Rated GCC Telcos Redefine Their Strategies

Considering moderate growth prospects for core telecom operations, GCC telcos are looking for new ways to expand their businesses and diversify revenue streams. The GCC telcos we rate are typically major local players, operate in a relatively favorable and stable regulatory environments, and benefit from their leading market positions and well-invested asset base. Even so, they suffer from a decline in some core telecom services, including fixed voice telephone and messaging services.

Mature markets provide limited possibilities

The GCC region's mature telecom markets, with mobile penetration rates of 130%-210%, offer limited organic growth prospects for telcos. We expect core telecom revenues in domestic GCC markets will grow by 1%-3% per year over 2024-2025 for our portfolio of rated GCC telcos. The growth rates of GCC telcos' international subsidiaries in developing countries with large customer bases and fast-growing populations are higher in local currencies than those in the GCC region. The latter have smaller subscriber bases, except in Saudi Arabia, which is the largest telecom market in the GCC and whose relatively lower mobile penetration rate in the peer group provides stronger upside potential. Geographical diversification risks include currency depreciation, higher cost inflation, competitive pressures, and higher country risks. GCC telcos' geographical diversification and the revenues they generate outside their domestic markets vary significantly, with 69% for Ooredoo QPSC (Ooredoo; A/Stable/A-1, as of year-end 2023), 52% for Bahrain Telecommunications Co. (Beyon; B+/Stable/B), 36% for Emirates Telecommunications Group Co. PJSC (e&; AA-/Stable/A-1+), and about 12% for Saudi Telecom Co. (stc; A/Stable/A-1).

Techcos are gaining ground

Rated GCC telcos--including Beyon, e&, Ooredoo, and stc--aim to enhance their techco services and have already expanded their non-telecom businesses over the past few years. Additional impetus was instigated by recent strategy announcements, for example stc's DARE strategy, which the company announced in 2018 (see chart 1). The series of strategic announcements ended with Beyon in late 2022.

Chart 1

Digital offerings vary

Telcos provide a plethora of non-telecom services, with cybersecurity, cloud services, internet of things, artificial intelligence, and data centers primarily targeting business-to-business (B2B) customers. Fast-growing fintech services are aimed at B2B and business-to-consumer (B2C) customers alike. Fintech offerings capitalize on digitalization trends, tech-savvy young populations in the Middle East, and underbanking in emerging markets. Rated GCC telcos' objectives are comparable but the extent of their investments differs. In the fintech space, for example, some launched licensed digital banks, while others only provide e-wallet services. Additionally, some rated GCC telcos diversified into adjacent areas, such as media and entertainment or e-gaming. Furthermore, GCC telcos established sizable investment funds to capture investment opportunities, particularly in the tech space.

Acquisitions abound

To scale up their non-telecom revenues, GCC telcos announced several small to midsize acquisitions, which exceed $1 billion, over the past two years (see table 1). We believe mergers and acquisitions (M&As) in the region will continue because of GCC telcos' healthy balance sheets and growth ambitions, as well as the fragmented IT market in the GCC region. This is regardless of relatively high acquisition multiples and some targets' limited profits.

Table 1

What's Next For GCC Telcos

GCC governments' digitalization and economic development agendas will support digital businesses and boost GCC telcos' consolidated revenues. We estimate non-telecom operations currently contribute about 15%-16% to rated GCC telcos' combined revenues. Digital businesses generate higher revenues in the case of more advanced telcos--including stc and e&--compared with Ooredoo and Beyon. While core telecom services will continue to account for most revenues and remain the overwhelming profit generators in the short term, we expect digital businesses will grow at a significantly faster pace. Based on our latest forecast, we expect investment grade-rated global software and services companies will expand by 8%-10% over 2024-2025, compared with 1.5%-3.0% for investment grade-rated global telcos.

GCC governments drive digitalization

Considering GCC governments' strong digitalization push, we think GCC telcos' growth rates could be higher than elsewhere since the development of a digital economy will spur e-commerce, fintech, streaming, and gaming. Digitalization will increase private and public spending in information and communication technology (ICT), which will benefit rated GCC telcos because of their leading market shares and close ties with various governments. For example, Solutions (stc's ICT subsidiary) generated about 44% of revenues from government-related customers in 2023. It recorded a strong revenue growth of 20%-25% over 2022-2023, also partly thanks to M&As.

