12 января '08

The Russian Telecommunication Market Development In December 2007

1. General Trends of the Market Development

1.1. Saturation Rate of Cellular Communications Market in Russia

According to data of J’Son&Partners, as of November of 2007 the number of cell subscribers in Russia grew by 1.3%. The amount of SIM cards, registered in Russia, grew to 169 mln. Penetration in Russia reached 119% and 172% in the Moscow License Area (MLA).

In November of 2007 the total monthly subscribers growth came to 2.2 mln (1.3%). Within 11 months MegaFon has been holding the leading position in the subscriber base growth all over Russia (30% according to results of November of 2007). The operator is followed by MTS (27%) and VimpelCom (18%).

In the MLA MegaFon remained the leader from July of 2006 to April of 2007. In May MTS took the leading position, which is still held by the operator (May – November of 2007). 38% of MTS subscriber base growth all over Russia is contributed by the MLA.

In the 3rd quarter of 2007 the income growth rate reduced to 35%, while in 2006 after CPP principle introduction the income growth rate had increased to 43%. Despite deceleration of some indexes, the market is growing. According to estimates of J&P, over 9 months of 2007 revenues of cell operators have reached 14.7 bn USD, equal to the revenues of 2006. According to forecasts from J&P, this years the cell market will reach 20 bn USD.

MegaFon is demonstrating the most dynamic development. The company’s revenue is growing faster than the market average revenue (41% in the 3rd quarter of 2007). MegaFon is followed by VimpelCom (35%) and MTS (26%). According to results of the 3rd quarter of 2007, MTS subscriber base is the largest (33%), while the share of MTS in the revenues is equal to the competitor VimpelCom (30%). At the same time VimpelCom lags behind MTS according to subscriber base (31%). The shares of MegaFon in subscriber base and revenues are 21% and 27% accordingly.

MegaFon is also a leader in the annual growth of subscribers. According to results of the 3rd quarter of 2007, the operator’s share in the total amount of new subscribers came to 32%. The same index of MTS reduced from 34% in the 1st quarter to 25% in the 3rd quarter of 2007. The same index of VimpelCom reduced from 24% in the 1st quarter to 15% in the 3rd quarter of 2007.

MegaFon is holding the leading position in the revenue growth. The operators’ revenues have grown by 1.4 bn USD compared to the 3rd quarter of 2006 (MegaFon – 31%, VimpelCom – 30% and MTS – 24%).

According to data from ComNews Research, in 2007 in Russia VAS (value-added services) revenues may generate over 2.75 bn USD. According to results of 9 months, SMS and MMS are leaders on VAS market, though the share of mobile internet is growing faster. VAS market in Russia has reached 1.9 bn USD (13.2% of the total Russian cellular revenue). According to the forecast from ComNews Research, in 2007 the total VAS revenues may exceed 2.75 bn USD. Over the 3rd quarter of 2007 VAS revenues have grown to 700 mln compared to 615 mln USD in the 2nd quarter.

The share of VAS in the total revenues of cell companies has grown to 12.9% compared to 12.4% in the 2nd quarter. SMS holds 55% of the total VAS revenue in Russia over 9 months of 2007. Content services is the second largest group (22%). It is followed by Basic Internet (18%). Basic VAS services (voice mail, CLIP, etc) hold 5% in the structure of VAS revenues.

As before, according to results of three quarters of 2007, VimpelCom remains the leader in terms of both absolute number of VAS revenue (31%). However, MTS is demonstrating the most rapid growth. Due to the growth the operator managed to decrease the gap in the 2nd quarter and to outstrip VimpelCom in the 3rd quarter. At present, MTS share of VAS in the total VAS revenues is 30%. MegaFon’s share of VAS is 28%. At that MegaFon has the biggest share of VAS.

