Description

Idea:

Vostok New Ventures is a Swedish Holding co with a 13.3% stake in Avito with 66% upside to my adjusted NAV.

While Vostok is run by respectable managers who are likely to create shareholder value with their other portfolio investments, this is truly an investment recommendation for Avito; Vostok is the only reasonable way to invest in it.

I believe Vostok’s stake in Avito is worth more than the whole of Vostok’s current reported NAV (it is currently marked at 62%); despite little visibility into the Avito financials (private co, Naspers is a co-investor which discloses some additional info), I estimate a 23% IRR of Avito’s value over the long-run.

The Company's last reported NAV was $736mm, so you are buying at a discount today; adjusting for my Avito valuation, I believe NAV is actually ~$1.1 bn. (or 66% upside).

Avito: Avito is the leading online classifieds business in Russia and the third largest in the world which operates across five verticals (auto, real estate, jobs, services, and general) while being the clear market leader in each. Vostok values its stake at $459mm implying a $3.45 bn. EV. I think Avito is easily worth double this.

Avito’s Business Quality

Classified online businesses are the textbook example of a network effect. Additional users bring about a higher implicit value to existing users of the platform as more cars, real estate, jobs, etc. are listed on the site which creates a virtuous cycle. This virtuous cycle, in turn, typically leads to a dominant service becoming twice as large as any other comparable service in its respective market; such a dynamic creates significant user stickiness and results in pricing power (which can be exercised via ad load and ad pricing for certain verticals or via higher subscription rates for others).

Historically, Avito has largely been bucketed in terms of valuation akin to other horizontal classified businesses (such as Blocket and Merktplaatz) that are not necessarily the market leaders in each of their verticals but whose value comes from being a “one stop shop.” The reality, however, is this diversification between each vertical for Avito is not coming at the expense of market domination. Over the past five years, the Company has focused on a strategy of “verticalization” with dedicated organizational heads, dedicated sales teams, and the development of add-on products for each vertical

Avito, today, is simply sub-scale in two of its recently launched verticals, auto and real estate. Over time, Avito will rightfully look more like a collection of specific verticals – with the added benefit of synergies between each. In fact, the grouping of such dominant verticals will serve as one of Avito’s key long term advantage – Avito gets natural economies of scale vis a vis standalone vertical competitors resulting in it being the low cost operator. Avito also is advantaged due to a single point of access for the whole portfolio of verticals – especially for a market like Russia where much of the additional internet capitas will come from a purely mobile point of access – this single point of access will prove instrumental for cementing Avito’s mindshare of consumers (much like a WeChat).

Avito’s Growth Potential

User Growth:

Russia lags significantly behind western countries in terms of internet penetration, with just over 100mm users compared to a population of 143mm (76% penetration rate). The number of internet users grows at around 6% per annum in Russia as a result as wealth naturally increases (though is more cyclical in Russia) and ease of connectivity expands to rural regions.  

Monetization

Avito has a huge monetization gap between other scaled vertical classifieds.

Over time, classifieds naturally garner increased pricing power which can be showcased in a variety of monetization mechanisms – the most common of which are subscription packages for listers (which often include ancillary services) and direct advertising on the portfolio sites. Below, you can see the evolution of this split over time for Avito as a whole. For such subscription based models, pricing comes up directly in-line with the visible ROI that being on the platform provides the lister; for advertising models it is a similar equation with the benefit of the ability to increase ad load for users without lower retention levels (as user stickiness increases over time).

To simplify this gap, the current sales run-rate for Avito is ~$286mm, or $2.62 per internet capita of Russia. This compares drastically with the monetization levels of such peer classifieds as REA (~$20 per internet capita) or TradeMe (~$30 per internet capita).  

Disclosure is thin on revenue breakdown, but in the recent Naspers presentation we get a better glimpse:

On a per user basis, this is how EBITDA has evolved:

Currently Depressed Margins

The Company has two recently created verticals, Auto and Real Estate. Its real estate vertical called domofond.ru – which is akin to a Zillow – launched back in 2014. While it is already run-rating at 112m visits (as disclosed in a 2016 presentation), it should still be considered in the early stages of its ramp and is likely at break-even margins. I believe the auto vertical is similarly at break-even margin.

