Al Mal institutes telecom sector coverage with UAE growth forecast at 8.6% to 2012
The UAE’s telecommunications market is a duopoly characterised by high GDP per capita (US$43,859 for 2007), an extremely high reported rate of mobile penetration (166.4% at year-end 2007), rapidly growing internet user penetration (44.7% YE2007) and steady fixed-line penetration (30.0% YE2007). Al Mal Capital Research released a note today saying that the two players however, Etisalat and du, remain poles apart. Former monopoly Etisalat commands approximately 80% of the UAE mobile market and is aggressively expanding international operations (15 overseas countries, 36 million proportionate subscribers). Meanwhile, du is still at an early stage of growth as it builds out its UAE network and operations. du commenced operations in December 2005, launched mobile services in February 2007 and is currently targeting a 30% market share by 2010.
Once du completes its mobile network roll-out, we can expect genuine increased competition within the UAE between the two players, said Al Mal, although it will be based less on direct price competition and more on special offers and promotions.While Etisalat should inevitably see its domestic market share decrease, the company’s growth and profitability should be driven by its rapidly expanding overseas operations.Population growth (with projected five year CAGR of 4.8%) should be the key driver for the UAE telecoms sector over the next few years, resulting in a combined CAGR of 8.6%. for Etisalat and du’s revenue from UAE operations, to AED 35.27 billion by 2012, up from AED 21.68 billion in 2007. In the case of Etisalat, we can expect international operations to become an increasingly important driver for the company’s profitability and the stock’s performance. Al Mal forecasts Etisalat’s overseas revenues from subsidiaries to grow at a 17.6% CAGR from 4% of total revenues in 2007 to 24% by 2012.
The firm initiated coverage of Etisalat with an ‘outperform’ rating and a DCF-derived target price of AED 26.34, giving a 33% upside. With an EV/EBITDA multiple of 6.1x our 2009 estimate, it feels the current valuation does not fully incorporate the impact from international operations over the next few years.
Al Mal initiated coverage on du with a ‘market perform’ rating, reflecting the 3.1% upside to its DCF-derived target price of AED 6.06. du should continue to gain subscribers, thanks to steady growth and churn in the UAE’s expatriate population. However, it feels the current valuation, at EV/EBITDA multiple of 19.2 in 2009 and 10.4 in 2010, fully reflects the growth potential, especially in light of the uncertainties with regards to subscriber quality and ARPU growth. Any reduction in royalty payments to the UAE government and relaxing of foreign ownership restrictions would act as additional catalysts for further price
appreciation. Although there are no changes expected in the immediate future, a 10% reduction in the royalty fee would increase our price target for Etisalat to AED 31.98 and for du to AED 6.93.
Telecom liberalisation, the WTO driver
The liberalisation of the UAE telecoms sector is driven by the UAE’s membership of the World Trade Organization (WTO), which it joined in 1996. In 1998 a total of 69 member countries agreed to open their telecommunications sectors to competition, under the WTO Basic Agreement on Telecommunications. The WTO aims for the global telecom sector to be completely liberalised, free from monopoly or government
protection by 2010.
However, the UAE negotiated concessions and, under current WTO rules, its deadline for complete telecoms market liberalisation has been extended until 2015. The telecoms sector in the UAE is regulated by the Telecommunications Regulatory Authority (TRA).
Etisalat monopoly broken
In February 2006, du received its integrated provider licence at a cost of AED 124.5 million, thereby ending Etisalat’s near 30-year monopoly on the provision of telecom services in the UAE. The TRA awarded incumbent Etisalat its integrated license in May 2006. As the incumbent operator, Etisalat did not have to pay an initial licence fee.The 20-year renewable licences allow both operators to provide full telecommunications services, including fixed network, national and international call services, national and international mobile services and internet connectivity.
Under the terms of the licences, Etisalat and du must both pay annual royalties, annual licence fees, radio spectrum fees and contribute to the Information & Communication Technology (ICT) Development Fund.
du for duopoly?
Although policies for mobile number portability (MNP), carrier selection and pre-selection have been drafted, they have yet to be fully implemented. Carrier selection has been implemented by du. Etisalat and du are in discussions, moderated by the TRA, as to how to implement MNP from a commercial and technical perspective. However, no timeline has been disclosed as to when implementation will occur.
Therefore, in the near-term we do not foresee any material impact to the two operators’ respective market segment shares. Until the solutions to these issues are fully implemented and du offers mobile network coverage comparable to Etisalat’s, the incumbent’s commanding market share should not be at risk.
In the fixed-line segment, the market is effectively delineated geographically, with du serving ‘New Dubai’ and the freezones of TECOM, and Etisalat the rest of the country. While carrier selection and preselection are available, it seems this is not having a material impact on market share. Additionally we believe neither operator will be easily able to gain access to the others’ telephone exchanges to allow it to install its own equipment.
Potential for third operator?
While there has been no official comment on the potential for a third licence being issued in the future, it is believed that, once du has profitably established itself, additional competition will be introduced either in the form of a third universal licence or as separate individual licences for fixed, broadband and ISP. There is no expectation, however, of any new licences being issued prior to 2010, by which time du should be well established and profitable.