According to ComNews Research, the mobile content segment remains the most interesting market of VAS. Beside cell operators, many other players exist on the market, for instance content providers. Moreover, the market is the youngest and offers various services. According to results of 9 months of 2007, the market of content services came to 423.9 mln roubles or 22% of the total VAS revenue, increasing from 131 mln USD I the 2nd quarter to 152 mln in the 3rd quarter. According to results of 9 months of 2007, MTS share in content service revenue structure is 40%, VimpelCom’s share is 28%, the share of MegaFon is 25% and the share of other operators is 5%. ComNews Research forecasts the total mobile content revenues can exceed 580 mln USD in 2007.

Growth rates of the Russian IT-market outstrips growth of the communications sector, making the segment the most dynamic in the Russian economics and attractive for investors, says Andrey Sharonov, Managing Director of Troika Dialog. According to their forecasts, in the nearest future an annual growth rate of the market will come to 20-25%, compared to 22% in 2000-2006.

Analysts speak of good potential of the IT-market. They say the forecasted growth is realistic. The forecast on the market development depends much on an approach to the sector. We can name single segments with rapid growth rates: mobile content market has grown by 23.6% for 2006, in 2007 18.7% growth is expected; the market of computer games (49.6% and 48% accordingly); context advertising (244% and 200%).

1.2. Offer of Standard and New Services

In 2007 VAS market grew by 38% to approximately 2.75 bn USD compared to 2 bn USD in 2006, ComNews Research reports. IKS-Consulting forecasts the slower growth (from 1.9 bn USD in 2006 to 2.3 bn USD in 2007).

SMS remains the most profitable for operators. According to iKS-Consulting, from 1.18 bn USD to 1.5 bn USD will be contributed by SMS. The revenue from content services will come to 479-580 mln USD. The revenue from mobile internet will be 475-510 mln USD. According to results of the year, the share of VAS will reach 14% in the total revenue of cell operators, compared to 13.5% last year. In the 3rd quarter VAS revenue of MTS was 13% of the total operator’s revenue (VimpelCom – 13.6% and MegaFon – 15-16% in 1H2007).

Mobile internet is a major catalyst of growth of the VAS market. In 2007 operators’ revenue from mobile internet will increase by 25%. Revenues from mobile content will grow by 22%. The service Ring Back Tone (RBT) is the most popular among subscribers of MTS and MegaFon. The market growth was also contributed by micro payments: services for 50-60 mln USD were paid by SMS in 2007.

In 2008 the largest Russian retailer Euroset is planning to launch itself as a mobile virtual network operator (MVNO). The corresponding proposals about cooperation have been already sent to MTS, VimpelCom and MegaFon. The company is planning to cooperate only in case it has a discount (no less than 40%) on traffic from the basic retailing tariff of the operators, president of Euroset Aleksey Chuikin says.

The market analysts say the prospects of the cooperation between Euroset and the Big3 operators are vague. According to experts, MVNO projects are bounded because of lack of clarity in the legislative regulating of MVNO activity and the surplus of mobile operators’ necessary facilities. Since March of 2007 Euroset has been providing cell communications services under its own brand on the basis of SMARTS networks. MegaFon is the most probable partner of the retailer, experts say.

The Infocommunication Union (ICU) has developed regulations about the complementary development of wireless broadband internet networks and cell communications networks in Russia. The matters of cell communications technologies development and the development of wireless broadband internet were considered in the report of ICU chief executive Andrey Skorodumov at the seminar of the International Union of Telecommunications.

The market analysts speak of good prospects of wireless broadband internet development. At present not everywhere it is possible to connect to Internet using wired devices. The share of wireless broadband internet in the total revenue from internet services, used by natural persons, is 8%. The index is higher in the corporative segment. Though we only speak of the fixed wireless internet, in the nearest future this technology development will continue as the service is in great demand. The prospects of mobile WiMAX are not evident as the service can face competition from developing cell communications networks.

In late April the 3G licenses were received by the three largest cell operators of Russia. MTS and MegaFon promised to invest 1 bn USD each in the 3G networks within 3 years. VimpelCom is planning to invest 300-500 mln USD in 2007-2008. In fact, only MegaFon is providing the 3G services in Petersburg. There are no vacant frequencies in other regions.

