Research Notes

Following the release of Uralsvyazinform's IFRS financial statement for FY06 and H107 and also new statements by the operator's management, we decided to update our valuation model for the company.

The company's 2006 performance turned out to be soft: operating efficiency weakened and deleveraging efforts stalled. We expect to see no sharp improvement in the company's aggregate margins in the foreseeable future. According to our forecasts, EBITDA margin will not top 33% over the next 6 years. The main reason is heavy debt obligations (in 2006 the operator's leverage was a record 3.67): cumulative debts have been exerting an adverse impact on margins notwithstanding expectations of a reduction in debts.

In H107, the company stabilized its indicators at a fairly low level, but the final conclusion about the operator's status can be drawn only after the release of its annual report.

The possible sale of RTO mobile assets (such rumors constantly circulate on the market) has not impacted so far our opinion about the telecom operator. At present, we value Uralsvyazinform along with its wireless division, but if information about asset sale receives confirmation, the target price of Uralsvyazinform's shares will be revised accordingly. Unfortunately, it is too early to speak about developments in this area, as even the approximate terms of an auction remain unknown. Alongside this, if mobile assets are divested at a fair price, Uralsvyazinform will only benefit from this, as it is quite difficult to compete with Big 3 operators on the regional market. On top of that, many operators are prepared to overpay to gain a sizeable customer base in one fell swoop.

As we have pointed out on numerous occasions, at present Svyazinvest's privatization (no matter what ongoing processes at the holding are called) do not directly influence RTO activities or their stock valuations. Investors have already become accustomed to minor news on the issue and it would be premature to speak about the influence of this process on the fair value of telecom operators until real decisions are taken to sell the state's interest in the telecommunications holding.

By and large, our financial model for Uralsvyazinform underwent marginal changes. For the time being, we do not see any considerable deviations from the company's expansion strategy. We assign a Hold recommendation to the company's prefs with a year-end 2008 target price of $0.040 and rate Uralsvyazinform's commons as Sell with a year-end 2008 target price of $0.064. The telecom provider's current stock valuations do not leave room for any upside. As of year-end 2008 the company's common shares will hold 3% downside and 2% upside for preferred stocks.

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