Rostelecom CEO Says Tele2 Russia Deal Will Create Value

OAO Rostelecom (RTKM) Chief Executive Officer Sergey Kalugin made his case for the planned combination of the state-run phone company’s mobile assets with Tele2 Russia, saying the deal will boost their competitiveness.

“Combining our mobile assets with Tele2 Russia, we will increase their value,” Kalugin said yesterday in an interview at Rostelecom’s headquarters in Moscow. “The combined business will grow faster under Tele2 management, which has proved its ability to develop regional mobile networks efficiently.”

Rostelecom is working with Tele2 Russia owners including state-run VTB Group (VTBR) to combine the two wireless operations, with Rostelecom owning 45 percent of the venture and Tele2 Russia the rest, Kalugin said. The merged carrier -- set to be worth about $7 billion, according to Otkritie Capital -- will be a stronger rival to OAO Mobile TeleSystems (MBT), OAO MegaFon (MFON) and VimpelCom Ltd. (VIP) as the market benefits from rising mobile Web-browsing.

The deal also lets Rostelecom focus on building its fixed-line operations into a phone, Internet and television service resembling Comcast Corp. (CMCSA), he said. A more focused fixed-line provider is better equipped to take advantage of rising online video demand.

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Tele2-branded sim cards sit on display at a Tele2 Russia Holding AB retail store in Nizhny Novgorod, Russia. Close

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Tele2-branded sim cards sit on display at a Tele2 Russia Holding AB retail store in Nizhny Novgorod, Russia.

Rostelecom seeks to split off its wireless business to a separate entity by the end of the year, a major step toward the tie-up, Kalugin said. The combined carrier may have an initial public offering in a few years -- in which case Rostelecom would have the right to boost its ownership to a controlling stake, said Kalugin, 47.

Raising Concerns

“As the government convened a shareholder meeting to split off mobile assets -- a step toward a merger with Tele2 Russia, it’s highly probable the merger will be approved by year-end,” Kalugin said. “That’s my opinion as a CEO, while the government will have to decide.”

The Russian government raised concerns that Rostelecom may lose control of its mobile business after the Tele2 Russia combination, Kommersant reported this week, citing Federal Property Management Agency documents.

Rostelecom rose 1.2 percent to 112.12 rubles at 5:19 p.m. in Moscow. The stock has lost about 7 percent this year, valuing the company at almost 300 billion rubles ($9 billion). Tele2 Russia is closely held by lender VTB, which bought the Russian unit of Sweden’s Tele2 AB (TEL2B) for $2.4 billion this year, and investors including President Vladimir Putin’s billionaire ally Yury Kovalchuk.

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Employees work in the reception area of the OAO Rostelecom headquarters in Moscow. Close

Employees work in the reception area of the OAO Rostelecom headquarters in Moscow.

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Photographer: Andrey Rudakov/Bloomberg

Employees work in the reception area of the OAO Rostelecom headquarters in Moscow.

Removing Risks

“Merging the wireless business with Tele2 Russia makes sense as Rostelecom has been less efficient in rolling out mobile networks,” said Alexander Vengranovich, an analyst at Otkritie. “By relying on the Tele2 team in mobile expansion Rostelecom removes risks, while remaining open to an upside.”

Tele2 Russia and Rostelecom together have more than 37 million mobile customers, trailing the 58 million to 73 million users at the larger competitors, according to AC&M Consulting.

In contrast to Western Europe, the Russian wireless market is expanding as more consumers browse the Web on smartphones and tablets. Russia’s mobile revenue climbed 9 percent last year, as data revenue surged 33 percent, according to AC&M.

Excluding its mobile unit, Rostelecom plans to boost sales 2 percent to 3 percent a year on average through 2018, though next year the increase may be higher than that, Kalugin said.

Fixed Growth

The company plans to upgrade the so-called last mile, or the part of its network connecting households to its core infrastructure, to fiber-optic technology. That will provide as many as 20 million households broadband access at speeds of 1 gigabit a second in two years, Kalugin said.

Rostelecom is set to offer so-called triple-play services, combining phone, TV and Internet, in the second half of 2014, Kalugin said. The company is working with content providers to offer exclusive high-quality content to attract users. It already agreed to provide programming from Stockholm-based Modern Times Group AB (MTGB)’s Viasat and local Gazprom-Media.

A focus on broadband should boost the multiples Rostelecom is trading at, Kalugin said. Comcast’s enterprise value is about 7.7 times its earnings, while for Rostelecom that number is 4.3, according to the Russian company. Comcast, the largest U.S. cable company, has boosted its market value by about a quarter this year to $123 billion amid broadband-user gains.

Investor Buyout

Last week, a Rostelecom unit acquired 7.5 percent of the company’s shares from investor Konstantin Malofeev at a premium, prompting criticism from the investor community and sending its stock lower.

Kalugin said Malofeev, who was a backer of Kalugin’s predecessor, was a “controversial shareholder.” It’s “common practice” to pay a premium to buy out large shareholders, and the premium Rostelecom paid was less than another investor was offering Malofeev earlier this year, Kalugin said. Julia Emm, a spokeswoman for Malofeev in Moscow, declined to comment.

Kalugin joined Rostelecom in March after Russia’s government urged it to replace CEO Alexander Provotorov, who previously worked for Malofeev’s Marshall Capital.

Kalugin was previously CEO of cable provider National Telecommunications, which Kovalchuk sold to Rostelecom in 2011. Prior to Rostelecom, Kalugin co-owned Web-movie service Zoomby.

As a result of the Malofeev buyout and previous purchases, Rostelecom has about 17 percent of its stock on its balance sheet as so-called treasury shares.

Rostelecom is proposing to sell treasury shares next year, Kalugin told reporters in Moscow this week. The sale may take place in a secondary public offering and will include stock bought from Malofeev, Kalugin said.

“We as management are proposing to sell treasury shares in an SPO next year in Moscow or London, depending on market conditions,” Kalugin said yesterday. “The government has to make a final decision on this.”

To contact the reporter on this story: Ville Heiskanen in Helsinki at vheiskanen@bloomberg.net

To contact the editor responsible for this story: Kenneth Wong at kwong11@bloomberg.net

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