One of the largest positions in the Orbis Global Equity Fund is Naspers, whose key underlying asset is a 29% stake in the Chinese internet juggernaut Tencent. Over Orbis’ history, there have been opportunities for a global investor to own shares which are also listed in South Africa. Indeed, we as Allan Gray have also communicated to our clients about the attractiveness of South African equities relative to global equities given starting valuations today. Naspers is an especially vivid illustration of the global research capability of our offshore partner, Orbis, and the benefit of adopting a global viewpoint to fully understand a company. Our colleagues at Orbis, Stefan Magnusson, from the Emerging Markets Investment team, and Edward Blain, from the Europe Investment team, provide their perspective on why Naspers represents a compelling opportunity for a global investor today.
Investing globally has its advantages. Our global investment universe lets us look anywhere for opportunities, our global research capability lets us analyse individual companies across the world in depth, and our unconstrained global mandate lets us invest behind our research rather than hugging an index.
Last quarter, we discussed a particularly prominent result of this approach: While the US is home to some of our highest-conviction ideas, just one-third of the Orbis Global Equity Fund is invested in the US, which accounts for two-thirds of the MSCI World Index. To be so heavily underweight the US, we must be heavily overweight somewhere else, and roughly a quarter of the portfolio today is invested in emerging market (EM) shares. True to our bottom-up approach, almost all of that EM exposure comes from just eight positions, including Naspers.
The view from our EMs team
Between ourselves and Allan Gray, we have known Naspers well for a very long time.
Allan Gray held Naspers at the inception of its first unit trust in 1998. At Orbis, our funds have owned Naspers on and off since 1998 – our initial research predating both the US$34m investment in Tencent, that would come to define Naspers’ value, and the formation of our dedicated EMs research team. In the EMs team, we have followed Tencent closely since 2008, during the initial work on the Chinese online game industry that led to our long-standing investment in NetEase. We have returned to analyse Tencent repeatedly over that time, joined in recent years by our colleagues in the Global Sector and Europe teams, and we discuss Naspers frequently with the team at Allan Gray. Across the Orbis funds, we have owned Naspers continuously since 2016, and we have also owned Tencent in some funds.
owning an excellent collection of businesses at a large discount strikes us as a compelling opportunity
Years of research has given us a deep appreciation of the strength of Tencent. Sitting in our EMs team in Hong Kong, it is challenging to appropriately convey Tencent’s scale to people outside China, but the business can be thought of in four main parts: social media, online games, payments, and stakes in other firms.
“Social media” is too small a term to describe WeChat, Tencent’s messaging-based super-app that is indispensable to daily life in China. WeChat is not like WhatsApp; it is like WhatsApp, Facebook, Apple News, PayPal, Spotify, Uber, Deliveroo, and the App Store all rolled into one. China’s near-billion internet users spend roughly four hours a day – over 40% of their internet time – on Tencent’s apps.
Tencent is also the largest online game operator in China, and a formidable competitor for NetEase. As it is for NetEase, running popular online games is incredibly lucrative for Tencent – the company’s self-developed arena battle game, Honor of Kings, is the highest grossing game of all time, both in China and globally.
In payments, Tencent’s WeChat Pay operates in a duopoly with Alibaba’s Ant Group. The two platforms dominate online and offline transactions, with Chinese consumers using QR codes rather than credit cards for everyday purchases.
On top of its operating units, Tencent holds an enviable portfolio of stakes in Chinese internet businesses and global gaming businesses. For Chinese businesses like Pinduoduo, Meituan, JD.com and Didi, Tencent is an attractive partner, as it can take a stake and use WeChat to help investee companies advertise and grow. And for game studios like Epic (developer of Fortnite) and Riot (League of Legends), Tencent ownership comes with the leading game distribution platform in China.
None of these businesses is without risk. China’s regulators have recently clamped down on fintech companies including Ant and Tencent, scuppering Ant’s planned initial public offering (IPO) and imposing capital requirements on digital lenders. The government is casting a more sceptical eye over potentially anticompetitive practices from dominant tech platforms. Exclusivity deals and preferential advertising practices have already come under fire, and closed ecosystems such as Tencent’s could be prised open, with wide-ranging implications. (Imagine Apple having to open up the App Store.) Game regulators have halted approvals in the past and could do so again. And, finally, China-US tensions could paint a target on Tencent’s back.
