April 2014 Egyptian Company for Mobile Services S.A.E. (mobinil) Analysts Contact: Egypt – Cairo Tel. (202) 3749 5616 Fax (202) 3749 6184 Opportunities/Strengths Marwa Ezzat M. Osman - Senior Risk Rating Analyst marwa.ezzat@merisratings.com Miglena Spasova - Senior Risk Rating Analyst miglena.spasova@merisratings.com Radwa Weshahy - Risk Rating Analyst radwa.weshahy@merisratings.com Rating Table: Current Rating Previous Rating Entity Rating: Senior Unsecured A- A Bond Rating: Senior Unsecured A- A- Negative Negative Category Rating Outlook Risks/Weaknesses Stand Alone Operating Statistics: Figures in EGP mn 3 Yrs Average* FY13 FY 12 FY 11 AROA % (1.5) (2.5) (1.0) (1.0) AROE % (10.3) (17.8) (6.5) (5.0) EBIT 842.4 588.6 825.0 1,113.6 8.5 5.9 8.4 11.4 3,282.8 3,065.8 3,344.1 3,438.5 33.3 30.7 34.0 35.2 EBIT Margin % EBITDA EBITDA Margin % * Based on FY11, FY12, and FY13 results. NB: EBITDA and EBIT figures exclude provisions and provisions no longer required Stand Alone Key Statistics: Figures in EGP mn Turnover 3 Yrs Average* FY13 FY12 FY11 9,864.9 9,995.0 9,831.9 9,768.0 16,447.0 15,967.7 16,596.5 16,776.7 Debt/EBITDA(x) 2.6 2.8 2.4 2.4 EBITDA/Interest Expenses (x) 3.6 3.1 3.8 4.1 Total Assets A strong and unified senior management team, with a clear vision and strategy, working hard on overcoming the existing obstacles. A clear shift in management strategy and focus on value creation, rather than sheer market share leadership. Strong shareholder and an experienced management partner, who have a strategic interest in their Egyptian operations. Simplified shareholding structure following Orange’s acquisition is reflecting positively on operations and by easing the complexity of the decision making process. One of the leading mobile operators in Egypt with proven track record and strong brand equity. The implication of the unified license on the business operation as well as on the future cash flow are still unclear. The volatility in the telecom industry is foreseen to further intensify competitive environment. Increasingly competitive and challenging operating environment, exerting negative pressure on margins and market share. Significant weakening in the operating and financial metrics due to a number of factors additionally aggravated by the increased political uncertainty and general deterioration in the macro-economic conditions. The Egyptian pound devaluation will exert extra pressure on the company’s business operation, especially on the capex exposure. High capex requirements needed for capacity expansion and network enhancement negatively affecting mobinil’s free cash flow generation. Loss of market leadership, further exacerbated by the loss of subscribers. * Based on FY11, FY12, and FY13 results. NB: EBITDA and EBIT figures exclude provisions and provisions no longer required 1 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil Summary Rating Rationale MERIS (Middle East Rating & Investors Service) reviewed the senior unsecured debt - NSR - of the Egyptian Company for Mobile Service (mobinil). MERIS has downgraded the entity rating to an “A-” grade from “A”, while maintaining the instrument rating at “A-”. The outlook for both the entity and the instrument ratings remains at "Negative Outlook". The change in the entity rating was triggered by the volatility in the telecom industry over the last years, which is expected to be further intensified over the short to medium term following the entrance of the fourth mobile operator. The timing of the changes in the industry dynamics is very critical for the already saturated mobile market in general and mobinil in specific, which already suffers from fragile credit metrics since 2011. Going forward, we expect that mobinil’s financial ratios will remain weak for at least 2014 with no prospects of recovery in the short term to levels commensurate with the previous rating category. MERIS is concerned regarding the company’s stressed operating and financial performance. The drop in performance was evident through (i) the notable decline in the quantitative aspects, witnessed in weak revenue growth, a significant deterioration in bottom line results, and profitability margins. This has also adversely affected the leverage and coverage positions; (ii) the loss of its lead market position as a result of the erosion in market share from 40% in 2010, to roughly 34% in 2013. Moreover, the recent devaluation of the Egyptian pound exposes the company to significant foreign exchange risk, which adds to the already sensitive cash flow metrics. MERIS views the capital expenditures related to network expansion and enhancement as a necessary requirement to maintain the company’s technological competitiveness in the market. It is worth mentioning that management/shareholders have implemented actions to mitigate the effect of the companies deteriorating domestic performance on credit metrics, including: i) exploring innovative financing options to enhance the cash resources, in order to relief the pressure on the leverage as well as coverage fronts, to a certain extent; ii) rationalizing the cost structure; iii) recommendation of the management to the board not to distribute dividends going forward (which was accepted in 2012). MERIS believes that management will continue its initiatives to mitigate the risk of the increasingly tough operating and regulatory environment; nonetheless, we are concerned that