VEON Ltd (VEON) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the VimpelCom Ltd first quarter 2012 investor and analyst call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Alexandra Tramont. Please go ahead.

Thank you. Good afternoon, ladies and gentlemen, and good morning to those of you connecting from the US. And welcome to VimpelCom's conference call to discuss the Company's first-quarter 2012 financial and operating results.

Before getting started, I would like to remind everyone that forward-looking statements made on this conference call involve certain risks and uncertainties. These statements relate, in part, to, one, the Company's plans to maintain profitable growth in its business units; two, the Company's expected future debt position and refinancing plans; and, three, the Company's financial performance objectives. Certain factors may cause actual results to differ materially from those contained in the forward-looking statements, including the risks detailed in, one, the Company's earnings release announcing first quarter 2012 financial and operating results and the related presentation; two, the Company's annual report on Form 20-F for the year ended December 31, 2011; and, three, other public filings made by the Company with the SEC, each of which are posted on the Company's website at www.vimpelcom.com and on the SEC's website at www.sec.gov.

If you have not received a copy of the first quarter 2012 financial and operating results release, please contact Investor Relations at +31207977234 and it will be forwarded to you.

In addition, the press release and the earnings presentation, each of which includes reconciliations of non-GAAP financial measures presented on this conference call, can be downloaded from the Company's website.

At this time, I would like to turn the call over to Jo Lunder, Chief Executive Officer of VimpelCom. Jo, please go ahead.

Thank you. Good afternoon to those in Europe and good morning to our guests from the United States. And welcome to our first quarter earnings presentation.

Let me start by introducing the members of the team sitting with me here in Amsterdam. I have Henk van Dalen, our Chief Financial Officer, who will be covering the financials in detail later on the call; and Gerbrand Nijman, our Head of Investor Relations.

Let me start with the highlights of the quarter. We are pleased with the progress we're making. The good performance led to almost 6% organic growth in revenues, year over year, reaching $5.6b. If we exclude ForEx impacts, EBITDA increased 5% compared to the same period last year, leading to a margin of 41%.

We are pleased with the positive trend shift in the EBITDA growth in Russia, which rose 9% organically. Revenue and EBITDA also showed strong growth in Asia and Africa, led by impressive performance in Pakistan.

We achieved strong subscriber growth in the first quarter with an increase of 12%, reaching 209m mobile subscribers. Our Asia/Africa business unit witnessed strong subscriber growth of 19%, exceeding the 86m mark.

Net income for the quarter reached $318m.

VimpelCom has not only delivered good revenue and EBITDA growth but we have also delivered a solid cash flow generation, with net cash from operating activities of $1.6b. The cash flow targets combined with profitable growth are fundamental KPIs for the Company, on which we are measuring our performance and, again, I'm satisfied with the progress and the results we are delivering in the first quarter.

Moving on to the strategic update and some main recent events, as you all know, Orascom Telecom Holdings has submitted a formal Notice of Arbitration against the government of Algeria. However, regardless of this notice, we would like to reiterate that we remain open and in discussions with the Algerian government to finding a mutually beneficial resolution to the solution in Algeria.

Recently, we also refinanced a significant part of our debt maturing in 2012 with the issuing of bonds in March and in April in Russia and Italy.

In late April, VimpelCom announced the sale of its controlling interest in GTEL Mobile in Vietnam. This action reflects the Company's ongoing strategic portfolio analysis, which is a core component of VimpelCom's value agenda. The portfolio review is aimed at focusing on allocating capital to those markets where the Company sees the best opportunities to generate shareholder value.

Also in April, the Russian Anti-monopoly Service named VimpelCom as a third party in its claim to validate Telenor's February purchase of 244m VimpelCom preferred shares from Weather II. In late April, a Russian court issued an injunction that prohibits VimpelCom from exercising certain specific shareholder rights in OJSC during the pendency of this case. However, the injunction does not prohibit VimpelCom from exercising its shareholder rights to approve dividend payments and to re-elect the current OJSC Board members. The first hearing on the merits of the FAS claim is scheduled for October 17, 2012.

And, as previously announced, we plan to pay the final dividend for 2011 of $0.35 per share before the end of June.

And, finally, we have appointed Maximo Ibarra, our CEO of our Italian business. Maximo has a strong track record in running the consumer business unit, the Wind, and broad experience in both the telecom sector and in other industries. I'm confident that Wind Italy will continue its successful track record of performance under his leadership.

Now moving on to the performance of the five business units, starting with Russia. In Russia, we see signs of progress. Our strategy has, in the first quarter, enabled us to deliver a double-digit revenue growth and a substantial improvement in EBITDA, reversing the negative EBITDA trend we have seen over the last quarters.

Let me spend some time to walk you through the progress we're making in Russia. The main cost reductions in the first quarter were in cost of sales due to a new dealer commission structure we implemented at the end of last year and in the payment commission for our services with our distribution partners. The new commission structure reflects the value in the lifetime of our customers instead of, as earlier, upfront payments.

We also made important progress in our plans to improve customer loyalty. We launched a customer experience program that includes initiatives aimed at improving the quality of services and increasing pricing transparency. Our program has been well received by our customers and we are pleased to see indications of increased customer satisfaction across our products and services.

We also achieved an improved cost level within technical and IT through a reduction of the cost per (inaudible) and channel renting, user network maintenance and planning optimizations, and ongoing contract negotiations with vendors. Furthermore, we signed a five-year agreement with Nokia Siemens Networks for extended network support in the central region, allowing us to substantially reduce operational expenses, including technical costs for mobile fixed and broadband networks. Our plan, now, is to employ this experience in other regions of Russia.

