Morgan Stanley Research (11 June 2018): Naspers Path to Value Creation
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Internet Services/ South Africa
Stock Rating Overweight
Industry ViewIn-Line
Price Target ZAc 540,000
Naspers
Naspers
Path to Value Creation
We evaluate Naspers' opportunity cost of investing $10bn in
food, classifieds or fintech against buying back its own stock.
We look at its track record against future opportunities and
conclude investment should lead to sustainable value creation.
We raise our PT to R5400 and are Overweight.
WHAT'S
CHANGED
Naspers (NPNJn.J)
From
To
Price Target
ZAc
510,000.00
ZAc
540,000.00
Naspers' decision to reinvest the $12bn of cash from the Tencent and Flipkart
sales has proven controversial
. The discount to our SOTP value has remained at
40% through the disposals. Many investors have argued that at that level it
would make most financial sense for the company to buy back stock. However,
on our calculations even a $10bn buyback would risk being just 6% accretive
given the immateriality on a SOTP value of $191bn.
We estimate the core could be worth R1,130 per share after reinvestment.
We
find that there are still attractive opportunities for investment in its core verticals
(food, classifieds and payments / fintech) which should increase the materiality
of the core against the Tencent investment, creating greater value long term. We
currently value its core investments at $26bn and new investments could add
$20bn if it is able to continue to deliver at least a 15% IRR on $10bn net cash,
adding up to a total of R1,100 per share. We incorporate this in our bull case. We
do acknowledge value creation from investments takes time, whereas a share
buyback would have an immediate impact. Our PT increase is mostly FX.
We evaluate its opportunities for investment in food, classifieds and payments /
fintech.
Consolidation in food delivery or classifieds can make the difference
between losses and 50%+ EBIT margins given marketing is their greatest cost.
Consolidation in these categories can therefore have an immediate impact on
value. Fintech / payments acquisitions help build scale in a low value - high
volume industry and raise barriers to entry as it becomes an integral part of
merchants' businesses.
We've gone through 10 years of filings to try to determine the IRR of its key
investments historically.
We find its successful exits have been done at an
attractive IRR of 14%. Its current investments in private assets would yield an IRR
of 25% at our SOTP valuations if the exit happened this year. Some assets have
realised negative IRR and some have been liquidated, but the cash investment
has also been very limited. We therefore think 15% IRR is achievable based on
historical returns.
1
June 11, 2018 03:00 AM GMT
Price Target
Price Target
ZAR5,400
ZAR5,400
Bull
Bull
ZAR8,000 (W
as ZAR7,100)
ZAR8,000 (W
as ZAR7,100)
Base
Base
ZAR 5,400 (W
as 5,100)
ZAR 5,400 (W
as 5,100)
Bear
Bear
ZAR2,600 (W
as ZAR2,500.)
ZAR2,600 (W
as ZAR2,500.)
Investment Thesis
Longer-term opportunity:
Naspers has
invested aggressively in building leading
Internet operations in emerging markets,
depressing near-term earnings. We believe
Naspers can deliver a significant improvement
in earnings as these investments mature,
leading to a reduction of the rump discount.
Attractive exposure:
Naspers offers
exposure to a range of attractive EM Internet
plays. Morgan Stanley is Overweight Tencent,
Mail.ru and MakeMyTrip, and we have a
positive view on the prospects for emerging
market e-commerce.
Undemanding valuation:
Naspers trades at
a 44% discount to our SOTP-derived fair
value.
Potential Catalysts
Consolidation, M+A in the portfolio.
Risks to Achieving Price Target
We view a pullback at Tencent as the single
most important risk.
Earnings risk remains due to the threat of a
global macro slowdown as well as
accelerated investment in e-commerce and
new ventures.
Positive free cash flow fails to materialise
in eCommerce.
SSA Pay TV macro environment worsens.
Competition is accelerating in eCommerce,
classifieds and Pay-TV in Africa.
