By Gordon Feller

The Russian economy is expected to continue its sustained and steady growth rate in 2006. When the final tally is in at the end of this year, the country’s total gross domestic product should grow by at least 6 percent, matching the past two years.

This economic strength has brought the interest of international investors and provides an opportunity for the satellite industry to introduce services into a country where development of such services has been trailing much of the globe. But to establish businesses and capitalize on the opportunity, satellite operators and service providers will have to remain patient while navigating a sometimes difficult road.

Lorenzo Sliusarev, S&P’s director in Moscow, points out that throughout the past 15 years of continuous restructuring and evolution of Russia’s political and economic environment, the use of satellite technology has been grossly neglected — as compared with the heyday of the Soviet Union. Of the large numbers of satellites produced and launched by the Soviet Union, many have become unusable, due in large part, he says, to both lack of proper maintenance of ground facilities and lack of investment. As a result, the use of satellite technologies in various sectors did not develop as in the West. Russian President Vladimir Putin "has recently been talking up the importance of resurrecting and actively developing new space technologies to meet Russia’s security and economic needs. While some new investments are mandated and expected in this sector, there now remains much uncertainty on when and how these will produce any tangible benefits. … In the near-to-medium-term future, we expect that satellite technologies and satellite communications will enter into a high-growth mode of development, supported by the government’s own strategic initiatives and the oil wealth effect with the economy as a whole."

Christopher Alfenito, director of sales with Miteq/MCL Inc., says that "although severely hampered by budgetary constraints, Russian satcom companies have continued to provide continually improved service to a growing international client base. Russian satcom engineers have an impressive can-do attitude. I have seen a significant and continuous improvement in the degree of professionalism throughout the past decade in spite of the obvious financial/political obstacles." Companies such as Russian Satellite Communications Co. (RSCC), Gaskom and Sovintel show real promise as they move into the international satellite communications marketplace, he says.

RSCC probably is the most interesting of the Russia companies. The national satellite communications operator provides services across many countries via the largest constellation of geostationary satellites operated by a Russian entity. The spacecraft, combined with a well-developed ground infrastructure of teleports and fiber-optic communication links, allows RSCC to sell a full spectrum of telecom services throughout the world, including TV/radio broadcasting, telephony, high-rate data transmission, video-conferencing, deployment of corporate network, says RSCC’s acting director general and CEO Yuri Izmailov.

Stefan Kollar, deputy director general for Moscow-based Intersputnik International Organization of Space Communications argues that market demand will continue to evolve "from providing satellite resources to full-scale solutions aimed at establishing multi-service networks, which in fact will lead to consolidation of efforts of satellite operators, equipment and technology providers, Internet and content providers." Satellite communications growth will occur in the video and Internet Protocol (IP) applications arena, though Intersputnik also will have to find its place in the promising IPTV segment in order to capitalize fully on the growing demand for services, he says. Broadband Internet, Voice-over-IP (VoIP) and TV program distributions will converge into a single triple-play package, he says.

In broadcasting, the most relevant development will be the introduction of interactive services and high-defitition (HD) TV as well as the usage of advanced codecs such as MPEG-4, Kollar says. In the area of two-way satellite access, Intersputnik is looking towards active implementation of open standards such as DVB-RCS, DVB-S2 and IPoS. Broadcasting and multimedia companies, as well as other corporate clients, will become major satcom customers. Kollar says that "there is a possibility for investments into digital content integration and distribution platforms to establish operator’s multimedia networks and interactive VSAT networks."

Nikolai Lukashevich, a director with Fitch Ratings in Moscow, has a more restrained view of the Russian market. "There has not been much retail demand for satellite telephony in Russia, despite the existence of vast areas without traditional means of communication," he says. "However, it is likely to be increasingly required by incumbent fixed-line telecom operators in Russia. Companies such as Dalsvyaz, Sibirtelecom and Uralsvyazinform all incur quite substantial costs providing tropospherical services to remote northern locations with low populations. Instead of constructing backbone lines across uninhabited territories with permafrost and no infrastructure, a much faster and cheaper option would be to use satellite technology to carry traffic to such distant nodes."

