CNBC Interview: President & CEO of Sistema, Mikhail Shamolin

Following is the unofficial transcript of an interview with Mikhail Shamolin, President & CEO of Sistema, by Geoff Cutmore of CNBC.

Geoff Cutmore (GC): I wanted to pick up with the line from yourself on the statement out on the 10th June on the first quarter numbers. And in statement you said 'a key milestone of the past few months was the signing of settlement agreements with Ural Invest.' Now clearly that is about the Bashneft business. The fact that you've put that in the statement now – does that mark closure as far as you and your company is concerned with the Bashneft affair?

Mikhail Shamolin (MS): Most certainly yes. What happened had a logical sequence of events if you look at the facts. The court back in Autumn decided that the deal of privatising or transfer of Bashneft from Russian Federation property into republic of Bashkeri property was non-constitutional back in 1993 and that is the decision that got reversed by the court and therefore all of the subsequent sales of the asset have been reversed again and we got a court order in spring against [inaudible] which recognised that we should be entitled to a return of the funds that we paid for Bashneft when we bought it. We signed a peace accord with Ural investment for peaceful return of this money back which, since it was not our fault that the transfer of Bashneft from state to republic of Bashkeri was recognised unconstitutionally, we had nothing to do with this, our deal, as a result, got reversed as well and we were entitled to receive the funds that we paid. From that perspective what happened has happened and we're going ahead.

GC: What are the scars like? Will they run deep as far as the business is concerned and how will that change the way that you approach state related entities in future because at the time, having your chairman under house arrest is a very painful experience for any company?

MS: Things like that happen in any country, in any economy. Those situations arise and you have to deal with them. One of the important facts when the court in spring gave us entitlement to the funds of our investment, the same court recognised Sistema to be a good faith buyer of Bashneft in 2008. Court already decided Sistema is a good faith buyer, so as far as our actions in this purchase are concerned we have no doubt, and that is recognized by court, that it was done correctly and no laws were broken. So basically if you talk about scars, we don't really have much to think about scars, what to do what not to do, our philosophy is very simple – we do deals which are absolutely legal, we do deals that create value and if you look at the numbers you'll see that we have created substantial value in terms of how the company was worth when we bought it and what the valuation was at the time when the situation arose back in 2014. The same approach we apply to all of our investments. We look at companies which are undervalued, which have poor management, maybe poor strategic planning and judgment and we apply our expertise and we've proven it in many cases in many turnarounds we have done in different assets that we can do it, and this is one of the key aspects of Sistema expertise, exactly how to breathe new life into a company and how to do a turnaround and how to create value through doing that. And we intend to do exactly the same.

GC: You said this could happen to any country, anywhere in the world, but when it happened western analysts said 'there you go, that's Russia all over again.' Has this changed the way you think about investing at home against investing abroad? Will you think in future investments going to other market places that offer good value in business terms and perhaps less political risk?

MS: Our key market and our key focus continues to be Russia because that's where we have our expertise and that's where we have our competitive advantages because we understand the market and understand the business and know how to create value. When you go to another market you immediately face hundreds of competitors who have been in this market for tens if not hundreds of years, if you talk about western European/United States for instance, and they know this market much better than you do and deals, so what chances do we have to find a good deal which was missed by 10 other competitors that are looking at deals every single day? You need to either develop or grow something in time – people, expertise, reputation – yes we can go abroad and do occasionally, one deal here and there when the opportunity presents itself, sometimes it happens. But if you talk about a reliable strategy of going abroad, the first question you need to answer is 'what is going to be your competitive edge?' If you cannot answer this question you are almost destined to lose all the money that you put in there. And as far as legal risks or business risks are concerned, I can give you numerous examples of very big names being awarded very large amounts of fines on charges which, I wouldn't say questionable, but would not have been expected a few years back so to say. Specifically banks after what happened in 2008/2009 and now you see criminal investigations taking policies, behaviours of certain institutions based on emails that were sent between traders and dealers to each other about 'I warned you that this fund is not good and you...' and so on. And they you get a $2 billion fine.

GC: So you're drawing a direct comparison between what's happened with western bankers and you're experience with Bashneft?

MS: No, I'm just saying when you talk about legally, the risks of doing business; it's never black or white. It's always an area where judgments can be made. All I can say is you can't vindicate Russia and you cannot say that things like that only happen in Russia and they don't happen anywhere else in the world. If you go to Russia things are going to be bad for you, if you stay in Western Europe or the US things will never happen to you – this is not true. You have risk all over the place and as far as we're concerned, our policy is to be very transparent, very honest in the way we do business. We comply with all the regulations and we try to do things the right way. And if sometimes circumstances work against us, we deal with this as any business would and I think we've [SOUND CUTS] – 16:55:10 – a lot in going through the process and it will only make us stronger along the way.

