Sistema Annual Report 2006

FY2006 Annual Report · Sistema

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annual report 2006

New shoots of growth
New Value for the Business

ANNUAL REPORT / 2006 New shoots of growth

Content

About the Company
Five questions for the Chairman
Five questions for the President
Strategy
Survey of Operational and Financial Results
Calendar of Events
Risks
Corporate Governance
Board of Directors
Key Management
Management Structure
Principles of Corporate Governance
Asset Structure
Shareholding Capital
General Information
Shareholding Structure
Share Price Performance
Dividend Policy
Share Structure and Performance
of Subsidiary Companies
Social Responsibility

A Reliable Foundation Businesses

Telecommunications
Technology
Real Estate

High Potential Businesses

Retail
Banking
Mass Media
Tourism
Radio and Aerospace Technology

Other Businesses

Insurance
Petroleum
Healthcare Services and Pharmaceuticals

Innovation and Venture Capital
Contacts

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ANNUAL REPORT / 2006 About the Company

About the Company

In the Business of Building Businesses

Key business areas
_______________________________________________________________

Sistema is the largest private sector consumer services company in
Russia and the CIS. Founded in 1993, the corporation develops and
manages a portfolio of market(cid:2)leading businesses in selected ser(cid:2)
vice(cid:2)based industries. In total, companies controlled by Sistema
serve more than 65 million consumers in Russia, the CIS and Eastern
and Western Europe. The corporation is focused on the develop(cid:2)
ment of advanced technologies not only to maximize its long(cid:2)term
return for shareholders, but also because it believes this represents
its primary contribution to the economic development of Russia as
well as the other markets where it operates.

Following an IPO in February 2005, 19% of Sistema's shares were
traded on the London Stock Exchange in the form of global deposi(cid:2)
tary receipts (GDRs) under the symbol 'SSA'. Sistema is also listed on
the Moscow Stock Exchange under the ticker 'SIST' and on the
Russian Trading System under the ticker 'AFKS'.

Sistema's primary business can be divided into two key areas: its core
foundation business, where its companies are established market
leaders, and high potential businesses, where the corporation's
operating subsidiaries have the opportunity to establish long(cid:2)term
market leadership in developing consumer market segments. The
corporation's foundation businesses are: Telecommunications, High
Technology and Real Estate. Sistema's high potential businesses are:
Retail, Finance, Mass Media and Venture Capital.

In addition, Sistema maintains a portfolio of other businesses,
including: Tourism, Radio and Aerospace Technology, Medicine and
Biotechnology. The corporation also has financial investments in
the Petroleum sector.

TELECOMMUNICATIONS

MTS, COMSTAR(cid:2)UTS, MTT, SKYLINK

TECHNOLOGY
SITRONICS

REAL ESTATE

SISTEMA(cid:2)HALS

RETAIL

DETSKY MIR

FINANCE
MBRD

MASS MEDIA

SISTEMA MASS MEDIA

TOURISM

INTOURIST

RADIO & AEROSPACE TECHNOLOGY

RTI SYSTEMS

Other business areas
_______________________________________________________________

INSURANCE
ROSNO

MEDICINE & BIOTECHNOLOGY

MEDSI, BINNOFARM

PETROLEUM

BASHNEFT, NOVOIL, UFANEFTEKHIM,
UFIMSKIY NPZ, BASHKIRNEFTEPRODUKT,
UFAORGSINTEZ

ANNUAL REPORT / 2006 New shoots of growth

Financial highlights

1 OIBDA is defined as operating income before depreciation

and amortization. Please see the MD&A for the whole definition
of OIBDA and a reconciliation of OIBDA to operating income.

ANNUAL REPORT / 2006 About the Company

Revenue by segments2

Assets by segments3

2 Before eliminations of intersegment revenue.
3 Before intersegment eliminations.

ANNUAL REPORT / 2006 New shoots of growth

Sistema

ANNUAL REPORT / 2006 New shoots of growth

Five questions for
the Chairman of the Board of Directors1

Vladimir
Evtushenkov

The Chairman of the Board
of Directors

ANNUAL REPORT / 2006 Five questions for the Chairman of the Board of Directors

New shoots of growth
New Value for the Business

Last year brought significant changes in Sistema's business
activities and listed company because the lion's share of
assets belonging to the group also became public. This
means that you are offering investors the opportunity to
choose: they can focus on any one of your subsidiaries or
invest directly in the holding company. How are these
changes reflected in your strategy?

The configuration of our business today is in some sense unique. We
have four publicly listed companies within a public parent company. As
a result, this presents us with tasks of new performance and complexity.

On one hand, we need to invest maximum efforts in growing the cap(cid:2)
italization of our public subsidiarity in order to meet the expectations
of our investors. On the other hand, we need to maintain the excep(cid:2)
tional growth rates of our non(cid:2)listed companies as their rapid devel(cid:2)
opment will change the balance of our portfolio in the near future. This
means we are providing the opportunity for investors to gain access to
these promising assets through the parent company.

If you plan to grow the share of non(cid:2)listed assets in the cor(cid:2)
poration due to their strong rates of growth, does this mean
that you are not preparing for the IPO of any of your com(cid:2)
panies in the near future?

We have never seen public listings as priority goals in themselves.
Rather, they serve as instruments for gaining access to capital for fur(cid:2)
ther development. Of course, it is a complex and expensive instru(cid:2)
ment. At this stage in the life of the corporation we have the oppor(cid:2)
tunity to maintain the aggressive growth of our businesses and build
their value. We are making use of the widest range of methods for
raising capital without resorting to IPOs. We have not dismissed the
idea of bringing our non(cid:2)public companies to the stock markets. But
at near time, we do not see any pressing need for doing this.

In your view, what should be the scenarios for the growth
in value of the public and non(cid:2)public companies? Are there
fundamental differences between these scenarios?

I would propose a somewhat different classification of our 'points of
growth': maturing markets, fast(cid:2)growing markets and markets with
significant future potential. Sistema's businesses are present in all of
these types of markets. Our telecommunications companies work in
maturing markets. Nearly all of our non(cid:2)public companies are pres(cid:2)
ent in fast(cid:2)growing markets (cid:2) and this includes the entire consumer
sector. These companies are Detsky Mir, Sistema Mass(cid:2)Media and
Intourist. I would also add Moscow Bank for Reconstruction and
Development and the listed Sistema Hals to this category.

Markets with strong, but not yet fully realized potential, are in the high(cid:2)
technology industry. Sitronics and RTI Systems are exploiting this diffi(cid:2)
cult, highly competitive but extremely promising marketplace.

It appears obvious that the 'points of growth' of an estab(cid:2)
lished business, such as, for example, mobile telephony, and
a business that is only emerging, such as Pay(cid:2)TV, should be
quite different. Both quantitatively and qualitatively. How
do you view these points of growth? How does one go
about increasing the capitalization of such different com(cid:2)
panies?

In maturing markets this is done first and foremost by increasing the
EFFICIENCY of the business. For example, the new management
team at MTS succeeded in doubling the capital of the company dur(cid:2)
ing the year. This resource has not yet been exhausted. We believe
that Mobile TeleSystems is still undervalued.

CONVERGENT PROJECTS, the basis for which was also established
last year, not only provide the opportunity to continue to improve
efficiency, but also establish new consumer market opportunities

Does this signify that, as a result of the search for new areas
of growth, Sistema may enter new industries or purchase
new assets?

We do not have the goal of further diversifying our portfolio. But we
are certainly working to make it more balanced. We are also striving
to open new markets within our existing business areas and areas
where they intersect with other markets. For example, does mobile
television represent a new market for us or not? Is it telecommu(cid:2)
nications or media? Also, there is our medicines division, which has
existed as part of the corporation for a number of years but which is
today, from our point of view, on the threshold of explosive growth,
again on the back of growing consumer demand.

Therefore, we are not conducting a deliberate and focused search
for opportunities in markets which are totally new for us. But we are
prepared for the development of promising growth points within
the corporation and contiguous areas of business.

The year 2006 clearly demonstrated that the potential of the indus(cid:2)
tries and markets where Sistema is already present provide us with a
full range of challenges. And we are ready to meet these challenges.

1 Questions for the Chairman of the Board of Directors were drawn from the top(cid:2)10 ques(cid:2)
tions most often asked of the management of the corporation by representatives of the
investment community and media within the survey of Sistema's business reputation.

ANNUAL REPORT / 2006 New shoots of growth

and therefore new sources of revenue. In addition, we see enormous
potential SYNERGIES in telecommunications with the purchase of a
minority shareholding in Svyazinvest by our fixed(cid:2)line operator,
Comstar. Joint and multi(cid:2)faceted work on this very promising proj(cid:2)
ect is already underway.

Entering NEW GEOGRAPHIES and markets also remains a focus of
our attention, although our internal criteria for analyzing potential
opportunities have become far more considered and strict. The
most important of these considerations remains the same: return on
invested capital.

The points of growth in growing markets are, of course, the markets
themselves. The rapid growth of consumer industries, which has
been driven by increases in welfare of Russian households, presents
us with a superb base for development. But our goal is TO GROW
FASTER THAN THE MARKET. Detsky Mir, for example, saw revenues
increase at twice the rate of the overall market. Sistema Hals grew at
nearly two times faster than the market.

REGIONAL EXPANSION is still another driver of growth in these
markets. Since all of our consumer businesses have a networked
character, entry into regional markets is the basis for development
today. Detsky Mir opened children's goods superstores in 33
Russian cities. Our Pay(cid:2)TV network under the unified Stream(cid:2)TV
brand now offers services to more than 1.5 million users covering
37 Russian cities.

The right combination of organic growth and the effect of MER(cid:2)
GERS AND ACQUISITIONS is a third means for building value in
fast(cid:2)growing markets.

In markets with significant growth potential, we will focus ourselves
on new projects and scientific research and development that
should produce UNIQUE PRODUCT OFFERINGS and services. Last
year, we launched a new development strategy for our Intellect
Telecom scientific research division. We are actively advancing our
work in the venture capital sphere. And we expect short(cid:2)term
results from this activity, which has acquired the moniker 'techno(cid:2)
logical radar' within the corporation.

Since technical breakthroughs cannot be achieved without the leg(cid:2)
islative and infrastructural support of the government, PRIVATE(cid:2)
PUBLIC PARTNERSHIPS are becoming still another driver in this
market. The GLONASS navigation system, the development of
which has been conducted on the platform of the Radio(cid:2)Technical
Institute, is an example of this kind of cooperation.

ANNUAL REPORT / 2006 Five questions for the Chairman of the Board of Directors

New shoots of growth
New Value for the Business

ANNUAL REPORT / 2006 New shoots of growth

Five questions for
the President1

Alexander
Goncharuk

The President

ANNUAL REPORT / 2006 Five questions for the President

New shoots of growth
New Value for the Business

Sistema is well known to the marketplace as an 'incubator'
for growing businesses. Three IPOs over the course of year,
each with a capitalization of more than US$2 billion, pro(cid:2)
vide an accurate tally of this work. Is the corporation
changing its approach to managing these listed companies
now that they've grown up?

The potential and quality of our public companies were reflected
by the high valuations made by the investment community. The
capitalization of Sistema Hals and Sitronics during their place(cid:2)
ments exceeded US$2 billion and Comstar exceeded US$3 billion.
The market value of MTS during the last year grew from US$13 to
US$20 billion.

It is clear, given the present scale of activity of our listed businesses,
that they no longer require the previous level of external control
and deep involvement in their operational activities. However,
strategic issues require attention. Previously, the efficiency indica(cid:2)
tors for these enterprises were numerous and detailed, now we have
only a relatively small number of KPIs for our listed businesses. But
these are fundamental ones. The main indicator of interest to us as a
management company is the growth of capitalization.

Is the corporation prepared to grow the next generation
of market leading companies, given its successful track
record thus far?

Sistema's strategy has always been based on leadership in the mar(cid:2)
kets where it operates. Certain conditions need to be met in order to
maintain this leadership in addition to the dint of our own efforts: a
favorable market situation, sources of financing, a thorough action
plan and strong management team. Today, our non(cid:2)public compa(cid:2)
nies have all of the necessary COMPONENTS OF LEADERSHIP.
Forecasts for consumer market growth remain extremely optimistic

and these are the markets where Detsky Mir, Sistema Mass Media
and Moscow Bank for Reconstruction and Development operate.
All of our business areas have carefully worked(cid:2)out M&A plans and
defined strategies for organic growth. Sistema is ready to invest sig(cid:2)
nificant funds in these businesses. Out of US$3 billion in investments
detailed in our 2007 budget, no less than half are earmarked to sup(cid:2)
port the rapid growth of our non(cid:2)listed companies. The manage(cid:2)
ment teams have proved themselves to be very effective in meeting
the goals set out for them by the shareholders. Therefore, we have
no doubts about the great promise of these companies.

In 2006, there were significant changes in the top manage(cid:2)
ment team of Sistema, both on the level of the operational
companies and in the corporate center. Are you satisfied
with the work of these new managers? And, moving for(cid:2)
ward, how does the corporation plan to shape the effec(cid:2)
tiveness of their work?

For a corporation such as Sistema, which is concentrated primarily
in high(cid:2)technology service industries, the effectiveness of manage(cid:2)
ment is a critical success factor. At every stage of development of the
company it requires specialists with different profiles and quali(cid:2)fica(cid:2)
tions. Entering global capital markets, developing current strategy, a
toughening competitive environment, the consolidation of whole
industries and functioning in an environment of transparency (cid:2)
these are all parts of the reality today. We are aware of the fact that
the growth in capitalization of the corporation and its operating
companies depends directly on the actions of management.

Therefore we are constantly working on both the management
structure of the corporation and the INCENTIVES we provide for
our people. We worked the entire year on optimizing the division of
responsibilities between the businesses and the corporate center,
developed and introduced option and bonus programs at our com(cid:2)

ANNUAL REPORT / 2006 New shoots of growth

panies and calculated the parameters we used to evaluate the per(cid:2)
sonal effectiveness of our managers. We also strengthened our team.
The main result of this work can be found in our financial results.

the beginning of the promotion of Stream(cid:2)TV as a national Pay(cid:2)TV
brand. Our most venerable brands, Detsky Mir and Intourist also
should acquire new attributes.

The search for new points of growth, through the effectiveness of
management, human resources policy and formulating strategy are
the goals today. And we hope that our investors and shareholders
will find that our efforts measure up to their expectations.

1 Questions for the President were drawn from the top(cid:2)10 questions most often asked of

the management of the corporation by representatives of the investment community and
media within the survey of Sistema's business reputation.

Two significant deals for the Russian market have become
strong financial indicators of the results of last year: the
purchase of a blocking stake in Svayzinvest and the sale of
shares in ROSNO. The first deal underscored the consisten(cid:2)
cy of the corporation's strategy in the telecommunications
market. The second, with its unprecedented price, demon(cid:2)
strated the ability of Sistema not only to profitably buy into
assets but also exit profitably. How do you evaluate the
long(cid:2)term impact of these circumstances for the develop(cid:2)
ment of the corporation?

Both deals required an unbelievable concentration of effort and the
highest level of professionalism from the management of Sistema.

The consolidation of all types of modern communications within
Sistema Telecom allowed us to build a unique level of INDUSTRY
EXPERIENCE. And we see very clearly the kind of opportunities for
synergies and convergent services that joint work with Szyavinvest
opens up: technical, organizational and financial. We are convinced
that this cooperation provides an opportunity for a breakthrough,
not just for our two companies, but for the industry as a whole.

Regarding ROSNO, we were satisfied by the results of our joint work
with our reliable partner of many years, the German insurance
group Allianz. Through our jointly coordinated efforts we created
not just a successful company but one of the best brands in Russia.
This is really valuable experience, because in the global economy,
the key to entering highly competitive markets will not only be
strong products but also strong brands.

So, the creation of an umbrella brand for Sistema Telecom,
a unique project for the Russian market, was brought about
for these reasons? How are you planning to use this newly
acquired experience in the future?

For a corporation whose business is primarily concentrated on con(cid:2)
sumer markets, it is difficult to overstate the significance of this step.
It is not so much the technology but the client, his requirements and
his satisfaction that is the key element in the strategies of the oper(cid:2)
ating companies. The main instrument for establishing communica(cid:2)
tions with the client is BRAND BUILDING. We continue to develop
actively the Sitronics high technology brand. The year 2007 marks

ANNUAL REPORT / 2006 Five questions for the President

New shoots of growth
New Value for the Business

ANNUAL REPORT / 2006 New shoots of growth

Strategic goals:

Strengthening leading positions in key markets:

Sistema remains concentrated on businesses that enjoy leading posi(cid:2)
tions in their sectors or that have clear potential to become market
leaders in fast(cid:2)growing market segments. Market leadership in con(cid:2)
sumer(cid:2)focused, technology driven industries allows the corporation to
leverage the equity of its brands to enter new market segments and
geographic markets and launch new, value(cid:2)added services that
increase profitability and enhance return to investors.

Diversification of the corporation's
portfolio of businesses:

Diversification across business lines has allowed Sistema to maxi(cid:2)
mize its exposure to a range of growing consumer markets. Today,
the corporation is focused on the balance of businesses within its
portfolio. Non(cid:2)telecommunications share of revenues has grown in
recent years. The corporation aims to continue to shift this balance
further through growth in existing businesses operating in emerging
sectors.

Maintaining solid cash flows from
businesses under management:

Sistema's restructuring of its businesses in recent years has allowed it
to consolidate its assets and establish more transparent and efficient
holding companies in each major business area. This process con(cid:2)
tinues as the corporation seeks to enhance long(cid:2)term revenue and
profit growth of its operating companies.

Preserving strong and solid financial position:

A combined approach of financial transparency, careful manage(cid:2)
ment of debt levels of the group and subsidiary level and a long(cid:2)term
approach to financial planning, help ensure that Sistema maintains
a robust financial position. The corporation maintains strict debt
level criteria to ensure an optimal structure of consolidated borrow(cid:2)
ing and enhance long(cid:2)term financial stability.

Maintaining the highest standards
of corporate governance:

Strategy

Long before Sistema's own IPO in February 2005, the company has
exceeded the requirements and expectations of corporate trans(cid:2)
parency. It continues to work to ensure the highest standards of
corporate governance and disclosure on the corporate and sub(cid:2)
sidiary level, to ensure efficiency in running the company, add to the
liquidity of its shares and those of its listed subsidiaries and to obtain
the most attractive terms available for borrowing.

Strategic principles:

Creating or acquiring promising companies:

While Sistema is concentrated on the growth of its existing busi(cid:2)
nesses, it is always reviewing opportunities to acquire companies
that can strengthen existing business areas or create new markets
where the corporation has strong potential synergies with existing
businesses.

Active participation in the development
and management of companies at an early stage:

Sistema's primary ability to add value to a business is its ability to
contribute considerable financial and management resources to a
company. The corporation has a clearly established track record of
building value across a range of businesses and creating sustainable,
market(cid:2)leading companies.

Attracting financial resources for investment
in the growth of companies:

The corporation has a long(cid:2)established presence in the global capital
markets and the ability to raise capital through a range of instruments.
Sistema plays an important role in attracting international investment
to build Russia's high(cid:2)technology, service(cid:2)based industries.

Defining clear exit scenarios for investment:

When Sistema invests in a business, it defines a clear exit strategy for
its investment directed at increasing value for its shareholders while
moving its companies to their next stage of development. These sce(cid:2)
narios include the sale of Sistema's stake to a strategic investor, an
IPO or integration into existing businesses.

ANNUAL REPORT / 2006 Survey of Operational and Financial Results

Survey of Operational and
Financial Results

A full discussion of Sistema's financial results during 2006, including a
management discussion of results, balance sheet and other important
information on methodology, including full definitions of certain ter(cid:2)
minology and ratios used in the results report, is contained in the
Management Discussion and Analysis included in this Annual Report.

The following section presents a brief overview of the company's
financial and operational results, according to US GAAP, for the year
2006. The operational and financial performance of each business
area is discussed in Section 2 of this annual report.

Highlights of the Year:
. Consolidated revenues up 43% year(cid:2)on(cid:2)year to US$10.9 billion
. OIBDA increased 35% year(cid:2)on(cid:2)year to US$4.0 billion
. Operating income rose 40% year(cid:2)on(cid:2)year to US$2.7 billion
. Net income increased 69% year(cid:2)on(cid:2)year to US$903 million
. Total consolidated assets increased 54% year on year
. Earnings per share rose 67% year on year to US$94.4

to US$20.1 billion

Group Operating Review

Sistema's consolidated revenues increased 43% to US$10,862 million
in 2006, as a result of a robust performance by the corporation's
Telecommunications segment and rapid growth in revenues at the
Group's non(cid:2)telecommunications operations. The non(cid:2)telecommu(cid:2)
nications businesses accounted for 31% of the Group's consolidated
revenues in 2006, compared to 22% in 2005. Organic year(cid:2)on(cid:2)year
and like(cid:2)for(cid:2)like growth was 35% in 2006, and amounted to US$10.8
billion, excluding businesses acquired or divested since the end of
the fourth quarter of 2005.

The corporation's OIBDA increased by 35% year on year from
US$2.982 billion to US$4.023 billion in 2006. The OIBDA margin in
2006 declined slightly from 39.3% to 37.0% as a result of slightly
lower margins in the Telecommunications, Technology, Insurance
and Retail segments. Sistema's operating income was up 40% from

US$2.0 billion to US$2.7 billion in 2006. The operating margin was
25% in 2006, compared to 26% in 2005.

Consolidated depreciation and amortization expenses were up by
26% in 2006, following growth in the Group's depreciable asset base
and the previously announced revision of the estimated remaining
useful life of MGTS analogue equipment. Selling, General and
Administrative (SG&A) expenses rose by 43% in 2006, from
US$1.414 billion to US$2.016 billion. A total of US$153.0 million in
2006, included in SG&A expense, reflects the fair value of non(cid:2)cash
compensation received by employees.

The Group's effective tax rate increased from 29% to 33% in 2006, as
a result of foreign gains on the exchange of non(cid:2)ruble denominated
long(cid:2)term debt and the effect of the stock bonus and stock option
awards at Comstar, and the option revaluation charge, which are
not tax(cid:2)deductible.

The increase in minority interest reflects changes both in the net
income of the Group and ownership's share in the Group's companies.

