As I researched two articles on Yandex (NASDAQ: YNDX), the “Russian Google,” one local competitor kept coming up again and again: Mail.ru (Other OTC / Grey Market: OTC:MLRYY). As many readers will have no idea about either company, MLRYY competes with YNDX to some degree across almost all internet verticals, but is a smaller company:
Notice the green highlight? MLRYY grew revenues 45.6% last year – although a lot of that growth was due to acquisitions – compared to 37.4% for the better-known YNDX. That deserves further investigation. Furthermore, MLRYY’s 29.2% EBITDA margin was slightly better and, although largely the result of some special situations at YNDX, the smaller company reported higher net income.
Is it worth taking a look at MLRYY? Well, most data suggest that about 100 million of Russia’s population of about 145 million are internet users. That’s a pretty big market – and that’s not counting Russian-speaking former U.S.S.R. countries.
A Brief History: A Fencing Champion and Russian Oligarchs
MLRYY is a survivor; emerging from the dark mists of the Internet twenty years ago. In 1995 Russian émigré Eugene Goland founded DataArt, a U.S.-based software engineering firm. A group of Russian programmers working for DataArt created an internet mail service (hence, the “mail.ru” name) which formed the core of Port.ru, a company founded in 1998 by Eugene Goland, Michael Zaitsev and Alexey Krivenkov. In 1999, Port.ru received a venture capital investment from Baelstra Capital Fund, led by financier and fencing champion James Melcher. Other venture capital investments followed. By 2000, Port.ru had created a number of verticals including Mail.ru, Base.ru, Travel.ru, Postcards.mail.ru, List.mail.ru, Talk.ru and Rating.port.ru.
Port.ru’s attempts to finance development of e-commerce, a search engine and other initiatives ended with the loud pop of the dot-com bubble. In 2001, Yuri Milner, today, according to Forbes, “Russia’s most influential tech investor,” but then leading a small internet incubator called NetBridge, orchestrated a merger with Port.ru assisted by Igor Linshits, who had helped form parts of Lukoil (OTCPK: LUKOY), changing the name of the company to Mail.ru and becoming CEO.
In 2003, Milner resigned as CEO, but remained as chairman, and formed Digital Sky Technologies (“DST”), an internet venture capital company. In 2006, Linshits sold his stake in Mail.ru to Tiger Fund and DST for an amount reportedly in excess of $100 million. In 2008, Alisher Usmanov, a billionaire Russian oligarch and – interestingly – president of the Fédération Internationale d’Escrime, the international governing body of fencing, also became a shareholder.
In September 2010, the company merged with DST, adopted the Mail.ru Group name and Dimitry Grishin, founder of Grishin Robotics, joined the company as CEO. In November, MLRYY went public on the London Exchange, raising approximately $912 million, implying a total valuation of $5.7 billion.
In March 2012, Milner stepped down as chairman and from the board of directors. CEO Grishin was named chairman. At this point, the company had attained its present corporate structure and direction.
An Ecosystem: Spaghetti Against the Kitchen Wall
“Ecosystem” is a current buzzword describing theoretically interrelated businesses that act to support and supplement each other. It is especially popular among internet companies as it lends a rationale, however specious, for any set of internet verticals and ancillary businesses thrown like sticky spaghetti against a kitchen wall. That brings us to MLRYY.
When you visit mail.ru you are visiting the central portal for everything the company does; the kitchen wall that connects all that sticky spaghetti. Here’s what you see translated into English:
As you can see, there are headings for verticals like email, games, dating and news. So that we can gain a better understanding of the company, I’m going to review and grade each major business segment. Note that what I’ve identified as business segment does not line up exactly with MLRYY’s financial reporting.
Email Services: No.1 in Russia
Email was the company’s original raison d’etre. Although now diversified, the company still operates the largest free email service on the RuNet, the “Russian Internet” – those domain names ending in “ru.” MLRYY’s free email includes unlimited mailbox size, attachments up to 20 GB, antivirus and antispam protection, etc. Although the company claims to be one of the “top five global email services by daily audience,” its 100 million active accounts make it a bit-part player on the world stage. In terms of accounts, Google’s (NASDAQ: GOOG, GOOGL) Gmail is generally acknowledged as No.1 in the world with over 1.5 billion, but the combined market share of Apple’s (NASDAQ: AAPL) iPhone, iPad and Apple Mail is higher in terms of installed email clients.
In Russia, based on email accounts, statistics suggest MLRYY is No.1 with 48.7%, Yandex is No. 2 with 32.5% and Google is No.3 with 13.6%. By any standard, however, the company’s email service is state-of-the-art. Here’s the first informational sign-up splash page in English:
Email is not a high-growth product. According to Palo Alto, California market research firm Radicati, the number of email accounts grew about 6% to 7% and the number of email users grew about 3% per year from 2015 to 2019. Radicati expects the number of email users to continue to increase at a slow but consistent 3% per year through 2022.
