Cash In Big on Russia’s Tech Market

April 1st, 2014
in contributors

Money Morning Article of the Week

by William Patalon, Money Morning

There's an old French proverb that says: Achetez aux canons, vendez aux clarions. That's "buy on the cannons, sell on the trumpets."

Follow up:

As a dyed-in-the-wool Contrarian investor, I'm a firm believer in the precept. In fact, back in the late 1990s, when New York money manager Anthony M. Gallea and I penned our book Contrarian Investing: Buy and Sell When Others Won't and Make Money Doing It, one of the opening lines was "Gloom makes us glad."

Bad news, you see, can create some of the biggest profit plays that you're going to find. Most retail investors just about stampede their way out of "bad-news" stocks. Those stocks get hammered down to ridiculously cheap levels.

For shrewd investors, this kind of situation creates a double-barreled winner because:

  • Well-chosen "bad-news" stocks can often recover their way to their former highs, meaning you have a built-in profit that you don't enjoy with most other stocks.
  • And, believe it or not, you also often face lower risks - since "bad-news" stocks have reached severely "oversold" levels. That means that the risk of additional downside moves has been minimized. This kind of terrific "high-reward/low-risk" stock can be the best kind of Contrarian play to find. And the best kind of "bad-news" stock to find is one where "external events" (those not related to the company's own operations or businesses) are the culprit behind the sell-off.

Now you see why I spend a lot of my time perusing the headlines and getting the "story behind the story" with some of the world's scariest news headlines.

You see, I know that, hidden in the "background noise," are some huge potential profits.

That's why I often look at the biggest negative news stories out there - and then look behind the headlines to see all the appealing investments the bad news is creating.

And right now, one of the splashiest "bad-news stories" you'll find is Russia...

And all that stuff about Ukraine, the Crimea, and Vladimir Putin has investors just about trampling one another to get out of Russian stocks.

And that's a big mistake.

In fact, Russian stocks - especially Russian tech stocks - offer some of the biggest profit opportunities we see today.

And there's one in particular that offers a massive potential upside.

And, best of all, it's a tech stock.

And since it is a tech stock, I called in our resident tech expert, Radical Technology Profits Editor Michael Robinson. I often consult with him in my Private Briefing column.

And so you can reap the maximum benefit from our discussion, I'm offering a partial transcript of the interview that I conducted with Michael late last week:

A Conversation with Michael Robinson

Patalon: As you know, Michael, I'm a longtime Contrarian. And there's an old French proverb that tells us to "buy on the cannons, sell on the trumpets."

So when I see what's happening in Russia right now, I can't help but wonder if it isn't perhaps worth a look.

Late last week, for instance, a White House spokesman was quoted as saying: "I wouldn't, if I were you, invest in Russian equities right now." When I see someone in a position of authority telling everyone that something isn't an investment... well, that gets me really interested. So let's take a look at Russia as an investment play. And Michael: Let's get into your wheelhouse... technology.

So let me start by asking you a basic question: What's happening in Russia, and why is that scaring investors?

Michael: The media, of course, is focused on what's happening in Ukraine and the Crimea, which Russia just annexed. It's one of the most significant changes to Europe's political map since the fall of the old Soviet Union.

But the real threat of an ascendant Russia isn't just political - it's about the shifting balance of power with a nation that has vast deposits of oil and gas. The fear is that Russia could become so energy-dominant that it could dictate political decisions to the rest of Europe.

I don't think that's going to happen, but you'll notice that Germany's [Chancellor Angela] Merkel has had a thing or two to say lately about [Russian leader] Vladimir Putin. She has a good reason to be worried: Germany gets 35% of its oil and gas supplies from Russia.

Unfortunately for Russia, this development is obscuring the fact that the country is working double-time to transition from an economy based solely on energy to one that is also high-tech, particularly in areas related to computing, where Russia has traditionally lagged the West.

That's heady stuff, Michael. What has all of that done to the shares of Russian-based companies, and why?

