Double down or get out?
It was hard to imagine, at the start of 2021, that Naspers shares would be among the worst performers on the JSE’s top 40 index come September, having dropped 22%, while Prosus would be 26% weaker. With their biggest asset still Chinese group Tencent, their share prices have been clattered by an increasingly interventionist Chinese state, intent on some heavy-duty social engineering. The FM asked Vestact’s Bright Khumalo and Old Mutual Invest’s Neelash Hansjee what all of this means for investors.
The statement last week from the Chinese Communist Party around gaming — that companies like Tencent were “urged to break from the solitary focus of pursuing profit or attracting players and fans” — sent Naspers and Prosus share prices crashing further. Does it diminish the investment case?
BK: Yes, it certainly does diminish the investment case and that's what the share price tells us. If things like earnings and dividends are a primary driver of share price movement in the long term, we should expect to see less share price appreciation from a business that downplays or disregards profits altogether.
NH: I think the important link is the social agenda, which is what this direction is talking to. The regulation change we saw with the education companies effectively shifted the business model from for-profit to nonprofit.
Last year, with Covid, you had a social crisis where the big winners were the tech companies — specifically gaming companies — which has caused excessive profits and huge amounts of wealth, and now we see the [regulators] trying to tone it down. Many blue-collar workers lost their jobs because of Covid, and now you’re trying to manage that inequality — so that’s the context. The Chinese don’t just talk the talk, they walk the walk, and the signs that regulations were coming were there last year with Alibaba. At some point it diminishes the ability to maintain the profitability of these companies, which does etch away at the investment case.
The perception was that the Chinese state had embraced capitalism wholeheartedly. This appears to have changed that. Are investors fooling themselves by thinking the Chinese bet is a one-way trajectory?
BK: In investing, you hope to get paid for the risk you assume. Anyone who's been an investor in China has to take the good with the bad. There is no bet that's a one-way bet, otherwise I would sell everything I own and place it on that bet until I go broke. This is not a bug but a feature of investing in Chinese markets. NH: The law of numbers suggests that there’s still long-term opportunity in China. There are just so many people, but I think we’re still unclear about this transition. Businesses are being disrupted and we don’t know how the economics of these businesses will look, let’s say, one or two or three years down the line. And then, are these businesses appropriately priced for that?
So what we’re looking for is what’s the growth rate of these companies down the line — because that’s unclear. What is really interesting about Tencent’s last results is that its costs went up because it employed 23,000 more people in one quarter because it’s trying to manage the social [aspect], and what’s to say it won’t hire another 23,000 in the next quarter? So its costs could still continue rising, but its revenue is being etched away, so we need a bit more certainty on those elements.
Still, do these statements suggest China is becoming uninvestable?
BK: The first-order consequences of the statement mean you run a private business the same way you run a not-forprofit organisation. However, the second-order consequences of what this means for the long-term investor aren't so obvious, and those who can figure this out can bet on the direction of the share price and make money from it. NH: No. Not uninvestable; the Chinese are regulating their economy and you need this period of transition to work through the system. They want investment in financial services, they’re opening up to the global banks and so on.
The problem is that most South Africans have exposure to Naspers and Prosus. What is the best option right now? Double down or get out?
This is not a bug but a feature of investing in Chinese markets
BK: This is the perfect time to play with the casino’s money. Use the proceeds and new cash to buy US-listed tech companies with better prospects than these. This has been another expensive lesson for investors on concentration risk.
NH: We’re still cautious. We’re still waiting to see the full fruit of regulation play through. What’s saying we can’t have another regulation like the education decision, where they just say a business must go from profit to nonprofit — that would completely kill a segment of the market. In that environment, it’s difficult to say you should double down.
How do you see this situation a year from now?
BK: I haven’t a clue!