08 January 2013 EEMEA/ Equity Research Wireless Services (Emerging EMEA (Europe))

MegaFon (MFONq.L) Rating OUTPERFORM* [V] Price (04 Jan 13, US$) 23.80 INITIATION

Target price (US$) 30.00¹ Market cap. (US$ m) 14,782.85 Enterprise value (US$ m) 18,598.2 Benefiting from mobile data growth in Russia

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. We initiate coverage of MegaFon with an Outperform rating and a US$30 [V] = Stock considered volatile (see Disclosure Appendix). TP per GDR. MegaFon is one of our key top picks in the EEMEA and Russia

Research Analysts telecom space, together with MTS and Mobily. MegaFon is a #2 mobile operator Olga Bystrova, CFA and a leading mobile data services provider in Russia with, in our view, a 44 20 7883 0293 network advantage in Russia currently. The company’s shares are listed on LSE [email protected] and MICEX after its IPO on 28 November 2012. Richard Barker 27 11 012 8051 Network advantage and strong execution in the market with above- [email protected] average growth rates: The company continues to benefit from early strategic network investment in conjunction with strong execution, which resulted in its #1 position in the fastest growing and still underpenetrated mobile data segment, and a one notch move to a #2 position in the Russian mobile market two years ago. We currently favour concentrated exposure to Russia with its relatively benign macro, competitive and regulatory environment in the context of the telecom sector, which also result in revenue growth rates at the high end relative to the sector on our estimates. Catalysts: 1) 4Q 2012 results most likely in March 2013; 2) dividend announcement in 2Q 2013 or earlier. Premium valuations could be justified if outperformance continues. On 2013E multiples, MegaFon is currently trading at 4.8x EV/EBITDA, 10.3x PE, 7.7% DY and 9.1% FCF yield. This is broadly in line with MTS (the key comp, at 4.6x EV/EBITDA, 10.2x PE, 7.3% DY and 8% FCFY) and is a discount to EEMEA telcos on 2013E PE and EV/EBITDA. The notable exceptions are FCF yields, on which MegaFon looks more attractive than MTS and more in line with the EEMEA sector mainly for 2014E. We use DCF as our main TP method, which yields US$30 per GDR with 26% upside potential, and implies premium valuations to the sector.

Share price performance Financial and valuation metrics

Year 12/11A 12/12E 12/13E 12/14E 24 Revenue (Rbl m) 242,608.0 271,260.4 287,714.9 304,564.7 23 EBITDA (Rbl m) 100,822.00 114,007.74 121,080.49 127,001.32 22 Pre-tax Profit Adjusted (Rbl m) 55,905.0 45,766.6 54,489.2 59,999.3 CS adj. EPS (Rbl) 70.49 67.44 70.11 77.25 21 Dec-12 Prev. EPS (Rbl) — — — — Price Price relative ROIC (%) 17.79 20.17 20.70 22.07 P/E (adj., x) 10.24 10.70 10.29 9.34 The price relative chart measures performance against the P/E rel. (%) 94.0 91.1 93.8 93.4 FTSE 100 IDX which closed at 6073.59 on 04/01/13 EV/EBITDA 4.0 5.0 4.8 4.4 On 04/01/13 the spot exchange rate was US$1.3/Eu 1. - Eu .77/US$1 Dividend (12/12E, Rbl) — IC (12/12E, Rbl m) 230,425.12

Performance Over 1M 3M 12M Dividend yield (%) — EV/IC 2.5 Absolute (%) 8.5 — — Net debt (12/12E, Rbl m) 116,647.3 Current WACC 11.0 Relative (%) 5.8 — — Net debt/equity (12/12E, %) 102.5 Free float (%) 15.0 BV/share (12/12E, Rbl) 183.5 Number of shares (m) 620.00

Source: Company data, Thomson Reuters, Credit Suisse estimates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

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08 January 2013

MegaFon MFONq.L Price (04 Jan 13): US$23.80, Rating: OUTPERFORM [V], Target Price: US$30.00 Income statement (Rbl m) 12/11A 12/12E 12/13E 12/14E Per share data 12/11A 12/12E 12/13E 12/14E Sales revenue 242,608 271,260 287,715 304,565 No. of shares (wtd avg) 620 620 620 620 EBITDA 100,822 114,008 121,080 127,001 CS adj. EPS (Rbl) 70.49 67.44 70.11 77.25 Depr. & amort. (47,676) (54,160) (56,178) (57,892) Prev. EPS (Rbl) — — — — EBIT (CS) 53,146 59,847 64,902 69,109 Dividend (Rbl) — 245.00 55.58 46.95 Net interest exp. 2,885 (6,070) (10,413) (9,110) Dividend payout ratio — 363.26 79.27 60.77 Associates — — — — Free cash flow per share 38.65 75.76 65.93 77.69 Other adj, (126) (8,011) — — (Rbl) PBT (CS) 55,905 45,767 54,489 59,999 Key ratios and 12/11A 12/12E 12/13E 12/14E Income taxes (12,320) (10,229) (10,898) (12,000) valuation Profit after tax 43,585 35,538 43,591 47,999 Growth(%) Minorities (6) (123) (121) (107) Sales 12.6 11.8 6.1 5.9 Preferred dividends — — — — EBIT (9.8) 12.6 8.4 6.5 Associates & other 125 6,401 — — Net profit (12.4) (4.3) 4.0 10.2 Net profit (CS) 43,704 41,816 43,470 47,893 EPS (12.4) (4.3) 4.0 10.2 Other NPAT adjustments (125) (6,401) — — Margins (%) Reported net income 43,579 35,414 43,470 47,893 EBITDA margin 41.6 42.0 42.1 41.7 EBIT margin 21.9 22.1 22.6 22.7 Cash flow (Rbl) 12/11A 12/12E 12/13E 12/14E Pretax margin 23.0 16.9 18.9 19.7 EBIT 53,146 59,847 64,902 69,109 Net margin 18.0 15.4 15.1 15.7 Net interest 2,885 (6,070) (10,413) (9,110) Valuation metrics (x) Cash taxes paid — — — — EV/sales 1.7 2.1 2.0 1.8 Change in working capital 5,890 1,196 (571) 474 EV/EBITDA 4.0 4.9 4.8 4.4 Other cash & non-cash items 35,374 42,179 46,960 47,693 EV/EBIT 7.6 9.4 8.9 8.1 Cash flow from operations 97,295 97,152 100,879 108,166 P/E 10.2 10.7 10.3 9.3 CAPEX (73,332) (50,183) (60,000) (60,000) P/B 1.6 3.9 3.6 3.2 Free cash flow to the firm 23,963 46,968 40,879 48,166 Asset turnover 0.63 0.78 0.87 0.91 Acquisitions (10,825) (8,439) (17,768) — ROE analysis (%) Divestments — — — — ROE stated-return on 17.1 18.1 36.7 36.2 Other investment/(outflows) (18,499) 84,502 — — equityROIC 17.8 20.2 20.7 22.1 Cash flow from investments (102,656) 25,880 (77,768) (60,000) Interest burden 1.1 0.8 0.8 0.9 Net share issue/(repurchase) — (46,406) — — Tax rate 22.0 22.3 20.0 20.0 Dividends paid — (151,863) (34,451) (29,100) Financial leverage 0.2 1.4 1.1 0.8 Issuance (retirement) of debt 7,121 121,121 (29,025) (17,250) Credit ratios (%) Other (11,964) (123,575) 29,025 17,250 Net debt/equity (15.8) 102.5 104.2 76.9 Cash flow from financing (4,843) (200,723) (34,451) (29,100) Net debt/EBITDA (0.4) 1.0 1.1 0.9 activitiesEffect of exchange rates (364) (347) — — Interest coverage ratio (18.4) 9.9 6.2 7.6 Changes in Net Cash/Debt 10,387 (160,334) (11,340) 19,067 . Net debt at start (33,300) (43,687) 116,647 127,987 Source: Company data, Thomson Reuters, Credit Suisse estimates. Change in net debt (10,387) 160,334 11,340 (19,067) Net debt at end (43,687) 116,647 127,987 108,921

Balance sheet (Rbl m) 12/11A 12/12E 12/13E 12/14E Assets 24 Cash and cash equivalents 87,396 48,183 7,818 9,634 Accounts receivable 11,430 12,193 12,528 13,084 23 Inventory 4,551 4,766 4,941 5,137 Other current assets 16,916 16,916 16,916 16,916 22 Total current assets 120,293 82,057 42,202 44,772 21 Total fixed assets 258,783 263,245 284,835 286,942 Intangible assets and goodwill — — — — Dec-12 Investment securities 2,002 2 2 2 Price Price relative Other assets 2,390 2,390 2,390 2,390 Total assets 383,468 347,694 329,429 334,106 Liabilities The price relative chart measures performance against the FTSE 100 IDX which Accounts payable 8,034 8,034 8,034 8,034 closed at 6089.84 on 04/01/13 On 04/01/13 the spot exchange rate was US$1.3/Eu 1. - Eu .77/US$1 Short-term debt 7,415 57,194 41,494 70,394 Other short term liabilities 34,524 40,483 42,224 45,358 Total current liabilities 49,973 105,711 91,752 123,786 Long-term debt 36,294 107,636 94,311 48,161 Other liabilities 20,569 20,569 20,569 20,569 Total liabilities 106,836 233,916 206,632 192,516 Shareholders' equity 276,632 113,778 122,798 141,591 Minority interest — — — — Total equity & liabilities 383,468 347,694 329,429 334,106 Net debt (Rbl m) (43,687) 116,647 127,987 108,921

MegaFon (MFONq.L) 2 08 January 2013 Key charts

Figure 1: MegaFon mobile and data revenue shares Figure 2: Mobile revenue growth rates in GEM mobile and Europe 40% 20% 36.0%

35% 15%

30.9% 10% 30% 29.2% 5% 27.3% 27.3% 25% 0% 19.7% 20% -5%

15% -10%

1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q

India Brazil

2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 China

Czech

Russia Turkey

Poland

Mexico

Hungary

Malaysia

MegaFon Indonesia

Mobile revenue share Mobile data revenue share Area Euro South Africa South

Mobile subscriber share CAGR 2009-2011 9M 2012

Source: AC&M, Credit Suisse research Source: Company data, Credit Suisse estimates

Figure 3: penetration for selected countries Figure 4: Current data pricing in Russia In US$ per GB 100% 22 20.9 90% 20 80% 18 70% 16 60% 14 12.5 50% 12 11.1 40% 10 8.2 30% 7.4 8 6.5 6.4 20% 6 4.7 4.5 4.9 10% 4 3.7 0%

2

US UK

Italy

India

Brazil

Egypt Spain

China 0

Russia Turkey

France

Mexico

Thiland Germany

Indonesia FY2010 1H 2011 FY2011 1H 2012 9M 2012 Philippines

2011 2015E MegaFon MTS Long-term network cost

Source: Credit Suisse Telecom equipment team estimates Source: Company data for MegaFon and MTS, Credit Suisse estimates

Figure 5: Network quality comparison, 3Q 2012 Figure 6: Telecom valuations: 3 year EBITDA growth vs # of / base stations* Spectrum/Subscribers 2012E EV/EBITDA multiple 0.09 9.0 Vodacom 0.08 Vodafone8.0

0.07 7.0 Etihad AT&T MTN 0.06 6.0 VimpelCom 0.05 Telefonica CR5.0 Qtel MegaFon Telefonica MTS Magy ar Verizon 0.04 France Tel 4.0 TPSA China Mob 0.03 3.0 0.02 Telkom SA 2.0 Tel Egy pt 0.01 1.0 0 MTS Vimpelcom MegaFon w/o MegaFon w Yota 0.0 -10% -5% 0% 5% 10% 15% 20% Source: Company data, Credit Suisse estimates Source: Credit Suisse estimates

MegaFon (MFONq.L) 3 08 January 2013 Table of contents

Executive summary 5 Investment positives 5 Investment risks 7 Valuation 8 MegaFon profile 12 Russian telecom market overview 16 Financial analysis 60 Valuation 75 Appendix 84 Management profile 84 Board of Directors composition and Director profiles 85 MegaFon’s network coverage 86 Russian mobile data tariffs 87 Russian mobile voice, SMS and bundled tariffs 89

MegaFon (MFONq.L) 4 08 January 2013 Executive summary Company description MegaFon is the #2 wireless operator in Russia, with approximately 63m mobile subscribers. Its main business is wireless voice, data, other value-added services and handset sales, mainly in Russia, with small exposure (1% of revenues) to peripheral CIS markets. The company also has exposure (6.4% of revenues in 3Q 2012) to fixed line retail and wholesale markets in Russia. MegaFon has US$8.7bn revenues in 2012E and cUS$1.3bn net profit. The company is c50%-owned by AF Telecom, a holding company majority-owned by , a Russian investor and entrepreneur, and 25%-owned by TeliaSonera, a global telecom operator. The shareholder structure changed in April 2012 when a third shareholder at the time, , exited the business by selling part of its 25.1% stake (14.4%) to MegaFon’s 100%-owned subsidiary, MegaFon Investments, and the remaining 10.7% stake to Mr. Usmanov’s AF Telecom. TeliaSonera also reduced its stake from an effective 43.8% to direct 35.6% by selling to AF Telecom its 26.1% stake in Telecominvest, whose main asset is a 31.3% stake in MegaFon. The company also paid a lump sum of US$5.15bn of accrued dividends to the three shareholders prior to the transaction. MegaFon listed its shares on London Stock Exchange and Russian MICEX on 28 November 2012 at US$20 per GDR and now has market capitalisation of US$14.8bn equivalent to US$23.8 per GDR. During the IPO TeliaSonera reduced its stake in MegaFon from 35.6% to 25% and MegaFon sold 4.4% of the total share capital from the shares owned by its 100% owned subsidiary MegaFon Investments. Investment positives

MegaFon’s strong historical execution has brought it to the #2 mobile position from #3 two years ago MegaFon started in St Petersburg as the #3 operator on a pan-Russia level with a discount-oriented strategy focused on younger consumers. Over time it has gained the #2 position in the market in terms of both subscribers and revenues, resulting in historically superior growth rates relative to competition and in a sector context.

Figure 7: MegaFon mobile and data revenue shares Figure 8: Mobile revenue growth rates in GEM mobile and Europe 40% 20% 36.0%

35% 15%

30.9% 10% 30% 29.2% 5% 27.3% 27.3% 25% 0% 19.7% 20% -5%

15% -10%

1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q India

2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 Brazil

China

Czech

Russia Turkey

Poland

Mexico

Hungary

Malaysia

MegaFon Indonesia

Mobile revenue share Mobile data revenue share Area Euro South Africa South

Mobile subscriber share CAGR 2009-2011 9M 2012

Source: AC&M, Credit Suisse research Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 5 08 January 2013

MegaFon’s early strategic network investment, in conjunction with execution, has placed it in the #1 position in the fastest growing underpenetrated mobile data services segment During the crisis years, when its key competitors were underinvesting in capex, MegaFon continued with a policy of substantial network investment. This was made possible by its relatively strong balance sheet versus its competitors, which was also to a lesser extent affected by the financial crisis, and was led by management’s and shareholders’ vision and execution. As a result, MegaFon has been able to build a competitive advantage in 3G network coverage and capacity, reaching #1 revenue market share in mobile data services in early 2010. The mobile data market in Russia is still underpenetrated and we expect fast growth rates in this segment. The operator with even a marginally superior network will, in our view, be in a strong position to benefit from this growth and continue to gain market share. Moreover, MegaFon can benefit from a first mover advantage in the 4G space via its MVNO agreement with its sister company, Skartel, which at this stage has the largest 4G network in the market and is best positioned in the dongles business. Finally, based on our analysis, mobile data pricing in Russia, and at MegaFon in particular, may be close to long-term network cost, implying limited downside risks to pricing and returns in the medium and long term. Although we expect aggressive price competition in data to continue in 2013, we see only limited downside risks to mobile data pricing from current levels for MegaFon specifically.

Figure 9: Network quality comparison, 3Q 2012 Figure 10: Current data pricing in Russia # of 3G/4G base stations* Spectrum/Subscribers In US$ per GB 0.09 22 20.9 20 0.08 18 0.07 16 14 12.5 0.06 12 11.1 0.05 10 8.2 7.4 8 6.5 6.4 0.04 6 4.7 4.5 4.9

0.03 4 3.7 2 0.02 0 FY2010 1H 2011 FY2011 1H 2012 9M 2012 0.01 MegaFon MTS Long-term network cost 0 MTS Vimpelcom MegaFon w/o Yota MegaFon w Yota

Note: MTS base stations information as of 2Q 2012 Source: Company data for MegaFon and MTS, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Concentrated exposure to Russia, which currently has a relatively benign macro, competitive and regulatory environment in a telecom sector context 99% of MegaFon’s revenues are generated in Russia, where the economy is relatively robust in a global and emerging market context. There is some correlation between telecom services consumption and economic growth—thus the currently relatively healthy economic backdrop is a positive for the outlook for telecom market growth. More importantly, the competitive environment in the telecom industry is relatively benign, with limited competition at this stage. Finally the regulatory framework has so far been less stringent than in other countries and the new regulator in our view has a balanced approach to industry regulation.

MegaFon (MFONq.L) 6 08 January 2013

Revenue growth rates are at the high end relative to the sector We expect the Russian telecom market to deliver mid-single digit growth rates in the medium term that are at the top end relative to the sector. We also assume that MegaFon could continue taking revenue share marginally (about 1pp over four years)—primarily from Vimpelcom among the BIG3 operators. If revenue market share gains continue due to continued strong execution and network advantage, this could warrant a premium valuation versus its peers.

Management focus on cash-flow generation and distribution of dividends We understand the management team is incentivised to maximise cash flows (EBITDA – capex). We believe that the current capex budget is sufficient to continue to deploy and maintain a superior network. We therefore think that there is a motivation to maximise cash flows that could translate into sustainable and potentially improving distribution of dividends. Moreover, given the intention to distribute excess cash flows and the way dividend policy is structured, we see potential upside risks to dividend distribution in the absence of material acquisitions and assuming the company is able to refinance scheduled debt.

The backing of a diversified shareholder base provides local support and global telecom expertise The combination of a well-connected and successful local businessman and a telecom operator with global expertise could help to minimise potential political/country risks, as well as execution risks. Investment risks

Relatively new management team has replaced the long-standing management team, which had a strong track record of execution Relatively recently (spring 2012), the top management at MegaFon was changed. The new management team’s track record is strong, in our view, and the new CEO has an extensive background in media, which could help create a competitive advantage in content and new services. The majority of the middle management team is unchanged, and the former CEO remains with the company as Chairman of the Board. Moreover, MegaFon continued to outperform its Russian peers, showing limited disruption in operational performance from the management change. However, the majority of market share gains and operational excellence were achieved under the previous management team. If execution continuity is not secured by the new management team beyond 2012, our forecasts and valuation assumptions could be at risk.

The new regulator potentially has a more proactive regulatory approach The Telecom Ministry also changed relatively recently, in May/summer 2012. We find the regulatory approach of the new telecom regulator team to be quite balanced – focusing both on consumer and operators. Having said that, we would expect more regulatory announcements going forward. At this stage we do not expect any material negative (or positive) regulatory changes in the sector—currently mobile number portability and change in regulation for charges from “national” and “intra-network” to a flat national roaming tariffs are the only regulatory initiatives that have been formally proposed. Nevertheless, there is uncertainty over how the new Telecom Ministry team could decide to change the regulatory landscape, which in turn presents a potential risk to the sector, MegaFon’s operations and our forecasts.

Potential loss of competitive advantage in network and execution MTS has ramped up its data network investment and increased CAPEX guidance for 2012, which may present risks to MegaFon’s continuing competitive advantage in data network and services, and outperformance continuity.

MegaFon (MFONq.L) 7 08 January 2013

Potential disruption in a benign competitive environment The telecom market environment in Russia is quite benign currently: pricing has been stabilising; expected regulatory changes are unlikely to change the mobile market landscape materially in our view; one of the operators, Vimpelcom, is capital constrained and is unlikely to become more aggressive in the near term; the opportunity for data spectrum for Tele2 seems to be increasingly remote; and Rostelecom’s execution of its mobile strategy has so far been behind schedule. However, competitive dynamics in the telecom sector are cyclical. The last round of competitive pressures, which lasted about a year and half, was over by the end of 2011. There is a risk, although not imminent at this stage in our view, that the competitive environment could deteriorate as a result of either Rostelecom’s more aggressive organic entry into mobile market and/or Tele2’s receipt of data spectrum.

Potential M&A risks According to the company, approximately US$233m of the IPO proceeds are to be used to repay and/or refinance existing debt and the remainder is to be used for general corporate purposes, including the continuing development and expansion of MegaFon’s network. The company is planning to pursue disciplined and selective M&A policy focusing on in- market strategic opportunities. Having said that the company has acquired a 25% stake in the largest mobile retailer, Euroset, and may be required to purchase an additional 25% stake in the second tranche from its shareholder. We think this acquisition makes a lot of strategic sense and in our base case scenario should be valuation neutral for MegaFon, it still may have M&A execution risks embedded. Moreover, MegaFon currently has a common shareholder with Yota which is also a counterparty to 4G MVNO agreement. Although there has been no indication that MegaFon may consider an acquisition of Yota in the future, which we think might be a natural avenue to explore and would make strategic sense, this could also potentially raise M&A risks.

Potential corporate governance risks Investors have expressed concern over: 1) potential corporate governance risks for MegaFon arising from the ownership structure and 2) the re-organisation of other assets which Mr. Usmanov, the major shareholder in MegaFon, owns, and their consolidation into a new holding structure which would be co-owned with Mr. Usmanov’s partners. We believe that the corporate governance risks this re-organisation presents are no more material than the corporate governance risks MegaFon had prior to this event, as Mr. Usmanov will retain 100% voting control over the holding. Moreover, the corporate governance risks that could potentially arise from the holding structure, which also owns assets with different profiles and in other sectors, does not differ materially in our view from the corporate governance risks embedded in MTS (our key comp for MegaFon) equity valuations (MTS is also majority owned by the holding structure, Sistema, which owns assets with different profiles and in other sectors of the economy). Valuation DCF is the main TP methodology We use DCF as our main target price methodology. Our DCF model yields US$30 per MegaFon GDR with 26% upside potential and implies the multiples presented in Figure 11 and the current multiples in Figure 12.

MegaFon (MFONq.L) 8 08 January 2013

Figure 11: MegaFon: Target Price implied multiples Target Price per GDR (US$) 30.0 Target Equity value (US$bn) 18.5 TP Implied multiples 2012E 2013E 2014E EV/EBITDA 6.0 5.7 5.3 PE 13.5 13.0 11.8 Dividend Yield (paid dividend) nm 6.1% 5.2% FCF Yield 8.3% 7.3% 8.5% Source: Credit Suisse estimates Cross check with multiple valuations MegaFon is currently trading at 4.8x EV/EBITDA, 10.3x PE, 7.7% DY and 9.1% FCFY for 2013E. This is broadly in line with MTS - the key operational and valuations comp for MegaFon in our view - at 4.6x EV/EBITDA, 10.2x PE, 7.3% DY and 8% FCFY. MegaFon’s current multiples are however at a discount to EEMEA telcos on 2013E PE and EV/EBITDA despite what we consider to be a more favourable sector environment. The notable exceptions are FCFY yields on which MegaFon looks more attractive than MTS and more in line with the EEMEA sector for both 2013E and 2014E. Given the balance of potential positives and risks, we think MegaFon’s equity should be valued at par with its key peer in Russia, MTS, and we think a premium valuation could be justified if the company continues to deliver superior execution and outperformance. The 2013E multiples implied by our target price for MTS are 12x PE, 5.2x EV/EBITDA and 6% DY and 7% FCFY. Our DCF model values MegaFon at par on DY and FCF metrics and at a slight premium on EV/EBITDA and PE multiples, which we think is justified. We also think that Russian telcos are currently undervalued by the market. Global telcos have derated since 2007 with PEs falling from 14x to 8x at the trough and c10-11x over 2009-2011 but have seen PEs going up to 12x by the end of 2012E. Russian telcos multiples have seen derating through most of 2012, improving towards the end of the year. Given the sector and macro environment we do not think Russian telcos deserve a discount to the global sector, particularly the stronger player in the sector.

MegaFon (MFONq.L) 9 08 January 2013

Key valuation peers and their comps Figure 12: MegaFon: Key valuation peers and comps Company Market Cap Dividend (US$m) PE EV/EBITDA FCF Yield Yield 2012E 2013E 2014E 2012E 2013E 2014E 2012E 2013E 2014E 2012E 2013E 2014E MegaFon 14,783 10.7 10.3 9.3 5.0 4.8 4.4 8.3% 9.1% 10.7% nm 7.7% 6.5% Key peers MTS (Consensus) 19,631 11.1 10.5 9.4 5.1 4.8 4.5 7.4% 9.8% 8.5% 5.9% 6.6% 7.8% MTS 19,631 10.8 10.2 9.5 4.7 4.6 4.3 6.6% 8.0% 8.8% 6.9% 7.3% 7.9% Vimpelcom (consensus) 17,845 10.3 9.3 7.9 4.3 4.1 3.8 8.9% NA NA 6.7% 7.9% 7.8% Vimpelcom 17,845 10.3 8.9 7.7 5.1 4.9 4.6 8.4% 8.6% 10.9% 7.3% 7.3% 7.3% Etihad Etisalat 14,327 9.1 8.2 7.9 7.0 6.2 5.7 6.7% 9.0% 10.4% 5.5% 7.2% 8.5% MTN 39,751 15.5 13.4 12.7 6.4 6.0 5.7 5.8% 6.9% 8.0% 4.9% 5.5% 6.1% Qtel 9,195 10.2 8.4 7.8 5.0 4.1 3.6 14.9% 12.8% 18.8% 2.9% 3.8% 4.8% Turkcell 14,524 13.2 11.8 10.8 5.6 5.2 5.5 4.6% 5.3% NA 2.8% 5.7% 5.0% Vodacom 22,554 18.3 15.4 14.5 9.1 8.4 7.9 5.8% 5.7% 5.9% 5.5% 5.9% 6.3% Average 12.1 10.7 9.8 5.8 5.4 5.1 7.7% 8.3% 10.2% 5.4% 6.3% 6.8% Min 9.1 8.2 7.7 4.3 4.1 3.6 4.6% 5.3% 5.9% 2.8% 3.8% 4.8% Max 18.3 15.4 14.5 9.1 8.4 7.9 14.9% 12.8% 18.8% 7.3% 7.9% 8.5%

Large Cap Emerging market stocks America Movil 91,763 12.0 11.1 10.3 5.8 5.2 4.8 13.7% 10.2% 10.2% 1.3% 1.8% 3.4% Advanced Info Service PCL 20,009 16.9 14.6 12.9 9.7 9.2 8.3 6.9% 3.5% 6.3% 5.9% 6.9% 7.7% Bharti Airtel Ltd 22,614 29.5 31.8 18.8 8.0 7.7 6.3 5.3% 4.5% 10.2% 0.3% 0.3% 0.3% China Mobile Limited 235,112 11.7 11.6 11.0 4.4 4.1 3.7 6.3% 6.9% 8.0% 3.7% 3.7% 4.6% DiGi.Com 13,345 31.0 23.1 22.0 13.7 13.0 12.5 4.5% 4.8% 4.8% 5.3% 4.4% 4.6% Maxis Berhad 16,222 24.1 23.9 23.7 12.4 12.7 13.0 6.0% 5.7% 5.6% 6.1% 6.1% 6.1% Average 20.9 19.4 16.4 9.0 8.7 8.1 7.1% 5.9% 7.5% 3.8% 3.9% 4.4%

Developed market comp AT&T 200,106 14.7 13.0 11.8 6.3 6.1 5.7 8.8% 7.8% 8.8% 5.0% 5.1% 5.2% France Telecom 29,445 7.7 8.6 9.8 4.1 4.2 4.3 17.0% 14.6% 13.1% 9.4% 9.4% 9.4% Telefonica 62,323 9.9 10.8 11.6 4.8 5.0 5.0 16.1% 10.3% 14.2% 0.0% 7.2% 7.2% Verizon 126,432 17.9 14.2 12.1 4.4 3.7 3.3 5.4% 8.1% 9.1% 4.6% 4.7% 4.7% Vodafone Group 126,241 10.7 10.6 10.6 7.5 8.2 8.4 7.1% -1.0% 6.1% 5.9% 6.4% 6.4% European integrated average 11.1 10.1 10.1 5.0 4.9 4.8 10.2% 10.3% 10.8% 7.6% 8.3% Average 12.0 11.2 11.0 5.3 5.3 5.3 10.8% 8.4% 10.4% 5.4% 6.8% 6.9% Multiples are based on prices as of 4 January 2013 Source: Credit Suisse estimates, IBES consensus

MegaFon (MFONq.L) 10 08 January 2013

Financials

Figure 13: MegaFon: Summary financials 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E CAGR CAGR 2009 - 2012E - 2011 2016E Rbls/US$ ave 31.7 30.4 29.4 30.6 32.0 31.1 30.4 30.4 30.4 30.4

Rbls m Revenues 181,883 215,515 242,608 129,864 71,234 271,260 287,715 304,565 318,613 335,286 15.5% 5.4% Growth yoy 18.5% 12.6% 14.2% 12.3% 11.8% 6.1% 5.9% 4.6% 5.2%

EBITDA, reported 88,192 97,774 100,822 53,800 32,138 114,008 121,080 127,001 131,884 138,256 6.9% 4.9% EBITDA margin, reported 48.5% 45.4% 41.6% 41.4% 45.1% 42.0% 42.1% 41.7% 41.4% 41.2% Growth yoy 10.9% 3.1% 9.7% 21.1% 13.1% 6.2% 4.9% 3.8% 4.8%

Net income, adj* 47,283 49,894 43,704 20,056 12,851 41,816 43,470 47,893 53,241 59,931 -3.9% 9.4% Net income margin, adj* 26.0% 23.2% 18.0% 15.4% 18.0% 15.4% 15.1% 15.7% 16.7% 17.9% Growth yoy 5.5% -12.4% -6.8% 0.6% -4.3% 4.0% 10.2% 11.2% 12.6%

Operating cash flow 79,350 86,613 97,295 51,529 30,641 97,152 100,879 108,166 112,773 119,469 10.7% 5.3% Cash capex 46,036 63,860 73,332 24,868 8,721 50,183 60,000 60,000 60,000 58,675 26.2% 4.0% Debt (new debt net of debt -9,784 -6,377 7,121 124,230 -10,328 121,121 -29,025 -17,250 -25,950 -19,855 repayments) Dividends -59 -147 0 -151,863 0 -151,863 -34,451 -29,100 -33,459 -37,074 2.5% Change in cash 6,085 -9,883 220 12,534 1,591 43,083 -40,365 1,817 -6,636 3,866 Ending cash balance 12,550 2,667 2,887 15,421 17,012 45,970 5,605 7,421 786 4,652

FCF (OCF-CAPEX) 33,314 22,753 23,963 26,661 21,920 46,968 40,879 48,166 52,773 60,794 -15.2% 6.7% FCF (OCF-CAPEX- 32,422 12,188 13,138 -125,202 13,481 -113,334 -11,340 19,067 19,314 23,721 Dividends)

Net debt (cash)** -34,518 -33,605 -45,689 155,965 139,887 116,645 127,985 108,919 89,604 65,883 Net debt / EBITDA -0.4 -0.3 -0.5 1.4 1.1 1.0 1.1 0.9 0.7 0.5 Net debt / equity 0.9 0.8 0.6 1.1 0.8 0.6 0.4 Total equity 183,914 233,126 276,632 71,700 86,627 113,778 122,798 141,591 161,373 184,230

US$ m Revenues 5,730 7,096 8,258 4,247 2,226 8,728 9,473 10,028 10,490 11,039 20.0% 6.0% EBITDA 2,779 3,219 3,432 1,759 1,004 3,668 3,986 4,181 4,342 4,552 11.1% 5.5% Net income, adj* 1,490 1,643 1,488 656 402 1,345 1,431 1,577 1,753 1,973 -0.1% 10.0%

FCF (OCF-CAPEX) 1,050 749 816 872 685 1,511 1,346 1,586 1,738 2,002 -11.8% 7.3%

Debt 898 1,080 1,357 5,260 5,147 5,427 4,471 3,903 3,049 2,395 Scheduled debt repayments 619 662 489 1,644 1,356 1,717 1,274 757 1,709 1,307 Cash 2,039 2,183 2,776 507 622 1,586 257 317 99 226 Net debt** -1,141 -1,103 -1,419 4,753 4,525 3,840 4,214 3,586 2,950 2,169

Dividends 4,966 0 4,886 1,134 958 1,102 1,221 2.5% * Adjustment for net income include the impact of one-offs (gains and losses for FX and derivatives for 2009-2012). ** The company estimates 3Q 2012E net debt at approximately US$4.5bn.

Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 11 08 January 2013 MegaFon profile Company description MegaFon is the # 2 wireless operator in Russia, with 27% subscriber share and 29% revenue share. It operates in three segments: wireless (88.5% of revenues in 3Q 2012), wireline (6.4%) and retail – sale of mobile handsets and accessories (5.1%). The main business—the wireless segment—includes mobile voice, data and value added services. 99% of wireless revenues come from Russia, with the remaining 1% coming from peripheral markets in the CIS (, South Ossetia and Abkhazia). The wireless segment’s revenues have grown c11% annually since 2009. The company has 62.8m users, comprising mainly B2C customers. Having started as the #3 operator, MegaFon became #2 in terms of total wireless subscriber and revenue share, and #1 in terms of mobile data traffic business in 2010. Its strategy over the past three years has been focused on early data infrastructure investment, which has led to a competitive advantage in 3G network coverage and quality. The company also has a 4G/LTE licence which it is currently rolling out and has an MVNO agreement with Skartel, which operates under the Yota brand and which until recently was the only 4G operator in Russia. MegaFon is also currently focusing on opportunities to grow content and other mobile value added services. MegaFon’s wireline business has grown mainly through acquisitions and contributes a smaller (6.4%) share to total revenues in 3Q 2012. The company provides various services in this segment: consumer broadband (about 30% of revenues), traditional voice and value added fixed line services to businesses and government organisations (c25%), and wholesales services to operators (c45%).The retail division—sales of handsets and accessories—is the smallest segment in MegaFon’s business, albeit fast growing in the past. In 3Q 2012, handset and accessories revenues grew 50.5% yoy (versus 75% growth in 1H 2012), mainly on the back of expansion of its own mobile distribution network. MegaFon manages 1,841 of its own stores and 1,821 third party monobrand stores where it sells a variety of services, equipment and accessories.

Figure 14: MegaFon: Consolidated revenue composition, Figure 15: MegaFon: Revenue growth by segment 3Q 2012 % in roubles

100% 374.8% 87.9% 90%

Retail 80% Wireline 4% 70% 7% 64.3% 60% 50% 40% 30% 26.9%

20% 15.5% 13.5% 10.7% 10.9% 10% Wireless 89% 0% Wireless Wireline Retail Consolidated

CAGR 2009-2011 9M 2012 yoy

Source: Company data Source: Company data

MegaFon (MFONq.L) 12 08 January 2013

Figure 16: MegaFon: Mobile and data revenue shares Figure 17: Network quality comparison # of 3G/4G base stations x spectrum / subscribers 40% 0.09 36.0% 0.08 35% 30.9% 0.07 30% 29.2% 0.06 27.3% 27.3% 25% 0.05

19.7% 0.04 20% 0.03 15% 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 0.02 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 0.01 Mobile revenue share Mobile data revenue share 0 Mobile subscriber share MTS Vimpelcom MegaFon w/o Yota MegaFon w Yota

Source: AC&M, Credit Suisse research Note: MTS base stations as of 2Q 2012

Source: Company data, Credit Suisse estimates Key development milestones

Figure 18: MegaFon: Key development milestones and revenue trends

Launch of 4G/LTE with Yota Acqui in sition of and other 1st Acquisition Net-by- 1st opera Net; 8 cities, tor to of Synterra targeting NorthWest operator Mega- cover 1st to & becomes 40 cities GSM in Europe Launch of Labs all launch 3G #2 in Russia launches by YE acquired to launch online store "MMS" regions network in in terms of ops 2012 nine other and in and 1st to Russia ST. Subscribers regional introduction Russia Petersburg "NorthWest GSM launch GSM" of EDGE operators "Mobile founded, TV launched and operations renamed in ST. MegaFon ~ 20x Petersburg

1993 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Note: Annualised 1H/2012 revenues; revenues are generally higher during the second half of the year Source: Company data Ownership structure Until April 2012, MegaFon was owned by three shareholders: TeliaSonera had a majority stake, with effective ownership of 43.8%, AF Telecom had effective ownership of 31.1%, and Altimo (telecom investment vehicle of which also owns Vimpelcom in Russia) had a 25.1% stake. AF Telecom is an investment vehicle that is 100%-owned by a Russian billionaire, Alisher Usmanov. In 2007-08, Mr Usmanov acquired direct and indirect stakes in MegaFon from IPOC (an entity then owned by Danish lawyer Jeffrey Galmond who, according to press reports (Vedomosti, Wall Street Journal, Forbes), was linked to former Russian Telecom Minister Leonid Reiman.

MegaFon (MFONq.L) 13 08 January 2013

In April 2012 TeliaSonera announced that Altimo was exiting the asset by selling a 14.4% stake to a subsidiary of MegaFon for US$2.16bn and the remaining 10.7% of its stake to AF Telecom, for US$1.61bn. As part of this transaction, MegaFon also released US$5.15bn of dividends to the three shareholders. We calculate the implied acquisition price of this transaction was US$15.8bn (including the US$200m additional consideration TeliaSonera paid to Altimo to finalise the sale). As part of the transaction, AF Telecom also acquired TeliaSonera’s 26.1% stake in Telecominvest, which owned 31.3% in MegaFon, thereby consolidating Telecominvest’s ownership. We calculate that the implied acquisition price of this transaction was US$15.3bn (including US$200m additional consideration TeliaSonera paid to Altimo to finalise the sale). As a result of this transaction, TeliaSonera owned 35.6%, Mr Usmanov, indirectly via his 100% ownership of Telecominvest, received 50%+, and MegaFon, through its subsidiary, owned the remaining 14.4% stake. In July 2012, following the transaction with Altimo, Mr. Usmanov entered into a swap with shareholders of Skartel, the 4G/WiMAX/LTE operator in Russia under the brand name Yota. This resulted in the formation of a new company, to which Mr Usmanov contributed his stake in MegaFon, and Skartel shareholders contributed their stakes in Skartel. As a result of this transaction, Mr. Usmanov reduced his effective stake in MegaFon from 50%+ to 41%. Mr. Usmanov will remain a controlling shareholder via his 82% ownership of the JVC which owns 50%+100 shares of MegaFon.

Figure 19: Shareholder structure prior to exit by Altimo in Figure 20: Shareholder structure after April 2012 April 2012 MegaFon TeliaSonera Mr. Usmanov Altimo TeliaSonera Mr. Usmanov Investments

100.0% 100.0%

AF Telecom AF Telecom 100.0%

26.1% 73.9% 35.6% 35.6% Telecominvest 8.0% 25.1% Telecominvest 18.7% 31.3% 31.3% 14.4%

MegaFon MegaFon

Source: Company data Source: Company data Alisher Usmanov is a businessman who is a long-term shareholder with strong digital media expertise and capabilities. According to the 2011 edition of Forbes magazine, Mr Usmanov is one of Russia's richest men and the world's 28th richest person. He has accrued his wealth from mining, lumber, and other investments. He is the majority shareholder of Metalloinvest, a Russian industrial conglomerate, which he founded to manage Gazprom’s metals interests. Mr. Usmanov is a co-owner of the Russian investment fund Digital Sky Technologies (DST), which owns direct and indirect stakes in Mail.ru, Vkontakte.ru, Facebook, and others. He is also a co-owner of the media holding which comprises UTV and Muz-TV, Disney and Semerka. Besides this, Alisher Usmanov personally owns the Kommersant and Sekret Firmy Publishing Houses, shares in the company SUP, which controls Internet website Livejournal.com and internet newspaper «Gazeta.ru». Mr. Usmanov’s majority owned holding, Garsdale Services Investment, indirectly owns 50% of MegaFon, 100% of Yota (Russian 4G operator) since July 2012, and 25% of Euroset, the largest mobile retailer, since December 2012.

MegaFon (MFONq.L) 14 08 January 2013

TeliaSonera—a leading Nordic telecom operator with operations in 15 countries—is also a long-term shareholder with strong telecom expertise and capabilities. IPO summary MegaFon listed its shares on London Stock Exchange and Russian MICEX on 28 November 2012 at US$20 per GDR and now has market capitalisation of US$14.8bn or US$23.8 per GDR. During the IPO TeliaSonera reduced its stake in MegaFon from 35.6% to 25% and MegaFon sold 4.4% of the total share capital from the shares owned by its 100% owned subsidiary MegaFon Investments. Current ownership structure is presented in Figure 21.

Figure 21: Current ownership structure

Telia- Mr. Rostechnol MegaFon Free Float Telconet Sonera Usmanov ogil Investments

82.0% 13.5% 4.5%

Garsdale Services Investment Ltd 100% 100.0% Yota AF Telecom

100.0% Telecominvest 10.0%

25.0% 50.0%

15.0% MegaFon

Source: Company data & Credit Suisse research Post the IPO, the company is targeting two independent Board Members, versus one previously, alongside three AF Telecom Board Members and two TeliaSonera Board Members, versus three previously. We present a summary of the current Board of Directors in the appendix of the report.

MegaFon (MFONq.L) 15 08 January 2013 Russian telecom market overview Macroeconomic and sociodemographic environment Of MegaFon’s business, 99% comes from Russia, which has a relatively healthy macroeconomic environment, with relatively high GDP per capita and real GDP growth, and a healthy fiscal position among other emerging countries. On the downside, the Russian economy is still experiencing relatively high inflation, unfavourable demographics and a high concentration towards the oil and primary resources sectors.

Figure 22: Real GDP growth for selected countries 10.0%

8.0%

6.0%

4.0%

2.0%

0.0% 2011 2012E 2013E

-2.0%

Euro Area Hungary Czech US Poland South Africa Russia Brazil Mexico Thailand Turkey Malaysia Indonesia India China

Source: Local statistics offices, Credit Suisse estimates

Figure 23: GDP per capita for selected countries Figure 24: Gross debt as % of GDP for selected countries In US$ 30,000 100% 90% 25,000 80% 70% 20,000 60% 15,000 50% 40% 10,000 30%

5,000 20% 10% 0 0% 2011 2012E 2013E 2011 2012E 2013E

India Indonesia China Thailand South Africa Russia Indonesia Turkey Mexico China Malaysia Mexico Turkey Brazil Poland South Africa Czech Thailand Brazil Malaysia Hungary Russia Czech Euro Area US Poland India Hungary Euro Area US

Source: Local statistics offices, Credit Suisse estimates Source: Local statistics offices, Credit Suisse estimates

MegaFon (MFONq.L) 16 08 January 2013

Figure 25: Inflation for selected countries Figure 26: Population under 14 years of age for selected countries; 2011 12.0% 35%

10.0% 30%

8.0% 25%

6.0% 20%

4.0% 15%

2.0% 10%

0.0% 5% 2011 2012E 2013E 0%

US Euro Area Czech China Malaysia

UK US

India

Brazil China

Thailand Poland Mexico Hungary Brazil Czech

Russia Turkey

Poland France

Mexico

Hungary

Thailand

Malaysia Germany South Africa Russia India Turkey Indonesia Indonesia Africa South Source: Local statistics offices, Credit Suisse estimates Source: World Bank estimates A Russian telecom market snapshot Telecom market composition and growth by segment As of 2011, 48% of overall telecom market revenues came from mobile services and 28% from fixed line services. The handset sale business has been, surprisingly, the fastest growing segment, with a 2009-2011 CAGR of 21%, followed by fixed line broadband (2009-2011 CAGR of 12.5%) and mobile services (2009-2011 CAGR of 8.5%). Fixed line broadband is expected to be the fastest growing segment over 2012-2015E, with 10.5% CAGR, and mobile is expected to grow in mid-single digits, according to third party estimates (AC&M and Direct-Info).

Figure 27: Russian telecom market structure and growth rates by segment Roubles in billions CAGR 2011-2015E CAGR 2009-2011 9.1% 2,028 6.0%

1,736 9.5% 1,607 544 1,501 20.9% 1,351 435 379 161 10.5% 324 12.5% 121 259 108 95 394 2.9% 85 366 364 352 (0.2%) 353

929 718 769 814 653 8.5% 4.9%

2009 2010 2011 2012 2015

Mobile Fixed Voice & other fixed products Fixed Broadband Handset

Source: AC&M, Direct Info

MegaFon (MFONq.L) 17 08 January 2013

A Russian mobile market snapshot Mobile subscriber penetration The Russian mobile market is one of the most penetrated in the broader EMEA and global emerging market space. Yet, reported levels of mobile subscribers and penetration continue to grow, which in our view is driven by factors such as:

■ the multiple SIM card phenomenon, which has always been a characteristic of the Russian market but may well be increasing due to growth in data only plans; and

■ high migration levels from CIS countries. While this is unlikely to change in the near future, we do not expect material growth in real mobile subscribers and penetration levels, and, importantly, we do not view it as a primary growth driver of the Russian market.

Figure 28: Mobile penetration for selected countries, Figure 29: Russia: Reported mobile subscriber and reported, 9M 2012 penetration trends, 9M 2012 Subscribers in millions (RHS); in % of population (LHS) 180% 170% 250

160% 160% 140% 200 150% 120% 150 100% 140%

80% 130% 100 60% 120% 40% 50 110% 20%

0% 100% 0 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q

India 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012

Brazil

China

Czech

Russia

Turkey

Poland

Mexico

Hungary Malaysia Euro Area Euro Mobile penetration (LHS) Mobile subscribers, m (RHS) South Africa South Source: AC& M, Credit Suisse research Source: AC&M, Credit Suisse research Mobile revenues as a percentage of GDP Despite mobile being a highly saturated market in terms of subscriber penetration, mobile revenues as a percentage of GDP are, and have been historically, below average in a context of Global Emerging Markets (GEM). We think this could be structural given large concentration in the Russian economy towards the resource-based sectors. However, with a relatively robust outlook for real GDP growth, we expect to see positive growth momentum in the Russian mobile sector continue, albeit below nominal GDP growth rates.

MegaFon (MFONq.L) 18 08 January 2013

Figure 30: Mobile revenues as a % of GDP for selected Figure 31: Russia: Mobile revenues as % of GDP (LHS) countries, 9M 2012 and relative to GDP trend (RHS) 3.5% 1.8% 30% 1.6% 3.0% 25% 1.4% 20% 2.5% 1.2% 15% 2.0% 1.0% 10% 0.8% 1.5% 5% 0.6% 1.0% 0.4% 0% 0.5% 0.2% -5% 0.0% -10% 0.0%

2008 2009 2010 2011 9M 2012

India

Brazil

China

Czech

Turkey Russia Poland

Mexico Mobile revenue as a % of GDP (LHS)

Hungary

Malaysia Indonesia Euro Area Euro Nominal GDP growth (In Roubles) (RHS) South Africa South Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Mobile revenue growth profile Russian mobile revenue growth started to improve at the end of 2011 and is currently above the GEM average. Within EEMEA, Russian mobile seems to be delivering one of the best growth rates in EEMEA, behind only Turkey. MegaFon has been outperforming the market.

Figure 32: Mobile local currency revenue growth for Figure 33: Russia: Mobile service rouble revenue growth selected countries yoy for major operators % 20% 40% 35% 15% 30% 10% 25%

5% 20% 15% 0% 10% -5% 5% 0% -10% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q

-5% 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012

India

Brazil

China

Czech

Russia Turkey Poland

Mexico -10%

Hungary

Malaysia

MegaFon

Indonesia Euro Area Euro

South Africa South MegaFon MTS Vimpelcom

CAGR 2009-2011 9M 2012 Tele2 Rostelecom

Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Russian mobile market structure The Russian mobile market is dominated by the BIG3 players: MTS, MegaFon and Vimpelcom. MegaFon gained the #2 position in 1Q 2010 and now (as of 3Q 2012) has a 27% market share in terms of mobile subscribers and 29% in terms of mobile revenues. MTS is #1 in terms of subscribers and revenues (31% each as of 3Q 2012). Vimpelcom lost its #2 place to MegaFon and now (as of 3Q 2012) has a 24% market share of mobile subscribers and a 28% share of mobile revenues.

MegaFon (MFONq.L) 19 08 January 2013

Figure 34: Russia: Mobile subscriber share dynamics Figure 35: Russia: Mobile revenue market share dynamics

40.0% 40%

35.0% 35% 32.1% 30.8% 30.7% 33.2% 30.0% 30% 31.4% 27.3% 29.2% 24.9% 25.0% 25% 27.3% 27.7% 19.7% 24.4% 20.0% 20%

15.0% 15% 9.7% 10.0% 10% 5.8% 5.9% 5.9% 7.2% 5.0% 5% 5.2% 4.2% 3.4% 0.0% 0% 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012

MegaFon MTS Vimpelcom MegaFon MTS Vimpelcom Tele2 Rostelecom Tele2 Rostelecom

Note: MTS uses 6-month subscribers counting rule, while others use Note: Revenue market share calculations are based on mobile 3-month subscribers counting rule. revenues reported by MTS, Vimpelcom, MegaFon and Tele2

Source: AC&M, Credit Suisse research Source: AC&M, Credit Suisse research The other mobile players currently in the market are:

■ Tele2, with a 10%/7% subscriber/revenue share respectively;

■ Rostelecom, which in 2010-11 consolidated the regional mobile assets of Svyazinvest as part of the state-owned telecom incumbent reorganisation, with 6%/.5% subscriber/revenue share respectively;

■ The other two players, SMARTS and MOTIV, are currently very small and we do not regard them as material players in the Russian mobile telecom market.

Figure 36: Russian mobile operators Prior to spring 2011 Current MTS MTS MegaFon MegaFon Vimpelcom Vimpelcom Tele2 Tele2 Uralsvyazinform Rostelecom + Skylink Sibirtelecom SMARTS Group SMARTS Group Cellular Communications MOTIV NCC Cellular Communications MOTIV New Telephone Company Note: NCC was acquired by Rostelecom in April 2011; New Telephone Company was bought by Vimpelcom in May 2011. Source: AC&M Mobile TeleSystems (MTS) MTS is the #1 mobile operator in Russia and, we think, the closest peer for operational and valuation benchmarking for MegaFon. It also operates a fixed line business in Russia where it has #1 position in the traditional fixed line and residential fixed line broadband segment in Moscow and is also #4 in Russia in terms of residential broadband subscribers, according to AC&M (the fixed line business is about 16% of Russian revenues). MTS also has exposure to the CIS (about 12% in total with the majority (c10%) coming from the Ukraine and the remainder from Armenia. Ukrainian operations have been performing well recently. However, the company lost its asset in , which

MegaFon (MFONq.L) 20 08 January 2013 was the third largest asset in its portfolio, this summer because of the government dispute (According to MTS’s press release from 17 September 2012, the government of Uzbekistan confiscated all assets of MTS’s subsidiary in Uzbekistan in connection with a criminal court judgement against four employees.). This has raised investor concerns over the benefits of business diversification within the CIS region in our view. We think that MTS is the closest peer for MegaFon in terms of both operational trends and relative valuations, because of its business composition and historical performance, and despite more material exposure to fixed line and CIS than MegaFon. MTS was established in 1993 by MGTS, T-Mobile, Siemens AG and several other shareholders. In 1996 JSFC Sistema acquired a majority stake in MTS and has remained the primary owner, with a 50.8% stake currently—the rest (49.2%) is free float. The company has been listed on NYSE since July 2000 and on MICEX since November 2003. Current market capitalisation is around $18bn. MTS started its mobile business with the launch of GSM services in 1994 and then expanded rapidly, both organically and through the acquisition of different operators. Further development led the company to CIS markets including Ukraine, Belarus, Uzbekistan, Turkmenistan and Armenia. Now MTS is the leading mobile provider in Russia, with a 31% subscriber market share serving above 70 million SIM cards. After buying MGTS, a Moscow telecom incumbent and pan-Russian alternative fixed line player in 2010, MTS also provides fixed voice, broadband and Pay-TV services, taking 18%, 17% and 11% market share in each of the segments respectively on our estimates. After the acquisition of the largest multibrand mobile retailer, Euroset, by MTS’s competitor, Vimpelcom, in 2009, MTS started expanding its monobrand retail chain, which is now ranked #2 in the mobile retail market in Russia. From the beginning of its operations, MTS’s strategy has been to remain the #1 player in the Russian mobile market. It has , 3G and now 4G/LTE licences on the federal level, having already launched services in Moscow, and expects to launch in a number of Russian regions by July 2013. It is also in negotiations with Skartel (4G/WiMAX/LTE player in Russia under Yota brand) for pan-Russian MVNO. Vimpelcom Vimpelcom is currently the #3 mobile operator in Russia in terms of subscribers and revenues. It also operates a fixed line business in Russia (17% of Russian revenues) where it has a #2 position in the residential fixed line broadband segment and shares the #2 position with MTS in the corporate broadband segment in Russia, according to AC&M. Although the majority of Vimpelcom’s business still comes from Russia (40%), the company is even more heavily diversified into emerging markets (CIS, Africa and Asia which contribute about 30% to revenues) and also developed Europe (Italy contributes another 30% to revenues). Because of this regional diversification as well as other issues that impact operations and valuations – shareholder dispute, government dispute in Algeria, high leverage – we do not think Vimpelcom is a key peer for operational and valuation benchmarking for MegaFon. Vimpelcom was established in 1992 in Moscow. In 1994 it began operating under the brand “” in AMPS standard and in 1997 the company launched a GSM-1800 network. In December 1998 acquired 25%+1 share in Vimpelcom. After years of organic growth and small acquisitions Vimpelcom began a new period in its history with the acquisition of the leading Russian alternative fixed line operator, Golden Telecom, in 2008. In 2009 Vimpelcom agreed to a merger with Kyivstar, the #1 player in the Ukraine owned by Telenor, which finally expanded Vimpelcom’s presence in the CIS and particularly the Ukraine, founding a new company “Vimpelcom Ltd” with headquarters in the Netherlands that combined both Vimpelcom and Kyivstar assets. By 2010 Vimpelcom had mobile and fixed line assets in Russia, Ukraine, Uzbekistan, Armenia, Tajikistan and Kazakhstan. In October 2010, Vimpelcom announced a merger with another holding— Weather Investments S.p.A—controlling Wind Telecom and Orascom telecommunication

MegaFon (MFONq.L) 21 08 January 2013 holding. The joint group became one of the largest emerging market mobile operators. However, because of the M&A focus and multiple changes at the top management level between 2008 and 2010, Vimpelcom underperformed in its core market, Russia, and lost its #2 market position to MegaFon and continues to underperform in Russia. The company is also currently underperforming in the majority of the CIS markets and showing first signs of underperformance in Algeria, its third largest asset. OJSC Vimpelcom was the first Russian company to be listed on NYSE. Its ADRs have been trading there since November 1996. The current market capitalisation is close to US$19bn. After several significant changes in shareholder structure and a number of other minor share transactions, Vimpelcom is currently owned by Telenor (43%), Altimo (47.9%) and Minority shareholders/Free float (9.2%). As a result of a stream of material acquisitions, Vimpelcom is now the most levered telco among the Russian and Emerging Market telecom players, with 2.5x net debt/EBITDA. The company is currently focusing on improving cash flow profile and deleveraging, improving operations in its core underperforming markets, Russia and Ukraine, and resolving the disputes among shareholders and with the government in Algeria. Vimpelcom also has 2G, 3G and now 4G/LTE licences on the federal level in Russia, planning to launch in a number of Russian regions by July 2013, and is in negotiations with Skartel (4G/WiMAX/LTE player in Russia under Yota brand) for pan-Russian MVNO. However, we view Vimpelcom as too capital constrained to be able to outperform the Russian mobile market in the medium term or lead price wars. Rostelecom Rostelecom is a diversified Russian telecom incumbent which was historically a long- distance player and was recently (2010-2011) integrated with Svyazinvest, the Russian state owned incumbent fixed and mobile services operator. It was formed during the Soviet era and built the majority of the copper infrastructure during that period. Rostelecom’s business now consists of five segments: fixed-voice, broadband, pay-TV services, mobile and other services. Rostelecom has traded on MICEX since 1997, RTS since 1998 and LSE since 2012 (it was delisted from NYSE in 2010). The current market capitalisation is US$11bn. Rostelecom is the #1 player on the fixed line market in Russia and is #5 in the mobile segment on our calculations. Rostelecom has been upgrading its infrastructure over time and its dominant fixed line position is quite strong in our view. The mobile segment, however, is fragmented, currently in a small number of regions, and has been underperforming the market. Rostelecom’s new management has been discussing various options to tap into the broader mobile space in Russia. The company received 2.1 GHz spectrum on a pan Russian level via the Svyazinvest transaction involving SkyLink, and also 4G/LTE spectrum in 700-800 MHz band together with other mobile operators. There was also a preliminary MVNO agreement with Skartel, which should have become effective this summer. However, Rostelecom has not yet begun operations on Skartel’s network due to a disagreement over terms (Rostelecom’s CEO said during a conference call and also was quoted in RBC Daily). Rostelecom has articulated its ambition to increase its share of the mobile market in Russia from 6% currently to 22%. It has been launching test and commercial 3G networks in the regions where it is already present in mobile voice business and has ambitions to launch in new regions in 2013. We are sceptical at this stage about Rostelecom’s ability to succeed in organically building out a comprehensive mobile business in Russia. Having said this, if it were to strengthen its mobile management team and attempt an organic roll- out, that could be a negative catalyst for the mobile market in Russia and could disrupt the currently benign competitive environment. We think that Rostelecom is more likely to attempt to do it via M&A.

