Since the global financial crisis, the world’s major central banks have pumped USD >25tr into the financial system Global QE Tracker – Atlantic Council. Because of record-low interest rates the only asset classes, which have provided attractive returns in the last years, have been stocks, real estate and startups. Nowadays, Western VC funds have significant capital to invest, but according to our experience only c. 5% of them are allowed to invest locally in countries such as Poland or Romania. While especially Poland has a vivid startup scene – according to PFR, the value of VC transactions in Poland reached a record of PLN 3.6bn/EUR 798m in 2021 after PLN 2.1bn/EUR 466m one year earlier and only PLN 156m/EUR 34m in 2018 Transakcje na polskim rynku VC w 2021 (pfrventures.pl) – CEE-based startups usually have to look for money among local business angels and VC funds, which often use EU funds.

Lack of “smart money” is the main reason, why there are still not many unicorns in CEE

The main problem, which startups in CEE are facing, is that these investors usually do not have experience how to scale up businesses on international markets and have relatively small tickets of EUR <1m, which corresponds to pre-seed or seed phase of startup funding. Thus, CEE-based startups are able to finance product development, but often have problems with raising financing for the market roll-out.

While many startups choose to conduct a capital increase and list their shares in the alternative NewConnect segment instead, during the next funding round they often realize that they are in a “death trap”, meaning that most institutional investors are not allowed to invest in them as they are too small in terms of market capitalization and still do not generate revenues. We believe that all this is a major reason, why in CEE and in Poland in particular there are still almost no unicorns, which is a description of startups with a market value of at least USD 1bn.

Solution: Establishing a holding company in Western Europe

In our view, a solution may be establishing a holding company in Western Europe. This would become an owner of the local operating company, which usually benefits from still 4-5x lower salaries in CEE and EU R&D grants. In our view, the Western holding company could raise “smart money” from Western business angels or VC funds much easier. In addition, it could ultimately be listed on one of the Western European stock exchanges such as Deutsche Börse, Stockholm or Euronext. Especially the Swedish and Amsterdam stock exchanges are considered the best ones in Europe for innovative Tech and Biotech companies.

The process of establishing a holding company in Western Europe is relatively easy. For example, in Germany there are two kinds of limited companies, which require EUR 25,000 (GmbH) and EUR 1 (UG) of initial capital respectively GmbH und UG (haftungsbeschränkt) – IHK Rhein-Neckar (ihk24.de). Set up costs equal max. EUR 900 and yearly costs of accountants and tax advisors c. EUR 2,000. A Dutch BV requires at least EUR 0.01 7 Things you need to know about the Dutch BV – FIRM24 initially, with likely similar founding and yearly costs as in Germany.

We at East Value Research have gained significant experience with consulting for startups over the last years and have built a strong network of brokers, consultants and investors. We stand ready to assist CEE-based startups with the establishment of a holding company in Western Europe and fundraising.

The EU is dependent on Russia, but this also holds vice versa

Over the last months, Russia has deployed at least 100,000 troops and heavy military equipment to its border with Ukraine. In addition, it has sent c. 30,000 soldiers to Belarus and 20 war ships to the Baltic Sea. While the Russian government denies that it plans to attack the Ukraine, Western politicians are very nervous and threaten Russia with sanctions. Many Western commentators fear that as retaliation state-owned Gazprom could stop gas deliveries to the EU, which would hit the European economies hard. According to ec.europa.eu, in 2019 Russia accounted for 41.1% of EU’s gas, 26.9% crude oil and 46.7% coal imports. Germany, where in 2021 gas and coal power plants still generated 10.5% and 29.7% of the country’s energy production, imports c. 36% of its oil, c. 51% of gas and c. 56% of coal from Russia (Sources: destatis, BAFA, Handelsblatt). In our opinion, this dependence will become even stronger in the coming years as the current German government plans to shut down all nuclear and coal plants by the end of 2022 and 2030 respectively and wants to build more gas power plants in order to cover periods when renewable energy sources will not be able to fully cover the domestic energy demand.

Although a conflict with the Ukraine and NATO seems totally irrational as Russia is strongly dependent on exports of oil, gas and coal and imports of technologically-advanced goods, the risk of a war has unsettled investors and has hit the Russian stock market hard. The Moscow Exchange Broad Market Index (RTS), which includes 100 companies, has declined by >30% to a level last seen in April 2021. Many blue chip companies, which even before the recent declines traded at single-digit P/Es and double-digit dividend yields, are now even more attractively valued.

