The International Finance Corporation (IFC) and European Bank for Reconstruction and Development (EBRD) recently closed a $138 million project financing for Moscow-area GSM mobile operator Sonic Duo. The operator is a joint venture between Sonera (35%) and local interest LV Finance (65%), through its subsidiary CT Mobile. The deal is something of a Russian landmark ? the first major international bank financing for a Russian telecoms project since 1998's financial crisis.

Hypovereinsbank and Nordea, the Nordic financial services group, are joint arrangers of the EBRD and IFC loans. They are also arranging an export credit facility.

Financing comprises $80 million in multilateral loans. The EBRD and IFC are each providing $40 million, made up of a $24 million A loan and $6 million of quasi-equity from their own accounts, and a $10 million B loan umbrella for the international commercial banks. The quasi-equity instrument features a bullet payment.

The joint multilateral approach is also significant. It suggests, among other things, a stronger interest in mitigating sovereign risk. ?Our dual involvement was really necessary to get this deal done successfully,? says IFC's Lance Crist, principal investment officer for telecoms. ?The way we've tended to approach central and eastern European deals is to team up where the risk concerns are greater, such as for larger transactions. Both institutions have strong and well established relationships with all the players involved ? and each see the strong need to strengthen telecoms infrastructure in Russia,? he adds.

The project's risk profile is reflected in the size of the A loan relative to the B loan: the multilaterals are keeping more debt than they usually would on their books through the A loan portion, given the somewhat constrained commercial risk appetite.

But nonetheless, the commercial banks are back, albeit with heavy cover. Nordea and Hypovereinsbank are each underwriting the $10 million EBRD-IFC B loans. In addition, they are arranging and underwriting a $58 million export credit facility, backed by Swedish agency EKN, and supported by Telefonaktiebolaget LM Ericsson. Nordea and Hypovereinsbank acted through their joint venture International Moscow Bank. Nordea is acting as facility agent.

The EKN guarantee is understood to be for 100% political and 50% commercial risk. The remaining 50% commercial risk is covered by equipment supplier Ericsson.

Tenor on the multilateral debt is 7 years, with the commercial debt also carrying a 7-year term. The deal is apparently priced to reflect the strong role that Sonera has to play in the market. Syndication of the ECA and B loan facilities is expected to be launched soon.

Currency risk is minimized by a ?sufficiently conservative business plan,? as well as a 60:40 debt/equity split. The project has a fairly robust capital structure and is not over-leveraged, and debt service cover ratios are understood to be very strong. The revenue pricing plan, though denominated in roubles, is pegged to the dollar, thereby curtailing currency risk. In addition, says Crist, ?on the macro level, we feel the rouble is unlikely to undergo serious devaluation in the medium term, so currency risk is minimal.? Assuming, of course, no radical shocks to the price of oil.

Says Crist, ?this deal is very important because it sends out clear signals to international lenders that there really is opportunity in the Russian market, and that there is also a way to mitigate the apparent risks and to develop viable businesses throughout the region.?

Raising commercial bank debt for telecoms deals has been difficult over the last year. But doing so in an emerging market poses even greater challenges. ?Our hybrid structure, which pooled risks between multilaterals, commercial banks, ECAs, sponsors and suppliers, is the optimal way to get such deals done in emerging markets,? says Hypovereinsbank's Philipp Meinecke, assistant vice president for telecoms.

Further multilateral involvement in emerging market telecoms deals is likely to be instrumental to their success. Says Crist, ?Our collective participation will continue to be very important, by virtue of the combined risk factors facing these markets, especially the ongoing degree of regulatory risk in many emerging markets in Europe.?

In fact, regulation of the Russian telecoms sector is one of the primary concerns for investors. Above all, the need for an independent regulator to separate policy making and enforcement (or the monitoring of regulatory practices) is seen by many as critical. Further issues to be resolved include deepening the transparency of licensing, as well as establishing a coherent tariff regime.

The current discrepancy throughout the sector between investment costs and return will hopefully lead to a substantial overhaul of the tariff structure, particularly if more foreign investment is required.

The investment supports the construction of Sonic Duo's GSM 900/1800 network, operating under the fledgling Pan-Russian brand Megafon. The latter was formed last year in a bid to create a nationwide operator. The business plan projects total investment over the next 5 years in the region of $250 million, with the rest of the financing coming from local banks and shareholders, in the form of equity and subordinated debt.

Sonic Duo is to build out Megafon's Moscow regional hub, with the rest of Russia divided up between several companies, including Northwest Telecom. The company hopes to acquire 20-25% of the Moscow market within the next three years. But it will face stiff competition from the two incumbent GSM operators, Mobile TeleSystems (MTS) and VimpelCom. The capital is the country's key market ? it has grown from a few hundred thousand users three years ago to over 3 million users. At least 5 million Muscovites will own mobiles by the end of the year.

The operator has been struggling to gain market share for some time. It had been largely constrained, and repeatedly delayed, by lack of 900MHz bandwidth. The government interceded recently, freeing up frequency that has traditionally been the domain of the Russian military.

Sonic Duo

Status: closed February 2002

Location: Moscow, Russia

Description: Financing for GSM mobile telecoms network build-out for a new entrant

Cost: $138 million

Sponsor: Sonera (35%), CT Mobile (65%), wholly owned subsidiary of LV Finance

Debt: $40 million commitments each from EBRD and IFC in the form of $24 million A loan, $10 million B loan and $6 million quasi equity tranche. $58 million ECA tranche

Arrangers: IFC, EBRD, Hypovereinsbank, Nordea

ECA: EKN

Equipment Supplier: Ericsson

Lawyers to lenders: Clifford Chance

Lawyers to multilaterals: Freshfields

Lawyers to sponsor: White & Case