MegaFon (MFONq.L) 22 08 January 2013

Tele2 Tele2 is the #4 mobile operator in Russia, 100%-owned by Swedish Tele2. It has 2G licences in 900 and 1800 MHz bands in 43 regions and has been successful in growing its revenue market share in Russia, from 4% in 2007 to 7% currently by launching new regions and following its price discount strategy. Tele2 currently does not have 3G or 4G licences and is in discussions with the government on potential tech neutrality in 1800 MHz band. If the company were to receive data spectrum, we think that may present marginal competitive risk to the mobile data market in Russia. We believe Tele2 is likely to be successful in deploying a 3G/4G data network and gaining data market share, but by the time it is able to roll out a comprehensive network, the BIG3 operators in Russia will likely already have a comprehensive 4G network. Moreover, we are sceptical at this stage about the outlook for tech neutrality in Russia. Skartel Skartel owns Yota, a Russian mobile internet brand. Yota provides 4G/WiMAX/LTE mobile internet services available through its branded USB-modems and routers. The company was founded in 2007 and in 2008 became the first provider to work with WiMax standard. The technology represented wireless internet access with faster than Wi- Fi speed and broader than Wi-Fi coverage, and was considered to be a good alternative to fixed line access such as ETTH or xDSL. Yota WiMax worked on 2.5–2.7 GHz band and was launched for the first time in Moscow and St. Petersburg. Yota had two devices for internet access: a USB-Modem and a router. Further shops started selling Yota branded WiMax and WiMax laptops. In November 2008, state technology holding “Rostechnologii” acquired 25.1% of WiMax Holding Ltd., the company that owns Skartel. By 2011 Skartel’s network covered Moscow, St. Petersburg, , Krasnodar and and had more than 700,000 subscribers. In 2011 Yota started considering LTE development in Russia. Skartel was the only company whose frequencies band was already suitable for LTE deployment, giving it an advantage over its mobile competitors. Yota launched its first LTE network in on 23 April 2012. Moscow was the third city where the LTE network was commercially deployed, on 10 May. Yota’s WiMax active subscribers in every covered city were allowed to change their WiMax devices to LTE modems free of charge during testing periods. One of the conditions of the deal with Mr. Usmanov (formation of a Joint Venture, Garsdale, consisting of 50% of MegaFon and 100% of Skartel in July 2012, according to Vedomosti reports) was that Yota has to provide non-discriminatory access to all willing operators via MVNO agreements. MegaFon was the first company to become a virtual operator on Yota’s network. The company launched 4G services together with Skartel in Novosibirsk and Moscow in April/May 2012 first as a promotion and then on a commercial basis in August 2012. 4G USB dongles were sold at a 50% premium to 3G dongles. As part of the two-way MVNO contract, in exchange for Yota’s network, MegaFon allows Skartel to use its own 2G/3G network infrastructure on an MVNO basis. The agreement with Yota is on full commercial terms and has a five-year duration plus an automatic renewal option for additional five years. MegaFon’s access to Skartel’s network is non-exclusive. Similar MVNO agreements were negotiated with Rostelecom, MTS and Vimpelcom. Reportedly (Vedomosti, Kommersant), Skartel has been offering two contract options under the MVNO agreement: federal and regional. Under the federal contract, the MVNO operator pays Skartel no less than $150m; Under the regional contract, the operator pays US$70m for operations in the central region and not less than $20m in any other region. Technically, Skartel’s network can serve only four operators, which means that Skartel will have to choose only two contenders out of the three. In , MTS already works as an MVNO with Skartel. Press reports (Vedomosti, Kommersant) suggested that Rostelecom, having almost signed the MVNO agreement earlier, raised a legal claim against Skartel.

MegaFon (MFONq.L) 23 08 January 2013

Yota now operates LTE networks in nine Russian cities together with MegaFon, in Kazan there are two MVNOs working on Skartel’s network: MTS and MegaFon. So far Yota’s main competitor operating in Moscow is MTS, which has recently launched its own LTE tests on Comstar’s WiMax network (Telecom Daily). The competition however will likely intensify, with all the BIG3 operators intending to launch their own LTE networks in 2013. Russian mobile market outlook Mobile market growth by segment: historical trends and outlook Russian mobile market growth—8.5% on average per annum over the past three years (2009-2011)—has been recently driven by mobile data and other value added services (VAS) excluding messaging. Data has delivered 44% CAGR over the past three years and other VAS, 24%. Voice is still the largest segment with around three-quarters of the market revenues but with significantly lower growth rates than data and VAS (mobile content + other mobile VAS), at +5% 2009-2011 CAGR, which is still better than the majority of developed and some emerging countries. SMS is currently 6-7% of the mobile market and is a stagnating segment: +2% CAGR over 2009-2011, as a result of saturation and data cannibalisation, a trend similar to many other markets. Third party estimates (AC&M and Direct-Info) imply that relative growth drivers are likely to remain the same, with mobile data and VAS growing c20% and c13% respectively per annum over 2011-2015E and voice / SMS at low single digits. As a result the overall market growth is expected to come down to c5% per annum. Overall we agree with the mid-single digit growth outlook for the Russian mobile market. We are however more optimistic on data and content, which we expect to grow around 23% and 16% respectively per annum over 2011-2015E, and are slightly more cautious on SMS (we expect SMS revenues to decline). Given the expected fastest growth rates in data and content, and MegaFon’s strategy focus on this area, we focus our analysis first on these two segments.

Figure 37: Russian mobile market: Historical trends and outlook Roubles in billions 1000 CAGR 2009-2011 929 CAGR 2011-2015E 8.5% 4.9% 814 95 769 800 47 13.2 718 66 58 24.1 50 160 653 46 52 2.3% 51 100 38 76 1.7% 600 53 50 20.5% 36 44.1%

400

5.0% 627 1.8% 583 599 529 567 200

0 2009 2010 2011 2012 2015E

Voice Data Messaging VAS (excl SMS)

Source: AC&M, Direct-Info Russian VAS market snapshot The Russian market for mobile value added services (VAS), which includes mobile data, mobile content, SMS and other services, currently (as of 3Q 2012, AC&M) accounts for about 26.5% of mobile revenues, which is around the sector average. However, there are a number of regions/countries with significantly higher VAS penetration rates: within EMEA—Europe and Poland; within GEM—Indonesia, Malaysia and China.

MegaFon (MFONq.L) 24 08 January 2013

The largest sub segment is mobile data traffic (44.6% as of 3Q 2012), which was also the fastest growing mobile VAS revenue stream until early 2012; the second largest is content (26.9% standalone and 31.7% with other VAS which includes mobile commerce and some mobile payments, as of 3Q 2012), which has also been the fastest growing VAS revenue stream for a few quarters in 2012, and finally SMS (24% as of 3Q 2012) with overall stagnating low to mid-single digit growth rates in the past three years and in some quarters declining revenues in absolute terms.

Figure 38: Total VAS as a % of mobile revenues, 3Q 2012 Figure 39: Russia: VAS market composition, 3Q 2012 45%

40%

35%

30%

25% Content + Other VAS, 31.7% 20% Data, 44.6%

15%

10%

5% SMS, 23.7%

0%

India

Brazil

China

Czech

Russia Turkey

Poland

Hungary

Malaysia

Indonesia Euro Area Euro South Africa South Source: Company data, AC&M for Russia, Credit Suisse research Source: AC&M

Figure 40: Russia: VAS revenue rouble growth yoy by Figure 41: Russia: VAS revenue rouble growth yoy by segment operator % % 60% 60.0%

50% 50.0% 40.0% 40% 30.0% 30% 20.0% 20% 10.0% 10% 0.0%

0% -10.0%

-10% -20.0% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012

Data Content + Other VAS SMS MTS Vimpelcom MegaFon Others

Source:A C&M Source: AC&M MTS at this stage has the largest revenue share of the overall VAS market, at 32.8% as of 3Q 2012, with MegaFon a close second with share at 32.5% and Vimpelcom’s at 27.7%. MegaFon has been gaining share of total VAS over time, as has MTS to a lesser extent. Vimpelcom’s share has remained relatively stable over time: the company underperformed materially in 2010 but has mostly regained share since then.

MegaFon (MFONq.L) 25 08 January 2013

Figure 42: Russia: VAS revenue shares, 3Q 2012 Figure 43: Russia: VAS revenue share trend by operator 35%

Others 30% 7.0%

MTS 25% 32.8% 20% MegaFon 32.5% 15%

10%

5% Vimpelcom 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q Q3 27.7% 200920092009200920102010201020102011201120112011201220122012

MegaFon MTS Vimpelcom Others

Source: AC&M Source: AC&M Russian mobile data market Russian mobile data market outlook The factors influencing the mobile data growth outlook in Russia are mixed but with a positive bias, in our view.

On the positive side: Internet penetration rates are still low: Mobile data (and internet in general) penetration is still low, particularly in the regions. We and consensus expect penetration growth primarily in the regions.

Figure 44: Wireless broadband penetration for selected Figure 45: Fixed line broadband penetration as % of countries, 2011 household for selected countries, March 2012

60% 90%

80%

50% 70%

60% 40% 50%

40% 30% 30%

20% 20% 10%

10% 0%

UK

Italy

India

Brazil

China

Czech Spain

Russia Turkey

Poland France

Mexico Hungary

0% Thailand

Malaysia Germany Russia Germany Italy UK France Spain Indonesia Africa South Source: Ovum, IDCWE, Telecom Services Database Source: Informa Telecoms & Media, Credit Suisse research

■ Internet penetration outside large metropolitan areas is lower and also experiences higher growth rates.

MegaFon (MFONq.L) 26 08 January 2013

Figure 46: Russia: Internet penetration in Russia, Spring Figure 47: Russia: Internet user growth yoy, January 2012 2012 80% 68% - 70% Moscow 5% 70%

60% St.Petersburg 15% 50% - 58% 50% Cities with >1 mln population 15% 40% 37% Cities with < 500k population 15% 30%

20% Cities with 0.5 - 1 mln population 28%

10% Villages 28%

0% 0% 10% 20% 30% Moscow and St. Russia Rural area Petersburg

Note: Internet users with mobile & fixed access Source: FOM Note: Internet users with mobile & fixed access Source: FOM Larger scale smartphone adoption is yet to come: Smartphone penetration and adoption rates are also low. Regional distribution in smartphone penetration is likely to be similar to internet penetration in our view; thus the majority of growth is likely to come from the regions. Although counterintuitive, Russian consumers still appear to be the least eager to adopt smartphones, as illustrated by the Credit Suisse GEM consumer survey published on 27 January 2012. This indicates that large-scale smartphone adoption in Russia is yet to come, particularly as prices of smartphones continue to decline globally and mobile data network quality improves.

Figure 48 Do you plan to upgrade to a Smartphone in the Figure 49: Smartphone penetration for selected countries next 12 months? 2011 Sample: those consumers who don’t currently own a smartphone and are planning to get a new one

60 100% 90% 50 80% 70% 40 60% 50% % 30 40% 30% 20 20% 10%

10 0%

US UK

Italy

India

Brazil

Egypt Spain

China

Russia Turkey

France Mexico

0 Thiland

Germany

Indonesia

Philippines

India

Brazil

Egypt Saudi

China Turkey Russia 2011 2015E Indonesia Note: defined as an Apple, RIMM, N- or E-series device, Source: Credit Suisse Telecom equipment team estimates Android or Windows Mobile Source: Credit Suisse Emerging Markets survey, Credit Suisse research Smartphone sales growing and pricing started to improve as well: Smartphone sales in Russia have been increasing and now account for c29% of all handset sales. While regular handset prices remained relatively stable, average smartphone prices have

MegaFon (MFONq.L) 27 08 January 2013 declined c20% since 2010—a trend similar to in other markets—but seem to have started to improve in in 2012. The average smartphone price in Russia now is US$350. We think that improving smartphone prices may be a positive sign, suggesting improving affordability.

Figure 50: Russia: Mobile handset sales Figure 51: Russia: Average handset price comparison In thousands of units In roubles 14,000 14,000 66.0% 70%

12,000 60% 12,000 10,000 50% 10,000 47.6% 8,000 40% 8,000 6,000 28.5% 30%

6,000 4,000 20% 29% 4,000 2,000 10% - 0% 2,000 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2010 2010 2011 2011 2011 2011 2012 2012 2012

- (LHS) Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Smartphone (LHS) 2010 2010 2010 2011 2011 2011 2011 2012 20112 2012 Revenue share of smartphones (RHS) Mobile handsets Smartphones

Source: MTS mobile retail report Source: MTS mobile retail report Network coverage and quality is improving: 3G coverage is effectively 70% of the population. Moreover, mobile operators have started rolling out 4G networks and offering 4G services in big cities and this is also under way across the country.

Figure 52: MegaFon: 3G network and coverage Figure 53: MegaFon: Expected 4G/LTE rollout schedule 4G/LTE population coverage in millions 90 83 83 83 80%

80 70% 40 37.3 72% 72% 70 67% 60% 35 60 50% 30 27.9 50 40% 40 25 27.6 30% 30 24 24.8 20 18.9 16.5 20 24% 20% 15 10 5 10% 10 0 0% 2009 2010 2011 9M 2012 5 # of 3G BS # of regions with 3G connectivity 0 0 3G population coverage Q1 2012 Q2 2012 Q3 2012 Q4 2012

Source: Company data Source: Company data LTE is looking like a potential threat to DSL, at least in theory, in our view

■ LTE could offer up to 60Mbps in each cell sector, shared between the users. Early users are likely to get very high speeds, but (from speaking with CTOs in Europe) LTE speeds/users will still be 10-20Mbps in a loaded network, similar to DSL.

MegaFon (MFONq.L) 28 08 January 2013

■ Furthermore, LTE has very low latency (round trip time), again making the experience similar to DSL.

■ Finally, at 800-900MHz, LTE should have good in-building coverage (in fact better than home-hub WiFi in many cases and much better than 3G@2GHz). In Russia, LTE frequencies operators received are 700-800MHz but also 2.5-2.6GHZ.

Figure 54: LTE can compete with xDSL on speed… Figure 55: …and latency

45 160

40 140 35 120 30 100 25 80

20 Latency(ms) 60 Max(Mbps) averagespeed 15 40 10

5 20

0 0 DSL VDSL FTTc FTTc+ LTE UMTS HSPA HSPA+ LTE DSL

Source: Credit Suisse research Note: VDSL in local exchange, FTTc = Source: Credit Suisse research Note: LTE expected to be around fibre to the cabinet with VDSL, FTTc+ also includes vectoring 10ms; typical actual DSL latency is 10-20ms There are factors that also weigh against strong fixed-mobile substitution in data however:

■ Prior experience. The 3G datacard experience was relatively poor in many markets, which could have a negative influence on some customers.

■ Pricing. Because it is a shared resource, mobile cannot offer or sustain flat rate pricing, whilst fixed line can and does. Monitoring usage is difficult in multi-dweller households. Any user wanting to avoid bill shock will stay fixed, in our view.

■ Demand for higher speeds. Demand for speeds higher than DSL are growing, driven partly by video.

■ Multiple devices. Households have an average 6 connected devices. A household is not going to share a datacard. A MiFi device (a WiFi hub connected to LTE) could work but is a big technology leap for the customer at this stage.

■ Custom. Some of the greatest disparities in fixed mobile substitution seem to be cultural more than technical or price. In Russia, 78% of internet subscribers do not have access to fibre/cable speeds and this is primarily the case in a semi-urban/rural environment. Although the national fixed line incumbent (Rostelecom) is upgrading DSL networks in the regions, we think it may take a long time and possibly in conjunction with LTE deployment by all mobile players. This may suggest that we may see a case for fixed mobile substitution in data in Russia, and LTE could play a role in that.

MegaFon (MFONq.L) 29 08 January 2013

Figure 56: Russia: Breakdown of households in terms of fixed broadband infrastructure / subscription

Primarily urban FTTx/Cable/ Ethernet 12.5 MM subscribers 22.3% HH

xDSL and other 21.6 MM Primarily semi-urban broadband 38.6% HH subscribers

10.7 MM Urban and non-urban DSL enabled households not subscribing to 19.1% HH fixed broadband

Households 11.2 MM Rural outside fixed broadband 20.0% HH footprint

2011

Source: Informa Telecoms and Media Availability of LTE handsets is improving globally: Historically faster network speeds have not really been the driver of the smartphone market. In fact, though 3G networks have been in existence since 2002, we think it was really the introduction of touch-screen technology, and perhaps the iPhone itself, that accelerated 3G adoption. However, we believe that with LTE, the significant leap in network speeds will push use of new applications, which in turn could drive incremental growth in the smartphone market. Apart from the issue of network rollouts, device availability remains the key driver of adoption in the case of a new technology standard. Here we would note that we have already seen significant improvements in terms of number of LTE smartphones available in the market. In fact, based on Credit Suisse’s proprietary smartphone database, we see a total of 27 LTE smartphones already announced or selling globally from a range of handset vendors including Samsung, LG, HTC and Nokia. With expectations for the next version of iPhone having support for LTE, we believe that could prove to be a major catalyst in terms of driving LTE smartphone volumes. In Russia some of these handsets are also available. Data pricing is already low, particularly for MegaFon: Data pricing in Russia could be close to the long-term network cost on our estimates. We are not expecting a material deterioration in data pricing for MegaFon, which declined 90% in 2009-2011 and where we expect only a 20% further decline (c3% per annum). This is based on the fact that MegaFon’s data pricing currently stands at US$ 4.5 per GB (US$ 4.9 for MTS) compared to US$3.7 long-term LTE network cost (Please refer to the Credit Suisse report published on 4 April 2012 by the European Telecom Team called Mobile pricing: Approaching cost in some markets now). It is noteworthy that MegaFon’s pricing was lower in 1H 2012 and evidence in 3Q 2012 suggests that it seems to be stabilising, while MTS is still experiencing price declines in data. This does not mean that there will be no price competition in data or price pressure in this segment in the short-term. We expect aggressive data pricing from all players to continue for a year or two in Russia, with price per GB possibly even falling below the long-term network cost until the network capacity is filled. We also note that long-term network cost continues to decline and thus long-term pricing will also decline alongside it. However, given the pricing and costs today, we do not see a material downside risk to long-term data pricing in Russia. MegaFon looks particularly well positioned to us, with lower pricing than the competition on our calculations.

MegaFon (MFONq.L) 30 08 January 2013

As a caveat, we think MegaFon’s data pricing may have been diluted by free traffic promotions with Yota in some cities since April / May 2012, in which case there will be more upside to revenue generating traffic growth but also more pricing pressure in the short term. Data usage elasticity has been significantly more than one on our calculations, although it has been falling, and fell to c2 in 1H 2012.

Figure 57: Monthly data usage, GB per subscriber: MTS Figure 58: Price per GB: MTS versus MegaFon versus and MegaFon versus Europe long-term network cost In US$

1.5 22 20.9 20 18 16 0.96 0.98 14 12.5 11.1 12 10.2 10 0.61 0.64 8.2 0.52 0.50 0.5 8 6.5 6.4 6 4.7 4.5 4.9 0.28 0.25 0.25 4 3.7 0.10 2 0 FY2010 1H 2011 FY2011 1H 2012 9M 2012 FY2010 1H 2011 FY2011 1H 2012 9M 2012 Europe Europe smartphone dongle MegaFon MTS Long-term network cost MTS MegaFon

Source: Company data, Credit Suisse European wireless survey 2011 Source: Company data for MTS and MegaFon, Credit Suisse estimates for long-term network cost

Figure 59: Cost per GB of increasing network capacity by building a new cell site UMTS HSDPA (7.2) HSPA+ LTE

Spectrum (Mhz) 2 x 10 2 x 10 2 x 10 2 x 10 Spectral efficiency (bits/s/Hz) 0.15 0.70 1.10 1.50

Full buffer capacity of sector - downlink (Mbps) 1.5 7.0 11.0 15.0 Average load (to avoid excessive latency) 86% 86% 86% 86% Utilisation rate (5.54 : 1) 0.18 0.18 0.18 0.18 Average sector/site (not all sites have 3 sectors) 2.40 2.40 2.40 2.40 Effective downlink capacity (Mbps) 0.56 2.61 4.10 5.59 Monthly site throughput - downlink (GB/month) 181 845 1328 1811

Full buffer capacity of sector - uplink (Mbps) 0.53 2.47 3.88 5.29 Average load 0.86 0.86 0.86 0.86 Traffic distribution factor 0.18 0.18 0.18 0.18 Average sector/site 2.40 2.40 2.40 2.40 Effective uplink capacity (Mbps) 0.20 0.92 1.45 1.97 Monthly site throughput - uplink (GB/month) 64 298 469 639

Incremental annual cost (usd) 138,127 149,691 154,881 165,424 Cost/month (usd) 11,511 12,474 12,907 13,785

Cost per Gigabyte used (usd) - 2007 US benchmark 47.0 10.9 7.2 5.6 Cost per GB used (usd) - 2010 Europe 30.5 7.1 4.7 3.7 Source: Credit Suisse research—4 April 2012 by our European Telecom Team report Mobile pricing: Approaching cost in some markets now

MegaFon (MFONq.L) 31 08 January 2013

Factors that look less positive for data growth in Russia Usage per data subscriber, which stood at almost 1 GB for MegaFon and 0.64 GB for MTS in 9M 2012, is not low either, compared to European countries where smartphone data usage is about 0.5 GB and dongle usage is 1.5GB currently. Having said that, we think that MegaFon’s data usage may also have been inflated/pricing deflated by free data promotions with Yota in April/May 2012. c26.5% total mobile VAS (data traffic + content + SMS) contribution to mobile revenues for the market and 33.5% for MegaFon is no longer that low in a sector context and is possibly at a point where growth in VAS may start slowing, as we have seen in other markets. Having said this, we think that the Russian VAS market may be different from some of the benchmarks we are considering due to higher content contribution and probably more developed content market. We therefore think there may be more room for growth in data traffic revenues and but possibly less for content growth. Russian mobile data market structure According to AC&M MegaFon became #1 in mobile data in Russia in early 2010 and is still the largest mobile operator in terms of data traffic revenues, with a 36% revenue share. This is most likely the result of a more material investment in the network, particularly 3G and transmission in 2009-2010. However growth rates in this segment have been declining for the market overall and the company has recently been growing more in line with competition. More aggressive data promotions by MegaFon recently could be one of the reasons, and MTS catching up on network investment could be another. We think there is room for MegaFon to start outperforming the market again:

■ once promotions are over;

■ if its agreement with Yota on 4G turns out to be on an exclusive basis; and

■ because on our calculations, MegaFon’s lowest data prices suggest that we could see some price stabilisation with a likely positive impact on revenues in a near-term.

Figure 60: Russia: Mobile data revenue growth yoy Figure 61: Russia: Mobile data revenue share trends

100% 45%

40% 80% 36.0% 35% 30.9% 34.0% 60% 30% 30.7%

40% 25% 28.4% 25.0%

20% 20% 15% 0% 10.0% 10% -20% 5% 5.0%

-40% 0% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012 200920092009200920102010201020102011201120112011201220122012

MegaFon MTS Vimpelcom Others MegaFon MTS Vimpelcom Others

Source: AC&M Source: AC&M MegaFon’s strategy in mobile data MegaFon’s stated strategy is focused on maintaining its premium network coverage and quality, and its #1 position in mobile data; we believe this strategy is achievable and we expect the company to continue to outperform the Russian market in the mobile data segment.

MegaFon (MFONq.L) 32 08 January 2013

Mobile data offers in Russia Mobile data offers in Russia currently are predominantly limited bundles and in most cases can be bought separately from regular mobile subscription. However, the usage limits are quite generous in our view: the lowest offer in the market currently has a 15- 30MB daily limit in Moscow, which on the monthly basis allows for at least 450MB of traffic in Moscow respectively—more than sufficient for an average smartphone user, on our calculations. In the regions, the lowest usage limit is 5MB per day / 150 per month, but there is only one tariff from MTS that offers that. Otherwise, traffic limits are more than 1GB per month. There are separate offers for smartphones, tablets and USB modems with different usage limits. In the regions, operators typically offer similar speeds and traffic bundles but at slightly lower prices. 3G modems prices from the operators currently start from Rbls 1149 (and models of up to Rbls 1950 are available depending on the speed). MTS and MegaFon have similar and more diversified dongle offers. 4G modems can be bought for Rbls 1990-2000 with MegaFon offering a marginally cheaper price. There is an element of dongle and smartphone subsidy, hidden or so-called reverse, where operators offers free traffic, voice or/and data for a purchase of a modem at cost or above. There are also selective direct subsidies for dongles in Russia currently but they are limited to temporary promotions. We think this marketing initiative is likely to intensify in the next two years. Finally, fixed line internet offers seem to be more competitive to mobile in Moscow than in the regions. We present more detailed tariff offers in the appendix of the report.

Figure 62: Data offers in Moscow, mobile and fixed Figure 63: Data offers in Novosibirsk, mobile and fixed Monthly limit, Speed limit, Price, Rbls per Monthly limit, Speed limit, Price, Rbls per MegaFon GB Mbps month Price per GB MegaFon GB Mbps month Price per GB 3G Smartphone 1.5 - 190 166.7 3G Smartphone 1 0.5 149 149.0 USB Modem 3 3 390 130.0 USB Modem Unlim 7.2 570 Fiber Unlim 20 400 MTS MTS 3G Smartphone 1.5 - 129 86.0 3G Smartphone 1.5 - 149 99.3 USB Modem 3 - 290 96.7 USB Modem 4 - 500 125.0 Fiber Unlim 5 390 DSL Unlim 3 300 Vimpelcom Fiber Unlim 20 450 3G Smartphone 2 - 210 105.0 Vimpelcom USB Modem 2 7.2 245 122.5 3G Smartphone 2 - 390 195.0 Fiber Unlim 5 430 USB Modem 3 - 495 165.0 Fiber Unlim 15 450 Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research The Russian mobile content market The mobile content market in Russia, in some respects, may be more developed than in some of the other countries we use in our analysis as benchmarks. We believe this partially explains the relatively high VAS contribution to revenues relative to internet and smartphone penetration levels in Russia compared with other markets. It could also indicate more limited upside potential for content revenues. In this context, we believe the vision and execution of the management teams of mobile operators will be key to success in the mobile content market.

MegaFon (MFONq.L) 33 08 January 2013

Figure 64: Russia: Content + other VAS market rouble Figure 65: Russia: Content + other VAS market shares revenue growth yoy % 100% 45%

40% 80% 35.8% 35% 33.5% 60% 30.9% 31.8% 30% 29.3% 40% 25% 24.8% 20% 20% 15% 0% 8.5% 10% -20% 5% 5.3%

-40% 0% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012 200920092009200920102010201020102011201120112011201220122012

MegaFon MTS Vimpelcom Others MegaFon MTS Vimpelcom Others

Source: AC&M Source: Company data, Credit Suisse research In the past 2–3 quarters, content has accounted for about 27-28% of the mobile VAS market and is the second largest subsegment after data traffic in terms of both revenue and growth. AC&M—the telecom consulting company that provides statistics for the Russian mobile market including VAS—includes the following products in content revenues:

■ Content Provider Access (CPA) – c60% of the content market

■ Ringback tones (RBT) – c20% of the content market

■ Mobile TV – c 20% of the content market

■ Other aggregation services such as WAP portals (via subscription fee and content), STK, USSD, iVR, ICBC, LBS – immaterial

■ SMS Gates and WAP/GPRS traffic sharing – immaterial For our analysis we also take into account other mobile VAS services—accounting for only 5% of the total mobile VAS market but a relatively fast-growing segment—which under the AC&M definition include m-commerce (mobile payments), basic VAS (Voice Mail, Caller ID/Anti-Caller ID and Conference Connection), CSD, VoIP (subscription fee), PTT (subscription fee), FMC (subscription fee) and Live Balance. Overall, we see potential for growth in mobile finance and mobile TV businesses in Russia but as an optionality rather than a base case scenario for mobile operators’ businesses.

Content Provider Access (CPA) CPA enables the content provider to distribute its mobile content to the subscriber base of the mobile operator. Content may include ringtones, logos, wallpaper, screensavers, games, quizzes, contests and could be distributed via premium SMS and MMS, bulk SMS and/or WAP. Mobile operators earn revenues via revenue sharing with the content provider. In Russia this is the largest segment (about 60%) of the mobile content market and is well developed because of the large number of small third-party content providers in the country historically. We see limited growth opportunity in this segment.

