Third Mobile Operator

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March 25th, 2007 Following the hotly contested third mobile license in Egypt and the relatively high price paid for it (Etisalat of UAE won with a bid at USD 2.9 bn – please refer to our equity note dated 5th July 2006), the third GSM license in the Kingdom of Saudi Arabia (KSA) was expected to be even more disputed. The stage was set to make it a landmark event in the race for international expansion pursued by several regional telecoms operators: profile of the market (young and large population, largest economy in the Middle East, mobile penetration of 79%, relatively high ARPU of USD 37/month), prominent bidders (MTC, MTN, Turkcell, Oger Telecom, etc.) set against the scarcity of opportunities in the region.

Sector Coverage Team Marc Hammoud +9714 3199 753 [email protected]

Just as in Egypt, the staggering winning bid of SAR 22.91 bn (USD 6.11 bn) that was offered by the MTC-led consortium came as a surprise, and well above our expectations. The second and third largest bids stood at USD 4.6 and USD 4.3 bn, respectively. Given the constraints on foreign investments in KSA, MTC’s holding in the consortium is at 50%, with the remaining 50% in the hands of local partners. Local partners include Saudi Plastics Factory, Almarai Company, Rakisa Holdings and Al Jeraisy Development Company. However, the company will have to float 40% of its shares before the start of operations and allocate another 10% to the Public Pension Agency and the General Organization for Social Insurance - 5% each. No further share sales will be allowed until two years after licensing. With a 25% stake after the Initial Public Offering (IPO), MTC will consolidate its stake in the company as an associate but will have full operational control over the business. MTC Consortium Post-IPO Shareholding Structure Saudi Investors 25%

MTC 25%

Organization for Social Insurance 5% Public Pension Agency 5%

Free Float 40%

Source: MTC, SHUAA Capital

We believe that one the reasons that pushed the price of the third mobile license in Saudi Arabia to USD 6.11 bn is the shareholding structure of the consortia enrolled in the bidding process. Indeed, local Saudi investors are cash rich and are looking for investment opportunities, in particular in the telecoms industry. On the other hand, local Saudi investors should ease the burden of financing the acquisition. MTC will have to fund USD 3.05 bn (50/50 equity/debt), representing its initial stake in the consortium until the company sells 40% of its shares through an IPO, which is expected to take place sometime in Q3 07, and 10% to the pension and social funds in the KSA. The third mobile license will be valid for 25 years, and includes an international gateway and the right to provide 3G services.

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Saudi Arabia mobile market overview There are currently two GSM and one iDEN operator in Saudi Arabia. 2004

2005

2006

Mobile subscriber base

Market share

Market Mobile subscriber base share

Mobile subscriber base

Market share

STC

9,146,000

100%

11,845,182

83.6%

13,800,000

69.2%

Mobily

-

0%

2,315,000

16.3%

6,073,000

30.5%

Bravo

-

0%

11,806

0.1%

68,191

0.3%

Total

9,146,000

100%

14,171,988

100.0%

19,941,191

100.0%

Mobile penetration

38.2%

-

57.6%

-

78.9%

-

GSM iDEN

Source: STC, Mobily, Wataniya, SHUAA Capital

In June 2006, the Communications and Information Technology Commission (CITC) - the country’s telecoms watchdog - introduced Mobile Number Portability (MNP), allowing mobile phone subscribers to switch their mobile number from one service provider to another at no cost. In our opinion, MNP should also help to bring service charges down and improve the quality of service as competition is expected to further intensify. MNP should also help the third mobile operator to grow its subscriber base and gain market share. How expensive was the price compared to other similar transactions in the region? If we were to assume that Mobily, the second mobile operator in Saudi Arabia, had paid the same price for its license, and if we value the company’s estimated 6.7 million mobile users as at Q1 07 by taking the average price of the eight latest transactions involving mobile operators in the region, we would reach a ‘market’ value for Mobily of SAR 39.82 bn (USD 10.62 bn) or SAR 79.6/share. Date

Name of operator

Acquired by % of acquisition

Total transaction price (USD mn)

Number of subscribers at time of acquisition

Price/subscriber (USD)

Apr-05

Celtel - Africa

MTC - Kuwait

100

3,360

5,658,000

594

Dec-05

Madacom - Madagascar

MTC - Kuwait

100

97

250,000

388

Dec-05

Telsim - Turkey

Vodafone - UK

100

4,550

9,700,000

469

Feb-05

Mobitel - Sudan

MTC - Kuwait

61

1,332

2,050,000

1,065

Investcom - Africa and ME MTN - South Africa

May-06

100

5,526

6,144,000

969

Vmobile - Nigeria

MTC - Kuwait

65

1,005

5,000,000

309

Jun-06

Umniah - Jordan

Batelco - Jordan

96

415

505,000

856

Mar-07

Wataniya - Kuwait

Qtel - Qatar

51

3,720

9,992,461

730

Average

-

-

-

-

-

673

May-06

Source: SHUAA Capital

USD

SAR

Mobily’s license value based on the amount paid by MTC for the third mobile license (mn)

6,109

22,910

Mobily’s value based on the average market price of each subscriber (mn)

