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Mobile Telesystems OJSC (NYSE:MBT)

Q2 2013 Earnings Call

August 20, 2013 10:00 am ET

Executives

Joshua B. Tulgan - Director of Investor Relations and Acting Director of Corporate Finance

Andrei A. Dubovskov - Chief Executive Officer, President, Member of Management Board, Director, Member of Disclosure Committee, Member of Strategy Committee and Member of Corporate Conduct & Ethics Committee

Alexey Valerievich Kornya - Chief Financial Officer, Vice President, Member of Management Board and Chairman of Disclosure Committee

Vasyl I. Latsanych - Vice President of Marketing, Member of Management Board and Member of Disclosure Committee

Analysts

John-Paul Davids - Barclays Capital, Research Division

Alexander Kazbegi - Renaissance Capital, Research Division

Herve Drouet - HSBC, Research Division

Alexander Balakhnin - Goldman Sachs Group Inc., Research Division

Dalibor Vavruska - Citigroup Inc, Research Division

Ivan Kim - VTB Capital, Research Division

Anna Lepetukhina - Sberbank Investment Research

Anna Kurbatova - BCS Financial Group., Research Division

Imari Love - Morningstar Inc., Research Division

Operator

Good day, and welcome to the Mobile TeleSystems Second Quarter 2013 Financial and Operating Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Joshua Tulgan. Please go ahead, sir.

Joshua B. Tulgan

Thank you very much, and everyone, welcome. Before beginning our discussion today, I would like to remind everyone that except for historical information, comments made during this call may constitute forward-looking statements which may involve certain risks. These statements may relate to one of the following issues: the strategic development of MTS's business activities, both in Russia and abroad; revenue and our subscriber dynamics; financial indicators such as operating income before depreciation and amortization or cash flow projections; operating indicators like average revenue per user, or value added services indicators; debt instruments and their usage; legal actions or proceedings directed at the company or its representatives; regulatory developments and their impact on the company's operations; technical matters as they pertain to our communications networks, including equipment licensing or network technologies; activities and lines of business that complement our communication networks; capital expenditures and operating expenses and macroeconomic developments within our markets of operation. A comprehensive overview of these issues is available in our Annual Report or Form 20-F, which is available on our website or through the U.S. SEC. Important factors could cause the actual results to differ materially from those contained in our projections or forward-looking statements. These statements may include company press releases, earnings presentations, our Form 20-F, as well as any other public filings made by the company with the United States Securities and Exchange Commission, all of which are available on the company website, www.mtsgsm.com, or that of the U.S. SEC at www.sec.gov. MTS disavows any obligation to update any previously made forward-looking statements spoken on this conference call or made any adjustments to previously made statements to reflect changes in risks. Copies of the presentations and materials used and referenced in this conference call are available on our company website. I'll now turn the call over to Mr. Andrei Dubovskov, President and Chief Executive Officer of MTS.

Andrei A. Dubovskov

Thank you, Josh. Ladies and gentlemen, thank you for joining us on today's conference call to discuss the company's financial and operating results of the second quarter 2013. Joining me today are Alexey Kornya, Vice President, Chief Financial Officer; and Vasyl Latsanych, Vice President, Chief Marketing Officer.

Overall, in the Q2, we witnessed the continuation of the positive operating trends we have seen over the past year. With the deconsolidation of our Uzbekistan operations and the adjustments retrospectively of past financial results, group revenue increased 5% year-over-year. In Russia, our revenues increased 4% year-over-year to 8 -- RUB 86.5 billion. Revenue was boosted by strong performance of our mobile and fixed operations. Mobile service revenues increased by 6% year-over-year to RUB 66.2 billion. Key growth factors include increased data adoption and further monetization of data traffic and messaging revenues.

As we discussed last quarter and over this quarter call, we firstly focus the strategy of our retail outlets to boost sales of lower-priced smartphones to drive further mobile Internet penetration in our subscriber base. Overall, smartphone penetration increased to over 37% on our networks. Our decision to reduce sales of smartphones is the key reason why revenue growth slowed year-over-year. Quarter-on-quarter, sales of handsets grew slightly to RUB 5.8 billion.

We continue to see market-leading growth in data traffic revenue, which grew 40% year-over-year. The growth was attributable to a number of factors, including the expansion of our data networks switch now at around 42,900 2G and 29,800 3G-based stations, as well as more than 2,000 LTE-based stations; improved downlink speeds through the deployment of HSPA+ and dual-carrier technology; the growing penetration of smartphones on the MTS networks; the success of new Smart family of tariff plans for accessing Internet from smartphones, which enabled us to double data usage compared to other prepaid tariff plans; partnership with the vendors to offer embedded mobile Internet services for customers purchasing certain smartphones and tablets in the MTS retail network; growth in the sales of app-enabled MTS branded smartphones priced between RUB 1,800 and RUB 4,600, which also already accounts for over 10% of smartphone sales in the MTS retail chain, and threefold year-on-year increase in the penetration of tablets, driven by the sevenfold increase in sales of tablets in the MTS retail chain as we increased sales of Samsung and Apple tablets and expanded our product portfolio with low-budget devices.

In Q2 2013, minutes of usage increased by 7% compared to the second quarter of the previous year. The increase is reflective of the rising share of tariffs with free on-net calling, namely Super Zero and Super MTS. Around 50% of subscriber base has already immigrated to this tariff. This translates into greater customer loyalty and a dramatic reduction in churn. During the quarter, churn rate decreased to 9.4% compared to 10.5% in Q2 2012. For the second quarter in a row, we demonstrate single-digit level of churn, which is a level we haven't seen since 2009.

