Development of the Telecommunications Market in Russia in May 2006

1. The General Trends of the Market Development

1.1. The Saturation Rate of the Cellular Communications Market in Russia

In April the amount of the cellular communications users in Russia increased by 2.3% and reached 134.7 mln (the increase by 45.4 mln people or by 50.8% as compared to April 2005). According to this figure Russia takes the third place in the world after China (393 mln) and the USA (204 mln). The penetration level in Russia is 93.7% (142% in Moscow and 123% in St. Petersburg). Meanwhile, the rate of increase in the active subscribers amount has been slowing down (91 mln by the end of the 1st quarter). This fact confirms experts’ forecasts about reaching saturation due to low incomes of the population by the Russian market.

By April 30 the consolidated MTS subscriber base along with the subsidiaries has been 61.77 mln (+1.2% as compared to March).

Within the 1st quarter of 2006 the cellular operators’ subscriber bases have increased by 5.2 mln and reached 100.7 mln on regional markets. But in the 1st quarter of 2006 the tendency to the regional markets’ share growth on the Russian market went down (the growth by 0.3% only). The volume of the subscriber bases increase was 42% from the volume of increase in the 4th quarter 2005.

In the 1st quarter of 2006 on regional markets Vimpelcom subscriber base increased up to 33.6 mln subscribers (the increase about 1.5 mln), MTS subscriber base grew up to 33.0 mln people (the increase about 1.5 mln). MegaFon subscriber base reached 17.6 mln subscribers 9the increase about 0.8 mln). The reasonable increase of the Big3 subscriber bases has allowed regional operators to take more then 29% in the subscriber bases increase.

According to the results of the 1st quarter of 2006, the total subscriber base of the Russian cellular companies, included in Tele2 holding, has reached 3.912 mln people. The increase for a year has been 147%. Tele2 holding is a shareholder of 14 Russian companies, 11 of which belong completely to the holding. The companies provide GSM cellular communications services in St. Petersburg and the Leningrad region, the Smolensk region, the Nizhni Novgorod region, the Kursk region, the Belgorod region, the Chelyabinsk region, the Omsk region, the Kemerovo region, the Irkutsk region and in the Udmurtiya republic.

According to the data by May 1, the Mobile Digital Communications company, Velcom brand, has increased its subscriber base by 2.1% (up to 2.140 mln actives subscribers).

According to the results of 2005 and IDC data, the mobile phones market has still showed a stable growth rate, though as compared to 2004 the rate has slowed down. The main trend is rise in prices in the average price segment. Purchases, connected with phones substitution are the main driving force on the market. As a result of the active promotion of phones in high and average price segments and the substitution of obsolete models for more expensive ones the delivery volume has increases by 21%. According to the results of 2005 the growth of the Russian market’s volume has exceeded 60% in the highest price segments (Premium segment – 69%growth, Extra Premium – 86%) as compared to 2004. The market growth rate was slowing down in proportion as the rates of the subscriber base extension were reducing.

Panasonic company has ceased the import of GSM mobile phones to Russia. But they states they will return to the market in 2008 approximately, when 3G networks appear in Russia.

1.2. The Offers of New and Standard Services

Since May1 MTS has introduced zone tariffing for its subscribers in overseas roaming, dividing the world on 5 zones. MegaFon has done the same since June 1. The common tariff and list of all possible calls have been set inside each group. Before, since July 4, 2005 Bee Line has turned to zone tariffing (8 zones).

MegaFon-Moscow has established a new service: the automatic setting of all modern mobile services with a SIM card, being inserted in a phone and activated by pressing a button.

The association of mobile phones providers and content, founded about a year ago, has declared a start of the action “The Quality has been tested” to improve the quality of mobile phones melodies, pictures, games and to legalize the market.

Google and Bee Line have declared the launch of the Russian project of mobile searching. The searching system Google has been instilled by the Russian operator in its WAP-portal.

Vimpelcom has declared the application of the system for protection from MMS viruses, developed in Kasperski laboratory, to the Russian Bee Line network.

