“No Regrets that We have not Bought Anyone”, Sergey Soldatenkov, CEO of MegaFon
Why MegaFon does not hurry to purchase assets as MTS and Vimpelcom did and how the company will be ahead of its competitors in revenue from mobile communications in Russia told us its CEO Sergey Soldatenkov
Igor Tsukanov
The Vedomosti
24.09.2009, 180 (2450)
This year MegaFon which traditionally was ahead of MTS and Vimpelcom in income growth rate started to give in to its competitors for the first time. Sergey Soldatenkov, CEO of MegaFon explained the fact in his interview to the Vedomosti: it was a result of crisis and the operator’s deliberate decision not to raise tariffs to help its customers “to go through hard times”. The company can afford such care: because it is an indisputable leader in cash amount among the Big Three. And MegaFon is not in a hurry to spend that cash on acquisitions.
— Recently MegaFon published its second quarter results. Revenue growth rates continue to decrease and besides they are lower than those of Vimpelcom. Is it an impact of crises or were there any marketing miscalculations? Probably MegaFon should have raised tariffs as Vimpelcom and sometimes MTS did?
— Both. When we published our first quarter results, we forecasted the revenue to grow by 5-7% this year. After seven months it grew by 6% year-on-year. Our assumptions came true. Though if you study revenue in detail, it contains a lot of different components. Revenue from voice services is flat and consumption of these services decreases. In Q1 demand fell significantly, in Q2 the situation stabilized, now there is no decrease. But the situation is different in different regions. For example, Far East decreased by about 6%, and Moscow by 17%. We in fact did not raise tariffs in the first half of the year, it was an ideologically important decision for the company — we want to help our customers to go through hard times, we want them to stay with us. We launched several anti-crisis solutions for this purpose this year: “Just for Communication”, “Fairy Tale” tariff, decreased prices by 50% for certain directions in international roaming, decreased prices of modems.
— Did people in Moscow begin to talk less on their mobiles?
— Moscow is a huge city, it is the business capital of Russia, and for corporate market crisis is a serious challenge. Besides there were a lot of foreign workers here, they left during the crisis. Another factor: formerly the companies paid for mobile communications of their employees, and under crises conditions they ceased to or began to pay for minimal expenses.
Besides in some of the regions pre-crisis level of MOU (minutes of use — the Vedomosti) was maximal - 400-500 minutes per subscriber a month. Now people in these regions cut their consumption to 300 minutes. All these facts influenced revenue.
— Then what gave you 5-6% of revenue growth?
— First, these figures include sale of equipment. And last year the Big Three operators mostly did not sell equipment. In Q4 we started to sell iPhones, then mobile modems, which are still sold well. The buyers make a deliberate choice and as a rule are not likely to change the operator.
Second factor of growth is data transmission. I think that voice communications will not grow for a long time. In MegaFon’s portfolio of tariffs there is one with a price per minute of only 5 kopeks, but it does not mean that its subscribers are ready to talk for 1000 minutes a month. The price has no such impact on demand as earlier. As for data transmission there is price elasticity and we have already launched unlimited tariffs for mobile internet. Besides, the price of modems was decreased by 2-3 times during this year.
All the operators of the Big Three have good 2G networks with EDGE working almost everywhere, now a competition in 3G will start. Therefore of course we want to attract as many subscribers for data transmission as possible, so that when 3G networks are comparable to 2G networks in their scale, these customers would stay with us.
There is a good example — St. Petersburg, where we were the first in Russia to launch commercial 3G network. It operates for almost 2 years and now about 50% of modems sold by us in Russia account for St. Petersburg. In the North-West we sell 30,000 modems a month, it is due to qualitative 3G communications in the region.
By the way we got support from our shareholders and increased our investment program for 3G development.
— How significant is the increase?
— I can not say precisely, because it is not correct to separate investments into 3G from the total amount of capital expenditures. Because the money is invested not only in base stations but for example also in back bone network which operates both for 2G and 3G. As for the number of UMTS base stations, their number will increase two times as compared to 2008.
