From Russia, with love

From the fourth floor corner office at 13, Mokhovaya Street in Moscow, the Kremlin’s massive facade dominates the view. Situated a stone’s throw from Russia’s seat of power, it’s the headquarters of the $28 billion (Rs 1.4 lakh crore) Sistema, the country’s largest publicly-held financial corporation. The office’s occupant, founder-chairman Vladimir Evtushenkov who built Sistema from scratch, is a Vladimir Putin confidant. Considered a Yeltsin-era oligarch—he prefers the term ‘mega magnate’ since it doesn’t signal unnecessary proximity to power—Evtushenkov accompanied Putin on business delegations to London in 2003 and New Delhi in 2011. He is regularly consulted by the government and is seen as the most outward-looking industrialist in modern Russia.

Evtushenkov brought his telecom business MTS—ranked 80th among the most valuable brands in the world by research agency Millward Brown—to India in late 2007, under a joint venture with Shyam Telelinks called Sistema Shyam Teleservices (SSTL). This was the Russian private sector’s first investment on foreign shores (investments in CIS don’t count as foreign) and a strategic one. India’s lingering proximity to the erstwhile Cold War super power also helped him persuade the government to back his move. Last March, the Russian government picked up a 17.14% stake in SSTL, its first and only such investment, for $600 million. Sistema now holds 56.68%, while Shyam and others constitute the rest. Evtushenkov says, “India is the market of the future with high growth potential.”

Sistema’s executive board director and CEO Mikhail Shamolin adds: “We want to be part of India’s growth and will be looking at all avenues from partnerships, joint ventures, and greenfields, to mergers and acquisitions in sectors where we have businesses.”

This fits into the larger strategy of building Sistema into a Russian multinational. In an interview with Britain’s Daily Telegraph in 2003, Evtushenkov said if he had a model “it is General Electric”. And, as Shamolin argues, they need to understand emerging markets (other than Russia, of course) first. “China is too competitive and difficult to understand, Africa is fragmented and not ready, and South America is too far away.” Privet India!

Within Sistema, there’s now an emphasis on discovering India, which its executives say is a great opportunity given that Russian companies have traditionally been inward looking. There are 20 Russians working at SSTL alone—a high number of expatriates in telecom. They are encouraged to travel, talk to customers and vendors, learn useful phrases in Hindi, and, most important, polish their English, a skill that’ll come in handy elsewhere in the world.

Sistema ultimately plans to somewhat mimic its Russian operations here. It is like Tata Sons, a holding company with interests in telecommunication, technology, oil and gas, radio and aerospace, banking, retail, tourism, and health care. Sistema is talking to state-run Oil and Natural Gas Corporation (ONGC) and other oil companies, both in the private and public sectors, for liquefied natural gas terminals and refineries in India and globally. It is talking about joining hands with Indians to build power stations and develop captive coal mining, and is even interested in retail. But, so far, the big chunk of the $2.8 billion it has invested in India since 2008 has been in telecom. This includes the Rs 1,280 crore it raised last month through non-convertible debentures, after raising Rs 920 crore in loans from ICICI Bank and Barclays Bank last September.

There’s been controversy as well. Lawyer Prashant Bhushan, allied to activist Anna Hazare, and one of the main voices of the ongoing anti-corruption movement here, has accused the government of shielding SSTL in the 2G telecom scam because of Moscow’s part-ownership of the company. SSTL refused to comment on this.

Meanwhile, in response to another petition filed by Bhushan (as part of the Centre for Public Litigation), the Supreme Court earlier this month cancelled all licences issued to mobile networks after 2008. A Sistema spokesperson says it’s “a little premature to offer detailed comments”. However, insiders say that the company will take part in future spectrum auction, and that it’s looking at acquiring assets of any player who exits in this turmoil.

As Shamolin says, telecom’s a great way to understand the idiosyncrasies of an emerging market. “Though telecom is highly competitive, it is the best platform to understand how the government and regulatory environment works in India. It also takes the company to the retail customer and helps it understand how the market behaves.”

