I do believe that HeadHunter Group PLC (HHR) is an innovative business model in Russia and countries close to Russia. Besides, the amount of traffic received is among the highest worldwide. Having said that, the risks for investors increased very recently. I took into account an eventual increase in the cost of debt and the cost of equity because of new sanctions from the EU and the United States. Besides, in my view, less applicants will send their CVs if the economy does not perform. International job seekers will likely send less CVs after the decline of the ruble. Under my two DCF models, the downside risk appears significant.
HeadHunter’s Business Model Appears Quite Innovative
HeadHunter is an online recruitment platform with interests in Russia, Azerbaijan, Kyrgyzstan, and Uzbekistan. The company is not only the largest online recruitment platform in Russia, it also claims to be a leader in the CIS region.
The company’s sales growth from 2016 to 2021 and the expectations of analysts for 2022 and 2023 really prove that we are talking about an innovative player:
Source: Investor Presentation
If we look at global numbers, the amount of traffic is quite impressive. Information taken from SimilarWeb implies that the company is the sixth largest job website in the world in terms of traffic. Under normal circumstances, I would bet that the revenue would increase as more clients try to access the site. Unfortunately, we are not having normal circumstances right now:
We enjoy strong user traffic dynamics and are the sixth largest job and employment website based on this metric globally, according to the latest data available from SimilarWeb. Source: Prospectus
Less Candidates in Russia Will Likely Drive The Business Of HeadHunter Group Down
Amid a war with Ukraine and sanctions from the European Union, in my view, less foreigners may be willing to work in Russia in the future. Take into account that if the number of professionals interested in Russian jobs decline, the company will receive less CVs. The recent decline of the ruble should also make Russian jobs less appealing. In sum, even taking into account new innovations from HeadHunter Group, I believe that there are many risks to take into consideration before buying shares.
The Company Offered A Detailed Explanation About Risks From Further Sanctions
In my view, it is right now necessary to remind investors about the risks coming from further sanctions from the United States against Russia. HeadHunter gave a long explanation in the prospectus about potential deterioration of the Russian economy:
Moreover, several additional pieces of proposed legislation directed at increasing U.S. sanctions against Russia remain under consideration. The proposed legislation, if enacted, could further affect, among other things, Russian sovereign debt, Russian energy projects and the Russian energy and financial sectors. Source: Prospectus
This, in turn, may result in a general lack of confidence among international investors in the region’s economic and political stability and in Russian investments generally. Source: Prospectus
HeadHunter does not report facilities in the European Union or the United States. I also believe that it may not have bank accounts outside Russia.
The principal executive office of our key operating subsidiary is located at 9/10 Godovikova Street, Moscow, 129085 Russia. We also lease operating office space in Yaroslavl, Saint Petersburg, Voronezh, Nizhny Novgorod, Krasnodar, Sochi, Rostov, Kazan, Ekaterinburg, Novosibirsk and Vladivostok, Russia; Minsk, Belarus; Kiev, Ukraine and Almaty, Kazakhstan. Source: Prospectus
With that, if HeadHunter cannot obtain liquidity in the international markets, because its shares cannot trade in Europe, the company may not be able to run its operations. With an eventual increase in the interest rates in Russia, HeadHunter may also see a massive increase in its cost of debt. As a result, financial analysts should increase the company’s WACC, which would push the valuation down. Ultimately, the price of the stock will most likely decline:
Such lack of confidence may result in reduced liquidity, trading volatility and significant declines in the price of listed securities of companies with significant operations in Russia, including our shares, and in our inability to raise debt or equity capital in the international capital markets, which may affect our ability to achieve the level of growth to which we aspire. Source: Prospectus
Anonymous May Try To Hack The Company’s Site
I am quite concerned about potential risks coming from the activity of hackers all over the world. The Guardian noted in a recent article that Anonymous declared war on Russia:
In the days since, the group has claimed credit for several cyber incidents including distributed denial of service attacks – where a site is rendered unreachable by being bombarded with traffic – that have brought down government websites and that of Russia Today, the state-backed news service. The DDoS attacks still appeared to be working on Sunday afternoon, with the official sites for the Kremlin and Ministry of Defence still inaccessible. Source: The Guardian
These hackers are targeting not only websites of the Ministry of Defense, but also TV channels. If hackers decide to target online businesses like that of HeadHunter, traffic will likely decline. As a result, I would expect a decline in revenue and future FCF. In the worst case scenario, the stock price would decline.
Balance Sheet: I Am Worried About The Loans Reported By HeadHunter
In the last quarterly report, HeadHunter reported a significant amount of intangible assets including a lot of goodwill. More than 51% of the total amount of assets are represented by goodwill and intangible assets. In my view, in the future, if accountants believe that the real value of the assets acquired is lower than expected, they may impair some intangibles. Let’s say that I do expect a lot of impairments if the the business activity declines in Russia:
Under normal circumstances, I wouldn’t be concerned about the total amount of loans reported by HeadHunter. Under the current conditions in Russia, the situation looks worrying. If interest rates increase significantly, HeadHunter may have to pay much more for new debt obligations. A company without loans may not have any problem. HeadHunter does report some debt, so I expect difficulties in the coming years:
My Two Valuation Cases
In the best case scenario, my free cash flow figures would go close to that of market estimates prior to the invasion of Ukraine. I expect 2023 sales of RUB25 billion, 2023 FCF close to RUB10 billion, and FCF/sales around 45% from 2024 to 2030:
If we also assume a WACC around 12.5% and an exit multiple of 5x 2030 EBITDA, the implied share price should be close to $28:
Now, taking into consideration new sanctions and potential cyber attacks against HeadHunter’s website, 2023 sales growth should stay close to -17%, and 2030 FCF would be around RUB13 billion.
Note also that I am also assuming that inorganic revenue growth will likely decline in the coming years. Also, some of the previously announced acquisitions may fail. Keep in mind that massive changes in the interest rates and rapid declines in the ruble may make the company’s future estimates fail. As a result, the company may not obtain expected synergies and the EBITDA margin, and FCF margins could decline:
If the company cannot finance its business because of an eventual increase in the interest rates, the cost of debt would increase. Under these conditions, I assumed a WACC of 27% and an exit multiple of 1.3x, which would imply a fair price of $4. Under the light of these results, I believe that the downside risk is more significant than the upside potential:
HeadHunter is a leader and innovative business in Russia and some regions close to Russia. Considering the amount of traffic received, the quality of the products appears high. With that, there are many risks coming from potential sanctions from the EU and the United States. Besides, if Russia becomes less appealing for foreign employees because of the decline of the ruble, HeadHunter will likely receive less CVs, and the business may decline. The risk of cyber attacks also increased very recently, and HeadHunter could be an easy target as we are talking about an online business model. Putting everything together, my DCF model implies a price of $4, so the downside risk is much more significant than the potential benefits. I would be very cautious with the stock.
Disclosure: We Don’t Own HeadHunter Shares