A Phone System So Bad It's Good For Investors

To get an idea of just how backward the Moscow telephone system is, try calling the headquarters of the local phone company. It can take seven hours of nonstop dialing to reach someone at Moscow City Telephone Co. (MGTS). But that kind of service doesn't seem to be bothering investors. As bizarre as it may seem, MGTS is Russia's highest-priced stock. Shares offered at 50 cents a year ago now trade for an astounding $217.50.

Actually, investor fascination with the Russian telephone business makes a lot of sense. After natural resources, telecommunications is one of the biggest and hottest markets in Russia. Opportunities abound, not just for equity investors but also for foreign suppliers of equipment and services. Case in point: Only 15% of the country's 280 million residents have phones, and the wait for a line can take years. "The market for mobile communications is more than doubling every year," notes Hassan Tavakoli, acting country manager for Motorola Inc. in Russia.

LOOSE WIRES. Now, the push is on to meet the growing demand. Players from AT&T to Siemens are grabbing equipment orders while U S West and Hughes Network Systems are setting up cellular and long-distance ventures (table). Direct foreign investment could exceed $500 million this year, vs. $665 million between 1992 and 1994. "Growth will be quicker and faster in the future," says Jan M. Goemans, managing director of AT&T Network Systems Russia.

But there's a loose wire or two in this market. Russia's primitive financial system and bureaucratic mind-set create problems. Local phone companies won't have enough money to pay for big upgrades until they are privatized and the rate structure is reformed. Equipment vendors often have to finance sales themselves because the purchasers can't get loans from Russia's banks. Last year, AT&T took fertilizer as payment for a voice and data network it sold to the city of Murmansk. And Russia's fees for certifying equipment for use are 10% higher than those in Western Europe.

Given such problems, foreigners are focusing on smaller deals. They are shying away from investments in the existing local network because upgrading the old system would cost billions of dollars with no paybacks for 10 to 15 years. Instead, they are jumping into international, cellular, or long-distance services that require less investment and can turn a profit in a few years.

High profit margins on cellular are making Russia one of the most lucrative markets for wireless phone providers in the world. Muscovites pay up to $5,000 to get a cellular phone connected, compared with $30 in the U.S. Russian businessmen are willing to pay the sky-high prices. "It's a bit of a status symbol," says Elizabeth L. Hamburg, an official of an investor group that holds a major stake in Vimpelcom Cellular Groupe. Earlier this year, Vimpelcom had to turn away customers when it ran out of capacity. Of the Moscow company's 10,000 subscribers, 95% are Russians. And they like to chat. Hamburg says the company earns $300 per month from each subscriber, compared with $70 to $100 in the U.S.

"VERY RISKY." Equipment suppliers such as AT&T, L.M. Ericsson, and Nokia Telecommunications are also enjoying an upsurge in sales. A few, such as Siemens and Alcatel, have put money into manufacturing joint ventures. Others are holding off. "We think this market is still very risky," says Osamu Watanabe, head of NEC Corp.'s Moscow office.

If Russia is to attract the billions of dollars it needs to modernize its phone network, it must continue to privatize its 86 local phone companies. A good starting point is a recent proposal by the Communications Ministry: Each local company would contribute 38% of its shares to a new company called Svyazinvest, making it a kind of phone company mutual fund. In turn, foreign investors could buy shares in Svyazinvest. However, this venture could be undone if a June recommendation to scale back privatization in telecoms and energy ventures is approved by the government.

One thing is certain: Politicians see value in telecom stocks. When MGTS auctioned off a 25% stake last spring, the winning bidder was a partnership created by the Moscow City government and Mayor Yuri Luzhkov.

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