Towers in Russia: rollouts, carve outs and buyouts

The Russian tower market has been through a period of seismic change over the last three years, with attitudes towards co-location changing enormously and every player taking steps to capitalise on a new emerging culture of infrastructure sharing. In this article we assess the state of the Russian market, discuss the changes which have been made and review some of the likely developments which could take place over the coming months and years.

It was widely reported that when Donald Trump won the US election, the Russian Duma (parliament) burst into spontaneous applause. After enduring sanctions since early 2014, it seemed Russia had gained an ally. Of course, this political detente didn’t last long, but nonetheless the Russian economy does seem to be gaining momentum after enduring some hard knocks and has proven remarkably resilient in the face of the twin threats of declining oil revenues and international sanctions.

The Russian economy achieved growth of 0.3% in Q4 2016 and is predicted to reach 1.1% growth in 2017, after two years of recession. Despite tough economic challenges, the Russian Central Bank (Bank Rossii) has remained strong and the financial market has continued to function throughout. In early 2015 the refinancing rate in Russia hit 17%, with banks lending at 20-25% as a result, strangulating new business growth in the country. Since this point the Bank Rossii has taken a stronger tack in order to protect macroeconomic stability, targeting a 4% inflation rate in 2017 to reduce the cost of borrowing and bringing the refinancing rate down to 9.5%. Of course by European standards this is still astronomical, but when compared to IRRs in the low teens being achieved in construction in Russia today, this rate creates a margin which at least makes growth possible.

At the recent TowerXchange Meetup Europe in London, the mood was cautiously optimistic, with Russian attendees and commentators agreeing that domestic capital has become available again, and with an interest in the tower industry. They feel domestic investors have started to see potential in the tower infrastructure asset class, with a healthy appetite for the bigger yields which Russia can deliver compared to the Western European market.

SIM penetration in the Russian Federation stands at 174% with 78% of connections prepaid, according to GSMA Intelligence. Currently only 41% of the market has mobile broadband, indicating there is a significant runway for growth in the market as 4G rollout completes and 5G begins.

The operator landscape is made up of four MNOs active across Russia; MTS, MegaFon, Vimpelcom and newcomer Tele2. Until recently, the idea of sharing infrastructure was an anathema to Russian operators, who saw their infrastructure as a key competitive differentiator. However, the increased density needs of 4G rollout, coupled with unprecedented financial difficulties as the Russian economy took a knock, has resulted in significantly more sharing activity over the last three years.

Many experts agree that the market is currently facing a perfect storm of competitive tension, low ARPU, high government pressure and capex intensive 4G rollout. Demand for data has increased dramatically but none of the operators have managed to benefit from that as yet due to a ‘race to the bottom’ on pricing. However the MNOs have each been able to cancel their unlimited excesses for the short term, meaning ARPUs should start to grow.

MTS: Russia’s biggest MNO, with 32.6% market share, Mobile TeleSystems (MTS) is 49% owned by Vladimir Yevtushenkov’s conglomerate Sistema, with a further 49% of the business listed on the NYSE, where it has been listed since 2000.

With a strong infrastructure across Russia, MTS has shown the least interest in selling towers, but has, however, taken steps in terms of both using third party towers and sharing their own structures. They are currently believed to be making around 5,500 towers (about 30% of their 16,000 total) available to third parties on a commercial basis, with a competitive approach to the market. In a statement on the MTS website, Vice-President of Technology and IT Andrey Ushatsky stated that “Our business-model allow us to provide potential tenants with favorable financial conditions. We would also like to announce that for our partners’ added convenience, we have devised a simple contract structure that does not require long-term obligations, additional fees for access to infrastructure, penalties for early termination and other factors that potential tenants will find attractive”

MegaFon: Russia’s second largest operator, MegaFon controls 25.6% of market share. Owned by Alisher Usmanov, who has been named both Russia and the UK’s richest person in the past, Megafon listed 17% of the business on the London Stock Exchange in November 2012, with less than spectacular results.

Although MegaFon has not expressed any public intention to sell their towers now, they have carved out their 14,000 towers into ‘First Tower Company’ and MegaFon General Director, Ivan Tavarin, told Bloomberg “We don’t think that if we are the first to sell our towers, we will be able to earn the biggest money and sign the best deal. We believe that if we thoroughly prepare, we’ll manage to pocket a high-quality investor and win a high-quality future operating history,”

BeeLine/Veon: Trading under the Beeline brand in Russia, mobile network operator Veon (formerly Vimpelcom) has 23.9% of the Russian market and also operates networks in Italy, Georgia, Armenia, Kazakhstan, Ukraine, Kyrgizstan, Tajikistan and Uzbekistan, Laos, Algeria, Pakistan and Bangladesh. Still 47.9% owned by Mikhail Fridman’s LetterOne investment business, 24.1% of shares are listed on the New York Stock Exchange following the company’s IPO in 1996, and a further 19.7% are owned by Telenor, a percentage which has been reduced significantly from 33%, including through an IPO of 70mn shares (~4%) on the Amsterdam Euronext, following controversies in Veon’s Uzbek operations.

