Research Department Egypt – Telecoms
Telecom Egypt
Company Report 31 March 2009
The Cash Dispenser Buy
We resume coverage on TE with a "Buy” recommendation. The stock Target Price (EGP) 20.94 trades at a 25.8% discount to peers on 2009e adjusted EV/EBITDA and Market Price (EGP)* 14.73 its stake in VFE is traded at a 41.4% discount to our fair value. Upside 42.2% Main growth drivers are TE’s stake in Vodafone Egypt (VFE) and the wholesale segment. TE offers decent FCF and dividend yields of 9.8% and 9.3% for 2009e. We Listed On EGX, LSE forecast dividend yield to reach 11.8% by 2012f. GDRs to Local Shares 1:5
Bloomberg Code ETEL EY Besides operating in a defensive sector, TE is enjoying a monopoly of Egypt’s fixed line RIC ETEL.CA market, has indirect exposure to the lucrative mobile market through its 44.95% equity
stake in VFE and owns a hefty 59% market share of Egypt’s broadband market. TE also Enterprise Value (EGPm) 25,556 has direct exposure to the mobile market by being the incumbent, as mobile traffic goes Net Debt (EGPm) 411 through its infrastructure thereby increasing the contribution of the wholesale segment Market Cap. (EGPm) 25,145 (TE’s main revenue driver) to total revenues, and offsetting the decline in retail Market Cap. (USDm) 4,466 revenues due to the fixed to mobile substitution trend. Additionally, TE’s tariff
rebalancing, introduced in 2H08, has partially offset the drop in retail revenues. Number of Shares (m) 1,707.1 Recently, the Ministry of Telecommunications has decided to postpone the offering of a Foreign Ownership Limit - second fixed line license for two years, a positive development for TE. Foreign Ownership Level - In a time when cash is king, TE provides us with a solid investment case given its strong cash flow generation ability, sound balance sheet, lack of significant future obligations, a cash position of EGP2.7 billion and a net debt/EBTIDA of 0.09x as of the end of 2008. As Avg. Daily Turnover (EGPm) 22.8 a result of de-leveraging and the lack of an acquisition target, we have assumed that TE Avg. Daily Turnover (USDm) 4.0 will return the excess cash generated to its shareholders. In line with this belief, TE’s management has proposed a DPS of EGP1.30 for 2008, the highest dividend payout in Shareholders Structure its history (80%), suggesting a dividend yield of 8.8%. We have maintained this level of Free Float 20% DPO going forward. TE also offers a FCF Yield of 9.8% for 2009e and we expect its FCFs Egyptian Government 80% to grow at a CAGR of 8.0% from 2010f-2012f. We believe that the financing of an acquisition is not an issue. Rather, finding a good target that fits TE’s criteria in the MENA region and the pricing of the deal are the real challenges.
We estimate revenues to grow at a 2010f-2012f CAGR of 2.4%, and EPS to grow at a Price Performance Chart higher CAGR of 10.2%, due to TE’s profitable equity stake in VFE offsetting the drop in voice revenue contribution to total sales. VFE contributed 41.9% to TE’s profit before 26 tax in 2008, but we expect this contribution to drop to 39.9% in 2009e as it is expected 24 ETEL to be a tough year for mobile players. We believe that consensus is overestimating TE’s 22 20 HCMI 2009 growth and expect some downward revisions to estimates along the course of the 18 year. Our 2009e revenue growth is a negative 0.1% vs. consensus estimate of 6.2% 16 and TE’s guidance of a flat to 1% top line growth. Our EBITDA margin for 2009e is 14 12 46.1% vs. consensus estimate of 50.9% and TE’s guidance of an EBITDA margin in the 10 high 40s. 8 6 We resume coverage on TE with a "Buy" recommendation based on a SOTP valuation D-07 J-08 M-08 A-08 M-08 J-08 J -08 A-08 S-08 O-08 N-08 D-08 J-09 F-09 M-09 using a DCF approach which yielded a target price of EGP20.94 per share * Price as of March 29, 2009 (USD18.59/GDR), offering an upside potential of 42.2%. TE trades at a 25.8% discount to peers on an adjusted 2009e EV/EBITDA multiple (adjusted to VFE’s net debt and EBITDA). The stock also trades at a 5.7% discount to peers on 2009e PER at 9.1x.
