July 20, 2016 UAE Telecom Sector Sector Report Trading ahead of fundamentals Etisalat: reiterate ‘Sell’ rating, revised TP at AED 14.2 o Stock at 18.9x earnings, remains ahead of its fundamentals o Most international operations face pressure due to unfavourable currency movements, regulatory headwinds and increasing competitive intensity; UAE remains stable o Expect strong YoY 2Q performance on back of absence of loss from Mobily and lower royalty charge Du: dividend play, rating at ‘Sell’ with a TP of AED 5.40 o 2Q16 earnings to decline YoY due to higher royalty charge o Removing restrictions on foreign institutional investors to be a trigger for the stock o Progressive dividends, with a yield of c. 5.2% at current levels UAE telcos trading ahead of fundamentals UAE telcos are trading at a P/E multiple of 18.6x for FY16, at a significant premium to their GCC peer group (excl. UAE telcos) average of 13.8x, primarily due to moderate competition in the UAE market and non-fundamental factors. Etisalat’s stock price has increased 57% since September 2015, when foreign investors were allowed to hold up to 20% stake in the company. Telecom In December 2015, Etisalat was included in the MSCI Emerging markets Index and FTSE Indices in March 2016, further fuelling demand for the company’s stock. Currently, only individual foreign nationals can invest in Du, but going forward, there is speculation that ownership restrictions on foreign institutions will also be lifted. Although we are not sure about the timeline, allowing foreign investors to buy shares in Du should lead to similar institutional flows as witnessed in case of Etisalat, during its MSCI and FTSE inclusion. Although we believe that both Etisalat and Du are well placed to benefit from strong UAE macros, current valuations are considerably ahead of the fundamentals, thereby driving our ‘Sell’ rating on both stocks. Etisalat remains the market leader in UAE; market share stabilises Etisalat remains the market leader in the UAE, with a c.54% of the total mobile subscriber base and revenue market share of c.71% in 1Q16, led by its dominance in the high-value customer segment and also fixed services segment. According to the UAE TRA, the country’s post-paid subscriber numbers stood at 2.8mn at end-FY15, with Etisalat having a strong market share of 63% and 1.77mn post-paid subscribers. SICO Research © SICO 2016 All Rights Reserved Attention is drawn to the disclaimer and other information in the end SICO RESEARCH UAE Telecom Exhibit 1: UAE mobile subscribers market share Exhibit 2: UAE telecom- revenue market share 100% 100% 30.3% 31.0% 31.5% 29.5% 80% 80% 32.5% 48.7% 47.4% 46.7% 45.2% 46.3% 60% 60% 40% 40% 67.5% 69.7% 69.0% 68.5% 70.5% 51.3% 52.6% 53.3% 54.8% 53.7% 20% 20% 0% 0% 2012 2013 2014 2015 1Q16 2012 2013 2014 2015 1Q16 Etisalat Du Etisalat Du Source: Du investor presentations, SICO Research Source: Du investor presentations, SICO Research As a result of its leadership in the high-value segment, Etisalat reported c. 25% higher mobile ARPUs at AED 110, compared to Du’s mobile ARPUs of AED 88. Due to increasing competition in the UAE telecom market (penetration rate was as high as 217% by February 2016 end), both telcos reported a YoY decline in mobile ARPUs in 1Q16, a trend that has been following for some quarters now, as seen in the Exhibit below. Exhibit 3: Quarterly mobile ARPUs (AED) 130 119 116 117 120 115 115 115 114 110 110 110 100 97 98 90 96 95 96 92 93 93 88 80 70 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Etisalat Du Source: Company Data, SICO Research Bitstream access to intensify competition; advantage for Du The bitstream access was launched in July 2015 for double play (fixed and broadband) with inclusion of TV services and double play for business customers expected by end-FY16. However, current provision of TV services by Du is confined to newer areas of Dubai, while Etisalat has a monopoly in the rest of the UAE. We expect Du to benefit once infrastructure sharing for triple play services (including TV) is implemented, leading to increased competition. Du’s fixed line revenues grew 14% YoY in FY15. We believe that fixed line network sharing partially contributed, since it allowed the company to operate beyond its existing network. Going forward, the cost incurred to install new fixed telecom infrastructure would be shared between the two telcos, which should result in lower capital expenditure for both companies. GCC roaming rate cut impact to be limited In April 2016, the UAE TRA directed an average 42% cut in roaming rates for mobile users travelling within the GCC region, in line with the intra-GCC agreement to reduce roaming rates. 