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Etisalat

(Emirates Telecommunication Corporation)

September 11th, 2012

Hold
Share price (AED, 09/09/2012): Target Price (AED): Potential return (%): 9.52 9.80 +3%

New Management New Direction?


Initiation of coverage post Q2 2012 results
Key highlights
As the largest UAE traded company with a capitalisation of AED75.0bn, Etisalat holds a special place among Emirati companies. Etisalat benefited from the stellar growth of the local economy over the past decades and in return made UAE more attractive for investors by building modern telecommunication infrastructure Excellent profitability allowed Etisalat to adopt an ambitious plan of international expansion that resulted in the current presence of Etisalats operations in 16 countries ranging from West Africa to Indonesia Arrival of du as a competitor to the UAE market in 2007 and the hit of the global economic crisis at the end of 2008 resulted in a disappointing revenue growth over the past two and a half years. Despite the lack of top line growth, Etisalat still shows excellent profitability with the Groups EBITDA margin over 50% and close to 60% for the key UAE market There has been a massive change in the top management team and Board of Etisalat over the past year. The Group has appointed, among others, new CEO, CFO and chairman with previous long standing chairman Mr. Mohammed Omran and six Board members replaced in July We agree, that the new management team brings hope to make significant changes in the Groups structure in order to stabilise the UAE market and boost the international share of revenues and profits by focusing on a handful of most promising markets. We could expect a significant announcement about a new Group strategy early next year, probably with announcement of FY 2012 results We initiate our coverage of the stock with a target price of AED9.80 per share based on the healthy dividend yield and long term prospects of the Group. However, we see only a limited potential for a short term price appreciation before the new strategy is announced and implemented, unless there is a foreign ownership of the stock is allowed. Such news could push Etisalats stock price quickly above our target price due to increased demand for the stock
Tel: +971 (2)627-1215 www.menacorpfinance.com

Market Cap. (AEDbn): Shares o/s (bn) : Free float: Enterprise Value (AEDbn):

75.03 7.91 40% 59.66

52 wk Range (AED): Bloomberg/Reuters :


Business plan forecasts:
IFRS - AEDm Revenue % of growth EBITDA % of EBITDA margin Profit before Royalty % of Op prof. margin Net profit % of Net profit EPS (AED) Company data, MENACORP estimates

8.50 / 10.40 ETISALAT:UH / ETEL.AD

2011A 32,242 1.0% 15,882 49% 10,442 32% 5,839 18.1% 0.74

2012E 33,082 2.6% 16,673 50% 14,555 44% 7,119 21.5% 0.90

2013E 34,330 3.8% 17,096 50% 15,033 44% 7,310 21.3% 0.92

2014E 35,684 3.9% 17,664 50% 15,646 44% 7,577 21.2% 0.96

CAGR 3.4% 3.6% 14.4% 9.1% 9.1%

Share price performance LTM to September 9th 2012 (AED)


13 12 11
-0.2%

14.8%

10
-7.9%

9 8 Sep-11

Dec-11
Etisalat (AED)

Mar-12
Du (rebased)

May-12

Aug-12
AD Index (rebased)

Performance

1M 4.9% 2.7%

3M 7.4% 1.2%

12M (7.9%) (7.7%)

Absolute (%) Relative (%) (1)

(1): Relative performance measures the stock price performance compared to AD Index evolution

