RESEARCH DIVISION BROKERAGE AND INVESTMENT CENTERS DIVISION

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1 May Saudi Telecom Sector Research Division Company Reports Please read Disclaimer on the back All rights reserved, AlJAZIRA CAPITAL

2 RESEARCH DIVISION AGM - Head of Research Abdullah Alawi a.alawi@aljaziracapital.com.sa Senior Analyst Syed Taimure Akhtar s.akhtar@aljaziracapital.com.sa Analyst Saleh Al-Quati s.alquati@aljaziracapital.com.sa BROKERAGE AND INVESTMENT CENTERS DIVISION General Manager - Brokerage Division Ala a Al-Yousef a.yousef@aljaziracapital.com.sa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa lalmutawa@aljaziracapital.com.sa Regional Manager - West and South Regions Abdullah Al-Misbahi a.almisbahi@aljaziracapital.com.sa Area Manager - Qassim & Eastern Province Abdullah Al-Rahit aalrahit@aljaziracapital.com.sa Aljazira Capital is a Saudi Investment Company licensed by the Capital Market Authority (CMA), License No

3 Table of Contents Executive Summary 1 Strong secular growth, led primarily by mobile services 3 Relatively moderate growth in fixed line segment 3 Saudi telecom sector remains attractive 4 Data a promising pillar of growth 6 Voice market saturating fast 6 Data, the most logical step forward tremendous potential 9 Saudi Arabia on the verge of a broadband boom 11 Enterprise segment, an untapped area of growth for data services 14 Increasing usage of mobile beyond basic services 17 Transition to next-generation network becomes inevitable 19 Focused growth strategy, strong balance sheet hold key 21 Geographic expansion at the core of STC s strategy 22 Mobily among frontrunners in wireless data segment 22 STC and Mobily better placed to fund growth 24 Capital restructuring, the top priority for Zain KSA 25 Managing costs efficiently holds significant importance 26 Saudi Arabia Telecom Sector Evolution 31 Regulations in Saudi Arabia s telecom sector 32 Key Investment Risks 33 Stiff competition to continue exerting pressure on ARPU 33 Competition effect to services quality 33 Liquidity risk 33 Economic and geopolitical risk 33 Valuation analysis 34 Companies that look attractive 35 Saudi Telecom Company 36 MOBILY 40 Appendix 1: Saudi telecom sector Key metrics 43

4 Executive Summary The Saudi telecom sector is the largest in the Middle East, with over 56.0 mn mobile subscribers and over SAR77.0 bn in consolidated revenues. After staying dormant until 2000, the sector recorded supernormal growth in the past decade, thanks largely to liberalization of the sector since Today, the sector is highly competitive, with private players vying for market share by aggressively cutting tariffs in fact, this has been the trend for five years now. The voice market is fast approaching maturity, with total mobile penetration reaching 198.0% during We expect the traditional Voice segment to grow moderately, given that penetration is already high and competition is intense. However, there is scope for penetration to increase beyond 200.0%. The Data segment is expected to emerge as a new area of growth for Saudi telecom operators, especially since the traditional voice market is maturing fast. The Kingdom s young and tech-centric demographics, the rising craze for smart devices, and relatively high income levels should drive data consumption. Demand for smartphones is also catching on rapidly in Saudi Arabia, with penetration increasing from 17.0% in 2010 to 25.0% in Another key impetus for growth in the Data segment is the rising demand for broadband services. Despite strong growth, broadband penetration continues to remain comparatively low in Saudi Arabia. Standard mobile broadband penetration in the Kingdom stood at 9.7% in 2010, significantly low compared to the developed markets average of 56.6% and the global average of 17.0%. Fixed broadband penetration was also low at 6.3% compared to developed markets (25.7%) and the world (8.5%). Strong growth in broadband usage coupled with a surge in 3G and 4G services is likely to increase demand for high-speed data consumption and (consequently) drive data revenues. Data revenue is expected to constitute 25.0% of Saudi telecom operators total revenue by 2014 compared to 15.0% in We expect Mobily to be the clear market leader in this segment primarily due to its focused strategy aiming at capturing fast growing mobile broadband market. STC would remain competitive in the fixed broadband market primarily owing to its strong fixed line network infrastructure. The Enterprise segment is quickly emerging as a new area of focus for Saudi telecom operators. The segment is currently highly underserved compared to some European and developed countries. Saudi Arabia s robust macroeconomic fundamentals and stable growth outlook are likely to spur the establishment of new businesses. This coupled with the growing need for sophistication and better operational efficiency amongst Saudi companies, especially SMEs, bodes well for the Enterprise segment. Operators providing one-stop solutions stand a better chance of gaining a competitive advantage in the Enterprise segment, especially while catering to large corporate accounts. We expect STC to have competitive advantage over other operators in the enterprise segment. The company s ability to cater larger corporate account via fully integrated and bundled offerings that include fixed and mobile voice, fixed and mobile broadband, internet, data and ICT services could prove to be a key differentiating factor. To support the increased data potential, telecom operators are investing heavily to upgrade their technological infrastructure. STC launched 4G mobile services in partnership with Nokia Siemens Networks and Huawei for commercial use in Saudi Arabia in late Zain also signed partnership agreements with Motorola, Ericsson, and Huawei to offer LTE services in Riyadh, Jeddah, and Dammam. It plans to expand to other major cities by the end of.

