Mobile TeleSystems OJSC

4 Marksistskaya Street
109147 Moscow
Russia
Telephone: (7) 095-766-0177
Fax: (7) 095-766-0100
Web site: http://www.mtsgsm.com

Public Company
Incorporated: 1993
Employees: 6,750
Sales: $1.36 billion (2002)
Stock Exchanges: New York
Ticker Symbol: MBT
NAIC: 513322 Cellular and Other Wireless Telecommunications

Mobile TeleSystems OJSC (MTS) provides cellular phone service to nearly 13 million subscribers in Russia and neighboring countries. The center of its operations is Moscow, where it shares the market with its major competitor, VimpelCom, and Sonic Duo, a recent arrival. However, acquisitions are helping MTS add to its subscriber base and establish a national footprint. The company holds licenses in most of Russia's 89 regions and operates in about half of them. In addition, its subsidiaries serve customers in the Ukraine and Belarus.

Established in 1993 as a joint venture between German and Russian companies, MTS was the first company in Moscow to offer service on the GSM (global system for mobile communications) standard. GSM eventually became the prevailing standard in the industry, helping MTS remain a market leader as the cellphone changed from an expensive status symbol for the rich to an accessible mass market product. The company has grown rapidly since its inception, negotiating cutthroat competition in a growing industry. MTS has been listed on the New York Stock Exchange since 2000. Principal shareholders are AFK Sistema, a Russian holding company with just over 50 percent, and T-Mobile, a subsidiary of Deutsche Telecom, with about 25 percent.

Origins

Russia seemed like an ideal market for cellular phones in the early 1990s. Fixed-line service was poor, and countless people were on waiting lists to get service set up by the government. Attracted by the potential of an untapped market, international companies brought their technical expertise to the private businesses and government organizations in Russia that had acquired licenses for cellular operations. Although the GSM standard was already the norm in Western Europe by 1991, the Russian cellphone industry operated on a number of different standards and frequencies in its early years. Analog standards such as NMT-450 (Nordic Mobile Telecommunications) and AMPS-800 (Advanced Mobile Phone Service) were cheaper than the digital GSM and required fewer base stations to cover a large area. The Russian government's policy was to license only one operator per standard in each region. The industry developed quickly and chaotically. By the mid-1990s, there were about 150 different operators nationwide, forming a patchy network of incompatible standards that forced users to switch phones or companies when traveling away from home.

The first cellular operator in Moscow was Moscow Cellular Communications, formed in 1992 when US West and Millicom International Cellular of Luxembourg teamed up with NMT-450 license holders. Later in 1992, a second company, AO VimpelCom, was founded by a Russian university professor, Dmitry Zimin, and entered the market on the AMPS standard. Mobile TeleSystems was created in 1993 when two German companies joined with several Russian telecommunications operators: DeTeMobil, a unit of Deutsche Telecom, held about 38 percent; the electronics manufacturer Siemens AG held about 10 percent; the Moscow City Telephone Network owned about 20 percent; and the remaining share was split among three smaller companies: ASVT, M-Bell, and TDSR.

MTS chose the GSM-900 standard for its operations, hoping that the advanced technology would give it a competitive advantage. GSM, a digital standard, was clearer, allowed for smaller handsets, and was more secure against pirating nonsubscribers. Because it was already Europe's standard, GSM offered greater potential for international roaming. The digital technology also gave users access to services such as call waiting, voice-mail, call forwarding, and eventually more advanced services such as text messaging and Internet access. MTS debuted its product at the Expo Com '94 technology exhibition in Moscow in June 1994. The next month, it started operations on an experimental basis with 217 subscribers.

At the time, Moscow Cellular Communications was the market leader in Moscow with 6,000 subscribers, and VimpelCom was just getting started with several hundred customers. MTS stated that it would rely on superior technology rather than a price war to gain a foothold in the market. Nevertheless, when commercial operations began in late 1995, MTS claimed that its deal was better than the competition: tariffs of 56 cents a minute, a $100 monthly fee, and a $750 charge for the initial connection to the network. The deal was only slightly, if at all, better than alternative providers; the main cost advantage was that the Siemens phones available through MTS were less expensive than other options. In general, prices for cellular phone service in Russia were sky-high compared to Western Europe. Because Russia's middle class was small, companies had little to gain by offering more affordable rates.

