Telenor’s gutsy decision to enter the Russian mobile telecoms market brought it unexpected success, says Sophie Roell.

Moscow, 1998. Everyone is leaving town. The rouble has collapsed, the stock market is in a tailspin and the feeling of hopelessness among foreign investors is tangible: this country is never going to get it right.

Enter Telenor, a gutsy Norwegian mobile operator ready to go where others feared to tread (its international portfolio already included GSM licences in Montenegro and Bangladesh). Earlier in the year, it had started negotiations with VimpelCom, a Moscow mobile operator with a New York Stock Exchange listing, which by then was in the midst of a Russian economic crisis and a few problems of its own. As VimpelCom’s share price plummeted from $60 to less than $5, Telenor came to a bold decision: it would proceed with its investment, committing $160m for a stake of just over 25% in the company.

Five years on and another $240m in investment later, that stake is worth nearly $1bn. It is testimony to a Russian foreign investment success story and the advantages of keeping calm when doing business there.

“The prospects for Russia were not very bright at that time,” says Henrik Torgersen, vice-president of Telenor International, who conducted the 1998 negotiations with VimpelCom. He recalls being the only person on a plane flying into Moscow while the planes flying out were bulging with expatriate families going home. “People thought there would be a recession here for many years to come. And $160m was a lot of money at that time. But we did it. We had some very serious discussions within our executive management and within our board, and we thought that this was a risk worth taking.”

With Russia’s economy booming, VimpelCom’s share price is back at $62 and it has moved from being a small Moscow player to become one of the country’s three national mobile networks. The others are Mobile TeleSystems (MTS), which is partly owned by Deutsche Telekom, and MegaFon, in which TeliaSonera has a stake. With most frequencies now taken, foreign investment in Russia’s cellular operators has probably reached the end of the line. “It’s now very difficult to come into the country,” says Alex Kazbegi, head of research at Renaissance Capital in Moscow. “Vodafone would have liked to be present here but it doesn’t have a proper entry point.”

Calculated risk

At the Marriott Grand Hotel in Moscow, Göran Olson, Telenor’s chief representative in Russia, hints that the company’s foray was never a huge gamble. With Russia’s low penetration rates, and sizeable population – as well as his own observation that the crisis was a Moscow-based financial one (catching headlines internationally but not much noticed in the Russian regions) – the downside did not look too severe.

And yet, until recently, the VimpelCom investment was far from a dead cert. Not least of the company’s problems was that it had backed the wrong technology, DAMPS, before it became clear that GSM, the standard backed by rival MTS, was the one achieving success. “We were in a difficult position in the spring of 1999, with an old technology, with a need to build a presence in GSM technology, while MTS was surging ahead,” recalls Mr Torgersen. MTS quickly picked off the best customers: those travelling abroad, in need of GSM roaming and with money to spend.

Telenor sent one of its own executives, Jo Lunder, to take charge of the makeover. Mr Lunder, who had already performed much the same technology transformation for Telenor in Norway, took his time, prepared to lose market share to competitors in the belief that quality of service would win the day. “When he had the quality he needed, then he started the marketing drive and the turnaround, and that was a successful operation. But it took almost three years to do it,” says Mr Torgersen.

Pragmatism pays off

Telenor’s strategy was pragmatic and did not aim for the stars (one analyst suggests that the Norwegian company “probably didn’t really expect its Russia venture would develop into such a successful operation”). Not for Telenor the high-end of the Moscow market, which MTS had already occupied anyway. Instead, it aimed for the capital city’s mass market and in particular pre-paid mobile phones.

“Prior to that, mobile service was considered a luxury,” says Dmitry Vinogradov, an analyst at Brunswick UBS in Moscow. “But afterwards it started to be a product that everybody uses. That was Telenor’s idea.” Pre-paid phones now account for 90% of VimpelCom’s customer base and are a key source of growth for both VimpelCom and its rivals. Overall, VimpelCom has a 52% market share in Moscow.

