Prosus NV – A Cheap Way Of Investing In Tencent


Prosus N.V. is a company you have probably never heard off. But if you are an investor who wants to gain exposure to fast growing tech companies, you would do well to get accustomed to it. After all, Prosus has exposure to segments of the markets that have long runways of growth ahead.

 

To understand the investment case surrounding Prosus, you need to understand the history surrounding it’s parent company, Naspers.

 

To keep it brief,  Naspers in 2001 made a prescient investment by buying a 33% stake in Tencent. Naspers paid $34 million for the stake in Tencent and today that stake is worth $128 billion! An over 65% IRR!

 

But whilst Napsers had a stake equivalent to $128 billion in Tencent, the share price of Naspers did not reflect this. When I last wrote about Naspers in 2017, it had a market cap of only $98 billion – a discount of close to 30% to its investment in Tencent.

 

Naspers has over the years consistently traded at a discount to its net asset value. So the company finally did something about it this year.  They have spun off their international internet assets division into an Amsterdam listed company called Prosus N.V.

 

Part of the logic for the spinoff was to do with liquidity and tax reasons as Amsterdam is more favourable than Johannesburg in this regard. This management hoped would close the discount. But whilst the discount has narrowed since I last wrote about them, there is still a sufficient discount to warrant investors whom want exposure to Tencent to buy into the company. 

 

Tencent 

Tencent holdings is an online gaming and social media giant in China. It aims to own the screen time of the Chinese population. To put it simply, imagine all of the products of Facebook (including Whatsapp), Youtube, Netflix, Apple Music, Visa, Paypal, Nintendo and EA Sports rolled into one company?

 

Tencent is broken down into 5 main businesses:

  1. Digital Advertising – WeChat has 938 million highly-engaged users.
  2. Mobile Payments – WeChat Pay is one of the largest mobile payment platforms in China.
  3. Video Game Publishing – High margin, high Return On Invested Capital business that throws off significant free cash flow
  4. Media Subscriptions – Over 100 million people subscribe to Tencent’s news platforms, music, video, movies, and original content (think Apple Music, Youtube, and Netflix combined)
  5. Ecommerce – Tencent is a partner & minority owner of JD.com; WeChat is also a potential ecommerce hub.



Tencent’s Financials

 

Here is the a brief summary of the financials which shows the fast growth the company has experienced:

 

  • Revenue has grown from $4 billion in 2011 to $51.82 billion in 2019 for a compound annual growth rate of 30%+

 

  • Net profit has grown from $1.5 billion in 2011 to $12.47 billion in 2019 for a compound annual growth rate of 30%+

 

  • Operating margins stand at 31%

 

  • Return On Invested Capital is at 20%!

 

  • Free Cash Flow is expected to be at $18 billion for 2019. This cash flow generated from mobile advertising and game publishing fuels investments in areas such as music, content, the cloud and more. The high returns on invested capital shows cash is wisely spent and the company is expected to continue growing at this fast clip.

 

The Economic Moat Surrounding Tencent And Its Meteoric Rise

In order to understand why Tencent has high returns and is able to grow so quickly, you need to understand its economic moat – something special the business possesses which allows it generate above average returns for a sustainable period.

 

Tencent has a huge Network effect. The Economist summarises the network effect:

 

“E-commerce is another driver of the business model. The firm earns fees when customers shop at one of the more than 10m merchants (including some celebrities) that have official accounts on the app. Once users attach their bank cards to WeChat’s wallet, they typically go on shopping sprees involving far more transactions per month than, for instance, Americans make on plastic. Three years ago, very few people bought things using WeChat but now roughly a third of its users are making regular e-commerce purchases directly through the app. A virtuous circle is operating: as more merchants and brands set up official accounts, it becomes a buzzier and more appealing bazaar.”

