5 ноября '07

The Russian Telecommunications Market Development in October 2007

1.1. Saturation Rate of Cellular Communications Market in Russia

1. General Trends of the Market Development

According to information from the Federal Customs Service, over three quarters of 2007 27.95 mln cell phones have been imported to Russia, i.e. 1.4 times as more compared to the same period of the previous year. The cost of the imported phones is 3.58 bn USD compared to 2.92 bn USD in 2006.

An average price of a handset has reduced by 20 USD almost and now it is 128 USD. An average retail price is from 212 USD to 240 USD.

In the list of imported handsets Nokia is a leader (41%), followed by Samsung (18%), LG (14%), Motorola (11%) and Sony Ericsson (10%).

According to the Federal Customs Service, the change in price has not been caused by customs procedures. The price has gone down due to “dynamic development of information technology”. All producers renovate their models, and old cell phones fall in price.

FCS also speaks of growth of expensive handsets import volume. Such handsets include functions of a computer, a navigator and a camera.

Retail prices are much higher than those declared in customs. According to data from Euroset, an average price of a handset is 212 USD now. According to estimates of DIXIS, an average price of a handset is higher, over 9 months the price has exceeded 240 USD. Euroset forecasts, in 2007 around 28 mln cell phones worth 6 bn USD will be sold on the Russian retail market. Euroset expects that 30-31 mln cell phones will be sold.
According to the past three quarters, instead of the expected decline on the cell phones market, we can observe small growth in the volume of sold phones, Cifrograd reports.

1.2. Offer of New and Standard Services

In September 27 of 2007 the Council of Infocommunication Union took a decision to begin realization of the project “Mobile Payment”, which is targeted to increase an access for Russia’s population to modern payment services by use of mobile communications networks. Objectives of the projects in the field of mobile payment are as follows:

- research and development of technical decisions;

- composition of proposals on the normative and legal base improvement;

- development of cooperation with the World GSM Association and other authorized international organizations.

The Council has approved “The Concept of Universe Payment Base for Payment for Goods and Services Using Existing and Prospective Networks of Communications”, which was developed in accordance with recommendations of the Ministry of Communications of Russia.

In the nearest future the Council is planning to develop a pilot zone for a universe payment base and to test major regulations of the Concept, to perfect cooperation of market participants and possible business models of mobile commerce, micro and macro payments, including those made by use of the prospective NFC technology.

Since November MegaFon-Moscow subscribers, connected to tariffs Light, will be able to watch TV programmes on their mobile phone screens.

1.3. Major Companies Potential (Capitalization, Profit)

Moody's Investors Service has raised AFK Sistema’s rating from B1 to Ba3, the forecast on the rating is “positive”. Moreover, Moody’s has raised ratings of the existing promissory notes of Sistema Capital S.A. and programmmes of middle-term notes (MTN) from B3 to Ba3.

Alexey Buyanov, senior vice president and chief of Sistema finance and investment complex, said the rating rise was reflecting the stable financial condition of the corporation and the stable level of profitability, contributed by the company’s key telecommunication assets.

Moody’s Investors Service has also raised rating of MTS from Ba2 to Ba3.

The forecast is positive. The agency notes the rise of MTS rating is caused by successful financial and operating results of the company in the 2nd half of 2006 and in the 1st half of 2007; by the strong ability to keep its market share on the Russian market, the strong position in Ukraine and other CIS countries.

According to results of the trading on the NY Stock Exchange in November 5, ADRs of MTS have grown to 76.09 USD, and the company capitalization has exceeded 30 bn USD. In November 8 the quotations went down and by 21.00 the company only cost 29.95 bn USD. Thus, MTS only needed 2 month to increase the market capitalization of the company from 25 bn USD to 30 bn USD. It had taken the operator 7 months to collect the previous 5 bn USD. Today MTS shareholders are speaking of a new target (40 bn USD).

VimpelCom is close to MTS. In November 9 ADR of the operator cost 28.93 USD and capitalization reached 29.42 bn USD. In September the company first excelled MTS according to capitalization for a short period of time.

