Mobile TeleSystems
(MBT) announced results for the second quarter with reported earnings of $1.49 per ADR beating the Zacks Consensus Estimate of 85 cents. Eastern Europe’s largest cellular operator reported revenue of $2 billion, down 23.3% year over year, hurt by the macroeconomic volatility across its markets. Net income dipped 14.6% from the year-ago quarter to $563 million on lower revenue, higher interest expenses and increased handset costs.

On a geographic basis, revenue rose 7% year over year in Russia, 4% in Uzbekistan, 35% in Turkmenistan and 3% in Armenia, while sales declined 8% in Ukraine.

Mobile TeleSystems added approximately 2.8 million customers in the quarter (up sequentially), primarily driven by a 2.3 million net subscriber growth in Russia. This was marginally offset by 155,000 subscriber losses in Ukraine. At the end of the second quarter, the company served approximately 99.5 million subscribers (67.4 million in Russia), up 9.4% year over year.

In Russia, quarterly churn (customer switch) fell to 6.9% sequentially, while increasing on a year-over-year basis. Russian ARPU (average revenue per user) climbed sequentially while decreasing from the year-ago quarter. Churn in Ukraine declined both sequentially and on a year-over-year basis but rose in Uzbekistan. ARPU in Ukraine grew sequentially despite falling from the year-earlier period.

Mobile TeleSystems maintained its leadership in most markets during the quarter. On a sequential basis, its market share in Russia and Armenia remained stable at 34% and 81%, respectively. The company gained market share in Ukraine (up 1% to 33%) while losing in Uzbekistan (down 1% to 45%) and Turkmenistan (down 2% to 85%).

During the first half of 2009, the company generated free cash flow of $109.2 million, down significantly from the $1 billion registered a year ago, due to higher capital expenditure. Mobile TeleSystems exited the quarter with approximately $1.6 billion in cash and cash equivalents and $4.6 billion in total debt.

Mobile TeleSystems is expanding its 3G network footprint through commercial service launches in selected cities of Russia and surrounding countries. It has launched 3G services in the three biggest Armenian cities and recently deployed the first phase of its 3G network in Moscow.

The company plans to spend up to $1.6 billion for upgrading 3G networks in Russia through 2011 to provide high-speed data transfer services to its customers. In order to meet the financing requirements associated with its aggressive network rollout plan, Mobile TeleSystems has secured a loan of €413 million ($578.2 million) from three international lenders. It expects to earn an additional $2.5 billion in sales from 3G services by 2011, including $2 billion from Russia alone.

Moreover, the company is aggressively pursuing acquisitions and strategic partnerships to strengthen its “mono-brand” mobile retail network while implementing cost optimization programs to lower operating expenses. To strengthen its retail distribution network, Mobile TeleSystems bought Russia-based retail chains Eldorado and Telefon.Ru. The mono-brand retail initiative is expected to provide the company with a competitive edge over rival VimpelCom (VIP), which has acquired approximately 50% of the multi-brand mobile retailer Euroset.

While we see expansion of the 3G network as a key growth driver, related costs to support network deployments and promotional initiatives may tighten free cash flow and margins in 2009. Moreover, increasing competition, foreign exchange exposure, regulatory challenges and market risk in Russia warrant a cautious view on the stock.

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