Investment Kinnevik AB (KINVB:SS)

Recommendation: Buy

Market Cap: SEK 71,294mm (US$11.5bn)

Upside: 400SEK+

Downside: 230SEK

Executive Summary

Kinnevik is a Swedish holding company with core holdings in Millicom (38% of NAV), Tele2 (17% of NAV), Modern Times (6% of NAV), and other publicly listed holdings collectively representing 2/3’s of NAV.  For 10+ years, Kinnevik has been investing in technology-based businesses, which today represent the remaining ? of NAV. The Upside Case valuation for Kinnevik lies in the unlisted holdings valuation potential, especially Zalando.

Investment Structure Options

Millicom, Tele2, and Modern Times (depending on position size) are large/liquid enough to short, so any/all of those slices of the Kinnevik NAV can be hedged out to create “Kinnevik Unlisted” exposure, if desired.

This note will address the investment merit of Kinnevik based on the Zalando IPO alone. Later notes will address the investment merits of Kinnevik major holding stakes, aiding in the hedge/no hedge decision.

Catalyst

For many years, Kinnevik and the market have been very conservative in ascribing value to Kinnevik’s non-listed technology holdings, typically carrying them at investment cost or at 1-2x sales (both the market and the company in its publication of its NAV estimate).

However, the recent success of Zalando, now the largest European e-commerce company  is poised to change that perception.  Should Zalando, through an IPO process this spring/summer, achieve the same 3-5x sales multiple now enjoyed by publicly traded peers (such as Asos Plc), the revaluation of Zalando could raise the NAV of Kinnevik by 50-150SEK all by itself, a potential 55%+ return.

• On Feb 14, 2014, the WSJ reported that Zalando’s owners have begun talking to Goldman, Morgan Stanley, and JP Morgan about a potential IPO of Zalando.

• Recent communication with IR indicates that a Zalando IPO is likely a 4Q2014 or 1H2015 event.

• Addition by Subtraction: Management is also looking at selling/spining/disposing all legacy assets (except MIllicom), which is another path towards unlocking the Zalando discount.

Background: Rocket Internet/Kinnevik Relationship

Rocket Internet, a German Internet VC company of which Kinnevik owns 24%, is the platform through which Kinnevik built its Internet holdings.

Background on Rocket Internet

Rocket Internet GmbH is a German online startup incubator founded in Berlin in 2007 by the Samwer brothers (Alex, Marc, and Olivier) who had made early fortunes founding Alando (a German version of Ebay) and Jamba!, which were sold to Ebay and Verisign for $50mm and $270mm, respectively. On the heels off those successes, they founded Rocket Internet in 2007.  The company's business model is to identify successful internet ventures from other countries (often the United States) and replicate them in predominantly emerging markets. To repeat, they do not attempt to innovate or invent business models - they copy successful business models (typically American ones).

• Rocket Internet starts/launches companies and handles all the admin initially (hiring, design, marketing, etc.) and

• Rocket lets the individual companies manage the business with best-practice input from Rocket Internet.

• Rocket relies on superior execution and market understanding to succeed. This becomes very evident when comparing the different businesses: Zalando and Zalora (and all other Zalando clones) have almost identical websites, product ranges, shopping carts, etc.

In July 2013, Rocket Internet raised $400 million from an investor syndicate led by Russian billionaire Leonard Blavatnik, Swedish investment firm Kinnevik, and J.P. Morgan. This is in addition to over $1 billion that Rocket raised in 2012. Today, Kinnevik’s 24% stake makes them the principal investor in the group.  Rocket has 15,000 employees in 40 countries serving a global client base and has made over 75 investments. Kinnevik has the right of first refusal in Rocket’s investments and mainly has invested in Rocket’s transaction-based ventures.

Zalando represents the “crown jewel” of Rocket and Kinneviks technology-based investments thus far. In addition, however, Rocket Internet’s other ventures span the globe, with solid positions on every populated continent. The main investments groups are:

• 35% of Bigfoot I (Dafiti, Lamoda, Jabong and partly Namshi)

• 39% of Bigfoot II (The Iconic, Zalora, Zando and Jumia)

• 26% of BigCommerce  (Lazada, Linio and partly Namshi)

Nearly all of these investments are in e-commerce, aligned with Rocket’s strengths and skill-set. Financial details are scarce, but none appear IPO-ready at this point.

Kinnevik reports the proportional part of revenues for its unlisted portfolio:

Kinnevik - Unlisted online investments as of Q4 2013

Among the best ways to gauge the strength of these unlisted technology businesses is the recent success these co’s have had raising additional rounds of capital from the VC marketplace:

• Dafiti: Online shopping in Brazil.

• Raised $70mm from Ontario Teachers (sole investor in round). Brings total capital raised to $225mm to date.

• Raised $10mm from Leon Group (Mexican Shoe consortium) earlier in 2013.

• Lamoda: Online shopping in Russia.