In 2006, net income grew 69% from US$534 million to US$903 mil(cid:2)
lion. One(cid:2)time, non(cid:2)recurring items include the write(cid:2)off of US$150
million investment in Bitel, Kyrgyzstan, by MTS, and a non(cid:2)cash
charge of US$60 million in connection with the issued Svyazinvest
put and call option.

The weighted average number of shares outstanding increased from
9,475,980 in 2005 to 9,570,050 in 2006, Sistema reported an 67%
year on year increase in basic and diluted earnings per share from
US$56.4 to US$94.4 in 2006.

Financial Highlights

Net cash provided by operating activities was up 19% to US$2.097
billion year(cid:2)on(cid:2)year during 2006.

Net cash used in investing activities in 2006 was US$5.3 billion and
included capital expenditures of US$2.4 million in 2006, compared
to US$2.5 billion in 2005. The Group spent US$631 million on acqui(cid:2)
sitions of businesses.

ANNUAL REPORT / 2006 New shoots of growth

Cash flow from financing activities amounted to US$3.4 billion in
2006, which primarily reflected proceeds of the initial public offer(cid:2)
ing of Comstar, which took place in February 2006, and the initial
public offering of Sistema(cid:2)Hals, which took place in November
2006, and additional debt raised by the Group.

The Group's net debt amounted to US$6.3 billion as at December 31,
2006, compared to US$3.9 billion as at December 31, 2005.

Credit Ratings

Independent ratings agencies consider a number of key factors in
determining the financial stability of the corporation and its sub(cid:2)
sidiaries, including total debt, current obligations, existing and
future liquidity needs and cash flow. Ratings can also be seen as an
outside evaluation of the corporation's overall strategy and its posi(cid:2)
tion versus its rivals in core business areas. Ratings take into account
corporate governance structures in place and protection for minor(cid:2)
ity shareholders. In addition, ratings reflect overall market condi(cid:2)
tions, in particular the ratings assigned to Russia's sovereign borrow(cid:2)
ing, may be seen as a benchmark of overall country risk.

Sistema's Ratings
_______________________________________________________________
Agency
S&P
Fitch Ratings
Moody's

Date Assigned
March 24, 2005
April 28, 2006
November 19, 2003

Outlook
Stable
Positive
Stable

Rating
BB(cid:2)
B+
B1

BB(cid:2)
Ba3

24/03/2005
10/12/2001

Ratings of Operating Companies
_______________________________________________________________
MTS
S&P
Moody's
MGTS
S&P
Moody's
Sitronics
Fitch
Moody's
MBRD
Fitch
Moody's

24/03/2005
19/01/2006

14/04/2006
14/12/2004

14/02/2006
16/02/2006

Stable
Stable

BB(cid:2)
Ba3

B(cid:2)
B3

B
B1

ANNUAL REPORT / 2006 Calendar of Events

January

Calendar of Events

provider with 724,000 subscribers in 17 metropolitan areas
across Russia.

In January, Comstar announced that its fixed(cid:2)line telecommuni(cid:2)
cations provider, subsidiary Comstar UTS, has acquired a 100%
stake in CTK Contrast(cid:2)Telecom, a leading alternative fixed(cid:2)line
operator in Sergiev Posad, one of the largest districts in Moscow
region.

Also in January, ROSNO acquired a 51% stake in Medexpress, a
provider of voluntary supplementary medical insurance in the
North(cid:2)Western region of Russia, for US$6.6 million.

During the month, Sistema Mass Media acquired GK Sendi, an
internet provider in Nizhny Novgorod, and Informservis, a cable
television operator in the same region, for US$6.3 million in
January 2006. Sistema intends to use these operations for further
development its digital TV and broadband networks in Russia's
regional markets.

February

Comstar undertook a successful IPO on the LSE in February 2006,
raising US$1 billion for the further development of the company.
Following the transaction, around 35% of its shares are in free(cid:2)
float and the transaction marked the successful completion of the
first stage of restructuring at the company following the consoli(cid:2)
dation of Sistema's fixed(cid:2)line assets in Comstar in late 2005.

On February 25, Sistema's Board of Directors approved previously
proposed changes to the corporation's Board and senior manage(cid:2)
ment. The changes included the appointment of Vladimir
Evtushenkov as Chairman of the Board of Directors and the
appointment of Alexander Goncharuk as President. It was also
announced that Evgeny Novitsky, the former Chairman of the Board
of Directors, would continue to serve as a member of Sistema's
Board of Directors.

Also in February, Sistema Mass Media and ECU GEST acquired 90%
and 10%, respectively, of JIR Broadcast and JIR Inc., the owners of
100% of United Cable Networks (UCN), for a total cash consider(cid:2)
ation of US$145.9 million. UCN is a Pay(cid:2)TV and broadband service

March

Comstar announced the acquisition of a 100% stake in Unitel for a
total cash consideration of US$4.8 million in March. Unitel is an
alternative wireless fixed(cid:2)line telecommunications company serv(cid:2)
ing customers in Moscow region.

Also in March, Sistema completed the previously announced acqui(cid:2)
sition of 44,564 Sistema common shares, equivalent to 0.46% of the
total outstanding shares, for a total cash consideration of $50.892
million. The acquisition was executed through Sistema Finance, a
fully owned subsidiary of Sistema.

Intourist purchased a 20% equity interest in Cosmos Hotel in
Moscow for approximately US$20.8 million, bringing its controlling
interest in Cosmos Hotel to 63.4% as part of the development of the
Tourist business area's hotel management group.

During March, Concern RTI acquired a 50% plus one share interest
in UralEleketro, and a 100% stake in UralElektro(cid:2)K, for a total cash
consideration of US$5.4 million. Both companies manufacture elec(cid:2)
tronic equipment.

Detsky Mir completed the acquisition of 99% of Tireks
Development, the owner of 30% stake in Sistema's subsidiary Dom
Igrushki (House of Toys), for a cash consideration of US$2.4 million
as part of the corporation's broader strategy of buying out minority
shares in order to streamline its businesses.

June

In June, Sitronics acquired a 51% voting stake of Intracom Telecom,
a provider of telecommunications solutions and services in Eastern
Europe and the Middle East. The total cash consideration for the
deal was US$150.6 million, including US$43.9 million payable upon
the completion of the due diligence process. In addition, Sitronics

ANNUAL REPORT / 2006 New shoots of growth

entered into a put option agreement to acquire the remaining 49%
of Intracom Telecom stock.

October

Comstar acquired 100% of Astelit, an alternative fixed(cid:2)line telecom(cid:2)
munications company, for US$7.8 million in June. Astelit holds
licenses for provision of integrated fixed(cid:2)line services across 51
Russian regions to large corporate customers and has over 200km of
its own fiber optic infrastructure in city centers. Astelit was subse(cid:2)
quently re(cid:2)branded as M(cid:2)Telecom.

Sistema Mass Media sold its ownership in Gazeta Metro in June for
US$1.9 million as part of its overall strategy of selling assets outside
of its core business segments of Pay(cid:2)TV, content and advertising.

July

In July, the Group disposed of Glorely, a subsidiary holding 35%
interest in Sistema(cid:2)Invest, the owner of the Group's energy compa(cid:2)
nies in the Republic of Bashkortostan, for a total cash consideration
of US$201.0 million.

Also in July, MTS acquired a 75% controlling stake in Dagtelecom
from Glaxen Corp. for US$14.7 million. Dagtelecom is a GSM(cid:2)900
mobile services provider with 1.7 million subscribers in the Republic
of Dagestan, in Southern Russia, with a population of 2.6 million
people.

In July, Intourist Overseas Limited purchased a 51% stake in Tatilya
Turizm Seyahat Insaat, a Turkish travel operator, for US$0.3 million.

August

In August, Sistema acquired an 81.25% stake in ZAO Sahles, the
owner of controlling stakes in the entities comprising Perm Motors
Group, for US$122.5 million. Perm Motors is one of Russia's largest
manufacturers of jet aircraft engines and industrial turbines and
substantially strengthens the capacity and product offerings avail(cid:2)
able to the corporation's Radar and Aerospace business area.

Also in August, the Group sold an 8% stake in MTK (KOMKOR)
together with an additional 3% acquired from a related party after
June 30, 2006, for US$20.0 million.

In October, Sistema acquired a 66% controlling stake through
directed new share issue in WaveCrest Group Enterprises Ltd.
(WaveCrest) for a cash consideration equivalent to GBP 20.0 mil(cid:2)
lion. WaveCrest is a global communications service provider offer(cid:2)
ing wholesale (operator) and retail (residential) telephony services,
using conventional circuit(cid:2)switched and Internet protocol (IP)
telephony. The deal represents a major cross(cid:2)border acquisition for
Sistema, strengthening the global reach and technological base of its
Telecommunications business area.

During the same month, Comstar announced the acquisition of
100% stake in two telecom operators in Kiev, Ukraine (cid:2) DG Tel and
Technologic Systems (cid:2) through its local subsidiary Comstar(cid:2) Ukraine,
for a total cash consideration of US$4.7 million, marking a major
expansion of Comstar's business in the fast(cid:2)growing Ukrainian
fixed(cid:2)line market.

Also in October, Comstar announced the purchase of a 75% stake
plus one share in Callnet, a transit operator, and Cornet, an Internet
Services Provider, which together represent the second largest alter(cid:2)
native telecommunications group in the Republic of Armenia. The
transaction is part of Comstar's strategy of expanding its presence in
fast(cid:2)growing CIS telecommunications markets.

Comstar also announced the acquisition of 1,605,500 ordinary
shares in MGTS. The acquired shares represented 2.01% of the MGTS'
ordinary shares, or 1.68% of the MGTS' total shares. Upon comple(cid:2)
tion of this transaction, Comstar(cid:2)UTS interest in MGTS amounted to
66.88% of MGTS' ordinary shares, or 55.73% of MGTS' total shares.

During the month, Sistema completed the purchase of 2% of its
stock for an amount of approximately US$239 million. The purchase
was completed through one of Sistema subsidiaries, Sistema
Finance.

Sistema subscribed to a total of 167,131 ordinary shares at the offer
price, which constitute 1.73% of the stock, offered by certain direc(cid:2)
tors of the Company. The total subscription was in the amount of
approximately US$207 million. The offer was conducted as part of
Sistema's plans to establish a share option program for the top man(cid:2)
agement of the corporation. The acquired shares are intended for
the funding of this program, and may also be used in connection
with certain future acquisitions.

ANNUAL REPORT / 2006 Calendar of Events

November

In November 2006, Sistema Hals listed its GDRs on London Stock
Exchange to raise funds for its further development. The IPO raised
US$409 million in the first such international listing by a Russian
property developer. Following the IPO, around 20% of the compa(cid:2)
ny's shares were in free(cid:2)float. With the transaction, Sistema Hals
achieved the highest(cid:2)ever valuation for a Central and Eastern
European real(cid:2)estate company at time of IPO.

December

In December 2006, Comstar announced the acquisition of a block(cid:2)
ing stake 25% plus one share in Telecommunication Investment
Joint Stock Company (Svyazinvest) from Mustcom Limited for a
total cash consideration of US$1.3 billion. The company arranged a
US$675 million six month loan facility with ABN AMRO Bank N.V. in
connection with this transaction. Svyazinvest is the holding compa(cid:2)
ny for Russia's regional fixed(cid:2)line incumbent operators. The transac(cid:2)
tion, in line with Comstar's announced intentions at the time of its
IPO, provides the company and Sistema with the ability to play a key
role in the development of Svyazinvest and the future of the coun(cid:2)
try's regional fixed(cid:2)line network, Russia's 'last mile'.

In December 2006, Comstar UTS announced that it has reached an
agreement with Intracom Holdings (ASE:INTRK) to subscribe to a
51% stake in Hellas On Line SA (HoL) for a cash consideration of
euro 47.9 million.

In December 2006, Intourist purchased 51% stake in a number of
companies comprising Riviera Holding, a tourist operator in Saint
Petersburg. Riviera Holding serves approximately 120,000 tourists
annually and operates in more than 20 countries of the world.

stake

a 74%

included

Throughout the third quarter, Sistema Mass Media acquired several
cable television operators in a number of Russian regions. These
purchases
Smolensk(cid:2)based
Teleradiotekhnika for US$1.2 million, 100% of Voronezh(cid:2)based
Elecom(cid:2)service for US$1.0 million, 100% of Telesat in Nizhny Tagil
for $0.4 million, a 74% share in a group of operators based in Ivanovo
for US$7.1 million, a 55% stake in Electronica in Balakovo for $0.8
million and 90% of Krasnodar(cid:2)based Sallak for US$0.2 million. These
acquisitions were in line with Sistema's strategy of growing its
regional presence in Russia's cable television market.

Events Following the End
of the 2006 Reporting Period

January 2007

In January 2007, Comstar obtained licenses for IP Voice and Data
transmission, including WiMAX services, in the twenty largest
regions in Russia. The licenses are valid until November 17, 2011 and
provide a base for the development of a new generation of corpo(cid:2)
rate and residential services in Russia's regions.

Sistema(cid:2)Hals announced signing of a US$187 million credit agree(cid:2)
ment with Eurohypo AG in January 2007 to finance the development
of a shopping centre on the Pulkovskoe highway, St Petersburg.

February 2007

In February 2007, Sistema announced the purchase of an additional
0.48% of its own stock, bringing the total amount of shares pur(cid:2)
chased by Sistema from March 2006 to date to 284,243 (2.95%) for
a total of US$347.3 million. The acquired shares are intended for the
funding of the corporation's share options program for its top man(cid:2)
agement and may also be used in connection with certain future
acquisition activity.

The IPO of Sitronics through the offering of GDRs on the LSE in
February valued the company at US$2.35 billion and was the biggest
international capital markets technology debut in five years and first
by an Eastern European technology company.

Also in February, Standard & Poors Ratings Services upgraded its
outlook on Sistema to «positive». Also it assigned a BB(cid:2) long(cid:2)term
corporate credit rating to Comstar, with a «positive» outlook.
Standard & Poors also assigned its ruAA Russia national scale rating
to the Group. At the same time the BB(cid:2)long(cid:2)term corporate credit
rating on the company was affirmed.

In February Sistema sold 46.19% of ROSNO shared to Allianz.
Sistema holding in ROSNO was redused to 3%, while Allianz stake
increased to 97%.

ANNUAL REPORT / 2006 New shoots of growth

March 2007

Sistema(cid:2)Hals announced the results of an independent valuation of
its real estate property and projects. According to the valuation car(cid:2)
ried out by Cushman and Wakefield Stules & Riabokobylko
(C&WS&R), the value of the Sistema(cid:2)Hals stake in the property and
projects increased by 35% in the period from June 30, 2006 to
January 1, 2007.

Sistema(cid:2)Hals was also included in the RUXX (Russian Industrial
Leaders Index) database, used as an indicator of Russian economy
for international investors.

Also in March, Comstar announced that it had been awarded licens(cid:2)
es to provide data transmission in the Kemerovo, Chelyabinsk,
Novosibirsk, Sverdlovsk and Tumen regions, as well as in the
Stavropol and Primorsky territories, and in the Republic of Tatarstan.
The licenses are valid until February 9, 2012 and further expand the
company's reach in high(cid:2)growth Russian regions.

During the month, Comstar sold its 45% equity stake in ZAO
Metrocom, an alternative fixed(cid:2)line telecommunications operator
based in St. Petersburg, to MST CJSC. The shares were sold for a total
cash consideration of US$20.0. Comstar acquired the stake in
September 2005 for US$12.2 million in cash. The sale was in line
with Comstar's intention to have controlling stakes in all of its ope(cid:2)
rations. Comstar is evaluating other means of expanding its opera(cid:2)
tions in the St. Petersburg area.

In March, Sitronics and ZTE Corporation signed a Memorandum of
Understanding concerning development of cooperation in Russian,
Chinese and international telecommunication markets. Sitronics
and ZTE Corporation will focus their efforts on setting up a joint
strategic R&D center for developing communication facilities and
consumer electronics.

Also in March, MTS announced its decision to write off costs associ(cid:2)
ated with the acquisition of a 51% stake in Tarino Limited, the indi(cid:2)
rect owner of Bitel LLP (Bitel), a Kyrgyzstan(cid:2)based GSM mobile tele(cid:2)
phone operator, at the end of 2005. The write(cid:2)off amounted to
US$150 million.

April 2007

In April 2007, an Extraordinary General Meeting of Svyazinvest
shareholders elected Sergei Shchebetov (Chairman of the Board of
Directors of Comstar) and Anton Abugov (First Vice President and

Head of Strategy and Development at Sistema) to the Svyazinvest
Board of Directors.

Also in April, Comstar announced the acquisition of a 100% stake in
Golden Line, a wholly owned subsidiary of Comstar Direct, for a
total cash consideration of US$10.2 million from Comstar Direct.

During the same month, Sistema acquired an additional 9.75% stake
in Sitronics. As a result of the transaction, Sistema now owns 60% of
Sitronics's issued share capital. The acquisition was made in accor(cid:2)
dance with an ongoing restructuring process and the planned conso(cid:2)
lidation of assets of the corporation aimed at optimizing the owner(cid:2)
ship structure.

Comstar announced in April that it had been awarded 10 licenses to
provide data transmission in the Krasnoyarsk, Krasnodar and
Khabarovsk territories, and the Volgograd, Vladimir, Irkutsk,
Leningrad, Tver, Saratov and Ulyanovsk regions in line with its strat(cid:2)
egy of expanding its presence in Russia's regional markets.

May 2007

In May the Russian Ministry of Information and Communications
announced the results of a tender for the 3G license. MTS was one of
three companies that received a federal license allowing it to pro(cid:2)
vide 3G services in Russia. In accordance with the conditions set
forth in the tender documentation, the winning companies are
required to begin commercial exploitation of a 3G network in the
period of two years from the time they receive the license. The 3G
network in Russia will compliment the existing GSM network. MTS
is planning to launch 3G services in the largest cities in Russia start(cid:2)
ing from the second half of this year.

ANNUAL REPORT / 2006 Risks

The consumer sectors of Russia and the CIS, where the corporation
conducts its core business, have grown impressively in recent years.
Nonetheless, the sector carries with it substantial risks that may effect
the pace of development at the corporation's subsidiaries. Therefore,
the evaluation and management of these risks is an important ele(cid:2)
ment in the strategy of Sistema. This approach allowed Sistema to
endure the 1998 Russian financial crisis with minimal losses.

The risks which could affect the corporation's business are diverse.
These risks reflect the emergence of processes and factors beyond
the control of Sistema.

Country Outlook

The past year has demonstrated another success of managed
democracy over the seven years Mr. Putin has been in power.
However, there is a risk that the well established course of political
stability and reforms will be upset getting closer to the election
cycle, or the smooth transition of power will fail. The neighboring
CIS countries have shown more political instability, which results,
for better or worse, in the influence of various political forces on
their national economies and especially the private companies.

Economic Performance

The strong performance of investments and consumer demand has
been sustained. Inflation has declined substantially and industry has
posted a remarkable recovery, and the steady growth of the stabi(cid:2)
lization fund is a strong indication that a prudent fiscal policy will
prevail. On the other hand, monetary and fiscal loosening contin(cid:2)
ued, and inflation in general and rising costs for consumer industry
are the two biggest macroeconomic risks, fueled by rising budgetary
spending, intact balance of payments pressures, and growth in reg(cid:2)
ulated tariffs. In the CIS countries there is a risk that positive eco(cid:2)
nomic trends can stall or reverse based on political instability. The
trend of Russian and the CIS countries' economic dependency on oil
and gas prices continued.

Risks

Exchange Rate

Sistema faces exchange rate risks linked to changes in the value of
the ruble as well as the grivna and the euro, to the US dollar. As a
result of inflation in Russia and other markets where it operates, the
corporation links its monetary assets and transactions to the US dol(cid:2)
lar. Also, a significant share of the corporation's capital expenditures
and operating and borrowing costs are dominated in US dollars. In
Russia and Ukraine, many of the corporation's services are priced in
US dollar equivalents. There is also a risk that nominal exchange rate
will not be controlled by the Central Bank of Russia in order to pro(cid:2)
tect domestic corporations from losing competitiveness.

Capital Markets

Sistema sees the risk of Russian equities underperforming average
emerging markets. The two principal reasons for the possible weak(cid:2)
ness appear to be the relative outperformance and the relative liq(cid:2)
uidity of Russian equity. There is a risk that capital inflows will be
smaller (cid:2) on the back of tighter global liquidity, political risks, high
market valuations, etc.

Interest Rate and Other Borrowings

Future changes in interest rates in Russia could substantially change
the cost of loans and raising additional capital. Sistema has a num(cid:2)
ber of capital intensive businesses, therefore changes in the cost of
borrowing could have a negative impact on the corporation. Also, if
Russia's sovereign debt rating were lowered, the corporate debt rat(cid:2)
ings of Sistema could be affected, making borrowing in internation(cid:2)
al debt markets more costly.

Investors, partners and other interested persons should consult
detailed risk summaries for Sistema contained in the Management's
Discussion and Analysis of Financial Condition and Results of
Operations.

Vladimir Evtushenkov
Chairman of the Board
of Directors

Alexander Goncharuk
President and Chief Executive
Officer of Sistema

Corporate
governance
Board of
Directors

Evgeny Novitsky
Director

Alexander Leiviman
Director

Stephan Newhouse
Independent
Director

Alexander Gorbatovsky
Independent
Director

ANNUAL REPORT / 2006
Board of Directors

Vyacheslav Kopiev
Deputy Chairman of the
Board of Directors

Dmitry Zubov
Deputy Chairman of the
Board of Directors

Sergey Drozdov
Director,
Senior Vice President,
Head of the Property
Group of Sistema

Nikolai Mikhailov
Independent
Director

Ron Sommer
Independent
Director

ANNUAL REPORT / 2006 New shoots of growth

Board of Directors

The Board of Directors, which reports to the General Meeting of
Shareholders, is the key corporate governance body at Sistema. It
carries out six primary functions: the definition of the corporation's
development strategy, establishing clear qualitative and quantitative
targets for the executive management and following through on
their execution; the efficient management of assets; the appoint(cid:2)
ment of key managers; continued improvement of the corporate
governance system and oversight of financial reporting audit and
internal control.

