Etihad Etisalat (Mobily):

Well connected

21 September 2008 Equity Research

12-month
BUY target price Current price
Target price*: SR78 SR78 SR45
Current price: SR45
Fair value: SR69
*12-month target >SR88 SR88-83 SR82-73 SR72-67 <SR67

Sell Consider Hold Consider Buy

selling buying
Share details

Market cap (SR million) 22,200 Investment summary

Shares outstanding (million) 500
Free float (million) 299
Earnings per share (SR) 3.2 Mobily is the brand name of the Saudi operations of Etihad Etisalat
Dividends per share (SR) 0 of the UAE. It is the second mobile phone operator in the Kingdom.
Book value per share (SR) 12.87 Mobily offers a suite of wireless communication products and
52-week high (SR) 76.75 services and is developing a national fiber optic network. We believe
52-week low (SR) 38.2 that at its current share price Mobily is undervalued.

Investment positives:
Share price • The influence of its largest shareholder, successful region
telecoms operator, Etihad Etisalat.
80
75
• Synergies in sales and services and potentially lucrative new
70 revenue streams from recent and ongoing acquisitions.
65
• A solid Kingdom-wide distribution network via franchises,
60
55 corporate outlets and dealers.
50 • Sophisticated marketing, which has allowed Mobily to build a
45
40
strong brand name after only three years of operations.
35 • The successful targeting of diverse groups within the Saudi
30
market.
06/01/2007
10/02/2007
17/03/2007
21/04/2007
26/05/2007
30/06/2007
04/08/2007
08/09/2007
21/10/2007
25/11/2007
05/01/2008
09/02/2008
15/03/2008
19/04/2008
24/05/2008
28/06/2008
02/08/2008
06/09/2008

• Operating in a sector of the telecoms industry that has strong

growth prospects.

Investment negatives:
Key ratios
• Competition from a third mobile operator, Zain, which recently
Price-earnings ratio (P/E) 14.03 started operations, will challenge financial performance.
Price-book ratio (P/B) 3.48 • Dominant in the prepaid market, which tends to be more
Return on equity (%) 23.7 unstable than the postpaid market.
Return on total assets (%) 7.5 • The balance sheet is highly leverage as a result of the a very
high level of debt.
Gross margin (%) 55.1
• The company operates with tight liquidity and a heavy debt
Operating margin (%) 22.7
burden, typical for a company that requires a large amount of
Quick ratio 0.36 spending in the early phase of operations.
Market risk (beta) 1.02
Company risk (standard deviation) 0.32
Earnings yield (%) 7.12

1
21 September 2008

Industry analysis
Over the last decade the Saudi telecommunications sector has been
transformed from a state monopoly into an open, competitive
industry. Liberalization began in 1998, when the responsibility for
providing telecom services was shifted from the Ministry of Post,
Telegraphs, and Telephones to a new company, Saudi
Telecommunications Company (STC). This was done to modernize
and improve efficiency in a sector that had struggled to meet the
demands of its customers. To expedite development of the
necessary infrastructure, Lucent Technologies won a $4 billion
contract to set up a fixed line network throughout Saudi Arabia and a
$700 million contract to develop a mobile phone network.

In 2001 the government passed the Telecom Act, which provided the
foundations for the legal structure of the industry and led to the
establishment of an independent regulator, the Communication and
Information Technology Commission (CITC). STC’s monopoly on
mobile services was broken in 2004, when Etihad Etisalat of the UAE
won the license to become the Kingdom’s second mobile operator.
Etihad Etisalat adopted the name Mobily for its Saudi operations and
offered a 20 percent stake on the Saudi stock market to become the
second listed Saudi telecoms company after STC, which floated a 20
percent stake the previous year.

Accession to the World Trade Organization in 2005 formalized the

government’s commitment to liberalize the entire telecoms sector
and this occurred when STC’s monopoly on fixed lines was ended in
2007. New fixed line licenses were awarded to consortia headed by
Bahrain Telecommunications, Hong Kong’s PCCW and Verizon of
the US. The new fixed line operators are expected to start operations
early next year. Last year the auction for a third mobile license was
won by Zain of Kuwait. Zain was listed on the stock market in March
2008 and formally commenced operations on August 26 this year.
Strong competition has stimulated the introduction of the latest
technology, greatly improved the range of services available and
pushed prices lower.

Telecoms timeline

E-transaction
ICT Ministry established, IT Program"Yasser", EasyNet,
added to CITC, liberalization Home PC Initiative
of VSAT
IPO of STC (20%) 3G Services launched,
Internet restructring, E-
transaction Act, E-crimes
Telecom bylaw
Act & Cert established
Zain begins operations

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Telecom Act and CITC W TO membership and
Liberalization of ISP sector
formed Mobily launches service
Third mobile license issued
and national frequency plan
established

Liberalization of data and

mobile services
Fixed line licences issued
to: Optical Communications
(Verizon of USA),
Mutakamilah (PCCW of
Hong Kong), and
Mobily receives license
Atheeb (Batelco of Bahrain).

