May 15, 2012
Executives
Alexandra Tramont – Vice President, Investor Relations Jo O. Lunder – Chief Executive Officer Henk van Dalen – Chief Financial Officer
Analysts
Cesar Tiron – Morgan Stanley & Co. Alexander Kazbegi – Renaissance Capital Dalibor Vavruska – ING JP Davids – Barclays Capital Dalibor Vavruska – Citigroup Alexander Balakhnin – Goldman Sachs Herve Drouet – HSBC Investment Bank Plc Igor Semenov – Deutsche Bank Victor Klimovich – VTB Capital
Operator
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.
Alexandra Tramont
Thank you. Good afternoon ladies and gentlemen, and good morning to those of you connecting from the U.S., 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 presentations, 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.
Jo O. Lunder
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. We 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 for the quarter. We are pleased with the progress we’re making.
The group performance led to almost 6% organic growth in revenues year-over-year, reaching $5.6 billion. If we exclude forex impact, EBITDA increased 5% compared to the same period last year, leading to a margin of 31%.
We’re pleased with a positive trend shift in 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 209 million mobile subscribers. Our Asia and Africa business units witnessed strong subscriber growth of 19% exceeding the 86 million mark.
Net income for the quarter reached $318 million. 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 $1.6 billion.
The cash flow targets combined with profitable growth are fundamental KPIs for our company on which we’re measuring our performance and again I am satisfied with the progress and the results we’re delivering in the first quarter. Moving on to the strategic effect and some main recent events, as you all know our Orascom Telecom holding has submitted a formal notice or 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 the significant part to our debt maturing in 2012 with the issuing of bonds in March and in April in Russia and Italy.
In the 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 were the company seize the best opportunities to generate shareholder value. Also in April, the Russian Antimonopoly Service named VimpelCom as a third-party in its claim to validate Telenor’s February purchase of 234 million VimpelCom preferred shares from Weather II.
In late April, a Russian court issued an injunction that prohibit VimpelCom from exercising certain specific shareholder rights in OJSC VimpelCom during the [tendency] of this case. However, the injunction does not prohibit VimpelCom from exercising its shareholder rights to approve dividend payments and to reelect the current OJSC Board members.
The first hearing on the merits of the fast 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 for our Italian business. Maximo has a strong track record in running the consumer business unit, the Wind, and broad experienced 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 sometime 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 and 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 the 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 levels within technical and IT through a reduction of the costs per [TRX] and channel renting due to network maintenance and planning optimization and ongoing contract negotiations with vendors. Furthermore, we signed a five-year agreement with Nokia Siemens Networks for extended network support in the central regions, allowing us to substantially reduce operational expenses, including technical cost 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 early communicated goal of delivering no less than RUB5 billion in annualized cost savings this year. However, as you’ve probably also seen in the release as a result of 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’ll continue to invest in our 3G network deployment, development, and the 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 the aim to participate in the LTE contest, which is expected to conclude 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 the earlier announced strategy.
Moving on to Italy, in Italy wind’s total revenues were stable with – underlying growth of 3% if we exclude the impact of the mobile termination rate cost. The marginal reduction in service revenues coupled with an increasing commercial OpEx and higher bad debt led to 3% reduction in EBITDA.
Wind’s mobile data offerings achieved strong results in the first quarter of 2012 with mobile Internet revenues increasing by 40% year-over-year as a result of penetration smartphone, tablet and data dongle. Our operating performance remained strong with Wind outperforming the market and further consolidating its market share in both mobile and fixed line.
Our mobile subscriber base grew 4% year-over-year to 21 million 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 an investment in HSDPA and LTE to grow our data business.
We will also continue to focus our efforts on strengthening our presence in new segments such as higher value for base subscribers and in the SME market. Moving to Asia and Africa, in our Asia, Africa business units, the operational excellence initiatives implemented have less profitable growth as we are seeing double-digits 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 43%.