Content revenues declined by 11% year-over-year due to the discontinuation of promotional campaigns relative to Q1 2012 and introduction of further measures to restrict non-solicited SMS-based services. This has led to a strong improvement in customer experience. This and other CRM-related activities have led to a threefold decrease in customer complaints since the first half of last year. This naturally is one factor that helped us to improve customer loyalty.

Messaging revenues again improved in Q2 2013 by 15% year-over-year as migration from feature phones to smartphones leads to increase in consumption of voice, data and messaging services. The quarterly decline in messaging revenues resulted from seasonal factors similar to previous years.

Our fixed line operations showed strong performance in spite of sustaining competitive pressures. Fixed line revenues increased 4% year-over-year to RUB 14.4 billion. Key growth drivers included network modernization in the regions. This enables us to migrate customers from a DSL to FTTB solutions. More than 85% of households based outside of Moscow are now connected via FTTB technology. We also continued to allow our digital TV platform offering up to 160 channels, including HD channels. The platform is already commercially launched in more than 80 cities out of 150 cities where we have presence in the fixed line services.

In Moscow, we're happy to report strong progress in implementation of our GPON project. As of today, we have around 1 million households basic and 40,000 -- 50,000 household subscribers actively using our GPON-enabled services. In our subscriber base, we see roughly 30% of households using bandwidth fixed line telephone and broadband Internet services. Overall, fixed line residential ARPU increased 5% year-over-year. Corporate ARPU increased 20% year-over-year due to 2 factors: we introduced new value-added services such as VPN functionality and other intelligent products and the launch of a number of B2B services, part of which constitutes a one-time revenue contribution from launch of projects in Moscow.

In Ukraine, we increased revenue by 5% year-over-year to UAH 2.5 billion. The growth was driven by an increase in the subscriber base and higher usage of value-added services. Data traffic revenue increased by 40% in spite of the absence of UMTS regions in the market. However, this increase was partially due to a reclassification of revenues from bundles. In Armenia, we increased revenue by 4% year-over-year, up to AMD 90.8 billion. Drivers include our continued effort to drive voice usage, as well as the focus on promotion of data usage from smartphones and tablets, and this retains the leadership position in the market with market share of 63.9%. And in Turkmenistan, we delivered a sequential 30% increase in revenues up to TMT 62.6 million. ARPU increased by 14% compared to Q1 2013. The growth was driven by a promotion of tariffs stimulating on-net calling. Our market share remained stable during the quarter. Going forward, we plan to end tariff investments in 2G and 3G networks as they'll make additional investments in our IT services to improve customer experience.

Now, Alexey Kornya will further discuss the group's profitability and financial performance.

Alexey Valerievich Kornya

Thank you, Andrei. In second quarter 2013, group OIBDA increased by 10% year-on-year, up to RUB 44.4 billion. As Andrei related, we deconsolidated Uzbekistan during second quarter and separately stated historical numbers. Nevertheless, our strong OIBDA growth rate is attributable to both organic and inorganic factors. In second quarter 2013, group OIBDA margin increased by 1.9 percentage points year-on-year to 45.5%. Organically our OIBDA margin increased relative to first quarter 2013, yet we realized about 200 basis points of improvements due to a number of one-off factors year-on-year, including the receipt of RUB 125 million in relation to our global settlement of issues related to litigation surrounding our acquisition of Bitel in 2005, which impacted OIBDA in the amount of USD 27 million, and accounted for roughly 1/2 of our inorganic OIBDA margin gain. A positive impact from an accelerated recognition of discounts for all the costs normally realized in the third quarter, which will lessen the positive impact from roaming we normally see in third quarter. And there is also some accrued expenses due to a lower realization in costs in P&L -- of costs in P&L, including inventories and other factors.

In Russia, OIBDA rose by 6% year-over-year to RUB 39.2 billion. For the quarter, we delivered strong OIBDA margin of 45.4% compared to 44.6% margin in second quarter 2012. We are seeing margin improvements due to rising -- raising data traffic revenues in total revenues in reduced handset sales. Our top line performance in rising data consumption and continuous cost control initiatives continued to offset inflationary pressures such as rising personnel costs, higher [indiscernible] and network maintenance costs.

In the Ukraine, OIBDA increased by 6% year-over-year to UAH 1.3 billion. The growth was reflective of increasing contribution of high-marginal data services in total revenues and overall cost control. Overall, our OIBDA margin in Ukraine continues its upwards trend and registered an impressive 52.5%. In Armenia, our OIBDA for the second quarter came in at AMD 10.4 billion, which translated into a healthy margin of 52.3%. Our OIBDA dynamics was in line with the top line growth. In Turkmenistan, we generated OIBDA of TMT 20.7 million, for a margin of 33.1%, an improvement of nearly 600 basis points from our first quarter performance.

In second quarter, net income rose to RUB 29 billion. As I explained, we realized a positive gain due to our settlement of Bitel through reversal of provisions for the acquisition of 49% stake of Tarino Limited, the owner of Bitel in 2005, in the amount of USD 223 million, as well as the USD 125 million in compensation we received in cash. At the same time, we witnessed a noncash ForEx loss in the amount of RUB 3.1 billion due to weakening of the ruble versus the U.S. dollar and euro and its impact on our debt variation.

During the quarter, our total debt increased to RUB 247 billion as MTS stepped in local and international capital markets. In April 2013, we placed our first exchange-traded ruble bond in the amount of RUB 10 billion. In May 2013, we returned to the international market successfully completing Eurobond offering in the amount of USD 500 million. In June 2013, we repurchased our 03-series ruble-denominated bond in the amount of approximately RUB 2 billion and after the reporting period, RUB 3.20 billion in behavioral loan facilities. During the quarter, in order to reduce exposure to currency risk on short-term loans, we also completed an early redemption of a number of behavioral loans in the total amount of 35 -- USD 32.5 million. Since the beginning of the year, we have also concluded ForEx changes on roughly USD 600 million of our U.S. dollar-denominated debt.

