Naspers needs to prove investors wrong
At the recent Naspers annual meeting, shareholders were at serious odds with management about the value of their contribution to the company. Amid all the
sturm und drang and misconceptions about how to measure the performance of the managers, some facts of the matter deserve proper recognition. That is, Naspers managers are expected — emphasis on expected — to destroy the wealth of their shareholders on a heroic, or is it tragic, scale.
Were Naspers simply a pure clone of Tencent (that is, the company did nothing but collect and distribute to shareholders the dividends it received for its 34.33% share of Tencent), the Naspers stake would be valued as is Tencent itself, worth close to R1.6-trillion. The market value of Naspers is much less than this — about R1.3-trillion, a staggering R300bn less than the value of its Tencent stake.
The correct logical conclusion to come to is that the market expects Naspers managers to destroy value for them. That is, the ambitious capital-investment programme is worth much less (net present value) than the volume of capital the Naspers management is expected to deploy over the economic life of the company.
Unfortunately for management, the market has recently become much more pessimistic about their capabilities. In January, the expected destruction of value was a mere R98bn compared with almost R300bn now.
It may be concluded that the better Tencent performs and so adds to the balance sheet strength of Naspers, the more ambition it allows Naspers managers and so the more value destruction the market expects from it.
The recent operating performance of the Naspers subsidiaries gives very little cause for believing their fortunes are about to turn for the better.
Its cash flow return on investment dropped from -3.6% in 2016 to -10% in 2017. In other words, the operating core of Naspers is destroying value by generating a return on capital far below its opportunity cost of capital. This is nothing new. Cash flow return on investment has been dropping since March 2011. (Credit Suisse HOLT Lens).
Equity is not free and no rational investor wants to give it away for nothing. If we apply a capital charge on the use of Naspers operating assets, its economic profit drops from -R6.2bn in 2016 to -R11bn in 2017. Consistent with these negative returns is that the growth in the sales of these operating subsidiaries has turned negative and the (cash earnings before interest, taxes, depreciation and amortisation) operating margins that were well over 20% between 2004 and 2010 are now barely positive. In 2015 and 2016, the growth in Naspers assets (excluding Tencent) has been at an ambitious 40% annual rate.
Naspers managers and its shareholders clearly have a very different view of its prospects. Time will tell who has the more accurate view of the capabilities of Naspers management. One would nevertheless recommend that management put a time limit on their ability to prove the market wrong. If in five years, the market continues to value Naspers as a serial value destroyer, its managers should be willing to cut their losses by radically reducing its investment spending and unbundling or disposing of unprofitable subsidiaries.
Any expectation that Naspers is willing to adopt a much more disciplined approach to its capital allocation would add immediate value for the company’s shareholders.