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Mobile TeleSystems (NYSE:MBT)

Q3 2006 Earnings Call

November 29, 2006 10:00 am ET

Executives

Andrei Terebenin - IR

Leonid Melamed - President and Chief Executive Officer

Vsevolod Rozanov - Chief Financial Officer

Mikhail Shamolin - Vice President, Head of MTS Russia

Adam Wojacki - Director of UMC

Analysts

Alex Kazbegi - Renaissance Capital

Vladimir Postolovsky – UBS

Alex Kuznetsov - Bear Stearns

Sergei Arsenyev – Goldman Sachs

Rhys Summerton- Citigroup

Alexei Yakovitsky - Deutsche Bank

Olga Bystrova - Credit Suisse

Nadejda Golubeva - Aton

Evgeny Golossnoy - Troika Dialog

Ben Joseph – Thames River Capital

Barry Schumacher - Alsa Bank

Stephen Pettyfer - Merrill Lynch

Anna Bossong - CA-IB

Leah Miller – HSBC

Jeff Motave - Standard Pacific

Felix Fischer – HBC

Presentation

Operator

Ladies and gentlemen, welcome to the third quarter 2006 financial results for Mobile TeleSystems conference call on Wednesday the 29th of November 2006. (Operator Instructions) I will now hand the conference over to Mr. Andrei Terebenin. Please go ahead, sir.

Andrei Terebenin

Good day, ladies and gentlemen and welcome to MTS conference call to discuss the company’s third quarter 2006 financial operating results. Before beginning our discussion, 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. The statements may relate to one of the following issues: the strategic development of MTS business activities both in Russia and abroad; revenue and/or subscriber growth; syndicate loan facilities and their usage; legal actions or proceedings directed at the company or representatives; regulatory changes and the impact on company’s operations in the market in which we operate; financial indicators such as: operating income before depreciation and amortization, average revenue per user, cash flow projections, and return on invested capital, capital expenditures and operating expenses.

Important factors could cause the actual results to differ materially from those contained in our projections or forward-looking statements. These statements may include the company press releases, earnings presentations, MTS annual report on Form 20-F, as well as 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.1mtsgsm.com or on the United States Security and Exchange Commission and www.sec.gov.

MTS disowns any obligation to update any previously made forward-looking statements, or on this conference call, or make many adjustments to the previously made statements to reflect changes and risks. Copies of the presentation and materials used in reference to this conference call are available on our company website.

Participating on the call today are: Leonid Melamed, President and Chief Executive Officer; Vsevolod Rozanov, Chief Financial Officer; Mikhail Shamolin, Vice President, Head of Business Unit MTS Russia; and Adam Wojacki, General Director of UMC.

Now Leonid will you take you through the quarter.

Leonid Melamed

Ladies and gentlemen, thank you for joining us on our third quarter conference call. For the third quarter 2006, MTS has delivered its strongest quarter to date, a sign of our commitment and implementation of our 3+1 strategy. That is, strengthening our leadership in Russia, growth and synergies in CIS, creating value in growth markets, and adding value through additional business opportunities.

Revenues for the group reached nearly $1.8 billion, while our OIBDA margin came in a 53.6%, an improvement driven in part by top line growth and operational enhancements throughout the group.

In Russia, as a part of our goal of strengthening leadership, revenue grew to over $1.3 billion, a 30% year-on-year increase and 22% improvement from the second quarter. The factors which contributed to our growth include:

  1. Revenue stimulation such as an increase in new subscribers and organic growth in usage, as we both introduced and transitioned to our new tariff structures.
  2. Rise in interconnect revenues.
  3. Seasonal factors such as higher roaming revenues, and greater voice usage among our subscribers.

In Ukraine, as a part of our goal to improve operational efficiency, UMC delivering an OIBDA margin of 56.4%, a 4.7 point improvement from Q2. As part of our goal in regaining our leadership position in the market, UMC accelerated its ongoing network roll out, and increased its distribution in Ukraine to slow its declining market share though UMC boasts postpaid leadership and the market’s highest APPM.

Looking ahead we expect market share to stabilize in our networks increased capacity and quality as well as broadened distribution, which will allow UMC to resume its growth and share of subscribers and revenues. We view it is an encouraging sign that UMC led the market in net adds for October 2006.

In Uzbekistan and Turkmenistan our subsidiaries built upon their leadership positions in each of the respective markets during the quarter. We have introduced our new brand in both markets and continue to expand our networks in each. In August, we were pleased to get our 1 millionth subscriber in Uzbekistan. We improved our market share to 53%, reaching 3 million subscribers in October, driven in part by our re-branding of the operation and the network build.

As part of our strategy to create value in growth markets, we continue to pursue ways to increase our footprint, though we didn’t make any significant acquisitions this quarter. Prices in our view were simply to high to justify, but we continue to look for opportunities and potential synergies with our existing and planned business activities.

Now, Vsevolod Rozanov will take you through the numbers.

Vsevolod Rozanov

Thank you, Leonid. While revenue growth in Russia certainly aided the business units margin improvement, our 3+1 strategy aimed at cost efficiency and process excellence helped us to deliver a 52.4% OIBDA margin from Russia. Examples of this efforts included: a reduction in advertising expenses; decrease of general and administrative expenses; greater financial control which yielded a reduction in bad debt provision by 25%.

In Ukraine, revenues for the quarter were $414.6 million, 24% rise over year 2005 and 16% improvement for Q2. Driving this revenue growth was seasonal increases in volume, control of the traffic mix to improve APPM, plus completion of the main phase of the accelerated network rollout project, which improved network performance and facilitated increases in the volume of traffic handled.

Building on our momentum in Q2, we witnessed the rise of $49 million in OIBDA, which led to a further 4.7 OIBDA margin improvement through promoting our traffic, altering our subscriber acquisition policies to reduce handset subsidies, and additional cost control programs in line with our efforts to instill process excellence throughout the organization. We are witnessing considerable growth throughout our operations in the CIS.

In Uzbekistan, improving network coverage and quality also contributed to $9.3 million rise in revenue from Q2. OIBDA for Uzbekistan improved to $22 million. In the process, we earned a healthy margin of 59.9%. In Turkmenistan, revenue increased $9 million to nearly $53 million. The one-time charge for license usage fees negatively impacted our OIBDA margin. Looking ahead, we expect our foreign subsidiaries, in particular Uzbekistan, to constitute a more visible presence in our quarterly results.

For the group, we have seen a significant improvement in the bottom line performance. Net income rose 40% year-on-year and nearly 39% from Q2 to over $486 million, aided in part by slower appreciation of the ruble. Free cash flows reached $407 million for the first nine months of the year.

We continue to show strength on our balance sheet. As of September 30th, our debt level remained stable at $2.7 billion, while net debt to OIBDA dipped below 1X.

Regarding our share repurchase program, we didn’t receive approval until late October, and thus we were not permitted to launch our program in Q3.

Now, I am passing the call back to Leonid.

Leonid Melamed

Thank you, Vsevolod. Let me continue by following up on our 3+1 strategy implementations. As part of our goal of seeking additional opportunities to enhance our competitive position, we continue leveraging our position with the [Sistema Telecom] to test convergent projects in our home market.