Petr Molik p.molik@menacorpfinance.com + 971 4 3254 423

Bin Hamoodah Tower , Khalifa Street, P.O. Box 108377, Abu Dhabi, UAE

Etisalat The telecom that helped build the country

Created in 1976, Emirates Telecommunication Corporation (Etisalat) is without a shadow of doubt one of the leading companies that contributed to the development of the United Arab Emirates as a modern country with a first class telecommunications infrastructure necessary for any developed economy. Together with a stable political and business friendly environment, unprecedented real estate boom and high capacity transport infrastructure, Etisalats investments and business expansion has been instrumental in attracting investments to the UAE and making Dubai and Abu Dhabi fully connected to the global business environment. Etisalats IPO in 1983, prior to the massive boom in countrys economic development is still affecting the company in several ways. Firstly, the Federal Government kept a 60% stake in the company, keeping the company de-facto state controlled even if driven by economic targets. Secondly, the remaining 40% of the companys capital has been made public with many stocks given to the Emirati citizens at the time. Given the strategic interest of the company, ownership of Etisalats stocks have been (and still remain) restricted for non-UAE residents. The subsequent boom in telecommunications in the UAE both benefited from and supported future growth of the local economy. Etisalats stock price was booming as a typical growth stock despite being subjected to a 50% royalty (tax) rate on its profits, handicapping the stock performance against other companies without tax requirements. Despite the additional taxation, the stock has been a strong performer and distinguishes itself from other stocks by several specifics: As the biggest traded company in the UAE by market capitalization, Etisalat has become a de-facto benchmark for Abu Dhabi Securities Exchange (And the main component of the Abu Dhabi General Index) Being among some of the first publicly listed companies and a strong performer with increasing dividends, Etisalat quickly became popular as a buy and hold stock for many Emiratis who kept the stock faithfully despite the drop and lacklustre performance after 2008 The Federal Government has been more than happy by not only keeping control of the strategic company, but also through reaping major recurrent income (half of all the profits received as royalty and 60% of all dividends as shareholder). These revenues are not critical for the functioning of the Federal budget, but represent a diversification from predominant revenues from Oil & Gas sector Etisalat, together with a handful of other companies such as ADNOC or Emirates, has a critical role in the countrys economy. Being the only one which is publicly traded, it is a strong indicator of the markets view on the UAE economy

Strategy of the past decade Spend to grow

Etisalat found itself in an enviable position at the beginning of the new millennium. The Emirati economy was booming, Etisalat had a market monopoly and thousands of new residents were coming to the country every week. Among the first things the new businesses and residents needed were a mobile phone number and a landline with internet connection. The business was booming. Internet telephony didnt exist and the monopoly position allowed Etisalat to charge high prices for both domestic and especially international calls. The prices were high, but subscribers were ready to pay them. As a result of their success, Etisalat found itself with significant net cash available even with regular dividend payments and significant capital expenditure in fixed and mobile networks in the UAE. We must remember, that almost all of the major mobile operators in Europe and US were heavily indebted at the time from expensive acquisitions and excessive bidding for various 3G licenses. When the major operators such as Vodafone, Deutche Telekom or France Telecom were forced to consolidate and deleverage, telecoms in the GCC region Etisalat, Saudi Telecom or Zain benefited from their domestic monopolies and generating healthy cash-flows. Etisalat found itself at a crossroad remain a domestic operator paying excessive dividends to the Federal budget and to its shareholders or use the cash for a global expansion. The decision to become a global player was the right one for several reasons: A possibility of another UAE telecom operator has been suggested to promote competition and better prices for consumers. Despite Etisalats competitor du didnt start its operation until 2007, Etisalat couldnt hope to keep the monopoly position long term Revenue streams from other regions would represent a good diversification from 100% dependence on the local economy New telecom operators in frontier or emerging markets were supposed to grow even faster than the UAE Cash generated from UAE gave Etisalat flexibility to invest without risks of excessive leverage Etisalat acquired a know-how of fast network development and modernization servicing a booming local economy The move towards a global telecom operator, designed and promoted by former Chairman Mohammad Hassan Omran lasted several years and achieved to create a portfolio for consolidated and associated business holdings operating in 16 countries as described on the next page:

Etisalat Group as of 31 December 2011 Region Country Name Ownership

Consolidated entities UAE Egypt Africa UAE Egypt Niger, Central African Republic, Gabon, Benin, Togo, Ivory Coast Sudan Tanzania Afghanistan Sri Lanka UAE Associates GCC Africa Asia Saudi Arabia All GCC Nigeria Pakistan Indonesia Mobily Thuraya Etisalat PTCL / ufone PT XL Axiata 27.5% 28.0% 40.0% 23.4% 13.3% Etisalat Etisalat Misr Atlantique Telecom / Moov Canar Zantel Etisalat Afghanistan Etisalat Lanka Etisalat Services Hold. 100.0% 66.0% 100.0% 89.0% 65.0% 100.0% 100.0% 100.0%

