Telecom Egypt Credit Rating

This analysis provides a discussion of the factors underpinning the credit rating.

April 2009

Telecom Egypt S.A.E. (TE) Opportunities/Strengths

• Natural monopoly position in the Egyptian

telecommunications market, with a strong and

reputable brand name.

• Solid and proven track record, in addition to

government support.

• Strong performance, financial profile, relatively low

debt financing profile and healthy margins.

• Well designed internal reform program, which has

started to reap some fruit.

• Presence in high growth markets with low to modest

levels of telecom penetration (both fixed-line and

mobile).

• Reasonably sophisticated and modern connectivity

infrastructure, coupled with a good customer base.

• Playing a strategic role in developing the

telecommunications industry in Egypt.

• Solid cash flow position exceeding operation and

Capex need.

Risks/Weaknesses • Voice traffic migration from fixed to mobile.

• Some drawbacks in the human resource element and

public sector mentality are considered a challenge to

TE’s performance.

• Being subject to event risk due to rapid technology

changes.

Analyst Contacts:

Rating Table:

Category Current Rating

Previous Rating

Entity Rating: Senior Unsecured AA AA

Bond Rating: Senior Unsecured AA AA

Rating Outlook Stable Stable

Operating Statistics: Figures in EGP mn FY08 FY07 FY06 FY05

AROA (%) 8.5 6.1 6.1 5.6

AROE (%) 11.1 8.6 8.8 8.0

Operating Margin (%) 19.9 20.9 22.6 21.0

EBITDA 4,360.2 4,662.1 4,781.5 4,387.9

EBITDA Margin (%) 45.5 48.9 51.7 51.1

Balance Sheet Statistics: Figures in EGP mn

FY08 FY07 FY06 FY05

Turnover 9,577.2 9,534.0 9,241.8 8,358.0

Total Assets 32,584.8 33,340.7 35,151.1 31,896.2

Debt/EBITDA (x) 0.8 1.1 1.6 1.1

EBITDA/Interest Ex. (x) 12.1 7.8 12.2 11.5

All analysis is based on audited unconsolidated financial statements.

Egypt – Cairo Tel. (202) 3749 5616 Fax (202) 3749 6184

Mohamed Adel - Risk Rating Analyst [email protected]

Ahmed Badr El Din - Junior Risk Rating Analyst [email protected]

Telecom Egypt (S.A.E.) TE

MERIS Analysis April 2009

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Company Profile Telecom Egypt (TE) was incorporated in 1998 as a joint stock company. TE is the incumbent provider of telecommunications services in Egypt, providing fixed line telephony, connectivity to all mobile operators and controlling 100% of wholesale internet and data business. TE is one of the largest bases in the MENA region and the sole provider of fixed-line services in Egypt with more than 11.7 mn subscribers in December 2008. Currently, the Egyptian government accounts for 80% of TE's shareholder structure (down from 100% in 2005); the remaining amount is free float launched in both “Cairo and Alexandria Stock Exchange” and “London Stock Exchange”.

In November 2008, the Egyptian Ministry of Communications and Information Technology announced that the Egyptian government will postpone offering a second tranche of its 80-percent stake in Telecom Egypt beyond 2009 as a result of the current market turmoil. It is worth mentioning that, by law, the government has to retain a majority shareholding in the Company, which strengthens TE’s position; although the level of government support after the partial sale of its equity stake has not been tested yet. Management highlighted the need to operate efficiently as a stand alone/corporate entity with limited influence and intervention from the government. Generally, it is difficult to assess the degree of change in government support factors until it is tested.

