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MTS’s Dubovskov Looks to Sustain Growth in Russia’s Mature Mobile Sector

The CEO is selling cheap smartphones to drive data usage and is pushing into banking.

Moscow-based Mobile TeleSystems has been Russia’s leading cell phone carrier for most of the time since it introduced GSM service to the country in 1994. The company is also the largest cellular provider in Eastern Europe, with 100 million subscribers across the countries of the former Soviet Union. But Andrei Dubovskov has had no time to rest on his laurels since taking over as CEO in March 2011.

Last year Dubovskov, 47, pulled out of Uzbekistan, where MTS had a 40 percent market share, after several executives were arrested on fraud and money laundering charges and the government imposed a $600 million bill for back taxes. MTS took a $1.1 billion write-down, which contributed to a 30 percent drop in net profit, to $1 billion, for 2012. In November the company’s chief Russian rival, MegaFon, raised $1.7 billion in a London IPO. Building on a lead in 3-G and 4-G technology, MegaFon has since whittled MTS’s advantage in subscriber numbers and drawn close to it in market capitalization, at $18.3 billion in mid-June versus $18.8 billion for MTS.

Earlier this year MTS lost out in a bid to acquire the Russian assets of Swedish cellular provider Tele2. The deal had political overtones: Russia’s state-owned VTB Bank bought the operation for $3.55 billion even though MTS, which is 50.8 percent owned by Vladimir Yevtushenkov’s Sistema, and No. 3 carrier VimpelCom,, controlled by Alfa Group Consortium oligarch Mikhail Fridman, had teamed up on a $4.25 billion bid. Market analysts expect VTB to sell Tele2 Russia to the former state telephone monopoly, Rostelecom, creating a fourth national player and increasing the competitive pressure on MTS.

Dubovskov acknowledges that the days of skyrocketing growth in Russia’s cellular business are over, but he still sees opportunities to boost margins. He is introducing low-cost smartphones to boost subscribers’ data usage; investing heavily in fiber-optic broadband in the Moscow region, where MTS operates a fixed-line business; and leveraging the company’s retail outlets across Russia to provide banking services. The CEO is also promising to increase dividends by one third, to an annual total of 40 billion rubles ($1.2 billion).

His efforts appear to be working. The company’s New  York Stock Exchange–listed American depositary receipts closed at $17.66 on June 24, down 8.4 percent since Dubovskov took the helm in 2011, while the Russian stock market’s dollar-denominated RTS Index has lost 37.2 percent during that period.

Dubovskov, a 20-year cellular veteran who ran Tele2’s operations in the central Russian province of Nizhny Novgorod before joining MTS in 2004, discussed his strategy with Institutional Investor Senior Contributing  Writer Craig Mellow during a recent visit to New York.

Institutional Investor: Your top competitor, MegaFon, has drawn even with your company in market capitalization. How will MTS react?

Dubovskov: Our only reaction is to stick with our long-term strategy. The most important point is substituting data services for voice. Our income from data is rising quickly to equal income from voice. We see our competitors, MegaFon and others, trying to copy and follow us in this development.

In the first quarter you added just 5,000 new subscribers, while MegaFon added 107,000 and Tele2 166,000. Does that worry you?

No, it doesn’t. With the high levels of penetration in Russia today, adding new subscribers may not be worth the expense. We are more concerned with the activity of existing subscribers — growth in traffic, in data usage and so on. Here you can observe that we are growing fastest. We have also lost the fewest subscribers for many quarters in a row. Our customers are the most loyal.

At the time of MegaFon’s IPO, analysts talked about its advantage in 3-G technology and licenses for 4-G. Can you catch up?

We do admit that for several years, notably in the 2008–’10 period, MegaFon spent more than us on its 3-G network, and as a consequence they now earn more from data transmission. But over the past few quarters, we have been closing the gap in data revenue, and that is happening because we have built out our own network.

One reason we spent less on 3-G in the past is we were paying very nice dividends to shareholders. Now that they are public, they have to play by the same rules as us.

Is it reasonable to look at the Russian cellular market like a Western market before the widespread adoption of smartphones?

There are no real technical differences. If anything, our market and the Russian government demand the highest standards. But commercially, there is a difference: Smartphone penetration in our Russian subscriber base is now 20 to 22 percent, compared with 40 percent or more in the most developed markets.