In Ukraine, we were recently awarded a CDMA 400 license, a platform that would allow us to introduce wireless broadband access in both major cities and in rural areas not serviced by wireline access. Success of this initiative may lead us to pursue similar projects in other markets. We are also seeking to broaden our convergence work with ComStar. One project we are also introducing is WiFi access throughout both MTS subscribers and roamers on our network. We are also pursuing fixed-mobile convergence projects including services that allow MTS private access to ComStar’s MPLS networks and vice versa for intra-office calling and VPN remote access to GPRS service.

In addition, we will also explore ways to integrate our company-owned points of sales without the Sistema Telecom companies to increase distribution and achieve greater cost efficiency. I firmly believe our customers in Moscow and in the regions will relish the opportunity to sign up for mobile phone, landline, home, broadband internet access and even television subscriptions in one convenient location. This has the potential to create a great deal of additional value for our customers.

With strong performance both in Q3 and Q2 throughout the organization, we feel comfortable raising our 2006 guidance for revenue to not less than 20% top line growth. Our target of 50% OIBDA margin remains unchanged and we expect our group CapEx spending to remain roughly at the $1.8 billion level.

Considering we are reporting Q3 numbers, it would be premature to comment on guidance for 2007. In January, after the winter holiday, we will be ready to give you an idea of our outlook for 2007. Certainly the centerpiece of our efforts will be to encourage greater voice and data usage on our network, but 2007 might offer MTS the possibility to reach our customers in even more compelling ways.

Now, we would like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Alex Kazbegi - Renaissance Capital.

Alex Kazbegi - Renaissance Capital

Good evening. First of all, congratulations on the great numbers. Several questions, but maybe I can lump them in one. If you could give us the split of the contribution of various factors to the ARPU strengths, especially in Russia, that’s the first question.

I will specify what I mean here. If you could discuss a bit more on how much was from the interconnect, how much was from the introduction of the call setup charge, how much was roaming, and so on and so forth?

Secondly, maybe you could discuss a bit more in detail the impact of the calling party paid in particular, what happened with the traffic, how the traffic has been distributed, how was it prior to introduction of CPP, what happened in the Q3 and whether that trend you have seen in Q3 is actually still visible and continues into Q4 as we speak now?

Well I have a number of others, but let me restrict myself to a third one. Could you maybe comment? There has been quite an increased discussion of the possibility of issuing 3G licenses from the very beginning of 2007, and I think unlike the previous talks, this time there is a talk about that the license should be [inaudible] and come with certain obligations which obviously could mean potentially much higher CapEx than anybody would have thought before. If you could comment, that would be great as well. Thank you very much.

Leonid Melamed

Thank you. Let me give the floor to Vsevolod to answer about the ARPU and thank you for the congratulations.

Vsevolod Rozanov

Thank you for the congratulations as well. Speaking about ARPU, we can say that the contribution of different factors to ARPU increase was the following: we approximately estimate the contribution of seasonal factors including increased roaming as 50% of the increase. We believe that the introduction of the interconnect, including the introduction of CPP included in the interconnect revenues and loss of a certain amount of revenue from incoming calls constitute approximately minus 10% of the Q2 results. We attribute approximately a 60% increase due to our marketing efforts, which might be described further by Leonid.

Leonid Melamed

Now, overall CPP effect in absolute terms was slightly negative on the revenue. We have successfully compensated most of it by introducing several new offers to the market and by implementing the segmented marketing strategy. The effect of CPP on traffic was neutral in July and August. There was no change in fixed to mobile incoming traffic. In September we saw 64% growth in fixed to mobile traffic. Although since the fixed to mobile has fairly low share of total traffic, to 8%, overall the total traffic grew no more than by 2% to 3%.

Alex Kazbegi - Renaissance Capital

Does that growth continue in Q4 as well?

Leonid Melamed

It is still early to tell we are still watching it. We see a change but we don’t see a dramatic change.

Alex Kazbegi - Renaissance Capital

Right. Can I ask also what marketing efforts do you attribute specific conversion of the dollar tariffs into the ruble territory, is that marketing effort part of that as well?

Leonid Melamed

Of course it’s a part it. We are moving towards introducing ruble tariffs in the market and that will be part of our marketing efforts in 2007 as well.

Alex Kazbegi - Renaissance Capital

How many subscribers are still on the tariffs as of now?

Leonid Melamed

On the old ones?

Alex Kazbegi - Renaissance Capital

Well overall, yes.

Leonid Melamed

As we were telling to you in the conference call after Q2 we have very successfully introduce the new carrier plan called First and this tariff plan had a higher price for the first minute and a lower price for second and other minutes and stimulated our subscribers to talk more. The launch of this tariff plan was very successful. In autumn we launched another tariff plan called Red which was a tariff plan oriented towards use and this tariff plan allowed a very affordable price for calls inside this tariff among people who are on the same tariff plan and that’s stimulated MTS subscribers and also non-MTS subscribers to join the tariff plan and talk more, which increase the MOU. We also had a positive effect on ARPU on this tariff plan. Both tariff plans have been advertised in both rubles and dollars in different regions. This is basically the start of our ruble transition. But so far, the majority of our customer base is still sitting on the dollar tariffs.

Alex Kazbegi - Renaissance Capital

Thank you.

Adam Wojacki

Let me answer the question about 3G. We would like to participate in the tender that we are waiting to happen either the end of this year to the middle of next year. We understand that we will have to make a rollout of the network in the bigger cities since it will be an importance marketing part of our activity. We are still investigating the business case to prove the size of the rollout for the overall network in 3G, and that’s why I cannot comment now about the additional CapEx that this rollout would require from us. But, we also have to make a statement that could be good reason for us move a good portion of our 2G CapEx to 3G CapEx in order to save our capital investments by using 3G UMTS technologies to increase the capacity of our network in a cheaper way like we can achieve now by using the 3G technologies once the majority, we understand that to the end of 2008 more than 40% of our subscribers who have 3G handsets.

Alex Kazbegi - Renaissance Capital

Would you be able to give us some guidance on the CapEx for 2007 and whether it will be excluding or including the 3G?

Leonid Melamed

As I’ve said in my speech we would like to withdraw ourselves from making any guidance for 2007 until the end of January.

Operator

Your next question comes from Vladimir Postolovsky - UBS.

Vladimir Postolovsky – UBS

Good afternoon. Once again congratulations on the fantastic results. Three questions from me as well. The first one is on service costs, which didn’t go up as much as we expected them to on the back of the mobile termination charge introduction. Were there anything improvements on the service side that you could attribute that to?

If you look at growth quarter on quarter, it was exactly the same as last year, which would be explained by seasonality but this year you had exceptional factors too. Any comments on that would be appreciated.

The second thing is, you mentioned in your presentation approving a share repurchase program. Are you talking about the ADRs buyback that you previously highlighted, or is it something else?

Can I go back to this ARPU question, just to clarify? When you say that CPP plus interconnect is minus 10 and marketing is plus 60%, do you include the call setup charge and cumulative negative CPP in the first category? Then you said the negative implication of CPP and the introduction of mobile to mobile interconnect in that minus 10; and ruble and call setup charge in plus 60%. Can you confirm that please?