MegaFon (MFONq.L) 34 08 January 2013

Ringback tones (RBT) Ringback tones, approximately 20% of the content market, are popular in Russia and in Asia and Africa. This service has stabilised recently in Russia and elsewhere and we believe there is little growth potential. Mobile TV Mobile TV represents approximately 20% of the content market. In this segment mobile operators can generate revenues via subscription to TV channel packages that can be shown on mobile devices and through mobile advertising. Mobile TV has recorded strong growth rates in the past and many operators globally now offer this service. However, a number of operators have not been successful in growing this business into something more material (eg, Hutchison and BT). Expert opinion on the outlook for Mobile TV globally and Russia in particular also varies. We are sceptical in this respect and do not expect material growth rates in Mobile TV in our base case scenario. We also believe investors are unlikely to pay for this option now, although we highlight some of the opportunities that are available in this subsegment. First, TV broadcasters are interested in supporting Mobile TV. However, broadcasters have had to grapple with a lack of devices that are capable of receiving a DVB-H signal. For example, the DVB-H standard for mobile broadcasting failed to take off in Europe because Mobile TV providers were unwilling to subsidise the devices, which in turn led to a dearth of devices in the market. Mobile operators, however, have faster networks, a wide range of devices now that were not available before with larger screens and better resolution, all of which are currently available in most markets and in Russia. Capacity may remain an issue even with LTE, as additional technologies may be required to avoid a potential bandwidth crunch. Mobile operators can still benefit from both trends—development of mobile DTV-capable devices or new technologies for mobile operators. However, we believe this is an optionality at this stage rather than a base case for mobile operators. Having said this, there is some evidence that such a business model does exist and that it can be successful. Below is an extract on China Mobile from the report by Credit Suisse analyst Colin McCallum China Telecom Sector: Quantifying the new data wave dated 26 July 2010: “China Mobile in March 2010 launched a mobile TV service, called China Multimedia Mobile Broadcasting (CMMB). The service was standardized and developed by State Administration of Radio, Film, and Television (SARFT) subsidiary the China Broadcasting Corporation (CBC) in conjunction with China Mobile. The content, TV programming, is actually delivered to special handsets (of which there are currently 25 models from 14 different manufacturers) via DVB-SH satellite and CBC terrestrial towers. Customers pay Rmb6/month to enjoy six different channels for a month, and all of the content is provided by SARFT (in Shanghai, for example, the package includes three CCTV channels, two Shanghai channels and one Jingcai movie channel). For the CMMB Mobile TV service, China Mobile is therefore simply providing the customer base and, perhaps more importantly, a means of billing and revenue collection; the Rmb6 is deducted from the subscribers prepaid card balance. For these services, China Mobile retains 30% of the revenue collected (Rmb1.8/month). More interestingly, should the number of subscribers cross the 50 mn mark; the CBC has agreed that China Mobile’s revenue share should increase to 40% of the revenue collected. Thus, scale can actually attract an even greater slice of the content revenue pie. We note that the service is proving much more popular than had initially been expected, in particular due to demand from migrant workers, and that CMMB has already breached the 1 mn customer threshold.” Mobile payments Growth in mobile payments is characterised by low credit card penetration—8% in Russia versus 90% in the UK and other developed European countries, and 15-20% in Eastern Europe (according to www.paymentcardyearbooks.com) and ongoing substitution of cash by electronic payments by card and phone. This is further enabled by Near Field Communication (NFC).

MegaFon (MFONq.L) 35 08 January 2013

Figure 66: Mobile money as a % of total service revenue

16%

14%

12%

10%

8%

6%

4%

2%

0% Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211 Q311

Safaricom Vodacom Telenor Pakistan MTN Milicom

Source: Company data, Credit Suisse research Mobile being used as a means of payment was one of those year-2000 ideas that was discarded. However, mobile money has been gaining momentum and demand for mobile payments in Africa, for example, is also cutting churn significantly, with the customer’s mobile number becoming their bank account number. There are three business models emerging currently:

■ Transfer payments. This is well established in Africa (16% of Safaricom revenues in Kenya in 2011) and growing in other GEM markets but seems to have limited potential in developed markets for now.

■ Carrier billing. According to our channel checks, application developers are finding 5- 10x more demand if app downloads are charged to a mobile bill (with one or two clicks) rather than credit card. Mobile operators are commanding up to 20–30% of the app payment for this carrier billing service (c5% in Russia) and the segment is booming.

■ NFC. Low power radio chips allow a customer to swipe a retailer’s check-out with their phone as a means of payment—with the payment charged e.g. to bill. This is real world carrier billing. There is also potential to grow into broader banking services. Operators can borrow at similar or cheaper rates than many banks currently, have stronger brands in most cases, similar retail presence and have established credit skills (learned through the handset subsidy and post paid business). It is just one more step to become a bank. DoCoMo recently bought a bank in Germany and Telenor one in Pakistan. Most recently, on 25 October 2012, MTS announced its acquisition of a 25.094% stake in MTS bank, where they have planned to share the proceeds from their payment platforms in a ratio of 70% to 30%. This partnership would also help MTS to provide credit from the bank to the subscriber for the smartphone purchases being made by its customers, helping to enhance costumer experience and brand leveraging. Turkcell also announced on 5 October 2012 the launch of its mobile wallet solution, Turkcell Wallet, which can be used on all mobile phones by Turkcell customers and aims to provide simple financial services in Turkey. It would offer a feature that enables physical or online shopping by just using the mobile phone number, instead of the credit card; Turkcell Wallet is a SIM based application. The transactions can be initiated through the SIM menu on all phones, or with a native application on smartphones, and it supports contactless payment on NFC-enabled phones.

MegaFon (MFONq.L) 36 08 January 2013

For mobile operators, this is an opportunity with upside potential which we do not think is in consensus expectations for listed stocks. It is not in our base case scenario for MegaFon, either in terms of ARPU growth or churn reduction. The contribution could start at a low level but is an important trend which is likely to gain focus among investors over time. However, this is also a segment in which mobile operators will be competing with banks, credit card companies, payment companies and internet portals, and thus execution once again would be critical for success. It is also likely that an operator pursuing mobile payments may have to buy a bank or another financial institution.

Mobile advertising The mobile advertising market also seems to be an attractive segment as mobile allows advertisers to target specific user groups and address a large audience size equivalent to or larger than TV and social networks. This is also a segment in which third parties have been successful. This is already happening to some extent either through location-based advertising (LBA— a new form of advertising that integrates mobile advertising with Location Based Services (LBS) by pinpointing consumer location and providing location-specific advertisements on mobile devices), SMS/MMS or Mobile TV advertising. We believe this segment also has potential, although it is more of an optionality currently than a material factor.

Cloud & IT An effectively non-existent revenue stream in the Russian market at this stage, Cloud & IT demand is also likely to increase as both would be driven by business applications and private demand. However, telcos are competing with various companies (in hardware, software and consumer internet) for share and we believe it is unlikely to become a material segment for the telcos business. However, we note that there is no single large local provider of cloud services in Russia currently, which could be construed as an opportunity.

Machine to Machine Machine to Machine will be used for vertical industrial use development and horizontal product development for both the B2B and B2C categories. Industry verticals could include power and transportation, and horizontal products might include metering solutions, such as Smart metering. B2C products would include security cameras and pet trackers. Increasing SIM card penetration of electronic devices and the option to offer integrated products beyond “connectivity only” are the drivers of this business.

Prospective emerging services Examples of products here include mobile health applications, electronic learning and security, and are developed in cooperation with application developers and experts in the specific field. This is not yet developed in Russia and at best would be a very marginal opportunity for a telecom operator, in our view.

MegaFon (MFONq.L) 37 08 January 2013

Current mobile VAS offers in the Russian mobile market Figure 67: Russia: Current mobile VAS offers MegaFon MTS Beeline Anti number-detector 5 Rbls/day + 10 Rbls installation 3.95 Rbls/day + 17 or 34 Rbls 3.77 Rbls installation (depends on tariff) Voice mail 2 Rbls 2.3 Rbls 1.15 Rbls Promised payment free 5 Rbls/day free Mobile payments + + + Mobile money transfer 5 Rbls/transfer 7 Rbls/transfer 4.95% Melody instead of hoot 1.70 Rbls/day 85 - 98 Rbls/month 30 - 70 Rbls/month Melody package instead of 1 -5 Rbls/day 75 - 120 Rbls/month hoot TV and video portal 4 - 10 Rbls/day 8 Rbls/day 8 - 12 Rbls/day Friend`s occurrence 3 Rbls/day 10 Rbls/request 1.7 Rbls/day determination ATM, Café, Cinemas etc 9 Rbls/request 10 Rbls/request 3 Rbls/day dislocation Acquaintances 3 Rbls/day + 2 Rbls/SMS 5 Rbls/day Autopayment 0.5 Rbls/day Source: Company data, Credit Suisse research MegaFon’s strategy and positioning in the mobile content market MegaFon’s position in the Russian content market MegaFon’s market share in the content market has been relatively stable—between #2 and #3 for the past several years—competing mainly with Vimpelcom as MTS has remained the number one. MegaFon (as of 3Q 2012) is the number 3 in content with about 30% revenue share of the Russian content market. MegaLabs MegaFon’s strategy emphasises the development of the content business and new services. To implement this strategy and in response to competition, the company has formed a separate entity, MegaLabs—an independent unit 100% owned by MegaFon whose objective is to focus solely on innovation with a more aggressive risk approach, without jeopardising the core business. MegaLabs was formed at the beginning of 2012, has about 250 employees currently (planned to be increased to 300 by the year end), has its own P&L and is fully supported by the functional units with relevant expertise such as marketing, technology and R&D, global partnerships and finance/back office. In addition to the launch of new innovative products and solution for B2B and B2C customers, the envisaged impact on the core business is 1. increase of data usage; 2. churn prevention; and 3. diversification away from a predominantly infrastructure business. VAS Media On 11 September 2012, MegaFon announced that it had completed a 100% acquisition of Felebior Holdings Ltd, which owns VAS Media, a company delivering multimedia content, ringtones, geolocation, mobile payment and other value-added services. The asset will be integrated under MegaFon`s subsidiary MegaLabs. The acquisition price was US$ 290.2 million, of which US$ 16.6 million was applied towards settlement of trade payables owned to VAS Media in respect of services provided prior to acquisition. VAS Media’s consolidated EBITDA for 1H 2012 was Rbl933m which is about 2% of MegaFon’s 1H EBITDA. The acquisition fits well with MegaFon’s strategy, in our view, and should help MegaFon to extend control over the value chain, provide enhanced capabilities to launch new products and clear content rights and aggregate content and reduce VAS costs.

MegaFon (MFONq.L) 38 08 January 2013

MegaFon’s view on the content market The company believes that there is strong demand for various content services and that the contribution of VAS (excl data traffic and SMS) to mobile revenues should increase from the current c 9% in Q3 2012. MegaFon’s revenues from mobile VAS excluding SMS contributed Rbl18.4bn to mobile revenues in 2011 with an accelerated 27% growth rate in 9M 2012. The entire addressable market on third-party estimates is almost 6x higher and is expected to more than double over the next three years. Having said that, this is the market in which MegaFon is competing and will have to compete with other players such as banks, independent payment businesses, internet companies, broadcasters and technology companies; thus success would require seamless execution in our view. Our base case scenario assumes that this market segment may present some growth opportunities but these are limited to overall data usage growth.

Figure 68: VAS (ex SMS)/ New products potential in Russia Roubles in billion

267

2.5x

95

108 62 42

18 49 46

12 5 22 MegaFon VAS 2011 VAS/New products 2011 VAS/New products 2015

VAS Machine to Machine Cloud & IT Content & Media Online advertising Mobile Payments

Source: Mobile Payments – 2015E mobile payments transaction value of US$13.7bn based on Arthur D. Little "M-Payments in M-BRIC” report (2010), market size for MegaFon based on assumed margin of 10%; Online Advertising (across all mediums) – Zenith Optimedia (forecast 2014E); Content and Media – AC&M; Cloud – Kominfo; M2M – Company estimates

Content & media Key products in this segment include customised media—ringtones and ring back tones, Mobile TV—subscription, video streaming, video on demand, navigation and geolocation, web services and social media. MegaFon is currently offering most of these products, and we believe there is demand for them. However, as we mentioned above, we believe the Russian ringtones market is saturated and that the Mobile TV outlook is not entirely straightforward. However, we think that cooperation with a social networks (including via MegaFon’s related company Mail.Ru) could create more opportunities to monetise a growing mobile social network audience.

Mobile finance The products in this segment include mobile payments, mobile transfers including peer-to- peer and mobile banking including micro loans. In Russia currently the commission mobile operators get for mobile commerce services in general is about 5%. MegaFon already offers an online card—MegaFon Visa—and other money transfer services.

MegaFon (MFONq.L) 39 08 January 2013

Although we see some potential upside, we do not include it in our base case scenario for MegaFon, either in terms of ARPU growth or in terms of churn reduction. The contribution is currently very small—although we do not have the precise number for the Russian market, we think it is no more than 1–2% of revenues.

Mobile advertising MegaFon already has a navigation product and is offering LBS advertising. We see upside potential for this segment, albeit more as an optionality at this stage. Potential product examples

Connected homes MegaFon has developed and we believe is planning to launch an integrated product linking customer internet connectivity with camera, security, utilities (water, electricity), metering, etc.

Three screen TV We believe MegaFon is also planning to offer a convergence product integrating existing mobile online video portal used on smartphones and tablets with TVs equipped with set top boxes as well as PCs/notebooks. Russian mobile voice revenues and outlook Mobile voice revenue growth rates have been improving recently from low single digits / negative in some cases to mid-single digits. Tele2 has appeared as the winner in the mobile voice market in the past several years, having gained 3.9% voice revenue since the beginning of 2009. Of the BIG3 operators, MegaFon was the only company not to have lost voice revenue share: in fact, we calculate that it gained 0.3%, with Vimpelcom being the weakest performer, having lost 3.5% voice revenue share and MTS having lost only 1pp since 1Q 2009.

Figure 69: Russia: Mobile voice rouble revenue growth Figure 70: Russia: Voice revenue market share yoy %

40% 35% 31.0% 35% 29.7% 30% 30.7% 30% 27.6% 25% 27.5% 25% 27.3% 20% 20% 15% 15%

10% 10% 5% 5.7% 6.3% 5% 0% 5.2% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 0% -5% 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q -10% 200920092009200920102010201020102011201120112011201220122012

MegaFon MTS Vimpelcom MegaFon MTS Vimpelcom

Tele2 Rostelecom Tele2 Rostelecom

Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Voice pricing in Russia has been improving in the past two quarters as MegaFon and MTS have become more rational on pricing competition. Vimpelcom continues to “normalise” its pricing and reduce the historical price premium, but this is not affecting the market and competition in our view. We believe Vimpelcom is merely following the market by matching tariff plans offered by competitors currently. Tele2 has also been rational in Russia lately.

MegaFon (MFONq.L) 40 08 January 2013

We assume we are unlikely to see material structural changes on tariffs (such as a move into unlimited voice, SMS, data bundles) and / or the market structure (consolidation or an aggressive mobile rollout by Rostelecom) in the near future. Under this scenario we expect effective voice pricing to fall at low single digits. Voice elasticity in Russia has been very volatile in our view because of the material changes in GDP growth expectations in the past and changing competitive dynamics. On our calculations, in 2011 and Q3 2012 mobile voice elasticity was between 0.8 and 1.3 (it varied among operators depending on how aggressively they were adding subscribers in our view with MegaFon having lower and MTS higher elasticity). In Europe price elasticity of voice usage has effectively been zero, albeit still positive. As macro growth in Russia is unlikely to accelerate materially, we believe voice elasticity is unlikely to change materially either. Relatively strong real GDP growth of 3–4% should remain the key driver of positive low single-digit usage growth, in our view. A number of European operators also note cannibalisation of voice by data usage growth. It is difficult to say whether this is also happening in Russia currently as MOUs continue to grow at low single digits. We would not exclude a risk of voice cannibalisation in the future, although we do not include this in our current base case forecasts.

Figure 71: Russia: Voice ARPM growth yoy in roubles Figure 72: Mobile ARPM versus MOU for selected markets, 3Q 2012

10% 0.16

0.14 5% Czech 0.12 0% Hungary 0.10 -5% Poland Malaysia 0.08

-10% (US$) ARPM 0.06 Brazil

Turkey -15% 0.04 Russia 0.02 China -20% India 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 0.00 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012 0 100 200 300 400 500

MegaFon MTS Vimpelcom Tele2 MOU (min)

Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research

MegaFon (MFONq.L) 41 08 January 2013

Figure 73: Voice price elasticities, 3Q 2012 (Calculated in local currencies)

1.8

1.6

1.4

1.2

1

0.8

0.6

0.4

0.2

0 Brazil Czech Poland Hungary UK Russia Turkey Malaysia India

Source: Company data, Credit Suisse research Mobile termination rates (MTRs) in Russia are already low in a global sector context, although once Europe reaches targeted 1 Euro cent MTR, Russia’s will look at a premium. There has been no discussion, to the best of our knowledge, on any potential MTR changes in Russia. Thus we do not see this as a potential risk to pricing in the foreseeable future. Effective pricing in Russia is already below MTR levels, so even if MTRs are reduced in the future, potential impact on retail pricing is likely to be more limited than it has been in some other markets in our view. Figure 74: Mobile termination rates: Russia vs selected Figure 75: Voice ARPM vs MTR in Russia, 3Q 2012 countries, 3Q 2012 In roubles In US$ cents 1.0

15.0 0.9

0.8 12.5 0.7

10.0 0.6

0.5 7.5 0.4

5.0 0.3

0.2 2.5 0.1

0.0 0.0

MTS MegaFon Tele2 Vimpelcom MTR India

Brazil

Egypt

Czech

Russia Turkey

Poland

Nigeria

Ukraine

Hungary

Morocco Kazakhstan South Africa South Source: Credit Suisse research Source: Company data, Credit Suisse research The Russian SMS market The SMS market globally has seen some stagnation. In Europe SMS revenues have been declining at low single digits for a while now and many operators have been citing SMS cannibalisation by data usage and smartphones. In Russia in 2011 SMS revenues also

MegaFon (MFONq.L) 42 08 January 2013 started seeing negative trends but recovered at the end of the year—we think because of the introduction of bundles in our view. We are pessimistic about the SMS growth outlook in Russia. With smartphone and data growth we think cannibalisation could be a risk. We believe operators in Russia, like their European counterparts, will start to introduce bundles, which could lead to price pressure but not SMS volume growth.

Figure 76: Russia: Messaging rouble revenue growth yoy Figure 77: Russia: Messaging revenue market shares % 40% 40%

30% 35% 36.0% 28.7% 20% 30% 27.4% 27.0% 10% 25% 26.6% 24.0% 0% 20%

-10% 15% 17.3% 13.0% -20% 10%

-30% 5%

-40% 0% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012 200920092009200920102010201020102011201120112011201220122012

MegaFon MTS Vimpelcom Others MegaFon MTS Vimpelcom Others

Source: AC&M Source: AC&M Current tariff offers in Russia Most of the tariffs in Russia are still structured on a per minutes/per SMS basis while data pricing structure includes both bundled data packages and per MB usage. Most operators offer tariffs with free on-net calls. Also the BIG3, but not Tele2, started offering bundled tariffs for voice, SMS and data. In Moscow, for example, for Rbls 1000 (cUS$32) per month one can buy 900 voice minutes, thousands of SMS and between 1GB and 2GB of data. On these bundles, MegaFon offers unlimited free on-net calls (both in Moscow and the regions). MegaFon however offers the lowest data package in Moscow (30 MB per day equivalent to 0.9GB per month) while Vimpelcom the highest (2GB per month, although Vimpelcom’s speed experience is the poorest among the BIG3 based according to AMC survey (see Figure 88–Figure 90). In the regions, bundles are cheaper but with fewer minutes included. MTS offers free data traffic in some regions (although speed is not clear and not guaranteed) and Vimpelcom has the lowest data package offering on these bundles. We think that tendency to move towards voice and SMS bundles, possibly unlimited on and off-net, is likely to become a trend in Russia in the next couple of years. With data, it is not yet clear and we think the likely scenario is similar to US and Europe where operators will be offering limited data packages. We provide detailed tariff tables in the Appendix.

MegaFon (MFONq.L) 43 08 January 2013

The Russian regulatory environment

Figure 78: Ministry of Communications and Mass Media organisational chart

Mnistry of Communications and Mass Media Minister - Nikolai Nikiforov

Federal Supervisory Service for Communications, Federal Press and Mass Federal Communications Information Technologies Media Agency ("Rospechat'") Agency ("Rossvyaz") and Mass Media ("Roscomnadzor")

Source: minsvyaz.ru The telecommunication sector is regulated by the Ministry of Communications and Mass Media. The Ministry, led by Nikolai Nikiforov, who was appointed as the minister in May 2012, is responsible for setting a policy, adopting regulations and conducting supervision in the communications space. The Ministry controls and coordinates the activity of its dependent bodies, “Roscomnadzor” and “Rossvyaz”. Roscomnadzor acts as the licensing body for activities in the area of , issuing permissions for radio frequency use and other responsibilities. Rossvyaz is responsible for the allocation of numbering resources and certification. The key regulation topics that could be relevant to the Russian mobile operators include spectrum allocation, MTR regulation, roaming regulation, mobile number portability, MVNO regulation, local loop unbundling and net neutrality. Spectrum allocation 2G, 3G and 4G spectrum auctions have already been held and frequencies accompanying licences have been granted. The licences have specific expiration dates in Russia currently and can be extended or renewed upon expiration. The lump sum cost of licences has been nominal—latest LTE licences were granted with no cost but had an investment commitment requirement, 3G licences in 2007 were awarded for a price of Rbls 1m (cUS$30,000). Operators also make ongoing frequency payments which were immaterial but have been gradually increasing over time (40-45% increase in 2012). The government has also been considering the introduction of payment for the spectrum allocated to incentivise the use of spectrum. The licences also have specific terms setting out dates for network rollout and coverage, the number of base stations and the required investment capex. The government has the right to confiscate the licences if the licence requirements for commercial launch has not been met. 2G and 3G coverage licence terms have already been met. In July 2012, four 4G/LTE licences were won by MTS, Vimpelcom, MegaFon and Rostelecom. These 4G/LTE have the following terms:

■ Each operator gets 4x7.5 MHz lots in the 720-865 MHz band and 2x10 MHz lots in the 2.5-2.7 GHz band;

MegaFon (MFONq.L) 44 08 January 2013

■ The deadline for network launch is 1 June 2013 and the requirement is to finish the required network rollout by 2019;

■ Each operator is to invest cUS$ 500m per year in capex for LTE network plus there will be convergence costs in the amount of approximately US$3bn (Rbl100bn) in total for all operators. This implies total capex for LTE of cUS$4.5bn per operator over seven years or cUS$650m per annum. There was much debate regarding the conversion costs in the press (Vedomosti) that suggested the following: 1. Conversion deadlines may be reduced from 7-10 years to 2-3 years, 2. Estimates for conversion costs could range between US$2bn and US$6bn and if the military was not using the spectrum it could be zero. There has been no clarity or further discussions since. Vedomosti and Kommersant also reported that former Deputy Minister Naum Marder proposed that regional 4G licence tenders in 10 regions in the 2570-2620 MHz band would be conducted no later than nine months after July 2012, when the federal licence tenders were held. Former Telecom Minister, Igor Shchegolev, reportedly agreed with that and the frequency committee was reportedly studying the availability of spectrum. However this was effectively done under the previous Ministry and we have not seen any news flow on the regional 4G licence tenders since then. However, there has been a recent discussion, according to the press, on the licence tenders in the 1800 MHz band with tech neutrality which would be of interest to Tele2. We discuss this in the next section on tech neutrality. Technology neutrality Tele2 is the biggest supporter and beneficiary of the introduction of tech neutrality in Russia. There is conflicting information currently on whether and when technology neutrality could be introduced. There have been tests conducted in conjunction with Tele2 to test 3G/LTE in the 1800 MHz band. According to Tele2, the results of these tests were positive and the research institute which conducted the tests has given a positive recommendation to the government. Moreover, Vedomosti reported that the Ministry had formulated draft proposals for telecom law amendments to be considered in 2013 which included, among other things, consideration for tech neutrality with the positive recommendation from the working groups. However, Vedomosti reported on 27 September that the initiative of the Telecom Ministry to introduce tech neutrality and minimum channel limitations for various technologies was not supported by other ministries that are part of the frequency committee due to insufficient analysis. The decision was delayed until further analysis is undertaken. Also allocation of some regional spectrum in 1800 MHz band on tech neutrality principle was cancelled and these will be allocated as GSM spectrum. We remain sceptical that technology neutrality will be introduced in Russia in the near term in general and on Tele2 receiving tech neutrality in 1800 MHz. Mobile number portability (MNP) MNP, successful for years in Europe, has not yet been enforced in Russia, although it has been discussed. As far back as 2005, the Telecom Ministry had laid out the rules for retaining mobile phone numbers. In May 2012, it published a draft law according to which MNP should be implemented from 1 January 2014. The main issues surrounding MNP have been the technical aspects of number switching as numbering capacity is allocated and paid by operators/subscribers on a pre-fix basis; the other key question has been whether the subscriber would have to pay to retain their phone number. We are not concerned with the potential competitive impact of the MNP introduction. There has been limited impact on market shares in other mobile markets from this regulatory initiative. We believe the introduction of MNP would likely adversely affect the weakest players (we consider Vimpelcom and Tele2 to be the weakest players currently) if they continue to lack comprehensive data product, while MegaFon and MTS should be net beneficiaries.

MegaFon (MFONq.L) 45 08 January 2013

Mobile Virtual Network Operator (MVNO) The MVNO market is underdeveloped. According to AC&M, MVNO served less than 1m users in Russia at the end of 2011 mostly in Moscow, or less than 1% of the main operators’ customer base. Yota’s partnership with MegaFon and possible MVNO agreements with some other operators can enhance the MVNO subscriber base. MVNO agreements are regulated by the Ministry. Mobile termination rates (MTRs) Mobile termination rates are not currently regulated in Russia and are set by operators on a commercial basis. The current rates are Rbl 0.95-1.1, or 3.0–3.5 US$ cents, at the lower end of the sector average, but would be above the European average were it to reach the 1 euro cent target. Roaming regulation Roaming is currently not regulated by law. However members of the GSM Association follow the Association’s rules. There has been an increased focus on roaming regulation by the government in Russia since 2010 when operators were effectively forced to reduce international roaming prices. In 2011, MegaFon cut its basic tariff for roaming by 80% in 44 countries and other operators followed suit. More recently, the government has commented on the high international roaming charges and has also started to focus on domestic roaming, and there was a discussion on potentially abolishing it. ITU, The United Nations agency for ICT, is also backing international roaming regulation. The ITU stated that governments and regulators should take a variety of actions that would result in the protection of mobile consumers from expensive mobile charges. With the exception of the European Union, binding regulation on roaming charges is absent within and between regions in the rest of the world. It is too early to gauge potential impact of any roaming regulation or price changes until details are announced, if at all. However, in 2011 in Russia this led to positive usage growth with elasticity possibly more than 1. Local loop unbundling The framework for the unbundling of the local loop has not yet been established in the Russian market. Net neutrality Net neutrality has not been implemented in Russia. However, there is potential upside for operators if large consumer internet companies were prevented from using infrastructure for free. However, this is a difficult topic to discuss in both the Russian and global context given its political overtones stemming from the presence of global internet players in the market.

MegaFon (MFONq.L) 46 08 January 2013

Spectrum allocation in Russia We think MegaFon and MTS have marginally better spectrum portfolios than Vimpelcom (due to UMTS 900 use and additional spectrum in Moscow) and Rostelecom (due to a more limited 2G footprint).

Figure 79: Spectrum landscape in Russia Spectrum band (MHz)/standard 453-475.5/ 720-865 880-915/ 1710-1785/ 1900- 1920-1980/ 2300-2400 2500-2570/ 2570-2620 463-467.5 925-960 1805-1880 1920 2110-2170 2620-2690 2010-2025 CDMA-450 LTE GSM-900 GSM-1800 BWA UMTS 2100 LTE LTE LTE UMTS-900 MegaFon - 4x7.5 MHz 2x5 MHZ to 2x14.6 MHz to + 2x15 MHz + 2x10 MHz 25 MHz 83/83* 2x15.2 MHz 2x29.8 MHz and 1x5 MHz 83/83* 1/83* 83/83* 83/83* 83/83* MTS - 4x7.5 MHz 2x4.8 MHz 2x14.2 MHz to + 2x15 MHz + 2x10 MHz 25 MHz 83/83* to 2x14 MHz 2x29.4 MHz and 1x5 MHz 83/83* 1/83* 83/83* 83/83* 83/83* Vimpelcom - 4x7.5 MHz 2x0.8 MHz 2x12 MHz to + 2x15 MHz + 2x10 MHz + 83/83* to 2x13.6 2x20.8 MHz and 1x5 MHz 83/83* MHz 68/83* 81/83* 83/83* SkyLink (Rostelecom) 2x4.5 MHz 4x7.5 MHz 2x6.6 MHz 2x5.2 MHz to + 2x15 MHz + 2x10 MHz + 67/83* 83/83* 1/83* 2x15 MHz and 1x5 MHz 83/83* 41/83* 69/83* Rostelecom - + 2x1 MHz to 2x14.8 MHz to + 2x15 MHz 30 MHz to + + 2x8.4 MHz 2x15 MHz and 1x5 MHz 70 MHz 28/83* 33/83* 3/83* 39/83* Tele 2 GSM 900 and 1800 8-25 MHz in 43 regions (depending on the region)* Yota - + + + + + - 2x30 MHz + 83/83* Osnova Telecom - + + + + + 30MHz to + + 100 MHz 83/83* Antares, Arthur, Integral - + + + 20 MHz + + + + 83/83* Source: Company data. * number of regions under coverage/total number of regions; + spectrum potentially available for LTE. Licences for 450 MHz spectrum are owned by SkyLink which is in the process of being operationally integrated with Rostelecom. Licences for the 720-862 MHz spectrum were awarded to MegaFon, MTS, Vimpelcom, and Rostelecom in July 2012. These frequencies are used by the military and need to be refarmed. The 2G spectrum (GSM-900 and GSM-1800 standards) has been allocated to the BIG3 operators, Tele2, Rostelecom mobile subsidiaries, Skylink and the remaining smaller regional operators. MegaFon and MTS use UMTS - 900 in two regions. The only owner of licences for the 1900–1920 spectrum is the Antares group of companies controlled by private entrepreneurs. The future use of this spectrum is not clear. The 3G spectrum in the UMTS 2100 standard was awarded to the Big-3 in 2007 and allocated to Skylink and Rostelecom in 2010. Licences for the 2300-2400 spectrum for 39 regions were awarded to Rostelecom and RTOs in March 2010. In September 2011 they were also allocated to Osnova Telecom. There is no development on this band yet due to a lack of military approval. Licences for 2500-2570/2620-2690 spectrum were allocated to Yota nationwide (2x30MHz channels) and awarded to MegaFon, MTS, Vimpelcom and Rostelecom in July 2012 (2x10 MHz) as part of the LTE licence tender. Licences for the 2570–2620 spectrum have been allocated to MegaFon and MTS (25 MHz) in the Moscow region.