Our net debt to last 12 months' OIBDA ratio came down quarter-over-quarter to 1.0 due to improvement in operating performance and our success in maintaining the portfolio through early redemption of loans, repurchase of bonds and the timely advantages placed in the securities.

Free cash flow for the first half of the year improved to RUB 45.2 billion, a 34% increase over the first half of 2012. During the quarter, we confirmed our commitment to increase shareholder return. In early August, MTS Board of Directors set the date for the company's extraordinary general meeting of shareholders for September 30, 2013. The board also recommended that the extraordinary shareholder meeting approve semiannual dividend of RUB 5.22 per ordinary MTS share, RUB 10.44 billion -- RUB 10.44 per ADR, amounting to the total amount of RUB 10.8 billion on the basis of company's first half 2013 financial and operating results. In the recommendation, which is approved by the Board of Directors, MTS will pay out around RUB 41.0 billion in 2013 calendar year. This is in line with our new dividend policy that calls for distribution in the form of dividends of the amount equal to at least 75% of free cash flow for the relevant financial period or if greater, RUB 40 billion per year.

Andrei A. Dubovskov

Thank you, Alexey. Regarding guidance, with the half year past, we are comfortable reiterating our revenue guidance. We see growth in our core markets of 5% to 7%. Factoring in the effect of the deconsolidation of our Uzbekistan subsidiary, this should imply 5% to 7% growth for the group as well. Key factors in determining this growth remain: stable voice revenues, increased adoption of data services and sustained sales of smartphones and subscriber dynamics. For OIBDA, we are pleased to raise our OIBDA margin guidance to over 43% for the year, considering our strong organic performance in the first half of the year, our one-off gains in Q2 related to the settlement of our Bitel legal case and other factors, seasonal factors and continuation of the current stable competitive environment.

Over the next 2 to 3 years, we should see a comparable improvement in our margin for the period of 2013-2015. We believe that our OIBDA margin will be in the range of about 42%. For now, we also reiterate our company's guidance of 20% of revenues or approximately RUB 80 billion. We continue to improve our 3G networks and will begin a broader rollout of our 4G/LTE later this year. Towards the end of the year, prior to or during our Q3 disclosure, we will revisit CapEx spending. Russian M&A activity in the market will require us to examine our plans in the context of overall development for 4G/LTE networks. We are currently evaluating whether or not it will be necessary to further invest in our networks and accelerate our rollout of LTE. And we will report later on if any impact this may have on our CapEx spending in 2013 and 2014.

Overall, we are successfully executing on our 2 key commercial goals. The first is driving data growth. Our roughly 40% growth in data revenues reflects higher usage and increasing adoption on our network, using our retail network as a platform. We are focusing on the sales of lower-priced smartphones to drive greater data adoption. This is critical because we believe that future growth in mobile service revenue will be driven by the migration of customers from feature phones to smartphones. On average, we see an increase in the customer spend on data services of over -- of well over 2x when someone upgrades their phone from a feature phone. With sales of smartphones in our network now at roughly 38%, we see smartphone penetration increasing by 1% per month. This translates into sustained revenue gains.

Over the past 6 quarters, we have also introduced new tariff designs to both stimulate usage and monetize data services. Our Smart and Super Zero family of tariffs posted bundles to leverage rising voice usage to encourage more SMS and data revenue. Year-over-year, we see a 3 percentage point increase in the number of customers who use data services. The data tech rate now exceeds 40% of our subscriber base and reached the market. Network quality is also a key element of data growth. Since the end of 2011, we have expanded our 3G network by nearly 50% and launched 4G services in Moscow and also in Russia. This allows customers to use our data solutions at home, at work and points in between, like weekend data. Driving loyalty is the second element of our commercial policy. Since 2011, we have reduced our quarterly churn by nearly 3 percentage points. In addition to the improvement in sales channels, we have discussed before on these calls, a core driver of our improvement is higher voice usage. As we described, voice usage creates affinity, which encourages the use of other products, but also creates a network effect.

Increased voice calling brings customers to the network by increasing the value that they receive from on-net calling. It also pulls more people into their networks and our networks, and customers become thicker and less likely to churn. We have also taken a wide range of measures to improve the customer experience. This includes mitigating the negative impact from unsolicited SMS and content services through anti-spam measures and stricter review of services to better protect our customers. Further investments in IT security systems and customer relationship management services, overall, has allowed us to improve our customer experience. For example, complaints about unsolicited SMS are now 3x less than they were 1 year ago, and we continue to improve our networks. Average download speeds have improved nearly 3x since 2011.

Overall, our focus on data growth and improving customer loyalty has formed the core of our commercial strategies for the past year. This has allowed us to sustain our growth by delivering greater value for both our customers and shareholders. By the end of this year, we will present to our Board of Directors and shareholders a new strategy to better the present alignment of development in our core markets and the financial strategies for subsequent years. But until then, we continue to deliver on creating value in our markets.

Thank you for your attention, and with that, I would like to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] We will now take our first question today from J.P. Davids of Barclays.

John-Paul Davids - Barclays Capital, Research Division

I'll start with 2 questions, please. The first one, in your outlook and in your CapEx section, you referred to market developments, recent market developments. Can you be a bit more specific about what you are talking about there that is causing you to review your CapEx projections? The second question, please, is on your new Smart tariffs. Can you talk a little bit about what impact these are having on customers, particularly if you've got any anecdotes in terms of ARPU development as a customer migrates onto these tariffs if you're seeing a positive ARPU development on Day 1.