Vsevolod Rozanov

Thank you, Vladimir. I will try to take all of them. First off, speaking about the service costs, the difference we’ve seen the increase of interconnects but also we’ve seen the significant drop off in the cost of handsets subsidies and the cost of other accessories both in Ukraine where we are significantly decreasing the cost of handset subsidies and in Russia we are trying to minimize very low margin sales of handsets, so that’s partially helped to compensate the service costs.

Speaking about the share repurchase program, yes I would like to confirm that we are speaking about the ADR repurchase. We don’t call it buyback, but it is actually what you mean.

Speaking to the ARPU reconciliation, I would like to say that we do not have a call setup charge in August of this year and we include this into the marketing effect of the increase of ARPU.

Vladimir Postolovsky – UBS

And mobile to mobile interconnect, into CPP and other?

Vsevolod Rozanov

This is minus 10.

Vladimir Postolovsky – UBS

Maybe you could give us the number of what the total interconnect revenues from mobile operators in Q3?

Vsevolod Rozanov

It was approximately $120 million.

Vladimir Postolovsky – UBS

Okay, thank you very much.

Operator

Your next question comes from Alex Kuznetsov - Bear Stearns.

Alex Kuznetsov - Bear Stearns

Good afternoon. I would like to join the greetings with your impressive results I have a couple of questions. First of all, we have noted a significant 9% increase in the effective tariff in Russia. Could you explain the reason for such a trend? In the past, the trend was rather negative.

Second, could you outline the reason for 77% increase in accounts receivable in the third quarter?

Mikhail Shamolin

Can you elaborate a little bit? What do you mean on the 9% increase in tariff plan?

Alex Kuznetsov - Bear Stearns

Well, I mean increase in effective tariff, so if you take ARPU and divide it by minutes of use, we found out that actually effective tariff went up by 9%.

Mikhail Shamolin

A couple of new tariff plans that we have introduced in the marketing including the First tariff plan had higher APPMs Average Price Per Minute on it in the old tariff plans, and despite the fact the sales of that tariff plan has been exceptionally successful and that drove the overall level of APPM a little bit higher then it was in June. So that was the major effect. Also, changing our existing tariffs after the CPP introduction in particular, changing the structure of first minute cost versus the other minutes also contributed to that.

Alex Kuznetsov - Bear Stearns

So, that means that some subscribers were not really rational in joining the First tariff plan instead of other options?

Mikhail Shamolin

The plan was well positioned in the market and well advertised was quite popular because it stimulated the subscribers to talk more. Also competition allowed us to do it.

Vsevolod Rozanov

Generally speaking, I think there are three major reasons behind that. First is the general growth of the business in Q3 comparing to Q2. Second is a seasonal increase in trade receivable related to roaming. The third, which is the most important, is actually a trade receivable related to new interconnect, due to specifically to interconnect, because what happened is basically we started to negotiated and sign the majority of contracts in the course of July and August, and with the operators the bills were actually sent, they were invoiced, but not all of them were paid. We believe that we will be back to normal over the course of Q4.

Operator

Your next question comes from Sergei Arsenyev - Goldman Sachs.

Sergei Arsenyev – Goldman Sachs

Good afternoon. Can I just ask you two questions please? First on the share repurchase program. When you first introduced the notion of the share repurchase program in the second quarter results, the share price was obviously substantially lower than it is now. When you talked about it, you were saying that this represented a great investment opportunity from you point of view. Obviously now with the share price at $47, do you still view MTS share price as a similarly attractive investment opportunity as when you first mentioned the program?

My second question is on Ukraine and on the advertising and marketing expenses which dropped so substantially. You said that this reflects an increase in gross additions, I am just trying to see how sustainable this number is going forward? Thank you.

Leonid Melamed

When we think about the potential price of our stocks , we observe the recommendations of the analysts to the customers. So we just look for the numbers delivered by analysts and also look into our own long-term business plans to understand how do we value our company, what can we recommend to our investors? So, from our viewpoint and based on the valuations done by analysts whose consensus we do agree, the promising market price of the stock of ADR for MTS is at the level of $52 to $55 as it was until today. That’s why it's looks like that $47 is still an attractive price to buy.

Adam Wojacki

As for the question for Ukraine is concerned, one clarification. Advertising and marketing expenses were at the similar level for the previous quarter. The explanation is they dropped as an element in subscriber acquisition costs. We acquired more subscribers with the same level of advertising and marketing expenses. It was a visible drop.

Sergei Arsenyev – Goldman Sachs

Right but do you see this as a sustainable trend that it will cost you just as much to attract an ever-increasing number of subscribers?

Adam Wojacki

Well you know, when we talk about the SAC there were a number of elements in our policy in the Q3 which helped us to reduce the SAC and we see the continuation of this policy as a very feasible element and activity for Q4. So, yes we plan to keep it at a similar level in the Q3.

Operator

Your next question comes from Rhys Summerton- Citigroup.

Rhys Summerton- Citigroup

Good afternoon. I just had two questions, one on the change in the traffic mix. I wonder if you could give us the on-mix/off-mix component of traffic in the Ukraine and in Russia?

The second question I had is looking at your numbers on the EBITDA excluding handsets you are looking at an extremely high margin, better than it was this time last year. Are there any obvious expense items which stand out which going forward you can still address to keep this margin at a similar level or even improve on it? Thanks.

Adam Wojacki

On the traffic side, net outgoing traffic remains stable, on net incoming, a slight decrease; mobile incoming a slight increase; mobile outgoing a slight decrease; and fixed incoming significantly increased, 64% as I said in September.

Vsevolod Rozanov

Well, speaking about the EBITDA trends we obviously do not give you any guidance for the next year. What we can observe at this stage is that we definitely see significant margin pressure from both interconnect from marketing and advertising costs, plus the dual commissions. But, generally speaking, I think we will get back to you in January to discuss the developments of EBITDA and EBITDA margins for next year.

Operator

Your next question comes from Alexei Yakovitsky - Deutsche Bank.

Alexei Yakovitsky - Deutsche Bank

Yes. Good evening. Congratulations on the exceptional numbers. To come back to the ARPU issue, can you maybe strip out new interconnect revenue that you receive from fixed mobile interconnect that didn’t exist in the second quarter and tell us what ARPU was, excluding this new increment in your revenue line for the quarter?

The second question is, I wonder if you can give us some feel for the current trends in the fourth quarter. Have you seen the same collapse if you will, in ARPU that we did see in the previous few years in the fourth quarter? Or are you seeing some weakness but it’s no where as dramatic as it used to be?

Finally, you raised your revenue for the year for 2006 but you left your EBITDA margin guidance unchanged. Would you say that your EBITDA margin guidance now is more conservative that it was three, four, five months ago?

Vsevolod Rozanov

ARPU, the absolute increase comparing to Q2 was approximately $50 million. In terms of interconnect revenue, does that answer your question?

Alexei Yakovitsky - Deutsche Bank

It’s sort of does, but does that include some increase in the mobile to mobile interconnect which was seasonal, right?

Vsevolod Rozanov

Yes.

Alexei Yakovitsky - Deutsche Bank

If you can just strip out, break this down into the actual old interconnect which was mobile to mobile and the new fixed mobile interconnect?

Vsevolod Rozanov

We still have yet to draw conclusions on the trends here because we definitely didn’t see any effect on traffic in July and August.

Alexei Yakovitsky - Deutsche Bank

Okay. Thank you.

