Picking winners

Analysts at Morgan Stanley remain bullish about telecoms stocks in the EMEA, believing a combination of well-entrenched positions, low penetration levels and pent up demand for telecoms services will help operators maintain strong operational and financial positions. However, research analysts at the investment bank identify Zain and Maroc Telecom as operators exposed to factors such as significant growth of competition in their markets, and of execution risk across a diversified portfolio, therefore predicting limited upside to these stocks’ performance

For now, analysts at  Morgan Stanley believe 2009 looks like another year of uncertainty. The investment bank’s global emerging market economists have lowered their growth forecasts for 2009 four times in the last six months to 3.1 per cent from 6.6 per cent. And while it is forecast that the telecoms sector in the EMEA region is likely to be impacted by the global economic slowdown, Morgan Stanley views telecoms as defensive and continues to recommend investors take an overweight position in EMEA telecoms, particularly through H109 and in the context of other emerging market sectors.

Below, Comm. extracts the ratings Morgan Stanley has awarded to certain telecoms stocks across the Middle East and Africa. By way of clarity, the definitions of rating terms are given below:

Overweight
The stock’s total return is expected to exceed the average total return of the analyst’s industry (or industry team’s) coverage universe, on a risk-adjusted basis, over the next 12-18 months.

Equal-weight
The stock’s total return is expected to be in line with the average total return of the analyst’s industry (or industry team’s) coverage universe, on a risk-adjusted basis, over the next 12-18 months.

Underweight
The stock’s total return is expected to be below the average total return of the analyst’s industry (or industry team’s) coverage universe, on a risk-adjusted basis, over
the next 12-18 months.

OVERWEIGHT PICKS

Qtel
Why?
– Qtel operates in a combination of cashgenerating mature markets, such as Qatar and Kuwait, and high growth markets, such as Iraq and Algeria.
– We expect customer stickiness, lower royalty payments and limited margin pressure in Qatar as a second mobile operator starts operations in 2008.
– Change in royalty fee calculation from 25 per cent of net income to 12.5 per cent of income from licence activities.
– Valuation is appealing, in our view, with the stock on 4.4x 2009e P/E.

Key value drivers
– The key value drivers are market share, EBITDA margins, scale and capital expenditure.

Potential risks
– Competition is becoming tougher in Kuwait and Qatar, but we have conservatively included market share losses and EBITDA margin pressure for both these markets.
– Increased competition in Indonesian mobile market.

Turkcell
Why?
– Defensive stock characteristics, given the balance sheet strength (US$3 billion in net cash) and cash generation (12.9 per cent ’09 FCFE yield).
– More supportive top-down story: Turkey is a net beneficiary of lower oil price and was early in the cycle to devalue currency, so the incremental FX risks for Turkcell may be less pronounced, compared to other US$ reporting stocks.
– Valuation at 3.3 times 2009e EBITDA and 13 per cent 2009e FCFE yield is appealing.
– Operationally, Turkcell is regaining momentum in the market versus the competition; this offers scope for earnings surprises.

Potential risks
– Regulation is still a major structural overhang and we cannot rule out renewed regulatory pressure on retail pricing.
– Overpayment for acquisitions.

Key value drivers
– Improving operational momentum against the competition and continued resilience of dominant market position.
– Execution on M&A opportunities at attractive valuations.
– Return of cash to shareholders and improved capital structure.

MTN
Why?
– Well positioned to benefit from subscriber growth in sub-Sahara Africa; we forecast penetration increases from 19 per cent in 2007 to 48 per cent by 2017.
– Pent-up demand combined with limited capacity in markets such as Nigeria should help limit pricing pressure in 2008 and should offset, in part, the negative effects of higher inflation.

Potential risks
– Increasing competition in key markets, such as Nigeria; conservatively, we forecast revenue share drops from 51 per cent in 2008 to 39 per cent by 2017.
– EBITDA margin erosion in key market due to regulation and competition.
– Exposure to niche markets – including Iran and Sudan – increases the risk of geopolitical issues.