Another strategic focus is to improve the organizational effectiveness, including increased focus on outsourcing. We expect, also, this area to yield results, going forward. We remain committed to our earlier communicated goal of delivering no less than RUB5b in annualized cost savings this year. However, as you've probably also seen in the release, as a result of a transitioning into a new commercial model in Russia, we have a planned and expected decline in our subscriber base, quarter on quarter. CapEx to revenue last 12 months stood at 21%. We will continue to invest in our 3G network deployment development and we aim to match our main competitors in terms of population coverage in the main cities in our 43 key strategic regions by 2013.

Mobile data continues to be one of the fastest growing revenue streams for our business in Russia, and we are increasing our focus on promoting mobile data services to a wider audience. The upcoming LTE auction is an important building block in this strategy and we aim to participate in the LTE contest, which is expected to go through in July this year. We are confident that the conditions announced earlier this month will enable us to achieve a rapid network deployment in Russia.

As a summary, we are pleased with the progress in Russia and we will continue to execute on our strategy.

Moving on to Italy. In Italy, Wind total revenues were stable with, though, an underlying growth of 3% if we exclude the impact of the mobile termination rate cuts. The marginal reduction in service revenues, coupled with an increase in commercial OpEx and higher bad debt, led to a 2% reduction in EBITDA. Wind's mobile data offerings achieved strong results in the first quarter of '12, with mobile Internet revenues increasing by 40% year over year, as a result of our own penetration of smartphone, tablets and data dongles.

Our operating performance remains strong with Wind outperforming the markets and further consolidating its market share in both mobile and fixed line. Our mobile subscriber base grew 12%, year over year, to 21m, driven by the success of bundled offerings and growth in mobile broadband which saw double-digit subscriber increase year over year.

Going forward, we will continue focusing our efforts on maintaining our strong relative performance and on investment in HSDPA and LTE to growth our data business. We will also continue to focus our efforts on strengthening our presence in new segments, such as high-value postpaid subscribers and in the SME market.

Moving to Asia and Africa, in our Asia/Africa business unit, the operational excellence initiatives implemented have led to profitable growth as we see -- as we're seeing double-digit organic EBITDA growth surpassing organic revenue growth in most operations, leading to an improved EBITDA margin of 46%.

Our performance in Pakistan was quite impressive with Mobilink delivering an organic revenue growth of 10%. EBITDA also increased by 15% in local currencies, driven by tariff optimization and improved cost control leading to an EBITDA margin of 42%.

Our operation in Algeria continues to display strong resilience with revenues up 7%. EBITDA increased 8% in local currency, supported by strong cost savings. Our EBITDA margins remain at around 60%.

In Bangladesh, our subscriber base showed an impressive growth of 23%, driven by a more effective acquisition strategy following the SIM tax reduction in June 2011. Revenue and EBITDA showed double-digit growth, largely as a result of strong top-line growth and operational excellence initiatives.

Moving on to our Ukrainian business unit, we continued to deliver healthy top line growth, driven by growth in both mobile and fixed businesses, while maintaining our leading market positions. Mobile revenues were up 2% year over year, mostly driven by the continued strategy of transition to bundles. Fixed line revenues increased 16% year over year, mainly due to an 82% increase in fixed residential broadband revenues.

EBITDA declined year on year, mostly due to higher interconnect costs, growth of network costs and other operational expenses as a result of higher traffic and inflation. In the first quarter of '12, EBITDA margins were slightly lower than the full year '11 margin of 53% but the Company expects this to be temporary and we have measures in place to improve the margins, going forward.

Then the last of our five business units, the CIS. The CIS business unit was able to deliver strong revenue growth to maintain high quality subscriber growth despite the competitive environment, which was also affected by certain regulatory measures in key markets. Organic revenue grew by almost 9% as a result of product quality improvements and efficient sales and marketing efforts, resulting in an increase in our subscriber base of 28%.

EBITDA margin this quarter was about 43%. To secure profitable growth, an operational excellence program is now underway in all markets focused on continued data development and network expansion to support expected traffic and revenue growth.

In Kazakhstan, our largest CIS market, we saw organic revenue growth of 5% in the first quarter. EBITDA remains strong but declined due to the competitive environment, limitations on tariffs introduced by the regulator as well as consolidation of lower margin FTTB business since April 2011. As a result, EBITDA margin declined by almost 6 percentage points; however, we expect this to be partly recovered throughout the rest of the year.

In Uzbekistan, revenues and EBITDA increased by 33% and 30%, respectively. EBITDA margins declined slightly as a result of increased competition and an increased tax. Our CIS network expansion is in progress and we continue to roll out both 2G and 3G networks, but the CapEx decreased in line with our strategy.

I will now pass the floor to our CFO Henk van Dalen, who will discuss the Group financials more in detail.

Thank you, Jo. As a reminder, we are presenting our results today on a pro forma basis unless otherwise noted. We believe pro forma financials provide the most meaningful comparison of financial performance for the quarter. The pro forma information presented reflects what the Company's results of operations would have looked like had the Company's transaction with Wind Telecom occurred on January 1, 2011.

VimpelCom Limited's results presented are based on IFRS as of this year. The unaudited pro forma condensed combined financial information prepared in accordance with IFRS for the quarters and for the full year 2011 was published on May 2, 2012 and is available on our website.