• Last round raised $130mm, June 2013 led by Access Industries (Blatvanik), Summit Partners, Tengelmann Ventures.

• Previous round “between $40 and $80mm”, led by JP Morgan, Sept 2012.

• Jabong: Online shopping in India.

• Raised $100mm in Jan 2014, led by Rocket. Other investors include CDC. (Note e-commerce is nascent in India, at just 0.5% of total market).

• Zalora: Online shopping in Southeast Asia (Singapore, Indonesia, Malaysia, Brunei, the Philippines, Thailand, Vietnam, Taiwan and Hong Kong).

• Last round raised $100mm, June 2013, led by Rocket, including Summit Partners, Kinnevik, Verlininvest, Tengelmann Ventures.

• Prior round: “significant $10+ mm” by JP Morgan, March 2012.

• Prior round: $26mm by Tengelmann Ventures, March 2013.

• Zando: Online shopping in South Africa.

• Jumia: Online shopping in Africa.

• $35mm from Millicom, June 2013

• $26mm from Summit Partners, 2012 (Series A funding).

• Linio: Online shopping in South America and Mexico.

• Last round raised $50mm, November 2013.

• Lazada: Online shopping in Southeast Asia (Indonesia, Malaysia, Thailand, Philippines, Vietnam).

• Raised $130mm, June 2013 ($236mm total).

• Namshi: Online shopping in MIddle East.

Rocket’s intentions for this portfolio is probably best summed up by this quote, taken from techcrunch.com:

“We have been building companies for the last 15 years in the internet space. We have long-term investors like JP Morgan and Summit and Kinnevik,” Rocket Internet co-founder Oliver Samwer told me in an interview at the time. “What they all share are two things: They are very long term oriented, and they are very international. They have a global perspective. The one benefit that we have is that we feel and think very much the same way they do. We start from scratch, and we have created sustainable companies, long-term investments where it is up to us to choose the route to liquidity.

Zalando – IPO Ready Value Driver

Zalando targets the European retail market (EUR $500bn+), where online currently only accounts for ~7% of total apparel spending. Kinnevik has invested in Zalando in several stages, bringing its stake to 38%, (29% directly and 9% via Rocket Internet), for which it paid SEK 5.6bn.  Zalando operates in 14 European markets: Germany, Austria, the Netherlands, France, Italy, the UK, Switzerland, Belgium, Sweden, Spain, Denmark, Finland, Norway and Poland. Roughly half of Zalando’s revenues are from shoes and half are from outside of Germany.

Asos Plc is the most comparable publicly traded company to Zalando, itself a pure-play e-commerce company with an emphasis on apparel. While ½ the size of Zalando on a sales basis, Asos is profitable with an estimated 2014 EBITDA margin of 14%, while Zalando, for whom detailed financials are not available, was reported by Kinnevik to have a -6% EBITDA in its annual update (Note that Zalando is EBIT breakeven in its core markets of Germany, Austria, and Switzerland). Heavy investments in proprietary logistics centers are likely impacting margins as well.  Kinnevik has referred to “ramp up costs” for Zalando in its reporting, but did not quantify these costs.  Since detailed financials are not available, it is impossible to know what if any accounting policies might be adversely affecting Zalando’s margins. Zalando’s upcoming IPO prospectus will likely shed more light.

Setting aside profitability measures of valuation for now, note that Asos Plc trades at 5x and 4x 2014E and 2015E revenues, respectively. The table includes revenue projections for both Zalando and Asos, as well the projected valuation per Kinnevik share of Zalando only at 3x and 4x Revenues per share valuations.

Zalando Revenue Projections, Euro’s (Source: Goldman)

The table above shows the potential value per Kinnevik share of ZALANDO only assuming Zalando is able to achieve an EV/Sales on par with Asos.

Zalando accounts for 51 SEK/share of Kinnevik today, at Kinneviks conservative 2x trailing sales valuation.

KINNEVIK NAV MODEL

Notes to NAV Model

(a) Includes A & B shares.

(b) Includes holdings in: BillerudKorsnas AB, Black Earth Farming, CDON Group, Transcom Worldwide, Seamless Distribributors.

Note that the Unlisted Holdings valuations employ a highly conservative 1-2x sales or cost-basis valuation method, on a case-by-case basis.

Next Steps/Open Issues:

• Kinnevik is in a quiet period as the Zalando IPO is prepared (not that information flowed freely before the IPO “leak”. The 2013 Annual report was the first time any metric of Zalando’s profitabilty was shared, and to-date only annual sales growth data has been available).

• Kinnevik’s CEO Mia Brunell Livfors announced in January 2014 she is stepping down after 20 years with the company. She is staying on till a replacement is found.

• March 14, 2014 - Kinnevik invests $90mm in Quikr, an Indian Online and mobile Classified Ad’s company, makes its 2nd (confirm) technology investment outside of Rocket Internet. Other investors included: eBay, Omidyar Network, venture capital firms Matrix Partners India, Nokia Growth Partners and Norwest Venture Partners.