In the 3rd quarter of 2007 Tele2 Russia was still demonstrating subscriber base growth and high profitability of operations.

According to results of the period, operating proceeds have reached 192 mln USD, increasing by 62% compared to the same period of 2006. EBITDA of the company was 64 mln USD. EBITDA margin was 33% (in the 3rd quarter of 2006 EBITDA – 29.8 mln USD, EBITDA margin – 25%).

The company subscriber base has increased by 647 000 people. Pure flow of subscribers is 711 000 mln people, including subscribers of Tele2-Irkutsk (Corporation Severnaya Korona), sold in August of 2007.

ARPU has become 15 USD compared to 7.56 USD in the 3rd quarter of 2006.

In August of 2007 Tele2 Russia and VimpelCom signed a ten-year agreement about national roaming. Tele2 also declared about the sale of its operations in Irkutsk to VimpelCom. In early October of 2007 Tele2 Russia declared about acquisition of Telecom Eurasia company, working in the Krasnodar region, from SMARTS. Due to the acquisition Tele2 Russia is now working in 17 regions of Russia, the total population of which is 41 mln people.

Results of Tele2 Russia activity in January - September of 2007:

Subscriber base of the company has increased by 45% over the year. As of September 30 of 2007 it came to 7 996 thousand subscribers.

Speaking of plans in Russia, president and CEO of Tele2 Russia Carl-Magnus Stenberg is planning to extend an area of coverage by entering new regions: due to obtaining of licenses as well as due to acquisitions of companies. The company finds it possible to work in a corporative segment, especially in the field of providing of small and middle business enterprises with mobile communications.

In the 3rd quarter of 2007 revenue of TeliaSonera from Russia’s MegaFon increased by 54.1% to 1.173 bn Swiss crowns, compared to 761 mln Swiss crowns in the 3rd quarter of 2006 (1 USD=6.4 Swiss crowns).

According to preliminary data, over the 3rd quarter of 2007 proceeds of the federal network of Telefon.Ru mobile communications shops have increased by 27.5% compared to the previous quarter. Over 3 months the company’s turnover has come to 2.8 bn roubles compared to 2.2 bn roubles in the 2nd quarter. The proceeds have grown by more than 80% compared to the 3rd quarter of 2006. Over the reported period 309 thousand mobile phones at 1.7 bn roubles have been sold.

Over the quarter an average price of a sold mobile phone has increased from 5321 to 5606 roubles. In the total volume of Telefon.Ru sales, a share of Nokia has reached 58%. It is followed by Samsung (20.2%), Sony Ericsson (17.1%).

Over the 3rd quarter of 2007 SIM-cards sales volume has grown by 28% compared to the 2nd quarter and has come to 410 thousand cards. A share of MegaFon connections is 32%, shares of MTS and BeeLine come to 23% and 22% correspondingly. The rest 23% of connections belong to other operators.

RBC Daily has mentioned analysts’ opinions about prospects of Russian cell operators’ capitalization.

Analysts expect MTS will remain a leader of the Big3 according to proceeds volume by 2015. A leader according to capitalization is not clear: VimpelCom had been holding the leading position for a short period of time, though later MTS became a leader again. The alignment of forces can change in case one of Big3 operators manages to agree about a large absorption.

According to Alfa Bank estimates, the first eight independent operators cost more than 8 bn USD. There is no obvious leader in the competition between MTS and VimpelCom. Analysts say VimpelCom is growing faster than MTS. According to the forecast of Alfa Bank, in 2009 the company will take the leading position according to proceeds in Russia, taking 36% of the market compared to a 35% share of MTS and a 29% share of MegaFon. However, consolidated proceeds of MTS will remain higher. The prospect of the competition between the companies has not been clear yet. Alfa Bank gambles on VimpelCom. Analysts say the operator will finally take a leading position within 12 months. Not long ago VimpelCom outstripped MTS for a short period of time. Today MTS capitalization is higher again: by 420 mln USD approximately.