Mikhail Shamolin

Regarding the question of the focus for ARPU for the fourth quarter, I can say that we don’t plan any aggressive marketing strategy for December as we have not started any of the strategies in November of this year. That’s why if everything would be in accordance with our plan, we can focus the ARPU for the fourth quarter at a level of about $8. OIBDA margin whether the 50% annual focus is conservative, I would say that it is realistic since we would definitely have some reduction in revenues in the fourth quarter at least for the seasonal reasons. As long as we don’t have tremendous advertisements and costs, still the pressure of cost would be quite heavy on that. That’s why we would say that 60% annual margins that we’ve been fighting for the last six months is still a realistic forecast.

Operator

Your next question comes from Olga Bystrova - Credit Suisse.

Olga Bystrova - Credit Suisse

Several questions from me. First of all, what would be your policy for the fixed exchange rate, because it is currently at $28.70. Are you planning to revised it to reflect averages in the past six months or a year, going forward?

The second question is CapEx in Russia in the third quarter was about slightly more than 17% of sales. Can we, for example, assume that with you having undergone some of the efficiency analysis, do you think this could be a longer-term CapEx guidance for you in Russia?

The third question is maybe you can help me reconcile the ARPU figures in Russia for contract prepaid and blended because what I am seeing here is contract ARPU has grown 2% quarter on quarter; prepaid ARPU grew 11% quarter on quarter, but blended ARPU grew 15% quarter on quarter. So, I might be doing something wrong, but it doesn’t adapt for me.

Vsevolod Rozanov

Thank you. To answer your first question about the exchange rate policy, I would say that in December we don’t forecast any change and in the beginning of the next year we plan to pass to ruble tariffs. This question would be, by definition not relevant from that time and onwards. We until now understand that the exchange rate is a marketing element for us and we have to balance the price for our tariff plans, and as long as the competition in general terms the attractiveness of our plans allow us to keep the rates high whether we achieve it by exchange rate or by just difference prices for different minutes, we keep the prices on the level that we have now.

CapEx revenue indications and guidance, as we said, we would withdraw ourselves from offering any guidance for 2007. What we can prove now is that except with UMTS introduction and maybe some big potential M&A deals that are not in the pipeline right now, but can happen, we focus the reduction of CapEx in absolute numbers in the next year compared with the year 2006.

Mikhail Shamolin

Well, speaking about ARPU we usually do not disclose a breakdown of the ARPU according to the customer segments.

Olga Bystrova - Credit Suisse

Well, first of all thank you very much for the first two answers. But, the third one, in your presentation you have contract ARPU of $29.60 and prepaid ARPU of $5 which according to the same numbers in the presentation have grown 2% and 11% respectively, but the blended ARPU grew 15%. If you do a weighted average calculation then it doesn’t add up, that is why I’m asking. So, it is all in the presentation.

Vsevolod Rozanov

So, just to answer your question then, the post-paid ARPU and pre-paid ARPU numbers which are in the presentation they are excluding the interconnect charges. So, basically altogether and including interconnect they add up to the ARPU average, ARPU numbers which are in the presentation as well.

Olga Bystrova - Credit Suisse

But, for the second quarter did contract and pre-paid ARPUs include interconnect or not?

Vsevolod Rozanov

No. That’s consistent numbers.

Olga Bystrova - Credit Suisse

And if I may, maybe a follow-up question. In terms of competitive dynamics that you are mentioning several times that seems to be quite favorable and has been for the past quarter, do you see any indication of the potential change of the dynamics in the market from your competitors?

Mikhail Shamolin

We hope that the environment will stay in the area that it is right now. It means that we hope that the pricing discipline would be followed up by both of our main competitors in the territory of Russia, if you talk about Russia. Thank you.

Operator

Your next question comes from Nadejda Golubeva - Aton.

Nadejda Golubeva - Aton

Good afternoon. Congratulations on great numbers. I have several questions if possible. First of all, when you are answering about your revenue growth guidance of 20% year on year, if we had to get three quarters, a multiple of 2005 volume by 20%, when we come to the fourth quarter the revenue should go down by 20% quarter on quarter. So, could you comment on this, please? Do you prefer to be extremely conservative? Why is it such a sharp drop expected in the fourth quarter? This is the first question.

The second question is about interconnect. When analyzing your interconnect costs, could you tell us please whether you had interconnect agreements with just Megafone and VimpelCom? What I am looking for, what percentage of potential contracts with all other operators did you have in the third quarter? What can we expect going forward?

Finally, I have a question about CapEx. So, I understand that it’s premature to give any guidance, but still it would be very helpful if you could breakdown your third quarter CapEx in Russia for coverage, maintenance and upgrades if possible. It would really help us.

Finally, could you give us the latest traffic profile? How much traffic in total is on-net and could you split it into incoming and outgoing? Also, could you give us the other traffic? Thank you.

Leonid Melamed

Thank you very much for the questions. To answer your first one, I’d like to attract your attention that in my speech I have mentioned the phrase that we increased our focus on revenue until the end of this year compared to 2005 not less than 20%. It means that 20% is a conservative forecast.

Nadejda Golubeva - Aton

Okay. It just looks very, very conservative.

Leonid Melamed

For the second question I pass the floor to Vsevolod.

Vsevolod Rozanov

Thank you. Speaking about interconnect agreements, I wouldn’t be able to give you the exact number of agreements, but I can tell that with the existing agreements we cover ultimately 98% of the potential revenue.

Speaking about CapEx, as was said, we will be able to provide guidance for next year during January, and I think Leonid already mentioned that we are likely to see that the CapEx is not going to be higher than the guidance for this year.

Nadejda Golubeva - Aton

But, basically, I’m not asking for any forecast. I’m just asking whether it is possible to breakdown the already reported CapEx for the third quarter say for coverage, maintenance, and upgrades, just very roughly, because it will really help us.

Vsevolod Rozanov

Quarter to quarter we see an increase in the CapEx spent on capacity rather than coverage, and again we saw this trend increase. Basically, as we see that the capacity CapEx is approximately 40% to 45% this remains the case for Q3.

For the traffic profile I’m passing over to Mikhail.

Mikhail Shamolin

In terms of traffic profile, about 50% of total traffic in September was on-net traffic. About 50% was mobile incoming and mobile outgoing, and 20% was fixed incoming and fixed outgoing.

Nadejda Golubeva - Aton

Okay, and what about fixed to mobile and mobile to fixed? Is it the same, is it symmetrical or not?

Mikhail Shamolin

Fixed to mobile and mobile to fixed was very similar in June and July and August, and in September fixed to mobile increased over the mobile to fixed.

Operator

Your next question comes from Evgeny Golossnoy - Troika Dialog.

Evgeny Golossnoy - Troika Dialog

I just have a question on Ukraine, and you know Ukrtelekom is going to introduce 3G network, and they say somewhere in the first half of next year, probably as soon as the end of March. I understand that 3G is at too early a stage to say what the implications would be for Russia, not to mention Ukraine. But nevertheless, I’m sure that given the level of power they probably have within the government companies, do you think there is a danger that a lot of corporate customers, especially the government-based companies, could be switched to Ukrtelekom from all the mobile operators -- including yourself? Looking through your numbers you have almost a quarter of your revenues in OIBDA coming from Ukraine. So, do you think there is any kind of danger from that initiative from the local incumbent on your business? Thank you.