Key Performance Indicators (IFRS)
Fiscal Year 08 09E 09C 10F 10C Revenues (EGP Mil.) 10,117 10,108 10,746 10,435 10,668 EBITDA (EGP Mil.) 4,674 4,656 5,464 4,801 5,206 EBITDA Margin* 46.2% 46.1% 50.9% 46.0% 48.7% Net Income (EGP Mil.) 2,621 2,764 3,262 3,139 3,562 NematAllah Choucri EPS (EGP) 1.54 1.62 1.91 1.84 2.09 +2 02 3749 6008 (Ext. 451) EPS Growth 10.1% 5.5% 12.6% 13.6% 9.2% [email protected] Net Debt/EBITDA (x) 0.09x -0.58x -0.21x -0.92x -0.49x P/E 9.59x 9.10x 7.71x 8.01x 7.06x May Khamis EV/EBITDA 5.47x 4.82x 4.67x 4.32x 4.84x +2 02 3749 6008 (Ext. 456) Adjusted EV/EBITDA 3.65x 3.15x - 2.80x - [email protected] Dividend Yield (%) 8.8% 9.3% 10.0% 10.0% 10.2% Free Cash Flow Yield 12.3% 9.8% 14.2% 11.0% 16.3% *Disclaimer See Page 16 * According to IFRS, employees’ appropriations are part of operating expenses leading to a lower EBITDA margin as compared to the one reported under EAS. E = HC's Estimates; F = HC's Forecasts; C = Consensus Estimates www.hc-si.com
Egypt – Telecoms
Financial Statements and Ratios (IFRS)
EGP Million 2008* 2009e 2010f 2011f 2012f 2013f
Income Statement Retail Revenues 6,181 6,073 6,176 6,194 6,224 6,267 Wholesale Revenues 3,936 3,943 4,075 4,253 4,435 4,613 TE North Revenues - 93 185 185 185 185 Reported Revenue 10,117 10,108 10,435 10,633 10,844 11,066 Growth in Revenue (%) 1.2% (0.1%) 3.2% 1.9% 2.0% 2.0% Total Operating Costs (excl. D&A) (5,011) (5,095) (5,369) (5,610) (5,880) (6,169) EBITDA 4,674 4,656 4,801 4,788 4,759 4,722 EBITDA Margin 46.2% 46.1% 46.0% 45.0% 43.9% 42.7% Depreciation & Amortization (2,739) (2,681) (2,595) (2,319) (2,200) (2,084) Operating Profit 1,896 1,975 2,206 2,469 2,559 2,638 Operating Margin 18.7% 19.5% 21.1% 23.2% 23.6% 23.8% Investment Income 1,312 1,347 1,384 1,336 1,417 1,508 Net Interest (112) 53 179 320 463 601 Profit Before Taxes (PBT) 3,134 3,375 3,769 4,125 4,439 4,747 Taxes (505) (602) (621) (669) (725) (777) Minority Interest (8) (8) (9) (11) (13) (15) Net Profit 2,621 2,764 3,139 3,444 3,701 3,955 Net Profit Margin 25.9% 27.3% 30.1% 32.4% 34.1% 35.7%
Earnings Per Share (EPS) 1.54 1.62 1.84 2.02 2.17 2.32 Growth in EPS (%) 10.1% 5.5% 13.6% 9.7% 7.5% 6.9% Dividends Per Share (DPS) 1.30 1.38 1.47 1.61 1.73 1.85 Dividends Payout (%) 84.5% 85.0% 80.0% 80.0% 80.0% 80.0%
Balance Sheet Assets Intangible Assets 155 123 92 60 28 0 Tangible Assets 18,640 16,939 15,964 15,139 14,357 13,606 Investments 7,033 7,302 7,786 8,254 8,750 9,278 Total Fixed Assets 25,828 24,364 23,842 23,453 23,135 22,885 Total Current Assets 8,042 9,649 11,448 13,246 14,985 16,673 Total Current Liabilities 5,266 5,420 5,610 5,899 6,176 6,448 Total Long Term Liabilities 1,935 535 985 1,405 1,795 2,155 Minority Interest 38 46 56 67 80 94 Total Shareholder’s Equity 26,631 28,013 28,641 29,330 30,070 30,861
Key Ratios Net Debt/EBITDA 0.09x (0.58x) (0.92x) (1.28x) (1.64x) (2.00x) RoAE 10.1% 10.1% 11.1% 11.9% 12.5% 13.0% CAPEX to Sales 9.1% 16.2% 15.5% 14.0% 13.0% 12.0%
* We have adjusted 2008 EAS figures to reflect IFRS figures as the IFRS statements are not yet released.
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Egypt – Telecoms
Valuation
We resume coverage with a “Buy” recommendation based on a target price of EGP20.94/share (59% fixed line business and 41% VFE), a 42% upside to market price. TE trades at a 25.8% and 5.7% discount to peers on 2009 adjusted EV/EBITDA and PER. TE’s stake in VFE is traded at a 41% discount to fair value and at a 26% discount on 2009e EV/EBITDA.
We resume coverage on TE with a “Buy” recommendation, a 42% upside potential We resume coverage on Telecom Egypt with a "Buy" recommendation based on a SOTP valuation using a DCF approach which yielded a target price of EGP20.94/share (USD18.59/GDR), implying a 42.2% upside potential. We have estimated VFE’s contribution at 41.4% to our fair value per share. We have applied a WACC of 15.0% to our free cash flows, using a perpetual growth rate of 1.0% (lower from a perpetual growth rate of 2.0% which we are currently using for mobile players) and a beta of 0.8x. We would like to note that TE's large equity weight of 93.9% is increasing our WACC, while we have decreased our RFR to 10.0%, reflecting the MPC’s decision of lowering overnight deposit and lending rates.
Chart 1: Breakdown of contribution to our SOTP Valuation
VFE 41.4%
Fixed Line 58.6%
Source: HC Brokerage
Table 1: TE’s WACC calculation
Debt Weight 6.1% After-Tax Cost of Debt 8.8% Equity Weight 93.9% Risk Free Rate 10.0% Beta 0.83 Equity Risk Premium 6.5% Cost of Equity 15.4% WACC 15.0% Source: HC Brokerage
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Egypt – Telecoms
Table 2: TE’s discounted cash flow calculation
EGP Million 2009e 2010f 2011f 2012f 2013f EBITDA 4,656 4,801 4,788 4,759 4,722 Tax (602) (621) (669) (725) (777) CAPEX (1,639) (1,589) (1,463) (1,386) (1,306) Change in Working capital (6) (108) (56) (79) (84) Free Cash Flow 2,408 2,484 2,600 2,570 2,555 Present Value of FCFs 2,169 1,946 1,771 1,522 1,316 Terminal Value 9,493 Enterprise Value 18,215 Stake in VFE 14,816 Net Debt & other 2,713 Equity Value 35,744 TE number of shares 1,707 Price Target (EGP) 20.94 Source: HC Brokerage
Table 3: Sensitivity analysis of value per share to WACC and perpetual growth rate
Perpetual WACC (%) Growth Rate (%) 14.0 15.0 16.0 0.0 21.23 20.52 19.89 1.0 21.73 20.94 20.25 2.0 22.32 21.43 20.66 Source: HC Brokerage
VFE contributing EGP8.7/share to our valuation for TE
We have applied a 30% debt weight in our DCF valuation for VFE and a WACC of 13.4%, arriving at an equity value
of EGP33.0 billion, of which TE’s stake is estimated at EGP14.8 billion. This translates into a value per share of EGP8.7, representing 41.4% of TE’s fair value per share of EGP20.94. We used a perpetual growth rate of 2.0%, higher than the 1.0% used for the fixed line business.
