Russian internet: Economics and investor perception © Александр Балахнин. Goldman Sachs #izso2011

Alexander Balakhnin OOO Goldman Sachs Bank +7 (495) 645 4016 [email protected]

Russian internet: Economics and investor perception

The Goldman Sachs Group, Inc.

May 2011

The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

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Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.

Goldman Sachs Research

Goldman Sachs Global Investment Research

2

Key internet activities

Key internet activities cover communication, entertainment and commercial needs of people

Normally, internet properties are involved in more than one internet activity

A variety of activities helps increase reach of product, improve relevance, build dominance

Some internet activities are more complementary than others

Source: Goldman Sachs Research


3

Drivers of internet properties’ success

We identify three drivers for the long-term success of internet properties: Dominance, Relevance and Monetization

While niche projects may exist, they are vulnerable in the long term, as dominance enables more time for business model adjustment

While monetization is the primary goal of any project, it may have a negative impact on relevance and building dominance

However, without monetization, it is nearly impossible to build relevance and dominanceSource: Goldman Sachs Research .


4

How are properties monetized?Internet monetization matrix


banner contextualsuper-

focusedlisting fees

API revenue sharing

virtual items paid service

social networking

communications

MMO

e-commerce

mobile VAS

portals

payment systems

search

ADVERTISING IVAS


5

Need to be an innovative leader to existInternet properties’ survival cycle

Long-term sustainability requires ongoing replication of previous success

Successful product may soon become profitable, but product life is short

Resting on laurels gives competitors an opportunity, which may push a property out of business

Monetization should be innovative, as it threatens dominance build-up

Product build-up may require inorganic development

Source: Goldman Sachs Research estimates


6

Reasons for high bargaining power of internet properties


Monetization is negative for business long termand hence inventory supply is managed wisely

Supply is less competitive than it may look

Competition risks are imminent for internet properties; but it is difficult to replicate somebody’s

success

Start-ups hit ratio is close to zero


7

Case study: Economics of successCash flow generation of Odnoklassniki and VKontakte

Source: Company data, Goldman Sachs Research .

Internet start-ups require sufficient investments for a long period of time

Profitability is high, but it is compensation for low initial visibility

Even after years of investment, success and dominance are not guaranteed

Odnoklassniki (US$ mn) Vkontakte (US$ mn)

-5.0

33.0

1.520.9

46.7

68.9

-3.1

-17.1

-21.8

-31.4

-4.0 -4.9

-7.4

-10.3

-15.0

-5.0

5.0

15.0

25.0

35.0

45.0

55.0

65.0

75.0- OK accumaluated cash flow

- Revenues

- Opex & taxes

- Capex

2008 2009 20102007

-2.0

3.3

5.3

27.3

47.4

-0.6

-3.2

-12.0

-25.9

-2.1-6.0

-10.9

-14.1

-15.0

-5.0

5.0

15.0

25.0

35.0

45.0- VK accumulated cash flow

- Revenues

- Opex & taxes

- Capex

2008 2009 20102007


8

Mail.ru profitability and cost structure

Source: Company data, Goldman Sachs Research estimates

Profitability structure (2010) Cost structure (2010)

Personnel expenses

51.6%

Depreciation and

Amortisation14.1%

Marketing expenses

11.2%

Server hosting expenses

6.1%

Other Costs16.9%

Personnel expenses

29.1%

Depreciation and

Amortisation8.0%

Marketing expenses

6.3%


3.4%

Other Costs9.5%

EBIT43.7%


9

Odnoklassniki profitability and cost structure

Source: Company data, Goldman Sachs Research estimates

Profitability structure (2010) Costs structure (2010)

Personnel expenses

31.5%

Depreciation and

Amortisation19.5%

Marketing expenses

2.5%


29.3%

Other Costs17.1%

Personnel expenses

12.9%

Depreciation and

Amortisation8.0%

Marketing expenses

1.0%


12.0%

Other Costs7.0%

EBIT59.1%


10

Internet advertising geared to GDP growthAdvertising market drivers

Source: Goldman Sachs Research estimates

Russian GDP growth

Advertising penetration growth

Internet share growth

Russian GDP is growing rapidly on the back of high resource prices and booming domestic

