Saudi telecoms companies innovate in a challenging market

With two new players entering the market, a major mobile operator dealing with fallout from systematically overstating revenues while understating costs, and the third mobile licence operator continuing to operate at a loss since its launch seven years ago, the Saudi telecoms sector is experiencing interesting times.

The challenge to mobile voice and text revenues posed by free over-the-top (OTT) apps, such as WhatsApp and Skype, as well as increased use of YouTube and social media apps like Twitter and Snapchat, has played a part in shifting the emphasis for the Kingdom’s domestic operators towards data and mobile broadband, but also towards more profitable markets such as the government and corporate sectors, and the bundling of telecommunications and IT services. This planned convergence in service provision in an intensively competitive market offers the prospect of mergers and acquisitions, according to industry insiders.

Fixed Telephony

There were 4.7m fixed lines in 2014, 10,000 fewer than in 2013 and 140,000 fewer than in 2012, according to data released mid-way through 2014 by the Communications and Information Technology Commission (CITC). This slight decline in year-on-year total fixed-line numbers took place at the same time as a rise in the total number of households and an increase in the overall size of the population.

CITC records show the number of fixed lines per household, or household tele-density, has fallen to 15.1%, its lowest level since 2010, when it was 15%. In 2012, household tele-density reached a peak of 16.4%. A year earlier, in 2011, the total population divided by the number of fixed lines peaked at 69.3%. The tele-density figure for 2014 was 62.6%, the lowest figure in the years from 2008 to 2014. In the two years since 2012 fixed-line operators have lost 100,000 residential customers and 40,000 business users, which is also a global trend as more individuals and smaller business rely on mobile phones and voice data programmes.

Fixed Broadband

In contrast to the decline in fixed lines, fixed broadband subscriptions have been rising, according to CITC data. Fixed broadband subscriptions including DSL, fixed wireless and fibre to the home (FTTH) or business grew to 3.18m by mid-2014, up from 2.92m in 2013 and 2.54m in 2012. At the same time ADSL subscriptions have been falling, from 1.87m in 2012 to 1.85m in 2013 and 1.83m in 2014, but fixed wireless subscriptions have been increasing from 0.6m in 2012 to 0.8m in 2013 and 1m in 2014. Fibre services subscriptions have grown rapidly from 118,000 in 2012 to 258,000 in 2013 and 368,000 in June 2014.

According to CITC, fixed broadband penetration stands at 48.4% of households. Telegeography’s “GlobalComms” database on the Saudi Telecom Company (STC), dated September 2014, said there were 400,000 FTTH subscribers by that time and a total of 2.32m fixed broadband subscribers in all in the Kingdom, with STC having a 77.5% share of the retail subscriber market. By October 2014 STC’s fibre-optic network, which launched in August 2010, extended to 600 locations in 16 cities and by June 2014 it was available to 900,000 homes. In December 2014, in a statement to the Saudi Gazette, Mobily said the firm was aiming to connect 1m homes by the end of 2014, though this was substantially overestimated, with figures indicating less than 20% of the goal was achieved by mid-2015.

Fixed-Line Operators

The fixed-line market for voice services has witnessed strategic corporate realignment since 2013, when state-backed STC, which has the lion’s share of fixed-line customers, began to focus on the segment. Its only rival in the fixed-line space was Etihad Atheeb Telecom, known as GO Telecom, which was awarded a 25-year licence in 2009 and had 268,200 customers at the end of 2013, some 5.7% of the total.

In 2013 it appeared that Saudi Arabia’s second-largest mobile operator, Mobily, was interested in acquiring a controlling stake in GO through its subsidiary Bayanat Al Oula. A memorandum of understanding was signed between Bayanat and GO’s founding shareholders, but in May 2014 GO announced the deal was off, and in June a new deal of a different sort was announced by GO and STC. In the indefeasible rights of use (IRU) agreement, STC granted GO 30,000 ports on its fibre network for SR408m ($108.7m) to be paid over five years. The IRU allows the firms to agree on increasing the number of ports to 100,000. In June 2014, it was announced that GO had secured a marketing agreement worth SR309m ($82.3m) with STC, under which GO will market STC products to its business clients, particularly small and medium-sized enterprises, for 30 months. The deals enabled STC to deny mobile operator Mobily access to the fixed-line segment.