Due to Avito being a private company, there is limited disclosure, but in a presentation from a year ago, Vostok disclosed both verticals’ annual revenue contribution:

Real estate:

Auto:

As a result, you can back into the scaled vertical margin structure by taking the revenue contribution of the auto and real estate verticals and backing this out from the EBITDA margin calculation. Doing this analysis gets me to a true 70-80% margin for the mature classifieds owned by Avito (I am using year old numbers for auto & real estate contribution compared to the current consolidated run-rate; if you use year-ago comparable consolidated top-line you get to an implied 80% margin):

Valuation

Top-line: The main factors for the top line growth are the number of users and pricing garnered. The user growth is largely a function of Russian internet penetration + increased adoption of the Avito platforms naturally over time. At 6% growth in users from the underlying increase in Russian internet penetration plus a few percentage points of new users from first-time servicing and share attrition, users will grow in the 9-10% range per annum. I expect monetization to run in the mid-to-high single digit range as pricing is improved on a like-for-like basis as the virtuous cycle of these dominant classifieds continue but also as the level of monetization increases (seen by increased ad load, increased paid listings, and the provision of additional “value-added services”) for an annual revenue growth in the range of 17% or so.

Operating leverage: As described, the auto and real estate verticals are currently sub-scale and a drag to the consolidated margin structure. As these near scale and fixed cost is leveraged in Avito’s currently more mature verticals, I expect the ebitda margin to go to a terminal 80%, or about 200-300 bps per annum.

Avito earnings growth: Adding up the above factors, I expect Avito's earnings to CAGR around 19%.

IRR: Just accounting for the earnings that the 13.3% stake in Avito contributes to the consolidated Vostok fund amounts to a current FCF yield of around 3%; so the total IRR of Avito is 22% (with a 5-10 year horizon likely to sustain this rate of growth).  

Assuming five years of compounding at this rate, Avito would be worth $6.35 bn. today (22% annual growth at a PV8) assuming the same exit multiple as the Avito is currently marked to NAV. This would imply that Vostok’s stake, today, is worth ~$845mm.

Appendix 1, Sanity Check:

As a sanity check, some high-level comparisons on a vertical-by-vertical basis (from Vostok's Q3'17 report):

Appendix 2, Reason for Mispricing:

The reason for the divergence between Avito’s value and Vostok’s value is simple, Vostok marks their Avito investment using a peer forward EV/EBITDA analysis, which is wholly flawed.

The company uses 10 companies to get to their peer median FWD EV/EBITDA for use in their NAV build-up but only discloses five of them (REA, Rightmove, Autotrade, Scout24, and 58.com). In Q3’17, this peer group amounted to a median forward EV/EBITDA of 16.3x.

I reached out to IR to potentially get disclosure on the rest, and the answer was:

“The rest of the peer group are the usual suspects when it comes to listed online classifieds but I am afraid I can’t give you any additional names than those listed in the report.”

Regardless of the actual peer set they use – the reality is this multiple (16.3x forward) is too low to use for such a business as Avito on an absolute basis.

The comp list they use is made up of companies which:

1. Are not all entirely similar businesses – operating mostly in more mature markets
2. Have been fully scaled in their respective vertical and as a result have no significant margin expansion potential
3. For the most part encompass just one vertical with no extraneous growth expenses

Clearly the case calls for a more sophisticated analysis than just using Vostok’s peer valuation methodology. I think a key reason for their converatism is that it is in their best incentive to keep the HoldCo stock at a depressed price so they can repurchase shares cheaply:

HoldCo share repurchases: Given Vostok’s managers are currently finding little opportunity for new portfolio investments, they have recently begun repurchasing shares of the fund with excess cash. As long as this dynamic continues expect a share contraction in the range of 3% or so.

Appendix 3, Large Unconsolidated Cash Balance at Avito

Another lever to the valuation, though I do not adjust for this, is the fact that Avito has a large net cash position that is not consolidated on Vostok’s balance sheet.

You can roughly back into this by taking a look at Naspers’ disclosure. Naspers bought a stake in Avito back in October 2015 and at the time described how their valuation was based on a $2.7bn valuation inclusive of $240m of cash at the Avito level. I assume a certain cash conversion from EBITDA (60%) and add that to $240m to get to a current Avito cash level of $380m.

Catalyst

• Additioinal share repurchases effectively below NAV
• Eventual IPO/Sale of Avito or other portfolio companies