the end-user cannot really discern any difference in webpage download

time (see following chart). A 20Mbps connection should also offer sufficient capacity to transmit

4K TV. The transmission speed requirement is likely to decrease with the introduction of new

coding and compression algorithms. At the same time, we would expect 5G FRA equipment to

be cheap as it would be designed for the mass-market and for integration into smartphone

chipsets. In our view, this should ensure 5G FRA becomes an attractive proposition to deliver

fixed wireless broadband where there is no fixed line alternative.

Average webpage download time, by advertised download speed

Source:FCC report, 2016 Measuring Broadband America Fixed Broadband Report

Convergence could be accelerated through 5G

In our global telecom thematic FT5G: What the telecoms sector need is a new acronym, we

demonstrated that fixed and mobile networks are more compliments than substitutes. Our analysis

shows that triple-play (Fixed, TVoIP, Broadband) is accretive but quad-play has a greater risk of a

negative-sum game due to more significant discount expected for taking mobile as an add-on

service. In theory, convergence can provide a means of cross-selling and up-selling. However, this

may be at the expense of other providers if the new services are not incremental, therefore

becoming a zero-sum game. In this case, mobile-only players will have to fight back via price

discounting (since they lack the relevant fixed-line infrastructure to counter by other means), and

hence the revenue picture is liable to become a negative-sum game. The graphs below illustrates

that discount is still the most important criteria for the end consumer in taking a bundle.

0

1

2

3

4

5

6

7

8

9

0 25 50 75 100 125 150

Ave

rag

e w

ebp

age

do

wn

load

tim

e (s

eco

nd

s)

Advertised download speed (Mbps)

Cable DSL Fibre Satellite Multiple

5G FRA could be a strong

substitute for satellite

broadband

Facebook is already targeting

rural emerging markets

through project ARIES

Attractive proposition for

fixed wireless broadband

where there are no fixed lines

Diversified operators at an

advantage through bundles

versus pure mobile

competitors

39


16 March 2017

Reasons for taking a bundle (Proportion of respondents)

Source: Plum Consulting, Ofcom (2010)

Diversified/Converged operators likely to get a cost advantage

While quad-play may not be revenue accretive, bundles can significantly improve margins.

Operators such as Magyar Telekom have demonstrated that converged bundles can

significantly decrease churn and increase customer loyalty. 5G will mean more convergence all

round as backhaul and density of sites will increase. Associated backhaul costs will be cheaper

if the operator owns the network. In this case converged operators are likely to enjoy cost

advantage over pure-play competitors. If quad-play is required in selling broadband in the

bundle or 5G as a new product, operators will not incur wholesale costs if they own their

network and in particular their backhaul and backbones. On the other side, it will be difficult for

pure-play mobile players to be credible bundlers of broadband/payTV or have a cost advantage

over their competitors if they themselves do not own the fixed lines infrastructure. Even if

incumbents are obliged to resell infrastructure, they will earn a return in excess of capital cost.

The value of fixed lines assets/backhaul infrastructure is likely to increase for pure mobile

operators and the transition to 5G is likely to accelerate that trend.

5G impact for EEMEA telcos

In the previous sections, we have highlighted the 5G opportunities and threats to EEMEA

telecom operators. We believe EEMEA telecoms operators will have a greater chance of

monetising and/or improving margins if they operating in countries where:

Access to spectrum is cheap and channelled to existing operators instead of disruptors on

new entrants (e.g. Russia, GCC)

License and frequencies are tech neutral (most EEMEA countries)

Net neutrality is not required and zero rating pricing of content is accepted by regulators

(Russia, GCC)

Disruptive new entrants (Google Fi) or technology (VoIP) are limited for national security

reasons (Russia, GCC)

There are opportunities for broadband to Rural urban mid size cities through 5G Fixed

Radio Access with a lack of fixed alternatives (Cable, Fiber, xDSL) in those regions (some

regions in Russia, Turkey, Sub-saharan Africa, South Africa)

Competition is limited to three players with no small players (danger of layering)

(e.g. Turkey, GCC, South Africa)

We believe countries like Russia, those in GCC and and South Africa should provide a relatively

good environment with which to monetise 5G opportunities while limiting potentially disruptive risks.

0%

10%

20%

30%

40%

50%

60%

70%

80%

Cheaper Convenience - onesupplier

Convenience - one bill Easier to budget Good experience withprevious supplier

With 5G, value of fixed lines /

backhaul set to increase for

pure mobile operators


16 March 2017

40

In our view, EEMEA telecom operators are more likely to succeed if they present the

following characteristics:

Diversified fixed and mobile operations (5G fusioning with WiFi, wireless automatic offload)

competing with pure mobile operators

Are able to invest and deep pocket (densification of cells)

Superior tech neutral spectrum

Strong innovation skillsets in service layers

Strong software skillsets

How do EEMEA telcos scores on 5G monetisation

The following table ranks each EEMEA telecoms operator we cover according to four key

criteria. The scores range from 1 (least positive) to 5 (most positive).

The companies that rate highest are those with:

The most room to monetise 5G. Operators with a high potential for data and connectivity

growth; strong opportunities in 5G Fixed Radio Access, have investment capacity to meet

demand and are ready for bundles. We think integrated operators (i.e. those with fixed and

mobile operations) with access to premium content are better positioned against pure

mobile operators.

Low level of services substitutes or rational competition. Countries where there is in-market

consolidation fare better. We have observed more rational competition post-merger as the

number of players and substitutes diminishes. Conversely, markets with potential new entrants

score worst. The objective of smaller players is to gain market share and reach critical mass.

In pursuit of that goal, they can become aggressive on tariffs (and in some cases irrational).

With 5G, small players may introduce a risk of significant discount through layering. Two- or

three-player markets generally rank higher than four- or five-operator markets. Security

concerns (telecoms are perceived as strategic assets) could inhibit deep pocketed international

new entrants.

Accommodating regulation on 5G. We like markets that present fewer regulatory

constraints and companies operating in such countries rank highly. We prefer beauty

contests to auctions as it enables operators to buy spectrum at more advantageous prices.

We favour technology-neutral licenses because existing spectrum can be used for 5G. The

absence of net neutrality policy also helps existing telcos monetise data traffic through

prioritisation. Zero-rating data content could also advantage operators with content.

An adequate business model with 5G dynamics. Companies that have superior network,

superior spectrum and strong innovation and software skills (digital agenda) and are

diversified rank higher, as do those with adequate strategies that address cannibalisation of

voice by data. These plans can be in the form of data-tiered packages, convergence

services and strong brand positioning. In more mature markets, we welcome site-sharing

and a more cooperative approach among players as long as it is limited to the passive

network element. Companies with business models that relinquish control of the active

network rank low: this presents a risk at times of new technology roll-out cycles such as 5G.

We summarise the score for each company in the table below. Overall Russian telcos (MTS,

Megafon), Turkcell and MTN score well. In MENA, Ooredoo and Saudi Telecom have the

highest scores in their regional group.

41


16 March 2017

Thematic Score (Long Term)

higher points for countries with strong opportunities in

FRA with low substitutes, diversified and ready for bundles, with still high

potential for data and connectectivity growth

higher point for consolidation and low

competition and substitute, lower points for new

entrants, more than 3 players with a weak players

higher point for tech neutral licenses, no net neutrality

(+1), light regulation, cheap spectrum, zero pricing

content accepted

higher point for diversified operators, with superior

spectrum, superior network with strong balance sheet

and strong software and innovation skills

5G Company data monetisation ability

Competitive threats and risk 5G regulation Company model adequate to 5G drivers

Overall score

Companies (high=5, low=1) (Good=5, Bad=1) (low=5, high=1) (excellent=5, bad =1)

Etihad Etisalat(Mobily) 3 3 4 2 12 Etisalat 4 3 4 4 15 Global Telecom 4 4 4 3 15 Magyar Telekom 3 3 3 3 12 Megafon 5 4 4 3 16 Mobile Telesystems 5 4 4 4 17 MTN Group 4 4 4 4 16 O2 CZ 3 3 2 3 11 Ooredoo 4 3 3 3 13 Orange Polska 2 2 2 3 9 Rostelecom 2 3 3 3 11 STC 4 3 3 4 14 Telkom SA 3 2 3 3 11 Turk Telekom 4 4 3 4 15 Turkcell 4 4 4 4 16 VimpelCom Ltd 3 4 4 5 16 Viva Kuwait 2 2 3 3 10 Vodacom Group 3 3 3 3 12 Vodafone Qatar 2 3 2 3 10 Zain Group 3 3 3 3 12 Zain KSA 2 3 4 1 10



16 March 2017

42

Short-term drivers

We look at what we see as the three key drivers of short-term share price performance for

EEMEA telcos. We acknowledge the fact data is becoming the most significant growth driver

and have analysed data monetisation and affordability. We quantify the impact of currency

fluctuation: there is much more dislocation between countries and significant disparity among

EEMEA telcos. Lastly, we analyse each company’s OpFCF and dividend outlook because

investors still perceive the sector as a dividend yield play.

The table below ranks each company under our coverage relative to the above-mentioned

factors. The scores range from 1 (least positive or negative) to 5 (most positive). The scoring

methodology is detailed in the previous sections.

The valuation score is based on: the target price upside; 2018e EV/EBITDA, EV/OPFCF;

dividend yield relative to the sector average.

Potential winners and losers

ZAIN, MAGYAR, O2 CZ, TCELL rank favourably on short-term

drivers

Russian/Turkish telcos and MTN are well positioned for the long-term

impact of 5G

Key Buys: TCELL, VIP, MTN and MAGYAR on short-term drivers

Short-term drivers

Data affordability and monetisation

FX sensitivity Dividend outlook Overall score

Etihad Etisalat(Mobily) 3 5 1 9 Etisalat 4 3 5 12 Global Telecom 2 4 2 8 Magyar Telekom 3 4 5 12 Megafon 3 2 3 8 Mobile Telesystems 3 2 4 9 MTN Group 3 3 3 9 O2 CZ 3 5 5 13 Ooredoo 3 5 4 12 Orange Polska 1 3 3 7 Rostelecom 3 3 3 9 Saudi Telecom Company 4 3 4 11 Telkom SA 3 3 3 9 Turk Telekom 4 1 4 9 Turkcell 5 2 2 9 VimpelCom Ltd 3 2 4 9 Viva Kuwait 2 4 2 8 Vodacom Group 3 3 3 9 Vodafone Qatar 2 4 2 8 Zain Group 3 5 5 13 Zain KSA 1 5 1 7

Source: HSBCe

43


16 March 2017

Valuation score

Company EV/EBITDA EV/OPFCF PE DCF upside Yield Average

valuation score

Etihad Etisalat(Mobily) 6 4 3 20 9 8 Etisalat 9 12 4 3 18 9 Global Telecom 22 22 18 19 1 16 Magyar Telekom 12 16 10 16 16 14 Megafon 13 15 14 12 15 14 MTS 14 17 16 7 8 12 MTN Group 8 9 7 14 7 9 O2 CZ 4 8 6 6 19 9 Ooredoo 10 11 9 1 17 10 Orange Polska 15 13 1 11 14 11 Rostelecom 21 19 15 8 4 13 Saudi Telecom Company 7 6 8 13 20 11 Telkom SA 18 14 12 15 5 13 Turk Telekom 16 18 17 10 12 15 Turkcell 11 10 13 17 3 11 VimpelCom Ltd 19 21 20 21 21 20 Viva Kuwait 20 5 11 5 11 10 Vodacom Group 5 7 5 18 6 8 Vodafone Qatar 2 3 21 4 13 9 Zain Group 17 20 19 9 22 17 Zain KSA 3 2 21 2 9 7


We then rank operators in quintiles to get a net thematic long-term 5G score. We do the same

for our valuation scoring. A high net valuation score means a stock looks cheap relative to its

peers based on the four selected valuation criteria. We compare this with our valuation score in

the bubble chart overleaf. On both valuation and ST drivers, Zain Group ranks best in GCC,

VIP, Magyar Telekom and TCELL in EEMEA. In South Africa, the scoring does not highlight any

significant difference between operators.

Net ST Thematic score vs Net Valuation score

Company Net thematic score Net valuation score

Etihad Etisalat(Mobily) 2.6 1.9 Etisalat 3.2 2.6 Global Telecom 2.5 4.6 Magyar Telekom 3.2 4.1 Megafon 2.5 4.5 Mobile Telesystems 2.6 3.5 MTN Group 2.6 2.3 O2 CZ 3.4 2.1 Ooredoo 3.2 2.8 Orange Polska 2.3 2.3 Rostelecom 2.6 3.9 Saudi Telecom Company 3.0 3.0 Telkom SA 2.6 3.5 Turk Telekom 2.6 4.3 Turkcell 2.8 3.4 VimpelCom Ltd 2.6 5.0 Viva Kuwait 2.5 3.0 Vodacom Group 2.6 1.5 Vodafone Qatar 2.5 1.9 Zain Group 3.4 4.8 Zain KSA 2.3 1.4

Source: HSBCe


16 March 2017

44

Short-term thematic score vs Valuation relative

Source: HSBC

Long-term driver: 5G

5G brings opportunities as well as threats that will have a long-term impact on the fundamental

drivers of EEMEA telcos. We think the more successful operators are those with:

diversified fixed and mobile operations (5G fusionning with WiFi, wireless automatic offload)

or those who are not competing against diversified operators;

the ability to invest in the densification of cells,

superior spectrum which is technology-neutral

improving innovation and software skillsets

The companies with the highest scores present the following characteristics:

Most room to monetise 5G

Low level of services substitutes or rational competition

Accommodating regulation on 5G

A business model adequate with 5G dynamics

We summarise the score for each company in the table below. Overall, Russian telcos Turkcell

and MTN score best. In MENA, Ooredoo and STC have the highest scores in their region.

Mobily

Etisalat

GTH

MagyarMFON

MTS

MTN

O2 CZ

ORDS

OPL

RTKM

STC

Telkom SA

TTKOM

TCELL

VIP

Viva

Vodacom

Vod Qatar

Zain

Zain KSA

1

2

3

4

5

6

1 2 3 4 5

Val

uat

ion

Rel

ativ

e

Short term thematic Relative

Key :Buy =Hold =


45


16 March 2017

Thematic LT score breakdown

5G data

monetisation ability Competitive threats

and risks 5G Regulation

Company model adequate to 5G

dynamics Total Score

Mobily 3 3 4 2 12 Etisalat 4 3 4 4 15 Global Telecom 4 4 4 3 15 Magyar Telekom 3 3 3 3 12 Megafon 5 4 4 3 16 MTS 5 4 4 4 17 MTN Group 4 4 4 4 16 O2 CZ 3 3 2 3 11 Ooredoo 4 3 3 3 13 Orange Polska 2 2 2 3 9 Rostelecom 2 3 3 3 11 STC 4 3 3 4 14 Telkom SA 3 2 3 3 11 Turk Telekom 4 4 3 4 15 Turkcell 4 4 4 4 16 VimpelCom Ltd 3 4 4 5 16 Viva Kuwait 2 2 3 3 10 Vodacom Group 3 3 3 3 12 Vodafone Qatar 2 3 2 3 10 Zain Group 3 3 3 3 12


We then rank operators by quintiles to get a net thematic long-term 5G score. We do the same

for the valuation scoring. A high net valuation score means a stock looks cheap versus peers

based on the 4 selected valuation criteria. We compare this with our valuation score in the

bubble chart overleaf.

Our analysis shows Turkcell and Russian telecoms score best on valuation and 5G long-term

drivers. MTN perform wells in Africa and so does STC in the Gulf. The lowest ranked are Zain

KSA, Vodafone Qatar and Viva. In spite of its diversified network infrastructure, CE3 operators

rank in the medium quintile due to a combination of factors: heavy competition from cable

operators, large penetration of OTT (which can become a larger risk with 5G) and unhelpful

regulation (potential high spectrum cost).


Company Net thematic score Net valuation score

Etihad Etisalat(Mobily) 2.3 1.9 Etisalat 3.4 2.6 Global Telecom 3.4 4.6 Magyar Telekom 2.3 4.1 Megafon 3.9 4.5 Mobile Telesystems 4.6 3.5 MTN Group 3.9 2.3 O2 CZ 1.7 2.1 Ooredoo 3.0 2.8 Orange Polska 1.2 2.3 Rostelecom 1.7 3.9 Saudi Telecom Company 3.2 3.0 Telkom SA 1.7 3.5 Turk Telekom 3.4 4.3 Turkcell 3.9 3.4 VimpelCom Ltd 3.9 5.0 Viva Kuwait 1.4 3.0 Vodacom Group 2.3 1.5 Vodafone Qatar 1.4 1.9 Zain Group 2.3 4.8 Zain KSA 1.4 1.4

Source: HSBCe


16 March 2017

46


Source: HSBC

Conclusion

We highlight operators that score well on short-term drivers (affordability, currency impact,

dividend trend) as well as long-term factors (5G data monetisation, competitive threat and risks,

5G regulation, company model adequate to 5G dynamics and upcoming challenges). The table

below summarises our overall analysis.

ST scoring vs LT 5G scoring vs Valuation scoring

Highly ranked Lowly ranked

ST score Magyar Telekom, 02Cz , ZAIN, TCELL, Etisalat ZAINKSA, VIVA, VFQS 5G positioning score

MTS, MFON, TCELL, MTN, VIP, VIVA, VFQS, OPL,

Valuation Score (high=Cheap) ZAIN, GTH, TTKOM, TCELL, VIP, MFON, RTKM VFQS, VOD, 02Cz

Bold = Buy-rated Source: HSBC estimates

In consideration of the thematic scores and valuation score, we highlight our Buy-rated companies:

Turkcell, VimpelCom, MTN over the long-term and Magyar Telekom, Turkcell in the short-term.

Turkcell: Our bullish view on Turkcell is driven mainly by significant improvements in operational

trends. We expect Turkcell’s digital strategy to lead to an improvement in ARPUs, lower churn

rates and higher EBITDA margins. Given its infrastructure in mobile and fixed line segments, we

think Turkcell is successful in executing a convergence strategy. We expect the FCF outlook to

improve over the next few years driven by improving margins and declining capital spending. We

believe Turkcell’s capital spending cycle will reverse from FY17e. Capital expenditure peaked in

FY16, mainly driven by accelerated 4.5G rollout and volatility in TRY/ USD. Given the robust

growth outlook, we think Turkcell is attractive based on relative valuation.

VimpelCom: Our positive view on VimpelCom is driven mainly by improving dividend outlook on

the back of improving free cash flows. VimpelCom guides for equity free cash flow of more than

USD1bn for FY18 (compared to USD588m in FY16 and guidance of USD700-800m in FY17).

Management guides for low single digit growth in revenue and EBITDA. The growth in equity

free cash flows will be driven mainly by improvement in capital efficiency. VimpelCom’s

emphasis on disposing non-strategic assets will help it to reduce the capex/sales to c15% over

the medium term (currently 17-18%). Given the robust free cash flows over next few years, we

see significant scope for dividend improvement at VimpelCom.

Mobily

Etisalat

GTH

MagyarMFON

MTS

MTN

O2 CZ

ORDSOPL

RTKMSTC

Telkom SA

TTKOM

TCELL

VIP

Viva

Vodacom

Vod Qatar

Zain

Zain KSA

1 2 3 4 5

Val

uat

ion

Rel

ativ

e

Thematic Relative

Key :Buy =Hold =


47


16 March 2017

MTN: MTN finds itself in a unique ‘capex hike’ and ‘FX headwind’ cycle, which is contracting

FY17e FCF margins. We believe the base is suitably low for FCF/dividend delivery to exceed

expectations over the next 12-24 months, despite higher Iranian repatriation and ZAR concerns

recently. Over the past three to five years the coefficient of variation (std dev/mean) for MTN’s

FCF yield and dividend yield has been significantly lower than that for EV/EBITDA and PE.

Cash-earnings and yield dynamics still drive MTN’s rating, and valuation is attractive on a

current forward FCF yield of 7.4% (1.8 std deviations above mean). Operational progress,

specifically data/VAS monetisation, will be significant over the medium term. All three engines

are growing strongly and are set to come off elevated-capex bases. Dividend transformation on

a two-year basis is meaningful with additional optionality if Nigeria repatriation can commence.

FY18e will be a transformational FCF/EBITDA period; we expect investors to start positioning

for this in 2017. In FY18e the effects of Naira depreciation will hit and the SA/Nigeria capex

bump-up will be in the base; we expect FY18e proportionate FCF to grow 31% y-o-y and

proportionate EBITDA to grow 10.2% y-o-y. Given the initiation of a progressive dividend theme

and new CEO/CFO placements in March/April 2017, we expect the market to price in the FY18e

recovery beforehand.

Magyar Telekom: Our bullish view on Magyar Telekom is based on an improving dividend

outlook supported by growth in FCF. We expect FCF to grow significantly on lower near-term

capex. We expect capital spending to decline by over10% y-o-y in FY17e and FY18e and

operating margins to be roughly stable in FY17e. Our cautious view on margins is mainly driven

by the entry of Digi and potential competitive pressures in Hungary, but we expect the impact of

Digi to be limited due to the lack of a mandatory national roaming agreement in Hungary.

Margin improvement should continue gradually and we expect EBITDA margin to reach c35%

over the next five years (compared with 32.7% in FY16). Based on improving margins and

declining capex, FCF yield looks robust over the next few years. The leverage ratio should

decline significantly, leaving significant scope for improving dividend: we have FY17e dps at

HUF30 (vs FY16 dps of HUF25). Magyar Telekom’s dividend policy is to maintain leverage ratio

(net debt/total capital) under 40%.


16 March 2017

48

Valuation methodology and assumptions for EEMEA telcos

Company Valuation Methodology Assumptions

Etisalat Relative valuation based SOTP EV/EBITDA 17e of 6x times for UAE, EV/EBITDA 17e of 5x for Maroc Telecom Global Telecom DCF based SOTP WACC of 14%, 12.6% and 12.2% for Algeria, Pakistan and Bangladesh

respectively Magyar Telekom DCF COE of 10.9%, RFR of 4.8%, Beta of 1.1 and MRP of 5.5% Megafon DCF COE of 14.6%, RFR of 8.5%, Beta of 1.1 and MRP of 5.5% Mobile Telesystems DCF COE of 14.6%, RFR of 8.5%, Beta of 1.1 and MRP of 5.5% Mobily (Etihad Etisalat) DCF WACC of 8.1%, COE of 9.4%, RFR of 2.5%, MRP of 7%, Beta of 1 MTN Group DCF based SOTP and DCF COE of 18.1%, RFR of 12%, Beta of 1, MRP of 6% O2 CZ DCF COE of 8%, RFR of 2.5%, Beta of 1 and MRP of 5.5% Ooredoo Relative valuation based SOTP EV/EBITDA 17e of 5.5x for Qatar, EV/EBITDA 17e of 3x for Iraq Orange Polska DCF COE of 9%, RFR of 3.5%, Beta of 1 and MRP of 5.5% Rostelecom DCF COE of 14.6%, RFR of 8.5%, Beta of 1.1 and MRP of 5.5% Saudi Telecom Company DCF and SOTP WACC of 6.6%, RFR of 2.5%, MRP of 7%, Beta of 0.73 Telkom SA DCF and SOTP COE of 13.5%, RFR of 8.5%, MRP of 5%, Beta of 1 Turk Telekom DCF COE of 16%, RFR of 10.5%, Beta of 1 and MRP of 5.5% Turkcell DCF COE of 16%, RFR of 10.5%, Beta of 1 and MRP of 5.5% VimpelCom Ltd DCF COE of 14.6%, RFR of 8.0%, Beta of 1.1 and MRP of 5.5% Viva Kuwait DCF WACC of 6.5%, RFR of 2.5%, MRP of 4.5%, beta of 1 Vodacom Group Discounted medium term

terminal value Terminal FCF Yield of 7.5%

Vodafone Qatar DCF WACC of 8.9%, COE of 13.2%, RFR of 2.5%, MRP of 7%, Beta of 1.53 Zain Group Relative valuation based SOTP EV/EBITDA 17e of 5x for Kuwait, EV/EBITDA 17e of 3x for Iraq and Sudan Zain KSA DCF WACC of 9%, COE of 12.1%, RFR of 2.5%, MRP of 7%, Beta of 1.4

Source: HSBC

Companies section

49


16 March 2017

Company description

Etisalat is the incumbent telecom operator in the UAE with leadership positions in the fixed and

mobile segments. It expanded internationally through a series of acquisitions and greenfield

projects and today 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). It also owns operations in South Asia

(Afghanistan, Pakistan, Sri Lanka). The UAE still represents half of group revenues and EBITDA

while Maroc Telecom (IAM MC, MAD142.80, Not rated) represents the bulk of the balance. For

the purpose of this thematic report, we only consider Etisalat’s key markets: UAE, Morocco,

Pakistan and Egypt.

Short-term drivers

Affordability, spend dynamics and potential for data monetisation

We expect Etisalat to continue to monetise data in the UAE relatively unimpeded. The UAE

telecom sector is characterised by high smartphone penetration (c. 70%), high average

smartphone selling price (USD300+) and pricing that is commensurate with income levels. The

UAE is a two-player market and perhaps the only GCC market where there is a modicum of

pricing rationality. Both operators have so far eschewed unlimited data pricing plans or free

handset bundles. Instead, they have been using data allowance as a retention tool whereby a

longer contractual commitment boosts monthly data allowance.

Instead, we think the challenge lies more in the international operations (Egypt, Morocco,

Pakistan and Western Africa), which in aggregate represent nearly 40% of group revenues. We

think competitive intensity – the majority of these markets have three or four players – as well as

significantly lower GDP/per capita, may inhibit Etisalat’s capacity to monetise data.

Currency impact

We expect negligible currency impact over the short term. We estimate the group has 70% of

debt and capital expenditure denominated in either USD or EUR.

Etisalat has no currency exposure from its UAE domestic operations (just over 50% of group

revenues) given that the AED is pegged to the USD. Instead, exposure lies in the domestic

operations of Maroc Telecom, and Egypt and Pakistan. These three markets contribute a third

of group revenues.

Etisalat (ETISALAT UH)

Cash generation suggests scope for dividend increase

Etisalat ranks best among GCC operators for 5G on our scorecard…

…however, rich valuation means we rate the stock Reduce with a

AED14.9 TP

Eric Chang*

Analyst

HSBC Bank Middle East Limited

[email protected]

+971 4 423 6554

Nikhil Mishra* EEMEA Telecom Associate

Bangalore

* Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations


16 March 2017

50

The MAD has weakened over the past three years and is now trading around 10 (to the USD).

HSBC expects the USD:EGP to settle around the 18 level by year-end. The PKR has been

stable for the past year and a half. We highlight that Maroc Telecom has significant operations

in Western Africa but currency fluctuation will have minimal impact on Etisalat because the XFA

is pegged to EUR.

Dividend outlook

Etisalat has maintained a prudent balance sheet, alternating between net cash and minimal net

debt positions. We do not expect management to deviate from that. The company does not

have a defined dividend policy other than an interim and final dividend payment. We therefore

expect an annual dividends increase of AED 0.05 per share from FY2017e. Current dividend

yield at half the free cash-flow yield suggest the UAE incumbent has significant room to

increase pay-out.

Long-term driver: 5G expected impact

Monetisation

We see Etisalat as be well placed to capitalise on the 5G opportunity. It has leading positions as

an integrated operator in the UAE and Morocco. We note that it does not offer any converged

bundles that include mobile services in either market.

We see opportunity where the topography allows FRA to substitute or even complement a fixed

network. For example, the technology could be being rolled out outside the Nile delta or in

Pakistan’s mountainous regions.

Competition

We discount the risk of new entrants. The markets in which Etisalat has a presence would

struggle to support an additional operator that might not be wholly driven by profit motives.

In the UAE, competition remains rational. Both operators have so far eschewed unlimited data

pricing plans or free handset bundles. Instead, they have been using data allowance as a

retention tool whereby a longer contractual commitment boosts the monthly data allowance.

The UAE government has limited the array of services offered by OTT players (example VoIP)

in the interests of national security; thus we see limited threat from Google or Facebook.

Competition is somewhat more elevated in the international operations. We note the Moroccan

regulator has designated Maroc Telecom a dominant operator which may level the playing field.

In Egypt, we expect Telecom Egypt’s entry into the mobile segment to disrupt the market

although there is no clarity on the commercial launch of services. We note however that its

mobile license (obtained in summer 2016) required it to “make the services available within six

months”, which has since lapsed. In Pakistan, PTCL lags its mobile competitors.

Regulation

On this metric, Etisalat scores highly due to the regulatory landscape in the UAE. In its domestic

market, the telecom license is independent of the transmission technology. The regulator’s

influence has so far been relatively benign.

We have not attributed the highest score due to increasing regulatory headwinds in the

international markets. Often, as in the case of Egypt and Morocco, operators need to bid

separately for a 4G mobile license and the relevant spectrum. In addition, we note the

Moroccan regulator has designated Maroc Telecom a dominant operator but has yet to impose

any regulation or constraints on it.

51


16 March 2017

Business model

From its experience as an integrated telecom operator in the UAE, Etisalat has deployed

data-enabled mobile networks in record time in Egypt and Saudi Arabia. Its 2014 acquisition of

Maroc Telecom adds to that knowledge base.

We see the case for 5G roll-out and adoption in the UAE but are circumspect about the potential in

its international markets. Competition and low GDP per capita conspire against an extensive roll-out.

Investment thesis

Despite its high relative ranking in our scorecard, we note that on a fundamental valuation

Etisalat trades at a significant premium to the EEMEA telecom sector average: 2017e

EV/EBITDA of 5.7x (EEMEA average 4.7x) and P/E of 18.9x (EEMEA average 11.1x). This

highlights its strong competitive positions (as the incumbent) in the UAE and Morocco, also

reflected in EBITDA margins in excess of 50% and its high cash generation. Nevertheless,

current multiples would presume that turnaround of its international operations (West Africa,

Egypt and Pakistan) is imminent and these subsidiaries’ EBITDA margins would converge with

those in the UAE and Morocco.

Valuation and Risks

Etisalat: ETISALAT UH, AED17.85, Reduce, TP AED14.90

We value Etisalat on a sum-of-the-parts methodology. We continue to value the UAE operations

on 6x 2017e EBITDA and Maroc Telecom (IAM MC, NR) at 5x 2017e EBITDA. We update the

current market value of PTCL (PTC PK, PKR 16.87, Not Rated). We value Egypt on 5.5x 2017e

EBITDA. We value Mobily at its TP of SAR27.20. We roll-forward net debt to 2017e year-end.

Our estimates are broadly unchanged. We have a AED14.90 TP, which implies 16.5%

downside. We rate the stock Reduce because valuation continues to look rich despite its strong

cash generating assets.