The current composition of Sistema's Board of Directors was
approved at the Annual General Meeting held on June 30, 2006. In
the interests of transparency and clear corporate governance proce(cid:2)
dures, of the 11 directors on the current Board, four are independ(cid:2)
ent directors and further four are non(cid:2)executive directors.

Vladimir Evtushenkov
Chairman of the Board of Directors

Vladimir Evtushenkov was born in 1948 in the Smolensk region. He
graduated from the D. Mendeleev Moscow Chemical Engineering
Institute in 1973, and in 1980 from the School of Economics of the
Moscow State University where he earned a Doctorate in
Economics.

From 1975 to 1982, Mr. Evtushenkov worked as Deputy Director
and Chief Engineer at the Karacharovo Plastics Works. From 1982
until 1987 he was Chief Engineer and subsequently first Deputy
General Director of the Polymerbyt Scientific and Production
Association. He was appointed head of the Technical Administration
of the Moscow City Executive Committee in 1987 and in 1988
became head of the Central Administration on Science and
Engineering of the Moscow City Executive Committee. In 1990 Mr.
Evtushenkov moved to chair the Moscow City Committee on
Science and Engineering.

Chairman of the Board. Before Sistema's IPO on LSE, Mr.
Evtushenkov became President of Sistema. In February 2006, he was
again appointed the Chairman of the Board. He is the majority
shareholder of Sistema.

He has been a member of the Bureau of the Board of Directors of the
Russian Union of Industrialists and Entrepreneurs since 2000. In
2001, he became head of the Union's Committee on industrial poli(cid:2)
cy. He has been a member of the Board of Directors of the Russian
Chamber of Commerce and Industry since 2002. Mr. Evtushenkov is
also a member of the Government Commission on Science and
Innovation Policy and a member of the Russian President's Council
on Science and High Technology and the National Council on
Corporate Management. In March 2004, he was elected Chairman of
the Council of Trustees of the Development Fund for the State
Russian Museum.

Alexander Goncharuk
President and Chief Executive Officer of Sistema

Alexander Goncharuk was born in 1956, in Sevastopol. He graduat(cid:2)
ed with honors from both the Sevastopol Naval Engineering
Academy in 1978 and the A. Grechko Naval Academy in 1987. From
1987 to 1991 Mr. Goncharuk served as a senior officer at the Main
Headquarters of the Navy. He later became General Director of the
company ACO Leader.

Mr. Goncharuk became Member of the Board of Directors of
Sistema in 1996. From 1995 to 1998, he served as Vice President of
Sistema. His group company positions included the post of
Chairman of the Board of MTS (in 1998 and from 2002 to 2003),
having also served as Deputy Chairman of the Board in 1997 and for
the first half of 1999. Mr. Goncharuk was President of Sistema
Telecom from 1998 to 2003. Between 2003 and 2006, he was
General Director of Concern Sitronics (CSC). In addition to serving
on the Sistema Board, he has also been elected to the boards of
Sistema Telecom, MTS and Concern Sitronics. Since February 2006,
Mr. Goncharuk has been the President of Sistema.

Evgeny Novitsky
Director

In 1993, together with a group of like(cid:2)minded people, he founded
Sistema. From the company's inception until 1995, he served as its
President and from January 1994 to January 2005, he also served as

Evgeny Novitsky was born on November 19, 1957, in the Tomsk
region. He received a degree in Engineering from the C. Bauman
Moscow School of Engineering in 1985, and from 1989 to 1990

ANNUAL REPORT / 2006 Board of Directors

studied management at the Moscow State Institute of International
Relations and at Manchester Business School, University of
Manchester (UK).

Mr. Novitsky was an engineer(cid:2)mathematician at the C. Bauman
Moscow School of Engineering from 1985 to 1987 and continued
his studies there as a postgraduate until 1990, working on scientific
and engineering projects in the defense industry. From 1991 to
1995, he headed the development and production of computers as
well as assembly of IBM computers at the Kvant plant in Zelenograd.
He also participated in a project to convert a missile launch vehicle
based on the SS(cid:2)20 missile platform for peaceful uses. He was also
Chairman of the Board of IVK, a Russian information technology
company. In addition, he is the author of a number of publications
and a monograph and is a Member of the Board of Trustees of the C.
Bauman Moscow School of Engineering.

Mr. Novitsky joined Sistema in 1995 as Director and President and
continued in these roles until January 2005, when he became
Chairman of the Board, a post he held until February 2006. Since
then he has remained on the board as a non(cid:2)executive director. He
also serves as Chairman of the Board of two Sistema group compa(cid:2)
nies, CSC and Concern RTI(cid:2)Systems and is a member of the manage(cid:2)
ment board of a fourth, ECU GEST Holding.

Dmitry Zubov
Deputy Chairman of the Board of Directors

Dmitry Zubov was born in 1954 in the Gorky region.
He graduated from the S. Ordzhonikidze Moscow Aircraft Institute
in 1977 and is a Doctor of Economics.

In 1978 and 1979, Mr. Zubov worked as a foreman at the Lukhovitsky
Engineering Plant and subsequently served as secretary of the
Komsomol Committee until 1983. He headed the All(cid:2)Union School
for training team leaders of Komsomol Youth brigades from 1983 to
1986. He then served in the department for working with youth at the
Central Committee of the Leninist Young Communist League of the
Soviet Union from 1986 to 1988. From 1992 Mr. Zubov was General
Director of AOZT Alon until 1996, when he became Deputy Chairman
of the Board of Moseximbank. In 1998 he became a Director on the
boards of ABN(cid:2)Sistema and PromKhimInvest.

Mr. Zubov has been working at Sistema since 1999 and has been
Deputy Chairman of the Board of Directors since 2000. He holds a
number of senior positions in group companies including Chairman
of the Board of Sistema Hals and Project Construction Union
Sistema(cid:2)Hals.

Vyacheslav Kopiev
Deputy Chairman of the Board of Directors

Vyacheslav Kopiev was born in 1954 in Moscow. He holds degrees in
Engineering and Law and graduated from the Cybernetics
Department of the Moscow Institute of Engineering and Physics
(MIPHI) in 1977 and from the Law Science Department of the
Russian Academy of Management in 1993. Mr. Kopiev also graduat(cid:2)
ed with honors from the Economy Department of the International
Marketing and Management Academy in 1994. He is the author of
over 70 scientific works.

As a senior engineer at MIPHI, in 1977, Mr. Kopiev was appointed to
work in the Krasnogvardeisky District Komsomol Committee. From
1980 to 1989, he was Deputy Chairman of the Moscow City Council
of Young Scientists and Specialists as well as the Moscow City
Council for the Development of the Scientific and Technical
Abilities of Youth. In 1989, he was elected First Secretary of the
Moscow City Committee of the Komsomol and in 1990, became
Second Secretary of the Komsomol Central Committee. From 1989
in the
onwards, Mr. Kopiev occupied
Administrative Board of the Union of Engineering Societies and
between 1992 and 1997 was Director for International Relations
and Innovation. From 1990 to 1997, he served Chairman of the
Board of Directors of JSC Sputnik. In 1995, Mr. Kopiev became
Deputy Chairman of the Executive Committee of the Russo(cid:2)British
Chamber of Commerce.

leading positions

Mr. Kopiev joined Sistema as Vice President in 1997. He served as
Senior Vice President and Chief of the External Business Relations
Group from 2000 to 2003. He has been a Director since 2001. Since
2003 he has served as Deputy Chairman of the Board. He holds a
number of other senior corporate positions, mostly within group
companies, including Chairman of the Board of Sistema Mass Media,
Intourist, Rosbalt Information Agency and Literaturnaya Gazeta
(Literary Gazette).

Alexander Leiviman
Director

Alexander Leiviman was born in 1949 in Chernovtsy.
From 1972 to 1973, Mr. Leiviman worked as deputy shop foreman at
MosBytKhim. From 1975 to 1977, he was senior staff scientist at the
Institute NIPIOTSTROM in Novorossiisk. Mr. Leiviman occupied a
number of leading positions at the chemicals plant in Chernovtsy
from 1978 to 1992 when he became Deputy General Director of the
Innovation Fund of the Moscow Mayor's Office.

ANNUAL REPORT / 2006 New shoots of growth

Mr. Leiviman has been a Director of Sistema since 1993, joining as
Deputy Chairman of the Board, a post he held until 1998. From 1993
until 1996, he served as Vice President and from 1999 to 2002, as
First Vice President and Chief of the Finance and Investment Group.
Other corporate roles include: President of Sistema(cid:2)Invest (1996(cid:2)
1997), President of Intourist (1997(cid:2)1999) and Director of MTS
(1998(cid:2)2002). Mr. Leiviman has been General Director of Sistema
Mass Media since September 2003 and is also Chairman of the Board
of Concern Radio(cid:2)Centre, Maxima Advertising Agency, Gazeta
Metro, Zolotoy Vek Film Studio and Sistema(cid:2)International IG. His
current Board appointments include: Sistema Telecom, Sistema
Mass Media, Intourist, Narodnoye Kino, New Line of Stars Studio, TV
Project and TV Stolitsa. He is also on the management board of ECU
GEST Holding.

Nikolai Mikhailov
Independent Director

Nikolai Mikhailov was born in 1937 in the Bryansk region. He grad(cid:2)
uated in 1961 from the N. Bauman Moscow School of Engineering
and subsequently worked at several defense and scientific and pro(cid:2)
duction enterprises. From 1979 to 1987, he headed the Scientific
Research Institute for Wireless Radio Set Construction. From 1987
to 1992, he managed international JSC Vympel. Between 1996 and
1997, Mr. Mikhailov was Deputy Secretary of the Russian Security
Council and from 1997(cid:2)2001 First Deputy Minister of Defense of the
Russian Federation.

Mr. Mikhailov is a Doctor of Economics (1967), Professor (1992),
Grand Doctor of Philosophy (1997) and author of over 100 scientif(cid:2)
ic publications dealing with major radio(cid:2)electronic systems. He is a
full member of a number of industry(cid:2)related and international
academies and chaired one of the departments at the Moscow
Physics and Technologies Institute for over 10 years. He has received
numerous honors, including Laureate of the USSR State Prize
(1984), State Prize of the Russian Federation (1997), Order of the
Red Banner of Labor, Badge of Honor, 4th(cid:2)Degree Merit to
Motherland and a number of medals.

Mr. Mikhailov has been a Member of the Board of Sistema since
2000 and from 2001 serve as Advisor to the Chairman. He is on the
Board of the following companies: Concern RTI Systems, Business
Informatization System, Kamov, NII Stali and Sistema Venture.

Sergei Drozdov
Director, Senior Vice President, Head of the Property Group of Sistema

Sergei Drozdov was born in 1970 in Archangelsk. He graduated in
1993 from the S. Ordzhonikidze State Academy of Management in
Economics. Mr. Drozdov was head of the Administration for
Financial Innovation and Marketing at the Moscow Property Fund
from 1994 to 1995.

Mr. Drozdov has been working at Sistema since 1995. He managed
the Department of Development and Investments from 1995 to
1998 and from 1998 and 2002, served as Vice President, Acting
President and First Vice President of Sistema(cid:2)Invest. He became
Acting First Vice President and Head of the Department for
Corporate Property in May 2002. In September 2002, he was
appointed Director and First Vice President of Sistema and Chief of
the Property Complex. He holds a number of other senior corporate
positions, mainly among group companies, including Chairman of
the Boards of Detsky Mir, Reestr, Detsky Mir Center and NII Stali. Mr.
Drozdov also serves on the Boards of Sistema Telecom, MGTS, CSC,
Sistema(cid:2)International, Medical Technology MTH, Olimpiyskaya
Sistema, Intourist Hotel Group and M(cid:2)Consult.

Alexander Gorbatovsky
Independent Director

Mr. Gorbatovsky has been a Director at Sistema since August 2004.
He also serves as Chairman of the Board of MMZ No.3. From 1993
until 1997, he was General Director of Kedr(cid:2)M and from 1997 until
2002, was President of Sistema(cid:2)Neft.

Ron Sommer
Independent Director

Ron Sommer was born in 1949 in Israel. He studied mathematics at
the University of Vienna, where he earned his doctorate in 1971. Mr.
Sommer began his professional career with the Nixdorf Group in
New York, Paderborn and Paris. In 1980, he was appointed
Managing Director of the German subsidiary of the Sony Group. In
1986, he became Chairman of the Management Board of Sony
Deutschland, and was subsequently appointed President and Chief
Operating Officer of Sony Corporation of America in 1990. In 1993,
Mr. Sommer served at Sony Europe in the same function. From May
1995 to July 2002, he served as Chairman of the Management Board
of Deutsche Telekom AG. Mr. Sommer is a member of the Board of

The Strategy Committee analyzes strategic issues affecting the de(cid:2)
velopment of Sistema and its operating subsidiaries. The committee
reviews financial strategy and the work of financial divisions, the
strategy and projects of business areas and the activity of the divi(cid:2)
sions within the corporation's central management structure.

The Audit Committee oversees the preparation of financial reports,
the meeting of financial targets and the audit of the financial report(cid:2)
ing of Sistema and its subsidiary companies. In addition, the com(cid:2)
mittee supervises the work of all external auditors and provides
guidance over the appointment and compensation of auditors.

The Nomination and Compensation Committee provides the Board
of Directors with recommendations for management appoint(cid:2)
ments, selects candidates for election to the boards of affiliate and
subsidiary companies. In addition, the committee develops policies
for the corporation for developing incentive programs, including
recommendations for salary and compensation of senior managers.

The Committee for Sustainable Development and Corporate
Governance develops proposals for further improving the corpo(cid:2)
rate conduct of Sistema and its affiliate companies as well as recom(cid:2)
mendations regarding issues of sustainable development, corporate
responsibility and information disclosure. The committee also
reviews issues of corporate governance at subsidiary companies and
develops respective standard internal documentation.

The Committee for Investor Relations develops policies for de(cid:2)
veloping communications with the investment community. It also
strengthens Sistema's IR function with respective documentation
and develops recommendations regarding specific investor rela(cid:2)
tions issues.

ANNUAL REPORT / 2006 Board of Directors

Directors of Motorola, a member of the Supervisory Board at
Munchener Ruckversicherung (Munich Re) and Celanese. He is also
a member of the International Advisory Board of The Blackstone
Group. Since May 2003, he has been serving as Chairman of the
International Advisory Council of Sistema. Mr. Sommer was elected
as a non(cid:2)executive independent member of the Board of Directors
of Sistema in June 2005.

Stephan Newhouse
Independent Director

Stephan Newhouse was born in 1947. He attended Yale University
where he earned a Bachelor of Arts degree cum laude in 1969. After
serving as an officer in the United States Navy from 1969 to 1972, he
went on to attend the Harvard Business School where he earned his
MBA with Distinction in 1975.

From 1975 to 1979, he worked in the investment banking division
of the First Boston Corporation. He is a Director of Harbor Point
Limited, a Bermuda based re(cid:2)insurance company and Shanghai AJ
Trust Company, a Chinese financial services group.

Stephan F. Newhouse is the former President of Morgan Stanley and
also former Chairman of Morgan Stanley International Inc, the hold(cid:2)
ing company for all of Morgan Stanley's non(cid:2)North American sub(cid:2)
sidiaries.

Mr. Newhouse joined Morgan Stanley in 1979, became a Managing
Director in 1988, Vice Chairman in 1997, Chairman of Morgan
Stanley International in 2000, and President of Morgan Stanley in
December of 2003 in which capacity he served until April of 2005.
For the three years prior to being named President of Morgan
Stanley, he was also Co(cid:2)President and Chief Operating Officer of
Morgan Stanley's Institutional Securities and Investment Banking
Group, which includes the global institutional equities, institutional
fixed income and investment banking operations of Morgan
Stanley. He was appointed to the Management Committee of
Morgan Stanley, the parent company, in 1998.

Committees of the Board of Directors

Five committees exist on the Board of Director level to provide
oversight, on behalf of all shareholders, of key issues affecting the
corporation's development. These committees are: Strategy; Audit;
Nomination and Compensation; Sustainable Development and
Corporate Governance, and Investor Relations.

ANNUAL REPORT / 2006 New shoots of growth

Corporate governance
Key Management

Alexander Goncharuk
President

Anton Abugov
First Vice President,
Head of Strategy and
Development

Alexey Buyanov
Senior Vice President
Head of Finance and
Investment

Ruslan Almakaev
Vice President
Head of Economic
and Information
Security

Sergey Drozdov
Senior Vice President,
Head of the Property

Sergey Cheremin
Vice President Head of
External Relations

Denis Muratov
Vice President
Head of Innovations and
Science

ANNUAL REPORT / 2006 New shoots of growth

Key Management

The Management Board reports to the Board of Directors and is
responsible for both the day(cid:2)to(cid:2)day management of Sistema and
executing the strategies defined by the Board.

Alexander Goncharuk
President and Chief Executive Officer, Sistema

Mr. Goncharuk became Member of the Board of Directors of Sistema
in 1996. From 1995 to 1998, he served as Vice President of Sistema.
His group company positions included the post of Chairman of the
Board of MTS (in 1998 and from 2002 to 2003), also served as
Deputy Chairman of the Board in 1997 and for the first half of 1999.
Mr. Goncharuk was President of Sistema Telecom from 1998 to 2003.
Between 2003 and 2006, he was General Director of Concern
Sitronics (CSC). In addition to serving on the Sistema Board, he was
also elected to the boards of Sistema Telecom, MTS and Concern
Sitronics. Since February 2006, Mr. Goncharuk has been the President
of Sistema.

Anton Abugov
First Vice President, Head of Strategy and Development

Anton Abugov was born in 1976. He graduated from the National
Economics Academy under the Government of the Russian
Federation. In 1995, Mr. Abugov was involved in developing infra(cid:2)
structure and a regulatory framework for the securities market in
Russia. Between 1995 and 2002, Mr. Abugov was head of corporate
finance at UFG (United Financial Group), seeing through a number
of major fundraising, strategic consultancy, and merger and acquisi(cid:2)
tion projects in various industries in Russia and Eastern Europe. In
1999, he was an adviser to RAO UES.

Between 2003 and 2006, Mr. Abugov was Managing Director of AKB
Rosbank, in charge of its Corporate Finance Department. Prior to
Rosbank, he was a partner in Eurasia Capital Partners, overseeing
investment projects in Eastern European telecoms and Russian
petrochemical businesses. From 1997 to 2006, he was strategic
adviser to the TAIF Group of Companies, one of the biggest finan(cid:2)
cial(cid:2)industrial groups in Russia.

Alexey Buyanov
Senior Vice President, Head of Financial Group

Alexey Buyanov was born in 1969, in Moscow. He graduated in 1992
from the Moscow Physics and Engineering Institute (MPEI) speci(cid:2)
alizing in applied mathematics and physics and was an intern
researcher at the Institute of Mechanics Problems (IMP) of the
Russian Academy of Sciences from 1992 to 1994.

Mr. Buyanov joined Sistema in 1994 and occupied various posts at
the Property Group until 1995 when he was appointed Head of
Administration at Sistema(cid:2)Invest, later becoming Vice President in
1996 and First Vice President in 1997. He also served as Vice
President of MTS from 1998 to 2002. Also in 2002, he was appoint(cid:2)
ed Vice President of Sistema and Head of the Financial Restructuring
Department.

Later that year, Mr. Buyanov became First Vice President and Head
of the Finance and Investment Group. He is also a Member of the
Board of the following companies: MTS, Sistema Telecom, MBRD,
East(cid:2)West United Bank, Sistema(cid:2)Hals, Alliance(cid:2)Rosno Asset
Management, Comstar(cid:2)UTS.

Sergei Drozdov
Senior Vice President, Head of the Property Group

Mr. Drozdov has been working at Sistema since 1995. He managed
the Department for Development and Investments from 1995 to
1998 and from 1998 and 2002, served as Vice President, Acting
President and First Vice President of Sistema(cid:2)Invest.

He became Acting First Vice President and Head of the Department
for Corporate Property in May 2002. In September 2002, he was

Denis Muratov
Vice President, Head of Innovations and Science

Denis Muratov was born in Sverdlovsk, now re(cid:2)named Ekaterinburg,
in 1970. He graduated from the Sverdlovsk Institute of Architecture
and the Chalmers University of Technology in Goteborg, Sweden.
Between 1992 and 2004, he worked in Sweden, where he headed up
several companies: Anton Invest AB, Nordic Industrial Development
AB, Scantat AB and Media Resources International Scandinavia AB.
In 2004, Mr. Muratov was appointed General Director of the Idea
Innovation and Industrial Technopark in Kazan, and served as eco(cid:2)
nomic advisor to the First Vice Prime Minister of the Republic of
Tatarstan. In February 2006, he was made Sistema's Vice President
for Innovation and Science.

ANNUAL REPORT / 2006 Key Management

appointed Director and First Vice President of Sistema and Chief of
the Property Complex. He holds a number of other senior corporate
positions, mainly among group companies, including Chairman of
the Boards of Detsky Mir, Reestr, Detsky Mir Center and NII Stali. Mr.
Drozdov also serves on the Boards of Sistema Telecom, MGTS, CSC,
Sistema(cid:2)International, Medical Technology MTH, Olimpiyskaya
Sistema, Intourist Hotel Group and M(cid:2)Consult.

Sergey Cheremin
Vice President, Head of External Relations

Sergey Cheremin was born in 1963 in Kislovodsk. He graduated with
honors in 1989 from the Moscow State Institute of International
Relations with a specialization in international journalism and com(cid:2)
pleted his postgraduate course at Moscow State University specializ(cid:2)
ing in global economic issues. In 1992, he was an intern at the New
York Institute under the Investments and International Accounts
Program and in 1993 joined a course for banking specialists at
Fairfield University (USA).

From 1991 to 1992 Mr. Cheremin was Deputy CEO at Printbank
and from 1992 to 1998 worked as the CEO of the Moscow Export(cid:2)
Import Bank. Between 1998 and 2000 he was Vice President of
Ural Trust Bank and from 2000 to 2003 was Adviser to the
President of Severo(cid:2)Vostochny Alliance Bank where he subse(cid:2)
quently became President. In 2004, he was appointed CEO of
MBRD Bank and has acted as the Chairman of the Board there
since April 2005. Since this time, he has also served as Sistema's
Head of External Relations.