Yet we must weigh those risks in the context of Tencent’s cash generation, growth potential, and valuation. The company generated US$16bn of free cash flow last year and should be able to grow that number at a near-20% annual rate. Stripping out the value of its stakes in other firms, that leaves Tencent trading at 33 times free cash flow – not optically cheap, but not unreasonable given the fundamentals.
Through Naspers, we can gain exposure to Tencent and these other ... technology businesses at a 50% discount
And Tencent is not the only great company in the Naspers stable. Naspers also offers exposure to a range of interesting EM tech businesses such as Delivery Hero, Mail.ru, takealot.com, and PayU, to name just a few.
Through Naspers, we can gain exposure to Tencent and these other EM technology businesses at a 50% discount. This looks attractive, even when applying an appropriate holding company haircut. As Ed discusses below, that comes with complexity, but owning an excellent collection of businesses at a large discount strikes us as a compelling opportunity.
The view from our Europe team
How does a stockpicker in Europe end up investing in Naspers?
Our work in the Europe team started more than a year ago when Naspers created a company called Prosus to hold its stakes in Tencent and other international internet companies. The move was intended to narrow the discount between Naspers and the value of its underlying assets. Naspers listed Prosus in Amsterdam, which overnight created one of the biggest tech businesses in our backyard.
Researching Tencent, Prosus, and Naspers has been fascinating, both in qualitative terms and, at the holding company level, in terms of price paid relative to value received. Starting with Tencent’s operating businesses, the discounts stack up as we move through the holding companies.
Tencent is one of the world’s greatest businesses; perhaps it isn’t too much of a stretch to say it could be the greatest. While regulation could weaken Tencent’s position in the future, the company’s competitive moats are formidable today. WeChat gives it both a powerful distributive capability for its current businesses and something to offer potential investees that other suitors cannot match.
Tencent is one of the world’s greatest businesses; perhaps it isn’t too much of a stretch to say it could be the greatest
Tencent’s business is both better quality and better value than it appears because the accounting is conservative on both the income statement and balance sheet. On the income statement, most growth investments are either expensed or are off the statement altogether in the form of foregone revenues. On the balance sheet, Tencent is itself a holding company, and lots of investments in associates are held well below current value.
One level up is Prosus, a holding company which holds a 29% stake in Tencent as well as a cash pile and a range of international internet companies. In addition to those Stefan mentions above, Prosus holds a range of leading online classified businesses in verticals such as real estate and autos. Here, our research on Auto Trader and Rightmove in the UK has helped us understand the outstanding economics of leading classified businesses, with the number-one player often earning operating margins of 60% or higher. Prosus’ classified businesses are ranked number one in dozens of countries globally. If we roll these assets in together with the Tencent stake, Prosus appears to trade at roughly a 40% discount to the value of its underlying parts.
Naspers listed Prosus in Amsterdam, which overnight created one of the biggest tech businesses in our backyard
Another level up is Naspers, which owns 73% of Prosus. Naspers trades at a roughly 20% discount to its Prosus stake, and at a roughly 50% discount to its net asset value. By the time we’ve worked our way up the capital structure via Prosus to Naspers, we appear to be paying less than 20 times core earnings for Tencent. But this discount comes with significant risks and complexity.
The complexity comes from several sources. Naspers’ ownership structure is atypical for a start, and while the company previously trimmed its Tencent stake and then created Prosus without negative tax consequences, tax concerns do somewhat limit the company’s restructuring options. Management also frets about Naspers’ very large weight in South African stock market indices. Listing Prosus was intended to help by moving some of this market value from South Africa to Europe, but the discount persists.
Recently, Naspers announced a voluntary exchange where Prosus will offer to buy Naspers shares from existing shareholders in exchange for shares of Prosus. The transaction is meant to narrow the discount, but it is complex and will result in a large cross-shareholding, neither of which is typically rewarded by the market. In addition, the proposed exchange ratio is more favourable to existing Prosus shareholders.
We are assessing the deal, and we and our counterparts at Allan Gray have engaged with the company to understand their reasoning and express our views. This share exchange is not likely to be the end destination for Naspers. Looking ahead, we favour actions that simplify Naspers’ structure to unlock the value of its underlying assets.
While the transaction is a reminder that the Naspers discount has strings attached, we ultimately come back to valuation, and the discount remains appealingly large. Once one strips out the various investments at each level, the multiple paid for core Tencent’s free cash flow at the Naspers level is very probably below the global market average, even with valuation haircuts on the investments. That feels like compelling value indeed.