Description

Please see my writeup on Tencent from earlier this year. Prosus’s Tencent stake alone is worth more than Prosus’s current market cap. In this writeup, I’ll focus on the Prosus investment dynamics, but since so much of the risk and value being underwritten is the Tencent stake, it seems sensible to connect the two

A summary of the investment thesis

• Prosus has transitioned from an aloof investment holding company, to a somewhat more shareholder-friendly, responsive investment investment vehicle

  • Management remuneration incentives were a key driver of this transition

  • 2022 -> 2023 saw a sharp drop in the discount, explained by management remuneration being disproportionately linked to the NAV discount, as measured at end of March 2023

  • Those incentives were not explicitly extended for 2024. The market viewed this as negative, or at least a limiting positive, consistent with signals that a discount of 30-35% was appropriate

  • However, what the market seemed to discount: those 2023 incentives were subject to clawback provisions, requiring the discount to be managed through end of March 2024

  • That expiry has unsurprisingly driven an increase in the discount to >40% 

• As a result, I think this presents in asymmetry in Prosus with respect to the discount

  • Although the outsized remuneration incentives are not currently active, nothing has changed about management’s attitude towards the discount

  • If the discount drops further, management can extend their NAV-accretive repurchases, funded by sales of Tencent

  • At any time, management can reinstate the remuneration policy to incentivize the discount to return to 30% or lower

  • The discount could drift lower from here, offering an even better entry point. But the recent expiry of the clawback leads me to believe this is likely the period of minimal management incentive to lower the discount

• The portfolio of assets is cheap

  • Tencent is cheap. It is the dominant internet platform, and one of a few candidate tech leaders, for China. It trades at an undemanding valuation, continues to grow, and benefits from a powerful position in the Chinese domestic economy

  • Again, please see my writeup from earlier this year for a much more detailed take on how attractive Tencent is

  • The rest of the portfolio is arguably fair. I would prefer to see Prosus invest less aggressively, and sell down some of its portfolio assets. But their marks are reasonable. The investment track record is good

• The combination of the discount and the quality of the Tencent investment are what make this truly interesting

  • Each in isolation seems only slightly compelling

• Concerns about buyback tax are overblown

  • There is concern about a new Dutch law taxing buybacks effectively as dividends, that would make Prosus’s discount management policy more expensive

  • While this is a concern, it’s overblown. The law is likely to be amended or overturned this year, before it takes effect in 2025

  • In the unlikely event it takes effect, Prosus has a number of workarounds, including listing elsewhere. While this would be extreme, or too much overhead, for many companies, for Prosus, managing the NAV discount is their primary purpose

  • Less likely, Tencent could acquire Prosus’s stake to “bring it home”. And there have been speculation for Middle East SWFs to acquire the stake, which could be viewed favorably by the central government

  • Again, it seems unlikely, but these are paths on which the buyback tax could end up being a positive catalyst if

    • it forced management’s hand in managing the discount on a shorter horizon

    • Removing an overhang in the process

Company Overview

Prosus N.V. is a global consumer internet group and one of the largest technology investors in the world, headquartered in Amsterdam, Netherlands. Initially viewed as a somewhat aloof investment holding company primarily known for its sizable stake in Tencent Holdings Ltd., Prosus has actively transitioned towards becoming a more responsive and shareholder-friendly investment vehicle. This strategic shift is part of a broader effort initiated by its majority owner, Naspers, which spun off Prosus in 2019 to better highlight and leverage its global internet assets.

Under its new structure, Prosus has demonstrated a more proactive approach to governance and investor relations. Management has engaged in more transparent and frequent communications with shareholders, providing clearer insights into the company’s strategic decisions and financial performance. This change is aligned with a broader corporate strategy aimed at reducing the historic discount to net asset value (NAV) at which Prosus shares trade relative to the underlying value of its investments.