Key value drivers
– South Africa and Nigeria account for 63 per cent of our target enterprise value for MTN.
– Revenue share and ARPU are the key operational metrics that drive value.

Telecom Egypt
Why?
– Local tariff rebalancing in 2008 should support EBITDA margin and continued revenue growth.
– Growth potential in broadband, with line penetration at just two per cent and the government pushing for higher PC penetration/literacy.
– Valuation looks undemanding on a fixedline FCF yield for 2008e of 24 per cent compared with an 11 per cent Egyptian Central Bank discount rate.

Key value drivers
– Exposure to a still-growing mobile industry, with 45 per cent stake in Vodafone Egypt. Penetration is just 43 per cent and elasticity on usage is showing positive trends.
– Mobile competition becoming tougher in three-player market.
– International gateway revenues. Highly profitable revenues from its international gateway business are at risk in the long term.

Potential catalysts
– Government has announced it is considering selling a further 20 per cent stake in the company from 2009. While this will act as an overhang ahead of any transaction, it should help to improve liquidity.

Millicom
Why?
– Diversified exposure to under penetrated markets with total population of 290 million and blended penetration of just 40 per cent.
– Strong execution model, well suited for lower-income markets.
– Risk reward with 68 per cent upside to our base case, 166 per cent to bull case and only seven per cent downside to our bear case is appealing.

Potential risks
– New competition in Honduras, Ghana and Cambodia, all of which are significant markets
– Execution in Democratic Republic of Congo (DRC) and Colombia could prove tougher.
– More severe ARPU dilution in Central America as economies suffer from economic slowdown and if elasticity disappoints.
– Fragmented footprint implies potential execution risks.

Key value drivers
– Acceleration in penetration growth in Africa from the current sweet spot of 20 per cent.
– Continued market share gains across the board.
– More successful execution in Colombia, which has proved tougher to date.
– M&A potential should offer share price support in the medium term.
– Exit from smaller markets at attractive valuations

EQUAL-WEIGHT PICKS

Mobinil
Why?
– Mobinil offers pure play exposure to growth opportunity in Egypt. Low current usage levels suggest potential upside.
– Stock is relatively inexpensive at 3.7x2009e EV/EBITDA with 10.9 per cent CAGR 2007-10e; it trades on a 2008e dividend yield of 10 per cent and currently pays out 75 per cent of net income.
– But, pressure on dividends… Payment for licences including 3G – needed for voice spectrum as well as data services – could pressure dividends in medium term.
– … and market share and margins pressured in threeplayer market. Our base case forecasts 27 per cent market share for Etisalat longer term. EBITDA margins remain under pressure in the medium term.

Key value drivers
– Rising mobile penetration. Egyptian penetration is just 43 per cent and will benefit from falling equipment prices and increased competition; we forecast 77 per cent by 2017.

Potential catalysts
– Announcement of secured funding for 2010 requirements.

Zain Zambia
Why?
– Market dominance set to continue.
– Customer stickiness due to high on-net traffic and better network quality.
– We forecast stable EBITDA margins and high free cash flow.
– High growth of penetration in Zambia, most of it coming to Zain.

Potential risks
– Competition becoming tougher, but we have conservatively included market share losses in Zambia after entry of fourth operator. It also risks losing key employees to new entrant.
– Possible price war leading to lower ARPUs and increased capex to maintain network quality.
– Zambian kwacha depreciates due to higher current account deficit and low capital flows into the country.

Key value drivers
– The key value drivers are market share, EBITDA margins and higher penetration in rural areas.

Orascom Telecom
Why?
– Attractive risk-reward profile with an increasingly probable bull case for Algeria …
–  … but uncertainty over strategic direction and increasing macro risk in markets such as Pakistan and Egypt make a re-rating of the stock a more medium- to long-term event …
– … and uncertainty over funding a potential put option on Weather Capital’s exchangeable bonds could act as an overhang for the stock in 2009.
– Valuation is fair, trading at a 2009e EV/EBITDA of 4.3x with a 2007-10e EBITDA CAGR of 7.6 per cent, but we see risk to group free cash flow from rolling out its businesses in Canada and North Korea.