From the standpoint of all of the world’s national markets, David Hartshorn, secretary general of the Global VSAT Forum in Washington D.C., says that "Russia is the single largest country in the world that has yet to embrace satellite-based communications." One example Hartshorn cites is operational VSAT deployments in the Russian Federation — which currently number in the low tens of thousands. Hartshorn is quick to point out that "this stands in stark contrast to India, which has an installed base that is three orders of magnitude greater, with average annual growth rates of 30 to 50 percent."

"The low rate of VSAT use largely is due to national policy," Hartshorn says. "The Russian government has traditionally maintained draconian VSAT regulations — with aggregated license fees averaging $10,000 per terminal — as well as a protectionist stance with regard to delivery of satellite services by non-Russian interests. Fundamentally, satellite has been kept in a box because it is seen as a threat to ROI [return on investment] for terrestrial infrastructure and it is seen as a security threat."

More than many markets, Hartshorn believes that Russia has far greater potential to apply satellite-based services for vertical markets. Hartshorn lists the priorities: "mobile backhaul, oil & gas, forestry & mining, e-government… even consumer broadband." It is only a matter of time before the cost-effective solutions provided by the satellite industry are liberally applied in Russia. The question for Hartshorn and his colleagues is "how much more time?"

There are positive developments on the front. Neil Pole, Radyne Comstream Inc.’s director of sales, says that the expansion of telecoms infrastructure within Russia throughout the next few years will be driven by legislation passed in 2005. The Universal Service in Communication legislation mandates that every village in Russia with more than 500 citizens should have a phone and every village with more than 1.000 citizens should have a phone as well as an Internet connection. A major part of this infrastructure rollout will be by terrestrial connectivity, but satellite communications will play a significant role in meeting these requirements in remote regions of the country. Preliminary calculations indicate there are about 30,000 villages that require phones, and a further 20,000 villages that require both phones and Internet. That means a potential market for 50,000 VSAT sites, and meeting that demand could take more than 10 years, Pole says.

Kollar says that "in the past two years a substantial shift has occurred in the area of regulations related to VSAT usage in Russia. The decision of the State Radio Frequencies Commission regarding the introduction of the simplified procedure for such stations provided for the development of the VSAT market and, consequently, for active implementation of new applications based on satellite technology," he says. "It is expected that the Russian Telecommunications Administration will provide further support to the initiatives coming from operators and National Assembly of Satellite Communications to simplify procedures and change focus from control and process management in the industry to active support of operators in promoting satcom technologies in Russia."

For the past eight years, GVF and their Moscow-based affiliate, Russia’s National Assembly of Satellite Communications, have been urging the administration to implement licensing reform, and last year Hartshorn says that they finally agreed. "The catch? Only entities using Russian satellite capacity were eligible for the improved licensing regime."

What is the prognosis for the next few years? Will there be major new transactions in the Russian telecoms sector — particularly ones that effect the demand for satellite communications? According to estimates by Ernest and Young, the answer is yes. "The total value of the Russian mergers and acquisitions market for 2005 was about $50.2 billion, an almost 65 percent increase compared to 2004, according to "Mergers and Acquisitions in the CIS: Market Overview." Foreign investments are becoming more diversified, with more focus on the consumer products and financial services sectors. On the domestic market, the largest deals were executed by state-controlled companies, while private companies substantially increased their own activity.

Major Russian players also expanded abroad, including other CIS [Commonwealth of Independent States] markets. Ernest and Young recorded an almost four times growth in the value of outward deals year-over-year and believes that the Russian merger and acquisition market continues to possess significant growth potential. It is likely that the market will experience an increase in activity in 2006, supported by high energy and mineral resources prices, strong economic growth and an improving corporate governance and transaction culture in Russia.

In light of the above concerns, are investors likely to bring new technology and capital into Russia’s telecoms sector? Foreign investors are meeting their business objectives, with year-on-year sales and profits increasing dramatically in 2005, according to "Russia: Investment Destination 2006," released in May by PBN Co. More than 90 percent of the 155 companies surveyed plan to increase both their business operations and investment during the next three years. Bureaucracy and red tape, corruption, inadequate legislation, and selective interpretation and application of laws continue to provide big obstacles to companies seeking to do business in Russia, but there are big rewards for those investors who make it through the gauntlet.