In addition to its strategic stake in Tencent, Prosus manages a diverse portfolio that spans various high-growth sectors such as online classifieds, payments and fintech, food delivery, and e-commerce. These investments are spread across a number of emerging and established markets, each selected for their high barriers to entry and significant long-term growth prospects. The company’s approach to these investments has evolved, focusing not only on financial input but also on adding value through strategic guidance, which includes leveraging synergies across the portfolio to enhance overall performance and growth.

This transformation into a more engaged and proactive entity reflects a commitment to unlocking value for shareholders, and it underscores the management’s dedication to closing the gap between the market valuation of its shares and the intrinsic value of its underlying assets. These efforts are complemented by tangible actions such as strategic buybacks, portfolio optimization, and a more disciplined capital allocation strategy aimed at enhancing shareholder returns.

Management Incentives and Strategic Shift

A pivotal factor in Prosus’s evolution has been the restructuring of management remuneration incentives, which aligns the interests of the executive team more closely with those of shareholders. This alignment has been crucial in driving the company's transition from a passive holding company to an active, strategic investor that prioritizes shareholder value.

Remuneration Structure

The remuneration policy for Prosus’s management has been carefully designed to incentivize long-term value creation rather than short-term financial metrics. Key components of this policy include:

• Long-term Incentive Plans (LTIPs): A significant portion of management compensation is tied to long-term performance metrics, including the growth in shareholder value and the reduction of the discount to NAV. These LTIPs often take the form of stock options or performance shares that vest over multiple years, contingent upon achieving these strategic goals.

• Annual Performance-Related Bonuses: These are linked to both financial performance and strategic milestones, such as successful integration of acquisitions, operational improvements in existing investments, and advancements in corporate governance practices.

• Equity Stakes: Encouraging executives to hold equity in the company ensures that their personal financial outcomes are directly tied to the company's stock performance, further aligning their actions with shareholder interests.

Impact of Incentives on Corporate Strategy

The revamped incentive structure has had a direct impact on corporate strategy, guiding management decisions towards initiatives that are expected to enhance long-term shareholder value. This strategic orientation has manifested in several ways:

• Proactive Portfolio Management: Management has taken a more hands-on approach in managing the investment portfolio, actively seeking opportunities to rebalance and optimize asset allocation. This includes making tough decisions such as partially divesting from high-value stakes like Tencent to reinvest in more undervalued, high-potential areas.

• Shareholder Engagement and Transparency: There has been a marked increase in efforts to engage with shareholders through regular updates, detailed disclosures, and clearer explanations of strategic decisions. This open line of communication helps to build trust and provides transparency, which is critical for valuation.

• Focus on Reducing NAV Discount: A key performance indicator for management has been the reduction of the substantial discount at which Prosus’s shares trade relative to its NAV. Initiatives such as share buybacks and structural corporate actions have been implemented to address this issue directly.

Overall, the restructuring of management remuneration at Prosus has been a cornerstone in its transformation. By tying executive compensation to the achievement of long-term strategic goals and aligning these with shareholder interests, Prosus has positioned itself as a more dynamic, proactive, and responsive investment vehicle capable of delivering substantial shareholder value over time.

Reduction in NAV Discount: 2022-2023 Analysis

A significant development in Prosus's journey toward greater shareholder alignment during the 2022 to 2023 period was the sharp reduction in the discount to Net Asset Value (NAV) at which its shares traded. This positive shift can be largely attributed to the incentive structure within management's remuneration, which was disproportionately linked to reducing the NAV discount by the end of March 2023.

Focused Remuneration Strategy

Management compensation was structured to heavily reward the narrowing of the NAV discount, particularly measured at a critical benchmark date—end of March 2023. This approach included several elements:

• Performance Metrics: A considerable portion of the annual bonuses and long-term incentives for senior executives was directly tied to specific targets for reducing the NAV discount. These targets were clearly defined and communicated to both management and shareholders, establishing a transparent goal that guided executive actions throughout the year.