Ruslan Almakaev
Vice President,
Head of Economic and Information Security Group

Ruslan Almakaev was born in 1963 in Kharkov. In 1994 Mr.
Almakaev graduated from Kharkov State University and in 2003
from the Krasnodar State University specializing in methods and
systems of macroeconomic processes.

From 1993 to 2002, he worked as a Deputy Director General of
AOZT Commercial and Industrial Company Eurasia and was an
assistant to a member of the State Duma (parliament) of the
Russian Federation, Deputy General Director of the regional public
fund for the defense of Russian Air force workers and workers of
the aviation fund (The Russian Aviation Fund). From 2002 to 2003,
Mr. Almakaev was Head of the Department for Non(cid:2)Corporate
restructurings at Sistema.

ANNUAL REPORT / 2006 New shoots of growth

Corporate governance
Management
Structure

ANNUAL REPORT / 2006 Corporate governance

ANNUAL REPORT / 2006 New shoots of growth

Corporate governance
Principles of Corporate Governance

Sistema is in the business of building businesses and maintaining and
enhancing world(cid:2)class systems of corporate governance for both the
corporation and its subsidiaries. Good corporate governance for a
company represents an important competitive advantage for the cor(cid:2)
poration. Managing a portfolio of leading consumer(cid:2)focused busi(cid:2)
nesses, Sistema sets high standards for its operating companies as they
develop, tap into debt and equity markets and continue to evolve as
public companies. In turn, the corporation's directors set the highest
standards of transparency and the corporation has demonstrated a
long(cid:2)term ability to restructure rapidly to respond to changes in the
marketplace and make its business more transparent.

A large corporation is a complex body. Its efficient management
requires a high level of professionalism, precision and operational
skills in taking decisions. The right set of corporate governance
procedures allows managers and directors to achieve their goals for
developing the business efficiently and crucially maintain the trans(cid:2)
parency of the company, the observance of minority shareholder
interests and the necessary divisions of authority as well as a joint
decision making approach. Doing all of this is ever more important
for the modern corporation.

The principles and procedures of Sistema's corporate governance
practices are defined by the company's charter. These rules define the
corporation's relationships and communications with investors,
employees, business partners, customers and government bodies.
Specific codes on ethics and corporate conduct have been approved
by the Board of Directors and are binding on directors and managers.

Sistema has developed and confirmed at the Board of Directors level
the rules that establish a clear set of procedures for all levels of gov(cid:2)
ernance, including Annual and Extraordinary General Meetings of
Shareholders, the Board of Directors, President, Executive
Management, Audit Commission and so forth. Specific regulations
cover information disclosure, dividend policies, procedures for inter(cid:2)
nal financial control, the composition of the Board(cid:2)level commit(cid:2)
tees, management and mitigation of risks, conducting significant
transactions and internal communications at all levels.

Since Sistema itself became a public company with its IPO on the LSE

in February 2005, the company is bound by additional stock
exchange listing rules and securities markets regulations in the UK
and Russia. Long before its IPO, Sistema has sought to exceed the
minimum requirements for corporate governance set by the legisla(cid:2)
tion. For instance, it began reporting its financial results prepared
according to US GAAP requirements back in 1997 and the first
board(cid:2)level supervisory committee was established in 2001. In 2002,
three years before the IPO, Sistema became the first Russian compa(cid:2)
ny to voluntarily disclose the identity of its beneficial owners.

The corporation took these steps not just because it allowed it to
raise capital and attract business partners but because, as its
founders believed, the corporation's long(cid:2)term success rested on
mutually advantageous relationships with all stakeholders. Building
an innovation(cid:2)led business is closely tied with developing a truly
globally competitive economy in Russia. In this and many other
ways, good corporate governance and social responsibility are tight(cid:2)
ly linked.

But while the charter and other normative documents are made to
be comprehensive, they were also designed to be flexible enough to
accommodate a rapidly changing marketplace. As with any compet(cid:2)
itive advantage, high standards and innovation in corporate gover(cid:2)
nance require continuous change. Sistema is competing in an ever
more crowded global marketplace to attract new investors who will
maximize the price and liquidity of its shares. In Russia alone, accord(cid:2)
ing to recent estimates, there are around 25,000 open joint(cid:2)stock
companies. The country's sovereign debt has reached investment
grade and booming equity and debt markets have seen a surge in
stock market listings. Some 16 listings in 2006 raised around US$20
billion in capital. Depending on a range of factors, some commenta(cid:2)
tors suggest the number of listings could reach 30 in 2006, including
a number of consumer(cid:2)sector companies floating on Russian stock
exchanges as well as international listings.

Sistema itself has been a major driver in this boom. The company's
mobile communications operating company, MTS, which was listed
on the New York Stock Exchange in 2000, performed the first
Russian IPO after the Russian financial crisis of 1998. Sistema's IPO in
February 2005 on the LSE was the largest Russian IPO ever conduct(cid:2)

Local and national governments and regulators and social organiza(cid:2)
tions are therefore important partners for the corporation

In April 2006, the Russian Institute of Directors and ratings agency
Expert RA confirmed their top rating of 'A' for Sistema's corporate
governance practices. In the report, their experts praised a high level
of both financial and non(cid:2)financial reporting, the inclusion of the
interests of all stakeholders in the corporation's decision(cid:2)making
process and overall levels of corporate responsibility.

ANNUAL REPORT / 2006 Corporate governance

ted at the time, raising a total of US$1.56 billion. The IPO of combined
fixed(cid:2)line operator Comstar was the second largest one year later.
The listings of Sistema(cid:2)Hals and Sitronics set benchmarks for their
sectors.

These successful transactions demonstrated Sistema's ability to
meet and exceed the strict disclosure and governance require(cid:2)
ments of these markets. They also underscore that Sistema and
companies in the holding now must compete globally against
industry peers and other innovative emerging market companies.
Along with delivering the right financial ratios, Sistema needs to
demonstrate to portfolio investors that, whatever the size of their
shareholding, their financial and legal rights and interests will be
protected to the maximum degree and they will be allowed to
participate in how Sistema is run.

The practice and standards of good corporate governance, com(cid:2)
bined with delivering strong financial results, work to establish trust
in the corporation within the Russian and international investment
community. It ensures Sistema can draw on the experience of leading
global advisors and engage in an ongoing dialog with experienced
investors. Sistema places particular importance on the development
of effective investor communications. In 2003, the corporation cre(cid:2)
ated a dedicated Investor Relations department. Its main task is to
provide investors, creditors, analysts, the financial media and other
stakeholders with the required information about Sistema's financial
and investment activities.

Sistema's directors and managers seek to deliver the best possible
return on investments in the corporation's shares and bonds. The
corporation has an established dividend policy and aims that divi(cid:2)
dends are paid regularly and predictably while insuring profit is also
re(cid:2)invested in development in order to ensure the long(cid:2)term growth
in the corporation's capitalization. Sistema aims to increase the liq(cid:2)
uidity and value of its securities and engage in an ongoing dialog with
its investors through events such as Investor Days and road(cid:2)shows
conducted regularly in Russia and in global centers of capital. In addi(cid:2)
tion, Sistema conducts regular surveys to determine the identity and
scope of its shareholder base in order to better communicate infor(cid:2)
mation to current and prospective shareholders, beyond the bounds
of exchange(cid:2)mandated disclosure.

Effective corporate governance involves taking into account the
interests of all stakeholders. As a fast(cid:2)growing corporation that is
constantly expanding its geographic presence and entering new
product categories and sectors, this base of stakeholders is steadily
increasing. This in turn requires new efforts by Sistema's managers
and directors to ensure the needs of these groups are taken into
account during the decision(cid:2)making process of the corporation.

ANNUAL REPORT / 2006 New shoots of growth

Corporate governance
Asset Structure

The table on the next page outlines Sistema's beneficial ownership
and voting interests in subsidiary and associate companies where
the corporation's ownership exceeds 20% of total ordinary shares.
This list reflects shareholdings as of December 31, 2006.

Since the end of the reporting period, in February 2007, Sistema has
sold 17.5% of its shares in Sitronics through an initial public offering
on the London Stock Exchange and listings on the Moscow Stock
Exchange and Russian Trading System.

On February 21, 2007, Sistema announced that it would sell 46.19%
of ROSNO shares to Allianz as part of a share purchase agreement.
Following the agreement, Sistema's shareholding in ROSNO was
reduced to 3%.

ANNUAL REPORT / 2006 Corporate governance

Company
% of total ordinary
shares owned by Sistema
_______________________________________________________________

Telecommunications Business Area
_______________________________________________________________

Mass Media Business Area
_______________________________________________________________

Mobile TeleSystems
Comstar United(cid:2)TeleSystems
MGTS
Sky Link
MTT
Svyazinvest

53%
59%
33%
50%
43%
25%

Medicine & Biotechnology
Business Area
_______________________________________________________________

Medsi
Medsi(cid:2)2

67%
74%

High(cid:2)Technology Business Area
_______________________________________________________________

Sitronics

85%

Sistema Mass(cid:2)Media

100%

Tourism Business Area
_______________________________________________________________

Intourist

66%

Radio & Aerospace Technology
Business Area
_______________________________________________________________

Concern RTI Systems

100%

Oil(cid:2)extracting and oil(cid:2)refining assets
_______________________________________________________________

ANK Bashneft
Ufimsky NPZ
Novoil
Uralneftehim
Ufaorgsintez
Bashnefteproduct

21%
24%
27%
23%
23%
25%

Real Estate Business Area
_______________________________________________________________

Binnofarm

100%

Sistema(cid:2)Hals

80%

Biotechnology Business Area
_______________________________________________________________

Insurance Business Area
_______________________________________________________________

ROSNO

49%

Finance Business Area
_______________________________________________________________

AKB MBRD
95%
East(cid:2)West United Bank S.A., Luxembourg 51%

Retail Business Area
_______________________________________________________________

Detsky Mir Center
Detsky Mir

100%
75%

ANNUAL REPORT / 2006 New shoots of growth

Shareholding Capital

General Information on Shareholding Capital

Shareholding Structure

Sistema Joint Stock Financial Corporation was registered at the
Moscow Registration Chamber on July 16, 1993. The corporation is
registered at Prechistenka Street, House 17/8/9, Building 1, Moscow,
119034, Russian Federation.

The charter capital of the corporation is 868,500,000 rubles and
consists of 482,500,000 ordinary shares with a nominal value of 1.8
rubles.

Sistema's shares are listed on the London Stock Exchange in the
form of global depositary receipts (GDRs) under the symbol 'SSA'.
One GDR represents one ordinary share. Sistema's ordinary shares
are traded on the Russian Trading System, under the symbol 'AFKS'
and the Moscow Stock Exchange (MSE) under the ticker 'SIST'.

In addition, as of the end of 2006, a number of debt obligations
issued by subsidiaries of the corporation traded on the financial
market.

As of December 31, 2006, the corporation had 22 entities and 12
individual shareholders, including 8 nominees. While the identities
of the corporation's GDR holders are not generally reported to the
corporation, Sistema undertakes regular research to discover the
identity of its GDR holders. Such research allows the corporation to
provide as much information as possible to the largest number of
shareholders and is aimed at increasing the transparency of the cor(cid:2)
poration and providing greater liquidity for its shares on Russia and
international exchanges.

Between March 2006 and mid(cid:2)February 2007, Sistema purchased
284,243 of its own shares, equivalent to 2.95% of its outstanding shares,
for approximately US$347.3 million dollars. This share 'buy(cid:2)back' was
conducted as part of a previously announced plan to establish a share
option program for the corporation's top management and these
shares may also be used in future merger and acquisition activities.

Sistema Shareholders as of December 31, 2006

ANNUAL REPORT / 2006 Shareholding Capital

Share Price Performance

Dividend Policy

Since February 2005, when Sistema completed an initial public
offering (IPO) on the London Stock Exchange, 19% of the corpora(cid:2)
tion's outstanding shares have been in free(cid:2)float in the form of glo(cid:2)
bal depositary receipts (GDRs). Sistema's GDRs are listed on the LSE
under the ticker 'SSA' and fifty GDRs represent one ordinary share.

In addition, Sistema's shares are traded on the Russian Trading
System, under the symbol 'AFKS' and the Moscow Stock Exchange
(MSE), under the ticker 'SIST'. Sistema's ordinary shares are a com(cid:2)
ponent of the MSE's technical index.

For the year 2006 as a whole, Sistema's GDR price on the LSE rose
26.6%, from US$23.5 on January 2, reaching US$32.0 on the last trad(cid:2)
ing day of the year, December 29. The 12(cid:2)month high share price was
achieved on December 28. The yearly low came on June 26, when the
closing price was 18.1. Price momentum was driven by company
news, particularly interim financial results, such as the third quarter
set of results released on December 21, as well as broader trends in
the Russian economy the broader investor strategies linked to their
desire to hold shares from emerging markets.

Sistema encourages current and potential investors to seek inde(cid:2)
pendent, expert financial advice when making decisions regarding
the purchase and sale of shares. Sistema's equity shares, as well as its
outstanding bond issues, are covered by analysts from a number of
Russian and international brokerage houses. A list of these analysts,
including contact details, is published on www.sistema.com and reg(cid:2)
ularly updated.

Sistema (cid:2) GDR Closing Price on LSE

Sistema's Board of Directors is guided by the corporation's current
dividend policy as established in August 2005 when making its divi(cid:2)
dend recommendation to the Annual General Meeting. The target
payout level stands at 2% of the corporation's consolidated net
income under US GAAP. This policy aims to both provide for a pre(cid:2)
dictable sizeable dividend flow and maintain a dividend history
while simultaneously giving the opportunity to re(cid:2)invest profits to
meet Sistema's capital requirements in order to maintain sustainable
growth.

At the Annual General Meeting held on June 30, 2006, the share(cid:2)
holders approved a cash dividend of RUR 28.0 per share (equivalent
to US$1.03 per share or US$0.02 per GDR) for the twelve months
ended 31 December 2005. The total dividend payable amounts to
RUB 270.2 million (US$9.98 million), which is equivalent to approx(cid:2)
imately 2% of Sistema's US GAAP consolidated net income for 2005.
In recent years, the company paid a dividend equivalent to approx(cid:2)
imately 1.3% of its consolidated net income for the year 2003 and
dividend payout equivalent to approximately 2.1% of consolidated
net income for the year 2004.

ANNUAL REPORT / 2006 New shoots of growth

Share Structure and Performance
of Subsidiary Companies

MTS

Comstar(cid:2)UTS

Mobile TeleSystems placed a Level III ADR issue through its IPO on
the New York Stock Exchange (NYSE) on June 30, 2000. The current
ADR to ordinary share ratio is 1:5, following a 1:4 ADR split in
January 2005. MTS's shares trade on the NYSE under the symbol
'MBT'. The company's major trading volumes are on NYSE.

MTS's depositary receipts are also traded on the LSE (ticker: MBLD),
Frankfurt Stock Exchange (ticker: MKY), Berlin Stock Exchange and
Munich Stock Exchange. MTS shares are traded on the Russian
Trading System (RTS) as a non(cid:2)listed security and were included on
the RTS Index in March 2006 with a 5.7% weighting. Common
shares of MTS have been included on the MICEX "B" Quotation List
under the ticker 'MTSI'.

Presently, the company has 1,993,326,138 ordinary shares with a
nominal value of RUB0.1 per share. As of December 31, 2006,
Sistema owned 53% of Sistema's shares and 46% of shares were in
free(cid:2)float.

MTS's ADR price closed at US$35.0 on the first day of trading of the
year and reached a high of US$50.18 on December 27, 2006, before
closing at US$50.08 on the last day of trading of 2006. As of
December 31, 2006, the company's market capitalization was
US$19.97 billion.

In February 2006, Comstar completed an IPO of 146,500,000 com(cid:2)
mon shares. These shares included 139,000,000 newly issued shares
and 7,500,000 shares sold by shareholders. The shares were admit(cid:2)
ted to trade on the London Stock Exchange (LSE) in the form of
global depositary receipts (GDRs) at the value of 1 GDR per 1 com(cid:2)
mon share.

Currently, the Group has 417,940,860 outstanding shares with a
nominal value of RUB1 per share. As of December 31, 2006, Sistema
directly or indirectly owned 59% of Comstar's common shares.
Approximately 34% of Comstar's shares are in free(cid:2)float, traded in
the form of GDRs on the London Stock Exchange, under the ticker
'CMST'. A very limited number of common shares are traded on
Russian stock exchanges, primarily the Russian Trading System
(RTS) and the Moscow Stock Exchange, also under the ticker 'CMST'.

Comstar's GDRs closed at US$6.87 after their first day of trading on
the LSE on February 7, 2006 and reached their 2006 calendar year
high of US$8.59 on December 27th, 2006. The company's market
capitalization as at December 31, 2006 was US$3.51 billion.

MTS (cid:2) ADR Closing Price on NYSE

Comstar (cid:2) GDR Closing Price on LSE

ANNUAL REPORT / 2006 Shareholding Capital

Sistema(cid:2)Hals

Sistema(cid:2)Hals's shares were admitted to trading in the form of GDRs
on the LSE on November 8, 2006. The company offered 1,738,650
newly issued shares and 112,171 shares from selling shareholders.
In addition, the underwriters exercised an option to purchase
168,256 ordinary shares in the form of GDRs to cover over(cid:2)allot(cid:2)
ments in the offering. The shares were offered at US$10.7 per GDR
and US$214.00 per ordinary share, representing a ratio of 20 GDRs
per ordinary share.

Sistema(cid:2)Hals's shares are traded in the form of GDRs on the LSE
under the symbol 'Hals' and the ordinary shares were included in the
'V' list of MICEX under the ticker 'HALS' on October 9, 2006 and in
the 'V' list of the Moscow Stock Exchange on October 17, 2006.

Currently, Sistema(cid:2)Hals has 9,813,084 ordinary shares. As of
December 31, 2006, Sistema owned 80% of the ordinary shares of
Sistema(cid:2)Hals and 20% were in free(cid:2)float.

The company's shares were sold at an offer price of US$10.7 per GDR
and reached a high of US$13.5 on December 20, 2006, before clos(cid:2)
ing at US$13.3 on the last day of trading of the year. As at December
31, 2006, the company's market capitalization was US$2.61.

Sistema(cid:2)Hals (cid:2) GDR Closing Price on LSE

ANNUAL REPORT / 2006 New shoots of growth

Social Responsibility

The social responsibility of a large corporation today is a reflection
of the complex network of relationships within a modern market
economy. A critical component of responsibility is the nature of the
business the corporation conducts and the contribution of its prod(cid:2)
ucts and services to the economy as a whole. The relationship
between a company and the community where it operates, is
reflected by how it deals with its employees, its support for the local
educational and scientific institutions, that train its future workers
and management of the environmental impact of its activities. A
socially responsible corporation also fosters a dialog with its many
stakeholders, including government, consumers, workers, regula(cid:2)
tors, business partners and investors so it can address any possible
concerns about the impact of its activities.

Sistema sees its primary social contribution as its business itself and
this is incorporated in the vision and strategy of the corporation. Its
social activities are integral parts of its mission as a company. By
building service(cid:2)oriented, high(cid:2)technology businesses, the corpora(cid:2)
tion is fostering the creation of an innovation economy in Russia
and helping to diversify the economy to compete in the global
economy. These services are helping to build a better quality of life
in the future, tying individuals and businesses together through bet(cid:2)
ter communications, building modern housing, offices and infra(cid:2)
structure and offering financial services, that allow consumers to
buy their first house or a new car.

The corporation has played an important role in the growth of cap(cid:2)
ital markets in Russia and the inflow of investment into Russia in
recent years. The IPOs of Sistema and its operating companies
Comstar, Sistema(cid:2)Hals and Sitronics have injected capital into key,
value(cid:2)creating parts of the economy and increased the overall
investment attractiveness of the Russian market as a whole. A size(cid:2)
able proportion of this investment has been directed at developing
emerging sectors of the economy, creating better paying jobs and
developing services, that were absent just a few years ago. Sistema's
development of venture(cid:2)capital funds in partnership with the
Russian federal government and regional administrations is also
helping to foster new sources of capital for new firms, helping the
government meet its declared strategy of developing high techno(cid:2)
logy as a national priority.

Sistema continues to work to build a more comprehensive social
dialog with consumers, regulators and federal and local govern(cid:2)
ment officials in the markets where it operates. One aspect of this
process is the corporation's established policy of information
openness. Sistema aims to disclose all material information about
its business activities as quickly as possible through all distribution
channels. If something adverse or unexpected happens, the com(cid:2)
pany believes it is not only its obligation but to its benefit to share
this information. Trust is critical to sustaining its many relation(cid:2)
ships in society.

Constructive dialog is also conducted through the business and
social organizations the corporation and its directors belong to and
through the media. In July and August of 2006, the corporation con(cid:2)
ducted a perception study of stakeholders from government, the
media, the Russian investment community, employees at local affil(cid:2)
iates and business and non(cid:2)profit partners. The results allowed the
corporation to see what it is doing right and what it can still do to
foster dialog and to see how others view it today. Ultimately, the
question before the corporation is: what information do stakehold(cid:2)
ers need from us and what are their concerns?

As a high(cid:2)technology, consumer(cid:2)sector company, the quality and
motivation of its more than 90,000 employees and managers is of
vital importance and human capital is Sistema's most important
resource. The corporation prides itself on a culture of teamwork and
shared priorities. Motivation of personnel includes not only wages
and bonuses but also the prospect of advancement and a sense of
security about their future and that of their families.

Sistema was one of the first companies in Russia to develop its own
Corporate University. This and other extended education and train(cid:2)
ing programs provide workers with the opportunity to enhance
their qualifications and move into new fields. Sistema has estab(cid:2)
lished programs with a range of leading Russian universities and
research institutes for training its employees, while also financing
the creation and expansion of faculties and programs in various
technical fields. Yearly performance reviews for workers and sup(cid:2)
port in career planning allow employees to set goals for their devel(cid:2)
opment at Sistema, while knowing just what is expected of them.

ANNUAL REPORT / 2006 Social Responsibility

In its charitable activities, Sistema applies the same strict criteria as it
does for any other aspect of its business: its social programs should
provide real and verifiable results that in turn improve society. The
Sistema Charitable Fund is focused on supporting the development
of science and education, preserving Russia's cultural and artistic
heritage for future generations, promoting sport and aiding the
development of local communities. All of these activities share the
common goal of creating a more vibrant and educated society.

