Naspers: Should you get in or out?

A negative research report is enough to send fear rippling through companies these days. Following the Steinhoff disaster in December, which coincided with a scathing report by Viceroy Research, Capitec and Resilient have felt similar tremors – and seen their share prices drop – following reports by Viceroy and 36ONE respectively. 

A mere rumour of a report in the making is enough to send a share price plunging – just ask Aspen. 

So in January, when Investec issued a report saying Naspers* “deserves a 30% discount on all of its assets”, the largest South African company and most expensive and most successful share on the JSE fell 16%.

Interestingly, Investec issued another report just a few weeks later, changing its position from hold to buy. (Investec would not release the initial report to finweek, and declined to comment on it.)

Although the share price may be under pressure, investors are not rushing to dump Naspers. 

This is because, at R3290 a share and accounting for 19% of the FTSE/JSE All Share Index (Alsi), Naspers reigns supreme on the exchange. 

Over the past five years, the Naspers share price grew over 440%. Even in the last year, when the Alsi grew 14%, Naspers recorded a 54% increase. 

It trades at a massive price-to-earnings ratio (P/E) of 95.

Its heady price makes it an investment proposition only for the well-heeled, but you can be sure it features strongly in the bulk of pension and retirement fund portfolios, unit trusts and exchange-traded funds (ETFs). 

There is good reason for this. Naspers is the only vehicle to get exposure, at a discount, to a fast-growing global internet giant, the China-based Tencent, through its 34% stake in the Hong Kong-listed Tencent Holdings. 

Discount
 
With Tencent representing 150% of the value of Naspers, you get Tencent at a discount and the group’s other substantial assets are thrown in for nothing.
 
“It is a unique asset in the SA market, and we are fortunate to have something of this nature given the structure and make-up of the JSE," says Anthony Sedgwick, director and portfolio manager at Abax Investments.

“It has the most exciting growth prospects relative to anything on the JSE. But the price is a function of anything Tencent does. Tencent is off its peaks, but it still trades on a steamy valuation number [P/E of 263].” 

All of Naspers’s other interests, which include substantial e-commerce, internet, video entertainment and media businesses in more than 120 countries, make up just 10% of Naspers’s net asset value (NAV). 

“All the all other stuff combined is worth 10%, and is becoming a smaller and smaller pimple on the back of a bigger and bigger rhinoceros. 

Yet these make up a substantial business which employs many people and a management team and requires significant expenses to run and operate. Everything is about Tencent – what the rest does, no one cares,” Sedgwick says.

This discount concerns investors. At Naspers’s investor day in New York on 12 December, chief financial officer Basil Sgourdos said analysts valued other assets at $180bn, but he and CEO Bob van Dijk didn’t have a convincing plan to unlock this value.

Peter Takaendesa, portfolio manager at Mergence Investment Managers, says that “the discount Naspers is trading at compared to its shareholding in Tencent as well as the wider discount to the fair value of its total portfolio is probably not that relevant over the short term, but provides an opportunity for long-term investors who are comfortable with Tencent’s risk-return profile and also believe Naspers will win in some of its huge investments in e-commerce.

“It may be difficult to reduce the discount over the short term,” he says, “but there are ways to close the discount longer term, like listing the e-commerce investments separately or selling some of them to other bigger global technology investors.

“These businesses are still in development stage and exiting or reducing exposure now is unlikely to maximise returns for shareholders.” 

Delphine Govender, co-founder and chief investment officer at Perpetua Investment Managers, says the investment case is twofold. 

“Some own it for a cheap entry to Tencent, while some own it for the future profitability of the non-Tencent operations, which are currently being valued at an effective negative value.”

Naspers’s Sgourdos says the “discount widening matters to us and we are hard at work on assessing what action we can take”. But “long-term value creation comes through great investments that deliver earnings, cash flows and returns well ahead of our cost of capital”.

“There are many things that drive the discount. The most significant are FDI [foreign direct investment] flows, our absolute size on the JSE, R/$ movements and several other market-driven factors. Trying to second-guess the markets and addressing some of the structural challenges is not easy and very risky.”

Sgourdos adds that it is clear there is no easy near-term structural fix.

“Some of the ideas floated will simply have zero impact, others may have short-term impact but it’s questionable whether they will be sustained over the long term, and then there are some that could make a real impact but come with some meaningful consequences for the group that need to be carefully navigated. We are working on assessing viability and ability to execute and mitigate risks on the ones we are most convinced of.”

However, Naspers will “not make short-term reactionary and/or poorly considered moves which undermine long term value creation”, he says. “Any potential solutions will take time to craft and deploy, so it’s hard to put a timeline to these things. What we can say is that it is getting significant attention and focus and is a priority for us, right up there with continuing to drive the overall financial performance of the group, which we believe will ultimately drive value over the long term.”

