Published in June 2005

1. P.O. Box 26893
Manama, Bahrain
Telephone: +973 17 533570
tarek.fadlallah@bh.nomura.com
1
Monday 20th
June, 2005
-50%
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06
Nasdaq Saudi UAE Oil
November 1998
March 2000
-58%
-78%
The Great Arabian Bubble
Red Alert
There are some exciting and hugely encouraging ongoing developments within the GCC that augur well
for the long term economic development of the region.
Aided and abetted in no small measure by buoyant oil prices, soaring property values and a boom in
tourism the region is also benefiting from sweeping economic reforms and business deregulation.
Despite these positive developments however it is getting increasingly difficult to justify the rapid rise in
stock prices across the regional bourses particularly given the deterioration in valuations.
The chart below shows the Saudi Tadawul Index, UAE General Index and WTI oil since January 2002.
For comparison the NASDAQ index from November 1996 to November 2001 has been superimposed.
NASDAQ appeared overvalued as early as November 1998 but investors who sold their shares at that
point must have felt like fools as the market doubled over the next fifteen months.
However they were eventually vindicated after the index declined -78% from its subsequent highs and
more than halved from its November 1998 levels!

2. P.O. Box 26893
Manama, Bahrain
Telephone: +973 17 533570
tarek.fadlallah@bh.nomura.com
2
Monday 20th
June, 2005
Sign of the Times
The sight of university students flaunting shimmering new sports cars at the local shopping mall may not
be unusual but the fact that these are being self-financed by stock market profits ought to be raising alarm.
Such images are reminiscent of New York taxi drivers throwing away their keys to become NASDAQ day
traders or Japanese housewives funding luxury lifestyles through real estate speculation in the 1980s.
Stock Market Performance:
(as at 19th June) Saudi Arabia UAE Kuwait Qatar Oman MSCI-World
2005 (YTD) 69.8% 111.8% 33.7% 56.4% 63.1% 0.1%
2004 84.9% 88.4% 33.8% 64.5% 23.8% 13.4%
2003 76.2% 32.1% 101.7% 69.9% 42.1% 32.1%
Source: Bloomberg
While no two bubbles are identical they tend to share common characteristics some of which are becoming
evident across the GCC markets particularly in Saudi Arabia and the UAE.
One principle characteristic is that participants and vested interests discard universal valuation benchmarks
to validate the higher prices on the basis of some new paradigm.
Stock market gains today are said to be durable because they rest on a sound economic basis revolving
upon economic reform, a structural rise in oil prices, a boom in real estate and increased regional liquidity.
But it is instructive to note that every bubble in history including the one preceding the Great Crash has
been rooted in sound fundamentals only to spiral out of proportion through excessive speculation.
• In the 1980s the bubble in Japan was sustained by rising asset prices, low interest rates, soaring
exports and an appreciating currency – but prices ran too far and valuations deteriorated.
• In the 1990s the bubble in internet stocks was based on a genuine revolution in technology that
has radically changed our world – but prices ran too far and valuations deteriorated.
Another characteristic evident across the GCC is that corporate profits become highly leveraged into the
rising trend in asset prices – property and stocks – that develops into a virtuous circle feeding upon itself.
A third major characteristic is that retail investors (often borrowing heavily) embrace risk without concern
and plunge wholeheartedly into stocks for fear of being excluded from the enriching party.
Although investors would like to believe that their markets are unique and that this particular situation is
different the likelihood is that the GCC markets are destined to play by the universal rules that govern
markets from Toronto to Tokyo and Timbuktu.
A case can made for a correction in all GCC markets but this note will focus on the Saudi Arabian market
due to its scale, extraordinary valuations and its potential impact on neighbouring states.