When selecting projects to support, Sistema looks for those that
have a unique and innovative character. One characteristic project
sponsored by the corporation is the creation of regional informa(cid:2)
tion and educational centers called 'The Virtual World of the Russian
Museum'. Thanks to the latest technology developed for the project,
millions of Russians across the country are able to make virtual vis(cid:2)
its to the collection of the Russian State Museum. The corporation's
projects range from the creation of three(cid:2)level support for profes(cid:2)
sional training, the founding of departments in universities and
technical institutes, to organizing youth hockey and rugby tourna(cid:2)
ments and supporting Russian Olympians. The link between these
programs is that they promote education, healthy lifestyles and
achievement.

Sistema has adopted internationally recognized principles of sus(cid:2)
tainable development and corporate social responsibility and inte(cid:2)
grates them into its business practices. The corporation became one
of the first companies in Russia to sign the Global Compact of the
United Nations (UN(cid:2)GC) in 2002. In 2003, Sistema joined the World
Business Council for Sustainable Development (WBCSD). As with
other WBCSD members, the corporation has committed itself to
maintain a high level of transparency and responsibility in all
aspects of its business.

ANNUAL REPORT / 2006 New shoots of growth

A Reliable
Foundation
Businesses

ANNUAL REPORT / 2006 New shoots of growth

Sistema Telecom
is Russia's largest
telecommunications
company, servicing
around 80 million
subscribers.
The company includes
more than 50
telecommunications
operators working in
all of the main
segments of the
telecommunications
market.

A Reliable Foundation
Telecommunications

Sergey
Schebetov

CEO,
Sistema Telecom

ANNUAL REPORT / 2006 A Reliable Foundation Telecommunications

Marketplace

Business

The market for telecommunications services continues to be one of
the most dynamic and competitive sectors in Russia and the CIS today.
The sector's significant growth potential is apparent in all key sectors
of the telecommunications business. According to preliminary data
from the Russian Ministry of Information Technologies and
Telecommunications, the total volume of the Russian telecommu(cid:2)
nications market grew 21% year(cid:2)on(cid:2)year in 2006 to over $27.5 billion.

In 2006, both wireless and fixed(cid:2)line segments saw strong growth,
although the mobile segment saw a far higher degree of market
saturation and consolidation around three major wireless players.
Mobile telephony penetration reached 104.6% at the end of 2006,
representing an increase of 18% compared to 2005. Russia had
151.9 million mobile telephony subscribers, an increase of 26.2
million.

Fixed(cid:2)line services for both residential and corporate subscribers,
including voice, data(cid:2)exchange and Internet broadband are
developing dynamically, although there is still considerable
unmet demand for services. Fixed(cid:2)line penetration for Russia as a
whole was 57.2% of total households in 2006. Moscow's broad(cid:2)
band penetration rate, measured by numbers of households, was
26% at the end of 2006. However, broadband penetration for
Russia as a whole was around 4.5%, compared to other Central
and Eastern European markets such as Hungary (11.4%) and
Poland (10.6%). Excluding Moscow, this rate was around 2.0% at
the end of 2006.

The level of competition in the Russian telecommunications market
is increasing rapidly. The provision of value(cid:2)added services for both
fixed(cid:2)line and wireless subscribers is key to both increasing margins
and building customer loyalty. Recent regulatory changes in the
Russian telecommunications sector have also had an impact on the
competitive landscape. Tariff regulations for interconnect and traf(cid:2)
fic exchange came into effect in October 2005. The principle of
Calling Party Pays (CPP) was introduced from July 2006.

Outside of Russia, markets in the CIS countries offer significant long(cid:2)
term growth potential. These former Soviet republics have seen
rapid economic growth, high rates of consumer spending and con(cid:2)
tinuing, low rates of penetration of telephony services relative to
Russia and Central and Eastern European peers. In addition, a num(cid:2)
ber of markets in Central and Eastern Europe offer strong growth
potential in particular segments, such as broadband Internet, and
provide low(cid:2)cost base for technology development.

Telecommunications represents a core, long(cid:2)term business for
Sistema. Sistema Telecom is managing the companies in the
Telecommunications business unit. Sistema Telecom is developing
businesses along two key lines, wireless and fixed(cid:2)line communica(cid:2)
tions. At the same time, it is building convergent services acros
wireless and fixed(cid:2)line. Sistema Telecom is delivering value(cid:2)added
services such as Internet banking employing synergies with other
business areas at Sistema.

Wireless Communications

Mobile TeleSystems (MTS) operating in the wireless communica(cid:2)
tions market is Sistema's largest asset and the leading cellular opera(cid:2)
tor in Eastern Europe. MTS is one of the top(cid:2)10 mobile companies in
the world in terms of subscriber numbers. The company is the leader
in Russia's highly competitive mobile telephony market, with a mar(cid:2)
ket share of 33.7%. MTS is also one of the market leaders in Ukraine,
through its subsidiary UMS and a leading player in the emerging
mobile markets of Belarus, Turkmenistan and Uzbekistan. As of
December 31, 2006, MTS had 73 million subscribers in Russia and
the CIS. 2

Sistema is MTS's largest shareholder, with 53.1% of its shares. The
company has been listed on the New York Stock Exchange since
2001 and 46.4% of its shares are in free float. A further 0.5% belongs
to other investors.

Fixed Line

Comstar(cid:2)United TeleSystems (Comstar) is an integrated holding
under Sistema Telecom's management that encompasses all fixed(cid:2)
line businesses of Sistema, including the leading incumbent and
alternative fixed(cid:2)line operators in Moscow and growing regional
and international alternative fixed(cid:2)line services. It operates under
three umbrella brands, Comstar (alternative fixed(cid:2)line), MGTS
(Moscow's incumbent fixed(cid:2)line provider) and Stream (broadband
Internet and content).

In addition, the holding is a leading provider of residential and busi(cid:2)
ness Internet broadband, data exchange and IPTV, Wi(cid:2)Fi and hybrid
fixed(cid:2)line and mobile technology solutions in Russia.

At the end of 2006, Comstar had over four million fixed(cid:2)line

ANNUAL REPORT / 2006 New shoots of growth

subscribers and 359,895 broadband customers in Moscow and
Moscow Region. The Group's Comstar and MGTS stand(cid:2)alone net(cid:2)
works in Moscow provide unrivalled capacity and form the base for
a future New Generation Network.

In February 2006, Comstar conducted a successful IPO on the
London Stock Exchange and around 35% of its shares are in free(cid:2)
float. In addition, since December 2006, Comstar(cid:2)UTS has become a
25% plus one shareholder of Telecommunication Investment Joint
Stock Company (Svyazinvest).

Results

Consolidated revenues in the Telecommunications segment grew
27% to US$7.48 billion in 2006. Revenue growth outpaced the overall
rate of the telecommunications market for the sixth year in a row.
OIBDA increased 24% during the year, reaching US$3.62 billion.

Joint capitalization of companies under Sistema Telecom's manage(cid:2)
ment grew by nearly 50% to US$20 billion. At the same time, the
share of telecommunications revenues in the consolidated revenues
of the group stood at 69% in 2006, compared to 78% in 2005 and
80.5% in 2004. This reflects Sistema's long(cid:2)term strategy of reducing
the share of telecommunications in its overall revenues, while
ensuring the business area remains part of its solid foundation for
long(cid:2)term profit growth.

In May 2006, the corporation launched a common visual brand iden(cid:2)
tity for all of its operating subsidiaries in the telecommunications
businesses. The common umbrella brand identity shares the simple,
timeless form of an egg. For consumers and business partners, the
common look and feel of the brands conveys shared traits of reliabil(cid:2)
ity, innovation and a customer(cid:2)first approach across the Group. For
the companies themselves, the brand represents current and poten(cid:2)
tial synergies that can help each business achieve its goals.

During the year, the corporation purchased and later sold to a relat(cid:2)
ed party the first telecommunications asset outside of Russia and the
CIS (UK wholesale operator WaveCrest LLC) and signed an SPA with
Greek broadband Internet provider Hellas On(cid:2)Line. The acquisitions
underline Sistema's emergence as a truly global player in the sector
and provide additional exposure to growing markets. For example,
Greece had the lowest broadband penetration rate in Europe at
around 6% of households at the end of 2006, versus the Western
European average of around 36%.

MTS

MTS exceeded all market growth forecasts in 2006 and contributed
the majority of revenues in the Telecommunications segment.
Dynamic revenue and earnings growth, international expansion
and maintenance of market share, were accompanied by the
appointment of a new senior management team and adoption of a
new long(cid:2)term strategy aimed at maintaining and enhancing mar(cid:2)
ket share. Cost optimization across the company was a primary driv(cid:2)
er of bottom(cid:2)line growth.

According to the company's US GAAP audited results, MTS's consol(cid:2)
idated revenues increased by 27% year(cid:2)on(cid:2)year to US$6.38 billion,
compared to US$5.01 billion in 2005. Net income increased by 11%
to US$1.25 billion in 2006. For the first time in the company's histo(cid:2)
ry, MTS became free cash(cid:2)flow positive, with US$646 million. During
2006, the company made a record dividend payout of US$562 mil(cid:2)
lion for full(cid:2)year 2005.

In April 2006, MTS appointed Leonid Melamed as CEO and Vsevolod
Rozanov as a new CFO. Following these moves, the company adopt(cid:2)
ed a new '3+1' strategy aimed at maintaining and enhancing market
leadership, continuing growth and creating value. MTS is focused on
strengthening its Russian market leadership, establishing leadership
in CIS markets, building a base for selective acquisitions internation(cid:2)
ally and exploring additional opportunities for launching conver(cid:2)
gent services and pursuing vertical integration.

Comstar

Comstar achieved both impressive revenue and earnings growth,
while carrying out an IPO and major restructuring during 2006.
According to the company's US GAAP audited for the full year, con(cid:2)
solidated revenues increased by 23% to US1.12 billion, compared to
US$907.6 million in 2005. Underlying net income increased by 69%
year(cid:2)on(cid:2)year to US$178.1 million, compared to US$105.9 million in
2005.

After completing the first stage of restructuring and consolidation in
late 2005, Comstar undertook a successful IPO on the LSE in February
2006, raising US$1 billion for the further development of the compa(cid:2)
ny. During 2006, the company created an integrated Group headed by
a new corporate center with five operating subsidiaries: Comstar
Moscow, Moscow City Telephone Network (MGTS), Comstar Direct,
Comstar Regions and Comstar International.

ANNUAL REPORT / 2006 A Reliable Foundation Telecommunications

During 2006, Comstar retained its leadership in the Moscow broad(cid:2)
band market with a 38.4% share at the end of 2006. The total num(cid:2)
ber of broadband subscribers in Moscow was increased by 44% to
359,895 customers during the year. Stream accounted for 18.1% of
the Pay(cid:2)TV market in Moscow at the end of 2006 in terms of sub(cid:2)
scriber numbers, compared to just 2.1% the previous year. The 'dou(cid:2)
ble play' subscriber base in Moscow grew twelve(cid:2)fold over the pe(cid:2)
riod, reaching 83,328 customers. MGTS further enlarged its sub(cid:2)
scriber base, reaching a total 3.6 million residential subscribers in
Moscow. In addition, Comstar added 1,180 corporate subscribers
through acquisitions in Ukraine and Armenia.

In addition to strengthening its position in Moscow and other
regions of Russia through new product launches and selective
acquisitions, such as Moscow Region alternative operator Astelit,
Comstar expanded into the Ukrainian market. In the fourth quarter
of 2006, Comstar acquired Kiev(cid:2)based fixed(cid:2)line carriers DG Tel and
Technologic Systems. In December, Comstar purchased alternative
carriers CallNet and Cornet in Armenia. The signing of an SPA with
Hellas On(cid:2)Line during the same month provided Comstar with an
opportunity to develop its first operations outside of the CIS.

In late July, Eric Franke was appointed CEO of Comstar bringing
some 20 years of experience in international telecommunications
and 10 years in senior positions in Russia and the CIS to the job. In
addition, a new executive team was put in place, including
Alexander Gorbunov, VP for Strategy and Development, Nikolay
Tokarev, CFO and Wolfgang Broeuer as CTO.

The acquisition of the blocking stake in Svyazinvest by Comstar in
December 2006 was in line with Sistema and Comstar's declared
strategy of participating in the development of Russia's incumbent
fixed(cid:2)line telecommunications sector. In the short term, Sistema
and Comstar will seek to work with Svyazinvest's management and
other investors to grow the value of the company and make its
structure both more transparent and efficient. Looking forward, the
Group has the potential to help Svyazinvest exploit synergies with(cid:2)
in the holding and develop new products. In the longer term,
Sistema and Comstar aim to play a role in any potential future priva(cid:2)
tization or other transaction involving the holding.

1 Source: Comstar, Direct Info, by number of households
2 Source: Sistema Telecom handbook
3 Source: Direct Info, 4Q2006, including individuals, who connect to the Internet

through Comstar Direct channels, by number of subscribers

ANNUAL REPORT / 2006 New shoots of growth

Sitronics
is a leading Eastern
European high
technology company.
The IPO of Sitronics
was the second
largest ever
placement by
a technology
company in the
history of the
London Stock
Exchange.

A Reliable Foundation
Technology

Evgeny
Utkin

President,
Sitronics

ANNUAL REPORT / 2006 A Reliable Foundation Technology

Marketplace

Sistema's Technology business is represented by Sitronics, which oper(cid:2)
ates in fast(cid:2)growing markets for telecommunications solutions,
including software, equipment and systems integration, IT solutions
and microelectronic solutions. During 2006, this business area con(cid:2)
tinued to see dynamic growth, while key market segments continued
to show long(cid:2)term growth potential in the company's key markets:
Russia, the CIS, Central and Eastern Europe, the Middle East and Africa.

Telecommunications Solutions

According to data from market research group IDC, the total market
for telecommunications equipment of the type produced by
Sitronics in Russia, the CIS and Central and Eastern Europe was
worth approximately US$4.6 billion in 2005. The market in Russia
alone was estimated at US$1.9 billion. This total includes estimated
expenditure on new generation fixed(cid:2)line networks (NGNs) of
US$85 million, time(cid:2)division multiplexers (TDM) of around US$422
million, broadband access of around US$25 million and products,
programming support and services for WiMAX networks of around
US$25 million.

IDC forecasts indicate that overall demand for equipment in
Sitronics's key international markets will grow by 5.8%. A significant
part of this growth is attributable to the Middle East and Africa, where
growth in 2006 was expected to have reached 39.6% and in the CIS,
including Russia and Ukraine, where growth of 30.3% was forecast.

The demand for equipment for telecommunications infrastructure
in the markets where Sitronics operates is driven by relatively low
levels of mobile penetration compared to developed markets and
often poor quality of fixed(cid:2)line infrastructure. According to the
International Telecommunications Union (ITU), mobile penetra(cid:2)
tion in Russia in 2005 was 83.6% compared to 37% in Ukraine. In
2006, this level reached 104.6% in Russia and 79.3% in Ukraine1.
Operators are investing in new equipment and services to provide
multimedia and other value(cid:2)added content, with the prospect of
launching third(cid:2)generation (3(cid:2)G) services as governments make
licenses for these frequencies available. Investment in WiMAX and
other alternative wireless and convergent technologies allow oper(cid:2)
ators to provide corporate clients with services that circumvent
poor fixed(cid:2)line infrastructure.

Low(cid:2)levels of fixed(cid:2)line penetration have driven substantial invest(cid:2)
ment by alternative operators in infrastructure for commercial and

residential customers. More recently, restructuring of fixed(cid:2)line
incumbent operators has fuelled demand for technology to upgrade
existing networks. According to ITU, at the end of 2005, fixed(cid:2)line
penetration in Russia stood at 27.9% and in Ukraine at 25.8%. Fixed(cid:2)
line penetration in Russia reached 57.2% of households in 2006.
Increasing demand for broadband Internet services, including IP
telephony and gaming, is also driving investment in technology.
Broadband penetration rates in Central and Eastern Europe and the
CIS trail levels in Western Europe and North America. As of June
2006, broadband penetration in the US was 17% and in Western
Europe 19.3%, compared to 2% in Russia, 0.1% in Ukraine, 2.8% in
Greece and 7.5% in Czech Republic2.

Information Technology

IDC forecasts indicate the global market for IT equipment, pro(cid:2)
gramming and services was worth US$1.17 trillion in 2006 and will
grow at an average annual rate of 6.0% through 2010. Growth in the
global market for equipment was forecast at 7.6% in 2006, in pro(cid:2)
gramming at 7.8% and in services by 5.9%. The IT market in Central
and Eastern Europe was forecast to have reached a total value of
US$35.9 billion in 2006. In Russia, the analogous figure was 14.3 bil(cid:2)
lion. Purchases of equipment has been the main driver of the IT sec(cid:2)
tor in these countries in recent years, although services, such as sys(cid:2)
tems integration, are forecast to grow at the fastest rate, at 17.2% per
annum through 2010 in Central and Eastern Europe, versus 13.6%
for the market as a whole. In Russia, the rates are forecast at 24.7%
compared to 17.8% accordingly.

Microelectronic Components

According to research group Gartner, the global market for semi(cid:2)
conductors grew from US$155.6 billion in 2002 to US$235 billion in
2005. The market is predicted to grow by an average annual growth
rate of 6.4% between 2005 and 20103, reaching a value of US$321
billion. In Russia, the market for semi(cid:2)conductors doubled from
US$400 million in 2002 to US$800 million in 2005 and is forecast to
grow by an annual rate of 25.4% between 2006 and 20103. The
largest consumers of microelectronic components in the Russian
market are producers of industrial electronics, communications
equipment makers and the defense industry.

ANNUAL REPORT / 2006 New shoots of growth

Business

Sitronics is a leading provider of telecommunication solutions,
including software, equipment and systems integration, IT solutions
and microelectronic solutions in Russia and the CIS with a strong
presence in Central Europe. It is majority owned by Sistema.

With the recent acquisition of Intracom Telecom in Greece,
Sitronics has a strong presence in Eastern Europe and a growing
presence in the Middle East and Africa. The company is particularly
well(cid:2)positioned to exploit fast(cid:2)growing markets in CIS, Eastern
Europe, Middle East and Africa ('EEMEA') as well as Central and
Eastern Europe ('CEE').

Sitronics serves over 3,500 clients, maintains offices in 29 countries
and exports its products and services to more than 60 countries. The
company has over 10,000 employees, with around 4,600 involved in
research and development.

The company's key Telecommunication Solutions operations are
based in Prague, Czech Republic and Athens, Greece, while the com(cid:2)
pany's IT Solutions and Microelectronic Solutions divisions are
based in Kiev, Ukraine and Zelenograd, Russia, respectively.

Sitronics has developed strategic alliances in its home markets with
Cisco Systems, STMicroelectronics, Infineon and Giesecke &
Devrient for certain products and services. The company also has
vendor relationships with Siemens, Ericsson, Motorola, ORACLE,
Intel, Sun Microsystems and Microsoft. Key customers include
Sistema group companies, such as MTS, Comstar UTS and MTT, as
well as OTE, Cosmote, Vodafone, Ericsson, Arcelor Mittal (formerly
Mittal Steel), Banca Intesa and TCL.

The IPO of Sitronics on the LSE valued the company at US$2.3 bil(cid:2)
lion, underlining the company's emergence as the leading high(cid:2)
technology company in the CIS and Central and Eastern Europe,
with a growing presence in the fast(cid:2)growing markets of the Middle
East and Africa. The company's strategy continues to seek organic
growth while pursuing carefully selected mergers and acquisitions
to enhance both its geographical reach and research and develop(cid:2)
ment and production capabilities.

As part of its long(cid:2)term strategy, Sitronics has focused on key tech(cid:2)
nology segments: telecommunications solutions, IT solutions and
microelectronics solutions. In addition, the company also has a con(cid:2)
sumer electronics business and provides contract production of
electronics (EMS).

Sitronics is developing its telecommunications solutions business
on the base of two key operating companies, Strom Telecom, based
in Czech Republic and Intracom Telecom, based in Greece and

acquired in 2006. These units develop and produce equipment, pro(cid:2)
vide programming solutions and support and provide systems inte(cid:2)
gration services.

The IT solutions business is driven by Ukrainian group Kvazar(cid:2)Micro.
Kvazar(cid:2)Micro has operations in several Central and Eastern
European countries and is a key platform for further developing the
company's higher margin systems integration and consulting busi(cid:2)
ness in Russia, the CIS and internationally.

The microelectronic solutions unit of Sitronics is based in Russia's
long(cid:2)established electronics research and production center of
Zelenograd around the NIIME and Mikron enterprises. In addition,
the company has the VZPP(cid:2)Mikron production plant in Voronezh.
Microelectronic Solutions is focused on design and production of
integrated circuits and smart cards for both private sector and state(cid:2)
run enterprises in the aerospace, defense, consumer and other
industries in Russia and internationally. In July 2006, Sitronics
microelectronic solution started the project for modernization of
production facilities with the introduction of 0.18 micron E2PROM
technology, representing an unparalleled technological break(cid:2)
through for Russia.

Results

During 2006, the High Technology segment was again one of
Sistema's fastest growing business areas. Revenues grew 67% year(cid:2)
on(cid:2)year to US$1.61 billion in 2006, compared to US$961.1 million in
2005. OIBDA increased 11% to reach US$172.2 million.

Ahead of the company's successful IPO on the LSE in February 2007
saw the company raise US$402 million, Sitronics undertook a num(cid:2)
ber of key steps to improve its corporate governance and increase its
efficiency. The company appointed independent directors to its
board and continued to buy(cid:2)out minority shareholders in its operat(cid:2)
ing subsidiaries, including the purchase of the remaining 3.2% of
Micron's shares, bringing its ownership to 100%.

The European Bank for Reconstruction and Development (EBRD)
acquired 3.7% of Sitronics shares ahead of the IPO, providing addi(cid:2)
tional funding and expertise for the company. Earlier in the year, the
company placed a US$200 million Eurobond issue at 7.875%, one of
the lowest bond interest rates achieved by a Russian corporate
issuer.