2
21 September 2008

The current position

Fixed line penetration Fixed lines: Growth in the number of fixed lines in the Kingdom
4.0 80 averaged 4 percent over the last six years and at the end of 2007
3.5 70 there were 4 million fixed telephone lines, 73 percent of which were
3.0 60 in residences. This gives Saudi Arabia the second largest number of
2.5 50 fixed lines in the Middle East, after Egypt. Total teledensity is around
(millions)

(percent)
2.0 40 16.3 percent (163 telephones lines for every 1,000 inhabitants). This
1.5 30 is above the average for the Arab countries and the developing
1.0 20 world, but at the low end of the GCC states. The introduction of
0.5 10 competition in the fixed line sector should lift teledensity over the
0.0
2001 2002 2003 2004 2005 2006 2007
0 years to come.
Business lines Residential lines
Households teledensity (RHS) Population teledensity (RHS)
Mobile: The number of mobile subscribers in the Kingdom has
Source: Jadwa, Mobily, STC, CITC
surged from just 2.5 million in 2001 to 28.4 million at the end of 2007.
Last year alone there were 8.7 million new subscribers. Mobile
penetration stood at 116 percent at the end of last year, below the
Mobile phone subscribers rates in most other GCC countries, but well above the average
30
elsewhere in the region (note that data in the table below is for
2006). Research from CITC indicates that prepaid subscribers
25
(where users purchase credit in advance) constitute the majority of
20
subscribers (83 percent).
(millions)

15
Internet: At the end of 2007, there were 6.4 million internet users in
10 the Kingdom, the largest number of users anywhere in the Arab
world. Internet penetration was 26 percent. The number of internet
5
users has grown by around 36 percent per year since 2001.
0 Broadband subscribers surged from 24,000 in 2004 to over 623,000
2001 2002 2003 2004 2005 2006 2007
Post-paid Pre-paid at the end of 2007 and were up nearly ten-fold over the last two
Source: Jadwa, Mobily, STC, CITC years. Growth in internet use, particularly via broadband, has been
constrained by the lack of service providers. Liberalization of fixed
line services should improve the availability of this technology.

Regional telecoms indicators (2006)

Fixed Mobile Internet

Fixed Lines Mobile Subscribers Internet Users
Teledensity (Million) Penetration (Million) Penetration (Million)
Internet users
Algeria 8% 3.0 61% 21.0 10% 3.5
7
Bahrain 25% 0.2 115% 0.8 23% 0.2
6
Egypt 15% 11.0 28% 17.0 5% 3.8
5 Jordan 11% 0.6 80% 4.5 10% 0.7
4
KSA 18% 3.8 82% 19.6 20% 4.7
(million)

Kuwait 19% 0.5 100% 1.8 25% 0.8

3

Lebanon 18% 0.6 29% 1.0 14% 0.8

2
Oman 16% 0.4 70% 1.2 9% 0.2
1
Qatar 28% 0.3 100% 0.2 14% 0.1
0 Syria 19% 3.2 27% 3.5 10% 1.7
2001 2002 2003 2004 2005 2006 2007

Source: Jadwa, Mobily, STC, CITC

UAE 30% 1.5 126% 5.0 40% 1.7
Yemen 5% 1.0 12% 2.0 5% 0.9
Averages
Arab World 11% 35% 7%
Developed
countries 52% 82% 60%
Developing
countries 15% 30% 10%
World 20% 40% 16%

Source: Jadwa, CITC

3
21 September 2008

Growth drivers
The following are the main drivers of growth in the telecoms sector:

• Demographics: Saudi Arabia has a young and fast-growing

population. Around 32 percent are between the ages of 15 and
29, the age range that is a major target for all the telecom
Young population operators. The continued influx of expatriate workers (over 1
70 + million new work visas were issued last year) will add to the
60 to 69
demand for telecoms.
50 to 59

40 to 49
• Hardware costs: Technological innovation and competition
within the retail sector is likely to continue to reduce the cost of
(age)

30 to 39

20 to 29
mobile handsets and computers and drive further subscriber
growth. The fall in the cost of computers is greatly increasing
10 to 19
demand for internet connectivity and broadband services.
0 to 9

0 5 10 15 20 25 30
(per cent of total)
• Foreign competition: New foreign telecoms operators in the
Kingdom will stimulate greater competition, lower prices and
introduce new services and technologies, stimulating demand for
telecoms.

• Government policy: The government is promoting greater use

of the internet. Schools and colleges are being provided with
internet access and a government program is in place that allows
individuals to purchase computers at low prices. In addition, the
economic cities under development are being fitted with the most
up to date technology and Riyadh governorate plans to cover the
whole city with wireless internet access.

• Availability of connectivity technology: Increased availability

of 3G technology (which provides wireless internet via several
devices) gives access to the internet to customers where fixed
lines (and therefore dial-up internet connections) are unavailable.
It also allows the convenience of mobile access to the internet.

• Greater availability of Arabic language internet content: The

growing amount of Arabic language software and websites will
increase the demand for internet access.

Revenues
Telecom revenues have leapt from SR20 billion in 2001 to SR43
billion in 2007 as the number of subscribers has surged. The mobile
business accounted for approximately 80 percent of telecom revenue
in 2007, compared to 40 percent in 2001.
Telecom revenues
45 The following factors explain why revenues from mobile services
40 have outpaced those from fixed lines:
35

30
• Convenience of immediate access and having a roaming
(SR billion)

25
network across the region.
20
• The inclusion of variety of attractive features such as cameras
15
and internet access.
10
• Cheaper local and international call fees than from fixed lines.
5

0
• Quicker and easier to set up than a fixed line.
2001 2002 2003
Fixed and data services
2004 2005 2006
Mobile services
2007
• Improved coverage and reliability of the mobile network owing to
more mobile phone masts.
Source: CITC

4
21 September 2008

Impact of the new operator

The entry of Zain into the market will heighten competition. STC was
slow to react to Mobily and lost 31 percent of its market share in
Mobily’s first year of operations. Both existing operators are in a far
better position to cope with competition this time around. In order to
sustain subscribers and profitability, STC has made major
investments in technology and improved its customer service
program. Mobily has been marketing aggressively and building up its
provision of sophisticated technology in preparation for Zain.
Nonetheless, Zain is an experienced regional operator and we
expect it capture up to 5 percent of the market share in its first year.

