mobile telecommunication company (zain) - riyad · pdf filefebruary 82, 2016 3 mobile...

Mobile Telecommunication Company (Zain) Reinstating Coverage

Hold 12-Month Target Price SAR 9.50

8 Red Years and Breakeven Not In Sight

After 8 operational years, the third telecom operator in Saudi continues to record losses. To absorb those losses, Zain has recorded two reductions to its original paid up capital of SAR 14 billion in four years depleting it to SAR 5.8 billion. The record high license cost, frequent change in management, overweighting debt and being a late entrant in the market with a penetration of 145% are believed to be factors keeping it back. The company was able to register a surprising customer base north of 2 million in its first quarter of operations and was able to reach 11.9 million in 2015 implying a market share of 22%. In our analysis, full year operational break-even may be achieved in the short-term, but bottom line is likely to stay in the red zone over the medium-term. We reinstate coverage on Zain with a target price of SAR 9.50 but a Hold rating due to credit, liquidity and legal concerns.

Fluctuating performance

The company witnessed a fluctuating top line between the years 2011-2015 recording a CAGR of 1%. Telecom companies’ top line is a factor of their customer base and average revenue per user (ARPU). Despite its remarkable customer base growth (CAGR of 12% between 2011-2015 reaching 11.9 million), Zain’s ARPU has recorded a CAGR of -9% in the same period, reaching SAR 47. It is evident that its strategy is to pursue a pricing game to tackle market share, a strategy pursued by most third operators in big markets. In our analysis, we find that further price reduction would not assist the company in accelerating profitability.

Missing mile-stones, high possibility of debt rescheduling Over the last few years, financial results have been below plan and Zain breached one of its loan covenants, which was later waived. In January 2015, the company revised its business plan and reported that it is negotiating with lenders to reset the new covenants. Missing its business plan’s milestones with debt bulks maturing soon imposes further pressure on the company and may signal that its strategy may take longer to yield. The company currently stands on a debt amount nearing SAR 16 billion, of which SAR 11 billion will be due over the next 3 years. We doubt the ability of the current cash flows to service the maturing debt, hence, it is highly likely that the company will call for debt rescheduling.

Possible scenarios

We believe that the company may encounter one or more of the following scenarios: i) Debt rescheduling; as its books are overweighed by SAR 11 billion in debt with a tight maturity schedule over the next 3 years and the estimated cash flows are unlikely to be able to service debt. ii) License extension by regulator; this will ease-off amortizing impact which accounts for over SAR 900 annually, iii) Zain Group assistance; the Group may find carrying a portion of debt due to commercial banks beneficial to ease-off the huge interest impact and iv) Sell-off & lease-back transmission towers; which was pointed out in the Group announcement in 2015.

Attractive valuations, yet neutral rating Despite a fall of 55% in its share price in the last 12 months and our valuation yielding a target price of SAR 9.50 (16% upside from current price), we believe that there are credit, liquidity and legal concerns. Considering qualitative factors, we do not recommend a Buy at this stage; instead, we reinstate coverage with a Hold recommendation.

Key Financials

FY December 31 (SAR mln) 2015A 2016E 2017E 2018E

Revenue 6,741 7,232 7,557 7,935

EBITDA 1,629 1,795 2,039 2,221

Net Profit (972) (835) (624) (405)

EPS (SAR) (1.7) (1.4) (1.1) (0.7)

BVPS (SAR) 7.8 6.4 5.3 4.6

ROAE (21.4%) (22.5%) (20.2%) (15.1%)

ROAA (3.7%) (3.4%) (2.6%) (1.8%)

P / B .8x .9x 1.1x 1.3x

EV/ EBITDA 9.2x 8.3x 7.3x 6.7x

February 82, 2016

Expected Total Return

Price as on Feb-82, 2016 5.09

Upside to Target Price 0.19%

Expected Dividend Yield 0.00

Expected Total Return 61. .9 %

Market Data

52 Week H/L 13.80/5.45

Market Capitalization SAR 3,444 million

Shares Outstanding 583.73 million

Free Float 51.15%

12-Month ADTV (999’s) 6,609

TASI Weight 0.30%

Reuters Code 7030.SE

Bloomberg Symbol ZAINKSA AB

1-Year Price Performance

Source: Bloomberg

Zain TASI TTI

Feb -24, 2016 5.09 5,070 1,424

Total Change

6-months (33.7%) (15.4%) -13.6%

-39.4% -23.6%

-36.2% -51.5%

8.0%

1-Year (55.2%) (36.1%) (18.2%)

