Telecom Industrial 21 June 2016 - gulfbase.com is rated as A- by S&P. Based on a mix of DCF and relative valuation methodologies, ... Saudi Telecom Telecom – Industrial 21 June 2016

Saudi Telecom Telecom – Industrial STC AB: Saudi Arabia

21 June 2016

Rating OVERWEIGHT

Target price SAR80.00 (25.3% upside)

Current price SAR63.83

Please see penultimate page for additional important disclosures. Al Rajhi Capital (Al Rajhi) is a foreign broker-dealer unregistered in the USA. Al Rajhi research is prepared by research analysts who are not registered in the USA. Al Rajhi research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities, an SEC registered and FINRA-member broker-dealer.

Key themes

We expect the company to start announcing more details, post shifting to an IFRS regime. We expect minimal impact from GCC roaming rate cuts as well as interconnection rate cuts. Near term, Q2 is likely to be impacted by seasonality and finger print regulatory requirement. STC is one of the key beneficiaries of the Kingdom’s Vision 2030 blueprint.

Share information

Market cap (SAR/US$) 127.7bn / 34.04bn

52-week range 55.59 - 73.02

Daily avg volume (US$) mn

Shares outstanding 2,000mn

Free float (est) 16%

Performance 1M 3M 12M

Absolute 0.3% -7.5% -4.6%

Relative to index 2.6% -9.8% 26.6%

Major Shareholder:

Public Investment Fund 70.0%

Gen. Organisation for Social Insce. 7.0%

Valuation

12/14A 12/15A 12/16E 12/17E

P/E (x) 11.6 13.8 12.4 11.0

P/B (x) 2.1 2.1 2.0 2.0

EV/EBITDA (x) 5.8 5.6 5.4 5.1

Dividend Yield 5.5% 6.3% 6.7% 7.0% Source: Company data, Al Rajhi Capital

Performance

96.0

105.0

114.0

123.0

132.0

141.0

53.0

58.0

63.0

68.0

73.0

78.0

Price Close Relative to TADAWUL FF (RHS)

-10

30

70

06/15 09/15 12/15 03/16

RS

I10

Source: Bloomberg, Company data, Al Rajhi Capital

Company summary

STC is the incumbent in the Saudi Telecom sector. It has a dominance in fixedline space and has captured around half of the mobile market. STC also has operations internationally, which constitute ~10% of its topline.

Saudi Telecom Company OW: Safe bet We believe STC is one of the safe bets in current times with meaningful upside

and healthy dividend yield. Post a shift to IFRS accounting standards from Q1

2017, we believe there will likely be additional financial disclosures giving

more clarity on the business. In the long term, STC will be the key beneficiary

of the technological transformation of the Kingdom as outlined in the recently

released NTP program, in our view. Near term, we believe Q2 will be impacted

by the ‘finger print’ exercise and Ramadan seasonal effect. However impact of

GCC roaming rate cuts will be benign and, the second set of regulatory

interconnection cuts will be insignificant in our view. The company is

employing strategies to push ARPU up, such as phasing out one-time data

plans for prepaid subscribers. With major impairments done in 2015 at its

challenging international JVs, the company looks much leaner and cleaner. A

tower sale and lease back, if implemented, will barely move the stock price in

our view. Key downside risks to our estimates are increased provisions, and

high number of subscriber accounts cancelled post finger print exercise. Our

dividend estimates imply an attractive yield of 6.7%, which makes STC one of

the top dividend picks in the Kingdom. We maintain our Overweight rating on

the company with a TP of SAR80/share.

Safe bet. Being the dominant player in a defensive sector, with solid cash flow

generation and high dividend yield, the company is one of the safe bets in the

Kingdom especially in the current market environment. Long term, we believe

STC will likely be the key beneficiary of the Govt.’s technological transformation

as outlined in Vision 2030 document. The mandatory move to IFRS accounting

standards would be a medium term catalyst for the stock in our view, if

additional Key Performance Indicators (KPI) are also reported.

Weaker Q2. Q1 was relatively weak, with 3% top-line growth (partly attributed

to allocation of resources to finger print activity) after posting 10% growth in

2015. Q2 will be weaker given the continued impact from finger print exercise,

and Ramadan, partly offset by higher contribution from Viva Kuwait.

Barely any impact from regulatory decisions. Recent regulatory decision to

cut GCC roaming rates will barely make an impact. Moreover, these are highly

price elastic services. Cut in interconnection rate cuts will be insignificant as well

given symmetric interconnection rates and higher on-net calls in our view.

Valuation. The company is one of the top 10 picks in terms of dividend yields

and is rated as A- by S&P. Based on a mix of DCF and relative valuation

methodologies, we value the stock at SAR80/share and maintain OW rating. Key

downside risks include cancellation of active accounts that have not provided

finger prints, impairments at international subsidiaries and regulatory fines.

