Mobile penetration rates high as competition increases in Saudi Arabia

Accounting for 6% of GDP and 10% of non-oil GDP in 2016, according to the Communications and Information Technology Commission (CITC), Saudi Arabia’s ICT sector plays an important part in the Kingdom’s economy. Spending in the sector exceeded SR130bn ($34.7bn) in 2016, and in 2017 it was expected to have reached SR138bn ($36.8bn) despite economic headwinds. The government’s recently finalised economic strategy places ICT at the centre of the nation’s development, and telecoms players, hardware and software providers, and service operators all stand to benefit from the array of state-directed initiatives it has set in motion. Nevertheless, challenges in the sector remain. Lower oil prices have curtailed private sector spending on ICT, and increasing competition in the market has squeezed margins. Regulatory changes, too, have added pressure to ICT companies’ bottom lines over the past year, and the industry is responding by reining in expenditure and shifting the strategic focus to new products and services. “We generally see ICT services demand growing across the board, although the market will be slower in the near future,” Ayman Al Johani, CEO of infrastructure services specialist Data Link, told OBG. “In the long term and across all sectors, e-service, and operations and maintenance are good opportunities for small and medium-sized enterprises.” All this makes for an interesting period in this dynamic area of the economy.

History

The size of Saudi Arabia’s territory means that telecoms have been a crucial economic enabler since its foundation. The late King Abdulaziz acknowledged the importance of connecting remote areas when he established the Directorate of Post, Telegraph and Telephone in 1926 – an innovation which took place even before the unification of the Hejaz and Nejd to form the present Kingdom. This period saw the government begin its construction of a wireless radio network with nationwide coverage, as well as the expansion of an international telegraph system across the Red Sea to connect Jeddah with Port Sudan. In 1932, the year in which Saudi Arabia officially came into being, Riyadh received its first private branch exchange, a 50-line-capacity unit located in the Palace of Governance. In 1934 a public telephone service was established in the Kingdom for the first time, and by the 1950s the government was overseeing the development of a wireless telephone network to connect the different regions. The 1960s saw the arrival of telex machines, the movement spearheaded by the Lorenz 331 and Siemens T 72-inch – the first Arabic-enabled telex devices. By the end of the decade telex innovation had gone international, with the installation of the first microwave connection between Dammam and Bahrain.

Advancements

The sector underwent a significant organisational shake-up in 1975, with the establishment of the Ministry of Post, Telegraph and Telephone (MPTT), which assumed regulatory responsibility for a sector which featured 130,000 telephone lines and total annual revenue of around SR250m ($66.7m). On the technical side, the next step forward came in the mid-1980s, with the arrival of the Kingdom’s first fibre-optic network. With the new infrastructure came a raft of telecoms centres and complexes, established all over Saudi Arabia. The following years saw a series of rapid advances, including the country’s first satellite operations, very small aperture terminal services and a smart net data transfer network. Between 1998 and 2001 the sector experienced another significant organisational change. Responsibility for post, telegraph and telephones was taken from the MPTT and handed to a new joint-stock company – Saudi Telecom Company (STC). Shortly afterwards, the government issued the Telecommunications Act and established the Saudi Communications Commission, which was later to become the CITC. The new body was mandated to regulate the sector according to the new act, a role it continues to perform to this day. The MPTT, meanwhile, was renamed to better reflect the modern sector, becoming the Ministry of Communication and Information Technology (MCIT).

Under this framework the ICT sector rapidly expanded, particularly after the 2004 liberalisation of the mobile phone segment and the issuing of a second mobile operator licence to the Saudi firm Mobily. Fixed-line telephony was liberalised in 2007, the same year in which the Kingdom welcomed its third mobile operator, Kuwait’s Zain. More recently, the government has begun to issue licences for virtual network operators, a move which has ramped up competition in what has become one of the region’s most vibrant telecoms industries.

Fixed Lines

Since its partial privatisation and separation from the MPTT in 1998, STC has remained the dominant fixed-line telecoms player in the Kingdom. The government retains a majority interest in the company through a 70% stake held by the Saudi Public Investment Fund, as well as smaller holdings held by the Public Pension Agency and the General Organisation for Social Insurance. The public float stood at 16.23% of the company as of January 2018.

Over the past two decades the company has continued to expand its offerings in fixed, mobile and data services, maintaining its position as the leading telecoms services provider in Saudi Arabia. It has also expanded its international footprint by acquiring a 25% stake in Indonesia’s Axis Group in 2007, which in turn operates a number of mobile networks in India and Malaysia. Other key investments include the 2013 acquisition of push-to-talk mobile operator Bravo and a 51.8% share in Viva Kuwait.