Table 4: VFE’s KPIs and discounted cash flow calculation
EGP Million 2009e 2010f 2011f 2012f 2013f EBIT 4,002 4,228 4,564 4,855 5,183 Tax (646) (693) (743) (788) (839) CAPEX (2,324) (2,218) (2,081) (2,049) (2,013) Depreciation 1,937 2,079 2,230 2,364 2,516 Change in Working capital (258) (277) (297) (315) (335) Free Cash Flow 2,711 3,119 3,672 4,067 4,512 Present Value of FCFs 2,441 2,476 2,570 2,510 2,455 Terminal Value 21,938 Enterprise Value 34,392 Net Debt & other (1,431) Equity Value 32,961 TE’s stake in VFE 44.95% TE share of VFE Equity Value 14,816 TE number of shares 1,707 Value/share for TE 8.7 Source: HC Brokerage
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Egypt – Telecoms
Different scenarios suggest deviations of (5%) to 6% from our DCF value per share Factors affecting our valuation for TE are i) VFE’s mobile market share, ii) the fixed to mobile substitution trend, and
iii) higher/lower EBITDA margins. We have tested the upside/downside effects of those factors on TE’s valuation, which yielded deviations in the range of (5%) to 6% from our base case value/share.
Table 5: Sensitivity analysis of value per share for 2009e-2011f VFE Market Share (%) Fiercer/Milder F2M EBITDA Marg. DCF Value (%) Worst Case Lower by 2% Annual net adds of 100K 44.0%-43.0% EGP19.95 Base Case 40.5%-37.9% Annual net adds of 200K 46.1%-45.0% EGP20.94 Best Case Higher by 2% Annual Net adds of 400K 50.5%-49.0% EGP22.10
Source: HC Brokerage
Stock price catalysts which could lead to higher valuation in the short-term
1) TE making an acquisition. TE is looking to acquire an existing integrated MENA player. As of the end of 2008, the company had a cash balance of EGP2.7 billion and a net debt/EBITDA of 0.09x, suggesting a strong balance sheet and ample borrowing capacity. We believe that if management doesn’t find a suitable acquisition target in 2009, it can maintain the high dividend payout ratio of 2008, positively reflecting on the dividend yield. 2) Signing new submarine cable contracts. Contracts signed by TE to date are worth USD176 million. TE is trying to capitalize on its geographical location and capture part of the growth of Asian bandwidth demand through this LoB. Although this LoB contribution is below 2% by 2010, according to our estimates, it enjoys a high EBITDA margin. 3) Further increase in dividend payout ratio. Given the lack of an acquisition target and a low net debt of EGP411 million in 2008, we believe that TE will increase its dividend payout unless it implements a share buyback, which we don’t expect to take place in 2009. As a result, we have assumed a dividend payout of 80% over our forecast horizon. If the company further increases its dividend payout ratio, this could act as a stock price catalyst.
Table 6: Dividend Assumptions
EGP Million unless otherwise stated 2006 2007 2008 2009e 2010f 2011f 2012f Net debt 6,869 3,679 411 (2,713) (4,414) (6,152) (7,827) Net income 2,442 2,381 2,621 2,764 3,139 3,444 3,701 Dividend payout (%) 48.9% 71.7% 84.5% 85.0% 80.0% 80.0% 80.0% Total dividends 1,195 1,707 2,215 2,350 2,511 2,756 2,961 DPS (EGP) 0.70 1.00 1.30 1.38 1.47 1.61 1.73 YoY change (%) 40.0% 42.9% 29.7% 6.1% 6.9% 9.7% 7.5% Dividend Yield (%) 4.8% 6.8% 8.8% 9.3% 10.0% 11.0% 11.8%
Source: TE and HC Brokerage
Downside risks to our valuation Despite our belief that it is a value stock, we note that TE is facing important challenges. 1) Strong competition from mobile operators. This competition is manifested in the fixed to mobile substitution trend, which led to a decline in voice revenues. However, voice revenues picked up after the recent tariff rebalancing which was introduced in July 2008. Also, the increasing contribution of highly profitable wholesale revenues is cushioning against the drop in retail revenues. We have factored in this strong competition in our estimates through assuming pressure on the company’s margins from current levels. 2) Mobile operators establishing their own backbone. Mobinil and Vodafone Egypt have being arguing that Telecom Egypt is overcharging them for the use of its infrastructure. Should one or both of the companies establish their own backbone, this will constitute a threat to our valuation. However, we believe that this is unlikely to take place soon given the tight credit environment both companies are currently operating in and the postponement of the second fixed line license for two years, all of which makes using TE’s infrastructure more practical for them.