MVNOs: Market segment or market figment?
A Mobile Virtual Network Operator (MVNO) does not have network infrastructure of its own but instead leases network capacity at a discounted rate from a licence-holding operator and resells it to customers with additional services. MVNOs arguably enable the much larger licence-holding operator to capture previously untapped segments of the operator’s market at reduced risk and cost, thereby increasing and
sustaining market share. There are now more than 300 such operators across the world and, in some countries, they outnumber licensed operators.With respect to Middle East, Africa and South Asia, (MEASA) telecom operators’ opportunities for regional expansion, while available, are not unlimited; competition for the dwindling number of greenfield licences being auctioned has escalated contenders’ bids to potentially value-destructive price levels. While opportunities for consolidation and acquisition across the three regions will continue to remain available for the foreseeable future, the acquisition-driven GCC telecom players will need to explore alternative means of generating revenues and optimising efficiency and MVNOs may be a viable solution.
MVNOs have already established operations in the Middle East, though services have been slow to launch, largely due to regulatory obstacles. Jordan remains the only MENA country thus far to have created a legal and regulatory framework; Saudi Arabia-based MVNO i2 officially launched its services in Jordan in May 2008.As for the UAE, we feel an MVNO entrant is unlikely during the next couple of years, primarily because the regulatory framework for MVNOs is not in place. Additionally, du is still expanding its mobile network infrastructure. Furthermore, the existing infrastructure is already at full capacity utilisation in some of the key urban areas. Until one, or both, operators have sufficient excess capacity to lease to a virtual operator, the added value of an MVNO in the UAE remains slim, at best.
UAE industry projections
Record high oil prices have led to an economic boom in the GCC, resulting in rapidly growing expatriate populations, especially in the UAE, which has an estimated 80% expatriate population. Al Mal forecasts the UAE population to grow at a five-year CAGR of 4.8% to 6.3 million in 2012, up from 4.6 million in 2007. This is in line with a historical CAGR of 4.87% between 2001 and 2007.
Assuming no new market entrants, we can expect the overall UAE telecoms market to grow at a CAGR of 8.5%, from AED 21.68 billion in 2007, AED 27.27 billion in 2008 and to AED 29.72 billion in 2009. By the end of 2012, we project total UAE telecom revenues for the two operators to be AED 35.27 billion.
Mobile
Al Mal forecasts the UAE mobile market to grow from 7.7 million subscribers in 2007 to 9.2 million in 2008 and to 11.9 million by 2012. Given the already very high penetration rates in the UAE, we can expect penetration rates to grow modestly from 166% in 2007 to 188% by 2012. Penetration jumped over 38% in 2007, from 127% in 2006, to 166% in 2007; that is impressive growth for any market, let alone one that already has penetration over 100%. At face value, these rates imply that there are nearly two SIM cards per person in the UAE.
However, the high penetration levels in the UAE may not tell the full story. There are several reasons why the mobile penetration rate is likely to be inflated:Definition of ‘active subscriber’: Until recently both Etisalat and du defined mobile customers as any customer who generated revenues in the financial year, regardless of how active the customer was. The TRA has since defined an ‘active subscriber’ as follows: any mobile customer who has either made a call, sent an SMS or MMS, or received a call within the last 90 days. As of first qusrter 2008 results, du has restated its mobile subscriber base, with 1.76 million mobile customers being restated as 1.43 million active
subscribers. Etisalat is expected to do the same on the release of second quarter 2008 results.Special introductory offers by du: Attractive introductory offers have incentivised many to open a du account as a trial, while still maintaining their Etisalat account. For example, du is offering a SIM for AED 55 with AED 54 worth of talk time, effectively costing the subscriber only AED 1. This may distort subscriber numbers in the short term, but as the introductory offers expire we expect that users will eventually migrate to a single provider based on quality of service and their unique requirements. More importantly, the ARPU numbers should offer a more consistent metric for investors to follow.
Business visitors using local SIM: Regular visitors to the UAE, mainly from other GCC countries, tend to use a local SIM when in the UAE to avoid roaming charges.High level of tourism: Tourists buy a SIM for the duration of their stay or expatriates maintain a spare SIM to lend to visiting friends and family.Local and expatriate population having multiple handsets: Many users are opting for one phone for business and one for personal use, as well as the use of devices such as Blackberries.Growth in mobile broadband: Mobile broadband requires a SIM card to work. Whilst the same SIM card can be used for both voice and data, some users will opt to have two SIM cards for convenience, especially if the SIM used for mobile broadband is used in a modem or directly inserted into the computer.Al Mal projects total mobile revenues to grow from AED 13.70 billion in 2007 to AED 18.02 billion in 2008 and to AED 21.08 billion by 2012. However, it sees monthly ARPUs declining from AED 163 in 2008 to AED 157 in 2009 and further to AED 148 by 2012, owing to competitive pressures.