2-Year (66.6%) (34.4%) (50.6%)

F2016E SAR mln

Revenue 7,232

Gross Profit 4,196

Operating Income (Loss) (42)

Net Income (834)

EPS (SAR) (1.43)

40

50

60

70

80

90

100

110

F M A M J J A S O N D J

ZAIN KSA TASI TTI

Abdulaziz A. BinZaraah [email protected]

+966-11-203-6816

Riyad Capital is licensed by the Saudi Arabia

Capital Markets Authority (No. 07070-37)

mailto:[email protected]

February 82, 2016

2


Reinstating Coverage

We reinstate coverage on Mobile Telecommunication Company (Zain Saudi Arabia) with a Hold rating. This report contains a brief overview on the Telecom Sector in Saudi Arabia as well as our outlook for Zain along with our estimate of its expected results.

Telecom Sector in Saudi Arabia

Overview

According to the latest report issued by CITC, the telecom sector regulator in the Kingdom, in 2015 the number of mobile subscriptions has reached 53 million compared to 51.6 million in 2010 recording a CAGR nearing 1% over the period while the number of broadband over mobile has spiked to reach 35.7 million in 3Q2015, a CAGR of 52% since 2010.

The Mobile and data segments witnessed a massive growth fueled by the young population (64% of the Saudi population is below the age of 34) and adoption to new technologies i.e. smart phones. In the following sections, we provide an overview over the mobile segments and its services accompanied by our future outlook.

Mobile market overview

The Saudi mobile market is considered the largest in the region. Pre-paid subscribers accounted for 85% while 15% are postpaid subscribers. Mobile penetration has reached 611% in 2015, sliding from its all-time high at 188% in 2011 due to the labor correction campaign along with the restriction of selling and recharging unidentifiable SIM cards were responsible for the lower rates.

Mobile Broadband overview

The total number of mobile broadband subscriptions witnessed a noticeable increase reaching 35.7 million and a penetration rate of 114 % in 3Q2015. The key reason for this growth is mainly attributed to the young population in the Kingdom, healthy expansion in the use of smart phones and availability of various data packages suitable for different users. Moreover, the increase in geographical coverage of 3G and 4G networks has assisted the total number of subscriptions to hike recording a CAGR of 52% in the last 5 years.

Subscriber base

Telecom operators find the subscriber base a key asset. Amongst the local operators, Zain enjoyed an increasing customer base registering a CAGR of 12% over the last 5 years. Competitive prices and availability of various packages has assisted Zain in registering such a hike. Furthermore, Zain was the first mover in discount over per minute rate after the reduction of termination fees by CITC in 2015, which explains the increase in 2015 customer base

Indicator 2010 2011 2012 2013 2014 2015

Mobile phone subscriptions 51.6 53.7 53.0 50.8 52.7 53

Pre-paid 45.3 47.1 45.7 43.9 45.9 44.9

Post paid 6.3 6.6 7.3 6.9 6.8 8.1

Broadband subscriptions over mobile 4.4 13.3 14.8 17.2 32.1 36*

Internet users 11.4 13.6 15.8 16.5 19.6 21.1*

Table 1: Number of mobile subscribers and internet users (mln)

Source: CITC, * Estimated

Operator 2011 2012 2013 2014 2015 CAGR %

STC 24.2 23.9 22.9 23.6 23.5 -0.7%

Zain 7.5 7.5 8.5 9.1 11.9 12.2%

Mobily 20.9 21.7 19.4 20.0 17.7 -4.1%

Source: Zain website, CITC, Riyad Capital

Table 2: Estimated number of subscribers per operator (mln)

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Recognized as high entry cost and continuous spending sector

The telecom industry has been recognized as a capital intensive industry due to high license cost and other regulatory fees. Zain and Mobily obtained a 25 years license paying SAR 23 billion and SAR 12.2 billion respectively. In addition to the high entry cost, telecom operators’ continue spending to lay infrastructure and match the evolving technology. STC has been ahead in the game in Capex due to landline expenditures.

