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CEO’s address to shareholders

CEO’s address to shareholders

Dear Shareholders, Partners, and Colleagues,

MegaFon demonstrated strong operating and financial performance in 2017, returning to growth in respect of several key indicators and achieving the goals set at the start of the year. We operate in a highly competitive market which has been stagnating for a long time due to oversupply and ongoing price reductions driven by overzealous competition.

In the reporting period, the market demonstrated a positive trend for the first time in several years, largely as a result of reduced price competition.

MegaFon’s development throughout the year was underpinned by its new strategy which seeks to transform the Company into a digital market leader and the first-choice data provider for customers through offering best-in-class products and services and opening up new opportunities for subscribers.

Our new positioning and slogan, “MegaFon. Starts with You”, reflect this evolution of our business philosophy. MegaFon does not sell minutes and gigabytes any longer; instead, we provide opportunities — digital services, content, video, audio and communication via social networks and messenger services. We are building an ecosystem of digital solutions and are applying smart pricing initiatives based on big data analysis to constantly improve the appeal of MegaFon’s services.

The successful closing of the transaction to divide Euroset’s assets, completed in February 2018, was an important milestone for MegaFon. We hope it will stabilise the mobile retail market in general and enable both MegaFon and VEON to successfully implement their respective strategies for sales network development. Under this agreement, VEON acquired approximately 1,700 points of sale, transferred its 50% interest in Euroset to MegaFon and paid a cash consideration of RUB 1.2bn as its share of Euroset’s outstanding liabilities. As a result, MegaFon now owns 100% of Euroset, which continues to own approximately 1,700 points of sale. We are currently considering various options for Euroset’s strategic development to support and strengthen our presence in the monobrand store space.

OPERATING AND FINANCIAL RESULTS

In line with our new strategy, in 2017 we focused on improving our network, developing digital services and delivering a better subscriber experience. We put our top priority on increasing the quality and long-term potential of our existing customer base, rather than focusing simply on the gross number of new subscribers.

The steps we took helped us improve our key performance indicators. Revenue grew by 1.8% to RUB 321.8bn. At the same time, customer lifetime value, or LTV 1, increased by 20%. The negative trend in OIBDA, which had persisted over several years, finally ended and returned to growth: OIBDA for the full year 2017 was up 0.6% to RUB 121.9bn. The revenue and OIBDA growth were driven by an increase in revenue from our commercial initiatives, including the launch of our new “Vklyuchaisya!” (“Connect!”) tariff line, reductions in communications services costs due to lower line lease rates and a shift from satellite to less costly terrestrial communication channels.

OIBDA growth was also supported by optimisation of our own retail network and lower tax expenses on operations.

MegaFon maintains a comfortable Net Debt/OIBDA ratio of 1.92x, continues to effectively manage its debt portfolio and is focused on further optimisation of its funding structure.

MegaFon’s subscriber base held steady in 2017, while the percentage of data users increased. At the end of 2017, MegaFon had 77.1 million subscribers, including 75.4 million in Russia. Today, over 41.8% of our subscribers use mobile internet and we expect that percentage to grow going forward. At the same time, the average annual mobile traffic per user increased by 52.2% to over 6.5 GB and the average monthly revenue per data services user (ARPDU) grew by 3% to RUB 237.

We recognise that the digital economy relies on a comprehensive advanced infrastructure. In the reporting period, we continued upgrading our network and completed all our construction projects planned for 2017, while optimising costs and maintaining CAPEX at RUB 56bn. The main part of 2017 CAPEX was spent on LTE and LTE Advanced network development through both coverage expansion and network capacity increases and we continued to invest in upgrading our 2G and 3G networks.

In July 2017, JSC First Tower Company was set up to improve management of MegaFon’s tower infrastructure and monetise it through leasing out its assets. Over 15,500 towers and other related assets worth a total of over RUB 17.2bn were transferred to the new company.

