Investor sentiment towards Naspers and Prosus appears to be warming in early 2024 after uncertainty over Chinese tech company Tencent weighed heavily on these shares in 2023.
Naspers and Prosus trade at significant discounts (43% and 38% respectively) to Tencent, in which they both have a significant shareholding, and to their own net asset value. Their inability to unlock this value, and uncertainty over Tencent and the Chinese economy, has resulted in some nervousness among investors, especially given their dominance in terms of value and trade on the JSE.
In December 2023, the introduction of proposed draft gaming regulations by the Chinese regulator, which set limitations on the amount that users can spend on games, saw Naspers lose 9.7% and Prosus lose 10.6%, while Tencent was down 13% in rand terms. But there has been some recovery in January, after fund managers bought into the dip. The recovery was assisted even further with the Chinese regulator removing the draft legislation from its website in late January.
Pressure on the Naspers and Prosus share prices stems from Tencent’s market value being directly affected by ongoing Chinese regulatory tightening on gaming and a softer than expected Chinese consumer recovery post-Covid, but also indirectly by increasing geopolitical risk premium for Chinese stocks, according to Abax Investments, which manages Amplify Investment Partners’ Amplify SCI* Flexible Equity Fund.
This made several of Amplify’s managers consider Naspers and Prosus good value at current levels, and some used the opportunity to buy.
Laurium Capital, which manages the Amplify SCI* Balanced Fund, said the draft regulations will be less material to Tencent’s earnings in the long run as gaming accounts for around 35% of its profits, while domestic Chinese gaming, which is affected by the regulations, only accounts for around 25%. Laurium added that the initial market reaction was overdone, and there is significant value in Tencent, Naspers and Prosus.
Amplify SCI* Equity Fund manager Oyster Catcher Investments’ interpretation of the regulations and calculations indicated that the impact on Tencent’s earnings would be limited, and it used the opportunity to increase its position.
It expects the market to keep a discount in the share price “to account for a higher likelihood of more government intervention in the sector in the short term”, and to change once there is more clarity. It said the government was more likely to support the sector than regulate further, but welcomed the confusion which creates opportunities.
Abax said the financial impact of the new regulations is relatively benign, although the longer term impact is less clear. It does not expect the Chinese risk premium to disappear any time soon, and said the Chinese consumer rebound post Covid has been more muted than expected.
Tencent is well-managed, with diversified products and with growth drivers in short form video account and advertising and international gaming. With a core PE (excluding its investment portfolio) at 12X, it is well below historical ranges and looks attractive given its formidable products and expected cash generation, Abax said.
Weighing regulatory and risk premium concerns against the attractive valuation leaves Abax net positive on Tencent, and by implication on the valuation of Naspers and Prosus. It used the weakness to increase its weighting to Naspers and Prosus, but remains wary of the risks and manages this through the size of its exposure, which is 1.5% in the wider Tencent, Naspers and Prosus.
All Weather Capital, which manages the Amplify SCI* Enhanced Equity Retail Hedge Fund said it used the weakness to cautiously add to its position. It said Chinese equities offer compelling value in absolute terms, relative to their own history and comparing to developed and emerging markets.
All Weather considers Naspers, Prosus and Tencent as having compelling bottom-up fundamentals that deliver strong returns over the long run from attractive prices at the present level.
Looking ahead, Laurium Capital said senior members of its team who visited China in December were very positive on the specific growth prospects of Tencent over time, given its dominant position in the Chinese internet landscape. They were less optimistic on the overall Chinese economic outlook in the absence of significant stimulus, and sanguine around the regulatory backdrop given the recent unpredictable history.
Oyster Catcher expects the regulation, if implemented in its current form, to have a very limited impact. As Tencent has a high expected four-year internal rate of return, delivered largely through the growth of earnings, it has an overweight position.
All Weather said while it has increased position sizes, it was “wary of doubling down on the same exposure given how intertwined the fate of the Chinese market is with South African equity performance.”
It said increased regulatory uncertainty adds to already negative sentiment towards China, and this may limit the potential rerating of the shares back towards historical levels. Even without a rerating towards historical average ratings, the shares offer compelling upside.
*Sanlam Collective Investments
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