Zain will put pressure on pricing, margins and customer retention. All
the operators are likely to offer more competitive pricing plans that
will hit average voice revenue per subscriber and additional features
and services including high-speed data, imaging, entertainment and
location-based services. We also expect a greater differentiation
between the services offered to different types of customers.

The company

Mobily is a joint stock company with an authorized and paid up

capital of SR5 billion. It has announced that it will increase its capital
by 40 percent to SR7 billion through a rights issue. There are
currently 500 million shares outstanding. Mobily is the brand name of
the Saudi operations of Etihad Etisalat of the UAE. It is the second
operator of mobile phone services in Saudi Arabia.

A consortium led by Etihad Etisalat of the UAE won the second

mobile phone license in Saudi Arabia in August 2004 with a bid of
SR12.2 billion. It also acquired a 3G license for another SR753.8
million in December 2004. In order to operate in the Kingdom, Etihad
Etisalat was required to have at least five Saudi investment partners
and float 20 percent of its capital on the stock market. The initial
public offer was oversubscribed by 51 times and the company was
listed on the stock market in October 2004.

Etihad Etisalat adopted the brand name Mobily and started operating
in the Kingdom in 2005. The management of Mobily entered into a
service agreement with Etihad Etisalat which requires Mobily to pay
an annual management fee of SR37.5 million ($10 million). Etihad
Etisalat provides consulting services in areas such as the provision
of customer services, management of capital investment and senior
management services.

Mobily now offers a suite of wireless communication products and

services that are designed to meet the needs of its targeted
customer groups: individuals, businesses and government.
Aggressive advertising, competitive pricing and product innovation
have enabled Mobily to build up its subscriber base to 11.1 million at
the end of 2007 (around 47 percent of the total market). Mobily
dominates the market for prepaid mobile calls. Mobily distributes
through owned and operated flagships, franchise-based fully
branded outlets and co-branded outlets. In addition, it has 939
preferred dealers and over 4,000 dealers/sellers throughout the
Kingdom.

5
21 September 2008

Ownership structure
2004 2008
Etisalat UAE-based telecoms service provider 35% 26.25%
GOSI State-owned private sector pension
fund manager 15% 11.25%
Saudi Investors Abdul Aziz Alsaghyir Investment Co. 7% 5.63%
Abdullah & Said M. O. Binzager Co. 4% 3.38%
Al Jomaih Holding Co. 6% 4.5%
Riyadh Cables Group Of Companies 6% 4.5%
Rana Investment 6% 4.5%
Listed on the stock market 20% 40%

Technology
Mobily’s technological platform is of a high standard. At the end of
2007 Mobily had 4,843 base stations covering the majority of the
Kingdom, 993 of which were enabled to provide 3G services. (A
base station is a radio transmitter that is the hub of a wireless
network and a bridge that connects between a wired and wireless
network.) The buildup of Mobily’s 3G network has allowed it to offer
internet services where dial up connections are unavailable. This
technology has made a major contribution to Mobily’s operations and
will be the main revenue driver in the coming years.

A key technological development for Mobily is the SR1 billion Saudi

National Fiber Network. This 12,500 km network will cover all the
major cities in the Kingdom and the project involves the installation of
several of wireless base stations to establish high-capacity data
centers and the laying of fiber rings in Riyadh, Jeddah, Khobar and
Dammam. It should be completed by the end of 2008 and once
operational it will allow Mobily to transmit data and phone services
for both landline and mobiles at ultra high speed. This wireless
offering will compete with STC, which is currently the only operator in
the Kingdom that provides users with internet connectivity via DSL
(Digital Subscriber Line, a technology that allows digital data to pass
through telephone lines or networks). It should be heavily used as
the Kingdom steps up usage of wireless internet access.

Products and services

At the end of 2007 Mobily was offering 44 services, ranging from
entertainment to connectivity, targeted at specific segments of the
Saudi market including youth, women and business. It was the first
operator to specifically target the corporate sector, forming Mobily
Business which is separate from the company’s mass market
consumer offerings. Mobily Business introduced the BlackBerry to
the Kingdom and as a result more than 20 banks and corporate
institutions are registered Mobily Business customers. Mobily has
also introduced high-speed mobile internet offers, which include
unlimited download packages and discounts to customers who use
various internet connectivity technologies (GPRS and HSDPA).

Mobily has done a solid job of creating loyalty to programs to retain

subscribers. It runs a reward program called Neqaty, under which all
Mobily subscribers are automatically awarded points in line with their
spending. Subscribers can redeem their points for text messages,
internet usage or products at partner retailers. Loyalty programs are

6
21 September 2008

an important way of maintaining customers tempted by the launched

of Zain.

Acquisitions
Mobily has acquired two Saudi information technology companies.
The first, Bayanat Al-Oula for Network Services, is a data service
provider that offers data and online services. Prior to the acquisition
in September 2007, Bayanat was granted a license from CITC to
construct and operate a new national optical, data, and wireless
network. In addition, Bayanat is currently constructing and running
an international gateway through which connectivity to the internet
and other internet service providers will be established. This
acquisition allows Mobily to diversify its services by entering into the
WIMAX (Worldwide Interoperability for Microwave Access) market
and provide data communication services to its customers. (WIMAX
is a technology that provides high-speed wireless data transmission.)

In July 2008, Mobily was approved by the CITC to acquire Zajil, the
Kingdom’s first internet service provider (ISP), for SR80 million. Zajil
has been providing data and network communication services since
1989 and has a strong client base including some government
ministries and leading corporations. It has partnered with local and
international players such as Cisco and IBM.