MLRYY’s cloud storage product, Cloud Mail.ru, is part of the Email Services segment. A relatively new consumer-oriented service, Cloud Mail.ru provides users with cloud storage for all popular mobile and desktop platforms. The Email Services segment also includes Search Mail.ru, since 2013 MLRYY’s in-house developed search engine. Search Mail.ru is No.3 in the Russian search market, but this means little as, according to Russian SEO firm AURORA, its market share to date in 2020 was hovering around 2%.
E-commerce: No.1 in Food Delivery in Russia
MLRYY was late to the e-commerce party, but, with new partners state-controlled Sberbank (OTCPK: OTCPK:SBRCY) and Alibaba (NYSE: BABA), is poised for real progress. The company’s e-commerce segment includes Delivery Club, the largest online food delivery platform in Russia, Citymobil, a taxi and ride hailing service, Youla, a “location based” marketplace and Pandao, a cross-border e-commerce platform.
The fragmented e-commerce market is growing rapidly in Russia. According to an article entitled “Russian E-Commerce Market Grows by 26%” in the September 3, 2019, edition of The Moscow Times:
Russians have embraced e-commerce, which is growing ten-times faster than the real economy and traditional retail. Online sales currently account for about 4.5% of Russia’s total retail turnover, but that has been more or less doubling every year in recent years and is on course to make up 8% of retail turnover by 2021.
Perhaps due to the legendary winters, food delivery is increasing in popularity in Russia. Statista estimates that the Russian food delivery market will increase at a 12.6% annual growth rate from revenues of $1.9 billion in 2019 to $3.0 billion in 2023. Delivery Club holds the No. 1 market share among independent food delivery businesses. According to a Deloitte CIS Center report, in 2019 restaurant-owned delivery accounted for 63% of the Russian food delivery market with Delivery Club and Yandex.Eats following at 31% and 26%, respectively. The Delivery Club platform serves over 12,000 restaurants in over 120 cities with 90% of orders per day made from mobile devices. With their lime green uniforms, Delivery Club’s staff are ubiquitous in Russian cities.
Delivery Club is growing rapidly; revenues increased about RUB 2.5 billion or 131.2% from RUB 1.9 billion in 2018 to RUB 4.4 billion in 2019.
Delivery Club and Citymobil, MLRYY’s taxi and ride hailing product, received a boost through a joint venture finalized November 19, 2019 with $482.7 billion-asset Sberbank, Russia’s largest bank. Sberbank is in the process of creating, predictably, “an ecosystem of convenient online services in different areas for any life circumstances.” The bank partnered with Yandex to create Beru.ru, an e-commerce website, but amid rumors of partner conflict, choose MLRYY for food delivery and transportation services.
The 45% – 45% joint venture (10% reserved for compensation), called O2O for “online-to-offline,” will be funded with RUB 47.0 billion in cash plus an additional RUB 17.6 billion contingent on KPI’s being met by November 2020 – a surprisingly short period. About 80% of the total possible cash investment of RUB 64.6 billion will be provided by Sberbank. In terms of businesses, MLRYY’s major contributions were Delivery Club – the prize – and its 29.7%-ownership in Citymobil (and a promise to up its stake to 80% before deal close). Sberbank contributed its 35% share in SberFood, an online restaurant reservation and payment service. Per MLRYY’s November 19, 2019 Press Release, cash investment in the joint venture will be used “to drive organic development, consolidate assets and fund potential transactions in the food-tech and mobility segments that are complementary to the existing O2O businesses.”
In a separate, but related transaction, Sberbank acquired 35% of the ownership stake of MF Technologies, a government-controlled digital economy incubator, in MLRYY for RUB 11.3 billion, giving the bank a small 1.82% ownership position but 20.3% of the voting rights in MLRYY. Three years after the creation of O2O, Sberbank has the right to request the approval of MLRYY’s board of directors and shareholders for an exchange of Sberbank’s share in O2O at fair market value into not more than 20% of MLRYY’s shares. For investors new to Russian companies, Sberbank or other state-controlled companies are commonly used to funnel funds into businesses seen as important to Russia, but the funds always come with strings attached.
Does Citymobil matter? No, not yet. For 2019, according to a Royal Bank of Canada (NYSE: RY) study, taxi aggregators were estimated to account for about 60% of the Russian taxi market, with Yandex.Taxi being the market leader with a 27% share. Vezyot, a recent Yandex acquisition target, accounts for 12% with Maksim at 9%, Gett at 5% and Citymobil at 1%.
