MARC TALPERT: Prosus is a mix of valuation unlock and growth potential

It will be hard to find a saver who is not aware of the JSE heavyweights Naspers and Prosus. While the performance of both these stocks has disappointed in the past 12 months, their contribution to the local savings industry has been immense when you consider longer time periods. Naspers has generated a cumulative total return of nine times over the past decade vs the JSE all share index’s return of 1.7 times over the same period.

The more important question now becomes: can this performance be repeated over the coming decade, especially when the primary driver of this historic performance was Tencent?  

In our view, while Tencent is still very important for the investment case of Naspers and Prosus, it’s the non-Tencent assets that will be significant drivers of long-term value creation. This is a portfolio of assets that is now worth about $60bn based on our assessment of value, which compares to the spot value of the Tencent shareholding of $170bn.

Tencent – a diversified business

The Chinese regulatory environment has undoubtedly become important when thinking about the outlook for Chinese technology businesses. However, it’s important to consider regulation and its effect on the individual businesses, as the long-term impact on a case-by-case basis will most likely be different. At a high level, Tencent has historically navigated regulations well, and has exercised admirable restraint in adhering not just to the letter, but also to the spirit of the law. Historically, it has left money on the table, which positions it relatively better than its peers, in our view.

Gaming 

Tencent has a global gaming business, and its ex-China segment already represents 26% of its total gaming business, due to its ownership of iconic gaming studios such as Riot Games (the maker of League of Legions) and Supercell (the maker of Clash of Clans). So, while the Chinese gaming business is exposed to regulatory tightening, most notably a clampdown on the game time and spending of minors, it should be noted that minors contribute less than 5% of gaming revenue.

Also, gaming is a cost-effective entertainment activity; overall game spending across adult user demographics is therefore likely to remain robust. Another important consideration is that China represents 25% of the global gaming market, and thus, by expanding globally, Tencent’s gaming business has effectively tripled its addressable market in what is a structurally growing industry.

Advertising

Tencent has always been restrained in monetising its share of online consumer time; Tencent apps have a 36% share of time spent online in China vs their 11% share of the advertising market. So, while we don’t expect the two to converge completely, the mini programme ecosystem that exists within WeChat is driving a significant amount of commercial activity, creating a situation whereby advertising spending can be tracked and attributed to consumer spending. This is supportive of improved advertising pricing due to the high (and directly measurable) return on investment being achieved by advertisers. There is already 1.6-trillion yuan (and growing in triple digits) of gross merchandise value moving through this ecosystem, and we expect the level of commercial activity to continue to increase.

Fintech

Tencent’s fintech business is now dominated by payments, which, while not immune to regulatory intervention, are less exposed than other areas, such as credit. Growth within the fintech segment has always been managed conservatively due to management’s acknowledgment of the regulated nature of financial services. Therefore, the changes required due to new regulations are marginal. Less than 20% of Tencent’s payments volumes relate to consumption, as volumes are still dominated by peer-to-peer payments, which are not monetised. We expect the level of consumption volumes to grow faster than peer-to-peer volumes, which should drive robust revenue growth. The other part of the fintech business that we feel has lots of potential is wealth management.

Investment portfolio

Finally, an underappreciated aspect of Tencent’s business is its astute investment ability, resulting in an investment portfolio worth about $220bn (about 38% of the company’s market capitalisation). It remains an active investor across the globe and intends to deploy 60%-70% of all free cash flow generated into investments, which, based on its investment track record, should yield attractive returns.

While we think Tencent is an attractive stand-alone asset, we believe that the upside potential of the Naspers/Prosus ex-Tencent portfolio is underappreciated. The material pillars include food delivery (a space we believe to still be early in its innings, with material long-term structural growth drivers); classifieds (a segment that the group has been investing in for many years); payments/fintech (where scale has recently been expanded via Prosus’s payments business PayU’s acquisition of BillDesk in India); and education technology (addressing the important need for continuous adult education).

Prosus holds a 29% stake in Tencent, which now represents about 140% of Prosus’s market capitalisation. This stake does not take into account the ex-Tencent assets (discussed above), which in our view are underappreciated by the market and represent another 33% of Prosus’s current market capitalisation, based on our assessment of their value. When you consider that Tencent has an investment portfolio that accounts for 38% of its current market capitalisation, coupled with a diversified business spanning games, social networks, fintech and cloud, which are all at different levels of maturity, we feel that, notwithstanding the regulatory headwinds facing Tencent’s business, the company is still well placed to deliver both double-digit revenue and profit growth over the next few years.

We believe that Prosus shares represent a rare combination of both valuation unlock and growth potential, which combine to offer an extremely attractive opportunity for investors.

• Talpert is an investment analyst and portfolio manager with Coronation Fund Managers.