In order to provide DSL lines, Zajil and other internet service

providers are currently completely dependent on STC, which is the
Kingdom’s only DSL provider. When Bayanat’s network is complete,
use of Zajil as an ISP will be a useful source of revenues to Mobily.
As the new network is likely to result in lower internet browsing fees,
it may attract other ISPs from the STC network and further boost
Mobily’s revenues.

In order to save costs and enhance its customer service, Mobily

InfoTech was established in Bangalore, India in March 2008. This
will provide IT solutions and consulting services to the parent
company in areas such as billing, customer relationship
management and service provision. The company so far has more
than 100 employees and it is planning to further expand by the end
of the year.

Brand recognition
Mobily has invested heavily to establish a strong brand name in the
Kingdom. It uses television, newspapers and billboards and
sponsors a leading football club in order to target both the 15-30
year old age range and the business market. It has targeted these
two sectors in particular, as they are the heaviest spenders on
mobile technology. Capturing and locking in these customers will
provide a solid basis for further revenue generation. The company’s
marketing and advertising costs went up by 28 percent last year to
SR466 million. We view the hefty advertising spending to be
necessary, since the company has been in operation only three
years and is now facing new competition.

Management
We met with Mobily’s management in preparing this report. They

7
21 September 2008

consist of a strong set of professionals combining industry specialists

with broader experience. The management team has so far delivered
on its business plan and has been aggressive in introducing
technology, products and services in the Kingdom. Intensified
competition following the introduction of Zain will test the
management’s ability to continue to innovate to retain mobile
subscribers.

The telecom sector in the Kingdom is suffering from a shortage of

industry experienced professionals. Higher salaries will be an
inevitable result of this and some delays to the roll-out of new
services are possible. Mobily had more than 3,000 employees at the
end of 2007, more than 80 percent of which are Saudis (its
Saudization requirement is 30 percent).

Financial analysis
Mobily’s revenues have grown in line with its subscriber base. Total
revenues grew by 44 percent last year to SR8.4 billion owing to
rising receipts from calls. Revenues fall under the following
categories:

• Usage: Revenues from all outgoing calls and other chargeable

events, such as text messaging and downloading. Usage
accounted for 77 percent of Mobily’s revenues in 2007.
• Interconnect revenue: Revenue collected from other telecoms
operators for the use of Mobily’s network. This accounted for
around 17 percent of Mobily’s revenue in 2007.
Revenue breakdown • Rental fees: Line rental fees are charged on a monthly basis for
post paid customers and accounted for 3.5 percent of the total
revenues in 2007.
Interconnect
• Visitor roaming: Roaming revenue comes from when visitors
revenue
17% use Mobily’s network while in the Kingdom and when Mobily
customers use their phones outside the Kingdom. These
Usage
77%
Visitor roaming
1%
accounted for 1.3 percent of revenues last year.
Other
2% • Activation fee: A one-time fee paid by a new subscriber in order
Activation fees
0%
to activate a line. It made up 0.3 percent of Mobily’s revenues
Rental fees
3%
last year.
• Other: All other revenues make up of 1.6 percent of the total
revenue in 2007.

While costs have risen owing to subscriber growth, they have done
so at a lower rate than revenues. Interconnection costs accounted
for almost half of Mobily’s costs last year, followed by transfers to the
government, which more than doubled last year.

Gross margin measures the percent of total sales revenue that

Mobily keeps after incurring the direct expenses associated with
producing services sold. Gross margins have improved in line with
higher revenues. In 2007, Mobily’s gross margin was 55.1 percent.
The net profit margin became positive in 2006 at 12.0 percent and
rose to 16.6 percent last year.

Profitability ratios have improved in line with the rapid growth in

subscriber base. Profitability ratios because positive in 2006 and
generally improved during 2007. Return on equity was 23.7 percent
and return on invested capital reached 15 percent last year.

8
21 September 2008

Profitability ratios
(percent)
2005 2006 2007
Net profit margin -70.3 12.0 16.6
Return on total assets -14.4 4.1 7.5
Return on equity -29.5 15.5 23.7
Revenue and cost of operations Return on invested capital -59.0 16.5 15.0
9

8
In 2007 Mobily secured a Sharia-compliant financing package of
7
SR10.8 billion from local, regional and international financial
6
institutions. For the largest component of this, Mobily used airtime
minutes as the underlying commodity, selling these to financial
(SR billion)

4 institutions. They are then sold back to Mobily with a small premium
3 and Mobily distributes the airtime minutes to its subscribers. This
2 injection of cash was to repay a short term loan of SR7.1 billion and
1 to finance future expansion. Mobily has also secured working capital
0 and financial support Murabaha facilities. According to the
2005 2006 2007
Operating revenue Cost of operations management these have yet to be utilized.

Financing facility
SR million
Airtime financing facility 9,178.50
Working capital Murabaha facility 750.00
Financial support Murabaha facility 843.75

Mobily will pay back the loan over six years on a semi annually
basis. The repayment amount varies depending on interest rates and
other terms. By structuring the loan this way it is a long-term liability,
whereas the loan it repaid was a short-term liability. Mobily also
received a short-term financing facility from local financial institutions
of SR1.5 billion to finance the acquisition of Bayanat al-Oula.

Converting the debt to long term has the effect of improving the
liquidity ratios, though they remain very low because of the large
borrowing and spending in the early phase of Mobily’s operations.
The current ratio, which compares current assets to current liabilities,
is increasing from a very low base, as is the quick ratio, which
measures the amount of liquid assets available to offset current debt.
Ratios under 1.0 are considered weak and should move to more
healthy territory over the coming years.

Liquidity ratios
2005 2006 2007 2008H1
Current ratio 0.11 0.18 0.52 0.37
Quick ratio 0.03 0.11 0.36 0.27
Net working capital (SR million) -9,602 -9,502 -2,916 -5,865

Debt ratios have improved in the past three years as the company
has ramped up operations.