5 Mobily has signed up with Samsung and Huawei to deploy its network, and also has plans to upgrade its WiMax network. A targeted growth strategy and healthy balance sheet are key focus areas for Saudi operators, given the rising competition and significant investment in infrastructure. Both STC and Mobily have a strong balance sheet and are well capitalized to fund growth. Commoditization of the mobile voice market and stiff competition in the domestic market have encouraged telecom operators to reduce tariffs for both standard and bundled services. STC s blended ARPU plunged 47.3% during FY to SAR72.0. Blended ARPU is expected to continue declining in Saudi Arabia during -14 due to growth in subscriber base and price reduction amid aggressive competition. However, the growing demand for mobile broadband and Value Added Services (VAS) services should help operators to partially offset the deterioration in ARPU. The rate of decline in ARPU in Saudi Arabia should fall by 2.0%-2.5% over the next three years. Hence, operators would do well to manage variable costs efficiently as a means to gain competitive advantage. Initiatives such as infrastructure sharing with existing operators, optimizing spectrum utilization, and technology optimization could help operators control variable costs and protect margins. We initiate coverage on three Saudi Arabian Telecom companies Saudi Telecom (STC) and Etihad Etisalat (Mobily), both with Overweight rating. We are considering STC (potential upside of 31.4%) due to its strong presence in the fast-growing fixed broadband and enterprise segments. International expansion in high-growth markets also provides potential to unlock value in the long term. In the case of Mobily (potential upside of 28.1%), its advantage in the mobile broadband segment and focus on achieving operational efficiency through cost minimization are key positives. Figure 1: Our picks from the Saudi Telecom Sector Unit STC Mobily 12-Month Target Price SAR Potential Upside % Current Market price SAR Market Capitalization SAR mn 84,200 47,775 YTD price change % P/E (12E) X P/B (12E) X EV/ EBITDA (12E) X Dividend Yield (12E) % Source: Zawya, AlJazira Capital

6 Strong secular growth, led primarily by mobile services The Saudi telecom sector has been a model of brisk growth in the past decade. The sector has come a long way in its transition from a slow, government-owned monopoly to a fiercely competitive market. The total domestic telecom services revenue grew at a robust CAGR of 13.2% to SAR60.6 bn during Total sector revenue (comprising of mobile/gsm, fixed and data and international operations), increased at a CAGR of 17.7% to SAR77.2 bn during the same period. This can be ascribed to the strong growth in subscriber base (primarily mobile subscribers) since 2004, when the sector was liberalized, making mobile services more affordable in the Kingdom. The government s efforts to open up the telecom sector 2004 onwards proved to be the key trigger for the phenomenal growth in the mobile segment. The Communications & Information Technology Commission (CITC) was established in 2003 to promote competition and provide optimal telecom services in a transparent regulatory environment. As a first step in this direction, in August 2004, the government awarded a mobile license to UAEbased Etisalat to compete against and break the monopoly of Saudi Telecom Company (STC). Competition in the industry intensified with issuance of more mobile licenses in The entry of new players encouraged companies operating in the sector to ramp up scale and adopt new technologies. In fact, telecom operators have invested SAR31.0 bn over the last three years ( ) to upgrade and develop technological infrastructure. The outcome of this has been beneficial for consumers. ARPU levels have fallen by more than 50.0% since 2005, and companies have been launching attractive packages since The mobile segment s growth can also be ascribed to strong demand side factors, such as attractive demographics (population growth of 2.5% per annum) and rising income levels in the last decade. Relatively moderate growth in fixed line segment Growth in KSA s fixed line market has not kept pace with the mobile market, partly due to a higher established base and the fact that competition in this segment is not very intense. Fixed line subscriptions increased at CAGR of 3.6% to 4.5 mn since With 3.3 mn residential fixed line subscribers, household density stands at 73.9% (in other words, 73.9% of Saudi households have fixed lines). Past trends indicate that over the last four years, household density for fixed lines averaged 73.5%, and has declined from 74.5% in Teledensity of fixed lines may increase marginally as a significant proportion of the population lives in areas that are too remote, or prefer to rely solely on mobile phones. In fact, in our opinion, 18% of Saudis live in outlying/remote villages, where establishing fixed line telephony may be not feasible in terms of both cost and implementation.