Intense local competition

With the presence of 5 mobile operators, 2 of which are virtual operators, the competition is intensifying leading operators to lower package price in order to maintain market share. It is estimated that in 2015, the market’s biggest player, STC, had 44% market share whereas Mobily and Zain were 34% and 22% respectively.

ARPU under pressure

Sector’s Average revenue per user (ARPU) declined between 2011 and 2015 recording a CAGR of -9%. Sector’s monthly ARPU was around SAR 78 in 2015 compared to SAR 92 in 2011, a result of the intense competition which caused price reduction through packages offered.

Telecom market outlook

The mobile market demand is mainly driven by the local population which grew at a pace of 2.6% in 2015 according to CDSI. We estimate that the number of subscriptions will grow at a CAGR of 2.8% between 2016-2019 with a steady penetration rate reaching 170%.

The data market is expected to continue its rapid growth, a result of the kingdom’s youth population coupled with the reachability to smart devices in terms of price. We have estimated data subscriptions to grow at a CAGR of 10% between 2016-2019.

Operator 2011 2012 2013 2014 2015

Mobily 5,583 2,762 5,612 4,311 3,463

STC 5,769 5,375 6,100 6,142 10,347

Zain 1,195 1,055 904 663 1,582

Total Sector Capital Spending 12,547 9,192 12,616 11,116 15,392

Source: Companies Reports

Table 3: Sector's CAPEX spendings (SAR mln)

Exhibit 1: Market share by number of subscribers 2006-2015

Source: Market Definition, TeleGeography GlobalComms Database 2014, Riyad Capital

0%

15%

30%

45%

60%

75%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

STC Mobily Zain

Table 4: Telecom sector outlook

Measure 2016E 2017E 2018E 2019E

Saudi population (mln) 32.4 33.2 34.0 34.9

Mobile phone subscribers (mln) 54.5 56.0 57.5 59.2

Penetration rate (%) 168% 169% 169% 170%

Source: Riyad Capital

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Zain Overview

Mobile Telecommunications Company (Zain Saudi Arabia) was established in 2007. It is majorly owned by Zain Group and institutional investors by 48.85%, the remaining 51.15% is held by the public.

Pre-start concerns

Zain commenced its operations in the Saudi market in late 2008 as a third operator when the penetration rate was at 145%, which created initial difficulties. Despite the challenging start, the company managed to establish a customer base of 2 million users, capturing 5.6% of the market share in its first operational quarter, and nearly tripled the number in the year after, arriving at 11.9 million subscribers in 2015, implying a market share of 22%.

Kick-off with a record high license

Zain started its operations in 2008 after obtaining a 25 years license at a cost of SAR 22.91 billion in addition to SAR 449 million capitalized financing costs, the highest license fee the Kingdom has witnessed. The license cost was paid in advance imposing pre-start financial pressure on the company. It is worth noting that Mobily license cost was SAR 12 billion for 25 years.

Increasing subscriber-base, decreasing ARPU

Competitive prices and availability of various packages in addition to the geographical coverage and service quality are key metrics in the industry to increase the customer base. Zain has managed to provide a wide number of mobile packages along with covering more than 94% in of the Kingdom’s geographical map in 3Q2015. This led Zain’s customer base to register a CAGR of 12% in the last five years. However, since its introduction, Zain pursued a low pricing strategy pressuring its top and bottom lines. The strategy imposed pressure on the company’s average revenue per user (ARPU) delaying profitability.

Missing milestones

In 3Q2014, Zain’s financial results were below its earlier approved business plan. Also, the company fell below one of its loan covenants, which was not considered an event of default as per the terms of the Murabaha Financing Agreement. In January 2015, the company revised its business plan and reported that it is still negotiating with lenders to reset the new covenants according to the newly introduced business plan. In our analysis, we find that it may be challenging for the company’s operational cash flow to be able to meet its financial obligations on maturity. Therefore, we believe that the company may reach its lenders for rescheduling of its debt, which may further delay profitability due to higher cost of borrowing.

