Research Notes

We have upgraded our recommendation on MTS stock to reflect updated FY07 forecasts and our more upbeat short-term outlook on the telecom industry.

MTS management headed by CEO Leonid Melamed managed less than a year ago to reshape the telecom's strategy seeking to dramatically increase subscriber base towards lifting ARPU and margins and retaining leadership in the number of Russian subscribers at the same time. Furthermore, MTS is moving ahead with its staff reduction and restructuring programs which have already had a positive impact on the efficiency of its operations.

MTS' financial performance improved significantly in 2006, as the operator reported higher-than-expected margins in Q306 and ARPU equal to the FY05 figure. Although market conditions were quite favorable in that period, we are inclined to believe that this marked improvement in MTS' financials was mostly due to management's strategic moves and hope that the operator will remain firmly on track to deliver such strong financial results in the long run.

The Big 3's subscriber base figures in 2006 point to status quo in the Russian telecom sector, as the market shares of major telecoms remained almost flat y-o-y. In our opinion, price wars and distribution of free SIM cards appear to be a thing of the past now, which could result in slower growth rates of subscriber bases, but higher ARPU.

In our opinion, the fact that, according to some media reports, Big 3 operators are looking to join forces to roll out G3 networks is a major cause for concern. The track record of European telecoms who failed to establish 3G services on a large commercial scale and make them as ubiquitous as 2G, gives us every reason to believe that the roll-out of 3G in CIS could be undermined by sluggish demand and excess investments. Therefore, we will not factor 3G projects into our market cap valuation models on 3 Big operators until more detailed and comprehensive information is released on anticipated investments in these projects.

Overall, we are upbeat about MTS' prospects and current policies, although we note that these factors have already been priced into the operator's stock valuations. We raise our target price to $10.47 for MTS common shares and to $52.34 for ADS, assigning a Hold recommendation to both securities.

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