Mobile Market

The number of mobile subscriptions was static in 2014, at 51m, according to CITC data. Mobile penetration slipped from 169.7% in 2013 to 169.3% in 2014, down from a peak of 188% in 2011 – mainly due to a change in how active subscribers are measured. The vast majority of contracts, 88%, are for pre-paid SIM cards, which accounted for 44.8m, while just 6.6m were based on long-term post-paid contracts.

The total numbers of post-paid contracts grew steadily to 7.3m in 2012, but have fallen in the two years since then. Mobile phone handsets in Saudi Arabia are sold unlocked, making it easy for users to switch SIM cards belonging to different operators. The predominance of pre-paid SIMs makes it difficult for regulators such as CITC, and for the mobile operators themselves, to measure how many SIM cards are being actively used. For this reason, sales revenues are a more accurate measure of company performance than subscriber numbers. Many users have multiple SIMs.

Smartphone Usage

Saudi Arabia’s consumers have a reputation for early adoption of new technology and this is reflected in their use of smartphones. Usage figures collated by Google’s Consumer Barometer shows that smartphones are the devices most commonly used to access the internet in Saudi Arabia, and that 82% of users take action or make a purchase based on the information they find. CITC figures show the number of mobile broadband subscriptions has increased to 20.7m, representing a population penetration rate of 68.3% in 2014, up from 47.6% in 2013, and was 2.7m in 2010.

The number of internet users reached 18.3m in 2014, representing a penetration rate of 60.1%, according to CITC’s latest report. Telegeography’s “CommsUpdate” on STC, published in October 2014, showed that of the 23.1m subscribers using its services, 9.45m were using 3G services and 750,000 were using 4G long-term evolution (LTE). STC’s 4G LTE service covered 85% of areas in the country in October 2014 and it hoped to extend this to 95% by the end of the year, according to the report. All three mobile networks in Saudi Arabia launched 4G LTE services in September 2011.

Operators

STC is the dominant player in the mobile market, where its rivals are Etihad Etisalat, which trades as Mobily, and Zain. Although all three companies are listed on the Saudi Stock Exchange, STC is effectively a state-owned entity, with 16.4% of its equity floated on the exchange and the remainder in the hands of the sovereign wealth fund, the Public Investment Fund, and state pension organisations. With a market capitalisation of SR129bn ($34.4bn) in March 2015, it is the largest telecoms operator in the Middle East, and through its affiliates it has interests in Kuwait, Bahrain, India, Malaysia, UAE, Turkey and South Africa.

In March 2014 STC concluded the sale of its Indonesian outfit Axis for $865m. Mobily’s largest shareholder, with 27.4% of its shares, is the Emirati telecoms firm Etisalat, while Saudi Arabia’s General Organisation for Insurance owns an additional 11.4%. The Kuwaiti telecommunications company Zain owns a 37% stake in the third mobile operator in the Kingdom, which trades under the same name. There has been competition between STC, Mobily and Zain, and as 2015 started, the sector was adjusting to the fallout from an investigation into Mobily’s accounting practices and awaiting the results of arbitration on a SR2.2bn ($586.3m) dispute between Mobily and Zain.

Mobily Investigation

In October 2014 investors were waiting for Mobily to report its third-quarter earnings, when the firm announced an accounting error, which meant its earnings for the previous 18 months would have to be restated. Trading in the firm’s shares was temporarily suspended and the Capital Market Authority (CMA), announced an investigation. The company began an internal investigation and then-CEO Khalid Omar Al Kaf was suspended pending the result. In late February, the CMA temporarily suspended trading in Mobily’s shares again when it was revealed that a preliminary set of financial results reporting a net profit of SR220m ($58.6m) had been revised and replaced with a net loss of SR913m ($243.3m). Al Kaf resigned in late February and on March 1, 2015, Mobily announced it would cooperate fully with a CMA investigation, which would involve interviews with staff, site visits and a thorough review of its financial statements.

