Description

Thesis Summary

Ozon is the number two ecommerce player in Russia, a country experiencing a rapid shift toward online commerce.  While Wildberries currently claims the title of ‘number one’, there are signs which suggest Ozon has the potential to become number one in the next decade.  Logistics have historically been under-developed in Russia and Ozon is building a system which will eventually provide material competitive advantage.  In recent years, great strides have been made under the leadership of Alexander Shulgin: the company has built a meaningful 3P business, become number two in ecommerce, entered new business categories and begun its journey in fintech.  At a $10.5 billion starting market valuation, USD returns in the mid-twenties through the end of the decade are possible, even without becoming the leading ecommerce platform. 

Business Overview

Ozon is known as the “Amazon of Russia,” having started as an online book seller in the late 1990s.  After years of middling performance, perhaps because it was too early and perhaps because of management issues, Ozon began to grow rapidly in recent years and has compounded GMV at 70% in the five years through 2020.  It has been privately backed by reputable firms, including Baring Vostok and Index Ventures and went public on Nasdaq in late 2020.  The company currently has 18.4 million active buyers and is well on its way to exceeding 20 million by the end of 2021, which is approaching 50% of all active ecommerce buyers.  Combined with already strong unaided awareness, Ozon appears well on its way to building one of the top consumer internet brands in Russia. 

Alexander Shulgin

Alexander was 43 at the time of the Ozon IPO.  He spent 13 years at Coca-Cola Hellenic between 1997 and 2010, becoming CFO of the company’s Russian division.  Coca-Cola Hellenic is now a GBP 9 billion public company and Russia is its largest volume country.  Alexander moved to Yandex as their CFO in 2010 and became CEO of the company’s Russian division (vast majority of the business) in 2014.  During his time as CEO, the Russian business nearly doubled to RUB 87.5 billion of revenue ($1.2 billion).  In late 2017 he was named CEO of Ozon.  1P GMV will have more than tripled in his first four full years at Ozon and the company will have launched a 3P business from scratch which will exceed 60% of total GMV in 2021.  Ozon has been highly successful under his leadership after years of mediocre performance.  The major strategic steps during this period are all decisions investors would broadly support.  Even if not an inspirational founder, Ozon seems well managed under his leadership.  Alexander is well incentivized and at the IPO owned 2.56 million shares (via vested options and RSUs), which would now be worth $128 million.    

Business Opportunities

• The biggest opportunity for Ozon is to simply capture a modestly growing share in a country rapidly adopting ecommerce.  Russian ecommerce penetration remains well-below peer countries.  From current levels, the ecommerce market could grow 5x through the end of the decade if penetration reaches 35%.  With more mature markets quickly approaching those levels in 2021, this seems a reasonable possibility.  By the end of 2021, Ozon will have captured 10% of the domestic market and its share will have grown 4x in six years.  Projections contemplate a 25% market share in 2030 for Ozon, which leaves considerable room for a comparably large competitor. 

• Ozon may be behind on capturing the fintech opportunities available to it, but it is making early progress.  Russia is a well-developed banking market with strong fintech competition like TCS (perhaps unlike SE Asian or LatAm ecommerce peers in recent years), but it still seems the opportunity is meaningful even if Ozon is not the next TCS.  In six quarters since launch, Ozon Card has penetrated 5% of buyers and we estimate a high single digit percentage of GMV.  Additionally, Ozon’s first merchant product (a flexible working capital product) penetrated 5% of the seller base in just its first quarter.  The company recently bought a small bank and is embarking on building deeper solutions in merchant finance and payments.    

• Grocery and fast delivery are scaling quickly around the globe and Russia appears no different.  Ozon began investing in its ‘Ozon Express’ (grocery and one hour delivery) in Moscow late in 2020 and GMV from Express reached 10% of the company’s Moscow total by the end of Q2 2021.  It has invested considerable dollars in logistics and dark stores to build this business and recently moved beyond Moscow to St. Petersburg.  Management has described its efforts here as “aggressive.”