Our operations in Algeria continues to be quite strong resilient with revenues up 7%, EBITDA increased 8% in local currency supported by strong cost savings. Our EBITDA margin remained flat at around 60%.
In Bangladesh, our subscriber base showed an impressive growth of 23% driven by a more effective acquisition strategy following this impact reduction in June 2011. Revenue and EBITDA showed double-digit growth largely as a result of strong top line growth and operational excellent initiatives.
Moving onto our Ukrainian business units, we continue to deliver healthy top line growth driven by growth in both mobile and fixed businesses while maintaining our leading market position. Mobile revenues were up 2% year-over-year mostly driven by the continued strategy of [transition] to bundle.
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 cost, growth of network costs and our operational expenses as a result of higher traffic and inflation.
In the first quarter of 2012, EBITDA margin were slightly lower than the full year 2011 margin of 53%. But the company expect this to be temporary and we have measures in place to improve the margin going forward.
Then the last of our five business units to CIF. The CIF business unit was able to deliver strong revenue growth and 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 above 42%, to secure profitable growth and 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 CIF market which show organic revenue growth of 5% in the first quarter, EBITDA remained strong but declined due to the competitive environment, limitations on tariff introduced by the regulator as well as the 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 margin declined slightly as a result of increased competition and an increased tax.
Our CIF network expansion is in progress and we continue to roll out the 2G and 3G network. 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.
Henk van Dalen
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 that the company’s results of operations would have look like had the company’s transaction with Wind Telecom occurred on January 1, 2011.
VimpelCom Ltd. results presented are based on our (inaudible) as of this year.
We all know the pro forma contains combined financial information prepared in accordance with our less 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 the period have been subject to rounding adjustments.
As a result certain numerical figures shown as tables 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 alluded and as previously announced the company published its full year 2011 audited financial results under IFRS when it filed this 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 the strong performance across all 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, up 9% and 12% respectively while the performance in CIS showed a 2% increase year-on-year. Overall growth was probably 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 pipeline applied to intangible assets associated with customer relationships as part of the Wind Telecom acquisition or amortization of (inaudible) 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 2012 compared to the first quarter of 2011.
Lower net gain realized from investments in short entities mainly related to our investment to (inaudible) and fair value changes of derivatives. In the first quarter 2011, the foreign exchange gain was $168 million.
During the first quarter 2012, the gain already amounted to $63 million mainly due to lower U.S. dollar exposure in Russia.
Net income decreased by 29% year-on-year as a result of the increase in income tax expense of $45 million and $48 million exchange in profit $40 billion compared with the two month consolidating interest mainly related to a stronger performance in Orascom Telecom. Then to the figures on an actual basis, 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 cost as a result of the Wind Telecom acquisition. Net losses from associated entities mainly due to lower profits from (inaudible) and losses from the investment in Canada as well as lower gains from foreign exchange rates movements mainly attributable to the lower U.S.
dollar exposure in Russia, the increase in the effective income tax rate driven by higher non-deductible expenses and long recognized losses in the telecom entities as well as the effective erosion of tax divisions in Russia in the first quarter 2011 and higher profitability to non-consolidated investment led to a decrease of net income of 36% to $380 million on actual basis. Then there is only a little bit of more detail on the debt and cash rates as a group.
On a consolidated basis, the actual net cash from operating activities in the first quarter was $1.6 billion and the free cash flow after cash CapEx resulting was $735 million. Gross debt increased in the first quarter from $26.9 million where USA was $28.6 million mainly due to the issuance of unit bonds for RUB35 million in case approximately $1.2 billion for general purposes and debt redemption, coupled with a $670 million movement as a result of (inaudible).
We ended the quarter with a balance of cash and cash equivalents of $4.3 billion. This cash balance is temporarily high, while it is affected by the $1.2 billion cash resulting from the 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 $24.3 billion leading to a net debt in the last 12 months EBITDA ratio of $2.5 billion at the end of the quarter on pro forma basis.
