Naspers’ core businesses and their respective competitive positions are described below:

Pay-TV

Naspers’ primary business is Pay-TV, providing 58% of the company’s revenues and 85% of EBITDA.  The company offers Pay-TV services to approximately 2.2 million households through its Multichoice and NetMed subsidiaries and joint ventures, M-Net and SuperSport.  Nearly all of the Pay-TV services are supported by a satellite platform.

Pay-TV South Africa. This segment represents approximately 32% and 49% of the company’s revenues and EBITDA, respectively.  With 1.4MM subscribers, 85% of which are digital, Multichoice is an entrenched, dominant player with significant scale.  South Africa has seen rapid growth over the last several years, with subscriber growth of 3%, 7%, 9% and 11% in FY04, FY05, FY06 and FY07, respectively.  That said, South Africa is becoming a mature market, and management has stated that future growth may not continue at its recent rapid pace. South Africa’s GDP has grown at a 4.1% CAGR over the last 5 years, and the country is expected to grow at a slightly slower pace going forward, in part due to the current energy issues the country is facing. Penetration has reached 17% of TV households, with approximately 7.5 million TV households in South Africa.  Additionally, ARPU (average revenue per unit) has been favorably impacted by continued migration to digital Pay-TV and increased PVR (personal video recorder) sales.  These factors helped drive 20% and 30% revenue and EBITDA growth in FY07, respectively.  Revenue and EBITDA growth rates were even more impressive in the first half of FY08: 20% and 45%, respectively.

Pay-TV Africa. This segment represents approximately 13% and 21% of the company’s revenues and EBITDA, respectively.  Sub-Saharan Africa is a mostly undeveloped region with significant growth prospects going forward.  Naspers has been able to take advantage of this growth by cost-effectively leveraging its South African Pay-TV platform and distributing it throughout Africa.  Moreover, growth in this business has been booming due to the fact that there is very little competition for Multichoice, as it enjoys a near monopoly on the Pay-TV market.  As in South Africa, competition has come and gone, exemplifying Multichoice’s entrenched competitive position.  These favorable competitive dynamics have allowed Multichoice to grow to over 470,000 subscribers in Sub-Saharan Africa, achieving a 10-year CAGR of 16.4% from 1997-2007, and there remains ample room for continued strong growth.  In FY07, Multichoice Africa grew revenue by 42% and EBITDA by 60%, illustrating the high growth potential in this business segment.

In many Sub-Saharan African nations, MultiChoice operates through agents or franchisees.  The agents and franchisees conduct marketing and advertising activities to build MultiChoice Africa’s subscriber base and collect subscription revenues on behalf of MultiChoice Africa.  They retain a portion of the subscription revenues they collect as compensation for their services and remit the balance to MultiChoice Africa.

Pay-TV Greece and Cyprus. This segment represents approximately 9% and 7% of the company’s revenues and EBITDA, respectively.  Naspers’ Pay-TV operation in the Mediterranean, NetMed, holds the #1 position in the region.  Although the Pay-TV business is slower growth in the Mediterranean than in Africa, there remains significant room to grow through increased penetration, which is currently at approximately 9%. For reference, the European Union has approximately 30% penetration, significantly higher than Greece and Cyprus. 

Management plans to sell this business as it is slower growth and not in-line with the company’s core strategy to focus on emerging markets. This sale process continues to progress with a number of bidders showing interest.

M-Net and Supersport.  This segment represents approximately 4% and 16% of the company’s revenues and EBITDA, respectively.  Naspers’ joint ventures M-Net and SuperSport continue to play a role in growing the subscriber base through the delivery of premium thematic channels and exclusive content.  M-Net provides premium entertainment channels and SuperSport provides premium sports channels carried by MultiChoice on its Pay-TV platforms in Africa.  In November 2007, Naspers received approval to purchase the remaining 38% stake in M-Net/SuperSport from Johncom, making Naspers the sole owner.  Notably, approximately 45% of Pay-TV costs are programming costs, making Naspers’ ownership of content sourcing companies a significant strategic advantage.