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Egypt – Telecoms
3) The offering of a second fixed mobile license. We rule out the possibility that this could take place any time soon given the current global turmoil, the government’s recent decision of postponing offering the license for two years and the possibility of offering a WiMAX license instead. Also, we don’t believe that the license will attract much interest given Egypt’s current low fixed line rates relative to the world and the strong competition from mobile players. However, we have factored in a second fixed line player by the end of 2011 (at the earliest in our view), and estimated that it will capture a market share of 10% by then.
Chart 2: Fixed tariff rates comparison
0.30 Local landline 0.25 Landline to mobile 0.20 0.15 0.10 0.05 0.00 Average tariff USD Average in Etisalat France BT Telecom STC Tunisie Du Qtel Deutsche Telecom Egypt Telecom Telekom
Source: Fixed line players and HC Brokerage
4) Fiercer competition from mobile players in the broadband market. Mobile players have started making competitive offers for broadband services. If this trend continues, we expect that it will eat from TE Data’s (95% owned by TE) current market share of 59%. For instance, Vodafone Egypt offers monthly subscriptions for 2 Mbps internet speed, in addition to 100 free on-net voice minutes, at EGP222/month vs. TE Data’s price of EGP375/month. However, mobile players are not expected to capture a high broadband market share as these services eat from mobile players’ spectra.
TE trades at a 25.8% and 5.7% discount to peers on 2009 adjusted EV/EBITDA and PER
TE trades at a 25.8% discount to peers on 2009e adjusted EV/EBITDA multiple of 3.2x and at a 5.7% discount to
peers on 2009e PER multiple at 9.1x. The unadjusted 2009 EV/EBITDA multiple of 4.8x (unadjusted to VFE’s net debt and EBITDA) suggests that TE is trading at a 11.2% premium to peers.
Chart 3: Telecom Egypt vs. global peers (integrated, Fixed Line and mobile) on multiples
16.0 Bharti 14.0 Verizon Telefonica Manitoba Deutsche Telecom AT&T 12.0 Bezeq Coms tar KPN 10.0 BelgacomTel. Italia PT Telekom Austria TE Batelco TeliaSonera 8.0 FT Magyar Etisalat OTE Indosat Telenor 6.0 P/E (2009e)P/E BT Swisscom 4.0 2.0 0.0 -10% -5% 0% 5% 10% 15% 20% EPS CAGR (%) (2009e-2011f)
i) EPS CAGR (%) (2009e-2011f)
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Egypt – Telecoms
9.00 8.00 Bharti ) 7.00 TeliaSonera 6.00 AT&T KPN Telefonica Bezeq 5.00 Manitoba Zain PT OTE Telekom Austria Belgacom 4.00 FTTI Verizon BT Swisscom Telenor DT TE 3.00 Etisalat Magyar Telekom
EV/EBITDA (2009e EV/EBITDA 2.00 1.00 0.00 -5% 0% 5% 10% 15% 20% 25% EBITDA CAGR (%) (2009e-2011f)
ii) Adjusted EBITDA CAGR (%) (2009e-2011f) Vs. (2009e) Source: Bloomberg and HC Brokerage
Market is valuing TE’s stake in VFE at a 41.4% discount to fair value and the stake is traded at a 26.3% discount on 2009e EV/EBITDA
We have applied a 30% discount to TE’s fixed line peers 2009e EV/EBITDA multiple of 4.24x, arriving at an equity value
for the fixed line business of EGP16.5 billion (EGP9.6/share). Deducting this value from TE’s current market cap of EGP25.1 billion, we arrived at an implied market value for TE’s stake in VFE of EGP8.7 billion (EGP5.1 per TE share) and a market value for VFE as a whole of EGP19.3 billion. This exercise suggests that VFE’s stake is traded at a 41.4% discount to fair value, according to our valuation of EGP8.7 per TE share.
Further proof that VFE is undervalued can be found by comparing its 2009e EV/EBITDA multiple of 3.49x (based on the implied market value) to mobile peers, which suggested that VFE is trading at a 26.3% discount to peers. We note that VFE’s EBITDA CAGR (2009e-2011f) is slightly lower than that of Mobinil, as we expect that VFE’s 2009e EBITDA would come under pressure due to a larger contribution of roaming revenues to total sales as compared to Mobinil. Roaming revenues are expected to come under pressure in 2009 due to lower numbers of tourists visiting Egypt. Also, as the market approaches saturation, we expect that Mobinil would capture the highest share of growth in the number of subscribers due to its subscriber oriented strategy.
Chart 4: VFE peer comparison on 2009e EV/EBITDA
10.00
e 8.00 Bharti Maroc Telecom
6.00 Reliance Partner Cellcom Mobinil
4.00 OTH VFE MTN Zain Qtel Etisalat Turkcell EV/EBITDA 2009 2.00
- -5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% EBITDA CAGR (%) (2009e-2011f)
Source: Bloomberg and HC Brokerage
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Egypt – Telecoms
Multiple valuation suggests that TE is worth almost double the current share price
Multiple valuation also suggests that TE is undervalued. We have conducted this valuation on an EV/EBITDA multiple for
2009 after adjusting for VFE’s net debt and EBITDA, which yielded a value per share of EGP26.8/share, almost double the current share price.
