Bio-metric verification takes its toll on 2016 performance

High leverage and contingent events overshadow strong operational performance. Zain Saudi has made strong progress on the operational side of the business during 2013-15. However, concerns remain on the financing side and contingent events. There is (i) scheduled debt repayment of SAR8.2bn in 2018 (3.9x 2018e EBITDA) (ii) pending lawsuit with Mobily (iii) dispute on Zakat assessment (iv) high level of accumulated losses as a % of share capital (v) need for equity financing (vi) uncertainty over tower sale.

Fairly valued both on a DCF and relative valuation basis. Zain KSA is trading at a 2017e EV/EBITDA of 8.5x compared to GCC telcos average of 4.6x. The premium, we believe, more than accounts for the higher growth trajectory (2016e-2019e EBITDA CAGR of 8.6%) for Zain Saudi. In addition, our DCF based value is SAR7.4/share offering a potential upside of 9.6%. Thus we recommend a HOLD for the stock.

Bio-metric verification to weigh in on 2016 performance. After a sharp rise in EBITDA margins in 2015 to 24.2% from 17.6% in 2014, EBITDA margins are expected to decline slightly in 2016 to 24.1% largely due to the costs associated with bio-metric verification. In addition we might see further declines in industry mobile subscriber base as unverified subscribers are disconnected after the verification deadline lapsed in July 2016.

Catalysts. With the key risks in mind, there are certain events which can trigger a stock price rally. (i) Extension of the license term (ii) Restructuring/re-financing of the Murabaha facility (iii) Further cuts in MTR or introduction of asymmetric termination rates (iv) Sale of mobile towers (v) Settlement of lawsuit with Mobily and dispute on Zakat in Zain Saudi’s favor.

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