Alexey Valerievich Kornya

Andrei, let me take the first question. It's Alexey Kornya. We are, right now, moving through the process of revision of our strategy, which is the normal annual process, so there is nothing extraordinary. And this will be brought to the Board of Directors in the September, October. So we expect that after this discussion, we'll have more visibility towards our midterm perspectives. And that includes also the CapEx section. So far, we do not expect any dramatic changes or significant changes in our CapEx guidances. However, we want to reserve for ourselves the room to return to this topic, specifically following market developments, which is customer adoption of data tariffs and so on and so forth. And that includes also recent deal between MegaFon and Scartel recently announced transaction. So we do not -- again, we do not expect any significant change towards our CapEx outlook at this stage. Still, we reserve ourselves some right to return to this topic.

Andrei A. Dubovskov

It's Andrei Dubovskov. I just want to add some points of view. We do not understand why we need to revise dramatically our CapEx, speaking about Scartel and MegaFon deal because, in our opinion, in each Russian regions, we'll be the only one competitor named MegaFon/Scartel instead of 2 competitors, which we have right now.

Vasyl I. Latsanych

The second question will be taken by myself. This is Vasyl Latsanych. The Smart tariffs are something we put a crate back on because we do believe that the people should be using much more data and that should be not restricted in voice tariffs than they are using data because data provides us higher marginality and better stickiness when it's used together with voice. Regarding the anecdotal or general performance, the Smart tariffs came instead of previously known Maxi tariff plans, Maxi tariff family. And with the introduction of Smart tariffs, we have doubled the share of such tariffs, integrated tariff plans and fully integrated tariff plans in our general share of the -- in general tariff mix. That comes on the backdrop of some 20% decrease of the ARPU amongst the customers who are now connected to Smart versus those that connected to Maxi before. But at the same time this doubling of the total number -- of the total number of customers connecting to this tariff gives us as an uplift because the other part comes from -- the other half comes from the tariff plans from the segments that were using cheaper tariff plans in the past, and we have more than 50% uplift versus the previously used tariff plans of mid to low segments before launching the Smart. So in overall, we do have a healthy uplift in average ARPU of higher-range tariffs when we talk about Smart, though it is in the segments slightly lower than it used to be before, but the segment got twice bigger.

Operator

Our next question today comes from Alex Kazbegi of Renaissance Capital.

Alexander Kazbegi - Renaissance Capital, Research Division

Can I maybe again touch base on the CapEx side? Do you mind splitting, so to say, roughly what amount has been spent so far -- or for the full year actually on GPON on pay-TV? So to say not just the fixed line, not the sort of transmission side, but mostly on the GPON and pay-TV. And if I understand correctly also you are planning to increase those spending on the GPON to finish the project this year. So I should be assuming that from the next year, the fixed line spending, again non-transmission-based spending, probably will come down. Is that so to say the right understanding and expectation? And also related to that, is it possible as well that towards the end of the year, you could revise CapEx actually downwards rather than upwards given that you have quite a task to invest quite a significant amount in the second half of the year given how much you spend in the first half? Secondly, just on the, so to say, subscriber additions, generally the pace of subscriber additions you see on your network vis-à-vis competition. Do you think there is a need again to increase the subscriber additions on your side? Are you, so to say, generally happy with the overall coverage in terms of the sales points in terms of your, so to say, distribution channels? And lastly, just on the dynamics of the average smartphones, I mean, you gave us the range in terms of the smartphones you sell on the network, but I was wondering if the average prices generally, what is the tendency there, they're raised in terms of customer spending more per smartphone or it's actually coming down?

Alexey Valerievich Kornya

Thank you for the question. Let me take the one on the CapEx. This is Alexey Kornya. So the total amount of CapEx spend in our fixed business, including GPON and MGTS spend is around about 20%. We do not expect that this size will sizably increase looking forward. At the same time, we do not expect to slow down or to decelerate our investments in GPON. So we believe that our project is going on track and will just continue. We do not see any reasons for revision of our CapEx guidance for this year downwards as well because we have normal seasonality related to buildup cycle where you have a higher CapEx spend in the second half of the year versus the first half of the year, so we are going on track with our guidance, CapEx guidance for this year and we're just maintaining that.

Vasyl I. Latsanych

This is Vasyl, and I will try to answer for the next 2 questions. The first one is about the acquisitions. Well, this thing is very seasonal, so we will definitely see an increase of acquisition numbers on the -- in the third quarter versus the second quarter. That is usually happening in third quarter due to higher tourism season and general higher market activities. And I think that will be appropriate for every big carrier in Russia. We will increase the number of sales, but not through the push methods but through our normal marketing activities and sales activities in our existing channels. We are generally happy with the existing channel strategy that we have, whilst you may see in our reporting that we have increased the number of owned sales -- owned stores, mono-brand stores and slightly decreased the number of franchised mono-brand stores due to higher efficiency of the owned stores. So this is rather on the safe and positive side of our distribution channels mix. At the same time, the core thing that we put in our -- and cornerstone in our strategy is the fact that we have the lowest churn in Russia going down to 9.4% in the second quarter of 2013, which makes us being a bit less aggressive than might need to be our competitors in the market chasing the sales for every -- any reason to compensate the higher churn figures that they are having at the moment. So we understand that having the lowest churn in the market, continuously lowering that number, gives us a pleasure of not being extremely aggressive in the sales and not pursuing some channels where the sales might be of a lower quality. Regarding the next question of dynamics on the smartphones. The smartphones -- with the smartphones, we are continuing our previously announced policy of selling more and more affordable smartphones to the market, and we have recently launched another most affordable smartphone in Russian market for the price of RUB 1,890, and that comes with a fully functional Android core. So this smartphone is definitely attracting some customers who are now the top-spending customers, and increasing our smartphone penetration to our reported 28% in the base will definitely drive the average ARPU of the smartphone users slightly down because we are going deeper and deeper into a lower segment of our base and the market as a whole. But we are not scared of this because with every new smartphone connected, we have about doubling of customers' data usage and respectively, payments to our network for the data, which is delivering us higher marginal ARPUs than the previously used voice services on the feature phones. So we are not afraid, as I said before, to have customers switching from per-minute payment into bundle and even totally free on-net bundles like in Smart tariffs, unless customers are paying for the data transmission, which is much more enabled with the smartphone penetration and -- smartphones than with the feature phones. So we do see slight decline in average smartphone user ARPU but, at the same time, because of the smartphone ARPU being definitely higher than the feature phone ARPU, migration delivers us additional ARPU into the base with the same customers.

