Russian IT Market:Big Picture, Segments & Case Studies

Russian IT Market:Big Picture, Segments & Case Studies

US-Russia Technology Symposium at StanfordJanuary 29-30, 2004

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ContentsContents

• Russian Macroeconomic Overview

• Russian IT Market Overview

• Review of Selected Russian Software Players

• Russian Macroeconomic Overview

• Russian IT Market Overview

• Review of Selected Russian Software Players

3

The economy keeps growing faster than expected…The economy keeps growing faster than expected…

Source: EIU, December 2003

• Devaluation and investment catalyzed growth surge in 1999-2001

• High oil prices support continued growth

• Domestic consumption surge, as seen in retail and other sectors

• Devaluation and investment catalyzed growth surge in 1999-2001

• High oil prices support continued growth

• Domestic consumption surge, as seen in retail and other sectors

Russia GDP Year-on-Year Change

Russia GDP Year-on-Year Change

Russia GDP Nominal & PPP (US$ ‘000 per capita)

Russia GDP Nominal & PPP (US$ ‘000 per capita)

6.3%

10.0%

6.7%4.4%5.0%

4.3% 4.3%4.1% 4.1%

0.0%2.0%4.0%6.0%8.0%

10.0%12.0%

1999

2000

2001

2002

2003

2004

F

2005

F

2006

F

2007

F

Real GDP growth (%)

$5

$7

$9

$11

$13

$15

1999

2000

2001

2002

2003

2004

F

2005

F

2006

F

2007

F

$0

$1

$2

$3

$4

Russia's GDP (US$ per capita)Purchasing power parity Rb:US$ (av)

4

0 200 400 600 800 1000

US$ b

2002 GDP 2008F GDP

…and is already the 10th largest economy in PPP terms…and is already the 10th largest economy in PPP terms

Russia expected to overtake Brazil by 2008 and become 4th largest emerging economy

Russia expected to overtake Brazil by 2008 and become 4th largest emerging economy

Russia’s peer group (nominal GDP)Russia’s peer group (nominal GDP)

Source: EIU, Oct 03; EY Analysis

0 500 1000 1500 2000 2500

Mexico

Canada

Russia

Brazil

UK

Germany

US$ b

Russia’s peer group (PPP GDP)Russia’s peer group (PPP GDP)

On PPP basis, Russia is already the 10th largest global economyOn PPP basis, Russia is already the 10th largest global economy

5

0

5,000

10,000

15,000

1999 2000 2001 2002 2003E

$ m

ln

FDI Financing

FDI and Cross-Border FinancingFDI and Cross-Border Financing

The debt capital markets have “reopened” for Russia…The debt capital markets have “reopened” for Russia…

• Access to financing has improved. After Russian rating was raised to investment grade (Baa3) by Moody’s, this should continue.

• Ruble bond market develops with placements expected to exceed $3 billion in 2003.

• Eurobond volumes are booming.

• Access to financing has improved. After Russian rating was raised to investment grade (Baa3) by Moody’s, this should continue.

• Ruble bond market develops with placements expected to exceed $3 billion in 2003.

• Eurobond volumes are booming.

Source: E&Y research and analysis

0.1

1.4

4.0

7.6

0

2

4

6

8

2000 2001 2002 2003

0.1

1.4

4.0

7.6

0

2

4

6

8

2000 2001 2002 2003

Gross Proceeds from Eurobonds (US$ b)Gross Proceeds from Eurobonds (US$ b)

Note: cross-border financing includes Eurobonds, syndicated loans & IPOsNote: cross-border financing includes Eurobonds, syndicated loans & IPOs

6

1

0

6

3

0.00

0.20

0.40

0.60

0.80

1.00

1.20

2000 2001 2002 2003

USD

bn

0

1

2

3

4

5

6

Num

ber of issues

Total size No of issues

.and the equity capital markets are up, but don’t (yet) fuel new substantial financing .and the equity capital markets are up, but don’t (yet) fuel new substantial financing

• RTS index now above the pre-crisis peak.

• Yet oil companies and Gazprom account for over 80% of market capitalization…

• …and equity financing is not really an important source of new capital, particularly for tech companies

• RTS index now above the pre-crisis peak.