7 Saudi telecom sector remains attractive The Saudi telecom market witnessed relatively strong growth in 2010 in comparison to other developing economies in Asia and developed markets in Europe and North America. Telecom revenue in Saudi Arabia grew 16.0% in 2010 compared to Asia (4.0% growth), Europe (9.0% growth) and North America (12.0% growth). The overall GCC telecom market grew 17.0% in Kuwait 5.1 South Africa 9.8 Bahrain 9.8 Figure 2: KSA telecom robust revenue growth Indonesia Malaysia China Saudi Arabia Source: Bloomberg, AlJazira Capital Brazil UAE India CAGR ( ) China 8.1 India 10.2 Brazil 12.7 UAE 13.3 Figure 3: Healthy operating margins as well South Africa Kuwait Source: Bloomberg, AlJazira Capital Indonesia Saudi Arabia Oman Average ( ) Another contributing factor to the robust performance of the Saudi telecom industry is the growth of broadband penetration at an average CAGR of 123.0% during the last five years. In 2010 alone, the number of broadband subscriptions increased to 4.4 mn from 2.8 mn in However, broadband penetration remained low in comparison to developed markets, indicating there is further room to grow. Overall broadband penetration in Saudi Arabia stood at 15.6% in 2010, less than the 24.6% average for developed countries, but higher than the global average of 8.0% and the 4.4% average for developing countries. The Saudi telecom sector benefits from a favorable demographics profile and relatively high income levels. Approximately 57.0% of the population is under 30 years of age. Additionally, the GDP per capita income of Saudi nationals (USD19,890 per person in 2011) is much higher than other developing economies such as India (USD1,527 per person) and China (USD5183 per person). Therefore, ARPU levels in Saudi Arabia (USD20.8 in 2010) are higher compared to other emerging markets like India (USD2.8). Saudi Arabia s relatively younger demography and high income levels bode well for the telecom sector. The Saudi telecom sector s contribution to GDP was relatively low compared to developed economies, but better than developing countries such as India, China and Russia. The telecom sector contributed just 2.7% of Saudi Arabia s GDP. In comparison, the telecom sectors of developed economies such as UK and Spain contributed 4.3% and 4.1%, respectively, of the GDP. Nevertheless, the Saudi telecom sector has potential to grow further, especially considering that income levels are expected to increase at a healthy CAGR of 3.5% during

8 Figure 4: Our picks from the Saudi Telecom Sector 4.5 Brazil UK 4 Bahrain Spain Telecom Revenue (% of GDP) Saudi Arabia China Russia Oman Kuwait Australia Japan Italy US Singapore Germany Canada UAE India France Qatar 0 10,000 20,000 30,000 40,000 50,000 60,000 GDP per capita (USD) Source: Zawya, AlJazira Capital; Note:

9 Data a promising pillar of growth Most of the supernormal growth in Saudi Arabia s mobile segment in the last decade came from the voice segment. However, high-end data services, including broadband internet, are expected to lead the next wave. We believe the stage is set for Saudi telecom operators to capitalize on the Kingdom s immense potential in the Data segment. Saudi Arabia s young and tech-centric population, the growing popularity of smart devices, and the improved technical capabilities of operators would enable use of richer media content and drive data consumption. Furthermore, the Kingdom s significant potential in broadband, given its current underpenetrated nature, also augurs well for the Data segment. Wireless broadband, in particular, is likely to receive significant impetus with the introduction of 4G services. We expect the number of 3G and 4G subscribers to increase significantly over the next five years, especially with the introduction of mid- and low-end smartphones. The Enterprise segment is expected to emerge as another growth avenue for Saudi telecom operators. Currently, the segment is highly underpenetrated with SIM penetration less than 1%. However, Saudi Arabia s robust macroeconomic fundamentals are likely to spur the establishment of new businesses. The growing need for sophistication and a cost-effective one-stop-shop solution would also encourage telecom operators to tap this segment and offset saturation in the voice market. Voice market saturating fast The voice market is fast approaching maturity with significantly high penetration rates. As reported by the CITC, the number of mobile subscribers in KSA increased at an exponential CAGR of 34.0% during to reach 56.1 mn. This pushed total (including in active subscribers) penetration to 198.0% in 2011 compared to just 12.0% in The speed at which penetration increased from 100% to over 140.0% is remarkable. Total penetration increased from 12.0% to 138.0% in eight years ( ). It took just three years ( ) for penetration to advance from 167.0% to 198.0%. Very few emerging and developed countries in the world have witnessed a penetration spike as rapid as this. Our analysis suggests that the penetration rate in most developed countries already exceeded 50.0% in the early part of the decade. However, these markets currently lag Saudi Arabia in terms of penetration. Another factor that has emerged as a driving force for penetration over the last five years is the so-called double-sim (Two SIM cards/accounts per individual) effect. In our view, this trend has been induced by factors such as the relatively high number of foreigners/ expatriates using prepaid connections in Saudi Arabia roughly 87.5% of customers in the Kingdom use prepaid connections. Expatriates account for approximately 30.0% of the Saudi population, significantly higher than OECD average of %. Foreign workers and expatriate businessmen living in the Kingdom generally hold more than one SIM/ account. In fact, most businessmen use a smart phone besides their standard phone at the high end of the market. Furthermore, the propensity of Saudis to spend more has increased in tandem with rising income levels. Backed by high oil prices during the decade prices reached USD147 in 2008 compared to USD23 in 2002 per capita income doubled to around SAR80,000 (USD19,890) from SR32,900 (USD8,785) % % % 81% % % % % % Source: CITC, AlJazira Capital, * AlJazira estimate Figure 5: Voice market fast approaching maturity with robust growth in mobile market Subscribers (mn) % % 198 % 200 % 150 % % * 50 % 0 % Pre - paid subscribers (LHS) Total subscribers (LHS) Post - paid subscribers (LHS) Penetration (RHS)