Quite frankly, it's been a disaster. But savvy investors can profit from all that fear out there. Wall Street is worried because Russia is such a huge and powerful country. In particular, the Street is down on Russia right now. S&P just downgraded the nation, citing geopolitical risks and the fear of sanctions from the West.

As a result, Russian stocks have generally been getting hammered. To keep the data clean and discrete, I ran the charts over the last three months. In that period, energy giants Gazprom OAO (OTC: OGZPY) and CNOOC Ltd. (ADR) (NYSE: CEO) are both off more than 18%. The steel company Mechel OAO (ADR) (NYSE: MTL) is off 24%.

Let's turn specifically to tech... I've said many times that I consider you to be one of the very best tech-newsletter gurus in the market today. Tell us about Russia's tech sector. Is it vibrant? Are there areas of specialization? Is there a "Silicon Valley" equivalent, like you have here in the U.S. and in countries like Israel and India?

Great question. To understand what's happening with Russian tech today, you have to go back to the old Soviet Union in the Cold War. This is where I have an advantage over other tech analysts.

Fact is, I've been following this area for nearly 40 years. My Dad was the senior military editor at Aviation Week & Space Technology, and he covered the Soviet military and aerospace industry. It's a subject that he and I have been talking about since I was in high school.

The Soviets/Russians actually had some great science and technology in areas like missile warheads and rocket boosters, aerospace engineering, and the electromagnetic pulses that can knock out electronics.

And let's not forget that the U.S. space program right now relies heavily on Russian rocket booster tech - without which we would have no way to get our astronauts to the International Space Station (ISS).

As someone who grew up following the Apollo space program, I have to say that's pretty fascinating stuff, Michael.

It really is pretty amazing.

So what about Russia's tech sector?

Having said all that, there is no equivalent of Silicon Valley in Russia today, though the government is working to start one up. See, the old Soviet Union intentionally scattered their technology around the nation, putting them into nondescript "science cities" that literally were not on any map.

The scientists in those hamlets had little contact with the outside world. But they were motivated to make breakthroughs because they wanted to compete with the Americans - and they didn't want to get shot or go to a work camp.

But that would seem to leave Russia with a problem... in that there's no concentrated area that has the kind of high-tech "critical mass" that we enjoy here in the United States.

That's exactly right, Bill. But in the last decade or so, entrepreneurs have been ramping up. And the Russian government wants to invest hundreds of millions of dollars - if not much more - into that nation's version of Silicon Valley.

What companies are the actual tech leaders in Russia? And what businesses are they in?

Where the Russian tech industry is doing really well right now is in two broadly related areas - telecommunications and e-commerce.

Russia is like India and China in the sense that the masses are clamoring to join the Internet revolution. They want to get online with laptops and mobile devices.

Most investors don't know this, but roughly half of the 140 million citizens in Russia proper, so to speak, are now online - one of the highest percentages in that part of the world.

With that in mind, the four main Russian tech leaders investors should know about are:

  • VimpelCom Ltd. (ADR) (Nasdaq: VIP), a broad telecom play. The company provides both fixed and wireless web access, as well as mobile communications and services. The company has a number of subsidiaries that, taken together, have something like 215 million subscribers.
  • Mobile Telesystems OJSC (ADR) (NYSE: MBT), a straight-up mobile play that operates in the Russian Federation, Ukraine, Uzbekistan, Turkmenistan, and Armenia. Plus, it has a strategic relationship with one of Europe's major players, Vodafone Group Plc (ADR) (Nasdaq: VOD).
  • Qiwi PLC (Nasdaq: QIWI), a leader in electronic payments through kiosks, the web, and mobile platforms. It's Russia's version of PayPal - so we better not tell Carl Icahn... he might start a campaign to break up that company, too.
  • And Yandex NV (Nasdaq: YNDX), which is the "Google of Russia." Yandex operates the world's fourth-ranked search engine and enjoys a 60% market share in its home country. Google, with about a quarter of the market, is a very distant second there.

That's a great rundown on Russia's tech leaders. Are there any worth buying at this level? And why?

I like all four... for different reasons. But if I had to pick only one right now, I'd go with Yandex. The company has a wide range of hooks in the market for web services.

