Contingencies, Commitments and Operating Risks

Political and economic conditions in Kazakhstan

The economy in the Republic of Kazakhstan continues to display some characteristics of an emerging market.  These characteristics include, but are not limited to, the existence of a currency that is not freely convertible outside of the country and a low level of liquidity of debt and equity securities in the markets.

Additionally, the telecommunication sector in Kazakhstan is impacted by political, legislative, fiscal and regulatory developments in Kazakhstan.  The prospects for future economic stability in Kazakhstan are largely dependent upon the effectiveness of economic measures undertaken by the government, together with legal, regulatory and political developments, which are beyond the Group’s control.

The financial condition and future operations of the Group may be adversely affected by continued economic difficulties that are characteristic of an emerging market.  Management is unable to predict the extent and duration of the economic difficulties, nor quantify the impact, if any, on these consolidated financial statements.

Legal proceedings

The Group is party to certain legal proceedings arising in the ordinary course of business. In the opinion of management, there are no current legal proceedings or other claims outstanding that, upon final disposition, will have a material adverse effect on the financial position of the Group.

Taxation

Kazakhstani tax legislation and practice is in a state of continuous development and therefore is subject to varying interpretations and frequent changes, which may be retroactive.  Further, the interpretation of tax legislation by tax authorities as applied to the transactions and activities of the Group may not coincide with that of management.  As a result, transactions may be challenged by tax authorities and the Group may be assessed additional taxes, penalties and interest.  Tax periods remain open to retroactive review by the tax authorities for five years.

The Group’s management believes that its interpretation of the relevant legislation is appropriate and the Group’s tax, currency legislation and customs positions will be sustained. Accordingly, at 31 December 2012 no provision for potential tax liabilities has been recorded (2011: nil).

Government investigations

During 2010-2012 the Company was subject to a number of investigations by various government authorities aimed at a reduction of the Company’s roaming tariffs and elimination of the roaming threshold:

(i) Roaming threshold investigation

In 2010, the Company was subject to an investigation by the Agency of Competition Protection of the Republic of Kazakhstan (the “Agency”) related to alleged infringement of the antimonopoly legislation by GSM operators of CIS countries.

On 3 July 2010, the Agency filed a protocol based on respective conclusion to an administrative court charging the Company with impingement of consumers’ rights by setting threshold for the subscribers’ minimum cash balance to access roaming services.

The claimed penalty amount was 15,783,472 thousand Tenge calculated as 10% of the Company’s total revenues generated from 1 January 2009 to 31 March 2010.

After several claims and counterclaims filed during 2010, the Company was able to defend its position and conclusion of the Agency was cancelled by the judgment of the court of cassation and entered into legal force immediately.

The Agency filed a claim to higher court instances and in August 2011, the Supreme Court returned the case to the first instance for additional investigation. On 24 August 2012, the Almaty Administrative Court ruled in favour of the Company and terminated the proceedings. The Agency is, however, entitled (but not obliged) to file a petition to the Prosecutor’s Office of Almaty or General Prosecutor’s Office seeking reinstatement of the case via Prosecutor’s Office or General Prosecutor’s Office protest.

The Company believes it will be able to defend its position as it believes that setting such threshold for prepaid subscribers was in line with market terms and is not considered to be expression of dominant position of the Company.  The Company’s management believes that current legislation does not contain any restrictions on setting the thresholds for access to roaming services.  Accordingly, no provision has been recorded in these consolidated financial statements as of 31 December 2012 (31 December 2011: nil).

(ii) Roaming tariffs investigation

The Agency has also performed an examination of the Company’s roaming tariffs for the period from 1 January 2009 to 31 March 2010.  Based on the results of the examination, in November 2010, the Agency issued a protocol on administrative violation alleging the Company misused its dominant position through setting overstated roaming tariffs for subscribers from the Russian Federation. The Agency applied to administrative court to initiate the administrative case. 

The claim amount was 15,783,472 thousand Tenge, calculated as 10% of the Company’s total revenues generated during the examined period, plus revenues from roaming services for the year 2009 of 2,554,940 thousand Tenge.

After several claims and counterclaims filed during 2010, the Company was able to defend its position and conclusion of the Agency was cancelled by the judgment of the court of cassation, which entered into legal force immediately.

In February 2011, the court of first instance ruled in favour of the Group with respect to the investigation of roaming tariffs.  The Agency filed a claim to higher court instances and in January 2012, the Supreme Court returned the case to the first instance court for additional investigation.

On 1 March 2012, Specialized Inter District Administrative Court of Almaty ruled to terminate the administrative case against the Company for lack of elements of offense. Even though the Agency has a right (but not the obligation) to appeal through the General Prosecutor’s Office, the Company believes that it has not violated any laws and regulations with respect to roaming tariffs.

The Company believes that it has not violated any laws and regulations with respect to roaming tariffs.  The Company has been consistently reducing its roaming tariffs recently and taking other measures in this respect.  Management is confident that the Company’s position will be fully sustained. Accordingly, no provisions have been recorded in these consolidated financial statements as of 31 December 2012 (31 December 2011: nil).