Certain amounts and percentages that appear have been subject to rounding adjustments. As a result, certain numerical figures shown as totals, including in tables, may not be exact arithmetic aggregations of the figures that precede or follow them.

The actual financial results of the first quarter of 2012 have not been audited and, as previously announced, the Company published its full-year 2011 audited financial results under IFRS when it filed its annual report on Form 20-F for the year ended December 31, 2011 on April 30, 2012.

Now turning to the financial highlights on a pro forma basis, total operating revenues in the first quarter 2012 increased 3%, year on year, with a strong performance across most business units. Overall organic revenue growth was 6%.

EBITDA increased 1%, year on year, impacted by unfavorable currency movements. Excluding these ForEx effects, EBITDA increased 5% compared to the same period last year. Strong, organic EBITDA growth was seen in the markets of the business units of Russia and Africa and Asia, both 9% and 12%, respectively, while the performance in CIS showed a 2% increase, year on year. Overall growth was partly offset by the year-on-year organic EBITDA decline in Ukraine and Italy.

EBIT, which increased by 12% year on year, was positively affected, as reported previously, by the declining amortization pattern applied to intangible assets associated with customer relationships as part of the Wind Telecom acquisition where amortization of later periods is lower than the amortization in the year of acquisition.

The profit before tax was negatively impacted by the lower foreign exchange gain in the first quarter of 2012 compared to the first quarter '11, lower net gain realized from investments in associated entities, mainly related to our investment in Euroset and fair value changes of embedded derivatives. In the first quarter '11, the foreign exchange gain was $168m, while in the first quarter '12 the gain only amounted to $63m, mainly due to the lower US dollar exposure in Russia.

Net income decreased by 29%, year on year, as a result of the increase in income tax expense of $45m (sic - see presentation) and $48m change in profit for the period attributable to non-controlling interest, mainly related to a stronger performance in Orascom Telecom.

Then to the figures on an actual basis. The revenues more than doubled year on year, and EBITDA and EBIT increased 92% and 62%, year on year, respectively, as a result of the combination with Wind Telecom in April 2011.

Profit before tax decreased by 9%, year on year, due to additional finance costs as a result of the Wind Telecom acquisition. Net losses from associated entities, mainly due to lower profits from Euroset and losses from the investment in Canada as well as lower gains from foreign exchange rates movements, mainly attributable to the lower US dollar exposure in Russia.

The increase in the effective income tax rate, driven by higher non-deductible expenses and non-recognized losses in Wind Telecom entities as well as the effect of the reversal of tax provisions in Russia in the first quarter '11, and higher profit attributable to non-controlling interest led to a decrease of net income of 36% to $318m on an actual basis.

Then, as normal, a little bit more detail on the debt and cash ratios of the Group. On a consolidated basis, the actual net cash from operating activities in the first quarter was $1.6b and the free cash flow after cash CapEx resulting was $735m.

Gross debt increased in the first quarter from $26.9b to $28.6b, mainly due to the issuance of ruble bonds for RUB35b, which is approximately $1.2b, for general purposes and debt redemption, coupled with a $670m movement as a result of FX.

We ended the quarter with a balance of cash and cash equivalents of $4.3b. This cash balance is temporarily high as it is affected by the $1.2b cash resulting from ruble bonds. As mentioned, this will be mainly used for debt redemption in the period to come so the cash balance as a result, of course, will reduce.

Net debt declined to $24.3b, leading to a net debt to the last 12 months EBITDA ratio of 2.5 at the end of the quarter on a pro forma basis.

Then a little bit on the debt composition and the maturity profile. Total gross debt as said $28.6b with an average weighted interest rate of 8.5%. Our balance of foreign exchange exposures in gross debt remains diversified across the euro, the ruble, the dollar and other currencies. And, as Jo already mentioned, we refinanced a significant part of the debt maturing in 2012 with the issuance of bonds in March and April in Russia and Italy, respectively.

In the first quarter 2012, OJSC VimpelCom completed the bond issue for RUB35b, mainly to refinance the existing debt and obtained vendor financing for RUB1.6b, which is about $53m, in March and April.

Wind issued a tap of Senior Secured Notes due 2018 for $0.7b to refinance existing debt.

And on May 3, OTH AGM approved a $2.5b uncommitted intercompany credit facility from VimpelCom Amsterdam BV.

Now, furthermore, I think it's important to notice that we still have substantial undrawn committed revolving credit facilities in place for a total of $1.5b. There is a peak in the maturity profile in 2017 caused by the Wind Italy debt, but we plan to refinance this before that date. However, this will not be completed before the end of 2013 and timing will depend on market circumstances, of course.

And, as usual, and finally, I give you a little bit more detail on the current financing structure, which is not in any major way different from what it was. On this slide, the structure is shown as comprising of three blocks that I will go through very briefly.

The first is the ring-fenced block of debt related to Wind Italy. That is the circle that you see on the right-hand side that's about $14.7b of debt as at the end of the first quarter. That block of debt is ring fenced in the sense that it has no recourse on VimpelCom Limited or any of the other companies in the Group, so it is really on a standalone basis.

The second block of debt is $1.1b in local entities of Orascom. Those local entities have their position and they do not have recourse on VimpelCom Limited.

And the third block of debt has to do with OJSC VimpelCom and VimpelCom Limited, which is the block you can see on the left-hand side totaling $12.8b with a portion of the debt distributed to VimpelCom Holding and a portion to OJSC VimpelCom. From this position also, OTH and Weather Capital SP1 are funded with an intercompany loan.