Asia

Source: Etisalat Annual Report 2011

An investment to acquire such a holdings portfolio has made Etisalat one of the Top 15 global telecom operators and second biggest regional telecom behind Saudi Telecom, but it came at a price it required substantial cash expenditures. According to Reuters, Etisalat spent more than AED46bn (USD12.6bn) between 2004 and 2009 on acquisitions of companies, licenses, minority holdings and investments. Some of them were successful, the majority of them were lacklustre or failures. Given the various criteria for comparison and differences between the countries, we analyze their contributions in context of Etisalats overall profits and cash flows. On the surface, Etisalat boosts some impressive figures for its foreign holdings. From a total of 172 million Etisalat subscribers (as of Q2 2012), more than 163 million are outside of UAE (95%). Even if a significant part of those 163 million subscribers contribute to the Associates that are not consolidated by the Group, they contributed only AED2.3bn of consolidated revenues in Q2 2012, which is 28% out of the total AED8.3bn of revenues for the quarter. Profitability was however lacking as only AED713m (17%) of the AED4.26bn consolidated EBITDA for the last quarter came from abroad. Looked at from the other side, after a decade of expansion and massive spending, a mere fraction of Etisalats clients from UAE accounts for more than 82% of the Groups EBITDA despite intensifying domestic competition from du. What went wrong and where were the mistakes made? Were flops such as the overpayment for PTCL in Pakistan, the abandonment of Iranian operations and the costly retreat from India necessary or preventable? We present the following reasons as explanations for unimpressive investment track record of the company: Too much money. Etisalat generated a lot of cash that was allocated for acquisitions. Fundamental questions relating to returns on investments were neglected or the projections were overly optimistic when buying companies and licenses. An acquisition of 26% stake in PTCL in Pakistan for AED9.4bn (USD2.56bn) is an example of excessive price

Lack of competition in UAE. Etisalat has been a monopoly in UAE for more than 30 years. The company acquired a good know-how in fast network development but lacked knowledge and management skills in addressing the competition and outsmarting them through marketing, pricing or quality. During an expansion, Etisalat never acquired a stake in the market leader, but always in the challenger competing in the market with other telecom(s), some of them with a significant head start Lack of synergy between the holdings. Etisalats holdings range from West Africa to Indonesia. These countries simply do not have much in common. It can be said that Etisalat operates without a clear strategy that would allow savings in roaming costs, global marketing or brand image, unlike global players such as Vodafone, O2 or TMobile. Operations such as Sudan and Afghanistan are also examples of business ventures with numerous risks and very limited upside if successful Late arrival. This often resulted in a unfavourable starting position. This contributed to the deficiencies of development in the competitive markets as described above. This has been especially true for the abandoned operations in India. Despite the poverty of a big part of Indian population, the 1 billion potential clients represent the most dynamic market of this decade (given that the Chinese market is strictly regulated). With dozens of local operators, the Indian market would be an ideal place for a strong player to consolidate a position by targeted acquisition. Unfortunately, late arrival and lack of transparency in the licensing process led to a revocation of an awarded licenses and a significant loss for Etisalat Group (AED3.0 bn write-down in total of which AED2.0 bn for the Group and AED1.0bn net loss after royalty) at the end of 2011 Association with unsuitable local partners. This has been given as the main reason for the fallout of the Indian venture, where the 45% / 55% ownership structure and legal problems of the local partner led to long term delays in investments and ultimately to the failure of the whole operation The swansong of the ambitious plans for Etisalats business development was the failed project of acquisition of a stake in Zain, Etisalats Kuwaiti competitor for AED44bn (USD12bn). We can only speculate, how Etisalats holdings would combine with those of Zain (with overlaps in Saudi Arabia and Sudan) Although the preliminary offer has been accepted for the divestment of Zains 25% stake in Zain Saudi Arabia, the deal was never finalised as Etisalats management cited political unrest in the region and non-unanimous agreement among Zain shareholders as reasons for discontinuing the negotiations At the same time, we can point out that Zain (despite being half the market capitalisation of Etisalat) is an example of successful international expansion. Zain, being limited by a small domestic market had to focus on successful development of international operations. The company had concentrated on MENA region that allowed a development of a strong brand image within the region with clear synergies for the Group. Without forgetting the above mistakes, we must point out that some of the acquired operations have substantial value and despite the immediate weak contribution to the Group, they could be a successful part of Etisalats future if properly managed. Markets of Egypt, Nigeria and Saudi Arabia have both favourable demographic and decent expected economic growth in the coming years which can increase the value of Etisalats holdings in these countries. As showed above, UAE operation still represents a majority of the Groups share of revenue and absolute majority of the Groups profits. We will therefore focus on the UAE market dynamic greater detail.