Period End (SAR) 12/13A 12/14A 12/15A 12/16E 12/17E

Revenue (mn) 45,605 45,826 50,651 52,071 54,006

Revenue Growth 1.9% 0.5% 10.5% 2.8% 3.7%

Gross profit margin

EBITDA margin 38.1% 40.7% 38.1% 37.4% 37.9%

Net profit margin 21.7% 23.9% 18.3% 19.8% 21.5%

EPS 4.95 5.48 4.63 5.16 5.81

EPS Growth 38.2% 10.7% -15.5% 11.6% 12.5%

ROE 18.9% 18.7% 15.2% 16.8% 18.3%

ROCE 16.2% 15.5% 16.0% 15.7% 16.3%

Capex/Sales 16.3% 13.3% 18.3% 18.0% 18.0% Source: Company data, Al Rajhi Capital

Pritish K. Devassy, CFA Head of Equity Research

Tel +966 11 2119370, [email protected]

Saudi Telecom Telecom – Industrial 21 June 2016

Disclosures Please refer to the important disclosures at the back of this report. 2

Well positioned for the long term

In the last year when oil prices declined 19.5% and TASI was down 31%, STC’s share price

was relatively stable with only 4.5% decline . Being the dominant player in a defensive sector,

STC is one of the safest bets in the market with a meaningful upside and attractive dividend

yield of 6.7%. It continues to trade below its historical (2-year) EV/EBITDA multiple and its

peers as well. We believe it will continue to remain defensive and is well positioned for the

long term. In the short term, STC will shift to IFRS reporting standards from Q1 2017 as all

listed companies are mandated to implement IFRS accounting standards beginning from

2017. We believe this will lead to a lot more financial details being reported. If the company

starts reporting additional details (beyond that mandated by IFRS) such as detailed revenue

mix, subscriber data etc., then this would eliminate some “opacity discount” applied on the

stock and could push the stock above its current trading band of around SAR60-65 in the

past year. The reverse phenomenon was seen in 2013, when the company started accounting

for some of the non-core assets as associates and JVs instead of fully consolidating and this

led to more clarity (downward revision) of domestic business drivers, pushing the stock

lower.

Key beneficiary of NTP

While the above is likely to only eliminate the perceived discount, the company will see

tangible value created as STC is likely to be the key beneficiary in the technology

transformation of the Kingdom. As per Vision2030, Saudi government is committed to

expanding telecom coverage and capacity, especially for high speed broadband through

investment in infrastructure within and around cities. In addition, the Government will also

work on improving regulations and build effective partnership with providers, enabling them

to build essential infrastructure and simultaneously encourage local investments. We believe

STC being the leading telecom provider is well-placed to benefit from this broadband push.

As per the NTP document, the Govt plans to increase FTTH penetration to 80% in 2020 from

44% currently. STC has already laid down FTTH cables of 147,000 km and has the largest

internet gateway in the Middle East, with a capacity of 1,533 gigabyte per sec and more than

12,000 terabyte daily giving it the easy advantage. Not just Telecom, the company is investing

into cloud and IT as well. We have summarised the salient targets for the telecom and related

sectors set in the NTP book:

- Increase the contribution of the IT industry to non- oil GDP from 1.12% to 2.24%

- Increase the frequency of spectrum available for telecom services out of the total

allocated resources from 42% to 80%

- Increase FTTH coverage in densely populated urban areas from 44% to 80%

- Broaden wireless broadband network coverage (more than 10mbps) in remote areas

from 12% to 70%

- Increase the number of internet users in the Kingdom from 63.7% to 85%



Minimal impact of regulatory changes While telecom companies across the globe have experienced regular regulatory actions, the

Saudi Telecoms sector had been immune till 2015. Starting from 2015, the Saudi telecom

sector saw a flurry of changes – cutting of interconnection rates (twice), GCC roaming rate

cuts, 100% Saudization of telecom sector, finger print requirement etc. Most of these were

not totally unexpected, as discussions on most of the changes were on-going in the past, with

only the timelines unknown. The impact of these new regulations- cutting GCC roaming

rates, reduction in termination fee, etc. were widely feared to be a downside risk for the stock.

Based on our analysis and discussion with the companies the impact is likely to be minimal.

Cut in GCC roaming rates

GCC countries decided in June 2015 to gradually reduce the roaming rates in phases, as a

part of the economic integration plan among the GCC countries, which includes outgoing

voice calls, SMS and data services. This was after the initial set of cuts (setting the price caps)

which was only on outgoing calls, implemented way back in 2012.

The new reductions of roaming charges will be on both inter-operator wholesale level and

end user retail level and will take place gradually, over a three years period, for voice calls and

SMS services, and over a five years period for mobile data services as seen below.

Figure 1 Revised roaming rates for a typical GCC telecom company*

Rates Prev.

As of 1

April

2016

As of 1

April

2017

As of 1

April

2018

As of 1

April

2019

As of 1

April

2020

Within the Visited Country (SAR) 1.06 1.00 0.96 0.92 - -

To other GCC Member States including home country (SAR) 2.55 2.46 2.38 2.31 - -

Calls received while roaming(SAR) 1.31 1.35 1.08 0.85 - -

SMS (SAR) 0.30 0.31 0.27 0.23 - -

Data (SAR) / MB 4.88 5.00 3.27 2.31 1.92 1.61 Source: Al Rajhi Capital, CRA Qatar,. *Mobily’s roaming rates, Emirates247

Based on our understanding, call prices are to be cut by a total ~40% over a 3 year period.

