Under the Banner of Innovation

AFK Sistema is the only highly diversified concern in the upper part of the rating. The ambitions of its owner Vladimir Yevtushenkov go even farther: he is talking about creating a global innovative industry.

When in September the Russian authorities announced the objective of developing high-tech industries, premier Mikhail Fradkov told the cabinet in one of its sessions that unless they hurried up with the development of an appropriate program, “we would be left with only Yevtushenkov”.

At the time of its inception in 1993, Sistema was considered to be backed by the Moscow government, since the founder of the holding Vladimir Yevtushenkov had been the head of the Moscow Committee for Science and Technology. When in that position, he had helped with the provision of a loan for the establishment of the first Russian mobile operator Vympelcom. Later, Yevtushenkov left the office and his newly-established company became one of the shareholders in Vympelcom. Rumors that Moscow’s mayor Luzhkov and his team were among the shareholders of Sistema had been around for 12 years, until the IPO at the London Stock Exchange when the company publicized the information about its shareholders: at that point, more than 75% (now it is 63.1%) were held personally by Yevtushenkov, and the other shareholdings were small and most of them in the hands of other managers of the company. During the years, Sistema has become a colossal multi-sector holding company, and its owner has become the only ”oligarch” whose wealth does not come from either raw material or banking sectors.

From Civil Engineering to Microchip Production

The impressive list of Sistema’s businesses includes tourism (VAO Intourist), retail Detskiy Mir – (Children’s World chain), insurance (ROSNO), development and construction (Sistema-Gals), banking (the Moscow Bank of Reconstruction and Development), advertisement and cable TV (Sistema Mass Media), and, of course, the telecoms division, including the Mobile Telesystems – MTS, the leader of the Russian mobile communications market, and two leaders in fixed telephony, MGTS and Komstar United Telesystems. Raw material assets were added to Sistema’s many holdings last August when Yevtushenkov bought controlling stakes in seven Bashkirian oil companies.

Despite ramifications in so many industries, the founder of the group keeps saying that high technologies and everything associated with them - telecommunications, microelectronics, and software development - form the strategic line of his business. Sitronics, the latest addition to the empire, is represented by the Czech producer of communications equipment and complex software developer Strom Telecom, the recently acquired Greek company Intracom Telecom, systems integrator Quasar-Micro, microchip producer Micron (a company from Zelenograd, a high-tech city outside of Moscow), and consumer electronics producer Sitronics.

Sistema started off in Zelenograd in 1997, acquiring old-time Soviet-style enterprises that had been dragging miserable existence after the break-up of the Soviet Union. The average age of the personnel was more than 50, and the equipment and machinery were beyond retirement age. When the Russian government urgently needed to produce several hundred thousand foreign passports for the residents of the Russian exclave in Kaliningrad region, it had to procure crystals for the purpose from Philips. Now, the equipment required to do the job is being installed at Sistema’s Micron factory.

The revenue growth of this business unit has been more than impressive at annual 100% during three years. However, out of Sitronics’ RUR 955 million revenue in 2005, only 6% was contributed by microelectronics unit. The reason, according to the head of Sitronics – Microelectronics Solutions Gennady Kvasnikov, is in weak domestic demand. The demand will be picking up soon: Sistema helped lobby a government program for the development of the electronic industry of Russia, which, among other things, requires that domestically produced chips be built into IDs to be implemented on a national scale. If it gets the order, Sitronics plans to create its own “clean room”, a crystal-producing factory that would allow cutting the current technological lag from the leading world producers from 15 years to 1.5 years. The success of the project, though, will largely depend on the authorities, i.e. whether or not they would favor a domestically-owned business when they place the order. Recently the Malaysian Kedah Wafer Emas (KWE) announced plans to create its own microelectronic production in Russia (microchips, solar panels and microelectronic devices for motor vehicles) at the premises of the federal unitary company Frunze Factory in Nizhniy Novgorod. KWE intends to produce chips with densities of 0.11-0.13 to 0.065 microns, while Sitronics plans to implement a less progressive technology of 0.18 microns in 2007. What makes Sistema less anxious is the fact that the Malaysians only have a plan at the level of a protocol on intent rather than a real project.

The Egg

Created as a telecommunications company, AFK Sistema continues to derive the main part of its profits from that division, although 2005 was not a very good year compared to the previous ones. MTS continues to be an undisputed leader in mobile communications in terms of the quantity of subscriptions (66.6 million as of October 1, 2006, against Vympelcom’s 51.9 million and Megaphone’s 28 million). But other indicators show that the industry leader has problems, too. Although an unquestionable leader in revenue (RUR 112.023 bln in 2005, which is more than the other two combined), the growth rate was lower than that of its rivals - MTS gained 26.5% in sales in 2005 against 2004, while Vympelcom grew by 49.2%, and Megaphone by 58.4% (See Table – Largest Telecoms). The price of MTS shares practically did not change from September last year to this September, while those of the closest competitor (Vympelcom) rose by almost a third during the same period.

The management team of Sistema has taken a number of steps recently to overcome the emergent problems. One is a rebranding campaign covering the whole telecommunications division. MTS now operates under the symbol of a white egg against a red background, which in the opinion of brand developers, should symbolize “simplicity” and “perfection”. They also replaced the top management of MTS, inviting Leonid Melamed as the CEO, who had managed the ROSNO insurance company and brought it to the position of a market leader.

Vladimir Yevtushenkov has set three targets for the new management: make the company a global operator, maximize shareholder dividends, and bring the company’s capitalization above USD 20 billion (it was USD 15.1 billion as of last October).

MTS has the capability to reach those targets, with all the managerial and financial resources available in Sistema holding. One example of how these resources can be put to use was the most successful Russian IPO February last year at the London Stock Exchange, which raised more than USD 1.5 billion, or a later (February 2006) IPO of another Sistema company, Komstar-OTS, which got about USD 1 billion for 35% of its shares. Investment promise of Sistema is corroborated by the phrase pronounced by Yevtushenkov in 2000: “I am not a tactic. I am a strategist”. When said by a person, who has managed to create a multi-billion empire from scratch, the phrase sounds quite convincing.