Mikhail Smirnov became president and director of MTS in 1995. By the end of 1996, MTS had 19,000 subscribers and reported net revenues of $53.6 million. In 1997, the rival company VimpelCom, recognizing that GSM was the standard of the future, acquired a license for the GSM-1800 frequency. The former market dominator, Moscow Cellular Communications, remained on the outdated NMT-450 standard and gradually faded as a competitive threat. MTS and VimpelCom would share the largest piece of the Moscow market over the next several years.

Price Wars and Mass Market Competition in the Late 1990s

VimpelCom's competitive threat grew in 1998 when the government broke with its one-operator-per-frequency policy and issued VimpelCom a GSM-900 license. The lower frequency was more feasible operationally than the 1800 frequency. Smirnov protested the loss of his company's exclusive right to GSM, since Moscow was the only place where two licenses had been issued for the same frequency. Government officials claimed that First Deputy Prime Minister Boris Nemtsov helped VimpelCom get the license in exchange for financial assistance to the Russian Space Agency. MTS threatened to sue but did not. In September 1998, MTS acquired Rosico, a company with a license for the 1800 frequency, which solidified MTS's ability to offer competitive GSM service. By using two GSM frequencies, a company was less likely to overload its network.

By mid-1998, AFK Sistema, an investment vehicle owned by leaders in the Moscow government, had amassed a 47 percent share in MTS. Sistema also owned the Moscow city telephone network, which meant that MTS was able to pay lower interconnect fees. In early 1998, MTS was preparing to list on the New York Stock Exchange and had appointed Deutsche Bank and ING Barings as investment banking advisers. However, the August crash of the ruble put those plans on hold. In the wake of the economic crisis, nationwide cellphone use fell about 30 percent. The situation promised to winnow a fragmented and high-priced market down to the strongest contenders.

By the end of 1998, MTS had 114,000 subscribers and a 34 percent market share in Moscow. Early in 1999, MTS surpassed VimpelCom for the first time in terms of market share. MTS had cultivated a rich subscriber base and a reputation for better coverage in Moscow. Now, in tougher economic times, cellphone companies felt the necessity to lower their rates. They offered reduced tariffs to entice subscribers to "thaw out their cellphones." VimpelCom brought the price war to a new level in October 1999 with the introduction of its "phone in a box," the first cellphone package that was affordable for the general population. For only $49, Moscow residents could get a handset and a $10 prepaid phone card. The connection fee was waived. The package proved to be very popular, and many stores sold out within days. VimpelCom was selling the package at a loss, but the offer transformed cellphones from a luxury item to a mass market product.

MTS claimed not to be concerned with VimpelCom's move to grab market share. "We're interested in real subscribers, not inflated figures," said Igor Timofeyev, director of marketing at MTS. "Most of the people who bought these cheap phones can't afford the monthly upkeep and will stop using them within a couple of months." Nevertheless, MTS responded with some changes to make its package more attractive. It cut tariffs and handset prices and began selling prepaid cards in ticket booths of the Moscow Metro. Prepaid cards were a great step forward in convenience, especially since credit card and debit systems were underdeveloped in Russia. Before the advent of prepaid cards, customers had to stand in line for hours to pay bills at service centers. MTS's net income in 1999 was $85.7 million on revenues of $358.3 million.

Company Perspectives:

Our primary goal is to maintain our position as a leading national mobile operator in Russia. In addition, we intend to take advantage of opportunities to expand our network coverage in the Russian Federation and other countries of the CIS.

New York Stock Exchange Debut: 2000

By mid-2000, MTS and VimpelCom each had about half a million subscribers. Plans for a public offering on the New York Stock Exchange were back on the table. The proceeds would be used to upgrade MTS's network, improve service in Moscow, expand into the regions and invest in new technology such as Internet access (WAP, or Wireless Application Protocol) and high-speed data transmission. The planned initial public offering (IPO), the first by a Russian company since the 1998 crash, was anticipated as an indicator of investor confidence in post-crash Russia. MTS's performance proved to be respectable. In May 2000, Mobile TeleSystems CJSC (closed joint stock company) merged with RTC OJSC, a company it had acquired in 1998, to form Mobile Telesystems OJSC (open joint stock company). On July 6, the company raised $305 million in an IPO of shares priced at $21.50 each, which set the value of the company at $2.1 billion. Although the IPO was risky, investors were reassured by the fact that MTS had a corporate governance code, was able to provide GAAP accounting figures for its entire seven-year history, and that Deutsche Telecom was a major shareholder. MTS President Smirnov stated, "We took a risk. We had to overcome a big psychological barrier between us and western investors. Obviously, the greater expectation of stability under the new president [Vladimir Putin] helped."