Etisalat SOTP

EBITDA EV % EV % (AEDm) 2017e /EBITDA stake (current) of EV

UAE 16,192 6.0x 100.0% 97,150 76.6% Maroc Telecom 6,957 5.0x 48.4% 16,838 13.3% Egypt 1,026 5.5x 66.0% 3,726 2.9% Pakistan 1,594 2.9x 23.4% 1,018 0.8% Asia 322 3.0x 100.0% 965 0.8% Subsidiaries 119,697 Mobily 4,043 27.0% 5,536 4.4% Nigeria 658 5.0x 40.0% 1,316 1.0% Associates 6,852 Other interests 296 0.2% EV 126,845 Debt 22,389 Cash -22,464 Adj. for minority's share in debt -3,315 Net debt -3,390 Equity value 130,235 Issued shares (m) 8,696.75 FV 14.90


Key upside risks include: Competition easing in Morocco, Egypt and Pakistan; Mobily

achieving a quicker-than-expected turnaround; a formal dividend policy; any further easing of

foreign ownership for the company; a weakening of the USD, which would have a positive FX

impact on Etisalat's earnings as almost half its revenues are non-dollar pegged.


16 March 2017

52

Relative valuation

Etisalat trades ahead of the sector average on a forward EV/EBITDA multiple. The share

price re-rating started when foreign ownership rules were relaxed in the summer of 2015.

Looking at estimates revision, it appears the consensus has become more prudent.

Etisalat’s dividend yield remains respectable at 5% for 2017e vs the peer average of 6x.

ETISALAT: Valuation Benchmark relative

Source: Thomson Reuters Datastream, HSBC estimates

Recent performance Relative valuation

1W 1M 3M 6M 12M

Price return 1.4% 0.3% -3.0% -10.1% -5.3%

Total return 1.4% 0.3% -3.0% -10.1% -1.2%

Total return vs EEMEA index (USD) 2.6% 0.2% -7.9% -12.0% -18.7%

Total return vs MSCI EEMEA Telecom (USD) 0.7% -1.7% -8.2% -12.9% -8.9%

Price return vs ADX 1.0% -0.1% -4.6% -11.7% -5.4%

Price Return (USD) 1.4% 0.3% -3.0% -10.1% -5.4%

Total Return (USD) 1.4% 0.3% -3.0% -10.1% -1.2%

1yr fwd EV/EVITDA Sales estimates revision

1yr fwd EV/OpFCF EBITDA estimates revision

Capped at +/-50x levels

Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision

3

4

5

6

7

Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17

EV/EBITDA Average -2 SD +2 SD

0

2

4

6

8

10

12


EV/OpFCF Average -2 SD +2 SD

0.0%

2.0%

4.0%

6.0%

8.0%


Yield premium vs GSec D/Y GSec 10Y bond yield

22,440

23,650

24,860

26,070

27,280

28,490

29,700

30,910

Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17

2015 2016 2017 2018 2019

45,410

48,560

51,710

54,860

58,010

61,160

64,310

67,460

Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16

2015 2016 2017 2018 2019

0

4,460

8,920

13,380

17,840

22,300

26,760

31,220


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e

EV/EBITDA EV/opFCF D/Y

53


16 March 2017

Financial statements

Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (AEDm)

Revenue 52,360 52,591 54,778 57,358

EBITDA 25,298 26,091 27,064 28,184

Depreciation & amortisation -7,543 -7,580 -7,869 -8,163

Operating profit/EBIT 17,755 18,511 19,195 20,021

Net interest -442 -176 -149 -152

PBT 10,693 10,677 11,302 12,006

HSBC PBT 12,202 10,677 11,302 12,006

Taxation -1,206 -801 -848 -900

Net profit 8,421 8,207 8,619 9,080

HSBC net profit 9,930 8,207 8,619 9,080

Cash flow summary (AEDm)

Cash flow from operations 23,254 26,174 26,652 28,031

Capex -7,092 -9,636 -9,995 -10,704

Cash flow from investment -7,092 -9,636 -9,995 -10,704

Dividends -8,708 -7,827 -8,262 -8,262

Change in net debt -2,075 1,322 615 354

FCF equity 14,515 15,562 15,660 16,275

Balance sheet summary (AEDm)

Intangible fixed assets 28,808 29,450 28,822 28,323

Tangible fixed assets 42,450 48,574 51,328 54,367

Current assets 44,358 41,951 41,562 38,192

Cash & others 23,676 22,464 21,849 18,188

Total assets 122,546 128,627 130,634 130,309

Operating liabilities 40,143 41,464 41,278 41,416

Gross debt 22,279 22,389 22,389 19,082

Net debt -1,398 -75 540 894

Shareholders' funds 42,701 45,184 45,541 46,360

Invested capital 51,796 56,047 58,585 61,278

Ratio, growth and per share analysis

Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 1.2 0.4 4.2 4.7

EBITDA -4.6 3.1 3.7 4.1

Operating profit -6.3 4.3 3.7 4.3

PBT -0.9 -0.2 5.9 6.2

HSBC EPS 1.8 -17.4 5.0 5.3

Ratios (%)

Revenue/IC (x) 1.0 1.0 1.0 1.0

ROIC 32.7 34.5 33.5 33.2

ROE 23.0 18.7 19.0 19.8

ROA 8.6 8.1 8.3 8.7

EBITDA margin 48.3 49.6 49.4 49.1

Operating profit margin 33.9 35.2 35.0 34.9

EBITDA/net interest (x) 57.3 148.4 181.4 185.1

Net debt/equity -2.5 -0.1 0.8 1.3

Net debt/EBITDA (x) -0.1 0.0 0.0 0.0

CF from operations/net debt 4932.6 3134.7

Per share data (AED)

EPS Rep (diluted) 0.97 0.94 0.99 1.04

HSBC EPS (diluted) 1.14 0.94 0.99 1.04

DPS 0.85 0.90 0.95 0.95

Book value 4.91 5.20 5.24 5.33

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 2.8 2.8 2.7 2.6

EV/EBITDA 5.8 5.7 5.5 5.2

EV/IC 2.9 2.6 2.5 2.4

PE* 15.6 18.9 18.0 17.1

PB 3.6 3.4 3.4 3.3

FCF yield (%) 9.7 10.5 10.6 11.1

Dividend yield (%) 4.8 5.0 5.3 5.3

* Based on HSBC EPS (diluted)

Issuer information

Share price (AED) 17.85 Free float 40%

Target price (AED) 14.90 Sector Diversified Telecoms

Reuters (Equity) ETEL.AD Country United Arab Emirates

Bloomberg (Equity) ETISALAT UH Analyst Eric Chang

Market cap (USDm) 42,260 Contact +971 4 423 6554

Price relative

Source: HSBC Note: Priced at close of 08 Mar 2017

8.00

10.00

12.00

14.00

16.00

18.00

20.00

22.00

24.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

22.00

24.00

2015 2016 2017

Etisalat Rel to DUBAI FINANCIAL MARKET INDEX

Financials & valuation: Etisalat Reduce


16 March 2017

54

Company description

Global Telecom is a diversified telecom operator with a presence in Algeria, Pakistan and

Bangladesh. Algeria contributes c35% of total group revenue, Pakistan contributes c44% and

Bangladesh contributes c21%. Global Telecom holding recently cancelled its GDR programme

and is now listed solely on the Egypt stock exchange.

Short-term drivers

Affordability, spent dynamics and potential for data monetisation

Smartphone and mobile data affordability is very low in Algeria, with currently around 40% of

mobile users there using mobile data services. Despite a significant untapped data usage market

we think further growth in mobile data penetration will be slower than other EEMEA markets.

Currently the price of the most affordable smartphone in Algeria represents around 40% of

average monthly disposable income. Moreover high competitive intensity and tough

macroeconomic conditions lead to high churn rates and ARPU erosion in Algeria in the short term.

The data monetisation opportunity in Bangladesh is impacted by aggressive competition, which

increased post the SIM-verification. The 3G network gap in semi-rural and urban areas will also

impact data growth in Bangladesh in the near term.

However, Pakistan should partially offset the slowdown in Algeria and Bangladesh. The recent

merger of Mobilink and Warid will impact mobile data growth in Pakistan further.

Dividend outlook

Global Telecom scores poorly on this parameter. It has not paid a dividend since 2009 and we do

not see any change in the company’s stance over dividends in the short term. The high competitive

intensity and tough macro in Algeria will lead to high churn rates and ARPU erosion. Post the recent

SIM verification programme competition appears to have grown more intense in Pakistan.

Global Telecom Holding

(GTHE EY)

Short term: Competitive intensity in Algeria and Bangladesh likely to

impede growth

Long term: Focus on turning asset-light in key operating markets is

positive

Maintain Hold, cut TP to EGP8(from EGP8.7)

Herve Drouet* Head of EEMEA TMT Equity Research HSBC Bank plc

[email protected]

+44 20 7991 6827

Venkata Velagapudi*, CFA

EEMEA Telecom Associate

Bangalore


55


16 March 2017


GTH is in a reasonably good position in Pakistan and Bangladesh to capitalise on a 5G launch

and we expect rational competition to help sustain strong margins over the medium term.

However, we are conservative about the prospects of GTH post a 5G launch in Algeria due to

the intense price competition there.

Spectrum prices should remain reasonable in our view. The strategic focus of the parent

company (VimpelCom) to turn asset light and dispose of non-strategic assets like towers may

be positive over medium term.

Investment thesis

We expect Bangladesh to be the key driver of growth for GTH. The recent consolidation of

Mobilink (GTH’s Pakistan segment) and Warid will help to improve margins further. However

growth outlook could be impacted by the Algeria and Pakistan segments. We expect revenue

and EBITDA to grow at c8% in the near term. GTH’s valuation looks attractive on our estimates,

trading at a 1 year forward EV/EBITDA multiple of less than 3x compared with the EEMEA

average of c5x. However, the company may prefer to deleverage rather than pay dividends to

shareholders over near term. We view the delisting of the GDR negatively as it will reduce

liquidity and limit investor access to the local listing in Egypt, with the potential associated risks

(cash repatriation constraints).

Change in estimates

We cut our estimates based on lower than expected Q4 2016 results and our revised expectations.

Old vs New estimates

Old 2017e 2018e 2019e

Revenue 3,370 3,559 3,759 EBITDA 1,488 1,567 1,651 Net profit 189 247 345 New 2017e 2018e 2019e Revenue 3,208 3,270 3,370 EBITDA 1,397 1,494 1,531 Net profit 180 225 286 Old vs New 2017e 2018e 2019e Revenue -5% -8% -10% EBITDA -6% -5% -7% Net profit -5% -9% -17%

Source: HSBCe

Valuation and Risks

Global Telecom Holding, GTHE EY, EGP7, Hold, TP EGP8

We cut our DCF-based SOTP target price to EGP8 from EGP8.7 for the local shares, driven by

our reduced estimates. We use a WACC of 14% (Previously 12.3%) to value the business in

Algeria, 12.6% for Pakistan and 12.2% (Previously 10.8%) for Bangladesh. We use a USD: EGP

spot exchange rate of 17.5 (18.7 previously). Our TP implies upside of 14.3% and we rate the

stock Hold as we anticipate short-term selling pressure from the GDR programme cancellation.


16 March 2017

56

GTH sum of the parts valuation

EV Stake GTH's share in EV

Algeria 2044 49% 2044 Pakistan 2058 100% 2058 Bangladesh 891 100% 891 Total EV 4993 4993 Group net debt -1995 -1995 Minorities -693 -693 Non-Core assets 481 100% 481 Contingent Liability -67 -67 Equity value 2786 2719 Shares (fully diluted) (in millions) 5246 5246 Value per share(USD) at 2017 end 0.52 Current Fair value 0.46 USD-EGP exch rate 17.5 Target price (EGP) 8.0

Source: HSBCe

Main upside risks: higher market share gain and margin recovery in Algeria from the recent 4G

launch and superior cash return from potential sale and lease back of tower businesses in

Pakistan and Bangladesh.

Main downside risks: continuous erosion of the Algerian telecom markets due to increased

competitive pricing, increasing competitive pressure in key operating markets like Pakistan,

Bangladesh and Algeria.

57


16 March 2017

Valuation Relative

One of the cheapest on most relative ratios versus the EEMEA telecoms sector but no

dividend yield

Back to historical valuation relative after strong share price performance

Relatively stable consensus trend in particular on opFCF

Global Telecom Holding: Valuation Benchmark Chart

Source: Thomson Reuters Datastream, HSBCe


1W 1M 3M 6M 12M

Price return 10.2% -4.9% 18.6% 69.1% 218.2%

Total return 10.2% -4.9% 18.6% 69.1% 218.2%

Total return vs EEMEA index (USD) 1.8% -3.1% 16.6% -17.1% 23.3%

Total return vs MSCI EEMEA Telecom (USD) 9.6% -6.9% 13.4% 66.3% 210.6%

Price return vs EGX 4.1% -1.2% 5.9% 13.6% 117.3%

Price Return (USD) 0.6% -3.0% 21.5% -15.2% 40.6%

Total Return (USD) 0.6% -3.0% 21.5% -15.2% 40.8%





0

1

2

3

4

5



0

10

20

30

40

50

60

70



0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%



1,130

1,240

1,350

1,460

1,570

1,680

1,790

1,900


2014 2015 2016 2017 2018

2,620

2,840

3,060

3,280

3,500

3,720

3,940

4,160


2014 2015 2016 2017 2018

0

360

720

1,080

1,440

1,800

2,160

2,520


2014 2015 2016 2017 2018

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

58


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (USDm)

Revenue 2,957 3,208 3,270 3,370

EBITDA 1,294 1,397 1,494 1,531

Depreciation & amortisation -667 -669 -659 -649

Operating profit/EBIT 627 727 834 881

Net interest -258 -269 -277 -264

PBT 436 459 544 633

HSBC PBT 406 459 544 633

Taxation -147 -166 -204 -226

Net profit 155 180 225 286

HSBC net profit 126 180 225 286

Cash flow summary (USDm)

Cash flow from operations 913 973 1,051 1,064

Capex -465 -583 -596 -608

Cash flow from investment -473 -583 -596 -608

Dividends 0 0 0 0

Change in net debt 13 -321 -439 -449

FCF equity 424 378 418 433

Balance sheet summary (USDm)



Current assets 1,165 2,173 2,621 3,085

Cash & others 606 1,608 2,047 2,496

Total assets 5,598 6,520 6,892 7,329


Gross debt 2,602 3,283 3,283 3,283

Net debt 1,995 1,675 1,236 787

Shareholders' funds 404 584 809 1,095



Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 0.9 8.5 1.9 3.1

EBITDA 1.1 7.9 6.9 2.5

Operating profit 25.1 16.1 14.7 5.6

PBT 206.9 5.3 18.7 16.2

HSBC EPS 435.2 43.3 24.7 27.5

Ratios (%)

Revenue/IC (x) 1.2 1.4 1.4 1.5

ROIC 16.9 19.6 23.0 25.7

ROE 33.6 36.4 32.2 30.1

ROA 8.9 8.1 8.1 8.7

EBITDA margin 43.8 43.5 45.7 45.4



Net debt/equity 374.3 202.9 106.0 50.0

Net debt/EBITDA (x) 1.5 1.2 0.8 0.5

CF from operations/net debt 45.8 58.1 85.0 135.2

Per share data (USD)

EPS Rep (diluted) 0.03 0.03 0.04 0.05

HSBC EPS (diluted) 0.02 0.03 0.04 0.05

DPS 0.00 0.00 0.00 0.00

Book value 0.08 0.11 0.15 0.21

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 1.4 1.2 1.1 0.9

EV/EBITDA 3.3 2.8 2.4 2.0

EV/IC 1.8 1.7 1.6 1.4

PE* 16.5 11.5 9.2 7.2

PB 5.1 3.5 2.6 1.9

FCF yield (%) 18.5 16.6 18.3 19.0

Dividend yield (%) 0.0 0.0 0.0 0.0


Issuer information

Share price (EGP) 7.00 Free float 48%

Target price (EGP) 8.00 Sector Wireless Telecoms

Reuters (Equity) GTHE.CA Country Egypt

Bloomberg (Equity) GTHE EY Analyst Herve Drouet

Market cap (USDm) 2,074 Contact 44 20 7991 6827

Price relative


0.77

1.77

2.77

3.77

4.77

5.77

6.77

7.77

0.77

1.77

2.77

3.77

4.77

5.77

6.77

7.77

2015 2016 2017

Global Telecom Rel to EGYPT HERMES INDEX

Financials & valuation: Global Telecom Hold

59


16 March 2017

Company description

Magyar Telekom is a diversified telecom operator in Hungary, Montenegro and Macedonia. The

Hungary segment contributes c87% of group revenue, of which mobile represents c53% and

fixed line, c33%.

Short-term drivers


Currently, mobile data users comprise 48% of the total mobile subscriber base for Magyar

Telekom, and mobile data revenue constitutes c26% of mobile service revenue. The improving

macro in Hungary should lead to increased smartphone penetration enabling the mobile data

revenue to grow further. Smartphone penetration is at 61% for Magyar Telekom. The most

affordable smartphone costs less than 4% of monthly PPP-adj GDR per capita in Hungary and

the average mobile data price per GB accounts for 0.34% of PPP adjusted GDP per capita.

Currency impact

We expect the currency impact to be negligible for Magyar Telekom short-term as USD:HUF

exchange rate is forecast flat over 2017, as per HSBC’s FX strategists. Roughly 20% of

Magyar’s debt comprises EUR-denominated debt; however there is a cross currency swap that

completely hedges this. Around 67% of Magyar Telekom’s capital expenditure is in hard

currency for FY16.

Dividend outlook

We looked at Magyar Telekom’s dividend outlook based on the attractiveness of dividends and

its ability to maintain them. We are encouraged by a reduction in leverage over the past few

quarters, with Q4 2016 leverage ratio (net debt/ (net debt + equity)) falling to below 40%

(39.3%). Magyar Telekom announced a dividend of HUF25 per share for FY16. We estimate

DPS of HUF30 in FY2017 .Magyar Telekom’s dividend policy is to keep the leverage ratio (net

debt/total capital) under 40%. We forecast this falling to 33.2% by end-FY18 and 29.2% by end-

FY18, which implies significant room for further dividend improvement.

Magyar Telekom (MTELEKOM HB)

Short-term drivers look encouraging, mainly due to dividend outlook

Moderately placed to benefit from 5G.Convergence strategy and

network sharing will help but completion and regulation challenging

Attractive based on valuation score; Maintain Buy and HUF580 TP


[email protected]

+44 20 7991 6827



Bangalore



16 March 2017

60


We expect Magyar Telekom to be moderately well placed to capitalise on the benefit of 5G. Given

its mobile and fixed operations, we think it is well placed to offer bundled services and would be at

an advantage as a diversified incumbent with a strong presence in fixed broadband. Currently, its

Magenta1 offer is being well received by the customers in Hungary, with over 113k subscribers

using Multi play Magenta1. Over 50% of Magenta1 subscribers have at least 30Mbps fixed

broadband, with the share of plans including unlimited mobile voice and SMS at close to 50%.

Although, there is a potential four mobile operator (Digi, NR) in Hungary in FY17, we believe the

competitive challenge will be limited by the lack of a mandatory national roaming agreement

and limited quantity of spectrum available to Digi. With potential 5G fusion with WiFi, cable

operators such as Liberty Global (LBTYA.OQ, USD, Buy) could play a role as well as some OTT

players such as Facebook (FB.OQ, USD137.7, Not rated) or Google (GOOGL.OQ, USD853,

Not rated) This could be potential threat to 5G monetisation.

The regulatory framework is unlikely to be supportive with net neutrality in place and additional

spectrum likely to be auctioned at a significant price. We do not see any major changes to the

existing regulatory environment in Hungary in the medium term. We think Magyar Telekom’s

business model can deal with 5G dynamics as it has a strong balance sheet, continues to invest

and is developing its software skills. The company has a 4G network sharing agreement with

Telenor, which is one reason for its reduced capital spending over recent quarters. We expect

Magyar Telekom to continue to collaborate with other players to reduce the capital expenditure

required for 5G roll out as well.

Investment thesis

Our bullish view on Magyar Telekom is based on improving dividend outlook supported by

growth in FCF, which we expect to grow significantly owing to lower capex in the near term.

We expect capital spending to decline by over 10% y-o-y in FY17e and FY18e and operating

margins to be roughly stable in FY17e. Our cautious view on margins is mainly driven by the

potential entry of Digi and competitive pressures in Hungary. However, we would expect Digi’s

impact to be limited due to the lack of a mandatory national roaming agreement in Hungary. We

expect gradual margin improvement to continue, with EBITDA margin reaching c35% over the

next five years (vs 32.7% in FY16).

Based on improving margins and declining capex, we expect FCF yield to be robust over the next

few years, with the leverage ratio declining significantly. This leaves significant scope for improving

the dividend: we estimate HUF30 FY17 dps (vs HUF25 in FY16). Magyar Telekom’s dividend policy

is to keep the leverage ratio (net debt/total capital) under 40%: we expect this to fall to 33.2% by end-

FY17e and 29.2% by end-FY18e, implying significant room for further dividend improvement.

Based on an improving FCF outlook, Magyar Telekom looks attractive based on 1 year forward

EV/Operating FCF. It trades at a 1 year forward EV/Op FCF of 8.7x (compared to the EEMEA

average of 11.8x).

Valuation and Risks

Magyar Telekom: MTELEKOM HB, HUF500, Buy, TP HUF580

Our fair value TP of HF580 for Magyar Telekom is based on DCF model assuming a COE of

10.9%, RFR of 4.8% (based on the historical Hungarian long-term sovereign yield average),

MRP of 5.5% and a beta of 1.1. Our fair value target price of HUF580 implies upside of 16.0%

and we rate the stock Buy, mainly driven by its improving cash flow and dividend outlook.

Downside risks include more aggressive competition in the domestic mobile segment, a

weaker than expected recovery in the EBITDA margin, a slowdown in the Hungarian economy

and lower than expected dividends.

61


16 March 2017

Valuation Relatives Attractive valuation on EV/OPFCF 17e versus EEMEA telecom sector

High Dividend yield with significant spread

Rising EBITDA consensus estimates and stable OpFCF expectation

Magyar Telekom: Valuation Benchmark Chart



1W 1M 3M 6M 12M

Price return -0.4% -2.4% 2.6% 10.7% 12.6%

Total return -0.4% -2.3% 2.7% 10.9% 16.3%

Total return vs EEMEA index (USD) -0.3% -4.5% -1.8% 1.3% -5.4%

Total return vs MSCI EEMEA Telecom (USD) -1.1% -4.4% -2.6% 8.0% 8.7%

Price return vs Budapest exchange 1.9% -2.3% -3.7% -3.4% -16.3%

Price Return (USD) 0.0% 0.0% 0.0% 0.0% 0.0%

Total Return (USD) -1.5% -4.4% 3.2% 3.2% 12.1%





3

4

4

5

5

6



-40

-20

0

20

40

60



-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%



171,480

175,390

179,300

183,210

187,120

191,030

194,940

198,850


2015 2016 2017 2018 2019

567,640

579,430

591,220

603,010

614,800

626,590

638,380

650,170


2015 2016 2017 2018 2019

0

25,510

51,020

76,530

102,040

127,550

153,060

178,570


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

62

Financials & valuation: Magyar Telekom Buy Financial statements

Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (HUFm)

Revenue 602,651 560,555 557,559 564,365

EBITDA 197,039 182,562 184,906 190,296



Net interest -23,574 -18,522 -17,713 -16,805

PBT 52,748 52,126 57,762 71,763

HSBC PBT 50,967 52,126 57,762 71,763

Taxation 4,397 -13,553 -15,018 -18,658

Net profit 54,201 35,600 39,192 49,518

HSBC net profit 34,772 35,600 39,192 49,518

Cash flow summary (HUFm)


Capex -98,000 -84,699 -75,577 -72,112


Dividends -22,686 -31,282 -31,282 -31,282

Change in net debt -32,836 -83,671 -45,424 -52,146

FCF equity 78,848 63,521 75,241 79,788

Balance sheet summary (HUFm)



Current assets 193,978 277,485 322,309 375,816

Cash & others 15,909 102,303 147,727 199,873

Total assets 1,175,529 1,231,822 1,242,792 1,266,683

Operating liabilities -182,372 -228,650 -228,160 -230,228

Gross debt 392,466 395,189 395,189 395,189

Net debt 376,557 292,886 247,462 195,316


Invested capital 1,322,971 1,339,148 1,304,204 1,278,018


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue -8.2 -7.0 -0.5 1.2

EBITDA 5.2 -7.3 1.3 2.9

Operating profit 8.2 -11.2 6.8 17.3

PBT 16.3 -1.2 10.8 24.2

HSBC EPS 4.0 2.4 10.1 26.3

Ratios (%)

Revenue/IC (x) 0.5 0.4 0.4 0.4

ROIC 4.4 3.9 4.2 5.1

ROE 6.7 6.6 7.2 8.8

ROA 6.3 4.4 4.6 5.4

EBITDA margin 32.7 32.6 33.2 33.7



Net debt/equity 64.8 49.8 41.2 31.4



Per share data (HUF)

EPS Rep (diluted) 51.98 34.14 37.59 47.49

HSBC EPS (diluted) 33.35 34.14 37.59 47.49

DPS 25.00 30.00 30.00 30.00

Book value 516.42 520.56 528.14 545.63

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 1.6 1.5 1.4 1.3

EV/EBITDA 4.8 4.7 4.4 4.0

EV/IC 0.7 0.6 0.6 0.6

PE* 15.0 14.6 13.3 10.5

PB 1.0 1.0 0.9 0.9

FCF yield (%) 13.9 11.3 13.5 14.3

Dividend yield (%) 5.0 6.0 6.0 6.0


Issuer information

Share price (HUF) 500.00 Target price (HUF) 580.00 +

16

.0

%

Reuters (Equity) MTEL.BU Bloomberg (Equity) MTELEKOM HB

Market cap (USDm) 1,767 Market cap (HUFm) 521,371

Free float (%) 41% Enterprise value (HUFm) 854,420

Country Hungary Sector Diversified Telecoms

Analyst Herve Drouet Contact 44 20 7991 6827

Price relative

Source: HSBC

Note: Priced at close of 08 Mar 2017

200.00

250.00

300.00

350.00

400.00

450.00

500.00

550.00

200.00

250.00

300.00

350.00

400.00

450.00

500.00

550.00

2015 2016 2017

Magyar Telekom Rel to BUDAPEST SE

63


16 March 2017

Company description

Megafon is a diversified telecom operator with a presence mainly in Russia. More than 98% of

revenue comes from Russia, with the mobile segment contributes c92% of revenue from

Russia. Fixed line segment contributes c8% of revenue from Russia.

Short-term drivers


The cost of the most affordable smartphone in Russia represents c14% of monthly disposable

income. Mobile data prices are very low in Russian relative to EEMEA peers, with competitive

retailers incentivising mobile users to churn. We would like to see less aggressive promotion,

which could be driven by a shift of the Russian mobile operators towards more monobrand

shops. The split of Euroset shops between Megafon and VimpelCom will be a key catalyst in

our view. The tough macro in Russia may impede the ability to monetise data in the near term

but this could improve medium-term.

Currency impact

We expect Megafon to be at moderate risk from currency impact due to exchange rate

movement. A significant portion of capital expenditure is denominated in hard currency and 23%

of gross debt is in hard currency. HSBC FX strategists forecast RUB depreciating c6% y-o-y in

FY17 relative to USD. This may be a downside risk to Megafon as it may limit the capital

spending capability.

Dividend outlook

Megafon has the highest dividend yield among EEMEA telecoms, at c12%. Given robust free

cash flows and lower leverage, we expect the high dividend yield to be sustainable over next

few years.


We expect Megafon to be well placed to benefit from the launch of 5G in the medium term.

The recent acquisition of mail.ru will enable Megafon to diversify sources of revenue for

Megafon and reflects its intention to become a diversified player rather than being a

conventional telecom operator. Given that mail.ru is one of largest internet service providers in

Russia, the collaboration could create significant opportunities after 5G launch.

Megafon (MFON RX)

Short term: Dividend outlook seems attractive

Long term: Benign regulation in Russia and focus on diversifying the

operations will help

Maintain Buy and RUB700 TP

Herve Drouet* Head of EEMEA TMT Equity Research

HSBC Bank plc

[email protected]

+44 20 7991 6827



Bangalore



16 March 2017

64

We expect competition to turn rational gradually. The potential entry of disruptive new entrants

or technology players is limited in Russia due to security concerns. The Russian telecom

regulator is benign in terms of spectrum allocation as the mobile operators are allocated

spectrum at a low cost and the frequencies allocated are tech neutral. A lack of strict

enforcement of net neutrality is also positive for Russian telecoms.

Based on these factors we view Megafon to be well placed to capitalise on the 5G launch.

Investment thesis

Our bullish view on Megafon is mainly driven by the strong dividend outlook and robust cash

flow generation that will sustain it. We expect Megafon to offer the highest dividend yield among

EEMEA telecoms. FCF yield will be supported by declining capital spending, supported in the

near term by factors such as investment project prioritisation and optimisation of technical

solutions. We see Megafon as being at least risk among the Russian telecoms from the

potential cost of data storage units in the next few years.

The growth outlook for Russian telecoms is weak over the next few years driven by a saturated

market and tough macro-economic conditions in Russia. The recent acquisition of mail.ru

implies Megafon’s intention to shift away from being a traditional telecom service provider. We

expect Megafon to grow at low single digit over the next two to three years. However, free cash

flows are strong as low growth should be offset by limited capital spending.

Valuation and Risks

Megafon: MFON RX, RUB628.7, Buy, TP RUB700

We value Megafon GDR using a DCF model assuming a COE of 14.6%, RFR of 8.5%(based on

the sovereign yield of Russia), MRP of 5.5% and a beta of 1.1. Our TP remains unchanged at

RUB700. Our TP implies upside of 11.3%, and we rate the stock Buy given the attractive

valuation and dividend outlook. For Megafon ADR (MFON LI), we maintain our fair value TP of

USD10.80 using an exchange rate of USD1/RUB65.

Key downside risks to our rating and estimates include: increased competition and aggressive

entry of T2RTK in the Moscow region; a more-aggressive-than-expected decline in data pricing;

a sustained weakening economic outlook; and regulatory uncertainties.

65


16 March 2017

Valuation relatives

Looks attractive on EV/opFCF and EV/EBITDA versus sector

Consensus estimates on sales and EBITDA has increased recently due to the consolidation

of Mail.ru.