2 SICO RESEARCH UAE Telecom We believe that the impact on the telcos’ bottom line will not be material because of increased elasticity of roaming usage and lower interconnection charges. Our interaction with management of other GCC telecom operators validates this view. Competitive pricing; Du offers slightly better value and more flexibility Etisalat and Du have comparable pricing in major segments, but the latter is providing marginally extra talk time/data for same cost. The post-paid price comparison of both telcos suggests that in the low-value segment, Du offers better value in terms of higher talk time at 300 mins compared to Etisalat’s 200 min for AED 150/ month plan. In the medium- range plans, both telcos provide similar value at AED 300/month. In the premium segment, Etisalat’s plans are relatively data heavy with 100GB of data and 1000 mins of flexible talk time for AED 1,000/ month, which Du compensates with higher talk-time of 2,500 mins along with 50 GB of data at the same price. As per our analysis, Du offers better value for money to subscribers in the lower price range. Additionally, in terms of flexibility, we believe Du offers more flexible plans, with an option of contract-free plans in both low- and high-value segments, albeit with lesser benefits. However, Etisalat restricts the plans with 12- and 24- month contracts. Exhibit 4: Post-paid pricing comparison Plans (AED) Service Etisalat Du Talk time (mins) 200* 300* 150- Flexible mins Data (GB) 6 6 Talk time (mins) 1200 1200 Emirati- 300 mins Data (GB) 2 2 Talk time (mins) 1000* 2500* Premium- 1000 Data (GB) 100 50 *Note- Flexible minutes for local/ international calls or incoming roaming Data as of 15 July 2016 Source: Company Data, SICO Research Further increase in royalty rate for FY17 remains a risk to the sector Du’s royalty fee is set to increase and match Etisalat by FY16 with the latter’s royalty rate on profit declining in FY16. During this period, both operators need to pay 15% royalty on revenues and 30% on profits (after excluding revenue royalty). As a result, we expect Du’s royalty expense at AED 2.2bn, up 12% YoY compared to Etisalat’s decline of 9% YoY to AED 5.5bn. The royalty rates have not yet been disclosed for FY17 and beyond, but we have assumed royalty rates to be equal to FY16 rates. Exhibit 5: Royalty rates for UAE telcos Etisalat Du Royalty on Royalty on Royalty on Royalty on Years revenue profit revenue profit 2012 15.0% 35.0% 5.0% 17.5% 2013 15.0% 35.0% 7.5% 20.0% 2014 15.0% 35.0% 10.0% 25.0% 2015 15.0% 35.0% 12.5% 30.0% 2016 15.0% 30.0% 15.0% 30.0% Source: Company Data, SICO Research 3 SICO RESEARCH UAE Telecom Emirates Telecommunication Corporation Price Data (AED) Current Price 20.00 Continues to rally on institutional flows Target Price 14.20 52 wk High/Low 20.00/11.40 Reiterate ‘Sell’ recommendation, TP at AED 14.2/sh Ratings We reiterate our ‘Sell’ recommendation for Etisalat with a one-year blended Short-term Neutral target price of AED 14.2/sh, a downside of 29% from the current level. The Long-term Sell stock is currently trading at a P/E multiple of 18.9x on our FY16 EPS of AED Risk Profile Normal 1.06, ahead of peer group average of 13.8x, which we believe is mainly due to price increase after opening up for foreign investors and the stock’s inclusion Market Data in MSCI and FTSE Indices. Etisalat’s stock has rallied 57% since September 2015, Sector Telecom when it was opened up for foreign investors, compared to 0.1% decline in Abu Telecom Market Cap USD 47.4bn Dhabi exchange index during the same period. We expect Etisalat to pay a Primary Market Abu Dhabi dividend of 80 fils/sh in FY16, translating to pay-out ratio of 76% - in line with Other Exchg the past three years’ average - and a dividend yield of 4%. Reuters ETEL.AD Exhibit 6: Etisalat- Blended Valuation Bloomberg ETISALATUH (price in AED, per share) Target Price Weightage Free Float 40% DCF 13.3 50.0% Price/ Earnings 15.0 50.0% Du – TP 14.2 Valuation Ratio Current Price 20.0 2016E 2017E % Up (Down) Side -29.2% P/E x 18.9 17.1 Source: Company Data, SICO Research P/BV x 3.8 3.6 Expect robust 2Q16 earnings at AED 1.9bn, led by Mobily’s turnaround and EV/EBIDTA 7.0 6.8 lower royalty Div Yld % 4.0 4.3 We expect Etisalat to report higher 2Q16 earnings at AED 1.9bn, up 25.3% YoY from AED 1.5bn.