When the irregularities in its accounts were announced in October 2014, it was suggested that anticipated sales from a promotional campaign had been accounted for as revenue. The firm’s March statement on the Saudi Stock Exchange website said, “The company made a deduction of SR905m ($241.2m), for deferred promotion costs and other items, from the recurring telecom revenues in 2014.” Mobily’s market capitalisation then fell from SR61.6bn ($16.4bn) in October 2014 to SR30.1bn ($8bn) in March 2015.

In May 2015 local press reported that the CMA had referred nine current and former Mobily officials to the Bureau for Investigation and Public Prosecution for violating trading regulations. While none of the individuals in question were identified, Mobily did release a statement that it was cooperating with authorities.

The results of the investigation have also led to more stringent reporting requirements for other firms. CMA-issued fines rose 46% year-on-year in the first quarter to SR1.83m ($487,695) as the authority tightened oversight. The investigation has ensured more accurate disclosures. Turki Fadaak, head of research and advisory services at AlBilad Capital in Riyadh, told Reuters, “What happened set the alarm bells ringing and pushed board members to revise their roles, made investors carefully check financial statements and caused company management to review accounts. It has made us, the analysts, keen on meeting with management more often, and caused us to look at everything being said and everything that managers announce.”

Arbitration Hearing

Another source of uncertainty has been an ongoing legal dispute between Mobily and Zain. In February 2015 Zain announced that the arbitration panel had given Mobily until May 23, 2015 to submit a detailed statement on the claim and that Zain would then have a further two and a half months to respond, at which point the arbitration panel would request further input from the two companies over a two-month period, suggesting there might not be a resolution of the issue until late 2015.

The dispute dates back to a service agreement between the two companies in May 2008, under which Mobily provided services, including national roaming, site sharing, transmission links and international traffic. Mobily said Zain should pay SR2.2bn ($586.3m), but Zain valued the services at only SR13m ($3.5m).

Capital Cut

In January 2015 Zain announced the CMA had approved a 45.96% reduction in the company’s capital from SR10.8bn ($2.9bn) to SR5.8bn ($1.5bn) to write off its accumulated losses to September 30, 2014. In the same month Zain announced it had reduced its net loss by 23% in 2014, with the company reporting gross profit of SR3.2bn ($852.8m), up 2.81% on SR3.1bn ($826m) in 2013. The company incurred net losses of SR1.27bn ($338.5m) over the 12-month period in 2014, down from the SR1.65bn ($439.7m) reported in 2013. At the same time Zain noted an increase of 147% in internet service subscribers and a 621% uptick in internet traffic during 2014.

Market Share

According to figures from the GlobalComms database, STC’s share of the mobile market in September 2014 was 44.4%, down from 47.4%, but still significantly higher than Mobily with 38% and Zain with a 17.3% share. However, this is likely to change in 2015 due to the investigation into Mobily’s finances. Zain was also facing a significant financial burden from call termination charges, which are levied when a call from one network terminates on a rival network, with the originating network paying a termination fee.

In February 2015 Zain welcomed news that CITC had cut these termination charges by 40%, from SR0.25 ($0.07) to SR0.15 ($0.04). A report from CITC in September 2014 had found that termination fees in countries benchmarked against Saudi Arabia were SR0.02 ($0.01) to SR0.13 ($0.03), suggesting there may be further cuts in the fees in the future. Zain Saudi’s CEO, Hassan Kabbani, told local press. “The CITC new regulations regarding mobile and fixed termination rates will increase competitiveness in the market and allow consumers to freely move between operators.”