Table 7: Multiple Valuation (2009e EV/EBITDA) EGP Million unless otherwise stated Peers’ EV/EBITDA for 2009 4.24x Enterprise value (adjusted for VFE EBITDA) 44,957 Net debt (adjusted to VFE net debt) 2,069 Equity Value 47,027 TE number of shares 1,707 Value/share 27.5 Source: HC Brokerage
Decent FCF and dividend yields TE offers some of the highest FCF and dividend yields among its peers, at 9.8% and 9.3% for 2009e. The reason behind the drop in 2009e FCF yield is higher CAPEX of 16.2% of sales compared to 9.1% of sales in 2008. Based on our forecasts, the company's FCF is expected to grow at a CAGR of 8.0% for 2010f-2012f. We estimate TE's FCF yield to reach 11.8% by 2011f.
Chart 5: Telecom Egypt vs. GEM peers in terms of dividend and FCF yields for 2009e
Div. Yield (%) FCF Yield (%) 16.0% 12.0% 8.0% 4.0% 0.0%
. r a . t i l a m E T q T a i N E a t -4.0% e T m o i l c n a r in r c o m T o e F r n o l T i B D n t ta P I a e a a n c o c z s I K OT z n r e c e le i s Z h -8.0% o l a u T r ti o a f s g B e e B e s l A m & E S y le i T o V g T e . T a e l w l c li -12.0%a B e A T a S le e M g T e T -16.0% tu T r o -20.0% P
Source: Bloomberg and HC Brokerage
Chart 6: TE’s FCF Yield
13.1% 12.4% 13.0% 12.3% 11.8% 11.0% 11.0%
FCF YieldFCF (%) 9.8%
9.0% 2007 2008 2009e 2010f 2011f 2012f
Source: HC Brokerage
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Egypt – Telecoms
Telecom Sector Shows Impressive Resilience Starting 4Q08
TE outperforms HCMI, MSCI World Telecom and MSCI EMEA Telecom indices starting 4Q08. Despite the fixed line market being near saturation, the wholesale segment offers growth potential. Ample room for growth in the mobile and broadband markets. Due to the defensive nature of the telecom sector, it showed impressive resilience with the heightening of the world
financial crisis in 4Q08, with MSCI World Telecom index outperforming MSCI World index. The charts below support our arguments on the sector in general and TE in particular. MSCI EMEA Telecoms index outperformed the MSCI EMEA index in 4Q08, but underperformed MSCI World Telecom Index (due to volatility of emerging markets). TE outperformed the Egyptian market, MSCI World Telecom and MSCI EMEA Telecom indices starting 4Q08.
Chart 7: We believe in the defensiveness of the telecom industry in light of global slowdown
90 MSCI World 90 MSCI World Telecom 80 80 MSCI World MSCI EMEA Telecom 70 70 Telecom MSCI EMEA TE 60 60 MSCI EMEA 50 Telecom 50
40 40
30 30
20 20 D- J- F- M- A- M- J- J- A- S- O- N- D- J- F- M- D- J- F- M- A- M- J- J- A- S- O- N- D- J- F- M- 07 08 08 08 08 08 08 08 08 08 08 08 08 09 09 09 07 08 08 08 08 08 08 08 08 08 08 08 08 09 09 09
Source: Bloomberg, HC Brokerage
Table 8: Telecom Market Outlook 2007 2008 2009e 2010f I) Mobile Market Mobile Penetration 40.9% 55.0% 64.5% 70.0% Market Subscribers (000) 31,054 42,554 50,852 56,237 Growth in market subscribers 75.1% 37.0% 19.5% 10.6% Vodafone Subs. (000) 13,333 17,611 20,595 21,989 VFE Market Share 42.9% 41.4% 40.5% 39.1% Mobinil Subs. (000) 15,118 20,115 23,595 25,813 Mobinil Market Share 48.7% 47.3% 46.4% 45.9% Etisalat Subs. (000) 2,600 4,830 6,662 8,436 Market Share 8.4% 11.3% 13.1% 15.0%
II) Fixed Line Market Fixed Line Penetration 13.9% 14.2% 14.3% 14.3% TE Market Subscribers (000) 11,229 11,703 11,953 12,154 TE Net adds (000) 422 474 250 201
III) Broadband Market Broadband Penetration 2.2% 3.5% 4.7% 4.8% TE Data* Market Share 52.0% 59.0% 60.0% 60.4% TE Data subscribers (000) 222 424 595 630
*TE Data is 95% owned by TE Source: Telecom Egypt, Mobinil, Vodafone, HC Brokerage
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Egypt – Telecoms
A) Fixed line market near saturation while broadband market remains under-penetrated The number of fixed line subscribers grew from 5.85 million in 2000 to 11.7 million in 2008, implying a CAGR of 8.6% from 2001-2008 and a penetration rate of around 14.2% (according to our estimates). Egypt's households with fixed line telephones comprise roughly 73% of the population, which implies that there is a limited potential for growth. We have factored this in our assumptions of annual net fixed line additions of around 200K. We believe that the growth in the fixed line market would be mainly on the back of the growing wholesale segment and new services offered, rather than due to an increase in the number of fixed line subscribers. We believe that new marriages are one of the key growth drivers in fixed line net adds. Total fixed line net additions to new marriages are expected to drop going forward, reflecting the fixed to mobile substitution trend. The number of internet subscribers grew from 5.5 million in 2000 to 11.7 million in 2008, implying a CAGR of 9.9% from 2001-2008 and a penetration rate of 14.6%. Only around 15% of Egypt's households use the internet, implying a huge potential for growth. Egypt’s broadband penetration rate is below 4% with 719,000 total market subscribers, of which TE Data captures a 59% market share.
