Investor sentiment for Russia’s largest search engine was bearish heading into earnings with Russia’s economy expected to be flat for the year, the worst performance since 2009. International sanctions linked to the Ukrainian conflict have taken their toll. Additionally, Google, Yandex’s largest competitor in Russia and neighboring Eastern European counties, reported slowing growth earlier in the week. Yandex released Q3 earnings results today and to the surprise of many, the company posted strong numbers.
Analyzing the Numbers
Yandex reported Q3 revenues of RUR13.1B ($331.5M), up 28% YoY. Russia still accounts for the majority of Yandex’s business as the international segment accounted for only 7% of revenues. Yandex exposure to the geopolitical tensions between Russia and Ukraine is nominal as approximately only 1.5% of total revenue is generated from Ukraine.
The Russian Ruble depreciated a staggering 17% against the USD during the third quarter which is why revenues translated to USD have declined. The struggling Russian macroeconomic environment and economic sanctions have had marginal effects on Yandex operations thus far. If this continues, it serves as a de-risking feature for Yandex which resumes execution despite surrounding turmoil.
Mobile continues to be a point of emphasis for Yandex as 23% of searches came from mobile devices, which also accounted for 16% of total revenue for the quarter. This trend is expected to become a larger component of operations. Yandex appears to be well prepared for the shift towards mobile as the company has allocated much of their development costs towards mobile applications.
Full-year 2014 ruble-based revenue is expected to grow 27%-30% YoY, narrowed up from the prior 25%-30% guided last quarter.
Yandex reported an operating margin of 34.4%, up 260 basis points from Q3 2013 figure of 31.8%. Cost control was the main reason for this margin expansion as the company saw cost of sales, as a percentage of revenue, decline YoY by 200bp. Additionally, SG&A expense, as a percentage of revenue, came in at 14%, the lowest level ever.
The only proportionate cost that increased YoY, as a percentage of revenue, was product development. Product development costs increased, as a percentage of revenue, from 14% in Q3 2013 to 16% in Q3 2014. This increase is reflected by the greater headcount (166 employees added during Q3) as Yandex continues to invest in new products like Auto.ru and ADFOX.
Yandex has shown the ability to manage its costs of sales and SG&A, while allocating more funds towards investments like product development that are expected to deliver top line results in the near future. This is a sign of excellent management team and cost control.
Yandex ended the quarter with $1.1 billion in cash and cash equivalents. During the quarter, Yandex repurchased 600,000 shares (equating to 0.2% of total S/O) out of the total 3M shares in the authorized share repurchase program. Additionally, Yandex repurchased $50M of 1.125% convertible debt for a discounted value of $45.6M.
Looking ahead, I expect Yandex to continue adding value to shareholders through further repurchases of convertible debt and share buyback. The company has an approximate $500M of convertible debt and 2.4M shares remaining in the current repurchase program. An already strong cash balance and the ability to generate positive cash flows will ensure that the current methods of financial engineering are continued.
Google’s Struggles Not Applicable to Yandex
Google (GOOG) stock nearly reached its 52 week low earlier this week after reporting disappointing Q3 earnings. The street was expecting Google to report around 22% YoY growth in paid clicks. Google’s actual figure grew 17% YoY, the slowest pace in six years. This, coupled with the concerning trend of a falling cost per click (Google reported -2% YoY) had Wall St questioning the growth of Google’s bread and butter; online advertising.
Yandex, on the other hand, reported a 19% YoY growth in paid clicks and 8% YoY growth in cost per click (see below).
The slowing growth in paid clicks can be attributed to the struggling Russian economy. However, even with a far from ideal macroeconomic setting, Yandex saw a rise in what advertisers were willing to pay per click, something Google has seen declining in the last two years. Despite the challenging macro environment in Russia, Yandex expects YoY growth to be in the 27%-30% range.
When compared to other search giants, Yandex can be considered a value play.
Yandex is seeing greater growth and higher margins than competitor Google, yet is being valued at similar multiples. Not to mention that Google’s margins have deteriorated from the mid 30% back in 2010 to low 20% now. Yandex, for comparison sake, have stayed relatively flat in the mid-low 30% range.
Yandex is not seeing the same growth figures as the Chinese Baidu (roughly 50% top line growth). However, Yandex has been growing at a rate ~ 30%, which is nothing to be discounted for. When it comes to multiples though, Yandex receives much lower metrics than Baidu.
Market Punishes Yandex in the face of Geopolitical Tensions
As a result of the conflict between Russia, Ukraine and the Western nations, Yandex has seen share price reach depressed levels. The company boasts strong growth that should continue with expansion internationally and into mobile. Moreover, margins are expected to remain constant with active cost controls and shareholders will see returned value through financial engineering. Yandex Q3 results demonstrated that the Russian search giant could be seen as a defensive stock that will continue to successfully maneuver despite the economic turmoil in areas it operates.