The cuts are only 2-3% in 2016 and higher in 2017 and 2018 by ~18%. Post 2018, prices will

be cut only for data as seen below:

Figure 2 Changes in rates over the years

% change Weights 1st year 2nd year 3rd year 4th year 5th year

Within the Visited Country 13% -6% -4% -4%

To other GCC Member States including home country 13% -4% -3% -3%

Calls received while roaming 15% 0 -20% -21%

SMS 5% 0 -13% -15%

Data 54% 0 -35% -29% -17% -16%

Weighted average -1.2% -23.1% -20.6% -9.1% -8.7% Source: Al Rajhi Capital, CRA Qatar, Emirates247

This will lead to collective user savings of ~ $1.13bn (SAR4.24bn), reducing the financial

burden on GCC users (Source: GCC Economic affairs). We believe this to be over five years

with calculations as shown below:

Figure 3 Calculation of cumulative user savings

In USDm Current year 1st year 2nd year 3rd year 4th year 5th year

GCC Roaming revenues 757 748 575 457 415 379

Savings per year 9 182 300 342 378

Cumulative savings 1,211 Source: Company data, Al Rajhi Capital



STC does not provide exact contribution of roaming revenues which makes it difficult to

calculate the impact of roaming rate cuts. Based on GCC regulatory data, we calculate GCC

roaming revenues to be 1.3% of total telecom revenues. This is below the industry average

(5% of top line for average European telecom company) as this takes into account only GCC

roaming revenues (as against international roaming revenues).

As STC has significant contribution from fixed line segment and others, GCC roaming

revenues could be less than 1% of top line. As per GCC regulatory data, the average GCC

margins are likely to be around 50% (average of inbound and outbound margins). Applying

the percentage of inbound and outbound visitors to and from Saudi Arabia on the margins,

we arrive at an average 45% margin for roaming calls for the Saudi Telecom players.

Figure 4 Calculation of margin for roaming services

2014 data (in thousand trips) Inbound tourists Outbound tourists

All inclusive 18,259 20,051

GCC alone 6,057 10,013

Weightage based on direction of visits 26% 19%

Average margin 45% Source: SAMA, Al Rajhi Capital

Thereby with a 1% revenue contribution and 45% net profit margin, the impact

on STC will be minimal at SAR90m spread over next 3 years with 2016 impact to

be less than SAR10m.

Second round of rate cuts on mobile and fixed lines

Saudi Arabia’s Communication and Information Technology Commission (CITC) announced

the second revision of the interconnection rates for mobile and landline in March 2016. The

initial rate revision was announced in February 2015, when interconnection rates were

reduced by 40% to SAR0.15 (from SAR0.25) for mobile and for landline by 30% to SAR0.07

(from SAR0.10). Zain acted on it by reducing the call rates to SAR0.19 for all calls, followed

by Mobily in June 2015, introducing new plans that slashed their on-net, off-net calls and

SMS rates to SAR 0.19.

The second set of rates cut was announced in March 2016, under which mobile

interconnection rates were reduced by 33% for mobile to SAR0.10 and landlines by 36% to

SAR 0.045. With the cut in interconnectivity charges, CITC is looking to increase competition

among the existing operators and also enable the MVNOs to compete in the already saturated

market. We believe the current termination rates are in-line with the global average

(SAR0.08 for MTRs) and do not expect any more big cuts in the near future.

In a hypothetical ideal scenario with symmetric interconnection rates, there should be no

impact of cut in interconnection rates as interconnection revenues should equal

interconnection expenses. However in the case of the telecom sector in the Kingdom we

estimate the percentage off-net calls lesser than the ideal scenario. As per our understanding

with all the bundled packages promoting on-net calls, there is a high percentage of on-net

calls in the Kingdom. Also the termination rates are symmetric. Hence, we believe that

the decline in interconnection rates should be insignificant as was seen post the

first set of cuts. For the smaller companies this should be only slightly beneficial, as was

noticed in the financials post the first cuts. Overall the net result was that it increased

competition as Zain cut its call rates to 19halalas.

As mentioned above, we believe the net impact of the second rate cut will be similar to the

first wherein all the companies saw a 10-13% reduction in access charges (see table). For

STC we estimate access charges to decline by 10% in 2016. As there was no major

impact on financials post the first cuts, one could estimate at a similar decline for

interconnection revenues as well.



Figure 5 Reported Access charges (in SAR bn )

2012 2013 2014 2015

STC 8.2 7.6 7.2 6.4

-7% -6% -11%

Mobily 5.8 5.2 5.0 4.3

-11% -3% -13%

Zain 1.9 1.9 1.7 1.6

-3% -9% -10% Source: Company data, Al Rajhi Capital

Finger print regulations

In Jan 2016, the CITC issued directives to all telecommunication service providers in the

Kingdom to take fingerprints of subscribers of mobile telephone services. The period (post

grace time) ended on June 2 for prepaid subscribers. The lack of numbers disclosed by CITC

does not help us in estimating the impact from this. However initially around 18m finger

prints were not registered at the start of the year (Arabnews). We believe that extensions will

be provided so that most active accounts will not be suspended or cancelled. All the

companies are aggressively trying to ensure its subscribers are all covered. STC has

introduced double credit for those validating their numbers between May 21 and June 21-

though is valid only for two days.