1.3. Major Companies’ Potential (capitalization and profit)

While the market share of MegaFon according to subscriber base increased from 19% in the 3rd quarter of 2006 to 20.55 in the 3rd quarter of 2007, its share according to proceeds among the Big3 operators increased from 29.4% in the 3rd quarter of 2006 to approximately 31.5% in the 3rd quarter of 2007. EBITDA margin of MegaFon has come to 51.6% over 9 months of 2007. According to Fitch, being the third large operator according to subscriber base, MegaFon has good prospects to increase its market share due to shares of the competitors.

In the 3rd quarter of 2007 ARPU was 15 USD, increasing considerably compared to 11.8 USD in late 2006. The growth was caused by several factors, including growth of MoU, stabilization of an average price for a minute and appreciation of the rouble. MegaFon’s ARPU is the highest among the Big3 operators. This is a result of the company’s marketing policy targeted on the optimal correlation of price and quality and the conservative method of active subscribers definition. It would be difficult for the company to maintain high ARPU, because of the tough competition and because the competitors begin to follow the same conservative policy, counting the subscribers outflow.

Despite the cessation of the court examination between IPOC and Altimo, the concern over the corporative management remains a factor, which affects the company’s credit capacity because of the complicated property structure, Fitch notes. At the same time Fitch believes, the shareholders, struggling for control over the company, will hardly undertake any actions which will reduce the value of their investments in the company. Too high dividends or a weak shareholder, taking control over the operator, will affect MegaFon’s ratings.

Since 2006 MegaFon has begun to generate free funds. Due to this, Fitch believes, the shareholders will probably prefer to get dividends in a short-term or medium-term prospect.

In the 3rd quarter net profit of AFK Sistema under US GAAP reduced by 53.3% to 228.2 mln USD. The proceeds increased by 37% to 3.7 bn USD, operating profit went down by 10.2% to 943.2 mln USD. Net profit was affected by losses of Komstar and Sitronix

This summer AFK Sistema declared the company intended to develop its nonpublic assets. According to the company’s management, they intend to invest over 100 mln USD in each of the segments: development of retailing, banking and mass media. In Sistema Mass Media the investments will be spent on regional companies absorption, mobile television and content development.

1.4. Market Extension Due to Overseas Expansion

Altimo and its minority shareholder, senator Gleb Fetisov (14.35% in February) are negotiating about entering the Burmese market of cell communications with several telecommunication projects. Altimo withheld comments. Fetisov and Altimo work independently in Burma. The holding wants to get a cell license and makes an agreement with a local partner. The memorandum about mutual understanding has been already signed. The senator wants to buy a share in the local monopolist of communications, the state-owned company Myanmar Posts and Telecommunications (MPT) and is negotiating about the matter with the Burmese officials.

2. Regulator’s Actions and Legal Field Dynamics

2.1. Assessment of Legality of the Past Privatizations, Merges and Absorptions by Legislative and Law Enforcement Bodies

On December 10 the Moscow Arbitration Court prohibited Rossvyaohrankulturi from distributing licenses for GSM networks construction in 42 regions of Russia. The Court answered the claim of Summa Telecom, which is contesting lawfulness of the tenders’ terms and conditions changing with the regulator. Companies, which will not receive licenses in the framework of the secured measured, can appeal the decision and demand the recovery of expenses from Summa telecom. The regulator will not be able to distribute licenses till January 14 of 2008, when the Arbitration Court will be considering the claim. According to the regulator, they are ready to contest the decision of the Court. Sky Link, having won licenses in 42 regions of Russia according to the results of the tenders, held under new conditions, can become a major victim of the dispute between the regulator and Summa Telecom.

