MEGAFON Annual Report 2016

Financial Review

2016 was a challenging year for the telecoms industry. Despite macroeconomic volatility that affected consumer behaviour, and intense competition in the industry, MegaFon delivered performance in line with the previously announced guidance.

Facing uncertainty, we took measures to consolidate the Company’s market position and expect these actions to improve MegaFon’s future performance. Given the high mobile penetration rates in Russia (almost 180% (1) ), we decided that pursuing the policy of building up our customer base was no longer economically viable. This led us to prioritise maintaining the loyalty of our existing customers, by improving the quality of our services and by offering a wider range of the best products and services. We do our best to retain every customer for a long time. At the same time, we continued to develop our value-added services to stimulate growth of revenue from mobile data services.

MegaFon’s financial performance in 2016 fully reflects the conditions in the Russian telecoms market. Our consolidated revenue of RUB 316bn increased by 0.9% year-on-year, while the growth of mobile data revenue slowed down and the adjusted OIBDA margin decreased to 38.3%. In contrast, sales of equipment and wireline revenue showed a positive trend.

Maintaining MegaFon’s shareholder value remains our top priority. Therefore total declared dividends amounted to RUB 50bn in 2016 (stable year-on-year).

The project is a priority for the Company. Our goal is to create an unparalleled, multi-functional, world-class service centre.
Chief Accountant of MegaFon, Director of Shared Services Centre

Shared Services Centre

Why does MegaFon need a Shared Services Centre (SSC) and what does it mean for the Company?

We live in an ever-changing environment, and the pace of change keeps accelerating steadily. As our customers increasingly choose to go digital, digitalisation of the environment also intensifies. These are new challenges for our business, which must also develop rapidly, adapting to the evolving landscape to meet customer expectations, while maintaining a strong focus on operational excellence.

The SSC project is a priority for the Company. Our goal is to create an unparalleled, multifunctional, world-class service centre that will cut the costs of support functions and deliver improved manageability, better quality of internal services, higher transparency and scalability of our operating model. Co-locating functions within the SSC brings significant synergies, aligns the goals and objectives across the company’s functions and speeds up the implementation of changes to our operating processes and procedures.

In the future, we plan to enter the commercial market and start offering services to external customers, beginning with MegaFon’s SME customers. We see significant growth potential in the market for accounting support services and believe that the SSC will find its market niche. We strive to make our SSC the best in Russia and beyond.

How is the SSC organised?

The SSC is multi-functional and comprises seven service categories. These are Treasury and Accounting, Planning and Support for Order Processing, Financial Control, HR Management (HR administration and recruitment), Receivables Administration, Internal Control, and Support of corporate business operations.

The foundation of the SSC is a unique serviceoriented culture, focused on internal customer needs. We strive to anticipate customer needs and to be proactive by regularly offering new solutions to improve service quality and customer satisfaction. "Pikta" is a name that invokes a sense of modernity, digital development, technology advancement and ambitiousness. Key communication channels with internal customers are our shared support centre, a HP Service Manager system, and a self-service portal. The use of these dedicated channels enables monitoring and improvement of customer experience. Ongoing improvements to services for internal customers, controllability and stability of functions transferred to the SSC, cost optimisation, and need-based process scalability are the key pillars of the SSC philosophy. We assess SSC performance using KPIs subdivided into service quality, operational efficiency and cost efficiency categories. These KPIs help us track quality and cost indicators for SSC services on a regular basis.

What results has the SSC achieved so far?

The SSC was launched in July 2016 in Samara. As at the end of 2016, the SSC serviced the Volga and Moscow branches and two subsidiaries of MegaFon. In the initial few months since its opening, the SSC has processed over 700,000 transactions and documents for our customers and received over 22,000 requests via different channels.

In late January 2017, the SSC conducted a quarterly customer satisfaction survey (NPS), and I am pleased to say that the net promoter score has grown compared to Q3 2016. The KPIs monitored by the SSC since its launch are also on a positive trajectory, and we keep delivering more improvements. At present, our top priority is to align our activities with the new operating model of MegaFon. The Shared Services Centre is expected to reach its full capacity in 2018.


In 2016, MegaFon’s consolidated revenue grew by 0.9% year-on-year to RUB 316.3bn, fully in line with the Company’s guidance. Russian revenue increased by 1% to RUB 311.6bn and accounted for 98.5% of the total consolidated revenue. The growth was driven by higher sales of handsets and equipment, and positive trends in the fixed-line segment.