Table 5: Key figuers

2011 2012 2013 2014 2015

Saudi population (mln) 28.38 29.20 29.99 30.77 31.56

Mobile phone subscribers (mln) 53.70 53.10 50.80 52.70 53.00

Zain Subscribers base (mln) 7.57 7.50 8.46 9.01 11.90

Zain Subscribers Growth (%) - -1% 13% 7% 32%

Estimated market share (%) 14% 14% 17% 17% 22%

Source: Company Website,CDSI, CITC, Riyad Capital

2011 2012 2013 2014 2015 CAGR (%)

Subsribers base (mln) 7,567 7,495 8,461 9,011 11,893 12%

Monthly ARPU 70 68 64 57 47 -9%

Source: Company Website, Riyad Capital

Table 6: Number of subscribers and monthly ARPU

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Two capital reductions, 1 right issue in 4 years

Initially, Zain started its operations with a capital of SAR 14 billion. The capital was later reduced in 2012 to SAR 4.8 billion to off-set SAR 9.2 billion incurred losses. In the same year, the company put up SAR 6.0 billion in rights issue to be utilized in debt repayment and 4G network expansions. Later in 2015, the company reduced its capital by SAR 5 billion again to absorb accumulated losses in a turn-around plan by the company’s management. These events have affected the company’s capital structure where the current debt/ capital has reached 2.8x.

Operational breakeven in 2Q2015, losses to continue

Zain was able to achieve operational breakeven in 2Q2015, reporting a positive operating income of SAR 940 thousand compared to losses of SAR 136 million in the same period of 2014. Despite recording a positive quarterly operational profit, the company recorded a net loss of SAR 972 for the full years of 2015 due to high financial charges. We believe that the company will be able to post operating profits in 2017, yet, losses will continue over the medium term, due to the impact of high financial charges.

Overweighed by debt

As per 2015 financial statements, the company holds SAR 11 billion of debt due to commercial banks maturing in 3 years. In addition, the company owes SAR 5 billion to founding shareholders and other debtors. All debt is subject to interest, however, the amount of SAR 3.9 billion due to founding shareholders has no maturity schedule yet and interest is capitalized until commercial debt is retired. Banks repayment schedule is as follows:

Reasons for continuous losses

Zain has suffered continuous loss for the last 8 years. We believe the main reasons of the continues losses can be summarized in i) Paying a high license price, which caused financial stress and resulted in high financial charges ii) Being the third entrant in a market where penetration rates were 145%, and facing tough competition forcing the company to reduce its prices, which resulted in weak cash flow. Finally, frequent management change has not helped as since inception in 2007, Zain has witnessed four CEOs and more than nine changes in the Board room. We believe the frequent change in leadership is caused by pressure to find a turnaround plan.

SAR 2.2 billion claimed by Mobily, SAR 620 million claimed by DZIT

In 3Q2014, Mobily announced that it requested the referral to arbitration with regard to dues resulted from the Service Agreement signed with Zain regarding providing services that include national roaming, site sharing, transmission links and international traffic. An amount of SAR 2.2 billion was claimed by Mobily as of 30 November 2013 for which Mobily tried to reach an amicable settlement with Zain. A year later, Mobily increased its provisions by SAR 800 million. In the absence of legal judgment or further clarification, it would be challenging to draw conclusions regarding the case.

On the other hand, in July 2015, Zain received a letter from the Department of Zakat and Income Tax (DZIT) claiming a total amount of SAR 620 million of which SAR 253 million is Zakat and the remaining SAR 367 million is delay fees. The company replied to the letter explaining its justification, no reply was announced back by DZIT, however, the company has assigned a provision in this regard. In our meeting with company’s management, they explained that those cases are still under review, and conclusion cannot be drawn in the current time. Given the company’s current financial position, the echo of the pending cases are high and increases the risks associated with the investment.