Attractive dividend yield but spread reduced by high Russian sovereign yield

Megafon: Valuation Benchmark Chart



1W 1M 3M 6M 12M

Price return -6.6% -1.2% 5.6% -7.8% -27.4%

Total return -6.6% -1.1% 9.9% -4.0% -18.0%

Total return vs EEMEA index (USD) -5.1% 0.4% 14.5% 2.9% -14.9%

Total return vs MSCI EEMEA Telecom (USD) -7.3% -3.2% 4.7% -6.8% -25.6%

Price return vs MICEX -4.9% 6.3% 13.9% -6.5% -33.5%

Price Return (USD) -5.6% 0.0% 13.3% 0.0% -10.5%

Total Return (USD) -6.3% 0.4% 19.4% 4.8% 2.6%





0

1

2

3

4

5

6

7



0

2

4

6

8

10

12

14



-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%



115,610

121,280

126,950

132,620

138,290

143,960

149,630

155,300


2014 2015 2016 2017 2018

305,390

312,050

318,710

325,370

332,030

338,690

345,350

352,010


2014 2015 2016 2017 2018

0

18,230

36,460

54,690

72,920

91,150

109,380

127,610


2014 2015 2016 2017 2018

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

66


Year to 12/2015a 12/2016e 12/2017e 12/2018e

Profit & loss summary (RUBm)

Revenue 313,383 316,356 318,382 330,020

EBITDA 132,357 120,516 125,666 135,261



Net interest -13,192 -16,230 -16,923 -18,190

PBT 51,550 40,389 44,977 54,754

HSBC PBT 60,665 40,866 44,977 54,754

Taxation -12,334 -10,327 -10,575 -12,593

Net profit 39,016 30,042 34,381 42,140

HSBC net profit 46,512 31,446 34,381 42,140

Cash flow summary (RUBm)


Capex -72,267 -67,748 -63,832 -63,461


Dividends -48,038 -48,625 -50,003 -50,003

Change in net debt -3,214 26,385 15,839 8,475

FCF equity 35,568 26,482 33,916 39,509

Balance sheet summary (RUBm)



Current assets 83,552 62,701 63,005 64,751

Cash & others 37,649 25,000 25,000 25,000

Total assets 454,536 439,554 455,994 457,805


Gross debt 219,680 233,416 249,255 257,730

Net debt 182,031 208,416 224,255 232,730




Year to 12/2015a 12/2016e 12/2017e 12/2018e

Y-o-y % change

Revenue -0.4 0.9 0.6 3.7

EBITDA -4.4 -8.9 4.3 7.6

Operating profit -8.8 -20.9 4.7 16.0

PBT 2.3 -21.7 11.4 21.7

HSBC EPS -10.2 -32.4 9.3 22.6

Ratios (%)

Revenue/IC (x) 1.0 1.0 1.0 1.0

ROIC 18.4 14.9 15.2 17.7

ROE 30.4 22.7 28.5 38.7

ROA 11.1 9.9 10.9 12.6

EBITDA margin 42.2 38.1 39.5 41.0



Net debt/equity 123.2 162.2 198.6 221.5



Per share data (RUB)

EPS Rep (diluted) 62.93 48.45 55.45 67.97

HSBC EPS (diluted) 75.02 50.72 55.45 67.97

DPS 56.45 80.65 80.65 80.65

Book value 238.55 207.34 182.14 169.46

Valuation data

Year to 12/2015a 12/2016e 12/2017e 12/2018e

EV/sales 1.7 1.7 1.7 1.7

EV/EBITDA 3.9 4.5 4.4 4.2

EV/IC 1.7 1.7 1.8 1.8

PE* 8.4 12.4 11.3 9.3

PB 2.6 3.0 3.5 3.7

FCF yield (%) 10.6 7.9 10.2 11.9

Dividend yield (%) 9.0 12.8 12.8 12.8


Issuer information

Share price (RUB) 628.70 Free float 15%

Target price (RUB) 700.00 Sector Diversified Telecoms

Reuters (Equity) MFON.MM Country Russian Federation

Bloomberg (Equity) MFON RX Analyst Herve Drouet


Price relative


280.00

480.00

680.00

880.00

1080.00

280.00

480.00

680.00

880.00

1080.00

2015 2016 2017

Megafon Rel to RTS INDEX

Financials & valuation: Megafon Buy

67


16 March 2017

Company description

Mobile Telesystems (MTS) is a diversified telecom operator with a presence in Russia, Ukraine,

Turkmenistan, Armenia and Belarus. MTS Russia contributes c91% of overall group revenue

and MTS Ukraine contributes c7%. The mobile segment contributes c86% of MTS Russia’s

overall revenue and fixed line contributes c14%.

Short-term drivers


We estimate almost half of mobile users in Russia have a smartphone, with the price of the

most affordable smartphone representing around 14% of monthly disposable income in Russia.

Mobile data prices are very low in Russia relative to EEMEA peers, with competitive retailers

incentivising mobile users to churn. We would like to see less aggressive promotion, which

could be driven by a shift of the Russian mobile operators towards more monobrand shops. The

split of Euroset shops between Megafon and VimpelCom is a key catalyst in our view. The

tough macro in Russia may impede the ability to monetise data in the near term but this could

improve medium term.

Currency impact

We expect MTS to be at a moderate risk of a currency impact due to exchange rate movement,

with 50-60% of capital expenditure denominated in hard currency and 27% of gross debt in hard

currency. HSBC FX strategists forecast RUB depreciating c6% y-o-y in FY17 relative to USD,

thus MTS is likely to be vulnerable to currency risk to some extent over the short term.

Dividend outlook

We expect a near-term dividend yield of c10%. Currently we do not factor any potential fine

related to Uzbekistan spectrum allocation into our estimates. However, this may be a downside

risk to free cash flow generation, which may impact the dividend outlook. However, the dividend

yield spread over sovereign yield is limited for MTS.


We expect MTS to be well placed to benefit from the launch of 5G. Given the infrastructure in

both mobile and fixed line segments MTS is in a good position to offer convergence services.

We expect competition to turn rational gradually and the potential entry of disruptive new

Mobile Telesystems (MTSS RX)

Short term: Moderate currency risk and potential fine from

Uzbekistan may impact the dividend outlook

Long term: Diversified operations and supportive regulation will help

Maintain Hold and RUB250 TP


HSBC Bank plc

[email protected]

+44 20 7991 6827

Venkata Velagapudi*, CFA EEMEA Telecom Associate

Bangalore



16 March 2017

68

entrants or technology players is limited in Russia due to security concerns. The Russian

telecom regulator is benign in terms of spectrum allocation as mobile operators are allocated

spectrum at a low cost, and the frequencies allocated are tech neutral. A lack of strict

enforcement of net neutrality is also positive for Russian telecoms’ further monetisation.

MTS’s intention to lease its towers in Russia will be positive over medium term and should be a

key revenue source as operators look to rent towers to lower the burden of capital spending.

The company’s execution skill is one of the strongest within the Russian telecoms operators in

our view, and it is gradually increasing its skills in software and in developing digital services.

MTS has developed and launch mobile payment services, e-commerce platform and is

developing ICT activities for corporates.

Based on these factors MTS looks well placed to capitalise on the 5G launch.

Investment thesis

The outlook for growth is limited in the near term for Russian telecoms, with MTS’s revenue

growing at under 2% y-o-y over the next two years on our estimates. Operating margins are

under pressure due to a higher proportion of revenue coming from equipment sales. The volatile

currency may impact the capital spending capability for MTS.

Free cash flow should be strong for MTS, although there are potential risks, such as a fine

related to Uzbekistan and data storage costs. These costs could compel MTS to stay

conservative while paying dividends in the short term.

Valuation and Risks

Mobile Telesystems: MTSS RX, RUB270, Hold, RUB250

Our fair value TP of RUB250 is DCF-based, assuming a COE of 14.6%, RFR of 8.5% (based on

the Russian sovereign bond yield) and beta of 1.1 and MRP of 5.5%.

Our TP of RUB250 implies a downside of 7.4%, and we reiterate Hold rating due to its better

than average dividend outlook relative to most of the EEMEA peers.

For the MTS ADR (MBT US), we maintain our TP of USD7.70 using USD/RUB exchange rate of

65 (unchanged) and one ADR equaling two shares.

Key downside risks include potential legal penalties related to Uzbekistan, increased

competition and aggressive entry of T2RTK in the Moscow region, a decline in data pricing,

sustained weakening economic outlook and regulatory uncertainties.

Key upside risks include no fine payment for Uzbekistan operations, RUB appreciation relative

to USD and better-than-expected growth in key markets such as Russia and Ukraine.

69


16 March 2017

Valuation relatives

Looks attractive on EV/opFCF but fairly priced on EV/EBITDA versus sector and history due

to good recent share price performance

Consensus estimates on sales and EBITDA declining but stable on OpFCF

Attractive dividend yield but spread limited due to high Russian sovereign yield

MTS: Valuation Benchmark Chart

Source: Datastream, HSBCe


1W 1M 3M 6M 12M

Price return -1.2% -0.4% 6.3% 9.6% 12.7%

Total return -1.2% -0.4% 6.3% 15.5% 25.8%

Total return vs EEMEA index (USD) 0.0% 0.8% 10.3% 24.1% 39.4%

Total return vs MSCI EEMEA Telecom (USD) -1.9% -2.4% 1.1% 12.7% 18.2%

Price return vs MICEX 0.5% 7.1% 14.5% 10.8% 6.6%

Price Return (USD) -2.7% 0.0% 16.1% 20.0% 38.5%

Total Return (USD) -1.2% 0.8% 15.2% 26.0% 56.9%





0

1

2

3

4

5



0

5

10

15

20



-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%



165,920

169,970

174,020

178,070

182,120

186,170

190,220

194,270


2014 2015 2016 2017 2018

397,350

410,990

424,630

438,270

451,910

465,550

479,190

492,830


2014 2015 2016 2017 2018

0

20,810

41,620

62,430

83,240

104,050

124,860

145,670


2014 2015 2016 2017 2018

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

70


Year to 12/2015a 12/2016e 12/2017e 12/2018e


Revenue 426,639 435,053 442,891 448,938

EBITDA 175,665 171,319 171,896 176,806



Net interest -20,973 -23,535 -19,283 -18,667

PBT 62,491 66,128 73,489 79,006

HSBC PBT 72,220 65,452 73,489 79,006

Taxation -13,269 -15,377 -16,902 -18,171

Net profit 51,307 51,726 57,672 62,003

HSBC net profit 57,694 51,372 57,672 62,003



Capex -96,111 -83,563 -78,150 -74,307


Dividends -50,704 -50,715 -50,715 -50,715

Change in net debt 31,584 -17,969 -7,804 -15,479

FCF equity 45,432 49,475 56,993 64,926




Current assets 159,017 102,512 103,688 104,595

Cash & others 83,304 40,000 40,000 40,000

Total assets 653,378 561,958 562,159 558,241


Gross debt 345,869 284,596 276,792 261,313

Net debt 262,565 244,596 236,792 221,313




Year to 12/2015a 12/2016e 12/2017e 12/2018e

Y-o-y % change

Revenue 3.9 2.0 1.8 1.4

EBITDA 0.1 -2.5 0.3 2.9


PBT -9.1 5.8 11.1 7.5

HSBC EPS -20.4 -11.0 12.3 7.5

Ratios (%)

Revenue/IC (x) 1.1 1.2 1.3 1.4

ROIC 18.5 19.1 21.5 22.9

ROE 35.4 36.8 47.0 47.0

ROA 11.4 12.0 13.1 13.9

EBITDA margin 41.2 39.4 38.8 39.4



Net debt/equity 155.9 198.7 183.6 159.1




EPS Rep (diluted) 25.81 26.02 29.01 31.19

HSBC EPS (diluted) 29.02 25.84 29.01 31.19

DPS 19.62 25.50 25.50 25.50

Book value 80.54 60.03 63.53 69.21

Valuation data

Year to 12/2015a 12/2016e 12/2017e 12/2018e

EV/sales 1.8 1.8 1.7 1.7

EV/EBITDA 4.5 4.5 4.4 4.2

EV/IC 2.0 2.3 2.3 2.3

PE* 9.3 10.4 9.3 8.7

PB 3.4 4.5 4.3 3.9

FCF yield (%) 8.7 9.5 10.9 12.4

Dividend yield (%) 7.3 9.4 9.4 9.4


Issuer information



Reuters (Equity) MTSS.MM Country Russian Federation

Bloomberg (Equity) MTSS RX Analyst Herve Drouet


Price relative


140.00

160.00

180.00

200.00

220.00

240.00

260.00

280.00

300.00

140.00

160.00

180.00

200.00

220.00

240.00

260.00

280.00

300.00

2015 2016 2017

Mobile Telesystems Rel to RTS INDEX

Financials & valuation: Mobile Telesystems Hold

71


16 March 2017

Company description

Mobily is a Saudi mobile operator with an extensive fibre network in the Kingdom. It was

established in 2004, shortly after the Etisalat-led consortium won a GSM and 3G license (for

SAR13bn). The following year the company listed on the Saudi Exchange and built a 3G network

with 79% population coverage at launch.

From the outset, Mobily decided network investments and marketing would be key to its

commercial success. 1m subscribers joined Mobily within 90 days of launch. The second

entrant was EBITDA-positive in Q4 2005 and turned profitable by Q1 2006. Free cash flow

generation started in Q3 2006.

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 programmes as well

as ii) 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, SAR3.8bn of

profits was restated from the 2013 and 2014 financials. Market reaction was unequivocal and

Mobily’s share price contracted by two-thirds.

Short-term drivers


We do not view affordability (handsets or services) as an issue given Saudi Arabia’s oil wealth.

However, telecom spending may be under pressure as the Saudi government’s efficiency drive

reduces allowances and subsidies.

We see data as a key driver of revenue growth. Mobile penetration in the Kingdom is in excess

of 150% whereas smartphone penetration is estimated to be 60%. Data monetisation is hence

correlated to the intensity of competition. We think Zain KSA and Mobily are unlikely to indulge

in value-destructive price wars as both need to resolve their high leverage.

Currency impact

We do not see any currency impact because the company only operates in Saudi Arabia where

the currency is pegged to the dollar.

Mobily (EEC AB)

Mobily is still in turnaround phase

Long-term drivers moderately supportive

Maintain Buy and TP SAR27.20

Eric Chang*

Analyst


[email protected]

+971 4 423 6554

Nikhil Mishra*


Bangalore



16 March 2017

72

Dividend outlook

We do not factor any dividend payments in the forecast period. We think management would

consider dividend payments once the operator returns to net profit and deleverages to a

sustainable level.

Mobily has been in discussion with STC to share telecom towers. An agreement would allow

opex and capex savings and should improve cash flow generation.


According to our scorecard, Mobily is in a moderate position to benefit from the 5G opportunity.

Monetisation

On this criteria, we rate Mobily one notch lower than STC given the latter’s extensive fixed

infrastructure (and, crucially, the link to the last mile). We acknowledge Mobily’s significant

network capex spend (although there is no disclosure on the proportion allocated to mobile or

fixed). We think the unified license introduced late last year will help the Etisalat affiliate target

the high value consumer and corporate segments.

Competition

We expect competition to remain rational and support 5G monetisation. We do not envisage

Zain KSA or Mobily engaging in value-destructive price wars because both companies need to

resolve their high leverage. In addition, we discount the risk of new mobile entrants given the

penetration rates and the fact that two out of three network operators struggle with profitability.

Regulation

In Saudi Arabia, the regulator has not introduced any regulation on net neutrality and the

practice of zero-rating. The introduction of a unified license has brought some respite to Mobily

and Zain KSA.

Business model

We think Mobily has a reasonable opportunity to monetise the 5G opportunity. It has invested

heavily in mobile and fixed infrastructure; it has adequate spectrum for the provisioning of 4G

services; the unified license may be a stepping stone to offering convergence services; and

Mobily benefits from a technical services agreement with its main shareholder Etisalat.

We have written at length in the thematic section of this report about the network densification

that 5G technology will impose. In that context, current discussions with STC to form a TowerCo

joint-venture would allow all parties to achieve lower capex and opex. Talks have so far focused

on the sharing of passive network element.

Investment thesis

Mobily has lost market share in the past two years and needs at least to stem the decline if not

reverse it. However, we think it is more likely to focus on improving ARPU growth (better for

profitability) rather than market share in order to drive up revenue.

The unified license should open up revenue streams and, most importantly allow the Etisalat

affiliate to monetise its extensive fibre infrastructure. We see profit potential but find it difficult to

quantify given lack of disclosure.

We do not see Mobily’s debt load and low profitability as insurmountable challenges.

Management has been effective with cost control and negotiations with various stakeholders: it

now needs to show its mettle with revenue growth.

73


16 March 2017

Valuation and Risks

Etihad Etisalat (Mobily), EEC AB, SAR21.65, Buy, TP SAR27.20

We value Mobily on a DCF, using a WACC of 8.1% based on following assumptions: cost of

equity of 9.4%, risk-free rate of 2.5% and equity risk premium of 7%. We use a beta of 1 and

long-term growth rate of 2%.

Our target price of SAR27.20 implies 25.6% upside and we rate the stock Buy as we see an

improvement in the regulatory environment and competitive landscape. We think the unified

license will open up new revenue and profit streams.

Downside risks include: Zain KSA pursuing market share instead of profitability; failure to

secure additional spectrum to facilitate continued broadband growth.


16 March 2017

74

Relative valuation

Mobily trades at a forward EV/EBITDA multiple that is significantly ahead of its peers. This

is a reflection of its turnaround phase where high debt and low profitability lead to higher

multiples.

Estimates revisions suggest consensus remains sceptical of Mobily’s turnaround story.

We do not expect dividend payments to resume. The company remains in turnaround mode

and its priority is to deleverage.

Mobily: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return 1.3% 0.8% -12.3% -3.6% -14.7%

Total return 1.2% 0.7% -12.2% -3.4% -14.8%

Total return vs EEMEA index (USD) 2.5% 0.6% -17.1% -5.2% -32.1%

Total return vs MSCI EEMEA Telecom (USD) 0.5% -1.3% -17.4% -6.2% -22.4%

Price return vs Tadawul 1.2% 0.8% -10.2% -16.4% -23.1%

Price Return (USD) 1.6% 1.6% -12.2% -3.0% -14.5%

Total Return (USD) 1.3% 0.7% -12.1% -3.3% -14.7%





3

5

7

9

11

13



-10

0

10

20

30

40

50

60

70



-5.0%

0.0%

5.0%

10.0%

15.0%



1,940

2,960

3,980

5,000

6,020

7,040

8,060

9,080


2015 2016 2017 2018 2019

11,350

12,970

14,590

16,210

17,830

19,450

21,070

22,690


2015 2016 2017 2018 2019

0

10

20

30

40

50


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


75


16 March 2017


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (SARm)

Revenue 12,569 12,990 14,657 16,298

EBITDA 4,009 4,130 4,938 5,726


Operating profit/EBIT 235 619 1,395 2,121

Net interest -481 -525 -558 -562

PBT -246 94 837 1,559

HSBC PBT -246 94 837 1,559

Taxation 43 -2 -21 -39

Net profit -203 92 816 1,520

HSBC net profit -203 92 816 1,520

Cash flow summary (SARm)


Capex -5,112 -3,551 -3,801 -5,101


Dividends 0 0 0 0

Change in net debt 1,465 542 -369 96

FCF equity -3,810 -487 369 -96

Balance sheet summary (SARm)



Current assets 7,780 7,841 8,409 8,807

Cash & others 1,216 755 831 728

Total assets 41,193 40,926 41,751 43,644


Gross debt 15,209 15,290 14,997 14,990

Net debt 13,993 14,535 14,166 14,262




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue -12.9 3.3 12.8 11.2

EBITDA 36.3 3.0 19.6 16.0

Operating profit 163.7 125.3 52.0

PBT 790.4 86.3

HSBC EPS 790.4 86.3

Ratios (%)

Revenue/IC (x) 0.4 0.4 0.5 0.5

ROIC 2.2 3.1 5.5 7.6

ROE -1.3 0.6 5.1 8.9

ROA 0.6 1.5 3.3 4.9

EBITDA margin 31.9 31.8 33.7 35.1



Net debt/equity 91.1 94.2 87.2 80.2



Per share data (SAR)

EPS Rep (diluted) -0.26 0.12 1.06 1.97

HSBC EPS (diluted) -0.26 0.12 1.06 1.97

DPS 0.00 0.00 0.00 0.00

Book value 19.94 20.05 21.10 23.08

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 2.4 2.4 2.1 1.9

EV/EBITDA 7.6 7.6 6.2 5.4

EV/IC 1.0 1.0 1.0 1.0

PE* 182.0 20.4 11.0

PB 1.1 1.1 1.0 0.9

FCF yield (%) -22.9 -2.9 2.2 -0.6

Dividend yield (%) 0.0 0.0 0.0 0.0


Issuer information

Share price (SAR) 21.65 Free float 61%

Target price (SAR) 27.20 Sector Wireless Telecoms

Reuters (Equity) 7020.SE Country Saudi Arabia

Bloomberg (Equity) EEC AB Analyst Eric Chang


Price relative


12.00

17.00

22.00

27.00

32.00

37.00

42.00

47.00

52.00

12.00

17.00

22.00

27.00

32.00

37.00

42.00

47.00

52.00

2015 2016 2017

Etihad Etisalat(Mobily) Rel to TADAWUL ALL SHARE INDEX

Financials & valuation: Etihad Etisalat(Mobily) Buy


16 March 2017

76

Company description

MTN Group is the largest mobile telecom operator across Sub Saharan Africa and the Middle

East. The company’s four largest markets account for c67% of total revenue – SA 30%, Nigeria

19%, Iran 11% (proportionately consolidated) and Ghana 7%. The remaining 17 markets

account for roughly one third of revenue. The data theme has significant scope to grow:

currently 26.9% of total revenue is through data and we highlight half of MTN Nigeria’s data

revenue relates to digital and VAS – thus data connectivity revenue remains at relative low

levels in comparison to other EEMEA markets.

Short-term drivers


The data theme has significant scope to grow across MTN’s footprint: currently 26.9% of total

revenue is through data: we highlight half of MTN Nigeria’s data revenue relates to digital and

VAS – thus data connectivity revenue remains at relative low levels in comparison to other

EEMEA markets. MTN Iran (Irancell), MTN Ghana and MTN SA are more developed in terms of

data monetisation, with approximately 42% of revenue being derived from data services. Nigeria

data monetisation is more in line with the rest of MTN’s footprint, with data revenue only

accounting for 21.1% of revenues. MTN is investing at a high rate into 3G/LTE network capability

across its footprint, recent spectrum purchases in Nigeria and Ghana will also support greater data

monetisation in these markets over the medium term. In 2016 data traffic grew 143% y-o-y at MTN

Group, whilst effective data tariffs declined 56% y-o-y (in constant FX terms). Handset

procurement is predominantly driven by the unofficial market (no tax and duties), thus handset

pricing across sub-Saharan Africa (SSA) is cheaper than other EEMEA markets. Smartphone

penetration in Nigeria, at 32%, is relatively high given low wealth dynamics in this market – the

cheapest handset in Nigeria accounts for 2.24% of annual GDP per capita (PPP adj) versus

EEMEA average of 0.34%. However no alternative entertainment, connectivity and communication

exists for consumers. Data pricing at USD3.2 per GB remains elevated in Nigeria compared to

other EEMEA markets, at 0.64% of PPP adjusted GDP per capita.

MTN Group (MTN SJ)

FY18e should be a transformational FCF/EBITDA period for MTN;

multiples are likely to start reflecting this in 2017e

Well placed to benefit from 5G in Iran, Ghana and Nigeria –

regulatory/spectrum/competition makes SA more uncertain

Attractive based on data/VAS/dividend transformation. Maintain Buy

and ZAR141.5 TP

Ziyad Joosub*

Analyst HSBC Securities (South Africa) (Pty) Ltd

[email protected]

+27 (0)11 676 4223

Ramesh Pantagolusula*


Bangalore


77


16 March 2017

Currency impact

Around half of MTN Group’s NAV is based in SSA, whilst approximately 33% of MTN’s debt

comprises USD-denominated debt. Due to extensive tower leasing agreements and managed

service contracts, opex in SSA markets for mobile network operators is 20-33% dollarised.

Around 50-60% of SSA mobile operator’s capital expenditure is in hard currency for FY16.

MTN’s fundamentals and FCF margin will likely continue to be impacted by Naira/Cedi

weakness and ZAR strength over the next 12 months. MTN SA, which accounts for 30% of

revenue and 40% of NAV, will benefit from a FCF and margin perspective due to the recent rally

in the ZAR currency. Iran on the other hand will also have a moderate negative impact from a

weaker Iranian Rial as Central Bank administrators’ medium-term target is for a convergence of

the official and unofficial market FX rates. Overall FX will serve as a significant dilutor for MTN

near-term; however we believe this is priced in and we expect report growth metrics to

accelerate meaningfully in FY18e once a weaker Naira and stronger ZAR are in the base.

Dividend outlook

MTN Group will continue its aggressive investment cycle in key markets through 2017e, capex

intensity across the Group is anticipated to be around c23-25%, whilst key markets of South Africa,

Iran and Nigeria will all likely have capex intensity in excess of 26%. Given the high investment

cycle, management has maintained a minimum dividend of ZAR7 for FY17e – unless a substantial

FX/macro change occurs over the next 12 months. Thus dividend will serve to underpin the

valuation near-term rather driving share price upside. Once MTN starts normalising capex in

FY18e, we anticipate substantial FCF growth and dividend transformation. Given the capex

normalisation cycle will take two to three years and be accompanied with accelerating growth

trends (low FX-induced base, higher data monetisation and network leadership) we expect FCF

and dividend growth to be multi-year theme at MTN from FY18e. We expect the market to start

positioning for better organic growth, FCF margin expansion and progressive dividend in 2017e.


MTN looks relatively well placed to capitalise on the benefit of 5G, specifically in markets

outside of South Africa, where the recent investment cycle in addition to spectrum acquisitions

will likely place MTN in a leadership position in transmission, fibre and 4G across key markets

(Nigeria, Iran and Ghana). Africa remains underpenetrated from a fixed-line perspective, whilst

spectrum allocation is structurally low compared with other regions globally. For South Africa

specifically, we believe Vodacom (VOD SJ, ZAR149, Hold) is best positioned for 5G but only

moderately. MTN has front loaded capex into its South African operations over the past two

years and has made meaningful steps in closing the network gap with Vodacom. Thus the

South African operation has room to monetise 5G given ongoing network progression; however

unless there is clear evidence of MTN capturing higher ARPU subscribers from Vodacom SA

(unlikely in our view), MTN will monetise 5G at a lower quantum than Vodacom given our

expectations for relatively equal spectrum holdings over the medium term for both operators.

Consolidation a theme in SSA, whilst South Africa and Iran will only see new entrants in

the form of MVNOs. Nigeria, Ghana and other SSA opcos are likely to exhibit ongoing

consolidation given (1) the higher capex required for mobile data proliferation and monetisation

in addition to (2) lower ROICs across SSA post FX depreciation across the landscape. This

could be a moderate risk for MTN as smaller players combine to drive scale and balance sheet

benefits: given its leadership position in key markets we do not expect MTN to participate in any

in-market consolidation initiatives over the medium term. Overall, we believe lower

fragmentation across countries in SSA will drive better unit economics and incremental returns

on capital for operators, thus from a market structure perspective we believe 5G economics will

increasingly become more attractive as SSA mobile markets progressively consolidate. For SA


16 March 2017

78

and Iran, we do not expect a new entrant of scale to enter the market given relative levels of

maturity and existent scale of incumbent operators, the launch of multiple MVNOs will be more

thematic in these markets. In Iran every operator needs to support 2 MVNO’s, according to MTN

management MTN Iran is close to finalizing the launch of two MVNOs on its network. For both

South Africa and Iran we expect MVNO launches to be characterized by differentiated services

in data provision and/or fintech to capture consumer incremental spend, rather than aggressive

market share gain initiatives that look to replicate all of incumbent operator services.

Regulatory bottlenecks remain a constraint to technology evolution and spectrum

allocation in South Africa; however we expect the regulatory environment to be

supportive in Nigeria, Ghana and Iran. The allocation of spectrum, specifically the digital

dividend, in South Africa and Nigeria has continuously been held up and/or delayed due to

administrative/macro and legal issues. Whilst the regulator’s intention is to support the private

sector to drive broadband transformation, spectrum allocation and analogue switch-over

ambitions have continually been delayed due to administrative and regulatory complexities. The

NCC in Nigeria has been more forthcoming recently on making spectrum expeditiously available

to operators; more importantly recent spectrum allocation to MTN (2600MHz in June 2016) was

completed at a relatively attractive price of USD67m. We believe MTN Nigeria is well positioned

to secure the requisite spectrum for 4G/5G initiatives given its FCF margin and balance sheet

advantages relative to peers in Nigeria. In South Africa spectrum allocation and the structure it

will take remains opaque given the Ministry of Telecommunications’ recent ICT white paper

recommending a wholesale model be followed for spectrum access in South Africa;

nevertheless we believe all operators are equally impacted by the regulations and on a relative

basis MTN has a marginal advantage given its new BEE deal is already complete (level 4 BEE

rating needed in order to participate in spectrum auctions). In Iran, we expect Regulators to be

supportive of new technology launches. According to the Research Center of Communications

and Information Technology in Iran, by 2025, 5G Internet access is targeted to have 100%

penetration in Iran. The Ministry of Telecommunications in Iran has established a 5 year

roadmap where they aim to ensure the 5G experience and roll-out in Iran is to be executed

more successfully than was 4G and 3G, the five year roadmap also emphasizes enhancing the

role of the private sector in launching 5G.

Investment thesis

Our positive thesis on MTN is based on three key themes: (1) wide-scale organic operational

progression and higher incremental returns on capital over the medium term; (2) capex

normalisation post FY17e will create a multi-year FCF and EBITDA margin expansion cycle; and

(3) revenue share gains will be achieved in key markets due to digital/VAS/data leadership.

Solid medium-term growth, yield, and capital return outlook. Macro and FX pressures

have driven a moderation in competitor/regulator intensity and an in-market consolidation

theme across MTN’s footprint. This was evident in MTN’s FY16 results where all major

markets are exhibiting strong sequential accelerations in revenue growth. In our view, the

market is clearly questioning MTN’s capital allocation ability and macro stability of its

footprint. Whilst a harsh macro and FX environment has driven steep declines in MTN’s

value over the past two years, we believe the next 2 years at MTN will be characterised by

organic execution and strong secular trends (data/VAS/digital monetisation) driving

progressively higher incremental yield and returns on capital.

FY18e will be a transformational FCF/EBITDA period; we expect investors to start

positioning for this in 2017. In FY18e, the impact of the expected depreciation of the Nigerian

Naira and Iranian Rial, and elevated big-market capex bump-up will be reflected in the base;

we expect FY18e proportionate FCF and EBITDA to grow 138.5% y-o-y and 7.8% y-o-y.

79


16 March 2017

Given that: (1) ZAR7 dividend guidance should underpin valuation near term; (2) CEO/CFO

placement should ensure a refinement of strategy and communication thereof; and

(3) operational progression and potential revenue/EBITDA upgrades over the next 12 months,

we expect the market to progressively start pricing in the FY18e recovery this year.

Data/VAS leadership indicates progressive revenue share gains in key markets.

Incremental growth in Africa mobile is concentrated in data, with substantially higher

network and/or spectrum investment into key markets (Nigeria, Iran and Ghana) relative to

competitors and data/VAS/digital leadership. We struggle to see a scenario where MTN

does not secure disproportionate service revenue share over the medium term.

Valuation and Risks

MTN Group: MTN SJ, ZAR122.87, Buy, ZAR141.5

DCF-based SOTP valuation. Our target price is based on an equal weighting of our DCF

valuation of ZAR142 and a DCF-based SOTP valuation of ZAR141, from which we subtract the

PV of periodic regulatory fines that MTN Nigeria must pay over the next 3.5 years (-ZAR3.80).

