There's an interesting move going on in Russia these days, and it has nothing to do with oil, natural gas or mineral resources.

The country's telecommunications sector has long been a preferred destination of foreign portfolio investment, with a handful of internationally listed firms in both the fixed line and the wireless sectors.

Now, two of these - wireless operator Vimpel Communications (NYSE:VIP) and integrated voice, data and internet service provider Golden Telecom (Nasdaq:GLDN) - are in talks that could lead to VimpelCom taking a 44% stake in Golden Telecom, en route to a possible controlling majority.

Such a move could produce a dominant Russian telecom player with the potential to expand into other attractive regional markets.

The Wild, Wild East

Russia's business culture is as colorful in the telecom sector as anywhere else in the country. The wireless sector is dominated by three players - VimpelCom, MTS Mobile TeleSystems (NYSE:MBT) and MegaFon OAO. Between them, they account for 87% of the country's 154.4 million subscribers as of June 2007.

Alfa Group, one of the large diversified industrial conglomerates known famously as "oligarchs", owns 44% of VimpelCom and also owns 26% of Golden Telecom. AFK Sistema, another giant conglomerate, is the principal shareholder in MTS Mobile. These shareholders have deep pockets (they all count valuable oil and resource interests among their holdings) and are intensely competitive with each other.

Alfa also has a foreign strategic partner, ASA Telenor of Norway, that is a co-investor in both VimpelCom and Golden Telecom. With the competitive structure of the wireless market fairly well established, Alfa and Telenor have been looking for other ways to increase their standing in the telecom pecking order.

Complementary Skill Sets
A merged VimpelCom/Golden Telecom would occupy an impressive position in all the major liberalized sectors of Russia's telecommunications market. VimpelCom has a 32% share of the wireless market, second to MTS' 34% and well ahead of MegaFon's 21%.

I should add that the 154.4 million subscribers (as of June 2007) exist in a country whose total population is 141.4 million, implying a penetration rate of 109.2%. That penetration rate is actually much higher in the two major markets of Moscow and St. Petersburg. As elsewhere in Europe, Russian mobile telephony has grown at an explosive pace since the latter part of the 1990s.

On the other hand, Golden Telecom has a strong position in the lucrative business-consumer-services and carrier-operator-services sectors, where it provides integrated voice, data and internet services and solutions. It maintains connectivity points of presence in 18 of the 20 largest regional markets, accounting for about 50% of Russia's fixed-line telecom traffic.

Sector in Favor
The stock market has rewarded Russian telecoms so far this year. While the MSCI Russia Country Index has appreciated a scant 3.03% year to date, VimpelCom and MTS are both up more than 40% and Golden Telecom by more than 30%. At these levels VimpelCom is not cheap, with a P/E ratio of about 24 and a price-to-book ratio of around 5.

MTS is a bit cheaper from an earnings standpoint, with a 19.5 P/E ratio, although at 5.62-times book value, it is slightly more expensive on a price-to-book basis. Moreover, there is a great deal of country risk in any Russian telecom stock, as the vast majority of revenues are derived from either Russia or other major former Soviet Republics such as Kazakhstan (where VimpelCom has a 50% wireless market share), Ukraine, Belarus, Azerbaijan and Armenia.

In the telecom markets of Eastern Europe and the former Soviet Union, competitive advantage is likely to come from two primary sources:

  1. Leadership in integrating technology and service platforms targeting the more lucrative market segments
  2. Market share growth through expansion into new business and geographic markets

Wireless penetration levels are over 100% in most countries in this region, so, for mobile providers especially, it is imperative to position for growth in other segments.A combined VimpelCom-Golden Telecom would seem to have the basic ingredients in place to carry this out.

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Tickers in this Article: VIP, GLDN, MBT

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