I will now turn the call back to Jo for his final remarks.

Thank you, Henk. Before we open the call for questions, let me summarize the picture in a few words. Overall, I'm pleased with the performance in the first quarter. We see now signs of the business profile that we're targeting with strong organic revenue and EBITDA growth, combined with improved cash flows.

Going forward, we see more upsides and improvement potential for our Russian operations and we believe a trend shift is now underway in Russia.

In Asia and Africa, our operations continue to display a resilient growth profile and we are seeing an acceleration of the growth actually in Pakistan and in Bangladesh.

The absolute performance in Ukraine is still very strong. But regardless we are now implementing initiatives and we expect to achieve improved margins in the remainder of this year.

Our operations in Italy continued to outperform the market and it delivered a solid performance despite regulatory pressure and the economic slowdown we all know by now.

And the CIS market also continued to provide strong growth and improved cash flows; however, faced with increased regulatory and competitive pressure.

Going forward, we remain focused on, step by step, implementing our strategy with focus on profitable growth, cost control and increased cash flow to, by that, increase hopefully shareholders' value, going forward.

With that, let me open the floor for questions. Operator?

(Operator Instructions). Our first question comes from Cesar Tiron from Morgan Stanley. Your line is open.

Yes, hi. I have two questions actually. The first question would be to understand if, in Russia, you delayed any expenses as part of this new dealer commission structure because surely you haven't paid for the SIM cards that were activated in Q1 as part of this scheme. Are we going to see some of those expenses in Q2 or Q3?

And my second question would be to understand better this loan you made to Orascom. Particularly, I wonder about the size of this loan because, while I do understand that most of the Orascom cash is in Algeria and Orascom needs this cash to basically operate its business, surely the size of the loan is quite significant. And even accounting for possibly 3G licenses in Pakistan and the fact that the other Orascom businesses are not free cash flow breakeven, I don't understand why the loan has been so significant; if you can please explain.

Thank you very much.

Indeed. Let me kick off with Russia and then Henk can explain the second question. With respect to dealer commissions and cost of sales in Russia, there is a real change in the commission structure and there is a real change in the commission level. And, basically, it's moved from upfront payment to value-based payment. And the P&L is, of course, 100% reflecting the reality of that and exactly when the cash are being paid as a result of this has nothing to do with EBITDA margins and the profitability that we show in Russia right now.

Cesar, on the Orascom intercompany loan, it's probably good that I take you back a little bit to the start of this Company after the Wind Telecom transaction. The moment that Wind Telecom transaction was effected, we also brought all the debt which was at the level of Orascom, and that was put into an intercompany loan. There were various reasons for that but the main reason was that that was indeed also the best way to secure a continued funding for Orascom, going forward. That original level of intercompany loan and credit facility was up to $2.7b and that particular facility has now been fully drawn.

And what has been brought in place now is effectively an additional facility of $2.5b, which indeed, as you already expect, is expected to be sufficient for quite some years to come but that prevents us from going to the shareholders meeting, you could say, every year to make sure that there is such an intercompany facility in place. So this effectively from an effectiveness reason that we did it and it is completely in line with the structure that was put in place at the moment that we acquired Wind Telecom.

The interest rate, by the way, on this particular facility is 12.5% and that is big interest but it's going to [fall] also if the results of the Company are now going to be paid in cash.

Okay, thank you. Sorry, just a very quick follow-up question on these sales and marketing expenses. Just if you take an example of the subscribers that have become VimpelCom, that have been the SIM cards that have been activated in Q1 2012, some of the subscribers obviously generated revenues in Q1 2012 but probably you haven't paid dealer commissions because, if I understand, under the new scheme you have with the dealers, you only pay for the ARPU generated by those subscribers and only after six months; am I incorrect?

Yes, this is one of the structures being put in place but, of course, dealer commissions are quite accurately reflected accounting-wise in terms of the underlying cost of the dealer structure so there is no cost being built here now that hits us later. It's tied to the value and it's tied to the revenue base.

Thank you very much.

Our next question comes from Alex Kazbegi from Renaissance Capital. Your line is open.

Yes, good afternoon. My first question is basically just on mobile data, just to understand, maybe, for the two major markets, Russia and Italy, what is the smartphone penetration on your network now and how fast did you see the data, so to say, growing and what do you see again? Are these accelerating? What is the trend you are seeing coming besides what was, of course, seen through the numbers?

Secondly, on the CIS side, especially in Kazakhstan; your performance was clearly on the ARPU side, better than what your competitors have shown, which seen quite a substantial decrease in the ARPU levels. So I was just wondering, is this something temporary or do you think you sustainably can outperform the others and you don't see this as a risk in coming quarters that there will be still quite a significant price erosion coming through there? Thank you.

Thank you, Alex. Specifically on smartphone penetration into Russia, we are at 13% right now, and Italy we are at approximately 30%. You saw the data growth in Italy, year on year, (technical difficulty) approximately 40% last year and I expect that growth to continue, given the fact that we are now making our network in Italy LTE-compliant so that we can start developing the 3G network into also LTE capabilities when we reach the end of '12, early '13 because we get the 2,600 spectrum at the end of this year and we get the 800 spectrum in Italy at the beginning of '13. So I think you will see, gradually, the bigger cities starting to pick this up in 2013, assuming devices being available. But I think the trend you see right now will continue in Italy this year and, hopefully then, when LTE is coming next year we will see a further uptake there.