Alexander Kazbegi - Renaissance Capital, Research Division

Okay. And then would you say that this double the uplift on the ARPU when you move to the feature -- to the smartphone also applies to the cheaper smartphones, RUB 1,890-worth phones?

Vasyl I. Latsanych

Well, yes. My number is average, so we should consider that this goes from the cheaper phones to the more expensive phones. But the pattern of migration, and by the way, I said data ARPU, it's not total ARPU doubled. I would be happy -- the total ARPU would double, but it's data ARPU. I have to say that this is, first of all, applicable to the cheaper smartphone users because on the higher end, we normally don't have the straight entrants from a feature phone to a smartphone. We are seeing that from -- for the smartphone, starting with $200 and above, people are buying these smartphones after they had some previous lower-range or older smartphone, whilst the lower range smartphones of up to $200 are those that people are migrating to from the feature phones. And this was like 90% to 10%, so 90% of the new customers of cheaper smartphones are previously feature phone users. 90% of customers buying expensive smartphones are previously cheaper or older smartphone users.

Operator

Our next question comes from Herve Drouet of HSBC.

Herve Drouet - HSBC, Research Division

My first questions will be on the margins and especially the difference between fixed and mobile in Russia. I was wondering if you can give us a split between the 2. I mean, according to the comments you gave, it looks like most of the improvements on the margins looks like to come from the mobile side with lower handset sales for instance. And I was wondering if some of the costs, and especially of the CapEx of the GPON may be put under cost because of contractual work that may potentially put some less positive impact on the fixed line margins. So I just wanted to have a picture there from your side. My second question is regarding your guidance, especially after 2013, which looks relatively healthy on OIBDA margin at the group level of 42%. I was wondering, I mean, are you relatively positive on the potential impact of -- limited impact of mobile number portability still, and also the impact of the Scartel deal with MegaFon, especially on the impact on the margins for you. And the final question is regarding SMS. And I'm always puzzled by the good SMS growth we see in Russia, and especially on your numbers, and I was wondering, are Russian subscribers not using chat -- online chat and do you start to see any cannibalization from those online chats on SMS, or it's still not the case.

Alexey Valerievich Kornya

Thank you for your question. As for the difference between margins in fixed and mobile, it is not possible to differentiate when you have one merged business because practically you are using the same infrastructure, transport network. Sometimes even commercial expenses are very, very all relating. So we don't see any specific trends in the fixed business, which would imply that there is pressure or some difference in the developments in the fixed business versus mobile. So I think where we merged, we continue pretty much the same development in optimization of our costs in -- synergistically imposing mobile and fixed together. However, it's not -- to sum it up, however, it is not possible to split costs between fixed and mobile. You can split revenues but not costs. So we don't see any extraordinary trends, and we cannot say whether in fixed it's low or higher. And as for GPON project, it is predominantly CapEx expense, in which we see right now. However, in the long or in mid run, of course, that will help us very much in the optimization of our costs. That's including headcount, technical personnel, that includes maintenance costs so like through completion of these projects, we'll be able to, of course, optimize our costs. However, not -- that is not what we'll see this year or the next year when we go through these projects. That's basically -- on the margin, as for margin guidance, we see that the number of factors will be putting pressure, including MNP commercial costs on the margins. However, we don't expect them to be that strong that we'll not be able to compensate that through data, revenue growth. That is why we adjust guidance some slight reduction in the margin over the next couple years. However, as we are guiding, we will see some margin reductions through the period 2013, 2015 pacing that we are guiding for this year more than 43% in margin.

Herve Drouet - HSBC, Research Division

Okay. On SMS?

Vasyl I. Latsanych

Yes, I'm Vasyl. I will be answering the SMS question. Yes, we are aware of the issue of IPs messaging cannibalization all around the world, specifically, in Europe. We believe that, that comes in package with much higher smartphone and data penetration, which we have not reached yet, and at the same time with probably a pretty expensive SMS tariff that were promoted by most of the European carriers. At the moment, we do see certain migration of high-end users into iMessaging or Vibers, but still we do not see it as a threat, and we are trying to take some preventive measures, which are also falling into the line of SMS revenue increase, which is bundling the SMS packages into the integrated tariff plans. This is not something we created here. This was widely used in Europe and is still used in Europe as a protection mechanism for those networks where SMS is dramatically falling down. We are using it as a preventive measure to sell to the people tariff plans where SMS would be bundled and certain number of SMSs will be already allocated to the user and respectively, the revenue would be allocated to the line. That gives us a better preparation for the times where the IP messaging may be going out of control, like it happened in some countries, but we are still not seeing the signs of it happening in Russia.