This review is based on MegaFon’s IFRS audited consolidated financial results for the year ended 31 December 2016. The consolidated data includes the financial results of MegaFon’s majority-owned operating subsidiaries in Tajikistan, Abkhazia and South Ossetia.


Item 2016 2015 Change, y-o-y
Revenue, RUB bn 316,3 313,4 +0,9%
Adjusted OIBDA(1), RUB bn 121,1 132,4 -8,5%
Adjusted OIBDA margin 38,3% 42,2% -3,9 п.п.
Net profit, RUB bn 25,5 39,0 -34,7%
Net profit margin, % 8,1% 12,5% -4,4 п.п.
CAPEX, RUB bn 65,6 70,2 -6,5%
Free cash flow, RUB bn 46,9 53,8 -12,8%
Net debt, RUB bn 196,9 180,8 +8,9%
Net debt/LTM OIBDA, x 1,63x 1,37x +0,26x

(1) Adjusted OIBDA is shown for 2016. Adjusted OIBDA is OIBDA net of impairment charge in the amount of RUB 3.4 billion related to the goodwill allocated to the Broadband Internet cash generating unit.



In 2016, adjusted OIBDA decreased by 8.5% year-on-year to RUB 121.1bn, which exceeded the Company’s guidance. The adjusted OIBDA margin shrank by 3.9 p.p. from 42.2% in 2015 to 38.3% in 2016. The decline in adjusted OIBDA is attributable to service costs growing on the back of higher sales of equipment and accessories, change in the revenue structure towards lowermargin segments, higher dealer commissions resulting from the expansion of our subscriber base, and higher rent expenses and network maintenance costs resulting from network expansion and inflation. This decline was offset by decreases in selling and marketing expenses, employee benefits and social charges, and frequency fees.

In 2016, net profit decreased by 34.7% yearon- year to RUB 25.5bn, mostly due to an impairment charge in the amount of RUB 3.4bn relating to the goodwill allocated to the Broadband Internet cash generating unit, which reflected the rapid decline in returns in the retail broadband segment and revisions in management forecasts in this segment in response to the current challenging economic environment and competitive pressures.

Net debt grew by 8.9% from RUB 180.8bn as at 31 December 2015 to RUB 196.9bn as at 31 December 2016, mostly due to dividend payouts. Despite this, MegaFon maintains an acceptable debt level as net debt to adjusted OIBDA for 2016 stood at 1.63x (+0.26x yearon- year). As before, we pay significant attention to our leverage ratio and work to improve our capital structure.

Free cash flow in 2016 decreased by 12.8% year-on-year to RUB 46.9bn, driven largely by a 9.6% decrease (RUB -10.9bn) in cash flows from operating activities.



Mobile Revenue

Consolidated mobile revenue in 2016 decreased by 2.4% year-on-year to RUB 263.6bn, amidst stagnation in the traditional voice segment, rapid digitisation and the growing appeal of alternative OTT services. More pressure was put on mobile revenue by a growing share of subscribers choosing bundled tariffs, with tariff reduced in early 2016.

Mobile data revenue increased by 5.7% from RUB 79.9bn in 2015 to RUB 84.4bn by the end of 2016. The share of data revenue as a proportion of total consolidated revenue increased from 25.5% in 2015 to 26.7% in 2016. In the reporting year, growth in this segment slowed as more subscribers opt for bundled tariffs with higher mobile data allowances.

The number of mobile data users (3) grew by 5.9% to 31.7 million, thanks to the continuing promotion of mobile data services and the growing penetration of data-enabled devices (57.2% of all devices registered on the MegaFon network were data-enabled). At the same time, the number of data service users in Russia grew by 5.8% year-on-year, increasing to 41.0% of our total subscriber base in the country.

In 2016, ARPDU in Russia decreased by 1.3% year-on-year to RUB 230, in line with the year’s trend, i.e. a slowdown in mobile data revenue amidst a higher penetration of bundled tariffs with increased mobile data allowances, which were introduced in early 2016. DSU in 2016 increased by 30.4% yearon- year to 4,286 MB, resulting from the further roll-out of 4G/LTE networks and the growing penetration of data-enabled devices, including 4G devices, on MegaFon network.

In 2016, we continued to strengthen our leadership position in the mobile internet segment through the development of 4G and LTE-Advanced networks, as well as through the introduction of special tariffs and offers. By the end of 2016, MegaFon was the leading Russian mobile operator by the number of base stations. The total number of all base station types grew by 9% to 143,700 stations, with 4G stations accounting for about a fifth of the total. As at the end of 2016, 4G services were available in 82 Russian regions.