In February 2006, Sitronics significantly strengthened its telecom(cid:2)
munications solutions business and expanded its geographic reach

ANNUAL REPORT / 2006 A Reliable Foundation Technology

with the acquisition of Greek technology company Intracom
Telecom. The deal made Sitronics the leading high(cid:2)technology solu(cid:2)
tions provider in Central and Eastern Europe. The important role
played by the company in developing Russia's technological poten(cid:2)
tial was underlined by a visit and meeting held by Russian President
Vladimir Putin at Zelenograd in October 2006.

Sitronics emergence as the leading technology business in the
region was underlined by the company's selection as CISCO's only
global partner in Eastern Europe. The company also began con(cid:2)
struction of a 'turn(cid:2)key' telecommunications network for ITC in
Saudi Arabia.

Sitronics also began implementation of billing systems for Vodafone
in Czech Republic as well as billing projects in Serbia and Pakistan,
underlining its truly international scope.

During 2006, the company invested in modernization and expan(cid:2)
sion of its infrastructure, opening a new plant in Votitsa. As part of a
wider upgrade at its Zelenograd facilities, the company implement(cid:2)
ed an unprecedented project to modernize its micro(cid:2)electronics
production from 0.80 to 0.13 micron technology. In addition, a new
centralized research and development facility was opened and a
project developed to create a unified scientific and experimental
facility at Zelenograd. The company's R&D expertise led to the
award of a grant by the Russian state NIOKR program.

In order to strengthen its added(cid:2)value offerings, it also launched
production of smart cards, including SIM cards and RFID technolo(cid:2)

gy as well as chip modules. New product launches were made possi(cid:2)
ble by the acquisition of Intracom Telecom, including networks for
providing IPTV content, fixed(cid:2)line and wireless access. Key pilot
projects for NGN networks were also completed during the year.

Sitronics also invested in human resources, providing incentives for
senior managers and training for its employees. In March 2006,
Sistema transferred shares equivalent to 14.72% of Sitronics issued
share capital to Sitronics managers as part of a share option and
incentive scheme. Some 1,300 employees completed internships
and work experience programs during the year.

1 Ukraine data for 2006 from Business Monitor Int'l, based on operator

data excluding inactive subscribers.

2 Data from Analysis Research
3 Russian data from Electronica Publishing House

ANNUAL REPORT / 2006 New shoots of growth

Sistema(cid:2)Hals is one
of the key players
in the Russian market
for construction and
real estate. The IPO
of Sistema(cid:2)Hals was
the first placement
of a Russian
development
company in the
Western capital
markets.

A Reliable Foundation
Real Estate

Felix
Evtushenkov

President,
Sistema(cid:2)Hals

ANNUAL REPORT / 2006 A Reliable Foundation Real Estate

Marketplace

Sistema(cid:2)Hals is Sistema's main operating subsidiary in the Property
business area. Russia's real estate market is booming, based on conti(cid:2)
nued strong demand for commercial property not only in Moscow
but in an increasing number of Russian regional cities.

Sistema has been present in Russia's construction and property sec(cid:2)
tor since the mid(cid:2)1990s and the business area represents one of its
longest(cid:2)term investments. In recent years, this commitment has
paid off. Along with favorable macroeconomic conditions, changes
in the legal environment for development and property ownership
over recent years have helped foster one of the most dynamic prop(cid:2)
erty marketplaces in the world.

Russian and international companies have expanded their presence
in the country and require world(cid:2)class office space. An emerging
middle class is investing money in modern housing with modern
infrastructure and the rapid recent expansion of the mortgage lend(cid:2)
ing market is fuelling further demand. Another key area is the de(cid:2)
velopment of new hotels, particularly three star hotels for tourists
and four and five(cid:2)star hotels for business travelers in Moscow and
other large cities. The closure or long(cid:2)term renovation of a number
of hotels built in the Soviet era, including the massive Rossiya hotel
complex in central Moscow has sharply reduced capacity even as
demand is growing.

In late 2006, some 1.38 million square meters of Class A office space
had been completed or was in the pipeline in Moscow1. According
to real estate group Cushman & Wakefield Stiles & Riabokobylko
(C&WS&R), the amount of Class A and B office space in Moscow
alone is due to double over the 2007 to 2008 period but this is still
insufficient to meet expected demand. In terms of prime office
stock, total retail stock and number of international grade hotel
rooms per capita, Moscow continues to lag Central and Eastern
peers by a wide margin, suggesting continued upside potential.
Vacancy rates for Class A and B offices were 1.2% and 3.5% respec(cid:2)
tively, according real estate consultant Colliers, the lowest levels in
six years. These levels are predicted to drop even further in 2007.

Russia's ongoing 'retail revolution', characterized by rising con(cid:2)
sumer disposable incomes and spending, and a shift toward mod(cid:2)
ern retail chains, saw 11 retail complexes with 377,900 square
meters of trading space opened in 2006 in Moscow alone. This re(cid:2)
presented a 30% increase in retail capacity in a single year2.
International and Russian retailers expanded rapidly outside of
Moscow as well, with large players such as cash and carry player

Metro and supermarket group X(cid:2)5 retail expanding in emerging
regional markets such as the Urals and Siberia. Outside of Russia,
booming economies in the CIS and years of limited investment in
modern residential and commercial property has created substan(cid:2)
tial unmet demand.

Business

Sistema(cid:2)Hals is a major diversified company operating in the real
estate markets of Russia and the CIS. The company provides inte(cid:2)
grated, high(cid:2)quality services directed in four key strategic business(cid:2)
es: real estate development, project and construction management,
asset management, and facility management. In providing develop(cid:2)
ment services, Sistema(cid:2)Hals sees through the entire life(cid:2)cycle of a
property through a carefully defined system, from the initial design
through to its management.

As part of asset restructuring during 2005 and 2006, the corpora(cid:2)
tion's real estate portfolio was transferred to Sistema(cid:2)Hals, which
had previously operated as a developer of commercial property.
Now operating as the legal owner of the corporation's property
portfolio as well as a project management company, Sistema(cid:2)Hals
has considerably increased its capitalization and attracted finance
for development through a successful IPO on the LSE in November
2006. Today, the company aims to become the largest real estate
developer and a leading real(cid:2)estate asset portfolio manager in Russia
and the CIS.

Since its founding in 1994, Sistema(cid:2)Hals has completed more than
30 projects with a combined area of more than 250,000 square
meters, including such landmark buildings as the Russian headquar(cid:2)
ters of DaimlerChrysler, the Hals Tower office complex, the head(cid:2)
quarters of TMK and the MaMaison hotel chain for the ORCO
Property Group, among others. One of company's key competitive
advantages in the Russian and CIS real(cid:2)estate sector is the ability to
manage projects in practically every market segment. Sistema(cid:2)Hals
has built up a broad and well(cid:2)balanced portfolio of assets in grow(cid:2)
ing segments of the Russian real estate market. The company focus(cid:2)
es on the construction of Class A and B offices, mixed(cid:2)use complex(cid:2)
es, business(cid:2)class residential housing, single(cid:2)family homes, and land
developments.

Today, Sistema(cid:2)Hals is building the Lenigradsky Towers complex,
consisting of two buildings including the future headquarters of
Siemens in Moscow and valued at US$159.3 million as of 1 January
2007. In addition, the company is managing the long(cid:2)term project

ANNUAL REPORT / 2006 New shoots of growth

of redeveloping buildings owned by Comstar(cid:2)UTS subsidiary MGTS
made redundant by modern technology. Other projects include the
renovation of the landmark Pekin hotel in central Moscow and a
range of other projects.

In October 2006, Sistema(cid:2)Hals had the highest market share of any sin(cid:2)
gle company engaged in Class A office development in Moscow, at
9.5%. This figure includes completed projects, projects under construc(cid:2)
tion and announced projects3. In the beginning of 2007, Sistema(cid:2)Hals
was present in seven regions in Russia and Ukraine with a number of
additional regional cities earmarked for future expansion.

Results

The Real Estate business unit reported 261% revenue growth in
2006, reaching US$282.9 million, compared to US$78.4 million in
2005. OIBDA increased by 645% to US$93.1 million. The real estate
development division remained one of the primary growth drivers
in the business area and accounted for 72% of total revenues in
2006, compared to 52% in 2005.

Primary contributors to this growth were the sale of the Pokrovka 40
development project, a mixed(cid:2)use Class A office and hotel complex
in central Moscow for US$84.4 million and the sale of the
Yartsevskaya 27 residential project in Moscow for US$20.3 million.
The Pokrovka 40 project saw a selling price of office space of
US$4,828 per square meter. Other key projects completed during the
year include a residential housing complex at 15 Elninskaya Street
with 178 apartments ranging from 55 to 250 square meters in area.

Sistema Hals's project construction management division con(cid:2)
tributed a US$19 million increase in revenues while, asset manage(cid:2)
ment revenues increased 80% year(cid:2)on(cid:2)year in 2006 to US$27 mil(cid:2)
lion, due to increasing resale of housing as part of the asset restruc(cid:2)
turing program and an increase in rental revenues from single(cid:2)fam(cid:2)
ily housing. Average rental rates increased 39.8% year(cid:2)on(cid:2)year
reflecting the continued strength of the market.

The IPO of Sistema(cid:2)Hals on the London Stock Exchange in early
November 2006 raised US$409 million in the first such internation(cid:2)
al listing by a Russian property developer. The offering was more
than five(cid:2)times oversubscribed. Following the IPO, 20% of the com(cid:2)
pany's shares were in free(cid:2)float. With the transaction, Sistema Hals
achieved the highest(cid:2)ever valuation for a Central and Eastern
European real(cid:2)estate company at time of IPO. Around 70 to 80% of
the proceeds from the transaction were earmarked for investment

in existing development projects with remainder set aside for pos(cid:2)
sible future mergers and acquisitions and other corporate goals.

In March 2007, the corporation announced the results of an inde(cid:2)
pendent valuation of its real estate property and projects. According
to the valuation carried out by C&WS&R, the value of the Sistema(cid:2)
Hals stake in property and projects increased by 35% over the pe(cid:2)
riod from June 30, 2006 to January 1, 2007. C&WS&R has deter(cid:2)
mined that on January 1, 2007, the aggregate market value of each
100% stake in the 88 projects and properties amounted to
US$2,546,825,000, of which the stake of Sistema(cid:2)Hals (less the
minority interests) amounted to US$2,039,536,454.

Geographic and portfolio diversification remains a continued focus.
In March 2007, Sistema(cid:2)Hals acquired a 67.58% stake in the Kamelia
Health Spa OJSC which holds a long(cid:2)term (49(cid:2)year) lease for a 6.3
hectare plot of land at 89 Kurortny Prospekt, in the Khostinsky dis(cid:2)
trict in the town of Sochi. The buildings of the Kamelia and Intourist
hotels are located on this land. Sistema(cid:2)Hals is planning to build a
60,600 square metre multi(cid:2)use complex on this land, to include a 4(cid:2)
or 5(cid:2)star hotel and an elite club(cid:2)style apartment complex as well as
internal infrastructure facilities.

The shopping and entertainment complex Detsky Mir in Kazan is due
to open during the third quarter of 2007. Another key retail project
entering early 2008 is the Hals Mart/Leto project under construction
in St Petersburg, which will have a floor space exceeding 100,000
square metres. When construction is complete, Sistema(cid:2)Hals plans to
keep the project in its asset portfolio to earn income from rental of
retail space. The main anchor tenants will be a major hypermarket
chain operator, a modern multiplex cinema, and major electronics,
sports goods, computer and domestic appliance retailers.

Another key project due for completion in 2007 is the Aurora resi(cid:2)
dential development with an estimated value of around US$48.4
million and located in Stepan’kovo in Moscow Region. The total
property comprises more than 90 hectares divided into 132 sepa(cid:2)
rate plots as well as a riverside plot held for development of a yacht
club. In addition, Sistema(cid:2)Hals acts as construction manager and
technical supervisor for the city of Moscow's US$1.3 billion
Krasnopresensky Prospect infrastructure project aimed at connect(cid:2)
ing central Moscow to the MKAD orbital highway.

1 Source: Cushman&Wakefield Stiles&Riabokobilko
2 Source: Colliers International
3 Source: www.developery.ru

ANNUAL REPORT / 2006 A Reliable Foundation Real Estate

ANNUAL REPORT / 2006 New shoots of growth

High Potential
Businesses

ANNUAL REPORT / 2006 New shoots of growth

Detsky Mir
is the largest retail
network of children's
superstores in Russia.
68 stores work
under this
trademark in 33
Russian cities.

High Potential
Retail

Maxim
Entyakov

CEO,
Detsky Mir Center

ANNUAL REPORT / 2006 High potential Retail

Marketplace

Business

Sistema's retail business is operated through the Detsky Mir group
and it owns the leading retailer of children's goods in Russia operat(cid:2)
ing under the same name. Detsky Mir, which means Children's
World, is one of Russia's oldest, most recognized and most trusted
retail brands with a 50 year history and an iconic flagship store in
central Moscow on Lubyanka Square.

The market for children's products represents a key long(cid:2)term
growth opportunity for Sistema. Russia's continued economic
growth and stability has driven increases in real disposable incomes
across the country while encouraging Russians to have more chil(cid:2)
dren after more than a decade of falling birthrates. Recent initiatives
by the Russian government now provide increased monetary and
social support for new parents.

In 2006, the Russian market for children's products was worth
around US$7 billion and is predicted to grow to US$8.4 billion in
2007. Russia's official statistics agency, Rosstat, estimated that chil(cid:2)
dren accounted for more than 15% of the population of the country
in 2006. For example, investment bank Deutsche UFG calculates
that the Russian consumer sector as a whole will grow by an average
annual rate of 22% between 2006 and 2010.

At the same time, modern retail networks are rapidly emerging
across Russia, replacing traditional, poorly regulated outlets such
as open markets and kiosks. This tendency is being actively sup(cid:2)
ported by Russian federal and local authorities who seek to create
modern, reliable, high(cid:2)quality and safe channels to market for
consumers while increasing the tax base. For Russia as a whole,
modern retail formats accounted for around 20% of all consumer
spending in 2006 and in Moscow this figure reached 40%. Around
30 retailers operate in the children's good segment, although
most of these are relatively small with turnover under US$40 mil(cid:2)
lion in 2006.

Patterns of purchasing children's products are dictated by income
levels, with an emerging middle class spearheading consumption
and children themselves playing an ever increasing role in dictating
purchasing decisions. For wealthier parents, representing 20% to
25% of the population, time is at a premium. Parents seek a one(cid:2)stop
shopping experience offering high levels of service, comfort and the
availability of a wide choice of products from well(cid:2)known compa(cid:2)
nies. Consumers on more limited incomes represent 45% to 60% of
the population. They are price sensitive and their demand is limited
to a narrower range of necessary goods.

Sistema has been a shareholder in Detsky Mir since 1996 and runs
the retail business through Detsky Mir Center, a 100% owned sub(cid:2)
sidiary of the corporation. Since acquiring control of the group,
Sistema has spearheaded an aggressive expansion of the chain,
while securing stable revenue and earnings growth. In an environ(cid:2)
ment of increasing competition in the retail sector for children's
goods, Detsky Mir's key competitive advantages include a strong and
long(cid:2)established brand, a wide product offering (up to 150,000
products), high quality goods, attractive store locations and a high
level of customer service.

As of December 31, 2006, Detsky Mir operated 20 stores in Moscow
and the surrounding Moscow Region and 45 stores in the regions
with a total retail space of 108.6 thousand square meters. Detsky Mir
stores are located in convenient, high(cid:2)traffic locations such as shop(cid:2)
ping centers that are easily accessible by public transportation.

Detsky Mir also controls C(cid:2)Toys, a leading Russian importer and dis(cid:2)
tributor of toys that include some of the world's best(cid:2)known brands.
C(cid:2)Toys is the exclusive Russian distributor of such brands as Bratz,
Brio, Famosa, M&C, Gund, Lanard, Shelcore, Ja(cid:2)ru and Playmates
and an official distributor for Hasbro and Lemmi childrenswear.

The corporation's goal in the Retail business area is to maintain and
enhance its market leadership in the children's goods segment of
the retail market in Russia. The strategy of Detsky Mir is to expand its
presence in Russia's regions and enter CIS markets. The chain will
expand both in Moscow and other large Russian and CIS cities using
its strengthened retail formats. An aggressive expansion policy will
help the company benefit from consolidation in the currently high(cid:2)
ly fragmented retail marketplace. Currently the top(cid:2)three retail play(cid:2)
ers are accounting for only 10% of the total market. However, con(cid:2)
sumer preferences for the service, quality and convenience of mod(cid:2)
ern retail formats will drive rapid consolidation.

The primary target market for Detsky Mir is the emerging Russian
middle class and its product range focuses on the 0(cid:2)10 children's
and 10(cid:2)14 pre(cid:2)teen segments. At the same time, the company con(cid:2)
tinues to expand its product offerings and proposes the latest prod(cid:2)
ucts to its customers, while entering new categories, such as prod(cid:2)
ucts for nursing babies and expectant mothers. The company's pric(cid:2)
ing proposition offers consumers prices that compete with those of
department stores, hypermarkets and other 'universal retailers',
while its large store formats allow a wider selection of goods to com(cid:2)
pete successfully against specialist retailers.

In order to enhance margins, the retail business area began the
development of private label goods under its own trademarks. At
the same time, the company continued to strengthen its terms of
trade to reduce the price paid to suppliers and this enabled it to
increase gross margins to 35.6% in 2006, compared to 31.3% in 2005.
For shoppers, a 'one(cid:2)stop shop' was developed during the year that
aims to provide busy shoppers with a single place to buy everything
they need.

Restoration of the company's flagship store in central Moscow,
opened in 1957, began in 2006. The ambitious restoration will see
the store turned into a fully fledged shopping and entertainment
complex, with usable space increased from 22,000 square meters to
37,800 square meters. Some 150 other stores will share the complex
with Detsky Mir and it will include cinemas and play areas to pro(cid:2)
vide a complete experience for the entire family.

1 Defined as stores opened before December 31, 2005.

ANNUAL REPORT / 2006 New shoots of growth

Detsky Mir appeals to its target market by providing friendly and
convenient shopping environments that meet busy lifestyles. The
company undertook the modernization of its existing stores in
2005. The company had used Sistema's proven expertise in deliver(cid:2)
ing high levels of customer service to further improve service levels
in its stores and put in place a single call center and website
(www.detmir.ru) that allow consumers to easily find its products
and shops.

Results

The Retail business area, increased its revenues by 61% year(cid:2)on year
in 2006 to US$335.3 million in 2006, compared to US$208.0 million
2005. OIBDA increased 73% to US$20.9 million. Same(cid:2)store sales1 in
the business area increased by US$84.6 million to US$218.3 million
during the year. The combined retail space operated by the corpora(cid:2)
tion nearly doubled year(cid:2)on(cid:2)year to 108.6 thousand square meters
compared to 54.6 thousand square meters at the end of 2005.

As expected, profitability in the business area was impacted by the
costs of the expansion of the Detsky Mir retail network. At the end
of 2006, Detsky Mir had 65 stores in 27 regions in Russia, compared
to 36 stores in 14 regions at the end of 2005. As of the end of March
2007, the company had 68 stores. Regional expansion saw the share
of retail sales outside of Moscow grow to 33.1% of revenues in the
business area, compared to 24.5% in 2005. Also during the year,
Detsky Mir obtained a five(cid:2)year, US$20 million loan from
Gazprombank to accelerate the retailer's regional expansion.

The growth in retail network in 2006 is expected to spread and will
enable the company to continue to benefit from increased con(cid:2)
sumer purchasing power and will allow it to secure a sizeable foot(cid:2)
print in the prime segment of the retail market. С(cid:2)Toys, the corpora(cid:2)
tion's wholesaler of consumer goods, accounted for US$42.8 million
in revenues during the year.

In 2006 Detsky Mir group adopted a new strategy aimed at estab(cid:2)
lishing clear national leadership in the retail markets of Russia and
the CIS for children's products for the 0 to 14 age group. Due to
investments in modernization over the last few years, all of the
stores in chain now share unified retail formats, have centralized
marketing, stock planning and selection, purchasing, merchandis(cid:2)
ing, human resources and logistics activities. These factors ensure
common high levels of quality while allowing Detsky Mir to imple(cid:2)
ment its aggressive expansion policy while still focusing on reducing
costs and increasing synergies across the chain.

ANNUAL REPORT / 2006 High potential Retail

ANNUAL REPORT / 2006 New shoots of growth

MBRD is aggressively
developing in the fast(cid:2)
growing market for
retail banking services
in Russia. The purchase
of a controlling
shareholding in
Luxembourg(cid:2)based
East(cid:2)West United Bank
is the first step to trans(cid:2)
forming the Moscow
Bank for Reconstruction
and Development
into a fully fledged
banking group.

High Potential
Banking

Sergey
Zaitsev

Chairman of the
Management Board

ANNUAL REPORT / 2006 High potential Banking

Marketplace

Sistema's banking business, the Moscow Bank for Reconstruction
and Development (MBRD), has developed rapidly into one of
Russia's leading retail banking networks, having entered the sector
in 2004.

Overall, the Russian banking sector has benefited from Russia's
macroeconomic growth and implementation of key legislation in
recent years aimed at ensuring stability and encouraging the develop(cid:2)
ment of previously under(cid:2)developed areas, such as consumer loans.
The combined asset value of Russian banks grew by 44% in 2006,
reaching RUB14 trillion (US$516 billion). Bank assets grew from
45.1% of GDP in 2005 to 52.8% in 2006. Growth was fuelled by the
development of both corporate and retail banking. Legislation
enacted in 2005, including a deposit guarantee program for qualify(cid:2)
ing banks added stability to the sector. The law 'On Credit Histories'
also passed that year, driving the market for consumer credit and
spurring the development of the retail banking sector.

Deposits from individuals rose by 38% during the year from
RUB2.8 trillion (US$103 billion) to RUB3.8 trillion (US$140 bil(cid:2)
lion). Despite this rate of growth, the share of individual deposits
in the sector fell somewhat, from 28.3% in 2005 to 27% in 2006.
This was due to increased share of funds from commercial enter(cid:2)
prises and international loans, as well as the development of pri(cid:2)
vate pension and share funds as an alternative destination for con(cid:2)
sumer deposits.