Internet
The UAE has one of the highest rates of internet broadband penetration in the MENA region. However it remains low compared to the more developed markets of Western Europe and North America, thereby offering ample opportunity for growth.Al Mal projects Internet penetration to continue the rapid growth (16.1% CAGR since 2005) we have seen in recent years. Current UAE Internet penetration figures assume 2.4 users per subscription, according to the TRA. Over the next few years, can expect growth in both users and subscriptions, coupled with a fall in the number of users per subscription. Al Mal projects the number of subscribers to increase from 0.90 million in 2007 to 1.15 million in 2008, 1.44 million in 2009 to 2.66 million in 2012. Revenues from Internet subscriptions should grow from AED 1.46 billion in 2007 to 1.82 billion in 2008, AED 2.19 billion in 2009 and to AED 2.95 billion by 2012.Beyond the forecast period to 2012, Al Mal said it sees fixed-line broadband to mobile broadband substitution occurring; however, prices for mobile data packages would need to decrease dramatically for this to occur.
Fixed-line
The number of fixed-line subscribers is forecast to grow from 1.39 million in 2007 to 1.50 million in 2008, 1.63 million in 2009 and to 1.90 million by 2012. The modest fixed-line net additions are driven by population growth; however, penetration is still expected to remain constant at around 30% from 2008 to 2012.
Regulatory environment
The UAE’s Telecom Regulatory Authority was formed in 2003 with the aims of:
i) building and implementing a regulatory framework to foster and facilitate competition between telecom operators in accordance with World Trade Organization stipulations, and
ii) helping meet the federal government objective of turning the UAE into a regional ICT hub by developing training institutes and encouraging research and development.The TRA is funded through licence and spectrum fees as well as government funding via royalty fee payments.National roaming: The TRA requires Etisalat to offer roaming services to du on Etisalat’s own mobile network. As du continues to expand its own mobile network infrastructure, it is becoming less reliant on the roaming agreement. It is understood that du is still utilising a limited amount of Etisalat’s network in the Western and middle regions of the UAE.Mobile Number Portability (MNP): Initially MNP was planned to be introduced at the same time as du launched its mobile services, but its introduction has been delayed. The TRA has now stated that it intends to introduce MNP in 2008. If this is implemented on the basis of full number portability, including the prefix carrier code (050 for Etisalat, 055 for du), this will be have a material impact in determining market share and subscriber growth. However it is well known that telephone number are “sticky”. Without full number portability, users may be deterred from changing their operator because of the inconvenience of having to inform all their existing contacts of a new telephone number and the potential cost of having to changing business cards and other stationery.
Voice-over-Internet Protocol (VoIP): VoIP is allowed to be used on private telecommunication networks, i.e. corporate networks, but not to make international calls or calls to other networks. This means use of VoIP services like Skype, Net2Phone and Vonage are banned in the UAE. Under their licence terms, both
Etisalat and du can provide VoIP services to the public, but neither operator provides such service nor has indicated they will do in the future. We assume that the UAE’s ban on VoIP services such as Skype will continue for the time being. VoIP services were accessible from the free zone areas serviced by du, but have been blocked recently as du complies with the TRA policy on VoIP.Interconnection: Until recently, du enjoyed an unofficial monopoly of fixed-line services in most of the areas colloquially known as ‘New Dubai.’ Within most New Dubai areas, Etisalat’s internet, voice telephony, and TV services are delivered via du’s infrastructure. At the same time, du relies heavily on Etisalat’s wireline infrastructure for outgoing voice and data traffic from New Dubai.
Carrier selection and pre-selection: Under TRA regulations, fixed-line carrier and pre-selection is allowed and has been implemented by du, while Etisalat in the process of implementation. Once implemented fully, we could see users taking advantage of du’s cheaper peak time international charges. This should encourage Etisalat to lower its international call rates.
Evolving telecoms sector requires additional policies
Whilst the key regulatory policies are in place, additional policies are required to regulate new developments in the telecoms sector. Regulation is required in the following areas:
i. To regulate the activities of MVNOs that would require licenses to operate in the UAE.
ii. Both Etisalat and du are currently trialing WiMax and additional regulation would be needed to cover the deployment of WiMax and what services it could be used to provide.
iii. Many believe it would be beneficial for the country to have redundancy in the national backbone.
However, there are cost savings to be gained by both operators, (especially du) by sharing infrastructure. This is especially true with respect to the local loop, which would be costly to replicate, and potentially
reduce ROI, given the relatively small size of the UAE population. This would require regulation for local loop unbundling (LLU). LLU does raise issues regarding ownership and maintenance of any shared infrastructure, issues that would need to be resolved through additional regulation.As the UAE government has substantial shareholdings in both the operators, it is likely the regulatory regime will remain relatively benign towards both operators. The focus should be on developing regulation, to allow competition to develop over time, and protecting du from the market strength of Etisalat. This is in contrast to some of the more developed markets, where the focus is on reducing prices for the end
consumer , by capping return on investment on all or some of the services provided.
Investment thesis
Owing to the differences between Etisalat and du in terms of business strategy and maturity of the business lines, our investment approach is very different for both entities. In essence, Al Mal said it views Etisalat’s UAE operations as a “cash cow,” with an attractive dividend and the means to invest in growth opportunities internationally. du is a start-up operation competing against an entrenched former monopoly, with future performance linked to the development of the one market, the UAE.