When the Sberbank joint venture closed, MLRYY’s December 19, 2019 Press Release claimed “the creation of Russia’s leading platform in mobility and food-tech,” but Yandex, with its very strong Yandex.Taxi operation, arguably has the stronger combined “mobility and food-tech” product offering.
The other sizable business within MLRYY’s e-commerce segment is Youla, a free mobile-first (about 60% of users) classified ads website launched in 2015. The longer-term plan for Youla is to serve more as a portal for verticals like auto, real estate, etc. Furthering the “ecosystem” concept, Youla is integrated with MLRYY’s social network websites Odnoklassniki (“OK”) and VKontakte (“VK”). With 5.2 million unique visitors in February 2020, for example, Youla ranked as the No. 2 general classified site (private users posting items) in Russia according to Yandex.Radar, but lagged far behind Naspers (OTCPK: NPSNY) No.1 Avito.ru which had 46.1 million unique visitors. Like Delivery Club, Youla is relatively small, but growing rapidly with a revenue increase of RUB 1.0 billion or 90.9% from RUB 1.1 billion in 2018 to RUB 2.1 billion in 2019.
There is no truly dominant e-commerce player in Russia like Amazon (NASDAQ: AMZN) in the U.S. MLRYY essentially threw in the towel on its 10th place Pandao e-commerce marketplace by entering a complex joint venture with Alibaba. As the table below indicates, BABA’s AliExpress was already the runaway No.1 e-commerce marketplace in Russia with 152 million monthly visits compared with 61 million for No. 2 privately-owned Wildberries.
SOURCE: East-Digital News Russian E-Commerce Report Updated December 2019
The joint venture, called AliExpress Russia JV (“AER”), closed October 9, 2019 with four major players – the second number after each owner’s economic share equals voting rights:
- Alibaba invested $100 million and contributed AliExpress Russia for 55.7% (49.9%) of AER.
- MegaFon, the third largest Russian telecom, sold its 9.97% economic stake in MLRYY to Alibaba in exchange for 24.3% (30.2%) of AER.
- MLRYY contributed Pandao and invested $100 million at closing and $82 million due within 12 months in exchange for 15.0% (18.7%) of AER.
- RDIF, the $10 billion Russian sovereign wealth fund, invested $100 million into AER for 5.0% (1.2%).
Note that RDIF has a call option to acquire another 7.9% from Alibaba for $194 million. Was this a forced marriage? It’s worth noting that no ownership combination allows Russian entities to own less than 50.1% of the voting rights. I suspect Mr. Putin decided that a Chinese-controlled and shareholder-owned entity was not going to be the No.1 e-commerce website in Russia. We can safely conclude that AER is No. 1 in the fragmented market of Russian e-commerce.
Needs work. The AER joint venture with Alibaba saved MLRYY from irrelevance. Youla is promising, but lags far behind the market leader. It’s too early to judge the joint venture with Sberbank in food delivery and ride-hailing, but the investment can only help.
Social Networks: No. 1 and No.2 and No.6 in Russia
MLRYY dominates the Russian social networking market with three very strong offerings, VKontakte (“VK), Odnoklassniki (“OK”) and Moy Mir.
Founded by Pavel Durov in 2006, VK is often called the “Russian Facebook.” VK, “in contact” in English, is the No. 1 website in Russia – and undoubtedly the No. 1 social network website – by a number of metrics. For example, according to web analytics service Yandex.Radar, there were 184 million visitors to VK in February 2020, compared to 115 million for No. 2 website OK. In terms of visits, market research firm SimilarWeb currently ranks VK as the No.1 website among Russian social networks (No. 2 of all Russian websites to Yandex.ru) and No. 13 of all websites in the world. VK’s website describes the company’s mission as “…to connect people, services and companies by creating simple and convenient communication tools.”
VK was acquired by MLRYY through a series of transactions culminating in the September 16, 2014 purchase of 48% from United Capital Partners for $1.5 billion thereby achieving 100% ownership and control. United Capital was founded by Ilya Sherbovich, who, according to a June 26, 2013 article in the Financial Times, “helped craft deals for people close to Vladimir Putin throughout his career.” After the change in control, CEO Durov left the country for Buffalo, New York where he and ex-VK employees founded Telegram, an encrypted messaging app with over 300 million users.