2.2. Struggle with Illegal Entrepreneurship

In November MegaFon paid 315 mln roubles to the budget in accordance with the tax claims for 2004-2006. The payment includes sums on profits tax and value-added tax, charged by the Federal Tax Service according to results of the inspection, and fines. At present FTS is holding the same inspections in MegaFon’s subsidiaries in regions of Russia. According to the management of the operator, the company observes tax laws, however, the tax bodies must have different opinion on the matter.

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

3.1. Investments in Extensive Growth and Innovative Development

According to data from the Ministry of IT and Communications, over 9 months of 2007 foreign investments in the sector in Russia have reduced by 33.5% to 2.58 bn USD (63.28 bn USD), compared to the same period of 2006. In contrast, Russian investments in communications have grown by 28.3% to 81.78 bn roubles.

Over 9 months of 2007 the revenue from communication services has increased by 26.7% to 750.5 bn USD compared to the same period of 2006. Over a half of the revenue is contributed by cellular communications (329 bn roubles).

Foreign capital will be attracted by large companies, providing services of broadband internet. In particular, IPO of Transtelecom is possible next year.

Mobile communications is the largest segment of the sector. Cell operators are managed mainly by Russian shareholders. According to estimates of J’son&Partners, in 2007 the total revenue from cell communications will increase by 35% to 19 bn USD.

The geography of the capital inflow has not changed significantly. Russian companies turn to direct schemes of financing. Earlier offshore companies were been created, in Cyprus for instance. Now entrepreneurs believe business conditions in Russia are reliable. Foreign investors are less interested in the Russian cell market because of its growth slowdown.

According to estimates of director of Bee Line Moscow region Nikolai Nifontov, in 2007 one of the most important events was closing of DAMPS network in the region this autumn. The company’s history began from the network in 1993. The network closing is caused by the end of the license term and transfer of frequencies to digital television. At present Bee Line possesses over 2500 base stations in the Moscow region. 60 stations more are ready to be launched and around 600 are being constructed. The company has launched the MKAD project, according to which 70 special base stations will be set alongside the highway. Bee Line provides cell communications services at 100 stations of the Moscow Underground. In 2008 the operator is planning to cover all stations. Concerning the 3G networks development, there are no vacant frequencies. It not only concerns Bee Line, but other GSM operators as well. The 3G networks development is postponed to 2008.

VimpelCom has declared about closing of the private tender among suppliers of equipment and services fro 3G network in Russia. The supplied equipment was divided on 5 lots. 2 winners were chosen in each lot They were Ericsson and Huawai. The lot for delivery of the Home Location Register was won by Ericsson with the equipment of Blueslice company

3.2. Success and Failure in New Assets Acquisition

VimpelСom is preparing to buy Golden Telecom. At first the deal was approved by the committees of independent directors of both operators, then by members of their Boards of directors. On or before January 18 Lillian Acquisition will commence a tender offer to acquire 100% of the outstanding shares of GT’s common stock at a price of 105 USD per share, implying a total equity value of around 4.3 billion USD.

The deal will result in creation of the largest Russia’s operator, providing all telecommunications services. VimpelCom will be able to use communication backbones of GT and to strengthen sales in the corporative segment. The company will be also able to enter the mass market of broadband internet. And GT will extend the territory of its business.

Owners of at least 63.3% of GT shares must accept an offer. The limit was defined by independent directors of GT. But 63.8% of the company belong to 4 shareholders: Altimo, the telecoms asset of Alfa Group, (26.6%), the Norwegian Telenor (18.3%), Rostelecom (11%) and Inure Enterprises, owned by Alexander Mamut (7.9%).

Volgatelecom’s Board of directors has approved an offer to acquire 97.03% of SMARTS shares. According to experts, the value is over 700 bn USD. They say in the company, the operator could buy a 100% share of SMARTS, to leave a part of the assets and sell the rest ones. Otherwise, there can be a contradiction between Volgatelecom and SMARTS shareholders.

3.3. Personnel Changes

VimpelCom has prolonged a contract with Alexander Izosimov as CEO of the company till January 1 of 2010.

