Telecom shares – what next
Telecom scrips in the region offer a good potential, but there is a need for investors to choose their stocks carefully. Kuwait’s Zain is one of the most successful telecom operators in the GCC and the recent IPO of its Saudi venture was a success

By Matein Khalid

Cost inflation, mergers, entry of new operators and multimedia convergence/data services have all created opportunities and risks in Gulf and Arab telecoms. I believe the correction that began in the Egyptian stock market in April will continue, with a potential 20 per cent downside risk in case for the rest of 2008. Egypt’s valuations are at an unjustified premium to other emerging markets and even Gulf countries like Kuwait, Bahrain and the UAE. Yet Egypt has the highest inflation rate in the Middle East, at 20 per cent and the most populous Arab nation is vulnerable to food inflation, because so many millions of its poorest citizens survive on subsidised bread.

While President Mubarak raised public sector wages by 30 per cent, the fact remains that no less than half of Egyptian government expenditure is wages and subsidies, meaning that a spike inflation almost guarantees a public finance black hole. The fact that Egypt’s inflation nightmare is taking place at a time of exceptional credit market stress and a spike in risk aversion among international fund mangers means its stock market is at risk of hot money outflows.

Telecom experience
This was proven by Telecom Egypt, the incumbent fixed line operator that has a 45 per cent stake in Vodafone Egypt, where payroll costs soared 17 per cent in 2008. It is therefore no surprise that Telecom Egypt shares fell from 24 EGP (Egyptian pound) to their current EGP16.50 price. Yet I doubt if Telecom Egypt falls much below EGP15 because, despite the adverse impact of inflation on its profitability, (wage costs are no less than fifty percent of all costs), it is one of the cheapest telecom shares in the Arab world with the highest free flow yield. Its Vodafone stake is a growth engine, with higher margins, average revenue per user (ARPU) and usage metrics than even MobiNil. Telecom Egypt would be a buy at EGP15 for a EGP20 target or a point where its dividend yield would be almost 10 per cent and its enterprise value/ EBIDTA a rock bottom two times The DP World IPO for instance, was priced at 22 times EV/ EBIDTA).

Etisalat, the dominant UAE telecom incumbent, has lost its monopoly status with the establishment of du, the new telecom operator. However, no less than 90 per cent of its revenues and profits are still derived from its home market, one of the most mature fixed line, mobile and Internet markets in the Arab world, with no less than 130 per cent mobile teledensity ratios. This is the reason why Etisalat has been forced to expand abroad, including bidding aggressively for assets like Altantique Telecom, where it has a 82 per cent stake and licenses in several West African countries. Moreover, while its UAE business is an extraordinary cash cow, most of Etisalat’s international ventures are loss making, though Etisalat Misr and Mobily (its Saudi Arabian venture) have great potential. Though the creation of du has not been followed by a classic price war, there is also a higher degree of competition in the home market, primarily in promotions and bundled services.

Changing mores
The next catalyst for Etisalat is a conversion to a corporation governed by UAE Companies’ Law, an event that will be a milestone in the history of the UAE stock exchange because it will open Etisalat to foreign ownership. Meanwhile, Etisalat is 60 per cent owned by the UAE federal government. Another catalyst for the Etisalat share price is multimedia convergence, mobile broadband and data services as the UAE seeks to build a “knowledge society”. Etisalat also has valuable stakes in Qtel, Sudantel and Indonesia’s Excelcomindo and Thuraya through its investment in ICOS Satellite ventures. Etisalat now trades at a modest price earnings multiple of 11 and offers a dividend yield of three per cent higher than one year dollar LIBOR money markets. I believe Etisalat can be viewed as a conservative, long term holding at UAE Dhs18 for a UAE Dhs24 one year target.

While Kuwait’s Zain is one of the most successful telecom operators in the GCC and the recent IPO of its Saudi venture was a spectacular success in the kingdom, Zain’s share price more than incorporates its past success and franchise value, with a premium valuation to both its Kuwaiti peer Wataniya. Moreover, a third operator in Kuwait will hit Zain’s cash flow and to other GCC and Arab world telecoms. I would also take profits on Saudi Zain at 25 Saudi riyal, which has risen an impressive 150 per cent from its IPO price on nothing else but, to quote Alan Greenspan’s term “irrational exuberance” by speculators. Similarly, I cannot justify buying Qatar Telecom (Qtel) at its current Qatari riyal 190, even though it has fallen from its recent high of 255 Qatari rials. Qtel still derives most of its revenues and profits from its home emirate, even though Algeria, Oman and Iraq could become its growth drivers in the future. It is also now evident that Qtel paid too much for Kuwait’s Wataniya and Vodafone’s entry in Qatar will hit Qtel’s home market cash cow. I am also skeptical about Qtel’s recent purchase of Temasek’s stake in Indosat at a moment when a third of the Indonesian budget is food and fuel subsidies, making Jakarta shares and the rupiah extremely vulnerable to crude oil prices, inflation, social unrest and global risk aversion by fund managers. For similar reasons, I believe the golden age of investing in Orascom Telecom is now over, with rising mobile identities and rising competition in its growth markets of Algeria and Iraq.

However, it is dangerous to short the Orascom Telecom GDR because its high free cash flow leads to share buybacks and there is the tangible prospect that Orascom Telecom, the flagship of the Sawiris empire, could very well be a takeover candidate.

Saudi Telecom (STC), the dominant incumbent telecom operator in Saudi Arabia, has now lost its fixed line and mobile monopolies as new entrants like Mobily (Etisilaat- Etihad) and Kuwait’s Zain Group have entered the telecom market of the most populous state in the GCC. Yet Saudi Arabia’s 26 million population also attracts telecom operators because half of all Saudis are below the age of eighteen, making them early adopters of mobile, broadband and Internet data services products. STC has lost market share to Mobily since 2005, with its mobile market share falling from 82 per cent in 2005 to 60 per cent now. With 14 million subscribers, Mobily is now an established second operator in the Kingdom’s telecom market, though Zain recently floated its shares in the IPO and will cannibalise subscribers from both STC and Mobily. Since Saudi Arabia’s mobile telecom penetration rate is above 100 per cent, West Europe levels, meaning subscriber growth will be difficult in the kingdom.

STC is the largest telecom operator in the Arab world. STC also has stakes in high growth emerging telecom markets. These stakes include a 35 per cent stake in Oger Telecom, founded by Rafik Hariri, who owns mobile and fixed line telecoms in Turkey, South Africa, Lebanon and Jordan. In addition, STC has taken a strategic stake in Maxis Communications, which owns stakes in India’s Aircel and Indonesia’s PT Natrindo Selular. Zain and Mobily will erode STC’s dominant market share in the Kingdom. Southeast Asia and the Indian subcontinent will compensate for STC’s slow growth in the kingdom. STC is cheap at 11 times current earnings, a significant discount to its GCC peers. STC is a buy below 60 Saudi riyals for a potential one year target of 75 SR.

The author is a renowned investment banker based in Dubai.
 

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