Adam Wojacki

Thank you for the question. Yes, definitely long-awaited Ukrtelekom’s launch of 3G services; it has been postponed a few times. Now the date which we hear is May, end of the first half of the year. As far as our customer base, it was mentioned during Leonid’s speech that we have been awarded CDMA license which can provide a similar level of services and we plan to develop the technology in Ukraine and offer it to our business customers.

We are already working with our business clients, offering them the convergence services on the bundled side, and the future remains to be seen, but we are ready for the Ukrtelekom launch of 3G services in Ukraine.

Evgeny Golossnoy - Troika Dialog

My question was not really that your technology would be inferior to Ukrtelekom technology, but probably what kind of level of power you think they might have the way they could switch away, churn away the customers from yourself, especially given that UMC is basically still the core operator in terms of providing the services to business customers?

I am sure that your technology will be not worse than Ukrtelekom but you know, if somebody would have an order from somebody to switch probably they should follow. Do you think there is a real danger, or do you think it will take such a long time that you can restructure the business in the proper way to avoid any kind of dilution of your business?

Leonid Melamed

The internal communication policy of the company doesn’t allow us to comment on the activity of the competitors. That’s why I believe we have provided the most what we can give in this situation.

Operator

Your next question comes from Ben Joseph – Thames River Capital.

Ben Joseph – Thames River Capital

Hi there, thanks for the call, just two questions. Can you just comment a little bit more on the tax and the bad debt expense, please? Just a little bit more color as to why the tax rate was low and the bad debt expense you mentioned, better control there, if you can just outline the outlook going forward and whether you expect bad debt to be so well contained in future quarters?

Can you just confirm the dividend policy? With regard to dividend policy, how it might be affected by future acquisition and M&A activity? Thanks.

Vsevolod Rozanov

I will start with the first question. Speaking about tax, we have seen that due to the less magnitude of the forex appreciation we have seen that effective tax rate for this quarter was significantly lower. And speaking about bad debt expense we believe that we are not going to see a significant drop in this item. But we are constantly working on decreasing it, and we are likely to see further improvement on this item going till the end of next year as we plan now. For the dividend portion I’ll pass over to Leonid.

Leonid Melamed

Thank you. First of all I have to also admit that we don’t comment not only on the future of our competitors, but also the future of our shareholders, and the dividend policy is mostly the question of their agenda. We just witnessed the situation when last year, the shareholders decided to increase the dividends paid as a portion of our net income. We understand that we have a good chance to offer them bigger net income this year to decide how it should be divided.

We have not yet finalized our portfolio for the next year and that’s why to give any concrete indication for you what’s going to be the recommendation from the management in this area it would be premature.

Operator

Thank you. We have a follow-up question from Mr. Alex Kazbegi from Renaissance Capital. Please go ahead, sir.

Alex Kazbegi - Renaissance Capital

Yes, a couple more, please. I think you mentioned on Turkmenistan that the reduction of the OIBDA margin was due to the one-off license effect. If you could just comment on that, whether the OIBDA margin is going to shoot up back to the 60s or 70s, where it was I think one quarter ago?

Secondly, if you could discuss the possibility of rolling out the WiFi network together with ComStar in Moscow, how tangible these plans are, first of all. Secondly, when is that going to happen? Do you know how you plan to split the revenues? Who is actually going to be the leader, if you wish, in this project?

Lastly, I noticed that your depreciation has been growing quite slower in the last two quarters compared to the previous years, despite fairly high capital expenditures. Any reasons for that, or anything that you could add to that would be great. Thank you.

Vsevolod Rozanov

Thank you. I will start with the first question. Speaking about Turkmenistan, we believe that your assumption might be reasonable. We also plan that after a certain one-off charges we incurred in Q3, the OIBDA margin will be back to higher numbers. We obviously wouldn’t be able to comment on the exact numbers, but I think that there is obviously an upward trend in that market situation we are currently in.

I will also answer the third question before passing the word to Leonid. Speaking about depreciation, we have seen lower cap-ex numbers during the last three or four quarters, so basically that was the key reason for the lower depreciation number you see in our financials.

Alex Kazbegi - Renaissance Capital

There wasn’t any policy change or any write-offs there? It is just purely because of that?

Vsevolod Rozanov

Yes.

Leonid Melamed

Our business plan on WiFi hotspots with ComStar, in general terms, we are not in a position to invest into this activity together with ComStar. We understand that our business task from a marketing point is to deliver to the majority of our customers and those who are on roaming with MTS the ability to have an easy access and easy paying solution once they communicate with WiFi hotspots. A second task is to create more of those hotspots for the convenience of our customers. That is why we are prepared to cooperate with different providers in order to create this way of the easy payments and easy access to our customers.

Of course, in Moscow, we will mostly cooperate with ComStar. Once they are going to invest in users, we understand they probably will see it like their business and for us to be mostly the vehicle to service our customers better.

Alex Kazbegi - Renaissance Capital

So mostly to the complex, you are charging and collecting revenues rather than yourself, more than from [inaudible]?

Leonid Melamed

It is under discussion now, but the key piece in the end will come to the providers, means to ComStar, with some commission for us.

Alex Kazbegi - Renaissance Capital

Thanks very much.

Operator

Thank you. The next question comes from Mr. Barry Schumacher from [Alsa] Bank. Please go ahead with your question, sir.

Barry Schumacher - Alsa Bank

Good evening, gentlemen. Congratulations again on your great results. Most of my questions have been answered. I just have two quick questions. The first one on Ukraine. Great results, 56% OIBDA margin, and Andrei mentioned before the increased competition with U-Tel and 3G, and we know VimpelCom has entered the market. Do you think this type of margin is sustainable going forward?

My second question is in regard to the ADR repurchase. A couple of questions, maybe you can elaborate. Why ADRs and not the locals, which trade at almost a 10% discount in buying back shares? Also, was there a change in the year that you lapsed from when Deutsche Telecom placed its 10% of MTS shares on the local exchange versus when you decided to buy back that 10%? If you could elaborate on that, that would be great. Thank you.

Adam Wojacki

Answering the question on Ukraine, on the high OIBDA margins, again as it was said before, it was a deliberate set of activities which we undertook at the end of Q2 and throughout the Q3, promoting on-net traffic and with a subscriber base of about 70 million. That is one contributing factor to keep the OIBDA margin on the high levels.

Offsetting subscriber acquisition costs and subscriber policies, as you know, in the mature market, this is the natural thing to do. Also, you know, the additional cost control programs, like building out our own transmission network. That is why not having a need to lease lines from other operators, and keeping the operation maintenance under control.

Those were the activities which helped us to contribute to high OIBDA margin. We hope that this is not only one-off activity but that the activities and the result will help us to keep the OIBDA margin above 50% for the quarters to come.

Vsevolod Rozanov

Speaking to the second question, I would like to mention that the decision to repurchase ADRs was made, as we discussed during the Q2 results conference call, on the basis of several reasons.

A few reasons were mentioned, and among them were reasons of using the repurchased ADRs as a financing and there was certain potential mechanisms were announced, such as the potential convertibles, convertible bonds to be issued in relation to those ADRs. Also, using it as a currency for potential use makes actually ADRs more flexible instruments, but we are also currently looking at what is going on in the local share market.