these actions might not be sufficient to fully offset the company's increased business risk amidst a challenging industry and macroeconomic conditions. Moreover, we believe that further cost cutting opportunities might be diminishing, on top of rising pressure on the financing need. In a recent action, the Telecom Ministry has announced the unified license preliminary term sheet, which gives the local telecom operators the rights to provide all the telecommunication services. There are several details/aspects are still under negotiation, including the detailed payment terms, therefore, the implication of the proposed license on the business operation as well as the future cash flow is unclear. Mobinil issued the second unsecured bullet bond amounting to EGP 1.5bn in 2010, which will be maturing in January 2015. At the time of issuance, the bullet feature of the instrument placed the bondholders in a structurally subordinated position in terms of payment compared to the other lenders of the company. MERIS has reviewed this clause taking into consideration that the bond is fully due early next year, and the bondholders will be repaid before certain of the existing lenders. As such, MERIS affirmed the bond rating at A-, with a Negative outlook. Rating Outlook The negative outlook reflects the increased risks to M mobinil business from the challenging operating/industry environment, which might impose further pressure on the company’s business operation and financial performance. The outlook could move to stable if there is more clear perspective in the regulatory and macroeconomic environment and there is a stable and contained foreign currency market. A return to positive profitability growth across the industry, combined with stable margins and sustainable cash flow, would also lead to a stable outlook. What Could Change the Rating Up Although not currently expected in view of the recent rating action, MERIS could consider a rating upgrade if the company: i) improves its financial profile by enhancing its operating margins, cash flow metrics and leverage position to level close to 2010 results; ii) strengthens its cash-flow generation, translating into sustainable positive free cash flows; iii) debt protection and coverage ratios were to strengthen significantly as a result of improvements in its free cash flows and reduction in debt; iv) succeed in fully integrating its business with the key shareholder and thereby realize marketing and operational synergies. What Could Change the Rating Down The rating could be further downgraded if: i) the company’s financial performance continues its downward spiral as a result of the increased intensity in the competitive environment and the stressed macro-economic conditions; ii) the cash flow metrics weaken further under the pressure of dividend distribution and/or excessive capex/investment outlays, which might result in additional indebtedness. 2 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil Company Profile The Egyptian Company for Mobile Services (ECMS) is a leading wireless telecom service provider in Egypt. ECMS operates under the brand name mobinil and has 34.8mn subscribers as of December 2013 (33.8mn as of December 2012), which translates into a market share of approximately 34%. Its network of 6620 sites at the end of 2013 and 34 switches currently covers most of the urban areas in Egypt, or 99.66% of the population. ECMS was initially established in November 1997 by the state-owned Arab Republic of Egypt National Telecommunication Organization (ARENTO), which was succeeded by Telecom Egypt (TE). The company commenced its operations in May 1998, when all the mobile-related assets of TE were sold off to Mobinil Telecommunications, a consortium comprised of one local and two international telecom giants, Orascom Telecom Holding (OTH) France Telecom (FT), and Motorola. Afterwards, the company was owned by two of its founding shareholders OTH and FT/Orange Group, with direct and indirect ownership of 34.6% and 36.4% respectively. The remaining 29% of the shares represented free float. OTH name was changed to Orascom Telecom Media Technology (OTMT) in light of the acquisition of VimpelCom Ltd. In 2012, Orange acquired additional stake in mobinil, ultimately gaining majority control of the company with a total shareholding of roughly 94%. As a result, OTMT’s share was reduced to only 5% and the balance represents free float. According to management, it is not foreseen to have any significant changes in the shareholding structure, if the macro-economic conditions remain challenging as they are today”. Key Rating Considerations BUSINESS RISK FACTORS FACTOR 1: Size, Scale, Business Model and Competitive Environment Mobinil is a leading mobile operator in Egypt. It is the second largest national player in terms of subscribers, roughly 34.8mn subscriber as of December 2013, reporting 2.9% growth rate on Y-o-Y basis, compared to 33.8mn as of FY12. Management views the decline in the growth of the subscriber base in line with its revised strategy to focus on capturing value driven/ high quality customers. With equal note, despite the moderate size and scale of the business by industry norms, Mobinil still enjoys some of the benefits of larger companies by making use of the strength and size of its strategic shareholder (Orange) and management partner (OTMT), when making equipment purchases and entering