Key Rating Considerations

FACTOR 1: Size, Scale, Business Model and Competitive Environment

TE generated EGP 9.57 billion as total revenue in 2008, up by 0.5% on a Y-O-Y basis. The revenue stream is generated from retail (57% of total revenue compared to 59.6% in FY2007) and wholesale (43% of the total revenue compared to 40.4% in FY2007). On the subscribers' side, the retail subscriber base increased by 4.2% to reach 11.7 mn customers in December 2008; however, this growth is not reflected in the Company's total retail revenue as most of the additions occurred in the final quarter of 2008. On the retail revenue side, the company implemented a tariff rebalancing in July 2008 trying to mitigate some of the effects of the fixed-to-mobile substitution. But the tariff rebalancing was reflected only on the subscription fees and local voice revenue, up by 12.5% and 13.7% respectively after raising the subscription fees from EGP 10 to EGP 12 for residential customers and EGP 16 to EGP 24 for commercial customers. For long distance fixed-to-international and fixed-to-mobile calls, the tariff rebalancing failed to stop, correct, or soften the decline in revenue as a result of the lower termination rates applied between mobile operators. Each offered a retail price which is lower than the termination fee that TE paid to them; meaning that TE was unable to offer its customers a rate which can compete with that offered by the mobile operators. The revenue generated from long distance, fixed-to-international and fixed-to-mobile decreased by 13.7%, 13.2% and 25.6% respectively. MERIS acknowledges a threat to TE's retail revenue due to the development of mobile operators that attract voice traffic by offering greater mobility, as well as limited growth in the overall fixed line operation. Although fixed to mobile substitution is negatively impacting TE's retail revenue, it is boosting the Company's wholesale revenue as a result of mobile operators' usage across TE's network infrastructure for handling their traffic for local and international calls. Telecom Egypt's revenue from wholesale has increased by 6.7% on a Y-O-Y basis to reach EGP 4.11 billion, with a flat growth on the international wholesale revenue. As of December 2008, fixed-line subscribership reached 11.7 mn customers, with switching capacity of 14.3 mn. Recently, TE has released its target to increase the number of subscribers in 2009 by 100,000 – 200,000. 473,690 subscribers were added in 2008, which is 58% higher than their 2008 target. TE has decreased its 2009 target in line with the expected slow down in the economy. 74% of the customer mixes are located in Greater Cairo and Alexandria. Over 91% of the customer base is comprised of individual or household subscribers, while wholesale/commercial business accounts for the remaining balance. MERIS views the competition between Telecom Egypt and the mobile operators as increasingly intensifying, which will push towards a change in the fundamentals of the telecommunications market; subsequently impacting the servicer's profitability.



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Factor 2: Operating Environment

(a) Regulatory Framework

In MERIS’s view, the regulatory environment in Egypt is still somewhat volatile with a considerable degree of uncertainty. Liberalization of the Egyptian telecom market started in 1998 after signing the WTO Basic Telecommunications Agreement (BTA), through the issuance of two mobile network operating licenses and turning Telecom Egypt, the state-owned incumbent operator, into a joint stock company. Furthermore, 1998 saw the establishment of the Ministry of Communications and Information Technology (MCIT) with the responsibility of developing Egypt’s ICT infrastructure, stimulating the knowledge economy and forging an e-government strategy and a legal framework that is in line with international digital requirements. Liberalization was further advanced by the Telecommunication Regulation Law (No. 10) of February 2003. A central aspect of the law was the creation of the National Telecom Regulatory Authority (NTRA), which replaced the Telecom Regulatory Authority (TRA) in 2003 and took over all the regulatory functions as an independent regulatory authority. The NTRA has the power to monitor the performance of operators, grant all telecommunication operating licenses and penalize deviations from licenses. Since 2003, it has awarded over 20 licenses to operators who offer telecom services to the Egyptian market, including mobile, payphone, prepaid calling cards, internet, data and VSAT (satellite) services. In 2006, the NTRA deregulated Telecom Egypt’s monopoly of domestic and international telephone service. The NTRA has also announced an auction for a second fixed-line license; however, so far the tender has been postponed three times and might remain on hold for a long time, given the current status of the global economy. While liberalization has been progressing relatively smoothly, criticism has centered on the overprotection of TE, the incumbent telecom operator. Among some of the challenges to the liberalization process is the role of the Minister in overseeing both the regulator and Telecom Egypt, a dual role that makes for a difficult balancing act. The intricate position of the regulator has been played out in the recent interconnection dispute between mobile operators and Telecom Egypt (TE). The NTRA had sided with TE’s decision to lower its fixed-to-mobile termination rates, despite the existing effective agreement between TE and the wireless operator. Mobinil and Vodafone have appealed the decision and have filed a law suit against the NTRA to resolve the interconnection dispute. The continuous decline of interconnection rates is perceived as a main threat to the wireless operator, putting downward pressure on its revenues and returns. Furthermore, the implication of the new regime on consumer behavior is considered another concern, as it might result in a traffic shift towards the fixed-line service, which will again negatively affect mobile operators.

