Following the launch of Mobily's mobile phone services in 2005, STC lost its monopoly in mobile phone services and as a result its market share in the wireless segment declined. Accordingly, we have revised our projections for STC to reflect the company's declining market share and squeezed margins on the back of rising competition from "Mobily", as well as the expected entry of a third mobile operator and another landline operator in 2008 which will break STC's monopoly of landline phone services. We believe that STC's profitability would be negatively affected by intense competition in both the wireless and the wireline segments.
The combination of the revised projections and the revised cost of equity have led to a DCF value of SR81.7 per share. Based on a forward P/E multiple of 11.3x 2007 projected earnings for the GCC Telecom sector, the peer valuation method results in a valuation of SR76.1 per share. Assigning an 80% weight to the DCF value, and a 20% weight to the relative value, the weighted average share value of STC came out to SR80.6 per share. At its current market price of SR73.0 (on February 19 ,2007), STC's share is quoting at a discount of 10.3% to its fair value. We therefore upgrade our earlier recommendation on STC's stock from ‘Reduce’ to ‘Buy’.
Recent Developments
Around eight consortia, comprising Saudi and foreign investors and multinational companies are reportedly competing to win Saudi Arabia's third mobile license, which is expected to generate SR15bn (US$4bn) for the Saudi government. Etihad Etisalt (Mobily), which had successfully grabbed the second GSM license in the Kingdom in 2005, is competing for the second fixed line phone license in Saudi Arabia.
The Kingdom's telecom regulator extended the deadline for submitting applications for the new mobile license to February 24, 2007 and for the fixed-line license to March 10, 2007. The new licenses will break the monopoly of STC on landline phone services and add a third mobile phone operator.
In Feb-07, the Saudi government decided to reduce the fees levied by the government for land and mobile phone services from 15% to 10%. In addition, it has decided to increase the volume of shares to be offered for public subscription. The decision entails that any company licensed to provide mobile phone services has to float 40% of its capital for public subscription while any new land phone company must float 25% of its capital.
Financial Performance Review – FY06
STC reported net income of SR12.8bn in FY06, a modest increase of 2.8% over FY05, and 12% below our forecasted net income of SR14.6bn for 2006. The company reported an EPS of SR6.4 in 2006 as compared to SR8.3 reported in the previous year. The return on equity (ROE) decreased slightly from 37.9% in 2005 to 37.5%.
Revenues rose by 3.8% in 2005 reaching SR33.7bn. Though, the wire-line and wireless services both witnessed a growing trend during the year, the wire-line services reported an increase of 8.2% (SR9.76bn in FY06), whereas revenue from wireless services increased by a modest 2.2% aggregating to SR24bn in FY06.
The growth in revenues from the wireless segment was affected by the entry of STC's competitor, "Mobily" which launched its mobile phone services in early 2005 and therefore ended STC's monopoly of mobile phone services.
In order to maintain to its market share, the company has been employing aggressive marketing strategies. Accordingly, SG&A to sales ratio increased to 7.3% in FY06, up from 5.7% in FY05.
STC's mobile subscribers base is estimated to have increased by 19% to reach 13.8mn at the end of 2006. The increase in subscribers base coupled with rate reductions and increased discounts offered in line with the company's marketing strategy have led to a decline in the blended Average Revenue per User (ARPU) to around US$39/month.
STC’s Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) reported a yearly decline of 3.2% in FY06 on the back of higher operating expenses. Operating expenses to sales ratio increased to 42.7% in FY06 up from 40.6% in FY05. Gross profit margin declined to 57.3% in FY06 down from 59.4% in FY05, while EBITDA margin declined to 50.1% down from 53.7% in FY05.
STC increased its share capital from SR15bn to SR20bn through stock dividends of one bonus share for each three outstanding shares, with a total value of SR5bn transferred from retained earnings. The capital market regulator also reduced the par value (from SR50 to SR10) for all listed stocks on Saudi stock exchange. As a result, STC now has 2 billion shares outstanding with a par value of SR10 per share
