FOCUS: MTS, Vimpelcom Hope Chatty Russians Can Prolong Growth

MOSCOW -(Dow Jones)- Russia's two biggest mobile operators will struggle to maintain their impressive growth unless they squeeze more out of customers at home and successfully exploit foreign markets, experts say.

U.S.-listed Mobile TeleSystems, or MTS, and VimpelCom have captivated foreign investors, with annual revenue growth of more than 25% for the past five years, as Russia's increasingly affluent population embraces cellular services.

But after a rapid surge, the Russian market is near saturation. To sustain growth, mobile firms need Russians to spend more on calls and, to a lesser extent, they must win new subscribers in the former Soviet Union and Asia.

"MTS and VimpelCom both have strong operating performances; the problem is, no one knows how much further they can grow," said a London-based investor who watches the stocks closely.

The two companies insist that Russia - which generates more than three-quarters of their combined revenue - holds the key to growth for the time being, as rising disposable income encourages customers to spend more time chatting.

"For the next three to five years, it's absolutely logical to expect usage growth of at least 10%," said VimpelCom Deputy Chief Executive Nikolai Pryanishnikov.

MTS also expects average talk time per subscriber to rise at least 10% a year, which is in line with the rise in real Russian incomes. Average monthly revenue per registered user, or ARPU, rose more than 15% in the 12 months to September, reaching $11 for VimpelCom and $10 at MTS, driven chiefly by more talk time. "We're not expecting a significant increase in prices; the growth will come from usage," said MTS' strategy director, Michael Hecker.

On top of rising income, Hecker says part of this growth will come as Russians increasingly use mobiles as replacements for fixed-line phones, an effect that has boosted cellular operators in other developing markets, including India and China.

Hecker expects to continue attracting new subscribers, albeit at a much slower pace, while non-voice services such as text messages, which generated $2.2 billion for Russian operators in 2006 - around 15% of Russia's overall mobile market - will also contribute.

MTS expects such services to grow in tandem with calls over the next five years and believes inadequate fixed-line coverage will also encourage people to access the Internet via smartphones and laptop computers. MTS and VimpelCom last year won licenses to provide third-generation services in Russia, and are now building networks that will enable them to offer services like video telephony and mobile TV.

Analysts stress that Russians still spend less than customers in other developing countries, such as Turkey, where monthly ARPUs are around 30% higher.

The most bullish expect Russian ARPU to reach $15 within three years, but others are more skeptical, arguing that subscribers will only use their phones more if operators trim their already low tariffs, something they appear reluctant to do.

"The key issue is whether consumers in Russia already speak enough and the operators simply surrendered too much pricing power," Deutsche Bank said in a recent report.

Tariffs have gradually fallen in recent years, in spite of a boost in 2006 from the industry-wide switch away from U.S. dollar-denominated packages to setting call charges in the appreciating local currency.

"Usage has always been stimulated by lowering prices. It's wishful thinking to expect Russia to be any different," said Tibor Bokor, an analyst at Moscow-based investment bank Renaissance Capital, which expects ARPU of around $14 in 2012, compared with Deutsche Bank's forecast of $18.

Outside of Russia, the operators are focused on less mature markets within the Commonwealth of Independent States, where another 140 million people - mostly Russian-speaking - are rapidly signing up for cellular services.

Operators hope the CIS will be a significant source of revenue in the medium term as economies there expand, boosted by exports of natural resources and wealthy regional investors.

Moscow retains strong political and cultural links to many CIS countries, including Kazakhstan and Uzbekistan, which broadcast Russian TV channels that expose people to the MTS and VimpelCom brands, even before they arrive.

But unlike in Russia - where the two operators vie for market share with just one nationwide provider, privately held OAO MegaFon - some big Western companies have turned to the CIS for new customers as growth at home slows.

Ukraine, for example, is the CIS' second-largest market but it is also among its most competitive, with the arrival of Turkcell Iletisim Hizmetleri pushing down call charges and, in turn, hurting profitability at both MTS and VimpelCom.

Meanwhile, Telekom Austria last year paid EUR730 million for a 70% stake in MDC, the second-largest operator in neighboring Belarus. That deal muscled out VimpelCom, which was also keen to enter the region's fourth-biggest market.

Elsewhere, Sweden's TeliaSonera has long been a major force and is stepping up investments in countries including Kazakhstan, Uzbekistan, Azerbaijan, Georgia and Moldova through its Fintur joint venture with Turkcell. MTS remains absent from booming Kazakhstan and is now considering starting its own greenfield operations there.

"CIS markets are just as significant for TeliaSonera as the Nordic and Baltic regions," a TeliaSonera spokesman said.

MTS and VimpelCom are generating large amounts of free cash, with the latter branching out into the fixed-line sector earlier this year through its $4.3 billion purchase of alternative provider Golden Telecom (GLDN). Countries further afield have also become an avenue for growth.

VimpelCom sees deals outside the region as a strategic priority and last year announced plans to spend $1 billion establishing an operator in Vietnam, a nation with which Russia has traditionally enjoyed strong political ties.

Analysts have greeted that move with cautious optimism, but some market participants are apprehensive about prospects in countries outside the CIS.

"There are a lot of question marks over the deal, as it won't be easy to create value," warned Kent Nordin, who assesses Russian operators for portfolio investor Prosperity Capital, which he says is underweight in Russian mobile operators.

MTS has so far restricted itself to the CIS, but its parent company, London-listed conglomerate AFK Sistema, has pledged to spend up to $7 billion on creating a mobile provider in India, where Richard Branson's Virgin Mobile earlier this month signed a partnership deal with local industrial group Tata.

Sistema believes the Indian market will be central to its growth, while MTS' chief executive has said the company would consider buying the Indian operator if Sistema eventually sold it.

"Five years ago, Russia itself was one such market. Russian investors know how to achieve exponential growth," the head of Sistema's telecoms arm, Vitaly Savelyev, said.

-By Will Bland, Dow Jones Newswires; +7 495 974 80 55; william.bland@dowjones.com

(END) Dow Jones Newswires

Posted to the site on 11th March 2008