Table 7: Commercial debt maturity schedule (SAR million)

2016 2017 2018

Debt principal 2,882 1,832 6,352

Source: Company Reports

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MVNO delay

Late 2014, Etihad Jawra (Lebara) and Virgin KSA were licensed to operate as MVNOs signing agreements with Mobily and STC respectively. Dubai based, Axiom Telecom, the third MVNO applicant, faced hurdles. Later, CITC re-tendered the license and postponed the application date until January 11, 2016. Later the application date was postponed again until April 2016 on the request of applicants.

Potential scenarios on the road

With a huge debt amount maturing soon and accumulated losses reaching 21.8% of capital by the end of 2015, Zain will face looming times especially with the current cash and profitability levels. We believe that the company will face one or more of the following scenarios

#1 Debt rescheduling/refinancing

With an amount of SAR 11 billion in debt by the end of 2015, the estimated operational cash flow is unlikely to be able to service maturing debt. We believe that the company will reach out to lenders for debt rescheduling, in addition we believe that the company will need further financing to fund its operations. This was confirmed during our meeting with the company’s management.

Impact: If this scenario occurs, the cost of commercial finance will be higher, we have accounted for that in our analysis and assumed the increase of borrowing cost.

#2 License extension

The high license cost at SAR 23 billion is considered a major obstacle preventing Zain from being profitable, an option we believe that is likely is that Zain will negotiate with CITC to extend the license term to ease-off amortization. In our meeting with the company’s management, they have confirmed that this option is being in discussion.

Impact: Based on our assumptions, if the license is extended by 5 years, amortization will ease-off, yet, breakeven point is not on sight.

#3 Zain Group assistance

An alternative Zain Group may consider is providing further assistance to Zain-KSA by partially taking on its debt to provide relief from high commercial loan financial charges. This option was considered as a result of observing past behavior where Zain Group has provided Zain KSA with interest bearing debt, yet, neither the debt principal nor the interest were scheduled until the commercial loans are fully retired.

Impact: The Impact of this scenario will be dependent on the amount of debt and the repayment schedule.

#4 Sell-off and lease back transmission towers

Selling-off and leasing back transmission towers seems to be a last reserve for telecom companies. In mid-2065, post Mobily’s financial statement adjustments, the company suffered low liquidity and high short term liability position where selling-off and leasing back transmission towers was an option. Also, Zain Group has announced in early 2015 that it has appointed advisors to study the potential sale of its transmitter towers in some of the eight markets in which it operates, not citing Saudi Arabia specifically. Zain KSA operates around 5,000 towers in Saudi Arabia, according to TowerExchange. The option of selling-off transmission towers might be a likely option especially that towers are not pledged, according to the financial statements. Impact: The financial impact of selling-off 5,000 transmission towers will add a value between SAR 1.8-2.5 billion, and will cut-back depreciation by SAR 500-800 million annually. Hence, the company may be able to break-even in the medium-term and will be able to partially service debt in the short run.

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Financial Analysis

Fluctuating top line, declining cost of services

Since 2011, the company witnessed a fluctuating top line recording a CAGR of 1% over the years 2011-2015, reaching SAR 6.7 billion. Telecom companies’ top line is a factor of the number of subscribers and average revenue per user (ARPU). With regards to the number of subscribers, Zain has registered a steady growth recording a CAGR of 12% between 2011 and 2015. The majority of the growth took place in the years 2014 and 2015 due to the introduction of the new pricing scheme after the reduction of the termination fees by CITC. In our analysis, we forecast the number of subscribers to grow at a CAGR of 5% between the years 2016 and 2019 reaching 14.8 million subscribers, capturing a market share around 25%. Our assumption takes into account increasing population at a pace of 2.1% and penetration rate going from 168% to 170%

On the other hand, ARPUs followed a decreasing trend throughout the years. It is evident that its strategy is to pursue a pricing game to tackle market share. Monthly ARPU has recorded a CAGR of -11% nearing SAR 47 in 2015 compared to SAR 70 in 2066. In our analysis, we don’t foresee that ARPU will witness intrinsic decreases over the medium term.