• Tactical Execution: In response to these compensation incentives, Prosus's management undertook several strategic actions designed to directly influence the market’s perception and the actual value discrepancy:

  • Strategic Asset Sales and Buybacks: The company accelerated certain asset sales, including parts of its Tencent holdings, to improve liquidity and fund substantial share buyback programs. These buybacks helped to reduce the number of outstanding shares, thus potentially increasing the per-share value of remaining investments.

  • Improved Financial Disclosures: There was an enhanced focus on financial communication, with more detailed and frequent disclosures about the value and performance of underlying investments. This effort was aimed at providing a clearer picture of the intrinsic value of Prosus’s diverse assets.

  • Market Engagement: Management increased their engagement with institutional investors and analysts, focusing on educating the market about the true value of its portfolio beyond the headline Tencent stake. This included investor days, more aggressive public relations campaigns, and targeted discussions with financial media.

Outcome and Impact

The focused efforts on reducing the NAV discount were met with considerable success by the end of March 2023, as evidenced by a significant narrowing of the discount. This outcome not only benefited the management through direct financial incentives but also aligned with shareholder interests by effectively raising the market value of their investments in Prosus.

• Shareholder Value: The reduction in the NAV discount directly translated into higher share prices, benefiting all shareholders and improving overall market sentiment towards Prosus.

• Management Alignment: By tying a large portion of compensation to the reduction of the NAV discount, management’s objectives were closely aligned with those of long-term shareholders, fostering a culture of mutual interest and focused corporate governance.

This strategic period marked a pivotal point in Prosus’s corporate governance, where direct financial incentives were successfully employed to drive management behavior that aligned with broader shareholder goals, leading to tangible improvements in shareholder value.

Uncertainty in Incentive Extension: Market Reaction and Implications for 2024

As we moved from the success of reducing the NAV discount in 2023, an emerging concern for investors in Prosus was the company's decision not to explicitly extend the management remuneration incentives linked to the NAV discount into 2024. This development was interpreted by the market with a degree of skepticism, impacting the investor sentiment and the perceived future trajectory of the company's share price.

Market Interpretation

• Perceived Negativity: The lack of explicit continuation of these incentives led the market to view this as a potentially negative development. Investors had grown accustomed to the aggressive pursuit of reducing the NAV discount, supported by direct management incentives. The absence of a clear continuation of these policies created uncertainty about the future strategic priorities of Prosus’s management.

• Limiting Positives: While the previous years had seen tangible benefits from focused incentive strategies, the market's reaction to their discontinuation suggested a tempering of expectations. Investors might now believe that without these incentives, the likelihood of sustaining the reduced NAV discount or achieving further reductions could be lower.

• Consistency with Discount Expectations: This change was consistent with signals from some market participants that a discount of 30-35% might be deemed appropriate or inevitable given the structural and systemic factors affecting holding companies like Prosus, which invest heavily in tech sectors that are often volatile and geographically diverse.

Strategic Implications for 2024

• Impact on Stock Performance: The uncertainty around incentive structures may lead to more conservative stock valuations, as investors adjust their expectations for the pace and probability of further reductions in the NAV discount.

• Corporate Strategy Reevaluation: This situation presents an opportunity for Prosus’s management to reassess its strategic approaches to value realization. Without the clear-cut incentives for reducing the NAV discount, management may need to explore other strategies to add shareholder value, such as enhancing operational efficiencies, pursuing strategic acquisitions, or improving the profitability of existing investments.

Clawback Provisions and Their Market Impact

In a critical twist to the incentive narrative at Prosus, the successful 2023 incentives designed to reduce the NAV discount were subject to clawback provisions. These provisions mandated that the reduced NAV discount had to be maintained through the end of March 2024 to avoid the reversal of the financial benefits awarded to management. This condition added a layer of complexity and risk to the incentives, influencing both management behavior and market perceptions.

Overlooked Market Dynamics

• Market Oversight: While the market initially reacted negatively to the non-extension of the 2023 incentives into 2024, it seemed to overlook the impact of the clawback provisions. These provisions effectively meant that management was still under pressure to maintain a reduced NAV discount beyond the immediate term of the incentives.