1.3. The Main Companies’ Potential (capitalization, profit)

According to the results of the 1st quarter, ARPU negative dynamics has been predicted to Vimpelcom anD MTS by analysts. The rates of ARPU reduction are expected to be quite equal for the leaders (9-11%) on the Russian market. Sistema has published the report of financial results in 2005 according to US GAAP. The telecommunications segment proceeds have increased by 27.6% up to 5.89 bln USD. That is caused mostly by the increase in MTS proceeds, that reflects the continuous growth of the subscriber base in Russia and the CIS countries. By the end of the 1st quarter of 2006 the net income according to RSBU has increased by 46.1% as compared to the 1st quarter of 2005 and reached 6.611 bln roubles. In June 1 Vimpelcom published a statement for the 1st quarter of 2006. The pure operation proceeds have reached 936.9 mln USD (+46%), the net profit has reached 150.2 mln USD (+37%). The subscriber base is 50 mln users approximately, including 3.7 mln in the CIS countries. The 1st quarter of 2006 has become the 26th quarter of the proceeds increase. Vimpelcom has also increased its market share in Kazakhstan up to 40.6% as compared to 37.2% in the previous quarter. Besides, in Uzbekistan 195.4 mln USD approximately have been invested in the property and equipment buying and 261 mln USD have been invested in buying of mobile phones. Thus, the amount of countries Vimpelcom is working in has been increased to five. For the second year MTS intends to pay dividends, record for the telecommunications branch, - 561 mln USD or 50% approximately of the net profit according to US GAAP. Last year MTS paid dividends of 410 mln USD or 40% of the net profit.

Vimpelcom informed the company does not pay dividends on simple shares traditionally and is not going to do that in 2006. MegaFon does not pay dividends either.

According to the results of the 1st quarter, according to RSBU, SMARTS declared the pure losses of 125 mln roubles (for the 1st quarter of 2005 the net profit has been 13.7 mln roubles). Analysts explain that by the unfavourable competition environment for non federal operators in the countries, and partly, by raiders’ attacks for the company.

Uralsvyazinform has introduced the operational and financial statements for the 1st quarter of 2006 according to RSBU. Because of finishing of joining the parent company by the subsidiaries, providing the cellular communications services (Ermak RMS, The South Ural Cellular Phone, Tumenruskom) and services of data communications (Uralkom, VSNET), since July 1 2005 the financial accounts of Uralsyazinform according to RSBU have included the property, obligations and the activity results of the joined companies. The proceeds have increased by 16.6% (7630 mln roubles), the net profit has grown by 80.4% (1016 mln roubles), the profit in GSM cellular communications segment has become 4.7 times as much (305 mln roubles). The amount of subscribers has increased by 60.6% (786 thousand people).

1.4. The Market Extension Due to Overseas Expansion

The Interregional Transit Telecom (MTT) company and the Ukrainian cellular operator Kievstar GSM has made an agreement of the direct joining of the networks.

MTT and Uzbektelecom, the largest cellular operator in Uzbekistan, signed an agreement about the internetworks cooperation, concerning the wired and mobile communications. For a year and the half Euroset has opened 200 saloons in 50 towns of Kazakhstan.

2. The Regulator’s Activity and the Legal Field Dynamics.

2.1. The State Assets Privatization

Rosimushestvo offered to send the whole Syazinvest’s net profit for 2005 to pay dividends. Some commentators consider that as a sign of the company’s privatization, being prepared,

2.2. The Evaluation of Legality of Merges and Absorptions Held by the Legislative and Law Enforcement Bodies

The Zurich Arbitrage has declared the head of the Ministry of Information and Communications Leonid Reiman an indirect co-owner of MegaFon and established the guilt of him in personal enrichment at the expense of the state. According to the information of Reuters agency, Reiman appeared in the case as witness 7. The Court concluded, that the witness had been an owner of IPOC fund, registered on Bermudas, owing 8% MegaFon shares and struggling for its control holding with Alfa-group, an initiator of the investigation, Reiman denies his complicacy to the fund. The Court has also established, the witness “a high ranking officer” did not try to protect the state’s interests while “dithering” of its control share holding in CT Mobile company, owing 65% shares of the cellular operator Sonic Duo, later included in MegaFon. He also blocked licensing of MTS for work in St. Petersburg and thus tried to make the company buy Telecom CCI company, that belonged mediately to IPOC and other off shore companies.

In fact, the Zurich Tribunal is an expert council and does not possess authorities to article, give judgments, call witnesses and divulge their names.