The Kingdom’s second fixed-line operator arrived in 2009. Under the licence granted to it by the CITC, Etihad Atheeb Telecom, which trades under the name GO, was granted permission to operate a public fixed telecoms network, including international gateways, and to provide fixed-line communication services at the local, national and international levels. By 2015 the company had 200,000 customers across the Kingdom.

In the first quarter of 2017 the total fixed-line subscriber base in Saudi Arabia stood at 3.75m, according to the CITC, divided almost evenly between residential and business lines. This represents a household penetration rate of 32.9%. The household penetration rate has been declining over recent years as an increasing number of Saudi citizens and residents have found it more convenient to use a mobile device as their principal means of telecommunication. Fixed-line household density stood at 68% as recently as 2012, with the bulk of the subsequent decline in numbers coming from residential lines.

Mobile Growth

The adoption of mobile telephone technology in Saudi Arabia has been rapid since the turn of the century. In 2001 the mobile penetration rate stood at just 12%, according to the CITC. The market was then served by a single operator, with customers holding post-paid accounts only. This scenario changed with the market liberalisation of 2004, after which consumers benefitted from increasingly competitive pricing. Pre-paid accounts, in particular, drove sector expansion and by 2007 the Kingdom’s telecoms operators held 28.4m subscriptions between them – a penetration rate of 113%.

The ease with which Saudi residents could obtain pre-paid SIMs propelled penetration to 188% by the beginning of 2012, when there were 53.7m subscriptions in the Kingdom, a period which represents the high-water mark for subscriptions and penetration.

Since that time there has been a rationalisation of the market: by the second quarter of 2017 mobile subscriptions stood at 43.6m, with the SIM penetration rate standing at 137%. The majority of subscribers, around 78% of them, continue to be pre-paid customers; however, the industry has succeeded in shifting nearly a quarter of the customer base to the more revenue-stable post-paid deals.

Mobile Players

Saudi Arabia is home to three mobile network operators (MNOs), which vie for business in a segment where penetration rates are considerably higher than those seen in the fixed-line business. As with the fixed-line arena, STC is the dominant mobile player, although the absence of official data leads sector observers to rely on approximations with regard to market share. In 2016 Riyadh-headquartered Aljazira Capital estimated that STC claimed between 49% and 52% of the mobile market.

Mobily, also known as Etihad Etisalat Company, entered the scene following the market liberalisation in 2004, and is thought to account for between 25% and 28% of the total customer base. The UAE’s Etisalat maintains a 26.3% stake in the company, while the Saudi ownership is two-fold: public investors hold 40% of the company’s shareholding, while institutional investors claim a 33.8% stake.

The Kingdom’s third MNO is Zain, part of the Kuwait-based Zain Group, which entered the market in 2008. Nearly 54% of the company is held by the public sector, while Zain’s largest institutional investor is the Kuwait Investment Authority, which retains a stake of 24.6%. The company runs mobile operations in eight countries across the Middle East and North Africa, which between them serve approximately 47m customers. In Saudi Arabia Zain claims a market share of 23%, with a customer base of around 10.7m.

Zain’s arrival to the market resulted in a high level of competition for subscribers over the past decade. It was raised still further in 2014, with the licensing of two mobile virtual network operators (MVNOs). Both of them work with fixed ties to the MNOs: Virgin Mobile Middle East and Africa (VMMEA) works with STC, while Jawraa Lebara is linked to Mobily. The CITC is continuing the process of selecting a third MVNO to work with Zain. In 2017, after two years of operation, VMMEA announced it had passed the 2m subscriber mark. Lebara, after slower growth in 2015, gained momentum in 2016 to surpass 1.3m subscribers.

Performance

With triple-digit SIM penetration rates and an increasing number of market participants, the profitability of Saudi Arabia’s telecoms firms is under pressure. The full-year earnings of STC declined by 7.8% in 2016, to SR8.5bn ($2.3bn), compared to the SR9.3bn ($2.5bn) of 2015. Mobily posted a net loss for 2016 of nearly SR203m ($54.1m), which represented an improvement on the loss of approximately SR1.1bn ($293.3m) in 2015. The company’s earnings before interest, tax, depreciation and amortisation, however, showed positive growth of 31.9% in 2016, reflecting its efforts to improve profitability. Zain, meanwhile, has reported annual losses since its inception, and in 2016 the telecommunication company reported a net loss of SR980m ($261.3m). In broad terms, however, net losses have been decreasing year-on-year, and in the first quarter of 2017 the company reported its first quarterly profit.