Asked about speculation that Naspers would list e-commerce businesses in Amsterdam, Sgourdos says listing of assets “is something we have considered and done in the past and something we will do into the future”, but no decisions have been made “and as a matter of policy we don’t comment on these aspects until we decide and execute”. 

“If we did pursue a listing, there are several options and exchanges we could follow, with Amsterdam being one of many,” he adds.

E-commerce investments

Under Van Dijk, who has been CEO for almost four years, there has been progress in the group, whose subsidiaries include everything from the mail.ru internet business in Russia to DStv, Media24 and OLX.

In the six months to September, group revenues increased 33% to $9bn, with businesses outside SA contributing 82% of revenues, up from 80% a year ago. Core headline earnings grew 65% to $1.5bn. 

Internet revenues account for 77% (72% in the previous year) of group revenues, and were up 42% (lower than the previous year’s 52%) to $6.9bn. 

The 47% increase in trading profit again reflect Tencent and “declining losses in several e-commerce units”, which continue to scale. 

The results reflect the total dominance of Tencent, but also point to the breadth of companies and revenue and profit opportunities which are hidden in the Naspers share price.

Naspers has invested heavily in e-commerce, with many analysts believing this has been done in the hopes of finding “the next Tencent”. 

E-commerce investments remain high risk, but have high potential returns as some are still in the development phase and have huge potential markets over the long term, explains Takaendesa. 

“There are encouraging signs as losses in their global classifieds portfolio (mostly OLX) are starting to reduce and Naspers has realised significant profits from some of its investments harvested recently, such as the disposal of Allegro for $3.2bn.” He says the profitability path and sustainability of most of the new e-commerce businesses is still not clear, “but consumer adoption rates are quite encouraging”.

“The key competitive advantage in most consumer e-commerce businesses is operational scale and related network effects,” he says.

“This business model requires investors with strong balance sheets to sustain relatively long periods of making losses, and Naspers is one of those companies.” 

Whether any of these new investments will be another Tencent is doubtful, says Takaendesa, as Naspers competes with large US companies outside China, “but we believe Naspers will be one of the winners in emerging markets”.

Apart from Tencent, analysts often point to DStv as another example of where Naspers showed vision. 

But with the launch of Netflix on the continent, and DStv’s high rates, DStv’s future is less certain. 

“Naspers remains the market leader in African pay-TV services with about 12m subscribers in 50 countries and still growing,” says Takaendesa. 

While this will be affected by the growth in online and on-demand entertainment, he says there will be slower adoption in Africa, where internet penetration is low and data connectivity expensive. 

While Naspers is adapting with Box Office, Showmax and online access, growth will be under pressure. 

However, solid returns and cash flow will be generated in the medium term, he explains. 

Over the long term, DStv’s profitability is deteriorating and the competitive threats are great, says Perpetua’s Govender. 

“The fact that DStv is now giving away for free access to offerings such as Showmax is revealing in terms of the kind of actions that need to be adopted to simply gain market share, which comes at a major cost to profitability.”

Media assets

What were once core media assets (like pay-TV and Media24) don’t have great prospects, but they generate cash, have been sized appropriately, and have increased online news presence, says Sedgwick. 

Takaendesa expects Naspers to exit “when free cash-flow generation becomes less attractive”.

Naspers won’t comment on this, other than to say that it regularly assesses future earnings and cash potential against other strategic alternatives, “and where it makes sense and we can execute, we do so”.

Naspers says it has reinvigorated subscriber growth in the video entertainment business and stabilised the negative impact of significant currency devaluations in sub-Saharan Africa, “and we are on a good forward trajectory”.
 
Top-line growth in South Africa will slow in the core operations, but Naspers is investing in connected products and services like Showmax. 

There is also still room to grow in sub-Saharan Africa and mid- and lower-tier packages continue to gain good traction. 

In Media24, Naspers is focusing on cost controls and is managing the assets for profitability. 

Sgourdos says: “We need a balanced portfolio given that we fund a significant part of our expansion from cash generated by operations and debt. As we bring more and more assets to profitability and cash generation we don’t only increase our investment capacity, but also flexibility we have around our portfolio of assets.”

He explains that Media24’s print operations remain profitable, and it has made great progress building SA’s largest online news destination, a sizeable online fashion business (Spree) and other online initiatives. 

“Media24’s future is in the online space and that is where it will invest and focus.”

Control structure 

Investors have raised a number of concerns about Naspers. 

The first is its antiquated control structure, with two classes of shares. 

