Naspers was the darling of the JSE in 2013, contributing a full 4,2% of the total market performance of 18% last year. But we believe that, although it may be a great business, Naspers does not represent a good investment.
Investors seem to be pricing the share for perfection, and then some. Eager to gain access to the Chinese market, via Naspers’s holding in the social media firm Tencent, investors have bid the stock up to a price to earnings (p:e) multiple of 61,5x. Naspers has had an average return on equity of 12% over the past five years, and is on a dividend yield of just 0,2%.
At closing market prices on 12 May, Naspers’s 34% stake in Tencent was worth R427bn against its own market capitalisation of R453bn, representing 94% of total value. If one accepts Tencent as fairly valued, then Naspers does present an interesting investment case, with the rump of its assets in Mail.ru, pay television and e-commerce on offer for very little.
We believe, though, that you have to assess the intrinsic value of Tencent (as opposed to using the market price) to better understand the valuation around Naspers, given the fact that Naspers has become a proxy for Tencent, with Naspers’s market price movement reflecting what happens in Hong Kong. The key question therefore becomes the following: what does Tencent need to deliver over the next 10 years to justify its current valuation?
We used a free cash flow approach with the most recent financial data available from Tencent to estimate this. Based on our estimates, Tencent will need to grow operating income (or earnings before interest and tax) at a compound annual growth rate of 24,6% over the next 10 years in nominal terms. What is worth further emphasis, is that we assume that this will be very high-quality growth — in other words, that Tencent will maintain its current return on invested capital (ROIC) of 55% over this period. Seen against the cost of capital of 9,5%, we can’t help but feel that this spread will close in coming years as competition intensifies, which will erode margins and necessitate increased investment. In turn, lower ROIC will require even higher growth rates to justify the current valuation.
Finally, at current levels, we estimate that investors are valuing Tencent at an intrinsic p:e of 48 times, with 80% of the valuation stemming from growth investments that the company will make over the next decade and 20% of the valuation from investments the business has already made. In other words, Naspers is priced for growth — and quite spectacular growth at that. We prefer to buy businesses where most of the value is explained by cash flows from investments the company has already made and where growth is given to us as a free option.
For these reasons, we believe that a company such as SinoMedia makes much better investment sense than Naspers or Tencent. A relatively small business, SinoMedia is listed in Hong Kong and operates primarily in China. The stock has been listed since 2008, having been formed in 2005, and has built up 1 600 clients in the region.
SinoMedia is largely a wholesale purchaser of advertising space from the television and broader media sector in mainland China, which it then sells on to its various clients. SinoMedia owns the rights to CNBC in China as well as CCTV — the company has 39 501 minutes of advertising time to sell — while clients include the likes of BMW, Ping AN Insurance and Sony.
SinoMedia also boasts three other divisions: integrated brand communications; content production (notably TV advertisements); and new media investment and integration. In addition, SinoMedia owns stakes in several Internet-based companies, so it is increasingly encroaching on the Tencent digital space.
The stock offers many of what we consider to be key investment ingredients, including a return on equity of 35%, net income growth of 25%/year over the last five years and undemanding valuation multiples. The latter comes in the form of an earnings multiple of 8,1x and a trailing dividend yield of 2,1%.
Thematically, this stock affords us the opportunity to gain exposure to the rapidly growing Chinese media market at a compelling price. This is explained, in part, by the fact that the counter is not listed on the Chinese stock exchange and has therefore not captured all of the attention that many other shares have. As always, Cannon’s investment approach emphasises buying good businesses, but at the right price.
- Victor von Reiche is senior investment analyst at Cannon Asset Managers and Andrew Dittberner is senior investment manager at the same firm