Rostelecom restructures debt and operations

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In 1993 the government split Russia's telecoms system into 88 regional telcos, Rostelecom and some smaller telcos. In 1994 Rostelecom was partially privatized, with the state retaining a controlling interest. Deputy director-general Nina Shemetova explains to Basil Ballhatchet how Rostelecom has changed tack since Russia's economic crisis in 1998.

Until 1990 all telecoms services were provided in the Soviet Union by a single state telco managed by the Soviet ministry for telecommunications. In 1990 a joint stock company, named Sovtelecom, was established. It was allocated all the telecoms assets and operations for the Soviet Union. In 1991, following the coup in August and the subsequent dissolution of the Soviet Union, the company was renamed Intertelecom. With the establishment of the CIS (Commonwealth of Independent States), the newly independent countries separated their telecoms assets from Intertelecom.

This constituted only the first phase in the fragmentation of the country's telecoms assets. In 1992 the Russian government split Russia's share of Intertelecom into 88 regional telcos, grouped the international and domestic long-distance assets and placed them into a new joint stock company, which was called Rostelecom.

At that time, the telecoms system was underdeveloped and virtually obsolete. Russia had only 1,000 international channels and one international switch in Moscow. The domestic long-distance network had almost no automatic exchanges. The telecoms network was only 12% digitized and teledensity stood at 16%.

Privatization and competition in the Russian market
In 1993 Rostelecom was partially privatized. The company's authorized capital was split into 25% preference shares (subject to limited voting rights) and 75% ordinary shares. The state retained a 51% controlling stake of the ordinary shares, while the remaining ordinary shares were sold to Rostelecom's staff and the public. The preferred shares were distributed to Rostelecom's staff.

In 1994 the government had also sought to increase competition by establishing a holding company, Svyazinvest and transferring to the company the Russian state's 51% controlling stake in virtually all the privatized regional telcos. In 1997 the government transferred its 51% stake in Rostelecom to Svyazinvest prior to the sale of 25% plus one share in an auction open to both domestic and foreign investors.

A consortium comprising Soros Capital, Morgan Stanley Asset Management, Deutsche Morgan Grenfell and Uneximbank was the winning bidder. However, the Russian state did retain 51% of Svyazinvest, thereby holding a controlling interest in all Russia's incumbent telcos.

As an indication of the operator's more liberalized strategy, Rostelecom has aggressively sought capital for its modernization programmes. In 1997 it became only the second Russian company after another operator, VimpelCom, to be listed on the New York Stock Exchange, following the issue of ADRs. It also embarked on a number of joint ventures with foreign operators and was implementing a radical modernization programme, when Russia was hit by economic collapse and the ensuing Russian currency crisis in August 1998.

Non-payments and the rouble's depreciation had a severe impact on Rostelecom's revenues and its ability to repay outstanding loans. Consequently its network modernization programmes have been virtually curbed, as Rostelecom seeks ways to cut costs. It has also been rumoured that Rostelecom may be merged with Svyazinvest to yield economies of scale. If this were to go ahead, it is likely that Rostelecom's president Oleg Belov would become the president of the new entity.

In an interview with Global Telecoms Business, Nina Shemetova, deputy director-general discusses Rostelecom's network modernization programme, the impact of the Russian economic crisis on Rostelecom and the domestic telecoms environment, international ties and the prospects of a merger with Svyazinvest.

Shemetova explains how the operator was affected by the currency crisis: "Obviously the financial crisis seriously affected Rostelecom. In terms of our main sphere of operations, the crisis had no affect and we continue to provide services. In actual fact in 1998 we witnessed a certain increase in traffic volumes on 1997 levels.

However, the crisis adversely affected financial plans and results. This was attributable above all to Rostelekom's significant hard currency debts on loans. The consolidated accounts payable of our leasing company exceed $500 million. At the same time Rostelekom's revenues are accrued primarily in roubles, as we have rouble tariffs."

Owing to the rouble's depreciation against foreign currencies, Rostelecom suddenly would have had to increase tariffs fivefold to repay outstanding loans, as Shemetova makes clear: "To repay the loans we required five times as many roubles as was the case at the start of 1998. However, our tariffs were not increased five-fold. They increased by only 30%. So you have a situation where the rouble revenue base increased by 30%, while our obligations rose five-fold. To buy one dollar in 1998 you needed six roubles. Now if we want to buy dollars to repay these loans, we need 30 roubles for each dollar. This is a financial problem that we were forced to tackle at the end of 1998 and even more so in 1999."