2.3. The Struggle with Illegal Entrepreneurship

The large channel of contraband electronics delivery in the guise of diplomatic cargo for embassies of some African countries was closed in Moscow. Using personal links, the unfair entrepreneurs drew up fraud letters of attorney and letters of guaranty, confirming, that the ordered goods were imported for personal use of the embassies’ officers or for needs of diplomatic missions. Euroset has sent letters to President of Russia and Chairman of the government of the Russian Federation, containing the complaint of the actions of the enforcement bodies, having obliterated the forfeited Motorola phones. According to anonymous sources, President has demanded to settle the problem, and in accordance with his resolution M.Fradkov has charged G.Gref with preparing of amendments to the legislation, concerning sales of forfeited and arrested property. The amendments must exclude a possibility of sales of the property, arrested as material evidence without a decision of a court. And a process of selling of forfeited property must be public.

Meanwhile, Euroset has blocked temporally Motorola phones delivery. According to the evaluations, it will not yield significant losses to the company.

The Russian company RussGSP has charged Motorola with violation of the patent rights, the force of which is spread for seven Motorola phone models, sold in Russia. The patent was violated by Euroset, that sold the phones, and Motorola, that produced them and delivered to Russia. RussGSP intends to exact from Motorola signing of an license agreement, in the frames of which the producer will pay to RussGSP for the right of the phones delivery to Russia. And cellular retailers will pay to RussGSP for the right to sell those phones. In May 22 Motorola company commented officially on the charges, stating, that the claims of RussGSP were invalid. Moreover, patent disputes must be considered in Rospatent instead of the General Prosecutor’s Office. SMARTS has sent declarations to Minister of Justice U. Chaika and Chairman of Supreme Court of the Russian Federation V. Lebedev, concerning the fact, that the secured measures, regarding the company’s actions, had not been removed. They declare that more then a year ago the company became a target for planned attack of raiders. Since 2005 the claims, aimed to take secured measures in the form of seizure of the whole SMARTS share holding, have been received by different courts of Russia. They mention that the decisions of the court about the measures removal were not executed. As a result SMARTS shares are being constantly under arrest. The company’s shares belong to shareholders, having no relation to the participants of the lawsuits. Decisions about the shares seizure are made in courts of general jurisdiction, though an arbitrage only has a right to take such decisions.

2.4. The Regulator’s Activity Evaluation by entrepreneurs and Mass Media

The conditions and consequences of CPP (Calling Party Pays) principle introduction since July 1 are being discussed actively. According to forecasts, the cost of outgoing calls can be increased by 25-30%.Operators do not exclude the possibility of a minute cost increase in current tariff plans. The main disputes concern the issue of amount of compensation for a call finishing when calling from a wired phone to a mobile phone. But MegaFon’s representatives think, until FST makes any official declarations, it is early to speak of any figures.

According to the statement of Minister of Information and Communications L. Reiman, tariffs for calls from wired phones to mobile ones will be approved no later then in June 20. In his opinion, the abolition of payments for all incoming calls will lead to some cost increase on calls in wired communications networks and income reduction of cellular operators. Reiman emphasized, the Ministry had not precipitated to apply the practice, but the State Duma deputies had decided to accelerate the process and voted for the corresponding draft law.

3. The Companies’ Activity and Decision Making, Having Influenced Most the Market Development

DIXIS group of companies, following the policy of penetration in Russian regions, is extending the saloons network by means of the franchise agreements in Nizhni Novgorod, Ekaterinburg (Tehmarket project). The company has bought Mobile retailing network (72 stores, most in the Rostov region) in the South Federal Region and now the company has 132 saloons and 25 franchise saloons. To compare, Euroset has 414 saloons. MTS has got a credit of EBRR (the European Bank of Reconstruction and Development) for 112 mln USD. The maturity of 138 mln USD from 150 mln of the credit, got in 2004, was prolonged. The funds are aimed to penetration in Russian regions and the CIS countries. In May 4 FSFR (the Federal Service on Financial Markets) registered the issue of bonds 02 000 “Euroset Trade House” on 3 bln roubles. The funds are expected to be used for goods buying.