Having carved out around 12,800 towers into National Tower Company, Veon announced their intention to sell their Russian infrastructure to a third party, following a successful sale and leaseback process in Italy with the sale of their Wind towers to Cellnex. As early as September 2016, the Russian press speculated that the successful bidders in the process were incumbent heavy hitters Russian Towers, however reports on the process have gone quiet over the first few months of 2017, and there remains doubt as to whether this on/off deal will finally reach an agreement.

Tele2: With just 8.5% of market share, Tele2 is the smallest mobile network operator in Russia, as well as the newest. Launched in 2003 by Swedish Tele2 AB, the company took on its current form in 2013, when Tele2 sold their Russian subdivision to VTB Group, one of Russia’s largest banks, and in 2014 merged with Russian operator Rostelecom, opening up their remit to the whole of the Russian territory and giving access to new markets. The organisation has grown fast, with heavy reliance on third party network infrastructure for that growth, in particular in urban areas.

Believed to have proprietary infrastructure of around 9,000 structures, there have been unconfirmed reports that the Tele2 towers are on the market. But with question marks over the quality of the network and Tele2’s position as a potential anchor tenant, as well as uncertainty about the Veon deal, it seems this transaction is also progressing slowly.

In last couple of years Russia has seen the independent tower industry coming of age. Companies like Russian Towers and Vertical have built the capabilities and capacity to be able to offer very efficient solutions to the MNOs which is now becoming seen as a standard. Another key driver for this increased openness to sharing is the Tele2 rollout in Moscow, where Tele2 did very little work in house and around 90% of the towers and poles constructed in the oblast were completed by towercos. As a result of this, and the economic drivers making MNOs assess their opex spend more carefully, there has been a shift in mentality in terms of infrastructure sharing, and managed services in general.

Even in MNO-owned towers, there is an increasing move towards using managed service providers, with Veon outsourcing maintenance on their mobile and fixed line network to Nokia and Huawei and transferring around 3,000 employees in the process.

The accelerating 4G rollout in Russia has also helped independent towercos to find their place in the market, as a focus on city infrastructure requires specialist skillsets and understanding of permitting and processes which MNOs are happy to outsource. Russian towercos acknowledge that they need to become more creative and innovative in terms of providing appropriate solutions in an urban environment. Site legality, swift connection to electricity and visual aesthetics will all become matters of priority as cell site density increases dramatically and requires new base stations, new poles and new towers in the next three to five years.

Russian infrastructure is already heavily urban focussed and many of the structures offered by independent towercos are street poles and city infrastructure rather than macro towers. This focus on urban networks has lead many Russian tower experts to focus on the potential for active network sharing, particularly in terms of small cell infrastructure, which will drive towercos to find a new service-based approach to their customers in order to continue to grow. The potential for upsides in terms of service offerings which can be driven by 5G is huge, and towercos are well positioned to capture this if they move away from an exclusive focus on ‘vertical real estate’. However, entering the active infrastructure market is a huge step, and not one which will necessarily yield short term rewards, as Russia is behind the curve of 5G rollout compared to the rest of Europe.

There are currently three towercos of scale operating in the Russian market, all of whom are driving towards significant growth.

Russian Towers: The largest and most established of the Russian towercos, Russian Towers was founded in 2009 and currently operates around 2,500 towers and poles across Russia. With a focus on growth through both organic and inorganic means (Russian Towers has rolled up several small private towercos), they have also worked hard to form partnerships with local governments and transport authorities to continually improve and grow the scope of their offering. Linked most recently with the acquisition of the Veon (National Tower Company) towers in Russia, Russian Towers is backed by an impressive range of investors including UFG Asset Management, the EBRD, Macquarie, Suitomo Corporation, ADM Capital and the IFC, meaning they have the financial digestive capacity to match their expertise and are currently front runners when it comes to opportunities to acquire portfolios of significant size.

Vertical: Founded in 2013 and based in Moscow, Vertical has grown their portfolio to around 1,600 towers in total, taking advantage of Tele2’s roll-out activity in the region for much of this growth. By 2016, Vertical had gained enough momentum to take part in the bidding process for the Veon towers, and remain ambitious to grow in the Russian market.

Service-telecom: The youngest of Russia’s towercos, Service-telecom was founded in 2015 and has built around 350 towers in their first year of operations. Also highly ambitious and led by a new generation of business graduates, they hope to shake up the Russian market and capitalise on the potential for rapid growth. Service-telecom are eyeing the potential for acquisitions in the Russian market with enthusiasm and investing heavily in rapid organic growth.