Meanwhile, a new cellphone company was preparing to enter the market in Moscow. Sonic Duo, a company jointly controlled by the state-owned Svyazinvest and by Sonera of Finland, had been granted an operating license in May 2000, but no operating frequencies were available. In September 2000, Russia's Communications Ministry seized several 900 MHz channels from MTS and VimpelCom, intending to give them to Sonic Duo, but the action was annulled in the face of stockholder protests. In the summer of 2001, for reasons that the press could only speculate about, MTS handed over some unneeded radio frequencies to make space for a third operator. Sonic Duo launched in November 2001 on the GSM standard under the brand name Megafon. MTS and VimpelCom countered with expanded marketing campaigns and billing simplifications. By early 2003, Sonic Duo had acquired a 5 percent market share. At the end of 2000, MTS had 1.2 million subscribers and revenues of $535.7 million.

As cellphone technology advanced, MTS made sure it would be able to offer cutting-edge services. In 2000, the company had launched WAP service, which allowed subscribers to access e-mail or purchase goods online with their cellphones, but the feature was slow to catch on. As a result, MTS moved cautiously the next year in testing general packet radio service (GPRS), a technology that allowed for transmittal of broadband wireless data.

Expanding Through Acquisitions: 2001 and Beyond

A more reliable strategy for increased profits was expansion outside Moscow through acquisitions. MTS's goal was to create a single GSM network across Russia with seamless roaming. President Smirnov, quoted in the Financial Times in November 2001, said, "Our strategy is to become the first truly national mobile cellular operator in Russia by integrating our regional networks into a single unified network, developing standardized tariffs, and deploying integrated nationwide customer service and billing systems." In May 2001, MTS purchased Telecom XXI, a company that held GSM licenses for ten regions in the northwest but had no subscribers. The acquisition would allow MTS to compete in the St. Petersburg market. Service was launched in December of that year with celebratory fireworks, and the company attracted 775,000 subscribers in its first year. In August 2001, MTS gained control of Telecom 900 Ltd., a company that held stakes in several smaller operators in the Ural, Siberian, and Far Eastern regions. The purchase won MTS another 117,000 subscribers. That fall, MTS beat out Russian, Austrian, and Saudi Arabian companies to win a tender for an operating license in Belarus. MTS formed a joint venture there known as Mobile Telesystems LLC but delayed starting work until the next year. Finally, the company also opened a network in Nizhny Novgorod, the provincial capital of the Volga region. This was the first GSM network in the city, and prospective customers lined up at the office door even before it opened.

Regional expansion looked ever more attractive as the market grew crowded in Moscow. Morgan Stanley reported in 2001 that only 1.5 percent of Russian regional residents had mobile phones, compared with 19.2 percent in Moscow. Although MTS had over half the Moscow market by the end of 2000, in September 2001 VimpelCom beat MTS in the number of new subscribers for the first time in nearly two years. VimpelCom had a new tariff system, so MTS responded with three new billing plans that offered lower per-minute rates and had lower monthly fees than the two plans previously available. In addition, an aggressive and, according to MTS, misleading marketing campaign by VimpelCom helped it continue to attract the majority of new subscribers. Net revenues at MTS continued to rise, but the average revenue per user was declining. At the end of 2001, MTS had 2.65 million subscribers and a $205.8 million profit on $893.2 million in revenues.

Further acquisitions helped MTS continue its growth in subscribers and revenues. In March 2002, the company bought a controlling share in OJSC Kuban, the top regional operator in Russia with several hundred thousand subscribers in the southern Black Sea region. In May 2002, MTS bought BM-Telekom, located in the Volga River republic of Bashkortostan. By this point, MTS was operating in 29 regions across Russia. Further acquisitions in 2002 included Mobicom-Barnaul in the Altai region, Dontelecom in the Rostov region, and Bit LLC, which had GSM licenses for four different regions. Late in 2002, MTS introduced the "Jeans" tariff plan aimed at low-spending cellphone users. By the end of the year, the company had 6.64 million subscribers.

