Description

Highly recommend reading gocanucks97’s write-up from 2014, as much of the business is still the same with respect to search, penetration, Russia risks, etc. Link here: https://valueinvestorsclub.com/idea/YANDEX_NV/6285400819

In this write-up we don’t delve too deeply into specifics on Yandex's business model, rather we focus on two key drivers that the market appears to be missing. 

SUMMARY

Yandex is an attractive business with significant barriers in both its core search and e-hailing taxi segments. Two recent laws were enacted in December of 2019, which will significantly increase the strength of Yandex’s competitive advantage, and appear likely to meaningfully increase the earnings power of both businesses. 

The first law implemented requires pre-installation of Yandex applications on all smartphones, computers, laptops, Smart TVs, and tablets in Russia beginning July 1st of this year. The effect of which will likely be a significant expansion of Yandex’s search market share, with mobile market share increasing to 55-60% over the next 2 years (from 50% in 2019), and desktop market share increasing to 70%+ (from 68% in 2019). We believe this will result in a re-acceleration in search revenue and a decrease in distribution Traffic Acquisition Costs (TAC), driving our base case revenue & EBITDA estimates +10% and +20% above consensus, respectively. 

The second law implemented requires drivers for e-hailing taxi aggregators to register as self-employed, giving them the ability to work with the taxi aggregators directly, instead of through a taxi fleet middleman. The Russian market historically has operated differently from most countries in that e-hailing companies like Yandex.Taxi and Uber used taxi fleets due to cost-prohibitive regulations. The new law effectively disintermediates taxi fleets, which historically accrued ~25% of each ride’s commission. This ~25% will now accrue to Yandex, which drives our base case EBITDA estimates +40% above consensus. 

We see +40-60% upside over the next 1-2 years given what we believe are reasonable assumptions, with recent history as a gut check, outlined below.

THESIS DETAIL

1. Regulatory boost to Yandex’s search market share – we’ve seen this play out before.

In 2017, Russia’s Federal Antimonopoly Service (FAS) ruled that Google was anticompetitive in forcing users to use Chrome by default. The FAS settlement required a dialog box to pop up in Chrome for existing Android users, prompting the user to choose their default search engine. The settlement also made it easier for Yandex to strike deals with smartphone OEMs to preinstall Yandex apps on the home screen. As a result,  Yandex’s Android market share (based on sessions) increased from 38% to 55%, and Yandex’s total search market share increased from ~55% in 1Q17 to ~58% today. 

Due to market share gains, Yandex core Search revenue accelerated from +19% y/y in 2017 to +23% y/y in 2018 and +22% y/y in 2019E. Concurrently, from 2Q17 to 3Q18 incremental EBITDA margins in the Search segment were ~55-80% (avg. ~70%). This drove Search segment EBITDA margin expansion from 46% in 2017 to 50% in 3Q19

This year, a more impactful law will come into effect on July 1st of this year. It requires Yandex applications to be installed on all smartphones, laptops, tablets, computers, and SmartTVs. The bill was signed into law by Putin in December of last year, and per industry conversations, Russia’s Ministry of Communications has confirmed Yandex’s placement earlier this month. 

The advertising TAM in Russia is approx. ~$9bn with low digital penetration (~45%). Penetration has been increasing at approx. 3pts per year. Consensus forecasts are for this trend to generally continue, but we believe there is incremental upside from a recent price hike in linear TV CPMs, which we’ll leave out of this note for sake of brevity. If we take market forecasts of ~17-18% digital advertising growth, and ~19-20% search-based advertising growth, and assume ~4pts of Yandex search share gains, this would imply Yandex search revenue grows at a +24% CAGR from 2019-2021E.  Current consensus has growth decelerating to +17% over the same period. Our assumption of market share gains is driven by 7pts of mobile share gains & 2pts of desktop share gains.

Perhaps more pronounced than the impact to revenue is that to margins. Search inherently has high incremental margins, but due to the new law, Traffic Acquisition Cost (TAC) paid to distribution partners will likely see a larger benefit than that to the topline. 

Conversations with Yandex partners suggest TAC as a % of Owned & Operated (O&O) Search revenue will decline by approx. 3pts, from ~8% of O&O Search revenue to ~5%. We take a slight haircut and assume a 2pt benefit to TAC and 2pts of opex leverage (with the rest re-invested), which yields EBITDA margins expanding from ~48% to ~51% over the next 2 years and total Search EBITDA ~20% above consensus estimates. 

Our base case implies ~58% incremental EBITDA margins over the period compared to consensus estimates of ~49% incremental margins, and ~70% incremental margins over the prior period when YNDX benefited from the FAS ruling. Given the FAS ruling primarily impacted revenue and the new law impacts TAC, incremental margins should arguably be even higher. Assuming 70% incremental margins yields 2021 EBITDA ~30% above consensus.