Our DCF-based SOTP makes use of a cost of capital ranging between 12% and 20.5%,

depending on the region that we value. For our DCF, we use a cost of equity of 18.1% derived

from a country-weighted risk-free rate of 12%, beta of 1.0 and a market risk premium of 6.0%.

Our ZAR141.5 TP implies 15.2% upside and we rate the stock Buy as we see organic

operational progression and higher incremental returns on capital, FCF and EBITDA margin

expansion and revenue share gains.

Key downside risks include: (1) macro, political and FX volatility – particularly unforeseen

ZAR strength; (2) negative regulatory or competitive evolution in Nigeria and South Africa;

(3) imposition of higher telecom taxes/VAT rates; (4) sanction evolution in Iran that might impact

cash repatriation; and (5) unforeseen extension of capex bump-up cycle into FY18e, large-scale

M&A and operational disappointments.


16 March 2017

80

Relative valuation

Valuation relatively cheap versus the sector

Improving EV/EBITDA multiple

Low div yield relative to G Sec10 year bond yield

MTN Group: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return 5.0% 6.2% 4.2% 5.2% -17.0%

Total return 5.0% 6.2% 4.2% 5.2% -9.8%

Total return vs EEMEA index (USD) 5.9% 8.7% 4.0% 10.4% -10.9%

Total return vs MSCI EEMEA Telecom (USD) 4.3% 4.1% -1.0% 2.4% -17.4%

Total return vs JSE 5.5% 6.9% 2.4% 7.7% -10.8%

Price return vs JSE 5.7% 7.1% 2.7% 8.9% -15.2%

Price Return (USD) 4.8% 8.7% 8.9% 12.3% -2.0%

Total Return (USD) 4.8% 8.7% 8.9% 12.3% 6.5%





3

4

5

6

7

8



0

5

10

15



-5.0%

0.0%

5.0%

10.0%

15.0%



45,720

51,100

56,480

61,860

67,240

72,620

78,000

83,380


2015 2016 2017 2018 2019

131,280

138,270

145,260

152,250

159,240

166,230

173,220

180,210


2015 2016 2017 2018 2019

0

10,270

20,540

30,810

41,080

51,350

61,620

71,890


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


81


16 March 2017


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (ZARm)

Revenue 147,920 134,148 140,070 150,344

EBITDA 51,981 46,640 50,175 55,159



Net interest -2,339 -2,166 -4,505 -2,827

PBT 7,409 22,825 24,786 31,166

HSBC PBT 5,243 22,164 26,347 30,999

Taxation -8,346 -7,092 -8,431 -9,920

Net profit -937 15,732 16,355 21,246

HSBC net profit 8,730 13,037 15,498 18,234

Cash flow summary (ZARm)


Capex -29,899 -29,647 -23,824 -23,737


Dividends -19,792 2,616 -12,619 -13,948

Change in net debt 39,594 -610 1,682 594

FCF equity 14,140 8,129 12,429 18,092

Balance sheet summary (ZARm)



Current assets 79,611 77,484 78,058 82,206

Cash & others 28,395 27,850 27,633 29,585

Total assets 268,700 285,248 296,186 309,785


Gross debt 86,954 85,799 87,265 89,811

Net debt 53,731 53,121 54,804 55,398




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 0.6 -9.3 4.4 7.3

EBITDA -24.0 -10.3 7.6 9.9


PBT -79.6 208.1 8.6 25.7

HSBC EPS -62.6 49.3 18.9 17.7

Ratios (%)

Revenue/IC (x) 0.8 0.7 0.7 0.7

ROIC -1.7 8.2 8.6 9.7

ROE 7.0 11.8 12.7 13.9

ROA -0.4 6.2 6.6 7.6

EBITDA margin 35.1 34.8 35.8 36.7



Net debt/equity 51.1 43.6 42.1 39.6



Per share data (ZAR)

EPS Rep (diluted) -0.50 8.44 8.78 11.40

HSBC EPS (diluted) 4.68 7.00 8.32 9.78

DPS 7.00 7.00 8.05 8.86

Book value 55.53 64.26 68.63 73.83

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 1.9 2.1 2.1 1.9

EV/EBITDA 5.5 6.2 5.8 5.3

EV/IC 1.6 1.5 1.4 1.3

PE* 26.2 17.6 14.8 12.6

PB 2.2 1.9 1.8 1.7

FCF yield (%) 6.0 3.5 5.3 7.7

Dividend yield (%) 5.7 5.7 6.6 7.2


Issuer information

Share price (ZAR) 122.87 Free float 75%

Target price (ZAR) 141.50 Sector Wireless Telecoms

Reuters (Equity) MTNJ.J Country South Africa

Bloomberg (Equity) MTN SJ Analyst Ziyad Joosub

Market cap (USDm) 17,704 Contact +27 (0)11 676 4223

Price relative


85.00

135.00

185.00

235.00

85.00

135.00

185.00

235.00

2015 2016 2017

MTN Group Rel to JSE ALL SHARE

Financials & valuation: MTN Group Buy


16 March 2017

82

Company description

O2 CZ is a diversified telecom operator with a presence in Czech Republic and Slovakia. O2 CZ

span off the infrastructure assets into a separate company (CETIN) in 2015.

Short-term drivers


We estimate Smartphone penetration for O2 CZ to be above 50%. We observe the price of the

most affordable smartphone to be around 9% of the average monthly disposable income in

Czech Republic. The average price of mobile data as a percentage of GDP (PPP) also looks

low for O2 CZ, but data monetisation will be limited by competitive pressures in the B2B

segment. In February 2017 the regulator made some comments about the potential regulation

of data services retail prices (Source: Reuters), which could limit data monetisation further.

Currency impact

We expect the currency risk to be insignificant for O2 CZ, with around 21% of its capital

spending in hard currency and debt is completely denominated in local currency. HSBC’s FX

strategists forecast the CZK to appreciate by c3% y-o-y relative to USD by end-2017e, which

should benefit capital spending slightly.

Dividend outlook

We assume a dividend pay-out ratio of 100% for O2 CZ given its policy to maintain a 90-110%

pay-out ratio. Given robust FCF generation and low leverage we expect O2 CZ to be able to

comfortably maintain the high dividend pay-out ratio over next few years. O2 CZ intends to

distribute CZK4 per share from the share premium. DPS of FY16 is CZK17 per share (excluding

the share premium). We expect the dividends to remain at the same level assuming a pay-out

ratio of 100% based on historical track record, implying a regular dividend yield of c6%. The

distribution of share premium adds another 1.5% to the yield. The spread of the dividend yield

over the sovereign yield is one of the highest among the peer group, enabling O2 CZ to score

well on this metric.

O2 CZ (TELEC CP)

Dividend outlook looks attractive; moderate potential to monetise

data due to regulation risk on retail data services

Competition in the B2B segment may be the key barrier to benefiting

from 5G launch, structural separation is also a risk

Maintain Hold and CZK270 TP


HSBC Bank plc

[email protected]

+44 20 7991 6827


Bangalore


83


16 March 2017


We see competition in the B2B segment as a key barrier to benefiting from the launch of 5G. O2

CZ span off its infrastructure assets into a separate entity in 2015; and lack of infrastructure

assets may limit the extent of 5G rollout.

With 5G potentially being combined with Wifi, cable operators such as Liberty Global could play

a role, as could some OTT players such as Facebook or Google, and this could pose a threat to

5G monetisation in CE3.The regulatory framework would unlikely be very supportive with net

neutrality in place and spectrum pricing could get expensive in Czech Republic, based on

history. We do not see any major changes to the existing regulatory environment in Czech

Republic in the medium term, while there is likely to be some political pressure to regulate and

reduce retail data pricing.

O2 CZ is gradually developing its software skills, proposing more media content and venturing into

digital services (through a startup accelerator). It is gradually shifting its skills into software

development and is looking at expansion into new services such as insurance for hardware or travel.

Based on these factors we expect the long-term impact of 5G on Czech Republic to be moderate.

Investment thesis

We see O2 CZ’s revenue and EBITDA growing at low single digits over the next few years.

Mobile data revenue should see strong growth, partially offset, however, by intense B2B

competition. In the fixed line segment, the structural decline of fixed voice will be offset by

growth in the fixed BB segment, while B2B remains under pressure in fixed line segment as

well. We view the potential for operating margin improvement at O2 CZ as limited, with

operating margin at around c27% over the next few years.

Although the growth prospects for revenue and EBITDA look limited for O2 CZ, a lower capital

spending requirement should drive free cash flow. Given the completion of spectrum payments

and spectrum rollout costs in FY15 and FY16, we expect capital expenditure to decline over the

next few years. We factor capex/sales of c7% in FY17e (compared to c9% in FY15 and c8% in

FY16). We estimate the FCF yield to be c7% and c8% for FY17e and FY18e respectively.

We are bullish about the dividend outlook for O2 CZ, which offers the highest spread over

sovereign yield among EEMEA telecoms.

Valuation and Risks

O2 CZ: TELEC CP, CZK272, Hold, TP CZK270

We value O2 CZ using a DCF model, assuming a COE of 8%, a RFR of 2.5%, a beta of 1 and

MRP of 5.5% (all unchanged). Our RFR corresponds to the 5-year market average of the Czech

10-year Sovereign yield. Our TP of CZK270 implies 0.7% downside and we rate the stock Hold.

Upside risks include better than expected margin expansion and higher than expected revenue

growth. Higher than expected dividend may be another upside risk.

Downside risks include a decline in margins, the risk of exclusion from MSCI CZ index, and a

stake sale by PPF (major shareholder) to increase free float


16 March 2017

84

Valuation relatives

Above EEMEA telcos average on EV/EBITDA but in line with sector average on EV/OPFCF

High dividend yield and spread versus Czech sovereign bond

No significant change in consensus estimates

O2 CZ: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return -0.6% 1.6% 16.3% 15.8% 11.1%

Total return -0.6% 1.6% 16.3% 15.9% 18.9%

Total return vs EEMEA index (USD) 0.6% 0.1% 10.7% 6.6% -3.9%


Price Return (USD) -0.6% 0.2% 15.6% 8.5% 6.1%

Total Return (USD) -0.6% 0.2% 15.6% 8.5% 13.5%





0

2

4

6

8

10

12



0

5

10

15

20



0.0%

10.0%

20.0%

30.0%

40.0%

50.0%



7,900

9,280

10,660

12,040

13,420

14,800

16,180

17,560


2015 2016 2017 2018 2019

35,740

37,060

38,380

39,700

41,020

42,340

43,660

44,980


2015 2016 2017 2018 2019

0

2,090

4,180

6,270

8,360

10,450

12,540

14,630


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


85


16 March 2017


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (CZKm)

Revenue 37,593 38,076 39,101 40,011

EBITDA 10,451 10,348 10,639 10,899



Net interest -90 -323 -279 -219

PBT 6,742 6,550 6,867 7,227

HSBC PBT 6,662 6,550 6,867 7,227

Taxation -1,485 -1,310 -1,373 -1,445

Net profit 5,257 5,240 5,494 5,781

HSBC net profit 5,330 5,240 5,494 5,781

Cash flow summary (CZKm)


Capex -2,936 -2,822 -2,631 -2,474


Dividends -4,946 -5,366 -5,240 -5,494

Change in net debt 1,828 -453 -1,199 -1,340

FCF equity 5,949 5,868 6,375 6,761

Balance sheet summary (CZKm)



Current assets 11,235 11,141 11,346 11,528

Cash & others 4,137 4,000 4,000 4,000

Total assets 33,306 32,558 31,902 31,105


Gross debt 6,976 6,386 5,187 3,847

Net debt 2,839 2,386 1,187 -153




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 0.3 1.3 2.7 2.3

EBITDA 1.4 -1.0 2.8 2.4

Operating profit 3.3 -1.9 4.0 4.2

PBT 2.1 -2.9 4.8 5.2

HSBC EPS 5.7 -1.7 4.8 5.2

Ratios (%)

Revenue/IC (x) 1.0 1.0 1.1 1.1

ROIC 15.2 15.0 15.8 16.5

ROE 29.7 29.9 31.4 33.0

ROA 16.8 16.8 17.8 19.0

EBITDA margin 27.8 27.2 27.2 27.2



Net debt/equity 16.2 13.6 6.8 -0.9


CF from operations/net debt 323.8 362.2 764.3

Per share data (CZK)

EPS Rep (diluted) 16.65 16.60 17.40 18.32

HSBC EPS (diluted) 16.88 16.60 17.40 18.32

DPS 17.00 16.60 17.40 18.32

Book value 55.46 55.46 55.46 55.46

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 2.3 2.3 2.2 2.1

EV/EBITDA 8.3 8.3 8.0 7.7

EV/IC 2.3 2.4 2.3 2.3

PE* 16.1 16.4 15.6 14.9

PB 4.9 4.9 4.9 4.9

FCF yield (%) 7.1 7.0 7.6 8.1

Dividend yield (%) 6.3 6.1 6.4 6.7


Issuer information

Share price (CZK) 272.00 Free float 22%

Target price (CZK) 270.00 Sector Diversified Telecoms

Reuters (Equity) SPTT.PR Country Czech Republic

Bloomberg (Equity) TELEC CP Analyst Herve Drouet


Price relative


28.00

78.00

128.00

178.00

228.00

278.00

28.00

78.00

128.00

178.00

228.00

278.00

2015 2016 2017

O2 CZ Rel to PRAGUE SE-50

Financials & valuation: O2 CZ Hold


16 March 2017

86

Company description

Ooredoo is the incumbent telecom operator in Qatar. It has international operations in the

Middle East (Kuwait, Oman, Iraq and Palestine), North Africa (Algeria and Tunisia) and Asia

(Indonesia and the Maldives).

Ooredoo Group (ORDS QD) is the holding company for the Qatari operations as well as listed

entities in Kuwait, Oman, Indonesia and Iraq.

Ooredoo Kuwait (OOREDOO KK, KWD 1.18, 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 the Maldives. The

unit remains listed on the Kuwaiti exchange despite its limited free-float (7.3%).

Ooredoo Oman (ORDS OM, OMR 0.58, Not Rated) started as a mobile operator but

eventually expanded to fixed services. The company listed on the Muscat Securities

Exchange in 2011 and the Ooredoo group owns a 55% stake.

Indosat (ISAT IJ, IDR7000, Buy, TP IDR7,800). Ooredoo initiated its investment in the

Indonesian mobile operator in 2008. The following year, Ooredoo obtained control by

increasing its stake to 65%.

Asiacell (TASC IQ, IQD 5.81, Not Rated). Ooredoo owns 64% of the Iraqi mobile operator.

It is second to Zain in this market. 3G services were launched in 2016.

Short-term drivers


In Qatar, Ooredoo remains the dominant mobile operator with two-thirds share of the overall

market and, more importantly, 62% of the high-value post-paid segment.

We think the challenge lies more in its overseas markets that in aggregate represent nearly 75%

of group revenues. We think competitive intensity – the majority of these markets have either

three or four players – as well as significantly lower GDP/per capita may inhibit Ooredoo’s

capacity to monetise data.

Ooredoo (ORDS QD)

Dividend outlook is improving…

…but competition intensity will prevent Ooredoo from fully monetising

data and 5G opportunities

Maintain Reduce; increase TP from QAR78 to QAR91 as we bring in

its stake in Asia Mobile Holding at book value

Eric Chang*

Analyst


[email protected]

+971 4 423 6554

Nikhil Mishra*


Bangalore


87


16 March 2017

Currency impact

GCC markets (Qatar, Kuwait, Oman) represent 40% of group revenues. Ooredoo’s greatest

local currency exposure is in Indonesia (Indosat contributes 25% of group revenues), Iraq (13%

of group revenues) and Algeria (11% of group revenues). All three currencies have been stable

relative to USD.

From a debt perspective, we see little impact from currency fluctuations: 78% of group debt is

denominated in USD and QAR, the majority of which is at the parent level. In Indonesia, we see

minimal risk of currency mismatch given Indosat has largely refinanced debt in IDR.

Dividend outlook

Ooredoo appears to be winding down its high-investment phase, with management guiding to

lower capex in 2017. We expect free cash flow to improve, which will allow Ooredoo significant

headroom to increase dividends. For 2016, the Board recommended a dividend of QAR3.50, a

17% y-o-y increase.


Monetisation

We think Ooredoo’s prospects are greatest in Qatar due to its market structure. We see larger

challenges overseas where most markets comprise three to four players. Indonesia and Algeria

remain highly competitive: the introduction of 3G and 4G services has not prevented ARPU from

declining. Kuwait would be a structurally attractive market: wireless broadband is the preferred

internet access for residential customers. Instead all three mobile operators have competed on

price to gain or maintain market share, thus eroding market value.

Competition

Despite market liberalisation in 2009, Ooredoo remains the dominant operator in Qatar with a near-

monopoly on fixed services and two-thirds market share in mobile. In all international markets, we

expect competition to remain elevated or even intensify. The government of Oman has invited bids

for a third mobile license. In Burma, a fourth entrant is expected to launch this year.

Regulation

The Qatari regulator has so far been quite supportive of the incumbent and we expect it to

extend this support in an effort to ensure the country is 5G ready before the 2022 FIFA World

Cup. Internationally, we believe regulation will be relatively benign. In Indonesia, our Asia

telecoms team thinks the regulator may even be supportive of Indosat (ISAT IJ, IDR7,000, Buy)

and XL Axiata (EXCL IJ, IDR2,830, Hold) to enable a more balanced competitive environment.

Business model

Ooredoo has been focusing on data, which represents 40% of group revenues and has rolled

out 4G in eight of its ten markets. In Qatar, the business model is quite supportive as it is the

only well-integrated player in the market. In Kuwait, Iraq and Algeria, Ooredoo is a pure-mobile

operator as fixed line services are either under-developed or a state monopoly.

Investment thesis

We have had three investment concerns over the past year: competition, currency risk and

capital intensity. Only one – competition – remains material, with Algeria, Kuwait, Iraq remaining

highly competitive with little prospect of rationality.

We see risks of a new entrant in Burma and potentially in Oman. In Burma, a fourth mobile

operator is expected to start operations later this year. In Oman, the regulator has invited bids


16 March 2017

88

for a third mobile license despite near-saturation of the market. We see a risk of Ooredoo

repeating its Kuwait experience, where it saw revenues and profits pressure, and where its

Kuwaiti subsidiary even ceded its market position to the new entrant. We think Burma is most at

risk given that Ooredoo’s operating and financial performance lag that of Telenor’s (TEL NO,

NOK136.30, Hold).

Changes to our estimates

We increase our EBITDA margin estimates by 1.4ppt for both 2017e and 2018e. The company

was able to improve its EBITDA margins by 1ppt during 2016, despite revenue growth of only

1%. The company guides for EBITDA growth in the range of 0% to 3%, while we estimate

2017e EBITDA growth at c2%.

Ooredoo: change in estimates

_______________ New _________________ _______ Previous _______ _______ Change ________ 2017e 2018e 2019e 2017e 2018e 2017e 2018e

Revenue 33,759 34,810 35,706 33,582 35,360 0.5% -1.6% EBITDA 13,695 14,030 14,332 13,162 13,772 4.0% 1.9% margin 40.6% 40.3% 40.1% 39.2% 38.9% 1.4% 1.4% Net profit 2,604 2,584 2,666 2,207 2,799 18.0% -7.7% DPS 3.75 3.75 3.75 3.25 4.25 15.4% -11.8% Capex -7,512 -7,867 -8,114 -6,670 -6,755 12.6% 16.5% % revenue 22.3% 22.6% 22.7% 19.9% 19.1% 2.4% 3.5%


Valuation and risks

Ooredoo: ORDS QD, QAR99, Reduce, TP QAR91 (from QAR78)

We value Ooredoo using a sum-of-the-parts approach.

In Qatar, Ooredoo’s market leadership is uncontested and we use a target multiple of 5.5x

2017e EBITDA.

We value the Indosat stake at HSBC’s target price of IDR7,800 (ISAT IJ, Buy, TP IDR7,800,

covered by Neale Anderson).

We value Algeria, Kuwait, Oman, Palestine and Tunisia on 4x 2017e EBITDA reflecting the

competitive intensity.

For Ooredoo’s operations in Iraq, Burma, and the Maldives we assign a multiple of 3x

2017e EBITDA. This low multiple reflects: geopolitical instability in Iraq, greenfield

operations in Burma and limited growth prospects in Maldives.

We increase our TP to QAR91 (from QAR78) as we bring in Ooredoo’s stake in Asia Mobile

Holdings at book value. Our new TP implies downside of 8.1% and we rate the stock Reduce as the

intensity of the competition may not afford an improvement in margin or lower capital intensity.

89


16 March 2017

Ooredoo SOTP

EBITDA EV % EV % (QARm) 2017e /EBITDA stake New of EV

Qatar 4,105 5.5x 100.0% 22,579 44.8% Oman 1,527 4.0x 55.0% 3,359 6.7% Iraq 1,954 3.0x 64.1% 3,758 7.5% Indosat 3,738 3.7x 65.0% 8,984 17.8% Burma 94 3.0x 100.0% 283 0.6% Kuwait 528 4.0x 92.1% 1,946 3.9% Algeria 1,341 4.0x 73.7% 3,953 7.8% Tunisia 714 4.0x 84.1% 2,401 4.8% Maldives 217 3.0x 92.1% 601 1.2% Subsidiaries 47,852 Palestine 97 4.0x 44.6% 174 0.3% Asia Mobile Holdings 25.0% 2,326 4.6% Associates 2,500 EV 50,362 Debt 2017e 45,485 Cash 2017e -23,997 Adjustment for minority's share in debt -363 Net debt 2017e 21,126 Equity value 30,358 Issued shares (m) 320.32 FV (QAR) 91.00


Key upside risks include: favourable FX movements; maintaining market share in Qatar

especially in (the high-value) post-paid segment; positive geopolitical developments particularly

in Iraq and Tunisia; easing of competitive intensity in some of the key markets.

Valuation and risks Indosat (ISAT IJ, IDR7,000, Buy, TP IDR7,800)

We calculate a fair value target price of IDR7,800 for Indosat using a DCF-based

methodology. We apply: a cost of equity of 9%; a debt/capital ratio of 50%, a terminal

growth rate of 1%. This returns a WACC of 7.5%.

Downside risks: Key downside risks are higher competition than expected, and foreign

exchange-related weakness.

Neale Anderson* Analyst

The Hongkong and Shanghai Banking Corporation Limited

[email protected]

+852 2996 6716



16 March 2017

90

Relative valuation

Ooredoo trades in line with the sector. We highlight that it has reversed to its average

forward EV/EBITDA multiple.

While consensus revenue estimates have been relatively stable, we note consensus has

been more sanguine on Ooredoo’s profit outlook. We highlight a significant increase in

2018 EBITDA estimates over the last six months. We do not share that optimism as long as

competition remains elevated in its international markets.

The dividend yield has seen an uptick after the announcement of a dividend increase for

fiscal 2016.

Ooredoo: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return -7.8% -5.7% 1.2% 2.6% 13.7%

Total return -7.7% -5.7% 1.2% 2.6% 17.8%

Total return vs EEMEA index (USD) -6.6% -5.8% -3.7% 0.7% 0.4%

Total return vs MSCI EEMEA Telecom (USD) -8.4% -7.7% -4.0% -0.2% 10.2%

Total return vs QE -4.9% -4.7% -3.8% 2.7% 14.7%

Price Return (USD) -7.9% -5.7% 1.1% 2.6% 13.5%

Total Return (USD) -7.7% -5.7% 1.2% 2.6% 17.8%





3

4

4

5

5



0

5

10

15

20

25



-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%



11,820

12,400

12,980

13,560

14,140

14,720

15,300

15,880


2015 2016 2017 2018 2019

31,320

32,420

33,520

34,620

35,720

36,820

37,920

39,020


2015 2016 2017 2018 2019

0

1,810

3,620

5,430

7,240

9,050

10,860

12,670


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


91


16 March 2017


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (QARm)

Revenue 32,503 33,759 34,810 35,706

EBITDA 13,365 13,695 14,030 14,332



Net interest -1,809 -1,753 -1,887 -1,832

PBT 3,570 4,148 4,338 4,620

HSBC PBT 3,221 4,148 4,338 4,620

Taxation -823 -956 -1,000 -1,065

Net profit 2,193 2,604 2,584 2,666

HSBC net profit 1,843 2,604 2,584 2,666

Cash flow summary (QARm)


Capex -8,359 -7,012 -7,367 -7,614


Dividends -961 -1,121 -1,201 -1,281

Change in net debt -367 -2,758 -2,389 -2,428

FCF equity 2,315 3,746 3,505 3,581

Balance sheet summary (QARm)



Current assets 24,747 32,393 33,658 34,593

Cash & others 16,502 23,997 25,136 25,963

Total assets 90,515 97,380 98,207 98,875


Gross debt 40,748 45,485 44,235 42,635

Net debt 24,246 21,488 19,100 16,672




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 1.1 3.9 3.1 2.6

EBITDA 2.8 2.5 2.4 2.2


PBT 17.7 16.2 4.6 6.5

HSBC EPS -14.5 41.3 -0.8 3.2

Ratios (%)

Revenue/IC (x) 0.6 0.6 0.7 0.7

ROIC 9.9 11.5 12.1 12.5

ROE 8.4 11.4 10.7 10.4

ROA 4.7 5.1 5.2 5.4

EBITDA margin 41.1 40.6 40.3 40.1



Net debt/equity 83.6 69.3 57.7 47.2



Per share data (QAR)

EPS Rep (diluted) 6.84 8.13 8.07 8.32

HSBC EPS (diluted) 5.75 8.13 8.07 8.32

DPS 3.50 3.75 3.75 3.75

Book value 69.26 73.63 77.80 82.05

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 1.8 1.7 1.6 1.5

EV/EBITDA 4.4 4.2 3.9 3.7

EV/IC 1.1 1.1 1.1 1.0

PE* 17.2 12.2 12.3 11.9

PB 1.4 1.3 1.3 1.2

FCF yield (%) 6.6 10.6 9.7 9.7

Dividend yield (%) 3.5 3.8 3.8 3.8


Issuer information

Share price (QAR) 99.00 Free float 36%

Target price (QAR) 91.00 Sector Wireless Telecoms

Reuters (Equity) ORDS.QA Country Qatar

Bloomberg (Equity) ORDS QD Analyst Eric Chang


Price relative


53.00

63.00

73.00

83.00

93.00

103.00

113.00

123.00

133.00

53.00

63.00

73.00

83.00

93.00

103.00

113.00

123.00

133.00

2015 2016 2017

Ooredoo Rel to DSM 20 INDEX

Financials & valuation: Ooredoo Reduce


16 March 2017

92

Company description

Orange Polska is a diversified telecom operator in Poland. The mobile segment contributes

c56% of group revenue and fixed line contributes c44%.

Short-term drivers


Currently, we estimate smartphone penetration to be above 50% in Poland with the price of the

most affordable smartphone accounting for c11% of monthly disposable income. We expect this

to drive rapid smartphone penetration over the next few years. Poland has the most affordable

data pricing in EEMEA, with 1GB of mobile data costing less than USD1 on average; thus

mobile data usage in Poland is increasing rapidly. The opportunity for data monetisation is likely

limited, however, due to the intensity of competition in the country.

Currency impact

We expect the currency impact for Orange Polska to be limited, with an estimated c28% of

capital spending in hard currency. Around 20% of debt is in hard currency, but is fully hedged by

a cross currency swap. HSBC’s FX strategists forecast PLN depreciation of c4% y-o-y in FY17;

thus Orange Polska’s capital spending could be at moderate risk due to potential PLN

depreciation.

Dividend outlook

Orange Polska decided not to pay a dividend for FY16 in order to maximise cash allocation to

strategic investment projects like fibre rollout; however we are a bit sceptical about this strategy

to skip dividends. We expect dividends to resume from FY17e and factor DPS of PLN0.25 for

FY17 implying c5% yield.


We are conservative about Orange Polska’s capability to monetise data by offering bundled

services because of the tough competitive environment in Poland, where competitive risks

remain high for the medium term. Spectrum payments were very high in the latest spectrum

auctions relative to those in other EEMEA markets. High spectrum payments for 5G may limit

Orange Polska’s capital spending capabilities.

Orange Polska (OPL PW)

Most affordable data pricing but limited scope to monetise; dividend

suspended in 2016

Tough competition and regulation is the key barrier to capitalising on

5G launch

Valuation score attractive; Maintain Hold and PLN5 TP


HSBC Bank plc

[email protected]

+44 20 7991 6827



Bangalore


93


16 March 2017

Investment thesis

Operational conditions remain tough for Orange Polska, with revenue growth likely impacted by

declines in fixed and infrastructure projects, and mobile revenue growth facing competitive

pressures post 4G launch. Mobile service revenue will be impacted by new roaming regulations

and uncertainty in the prepaid segment. Orange Polska’s corporate segment is likely to continue

to suffer from low tariffs in mobile broadband, leading to cannibalisation. It has also signaled it

wants to defend market share, and pricing could remain aggressive. Mobile equipment sales

growth will be lower than in FY16 according to management. Cable operators such as UPC, are

upgrading their networks with docsis 3.1 which will remain competitive against Orange Polska’s

G-fast offering in fixed line broadband. We expect revenue to decline by c4% in FY17e driven

by a c5% decline in fixed line revenue.

Despite our conservative view on the fundamentals, Orange Polska looks attractive on

valuation. The share price has declined 15% y-t-d (vs Index at -14%) and valuation is now less

expensive – 4.5x 2017e EV/EBITDA, giving dividend yield for FY16e of 4.6%.

Valuation and Risks

Orange Polska: OPL PW, PLN4.67, Hold, TP PLN5.0

We value Orange Polska using a DCF model assuming a COE of 9%, RFR of 3.5% based on

the sovereign bond yield of Poland, MRP of 5.5% and a beta of 1 (all unchanged). Our fair value

target price of PLN5 implies 7.1% upside and we rate the stock Hold as we see a possible

catalyst in the form of accelerated real estate sales that have been freed by the company, and

there is room to improve working capital by selling handsets client receivables.

Upside risks include less competition than expected in the mobile segment, consolidation in

Polish telecom sector and a better-than-expected macro and regulatory environment.

Downside risks include more aggressive competition in the domestic mobile and fixed

segment, lower than expected dividend, worsening of macro in Poland.


16 March 2017

94

Relative valuation

Orange Polska is currently trading in the lower half of the EV/EBITDA and EV/OPFCF

1 year forward multiple range. It is trading in line with its historical valuation relative

Consensus estimates have been revised down due to continuing decline in the legacy

business, and headwinds from competition and European mobile roaming regulation.