Experts from Troika Dialog doubt VimpelCom will manage to hold the leading position. Altimo and Telenor have “overheated” VimpelCom shares, trying to get influence in the company. It is doubtful that the buying-up will continue, the experts from Troika Dialog say. A purchase of one of independent cell operators may define a leader of the competition.

According to Alfa Bank estimates, independent operators, including Tele2 Russia, SMARTS, Motiv, Akos, Novaya Telefonaya Kompaniya and three cell subsidiaries of Svyazinvest are attractive either to VimpelCom or to MTS or to both companies simultaneously. For instance, Novaya Telefonaya Kompaniya is attractive for VimpelCom as the operator has covered not all regions in the Far East. VimpelCom is also interested in the Yekaterinburg Motiv as MTS has strong positions in the region. While SMARTS is negotiating with VimpelCom, MTS and Tele2, Alfa Bank reports. If the operator agrees to merge with Tele2, a new player will appear on the market, which will control a 7% share of cell communications in the country. Without taking into account possible deals, VimpelCom is taking an advantageous position. The company is increasing its market share more rapidly due to successful marketing. The company also succeeds in the segment of additional services (data communications and others), so, we expect, 3G networks development will bring the operator out to the 1st place in Russia according to proceeds, says Vitali Kupeev, analyst from Alfa Bank.

According to the analysts from Troika Dialog, in fact VimpelCom is growing faster than MTS, but the gap must be reduced. Firstly, it must happen due to the company’s new management activity. Secondly, MTS lost VimpelCom, because the company was mostly introduced on difficult markets outside Russia. The CIS brought the company 25% of proceeds, while VimpelCom had 86% of proceeds on the Russian market. Now VimpelCom is developing actively in Ukraine, and in future it will result in slowdown of the company growth.

2. Regulator’s Activity and Legal Field Dynamics

2.1. News in Legislation and Other Changes in Legal Field

Rossvyazohrankulturi has prohibited to use roman type in information messages for cell subscribers. The decision was taken according to results of the control of several companies, providing mobile radio- and telecommunications service. Mobile operators were given a direction in accordance with which SMS posting should be introduced on the basis of Cyrillic alphabet.

According to the market analyst, the innovation is unessential for users. However, a small part of them will not be able to receive SMS. Abolition of roman type use for subscribers as a sequel of the taken decision is unlikely, analysts say. It would be difficult to realize from technical and economic points of view.

2.2. Struggle with Illegal Entrepreneurship

The sitting of the Basmani Court of Moscow on the criminal case of SMARTS owner Gennadi Kirushin has been postponed to October 29. Kirushin, charged according to four articles of the Criminal Code of the RF, gave a written undertaking not to leave a place. The charges were preferred against the Volga region operator because of violation of nine base stations exploiting. SMARTS management is sure that the administrative case was transformed into a criminal case due to efforts of raiders, who try to reduce the price of the operator’s assets. The market analysts believe raiders are connected with the charges of the owner of the operator. However, the criminal case will not influence activity of the company due to positive dynamics of its financial indexes, experts note.

After re-examination the Moscow Arbitration Court has answered partially to VimpelCom’s suit against the Federal Tax Service, reducing payments according to the tax claims for 2003-2004. According to the court decision, the company must pay 108.2 mln roubles.

The conflict regarding tariffs on interconnect between MegaFon and FAS, has been settled. In October 8 the Arbitration Court of the Moscow Circuit dismissed MegaFon’s appeal, declaring the company had violated the antimonopoly legislation. Now the operator has to re-make agreements with regional operators and pay illegal 100 mln roubles to the state budget. Thus, the court has upheld the decision of the Moscow Arbitration Court regarding interconnect tariffs interconnect.

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

3.1. Success and Failure in New Assets Acquisition

After Altimo AFK Sistema is viewing a possibility of entering the telecommunication markets of Vietnam and Indonesia in addition to the Indian market, which the company has almost entered, buying the local operator Shyam Telelink.

According to analysts, growth of interest of Altimo, Sistema and MTS and VimpelCom, which belong to them, to Asia may result in strong competition between two holdings in the region. It had already happened in the CIS, where at least two Russian companies were aspiring to each asset, displayed for sale.