MegaFon (MFONq.L) 47 08 January 2013

4G spectrum and status Yota (the brand under which Skartel operates), which has been historically focused on offering mobile broadband services using WiMAX, commenced its LTE rollout early this year. The service is already available in Moscow, Novosibirsk, Krasnodar, , Sochi, , Ufa, Kazan and St. Petersburg. More than 40 cities are expected to be covered by the end of 2012.

Yota has a bilateral MVNO agreement with MegaFon through which MegaFon can run its LTE services anywhere Yota does and Yota can use MegaFon’s 2G and 3G networks. Similar MVNO agreements are available all operators but so far only MegaFon and MTS (pilot in Kazan) have launched 4G MVNO service with Yota.

Besides MegaFon and MTS, Vimpelcom and Rostelecom were granted LTE licences in the 4x7.5 MHz nationwide spectrum in the 720-860 MHz band and the 2x10 MHz nationwide spectrum in the 2530-2650 MHz range in July 2012. According to the licence requirements, the LTE service on this spectrum has to commence by July 2013. MegaFon and MTS were also awarded an LTE TDD licence in the 2.6/2.7 GHz band in Moscow in early 2012 for which service has to commence by end-2013. MTS launched it in September 2012, while MegaFon has not yet used its spectrum.

In addition to the 4x7.5 MHz nationwide spectrum, Rostelecom received a 30 MHz spectrum in the 2.3/2.4 band in early 2010 that would cover a third of the population (39 regions) but the launch has been delayed due to frequency issues. Moreover, Rostelecom had a preliminary MVNO agreement with Skartel which did not become effective in the summer as was expected, and the issues are currently being considered in court.

There is one more potential player in the LTE market—Tele 2—which plans to trial its LTE network in the 1800 MHz band. However, the government has not yet allowed tech neutrality, although it could still be considered in 2013. MegaFon’s network quality Through heavy capital investment in the past and a recent MVNO agreement with Yota on 4G services, we think MegaFon has been able to gain a competitive advantage in infrastructure. We believe this is one of the key positives of MegaFon’s operating business. However, competition (predominantly MTS at this stage) has also increased capital investments, which could pose a risk to MegaFon’s continued outperformance.

Network overview MegaFon has developed its mobile communications business through organic growth, which resulted in a highly scalable network capable of adapting flexibility to new technologies.

Operating in the 900 MHz and 1800 MHz frequency bands, MegaFon’s 2G mobile communication services cover 92% of the population and serves 31,283 2G sites as of 3Q 2012.

MegaFon was the first to launch the 3G/UMTS network in St. Petersburg in 2007 and after three years the 3G technology was available in all regions in Russia. Currently, around 72% of the population has access to MegaFon`s 3G services. The company operates in the 2100 MHz country-wide frequency band, the 900 MHz band in Moscow and the region and has 27,621 3G sites as of 3Q 2012. All network equipment is HSDPA/HSUPA enabled allowing for a theoretical speed of up to 14 Mbps and 38% of 3G base stations support HSPA+ technology, allowing for a theoretical speed of up to 21 Mbps.

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In April 2012 MegaFon launched 4G services through its agreement with Yota. The services are currently available in Moscow, Novosibirsk, Krasnodar, Samara, Sochi, Vladivostok, Ufa, Kazan and St. Petersburg and are planned to be expanded to over 40 Russian cities by the year-end. MegaFon is also planning to build its own LTE network and could potentially consider network sharing with other operators which we think could optimise return on capital. MegaFon’s LTE devices allow subscribers to use GSM and 3G technologies. On average c40% of data traffic, which is around 200 Tb, is generated by subscribers on GSM and 3G networks. MegaFon LTE subscribers account for up to 5% of total regional traffic.

Figure 80: MegaFon: # of 2G and 3G base stations and 3G Figure 81: MegaFon: Expected 4G/LTE rollout coverage 4G/LTE population coverage in millions In thousands 90 83 83 83 80%

80 70% 40 37.3 72% 72% 70 67% 60% 35 60 50% 30 27.9 50 40% 40 25 29.3 31.3 26.8 27.6 28.2 30% 30 24 24.8 20 18.9 16.5 20 24% 20% 24 15 10 5 10% 10 0 0% 2009 2010 2011 9M 2012 2012 5 0 # of 2G BS # of 3G BS 0 # of regions with 3G connectivity 3G population coverage Q1 2012 Q2 2012 Q3 2012 Q4 2012

Source: Company data Source: Company data

Figure 82: Data traffic generated by LTE users across MegaFon network In Tb 600

61.8% 400

64.6% 38.2% 200

35.4%

59.1%

40.9% 0 Apr-12 May-12 Jun-12 Jul-12

GSM and 3G network 4G network

Source: Company data

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Network quality analysis Relative to its business, MegaFon has invested the most in the mobile network among the key Russian mobile operators since 2009 – 26% of revenues versus about 21%, 16% and 20% for MTS, Vimpelcom and Tele2 respectively. We would note that the main reason MTS’s capex is higher than MegaFon’s in absolute terms is MTS’s investment in the fixed line network in Moscow, which we estimate at about US$0.8bn–1bn during 2009-9M 2012. As a result MegaFon now has the highest number of 3G base stations among the BIG3 operators. We also calculate that MegaFon has the best quality of the network measured as 3G/4G base stations x data spectrum / number of subscribers. This network quality premium is particularly pronounced if Yota is taken into account. Figure 83: The BIG3: Network quality comparison Figure 84: Breakdown of 3G investment between # of 3G/4G base stations x spectrum / subscribers coverage and capacity 100% 0.09 80% 78% 0.08 66% 0.07 60%

0.06 40% 21% 0.05 20% 0.04

0.03 0% 2009 2010 2011 0.02 Capacity Coverage 0.01 2G sites used for placement of 3G BS (NodeB), EoP

0 MTS Vimpelcom MegaFon w/o Yota MegaFon w Yota

Note: MTS base stations as of 2Q 2012 Source: Company data, Credit Suisse research

Source: Company data, Credit Suisse research

Figure 85: Cumulative capex in Russia, 2009-9M 2012 Figure 86: The BIG3: # of 3G base stations In US$ billions and as % of revenues In thousands 8 30% 26% 27.6 7 25.0 25% 6 21% 16% 20% 20% 5 18.0 4 15% 6.9 7.5 5.0 3 10% 2 5% 1 0.9 0 0% MegaFon MTS Vimplecom Tele2

Cumulative Russian CAPEX, 2009-9M 2012, bln US$ MegaFon MTS VimpelCom* Cumulative Russian capex % of cumalative Russian sales, 2009-9M 2012

Source: Company data Note: MegaFon as of Sept 2012, MTS as of June 2012, Vimpelcom as of Sept 2012 as discussed in conference call Source: Company data

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MegaFon has been gradually shifting 3G investment from coverage to capacity and the split was 50%/50% in 2011. According to AMC, a Russian consulting company that measures telecom network quality, as of 2Q 2012, MegaFon’s network delivered the highest data speed among the BIG3 operators both in the regions (1.4 Mbps) and in Moscow (2.4 Mbps). Additionally, MegaFon’s network screens best in terms of 2G and 3G coverage and quality.

Figure 87: Average download speed across Russia, 2Q Figure 88: Average 3G download speed in Moscow and 2012 across Russia Kbps Mbps

115 113.4 2.4

110 1.7 1.4 105 1.3 105.2 1.2 0.9 100

96.0 95

90 MegaFon MTS Vimpelcom Moscow Russia

85 MegaFon MTS Vimpelcom

Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research

Figure 89: 3G network coverage points, Q2 2012 Figure 90: 3G network quality points, Q2 2012 7 8 6 7 6 7 7

6 5 5 5 4 3.5 4 3 2.5 3 2.5 2.5 2 2 2 2

1 1 1 1

0 0 MegaFon MTS Vimpelcom MegaFon MTS Vimpelcom

3G network coverage points Number of regions where ranked #1 3G network quality points Number of regions where ranked #1

Source: AMC Source: AMC

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Figure 91: 2G network coverage points, Q2 2012 Figure 92: 2G network quality points, Q2 2012

7.0 6.5 7 6.0 6.0 6 5.0 5.0 5 5.0

4.0 3.5 4 3.0 3.0 3.0 3 2.0 2.0 2 2.0 1.0 1.0 1.0 1 0.0 0 0.0 MegaFon MTS Vimpelcom MegaFon MTS Vimpelcom 2G network coverage points Number of regions where ranked #1 2G network quality points Number of regions where ranked #1

Source: AMC Source: AMC

Figure 93: Success in 2G voice connection (CSR), Q2 Figure 94: 2G voice connection break (CDR), 2012 2012 1.9% 99.0% 1.6%

98.9% 1.4%

98.6%

MegaFon MTS Vimpelcom MegaFon MTS Vimpelcom

Source: AMC Source: AMC MegaFon has a universal, scalable backbone network in Russia, the second largest after Rostelecom, supporting both the mobile and fixed businesses. 104,000km of existing network and expanding backbone in the South, Far East and Eastern Siberia with 0.9 Tbps average combined throughput we think could ensure independence from nationwide provider Rostelecom. The company has been replacing microwave backhaul by local fibre- optic links. 53% of urban base-stations and 8% of non-urban base stations are already connected via fibre. The company is now focusing on the construction of regional urban fibre-optic links. MegaFon is one of the largest users of satellite frequencies in Russia, allowing it to deal directly with satellite operators. Satellite frequency allocation MegaFon and a total transmission capacity of 755 MHz allows MegaFon to cover the entire territory of Russia, providing connectivity to remote base stations and fixed-line customers.

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Figure 95: MegaFon: % of urban 2G and 3G base stations Figure 96: MegaFon: % of administrative centres connected via fibre connected via fibres

53% 53% 35%

45%

20% 25%

10%

2009 2010 2011 9M 2012 2009 2010 2011

Source: Company data Source: Company data

Figure 97: Development of MegaFon’s backbone network, `000s kilometres

120

100

80 47.5

60 103.9 25.1 40

20 31.3

0 2009 2010 2011 9M 2012

Source: Company data Distribution network In common with MTS, MegaFon has been focusing on the strategy of reducing third-party multibrand stores and increasing own stores. This strategy provides a “one-stop-shopping” experience and a more customised service to customers, which is particularly important for higher speed data products and equipment as well as to sell MegaFon’s customised equipment. The company also has distribution agreements with Euroset and Svyaznoy, the largest multibrand wireless services and equipment retailers in Russia.

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Figure 98: MegaFon: distribution points of sale Figure 99: MegaFon: Share of sales of various distribution points of sales

4,500 30,000 27,000 4,000 25,000 27000 27,000 25,000 3,500 12% 0.081 12% 23% 33% 3,000 1,900 2,000 20,000 18,000 1821 25% 2,500 16500 16,000 0.467 16,000 15,000 45% 2,000 14,000 12,000 29% 49% 1,500 2,201 10,000 30% 1,250 14% 0.171 1,000 1841 1,900 1,598 5,000 15% 500 1,051 13% 33% 448 23% 29% 0.281 - - 15% 2009 2010 2011 9M 2012 2013 Target 2009 2010 2011 9M 2012 2013 Target 3rd party MegaFon monobrand Owned-and-operated Owned-and-operated 3rd party MegaFon monobrand indep. Owned local multibrand (RHS) Alternative POS (RHS) indep. owned local multibrand Alternative POS

Source: Company data Source: Company data, Monobrand channels in bold. However, the economic benefits of either strategy are not that straightforward. Given MegaFon’s customer ARPU generated in each store type, own stores seem to be delivering the best-quality customer, followed by federal multibrand stores, such as Euroset and Svyaznoy. In terms of costs, MTS, which has the most extensive monobrand (including third-party franchisee stores) network, seems to be generating the lowest sales and marketing costs (6% recently down from 8% in the past two years) and also the highest margins. Vimpelcom, which at the other end of the spectrum has been primarily utilising its ownership relationship with the largest multibrand retailer, Euroset, has higher sales and marketing costs (8% recently down from 10% in the past two years) but has seen higher margins historically than MTS. Vimpelcom’s margins have deteriorated recently, but it may have been driven by various operational and broader shareholder issues and its move to IFRS in 2011.

Figure 100: MegaFon: Subscriber quality by retail chains, Figure 101: Russian BIG3: EBITDA margin trends 9M 2012 Ranges for ARPU in Roubles 50% 430 410 390 370 48% 350 330 45%

43%

40%

38%

Owned & operated 3rd party MegaFon Multibrand retail & other 35% monobrand POS 2009 2010 2011 9M 2012

Lower range Higher range MegaFon MTS Vimpelcom

Source: Company data Source: Company data

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MegaFon, however, has built a competitive own distribution chain in our view. It still has fewer own and third-party monobrand points of sales than MTS, but the numbers are converging and Vimpelcom still stands out with its multibrand exposure.

Figure 102: Key distribution networks in Russia

1,655 1612 5252 2,000 1821

3189 2,933 3,000 2776 1,900 1841

Euroset 3Q 2012 Svyaznoy 3Q 2012 MTS retail 3Q 2012 MTS retail 2012E MegaFon retail 3Q MegaFon retail 2013E Vimpelcom retail 2Q 2012 2012*

Own stores Franchisee/3rd party monobrand stores

Note: Euroset, Svyaznoy as of Sept 2012; Other as indicated. * Including own and franchisee monobrand stores Source: Company data MegaFon’s retail network sells a variety of mobile equipment with handsets accounting for c80% of sales value; Samsung and Nokia are the primary handset manufacturers. Customised handsets—about 10% of total handset sales—are supplied by Huawei (75%), TechnoligaDevices (10%), ZTE (5%) and Acer+Lenovo (5%). Selling customised equipment allows control of the end-user experience, which helps to increase the consumption of MegaFon VAS. According to MegaFon, this business on average generates a 50% higher ARPU and has a positive impact on its brand image. Furthermore, MegaFon incurs minimal incremental costs to procure customised equipment. MegaFon’s dongle sales more than doubles every year since 2009 to 2011 driven by its strong position in mobile data, the increased take-up of mobile broadband and also growth of own retail stores. MTS has higher dongle sales but we think this is a direct consequence of its larger own retail network.

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Figure 103: MegaFon: Handset sales by volume, 2011 Figure 104: Russia: Dongles sales of MegaFon vs MTS Thousands of units

Fly Others Alcatel 3% 1% 5% 6,000 LG 6% 4,984 5,000 Megafon 4,432 customised phones Samsung 4,000 10% 38% 3,124 3,000 2,688

2,000

Nokia 975 37% 1,000

- 2009 2010 2011 MegaFon MTS

Source: Company data Source: Company data Acquisition of Euroset On 6 December 2012, MegaFon completed its previously announced transaction to acquire an indirect stake of 25% in Euroset. According to the terms of the deal, Lefbord Investment limited, which became equally owned by MegaFon and Garsdale Services Investment Limited in December 2012, acquired 50% of Euroset Holdings Ltd for USD 1.07 billion, implying a valuation of USD 2.3 billion (Including net debt). In addition to this, a payment of USD 100 million will be made to Euroset by both acquirers if Euroset meets certain targets in the first half of 2013. MegaFon may be required to buy out a 50% Garsdale’s stake in Lefbord, thereby consolidating its ownership in Euroset to 50%. We believe execution is key in the mobile retail business model. MegaFon expects the following benefits from this acquisition:

■ Potential capex savings owing to a slowdown in the expansion of MegaFon’s own retail network—we think this would be the biggest potential positive from such an acquisition and could be margin-accretive in the short term;

■ Enhanced retail distribution capabilities – we think that the exposure to the largest mobile retailer in Russia would allow MegaFon to achieve better distribution coverage than MTS, which is the current market leader;

■ Lower subscriber acquisition costs via reduction in commission rates – there is potential for this but we would be cautious to forecast a material change before we see material and consistent evidence of this in the results. Once again, however, it will all depend on execution and a properly positioned and managed mobile retail chain with strong support from the shareholders;

■ Improved churn management – which we think is possible if the chain is managed properly and becomes quasi-monobrand (as it most likely would over time);

■ Economies of scale through pooled purchase – we think the impact will be marginal as Euroset is already a large enough purchaser of equipment. MTS has invested about US$600m in its monobrand network (about 4,388 stores both own and franchisees) to date on our estimates. From that perspective US$535m for a 25% stake in Euroset and up to US$1.3bn (including the second 25% stake and depending on

MegaFon (MFONq.L) 56 08 January 2013 the time MegaFon choses to wait) with access to 5,260 stores (even assuming 50% exposure due to Vimpelcom’s presence) does not seem excessive. MTS said recently that without retail its EBITDA margin would have been 48% in Russia versus the reported 44.5%. Based on this simplified calculation we estimate that if MegaFon were to abandon further plans for own distribution network rollout, it could result in a 0.5-1.0pp EBITDA margin uplift which on our estimates could lead to a potential positive valuation impact of at least US$200m-800m. This is excluding potential synergies from more flexibility on sales and marketing costs and potential synergies in handset purchases. Fixed line business strategy MegaFon’s wireline business contributes 6.4% share to total revenues and grew mainly through acquisitions. The company provides various services in this segment: consumer broadband (about 30% of revenues), broadband, traditional voice and value added fixed line services to businesses and government organisations (c25%), and wholesales services to operators (c45%). We think in this segment the company will be focusing on growing its presence primarily in B2B and B2G segments where it currently has 13% and 7% market share, according to Direct-Info, and which could be at least theoretically expanded. However we think the company may not have a strong position in the faster growing residential broadband segment as it is a late entrant in the sector compared with MTS and Vimpelcom. In the residential broadband segment MegaFon operates via Net-By-Net which was acquired in June 2011. Net-By-Net is present in Moscow where it is a #5 operator with 8% market share and selected regions of the Central district of Russia. It has only 2% market share on the pan-Russian level on our calculations (according to AC&M). Moscow is highly penetrated with >70% internet penetration and only 5% growth in internet users (according to FOM) and is also the most competitive market within Russia. Net-By-Net has to compete with MTS, Vimpelcom, Rostelecom and Akado, of whom the first three are credible and strong competitors. We believe MegaFon is not planning to invest in fixed line broadband in the regions and is not planning to aggressively compete on the Moscow fixed line broadband market. We forecast flat revenue growth for Net-by-Net. Below we nevertheless provide an overview of the Russian fixed line broadband market and competitive dynamics as this also has implications for the mobile broadband market dynamics in Russia. There are five major federal broadband operators in Russia serving three broadband technologies: xDSL, ETTH and GPON. Rostelecom has historically been the segment leader. After acquiring seven RTOs, the company gained 7.6m broadband audience and developed infrastructure which provided it with a 40% subscriber / 67% revenue broadband market share on our estimates and an opportunity to operate across Russia using all the three technologies. According to the company’s strategy, Rostelecom intends to switch to FTTx (fibre to the) from xDSL. The technology may help to further increase ARPU as it provides 10x the speed of xDSL. The company expects to see not only FFTx subscriber growth but that of xDSL since xDSL equipment previously used in cities where FTTx now operates will be widely used in rural areas. Management expects the continuous increase in subscribers to help Rostelecom take 50% market share in broadband services by 2015. Beeline is the number two broadband provider with 11% market share on our estimates. In the regions where Beeline operates it uses the high-speed and more effective technologies ETTH and GPON. This helps Beeline to keep its ARPU at Rbls 410 and take 12% market share by revenue in the broadband segment.

MegaFon (MFONq.L) 57 08 January 2013

MTS, which also provides broadband services in Moscow and the regions, accounts for a 10% subscriber / 9% revenue share of the broadband market in Russia but has a dominant position with 29% subscriber market share in Moscow via its subsidiary Comstar/MGTS. MTS fixed line network, similarly to Rostelecom, was originally copper and DSL in Moscow. However, the network has been gradually upgraded and now MTS provides fixed line broadband access services via ADSL / ADSL2+ and fibre. MTS intends to develop its network and is currently investing in a GPON project in Moscow. ER-Telecom is a broadband operator working in 42 regions in Russia and serving a 1.9m broadband subscriber base as of 2Q 2012. The company had 11% subscriber market share in Russia as of 2Q 2012. The company was established in 2001 in Perm by merging two local telecommunication companies. It is currently owned by “Perm Financial Production Group” (75.5%), Baring Vostok (10%) and the company’s management (14.5%). ER-Telecom’s key target is to obtain a 20% market share in terms of revenues in the broadband and Pay-TV market by 2014E. In the next 2–3 years ER-Telecom intends to actively develop its services in the regions it is already present and build its own networks in new cities with a population of above 200,000. Akado is a broadband and Pay TV operator with a presence mainly in Moscow, St. Petersburg and Ekaterinburg. The company has 4% subscriber market share with 774,000 residential broadband customers. Akado is fully owned by Renova Group of Mr. Vekselberg.

Figure 105: Main Russian broadband operators and the technologies Broadband Technology Operators Rostelecom xDSL/ETTH/GPON Beeline ETTH/GPON MTS xDSL/ETTH/GPON ER-Telecom ETTH/GPON Akado ETTH/GPON Net-By-Net ETTH/GPON Source: AC&M, Company data

Figure 106: Russia: Residential broadband subscriber Figure 107: Moscow: Residential broadband subscriber market shares, 2Q 2012 market shares, 2Q 2012

MegaFon (NetBy Net) Other MegaFon Others 8% 10% (NetBy Net) 19% 2% MTS 29% Akado Rostelecom 4% 42% Rostelecom ER-Telecom 11% 11%

MTS 11% Vimpelcom Vimpelcom 11% AKADO 20% 22%

Source: AC&M Source: AC&M

MegaFon (MFONq.L) 58 08 January 2013

Recent management changes Below we highlight several management changes that have happened at MegaFon this year. The detailed biographies of the management and the Board of Directors is presented in the appendix of this report. As we mentioned earlier, we are not concerned with the recent management changes as we believe that the background and track record of the current top management is quite robust. However, since execution continuity is critical to our financial and valuation analysis of MegaFon, it is an important component of our assumptions.

■ On 20 April 2012, Ivan Tavrin, who had previously been the first deputy chief executive officer of MegaFon, became the CEO, replacing Sergey Soldatenkov, who had been in this position for 10 years and whose contract was set to expire in June 2012. Mr. Soldatenkov remains the company’s Chairman of the Board of Directors. Mr. Tavrin has extensive experience of 15 years in the Russian media industry. His most recent experience includes being a shareholder, Chairman of the Board and CEO of UTH (TV broadcaster) and serving on a board of Directors of Kommersant Holding and Mail.Ru. On 9 June 2012, Konstantin Likhoedov, who had previously worked as Disney’s CEO, became MegaFon’s Moscow branch Director.

■ On 17 July 2012, Igor Shirokov was appointed as deputy CEO in Infrastructure. He took over the operations, development and building departments previously managed by technical director Igor Parfenov who had resigned.

■ On 9 August 2012, Evgeniy Chermashenev, ex-CEO of UTV subsidiary “Viberi Radio”, became corporate market director having replaced Konstantin Solodukhin who had resigned.

■ On 3 September 2012, Andrei Eremkin, central branch head was replaced by his first deputy Pavel Korchagin.

MegaFon (MFONq.L) 59 08 January 2013 Financial analysis Revenues We forecast MegaFon should deliver 5.4% revenue CAGR over 2012–16E, down from 15.5% in 2009–11. Russian mobile revenues—88% of total revenues We expect Russian mobile revenues to grow 5.6% CAGR over 2012–16E, down from 10.7% in 2009–11. Russian mobile voice revenues We expect Russian mobile voice revenues to deliver low single digit growth rates (+1.3% CAGR) over the forecast period (2012–16E) after +5% CAGR over 2009–11. The key assumptions we use in our forecasts are: ■ Relatively flat subscriber base: With already high Russian mobile penetration levels, and assuming higher population levels because of immigration and the multiple SIM card phenomenon, we do not expect subscriber growth to be a driver of revenues. It is possible that headline subscriber figures continue to show net additions but we do not expect these to drive revenue growth. We believe a relatively flat subscriber base assumption allows us to more accurately forecast KPIs, such as ARPU and MOU; without subscriber base dilution, these should reflect true spending trend per subscriber. Our forecasts imply c1% subscriber base CAGR over the forecast period.

■ Voice elasticity: We assume price elasticity of 0.25 and income elasticity of 0.5 for MegaFon for 2013E-2016E. The main driver of these assumptions are the historical average in Western Europe and our assumption of 0.5 income elasticity of usage.

■ Pricing trends: We assume that mobile blended voice pricing will be falling in low single digits in the forecast period. Although outgoing voice pricing has fallen 11% on average between 2009 and 2011, we expect the trend to stabilise as blended outgoing prices are currently at, or below, MTRs on average. However, owing to MegaFon’s focus on on-net traffic and developing technological options (over-the-top VoIP), we think prices could well remain below MTR levels unless competitive dynamics change materially to the positive.

■ Voice usage trends: We forecast mobile minutes of use to grow at low single digits based on our assumptions above.

■ Voice ARPU: We expect a stabilisation in voice ARPU over the forecast period after c3% decline per annum in 2009-2011. The reason for the change to a more stable trend is because we assume a relatively flat subscriber base which reduces dilution.

Russian mobile data We expect Russian mobile data traffic revenues to grow 20% CAGR over 2012-2016E after c60% CAGR over 2009-2011. The key drivers of this revenue segment are:

■ Mobile data subscribers: We expect mobile data subscribers to deliver 14% CAGR over the forecast period after 23% growth in 2009-2011. On our assumptions, mobile internet users will increase from 33% to c60% by 2016E. This is in line with the suggestions from the Credit Suisse’s European telecom team’s 2011 European wireless survey – two-thirds of the mobile operators expected that more than 50% of their customers would have a data plan in several years’ time. Our forecasts suggest a slightly slower adoption rate as smartphone adoption psychology is still developing.

■ Data pricing: We see limited downside risk to pricing in the medium term as pricing per MB for MegaFon is already low at US$4.5 per GB. As we discussed earlier in the mobile data market section, given the long-term cost of 1GB of data under LTE of

MegaFon (MFONq.L) 60 08 January 2013

around US$3.7, we do not think prices could fall significantly lower for a prolonged period. However, we see the risk of competitive pressures in the data segment continuing into 2013 but we expect effective pricing to stabilise and potentially start to grow from 2014.

Russian mobile content We see mobile content (excluding SMS and data traffic) growing in low double digits (c12% over 2012-2016E down from 34% in 2009-2011). The main argument, as we discussed in the mobile content section, is that some of the historically fast-growing divisions, with large contributions to content revenues (such as Mobile TV, Ringback tones), may have reached saturation point in Russia; we have seen some unsuccessful practices in other countries for Mobile TV and a stagnation in the Ringback tone businesses. However, we see room for growth in other subscription-based content services which are well developed by numerous third party content providers in Russia. We also see mobile payments as potentially growing revenue streams for mobile operators. However, we do not expect a material increase in content contribution to overall mobile revenues, which we forecast to increase from c10% in 1H 2012 to 12.5% by 2016E.

Russian SMS business As we have seen in many other countries and have started to see in Russia, messaging revenues are on the decline driven by smartphone applications and despite an attempt of bundling in Russia. We forecast a c2.4% decline in messaging revenues for MegaFon over 2012-2016E compared with flat messaging revenues in 2009-2011. CIS mobile revenues—1% of revenues In the CIS, MegaFon has exposure to Tajikistan, South Ossetia and Abkhazia. However, this business is not of a size which we believe warrants detailed modelling. We assume the business will remain at 1% of revenues for the forecast period. Wireline business—6.4% of revenues MegaFon’s wireline business has grown mainly through acquisitions; in 3Q 2012 organic growth was about 13% yoy. The business comprises c30% revenues from internet access which although we expect to grow c10% over the next three years for Russia, we think growth rates are likely to be significantly less for MegaFon given its focus on the Moscow residential broadband market; c25% fixed voice, and the remaining 45% carrier service, both of which we expect to grow in low single digits. Fixed line services in other segments - B2B, B2G, B2O - could potentially present some upside risks to our forecasts. We therefore view this as an option for MegaFon but do not yet incorporate the company gaining market share materially in these segments in our base case scenario. As a result, we see wireline business revenue growth in low single digits CAGR over 2012- 2016E. Handset and equipment business—5% of revenues We expect the company to grow at rates slightly below the market which, according to third party forecasts from AC&M and Direct-Info, is estimated to grow around 9-10% over 2012-2016E. We think the market has been increasingly dominated by the roll-out of operators’ own distribution platforms which we explicitly assume are not going to continue to the same intensity. We think that handset promotions in 2010 and 2011 also drove strong growth in handsets and we expect these to normalise given our expectations of a more benign competitive environment. With the acquisition of Euroset, the handset sales business and promotions are likely to be outsourced to Euroset.

