A Few Reasons Why Yandex Could Get Better

| About: Yandex N.V. (YNDX)
This article is now exclusive for PRO subscribers.

The Internet information providers industry offers entrepreneurs one of the simplest avenues for starting a business. However, the challenge is always making the investment worthwhile. Even giant companies like Facebook (NASDAQ:FB), Google (NASDAQ:GOOG), and Yahoo! (YHOO) have found it difficult to monetize their mammoth levels of traffic. Majorities of the success stories in Internet-based businesses come from the U.S, but Europe is not far behind.

Yandex (NASDAQ:YNDX) is the most promising Internet information provider in Europe, and is among the success stories to emanate from the region as far as Internet-based businesses are concerned. Headquartered in Russia, Yandex has managed to see off competition from industry giants like Google and Yahoo, at least from its home country.

Strong fundamentals back product development

Incorporated in the same year by Facebook, Yandex's current revenue potential is nowhere close to the social networking giant's levels. However, the two operate in slightly different sub-industries, and have different targets in terms of market segments. That said, Yandex's performance has been solid and its ratio of cash to revenues is amazing. Yandex sits on a sub $290 million in total cash, while its trailing 12-month revenues stand at just over $1 billion.

Additionally, Yandex's balance sheet indicates that the company is free of debt, which means that there is little suppression on operating cash flows. This provides the company with cash to invest in new products, which are vital for growth. Currently, Yandex is available in five versions; the parent Russian version, Belarusian, Turkish, Uzbekistani, and Ukrainian. The company is also aiming to expand its localized versions to other countries, which will need cash.

Yandex's main challenger in its home country is Google's Russian version (Google.ru). It ranks third in terms of traffic in the European nation, while Yandex is ranked first based on Alexa rankings. Yandex commands more than 60% share of the Internet search market in Russia, and based on its localized versions of its websites, there is a huge chance that it will stretch its dominance to the former United Soviet Socialist Republic (U.S.S.R) affiliate countries, and more in the eastern Europe.

The company also launched two versions of its mobile browsers, one for the android-based smartphones, and another for iPads, during the most recent quarter to cater for android and iPad users. This is strategic because android platform dominates the smartphone industry, while iPads are the most popular tablets in the world.

Double-digit growth rates

During Q2, Yandex reported 35% growth in revenues, while net income increased by 47% from the same quarter last year, depicting a similar trend experienced in Q1. For the half-year results, revenues grew by 36%, while net income was up 37% year-over-year. The company projected a revenues growth rate of about 34%-38% for the full year, 2013.

Traffic acquisition costs (NYSE:TAC) increased by 28% from the same quarter last year. Paid clicks on the other hand, increased by 29%, a percentage point above TAC. On the downside, Yandex's cost per click increased by 5% during the quarter, compared to Google's decline of 6%.

The company relies heavily on text-based advertising, accounting for about 88% of the overall revenues, based on results from Q2, while display advertising accounted for 9%. Text-based advertising revenues from Yandex's websites were up 37%, while display ad revenues increased by 31%. Yandex's primary search platform uses a keyword tool similar to Google Adwords, dubbed Yandex.Direct.

The company has several platforms designed to accommodate display ads, including the home page, maps and traffic, weather, jobs and mobile among others. Additionally, the company has an e-commerce platform, where users can buy products online, dubbed Market. These are just but a few of its sources of ad and payments revenue.

Some of these products are quite similar to what Yahoo offers, that is, weather and Music. The company also has a mail service, which I believe in the future, can be enhanced to some sort of a social platform, thereby improving engagement. The company had earlier this year launched a social app, dubbed wonder, which was instantly blocked by Facebook.

Therefore, this is one of the areas the company lags behind, and which it will need to build on. Whilst Facebook stands tall in social media, Yandex may have to follow the way of Google+ and come up with its own social platform. This will also help the company boost the revenue from display ads.

Yandex's margins are impressive enough to absorb investment shocks

As noted before, Yandex financial position is strong enough to support investment in new products. Its main cash outflow, other than business expenses, is the share buyback program, whereby it intends to burn out some $12 million in share repurchases. The company has already paid up $4 million based on the most recent quarter results. Does this put strain on the cash? Well, you could say so, but the company's margins are strong enough to allow more capital investments in product development.

The company has a gross margin of 76% compared to Google's 57% and Yahoo's 69%. Its operating margin is even better at 34%, while Google's and Yahoo's stand at 24% and 16% respectively. However, Google and Yahoo hold massive amounts of cash compared to what Yandex has in its coffers, and have better cash to annual revenue ratios.

Nonetheless, with the company targeting to launch in more countries with its localized search page, there is a huge potential for growth, which could increase revenue potential and earnings.

The bottom line

Yandex has already done well by launching the two mobile browser platforms for android-based smartphones and iPads. However, this is just one-step into mobility and will need to come up with several customized products to foster growth.

Social media is Facebook's business to lose, but without a social platform, Yandex may continue to struggle with display ad revenues. A social platform will be crucial in targeting ads to users.

Finally, the company dominates the Russian market. However, it may need to expand to other related countries like Armenia, Poland, Austria and Hungary among others in order to increase its addressable market. This will be aided by the fact that most Eastern European countries value their local languages, and hence cannot effectively make use of Yandex's English version of the search platform.

Disclosure: I 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.