Still, the Russian banking sector is in many ways under(cid:2)developed
and fragmented, with a large number of small banks and treasury
banks serving a single corporate client. The top 50 largest banks in
the country accounted for around 75% of assets in 2006. Notably,
the growth in banking capital has not kept pace with the growth in
assets. On one hand this is linked to organic profit growth in the sec(cid:2)
tor, with average return on equity for Russian banks at around 25%.
However, this is also indicative of the reluctance of many bank own(cid:2)
ers to direct significant funds to build the capitalization of their
banks. The result is that a number of large banks are approaching
the threshold of their minimal capital reserve requirements, con(cid:2)
straining further growth in the near term.

Despite these constraints, Russia's banking sector still demonstrates
considerable long(cid:2)term growth potential as measured against peers
in Central and Eastern Europe. While universal service banks have
long dominated the sector, more narrowly focused institutions, such
as mortgage lenders and consumer credit providers, have seen

strong recent growth as increasing consumer spending power, cou(cid:2)
pled with an enhanced ability to judge consumer creditworthiness,
lowered credit risks.

Business

Sistema's primary banking business is MBRD. In the past, the MBRD
acted primarily as an in(cid:2)house treasury function for Sistema. Today,
however, MBRD is a fully fledged bank, offering a full range of ser(cid:2)
vices to corporate and consumer clients. It has focused on retail
banking as its main avenue of development since 2004, when the
bank launched a retail banking business using a business model,
developed with the participation of international consulting firm
Deloitte & Touche CIS.

The bank has built a balanced consumer credit portfolio through the
expansion and improvement of its service offerings. At the beginning
of 2007, MBRD offered 16 mortgage programs and concluded an
agreement with the Russian Agency for Mortgage Housing Credit and
regional operators. The bank has been able to attract new customers
by repeatedly lowering its interest rates on credit, reducing ruble
rates by 3% and US dollar rates by 2.5%. MBRD was also able to reduce
the required upfront payment from 30% of cost of the property to
just 10% during 2006. The maximum credit amount was doubled to
RUB16.2 million or from US$200,000 to US$500,000. The number of
homebuilders accredited by the bank also increased and now covers
50% of builders operating in Moscow Region.

In the market for automobile loans, the bank concluded around 70
agreements with leading car dealers in Moscow and Moscow Region
during 2006, significantly expanding its potential consumer base.

MBRD offers another opportunity for Sistema to develop consumer
services across its business areas and to gain access to the more
than 65 million customers served by the corporation. The bank and
MTS have developed internet and mobile access for customers and
offers a range of banking services to existing clients in other busi(cid:2)
ness areas.

Results

MBRD demonstrated robust revenue growth of 114% year(cid:2)on(cid:2)year in
2006 to US$228.2 million from US$106.8 million in 2005 due to the
rapid growth in its retail business.

ANNUAL REPORT / 2006 New shoots of growth

OIBDA increased by 161% to US$37.2 million.

MBRD has been able to expand its consumer and corporate client
base by spreading its presence both in Moscow and in Russia's
regional markets. As of year end, MBRD's retail network included 16
sub(cid:2)branches and 50 mini(cid:2)branches in Moscow and 55 in Russia's
regions, a five(cid:2)fold expansion of the bank's branch network during
the year. The bank had 171,000 credit cards issued as of December
31, 2006.

In 2006, MBRD accelerated the development of its retail banking
business, increasing its retail credit portfolio five(cid:2)fold to 9.7 billion
rubles (US$370.0 million) from RUB 1.7 billion (US$58.2 million).
The bank rose from 51st to 31st place among the largest banks in
Russia by size of its retail credit portfolio. Just two years ago, MBRD
was 173rd among Russian banks by this indicator. The bank has
developed a balanced consumer credit portfolio, simultaneously
developing mortgage and automobile loans along with unsecured
consumer credit and credit card issuance.

The growth of retail banking operations allowed the MBRD to
improve its position in the overall banking sector. The banks assets
grew 81.6% in 2006, to RUB 58.1 billion (US$2.2 billion) from RUB
32.0 billion (US$1.1 billion). In terms of net assets, the bank moved
from 34th to 31st place among the largest banks in Russia.

According to rating agency RBC, MBRD was the second fastest
growing mortgage issuer in Russia in 2006, with issuance of mort(cid:2)
gage credits increasing 72(cid:2)fold to US$105.3 million. By the end of
the year, the bank had reached 22nd place among the largest mort(cid:2)
gage institutions in Russia. During the year, the bank issued automo(cid:2)
bile loans worth US$155.9 million becoming the 16th largest
Russian bank in terms of auto loans issued, a more than three(cid:2)fold
increase over 2005 levels.

In March 2006, MBRD
issued $60.0 million 8.875% Loan
Participation Notes to finance a subordinated loan. The notes will
mature in March 2016 and are listed on the Luxembourg Stock
Exchange.

The bank's efforts were reflected by its award for 'Dynamic Growth
in Consumer Credit' at the Financial Elite of Russia awards as well as
overall laureate for achievements in the field of finance.

ANNUAL REPORT / 2006 High potential Banking

ANNUAL REPORT / 2006 New shoots of growth

Sistema
Mass Media is a
leading company
in the Russian
Pay(cid:2)TV market.
In 2006, the number
of Pay(cid:2)TV subscribers
under the Stream TV
brand reached
1.5 million
households.

High Potential
Mass Media

Mikhail
Dunaev

CEO,
Sistema Mass Media

ANNUAL REPORT / 2006 High potential Mass Media

Marketplace

Sistema Mass Media (SMM), the corporation's primary operating
company in the media business area is focused on Pay(cid:2)TV, content
and advertising. These segments represent key, technology(cid:2)driven
businesses in the Russian media market as the corporation not only
adapts to, but also drives the development of new media platforms
and technologies.

The Russian Pay(cid:2)TV market has developed at a rapid pace in recent
years, with growth rates exceeding 30%. The market is expected to
continue to grow quickly but remains at an early stage of market
development, with considerable fragmentation and a number of
local operators. According to market research group J'son &
Partners, the number of Pay(cid:2)TV household subscribers at the end of
2006 stood at 6.6 million, an increase of 43% year(cid:2)on(cid:2)year com(cid:2)
pared to 2005. The total number of subscribers is expected to grow
to 11.7 million households by 2008.

The Pay(cid:2)TV market is consolidating, with companies such as SMM
acquiring smaller local cable operators. At the same time, the largest
operators are getting increasingly focused on developing the con(cid:2)
tent, while the smaller players are concentrating in expanding cov(cid:2)
erage and their overall technical capacity. 'Hybrid' operators are
emerging in Russia, including Sistema with its umbrella Stream
brand, which provide cable TV, IPTV, broadband and content from a
single source.

Russia's expanding media market and ongoing consumer market
boom has seen its advertising market grow at one of the highest
rates of any major world market in recent years. The volume of the
Russian advertising market was around US$4.2 billion over the first
nine months of 2006, representing 27% growth year(cid:2)on(cid:2)year.

Business

Sistema manages its media business area through the vertically inte(cid:2)
grated Sistema Mass Media holding company. Previously, SMM was
active in advertising and print distribution, and was also engaged in
publishing, terrestrial TV broadcasting and news services. However,
following a major restructuring conducted in 2004(cid:2)2006, the com(cid:2)
pany exited a number of businesses to focus on high(cid:2)revenue, high(cid:2)
technology segments of the media market.

Today, SMM is focused on the development of the Pay(cid:2)TV business,
including network operation, media content production and adver(cid:2)
tising. These core business segments will be increasingly combined
and deployed over new technological platforms, including DVB(cid:2)H
and IPTV, developed by SMM, other Sistema business areas and
international partners.

In Pay(cid:2)TV, SMM is developing its business under the Stream(cid:2)TV
brand. The strategy of the corporation in this area is to create a large
media group combining Pay(cid:2)TV operations and multi(cid:2)media servic(cid:2)
es, content and other linked businesses. This strategy is focused on
developing content and advertising and exploiting emerging tech(cid:2)
nologies such as mobile and Internet content.

SMM is establishing nation(cid:2)wide coverage for its Pay(cid:2)TV network in
Russia. In 2005 and 2006, the company acquired regional cable tel(cid:2)
evision operators Regional Cable Networks (RCN) and United Cable
Networks (UCN) and became the leading cable television operator
in Russia's regions. SMM is in the process of re(cid:2)branding recently
acquired and consolidated local cable operators under the umbrella
Stream(cid:2)TV brand and modernizing infrastructure to provide
'double(cid:2)play' (Internet and Pay(cid:2)TV) services.

At the end of 2006, SMM had cable television operations in 37 Russian
cities covering a population of around 15 million people. At the end of
2006, according to data from J'son & Partners, SMM had a 15% share
of the Russian Pay(cid:2)TV market, making it by far the largest single play(cid:2)
er in a fragmented marketplace. Even as the company builds up its
market share, it is driving deployment of new technology following
successful pilot projects for mobile television during 2006.

SMM's Tema Productions subsidiary provides financing and produc(cid:2)
tion services for film production, manages content and rights
libraries and will requisition film and television content from the
company's film and television studio complex under development
in St Petersburg.

SMM's integrated communications group Maxima, was rated the
11th largest agency in terms of media buying in Russia by
Kommersant newspaper in 2006. At the end of the year, Maxima was
present in Russia as well as Ukraine, Belarus and Kazakhstan as the
company seeks to build upon fast(cid:2)growing advertising and con(cid:2)
sumer markets in the CIS. Maxima provides a strong and established
media buying platform that is integral to SMM's combined Pay(cid:2)TV,
content and advertising business.

negotiations with international partners for further developing the
potential of this technology. The company also began the modern(cid:2)
ization of its regional cable operators with new technology
(FTTB/HFC/MetroEthernet) to provide double and triple(cid:2)play serv(cid:2)
ices for subscribers.

The company expanded its Maxima advertising business into other
CIS markets and opened offices in Belarus and Kazakhstan during
the year. The advertising group prepared a development plan for
Russia's regions in 2006 to build upon rapid recent growth in
regional advertising, which is being driven in part by the recent
expansion of large Russian and international FMCG producers and
retailers into regional markets.

ANNUAL REPORT / 2006 New shoots of growth

Results

In 2006, the Media business area reported a 104% year(cid:2)on(cid:2)year
increase in revenues to US$106.7 million compared to US$52.4
million in 2005. OIBDA increased 203% to US$26.6 million. The
results reflect the positive impact of the major restructuring of the
business that took place in 2005 and continued in 2006 as well as
growth in the three key priority business segments: Pay(cid:2)TV, con(cid:2)
tent and advertising. The company had 1.5 million subscribers at
the beginning of 2007.

The company UCN (one of the country's largest cable television
operators and providers of broadband Internet access), acquired
in February 2006, contributed US$45.5 million in revenues in
2006, along with revenues of US$14.5 million generated by other
companies acquired since the end of 2005. The company spent
around US$200 million on acquisitions and network moderniza(cid:2)
tion in 2006.

In 2006, SMM concluded the restructuring begun in 2005 with the
sale of television channel TV(cid:2)Stolitsa, the newspaper Metro, as
well as stakes in the news agency Rosbalt and others. With these
disposals, SMM has completed its exit from areas outside of its
core Pay(cid:2)TV, content and advertising businesses. The company
has implemented a new affiliate structure to manage its cable
operators and purchased remaining minority shareholdings in
these companies, with assets consolidated under its Stream(cid:2)TV
subsidiary.

At the same time, the company had focused on its growing content
business and launched a fifth TV channel featuring its own produc(cid:2)
tion on a CIS(cid:2)wide scale. All the content production will be carried
out by a specialized subsidiary, Stream Content. SMM has completed
seven films for cinema release during the year. Investment in pro(cid:2)
duction facilities, including studios, continued in 2006 and the first
new studio in St Petersburg is due to open during the first half of
2007. SMM plans to bring its content business under the manage(cid:2)
ment of a new subsidiary, Stream(cid:2)Content. In addition, the compa(cid:2)
ny conducted negotiations with major international studios to
acquire branded content to attract and retain subscribers.

SMM continued to develop promising technologies such as content
for portable and mobile devices and conducted a pilot project for
broadcasting, in DVB(cid:2)H format. In addition, the company acquired
frequencies in 16 largest Russian cities (top markets) for DVB(cid:2)H
broadcasting that will be used to develop the potential market for
mobile TV in 2007 and 2008. Entering 2007, the company was in

ANNUAL REPORT / 2006 High potential Mass Media

ANNUAL REPORT / 2006 New shoots of growth

Intourist
is best(cid:2)known
tourist company in
Russia. In 2006, the
number of foreign
and Russian tourists
serviced by the
company reached
more than
550,000 clients.

High potential
Tourism

Alexander
Arutyunov

President,
Intourist

ANNUAL REPORT / 2006 Hihg potential Tourism

Marketplace

Intourist is Sistema's single business in the tourism industry and pro(cid:2)
vides comprehensive services for Russian tourists traveling abroad
and domestically as well as for international visitors to Russia. The
company is a leading operator in Russia's fast(cid:2)growing tourist industry,
worth around US$9.7 billion in 2006 (total outbound, inbound and
domestic market segments).

The 'inbound' and 'outbound' tourism markets in Russia are driven
by different, sometimes opposed dynamics, such as exchange rate
levels. However, both of these key segments have seen continued
strong growth driven by sustained economic and political stability
in Russia. According to experts, the value of the market is forecast to
grow at an average annual rate of 15.5% for the period 2005 to 2011
and will gain a total value of US$19.6 billion by 2011.

The inbound market grew by an estimated 16% in value terms in
2006 to US$740 million and is forecast to grow by around 10%
through 2011. A challenge for the market is shortage of rooms in
Moscow and in St.Petersburg caused by the shutdown of some older
hotels, and historic lack of hotel capacity as measured by number of
hotel rooms per capita compared to other Central and Eastern
European capitals. However, a number of hotel projects are current(cid:2)
ly nearly completion and is expected to overcome this shortage of
hotel rooms by 2008. Meanwhile, government efforts to encourage
visitors to see Russia's historic and cultural attractions, and improv(cid:2)
ing levels of service and infrastructure in the regions are encourag(cid:2)
ing growing numbers of tourists.

Outbound and domestic Russian tourism continued to grow
dynamically in 2006 due to rising disposable incomes and broader
economic confidence among consumers. The market was worth
approximately US$9 billion in 2006, representing a 18% year(cid:2)on(cid:2)
year increase. Dynamic growth is forecasted to continue over the
five year period through 2011, with average annual market value
growth of 15%.

Tourists are moving away from traditional package destinations for
Russian visitors to destinations such as Spain, Italy, the UAE, Tunisia
and Thailand. Tour packages became more costly during the year
due primarily to higher fuel costs for airlines and hotel rates growth
in many popular destinations. For Russians traveling domestically,
large(cid:2)scale investment by domestic and international developers in
building world(cid:2)class hotel and resort facilities in destinations such
as the Black Sea coast is spurring domestic travel.

Russia's tourist market is very fragmented and characterized by the
presence of numerous operators and high levels of competition.
However, there are indications of consolidation in the marketplace.
The top 50 tour operators accounted for sales of around US$3.1 bil(cid:2)
lion in 2006, up 26% year(cid:2)on(cid:2)year1 , ahead of the 18% growth rate for
the market as a whole. Diversification of services into management
of hotels and resorts and the ability to provide both Russian and
international travelers with complete tour packages allow larger
operators to build market share and insulate themselves against
cyclical or temporary drops in one market segment.

Business

The Intourist holding is Sistema's primary asset in the Tourist busi(cid:2)
ness area and the company is the oldest and best(cid:2)known tourist
business in Russia. Intourist was founded in 1929. In Soviet times, it
was the monopoly provider of tourist services. In 1992, the assets of
Intourist were restructured, the result of which left the company
with only international and domestic tour operators. All of the other
assets, including hotels and tour buses, were put under the control
of the Russian government.

In 2006, following the completion of a significant restructuring in
2005, Intourist had established itself as a leading universal operator
in the tourist market. Today, Intourist aims to create a fully integrat(cid:2)
ed tourism group by exploiting synergies between its key business
areas: tourism, retail chain, hotels and transport. This approach
allows the group to develop high quality products at the right price
for the client.

The company served more than 600,000 clients in 2006 and its pri(cid:2)
mary competitive advantage is its ability to provide a comprehen(cid:2)
sive range of services through its international and domestic net(cid:2)
work of partners as well as overseas subsidiaries. The key acquisi(cid:2)
tions of large Russian tour firms Riviera and Skyway during 2006 fur(cid:2)
ther strengthened Intourist's leading position in the marketplace.
The ability to offer comprehensive solutions was further bolstered
by the company's acquisition of Russia's leading broker for chartered
flights, Megapolis(cid:2)Aviacharter.

With these recent moves, Intourist has strengthened its ability to
provide complete, higher margin tour packages to such mass(cid:2)mar(cid:2)
ket (Turkey and Egypt) as well as sub(cid:2)mass(cid:2)market destinations as
Spain, Italy, Tunisia, Greece and Goa in India. At the same time, the
company increased its range of travel solutions for corporate and
government clients.

ANNUAL REPORT / 2006 New shoots of growth

Another key advantage for Intourist is its unrivalled international net(cid:2)
work. Currently, the company has 10 affiliate companies overseas
with 7,000 partners in 168 countries. This allows the company to pro(cid:2)
vide comprehensive travel services world(cid:2)wide. In addition, Intourist
has a sales network present in 34 of Russia's regions. The network is
one of the largest in terms of numbers of points of sale and the com(cid:2)
pany's goal is to make it the largest such network in Russia.

The hotel business represents another priority growth area for
Intourist and the corporation. The Intourist Hotel Group subsidiary
operates both company(cid:2)owned and third(cid:2)party owned hotels, with
some seven hotels in Russia and two international locations. Today,
the company's hotel network has the largest number of rooms of
any Russian hotel operator, with around 2,300 as of December 31,
2006. Within Russia, the hotel business is concentrated on adding
three and four star hotels in Moscow and such tourist destinations as
the Golden Ring cities and Black Sea coast to its network.
Internationally, the group is focused on the operation of three(cid:2) and
four(cid:2)star properties and business hotels in leading tourist locations.

The goal of the hotel business is to operate hotels in order to maxi(cid:2)
mize the sales and earnings potential of each facility. This entails the
introduction of rigorous accounting and management systems and
application of the corporation's wider experience in areas such as
human resources and IT. In addition, hotels operated by Intourist
benefit from synergies within the company including access to the
company's retail sales network and inclusion in tour packages.

Another priority area for Intourist is transport services. Intourist is
currently Russia's largest broker for charter flights, a fast(cid:2)growing
business area. In addition, the company runs tourist bus services, a
segment that has seen rapid growth due to an increase in the num(cid:2)
ber of international and domestic tourists in the country.

In the beginning of 2007, Sistema and its affiliated companies con(cid:2)
trolled over 65.10% of the Group. The second and third principal
shareholders are Moscow City Government and GAO Moskva.
Owned by the Moscow City Government, GAO Moskva is focused
on developing the city's potential as a tourist destination.

Results

Intourist's turnover significantly increased to US$338 million in
2006, while revenue reached to US$270 million in 2006. The com(cid:2)
pany serviced more than 547,000 clients during the year, including
152,000 inbound tourists

In terms of market share, Intourist's share of the inbound market
increased to 9.8% in 2006, compared to 9.5% in 2005. The company's
share of the fragmented outbound tourist market grew ten(cid:2)fold to
3.0% in 2006, making the company one of the top(cid:2)three Russian
companies in the market. Tour Operating accounted for around 66%
of revenues during 2006.

The acquisition of Megapolis(cid:2)Aviacharter at the beginning of 2006
was a major step that has made Intourist the leading broker for char(cid:2)
ter flights in Russia. This significantly strengthens the ability of the
company to offer comprehensive travel packages, and provides a
clear opportunity to build upon synergies between Intourist's Tour
Operating and Transport business areas.

During 2006, Intourist completed a number of important acquisi(cid:2)
tions to strengthen its core Tour Operating business, including 51%
of the Riviera Holding group and Skyway. Riviera, the leader in the
Northwest region of Russia and the largest tour operator in St
Petersburg, has operations in more than 20 countries and serves
around 120,000 clients annually. Skyway is a major Moscow(cid:2)based
tour operator in the marketplace since 1994 and leader in Egypt(cid:2)
bound tours. The addition of these companies allows Intourist to
offer a broader range of complete packages to more destinations,
including key mass(cid:2)market and sub(cid:2)mass market destinations.

Intourist also made two important acquisitions to strengthen its
leading market position as hotel operator and management compa(cid:2)
ny. The company increased its share in Moscow's Cosmos Hotel to a
63.4% stake and also acquired Moscow's landmark Pekin Hotel,
which enjoys a prime location in the city and is currently in the
midst of a major renovation project.

In addition, the company continued to expand and restructure its
sales offices in Russia. At the end of 2006, the company had 102 own
retail sales outlets and 31 franchised sale offices in Moscow, St
Petersburg and Russian regions.

Following the successful restructuring in 2005, in 2006 Intourist
created a divisional corporate structure for the group reflecting key
priority areas for long(cid:2)term development. Divisions for Tour

ANNUAL REPORT / 2006 Hihg potential Tourism

Operating, Retail Sales, Transport Services and Hotel Business were
created under the Intourist management company.

Intourist's strong financial results and focused restructuring helped
to achieve first place in the 2006 Top(cid:2)50 rating of Russian tour oper(cid:2)
ators published by financial newspaper Kommersant in conjunction
with information agency Turinfo. Previously, the company had
never gained a higher position than sixth place.

1 Data from Kommersant/Turinfo ratings

ANNUAL REPORT / 2006 New shoots of growth

RTI Systems
is one of Russia's
largest defense
companies and is
developing unique
and highly complex
projects in the
sphere of defense
technology.

High potential
Radio and Aerospace Technology

Sergey
Boev

CEO,
RTI Systems

ANNUAL REPORT / 2006 Hihg potential Radio and Aerospace Technology

Marketplace

Business

Sistema's Radio and Aerospace Technology business area includes
the RTI Systems holding and its subsidiaries. The company carries
out the design, production and implementation of major systems
projects, including radar systems and sets, aerospace control sys(cid:2)
tems as well as building of power equipment.

