By Andrew Dittberner
I am sure that everyone has been taking note of the Naspers & Prosus share price movements yesterday and today. This extends a severe downward trend going back to January 2021 where the total decline for both counters is in the region of 62%. This follows a decline in Tencent’s share price of an equal amount over this time period. Importantly, Tencent (and by association Naspers & Prosus) are not alone, as it has been a Chinese tech wide sell-off, suggesting this is not about individual company fundamentals. Rather concerns around the regulatory environment and the geopolitical risks appear to be at the forefront of investors’ minds, and how they may impact the longer-term outlook for the businesses. Given the extended period that this uncertainty has persisted, it is my sense that market participants are extremely jittery around any form of negative news (whether noise or signal) that is published.
The Chinese tech rout today has been described as the worst since the global financial crisis. The reasons for this sell-off is twofold. First, the SEC has identified five companies that are at risk of being delisted if they fail to comply with certain auditing requirements, this is despite the Chinese securities regulator saying it will cooperate with the SEC. The second reason is due to JPMorgan downgrading the target prices of 28 Chinese tech companies (including Tencent). Going through the new price targets, it strikes me that most of them are not far off where the shares currently trade. Previously, many of the target prices were north of 100% higher than current prices. I’ll let you reach your own conclusions on the realism of analysts’ target prices. Needless to say, the market did not like this news. JPMorgan believes investors should avoid Chinese tech stocks on a 6 – 12 month view given that sentiment and technical are driving the market. However, they still see many opportunities on a three year view. Thankfully, we are not short-term traders.
Yesterday Tencent sold off on the back of the news that users were able to transfer funds on WeChat for illicit purposes. Furthermore, it was also found that WeChat was non-compliant with other rules requiring Tencent to identify users and merchants transacting on the platform. The Wall Street Journal published an article stating that the business potentially faces a record fine. In my view, it is purely speculative for the market to wipe-out 10% (about $40bn) in value on this news. I doubt the relevant regulatory body takes guidance from the Wall Street Journal when setting fines for non-compliance. However, $40bn would surely be some sort of record. Through the course of last year Tencent largely flew under the radar from a regulatory perspective. As a result, Tencent has significantly outperformed its peer group (Kraneshares China Internet ETF universe) since the sell-off began in January 2021.
Thankfully we have been here before. Through the course of 2018 Tencent sold-off significantly due to the regulatory body not granting licenses. After an extended period of drawdowns which lasted just short of a year, Tencent did recover. See graph below. We can never say that history will 100% repeat itself, however, the odds are on our side.
We’ve been here before…
I recently described Tencent as the Chinese Berkshire Hathaway, given its sprawling investment portfolio that sit alongside the operating assets. As such, if we follow a similar approach to valuing the business on a sum of the parts (SoTP) basis, it appears that the operating business is priced on a PE ratio of 10x, which is incredibly cheap for a business of this nature. If we apply the discount that Prosus trades at relative to its underlying listed assets only (excluding unlisted assets or pricing them at zero), then the look through PE ratio to the operating business of Tencent is 6x.
While acknowledging the risks from a regulatory and geopolitical perspective, we do not believe that Tencent should be trading on such depressed multiples, neither do we believe that Tencent is going to zero. There is significant balance sheet headroom at both Tencent and Prosus to weather the current risk-off sentiment. However, given the current global environment it is unlikely to be a smooth ride.
Andrew Dittberner is the Chief Investment Officer at Old Mutual Wealth Private Client Securities
BUSINESS REPORT