into roaming agreements. Furthermore, mobinil’s commercial and marketing departments maintain strong links with their counterparts at Orange, sharing best practice and market knowledge. Thus, the relationship with its strategic shareholder and management partner gives the company some additional strength, beyond that of a pure independent player. The company’s business operations experienced a number of challenges over the last years, due to various internal as well as external factors, which was reflected in substantial changes in the company’s profile. The serious drop in performance started in 2010, the main challenge facing the company was the limited dial up numbers, which suppressed the company’s growth prospects. In 2011, the company faced a number of obstacles of various nature, which adversely affected its operations and financial performance. The main causes for the company’s weakened position in 2011 included the boycott campaign in 2011, following the highly politicized tweet and the subsequent loss th of subscribers and brand damage, in addition to the political and economic turmoil, following the January 25 Revolution . The combined effect of all these events was reflected in a significant drop in mobinil’s market share from approximately 40% in 2010 to roughly 34% in December 2013, a decline in EBITDA figure by roughly 32% (between FY10 and FY13). Going forward, the challenging operating environment as well as the stressed macro-economic conditions added further pressure to the performance. With equal note, the introduction of the unified license, which is expected to materialize in the short term horizon, is anticipated to further stress the market fundamentals and intensify the competitive environment. The management team, which is one of the positive key rating consideration, has a solid experience in the telecom industry both in the local and the international markets. MERIS met with the top management and believes that they form a strong and unified team with a clear view and strategy for the company’s way forward. The team is well aware of the challenges and is working hard to overcome the existing obstacles, which is considered a positive factor to the rating. 3 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil Historically, mobinil’s strategy has focused on growing its subscribers’ numbers and was the first to introduce new aggressive offers to the market, maintaining leading market share until 2010/2011. However, in light of the saturation of the local mobile market, management reviewed the growth strategy to include a more pronounced shift towards value creation. Nonetheless, management underscored the need to maintain a leading market share as well. This was reflected in low net ads figures over the last two years (FY13: 968K, FY12: 926k, compared to 2.7mn in FY11). As part of its value oriented strategy, management is planning to expand rapidly on the data/broadband front, taking into account the low penetration rate, which offers high growth opportunities. In this regard, mobinil will in particular capitalize on its fully owned subsidiary Link Dot Net, which was acquired in 2H10. Mobinil offers a diversified product mix covering both the corporate and retail market segments. With regard to the retail segment it continued pursuing a dual strategy, targeting both the lower and higher ends of the market. Staying close to the customers, understanding their needs and creating the right products to address the clients’ different needs is at the core of mobinil’s commercial strategy. Voice telephony is the main revenue stream for the company, but following the rollout of the 3G network, it also provides other services such as mobile broadband. Going forward, the company will continue expanding in value-added services, broadband services and others to compensate for the expected decline in the voice business. In terms of business model, mobinil is a local wireless operator with a focus on growing its operations organically and with no appetite for regional or international expansion. In general, MERIS views a mobile only operation as a less robust business model than a fully integrated telecom provider. Integrated players have sounder platforms for adopting a range of new products and benefit from the diversity of their business risks. Nevertheless, pursuing an integrated business model in Egypt is currently not an option for the wireless operators, as long as Telecom Egypt remains the sole provider of fixed-line services. The award of the unified license including second fixed-line operator license has been postponed several times by the government. The Unified license is assumed to liberalize the local telecom market. In a recent action, the Telecom Ministry announced the preliminary outline for the proposed license terms and conditions. The unified license is an integrated license, with four components. It will give the telecom operators the rights to provide all the telecommunication services, such as, voice services (mobile and fixed lines), transmission fibers, international gateway, and full unbundling…etc. It will include: 1) granting Telecom Egypt the right to initially enter the local mobile market by a virtual network, capitalizing on the existing operators mobile networks and once Telecom Egypt acquired the frequency offered, it will start building their own mobile networks to be ready for the second