UAE Paradise lost

As stated above, UAE used to be a paradise on earth for Etisalat until 2008. Economy was booming, mobile subscribers were growing by double digits and they paid almost any price. Two thing disrupted the perfect world of Etisalat arrival of du and impact of financial crisis at the end of 2008. Starting its commercial operations in February 2007, the success of du surprised even the optimists when the company grew from practically no revenues to AED8.9bn revenue for the FY 2011, while Etisalat lost some ground on the market to finish 2011 with a revenue of AED23.5bn while keeping a 72.6% market share of the UAE telecommunications revenues, as showed in the graph below.

We can observe that although the overall market grew moderately over the past years (20082011 CAGR of 1.7%) du managed to capture close to 30% of the market revenues despite arriving shortly before the end of the economic boom strong starting position of Etisalat. Given the very different starting conditions of both operators it is nor fair to compare relative growth figures, despite dus impressive achievement of 30.9% CAGR of revenues over the period. Etisalat has been loosing about AED1.0bn / year of revenues in favour of du. The emergence of du as a competitor had to be expected, but the growth, especially in the mobile communications and mobile subscriber base surprised many. As of Q2 2012, du accounts for a 45.1% mobile subscriber market share with 5.7 million subscribers when Etisalat stood at 7.0 million in the same period. In terms of revenue, Etisalat reported AED5.64bn of revenues from the local market while du announced AED2.45bn of revenue for the second quarter (giving it 30.3% market share of revenues). The ARPU (Average monthly Revenue per User) for mobile subscribers is still higher for Etisalat (AED131) than for du (AED112). This is easily explained by Etisalats higher legacy share of heavy users as well as companies that tend to spend more than retail subscribers. Etisalat also benefits from being the preferred roaming partner for other telecoms capturing lucrative roaming revenues and is confident to be be able to keep its advantage in extracting higher rpm (revenue per minute) from its subscribers thanks to some unique services offered by its network

As we can observe below, the UAE market is amongst the most lucrative in the GCC region allowing both mobile operators superior profitability

Given the specifics of different businesses, revenue can translate differently in the companys profitability. The logic of telecommunications business is relatively straightforward in allowing a significant operating leverage to a well run operator. There is a significant amount of fixed cost and investments required to build and maintain infrastructure, technical and client support and other services. Once covered, the cost of an additional minute of use in the network is very small allowing most of this additional revenue per minute to be translated into revenues. As we can see on the next page, the goals of both telecoms are radically different. Where Etisalat strives to maintain its superior margins by steering away from a competition on price alone, dus goal after is to apply maximum operating leverage. To achieve that du has been striving for a maximum revenue base possible to cover its fixed cost base first and grow its margins from that.

As of Q2 2012, Etisalats UAE EBITDA margin stands at 59.4% and du achieved a 38.4% margin in the same quarter. The loss of a significant part of the UAE telecom market to the competitor has been unexpected, especially in the mobile category with du achieving about 45% of the mobile subscribers in the UAE. The split of management focus between different geographies and post-crisis price sensitivity of the UAE residents have been given as reasons for the slip in market share. Despite that, Etisalat still holds a dominant position in some segments, notably for business customers. We dont doubt that Etisalat has both the resources and capability to fight back in the local market and wrestle some market share back in his favour. The challenge though, would be to manage it without negative impact on profitability of the UAE operation that underpins the whole cash flow generation of the Group On top of the ongoing competition with du, there may also be additional changes in the nature of the market that we need to factor in when considering a potential for future profitability.

There were recent rumours about the market regulator (TRA) allowing the mobile portability between networks. The telecoms specialists consider this as a rather marketing feature rather than a threat to any particular operator as examples from other countries show that relative market share remain practically unchanged when mobile number portability was implemented. A much more serious threat to the future telecom revenues in the region would be the growth in VoIP (Voice over Internet Protocol) technologies such as Skype that would have a negative impact on lucrative international calls given the percentage of expatriate residents in the region. Both Etisalat and du are aware of the trend and try to slow it down but they will have to accept it in and adapt to it near future. There is also a public promise to open the UAE market for a third mobile operator in 2015. Without speculating that far in advance, we believe that the new operator coming to UAE would be either a virtual or pure mobile operator sharing or licensing parts of the infrastructure from existing operators. Although the market should be fully saturated by then, a regional multinational telecom could be interested in covering the UAE territory better than with a roaming agreement. To counter the potential risks, Etisalat can focus on several potential sectors to extract additional value. Ongoing cost saving plan looking for efficiencies through outsourcing of centralised purchases will certainly contribute to offset some losses in revenue. The measures to generate some top line growth should include promotion of fast mobile data services (4G / LTE), especially with widespread usage of smartphones in the population. Etisalat also holds a strong competitive advantage with investments in the optical FTTH network (Fibre To The Home) capable of highest speeds in data transfers. Although we are sceptical about Etisalat ability to properly monetize this newest technology, we still consider is a competitive advantage for the future.

