When I invest, I usually prefer direct exposure compared to holding Company due to poor capital allocation of the parent company, additional layers of costs, and skewed corporate governance. There are a few exceptions when I think it is better to get exposure through holding Company. I believe one such example is Prosus (PROSY; PROSF).
Prosus is a Dutch holding company that was spun off from the South African Naspers a year ago. The main asset is a 31% stake in Tencent. Other meaningful investments are Mail.ru, Ctrip.com, and DeliveryHero. Prosus has a primary listing on Euronext Amsterdam (AEX: PRX) and a secondary listing on the Johannesburg Stock Exchange (XJSE: PRX) and is majority-owned by Naspers.
Prosus has two broad categories: Ecommerce and Social & internet platforms. Within E-commerce, the business is organized within five subcategories: Classifieds, Payments & Fintech, Food delivery, Etail, and Ventures.
The most important part of the Prosus case is capital allocation. Prosus tries to build global technology leaders that are focus on addressing significant social needs in high growth markets, where they can create sustainable leadership positions. They are focused on specific markets they know well and where their companies benefit from network effects as they grow.
So far, Prosus was successful in allocating capital. Of course, Tencent is once in a lifetime investment, and it is not reasonable to expect to repeat any time soon. Other investments have provided a compelling return so far.
All internet investments (incl Tencent) produced a mind-blowing track record (NYSE:IRR) of 38% since 2002. If you take out Tencent, the investment return on the current internet companies has been 20% compounded annually.
It is interesting to see that Prosus delivered attractive returns across its key segments. These three segments are the basis for future development.
Ability To Say No
To achieve extraordinary results, you need to have the ability to say no, when the terms are not attractive. During the recent period, Prosus has twice said no, or it is better to say they were outbid. These two examples gave me confidence in management that they are shrewd and disciplined capital allocators despite the fact they achieved an excellent result.
The first example was last year when Prosus approached to buy Just Eat. Namely, in October 2019, Prosus made a cash offer of £4.9bn to acquire Just Eat, but Takeaway won the battle and acquired the Company.
The second example was a battle for eBay’s classifieds unit in July 2020. The eBay classifieds business includes several online marketplaces separate from the Company’s auction platform. Its brands include Kijiji, which is commonly used in Canada and Italy, and Gumtree, a classifieds site popular in the U.K., Australia, and South Africa. It also owns Bilbasen, a Danish online vehicle marketplace, and British car search website Motors.co.uk. Prosus was outbid in this process as well. eBay agreed to sell its classified ads business to Norway’s Adevinta in a deal worth $9.2bn.
You can’t deny the strategic rationale behind these two deals, but it is even more important to stay at the course and not overpay for future synergies.
The best way to approach Prosus valuation is through sum of the parts method (SOTP). The primary stake is Tencent, in which Prosus has 31%. Based on the current market valuation of Tencent, this stake is valued at $208bn. Based on an appraisal provided by Prosus during the Investors day last year, other investments in operating businesses are worth around 25bn. I believe some of these investments are worth more due to COVID-19 disruption, which accelerated the digital shift. Nevertheless, I will keep the last estimate. At the end of the previous reporting period (March 2020), Prosus had a net cash position of $4.5bn. When we put pieces together, then the value of Prosus is around $238bn. On the other side, the current market cap of Prosus is $155bn, which is upside over 50%.
Investing Through Holding Company
I don’t want to argue about the merits of holding discounts. I think many holding companies deserve to trade at wide discounts. In the case of Prosus, I think it doesn’t make sense to trade at such a deep discount. If we exclude investment in Tencent, I think Prosus management did an excellent job allocating capital. They have created several leaders in emerging markets with plenty of opportunities for further growth. Corporate governance seems fine. Prosus has high-level transparency. They had Investors Day with plenty of analysts in December last year. Regarding extra costs related to holding structure, they are high, but if we put them into terms of market cap, they not so high. Selling, general, and administration expenses were $134m at the end of the fiscal year 2020, and I believe they don’t deserve a more significant discount than 1-3%.
When I talk about Prosus, the primary risk is related to Tencent and its significance for the investment case. Tencent is a great company, but on the other side, it faces many different threats. Before someone invests in Prosus, it should adequately assess all risks related to Tencent. There are many risks associated with Tencent, but the following should be highlighted: (i) external (US-China dispute) and internal (relationship with the local government) political risk; (ii) macroeconomic risks; (iii) regulation; (iv) accounting and transparency; (v) dependence on online gaming; (vi) Tencent capital allocation.
Also, before someone invests in Prosus, it should understand that Prosus invest in young internet companies, which some of them are not profitable. Prosus is dependent on M&A deals and further acquisitions. Despite the recent two examples when they said no or better to say they were outbid, there are many examples when companies depend on M&A growth to fail with the strategy. There are also many other risks related to Prosus, but I would highlight the following: (i) unexpected changes in the value of the assets; (ii) currency exchange fluctuations: (iii) most of Prosus businesses are subject to extensive laws and regulations; (iv) failing to attract and retain sufficient talent to execute strategy; (v) failure of software, systems or infrastructure; (vi) COVID-19 impact on weak businesses; (vii) political risks.
Putting it all together, Prosus is a good vehicle to get exposure to Tencent. Market view the investment in Prosus primarily as an investment in Tencent, which is logical when we consider that stake in Tencent is higher than the market cap of Prosus. If we exclude all other businesses which Prosus own, even then investors get exposure to Tencent at a discount through Prosus.
I believe Prosus management showed a solid track record with the ability to efficiently build other businesses and allocate capital. Also, we should credit them to keep investment in Tencent. Many investors would sell the stake in Tencent many years ago. This ability is highly valuable characteristics but seems underestimated currently.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.