The year 2003 started out on a sour note when a pirated CD containing personal data from MTS's customer database appeared for sale on the streets of Moscow. Similar leaks had occurred before at other companies. A company spokesperson suggested the data may have been sold by a low-level official at the Federal Security Service, since mobile phone operators were required to hand over customer information to that agency. MTS offered its subscribers personal identification numbers to prevent others from abusing their phone numbers.

Key Dates:

1993:: Mobile TeleSystems (MTS) is formed in a German-Russian partnership.
1995:: Commercial operations begin in Moscow on the GSM standard.
1998:: Rival VimpelCom acquires a GSM license; MTS has 114,000 subscribers.
1999:: VimpelCom's "phone in a box" starts a price war.
2000:: MTS debuts on the New York Stock Exchange; the company boasts 1.2 million subscribers.
2001:: MTS begins expanding through regional and international acquisitions; the company now has 2.65 million subscribers.
2003:: MTS purchases Ukrainian Mobile Communications; the number of the company's subscribers climbs to 12.8 million.

Acquisitions continued in 2003. The most notable was the purchase of Ukrainian Mobile Communications in March. The company was the Ukraine's second largest mobile operator with 1.5 million subscribers. For MTS, the Ukraine presented a less stable business climate but lower operating expenses and greater potential for expansion. MTS also bought a controlling stake in Taif-Telcom, the largest operator in the Volga republic of Tatarstan. That spring, AFK Sistema also bought a 10 percent stake from Deutsche Telecom, which meant that Sistema had a controlling interest and MTS could be registered as an official Russian cellular company.

MTS's second quarter report for 2003 stated that the company had 12.8 million subscribers and net revenues over the first six months of $606 million. In August, Mikhail Smirnov's term as president expired and the board nominated Vassily Sidorov, a former director for finance and investments at Sistema-Telecom, as the new president. Sidorov announced that he would carry on the existing strategy at MTS, strengthening the company's position in its existing markets and expanding into new ones.

Principal Subsidiaries

Bit LLC; Telecom-900; Telecom XXI; BM-Telecom; MTS Barnaul; Dontelcom; MSS (83.5%) Kuban GSM (52.7%); JV UMC (83.7%); ReCom (53.9%); TAIF Telecom (51%); UDN-900 (51%); Mobile TeleSystems LLC (49%).

Principal Competitors

VimpelCom; Sonic Duo.

Mobile TeleSystems OJSC

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Mobile TeleSystems OJSC

4 Marksistskaya Street
109147 Moscow
Russia
Telephone: (7) 095-766-0177
Fax: (7) 095-766-0100
Web site: http://www.mtsgsm.com

Public Company
Incorporated: 1993
Employees: 6,750
Sales: $1.36 billion (2002)
Stock Exchanges: New York
Ticker Symbol: MBT
NAIC: 513322 Cellular and Other Wireless Telecommunications

Origins

Price Wars and Mass Market Competition in the Late 1990s

Company Perspectives:

New York Stock Exchange Debut: 2000

Expanding Through Acquisitions: 2001 and Beyond

Key Dates:

1993:: Mobile TeleSystems (MTS) is formed in a German-Russian partnership.
1995:: Commercial operations begin in Moscow on the GSM standard.
1998:: Rival VimpelCom acquires a GSM license; MTS has 114,000 subscribers.
1999:: VimpelCom's "phone in a box" starts a price war.
2000:: MTS debuts on the New York Stock Exchange; the company boasts 1.2 million subscribers.
2001:: MTS begins expanding through regional and international acquisitions; the company now has 2.65 million subscribers.
2003:: MTS purchases Ukrainian Mobile Communications; the number of the company's subscribers climbs to 12.8 million.

Principal Subsidiaries

Bit LLC; Telecom-900; Telecom XXI; BM-Telecom; MTS Barnaul; Dontelcom; MSS (83.5%) Kuban GSM (52.7%); JV UMC (83.7%); ReCom (53.9%); TAIF Telecom (51%); UDN-900 (51%); Mobile TeleSystems LLC (49%).