3.1. Success and Failure in New Assets Buying In Russian and Overseas

MTS has sent a preliminary application for participation in the tender on the state share holding of Mobi 63 cellular operator, offered for sale by the Serbian Agency on Privatization. The state share holding includes a 10-year license for whole Serbia. The initial price is 800 mln euro. Preliminary applications were also sent by Detsche Telekom (Germany), Teliasonera and Tele2 (Sweden), Telenor (Norway), France Telecom (France), Emirates Telecommunications Corporation, Mobilkom Austria (Austria), Discount Investment Corporation (Israel), Orascom Telecom (Egypt). The results will have been known by the late July

3.2. The Companies’ Activity on Stock Markets of Russia

FSFR has registered the issue of bonds of Dixis Trading, the company, included in Dixis group. The aims of the loan are re-financing of the credit portfolio, development due to absorption of regional retailing networks. The issue volume is 1.8 bln roubles, time of the circuit is by July 20, 2009.

The board of directors of Sibirtelekom approved May 24 as a date of starting of floatation of bonds 07 on 2 bln roubles. The aim is re-financing of debts on the loans and financing of investment projects.

3.3. Personnel Changes in the Main Companies

Vsevolod Rozanov, having taken the position of deputy general director on economics and finance of Komstar-OTS, has moved to the post of vice-president on finance and investment of MTS. Nikolai Tikarev has been assigned a new deputy general director on economics and finance in Komstar. The position of general director of Sky Link, quitted by Raisa Rozinova in the early May, will be held by Alexander Nesterov, having headed the Nizhni Novgorod branch office of Tele 2.

4. The Conflict Zones and Interests Opposition Fields

The American corporation MCT Corp, working in Russia under Indigo brand, is selling the rest cellular assets: 4 north-western assets must be sold by September 1. The buyer is the Cyprian off-shore company Eventis Telecom, belonging to natural persons, related to the group of “Petersburg’s telecommunications workers”, Vladimir Androsik and Dmitri Ivanter. Earlier Eventis has already participated in the other deal, when since 2005 MCT Corp started finishing the business in Russia, having sold Lipetzk Mobile to Tele 2. That deal was followed by a larger sale: 100% shares of VostokMobileVolga company.

The negotiations, concerning the issue of buying of the Ukrainian largest mobile company Kievstar GSM by Vimpelcom have been broken. In June 1 Vimelcom declared the rejection of the deal in public. It is known, the offer for the purchase was made in the early February. According to general director of Vimpelcom Alexander Izoimon, that was caused by Telenor’s position in the negotiations with Alfa group. Altimo accepted the decision of Vimpelom’s authorities and was ready to further discussion. It is necessary to mention, in May 31 the Norwegian company addressed to Vimpelcom, asking to prolong the negotiations to July 1, but got a refusal.

Altimo sent a letter to Telenor, asking to take into account all changes in the corporate management of Kievstar. That can deprive the Norwegian company of a right to consolidate Kievstar’s figures in their financial accounting as presently no one of the shareholders is able to control Kievstar fully. Telenor is disputing Altimo’s position as, being guided by the invalid decision of the Kiev Economic Court.

Alfa group has began a lawsuit against its subsidiary Storm, owing 43.5% shares of Kievstar. We speak of abolition of the agreement, that gives Telenor an advantage in Kievstar’s board of directors. The Kiev Economic Court declared the decisions of Kievstar shareholders, that regulated the order of the company’s board of directors election, were invalid. In April 25 the court answered to a claim of one of the Alfa’s companies, the Cyprian Alpren against Storm and considered that general director of Storm had signed lawlessly the agreement about an order of voting and the related agreement of Kievstar shareholders. General director of Storm signed the agreement without approval of the company’s participants. According to the agreement, Telenor has 5 places in Kievstar board of directors, and Storm has 4 places. Afterwards, those norms were transferred to the agreement of shareholders and to the charter of Kievstar. The agreement had been signed before Alfa bought 100% of Storm (before 2004 the company has possessed 51%)

In May 15 the Moscow Arbitrage dismissed the first of three claims, brought by the Norwegian Telenor, attempting to appeal against buying of the Ukrainian Radiosystems by Vimpelcom. The Norwegians did not agree with the decision of the court and promised to appeal it.

Altimo and the Turkish Cukurova have brought two representatives of Altimo and an independent director to the board of directors of the largest Turkish cellular operator Turkcell. The candidatures were not adjusted with TeliaSonera. Representatives of Teliasonera voted against all three candidates, but could not prevent the election. Mehmet Emin Karamehmet and Mehmet Bulent Ergin have entered the board of directors from Cukurova,. Oleg Malis and Aleksey Hudyakov are representatives of Altimo. And Anders Igel and Erdal Durukan represent TeliaSonera.