The Russian Telecommunications Market Development in July 2007

1.General Trends of Market Development

1.1. Saturation Rate of Cellular Market in Russia

According to the published data of the preliminary analysis of Russia’s cellular communications markets in the 1^{st half a year of 2007, by the 2nd quarter of 2007 the subscriber base of cellular operators in Russia had been 160 mln users according to number of SIM cards and the actual subscriber base had been 77.8 mln users.}

According to estimates of Euroset company in the 1st quarter of 2006, 20.5 mln SIM cards of cellular operators were sold, 21% less compared to the 1st quarter of 2006.

In 2007 the market retailers will probably sell 43 mln SIM cards. 10.6 mln of them will be sold to new actual subscribers, the rest SIM cards will be acquired by existing subscribers and those migrating between operators.

In the 2nd quarter of 2007 on the Russian market of cellular retail 6.61 mln cell phones were sold at 1.40 bn USD, 6% less than the cellular retail in the 2nd quarter of 2006, though 5.3% more in money terms.

For the 1st time in the history of the Russian retail market in the 2nd quarter of 2007 sales of cell phones were lower than in the 1st quarter. The reduction was around 100 thousand cell phones, i.e. 1.4% (6.71 mln phones in the 1st quarter). In the 2nd quarter of 2007 the sales proceeds also reduced by 1.4% compared to the 1st quarter (1.42 bn USD in the 1st quarter). In total for the 1st half of 2007 13.32 mln cell phones at 2.82 bn USD have been sold in retail nets of Russia, reducing by 1.4% compared to the 1st half of 2006. Though the sales proceeds have grown by 8.8% compared to the 1st half of 2006.

In the 1st half of 2007 an average price of a cell phone, sold by retail, was 212 USD, growing by 11.5% compared to the 1st half of 2006. Over the lifetime of cellular communications in Russia by the 2nd quarter of 2007 139.4 mln cell phones had been sold in Russian retail nets.

In 2007, according to the forecast, the share of cell phone replacement, will be 74%. In the 1st half of 2007 in Russia 9.86 mln of 13.32 mln cell phones were bought for replacement. However, according to the forecast, the replacement volume will be 26% of the amount of real subscribers, i.e. a quarter of real subscribers will replace their phones.

Supposing that on the Russian market the ratio of sold phones number and SIM cards number will remain 0.65 to the end of the year, the number of sold cell phones in 2007 will be 28 mln, taking into account the forecasted 43 mln sold SIM cards .

Around 70 % of aggregated proceeds from cell phones sales are provided by 42 % of sold phones, costing more than 200 USD.

In the 2nd quarter of 2007 12.6 mln cell phone accessories at 99.5 mln USD were sold on the Russian market of cell phone accessories retail sales.

According to information of AC&M Consulting, over June of 2007 cellular communications subscriber base has increased by 1% compared to May up to 1.7 mln people. At that, growth rate has gone down by 395 compared to the same index in 2006. Penetration according to the number of SIM cards reached 110% in June, growing by 1.2% compared to May. Penetration in the Moscow License Area (MLA) was 165%, in St. Petersburg – 143%, in regions - 101%.

By 30 June of 2007 the consolidated amount of MTS subscribers had reached 74.67 mln people, the company informs.

By late June of 2007 the amount of Euroset stores had reached 4, 833 in 11 CIS and Baltic countries. Over the 2nd quarter of 2007 the company’s turnover has been 1.34 bn USD, growing by 6.5% compared to the 1st quarter of 2007 and by 34.8% compared to the same period of 2006. In the 1st half of 2007 aggregate turnover of the company was 2.6 bn USD, increasing by 41.6% compared to the same period of 2006.

In the 2nd quarter of 2007 Euroset sold 2.99 mln cell phones through its net, 3% less than in the 1st quarter. However, in the 2nd quarter of 2007 the sales proceeds grew by 0.2% compared to the 1st quarter of 2007 and by 8.8% compared to the company’s sales in the 2nd quarter of 2006.

Over the 1st half of 2007 the company has sold 6.08 mln cell phones, 20% more than over the same period of 2006.