10 It is important to consider the active penetration (excluding inactive accounts), while analyzing the mobile penetration rates in Saudi Arabia. This is due to the presence of sizeable number of inactive accounts in Saudi Arabia which may give a misleading picture with reference to mobile penetration. This can be gauged from the fact that penetration of active mobile subscribers (SIMs which have been in use in the last 90 days) stood 165.4% in 2011 compared to total penetration of 198.0%. In our opinion, the large number of inactive accounts can be ascribed to significant number of religious and business travelers visiting Saudi Arabia who require access to temporary SIMs. According to Kingdoms Ministry of Hajj on an average mn religious tourists visits Saudi Arabia each year for pilgrimage. Massive flow of religious tourists visiting Saudi Arabia for Hajj coupled with temporary business travelers play a key role in influencing inactive mobile accounts. Figure 6: Active penetration is high as well Source: CITC, AlJazira Capital Subscribers (mn) % 120% 80% 40% 0% Active subscribers (LHS) Active penetration (RHS) 2011* Figure 7: Comparatively high penetration* Source: CITC, ICT, AlJazira Capital, *Active penetration Mobile Penetration % Hong KSA Kuwait UAE Qatar UK Germany France US China India Outlook for voice segment: Moderate growth expected We believe the traditional voice market is fast approaching maturity and saturation, with overall penetration reaching 198.0% during The growth would be moderate and difficult to come by with ever increasing competition, especially when CITC is planning to issue licenses to Mobile Virtual Network Operators (MVNO), which, thus far exist only in Oman within the GCC region. We believe that with such high penetration levels and the likely entry of MVNOs, the traditional voice market would take a breather in terms of growth in subscriber base/penetration. However, there is still room for penetration to increase beyond 200.0%. This, in our view, can be attributed to the potential for use of multiple SIMs by low-income Saudis and expatriates. Another key potential driver of penetration in the voice segment is the growing demand for smart phones. This would be complemented by the anticipated healthy growth in population. IMF expects KSA s population to grow 2.2%-2.5% during , which, in our opinion, would add 7.9 mn new subscribers by Consequently, we expect mobile penetration in KSA to reach 211.0% in 2014 after increasing to 209.0% in We further anticipate active penetration rate to increase to 175.4% and 177.1% in 2013 and 2014, respectively.

11 Figure 8: Moderate growth in mobile penetration (F-2016F) Source: AlJazira Capital Subscribers (mn) % 180% 175% 170% 165% 160% % 2011E F 2013F 2014F 2015F 2016F Active subscribers (LHS) Active penetration (RHS) Extracting further value from subscribers will be pivotal Over the last five years, Saudi telecom operators focused on capturing market share in the Voice segment by aggressively adding new subscribers. However, this came at the expense of declining ARPU levels, as operators lured subscribers by reducing voice tariffs. According to our estimate, Saudi Arabia s blended ARPU plunged 56.7% during to SAR78.0, as both STC and Mobily reduced mobile tariffs to add subscribers. However, now that penetration has reached as high as 198%, these operators need to revisit their strategy and focus on deriving additional revenues from existing customers by increasing usage per subscriber. In other words, operators need to shift focus from gaining market share to being competitive. One such strategy adopted by players, such as STC and Mobily, is to increase the proportion of postpaid subscribers in the total subscriber base. This can be evinced from the fact that growth in postpaid subscribers (11.0%) outpaced the growth in prepaid subscribers (8.4%) for the first time during Mobily s management claims 12.0% of its subscribers currently hold postpaid connections, and this is expected to grow further in the coming years. Around 25.0% of STC s subscribers have postpaid connections. With the traditional Voice segment reaching maturity, operators would need to derive additional value from existing customers by increasing usage per subscriber. Figure 9: Growth in prepaid Vs post paid subscribers Source: AlJazira Capital Subscribers % % % % % % % % % % 0. 0 % E Prepaid subscribers (LHS) Prepaid subscribers growth% (RHS) Post paid subscribers (LHS) Post paid subscribers growth% (RHS)