Leverage ratios

2005 2006 2007 2008 H1

Long-term debt to total capital 0.29 0.26 0.57 0.46
Debt to equity ratio 3.12 2.9 2.36 1.14
Equity to total assets (%) 24 26 30 27.9
Equity to total capital (%) 71 74 43 46.8

9
21 September 2008

Asset composition (end-2007) After three years of operation, Mobily’s assets have increased by 23
Cash Short term
percent. Licenses accounted for 57 percent of total assets at the end
4% investments
4%
of 2007, followed by property, plant and equipment which accounted
Accounts
Plant, property
and equipment,
receivable, trade for 28 percent of the total. Accounts receivable almost doubled last
7%
net
28%
year and made up nearly half of the company’s current assets at the
end of last year. As of first of half of 2008 current and quick ratio
have declined and net working capital has gone further into negative
Title territory.
Licenses
57%
Liabilities are up by 13 percent since 2005, mainly because of
additional borrowing for expansion and maintenance. Long-term loan
is the largest liability, accounting for 57 percent of the total at the end
of 2007, followed by short-term creditors, which accounted for 22
Liability composition (end-2007) percent. Liabilities to short-term creditors more than doubled last
Accured year due to an increase in purchases from suppliers.
expenses
9%

First half 2008 results

Short-term
ceditors
22%
Results for the first half of 2008 were encouraging. Net income was
Long term loan Due to related up by 40 percent compared to the first half of 2007. Sales were
57% parties
1% driven by a substantial increase in subscribers, expanding by 24
Title Other Payable
4%
Current portion
percent, and supported the 22 percent increase in operating income.
of long term
loan
Sophisticated 3G products have contributed strongly to the revenue
7% growth, though we believe that prepaid and post paid mobile
business remain the main revenue drivers. Total assets increased by
30 percent, largely driven by the acquisition of Bayanat al-Oula.
Current liabilities were up by 122 percent, caused by higher short
term borrowing to finance the Bayanat acquisition and the airtime
financing facility.

Quarterly performance
(SR ‘000)
First Half Second Quarter
2007 2008 2007 2008
Service revenue 3,905,162 4,851,341 2,028,608 2,543,553
Gross profit 2,094,306 2,636,613 1,108,899 1,413,011
Net income 554,455 774,421 303,845 448,407
EPS (SR) 1.11 1.55 0.61 0.90

Valuation
We base our valuation of Mobily on a combination of the discounted
cash flow (DCF) and relative valuation approaches. We have
assigned 70 percent weight to the DCF and 30 percent to relative
valuation.

DCF valuation calculations

• Risk free rate: 4.11 percent.
• Equity risk premium: 9.30 percent.
• Beta: 1.02.
• Terminal growth rate: 3 percent.

Projected cash flows: We project that net income growth will

average 22 percent per year based on Mobily maintaining its market
share in the growing mobile market, an increase in broadband
penetration and strong revenues from the new fiber optic network.

10
21 September 2008

The total mobile penetration rate is expected to increase to 133

percent in 2012, from 116 percent in 2007. This is a much lower rate
than over the past years, but given the high population growth, still
equates to a healthy increase in absolute terms. As the wireless
industry continues to mature, we judge that Mobily’s future growth
will be increasingly dependent on its ability to provide a technology
platform that allows existing customers to upgrade their services.
This will require Mobily to expand network coverage, improve
network quality and broaden its array of products and services,
which will be reflected in high investment and marketing expenditure.
We think Mobily will maintain around a 40 percent market share.

Telecom projections
2008 2009 2010 2011 2012
Fixed line penetration (%) 16.8 16.6 16.7 16.6 16.5
Mobile penetration (%) 117.2 125.6 127.4 129.3 131.7
Internet penetration (%) 32.6 43.3 56.6 66.9 82.0
Broadband penetration (%) 3.8 3.9 4.1 4.5 4.9
Computers (per 1,000 population) 232.0 251.0 268.0 288.0 308.0
Total IT spending (US$ m) 7,772 8,549 9,319 10,064 10,869

Broadband penetration is expected to more than double over the

next five years to reach 23 percent by 2012. Broadband will be the
primary driver of growth for Mobily and its greater penetration should
result in significant revenues from the company’s fiber optic network.

The commencement of operations by Zain will put pressure on

pricing, margins and customer retention. Zain has initiated some high
profile offers since it launched in August and we expect it to achieve
a market share of 5 percent by the end of this year. Mobily has
agreed to allow Zain to use its telecom infrastructure for its early
years of operations, which will open another revenue stream.
Mobily’s net income will also benefit from an agreement to outsource
network operations that will reduce operating costs by around 20
percent from 2008. We assume that there are no further entrants to
the mobile market over the next five years.

We selected the net cash flow to equity (NCFe) approach as the

appropriate measure of economic income to use in this valuation.
Net cash flow represents the maximum amount of cash that could be
distributed to shareholders without affecting the company’s normal
operational cash requirements. We calculated net cash flow to equity
by adding back depreciation and deducting capital expenditures,
debt repayments and increases in working capital from net income.
We believe that Mobily has sufficient funds to finance its operations
and management has told us that they do not plan to assume any
new debt.

We calculated that the present value of the company’s NCFe for

fiscal years 2008 through 2013 is approximately SR6.3 billion.
Mobily will continue to generate cash flows beyond the discrete
projection period and we have selected a long-term growth rate of 3
percent as appropriate for Mobily’s net cash flow. Combining the
present value of the terminal cash flow with the present value of the
discrete cash flow projections results in a total value of Mobily of
SR40.5 billion. Based on the above, the DCF results in a fair market
value of Mobily’s common stock on the valuation date of SR 80.9.