(b) Technology Risk MERIS’s rating takes into consideration the Company’s exposure to technological advancement and how well positioned it might be in handling such developments. The rating also factors in the potential capital expenditure implications of any technological improvements and advances. TE has been in an expansion mode in recent years. Capex figures reported their highest levels in 2005 by EGP 2.4bn, around 85% of which will be directed to new installations. Capex is expected to increase in 2009 to EGP 1.5 – 2.0bn mainly as a result of TE North project, greater broadband requirements for existing subscribers, and the upgrading of the transmission network to cater for the increasing needs of mobile operators and ISPs. TE's capex has decreased 6.2% on Y-O-Y basis reaching EGP 740 million for 2008 in line with the rationalization program and due to delays in completing some of the cost control systems.

(c) Market Share

TE has strong presence in all the telecommunication and information technology services/industries in Egypt (i.e. mobile, Internet data services ... etc), either directly through subsidiaries and affiliates, or indirectly through revenue sharing agreements. TE is enjoying a monopoly position in the fixed line business, with a strong presence in other telecommunication businesses. TE retains a strategic stake in the local mobile market through its 44.95% stake in Vodafone Egypt with a total subscriber base of more than 17.6 million, representing 42.7% share of the Egyptian mobile market as of December 2008. TE is penetrating the fastest growing segments in the domestic telecom market, namely the internet and data service, through a majority owned subsidiary: TE Data, with a 95.04% shareholding stake. TE Data’s



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Revenue and Profitability

Figures in EGP mn FY08 FY07 FY06 FY05

Revenue 9,577.2 9,534.0 9,241.2 8,358.0

Growth (%) 0.5 3.2 10.6 7.9

EBIT 1,904.7 1,992.3 2,087.5 1,757.0

EBITDA 4,360.2 4.662.1 4,781.5 4,393.0

EBITDA Margin (%) 45.5 48.9 51.7 52.5

Operating Profit Margin (%)

19.9 20.9 22.6 21.0

Interest Expense (359.7) (599.1) (392.7) (381.4)

Interest Income 153.0 78.9 45.9 24.9

Net Income 2,796.7 2,078.8 2,049.6 1,835.7

Net Income Margin (%)

29.2 21.8 22.2 21.9

ADSL subscribers increased by 91% in 2008 to reach more than 424 thousands, capturing 59% market share from other seven ADSL players. It is worth mentioning that TE is considered the sole provider for internet and data network/infrastructure in the local market. TE North: Capitalizing on the geographic position of Egypt and targeting a more diversified revenue base, Telecom Egypt expected to start the operation of TE North project by the end of 2009 to increase the service footprint of the existing TE Transit Corridor and to lower the cost point of the group retail internet arm. MERIS expects this diversified income stream to reflect positively on the Company's business operation.

Factor 3: Management’s Financial Strategy

Management's strategy and tolerance for the financial risk will directly affect debt levels and credit quality and it is therefore a key rating determinant. Regarding the cash distribution policy, TE's aim is to provide its shareholders with steady and regular cash remuneration, taking into account the availability of appropriate investment opportunities. TE announced the Board's approval for a dividend distribution of EGP 1.3 per share which is 87% as a dividend payout ratio compared with 91% in FY2007 On the debt side, Telecom Egypt maintains a very healthy debt profile; the debt to EBITDA ratio is 0.8 times. The Company does not have any short term refinancing requirements and uses its organic cash flow to fund its long term debt according to the repayment program and to finance its capex commitments. Telecom Egypt will be very selective in any regional green field investments or acquisition transactions on the background of the incident of liquidating TE's investment in Algeria. TE and OT were awarded the

second fixed line license in 2005; however, as a result of difficulties with the Algerian regulator regarding the unfair competition and dumping practices by the incumbent, TE's venture was forced to exit from the Algerian market realizing a loss of EGP 446.7 million.

FACTOR 4: Operating Performance

The level and stability of operating margins is a key consideration in assessing risk to debt holders. MERIS reviews the EBITDA margin trend as well as the absolute level of EBITDA for this purpose. Telecom Egypt holds a strong position in this category, reflecting healthy EBITDA margins over the last years. The reported EBITDA margin for TE in 2008 is 45.7% (on standalone financials). The EBITDA figure deteriorated by 340 basis points compared with 2007. However, the Company’s profitability is expected to be negatively affected in the future as a result of intensified market competition and the uncertainty in the macro economic conditions.