The main problem is not our laws or anything else; it is the relatively low earnings of average Russians. We cannot adopt the subsidy model for smartphones because at our average price per minute we would have to subsidize them for five or ten years. So we are doing everything we can to lower the price of smartphones to about $100. We already have these products on the market under our own brand. I think within a year or two they will enable us to close the smartphone gap.

How is it possible to offer them so cheaply?

We sell phones on the Android standard made by Chinese producers like Huawei and HTC. The days are gone when Chinese manufacturers were known for poor quality. We use them for our phones and, along with European producers, for our network equipment too.

You can buy a phone today in one of our branded stores for about 3,000 rubles, or about $100. That phone helps reorient a subscriber who was only using voice. They go on the Internet, their demands change, and then they will switch to a more expensive smartphone.

The company has been profitable for the past few years but is not growing quickly anymore. Is this what investors can expect for the future?

Our guidance for the next few years on revenue is 5 to 7 percent annual growth, whereas five years ago we were growing by 20 to 25 percent. Cell phone penetration in Russia has reached 140 to 150 percent, which tells you the market is very mature and very competitive.

One important new element in our business is financial operations. We see major synergies between telecom and the financial sphere and are advancing full-speed in that direction. Already, every third smartphone that we sell in our branded stores — and we have a chain of about 4,500 across Russia — is sold with credit that we provide on-site. We expect that to generate a significant part of our revenue going forward.

MTS has a presence in four other countries of the former Soviet Union. How important are they to the business?

We earn 85 to 90 percent of our revenue in Russia, roughly $11 billion out of $12.5 billion last year. The No. 2 market is Ukraine, which accounted for a little over $1 billion. So the operations in Turkmenistan, Armenia and Belarus are not material.

Was the investment in Uzbekistan a blunder?

I was not running the company when that purchase was made, so it’s hard for me to comment. There will be no more consequences; we wrote off all the losses. The positive side of the story is we are now basing our dividends on free cash flow rather than net profit. The losses on our Uzbek business were purely on paper; they had no influence on our ability to pay dividends or invest. Besides that, we have taken responsibility for raising our dividend payments over the next three years from R30 billion a year to R40 billion.

What about expanding outside the former Soviet Union?

No. We consider it the wrong strategy to expand too much geographically. You just have to look at our competitor [VimpelCom], which has expanded into North Africa, Southeast Asia, Western Europe and even Canada. All those countries demand big capex. We can imagine what a headache this is for our colleagues in management there.

This competitor has slipped to No. 3 in Russia from No. 2 just two years ago, and the reason is underinvestment. The company is trying to use Russia and Ukraine as a cash cow to pay the enormous debt for its acquisitions elsewhere. So, no, we think throwing ourselves around the whole world would not be the right thing to do.

What about a merger between Tele2 and Rostelecom? Does the prospect of a fourth national cell carrier within Russia threaten you?

We are not afraid. The time when anyone could easily change the shape of this market is past. You have two companies that each have strength in just a few regions and between them have absolutely different cultures and management styles. This is not something we need to worry about for the next three to five years.

But this will be a state company in a sector that has always had basically free competition between private companies.

There is a difference between a strategic economic sector like hydrocarbons and a mass-market business like ours. The advantages of administrative resources would be much harder to realize in a mass market. The state itself admitted long ago that it is not the most effective owner.

So what do you worry about?

Unquestionably, our main challenge is our capex. Every year for the past five years, we have spent about $2.5 billion on capital expenditure. We are just now completing our 3-G network throughout the Russian Federation and are already spending on 4-G infrastructure in Moscow and a few other cities.

We also own the fixed-line monopoly Moscow City Telephone. We launched a program in 2011 to replace all the copper wires in the whole city with fiber-optic cable. That’s more than 4 million users. We are absolutely certain that this is a correct strategy, because Moscow is so rich compared to the rest of Russia. But it is expensive.

Can you say a little more about your financial operation, MTS Bank?

Here we are undeniably ahead of our competitors. We have more than 100 million subscribers, and essentially we know everything about them. With this knowledge it is much easier for us to do credit scoring. For years we have already provided money transfer services and bill payment through the mobile phone. We have the largest retail presence in our industry. It’s not only us, of course. In the African market, Japan, South America, many cellular carriers have entered the financial sphere.

You forecast that the bank will generate 5 percent of MTS’s profit in five years. Are you being cautious in your guidance?

We are always cautious. On the other hand, 5 percent of net profit is not so little. That’s tens of millions of dollars. • •

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