In general MegaFon’s corrected budget in rubles will stay at the level of previous pre-crisis year — about 48B RUR. I’d like to draw your attention to the fact that it was planned to be 30-40% less.
— If revenue from voice transmission decreases than probably the share of non-voice services in MegaFon’s revenue should grow?
— Their share is the same as last year — 16-17%. However it is important that the revenue structure of these services has changed. Before now 50-55% was generated by SMS, and data transmission accounted for only 5-7%, nowadays data transmission accounts for 30%, and SMS account for about 35%.
We see explosive growth of internet traffic consumption. This revenue does not grow that fast as we decrease prices on data services.
— In May you announced you goal — in Q4 2009 MegaFon should become leader in revenue from mobile operations in Russia. But the company still ranks third…
— Nevertheless we are in the process of achieving it. Unfortunately it has not been achieved yet: we saw some lagging behind the competitors in Q1. It is caused by different reasons. First, we did not raise tariffs. Second, in Q2 due to the crisis we adopted a wait and see attitude, did not push our marketing activities, did not stimulate sales growth etc. That is why in Q1 we had very high EBITDA margin - 50%. In Q2 it decreased to 47% — we spent money on commercial activities, during the last 4 months our subscriber base grows by 1 mln. subscribers every month. In Q3 we’ll begin to catch up with the competitors.
— Where does this 1 mln. subscribers come from at the market with penetration level, even at the least estimate, is about 80%? For example your competitors gave out free or almost for free their SIM-cards — do you also give out contracts?
— We do not follow such a policy — we do not give out SIM-cards. There is a certain layer of customers, who are usually called switchers, who churn from one network to another all the time, change one offer to another, sometimes even within one network. This layer is not so small and all marketing campaigns are aimed at such customers. The logics is the following: if a subscriber stays a certain period of time in one network and gave at least one dollar to an operator, it is good. Retail begins to help to “turn over” such customers. We understand that such customers come to get cheaper tariffs, their ARPU (average revenue per user — the Vedomosti) is lower than that of loyal customers with stable preferences. However we noticed that if a person buys a SIM-card in our own outlet, his ARPU is 1.5 times higher. Because he was not only sold a contract but also given a consultation, proposed to use additional services which would be useful and beneficial for him. That is why we decided not to buy an existing dealer network (though some time ago we had such plans), but to create our own retail network which would be developed via our subsidiary “VideoFone”. Of course, it will take some time.
In general, churn level has not changed during this year, it stays at 3.5% a month.
— You have said: it is good, if a subscriber gave at least one dollar. But this dollar should cover the expenses that an operator incurred to attract the customer?
— Right. That is why it is important to decrease subscriber acquisition costs. But operators can not be compared by this indicator in a linear fashion. For example, Vimpelcom bought 49.9% of Evroset shares — in fact, these are subscriber acquisition costs, but in financial statements they are reflected as investments.
— Why did MegaFon decide not to buy Dixis and Cifrograd?
— That’s simple. We wanted to buy these chains but they turned out to be nothing to buy. There are no assets, stores are rented, and a huge debt these companies are burdened with — about $200 M — would become our burden. By the way, Telephone.ru was the most attractive asset in mobile retail for us, however MTS made a higher bid for it.
— Now you have completely changed your mind about buying retailers, haven’t you?
— As for now — yes, we have. We do not regret that we have not bought anything. The future will show whether we are right or not.
— There have been recent gossips about the operator’s interest to the Moscow chain Ion…
— Ion is really good. It is a shop format that will have a great future in our opinion. It is not just about selling handsets and SIM-cards. Ion has high-skilled employees capable of providing advice to the customer, offering him \ her the best solution among the various options. It is very important for selling complex equipment and Hi-Tech services. We and Ion are thinking about possible cooperation; however MegaFon is not going to buy any interest in this Company so far.
— Are you satisfied with your partnership with Euroset?
