Global Investment House – Kuwait - Saudi Telecom (STC), was established in 1998, and had a full monopoly over the telecom market until 2003, when the VSAT market was liberalized. Subsequently, STC's monopoly in the mobile market was ended when the second mobile license was granted in 2004 to Etihad Etisalat Company (Mobily). In March 2007, a consortium led by Zain of Kuwait won the third mobile license with a bid of US$6.1bn, and launched its services in 2008. The fixed market was liberalized when three consortia- led by Bahrain Telecommunications (Batelco), Hong Kong's PCCW and US based Verizon Communications won three fixed line licenses in April 2007, bringing the total number of fixed line licenses in the kingdom to four and ending STC's monopoly over fixed lines. STC was awarded a 3G license in July 2005 for SR753.7mn, and launched its 3G network in June 2006.
As a result of increasing competition in the Saudi telecom market, the company started considering inorganic growth opportunities. Accordingly, the company started expanding outside its home market beginning with the Maxis deal which gave STC foothold in Malaysia, India, and Indonesia, Later, STC won the bid for a 26% stake in Kuwait's third mobile service operator. Finally, STC acquired a 35% stake in Oger Telecom, which gave STC presence in Turkey and South Africa.
Performance Analysis
STC reported operating revenues of SR34.5bn for 2007, increasing by 6.4% over 2006 operating revenues. STC's operating revenues includes revenues from the wireline and wireless segments. Revenues from the wireline segment dropped by 4.8% to reach SR9.3bn, whereas revenues from the wireless segment grew by 11.2% to reach SR25.2bn in 2007. We expect further pressure in the wireline segment in STC's home market after the liberalization of the fixed line segment and the granting of three new licenses. In addition, the mobile market will have a third competitor in 2008, squeezing STC's market share. However, we expect operating revenues in both the wireline and wireless segment to improve on the back of STC's foreign acquisitions, after factoring in the company's recent acquisition of 35% of Oger Telecom, and the launch of Kuwait's third mobile operator, expected in 2008.
Chart : Revenue Mix
Source: Company Reports, Global Research
Net profit for 2007 stood at SR12bn, dropping by 6.1% on a y-o-y basis. Net profit margin declined from 39.5% in 2006 to 34.9% in 2007. Return on equity stood at 33.5% in 2007, while return on assets stood at 17.5% declining from 37.5%, and 27.8% in 2006 respectively. Going forward, despite the expected increase in competition in STC's domestic market, we expect earnings to improve on the back of STC's recent foreign acquisitions which are expected to add to the company's bottom line.
Total assets increased by 49% to reach SR68.8bn in 2007 compared to SR46.1bn in 2006 on the back of consolidating the company's financial statements. Starting from fiscal year 2007, STC fully consolidated its investment in Arabian Internet and Communications Services Co. "AwalNet", and "Tejari Saudi Arabia" in which the company holds 100%, and 50% respectively. In addition, it proportionately consolidated its 25% investment in Binariang, and its 51% investment in PT Natrindo Telepon Seluler (NTS). STC's intangible assets increased from SR731.7mn in 2006 to SR13.8bn in 2007, on the back of the goodwill arising on the consolidation and acquisition of Binariang, coupled with the goodwill arising on the acquisition of NTS.
Chart : Asset Structure
Source: Company Reports, Global Research
STC reported strong results in H1 2008 compared to the same period in 2007. The company's total revenues grew by 36.3% to reach SR21.6bn. Fixed line revenues witnessed a higher growth rate than that of the mobile segment, growing by 59.1% to reach SR6.6bn, while revenues from the mobile segment grew by 28.3% to reach SR14.9bn. STC's net profit for H1 2008 stood at SR6.8bn compared to SR5.8bn reported in the same comparative period in 2007.
Outlook & Valuation
We expect the company's mobile market share in its home market to shrink further after the third operator, "Zain" launched its operations in August 2008. In addition, we expect STC's fixed line segment to be impacted when the three awarded companies Batelco-Atheeb, Hong Kong's (PCCW), and MCI International-Verizon begin their commercial operations, expected at the end of 2008. However, despite the increase in competition in STC's local market which is likely to put pressure on the company's market shares and pricing strategies, we believe that the Saudi market still holds potential giving the size of the market, and favorable demographics with around 32% of the population in the age of 10 to 24, coupled with the relatively lower mobile penetration rate, and a very low penetration rates in the broadband and data segment.
Despite the intensive competition in its home market, we expect STC's performance to improve on the back of the company's overseas expansions. We expect that STC's expansion strategy to pay off starting from 2008 onwards, the company's Oger Telecom deal is expected to boost STC's fixed line revenue through Turkey's fixed line operator, Turk Telecom. In addition, through its recent acquisitions, STC gained presence in the mobile segment of Malaysia, Indonesia, and India through Maxis, as well as Turkey, and South Africa through Oger Telecom. We expect STC's revenues to grow by a CAGR of 9.2% during our forecast period (2008-2011), with an 8.5% CAGR for the fixed line segment and a 9.4% CAGR for the mobile segment.
At the current market price (Aug.31 2008), STC trades at 8.9x and 8.2x its earnings and 3.4x and 3.2x its book value for 2008F and 2009F respectively. We have used the Discounted Cash Flow (DCF) to value STC. The DCF model is based on a 4-year (FY2008-FY2011) explicit forecast period for the Free Cash Flow to Firm (FCFF). Our DCF valuation estimates the fair value of STC's stock at SR78.75, which is 21.6% higher than the current market price of the stock. We therefore reiterate our "Buy" recommendation for STC.
