Saudi telecom market analysis highlights private sector financing gaps and dominance of state-owned STC

Chart 53: Data as % of mobile service revenues Chart 54: Household Broadband penetration 50,000 ait 50,000 Kuwait 45,000 many 45,000 UAE o 40,000 40,000 w w S 35,000 S 35,000 ae : = # 30,000 8 30,000 a) =) ge 25,000 25,000 20,000 ; 8 Zz" fgentina Chile = mais = 15,000 ey mw Brazil & 15,000 10,000 South Africa : Hunga Nigeria J BR. sia 1 "0,000 Indonesi Ser Brazil Romtih a my 5,000 i ina South Africa 5.000 Tunisia OMe@HAa Russia 0 0% 10% 20% 30% 40% 50% 0% Pakjsgan 40% 60% 80% Data as % of service revenues Broadband household penetration Source: BofA Merrill Lynch Global Research, Telegeography and company data Source: BofA Merrill Lynch Global Research, Telegeography and company data Private sector participation and investment will be crucial... Whilst the government has earmarked cUS$2bn for the expansion of FTTH and wireless infrastructure (with a view to ultimately increasing internet usage), we believe this will likely be insufficient to meet the needs of the NTP’s ambitious targets (based on costs of rolling out existing wireless and FTTH networks). As such, we believe the private sector (Zain KSA, Mobily and STC) will be key contributors to the financing of the expansion plan. ..intensifying the case for creation of a Saudi tower company The Saudi telecom service providers have invested heavily in rolling out high speed wireless networks and, in the case of Mobily and STC, FTTH networks (not to mention license costs). This has seen the balance sheets of both Mobily and Zain KSA reaching relatively high gearing levels; thereby limiting their ability to step up capital expenditure for a sustained period. Consequently, we believe the focus on raising capital (to fund the expansion programmes) from the spin out of their Tower portfolios will only increase. We see Zain KSA as the key beneficiary of this given they have the most highly geared balance sheet amongst Saudi Telco peers. Mobile market share gains for Zain KSA and Mobily increasingly important Whilst the Saudi government has taken steps to introduce competition in the telecommunications industry, its moves to open the market have thus fallen short of this objective. Specifically, government-owned STC retains more than 60% revenue market share in Saudi Arabia, giving it a dominant position in the market, whilst Mobily and Zain KSA have only managed to achieve c25% and 15% revenue market share respectively. This, in our view, has likely been driven by a number of factors including: (1) the relatively high cost of market entry (ie licenses) for both Mobily and Zain KSA, which has lumbered both with high operating costs; (2) high royalty costs, which amount to c16% of revenues generated in Saudi Arabia (with some exceptions, including data), arguably inhibiting requisite marketing and infrastructure spend. We note both Mobily and Zain KSA remain loss making; and, (3) the relatively high mobile termination rates, which arguably afford an advantage to STC and prevent Zain or Mobily from competing more aggressively on price. For the realisation of the NTP, we believe it is important that all private sector players are realising sufficient rates of return and FCF generation to be able to finance the requisite growth in infrastructure. We note both Mobily and Zain KSA were loss making in 2015 and are expected to return sub 5% ROE’s in both 2016 and 2017 (according to OS merrill Lynch GEMs Paper #26 | 30 June 2016 49 HOUSE_OVERSIGHT_016159