In the 2nd quarter of 2007 Euroset sold 3.4 mln SIM cards of cellular operators, 9% more than in the 1st quarter of 2007 and 5% less compared to the 2nd quarter of 2006.

Over the 1st half of 2007 6.53 mln SIM cards of cellular operators have been sold by the company, 6.6% less compared to the same period of 2006. The decline in sales can be explained by saturation of the SIM cards retail sales market

1.2. Offer of New and Standard Services

Vimpelcom and its shareholders Alfa Group and Telenor are discussing a possibility of redemption of their shares in Golden Telecom, the second largest operator of fixed-line communications in Russia according to proceeds. As a result one more holding may appear, which will provide services of mobile communications in 7 countries and services of fixed-line communications and broadband access to Internet in 3 of them. Vimpelcom’s subscriber base numbers 58.4 mln subscribers in Russia (48.8 mln) and in six CIS countries.

1.3. Major Companies’ Potential (capitalization, profit)

The general meeting of MTS shareholders has made a decision to pay dividends according to results of 2006: 9.67 roubles per a share of MTS (around 1.87 USD per ADR). Thus, the overall sum of dividends will be 19.28 bn roubles (747.44 mln USD). The payment will be conducted by the end of 2007.

Tele2 reported for the 2nd quarter of 2007. According to the report, in Russia the company’s revenue has grown 2.2 times (to around 188.6 mln USD) compared to the same period of 2006. The overall revenue of the holding has only increased by 5.8% and reached 1.96 bn USD. Thus, cellular business in Russia brings Tele2 one tenth of the company’s revenue. In the 2nd quarter EBITDA of Tele2 Russian business grew 5.6 times to 61.9 mln USD. The company’s profitability according to EBITDA was 33% compared to 13% in the 2nd quarter of 2006. ARPU of the company increased by 27% (to 8.38 USD) compared to April-June of 2007 and by 8.8% compared to the 1st quarter of 2007. Earlier the operator had gambled on services cheapness.

According to international standards of financial accounting (MSFO), over 2006 the proceeds of Sibirtelecom have been 30.175 bn USD, growing by 10% compared to 2005. Net profit of the company has reduced by 21% to 1.160. The company’s net profit according to MSFO has been even lower than the profit according to Russian standards (105 mln USD). The revenue of Sibirtelecom consists of 27.4% of cellular communications, 26.8% of local communications, 15.2% of service providing to Russian operators, 12.3% of intrazone telecommunications services, 5.7% of Internet, data communications, IP-telephony and intellectual networks services.

Telefon.Ru company (the federal network of mobile communications stores) declared that over the 1st half of 2007 the company’s proceeds have grown more than 2 times compared to the same period of 2006.

A share price of Russian companies on the New York Stock Exchange was as follows:

Vimpelcom – 105.8 USD (117 USD in July 25)

MTC – 63.8 USD

1.4. Market Extension Due to Overseas Expansion

MTS-Uzbekistan informed its subscriber base has reached 2 mln people. Since the beginning of the year the subscriber base growth has been 550 thousand people, i.e. 38%. The rapid growth rates confirms leadership of the company on the mobile communications market of the country. The wide range of innovative services and international roaming in more than 136 countries of the world are available to subscribers of MTS-Uzbekistan. The operator has a license for 3G and WiMAX networks construction. The 1st stage of 3G and WiMAX launch is timed for 2008.

The number of active MTS subscribers in Byelorussia has reached 3.5 mln people. Today 54% of mobile communications users choose MTS. The company has been holding the 1st place in the country since the autumn of 2004, when it became the first Bylelorussian operator, connecting 1 mln subscribers. In November of 2005 the army of the company’s subscribers doubled. As of November 24 of 2006 the operator had overpassed the point of 3 mln users.

