31 Aug 2021

What Naspers and Prosus tell us about risk

Prof Brian Kantor

Head of the research institute at Investec Wealth & Investment

The recent volatility in the price of Tencent has given a lesson in risk for Naspers or Prosus shareholders.

Get Focus insights straight to your inbox

Sending...

Please complete all required fields before sending.

Thank you

We look forward to sharing out of the ordinary insights with you

Sorry there seems to be a technical issue

South African savers dependent on their pension and retirement plans will have become aware that the actions of the Chinese Communist Party are sometimes more important than the actions of the ANC. This is because of their likely large stake in a Chinese internet giant, Tencent, held through their shares they own in JSE-listed Naspers and via its controlling stake in Amsterdam and JSE (secondarily) listed Prosus.

Tencent, which owns WeChat and some of China’s most popular gaming apps, has been a profitable investment for Naspers, but has been highly volatile of late.

Because of the greater uncertainty about the policies the Chinese will apply to Tencent, Alibaba, Baidu and their peers, a share in Naspers has become riskier to hold and therefore less valuable. Shareholders taking on more risk require compensation in the form of higher expected returns, and this usually means a lower entry price and a lower current share price.

The risk to any asset holder is simply the risk that the price of the asset they hold may rise or fall from its current level, should they have to cash in their investment at some unknown point in time. The chances of a rise or fall from the current market-determined price, assuming a well-informed active market in them, will be about the same 50% on any one day. Market prices follow a random walk, rising and falling in an irregular sequence. Hopefully, these random movements come with an upward drift to bring actual returns in line with the higher expected returns, which makes holding risky assets a rational choice for the long-term investor.

Shareholders taking on more risk require compensation in the form of higher expected returns, and this usually means a lower entry price and a lower current share price.

In riskier times, the daily moves up and down become significantly wider, while the average move over any extended period will still stay close to zero. When the sense of the future becomes less certain, volatility of share prices increases, the standard deviation of daily moves about the average of almost zero widens, and the cost of insuring against such changes in the form of an option to buy or sell the share or index inevitably increases. This has been the case with Naspers.

The recent increase in the daily volatility of Naspers has been extraordinary. The daily share price decline of 7% and then an increase of 10% on 10 August were truly exceptional. They reveal how difficult it has been for well-informed investors to make up their minds about what the future will hold for Tencent, Naspers and Prosus (these observations relate to the period before the recent Naspers / Prosus share exchange, but the point remains broadly valid). The standard deviation of daily moves in the Naspers share price (30-day moving average) has almost trebled since June 2021.

Naspers – daily percentage moves and 30-day standard deviation moving average

Naspers – daily percentage moves and 30-day standard deviation moving average graph

Source: Iress, Investec Wealth & Investment, 10/08/2021

Volatility compared – S&P 500 (VIX), JSE Top 40 SAVI and Naspers

Volatility compared – S&P 500 (VIX), JSE Top 40 SAVI and Naspers graph

Source: Iress, Investec Wealth & Investment, 10/08/2021

The rewards for holding on to your Naspers or Prosus shares remain to be seen. The China risks may decline, and in that way help add value. Naspers management also hopes, following the recent share exchange, that the value of both counters will be enhanced by the shares trading more closely to the market value of their Tencent Holdings. They are rejigging the allocation of the Tencent holding between Johannesburg and Amsterdam to attract stronger investor interest to reduce this discount to the sum of its parts, mostly Tencent.

My theory is that the value lost by shareholders is mostly because of scepticism about the value of the acquisitions and investments made by Naspers / Prosus. They are expected to return much less than investors could earn for themselves taking on similar risks, and hence investors and analysts are writing down the value of this expensive investment programme when they estimate the value of the two counters. The more invested, the more value destruction expected, the lower the value of a Naspers or Prosus share and the larger the discount. With the completion of the latest restructuring, we will see the alternative theories of the discount put to the market test.

If my theory holds – though it would be a bitter consolation – then the one possible outcome for shareholders is that Naspers / Prosus management will have to be more disciplined and constrained in their investment and borrowing programmes, should the Tencent share price remain under pressure. That may well lower the discount to net asset value of the two counters.

About the author

Brian Kantor headshot

Prof. Brian Kantor

Economist

Brian Kantor is a member of Investec's Global Investment Strategy Group. He was Head of Strategy at Investec Securities SA 2001-2008 and until recently, Head of Investment Strategy at Investec Wealth & Investment South Africa. Brian is Professor Emeritus of Economics at the University of Cape Town. He holds a B.Com and a B.A. (Hons), both from UCT.

Get Focus insights straight to your inbox

Sending...

Please complete all required fields before sending.

Thank you

We look forward to sharing out of the ordinary insights with you

Sorry there seems to be a technical issue