International holdings and Associates


Although the first look at the international holdings of Etisalat may seem overwhelming given the variety of geographies, holding structures and number of clients. I would be best to start by examining the two following graphics that will help us focus on the truly important parts of Etisalats international operations. As you may see, Etisalat changed its reporting in the fourth quarter of 2011 to give its performance figures by clusters containing a single market or several different countries grouped together. The Group currently reports the breakdown of revenue, EBITDA and other metrics for: UAE: covers Etisalats domestic operations Egypt: reports the performance of Etisalat Misr in Egypt Africa: Aggregate figures for Ivory Coast, Benin, Togo, Gabon, Niger, Central African Republic, Tanzania and Sudan Asia: Combines results from Afghanistan and Sri Lanka

The split may seem logical, but we must not forget that other entities managed and understood to be a part of Etisalats global footprint that should be logically part of Africa cluster (Nigeria) or Asia cluster (PT XL Axiata in Indonesia) are not included due to their status as non-consolidated Associates. The graphics of revenue and EBITDA distribution between different clusters points us towards the key international holdings of the Group.

Etisalat Misr, the third Egyptian mobile operator with close to 20% market share represents as of today 15% of Etisalats total revenues and 11% of the EBITDA. Its EBITDA margin of 38% is in line with current profitability of du in UAE. Whatever the decision on the future of other assets will be, Egyptian operation will certainly be a cornerstone of its restructured international holdings. Etisalat owns two thirds of Etisalat Misr

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African and Asian consolidated assets represent only 14% of the Groups revenue and 5% of EBITDA despite covering 10 different markets. This draws us to point out following observations: Firstly, Etisalat is rightly dissatisfied with its current state of diversification as the domestic market still represents 68% of revenues and 79% of consolidated EBITDA. Compared to Etisalat, other regional telecoms such as Qtel in Qatar managed the international diversification with more success by keeping a dominant position on its home market but limiting its dependence on it in the long term. Moreover, despite declaring its intention to increase the percentage of International contributions to the Groups financial results, Etisalat will be hard pressed to compensate any slack in the UAE market through international growth. To compensate a 1% drop in domestic revenues, International revenues must grow by 2.2% to compensate. It is even worse for EBITDA, where a 3.7% of international growth is needed in order to replace every 1% lost in the UAE. Looking for a potential silver lining, we could assume that given the relatively small contribution of the other consolidated operations, each of them (with clear exception of Egypt) could be a candidate for divestment following the new management strategy without a major impact on the overall Etisalat Group. On the other hand, the minority stake investments reported as Associates in Etisalats accounts are currently some of the best assets of the company. Both companies. Etihad Etisalat competing as challenger in the Saudi market under Mobily brand and PT XL Axiata in Indonesia are listed entities. Etisalats respective ownership shares of 27.5% and 13.3% are currently worth AED13.2bn and AED2.9bn in market capitalisation. That is not to suggest that Etisalat considers selling those stakes. We presume that rather the opposite is true and Etisalat would be keen to increase its ownership share if possible. Etisalat has also been pleased with the progress of the Nigerian operation that achieved more than 13 million subscribers and recently announced positive EBITDA margin. Etisalat controls 40% of the Nigerian operator. The only challenging asset among Associates remains the PTCL / ufone network in Pakistan, whose value for the Group is uncertain. Etisalat can be happy to own a share of the high quality assets listed above and exercise a degree of management control in them, but their status of unconsolidated entities and problems with allocation of resources to these entities will present a predictable challenge for the future. Also, any improvements achieved by those companies wont directly reflect in the headline figures of the Etisalat Group. We discuss this in more detail in the section about possible future strategies for the Group.