Chart 8: Egypt’s Fixed Line market near saturation, while broadband market remains under- penetrated
2.5% 30% China 2.0% Algeria 25% Thailand 20% 1.5% Jordan Syria Morocco 15% Sri Lanka Egypt Tunisia
(%) 1.0% 10% Jordan Algeria Yemen Morocco Thailand Sri Lanka 0.5% Egypt 5% Indoensia Tunisia Bangladesh India Pakistan India Indonesia Fixed LinePenetration 0% Pakistan 0.0% Syria Broadband Penetration (%) 1,200 2,600 4,000 5,400 6,800 8,200 2,400 4,400 6,400 8,400 GDP per capita (PPP/USD) GDP per capita (PPP/USD)
Source: CIA Fact Book, IMF, Bloomberg, Regulators and HC Brokerage
Chart 9: Net fixed line additions to new marriages (%)
80% 73.8% 71.9% 70% 69.7% Fixed lines net additions to new 60% 50% marriages (% ) 40% 34.9% 30% 25.8% 27.5% 20% 22.3% 10 % 2006 2007 2008e 2009f 2010f 2011f 2012f
Source: CAPMAS, CIA World Fact Book, UNDP and HC Brokerage
B) Mobile segment still showing strength We believe that the Egyptian mobile market is still attractive given Egypt's penetration rate of around 55%, which we expect to reach 73% by 2011f. We expect growth to be at a decelerating rate as the market nears saturation by 2013f, with a penetration rate of 80% representing Egypt's addressable market. On-net offers promoting multi-sim usage (10-20% of subscribers) are increasing penetration rates beyond human penetration. Chart 10: Egypt is still one of the under-penetrated countries
100% 80% Jordan Algeria 60% Morocco Pakistan Egypt 40% Sri Lanka (2007) Indonesia Syria 20% Bangladesh India China Yemen 0% Penetration Rate 1,000 2,000 3,000 4,000 5,000 6,000 7,000 GDP per capita (PPP) (2008) in USD
Source: CIA Fact Book, IMF, Bloomberg, Mobile Operators, Regulators, HC Brokerage
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Egypt – Telecoms
Well-equipped to Weather the Storm and Emerge in Good Shape
The defensive nature of the telecom sector and TE's monopoly in the fixed line market are favorably positioning the company. Investment in VFE is securing good exposure to the lucrative mobile market and a decent bottom line growth, offsetting any drops in operating income. TE's good cash flow generation, sound balance sheet and lack of significant future financial obligations will allow TE to weather the storm. FCF yield of 9.8% and dividend yield of 9.3% for 2009f.
Table 9: TE’s: KPIs EGP Million unless otherwise stated 2007 2008 2009e 2010f 2011f 2012f Retail Revenues 6,141 6,181 6,073 6,176 6,194 6,224 Wholesale Revenues 3,852 3,936 3,943 4,075 4,253 4,435 TE North Revenues - - 93 185 185 185 Total Revenues 9,993 10,117 10,108 10,435 10,633 10,844 growth in revenues 5.0% 1.2% -0.1% 3.2% 1.9% 2.0% EBITDA 5,227 4,674 4,656 4,801 4,788 4,759 EBITDA Margin 52.3% 46.2% 46.1% 46.0% 45.0% 43.9% Investment Income (VFE) 1,023 1,312 1,347 1,384 1,336 1,417 % of Investment Income to PBT 35.3% 41.9% 39.9% 36.7% 32.4% 31.9% Net Income 2,381 2,621 2,764 3,139 3,444 3,701 growth in net income -2.5% 10.1% 5.5% 13.6% 9.7% 7.5% NPM 23.8% 25.9% 27.3% 30.1% 32.4% 34.1% CAPEX 945 919 1,639 1,589 1,463 1,386 CAPEX/sales 9.5% 9.1% 16.2% 15.5% 14.0% 13.0% Net debt/EBITDA 0.70x 0.09x (0.58x) (0.92x) (1.28x) (1.64x)
Source: TE and HC Brokerage
Growing wholesale revenue and tariff rebalancing to offset the drop in retail revenues
Being the incumbent, enjoying monopoly in Egypt’s fixed line market and having a 59% broadband market share all
place TE in an advantageous position. The company benefits from any upside in Egypt’s mobile market through mobile traffic that uses its infrastructure, compensating it for the continuous drop in retail revenues due to the fixed to mobile substitution trend. As a result, wholesale revenue contribution to total revenues has been increasing and is expected to reach 41% in 2012f from 39% in 2008. TE’s tariff rebalancing and the new interconnect rates introduced in 2H08 have also cushioned against the drop in retail revenues. TE’s management is continuously introducing promotional offers to face strong competition from mobile players. The new revenue stream by the submarine cables line of business (TE North) will start contributing to total sales by 2H09 with yearly revenues of around EGP185 million. We have not factored in any asset sale related to TE North due to the lack of sufficient information regarding the accounting treatment of the proceeds. Internet and data revenue (part of retail revenues) contributes less than 6% of total revenues currently and is expected to contribute by 8% by 2011f. In general, we identify the wholesale segment as the main revenue driver going forward and not the growth in fixed line subscribers numbers. We estimate total revenue to grow at a 2010-2012f CAGR of 2.4%, however the growth of wholesale revenue alone for the same period is expected at 4.0%, on the heels of a growing mobile to international contribution. The global economic slowdown is expected to negatively affect TE’s international revenues (28.4% of 2008 sales and part of wholesale revenue) due to lower expected roaming revenues, reflecting the drop in the number of tourists visiting Egypt. We expect 2009 sales to decline by 0.1% from their 2008 level, in line with management guidance of a flat to 1% YoY growth in sales.