Key value drivers
– ARPU and EBITDA margin are the key value drivers for Orascom.
– In terms of markets, Algeria is the most important, accounting for around 60 per cent of our fair value; Pakistan accounts for just over 20 per cent.

Potential risks
– Further earnings volatility from increased competition in key markets such as Algeria.
– Forced sale of Orascom Telecom stock by Weather Capital to raise funds to meet a put option on its exchangeable bonds in February 2010.

Safaricom
Why?
– Dominant market position with over 80 per cent market share and relatively low real mobile penetration rates of less than 30 per cent …
–  … though increasing competition means Safaricom will see pressure on its market and revenue share will likely decrease over the next few years.
– We think the stock should retain a scarcity value in light  of its importance in respect of regional stock markets and its attractive growth profile.
– But, valuation is less appealing with the stock trading at 4.1x F2009 EV/EBITDA compared to 4.9x for its EMEA peer group. On 2008e P/E the stock trades at 8.8x compared to its peer group at 7.6x

Key value drivers
– Key value drivers include revenue share, EBITDA  margin and clarity on its dividend policy.

Potential risks
– High inflation could impact purchasing power of users, leading to lower than expected elasticity and lower ARPU.
– Higher selling and marketing costs from increased competition in the market.
– Geopolitical uncertainty following the post election unrest experienced during 1Q08.

Wataniya
Why?
– We foresee subscriber growth from under-penetrated markets and EBITDA margin expansion as key markets such as Algeria gain scale.
– Customer stickiness in Kuwait should help protect the subscriber base when the third national mobile licence is issued.
– Scale benefits from Qtel acquisition, including access to cheap debt and consolidated purchasing agreements.
– Valuation is expensive: 2009e proportionate EV/EBITDA of 5.3x with a 2007-11e EBITDA CAGR of 13.7 per cent versus average 3.9 per cent and 10.6 per cent CAGR.

Potential risks
– Competition becoming tougher in Kuwait as third licensee enters market.

Key value drivers
– The main value drivers are market share, EBITDA margins and scale.

UNDERWEIGHT PICKS
Zain
Why?
– Despite a 60 per cent drop in the stock price over the past 12 months, we think valuation is unattractive at 4.7x 2009e proportionate EV/ EBITDA, compared to 3.9x for the EMEA peer group.
– Our DCF fair value of KWD1.3 suggests the stock is fairly valued.
– Zain is exposed to African mobile growth, but competition is becoming tougher in key markets. It faces execution risk across a diversified portfolio, and has exposure to highly volatile and niche markets.

Key value drivers
– Substantial footprint in sub-Saharan Africa with exciting growth prospects.
– Access to ‘cheap’ debt.

Potential catalysts
– Acquisitions in highgrowth African markets to consolidate footprint.

Maroc Telecom
Why?
– Valuation unattractive: Our underweight rating is a relative call as the stock is trading at a dividend yield of 8.1 per cent, below the peer group average of 9.2 per cent, and a P/E premium of ~42 per cent to peers (on 12.7x versus 8.9x).
– Increased risk aversion may lead to a de-rating of the stock in the medium term.

Key risks
– Third licence in 2G category.
– Further regulatory restrictions on promotions.
– Success in integrating and turning around acquired businesses.

Key value drivers
– Muted impact from competition: despite new entrants to the market, Maroc Telecom has shown resilient ARPUs and revenue share.
–  Continued 100 per cent dividend payout and 2009e dividend of MAD11.84, there is the possibility of a special dividend of up to ~MAD6 per share.
–  Stabilised fixed-line customer base, increasing broadband revenues.
– Still room for growth in the subscriber base, with mobile penetration at 70 per cent.

Potential catalysts
– Possible special dividend payment of MAD6.
– Announcement of further acquisitions.

This information has been extracted from a Morgan Stanley equity research note entitled, EEMEA Telecom – Staying OW in EEMEA context; Introducing New PT Methodology, issued on January 16