All the three telecom companies revealed that costs increased in Q1 because of this exercise

and this is likely spill over to Q2 as well. Based on our understanding of STC management

discussion, not just an impact on costs, Q1 sales also were slightly impacted because of

allocation of sales force to implement this. This will be less pronounced in Q2 2016 but

nevertheless will have an impact relative to its normal run-rate prior to the exercise.

We ran a scenario analysis on the possible impact using the 18mn subscribers mentioned

above as the starting point and using STC’s market share of 49%, we arrive at the following

results:

Figure 6 Scenario Analysis

% of accounts cancelled Revenue impact (SAR '000) % of 2015 Revenues

1% 97,090 0.2%

2.50% 242,726 0.5%

5% 485,452 1.0%

7.50% 728,178 1.4%

10% 970,904 1.9% Source: Company data, Al Rajhi Capital

Even after cancellation of 10% accounts, the impact is a paltry 2% of 2015 top-

line because STC’s top-line is diversified across PSTN, fixed broadband and

international businesses.

On other regulations, lastly, the Ministry of Labor and Social Development’s decision to

Saudize the telecom industry will barely have an impact on the telecom revenues.



Pushing up ARPU

Change in mobile data strategy –shift to higher ARPU band

We note that the company has been actively making changes in its data plans. Based on our

observation of its data plans, STC has made two changes–

a) It has changed all one-time internet plans for prepaid customers to recurring plans

b) The company has made some changes that could increase its average ARPU. For

example a 2GB plan used to cost SAR100 per month. Now this plan has been

eliminated and there is only a 1GB plan which costs SAR90 per month. The next

higher data plan is a 5GB plan that costs SAR200. This should ideally provide an

incentive for customers to shift to higher bands package for better value.

Ideally, if customers continue to stick on with STC, this will result in higher ARPUs but

there are obvious risks to the change, the key risk being migration of subscribers to

competitors given its cheaper plans. Please see appendix for the plans.

Taking to the next level through Jawwy

Being a commoditized product, differentiation in telecom products is about unique

packaging. Following the trend in developed markets, 2012 saw the advent of bundle-based

competition in Saudi Arabia. STC was able to leverage its fixed line infrastructure to offer

bundles that combine fixed voice, IPTV and ADSL/FTTH broadband, while Mobily and Zain

KSA competed on bundled offers that combine voice and data. Now STC is taking to the next

level with its unique service “Jawwy”. STC is aiming to take higher market share with Jawwy

wherein one can design his or her own bundles with more or less of data or voice depending

on the need. This is the next level post bundling products in our view. The impact is

too early to be estimated, however this shows that STC is actively trying to capitalize on its

leadership position and its strength as an integrated player.

Wireline data advantage

STC is the major beneficiary of the increase in fixed broadband revenues as we estimate STC

to have bulk of the revenue market share in fixed-line and data revenues. Thus despite

market penetration being saturated for mobile business, it enjoys dominance in the

fixed broadband space. Given entry of new content based services (eg. Netflix) and fair

usage limit for mobile broadband, there is likely to be a shift from mobile broadband to fixed

line broadband gradually, which have unlimited data packages.

Figure 7 Saturated mobile market Figure 8 Total Fixed Wireline and Wireless data subscribers in Saudi Arabia

Title:

Source:

Please fill in the values above to have them entered in your report

53,700

53,000

50,800

52,700 52,800

4.1%

-1.3%

-4.2%

3.7%

0.2%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

49,000

49,500

50,000

50,500

51,000

51,500

52,000

52,500

53,000

53,500

54,000

2011 2012 2013 2014 2015

Mobile subscribers ('000) y-o-y growth

Title:

Source:


2.0

2.5

2.93.0

3.6

12.1%

30.3%

15.0%

3.8%

17.5%

0%

5%

10%

15%

20%

25%

30%

35%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2011 2012 2013 2014 2015

Fixed Wireless and Wireline Broadband lines(mn) y-o-y growth

Source: CITC, Al Rajhi Capital Source: CITC, Al Rajhi Capital



International operations

The book value of its investments in joint ventures has reduced to ~SAR5bn in 2015 from

~SAR12bn in 2012, mainly because of impairments at Oger Telecom, one of its challenging

JVs. After significant impairments to Oger, we believe there is not much downside from

this level (reduced to SAR0.48bn from SAR2.23bn). While this will not impact our

valuation, this lowers EPS of the company.

Figure 9 Investments in joint ventures (SAR 000's)

2012 2013 2014 2015

Binariang GSM Holding - Malaysia 6,633 4,256 4,565 4,566

Oger Telecom Ltd. U.A.E. 5,313 3,713 2,234 487

11,946 7,969 6,799 5,053 Source: Company data, Al Rajhi Capital

Viva Kuwait

The company increased its stake in VIVA Kuwait to 51.8% (from ~26%) in February 2016,

and is the currently the largest contributor within its international segment. Based on our

estimates, we expect the increase in stake will result in an incremental net profit growth of

~2% in 2016. Similar to Saudi Arabian telecom market Kuwaiti market is saturated but its

ARPUs are higher than the domestic market and will benefit from increase in margins.