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Chart 11:Revenue mix 2008-2012f
2012f 2008 Wholesale Wholesale revenues rev enues 41% 39%
TE North 2%
Retail revenues Retail 57% rev enues 61%
Source: HC Brokerage
VFE, always to the rescue!
TE is enjoying an indirect exposure to the lucrative mobile market through its 44.95% equity stake in VFE, and
hence VFE’s contribution to TE’s net income has cushioned it against drops in operating income from TE’s fixed line business. In 2008, TE’s top line growth was a mere 1.2%; however, the company recorded a 10.1% YoY growth in bottom line due to VFE’s contribution of 41.9% to TE’s 2008 profit before tax. Although VFE comes second after Mobinil in terms of market share by subscribers, the company enjoys higher ARPUs compared to Mobinil due to a larger postpaid subscriber base (4% for VFE compared to 3% for Mobinil), which positively reflects on its margins. We expect VFE to capture a market share of 40.5% in 2009 (20.6 million subscribers) compared to 46.4% for Mobinil (23.6 million subscribers) and down from 41.4% in FY08, reflecting higher market penetration rate and increased competition. We expect VFE’s ARPU to continue to decline until it lands in 2010f at EGP52.14 (USD9.26). We estimate VFE’s EBITDA margin to range from 45-46% over our forecast horizon. We expect 2009 to be a tough year for mobile players, leading VFE’s net income to increase by 2.7% YoY due to lower margins (ARPU dilution) and lower roaming revenue contribution, and to contribute by 39.9% to TE’s profit before tax.
Table 10: VFE’s Forecast
EGP Million 2008 2009e 2010f 2011f 2012f Mobile penetration rate 55.0% 64.5% 70.0% 73.0% 76.0% Market subscribers 42,554 50,852 56,237 59,761 63,399 VFE’s market share 41.4% 40.5% 39.1% 37.9% 37.9% VFE’s closing subscribers 17,611 20,595 21,989 22,649 24,028 Net adds 4,278 2,984 1,394 661 1,379
VFE’s average subscribers 15,472 19,103 21,292 22,319 23,339 Blended ARPU (EGP) 55.70 54.03 52.14 53.44 54.11 Total Revenues 11,577 12,911 13,863 14,866 15,763 EBITDA 5,557 5,939 6,308 6,794 7,220 EBITDA Margin 48.0% 46.0% 45.5% 45.7% 45.8% Net Income 2,918 2,996 3,078 2,973 3,153 NPM 25.2% 23.2% 22.2% 20.0% 20.0% Source: Vodafone Group, TE and HC Brokerage
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Chart 12: ARPU and subscriber base comparison
95 88.1 96.8% Mobinil Dec.08 96.0% Mobinil 85 79.4 VFE 96.7% 75.0 75.0 Jun.08 95.8% VFE 75 69.0 71.0 96.6% 66.2 Mar.08 95.5% 63.2 65 62.1 61.5 95.8% 59.0 Sep.07 95.5% 55.0 55.7 94.9% 55 Jun.07 95.1% 48.0 47.0 47.0 47.0 45.0 44.0 92.4% 45 Dec. 06 94.5%
Blended ARPU(EGP) 38.6 Sep.06 90.8% 35 93.8%
7 8 90% .06 .07 0 07 08 0 08 p ar Se Dec.06 M Jun. Sep.07 Dec. Mar. Jun. Sep. Dec.08 % of Prepaid Subscribers
Source: Vodafone Group, Mobinil and HC Brokerage
Chart 13: Mobinil and VFE EBITDA margin comparison*
54% 52.8%
52% 50.0% 50.3% 50% 47.3% 48.8% 48.7% 48% 48.9% 46% 46.4% 47.0% 44% 45.8% Mobinil 44.4% VFE EBITDA Margin (%) Margin EBITDA 42% 43.0% 40% 2H06/07 FY07 1H07/08 2H07/08 FY08 1H08/09
* We have adjusted Mobinil's quarters and figures to correspond to VFE's financial reporting period. VFE’s fiscal year ends in March 31.
Source: Mobinil, Vodafone, HC Brokerage
Efficiencies on the cost side to help TE in recording a decent EPS CAGR of 9.5% for 2009e- 2011f We expect 2009e EBITDA margin to come in flat at 46.1%, in line with management guidance of an EBITDA margin
in the high 40s for 2009e. We were conservative in our EBITDA estimates and expect EBITDA margin to range from 46.1% in 2009e to 43.9% by 2012f. We attribute the pressure on the margin to the strong competition from mobile players (the fixed to mobile substitution trend), the YoY increase in wages and salaries which represented around 22.5% of sales in 2008, and the impairment loss on receivables which we expect to recur annually going forward. TE’s management is planning to reduce its labor force by 10% over the coming 2-3 years, a positive step in our view given TE’s large labor force of around 55,000 as of April 2008. On a more positive note, TE’s management was capable of decreasing interconnect costs in 2008 to 12.4% of sales from 13.7% in 2007 and is expected to further drop to 11.0% of sales in 2009e. Despite the expected 46.1% EBITDA margin for 2009e, TE will still enjoy higher margin as compared to international peers. We expect 2009e bottom line to grow at 5.5% YoY to EGP2.8 billion, lower from 2008’s bottom line growth rate of 10.1% as 2009 is expected to be a tough year for mobile players, resulting in a lower contribution from VFE coupled with the expected drop in margins. We estimate TE’s bottom line to grow at a decent 2009e-2011f CAGR of 9.5%.
