Telecominvest Recruitment

On October 12th 1998 CEO of Telecominvest and his young energetic CFO were in New York, continuing their meetings with international institutional investors. The CEO was scheduled to speak at the investor conference at the New York offices of CAIB Investmentbank AG, which hosted the conference. For both men this was the first time they appeared in front of an audience of portfolio investors, and they were looking forward to acquainting the world with Telecominvest and the post-crisis business environment in Russia in October 1998. The CFO was also eager to make sure that his new boss understood the importance of these meetings and saw how different they were from industry and hardware supplier-oriented events.

When introduced to an international equity analyst from one of the leading investment companies, the CEO of Telecominvest was disappointed to learn that the analyst had never heard of Telecominvest and its business before. Having spoken at international industry and supplier conferences almost on a monthly basis and having made extensive connections among Western European telcos, the CEO was bewildered with his discovery. A leading telecom player in the northwest Russia and St. Petersburg in particular and a relatively small private company, it was completely unknown in the universe of emerging markets financial investors. Clearly, whatever the CEO and the company board had in plans for Telecominvest, they had a long way ahead of them .

Introduction

Telecominvest is a holding company with investments in telecommunication businesses in North-west Russia. Backed by its influential shareholders, St. Petersburg telephone Network, St.Petersburg Long Distance and International Telephone Company and First National Holding S.A. - a Luxembourg affiliate of Commerzbank A.G. of Germany, the company developed rapidly, creating and occupying niches in most lucrative segments of telecommunications industry. At the end of 1998 the TCI group had a 65% share of the cellular market outside St. Petersburg, 88% of the cellular market of St. Petersburg, 9% of fixed line telephony, 22% of the internet services and operated 94% of St. Petersburg's payphones.

With a number of important investments planned on the holding and subsidiary company levels for the not so distant future, the main challenge for Telecominvest management was to secure the sources of long-term financing. This task was especially difficult; given the after-crisis stock market conditions at the end of 1998, extremely negative sentiment of portfolio investors towards Russia and potential conflicts of interests between strategic partners of Telecominvest.

Russian Economic and Political Situation in 1998

Political and Economic Transformation

Before 1985 Russia was a centrally planned economy. In April of 1985, Gorbachev came into power with an understanding that something had to be done about the collapsing economy. In 1986 Gorbachev proclaimed perestroika and glasnost and in 1987 decentralized economic decision-making. In an address to the nation on December 25, 1991, President George Bush declared that "the United States recognizes and welcomes the emergence of a free, independent, and democratic Russia, led by its courageous president, Boris Yeltsin". By the end of December the Soviet Union had been dissolved, succeeded by 12 newly independent states. Boris Yeltsin was elected President of Russia, the largest of the new states. As president of the Russian Federation, he held much of the power over Gorbachev who had been elected President of the Soviet Union in 1990.

In January of 1992 prices were freed leading to a tripling overnight. Three and four figure inflation followed through to 1995, coupled with a constant decrease in output. In June 1992 Russia was admitted as an associate member to the group of major industrial powers, the G7, with the right to attend meetings as an observer. Unhappy with observer status only, Russia is seeking formal admission and a name change from the G7-plus-one, to the G8. In 1997 Russia joined the Paris Club of creditor nations, and undertook a deal in which it agreed to reduce its claims on third-world debtor nations from 100% to 75%, in exchange to win back some of the $140bn lent to Soviet allies during the cold war.

A multi-tier economy has developed in Russia. The old state sector, which is now largely privatized, has three tiers. The first tier is primarily oil and gas production. This sector showed small declines (5-10%) and is now growing at 3-5% a year. The second tier includes electric utilities, telecommunications, weapons and the chemical industry. These industries are growing slowly after a decline of 20-30%. The third tier is the rest of old state economy. It is comprised of textiles, apparel, agriculture and manufacturing. These sectors have declined by 80-90% and are still declining. The entrepreneurial sector, outside of the former state economy, is burgeoning and there is money to be made. The sector is spreading into telecommunications and parts of manufacturing.

Economic Crisis

The economic crisis had been building throughout 1998 starting with the crash of the Russian stock market in mid-1998, coming to a head on August 17th as a result of key decisions made by Prime Minister Sergei Kiriyenko's reformist government. Significantly, the Central Bank widened the scope of currency fluctuation it was prepared to accept before intervening in the market. Currency speculators had spotted a weakness in the Russian economy, and the central government could no longer to artificially support the Ruble without dramatically affecting the foreign reserve position of the state. In mid-August the Ruble was trading at Rb7/$1 but plunged to a low of Rb20/$1, finally stabilizing at Rb16/$1 after an unexpected intervention by the Central Bank. Adding to the currency crisis, in August 1998 the government unilaterally extended the maturities of short-term government bonds (GKO's and OFZ's) from 3-three months to maturities ranging from 3 to 5 years yielding between 20-30%. In so doing, the government had effectively defaulted on Rb281,000m of government debt, (equivalent to $43bn). Investors wishing to convert bonds to cash received one fifth of the value. Some foreign investors were hurt, but more importantly, it hurt the Russian banks. The banks were heavily exposed to the GKO market causing many banks and inter-bank operations to freeze. A three-month moratorium was placed on Russian banks' debt repayments to foreign lenders. Many small banks were lost, with larger banks being saved by the