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Prosus investors must understand Tencent’s uphill struggle

By David Whitehouse
Posted on Wednesday, 4 September 2019 08:27, updated on Tuesday, 8 October 2019 14:39

Cosplayers introduce Tencent's "Eastward Legend: the Empyrean" at the China Digital Entertainment Expo in Shanghai in August. Tencent is the main asset being offred by Naspers in Amsterdam. REUTERS/Pei Li

The legendary status of Tencent as an investment within the portfolio of the South African holding company Naspers risks blindsiding investors considering exposure through the listing of the stake in Amsterdam.

Tencent is the main asset in the Prosus unit, which Naspers says will be valued at about $100bn when it’s listed in Amsterdam on September 11.

But the fact that there is widespread positive analyst consensus on Tencent shares does not make them a slam-dunk buy, argue Rickin Thakrar and Arun George at Global Equity Research in London in two pieces of research published on Smart Karma in May.

Tencent relies on investing in high-user businesses to drive revenue growth for its value-added services, cloud and payments services, Global Equity Research says.

The result is that most forecasts underestimate the growth dependency of Tencent’s gaming and social media businesses on its venture capital arm and drastically understate the capital expenditure required to sustain growth.

  • Most discounted cash flow calculations used to value Tencent are “intrinsically flawed”, Global Equity Research says.
  • Investments are based on numbers of users, and “irrespective of profitability”, the research says.
  • The analysts estimate Tencent has spent US$50bn on equity investments in the past three years, which is eight times its internal capex.
  • The startling fact is that once investments are taken into account, Tencent is not generating cash.

The investment-heavy business model combines with slowing growth prospects for Tencent in China.

  • The key risk for Tencent’s smartphone games business is that it has become “too dominant” in China. In an environment of declining market growth, new blockbuster games will “cannibalise” existing offers, the analysts write.
  • The company’s share of China’s mobile ad market measured by revenue has remained stable at around 15% over 2016-18.
  • The launch of mini-games has not resulted in meaningful revenue.
  • China’s smartphone game revenue growth is forecasted to decline from a compound annual growth rate (CAGR) of 27% over 2016-18 to 17% in 2018-21.
  • And the country ’s mobile game publishing revenue growth is forecasted to decline from a CAGR of 14% over 2016-18 to 7% in 2018-21.

Narrowing Naspers discount

The Prosus listing is set to “go well”, and investors in Naspers are likely to benefit as, over time, it will reduce the discount to net assets at which the shares trade, argues Peter Takaendesa, an analyst at Mergence Investment Managers in Cape Town.

  • The benefits of listing Prosus include attracting a “new group of Naspers buyers”, as developed markets investors will now access to the shares in Europe and the concentration risk caused by Naspers’ size on the Johannesburg will be reduced, though not eliminated, Takaendesa says.
  • Mark Lawrence, vice president at T. Rowe Price in the UK, agrees that European investors “are hungry for the technology platform businesses that Prosus offers.”
  • The fact that Naspers is listing its Tencent stake without at market value with no capital gains tax is a “huge net asset value accretion move,” he says.
  • Takaendesa, however, points out that individual Naspers investors – those not part of pension funds – will have to pay capital gains tax now if they receive Prosus shares on listing. They have the option to ask for more Naspers shares instead.

Bottom Line: Naspers investors are likely to benefit from the Prosus listing – but new investors need to understand that the best of the Tencent growth story is already over.

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