Russia Is Different, in Oh-So-Many Ways

When investing outside U.S. borders, one of the hardest problems an investor faces is getting a feel for the culture of the country in which their company operates. These past few months, for example, have seen a heated debate between investors who see great value in the low P/E ratios of Chinese small caps such as Longtop Financial (NYSE: LFT  ) and the shorts who have a different read on the numbers -- namely, that they're totally bogus, and the companies frauds.

The longs' case didn't get much help last week, when Longtop's auditor accused the company of "deliberate interference" in its efforts to confirm that the company's numbers were accurate. Even Chinese nationals have urged investors to "never trust what you hear" in China, because if you do, you will get taken for a ride.

I'm agnostic on the China small-cap debate. But it's probably an overreaction to assume that all foreign companies are out to deceive you. A few weeks ago, I had the chance to sit down with Alexey Kornya, CFO of Russia's Mobile TeleSystems (NYSE: MBT  ) , to talk shop about the telecom business in Russia. One of the first things Kornya did was set me straight about his company's performance: It's doing fine and growing fast, though nowhere near as fast as the analysts on Wall Street seem to think.

And that was just the beginning of the insights, as Kornya pulled back the curtain for us on a few of the mysteries of Russia's telecom market.

An Apple a day? Who can afford that?
Rich Smith:
Aleksey, one of the biggest sections of your annual report is a discussion of risk, all the many, many risks in Russia. One risk you mention has something to do with Apple (Nasdaq: AAPL  ) potentially suing you for not buying as many iPhones as you had planned. What gives? Are iPhones not popular in Russia?

Alexey Kornya: Well, I think they are quite popular, but there just aren't many people who are able to pay $1,000 for the handset.

Smith: OK, so it's a premium product.

Kornya: Yeah, it's a premium product. People, you know, as soon as they have money, they are willing to buy it. They like it and Apple is quite popular, but I think there are not that many people who are ready to pay that kind of money for this product. So in years past we weren't as successful in selling them as we had expected.

So the risk which is described in regard to Apple is that we have a commitment to take and sell a certain number of these handsets, and we are not meeting this commitment. But realistically, this is not a risk for us, because we don't expect Apple to be too upset with us for not selling their product in the agreed amount. We have the third-largest retail network in Russia, and this is a major channel of distribution for Apple.

Smith: So what handsets are selling better than Apple?

Kornya: There are Chinese makers who sell for $20 or $35. There's also Nokia (NYSE: NOK  ) for $30, and so on and so forth. So of course, in terms of volume of handsets, they're selling tens of times, hundreds of times more. Samsung is also quite popular in Russia.

Smith: Motorola Mobility (NYSE: MMI  ) was very big in Ukraine a few years ago. How is it in Russia now?

Kornya: Yeah, well, they had the Razr, which was quite popular here for a while, but now they don't have a product as popular as the Razr. They just closed the office here.

Smith:What about the Google (Nasdaq: GOOG  ) Android phones? How are they selling?

Kornya: They're selling well. But still, if you take the number of handsets that are being sold, of course this is a kind of premium product, too. I think it's not more than 10% of all handsets we sell. So the question is, how quickly will the prices go down? The quicker prices decline, the more users you will have.

Smith:By the way, when you sell a mobile phone, is it subsidized?

Kornya: No, they are not subsidized. There are no handset subsidies in the market.

And speaking of handsets …
Kornya:
Now, to sketch out the handset market for you, Euroset is in the process of doing an IPO. They are the No. 1 Russian mobile handset retail network, and they are very good, right now doing around $2 billion in revenues  annually -- but we are not that much less than they are in terms of size. They have 4,000 stores where they sell handsets, and we have 2,300. [Editor's note: Soon after this talk with MTS, Euroset shelved its IPO plans.]

So our market share at the end of 2010 was about 16% or 17%. And remember that we built this business from nothing over just two years' time. We basically made the business and created value of $1 billion or $2 billion in about two years. Also, we have better prospects for developing and growing into this market than, say, Euroset. Euroset thinks they will grow. But we have the power of MTS, with mobile operations to help support our growth in this segment of the market.

Smith: Speaking of competition, if you could pick any of your competitors and shoot them with a silver bullet, who would it be? Would it be Euroset? Who would you most like to not be there anymore?

Kornya: Well you know, I think that to a certain extent we're in a quite balanced situation in the market. We would of course like to have less competition than we have. At the same time, we have a balanced situation that allows us to develop ourselves and to be better. As soon as the market becomes unbalanced, someone starts acting irrationally and loses a lot of value in that.

So this is difficult to answer. Our competitors operate in different segments, but we have this same basic level of competitive threat to us. Removing any one of them would be better for us, but I don't have any specific preferences.

Smith: OK. Coming at it from a different direction, can you pick one of your competitors that's doing something you really admire? Does anyone jump out at you as just really doing a great job at something?

Kornya: No, I think no one does something better than we do. We are all doing similar things. In certain things we are more advanced -- for example, developing full-service retail -- and now our competitors are just following us. So we are the first ones to realize the importance of retail. Megafon, I would say, has been the most aggressive, acting the most aggressively in the market recently. That is why if we could reduce the level of aggressiveness of Megafon …  I guess I find it easier to answer your first question than the second.

"Convergence" is a buzzword, even in Russia
Smith:
In one of your annual reports you mentioned that Vimpelcom (NYSE: VIP  ) has been integrating fixed-line services into mobile, and they were kind of extending the same brand to envelop them all. Is that something that MTS wants to do or something you admire?

Kornya: All the key players worldwide are doing convergence, integrating fixed and mobile. This is what we're doing; this is what Vimpelcom is doing. That's something which happens in every market. It's not something unusual. Convergence is one of the answers to how to create value in the market.

Smith: Is anyone doing bundling? Any bundled deals here yet?

Kornya: Bundling -- fixed plus mobile?

Smith: Right. For example, mobile, fixed, cable, Internet, that kind of bundle? They call it "bundling" in the U.S.

Kornya: We've started doing that. Vimpelcom was doing that already. So I think there are two players in the market who are. We are not that aggressive in that activity, because full integration has not yet happened.

Smith: And what services get bundled now? Like in the U.S., you've got your long distance, you've got your cable and your Internet -- that's probably the most popular bundle.

Kornya: Well, it depends on the region, because in some Russian regions we have a presence in cable TV and fixed broadband, for example, and so we are bundling cable TV and fixed broadband. In Moscow we also have fixed voice.

In other regions, in most of the regions, we are able to bundle fixed broadband plus mobile broadband. But as we develop further, we will add to our bundling.

Smith: How big is satellite TV now, as compared to cable?

Kornya: It's not that big in the market. I can't tell you the exact figures, but we just have a couple of these big satellite TV providers: NTV-Plus and a few others. I don't think there is a big market for this in Russia.

This concludes part 3 of our conversation with MTS. Tune in again tomorrow for the final installment -- or, if you like, bookmark this page and check back tomorrow. We'll add a link here for easy access to subsequent installments as they go up.

In the meantime, did you miss parts 1 or 2 of this interview? Read them here and here.

Fool on!

Fool contributor Rich Smith owns shares of Google, but he holds no other position in any company mentioned. See his holdings and a short bio. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services have recommended buying shares of Apple and Google and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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