GC: And the chairman's fine? Mr Yevtushenkov doesn't experience any hangover from what happened to him – he's OK?

MS: I think he should speak for himself about this. It's very difficult for me to judge. As far as Sistema as a business, we are moving and we are healthy and we are planning and we are executing and we are acting. He is fully involved in the daily operations and very active in supporting us. So yes we're working and we're optimistic about the future.

GC: Who ends up with Bashneft?

MS: Right now it's the state, for the state to decide. I've seen many articles and many statements about potential privatisation. I haven't seen/heard any official announcements. We'll see.

GC: Can I move you along, because I want to talk to you some more about where you're going to invest. The Russian market looks very cheap when you look at equity valuations on a PE basis. Obviously this is an economy undergoing sanctions and it's experienced very low rates of growth. As you look in Russia and outside, do you see screaming value anywhere?

MS: Oh yeah, that's one of the key reasons why we continue to focus on Russia as a market because we do see lots of opportunity here. The thing is, it's almost impossible to generalise and talk in kind of common terms about things. It's purely on deal to deal and asset to asset basis. In the same industry, a pulp and paper, in which we made a recent acquisition, a company called Segheza group. This is a sector which has a great variety of results. From complete losses and all the investments gone and no future and everything is bleak and all kinds of problems, ecological and such, and you have companies like the one we invested in, because it's working in the right sector, it is specialising in sack paper and plywood which is in demand internationally. It's got its own resource base. It's got equipment and production facilities which are modern standard and with modern improvement we can significantly increase financial results. First of all EBITDA which already this year, we see that we can double or triple as compared to last year. So in the same industry, which you can say is very heavy if you talk to specialists around the world, you know pulp and paper, you can find pockets of opportunities and if you can describe for yourself exactly why this is an opportunity and what is the path to growth you can make money. And if you look at many assets in Russia you will often see assets which are undermanaged. Sometimes the owners of the business don't see a future for themselves or for the business. They're not developing the business but rather milking it for cash and we can be a much more efficient owner who believes in the future. By reinvesting in growth and managing business strategically we can create a much stronger value.

GC: Would it be fair to say that the sanctions perversely have created much richer pickings for domestic private sector companies that have capital?

MS: Well I think sanctions definitely boosted the desire and created pockets of capabilities to develop new businesses and sectors where formerly competition from foreign goods were prohibitive– don't even think about starting this business. There is a dedicated government effort to support certain sectors and growth in sectors and yes we do see opportunities. Let's take agriculture, a sector which has a bright future in Russia. Russia is one of the biggest wheat producers in the world and Russia has the space and conditions for quality wheat production at optimal cost which is going to be internationally competitive for many, many years to come. And the global demand for wheat is increasing every year with the growth of global population so this is clearly a sector in which we are investing and we know we're going to make money there. There are many examples like this. So yes. Also what happened with the oil price is a very good stimulus to start developing industries which have not yet been developed to the extent that they could have been in Russia. And we're entitled to take this opportunity.

GC: Can I ask you about India because the company's had a bruising experience in the past, with the cancellation of the CDMA licences and then you were in a situation where you looked like you were going to sell on your operation. That decision turned into 'we're now looking at a joint venture with Relian.' When do you think that deal will finally be sealed and would you have pursued the joint venture route if Mr Modi hadn't become leader of the country?

MS: For confidentiality reasons I can't give you much information about the specific negotiations and potential outcome but in general I can tell you that the Indian telecommunication market, in terms of size and opportunity still remains to very attractive for investors because it's a massive amount of customers that don't yet have access to mobile internet and that seems to be a trend, a growing trend, as we see here in MTS domestically and our international partners Vodafone. We do see the opportunity but the question is what is the best approach to seize this opportunity. The main complication in India is the Indian government has been very demanding in terms of financial resources, money, that they wanted to get for frequencies because they treat frequencies as a natural resource that is short in supply and therefore they've been trying to maximize the value therefore they were splitting this frequency resource in many small buckets and selling it through auctions to multiple bidders so you have fierce competition in India and very small frequency resource. Our company was fortunate enough to get certain frequency even though we had this period when it was taken away and we had to purchase it again in an auction. This frequency creates value for the data business so this the basis on which we look at setting joint ventures to maximise our chances of gaining the market share because consolidation of frequency resource and consolidation of players in the telecom market is an absolute necessity not only for the players to be profitable but also for the market to be successful. If you have 10 bands of 5mhz frequency belonging to 10 different operators, none of them can build a working, functioning, LTE network because LTE which is the last generation of mobile internet cannot work with the five frequency efficiently. You cannot get the speeds or the capacity needed. You need to combine the spectrum and at least have 20mhz or better even more to really deliver what is needed to have a quality mobile internet. This is the trend on which the country is going to be growing and I hope Mr Modi and his government who have been saying very positive and good words about supporting business growth and supporting international investment growth and continue down this path will help the telecom sector to consolidate.

