Ill Neo-Soviet Winds Blowing in Russia’s Telecom Market

Eugene Iladi, writing on Prime Tass:

A new storm is brewing in the fiercely competitive, but lucrative, Russian telecommunications market, threatening the stakes of established operators and the stability of the sector.

The granting of new LTE licenses (Long Term Evolution or 4G technology) is shaping to become a potential battleground between Russia’s so-called “big three” mobile telecom operators, Mobile TeleSystems (MTS), VimpelCom and MegaFon, and two newly established start-up competitors, Osnova Telecom and Red Telecom.

The Russian State Radio Spectrum Committee and the Ministry of Telecommunications are in charge of disposing of the licenses and have come under tremendous pressure to grant the new LTE technology spectrum to newcomer start-ups, such as Osnova and Red, without a public tender. How transparent and fair this process unfolds will determine the shape of the Russian telecom industry and the future of foreign investment in the country. Estimated at nearly $40 billion for last year alone, and expected to grow to $48.5 billion by 2013 according to a Pyramid Research survey, Russia boasts Europe’s largest and fastest-growing telecom market.

At the end of May the Defense Minister, Anatoliy Serdyukov, wrote a letter to President Dmitry Medvedev indicating that “no less than 60 MHz” in the ranges of 2.3-2.4 and 2.5-2.7 GHz (the 4G bandwidth) would be necessary to develop a network and asking for support in granting the licenses to Osnova Telecom, as reported by Vedomosti, a leading Russian business daily publication.

Registered on June 3 of this year, Osnova Telecom lists Aykominvest as a majority shareholder, with the remaining 25.1 percent stake belonging to Voyentelekom, which is controlled by the Ministry of Defense. Aykominvest is owned by Vitaly Yusufov, a 28-years-old former Gazprom and Nord Stream top executive turned entrepreneur in August of 2009.

He is also the son of a former energy minister, Igor Yusufov, an influential Kremlin insider who served under Vladimir Putin. Yusufov Sr. was deputy industry minister and headed the State Reserves Committee, the agency responsible for certifying Russia’s mineral deposits, oil and gas reserves before becoming Russia’s energy minister from 2001 to 2004. A Gazprom Board director since 2003, he is close to Dmitry Medvedev serving as a presidential special envoy for international energy cooperation and has a long history of service to Vladimir Putin dating back to the ‘90s when the latter rose through the ranks of St. Petersburg’s administration.

Power Politics

Medvedev instructed the Ministry of Defense to “take all essential measures jointly with the Ministry of Communications according to the established procedures,” Vedomosti reported.

On July 6, the “big three” countered with a letter to Minister of Telecommunications and Mass Media, Igor Shchegolev, urging for a “precise and transparent” solution to the allocation of LTE licenses. Moreover, last week, the chief executives of MTS, VimpelCom and MegaFon cosigned a letter to Prime Minister Vladimir Putin asserting the granting of 4G licenses, outside of an open tender process, to newly established and inexperienced start-ups could cause “negative consequences for the vast majority of the population of Russia, our companies and the State as a whole,” Vedomosti reported.

The executives also pointed that it would take anywhere from five to seven years and at least $5 billion for a start-up company to build its own 4G network starting from scratch, while established major telecom operators can develop the service at a fraction of the cost and time, on the back of their existing GSM and 3G infrastructure.

Current legislation requires public tenders/auctions when allocating limited resources such as spectrum. Granting frequencies and licenses on non-competitive basis, without predefined terms, conditions and procedures, goes against the law and the normal business practice and will negatively influence the overall investment environment in Russia, while also dramatically decreasing market capitalization of GSM/3G operators.

The major telecom operators stressed their business models and potential for healthy growth took into account being able to expand their reach and meet growing demand for bandwidth and data transmission speed, which is exactly what LTE technology offers. The operators made multiple applications to the regulators for new spectrum both in the existing 3G band (2.1 GHz) and in the LTE bands of 800 MHz, 2.3-2.4 GHz and 2.5-2.7 GHz. With years and billions of dollars of development behind them, serving more then 170 million customers combined, MTS, VimpelCom and MegaFon are demonstrating significant growth of data services revenues. MTS and VimpelCom ADRs have traded for years on NYSE and all three have consistently reported robust results and weathered the global economic crisis without significant losses.