Decline in international and national long-distance tariffs
Shemetova provides more details on the impact on revenue from the depreciation of the rouble: "The price of $0.47/minute in 1998 amounts to 2 roubles 80 kopecks at the rate of $1=6 roubles. However, if you take those same 2 roubles 80 kopecks at the current exchange rate of 25 roubles, you get $0.11, instead of $0.47. In other words, Rostelecom's prices have declined. As I said, we have to repay outstanding loans. The dollar price has not changed. However, the tariff in dollar terms has declined from $0.47-0.11 since 1998."

At the same time such rates provide Rostelecom with a price advantage: "In terms of competition today we stand out from international operators in Russia: their prices of $0.40 remain unchanged in 1999. So they could reduce their prices to $0.35. However, in roubles their price would have increased twice or three-fold. Our tariffs are denominated in roubles. They have risen 30% in rouble terms, but have contracted four times in dollar terms. So you have a totally different picture.

Today in Russia Rostelecom's tariffs are lower in rouble terms than the rates of all other operators with their own networks. So our rates are competitive and we perceive no need to reduce them. Furthermore, if we were to reduce our rates, we would be unable to meet our obligations to our creditors."

Rostelecom's ability to raise domestic tariffs is hampered by existing regulations: "In terms of tariffs, we have the following system. Tariffs are set separately for international and inter-city traffic. At least that is how things look officially. Rostelecom can set independently tariffs for international traffic. However, the ministry for anti-monopoly policy regulates operator tariffs for local and long-distance calls."

This situation clearly restricts Rostelecom's ability to increase long-distance income, which is the largest revenue generator for the operator, as Shemetova explains: "In actual fact long-distance revenues accounted for 90% of our gross revenues over the past few years. In some years inter-city traffic accounted for a higher percentage of revenues than international traffic and then vice-versa, but they were on the whole fairly level. This depended on tariff levels and different deductions. We also have a traffic category that we refer to as CIS traffic. We used to incorporate revenues from this traffic in inter-city revenues: now this income is attributable to international revenues.

However, in general long-distance traffic accounts for 90% of total revenues. We doubt that anything will change. Maybe long-distance traffic will account for an even higher share, as other types of service account for an insignificant amount."

The operator has derived one benefit: as Shemetova notes, it has managed to regain market share that it lost to competitors in the domestic long-distance market owing to their inability to meet the tariffs set by Rostelecom: "The tariffs of other operators increased sharply in rouble terms for the simple fact that they were denominated in hard currency. A number of customers returned to Rostelecom, as our tariffs are lower."

However, Rostelecom also has to confront the problem of non-payment: "Customers are becoming insolvent: they don't pay for services, such as TV broadcasting. So we deliver the services, but customers don't pay. How can we protect our revenues? First of all, increase the range of services and secondly increase tariffs. Despite the unpopularity of such measures, we have to raise rouble prices, although they have fallen in dollar terms."

Owing to the rouble's depreciation, Shemetova believes that the operator doesn't need to rebalance tariffs: "We don't perceive any need to subsidize international calls or any other calls. This problem is faced above all by regional operators in Russia. They have low local tariffs, which don't even cover the cost price of the phone calls. Consequently, they have to maintain very high inter-city tariffs and cover losses from local calls with the revenues earned from inter-city tariffs. So this is a problem for regional operators, but does affect Rostelecom indirectly."

Rostelecom has been affected by the inability of a number of regional telcos to repay outstanding debts to the operator. Shemetova outlines the new strategy that Rostelecom is applying to improve the collection of revenue from regional and local operators: "We are establishing stringent demands with such operators: they must make 100% current payments. They have to make full payments for the current period. In 1998 they met these demands. However, there are other previous unpaid debts as of August 1998: Rostelecom stated that it would not demand immediate repayment of unpaid debts which had accrued as of August 1, provided that these operators effected on time all current payments. And this mechanism is working. Operators are paying in full for services. Old debts remain. They are denominated as bills of exchange. Today we are more concerned that these operators keep up regular payments for current services, in order to understand how much we will obtain. To obtain old debts, we will clearly need to devise new repayment schemes, deferral schemes."

Curtailing investments and cutting staff
Rostelecom was forced to cut back sharply on investments, in particular its capital construction programmes for 1999. This followed a significant network modernization programme launched in 1992. Shemetova talks about the digitization of the network: "Over five years our network was upgraded at a rapid rate. In 1991-1992 the network was all analogue. Between 1993-95 the international network was fully digitized. The international telecommunications network was built over a four-year period from 1992-96, using new equipment, fibre-optic cables. The national inter-city network was also 100% analogue. However, by the end of 1998 it was already 50% digital.

