The Naspers dilemma

2015-05-17 11:50
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Cape Town - The massive growth in Chinese markets is highly relevant to the South African market at this stage, said Daniël Kriel, CEO of Sanlam Private Wealth, in a special focus on Naspers.

He said the value of Naspers [JSE:NPN] is determined mainly by the Chinese technology giant Tencent, in which the South African internet giant holds a 34% stake.

Approximately 75% of Naspers’ value is made up of the investment in Tencent, currently the biggest internet company in China. The value of Naspers’ interest in Tencent is worth R780bn, about the same as Naspers’ current market capitalisation.
"The Shanghai Composite Index has already doubled since August 2014 and, over the last nine months, Chinese shares have been the best performing worldwide. Since the beginning of the year, the index has already increased by 30% in dollar terms," explained Kriel.

"Valuations appear dangerously high with 18% of the shares on the secondary Shenzhen stock exchange trading at a future price/earnings ratio (p/e) of more than 100. For the year to date, 244 (one in every six) Chinese shares have already doubled in price."

He pointed out that many analysts feel these levels remind them of the highs reached by technology shares prior to the dot-com bubble in 2000.

Locally, the Naspers share price for the first time broke through the R2 000 price level during the past month – an increase of 430% since 2012.

"Investors have been amply rewarded for their trust and, during the last few years, the share has been one of the core shares in our client portfolios," said Kriel.

"However, as investment managers we have a responsibility to seriously ponder over the future of the share in our portfolios and during the last month there has been some robust debate in our investment team."

Divergent opinions

Alwyn van der Merwe, director of investments at Sanlam Private Wealth, confirmed that there are strongly divergent opinions concerning the investment merits of Naspers.

"How is it possible, for example, that two of the largest institutional investment houses can differ drastically in their view of Naspers? The one invested 12% of its funds in Naspers, whereas the other one channelled only 2%," said Van der Merwe.

He explained that differences of investment opinions could be on two levels. Firstly, the view on the future success or otherwise of the company could differ drastically from one investor to another.

The second difference lies in the price one investor is prepared to pay for the future profit stream relative to other investors.

"Therefore, investors may share the same view on the prospects, while differing totally on the price to be paid for the future profits," said Van der Merwe.

"Over the past eight years, Naspers has been one of the stalwarts in our portfolios. Given the astronomical movement in the share price and the high valuation put on Tencent we have sold a small percentage recently and included profits."

Thereafter, however, the share price has continued to rise.

"The profits have not necessarily been better than we expected, but the market has priced the share as if the present profit momentum would continue. We know this is not going to happen since any company’s growth curve will level off," said Van der Merwe.

"In the information technology sector it is also very difficult to pre-estimate the growth curve since trends can change in no time."

He explained that it is difficult to determine the intrinsic value of Naspers, and Naspers appears to be expensive relative to its calculated intrinsic value.

Sanlam Private Wealth (SPW) has clients who want their money to be invested according to a strict value orientation, explained Van der Merwe.

"Because it is difficult to determine the intrinsic value of Naspers, and because Naspers appears to be expensive relative to its calculated intrinsic value, we have decided to sell the share for those clients," he said.

"For the majority of our clients who are not dogmatic about the value style, we are maintaining our current position in the portfolios. This position is monitored continuously. When our research indicates that the price of the share significantly exceeds its value, we will consider selling the share."

Cash cow and its 'rump'

SPW investment analyst Renier de Bruyn said, because the value of Naspers’ 34% interest in Tencent is worth R780bn, about the same as Naspers’ current market capitalisation, it can, therefore, be argued investors buying into Naspers are paying for Tencent and essentially receiving the remaining assets of Naspers (the so-called "rump") for free.

"The cash cow in the rump is the pay-TV business MultiChoice, which operates DStv in SA and other African countries. Naspers has used the bulk of this cash flow to acquire and develop new internet businesses. Many of these internet businesses are still in a loss-making phase, but are well positioned to become future cash cows," said De Bruyn.

"Naspers has managed to build a particularly strong presence in online classifieds... Naspers has established market leadership in online classifieds in most of the large emerging economies through its OLX, Avito, Dubizzle and (via Tencent) brands."

These businesses are expected to enter the monetisation phase in the next few years and turn from loss-making to meaningful profit contributors for Naspers.

"Although there may be concerns around Tencent’s valuation, the company has a strong profit track record and barriers to entry created by the network effect of its social network platforms," said De Bruyn.

"In my view, Naspers’ management has positioned the business well for the future. The focus has not been on maximising short-term profits, but rather on achieving market position and scale for maximum future monetisation. In some countries they are in the process of merging with competitor businesses, effectively turning a two-horse race into a one-horse race, further cementing market dominance for the future."

If he uses the current listed market price for Tencent and estimate reasonable fair values for the remaining businesses in Naspers’ rump, the sum-of-the-parts value amounts to R2 490 per Naspers share, 75% attributable to Tencent.

"Although I cannot ignore the valuation concerns around Tencent, I find some comfort in the attractive discount that Naspers trades to its sum-of-the-parts value and further potential upside to the value of the rump assets given the scale potential of these businesses. Naspers’ financial strength and expertise makes it a partner of choice with rising internet businesses, enabling it to continuously exploit new growth opportunities which are not publicly available," said De Bruyn.

"As a whole, growth in the global economy is slow, but it is changing its shape, creating winning and losing companies. Naspers is on the winning side and I will therefore hold onto my Naspers shares in the context of a diversified portfolio – even though its performance may be volatile."

Tencent in perspective

Portfolio manager Emile Fourie pointed out that public and private high-tech companies are demanding high multiples worldwide. The median Chinese technology company has a P/E ratio double that of the median US technology company at the height of the US dot-com bubble.

In 2014, Tencent earned about $3.54bn and at $186bn market cap, and is selling at a P/E ratio of 53. The current share price is, therefore, pricing in significant growth over a long period of time.

"One might argue Tencent has grown earnings at 24% per annum over the past five years and has excellent growth prospects. But remember the company is now one of the 30 biggest in the world," said Fourie.

"At a 53 P/E, very high earnings growth is required, yet few big companies manage to grow earnings per share by more than 15% per annum over 20-year periods. Very few big companies in any industry managed a high growth rate over a long period," said Fourie.

"The other challenge facing Tencent comes from the nature and history of the technology industry. Between 1919 and 1939 there were about 300 airplane manufacturers and only a handful are still alive today. The same applies to almost all life-changing inventions of the past, from cars and cameras to televisions, computers and cellphones."

Online gaming has been the big driver of Tencent’s growth, and today makes up about 57% of its revenue.

"I find it difficult to forecast the long-term future of online gaming in China with confidence, especially when armed with knowledge of the history of technology," said Fourie.  

"Even though Tencent’s long-term growth prospects remain positive, history illustrates the danger of paying expensive-looking prices for tech companies."

In his view value investors should ask what the probability of long-term success for the Tencent investor is at current levels.

"Given the size of the company, the complexity of valuing a fast-changing tech company and the high current price discounting aggressive future earnings growth, I find it difficult to have confidence in Naspers (as Tencent has been the historic driver and still currently is by far the most dominant asset in Naspers) on a probability basis, and have, therefore, sold Naspers in the value equity portfolio," said Fourie.

* Fin24 is part of Media24, a subsidiary of Naspers.

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