And a little bit on the debt competition and the maturity profile. Total gross debt was at $28.6 billion with an average rate of 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 maturity 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 RUB35 billion mainly to refinance the existing debt and obtain vendor financing for RUB1.6 billion, or we just about $53 million in March and April. Wind issued a tape of Senior Secured Notes due 2018, $4.7 million to refinance, adjusting that.
And on May 03, OTH AGM approved, $2.5 million uncommitted inter-company growth facility from VimpelCom Amsterdam BV. And furthermore, I think it’s important to notice that we still have substantial undrawn committed revolving credit facilities in place for a total of $1.5 billion.
There is a peak in maturity profile in 2017 caused by the Wind Italy debt, it’s meant to refinance this before that date. However these will not be completed before the end of 2013 and timing will depend on moderate circumstance of course.
And as usual and finally, I will give you a little bit more detail on the current financing structure, which is not in any measure of difference than it was. So on this slide, the circle shown has 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 $14.7 billion of it as of the end of the first quarter. That block of debt is ring fenced in the sense that it has more recourse on VimpelCom Limited than any of the other companies in the group.
So we have really almost done the numbers. The second block of that is $1.1 billion in local and these are Orascom, those are in that position and they do not have recourse on VimpelCom Limited.
And the third block of debt has to do with OJSC and VimpelCom Limited which is the block you can see on the left hand side totalling $12.8 billion 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 inter-company loan.
I will now turn call back to Jo for his final remarks.
Jo O. Lunder
Thank you and before we open the floor for questions, let me summarize the picture in a few words. Overall, I am pleased with the performance in the first quarter.
We see now signs of the signs of the business profile that we're targeting with strong organic revenue and the EBITDA growth combined with increased cash flows. Going forward, we see more up sights and improvement potential for our Russian operation and we believe a trend shift is now underway in Russia.
In Asia and Africa, our operations continued to display our resilience to our 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 margin in the remainder of this year. Our operations in Italy continued to outperform the market and it delivered a solid performance despite a regulatory pressure and the economic slowdown we all know by now.
And the CIS market also continued to provide strong growth and improved cash flow. However, they would increase the regulatory and competitive pressure.
Going forward, we will remain focused on step-by-step implementing our strategy. We will focus on profitable growth, cost control, and increased cash flow through – well that increase hopefully you should hold this value going forward.
With that let me open the floor for questions. Operator?
Operator
(Operator Instructions) Our first question today comes from Cesar Tiron from Morgan Stanley. Your line is open.
Cesar Tiron – Morgan Stanley & Co.
Yes, hi. I have two questions actually.
The first question would be to understand if in Russia, you delayed in 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, so are we going to see some of those expenses in Q2 or Q3? And my second question would be to understand better if this loan you made to Orascom, particularly I wonder about the size of this loan because, when 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 [switches] I think in Uzbekistan and the fact that the Orascom continues on our free cash flow which even I don’t understand why the loan has been slower so significant, if you can you please explain?
Thank you very much.
Jo O. Lunder
Let me kick off with brush on them, Henk can explain the second question. With respect to the 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.
Henk van Dalen
Cesar, on the Orascom inter-company loan, it’s probably going to take you back a little bit to the start of this company after the Wind Telecom Transaction. So at the moment that Wind Telecom Transaction was affected, we also brought all the debt, which was at the level of Orascom and that was put into an inter-company loan.
There were various reasons for that, but the main reason was that, that was indeed also the best way to secure a company with funding for Orascom going forward. And that original level of inter-company loan and credit facility was up to US$2.7 billion.
And that particular facility has now been fully drawn. And what has been brought in very small is effectively an additional facility of US$2.5 billion, which indeed as you already expect is expected to be sufficient for quite some years to come, whether it prevents us from going to the shareholders meeting, you could say every year, to make sure that there’s such an inter-company facility in place.