Could you please repeat the second part of the question?

Barry Schumacher - Alsa Bank

Sure, sure. The second part was related to Deutsche Telecom’s placement approximately a year before your announcement of the repurchase. I am just curious to know, did something strategically change in your minds during that year?

Vsevolod Rozanov

Well, I would say that there was a totally new team in place at MTS, but I think it was just a question to our Board, to our shareholders, and we cannot comment on that.

Barry Schumacher - Alsa Bank

Thank you.

Operator

Thank you. The next question comes from Mr. Stephen Pettyfer from Merrill Lynch. Please go ahead with your question, sir.

Stephen Pettyfer - Merrill Lynch

Hi, a few questions, please, both on costs. Firstly, in Russia, I noticed that within SAC, your dealer commissions have stepped up notably quarter on quarter. Is that a sustainable new level we are at in terms of commissions, or is that commiserate with something else behind that move?

Secondly, just more generally, my impression three months ago or four months ago was that you had a lot of plans afoot in terms of cost reduction. Given the good results today, have you seen just the execution on that program being brought forward, or do you still feel you have more to go? Thank you.

Mikhail Shamolin

On the dealer commission, starting January, 2006, we have introduced a new dealer commission payment scheme, which is based on the revenue sharing principal, which means that we share the revenue we get from the subscribers with the dealer for a fixed period of time and we top it at a certain level. Of course, while we were enjoying higher ARPU on our new subscribers, we also had to share more with the dealers, so you saw an increase in the dealer commission.

We are undertaking steps to review our dealer commission for 2007. We will be regulating the maximum level of payments we are making to dealers, as well as our pricing policy, which will allow us to share some of the revenue we get from actually selling the contract to our subscribers through the dealers. I would not expect the dealer commission to grow significantly in 2007.

Vsevolod Rozanov

Answering the second question, I would say that and stress that we place extremely great importance for the cost reduction program which we are implementing at MTS. We, as we mentioned before, we see the growing margin pressure, specifically in Russia, and we believe that the implementation of the cost reduction program, which we announced for the next two years, at least. It is more or less an ongoing effort which will not be diminished by the positive trends in the revenue growth.

Operator

Thank you. We have a follow-up question from Mr. Vladimir Postolovsky. Please go ahead, sir.

Vladimir Postolovsky - Brunswick UBS

Thank you. A couple of questions for me as well. Ukraine, if there was anything which did not look great in Q3, it was the churn rate in the Ukraine was quite high. Could you tell us what is happening in Q4? Obviously you removed some subsidies. You increased pricing at the same time [Intercom] was coming in. Do you see that as a serious pressure, or was it just a one-off quarter?

The second question, you mentioned those receivables relating to the [inaudible] arrangement. My question is how confident are you, 100% confident or less, in the recovery of those receivables? Some of the operators might argue that I bet they do not want to pay that respectively. If you could also break down those receivables which are the receivables from fixed line operators and from the new mobile operators that signed those agreements with you in Q3.

You mentioned 8 over ARPU that you think is achievable in Q4. It still sounds a bit conservative to me, to be honest. I understand the analogy, but at the same time, you have [ROBO] still working for you. You also will have carry-over effects from all those marketing initiatives, like no set up charge or higher first minutes, whatever you want to call it. Don’t you think that it might allow you to have a higher ARPU, and didn’t have a significant drop in quarter-on-quarter at all?

Related to that question, what do you see -- how strong is the underlying usage growth? If you take an existing subscriber and try to forget about the historic subscriber meets dilution on negative impact, for the existing customer, and maybe even try to think of put aside also multiple SIM-card usage, for the existing physical customer, what do you think the annual usage growth is at the moment?

I am terribly sorry, and the final question is on cap-ex. I appreciate that you are not giving any guidance for ’07, but maybe qualitatively rather than quantitatively, you mentioned that you expect it to be not higher than in ‘06, but I think most people expect it should come down quite significantly. Can you say that, at least directionally, this is the right assumption? Will it come down as opposed to going higher? Thank you.

Adam Wojacki

Answering the question on the churn in the Ukraine in the third quarter, yes, the churn in the third quarter in the Ukraine was higher than the previous quarters. Two major contributing factors. The first was, according to our churn methodology, we were churning off the clients which we acquired in the new year promotion half-a-year before, and this is the main contributing factor. The other, the entrance of the third and the fourth operators.

Regarding Q3 to Q4, we have seen that the main wave of the new year customers, those acquired in the new year promotion, have passed and we have seen the reduction in churn, so we expect the churn to be reduced in Q4 this year.

Leonid Melamed

Thank you, Adam. Vsevolod, please.

Vsevolod Rozanov

Speaking about receivables, obviously one cannot be 100% sure, but I would say that I am 99.5% sure that these receivables are only delayed in time because there is basically a limited number of counterparts. We were in discussions with them, and I think that the delay in receivables is 100% of a technical nature rather than of other nature, because of the complexity of the processes that the first time the general agreements and the sort of corporate level or the Russian level, and then have to sign the contracts with each particular subsidiary in each particular region we operate in, so it is just a process which takes time.

Vladimir Postolovsky - Brunswick UBS

But generally everybody is happy to pay from the first of July?

Vsevolod Rozanov

Sorry?

Vladimir Postolovsky - Brunswick UBS

Generally, everybody is happy to pay from the first of July?

Vsevolod Rozanov

Well, it is a two-way process. It is actually us also paying our counterpart, so basically there are no discussions or issues that certain revenues will not be incurred starting July 1st. It actually will be starting July 1st in most cases.

Leonid Melamed

Regarding the ARPU forecast for Q4, we still would like to be realistic in our prognosis and regard the forecast of ARPU around 8 as a realistic prognosis. Due to the signal factor, due to the competition factor, we understand that it is already far higher than what we anticipated in the beginning of the year, and we think it is a realistic prognosis. I will pass it to Mikhail.

Mikhail Shamolin

MOU growth is at the very basic foundation of our marketing policy this year. We have introduced a number of tariff options, like unlimited weekends and unlimited nights, for instance, which our subscribers can purchase for a very low fixed fee and talk free for two days, or for a night. All that contributes to increase of usage, so we do see the actual usage increase on top of pure seasonality factors, and we hope that we will see this increase in the future.

In Russia, the usage of both voice and data services is much lower than in Eastern and Western Europe, for instance. While you see the income per capita increase in Russia, you would also expect the MOU to go up, and this is what we see.

Vladimir Postolovsky - Brunswick UBS

You are not able to give a rough estimate, right, as to what you think the underlying average usage growth is at the moment?

Mikhail Shamolin

Could you repeat the question, please?

Vladimir Postolovsky - Brunswick UBS

Would you be able to give a rough estimate of what the underlying average usage growth for typical subscriber is today?

Mikhail Shamolin

I do not think we are ready to reveal this information. I can only say that it is growing.

Vladimir Postolovsky - Brunswick UBS

Fair enough. And cap-ex?

Mikhail Shamolin

One more thing I wanted to add. The real penetration in Russia is still low enough to allow some room for growth, which also will have its impact on MOU.