consumer demand

Growing middle class and economic growth increase advertising

spending as a share of GDP

Internet share in total advertising budgets

increases as internet penetration expands


11

Internet advertising will benefit from GDP and penetration growth

10

100

1000

1,000 10,000 100,000

Argentine

Armenia

AustraliaAustria

Bahrain

Belgium

Brazil

Bulgaria

Canada

Chile

China

Colombia

Costa Rica

Croatia

Czech

Denmark

Ecuador

Egypt

Estonia

Finland

France

Georgia

Germany

Greece

Hungary

Indonesia

Ireland

IsraelItaly

J apan

Kazakhstan

Kuwait

Latvia

Lebanon

Lithuania

MalaysiaMexico

Nitherlands

New Zealand

Norway

Oman

Panama

Peru

Philippines

Poland

Portugal

Romania

RussiaSaudi Arabia

SingaporeSlovakia

Slovenia

South Africa

SpainSweden

Switzerland

Thailand

Turkey

UAE

UK

Ukraine

Uruguay

United States

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1,000 10,000 100,000

Argentine

Australia

Austria

Bahrain

Belgium

Brazil

Canada

Chile

China

Costa Rica

Denmark

Estonia

Finland

France

Germany

Greece

Hungary

Ireland

Israel

Italy

J apanKuwait

Latvia

Mexico

Nitherlands

New Zealand

Norway

Oman

Peru

Poland

Portugal

Romania

Russia

Singapore

SpainSweden

Switzerland

Turkey

UAE

UK

UkraineUruguay

United States

Source: IMF, ITU, Zenith Optimedia, Goldman Sachs Research estimates.

Advertising spend per capita (y-axis) vs GDP per capita

(x-axis US$)

Ad spend as a share of GDP (y-axis) vs GDP per capita

(x-axis, US$)

Advertising spending in Europe, split by media Internet as a share of ad budget vs broadband penetration

30.3% 30.8% 30.6% 31.4% 31.7% 32.6% 32.4% 31.3% 30.8% 30.2% 30.4%

57.3% 55.9% 55.6% 54.3% 52.7% 51.1% 48.9%47.3% 45.4% 43.5% 41.1%

5.2% 5.3% 5.2% 5.4% 5.6% 5.7%5.7%

5.6%5.5%

5.5%5.6%

5.8% 6.0% 6.4% 6.6% 6.7% 6.4%6.7%

6.5%6.5%

6.5%6.3%

3.2% 5.4% 8.5% 11.1% 13.5% 15.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

TV Print Radio Cinema / indoor Outdoor Internet

R² = 0.82

0%

5%

10%

15%

20%

25%

30%

5% 15% 25% 35% 45% 55% 65% 75% 85% 95%

Norway

Denmark

Sweden

Netherlands

Canada

France

Germany

FinlandUnited States

Hungary

SpainPoland

Czech RepublicRussia


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Moscow is primary target for advertisersYet regions becoming more attractive

Source: GKS, Goldman Sachs Research estimates.

Disposable income per capita (2010E, monthly, Rub ‘000)Regional disposable income

Historically, Russian advertisers have predominantly focused on Moscow as it has substantially higher disposable income than the regions

However, regional income per capita is growing faster than Moscow, now exceeding US$500/month, making regions a more attractive target for advertisers

1,8562,514

3,2904,265

5,277

6,785

8,642

10,781

13,39812,718 14,524

4.3

4.1

3.83.9 4.0

3.7

3.43.3

2.62.4

2.3

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010E

Disposable income per capita, regions (monthly, Rub) Convergence Moscow/regions

32.7

20.1

16.4 16.1 15.914.7 13.7 13.4

12.0

0

5

10

15

20

25

30

35

Moscow Ural region Far Eastern region

North-West region

Russia, avg Central region (ex Moscow)

Siberian region

Volga region Southern region


13

GDP growth, expansion in the regions will drive internet advertising spending

Internet ad spend, internet as a share of total ad spend

Source: Zenith Optimedia, GroupM, CIA World Factbook, Company data, Goldman Sachs Research estimates.

Split between contextual and display advertising in Russia

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

DisplayAd Market share in Total Internet Ad Market

ContextualAd Market share in Total Internet Ad Market

Search as a share of GDP Regions’ share in local SE revenues and search requests

13 bps13 bps

12 bps

6 bps

4 bps 4 bps 4 bps3 bps

United Kingdom

Korea United States World Rest of world J apan Russia China

12.7 17.6 19.025.9

37.1

53.4

72.2

92.4

116.2

0.4% 0.4% 0.5% 0.6% 0.9% 1.2% 1.6%

5.4%6.4%

9.3%

10.8%

12.2%

14.0%

15.8%

17.6%

19.4%

0%

5%

10%

15%

20%

25%

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010E2011E2012E2013E2014E2015E

Internet Ad Spend (RUB bn) as a % of total

25%28% 30%

33%37%

47%

57%

66%

2006 2007 2008 2009 2010

Regions share in local SE revenues Regions share in search requests


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Reg AC

I, Alexander Balakhnin, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report.

DisclosuresMay 24, 2011


16

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Russian internet: Economics and investor perception © Александр Балахнин. Goldman Sachs #izso2011