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Management overhaul
Given the importance of the Group for the local economy and the ubiquity of Etisalat in the local business news, most of the public is aware of the several changes in the highest levels of the Etisalats management team. However, only when presented together, we get the true picture of the major overhaul that took place in the last 12 months. Mr Ahmad Abdulkarim Julfar has been promoted as the new Group CEO in August 2011 after serving as Groups COO since 2006. New Group CFO, Mr. Serkan Okandan has been installed in December 2011 and Mr. Saleh Al Abdooli became the CEO of the UAE operations in April 2012. Finally Eissa Al Suwaidi replaced a long standing Mr. Mohammed Omran as Groups chairman this July and Mr. Ahmed Al Awadi became the CFO of Etisalat UAE just couple of weeks later in August. Also six new Board members were appointed in July, together with Mr Al Suwadi appointment. In summary, Etisalat managed to change in one year Groups chairman, part of the Board, Group CEO, CFO and both CEO and CFO for its most important UAE operation. The scope of the changes is almost unprecedented for a company not subjected to a takeover, merger or other major event. On the positive side, we believe that the new management team will be able to fresh look on the Groups holdings as the new managers were mostly not involved in the acquisition decisions of the past. The new direction of the all important UAE operation could lead to a stronger competitive position against du in the future. That said, it would be certainly short-sighted to expect major changes in the coming months. We assume that the Group is undergoing a strategic review and the changes in strategy (or new elements of it) will be announced at best in early 2013 at a separate occasion or more likely together with FY 2012 results. We remain slightly optimistic about the potential for the change in course of the Groups operations and trimming down some of the underwhelming holdings. We are however afraid that given the size and internal politics of the Group, Etisalat could opt to steer away from any radical cuts and continue largely unchanged, trying to manage its operations in more than a dozen of countries dividing its focus and investments between many of them. In any case, we shall know more about the new management position in about 6 month time.

Possibilities for future Groups strategy


Considering the facts stated above, we wish to point out in advance that the options listed hereafter do not assume that a particular decision or strategy will be adopted by the company after the strategic review, but should merely give an investor a range of options that can realistically materialise next year or afterwards and impact Etisalat in the long term.

Maintaining the status quo


This strategy would keep the current scope of the Group or made only minor tweaks in auxiliary operations. The Group would announce its focus on quarter by quarter improvements in each market with a target to competing strongly in UAE and generate maximum growth in revenues and margins in international operations to increase their respective importance for the group. We consider that such a strategy would be a disappointment for the market and the investors. It would tamper down the optimism about a possibility of a significant change that came with new management if it merely continues in the tracks of the old one. Our negative view of this option comes from the previous track record of the Group in simultaneously managing more than a dozen of operations successfully that has yet to be demonstrated by the new management team.

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Group wide restructuring and / or partial asset disposal


The second option is highly likely to be announced in some capacity; however the size and scope are uncertain. We believe that the change in regime gives Etisalat an opportunity to announce significant divestments as a part of the new refocus story that would be taken positively by the market. Give the current company footprint we consider that any of the Asian or African assets (with exception of Nigeria and Egypt) could be divested. The negative impact on consolidated results (in case of consolidated assets) could be compensated by an increase in market capitalisation due to the new strategy announced for the Group as a whole. As an added bonus, Etisalats healthy balance sheet gives it the luxury to wait for the right bid for the potential divestment and not being forced in a fire-sale type of operation that would have a negative impact on price.

New small scale acquisitions


The company could announce its desire to enter new markets by acquiring either an existing local operator or a new telecommunication licence. As stated above and given the numerous challenges facing the group as is, we consider this option highly unlikely in the coming 12 months but realistic in the medium term. It is our understanding that Etisalat want to stand out of the chaotic Indian market, but would be open to possible additions to its footprint on an opportunistic basis (eg. assets with the right fit for the right price). We believe that at this stage, Etisalats preference would be to buy an existing telecom operation rather than an additional licence that would necessitate starting from scratch. The management confirmed to us that just this year, they decided to not bid on a third mobile license in Cameroon as the opportunity was judged not attractive enough. The market reaction on such an investment would depend on many factors, notably price, geography and especially the belief that Etisalat has a necessary expertise to integrate new assets to the Group without losing focus on existing markets. That is why we believe that it will be more credible to tackle the group restructuring or divestments before announcing a new acquisition unless there is a great opportunity that presents itself in the market.