GC: Feel like I've just had a lesson in how the telecom industry works. I believe you have a majority stake in a telecom company in Greece?

MS: In Greece, we do have. It's not really a telecom company; it's a company that produces a certain segment of telecom equipment, namely radio relays and does some consulting and systems integration work. It's called Intracom.

GC: So at the moment, Greece is under a great deal of pressure funding wise. The knock on effect of that has obviously to bring down valuations across the Greek economy. Do you see at any point increasing your position in Greece, perhaps taking stakes in other businesses as they become ripe for deals?

MS: We're evaluating opportunities all over the place. But again it comes back to the first question we discussed. What should be our competitive advantage? The information about assets in Greece being cheap is information available to everyone. All the global funds – Black Stone, Black Rock, KKR, JP Morgan Goldman Sachs, everyone, all know that this is the fact so all of them have their offices, private equity funds in Europe, in Greece, in London, very close, people working on assets. All of them are looking for good deals and all of them are screening 10 deals a week probably and they're picking and choosing the one's that they really believe in. We need to have a qualification to get in and get access to a deal to which other temp guys would not get access. Either we need some unique knowledge/connection/capability or we need to be prepared to pay more than those guys will and if we are prepared to pay more we need to understand why are we prepared to pay more? Are we going to be a more qualified investor? Do we have a unique set of project management or industry skills? We have a very qualified team sitting here in MTS (undisputed leader of Russian Telecom market) – yes we can use the expertise accumulated by this team to apply it to an asset in Greece or anywhere - telecom asset- which is not well run and by improving the management we can create substantial value.

GC: But you don't see anything in Greece at the moment that looks compelling or you're negotiating for?

MS: We're looking at the situation but I can't name you any names right now.

GC: Just to wrap up, the Russian economy has been in a difficult place for the last 18 months. Even the World Bank is now saying that the worst may be behind us. Can I ask what your feeling is on this? I think we'd all like to believe recovery is taking place but it feels like a very different Russian economy that we're in, perhaps less market oriented, more kremlin control and more focussed on ring fencing oil, gas and mineral assets. Is that how it feels to you?

MS: It does not. It does feel completely differently. The attention the government is paying to business and receptiveness, to hear messages from business has increased tenfold over the last 18 months and it is clear why. Once the oil price drops and the revenues, filling the state budget, [are ] reducing, then the question is where are those revenues going to come from in the future. There are only to sources. Business and individual income tax, various other taxes. But the platform is business. If your business is not developing, who is going to increase tax payments, who is going to fill the state coffers? You either give up on the market economy altogether and say the market economy is finished and we are moving to some kind of controlled, planning economy of soviet type, which I see no indication that this is happening in any of the statements or intentions, I don't see that. I see that Russia has committed itself to be a market economy and will continue to be a market economy in the future. And if that is the case, the only way out of the situation is to increase the labour productivity on which the president of Russia and many ministers have spoken. But to increase the productivity you have to start new enterprises, you have to put new equipment you need to put in place, new technologies you need to develop new industries and so on and so forth and who is going to do it? Yes the government is playing its own role with the state enterprises and so forth but there are many, many, many industries and enterprises that are private that are growing and contributing. If you look at what the government has done to support certain industries including banks, not only state banks but also a bunch of commercial banks that have been re-capitalised to stimulate funding in particular industries. The recapitalisation of the central bank, we also have MTS bank in our portfolio and we're also looking to receive re-capitalisation from the central bank, not because we desperately need it but because it's a good opportunity to increase our portfolio. But there are conditions with which this re-capitalisation comes from, and condition number 1 is that we have to fund certain sectors in a certain amount in a certain period of time then you can look at the support of agriculture, particular enterprises, industries which are of vital importance and the whole package of government support is 1.6tn roubles I believe. Also by the way supporting mortgages, which again is very important. We have another business in real estate development; it's very important to maintain demand for housing, because it supports the industry, the cement industry and so on and so forth. So yeah, I don't think we are being fenced out or in.

GC: It's fascinating you say it, and I'll just bring it back to the beginning. So the western analysts who said 'Bashneft is an example of state control returning to the Russian economy' they've just misunderstood what the whole story is about?

MS: It's very difficult for me to discuss whatever the political intentions behind Bashneft's situation. All I can tell you, what happened, happened. I'm not really trying to look for any conspiracy theories behind it because this is not productive and doesn't help us moving forward. What I'm saying is we do see multiple opportunities, if you look at our financials in 2014 and Q1 in 2015 you see that we are doing a pretty good job managing without Bashneft. So we understand why we can do things here and we will continue to do it until we can.