Founded in 2006 by Albert Popkov, OK, “classmates” in English, is the No. 2 social network in Russia. As the name suggests, OK was originally designed to re-connect classmates and old friends. As noted above, the website’s 115 million visitors in February 2020 ranked No. 2 to sister network VK. SimilarWeb currently ranks OK at the No. 2 website among Russian social networks (No. 6 of all Russian websites) and No. 23 of all websites in the world. The platform is the leader in videos viewed among Russian social networks. In August 2010, before its merger with Mail.ru and November IPO, Yuri Milner’s investment firm DST became the 100% owner of OK by purchasing the remaining 20% owned by founder Popkov.
Moy Mir or “My World” is the No. 6 ranking social network website in Russia – and the No. 3 ranking Russian social network website – per Yandex.Radar with 11.8 million visitors in February 2020. The site was conceived and introduced by MLRYY’s own in-house team in 2007 as a portal to other MLRYY verticals but developed a life of its own as an independent social network. In 2015, MLRYY re-positioned the site to serve people with similar interests with an emphasis on music, video and games.
While the company does not break out revenue for each social network, the company’s 4Q 2019 Investor Presentation indicated that VK emerged as the star with revenue increasing about RUB 3.7 billion or 20% to RUB 22.1 in 2019 from RUB 18.4 billion in 2018.
Dominant local market position, slower growth being re-charged by new investment and tighter focus on monetization.
Instant Messaging: Bit Player
MLRYY owns three instant messaging applications; TamTam, ICQ and Agent Mail.ru. These applications support and supplement other parts of the “ecosystem,” but also reach a large part of the Russian audience that is mobile-only. TamTam – mobile only – seems the most fully developed with basic features like texting and the ability to place HD-quality audio and video calls, augmented by chat groups, moderated channels, unlimited cloud storage, the ability to send files up to 2 GB plus an embedded mini-player for video and audio messages. The other applications, ICQ and the vaguely Cold War-sounding Agent Mail.ru are more basic and available in mobile and desktop versions. In terms of monthly active users, MLRYY’s messaging applications are also-rans with TamTam reporting 7 million “registrations,” ICQ 11 million and Agent Mail.ru 18.8 million. To give you some idea of the size of messaging applications, as of October 2019 according to Statista, the three largest , Facebook’s (NASDAQ: FB) WhatsApp and Messenger and Tencent’s (OTCPK: TCEHY) WeChat had 1.6 billion, 1.3 billion and 1.1 billion monthly active users, respectively. Any monetization of the three MLRYY messengers will not be significant.
Decent products, useful as part of MLRYY “ecosystem,” but lack critical mass.
Games: The Growth Engine
Internet games are a huge business worldwide. Per a June 2019 report from market research firm Newzoo:
There are now more than 2.5 billion gamers across the world. Combined, they will spend $152.1 billion on games in 2019, representing an increase of +9.6% year on year.
In Russia, revenues from digital games are growing rapidly as the predominant “free-game” culture fades and players adapt to paying for their game experience. In a report published in November 2019, Superdata estimated that Russia would surpass France in 2019 as Europe’s third largest digital game market with a 57% increase from $1.7 billion in revenue to about $2.7 billion.
Digital games are MLRYY’s second most important revenue source accounting for about 37.8% of total 2019 revenue. It’s a tremendous growth area as well; the company reported RUB 36.4 billion in games revenue in 2019, up an amazing 131.8% from RUB 15.7 billion in 2018. To put this in perspective, however, that’s $582.5 million in games revenue or 0.0004% of the total 2019 $152 billion world digital games market. MLRYY’s total registered user base across all platforms is 605 million, but according to Wikipedia there are 28 single PC-based games and 27 mobile-based games from a variety of developers and publishers with more than 100 million registered users – and two with more than 1 billion.
In order to concentrate its efforts in the Games segment, management adopted the My.Games brand in mid-2019 as an umbrella for all digital games products. My.Games operates in four areas; 1) Client, 2) Mobile, 3) Esports and 4) Investments.
In the Client area, MMO / MMORPG products (“massively multiplayer online” / “massively multiplayer online role playing game”) like Warface, ArcheAge and Perfect World are developed by independent studios or in-house and published or co-published by My.Games.
Warface, the No. 1 PC-based (i.e., the PC is the online access point) game in Russia, is a good example. It was developed by Crytek GmbH, an independent German games developer and co-published by My.Games and Microsoft (NASDAQ: MSFT).
According to Newzoo, mobile platforms worldwide accounted for about 45% of all digital gaming, growing about 10.2% to reach an estimated $68.5 billion in 2019. In Russia, per Yandex, mobile gaming accounted for 34% of revenue and increased at a 29% rate over 2019. MLRYY’s mobile games are well-positioned in the Russian mobile market, accounting for 64% of Games segment revenue in 2019 with a goal of accounting for 80% by 2022. I suspect few U.S. gamers will be familiar with My.Games mobile game titles like Hustle Castle, Hawk: Freedom Squadron or Left to Survive.
