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Over the past several days, we've let you lean over our shoulder and listen in on our talk with Alexey Kornya, CFO of Russia's Mobile TeleSystems (NYSE: MBT ) . We've discussed how a dividend yield on par with those paid by American telecoms AT&T (NYSE: T ) and Verizon (NYSE: VZ ) came about -- and why it's both crucial to the company's investment case and to its relationship with its largest shareholder. We've discussed the universal attractiveness of the iPhone -- and why the darn thing just isn't selling in Russia regardless. And we've discussed the various risks of doing business in Russia in general -- everything from rating the competitors to gauging the risks and benefits of expanding into the "Wild East" of the former Soviet republics.
Today, in our final installment of this interview, we get down to the very nitty-gritty of MTS's business, as we wrap up our talk.
A few words for wonks
Rich Smith: Alexey, I've been going over MTS's financial statements, and one thing I noticed is that free cash flow … you all seem to define it a little bit differently from how we do it. But generally speaking, your free cash flow is 2 to 3 times reported earnings under GAAP in the United States. Is this a consequence of a lot of infrastructure having been built already and you don't have to build anymore? Or have you cut back on infrastructure during the crisis, and should we expect more spending down the road?
Alexey Kornya: There are two things to consider here. First, we require conservatism on capex spending, and second, we have a high EBITDA margin. We used to have about a 50% margin in our core telecom business. Now it has gone down to the mid-40s, but this is still a very lucrative market. If you compare it to Europe -- if you compare it to any other country's telecom operators -- they're usually straggling along in the low 30s or something like that. So I think we are enjoying so far one of the most lucrative margins.
[Editor's note: The Fool's research bears this claim out. While Telefonica (NYSE: TEF ) of Spain has a 36% EBITDA margin, 32% EBITDA margins are the norm at Telecom of New Zealand (NYSE: NZT ) and Britain's Vodafone (NYSE: VOD ) . Turkey's Turkcell (NYSE: TKC ) gets by on less than 29%. According to Capital IQ, MTS's EBITDA margin for the last 12 months was 41.7%.]
How do you say "Warren Buffett" in Russian?
Smith: I want to ask you a big picture question now, with specific implications for MTS. Right now, your foreign debt is primarily dollar-denominated, and euro-denominated?
Kornya: Yes. Primarily, it's dollar-denominated. We have 25% in foreign denominations, and I think about 90% of that is in dollars. Twenty-five percent of all debt in hard currencies, and out of that, 90% in U.S. dollars.
Smith: OK, but you've said that MTS wants to switch to more ruble-denominated debt as opposed to foreign currencies?
Smith: Back in the U.S., Warren Buffett says that he expects the dollar to be losing value over the next five, 10, and 20 years. We know that in Europe, the euro is in trouble. But if Russia's ruble is going to be stable, for example, would it not make more sense to take out debt in foreign currency and then pay it down with strong rubles? Pay down weak-currency foreign debt with strong domestic currency? Or is there some other reason for your preferring ruble debt?
Kornya: The reason is simple: We are in the telecommunications industry, and we view ourselves as the company which makes our money in telecommunications. We're not here to make money in currency speculation. So if we have 90% of our cash flow in rubles, then in order to balance this risk we need to have our debt -- our cash outflow -- also in rubles. If we were to put our debt in dollars, then we would have created a risk that had nothing to do with our business.
Now, of course I have a view similar to Warren Buffett's. I do believe the U.S. dollar will depreciate, taking into account all the quantitative reasons. And there will be inflation probably in the market and so and so forth. Still, as a business, we are making money from something else entirely. We are making it from providing telecommunications services to our customers. So we need to earn our money from that, and not from other things.
Buffett translates in any language
Smith: Thanks, Aleksey. So conversely, what's the general view in Russia now on the ruble? Is it going up, going down?
Kornya: Well, it's strengthening. It's strengthened about 5% to 10% over the last four months. But you know, it all depends very much on the price of oil. If the price of oil goes to $200, then you know, we're lucky -- everything is fine. If the price of oil is going down … well, I think the way MTS reacted during the crisis demonstrated that we are a very defensive stock.
I mean, when oil prices went down, all these companies which are exporters and which are really dependent on the oil cycle suffered. We are not in that cyclical industry. We are more stable. Still, you know, it will of course have an effect on disposable income for people, and then there is the potential that they will spend less on telecom services. But still, telecommunications is one of the things which you can't give up. That is why we believe we are quite a good defensive stock in terms of value. And the crisis showed that as well, as we remain a stable infrastructure business in times of fluctuation.
Smith: Interesting. That's something that we're always seeing, that when the price of oil goes down, everything in Russia sells off. So is there some logic to that, in that disposable incomes go down?
Kornya: Yes. You see, if oil goes down, our exports … right now our exports and imports are in balance. If you look at where Russia's trading balance is going, our export revenues are going up. But we are using these revenues primarily for the population buying imports, by car corporations importing equipment, by importing goods. So the trade balance, even though it's positive and it's growing, it's still kind of balanced.
But if the price of oil goes down suddenly, then yes -- we have a large foreign currency reserve in Russia. I think we are No. 3 in the world in terms of our foreign currency reserve, but still this will mean that our revenues as a country will go down dramatically. And we'll have cut down on imports and on workforce payments, and so on and so forth. But at the same time, if the price of oil will be stable, we'll benefit from that.
I think the main reason the price of oil is rising is because of inflation. The price of oil is kind of a reflection of inflation. Inflation comes from the fact that there were a lot of dollars printed recently, and unless these dollars go away, the price of oil should not go down. If that's the case, then we'll really benefit from having a ruble-based cash flow and being a ruble-based company.
You make the call
Heads, MTS wins from a high-inflation, high-price-of-oil world. Tails, it doesn't suffer too much, and it suffers less than many other Russian companies, if oil prices take a dive? Sounds like a good situation to me. Now that you've heard MTS's read on things, we'd like to hear what you think about the company. Vote in the poll below, and be sure to check out parts 1, 2, and 3 of this interview.