And Russia is then, I think, going to follow the same path we've seen in Italy but, of course, it is behind and, as you know, the beauty contest that was announced first week of May is concluding in July. And realistically I think we'll look at if we've been granted the 2x7.5 megahertz blocks, the four blocks is up for the contest. If we get one of them that we hope and believe we will, I think probably the second half of 2013 is the most likely timing of the commercial launch of LTE and probably then Moscow, St. Petersburg and the biggest cities with more than 1m inhabitants.

So I think you can look to see some (inaudible), growth rates, penetration rates when now Russia start to do that.

On Kazakhstan, Alex, I -- can you clarify what you actually asked on Kazakhstan?

Well, I looked at K-Cell and Tele2 and they reported actually quite bigger decreases in the ARPU around let's say 20%, quarter on quarter, whereas you had, I think, 13% or 12%. So the question is that's quite a big divergence in the impact of the price erosion or whatever it is so that's why I was just wondering what is the competitive situation there and how is it going to be panning out, from your point of view, in coming quarters?

Yes, in Kazakhstan, I think what we see there now is basically the size we have compared to the rest is reflecting a little bit that picture and the fact that we also had regulation on maximum prices on both on-net and off-net pattern of traffic being put in place by the regulator at the end of '11/early'12 is basically affecting our business there so it's a combination of competitive pressure from a smaller player, together with those regulations that leads to that drop in -- that you addressed and also the EBITDA margin.

That being said, I still think that we're now starting to move to more bundles and taking advantage of the capacity available in the network, and with that and a few other measures put in place we'll probably not correct the full 6 percentage points drop in Kazakhstan this year but I think we will see an improvement in the margins for the remainder of the year.

Okay, thank you.

Our next question comes from Tibor Bokor from ING. Your line is open.

I have a question on the smaller markets that outperformed in the first quarter, Uzbekistan and Pakistan, if you could little bit elaborate whether it's a temporary or whether we should be upgrading our estimates for the rest of the year in these two markets. Thank you.

We -- as you know, we don't give specific guidance on individual markets, even though I commented on Kazakhstan right now. But, I think, if I -- if you allow me, I can try to be a little more general maybe.

It looks like the measures that we put in place in Pakistan in the last three months of '11 is now starting to yield results. And we believe there are still upsides in Pakistan with respect with -- to both growth and performance. So, we expect Pakistan to reflect -- we think it's a trend shift also in Pakistan from what we've seen in the last year, what you see now in the first quarter. We -- at least our ambition is to continue that development going forward.

In Uzbekistan, we are affected a bit with that [$0.30] tax on subscribers. And that's hurting a little bit now. But, there's nothing in our relative performance in Uzbekistan that is suggesting a weak performance. It's more a regulatory pressure and the margin a bit weaker as a result of that. But, again, in Uzbekistan, we also feel comfortable that we have this momentum.

Thank you very much.

Our next question comes from JP Davis from Barclays. Your line is open.

Thank you. A couple questions on Russia and then one on Canada, please. Firstly, on Russia, could you comment on your strategy of getting more on-net traffic, improving the traffic mix with on-net tariffs?

And then the second part, could you comment on how progress is going in the areas or the 25 regions you identified as growth regions in your Strategy Day in the third quarter last year?

And then on Canada, it seems more positive rhetoric in the release in terms of the possibility to invest there. Does that in any way impact where it falls within your buckets of a one-, two-, or a three-type operator, i.e. are you still considering it for portfolio contribution analysis? Thank you.

Very good. On the first question, on-net traffic inertia, I think we are now as part of the concept of profitable growth part of that concept is clearly to offer growth with a service margin and improve the service margins going forward. We think that's possible. We think there are different ways of doing that and stimulating to on-net traffic is (background noise).

So, we will continue to do that. And if our strategy is turning out to be a successful one in Russia, you will see also the service margin of the business growing in the year we have ahead of us and being helped, as I said, by a number of activities, including more on-net traffic.

And then on the regions that we identified as our priorities on the Capital Markets Day, clearly, we focus more on those than others. And we have talked about closing the gap and on 3G base stations a couple of times on earlier calls. And there is still a gap between the number of 3G base stations of VimpelCom and our two main competitors in Russia.

But, we expect now within the next 12 to 15 months that, in the prioritized regions of Russia, we will have closed that gap, so which means that when we start rolling out LTE in the big cities and regions, we will be having the same coverage and the same capacity on 3G in Russia. So, we believe that prioritization, we did not shooting after every region in order to close the gap. But, focusing on the most profitable and most important ones has turned out to be a quite successful way to regain our profitability and position in Russia.

But, when it comes to Canada, I think, first of all, I comply with your assessment that change in foreign ownership law in Canada was the favorable decision for VimpelCom and Orascom.

I think what we are going to do in [Hanover] now is basically to take our time to think through the different options we have there. As you see now from the performance today, we have our arms around the business now. We have a good profile in the running. We have growth. We have a good cash flow. So, we have also now time and flexibility to make sure that we are doing the right thing in Canada.

And there's a lot of interest, of course, around our position in Canada right now, also in the light of the changed law. So, there are multiple options available there. And we will report back when we have decided which one we believe is best for the company to choose and to follow.

Thank you.

Our next question comes from Dalibor Vavruska from Citigroup. Your line is open.