Figure 10 Blended average ARPU in SAR

Viva Kuwait STC Saudi

2012 89.0 73.9

2013 85.9 68.3

2014 103.1 63.3

2015 114.7 90.0 Source: Company data, Al Rajhi Capital

Impact of shifting Ramadan – seasonality

Usually Ramadan period is a weak period for businesses in the Kingdom and telecom

business is no exception. As Ramadan shifts forward by 2 weeks annually, this year most of

Ramadan will fall in the month of June. Q2 in 2016 will be weaker than Q2 2015 because of

this shift. In contrast Hajj season is positive for telecom business as volume of calls is likely to

be higher.

Figure 11 Ramadan shifting into Q2 this year

Year Ramadan Quarter Hajj Dates Quarter

2011 01 Aug - 31 Aug Q3 2011 02 Nov - 07 Nov Q4 2011

2012 20 Aug - 19 Aug Q3 2012 21 Oct - 26 Oct Q4 2012

2013 09 Jul - 8 Aug Q3 2013 10 Oct - 15 Oct Q4 2013

2014 28 Jun - 28 Jul Q3 2014 29 Sept - 4 Oct Q3 -Q4 2014

2015 18 Jun - 18 Jul Q2 - Q3 2015 19 Sep - 24 Sep Q3 2015

2016 07 Jun - 07 Jul Q2 2016 8 Sep - 13 Sep Q3 2016 Source: timeanddate.com, Al Rajhi Capital



Tower sale and leaseback option

While sale and leaseback activity is common in the real estate sector in the Middle East,

telecom tower sale and lease back activity is unprecedented in the Kingdom. Mobily and Zain

KSA are looking at options to sell their towers. As per Argaam, even STC is considering sale of

its mobile towers, which is a bit surprising because company already has sufficient cash and

the company has the widest network coverage in the Kingdom. Based on our interaction with

the company, despite there being no real need for the company to sell its tower assets and

lease it back, they would be interested only if it is financially lucrative and as it improves

efficiency. For Mobily and Zain, a tower sale would help them reduce debt and reduce their

financial expenses. A tower sale would lower capital needs and also help the company focus

on its core business.

What is the possibility in Saudi Arabia? We believe a tower company will find a deal less lucrative in the Kingdom relative to other

markets because:

The market is already saturated with mobile penetration at 167.5% - implying not

much room for mobile towers (relatively to other markets). Topline growth for a

tower company comes from potential increase in new shared sites and tenancy.

In Saudi Arabia there are only three operators – so there is a lesser pool of targets to

increase the tenancy ratio.

On average the existing tenancy ratio average is quite high for tower companies –

which will likely not be the case in Saudi Arabia.

Contrary to the perceived notion, cost of running tower sites in the Kingdom is

higher than market average, because of high real estate rentals . We believe

operating costs could be more than US$10,000 annually. Thus the lease rates will be

higher.

What is the financial impact? As for the financial impact, a sale and lease back offer will result in lower EBITDA as the

company will have a higher lease rate compared to existing tower related operating expenses.

However the decrease in net income will be partly mitigated by reduction in financial

expenses (or increase in interest income) and lower depreciation. This cash received could

help them deleverage, meet debt and other obligations and even could even free capital for

activities such as M&A. There are disadvantages as well (especially for the market leader) as

this could give up competitive advantage by sharing towers assets with competitors.

Contrary to general perception of lower costs of operating a tower in Saudi Arabia, relative to

other markets because of lower fuel costs, operating costs of a tower is higher at around

~SAR4,000/month, which translates to ~US$13,000 annually (based on our interaction with

one of the companies in the region). This is in line with the expenses in the US which come to

US$12,000-14,000 per tower annually. The lease rates in the US are at around US$20,000.

Lease rates ideally are dependent on a lot of variables such as the tenancy ratio, cost of

maintaining a tower, cost of building a tower etc. The exact details are not available, but it

would be logical to assume higher lease rate in Saudi Arabia, than in the US given possibly

lower tenancy ratios in the Kingdom.

Using these assumptions for 5,000 towers, entering into a tower deal would

reduce EBITDA by SAR169mn, insignificant compared to 2015 EBITDA of

SAR19.2bn.

Assuming an EV/EBITDA of 7x, this would mean the company should benefit only if the

tower sale proceeds are greater than SAR1.2bn (EV EBITDA of 7* reduction in EBITDA of

SAR169mn), which would mean value per tower of USD63k. This we note is much lower than

the valuation of ~USD150k per tower, reported in the media. Logically speaking, given that a

tower sale is not too important for STC as compared to Zain and Mobily, a deal will not be

struck unless it is positive for the company. However this would not have a material impact

on the company.



Among the best dividend yields in the Kingdom

Working capital increased

STC saw a surge in its accounts receivables in 2015, which is mainly attributed to Govt. receivables. The accounts receivables still at SAR12.6bn is not a worry for two reasons:

a) Based on historical evidence, Govt. could delay payments but will not default

b) The company has to pay fees every year to Govt. of around 4bn and so these receivables can be netted if required in the future. Already Government payables are at SAR2bn.

However, provisions notably surged 41% to 1.7bn from 1.2bn compared to only a 10% increase in revenue in 2015.

Dividend policy

Based on its new dividend policy (from Q4 2015), STC will continue to pay a dividend of

atleast SAR1 per share quarter (SAR4 per year) for the next three years. However, the

regulatory changes and increased working capital requirements have not helped the company

to increase its dividend payments. We believe STC will continue to generate a healthy FCF

(SAR4.5/share in 2016 and SAR5.3/share in 2017) which will allow it to maintain its dividend

payout and sustain a healthy cash position. Our forecast for STC’s annual dividend is

SAR4.25 per share, with a dividend yield of ~6.7%.