Esports are a fairly new phenomenon. Primarily as advertising, MLRYY sponsors and organizes tournaments and broadcasts featuring online multiplayer games. The company has sponsored more than 200 tournaments with combined prizes of over RUB 40.0 million over the past five years.
When we review MLRYY’s financials – particularly the growth in the games area, we’ll see how neatly Mail.Ru Games Ventures (“MRGV”) fits into the company’s plans for games. MRGV invests in promising games and gaming companies – up-and-coming game developers as well as established studios in need of additional resources for scaling their business. The current portfolio has more than 10 gaming projects, including the mobile action RPG Guild of Heroes from Russian studio BIT.GAMES and mobile online shooter Tacticool from Russian-Finnish developer Panzerdog. Like a typical venture capital firm, MRGV provides investment, but also more in-depth marketing and operational support. MRGV seeks to either publish the game project under development for the Russian or expanded market or ideally roll-up the game developer and obtain all rights through acquisition.
A small but up-and-coming player in the world’s online gaming market.
B2B: Leveraging In-House Expertise
MLRYY offers a number of business-oriented tools and services, which on a combined basis grew RUB 532.7 million 141.0% to RUB 1.0 billion in 2019 from RUB 467.3 in 2018. The crown jewels of its B2B offerings; MyTarget and MyTracker, were originally developed as in-house tools. MyTarget is an advertisement platform providing businesses access to web and mobile users of the largest services and social networks in Russia and the CIS, including over 6,000 third-party applications and mobile websites. MyTracker is the largest mobile analytics platform in Russia providing developers and advertisers with predictive analytics, detailed statistics and other information about the mobile users of a product.
Other services include:
- MyWidget, a free tool for media, bloggers and other content generators.
- Business-oriented email software and an associated custom domain name service.
- Tarantool, an open-source software database management system.
- Rating Mail.ru, a website analytic tool.
- Teambox, cloud storage for documents, files and archives for business teams.
- Icebox, cloud storage for large amounts of any type of data for developers and providers of online services.
- Infra, a cloud service for creating and managing virtual servers
There are also services and software for predictive customer analytics, mailing list management, and written content analytics.
Fast-growing but relatively insignificant (about $16.0 million in revenue per year) monetization of in-house developed systems.
Media: Solid Verticals for the Russian Market
MLRYY’s current media verticals are the refined and evolved successors to the verticals originally created by predecessor company Port.ru circa 2000. Today, MLRYY owns 11 popular online media resources:
News/reviews of high-tech software and hardware
Most popular Russian-language website for women with news, videos, columns, how-to articles, etc.
Articles, news, reviews, videos, and references materials for car enthusiasts.
World and local daily news source for Russia and CIS states.
Most popular Russian-language website for health and medical information.
Most Russian-language popular website dedicated to mothers and children.
News, articles, videos, reviews, schedules and online streaming for TV and movie fans.
Apartments, houses, and commercial properties for sale or rent.
News, articles, videos and product reviews for pet owners.
Website for ordering medicines and medical supplies for pickup at local pharmacies.
News, articles, videos for sports fans, also broadcasts events.
MLRYY does not provide detail on advertising revenue and fees associated with its media properties.
A qualified “A” for a good set of verticals with a large Russian-speaking audience, but are they making any money?
Management: Where are the Founders?
We have to backtrack a bit here. Remember Eugene Goland and his buddies Michael Zaitsev and Alexey Krivenkov who created the original email core of MLRYY? Remember VK’s founder, the mercurial but brilliant Pavel Durov? How about Albert Popkov, founder of OK? None are now associated with the company. There has been a huge management and creative technological vacuum. It’s as if Jobs, Gates, Bezos, Zuckerberg and Musk had been forced out of their various firms early in the development process.
The company’s financial performance has suffered from the lack of founder-level management, technological know-how, creativity and strategic vision. While the MLRYY “ecosystem” might have the largest audience in Russia and capture the most screen time, it’s done little for shareholders. The company has struggled to monetize its early advantages in email and social networks in its core Russian and CIS market. Current management may have found a path to sustainable growth through joint ventures with strong partners and online games, a volatile and “hit-driven” market, but the actual and potential growth has been acquired. The stock price graph below shows the result.
Management reports segment and other financial information in two ways; on a management accounting basis, particularly for segment information, and according to IFRS, the International Financial Reporting Standards set by the London-based International Accounting Standards Board (IASB). While I have used management’s accounting where necessary to provide context and comparisons, all information presented in this section is based on IFRS.
