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Picture: BLOOMBERG
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Half of the 21% return delivered by the FTSE/JSE all-share index last year came from its largest share, Naspers. At Investec Asset Management, we don’t own Naspers in the Investec Opportunity or Cautious Managed funds.

Our zero exposure has been a key question for a number of our clients, given that the multinational internet and media group has been a significant driver of equity returns.

Naspers’s dominance in our market reminds us of some of the market structures seen at the turn of the century. Those investors who were involved in the financial markets in 1999–2000 will remember the contribution that Dimension Data made to the South African stock-market performance. Investors may also recall the substantial contribution – more than 80% – that Anglo American and BHP Billiton made to the South African market at the top of the 2006–08 commodity cycle. The local market is narrow and often driven by one or two holdings. 

We are not thematic investors. When we add any share to the portfolio, it has to meet quality criteria

The healthcare, technology and consumer staples sectors are a fertile hunting ground for quality companies, primarily due to their ability to create barriers to entry. In SA, there is a dearth of technology and healthcare businesses, whereas these opportunities abound across global markets.

As investors are exposed to a narrow and concentrated set of opportunities in SA, we believe that adding a quality offshore component to a South African portfolio provides complementary exposures. This forms an integral part of diversification.

Aside from the complementary exposure benefit, we are finding superior quality businesses offshore that have proven their ability to deliver high-quality profits, sustainable growth in earnings and cash flows, and high returns on invested capital.

Defining a quality tech business

We recognise the dynamic role that many technology businesses play in shaping the world. To this end, our Investec Global Franchise Fund, and the offshore vehicles of the Investec Opportunity and Cautious Managed funds, provide exposure to an array of higher-growth technology opportunities. This diversity of technology holdings ensures we avoid a single-stock, single-geography/jurisdiction approach where we are too exposed to regulatory risk in a particular market.

We are not thematic investors. When we add any share to the portfolio, it has to meet quality criteria. The valuation needs to make sense; the company should have clear and strong secular drivers for growth (not seasonal or cyclical); and, importantly, it should generate cash. What the company decides to do with this cash is also of utmost importance. Capital allocation decisions should be value accretive.

That is how we evaluate any business for inclusion in our portfolios. So which technology companies have a position in our portfolios?

  • We have exposure to NetEase, the second-largest manufacturer of games in online China, which is further globalising its footprint. Its market cap is a 10th of Tencent’s, but its revenue growth for the overall business has been about 30%. Most importantly for us, we can value the business on a free cash-flow yield basis as it generates cash, and it is trading on a valuation that is roughly half of that of Tencent. 
  • We own PayPal and Visa, two well-established businesses that are growing rapidly. They have strong network effects and we can also value them in terms of their free cash-flow yields. The payments space is an area that Tencent is trying to grow, via Tenpay and Alipay, but those are still fledgling efforts at this stage.
  • In terms of exposure to e-commerce opportunities, Priceline is a key holding for us. The travel industry is fragmented and we see great growth opportunities for a market leader.
  • We have exposure to internet security, an area we are excited about as there are clear drivers of returns. Cyber-attacks are on the rise, and companies will have to spend more to ensure their networks are sound and can withstand attacks. Check Point Software Technologies has a large array of products and solutions that address the security needs of network clients.
  • And last, in the software space we own Intuit, which provides a number of accounting solutions.

Holding Naspers means having a concentrated exposure to Tencent, the Chinese internet company that operates within a state-dominated economy. China is growing strongly, which has benefited Tencent materially over the past few years.

ABOUT THE AUTHOR: Clyde Rossouw is a portfolio manager and co-head of quality at Investec Asset Management
ABOUT THE AUTHOR: Clyde Rossouw is a portfolio manager and co-head of quality at Investec Asset Management

We believe Tencent is a quality business, operating in an industry with strong secular and structural growth drivers. However, the valuation is extremely rich at this point in the cycle, providing us with an insufficient margin of safety should valuations normalise.

So why do we not hold Naspers, a supposed discounted entry point to Tencent? Largely, we believe our process has captured and replicated various opportunities that Tencent and the Naspers “rump” offers, while, most importantly, retaining control over our capital allocation decisions.

Our diversified technology holdings therefore reflect an investment in innovative companies that are well placed to navigate an ever-changing landscape.

This article was paid for by Investec Asset Management.

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