MegaFon has launched a network in Altai Republic, the last subject of Russia, the company had not covered yet. Now subscribers of the operator can use its services all over the country. The company did not buy ready nets from regional operators and created a technical base from the very beginning, says CEO of Megafon Sergey Soldatenkov. For 5 years since foundation the company has invested around 4 bn USD in the network development. This year they are investing 1.2 bn USD. MegaFon has not planned to enter overseas market to present day. Beside Russia, the operator was only represented in Tajikistan, where it possesses a 75% share of TT-Mobile, the second largest operator in the country according to the number of subscribers (around 165 000). According to Soldatenkov, today MegaFon is ready to acquire operators in the CIS countries. The company is interested in Armenia, Kirgyzia and Uzbekistan, where penetration of cellular communications has not been very high yet. The operator hopes to become the second or the third participant of the market.

In July of 2006 Svyaznoy company and Belaya Bezha company agreed to combine efforts for work on the Byelorussian market. As a result the retail nets Focus and MegaPlus have got a right to work under a common brand. The companies have also obtained financial possibility to construct a network of mobile communications centers, including high-performance methods and techniques of sales. Entering the Byelorussian market, Svyaznoy has got a basis for work in the form of a net of more than 100 stores. The two companies integration will allow to create a big and strong player on the Byelorussian market of mobile retail.

The largest world producer of computer and electronics Apple is opening a representing office in Russia. The company has already started searching employees for the capital office, which will do marketing research and promote the company’ production on the Russian market. In Moscow the representative office of the company will be opened either in the autumn of 2007 or in early 2008. The Russian distributor of Apple IMS Russia will be still responsible for sales of the company’s production.

2. Regulator’s Activity and Legal Field Dynamics

2.1. News in Legislation and Other Changes In Legal Field.

According to results of the session of Security Council of the Russian Federation, the Strategy of Russian Information Society Development was approved. President of the RF V.Putin has posed an objective to become one of the leaders of the global information area by 2015. According to his instructions, commission must be founded under the presidium of the President Council on Science, Techniques and Education.

Deputies of State Duma have postponed the time of effectiveness of the law No14 FZ “On Alteration to the Federal Law “On Communications”. Changing of the networks registration order was postponed for 180 days. The decision was made because additional normative documents must be prepared and powers must be re-distributed after the new department Rossvyaohrankulturi had occurred. The process of the new regulator’s activity organization has not been finished yet so licensing for communications networks exploitation has been suspended as well.

The results of the tender commission session, held in July 17, on distribution in the Far East of cellular communications frequencies of GSM standard were declared. On the first of two tenders Rossvyazohrankulturi put up 11 sets of frequencies for cellular nets of GSM 1800 MHz in the Khabarovsk region, Sakhalin, Yakutiya, the Amur and Magadan regions and the Evreyski Autonomous region. On the second tender one set of frequencies in 900 MHz band in the Evreyski Autonomous region was put up. Most lots were acquired by Summa Telecom. The Yakutian telecommunication companies Esotel-Rustelecom and Svtcom acquired licenses GSM-1800 in Yakutia. Bit company (a subsidiary of Dalsvyaz) got GSM – 1800 in Sakhali. Besides, the Moscow company Streamton won licenses in the Evreyski Autonomous region and the Magadan region.

Rossvyazohrankulturi has postponed conduction of 8 tenders on licensing of communications service providing in GSM 900/1800 standard. Svetlana Vlasova, Deputy Chief of Rossvyazohrankuklturi, was authorized to produce changed criteria and an order of evaluation of participants’ tender offers in August 7.

According to words of Rossvyazohrankulturi representative Evgeni Strelchik, operators will not have to rearrange applications for participation. They will only have to qualify information in them.

The item on violations in operators’ activity, revealed by the oversight bodies, may be corrected. The commission members are discussing a possibility of equating eliminated violations with their absence.

Operators may also be obliged to use one source, when indicating settlements where they plan to deploy their networks and the population in order to avoid discrepancy.

Moreover, a representative of FAS should enter the commission.

The government of the Russian Federation prohibited to use mobile terminals of some satellite communications systems and mobile phones of CDMA-800 standard according to the resolution of June 25 of 2007 “On Making Alteration to the Resolution of the RF government of October 12 of 2004 No 539 “On Registration Order of Radio-Electronic Facilities and High Frequency Devices”. The resolution is taking effect in 30 days after signing. The resolution includes a list of radio-electronic facilities, which should be registered. The list of the facilities, permitted for use without registration in Russia, has been supplemented with several items.