Merger / partnership with another multinational operator


Suffice to look at the last years abandoned merger with Zain to see a blueprint for such an operation. Zain operation can be judged with hindsight as an attempt at merger of two operators with great fit (no assets overlap) that failed on disagreement about the right price. We consider, that although highly improbable in the short term a major operation (rather than acquisition of single market operators) can materialise again in medium term. Etisalat certainly has the critical size, healthy balance sheet and wealthy owners to be a serious partner for almost any future major size deal it decides to initiate.

Additional investments in existing operations deemed as strategic


This should probably be a part of any new strategic plan with the company declaring its intention to focus on selected markets that are deemed strategically important for the future of the Group. Given our current understanding of Etisalat, the key markets would certainly include the UAE, Egypt and Saudi Arabia and in all probability Nigeria and Indonesia.

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The problem of this decision would not be its business logic to select the markets with favourable demographic, GDP growth or potential profitability, but rather the degree of control and accounting treatment of these assets. From the five countries listed above, only the UAE operation is fully owned by the Etisalat Group. Although Etisalat exercises a significant degree of management control in other markets, an additional investment in an entity with a minority partner (such as Egypt) can be less straightforward than in the local market. Moreover, the operations in Saudi Arabia, Nigeria and Indonesia are not consolidated and it will require additional effort for Etisalat to communicate to the public a logic of major investment in an entity that does not reflect in the consolidated figures of the Group.

Investment in UAE telecoms


A local investor in Etisalat (and there are no international ones given the current restrictions) cannot escape a comparison with du stock when considering an investment in telecommunication sector. On the surface, there are some similarities as both companies generate a totality (du) or a significant part (Etisalat) of their revenues from the UAE market. However, an investor must be aware that despite these easy similarities, the business and investment profile of both companies is dramatically different. Firstly, we must consider that a market reaction on identical news would be radically different in case of du and Etisalat. Reporting a 40% EBITDA margin in the coming quarters would be celebrated as a great achievement by du but would be greatly disappointing for Etisalats investors. Analogically, given the respective revenue figures of both companies from UAE market, achieving a 5% revenue growth would be much easier target for du than for Etisalat. In the short term, du is the company with much more potential to post positive news, attractive growth figures, margin improvements and dividend increases all of which can drive the stock higher. All of which gives in our opinion the du stock an edge in the short run over Etisalat. The challenge for the company will come in couple of years, when the local market shares stabilise and du will have to decide if they will dare an international expansion, associate itself with one of the multinational operators or stay alone as a one market telecom with limited growth opportunities. Etisalats positioning for overall growth and ultimately the potential for its stock appreciation looks much more challenging in the short term. The absolute size of the company that gives the Etisalat Group a long term edge in cost optimisation, strategic positioning and flexibility in resource allocation can a hindrance on a day-to-day basis as local competitors can be more nimble as competitors. We are optimistic that the new management of the Group can overcome this with improvements in organisation structure, but the changes will take time to be implemented. Moreover, as we described above the absolute size of revenues and excellent EBITDA margin generated by the UAE business will make it difficult for Etisalat to show a significant growth for both local revenues and margins in the coming year. The international operations have a much bigger margin for improvement but their respective weight in consolidated results will water them down when reported on the Group level. We conclude that a long term investor in Etisalat would be advised to not expect a quick appreciation in the stock price before the newly installed management regime announces its plans for the overall Group strategy as well as plan for specific countries. In the meantime an attractive dividend yield and strong cash position of the company will give to the investor a margin of safety for limited downside while waiting. A speculative investor hoping for strong growth in stock price will probably find more suitable candidates in other stocks.