While there are encouraging signs of improvement on the income statements of the Kingdom’s MNOs, a number of significant challenges to profitability have yet to be overcome. One of them has largely run its course in the financial statements, but represents a hurdle to future expansion nonetheless. In 2016 the CITC implemented the decision it made a year earlier to require all telecoms subscribers to register their fingerprints. The new rule was applied to all Saudi customers, as well as visitors, Gulf citizens, and Hajj and Umrah pilgrims. In early 2016 MNOs and MVNOs began the first phase of implementation, scanning and recording the fingerprints of new customers with registration devices linked to the National Information Centre. The registration system replaces a previous mechanism by which customers signed written contracts including their full name, national identity number, nationality, phone number and details about the service requested, which the CITC deemed vulnerable to fraud by people using forged identification cards.

Falling Revenues

The fingerprint requirement, alongside high penetration levels and the negative effects of a low-oil-price environment, contribute to the single-biggest challenge facing the Kingdom’s MNOs: a declining trend in average revenue per user (ARPU). This trend is not limited to Saudi Arabia, however. As mobile markets around the world have matured, every region besides Asia has experienced downward pressure on ARPU since 2011. North America witnessed a 2% decline in ARPU between 2011 and 2016, according to consultancy PwC, while Western Europe and Latin America have seen drops of 6% and 10%, respectively. In the Middle East, ARPU fell by 4% over the same period, as software such as Skype and Viber undermined revenue on traditional voice calls.

In Saudi Arabia, a price war in the provision of data is playing a significant part in this decreasing ARPU trend. While the nation’s fixed-line operators have been providing customers with broadband services for years, the mobile operators are by far the biggest broadband players in the domestic market. In the first quarter of 2017, 3.25m Saudi residents held fixed broadband subscriptions, according to CITC data, which represented a household penetration rate of 44.2% – only a modest advance on the 40.9% seen in 2012. Conversely, there were 25.25m mobile broadband subscribers at the beginning of 2017, and the mobile broadband penetration rate of 79.6% was a significant gain on the 42.1% of five years earlier. Revenues from data services now account for a large proportion of ARPU, more than 50% in the case of Zain, for example. With three MNOs and two MVNOs struggling for market share in this important segment, data prices have followed a consistently downward trend.

Converging Technologies

Declining ARPU for voice and data services is compelling telecoms firms to look for new revenue streams. Saudi Arabia’s MNOs have already shifted their focus from the crowded voice and data space to establishing themselves as comprehensive enterprise solutions providers, offering integrated ICT packages which include data centres, managed services and cloud services. The CITC’s most recent research on non-core telecoms activities, published in 2015, revealed the rapid uptake of these technologies: spending on data centre services increased by 48% between 2011 and 2014, and spending on managed and cloud services grew by 55% and 373%, respectively. This trend has been significantly accelerated by the 2016 levelling of the regulatory playing field, which resulted from the CITC rolling out its new unified licence.

The new regulatory framework enables MNOs to extend their existing licences and include landline telephone and fixed internet services within their operations, as well as their pre-existing mobile services. This marks the end of an era in which STC was the only operator permitted to adopt such an integrated approach to the market. In October 2016 Zain became the first MNO in the Kingdom to gain the new licence, and in February 2017 Mobily acquired a unified licence valid until 2034 for SR5m ($1.3m). As well as the initial fee, the government charges a 5% levy on each telecoms company’s annual net income as part of the agreement. For companies such as Zain, the newly granted regulatory freedom means playing catch-up with regard to infrastructure, a challenge which the company has indicated it will answer by teaming up with established players: in October 2016 the company revealed that it had signed an open-ended letter of intent with Dawiyat Telecom, a wholly owned subsidiary of Saudi Electricity Company, which will allow Zain to utilise its 51,000-km fibre-optic network.

Data Providers

As well as STC, there are two other licensed data service providers (DSPs) in the Kingdom. Integrated Telecom Company (ITC) was established as a subsidiary of Al Mawarid Group in 2005 and operates its own infrastructure, with landing stations at Jeddah and Al Khobar connecting submarine cabling to the 17,000-km Saudi National Fibre Network. ITC has strategic partnerships with many international technology companies, including Cisco Sun Microsystems, Oracle and HP. In 2017 the company signed agreements with the MCIT and the CITC to implement the high-speed fibre-optic broadband initiative, which forms part of the government’s drive to extend broadband services to 80% of the population by 2021 (see analysis).

