Research Notes

We resumed coverage of Far East Telecom stocks and set the fair year-end 2008 price for the telecom operator's commons at $6.121 and $5.624 for prefs, assigning a Buy recommendation to the telecom company's shares.

Far East Telecom, the smallest among RTOs, has been making quite efficient use of its primary competitive advantage (last mile access) and has ramped up quite rapidly the proportion of VAS earnings in its consolidated revenue: it has grown from 5% to 12% over the past 5 years. We believe that such robust growth will act as a springboard for RTOs to expand their business in the segment of non-regulated telecom services.

According to our forecasts, despite the operator's far from favorable location it will be delivering strong improvements in its financial showings. This will be partly attributable to the close attention paid by the President and the Russian government to the Far East and the adoption of a federal program for regional development will give a shot in the arm to many industries of the region. In turn, telecommunications companies, as an infrastructural component of business activities, will also stand to gain.

It cannot be said that Far East Telecom's financial standing is very strong because of its ambitious investment program (the proportion of capital outlays in sales has jumped from 9% to 44% in the past five years), while Net debt/EBITDA reached 2.38 in 2006. Based on 2006 performance, among RTOs this indicator was softer only at Uralsvyazinform and South Telecom Company. Furthermore, deterioration in recent years has been recorded in such indicators as ROIC, ROA, financial stability and liquidity. On top of this, we expect that by the end of 2007 the situation will gradually start to improve and Far East Telecom will report lower net debt than EBITDA by 2013.

Cellular operations, which although exhibit strong growth in sales (mobile revenue spiked 6-fold in the past five years), is not a priority area for Far East Telecom as the company will hardly come out on the winning end in the competitive struggle with federal mobile majors. Therefore the decision adopted to divest wireless assets looks logical and timely especially in light of the fact that some buyers (VimpelCom, to be more precise) could shell out the entire amount for assets immediately. We estimate the value of Far East Telecom's mobile assets at $114 mln.

We did not build the "privatization factor" into our valuation models, as it looks uncertain: there are several scenarios for Svyazinvest's future under review and it's not clear right now which scenario will prove to be the most convincing.

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