AFK Sistema does not intend to stop on entering the Indian market, and the company is expecting a universe license for work all over the country, says AFK president Alexander Goncharuk in the interview to Die Welt. The holding is considering possible variants of investment in Vietnam and Indonesia. Goncharuk explains, Sistema has decided temporally not to focus on joint projects with leading European telecommunication companies. He says, in particular, Sistema has faced opposition, while thinking over a possibility of acquisition of a share in Deutsche Telekom. Since then the holding has not dealt with the company shareholders, though it is not inconvincible the company will get back to the negotiations in future.

3.2. Actions of Companies on Stock Markets

HSBC Bank plc lends VimpelCom a credit worth 2.1 bln roubles for 7 years. The agreement is the 1st long-term rouble export credit of the bank on the Russian market. The Swedish company EKN acts as an expert credit agency of the deal. The credit line is to be used to finance service provision and equipment delivery by the telecommunication company Ericsson AD (Sweden).

HSBC Group is one of the large organizations, providing banking and financial services. HSBC Bank (PP), the subsidiary of HSBC Bank plc., does business on the Russian market. The bank offers a wide range of corporative and investment banking products to multinationals, Russian companies and financial institutes, which work in Russia.

In the nearest future VimpelCom may also declare about obtaining of a syndicated credit worth 4.5 bln USD, the biggest credit in the company’s history, Interfax reports.

According to the market participants, the operator will spend the funds on acquisition of Golden Telecom holding and the Kirghiz operator Sky Mobile. But experts warn, the deal with Golden Telecom may not be approved by VimpelCom minority shareholders.

3.3 Personnel Changes in Major Companies

AFK Sistema has declared about appointment of Vitali Savelyev, former deputy minister for economic development and trade, the 1st vice president of the company. Since November 1 Savelyev will head the complex of telecommunication assets development Sistema Telecom in the corporation.

Speaking of the appointment, president of Sistema Alexander Goncharuk said that the telecommunication complex, managing the key assets of AFK Sistema, had ambitious objectives. They include growth of operating efficiency in conditions of strong competition and well-developed regional and international expansion.

Summa Telecom has introduced its Board of directors:

Galaev Magomed, Koshkin Sergey, Moshkovich Gennadi, Safin German, Tomaeva Zarina. Galaev Magomed has been elected Chairman of the Board.

According to results of the meeting of the new Board of directors, Sheremetyev Alexey, the former 1st deputy CEO of Summa Telecom, has been appointed CEO of the company.

Euroset has declared about appointment of Andrey Rukavishnikov vice president on marketing and advertising. Euroset president Alexey Chuikin said they had had an objective to make a team. Rukavishnikov has 15-year experience of work in leading Western and Russian companies, which produce consumer goods. In 2003-2006 he was working as a vice president on marketing in the brewing company Baltika.

The American company Motorola has defined a candidature for the position of the head of the company’s representative office in Russia. The position has been taken by Maria Tasheva, who was in charge of the company’s relations with the state bodies before.

Sergey Ovcharenko, the former alternate head of Motorola representative office, has quitted the company.

4. Conflict Zones and Interests Opposition Fields

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

Today the sharpest struggle in Russia concerns licenses for GSM communications service provision.

According to results of the recent tenders for GSM license in 5 regions of Siberia, Sky Link has obtained a right to provide mobile communications services in 4 regions. The operator’s subsidiary Novosibirskaya Sotovaya Svyaz – 450 has become an owner of 5 GSM licenses in the Irkutsk (2), Tomsk, Chita regions and in the Aginsk Buryat Autonomous region. Sky Link is planning to create a two-standard (GSM/CDMA) network on the basis of regional frequencies. The operator expects it will earn 4.5 bln USD, taking around 15% of the money volume of cell communications market.

Meanwhile, a group of cell operators, displeased with results of the tenders, sent a claim to Prime Minister of Russia Victor Zubkov. Presently the letter has been signed by heads of Dalsvyaz subsidiaries, Akos and BIT, Uralsvyazinform, Summa Telecom and the subsidiary of Sibirtelecom, Baikalinvestcom.