Operator

We will now take our next question from Alex Balakhnin of Goldman Sachs.

Alexander Balakhnin - Goldman Sachs Group Inc., Research Division

I have 3 questions, I think, if I may. First is on your improved profitability on the handset sales. Just wondering what is the main driver. Is it better bargaining power with your suppliers, with the vendors, or do you have to change the revenue mix to more profitable proprietary devices? My second question is on the potential for the upgrades within the data bundles, you are quite efficient in selling the data bundles. But I was wondering if you see a -- well, people upgrading from cheaper bundles to more expensive bundles, and if you could share any statistics here or any like anecdotal evidences, preferably with numbers, that would be very helpful. And my last question is, with more sort of -- with the bigger contribution of data to your revenue mix, do you think your service revenue profitability has a further potential for improvement and your 42% OIBDA margin outlook may prove to be overly conservative?

Alexey Valerievich Kornya

Alexander, let me just specify, when you talk about our conservative margin guidance, to what exactly you refer?

Alexander Balakhnin - Goldman Sachs Group Inc., Research Division

To 42% OIBDA margin. I mean, given that your -- well, data contribution to your revenue mix is growing with all your efforts and data has a better gross margin, do you think there is a potential for higher profitability in the medium term?

Andrei A. Dubovskov

It's Andrei Dubovskov, Alex. You're absolutely right, speaking about data revenue and marginality in this area. But that has to be more conservative because nobody knows what kind of changes we are reaching in 2014, speaking about a lot of factors, including MNP, national roaming, some impacts from the Scartel Yota deal, some changes in legislation area, et cetera. And speaking about our behavior in our guidance, I think it will be better for all of us to be more conservative. So at 42%, it's a normal level for next some years, starting in 2013 until 2015.

Alexey Valerievich Kornya

Okay, let me then start from the question on the handset margin. Yes, we do indeed realize some improvement on the gross margin through improvement in handset margin, which is related to the part that we have not participated aggressively into some price wars or in some aggressive promotions for handset in the market. So we're rather focused on profitability of our handset sales than on volumes. That basically reflected that, you see, we were not that aggressive on the volumes, on the total revenue field. We were more focusing on the split, so promoting smartphones and we're more focused on the margin of our handset sales. So that basically reflected in some margin improvement from handset sales. As for part related to bundles, I'll pass over to Vasyl.

Vasyl I. Latsanych

Thank you, Alexey. The first question was the main driver of higher volume and respective impact in the marginalities. Alexey started to answer this question. I will just have to add that though the cheaper handsets do not represent a better marginality than the more expensive handsets, overall decrease of the handset sales in the ruble dollar term in our revenue will inevitably have a positive impact on OIBDA because any smartphone sales in terms of OIBDA margin is lower than the service sales. So with lower phone sales, devices sales, we will see an improvement in the margin of the company as a whole. The next question is about the contribution of the data to revenue mix and thus, mobile service revenue have further room for the growth. That's, for sure, yes. And there was a question about the migration of the customers from a cheaper, smaller data plan to a higher data plan. This is within our matrix of development, so within the matrix, we have various steps. One of them is entertaining people to join the world of the mobile data. And the other ones, other steps are about taking the people from a lower bundle to a higher bundle, which usually comes with the phone upgrades or the usage upgrades. We are trying to have both issues addressed. We have a number of activities going on with the different vendors like Nokia and HTC, who are promoting their smartphones on our network, and we are having co-promotions when even our vendors are participating in creation of the special data bundles for our customers. And those bundles with more expensive handsets have a tendency to be bigger, for sure. So this is one of the ways of development of people, and the other way is when we are targeting with our specific offers, and that's mostly a CRM job. Those customers that we see as having a potential for increase of the bundles, and we propose them to try a higher bundle, and then sign up for a bigger bundle for the future periods. Though this is rather for more developed usage as we have -- than we have at the moment is Russia. So our primary target is to increase the penetration as a whole, and then the secondary target is to increase the usage of those who already penetrated. So we have this as a work stream, but it's rather a secondary job at the moment.

Andrei A. Dubovskov

And the third target in this area to increase our margin, speaking about [indiscernible], of course.

Operator

Our next question today comes from Dalibor Vavruska of Citigroup.

Dalibor Vavruska - Citigroup Inc, Research Division

First, I wonder if you can make any comment about the market share trends that you see in the market. I mean, there are obviously different ways of looking at this. I think you added a little bit fewer subscribers this quarter compared to your competitors. Also, when we calculate service revenue market share based on the reported ARPUs and the average subscriber numbers, which is not exactly consistent with the service revenues reported by the companies, but on any case, on this basis, it seems that you lost a little bit to both the VimpelCom and to MegaFon in the second quarter. And I'm just wondering whether this is just like a quarterly deviation, or whether something is happening in terms of whether you're noticing your competitors, especially with VimpelCom, this comeback when they are saying that they're now -- as of now, they want to start gaining market share, whether you're noticing any changes in the competitive behavior. My -- and also if you can comment about the potential -- about your thoughts, I think you already mentioned actually that in terms of the introduction of MNP and then potential attacks of some of your competitors in the high end of the market and how do you see that playing out. And my second question is, again, I think it was already discussed to some extent. On the CapEx side, I noticed, Andrei, that in the -- in your recent institutional investor interview, you mentioned that if you were -- if -- and the journalist asked what is your main worry, you kind of referred to the CapEx area. Now we saw in the presentation that you highlighted that you maintained dividends or dividend policy even if something happens to CapEx. I mean what -- do you think that there can be some crisis scenarios, in which case you may have to raise CapEx? I know you said you wouldn't in a base case, but I mean, are you working with some scenarios where potentially, you are thinking about some upward changes in CapEx?