Risk Reward
Risk Reward
Positive momentum, structurally appealing
Positive momentum, structurally appealing
Z
Source: Thomson Reuters (historical share price data), Morgan Stanley Research estimates
All listed associates at target price. $13bn for Core Internet including
$8.2bn for Classifieds. Holding discount of 25% applied to associates.
134% upside to current share price
134% upside to current share price
Upgrades and multiple expansion:
All listed associates at bull case. Holding
discount of 15%. $18bn valuation for core Internet assets, including Avito and
OLX. $20bn of net cash assuming a 15% IRR. Pay TV multiple 20% higher.
58% upside to current share price
58% upside to current share price
Listed associates at target price.
$13bn for Core Internet including $8.2bn for
Classifieds.
Holding discount of 25% applied to associates. African Pay-TV
margins 16% in FY18.
24% downside to current share price
24% downside to current share price
More downside:
Listed associates at bear cases. Holding discount of 30%. Pay-
TV 2017 EBITDA multiple 3x and $3.2bn valuation for core Internet assets.
2
Return analysis
Naspers' decision not to do a buyback after raising cash from Tencent and Flipkart has
been controversial.
Naspers has raised $9.6bn from the sale of a 2% stake in Tencent
and $2.2bn from the sale of Flipkart since March. With the shares trading at a 40%
discount to fair value many investors have argued that buying back its own shares
would be the most attractive investment. Naspers instead has chosen to reinvest the
cash in its three key verticals: food, payments and classifieds. In this section we argue
that Naspers
has enough of a positive track record to assume it could deliver a 15% IRR
on the new cash. In the next section we explore the potential investment areas.
Conversely, we believe a share buyback might only have a 6% impact on the share price
given the low yield against its SOTP valuation.
A $10bn buyback might only drive a 6% appreciation of the
share price...
Earnings are irrelevant for Naspers, so we estimate
the accretion based on its SOTP valuation. The market is currently
assuming the cash will be burned, so by using it to buy back stock
it will eliminate the discount on the cash. However, because of the
small size relative to the value of its Tencent stake ($157bn), it
would only increase the SOTP value per share by 4% and add 6%
additional share price upside, on our calculations. See
Exhibit 1
. It
could potentially be greater if it were to act as an effective signal,
but there is limited evidence to support this would ultimately
lead to value creation. Companies that buy back shares
consistently do tend to trade at premiums (see
report
), but even
if Naspers did not invest in new ventures we believe it would be a
couple of years away from delivering enough FCF to sustain an
ongoing buyback program. Naspers has said it would consider
share buybacks when it is generating excess cash (see
here
).
...whereas we believe creating value at the core should have a greater impact on the
discount over the medium to long term
.
Our analysis of previous investments suggests
it could deliver a 15% IRR over 5 years. If the company invests in consolidating and
enlarging the major verticals (classifieds, payments, food, etail), we think the market will
have more confidence in assigning value to these assets. If we assume it generates a 15%
IRR from investing $10bn, it would add another $10bn of value (an additional ZAR287
per share). We are already valuing the non-Tencent assets at $23bn so that would take
it to $43bn. It would also make a 40% discount worth $80bn, which we think
could
make it increasingly hard
for investors to ignore. We do acknowledge we are talking
about longer time frames here.
We estimate Naspers has c.$12bn of cash available to make investments.
It recently
raised $9.6bn from a 2% stake sale in Tencent and $2.2bn from the sale of its Flipkart
stake. We estimate its cash at the end of FY18 was $2.5bn and it had the ability to draw
up to $2bn from an RCF. Net of the c.$3bn already committed and $1bn of debt
maturing in FY20, we estimate the cash headroom is c.$12bn. Naspers has been investing
c.$2bn p.a. over the last few years so at that rate it should have enough cash to take it
Exhibit 1:
A $10bn share buyback would only technically add 6% to
the current share price
Source: Morgan Stanley Research estimates
through the next 5 years.
