DELPHINE GOVENDER: Standing up to Goliath

The biblical story of David and Goliath tells of a heavily armed man, Goliath, who is brought down by a young shepherd, David, who wins by simply but accurately hurling a stone from his sling.

At its centre, the tale deals with the unexpected ability of the perceived underdog to score an improbable victory. Best-selling author Malcolm Gladwell explored this topic in his book David & Goliath, and specifically discussed what he termed "asymmetrical conflicts".

One such asymmetrical conflict is brewing in the investment community and involves a corporate giant: SA-listed and -domiciled Naspers, alongside its 73.2%-owned, Dutch-listed internet assets division, Prosus; and on the other side, most of Naspers’ institutional shareholders.

In an unprecedented move, 36 investment managers recently co-signed a letter addressed to the Naspers and Prosus nonexecutive directors (who are identical, which in itself adds real complications for how independent these directors can be). The letter voiced opposition to a proposal which would see Prosus buy up to 45.4% of Naspers N shares in exchange for Prosus stock, newly listed on the JSE.

At the same time, several other institutional investors (domestic and global) have directly engaged with the boards, publicly and privately, to express similar and related concerns. Rarely have we seen such an open, unified and vocal institutional investor reaction.

The root cause of this investor discontent is that the value created by Naspers’s hugely successful investment in Chinese tech company Tencent has not fully reached Naspers and Prosus (but especially Naspers) shareholders.

As detailed in the FM’s cover story of May 20, the market value at which Naspers and Prosus shares trade is at a huge discount to the market value of the Tencent stake, as well as the other assets in both businesses (NAV). This discount sits at greater than 50% for Naspers and more than 35% for Prosus.

The Naspers and Prosus boards argue that their proposed transaction, whose "sole objective is to almost halve Naspers’s weighting on the JSE shareholder weighted index" will directly and sustainably address a key driver of the Naspers discount to its NAV.

But the transaction is complex and complicated, and favours Naspers and Prosus shareholders quite differently. It also introduces a cross-holding between the two companies. At the moment, Naspers owns a majority stake in Prosus, but following this transaction Prosus is expected to own a large stake in Naspers. If the existing complexity and lack of transparency (not simply index weight) have played a role in driving the discounts to NAV at which Naspers and Prosus trade, there seems to be little prospect for how this complex deal can sustainably result in the opposite.

So a conflict of opinion between the boards and the majority of institutional investors evidently exists, but what of the asymmetry? There’s the rub.

Prosus shareholders who must vote on approving this proposal are dominated by Naspers; and Naspers has an archaic entrenched voting structure (the Naspers A share), which endows Naspers and Prosus board chair Koos Bekker, and a select group of friendly investors, with shares that carry 1,000 votes per share, vs institutional shareholders, whose Naspers N shares carry only one vote per share. It means the Naspers A shares carry more than 50% of the votes, despite commanding a significantly lower economic interest.

Naspers A shareholders will naturally vote in favour of this proposed transaction, and with Dutch company laws seemingly requiring only a simple majority, the transaction will inevitably be approved at a Prosus level. Prosus shareholders outside Naspers who are opposed to this transaction should vote against it, even if their ammunition seems, in this context, the equivalent of shooting blanks.

The only remaining right a Naspers institutional shareholder might have is to not accept Prosus’s voluntary offer for Naspers shares. As it stands, the 2.27 times exchange ratio of Prosus for Naspers shares does not adequately consider the fact that the discount to NAV at which Naspers trades is considerably higher than the discount to NAV that Prosus trades at, thereby making the exchange ratio more favourable to Prosus shareholders. Institutional Naspers shareholders (especially SA ones) should therefore collectively push back and fight for a better exchange ratio.

However, in the absence of such an action or, crucially, a belief that such a victory might be won, each institutional investor will probably act in their respective interests and accept the current ratio in order to not be left with excessive Naspers shares. In other words, the classic prisoner’s dilemma.

Does this mean this David and Goliath story has no traditional victorious underdog ending?

The way I see it, it doesn’t. But the more I observe it, the real battle here should not be about institutional investors (David) vs the Naspers and Prosus boards (Goliath).

Rather, the target should be a joint, commonly focused one: to transparently and simply focus on unlocking value.

If institutional investors are stewards of their clients’ capital (they are, after all, the real owners of the company), and company directors are operating with the highest levels of governance in relation to these owners, these objectives should be mutually achievable, not exclusive.

Complex deals that entrench opacity have never been able to create value, no matter the situation. And giants need not present power in a way that they believe they are expected or entitled to, especially when the intended victory does little to actually guarantee lasting success.

If a full or partial unbundling of Tencent is not an option (for reasons we don’t know), then so, too, should this voluntary share offer be seriously reconsidered, or halted by the Prosus and Naspers boards.

Instead the focus should shift.

Use excess cash on aggressive share buybacks. Sell assets at favourable prices and distribute the proceeds.

Apply a laser focus to aligning management’s incentives with a reduction in the NAV discount: fatigued institutional investors seem willing to, even now, support rewards to management whose actions arguably resulted in the discount widening in the first place.

These are simple and effective measures, which could see victory for all of the 84,000 Naspers shareholders and 74,000 Prosus investors.

They might, finally, reap the full benefits of what their respective investments should have been delivering all along.