Investing in a holding company with heavily discounted assets, such as South Africa’s Naspers, is one thing.
But if the underlying assets are themselves at risk, the equation changes. When those risks are driven by an ideologically led Chinese government crackdown on the tech sector, then the risks are opaque and hard to quantify.
Throw in the historically emotive language of “spiritual opium” being used in state-controlled Chinese media to describe computer games, and investors in South African tech conglomerate Naspers and European-listed vehicle Prosus, whose most valuable holding is their stake in China’s Tencent, face a dilemma over whether to head for the exit.
- Tencent on Tuesday said it would act to restrict access to its Honor of Kings game after state media singled out the game in its “opium” comment. That was enough to wipe $60b from Tencent’s market value.
- The mid-nineteenth century opium wars fought by Britain in China forced the concession of commercial rights and territory after China tried to suppress British opium imports from India.
“The unpredictable and broad-based interventions from the Chinese government have probably damaged foreign investor confidence” and it could take a long time to fully rebuild trust, says Peter Takaendesa, head of equities at Mergence Investment Managers in Cape Town. The Communist Party of China is “firing bullets from many different organisations of the government” and targeting “a very broad range” of technology targets, he says.
- “Data security and business practices seen to contribute to increased inequality and industry competition appear to be key targets of policy changes.”
- This means that Tencent will have to “significantly increase investment in order to comply with the new regulatory framework.”
- There’s no telling how long the crackdown will last or how far it will go. “I doubt anyone knows where they will end and how aggressive the enforcement will be,” Takaendesa says.
Lack of Visibility
Holding companies which trade well below their asset values are often a target for shareholders who seek to pressure management into action to reduce the discount. The dual voting structure at Naspers, which favours management and insiders at the expense of shareholders, means that mechanism is absent. The result has been a long-term discount at Naspers of between 30% and 40%.
Mergence still believes in the long-term growth prospects of the overall internet sector in China, key parts of Tencent’s business model and the company’s management team. But, says Takaendesa, “it is always very difficult for investors to gain conviction when there are major regulatory changes and what appear to be unpredictable authorities.”
- Takaendesa says it is unlikely that Naspers and Prosus will materially change their communicated plans to reduce the discount having committed to not selling Tencent shares over the next three years.
“Investors have very little visibility,” says Wium Malan, an equity analyst with Smart Karma in Cape Town. The rhetoric from regulators that there will be a six-month period of intense scrutiny ahead means more negative news flow is likely, he says.
- There is already a lot of negative sentiment towards Naspers and Prosus management as a result of the share exchange offer approved in July, Malan says.
- Underperformance by Tencent shares tends to increase the ire from local institutional investors and China’s tech sector woes increase the pressure on management to come up with new ways to reduce the discount, he adds.
Some South African domestic institutions may be obliged to hold at least some Naspers stock due to constraints in their mandates and portfolio risk mitigation efforts, Malan says.
- There is “very little on the short-term horizon to promise a material reduction in the holding company discount,” he adds.
- “For emerging market funds, who are bullish on Tencent given the recent correction in share price, I think they are likely best served by owning Tencent directly.”
The Naspers and Prosus vehicles do nothing to protect investors from the growing risks in China’s tech sector, but simply build in structural discounts which shareholders have no power to reduce.
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