PROSF - Prosus: Finally Unlocking Shareholder Value

• Prosus stock soared after announcing an open-ended buyback program to close the discount to NAV.
• The discount gap already narrowed from 61% to a 44% discount to NAV.
• Prosus will continue selling Tencent shares to fuel buybacks, in turn increasing NAV per share.

The thesis is playing out

A month ago I published my first article on Prosus ( OTCPK:PROSF ), outlining the shareholder value creation opportunities due to the severe discount on Net Asset Value ((NAV)). Since then the thesis played out perfectly with Prosus shares being up 33% versus a 6% decline in the S&P 500 over the same period. Prosus is still a buy after initiating its updated capital allocation strategy to close to gap to NAV.

For clarity's sake: All stock prices referenced in this article will be for the stock listed in the Netherlands: PROSF. Each PROSY stock represents 1/5 of the NL-listed stock.

Buybacks, as long as it takes

Prosus released its FY 22 report this week and announced this new open-ended , multi-year share repurchase program. This is exactly what I wanted to happen in my last article. Back then Prosus traded at a 61% discount to its NAV and a 49% discount just to its stake in Tencent.

Prosus wants to use this discount lever to enhance shareholder value by buying back shares until the discount gap is closed. Management didn't address a specific range for when the discount gap would be acceptable again, but I am assuming they are aiming somewhere in between 10-25% discount.

How the buyback is going to create value

The company gave us a great slide to illustrate how the buybacks will create value for shareholders. The NAV of the company currently is significantly higher than its enterprise value. By buying back shares, the company realizes the value of its assets into cash and buys back the discounted shares. In the illustrated example we can see that a $10 billion buyback represents a 9% gain in NAV per share or in other words selling 6% of its NAV allows the company to buy back 13% of shares outstanding.

How the buyback is going to be financed

In my latest article, I mentioned that one of the risks for Prosus is they were in a voluntary lock-up period and thus restricted for another 2 years from selling any Tencent shares. That is why I expected them to profit off Tencent potentially spinning off more assets, as they did with JD. It turns out that Prosus reached out to Tencent and is allowed to back out of its lock-up period. Tencent is okay with the buyback and according to CNBC expects the impact of the share sale to be limited. In the earnings, call management mentioned that the buybacks will be exclusively funded by Tencent share sales and that at the end of the day it doesn't impact its relationship or conviction in Tencent. After all, the amount of Tencent per share of Prosus will go up through the buybacks. Prosus also sold the 4% stake in JD.com ( JD ) which it received as a special dividend from Tencent, as it wasn't aligned with the company strategy. The funds from Tencent will be used for liquidity reasons so that funds from Tencent sales can be 100% used for buybacks.

Other highlights from the earnings report

Really the main point in my investment case for Prosus is the discount on its NAV. I normally only invest for the long-term, but Prosus is one of the rare cases where I am more short-sighted, so I'll keep the rest short.

Merger and acquisitions

Prosus historically used its cash flows from operations and from sales of prior investments to acquire new stakes in companies. Their portfolio is well-diversified mainly into different parts of what they call eCommerce. I'd argue that EdTech does not fit this at all, what does a coding platform like Stack overflow have to do with eCommerce?

In the earnings, call management stated that:

The bar is high [for M&A]. For us to make significant external transactions it has to look exceptionally good in terms of return and value creation. We do look for opportunities but the bar is exceptionally high.

This statement was very reassuring for me because at these levels of internal discount it makes no sense to acquire new businesses in my opinion unless they offer better returns of course. Considering the size of the discount, these opportunities would need to be significantly undervalued.

eCommerce growth and chasing profitability

eCommerce was another highlight of the report, growing over 50%, while management also talked about getting the segment to profitability soon. I am not glad to hear this, since I see a better use for Prosus' cash at the moment in share repurchases.

Sum of the parts analysis (SOTP)

Like in my last article, I did a Sum of the analysis to value Prosus. Last time Prosus was trading at a 61% discount to NAV and 49% discount to its Tencent stake. With the recent 34% increase of Prosus shares, the discount also narrowed. It still represents a big opportunity with a 44% discount to NAV and 28% to the Tencent stake, but the gap already narrowed just from the buyback announcement.

Conclusion

Considering that Prosus is committed to getting this discount to acceptable levels(which I assume are around 10-25%) there is still enough upside in the stock and I rate it a buy. The company still has risks and valid reasons to trade on a discount, just the amount of discount is still quite exaggerated. I will continue to hold onto my shares as long as the discount gap is wide, but contrary to my usual buy and hold strategy, I am planning to sell out of Prosus eventually.

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