Vsevolod Rozanov

The last question related to cap-ex. I think it is very close. We connect it with what Mikhail just said, that we still see certain room for MOU growth in Russia, thus we believe that it is too early to expect a significant drop in capital expenditures in the coming year. What we can say at this stage is that again, just to reaffirm that the cap-ex for the group for next year is unlikely to exceed the cap-ex for this year.

We are also likely to see the redistribution of cap-ex between the countries, because there are certain businesses, such as Uzbekistan, for example, Ukraine, definitely require more cap-ex as there is more opportunity for the growth.

Basically, this is the outline for the next few years. The cap-ex to sales ratio is likely to drop over the course of the next few years, and more details will be revealed during the January call on guidance.

Vladimir Postolovsky - Brunswick UBS

Thank you very much.

Operator

Thank you. The next question comes from Ms. Anna Bossong from CA-IB. Please go ahead with your question.

Anna Bossong - CA-IB

Thank you very much. My first question concerns the rise in fixed-to-mobile traffic in September. I wondered if you could give us an idea if that was carried over the full third quarter, how much of an impact it might have had on ARPU. Should we say because there was only a two percentage point increase in fixed-to-mobile traffic that it only affects ARPU by that sort of quantity, or is it a more significant factor?

Secondly, do you think it will put pressure on your mobile-to-mobile tariff if you try and draw that traffic back into your network? How do you see it impacting your fourth quarter ARPU?

My second question is on the Turkmenistan one-time charge. If you could perhaps tell us how much that was.

My third question was just on the general cost-cutting. You did a great job in the third quarter of cutting costs. Is there more cost-cutting in the fourth quarter to come in terms of G&A and that sort of thing? Thank you.

Mikhail Shamolin

The increase in fixed-to-mobile traffic in September, as I said, was 64%, but the share of this traffic in total traffic has been around 6% to 8%, so the impact on total traffic was not significant and therefore if we take September statistics as a trend, the impact would not be significant, but again as we said, it is too early to tell at this point if the impact of CPP and the change in fixed-to-mobile, so we will see in the next few months how that will develop.

On the pressure on mobile-to-mobile traffic, again, we did not see a significant pressure. We, as I said, continue to have 50% of our traffic as on-net traffic and that so far did not change our marketing policy.

Vsevolod Rozanov

The third question was, correct me if I am wrong, related to the one-time charge in Turkmenistan, right?

Anna Bossong - CA-IB

Yes, that’s the second question. The third one about your cost-cutting in the fourth quarter, what you can do versus the third.

Vsevolod Rozanov

Yes, so speaking about the one-time charge, that was approximately $5 million, just a little bit above $5 million.

Speaking about the Q4 efforts on cutting costs, we continue to find ways and change the business processes in order to extract more value for our shareholders. We definitely are not going to see any one-time decreases, but we will significantly -- there is definitely room for further decreases in areas such as working with our vendors, and we expect the results to actually materialize in Q4 and Q1, as when we started our new approach in the business this year.

We also are going to see certain decreases in costs related to personnel, as we are working on the optimization of the number of employees. We also can expect certain positive signs from optimizing our market and advertising costs as well. Those are basically the key areas for cost optimization. Thank you.

Leonid Melamed

I want to add to this, that there has been a set up of one-time measures that have been deliberated in spring of this year, and they are going to be finalized at the end of this year. Until that time and always, we will pass to what is called business as normal, business as usual by putting top-down, attractive challenges for our business units and macro agents regarding the top-line and bottom-line, and creating on the group center the guidance of expenses parameters that we consider to be fulfilled on the regional level. By then, we will have good enough proposals and dialogs. This is what we call business as usual for MTS. No more one-time cut-ups.

Anna Bossong - CA-IB

Excellent, thank you. Could I just follow-up along the advertising cost side? Usually in the first, fourth quarter there is a lot more attempt to gain subscribers and to boost marketing and advertising. Is it the case that now the market is quite mature in Russia and therefore that is why you are not looking to increase spending, but rather [profit] in the fourth quarter? Or is it something else?

Leonid Melamed

As we have said on the conference call for the results of Q2, we have changed the way we estimate our advertising expenses. By that, we have realized certain cost reduction opportunities for us. We would proceed the new methodology, that we have deliberated and we have chosen, actually, to keep on for us in the year 2007.

In general terms, we understand we have good potential of future reductions in media buyings, et cetera, but from another hand, we have a big pressure on media inflation. They say that it is going to be quite sufficient in the next year due to several factors on the media market. That is why it would be premature to say whether in general terms, our budget would next year be significantly lower or just lower than this year, but we believe it definitely would not be higher, especially because we will not have rebranding one-time effects that we had this year.

Anna Bossong - CA-IB

Thank you very much.

Operator

Thank you. Our next question comes from [inaudible]. Please go ahead with your question.

Unknown Analyst

Yes, I have some clarification on your traffic structure in September. As you mentioned, 50% is on-net traffic, both incoming and outgoing. Then another 20% is the fixed-to-mobile, both incoming and outgoing, of which you mentioned a couple of minutes ago, 6% is fixed-to-mobile incoming, right? Which means that 14% really is outgoing from the mobile to fixed, and that makes it for 30% mobile-to-mobile. Is this correct?

Vsevolod Rozanov

Let us come back to you with the more detailed answer to this question with the numbers.

Operator

Your next question comes from Alex Kuznetsov - Bear Stearns.

Alex Kuznetsov - Bear Stearns

Good afternoon. I have a couple of follow-up questions. First of all, have you done some estimates of elasticity and have you estimated if increase in tariff, minutes of use of your customers on the tariff? Secondly, given the strong revenue expansion in the third quarter, do you expect that your revenue-based market share in Russia rose in the third quarter?

Vsevolod Rozanov

Well, on the second one, we will know tomorrow I guess.

On the first one, I will say that there are two interesting trends. On one side, there is fairly high elasticity for lowering the price. So, market offers with the lower price points are usually taken very good by the mass market and we typically see very quick and high sales pick-up. On the other side, price increase to the existing customers does not change their behavior much. So, elasticity there is quite low. We are trying to balance between the two to have a consistent marketing voice.

Alex Kuznetsov - Bear Stearns

Thank you very much. One more clarification on Turkmenistan. As you pointed out, you had to pay a significant fee for license. Is it included in subscriber acquisition costs because I have noticed quite a significant SAC expansion? Also, I was under the impression that this special agreement with the Turkmen government was enacted last year. So, I am quite curious why there is such a dramatic change this quarter?

Leonid Melamed

First of all, license fee was not included in subscriber acquisition costs and the as you call dramatic increase in SAC for Turkmenistan this quarter was justified by the rebranding which was done there in Q3. We rebranded three countries out of five in the Q2. There was a rebranding in Turkmenistan in Q2, first three countries and Turkmenistan and the UMC rebranding is scheduled for next year.

As for the special agreement with the Turkmen government, that’s basically – yes, that was signed when the company was acquired. So, basically, it's more or business as usual for us.

Alex Kuznetsov - Bear Stearns

You paid approximately the same, about $4 million in the previous quarter? You highlighted that last quarter you have paid approximately $5 million as ongoing license fee. Does that mean you paid approximately the same amount in the second quarter?

Leonid Melamed

No. That means that there was approximately same amount last year.

Alex Kuznetsov - Bear Stearns

Thank you.

Operator

Your next question comes from Olga Bystrova – Credit Suisse.