MegaFon (MFONq.L) 61 08 January 2013

Figure 108: MegaFon: Consolidated revenue model Roubles in millions, unless otherwise stated Revenues model 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E CAGR CAGR 2009- 2012E- 2011 2016E

Total Revenues 181,883 215,515 242,608 129,864 71,234 271,260 287,715 304,565 318,613 335,286 15.5% 5.4% Growth yoy 18.5% 12.6% 14.2% 12.3% 11.8% 6.1% 5.9% 4.6% 5.2% Growth pop 0.8% 6.7%

Wireless revenues 178,824 202,837 218,994 115,541 63,067 240,398 255,133 270,474 283,297 298,695 10.7% 5.6% Growth yoy 13.4% 8.0% 11.0% 10.6% 9.8% 6.1% 6.0% 4.7% 5.4% Growth pop 0.5% 5.7% % of revenues 98.3% 94.1% 90.3% 89.0% 88.5% 88.6% 88.7% 88.8% 88.9% 89.1%

Wireless service revenues, 177,603 201,147 216,904 114,289 62,159 237,793 252,369 267,543 280,227 295,458 10.5% 5.6% Russia Growth yoy 13.3% 7.8% 10.8% 10.1% 9.6% 6.1% 6.0% 4.7% 5.4% % of wireless revenues 99.3% 99.2% 99.0% 98.9% 98.6% 98.9% 98.9% 98.9% 98.9% 98.9%

Wireline revenues 674 7,496 15,194 8,834 4,560 18,233 18,689 19,156 19,635 20,126 374.8% 2.5% Growth yoy 1012.2% 102.7% 35.4% 13.2% 20.0% 2.5% 2.5% 2.5% 2.5% Growth pop 1.9% 3.5% % of revenues 0.4% 3.5% 6.3% 6.8% 6.4% 6.7% 6.5% 6.3% 6.2% 6.0%

Sales of handsets and 2,385 5,182 8,420 5,489 3,607 12,630 13,893 14,935 15,682 16,466 87.9% 6.9% accessories Growth yoy 117.3% 62.5% 74.8% 50.5% 50.0% 10.0% 7.5% 5.0% 5.0% Growth pop 4.0% 33.4% % of revenues 1.3% 2.4% 3.5% 4.2% 5.1% 4.7% 4.8% 4.9% 4.9% 4.9% Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 62 08 January 2013

Figure 109: MegaFon: Key KPIs for the Russian mobile business KPIs / Assumptions: 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E CAGR CAGR Russian wireless 2009- 2012E- 2011 2016E

Total mobile subscribers, 50.2 56.6 61.6 62.1 62.8 63.5 64.0 64.5 65.0 65.5 10.8% 0.8% period end (m) Growth yoy 12.7% 8.9% 7.7% 5.1% 3.1% 0.8% 0.8% 0.8% 0.8% Growth pop 0.7% 1.2% Total mobile subscribers, 46.8 53.4 59.1 61.8 62.4 62.6 63.8 64.3 64.8 65.3 period average (m) Growth yoy 14.2% 10.7% 8.3% 6.4% 5.9% 1.9% 0.8% 0.8% 0.8% Growth pop 4.6% 0.9% Total mobile subscribers 6.4 5.0 0.4 0.7 1.9 0.5 0.5 0.5 0.5 net adds pop (m)

Mobile ARPU blended 322.0 312.0 311.0 309.0 333.0 320.1 333.3 350.6 364.4 381.3 -1.7% 4.5% (Rbls) Growth yoy -3.1% -0.3% 2.0% 3.7% 2.9% 4.1% 5.2% 3.9% 4.6% Growth pop -0.6% 4.7%

Mobile MOU (min) 275.0 284.6 287.8 292.4 301.0 302.6 311.5 319.7 328.1 336.7 2.3% 2.7% Growth yoy -5.4% 3.5% 1.1% 2.4% 4.2% 5.1% 3.0% 2.6% 2.6% 2.6% Growth pop 1.6% -1.0%

Mobile ARPM blended 1.17 1.10 1.08 1.06 1.11 1.06 1.07 1.10 1.11 1.13 -3.9% 1.7% (Rbls) Growth yoy -6.4% -1.4% -0.4% -0.4% -2.1% 1.1% 2.5% 1.3% 2.0% Growth pop -2.2% 5.8% Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 63 08 January 2013

Figure 110: MegaFon: Russian mobile voice model Roubles in millions, unless otherwise stated Mobile voice 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E CAGR CAGR 2009- 2012E- 2011 2016E

Voice revenues 145,200 156,200 160,100 80,700 44,602 167,764 169,298 171,799 174,348 176,945 5.0% 1.3% Growth yoy 7.6% 2.5% 5.4% 5.5% 4.8% 0.9% 1.5% 1.5% 1.5% Growth pop % of wireless revenues 81.2% 77.0% 73.1% 69.8% 70.7% 69.8% 66.4% 63.5% 61.5% 59.2% Voice Outgoing revenues 119,468 127,056 124,570 61,822 34,793 128,226 127,813 128,891 129,971 131,052 % of voice revenues 82.3% 81.3% 77.8% 76.6% 78.0% 76.4% 75.5% 75.0% 74.5% 74.1% Interconnect revenues 25,732 29,144 35,530 18,878 9,809 39,538 41,485 42,908 44,377 45,893 % of voice revenues 17.7% 18.7% 22.2% 23.4% 22.0% 23.6% 24.5% 25.0% 25.5% 25.9%

Mobile ARPU voice (Rbls) 258.8 243.7 225.7 217.5 238.1 223.4 221.2 222.7 224.3 225.9 -6.6% 0.3% Growth yoy -5.8% -7.4% -2.7% -0.9% -1.0% -1.0% 0.7% 0.7% 0.7% Growth pop

Mobile MOU (min) 275.0 284.6 287.8 292.4 301.0 302.6 311.5 319.7 328.1 336.7 2.3% 2.7% Growth yoy -5.4% 3.5% 1.1% 2.4% 4.2% 5.1% 3.0% 2.6% 2.6% 2.6% Growth pop 1.6% -1.0%

Mobile ARPM voice 0.94 0.86 0.78 0.74 0.79 0.74 0.71 0.70 0.68 0.67 -8.7% -2.4% blended Growth yoy -14.3% -9.0% -8.4% -5.0% -4.9% -5.8% -3.8% -1.9% -1.9% -1.9% Growth pop -5.1% Mobile ARPM voice 2.97 2.82 2.67 2.43 2.47 2.38 2.34 2.29 2.25 2.21 blended (US$ cents) Mobile voice elasticity yoy -0.4 0.4 0.1 0.5 0.9 0.9 0.8 1.4 1.4 1.4

Mobile ARPU voice 212.9 198.2 175.6 166.6 185.8 170.7 167.0 167.1 167.2 167.3 -9.2% -0.5% outgoing (Rbls) Growth yoy -6.9% -11.4% -6.4% -2.2% -2.8% -2.2% 0.1% 0.1% 0.1% MOU outgoing 165.0 170.8 172.7 175.4 180.6 181.6 186.9 191.8 196.9 202.0 2.3% 2.7% Growth yoy 3.5% 1.1% 2.4% 4.2% 5.1% 3.0% 2.6% 2.6% 2.6% Mobile ARPM voice 1.29 1.16 1.02 0.95 1.03 0.94 0.89 0.87 0.85 0.83 -11.2% -3.1% outgoing Growth yoy -10.1% -12.4% -8.6% -6.1% -7.5% -5.0% -2.5% -2.5% -2.5% Mobile ARPM voice 4.07 3.82 3.46 3.11 3.21 3.03 2.94 2.87 2.80 2.73 outgoing (US$ cents) Mobile voice outgoing 0.14 -0.08 0.02 0.44 0.45 0.25 0.25 0.25 0.25 elasticity yoy - Price Mobile voice outgoing 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 elasticity yoy - Income

Mobile ARPU voice 45.9 45.5 50.1 50.9 52.4 52.6 54.2 55.6 57.1 58.6 incoming off-net (Rbls) Growth yoy -0.9% 10.1% 11.5% 4.2% 5.1% 3.0% 2.6% 2.6% 2.6% MOU incoming off-net 48.3 47.9 52.7 53.6 55.1 55.4 57.1 58.6 60.1 61.7 Growth yoy -0.9% 10.1% 11.5% 4.2% 5.1% 3.0% 2.6% 2.6% 2.6% MTRs (Rbls) 0.95 0.95 0.95 0.95 0.95 0.95 0.95 0.95 0.95 0.95 MTRs (US$ cents) 2.99 3.13 3.23 3.11 2.97 3.06 3.13 3.13 3.13 3.13 Note: Except for voice revenues and MOU for 2009-3Q 2012, all other figures are based on our assumptions and calculations. Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 64 08 January 2013

Figure 111: MegaFon: Russian mobile data model Roubles in millions, unless otherwise stated Mobile data 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E CAGR CAGR 2009- 2012E- 2011 2016E

Data revenues 10,700 18,500 26,800 16,000 9,036 34,556 43,937 53,330 60,464 70,583 58.3% 19.5% Growth yoy 72.9% 44.9% 29.0% 33.5% 28.9% 27.1% 21.4% 13.4% 16.7% Growth pop % of wireless revenues 6.0% 9.1% 12.2% 13.8% 14.3% 14.4% 17.2% 19.7% 21.3% 23.6%

Mobile data subscribers, 12.6 16.2 19.1 19.3 20.0 22.5 26.5 30.5 34.3 37.7 23.1% 13.7% period end (m) Growth yoy 28.6% 17.9% 19.9% 16.3% 18.0% 17.5% 15.0% 12.5% 10.0% Growth pop 3.6% % of total subscribers 25.1% 28.6% 31.0% 31.1% 31.8% 35.5% 41.4% 47.2% 52.7% 57.5% Mobile data subscribers, 12.6 14.4 17.7 19.2 19.7 20.8 24.5 28.5 32.4 36.0 18.4% 14.7% period average (m) Growth yoy 14.3% 22.6% 18.9% 18.0% 18.0% 17.7% 16.1% 13.7% 11.2% Growth pop

Mobile ARPU data per data 86.0 113.0 133.0 140.0 144.0 138.3 149.4 156.1 155.7 163.5 24.4% 4.3% user (Rbls) Growth yoy 31.4% 17.7% 7.7% 9.1% 4.0% 8.0% 4.5% -0.3% 5.0% Growth pop Mobile ARPU data per ave 17.8 28.9 37.8 43.1 48.2 sub (Rbls)

Data usage (MB per month 47 256 628 983 1,006 1,004.8 1,205.8 1,326.3 1,392.7 1,462.3 265.5% 9.8% per data sub) Growth yoy 444.7% 145.3% 85.5% 78.4% 60.0% 20.0% 10.0% 5.0% 5.0% Growth pop 56.5% 2.3%

ARPMB (Rbls) 1.83 0.44 0.21 0.14 0.14 0.14 0.12 0.12 0.11 0.11 -66.0% -5.1% Growth yoy -75.9% -52.0% -41.9% -38.8% -35.0% -10.0% -5.0% -5.0% 0.0% Growth pop ARPMB (US$ cents) 5.76 1.45 0.72 0.47 0.45 0.44 0.41 0.39 0.37 0.37 Note: Except for data revenues, data ARPU and data usage for 2009-3Q 2012, all other figures are based on our assumptions and calculations. Source: Company data, Credit Suisse estimates

Figure 112: : MegaFon: Mobile VAS excl SMS and data model Roubles in millions, unless otherwise stated Mobile VAS (excl. SMS) 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E CAGR CAGR 2009- 2012E- 2011 2016E

VAS revenues 10,200 14,400 18,400 11,100 5,531 22,886 26,824 30,413 33,715 36,523 34.3% 12.4% Growth yoy 41.2% 27.8% 35.4% 12.8% 24.4% 17.2% 13.4% 10.9% 8.3% % of wireless revenues 5.7% 7.1% 8.4% 9.6% 8.8% 9.5% 10.5% 11.2% 11.9% 12.2%

Average subscribers (m) 46.8 53.4 59.1 61.8 62.4 62.6 63.8 64.3 64.8 65.3 12.4% 1.1%

Mobile ARPU VAS per ave 18.2 22.5 25.9 29.9 29.5 30.5 35.0 39.4 43.4 46.6 19.4% 11.2% sub (Rbls) Growth yoy 23.6% 15.4% 25.0% 6.0% 17.5% 15.0% 12.5% 10.0% 7.5% Growth pop -1.3% Note: Except for VAS revenues for 2009-3Q 2012, all other figures are based on our assumptions and calculations. Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 65 08 January 2013

Figure 113: : MegaFon: Mobile SMS model Roubles in millions, 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E CAGR CAGR unless otherwise 2009- 2012E- statedMobile SMS 2011 2016E

SMS revenues 11,500 12,000 11,600 6,500 3,019 12,586 12,309 12,001 11,700 11,407 0.4% -2.4% Growth yoy 4.3% -3.3% 10.2% 15.3% 8.5% -2.2% -2.5% -2.5% -2.5% Growth pop % of wireless revenues 6.4% 5.9% 5.3% 5.6% 4.8% 5.2% 4.8% 4.4% 4.1% 3.8%

Total outgoing SMS (bn) 14.0 16.8 18.1 9.6 5.0 19.6 20.2 20.7 21.3 21.9 13.7% 2.7% Growth yoy 20.0% 7.7% 5.5% 25.0% 8.5% 3.0% 2.6% 2.6% 2.6% Growth pop

ARPSMS (Rbls) 0.82 0.71 0.64 0.68 0.60 0.64 0.61 0.58 0.55 0.52 -11.7% -5.0% Growth yoy -13.0% -10.3% 4.4% -7.8% 0.0% -5.0% -5.0% -5.0% -5.0% Growth pop 5.6% -10.8% ARPSMS (US$ cents) 2.59 2.35 2.18 2.21 1.89 2.06 2.00 1.90 1.81 1.72 Note: Except for SMS revenues and outgoing SMS volume for 2009-3Q 2012, all other figures are based on our assumptions and calculations. Source: Company data, Credit Suisse estimates Operating costs Cost of services We expect relatively flat margins between 2011 and 2016E. In the short term we see margins improving slightly—about 40bp—in 2012E and 2013E on the back of the overall favourable market environment manifested in the end of competitive price and cost wars. We also expect ownership exposure to Euroset to ease potential margin pressure from sales and marketing expenses and also costs associated with the continued roll out of own distribution network. We also expect the acquisition of VAS Media, which generated 90% of its revenues from MegaFon’s subscribers, to improve VAS’ gross margin to 20% from 32% as of 1H 2012, and the normalisation (to zero) of handset margins should also have a positive impact on margins. We conservatively forecast slight deterioration in the medium term between 2014E and 2016E, on the expectation of a likely deterioration in competitive environment. Operating costs We expect sales and marketing expenses to be lower than current levels in terms of % of revenues as it appears slightly high compared with immediate peers. MTS’ sales and marketing costs have been declining from 8% of revenues in 2010 and 2011 to 5.4% in 3Q 2012. Vimpelcom – whose business model in Russia resembles MegaFon’s more closely given the mobile-fixed line revenue mix and also MegaFon’s exposure to Euroset in our view – has seen sales and marketing costs in Russia declining from 9%-10% in 2010 and 2011 to about 8% in 9M 2012. We do not believe that the change in dealership commission structure (from fixed to revenue based), which was introduced late 2011/early 2012, is likely to significantly lower these costs in the long term. We think that MegaFon, with sales and marketing costs representing 9% of revenues, may have some room to improve efficiency of sales and marketing particularly with the acquisition of Euroset. We assume that sales and marketing costs as % of revenues will fall to 7% in 2012-2016E from 9% in 2011. On the downside, however, we see salary cost growth potentially putting pressure on margins with mid-single revenue growth assumption. Salary growth in Russia was 13% in 1H 2012 and is expected to be 17.5% in 2012E with growth in MegaFon’s salary and social charges of 18.4% yoy in 3Q 2012 and 13 % yoy in 9M 2012. We assume that, in 2H 2012 and the full year 2012E, MegaFon’s salary and social charges will be closer to the salary growth of the overall economy which implies some margin pressure from staff- related expenses for the full year. Nominal GDP growth is likely to be in high single digits on Credit Suisse estimates and we think salary growth could be close to that.

MegaFon (MFONq.L) 66 08 January 2013

Figure 114: MegaFon: Consolidated gross profit forecast Roubles in millions, unless otherwise stated Cost model 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E

Cost of revenues 37,204 48,423 58,896 32,796 17,349 67,432 71,730 76,800 80,712 84,989 % of revenues 20.5% 22.5% 24.3% 25.3% 24.4% 24.9% 24.9% 25.2% 25.3% 25.3% Growth yoy 30.2% 21.6% 22.2% 12.5% 14.5% 6.4% 7.1% 5.1% 5.3%

Cost of services 33,128 41,648 47,644 27,341 14,096 55,212 57,837 61,865 65,031 68,523 % of wireless and wireline 18.5% 19.8% 20.3% 22.0% 20.8% 21.3% 21.1% 21.4% 21.5% 21.5% revenues % of revenues 18.2% 19.3% 19.6% 21.1% 19.8% 20.4% 20.1% 20.3% 20.4% 20.4% Growth yoy 25.7% 14.4% 28.1% 11.2% 15.9% 4.8% 7.0% 5.1% 5.4%

Interconnect charges 30,400 36,700 40,600 22,700 11,940 46,628 50,068 53,179 55,492 58,184 % of wireless voice, data, 18.1% 18.9% 19.0% 20.3% 19.5% 20.0% 20.5% 20.8% 20.9% 20.9% SMS, wireline revenues % of revenues 16.7% 17.0% 16.7% 17.5% 16.8% 17.2% 17.4% 17.5% 17.4% 17.4% Growth yoy 20.7% 10.6% 24.7% 11.5% 14.8% 7.4% 6.2% 4.3% 4.9%

Roaming expenses 1,800 1,800 1,700 1,100 577 2,291 2,404 2,528 2,628 2,760 % of wireless voice, data, 1.1% 1.0% 0.9% 1.1% 1.0% 1.1% 1.1% 1.1% 1.1% 1.1% SMS revenues % of revenues 1.0% 0.8% 0.7% 0.8% 0.8% 0.8% 0.8% 0.8% 0.8% 0.8% Growth yoy 0.0% -5.6% 22.2% -16.1% 34.7% 5.0% 5.1% 4.0% 5.0%

Cost of VAS 900 3,200 5,300 3,600 1,520 6,294 5,365 6,159 6,912 7,579 % of VAS revenues 8.8% 22.2% 28.8% 32.4% 27.5% 27.5% 20.0% 20.3% 20.5% 20.8% % of revenues 0.5% 1.5% 2.2% 2.8% 2.1% 2.3% 1.9% 2.0% 2.2% 2.3% Growth yoy 255.6% 65.6% 63.6% 14.0% 18.7% -14.8% 14.8% 12.2% 9.7%

Cost of handsets, 4,076 6,775 11,252 5,455 3,253 12,220 13,893 14,935 15,682 16,466 accessories and SIM-cards sold % of handsets and 170.9% 130.7% 133.6% 99.4% 90.2% 96.8% 100.0% 100.0% 100.0% 100.0% accessories revenues % of revenues 2.2% 3.1% 4.6% 4.2% 4.6% 4.5% 4.8% 4.9% 4.9% 4.9% Growth yoy 66.2% 66.1% -0.7% 18.3% 8.6% 13.7% 7.5% 5.0% 5.0%

Gross profit (Rbls m) 144,679 167,092 183,712 97,068 53,885 203,829 215,985 227,764 237,901 250,298 Gross margin 79.5% 77.5% 75.7% 74.7% 75.6% 75.1% 75.1% 74.8% 74.7% 74.7% Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 67 08 January 2013

Figure 115: MegaFon: Consolidated operating cost and EBITDA model Roubles in millions, unless otherwise stated 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E

Total operating expenses 56,487 69,318 82,890 43,268 21,747 89,821 94,905 100,763 106,017 112,042 excl D&A % of revenues 31.1% 32.2% 34.2% 33.3% 30.5% 33.1% 33.0% 33.1% 33.3% 33.4% Growth yoy 22.7% 19.6% 14.4% 1.3% 8.4% 5.7% 6.2% 5.2% 5.7%

Salaries and social charges 13,514 19,061 23,604 12,967 6,494 26,791 29,447 32,309 35,281 38,527 % of revenues 7.4% 8.8% 9.7% 10.0% 9.1% 9.9% 10.2% 10.6% 11.1% 11.5% Growth yoy 41.0% 23.8% 10.5% 18.4% 13.5% 9.9% 9.7% 9.2% 9.2%

Sales and marketing 17,361 19,471 21,841 10,421 5,306 22,379 22,298 22,842 23,099 23,470 % of revenues 9.5% 9.0% 9.0% 8.0% 7.4% 8.3% 7.8% 7.5% 7.3% 7.0% Growth yoy 12.2% 12.2% 19.3% -18.3% 2.5% -0.4% 2.4% 1.1% 1.6%

Advertising 6,200 6,924 7,432 4,020 2,145 8,816 8,631 9,137 9,558 10,059 % of revenues 3.4% 3.2% 3.1% 3.1% 3.0% 3.3% 3.0% 3.0% 3.0% 3.0% Growth yoy 11.7% 7.3% 24.3% 18.9% 18.6% -2.1% 5.9% 4.6% 5.2%

Commissions to dealers 11,161 12,547 14,409 6,401 3,161 13,563 13,666 13,705 13,541 13,411 % of revenues 6.1% 5.8% 5.9% 4.9% 4.4% 5.0% 4.8% 4.5% 4.3% 4.0% Growth yoy 12.4% 14.8% 16.4% -32.7% -5.9% 0.8% 0.3% -1.2% -1.0%

Rent and utilities 8,919 11,231 14,040 7,769 4,102 16,004 17,263 18,274 19,117 20,117 % of revenues 4.9% 5.2% 5.8% 6.0% 5.8% 5.9% 6.0% 6.0% 6.0% 6.0% Growth yoy 25.9% 25.0% 15.5% 14.4% 14.0% 7.9% 5.9% 4.6% 5.2%

Network repair and 3,502 4,322 5,162 2,459 1,330 5,154 5,395 5,634 5,815 6,035 maintenance % of revenues 1.9% 2.0% 2.1% 1.9% 1.9% 1.90% 1.88% 1.85% 1.83% 1.80% Growth yoy 23.4% 19.4% 5.0% -9.9% -0.2% 4.7% 4.4% 3.2% 3.8%

Radio frequency fees 2,651 2,963 3,527 2,038 974 4,069 4,316 4,568 4,779 5,029 % of revenues 1.5% 1.4% 1.5% 1.6% 1.4% 1.5% 1.5% 1.5% 1.5% 1.5% Growth yoy 11.8% 19.0% 17.8% 7.9% 15.4% 6.1% 5.9% 4.6% 5.2%

Bad debt expense 1,122 1,182 1,437 813 392 1,698 1,801 1,907 1,995 2,099 % of revenues 0.6% 0.5% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% Growth yoy 5.3% 21.6% 10.0% 13.3% 18.2% 6.1% 5.9% 4.6% 5.2%

Other 9,418 11,088 13,279 6,801 3,149 13,726 14,386 15,228 15,931 16,764 % of revenues 5.2% 5.1% 5.5% 5.2% 4.4% 5.0% 5.0% 5.0% 5.0% 5.0% Growth yoy 17.7% 19.8% 16.8% -0.5% 3.4% 4.8% 5.9% 4.6% 5.2%

EBITDA reported (Rbls 88,192 97,774 100,822 53,800 32,138 114,008 121,080 127,001 131,884 138,256 m) EBITDA margin reported 48.5% 45.4% 41.6% 41.4% 45.1% 42.0% 42.1% 41.7% 41.4% 41.2% Source: Company data, Credit Suisse estimates Profitability Our margin forecasts imply about 40bp margin pressure from 41.6% in 2011 and c150bp from 42.7% in 9M 2012 to 41.2% in 2016E. This is in line with management’s objective to keep margins above 40% (for the company: MegaFon management stated during the

MegaFon (MFONq.L) 68 08 January 2013 analyst presentation that its target was to keep EBITDA margins above 40%). In comparison, MTS (US GAAP) and Vimpelcom (IFRS) currently have margins at roughly 44.5% and 43% respectively in Russia (as of 9M 2012) which in our view presents more upside than downside risks to our profitability assumptions for MegaFon in the medium term..

Figure 116: Russia: Margin trends of the BIG 3

50%

48%

45%

43%

40%

38%

35% 2009 2010 2011 9M 2012

MegaFon MTS Vimpelcom

Source: Company data CAPEX As we discussed in the network section of the report, MegaFon has invested more than its competitors in the past three years. The company’s budgeted CAPEX plans imply Rbls 55- 60bn per annum for the three years from 2013E but said in the prospectus that 2012E CAPEX would be between Rbls 45bn and Rbls 50bn. We think medium-term CAPEX plans are reasonable particularly given historical investment relative to competition – implying 19-21% of revenues on our estimates. In our base case scenario, we use the top end of the budget, i.e. Rbls 60bn for 2013E-2015E. Balance sheet, capital structure and leverage As of 3Q 2012, MegaFon had US$5.1bn of debt representing 1.1x Net Debt/EBITDA (annualised 2012E). MegaFon’s debt is investment grade - S&P rating BBB- with negative outlook. 72% of debt is in roubles, 26% in US$ and the remaining 2% in euros. Average interest rate on MegaFon’s debt currently is 7.3% with rouble debt average cost of 8.9% (the latest rouble bond placement was priced at 8.05% - at a small premium to MTS’ bonds with similar maturity on our analysis), the bond issue was 3x oversubscribed and the coupon range reduced from 8.20%-8.45% to 8%-8.1%. The company has changed its capital structure relatively recently after the deal between Alfa Group, AF Telecom Holding and TeliaSonera, by raising US$5.3bn of debt in 2Q 2012. The repayment schedule implies about US$1bn debt repayment every year. The company considers 1.2-1.5x net debt / adjusted OIBDA (which the company calculates as reported net income + non-cash charges such as minority interest, FX gain/loss, bad debt expense + depreciation and amortisation) to be an optimal capital structure which we believe is reasonable in the telco sector context On our cash flow forecasts, the company will be able to repay part of its debt from cash flows after dividend payments.

MegaFon (MFONq.L) 69 08 January 2013

Figure 117: EEMEA telecom operators: Net debt/EBITDA, 2012E 3.0 2.5 2.0 1.5x 1.5

1.0 1.2x 0.5 0.0 -0.5 -1.0 -1.5

-2.0

Qtel

MTS

MTN

TPSA

Turkcell

Vodacom

Telkom SA Telkom

Vimpelcom

Rostelecom

Turk Telekom Turk

Etihad Etisalat Etihad

Telecom Egypt Telecom Cesky Telecom Cesky Magyar Source: Credit Suisse estimates Dividend policy and capacity Because of the long-standing shareholder dispute which was resolved after the deal with Alfa Group and resulted in a simplification of the shareholder structure, the company historically did not pay dividends despite being net cash positive; instead, it invested in the network. We calculate that the company generated a cumulative US$3.5bn in FCF over 2002-2011 during which it was FCF positive from 2006 onwards. The company is committed to a firm dividend policy which states dividend payments should be equal to 1) a maximum of 50% of net profits or 70% of cash flows and 2) a value, which may be negative, corresponding to the net debt capacity within the bounds of the optimal capital structure of 1.2-1.5x Net debt / EBITDA. The definitions, for the purpose of the dividend policy, are as follows:

■ Net profit = net income + non-cash items for the last financial year

■ Cash flows = Net profit + depreciation and amortisation - capital expenditures for the last financial year. On our forecasts, the company will be able to distribute at least cUS$1.1bn of dividends in 2013, cUS$1bn in 2014, cUS$1.1bn in 2015 and cUS$1.2bn in 2016E but the upside risks to this assumption could be quite material (50% or more) if the company does not undertake material acquisitions, is able to annually refinance the schedule debt payments and makes the decision to distribute excess cash flows that would correspond to net debt/EBITDA of 1.2-1.5x.

