Prosus N.V. - Emerging Markets Tech Powerhouse or Tencent Derivative? Either way it represents an asymmetrical investment opportunity.

I recently came across an old investment thesis I submitted to Value Investors Club in November 2022. It was rejected. The subject was Prosus, then trading at €26.05. Today, it’s at €46.48. I held the stock into the mid-30s and sold—too early, in hindsight.

At the time, Tencent (Prosus’s primary asset) was trading at HKD 266.10. Today, it’s at HKD 501.50. In other words, while Prosus appeared to offer a margin of safety, Tencent turned out to be the better investment—and likely still is.

Below is the original write-up, unchanged.

Investment Idea

Prosus N.V. (AMS: PRX) is a global consumer internet group focused on emerging economies. Prosus is located in the Netherlands and trades on the Amsterdam Stock Exchange and is best known for its 28% stake in Tencent Holdings (HKG: 0700), the Chinese technology behemoth that owns super-app WeChat (Weixin).

The uncertainty surrounding the future of gaming in China, technology regulation in China, increasing geo (US-China) tensions around Taiwan, plus general global Big Tech anti-sentiment has weighed on the valuation of Tencent and, by association Prosus. The current valuation provides a compelling entry point for investors to acquire one of the world’s greatest compounders at a significant discount with full optionality on a host of other high growth opportunities within the Prosus stable.

Background

Prosus was spun-off from South African entity Naspers in 2019. Naspers is a former South African media conglomerate turned investment powerhouse which was transformed by Koos Bekker and his US$32 million investment in Tencent back in 2001.

Over the past few years, Prosus has quietly built up an impressive portfolio of investments in fast growth sectors ranging from Food Delivery, EdTech, Payments and Classifieds. Due to the enormous TAMs and winner-takes-most nature of most of these industries, Prosus (and its investee companies) have focused on revenue growth over the bottom line. We believe that the portfolio is well constructed to take advantage of some strong secular tailwinds and is primed for a long runway of continued growth.

Overview of Prosus’ Portfolio

According to its website “Prosus is a global consumer internet group and one of the largest technology investors in the world. Operating and investing globally in markets with long-term growth potential, Prosus builds leading consumer internet companies that empower people and enrich communities. The group is focused on building meaningful businesses in the online classifieds, food delivery, payments and fintech, and education technology sectors in markets including India, Russia, and Brazil. Through its ventures team, Prosus invests in areas including health, logistics, blockchain, and social commerce. Prosus actively seeks new opportunities to partner with exceptional entrepreneurs who are using technology to improve people’s everyday lives.”

In its five main pillars: 1) classifieds, 2) food delivery, 3) payments, 4) education technology and 5) etail/ecommerce, we estimate that Prosus has invested in the region of US$16 billion in just its non-listed assets.

For the last year or so Prosus’ market cap has approximately equaled the value of its stake in Tencent meaning that the market has essentially discounted Prosus’ non-Tencent assets to less than zero. Tencent itself is down almost 80%+ from its all time high set in February 2021.

Closer analysis shows that a number of Prosus’s other (non-Tencent) businesses are well positioned to become (or are already) the market leader in industries with strong tailwinds and huge total addressable markets. Management estimates that its unlisted assets are worth upwards of US$40 billion based on latest funding rounds and other publicly available information. We believe that this estimate by management is too optimistic in light of current market conditions but even if we apply a cost basis to the non-listed assets, Prosus is still trading at a c. 46% discount to NAV.

A closer analysis of Tencent reveals that it generated around US$20 billion in Free Cash Flow in 2021 and has a portfolio of high quality listed and non-listed assets valued at US$100bn. Based on current market cap, it trades at just 13x TTM FCF, however, after adjusting for net debt and our conservative estimate of the value of its listed portfolio, Tencent trades on only 7x TTM FCF.