“In Naspers, the majority of shareholders own the class share with the reduced voting rights despite the fact that they have majority economic interest,” says Govender. This has resulted in “a disenfranchisement of shareholders which erodes their rights".

“We saw this work against Naspers shareholders last year where I believe more than 60% voted against the remuneration policy; however, the resolution still passed due to the high voting shares which voted in favour,” she explains.

Sedgwick adds: “We would want them to eliminate one class of shareholder. The shareholding structure exists because, historically, political masters could control the press. That was an apartheid relic, and it is appropriate now that we move on and are equal shareholders.”

This is a legacy issue and has mixed implications for investors, says Takaendesa. “While Naspers has made visionary investments and delivered stellar returns to shareholders in the past, despite the existence of this control structure, the same structure could disadvantage minority N-share investors in some instances.”

He says that if changes to the treatment of unequal voting structures in the MSCI indices are implemented, Naspers’s weighting could more than halve and this could have a serious impact on the share price as global investors reduce their shareholdings. But, if they are implemented, there will be a three-year grace period. 

Naspers says the MSCI has recently re-opened the consultation on the treatment of differentiated voting rights with a proposal to adjust the weights of stocks in the MSCI Equity Indexes to reflect company-level listed voting power in addition to free float. 

“We don’t agree with the rationale for the changes,” says Sgourdos. “In our opinion they are aimed to appease passive investors and, while an important and growing investment class, they are not the only investors, and we believe indices need to look broader than just a category of investors. 

“Think about the potential consequences here. Funds tell their investors that they are delivering returns ahead of the benchmark, but what they don’t tell them is that the benchmark underweights some of the most successful, fastest-growing and highest-returning assets and had they allocated capital there, the returns would have been even higher.”

Sgourdos explains that the two classes of shares, as well as the control structure, have been in place since listing in September 1994 and were implemented “to secure Naspers’s independence and stability of control, factors that are an important part of Naspers’s ongoing success as it allows for investment in assets and countries where ownership stability is essential”.

“This stability has been key in delivering the value that we have,” he says, and “the needs for independence and stability of control remain and are even more important as we enter more countries and partnerships, so we have no plans to remove it”.

Naspers adds that differentiated voting rights and control structures are not uncommon in the media and internet sector, including Schibsted Media in Norway (Tinius Trust), Bertelsmann in Germany, News Corporation and the Daily Mail and General Trust in the UK, and Google. Alibaba, Snapchat and others have implemented similar structures.

Tencent 

Another concern is uncertainty over Naspers’s control of Tencent.

Naspers says there are no restrictions on buying or selling Tencent shares “and no contracts nor agreements that govern our investment. We hold shares on the Hong Kong Stock Exchange in the same form as every other Tencent shareholder.”

But Govender says the investment in Tencent on the Hong Kong exchange gives shareholders rights to revenue, earnings and dividends, but not ownership rights to the underlying Chinese company. 

Tencent Holdings shareholders have no claim on the assets of the company due to Chinese legislation which prohibits foreign ownership of the assets of internet and media companies, she says. Variable interest entities (VIEs) were established to enable access to foreign pools of capital, but their legal certainty has not been tested and there is a risk VIE structures may have to unwind in future. 

In addition, she says, because of the layers between Tencent Holdings and the underlying core Chinese Tencent operation, there is a risk that assets in the underlying operation could be potentially excluded from the Tencent Holdings structure without the Tencent Holdings shareholders having any say about or knowledge of this. 

While this is a risk to all Tencent Holdings shareholders, “it is most meaningfully a risk to Naspers”, given the materiality of the Tencent Holdings investment for Naspers.

Govender says Naspers will not be able to unlock value by unbundling or selling Tencent “as there appears to be further opacity and uncertainty too over other contracts or agreements which might govern Naspers’s investment in Tencent Holdings”. 

Takaendesa says the same applies to companies like Alibaba. “It would be naïve to dismiss the risk outright, but we think it’s unlikely that a credible government that has been fully aware of the existence of these structures would just change things retrospectively and detrimentally to global investors who have helped fund these Chinese internet giants.”

Corporate governance 

Yet another concern is over corporate governance, particularly relating to the Guptas’ ANN7 after it was revealed that MultiChoice would pay ANN7 R150m a year. MultiChoice admitted there had been procedural shortcomings and has cancelled the contract, but this did not sit well with investors. 

The manner in which management dealt with the issue was initially “very dismissive to the market”, says Govender. Its stance at the time was that it could not be expected to know everything that was happening in each of its underlying businesses.

“This was a disingenuous stance in my opinion, as outside of Tencent, MultiChoice is the most profitable operation in the group and it was incumbent on management at the board to be completely alive to these reputational risks and governance ethos in their operations,” she comments.