So over the past six years Rostelecom invested $2 billion in this network which is now 50% digitized. To make this network 90-95% digital, our engineers projected the investment of another $2 billion over the next five years. And Rostelecom set itself the goal of implementing this plan. Unfortunately, starting in 1999 we have been forced to sharply cut and reduce the level of capital investments. In 1999 Rostelecom's capital investments will total no more than $280 million. We have no other capital available for investments, as all other cash will be channelled into loan repayments."

In addition to these cutbacks, Rostelecom will have to reduce staffing levels. Alexander Kabanovsky, a telecoms equity analyst at Warburg Dillon Read, notes: "They have to become a more efficient operator, because the company has right now about 33,000-34,000 employees. That is far too much for a company such as Rostelecom."

Shemetova says that the operator launched such a programme in 1998 to raise efficiency: "In 1998 we reduced staffing levels considerably. At the start of 1998 Rostelecom employed 37,500 people. By the end of 1998 staffing levels had been reduced by 3,500 to 34,000, or 8% in percentage terms. In 1999 there will be further staff reductions, but the reductions will be smaller this year, maybe in the range of 3-4%. The exact figure will depend on our ability to implement our line modernization (digitization) programme, as this is the main factor behind the removal of old analogue lines. This will imply a reduction in costs and staff, as digital equipment requires less staff than its analogue equivalent."

However, as Shemetova notes, the investment cuts may slow down the staff reduction programme: "We projected that we would be able to reduce staffing levels significantly over the next five years, as the digitization programme was being implemented at a rapid rate. Now, however, this process has slowed, as we have been obliged in 1998 and 1999 to reduce to a minimum our capital investments in fixed asset regeneration and digitization, as we lack the requisite resources to fulfil the modernization programme."

No new loans available as Rostelecom repays outstanding debts
Shemetova adds that this situation is attributable to Rostelecom's need to repay outstanding loans and the unavailability of new resources: "We are reducing radically our programmes, so that we can channel all our capital into plans to fulfil our obligations and repay outstanding loans. Unfortunately, it is very difficult to attract new loans and maybe even impossible. In practice western banks don't want to provide any loan facilities to companies in Russia and that includes Rostelecom. They propose very complex and expensive financing models. Therefore we cannot agree to them. At the same time we cannot obtain loans on the same terms that we obtained in the past. Our own equity resources remain rouble-denominated and have only increased by 30%. Consequently we are forced to wait for money, accumulate it and repay previous loans."

Rostelecom is likely to book a net loss for 1998 owing to hard currency losses caused by the revaluation of Rostelecom's hard currency debt. Shemetova notes: "As I said, outstanding debts amount to $500 million. When these debts are accounted for under Russian accounting principles, the translation of these debts into roubles lead to the creation of what is known as exchange rate losses. This negative difference is posted to the company's financial results. So these debts constitute de facto company losses. For the first time in Rostelekom's history we recorded a loss in 1998, not from actual operations, but instead from the translation of all payables at the rouble/$ exchange rate."

According to Shemetova, these losses do not reflect Rostelecom's actual operating results: "I would say that these are in fact artificial losses, as we did not sustain any real losses. We do in fact have operating margins. In other words costs don't exceed revenues. The gross proceeds are higher than actual costs. However, the exchange rate difference is then added to the gross profits, leading to a loss. So the exchange loss is almost comparable to total gross proceeds for 1998. And this yielded a 30% loss from gross proceeds."

Rostelecom's attempts to improve efficiency by staff reductions and increases in the traffic volume have also been hampered by a contraction in international communications traffic since the crisis. Shemetova comments: "Although we are reducing staffing levels, we don't know if we will be able to increase the volume of services, as the solvency of clients has fallen. At the same time the international telecommunications business in Russia has been contracting. These factors have had an indirect impact on the range of services that Rostelecom can offer: the volume of services may even fall in 1999. And this is a factor that we cannot really influence. It is dependent on the foreign economic situation in the country."

Prospects for merger of Rostelecom and Svyazinvest
In the circumstances, it may now be the right time for a merger of Rostelecom and Svyazinvest. Rumours have been circulating about a possible merger for some time. Shemetova provides some clarity about the current situation: "That is definitely a rumour for the time being. No official decisions have been taken on this issue at any level. However, discussions have now been initiated at certain conferences and round tables that have been convened. So this rumour has progressed from the rumour stage to a discussion stage. However, for the time being discussions are being held at the level of analysts and consultants on the best way forward, on the various options, if this is a good or bad thing. But, as I just said, no official decisions have been issued. Such a merger may take place, but nobody knows when and nobody knows what the final structure would be."

A merged company would facilitate the restructuring of the sector that is required today. According to Kabanovsky: "The Russian telecoms sector is in desperate need of restructuring, because it makes no sense in the way that it is structured with so many local operators. It has 89-91 local operators, serving in most cases non-profitable regions. It needs to restructured and changed. There has to be more control of tariffs by operators."