The Ministry of Information and Communications and Rossvyaz have prepared amendments to the resolution of the government on description of communications services and a list of licensing conditions, according to which operators will be obliged to make allocation to reserve of the universal service of communications. Vedomosti quotes Deputy Chief of Rossvyaz Sergey Bulanch reporting that at present only 1000 of 7000 operators transfer their means correctly. Discrepancies in normative documents do not allow the body to make small operators pay. In case the government supports the officials, operators can lose their licenses because of default of payment.

2.2. Struggle with Illegal Entrepreneurship

Sellers of an imitation Vertu have activated on the Russian market. An imitation copy can be bought for 20 thousand roubles, while its real price is around 5 thousand USD. However, producers of Vertu believe that the imitations do damage neither to their image nor to sales. According to the information of the analytical agency Sotovik, about 1300 Vertu are sold in Moscow monthly. The price is about 5 thousand USD. Chinese imitations of luxury phones appeared on the Russian market a year ago.

3. Actions and Decisions of Companies, Influencing Most the Market Development

3.1. Success and Failure in New Assets Acquisition

Alisher Usmanov has acquired a 15% share of Telecominvest. His interest was represented by AF Telecom Holding, which bought the share holding of Telecominvest, North-Western Telecom informs. As a result Usmanov has become an indirect owner of a 4.7% share of MegaFon. The holding is equal to 449, 990 shares of the company. The cost of the deal is 410 mln USD.

According to official information, there were 5 business proposals for the purchase of Telecominvest. AFK Sistema, Altimo, FNH and some Kirghiz company were among the applicants. The proposal of Renaissance Capital was the most appeal. The bank worked in favour of AF Telecom Holding. According to information from the Common State Register of Legal Persons, AF Telecom Holding was registered in May 18 of 2007. The chartered capital of the company is 10 thousand roubles. The founder of the company is the Cyprian company Marevon Engineering Limited, registered in December 29 of 2006. The major kind of activity is wholesale trade.

According to official results of GSM frequency tenders in the Far East, VimpelCom has obtained 2 licenses for work in the Magadan and Evreyskaya regions. Summa Telecom won six lots and obtained GSM-900/1800 licenses for service providing in the Evreyskaya region and GSM-1800 licenses in the Sakhalin region, the Khabarovsk region, Yakutiya, the Amurskaya and Magadan regions. Summa Telecom plans to become the 4th federal GSM operator in Russia.

CEO of Summa Telecom Sergey Koshkin says the company has a good chance to win GSM tenders in 61 subjects of Russia. The company is ready to invest around 1 bn USD in the network construction. At present Summa Telecom has already had more than 50 licenses, the most valuable of which is a license for WiMAX services providing. In January the company obtained a Russian license for data communication services providing and IP-telephonia. In late 2006 the company started WiMAX nets constructing. The company is planning to launch the largest sectors of the wireless network in early 2008. Moscow, St. Petersburg, Vladivostok and Tumen will be the first cities for coverage. The operator is planning to provide triple-play services (telephone, Internet and TV). In case the company obtains GSM frequencies, the company intends to consolidate GSM and WiMAX services. “GSM and WiMAX convergence is more profitable than 3G,” mr. Koshkin says.

DIXIS group declared that Gadget Service company, a leading participant of the market of mobile techniques service, is a part of the holding. Service centers of the company provide warranty repair and tuning of equipment for Nokia, Sony Ericsson, Samsung, LG, BenQ Mobile, Pantech, Sitronics, Sharp, Canon and FujiFilm.

Gadget Service has agreements of partnership with more than 100 companies in almost all subjects of Russia.

More than 200 engineers work in the company that allows to do more than 60 thousand repairs every month. According to the company’s estimates, around 25% of the Russian market of mobile communications facilities repair belongs to Gadget Service.