Sedgwick adds that the MultiChoice issue was “handled well from a governance perspective and we were pleased with outcome”. For him, governance issues relate more to Naspers's A and N shares and the level of control of A shareholders, but “for us, this is not a strong enough reason to not own the shares”. 

Govender says her concern “is that we see many separate flags which, when you combine [them], start to raise some real concerns about how the company is being run”.

These include the unequal voting structure, which aligns the high voting shareholders to management more than other shareholders; the opacity in the agreements over the Tencent holding; “the pushback from the company in respect of variant (negative) views that the investment community might have about the business strategy; the ongoing delay in the monetisation of the non-Tencent investments over the past few years – revealing deteriorating returns to shareholders – and successive years of negative cash conversion.”

Outlook 

Sedgwick says it is time “to make a judgment call” on the discounted assets. “They need to split the two, they [non-Tencent assets] no longer need the dividend stream to support funding and their equity is worthless. 

“It is great that we get the chance at 40% discount to trade in Hong Kong. It is a great opportunity, but it is important that Naspers paper has value. Why would any company offer a discount to NAV?” 

Sedgwick says Naspers, and chairman Koos Bekker in particular, can “take enormous credit for two large successes – the evolution from print media to pay TV, and the investment in Tencent. 

“As longer-term investors, we feel this is a unique-natured asset, with exciting growth prospects, and we believe that eventually, some sort of unlock of value will occur.”

Govender says Naspers now effectively represents more of a “venture capital fund” with many stakes in many operations, and that management is looking to uncover the next potential “Tencent-type” investment. But the chances of another deal of this magnitude of success are low, “and virtually nil in [her] opinion”.

She adds: “The investment environment that Naspers are now deploying capital into is very different to 2001, when they purchased the stake in Tencent. There is significantly more competition for assets now, and also you are competing with other acquirers who have significantly deeper pockets, such as Amazon and Facebook.

Takaendesa comments: “Key to the long-term investment case for Naspers is finding other growth engines that will drive the group forward when pay-TV and Tencent start to slow.” This is where the company is searching for another gold mine in e-commerce and other new ventures such as education, he says. 

HOW YOU CAN INVEST IN NASPERS

As many individual investors cannot afford the company's shares, many look to invest in unit trusts or exchange-traded funds (ETFs) with a significant Naspers weighting. 

At the same time, there are concentration risks for small investors putting their money into unit trusts and ETFs with a high Naspers weighting, especially as many may already have high exposure to Naspers through pension or retirement funds. (Also see page 26.)

Naspers commands a weight of 23% in the Shareholder Weighted Index (Swix) and 19% in the All Share Index (Alsi), and rules of prudent portfolio management and diversification indicate that a single stock should not command more than 10% in a client’s end portfolio, Perpetua Investment Managers’ Delphine Govender says. 

“We now end up in a situation where many funds hold a high exposure to Naspers simply by virtue of its size in the index and not necessarily because they believe it is the most attractive investment in the market.”

Naspers has been an excellent investment for South African investors, but largely due to “the price performance of Tencent, and an investment environment that has been particularly favourable to the pricing of technology/internet stocks. 

“Naspers’s non-Tencent operations have cumulatively regressed in terms of their profitability over this time,” she says.

Mergence Investment Managers’ Peter Takaendesa says Naspers makes up more than 20% of the older benchmarks such as the Swix, but less than 10% of the old CAPI index and the recently launched Capped Swix benchmark index.

“We have encouraged most of our clients to migrate to the Capped Swix index benchmark as we believe the concentration risk is much reduced … and we also believe investors should not avoid Naspers outright given its long-term growth potential.”

BUY, SELL OR AVOID?

Perpetua Investment Managers is not investing in Naspers. “Given that I am of the view that Tencent is currently overvalued, and that there are some real (not just perceived) risks in Naspers as an investment, at current share prices I would not be investing in the company,” says Delphine Govender, co-founder and chief investment officer at Perpetua. 

Peter Takaendesa says Mergence Investment Managers is holding “for a long-term investment view as we see the risk-return profile as quite balanced at this stage and we have addressed the portfolio concentration risk by limiting our Naspers exposure in portfolios that allow us to do so”. 

“We like the Tencent business model and the company has delivered growth ahead of market expectations over the past few years, but we are concerned that its valuation is looking a bit full and likely to be one of the reasons Naspers is trading at a bigger discount now – Naspers domestic investors want some margin of safety on its Tencent holding.”

At this price it is a buy, says Abax Investments’ Anthony Sedgwick. “If Tencent does come down, we will see that as a fantastic buying opportunity.”

Of the 11 analysts polled by IRESS, all 11 rate the stock a buy.

*finweek is a publication of Media24, a subsidiary of Naspers.