According to authors of the letter, the market of GSM communications is monopolized by the Big3 operators, supported by regulating authorities. The companies are also displeased with tenders holding in regions, noting that pretensions to regional frequencies, declared by the Big3, do not make fair competition possible.

According to experts, the situation around GSM tenders is caused in many respects by the protracted transfer of branch regulators’ powers to the recently created Rossvyazohrankulturi. The letter to Viktor Zubkov is almost the same as the letter to the former Prime Minister Mikhail Fradkov, sent this August.

Meanwhile at the preliminary sitting of the Arbitration Court of Moscow VimpelCom withdrew its suit against Rossvyaz. The operator, disagreed with results of the regional GSM tenders, intends to prove its case and insists on declaring the tenders results invalid. The first sitting concerning VimpelCom’s suit against Rossvyaohrankulturi is scheduled to November 1.

According to the market analysts, VimpelCom’s initiative is logical as the company’s actions meet requirements of the legislation. The decision of the operator to withdraw a suit against Rossvyaz is obviously caused by transfer of Rossvyaz functions to Rossvyazohrankulturi, they say. Thus, VimpelCom has little chance to win the case.

According to results of the tenders for GSM 900/1800 licenses, held on July 18 and 19, the most lots (13) in the Far East regions were received by Summa Telecom, a company, yet inexperienced in communication services provision. VimpelCom has only won 5 lots, getting frequencies in Yakutiya, the Magadan region and the Jewish Autonomous region. They say in the company, according to the tenders conditions, operators, having already been provided services in areas of a tender, get the better of others.

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

After 2 years of work without a budget, approved by shareholders VimpelCom was been informed that the company co-owners the Norwegian Telenor and Altimo are ready to agree on the company financial strategy for 2008. Telenor agrees to approve the operator’s business plan in case it is reasonable.

In 2006 the company put to the vote two business plans: concerning Ukraine and other operations of VimpelCom.

Until recently Telenor, owning 29.9% of VimpelCom voting shares, has refused to vote for the operator financial plan for 2006 and 2007. In contrast, another co-owner of VimpelCom Altimo (42.4% of shares) has supported plans of the company management. A new budget will be considered on the meeting of shareholders in December.

However, according to most of the market analyst, neutrality of the Pecherski Court’s decision is doubtful as the court is well-known for its odd decisions in the framework of the political life of Ukraine.

According to estimates of Sistema president Alexander Goncharuk, the decision to transfer the Kirghiz operator Bitel to Sky Mobile is unfounded from the legal point of view. He explained Sky Mobile was one of 14 respondents under Sistema’s suit about restoration of rights to Bitel and damage.

4.3 Competition in Struggle for New Assets and Markets

Overseas the 3rd quarter of 2007 Kievstar collected more than one third of all new subscribers (36%) and remained a leader on the market (43%), says the head of Telenor representative office in Ukraine Trond Moe. Telenor owns a 56.5% share of Kievstar.

The share of Kievstar competitor MTS-Ukraine (the former UMS) was only 4%. Since early 2005 Kievstar share has not changed, while MTS share has reduced from 44% to 37%. The 7% has been taken by small operators,
Astelit mainly (controlled by the Turkish Turkcell).

“Recently competition has increased on the Ukrainain cell market and MTS has not withstood pressure of Astelit on mass market,” says the top manager from Telenor.

Norwegian Telenor and Alfa Group are still disputing in court regarding the Ukrainian operator Kievstar. In October 23 the Pechorski Court of Kiev declared invalid the decision of the International Commercial Arbitration Court of New York concerning the suit of the Norwegian Telenor about Alfa’s violation of the Kievstar Shareholders Agreement. According to the Ukrainian court’s verdict, Alfa’s structure Storm is not obliged to sell assets of Kievstar or other competing operators, owned by the company.

- operating proceeds over the period have come to 529 mln USD (266 mln USD over the same period of the previous year. EBTDA of the company – 167 mln USD. (43.6 mln USD in January- September of 2006). EBITDA margin – 32%, compared to 16% in 2006.

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