Chairman of Euroset Board of directors Evgeni Chichvarkin informed the company “intends to take the business out of Byelorussia because of economic inefficiency caused by big taxes and a large share of “grey” import. The head of Euroset Ales Mukhin confirmed this to “Byelorussian News”.

Earlier the company had left the market of Azerbaijan, just after entering it with 5 stores. “The taxes have increased by 10% there and we are moving towards losses already,” Chichvarkin said.

In the frames of realization of the strategy on minority shares consolidation in the subsidiaries, MTS has acquired a 26% share holding of Uzdunrobita for 250 mln USD from a private investor. Due to the deal MTS share in Uzdunrobita has reached 100%. Today MTS Uzbekistan is the largest operator of cellular communications in Uzbekistan. As of May 31, 2007 MTS subscriber base in Uzbekistan was 1.85 mln people.

3.2. Actions of Companies on Stock Markets of Russia

According to information from AFK Sistema, in September 17 at the extraordinary general meeting (EGM) its shareholders will discuss a share split of 1:1000.

Now the chartered capital of the corporation is 868.5 mln roubles and consists of 9.65 mln common shares of 90 roubles each. As a result of the split the capital will be divided into 9.65 bn common shares of 0.09 roubles. Thus, GDR of AFK Sistema will correspond to 20 shares.

Senior Vice President of AFK Sistem Alexey Buyanov believes, the share split will raise liquidity of shares and interest to them on the Russian market. Now shares of AFK Sistema are traded in RTS and on the Moscow Stock Exchange.

Analysts from IC Troyka Dialog have increased ADR of VimpelCom by 36% from 99 to 135 USD per a deposit. Experts expect the two largest operators Altimo and
Telenor will continue acquiring VimpelCom shares on the open market, contributing to the securities growth.

3.3. Personnel Changes in Major Companies

According to the decree of Prime Minister Mikhail Fradkov, Anatoli Vilkov, a deputy director of Rosohrankulturi, and Svetlana Vlasova, a deputy director of Rossvyaz, were appointed deputy directors of the Federal Service on Supervision over Keeping to Legislation in the Sphere of Mass Communications and Cultural Heritage Protection (Rossvyazohrankulturi). Thus, four of five deputies have been already appointed. Earlier Alexander Romanenkov and Sergei Sitnikov had been appointed for the same position. The market analysts note the appointments of deputies from different departments conform to two major directions of Rossvyazohrankulturi’s activity.

The Board of AFK Sistema approved a reorganization plan, according to which Sistema Telecom, managing all telecommunication assets of Sistema, will become a subdivision of the holding.

According to AFK President Alexander Goncharuk, the Board decided to transform Sistema Telecom into a structural subdivision of AFK, named the Complex of Telecommunication Assets Managing. The subdivision will be deprived of “all non-sectoral functions”: finance, security, personnel policy, etc. The subdivision activity will include “industrial policy” and “ technical policy”.

The subdivision will be headed by “a well-known top-manager, working in a large European telecommunication company”. AFK President emphasized the changes in the holding structure must raise investment appeal of the corporation. The total staff of Sistema and Sistema Telecom will be three times reduced (now the staff consists of 290 employees).

In June 29 MTS declared the results of the annual general meeting of shareholders and the decisions made.

A new composition of MTS Board of directors was elected:

VimpelCom shareholders elected 4 representatives of Altimo, 4 representatives of Telenor and 1 representative of minority shareholders to VimpelCom Board of directors. The present Chairman of VimpelCom Board David Haines was elected an independent director of the minorities.

Altimo, managing Alfa Group telecommunication assets, collected 44% of Vimpelcom voting shares to the meeting of shareholders so the company could step out of the agreement with Telenor, owing a 29.9% share. But as that happened after the meeting register was closed, nothing changed formally: 10 candidates were nominated for 9 seats in the Board, i.e. 3 major and 2 independent candidates from each major shareholder, according to the Shareholders Agreement.

The elected direct candidates were:

Andrey Pyatahin became a new head of the VimpelCom Directory on Corporative Sales. In the Moscow region the Directory is headed by Oleg Nudnov.