Vasyl I. Latsanych

Thank you for the question. This is Vasyl. I will start. That was quite a lengthy question. So my first answer, quite a short one, will be to the customer number, market shares. As we were giving the customer number growth for the last 4 quarters, the -- not including the second quarter of '13, we don't see an issue with us being slightly lower in just one quarter. And also, we believe that this is leveling up of the market shares, which tend to be pretty stable in Russian markets. So we don't see any redistribution of the market shares on the customer numbers mid- to long-term. One quarter is always one quarter, we should not be paying too much attention to one quarter's sales. In terms of revenue, we have a very stable position year-over-year. We check, specifically, we did not lose any revenue market share. Yes, there is some redistribution in between the revenue market shares of our competitors, but that is not posing any threat to our dominating market share in Russia.

Andrei A. Dubovskov

Dalibor, it's Andrei Dubovskov, and thank you for your question. Speaking about CapEx. We are not waiting for a dramatical increase in our capital expenditure, like I described it earlier because in Russian market right now, we have only the 2 big projects, I mean, GPON and LTE network. And speaking about your question about the previous scenario, let me attract your attention to the fact that right now, we have the lowest multiple. Speaking about ratio, debt and OIBDA, and if market changes will let us to increase our capital expenditure, it will be very easy for us so.

Dalibor Vavruska - Citigroup Inc, Research Division

I don't know if you'll allow me one very quick follow-up. It's on the Scartel situation. I mean clearly, the MegaFon now has a certain advantage in terms of ownership of this 2.5 to 2.7 spectrum. I mean, do you foresee any circumstances, for example, skyrocketing traffic in the cities, in which case this could be an advantage and in which case, it could be actually a disadvantage on your side and which you would have to compensate by potentially higher CapEx and density of the base stations, et cetera? I think it's -- I think that's the kind of line of argument of your competitors. I would just like to see your view on that as well if you'll allow me.

Andrei A. Dubovskov

Thank you, Dalibor. We don't think that there is any short-term advantage taking this transaction in view. Long term, we think that there are new technologies which, like, LTE advanced specifically that will allow to accumulate spectrum from different bands that will basically allow us to be absolutely competitive in this market. So we don't -- in that light, we don't see neither short-term nor long-term threat towards our capability to satisfy clients' demand and client services. We don't expect also no significant growth in traffic. And we think that traffic is growing already at a good pace, and we do not expect any change.

Alexey Valerievich Kornya

Dalibor, we're absolutely sure that for the next 5 to 7 years, we have enough frequency band, we have enough investment possibilities, and we have enough technology advantages for support our current level market share and to increase our market share in this market.

Operator

[Operator Instructions] We will now take our next question from Ivan Kim of VTB Capital.

Ivan Kim - VTB Capital, Research Division

One question on your traffic preference, basically whether you see further upside from increase of contribution on that, and basically related to that, whether you see further potential in improvement in churn or you think that the churn is probably around the levels where it should be in the prepaid market like Russia. And secondly, on your voice revenue's dynamics, in the second quarter, your voice revenue year-on-year have slowed to 0% growth versus 2% growth in the first quarter. It's not something extraordinary, of course, but I'm just wondering whether there is any trend behind that or any story behind that, you can tell us.

Vasyl I. Latsanych

If I can answer, I have picked up the 3 questions. This is Vasyl. First one, what is happening with the on-net. We have a pretty stable situation with high level of on-net, possibly the highest level in Russia. And as we know from our Ukrainian experience, this, first of all, contributes to better stickiness of the customers. So this is one of the factors. We have the lowest churn in the market because customers are more satisfied. And the second, that plays very important growth for attractiveness of us as the carrier for most of the customers when people see that our minutes of use are cheaper on average than our competitors' minutes of use, and they can use more minutes of use for the same amount of money. The ARPUs, if you take a look at the competitive ARPU situation in Russia, stays pretty comparable in between the carriers, but the minutes of use are those that differ with our on-net traffic, the minutes of use are increasing. This is how we are making customers more loyal, and this is why we see the churn improving quarter-over-quarter. If you ask me whether it can be improved any more, if you could take a look at our reporting, our Ukrainian number is 6.0 of quarter churn in Q2 starting in '13. That's quite a remarkable and almost never-before-achieved number in Ukraine. So for Russia, even 9.4 is unheard of in terms of the lowest churn possible. But looking at Ukraine, which has very similar markets, I want to believe that there is a better chance for Russia to go even lower. But I wouldn't commit to it because Russia still is a bit different market from Ukraine. I don't expect churn to be any significantly upwards from this number, unless short-term, for some seasonal periods, especially in summer churn is usually going a bit up because of the touristic season. The voice 0% growth is something we've got ourselves ready quite long ago and we realize that this will be the inevitable development of the market, and that's why we are putting such a big bet on development of the data, which will have to replenish the absence of growth of the voice revenues. This is why 40% of data year-over-year is so much important to us, and a 0% to 2% of growth of voice services is something we really expected to see in this market. There is no surprise with this one.

Operator

Our next question today comes from Anna Lepetukhina of Sberbank.

Anna Lepetukhina - Sberbank Investment Research

I have a question about kind of one-off factors that impacted EBITDA margin in the second quarter of 2013. Can you probably explain whether you expect kind of additional one-offs in addition to Bitel effect to have an impact in the following quarters? And also on your revised guidance for the EBITDA margin, does it take into account the necessity to increase advertising spending ahead of MNP and kind of potential competition pressure from Rostelecom entering the market in Saint Petersburg?