— In order to build one’s own retail, one needs time. The contract with Euroset is relevant for us as it gives us stability, guaranteed additions. Our contract term is 18 months, and after its expiration we shall appraise our progress with establishment of our own sales chain and shall make a decision whether it is reasonable to prolong the contract with Euroset. It is clear that this partnership is not cheap; it is more expensive than similar cooperation with local dealers. Hence, we buy time needed not to lose our market share to the rivals. In QI our share in the attracted subscribers was lower than that of our peers, in QII the situation improved, and we may even become the leaders in Q3. Currently we are actively using all sales channels; Euroset share in all additions is only 20%.
— You said that by the end of the year MegaFon may have spent up to $500 M for acquisitions in the fixed-line business. Will it?
— We are consistently making the plans we announced at the beginning of the year true. The only thing I would like to specify is what one should understand by fixed line in our case. Voice communication in the fixed networks is interesting for us only when it is sought for by the corporate customers. We do have our own fixed numbering capacity: in some cities it is – 5,000 numbers, in some — 10,000, and in the others — 15,000; we are working in the fixed telephony market not in the mass but in the business segment. We make a bundled offer to organizations that includes numbering, fixed domestic long distance communication, broadband Internet-access, mobile communication, i.e. all kinds of services.
Evaluating feasibility of a fixed-line operator acquisition, we rely on the fact whether the company has corporate customers besides other merits. For example, we want to buy Synterra partially because it is a group of companies, one of which — “PeterStar” — serves 60-70 % of the business customers in the North-West. We can offer mobile communication as an additional service to them and form the same convergent offer as Vympelcom provides with Golden Telecom. Therefore this asset is important for us. Besides, Synterra has a large trunk-line business, we would use trunk channels of the company in order to enter the long-distance market. It is also an important direction we are going to deal with, and that is why we invited the former CEO of MTT and Rostelecom Konstantin Solodukhin.
Mentioning broadband, home networks — we practically don’t deal with them. Speaking about acquisitions in the broadband area, it must be a large operator — Akado, Net by Net, ER-telecom… We are in negotiations with these operators; however there is no much progress so far, we have made more progress in negotiations with Synterra.
— Don’t you have any concerns that a significant part of Synterra channels is rented from Svyazinvest interregional operators? At the same time another subsidiary of Svyazinvest – Rostelcom – has recently ceased leasing out channels to Synterra having provided it with the “dark fiber” instead?
— We have investigated these risks. Replacement of the channels with fiber is not a problem for us. It is a familiar operation for us to “lighten” fiber.
— But how will it influence the value of the transaction?
— That is a different question. Now an investment bank is working on the deal, and another independent valuation will be provided later. However all risks are obvious, there is nothing hidden there, everything has been checked already. As this is our first acquisition of a company and, perhaps, we are not really experienced at such things, we want to show our shareholders that we understand what we are doing.
— Have you made a decision on the price of the purchase?
— Not yet, there is just an indicative valuation — in the range “from…to”. Our shareholders know what the range of the indicative Synterra value is. Mow additional parameters are being discussed: initial amount of payment, payment delay terms etc.
— Analysts valuation of Synterra is $500-700 M. Is your valuation about the same range?
— I apologize but it is confidential information.
— Is it true that MegaFon has got an exclusive for negotiations with Synterra shareholders?
— That is right, we have time till the middle of October.
— At the beginning of 2009, MegaFon announced entering South Ossetia and Abkhazia. How is business progressing there? Are you thinking of rebranding of the companies acquired?
— The markets of Abkhazia and South Ossetia are significantly different. In Abkhazia we have acquired the controlling interest in Aquafon, the operator which has been working for a long time and is the leader in the local market. In Abkhazia cost effectiveness of business is even higher than in some Russian regions, for instance, Aquafon is paying out dividends. By the way, there is a working 3G network in Abkhazia. The subscribers show consistent loyalty to this brand, that is why I think it is not reasonable to change it.
South Ossetia is an absolutely different market; everything was destroyed there during the armed conflict, we are virtually building a new network. It is possible that we will act under MegaFon brand in South Ossetia.