Consensus expect stabilisation in 2018

Dividend yield expectations have been reduced post the 2016 dividend suspension

Orange Polska: Valuation Benchmark chart

Source: Thomson Reuters DataStream, HSBCe


1W 1M 3M 6M 12M

Price return -1.1% -10.4% -14.6% -18.8% -24.6%

Total return -0.9% -10.2% -14.5% -18.8% -20.8%

Total return vs EEMEA index (USD) 0.0% -11.4% -17.3% -25.7% -41.5%

Total return vs MSCI EEMEA Telecom (USD) -1.5% -12.2% -19.7% -21.6% -28.4%

Total return vs Poland index 1.0% -15.4% -29.0% -40.5% -46.6%

Price Return (USD) -1.4% -10.5% -11.7% -23.6% -26.9%

Total Return (USD) -1.2% -11.3% -12.4% -23.8% -24.1%





3

4

4

5

5

6

6



-100

-50

0

50

100



-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%



2,710

2,880

3,050

3,220

3,390

3,560

3,730

3,900


2015 2016 2017 2018 2019

10,940

11,100

11,260

11,420

11,580

11,740

11,900

12,060


2015 2016 2017 2018 2019

0

580

1,160

1,740

2,320

2,900

3,480

4,060


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


95


16 March 2017


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (PLNm)

Revenue 11,538 11,115 11,082 11,182

EBITDA 3,163 2,920 3,038 3,154



Net interest -359 -310 -306 -290

PBT -1,713 -172 48 100

HSBC PBT 9 -172 48 100

Taxation -33 -8 -10 -20

Net profit -1,746 -179 38 80

HSBC net profit -24 -179 38 80

Cash flow summary (PLNm)


Capex -1,989 -2,045 -1,959 -1,920


Dividends -328 -328 -328 -328

Change in net debt 2,950 -588 -369 -606

FCF equity 807 550 695 923

Balance sheet summary (PLNm)



Current assets 2,418 2,740 2,733 2,753

Cash & others 262 600 600 600

Total assets 22,588 22,172 21,441 20,617


Gross debt 7,194 6,944 6,575 5,970

Net debt 6,932 6,344 5,975 5,370




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue -2.6 -3.7 -0.3 0.9

EBITDA -7.8 -7.7 4.0 3.8


PBT -709.6 109.1

HSBC EPS -111.6 109.1

Ratios (%)

Revenue/IC (x) 0.5 0.4 0.4 0.5

ROIC -4.6 0.6 1.1 1.3

ROE -0.2 -1.8 0.4 0.9

ROA -12.3 0.7 1.3 1.5

EBITDA margin 27.4 26.3 27.4 28.2



Net debt/equity 69.3 66.8 64.9 67.3



Per share data (PLN)

EPS Rep (diluted) -1.33 -0.14 0.03 0.06

HSBC EPS (diluted) -0.02 -0.14 0.03 0.06

DPS 0.00 0.25 0.25 1.00

Book value 7.63 7.24 7.02 6.08

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 1.2 1.2 1.1 1.1

EV/EBITDA 4.3 4.5 4.2 3.8

EV/IC 0.5 0.5 0.5 0.5

PE* NM NM NM NM

PB 0.6 0.6 0.7 0.8

FCF yield (%) 12.0 8.2 10.4 13.8

Dividend yield (%) 0.0 5.4 5.4 21.4


Issuer information

Share price (PLN) 4.67 Free float 50%

Target price (PLN) 5.00 Sector Diversified Telecoms

Reuters (Equity) OPL.WA Country Poland

Bloomberg (Equity) OPL PW Analyst Herve Drouet


Price relative


3.90

4.90

5.90

6.90

7.90

8.90

9.90

10.90

11.90

3.90

4.90

5.90

6.90

7.90

8.90

9.90

10.90

11.90

2015 2016 2017

Orange Polska Rel to WIG 20

Financials & valuation: Orange Polska Hold


16 March 2017

96

Company description

Rostelecom is a wireline operator composed of a nationwide backbone transport network, local

telephony services, and adjunct wireline services such as broadband and IPTV. It owns a 45%

stake in mobile operator T2RTK (Joint venture of Rostelecom and Tele2) in Russia

Short-term drivers


We expect growth in fixed broadband data to drive growth for Rostelecom. The tough macro

and intense competition in Russia may impede data monetisation capability short-term.

Currency impact

Almost all group debt is in denominated in local currency (RUB), as is a significant portion of

capex, which makes Rostelecom to be resilient to currency risk in our view.

Dividend outlook

Rostelecom has a dividend policy to pay 75% of FCF or at least RUB45bn over 2016-18,

whichever is lower. Based on our estimates Rostelecom’s dividend yield will be around c8%

short-term. Given the robust FCF yield and healthy leverage ratios, we see this as sustainable,

assuming there is no significant M&A activity.


Rostelecom is moderately well placed to benefit from the 5G launch, with a lack of mobile

infrastructure the key hurdle. We expect competition to turn rational gradually, while the

potential entry of disruptive new entrants or technology players is limited in Russia due to

security concerns. According to news reported by Reuters on 6 March 2017, Rostelecom is

considering the need to have a controlling stake in mobile operator T2RTKM (the fourth mobile

operator in Russia).

The key question is whether Rostelecom will acquire the remaining 55% stake in T2RTKM from

VTB (VTBR.MM, RUB0.066, Reduce). The mobile operation is highly leveraged and there could

have a negative impact on the balance sheet, with a possible transfer of value to VTB if there

were to be an acquisition.

Rostelecom (RTKM RM)

Short term: Dividend outlook looks healthy assuming no M&A

Long term: Lack of mobile infrastructure may impact the data

monetisation capability post 5G launch

We switch our primary coverage from the ADR to the local listing.

Hold, cut TP to RUB84 (from RUB88)


HSBC Bank plc

[email protected]

+44 20 7991 6827



Bangalore


97


16 March 2017

Investment thesis

We have a conservative outlook regarding Rostelecom’s medium-term growth. The tough macro

in Russia and competitive pressures in the B2B segment will limit the growth of revenue and

EBITDA in our view. But we view dividends and valuation as attractive. One potential issue is

the lower and delayed public investment in the BDD project. Another risk is the possible

acquisition of the remaining 55% stake in the mobile associate tele2RTK: acquiring a controlling

stake could be at a large premium, with an impact on dividend and ROIC. We estimate around

c8% dividend yield for Rostelecom near-term. The stock trades at c3x 2017e EV/EBITDA

(compared to EEMEA average of c5x).

Change in estimates

Change in estimates

Old 2017e 2018e 2019e

Revenue 301,128 312,415 - EBITDA 100,242 104,756 - Net Profit 15,419 22,155 - New Revenue 300,171 310,189 318,116 EBITDA 98,003 102,422 105,982 Net Profit 13,987 19,890 21,386 Old vs New Revenue 0% -1% - EBITDA -2% -2% - Net Profit -9% -10% -

Source: HSBC

We revise our estimates post Q4 2016 results, slightly lowering operational and capital

spending estimates to be in line with the management guidance.

Valuation and Risks

Rostelecom: RTKM.MM, RUB76.5, Hold, TP RUB84 (from RUB88)

We switch our primary coverage from the ADR to the local listing. We value Rostelecom using a

DCF model assuming a COE of 14.6%, RFR of 8.5% (based on sovereign yield of Russia), and

MRP of 5.5% and a beta of 1.1 (unchanged). We reduce our TP to RUB84 from RUB88. Lower

TP is due to lower estimates partially offset by lower capex estimates. Our TP implies an upside

of 9.8% and we rate the stock Hold due to the weak growth outlook. For the ADR (RKMD LI,

USD7.86 as of 14 Mar), Our TP is unchanged at USD8.10 (using an exchange rate of 62

(65 earlier) for RUB/USD and 1 ADR= 6 shares.

Key downside risks to our view include liberalisation of the fixed-line market, fixed-to mobile

substitution, and accelerated adoption of new internet communication technologies, changes to

fixed-line licensing and other developments in the competitive environment.

Key upside risks to our valuation include a better-than-expected Russian macro environment,

as well as a better-than-expected performance from T2RTK.


16 March 2017

98

Relative valuation

Looks cheap on V/EBITDA and EV/OPFCF

But estimates consensus continue to erode with fear of potential M&A

Dividend spread still negative and at risk if M&A activity

Rostelecom: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return -2.8% -9.7% -13.0% -7.2% -19.3%

Total return -2.8% -9.7% -13.0% -7.2% -13.9%

Total return vs EEMEA index (USD) -1.5% -8.5% -10.6% -0.6% -9.8%


Price return vs MICEX -1.1% -2.2% -4.7% -6.0% -25.3%

Price Return (USD) -2.4% -8.0% -5.8% 1.3% 1.3%

Total Return (USD) -2.7% -8.5% -5.6% 1.3% 7.6%





3

4

4

5

5



0

2

4

6

8

10

12

14



-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%



92,560

95,370

98,180

100,990

103,800

106,610

109,420

112,230


2014 2015 2016 2017 2018

295,550

298,220

300,890

303,560

306,230

308,900

311,570

314,240


2014 2015 2016 2017 2018

0

10,580

21,160

31,740

42,320

52,900

63,480

74,060


2014 2015 2016 2017 2018

2017e 2018e 2017e 2018e 2017e 2018e


99


16 March 2017


Year to 12/2016a 12/2017e 12/2018e 12/2019e


Revenue 297,446 300,171 310,189 318,116

EBITDA 95,207 98,003 102,422 105,982



Net interest -17,175 -15,524 -15,909 -15,501

PBT 16,723 18,164 25,433 27,150

HSBC PBT 16,712 18,164 25,433 27,150

Taxation -4,693 -4,178 -5,543 -5,764

Net profit 12,030 13,987 19,890 21,386

HSBC net profit 12,868 13,987 19,890 21,386



Capex -61,857 -61,924 -61,739 -61,469


Dividends -13,295 -15,243 -15,243 -15,243

Change in net debt 3,459 -1,234 -5,304 -8,142

FCF equity 11,279 16,477 19,182 23,164




Current assets 68,872 89,554 91,057 92,246

Cash & others 4,257 25,000 25,000 25,000

Total assets 555,682 573,974 576,136 575,463


Gross debt 187,105 206,614 201,310 193,169

Net debt 182,848 181,614 176,310 168,169




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 0.0 0.9 3.3 2.6

EBITDA -5.6 2.9 4.5 3.5


PBT -14.2 8.6 40.0 6.7

HSBC EPS -16.4 8.7 42.2 7.5

Ratios (%)

Revenue/IC (x) 0.8 0.8 0.8 0.8

ROIC 7.7 7.6 7.8 8.0

ROE 5.3 5.7 8.1 8.5

ROA 4.6 4.6 5.6 5.8

EBITDA margin 32.0 32.6 33.0 33.3



Net debt/equity 73.5 73.4 70.0 65.1




EPS Rep (diluted) 4.67 5.43 7.72 8.31

HSBC EPS (diluted) 5.00 5.43 7.72 8.31

DPS 5.92 5.92 5.92 5.92

Book value 94.88 94.40 96.20 98.59

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 0.9 0.9 0.9 0.8

EV/EBITDA 2.9 2.8 2.6 2.5

EV/IC 0.7 0.7 0.7 0.7

PE* 15.3 14.1 9.9 9.2

PB 0.8 0.8 0.8 0.8

FCF yield (%) 12.1 17.6 20.2 23.8

Dividend yield (%) 7.7 7.7 7.7 7.7


Issuer information



Reuters (Equity) RTKM.MM Country Russian Federation

Bloomberg (Equity) RTKM RM Analyst Herve Drouet


Price relative


48.00

58.00

68.00

78.00

88.00

98.00

108.00

48.00

58.00

68.00

78.00

88.00

98.00

108.00

2015 2016 2017

Rostelecom Rel to RTS INDEX

Financials & valuation: Rostelecom Hold


16 March 2017

100

Company description

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 took

place in stages. In 2004, the CITC awarded the second mobile license to Mobily and the fixed-line

market was liberalised in 2007 with the award of three new fixed-line licenses.

Despite the competitive pressure from market liberalisation, STC was late in seeking international

diversification, deploying capital by acquiring minority stakes with mixed results. Currently, the

company is limiting its expansion ambitions to the Middle East. Its subsidiaries in Kuwait and

Bahrain have performed well despite being the third entrant in these small markets.

The rationalisation of STC’s international operations has resulted in a positive impact on its

financials and on investor sentiment. In terms of revenue contribution, Saudi Arabia represents

90% of the group while Kuwait and Bahrain contribute the balance. Domestic operations remain

the key driver as the size of the Kuwaiti and Bahraini markets limits upside potential. For the

purpose of this thematic report, we focus on STC’s operations in Saudi Arabia and Kuwait.

Short-term drivers


We do not view affordability (handsets or services) as an issue given Saudi Arabia’s oil wealth,

but telecom spending may be under pressure as the Saudi government’s efficiency drive


We see data as key driver of revenue growth. Mobile penetration in the Kingdom is in excess of

150% whereas smartphone penetration is estimated to be 60%. Data monetisation is hence

correlated to the competition intensity. We think Zain KSA and Mobily are unlikely to indulge in

value-destructive price wars as both need to resolve their high leverage. We do not award STC

the highest score in our ranking on this metric on account of Viva Kuwait’s low data monetisation.

Currency impact

We do not see any currency impact because the company only operates in the Gulf where the

currencies are pegged (in one form or another) to the USD.

Saudi Telecom Co (STC AB)

STC has a solid base from which to deliver on 5G monetisation

Unleveraged balance sheet is supportive of the dividend policy over

the medium term

Maintain Hold and SAR71 TP

Eric Chang*

Analyst


[email protected]

+971 4 423 6554

Nikhil Mishra* EEMEA Telecom Associate

Bangalore


101


16 March 2017

Dividend outlook

The incumbent established a dividend policy in November 2015 that calls for the payment of a

minimum of SAR1 per share per quarter. The policy is valid until Q3 2018. We forecast an

annual increase of SAR0.25: STC should be able to meet our expectations based on its cash-

rich balance sheet. However, we see limited scope for a marked increase because our dividend

estimate is significantly higher than free cash-flow.


Monetisation

Overall, we believe STC has reasonable opportunities for monetisation. In its domestic market,

we believe the incumbent’s extensive fixed infrastructure (and crucially the link to the last mile)

is a significant competitive advantage.

Monetisation can improve if competition in Saudi Arabia and Kuwait becomes rational (see also

the Viva Kuwait company section). The unified license in Saudi Arabia will allow competitors to

chip away at its near-monopoly on fixed and data services.

Competition

In the Saudi mobile segment, we expect competition to remain rational. We do not envisage Zain

KSA or Mobily engaging in value destructive price wars because both companies need to resolve

their high leverage. In addition, we discount the risk of new mobile entrants given the penetration

rates and the fact that two out of three network operators are struggling with profitability. However,

Mobily may pose some threat to STC’s monopoly on fixed and data services.

In our opinion, Kuwait is by far the most competitive telecoms market in the Gulf. The three

operators have nearly a third of market share, with Zain preserving its leadership. In 2016,

Ooredoo was the only operator that managed to grow revenues (+5% y-o-y). Revenues for Zain

and Viva were flat and Viva’s subscriber base stagnated in 2016, showing the limits of an

aggressive pricing strategy. We would like to see greater rationality in the pricing strategy but

think it is unlikely.

Regulation

In Saudi Arabia, the regulator has not introduced any regulation on net neutrality and the

practice of zero-rating. The introduction of a unified license increases competition on fixed and

data services.

Kuwait established a regulator last year but its format and strategy are yet to become apparent

and at this stage, its role and function remains unclear. We note the provisions of international

gateways and fixed line services are the sole prerogative of the Ministry of Communications.

There have been talks about privatising these services but nothing has transpired to date.

Business model

As the incumbent, STC has a structural advantage over its Saudi competitors: it is the only

integrated network operator in the Kingdom, and its network allows it to dominate the corporate

and government segments. We also presume STC has the best mobile network and greater

spectrum. Discussions with Mobily to form a TowerCo joint-venture would allow all parties to

achieve lower capex and opex in our view.


16 March 2017

102

Investment thesis

STC is currently by far the biggest telecom operator in Saudi Arabia – it has the highest market

share in the mobile segment and is the dominant player in the fixed line segment. Broadband,

especially mobile, has been the driver of growth for telecoms in the region. STC’s leadership in

Saudi Arabia has been a key competitive advantage as it was a net beneficiary of data growth.

This has translated into high cash generation and a solid balance sheet. We still think its high

cash balance will lead – over time – to increased dividend pay-out (we forecast an annual

increase of SAR0.25). However, we see limited scope for a marked increase as our dividend

estimate is significantly higher than free cash flow. In light of deteriorating financial performance,

de-regulation of the Saudi telecoms market and challenging economic conditions, we think STC

may be more prudent with its net cash position. Moreover, STC’s trade receivables have nearly

doubled, from SAR8.2bn (63 days) in Q4 2014 to SAR18.5bn (140 days) in Q4 2016. We think

this could be related to STC’s government-related accounts and highlights the possibility of

receivables write-downs.

Valuation and risks

STC: STC AB, SAR65.75, Hold, TP SAR71

We value STC on equal weighting of DCF (cSAR75/share) and a multiples-based SOTP

(cSAR67/share). Our TP of SAR71 implies 8.0% upside and we rate the stock Hold in light of

deteriorating financial performance, de-regulation of the Saudi telecoms market and challenging

economic conditions.

STC Valuation (SAR)

Weight Fair value Target price calculation

DCF 50% 75.45 37.73 SOTP 50% 67.12 33.56 TP 71.29 (rounded to 71.00)


DCF

We calculate a DCF fair value of SAR75.45. The key assumptions remain the same: WACC 6.6%,

risk free rate of 2.5%, equity risk premium of 7% and beta of 0.73 (as calculated by FactSet).

Sum-of-the-parts

Core Saudi operations are valued at 5.5x 2017e EBITDA

Viva Kuwait (VIVA KK, Reduce) stake at our target price of KWD0.74.

Viva Bahrain operations are valued at 4x 2017e EBITDA

We assign no value for STC’s 35% stake in Oger Telecom

We value Maxis (MAXIS MK, MYR 6.40, Reduce, covered by Piyush Choudhary) at

HSBC’s target price of MYR5.15. This is based on a cost of equity of 6.5%, cost of debt of

c5.0% and terminal growth rate of 0.5%

103


16 March 2017

STC SOTP

SARm EBITDA EV % EV % 2017e /EBITDA stake of EV

Saudi Arabia 19,471 5.5x 100.0% 107,091 91.7% Viva Kuwait 1,598 51.8% 2,357 2.0% Viva Bahrain 520 4.0x 100.0% 2,079 1.8% Subsidiaries 111,527 Oger Telecom 35.0% 0 0.0% Maxis 16.2% 5,308 4.5% Associates 5,308 EV 116,835 Debt 5,881 Cash -24,858 Minority's share in net debt 1,566 Net debt -17,410 Equity value 134,245 Issued shares (m) 2,000.0 FV (SAR) 67.12


Upside risks: higher dividend in the coming quarters; Viva Kuwait focusing on profitability

instead of market share; Oger Telecom (of which STC owns 35%) solving its debt problem in an

equity accretive manner

Downside risks: we highlight the possibility of receivables write-downs. Trade receivables

continue to go up and now exceed SAR18bn; an extended period of low oil prices would have a

deeper impact on the Saudi economy and telecom spending; higher competition in the mobile

segment (from Zain KSA and the MVNOs) and in the ICT segment (Mobily); a further cut in

termination rates in Saudi Arabia would impact revenue and margins as STC is the leading

operator in the country; given its significant net cash position, STC could take part in dilutive

M&A activity. We believe the possibility is lower as the company seemed to have learnt from its

past experience.


16 March 2017

104

Relative valuation

STC trades at the higher range of sector multiples.

We observe an interesting trend in consensus estimates. The consensus is becoming

sanguine on revenue growth prospects but has been more cautious on profit as seen in the

recent EBITDA estimates downgrades.

The dividend yield, while attractive, has compressed as the share price lost some steam

during Q4 2016.

STC: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return 1.2% 1.2% -8.9% 14.3% -3.0%

Total return 1.1% 1.2% -9.0% 16.3% 3.6%

Total return vs EEMEA index (USD) 2.3% 1.2% -13.9% 14.4% -13.8%

Total return vs MSCI EEMEA Telecom (USD) 0.5% -0.8% -14.2% 13.4% -4.0%

Price return vs Tadawul 1.2% 1.2% -6.9% 1.4% -11.4%

Price Return (USD) 0.8% 0.8% -9.1% 14.0% -3.0%

Total Return (USD) 1.1% 1.2% -8.9% 16.3% 3.6%





3

4

5

6

7

8



0

5

10

15

20



0.0%

2.0%

4.0%

6.0%

8.0%

10.0%



17,970

18,640

19,310

19,980

20,650

21,320

21,990

22,660


2015 2016 2017 2018 2019

45,100

46,840

48,580

50,320

52,060

53,800

55,540

57,280


2015 2016 2017 2018 2019

0

3,030

6,060

9,090

12,120

15,150

18,180

21,210


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


105


16 March 2017


Year to 12/2016a 12/2017e 12/2018e 12/2019e


Revenue 51,845 52,952 55,456 57,567

EBITDA 18,256 18,213 18,538 18,848



Net interest 561 175 283 233

PBT 9,510 9,870 10,797 11,215

HSBC PBT 9,803 9,081 9,934 10,318

Taxation -751 -789 -863 -897

Net profit 8,539 8,835 9,686 10,070

HSBC net profit 9,583 8,835 9,686 10,070



Capex -10,561 -10,100 -10,371 -10,608


Dividends -8,031 -8,375 -8,875 -9,375

Change in net debt 1,157 1,624 3,498 3,356

FCF equity 8,855 6,287 5,868 6,502




Current assets 46,899 46,425 41,415 38,272

Cash & others 24,858 21,834 16,936 12,498

Total assets 101,854 102,851 100,187 99,787


Gross debt 5,881 4,481 3,081 2,000

Net debt -18,976 -17,353 -13,854 -10,498




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 2.4 2.1 4.7 3.8

EBITDA -5.4 -0.2 1.8 1.7


PBT -9.3 3.8 9.4 3.9

HSBC EPS -8.4 -7.8 9.6 4.0

Ratios (%)

Revenue/IC (x) 1.5 1.5 1.4 1.4

ROIC 30.7 28.1 25.9 23.7

ROE 15.9 14.7 15.9 16.4

ROA 9.0 9.0 9.9 10.4

EBITDA margin 35.2 34.4 33.4 32.7


EBITDA/net interest (x)

Net debt/equity -31.1 -28.0 -22.1 -16.6

Net debt/EBITDA (x) -1.0 -1.0 -0.7 -0.6

CF from operations/net debt


EPS Rep (diluted) 4.27 4.42 4.84 5.03

HSBC EPS (diluted) 4.79 4.42 4.84 5.03

DPS 4.00 4.25 4.50 4.75

Book value 29.87 30.29 30.63 30.91

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 2.0 2.0 2.0 2.0

EV/EBITDA 5.8 5.9 5.9 6.0

EV/IC 3.0 2.9 2.7 2.5

PE* 13.7 14.9 13.6 13.1

PB 2.2 2.2 2.1 2.1

FCF yield (%) 7.1 5.1 4.7 5.3

Dividend yield (%) 6.1 6.5 6.8 7.2


Issuer information


Target price (SAR) 71.00 Sector Diversified Telecoms


Bloomberg (Equity) STC AB Analyst Eric Chang


Price relative


47.00

57.00

67.00

77.00

87.00

97.00

107.00

47.00

57.00

67.00

77.00

87.00

97.00

107.00

2015 2016 2017

Saudi Telecom Company Rel to TADAWUL ALL SHARE INDEX

Financials & valuation: Saudi Telecom Company Hold


16 March 2017

106

Company description

Telkom is a diversified telecom operator in South Africa. The fixed-line segment contributes

66% to revenue, the mobile segment 14% and BCX (Telkom’s IT arm) c17.5%. Enterprise

services account for c50% of revenue, consumer services 30% and wholesale services 20%.

Short-term drivers


Through price leadership, Telkom Mobile has been very successful in the 4G mifi router space

and is now looking to monetise the smartphone segment more efficiently with its FreeMe

packages; initial indications are that FreeMe is generally being used as a secondary SIM by

subscribers – nevertheless uptake of both 4G mifi router’s and FreeMe continues to be robust,

with mobile broadband subscribers increasing 44.5% to 2.28m in H1 2017. South Africa fares

well against EEMEA peers with the cheapest smartphone representing 1.6% of PPP-adj GDP

per capita and c7% of monthly disposable income (adjusted for cost of living). Data pricing

remains elevated in South Africa at USD10.7 per GB on a blended basis, forming 0.99% of PPP

adjusted GDP per capita – however we note Telkom Mobile prices data at a discount. Mobile

data remains a key driver for Telkom, and this is likely to continue near-term due to spectrum

allocation delays in South Africa, as it has spectrum advantages in the 1800/2300MHz bands.

On the fixed-line data side Telkom continues to price at a premium (20-40%) to competitors,

with only 0.3% growth in fixed broadband subscribers in H1 2017 and c19,000 FTTH

subscribers, ADSL subscriber numbers are falling at Telkom with FTTH net-adds not making up

for the decline. Given this growth drag and that only 13-14% homes passed have FTTH

connectivity (high competitive intensity), we do not see FTTH as a transformational growth

driver near-term. Approximately 65% of fixed-line data revenue is driven by connectivity; while

(1) competition in FTTH; (2) pricing in Enterprise; and (3) LTE cannibalisation of ADSL limit

growth prospects we expect data connectivity revenue to improve to 2-3% in the medium term

(from 0.3% in H1 2017) as Enterprise pricing pressure eases and migration from legacy leased

lines to Megalines and Metro Ethernet accelerates.

Telkom Group (TKG SJ)

With growth uncertainty around BCX/Enterprise and higher

capex/D&A, we expect benign growth in FCF/EBITDA/HEPS

Moderately placed to benefit from 5G. Convergence strategy and

network sharing will help but completion and regulation challenging

No compelling growth/rating drivers exist near-term. Maintain Hold

and ZAR77.0 TP

Ziyad Joosub*

Analyst

HSBC Securities (South Africa) (Pty) Ltd

[email protected]

+27 (0)11 676 4223

Ramesh Pantagolusula*


Bangalore


107


16 March 2017

Currency impact

We expect the currency impact to be negligible for Telkom over the short term given its low

exposure to dollarised debt of only 3.8% and that the ZAR has strengthened c15% against the

USD over the past 4-6 months. Savings on capex through the recent strengthening of the ZAR

are likely to drive better investment yields as the company can invest a greater USD amount of

capex: we note capex is guided for in ZAR terms; hence we do not expect any reduced

guidance on this front given recent ZAR strength and heightened capex guidance by

competitors (MTN South Africa specifically).

Dividend outlook

We believe Telkom will continually invest in greater 3G/4G/LTE capability in order to

(1) facilitate optimal growth and market share gains; (2) support greater business scale;

(3) maintain price leadership; and (4) avert network congestion issues due to traffic/revenue

concentration of BTS’s in key metropolitan areas. Management has stated that Telkom will push

ahead aggressively with fibre rollouts over the next 12 months. Whilst we foresee no dividend

transformation at Telkom, outside of any unforeseen M&A, we believe the dividend is secure

and will largely underpin current valuations as it is fully covered by internal FCF generation

(80% of FCF), while Telkom’s balance sheet (0.3x 2017e net debt to EBITDA) also remains

unlevered. We see little scope for extraordinary cash returns at Telkom (buyback, special or

higher payouts) with the balance sheet being used for spectrum and potential bolt-on

acquisitions (IT, FTTH retail ISPs) and “higher-capex/flat-FCF” is set to be a multi-year theme in

our view.


Fixed-line infrastructure and fibre advantage to erode overtime, 5G will be a competitive

and level playing field; key advantage will be in the IT software for Enterprise. In theory

Telkom, due to its spectrum and extensive fibre and wifi advantages, is the best positioned

operator to monetise 5G relative to Vodacom SA and MTN SA– also given its scale, 5G

provides Telkom with the highest growth optionality of listed MNOs in South Africa. While the

incumbent fixed-line operator lacks appropriate mobile scale and penetration into high ARPU

smartphone, nevertheless Telkom should benefit from 5G mifi-like products and establish a

strong position in the second data-SIM market. Telkom’s ability to sustain its balance sheet

capacity longer-term is debatable given it needs to invest for growth, which could be through

M&A, whilst defending its dividend pay-out level as well (80%+ of FCF). No operator in South

Africa has “excess” low frequency spectrum except Neotel (not listed), which has no mobile

infrastructure – thus low-frequency spectrum advantages until the digital-dividend spectrum

allocation is finalised appear minimal. We believe most of the 4G/5G wallet will reside in key

metropolitan areas in South Africa; whilst Telkom has extensive fixed-line infrastructure

nationwide-wide, we believe that by 2020 its fibre density advantage to MTN and Vodacom will

reduce meaningfully in key metropolitan areas. Independent fibre provider rollouts (where

transmission can be leased from) and higher fibre investment by MTN, Vodacom and Cell C is

likely to erode Telkom’s fixed-line advantage in key urban centres and business parks. A key

advantage for Telkom will be its IT scale post its acquisition of BCX and its existing Enterprise

segment scale, Telkom’s ability to drive 5G as an agile software-defined network infrastructure

for IOT Applications will be a key determinant to how successful it is in 5G.


16 March 2017

108

Investment thesis

We forecast 2H17/FY18 revenue growth of only 0.4%/1.7% y-o-y, while mobile (data/voice)

dynamics remain relatively robust and Openserve/wholesale revenue appears to be stabilising

(greater demand seen from MNOs and FTTH ISPs) – we remain concerned on revenue

dynamics at BCX/Enterprise. These segments have high public-sector exposure on the back of

slumping tax revenue and benign growth – the South Africa government’s robust fiscal

consolidation agenda looks likely to continue. We see little scope for immediate cost

transformation, as employee annual attrition of 3% (1% organic and 2% outsourcing) is offset by

a 5% average annual salary increase. Overall, we expect 20-40bps margin expansion a year at

Telkom, which combined with a subdued 3-year revenue CAGR of 2.3% drives our FY17-20

EBITDA CAGR forecast of 3.2%.

1 year forward FCF-yield and PE of 6.4% and 11.0x are 2.2 and 1.0 standard deviations above

their means; the initiation of a fixed dividend-policy has driven a structural re-rating of Telkom.

We believe the dividend is secure and will largely underpin current valuations as it is fully

covered by internal FCF generation (80% of FCF), while Telkom’s balance sheet (0.3x 2017e

net debt to EBITDA) also remains unlevered. An outlook for “slow-growth” + slow “multiple-

contraction” underpins our Hold rating. Asset-base/invested-capital build-up due to higher-capex

cycle will drive a slow reduction of ROE/ROIC over the medium term; we thus expect multiples

to gradually contract. HSBCe EBITDA/FCF/HEPS 3 year CAGR of 3.2%/3.6%/5.2% will not be

sufficient to offset the de-rating in our view.

Valuation and Risks

Telkom SA, TKG SJ, ZAR69.8 Hold, TP ZAR77

We value Telkom South Africa on a 50/50 split between our SOTP valuation of ZAR77.0 and

our DCF for the company as a whole of ZAR76.5 to arrive at a final fair value target price of

ZAR77. Our DCF valuation is based on explicit cash flow forecasts for six years to FY2022e and

assumes a second-stage growth into perpetuity of 1.0% for the fixed-line business and 2% for

the mobile segment. Our DCF based SoTP valuation for the whole company is based on a COE

of 13.5%, RFR of 8.5%, equity risk premium of 5% and a beta of 1.0. Our ZAR77 TP implies

10.3% upside and we rate the stock Hold based on our expectation for slow-growth plus slow

multiple contraction.