So there’s 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 (inaudible) also if the results of the company allow that paid in cash.
Cesar Tiron – Morgan Stanley & Co.
Okay, thank you. Sorry, just a very quick follow-up question on these sales and marketing expenses.
I guess 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 output generated by those subscribers and only after six months, am I correct?
Unidentified Company Representative
Yep. This is (inaudible) structures being put in place, but of course, dealer commissions are quite actually reflected accounting wise in terms of underlying cost of the dealer structure.
so there is no cost being built here now that gives us later it’s tied to the value and its tied to the revenue base.
Cesar Tiron – Morgan Stanley & Co.
Thank you very much.
Operator
Our next question comes from Alex Kazbegi from Renaissance Capital. Your line is open.
Alexander Kazbegi – Renaissance Capital
Yes, good afternoon. I think the first question is basically just on mobile data, just to understand maybe for the two major markets, Russia and Italy.
what is the smartphone so to say penetration on your network now and how fast did you see the data so to say growing and what do you see again, that is accelerating, what is the trend you are sort of seeing, I mean besides what we’ve of course seen certainly probably numbers. Secondly, on the CIS side, especially in Kazakhstan, I mean your performance was clearly on the upper side better than what your competitors have shown, which seemed quite a substantial victories in the upper levels.
so I was just wondering I mean there’s something temporary or do you think you sustainably can sort of say outperform the others and you don’t see this as a risk in coming quarters that there will be – there are quite a significant price erosion coming through that? Thank you.
Unidentified Company Representative
Thank you, Alex. And first specifically on smartphone penetration in Russia, we’re at 13% right now and Italy, we’re at approximately 30%.
So you saw the data growth in Italy year-on-year on mobile data was approximately 40% last year, and I expect that growth to continue given the fact that we are now making our network in Italy LTE and compliance, so that we can start developing the 3G networking of LTE capabilities, then we reach the M.12 early ’13, because we get to 2600 spectrum at the end of this year, and we get the 800 spectrum in Italy at the beginning of the ‘13. So I think you will see gradually the biggest series starting to pick this up in 2013 as unique devices being available.
but I think that the trend here right now will continue probably this year and then hopefully when LTE is coming next year, we will see a further up tick there and Russia is then, I think on the follow some of the same path, we’ve seen in Italy, but of course it’s behind and as you know the – contest is that was announced first week of May, is concluding mid-July, and realistically I think we look at, if we being granted the two times 7.5 megahertz block to full box size, this is up for the contest, if we get one of them that we hope and believe we will. I think probably second half of 2013 is the most likely timing of the commercial launch of all LTE and probably end market closing periods and the bigger series with more than 1 million.
So I think you can sort of look to following points of growth say penetration rates and then I would have just start giving that. On CapEx side, Alex, can you clarify what you actually ask on Kazakhstan?
Alexander Kazbegi – Renaissance Capital
Well, I looked at the Weather – the case Weather II, and I mean they reported actually quite so to say bigger traders in the half way round, so to say 20% quarter-on-quarter as you had I think 13% or 12%, so the question is it’s quite a big diversions in the impact of the either 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?
Jo O. Lunder
Yeah, in Kazakhstan, I think what you see there now is basically the sites we have compared to those is reflecting a little bit of picture and the fact that we also have regulation on maximum prices on both or less than off net passenger traffic being put in place by the regulators at the end of ‘11 or early ‘12 is basically affecting our business there. So it’s a combination of competitive pressure from a smaller player together with those regulation that lead to that drop in – that addressed and also in the EBITDA margin, and that being said, I still think that we now starting to move to more bundles and taking advantage of the capacity available in the network, and with that in a few other market improvement sites, we will probably not correct the full six percentage point drop in Kazakhstan by this year.
But I think we will see an improvement in the margin for the remainder of the year.
Alexander Kazbegi – Renaissance Capital
Okay. Okay, thank you.