Shemetova perceives similar benefits: "To be able to implement the restructuring programme or make the telecoms complex manageable and attractive to investors, Svyazinvest or Rostelecom or a merged company needs to have real levers of influence over the business and the actual process of service provision. In other words this company would need to be simply an operator, a production structure, rather than some incomprehensible entity as is the case today with Svyazinvest. It needs to be a structure that can really exert an influence on production, development and the provision of services. Such a company would be of more interest to investors and would be more able to update the telecoms sector in Russia, or what I would also call the national network.

At the moment, the 100 operators that focus on the national network fail to link their strategies properly. This sometimes leads to a paradoxical situation, where money is being invested but it is impossible to buy them, as they do not meet the development levels of their partner/operator. At least a merged company would make it possible to implement a uniform technical policy and a one-tariff policy. In other words we could establish uniform plans and a uniform programme. This would be the best solution."

Kabanovsky agrees that such a merger could only contribute to Rostelecom's success: "I think that it is one of the most progressive Russian companies, one that implemented IS early on and maintains a good relationship with investors. Basically, Rostelecom has the tools required to drive some of the changes that need to take place in the Russian telecoms sector. I think that they could be much more effective with a strong foreign partner. The possible move with Svyazinvest could be a key move, as they own the regional companies. A merger of that magnitude would give Rostelecom the power to start reshaping the industry. It certainly would not be a process without its pitfalls and problems, but then Rostelecom would have the mandate to carry out some of the changes."

Option of a foreign partner and current joint ventures
Kabanovsky stresses that an international strategic investor could help Rostelecom significantly in the long run: "One challenge for Rostelecom is to become much more aware of the global developments in the telecoms sector and start looking for more international relationships, because it seems at this point in time that Rostelecom has a very Russia-focused view. The company is very politicized. There is nothing that can be done about that, as it is one of the key assets for the government. Rostelecom has to start looking at gaining some strong international partners, not just for joint ventures on a small scale, but really for an international partnership to provide Rostelecom with access to more traffic, because at this point they have done a pretty good job in modernizing their networks and expanding them. Now they have a different problem: that is under-utilization."

Shemetova believes that the operator can remain independent and indicates that Rostelecom has no plans to involve a strategic partner: "People always ask us about our attitude to a potential strategic foreign equity investor. However, Rostelecom has always assumed an independent course without the involvement of any strategic investor. We feel that we can rely on our own resources, that we have the requisite professional skills and financial resources and that we don't need a foreign equity partner to develop our business. So Rostelecom has never considered selling a stake to a foreign operator and has no plans to do so now."

Rostelecom has set up joint ventures with foreign operators, including GTS and US West. As Shemetova points out, the two JVs have recorded good results: "We set up a JV with GTS, Sovintel. We have a 50% equity holding. We maintain good partnership relations with GTS. Sovintel is one of the biggest alternative operators to Rostelecom. It is a very efficient JV with good turnover and financial indices. We expect to earn dividends from our involvement in this JV. Similarly we own 50% of the JV that we established with US West, Intelkom. There have been some differences in this project, but they are being resolved. At one point in time they planned to sell their stake in the JV, but in the end they changed their mind. Intelkom also has good financial indices and is growing."

Joint venture with Globalstar reflects new cellular strategy
In cellular Rostelecom decided to form a JV with Globalstar and sell stakes in five-six cellular enterprises. Shemetova explains the reasoning behind the decision: "There was a point in time when we tried very actively to participate in these cellular operations in different Russian regions. Then the Globalstar project appeared. We established a joint venture with Globalstar, Globaltel in Russia, taking a 51% majority holding. This JV will in actual fact become a very promising long-term cellular competitor to other operators in Russia. It will use GSM. We believe that this JV has better long-term prospects and that we need to build on these opportunities.

We don't have a controlling interest in the cellular operators that you mentioned. So we decided that there was no need to compete, using these operators with other enterprises that we own. In other words we felt that we were investing in companies that would become our competitors. So we decided to sell our stakes in these cellular companies and invest all our resources in one company, Globaltel, which will be providing services in the cellular and satellite sector, based on the Globalstar system."

Shemetova links the operator's development with the domestic economic situation: "Most importantly, we want to see a recovery in the country's economic situation, so that we can continue to implement our task of establishing a 100% digital network. This is essential. Once the requisite measures have been taken to establish a calm economic situation, everything will be fine. We will work to complete the business that we started in 1992. However, we cannot say that we are convinced that this will happen soon. All we can do is hope for the best."