Looking at the table below, investors must ask whether the 2018 – 2019 period was the end of the strategic drift and the beginning of sustainable growth. Green is good, yellow bad:
Here’s an easy way to assess the company’s sources of revenue against their 2018 – 2019 growth:
The legacy businesses of MLRYY; online advertising, community IVAS and other sources comprised 62.2% of revenue in 2019 but accounted for only 31.3% of revenue growth. MMO games accounted for 37.8% of revenue, but 68.7% of revenue growth. The future primary growth driver is apparently MMO games.
Online advertising has grown at a 25.3% CAGR since 2015 – that’s good. The growth has been consistent and organic with the big jump in revenue, RUB 9.5 billion or 42.2%, coming between 2017 and 2018 due to the company’s renewed focus on “adtech” coinciding with the acceleration of the shift in client advertising budgets in the Russian market to online and in online towards video, mobile and social networks. During 2019, MLRYY’s “adtech” and online advertising revenue were supplemented by the acquisition of Native Media LLC, a video ad platform.
We’ve touched on the stellar revenue growth in MMO games, a 47.6% CAGR from 2015 to 2019 – and 68.7% of MLRYY’s revenue growth between 2018 and 2019. The majority of the huge RUB 20.7 billion or 131.5% increase in revenue between 2018 and 2019 was organic growth resulting from existing games including Warface, Hustle Castle and War Robots and new releases Lost Ark and American Dad! Apocalypse Soon. There was also a full-year 2019 contribution to revenue from 2018 acquisitions ESforce, an esports company, and Bitdotgames Publishing Limited, a mobile games developer, and revenue contributions from two smaller 2019 roll-ups of joint venture mobile games developers Panzerdog and Swag Masha. In 2019, MMO games provided about RUB 5.2 billion or 18.7% of EBITDA on 37.8% of revenue.
Community IVAS, our first yellow highlight, grew at a 6.5% CAGR from 2015 to 2019, the slowest rate among MLRYY’s financial reporting segments. Revenue growth was higher in the 2018 – 2019 period, however; a RUB 1.9 billion or 13.7% increase to RUB 15.8 billion from RUB 13.9 billion. Acquisitions during this period helped increase revenue. With the purchase of virtual gifts, in-game items and fee services slowing, MLRYY has been rolling up joint ventures – many of which support or feature in multiple parts of the “ecosystem” – at a rapid pace:
- 33 Slona, a digital real estate agency in 2018
- Consult Universal Corp, a cash-back technology provider also in 2018
- Salerton Investments Limited, owner of United Media Agency, an aggregator and distributor of music for online streaming in February 2019
- Surfingbird LLC, owner of Relap, a personalized recommendation platform, in May 2019.
- Worki, a job search platform in December 2019.
In December 2019 MLRYY acquired control of educational online platform Skillbox by increasing its share to 60.3% paving the way for yet another joint venture roll-up.
For all segments combined, revenue has increased at a 26.2% CAGR from 2015 through 2019, a very respectable rate of increase, highlighted by the RUB 30.1 billion or 45.6% increase from 2018 to 2019.
Operating costs, another yellow highlight, increased at a 30.5% CAGR from 2015 to 2019, outpacing the 26.2% annual average growth over the same period, however, it’s worth noting that costs really exploded between 2017 and 2018, up RUB 24.9 billion or 66.4% year-over-year – preceding the huge 2018 – 2019 revenue increase. In other words, the investments appear to have paid off. Other than RUB 4.3 billion in stock compensation expense or about 17.2% of the increase, management noted organic causes directly related to increased agent/partner fees and marketing expenses.
The 18.7% EBITDA CAGR over the 2015 – 2019 period is more indicative of MLRYY’s earning power than the 47.4% CAGR for net income over the same period. The EBITDA margin shows signs of stabilizing after falling to a low of 5.4% in 2018 – a year which saw significant investment expenses. As we’ll see in the more detailed comparison of 2018 and 2019 results, net income has recently been subject to sizable valuation and impairment charges and de-consolidation gains.
Chairman Grishin and CEO Dobrodeev jointly commented in fiscal 2019:
2019 has been a pivotal year for us in our strategic goal of transitioning into an Internet ecosystem, to be formed on the basis of our strong and well-diversified product portfolio as well as complementary and well-funded partnerships.
The year did indeed have the “feel” of an inflection point based on the numbers; the establishment of a new, more stable base for the company’s future growth. There were 9 different consolidated acquisitions in 2019 in addition to two large joint ventures. We’ve already noted that 2019’s RUB 30.1 billion or 45.6% increase in revenue over 2018 was preceded by the huge RUB 24.9 billion or 66.4% increase in operating costs from 2017 to 2018. Those costs were brought under control in the 2018 – 2019 period – highlighted in green above, increasing “just” RUB 5.6 billion or 8.7%.