— At one of the recent meetings, MegaFon Board of Directors discussed the company’s business in Tajikistan. What was the reason?
— It was a routine item related to our need to strengthen our positions in this country. Several years ago [our subsidiary] ТТ Mobile was a recognized leader of the market, and now it is Top 3. Currently we are thinking how to make the investments contributed pay back, which steps we can make for that. We have been raising issues of TT Mobile rebranding and business strategy for a long time. During negotiations our partners agree with the necessity of rebranding, and later change their position. This issue was discussed at a session of the Tajik government! (The company representative said that today MegaFon announces launch of its brand in Tajikistan. Decision on rebranding was made at the current meeting of the Tajik government. — The Vedomosti)
MegaFon Board of Directors approved the steps that will make our politics in the Tajik market more aggressive. We believe that the actual level of penetration in Tajikistan is about fifty per cent. It means that there is still some potential in the market.
— In 2008, MegaFon refused to participate in the tender for the third GSM license in Iran. Do you now consider possibility to enter any other international markets?
— The recent proposal that we received was related to the issue of license in Turkmenistan, but the Board of Directors did not finalize their decision yet. We almost do not work in CIS countries, we do not study new markets. Therefore “MegaFon International” (established in 2008 to participate in international tenders - "Vedomosti") is now getting reorganized into the Department of MegaFon which will be responsible for network development in Abkhazia, South Ossetia and Tajikistan.
If we shall get interesting and reasonable offers to purchase foreign assets we shall certainly consider them. But so far there is no update on this.
Despite the crisis started one year ago, no major mergers in telecom occurred which were forecasted and all major operators have survived. Accordingly, assets values are at the pre-crisis level.
We got interested in Iran because it possesses big market - 75 million people with only two operators and 40% penetration. There is no other market with same potential.
— Expansion in Iran was managed by your First Deputy Alexey Nichiporenko, this summer he has left to Svyazinvest - to develop a strategy for its mobile business. Another First Deputy CEO - Alexander Volkov has also left the company. What is the reason of their leave, and how painful are these losses for the company?
— It is always painful when talented people and good managers leave the company. Is it really painful? – that under question, because throughout many years our company has been generating its HR reserve. The management system was designed so that in the regions we had not managers-administrators that receive a certain task to solve it but very talented people. In particular, Volkov was replaced by Valery Ermakov, former Director General of "MCS-Volga" (now Volga branch of MegaFon - "Vedomosti "). When Valery joined "MCS-Volga” it was number four on the market; Ermakov made it a leader in six years. And we have a lot people of like him: our chief accountant is from Volga region, IT-director is from Caucasus. For all the positions below the level of the director of the branch (I personally appoint people for this position) we announces a contest, first it goes inside the company, only if we do not find nobody within the structure we start to look for staff outside.
— Are you bothered by the fact that Nichiporenko who was with MegaFon right from the start, now runs a mobile business of Svyazinvest? And what do you think are the chances of "Svyazinvest" to become the fourth federal mobile operator in Russia?
— I am very glad when our managers are making progress, albeit not in MegaFon. But with one condition - they stand a pause in one year before going to competitors. For example, under my contract : I have no right to go to MTS or Beeline during one year period after I finish working in MegaFon.
— One year only?
— It is enough. Many things occur on the market during one year period, therefore what was considered a commercial secret of the company one year ago, shall not be a secret in one year time. And it is impossible to copy the main competitive advantage – the culture of the Company as it cannot replicated.
If Nichiporenko was engaged in operations of Svyazinvest, he would’ve been a strong competitor. But today he is developing the strategy of "Svyazinvest" which is quite different – that is his view as a strategist rather than an operational manager. We have good relationship, we do communicate and I completely understand the complexity of the objectives he has. If you ask me if I am ready to develop a strategy to grow mobile business of Svyazinvest, I would answer: No, I am not ready.
With regard to perspectives of "Svyazinvest" on the mobile market - yes, it can become a strong player. Perhaps via new 3G or 4G license. I do not think that "Svyazinvest" will be our competitor in 2G at the federal level. There is no other way than to invest approximately $5 billion to create a competitive network for size of Russia.
