• 3Q16 losses narrow on stronger margins Zain reported a 3Q16 net loss of SAR267mn, down 20% Y-o-Y, which beat our estimate of a net loss of SAR287mn. Despite a 7% revenue miss, the EBITDA margin beat our estimate by 6.4pp at a record 29.9%, mostly on lower distribution and marketing costs. Zain won some legal settlements, which led to some provisions reversal in its opex. Yet, the stronger EBITDA margin did not fully trickle down to the bottom line as net financing charges were high at SAR265mn, 21% above our estimate, due to higher interest rates in KSA. Zain said that the Y-o-Y revenue drop is due to: i) lower interconnection revenue due to the mobile termination rate cuts; ii) the biometric verification process impacting some revenue-generating subscribers; iii) seasonality effects; and iv) decline in pilgrims Y-o-Y.
• Strong margins will not be enough to offset market pressure The recent MTR cut continues to play in favour of Zain KSA, with gross profit margin this quarter recording 64.9%, the highest since inception. However, we expect revenue growth to remain under pressure due to the challenging macro-economic environment in KSA. The higher interest rate environment is a concern for Zain as it is highly leveraged and is vulnerable to rate hikes, we believe. We still view bottom-line profitability as essential to prevent shareholders’ equity from shrinking.
• Licence extension and universal licence are good steps; more needed The impact of the mobile licence extension will be reflected in 4Q16, and will cut annual amortisation charges by SAR433mn. Furthermore, the universal licence will help it offer integrated services to better address market needs, yet with a low burden on FCF as it will not incur much capex. We believe more initiatives are needed to help it out of the current financial difficulties it faces. The tower sale could be the next on the list, but we believe it is still some way down the road; management said a sale now hinges on the fate of the STC-Mobily potential transaction, which we do not expect to take place before 2H17.

Omar Maher
Karim Riad