“We are convinced that, at the end of the day, this is a volume game and, although we would also like to have the big spenders as our customers (everyone always wants that), the real economy is related to getting the volumes, especially in a country like Russia with 150 million people,” says Mr Torgersen.

Providing service to that population, stretched out over the vastness of Russia’s 11 time zones, is fast becoming a reality for VimpelCom. Russia’s provincials are not proving too poor to get mobile phones or spend money chatting on them. That was unexpected but, as Mr Lunder said when VimpelCom announced its latest results: “It is now evident that the regions are growing faster than Moscow.” The devaluation of the rouble has unleashed a spurt of growth among the industries scattered around the vast country, and Moscow and St Petersburg are no longer the only story.

Surprisingly, Telenor, which was so gutsy when the country was in crisis, opted for caution as the economy improved. Faced in 2000 with the decision of whether or not to finance VimpelCom’s growth beyond Moscow, the company decided it would not. Instead, it brought on board a Russian partner, the powerful Alfa Group, to pay for the expansion through a separate company, VimpelCom-R.

Partnerships pros

Analysts do not think that getting Alfa Group, an oil and banking conglomerate controlled by billionaire Mikhail Friedman, on board as a partner was necessarily a bad thing. They say that regional expansion probably would have been hard without it. Through its nationwide banking network, Alfa has political clout and experience in the regions that Telenor does not. Analysts also speculate that Alfa’s involvement was critical to VimpelCom getting an operating licence for the north-west and Urals region, which includes St Petersburg and hence is essential for any operator with national ambitions.

With VimpelCom and VimpelCom-R in the process of merging, Alfa looks set to do better than Telenor out of the deal. It will control 32.9% of VimpelCom’s voting stock, compared with Telenor’s 26.6%. As Mr Vinogradov says: “The merger terms that shareholders of VimpelCom-R received are, well, I wouldn’t say too generous – but they reflect the fact that the economics of the cellular projects in the regions are very, very attractive. And back in 2000, Telenor was very slow to recognise that regional potential.”

“We never look back,” Mr Torgersen says of what could be seen as a missed opportunity. “It was a business decision. We and our analysts did not expect the kind of growth in the regions that we saw later. And, partly because we did not see the kind of growth that we now see, the upside also looked limited. We knew that it could be a business but that it was a business with certain limitations, and we also knew that it was going to be difficult.”

Political taint

Predicting what the economy is going to do is one thing; in Russia politics is almost always the greatest source of uncertainty and attracts the most feverish attention from the business community. Telenor has not emerged unscathed. The most public incident took place two years ago, when the Ministry of Telecommunications decided, arbitrarily, to withdraw a certain frequency band from both VimpelCom and MTS. MTS manoeuvred its way out of trouble, but VimpelCom handled the situation by causing a big stink in the press. In the end, the ministry reversed its plans but the incident was not forgotten.

“It eventually blew over but the costs associated with Telenor’s very public airing of the dispute were high,” comments one analyst. He intimates it was part of the reason that rival MTS, which is perceived to be more Russian, was given the much-coveted St Petersburg licence before VimpelCom.

Mr Torgersen disagrees. He says that it was Telenor’s status as a foreign investor – and a long-term and committed one – that saved the day. “We don’t want to overestimate it, but we do have certain leverage with the Russian authorities,” he argues.

Uncertain future

The biggest question now is not what the Ministry of Telecommunications is planning but rather what Telenor’s partner, Alfa Group, is up to. The latest barrage of speculation was triggered by Alfa’s purchase in August of a 25% stake in MegaFon. Is this a conflict of interest? Is it a prelude to a merger of the two companies on Alfa’s terms? Is it going to turn into another example of the foreign investor getting a raw deal? At this stage, no one knows, possibly not even Alfa.

At Telenor, Mr Torgersen refuses to be fazed by the speculation. As the mobile industry expands into a multi-billion dollar business, the pressures on the government to favour certain players will be huge. But so far, he is satisfied. “We think that so far the market conditions and the regulatory environment we have experienced have been fair, and we think the Russian authorities are quite serious about creating an investment environment that foreign investors think is fair.”