In 2001 Andrey Pyatahin was employed to VimpelCom as Commercial Manager of the Lipetsk subsidiary. Later he also headed the Tambov subsidiary. Since 2004 Pyatahin had headed commercial operations of the company in the whole Ural region. In 2006 Pyatahin won a vacancy of Director on corporative sales of the Moscow region.

Oleg Nudnov, having been worked before as a head of the Moscow Region Department on work with key partners, came to VimpelCom in 2004. Before VimpelCom he had hold positions in military structures and the RF President Administration.

Sky Link shareholders have elected a new composition of the Board of directors.

The Board consists of:

Anton Abugov (born in 1976) was elected Chairman of the Sky Link Board of directors. From 1997 to 2006 he was a strategic councilor of TAIF Group, one of the largest financial and industrial groups in Russia. Since August of 2006 Abugov has been the 1st Vice President of AFK Sistema, a member of the Sitronics Board, of MTS Board and Svyazinvest Board.

Sky Link company also reported about Albert Safiulin’s appointment for the position of Deputy CEO on commercial activity. He will head the marketing and sales strategy realization. His major objectives are the tariff policy adjustment and development of goods and services promotion channels in operating companies.

Safiulin was born in 1962. 2005-2007 - CEO of the Moscow operating company Electro-Com; since February of 2007 - General Director on marketing of Electro-Com. The field of responsibility: operating activity organization, marketing strategy development, a new business directions development.

Kurilov Dmitry was appointed for the position of Sibirtelecom Commercial Manager. “Dmitry Kurilov is an efficient manager of the new wave, who has an experience of managerial work in Western companies”, comments Alexander Isaev, CEO of Sibirtelecom.

Kurilov was born in May 4, 1973.From June, 2005 to June, 2007 – Director of MVNO projects, Deputy General Director on state programmes, Deputy General Director on Tetrasvyaz development.

Gleb Groshenko was appointed an acting General Director of DIXIS Group. Before he had been holding a position of Deputy General director and Commercial Manager in the company. In DIXIS Group Groshenko has been working since September of 2006. Groshenko started working in the company as Commercial Manager, in February of 2007 he also began to work as Deputy General Director.

4. Conflict Zones and Interest Opposition Fields

4.1. Fields of the Most Active Struggle for Market and Assets Revision

Today the most active struggle concerns frequency distribution on the Russian market and competition between Russian and overseas companies for cellular communications markets in the CIS countries.

4.2. Contradictions between Entrepreneurs During and As a Result of Property Structure changes, Merges and Absorptions

Representatives of Alfa Group and IPOC agreed to sign an agreement. The groups agreed to renounce legal claims against each other, concerning the property rights in MegaFon and to end all court actions.

The Bermudan IPOC, which for 4 years has been struggling in international courts for a 25.1% stake in MegaFon, acquired by Alfa, is ready to renounce its claims. Its owners are negotiating with Alfa about a “peace agreement”, according to which they may step out of MegaFon.

The New York Arbitration has handed down a verdict on Telenor’s suit, in which the company charges Altimo of violation of Kievstar Shareholders Agreement. Telenor attempts Altimo is forbidden to bring any kind of case in courts of Ukraine and to prevent the Norwegian holding to work in Ukraine in the frames of ownership of the local cellular operator Kievstar.

However, the verdict of the Arbitration can be only announced after Altimo pays its part of costs. According to Telenor press service, the costs are around 25 000 USD. Vice President of the Russian holding Kirill Babayev explaines, the court of Ukraine forbade Altimo to undertake any actions in the New York Arbitration.

MegaFon subsidiary in Moscow is breaking with the second cellular retailer in Russia Svyaznoy.

MagaFon representatives discovered in May-June of 2007 that in 50% of cases Svyaznoy employees recommended not to connect to the operator and in 20% of cases they did not have appropriate SIM cards.

The operator will not revise relations with Svyaznoy outside the Moscow region as “problems in service” only concerns the capital, says MegaFon press-secretary Marina Belasheva.

President of Svyaznoy Maxim Nogotkov believes he will be able to settle the conflict by August 15.

4.3. Competition in Struggle for New Assets and Markets Overseas