The Kingdom’s third DSP is Bayanat Al Oula for Network Services, which since 2008 has been 99% owned by Mobily. The three DSPs serve businesses (including telecoms firms) and residences directly, as well as sell wholesale data to around 50 internet service providers licensed to operate in the Kingdom. All of them stand to benefit from an anticipated increase in demand for data centres, managed services and cloud computing, as new products continue to hit the market. “We have received good feedback on managed services, as companies are attempting to reduce costs,” Amjad Abdel Hafez, CEO of telecoms firm Nournet, told OBG. “People are now looking to outsource; both the enterprise market and medium-sized companies see IT as a means of enhancing efficiency. The range of managed services on offer is also increasing – we are seeing a lot more customer relationship management applications, for example.”

E-Government Projects

As well as developing private sector demand, Saudi Arabia’s e-government projects offer routes to revenue for ICT players. The country’s e-government programme, Yesser, was established in 2005 by the MCIT, the CITC and the Ministry of Finance (MoF). Since that time it has established a central government portal, which allows not only citizens, residents, businesses and visitors, but also other government organisations and businesses, to access e-services online.

Other key Yesser initiatives include the National Centre for Digital Certification, which provides a platform for the management of security keys used to authenticate e-service users’ identities, and the Yesser Data Centre, which facilitates the integration of data among government agencies. Other government departments are also digitising elements of their processing, with the MoF integrating all processes related to government tenders into its Monasafat digital system. It is hoped that this will cut decision-making time and increase transparency.

“The MoF is binding all government agencies to publish their tenders online through the e-Government Procurement Portal service (Monafasat); this will increase transparency,” Abdulaziz Alshamsi, CEO of Tabadul, the government’s e-services provider for trade, Customs and procurement, told OBG. “Not only that, Monafasat will be embedded in a bigger platform that the MoF is launching called Etimad, which will cover from contracting to invoicing and payment.”

The rationalisation of the government’s data network, however, remains a work in progress. Industry estimates as to the number of public sector data centres in operation range between 100 and 200, and there is a wide variation in design and hardware. The ongoing consolidation of public sector data presents a number of opportunities for ICT players, particularly those with globally derived expertise. HP, for example, is marketing its Cloud 28+ platform in the Kingdom, hoping to repeat the success it has enjoyed with European government entities with its open community of cloud-service providers, cloud resellers, internet service vendors and systems integrators. ICT firms are also offering government a wide breadth of managed services being developed for the private sector, with the objective of shifting their customers’ ICT spending from the capital expenditure column to the operational expenditure area of their income statements. “The government’s move towards outsourcing some IT departments to private sector companies is driving down costs and increasing the overall efficiency of the government’s delivery of services.” Mohammed Alshaibi, CEO of Tamkeen Technologies, told OBG.

Regulation

A number of government entities are charged with regulating and developing the rapidly evolving ICT arena. The MCIT is responsible for overseeing all ICT activity in the country, as well as planning and implementing the government’s strategy for the telecoms sector. The CITC is an independent government agency charged with licensing ICT companies, managing tariffs, content filtering and quality control (which includes blocking websites considered to contravene the Kingdom’s social codes).

The responsibilities and objectives of the CITC include providing “advanced, sufficient and affordable communications services; creating the proper climate to encourage fair competition; utilising frequencies efficiently; transferring telecoms technology and keeping abreast with its developments; realising clarity and transparency in processes procedures; and achieving the principles of equality and non-discrimination and protecting the public interest, as well as the interests of users and investors.”

A further level of regulatory oversight comes in the form of the Council of Ministers, which must sanction the issuance of any licence under the Telecommunications Act, which was promulgated in 2001. This piece of legislation establishes the legal basis for telecoms regulation and structure in Saudi Arabia, and represents the legislative backbone of the sector. It is augmented by supplementary legislation, the Telecommunications Act Bylaws of 2002, which outline the specific duties and procedures to be carried out by the CITC – the body with which sector participants are likely to have the most communication.

The decision by the CITC to require fingerprint registration for mobile subscribers illustrates how a single regulatory adjustment can have significant consequences for mobile operators’ bottom lines. In that instance, all major players in the market were affected, however other recent changes to the mobile regulatory framework have had different implications from one company to the next.

For example, when the CITC announced in 2015 that it would lower mobile interconnection charges by 40% the chief beneficiary was Zain; as the company with the smallest market share, its subscribers made more calls to the customers of other mobile operators, and therefore the revised schedule enabled the company to exceed its gross profit margin targets for that year.

Other recent regulatory changes include the publication of rules for access to physical facilities, which address issues such as the co-location and sharing of infrastructure, and the streamlining of the process by which products and services are introduced to the market, for example by abolishing the requirement for prior approval for products which are in line with established guidelines. In general, ICT players have a robust relationship with the regulator, and have shown themselves to be comfortable with opposing regulatory decisions that they deem unfair. For example, in 2016 Zain had four outstanding lawsuits against the CITC concerning disputes that ranged from objections to fines to a delay in the enforcement of the mobile number portability framework.