Note that Naspers’ Pay-TV businesses experience some seasonality.  There is an increase in the level of subscriber churn during the respective summer holiday seasons, particularly in Greece and Cyprus where the conclusion of the football (soccer) and basketball seasons coincide with summer, when many subscribers travel away from their primary residence and engage in other forms of leisure.  In Africa, the start of the European football (soccer) season is normally characterized by subscriber growth.

Naspers’ satellite Pay-TV business is attractive for several reasons, including high recurring revenue, significant customer stickiness due to premium product offerings, a monopoly position with large barriers to entry, lack of existing or likely future cable competition, and the ability to leverage its infrastructure across different geographies.

Naspers’ Pay-TV business’ recurring revenue stream and customer stickiness are attractive.  Approximately 50% of Naspers’ revenue stream comes from subscriptions, with the majority of this portion coming from the Pay-TV business.  Because of its strong dependence on subscription revenues, the Pay-TV business is less likely to experience a significant downturn if the South African economy were to slow. In addition, Multichoice offers a premium video product, sourcing most of its programming through exclusive, staggered, multi-year contracts.  Thus, new satellite competitors entering the market will be at a significant disadvantage because obtaining comparably attractive programming will be extremely difficult.

It is important to note that in South Africa, there is a large discrepancy between the upper and lower classes, and essentially no middle class.  Thus, Multichoice offers mainly one premium product, with a “cream of the crop” channel bouquet.  The company experimented with a lower priced product bundle, but did not have much success with it.  It seems the individuals who can afford Pay-TV services prefer the premium bundle.  This trend has allowed Multichoice to raise prices over time, and the standard satellite bundle is currently ~US$50 per month.

Multichoice has a near-monopoly on African Pay-TV, a business with large barriers to entry and lack of cable competition.  On the African continent, there is no competition from cable Pay-TV operators, and it is unlikely that this will change anytime soon.  Where there is cable in the ground, it is inferior (0.3MM vs. 0.5MM in most of developed world), and the distance between homes precludes a cable operator from economically building a network.  It is worth noting that Naspers’ Pay-TV business has a French, English, and Portuguese bouquet.

Although Multichoice currently enjoys an essentially monopolistic position in the Pay-TV market in South Africa, the company will face new competition in the coming months.  In November 2007, the Independent Communications Authority of South Africa (ICASA) announced that it had awarded five Pay-TV licenses to Multichoice and four new Pay-TV operators (most notably Telkom), essentially ending Multichoice’s long-running Pay-TV monopoly.  That said, given Naspers’ premium product offering, scale, and entrenched competitive position, the risk of new entrants displacing Naspers is very low.  While this new competition will likely drive up programming costs, Multichoice’s subscriber base most likely will not be significantly affected by the new competition. Over the past several years, rivals have tried to compete with Multichoice throughout Africa, though none have stayed around longer than a couple of years before exiting the market. 

In sum, the Pay-TV business is a wonderful business for Naspers.  Naspers has several core media businesses, but Pay-TV is by far its largest business.  The company’s near-monopoly position, the lack of cable competition or other prominent satellite providers, enormous scale, highly scalable infrastructure, marriage of content and distribution, a premium product bouquet and a strong brand all contribute to its enviable competitive position.  The Pay-TV businesses also have strong EBITDA margins – as a group the margin was 34% in FY07.  This business will likely continue to grow and generate significant free cash flow going forward.

Internet

Naspers offers a wide range of Internet services, including access to local content, e-commerce and subscriber management.  It has leading Internet operations in Africa, China and Russia and an operation in Thailand as well.  The Internet segment (excluding Tencent and minority investments, which are accounted for through the equity method) provides approximately 6% of the company’s revenues (5% from M-Web South Africa).

M-Web, Naspers’ South African Internet subsidiary with 21% EBITDA margins, is the largest ISP provider in the country with over 330,000 subscribers and is also the #1 content provider.  This marriage of content and distribution is very attractive, combining to make M-Web among the top Internet destinations in all of South Africa.  It is important to note that Internet advertising as a percentage of total advertising spend is very low as compared to developed economies (less than 1% vs. 6%+).  Thus, there is enormous room for growth.  Although currently thwarted by the lack of broadband penetration, should broadband gain penetration, Internet growth in South Africa will likely increase significantly.  It is also worth noting that there is no competition from cable due to the inferior cable in the ground and substantial distance between homes, thus making wireless the platform of choice.