Figure 12 Dividend yields and dividend per share estimates for STC

Title:

Source:


2.25

3.50

4.00 4.25

4.50

4.85

3.5%

5.5%

6.3%

6.6%

7.0%

7.6%

0%

1%

2%

3%

4%

5%

6%

7%

8%

0

1

2

3

4

5

6

FY13 FY14 FY15 FY16E FY17E FY18E

Source: Company data, Al Rajhi Capital.



Valuation

We use a mix of DCF and relative valuation methodologies to value the firm. For DCF

method, we employ a terminal growth of 1.5% and a WACC of 9.8%. As for relative valuation,

the company is trading below its peers as well as historical multiples on a EV/forward

EBITDA basis. As Tax (Zakat) is lower compared to its peers (as most of the Govt. related fees

etc. come above the EBITDA level), ideally STC should be trading at a higher EV/EBITDA

multiple.

Figure 13 Calculation of target price

Method Valuation Weight ARC Target

DCF 82.7 75% 62.1

Relative 71.7 25% 17.9

80.0

Fair Price as on today 80.0

UPSIDE 25% Source: Company data, Al Rajhi Capital, Bloomberg

We arrive a target price of SAR80 as seen above.

Figure 14 DCF Valuation methodology(on a per share basis)

Component Value

Appraised value of the enterprise 68.8

Add:

Sukuks / Investments 3.2

Value of associates and non-core assets 7.0

Less:

Net debt 8.3

Minorities (1.4)

Provisions & Other liabilities (3.3)

Target Price 82.7 Source: Company data, Al Rajhi Capital

Figure 15 Trading below peers and 2 year historical multiples(EV/EBITDA basis)

Title:

Source:


5

5.5

6

6.5

7

7.5

STC Comparables average

Source: Al Rajhi Capital, Bloomberg



Figure 16 Valuation multiples for peers

Est P/E Current Yr Est P/E Next YrEV/EBITDA

Current YrEV/EBITDA Next Yr

Saudi Telecom Co 11.68 11.37 5.74 5.68

Oman Telecommunications Co 9.76 9.58 4.28 4.19

Maroc Telecom 18.62 17.56 7.11 6.87

Bahrain Telecom Co 1.13 1.09 4.15 4.15

Partner Communications Co 53.22 171.44 5.88 6.23

Telkom Sa Soc Ltd 10.31 9.82 3.38 3.34

Emirates Integrated Telecomm 16.12 15.60 4.85 4.65

Bezeq The Israeli Telecom Co 13.36 13.48 6.87 6.81

Ooredoo Qsc 13.02 12.19 4.62 4.57

Emirates Telecom Group Co 18.29 17.31 6.74 6.50

Cellcom Israel Ltd 17.67 20.09 6.00 6.25

Vodacom Group Ltd 16.52 15.18 7.95 7.37

Mtn Group Ltd 10.98 10.37 4.76 4.61

Global Telecom Holding 38.29 10.44 2.71 2.72

Safaricom Ltd 17.03 14.77 8.06 7.27

Mobile Telecommunications Co 8.21 7.34 4.61 4.48

Etihad Etisalat Co 95.17 33.50 7.39 6.75

Telecom Egypt 6.30 6.65 3.61 3.67

Average 20.87 22.10 5.98 5.74 Source: Company data, Al Rajhi Capital, Bloomberg consensus estimates.

Risks

Near term downside risks are cancellation of active subscriber accounts which have not

complied with finger print requirement, impairments or unexpected regulations which can

affect its international operations which have been problematic in the past, further decline in

oil markets, negative outcome of their changes in its packages or data plans, regulatory risks

such as introduction of new fees or fines.



Appendix

Figure 17 Mobily prepaid plans

Package Bundle Fees/ SR MB Included Additional MB (SAR)

Internet Basic Free 0 2

Hourly Package 10 SR/ Hour Unlimited -

Daily Package 24 SR / Day Unlimited -

Internet 30 MB 10 SR / Month 30 MB 2





Internet 1 GB* 79 SR / Month 1 GB 2

Internet 2 GB 100 SR / Month 2 GB 2



Unlimited Internet 350 SR / Month Unlimited - Source: Company data, Al Rajhi Capital

Figure 18 Zain KSA prepaid plans

Package Plan Price (SAR) Validity

Internet Light Plans 500 MB 10 One Day

50 MB 15 One Month

100 MB 20 One Month

250 MB 30 One Month

500 MB 45 One Month

Internet Basic Plans 1 GB 69

3 GB 100

6 GB 200 One Month

40 GB 300

Internet Unlimited Monthly 500 Source: Company data, Al Rajhi Capital

Figure 19 STC prepaid plans

Prepaid Package Price Data Validity

Sawa 200 MB 30 SAR 200 MB 7 days with auto renew

Sawa 500 MB 50 SAR 500 MB 7 days with auto renew

SAWA 250 MB 50 SAR 250 MB 30 days with auto renew

SAWA 1 GB 90 SAR 1 GB 30 days with auto renew

Sawa 5 GB 200 SAR 5 GB 30 days with auto renew

SAWA 20 GB 350 SAR 20 GB 30 days with auto renew Source: Company website, Al Rajhi Capital