phase. The mobile license cost will be EGP 2.5bn, in addition to a revenue sharing agreement; 2) offering the existing mobile operators full unbundling/the virtual fixed license against EGP 100mn and certain revenue sharing agreement; 3) reviewing the terms and conditions to the international gateway license which was offered previously, whereby, mobinil and Vodafone will pay up front fees amounting to EGP 1.5bn and EGP 1.8bn respectively, in addition to 6% revenue sharing fees; and 4) offering the operators to enter into an infrastructure company that will have license to build a transmission network against EGP 300mn and certain revenue sharing agreement. Currently there are on-going negotiations between the telecom operators and several government authorities to finalize the license terms, at the same time to reach an agreement with regard to the other pending components (i.e. the fiber optic network ..etc) and to solve the existing disputes/conflicts between the telecom players. According to management they are currently exploring the feasibility of all the components under the license; therefore, the investments and capex needs attached to the license are not clear yet. MERIS believes that the outlook for the local mobile industry is negative, as we expect that the market dynamics will continue to intensify competition and further squeeze profitability margins to add extra pressure to the fully penetrated market. Moreover, the implication on the cash flow in the short term, is not certain yet; as it will depend highly on which component management will explore and the payment terms for each. On the other hand, the recent devaluation of the Egyptian pound as well as the uncertainty surrounding the th political and economic environment since the January 25 Revolution, add to the pressure on the company’s revenue especially that the consumer is anticipated to be increasingly price-sensitive. Factor 2: Operating Environment (a) Regulatory & Industry Framework In MERIS’s view, the regulatory environment in Egypt is still volatile with a considerable degree of uncertainty. Liberalization of the Egyptian telecom market started in 1998 through the issuance of two mobile network operating 4 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil licenses. Furthermore, 1998 saw the establishment of the Ministry of Communications and Information Technology (MCIT) with the responsibility of developing Egypt’s ICT infrastructure, stimulating the knowledge economy and forging an e-government strategy and a legal framework that is in line with international digital requirements. Liberalization was further advanced by the Telecommunication Regulation Law (No. 10) of February 2003. The law rests on four main pillars: information disclosure, free competition, the provision of unified services and user protection. A central aspect of the law was the creation of the National Telecom Regulatory Authority (NTRA), which replaced the Telecom Regulatory Authority (TRA) in 2003 and took over all the regulatory functions as an independent regulatory authority. While liberalization has been progressing relatively smoothly, criticism has centered on the overprotection of the incumbent telecom operator. Among some of the challenges to the liberalization process is the role of the Ministry of Communications and Information Technology in overseeing both the regulator and Telecom Egypt (80% government owned and the sole fixed line service provider), a dual role that makes for a difficult balancing act. The intricate position of the regulator has been played out in the recent interconnection dispute between mobinil and Telecom Egypt (TE) since 2007. NTRA had sided with TE’s decision to lower its fixed-to-mobile termination rates, despite the existing effective agreement between TE and the wireless operator. mobinil, as well as Vodafone, have appealed the decision and filed law suits against NTRA, to decide on which interconnection rate to apply (i.e. either the initially agreed upon rate stated in the contracts or the lower rate proposed by NTRA). At the same time, there is another lawsuit appealed by the same mobile operators against NTRA claiming that the regulator has no right to interfere in the termination rates agreed upon between telecom operators. On August 2013, the court ruled out a final and non-appealable decision on the first litigation, confirming the mobile operators rights to stick to the initial terms of the contracts between TE and mobile operators. As for the second lawsuit, it is still in court; however, there is no financial or any other obligation that may arise from the remaining case as it is on the substance of the problem not on the termination rate itself. Over the last three years, the dynamics of the telecom industry in Egypt notably have changed; due to the weak macroeconomic conditions and the low GDP growth rate, which keeps consumer price sensitive. MERIS believes that the outlook for the local mobile industry is negative, as the market will entail higher business risk, especially following the entrance of a fourth mobile operator. In general, the integrated incumbent operators such as TE might fare better than companies with just mobile or fixed offerings because they can offer bundled voice and data services, adding extra pressure to the already squeezed sector margins. Despite the fact that the changes in the market dynamics will enhance the