Naspers has an equity interest in Tencent, an operator of innovative real-time communication and online entertainment technologies and services in China, including the instant-messaging product QQ.  Tencent is listed on the Hong Kong Stock Exchange and its current market capitalization is US$11 billion.  Naspers acquired a 46.5% stake in May 2001, sold some shares during Tencent’s initial public offering, and currently owns 35.5% of the company.  At current prices, Naspers’ stake in Tencent is equal to approximately 58% of Naspers’ total market capitalization, which is up dramatically from ~25% one year ago.

Tencent has several attractive characteristics:

·          #1 real-time messaging and online entertainment service in Asia

·          #1 games portal in China

·          Massive, scalable instant-messaging platform, with 289 million subscribers and 32.6 million peak concurrent users

·          Strong, growing and “sticky” community with several untapped revenue sources

Along with its minority investment in Tencent, Naspers owns 32.6% of Mail.ru, the leading Russian internet portal. Mail.ru is the leading Russian website servicing the global Russian speaking community and has over 30 million unique monthly email users and approximately 2 million instant messaging users, which is ~2/3 of the total Russian instant messaging market.

Naspers’ most recent acquisition, Gadu-Gadu, is the most popular instant messaging site in Poland. The tender offer for all of Gadu-Gadu’s outstanding shares closed in December 2007, and Naspers now owns 97% of the company after paying approximately US$155MM.

Naspers’ Internet businesses in China, South Africa and Russia are by far the #1 players in each of their respective markets, exhibiting dominant competitive positions and significant growth opportunities.  With the numerous opportunities Naspers’ management is finding in emerging markets, investing in Internet companies has become Naspers’ primary investment area.

Print Media

Naspers has been in the South African print media business since 1915 and has gained extensive experience across various types of print media.  The print media segment provides 32% and 19% of the company’s revenues and EBITDA, respectively.  The company’s print media subsidiary, Media24, is the leading print media publisher and distributor in Africa, with its main operations in South Africa.  In South Africa, Media24 has dominant market shares in magazines and newspapers, 60% and 46%, respectively.  Media24 is also the holding company for Via Afrika, the book publishing and distribution business, and Naspers’ leading African private education business, Educor, although it currently plans to sell this business.

Overall, the South African print media market is reasonably saturated.  That said, there is likely potential for future growth in specific geographic and product areas.  In FY07, the print media segment grew revenues and EBITDA at 16% and 5%, respectively.

Media24 has several attractive characteristics, including a dominant market share, huge scale and strong brands, as it owns the largest and most popular newspaper and magazine titles in all of South Africa.

MANAGEMENT AND INVESTMENT STRATEGY

Naspers’ management team is experienced, extremely smart and well incentivized to grow share value over time.  Koos Bekker, current CEO of Naspers, led the founding team of M-Net in 1985 and was CEO of MIH, Naspers’ electronic media subsidiary.  Koos is a director of Media24, MIH, SuperSport, M-Net and other companies within the group.  He has been the CEO of Naspers since 1997.  Koos has been on sabbatical since April 1, 2007 and will return as active CEO on April 1, 2008.  Upon his return, Koos is expected to begin his final 5 years with the company (at the end of which he will be 60 years old – the group’s retirement age).  While on sabbatical, Cobus Stofberg has been the interim CEO.  It is worth noting that Koos takes no salary from the company and is paid solely through the appreciation of the company’s equity value.

Cobus Stofberg, current CEO and director of MIH, began his affiliation with Naspers in 1985 in partnership with Koos.  He has held a variety of positions, including COO of MIH. Prior to this, Cobus served as director of NetHold, NetMed and NetHold group companies.  Cobus and Koos have essentially worked in tandem for 22 years and have together compounded equity value at over 20% per annum.

Steve Pacak, current CFO and a director of Naspers, joined Naspers in 1988 as CFO of M-Net. He is also a director of Media24, MIH, SuperSport, M-Net and other companies within the group. In 1998, Steve was appointed as CFO and a director of Naspers.