Operator
Our next question comes from Dalibor Vavruska from ING your line is open.
Dalibor Vavruska – ING
Hi, I have a question on the smaller markets that outperform 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.
Unidentified Company Representative
We as you know we don’t give specific guidance on individual markets even though as I call the note on Kazakhstan right now. But I think if you allow me I can try to be a little more general maybe.
It looks like the measures that implied 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 to both growth and performance or so we expect Pakistan to reflect, we think it’s a trend shift out in Pakistan from what we’ve seen in the last year.
So what you see now in the first quarter at least our ambition is to continue that development going forward. In Uzbekistan, we are frankly the big bid at 30% dollar tax on subscribers and that’s hurting a little bit now.
But there is nothing going in our relative performance in Uzbekistan that is suggesting a week performance is more regulatory pressure and the margins are a bit weaker as a result of that. So again, in Uzbekistan, we also feel confident that we have big momentum.
Dalibor Vavruska – ING
Thank you very much.
Operator
Our next question comes from JP Davids from Barclays. Your line is open.
JP Davids – Barclays Capital
Thank you. A couple of questions on Russia, and then one on Canada please.
Firstly, on Russia, could you comment on your strategy of getting more unmet traffic, improving the traffic mix was on the tariff. And then the second part, could you comment on how progress is going in the areas over 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 [retric] in the release in terms of the possibility to invest there. Does that in anyway impact where it falls within your buckets of a one, two or three type operator?
Are you still considering it for a portfolio contribution analysis? Thank you.
Jo O. Lunder
Very good. On the first question, on the traffic inertia, I think we all know as part of the concept of profitable growth, part of that concept is clearly to offer growth for this service margin, and improve the service margin going forward.
We think that’s possible, we think there are different ways of doing that, and the stimulating to on that traffic is one of them. 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 (inaudible) and being helped assisted by a number of activities including a more unmet traffic. And then on the regions that we identified as our priorities on the capital market today, clearly we focus more on those than others.
And we have talked about closing the gap 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 prioritize regions of Russia. We will have closed that gap, so which means that when we start rolling out LTE in the big series end region, we will be having the same coverage, and the same capacity on 3G in Russia.
So we believe that prioritization we did not shooting of every region in order to close the gap, but focusing on the most profitable and most important one that 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 the foreign ownership law in Canada was the favorable decision for VimpelCom and Orascom.
So I think what we’re going to do kind of analysis 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 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 that which one we believe is the best for the company to choose and to follow.
JP Davids – Barclays Capital
Thank you.
Operator
Our next question comes from Dalibor Vavruska from Citigroup. Your line is open.
Dalibor Vavruska – Citigroup
Hello, good afternoon. Just three questions if I can.
One is on outsourcing. You mentioned that you started this project in the Central Region in Russia.
And if I’m not wrong, I think there is some outsourcing also going on in Italy. I’m just wondering, what is your general experience, what sort of outlook or upside you see in this network outsourcing in your major markets, and I know if its possible to quantify those, put it in context of your margin outlook for these countries?
The second question is on LTE, you’ve mentioned that you’re very interested in acquiring the license and that you are ready to start investing. And then obviously in terms of your CapEx guidance you’re still relatively careful about the spending.
So I’m just wondering, how does your network compare to LTE readiness compare to those competitors. And whether if LTE starts being a bigger issue in Russia now, whether that may not really to increase 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, I mean 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, et cetera? Thank you.
Jo O. Lunder
Thank you Dalibor, all good questions is 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 you have a very positive experience with the Nokia-Siemens networks in the central region that has led to lower operational expenses for that part of the network operation, and we plan out 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’s 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 stake home just related to that outsourcing project.
There is a very good upside if you're able to implement and execute, but we’re evaluating that project. We haven’t made a decision to execute or when to implement yet in Italy, but this certainly a long-term interesting opportunity and upsides.