(iii) Preliminary examination of relationships with cash payments service companies

The Company has received the Resolution of the Agency on preliminary examination of the antimonopoly legislation violation dated 22 June 2012. In accordance with the Resolution the Agency considers charging the Company with violation of the antimonopoly legislation in respect of relationships with cash payments service companies, which primarily operate self-service terminals.

In November 2012, the Agency completed the investigation. On 13 November 2012, the Agency issued an order for the Company. In its order, the Agency requested that the Company cease its violation of antimonopoly legislation by 4 December 2012 and notify the Agency of its remediation with the order by 10 December 2012. The Company has provided its response to the Agency, asserting that the Company is in compliance with antimonopoly legislation.

If the Agency challenges the Company’s position, it may issue additional instructions for the Company to cease its violation of antimonopoly legislation and assess a fine in the amount of approximately 3,236 thousand Tenge.

The management believes that no provision should be recorded in these consolidated financial statements of the Group as of 31 December 2012 as the Company believes that it has not violated antimonopoly legislation and that the allegations against it are unfounded.

 (iv) Investigation on alleged concerted action in setting and maintaining excessively high Interconnect tariffs

In late 2012, the Agency initiated an inquiry into a potential violation by the Company of antimonopoly legislation. Specifically, the Agency alleged that the Company and Kar-tel (Beeline trademark), as dominant market participants, engaged in concerted action in setting and maintaining excessively high interconnection tariffs, which were aimed at weakening their competitors, and  determined to launch an investigation. However, by its Resolution dated 7 January 2013, the Agency appointed an expert examination to be carried by the Ministry of Communication and Information of the Republic of Kazakhstan to assess the interconnect rates applied by Kar-Tel and the Company, with a breakdown of all costs attributed by them to this service.

If, in the course of its investigation, the Agency determines that the Company violated antimonopoly legislation, it may assess penalties in the amount of 10% of total revenue generated for the period during which the violation occurred, and may seek the confiscation of income earned as a result of the monopolistic activity (subject to the limitation that the period for which the confiscation of income is sought may not exceed one calendar year). Currently, it is not possible to quantify the amount of penalties to be sought, because the Agency has not yet determined certain key factors required to calculate the amount of penalties such as the period during which the possible alleged violation occurred.

As the Company has received only the Resolution on appointment of the experts, which does not constitute any further legal proceedings and used for decision making of the Agency for further actions whether to terminate the case or impose the fine,

the management believes that no provision should be recorded in these consolidated financial statements as of 31 December 2012.

Capital expenditure commitments

At 31 December 2012, the Group has contractual capital expenditure commitments in respect of property, plant and equipment totalling 4,285,230 thousand Tenge (2011: 2,608,078 thousand Tenge), mostly related to purchase of telecommunications equipment from Ericsson and ZTE Corporation.

Non-cancellable lease commitments

Where the Group is the lessee, the future minimum lease payments under non-cancellable operating leases are as follows:

In thousands of Kazakhstani Tenge 2012 2011
Not later than 1 year 4,800,000 4,162,000
From 1 to 2 years 4,840,000 4,200,000
From 2 to 3 years 4,780,000 4,300,000
Later than 3 years 760,000 4,300,000
Total non-cancellable lease commitments 15,180,000 16,962,000

Non-cancellable lease agreement is represented by the Telecommunication Services Agreement on lease of transparent communication channels and IP VPN network with Kazakhtelecom (Note 6) and a five-year fibre optics lease agreement with KazTransCom JSC for amount of 2,655,000 thousand Tenge.

Acquisitions and Investments

(i) Memorandum of understanding with Sonera

On 26 August 2012, Sonera and the Company entered into a memorandum of understanding (the “Buy and Sell MoU”), under which the Company has the right to require Sonera to sell to it, and Sonera has the right to require the Company to acquire from it, all participatory interests owned by Sonera in KazNet Media LLP (“KazNet”) together with all rights and obligations of Sonera under a framework agreement to buy all the participatory interests in the charter capital of KazNet (refer to “WIMAX Business Acquisition by Sonera” below) and all the participatory interests owned by Sonera in Rodnik Inc LLP (“Rodnik”) together with all rights and obligations of Sonera under the agreements to buy participatory interests in the charter capital of Rodnik (refer to “Investment in Rodnik Inc LLP by Sonera”).

Subject to satisfaction of the applicable conditions, each of Sonera and the Company is entitled to exercise its option at any time starting from nine months after the date of the offering of global depositary receipts and listing on local stock exchange, 13 December 2012. The purchase price that the Company will pay to Sonera for the acquisition resulting from the exercise of the option will be the amount of net cost incurred by Sonera in connection with the corresponding investments and acquisition transactions plus interest accrued on such amount.

Sonera has the right to terminate the Buy and Sell MoU at any time by serving a written notice to the Company.

Unless otherwise agreed by Sonera and the Company, exercise of these options is conditional upon Fintur having consented to, authorised or voted in favour of the acquisition to be made by the Company as a result of the exercise of such right.  In addition, completion of the acquisition contemplated by the exercise of options is subject to law, regulation and any requisite approvals.