Figure 20 STC data sim plans

Connet 4G

Infinity

package Package Name

Promotion

Fee

Infinity 6 Months (Data SIM & 4G Router) SAR 650

Infinity 12 Months (Data SIM & 4G Router) SAR 1,200

4G Router only SAR 180

Bundle Initial Subscription Price

Connect 2GB Data SIM 1 month SR 55

Connect 5GB Data SIM 1 month SR 90

Connect 4G USB 3 months SR 345

Connect 4G Router 3 months SR 405

Connect 4G Mini WIFI 3 months SR 395

Connect 4G Mini WIFI (Big Battery) 3 months SR 425

Connect 10GB Data SIM 3 months SR 270














Connect 4G Mini WIFI (Big Battery) 12 months SR 1430 Source: Company data, Al Rajhi Capital

Figure 21 Mobily data sim plans

Package 1 month 3 months 6 months 12 months

2GB SR 45 SR 105 SR 185 SR 350

5GB SR 80 SR 210 SR 370 SR 690

10GB SR 90 SR 230 SR 410 SR 765

20GB SR 95 SR 255 SR 450 SR 850

Infinity 60GB N/A N/A SR 490 SR 920 Source: Company website, Al Rajhi Capital



Figure 22 Zain data sim plans

Plan Price Validity

Free

Multi-SIM Free On-net SMS

Delight* (Pay as You Go) SAR 20 N/A N/A N/A

2 GB SAR 45 1 Month 0** 100

10 GB SAR 119 3 Months 0** 300

50 GB SAR 199 3 Months 3 500

200 GB SAR 299 3 Months 3 800

Unlimited SAR 349 3 Months N/A 1000

SAR 649 6 Months N/A 1500

SAR 1199 12 Months N/A 2000

Speed 4G Renewal Prices

Plan Price Validity Free On-net SMS

2 GB SAR 45 1 Month 100

5 GB SAR 69 1 Month 200

10 GB SAR 119 3 Months 300



Unlimited Plans Renewals Prices:

Plan Price Validity Free On-net SMS

Unlimited SAR 349 3 Months 1000

SAR 649 6 Months 1500

SAR 1199 12 Months 2000

*400 MBs, Pay As You Go 6 Halala/MB

**Up to 3 Multi-SIMs, SAR 10 per each Source: Company website, Al Rajhi Capital



Income Statement (SARmn) 12/13A 12/14A 12/15A 12/16E 12/17E

Revenue 45,605 45,826 50,651 52,071 54,006

Access Charges (18,191) (17,670) (20,306) (21,866) (22,147)

Employee Costs - - - - -

Government Charges - - - - -

S.G. & A. Costs (8,943) (9,095) (11,051) (10,718) (11,369)

Repairs & Maintenance Costs (1,104) (399) - - -

Operating EBIT 10,989 11,632 11,859 11,981 12,954

Cash Operating Costs (28,238) (27,164) (31,357) (32,584) (33,516)

EBITDA 17,367 18,661 19,294 19,487 20,490

Depreciation and Amortisation (6,378) (7,030) (7,434) (7,506) (7,536)

Operating Profit 10,989 11,632 11,859 11,981 12,954

Net financing income/(costs) (1,083) (496) (1,023) (216) (70)

Forex and Related Gains

Provisions - - - - -

Other Income 243 390 446 533 558

Other Expenses 897 638 (797) (845) (594)

Net Profit Before Taxes 10,448 12,163 10,486 11,452 12,848

Taxes (230) (775) (697) (755) (824)

Minority Interests (321) (429) (531) (368) (410)

Net profit available to shareholders 9,897 10,959 9,258 10,329 11,615

Dividends (4,500) (7,000) (8,000) (8,500) (9,000)

