Ben Aris in Moscow -

Despite the fast growth of the Russian economy, Svyaznoy's own business of selling mobile phone handsets was running out of steam. So, modelling itself on the UK's Tesco, it has decided to leverage its store network by becoming a bank too.

The first sectoral reform that the Kremlin tackled in 2000, telecommunications is probably the most mature of all Russia's consumer sectors. SIM card penetration is already well over 200%, making Russia by far the biggest mobile phone market in Europe and Svyaznoy controls about a quarter of all the sales of handsets, against its main rival Euroset's 50% share. The two dominate the handset business whereas in most other consumer segments in Russia the largest companies only control a few percent of the total.

Selling phones remains good business, with sales climbing by a steady 10-12% a year, or 38m-39m phones a year, says Dennis Ludovsky, CEO of Svyaznoy. But these days most of the profits come from people trading in their old phone for a smart phone and the add-ons that go with them, like mobile internet access.

With Svyaznoy's core business maxing out, in the last few years management was casting around for a way to leverage its huge retail network of 3,000 stores in 760 cities. The company had already gone down the obvious route of servicing phone bills and selling tablets or netbooks in its stores, but before the 2008 economic crisis broke it took a more radical turn by tying up with KIT Finance to offer financial services.

A phone bank

A medium-sized bank, KIT was growing very fast before the 2008 crisis, offering increasingly sophisticated financial services like online trading and mortgages to Russia's burgeoning middle class. The crisis nearly killed the bank, but not only has it recovered, it paid off all its debt early.

Concentrating on small and medium-sized enterprises, a bank like KIT doesn't want to go to the trouble and expense of setting up a vast retail network (it only has one branch), and take on the retail banking giants of VTB24 or Sberbank directly. But that is not to say it isn't interested in getting hold of some of those retail rubles. The joint venture it has set up with Svyaznoy would be the third largest retail bank in Russia if Svyaznoy's stores were re-classed as bank branches, meaning KIT can tap this network at little cost and less risk, while Svyaznoy gets a piece of some new action. "It might look a bit opportunistic, but it makes perfect sense," says Ludovsky. "We have already issued 1m credit cards and can offer very aggressive interest rates, as our cost base is so much lower than that of the established retail banks."

Svyaznoy has already expanded into utility and phone bill payments, and since it started selling non-government investment funds, known as PIFs in Russia, it has already become the third biggest player in the nascent mutual fund business.

The retail branches are not the only thing Svyaznoy has leveraged. As nearly every Russian has a mobile phone, traipsing down to the store to top up your account has become routine for the vast majority of people, so Svyaznoy enjoys 92% brand recognition. As such, in a country where most people remain extremely wary of financial services, Russians trust the company, as they are used to paying it money. "We have a very sexy offering for a bank with no retail network of its own," says Ludovsky, who says Svyaznoy has modelled itself on the UK's Tesco supermarket and Carphone Warehouse.

Last year, the company was toying with the idea of an IPO to raise the financing needed to expand the financial services part of the business (phone sales remain a cash rich part of the business). But rough market conditions in the second half of 2011 made that impossible and, like its main rival Euroset, these plans have been frozen for the meantime. "We are turning to private equity, as in the current market conditions this makes most sense," says Ludovsky.

In February, reports said that Svyaznoy plans to sell a 20-30% stake by April to raise about $300m for the development of the related banking unit, and has hired Deutsche Bank and Raiffeisen Bank International to find investors. Ludovsky tells bne Svyaznoy has already had several offers of investment from both Russian and international investors.

There are advantages to a private equity structure, Ludovsky explains, in that selling a private equity story is a longer process and so the potential investor is willing to spend more time listening, meaning the story can be sold on its own merits. Also the structure of the deal is more flexible so that pricing the company can be linked to the returns that the investment is expected to make.