MegaFon (MFONq.L) 70 08 January 2013

Figure 118: MegaFon: Cash flow and dividend/deleveraging capacity In US$ m

2,000 c3,500 5,150 1,800

1,600

1,400

1,200

1,000

800

600

400

200

0 2002-2011 2012E 2013E 2014E 2015E 2016E

FCF (OCF-CAPEX) Scheduled debt repayment Dividends

Note: 2012E dividend includes a one-off lump-sum payment of accrued dividends to the three shareholders prior to April 2012 when the shareholder structure changed, Altimo, AF Telecom and TeliaSonera. Excludes excess cash flow payments. Source: Company reports for 2002- 2008,-Credit Suisse estimates

MegaFon (MFONq.L) 71 08 January 2013

Summary financial statements

Figure 119: MegaFon: Consolidated income statement Roubles in millions, unless otherwise stated 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E CAGR CAGR 2009- 2012E- 2011 2016E

Revenues 181,883 215,515 242,608 129,864 71,234 271,260 287,715 304,565 318,613 335,286 15.5% 5.4% Growth yoy 18.5% 12.6% 14.2% 12.3% 11.8% 6.1% 5.9% 4.6% 5.2%

Cost of revenues 37,204 48,423 58,896 32,796 17,349 67,432 71,730 76,800 80,712 84,989 Gross margin 79.5% 77.5% 75.7% 74.7% 75.6% 75.1% 75.1% 74.8% 74.7% 74.7%

Operating expenses 56,487 69,318 82,890 43,268 21,747 89,821 94,905 100,763 106,017 112,042 % of revenues 31.1% 32.2% 34.2% 33.3% 30.5% 33.1% 33.0% 33.1% 33.3% 33.4% Growth yoy 22.7% 19.6% 14.4% 1.3% 8.4% 5.7% 6.2% 5.2% 5.7% Non-recurring expenses

EBITDA, reported 88,192 97,774 100,822 53,800 32,138 114,008 121,080 127,001 131,884 138,256 6.9% 4.9% EBITDA margin, reported 48.5% 45.4% 41.6% 41.4% 45.1% 42.0% 42.1% 41.7% 41.4% 41.2% Growth yoy 10.9% 3.1% 9.7% 21.1% 13.1% 6.2% 4.9% 3.8% 4.8%

Depreciation and 31,344 38,874 47,676 26,211 13,872 54,160 56,178 57,892 57,626 57,278 amortisation

EBIT 56,848 58,900 53,146 27,589 18,266 59,847 64,902 69,109 74,258 80,978 EBIT margin 31.3% 27.3% 21.9% 21.2% 25.6% 22.1% 22.6% 22.7% 23.3% 24.2%

Finance costs / (income) -1,598 -3,171 -2,885 1,114 2,388 6,070 10,413 9,110 7,581 5,937 Other costs / (income) 389 185 21 67 -58 9 0 0 0 0 FX loss / (gain) 2,192 700 105 11,352 -2,594 8,002 0 0 0 0

Profit before tax 55,865 61,186 55,905 15,056 18,530 45,767 54,489 59,999 66,677 75,041 Income tax expense 10,565 11,962 12,320 4,041 3,552 10,229 10,898 12,000 13,335 15,008 Effective tax rate, adj. 19.0% 19.6% 22.0% 23.9% 19.0% 22.0% 20.0% 20.0% 20.0% 20.0%

Minority interest 11 52 6 41 52 123 121 107 101 102

Net income, reported 45,289 49,172 43,579 10,974 14,926 35,414 43,470 47,893 53,241 59,931 Net income margin, 24.9% 22.8% 18.0% 8.5% 21.0% 13.1% 15.1% 15.7% 16.7% 17.9% reported Growth yoy 8.6% -11.4% -48.8% -0.9% -18.7% 22.7% 10.2% 11.2% 12.6%

Net income, adj.* 47,283 49,894 43,704 20,056 12,851 41,816 43,470 47,893 53,241 59,931 -3.9% 9.4% Net income margin, adj.* 26.0% 23.2% 18.0% 15.4% 18.0% 15.4% 15.1% 15.7% 16.7% 17.9% Growth yoy 5.5% -12.4% -6.8% ! -4.3% 4.0% 10.2% 11.2% 12.6% * Net income is adjusted for one-offs (FX and derivatives gains/losses) net of tax impact. Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 72 08 January 2013

Figure 120: MegaFon: Consolidated cash flow statement Roubles in millions, unless otherwise stated 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E

Operating cash flows Net income 45,289 49,172 43,579 10,974 14,926 35,414 43,470 47,893 53,241 59,931 Depreciation and 31,344 38,874 47,676 26,211 13,872 54,160 56,178 57,892 57,626 57,278 amortisation Working capital change 500 -7,087 5,890 3,972 5,571 1,196 -571 474 -88 162 Non-cash adjustments 2,217 5,654 150 10,372 -3,728 6,381 1,801 1,907 1,995 2,099 Operating cash flow 79,350 86,613 97,295 51,529 30,641 97,152 100,879 108,166 112,773 119,469

Investing cash flows Capex 46,036 63,860 73,332 24,868 8,721 50,183 60,000 60,000 60,000 58,675 Acquisitions 833 10,418 10,825 0 8,439 8,439 17,768 0 0 0 Increase in short-term and 14,073 15,275 18,948 -80,374 993 -84,296 0 0 0 0 long-term investments Other -639 -732 -449 -206 -88 -206 0 0 0 0 Investing cash flow 60,303 88,821 102,656 -55,712 18,065 -25,880 77,768 60,000 60,000 58,675

Financing cash flows Equity -63,883 0 -46,406 Debt -9,784 -6,377 7,121 124,230 -10,328 121,121 -29,025 -17,250 -25,950 -19,855 Dividends -59 -147 0 -151,863 0 -151,863 -34,451 -29,100 -33,459 -37,074 Other -740 -637 -1,176 -2,454 -310 -2,454 0 0 0 0 Financing cash flows -10,583 -7,161 5,945 -93,970 -10,638 -79,602 -63,476 -46,350 -59,409 -56,929

Effect of FX -2,379 -514 -364 -737 -347 -347 0 0 0 0

Change in cash 6,085 -9,883 220 12,534 1,591 43,083 -40,365 1,817 -6,636 3,866 Beginning cash balance 6,465 12,550 2,667 2,887 15,421 2,887 45,970 5,605 7,421 786 Ending cash balance 12,550 2,667 2,887 15,421 17,012 45,970 5,605 7,421 786 4,652

FCF (OCF-CAPEX) 33,314 22,753 23,963 26,661 21,920 46,968 40,879 48,166 52,773 60,794 FCF (OCF-CAPEX- 32,481 12,335 13,138 26,661 13,481 38,529 23,110 48,166 52,773 60,794 M&A/licences) FCF (OCF-CAPEX-M&A- 32,422 12,188 13,138 -125,202 13,481 -113,334 -11,340 19,067 19,314 23,721 Dividends) Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 73 08 January 2013

Figure 121: MegaFon: Consolidated balance sheet Roubles in millions, unless otherwise stated 2009 2010 2011 1H 2012 3Q 2012 2012E 2013E 2014E 2015E 2016E

Assets Cash and cash equivalents 61,664 66,221 87,396 16,639 19,225 48,183 7,818 9,634 2,999 6,865 Trade and other 6,122 9,516 11,430 11,919 12,087 12,193 12,528 13,084 13,397 13,933 receivables Inventories 1,219 3,081 4,551 4,575 4,924 4,766 4,941 5,137 5,272 5,477 Prepaid expenses and 7,135 7,114 7,987 6,640 6,694 7,987 7,987 7,987 7,987 7,987 other current assets Pre-paid income taxes 3,238 6,975 6,957 5,106 4,313 6,957 6,957 6,957 6,957 6,957 Deferred tax assets 772 1,166 1,972 2,690 2,266 1,972 1,972 1,972 1,972 1,972 Current assets 80,150 94,073 120,293 47,569 49,509 82,057 42,202 44,772 38,583 43,191 PP&E and intangible 164,598 221,158 258,783 253,694 255,650 263,245 284,835 286,942 289,316 290,714 assets Deferred tax assets 210 506 712 756 784 712 712 712 712 712 Deferred finance charges 1,222 1,425 1,678 2,234 3,387 1,678 1,678 1,678 1,678 1,678 and expenses Long-term deposits 0 305 2,002 3 2 2 2 2 2 2 Non-current assets 166,030 223,394 263,175 256,687 259,823 265,637 287,227 289,334 291,708 293,106 Total assets 246,180 317,467 383,468 304,256 309,332 347,694 329,429 334,106 330,292 336,296

Liabilities Short-term debt 7,811 12,171 7,415 52,394 28,494 57,194 41,494 70,394 58,204 35,695 Accounts payable to 6,864 10,308 8,034 5,485 3,850 8,034 8,034 8,034 8,034 8,034 equipment suppliers Trade and other payables 8,446 9,923 16,107 19,262 23,267 18,280 18,219 19,447 19,805 20,709 Subscriber prepayments 7,083 7,303 7,895 7,165 7,288 7,895 7,895 7,895 7,895 7,895 Accrued expenses 3,141 2,840 5,360 3,220 4,012 5,360 5,360 5,360 5,360 5,360 Deferred revenue and 1,290 1,779 2,612 3,614 4,043 2,612 2,612 2,612 2,612 2,612 other current liabilities Other current liabilities 1,450 2,550 3,062 2,845 6,336 8,137 10,044 12,038 14,137 Current liabilities 34,635 45,774 49,973 94,202 73,799 105,711 91,752 123,786 113,949 94,442 Long-term debt 19,335 20,750 36,294 120,213 130,620 107,636 94,311 48,161 34,401 37,056 Deferred income tax 2,070 8,256 10,543 10,607 10,637 10,543 10,543 10,543 10,543 10,543 liability Other non-current liabilities 6,226 9,561 10,026 7,534 7,649 10,026 10,026 10,026 10,026 10,026 Non-current liabilities 27,631 38,567 56,863 138,354 148,906 128,205 114,880 68,730 54,970 57,625 Total liabilities 62,266 84,341 106,836 232,556 222,705 233,916 206,632 192,516 168,919 152,066

Equity Common shares 581 581 581 581 581 581 581 581 581 581 Treasury shares 0 0 0 -63,883 -63,883 -46,406 -46,406 -46,406 -46,406 -46,406 Reserve fund 17 17 17 17 17 17 17 17 17 17 Additional paid-in capital 13,870 13,855 13,852 13,852 13,852 13,852 13,852 13,852 13,852 13,852 Retained earnings 169,199 218,371 261,950 121,061 135,987 145,378 154,277 172,964 192,645 215,400 Accumulated other -255 -261 -291 -484 -557 -291 -291 -291 -291 -291 comprehensive loss Total Megafon 183,412 232,563 276,109 71,144 85,997 113,131 122,030 140,717 160,398 183,153 shareholders' equity Noncontrolling interest 502 563 523 556 630 646 767 874 975 1,077 Total equity 183,914 233,126 276,632 71,700 86,627 113,778 122,798 141,591 161,373 184,230

Total equity and liabilities 246,180 317,467 383,468 304,256 309,332 347,694 329,429 334,106 330,292 336,296 Source: Company data, Credit Suisse estimates

MegaFon (MFONq.L) 74 08 January 2013 Valuation DCF is our main target price method The assumptions we use in our DCF model include:

■ Rouble cash flow forecasts;

■ A current rouble / US$ exchange rate of 30.4;

■ 8% Russia rouble risk free rate in line with the current Russian local currency bond yields ;

■ 5% equity risk premium which is in line with the ERP we use for other Russian telecom stocks;

■ US$ risk free rate and US$ ERP has averaged c7% and c6% respectively over 2002- 2012 (according to Credit Suisse EEMEA strategy team database). This puts US$ cost of equity at about 13%and our DCF model assumption is 13% for roubles= cash flows;

■ 1% terminal FCF growth rate (same as for the Russian mobile stocks);

■ 30% target leverage;

■ 8.05% debt cost which is the current rouble financing rate of MegaFon based on the latest bond placement;

■ Tax rate of 20%;

■ The resulting cost of equity and WACC assumptions are 13% and 11% respectively. We use a fully diluted number of shares and GDRs of 620m, which includes 62m shares owned by MegaFon invest. We choose to use a fully diluted number of shares for the following reasons:

■ We include the potential number of shares that could be used in the second stage of the Euroset acquisition – according to the prospectus, the agreement between MegaFon and Garsdale allows the use of cash or shares for the acquisition of the second tranche of the 25% stake in Euroset. We estimate, based on our fundamental valuation, that MegaFon’s second 25% stake in Euroset may equal to 19.5m to 24.5m shares/GDRs for this acquisition, depending on the year MegaFon choses to wait. We dilute shares instead of cash. This account for about 3.1-4% of the total outstanding share capital;

■ The long-term incentive plan of the CEO, Ivan Tavrin, allows him to purchase from MegaFon’s subsidiary, MegaFon investments,

■ A 1.25% stake in the company within 30 days after the IPO at the IPO placement price (US$20 per GDR and share), which he reportedly already executed, according to MegaFon’s website; ■ Additionally, a 1.25% stake every year of his employment anniversary for three years – May 2013E, May 2014E and May 2015E – at the IPO price. ■ These two transactions (Euroset acquisition and CEO incentive plan) could use the majority of the ‘treasury shares’ now owned by MegaFon. Our DCF model yields an equity value of US$18.5bn, and a target price of US$30 per MegaFon GDR. This suggests 26% upside potential and implies the multiples presented in Figure 124.

MegaFon (MFONq.L) 75 08 January 2013

Figure 122: MegaFon: DCF model Roubles in millions, unless otherwise stated DCF valuations 2011 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E

Revenues 242,608 271,260 287,715 304,565 318,613 335,286 Revenues growth yoy 11.8% 6.1% 5.9% 4.6% 5.2%

EBITDA 100,822 114,008 121,080 127,001 131,884 138,256 EBITDA margin 41.6% 42.0% 42.1% 41.7% 41.4% 41.2% EBITDA growth yoy 13.1% 6.2% 4.9% 3.8% 4.8%

Depreciation 47,676 54,160 56,178 57,892 57,626 57,278

EBIT 53,146 59,847 64,902 69,109 74,258 80,978

Effective tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0%

NOPAT 42,517 47,878 51,922 55,287 59,407 64,782

Depreciation 47,676 54,160 56,178 57,892 57,626 57,278 Capex 73,332 50,183 60,000 60,000 60,000 58,675 Acquisition 10,825 8,439 17,768 0 0 0 WC change 5,890 1,196 -571 474 -88 162 Net Investments 42,371 5,658 21,019 2,582 2,286 1,559 % of revenues 17.5% 2.1% 7.3% 0.8% 0.7% 0.5%

FCF 146 42,220 30,903 52,705 57,121 63,224 68,754 73,436 77,015 79,277 80,070 FCF growth 28857.7% -26.8% 70.5% 8.4% 10.7% 8.7% 6.8% 4.9% 2.9% 1.0%

Discounted Cash flow 42,220 30,903 47,468 46,334 46,189 45,238 43,518 41,104 38,107 34,664 Terminal Value 348,994 Note: All calculations are on pre-potential offering basis. Source: Company data, Credit Suisse estimates

Figure 123: MegaFon: DCF valuations Roubles in billions, unless otherwise stated PV of Free Cash Flows 342,623 Terminal Value 348,994 Net Debt 2013E 127,985 Equity value end 2013E 563,631

Rouble US$ exchange rate 30.4 # of GDRs (m) 620.00

Equity value end 2013E (US$ bn) 18.5 Equity value per GDR end 2013E (US$) 30.0 Source: Credit Suisse estimates

Figure 124: MegaFon: Target Price implied multiples Target Price per GDR (US$) 30.0 Target Equity value (US$bn) 18.5 Implied multiples 2012E 2013E 2014E EV/EBITDA 6.0 5.7 5.3 PE 13.5 13.0 11.8 Dividend Yield (paid dividend) n/a 6.1% 5.2% FCF Yield 8.3% 7.3% 8.5% Source: Credit Suisse estimates

MegaFon (MFONq.L) 76 08 January 2013

Figure 125: MegaFon: DCF TP per GDR sensitivity to terminal growth and WACC assumptions Terminal growth rate -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% WACC 8.0% 34.0 37.0 41.0 47.0 54.0 64.0 79.0 9.0% 30.0 33.0 36.0 40.0 45.0 52.0 62.0 10.0% 27.0 29.0 31.0 34.0 38.0 43.0 50.0 11.0% 24.0 25.0 27.0 30.0 33.0 37.0 41.0 12.0% 21.0 23.0 24.0 26.0 29.0 32.0 35.0 13.0% 19.0 21.0 22.0 24.0 25.0 28.0 31.0 14.0% 18.0 19.0 20.0 21.0 23.0 24.0 27.0 Source: Credit Suisse estimates Cross check with multiple valuations MegaFon is currently trading at 4.8x EV/EBITDA, 10.3x PE, 7.7% DY and 9.1% FCFY for 2013E. This is broadly in line with MTS—the key operational and valuations comp for MegaFon in our view—at 4.6x EV/EBITDA, 10.2x PE, 7.3% DY and 8% FCFY. MegaFon’s current multiples are however at a discount to EEMEA telcos on 2013E PE and EV/EBITDA despite what we consider to be a more favourable sector environment. The notable exception are FCFY yields on which MegaFon looks more attractive than MTS and more in line with the EEMEA sector for both 2013E and 2014E. Given the balance of potential positives and risks, we think MegaFon’s equity should be valued at par with its key peer in Russia, MTS and think a premium valuation could be justified if the company continues to deliver superior execution and outperformance. We think the arguments for a premium valuation could be the following: ■ Superior growth profile in the broader sector context; ■ Strong historical execution relative to competition; ■ Lower competitive and regulatory risks compared with most markets; ■ Marginal network advantage over its main competitor. The multiples implied by our target price for MTS are 12x PE, 5.2x EV/EBITDA and 6% DY and 7% FCFY for 2013E. Our DCF model values MegaFon at par with MTS on DY and FCF metrics and at a slight premium on EV/EBITDA and PE multiples, which we think could be justified.

MegaFon (MFONq.L) 77 08 January 2013

Key valuation peers and their comps

Figure 126: MegaFon: Key valuation peers and their comps Company Market Cap Dividend (US$m) PE EV/EBITDA FCF Yield Yield 2012E 2013E 2014E 2012E 2013E 2014E 2012E 2013E 2014E 2012E 2013E 2014E MegaFon 14,783 10.7 10.3 9.3 5.0 4.8 4.4 8.3% 9.1% 10.7% nm 7.7% 6.5% Key peers MTS (Consensus) 18,236 10.2 9.6 8.6 4.8 4.4 4.1 8.0% 10.5% 9.1% 6.2% 7.1% 8.4% MTS 18,236 10.0 9.5 8.8 4.5 4.4 4.1 7.1% 8.6% 9.4% 7.5% 7.9% 8.5% Vimpelcom (consensus) 19,506 10.7 9.7 8.3 4.4 4.2 3.9 8.1% 7.4% NA 6.2% 7.1% 6.9% Vimpelcom 19,506 11.3 9.8 8.4 5.2 5.1 4.8 7.7% 7.9% 10.0% 6.7% 6.7% 6.7% Etihad Etisalat 12,833 8.2 7.4 7.0 6.4 5.6 5.1 7.4% 10.1% 11.7% 6.2% 8.0% 9.5% MTN 34,291 12.5 11.3 10.4 5.3 5.0 4.7 7.2% 8.7% 9.8% 5.8% 6.6% 7.2% Qtel 9,141 10.2 8.4 7.7 5.0 4.1 3.6 15.0% 12.9% 18.9% 2.9% 3.8% 4.8% Turkcell 13,599 12.5 11.1 10.0 5.1 4.8 5.3 4.9% 5.6% NA 3.0% 6.0% 5.6% Vodacom 17,734 14.3 12.1 11.4 7.2 6.7 6.3 7.4% 7.3% 7.5% 7.0% 7.5% 8.0% Average 11.1 9.9 9.0 5.3 4.9 4.7 8.1% 8.8% 10.9% 5.7% 6.7% 7.3% Min 8.2 7.4 7.0 4.4 4.1 3.6 4.9% 5.6% 7.5% 2.9% 3.8% 4.8% Max 14.3 12.1 11.4 7.2 6.7 6.3 15.0% 12.9% 18.9% 7.5% 8.0% 9.5%

Large Cap Emerging market stocks America Movil 98,658 12.7 11.8 11.2 6.1 5.5 5.1 9.0% 9.9% 10.0% 1.2% 1.7% 3.1% Advanced Info Service PCL 20,360 17.2 15.0 13.5 9.8 9.4 8.6 6.8% 3.6% 6.0% 5.8% 6.7% 7.4% Bharti Airtel Ltd 19,560 24.0 20.2 14.8 7.0 6.3 5.2 6.5% 7.6% 14.1% 0.4% 0.4% 0.4% China Mobile Limited 222,684 11.2 10.9 10.3 4.2 3.8 3.5 6.6% 7.4% 8.6% 3.8% 3.9% 4.8% DiGi.Com 13,914 32.2 24.0 22.8 14.2 13.5 12.9 4.3% 4.6% 4.6% 4.2% 4.2% 4.4% Maxis Berhad 17,332 23.8 24.4 24.8 13.3 13.5 13.8 4.9% 5.2% 5.2% 5.7% 5.7% 5.7% Average 20.2 17.7 16.2 9.1 8.7 8.2 6.3% 6.4% 8.1% 3.5% 3.8% 4.3%

Developed market comp AT&T 221,183 15.9 14.3 13.0 6.7 6.5 6.2 6.9% 6.9% 7.7% 4.6% 4.7% 4.8% France Telecom 32,242 14.1 6.8 7.0 4.2 4.2 4.5 21.9% 20.3% 19.1% 12.8% 12.3% 11.8% Telefonica 61,744 9.5 9.6 10.1 4.8 4.8 4.7 14.8% 12.4% 16.0% 0.0% 7.2% 7.2% Verizon 134,266 19.1 15.7 13.5 4.6 4.1 3.7 4.3% 6.0% 7.1% 4.3% 4.4% 4.5% Vodafone Group 141,726 11.9 11.3 11.8 8.1 8.6 8.7 6.4% 5.9% 5.7% 5.3% 5.7% 5.7% European integrated 11.1 10.1 10.1 5.0 4.9 4.8 10.2% 10.3% 10.8% 7.6% 8.3% 8.6% average Average 13.6 11.3 10.9 5.6 5.5 5.4 10.7% 10.3% 11.1% 5.8% 7.1% 7.1% Multiples are based on prices as of 4 January 2013

Source: Credit Suisse estimates, IBES consensus Historical multiple trends for MTS and the global telecom sector We also think that Russian telcos are currently undervalued by the market (this argument excludes Vimpelcom as we think it is subject to higher risks than MTS and MegaFon). Global telcos have derated since 2007 with PEs falling from 14x to 8x at the trough and c10-11x over 2009-2011 but have seen PEs going up to 12x by the end of 2012E. Russian telcos multiples (MTS) have seen derating through most of 2012, improving towards the end of the year. Given the sector and macro environment, we do not think Russian telcos deserve a discount to the global sector and this is particularly true for the stronger player in the sector (competitors could deserve a premium to the local market in our view).

MegaFon (MFONq.L) 78 08 January 2013

Figure 127: MTS: 2012E consensus PE multiples Figure 128: Global telecom PEs: 2007- ytd 2013

12.0 9.0% 18.0 11.0 8.0% 17.0 10.0 7.0% 16.0 9.0 6.0% 15.0 8.0 5.0% 14.0 7.0 4.0% 6.0 3.0% 13.0 5.0 2.0% 12.0 4.0 1.0% 11.0 3.0 0.0% 10.0 9.0 8.0 01/01/2007 01/01/2009 01/01/2011 01/01/2013 12 month forward consensus EV/EBITDA 12 month forward consensus PE Global Telecom Services, 12m fwd PE Dividend yield Emerging Market Telecom Services, 12m fwd PE

Source: IBES Source: Thomson Reuters Premium growth in the sector context MegaFon has been delivering one of the fastest growth rates in the global mobile sector . We expect growth to remain at the top end of the range and we think this could support premium valuations if premium growth rates are sustained.

Figure 129: Global mobile revenue growth: History versus outlook

25%

20%

15%

10%

5%

0%

Qtel

DiGi

MTS MTN

-5% Maxis

Turkcell

Vodacom MegaFon

Vodafone

Vimpelcom

Bharti Airtel Bharti

China Mobile China

America Movil America

Etihad Etisalat Etihad Advanced Info Service Info Advanced

CAGR 2009-2011 CAGR 2012E-2014E

Source: Company data, Credit Suisse estimates Case study of premium valuations: MTS versus Vimpelcom In 2006-2007 Vimpelcom had superior execution, superior network and superior product, in our view, which resulted in operational outperformance and premium valuations versus its key competitor, MTS – the leading group at the time, as well as global peers.

MegaFon (MFONq.L) 79 08 January 2013

If MegaFon continues to deliver superior execution – and we believe the company has assets to do so – we think this could also support the argument for a premium valuation for MegaFon.

Figure 130: 12-month forward consensus P/Es: MTS Figure 131: 12-month forward consensus EV/EBITDAs: versus Vimpelcom MTS versus Vimpelcom 20.0 10.0 18.0 9.0 16.0 8.0 14.0 7.0 12.0 6.0 10.0 5.0 8.0 4.0 6.0 3.0 4.0 2.0 2.0 1.0 0.0 0.0

MTS Vimpelcom MTS Vimpelcom

Source: IBES Source: IBES Sensitivity of various multiple based valuations Below we also present a sensitivity analysis of MegaFon’s equity value to various multiple- based valuation methods and assumptions. We provide this as a reference point should investors choose to value MegaFon using multiple valuations.

Figure 132: MegaFon: equity value sensitivity to various P/E assumptions Target P/E multiples 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0

Net income, adj. 2012E 41.8 41.8 41.8 41.8 41.8 41.8 41.8 41.8 41.8 41.8 41.8 (Rbls bn) Equity value (Rbls bn) 292.7 313.6 334.5 355.4 376.3 397.3 418.2 439.1 460.0 480.9 501.8 Equity value (US$bn) 9.6 10.3 11.0 11.7 12.4 13.1 13.8 14.4 15.1 15.8 16.5

Net income, adj. 2013E 43.5 43.5 43.5 43.5 43.5 43.5 43.5 43.5 43.5 43.5 43.5 (Rbls bn) Equity value (Rbls bn) 304.3 326.0 347.8 369.5 391.2 413.0 434.7 456.4 478.2 499.9 521.6 Equity value (US$bn) 10.0 10.7 11.4 12.2 12.9 13.6 14.3 15.0 15.7 16.4 17.2

Net income, adj. 2014E 47.9 47.9 47.9 47.9 47.9 47.9 47.9 47.9 47.9 47.9 47.9 (Rbls bn) Equity value (Rbls bn) 335.2 359.2 383.1 407.1 431.0 455.0 478.9 502.9 526.8 550.8 574.7 Equity value (US$bn) 11.0 11.8 12.6 13.4 14.2 15.0 15.8 16.5 17.3 18.1 18.9 Source: Credit Suisse estimates

MegaFon (MFONq.L) 80 08 January 2013

Figure 133: MegaFon: equity value sensitivity to various EV/EBITDA assumptions Target EV/EBITDA 4.0 4.25 4.5 4.75 5.0 5.25 5.5 5.75 6.0 6.25 6.5 6.75 7.0 multiples

EBITDA 2012E (Rbls bn) 114.0 114.0 114.0 114.0 114.0 114.0 114.0 114.0 114.0 114.0 114.0 114.0 114.0 Net debt 2012E (Rbls bn) 116.6 116.6 116.6 116.6 116.6 116.6 116.6 116.6 116.6 116.6 116.6 116.6 116.6 Equity value (Rbls bn) 339.4 367.9 396.4 424.9 453.4 481.9 510.4 538.9 567.4 595.9 624.4 652.9 681.4 Equity value (US$ bn) 11.2 12.1 13.0 14.0 14.9 15.9 16.8 17.7 18.7 19.6 20.5 21.5 22.4

EBITDA 2013E (Rbls bn) 121.1 121.1 121.1 121.1 121.1 121.1 121.1 121.1 121.1 121.1 121.1 121.1 121.1 Net debt 2013E (Rbls bn) 128.0 128.0 128.0 128.0 128.0 128.0 128.0 128.0 128.0 128.0 128.0 128.0 128.0 Equity value (Rbls bn) 356.3 386.6 416.9 447.1 477.4 507.7 538.0 568.2 598.5 628.8 659.0 689.3 719.6 Equity value (US$bn) 11.7 12.7 13.7 14.7 15.7 16.7 17.7 18.7 19.7 20.7 21.7 22.7 23.7

EBITDA 2014E (Rbls bn) 127.0 127.0 127.0 127.0 127.0 127.0 127.0 127.0 127.0 127.0 127.0 127.0 127.0 Net debt 2014E (Rbls bn) 108.9 108.9 108.9 108.9 108.9 108.9 108.9 108.9 108.9 108.9 108.9 108.9 108.9 Equity value (Rbls bn) 399.1 430.8 462.6 494.3 526.1 557.8 589.6 621.3 653.1 684.8 716.6 748.3 780.1 Equity value (US$bn) 13.1 14.2 15.2 16.3 17.3 18.3 19.4 20.4 21.5 22.5 23.6 24.6 25.7 Source: Credit Suisse estimates

Figure 134: MegaFon: equity value sensitivity to various Dividend Yield assumptions Target Dividend yield 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0%

Dividend 2013E (declared 34.5 34.5 34.5 34.5 34.5 34.5 34.5 34.5 34.5 34.5 34.5 from 2012E earnings (Rbls bn) Equity value (Rbls bn) 689.0 626.4 574.2 530.0 492.2 459.3 430.6 405.3 382.8 362.6 344.5 Equity value (US$bn) 22.7 20.6 18.9 17.4 16.2 15.1 14.2 13.3 12.6 11.9 11.3

Dividend 2014E (declared 29.1 29.1 29.1 29.1 29.1 29.1 29.1 29.1 29.1 29.1 29.1 from 2013E earnings (Rbls bn) Equity value (Rbls bn) 582.0 529.1 485.0 447.7 415.7 388.0 363.7 342.3 323.3 306.3 291.0 Equity value (US$bn) 19.1 17.4 16.0 14.7 13.7 12.8 12.0 11.3 10.6 10.1 9.6 Source: Credit Suisse estimates Transaction implied valuations In April 2012, Altimo sold its stake in MegaFon to MegaFon and AF Telecom owned by Mr. Usmanov. TeliaSonera also exited Telecominvest – an investment vehicle which owned a 31.3% stake in MegaFon – by selling its 26.1% stake in Telecominvest to AF Telekom with a deferred payment structure. The equity valuations of MegaFon implied by these three transactions was between US$15.3bn and US$15.8bn (assuming Telecominvest’s primary asset is MegaFon and also taking into account additional cash payment of US$200m by TeliaSonera to Altimo). We would also note that Rouble / US$ exchange rate in April 2012 was about 5% lower than current exchange rate of Rbls/US$31.1 we use in our calculations.