On another note, the company has effectively managed its resources. Direct costs have witnessed a remarkable decrease. It registered 41% of total revenue in 2015 compared to 50% in 2012. As a result, gross profit margins recorded 51% in 2015 compared with 50% in 2016. The largest direct cost is the access charges (also known as termination fees) which contributed 25% of total revenues in 2015 whereas it recorded 33% in 2016. We believe that as the company increases its market share, it will be able to reduce the termination fees charged as the number of calls within the network increase. According to our analysis, we believe that the company will be able to capture a market share of 25% in 2019; therefore we forecasted gross profit margins to gradually increase to reach 59% in 2019 at SAR 9.9 billion.

Exhibit 2: Zain's number of subscribers and monthly ARPU (SAR)

Source: Company Reports, Riyad Capital

-

15

30

45

60

75

90

4

6

8

10

12

14

2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E

Mil

lio

ns

# of Subscribers Monthly APRU

Exhibit 3: Revenue (SAR mln) & Gross profit margin (%)


0%

15%

30%

45%

60%

75%

5,000

6,000

7,000

8,000

9,000

2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E

Revenue Gross profit margin

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Opex to decline by 3%

Opex has stood at steady levels in the last 5 years at 34% of total revenues. We expect opex to decline to reach 31% of total revenues as a result of the reduction of the intense marketing expenses, which will tone down as the company places itself well in the competition map. Furthermore, we believe that the company will attempt to reduce operating expenses, which will assist in increasing operating profits.

Operational break-even in sight

The company reached operational break-even during 3Q2015, however, over the year, the company recorded an operating loss at SAR 141 million compared to losses of SAR 534 million in 2014. According to our analysis, the company will be able to operationally break-even over the full year 2017, recording an operating profit nearing SAR 239 million.

EBITDA margins to reach 27%

EBITDA is forecasted to reach SAR 2.3 billion in 2019 registering a CAGR of 8% during 2016-2019. We forecast EBITDA margins to increase reaching 27% compared with 29% in 2015.

Exhibit 4: Opex (SAR mln)& (% of revenues)


27%

30%

33%

36%

-

1,000

2,000

3,000

2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E

OPEX OPEX %

Exhibit 5: Operating profit (SAR mln) & operating profit margin (%)


-20%

-10%

0%

10%

(1,500)

(1,000)

(500)

-

500

1,000

2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E

Operating Profit (Loss) Operating profit margin

Exhibit 6: EBITDA (SAR mln) & EBITDA margin (%)


0%

10%

20%

30%

-

500

1,000

1,500

2,000

2,500

2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E

EBITDA EBITDA (%)

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Financial charges eliminating profitability

Given its highly leveraged balance sheet, the company records interest expenses that diminish its profitability. As of 2015 financial statements, the company holds SAR 11 billion in debt due to commercial banks. In addition, the company owes SAR 5 billion of which SAR 3.9 billion due to its founding shareholders, the amount is subject to interest and no maturity schedule was agreed upon with the founding shareholders to repay the amount nor the capitalized interest until the current commercial debt is retired.

We expect that Zain will refinance its debt due to its limited ability to repay its maturing principal, which will hike its cost of debt. We assumed that the company will re-finance the amount of SAR 6.5 billion out of the maturing SAR 11.1 billion in the next 3 years.

Furthermore, over 2016-2019, we have assumed that the company will reach for notes and other debt instruments of an amount of SAR 600 million to sustain cash and fulfill operational needs. The current interest level stands at SAR 837 million. We expect interest to marginally decline from 12% of total revenue in 2015 reaching -10% in 2019 as the amount of debt outstanding will decline slightly.

Net losses to continue

Zain’s net losses are expected to persist given its current situation. However, we expect LPS to decline from SAR (1.67) in 2015 to reach SAR (0.46) in 2019. The company will be under pressure from interest expenses and depreciation and amortization, which are the main reasons for eliminating profitability.

