Emirates Integrated Telecommunications Company (du) Initiating Coverage HOLD June 7th, 2007 Current Price (AED) 5.20 Target Price (AED) 5.31 Investment Highlights 1-year Total Return 2% • We initiate coverage on Emirates Integrated Telecommunications Company (du) Company Data with a target price of AED 5.31 and a Hold recommendation. While we are opti- Country UAE mistic that du will emerge to secure a formidable portion of the country’s mobile Sector Telecom and fixed line telecommunications market, we believe the market is correctly Exchange DFM Shares Outstanding (mn) 4,000 valuing the strong growth prospects of the UAE’s second telecom carrier. Market Cap (mn) AED 20,800 • Due to their startup nature, du is expected to continue to show negative EBITDA Net Debt (mn) AED (1,099) Enterprise Value (mn) AED 19,700 and Net Income in the short term. We expect EBITDA and Net Income to be posi- tive by 2009. Margins are expected to approach regional peer averages and we Stock Data estimate these figures at 42.6% and 18.6% respectively, by the end of our projec- 52 Week High AED 7.25 tion period. 52 Week Low AED 4.83 • Our projections make two broad assumptions regarding policies of the Telecom- Div Yield 0% Beta vs. DFMGI 0.86 munications Regulatory Authority (TRA): 1) That the TRA implements the Local Bloomberg DU DB Loop Unbundling agreement which will have a material impact on the company’s triple-play strategy and fixed line delivery; and 2) That Mobile Number Portabil- ity (MNP) is introduced which will ‘grease the wheels’ of defection for du. While we anticipate these policies to be implemented, delays in such implementation could have a material effect on our financial projections. Performance—Past Twelve Months • The key risk in our price forecast is related to the number of assumptions we have 7.5 100 made based on limited historic data. It is important to note that du is a new oper- 7 90 ating entity and while we believe our assumptions are reasonable and have been 6.5 80 70 6 made on sound grounds, significant variance from our assumptions is possible and 60 5.5 likely. The principal assumptions investors should be aware of include but are not 50 Price 5 40 Volume (mn) Volume limited to: mobile penetration, market share, revenue growth, cost structure, mar- 4.5 30 4 20 gins, and capital spending. 3.5 10 3 0 Jun-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Financial Highlights Year-End as of December 31st AED (Mn) 2007E 2008E 2009E 2010E 2011E Revenue 998 2,567 4,414 5,944 7,254 Omar Rana, MA, MSc Revenue Growth - 157.2% 71.9% 34.7% 22.0% Managing Director [email protected] EBITDA (736) (11) 1,040 2,070 3,088 EBITDA Margin -73.7% -0.4% 23.6% 34.8% 42.6% Darren K Smith, CFA EBITDA Growth - - - 99.2% 49.1% Vice President [email protected] Net Income (1,044) (701) 109 764 1,346 Net Income Margin -104.6% -27.3% 2.5% 12.8% 18.6% Justin Tantalo Net Income Growth - - - 602.9% 76.3% Business Analyst [email protected] EPS (0.26) (0.18) 0.03 0.19 0.34 EPS Growth - - - 602.9% 76.3% Munira Mukadam Dividend Per Share - - - - - Business Analyst [email protected] Payout Ratio 0.0% 0.0% 0.0% 0.0% 0.0% Contact Us Valuation EV/Revenue 42.3x 10.8x 6.1x 4.6x 3.7x Gulf Capital Group Dubai International Financial Centre EV/EBITDA - - 19.0x 9.5x 6.4x Dubai, United Arab Emirates P/E - - 191.4x 27.2x 15.5x Tel: +971 4 363 5730 P/B 8.8x 12.6x 11.8x 8.2x 5.4x Fax: +971 4 363 5739 www.gulfcapitalgroup.com Dividend Yield 0.0% 0.0% 0.0% 0.0% 0.0% ROE -44.4% -42.5% 6.2% 30.3% 34.8% Gulf Capital Group does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decisions. TABLE OF CONTENTS FINANCIAL FORECASTS AND OVERVIEW........................................................................... 1 Revenue....................................................................................................................................................1 EBITDA ...................................................................................................................................................4 Net Income ...............................................................................................................................................5 Capital Expenditures ...............................................................................................................................6 VALUATION ................................................................................................................................. 7 Free Cash Flow ........................................................................................................................................7 Weighted Average Cost of Capital ...........................................................................................................8 Discounted Cash Flow Analysis ..............................................................................................................8 DCF – Sensitivity Analysis ......................................................................................................................9 Relative Value – Market Share v. Market Cap .....................................................................................10 FINANCIALS .............................................................................................................................. 13 APPENDIX A: COMPANY BACKGROUND............................................................................ 14 Ownership ..............................................................................................................................................15 Corporate Structure and Operations .....................................................................................................15 du’s Triple-Play – Fixed Line and More ..............................................................................................19 APPENDIX B: MENA MOBILE TELECOMMUNICATIONS OVERVIEW......................... 23 Liberalization in the MENA region ......................................................................................................23 MENA Mobile Operators ......................................................................................................................24 A Changing Landscape .........................................................................................................................25 MENA Mobile Penetration ....................................................................................................................26 Subscriber Growth Remains Strong ......................................................................................................26 Price Decline With Increased Competition ...........................................................................................28 June 7th, 2007 FINANCIAL FORECASTS AND OVERVIEW Emirates Integrated Telecommunications Company (du) was established in 2005 effectively ending the 30 year monopoly of the incumbent provider Emirates Telecommunications Company (Etisalat). The competitive dynamic has begun to settle in as the AED 16.3 billion market saw competition for the first time in February 2007. As would be expected by a new capital intensive telecom carrier, the first few years of operations will lead to losses for du. While the early years of battling Etisalat’s monopolistic legacy will be challenging, the UAE’s high GDP per capita and expanding population base will provide a favorable environment for du to become a profitable operating entity in a relatively short time. The company’s EBITDA and Net Income margins are anticipated to approach regional averages by the end of our projection period. We expect the company to be profitable by 2009, after two full years of operations Select financial highlights are displayed in Exhibit 1.0 Exhibit 1.0: du Financial Highlights 2007 – 2011 Year End - As of December 31st Net Income is AED (mn) 2007E 2008E 2009E 2010E 2011E Revenue 998 2,567 4,414 5,944 7,254 expected to be EBITDA (736) (11) 1,040 2,070 3,088 positive by 2009 EBITDA Margin -73.7% -0.4% 23.6% 34.8% 42.6% Net Income (1,044) (701) 109 764 1,346 Net Income Margin -104.6% -27.3% 2.5% 12.8% 18.6% Source: Company Reports, GCG Analysis Revenue Fixed Line Although the company’s nascent mobile operations are currently it’s most visible and advertised service, they do not yet dominate du’s top line. A majority of the company’s revenue is currently generated from its fixed line triple-play services in the free-zones of Dubai. These services were operational even before du’s incorporation and were subsequently acquired with du’s purchase of Tecom’s telecommunications assets. While the company has more than 25,000 fixed line customers, we expect fixed line growth to be slow until either: 1) A Local Loop Unbundling (LLU) agreement is implemented by the country’s Telecommunications Regulatory Authority (TRA) – expected in 2009, or 2) du has a significant portion of its own Next Generation Network built out. Under either scenario, it will be at least two years before fixed line services are fully operational to a majority of the UAE population. The company has not made a final decision on their strategy for tackling the fixed line market. It is very possible, and likely,