27four Investment Managers
1st December 2017
Would you bet your life savings on a Chinese internet company?
The ordinary South African’s monthly retirement fund contribution is invested in what is referred to as a balanced portfolio comprising on average 50% in JSE listed companies with the remainder in government bonds, cash and global securities. Now within the 50% one share makes up 24% of the overall value of the JSE. This means that the average South African saving for retirement has 12% of their savings invested in a single share.
The share we refer to is JSE listed technology company, Naspers, whose one-third holding in a Chinese internet company called Tencent has completely dominated performance of the share and quite astoundingly a big proportion of the total JSE return in 2017.
While the All Share Index was propelled to new all-time highs (breaking through the 60,000 point level) given the strong rally we have seen since the middle of June, the challenge to investors has been just how narrow a base these returns have come off. Since January 2017 only five shares have contributed an astonishing 75% of the total equity market return of 21.34%. With Naspers being the largest share in the index and having a year-to-date return of almost 90% it doesn’t take a maths degree to figure out that a significant portion of the market return has come from just one stock. With such a skewed market index and such dominant performance by a single stock, it is no surprise that the passive investing debate has received so much airtime.
More recently Naspers has been in the news because of their “captured” Multichoice business which forms part of the “rump of Naspers” which is all the assets held by Naspers excluding Tencent. This rump includes well-recognised brands such as Takealot, OLX, Property24, Media24, Spree, Flipcart as well as online German food delivery platform Delivery Hero among others. The majority of these internet businesses are still in the very early stages of their life cycle, still demanding considerable investment as they look to develop, cement and build scale across a number of their internet platforms and still prone to failure. Also, this rump appears plagued by short-term issues relating to governance, management incentive structures, the lack of voting rights for ordinary shareholders, short-term profitability issues in the ramping up phase across a number of these businesses, a cyclical downturn in the pay TV businesses and question marks over management’s ability to efficiently allocate capital. This means that the market actually thinks that this rump has a negative value of some R650-billion. Perhaps the price to pay for “capture”?
So the driver of performance for Naspers is the Chinese internet business Tencent whose share price performance this year has been nothing short of phenomenal, in excess of 120% year to date propelling the company’s market capitalisation past the $500-billion mark and for a brief period of time making it the fifth largest stock in the world ahead of social media operator Facebook. While the prospects for Tencent remain ever promising as the company looks to diversify its earnings base away from purely gaming through increasing its penetration in the mobile advertising market – a market worth some $54-billion in China – it may at face value seem like a sure bet and something one would want to invest all of one’s savings into.
But at what risk? Although Tencent has a similar market capitalisation and revenue base to Facebook it has earnings of around $10-billion compared to Facebook’s earnings of approximately $17.5-billion and while Facebook is global by every imaginable metric, Tencent is Chinese and nothing is certain so investors need to be aware of the risk when they consider just how much of their portfolio to allocate to a single stock.
This rapidly evolving and politically protected Chinese internet business poses a significant concentration challenge to a South African retirement investor given its complete dominance of Naspers’ share price and the size of Naspers in the South African equity market. A simple reality check shows that for the same market value of Naspers (R1,423-trillion) one could own a diversified mix of 44 stocks whose total combined value is R1.42-trillion, such as food retailers Shoprite, Woolworths, Spar, Pick n Pay, clothing retailers Truworths, Foschini, Mr Price, health care counters Mediclinic, Netcare, Life Health Care, mining shares Anglo American Platinum, Northam, Impala, Lonmin, Anglogold, Harmany, Gold Fields, Sibanye, technology and telecoms counters Datatec, Telkom, financial stocks Discovery, Peregrine, industrials Imperial, Barloworld, Nampak, PPC, Invicta, Raubex, food producers Tiger Brands, Pioneer, Tongaat, AVI, Distell, Oceana, Clover, Famous Brands and consumer services shares Clicks, Dischem, Tsogo Sun, Italtile, Curro, Massmart, Sun International and Holdsport.
So in short for the same price as Naspers, an investor could choose to own a diversified set of 44 companies with different drivers of earnings and dividends and most importantly a completely different range of company specific risks. In addition to that, this diverse set of companies currently generates almost six times as much earnings as Naspers does. The question then reverberates: How much of my life savings would I place in just this one opportunity over a diversified set of many opportunities?
Remember that great company Nokia? Your age will probably dictate whether or not you ever owned a Nokia mobile phone. At its peak in the early 2000’s when analysts were the most bullish on prospects for the company (forecasting as many as 1-billion customers on the mobile phone platform) the stock peaked at 20% of the Helsinki stock exchange index. In a period of one year between January 2008 and January 2009, the company shed 75% of its value with the overall index sinking 67.52% resulting in permanent impairment to capital for investors. As Spanish philosopher George Santayana elegantly summarised, “those who cannot learn from history are doomed to repeat it”.