Mark Sorour, current chief investment officer and head of M&A, began his career with Naspers in 1994 involved with corporate finance.  Prior to joining Naspers, Mark was an investment banker with Hill Samuel and Banque Indosuez and held various positions in the audit and corporate finance division of PricewaterhouseCoopers.

Koos is a widely respected and revered media player, who is an outstanding strategist, operator and capital allocator.  Collectively, the team runs Naspers in a collegial atmosphere as opposed to Koos calling all the shots, which has been key while Koos has been on sabbatical.  With respect to their geographically and technologically diverse businesses, Koos and the team learned early on that local managers are key to success in emerging markets.  They understand the value of a partnership, and they act as active, but not controlling, supervisors of their investments, leaving local management teams in place and providing guidance, assistance and direction where necessary, while maintaining several controls in place to protect their investments.  This is manifested in their strategy of taking minority stakes in emerging market media companies, although they have chosen to buy companies outright as well, depending on the political and legal situation.  Even when target companies are bought outright, Naspers often keeps the target’s managers in place. This partnership philosophy has served Naspers well over time, and it will likely continue to do so going forward. The power of this partnership philosophy, and the importance of it in the minds of emerging market companies’ management teams, is exemplified by Naspers’ ability to often win deals even when it is not the highest bidder.

Reference checks with Board members and fellow investors have put Koos Bekker, CEO, on par with Rupert Murdoch, with the caveat of Koos being savvier to local conditions and maintaining a much lower profile.  Specifically, one Board member of MIH stated that “if Naspers’ management team was an ‘A’, no management team in the U.S. deserved higher than a ‘B’” – quite a statement, no doubt.

Naspers has a strategy of investing excess cash flow from its electronic and print media businesses into emerging market companies, most commonly in BRICSA countries.  The management team has a superb track record of finding well-managed, well-positioned assets with little competition in under-penetrated, high growth markets, and paying attractive valuations for such assets.  They invest in the dominant player in a given product and geography, or a player who has the ability to become dominant in the future. Management also only invests in opportunities within their core skill set – media and content services – and have proven to be both prudent and effective allocators of capital.  Exemplifying their prudence and unwillingness to overpay, management has chosen not to buy anything in India, choosing instead to start-up home grown businesses to participate in growth in India.  Furthermore, management structures all of their deals with significant downside protection to limit their overall risk, and uses no or low levels of debt to finance their investments. (Naspers currently has net cash on the balance sheet.) Taking a focused approach with local management teams has provided Naspers with an enormous competitive advantage in investing in emerging market media assets. 

Several of Naspers’ recent and significant investments are highlighted below:

On December 18, 2007, Naspers offered to purchase 100% of Tradus, a UK based provider of online consumer trading platforms and related Internet services in 11 European countries, for US$1.8 billion. The Tradus acquisition would be Naspers’ largest acquisition to date. Tradus fits within Naspers’ acquisition strategy: the company has a leading market position in many of its high growth emerging markets (primarily Eastern Europe) and is lead by a strong management team. Eastern Europe contributes over 70% of Tradus’ consolidated revenues, and the eCommerce market in Eastern European countries is expected to grow 15-45% over the next few years, depending on the country.  Combining Tradus’ assets with Naspers’ existing emerging market internet assets, there should be significant opportunities to leverage the pro forma company’s internet assets across developing countries.

Although the strategic rationale for purchasing Tradus is compelling, the justification of the purchase price and funding method is not as compelling.  The acquisition multiples are approximately 50X P/E and 30X EBITDA, while Tradus is expected to grow EBITDA at 40%+ over the next few years. Clearly, there is significant growth potential and Tradus would likely be a springboard into the high-growth markets in Central and Eastern Europe, creating opportunities for further expansion in the region. The synergies with Gadu-Gadu are also easily apparent.

While the purchase price is more than full, our primary quarrel is with the possibility of issuing Naspers shares at extremely discounted prices as part of the transaction.  In the press release announcing the Tradus offer, Naspers outlined a funding scenario that involved issuing 42.3MM shares, representing 12% of shares outstanding, along with using some cash on hand and issuing debt. However, this illustrative funding structure was included in the press release for London stock exchange regulatory purposes, and management does not expect that the structure shown will turn out to be the permanent funding structure. Rather, they hope to fund the transaction solely with cash and debt.  We have expressed our view to management that issuing NPN shares at 2X EBITDA to purchase Tradus is value-destructive. Naspers management understands this rather obvious point and has expressed that they do not want to issue any equity as part of the transaction given Naspers’ current share price. 