3. P.O. Box 26893
Manama, Bahrain
Telephone: +973 17 533570
tarek.fadlallah@bh.nomura.com
3
Monday 20th
June, 2005
The Valuations
The following list of thirty large stocks in Saudi Arabia offers the clearest indication of the regional
overvaluation with an unweighted Price Earnings Ratio (PER) of 50.4x profits for 2004.
COMPANY PRICE PER PBR YIELD MARKET CAP MARKET CAP
(data as at 18th June, 2005) (SAR) (x) (x) (%) (SAR mn) ($ mn)
SAUDI BASIC INDUSTRIES CORP 1124.0 31.6 11.2 0.80% 449,602 119,894
SAUDI TELECOM CO 940.0 30.3 9.1 2.77% 282,000 75,200
AL-RAJHI BANKING & INVST CRP 1627.0 49.9 20.2 1.11% 146,430 39,048
SAMBA FINANCIAL GROUP 914.0 43.8 11.6 1.53% 109,680 29,248
SAUDI ELECTRICITY CO 128.5 72.9 2.4 2.72% 107,081 28,555
RIYAD BANK 840.0 41.9 9.3 1.71% 84,000 22,400
ETIHAD ETISALAT CO 690.0 - - - 69,000 18,400
SAUDI BRITISH BANK 1306.8 39.9 12.1 1.45% 65,338 17,423
BANQUE SAUDI FRANSI 1275.8 37.4 10.4 1.57% 57,409 15,309
ARAB NATIONAL BANK 938.0 40.2 9.8 0.83% 46,900 12,507
SAVOLA 1575.0 78.4 21.3 0.57% 39,375 10,500
SAFCO 859.0 52.1 8.8 0.93% 34,360 9,163
SAUDI INVESTMENT BANK 889.0 52.1 8.7 0.27% 30,559 8,149
SAUDI HOLLANDI BANK 928.0 31.5 8.1 1.62% 23,386 6,236
MAKKAH CONS 781.0 - - - 22,620 6,032
SOUTHERN PROVINCE CEMENT 857.0 33.0 9.5 2.92% 17,997 4,799
YANBU CEMENT 791.0 38.8 8.2 2.53% 16,611 4,430
SAUDI CEMENT 784.0 36.6 8.2 2.17% 15,994 4,265
NATIONAL SHIPPING/SAUDI 330.5 30.9 6.2 1.51% 13,220 3,525
BANK AL-JAZIRA 827.0 62.5 8.3 0.41% 12,405 3,308
YAMAMAH SAUDI CEMENT 1318.0 21.9 8.8 2.28% 11,862 3,163
ARABIAN CEMENT 878.3 34.4 7.4 1.82% 10,539 2,810
EASTERN CEMENT 807.0 38.6 7.1 2.48% 10,410 2,776
TABUK CEMENT 595.0 64.8 9.1 1.26% 8,330 2,221
MEDICAL APPLIANCES 671.8 123.1 5.2 0.74% 8,061 2,150
AMIANTIT 517.0 98.0 9.7 - 7,962 2,123
THE QASSIM CEMENT 814.0 29.7 6.6 2.70% 7,326 1,954
NATIONAL GAS & INDUSTRIAL 487.0 60.6 6.5 1.23% 7,305 1,948
REAL ESTATE / SAUDI ARABIA 463.8 - - - 5,565 1,484
TAIBAH 359.5 85.7 4.7 1.11% 5,393 1,438
Source: Bloomberg Average 50.4 9.2 1.52% 1,726,719 460,458
In fairness the weighted PER (excluding loss-making firms) is 39.2x due to the influence of heavyweights
SABIC (31x) and Saudi Telecom (30x) which are themselves expensive compared to their global peers.
The earnings yield of 1.98% (1/50.4) and dividend yield of 1.52% are low by international standards and
compared to the SAR discount rate of 3.95% while the Price to Book Ratio (PBR) of 9.2x is outrageous!