Revenue has increased in FY08 by 0.5% on a Y-O-Y basis with the increase in number of fixed line subscribers by 4.2% (FY08: 11.7mn; FY07: 11.23mn). A key driver to this growth was the promotional activities that TE launched in the final quarter. Despite the increase in operating figures in FY07 and FY08, EBIT and EBITDA margins dropped slightly as a result of impaired assets which mainly came from trade receivables, in addition to the increase in employee costs incurred in FY08 due to the two salary increases in January and May FY08. On the other



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hand, net income margin showed a jump, mainly attributed to the increase in “income received from subsidiaries”, the majority of which was sourced from Vodafone investment; which almost doubled over the last year (FY08: 1,333.2 mn; FY07: 771.6 mn).

FACTOR 5: Financial Strength

Improvement in Free Cash Flow Figures, Due to Increase in Dividends Received from Subsidiaries and

Reduction in Capex Investment revenue has shown an upward trend, peaking in FY08, which was associated mainly with VodafoneEgy dividends distribution. This revenue stream started to be significant to the Company’s cash flow, representing around 48% of net income generated in FY08. Going forward, the outlook for this inflow is still questionable, taking into consideration that the competition in the domestic mobile market is anticipated to intensify in the short term. On the other hand, there was a reduction in interest expense as a result of TE's debt reduction program, and an increase in interest income due to the increase in cash position which had lead to the highest dividend payout in its history of EGP1.30 per share.

Debt Structure:

As of December 2008, total debts are equivalent to EGP 3.27bn down from EGP 5.14 bn in FY2007. The Company’s debt profile is considered well spread with around 46% short-term in nature, including the current portion of long-term debts, bond installments due within the year and credit facilities. As of December 08, the medium to long-term debts are equivalent to approx. EGP 1.62 bn down from EGP 3.15bn, representing 50% of total financial interest-bearing obligations, divided between bonds (EGP 400.0mn) and bank loans (EGP 1.22bn). The latter consist of around 37% governmental loans and 16% local loans, with foreign loans accounting for the remaining balance. The majority of these debts were incurred while the Company was under the umbrella of the Egyptian Governmental loan bearing soft-term conditions. The maturity of some of these debts has been

Cash Flow & Coverage


EBITDA 4,360.2 4,662.1 4,781.5 4,393.0

Tax (512.17) (514.6) (466.1) (432.8)

Interest Paid (359.67) (599.1) (392.7) (381.4)

Investments (36.01) (69.9) (4,832.1) (722.6)

CAPEX (739.83) (789.1) (1,800.1) (2,418.

2)

Dividends Received 1,333.20 771.6 355.9 141.4

Dividends Paid (1855.37) (1,287.3) (1,085.6) (722.5)

Net Free Cash Flow (excluding working capital)

2,190.31 2,173.7 (3,439.3) (143.2)

Retained Cash Flow (RCF) 540.7 1,989.3 2,429.0 2,896.9

RCF/Capex (x) 0.7 2.5 1.3 1.2

EBITDA/ Interest Expenses(X) 12.1 7.8 12.4 11.5

Financial Leverage


Short-term Bank Debt 1,512.7 1,827.0 1,382.5 1,052.9

Long-term Bank Debt 1,626.0 3,151.0 6,105.4 3,734.8

Other Financial Obligations 132.1 162.7 168.9 115.9

Total Financial Obligations 3,270.9 5,140.8 7,656.9 4,903.6

Cash and Cash Equivalent 2,477.4 1,202.0 502.9 698.5

Net Financial Debt 793.5 3,938.8 7,154.0 4,205.1

Contingent Liab. & C. Commitments

328.5 376.2 397.2 550.5

Net Worth 25,555.0 24,658.2 23,909.9 22,706.5

Gross Debt /EBITDA (X) 0.8 1.1 1.6 1.1

Adjusted Debt / Adj. Capitalization (%)

17.7 24.8 32.6 24.6

Net Adjusted Debt / EBITDA (X) 0.3 0.9 1.6 1.1

RCF / Net Adj. Debt (X) 0.5 0.5 0.3 0.6



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Debt Structure

47%

12%4%

37%

Overdrafts & CPLTD Bonds Others LT Bank Loans

extended till 2036, which relieves the pressure on the Company’s cash flows. The EGP 2.0bn bond was issued in 2005 and is divided into two equal tranches: one bearing an annual fixed rate of 10.95%, and a floating rate (0.7% plus the Central Bank discount rate), to be paid quarterly. The issue is amortizing whereby the entire value of the issue will be redeemed within 5 years from 2005; as of December 2008 the bond was redeemed partially by 60% of the issued principle. Under the terms and conditions of the bond agreement, key covenants include: long-term debt to tangible net worth ratio is not more than 1.2 levels, debt service ratio not to fall below 1.2; in addition to interest coverage ratio not to fall below 3. As of December 2008, the Company has been in compliance with the above-mentioned covenants.

