Investors have made money in Russia almost exclusively by investing in commodities stocks — oil, gas and mining. Companies outside these hot sectors have been a disaster. While the Russian market is up 18.5% this year, NYSE-listed Mobile Telesystems (MBT) is down 25%. Here’s why MBT will continue its steep drop, and why you can make big profits shorting Russia’s market-leading (but sickly) cellular telephone company.
First, MBT’s profits are plummeting. It recently announced a first-quarter net profit of $184.4 million (using U.S. accounting principles). That’s down a whopping 24% from Q4 of 2005 and below market expectations of $234.1 million. Why the big drop? A double whammy of lower revenue and higher costs. Just how bad was the news? MBT’s CEO resigned on the spot.
MBT’s management blames the drop in revenues on the market’s seasonality. That’s odd, given that Vimpelcom, its biggest rival, grew its sales by 2.8% over the same period. Dig deeper, and you find that the drop in revenue is of MBT’s own doing. Products and tariffs launched last year brought a significant drop in revenues, in spite of the launch of a huge (and expensive) re-branding campaign. To add insult to injury, the new tariffs increased MBT’s churn rate and decreased average revenue per user.
Second, on the cost side, connection charges have increased substantially, hitting MBT’s operating margins like a ton of bricks. That means that each additional customer made MBT less money than it expected — with the difference going into competitors’ pockets. The new CEO Leonid Melamed’s turnaround plan? He has promised to be "aggressive" in cutting costs, mostly by cutting back on capital expenditures. But that’s robbing Peter to pay Paul. It also fails address the issue of declining revenues and increasing costs. Not a convincing turnaround strategy.
Third, the current market sentiment is highly unforgiving of risky Russian plays. When investors do get back into Russia, it will be into oil and gas stocks. And technically, MBT is heading in one direction — south. Even before the recent correction, more than half of the Russian companies floated on the London Stock Exchange since 2005 — almost all outside the natural resource sector — have tanked.
So sell Mobile Telesystems (MBT) at market today. Buy back the stock if it climbs back up to $32.50. For even greater potential profits, buy the September $25 puts (MBTUE.X).
PORTFOLIO UPDATE
Cognizant Technologies (CTSH) is performing strongly in a weak market, with the stock up 5% and the options up 40% over the last three weeks. The thought of taking some profits here is tempting, but let’s hold on to both the stock and options for more upside gains.
BHP Billiton (BHP), our commodities play, was featured in Business Week as Europe’s #1 company. BHP should recover nicely as markets settle and the commodity bull market resumes its run.
