Prosus: Between Deep Value And Tencent’s China Risk

Summary

  • Prosus is trading at a 61% discount to its net asset value.
  • Tencent’s new capital allocation strategy of spinning off investments could benefit Prosus in a big way.
  • Share buybacks at this suppressed valuation could unlock a lot of shareholder value and narrow the NAV gap.

Thesis

Three months ago I published an article about why I sold my Tencent position (8% of my personal portfolio at the time) and since then the stock dropped 15%. Even though I consider Tencent a hold after its further fall, I believe Prosus could be a good investment due to its immense discount on its net asset value. Prosus is a cheap proxy to own exposure into a basket of beaten-down companies with the main asset being Tencent. The stock does still have significant risks associated with it, but at the current valuation and discount, I believe it can be worth it to open a position.

Tencent’s performance since the last article (Author’s last Tencent article)

For clarity’s sake: All stock prices referenced in this article will be for the stock listed in the Netherlands: PROSF. Each PROSY stock represents 1/5 of the NL-listed stock.

The company

Prosus is a Dutch holding company that invests in a variety of assets in public and private markets. These investments include Food Delivery, Payments & Fintech, EdTech, Social Media and others.

The South African holding company Naspers spun Prosus off as its investments holding in 2019 and owns a 57% stake in Prosus and, thus, holds control of the company.

Prosus, then Naspers, made the deal of the century when they bought 46.5% of Tencent for $32 million back in 2001. They still own 28.8% of shares outstanding today, which values their stake at a cool $127 billion, an increase of 400000%. Simply mind-boggling.

Regional headwinds and funding

The company has been hit hard in the last year by its focus on two emerging markets: China and Russia.

The largest part of Prosus’ investment portfolio is invested in China, mainly in Tencent. Besides Tencent, they also own Trip.com, a Chinese-owned travel site and they received a large dividend of 230.75 million shares of JD.com from Tencent. China has experienced a big regulatory crackdown over the last year. I talked more about this in my article about Tencent. This affected the asset value of most of their portfolio considerably.

A smaller part of their portfolio recently plunged after Russia started an invasion of Ukraine. Prosus owns 26% of Mail.Ru/VK. Due to international sanctions against Russia, Prosus wrote off their entire stake in Mail.ru, a $700 million write-off. Another significant part of their portfolio is Avito, a company that mainly operates in Russia. Since then the company ceased all operations in Russia and Prosus wrote off a substantial part of this investment. More importantly, the dividend from Avito was responsible for 20% of the cash inflows into Prosus.

Avito dividends account for 20% of the inflow into the group.

The cash inflow from the dividends of Tencent, Avito, and other investments is being reinvested by Prosus into new investments. We can expect their inflows to decrease going into the next earnings, due to the Avito dividend being sanctioned away. Prosus could have used this money to reinvest in new companies at these depressed valuations we are seeing all over the market.

Tencent, the key point for Prosus

Chinese tech crackdown seems to ease

Over the last year, China has run a relentless crackdown on most of its big tech companies. Recently there have been signs that these crackdowns are easing, as growth in China is slowing amidst brutal lockdowns, the government needs to reinstate growth. Giving big tech a longer leash could be one of those measures. China regulators also openly encouraged companies to buy back shares and asked major shareholders to support stock prices in this market. It seems like they finally want their companies to be more shareholder-friendly.

Tencent’s changing capital allocation strategy

As I mentioned in my previous article in February, I believe Tencent is forced to switch up its capital allocation strategy. In the last 6 months, we’ve seen them pay out the majority of the JD.com stake as a special dividend and sell all their voting shares in Sea Limited (SE). These moves don’t fit in their old strategy in my opinion, and I believe that we will see more spin-offs, especially from other Chinese companies. The JD sale could have been influenced by regulators because Tencent has too much power over other tech companies in China. Some of the Chinese candidates for new spin-offs could be Meituan (17% stake, worth around $21 billion), Pinduoduo (16% stake, worth around $8 billion) and NIO (12% stake, worth around $3 billion). These spin-offs could unlock a lot of the net asset value of Prosus and reduce the discount significantly. The paid-out dividend (be it in cash or stock) can then be reinvested into new acquisitions or buying back stock.

Tencent’s valuation is historically low

Tencent has experienced a large multiple compression, dropping from a high of almost 40 times forward earnings to 23. This kind of valuation has last been seen in 2013 and although I agree that the compression is justifiable, I do not see a large downside on Tencent on a multiple basis.

Tencent valuation (Koyfin)

Prosus can’t liquidate Tencent until 2024

After Prosus sold 2% of its Tencent stake in 2021, the company went into a voluntary lockup period of three years to assure shareholders that they are committed to holding their remaining stake for the long term. This means that they cannot liquidate any more of their shares until April 2024. Their Tencent shares thus are not a liquid asset and in case of a further worsening of the situation in China, Prosus cannot counteract by reducing their exposure. It has to be noted that Prosus sold the shares and entered the lockup period before the crackdown in China. I believe that this is a big part of the reason why they are trading at such a big discount to the NAV.

Sum of the parts analysis (SOTP)

Due to the nature of Prosus’ business, it doesn’t make much sense to look at their revenues and earnings. They are a holding company and as such the best way to value them is a sum of the parts analysis going over their portfolio of investments and comparing the net asset value per share with the share price.

For my model, I took the current market data from the close on Friday, 13th May, 2022, for all publicly listed assets. I took the value management gave in the last publication for the unlisted assets.

Prosus SOTP valuation (Authors model. Data aggregated from Prosus IR, stock data from SA and Koyfin)

What can we take away from this analysis?

  1. Prosus trades at a 61% discount to its net asset value (NAV). Every $45.9 share represents $116.36 in NAV. Just the Tencent stake per share of $89.62 is almost a 50% discount.
  2. Every single public investment Prosus holds is in a significant drawdown, with the best performing asset still down a whopping 52% from all-time highs.
  3. Tencent accounts for $127.24/$165.21 billion of NAV, which is 77% of NAV and is currently in a 53% drawdown.
  4. As we can see below, Prosus significantly underperformed Tencent recently, in part due to Russian write-offs. The gap widened quite a bit.
Tencent vs Prosus performance (Koyfin)

Conclusion

Under normal circumstances, this would be a screaming buy! A holding company trading at a 61% discount to its NAV? But these aren’t normal circumstances. Several factors keep Prosus at this sharp discount:

  • Tencent stake cannot be liquidated for another 2 years
  • High concentration (73%) into a single asset that is in the crosshairs of regulators
  • Massive drawdown across the entire investment portfolio
  • Sinking cash inflows from sanctions against Avito
  • What will happen to the JD.com stake?

There is a lot of uncertainty around the business – the perfect storm. Tencent has a lot of issues, but it still is a functioning business that will create good cashflows. As an individual holding, I sold out of my Tencent stake a few months ago, but considering the massive discount to Prosus NAV, I consider Prosus a buy. Tencent’s best days could be behind them in my opinion. In my Tencent analysis, I mentioned that I expect them to spin off more investments to shareholders as they did with JD this year. This leads to a worse capital allocation for Tencent in my opinion, but Prosus profits from this and can extract value from its stake. Prosus hasn’t yet communicated what they intend to do with the JD shares, but I hope they decide to sell the shares and buy back stock at these prices. Prosus has a great opportunity here to exploit its large NAV discount and create great shareholder value. Prosus is not a buy and hold forever kind of stock here in my opinion. If the discount on NAV significantly narrows back to the 30% levels, I’d consider searching for other options.

Author: Stock Metal Investment, Seeking Alpha

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