4. P.O. Box 26893
Manama, Bahrain
Telephone: +973 17 533570
tarek.fadlallah@bh.nomura.com
4
Monday 20th
June, 2005
The Search for Value
Building precise valuation models for the GCC markets in the midst of an evolutionary period is very
complicated as it requires a clear understanding and an accurate evaluation of the ongoing changes.
The aggregated impact of reform, deregulation, growing inward investment, rising domestic consumption,
relaxed property rights for foreigners and the repatriation of regional wealth is difficult to assess.
Nonetheless the GCC is not the first region to undergo economic transformation and there are some
intuitive measures that can be used to evaluate whether markets are fairly valued in broad terms.
Market capitalisation is one measure that – while dependent on the number and size of listed firms – offers
some clues to guesstimate relative valuations although PERs and Yields are comparatively more objective.
Saudi Arabia China Korea Brazil Mexico Russia S. Africa
(TADAWUL) ('A' SHARES) (KOSPI) (BOVESPA) (BOLSA) (RTS INDEX) (ALL SHARE)
GDP ($bn) 310.0 7,262.0 925.0 1,492.0 1,006.0 1,408.0 491.0
Market Cap ($bn) 480.0 375.8 448.2 213.4 153.6 153.0 343.9
Ratio (%) 155% 5% 48% 14% 15% 11% 70%
PER(weighted) (x) 39.2 17.4 10.5 9.01 12.9 14.9 12.3
Div Yield (%) 1.5 2.1 2.5 24.7 1.7 2.3 2.8
Source: CIA Factbook, Bloomberg
The Saudi Arabian market capitalisation (which excludes the publicly owned oil sector and many of the
leading family firms that dominate the local economy) is now larger that the country’s GDP and
implausibly greater than the Korean KOSPI, Brazilian BOVESPA, Mexican BOLSA, Russian RTS, South
African ALL SHARE and the combined Shanghai and Shenzhen ‘A’ share indices.
The comparative valuation of Saudi Telecom offers a further insight into the disparity that exists at the
corporate level between Saudi stocks and global equities.
Country Company PER PBR DIV YIELD
China China Telecom 7.9 1.45 2.43
Korea SK Telecom 9.5 1.98 2.66
Brazil Tele Norte 11.5 1.87 6.78
Mexico Telefonos de Mexico 8.6 2.49 3.72
Russia Rostelecom 12.2 0.86 2.61
South Africa Telekom SA 9.1 2.84 4.51
Average 9.8 1.92 3.79
Saudi Arabia Saudi Telecom 30.3 9.12 2.77
(data as at 18th June, 2005) Source: Bloomberg
Taking into account the average valuation of the six emerging market telecom companies it seems highly
unlikely that Saudi Telecom is appropriately valued at current prices.
Given current global valuations investors should consider PERs of 10x-15x as appropriate benchmark
market multiples although certain high growth stocks would obviously justify premium multiples.

5. P.O. Box 26893
Manama, Bahrain
Telephone: +973 17 533570
tarek.fadlallah@bh.nomura.com
5
Monday 20th
June, 2005
PER
Fair Value?
0
5
10
15
20
25
30
35
40
45
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
10% Growth 20% Growth 30% Growth
Profits in Saudi Arabia have increased substantially in the past two years from a modest base but recent
history may not provide an accurate guide as to how fast profits will grow in the future.
Year 10% 20% 30%
2004 39.2 39.2 39.2
2005 35.6 32.7 30.2
2006 32.4 27.2 23.2
2007 29.5 22.7 17.8
2008 26.8 18.9 13.7
2009 24.3 15.8 10.6
2010 22.1 13.1 8.1
2011 20.1 10.9 6.2
2012 18.3 9.1 4.8
2013 16.6 7.6 3.7
2014 15.1 6.3 2.8
2015 13.7 5.3 2.2
2016 12.5 4.4 1.7
2017 11.4 3.7 1.3
2018 10.3 3.1 1.0
Annual Profit Growth Rates
Naturally the timetable for suggested normalisation not only requires profits to rise as expected but also
that stock prices remain unchanged for the duration of the adjustment phase.
If stock prices were to rise or profits fail to grow as expected the adjustment process would take longer.
Current valuations leave no margin for error.
Nonetheless assuming a positive and bullish stance
the table (left) and chart (below) offer a guide as to
how valuations could develop and normalise
assuming three base scenarios for profit growth.
Under an aggressive scenario of 30% profit growth
the market will achieve sensible PER valuations of
between 15x-10x by 2007-09 whereas lower
growth of 20% will require a further two years.
Under the conservative and perhaps sensible
assumption of 10% profit growth it will take until
2014-18 (up to thirteen years!) for PERs to correct
toward historically sustainable levels.

