Market reaction against Tencent a likely overreaction
The most sensible course for Naspers investors for the moment would be to do nothing
Tencent, through its holding of WeChat, has been caught up in the escalating China/US trade tensions, which has potential implications for holders of shares in Naspers and Prosus.
On August 6 US President Donald Trump issued two executive orders against Chinese tech companies, imposing a ban on US transactions with TikTok and WeChat on the grounds that “they threaten national security, foreign policy and the economy”. The ban comes into effect on September 20.
Tencent’s share price has fallen by about 9% (to its August 18 close) since the ban was announced. Though the tech sector has been on the back foot recently, Tencent has been a notable underperformer — despite reporting solid results — no doubt on this news.
Tencent’s direct revenue and profit exposure to the US is estimated at about 2%, though this in fact comprises largely gaming. So the direct effect as a result of the WeChat ban would seem to be minuscule. The other result potentially comes from Tencent’s investments in US companies (though we are not seeing anything to suggest that there are plans to expand the scope of this ban to cover those as well).
Tencent’s investments include stakes in companies such as Tesla, Epic Games, Activision Blizzard and Warner Music, with a total value of about $26bn (HK$21/share).
On the face of it, the sell-off seems to be an overreaction. However, it is worth keeping in mind that before this development Tencent’s valuation was looking relatively full, so it was certainly not that tolerant of any bad news when the executive order was announced. It is also likely that the market is discounting the possibility that this situation will escalate and have a more material impact on Tencent in future.
How material is Tencent for Naspers?
At the moment, Tencent accounts for about 87% of our Naspers net asset value (NAV). While Naspers aims to build its other internet investments in online classifieds, food delivery and fintech into sizeable global businesses in their own right, which, if successful, may dilute Naspers’s exposure to Tencent to some extent, this is likely to be a gradual shift. Thus, Naspers’s fortunes will remain closely linked to Tencent for the foreseeable future.
Currently we calculate the discount to net asset value for Naspers is 53.5% and for Prosus 32.5%. Recently Prosus has been outperforming Naspers, as can be seen from the widening gap between the two discounts. At present it looks as if it is at the widest point it has been since Prosus listed on September 11 2019. The Naspers discount is also close to the widest it has been (it did get a little wider in the severe market dislocation of March 2020).
The only reason we can think of to explain Prosus’s current outperformance is that investors may be positioning for the potential inclusion of Prosus in the Eurostoxx 50 Index in September. However, there is risk that Prosus may not be included because of the complicated two-step calculation that needs to be done. On an absolute market capitalisation basis alone, Prosus should easily qualify, but rules to limit a sector becoming excessively dominant may count against it. SAP and ASML are already major index constituents in its sector.
We think this is yet another example of the unforecastable “left-field” event risk to which investors are exposed with Tencent. So far it has bounced back from these events, leaving those investors who panicked and sold out living to regret the move.
Based purely on Tencent’s current direct exposure to the US, the market move already looks like an overreaction, implying it is too late to sell now unless you think there is worse to come. Tencent also reported strong second quarter 2020 results on August 12, which were above consensus analyst expectations. This was its fastest revenue-growing quarter in two years, driven by online gaming revenue, which jumped 40% year on year. The results confirm that Tencent is in a favourable space in terms of the pipeline for its all-important gaming division.
Given these points, together with the wide discount on Naspers at present, we think the most sensible course of action for investors is to do nothing. However, it is yet another “shot across the bows” to remind us that it is unwise to have an irresponsibly large level of single-stock exposure to Naspers.
• Gresty is an analyst at Anchor Capital
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