While Naspers has an extraordinarily strong track record with respect to capital allocation, issuing equity as part of the Tradus acquisition would be a black mark on their otherwise pristine record of capital allocation.

PRICE

Despite the current issues surrounding the potential funding method of the Tradus acquisition, Naspers is simply too cheap to overlook. Naspers’ core operations (excluding Tencent, Mail.ru, Gadu-Gadu and net cash) trade at 1.6X CY08E EBITDA, 4.3X CY08E P/E and 22.2% CY08E free cash flow yield, which is extremely attractive given the company’s growth prospects and dominant competitive position.  It is important to note that approximately 58% of Naspers’ current market capitalization comes from its 35.5% interest in Tencent.  Given the growth prospects of this business, Tencent’s shares seem reasonably priced as myriad growth opportunities remain for the company.  Currently, Tencent is trading at 24.3X CY09E P/E, while the company is expected to grow EPS by 40%+ over the next several years.  Nevertheless, Naspers’ shareholders have the option of eliminating their economic exposure to Tencent by shorting out Tencent stock.  Given the strength of the Naspers’ underlying electronic and print media assets, the strong likely growth in all of its markets and its premier management team, an investment in Naspers’ shares at current prices represents a very attractive long-term risk/reward.

RISKS

Dependence on South Africa: 

In FY07, approximately 73% of Naspers’ revenues were generated from its South African operations.  If the country were to experience a significant downturn in its economy, Naspers’ financial results would likely be adversely affected.  Although the country’s unemployment rates and crime rates remain high, South Africa is politically stable, and there seems to be no current threat of a regime change.  Currently, South Africa is experiencing power outages due to insufficient and poorly maintained electricity generation facilities.  In response to these outages, the state electricity supplier, Eskom, is aiming to cut electricity consumption by 10%. This is having an adverse effect on South African industries and most noticeably on the mining sector. South Africa's large gold, platinum and diamond mines were ground to a halt for five days in January when Eskom said it could not guarantee an uninterrupted power supply, and these mines have been ramping up production over the past week as they come back online.

Given that 50% of Naspers’ revenues are subscription based while only 17% of its revenues are advertising based, the company is not likely to be catastrophically impacted by a slowdown in the South African economy.

Increased Government Regulations:

Having a monopoly or near-monopoly position does not come without some drawbacks, and one of these is the obvious scrutiny from government officials.  Management believes that it has good relations with the South African government.  If these relations deteriorate, new and tougher regulations could potentially adversely affect Naspers’ financial results. Naspers must continue to “tread lightly” when increasing prices in its Pay-TV business because if it increases prices too far too fast, it could see increased price regulation from the government.

Capital Allocation / Future Investments:

The future success of Naspers’ business is dependent to an extent on management’s ability to continue to allocate capital efficiently and prudently.  There are of course also country and technology risks inherent in Naspers’ existing and future investments.  Given management’s outstanding long-term track record investing in emerging market media, our meetings and conversations with senior management and numerous references from a variety of sources, we are comfortable accepting these risks given the hefty potential reward on the other side of the scale both for investors and for Naspers’ management team, as well as low risk of long-term capital loss in this investment.

Currency Fluctuations:

Naspers’ core operations are reported in South African Rand (ZAR), and if one’s fund reports its returns on a US dollar basis, an investment in NPN would be adversely affected if the Rand significantly devalues relative to the U.S. dollar.  With the recent global investor movement away from risk and out of emerging markets, and the power issues specific to South Africa, the Rand has experienced some devaluation against the dollar.  Additionally, Naspers conducts business transactions in currencies other than its reporting currency.  Naspers is exposed to foreign exchange risk arising from various currency exposures primarily with respect to the U.S. dollar, the Naira, the Renminbi, the Euro and the Brazilian Real. 

CONCLUSION

An investment in Naspers is a very compelling risk/reward.  Naspers has an excellent competitive position in attractive industries, is run by a focused and smart management team and is currently trading at a price that represents a substantial discount to intrinsic value.