2. An e-hailing Taxi business that’s profitable? When the government is on your side and creates a virtual monopoly, yes.

Yandex was early to the e-hailing taxi market in Russia, and prior to Uber entering the market, it enjoyed 60%+ EBITDA margins. However, after Uber entered, a multi-year price and subsidy war ensued, driving margins as low as -276% in 3Q17. The battle was ultimately resolved in 2018 with Uber & Yandex.Taxi completing a merger, which virtually created a monopoly. 

Yandex has since increased its average commission from ~12% in 2016 to 20%+ today, while steadily removing subsides over the same period. From our conversations with the company and taxi fleets, we estimate that Yandex’s net take-rate is currently ~18% and EBITDA margins are ~20%. This is obfuscated in company filings by investment into food delivery and autonomous driving, with segment EBITDA barely breakeven. 

The Russian taxi market has historically differed from most countries, in that aggregators (e.g. Uber & Yandex.Taxi) work with taxi fleets rather than individual self-employed drivers. Taxi fleets employed the drivers, allowed them to use the fleet’s taxi license, and in exchange took 25%, or ~5pts, of the drivers’ ~20% commission. Why would anyone want to work with a taxi fleet and pay ~5% instead of getting their own taxi license and working directly with an aggregator like Yandex.Taxi? The reason was due to a complicated regulatory process for individuals to register as “entrepreneurs.” And even if an individual registered as an entrepreneur, it was cost-prohibitive to obtain a taxi license, and they would have to pay higher taxes than they would have to otherwise by working with taxi fleets. 

This dynamic changed in December of 2019 when a law was put in place implementing a tax system for individuals to register as “self-employed,” opposed to “entrepreneurs.” Yandex was a significant force behind the legislation as there was a clear opportunity to disintermediate the taxi fleet middlemen and capture the incremental ~5% of GMV. Legislators also saw a significant opportunity for new tax revenue, as drivers who worked for fleets wouldn’t typically report all, or any, of their income. It is a win-win-win scenario for drivers, Yandex & the government, but a big loss for taxi fleet owners. 

We have spoken with several taxi fleet owners, a few of whom were top 10 Yandex partners at various times in the last 5 years. All of the taxi fleets we have spoken to have already shut down operations, or are in the process of shutting down. They noted that now the only legal way for a driver to work with Yandex.Taxi is to register as self-employed. There is no longer a place for taxi fleets, and as a result, an incremental 5% of GMV at a 100% margin will be flowing through to Yandex over the next 2 years as this transition takes place.

Given these tailwinds, there appears to be a clear path to 30%+ margins over the next 2 years. Consensus estimates 13% consolidated Taxi margins by 2021, but things get murky when trying to do a comparison. Currently, Yandex embeds food delivery and autonomous driving within the Taxi segment, making it difficult for investors to assess the profitability of the e-hailing business (hence the opportunity). However, the company is planning to IPO the taxi business and give additional disclosure, which we expect to act as a meaningful catalyst for realizing the value of the core e-hailing asset.

RISKS

• Currency: YNDX reporting currency is in Rubles, but it trades USD. Translation effect can be brutal (e.g. 2018). 

• Country: This can easily turn into a debate on whether Russia is investible, as we can see what effect Sanctions can have on the market or the always perceived threat that Putin may wake up and decide the state should control <insert business name here>.

• Competition from e-hailing new entrants, such as Citymobil (backed by MAIL). Cash burn is an issue for them given Yandex’s size and near-monopoly position

• Tiktok / Bytedance: A risk that needs to be monitored closely. Thus far search ad budgets are not shifting, and social budget (e.g. VK * FB) hasn’t suffered, but that doesn’t mean we won’t someday see a BIDU-like scenario play out.

VALUATION

• Base Case SOTP: $68/share

• 18x 2021E Core Search EPS of $2.85 yields ~$51/share

• Yandex’s 59.3% stake in Yandex.Taxi valued 22x our 2021E Base Case EBITDA, or 1.3x 2021E GMV yields ~$15/share. Note that our Taxi valuation is relatively in-line with sell-side, though our estimates are significantly higher.

• No value ascribed to Classifieds or Yandex.Market

• ~$2 net cash

• Consolidated multiple

• YNDX is trading at ~14x consensus EV/FY20 EBITDA, which is a little less than a turn below its 3 & 5-year historical average (range of 9x to 21x). 

• Applying 14-15x to our Base Case consolidated 2021E EBITDA estimate implies $76-82/share.

Catalyst

• Search market share gains (you can follow daily by monitoring radar.yandex.com/search)

• Additional Taxi segment disclosure and Yandex.Taxi IPO