While the recent share price declines created many opportunities, investors should be selective

However, despite bargain prices we recommend to be selective. In our opinion, the biggest losers in case of a conflict with Ukraine and NATO will be companies, which are controlled by the Russian government or oligarchs that are close to Mr Putin. We also believe that it is wise to omit Russian banks and industrial conglomerates as they would likely be hit hard by a restricted access to foreign capital and technical equipment, which the President of the EU Commission has recently threated to introduce in an interview with German Handelsblatt.

We prefer companies that are controlled by investors without ties to Russian politicians, target Russian/CIS consumers and are not cyclical. Russia, which has grown its GDP at a CAGR of 6.7% since 1990 (Source: World Bank), has 142.3m inhabitants (Source: CIA World Fact Book), of which c. 75% in the Western part of the country and only 6% in the Far East. The whole CIS regions has a population of c. 240m people. In contrast to major Western economies, the Russian retail market is still very dispersed, with the 10 largest retailers accounting for just 37.4% of total food retail sales worth RUB 17.5tr (Source: X5 Retail Group). The E-Commerce sector is large and rapidly growing, with an estimated CAGR 2020-2024E of 6.9% from USD 21.6bn in 2020 (Source: esw.com). However, at the same time the share of online shoppers still equals only c. 52% compared to an EU average of 74% (Source: ec.europa.eu), which shows the tremendous growth potential of this sector in Russia.

Our Russian top picks

We recommend to take a closer look at PAO Magnit, Ozon Holdings PLC and Yandex NV, which can all be traded on Western stock exchanges.

Magnit Magnit at a glance – PJSC «Magnit», which has a free float of 61.1%, is the No 1 retailer in Russia when it comes to the number of stores and geographical coverage. As of 31/12/2021, the company, which has an expected DYield of 10.9% for 2021, operated in total 26,077 stores (supermarkets, drugstores, pharmacies, convenience stores, “ready-to-go“ & “ready-to-eat” shops with basic grocery and non-food items) and 45 distribution centers in 67 Russian regions. Apart from its activity in retail, Magnit also operates 4 agricultural and 13 food production sites for growing vegetables and production of dry food and confectionery. In 2021, the company’s revenues grew by 19.5% y-o-y to RUB 1.86tr (+7% Like-For-Like growth; 2,036 net store additions), gross profit by 20.1% to RUB 439.2bn (gross margin: 23.7% vs. 23.5% in 2020) and net income by 36.8% to RUB 51.7bn. The implied P/E 2021 equals 11.7x compared to a 3y historical average of 22.8x.

Ozon Holdings Ozon – about the company is the No 1 E-Commerce platform in CIS with >80m products, >90,000 active merchants, >25m buyers and c. 1m sqm of warehousing space across Russia. Apart from the online marketplace Ozon.ru, the company also operates the largest online travel company in Russia Ozon.Travel and owns a stake in the largest Russian digital book platform LitRes. It also develops FinTech services (Ozon FinTech) and is expanding into quick commerce and online grocery sales (Ozon Express). In 2021, Ozon grew its GMV (Gross Merchandise Value) by >125% y-o-y to RUB 445bn and the number of orders by c. 200% to 220m. However, adj. EBITDA and free cash flow strongly deteriorated due to the rapid growth, which is expected to reach at least 80% in 2022E. While in 9M/21 adj. EBITDA and free cash flow reached RUB -25.3bn (9M/20: RUB -8.1bn) and RUB -41.9bn (RUB -10.4bn) – for full-year 2021, they are not yet available – net cash as of 30/09/2021 equalled RUB 23.3bn, which makes a capital increase likely this year, in our view. Current cons. EV/Sales 2022E multiple is 1.1x compared to a 2y hist. average of 3.1x. 

Yandex Yandex, which is controlled by the family of its founder Arkady Volozh and the company’s staff, is the No 1 search engine in Russia and CIS. In addition, it provides services such as classifieds, food delivery, ride hailing and video & music streaming and conducts R&D in the area of autonomous driving. Thus, Yandex can be considered a Russian version of Alphabet. Apart from Russia, the company is also active in Turkey, Belarus, Kazakhstan, and the Ukraine. In 9M/21, Yandex generated revenues of RUB 245.8bn (+53.4% y-o-y), an adj. EBITDA of RUB 22.4bn (-28.6%) and adj. net income of RUB 5.4bn (-55.8%). The reason for the hefty decline of profitability were high investments in e-commerce, cloud and fintech services and self-driving business. At the end of September 2021, Yandex had net cash of RUB 4.3bn. Based on consensus estimates, the company’s stock is currently trading at an EV/Sales 2021E of 3.4x compared to a 3y hist. average of 5.5x.