INSTITUTIONAL INVESTOR

SEPTEMBER 12, 2014

What happens when a good company gets stuck in a bad — or at least decidedly out-of-favor — country? To judge by the performance of Yandex, Russia’s dominant Internet player, the country environment trumps.

Yandex, which is dual-listed on Nasdaq and theMoscow Exchange and domiciled in the Netherlands, behaved like a hot global tech stock in 2013, doubling in value. It’s not hard to see why. The company is one of the few local search providers around the world that has fended off Google in a fair fight, maintaining a share above 60 percent in a largely unrestrained Russian online market. Yandex also controls a large share of search engine traffic in Kazakhstan and Ukraine. This dominance stems in part from the search engine’s Russian-language-friendly user experience, including tools that try to gauge the user’s intention from his or her Russian syntax. The company has wielded its dominance to build a Google-esque raft of ancillary services such as e-mail, maps, news and comparative shopping. Fueled by brainpower rather than dubious privatizations or state contracts, Yandex is still controlled and run by one of its three founders, CEO Arkady Volozh.

Russia’s overall economy may be stagnating, but web traffic and advertising are not (see “ Russia’s Tech Industry Is a Vibrant Oasis in a Dull Economy”). Yandex’s revenue jumped 32 percent in the second quarter from a year earlier, to 12.2 billion rubles ($329 million), whereas earnings before interest, tax, depreciation and amortization climbed by 17 percent, to 5 billion rubles. None of that has mattered much to investors, though, compared with the souring global image of Russia, from which Yandex derives 94 percent of its turnover. The company’s shares have plummeted by one third this year to about $29 a share, whereas global peers like Google and Yahoo have essentially held steady. “Yandex is still fundamentally a good company, but it will stand or fall with Russia,” says Tom Adshead, Moscow-based equity portfolio manager at Verno Capital, an investment boutique based in New York that focuses on Russia and other states of the former Soviet Union.

Some of investors’ concerns about Yandex are objective. The ruble has declined by 9 percent this year against the dollar, depressing earnings in dollar terms. Second-quarter net profit actually fell 18 percent, to 2.4 billion rubles, as the company recorded a 625 million-ruble loss on dollar-denominated assets and debt. Russia’s macroeconomic stasis, with growth likely to hover around zero this year, will affect Yandex eventually, admits Gregory Abovsky, the company’s director of investor relations. He projects revenue growth will slow to around 20 percent in 2015. “I think that is pretty heroic, given the headwinds from the broader economy,” he says.

But Russian officials, thrown into a truculent, defensive mood by their confrontation with the West over Ukraine, have added to the perceived risks of investing in the country’s high-tech star. At a press conference in April, President Vladimir Putin ruminated that the Internet evolved as a “special CIA project and remains one to some extent.” Yandex in particular was “pushed to have a certain number of Americans and Europeans in its management,” the Russian president opined. “Some of its regulation is done abroad, and not only for the purpose of taxation but for other reasons.”

Pro-Kremlin legislators were quick to flesh out this vaguely threatening language from their chief. The State Duma, Russia’s lower legislative house, began to discuss a bill that would force Internet services to register as licensed media outlets, which in Russia means bearing potential criminal responsibility for publishing information without being able to prove its veracity and produce sources. “If that became law, we would have to shut down our aggregated news service,” Abovsky says.

Putin, as is typical of his recent behavior, took a step back from these aggressive advances. He addressed an Internet entrepreneurs’ conference in June, assuring the assembled technorati of their value to the motherland and promising to leave them unmolested. He left media licensing for Internet providers on the back burner, though it did go into effect for Russian bloggers as of August 1.

Analysts point out that restrictions on free speech, inimical as they may be to the ethos of the Internet, need not have much impact on the success of actual Internet companies, which really earn money in the personal and commercial realms. China’s restrictive environment has proved a great boon to Yandex’s counterpart there, Baidu, by scaring Google out of that nation’s market, notes Sergey Libin, an analyst with Raiffeisenbank in Moscow. “Chinese regulation created the local Internet sector,” he says. Baidu’s shares have surged by 20 percent this year.

So far, investors remain unswayed. Yandex shares continue to track the downtrodden Russian market. The company has established one bridgehead beyond the Russian-speaking world, entering Turkey in 2011. But success has been limited. Yandex holds about 5 percent of the search market there, and, says Abovsky, managers are entertaining no pipe dreams of escape from Russia. Within the country, he expects Yandex to grow by about 30 percent in 2014, in addition to the 20 percent next year, which would boost Russian revenues to something on the order of $2 billion that year. “It’s hard to find another market worth diversifying into from that,” he reflects.