service offering, it will further intensify the competition; as the companies will fight to gain or retain their market share. As such, the sector will remain on negative outlook due to the slow pace of the macroeconomic conditions and the intensified competition, this is reflected in uncertain sustainability of the revenue recovery, as well as margins and financial metrics. (b) Technology Risk MERIS’s ratings take into consideration a company’s exposure to technological advancement and how well positioned it might be in handling such developments. The ratings also factor in the potential capital expenditure implications of any technological improvements and advances. (c) Market Share As we highlighted earlier, mobinil’s market share was pressured significantly since 2010 culminating in the loss of its market lead to Vodafone in 2011; dropping from 40% to 34.2% as of FY13. As we mentioned earlier, the main reasons contributing to the drop in market share were the tweet-related political controversy, which led to a boycott campaign against the company, in addition to the challenging operating and market environment. Despite the fact that management is working hard on maintaining the current market share, the entrance of the fourth mobile operator is expected to further challenge the current position. On the subscribers’ front, mobinil’s subscriber mix remains predominantly prepaid, as the local market is predominantly prepaid in nature. Initially, the rapid expansion of prepaid services in the market has been the main tool for the operators in their quest for expanding their respective market shares. It is worth mentioning that the increasing prominence of prepaid tariffs, however, has been reflected in the operators’ declining ARPU levels, as prepaid spending levels are 6-7 times lower than postpaid levels. This stark difference in spending levels between the two market segments illustrates the acute need for operators to improve their subscriber mixes and introduce new services. Mobinil have slightly higher number of postpaid customers. Historically, Vodafone used to have a relatively better subscriber mix, as illustrated by its higher ARPU. However, following vodafone’s aggressive subscriber base 5 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil expansion initiatives, which led to the acquisition of mostly lower income clients, it has recently narrowed the gap with mobinil’s blended ARPU. Going forward, in accordance with management’s revised growth plan, mobinil will continue to focus on the postpaid segment, with relatively higher income generation capacity. Moreover, management introduced new postpaid bundle offers to cater to the needs of the upper bracket of the prepaid segment. These initiatives decreased the contribution of prepaid segment to the total subscriber base to 87% in 4Q13 compared to around 95%. This action was reflected in maintaining the global ARPU figures at the range of EGP 23 over the last two years. Factor 3: Management’s Financial Strategy 1 In May 2012, Orange (formerly France Telecom) acquired roughly 94% of mobinil’s capital, through its wholly-owned subsidiary, MT Telecom SCRL (“MT Telecom”). So far, there is no clear plan for fully integrating mobinil’s business into the FT group, nonetheless, the simplified shareholding structure increased the efficiency of running the business, through easing the complexity of the strategy formulation and decision making process. Historically, the dividends distribution practices, coupled with the fierce market competition has put significant pressure on the company’s cash flow position over the last few years. Mobinil used to follow a high dividend payout policy to meet its shareholders' objectives. The company’s cash flow has also been used to support the high capex and investment (i.e. 3G license payment) requirements, especially those associated with the payment of the 3G license and network upgrading. The company’s high dividend payout policy, coupled with the capital intensive nature of the industry have already constrained mobinil’s financial flexibility. Going forward, the company’s management has affirmed its orientation to balance the shareholders’ requirements with the need to maintain a healthy debt profile. Accordingly, the company will be flexible in reviewing the future strategy based on market, economic and funding conditions. The company’s financial strategy for the next 3 years is to maintain it within the covenants range and to continue to invest heavily to further upgrade and expand its network. At the same time, it is carefully assessing the feasibility of any other expansion initiatives in the local market (i.e. international gateway, 4G network, etc.). According to management, the financing needs for the coming years will cover mainly the unified license, if needed, and the capex/investment requirements. It is worth mentioning that the future cash flow requirements will depend highly on the terms and conditions of the proposed licenses. In terms of geographical expansion, mobinil remains committed to its growth within Egypt, with no appetite for further diversification by embarking on a regional expansion. The management strategy and tolerance for financial risk have a direct impact on the debt level and credit quality and is therefore paramount for the rating grade. Management will continue with the cost cutting initiatives which was introduced in 