Business and Financial Considerations

• Ozon GMV growth is in the top echelon of companies globally and has averaged 134% year-over-year the last six quarters.  Q2 2021 GMV growth against surging sales induced by COVID in 2020 reached 94%, among the highest in the world.  FY 2023 expected growth at 64% by Goldman Sachs far exceeds their comp set, including names like Sea, MercadoLibre, Coupang, etc.

• Order frequency is growing rapidly but remains low at fewer than 7 purchases per buyer the last 12 months (Polish ecommerce leader Allegro is already at 26).  Active buyers (purchased within last 12 months) on Ozon exceeded 35% of all ecommerce buyers in Russia in 2020, a number likely to grow much further this year with buyers already up 33% YTD. 

• Logistics are a material consideration for the P&L and for Ozon’s moat.  Russian third-party logistics services have not developed adequately in recent decades and Ozon could not rely on Russian Post.  While Ozon had begun to leverage its logistics costs per order through Q4 2020, the recent surge in spending and expansion of Ozon Express has resulted in deleveraging of this line item.  Projections and returns are particularly sensitive to assumptions on logistics costs, but properly scaled will be a material barrier to entry and competitive advantage, potentially even versus another large competitor.     

• Ozon built a large 3P business in just two years after multiple prior attempts and success here has positioned Ozon to compete well against Wildberries.  3P GMV is now 62% of the total and rising.  3P GMV grew at 155% in Q2 versus 1P growth of 39% and active sellers have almost doubled in just the first 6 months of 2021.  Gross margin rose more than 10% in less than two years as the 3P business has scaled.  It has enabled a large and growing advertising business which is already 2% of GMV and growing at more than 100%.        

• Current operating losses are large and expected to continue for multiple years and even contribution margin is negative (GP minus F&D).  To put the scale of investment into perspective, Ozon’s pre-tax loss in Q2 totaled RUB 15.3 billion which is an approximate run-rate of $800 million versus its current market cap of $10.6 billion.  For comparison, in the immediate aftermath of the .com crash in early 2001, Amazon had a market cap of $3.7 billion after just reporting a $480 million loss.  Ozon currently holds $1.7 billion in gross cash – nearly 2 years of current run-rate operating losses – against a $750 million convertible note that converts at approximately $86 per share.  Even accounting for $150 million per year in capital expenditure beyond current D&A, Ozon seems positioned to fund these losses, considering it should benefit from meaningful working capital flows and moderating losses. 

As previously noted, Ozon holds $1.7 billion in gross cash against a $750 million convertible and run-rate operating losses of approximately $800 million.  The convertible is priced at 1.875% and is due in February 2026, a year after current project profitability in 2025. 

While we’ve not made quarterly projections, analysts expect H2 2021 operating losses of RUB 26 billion and our projections now contemplate RUB 70 billion of operating losses and RUB 18 billion in interest expense from 2022 through breakeven.  In USD this would be $1.57 billion of losses to come before breakeven.  Combined with the prior projection of $150 million in incremental cap ex for three years, Ozon has approximately $2 billion in cash needs before breakeven which is just slightly more than its current cash of $1.7 billion.

If we’re conservative, Ozon should generate meaningful WC cash of RUB 70-90 billion through 2024.  In USD at the mid-point that would be $1.1 billion.  While it might put Ozon in a tighter position in the future, it seems the company should be able to fund itself to breakeven with its current business plan while also potentially handling repayment of the convertible if needed.

Competition and Landscape

Wildberries is top of mind when it comes to considering the landscape in Russia given that it is twice the current size of Ozon.  AliExpress and Yandex are multiples smaller than Ozon, and, of the two, Ozon shareholders should be more concerned about Yandex which has made considerable investments into its ecommerce business the last 12 months.  Sberbank and TCS also have ambitions in ecommerce but are tiny and are quickly being left behind. 

Wildberries has half the average order value and is believed to have a product mix skewed considerably to clothing and fashion.  At the time of IPO, Morgan Stanley (MS) estimated Wildberries had nearly 2x the SKU count in apparel and Ozon had more than 2x the non-apparel SKU count.  Goldman noted that Wildberries was making progress in diversifying its business, but that fashion and apparel were 50% of GMV in Q2 2020.  In products outside apparel, Ozon may be comparable in GMV size to Wildberries given that less than 10% of its mix was in that category through Q3 2020.  Ozon also appears to have considerably more un-aided brand awareness as this Q2 2020 chart from Ozon shows.