Key upside risks include: (1) Completion of BCX/Enterprise integration drives greater than

expected synergies; (2) stabilisation in public sector ICT contract pricing and competition;

(3) faster than expected mobile FCF break-even and growth; (4) value accretive M&A; and

(5) higher ordinary payout or initiation of buybacks and/or special dividends.

Key downside risks include: (1) Higher competitive intensity for South Africa mobile; (2) greater

than expected regulatory risk; and (3) unforeseen telecom taxes or operational surprises.

109


16 March 2017

Relative valuation

Valuation relatively premium versus history

Higher sales growth estimation

Consensus EBITDA estimates rising

Telkom South Africa: Valuation Benchmark relative

Source: Datastream, HSBCe


1W 1M 3M 6M 12M

Price return 3.3% -1.6% -4.4% 15.0% 22.2%

Total return 3.3% -1.6% -4.4% 17.1% 29.9%

Total return vs EEMEA index (USD) 4.3% 0.8% -5.0% 23.2% 36.0%

Total return vs MSCI EEMEA Telecom (USD) 2.7% -3.6% -9.6% 14.3% 22.3%

Price return vs JSE 4.1% -0.6% -5.9% 18.6% 24.0%

Price Return (USD) 3.0% 0.8% -0.2% 22.6% 44.3%

Total Return (USD) 3.1% 0.8% -0.1% 25.1% 53.4%





3

4

4

5

5

6

6



0

2

4

6

8

10

12

14



-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%



8,000

8,710

9,420

10,130

10,840

11,550

12,260

12,970


2015 2016 2017 2018 2019

30,550

32,740

34,930

37,120

39,310

41,500

43,690

45,880


2015 2016 2017 2018 2019

0

1,170

2,340

3,510

4,680

5,850

7,020

8,190


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

110


Year to 03/2016a 03/2017e 03/2018e 03/2019e


Revenue 36,044 40,867 41,544 42,794

EBITDA 10,954 10,599 10,794 11,298



Net interest -318 -341 -305 -267

PBT 5,263 4,518 4,630 4,968

HSBC PBT 5,263 4,518 4,630 4,968

Taxation -942 -994 -1,019 -1,143

Net profit 4,557 3,577 3,489 3,702

HSBC net profit 3,351 3,407 3,558 3,768



Capex -5,851 -6,895 -6,887 -6,848


Dividends -1,402 -2,040 -2,135 -2,261

Change in net debt 2,929 619 -330 -362

FCF equity 2,930 3,291 2,425 2,910




Current assets 12,912 10,519 10,486 10,587

Cash & others 2,548 1,635 1,662 1,712

Total assets 46,787 46,256 48,284 50,283


Gross debt 5,269 4,975 4,672 4,359

Net debt 2,721 3,340 3,010 2,648




Year to 03/2016a 03/2017e 03/2018e 03/2019e

Y-o-y % change

Revenue 13.8 13.4 1.7 3.0

EBITDA 22.0 -3.2 1.8 4.7

Operating profit 95.3 -12.0 -1.3 6.1

PBT 93.4 -14.1 2.5 7.3

HSBC EPS 54.2 -1.0 4.4 5.9

Ratios (%)

Revenue/IC (x) 1.5 1.6 1.5 1.4

ROIC 18.7 13.7 12.7 12.6

ROE 12.9 13.0 12.9 12.6

ROA 10.8 8.5 8.5 8.5

EBITDA margin 30.4 25.9 26.0 26.4



Net debt/equity 10.2 12.4 10.2 8.3




EPS Rep (diluted) 8.93 6.82 6.66 7.06

HSBC EPS (diluted) 6.56 6.50 6.79 7.19

DPS 2.73 3.89 4.07 4.31

Book value 50.14 50.04 56.45 60.87

Key forecast drivers

Year to 03/2016a 03/2017e 03/2018e 03/2019e

Access lines (000s) 3,288 3,150 2,994 0

ADSL subscribers (000s) 970 971 984 0

Fixed line EBITDA margin (%) 37.2 37.4 37.7 0.0

Valuation data

Year to 03/2016a 03/2017e 03/2018e 03/2019e

EV/sales 0.9 0.8 0.8 0.8

EV/EBITDA 3.1 3.3 3.2 3.0

EV/IC 1.3 1.3 1.2 1.1

PE* 10.6 10.7 10.3 9.7

PB 1.4 1.4 1.2 1.1

FCF yield (%) 9.5 10.6 7.7 9.2

Dividend yield (%) 3.9 5.6 5.8 6.2


Issuer information


Target price (ZAR) 77.00 Sector Diversified Telecoms

Reuters (Equity) TKGJ.J Country South Africa

Bloomberg (Equity) TKG SJ Analyst Ziyad Joosub


Price relative


46.00

51.00

56.00

61.00

66.00

71.00

76.00

81.00

86.00

46.00

51.00

56.00

61.00

66.00

71.00

76.00

81.00

86.00

2015 2016 2017

Telkom SA Rel to JSE ALL SHARE

Financials & valuation: Telkom SA Reduce

111


16 March 2017

Company description

Turk Telekom is a diversified telecom operator in Turkey. The fixed line segment contributes

c64% of group revenue and mobile contributes c36%. Turk Telekom’s mobile segment Avea is

the third largest operator in Turkey with a subscriber market share of c25%.

Short-term drivers


We are moderately optimistic about Turk Telekom’s ability to monetise data. Currently c75% of

its mobile subscribers use data services. The price of the most affordable smartphone accounts

for c14% of monthly disposable income in Turkey; for EEMEA peers, the median value of the

most affordable smartphone accounts for 10% of monthly disposable income. The average

price of mobile data at Turk Telekom is low relative to Turkcell and EEMEA peers.

Mobile data revenue has grown over 30% y-o-y in the past four quarters. Given the nationwide

fibre network and good quality spectrum to enhance the LTE experience, Turk Telekom looks

well placed to execute a convergence strategy. In the 4.5G spectrum auction concluded last

year, it acquired the 900MHz spectrum, thus eliminating its earlier disadvantage.

Currency impact

Turk Telekom looks the most vulnerable to currency risk among the EEMEA telecom operators.

Roughly 50% of its capital expenditure is in hard currency, and hard currency debt accounted

for around 82% of total gross debt. Moreover, HSBC’s FX strategists forecast TRY depreciating

by 12% y-o-y in FY17.

Dividend outlook

Dividend yield is dependent mainly on the USD/TRY exchange rate. In FY16, dividends were

not paid because of a net loss at group level due to sharp TRY depreciation. We expect

dividends to resume in FY17, with estimated dividend yield of c6%. Although we are

conservative about the actual dividend pay-out due to the volatile exchange rate (TRY/USD and

TRY/EUR), the company’s ability to pay a dividend should be good, driven by healthy FCF yield

and leverage. We expect FCF yield to be above 12% over the next two years, with leverage

(Net debt/EBITDA) at 1.3x by end-FY17e and 1x by end-FY18e.

Turk Telekom (TTKOM TI)

Vulnerable to exchange rate risk, which may impact dividend outlook

over short term

Well placed to benefit from 5G given the ability to execute

convergence strategy

Maintain Hold and TRY6 TP


HSBC Bank plc

[email protected]

+44 20 7991 6827


Bangalore



16 March 2017

112


Turk Telekom looks well placed to benefit from 5G in the medium term, with its diversified

infrastructure in both fixed and mobile. Data is gradually becoming the key driver in the Turkish

telecoms market and multi-play and convergence services are seeing significant traction, which

will change the way existing players compete. Turk Telekom has a natural advantage with

strong offers in both mobile and fixed lines services for residential and corporate customers. It is

the only operator in Turkey with nationwide fibre coverage and eliminated its disadvantage in

900MHz spectrum at the spectrum auctions, concluded last year.

We expect the Turkey market to gradually become rational in the medium term. Turk Telekom’s

mobile segment and the third largest mobile operator, Avea, has a c25% subscriber market

share and we believe it would make more economic sense to adopt rational pricing going

forward. Given the intention of operators in Turkey to collaborate at the capital spending level in

the medium term, the pricing environment should become more rational in the medium term.

Telecom assets are increasingly perceived politically as a strategic asset. Regulation is

relatively accommodating with tech neutral frequency already acquired for 4G and 5G although

spectrum price has been relatively expensive.

Turk Telekom’s business model still has a legacy as the national incumbent. However the

company has become leaner and more agile as it has restructured its organisation, and now

uses a common brand. It can also benefit from some premium media content it has acquired

(European football rights).

Investment thesis

Turk Telekom’s operational level estimates look healthy, with Mobile data and Fixed Broadband

the key drivers of revenue and EBITDA over the next few years. We are optimistic about Turk

Telekom’s strategy of focusing on operating free cash flow over FY17. It should comfortably

achieve its EBITDA guidance (TRY5.6-6bn) in FY17. Despite a volatile exchange rate, Turk

Telekom managed to limit capital spending in FY16 and we expect it to be able to continue

doing so in FY17, keeping it under TRY3bn. Over the medium term, Turk Telekom intends to

sharing capital spending with other operators in Turkey.

However, we remain conservative on Turk Telekom as the exchange rate (TRY/USD and

TRY/EUR) is likely to be volatile over the near term. Given its high proportion of debt and capex

in hard currency, Turk Telekom looks vulnerable to the currency risk. Net profit may be

impacted by the forex loss, which will in turn lead to a lower dividend pay-out.

Valuation and Risks

Turk Telekom: TTKOM TI, TRY5.7, Hold, TP TRY6.0

We assume a cost of equity of 16% and a risk-free rate of 10.5% (based on Turkey’s long-term

bond yield), with a market risk premium of 5.5% and beta of 1.0 (all unchanged). Our fair value

target price of TRY6.0 implies upside of 5.3% and we rate the stock Hold as we remain concerned

about potential TRY weakness, which could affect reported net profit in 2017. The stock currently

trades on an EV/EBITDA multiple for 2017e of 4.5x and adjusted PE for 2017e of 10.3x versus the

EEMEA telcos sector average of EV/EBITDA of 4.7x and adjusted PE of 11.2x.

Upside risks include: a quicker recovery of the TRY; a change in the dividend policy so that it is

not based purely on reported net income and also considers cash flow generation; and a more

favorable regulatory environment.

Downside risks include: increased competition; a more aggressive-than-expected decline in

data pricing; a sustained weakening economic outlook; a higher-than-expected forex loss; and a

lower-than-expected dividend.

113


16 March 2017

Valuation relatives

Attractive on EV/opFCF

Consensus has stabilised and may now increase

No Dividend in 2016 due to TRY currency but should resume in 2017

Turk Telekom: Valuation Benchmark Chart

Source: HSBCe , Datastream


1W 1M 3M 6M 12M

Price return -1.7% 2.7% 9.2% -2.4% -4.3%

Total return -1.7% 2.7% 9.2% -2.4% -0.5%

Total return vs EEMEA index (USD) -2.2% 2.2% -3.8% -24.9% -39.8%

Total return vs MSCI EEMEA Telecom (USD) -2.4% 0.7% 4.0% -5.2% -8.1%

Price return vs Borsa Istanbul -1.8% 1.2% -9.0% -17.2% -19.5%

Price Return (USD) -3.5% 2.2% 1.2% -23.0% -25.3%

Total Return (USD) -3.4% 2.3% 1.2% -23.0% -22.3%





3

4

5

6

7



0

5

10

15

20

25

30



-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%



4,870

5,230

5,590

5,950

6,310

6,670

7,030

7,390


2015 2016 2017 2018 2019

12,990

14,200

15,410

16,620

17,830

19,040

20,250

21,460


2015 2016 2017 2018 2019

0

750

1,500

2,250

3,000

3,750

4,500

5,250


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

114


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (TRYm)

Revenue 16,109 17,402 19,041 20,738

EBITDA 5,470 6,049 6,872 7,688



Net interest -504 -566 -529 -454

PBT -394 1,786 3,310 4,302

HSBC PBT 2,220 2,413 3,310 4,302

Taxation -329 -470 -794 -1,032

Net profit -723 1,316 2,516 3,269

HSBC net profit 1,871 1,943 2,516 3,269

Cash flow summary (TRYm)


Capex -3,026 -2,989 -3,067 -3,201


Dividends -841 -1,211 -1,211 -2,315

Change in net debt 2,447 -703 -1,257 -575

FCF equity 1,650 2,000 2,348 2,857

Balance sheet summary (TRYm)



Current assets 9,236 9,280 9,608 9,947

Cash & others 3,016 3,000 3,000 3,000

Total assets 26,874 27,820 28,388 29,200


Gross debt 11,540 10,820 9,564 8,988

Net debt 8,523 7,820 6,564 5,988




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 11.2 8.0 9.4 8.9

EBITDA 2.6 10.6 13.6 11.9


PBT -131.2 85.3 30.0

HSBC EPS -38.4 3.8 29.5 30.0

Ratios (%)

Revenue/IC (x) 0.6 0.6 0.6 0.6

ROIC 7.6 7.8 8.8 10.4

ROE 44.7 56.5 70.0 85.5

ROA -1.6 6.8 10.7 12.9

EBITDA margin 34.0 34.8 36.1 37.1



Net debt/equity 251.7 224.0 177.7 151.4



Per share data (TRY)

EPS Rep (diluted) -0.21 0.38 0.72 0.93

HSBC EPS (diluted) 0.53 0.56 0.72 0.93

DPS 0.00 0.35 0.66 0.86

Book value 0.97 1.00 1.06 1.13

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 1.7 1.6 1.4 1.2

EV/EBITDA 5.1 4.5 3.8 3.3

EV/IC 0.9 0.9 0.8 0.7

PE* 10.7 10.3 7.9 6.1

PB 5.9 5.7 5.4 5.0

FCF yield (%) 8.5 10.3 12.1 14.7

Dividend yield (%) 0.0 6.1 11.6 15.1


Issuer information

Share price (TRY) 5.70 Free float 13%

Target price (TRY) 6.00 Sector Diversified Telecoms

Reuters (Equity) TTKOM.IS Country Turkey

Bloomberg (Equity) TTKOM TI Analyst Herve Drouet


Price relative


4.60

5.10

5.60

6.10

6.60

7.10

7.60

8.10

4.60

5.10

5.60

6.10

6.60

7.10

7.60

8.10

2015 2016 2017

Turk Telekom Rel to ISTANBUL COMP

Financials & valuation: Turk Telekom Hold

115


16 March 2017

Company description

Turkcell is a diversified telecom operator with presence in Turkey, Ukraine and Belarus. Turkey

contributes c90% of group revenue, with c4% from Ukraine. Turkcell is the market leader in the

mobile segment in Turkey with a subscriber market share of c48%.

Short-term drivers


We are optimistic about Turkcell’s ability to monetise data. Currently a majority of subscribers

use a smartphone, with the most affordable smartphone accounting for around 14% of monthly

disposable income in Turkey. Through its consumer financing unit, Turkcell aims to enable

easier smartphone purchase. For EEMEA peers, the median value of the most affordable

smartphone accounts for 10% of monthly disposable income. Turkcell is able to charge higher

prices for mobile data in Turkey than its peers. It intends to focus on selling digital services

rather than selling raw data. Given the better quality and quantity of spectrum we are bullish

about Turkcell’s digital strategy.

Currency impact

Turkcell looks moderately vulnerable to currency risk among EEMEA telecom operators.

Roughly 50% of its capital expenditure is in hard currency, and hard currency debt forms around

75% of total gross debt. Moreover, HSBC FX strategists forecast 12% y-o-y TRY depreciation in

FY17. After considering hedging and cash reserves in hard currency, Turkcell has a net FX

exposure of USD125m as of end-FY16.

Dividend outlook

For Turkcell, the dividend payment hinges on the resolution of the shareholder dispute.

Dividend payments over the past two years (FY15 and FY16) have been cancelled due to the

deadlock. We assume a resolution in 2017. We therefore see a dividend of TRY0.50 per share

(based on a 50% pay-out ratio) for FY17e, to be paid and approved in 2018. If the shareholder

dispute is resolved, we cannot rule out the possibility of extraordinary shareholder dividends in

FY17 related to the unpaid dividends over the past two years. We do not factor any

extraordinary dividends into our model in order to stay conservative.

Turkcell (TCELL TI)

Potential for data monetisation strong driven by focus on digital

strategy; Dividend outlook to improve

Well placed to capitalise on 5G launch driven by the ability to execute

convergence strategy and rational competition

Maintain Buy and TRY14.2 TP


HSBC Bank plc

[email protected]

+44 20 7991 6827



Bangalore



16 March 2017

116


Turkcell is well placed to benefit from 5G over medium term in our view and data and digital

services will play a crucial role in driving growth. Superior infrastructure in mobile and good

infrastructure in fibre through superonline should enable it to offer multi-play and convergence

services. Turkcell’s position in the mobile segment is further strengthened since the recently

concluded spectrum auction. Increasing the fibre network across the nation will be the key for

Turkcell before the launch of 5G in Turkey and we see it improving its fibre coverage gradually

over the next few years. Currently Turkcell has fibre networks in 15 cities (vs Turk Telekom’s

presence in 81 cities) and is exploring options to share capital expenditure with other players,

such as Vodafone Turkey and Turksat, to build the infrastructure.

We expect competition to become more rational in Turkey over the medium term. Given the

intention of operators in Turkey to collaborate at a capital spending level, pricing should also

turn more rational.

Telecom assets are increasingly perceived politically as a strategic asset. Regulation is

relatively accommodating with tech neutral frequency already acquired for 4G and 5G, although

spectrum price has been relatively expensive.

Turkcell’s business model is increasingly turning towards digital applications, and there is

already a relatively well developed digital platform with significant premium contact.

Investment thesis

Our bullish view on Turkcell is mainly driven by significant improvement in operational trends.

We expect Turkcell’s digital strategy to lead to an improvement in ARPUs, lower churn rates

and higher EBITDA margins. Given its infrastructure in mobile and fixed line segments, we

expect Turkcell to be successful in executing a convergence strategy.

We expect the FCF outlook to improve over the next few years driven by improving margins and

declining capital spending. Turkcell’s capital spending cycle should reverse from FY17e: capital

expenditure peaked in FY16 mainly driven by the accelerated 4.5G rollout and volatility in TRY/USD.

Given its robust growth outlook, Turkcell looks attractive on a relative valuation, trading at 4.5x

2018e EV/EBITDA (a 12% discount to EEMEA average of 5x).We expect Turkcell to rerate to a

higher multiple given its accelerating growth, margin and FCF improvement. Other catalysts could

be the potential sale of Fintur and monetisation of the tower business through a stake sale.

Valuation and Risks

Turkcell: TCELL TI, TRY12.18, Buy, TP TRY14.2

We maintain our DCF-based fair value target price of TRY14.2. We assume a cost of equity of

16% and a risk-free rate of 10.5% (based on Turkey sovereign bond yield), with a market risk

premium of 5.5% and beta of 1.

Our TRY14.2 fair value target price implies upside of 16.6% and we rate the stock Buy based

on a robust growth outlook and improvement in margin and FCF outlook. Our target price for

Turkcell’s ADRs (TKC US, USD8.21) is USD9.70, using the equation of 1 ADR equaling 2.5

shares and USD/TRY of 3.66.

Downside risks relate to the regulatory environment and domestic competition, which may put

pressure on Turkcell’s margins and growth prospects. Weak macroeconomic prospects for Turkey

and Ukraine are other downside risks, together with a more aggressive-than-expected decline in data

pricing. Any potential sale of TeliaSonera’s stake in Turkcell may put the share price under pressure.

117


16 March 2017

Relative valuation

Valuation relatively cheap versus the sector and history

Superior growth

Consensus estimates rising

Turkcell: Valuation Benchmark Chart



1W 1M 3M 6M 12M

Price return -0.2% 9.2% 33.9% 22.3% 3.0%

Total return -0.2% 9.2% 33.8% 22.3% 3.0%

Total return vs EEMEA index (USD) -0.7% 8.7% 19.1% -5.4% -37.0%

Total return vs MSCI EEMEA Telecom (USD) -0.8% 7.2% 28.6% 19.5% -4.6%

Price return vs Borsa Istanbul -0.3% 7.7% 15.7% 7.4% -12.1%

Price Return (USD) -1.9% 8.8% 24.0% -3.6% -19.6%

Total Return (USD) -1.9% 8.8% 24.0% -3.5% -19.6%





3

4

5

6

7

8

9



-150

-100

-50

0

50

100

150



-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%



3,470

3,980

4,490

5,000

5,510

6,020

6,530

7,040


2015 2016 2017 2018 2019

11,250

12,600

13,950

15,300

16,650

18,000

19,350

20,700


2015 2016 2017 2018 2019

0

810

1,620

2,430

3,240

4,050

4,860

5,670


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

118


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (TRYm)

Revenue 14,286 16,079 17,974 20,085

EBITDA 4,620 5,257 5,995 6,805



Net interest 617 22 75 155

PBT 1,967 2,845 3,643 4,460

HSBC PBT 2,991 2,863 3,643 4,460

Taxation -423 -626 -801 -981

Net profit 1,492 2,212 2,834 3,470

HSBC net profit 2,738 2,230 2,834 3,470

Cash flow summary (TRYm)

Cash flow from operations 607 4,746 5,492 6,234

Capex -3,495 -3,212 -3,055 -3,214


Dividends 0 -1,106 -1,106 -1,417

Change in net debt 2,431 -211 -1,330 -1,603

FCF equity 1,374 1,458 2,261 2,840

Balance sheet summary (TRYm)



Current assets 13,351 10,877 11,180 11,518

Cash & others 6,052 3,500 3,500 3,500

Total assets 31,600 31,246 32,177 33,227


Gross debt 9,781 7,018 5,688 4,085

Net debt 3,729 3,518 2,188 585




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 11.9 12.6 11.8 11.7

EBITDA 11.6 13.8 14.0 13.5


PBT -7.0 44.6 28.1 22.4

HSBC EPS -4.2 -18.6 27.1 22.5

Ratios (%)

Revenue/IC (x) 0.8 0.8 0.9 1.0

ROIC 13.0 11.3 13.8 16.6

ROE 18.0 13.5 15.9 17.9

ROA 6.8 8.2 10.0 11.5

EBITDA margin 32.3 32.7 33.4 33.9


EBITDA/net interest (x)

Net debt/equity 23.2 20.5 11.8 2.9



Per share data (TRY)

EPS Rep (diluted) 0.68 1.01 1.29 1.58

HSBC EPS (diluted) 1.24 1.01 1.29 1.58

DPS 0.00 0.50 0.64 0.79

Book value 7.28 7.78 8.42 9.21

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 2.0 1.8 1.5 1.3

EV/EBITDA 6.2 5.4 4.5 3.8

EV/IC 1.5 1.4 1.3 1.3

PE* 9.8 12.0 9.5 7.7

PB 1.7 1.6 1.4 1.3

FCF yield (%) 5.5 5.9 9.1 11.4

Dividend yield (%) 0.0 4.1 5.3 6.5


Issuer information

Share price (TRY) 12.18 Free float 35%

Target price (TRY) 14.20 Sector Wireless Telecoms

Reuters (Equity) TCELL.IS Country Turkey

Bloomberg (Equity) TCELL TI Analyst Herve Drouet


Price relative


8.00

9.00

10.00

11.00

12.00

13.00

14.00

15.00

16.00

17.00

8.00

9.00

10.00

11.00

12.00

13.00

14.00

15.00

16.00

17.00

2015 2016 2017

Turkcell Rel to ISTANBUL COMP

Financials & valuation: Turkcell Buy

119


16 March 2017

Company description

VimpelCom is a diversified telecom operator with presence in Russia, Italy, North Africa, Asia

and CIS. VimpelCom Russia contributes 46% of group revenue, with Africa and Asia

contributing 34% and CIS contributing 14%. VimpelCom has announced its intention to list in

Amsterdam as well (expected in Q2 2017).

Short-term drivers


Currently c62% of VimpelCom mobile subscribers use some kind of mobile data services, with

the price of the most affordable smartphone representing c14% of monthly disposable income in

Russia. Given the tough macro in Russia, monetisation has been limited recently. Data pricing

is also cheap and competitive retailers incentivise mobile users to churn. We would like to see

less aggressive promotion, which could be driven by a shift of the Russian mobile operators

towards more monobrand shops. The split of Euroset shops between Megafon and VimpelCom

is a key catalyst in our view. However, we expect VimpelCom’s voice and data monetisation to

be driven by key segments such as Pakistan, Bangladesh and Ukraine. In Algeria, we expect

VimpelCom’s market share to gradually stabilise.

Currency impact

VimpelCom looks at moderate risk of a currency impact due to exchange rate movement in

Russia and Ukraine. A significant portion of its capital expenditure is in hard currency, with 73%

of group debt in hard currency. HSBC FX strategists forecast RUB depreciating c6% y-o-y in

FY17 relative to USD. Therefore we expect VimpelCom to be vulnerable to currency risk to

some extent over the short term.

Dividend outlook

The dividend outlook at VimpelCom improved significantly in FY16. The company announced total

dividends of USDc23 (including the regular USDc3.5 paid in December 2016), with USDc19.5 paid

in April 2017. The improvement in leverage ratio post the deconsolidation of Wind (Italy segment) is

in our view the key factor behind the improved dividends. We expect the current dividend yield to be

sustainable over the near term given the good FCF yield and controlled leverage and we see scope

for further improvement in dividends over the next two years.

VimpelCom (VIP US)

Short term: Significant scope for dividend improvement

Long term: Change of business model to technology company will be

positive ahead of 5G launch

Maintain Buy, cut TP to USD5.2 (from USD5.4)


[email protected]

+44 20 7991 6827



Bangalore



16 March 2017

120


VimpelCom reiterated the group strategy to transform into a technology company from a

conventional telecom company post the Q4 2016 results, which we think will be a benefit post

the launch of 5G, by creating new revenue streams and optimising capital spending.

It is a diversified operator in two of its key markets – Russia and Ukraine – which is also a

positive, putting it in a good position to offer convergence services. We expect competition in

Russia to become rational gradually.

The potential entry of disruptive new entrants or technology players is limited in Russia due to

security concerns. Consolidation in key markets like Bangladesh and Pakistan will help

VimpelCom. The Russian telecom regulator is benign in terms of spectrum allocation as the

mobile operators are allocated spectrum at a low cost. Spectrum prices may go higher in other

markets like Africa and Asia.

Lack of strict enforcement of net neutrality is a positive for the Russian segment. However, in

other Asian markets like Bangladesh and Pakistan net neutrality may be strictly enforced.

VimpelCom has been actively pursuing network sharing to reduce capital expenditure and, to

some extent, operating expenses. We expect this to continue post 5G launch.

Investment thesis

Our positive view on VimpelCom is mainly driven by an improving dividend outlook on the back

of improving free cash flows. VimpelCom guides for equity free cash flow of more than USD1bn

for FY18 (compared to USD588m in FY16 and guidance of USD700-800m in FY17).

Management guides for low single digit growth in revenue and EBITDA. The growth in equity

free cash flows will be mainly driven by improvement in capital efficiency. VimpelCom’s

emphasis on disposing non-strategic assets will help it to reduce capex/sales to c15% in the

medium term (currently 17-18%). Given the robust free cash flows we expect over the next few

years, we see significant scope for dividend improvement.

Change in estimates

We revise our model post Q4 2016 results, cutting our estimates as the Q4 2016 results were

lower than our expectations.

Old vs New estimates

Old 2017e 2018e 2019e

Revenue 9,107 9,431 - EBITDA 3,605 3,721 - Net Profit 1,444 1,781 - New Revenue 9,443 9,531 9,859 EBITDA 3,804 3,927 4,075 Net Profit 775 968 1,192 Old vs New Revenue 4% 1% - EBITDA 6% 6% - Net Profit -47% -46% -

Source: HSBCe

121


16 March 2017

Valuation and Risks

VimpelCom: VIP US, USD3.98, Buy, TP USD5.2 (from USD5.4)

We value VimpelCom based on DCF valuation. We assume a COE of 14.6%, RFR of 8% (based

on the sovereign yield of key operating markets), and MRP of 6% and a beta of 1.1 (all unchanged).

Our TP decreases to USD5.2 from USD5.40 due to lower estimates. Our target price of USD5.2

implies 30.7% upside from current levels and we rate the stock Buy.

Key downside risks include RUB and EUR fluctuations with the USD, macroeconomic volatility

and M&A activities or share overhang of the Telenor stake coming to the market. Other risks

include regulatory uncertainties related to deal approval, increased competition, weak economic

outlook, exposure to Ukraine and tougher-than-expected competition with Iliad’s entry in Italy.


16 March 2017

122

Relative valuation

Looks attractive on EV/EBITDA and EV/OPFCF versus peers

Dividend yield rising significantly

Consensus estimates rising since deconsolidation of Wind Italy.

VimpelCom: Benchmark Valuation chart



1W 1M 3M 6M 12M

Price return -4.0% -2.7% 8.6% -4.9% 5.4%

Total return -4.1% -2.7% 8.4% -4.0% 6.4%

Total return vs EEMEA index (USD) -2.9% -2.7% 3.5% -5.9% -11.0%

Total return vs MSCI EEMEA Telecom (USD) -4.8% -4.7% 3.2% -6.8% -1.2%

Total return vs NYSE -2.3% -4.7% 5.1% -10.5% -12.7%

Price return vs NYSE -2.2% -4.5% 5.9% -10.1% -10.6%

Price Return (USD) -4.0% -2.7% 8.6% -4.9% 5.4%

Total Return (USD) -4.1% -2.7% 8.4% -4.0% 6.4%





3

4

5

6

7

8



0

5

10

15

20



-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%



2,660

3,390

4,120

4,850

5,580

6,310

7,040

7,770


2015 2016 2017 2018 2019

7,260

8,770

10,280

11,790

13,300

14,810

16,320

17,830


2015 2016 2017 2018 2019

0

720

1,440

2,160

2,880

3,600

4,320

5,040


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


123


16 March 2017


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (USDm)

Revenue 8,905 9,443 9,531 9,859

EBITDA 3,232 3,804 3,927 4,075



Net interest -761 -690 -687 -640

PBT 434 1,477 1,669 1,896

HSBC PBT 936 1,477 1,669 1,896

Taxation -635 -608 -575 -549

Net profit 2,415 775 968 1,192

HSBC net profit 525 968 1,068 1,192

Cash flow summary (USDm)


Capex -2,104 -1,517 -1,496 -1,523


Dividends -60 -402 -443 -540

Change in net debt 1,616 -566 -667 -773

FCF equity -267 975 1,144 1,339

Balance sheet summary (USDm)



Current assets 4,550 5,210 5,223 5,272

Cash & others 2,942 3,600 3,600 3,600

Total assets 21,279 21,818 21,756 21,790


Gross debt 10,488 10,580 9,913 9,140

Net debt 7,546 6,980 6,313 5,540




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue -7.5 6.0 0.9 3.4

EBITDA 13.1 17.7 3.2 3.8


PBT 240.3 13.0 13.6

HSBC EPS -9.7 84.5 10.3 11.6

Ratios (%)

Revenue/IC (x) 0.8 0.8 0.9 0.9

ROIC 10.8 15.0 16.3 17.6

ROE 10.7 15.5 16.0 16.6

ROA 1.3 6.5 7.5 8.5

EBITDA margin 36.3 40.3 41.2 41.3



Net debt/equity 123.1 105.9 87.7 69.7



Per share data (USD)

EPS Rep (diluted) 1.38 0.44 0.55 0.68

HSBC EPS (diluted) 0.30 0.55 0.61 0.68

DPS 0.23 0.23 0.28 0.34

Book value 3.46 3.67 3.95 4.29

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 1.3 1.2 1.1 1.0

EV/EBITDA 3.7 3.0 2.8 2.5

EV/IC 1.0 1.0 1.0 1.0

PE* 13.2 7.2 6.5 5.8

PB 1.1 1.1 1.0 0.9

FCF yield (%) -6.2 21.9 25.0 28.5

Dividend yield (%) 5.8 5.8 7.0 8.6


Issuer information

Share price (USD) 3.98 Free float 11%

Target price (USD) 5.20 Sector Diversified Telecoms

Reuters (Equity) VIP.N Country Russian Federation

Bloomberg (Equity) VIP US Analyst Herve Drouet


Price relative


1.90

2.90

3.90

4.90

5.90

6.90

1.90

2.90

3.90

4.90

5.90

6.90

2015 2016 2017

VimpelCom Ltd Rel to RTS INDEX

Financials & valuation: VimpelCom Ltd Buy


16 March 2017

124

Company description

In 2007, the government of Kuwait established the Kuwait Telecommunications Company to

launch the third mobile operator in the country. STC bid and won a 26% stake for KWD248.7m

(USD931.4m). Commercial operations were launched in Q4 2008 under the ‘Viva’ brand.