2012, as it proved to partially contain the negative impact of the challenging operating environment. Going forward, management is planning to continue with the cost cutting strategy, although such opportunities might be increasingly difficult to find and implement, especially in light of the devaluation of the local currency, and the challenging operating environment which is excessively pressuring the cost structure. Furthermore, the company has plans to increase the tariff and to pass any potential cost/tax increases to consumers, in order to relief the foreseen pressure on the cash flow. FACTOR 4: Operating Performance Mobinil financial statements are audited by Ernst & Young. The company's financial statements have been prepared in accordance with Egyptian Accounting Standards (EAS). However, in the auditor's opinion, there are no material differences between EAS and the International Accounting Standards (IAS). For the entity rating, as well as the bond, MERIS analysis is based on the audited unconsolidated accounts (a stand-alone basis); as such we didn’t take into consideration Link Dot Net investment. Revenue and Margins Pressured on the Back of a Difficult Operating Environment Mobinil revenues have been almost stable over the last two years; while the decline continued on the EBITDA level. As the graph below shows, the decline was steeper on the EBIT front with roughly 29% drop in absolute figures as of December 2013. This was due to the instability in the political and economic environment, along with the devaluation of the local currency, in addition to the severe competitive pressure. Going forward, the pressured performance is 1 Orange long-term issuer and senior unsecured rating was downgraded in January 14th, 2014, to Baa1 from A3 by Moody's Investors Service. The outlook on the ratings is stable. 6 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil expected to continue in the short term horizon, in light of the intensified competitive environment. Accordingly, the profitability margin is expected to be further squeezed, in light of the increasing operating expenses. According to management, operating profitability is anticipated to be maintained at below 10%. In FY12 bottom line was hit dramatically to reach EGP 165.7mn in losses and EGP 401mn in FY13. The severe drop resulted from the overall poor operating performance, followed by the notable increase in interest expenses. In view of the saturation of the market, as well as the difficult macroeconomic and political environment in Egypt, MERIS believes that the coming years will continue to challenge the local mobile operators in general and mobinil in specific, especially after losing its leading position and the entrance of the fourth player into the local mobile marker. As we expect revenues will show limited growth in 2014, it is not clear how sustainable any recovery will be in the near future. In a recent action, the company published lately the 2013 full year results. Reporting 1.7% growth in revenue figure to stand at roughly EGP 10bn, while EBITDA figure has reached its bottom point at EGP 3bn. Also, the profitability margins is showing a downward trend with EBITDA and EBIT margins of 30.7% and 5.9%, respectively. The net income was dropped significantly to reach negative EGP 401mn. The continued decline in performance was due to the stressed macroeconomic conditions which negatively affected the performance, along with the devaluation of the Egyptian pound which inflated cost and expenses notably. Also the increase in interest rate contributed to the drop in the bottom line. Revenue & Profitability FY13 FY12 Revenue Growth (%)* Figures in EGP mn 9,995.0 1.7 9,831.9 0.7 FY11 9,768.0 (6.5) 10,450.1 (3.2) FY10 EBIT EBITDA EBITDA Margin (%) Operating Profit Margin (%) 588.6 3,065.8 30.7 5.9 825.0 3,344.1 34.0 8.4 1,113.6 ** 3,438.5 35.2 11.4 2,515.3 4,486.3 42.9 24.1 Interest Expense Interest Income (988.1) 67.9 (876.6) 68.4 (838.8) 42.6 (631.5) 43.5 Net Income/loss Net Income Margin (%) (401.4) (4.0) (165.7) (1.7) (171.0) (1.8) 1,378.0 13.2 * Y-o-Y Basis ** In an action to separate between the shareholders’ remunerations and employees’ profit sharing, management changed the accounting treatment of the employees’ bonus in 2011, to be accounted for in other operating cost (employees bonus accounts for EGP 225mn in FY11, and EGP 58mn in 1Q12). In terms of revenue mix, prepaid subscribers continue to be the company’s key driver NB: EBITDA and EBIT figures exclude provisions and provisions no longer required figures accounting for roughly 87% in FY13, compared to a historical average of 97% of customer base, which comes in line with management strategy to shift to the value share strategy. Although prepaid customers are expected to continue dominating the revenue mix going forward, a minor erosion of their share might be foreseen in light of the management intention to shift to a value extracting strategy. By service type, currently, voice revenue is considered the main revenue driver, accounting for more than 85% of revenues. Despite the fact that the share of non-voice and other revenues registered a significant increase by more than 60% in FY13, voice revenues will continue to have the dominant share on the medium term, since the Egyptian consumer is mainly voice oriented. Roaming revenue accounted for less than 2% of revenue down from 4% th in 2010, due to the drop in tourist visitors to Egypt since the January 25 revolution in 2011. 