I've heard that Yandex is so ingrained in the tech realm there that folks will say "I'm going to Yandex this," where here in the U.S. we'd say "Let me Google this."

That's exactly right, Bill. And here's the thing: Like Google here in the U.S., Yandex in Russia has evolved into so much more than just a search venture. Yandex operates a news site, an e-mail and e-commerce portal, auction-based advertising sites - not to mention navigator services, maps, and location-based services for a wide range of mobile products.

This is an important company - not just in Russia's tech economy, but in that country's economy in general. It got its start in 1989-1990 as a search system for the former Soviet government.

In a classic example of market overreaction, we're looking at a stock that's fallen from its 52-week high of $45.52 (set back on Jan. 9). This is a great, great company. And this is our chance to own it - on the cheap.

You said that when we talked last week. So just how cheap is this stock?

To start with, at the current price of about $30 a share, you're looking at a company with a market value of only $10 billion...

Versus $400 billion for Google.

That's right, Bill. And that substantively lower market value is partly due to the fact that Yandex's shares are just so incredibly cheap. The shares are down 28% since the third week of January on a classic overreaction. Bill, the "PEG Ratio" on this stock is 0.83.

And as "fundamental" investors well know, anything under 1.0 is probably a stock you need to take a closer look at... as one that's in bargain territory.

Yes. I know you're more of a fundamental guy, while I'm more of a technician, but just to explain to folks... the "PEG Ratio" measures a stock's valuation as a percentage of its earnings growth rate.

Well said, Michael.

Anyway, you have a PEG of just 0.83. But look at some of the company's other numbers. It has a 32% operating margin, a 32% return on equity (ROE), and a recent quarterly earnings increase of 47%. Yandex has grown earnings per share by an average of 42% over the past three years.

That's smoking.

It really is...

Now, it's true that the company missed guidance recently, correct?

Yes, but analysts are somehow ignoring the fact that this company's financial performance has been extraordinary. Revenue grew to $1.21 billion from $947 million a year ago. And margins haven't really degraded from their three-year average. This company is a consistently strong performer. In tech, I love companies like that.

What about the threat of European sanctions? Can that crimp margins and dilute that performance?

While I know that's been a worry for investors, I just don't think it's an issue. Europe and the United States have both imposed punitive sanctions on Russia.

With more to come...

Right... but I don't see them as an issue. The sanctions so far have been largely aimed at travel and at freezing the assets of specific groups of officials in Russia and Ukraine. I don't think so.

Most of those actions are aimed at Russia's energy-sector players... but aren't expected to hurt the economy itself. If they don't, Yandex won't be hurt, either.

What kind of profit potential are we looking at?

I'm forecasting that this stock could double in less than three years. The EPS growth rate is just phenomenal. This stock is trading at a discount to its true long-term value. Folks are just plain freaked out by what they're reading in the news.

Look at it this way. If Yandex just got back to its Jan. 9 closing high of $44.22, we're talking about profit of 45%. And that still doesn't price in all the growth in e-commerce and web services in Russia and the surrounding nations.

What catalysts will we need to see to make that happen?

Good news, plain and simple. Professional investors are worried right now about the impact any sanctions would have just as Europe is starting to show more growth. Once we see what the U.S. and its allies intend to do - if anything - about Russia's annexation of Crimea, we'll have more clarity.

That's the first step. But patient investors who make savvy plays now and who are willing to get into this for the long run will look back on this as a classic Contrarian move that leaves them well-paid for their time and courage.

Any general predictions about Russia's tech sector?

I expect Russia to become a major tech force in the years ahead. It's got nearly seven decades of experience in sciences, engineering, advanced materials, aerospace, and the like. And it's seen its old ally China vault ahead, so there is that rich competitive spirit.

Up to now, Russia hasn't done as good a job of getting military technology out into the civilian population as the U.S. has. But that's changing. The web has opened up the country to broader outside forces that are reshaping Russian society.

Vladimir Putin may very well be one of the world's most controversial rulers. But not even he can put the genie back in the bottle.

Thanks, Michael.

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