Transfer to Capital Reserve

12/13A 12/14A 12/15A 12/16E 12/17E

Adjusted Shares Out (mn) 2,000 2,000 2,000 2,000 2,000

CFPS (SAR) 8.30 9.21 8.61 9.10 9.78

EPS (SAR) 4.95 5.48 4.63 5.16 5.81

DPS (SAR) 2.250 3.500 4.000 4.250 4.500

Growth 12/13A 12/14A 12/15A 12/16E 12/17E

Revenue Growth 1.9% 0.5% 10.5% 2.8% 3.7%

EBITDA Growth 8.0% 7.5% 3.4% 1.0% 5.1%

Operating Profit Growth 12.8% 5.9% 2.0% 1.0% 8.1%

Net Profit Growth 38.2% 10.7% -15.5% 11.6% 12.5%

EPS Growth 38.2% 10.7% -15.5% 11.6% 12.5%

Margins 12/13A 12/14A 12/15A 12/16E 12/17E

EBITDA margin 38.1% 40.7% 38.1% 37.4% 37.9%

Operating Margin 24.1% 25.4% 23.4% 23.0% 24.0%

Pretax profit margin 22.9% 26.5% 20.7% 22.0% 23.8%

Net profit margin 21.7% 23.9% 18.3% 19.8% 21.5%

Other Ratios 12/13A 12/14A 12/15A 12/16E 12/17E

ROCE 16.2% 15.5% 16.0% 15.7% 16.3%

ROIC 32.2% 31.4% 30.9% 33.0% 34.6%

ROE 18.9% 18.7% 15.2% 16.8% 18.3%

Effective Tax Rate 2.2% 6.4% 6.6% 6.6% 6.4%

Capex/Sales 16.3% 13.3% 18.3% 18.0% 18.0%

Dividend Payout Ratio 45.5% 63.9% 86.4% 82.3% 77.5%

Valuation Measures 12/13A 12/14A 12/15A 12/16E 12/17E

P/E (x) 12.9 11.6 13.8 12.4 11.0

P/CF (x) 7.7 6.9 7.4 7.0 6.5

P/B (x) 2.3 2.1 2.1 2.0 2.0

EV/Sales (x) 2.4 2.4 2.1 2.0 1.9

EV/EBITDA (x) 6.3 5.8 5.6 5.4 5.1

EV/EBIT (x) 9.9 9.4 9.0 8.9 8.1

EV/IC (x) 3.1 3.0 3.2 3.0 2.9

Dividend Yield 3.5% 5.5% 6.3% 6.7% 7.0% Source: Company data, Al Rajhi Capital



Balance Sheet (SARmn) 12/13A 12/14A 12/15A 12/16E 12/17E

Cash and Cash Equivalents 960 5,467 4,504 5,536 7,279

Current Receivables 24,509 22,862 28,598 29,140 29,189

Inventories - - - - -

Other current assets 23,531 17,863 20,689 20,726 20,873

Total Current Assets 32,171 31,845 36,989 38,600 40,539

Fixed Assets 38,402 38,229 40,488 43,006 45,819

Investments 12,189 16,273 14,402 14,449 14,478

Goodwill

Other Intangible Assets 4,608 4,523 4,783 4,197 3,652

Total Other Assets - - - - -

Total Non-current Assets 55,199 59,024 59,672 61,652 63,949

Total Assets 87,370 90,869 96,661 100,252 104,488

Short Term Debt 1,561 1,997 1,903 1,903 1,903

Trade Payables 10,171 9,856 15,949 16,786 17,501

Dividends Payable

Other Current Liabilities 7,929 4,189 4,862 5,096 5,378

Total Current Liabilities 19,660 16,043 22,714 23,786 24,783

Long-Term Debt 6,976 7,785 5,744 5,744 5,744

Other LT Payables 4,570 4,937 6,240 6,573 6,932

Provisions - - - - -

Total Non-current Liabilities 11,547 12,722 11,984 12,317 12,676

Minority interests (67) 906 1,421 1,789 2,199

Paid-up share capital 20,000 20,000 20,000 20,000 20,000

Total Reserves 36,230 41,198 40,541 42,360 44,830

Total Shareholders' Equity 56,230 61,198 60,541 62,360 64,830

Total Equity 56,163 62,104 61,962 64,149 67,029

Total Liabilities & Shareholders' Equity 87,370 90,869 96,661 100,252 104,488

Ratios 12/13A 12/14A 12/15A 12/16E 12/17E

Net Debt (SARmn) (9,252) (10,032) (13,659) (14,691) (16,434)

Net Debt/EBITDA (x) (0.53) (0.54) (0.71) (0.75) (0.80)

Net Debt to Equity -16.5% -16.2% -22.0% -22.9% -24.5%

EBITDA Interest Cover (x) 16.0 37.7 18.9 90.1 291.8

BVPS (SAR) 28.11 30.60 30.27 31.18 32.42

Cashflow Statement (SARmn) 12/13A 12/14A 12/15A 12/16E 12/17E

Net Income before Tax & Minority Interest 10,448 12,163 10,486 11,452 12,848

Depreciation & Amortisation 6,378 7,030 7,434 7,506 7,536

Decrease in Working Capital (1,339) (1,742) 835 492 801

Other Operating Cashflow 984 182 2,167 506 552

Cashflow from Operations 16,472 17,633 20,922 19,957 21,737

Capital Expenditure (7,428) (6,100) (9,248) (9,373) (9,721)

New Investments (182) (616) (1,100) (521) (540)

Others (91) 133 (1,388) - -

Cashflow from investing activities (7,700) (6,584) (11,737) (9,894) (10,261)

Net Operating Cashflow 8,771 11,050 9,185 10,064 11,476

Dividends paid to ordinary shareholders (3,998) (6,470) (8,019) (8,500) (9,000)

Proceeds from issue of shares - - - - -

Increase in Loans (368) 1,238 (1,763) - -

Effects of Exchange Rates on Cash - - - 144 (144)

Other Financing Cashflow (147) (155) (160) 291 44

Cashflow from financing activities (4,512) (5,387) (9,942) (8,065) (9,101)

Total cash generated 4,259 5,663 (757) 1,999 2,375

Cash at beginning of period 3,508 960 5,467 4,504 5,536

Implied cash at end of year 7,767 6,623 4,711 6,503 7,911

Ratios 12/13A 12/14A 12/15A 12/16E 12/17E

Capex/Sales 16.3% 13.3% 18.3% 18.0% 18.0% Source: Company data, Al Rajhi Capital



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Disclaimer and additional disclosures for Equity Research

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