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Naspers: Must all good things come to an end?

Naspers is an exceptional success story but it may be difficult for it to continue its winning streak.

“Every once in a while, an up-or-down-leg goes on for a long time and/or to a great extreme and people start to say ‘this time it’s different’. They cite the changes in geopolitics, institutions, technology or behaviour that have rendered the ‘old rules’ obsolete. They make investment decisions that extrapolate the recent trend. And then it turns out that the old rules still apply and the cycle resumes. In the end, trees don’t grow to the sky, and few things go to zero. Rather, most phenomena turn out to be cyclical.” – Howard Marks, Oaktree Capital

A standout contributor to returns has been Naspers

South African investors have experienced solid investment returns over the past decade with the FTSE/JSE All Share Index (Alsi) returning almost 10% per annum versus inflation of 6% per annum.  The Industrials sector was the driver of these returns, delivering almost 17% per annum over the same period. The Financials and Resources sectors lagged Industrials, returning 13% and -1% per annum respectively over the same period.

Many industrial shares on the Alsi contributed in notable ways to the stellar returns achieved by this sector but the standout contributor has been Naspers. Naspers’s weight in the index has gone up a staggering 14 times in the Alsi and 15 times in the SWIX over the last 10 years.

Naspers index weighting

Weighting at March 1 2008

Weighting at February 28 2018

Alsi

1.3%

18.8%

SWIX

1.5%

22.5%

Source: Bloomberg

Naspers, which has its origins as a newspaper and magazine publisher and printer from the early 1900s, listed on the Johannesburg Stock Exchange in 1994. Since listing, the company has evolved into a multinational internet and media group – offering services in more than 130 countries and with operations now spanning video entertainment; gaming; internet communication and e-commerce. The game-changer for Naspers was its purchase of a stake in the Chinese media and internet company, Tencent. The investment in Tencent of $34 million in 2001 is now worth over $160 billion – in fact more than Naspers’ entire current market valuation.

Past returns are not a predictor of future returns

Naspers has been an outstanding investment for those who have held the share from almost any point since its listing until the present time. Much of this excess return can be attributed Naspers’s investment in Tencent, which itself has risen 43 times over the past ten years. The table below contrasts this incredible performance relative to other global technology stocks:

 

Cumulative returns over last ten years

Tencent

4 257%

Amazon

2 246%

Apple

897%

Google

368%

Source: Bloomberg

Where to from here?

There is, however, a conundrum facing South African investors. From this point, will Naspers continue to be as good an investment as it has been; or even as good an investment as the broader South African market? This question is becoming even more valid and poignant given that most South African investors have Naspers as one of their (if not the) largest investments in their portfolios.

While many investors use Naspers’s index weighting as their reference point for the quantum of their exposure to the share, we believe the position size of a share in an actively-managed investment portfolio should not be guided simply by the share’s weight in an index, but by the absolute return and risk expectations intrinsic in the share and company itself.

None so blind as those who will not see

When a share has rerated to the lofty price-earnings multiple Naspers has over the past few years, the implied margin of tolerance for negative surprises; missteps; trapped value or uncertain outcomes starts to reduce considerably. The virtually unanimous positive write-up on the stock by the sell-side stockbroking community points to a situation where the consensus opinion is appearing oblivious to some quite pertinent drawbacks in the company. We believe there appears to be mounting reasons to indicate that the return and risk dynamics for investing in Naspers from this point are not so obviously skewed in an investor’s favour. Some concerns we believe are understated include:

  • Unlocking trapped value is proving difficult: Naspers trades at a discount to the value of its stake in Tencent, despite the fact that Naspers comprises several other operations albeit none in the scale of profit of Tencent. This discount has widened over the past few years, not narrowed. This is attributed in part to the fact that these “other operations” in Naspers are collectively consuming considerably more cash than they generate. Just recently Naspers reduced its 33.2% stake in Tencent by 2% to 31.2% with all the cash raised being allocated to fund these other operations, and none of the proceeds allocated for immediate value unlock to existing Naspers shareholders via a share buyback or special dividend.
  • The probability of another “Tencent-type” return investment for Naspers is low – virtually nil. The investing environment is considerably more competitive especially considering there are many very large technology companies with strong balance sheets and lots of cash to deploy.
  • The required growth implied by the current share price for Tencent’s average revenue per user is very, very high. In addition, it is more probable that the overall rate of growth for Tencent will taper from current levels.
  • Naspers’ opaque voting control structure is archaic and highly disenfranchising to shareholders of the Naspers-N share (the most commonly held share class).
  • Naspers’s ownership in Tencent does not entitle it to the usual ownership rights entrenched in a standard shareholding, but instead only enshrines Naspers with a right to an earnings and revenue stream. This unusual ownership structure has some implicit risks and has not been legally tested under Chinese law.