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 remain in place and it has not changed with the latest announcement on LTE 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 do older 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 so for that reason 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 have given so far and I think so we’ll 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 slowed for practical purposes is basically a result for example in Russia, the Russian holidays I think in January, the weather et cetera, et cetera. But, when we talk about CapEx for the year, I think the guidance I just gave its like, if you look at, so you will see a catch up of all CapEx leading to that number later in the year.
And then on the FAS claim, I think it's very hard Dalibor, would you to speculate in what kind of scenarios that might play out. But the reality is that the order by the court is not prohibiting the Vimpelcom from exercising most shareholder rights in OJSC Vimpelcom.
And this includes rights to approve annual accounts. It includes rights to appoint external auditors get through dividend payments.
It's – we allow to reelect the current Board. So, there's nothing in the current order that is suggesting that it 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 fast claim for only. And as you know, Vimpelcom is only named as a third party here.
This claim is against Telenor and Weather II. But, again, as of today, there is nothing in the court order that is creating any difficulties with respect to our operations of our company.
Dalibor Vavruska – Citigroup
Thank you, Jo. I appreciate it.
Jo O. Lunder
Thank you.
Operator
Our next question comes from Alex Balakhnin from Goldman Sachs. Your line is open.
Alexander Balakhnin – Goldman Sachs
Yes, good afternoon. My first question is on the Algerian ownership resolution.
I mean, can you share with us how do you see the solutions tree it looks like now. And where do you think, where and when the (Inaudible).
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’re making all this dealer commissions, changes, et cetera. And in the same time, your churn is still high.
So, shouldn’t mean expect that little exchange to your scheme your growth [additions] will decelerate, and your churn will gradually come down, or it will stay at this level for a reasonable long period of time?
Jo O. Lunder
Okay very good. Let’s call a few Algeria forces.
I think the best way to look at Algeria and the situation there is basically that there are two parallel track segment, 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 OTA, and one of the member of the senior team, we received as you know a fine $1.3 billion, 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 here 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 moving its own life.
At the same time we are very open and still in negotiations with the government to find the solution that is satisfactory to them and to us. We would very much like to find a way to stay firm in Algeria.
We like the markets, we like the company, we like the opportunity. There is still a lot of growth opportunities on 3G and others.
So our [presently] really to find a solution, but it requires a balance solution that looks after our shareholders interest and if we cannot have that then we will for the first part I described, to file the international arbitration, it also that was going on right now in Algeria and I cannot comment on any details from discussions and negotiations and values or anything related to that we will return with bigger information than we have I think to share. And then on the question about qualitative strategy and there is good churn numbers et cetera.
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 delay 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 commissions structure to move it validate is an initiative here. And I hope a consequence of that will also be that that we could see churn be reduced and coming down to more appropriate levels that we can compare to other market.
But this is of course a lot coming on its own, we managed then implemented and executed. So I think so far the team in Russia has done a great job, as a Phase I and now we hope that we will see more aside coming and of course churn might be one upside we have in terms of again commercial cost of running the business.
So I agree with you that there is an upside on the churn level.
Alexander Balakhnin – Goldman Sachs
May I ask a quick follow-up, thanks for the clarification on the Algeria’s? I understand there are basically these two processes has going on some (inaudible).
But do you have any timeline in mind to say after with you or find it difficult and be impossible to run business as usual in Algeria and that would be a point where you are turning for the first option, which is full-fledged international arbitration. So do you have any (inaudible) where at this point is, if it exists?
Jo O. Lunder
I don’t think we have a hard (inaudible). I don’t think there is any point of our return.
So I think unfortunately it’s very hard to give you that data understand, give it very much like to have it. But I think it’s going to weaken our position and negotiations and likely we have resulting this.
So for the time being the operation in doing fine, you saw the growth and you saw the results in the first quarter. So my complement to the team in Algeria that is 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 in our results.
