It wasn’t the first time Naspers has issued a profit warning; its substantial investments in various e-commerce ventures, as well as the odd corporate restructuring, make it almost inevitable. But this is the first time Tencent has played a contributing role to an expected decline in core annual headline earnings.
As usual, management seems upbeat about its performance; 2022, it says, was “a year of progress”. Naspers remained focused on “delivering strong operational growth across our core segments”. It invested $6.2bn in new acquisitions and existing business to expand the group’s ecosystem and “to position the business for continued long-term growth in line with long-term strategy”. You get the message? This is all about good things happening some time in the future.
But all of that long-term investing came at a price; core headline earnings for the year are expected to be down 14%-21%.
The range was a little worse than the market had expected but investors took their lead from the Tencent share price, which has advanced 7% in the past month. Naspers ticked up after the release of the trading update and is about 14% up on the month. The longer-term picture doesn’t look so good, however: Naspers is down 40% on the year and Tencent is down 37%.
We want to see growth in profitability of the businesses they’re investing in
— Peter Takaendesa
Peter Takaendesa, portfolio manager and head of equity at Mergence Investment Managers, explains management’s upbeat note in the face of rather downbeat news. “That perspective is influenced by what management is looking at; it’s looking at ‘user activity’ and revenue growth where the figures are good,” he tells the FM, adding that what’s not so good are the profit figures. “We want to see growth in profitability of the businesses they’re investing in.”
Takaendesa accepts there won’t be much profit in the short term; he sees encouraging signs of many of the businesses making profits in the longer term, especially in classifieds and payments. For now, though, he says, as long as there are losses, the discount (to the sum of the parts) will not shift.
The good news, though not for those who reckon the management team’s capital allocation skills aren’t that well honed, is that the balance sheet is strong and gearing is low.
Zaid Paruk, portfolio manager and analyst at Aeon Investment Management, says maintaining its investment-grade rating is important for Naspers/Prosus. “It needs to be able to get cheap money if it wants to continue funding marginal companies.” For this it needs a strong balance sheet.
In this regard it’s concerning that Tencent’s dividend flow might come under increasing pressure given the strains it’s facing. In the year to end-March the Chinese tech group saw net profit plunge 51%. Naspers/Prosus now holds 28.9% of what is currently the most valuable company in China, after selling off 2% in April 2021.
And then there’s Russia-based Avito. Or rather, there isn’t. The online classifieds business was a significant cash contributor for Naspers/Prosus until Russia invaded Ukraine and sanctions pressure forced it into a sort of corporate limbo. No sign yet that it’s been sold.
However, even without Avito, Takaendesa believes the balance sheet is strong enough and says Naspers/Prosus does have other assets that could be sold, including the JD.com stake, which alone would raise a couple of billion dollars. But he says it’s important that there are no other pressure points, such as a continued squeeze on Tencent dividends.
In many countries it probably wouldn’t matter too much if the government took a dislike to you. In China it does
For almost 20 years it looked as though nothing could go wrong for Tencent. It used super-smart technology to endear itself to hundreds of millions of Chinese consumers, providing a growing array of seemingly indispensable services to an increasingly tech-savvy population.
As the company spread its tentacles across the economy, there seemed to be no thought of bumping up against any form of regulator. Its low-profile, circumspect CEO, Pony Ma, was moved to suggest five years ago that Tencent was a vital and indispensable player in the Chinese economy. There was no doubt this was what you might call a national champion, loved by the Chinese government, the Chinese people and, most of all, its grateful shareholders.
And then suddenly it all changed.
For the past two years it seems nothing can go right for this multinational technology and entertainment group. After years of being allowed to extend its influence by investing in hundreds of start-ups without any interference from regulators, suddenly the Chinese antitrust authorities got interested. They have not only started to block mergers but have fined the company for dozens of mergers made years ago. They have also insisted that Tencent allow competitors into its operating environment.
Earlier this month China’s State Administration for Market Regulation (SAMR) released its anti-monopoly report for 2021. Much of the report was focused on the “platform economy”, which essentially means Tencent and Alibaba. It was evident that the Chinese state, as represented by SAMR, was not as happy as Ma about the indispensability of Tencent.
According to the SupChina news service, in July 2021 a revised draft of the Anti-Monopoly Law of China proposed that the upper limit of fines for dominance be increased from ¥500,000 (about R1.2m) to a limit of 10% of the previous year’s sales turnover. Unlike the SA competition authorities, which have a similar limit, the Chinese authorities have given every indication they will happily go to the max.
In many countries it probably wouldn’t matter too much if the government took a dislike to you. In China it does. It’s not just merger and investment activity, Tencent was bypassed in the last round of gaming approvals and it has to live with restrictions on children’s access to the internet.
As things stand, if the Chinese Communist Party elects Xi Jinping general secretary for a third term later this year, it will mean Tencent’s growth opportunities rest in large part with its non-China investments, which are considerable. However, the instability of geopolitics doesn’t make this risk-free. There is also significant scope for Tencent growing the profits of its existing Chinese business without growing revenue.
Keith McLachlan, investment officer at Integral Asset Management, says Tencent is now operating in a much riskier environment than it was five years ago, through “no fault of its own”. He dismisses the concept of ex-growth but agrees the group is on a low-growth trajectory.
Not only is Tencent operating in a mature and saturated domestic market, but the hard Covid lockdowns have had a devastating effect on advertising revenue, notes McLachlan. He says Tencent could be doing something to pivot towards the state’s newly declared priorities, none of which relate to platform businesses, but it’s impossible to know. Just as it’s impossible to know if Ma is comfortable with the group operating in a lower gear and staying out of the limelight.
Paruk reckons if the pressure remains on, Tencent could still sustain a growth rate in the high single digits or mid-teens as management focuses on growing profitability and cash flow rather than turnover.
All in all it does seem inevitable that there will be pressure on Naspers/Prosus management to make its longer term a little shorter.
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