Digital revenues' relative contribution will increase

We estimate that rated GCC telcos' non-telecom operations could contribute 18%-25% to total combined revenues over the next three years. Our sensitivity analysis assumes low single-digit growth for telecom revenues and an organic growth of 10%-20% per year in non-telecom revenues. M&As could compound on the organic growth, resulting in much faster revenue accretion from tech related services. We think a material gap will remain between more advanced telcos, whose digital revenues could exceed 30%, and less advanced telcos, whose digital revenues will hover around 8%-14%. Currently, adjacent tech businesses are predominantly concentrated in GCC telcos' domestic markets. However, their gradual expansion to other markets, potentially via M&As, will accelerate growth. We think e&'s recent announcement to generate 40% of revenues from techco businesses by 2030 is achievable via a combination of organic and external growth.

Increase in non-telecom revenues will weigh on profitability

We forecast GCC telcos' EBITDA margins could shrink by 100 bps-300 bps over the next three years. This is because of the dilutive effect that results from lower-margin non-telecom services. The extent of the effect will vary, depending on the relative share of digital revenues. Based on our forecast for investment grade-rated global software and services techcos, we estimate that their EBITDA margins will be at 33%-34% over 2024-2025. This is about 500 bps-600 bps lower than our expectation of 38%-39% for global investment grade-rated telcos' S&P Global Ratings-adjusted EBITDA margins (see charts 2-4). It is worth noting that GCC telcos operate at even higher S&P Global Ratings-adjusted margins, which we expect will be 42%-43% over 2024-2025. We expect e&'s EBITDA margin, which stood at 43.7% in 2023, will increase by 300 bps-400 bps in 2024, thanks to the change in the royalties regime in the UAE and by another 200 bps because of the change in accounting after Vodafone becomes an associate (under our criteria, dividends from associates are added to EBITDA).

Chart 2

Chart 3

Chart 4

Tech businesses are less asset-intensive

Tech businesses' lower capital intensity could improve GCC telcos' already solid cash flow generation capacity. We expect investment grade-rated global techcos' capital expenditure (capex) will amount to about 4.0%-5.0% of revenues over 2024-2025, significantly below the 14%-16% we project for rated GCC telcos. GCC telcos will continue to invest in their networks and 5G, which will fuel the adoption of cloud technologies, big data, storage, and the internet of things. To enable such developments and improve connectivity, we expect telcos will invest in data centers and subsea cables. For example, Ooredoo and stc plan to invest $1 billion each in data centers over the next few years. Even though techcos' profitability is lower, we expect their cash generation potential is higher than that of telcos. For instance, Ooredoo disclosed during its capital markets day presentation in 2022 that its digital services only account for about 5.8% of revenues but for 18% of simple free cash flows, defined as EBITDA minus capex.

Accelerated digital revenue growth strategy comes with risks

GCC telcos' increasingly diversified business mix is positive, but competitive challenges and higher margin volatility are key risks. GCC telcos benefit from utility-type characteristics and a resilient performance, even during cyclical troughs, as well as high margins, especially in the post-paid segment. This is because of relatively favorable regulatory environments, with 2-operator markets in the UAE and Qatar and 3-operator markets in Saudi Arabia and Bahrain. By contrast, techcos operate in a highly competitive, significantly more fragmented and volatile environment, which could expose GCC telcos to competition from small to midsize regional players, major global tech groups, and hyperscalers. That said, we think GCC telcos benefit from a competitive advantage when dealing with government-related customers, given their local presence and well-established relations and reputations. Global techcos and hyperscalers generally collaborate with local partners in the region, which creates opportunities for GCC telcos to act as technology integrators or build data centers to cater to hyperscalers. Additionally, regional regulations may require that certain data remain in the domestic cloud, which could represent another protective barrier for GCC telcos.

Digital businesses offer meaningful monetization potential

We think recent changes in rated GCC telcos' corporate structures, such as the establishment of digital services in the form of stand-alone subsidiaries, suggest that telcos may consider partial monetization as these businesses ramp up. The continuing development of capital markets in the region can provide an exit opportunity for GCC telcos to manage their balance sheets, as demonstrated by several transactions in the past few years (see table 2).

Table 2

When Telcos Meet Fintech

GCC telcos, which capitalize on their existing subscriber base and leverage their network infrastructure, offer a convenient alternative to traditional banks on certain products and services. Yet, GCC telcos' fintech services vary in breadth and risk. Some of them established fully-fledged licensed digital banks, such as stc Bank--85% of which is owned by stc and 15% by Western Union--and e&, which holds a 25% stake in Wio. Beyon Money obtained an open banking license, while Ooredoo Money and e& Money operate as a mobile wallet services. Additionally, e& has exposure to another e-wallet service via its stake in Careem super app. The incorporation of digital banking services means that telcos must adhere to bank regulations, capital requirements, and stricter risk monitoring and compliance frameworks for their fintech operations.