‘Trees don’t grow to the sky’

One of the longest standing investment adages is “buy low and sell high”. Easy to grasp in theory, however, much more difficult to implement in practice. The difficulty comes in the counterintuitive forces which cause investors to want to hold their winners and sell their losers. In the case of Naspers, this has been a great story of investment success for investors. Both the company’s idiosyncratic features coupled with a highly positive investment environment for the technology sector have contributed to this success. But indeed “trees don’t grow to the sky”. Naspers has become a very tall tree. And sometimes it is hard to see the wood for the trees.

Delphine Govender, co-founder of Perpetua Investment Managers.

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“Naspers’s ownership in Tencent does not entitle it to the usual ownership rights entrenched in a standard shareholding, but instead only enshrines Naspers with a right to an earnings and revenue stream.”

This is not entirely accurate. Naspers holds the same ordinary Tencent shares that anyone else can buy/sell on the Hong Kong Stock Exchange. It is Tencent that holds its internet operating licenses via a VIE, as is the case with most Chinese internet companies like Alibaba, Baidu, NetEase, etc. It is certainly a risk, but it is not unique to Naspers and doesn’t relate to its holding in Tencent shares.

“Naspers’s ownership in Tencent does not entitle it to the usual ownership rights entrenched in a standard shareholding, but instead only enshrines Naspers with a right to an earnings and revenue stream.”

When I read statements like this (cr@p) about Naspers etc. – I really get spoofed, which always makes me think of the following humorous quote.

‘’An egghead is a person who stands firmly on both their feet in mid-air on both sides of an issue’’
Homer Ferguson (1954 -)

Naspers will go up if Tencent goes up.

Bigger question is why does Tencent keep going up? Hong Kong speculators? because the earnings fundamentals point to much lower valuations…

“When a share has rerated to the lofty price-earnings multiple Naspers has over the past few years, the implied margin of tolerance for negative surprises; missteps; trapped value or uncertain outcomes starts to reduce considerably. The virtually unanimous positive write-up on the stock by the sell-side stockbroking community points to a situation where the consensus opinion is appearing oblivious to some quite pertinent drawbacks in the company”

Delphine, the value investment community have been making comments like this about Naspers for well over a decade now. I was one of them. Yes, you might be right this time but broken clocks also gets it right twice a day. Not investing in Naspers or in the US FANGS for that matter has been the most costly mistake that any investor could have made post 2008. Value managers instead went for low PE stocks like Abil and Steinhoff – once again follwing your argument that it should re-rate to its long term average or the peer group average. Well we know what happened.

I really think it is time value investors move away from simplistic analysis and a blind faith in mean reversion to actually understanding businesses and its future cash flow prospects. Google continues to trade a lofty multiples, but if it continues to generate the cash that it has in the recent past, this is probably still cheap.

In all of your analysis you did not make any reference to the growth prospects or profitability of Tencent. Surely this should be at the heart of any discussion? I am not familiar at all with the business but what is the potential for Tencent to use its platform and client base to become a bank? Does Tencent monetise its vast subscription base as well as Facebook with targeted advertising? Or if you are negative where do you disagree from the market.

Just saying that growth ahs been strong for a while now therefore it must slow down is really not sufficient grounds for an investment decision.

waiting for the heard to call it to R5000….I think R2250 first

What are you basing your call on that Naspers is overvalued?

Assume you are presented with two options. Option A: Buy a company that will grow its earnings at 30% per annum for 20 years at a 30 PE and after 20 years you sell it after growth disappears and it derates to a 15 PE company. OR Option B: Buy a 8 PE company that grows earnings at 5% per annum for 20 years and then after 20 years re-rates to a 16 PE company. Once you have solved the math you’d know why value investors are such great commentators but such bad investors. Do the math!

The author states unlikely to produce another Tencent. Me thinks incorrect Flipkart??? Surely some more value to be unlocked with the sale of Flipkart to Amazon or Walmart.

Delphine has a terrible investing track record. I always feel so bad for her clients.

R147billion has been sold off in Tencent by Directors, the President and Chairman of Tencent AND their largest shareholder, Naspers in the last couple of months…..that should tell you something.
If it seems too good to be true, then it is too good to be true. When will investors learn as well as earn. Good time to take some profit

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