4,509

16,909

10,618

39,819

21.2

79.6

Total (mn) Value per share Source: SHUAA Capital

March 25th, 2007

2

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Another way to assess the price of this transaction is to compare it with other green field licences in terms of license fee per capita. As shown in the table below, the license fee per capita for this transaction was 67.2% higher than the previous most expensive transaction (Mobily), which in turn was by far more expansive than any other green field license award. Country Algeria

Licensee

Year of license

License cost (USD mn)

Population at year of license award (mn)

License fee per capita at year of license award (USD)

Nedjma - Wataniya

2003

421

31,900,000

13.2

Jordan

Umniah

2004

5.6

5,630,000

1.0

Oman

Nawras - Qtel

2004

105.3

2,710,000

38.9

Saudi Arabia

Mobily - Etisalat (including 3G licenses)

2004

3,451

23,900,000

144.4

Etisalat

2006

2,904

75,430,000

38.5

MTC

2006

6,109

25,300,000

241.5

Egypt Saudi Arabia Source: SHUAA Capital

We also compared the third mobile license in Saudi Arabia to the third mobile license in Egypt and to the second mobile license in Saudi Arabia:

Population at the time of license award (mn) GDP/capita at the time of license award (USD at PPP)

Saudi Arabia - 2nd mobile license

Egypt - 3rd mobile license

Saudi Arabia - 3rd mobile license

24.3

74.0

25.5

12,560

4,060

13,587

Mobile penetration at the time of license award

40%

20%

79%

Average ARPU at the time of license award (USD)

55.0

12.8

37.5

3,250

2,897

6,300

Price (USD mn) Source: SHUAA Capital

The main difference with the third mobile license in Egypt lies in the validity of the license - 25 years in Saudi Arabia vs. 15 years in Egypt, which gives the MTC-led consortium a longer period to maximise its return on investment. If we were to simulate a price for a 15year license based on the USD 6.11 bn paid for 25 years, we would arrive at USD 3.67 bn. Three possible market scenarios to assess the return on investment We took into account three different scenarios to assess the time it will take for MTC to pay back its investment. Scenario 1 - Worst Case Mobile penetration Monthly blended ARPU (USD) Market share Number of years required to breakeven on investment

Scenario 2 - Base Case

Scenario 3 - Best Case

Increased gradually to 121%

Increased gradually to 121%

Increased gradually to 121%

Decreased from 27.2 in 2008 to 22.1 in 2011 and 23.2 from 2014 onwards

Decreased from 25.3 in 2008 to 21.3 in 2011 and 22.1 from 2014 onwards

Decreased from 23.2 in 2008 to 20.0 in 2011 and 21.1 from 2014 onwards

Increased gradually to 20%

Increased gradually to 25%

Increased gradually to 30%

15.5

13.5

12

Source: SHUAA Capital

We expect MTC to start commercial operations in January 2008 and to invest USD 1.2 bn in Capex by 2010. According to a survey conducted by the Arab Advisors Group, 39.6% of mobile users have more than one line, of which 20.3% have the second line from a different network operator. Separate business and personal lines and cost savings were the two main reasons for having more than one line (53.9% and 22.8% of respondents with more than one line, respectively). This would mean that mobile penetration could actually go up to around 120% in the medium to long term if we assume the same ratio of people having more than one line in the country.

March 25th, 2007

3

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The monthly blended Average Revenue per User (ARPU) declined to around USD 39/ month and USD 34/month at the end of 2006 for STC and Mobily, respectively, from over USD 50 when Mobily entered the market. The sharp decline in ARPU can be attributed to increased competition that resulted in rate reductions and increased discounts from both operators. We see mobile telephony tariffs declining further as cost of calls are at best within regional call charge averages. Cheaper services combined to the fact that new subscribers (who belong to lower segments of the population) have less disposable revenues should in turn result in lower ARPU going forward, in particular for the third mobile operator. In Saudi Arabia, STC and Mobily have been offering On-net and Off-net rates. By offering cheaper On-net prices, MTC could attract a significant number of low income subscribers and create what we call a ‘network effect’, with friends, relatives and peers in general subscribing to the same network in order to reduce their bills. The more aggressive MTC will be, the more ARPU is expected to decline as it would mean that competition would be primarily based on prices. Base Case Scenario