Despite political and economic obstacles, there’s little doubt that the Russian market presents great potential, and although a long-awaited first sale and leaseback deal has yet to be consummated, there has been huge amount of activity in terms of carve outs, sharing strategies, partnerships, new towercos, towerco market consolidation and organic growth over the last two to three years.

National Tower Company’s attractiveness to towercos is indisputable and as the market hots up, the stakes for grabbing the first portfolio of scale to come to market get ever higher. As ever with the Russian market however, there are no certainties, and although Russian Towers have come close to sealing the deal, as yet no formal agreement has been made public.

The fact is that Russian towercos are no longer just competing with each other, but with their clients as well. MTS have clearly spelled out their aim to make 5,500 of their towers available for co-location and their ‘simple contract structure that does not require long-term obligations, additional fees for access to infrastructure, penalties for early termination and other factors that potential tenants will find attractive’ will doubtless present the towercos with a challenge as they look to secure sustainable and long-term revenue from their clients.

Megafon and Veon have carved out their assets, with the former taking a ‘wait and see’ approach to enable them to make a more informed choice. Veon’s appetite to monetise their towers has been clear, but now they have carved out a large portfolio of profitable assets in a growing market, it is possible they will decide to retain the portfolio and compete with the companies who have been bidding for their partnership. At this stage all options remain on the table, and an INWIT-style carve out and IPO may become appealing. While the Russian political and economic situation make the idea of an outside entrant to the market less likely than many other countries, it’s not outside the realms of possibility that a large international player may yet make a play for a share of the market as well.

As ever, the Russian market keeps everyone guessing to the end, but the steps taken over the last three years show a distinct change in attitude towards network sharing, third party infrastructure and control of passive assets. As 4G rollout increases pace, there are few signs that the market will slow down and TowerXchange continue to watch this space with interest.

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TowerXchange: Can you give us your thoughts on the Russian market in general? What trends are you seeing?

I think there are several trends happening at the same time, certainly a proliferation of sharing of all kinds. Everyone now realises it’s more efficient to share infrastructure. All the carriers have grown sufficiently and become mature and corporate, to the point where they can cooperate. Tower companies such as Russian Towers and Vertical are offering thousands of points of presence to the market.

There are almost no small carriers in the market.  Then there’s a trend for harmonisation of operations, meaning carriers are looking at harmonising their land leases or service contracts after a period of very rapid expansion. From the early 90s through to a few years ago it was a race for coverage, but that situation, coupled with lack of certainty regarding both market and legal rules – particularly in the 90s and early 2000s – meant there was a lot of haphazard expansion which has created an inefficient system. So now everyone is working to rationalise it and harmonise rights to towers and contracts across their infrastructure.

Also, related to the proliferation of sharing, every carrier is interested in hiving down their towers into a towerco even if they don’t want to subsequently sell them off. They’re trying to separate out their towers into a distinct business unit which will start operating as an asset, almost like a real estate investment trust where they own infrastructure and lease it.  This allows them to understand the cost and profitability of their tower portfolio on a stand-alone basis. As a result, carriers are now also looking at operational efficiencies on a stand-alone basis.

TowerXchange: Can you tell us about any trends you’re seeing in terms of site legality and legalisation in the Russian market?

There’s a huge variation regionally. I sense legalisation is also becoming a hotter topic because of the proliferation of both passive and active infrastructure. Towercos are becoming more significant players in the market and carriers are opening up to sharing infrastructure too. The proliferation of that sharing puts greater pressure on infrastructure owners to clean up the legal status of their assets.

If you’ve had infrastructure since the mid-90s and you know it’s not squeaky clean but you’ve got a history of dealing with particular landlords, you may have internalised the risks.  But if you’re putting part of your network on someone else’s tower and you don’t have that history, you need to make sure your network will continue uninterruptedly. So, I think there’s a new impetus across this market.

TowerXchange: Can you give us some insight into your experience running due diligence in the Russian market?

As with any infrastructure transaction, there are many non-tower company specific issues: the things you look at no matter what is being sold, such as liabilities and employees et cetera. In terms of towers, specifically, more often than not it goes back to legalisation. Land rights, real estate, in some places they’re on land leases which are often some sort of service agreement, there’s a spectrum of how close or how firm your rights are with regards to any particular piece of real estate.

Other issues relate to construction – whether the tower was constructed properly to begin with in the sense that it had proper permits to build and bring in to service.

Thirdly, there is the potential for complication in various contracts for interconnection, especially related to power. In some cases, towers are connected to the grid like any other customer but at other times these arrangements are incorporated into the ground leases and are fed off the landlord’s own connection. You look at risks in those contracts, not just propriety or impropriety but how good those rights are. If, for example, you have had a 15 year sequence of 11 month contracts, you know you’re only looking at 11 month commitment, so you have to ask what happens if the landlord wants to renegotiate the lease. It’s a stress test for quality.

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