MegaFon (MFONq.L) 81 08 January 2013

Figure 135: MegaFon: Transaction implied valuations Seller Altimo Altimo TeliaSonera Buyer MegaFon Investments AF Telecom (Mr. Usmanov) AF Telecom (Mr. Usmanov) Asset MegaFon MegaFon Telecominvest (31.3% stake in MegaFon) Stake acquired 14.4% 10.7% 8.2% Acquisition price (US$ bn) 2.16 1.61 1.45 Implied headline equity value 15.0 15.0 17.7 (US$ bn) Additional payment by 0.20 -0.20 TeliaSonera to Altimo (US$ bn) Implied adjusted equity value 15.8 15.3 (US$ bn) Source: Company data, Credit Suisse estimates Potential M&A risks According to the company, approximately US$ 233m of the IPO proceeds are to be used to repay and/or refinance existing debt and the remainder is to be used for general corporate purposes, including the continuing development and expansion of MegaFon’s network. The company is planning to pursue disciplined and selective M&A policy focusing on in-market strategic opportunities. Having said that the company has completed an acquisition of a 25% stake in the largest mobile retailer, Euroset, and may be required to purchase an additional 25% stake from its shareholder in 1-3 years’ time. Given the structure and valuations reported in prospectus, this would imply an initial cash outflow of US$535m in 2013 and from US$535m up to US$737m depending on how long the company chooses to wait to undertake the acquisition of the second tranche of the 25% from Garsdale. We think this acquisition makes strategic sense and in our base case scenario should be valuation neutral for MegaFon, although it still may have M&A execution risks embedded. Moreover, MegaFon currently has a common shareholder with Yota which is also a counterparty to 4G MVNO agreement. Although there has been no indication that MegaFon may consider an acquisition of Yota in the future, which we think might be a natural avenue to explore and would make strategic sense, this could also potentially raise M&A risks. Growth adjusted relative valuations Telecom operators with earnings and EBITDA growth rates similar to MegaFon trade in the range of 10x-12.5x PE and 4.5x-5x EV/EBITDA.

Figure 136: Telecom valuations: 3 year EPS growth vs Figure 137: Telecom valuations: 3 year EBITDA growth vs 2012E P/Es 2012E EV/EBITDAs 20.0 9.0 Vodacom 18.0 Verizon Vodafone8.0 Vodacom 16.0 TPSA MTN 7.0 Etihad AT&T 14.0 AT&T MTN 6.0 Telefonica CR China Mob 12.0 VimpelCom Vodafone Rostelecom Telefonica CR MegaFon MTS 5.0 Qtel MegaFon Qtel VimpelCom Telefonica MTS Telefonica 10.0 Magy ar Verizon Etihad France Tel 4.0 Rostelecom Tel Egy pt TPSA France Tel 8.0 China Mob Magy ar 3.0 6.0 Telkom SA Telkom SA 4.0 2.0 Tel Egy pt 2.0 1.0

0.0 0.0 -20.0% -15.0% -10.0% -5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% -10% -5% 0% 5% 10% 15% 20% Note: The main reason for lower earnings growth for Megafon Source: Credit Suisse estimates between 2011 and 2014E is a one off change in the capital structure in 2012 a result of which was an increase in leverage from effectively zero to 1.4x by the end of 1H 2012. Source: Credit Suisse estimates

MegaFon (MFONq.L) 82 08 January 2013

Returns comparison

Figure 138: EEMEA Telecom ROIC, 2012E Figure 139: EEMEA Telecom ROE, 2012E

45% 60% 40% 50% 35% 30% 40% 25% 30% 20% 15% 20% 10% 10% 5%

0% 0%

Qtel

Qtel

AT&T

AT&T

TPSA

TPSA

Verizon

Verizon

Turkcell

Turkcell

MegaFon

MegaFon

Telefonica

Telefonica

VimpelCom

VimpelCom

MTN Group MTN

MTN Group MTN

Rostelecom

Rostelecom

Turk Telekom Turk

Turk Telekom Turk

Etihad Etisalat Etihad

Etihad Etisalat Etihad

Telkom SA Ltd SA Telkom

Telkom SA Ltd SA Telkom

Telecom Egypt Telecom

Telecom Egypt Telecom

France Telecom France

France Telecom France

Vodacom Group Vodacom

Vodacom Group Vodacom

Vodafone Group Vodafone

Vodafone Group Vodafone

Magyar Telekom Magyar

Magyar Telekom Magyar

Telefonica O2 CR O2 Telefonica

Telefonica O2 CR O2 Telefonica Mobile Telesystems Mobile Mobile Telesystems Mobile Source: Credit Suisse estimates Source: Credit Suisse estimates

MegaFon (MFONq.L) 83 08 January 2013 Appendix Management profile Ivan Tavrin - Chief Executive Officer

■ Appointed Chief Executive Officer of MegaFon on 20 April 2012

■ Previously Deputy CEO and member of the Management Board since March 2012

■ Extensive experience in the Russian media industry and pioneer in its development over the past 15 years

■ Founded the advertising firm “Construct-Region” in 1997; developed into the largest agency in the regional advertising market

■ Closely involved in founding, owning and operating a number of successful Russian media companies, including Regional Media Group, Media One Holding, Vyberi Radio Group and TV-3

■ Currently Chairman of the Board and shareholder in media holding UTH (with interests in MUZ-TV and Disney Channel); previously held the post of CEO of UTH

■ Currently Chairman of Kommersant Holding and board member of Mail.ru

■ In 2009, awarded “Russia’s Media Manager of the Year”

■ Born in Moscow and graduate of the Moscow State Institute of International Relations (MGIMO) Mikhail Dubin - Executive Director Consumer Business

■ Appointed as Executive Director of Consumer Business in Oct 2012

■ Deputy CEO for Strategic Development since June 2010

■ Previously Deputy CEO of Telecominvest

■ Previously Head of Telecom Project Finance Group at Sberbank, having financed the majority of the largest TMT projects

■ 12 years of TMT experience Gevork Vermishyan - Chief Financial Officer

■ CFO since July 2011

■ Previously Director in Corporate Finance at AFK Sistema

■ 10 years of finance / 5 years TMT experience Valery Ermakov - Director, Regional Operations

■ Appointed as Director, Regional Operations in Oct 2012

■ COO since April 2009

■ Previously General Director of MegaFon Volga since 2001

■ 18 years of TMT experience Dmitry Kononov - Director for Business Development – M&A, Director of Investor Relations

■ Recently appointed Director of Investor Relations

MegaFon (MFONq.L) 84 08 January 2013

■ Director for Business Development – M&A since December 2008

■ Joined MegaFon in 2000

■ Served as the company’s CFO between 2002 and 2004

■ 19 years of TMT experience Oleg Butenko - CEO MegaLabs

■ MegaLabs CEO since 2012

■ Previously member of the Board at Telecominvest and Chairman of the Board at Centre of Media Technologies

■ 10 years of TMT experience with focus on business building and media/technology projects Board of Directors composition and Director profiles Sergey Soldatenkov Chairman of the Board Sergey Soldatenkov has been a board member since May 2012. He has been the Chief Executive Officer of MegaFon since 2003 through April 2012. He has held several positions including Deputy General Director for Commerce, Acting General Director & General Director of North-West Telecom. He has also been a Vice President at United Company GROS LLC. Mr Soldatenkov graduated from the Leningrad Institute of Aviation Instrument Engineering with a degree in radio engineering. Tero Kivisaari - Member of the Board of directors Tero Kivisaari has been a board member since April 2008. He is currently the President of TeliaSonera Eurasia, where he previously held the positions of Finance director and Vice president. He has degrees from the Helsinki University of Technology and the Helsinki School of Economics and Business Administration. Mr Kivisaari is a member of the Audit Committee Jan Rudberg - Independent member of the Board of directors Jan Rudberg has been a board member since June 2010. He has been a Corporate advisor since 2003, and is also Board chairman of Hogia AB. Previously, he was Executive vice president of Telia, CEO of Tele2, Executive vice president of Nordbanken, CEO of Enator, and CEO of Ericsson Information Systems Nordic. He is a graduate of Gothenburg School of Business Administration. Lars Nyberg - Member of the Board of directors Lars Nyberg has been a board member since May 2012. He has been President and CEO of TeliaSonera since 2007. Mr. Nyberg is also Chairman of DataCard Corp. and of Autoliv Inc. Between 1995 and 2003 he was Chairman and CEO of NCR Corp, where he continued as Chairman until 2005. Previously, Mr. Nyberg held several managerial positions in Philips, and was a member of Philips Group Management Committee. Mr. Nyberg holds a Bachelor of Science in Business Administration. Vladimir Streshinskiy - Member of the Board of directors Vladimir Streshinskiy has been a board member since June 2008. He is also the CEO of Telecominvest and a director at the Kommersant publishing house, Mail.ru Group Limited, UTH Russia Limited and New Media Technologies Capital Partners Limited. He is a graduate of the Moscow Institute of Physics and Technology (MFTI). Mr Streshinskiy is Chairman of the Finance Committee.

MegaFon (MFONq.L) 85 08 January 2013

Cecilia Edström - Member of the Board of directors Cecilia Edström has been a board member since May 2012. She has been a Senior vice president and Head of Group Communications of TeliaSonera since May 2008. Previously, Ms. Edström was Senior vice president and Head of Corporate Relations at Scania AB, where she held a number of senior positions since 1995. She started her career in corporate finance at SEB in 1989. She is also a member of the Board of BE Group AB. Ms. Edström holds a Bachelor of Science in Finance and Business Administration. Jan David Erixon - Member of the Board of directors Jan David Erixon has been a board member since May 2012. Mr. Erixon previously was Vice president of Products and Customer experience at Yota Group and Global brand director of Vodafone PLC. Currently Mr. Erixon is a partner in the business transformation consultancy The Zone and holds a position as dean at Strelka Institute in Moscow. Mr Erixon studied Media & Communication Science at Gothenburg University in and Information Systems at Kingston University in London. David Erixon is the co-founder of internationally renowned digital school Hyper Island and Scandinavian based design agency Doberman. MegaFon’s network coverage

Figure 140: MegaFon: 2G and 3G network coverage European Russia (1) Asian Russia(2) c.80% of Population c.20% of Population (3) Number of sites (% of total) Number of sites (% of total) (3) 2G: 25.1k (81%) 2G: 6.0k (19%) 3G: 22.6k (83%) 3G: 4.8k (17%)

2G coverage LTE/4G on air

3G coverage LTE/4G coming

Source: Company data

MegaFon (MFONq.L) 86 08 January 2013

Russian mobile data tariffs

Figure 141: Mobile data offers: Moscow Price in roubles MegaFon Name Speed Daily Limit Daily Price Phone 30 MB 5 Phone /smartphone 3G Smartphone 70 MB 10 Smapthone 4G 10 Mbps 100 MB 20 Phone /smartphone 3G+4G Smartphone 4G Pro 20 Mbps 200 MB 30 Monthly Limit Monthly Price Internet S 3 Mbps 3 GB 390 USB Modem/Tablets 3G Internet M 5 Mbps 6 GB 690 Internet L 10 Mbps 10 GB 990 USB Modem/Tablets 3G+4G Internet XL 20 Mbps 20 GB 1290 Internet XXL 30 GB 1590 MTS Daily Limit Daily Price MiniBit 15 MB 15 Daily Limit Monthly Price Phone /smartphone Bit 50 MB 149 Super Bit 100 MB 299 Limit Monthly Price Bezlimit na den` 250 MB/day 30/day Bezlimit - Mini 4 GB 500 USB Modem/Tablets 3G Bezlimit - Maxi 7 GB 700 Bezlimit - Super 12 GB 1000 Bezlimit - VIP 25 GB 1400 USB Modem/Tablets 4G Bezlimit -Super 4G Unlim free till 1st Oct Vimpelcom Monthly Limit Price Daily unlimited 2 GB 13/day Phone /smartphone Monthly unlimited 2 GB 390/month Daily unlimited + Wi-fi 2 GB 13/day Tablets Monthly unlimited 6 GB 600/month Prostoy 2 GB 3.30/MB USB Modem For USB modem 2 GB 295 Bezlimit 3 GB 495 Yota Monthly Limit Price 1 -15 Mbps 600-1350 USB Modem 4G Unlim Max 1400 Source: Company data, Credit Suisse research

MegaFon (MFONq.L) 87 08 January 2013

Figure 142: Mobile data offers: Novosibirsk Price in roubles MegaFon Name Speed Limit Price Phone/smartphone 3G Bezlimitniy 14.4 Mbps 30 MB/day 3 Rbls/day Phone/smartphone 3G Bazoviy 512 Kbps 1 GB 149 Optimalniy 1 Mbps 2 GB 249 Progressivniy 2 Mbps 8 GB 399 Maximalniy 14.4 Mbps 15 GB 690 Extremalniy 14.4 Mbps 30 GB 999 3G Modem ModemE 173 7.2 Mbps unlim 19 Rbls/day Modem E1820 14.4 Mbps unlim 19 Rbls/day Modem E367 21 Mbps unlim 20 Rbls/day Start 4G 10 Mbps 20 GB 799 4G Modem Uskorenniy 4G 20 Mbps 35 GB 1099 MTS Daily Limit Daily Price MiniBit 5 MB 10 Name Daily Limit Monthly Price Bit 50 MB 129 Phone/smartphone Super Bit 100 MB 199 Limit Monthly Price Bezlimit na den` 500 MB 30 Rbls /day Bezlimit - Mini 3 GB 290 Bezlimit - Maxi 20 GB 450 USB Modem/Tablets 3G Bezlimit - VIP 40 GB 650 USB Modem/Tablets 4G Bezlimit -Super 4G Unlim free til 1st Oct Vimpelcom Monthly Limit Price Daily unlimited 2 GB 7 Rbls/day Phone /smartphone Monthly unlimited 2 GB 180 Daily unlimited 2 GB 7 Rbls/day Tablets Monthly unlimited 2 GB 180 Prostoy 7.2 Mbps 50 MB/day 1.5 Rbls/mb USB Modem Startoviy internet 7.2 Mbps 2 GB 245 Optimalniy internet 7.2 Mbps 5 GB 395 Premium internet 7.2 Mbps 15 GB 645 Yota Monthly Limit Price 1-10 Mbps 400-950 USB Modem 4G Unlim Max 1000 Source: Company data, Credit Suisse research

MegaFon (MFONq.L) 88 08 January 2013

Russian mobile voice, SMS and bundled tariffs

Figure 143: Mobile voice, SMS and bundled tariffs: Moscow MegaFon Price SMS Data Name On net Off net 3.5 Rbls, 0 Rbls after Perehodi na 0 0 Rbls 6th minute, 1.5 Rbl 1.9 Rbls 6 Rbls /MB ater 30 minute

0.03 Rbl per second 0.03 Rbl per second Za 3 1.9 Rbls 7 Rbls /MB (1.8 Rbls per min) (1.8 Rbls per min)

1.2 Rbls, 2.4 Rbl for 1.2 Rbl, 2.4 Rbl for the 1.5 Rbls, 0.15 Rbl after О"Hard 3 Rbls /MB the 1st minute of talk 1st minute of talk 10 messages a day

1000 Rbls incl.: unlimited on-net minutes, 900 off-net minutes + 3000 SMS + 30 MB of data Bezlimitniy traffic a day MTS Price SMS Data Name On net Off net 0 Rbls, within 60 3 Rbls 2 Rbls Superpaying MTS. lessAfter than paying 400 400 Rbls Rbls or exceeding minutes a day Free limits 1.5 Rbls 3 Rbls 2 Rbls 15 Rbls/15 MB a day

Red Energy 1.9 Rbls 1.9 Rbls 1.9 Rbls 8.45 Rbls/MB

1000 Rbls incl.: 900 minutes + unlimited on net SMS and 30 off net SMS a day + 70 MB of data Maxi traffic a day Vimpelcom Price SMS Data Name On net Off net 1.5 Rbls, 2.75 Rbls for 1.5 Rbls, 2.75 Rbls for Go! 1.5 Rbls 8.45 Rbls/Mb the 1st minute of talk the 1st minute of talk

0 Rbls, within 60 Nol` somneniy. After paying above 390 Rbls 3 Rbls 2 Rbls 8 Rbls/Mb minutes a day paying less than 390 Rbls or exceeding limits 1.5 Rbls 3 Rbls 2 Rbls 8 Rbls/Mb

Prostoy 1.7 Rbls 1.7 Rbls 2.95 Rbls 8.45 Rbls/Mb

All inclusive XXL 1000 Rbls incl.: 900 minutes + 100 SMS a day + 2 GB of data traffic a month

Source: Company data, Credit Suisse research

MegaFon (MFONq.L) 89 08 January 2013

Figure 144: Mobile voice, SMS and bundled tariffs: Novosibirsk

MegaFon Price SMS Data Name On net Off net On net Off net

0.6 Rbls 0-6 min, 0 Perehodi na 0 Rbls 6-35 min and 1.1 Rbls 0.6 Rbls 1.5 Rbls 8 Rbls/MB after 35 min

Prostor obscheniya 0.4 Rbls 0.4 Rbls 1.2 Rbls 1.2 Rbls 8 Rbls/MB

Chestnoe slovo 1.1 Rbls 1.1 Rbls 1.1 Rbls 1.5 Rbls 1.1 Rbls/MB

21 Rbls a day (630 Rbls a month) inlc.: unlimited on-net calls, 10 minutes a day of off-net calls + 5000 Maximum 2012 - unlim 21 Rbls a day SMS a month + 30 MB of data traffic a day MTS Price SMS Data Name On net Off net On net Off net 0 Rbls within 30 0 Rbls within 30 1.3 Rbls 1.5 Rbls 8.45 Rbls/MB Super МТS. After paying 100 Rbls minutes a day SMS a day paying less than 100 Rblsles, or exceeding 0.5 Rbls 1.3 Rbls 1.5 Rbls 1.5 Rbls 8.45 Rbls/MB 30 min/30 SMS 0 Rbls, the option Red Energy 1 Rbl 1 Rbl costs 3 Rbls/day, 1 Rbl 8.45 Rbls/MB the option may be canceled

Maxi 325 Rbls incl.: unlimited on-net calls, 150 minutes of off-net calls + 30 SMS a day + free data traffic

Vimpelcom Price SMS Data Name On net Off net On net Off net 0.3 Rbls, 0.9 Rbl 0.3 Rbls, 0.9 Rbl 1.5 GB a month for Go! for the first minute for the first minute 0.9 Rbl 0.9 Rbl 5 Rbls a day, of talk of talk optionally Nol` somneniy. After paying above100 Rbls, 0 Rbls 1.3 Rbls 1.5 Rbls 1.5 Rbls 9.95 Rbls/MB within 60 min a day paying less than100 Rblsles or above 60 minutes a day 0.3 Rbl 1.3 Rbls 1.5 Rbls 1.5 Rbls 9.95 Rbls/MB

All inclusive L, unlim 900 Rbls a month 300 Rbls incl.: 200 minutes + 2000 SMS + 200 MB of data traffic a month

Tele2 Price SMS Data Name On net Off net On net Off net Vmeste deshevle 0.15 Rbl 1 Rbl 0.15 Rbl 0.55 Rbl 4.10 Rbls/MB 0.45 Rbl, 1 Rbl 0.45 Rbl, 1 Rbl starting from 61 starting from 61 0.45 Rbl 0.45 Rbl Tak prosto minute a day minute a day 4.10 Rbls/MB 0.15 Rbl, 1 Rbl 0.15 Rbl, 1 Rbl starting from 61 starting from 61 0.55 Rbl 0.55 Rbl Vse na svyazi minute a day minute a day 4.10 Rbls/MB Source: Company data, Credit Suisse research

MegaFon (MFONq.L) 90 08 January 2013

Companies Mentioned (Price as of 04-Jan-2013) Hutchison Telecommunications HK Holdings Ltd. (0215.HK, HK$3.45) KT Corp (030200.KS, W36,500) China Telecom (0728.HK, HK$4.3) China Unicom Hong Kong Ltd (0762.HK, HK$12.78) China Mobile Limited (0941.HK, HK$90.65) ChungHwa Telecom (2412.TW, NT$93.9) Taiwan Mobile (3045.TW, NT$103.5) Far EasTone Telecom (4904.TW, NT$73.7) Etihad Etisalat (7020.SE, SAR76.75) Advanced Info Service PCL (ADVA.BK, Bt205.0) America Movil (AMX.N, $24.19) Axiata Group Berhad (AXIA.KL, RM6.74) Bharti Airtel Ltd (BRTI.BO, Rs327.1) DiGi.Com (DSOM.KL, RM5.23) Total Access Communication PCL (DTAC.BK, Bt86.25) Entel Chile (ENT.SN, CLP$9875.5) Telecom Egypt (ETEL.CA, £E14.4) XL Axiata Tbk (EXCL.JK, Rp5,750) Facebook Inc. (FB.OQ, $28.76) France Telecom (FTE.PA, €8.507) Globe Telecom Inc (GLO.PS, P1078.0) Groupon Inc. (GRPN.OQ, $5.28) Idea Cellular Ltd (IDEA.BO, Rs109.7) PT Indosat Tbk (ISAT.JK, Rp6,850) Mail.Ru (MAILRq.L, $35.5) Mobile Telesystems (MBT.N, $19.0, OUTPERFORM, TP $22.0) MegaFon (MFONq.L, $23.8, OUTPERFORM[V], TP $30.0) Magyar Telekom (MTEL.BU, Ft392.0) MTN Group (MTNJ.J, R180.45) Maxis Berhad (MXSC.KL, RM6.59) NII Holdings Inc (NIHD.OQ, $7.0) Orascom Telecom (ORTEq.L, $3.29) Qtel (QTEL.QA, QR104.5) Reliance Communication Ltd (RLCM.BO, Rs80.6) Rostelecom (RTKM.MM, Rbl120.15) Telefonica O2 Czech Republic (SPTT.PR, Kč332.0) StarHub Ltd (STAR.SI, S$3.77) Singapore Telecom (STEL.SI, S$3.36) AT&T (T.N, $35.23) Turkcell (TCELL.IS, TL11.75) Telefonica (TEF.MC, €10.48) Philippine Long Distance Telephone (TEL.PS, P2650.0) Tele2 AB (TEL2b.ST, Skr118.1) TIM Participacoe (TIMP3.SA, R$7.98) Telkom SA Ltd (TKGJ.J, R17.1) PT Telkom (Telekomunikasi Indo.) (TLKM.JK, Rp9,100) Telekom Malaysia (TLMM.KL, RM5.94) TeliaSonera (TLSN.ST, Skr45.24) TPSA (TPSA.WA, zł12.5) Turk Telekom (TTKOM.IS, TL7.04) VimpelCom (VIP.N, $10.96, NEUTRAL, TP $7.0) Telefonica Brasil (VIVT4.SA, R$50.19) Vodafone Group (VOD.L, 160.05p) Vodacom Group (VODJ.J, R129.6) Verizon (VZ.N, $44.3)

Disclosure Appendix Important Global Disclosures Olga Bystrova and Richard Barker, each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

MegaFon (MFONq.L) 91 08 January 2013

Price and Rating History for Mobile Telesystems (MBT.N)

MBT.N Closing Price Target Price Date (US$) (US$) Rating 10-Jun-10 18.99 21.20 N 23-Jun-10 20.23 * 23-Sep-10 20.44 21.00 N 13-Oct-10 23.13 * 11-Mar-11 20.95 24.00 O 06-Jul-11 18.69 22.00 02-May-12 19.74 * 30-May-12 16.91 22.00 O * Asterisk signifies initiation or assumption of coverage. NEUTRAL OUTPERFORM

Price and Rating History for VimpelCom (VIP.N)

VIP.N Closing Price Target Price Date (US$) (US$) Rating 10-Jun-10 15.82 19.00 O 23-Jun-10 16.78 * 04-Oct-10 14.40 R 13-Oct-10 14.80 * 06-Jul-11 12.94 17.00 O 02-May-12 10.15 * 30-May-12 7.54 7.00 N * Asterisk signifies initiation or assumption of coverage.

OUTPERFORM REST RICT ED NEUTRAL

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin Ame rican and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; Australia, New Zealand are, and prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stock’s total return relative to the average total return of the relevant country or regional benchmark. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.

Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months.

MegaFon (MFONq.L) 92 08 January 2013

Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.

Credit Suisse's distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 42% (53% banking clients) Neutral/Hold* 39% (47% banking clients) Underperform/Sell* 15% (43% banking clients) Restricted 3% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research and analytics/disclaimer/managing_conflicts_disclaimer.html Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.

Price Target: (12 months) for Mobile Telesystems (MBT.N) Method: Our valuation on MTS is based on a DCF assuming 10.4% WACC and a 1% terminal growth.

Risk: Risks to our target price include: Increasing competition in key markets; ability to manage costs and improve margins in Russia; inability to refinance debt and as a result a risk to dividend payments.

Price Target: (12 months) for MegaFon (MFONq.L) Method: We value derive our TP using local currency DCF valuations with the following assumptions: 1) 11% WACC based on a) 8% Russian local risk free rate, 5% equity risk premium and 1 Beta resulting in 13% cost of equity, b) 8.05% cost of debt, 20% tax rate and c) 30% target leverage, 2) 12% terminal growth rate. USD target price is derived by using current rouble/USD exchange rate. As a secondary method we also user multiple benchmarking with MTS, MegaFon’s key operational and valuation comp in our view and other EEMEA mobile operators. Risk: Risks: 1) macro which could affect demand for telecom services, DCF assumptions and currency, 2) performance of the relatively new management team which could affect execution, 3) evolving regulatory framework and relatively new regulatory team which may potentially introduce more aggressive regulatory measures, 4) Improving performance and investment of key competitors in Russia and potential disruption in competition coming from currently smaller players, 5) M&A risks as the company is contemplating an acquisition of a stake in the largest mobile retailer and has sister companies in the same industry.

Price Target: (12 months) for VimpelCom (VIP.N) Method: Our valuation on Vimpelcom is based on a DCF assuming a 11.7% WACC and a 1% terminal growth rate. We use 7% equity risk premium in our WACC calculation which is 200bp higher than for MTS becuase of the corporate governance risks and two legal dispute currently outstanding which increase risks and uncertainty for equity investors in our view. Risk: Risks to our target price include: Prolonged injunction on Russian asset and a resulting restriction of access to Russian cash flows; Inability to access Algerian cash flows long-term; increasing competition in key markets; continuing market share losses in Russia; inability to refinance debt; further deteriorating shareholder dispute.

Please refer to the firm's disclosure website at www.credit-suisse.com/researchdisclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names The subject company (MBT.N, MFONq.L, VIP.N) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (MFONq.L) within the past 12 months.

MegaFon (MFONq.L) 93 08 January 2013

Credit Suisse provided non-investment banking services to the subject company (VIP.N) within the past 12 months Credit Suisse has managed or co-managed a public offering of securities for the subject company (MFONq.L) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (MFONq.L) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (MBT.N, MFONq.L) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (VIP.N) within the past 12 months As of the date of this report, Credit Suisse makes a market in the following subject companies (MBT.N, VIP.N). Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (MBT.N, MFONq.L, VIP.N) within the past 12 months Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml. The following disclosed European company/ies have estimates that comply with IFRS: (MBT.N, VIP.N). As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse Securities Johannesburg (PTY) Ltd ...... Richard Barker Credit Suisse Securities (Europe) Limited ...... Olga Bystrova

For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at www.credit- suisse.com/researchdisclosures or call +1 (877) 291-2683.

MegaFon (MFONq.L) 94 08 January 2013

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High volatility investments may experience sudden and large falls in their value causing losses when that investment is realised. Those losses may equal your original investment. Indeed, in the case of some investments the potential losses may exceed the amount of initial investment and, in such circumstances, you may be required to pay more money to support those losses. Income yields from investments may fluctuate and, in consequence, initial capital paid to make the investment may be used as part of that income yield. Some investments may not be readily realisable and it may be difficult to sell or realise those investments, similarly it may prove difficult for you to obtain reliable information about the value, or risks, to which such an investment is exposed. This report may provide the addresses of, or contain hyperlinks to, websites. 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This report does not constitute investment advice by Credit Suisse to the clients of the distributing financial institution, and neither Credit Suisse AG, its affiliates, and their respective officers, directors and employees accept any liability whatsoever for any direct or consequential loss arising from their use of this report or its content. Principal is not guaranteed. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. Copyright © 2013 CREDIT SUISSE AG and/or its affiliates. All rights reserved. Investment principal on bonds can be eroded depending on sale price or market price. In addition, there are bonds on which investment principal can be eroded due to changes in redemption amounts. Care is required when investing in such instruments. 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