Sonera has the option to sell (the “Put Option”) and the Company has the option to buy (the “Call Option”) the participatory interest. Strike price of both the options equals net costs incurred by Sonera, annually compounded using the interest rate (interest accruals begins when the costs are incurred or the receipts are cashed and ends when the participatory interest are transferred).

Neither the Put Option nor the Call Option can be exercised without the authorisation of Fintur. While Sonera owns more than 50% of the participations in Fintur, the minority holding has the power to block any significant transactions.

The contractual right of Sonera to sell the underlying assets (debt and equity interests and related rights and obligations) to the Company is a financial instrument (derivative). The agreement requires that the equity instruments will be transferred to the Company at their fair value (i.e.: at the future acquisition cost), so management of the Company believes that the value of the options is close to nil as the net costs incurred by Sonera equal to the fair value of underlying shares acquired.

Subsequent to this, the fair value of the option may change based on the variations in the value of the underlying businesses. Although the option is contingent upon Fintur’s approval, this will be reflected in the fair value of the option.

The value of the Company’s option to acquire the assets is nil as Sonera completed the acquisition on 14 January 2013, and the purchase price agreed at fair value at the date of transaction. In addition the exercise of the option by Kcell is conditional upon Fintur having consented to, authorized or voted in favor of the acquisition, that is currently not the case and also the option is not exercisable until 2014.

 (ii) WIMAX Business Acquisition by Sonera

On 13 August 2012, Sonera entered into a framework agreement with a third party to buy all the participatory interests in the charter capital of KazNet for a total consideration of US$170 million. The acquisition was completed on 14 January 2013.

As a condition precedent to Sonera’s purchase of the participatory interests in KazNet, KazNet acquired two limited liability partnerships in Kazakhstan, namely Aksoran LLP (“Aksoran”) and Instaphone LLP (“Instaphone”). Aksoran and Instaphone each holds certain radio frequency permits that are capable of being deployed for the operation of a WIMAX business in Kazakhstan. The KazNet group will own and operate a WIMAX business in Kazakhstan.

(iii) Investment in Rodnik by Sonera

Sonera negotiated an agreement with a third party to acquire 25% of the participatory interests in the charter capital of Rodnik.  Rodnik owns 79.92% of the total share capital of KazTransCom JSC ("KTC"). 

The purchase price for acquisition is US$20 million, subject to adjustments to be made based on the amount of net debt of Rodnik and KTC at the time the acquisition is completed.

On 13 August 2012, Sonera entered in a call option agreement with a third party under which Sonera has a call option to acquire another 75% participatory interest in Rodnik.  Pursuant to the terms of that call option agreement, the call option exercise price will be calculated based on fair market value of the participatory interest in Rodnik.

The acquisition of 25% of the participatory interests in the charter capital of Rodnik was completed on 14 January 2013.

Volatility in global financial markets

The ongoing global liquidity crisis which commenced in the middle of 2007 has resulted in, among other things, a lower level of capital market funding, lower liquidity levels across the banking sector, and, at times, higher interbank lending rates and very high volatility in stock markets.  The uncertainties in the global financial market have also led to bank failures and bank rescues in the USA, Western Europe, Russia, Kazakhstan and in other regions.  Indeed the full extent of the impact of the ongoing crisis is proving to be impossible to anticipate or completely guard against. The volume of financing has significantly reduced from August 2008 for economy as a whole.

Debtors of the Group may be affected by the lower liquidity situation which could in turn impact their ability to repay the amounts owed.  Deteriorating operating conditions for debtors may also have an impact on management's cash flow forecasts and assessment of the impairment of financial and non-financial assets.  To the extent that information is available, management have properly reflected revised estimates of expected future cash flows in their impairment assessments.

Management is unable to reliably estimate the effects on the Group's financial position of any further deterioration in the liquidity of the financial markets and its increased instability.  Management believes it is taking all the necessary measures to support the sustainability and growth of the Group’s business in the current circumstances.

Anti-monopoly legislation

On 18 October 2011, the Agency issued an order mandating inclusion of the Company in the State Register of Dominant and Monopolistic Entities of the Republic of Kazakhstan (the "State Register") in respect of certain services provided by the Company, including interconnection services. The Company challenged its inclusion in the State Register in a lawsuit initially filed to the Specialized Interdistrict Economic Court  of Astana in October 2011. The case was remitted to the Board of Appeals of the Astana Court for examination. On 3 January 2013, the Board of appeals of the Astana Court ruled to appoint expertise.  The Astana Court will schedule the further hearings when the experts provide their conclusion. Unless the court decides the Company is not considered as included in the State Register.

If the Company does not prevail on appeal it will remain on the State Register and its tariffs for interconnection services will become subject to regulation by the Ministry of Transport and Communication (the "Ministry"). The Ministry can reduce the Company’s interconnection tariffs, while interconnection tariffs of other mobile operators that have not been included in the State Register would remain unregulated.