Naspers :The investment case
30 January 2012 - Adrian Zetler
The investment case
By Adrian Zetler, equity analyst
Naspers is a share that has formed an integral part of our client portfolios for 10 years now and has contributed significantly to the outperformance of our funds during this time. After such a strong run, one might be tempted to lock in some of this outperformance, but we continue to believe that Naspers is a company that is trading at a substantial discount to its intrinsic value. Furthermore, in a market where we believe earnings for many companies are at a cyclical high, Naspers offers investors an earnings stream that is both defensive in nature and currently well below our estimate of a normal level. Its superior growth prospects, coupled with an earnings base currently depressed by abnormally high development spend (incurred to build new revenue
streams), means that Naspers is poised to show attractive earnings growth in the years ahead. Currently trading on a PE multiple of approximately 10 times our assessment of normal earnings, we see this as an attractive price to pay for a portfolio of high-quality media and internet assets. Naspers therefore continues to have a substantial weighting across client portfolios.
The Naspers story is truly remarkable, and one that we as South Africans should be particularly proud of. Led by Koos Bekker, the core Naspers management team has worked together for almost 30 years. This is an almost unprece-dented event in modern day business given the perennial problems that arise through the principal-agent relationship, and speaks of the success and returns this management team has generated for shareholders. Over the past 10 years Naspers has generated a return of 2 500%, or 21% CAGR (compound annual growth rate) for shareholders. From a traditional print media business generating 100% of its profits from South Africa, the company has evolved into a diversified portfolio of high-quality media assets spanning print, pay-TV and the internet, with a geographical spread covering all major emerging markets, including China, Russia, Eastern Europe and Latin America.
Naspers’s four largest investments are MultiChoice, Tencent, Mail.ru and Allegro, of which two – Tencent and Mail.ru – are separately listed in Hong Kong and London respect-ively. These four assets combined comprise more than 90% of our estimate of the company’s intrinsic value. However, at the current price per share of R445, Naspers is in fact trading below the market value of its stakes in Tencent and Mail.ru, which amount to R453. Therefore, an investor buying Naspers today is theoretically paying zero for its interests in pay-TV, print and all its other internet businesses (the ‘rump’), or buying Tencent and Mail.ru at a large discount. Our intrinsic value for this ‘rump’ is close to R300 per share. While we remain skeptical about the value the market places on Tencent, we believe the market has mispriced this portfolio of assets and created a great buying opportunity for long-term investors like us. Many of these businesses are dominant in the markets in which they operate and offer attractive growth prospects.
Due to its holding company structure, many market participants believe that Naspers should trade at a discount to the value of its underlying assets. Our view is quite different. This is a company run by a management team with proven ability in identifying and capitalising on major media and technological trends. Naspers pioneered pay-TV services in South Africa and was a founding investor in MTN – the largest mobile operator in Africa. It later went on to become a major investor in Tencent and Mail.ru – the largest internet companies in China and Russia respectively. It puzzles us as to why investors would demand a discount for such vision, when arguably it should attract a premium.
MultiChoice, or more commonly known as DStv, is a great business and one of the best in South Africa. Originally launched under the M-Net brand in 1986, today, Multi-Choice has nearly 4 million subscribers in South Africa and over 1.5 million across the wider African continent. Combined, these 5.5 million set-top boxes deployed in subscribers’ homes provide a significant barrier to entry for any new competitor contemplating entering the market. Furthermore, this critical mass in subscriber numbers provides Multi-Choice with a significant competitive advan-tage when it comes to procuring content, as it amortises the cost of the purchased content over a much larger user base than its competitors. Therefore, unless a new competitor is willing to outlay a huge amount of capital and, on top of that, endure years of operating losses, it is incredibly difficult to compete against MultiChoice.
A wonderful feature of pay-TV is that its subscriber base is relatively sticky due to the lack of quality in-home entertainment alternatives. The business is therefore almost impervious to economic cycles. This makes the Multi--Choice subscription-based revenue model relatively secure and provides a defensive earnings stream. Thus, notwith-standing the challenges posed by the global financial crisis over the past five years, MultiChoice was able to grow revenues by 20% CAGR and more than double its underlying operating profits during this period.