DIGITAL VALUE FOR SUBSCRIBERS

Products that create “digital value” for subscribers became our key revenue drivers in 2017. We launched a new tariff line “Vklyuchaisya!” (“Connect!”), which was developed using big data analysis. Within this new line, we offer flexible plans customised to each subscriber’s personal preferences. MegaFon’s financial and content services, such as MegaFon.TV, the MegaFon bank card, and other financial services, as well as smart services based on IoT technologies, are also gaining in popularity. During the year, we launched a number of new services with high potential — such as MegaFon.Music, MegaFon.Health, and the #Spetsii cashback and special offers service which in the future will become part of an ever-growing ecosystem of digital services.

For corporate and government clients, MegaFon acts as an integrator, offering comprehensive turnkey solutions. MegaFon’s corporate client base grew by 3.8% to 309,000 companies in 2017, moving the Company into the leading position in the B2X market for the first time, with a 33.5% share of the mobile segment. We increased our revenue from this segment by 16.1% as a result of growing mobile and M2M services consumption, as well as the implementation of comprehensive integration projects, such as developing a solution for monitoring and accounting for utility resources and creating a telecommunications infrastructure for the 2017 FIFA Confederations Cup and the 2018 FIFA World Cup.

We strive to contribute to the development of digital infrastructure at both the national and the regional levels. MegaFon leads the Information Infrastructure team for the Government’s ANO Digital Economy project and has already started implementing the Government’s digital agenda.

We are also implementing infrastructure projects as part of the “Digital Region” platform, including the introduction of smart solutions for transport, community services, utilities, government administration and security. Digital Region’s pilot projects include putting up smart road signs in Chelyabinsk and introducing smart public lighting in Bryansk. We have also launched a project to digitise several Russian regions under agreements with the regional administrations of the Udmurt Republic and the Ulyanovsk and Pskov Regions.

TECHNOLOGY LEADIRSHIP

We understand that we must keep our focus on advancing solutions and offering innovations to further enhance our leadership in technology. We offer the fastest mobile data services and have the highest number of 4G base stations in Russia. In 2017, MegaFon’s network grew by 10%, comprising 157,732 base stations at year end. FOCL length grew by 4% to 199,761 km. A Speed test by Ookla showed an industry-leading peak data download speed of 25.04 Mbit/s over MegaFon’s network. We are continuing our investments in the rapid expansion of the LTE network and at the end of 2017 LTE Advanced networks were operating in 38 Russian regions.

MegaFon is also actively involved in developing 5G networks, having signed a cooperative agreement with Rostelecom for a joint roll out. In 2017, MegaFon and Huawei set a new mobile data speed record for Russia, demonstrating a 5G base station in operation and hitting 35 Gbit/s during a trial. In 2017, we also tested Massive MIMO technology, during the demonstration the speed of mobile Internet in the sector reached 851 Mbit/s. MegaFon has been authorised by the Russian State commission on radio frequencies to use 3.4 GHz—3.8 GHz and 25.25 GHz—29.5 GHz frequencies for 5G trials during the 2018 FIFA World Cup. We plan to deploy the first trial 5G clusters on these operating frequencies during the World Cup.

MegaFon also became the first company in Russia to complete a bond placement using blockchain technology and was one of the first to do so globally. Following the placement, MegaFon used blockchain to complete the transaction. Our blockchain technology has the potential to become a new standard in transaction data sharing.

We plan to continue implementing our digital strategy throughout 2018 with a focus on further sharpening our competitive edge. So far, the objectives for our strategy have already been met and we expect our strategy to help further strengthen MegaFon’s market position in both the mid- and long-term.

We will focus on improving the quality of our subscriber base while striving to be the first-choice operator by delivering the best tariff plans, digital innovations and fast mobile data. We work hard to retain our retail and corporate customers for life.

To conclude, I would like to thank all MegaFon employees for their strong teamwork and expertise in 2017, and our partners for their trust and support. Over 25 years of development, MegaFon has accomplished a great deal in many areas, shaping the telecommunications industry along with the communications and digital environment in which we live today. I am confident that new and even more exciting and eventful developments await MegaFon as we innovate for the digital future.

Sergey Soldatenkov
Chief Executive Officer