• Yet oil companies and Gazprom account for over 80% of market capitalization…

• …and equity financing is not really an important source of new capital, particularly for tech companies

Source: EY Analysis; RTS

RTSRTS

Russian Equity Offerings Russian Equity Offerings

0

100

200

300

400

500

600

700

1996 1997 1998 1999 2000 2001 2002 2003 2004

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• Putin is almost certain to be re-elected in March 2004. Duma elections in Dec. 2003 resulted in Duma with “agreeable” working relationship with the president.

• YUKOS (Menatep) case brought negative publicity, but since then RTS has recovered, Central Bank reserves and the ruble (vs. USD) are up, and reforms seem to be on track.

The Putin era has ushered in improving stability…The Putin era has ushered in improving stability…

*EIU estimates, 2001

Source: VCIOM

President’s approval rating above 80%President’s approval rating above 80%

60%

70%

80%

90%

Dec-0

0

Dec-0

1

Dec-0

2

Dec-0

3

8

… with key structural reforms…lowering risks… with key structural reforms…lowering risks

• Tax reform: launched in 1999 (13% flat for individuals and 24% for businesses) has led to a larger, more diversified tax base. Starting January 2003, VAT has been reduced to 18%.

• Land Reform: new federal law will permit buying and selling of agricultural land plots, with restrictions, as of end of January 2004.

• Natural Monopoly Reforms: Russia has started to reform monopolies in the energy sector. This pace of reform will have a significant positive impact on economy.

• Banking System: can view weakness as strength – economy not over-leveraged like China, and system improving. While not perfect, a new law on private bank deposits took effect on December 27, 2003.

“The tax and legal systems offer acceptable risks for us,” says Sir John Brown, Chairman of BP, prior to placing $6bn into Russia. (EIU)“The tax and legal systems offer acceptable risks for us,” says Sir John Brown, Chairman of BP, prior to placing $6bn into Russia. (EIU)

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So what does the macro picture mean for Russian IT? So what does the macro picture mean for Russian IT?

• Increasing stability and improving environment for business in general

• Growing corporate market, with maturing focus on productivity.

• Much larger consumer market than it may appear.

• Access to financing improving (cost and terms of debt), but better for larger companies.

• Increasing stability and improving environment for business in general

• Growing corporate market, with maturing focus on productivity.

• Much larger consumer market than it may appear.

• Access to financing improving (cost and terms of debt), but better for larger companies.

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374760391

5,0216,007

Russian ICT Market –November ‘02 study estimated growth to US$ 20 bln by ‘05. New study indicates higher potential.Russian ICT Market –November ‘02 study estimated growth to US$ 20 bln by ‘05. New study indicates higher potential.

Sources: IDC, EITO, ACM, EY estimatesSources: IDC, EITO, ACM, EY estimates

831800

9,228

1,637

7,231

Segment ICT HW Software IT Services Data comm. services Voice telecomCAGR (2002-2005) 16% 22% 21% 20% 5%

Key 2003 Statistics:

• Mobile Subs. / Penetration: ~ 36 million / 25%

• Internet Subs. / Penetration: ~ 12 million / 8.3%

• PCs / Penetration: ~ 16 million / 11%

Key 2003 Statistics:

• Mobile Subs. / Penetration: ~ 36 million / 25%

• Internet Subs. / Penetration: ~ 12 million / 8.3%

• PCs / Penetration: ~ 16 million / 11%

(Figures in US $ Millions)

IT Growth:

• > 20% in 2003

• 15%-20% p.a. expected ’04-’07

IT Growth:

• > 20% in 2003

• 15%-20% p.a. expected ’04-’07

2001 Revenue2001 Revenue 2005 Revenue2005 Revenue

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Russia – ICT hardware: growth across all segmentsRussia – ICT hardware: growth across all segments

Sources: IDC, EITO, EY estimatesSources: IDC, EITO, EY estimates

• Corporate clients lead demand, and regions and retail will also drive future growth.

• E-Russia is promising and undergoing a refocus.