12 Data, the most logical step forward tremendous potential Given the limited growth prospects in the traditional voice market, the Data segment has emerged as logical option for Saudi operators to seek alternative revenues and mitigate slowdown in the Voice segment. The Data segment holds tremendous potential for growth, given that internet is fast achieving mass market exposure in Saudi Arabia. Value-added services (VAS), which is typically reported under the Data segment, is set to surge as a percentage of total revenue for Saudi telecom operators. Data revenue in Saudi Arabia is still low at approximately15% of the total revenues when compared to 40.0% for the developed markets of the world. We believe strong underlying growth drivers are in place to drive data consumption. Young, tech-centric population Saudi Arabia is the most populous country in the GCC. The Kingdom s population (around 28 mn 2010) has been growing at an average rate of 2.5% each year during the last five years. The population is expected to continue growing at the same rate in the coming decade. In addition, the population of Saudi Arabia is one of the youngest in the world, with 57.0% below the age of 30 compared to UAE (49.6%), Kuwait (54.4%), Bahrain (49.5%), and Qatar (44.8%). In terms of the ratio of population below the age of 30, Saudi Arabia also compares well with other emerging countries such as China (43.2%), Brazil (50.9%), Russia (37.1%), and Malaysia (56.2%). This is a crucial factor for growth in mobile services, especially for the Data segment, as the youth are generally more tech-savvy and adopt new products and services quickly. Besides, with around 8 mn expatriates, this segment accounts for 30.0% of the total population. We believe the expatriate population is another important contributor to growth in the mobile data segment. Figure 10: Saudi Arabia s young population base Source: United Nations Population Department, AlJazira Capital 100 % 90 % 80 % 70 % 60 % 50 % 40 % 30 % 20 % 10 % 0 % ,233 1, Saudi Arbia UAE Kuwait Oman Bharain Qatar India China Brazil Russia South Africa Malaysia S.Korea age group Other age groups Total population (mn) Smart devices catching on Saudi Arabia s young population demographics, rising income levels and an expanding electronics retail sector have fueled demand for smart devices like notebooks, smartphones, 3D technology, PDAs and 3G handsets, and high-end gaming and digital solutions. Smartphones are catching on fast in Saudi Arabia, given the enhanced user experience, superior technical capabilities and support for various applications and services. Since the launch of Blackberry in 2006, the Saudi market has been flooded with new devices by leading handset manufacturers. Apple s i-phone 3G made its first appearance when Mobily launched it in Google Android smart phones, currently led by Samsung and HTC products, have also entered the Saudi market in the last two years. Consequently, the smartphones segment exhibited rapid growth in Saudi Arabia, with penetration increasing to 25.0% in 2011 from 17.0% in According to Informa, a leading telecom data provider, the penetration of smartphones in Saudi Arabia is expected to reach 44.8% by With increasing demand for smart devices, demand for data services is likely to increase significantly in the coming years.

13 Evolution of mobile devices High income bracket ( Young/affluent/ corporates/ Mid income bracket ( Young population) Low income bracket ( Mass ) Voice SMS Gaming Music Camera Internet Browsing Mobile financial services MMS Social networking Broadband internet Basic computing Figure 11: Growth in smartphones penetration to drive demand for data Source: Informa, AlJazira Capital l 25.0% 75.0% Smartphones share Basic and feature phones share 44.8% 55.2% E