Alexander Balakhnin – Goldman Sachs
Understood, that’s very clear. Thank you.
Jo O. Lunder
Thank you.
Operator
Our next question comes from Herve Drouet from HSBC. Your line is open.
Herve Drouet – HSBC Investment Bank Plc
Yes, good afternoon. My first question is regarding LTE.
My understanding is you are planning to commercially launch 4G LTE in first half of 2013, will you expect that some of your competitors to commercially launch those types, before and will that impact potentially your commercial strategy in mobile data 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 costs or is it based on actual payment for commissions. So just to confirm that we undergo and to see any lag in some of the payments by [sections] those are conditions of the SIM cards have been purchased during first quarter?
Thank you.
Jo O. Lunder
Okay. LTE, was that relating to Russia or Italy?
Herve Drouet – HSBC Investment Bank Plc
Russia, yes please.
Jo O. Lunder
Russia, okay. first of all, I think that’s second half of 2013 and first half with respect to the commercial launch.
listen, I understand there are some debates intention on the timing, because we’d look like to at least MegaFon will launch something already this year. I understand that has a value in terms of a reputation, I don’t see it has a big commercial impact.
there are very limited LTE devices available. we will have HSDPA networks available with which our first quarter did build.
Again, there will be a competition into the mobile broadband, so there will not be 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 long investment cycles, and with the things we do now in Russia, I feel comfortable that also implementation of LTE will find its good shape in form.
And for that reason, to answer your question, the timing issue is not an issue that is on the top of my list of (inaudible). And then on, if I understood your question correctly on dealer commission three, we are accruing that, so it reflects the correct underlying cost of dealer commissions being paid, and then linked to the revenues being generated.
So this should not be synchronized with the way the book revenues and for that reason potentially building up future problems. so this is being accrued and this is being reflected the right way in the P&L.
Herve Drouet – HSBC Investment Bank Plc
Thank you very much. That’s very clear.
Jo O. Lunder
Thanks.
Operator
Our next question comes from the Igor Semenov from Deutsche Bank. Your line is open.
Igor Semenov – Deutsche Bank
Yes, hi. Thank you very much, there are couple of follow-ups on the previously discussed topics, one is the (inaudible) how does it impact your ability to form a new board at VimpelCom Ltd.
Level, and could you in general, give us an update what is trend 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 Algeria, how do the elections that recently happened in Algeria impact to your talks with the government, do you expect that there could be further delay, there could be changes in the I don’t know opinions of the government and their positions on this topic (inaudible) sort of general comments in this area?
Thank you.
Jo O. Lunder
Yeah. Let’s just take one step back on the first claim.
again, it’s first of all, VimpelCom is named as a third-party and the claim is against Telenor and it’s again whether to and it’s about Telenor’s acquisition of the preferred shares in VimpelCom Ltd. and then (inaudible) has put in place any junction.
and that restricts the OJSC VimpelCom from doing certain things for example deciding on major transactions, which is not a practical problem and also the company right now, because we have no such plans, but it does not impact of this important rights, that we need as shareholder in OJSC and that such things, that annual accounts approval of that approval of external auditor, approval of dividend payment, and also which allowed to elect the current OJSC VimpelCom board members. We are not allowed to elect a new board, but that’s not a practical problem either and then, if I understood also your 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 is almost need to comment on that, that should really be Telenor and other committee member 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.
Igor Semenov – Deutsche Bank
Okay just to summarize basically until October at least when the first sharing is suppose to take place. The board of VimpelCom Limited stays in place there will be no changes.
Correct.
Jo O. Lunder
That’s my understanding of…
Igor Semenov – Deutsche Bank
Yeah, okay
Jo O. Lunder
Okay. Yeah.
Igor Semenov – Deutsche Bank
Yeah. Okay.
And on Nigeria.
Jo O. Lunder
Yeah can you briefly repeat that one?