Viva was listed on the Kuwait Stock Exchange in late 2014. In December 2015, STC initiated a

voluntary tender offer at KWD1/share for the remaining 74% stake in Viva. The transaction

completed in January 2016 as STC secured enough shares to increase its stake to 51.8%.

Since operations started in 2008, the new entrant has 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. The STC subsidiary

overtook Ooredoo as the second largest player in 2013. Competition has been fierce and is

reflected in the ARPUs, which have nearly halved.

Short-term drivers


In Kuwait, affordability is not the issue preventing data monetisation given the country’s oil

wealth. In fact, we would argue that Kuwait is the most consumer-friendly market in the Gulf.

Operators significantly subsidise premium handsets in bundles, which include generous voice

and data allowances at a fraction of the cost seen in other GCC markets. This may partly

explain a mobile and smartphone penetration rate approaching 200%.

Currency impact

We do not see any currency impact because the company only operates in Kuwait where the

currency is pegged to a basket of undisclosed currencies.

Dividend outlook

Viva announced a maiden dividend of KWD0.01 in 2016. We believe its aggressive marketing

(handset subsidies, generous voice and data allowance) will require sustained capital intensity in

the near term. The combination of these two factors will dampen free cash flow generation and

limits the scope for increased dividends; hence we forecast dividends remaining at current levels.

Viva Kuwait (VIVA KK)

Aggressive marketing strategy weighs on dividend outlook

Moderate scope to seize any 5G opportunity

Maintain Reduce and KWD0.74 TP

Eric Chang* Analyst


[email protected]

+971 4 423 6554

Nikhil Mishra*


Bangalore


125


16 March 2017


Monetisation

We ascribe a low score to Viva on data monetisation. We estimate Kuwait has the highest data

consumption among the GCC countries, yet, increased traffic has not translated into higher

revenue growth. Overall, the Kuwaiti telecoms market has been growing at low single-digits

while Viva’s revenue growth flattened out in 2016.

Competition


operators have nearly a third market share while Zain has preserved its leadership. In 2016,

Ooredoo was the only operator that grew revenues (+5% y-o-y). Revenues for Zain and Viva

were flat. Viva’s subscriber base stagnated in 2016, showing the limits of an aggressive pricing

strategy. We would like to see greater rationality in the pricing strategy but think it is unlikely.

Regulation

Kuwait established a regulator last year but its format and strategy are yet to become apparent

and at this stage, there is no clarity as to its role or function. We note the provisions of

international gateways and fixed line services are the sole prerogative of the Ministry of

Communications. There have been talks about privatising these services but nothing has

transpired so far.

Business model

In our opinion, Viva’s marketing strategy is not sustainable as it stimulates usage while

revenues are not growing at a higher pace. We believe high data traffic may require sustained

network investments to keep pace. As a result, cash generation will likely remain sub optimal.

Investment thesis

We see limits to subscriber growth as the Kuwaiti market is fairly saturated and the market has

stopped expanding (in terms of subscribers), with penetration at nearly 200%. Viva has not been

spared the market’s woes. Subscriber numbers stagnated during 2016 (2.4m throughout the year) –

the company’s strategy of promotion-driven subscriber growth seems to have run its course.

In addition, cash generation remains sub-optimal due to its aggressive marketing strategy and high

capital intensity. We do not expect the situation to change much in the near future. Moreover, in the

absence of subscriber growth, revenues can only be driven by higher ARPU, especially data ARPU.

However, this would require higher data usage and hence continued investments to make sure

capacity keeps pace with usage. Viva was able to achieve a net cash position in 2016 despite lower

operating cash-flow y-o-y. But this appears to be largely on the back of lower capex, which may not

be sustainable. Both Zain Group and Ooredoo ramped up capex spend q-o-q in Q3 16. To remain

competitive, Viva will also have to continue its network spending.

We think Viva has limited potential to increase dividends. The STC subsidiary announced a

maiden dividend of KWD0.01 in 2016 (current yield at 1%). Given the low free cash flow yield,

we do not think there is scope for the company to increase dividends to interesting levels for the

equity investor. As discussed above, capex intensity should remain high near-term, allowing the

company limited room to push up its dividend.


16 March 2017

126

Valuation and Risks

Viva Kuwait: VIVA KK, KWD0.82, Reduce, TP KWD0.74

We value the company on a DCF using the following assumptions for the WACC calculation of

6.5%: risk-free rate of 2.5%, an equity risk premium of 4.5% and owing to its short trading

history (listing in December 2014) we use a beta of 1. Our assumptions for the terminal value

are EBITDA margin 48%, capital intensity of 40.5% and 2.5% terminal growth rate.

Our target price of KWD0.74 implies 9.8% downside and a 2017e PE of 10.1x (EEMEA average

11.1x) on a 0.8% 2016-18e EPS CAGR. We rate the stock Reduce as the operator’s strategy of

handset subsidies is not supportive of greater cash generation.

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 launching

another voluntary tender offer at a premium to its previous offer

127


16 March 2017

Relative valuation

Viva Kuwait appears cheap on forward EV/EBITDA. That is because the STC subsidiary

expenses subscriber acquisition cost. When factoring capex, it trades at a premium

(EV/OpFCF) to the sector but offers a lower dividend yield.

The consensus estimates support our investment thesis. There has been no significant

EBITDA and OpFCF upwards revisions. In fact, estimates for both metrics are expected to

be flat for the next three years.

The dividend yield (based on consensus estimates) suggest our dividend estimates may be

too conservative. We offer the following explanation: its capital intensive strategy does not

lend itself to further dividend increase.

Viva Kuwait: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return 0.0% -5.7% -8.9% -9.9% -16.3%

Total return 0.0% -5.8% -8.9% -9.9% -16.3%

Total return vs EEMEA index (USD) 1.2% -6.0% -14.2% -13.1% -35.2%


Price return vs Kuwait index 1.3% -5.6% -27.9% -32.4% -42.2%

Price Return (USD) 0.0% -6.0% -9.2% -11.2% -17.7%

Total Return (USD) 0.0% -6.0% -9.2% -11.2% -17.7%





3

4

5

6

7

8

9

10



0

5

10

15

20

25

30



0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%



80

100

120

140

160

180

200

220


2015 2016 2017 2018 2019

250

260

270

280

290

300

310

320


2015 2016 2017 2018 2019

0

20

40

60

80

100

120

140


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

128


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Profit & loss summary (KWDm)

Revenue 279 278 279 283

EBITDA 132 130 131 134



Net interest -2 -1 -1 0

PBT 42 42 43 44

HSBC PBT 42 42 43 44

Taxation -2 -2 -2 -2

Net profit 40 40 41 42


Cash flow summary (KWDm)

Cash flow from operations 121 119 123 128

Capex -98 -101 -105 -110


Dividends -5 -5 -5 -5

Change in net debt -21 -20 -21 -22

FCF equity 19 15 15 16

Balance sheet summary (KWDm)

Intangible fixed assets 47 47 47 47

Tangible fixed assets 138 152 170 189

Current assets 82 90 96 120

Cash & others 47 46 44 62

Total assets 267 290 313 356

Operating liabilities 88 86 85 86

Gross debt 47 25 4 -1

Net debt 0 -20 -41 -63

Shareholders' funds 133 178 224 271

Invested capital 133 158 183 208


Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 0.8 -0.4 0.3 1.6

EBITDA 0.7 -1.5 1.0 2.1


PBT -7.3 1.4 1.2 2.6

HSBC EPS -9.3 1.1 1.1 2.6

Ratios (%)

Revenue/IC (x) 2.3 1.9 1.6 1.5

ROIC 37.2 68.4 25.6 21.8

ROE 35.4 26.0 20.3 16.9

ROA 15.6 14.9 13.8 12.6

EBITDA margin 47.3 46.7 47.1 47.3



Net debt/equity -0.1 -11.5 -18.3 -23.2

Net debt/EBITDA (x) 0.0 -0.2 -0.3 -0.5

CF from operations/net debt

Per share data (KWD)

EPS Rep (diluted) 0.08 0.08 0.08 0.08

HSBC EPS (diluted) 0.08 0.08 0.08 0.08

DPS 0.01 0.01 0.01 0.01

Book value 0.27 0.36 0.45 0.54

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 1.5 1.4 1.3 1.2

EV/EBITDA 3.1 3.0 2.8 2.6

EV/IC 3.1 2.5 2.0 1.7

PE* 10.3 10.1 10.0 9.8

PB 3.1 2.3 1.8 1.5

FCF yield (%) 4.7 3.7 3.7 4.0

Dividend yield (%) 1.2 1.2 1.2 1.2


Issuer information

Share price (KWD) 0.82 Free float 50%

Target price (KWD) 0.74 Sector Wireless Telecoms

Reuters (Equity) VIVA.KW Country Kuwait

Bloomberg (Equity) VIVA KK Analyst Eric Chang


Price relative


0.53

0.73

0.93

1.13

1.33

0.53

0.73

0.93

1.13

1.33

2015 2016 2017

VIVA KUWAIT Rel to KUWAIT SE PRICE INDEX

Financials & valuation: VIVA KUWAIT Reduce

129


16 March 2017

Company description

Vodacom is primarily a mobile network operator with operations in South Africa, Tanzania,

Mozambique, Democratic Republic of Congo (DRC) and Lesotho. The South Africa unit

dominates, accounting for 81% of Group revenue and 86% of Group EBITDA in H1 2017.

Short-term drivers


Currently, mobile data and Enterprise services accounts for 41% and 24.5% of service revenue

at Vodacom South Africa. Active data customers of 19.3m represents 53% of the total active

subscriber base in South Africa. Data bundle sales in South Africa are growing 49% y-o-y in

3Q17 whilst effective price per MB is declining at 15.4% y-o-y, underpinning healthy data

conversions. Active smartphone penetration for Vodacom in South Africa stands at 45.6% with

average monthly data usage of 667MB. 4G economics are attractive at Vodacom; however

spectrum delays are hampering near-term effective monetisation of 4G infrastructure. Whilst

smartphone pricing has been hampered recently by a weaker ZAR, pricing transformation

should become more apparent given strong ZAR and availability of cheaper handsets. South

Africa fares well against EEMEA peers with the cheapest smartphone representing 1.6% of

PPP-adj GDP per capita and c7% of monthly disposable income (adjusted for cost of living).

Data pricing remains elevated in South Africa at USD10.7 per GB on a blended basis, forming

0.99% of PPP adjusted GDP per capita.

Currency impact

Near-term currency impacts for Vodacom are divergent across its International footprint and its

core South Africa operations. The South Africa business has c10% of opex in hard currency

excluding handset sales, whilst approximately 40% of capex is in hard currency. The recent

strengthening of the ZAR versus the USD (c15%) will drive better EBITDA/FCF margins at

Vodacom South Africa. However International Mobile continues to be impacted by FX volatility

in certain markets, thus FX translation losses on dollarised cash and debt facilities (which are

non-cash in nature) will dilute headline earnings and thus dividend progression.

Vodacom Group (VOD SJ)

Operational strength in South Africa encouraging, EPS/dividend

growth muted near-term due to FX, International weakness and one-

off costs

Well positioned to benefit from 5G monetisation given leading 3G/4G

network and fibre initiatives; however regulatory risk is significant

Looks fairly priced on valuation; Maintain Hold and cut TP to ZAR160

(from ZAR172)

Ziyad Joosub* Analyst

HSBC Securities (South Africa) (Pty) Ltd [email protected]

+27 (0)11 676 4223

Ramesh Pantagolusula* EEMEA Telecom Associate

Bangalore



16 March 2017

130

Dividend outlook

Vodacom’s dividend outlook is progressive given our expectation of acceleration in HEPS

commencing FY18e (March end); Vodacom’s dividend policy is to pay-out 90% of headline

earnings at least. H1 2017 results were characterised by flat earnings and dividend growth as

4.1% revenue growth was diluted by FX translation losses, tax and lower profitability of its

International opcos. Whilst H2 2017e should see better earnings/dividend progression we

expect attractive dividend growth of high single digits to only transpire in FY18e, once diluting

factors are in the base. With net debt to EBITDA of 0.8x and HSBCe proportionate FCF growth

of 15.1% FY16-19e CAGR – balance sheet capacity is sufficient to support 90% pay-outs.

Dividend progression is a function of earnings growth momentum, which in our view will only be

compelling relative to valuations in FY18e – if we also takes into account the high spectrum and

regulatory uncertainty in the key market of South Africa.


We expect Vodacom Group to be moderately well placed to capitalise on the benefits of 5G,

although it be may be lacking in terms of low frequency spectrum reserves and fixed broadband

scale – however we believe these limitations apply to all operators in South Africa. All MNOs in

South Africa have been limited in rolling out LTE coverage and have resorted to re-farming

spectrum because of the failure of ICASA and Governmental bodies to effectively initiate the

digital migration and allocation of the digital dividend to operators.

We do not expect Vodacom to maintain its 3G/4G revenue share in terms of 5G economics,

as we believe WBS will be a “new” and “key” player in the space – the company is already

leveraging off its existing spectrum assignments in the 1 800MHz and 2 600MHz bands for LTE

Advanced Pro (LTE-A) or 4.5G connectivity. WBS (Wireless Business Solutions, an independent

broadband service provider in South Africa) believes this will be a precursor to 5G, which will enable

WBS to be at the forefront of 5G adoption globally when it occurs. Vodacom should nevertheless be

a key player in the 5G space, due to its strong balance sheet and leadership in 3G/4G, high ARPU

subscriber base and software/content development. We also think it will have adequate fixed-line/wifi

capabilities by 2020e in key metropolitan centres where the majority of mobile data spend is

concentrated in South Africa – for example, Telkom has noted 4% of its network coverage accounts

for c70% of revenue.

If 4G/LTE-A is the foundation of 5G then Vodacom is better positioned than MNO peers to

launch 5G. Its entire network is 4G ready and 86% of base stations (thus all metro base

stations) are fiberised or connected to high-speed fibre. Transmission backhaul is strong

already, with 80% of traffic being carried on its own backhaul. With the initiation of a fibre JV

and access to WBO 4G spectrum, Vodacom’s network is relatively well positioned for 5G.

Vodacom has the requisite network leadership and innovation levels (be it for content/software

driven services and or product commerciality), whilst spectrum remains an issue – on a relative

basis we do not see it having any form of spectrum deficit relative to competitors.

BEE a level playing field for 5G. In South Africa the requirement for spectrum application is at

least level 4 BEE scoring under the new BEE ICT charter – we believe all larger operators are

on an even footing on this front. Thus we do not expect asymmetric regulations between MTN,

Vodacom, Cell C (not listed) and Telkom when it comes to spectrum allocation – potentially new

entrants will have more favourable terms but as mentioned above they will work in conjunction

with incumbents: (1) leasing excess spectrum, (2) leasing transmission/fibre, (3) proliferation of

MVNO license issues form “light” to “full-service” models. Thus economics for 4G/5G will be

shared to some extent in South Africa. Given that tougher/uncertain regulations on

spectrum/BEE will impact all operators relatively equally, we do not believe regulatory risk for

Vodacom/MTN is substantially different to that for Telkom.

131


16 March 2017

Consolidation remains a key theme but regulatory, pricing and/or funding hurdles have

muted large scale in-market consolidation in South Africa. Whilst fragmentation could occur

in South Africa, we believe this will take the form of smaller scale MVNO launches focused on a

key service or product (fintech, eCommerce, online video/content). We will likely also see more

infrastructure-spend and spectrum-sharing initiatives between operators over the medium term,

such as Vodacom's spectrum leasing deal with WBS and Vodacom's proposed fibre build-out

JV. Thus whilst operators may not own specific spectrum, access to spectrum and fixed-line

infrastructure will follow a more "open-platform" approach between operators. The Ministry of

Telecommunications’ recent ICT White Paper proposal for all spectrum to be housed in a single

WOAN (wireless opex access network) SPV from where all operators can lease capacity,

indicates the that new technology launches – such as 5G – could follow a leasing rather than

purchase arrangement between MNOs and Regulators (ICASA Africa and Ministry of

Telecommunications).

Investment thesis

Solid execution in South Africa not enough to offset macro/regulatory pressures – legacy

share price drivers are now reversing. Despite solid execution in its primary market, South

Africa, and a positive medium-term outlook for ROIC, FCF, and dividend expansion, we believe

near-term risks will continue to serve as an overhang on Vodacom's share price. More

specifically, key legacy share-price drivers are now reversing: these include: (1) multiple

expansion on the back of the 5-year "search-for-yield" trade driven by declining DM bond yields;

(2) a benign regulatory/competitive landscape in South Africa; and (3) FX tailwinds for the

International Mobile segment. We estimate approximately two-thirds of Vodacom's 19% PE

multiple de-rating over the past eight months can be explained by higher EU/DM bond yields;

given FX-related dilution from the International Mobile segment and still opaque

regulatory/spectrum outlook in South Africa, we believe ratings will remain under pressure.

However, BEE and Ministerial complexities with respect to spectrum will inhibit 4G

economics being priced in at Vodacom. The full sale of PIC’s 15% stake would move

Vodacom Group’s BEE ownership to 21.25% (6.25% BEE deal + 15% stake sale), yet

participation in ICASA’s spectrum auction Vodacom requires 30% BEE ownership of the South

Africa business or 27% BEE ownership at the group level. Increasing the BEE stake to 27%

would require: (1) potential Vodafone sell-down of a portion of its 65% stake; (2) equity

issuance; (3) a new BEE deal; or (4) a combination of all three. Whilst management remains

confident that BEE requirements will be resolved, we struggle to see investors paying for 4G

growth at Vodacom until there is more transparency on: (1) how it can achieve 27% BEE

ownership at the group level; and/or (2) how flexible ICASA will be with the BEE requirement.

That the Minister of Telecoms and Postal Services, Siyabonga Cwele, plans to take legal action

against ICASA for announcing the 4G spectrum auction adds further uncertainty to South Africa

MNOs receiving spectrum by early 2017.


16 March 2017

132

Change to our estimates

Revenue cuts: Driven by (1) deterioration in FX for International Mobile on ZAR strength,

(2) lower Q3 service revenue growth trends for Tanzania and DRC, (3) slower equipment sales

in South Africa

EBITDA cuts: (1) lower margin for South Africa data on initiation of WBS spectrum roaming

deal, (2) dollarised opex component for International Mobile (c20%) impacts margin in markets

where FX has declined.

HEPS cuts: (1) higher FX translation losses for International Mobile, higher tax rate and

finance costs.

Valuation and Risks

Vodacom: VOD SJ, ZAR149, Hold, TP ZAR160 (from ZAR172)

We set a fair value target price of ZAR160 (from ZAR172) based on our discounted

medium-term terminal value calculation. Given the attractive data growth story in South

Africa and easing competition, we believe it is appropriate at this juncture to discount 3 years of

growth (at an 11% discount rate) for a company such as Vodacom. We also believe it is fair to

assume a de-rating to a mature telco multiple, which we see as sustainable at 7.5% free cash

flow yield based on more mature EM/DM peers and a more stable South Africa bond yield

environment. Our TP adjustment is primarily driven by (1) FX headwinds and slower local

currency service revenue growth for International Mobile, (2) trimming our medium-term SA data

growth forecasts and (3) marginally higher medium-term capex forecasts.

Our new target price of ZAR160 implies 7.4% upside and we rate the stock Hold given

moderate upside and the uncertain regulatory backdrop and rating risk at Vodacom.

Earnings estimate revisions (ZARm)

March ending FY FY17e

(old) FY17e (new) % y-o-y Variance

FY18e (old)

FY18e (new) % y-o-y Variance

Revenue 84 279 81 908 2.3% -2.8% 89 174 84 765 3.5% -4.9% South Africa 65 068 64 862 4.1% -0.3% 68 460 67 543 4.1% -1.3% Tanzania 5 766 5 388 -2.8% -6.5% 6 175 5 380 -0.2% -12.9% DRC 6 214 6 004 5.3% -3.4% 6 520 5 936 -1.1% -9.0% Mozambique 3 290 2 684 -16.9% -18.4% 3 733 2 689 0.2% -28.0% Lesotho 924 924 -2.1% 0.0% 940 940 1.7% 0.0% International Mobile other 2 915 1 943 0.0% -33.3% 3 206 2 137 10.0% -33.3% Total International Mobile 19 780 17 614 -1.9% -10.9% 21 299 17 808 1.1% -16.4% EBITDA 32 232 32 006 5.5% -0.7% 34 408 33 868 5.8% -1.6% South Africa 26 732 27 171 8.6% 1.6% 28 446 28 937 6.5% 1.7% Tanzania 2 364 1 940 6.0% -17.9% 2 532 1 991 2.6% -21.4% DRC 1 740 1 681 7.3% -3.4% 1 858 1 692 0.6% -9.0% Mozambique 987 805 -14.0% -18.4% 1 157 834 3.6% -28.0% Lesotho 457 457 -2.1% 0.0% 465 465 1.7% 0.0% EBITDA margin 38.6% 39.1% 39.0% 40.0% Capex 11 498 11 223 -12.8% -2.4% 11 836 11 902 6.0% 0.6%

HEPS 966.3 912.6 6.1% -5.6% 1057.3 1027.5 12.6% -2.8% DPS 878.4 829.7 4.4% -5.6% 961.2 934.1 12.6% -2.8%


133


16 March 2017

Medium-term terminal multiple derived TP

Terminal Year FY2019e

Terminal FCF Yield 7.5% Terminal Value 228 294 Present Value at June-17 (at WACC of 10.5%) 191 181 Per Share 130 Total Discounted Dividends 44 678 Total Value 235 859

Implied Equity Value Per Share at Jun-17 R 160.6

Implied forward PE at TP date 15.1 Implied forward EV/EBITDA at TP date 7.5 Implied forward FCF yield at TP date 6.7%

Fair value TP 160.6


Key upside risks include: (1) Strengthening of DM bond yields and South Africa bond yields

beyond current expectations; (2) better than expected South Africa mobile data and enterprise

growth (3) South Africa margin expansion exceeds our base case expectations, (4) positive

regulatory surprises with respect to BEE and spectrum allocation over the medium-term,

(5) initiation of higher a higher dividend pay-out ratio by Vodacom (greater than 90% of HEPS).

Key downside risks include: (1) Normalisation of DM bond yield environment through a steep,

growth-led interest rate hike cycle; (2) pick-up in competitive intensity in South Africa mobile,

(3) operational surprises with respect to the South Africa business, (4) regulatory surprises with

respect to BEE implications on spectrum allocation over the medium-term, (5) BEE complexities.


16 March 2017

134

Relative valuation

Valuation at par versus the sector and history

Moderate growth

Consensus OpFCF estimates flat

Vodacom Group: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return 1.3% 0.5% 5.3% -3.3% 2.7%

Total return 1.4% 0.5% 5.3% -0.6% 8.0%


Total return vs MSCI EEMEA Telecom (USD) 0.7% -1.5% 0.1% -3.4% 0.4%

Total return vs JSE 1.9% 1.2% 3.4% 1.9% 7.1%

Price return vs JSE 2.1% 1.4% 3.8% 0.4% 4.5%

Price Return (USD) 0.9% 2.8% 10.1% 3.3% 21.0%

Total Return (USD) 1.1% 2.9% 10.0% 6.1% 27.5%





3

4

5

6

7

8

9

10



0

5

10

15

20



0.0%

2.0%

4.0%

6.0%

8.0%



25,210

27,290

29,370

31,450

33,530

35,610

37,690

39,770


2015 2016 2017 2018 2019

72,770

76,810

80,850

84,890

88,930

92,970

97,010

101,050


2015 2016 2017 2018 2019

0

4,970

9,940

14,910

19,880

24,850

29,820

34,790


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


135


16 March 2017


Year to 03/2016a 03/2017e 03/2018e 03/2019e


Revenue 80,074 81,908 84,765 90,005

EBITDA 30,345 32,006 33,868 36,670



Net interest -1,480 -1,945 -2,618 -2,377

PBT 20,130 21,147 22,434 25,139

HSBC PBT 20,130 21,147 22,434 25,139

Taxation -5,934 -6,861 -7,067 -7,667

Net profit 14,203 14,038 15,094 17,161

HSBC net profit 12,622 13,406 15,094 17,161



Capex -13,229 -11,223 -11,902 -12,365


Dividends -11,830 -13,420 -15,153 -17,127

Change in net debt 4,402 2,828 3,955 -3,945

FCF equity 9,618 10,955 14,626 15,829




Current assets 27,618 25,938 24,635 25,819

Cash & others 7,934 6,439 6,615 7,829

Total assets 78,703 80,262 83,918 90,316


Gross debt 29,125 30,458 34,589 31,857

Net debt 21,191 24,019 27,973 24,028




Year to 03/2016a 03/2017e 03/2018e 03/2019e

Y-o-y % change

Revenue 7.5 2.3 3.5 6.2

EBITDA 12.8 5.5 5.8 8.3


PBT 12.3 5.1 6.1 12.1

HSBC EPS 3.2 6.1 12.6 13.7

Ratios (%)

Revenue/IC (x) 2.4 2.2 2.1 2.0

ROIC 46.9 43.6 44.9 44.5

ROE 59.1 57.7 63.8 63.2

ROA 24.8 23.6 24.0 23.9

EBITDA margin 37.9 39.1 40.0 40.7



Net debt/equity 87.7 93.6 115.3 74.6




EPS Rep (diluted) 9.68 9.56 10.27 11.68

HSBC EPS (diluted) 8.60 9.13 10.27 11.68

DPS 7.95 8.30 9.34 10.62

Book value 16.47 17.47 16.51 21.93

Valuation data

Year to 03/2016a 03/2017e 03/2018e 03/2019e

EV/sales 3.0 3.0 2.9 2.7

EV/EBITDA 7.9 7.6 7.3 6.7

EV/IC 5.7 5.2 5.0 4.6

PE* 17.3 16.3 14.5 12.8

PB 9.0 8.5 9.0 6.8

FCF yield (%) 4.4 5.0 6.7 7.2

Dividend yield (%) 5.3 5.6 6.3 7.1


Issuer information


Target price (ZAR) 160.00 Sector Wireless Telecoms

Reuters (Equity) VODJ.J Country South Africa

Bloomberg (Equity) VOD SJ Analyst Ziyad Joosub


Price relative


110.00

120.00

130.00

140.00

150.00

160.00

170.00

180.00

110.00

120.00

130.00

140.00

150.00

160.00

170.00

180.00

2015 2016 2017

Vodacom Group Rel to JSE ALL SHARE

Financials & valuation: Vodacom Group Hold


16 March 2017

136

Company description

In December 2007, Vodafone and the Qatar Foundation consortium won Qatar’s second mobile

licence, and Vodafone Qatar was established shortly after. During summer 2009, the company

launched commercial operations and a listing on the Qatar Exchange. It won a fixed license in 2010

and 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 Q4 2016 (calendar) Vodafone had 33%

market share. 4G services were launched last year and Vodafone has been re-directed its focus

to the post-paid segment, Ooredoo’s stronghold.

Short-term drivers


Similar to all Gulf countries, affordability is not the issue preventing data monetisation and we

see reasonable potential for Vodafone Qatar. Currently, the second entrant’s smartphone

penetration is about 60% while monthly data consumption is around 1Gb. We think Vodafone

Qatar can improve on this metric by increasing its share of high-value customers (white collar

expats, Qatari nationals, corporates) in which Ooredoo is currently dominant with a two-thirds

market share.

Currency impact

We do not see any currency impact because the company only operates in Qatar where the

QAR is pegged to the dollar.

Dividend outlook

The company paid dividends in FY2014 and FY2015, but they were cancelled in FY2016 when net

losses widened. We note dividends have been paid when distributable profits – which the company

defines as net profit excluding amortisation charges – are in excess of QAR150m. In FY2017,

we forecast distributable profits of QAR153.7m but do not factor in a dividend payment. We

expect the company will retain a prudent approach to its balance sheet structure.

Vodafone Qatar (VFQS QD)

Ooredoo’s leadership appears unassailable…

…but 5G potential will be difficult to monetise with the current low-

value subscriber base

Maintain Reduce and QAR8.10 TP

Eric Chang* Analyst


[email protected]

+971 4 423 6554

Nikhil Mishra*


Bangalore


137


16 March 2017


Monetisation

We assign a low score on this metric due to its customer base and what we see as an

infrastructure disadvantage relative to the incumbent. In light of lower ARPU (relative to

Ooredoo) and data consumption, we believe (price-sensitive) expat labourers represent a

significant proportion of Vodafone Qatar’s customer base. We think data monetisation will be

greater if STC manages to chip away Ooredoo’s dominance of the lucrative post-paid segment.

Competition

We expect competition to remain rational. Vodafone Qatar needs to focus on profitability and

cash generation and aggressive pricing would not be supportive in that regard. From FY2018e

we factor in improving profitability to account for mobile pricing discipline.

Regulation

We believe regulation will be benign if not supportive of the smaller player.

Business model

Despite a fixed telecom license, Vodafone Qatar is mainly a mobile operator. The lack of a fixed

infrastructure (limited to a small area of Doha) puts it at a structural disadvantage. We highlight

that Ooredoo’s annual capex spend in Qatar is double that of Vodafone Qatar.

Investment thesis

Revenue growth is key to profitability as cost-optimisation runs through its limits. We see limited

upside from further cost reduction. In our view, Vodafone Qatar needs to drive revenue growth

to achieve profitability. The most obvious route would be to increase its market share in the

post-paid segment, where, since launching a post-paid product in 3Q13, Vodafone Qatar has

consistently increased its post-paid subscriber base and market share. This high-value segment

is still dominated by Ooredoo, however, with a two-thirds market share. On our estimates,

Vodafone Qatar’s post-paid ARPU is c. 50% lower than the incumbent’s.