We look at past returns to understand the potential value creation from the $12bn of
cash available
.
We have gone through its filings over the last decade to try to estimate
the IRR for the larger investments. We break them down into three categories:
Overall, we think Naspers has shown that it can create meaningful value and that it
also knows when to exit
. There are plenty of examples of Naspers' subsidiaries where
the cash on cash multiple would be >2x today with IRRs >15%. The transactions where it
has generated limited returns tended also to be the ones with the lower investment
levels. For example, it realised eTail is a category that could require high investment for
many years and exited some of these investments relatively
early.
Successful exits
–
avg IRR
14%
.
The most material exits (outside the Tencent stake)
have been Flipkart ($2.2bn, 33% IRR, 3.6x cash on cash) and Allegro ($3.2bn, 11% IRR,
2.4x cash on cash).
Private investments
– avg IRR 25%
.
In this category we include assets still held by
Naspers but not listed on an exchange. We base IRR calculations on our current
valuation for the assets. We calculate that a hypothetical IRR for eMag or Konga
would be 40%+, Takealot 21%, OLX 22% and Avito +18%. Less impressive would be
the returns on Letgo at +5% or Payments.
Listed assets –
avg IRR 51%.
This estimate is admittedly heavily skewed by the
investment in Tencent (59%). IRR at the current share price for Mail.ru would be 9%
(the ruble has depreciated >100% since its original investment so constant FX
would imply IRR of 19%), MMYT/Ibibo 32% and Delivery Hero 58% (impacted by the
short holding period).
Value destruction.
It has also sold some businesses at a loss or liquidated them,
although in no case did the net cash investment exceed $200m. All in all, they've
been offset by the successful exits of Flipkart and Allegro with a combined IRR of
11%. We think it's worth noting that the assets were purchased before the new CEO
came on board in April 2014.
4
Exhibit 2:
Classifieds: At our current valuation we estimate the IRR for classifieds is c.20%;
incorporating Ricardo, which was purchased in 2008 and sold at a loss in 2015, would lower the
IRR to 15%
Source: Company data, Morgan Stanley Research. Note: FY19 cash is based on our assumption for valuations of OLX, Avito and LetGo. Excludes cash
used for the acquisition of Sulit (Philippines) and Dealfish (Thailand) which are now part of OLX. Note: The company has said total investment for OLX
(incl. Avito) has been
$3.2bn so we have assumed FCF was c.$(200)m annually FY11-FY15. OLX and Avito are consolidated so we have incorporated their
FCF in calculations.
Exhibit 3:
eTail: We estimate the IRR for Naspers' investments in eTail would be 15% as a blend of the disposal proceeds of companies exited and
our current valuation for stakes held
(
1Company filings, Morgan Stanley Research. Note: For held assets the Mar-19 cash is based on our valuation for the assets. For consolidated positions including Allegro, 7Pixel, Net Retail, eMag or Takealot (from H218) we
should have included the annual FCF for an accurate IRR calculation. However, we only have data for the last two years. If we were to assume €30-50m of consolidated annual losses it would only take off 1% from IRR, partly due to
the higher impact of payout values.
5
Why IRR?
We would prefer to use measures related to ROIC, but
with the majority of internet assets being loss-making, we find
IRR
is the best metric. There are limitations to the metric given
accurate calculation requires the timing of exit, yet Naspers does
not see itself as a financial investor and rather as a long-term
partner.
Exhibit 4:
Listed assets: IRR
is over 30% for all listed assets
ex.
Mail.ru
Source: Company data, Morgan Stanley Research. Note: FY19 based on market values.
Note: The rouble has
depreciated by c140% since Naspers' initial investment in Mail.ru
6
Three focus areas for investment
Naspers has said that proceeds from recent sales would be invested to accelerate the
growth of classifieds, online food delivery and fintech businesses
, and to pursue other
"exciting" growth opportunities when they arise.