2005

2006

2007E

2008E

2009E

2010E

2011E

Population

24,600,000

25,260,000

25,942,020

26,642,455

27,361,801

28,100,569

28,803,084

Addressable population

18,204,000

19,197,600

20,494,196

21,846,813

23,257,531

24,166,490

24,770,652

Mobile Penetration rate

57.6%

78.9%

96.5%

106.4%

112.9%

116.5%

119.1%

Number of mobile operators

STC - Mobily

STC - Mobily

STC - Mobily

STC - Mobily - MTC

STC - Mobily - MTC

STC - Mobily - MTC

STC - Mobily - MTC

Year end respective market share

84% - 16%

70% - 30%

59% - 41%

50% - 40% - 10%

45% - 37% - 18%

42% - 35% - 23%

41% - 34% - 25%

Year end total mobile subscribers

14,171,988

19,941,191

25,046,136

28,352,226

30,903,926

32,727,258

34,298,166

Annual net additions

5,025,988

5,769,203

5,104,945

3,306,090

2,551,700

1,823,332

1,570,908

68.7%

27.2%

25.6%

13.2%

9.0%

5.9%

4.8%

Year end MTC subscribers

-

-

-

2,835,223

5,562,707

7,527,269

8,574,542

Annual net additions

-

-

-

2,835,223

2,727,484

1,964,563

1,047,272

YoY Growth

-

-

-

-

96.2%

35.3%

13.9%

Monthly blended ARPU in SAR Monthly blended ARPU in USD

-

-

-

95

87

83

80

-

-

-

25.3

23.2

22.1

21.3

YoY Growth

Source: STC, Mobily, SHUAA Capital

We have not included Bravo, the iDEN-based technology mobile operator, as our focus is on GSM mobile operators. Moreover, we do not expect Bravo to capture more than 1% market share in the medium to long term.

March 25th, 2007

4

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The table below presents the results of our Base Case scenario. (USD ‘000) Revenues EBITDA EBITDA margin Other costs PBT Tax (Zakat) Capex Capex/Revenues % ∑ Capex Change in working capital FCF

2007E

2008E

2009E

2010E

2011E

-

430,954

1,168,992

1,738,349

2,061,032

-107,000

16,700

327,318

764,873

865,633

-

3.9%

28.0%

44.0%

42.0%

-3,000

-21,548

-46,760

-52,150

-61,831

-110,000

-4,848

280,558

712,723

803,802

-

-

-7,014

-17,818

-20,095

-348,000

-306,000

-292,248

-225,985

-185,493

-

71.0%

25.0%

13.0%

9.0%

-348,000

-654,000

-946,248

-1,172,233

-1,357,726

-

-38,786

-93,519

-104,301

-103,052

-458,000

-349,634

-112,223

364,619

495,163

Source: SHUAA Capital

MTC’s international gateway, a recent reduction of interconnection rates (fixed line and mobile) and synergies with other existing operations in the Middle East (MTC is already present in four direct neighbours to the KSA) should help MTC to grow both its subscriber base and its profitability (margins) in the short term. Why MTC? MTC’s success in securing the third mobile license did not come as a surprise. Indeed, MTC, in our opinion, needed to add another large market such as Saudi Arabia to its existing operations in the Arab world. Apart from Iraq, MTC was only present in relatively small markets such as Kuwait (home market), Jordan, Lebanon, and Bahrain. Moreover, this was not MTC’s first attempt to enter Saudi Arabia. The company lost the tender for the second mobile license in August 2004 that was won by Etisalat of UAE with a winning bid of USD 3.25 bn. MTC also failed to win the third mobile license in Egypt that was also secured by Etisalat with a final bid of USD 2.9 bn. In our opinion, MTC fancied a market such as Saudi Arabia in order to be able to meet its ambitious new plan to reach an EBITDA of USD 6 billion (USD 1.97 bn at the end of 2006), double its market capitalisation to USD 30 bn (currently hovering around USD 20 bn) and have over 70 million customers (27.04 million subscribers at the end of 2006) that was announced in January this year. MTC is rapidly expanding beyond its domestic market, which has a mobile penetration rate of 80%. MTC now operates in 15 African countries through its subsidiary Celtel International, which it acquired for USD 3.36 bn in April 2005. More precisely, MTC acquired 85% of Celtel for USD 2.84 bn, with a pledge to buy the remaining 15% by the second anniversary of the closing date of the deal for USD 520 mn. The company also runs networks in Kuwait, Iraq, Jordan, Lebanon and Bahrain and is considering bidding for a stake in state-run Algerie Telecom.

March 25th, 2007

5

Missed Call?

Equities research

Telecoms operators’ debt level under scrutiny This latest acquisition once again raises our concern on the level of debt that telecoms operators are accruing in order to achieve their expansion strategy. Though operations are still highly profitable and generate strong cash flows, the staggering premiums paid for existing operations or green field licenses have obliged operators to take on substantial levels of debt. Over the past two years, most telecoms companies’ cash has melted away as a result of the increasing pace of the consolidation and the technological shift in the sector. Most telecoms operators that adopted an acquisition-based strategy saw their solvability (net debt level) and profitability deteriorating. Net Debt (Cash) – USD mn *

MTC

Etisalat Orascom Telecom (OTH) Qtel Wataniya

Dec-04

Latest available

(135)

4,666*

(2,124)

(486)

868

3,433

(377)

4,289

550

543

* Including the financing required for the third mobile license in Saudi Arabia Source: MTC, Etisalat, OTH, Qtel, Wataniya, SHUAA Capital

Interest expenses as a % of Net Profit MTC Etisalat Orascom Telecom (OTH) Qtel Wataniya

Dec-04

Dec-06

4.4%

28.9%

0.0%

4.5%

31.7%

47.2%

0.0%

1.1%

25.1%

21.4%

Source: MTC, Etisalat, OTH, Qtel, Wataniya, SHUAA Capital

March 25th, 2007

6

Missed Call?

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March 25th, 2007

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