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Chart 14: TE EBITDA margin relative to international peers
70% 60% 50% 40% 30%
(2009e) 20% 10%
EBITDA Margin 0%
t i . r r t ia n l a a q n a . a a E r l i e i m N E m T m c T r o T o N m l r ic o e o b a T a a a T t o P T F z z o o n D e n B n P o t s n c i t c I n s h I Z r c K O e r i le le K c i u s o le a o s t B a f B e n T e e m s e g S s E y A i le V l & T T i o g . T e a c l w e Ma T li w e l B e S T a A e S l Ma T e g T u T t r o P
Source: Bloomberg, HC Brokerage
Strong cash flow generation translates into a FCF CAGR of 8.0% (2010f-2012f) TE’s strong cash flow generation ability has helped it to maintain a strong balance sheet in a very turbulent financial
environment. TE’s cash position stood at EGP2.7 billion and its net debt/EBTIDA reached 0.09x as of the end of 2008, and the company has no significant future financial obligations. TE’s cash flows are boosted yearly by a hefty dividend income from its investment in VFE. VFE’s GAM approved on March 4, 2009 an interim DPS of EGP6.25 (a dividend income for Telecom Egypt of EGP674 million) which was paid on March 18th, 2009. TE received a dividend income from VFE of EGP1.3 billion in 2008, divided as follows: EGP494.5 million (EGP4.6/share) in 1Q08 and EGP817 million in 3Q08 (EGP7.6/share), which suggests that the newly approved DPS is higher 35.9% YoY. However, we don’t believe the dividend which will be paid in 3Q09 will be as generous as the one paid in 1Q09. We estimate a CAPEX figure of EGP1.6 billion for 2009e, representing 16.2% of sales and higher from EGP919 million in 2008, as TE is planning to cater to the growing wholesale LoB as well as expand in the broadband segment and make the necessary investments for TE North (EGP521 million, 31.8% of 2009e CAPEX bill). Management’s guidance for 2009e CAPEX was in the range of EGP1.5-2.0 billion. TE has no short-term financing requirements and of its total outstanding debt of EGP3.1 billion, EGP2.1 billion are due in February 2010 and the rest has longer maturities. TE offers attractive FCF and dividend yields of 9.8% and 9.3% respectively for 2009f, and we expect FCFs to grow at a CAGR of 8.0% from 2010f-2012f.
Table 11: Cash flow statement All figures in EGPMil. unless otherwise stated 2008 2009e 2010f 2011f Cash flows from operation 5,365 5,092 5,163 5,145 Dividends Received 1,321 1,077 899 869 Interest + Minority & taxes (342) 53 179 320 CAPEX & Investments (823) (1,639) (1,589) (1,463) Dividends Paid (1,707) (2,215) (2,350) (2,511) Cash flows pre financing 3,154 2,433 1,701 1,739 Financing (1,869) (1,526) 0 0 Net increase in cash 1,408 907 1,701 1,739
Free Cash Flow Yield 12.3% 9.8% 11.0% 11.8% Net Debt to EBITDA (0.09x) (0.58) (0.92x) (1.28x) CAPEX to Sales 9.1% 16.2% 15.5% 14.0%
Source: Telecom Egypt, HC Brokerage
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Higher 4Q08 impairment loss of assets lowers FY08 EBITDA margin
4Q08 results came in line with consensus with regards to top and bottom lines with deviations not exceeding 4%. However, the 4Q08 EBITDA margin was a surprise on the downside due to EGP479 million (EGP280 million in 4Q08 alone) impairment loss of assets (customers with overdue payments), resulting in an EBITDA margin for 2008 which was below consensus and 2007 materially. As of the end of 2008, TE’s balance sheet is looking strong as the company has repaid a significant portion of its debt and its cash balance has also increased notably to EGP2.7 billion resulting in a net debt/EBITDA below 0.1x. The cash balance will further increase in 1Q09 by EGP674 million with the company receiving a dividend income from VFE, but will go down by EGP2.2 billion during 2Q09 to pay the proposed DPS for FY08 of EGP1.30/share.
Table 12: Results KPIs* EGP Million unless otherwise stated Dev. from 2008 2007 YoY 4Q08 4Q07 Cons. Revenues 10,117 9,993 1.2% (0.9%) 2,625 2,515 EBITDA 4,676 5,069 (7.7%) (7.9%) 992 1,347 EBITDA Margin 46.2% 52.3% 36.8% 53.5% Inv. Income from VFE 1,312 1,071 22.5% 3.8% 353 329 Net Income 2,790 2,534 10.1% (3.7%) 601 831 NPM 27.6% 25.4% 22.9% 33.1% EPS (EGP) 1.63 1.48 DPS (EGP) 1.30 1.00 30.0% 13.7% Dividend Payout 79.6% 67.4% Net debt/EBITDA 0.09 0.71
* EAS figures are used here since actual IFRS figures are not yet released.
Source: TE, HC Brokerage
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Rating Scale Recommendation Upside Buy Greater than 25% Hold 0-25% Sell Less than 0%
Disclaimer This memorandum is based on information available to the public. This memorandum is not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities mentioned. The information and opinions in this memorandum were prepared by HC Brokerage from sources it believes to be reliable and from information available to the public. HC Brokerage makes no guarantee or warranty to the accuracy and thoroughness of the information mentioned in this memorandum, and accepts no responsibility or liability for losses or damages incurred as a result of opinions formed and decisions made based on information presented in this memorandum. HC Brokerage does not undertake to advise you of changes in its opinion or information. HC Brokerage and its affiliates and/or its directors and employees may own or have positions in, and effect transactions of companies mentioned in this memorandum. HC Brokerage and its affiliates may also seek to perform or have performed investment-banking services for companies mentioned in this memorandum.
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