PROSF - SaltLight Capital - Prosus: Unlocking The Tencent Discount

• Prosus stock price has an extremely high correlation to Tencent.
• The 2022 plan is to sell some of the Tencent investment and use the same proceeds to buy back discounted Naspers or Prosus shares in the market.
• Whilst valuations are depressed at the moment, PROSY could spin off all of the non-Tencent assets.
• We think management’s reluctance to undertake rational action is because they fear losing the stable dividend inflow from Tencent.

The following segment was excerpted from this fund letter .

Prosus ( OTCPK:PROSY )

Prosus was a helpful contributor to returns during the quarter (we hesitate to call it a 'victory' yet). The Prosus share price has an extremely high correlation to Tencent ( TCEHY - its largest investment). Yet over the last six months, the Prosus share price has traded at a substantial discount to its underlying assets.

Over and above this, Chinese companies, including Tencent, trade at a significant historical discount for the reasons we mentioned in our 1Q22 letter.

In effect, a Prosus shareholder was getting a discount on a discounted asset.

Figure 1 illustrates a simplistic representation of the value of Tencent investment owned by Prosus relative to the Prosus share price (on a per share basis) ^[1] . At one stage the Tencent investment value was double the Prosus market price.

Tencent Value Per share as a % of the Prosus Share Price

Companies trading at such substantial discounts rarely are in perfect shape, but the probability of a permanent loss implied by the market price in March this year was, in our view, wholly unjustified.

During the quarter we increased our investment in Prosus substantially.

Watching Prosus’ management deal with this discount has conjured up our childhood memories of Wile E. Coyote and Roadrunner cartoons (the Looney Tunes series). In these cartoons, Wile E. would spend each episode coming up with and executing elaborate plans to catch Roadrunner ^[2] .

For younger readers, a short episode is available here.

Rather than using the most obvious method that nature has given to Coyote, he devises complex schemes to catch his prey. Many of these schemes involved using, sometimes ludicrous, tools that were mail-ordered from ACME Corporation.

Sadly, for Coyote, the plans never end up working out. They inevitably backfire resulting in Road Runner speeding away and shouting, " BEEP BEEP !".

For years, the show ran in the same format. The cartoon’s director, Chuck Jones wrote in his book ten rules to guide writers of the show. Rules 7-9 are somewhat resonant with the Prosus saga. Just replace ACME corporation with ACME Investment Bank.

Rule 7. All materials, tools, weapons, or mechanical conveniences must be obtained from ACME Corporation [ACME Investment Bank].

Rule 8. Wherever possible, make gravity the Coyote's greatest enemy.

Rule 9. The Coyote is always more humiliated than harmed by his failures.

‘Unlock the Discount’ Project Plan #96

In May, Wile E., ahem , Prosus management announced another plan to unlock the discount. Unfortunately, we don’t have enough space to talk about the ostentatious cross-holding structure implemented in 2021. Or the Prosus listing plan of 2019. All with the purpose to unlock the discount…

As you may work out, these plans ultimately failed and resulted in a wider discount. Management’s remuneration over these periods followed Jones’ rule number 9.

The 2022 plan is to sell some of the Tencent investment and use the same proceeds to buy back discounted Naspers ( OTCPK:NPSNY ) or Prosus shares in the market. In theory, they're selling an asset worth $1 for 60c to buy the holding company share worth 40c.

Mathematically, this scheme is sound. Alarmingly, the maths works out that on a per share basis, an economic interest in Tencent GOES UP. Looney Tunes indeed!

To date, the discount has narrowed (see Figure 1). Only time will tell if Jones’ rule number 8 will apply, and gravity will be management’s enemy.

Unlocking the Prosus Discount

As we have discussed, Prosus * should * be spinning off Tencent. Some technical tax excuses have some merit.

Whilst valuations are depressed at the moment, they could spin off all of Prosus' non-Tencent assets (valued at less than zero by the market). Management could stay with the spun-off company and leave Prosus as a pure Tencent exposure on European and South Africa exchanges.

We think management’s reluctance to undertake rational action is because they fear losing the stable dividend inflow from Tencent. The regular dividend has provided a friendly source of capital to invest in new initiatives rather than having to go to the equity markets to raise capital.

We would expect that their capital allocation knives would be somewhat sharper if they had to undergo this process. There is also the fear that the Prosus spin-off will face the same indiscriminate selling process - which we believe has very high odds.

Where We See Value

Despite the share price discounts, we believe that the intrinsic value of the business will continue to compound at high rates over the coming years. Of course, buying at substantial discounts simply enhances our overall return.

Footnotes

[1] This is not a NAV discount calculation. We do not incorporate cash, debt and other investments.

[2] At the introduction of each show the ‘scientific names’ of Coyote ( “Carnivorous Vulgaris”) and Road Runner ( “Accelerati Incredibilus”) was stated.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

For further details see: