“When there is blood on the streets, buy property”
— Baron Rothschild, 18th century British nobleman
Given the situation in Russia and the recent sanctions, I have been trying to look for undervalued opportunities there. I am looking at a relatively limited set of companies (only those with ADRs traded in the US), but I think that is a good way to limit risk. This give me some comfort they are reasonably solid companies, something you cannot readily assume in general and specifically when it comes to investing in Russia.
I made a small investment in Gazprom (OGZPY) recently, primarily because the valuation is very very compelling (about 3x EBIT and 2.5x EBITDA), but I wanted to take a further look at Yandex (YNDX), which I see as a much more exciting company with very significant prospects.
Company: Yandex (YNDX)
Summary Investment Thesis: (1) Yandex is the leading search player in Russia with significant, stable market share and one of the few credible global alternatives to Google. (2) Continued internet penetration and online marketing spend in its core markets will provide the Company with tailwinds for several years and (3) the expansion beyond Russia has a lot of potential. (4) The company is generating significant cash flow and has been returning a meaningful portion to shareholders. (5) The valuation is high, but reasonable given the Company’s growth prospects and market.
(1) #1 Search Engine in Russia and Leading Global Search Player: Yandex has over 60% market share (of visitors) of the Russian search market. Google’s (GOOG) push into the market back in 2006 and 2007 took dramatic share from leading portal Rambler (see Page 7 of this presentation), but Yandex share has remained incredibly steady. It is hard to compete with Google, but for the last several years, Yandex has been doing it successfully in its home market.
There are basically three players of meaningful global scale in Internet Search: Google, Baidu and Yandex. Bing.com and Live.com from Microsoft (MSFT) get competitive global rankings on Alexa, but I find it hard to argue they will be a powerful force in the future. I am purposely omitting the major portals (Yahoo, etc.), which of course play in search, because I do not think search is part of their USP and I do not think they are likely to be the ultimate winners. Mail.ru should be mentioned by exception since it could pose a threat to the Company. With under 10% of market share in search however, I do not think it will be a major issue and they seem more focused on going down the social media route than on leaning on search.
(2) Tailwinds in Core Russian Search Market: Internet penetration in Russia today is at about 60%, compared to over 80% for most developed markets. 60% penetration is equivalent to the internet penetration in the US back in 2001-2002. This alone would imply over 30% growth in the underlying market over the next 10 years, and as a larger proportion of the audience is reached, advertising spend should switch dramatically to online. Even in the US today where internet penetration from a user standpoint has largely ‘run its course’, online ad spend still continues to grow significantly taking share from print, radio and (surprisingly, only a very little bit from) television.
(3) Turkey and Other International Opportunities: The Russian business should be enough to sustain the valuation, but there is a significant amount of optionality in expanding the business outside of Russia. That would make the Company a truly global player and a real alternative to Google. Yandex is the #2 search engine in Turkey, a large and fast growing market which is also enjoying the tailwinds of increased internet penetration. They currently have only about 2% market share, but have a stated push to get to 20-30% market share in the next few years. Needless to say, achieving that goal would be great for the Company’s prospects. I like is focused on actionable, achievable goals which would create lasting long term value, but it should be noted that increasing market share from 2% to 20% is a tall order and it remains to be seen if it can be achieved. The Company also has significant traffic in many of the former soviet republics, which are quite sizable economies and behind the curve on internet adoption. While somewhat speculative, I think their emerging market focus is key to what making this investment one with exciting prospects.
(4) Share Buybacks: Yandex’s operations are very cash generative. While there is a need for significant capital expenditures (and we should expect this to continue, certainly while the Company continues to grow), the Company has more recently demonstrated some commitment to shareholder value by spending significant amount of money buying back shares. The current level of buybacks may be above what is sustainable, but I like to see the Company taking advantage of a choppy market to buy back some shares.
(5) Valuation: I like to make investments which are attractive from an absolute value perspective. I prefer investing in a company where the earnings yield is material enough such that if there is no multiple expansion and earnings don’t grow materially, I still earn an acceptable return. This investment does not meet that criteria, but it does represent a case where I would expect the earnings to grow materially. The valuation has decreased dramatically this year, despite the Company continuing to grow and deliver strong results, I suspect as a result of the current situation in Russia.
I usually think of an earnings yield of 5% (a PE of 20x) as a minimum requirement to consider an investment for the long term. Yandex trades at about 25x earnings, which is 25% too expensive given that threshold, but given the coming uplift in penetration in Russia should raise the Yandex audience by over 30%, I think this is justified. Furthermore, it is relatively early days for Yandex in terms of optimizing the firms revenues and profits, something which Google has demonstrated can have a lot of power.
Conclusion: From a value standpoint, it is always hard to quantify how much we should “pay for growth”. I think Yandex represents an opportunity to buy a leading search franchise while paying a much lower premium for the upcoming growth of the business. It seems fairly likely that at the current valuation, the earnings will “grow into” a 2ox PE by 2015. Yandex is a good example of Growth At a Reasonable Price, if only because you have to take the risk of the political turmoil around it.