Exhibit 7: Debt (SAR mln), Debt/Capital (%) Exhibit 8: Debt break-down, 2015 (%)

Source: Company Reports, Riyad Capital Source: Company Reports, Riyad Capital

0%

20%

40%

60%

80%

100%

14,500

15,000

15,500

16,000

16,500

17,000

17,500

2011 2012 2013 2014 2015

Debt (SAR mln) Debt/capital

68%2%

25%

5% Banks

Notes

Advanced

fromshareholders

Dues to

relatedparties

Exhibit 9: Debt and Interest (SAR mln) Exhibit 10: Debt Principal & Estimated Op.CF (SAR mln)

Source: Company Reports, Riyad Capital Source: Company Reports, Riyad Capital

-

200

400

600

800

1,000

1,200

14,500

15,000

15,500

16,000

16,500

17,000

17,500

2011 2012 2013 2014 2015

Debt Interest

-

1,500

3,000

4,500

6,000

7,500

2016E 2017E 2018E

Commercial debt principal Forecasted O.C.F

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Valuation

We have used 2 methods to value Zain: discounted cash flow and target P/EBITDA.

1-Discounted cash flows (SAR 11.11)

Using the discounted cash flows model, we have assumed a risk-free rate of 3.70% and 10% as the market return (calculated by TASI geometric return in the last 20 years). Based on that, we have calculated the market risk premium at 6.30%. We have used a 2 year weekly beta obtained from Bloomberg in addition to cost of debt at 7.6% to arrive to a weighted average cost of capital at 8.05%. Our assumptions are:

Based on the discounted cash flow model, we arrive at a fair value of SAR 66.11.

2-Peer Valuation (SAR 8.12)

For this model, we used the P/EBITDA comparison method. To broaden our scope in the peer valuation, we have considered 4 peers from the regional telecom markets and their forward P/EBITDA ratios. We assured that comparable companies are not dominants in their countries to eliminate the possibility of high deviations. We have arrived at a fair price of SAR 8.12.

Table 8: Discounted cash flow valuation

Year 2017E 2018E 2019E

(SAR mln)

Risk Free Rate 3.70% NOPAT 233 440 526

BETA 1.06 Depreciation & Amortization 1,836 1,801 1,770

Market Risk Premium 6.30% Change in w orking capital -47 -61 -47

Cost Of Equity 10.38% Capital expenditures -632 -670 -710

Cost Of Debt 7.60% Free cash flow to f irm (FCFF) 1,391 1,510 1,540

Average Equity Weight 16.05% Present Value of FCFF 1,287 1,294 1,221

Average Debt Weight 83.95% Terminal Value 22,073

Perpetual Grow th Rate 1.00% Present Value of Terminal Value 17,500

WACC 8.05% Enterprise Value 21,302

-Net Debt -14,815

Equity Value 6,487

Shares Outstanding 583.73

Fair Value SAR 11.11


Assumptions

Table 9: Peer valuation

Company Country Forward P/EBITDA

Ooredoo Kuw ait 2.05

Zain Bahrain 2.23

Viva Kuw ait 2.96

Ooredoo Oman 3.33

Average - 2.64

Zain Forw ard EBITDA per share - 3.07

Fair Value SAR 8.12

Source: Riyad Capital, Bloomberg

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Recommendation

In our analysis, we found a combination of discounted cash flow method and peer valuation (P/EBITDA) method to be suitable as DCF provides an in depth analysis of the company’s operations and incorporate future potential and the P/EBITDA provides further insight on the market’s perception.

We allocate 50% of the valuation weight to the discounted cash flow methodology while the remaining 50% is allocated to the P/EBITDA peer valuation. Therefore, we assign a target price of SAR 9.50 to Zain providing an upside of 16% from current price. In this report, we reinstate our coverage for Zain with a Hold recommendation due to the credit and liquidity concerns and pending legal issues such as Mobily and DZIT claims.