14 Saudi Arabia on the verge of a broadband boom Development of the internet and broadband market plays a crucial role in influencing the demand for the data segment as it complements high-speed data provisions, applications and high-end gaming, and digital solutions. Although a recent phenomenon in Saudi Arabia, broadband internet has grown significantly over the last five years. The Kingdom is currently on the verge of a broadband boom with subscribers increasing at a CAGR of 133.5% to 4.4 mn during The number of standard broadband subscribers grew 31.3% Y-o-Y in 9M 2011, resulting in an overall penetration rate of 20.6%. The growth in the number of users can be ascribed to wider internet access, higher public awareness, and improvement in technological infrastructures. However, majority of this growth has come from wireless (Wimax & Mobile HSPA) broadband, the growing use of which enables customers to use a variety of data packages. Wireless connection accounted for 60.8% of total broadband connection in 2010, up from 47.6% in % Figure 12: Broadband market growing fast in Saudi Arabia Source: CITC, AlJazira Capital, as of 9M 2011, Note: Broadband subscribers for 2011 does not include Dedicated Mobile Data Subscriptions classified by CITC Subscribers (mn) % 20.0% CAGR ( )-133.5% 15.6% % 10.3% % % 4.1% 5.0% % 0.9% % * Fixed subscribers (LHS) Total broadband penetration (RHS) Mobile subscribers (LHS) Total broadband subscribers (mn) Despite strong growth in the broadband market, penetration levels continue to remain comparatively low in Saudi Arabia. Standard mobile broadband penetration 1 in the Kingdom stood at 9.7% in 2010, lower compared to the developed market average of 56.6% and world average of 17.0%. Furthermore, it remains low compared to some of the regional counterparts such as Bahrain (25.0%) and Oman (14.0%). At 6.3%, fixed broadband penetration was also lower compared to that of developed markets (25.7%) and the world (8.5%). Low broadband penetration, especially mobile broadband, provides an attractive opportunity to boost data revenue and offset the likely slowdown in the traditional voice segment. The uptrend in the number of broadband users is expected to continue; the Kingdom is likely to add 7.2 mn new standard broadband users by We believe the broadband growth cycle in Saudi Arabia would peak in with total subscribers increasing 32.4% Y-o-Y to 7.7 mn. Figure 13: Low fixed broadband penetration Source: ICT, AlJazira Capital Oman Kuwait Egypt Developing markets KSA Qatar World UAE Bahrain Developed markets Excluding subscriptions to dedicated data services over a mobile network which are purchased separately from voice services as a stand-alone service

15 Figure 14: Low mobile broadband penetration Source: ICT, AlJazira Capital Egypt UAE Developing markets Kuwait KSA Qatar Oman World Bahrain Developed markets Wireless broadband (Wimax & Mobile HSPA) to drive growth in data Although both mobile and fixed line broadband subscriptions are expected to surge, the former is likely to lead. Our rationale is based on the growing demand from the youth, increased affordability and growing popularity of smart/lifestyle mobile devices, and limited entertainment avenues in Saudi Arabia. With regard to supply side drivers, lack of technological infrastructure is no longer a hindrance as 3.5G/HSPA mobile services have emerged as an alternative to traditional copper-based fixed line DSL technology. Faster HSPA broadband is further supported by 21Mbps speed that would fuel broadband growth. Both STC and Mobily are well equipped, with 3.5G Wimax network, to support high-speed broadband. In addition, operators such as Mobily and Zain are aggressively investing in the acquisition of 4G and LTE (Long-Term Evolution). (The same has been discussed in detail in the following section on technological development and mobile infrastructure in Saudi Arabia.) We believe the following factors would also prove to be the key triggers for mobile broadband growth outpacing fixed line broadband. Operators may not find it economically feasible to cover the entire Kingdom through landlines given its huge land mass. There is a probability of multiplicity of connection in case of HSPA subscriptions as they are sold to individuals and not distributed among an entire household. Launch of 3G and 4G services provides further impetus for data consumption Demand for 3G and 4G services would be a key growth driver for the data segment, in our view. Our rationale is based on the fact that the data consumption level of 3G subscribers is 45% higher than that of 2G subscribers. Furthermore, owners of 4G-enabled smartphones (such as i-phone 4) use around 1.5 times more data than 3G owners. Hence, demand for 3G and 4G services would be crucial for sustaining growth in the data segment. In light of this, we present below our analysis of how the 3G and 4G market in Saudi Arabia is likely to progress in the next five years. The 3G subscriber base in Saudi Arabia has grown significantly in the last couple of years largely due to surging demand for high-speed internet amid increasing craze for devices such as smartphones and tablets. The 3G subscriber base has increased more than 50.0% during the period, and currently accounts for approximately 14.0% of total subscribers. While this would support the increasing data consumption, extension of 4G services in the Kingdom is likely to boost growth further. As discussed earlier, major players have invested in the acquisition of 4G technologies, and have tested LTE (commercially known as 4G) networks.