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21 September 2008

Relative valuation calculation

Relative valuation, or comparable company analysis, values a
company in reference to other publicly traded companies with similar
operating and financial characteristics. Some of the most commonly
used financial ratios for this process are the price-to-earnings ratio
(PE) and price-to-book value ratio (PB). A lower ratio than its peers
and the industry average may suggest that a stock is undervalued
and vice versa. The rationale for using the PE is that earnings power
is the main driver of investment value. The PB ratio measures how
much investors are willing to pay for a unit of the company’s net
asset value.

We compare Mobily against a peer group of selected regional

telecom operators. While some of these companies provide more
services than Mobily (such as fixed lines and cable television) and
operate in more than one market, we think there are enough
similarities for the comparisons to be valid.

Company Country Trailing P/E P/B

Mobily Saudi Arabia 14.0 3.49
Saudi Telecom Saudi Arabia 9.4 3.20
Etisalat UAE 10.9 3.12
Batelco Bahrain 10.1 2.31
Qatar Telecom Qatar 8.6 1.05
Omantel Oman 10.3 4.90
Zain Kuwait 16.3 2.99
Jordan Telecom Jordan 14.0 3.15
Peer group average 11.7 3.03

Mobily’s stock is currently trading at a trailing PE of 14.0, which is at

the top end of the selected operators, suggesting its share price is
relatively overvalued. From a PB perspective, the stock is more
closely in line with the average of the selected telecom operators.
Based on our analysis of the company’s future performance, we
have assigned Mobily forward 12-month earnings per share of
SR3.50 and forward book value per share of SR12.5.

Applying Mobily’s forward looking earnings per share to the

industry’s average one-year trailing PE of 11.7 gives a price for
Mobily’s shares of SR41.3. Applying Mobily’s forward book value per
share to the industry average of 3.03 gives a price for Mobily’s
shares of SR37.8. Averaging these results gives a share price for
Mobily of SR39.5.

Recommendation
Based on the two valuation parameters weighted 70:30 in favor of
the DCF, we arrive at a fair value of SR68.5. To get our 12-month
target price, we ran a DCF as of 12 months after the valuation date,
then discounted the resulting value by the current discount rate; we
leave the relative valuation unchanged as it is already forward
looking. This generates a 12-month target price for Mobily of SR77.5.
With Mobily currently trading at SR44.9, we recommend that
investors “buy”.

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21 September 2008

Price per
share (SR) Weights Contribution
Valuation method
Free cash flow to equity (DCF) 80.9 70% 56.6
Relative valuation (PE/PB) 39.5 30% 11.9
Fair value price (SR) 68.5
12-month target price (SR) 76.2

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21 September 2008

The Jadwa recommendation bar

12-month
target price Current price
SR78 SR45

>SR88 SR88-83 SR82-73 SR72-67 <SR67

Sell Consider Hold Consider Buy

selling buying

The bar on the front page of this report is Jadwa’s method of

conveying our investment recommendation as clearly and concisely
as possible. The bar is based on traffic lights, where green means
“go” (buy), yellow is “slow” (hold), and red is “stop” (sell). Our 12-
month target for the stock is the middle of the yellow area. This is the
price that we expect the shares to trade at in 12 months time. This is
different to fair value, which is our estimate of the fair value of the
company’s share price as of the valuation date.

We use five colors in our recommendation bar, with those on either

side of the yellow area signifying that an investor should consider
buying or selling the stock. The price range for each of these
alternatives is within the colored section. These price ranges have
been adjusted to take account of share price volatility (using the
stock's variance-mean ratio). The more volatile the share price, the
larger the price ranges.

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21 September 2008

Performance matrix
This table ranks Mobily’s performance against what we believe are the key success factors for the
sector it operates in (telecoms). A green rating is positive, yellow neutral and red negative.

Factor Measures Mobily status Rating

Valuation Fair market value of the company. The stock is under valued.
Management How efficiently and effectively the A strong management team that
company is run. have established a solid track
record.
Competitive The position of one business Mobily has a healthy position with a
position relative to others in the same variety of consumer groups, but will
industry. be challenged by Zain.
Brand recognition To promote the name of the Mobily has invested heavily to
business in the market and achieve successfully establish a strong
recognition. brand name.
Product mix The degree of homogeneity Mobily target diverse clients within
between products, product lines, the Saudi market. Recent
business lines and services. acquisitions will diversify revenue
streams.
Technology The extent to which the company Mobily's technology platform is of a
employs technology or needs to high standard.
make additional investments to
remain competitive.
Expansion potential Where the company is in its life The fiber optic network and
cycle and what future projects or integration of Zajil bolster Mobily's
plans does it have to maintain expansion potential in what is
growth momentum. already a fast growing sector.
Quality of Service Customers' impressions about the Mobily's subscribers are affected by
services provided. dropped calls and coverage issues.
Disclosure & How forthcoming and open the Mobily is one of the most
Transparency company is with regards to sharing transparent companies in Saudi
and disclosing information. Arabia and has a strong investor
relations department.
Profitability The end-result of a company's Profitability ratios have improved in
operations utilizing all resources at line with the rapid growth in
its disposal. subscriber base.
Activity How efficient management is in Activity ratios are generally on an
using its assets. upward trend, though the average
collection period has worsened.
Performance Efficient utilization of assets in Sales continued to grow as a
generating sales. percentage of both fixed assets and
total assets.
Liquidity Company's ability to meet short- Measures of liquidity have improved
term and current obligations on significantly, but remain very low
time. because of the large borrowing and
spending in the early phase of
operations.
Coverage Long term solvency and ability to Coverage ratios are improving.
deal with financial problems.
Leverage Capital adequacy and company's Mobily's balance sheet is highly
ability to meet long-term obligations leveraged.
and take advantage of opportunities
as they arise.