The Middle East offers a supportive environment for fintech innovation

GCC telcos predominantly develop their fintech services in their domestic markets in the Middle East, where a large expat population extensively uses remittance services. GCC telcos capitalize on the retention of their large customer base to drive growth. For example, e& reported a six-fold increase in remittances in 2023 for its e& money app (see table 3). According to Ooredoo, about 42% of its post-paid customers in Qatar--close to 12% of total customers in the country--are active fintech users. In a smaller market, such as the Maldives, these proportions are 28% and 6%. The reported user adoption rates are relatively high and hint at telcos' ability to leverage their existing customer base. Additional growth potential comes from international subsidiaries' further expansion, especially in emerging markets, where telcos' fintech services can improve financial inclusion.

Table 3

Telcos are not alone

Telcos' fintech ambitions face fierce competition from traditional financial institutions, e-wallet services offered by banks and competitor telcos, and an increasing number of neobanks. We think the usability of their fintech services, high smartphone penetration rates in the GCC region, and their extensive network and 5G coverage are GCC telcos' key competitive advantages. Banks will continue to dominate traditional lending segments, such as corporate banking, retail mortgages, and savings, while telcos will mainly focus on B2C end-markets and payment transfers, competing with banks by offering better rates and immediate execution. Only a few telcos will offer micro lending services.

Healthy Balance Sheets Leave Room To Manoeuvre

We expect GCC telcos will continue to balance their growth appetite, dividend payouts, and leverage. GCC telcos have robust cash flow generation capacities and operate at low leverage levels, with comfortable headroom within their respective rating levels. This provides ample financial flexibility to execute debt-funded growth in the tech space. However, telcos' wider group strategies also include the expansion of their core telecom businesses and shareholder-friendly dividend distributions.

Tower sales could reduce ratings pressure

While GCC telcos' expansion in the tech space is unlikely to put pressure on ratings, acquisitive financial policies and higher dividends could gradually reduce rating headroom (see table 4). To compensate for this, GCC telcos could monetize not only their digital assets but also their telecom assets, such as towers. Tower sales in the region have only just begun and recent deals could lead to the creation of major independent tower companies. Ooredoo signed an agreement with Zain to create an independent tower company that will span five countries. Ooredoo will receive an equalization payment from Zain. Saudi Arabia's Public Investment Fund made stc an offer of close to $3 billion for a 51% stake in its tower company Tawal.

Table 4

A balancing act

Over the next two to three years, ratings will depend on GCC telcos' growth ambitions in the core telecom segment, investments and growth in non-telecom services, and their ability to sustain low leverage in light of higher interest rates and funding needs for M&As. Given high cash flow generation, we expect GCC telcos will be able to fund organic growth from free cash flows. We consider all rated GCC telcos are government-related entities, which means the ratings on these telcos also hinge on the sovereigns' credit quality. The ratings on three GCC telcos are capped by sovereign ratings due to the companies' very strong links with the respective governments. Ooredoo is the only telco that received a three-notch uplift on the back of the extraordinary sovereign support we factored into the rating, considering its stand-alone credit profile (SACP) is below the sovereign rating on Qatar.

A modest leverage increase would leave the ratings on most GCC telcos unscathed

If rated GCC telcos' leverage exceeded our downgrade rating triggers and led to a downward revision of their stand-alone credit profiles (SACPs), we would not automatically lower the ratings on three out of four GCC telcos, all else being equal. This is because their SACP exceeds or is the same as the credit quality of their respective sovereign. If we lowered the SACP, e& would benefit from an uplift from sovereign support, stc's SACP would still be in line with the current sovereign rating on Saudi Arabia, and Beyon's SACP would continue to be above the sovereign rating on Bahrain. Assuming the sovereign rating on Qatar and the likelihood of support from the Qatari government remain unchanged, a downward revision of Ooredoo's SACP could lead to a similar rating action on Ooredoo, provided the three-notch uplift remains unchanged.

Related Research

• GCC Corporate And Infrastructure Outlook 2024: Holding Up Against Refinancing Needs, March 4, 2024
• Ooredoo Q.P.S.C., Feb. 26, 2024
• Industry Credit Outlook 2024: Telecommunications, Jan. 9, 2024
• Emirates Telecommunications Group Co. PJSC, Dec. 15, 2023
• What's On European Telecoms Investors' Minds?, Dec. 14, 2023
• Bahrain Telecommunications Co. Outlook Revised To Stable From Positive In Line With Sovereign; 'B+/B' Ratings Affirmed, Nov. 28, 2023
• Future Of Banking: Neobanks In The UAE Will Complement, Not Replace, Traditional Banks, Nov. 1, 2023
• Saudi Telecom Co., Aug. 8, 2023
• EMEA Telecoms: Relative Strength Ranking 2022, March 29, 2022