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Western investors eye Russia's wireless market

Rapid growth of the country's cell phone market has companies dreaming of a speed-dial to success. But the risks are high.

Given the reports of instability and corruption within its borders, Russia is not an obvious choice for foreign investment.

But for many Western financial companies in the cell phone carrier market, such factors pale alongside what they see as the Russian market's enormous possibilities.

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What's new:
Nearly 60 percent of Russians are still without cell phones. What's more, regulators are set to auction off more bandwidth, and Russian phone companies are looking for capital. To Western investors, it looks like a good call.

Bottom line:
Charges of corruption could make investors jumpy, but Russia's cell phone market is the second fastest growing in the world. As the country's biggest carriers extend the battle for customers from the cities to the rural areas, they'll likely do so with a few Western dollars.

More stories on cell phones

"We find that the country still offers some of the most attractive mobile revenue growth potential in our universe of coverage," JPMorgan Chase researchers wrote of the Russian wireless market in late September. "With robust organic growth potential in Russia, and attractive, moderate-risk international growth opportunities, we see very little to threaten the industry's currently very robust profitability."

The opportunity presented by the Russian market is difficult to deny. In 1999, about 1 percent of Russians owned a cell phone; just five years later, 90 percent of residents in Moscow and St. Petersburg, the country's main metropolitan areas, have gotten phones and service, with the help of major investments from foreign wireless interests.

Subscriber rolls of the top 10 Russian cellular operators have continued to grow this year. Revenue for all carriers through the first half of 2004 was up 58 percent compared with last year, and revenue is expected to reach $7.6 billion by year's end, according to Russia-based research company iKS Consulting.

And even if one views the metropolitan markets as saturated, nearly 60 percent of the country's people still do not have cell phones. Some have no telecommunications at all, because they live in areas that have simply been too difficult to reach with traditional land lines. In the cities, too, new types of service promise new levels of business.

After years of delays, Russian telecommunications regulators appear to be on the verge of auctioning off more spectrum--the lifeblood of cell phone service--to facilitate the launch of next-generation wireless broadband networks. Auctions are expected to begin in early 2005, opening up bandwidth that will allow for Web connections as fast as 2.4 megabits per second.

"The cell phone market in Russia is the second fastest growing in the world," said Max Smetannikov, vice president of business development for Global Advertising Strategies. "It's going to make more advances than the U.S. market, featurewise."

Any growth business has its risks, of course, and Russia's are magnified by the rapid-fire expansion of the nation's big three cell phone carriers--MegaFon, Mobile TeleSystems and Vimpel Communications--as they make plans to enter 70 of the nation's 89 markets. The two largest carriers, Mobile and Vimpel, have saturated Russia's two major mobile phone markets--Moscow and St. Petersburg--and are now engaged in a costly expansion into the hinterlands.

"The cell phone market in Russia is the second fastest growing in the world. It's going to make more advances than the U.S. market, featurewise."
--Max Smetannikov,
Global Advertising Strategies

The resulting debt loads are starting to weigh on the companies. Vimpel, which plans to spend another $300 million to fund, in part, more expansion, disclosed recently that its 2003 push into about 15 new areas is "causing a downward trend" on its average revenue per customer. The few remaining regional carriers have also borrowed substantial sums to fight the industry leaders' push into smaller markets.

Questions have also been voiced about the withdrawal of initial foreign partners, which have been cashing in their investments after the early boom in cell phones, leaving the market in the hands of "local money" for the first time. The prospect of this local control has raised concerns about the potential for corruption, an unsettling issue for Westerners.

"International investors will not have confidence in Russia unless and until they are convinced the corruption and abuse of the legal system are in its past and that abusers are dealt with," wrote Amy Ridenour, president of the National Center for Public Policy Research, a conservative think tank.

Specifically, critics point to questions of government favoritism. At least one official has been accused of depriving two leaders in the Russian mobile phone market of their frequencies to benefit another company, according to Anders Aslunder, a senior associate at the Carnegie Endowment for International Peace.

"It's not hidden. It's very out in the open," one source said of corruption in the Russian system.

Regarding the issue of local control, analysts say Russian investors such as Alfa Group appear more than adequate to fill the void left by the likes of Deutsche Telekom, which once invested heavily in Mobile TeleSystems. This local ownership should be able to continue the Russian telecommunications sector's five-year streak of 45 percent annual increases in foreign investment, said Jason Smolek, an analyst with the Lighthouse Group, an international consultancy based in Moscow.

Indeed, earlier this year, Vimpel appeared on an Investment Business Daily list of 10 recommended stocks.

Said one source familiar with the Russian market: "It's a very sleazy market, but Westerners can still make money."