• 4.5 million mobile handsets sold in 3Q03, comparing to 2.5 million in 2Q03 0

1

2

3

4

5

6

7

8

9

10

2000 2001 2002E 2003E 2004E 2005E

End-user telecom equipmentPeripheralsOther (incl. PDAs) hardwareServersPC

.

Hardware Market ‘00-’05E (US $ billions)Hardware Market ‘00-’05E (US $ billions)

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Russia – Software: healthy growth despite piracyRussia – Software: healthy growth despite piracy

0

100

200

300

400

500

600

700

800

900

2000 2001 2002E 2003E 2004E 2005E

System infrastructure

Development & Deployment Tools

Applications

Software Market ‘00-’05E (US $ millions)Software Market ‘00-’05E (US $ millions)

Sources: Business Software Alliance; EY estimatesSources: Business Software Alliance; EY estimates

International “Piracy League”International “Piracy League”

Country 2000 2001 2002

Vietnam 97% 94% 96%China 94% 92% 93%Russia 88% 87% 90%Indonesia 89% 88% 90%Ukraine/Other CIS 89% 87% 90%Pakistan 83% 83% 81%Nicaragua 78% 78% 78%

World average 37% 40% 39%

Software Piracy Rate To compete with pirates, Russian consumer software producers are forced into low pricing, apparently cross-subsidized by other segments: sales of domestic business applications and exports.

To compete with pirates, Russian consumer software producers are forced into low pricing, apparently cross-subsidized by other segments: sales of domestic business applications and exports.

• Software imports have leapt in recent years…

• Local software market also expanding (e.g. 1C, Kaspersky Lab, Parus, Cefei, ABBYY, etc.)

• Software imports have leapt in recent years…

• Local software market also expanding (e.g. 1C, Kaspersky Lab, Parus, Cefei, ABBYY, etc.)

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Russia – IT Services: the key channel still maturingRussia – IT Services: the key channel still maturing

0

200

400

600

800

1000

1200

1400

1600

2000 2001 2002E 2003E 2004E 2005E

Consulting ERP implementation Other implementation

.

IT Services Market ‘00-’05E (US $ millions)IT Services Market ‘00-’05E (US $ millions)

• Service revenues are difficult to measure (rigorous surveys needed)

• Revenues are primarily project-based, with annuity work (e.g. outsourcing) rising slowly

• Significant revenues from ERP implementations, and otherwise in the telecom industry

• Fragmented field, ripe for strategic and financial investment

• Service revenues are difficult to measure (rigorous surveys needed)

• Revenues are primarily project-based, with annuity work (e.g. outsourcing) rising slowly

• Significant revenues from ERP implementations, and otherwise in the telecom industry

• Fragmented field, ripe for strategic and financial investment

Sources: IDC, EITO, EY estimatesSources: IDC, EITO, EY estimates

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Russia – IT exports: rising but could be acceleratedRussia – IT exports: rising but could be accelerated• Niche packaged software (e.g. BUKA, Egar, ) and technology licensing

(e.g. Spirit, Kaspersly Lab)• Offshore programming, leveraging science-intensive strengths, has been

growing at a significant pace. For ease of measurement, we include onshore R&D centers of foreign companies (e.g. Intel, Motorola).

0

50

100

150

200

250

300

350

400

450

500

2000 2001 2002E 2003E 2004E 2005E

Customized software development

Wholly-owned R&D centers

License income

.

Russian Exports ‘00-’05E (US $ millions)Russian Exports ‘00-’05E (US $ millions)

Buka’s PC game, “Steel Monsters” coming in 4th quarter 2004.

Buka’s PC game, “Steel Monsters” coming in 4th quarter 2004.

Sources: IDC, EITO, EY estimatesSources: IDC, EITO, EY estimates

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Russia competes with West on price, and with China/India by adding value using scientific know-how and creativityRussia competes with West on price, and with China/India by adding value using scientific know-how and creativity

Russia can address China’s cost advantages with its skills advantage…

…and by subcontracting to teams in regions where salaries are 50-70% less than in Moscow.

Russia can address China’s cost advantages with its skills advantage…

…and by subcontracting to teams in regions where salaries are 50-70% less than in Moscow.