Hello, good afternoon. Just three questions, if I can. One is on outsourcing. You mentioned that you started this project in the center region in Russia. And if I am not wrong, I think there's some outsourcing also going on in Italy. I'm just wondering, what is your general experience? What -- how -- what sort of outlook or upside you see in this network outsourcing in your major markets? And I don't know if it's possible to quantify those, put it in context of your margin outlook for these countries.

The second question is on LTE. You mentioned that you're very interested in acquiring the license and that you're ready to start investing. And then obviously, in terms of your CapEx guidance, you still relatively carefree about the spending. So, I'm just wondering, how does your network compare to LTE readiness compare to those of competitors and whether if LTE starts being a bigger issue in Russia now, whether that may not lead to increased investment compared to what you're guiding, for example, for this year?

And my third question is about this FAS case. I'm just wondering, you made some statements about what it means, essentially saying that it's business as usual. I'm just wondering how strongly you think that you can interpret the court ruling, that it really doesn't influence the operational control that you have in the Russian subsidiaries and whether you see any threats, potential threats and that this could develop in a less favorable way, I mean, given the history of the company and what's happening in Algeria, etc. Thank you.

Thank you, Dalibor. All good questions, as always. Let's start with outsourcing. I'm sorry I cannot at this point in time quantify the sort of the bridge from outsourcing to EBITDA margins in Russia and Italy. That does depend, of course, on the magnitude of outsourcing and the deals that we decide to do.

But, what I can say about Russia is that we have a very positive experience with the Nokia-Siemens networks in the central region that has led to lower operational expenses, so for that part of the network operation. And we plan now to copy that concept into more regions.

So, that's part of overall operational excellence program we're running in Russia. And for that reason, I think, when I talk about more upside in Russia, I think these kind of initiatives are quite low-hanging fruit, even though there is a lot of work and planning that is required to make it happen. We still get more and more experience now in terms of how to do it. And we were able to implement that in a larger scale in Russia.

In Italy, we are not yet in the position to execute on the announced outsourcing projects. It was a time out the first part of this year. We plan to address the discussion again with the stakeholders related to that outsourcing project. There is a very good upside if you're able to implement them and execute. But, we're still evaluating that project. We haven't made a decision to execute or when to implement yet in Italy. But, there's certainly a long-term interesting opportunity and upside.

On LTE related to CapEx, we have said on the Capital Markets Day that CapEx should have a new target of 15% by 2014. That objective remains in place. And it has not changed with the latest announcement on LTE in Russia. And it has not changed with the spectrum we acquired in Italy.

So, what we do now is basically we do network swaps, and we do all the network planning and make sure that it's all LTE ready. And LTE is not going to be a big bang one-off investment. It's going to be a transition from 3G into 4G that enables mobile broadband and stuff like that. This is just another I would say technology expansion that the mobile companies have seen a number of times in the past.

And for that reason, we think we will be able to develop LTE networks, both in Russia within the CapEx guidance that we've given so far and that also we will do it within the CapEx guidance we have given for this year, which is for the Group 19% CapEx to revenues and for Russia below 20% CapEx to revenues.

And the CapEx spending you see in the first quarter I would not pay too much attention to, frankly speaking. It's been a little slow. It's not been slow for tactical purposes. It is basically a result that for example, in Russia, the Russian holidays in January, the weather, etc., etc. But, when we talk about CapEx for the year, I think the guidance I just gave is the right guidance to look at. So, you will see a catch up of CapEx leading to that number later in the year.

And then on the FAS claim, I think it's very hard, Dalibor, to speculate in what kind of scenarios that might play out. But, the reality is that the order by the court is not prohibiting VimpelCom from exercising most shareholder rights in OJSC VimpelCom. And this includes rights to approve annual accounts. It includes rights to appoint external auditors through dividend payments. It's -- we're allowed to re-elect the current Board.

So, there's nothing in the current order that is suggesting that this will influence operations or the flexibility of the Group. And as you all know, it's very hard for me to predict what the future will look like. Of course, things might change. So, of course, we watch the FAS claim thoroughly. And as you know, VimpelCom is only named as a third party here. This claim is against Telenor and Weather, too.

And -- but, again, as of today, there's nothing in that court order that is creating any difficulties with respect to our operations or our company.

Thank you, Jo. Much appreciated.

Thank you.

Our next question comes from Alex Balakhnin from Goldman Sachs. Your line is open.

Yes, good afternoon. My first question is on the Algerian ownership resolution. Can you share with us how do you see the solutions to look like now? And where do you think -- where and when the point of no return? And what do you expect from the Algerian government in terms of the steps there with how they're going to make?

And my second question is on the subscriber base quality in Russia. Obviously, you are making all this dealer commissions, changes, etc. And in the same time, your churn is still high. So, shouldn't we expect that with any of this change to a new scheme, your gross additions will decelerate, and your churn will gradually come down, or it will stay at this level for a reasonable long period of time?

Okay. Very good. Let's do Algeria first. I think the best way to look at Algeria and the situation there is that there are two parallel tracks right now. The first one is the fact that we have filed for international arbitration to protect our rights. We did that after the court decision against OCA and one of the member of the senior team. We received, as you know, a fine of $1.3b. And one of our employees was also sentenced to prison.

This has been appealed. The judgment has, of course, been suspended. And it's pending the appeal. So, this is the reason why we filed for international arbitration. That was a result of that court decision. And as I said, it's been appealed. And this is now leading its own life.

