Research Notes

The FY06 and Q107 financials recently released by MTS are compelling evidence that the steps taken by the new management team led by CEO Leonid Melamed to streamline the cellular operator's corporate structure and cut costs have produced a positive impact on MTS' financial and operating performance. In view of this, we updated our valuation model and the new forecasts are more upbeat than before.

By and large, we expect to see robust topline growth over the next three years and also EBITDA margin stabilize at 52-53% throughout the forecast period. A positive free cash flow against the backdrop of stable investment amounts will serve as a springboard for higher dividend payouts. Dividends equaling half of net income are an attractive investment factor.

Since MTS unveiled quite detailed 3G investment plans, and for the first time in our valuation model we factored in the commissioning of 3G networks in late 2007 or early 2008, for which the Big 3 obtained licenses this spring. Despite the fact that the number of 3G users will be modest and 3G networks will be rolled out only in some regions, the impact on sales will be quite tangible: if 3G operations add 1% to the company's aggregate revenue in 2007, it will be as high as 8% by 2015.

MTS' prospects on FSU markets remain vague since after the fiasco involving Bitel the company failed to show its ability to expand by way of CIS acquisitions. Unfortunately, we do no see any serious prospects for the situation to improve, at least for the time being. However, this factor is of a minor impact on MTS' fair value as the company remains the number one player in the FSU marketplace, with Russia and Ukraine as its primary markets.

The misfortune surrounding Bitel, which has already cost MTS $150 mln and it cannot be ruled out that another $170 mln will still have to be paid, has already been priced into the mobile operator's current stock valuations. We are not inclined to read this situation as a negative for MTS, as regional markets are quite tricky due to their reliance on relations with state authorities and these risks have already been priced in to a varying degree to the market value of FSU cellular operators.

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