• Risk of Clawback: The requirement to sustain the discount levels through another fiscal period introduced a continued, albeit indirect, incentive for management to keep striving towards maintaining lower discount levels. However, the presence of this clawback risk may have also led to conservative strategic decisions, potentially limiting more aggressive growth initiatives.

Consequences of the Clawback Expiry

• Increase in Discount: As the deadline for the clawback provision neared and eventually expired at the end of March 2024, the market witnessed an increase in the discount to over 40%. This rise can be attributed to several factors:

  • Speculative Trading: Investors anticipating the possibility of not meeting the clawback conditions might have engaged in speculative trading, leading to increased sell-off.

  • Realignment of Expectations: With the clawback risk expiring, and no new incentives announced to continue pressuring the discount downwards, the market likely realigned its expectations to a scenario where a larger discount is considered more sustainable or reflective of the underlying systemic and structural challenges Prosus faces.

Strategic and Market Implications

• Short-Term vs. Long-Term Focus: This scenario underscores a critical challenge in incentive-based management strategies—balancing the focus between achieving short-term targets (like maintaining a lower NAV discount for a specific period) and fostering sustainable long-term value creation.

• Communication and Strategy Adjustment: Going forward, it is imperative for Prosus management to clearly communicate its strategic plans for after the clawback period. Investors will be keenly observing how the company plans to manage its discount without the immediate pressure of clawback provisions, and whether new mechanisms or strategies will be introduced to stabilize or reduce the NAV discount.

Conclusion

The clawback provisions tied to the 2023 incentives at Prosus played a significant yet initially underappreciated role in shaping the company's NAV discount dynamics. The expiry of these provisions has led to a notable increase in the discount, highlighting the need for robust and sustainable strategies that align with long-term shareholder value rather than relying solely on short-term incentive mechanisms. For investors, understanding the interplay between these incentive structures and market behavior will be crucial in assessing Prosus’s future investment potential and governance quality.

Asymmetric Discount Dynamics

The current investment landscape for Prosus exhibits a notable asymmetry regarding the discount to Net Asset Value (NAV). This asymmetry emerges from several key aspects of Prosus's management strategy and market conditions that suggest a nuanced investment opportunity.

Persistence of Management's Commitment to NAV Discount Reduction

• Consistent Management Approach: Despite the non-extension of the outsized remuneration incentives that were previously linked directly to reducing the NAV discount, there is no indication that management’s fundamental attitude towards the discount has changed. The strategic intent to manage and potentially reduce the discount remains a priority, reflecting a continuous commitment to enhancing shareholder value.

• Potential for Continued Repurchases: Should the discount deepen further, it's important to recognize that management retains the capability to execute NAV-accretive share repurchases. These can be funded by liquidating a portion of its substantial Tencent holdings. Such transactions have historically been used to adjust the capital structure and improve the NAV per share, indicating a ready lever that management can pull if needed.

Flexibility in Incentive Structures

• Reinstatement of Incentives: Management holds the option to reinstate remuneration policies that specifically incentivize reducing the NAV discount. By reintroducing such incentives, possibly targeting a new threshold of 30% or lower, management can align their goals with shareholder interests directly and dynamically respond to market conditions.

Market Dynamics and Entry Points

• Potential for Further Discount: While the discount might drift lower, offering a potentially more attractive entry point, the recent expiry of the clawback provisions suggests that the current period may represent a time of minimal explicit management incentive to aggressively lower the discount. This scenario provides a complex but potentially rewarding situation for investors:

  • Opportunity in Timing: Investors might find an attractive buying opportunity if they anticipate that the discount will temporarily widen before management actions are potentially reintroduced to narrow it.

  • Risk Consideration: Conversely, the risk lies in the discount not being actively addressed in the short term, which could lead to volatility or a sustained wider discount if the market perceives a lack of proactive management engagement.