Analysts seem sceptical, and are concerned that Sistema has not been able to define the objective of its telecom investment. “Investors would like to see some improvements in cash flow,” says Mikhail Galkin, an analyst with VTB Capital, the investment banking arm of Russia’s second-biggest lender, VTB Group. “If Sistema’s money flows into untested territory, we need to see results before further investments,” says another Moscow-based analyst. His discomfort stems from a deal between Sistema and ONGC Videsh that is stuck.

Since 2010, Sistema has been trying to sell two of its oil businesses, Bashneft and RussNeft, to Imperial Energy, ONGC Videsh’s Russian arm. If the deal goes through, ONGC will become a shareholder in the two Russian firms’ annual oil production of 25 million tonnes (refining capacity of 20 million tonnes a year) as well as oilfields Trebs and Titov. Shamolin says Sistema is waiting for ONGC to make an offer: “It is purely a question of price.”

He argues that India should be seen as an overall opportunity, and not how specific businesses are doing. But the analysts aren’t off the mark. For SSTL to scale up, it needs shareholder permission to raise more capital (telecom guzzles cash), especially since a proposed public issue has been postponed. As SSTL’s chief financial officer Sergey Savchenko says in the context of the last two rounds of fund raising, “It was quite challenging to raise such significant long-term funds under the current uncertain regulatory environment in India, but business has to continue and grow.” And the progress of the telecom business may well determine Sistema’s overall India plans.

In September 2008, when journalists were flown from all over India to Jaipur where Sistema was showcasing its state-of-the-art telecom network control and command centre, the entire top management, including Evtushenkov, was present. It was the launch of CDMA mobile service Rainbow, the brand initially created by Shyam Telelink. The press conference was to be followed by an entertainment programme, but had to be cancelled due to a panic at a nearby temple where many people died. Evtushenkov and SSTL’s president and CEO Vsevolod Rozanov, who glimpsed the building crowd before the press conference, admitted later that they had never seen so many people in their lives. In some ways, the Jaipur crowds perhaps hinted at the India opportunity.

That day, Evtushenkov committed almost $7 billion to India, of which $4 billion was to expand capacity in telecom over four to five years. Today, the company is being forced to take a long-term view—it says it will spend the same amount over seven years.

MTS India could not borrow too heavily from its Russian origins. Product designs and campaigns might be replicated, but India required a new distribution model. For instance, Russia has highly organised mobile retail distribution with products being sold only through exclusive outlets. Even a town with a population of 3,000 has one for mobile gadgets. In India, a mom-and-pop store selling groceries retails SIM cards as an add-on business. This forced Sistema to learn a new way of selling. Then it realised that the hypercompetitive environment sucked up resources—that meant the Russians had to focus on cutting costs and increasing efficiencies. So SIM card packaging went back to the drawing board in Russia, to create something that was cheaper, hardier (to survive rough shop conditions), while still looking good.

But Sistema’s approach was more fundamentally different, even contrarian. By buying into Shyam in 2007, it had backed CDMA although it operates on the GSM platform in Russia and the CIS. And this at a time when there was evidence that two leading Indian CDMA players—Reliance Communications and Tata DoCoMo (erstwhile Tata Indicom)—were struggling to keep pace with GSM operators on subscriber acquisition.

One rationale could be that there weren’t any GSM players looking for partners then. And, unlike Telenor or Etisalat, which have access to GSM through their Indian partners, but arrived later, Sistema wasn’t willing to wait.

Within SSTL, CDMA is known to be a more difficult technology to work with. Cheenu Sheshadri, SSTL’s chief operating officer (south and west), earlier the chief strategy officer, says CDMA is not a growth engine and a difficult technology to do business in. “If the GSM spectrum roadmap is uncertain, CDMA does not even have one. Further, lack of a device ecosystem despite the best efforts by the vendors has curtailed the technology from having a mass appeal.” But he adds that if its inherent qualities on data are exploited (CDMA allows faster data transmission), a viable business can be built.