There are a great many write ups on Tencent available online and so we will stick to our own qualitative high level thesis on its long term prospects here, however, even if one was to take a more pessimistic view of its future, there is sufficient margin of safety/intrinsic value built into the portfolios of both Prosus and Tencent itself to warrant serious consideration as a deep value play.

We consider Tencent’s management team to be one of the world’s best allocators of capital, compounding FCF at over 30% per annum for the last 10 years. It has also shown itself to be politically astute over a long period of time. The value of Tencent’s investment portfolio has compounded at a rate of 73% p.a. over the last 10 years. Tencent is a great spawner, its core businesses have compounded revenues at a rate of 37% p.a. over the last 10 years.

Over the last few quarters, Tencent’s revenue growth has slowed down and is currently stagnant, however, management has taken evasive measures to cut costs and prioritise resources on only the most promising projects. The slowdown in domestic gaming revenues has resulted in the company focusing more energy on growing its staple of international gaming with a recent investment in Ubisoft (via the controlling parent) an example of the tweak to its strategy. In terms of its advertising business, we expect this to recommence growth later next year and its fintech/payments business division and cloud businesses are well positioned to capture market share as the economy recovers.

Double share buybacks create loopalooza effect

The management of Tencent and Prosus are aware of their relative discounts to intrinsic value and are actively pursuing shareholder buy-backs, investment divestments and other short-to-medium term shareholder friendly actions to narrow the gap. Examples of recent divestments include the return of US$16bn via the transfer of its stake in JD.com and the upcoming sale of its stake in Meituan scheduled for January 2023.

Prosus itself has embarked on an open-ended share repurchase scheme and is currently spending around US$250-300 million each week to buy back shares. On an annualised basis this equates to a yield of around 10%. Our figures for Net Shares in Issue above reflect our estimate of the number of shares repurchased since

Prosus last updated its own NAV estimate (30 September 2022).

Given the number of secular high-growth trends and markets that Prosus (and Tencent) are tapped into, the track record of both managements to create shareholder value and historically low valuations, we estimate that Prosus offers investors a 100-150% upside over the next 12-36 months.

Key Risks

The 2 key risks associated with owning Chinese technology stocks are 1) Chinese regulatory pressures and 2) China-US tensions (leading to a delisting of Chinese stocks or divesting pressure on Chinese investments in the US).

Tencent has attempted to navigate the first risk by building a decentralised ecosystem through WeChat and building up a diversified portfolio of international stocks. The second risk, while increasingly concerning, is a shared risk for both US and Chinese stocks that have any kind of nexus to each other’s countries/geopolitical supply chains including TSMC, Apple, Tesla, Starbucks and Nike. Tencent’s primary listing is in Hong Kong and so the main risk in holding via Prosus is relations between the EU/Netherlands and China which appear to be on a more solid footing.

Summary

Prosus market cap is below any conservative estimate of the intrinsic value of its unlisted and listed assets. Prosus’s largest holding, Tencent, is trading at historic lows. Tencent is a best-in-class global technology company with one of the world’s best capital allocators at its helm. Managements of both Prosus and Tencent are acutely aware of the large discounts to NAV that currently prevail and have already embarked on shareholder friendly repurchase and other divestment strategies to close the gap. Prosus’ own share repurchase programme currently implies an annualised yield of 10%.

Catalyst

• Tencent’s financial results over the coming quarters course correct to show signs of growth (c. 5-10%)

• Tencent continued divestment of maturing portfolio investments

• Continued Tencent share buybacks and other initiatives

• Recognition of extent and breadth of Tencent’s international gaming content

• Interest in Prosus’ substantial Indian exposure

• Re-valuation of Prosus’ other investments in EdTech, Online Food Delivery, Payments etc.

• Continued Prosus share buybacks and other initiatives

• Continued revenue growth of Prosus’s other investments, as a % of overall consolidated revenues

• De-escalation of US-China tensions

We do not hold a position with the issuer such as employment, directorship, or consultancy.

We and/or others we advise hold a material investment in the issuer's securities.