Conclusion

The current state of Prosus presents an asymmetrical opportunity largely because of the potential for management to adjust strategies in response to NAV discount movements. For investors, this situation offers a compelling scenario: the possibility of capitalizing on a deeper discount or benefiting from strategic corporate actions aimed at value realization. The key will be to monitor closely how management communicates and acts regarding the discount, as these will be crucial indicators of the trajectory of both the discount and the stock price. This period, characterized by a potentially lax approach to discount management, could indeed be the optimal window for assessing the true long-term value of Prosus's diversified investment portfolio.

Valuation and Strategy of Prosus's Portfolio

Prosus's investment portfolio presents a compelling value proposition, characterized by a blend of undervalued and fairly valued assets. This mix not only underpins the current investment thesis but also highlights strategic directions that could further enhance shareholder value.

Valuation of Tencent

• Tencent's Market Position: As the dominant internet platform in China, Tencent continues to be a cornerstone of Prosus’s investment portfolio. It stands out not only for its expansive role in the Chinese domestic economy but also as a potential tech leader on a global scale. Despite regulatory challenges and market fluctuations, Tencent maintains a robust growth trajectory and benefits from its entrenched market position.

• Tencent's Valuation: Currently, Tencent trades at what can be considered an undemanding valuation relative to its growth prospects and fundamental strengths. This valuation reflects a market that, while recognizing its current profitability and market position, perhaps undervalues its potential for further expansion and innovation.

• Previous Analysis: For a deeper understanding of Tencent’s intrinsic value and its role within the broader tech landscape, reference is made to a detailed analysis provided earlier this year, which exhaustively covers the reasons why Tencent represents an attractive investment on its own merits.

Here’s the outline of the Tencent investment thesis from the other idea (please see the post to see the outline fleshed out)

Tencent outline:

• Dominant internet platform – original “Super App”

  • Chat (if WhatsApp, iMessage and SMS consolidated)

  • WeChat Pay (40% share; duopoly with AliPay)

  • Games (standout category)

    • Recent move to building more content in-house

  • Mini Program (App Store)

  • Moments (Instagram/Facebook Feed)

  • Channels (TikTok / Reels)

  • Mediated business channel (marketing and ecommerce)

• Big Tech

  • Cloud

  • AI

    • China will have its own winner here. Tencent well-positioned

• China

  • Risk, yes

    • Geopolitical risk. Real, but low. A cliche, but you’re underwriting similar risks, at very different prices, with Apple and Tencent

    • Alignment. Facebook can focus on its shareholders; Tencent must balance its shareholders and the CCP. Larger risk, but mitigated by the encouraging capital allocation strategy (below)

  • Risks well identified. Meaning opportunity. Not just cheap, but unlike many Chinese companies, this one has a tremendous track record of executing on consumer-oriented growth

  • Politically best-positioned of major tech companies. Founder Pony Ma works within the system (contrast with Jack Ma’s fall from grace)

• Capital Allocation

  • Strategic VC -> divestment

  • Aggressive buyback

• Compare to Prosus

  • Prosus management incentives weak for reducing NAV discount further

• Valuation

  • Growing: revenues and margins

  • Under-monetized

  • Cheap

Assessment of the Remaining Portfolio

• Portfolio Valuation: Beyond Tencent, the rest of Prosus's portfolio is assessed as arguably fair in terms of valuation. While some investments are aggressive, reflecting Prosus’s strategy to capitalize on emerging tech sectors, the marks on these investments are considered reasonable given their market positions and growth potentials.

• Investment Strategy: There is a viewpoint suggesting that Prosus could benefit from a less aggressive investment stance. Specifically, it might be advantageous for Prosus to consider selling down some of its portfolio assets, particularly those that are either non-core or have reached maturity, thus potentially overvalued relative to their future growth trajectories.

• Track Record: Prosus’s investment track record supports the notion that its portfolio management strategies have historically been effective. The company has demonstrated a good eye for value and timing in its investment choices, which has contributed to its overall positive financial performance.