Igor Semenov – Deutsche Bank
Yeah, so you like some of the Nigeria how do they impact your negotiations with the government,
Jo O. Lunder
Well 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
Igor Semenov – Deutsche Bank
Okay. Great, thanks very much.
Operator
Our final question comes from Victor Klimovich from VTB Capital. Your line is open.
Victor Klimovich – VTB Capital
Yes, thank you. Good afternoon, May I have return back to the question regarding these internal loan to Orascom Telecom Holding, well the question is the following, so basically two questions.
First of all, how you will 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 do you expect this money, that will go to I mean in terms of countries, or will it be all countries or mainly to Pakistan and Bangladesh?
Thank you.
Henk van Dalen
Yes, the company loan of course is 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 stay within our own cash flow we will also affirm 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 drawn 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 to the main focus of it, is on the Orascom Holding on the one hand and the Pakistan, Bangladesh and Southern Africa on the other hand.
In addition to that of course the depreciation that we have in Canada that is the context of our court, Jo already explained that’s 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 huge possibility for investments in Algeria, but as far as these investments, are done of course, they are done within the context of the Algerian cash flow itself.
Victor Klimovich – VTB Capital
But if we return back so for example for the last five quarters your investments in both Pakistan and Bangladesh were approximately $700 million and you are talking about $2.5 billion, now so why is that big?
Henk van Dalen
That's what I indeed explained very early in the call because we never lost at that time its more a matter of efficiency. We have then not to go every time to the shareholders meeting of Orascom to ask for an inter company their credit facility.
So, actually, it is supposed to be in place and will be sufficient for the periods to come.
Victor Klimovich – VTB Capital
And for which time period, approximately?
Henk van Dalen
Well, under the current view it will be for certainly more than three years.
Victor Klimovich – VTB Capital
Okay, okay and may come back to another topic about your gross margin in Russia, what were the major drivers for this very significant improvements or it was approximately RUB4 billion decline in direct cost. Can you explain the major drivers here, quarter on quarter, of course?
Henk van Dalen
Quarter on quarter, yeah I think the EBITDA margin or gross margin?
Victor Klimovich – VTB Capital
No, no, no gross margin.
Henk van Dalen
The gross margin is of course also helped with the handset sales and also improvement in what I addressed earlier you on in the service margins and so I think those three effects add up to the gross margin and that’s why you also see in the improvement.
Victor Klimovich – VTB Capital
And what do you mean by service margin, my approximate calculation show it could be
Henk van Dalen
Yeah, okay, so understand you question. So in the packets of course we have referenced the gross margin and in that gross margin you have both cost of traffic, you have the service revenues that that relates to the traffic and the data, traffic and the network and that would track cost of traffic, interconnect and other related costs from that.
And when I referenced of this margin, I talk about the margin on the actual traffic and then the gross margin that we referenced in that number we have also included of course the handset sales as well and costs related to that. So that one then you will see an improvement in gross margin as you asked about, it’s all an improvement coming from handset sales and it is an improvement coming from what I call increased service margin, which is basically higher margin on the core profit.
It’s core products in traffic and data revenues in the network and that’s again as a result of bundles and average of net traffic and every initiatives related to the traffic itself. So, sorry for not clear on that.
Victor Klimovich – VTB Capital
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’s improved as we see but should we expect further improvements here or you’d think that this is quite at stable level?
Henk van Dalen
Well, 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 margins that that’s clearly something that we are now working on with optimizing credit 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 that we work on achieving.
Victor Klimovich – VTB Capital
Okay. Thank you very much that was very helpful.
Thank you.
Operator
That concludes the Q&A session. I will now turn the call back to management for closing remarks.
Henk van Dalen
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 are quite pleased with the start of the year. And we will work hard and implement the changes in 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 if necessary.
And with that I suggest to close the call and I wish everybody a good afternoon. Thank you.
Operator
Ladies and Gentlemen that does conclude today’s conference. You may now disconnect and have a wonderful day.