Description

Summary Thesis

Naspers is a South African media conglomerate with a diverse portfolio of internet, television, and print assets from around the world. Its largest asset is its 33% stake in the Chinese internet company Tencent, which has grown to become larger than Naspers itself. A confluence of fundamental and technical developments over the past two years have caused its valuation to tumble to all time lows.

NPSND Upside Target: $60 (30%); Downside Risk: $40; Risk/Reward: 1 to 3

Naspers is the largest company in Africa, though most of its value comes from outside of the continent. The 100-year old South African media conglomerate has evolved from a newspaper publishing business into a provider of broadcast television into a global internet venture capital fund. The focus of its venture funding business is websites/platforms with strong network effects and large TAMs, and its most successful investment (and largest asset) is its 3.151bn share (33%) stake in Tencent, the Chinese social media/internet platform, which has grown 4000-fold in value from Naspers’s original 2001 investment of $32mn.

The Tencent stake comprises 90% of the value of Naspers and 130% of Naspers’s market capitalization.  In other words, the market implies a value of NEGATIVE $30bn for Naspers’s other businesses (stubco), which most analysts value at around $20bn.  This setup provides the opportunity to buy some high quality, fast-growing businesses at a ~35% discount to NAV.

StubCo Businesses

Naspers has dozens of subsidiaries across half-a-dozen verticals. The highlights are:

Online Classifieds—the crown jewel of Naspers (apart from its TenCent stake) is its online classified businesses. Think Craigslist in the US, but with a better interface.  Other examples include: Gumtree (UK & Australia; owned by eBay), Trade Me (NZ; independent) and Leboncoin (France; owned by Schibsted). Naspers’s two main operating brands are Avito (Russia) and OLX (40+ developing countries).  These are fantastic businesses with strong network effects with the potential for high ARPUs & high margins once established. For example, finn.no & and trademe.co.nz generate nearly $20 EBITDA per citizen per year (on VIC, see Schibsted write-ups for more detail).

Naspers classifieds is the leading network in 35 countries—representing over 300 million monthly active users (prorated for JVs)—and it is monetizing in 12 of them. Because of the heavy investment in pre-monetization countries, this vertical is not yet profitable on a consolidated basis, but the TAM is large (they lead in India, Russia, Brazil & the Philippines), and their position is strong. For example, their Russian business Avito (70% owned) earned ~$120mn EBITDA in 2016 (nearly $1 per Russian citizen). Valuation estimates for this business range from $4-7.5bn, and the low end seems pretty safe, given that Avito alone is probably worth half of that. Management claimed on their last call that analyst estimates of $7bn, “undervalue the business substantially.”

Video Entertainment—African pay TV is the most profitable vertical within the StubCo, historically generating $3,500mn in revenues, $800mn of EBITDA, and $500mn of cash flow. The largest piece of this business is the South African Satellite TV business, which generates 100%+ of the group EBITDA, while their sub-Saharan African business (terrestrial digital broadcast TV) does $1bn+ in revenue at roughly nil margins. Subscriber growth has been strong, but they have suffered FX and margin challenges, leading to less impressive financial performance.

This business has been a nice cash generator for them, but the future looks to be more challenged, as content costs rise, and they face heightened competition and disruption risks. That said, Naspers has been thoughtful about the evolving landscape, and they do have some competitive advantages, including strong brands, scale, customer relationships, and limited exclusive content. Most valuations for this vertical fall in the high single digit billion USD: an 8-10x multiple on the $750mn of SA EBITDA, plus some positive value for the sub-Saharan business. I pencil in $5bn, reflecting a more pessimistic outlook.

Other Listed—in addition to its stake in TenCent, Naspers has minority stakes in three other listed companies. These are material to the value of the StubCo, but small relative to TenCent:

Other Ventures—the most significant are:

StubCo SOTP—Sum those four buckets together, along with ~$1bn of other investments and net cash to get ~$18bn or $8 per ADR in StubCo NAV. Add to $59 per ADR in TenCent NAV to get $67 NAV

Management

Robert van Dijk (44) was appointed CEO in April 2014 after leading the e-commerce group. He previously headed eBay Germany and worked for Schibsted before that. His compensation is primarily through phantom options tied to the e-commerce business.