Logistics are tough to compare and possibly shifting, but are worth considering.  At the time of IPO, MS estimated Ozon led Wildberries in number of own pick-up-points (PUPs) but that Wildberries had twice the PUPs including partners.  Ozon has increased its pick-up-points by 50% since IPO.  MS further estimated that Wildberries had 300k sq m of fulfillment space and Ozon had 225k.  By the end of 2021 Ozon expects to reach nearly 400k on its way to 1 million.  These comparisons don’t appear to tell the whole story as Wildberries logistics didn’t seem up to the challenge of surging Q4 2020 volumes, while, by most accounts, Ozon passed the test.  Ozon also recently began offering third-party logistics services to other ecommerce players which is clearly a testament to the strength of their system. 

Talent seems to be an issue for Wildberries.  The company underwent a highly publicized fight with engineering talent and dealt with a mass exodus in 2020.  Tegus calls have suggested the company lost nearly 2/3rd of its engineers and is struggling to compete against the top tier in attracting talent, which includes Ozon.  While Wildberries may have political connections which could bolster its prospects and provide certain advantages, the company doesn’t appear to be properly capitalized and might not be functioning at the same level as Ozon.  Wildberries also appears more focused on geographic expansion despite its recent issues and Ozon’s aggressive growth in its core market.  It isn’t surprising that Ozon is growing faster. 

There is a low probability Amazon meaningfully enters Russia at this point, unlike many of the European countries which investors must contemplate.  Politics, geography and existing market synergies all play a role in this assessment.  This strengthens the thesis relative to other European ecommerce platforms.    

Moat

Scale – While Ozon is currently number two in total GMV, there are emerging and improving scale benefits.  Admittedly some of these benefits would also be available to Wildberries.  The quantum of logistics investment at Ozon requires massive scale and order density to prove economic – especially in a 1P model.  There are few ecommerce companies that can reasonably deploy such capital and Ozon is one.  An ability to price aggressively, but profitably, also tends to be possible at scale for ecommerce platforms.  Goldman did a modest price study at the time of IPO which is shown below.    

Network Effects – Ozon has network effects in several areas.  Most importantly there are cross-side network effects in its marketplace business - given what can now be called a successful 3P business, Ozon can credibly claim these network effects.  The more buyers that shop on Ozon the more attractive is its platform to sellers, which improves selection which makes the platform more attractive to buyers. Improving S&M spend, cohort frequency, cohort retention and NPS all point to measurable network effects.  There are other areas of network effects (in varying importance) in areas like logistics and product reviews. 

Brand – Ozon may already lead in unaided awareness and there are anecdotal suggestions that Ozon is viewed as the modern general ecommerce platform.  Top ecommerce platforms become first choice destinations for consumers.   

Valuation and Return Potential

A mid-twenties USD return over a long period of time seems attractive relative to the risks and rewards, even in Russia.  This is particularly true when you consider the possible strength of the moat in a few years. 

Two other scenarios are summarized below:

• Reducing the terminal multiple from 35x to 20x reduces the IRR to 18.5%.  Despite what could be a high-quality, growing business in 2030 (EPS growing above 20%), Russia suffers from high government bond yields and often low P/E ratios for even leading companies.  Such a reduction in multiple is not out of the question. 

•  A more dire scenario would be to consider what would happen if Ozon is unable to properly scale its logistics costs per order.  Assuming only modest progress on cost per order and a terminal assumption of RUB 277 per order (50% plus higher than base case), Ozon would be little more than break even.  At 50% lower revenue and a 1x revenue multiple (along with additional dilution from capital raises), it would be hard to achieve more than a breakeven outcome.

 For reference on market cap and multiple potential it is worth thinking about some of the large key businesses in Russia.  

