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"When you boil it all down, it's the investor's job to intelligently bear risk for profit. Doing it well is what separates the best from the rest."
-- Oaktree Capital Management Chairman Howard Marks
Among the many "important things" that Marks discusses in his latest book, The Most Important Thing, risk management is perhaps the most important. As investors, we're all familiar with the concept of risk. There's risk in investing in a company that values itself in eyeballs. Risk in buying a profitless IPO.
This year, many investors sought to avoid risk by buying cheap tech stalwarts, but discovered that if your company is run by a lousy allocator of capital ... you may be soaking in risk despite efforts to the contrary. Cisco (Nasdaq: CSCO ) destroyed billions in shareholder value with its ill-fated entry into (and ignominious exit from) the consumer electronics market. Microsoft (Nasdaq: MSFT ) seems all but certain to do the same with its purchase of Skype, for a price tag three times as big as what the company fetched just a few months ago. Yet as we learn in today's installment from my talk with Mobile TeleSystems (NYSE: MBT ) CFO Alexey Kornya, whatever the risks of investing at home, once you cross U.S. borders, those risks can grow greater by orders of magnitude.
Big trouble in little Kirghizia
Rich Smith: Alexey, a few years ago you had to write off your investment in Bitel, and last year your Barash Communications subsidiary had its licenses suspended. Could you talk a little bit about happenings in Kirghizia and Turkmenistan? What's going on there? What happened, what's happening?
Alexey Kornya: Well, in Turkmenistan our licenses were suspended for reasons that were never justified, as we had always complied with the local legislation and requirements of the regulator. So we are looking for different ways of dealing with that, and looking for a solution to this situation. We have brought legal actions against the Turkmen Ministry of Communications in the International Court of Arbitration at the International Chamber of Commerce in Geneva. We also reserve the right to file an investment claim against Turkmenistan with the International Center for Settling Investment Disputes in Washington. At the same time, we are also engaging with the Turkmen authorities to get compensated for the losses we have incurred. However, taking our conservative approach, we believe that it was appropriate to take an impairment of our fixed assets there, especially as we have not been able to agree with the Turkmenistan government to restart operations over the last two, three months. So we took a conservative approach, and anything good that happens in Turkmenistan will be on top of what we expect.
With Bitel, the situation is that during the change of the governments in Kirghizia, our Luxembourg subsidiary, MTS Finance S.A., was acquiring this company from a group of private investors. But then it appears that this was stripped away. MTS Finance paid for the first half of Bitel, representing 51%. The sellers' position is that MTSF also has to pay for the other 49% since the sellers exercised their put option.
Following a dispute, MTSF received an award against it from an arbitral tribunal constituted under the rules of the London Court of International Arbitration. So MTSF is moving through the different legal processes and is considering its legal position. By 2006, MTSF had already taken reserves to account for all the money spent and we amended our consolidated financial statements for the group accordingly.
Smith: Is there any chance of that money coming back? For example, was the transaction insured? Is there a malpractice suit against whoever advised on it, anything like that?
Kornya: MTSF is still continuing to explore its legal position.
Mistakes were made
Smith: How foreseeable was this risk? Was it entirely a political risk or did somebody do the wrong due diligence, make a mistake?
Kornya: I think MTSF was kind of pressed for time in making the decision, because there was a political change coming, ongoing in that time in Kirghizia, so the decision had to be made quickly. And I think because of this very limited time, the wrong decision was taken; the wrong decision in the sense that yes, the risks were understood. They were reflected in the due diligence. The legal people advised against taking all this risk, but I think management at that time took a conscious decision to take those risks.
Smith: It was a calculated risk that just didn't work out?
Kornya: Right, it just didn't work out. And remember, this was back in 2005.
Smith: What have you all learned from this? How are you going to avoid something like this happening in one of the other ex-Soviet republics?
Kornya: I think that we realized that you should be more careful. ... You should pay proper importance and attention to the documentation with which you prepare and with which you go into the process. I mean, OK, you can do the wrong deal, but there are risks which you are still consciously taking.
But if you don't take such risks, you will miss a lot of opportunities for growth. For example, when we went into Turkmenistan the first time, we bought BCTI and the license of BCTI was canceled or suspended the very next day after we bought the Turkmen operations. But then we managed to find compromises with the government and that helped us very much; it worked out well. So we took a risk, the risk was high but it paid off in Turkmenistan. Turkmen operations were very profitable with an OIBDA margin over 60%. The value of BCTI has grown from the $47 million that we bought it for, to $585 million. So we made a return of more than 10 times over five years.
So sometimes you take risks working in such countries in Central Asia and it works out well; other times you take risks and you are not properly assessing them. I think it's really a question of assessing the risks and understanding whether the people with whom you deal are reliable partners. So probably we just need to adjust what we've done in our risk assessment.
Risks may vary, but lawyers are all the same
Smith: Staying on the subject of risks, how is the UMC transaction? In your annual report you mention there is a risk that Ukraine might overturn the privatization and try to reclaim UMC from you?
Kornya: Yes, this was challenged by the Ukrainian government but that was a long time ago and we don't see any. ... I mean, realistically, since it was challenged once we had to mark it up as a risk in the report, but in actuality this was settled a long time ago.
Smith: This was a lawyer just throwing everything in and the kitchen sink?
This concludes Part II of our conversation with MTS. Tune in again tomorrow for the penultimate installment -- or if you like, bookmark this page and check back tomorrow. We'll add a link here for easy clicking over to subsequent installments as they go up.
In the meantime, did you miss Part I of this interview? Read it here.