Following the successful $3.46bn bid for Saudi Arabia's second mobile license, Ettihad Etisalat is gearing up for an operational launch next month. The near-term outcome of Etisalat's entry will be a true test for the regulator, CITC, and its ability to remain independent from the incumbent, STC. Despite the vast growth potential of Saudi Arabia's mobile market, there are arguably reasons for concern for both the entrant and the incumbent.
The staggering $3.46bn license fee indicates optimistic assumptions about the future political, economic and regulatory environments in Saudi Arabia in light of the Kingdom's struggle to diversify its economy away from oil, the growing political tensions and the fact that the independence and authority of the regulator has not yet been fully tested. In this context, it should be noted that the success of Etisalat's launch next month is to a large extent dependent on STC's willingness to cooperate with the entrant. The high license fee was partially justified by Etisalat's ability to offer services over STC's network during the first four years of operation. However, such an agreement requires close cooperation on a technical and administrative level, leaving Etisalat at the mercy of STC's willingness to cooperate and the regulator's ability to enforce the agreement. Given the existing cross-over of influence and personnel between the regulator and the STC, we perceive this regulatory risk to be the most significant of the challenges facing Etisalat's entry.
STC faces a risk scenario of a commercial, rather than regulatory, nature. Well aware of the impending entry, the incumbent has taken a series of measures to prepare itself for competition. However, although there have improvements in terms of coverage, CRM and, to a lesser extent services, tariff reductions have made the bulk of STC's weaponry. Increasingly affordable mobile services have led to a rapidly growing subscriber base (net subscriber additions during 2004 reached almost 1.7m) and consequently, ARPU dilution, given the increasing share of low-end, prepaid, subscribers. This trend, coupled with Etisalat's outspoken ambition to target STC's existing high-end subscribers is arguably STC's main concern as it has the potential of putting a downward pressure on the incumbent's currently robust margins (its 2004 mobile EBITDA is estimated at almost 70%).
There is a strong pent-up demand in Saudi Arabia, not only for basic mobile services, but also for choice and there should be a strong interest for Etisalat's subscriptions and 3G services among STC's high-end subscribers. However, even if we disregard the risk of regulatory complications, we expect Etisalat's aversion towards a price war with the STC to limit its potential in terms of market share. We expect Etisalat to serve around 5m subscribers at YE2009, translating into a 25% market share, and generate annual revenues of $2.3bn, to be compared with STC's $6.6bn. Moreover, despite Etisalat's anticipated focus on the high-end, it's hardly a foregone conclusion that it will be able to achieve margins superior to those of the STC. A common denominator for almost all top-performers (in terms of profit margins) in the region is their scale advantage, being integrated mobile/fixed operators (Batelco, Etisalat in the UAE, Qtel, Omantel, Maroc Telecom) and, in some cases, their superiority in terms of market share, which often implies lucrative revenue streams from interconnection fees. In any case, we expect competition in Saudi Arabia's mobile market to put strong downward pressure on margins and both Etisalat and STC will have to get used to EBITDA margins in the region of 45-55% over the long term, rather than their current margins of 70-75%.