12,000 50% Profitability 10,000 40% 8,000 EGPmn 30% 6,000 20% 4,000 10% 2,000 0% 2007 -2,000 Revenues Net Income* 2008 2009 2010 2011 EBITDA* EBITDA Margin % 2012 2013 -10% EBIT* EBIT Margin % *Adjusted for employees' bonus retroactively for 2007, 2008, 2009 and 2010 7 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil Historically, mobinil has been more aggressive in terms of customer acquisition – especially in the middle and lowerend segments, which jeopardized its ARPU figures and profitability margins, which were relatively lower compared to its peer group. In 2011, management indicated a shift in its growth strategy towards value extraction in an attempt to ease the pressure on the company’s operating metrics. Nevertheless, given the intensified competitive environment, especially in a saturated market with more than 100% penetration, MERIS expects that the company’s margins will remain weak in 2014 with no prospects of recovery in the short term to levels commensurate with the previous range. FACTOR 5: Financial Strength Difficult Operating Environment, Challenging Credit Metrics Historically, the company has been generating strong operating cash flow. Nonetheless, the free cash flow position was pressured by the aggressive dividends distribution policy, coupled with the significant capex requirements. The cut down in shareholders remuneration, since mid-2012, relieved the pressure on the cash flow position to a certain extent. Going forward, in FY13, mobinil generated EGP 847.4mn negative free cash flow, which was mainly due to negative changes in working capital as well as the payment of EGP 750mn to the regulator against the last installment of the spectrum fees. A negative trend which is expected to continue in 2014. Cash flow & Coverage Figures in EGP mn FY13 FY12 FY11 FY10 Funds From Operation (FFO) - Dividends Retained Cash Flow (RCF) 2, 919.4 0.0 2, 919.4 3,301.8 0.0 3,301.8 3,233.1 (1,412.3) 1,820.7 4,063.9 (889.3) 3,174.7 Funds From Operation (FFO) +/- Changes in Working Capital Cash Flow From Operation (CFO) - Dividends - Capex - Investments (license Fees) Free Cash Flow (FCF) 2, 919.4 3,301.8 3,233.1 4,063.9 (1,134.6) (1,372.2) (900.0) (1,136.8) 1,784.9 1,929.6 2,333.0 2,927.1 0.0 (1,757.2) (875.0) (847.4) 0.0 (1,918.6) 0.0 (786.9) (1,412.3) (1,707.7) 0.0 (787.0) (889.3) (1,919.4) (1,850.0) (1,731.5) 1.8 3.0 1.7 3.8 1.1 4.1 1.7 7.1 RCF/Capex (%) EBITDA/ Interest Exp (x) As highlighted earlier, management demonstrated its commitment to scale down and even completely forego shareholder returns, when market conditions made such cash preservation tactics necessary. This conservative dividend distribution policy is viewed positively by MERIS. With equal note, the devaluation of the Egyptian pound is anticipated to impose serious pressure on the company’s credit metrics. As such, management might cut capex expenses to offset this challenge, to a certain extent. On the other hand, the future capex and investment requirements are unclear, taking into consideration that the detailed terms and conditions of the unified license are not fully released yet. 5,000 Cash Flow 4,000 EGPmn 3,000 2,000 1,000 -1,000 2007 2008 2009 2010 2011 2012 2013 -2,000 -3,000 Retained Cash Flow (RCF) 8 MERIS Analysis Cash Flow from Operations (CFO) Free Cash Flow (FCF) April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil In terms of interest coverage, mobinil's position deteriorated significantly from the 7x range to 3x in FY13, which is associated with the higher debt level linked to network enhancement, license fees and working capital requirements along with the drop in the EBITDA figures. A Highly Leveraged Debt Profile Mobinil's leverage position has been pressured over the last couple of years. The company’s borrowing Figures in EGP mn FY13 FY12 FY11 FY10 increased since 2010, after the EGP Short-term Debt 2,929.5 1,958.2 2,111.2 1,017.2 1.5 billion bond, which was followed Long-term Debt 5,647.6 6,119.3 6,300.8 5,968.2 by the EGP 2bn, seven-year Total Debt 8,577.1 8,077.6 8,412.0 6,985.4 unsecured syndicated loan in 2011 Cash and Cash Equivalent 660.1 969.8 1,208.0 546.3 and the EGP 2.9bn medium term syndicated loan undertaken in Net Debt 7,916.9 7,107.7 7,204.0 6,439.1 September 2012, which will mature in 2019. The latter is divided into two O. Financial Obligations (License fees) 0.0 750.0 750.0 750.0 equal tranches: (i) a medium-term Total Financial Obligations 8,577.1 8,827.6 9,162.0 7,735.4 loan amounting to EGP 1.1bn to partially refinance existing debts and Debt Adjustments: to finance capex and working capital Capital commitments & contingent L. 494.0 790.0 593.0 699.0 requirements; (ii) a declining revolving Adjusted Debt 9,071.0 9,617.6 9,755.0 8,434.3 facility amounting to EGP 1.79bn, to be paid gradually over the two years Equity 2,052.5 2,461.5 2,640.5 4,227.0 before the debt maturity. The loan entails a floating interest rate to be EBITDA – Capex / Interest Exp. (x) 1.3 1.6 2.1 4.1 paid semiannually. The favorable FFO + Interest Exp / Interest Exp (x) 4.0 4.8 4.9 7.4 terms and conditions of the newly Net Debt/EBITDA (x) 2.6 2.1 2.1 1.4 negotiated syndicated facility in a Gross Debt/Equity (x) 4.2 3.3 3.2 1.7 difficult political and macroeconomic Gross Debt/ EBITDA (x) 2.8 2.4 2.4 1.6 environment are a clear testimony to Adj. Debt / Capitalization (%) 87.4 