6. P.O. Box 26893
Manama, Bahrain
Telephone: +973 17 533570
tarek.fadlallah@bh.nomura.com
6
Monday 20th
June, 2005
The China Model
The performance of the Chinese stock market offers an illuminating illustration of how highly valued
markets can adjust even in a healthy macro-economic environment when profits are rising.
In July 1994 the Shanghai A index that consists of Renminbi denominated local shares began a sharp rally
propelled by the breathtaking pace of economic growth in China.
By June 2001 the index had risen 700% from 330 points to a record 2,337 points as local investors
celebrated China’s unprecedented period of double digit economic growth.
Valuations also soared with the market earnings multiple reaching a flabbergasting 62x in August 2000
after which they began a downward adjustment which has taken five years and cut PERs to around 17x.
800
1000
1200
1400
1600
1800
2000
2200
2400
Dec-99 May-00 Oct-00 Mar-01 Aug-01 Jan-02 Jun-02 Nov-02 Apr-03 Sep-03 Feb-04 Jul-04 Dec-04 May-05
Shanghai A Share Index
10
20
30
40
50
60
70
P/E Ratio
Economic Growth
The adjustment was partly due to an increase in earnings but owed much to the fact that the stock market
recorded a -55% decline during this period.
China has shown that it is possible for stocks to decline in spite of a buoyant economy and rising profits if
the starting point is high valuations.
This multiple contraction phenomenon is typical in emerging markets and follows a period of rapid share
price appreciation after investors have rushed to discount positive news well into the distant future.

7. P.O. Box 26893
Manama, Bahrain
Telephone: +973 17 533570
tarek.fadlallah@bh.nomura.com
7
Monday 20th
June, 2005
Scope for Correction
Excessive valuations can be adjusted either gradually through a drawn out period of sideways trading with
a downside bias or by a sharp correction with a messy aftermath.
And while it is possible that some of the GCC markets could correct gradually the nature of the rally and
the frenzied retail activity suggests that the correction will be both sharp and painful.
The use of leverage (either directly or indirectly) which has boosted the gains on the upside is likely to
amplify the risks to the downside with the upside overshoot being matched by a downside overshoot.
Since there are no technical signs that the GCC markets have peaked yet some investors may be tempted to
take advantage of the rising price trend to hunt some eleventh-hour profits.
Further gains among the GCC markets are certainly possible but an important lesson from the NASDAQ
debacle is that timing the market peak is very difficult even in efficient markets.
Unfortunately the trigger for a correction is rarely apparent except in hindsight and psychological factors
often play a crucial role – sometimes stocks fall because they fell yesterday and might fall tomorrow.
Furthermore once a post-bubble bear market is underway it can be both severe in depth and lengthy in
duration depending on the nature of the excesses and the market mechanisms in place to deflate them.
The Nikkei index fell -80% between December 1989 and April 2003 (one hundred and sixty months)
while the more efficient NASDAQ index declined an equally dramatic -78% in just thirty one months!
Strategy and Action Plan
Exposure to the most blatantly overvalued markets in Saudi Arabia, the UAE and possibly Qatar should be
aggressively reduced at current levels.
Saudi Arabia UAE Kuwait Qatar Oman Bahrain
TASI NBAD KSEI DSM MSM All Share
13,933 17,961 8,569 10,158 5,505 2,163
SELL SELL REDUCE REDUCE REDUCE REDUCE
Source: Bloomberg
Valuations in Kuwait, Bahrain and Oman appear reasonable if not cheap but these markets are unlikely to
be excluded from any regional price adjustments even if they might avoid the worst.
Notwithstanding the dire nature of this warning it may be prudent for investors to maintain some selective
exposure to attractively priced stocks for long term investment purposes (or in case we are wrong)!
Going forward local investors should consider a dollar averaging investment strategy in order to avoid
buying the highs or missing the lows.

8. P.O. Box 26893
Manama, Bahrain
Telephone: +973 17 533570
tarek.fadlallah@bh.nomura.com
8
Monday 20th
June, 2005
Conclusion
The bearish call on GCC stocks is no reflection on the long term prospects for regional economic growth
or the capabilities of local managers.
Instead it is a statement about the disconnect that now exists between the real economy and the financial
instruments that purport to represent them.
The GCC markets had been undervalued prior to the invasion of Iraq but have now become overvalued as
the initial euphoria and subsequent boom developed into what some might term “irrational exuberance”.
It is possible that the GCC markets provide an exception to the rule but if history is to be repeated then the
highs in the local markets may be imminent and may be followed by a period of severe declines.
Beware. Red Alert.
Regards
Tarek Fadlallah, CFA
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