Source: Aberdeen Group (Nov. 2001) and EY estimates; Pettily Rabin Todd & McGrath (2002) Source: Aberdeen Group (Nov. 2001) and EY estimates; Pettily Rabin Todd & McGrath (2002)

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Case Study 1: Buka – software gaming publisherCase Study 1: Buka – software gaming publisher

• A leading publisher and distributor of games and multimedia products in Russia/CIS, with international sales of its own gaming products (Battle Mages, Fair Strike, Echelon(Storm), Hard Truck).

• Well recognized brand in Russia -- one of 3 major players, controlling ~30% of the market of locally developed products

• Licenses its games in 70 countries all over the world, cooperates with 56 partners, including international publishing companies like Capcom, UbiSoft, Data Becker, Acclaim.

• Well-positioned to raise venture capital.

• A leading publisher and distributor of games and multimedia products in Russia/CIS, with international sales of its own gaming products (Battle Mages, Fair Strike, Echelon(Storm), Hard Truck).

• Well recognized brand in Russia -- one of 3 major players, controlling ~30% of the market of locally developed products

• Licenses its games in 70 countries all over the world, cooperates with 56 partners, including international publishing companies like Capcom, UbiSoft, Data Becker, Acclaim.

• Well-positioned to raise venture capital.

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Case Study 2: SPIRIT – proprietary SW technology developerCase Study 2: SPIRIT – proprietary SW technology developer

• Supplies embedded software products for telecom OEMs (wired and wireless)

• Exports to Japan, Korea, US and Europe -- its software is used in over 50 countries

• Largest eXpressDSP software house in Europe (TI processor sales data)

• Customers include Atmel, Furuno, Hyundai, NEC, Nortel, Panasonic, Philips, Samsung, Siemens, Texas Instruments, Toshiba + 100 other OEMs worldwide

• Looking at options as to restructuring and venture capital.

• Supplies embedded software products for telecom OEMs (wired and wireless)

• Exports to Japan, Korea, US and Europe -- its software is used in over 50 countries

• Largest eXpressDSP software house in Europe (TI processor sales data)

• Customers include Atmel, Furuno, Hyundai, NEC, Nortel, Panasonic, Philips, Samsung, Siemens, Texas Instruments, Toshiba + 100 other OEMs worldwide

• Looking at options as to restructuring and venture capital.

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Case Study 3: Kaspersky Lab – exporter of IT security productsCase Study 3: Kaspersky Lab – exporter of IT security products

• International software product & technology development firm

• Technological leader in anti-virus industry, with largest virus encyclopedia in the world -- offering products for data security

• Its products are available in over 50 countries, and it controls about 80% of the anti-virus market in Russia/CIS.

• World-class experts provide 24/7 technical support, updates of anti-virus database every 3 hours, and guaranteed cures within 24 hours against latest viruses

• Headquartered in Russia, with offices in Europe (UK, France, Netherlands), US, China and well-established multi-level network of over 300 partners.

• International software product & technology development firm

• Technological leader in anti-virus industry, with largest virus encyclopedia in the world -- offering products for data security

• Its products are available in over 50 countries, and it controls about 80% of the anti-virus market in Russia/CIS.

• World-class experts provide 24/7 technical support, updates of anti-virus database every 3 hours, and guaranteed cures within 24 hours against latest viruses

• Headquartered in Russia, with offices in Europe (UK, France, Netherlands), US, China and well-established multi-level network of over 300 partners.

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Case Study 4: EPAM –offshore software developerCase Study 4: EPAM –offshore software developer

• Provides software development and e-commerce/content services to clients in 30+ countries including Fortune 500 and leading software companies (e.g. Merrill Lynch, SAP, Reuters, Compaq).

• Secures cost advantage by combining local and offshore capabilities with market-facing offices in North American and Europe backed by OSD centers in Moscow and Minsk.

• Over 1,000 professionals globally

• Provides software development and e-commerce/content services to clients in 30+ countries including Fortune 500 and leading software companies (e.g. Merrill Lynch, SAP, Reuters, Compaq).

• Secures cost advantage by combining local and offshore capabilities with market-facing offices in North American and Europe backed by OSD centers in Moscow and Minsk.

• Over 1,000 professionals globally