At the same time, we are very open and still in negotiations with the government to find a solution that is satisfactory to them and to us. We would very much like to find a way to stay long term in Algeria. We like the market. We like the company. We like the opportunity. There is still a lot of growth opportunities on 3G and others. So, our presence is (technical difficulty) to find a solution.

But, it requires a balanced solution that looks after our shareholders' interest. And if we cannot have that, then we will follow the first path I described, the file -- the international arbitration route.

So, that's what's going on right now in Algeria. And I cannot comment on any details from discussions and negotiations on values or anything related to that. We will return with more information when we have things to share.

And then on your question about the quality of subscriber base, the churn numbers, etc., -- I think if you look at the churn levels in Russia, it's very high compared to comparable markets. And I think it is a result of the dealer commission structure and some of the competitive dynamics we've seen in the past. We have now taken an initiative to change that dynamic.

And what we've done with the dealer commission structure to move it to value based is an initiative here. And I hope a consequence of that will also be that we see churn being reduced and calming down to more appropriate levels that we can compare to other markets. But, this is, of course -- it's not coming on its own. It needs to be managed and implemented and executed.

So, I think we -- so far, the team in Russia has done a great job as a stage one. And now, we hope that we will see more upside coming. And of course, churn might be one upside we have in terms of, again, cost, commercial cost of running the business. So, I agree with you that there is an upside on -- at the churn level.

May I ask a quick follow up? Thanks for the clarification. And on the Algerians, I understand there are these two processes going on simultaneously. But, do you have any timeline in mind, say, after which you will find it difficult or nearly impossible to run business as usual in Algeria? And that would be a point where you are turning for the first option, which is for international arbitration. So, do you have any, like, idea where this point is if it exists?

I don't think we have a hard drop-dead rate. I don't think there is any point of no return. So, I think, unfortunately, it's very hard to give you that data. I understand you would very much like to have it. But, I think it's going to weaken our position in negotiations and the likelihood of also resolving this.

So, for the time being, the operation is doing fine. You saw the growth, and you saw the results in the first quarter. So, my compliments to the team in Algeria that it's capable of running a company with the limitations we have. And I think we'll just have to be a bit patient and not put a strict deadline on ourselves.

Understood. That's very clear. Thank you.

Thank you.

Our next question comes from Herve Drouet from HSBC. Your line is open.

Yes, good afternoon. My first question is regarding LTE. My understanding is you're planning to commercially launch 4G LTE in first half of 2013. Would you expect some of your competitors to commercially launch their service before? And would that impact potentially your commercial strategy in mobile data and broadband?

And my second question is just a confirmation from in your P&L how you recognize cost for commissions. Is it based on accrued cost, or is it based on actual payment for commissions? So, just to confirm that we are not going to see any lag in term of the payments by 6 points for the commission of the SIM cards that have been purchased during first quarter? Thank you.

Okay. LTE, was that relating to Russia or Italy?

Russia, yes, please.

Russia. Okay. Yes, first of all, I think that's the second half of 2013 and the first half with respect to --

Okay.

-- commercial launch. Listen, I understand there are some debates and tension on the timing because it looks like at least Megafon will launch something later this year.

I understand that has a value in terms of reputation. I don't think it has a big commercial impact. There are very limited LTE devices available. We still have HSDPA networks available, which offers quite good speed. So, again, there will be a competition into mobile broadband. So, there will not be a big bang change in terms of customer experience. I think so.

I'm not very concerned about being a little later than the others with the commercial launch. I still think these are all long investment cycles. And with the things we do now in Russia, I feel comfortable that also implementation or LTE will find its good shape and form. And for that reason, to answer your question, the timing issue is not an issue that is on top of my list of worries.

And then on -- if I understood your question correctly, on dealer commissions, we're accruing, though it reflects the correct underlying cost of the dealer commissions being paid and then linked to the revenues being generated. So, this should not be unsynchronized with the way we book our revenues and, for that reason, potentially building up future problems. So, this is being accrued. And it's being reflected the right way in revenue P&L.

Thank you very much. That's very clear.

Our next question comes from Igor Semenov from Deutsche Bank. Your line is open.

Yes, hi. Thank you very much. Just a couple of follow ups on the previously discussed topics. One is the FAS case. How does it impact your ability to form a new Board at VimpelCom Limited level? And could you in general give us an update where you stand in terms of the formation of the increased Board? When should we expect this to happen if at all?

And the second question is on the -- on Algeria. How do the elections that recently happened in Algeria impact your talks with the government? Do you expect that there could be further delays, there could be changes in the -- I don't know -- opinions of the government and their position on this topic? If you could provide any sort of general comments in this area. Thank you.

Yes, on -- let's just take one step back on the FAS claim again. It's -- first of all, VimpelCom is named as a third party. And the claim is against Telenor. And it's against Weather, too. And it's about Telenor's acquisition of the deferred shares in VimpelCom Limited.

And then FAS and the court have put in place an injunction. And that restricts OJSC VimpelCom from doing certain things, for example, deciding on major transactions, which is not a practical problem at all for the Company right now because we have no such plans.

It does not impact our good important rights that we need as shareholder in OJSC. And that is such things as annual accounts, approval of that, approval of external auditor, approval of dividend payments. And also, we're allowed to re-elect the current OJSC VimpelCom Board members. We're not allowed to elect a new Board. But, that's not a practical problem either.

And then, if I understood also your relevance to [resident] Telenor, I think the court said that resident Telenor cannot appoint Supervisory Board members at VimpelCom Limited. This is a shareholder issue. And it's wrong of me to comment on that. That should really be Telenor and Weather commenting on that.