Koos Bekker (64) has been the Chairman since 2015, and he is the controlling owner. He served as the CEO for two decades—during which his entire compensation was incentive-based stock options—and is the architect of modern Naspers. Prior to becoming CEO, he founded M-Net, MultiChoice (Nasper’s pay TV brand in South Africa), and MTN Group (telco that is one of South Africa’s five biggest companies).

Reasons for the Discount

Naspers is NOT overlooked and underfollowed. Here are various explanations for the low valuation/wide holdco discount, in ascending importance:

Investment Returns—the most obvious reason for a HoldCo discount is if the structure is delivering low returns. Measuring the returns (rate of value compounding) ex-TenCent is complicated, given the evolving portfolio of cash-flow negative businesses across different currencies, so we look at the growth in StubCo NAV, in USD over the last five years (corrected for dividends and equity capital raised during the period). This reveals a mid-teens IRR, which compares favorably to the emerging markets index (mid-single digits) and the all-world index (~10%). Other approaches likewise reveal no justification for the discount.

Falling StubCo Profits & Negative Cash Flows—EBITDA has declined each of the past three years, while development spend has gone up. There is a narrative in the market that these trends are evidence of management value destruction at the HoldCo. As illustrated above, this narrative is not supported by a more detailed analysis of the StubCo components. Furthermore, the StubCo profits look likely to inflect this year, as the CEO has guided that classifieds, eMag, and PayU may all be profitable this year, and there should be a partial recovery in the Pay TV business.

Capital Allocation Concerns—there has been some criticism of management’s capital allocation, but we see little evidence to be critical of this. Their investment process has been thoughtful, methodical, and disciplined. Some investments have been written off, but others have been home runs, with the net result being very good. And they are not the sort to dig in on an investment and throw good money after bad. Consider the following examples:

·        In late 2015, they invested $1.2bn in Avito at a lofty 65x EBITDA.  EBITDA has tripled since then and continues to grow at a high double-digit rate

·        Flipkart, in which they have invested several times over the years, was valued in a 2017 funding round at 3x Naspers’s weighted average investment valuation. Naspers showed discipline in declining to participate in a 2015 round at a $15bn valuation, though they did participate in the prior and subsequent rounds, both at ~$11bn valuations

·        One of CEO van Dijk’s first actions after taking the position in 2014 was negotiating a truce/JV with online classified competitor Schibsted across a number of emerging markets, mitigating hundreds of millions in competitive development spend in Brazil, Indonesia and other markets.

·        At the time of the last VIC writeup (Feb 2008), the market was concerned about their £950mn purchase of Tradus, a collection of ecommerce businesses for which they were paying a hefty premium. In 2016, they sold Allegro, the largest piece of Tradus, for over $3bn, after selling ricardo, another piece of Tradus, for $250mn the prior year.

Weakening Trends in Video Segment—heightened competition, growing content costs, FX volatility, and falling ARPUs/margins weighed on results last year. In particular, runaway inflation in Nigeria caused the sub-Saharan African business to deliver minus $350mn in EBITDA last year after operating at breakeven for the previous three. The fundamentals are not as weak as the headline EBITDA decline suggests: the FX issues are temporary, and Napsers continues to grow subscribers at a rapid pace.

Shareholder Agitation—several large shareholders (e.g., AIM&R, Allan Gray) have been agitating for the Board to liquidate or distribute the TenCent stake. In this campaign, they demanded more transparency on the benchmarks for management compensation while disparaging management’s track record. They made no progress in moving the Board (Bekker holds supervoting shares), but the smear campaign may have moved the stock.

Narrowing Moat for Classifieds—online classifieds are regarded as having impregnable moats. The network effects are extremely strong, and there are no examples of a challenger knocking off an established incumbent, though there are examples of well-heeled competitors trying and failing. There are now two cracks in that narrative.

