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CEO’s address to shareholders

CEO’s address to shareholders

Dear Shareholders, Partners, and Colleagues,

In 2016, MegaFon once again confirmed its position as a major player in the Russian telecommunications market and consolidated its leadership in technology.

In 2016, we took stock of the results we had achieved in the strategic development cycle that had ended a year before. We also closely analysed the new market environment and recent trends; specifically, the growing uptake of innovative digital technologies across all sectors of the economy, and the increased demand for simple and effective solutions which will enable subscribers to handle personal and business tasks in the most convenient and efficient way possible, by leveraging mobile data.

This review led us to revise our strategy. Given the high mobile penetration rates in Russia (179% in 2016), we decided it was no longer economically viable to continue pursuing the policy of prioritising the expansion of our customer base. This led to our decision to refocus on maintaining the loyalty of our existing customers, by providing better services and offering a range of unique products and services based on advanced technologies. Accordingly, we made the decision to abandon the old development model and embarked upon a digital growth path. This will be achieved by meeting the needs of digital customers in the most efficient way; through ensuring the perceived quality of connections and being the first to implement innovative products and services, to encourage our subscribers to stay with us for a long time.

With this in mind, in early 2017 we completed the acquisition of a controlling voting stake in Mail.Ru Group. This transaction will support the transformation of our business and further aide our transition from a traditional mobile operator to an integrated digital communications company. Through our partnership with Mail.Ru, we plan to develop completely new products and services that combine the benefits of mobile data and IT. We believe these efforts will not only signal a new chapter in the history of MegaFon, but probably in the entire Russian telecoms industry. 2016 marked the beginning of our transformation, as we sought to hone our historical competitive advantages, notably in technology and our diversified brand portfolio. We also re-organised our business, dividing it into Commercial and Operations divisions, and we strengthened the teams in charge of our new strategy. The Operations division comprises infrastructure, procurement and logistics, legal and GR. It is led by Mrs Anna Serebryanikova, who previously served as Legal Affairs and GR Director, and branch directors report directly to her. The Company’s Consumer Business Development and Corporate Business Development functions were combined into an integrated Commercial division. This is led by Mr Vlad Wolfson, who previously served as Director for Corporate Business Development.

FINANCIAL PERFORMANCE IN LINE WITH EXPECTATIONS

In 2016, the Russian telecommunications market remained highly competitive, with continued changes in consumer demand and the introduction of new regulations. All this certainly put pressure on the industry in general and on MegaFon’s performance in particular, as one of the key players in the market. However, despite the external challenges, we delivered solid results in 2016, in line with our previous guidance on key metrics.

The Company’s financial performance in 2016 fully reflected the overall situation in the Russian telecoms market. Our consolidated revenue grew by 0.9% year-on-year to RUB 316bn. Adjusted OIBDA decreased by 8.5% year-on-year to RUB 121bn. Total CAPEX for the year amounted to RUB 65.6bn, a reduction of 6.5% year-on-year. Although our capital expenditure was below guidance, MegaFon fully met its network construction targets due to better prioritisation of investment projects and optimized deployment of technology solutions.

MegaFon’s mobile subscriber base continued to grow, reaching 77.4 million as at the end of 2016. Further promotion of data services, along with continued growth in penetration rates of data-enabled devices among our subscribers, increased the number of mobile data users to 31.7 million, a 5.8% increase year-on-year. As at the end of 2016, over 57% of all devices registered on the MegaFon network were data-enabled. Mobile Internet users accounted for 41% of the Company’s total mobile subscriber base.

IMPROVING OPERATIONAL EFFICIENCY

Operational efficiency improvement is one of our priorities. In 2016, we continued a number of important organisational projects aimed at optimising internal processes and significantly reducing operating expenses. Let me mention some of our more important projects.

Our Unified Billing project was launched in 2015 and aims to merge several billing systems used across MegaFon branches and subsidiaries into a single billing platform. In 2016, the project entered a new phase, as we piloted the migration of subscribers from the existing billing systems and launched sales in the retail and fixed-line segments.

In July 2016, we established a Shared Services Centre in Samara, which will act as the Company’s back-office and a platform to co-locate several support functions, including procurement planning and support, accounting and reporting, financial control and treasury, and others. The Shared Services Centre will streamline and standardise business processes and improve business scalability. After the project is completed, we expect to achieve RUB 470 million in annual OPEX savings and the Shared Services Centre may start providing services to third parties.