TE Still Maintains Strong Debt Structure In FY08, the Company’s debt protection ratio measured by debt to EBITDA figures, has improved backed by the decrease in debt levels. Also, debt to equity ratio was improved for the same reason to stand at approx. 12.8%, compared to 20.8% in FY07 coupled by improvement in the Company’s leverage position, coverage ratios as measured by EBITDA to interest expenses to stand at 12.1x in FY08, compared to 7.8x in the previous year. This was mainly as a result of the decrease in debt balance during the year. Going forward, MERIS believes that the coverage ratio is anticipated to remain at its current level.

Other Considerations:

Liquidity Position is Considered Adequate…. Recent turmoil in the capital markets has highlighted the importance of having strong liquidity risk management. Telecom Egypt's liquidity profile is more than enough to cover its debt and other cash demands. As of December 2008, TE had around EGP 2,477mn in cash and cash equivalent, in addition to other unutilized credit facilities from different banks which can be drawn at any time.



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Annex 1: Investments



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Annex 2: Subsidiaries

Xceed acts as the IT arm for Telecom Egypt, the incumbent operator. Xceed started its call center operation business end of 2003, with state-of-the-art Contact Center that supports a wide array of inbound and outbound services that are customized to the clients' needs.

TE Data was established in 2001 by Telecom Egypt to function as its data communications and Internet arm. The company is the Internet Service Market Leader in Egypt.

Centra is a shareholding company established in ‘02. Its core business is to provide complete IT solutions and produce different models of a local brand platform of PCs, Servers and Notebooks of international quality.

MERC is a joint stock company that established in year 2001. It is a leading company in the fields of building, operating and managing wireless communications stations.



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Annex 3: Financial Summary of Telecom Egypt

Figures in EGP mn 31/12/2008 31/12/2007 31/12/2006 31/12/2005

Income Statement

Turnover 9,577.2 9,534.0 9,241.2 8,358.0 Operating Profit Margin (%) EBITDA 4,360.2 4,662.1 4,781.5 4,275.0 EBIT 1,904.7 1,992.3 2,087.5 1,751.9 Interest Income 153.0 78.9 45.9 24.9 Net Income 2,796.7 2,078.8 2,049.6 1,835.7 Balance Sheet

Cash and Equivalents 2,477.4 1,202.0 502.9 698.5 Total Assets 32,584.8 33,340.7 35,151.1 31,896.2 Short-Term Debt 1,512.7 1,827.0 1,382.5 1,052.9 Long-Term Debt 1,626.0 3,151.0 6,105.4 3,734.8 Total Bank Debt 3,138.7 4,978 7,487.9 4,787.7 Net Worth 25,555.0 24,658.2 23,909.9 22,706.5

Profitability Ratios

Average Return on Assets (%) 8.5 6.1 6.1 5.6 Average Return on Equity (%) 11.1 8.6 8.8 8.0 EBITDA Margin (%) 45.5 48.9 51.7 51.1 Net Profit Margin (%) 29.2 21.8 22.2 21.9 Liquidity Ratio Cash & Cash Equivalent/Total Assets (%) 7.6 3.6 1.4 2.2 Cash & Cash Equivalent/C. Liabilities (%) 47.0 22.4 10.1 13.1 Coverage Ratios EBITDA/Interest Expense (x) 12.1 7.8 12.2 11.2 Net Debt/EBITDA 0.2 0.8 1.5 0.9 Debt/Equity (%) 12.8 20.8 31.3 20.8



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Annex 4: National Rating Scale

© Copyright 2009, (“MERIS”) Middle East Rating and Investors Service. All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MERIS PRIOR WRITTEN CONSENT. All information contained herein is obtained by MERIS from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided “as is” without warranty of any kind and MERIS, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MERIS have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MERIS or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MERIS is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings and financial reporting analysis observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MERIS IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling.

Long Short

AAA

AA+

AA

AA- Prime 1

A+

A

A-

Prime 2

BBB+

BBB

BBB- Prime 3

BB+

BB

BB-

B+

B

B-

CCC+

CCC

CCC-

CC

C

Investment Grade

Speculative Grade

Quality of credit

Gilt edged

Very high

Upper-medium

Medium grade

Questionable

Poor quality

Very poor

Not Prime

Telecom Egypt Credit Rating

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