Addressing Concerns About Dutch Buyback Tax Implications

One of the key concerns facing Prosus currently is the potential impact of a new Dutch law that proposes taxing share buybacks effectively as dividends. This legislation, if implemented as originally drafted, could significantly increase the cost of Prosus's buyback strategy, which is a central component of its approach to managing the NAV discount. However, concerns surrounding this tax may be exaggerated for several reasons.

Likelihood of Legal Amendments or Reversal

• Potential Legal Changes: The law is still under scrutiny and may undergo amendments or be overturned before its scheduled enforcement in 2025. The Dutch legislative process allows for considerable debate and adjustment, particularly when laws impact major corporations domiciled in the Netherlands, like Prosus. The feedback from the business community and financial markets is likely to influence the final form of this legislation.

• Political and Economic Considerations: Given the potential economic implications of discouraging corporate buybacks—a key mechanism for returning value to shareholders—there is a strong incentive for lawmakers to consider adjustments to the law that would mitigate adverse impacts on the Dutch stock market and investment climate.

Strategic Workarounds for Prosus

• Alternative Listing Options: Should the tax become law in its current form, Prosus could consider listing its shares on another stock exchange with more favorable tax regimes. While re-listing involves significant logistical considerations and can be seen as an extreme measure, for a company like Prosus, where managing the NAV discount is a primary objective, such a strategic pivot could be justified.

• Acquisition Scenarios: Another less conventional but possible scenario involves Tencent or another major investor, like Middle East Sovereign Wealth Funds (SWFs), acquiring Prosus’s stake in Tencent. This move could "bring it home" in Tencent’s case, potentially aligning with Chinese governmental and economic strategies, or result in a strategic investment from SWFs, which might be seen as a positive by the central government.These acquisition scenarios, while speculative, highlight the range of strategic options available to Prosus to mitigate the impact of the buyback tax and manage the NAV discount effectively.

Positive Catalyst Through Forced Strategic Actions

• Shorter Horizon Management: If the buyback tax forces Prosus’s hand, it might lead to more immediate and decisive actions to manage the discount, potentially acting as a catalyst for strategic maneuvers that might otherwise take longer to unfold.

• Removal of Overhang: Addressing the buyback tax concern decisively could also remove an overhang on the stock, improving investor sentiment and potentially leading to a re-rating of the shares.

Conclusion

While the proposed buyback tax in the Netherlands is a concern for Prosus, the potential for legal changes, strategic workarounds, and the opportunity for this challenge to act as a catalyst for positive change should not be underestimated. Investors should monitor developments closely, but also consider the broader strategic flexibility that Prosus possesses in addressing this and other regulatory challenges. This flexibility and the range of strategic options available suggest that the impact of the buyback tax, while significant, may ultimately be manageable and might even spur beneficial strategic adjustments.

Some analysis:

https://www.legalbusiness.co.uk/co-publishing/sponsored-briefing-dutch-dividend-withholding-tax-exemption-for-share-buybacks-by-listed-companies-may-be-abolished-by-2025/

Risks to the Investment Thesis

While Prosus presents a compelling investment opportunity, it is subject to several risks that could impact its ability to achieve the projected outcomes. Investors should carefully consider these risks alongside the potential rewards.

Regulatory Risks

• Chinese Regulatory Environment: Given that a significant portion of Prosus's value is derived from its stake in Tencent, changes in the regulatory environment in China could have a substantial impact. China has shown a willingness to enforce strict regulations on technology companies, particularly in areas like data security, monopolistic practices, and overseas listings. Any adverse regulatory actions could affect Tencent’s business operations and, by extension, Prosus’s valuation.

• Dutch Buyback Tax: As previously discussed, the introduction of a buyback tax in the Netherlands could increase the cost of share repurchases, a key tool for managing the NAV discount. While there are potential workarounds, the implementation of this tax would complicate Prosus’s financial strategies and could deter investment if not adequately addressed.

Catalyst

• Resumption of management incentives to manage discount
• Discount-induced increase in buybacks
• Tencent stake sale