Last year, MegaFon also launched a SAP re-engineering project to migrate to the latest S4/HANA system. This nationwide SAP reengineering project covers eight branches and subsidiaries and involves 300 experts from MegaFon and SAP. It will significantly accelerate and facilitate key business processes in the Company.

MegaFon’s extraordinary General Meeting of Shareholders, held in September 2016, approved the reorganisation of MegaFon through the spin-off of the Joint-Stock Company First Tower Company. Controlling Russia’s largest tower portfolio, it will operate over 15 thousand mobile towers. This spin-off will allow MegaFon to apply a service-based approach to tower infrastructure management, improve performance by introducing best practices in management and servicing, realise savings through partnerships, increase CAPEX margin, and to benefit from active involvement in the fast-growing tower lease market.

TECHNOLOGY LEADERSHIP

Since its establishment, MegaFon has striven to be a technology leader in its industry by anticipating and, to a certain extent, driving the development and landscape of the Russian telecommunications market. A rapidly changing environment prompts us to look for new solutions and ideas and encourages us to make another successful ‘step beyond the horizon of the possible’, that MegaFon is already so well-known for.

At present, MegaFon operates one of the largest and most advanced infrastructures in Russia. The number of base stations grew by 9% in 2016 to 143,700 units, with 4G base stations accounting for a fifth of the total. Last year, MegaFon’s 4G Internet services were available to subscribers in 82 Russian regions, while subscribers in 27 regions can now enjoy LTE-Advanced 4G high‑speed Internet connection at speeds of 150–450 Mbit/s. The total length of our backbone network increased by 4% year-on-year and reached 130,600 km. As of the end of 2016, MegaFon had one of the longest FOCL networks among Russian mobile operators.

In 2016, MegaFon and its international equipment partners played an active role in the development of the next generation (5G) communication standard. In 2016, we conducted two tests, becoming the first company in Russia and one of the first companies globally to demonstrate superfast mobile Internet speed. In September 2016, we managed to achieve a speed of 4.94 Gbit/s during the test. It is an important step towards formation of the 5G standard, which will offer customers a fundamentally new, improved quality of service.

In July 2016, MegaFon and Nokia signed a memorandum of cooperation in the development of the 5G standard in Russia. This includes all technical aspects of its adoption and engaging with Russian regulators and international bodies concerning the requirements and parameters for its commercial launch. The partnership seeks to develop and test new solutions as part of joint pilots, which may include the construction of trial 5G clusters at Russian stadiums hosting the 2018 FIFA World Cup. We also see great potential in the Internet of Things (IoT). In 2016, MegaFon signed a memorandum of cooperation on the roll-out of IoT solutions with Huawei, and a strategic partnership agreement with the Russian Association of Industrial Internet to support the development of the IoT market in Russia, the drafting of universal industry standards and regulations, and the implementation of joint IoT projects. In addition, MegaFon and Huawei have joined forces to promote NB-IoT (Narrow Band IoT) in the Russian market, a new communication standard for the technology that significantly reduces power consumption by terminal devices, ensures broader signal coverage and penetration, and increases the maximum number of connected devices.

The Company is already offering products across all IoT application areas. Our existing infrastructure provides services to more than 3.9 million SIM cards installed in various connected devices. In 2016, we signed an agreement with Russia’s largest grid operator ROSSETI to fit out 300,000 substations with intrusion detection and telemetry systems by 2020. These systems will also monitor grid parameters, minimise power losses, control equipment performance online, and prevent equipment failures.

CONNECTING TO OPPORTUNITIES

We are confident that the future of the telecommunications market lies in the creation of a digital environment that is convenient and comfortable for users. MegaFon is consistently developing a diversified offering of fundamentally new products and services that will enable our retail and corporate customers to fully enjoy the benefits of new innovative technologies.

We have much work ahead of us in 2017 to transform MegaFon into a company that will fully meet the growing expectations of our customers in the long term. We have everything we need today to make this huge step forward – advanced technologies, a well-known brand, high-quality services and most importantly, an exceptional team of professional, like-minded people. I am confident that our team is well prepared to deal with new challenges and to further strengthen MegaFon’s position in every key segment of the market.

Sergey Soldatenkov
Chief Executive Officer