4. Conflict Zones and Interests Opposition Fields

4.1. Contradictions between entrepreneurs During and As a Result of Property Structure Changes, Merges and Absorptions

After the two-year break VimpelCom’s Board of directors approved the company’s budget for 2008. It is known, the Norwegian Telenor, one of the major shareholders of the operator (29.9%), voted against the budget for 2006 and 2007. That was caused by Telenor’s negative reaction on Vimpelcom’s acquisition of The Ukrainian Radiosystems (URS) and investments in its development. As a result in 2007 and 2007 VimpelCom was working without an approved by shareholders budget, on the basis of the account and business plan, worked out by the company’s management.

The Economic Court of Armenia declared VimpelCom had a right to register its trade mark Bee Line in Armenia. The conflict was caused by the fact that Bi Line company had already existed on the territory of Armenia when VimpelCom was going to register its mark.

The Russian Altimo , Alfa Group’s telecoms asset, informed about execution of the New York Arbitration Court’s decision, made in the framework of the conflict with the Norwegian Telenor about the cell operator Kievstar. Altimo has sold a part of 25% of shares, owned in the Ukrainian Radiosystems, to Intec Holding Ltd and a significant share in the Ukrainian cell operator Astelit to Viso Holding. According to market analysts, the execution of the court decision shows Altimo is ready to settle the conflict with Telenor. The Russian holding increases Telenor’s loyalty regarding the acquisition of Golden Telecom shares by Vimpelcom.

4.2. Competition in Struggle for New Assets and Market Overseas

Shareholders of the Indian operator Shyam Telelink, whose shareholder is Russia’s AFK Sistema, discussed the matter about compensation to the operator’s minority shareholders, who had received shares during the re-structuring of the company’s business. However, the operator has not started trading shares at exchanges and the minority shareholders are not able to sell their shares . They demand either to start trading shares of the operator or to find another way for them to quit the business.

AFK Sistema bought 10% of Shyam shares for 11.4 mln USD in September. Moreover, Sistema signed an agreement about acquisition of 41% more of the operator. As a result Sistema’s share in the chartered capital of Shyam will increase to 51%. The antimonopoly bodies of India allowed Sistema to increase its share in the operator to 74%. The shares could be acquired from the second large shareholder, the telecoms holding Shyam Telecom Ltd, which is controlling 80% of the operator. 10% of the operator belons to minority shareholders.

India is one of the most attractive areas for international investments in telecommunications. According to data from Gartner, as of September of 2007 there were 200 mln subscribers in the country (the population is 1.1 bn people). Another 30 companies are planning to enter the Indian market.

The High Court of Justice of Man Island has refused to consider the dispute regarding MTS’s rights to the Kirghiz operator Bitel. The court declared disputes around the asset had to be considered in Kirghizia. However, about two years ago the local courts declared Rezervespecmet was an owner of Bitel. At that, according to the decision of the London International Arbitration Court, the subsidiaries of MTS are owners of the Kirghiz operator. The company has sent a corresponding appeal. The market analyst have different opinions on the matter. Some experts are sure MTS has chance to win the struggle for Bitel. Others, in contrast, say the company has lost the struggle with Alfa after it wrote off the expenses of the deal .

The Supreme Court of the Bermudan Isles has confirmed the withdrawal of the mutual claims of the Bermudan fund IPOC (owning 8% of MegaFon), Telecominvest (31.3%) and Alfa Group’s structures, that were having legal proceedings for 25.1% of MegaFon shares for more than 4 years. It was confirmed by Chief Manager of Altimo Aleksey Reznikovich and CEO of Telecominvest Maxim Gorohov.

In August of 2003 Alfa bought the blocking holding of MegaFon from LV Finance for 295 mln USD. Alfa, IPOC and Telecominvest made an agreement about the cessation of the protracted dispute between MegaFon’s shareholders. The parties agreed to stop all court examinations and to withdraw all claims against each other. Altimo’s legal rights to a 25.1% share of MegaFon will not be contested by any party.

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