STC Results

While the termination charges may lessen its advantage over smaller rivals, STC’s most recent results were healthy. In its annual financial statements for 2014, STC posted revenues of SR45.83bn ($12.2bn), up 0.48% from SR45.6bn ($12.15bn), and net income of SR11bn, ($3bn) up 10.7% on the previous year’s SR9.9bn ($2.6bn). STC’s management said the firm was looking forward to competing in a more transparent market, in the light of the adjustments made by Mobily to its forecast revenues. “That inflated the market and caused others to overestimate growth potential,” Sacha Dudler, corporate performance management general manager at STC, told OBG. “Operators fought for imaginary market share and this led to irrational behaviour, price wars and value erosion.”

Virtual Network

It was in the midst of this rivalry that two new players – and a third also expected – entered Saudi Arabia’s mobile telephony market, but as allies of the two biggest existing operators. The new mobile virtual network operators (MVNOs) were Virgin Mobile MEA, which has negotiated a licence with STC, and Jawraa Group, controlled by London-based MVNO Lebara, which is using Mobily’s network. The two firms were granted licences in March 2014, but CITC decided against granting a licence to Axiom Union Mobile of Dubai, which had hoped to align itself with Zain. Virgin began operating in September 2014, and the two services are aimed at different segments: Virgin Mobile targets the youth market, while FRiENDi has focused on expatriate workers. Lebara launched in December to capture the middle- and lower-income segments.

The firm has done well in terms of distribution and customer uptake so far, with more than 25,000 points of sale for its SIM and SC cards, as well as 600 Saudi post shops around the Kingdom. The two MVNOs are being charged for network capacity by STC and Mobily, but intend to use niche marketing to target specific segments of the population. The appeal for network operators is that they can focus their attention on more lucrative segments of the population and on diversifying their business models as they see their traditional voice services cannibalised by data services. MVNOs are continuously grabbing market share, but visibility is low as to how successful MVNOs really are. Their combined subscriber base is estimated to be in the hundreds of thousands at this stage, below 5% market share.

Consolidation

In other parts of the telecoms sector mergers and acquisitions are taking place. The six companies working as distributors for Mobily were planning to merge in 2015 to improve margins. The CEO of one of the firms, Qanawat Telecom Company, Mohammed Sadyeh, told OBG he expected to see more consolidation across the sector as businesses adapted to saturated markets and erosion of revenue streams such as voice and text services. “I believe it is time for companies in Saudi Arabia to consolidate and I think we could see a number of mergers,” Sadyeh told OBG. “For instance, on their own, the Integrated Telecoms Company (ITC), Zain and GO cannot get enough revenue to support their operations, but together they could share resources. ITC has the fibre, Zain has the mobile and GO is talking to STC at the moment, but they have nothing STC needs. This is make or break decision time as the industry becomes increasingly competitive.”

Challenges

Keeping pace with technological changes and investing to ensure customers are able to benefit from the latest developments present telecoms firms with both challenges and opportunities. There are 750,000 4G users in the Kingdom and 400,000 FTTH subscribers. FTTH numbers are growing rapidly, but people living in major population centres have become used to their handset outperforming their DSL-based home broadband. There are also logistical challenges. “We are facing the same challenge as our competitors,” Dudler told OBG. “There is so much going on in this country that finding suppliers to roll out our fibre is difficult. So we are actually deploying much less than we would like to, and there’s a huge demand for fibre, especially in urban areas. Our customers want to have FTTH, but it’s not always easy to get it to them.”

Outlook

The new CEOs due to take the helm at both STC and Mobily in 2015 face a number of challenges in steering their companies through competitive and changing times. As they invest in expanding the infrastructure to connect more customers to a broader range of communications and entertainment services, companies in the sector have to address whether their revenues will come from connectivity or communication. “Today the main focus is 80% communication for these companies and 20% connectivity,” Sadyeh told OBG. “But I expect this to reverse, or at least to become 30% communication and 70% connectivity.”