However, if the 4G bandwidth is dished out in a preferential manner excluding the established Russian GSM/3G operators, they will not have any chance to develop LTE in the next three to five years and would see their future technological and commercial evolution effectively blocked. As a consequence, the revenue growth for these operators may slow down significantly and the customer base could decrease dramatically. Consumers would migrate to the faster LTE technology and be forced to change from GSM/3G mobile operators to the favored LTE start-up companies. The financial position and market share of the “big three” telecom operators would deteriorate, and eventually they could become extinct.

Implementing the non-competitive awarding of LTE licenses plan would smack of cronyism, reflect poorly and have negative consequences on Russia’s decision makers, market participants and end users alike.

Worrying Signs v. Source of Optimism

With an explosive mix of jockeying from Defense, Telecommunications, the President and the Prime Minister, a connected and ruthless start-up, as well as the “big three” telecom operators controlled by powerful Russian oligarchs and significant international telecom investors, the way Russia solves the current licensing “Mexican standoff” will speak volumes of the country’s direction regarding foreign investment and control of its major assets.

Lacking traditions and an effective reinforcement mechanism of private property protection laws, Russia ranks 143rd out of 179 countries in the 2010 Index of Economic Freedom, according to the Heritage Foundation.

In what may have been an early warning sign of escalation, the Federal Anti-Monopoly Service of Russia (FAS) started investigating MTS, VimpelCom and Megafon in March, alleging violation of anti-monopoly legislation by way of applying artificially high prices for roaming services. The FSA did not indicate a date by which it would consider or conclude the case, but, if roaming tariffs are determined to be in violation of current legislation, the parties could face hefty fines. The telecom operators believe there was no violation of the anti-monopoly legislation.

This could be part of an intensifying campaign, disturbingly reminiscent of the infamous Yukos affair earlier this decade. While in the meantime Russia has become more sophisticated in its control of business interests and revenues, the battle brewing on the awarding of LTE licenses has the makings of a major storm that investors should watch closely for signs of a renewed impetus of State control and interference in private business.

The current developments may be the first signs of a retrenchment and reshuffle of lucrative segments of the telecommunications industry underway in Russia. The Russian political leadership has purged the top oligarchs in the past, partly to solidify their grip on power and project Russian might, as well as to reassert State dominance over strategic economic sectors, and bestow economic favors on the inner circle of the moment.

Contrary to the more crude cases of the past asset grabs, the State may set the stage and prepare to manipulate licensing of telecom technology to allow State controlled firms and the new up-and-coming connected businessmen it favors, to develop their companies and leapfrog the established, long-term GSM/3G operators by neutering the latter and rendering them technologically obsolete.

The glimmer of hope is that the lessons learned during the messy and costly dismantling and nationalization of Yukos, the former largest private oil company in Russia, are causing the Russian leadership to thread more carefully and consider the consequences of such actions.

The good news is that the State Radio Spectrum Committee and Telecommunications Minister Shchegolev have postponed discussing the issue three times since May, most recently on July 15, and vowed to come up with a solution by the end of August at the latest.
The granting of the LTE licenses without tender and due process to Osnova Telecom and other well-connected start-ups has not taken place, so far, despite very powerful interests pushing for such a resolution.

Hard to predict if this process will ultimately amount to a new brutal culling of the oligarchs, an extra barrier to foreign ownership, or a transfer of coveted assets to the State and its cronies, but Russia can ill afford any of these scenarios.

The best way out of this conundrum, without egg on their face and a loud outcry from its Western partners that could trigger increased economic hardship and renewed political tensions, is for the Russian leadership to do the right thing and apply their own rules in a consistent and transparent manner. What easier way to show the world that Russia is past malfeasance, has come full circle through its transition, and is emerging as a steady, trustworthy partner and a secure investment destination, as it asserted along the way.

Eugen Iladi is a freelance writer covering topics related to technology, energy, business and politics

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