Russia Overview

Russia is a country with 146 million people (nearly 70% of the size of Brazil and nearly 8x the size Kazakhstan).  The country is well-endowed with natural resources, including oil and gas, which drive a large portion of its economy.  In 2019, the World Bank estimated oil and gas rents were 12% of GDP (Kazakhstan 15%, Brazil 2%, Norway 7% and the US 0.4%).  Politically, it has antagonized western interests across a variety of dimensions – notably cyber.  It has been aggressive outside its borders, including in Ukraine and Georgia.  During a long holding period we can expect multiple surprises geopolitically.  President Vladimir Putin seems intent on “ruling” Russia as long as he is alive.  This introduces potential risks and opportunities for the politically connected in the Russian economy, while raising questions about what happens when he is succeeded.

 A few additional highlights:

• Population growth has not exceeded 20bps the last several years and total population remains below the peak in 1993 – demographics are poor and suggest a decline in population through 2030

•  Real GDP grew 2.2% on average from 2017 through 2019 (almost half the rate of Kazakhstan)

•  Following a period of material FX depreciation in 2014/2015, the Rubble has fallen by 3% per year relative to the USD

•  CPI climbed at a rate of 4.3% per year from 2016 through 2020

•  2019 official debt to GDP was 19.5% in 2021 – among the lowest in the world

•  Budget deficit as a percent of GDP averaged 0.5% in 2015 through 2019 – with meaningful swings driven by oil and gas

•  Russia has operated with a current account surplus generally – which was 3.9% of GDP in 2019

•  Government bond yields are high in Russia.  The 10-year was recently quoted at 7.3%.

Risks

•  Russian politics and relations with the West could deteriorate even further.  Ozon is a high-profile company and is listed in the US.  It could become a target for Putin or become subject to the nationalistic considerations that have effected some of the Chinese companies listed here.  Russia could decide to become more aggressive with its territorial ambitions or cyber warfare. 

• FX, like in most EM countries, could prove problematic.  While we’ve incorporated a 4% annual decline in the RUB/USD exchange, it is likely to come in dramatic periodic episodes and could be more than contemplated.  There have been large RUB devaluations in the past.

•  Russia, and by extrapolation Ozon, are driven by oil and gas prices.  An investment in Ozon is in part a long bet on these commodities in a world trying to shift away from them.  Large moves in oil and gas can cause macro and banking issues in the country.

•  Competition is meaningful and Ozon is currently number two in terms of GMV.  While we believe Ozon will at least be a credible top two competitor, we’d prefer to start in the lead.  The signs suggesting Ozon could eventually become number one might be transitory or less meaningful than they appear.

•  Potential Wildberries political connections may be meaningful and are a wildcard.  This could have unexpected negative and positive implications for the competitive landscape.  While it doesn’t seem productive to destroy one of the country’s most visible and successful technology companies that has a global investment audience, anything is possible.

•  Margin potential is unproven and logistics costs, while critical, are particularly challenging to model.  There is some leap of faith that meaningful logistics investments will prove to be high ROI investments.  Our projections contemplate more than a 50% decline in F&D costs per order the next decade.  We estimate F&D costs would total 43% of GP dollars in 2030.  For comparison purposes, MS models Amazon (the best modeling we’ve seen on Amazon) to spend 27% of GP dollars in 2027 down from 37% in 2020.    

SimilarWeb Comparison

•  Ozon has more unique visitors and de-duplicated audience, but Wildberries has higher visits driven by greater frequency

•  Audience trend is now consistently higher for Ozon with the gap perhaps starting to widen slightly

•  Consumers spend significantly more time on Wildberries, but Ozon is improving significantly and Wildberries is trending lower

•  Ozon bounce rate had historically been significantly higher, but it is making rapid progress while Wildberries is flat at best

•  The pages per visit gap is also narrowing, though Wildberries maintains a lead

•  Ozon has a small but meaningful lead in exclusive visitors

•  Wildberries skews significantly more female versus the population, while Ozon is more representative

•  App install trends favor Ozon, though Wildberries has a better MAU base

Catalyst

• Ongoing GMV growth 
• Perception that losses have peaked - and leverage with F&D costs