We think investments in these categories
could be highly accretive, particularly when they lead to in-market consolidation. To
gauge the potential benefits of acquisitions in each of these areas, we take a closer look
at the competitive landscape and opportunity set. We have pulled together the main
competitors
in the three key categories based on the companies that Naspers sees as
direct competitors (taken from its Prospectus published
in December) and similar
companies based on complementary business models or geographical reach. This list
aims to be as broad as possible based on the regions where Naspers' key subsidiaries are
operating as well as key business models, but is not exhaustive. See
Exhibit 7
. Without
drawing individual conclusions, we explore the potential attractions of the different
strategies:
Exhibit 5:
Classifieds frequently have >50%
EBITDA markets in mature consolidated
markets
Source: Company data (last fiscal year), Morgan Stanley Research. *
Profitable countries only
Exhibit 6:
In food delivery the margin
difference between consolidated and
fragmented markets can be substantial
Source: Company data (last fiscal year), Morgan Stanley Research
Consolidation in food or classifieds could lead to significant marketing synergies
.
Both food delivery and classifieds are asset light marketplaces where the greatest
cost is marketing and the highest barrier to entry is the network effect. In cases
where competition is intense (e.g. food delivery in Germany, classifieds in India),
businesses can lose considerable amounts as they fight for leadership. The
company consolidating the market can afford to pay high multiples because a
developed and consolidated market frequently offers the leader 50%+ EBITDA
margins. In classifieds, markets that remain competitive include the US, India, Russia
or South Africa. In food delivery, the largest opportunities are in Central Europe,
South Korea, Latam and India, in our view
(see
Consolidation in food delivery:
Quantifying the upside
).
Adjacent categories in food delivery or verticals in classifieds could ensure
preservation of network effects.
Initially, food marketplaces limited their role to
passing the order to the consumer. We've then seen new marketplaces emerge that
do the delivery on behalf of the restaurants (e.g. Deliveroo, Swiggy). We've also
seen players that deliver other categories gain momentum in certain markets (there
have been widely reported failures in the US, but they seem to be working in
markets with low labour costs). Naspers could conceivably seek complementary
investments to Delivery Hero, iFood or Swiggy to ensure the retention of strong
network effects. In classifieds, the verticals with highest monetisation are real
estate, autos and jobs. While generalists benefit from frequent traffic,
complementary verticals can ensure maximisation of revenue. There are some
emerging new models that could also drive incremental revenue (Naspers recently
invested $89m in part exchange specialist Frontier Car Group).
Profitability in payments services is largely dependent on scale.
Payments is a high
volume, low value business. Consolidation allows leverage of technology and
banking relationships across a broader number of transactions, leading to higher
margins. PayU is still loss-making. Best-in-class industry players report EBITDA
margins (over gross revenue) of 10-15%. Both local and global consolidation should
drive synergies.
For the three key categories, we go through what it owns, how it has driven value
through investments so far, who it
sees as its competitors and what could be adjacent
categories.
Fintech offers the broadest range of opportunities on deeper verticals
. So far
Naspers is anchoring its fintech investments around payment service provider PayU.
The priority is to gain share with merchants rather than consumers (which is a more
competitive field, see
India's Digital Leap: Blue Paper Revisit - Exponential Growth In
Payments
). The combination of KYC data, bank relationships
and credit information
can help adjacent fintech businesses provide a superior offer. Even something like
remittances platform Remitly (in which Naspers recently invested $100m) could be
used to link payments directly into utility bills or grocery, leveraging the
relationships of PayU. It could be used to strengthen Kreditech's credit data. It
could also drive adoption of its consumer offer (even if that is not the focus).
Areas where it could leverage its expertise
. Naspers has long invested in classifieds,
and its subsidiaries have developed tech related to image recognition or
geolocation, for example. It could choose to buy underinvested assets in the areas
where it has superior knowledge.
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When reading prices above, please note that 5 ADRS=1 ordinary share of Naspers |