— The concept of "Svyazinvest" reorganization states that the best way of mobile business holding development is the consolidation with one of the operators from Big Three. You are not getting any proposals from Svyazinvest on this?
— Not yet.
— Shareholders of MegaFon have been discussing the dividend policy since spring. Is there any progress?
— The discussion continues. The dividend policy is needed first of all to ensure that investors have their benchmarks - we are not a public company. Different countries have different dividend policies: somewhere it is a percentage from net income, somewhere from cash-flow. The decision on dividends payment shall be finalized as soon as our shareholders shall establish their position.
— What do you think is the right way to calculate dividends – from net income or from cash-flow?
— I do not have an opinion on this matter. For me it is important that dividend policy is reasonable, that it does not become an obstacle for the development of the company. What is reasonable? For example, you can allocate a portion of Megafon’s funds for dividends which will not be a constraint for business development and potential acquisitions. Then we are "in favor". If however, the Company will have to borrow money on the market to pay dividends, it will not be a very reasonable policy. Our shareholders approach this issue very wisely and I am sure they will make well balanced decision.
— MegaFon accumulated a substantial cash reserve on its accounts - 59.23 billion rubles as of the end of June 2009. How does company manage these funds?
—We proceed with a conservative liquidity management policy. We are investing our funds in deposits only. The deposit program involves top ten global banks, including Russia's VTB, Sberbank. Any deposit is reviewed by a special committee under the Board of Directors providing recommendations to the Board. Additionally, we utilize risks hedging and I am proud that today Megafon has the opportunity to buy dollar at 26 ruble rate. This leaves a substantial amount of cash in the company.
— May be it is worth to cancel the core business and to start with financial operations?
—We are joking already that MegaFon is the bank. We have 47.6 mln. subscribers with all their money accounts. This money is free of charge for us. We deposit them in a bank and get our interest then we buy foreign equipment then we get loans from export-import agencies at 4-5% per annum for this equipment then deposit money in a bank ... As a result, we have high net profit. This is also because we are very competent in managing our fundraising and corporate financing.
— What is the average interest rate for MegaFon’s deposits?
— I cannot tell you that, it is a commercial secret. But it is quite high, above the market average although we have short-term deposits: after all we might need the money at any time. Banks are queuing to give us money. (He laughs) We say: You know we do not need it. And they reply: Well, take a little bit we are looking for good borrowers!
— How active is “AF Telecom Holding” of Alisher Usmanov that became company’s shareholder in the summer of 2008 with its involvement in MegaFon’s work?
— Fairly active. Telecommunications - is the new industry for our shareholders, they need time to understand the business. For example, Board of Directors has delegated the representative from "Telecominvest” to be the member of the Purchasing committee. On content issues we successfully cooperate with media resources controlled by shareholders.
— You are in charge of MegaFon for six years already, during this time both MTS and Vimpelcom have changed their management at least once. Are shareholders happy with you and are you bored with this business?
— No, I am not bored. If we were not progressing, then it would be boring. But we are evolving, we work not only in mobile but also in universal business - and that means we need to have new views, to create new approaches. Since everything changes, market competition is very high and it is very interesting for me and I have no thoughts about leaving. In June shareholders unanimously voted for the renewal of my contract which means they have confidence in me and our team managers. Probably now I'm one of the oldest CEO in telecom. (He smiles.)
— Let’s say the most experienced one.
— …Yes that’s a good term, I do not really fancy “oldest” neither. (He laughs.)
Every time you think that next year shall be calmer. No way! And it is good, because as soon as you stop, you will be overtaken for sure.
Liabilities
One year is the minimum period during which Soldatenkov is forbidden to move to competing companies in case he decides to resign from MegaFon. He says that one year is enough: "Many events occur on the market during one year period, therefore what was considered a commercial secret of the company one year ago, shall not be a secret in one year time. And it is impossible to copy the main competitive advantage – the culture of the Company as it cannot replicated.