Valuation and Risks

Vodafone Qatar: VFQS QD, QAR9.04, Reduce, TP QAR8.1

We value Vodafone Qatar on a DCF with the following assumptions underpinning the WACC of

8.9% (unchanged): risk-free rate of 2.5%, an equity risk premium of 7%, beta of 1.53 (as calculated

by FactSet). The long-term growth rate assumption of 2.5% is unchanged. Vodafone Qatar’s

valuation remains heavily back-ended and is based on the following long-term assumptions:

EBITDA margin of 45% and capital intensity of 16.3%.

Our TP of QAR8.10 implies 10.4% downside and we rate the stock Reduce as the operator’s

quest for profitability has been consistently delayed.

Key upside risks include: a resilient Qatar economy driving telecom spend; increased market

share in mobile (particularly in the post-paid segment) and fixed services; and better-than-

expected ARPU improvement would be a fillip to revenue.


16 March 2017

138

Relative valuation

We believe Vodafone Qatar’s share price has sharply de-rated because of a deteriorating

profitability outlook.

In the past six months, consensus revenue forecast have been stable while EBITDA

estimates have marginally increased. We highlight our forecasts err on the side of caution

and are more conservative.

In the left-hand side chart at the bottom of this page, we see that Vodafone Qatar’s dividend

yield do not offer any reward relative to holding a Qatar sovereign bond.

Vodafone Qatar: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return -2.2% -1.6% -4.9% -20.4% -25.4%

Total return -2.2% -1.6% -4.8% -20.4% -25.4%

Total return vs EEMEA index (USD) -1.0% -1.7% -9.8% -22.3% -42.8%


Total return vs QE 0.7% -0.7% -9.9% -20.2% -28.5%

Price Return (USD) -2.1% -1.7% -5.0% -20.4% -25.3%

Total Return (USD) -2.2% -1.6% -4.9% -20.4% -25.4%





3

13

23

33

43



0

10

20

30

40

50

60



-4.0%

-2.0%

0.0%

2.0%

4.0%



340

470

600

730

860

990

1,120

1,250


2015 2016 2017 2018 2019

1,920

2,130

2,340

2,550

2,760

2,970

3,180

3,390


2015 2016 2017 2018 2019

0

170

340

510

680

850

1,020

1,190


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


139


16 March 2017


Year to 03/2016a 03/2017e 03/2018e 03/2019e

Profit & loss summary (QARm)

Revenue 2,119 2,099 2,305 2,491

EBITDA 401 540 619 760


Operating profit/EBIT -415 -224 -128 10

Net interest -19 -27 -31 -28

PBT -466 -251 -159 -18

HSBC PBT -466 -251 -159 -18

Taxation 0 0 0 0

Net profit -466 -251 -159 -18

HSBC net profit -466 -251 -159 -18

Cash flow summary (QARm)


Capex -396 -310 -366 -407


Dividends -171 0 -178 -178

Change in net debt 134 -107 -246 -121

FCF equity -70 76 246 298

Balance sheet summary (QARm)



Current assets 508 657 929 1,077

Cash & others 130 255 501 622

Total assets 6,992 6,656 6,546 6,352


Gross debt 1,023 1,041 1,041 1,041

Net debt 892 786 540 419




Year to 03/2016a 03/2017e 03/2018e 03/2019e

Y-o-y % change

Revenue -8.1 -0.9 9.8 8.1

EBITDA -29.2 34.8 14.6 22.6

Ratios (%)

Revenue/IC (x) 0.3 0.4 0.4 0.5

ROIC 1.7 4.9 6.6 9.7

ROE -8.9 -5.2 -3.5 -0.4

ROA -6.2 -3.3 -1.9 0.3

EBITDA margin 18.9 25.7 26.9 30.5

Operating profit margin -19.6 -10.7 -5.5 0.4


Net debt/equity 18.1 16.8 12.0 9.7



Per share data (QAR)

EPS Rep (diluted) -0.55 -0.30 -0.19 -0.02

HSBC EPS (diluted) -0.55 -0.30 -0.19 -0.02

DPS 0.00 0.00 0.21 0.21

Book value 5.82 5.53 5.34 5.11

Valuation data

Year to 03/2016a 03/2017e 03/2018e 03/2019e

EV/sales 4.0 4.0 3.5 3.2

EV/EBITDA 21.3 15.6 13.2 10.6

EV/IC 1.5 1.5 1.6 1.7

PE* nm nm nm nm

PB 1.6 1.6 1.7 1.8

FCF yield (%) -0.9 1.0 3.2 3.9

Dividend yield (%) 0.0 0.0 2.3 2.3


Issuer information

Share price (QAR) 9.04 Free float 55%

Target price (QAR) 8.10 Sector Wireless Telecoms

Reuters (Equity) VFQS.QA Country Qatar

Bloomberg (Equity) VFQS QD Analyst Eric Chang


Price relative


7.50

9.50

11.50

13.50

15.50

17.50

19.50

7.50

9.50

11.50

13.50

15.50

17.50

19.50

2015 2016 2017

Vodafone Qatar Rel to DSM 20 INDEX

Financials & valuation: Vodafone Qatar Reduce


16 March 2017

140

Company description

Zain is Kuwait’s first mobile operator and has been the undisputed leader since it was established in

1983. 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 governments. In

many of these countries, Zain is the leading mobile operator with the highest share of post-paid

subscribers and quality spectrum. In addition, Zain has a 15.5% stake in Moroccan mobile operator

inwi, as well as a 37% stake in Zain KSA. Zain’s principal markets are Kuwait, Iraq and Sudan.

Short-term drivers


Affordability is an issue in Iraq and Sudan, which in aggregate represent nearly 40% of group

revenues. We think competitive intensity as well as significantly lower GDP/per capita may

inhibit Zain’s capacity to monetise data. Compounding these issues, Iraq is facing political as

well as economic difficulties, forcing mobile operators to absorb the 20% tax on mobile services.

In Kuwait, affordability is not the issue preventing data monetisation given the country’s oil

wealth. In fact, we would argue that the Kuwait market is the most consumer-friendly in the Gulf.

Operators significantly subsidise premium handsets in bundles, which include generous voice

and data allowances at a fraction of the cost seen in other GCC markets. This may partly

explain a mobile and smartphone penetration rate approaching 200%.

Currency impact

The currencies of Kuwait, Bahrain and Jordan are pegged to the USD. These three countries

represent 50% of revenues and 70% of profits. The main currency risk lies in Sudan (20% of

revenues, 25% of profits). The country is under US sanctions, making repatriating currency nearly

impossible. We also highlight Iraq represents 30% of group revenues and 10% of profits. As Zain’s

debt is mainly dollar-denominated, we estimate capital expenditure would follow the same proportion.

Dividend outlook

The company’s stated dividend policy is to pay out 70-80% of earnings. In light of its low

leverage, we would argue there is room for greater flexibility. On numerous occasions, Zain has

cut dividends to a greater extent than the EPS decrease and balance sheet warrants. For

example, in 2014, dividends were cut by 20% whereas net profit declined 10%. In 2015,

dividends were cut by 25% whereas net profit dropped 21%. In our opinion, cutting dividends

did not have the desired impact on (reducing) leverage.

Zain Group (ZAIN KK)

Low leverage and potential tower sale in Kuwait brighten dividend

outlook

Competition and macro factors may limit data or 5G monetisation

We maintain our Hold rating and TP of KWD 0.49

Eric Chang* Analyst


[email protected]

+971 4 423 6554

Nikhil Mishra*


Bangalore


141


16 March 2017

We await a management update on the tower sales process in Kuwait. The company previously

guided towards a transaction close in H2 2016. On our estimates, the disposal of its Kuwaiti

tower assets could generate proceeds of KWD 90m (based on 1,988 sites valued at USD150k).

We think the company would consider using the proceeds to pay a bonus dividend, similar to

when it sold its African assets.


Monetisation

As long as competition is not rational, we think Zain will have moderate opportunities in 5G.

Structurally, Kuwait should be an attractive market: wireless broadband is the preferred internet

access for residential customers. Instead all three mobile operators have competed on price to

gain or maintain market share, thus eroding market value. Given the geopolitical and economic

headwinds, we think Sudan and Iraq are far removed from a 5G reality.

Competition


operators have nearly a third market share while Zain has preserved its leadership. Ooredoo

was the only operator that managed to grow revenues in 2016 (+5% y-o-y). Revenues for Zain

and Viva were flat. We would like to see greater rationality in pricing and competition but think it

is unlikely.

In Iraq, revenues and profits have been under pressure due to geopolitical and economic

factors. In addition, the operators had to absorb a 20% sales tax on mobile services introduced

early last year. Neither Zain nor Ooredoo have been able to pass the added cost on to their

customers for fear of losing market share.

Regulation

Kuwait established a regulator last year but its format and strategy are yet to become apparent.

At this stage, its role and function are unclear. We note that the provisions of international

gateways and fixed line services are the sole prerogative of the Ministry of Communications.

There have been talks about privatising these services but nothing has transpired to date.

Business model

We do not think that Zain’s mobile-only business model is a limiting factor as the markets in

which it operates (save for Jordan) have limited fixed broadband infrastructure. Mobile networks

are therefore the only reliable internet access points.

Investment thesis

The stock has risen 45% in the past six months and now trades ahead of its 3-year historical

average. We believe a key driver of share price performance has been a broad-based market

rally in Kuwait. We attribute a significant portion of Zain’s performance to the strength of the

Kuwait Stock Exchange Index (+24% in the same period). However, unconfirmed reports of a

possible takeover of Zain (Mubasher, No sale offer by Adeptio for Kharafi’s stake in Zain, 22

January 2017) could have also fuelled outperformance over the past six months.

Zain’s key attractions are its market leadership and cash generation capacity in its key markets

(Iraq, Jordan, Kuwait, and Sudan). Vodafone, Orange and MTN are global operators with a

presence in the Middle East, but we think it unlikely they would look at expanding their footprint

further by acquiring Zain because of differing priorities. GCC telecom operators would present

the most obvious fit. Etisalat, Ooredoo and STC would be the only companies with enough

financial headroom to make an acquisition. But in such a scenario, overlapping operations


16 March 2017

142

would pose a risk as the regulator’s stance on in-market consolidation is untested. We highlight

that nearly all of Zain’s markets have three players, which would make consolidation perhaps

unlikely from a competition perspective (see M&A would face significant competitive hurdles,

28 February 2017)

Valuation and Risks

Zain Group: ZAIN KK, KWD KWD0.48, Hold, TP KWD0.49

We value Zain using a sum-of the parts approach.

We value Kuwait on 5x 2017e EBITDA as a reflection of its market leadership.

We continue to value Jordan and Bahrain on 3x 2017e EBITDA due to competitive pressure.

Despite its market leadership in Iraq and Sudan, we value these businesses on 3x 2017e

EBITDA to reflect the geopolitical risks

We continue to attribute zero value to South Sudan as the operations are marginally

EBITDA positive

We value Zain KSA at our target price of SAR7.10. We use DCF to value the company based on

a WACC of 9.3% (cost of equity of 13.0%, risk-free rate of 2.5%, 7.0% market risk premium).

Our target price of KWD0.49 implies 2.1% upside and we rate the stock Hold.

Zain: sum-of-the-part valuation

EBITDA EV % EV % Method (KWDm) 2017e /EBITDA stake of EV

Kuwait 163 5.0 100.0% 817 36.7% Multiple Iraq 120 3.0 76.0% 275 12.3% Multiple Sudan 110 3.0 100.0% 330 14.8% Multiple South Sudan 0 0.0 100.0% 0 0.0% Jordan 73 3.0 96.5% 211 9.5% Multiple Bahrain 22 3.0 54.8% 36 1.6% Multiple Lebanon 10 1.0 100.0% 10 0.4% Multiple Subsidiaries 1,679 Zain KSA 37.0% 121 5.5% Target price Other assets 424 19.1% Associates 546 EV 2,225 Adjusted net debt -323 Equity value 1,902 Issued shares (m) 3,901 TP (KWD) 0.49


143


16 March 2017

Upside risks include

Privatisation of the Kuwait government’s fixed line and international gateway assets may

generate revenue/opex/ capex upsides if Zain is able to acquire them at a reasonable price

Zain is still contemplating the sale of its Kuwaiti tower assets. Given its low leverage, the

company may elect to pay a significant portion of proceeds as a special dividend

Geopolitical situation improves considerably in some of its markets like Iraq, Sudan and

South Sudan

If competition in Kuwait becomes rational, all three operators could see pricing power and

improve their margins

Downside risks include

Geopolitical instability in Iraq and to some extent Sudan and South Sudan;

Negative FX movements in some of its markets impacting the group’s financial performance;

Press reports (Bloomberg, 19 July 2016; see our report No rationale for a foray into Egypt,

20 July 2016) about the company’s interest in a mobile licence in Egypt, if confirmed, could

compromise the balance sheet and the company’s ability to maintain dividends.


16 March 2017

144

Relative valuation

Valuation remains attractive relative to the sector. Zain trades at a marked discount.

The consensus’ outlook has become more positive. We observe a step change in 2017-19

EBITDA estimates.

Zain Group’s strong share price performance (+44% over the past six months, vs the index

at +24%) is the only factor behind the yield compression over the same period.

Zain Group: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return 0.0% -5.0% 13.1% 43.9% 26.7%

Total return 0.0% -5.0% 13.1% 43.9% 37.4%

Total return vs EEMEA index (USD) 1.2% -5.3% 7.7% 39.9% 17.6%


Price return vs Kuwait index 1.3% -4.9% -5.9% 21.4% 0.8%

Price Return (USD) 0.0% -5.2% 12.7% 41.8% 24.5%

Total Return (USD) 0.0% -5.2% 12.7% 41.8% 35.0%





3

4

4

5

5

6

6

7



0

5

10

15



0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%



450

470

490

510

530

550

570

590


2015 2016 2017 2018 2019

1,050

1,100

1,150

1,200

1,250

1,300

1,350

1,400


2015 2016 2017 2018 2019

0

80

160

240

320

400

480

560


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e


145


16 March 2017


Year to 12/2015a 12/2016e 12/2017e 12/2018e

Profit & loss summary (KWDm)

Revenue 1,157 1,094 1,181 1,249

EBITDA 504 513 557 589



Net interest -21 -21 -18 -10

PBT 202 223 312 356

HSBC PBT 236 246 312 356

Taxation -36 -31 -47 -53

Net profit 154 188 258 293


Cash flow summary (KWDm)


Capex -217 -166 -174 -183


Dividends -156 -132 -137 -156

Change in net debt 160 22 -191 -187

FCF equity 230 295 318 342

Balance sheet summary (KWDm)


Tangible fixed assets 902 904 867 841

Current assets 795 820 1,023 1,221

Cash & others 360 354 545 732

Total assets 3,495 3,447 3,598 3,757


Gross debt 965 982 982 982

Net debt 605 627 437 249




Year to 12/2015a 12/2016e 12/2017e 12/2018e

Y-o-y % change

Revenue -4.6 -5.5 8.0 5.8

EBITDA -2.6 1.8 8.5 5.8


PBT -17.6 10.6 39.8 14.1

HSBC EPS -22.3 11.9 22.1 13.6

Ratios (%)

Revenue/IC (x) 0.7 0.6 0.7 0.8

ROIC 14.0 15.2 18.1 20.7

ROE 11.9 14.2 17.4 18.5

ROA 5.6 6.3 8.3 9.0

EBITDA margin 43.5 46.9 47.1 47.1



Net debt/equity 35.0 39.4 25.7 13.8



Per share data (KWD)

EPS Rep (diluted) 0.04 0.05 0.07 0.08

HSBC EPS (diluted) 0.05 0.05 0.07 0.08

DPS 0.03 0.04 0.04 0.05

Book value 0.40 0.37 0.39 0.42

Valuation data

Year to 12/2015a 12/2016e 12/2017e 12/2018e

EV/sales 1.9 2.0 1.8 1.5

EV/EBITDA 4.4 4.4 3.7 3.2

EV/IC 1.3 1.4 1.3 1.3

PE* 9.8 8.8 7.2 6.3

PB 1.2 1.3 1.2 1.1

FCF yield (%) 14.2 18.3 19.4 20.6

Dividend yield (%) 6.3 7.4 8.4 10.5


Issuer information

Share price (KWD) 0.48 Free float 50%

Target price (KWD) 0.49 Sector Wireless Telecoms

Reuters (Equity) ZAIN.KW Country Kuwait

Bloomberg (Equity) ZAIN KK Analyst Eric Chang


Price relative


0.28

0.33

0.38

0.43

0.48

0.53

0.58

0.63

0.28

0.33

0.38

0.43

0.48

0.53

0.58

0.63

2015 2016 2017

Zain Group Rel to KUWAIT SE PRICE INDEX

Financials & valuation: Zain Group Hold


16 March 2017

146

Company description

In 2007, Zain Group led a group of Saudi partners (including Almarai) to bid for the third mobile

license in Saudi Arabia. The consortium won by paying SAR22.9bn (USD 6.1bn), double the

amount of Mobily’s license. Zain Group is the largest shareholder in Zain KSA, holding a 37%

stake, while a Saudi consortium owns 21% and the remaining 42% is free float. In February

2008, Zain KSA was listed on the Saudi stock exchange, Tadawul. The same year, in August,

the company launched its commercial operations, breaking the duopoly of STC and Mobily.

Zain KSA is the smallest of the three mobile network operators in Saudi Arabia and holds a

market share of around 22% (as of Q3 2016, source: Zain). It serves around 10.5m customers

through a network of over 8,000 sites. The company has seen significant management change

despite its short history. Peter Kaliaropoulos is the company’s sixth CEO, and Mehdi Khalfaoui

is the fourth CFO.

Short-term drivers


We do not view affordability (handsets or services) as an issue given Saudi Arabia’s oil wealth.

However, telecom spending may be under pressure as the Saudi government’s efficiency drive


We see data as key driver for revenue growth. Mobile penetration in the Kingdom is in excess of

150% whereas smartphone penetration is estimated to be 60%. Data monetisation is hence

correlated to the intensity of competition. We think Zain KSA and Mobily are unlikely to indulge

in value-destructive price wars as both need to resolve their high leverage.

Currency impact

We do not see any currency impact because the company only operates in Saudi Arabia where

the currency is pegged to USD.

Dividend outlook

Zain KSA has been operating for eight years and has yet to turn a net profit. We do not factor

any net profit or dividends in the forecast period. As is the case for Mobily, we think Zain KSA

management would consider dividend payments once it becomes profitable and deleverages to

a sustainable level. Zain KSA is seeking to sell its tower assets and intends to use proceeds to

pare down debt.

Zain KSA (ZAINKSA AB)

Leverage clouds any discussion about profitability

We see significant challenges with 5G

Maintain Reduce and SAR7.10 TP

Eric Chang*

Analyst


[email protected]

+971 4 423 6554

Nikhil Mishra*


Bangalore


147


16 March 2017


Monetisation

On this criteria we rank Zain KSA lowest in Saudi Arabia due to a lack of fixed infrastructure.

We note the third entrant is in discussion with fibre network owners for wholesale access. This

is most certainly efficient from the perspective of capital allocation (and the denominator in the

ROIC equation) but it limits revenue and profit upside.

Competition

We expect competition will remain rational and support 5G monetisation. We do not envisage Zain

KSA or Mobily engaging in value-destructive price wars because both companies need to resolve

their high leverage. In addition, we discount the risk of new mobile entrants given the penetration

rates and the fact that two out of three network operators are struggling with profitability.

Regulation

The CITC has not introduced any regulation on net neutrality and the practice of zero-rating.

The introduction of a unified license has brought some respite to mobile operators. The royal

decree extended mobile licenses by 25 years and effectively eliminates any concerns about the

cost (zero upfront) of mobile license renewal.

Business model

We award Zain KSA the lowest score on this metric for a variety of reasons. As the latest

entrant, the company had to rely on a pricing strategy to attract and retain subscribers. We have

noticed some evidence of greater pricing discipline: ARPU has been improving but not by the

same quantum as voice or data traffic. We think the exorbitant license cost has, in the past,

impeded Zain KSA from spending adequately on network infrastructure. Data traffic in a 5G

world will originate from fixed infrastructure but will increasingly terminate on a mobile network:

lack of a fibre network may be a penalising factor.

Investment thesis

Our Reduce rating is based on the premise that Zain KSA’s debt load is not sustainable and will

likely require another recapitalisation, which may be dilutive. Management has confirmed it is

considering a variety of options to address this, including the possibility of a recapitalization or a

debt-equity swap. The company will present its new strategy to the market in April.

A tower sale remains under consideration. Proceeds from the sale would be go towards debt

reduction. In our previous report (Saudi Telecoms: 2016, a year of regulatory upheaval, 6 December

2016), we stated proceeds from a tower sale are unlikely to significantly reduce leverage. Zain KSA

has lagged its nearest competitor Mobily (EEC AB, SAR21. 65, Buy) for many years in terms of

network investments, which means capital intensity should remain elevated in the medium term to

keep pace with competitors’ networks and increasing data usage.

Management has confirmed that no capex will be committed to developing a fixed infrastructure.

For the last-mile connectivity, the company is considering using wireless technology or

partnering with a network owner (for example Saudi Electricity). As such, we think upside to

profitability will be limited.


16 March 2017

148

Valuation and Risks

Zain KSA: ZAINKSA AB, SAR 8.75, Reduce, TP SAR7.1

We value Zain KSA on a DCF based on a 9.0% WACC. The assumptions behind the cost of

capital are as follows: 12.1% cost of equity (risk-free rate of 2.5% and equity risk premium of

7%, beta of 1.4); 7.3% cost of debt (corporate spread of 5.0%).

The target price of SAR7.10 implies 2017e EV/EBITDA of 9.8x (EEMEA average 5.6x) on a

10% 2016-18e EBITDA CAGR, and 18.9% downside: we rate the stock Reduce as we think the

company may need to raise further capital given its current balance sheet structure.

Upside risks

Greater penetration of the government and corporate customer segment: Zain KSA’s

growing customer base has been price-sensitive consumers (lower income expats, Saudi

youths). The government and corporate segment are generally high-value customers which

would allow the operator to expand margins

Greater mobile broadband usage could be a catalyst for ARPU increases. As usage increases,

customers will start to see the value of data and may be more inclined to pay for it.

149


16 March 2017

Relative valuation

Investors appear willing to discount the possibility/impact of a dilutive capital restructuring.

Zain KSA has seen a robust share price performance, returning 30% over the past six

months and 24% over the past year.

The (stock market) enthusiasm contrasts with the consensus forecasts which remains prudent.

We do not expect any dividend during our forecast period. The third entrant remains

loss-making and its priority is to deleverage.

ZAIN KSA: Valuation Benchmark relative



1W 1M 3M 6M 12M

Price return -1.0% 0.0% 5.1% 30.4% 24.1%

Total return -1.1% 0.5% 5.0% 30.6% 24.2%


Total return vs MSCI EEMEA Telecom (USD) -1.7% -1.5% -0.2% 27.8% 16.6%

Price return vs Tadawul -1.0% 0.0% 7.2% 17.5% 15.7%

Price Return (USD) 0.0% 3.7% 7.7% 33.3% 27.3%

Total Return (USD) -1.1% 0.4% 5.0% 30.3% 23.9%




OpFCF estimates revision

3

8

13

18

23



-100

-50

0

50

100

150



0

520

1,040

1,560

2,080

2,600

3,120

3,640


2015 2016 2017 2018 2019

6,280

6,630

6,980

7,330

7,680

8,030

8,380

8,730


2015 2016 2017 2018 2019

0

550

1,100

1,650

2,200

2,750

3,300

3,850


2015 2016 2017 2018 2019

2017e 2018e 2017e 2018e 2017e 2018e



16 March 2017

150


Year to 12/2016a 12/2017e 12/2018e 12/2019e


Revenue 6,927 7,178 7,481 7,650

EBITDA 1,802 1,998 2,178 2,304


Operating profit/EBIT -48 238 341 387

Net interest -925 -898 -914 -967

PBT -973 -659 -573 -580

HSBC PBT -973 -659 -573 -580

Taxation 0 0 0 0

Net profit -973 -659 -573 -580

HSBC net profit -973 -659 -573 -580



Capex -2,267 -1,800 -1,791 -1,760


Dividends 0 0 0 0

Change in net debt 281 513 662 595

FCF equity 930 -513 -621 -434




Current assets 3,312 3,268 3,481 3,337

Cash & others 919 859 1,202 1,098

Total assets 26,611 26,607 26,815 26,676


Gross debt 15,061 15,514 16,519 17,011

Net debt 14,143 14,656 15,318 15,913




Year to 12/2016a 12/2017e 12/2018e 12/2019e

Y-o-y % change

Revenue 2.7 3.6 4.2 2.3

EBITDA 10.6 10.9 9.0 5.8

Operating profit 43.2 13.6

Ratios (%)

Revenue/IC (x) 0.4 0.4 0.4 0.4

ROIC 5.1 5.0 5.6 6.0

ROE -23.9 -20.3 -21.8 -28.2

ROA -0.1 1.0 1.3 1.5

EBITDA margin 26.0 27.8 29.1 30.1

Operating profit margin -0.7 3.3 4.6 5.1


Net debt/equity 395.6 502.7 653.8 902.6




EPS Rep (diluted) -1.67 -1.13 -0.98 -0.99

HSBC EPS (diluted) -1.67 -1.13 -0.98 -0.99

DPS 0.00 0.00 0.00 0.00

Book value 6.12 4.99 4.01 3.02

Valuation data

Year to 12/2016a 12/2017e 12/2018e 12/2019e

EV/sales 2.8 2.7 2.7 2.7

EV/EBITDA 10.6 9.8 9.3 9.1

EV/IC 1.1 1.1 1.2 1.2

PE*

PB 1.4 1.8 2.2 2.9

FCF yield (%) 18.6 -10.2 -12.4 -8.7

Dividend yield (%) 0.0 0.0 0.0 0.0


Issuer information


Target price (SAR) 7.10 Sector Wireless Telecoms


Bloomberg (Equity) ZAINKSA AB Analyst Eric Chang


Price relative


4.50

6.50

8.50

10.50

12.50

14.50

4.50

6.50

8.50

10.50

12.50

14.50

2015 2016 2017

Zain KSA Rel to TADAWUL ALL SHARE INDEX

Financials & valuation: Zain KSA Reduce

151


16 March 2017

Notes


16 March 2017

152

Notes

153


16 March 2017

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: Herve Drouet, Ziyad Joosub and Eric Chang

With respect to the analysis pertaining to the valuation of Indosat in this report, the following analyst certifies that the opinion(s)

on the subject security or issuer and/or any other views or forecasts expressed herein accurately reflect their personal view and

that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation or views

contained in this research report: Neale Anderson

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 appropria te,

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.


16 March 2017

154

Rating distribution for long-term investment opportunities

As of 15 March 2017, the distribution of all independent ratings published by HSBC is as follows:

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.

For the distribution of non-independent ratings published by HSBC, please see the disclosure page available at

http://www.hsbcnet.com/gbm/financial-regulation/investment-recommendations-disclosures.

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.

To view a list of all the independent fundamental ratings disseminated by HSBC during the preceding 12-month period, please

use the following links to access the disclosure page:

Clients of Global Research and Global Banking and Markets: www.research.hsbc.com/A/Disclosures

Clients of HSBC Private Banking: www.research.privatebank.hsbc.com/Disclosures

HSBC & Analyst disclosures

Disclosure checklist

Company Ticker Recent price Price date Disclosure

ETIHAD ETISALAT (MOBILY) 7020.SE 21.31 15 Mar 2017 1, 5 ETISALAT ETEL.AD 17.65 15 Mar 2017 1, 5 MAGYAR TELEKOM MTEL.BU 495.00 15 Mar 2017 7 MOBILE TELESYSTEMS MTSS.MM 269.00 15 Mar 2017 5, 6, 7 MTN GROUP MTNJ.J 122.10 15 Mar 2017 4, 7 OOREDOO ORDS.QA 101.00 15 Mar 2017 1, 5, 6, 7 TURK TELEKOMUNIKASYON AS TTKOM.IS 5.68 15 Mar 2017 5, 6, 7 TURKCELL TCELL.IS 12.10 15 Mar 2017 2, 5, 6, 7 VIMPELCOM LTD VIP.N 4.05 15 Mar 2017 5, 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 28 February 2017 HSBC beneficially owned 1% or more of a class of common equity securities of this company.

5 As of 31 January 2017, 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.


and/or paid compensation to HSBC in respect of non-investment banking securities-related services.


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

Buy 45% ( 25% of these provided with Investment Banking Services )

Hold 40% ( 27% of these provided with Investment Banking Services )

Sell 15% ( 17% of these provided with Investment Banking Services )

155


16 March 2017

12 As of 10 March 2017, HSBC beneficially held a net long position of more than 0.5% of this company’s total issued share

capital, calculated according to the SSR methodology.

13 As of 10 March 2017, HSBC beneficially held a net short position of more than 0.5% of this company’s total issued share

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[574544]

EEMEA

telecoms

March 2017

Equities // Telecoms / EEM

EA

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

Main contributors

Issuer of report:HSBC Bank plc

8 Canada SquareLondon, E14 5HQ, United Kingdom

Telephone: +44 20 7991 8888Fax: +44 20 7992 4880

Website: www.research.hsbc.com

Hervé Drouet* Head of EEMEA TMT Equity Research HSBC Bank plc +44 20 7991 6827 | [email protected]

Hervé is Head of EEMEA TMT Equity Research. He has covered the sector for more than 14 years and has been ranked regularly, and ranked highly in numerous external surveys. He has 20 years’ experience in the media, telecoms and technology sectors, having been a senior management consultant in the TMT practice at Deloitte Consulting and a project manager for Schlumberger Technologies. He holds a MBA from London Business School and graduated from Ecole Supérieure d’Ingénieurs en Electrotechnique et Electronique in France.

Ziyad Joosub* Analyst HSBC Securities (South Africa) (Pty) Ltd +27 11 676 4223 | [email protected]

Ziyad Joosub joined the EEMEA TMT team at HSBC in May 2016. He had previously been an equity research analyst for a US investment house in Johannesburg for over eight years. He has covered South Africa TMT for over six years and has been a ranked Financial Mail and Institutional Investor analyst consistently over this period. Ziyad also spent two years as an associate in the consumer (retail) space. Before moving into equity research, Ziyad spent five years as a strategy and corporate finance analyst at a US investment bank. Ziyad is an honours graduate in Economic Sciences and Statistics from the University of the Witwatersrand.

Eric Chang* Analyst HSBC Bank Middle East Ltd +971 4423 6554 | [email protected]

Eric Chang rejoined HSBC in 2015 as an equity analyst covering the MENA telecoms sector. Prior to this, he was a MENA-focused buy-side analyst at a major UAE bank. Eric started his career at HSBC in 1997 as an equity analyst covering technology and media companies. Eric has a BA in Economics and Political Science from McGill University as well as a Masters in Finance from ESCP Europe.

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