For years, Tencent's (TCEHY 0.23%) largest shareholder, early investor Naspers (NPSNY -0.12%), along with its cross-held holding company subsidiary Prosus (PROSY -0.81%), has traded at a discount to its Tencent stake. Despite Naspers/Prosus' best efforts at financial engineering and diversifying its business into food delivery, digital payments, education technology, and e-commerce in emerging markets, the discount has continued to widen.
Just how wide? Based on its recent net asset value, incorporating both prevailing market prices and analyst estimates for private assets, Prosus trades at just over half of its net asset value (NAV), while Naspers is even cheaper, at around 45% of NAV.
In its recent earnings release last week, however, Naspers/Prosus announced its boldest move to close the discount yet. While previous moves have failed, this new strategy is bigger, bolder, and could tangibly increase intrinsic value per share in a significant way.
An open-ended repurchase program funded by Tencent sales
Even though Naspers and Prosus have attempted to diversify their assets, and Tencent's stock has declined over the past year, Tencent still accounts for 77% of Naspers/Prosus' NAV. Meanwhile, most of Naspers/Prosus' other businesses are growing strongly but don't produce much cash flow. While the company has lots of liquidity, it also has just as much debt as cash and would probably like the ability to make an acquisition if an opportunity arises in this adverse environment.
That leaves Naspers/Prosus with no other option to raise cash in order to buy back stock other than selling more Tencent. While the company initially said it wouldn't sell any more Tencent for three years after selling some of its stake in early 2021, management changed its tune, surprising the market last week.
The new plan is for an open-ended sale of Tencent shares, along with a simultaneous repurchase of Naspers/Prosus shares. According to management, it will buy Naspers and Prosus shares in equal proportion to their ownership of total assets, with Naspers having 42% of the economic interest in Prosus' assets and Prosus shareholders outside of Naspers owning the remaining 58%. The program will occur as long as there is a "significant" discount, although management didn't give specifics on what that meant.
While liquidating a very attractive, cash-flowing company like Tencent seems like a sacrifice, the discount is so large that Naspers and Prosus shareholders will actually see its ownership of Tencent increase on a per-share basis.
For instance, management gave an example in which it sold $10 billion of Tencent and repurchased $10 billion of Prosus shares. That would lower Prosus' net asset value by 5.9%, but Prosus' share count would decrease by 13.5%. The result? An increase in NAV per share of 9%. A $20 billion sale and repurchase at the same level would increase NAV per share by 20%, and a $30 billion sale and repurchase would increase NAV per share by 38%.
How this could be more effective than past moves
No doubt, Naspers and Prosus have made financial engineering moves in an attempt to close the discount before. However, this one seems like it has a much better chance of working.
In 2019, Naspers created Prosus, a separate holding company for its non-South-African assets. Naspers, a South African company, had become so large on the Johannesburg Stock Exchange that management believed its size was limiting the amount asset managers could purchase. The thinking was that by creating Prosus and spinning off Prosus shares to Naspers shareholders on the Euronext Exchange, Naspers' market cap would shrink on the JSE, even though its assets would not go down. They would merely be transferred out of South Africa.
However, that didn't work, likely because it created more complications with the two-company structure. In 2021, management then executed a share swap between Naspers and Prosus in an attempt to further shrink Naspers' weighting. However, that added even more complications, and the discount widened again.
Meanwhile, Naspers has sold Tencent shares in the past, both in 2018 and then in 2021. However, the cash from those proceeds, while going partly to a buyback, mostly went to buying more companies across classifieds, digital payments, e-commerce, and other ventures. Those assets have declined in value over the past year along with Tencent as the tech market has crashed, so the NAV per share didn't really improve.
However, this new change could work much better. The prior creation of Prosus was more of a financial engineering gimmick meant to decrease Naspers' weighting on an index. Meanwhile, investors aren't giving the company any credit for its diversification into other areas, still regarding the stock as a play on Tencent.
This move, however, is large and open-ended and seems to be a capitulation on management's part that it must do something different to be regarded as anything other than a Tencent proxy. Meanwhile, a large-scale repurchase will make a tangible difference in value per share immediately. Naspers' management has tried to do everything in its power to hang on to as much Tencent as possible for the long term, but investors have shunned that strategy because it hasn't addressed the discount. However, management now seems to be capitulating, finally declaring the huge and widening discount "unacceptable."
An interesting, idiosyncratic play in a tough market
I've been wrong in thinking Naspers/Prosus' past moves would help close the discount. However, this new strategy seems a bit different. With China now cutting interest rates and perhaps ending its regulatory crackdown on its tech giants, it's also possible Tencent may begin rising in value before U.S. indexes do. When you add this repurchase of Naspers/Prosus at half of its intrinsic value, it's an intriguing idiosyncratic option in an otherwise tough market.