16 Telecom operators in Saudi Arabia are likely to increasingly adopt 4G technologies to meet the surge in demand for data services. However, demand for 4G is highly influenced by factors such as consumers acceptance of high-tech technology, income levels (4G services would be expensive vis-à-vis 3G) and demand for sophisticated services. Historically, Saudi Arabian consumers have not been very flexible with regard to acceptance of hightech technology (3G was launched only in 2010) compared to some of the developed and emerging markets. However, the trend is quickly reversing as the younger generation is becoming tech-savvy. This can be gauged from the significant growth in the 3G subscriber base within just two years of its launch in the Kingdom. This coupled with rising income levels of the younger generation hold significant latent potential for 4G services in Saudi Arabia. In the near to medium term, demand for 3G is expected to continue outpacing 4G as the market is still highly underserved compared to few developed markets. Also, 4G service in the Kingdom is in its infancy as operators continue to tackle the challenges of revamping the technological infrastructure needed to support it. We expect the 3G subscriber base to increase at a CAGR of 14.6% to 27.7 mn during On the other hand, growth in the 4G subscriber base is expected to accelerate post 2013; it is expected to expand at a CAGR of 51.3% to 11.8 mn during Accordingly, we expect 3G and 4G penetration in Saudi Arabia at 87.7% and 37.5%, respectively, by Figure 15: Growth in 3G & 4G subscribers Source: AlJazira Capital Subscribers (mn) E F 2013F 2014F 2015F 2016F 3G subscribers 4G subscribers Figure 16: Share of 3G & 4G subscribers % Source: AlJazira Capital 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% E F 2013F 2014F 2015F 2016F 2G Subscribers 3G Subscribers 4G Subscribers We believe the strong growth in mobile broadband usage and the surge in demand for 3G and 4G services are likely to boost the demand for high-speed data consumption. This, in turn, would boost the VAS revenue of telecom operators which is typically reported under data revenues. Data revenue s contribution to total revenues is low for Saudi Arabia (accounting for approximately 15.0%) compared to that for developed markets (40.0%) and emerging markets such as China (22.0%). We expect data revenues to rise quickly in the coming years with increased data consumption and usage of VAS. Accordingly, we project data revenue, as percentage of total revenues, for Saudi Arabia to increase to 25.0% in 2014.

17 Figure 17: Low share of data revenues (%) Source: AlJazira Capital KSA Malaysia Korea Taiwan Singapore China Australia Developed markets HongKong Japan Figure 18: Data revenues expected to surge Source: AlJazira Capital Data as % of total revenue 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 25.0% 21.0% 15.0% 17.0% 12.6% 10.6% 8.4% E F 2013F 2014F Enterprise segment, an untapped area of growth for data services The enterprise/corporate segment holds significant growth opportunities for telecom operators in Saudi Arabia that are yet to be tapped. According to Booz & Company, enterprise SIM penetration in MENA countries, including Saudi Arabia, stands at less than 1.0% relative to 6.5% in European nations. Also, Information and Communication Technology (ICT) spending in Saudi Arabia is currently less than one-fifth of that in Western Europe and just one-tenth of that in the US. Furthermore, revenue from the enterprise segment accounts for 17.0% (on average) of the total revenue for major European operators. This provides ample opportunity for Saudi telecom operators to tap this market, especially considering that the Kingdom s macroeconomic fundamentals are sound. This, in our opinion, is crucial as demand for telecom services from the corporate sector is highly correlated to the economy s performance. The Kingdom s economy proved its resilience during the financial crisis of 2008 and emerged relatively unscathed from global economic slowdown. After remaining flat during 2009, the Saudi Arabian economy grew a healthy 4.1% in real terms during Provisional numbers indicate that the Kingdom s GDP is likely to expand 6.1% in 2011, where listed companies combined earnings grew 24.0% Y-o-Y during 9M The IMF expects Saudi Arabia s economy to grow at an average annual rate of 4.7% over the next five years. KSA, which was ranked 11th among 183 economies and the first in the MENA region in terms of ease of doing business in 2011, is expected to witness a substantial flow of new businesses.

18 The Kingdom s economy is fast moving from being traditionally oil-based to service-oriented, largely due to the government s diversification efforts. This, in turn, would require businesses to become more sophisticated in their infrastructure need. Saudi businesses would need advanced telecom services that can improve their efficiency and competitiveness. Enterprise demand for high-end telecom services (such as data services) holds significant potential in Saudi Arabia, given the increased need for mobility, seamless integration of communication functionality and web-based technologies. In addition, government initiatives are contributing to the growing need for advanced telecom services. The government has launched several e-projects that require major development of the telecommunication sector under the National Communications and Information Technology Plan (NCITP). Development of the King Abdullah Science Park (KASP) and Information & Communications Centre (ITCC) are two examples of the initiatives undertaken by the government. Figure 19: High proportion of enterprise revenue for European operators (2010) Source: GOSI, AlJazira Capital Revenue mix 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 74.7% 84.1% 83.0% 85.8% 25.3% 15.9% 17.0% 14.2% Swisscom Orange Telstra TeliaSonera Enterprise Consumer SME segment lucrative The number of business establishments in Saudi Arabia increased at a CAGR of 15.7% during This growth is largely driven by small and medium enterprises (SMEs), which are an integral part of the business environment in KSA. The number of SMEs in Saudi Arabia rose at an average annual rate of 20.0% during , accounting for more than 97.0% of the total business establishments. SMEs are also increasingly acquiring sophistication with the growing need for mobile and data services. SMEs are looking for integrated and customized cost-effective solutions to meet their mobile and data services needs. Furthermore, as SMEs in Saudi Arabia do not have in-house IT capabilities, there is ample opportunity for telecom operators to provide services that would help these businesses meet their specific objectives such as reduction in costs, increase in productivity and improvement in customer satisfaction. The number of business establishments as well as their telecom expenditure is expected to increase substantially, considering the positive macroeconomic outlook for the Kingdom and its improving business environment. Number of business establishment Saudi Arabia is expected to register a healthy growth of 12.0% during Robust increase in the number of enterprises in Saudi Arabia presents a key growth opportunity for telecom operators. Figure 20: Growth in business establishment to boost demand for corporate telecom services Source: GOSI, AlJazira Capital N. of enterprise (000') x CAGR Total: 15.7% CAGR Total: 12.0% x E 2011E E 2013E 2014E SME Large SMEs, Micros and others