 

To put it simply the super app that is WeChat is essentially the ‘operating system’ of China and touches everything in the country. It offer a highly valued user experience means that new and existing users are spending more and more time on the app. This in turn attracts businesses and advertisers to the platform as they want to sell its products to the users. This brings in even more users. This cycle goes on and on…

 

To date, WeChat has about 940 million users and this is growing at close to 23% a year! The app has 12 million official accounts ( think Facebook business pages). The average user spends 66 minutes a day on We Chat (more than Facebook and Instagram combines). Have a look at this from the Economist piece to find out why :

 

“Like most professionals on the mainland, her mother uses WeChat rather than e-mail to conduct much of her business. The app offers everything from free video calls and instant group chats to news updates and easy sharing of large multimedia files…

 

“Yu Hui’s mother also uses her smartphone camera to scan the WeChat QR (quick response) codes of people she meets far more often these days than she exchanges business cards. Yu Hui’s father uses the app to shop online, to pay for goods at physical stores, settle utility bills and split dinner tabs with friends, just with a few taps. He can easily book and pay for taxis, dumpling deliveries, theatre tickets, hospital appointments and foreign holidays, all without ever leaving the WeChat universe.”

 

We Chat has people locked into its ecosystem and this is a great strength as a business.

We Chat payments is also an interesting aspect as it is growing 200% year on year. It is used both online and offline. Its key strength is that it is cheap for merchants (businesses) to use and this has its own network effect in terms or bringing online more users. WeChat Pay has 40% market share in China with 600 million daily transactions.

 

Apart from having a huge networking effect, Tencent benefits from having a massive tailwind on its back and having a long runway aead of it. Firstly, Tencent is immune from foreign competition in China due to local regulation. Secondly, China has a rising middle class that is spending more time and money online and Tencent will be a big beneficiary of this.

 

Take online advertising for instance as a way of extrapolating the long runway. WeChat has ad revenue of $2.3 billion at present. A similar company – Facebook – had ad revenues of $2 billion in 2010 and only 6 years later this ballooned to $27 billion. We Chat has more users now than Facebook had in 2010. You can see where WeChats ad revenue is going!

 

The rising Chinese middle class will also benefit E-commerce. Tencent has a stake in another giant JD.com which did revenues of $38 billion last year. Furthermore, luxury brands such as Burberry have started selling products in We Chats platform. We Chat is fantastically positioned to extract a toll from the e-commerce industry.

 

One more advantage that Tencent has is that the company is still operated by its founder. Pony Ma (also called Ma Huateng) who started that company in 1998 owns just under 10% of Tencent and is focussed on creating long-term value by focusing on user experience. This is absolutely that way to go. Here is a great quote by Amazon founder Jeff Bezos “The balance of power is shifting toward consumers and away from companies. The right way to respond to this if you are a company is to put the vast majority of your energy, attention and dollars into building a great product or service and put a smaller amount into shouting about it, marketing it.”

 

Pony Ma knows all about changing and adapting and is always focussed on customer value. Here is an example. Tencent had a product called QQ, which was a desktop messaging platform that was also massively popular in China, and still has over 800 million users. Pony Ma recognized the shift to mobile, staffed two teams (one from QQ and one “outside” team) to solve the issue. The QQ team came up with a product that was very similar to QQ desktop, but the outsider team invented WeChat. As seen from this article, WeChat is the heart and soul of the company.

 

Tencent Valuation

Tencent currently has a P/E ratio in the high 30s. To most investors, this would seem excessively high and off putting. But the P/E ratio needs to be taken in context.

 

Consider what Charlie Munger (Warren Buffets business partner) said:
“If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.”

 

Looking at the financials of Tencent, its Free Cash Flows, high ROIC figures and economic moats, the current price of Tencent may be considered reasonable. 

 

But for those wanting an even cheaper way into Tencent, have a look at Prosus.



A cheap way to buy Tencent Shares – Prosus

 

Investors that want  a discounted entry into Tencent should look at Amsterdam listed Prosus. 

 

To keep it short, Prosus owns 31% of Tencent. At current market prices when writing the article. Prosus stake in Tencent is worth about $130 billion.

 

So how much is Prosus worth / its market cap? Only $118 billion. This means that buy buying Prosus shares, you are getting a 9% discount on Tencent shares. Crazy!

 

And that’s not all. Prosus in addition to holding a stake in Tencent, has numerous other investments. Some of these are Swiggy, India’s largest food-delivery platform, iFood, the leading online food-delivery platform in Latin America, Delivery Hero, a leading food-delivery platform and Letgo, a competitor of Craigslist Inc.

 

By buying into Prosus, you essentially get discounted Tencent shares and a whole lot of other businesses for free! From my perspective, this huge discount shouldn’t exist. This is an opportunity for investors to take advantage of this discount and ride the wave of growth the underlying companies provide.