Strategic Boost

These bodies will play an important role in the growth of the ICT sector over the medium term, as the government sets about implementing its national economic strategy. The sector features prominently in both Vision 2030, launched in April 2016, and the National Transformation Programme (NTP), which establishes a range of development targets to be met by 2020. One of the most important targets of the programme is providing “broadband services to all regions in the Kingdom by stimulating investment in infrastructure and tools for development, and technical and regulatory frameworks”. More specifically, government targets seek to establish 80% fibre-to-the-home (FTTH) coverage in densely populated urban areas (up from 44%), 55% FTTH coverage in urban areas (up from 12%), and 70% wireless broadband network coverage in remote areas, a significant increase from 12% (see analysis).

The MCIT is also charged with meeting a number of key targets, including developing a cadre of 20,000 skilled ICT employees by 2020 to meet the future needs of the market; developing and activating smart government transactions in order to move the nation’s UN e-government ranking from 36th to 25th; increasing the percentage of frequency spectrum available for telecoms services; creating an attractive environment for e-commerce; raising the Kingdom’s ranking on the UN Council for Trade and Development e-Commerce indices of business-to-business and business-to-consumer; and increasing the IT industry’s contribution to non-oil GDP. In moving to meet these targets, the MCIT and the CITC will open up new opportunities for the Kingdom’s ICT players, which now stand to recover revenue lost during the spending curtailments which followed the decline of oil prices in late 2014 and 2015.

New Technologies

New technologies will also provide a useful route to revenue over the coming period. In February 2017 Zain and Finland’s Nokia announced the successful conclusion of trials of advanced 4.5G features, including uplink carrier aggregation, 4×4 MIMO, downlink 256 QAM and uplink 64 QAM. The trials, which were undertaken in Jeddah, will help Zain Saudi Arabia move towards the next generation technologies of 4.5G Pro, 4.9G and eventually 5G. A month later, STC inked a memorandum of understanding with Sweden’s Ericsson aimed at helping the company to introduce its 5G framework, having already carried out its own 5G experiments and lab tests. Under the agreement Ericsson will carry out joint trials with STC, incorporating network tests on “very high speed”, “ultra low latency” and a “highly reliable extreme capacity broadband network”. Another interesting technological advance in the Kingdom is Massive MIMO, a concept based on using large numbers of antennae and beams to enhance spectrum utilisation among multiple user equipment, resulting in a better end-user experience. The technology was trialled in Dammam in cooperation with equipment vendor Huawei, achieving a peak downlink throughput of 677 Mbps. “Technology is evolving at speed,” Ahmad G Alharbi, president of Integrated Computer Systems, told OBG. “For those not agile enough to move with these advances, there is a risk of job losses and an increased likelihood of business consolidation.”

Outlook

The decision by the CITC to require fingerprint verification for all mobile subscribers has resulted in downward pressure on revenue in the short term, and in April 2017 another SIM restriction came into place in the form of a two-card limit for foreign residents, who make up more than a third of the Kingdom’s residents. However, the stricter SIM regulations could result in potential long-term advantages: post-paid subscriber numbers are likely to grow quicker than those for pre-paid accounts as a result of the changes, and MNOs will consequently benefit from the higher ARPU and lower switchover rate associated with this model of payment.

With high levels of competition ensuring that revenues will remain under pressure, cost cutting is likely to be an industry theme in the short term. Reducing unnecessary expenditure on infrastructure is one way in which telecoms firms can shore up their bottom lines. In March 2017 STC and Mobily were reported to be seeking a joint adviser to facilitate the merger of their mobile mast operations, while Zain announced plans to sell its mobile towers for more than $500m. This follows talks between the three MNOs over the possibility of establishing a tower company in a bid to reduce infrastructure costs by as much as 70%, which have yet to result in an agreement.

The rapid expansion of data centres, managed services and cloud services is expected to continue in the short term. The CITC anticipates that spending on these segments will surpass SR1bn ($266.6m), SR1.4bn ($373.2m) and SR476m ($126.9m), respectively, in 2019. The government’s drive to provide a workforce capable of meeting the skills demand arising from this trend received a useful fillip in 2017, with the signing of a memorandum of understanding between the MCIT and Oracle to train and certify more than 5000 Saudi graduates in next-generation IT skills. Similar deals are likely to be struck over the short term, as the government utilises the capacities of global IT firms to provide a quick fix to the human capital challenge.