The most important number below, highlighted in yellow, is the RUB 15.9 billion gain on deconsolidation related to the Sberbank and AER joint ventures. MLRYY recognized gains from the contribution of RUB 14.9 billion on CityMobil and Delivery Club and RUB 1.0 billion on Pandao to the Sberbank and AER joint ventures, respectively. The deconsolidation gain was equal to 71.2% of 2019 net income before taxes. Without that gain, net income before taxes would have been approximately RUB 6.4 billion compared to the reported RUB 22.3 billion, much more indicative of the company’s steady-state earning power. Although this adjusted net income before taxes would still be the highest since 2016, the 2015 – 2019 CAGR for income before taxes drops to a mediocre 8.0% with this adjustment:
After tax unadjusted net income rose RUB 26.9 billion to RUB 18.9 billion in 2019 from a loss of RUB 8.1 billion in 2018, but we apply the same 2019 15.4% tax rate to adjusted net income before taxes we get about RUB 5.4 million, a respectable increase, but not a home run.
What Do First Quarter 2020 Results Tell Us?
Chairman Grishin and CEO Dobrodeev released this statement summing up 1Q 2020:
While the current unprecedented situation means that 2020 has started with some significant challenges, we feel relatively well-positioned given our profitability and well-diversified revenue streams. Advertising, which accounts for less than 40% of the Group’s revenues has a clear correlation with local business performance and outlook, which started to be impacted by the combination of COVID-19 and the oil shock in March. However, MMO Games, which accounts for over 30% of revenues, has seen net positive effects since the back end of March, especially across traditional home PC and console platforms.
The developing weakness in online advertising revenue – highlighted in yellow below – resulted in a relatively small 10.8% increase over the prior period. Considering the economic impact of the coronavirus, management stated in the 1Q 2020 Press Release that this “might be the first-ever year that Russia’s digital advertising market experiences a decline.” MMO games, the first green highlight, continued their surge with a RUB 2.1 billion or 44.9% increase over 1Q 2018, supplying 51.5% of the growth in 1Q 2019. According to the 1Q 2020 Press Release, management noticed a “rise in engagement” with its games as the Russian government began issuing stay-at-home and closure orders in late March and early April.
SOURCE: the moscowtimes.com
Expected to be at a low point in revenue growth 1Q 2020, games instead outperformed.
Delivery Club, the food delivery business contributed to the Sberbank joint venture, has also experienced extremely rapid growth due to the pandemic with revenues increasing more than 210.0% to RUB 1.8 billion 1Q 2020. The service filled an all-time high 3.78 million restaurant orders in March, up 88% over March 2019. In early April Delivery Club began filling 1 million orders per week for the first time.
Overall, total revenues were up a healthy RUB 4.1 billion or 23.4% to RUB 21.6 billion 1Q 2020 from RUB 17.5 billion 1Q 2019, exceeding management’s 2020 growth guidance – which was withdrawn for all of 2020 on April 23.
Operating expenses improved on the favorable trend established in 2019, increasing just RUB 833.0 million or 5.1% to RUB 17.0 billion 1Q 2020 from RUB 16.2 billion 1Q 2019. Operating expenses are continuing to benefit from the deconsolidation of CityMobil, Delivery Club and Pandao, which all required heavy investment expenses. As a result, EBITDA – also a green highlight – more than tripled from RUB 1.3 billion to RUB 4.3 billion quarter-over-quarter.
At this point the green highlights end, as MLRYY’s share of the new joint ventures, both incurring heavy investment expenses, was a RUB 2.8 billion 1Q 2020 net loss – the second yellow highlight. MLRYY’s new partners and increased funding have accelerated the joint ventures investment phase, producing larger “below the line” equity method accounting losses for the company than it would have realized with less funding on a consolidated basis where the impact would have hit EBITDA.
The next yellow highlight, a RUB 6.4 billion impairment charge, resulted from management’s decision to conduct a coronavirus-motivated “stress-test” of goodwill for all assets. The review resulted in the write-down of goodwill related to search, email, portal and instant messengers. All other assets passed and no further write-downs are anticipated under current assumptions. The write-down was equal to about 4.5% of the RUB 140.7 billion on MLRYY’s balance sheet as of December 31, 2019.
The bottom line for 1Q 2020 was a disappointing RUB 6.0 billion net loss before taxes, equivalent after a small tax benefit to a loss of RUB 42.46 per share, down RUB 26.44 per share or 164.4% from the RUB 16.01 per share net loss 1Q 2019. In the last green highlight, management reduced shares outstanding by about 2.9 million or 1.4% through open-market purchases.