And our current Supervisory Board at VimpelCom Limited remains in place for the time being. I think that's the best summary of my understanding of the whole FAS claim.

Okay. So, just to summarize basically, until October at least when the first hearing is supposed to take place, the Board of VimpelCom Limited stays in place. There will be no changes, correct?

That's my understanding of --

Yes, okay.

-- FAS claim, yes.

Yes.

Yes.

Okay. And on Algeria?

Yes, can you briefly repeat that one?

Yes, so, the elections in Algeria, how do they impact your negotiations with the government? Yes.

Yes, I think it looks like that election is not causing any real setbacks for negotiations. And it's, of course, very difficult for me to give a precise judgment on that because I don't know exactly what's going on in the court circles. But, from what we understand, election was not a problem at all for the ongoing negotiations.

Okay. Great. Thanks very much.

Our final question comes from Victor Klimovich from VTB Capital. Your line is open.

Yes, thank you. Good afternoon. May I return back to the question regarding this internal loan to Orascom Telecom Holding? Well, the question is the following. So, basically, two questions. First of all, how will you fund this internal loan? So, should we expect any further borrowings on VimpelCom Amsterdam level, or what will be the actual structure of this intercompany loan?

And the second part of this question, where you expect this money will go to -- in terms of countries, will it be to all countries or mainly to Pakistan and Bangladesh? Thank you.

Yes, the company loan, of course, that's why this intercompany loan is funded from the availability that the Company has. So, first and foremost, when you look at the objectives that we have that we stay within our own cash flow, so now, we stays in our own cash flow.

We will also fund that intercompany loan within that particular context. There can, of course, always be timing differences in that. So, if there are timing differences, we have the ability to draw upon, for instance, for a very short period on revolving credit facility if we need to in timing fill the gap at a certain moment. And indeed, the main focus of it is on the Orascom Holding on the one hand and the entities in Pakistan, Bangladesh, and Saharan Africa on the other hand.

In addition to that, of course, there is the position that we have in Canada. But, that is in the context of what Jo already explained as part of our current analysis how to continue and how to go further with that particular business.

I think it's clear from all the information that, due to the restrictions that we have in Algeria, there is not a huge possibility for investments in Algeria. But, as far of these investments are done, of course, they are done within the context of the Algerian cash flow itself.

But, if we return back, so for example, for the last five quarters, your investments in both Pakistan and Bangladesh were approximately $700m. And you are talking about $2.5b now. So, why is that that big?

That's what I indeed explained very early in the call at the question that was asked at that time. It's more a matter of efficiency. We have then not to go every time to the shareholders' meeting of Orascom to ask for the -- for an intercompany credit facility. So, actually, it is supposed to be in place and will be sufficient for the periods to come.

And for which time period approximately?

Well, under the current view it will be for certainly more than three years.

Okay. Okay. And may I come back to another topic about your gross margin in Russia? What were the major drivers for this very significant improvement? So, it was approximately RUB4b decline in direct cosst. Can you explain the major drivers here quarter on quarter, of course?

Quarter on quarter, yes, I think you talk about EBITDA margin or gross margin now?

No, gross margin.

Yes, the gross margin is of course also helped with the handset sales and also improvement in what I addressed earlier on, on the service margin. So, I think those two effects add up to the gross margin. And that's why you also see the improvement.

And what do you mean by service margin? My approximately calculation shows that --

Yes, okay.

-- it could be --

Yes, okay. So, I understand your question. So, we -- in the packets, of course, we referenced the gross margin. And in that gross margin, you have both cost of traffic. You have the service revenues that relates to the traffic and the data or traffic in the network. And then you subtract cost of traffic interconnect and other related costs from that. That -- when I reference of this margin, I talk about the margin on the actual traffic.

And then the gross margin that you reference in that number, we have also included of course then the handset sales as well and costs related to that. So, when you see an improvement in gross margin, as you asked about, it's both an improvement coming from handset sales and it is an improvement coming from what I call this service margin, which is basically higher margin on the core profit, core products in traffic and data revenues in the network and as -- again, as a result of bundles and other on-net traffic and other initiatives related to the traffic itself. So, sorry for not being clear on that.

And should we expect any further improvement because your even service margin -- even if we exclude handset sales, of course, then your service margin went down quite significantly throughout 2011. Now, it improved, as we see. But, should we expect further improvement here, or you think that this is quite the stable level?

No, of course, I'm not in the position to sit here and promise anything. But, when we talk about upside in Russia, we talk about improvement in service margin. That's clearly something that we're now working on with optimizing tariff structures and bundles and everything related to that. And we talk about cost structures down the P&L that hopefully will lead to an increased EBITDA margin going forward. That's certainly an objective we have and something that we work on achieving.

Okay. Thank you very much. That was very helpful. Thank you.

That concludes the Q&A session. I will now turn the call back to management for closing remarks.

All right. So, thank you, everybody, for taking the time to dial in and all the good questions. I think it's very helpful, these calls, to try to explain the dynamic of the business. And as I said, we're quite pleased with the start of the year. And we will work hard and implement the changes and the strategy we've talked about and hopefully see some more progress going forward.

And with that, of course, we have our IR team sitting here in Amsterdam available for follow ups and questions and meetings if necessary. And with that, I suggest to close the call. And I wish everybody a good afternoon. Thank you.

Ladies and gentlemen, that does conclude today's conference. You may all disconnect. And have a wonderful day.