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Valuation
Given the size of the Etisalat Group and significant values attributed to Minorities and Associates, building a sum-of-the-parts valuation is dependent on individual assessment of various holdings. Our Enterprise value of AED59.7bn has been calculated by using market value weighted Minorities participations and deducing the reported book value of Associates as of June 30th. This method in all probability overestimates the real current Enterprise value of the group as the real value of Minorities is probably lower given that the most lucrative UAE operation is fully owned by the Etisalat Group. The real market value of Associates is also probably significantly higher than the figure reported on Groups balance as Etisalats shares in publicly traded entities of Etihad Etisalat (Mobily) and PT XL Axiata TBK are worth AED13.2bn and AED2.94bn respectively. Our Enterprise value leads us to a EV / EBITDA multiple of 3.62x and EV / (EBITDA capex) multiple of 4.83x using the last 12 month reported figures for both EBITDA and capex. The P/E ratio stands at 10.5x using the LTM normalised earnings of AED7.1bn. The P/E multiple is comparable with that of du standing at 11.9x. EV/EBITDA and EV/(EBITDA-capex) of du using the LTM aggregates are slightly higher standing at 4.59x and 7.61x respectively. In the case of Etisalat we consider the P/E ratio as a rather inaccurate indicator given the complexity of the group and numerous partially owned / controlled subsidiaries with different accounting treatment due to consolidation rules. The current EV / EBITDA multiple of 3.6x is well bellow all industry averages and would normally indicate a lack of confidence in the company or dire growth prospects for the future. In this case, we would explain such a low multiple by the lack of understanding of the real value of Associate holdings for Etisalat as they are not consolidated and appear as an additional line in the P / L statement. Although Etisalat does not wish to sell these valuable assets, it would be a long term boost for the Group to find a way to either achieve a threshold allowing their consolidation in the Groups results or if not possible, better educate the market and the public about the hidden value not reflected in the headline figures of consolidated revenue growth and EBITDA margin. However, in order to properly reflect the real market sentiment about Etisalat stock we must remind a potential investor of Etisalats specifics, notably the trading restriction for foreigners and buy and hold approach of long term local shareholders. Therefore, the metric most commonly used by the local market and media is the dividend yield currently standing at 6.3% with the price of AED9.52 as of September 9th. This is superior figure when compared to dus yield of 4.3%, however there is a good chance for du to increase its dividend from the current level of AED0.15 per share in the coming year. Given the Etisalats commitment to a stable dividend of AED0.6 per share paid bi-annually, we initiate our coverage of the stock with a target price of AED9.80 per share, implying a dividend yield superior to 6%. As mentioned before, we do not expect any major announcement about the new Group strategy before 2013 as well as any big surprise (positive or negative) delivered by the Q3 2012 results. Our financial projections assume an unchanged scope of Etisalats holdings which will almost certainly change in one way or another. The stock also trades bellow the psychologically important AED10.0 level since November 2011 while waiting on a new direction. The only catalyst that would have a significant impact in the short term would be a lift of restrictions on foreign ownership of the stock. Given the absolute size of the company, good dividend yield and its 30% weight in Abu Dhabi Index would make the stock highly attractive to every international diversified portfolio investing in GCC stocks. Such action would probably have a rather strong one-off effect on the stock pushing it significantly above our target price. We are aware that some consultation have taken place and rumours have circulated in the local media, but a speculation on such an announcement would be more suitable for a short-term trader, quite different from the majority of current Etisalat shareholders.

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Etisalat - Financial statements Profit & loss statement AEDm Revenue Growth y-o-y EBITDA % of Revenue Depreciation & Amortisation Impairments Associates Operating profit before royalty % of Revenue Federal Royalty Operating profit % of Revenue Net Financial Income (Expense) Tax Net profit % of Revenue of which Minorities Net Profit to shareholders % of Revenue 2011A 32,242 1.0% 15,882 49.3% (3,387) (3,044) 1,208 10,442 32% (5,840) 4,602 14% 33 (25) 4,610 14% (1,229) 5,839 18% 2012E 33,082 2.6% 16,673 50.4% (3,478) 1,360 14,555 44% (7,278) 7,278 22% 151 (280) 7,149 22% 30 7,119 22% 2013E 34,330 3.8% 17,096 49.8% (3,559) 1,496 15,033 44% (7,517) 7,517 22% 175 (308) 7,384 22% 74 7,310 21% 2014E 35,684 3.9% 17,664 49.5% (3,634) 1,616 15,646 44% (7,823) 7,823 22% 183 (333) 7,673 22% 96 7,577 21%

Cash flow statement AEDm Net Profit Dep. & Amort. & Imp. Other Income (Expense) Change in Working Capital Cash flow from Operations Cash flow from Investing Dividends Cash flow from Financing Net Increase / Decrease in cash 2011A 4,603 6,432 (845) (2,709) 7,481 (2,552) (4,744) (4,744) 185 2012E 7,149 3,478 (1,360) (1,049) 8,218 (3,134) (4,744) (4,744) 340 2013E 7,384 3,559 (1,496) (1,101) 8,345 (3,029) (4,744) (4,744) 573 2014E 7,673 3,634 (1,616) (1,146) 8,546 (2,858) (4,744) (4,744) 944

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