Financial Analysis and Valuation of Megafon DCF as the Base Model

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Coursework: Financial Analysis and Valuation of OJSC Megafon, Russia using DCF as the base model

Prepared by: Victor Amoasii
Word count: 3697

CONTENTS

1. Megafon overview and analysis of agency costs
2. Risk Profile Analysis
3. Weighted Average Cost of Capital
4. Megafon valuation
5. Capital investments risk analysis
6. Capital structure and dividend policy

Megafon overview and analysis of agency costs

Megafon is one of the leading three Russian mobile operators. Its majority shareholder is Alisher Usmanov, who controls 50% plus 100 shares through aseries of holding companies including Garsdale, which also owns stakes in Scartel (Yota) and Euroset. TeliaSonera owns a blocking stake of just over 25%. Megafon was listed on the London and Moscow stock exchanges in December 2012, with a free float of just under 15%.

Agency theorists treat the firm as a nexus of contracts between owners, employees, creditors, and others. Agency theory advocates (a) efficiency as a means to improve firm performance, and (b) the use of governance mechanisms to manage agency costs as the primary means of improving efficiency (Eisenhardt 1989; Fama and Jensen 1983).

In general, agency costs and corporate governance risks are considered to be very high in Russia. The main potential corporate governance risks associated with Megafon are generated by the fact that it is majority controlled by one shareholder, Alisher Usmanov, through a number of holding companies, in which various other assets (both related and unrelated to the telecom industry) are also held. This raises the potential risk of related-party transactions that may, in theory, be more beneficial to the controlling shareholder than to minority shareholders in Megafon.

Mitigating this risk to a large degree is:

(1) the presence of TeliaSonera as a minority shareholder with a blocking stake of 25.2%; (2) the board structure, in which Mr Usmanov is represented by only three out of seven directors, is counterbalanced by two TeliaSonera appointees and two may be regarded as genuinely independent;

(3) the requirement for a supermajority board vote in the case of major decisions; and (4) the stipulation that directors representing interested parties are not eligible to vote in the case of related-party transactions.

Overall, the corporate governance risks at Megafon are similar in many ways to the Russia's telecommunications industry. Arguably, the presence of a blocking minority shareholder in the form of TeliaSonera may help to reduce potential risks to minorities. It is also to be noted that top management has significant exposure to the share price in the form of share options (in the case of the CEO, Mr Tavrin) and phantom share options (other senior management).

Risk Profile Analysis
The main risks faced by Megafon may be summarized as follows: Competition. Megafon directly competes for 2G and 3G subscribers across the country with MTS and Vimpelcom. In some regions Megafon faces additional competition from Rostelecom and Tele2. Megafon’s competitors (apart from Tele2) posses significantly larger fixed line assets and are likely to realize higher synergies between their business units, which may result in greater challenges for Megafon on the competitive landscape. Additionally, Rostelecom is planning to expand its services into new Russian regions, including Moscow (currently operates only in the Urals, Volga and Siberia federal districts). Finally Megafon competes for 4G subscribers with its partner Yota and MTS, and may soon face additional competition from Rostelecom and VIP in that space. Revenue concentration. Roughly 89% of Megafon's business is attributable to wireless services (7% in wireline and 5% in retail distribution). Within the wireless market, Megafon continues to rely heavily on voice revenues (almost 60% of total), which...
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