First, a new generation of native mobile apps (e.g., Shpock, Wallapop, and letgo) are gaining traction. For example, Naspers seeded letgo in 2015 when the founder of OLX identified an opportunity to disrupt Craigslist in the US because the incumbent had not invested in mobile.  Naspers has since invested several hundred million USD in this venture, justified by the strong uptake and massive TAM. They are now the #1 classified app in the US, though this business is likely far removed from monetization. Second, Facebook and Amazon have launched products that compete with classifieds in select markets (e.g., Facebook Marketplace). Note that these players have launched competing products before that have failed to gain traction. Despite their rapid growth, there is not yet clear evidence that these new products are eroding the incumbents (i.e., they are growing by growing the market, not by taking share), but the threat is clear.

This risk is mitigated by several factors.  First, Naspers has more to gain through letgo than it has to lose through its legacy platforms, and its scale and focus on innovation make it well-positioned to play both offense and defense. Second, its most valuable classified property—the Russian platform Avito—is in a jurisdiction where the silicon valley giants have limited penetration. In fact, the company best positioned to disrupt Naspers in Russia is Naspers itself, through its ownership of Russia’s dominant social network! In other countries, too, Naspers has been thoughtful about cultivating its image as an emerging market-based alternative to the silicon valley giants, which may offer regulatory advantages. Finally, even if this business were to disappear tomorrow, its impact upon valuation would be muted: ~$2 per ADR against a $68 per ADR NAV.

Taxes—the Tencent stake is held in an offshore structure designed to ensure that corporate gains taxes will not need to be paid whenver the stake is sold. Naspers successfully used this structure to avoid taxes when it sold Allegro.  However, the embedded DTL on the Tencent stake is one-third of South Africa’s annual budget, and it is easy to imagine an exception being made.

Nonvoting Shares—there are two share classes: the publicly-traded “N” shares and the privately-held “A” shares. The A shares hold a 1% economic interest but control 65% of the voting rights. The structure is not uncommon, but analysts apply a 5% discount to shares to reflect the lack of control, which is roughly in line with the “A” share premium (Bekker paid 8x face for a block in 2006).

Funds Flow (technical)—perhaps the most important factor affecting StubCo’s valuation has been technical—when Tencent runs up sharply, Naspers struggles to keep up.  As Tencent benefits from global index fund flows, Naspers is hurt, as it represents >20% of the local index, which is above the cap of most funds. As Naspers’s share price rises, it triggers forced selling from funds whose sizing limits are hit. Furthermore, SA-focused active managers have long been underweight Naspers (and are increasingly underweight); this is unsurprising, given their mandates for SA exposure. Finally, as the largest component of the South African Index, Naspers is affected by macro fund flows, despite the fact that its African exposure is small.

Trade Structuring

I peg fair value at roughly a 10% discount to NAV, reflecting concern over potential taxation of the Tencent stake. Any “N” share discount related to the lack of voting control is offset by a premium reflecting the fact that the controlling shares are in good hands (Koos Bekker). Barring some unanticipated event (e.g., share buyback, spinoff of Tencent stake, etc.), I don’t see upside beyond that. This ceiling is reinforced by their 2015 equity raise. On the other hand, it’s hard to see this trading worse than a 40% discount, given its size, profile and quality.

The hedge ratio is nominally 1.44 shares of TCEHY per 1 share NPSND, but this is only an optimal structure if you expect TCEHY to fall. We have no such expectation—Tencent is a high quality business, and we are happy to get some exposure through a partial hedge.

Catalyst

While this idea offers quality and value, it is weak on the catalyst front. The main factors that got us here are likely to persist. Yet, we see reasons that make this idea timely:

Extreme valuation—stubco valuation is at an all-time low and $10 per ADR below where it was just six months ago. The market price of the stubco is negative, even after burdening the Tencent stake with full corporate gains tax.

Shareholder Agitation—though Bekker ruled out any major structural changes at the recent AGM, the recent shareholder unrest might lead to improved disclosures, a secondary listing, or other changes.

PayTV Stabilization—Revenues in the TV business experienced a $250mn decline due to currency effects (they hold hundreds of millions of USD value in the Nigerian Naira, which devalued 50% in the period). Any stabilization here would lead to improved StubCo profits.

Improved profitability in online businesses—the classified business, the payments business, and eMag are all primed to deliver their first profits this year.