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21 September 2008

The discounted cash flow model

The DCF method estimates value on the basis of future cash flows over an investment horizon using
empirical market data, macroeconomic and industry evidence and the underlying fundamental trends
of the subject company. The DCF method then applies a present value discount rate, known as the
required rate of return on investment, to project future cash flows, which results in an estimation of
net present value of projected cash flows.

The value of the company is estimated by projecting the cash flows that the company is expected to
produce and discounting those cash flows back to the valuation date using a discount rate that
reflects the related risk. An in-depth analysis of the company’s revenues, fixed and variable
expenses and capital structure were conducted.

DCF valuation calculations

Present value discount rate: We estimated the cost of Mobily’s equity capital (net of long-term
debt) using the capital asset pricing model which incorporates a risk free rate, a long-term risk
premium and a company’s stock beta.

• Risk free rate: The risk free rate is used as to measure the opportunity cost of investing. Since
DCF analysis is based upon a long-term investment horizon, the appropriate risk-free rate is that
of a long-term government security. We use the 10-year Saudi riyal bond issued by SAMA,
which yielded 4.11 percent on the valuation date.

• Equity risk premium: We calculate the equity risk premium as the average of the arithmetic
and geometric means of TASI historical returns, less the long-term rate of return on the 10-year
SAMA bond. The arithmetic mean of the TASI over the period from 1980 to September 21 2008,
was 15.99 percent. The geometric mean over the same period was 11.07 percent. The average
of the two is 13.5 percent, which is the market return. Accordingly, the equity risk premium is 9.3
percent.

• Beta: Beta is a measure of the risk inherent in the company’s investment returns. The market
(TASI) beta is always one. A stock beta that is higher than one, as in the case of Mobily (1.02)
indicates that the stock tends to more volatile (up or down) than the TASI (by 3 percent in this
case). Applying beta to the long-term equity risk premium gives a beta-adjusted long-term equity
risk premium of 9.45 percent .

The capital asset pricing model resulted in a total estimated cost of equity capital of approximately
13.55 percent. This is arrived at by adding the beta-adjusted equity risk premium and the risk free
rate.

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21 September 2008

DCF valuation

SR' 000 2008 2009 2010 2011 2012 2013 2014

Net income 1,845,685 2,354,488 3,340,996 3,811,396 4,092,616 4,385,397 4,640,318

+ Depreciation 1,896,687 2,104,240 2,342,926 2,525,919 2,626,564 2,732,243 2,843,205

- Capital expenditure (1,439,883) (1,037,765) (1,193,430) (914,963) (503,230) (528,391) (554,811)

-/+ Increase/decrease in working
capital (466,536) (595,714) (596,715) (457,481) (251,615) (264,196) (277,405)
+ Increase in long-term debt

= Net cash flow to equity 1,835,954 2,825,249 3,893,777 4,964,870 5,964,336 6,325,053 6,651,306

Estimating the discount rate

k = rf + (rm - rf)B

Risk-free rate (rf) 4.11%

Market return (rm) 13.41%
B (beta) 1.02
Discount rate (k) 13.55%

2008 2009 2010 2011 2012 2013

Discounted Value of Equity
(DFCFe) 1,561,922 2,116,731 2,569,160 2,884,956 3,052,141 2,850,479
Total DFCF 15,028,806

Terminal Cash Flow

Value in year 5 6,325,053
Assumed growth into perpetuity 3.00%
Present value of terminal cash flow 32.710,476
Total value of business (SR '000) 47,745,865
Debt repayment 7,277,000
Net value of business (SR'000) 40,468,865
Shares outstanding 500,000,000
Value per share (SR) as @ 20-
09-08 80.91

Current Price 44.9

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21 September 2008

Financial statements

Balance sheet

As of December 31
2005 2006 2007
SR '000 SR '000 SR '000
ASSETS
Current Assets:
Cash and cash equivalents 185,172 547,523 703,198
Prepayments and other current assets 71,061
Short term investments 782,765 716,688 810,295
Accounts receivable, trade 166,822 739,228 1,459,733
Inventories 32,075 38,048 69,190
Total Current Assets 1,166,834 2,041,487 3,113,477
Investments in affiliated companies
License Acquisition fees, net 12,313,626 11,800,160 11,286,694
Plant, property and equipment, net 2,757,207 3,847,532 5,478,552
Investments - - 1,836
Total Fixed Assets 15,070,833 15,647,692 16,767,082
TOTAL ASSETS 16,237,667 17,689,179 19,880,559

LIABILITIES & SHAREHOLDERS

EQUITY
Current Liabilities:
Accured Expenses 2,133,514 1,687,156 1,207,463
Creditors 876,118 1,516,376 3,076,067
Due to Related Parties 193,251 179,335 111,485
Other Payable - 320,294 623,687
Deferred Revenue 218,017 - -
Borrowings 7,348,129 7,839,943 1,010,625
Total Current Liabilities 10,769,029 11,543,104 6,029,327

Founding Shareholders Loan 1,600,000 1,600,000 -

Long-term debt - - 7,912,356
Employees End of Service Plan 2,650 13,096 26,349
Total Long-term Liabilities 1,602,650 1,613,096 7,938,705

Total Liabilities 12,371,679 13,156,200 13,968,032

SHAREHOLDERS' EQUITY
Share capital 5,000,000 5,000,000 5,000,000
Accumulated Loss (1,039,915) (467,021) -
Statutory reserve - - 137,955
Retained earnings - - 774,572
TOTAL SHAREHOLDERS' EQUITY 3,960,085 4,532,979 5,912,527