Alexey Valerievich Kornya

Anna, thank you for your question. We do not expect any additional factors, any additional one-off factors in the third and fourth quarter. So we expect business going as usual in the second half of the year. However, as I mentioned in my speech, there is early recognition of roaming discounts, which basically skewed a bit positive effect from higher roaming season from third quarter towards second quarter. So we are now with positive margin impact from higher roaming season in the third quarter, while we recognized how this impacts on the second quarter. But this is not a one-off effect. It's rather a redistribution. And as for the second part of the question, whether we expect any increase in our own spend taking in anticipation of MNP and entrance of Rostelecom in different markets, when we talk about MNP, everything is very much dependent on the behavior of key players in the market. So if there will be very aggressive and competitive -- competitively high environment following the MNP, then we'll probably see the reflection of that in the -- in our EBITDA figures. However, we do not expect that there will be overall aggressiveness in the market. And this is included in our forecast. Entrance of Rostelecom in the new markets will not significantly impact our guidance for the margin.

Anna Lepetukhina - Sberbank Investment Research

So just to clarify, did I understand correctly that kind of you assume base case scenario, so and it means that there is a downside risk for your EBITDA margin guidance if other players start aggressive campaign ahead of MNP introduction?

Alexey Valerievich Kornya

Well, we have some basic scenario, which implies some kind of -- some results from MNP introduction. And this basic results of -- this basis scenario is integrated in our guidance. If there will be more aggressiveness in the market or if there will be something extraordinary happening in the market, then, of course, that will impact our financial results. However, we do not expect that to see in the market.

Operator

[Operator Instructions] We will now take our next question from Anna Kurbatova of BCS Financial Group.

Anna Kurbatova - BCS Financial Group., Research Division

My question is again about data networks rollout. Could you elaborate a bit on your data dynamics in Ukraine and prospects, first of all, the prospects. So I wonder, you are -- where do you see the limit for your data growth in Ukraine? As far as you have no 3G there and you develop on the base of CDMA, as far as I remember technology only. So how many years do you think this growth could continue without 3G or any other kind of more advanced technology?

Vasyl I. Latsanych

Anna, this is Vasyl, thank you for the question. The question about Ukraine is always nice to answer because there are not too many of those. But this one is especially interesting and exciting because we see some very high numbers of the data traffic revenue growth in Ukraine, 40%. And this is the country where we don't have any other technology than 2G and edge technologies for data. That is, first of all, the result of a very low starting base where last year and the years before, data was very, very low penetrated in markets and the smartphones were just kicking in. So this market got very significant uplift by itself, plus we added some fuel by promoting the smartphones and getting the data pricing very -- to the very acceptable levels of the market. Historically, Ukrainian data market was highly overpriced and was affordable for only top users. Now we are making this market more and more affordable to the masses, trying to prepare ourselves for the future potential 3G license obtaining and development of the network and the market into the 3G data area. This is, for sure, also because we have introduced more bundled tariffs where we have not only voice, but similar to Russia, voice and data tariff plans, where data is -- comes as a part of the package. So this part of the revenue gets allocated towards the data in the overall accounting, and that makes the data grow even further above the penetration speeds. But nevertheless, our focus in Ukraine for the rest of 2013 and 2014 will be on increasing of edge penetration and smartphone penetration in Ukrainian market because we believe that Ukrainian market will inevitably follow the pattern that we see in Russian market, but the voice revenue will slowly decline or slowly -- sorry, the speed of the growth will slowly decline and will be replenished, replaced by the data increase and data revenue increase in the future.

Andrei A. Dubovskov

Anna, it's Andrei Dubovskov. I just want to remind you that in Ukraine, we have not that CDMA network in 450 range. And of course, it supports our data revenue in Ukraine. As you know, in Ukraine, all players have not have 3G or 4G license. And right now, we have approximately 400,000 client subscribers in this network and this is only data network without voice usage and of course, it's some advantages for MTS in Ukraine.

Anna Kurbatova - BCS Financial Group., Research Division

And may I ask also a question about your future data network development in Russia? You mentioned at the beginning of your speech some numbers of -- the number of base stations you have in Russia in different technologies. So the question is what are approximately your medium-term plans for new 3G base stations rollout as compared to LTE? For example, are you satisfied with this almost 30,000 3G base stations or are there plans to increase the number? So do you see the necessity to continue employing 3G?

Andrei A. Dubovskov

Anna, it's Andrei Dubovskov. We are not going to increase dramatically the number of our 3G base stations. As you know, we have approximately 30,000 base stations across Russia, and it's approximately the same level of our competitors. And speaking about our further development in this area, it can be just LTE networks, and there may be some tuning separation in 3G area.

Operator

Our next question comes from Imari Love of Morningstar.

Imari Love - Morningstar Inc., Research Division

I just had a quick question on the recurring OIBDA margins going forward. You spoke about Q2 one-offs related to the settlement of Bitel litigation and other factors. I wanted to try to gauge how much of that margin increase for your guidance was a reflection of one-offs versus what we can expect to see on recurring basis 2014 and beyond.

Alexey Valerievich Kornya

So the overall impact of our one-off factors, as I mentioned in my speech, is about 2 percentage points for the quarter figures. So from that, you can figure out what will be impact for the annual figures. We don't have any other one-offs for the year. And the rest of the improvement, it goes from organic reasons, from organic factors, which is data growth, operational cost optimizations and others.

Operator

There are no further questions in the queue at this time.

Joshua B. Tulgan

Okay, operator, thank you. And, ladies and gentlemen, thank you very much. We welcome you at any time to contact our Investor Relations department for further questions. Naturally, a webcast of this discussion will be available on our website if you wish to replay the call. In the meantime, we appreciate your interest and wish everyone a pleasant day.

Operator

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

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