Wireline Revenue (4)

Wireline revenue in 2016 increased by 9.5% year-on-year to RUB 25.7bn, due to subscriber base expansion in the B2B and B2G segments and the diversification of products and services. We observe, however, that growth rates in the segment begin to stabilise following the termination of some one-off contracts and the acquisition of GARS in Q4 2015.

Revenue from Sales of Handsets and Accessories

Revenue from sales of equipment and accessories increased by 35.5% from RUB 19.9bn in 2015 to RUB 27.0bn in 2016. This sizeable growth is associated with higher demand for more expensive high-end devices that were actively promoted in the controlled distribution channels, coupled with our attractive bundled tariffs.

Capital expenditures and free cash flow

In 2016, total capital expenditure declined by 6.5%, from RUB 70.2bn to RUB 65.6bn, which was mainly attributable to the high base effect, as CAPEX for 2015 included costs of the acquisition of frequency spectrum from SMARTS in the Volga region. MegaFon successfully completed its projects in construction and network development due to clearer investment project prioritisation and the optimisation of technical solutions. We continued to maintain a sufficient level of investment to improve the coverage of our 4G high-speed data transmission network across the network’s geography, as well as upgrading our 3G and 2G networks.

At the same time, adjusted OIBDA-CAPEX decreased by 10.7%, from RUB 62.2bn in 2015 to RUB 55.6bn in 2016, given a more prominent reduction in adjusted OIBDA compared to CAPEX.

Free cash flow was down 12.8% year-onyear in 2016 to RUB 46.9bn, primarily due to a 9.6% decrease in cash flow from operating activities.

Liquidity and financial stability

At the end of 2016, MegaFon had sufficient liquidity and a comfortable leverage position of 1.63x Net Debt / LTM OIBDA.

In 2016, MegaFon continued to implement its strategy to optimise its debt portfolio, by successfully extending its average life, securing lower interest rates on existing credit lines, and taking further efforts to mitigate FX risk. In 2016, the proportion of MegaFon’s debt with a maturity of five years or longer increased to 50%. In addition, the Company succeeded in growing its share of debt denominated in RUB equivalents to 90%, by raising loans in Russian roubles and implementing its hedging programme.

MegaFon enjoys access to funding and support from our financing counterparties. We monitor all developments and take necessary steps to mitigate any negative impacts. The Company’s credit rating, at the same level as Russia’s sovereign credit rating, enables borrowing under the best terms available in the market. In addition, MegaFon has access to adequate funding through credit facilities it has in place to meet current liabilities and back-up CAPEX.

Throughout 2016, we negotiated with key lenders and secured revisions of certain lending terms and mitigated refinancing risk. In July 2016, we extended the maturity of two credit facilities opened with Sberbank until 2022 and 2023 and opened a new credit facility with Sberbank expiring in 2022; we also increased the size of the credit facility opened with VTB and extended its maturity.

In April 2016, the Moscow Exchange registered the exchange-traded bond programme of PJSC MegaFon with an aggregate principal amount of up to RUB 80bn and a maximum maturity period of 30 years. Under the programme, in 2016, the Company placed two issues of its exchange-traded bonds. In particular, RUB 10bn exchange-traded bonds of the first issue were placed for a 3-year tenor in May 2016. It was a landmark deal for the Russian bond market, achieving the lowest coupon rate since 2014 among corporate borrowers (at the time of placement), 9.95% p.a. for three years. The bonds become due in May 2019. In June 2016, the second issue of RUB 10bn exchange bonds was placed for a 10-year tenor and is callable after five and seven years. This issue was the first bond placement with such a structure in the market. The coupon rate was set at 9.90% p.a. for the first five years.

During 2016, in line with the general trend in the Russian market for rouble-denominated bonds, the double-digit income from MegaFon’s bonds as at the beginning of the year fell below 10%. These changes were due to the lower cost of debt financing after the CBR key rate was reduced in June and September 2016, as well as much higher liquidity in the market. In 2016, the Company continued its efforts to mitigate FX risk. As at the end of the year, 92% of the Company’s deposits were denominated in US$.

(1) According to AC&M.
(2) Based on the IFRS consolidated financial statements audited by JSC KPMG.
(3) Including mobile data users in foreign subsidiaries.
(4) Wireline revenue means revenue from the fixed-line business.