19 How to target SME segment effectively? Identify customers based on key indicators such as telecom expenditure and service sophistication. Design customized and bundled solutions that would provide under one roof experience. For instance, STC s Flex plan is a postpaid plan that works with prepaid recharge vouchers. This allows SMEs to control their budgets by setting a fixed credit amount, which employees can access on monthly basis. Provide high-end SMEs solutions that would require minimal investment upfront (for instance, software-as-a-service (SaaS) and cloud computing services). In our opinion, the following business areas offer attractive opportunity in the broad enterprise segment: Net working services that are seamless and improve productivity; operators can offer integrated platform for voice, video, internet, messaging and other data services. Services providing comprehensive connectivity across branches, regions and nations. Management and maintenance of corporate network, cloud computing, and ancillary services such as implementation and management of network security. Real time services such as Internet Protocol telephony (IP) telephony, , and instant messaging, among others. Branch Offices Figure 21: Strong potential for endto-end enterprise solutions Source: AlJazira Capital Data Centre/Network control WAN ERP VOIP Video Calls Home Offices (SOHO) Headquarters Internet

20 STC competitively positioned in enterprise segment; Mobily playing catch up STC dominates the enterprise segment of the Saudi telecommunication industry, with more than 435,000 corporate accounts. The company has significant presence in SME segment, which accounts for 98.6% of its total corporate accounts. This indicates that STC must tap large business accounts to maintain its dominant position and generate more value from the enterprise segment. Mobily, although a late entrant, is increasingly capturing large corporate accounts. The company s deployment of the LTE infrastructure as well as its recent strategic partnership with Google Inc to provide high support for enterprise computing would help it in this regard. It has already secured some big-ticket corporate clients. For instance, Mobily was selected by SABIC for its IP VPN project, and chosen by the General Organization for Social Insurance (GOSI) for the Wahat Ghurnatah business park. We believe providing one-stop solutions would be the key to gain competitive advantage in the enterprise segment, especially while catering to large corporate accounts. STC offers fully integrated offerings that include fixed and mobile voice, fixed and mobile broadband, internet, data and ICT services. The company is engaged in developing the telecom infrastructure in new economic cities, focusing on services such as broadband, fiber-tothe-factory, Wifi, WiMAX and VAS. The product roadmap includes managed as well as advanced services such as cloud computing and M2M-based services. We believe STC has the scale as well as the advanced infrastructure required to grow in the enterprise segment. The company was the first operator to launch a cloud-based ehealth solution, Easy Clinic. In addition, STC s experience in serving big-ticket corporate accounts would give it a competitive edge, in our opinion. Its corporate clientele includes top Saudi Arabian organizations such as government ministries and major companies. Increasing usage of mobile beyond basic services Mirroring the trend in developed as well as emerging markets, consumers in Saudi Arabia are using mobile phones for several services beyond basics. Some of these are mobile financial services (MFS), e-commerce and healthcare-related services. MFS, particularly, has been gaining rapid traction over the last few years due to the dominant role of capital and financial markets in the Kingdom s economy. Although the service is in its nascent stage in Saudi Arabia, the potential for growth is significant, considering that financial institutes are looking to provide innovative and cost-effective banking solutions to customers through mobile phones. Internet and mobile banking services are rapidly emerging as major sources of information, sales and service; and efficient channels to interact with customers. In our view, Saudi Arabia is at an advantageous position to capture the MFS opportunity due to the following key factors: Established electronic platforms, such as the SADAD payment system, in the Kingdom provide a strong foundation. SADAD, a national electronic billing and payment (EBP) service, facilitates faster and more efficient centralized electronic billing and payment for consumers and business customers. Strong regulatory bodies such as the SAMA and CITC in KSA seek to create a standardized system. The Kingdom has a large expatriate population compared to other emerging markets. This opens up avenues for services, such as fund transfer, through mobile phones. Policies and legislative reforms by the SAMA ensure a strong legal framework for financial services. We believe MFS offers telecom operators the opportunity to complement and expand current offerings, and differentiate themselves from competitors in the long term.