So, by August 2009 SSTL had picked its strategy—wireless broadband. “We had a target of bagging 6% to 8% of the voice market, but realised pricing wouldn’t bring profit,” says Rozanov. With broadband users making up less than 1% of the market at the time and a ready data network, it was a perfect opportunity. According to a report by Analysys Mason, a telecom consultancy, the potential was huge, with wireless broadband subscribers expected to reach 1.2 billion by March 2016.

MTS India seized the opportunity and rolled out the CDMA EV-DO network, which was considered 3G outside India, and upgraded that further to offer data speeds of up to 9.8 megabytes per second.

Data speed is now its differentiator. MBlaze, its brand of dongles, offers 3.1 Mbps, which is 3G speed. However, since the Department of Telecom does not include EV-DO networks as 3G, and MTS India did not participate in the 3G auctions, it can’t call it 3G. Vodafone, the second-largest service provider in India, rides on the MTS network to offer 3G.

Today, MTS India has more than a million customers for data cards and dongles—around 34% of the market, and almost 65% of non-voice services comprise data access. These services contribute about 26% to the company’s top line. It wants to increase this to almost 50% by 2014. “We understand that 95% of data revenue comes from the top 100 towns in India and we are present there. On average, we have dedicated 50% of our network resources to data and provide better speed and coverage,” says Sheshadri.

Rozanov wants to open another front—smartphones with bundled offers. “The realisation for these devices is almost four to five times higher than dongles. Before 3G operators find their feet, we want to start with a combination of dongles and smartphones at $100,” he says, adding that iPhone-like devices may also be on the cards.

Of course, the CDMA numbers continue to disappoint. The Telecom Regulatory Authority of India reports say this market has dropped from 26% of the total wireless subscriber base in March 2008 to 13.4% in June 2011. Net subscriber additions are less than 4% of the total, average revenue per user (ARPU) is Rs 64 compared to GSM’s Rs 98. But Rozanov says he is on course to become Ebitda positive by early 2014. “MTS Russia took 14 years to become cash positive. MTS India is being judged on less than four years of operations.” MTS India’s revenue was Rs 523 crore with a negative Ebitda of Rs 1,504 crore in FY2010-11. In the first three quarters of FY2011-12, those figures are Rs 843 crore and negative Rs 1,324 crore respectively. So sales are up, losses declining, and Rozanov hopes that MTS India’s success will result in shareholder approval for more investments in the country.

Sistema is also preparing to bring in Glonass, a system of navigational satellites developed as a Russian alternative to GPS, and has begun getting the necessary government permissions. Says Shamolin: “Sistema is driven by opportunity and will not wait for one business to mature. We won’t wait for the telecom business to turn profitable.”

Along with Russian space agency Roskosmos, Sistema is exploring applications for intelligent traffic management. Glonass, which began life as a Cold War military application, is used in vehicles in Moscow and is being pitched as a serious contender for traffic systems in Delhi and Mumbai, apart from being embedded in mobile phones. But the project, a Putin favourite, needs to overcome glitches such as malfunctioning technology and dud satellites.

Sistema says its software company Sitronics, which began Indian operations in 2009, will create the ground for Glonass here. Sitronics handles SSTL’s billing solutions and tied up with Tech Mahindra last October to expand its presence among new operators and small and medium enterprises. “As security becomes high priority, we will use our Russian experience to gain a foothold here. We are not looking at eating into someone else’s pie. We will compete by making friends or by creating our own pie,” says Vikilov Timur, managing director of Sitronics India.

Although Indo-Russian ardour isn’t as intense as it once was, Russia and India are still all-weather friends in foreign affairs. These ties gave Sistema the confidence to bet big on India. Now it has to prove it can win in a free market.