The corporation's primary client in this business area is the Russian
Ministry of Defense and therefore its main market is the Russian mil(cid:2)
itary and defense sector. This market is valued at US$20 billion (This
is much higher than the 2005 level of US$7.7 billion cited in last
year's AR), based on total Russian state defense procurements in
2006, which grew by 10 to 14% year(cid:2)on(cid:2)year. The market for
weapons and military hardware was worth around US$7.8 billion in
2006. The market for information systems was valued at around
US$750 million.

The future market for defense contractors will be largely defined by
the State Program for Arms Development for 2007 to 2015, a pro(cid:2)
gram for the development and purchase of arms technology and
equipment for the Russian military approved in its final form in
November 2006. This envisions nearly RUB5 trillion (US$185 bil(cid:2)
lion) in spending over the period aimed at modernizing the Russian
armed forces.

The program aims to introduce a range of new technologies, includ(cid:2)
ing radar stations with high factory readiness, so(cid:2)called because they
are modular and can be easily upgraded and require less energy than
traditional systems. This innovative system has been developed and
delivered by RTI Systems.

In addition, in May 2006, the Russian president approved a list of
critical technologies for the development of the Russian economy.
The list defines a number of priority areas for scientific research and
development and serves as a basis for the disbursement of state
funding through Federal Target Programs directed to state and pri(cid:2)
vate sector R&D and production enterprises. For RTI Systems as a
high technology, R&D based company, these programs are an
important part of the development of its business.

For defense contractors, government contracts generally represent
orders for a fixed quantity of any given product manufactured over
the period of the lifetime of the contract. In order to secure conti(cid:2)
nued growth, RTI Systems seeks new clients among other state bod(cid:2)
ies and in the private sector while developing new technologies and
products for its existing and new clients.

RTI Systems and its subsidiary companies bring together leading
Russian enterprises with strong track records in management of
large(cid:2)scale projects in the high(cid:2)technology sphere and considerable
research and production potential. Its primary client, the Russian
Ministry of Defense, accounted for 69% of RTI Systems's sales in
2006. RTI Systems has developed the capacity to develop, build and
deliver high(cid:2)technology 'turn(cid:2)key' systems.

The company has established dominant positions in key segments
of the market for state defense contracts for information systems
and devices. These include a 92% share of contracts for information
systems for Missile Attack Early Warning Systems, a 93% share of
contracts for information systems for Anti(cid:2)Missile Defense Systems
and a 70% share for information systems designed to monitor air(cid:2)
space.

RTI Systems, using the highly developed technology base at its facil(cid:2)
ities, continues to carry out work on major technology projects on
behalf of the Russian government. These include systems for radar
monitoring of maritime borders and the adjacent 200 mile eco(cid:2)
nomic zone and information systems for counter(cid:2)terrorist opera(cid:2)
tions. Another key project underway for the Russian Ministry for
Emergency Situations is the development of 'situation centers' to
provide critical
information for the National Center for
Management of Crisis Situations and the All(cid:2)Russian System for
Information and Notification of the Population. Other major pro(cid:2)
jects include an integrated communications system based on geo(cid:2)
stationary satellite platforms and the development of the Glonass
civilian navigation system.

RTI Systems is constantly developing new technology to create new
products and expand its sales and market share. R&D costs account
for around 50% of the company's final products. Innovative prod(cid:2)
ucts allow RTI Systems to provide clients with superior and innova(cid:2)
tive technology and products that cannot be acquired elsewhere.
RTI System's researchers have registered 37 patents for new tech(cid:2)
nology developed at the company.

At the same time, the company seeks to diversify its client base and
a primary goal is to lower the share of defense orders among total
contracts from the 2006 level of 69% to 45%. The remaining 55% of
contracts are to be sourced from other state and government clients.

As part of Sistema's strategy of consolidating and restructuring
assets, Sistema combined a number of subsidiary businesses under

Management of Crisis Situations and conducted preliminary tests of
the center's automated management system. The All(cid:2)Russian System
for Information and Notification of the Population entered its con(cid:2)
struction phase.

In March 2006, RTI Systems purchased a 50% plus one share in
UralEleketro and 100% share in UralElektro(cid:2)K for US$5.4 million.
Both companies are producers of electronic equipment and the
acquisition further bolsters RTI Systems's competitive edge in the
growing market for building power machines. Later in the year,
UralElektro concluded its first defense contracts, worth US$1 mil(cid:2)
lion, for the supply of low(cid:2)voltage switching equipment. RTI
Systems's DMZ Kamov aerospace subsidiary, acquired in 2005,
signed a contract worth US$6.3 million for the repair of aviation
armaments.

In recognition of its efforts to provide continuing training and edu(cid:2)
cation for its workers, RTI Systems won its second award for
Qualification of Personnel and Systems for Training and Re(cid:2)Training
at the All(cid:2)Russian competition held by the Russian Organization for
High Social Effectiveness.

ANNUAL REPORT / 2006 New shoots of growth

RTI Systems to create a market leader in fast(cid:2)growing segments of
the radio and aerospace technology market. Three main business
areas were formed in 2005 and in 2006 RTI's main business areas
will be restructured along a clear divisional structure, including
Radio Equipment, Aerospace and Terrestrial Control Systems and
Power Equipment.

The Aerospace and Terrestrial Control Systems division was created
in late 2005. The main goal of the company in the next few years is
to expand its presence in the domestic and overseas markets for
military and civil control systems. The formation of the Power
Equipment Building division began in the first quarter of 2006 after
the acquisition of UralElektro. The company entered the market for
equipment which is relatively small in volume terms at around
US$430 million. The main goal in the next few years is to complete
the formation of the division and to enter the market for large sys(cid:2)
tems projects in this sector.

Results

Revenues in the Radio and Space Technology segment grew 93% to
US$248.9 million in 2006, compared to US$124.2 million in 2005.
OIBDA grew 64% to US$23.7 million.

During 2006, RTI Systems participated in a number of Federal Target
Programs (FTPs), in particular such major FTPs as the development
of the Russian defense industry. These programs have seen funding
grow historically by 6 to 7% a year, a similar rate to overall growth in
the economy.

RTI Systems has developed a modular radar system for the
Voronezh(cid:2)M early warning system, a high(cid:2)profile defense project
under the supervision of the Russian president. In January 2006, the
company conducted preliminary tests of the system and in
December 2006, the system entered into experimental combat duty
after extensive testing.

During the year, the company completed a radar system for surface(cid:2)
wave monitoring of the country's 200(cid:2)mile economic zone and
created a test(cid:2)model for over(cid:2)the(cid:2)horizon radar used for airspace
monitoring and control. Another key breakthrough was the testing
of onboard aviation and ship(cid:2)based data exchange systems.

In 2006, RTI Systems made important progress in completing
preparatory development work and preparing for the construction
of the surface section of the complex for the National Center for

ANNUAL REPORT / 2006 Other Businesses Radio and Aerospace Technology

ANNUAL REPORT / 2006 New shoots of growth

Other
Businesses

ANNUAL REPORT / 2006 New shoots of growth

Other
Businesses
Insurance

In February Sistema sold 46.19% of ROSNO shared to Allianz.
Sistema holding in ROSNO was redused to 3%, while Allianz stake
increased to 97%. The transaction was in line with the corporation's
long(cid:2)term development strategy, and the commitment of both
Sistema and Allianz SE to consolidate the control over the company
under one of them at a certain stage of ROSNO's development.

Insurance has been one of the fastest growing sectors of the Russian
economy in recent years. According to the Russian Federal
Insurance Supervision Service (FISS), the official insurance market,
including life insurance and all types of obligatory insurance, grew
by 21.0% to US$14.8 billion in 2006. Excluding insurance schemes,
the real market grew by 25.3% in 2006 and totaled US$11.6 billion,
according to ROSNO estimates. The market is forecast to grow by
20(cid:2)25% per year.

ROSNO is one of the largest universal Russian insurance companies.
In 2006, ROSNO offered more than 100 types of insurance to its
clients. The company's strategy and major principle is to take care of
its clients and provide them with high(cid:2)quality service. ROSNO's
insurance policies are held by over 17 million people and over
50,000 companies. The qualitatively new level of development
achieved by ROSNO has been the result of cooperation of two
strong shareholders complementing each other's strengths. The
leadership path chosen by Sistema as the company was being devel(cid:2)
oped was strengthened by the experience and technology con(cid:2)
tributed by Allianz.

ROSNO's regional network consists of 100 branches combined into
10 territorial directorates and 300 agencies all over Russia. Further
expansion in the regional markets is one of the key strategic priori(cid:2)
ties of ROSNO Group as well as development of retail sales. The
Group's priority insurance lines are Motor, Voluntary Medical
Insurance, Property and Life & Pension. In 2006 ROSNO had a 5.3%
official market share, making it the fifth largest player and 6.8% of
the real market, that placed the company third top insurer in terms
of premium volume.

In 2006 ROSNO Group GPW increased by 70% and reached US$787
million. Life insurance grew by 84% while non(cid:2)life grew by 43% in
2006. The major driver in life insurance was development of Allianz.
ROSNO Life agent network while VMI, Motor and OMTPL con(cid:2)
tributed to non(cid:2)life business development.

ANNUAL REPORT / 2006 Other Businesses

Other
Businesses
Petroleum

During the second half of 2005, Sistema acquired minority share(cid:2)
holdings in six raw oil processing and oil extracting companies
located in the Russian Republic of Bashkortostan. The total acquisi(cid:2)
tion costs were around US$600 million. The acquisition of the
shareholdings represents an opportunity to put shareholder's funds
into a financial investment for the short to medium(cid:2)term, while
waiting for opportunities to conduct future M&A deals to boost key
core businesses.

At the end of 2006, Sistema had 21% of the charter capital of oil
extracting company Bashneft (amounting to 26% of the voting
shares). It has 27% shares of the charter capital of Novoil (30% of the
voting shares), 23% of the charter capital of Ufaneftekhim (29% of
the voting shares) and 24% of the charter capital of Ufimskiy NPZ
(28% of the voting shares), all oil processing companies. In addition,
the charter capital of
Sistema had acquired 25% of
Bashkirnefteprodukt (27% of the voting shares), a company
involved in the retail sale of oil products, and 23% of the charter cap(cid:2)
ital (26% of the voting shares) of oil chemicals company
Ufaorgsintez.

The companies occupy a leading position in the oil(cid:2)energy market
in the region and operate across the production chain, from oil
extraction to petrochemicals. The shares of all of the companies are
quoted and traded on the RTS and were acquired from Bashkirskiy
Capital, which owns controlling shareholdings in all of the compa(cid:2)
nies. Bashkirskiy Capital approached Sistema with the offer to pur(cid:2)
chase the shareholding in order to access the corporation's long(cid:2)
standing experience in restructuring businesses. Sistema's managers
are working with Bashkirskiy Capital to create a transparent, verti(cid:2)
cally integrated holding with the goal of maximizing the sharehold(cid:2)
er value of each company as well as the holding. Sistema's manage(cid:2)
ment continues to believe that equity participation in the compa(cid:2)
nies, provides the corporation with the ability to make efficient use
of shareholder funds, to benefit from additional revenue from the
dynamic development of the oil sector.

ANNUAL REPORT / 2006 New shoots of growth

Other
Businesses
Healthcare
Services
and
Pharmaceuticals

Healthcare services

Sistema manages its healthcare services business through its Medsi
and Medsi(cid:2)II clinics in Moscow. The Russian market for paid health(cid:2)
care services grew by 18% year(cid:2)on(cid:2)year to US$5.3 billion in 2006,
with Moscow accounting for 35% of this market and growing 20%
year(cid:2)on(cid:2)year. The market for private medical clinics remains highly
fragmented, with the top(cid:2)three largest clinic operators accounting
for about 3% of the total market in 20061.

Medsi provides outpatient and primary care services to patients over
15(cid:2)years(cid:2)old while Medsi(cid:2)II specializes in pediatrics. Medsi is a full(cid:2)
service medical center for providing clinical diagnostics and treat(cid:2)
ment on outpatient basis. In addition, the center provides specialist
care in its dedicated Diabetes Center, 40(cid:2)plus Health Center and
Moscow’s first Center for Extracorporeal Healing. In 2006, Medsi
began the construction of an extension to its clinic. The extension will
allow Medsi to expand its range of services and more than double the
total size of the Medsi facilities. The extension will include an expand(cid:2)
ed Diabetes Center that will be the leading private diabetes treatment
center in Moscow. In 2006, Medsi served 32,618 patients.

The Medsi II children's clinic is Moscow's most advanced clinic of its
type. It has specialized clinics for non(cid:2)surgical vision correction,
allergies, immunological and metabolic disorders, diabetes, posture
correction and care for children under 12 months old. The clinic has
a Scientific Committee composed of leading scientists and academ(cid:2)
ics from the Russian Academy of Medical Science. The committee's
aim is to conduct pediatric research and introduce new technolo(cid:2)
gies and methods for prevention and treatment of pediatric illness(cid:2)
es. During the year, Medsi II provided services to 15,238 patients.

The Healthcare business area saw revenues increase 69% in 2006,
reaching US$16.9 million, with Medsi accounting for US$12.5 mil(cid:2)
lion in revenues and Medsi II for US$3.9 million. The company is
developing a strategic plan focused on creating the leading
provider of private medical care in Russia. This provider will aim to
render the fullest possible range of medical services to patients.

ANNUAL REPORT / 2006 Other Businesses

Pharmaceuticals

Created in March 2006, Binnofarm is Sistema's holding company for
its pharmaceutical and biotechnology assets. The Russian pharma(cid:2)
ceutical market has grown very rapidly in recent years: 36% year(cid:2)on(cid:2)
year in 2006 to US$12.3 billion, following 35% increase in 2005.
Russia's pharmaceutical market is currently dominated by foreign
manufacturers controlling 75% of the market, although the intro(cid:2)
duction of a national drug reimbursement program in 2005 drove
demand for cost effective domestically produced medicines.

Over the course of 2006, the consolidation of Sistema's pharma(cid:2)
ceutical and biotechnology assets under Binnofarm was complet(cid:2)
ed. The holding received a pharmaceutical license in May. At the
beginning of 2007, Binnofarm is a vertically integrated pharmaceu(cid:2)
tical and biotechnology holding. The company is growing in three
clearly defined directions: R&D and production facilities for inno(cid:2)
vative medicines, in(cid:2)house and out(cid:2)sourced production of generic
medicines and an outsourcing business for finished pharmaceuti(cid:2)
cals and other innovative chemical substances.

Binnofarm produces a range of finished innovative and generic
medicines. The company began the first industrial production of a
vaccine for hepatitis B in 2005. Binnofarm is the only company in
Russia conducting full(cid:2)cycle vaccine production from substance to
final(cid:2)form product and is developing production of an array of
immunobiological medicines. Binnofarm also produces central
nervous system analgesics together with the Federal State
Enterprise GZMP that accounted for around 50% of the Russian
market in 2006.

The Biotechnology segment posted US$53.7 million in revenues
compared to US$8.4 million in 2005. At the end of 2006, Binnofarm
had registered eight medicines in Russia, with another 50 submitted
for registration.

1 Sources: Russian Ministry of Health and Social Development,

Snegiri(cid:2)Group, FSGS, RosBuisnessConsulting

ANNUAL REPORT / 2006 New shoots of growth

Innovation and
Venture Capital

Research & Development Centers

Continuous innovation is critical to maintaining Sistema's com(cid:2)
petitive edge on both the corporate level and maintaining and
enhancing market leadership in each business area. Sistema's oper(cid:2)
ating companies have long maintained research and development
centers responsible for innovation as well as well established rela(cid:2)
tionships with leading research universities and institutes and inter(cid:2)
national technology partners.

In a rapidly changing marketplace for technology and services,
however, many of the lines between traditional businesses, such as
telecommunications and media, are rapidly disappearing. A 'silo(cid:2)
based' approach to R&D, where research is focused on a single or
small group of market segments, no longer makes sense. Therefore,
Sistema has moved to establish a single scientific and technical pol(cid:2)
icy for the corporation based on clear principles and goals and
aimed at focused, marketing driven innovation that leverages
economies of scale and synergies between business areas in the
sphere of R&D.

On the corporate level, Sistema has created a Department for
Innovation Projects to identify and coordinate priority R&D proj(cid:2)
ects for each business area and the corporation as a whole. It will
maintain a single database of ongoing innovation projects and
house a special service to ensure the corporation's intellectual prop(cid:2)
erty rights are protected in Russia and internationally. The depart(cid:2)
ment is also responsible for developing more systematic and effi(cid:2)
cient modes of collaboration with specialized research institutes
and universities. Sistema is also looking at how it can best make use
of new, government(cid:2)backed initiatives to foster innovation, such as
so(cid:2)called technical parks and special economic zones that provide
infrastructure support and tax incentives for research and develop(cid:2)
ment based work.

At the same time, the corporation plans to establish centralized
R&D centers in a number of its core business areas. Each center will
be responsible for developing and introducing new technology for
the operating companies in its business area. The relationship

between the R&D centers and operating companies is being struc(cid:2)
tured as a two(cid:2)way channel, with R&D driving new market launch(cid:2)
es, while operating companies provide expertise and intelligence
about market trends and consumer responses to new products.

In 2006, this strategy was successfully implemented in the
Telecommunications business area, where all research and develop(cid:2)
ment centers were unified in a single structure, Intellect Telecom.
The centralized R&D center represents one of the most important
resources available maintain both long(cid:2)term market leadership and
profit growth at Sistema's telecommunications operating compa(cid:2)
nies. The primary focus of Intellect Telecom is to create flexible solu(cid:2)
tions, such as those based on the application of a number of wireless
technology standards (such as UMTS, Wi(cid:2)Fi, WiMAX, DVB(cid:2)T and so
forth) to deliver multimedia content and services. Another strategic
focus is the efficient integration of digital mobile and fixed(cid:2)line net(cid:2)
works of the main telecommunications operators within Sistema
Telecom.

Sistema plans to establish similar centralized R&D structures in
other core business areas, with projects underway at high(cid:2)technology
holding Sitronics, radar and aerospace technology group RTI Systems,
Pharmaceuticals and Biotechnology "Binnopharm". The corporation
is also planning to strengthen its R&D efforts in other areas. One such
area is banking, where the rapid development of MBRD's retail bank(cid:2)
ing network requires innovative solutions to link branches and head(cid:2)
quarters more efficiently, share information and access data such as
consumer credit histories in order to provide customers with quick
responses to mortgage and other credit applications.

Venture Capital

Another important pillar of Sistema's innovation infrastructure,
put into place during 2006, is the corporation's leading role in estab(cid:2)
lishing venture capital funds to act as incubators for new technolo(cid:2)
gies, to develop existing business areas, and create opportunities to
develop new market segments. Last year, Sistema organized a num(cid:2)
ber of funds within private(cid:2)public partnership frameworks, working
with the Russian federal and regional governments to support the
development of the country's innovation infrastructure.

Sistema acts as the primary off(cid:2)taker of the projects and tech(cid:2)
nologies financed by these funds. All of the funds have been devel(cid:2)
oped as 50(cid:2)50 joint(cid:2)ventures between Sistema and third parties,
generally federal and regional government bodies. The volume of
Sistema's venture capital funds at the end of 2006 stood at around

newly developed GLONASS navigation system and others. As part of
GLONASS, Sistema is implementing a project aimed at creating a
new All(cid:2)Russian Cartographic Database with government support
for clients such as the Russian Ministry of Defense and the Ministry
for Emergency Situations. In future, GLONASS is expected to have
significant commercial potential for civilian use.

ANNUAL REPORT / 2006 Innovation and Venture Capital

RUB1.48 billion (approximately US$54.6 million). The venture
capital funds are oriented toward 'start(cid:2)up' companies and involve
a number of relatively small investments. The maximum invest(cid:2)
ment allowed in any single projects by any fund is 10% of the
fund's capital.

Besides capital, one of Sistema's key contributions to its funds is
strategic vision and pool of management skill to developing pro(cid:2)
jects. As with other areas of its business, Sistema has established a
range of KPIs for projects receiving venture finance. The corpora(cid:2)
tion has set return on investment criteria that require a minimum
return of 25% per year for its investment. The lifecycle of the venture
capital funds is seven years. At the end of this period, Sistema will sell
the business, develop it into a separate business area or realize its
investment through sale to a strategic investor.

Among the funds created in 2006 is the Moscow Venture Fund,
with capital of RUB1 billion (approximately US$37 million), estab(cid:2)
lished in cooperation with the government of the City of Moscow
and the Ministry for Economic Development and Trade. This fund is
focused in developing technology on the base of the city's large
complex of universities and research institutes, to ensure the city
develops the technological resources needed, to retain its position
as a leading global business center.

Another fund has been created in partnership with the adminis(cid:2)
tration of the Russian republic of Mordovia. The fund aims to devel(cid:2)
op the Saransk(cid:2)based assembly division of RTI Systems and foster
regional research and development capacity for both RTI and third(cid:2)
party customers. The fund has an initial capital of RUB280 million
(approximately US$10.4 million). A third fund has been developed
with the administration of Perm province around the base of Perm
Motors, a facility acquired by Sistema in 2006.

In order to implement projects that have reached an advanced
stage of development in the telecommunications and high(cid:2)technol(cid:2)
ogy area, Sistema has established the Correll Sistema Strategy Fund
with capital of US$75 million. Co(cid:2)investors in this fund are Sistema,
MTS, Comstar and Sitronics, with international fund management
firm Correll hired to provide management expertise as well as a 1%
contribution to the fund.

This fund has already been involved in developing a large num(cid:2)
ber of high(cid:2)potential projects that are providing revolutionary new
technology for Sitronics, MTS and other operating companies. This
technology includes technology for providing customized telecom(cid:2)
munications services, wireless Internet access, GPS through the

ANNUAL REPORT / 2006 New shoots of growth

Contacts

Sistema Joint(cid:2)Stock Financial Corporation

13, Mokhovaya str.
Moscow 125009, Russia
Tel.: +7 (495) 730(cid:2)0599, 737(cid:2)0101
Fax.: +7 (495) 730(cid:2)0330
http://www.sistema.ru

Irina Potekhina
Head of PR
Phone: +7 (495) 730 7188
potekhina@sistema.ru

Victor Kurilo
Head of IR
Phone: +7 (495) 629 2741
ir@sistema.ru

ANNUAL REPORT / 2006 Notes

Notes

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ANNUAL REPORT / 2006 New shoots of growth

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