Why Naspers is still attractive

After an extended period of stellar performance the Naspers share has now underperformed the market, as represented by the Capped Swix, over five years. Has something fundamental gone wrong at Naspers, or is there value to be had at the current price?

To understand, the business must be looked at in three parts: Tencent; the collection of other businesses; and the combined value relative to the share price.

The Tencent share price has taken a beating recently. There are many contributing factors: declining valuations for tech businesses globally, increasing regulatory headwinds in China, a slowing Chinese economy, US rules that may disallow Chinese companies from listing in the US, and a concern that some version of sanctions may be imposed against ownership of Chinese assets (similar to what has happened to Russian stocks).

Our view is that the intrinsic value of Tencent’s business has decreased and the risks have increased.

Research of regulations imposed by China suggests that some of the negative headlines are noise and will have only a marginal impact on Tencent. But this is not true in all cases. Some new regulations seem to be intended to transfer value from platform internet companies such as Tencent to consumers and small businesses, or seem driven by noneconomic objectives of the Chinese government that seem irrational to most Western observers. Some of these variables are inherently hard to predict, such as the Chinese government’s next regulatory action, or whether China will align itself more closely to Russia’s war in Ukraine, leading to sanctions from the West. These harder-to-predict issues argue for risk mitigation actions, such as a smaller position size in the portfolio.

Overall, Tencent’s business is still very well positioned in China, with many potential avenues for growth. The valuation is close to the lowest it has been since Tencent listed in 2004. But it is important to emphasise that the risks have increased, and the possibility of irrational or negative government actions cannot be ruled out.

Naspers started investing in internet businesses in the 1990s. Since 2014, it has invested more than $20bn (about R320bn), but has also realised some value from successes such as Flipkart (an Indian ecommerce company) and from trimming its stake in Tencent. Some of the investments are starting to reach maturity, such as OLX (an online classifieds business), but many are still in very early stages, such as education technology businesses.

Naspers has also placed big bets on online food delivery businesses such as Delivery Hero and iFood. These are growing rapidly and offer a large potential prize, but the jury is still out on whether they can be sustainably profitable.

The investments in these other internet businesses have been funded by dividends from Tencent, which is something investors have often criticised. Our approach is to look at the underlying businesses and investment decisions in detail, both to form a view of the intrinsic value of these businesses and to assess whether management has been allocating capital well on behalf of shareholders.

In Naspers’s case, this is complicated by many of these businesses being at an early stage, resembling a venture capital portfolio, which will have some failures and some large successes. Time will tell whether the investment track record of Naspers’s current management team has been good, but so far, the results, excluding Tencent, look unexceptional.

Our assessment of the value of these businesses is updated as new data emerges, but is currently lower than management’s assessment. Even so, the value is significant at an estimated $25bn-$40bn.

Market valuations of unprofitable, earlystage technology businesses have declined over the past year. While this was an overdue correction, it lowers the value at which Naspers can sell investments.

There are also positive consequences to lower valuations, such as allowing Naspers to invest new money at lower prices and potentially thinning out the field of competitors for some of its businesses, as capital will be harder to raise.

The Naspers holding company discount has been on a steadily increasing path, with big step changes when the Prosus structure was introduced in 2019, and again in 2021 when the share exchange and crossholding were introduced. Both of these were increases in complexity, which the market did not like. The current structure, while overly complex, does have the advantage that it is tax-efficient and there is potential for simplification down the line.

Much of the criticism of management for not pursuing a simple structure is valid, but it should be acknowledged that there are obstacles such as regulatory approvals, tax considerations and operational requirements. The current discount is very large at 64%; Naspers trades at less than half the value of its underlying investments.

The trend has been an increasing holding company discount, which has caused the Naspers share price to underperform Tencent. It is uncertain when and how the discount will narrow. But the substantial discount creates some margin of safety and the potential to unlock value.

Naspers management is coming under increasing pressure to unlock value from the structure, rather than pursue new investments. There are different ways in which the structure can be simplified, each with its own trade-offs, for example selling or partially unbundling Tencent, separately listing all the other businesses, or selling off assets individually.

The share price decline has been caused by several factors some outside management’s control and some selfinflicted. Some of these factors are likely to be permanent changes that reduce our estimate of the value of Naspers and Prosus shares, while some may be temporary in nature, creating opportunities for long-term investors. In this case, our view of intrinsic value has declined, but is still above the price at which the share is trading.

We think Naspers/Prosus presents an attractive opportunity, and it makes sense to own a fairly large position. Very importantly, we carefully consider the risk of loss, which plays into factors like the size of the position.

Allan Gray currently owns 1.28% of Naspers (as at end March).