Research Notes

More than six months have passed since we last updated our recommendation for MTS shares. The financial reports released for 1Q and 2Q and the events that happened to the operator in this period have caused us to update our financial model and our forecasts for the company.

The results shown by MTS in 1H 2008 were above our expectations: the company preserved a high revenue growth rate and an EBITDA margin at above 50%. The only negative aspect is that the company has developed primarily on its operations in Russia and does not show any robust results on its other operational markets.

MTS has lost ground in Ukraine, which is its second largest market after Russia: the operator has suffered losses to its customer base due to the aggressive activities of Astelit, the Ukrainian mobile operator which trades under the Life:) brand. We have downgraded our forecast for the customer base of MTS's subsidiary in Ukraine and this has had a negative impact on the target price of the operator's shares.

From a financial perspective, MTS is in perfect form: the company's margins are high, the revenue growth rate is still good, and its debts are not large. For this reason it was relatively easy for the operator to attract additional financial resources and a lot of investors were ready to lend a total of RUB 10 billion to the company, all amid a very complex market situation and against an almost complete lack of liquidity.

The company expanded its options program, but tightened its bonus awarding conditions simultaneously. However, the current options of USD 734 million reduced our target price for the company by 1.5%, since we are conservative on the potential payoffs to the management and perceive them as almost mandatory expenditures.

The 3G networks, a potential upside driver for the operator's ARPU, are currently being built very slowly: as of early August, MTS had launched 3G networks in Saint Petersburg, Kazan, Sochi, Nizhny Novgorod and Yekaterinburg, which does not seem much at all. We have slightly lowered our upbeat expectations as regards revenue from 3G networks.

In 1H 2008, VimpelCom changed its subscriber base accounting principles. As a result, the number of subscribers became almost a useless indicator, since the subscriber bases are no longer mutually comparable. To account for this change, we decided to modify our building principle for the Russian cellular communications market financial model: as of today, the basic indicator for evaluating a company's revenue is the total income of all mobile operators, not the penetration rate in a country, as it was before.

As a result of the above changes, the estimated target price for the company's common shares, based on the DCF approach, was slightly reduced to USD 15.36 per share as of late 2009, a 32% upside to the current level. We are extremely upbeat on MTS: it is one of only a few companies that combine absolute market leadership, good financial health and a serious upside potential.

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