TOTAL LIABILITIES &

SHAREHOLDERS' EQUITY 16,331,764 17,689,179 19,880,559

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21 September 2008

Income statement
As of December 31
2005 2006 2007
SR '000 SR '000 SR '000
Operating Revenue 1,661,737 5,840,815 8,440,432
Cost of operations (967,240) (2,680,466) (3,792,193)
Gross operating income 694,497 3,160,349 4,648,239
Provisions (52,650) (124,174) (291,847)
SG & A expenses (754,614) (1,035,671) (1,409,583)
Depreciation & amortization (739,141) (844,979) (1,030,919)
Total operating expenses (1,546,405) (2,004,824) (2,732,349)
Operating income, net (851,908) 1,155,525 1,915,890
Financial Charges (347,641) (478,680) (555,391)
Other Income 32,170 23,513 43,251
Income before Zakat (1,167,379) 700,358 1,403,750
Provision for Zakat
Provision for Tax (24,202)
Net Income (1,167,379) 700,358 1,379,548
Shares outstanding (units) 5,000,000 5,000,000 5,000,000
Earnings per share (EPS) SR (0.23) 1.40 2.76

Cash flow statement

For fiscal year ending December 31
2005 2006 2007
SR '000 SR '000 SR '000
Net cash provided by (used in) operating activities 1,325,742 1,928,010 2,153,202
Net cash provided by (used in) investing activities (15,776,607) (1,819,310) (1,878,177)
Net cash provided by (used in) financing activities 13,948,129 253,651 (119,350)
Cash and cash equivalents at yearend 185,172 547,523 703,523

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21 September 2008

Ratio analysis
Fiscal years ending December 31
2005 2006 2007
Liquidity
Current ratio 0.11 0.18 0.52
Quick ratio (Acid-Test) 0.03 0.11 0.36
Net working capital (SR million) (9,602) (9,502) (2,916)

Activity
Turnover:
Sales to net working capital (0.2) (0.6) (2.9)
Inventory 60.3 76.45 70.72
Receivables 19.9 12.9 7.7
Average collection period (days) 18 28 48
Days to sell inventory 6 5 5

Performance (Asset utilization ratios)

Sales to fixed assets 0.6 1.5 1.5
Sales to total assets 0.10 0.33 0.43

Profitability (per share)

Gross margin (%) 41.8 54.1 55.1
Operating margin before depreciation (%) 41.8 54.1 55.1
Operating margin after depreciation (%) -51.3 19.8 22.7
Pretax profit margin (%) -70.3 12.0 16.6
Net profit margin (%) -70.3 12.0 16.6
Return on:
Total assets (%) -14.4 4.1 7.5
Equity (%) -29.5 15.5 23.7
Investment (%) -59.0 16.5 15.3
Average assets (%) -14.4 4.1 7.5
Average equity (%) -59.0 16.5 26.9
Invested capital (ROIC, %) -59.0 16.5 15.3

Leverage (Balance sheet)

Long-term debt to total capital 0.29 0.26 0.57
Debt to equity ratio 3.12 2.90 2.36
Equity to total assets (Equity ratio, %) 24 26 30
Equity to total capital(%) 71 74 43

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21 September 2008

Summary of quarterly results

Balance sheet as on 30/09/2007 31/12/2007 31/03/2008 30/06/2008

Current assets 2,652,149 3,018,869 3,287,192 3,365,293
Inventory 40,626 69,190 71,035 85,635
Investments 0 1,836 1,836 0
Fixed assets 4,446,915 5,478,552 6,042,285 6,964,256
Other assets 11,415,062 11,286,694 11,158,328 12,650,538
Total assets 18,554,752 19,855,141 20,560,676 23,065,722
Current liabilities 4,719,863 6,003,909 6,625,677 9,316,131
Non-current liabilities 8,436,831 7,938,705 7,946,458 7,312,643
Other liabilities 0 0 0 0
Shareholder's equity 5,398,058 5,912,527 5,988,541 6,436,948
Total liabilities & shareholder equity 18,554,752 19,855,141 20,560,676 23,065,722

Statements of Income for the period ending 30/09/2007 31/12/2007 31/03/2008 30/06/2008
Sales 2,124,575 2,410,694 2,307,788 2,543,553
Sales cost 948,449 1,036,977 1,084,186 1,130,542
Total income 1,176,126 1,373,717 1,223,602 1,413,011
Other revenues 9,639 17,855 14,031 5,236
Total revenues 1,185,765 1,391,572 1,237,633 1,418,247
Admin and marketing expenses 461,503 434,456 112,073 199,277
Depreciation 264,253 281,715 292,395 319,714
Other expenses 149,385 144,741 504,980 448,363
Total expenses 875,141 860,912 909,448 967,354
Net income before zakat 310,624 530,660 328,185 450,893
Zakat 0 16,191 2,171 2,486
Net Income 310,624 514,469 326,014 448,407

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21 September 2008

For comments and queries please

contact:
Brad Bourland
Chief Economist
[email protected]

Gasim Abdulkarim
Equity Research Director
[email protected]

or the author:
Salman Aga
Equity Research Associate
[email protected]

Head office:
Phone +966 1 279-1111
Fax +966 1 279-1571
P.O. Box 60677, Riyadh 11555
Kingdom of Saudi Arabia
www.jadwa.com

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The information contained in this research (hereinafter refer to as “Research”) has
been obtained from various sources whose data is believed to be reliable and
accurate. Jadwa Investment does not claim and has no way of ascertaining that such
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are submitted solely for informational purposes. This Research is not an advice to sell
nor is it a solicitation to buy any securities, or to take into account any particular
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Research may be updated or changed at any time without prior written notice.

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