When Google (GOOG) went live as a search engine in 1998, it was more or less dismissed as a cute little project undertaken by a couple of Stanford guys.
And even when Google stock went public in 2004, the market wasn’t overly impressed … even though it controlled half of the search market at that time.
Two words: Big mistake.
Investors were a little more alert when Chinese search engine Baidu (BIDU) went public in 2005. But buy and large, they still missed the boat on spotting the “next Google” before the underlying stock took off.
With that as the backdrop, are U.S. investors right to be eyeing the Google of Russia — search engine Yandex (YNDX) — as the next big search opportunity? Let’s take a look.
The Case For YNDX
For starters, Yandex has left Google in the dust in Asia’s largest country. As of last month, YNDX controlled 62.2% of the country’s web-search market, while Google seemingly stuck at about a fourth of Russia’s search traffic. Plus, Yandex has been widening its lead for a couple of years now.
But dominance isn’t even what makes YNDX such an interesting idea. It’s acquisitions that have been making Yandex so investment-worthy.
In just the past couple of years, Yandex has taken on a partial stake in seismic data processor Seismotech; bought login service Loginza; outright purchased mobile software developer SPB Software; snagged startup news-delivery service The Tweeted Times; and most recently acquired movie and actor database sight KinoPoisk (think IMDB in Russian) … just to name a few.
That buying spree has paid off. The company’s revenue has grown from 8.7 billion rubles in 2009 to 28.8 billion rubles last year. Net income also grew from 2.01 billion rubles to 8.2 billion rubles for the same timeframe.
That’s annual sales growth of 49%, and earnings growth of 61%. Part of it was bought, while part of it was organic. Nevertheless, it was far more growth than Google was able to put up on either front for the same timeframe.
Plus, few expect Yandex to ease off on its acquisition efforts going forward. It’s got 6.2 billion rubles ($188 million) in the bank it could use to keep buying companies to widen its traffic and revenue funnel.
The Case Against YNDX
So yes, the parallels between Yandex and Google (and Baidu, for that matter) are uncanny.
There’s little denying that the Russian company borrowed several pages from Google’s playbook, and did so at an ideal time since Russia is just now entering its Internet heyday. It was only last year that more than 50% of the country’s population became regular users of the world wide web. That means Russian Internet access has hit a critical mass, and the usage statistics are only going to grow from here.
That’s good news for Yandex.
It’s not necessarily good news for YNDX stock investors, however. Because in simplest terms, it means the YNDX cat is out of the bag.
Russia is a booming market for web-based companies, with Internet advertising spending there expected to grow by 26% per year through 2015. But that potential is already baked into the YNDX stock price. Shares of YNDX stock are currently priced at a frothy 42 times trailing income, and nearly 30 times its projected earnings.
That’s hardly a bargain, especially with Google’s stock trading at a more palatable 26 times its trailing profits.
Even beyond the stock’s frothy valuation, there’s another looming pitfall for the company’s shareholder. While YNDX was able to carve out a business that generates nearly a billion U.S. dollars’ worth of revenue per year, it was largely able to do so because the Russian Internet market was still in its infancy as the company expanded, with little competition to get in its way.
Now that Yandex has demonstrated its market is not only viable, but vibrant, competition will start to trickle in.
These newcomers may not dethrone Yandex as Russia’s de facto Internet leader. But, in the same way Bing has nagged Google in the United States and Qihoo 360 (QIHU) has knocked Baidu’s search market-share down a couple of percentage points this year (Qihoo 360 now owns about 15% of China’s search market, ves. only about 10% at the end of last year), Yandex is vulnerable.
YNDX simply can’t buy big growth forever.
The Bottom Line
While Yandex has matured as a company, and the full maturation of Russia’s Internet industry is no more than a couple of years away, the company is still a solid long-term play.
It’s not, however, the “next Google.”
Instead, the best days of YNDX stock are probably behind it. That’s still not a bad position to be in, mind you, but the red-hot growth phase for Yandex stock is winding down, and it’s tough to believe the occasionally-misguided acquisitions (like a seismic data company) will be able to fend off competition as well as Google has in North America.
Investors looking for a big, budding Google-like opportunity may want to look to India, where Google currently owns an intimidating 90% of the search market, but only because no one has stepped up as a serious competitor yet.
That’s a huge opportunity, as Google doesn’t always hit the nail on the head in overseas markets — something Yandex has proven big-time in Russia.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.