96.0 94.6 97.3 the strong partnership of mobinil with FCF/Adjusted Debt (%) (9.9) 0.8 (8.6) (22.4) the local banks. In early 2014, RCF / Adjusted Debt (%) 32.2 34.3 18.7 37.6 management secured a new debt, amounting to EGP 2.26bn, from eight banks. The seven year debt carries approx. two years grace period and will be used for refinancing existing debts. With equal note, the syndicated loan also entails a floating interest rate, which will be paid semiannually. According to management, the company will operate within a target leverage range (Net Debt/EBIT) of around 2.0 – 3.0x. The company’s debt profile is considered well spread, with approximately 30% of the outstanding balance short-term in nature, containing the current portion of long-term debts and credit facilities. Meanwhile, management also, is exploring other sources of non-bank finances to secure its financial obligations. Financial Leverage Mobinil’s second unsecured bullet bond, issued in 2010 and maturing in January 2015, amounted to EGP 1.5bn. The bond bears a fixed coupon rate of 12.25%, payable semi-annually. It is non-convertible and callable after three years. Initially the bullet feature of the bond placed it in a structurally subordinated position in terms of repayment compared to the other lender of the company. As such and taking into consideration that the bond is due during the coming year, this clause has been reviewed and the bondholders will be repaid before certain of the existing lenders. As illustrated in the graph below, regardless of the notable increase in mobinil's indebtedness, the amortization of the loans is designed in a way, which alleviates the pressure on the company’s liquidity metrics. It is worth mentioning that roughly EGP 3bn of the company’s debt profile will mature over 2014 and the 1Q15. According to management these outstanding balances will be mostly funded through the already secured new loan. Drop in Debt Protection Ratios RCF figures dropped significantly in FY11 on the back of the deterioration in operating performance, as well as the excessive dividends distribution. This resulted in a substantial hit to the RCF/Adjusted Debt ratio, which declined from mid 40% range in FY09 to 18.7% in FY11. In 2012 the ratio has improved, thanks to the cut in the dividends distributions figures which reflected positively on the RCF position. It is worth mentioning that the adjusted debt ratio, 9 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil takes into consideration the debt obligation (bank debts as well as bonds), in addition to license payment obligations, capital commitments and contingent liabilities. The company’s indebtedness has been on the rise as reflected in the Gross Debt/EBITDA position, which deteriorated from 1x in FY09 to 2.4x in FY12 and 2.8x in FY13 . While, the gross debt to equity ratio is showing a downward trend over the last years, as a result of the shrinkage in the equity base, associated with the generated loss. At the same time, the net debt to EBITDA ratio has deteriorated as well, where it dropped from 0.8x in FY09 to 2.1x in FY12 and 2.6x in FY13. In terms of coverage, despite the deterioration, the company was still able to report healthy ratios with enough room to serve interest obligations after fulfilling its on-going investment needs. As detailed in the table above, EBITDA less Capex/Interest Expense ratio was around 1.3x, in FY13, compared to around 4.1 x in FY10. Times (x) 9 Indebtedness and Coverage 4.0 8 3.5 7 3.0 6 2.5 5 2.0 4 1.5 3 1.0 2 0.5 1 0.0 Times (x) 4.5 0 2008 2009 2010 2011 Gross Debt/Equity (x) Gross Debt/EBITDA (x)* EBITDA/Interest Expense (x)* (right axis) 2012 2013 Net Debt/Equity (x) Net Debt/EBITDA (x)* *Adjusted for employees' bonus retroactively for 2007, 2008, 2009 and 2010 Other Considerations Liquidity Position is Considered Adequate Mobinil's liquidity position is considered adequate. As of December 2013, mobinil had more than EGP 660mn in cash and cash equivalent. It is also worth noting that the single obligor limit with the banks improved significantly following the Orange takeover and the subsequent removal of mobinil from the OT group exposure. This has provided the company with additional opportunities for access to bank debt. As of January 2014, the company had short term credit facilities sourced from 12 different banks, amounting to roughly EGP 1.3bn. Around 40% of the total authorized limits were unutilized. Furthermore, mobinil has an additional available limit of EGP 1.8 billion as a revolving loan under the syndicated loans, in addition to another EGP 100mn under the EGP two billion facility, which is also supportive of its liquidity position. 10 MERIS Analysis April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil Annex 1: Shareholding Structure ECMS MT Telecom (MTT) 94% 11 MERIS Analysis Orascom Telecom Media and Technology Holding (OTMT) 5% Free Float 1% April 2014 Egyptian Company for Mobile Services (S.A.E.) mobinil Annex 2: National Rating Scale Gilt edged AAA Very high AA+ AA AA- Upper-medium A+ A A- Medium grade BBB+ BBB BBB- Questionable BB+ BB BB- Poor quality B+ B B- Very poor Quality of credit CCC+ CCC CCCCC C Short term Prime 1 Prime 2 Investment Grade Long term Prime 3 Not Prime Speculative Grade Quality of credit © Copyright 2014, (“MERIS”) Middle East Rating and Investors Service. All rights reserved. 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