To summarize 1Q 2020, we have good revenue growth, improving expense control and a solid gain in EBITDA. The gain in EBITDA was somewhat illusory, however, as losses from e-commerce projects simply migrated further down the income statement to become losses from the new joint ventures. The only real surprise was the impairment write-down. Without the impairment write-down, MLRYY would have reported a 1Q 2020 net loss before taxes of RUB 2.6 billion, about a 14% improvement over the 1Q 2019 net loss before taxes of RUB 3.0 billion 1Q 2019.
Valuation: 8% Discount to Fair Value
Typical valuation ratios and most comparisons with similar companies are uninformative for a non-SEC reporting Russian internet company and there is simply not enough information provided by the company to attempt a sum-of-the-parts valuation. I’ve fallen back on a simple, traditional DCF. Here it is:
The per share value in U.S. dollars is $27.67, about an 8% discount to the last reported $25.60 per share value in U.S. dollars per E*Trade. Here’s a simple way to bracket the per share values:
Ownership: Learn to Love Vlad
Look who owns big pieces of MLRYY in this slide from the 4Q 2019 Investor presentation; the Chinese, South Africans and the Russians. The 17.4% combined economic interest of Tencent and Alibaba and the 5.2% economic interest of MFT might as well have the Chinese and Russian flags marking their ownership percentages. How is it that Russia’s MFT has a 5.2% economic interest and a 58.3% voting interest? With any investment in a Russian company you have to be comfortable with situations of this type, but this one is unusually obvious – and it just might work in favor of the non-governmental investors.
While the owners of the 49.8% in free float – primarily through the LSE although in March the board approved a dual listing on the Moscow exchange – have a powerless 21.7% of the voting rights, there is an advantage to the shareholder structure. Almost $1.0 billion of capital flowing into joint ventures with MLRYY through two government-aligned entities did not happen by accident. There was also no reason for Alibaba’s AliExpress to seek MLRYY as a partner – unless they received an offer that was very difficult to refuse.
All investors benefit from the exceedingly low probability that Mr. Putin will ever allow MLRYY’s shares to sink very low for long – and there is a lot of pressure on management to perform. In a sense, Vlad has your back.
Conclusion: Pluses and Minuses
If these were ordinary times, it would be easy to recommend MLRYY as a speculative purchase for sophisticated investors with substantial portfolios seeking exposure to the Russian market. These, however, are not ordinary times.
- Speculative exposure to Russian tech beyond Yandex.
- Organic growth – augmented by acquisitions – is real; the company has reached an investable inflection point.
- The “fix” is in: the government-orchestrated Sberbank and AER joint ventures will provide MLRYY with nearly $1.0 billion in funding for food delivery, ride hailing and e-commerce.
- The DCF indicates a Base Case fair value of $27.67 per share compared to the most recent U.S. dollar close of $25.60 per share.
- Games have become the main driver of growth; there are other, safer plays on games with better risk/reward trade-offs.
- The company does not file with the SEC. Financial statements are available in English, but on an IFRS basis.
- No earnings consistency; per FactSet the 5-year average return on total capital is 1.68%.
- There is also the question of the stock’s liquidity. There is acceptable liquidity on the LSE with 2.65 million GDRs (Global Depositary Receipt) trading in June, but many investors will not have direct LSE access. Many U.S. investors, for example, will have to buy their shares on the Other OTC / Grey Market where about 133,506 GDR’s traded in the last 30 days. Quickly getting in and out of the GDRs might be a problem. As a side note, I believe the MLRUY ticker is inactive.
- Political risk, but this may be over-stated.
Recommendation: Not For Everyone
MLRYY is not a stock for everyone. It’s better left to sophisticated investors with larger portfolios who already have experience with relatively low-volume foreign (preferably Russian) securities. If you’re buying your first Russian tech stock, I would recommend YNDX. For those who fit this profile or are risk-takers…
There’s no hurry with MLRYY. It’s apparent, with MLRYY listing on the Moscow Exchange (MCX) July 2, that management is seeking more liquidity. As a consequence, I believe better trading action is probably on the way in the U.S. OTC market as well.
When I first considered writing this article, MLRYY was trading around $15.00 per GDR and it was an obvious buy. Now it’s trading at a 52-week high. I do not recommend buying the stock at this level since 1) the margin of safety is low relative to MLRYY’s historical volatility and 2) COVID -19 introduces too much uncertainty into 2Q 2020 and 2020 earnings. If you’re going to buy, wait until after 2Q 2020, evaluate the results and seek a lower entry point, maybe around $20.00 per share.
At the right price, MLRYY is an interesting speculative vehicle for investing in the growth of the digital economy and online gaming in Russia and the CIS.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.