Olga Bystrova – Credit Suisse

I have several follow-up questions if I may. I want to come back on the cost items again, specifically general and administrative expenses, which basically were flat quarter on quarter in the third quarter, and declined about more than 2 percentage points as a percent of revenues. Could you elaborate where did the savings come from? Has it all been done, or we can expect a continuation of those savings in the fourth quarter?

Second question in terms of your marketing policy in Russia are you planning to consider migration of subscribers from prepaid to post-paid base as your marketing policy?

A final question on the Ukraine, what in general do you expect in the fourth quarter this year? Is it currently a very aggressive market environment? What kind of promotions have started already? Do you see migration of subscribers from your network currently?

Vsevolod Rozanov

I will start with the first question. The G&A cost reduction were, as we have already discussed, there is a further potential to decrease G&A cost, but they are not likely to be that dramatic drop QonQ as we go forward. We will not be able to disclose the details of the specific cuts.

I will pass now to Mikhail to answer the second question.

Mikhail Shamolin

Thank you. This is Mikhail again. On postpaid and prepaid, in fact, the way it is classified in most cases, so-called postpaid customers are very much similar in the way they pay for mobile communication as prepaid, because actually on their contract, they keep money in the account. So, when we say postpaid we really should mean the credit customers, which take credit and then pay after they’ve used the services. So of course the share of these subscribers we are planning to grow. But this is not mechanically reflected in the reports, because as I said reports are classified based on the contracts and not all the contracts are credit contracts. But, yes, in our marketing policy we are planning to expand the share of credit subscribers.

Olga Bystrova – Credit Suisse

Thank you, and on the Ukraine, please?

Adam Wojacki

Yes, Adam Wojacki answering the question on Ukraine, the Q4 prospects. A few qualifying comments before I answer your question. This year we focused in Ukraine on building the strong base for the future profitable growth. We focused on building the good network coverage and good quality network. We were finalizing the accelerated network buildup into Q3, the same thing was with our distribution network. We have got now a very good distribution network which gives us the competitive advantage over our competitors.

Those two factors plus some branding fine-tuning allowed us to stabilize the situation in Ukraine, and in the last couple of months on the subscriber side we’ve seen the majority of net is coming to our network.

So, yes, in the Q4 the activities for New Year and the Christmas promotion has already started. The special October part is very encouraging. UMC is leading in the net subscriber rate and we will see the result in October and December.

Answering your question whether there is a migration between UMC and the newcomers, of course there is and going back from the new entrants to UMC and to KievStar is a natural fact of life, but the main question for us is that we will get the majority of the net adds, so that’s how we see Q4 now.

Operator

Your next question comes from Vladimir Postolovsky – UBS.

Vladimir Postolovsky – UBS

Last one, I promise. Going back to the traffic patterns, do I understand you correctly that the increase in fixed to mobile traffic that you’ve seen, you are seeing more than incremental traffic and you don’t believe that there is a negative impact on your on-net usage? Of that 64% growth in September I presume some of it should be seasonal, because people are coming back from holidays and start calling more fixed to mobile. You must have seen something like that in the past. So how much of that is seasonal and how much of that is genuine new traffic? Thanks.

Adam Wojacki

The increase that we saw in September in fixed to mobile has not led to the decrease in on-net or mobile-to-mobile traffic. There has been a slight decrease of mobile to fixed, but not as dramatic as the increase in fixed to mobile.

In terms of seasonality, I would say that you would actually see more seasonality on fixed to mobile in the first quarter while the day actually becomes shorter so people come to home earlier from work and prefer talking on the fixed and not on the mobile. So we haven’t seen the growth of it yet, but so far it has not impacted the revenue negatively. Of course, we had a much more dramatic impact from CPP because we stopped getting revenue from this.

Vladimir Postolovsky – UBS

So, you haven’t seen anything like that in September in previous years and you think the whole 64% is genuine impact of CPP?

Adam Wojacki

I cannot give you a specific number, but I would say majority of it is because of CPP.

Operator

Your next question comes from Leah Miller - HSBC.

Leah Miller – HSBC

Hi, let me congratulate you as well. I would like to ask a couple of credit-related questions, please. You mentioned that you might be issuing convertible bonds. Could you please tell us a little bit more about this? Does this mean that you are thinking of increasing leverage generally to optimize your capital structure? Or more in the sense that if you plan to pursue some acquisition opportunities? Thank you.

Vsevolod Rozanov

Well, convertible bonds were mentioned as one of the potential instruments, so nothing in the pipeline, or no practical steps about it were taken. So, generally speaking we are not intending to increase our leverage for the sake of increasing our leverage. But, obviously, we are pursuing the different opportunities as Leonid has mentioned in certain discussions for potential acquisitions in various countries. So, depending on the outcome of these discussions we definitely might see a certain increase in our loans. Thank you.

Leah Miller – HSBC

Do you plan to have a formal debt leverage target?

Vsevolod Rozanov

We are now discussing the overall financial strategy for the group and we are very like to have formal guidance on that in the first half of next year.

Leah Miller – HSBC

First half next year, okay. And just last question. If there aren’t any suitable acquisition opportunities or expansion opportunities, would you consider buying back your bonds?

Vsevolod Rozanov

Well, again, we are not going into details -- due to our lawyers’ advice -- into a discussion of our share repurchase program. Speaking about buyback of the bonds, again it's a little bit premature to discuss this. As I said we are thinking about financial strategy and we have multiple options. So, basically, I can’t answer your question at this stage.

Operator

Your next question comes from Jeff Motave - Standard Pacific.

Jeff Motave - Standard Pacific

A quick question on your joint venture in Belarus. Do you see any opportunity to potentially increase your stake and start consolidating that operation in the near future?

Leonid Melamed

Thank you very much for this question. Of course we are looking for this opportunity for some time already, and our partners there have all the proposals on the table. So, it mostly depends on the policy of the Belarusian government and we would be happy to buy the control for MTS.

Operator

Your next question comes from Felix Fischer – HBC.

Felix Fischer – HBC

Yes, good afternoon, also congratulations for the super results for this quarter. My question relates to potential acquisition opportunities. You mentioned that at the moment valuation seems to be too high and that nothing very concrete is in the pipeline. Could you share with us what coming down of valuation in the general markets would you think is necessary to make or to give you more interesting opportunities?

Leonid Melamed

We understand that the latest yields that we witnessed has been done at very high multiples to look at this part of the valuation, like multiples to revenues, EBITDA, and multiples to amount of subscribers. When we look at the deal the multiples should be closer towards our shareholders and what analysts think to be reasonable multiples for MTS. On the other hand we would like to see the potential synergy with the group of MTS that would allow us to increase the effectiveness of the operations of the potential target in order to prove that purchasing a company I would say at a much higher multiples that MTS has priced itself, is reasonable for our takeovers.

Operator

(Operator Instructions) Thank you. We have no further questions at this time.

Andrei Terebenin

Thank you, ladies and gentlemen. We welcome you at any time to contact our investor relations department for further questions. 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 you a pleasant day. Thank you again, and good-bye.

Operator

This concludes the third quarter 2006 financial results for Mobile TeleSystems conference call. Thank you for participating.

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Source: Mobile TeleSystems Q3 2006 Earnings Call Transcript
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