Table 10: Fair value conclusion

Fair Value Weight

DCF 11.11 50%

P/EBITDA 8.12 50%


4.06

Weighted Fair Value (SAR)

5.56

Target Price 9.62

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Table 12: Zain Summary Financials

Income Statement (SAR mln) 2015 2016E 2017E 2018E 2019E Cash Flows (SAR mln) 2015 2016E 2017E 2018E 2019E

Revenues 6,741 7,232 7,557 7,935 8,332 Net Income (972) (835) (624) (405) (271)

Cost of Goods Sold (2,790) (3,036) (3,136) (3,253) (3,416) Depreciation & Amortization 1,770 1,836 1,801 1,770 1750.123

Gross Profit 3,951 4,196 4,421 4,682 4,916 Interest Charged 838 799 869 863 818

Dis. & Marketing (2,047) (2,119) (2,123) (2,190) (2,299) Interest Paid (512) (448) (487) (450) (372)

General and Administrative (275) (283) (258) (271) (326) Operating Cash Flow 1,568 959 1,514 1,717 1,879

Dep. & Amort. (1,770) (1,836) (1,801) (1,770) (1,750) Additions to PPE & Intangible (1,582) (551) (506) (536) (568)

Operating Profit (141) (42) 239 451 540 Investing Cash Flow (1,582) (551) (506) (536) (568)

Financial Charges (838) (799) (869) (863) (818) Notes payable 330 170 100 - -

Commission Income 7 7 7 7 7 Debt (121) (1,381) (832) (1,351) (1,300)

Income before Zakat (972) (835) (624) (405) (271) Financing Cash Flow 300 (1,211) (732) (1,351) (1,300)

Net Income (972) (835) (624) (405) (271) Net Cash 286 (802) 276 (170) 11

Shares Outstanding (mln) 583.7 583.7 583.7 583.7 583.7 Cash at the Beginning 1,092 1,378 575 851 682

LPS (on current shares) (1.67) (1.43) (1.07) (0.69) (0.46) Cash at the End 1,378 575 851 682 692

Balance Sheet (SAR mln) 2015 2016E 2017E 2018E 2019E Ratios 2015 2016E 2017E 2018E 2019E

Cash and Cash Equivalents 1,379 575 851 682 692 Profitability

Account Receivables 1,093 1,229 1,360 1,428 1,500 Gross Margins 59% 58% 59% 59% 59%

Prepaid and others 1,521 1,591 1,663 1,746 1,833 Operating Margins -2% -1% 3% 6% 6%

PPE 5,007 4,799 4,615 4,501 4,446 EBITDA Margin 24% 25% 27% 28% 27%

Int. Assets 16,812 15,863 14,878 13,893 12,908 Net Loss Margins -14% -12% -8% -5% -3%

Others 132 133 134 135 136 ROAA -4% -3% -3% -2% -1%

Total Assets 26,048 24,480 23,803 22,701 21,848 ROAE -21% -22% -20% -15% -11%

Accounts Payable 286 311 321 333 350 Debt Ratios

Notes Payable 330 500 600 600 600 Debt/capital 78% 81% 83% 84% 85%

Current Portion of LT Debt 2,881 1,832 6,351 1,300 - Debt /Equity 356% 414% 488% 529% 555%

LT Debt 8,185 7,853 2,502 6,202 6,202 Interst Coverage Ratio* -.28x -.09x .49x 1.00x 1.45x

Deffered Revenue 732 785 821 862 905 Liquidity

Accrued Expenses 2,698 2,696 2,893 3,023 3,174 Cash Ratio .20x .09x .08x .11x .14x

Adv. From Funding Shareholders 3,966 4,317 4,700 5,113 5,559 Current Ratio .59x .60x .38x .68x .87x

Due To Related Parties 835 888 943 1,001 1,062 Others

Total Liabilities 21,497 20,763 20,711 20,014 19,431 EBITDA (SAR) Per share 3.07 3.07 3.49 3.80 3.92

Share capital 5,837 5,837 5,837 5,837 5,837 P/E N/A N/A N/A N/A N/A

Accumulated defecit (1,279) (2,114) (2,737) (3,142) (3,414) P/B .8x .9x 1.1x 1.3x 1.4x

Total Liab. and Equity 26,048 24,480 23,803 22,701 21,848 P/S .5x .5x .5x .4x .4x

* Commecrial DebtSource: Company Reports, Riyad Capital

February 82, 2016

13


Stock Rating

Strong Buy Buy Hold Sell Not Rated

Expected Total Return ≥

25%

Expected Total Return ≥

15%

Expected Total Return <

15% Overvalued Under Review/ Restricted

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reasonable care has been taken to ensure that the facts stated in this report are accurate and that the forecasts, opinions

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