On top of its defensive qualities, MultiChoice also offers particularly attractive growth prospects. Pay-TV penetration rates (as a percentage of TV households) on the African continent are amongst the lowest in the world, as can be seen in the chart below.
With the introduction of digital terrestrial television (DTT), MultiChoice can now offer far more affordable pay-TV packages and significantly increase penetration across the continent. While the roll-out costs of DTT networks will depress profits in the short term, MultiChoice is building a stronger business that will show years of attractive earnings growth. The Naspers internet strategy centres on businesses where network effects provide a strong barrier to entry. Its focus remains in emerging markets where internet and broadband penetration are still in the embryonic stage, but nevertheless offer attractive growth prospects.
The approach is aimed at creating a confederation of entrepreneurial businesses that is heavily reliant on incumbent, local managers to grow operations. Under this business model, Naspers can benefit from firstmover advantage in a given geography and leverage off the expertise within the group. The cross-pollination of ideas helps guard against mistakes and poor investment decisions.
Naspers’s largest internet asset is its 34% stake in Tencent, and undoubtedly its most successful investment to-date. Naspers’s original investment of $32 million in 2001 is now worth $19 billion (at current market prices) – a phenomenal return of almost 600 times its original investment in a little over 10 years! Tencent’s iconic QQ brand has become synonymous with the internet in China. Over the past decade it has evolved from a pure instant messaging service into a social networking platform, incorporating features from Facebook and Twitter – but with a Chinese twist. Tencent’s size and sticky user base of over 350 million provides a significant competitive advantage. Using its social network as a distribution platform it has become
the largest player in online games and virtual goods in China – generating close to $4 billion in sales in the last financial year alone. Given the low Chinese internet penetration (40%), its dominant market position and opportunities to monetise and grow a number of other revenue streams (e.g. e-commerce, online video and mobile internet), Tencent is poised to show very strong earnings growth in coming years.
Tencent is a complex stock to value. It is a young company with a relatively short operating history. Given that it is trading on a historic PE multiple of 33 times, we believe that much of the aforementioned growth story is already reflected in the current price. We have conducted a conservative valuation of Tencent and while on a stand-alone basis we do not find value, this does not cloud our overall assessment of Naspers. Even with the inclusion of Tencent at our assessment of its intrinsic value, we end up paying very little for the remaining high-quality assets in the Naspers portfolio.
Mail.ru is 29% owned by Naspers. In a nutshell it is a Russian version of Tencent, but also owns a number of minority stakes in well-known global internet companies such as Groupon, Zynga and Facebook. Mail.ru management plans to dispose of these minority investments upon the expiry of certain lock-up periods, potentially generating a lot of cash (up to 30% of our intrinsic value of Mail.ru) for shareholders (including Naspers) over time. Mail.ru is the leading internet company in Russia – an internet market which offers attractive growth opportunities.
Naspers sees e-commerce as its next pillar of growth. It is therefore reinvesting the cash flows generated from its past successes (pay-TV, Tencent and Mail.ru) to aggressively pursue the building of e-commerce platforms in its target emerging markets where e-commerce penetration is still low (relative to developed markets) and where e-commerce adoption is growing rapidly.
The scale of this investment is potentially game changing for the company. Since the acquisition of Allegro (the leading e-commerce company in Eastern Europe) in 2007 it has spent more than R25 billion (or 15% of its current market capitalisation) on acquisitions and organic develop-ment to build scale across its different product offerings. The nature of e-commerce necessitates long invest-ment cycles in order to ward off competition and establish a dominant market position, and we therefore expect it to be a drag on earnings for a number of years to come. This uncertainty and near-term earnings pressure is hard to endure for short-term speculators but plays into our long-term investment philosophy. We believe that the Naspers share price currently reflects limited probability of success in e-commerce but, given the optimism of management on this front and their impeccable investment track record, we believe this to be a mistake. Although a long time horizon is required, we view the pay-off profile of this invest-ment to be very attractive and provides additional upside optionality to our intrinsic value of the company.
ADRIAN ZETLER joined the Coronation investment team in 2009 as an equity analyst. He currently analyses a number of shares
spanning the media, pharmaceutical and sugar sectors. Adrian is a Chartered Accountant (SA) and CFA charter holder.
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Note to the editor:
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