Deep value investors like Cannon Asset Management find it hard to compute exponential growth – especially in share prices. And in the South African context, nothing in recent times compares with surging Naspers, a stock whose star shines ever brighter because of its 34% stake in TenCent, the Chinese Internet business whose growth keeps defying gravity. Rather than try explain it, Cannon’s CEO Geoff Blount says one approach is to look for alternatives in the same sector which have not yet been “discovered” by the investment community. In this interview he offers some suggestions – and warns one cannot totally rule out a Microsoft-type disappointment. – AH Â Â
ALEC HOGG: Naspers is a good performer, a great performer if you’ve been following the shares. If you happen to have bought them at around R400.00 per share and they’re over R1000.00 per share, I think you’d be smacking your lips. That’s happened only in the last two years. If you had the chance however, would you trade your Naspers for a company like SinoMedia? Sino whom? Geoff Blount is the Chief Executive of Cannon Asset Management and Geoff, your guys have just put together a report on this, saying ‘why buy Naspers if you can get SinoMedia’ and I suppose you might really be saying many other media companies are actually available in China to the investors today.
GEOFF BLOUNT: Absolutely. I suppose it’s a big disingenuous because we’re using Naspers as a proxy for Tencent, so the reality is why buy Tencent when you can buy SinoMedia or, for that matter, other businesses that are exposed to the Chinese media technology sector – to social media? The conventional wisdom goes that it doesn’t matter what you pay for Tencent, you’re going to make money out of it, and we just think that perhaps there are better opportunities. One thing is that you can buy Naspers in Rands and if you want to buy SinoMedia, you have to take your money out of your allowance and buy the share directly. It is however, a proxy for many businesses in Hong Kong and in China that we think can give you the Chinese (let’s call it growth story) in this sector, which has significantly lower multiples.
ALEC HOGG: Both you and I have seen this movie before. Do you remember a stock called Dimension Data?
GEOFF BLOUNT: Absolutely.
ALEC HOGG: You can’t lose money on Dimension Data. For years, you couldn’t, but you did……
GEOFF BLOUNT: In the late nineties, I was a Fund Manager at BOE Private Bank and I remember we had saying ‘you’re damned if you do and damned if you don’t’ because you knew that DiData was expensive, but if you didn’t own it your clients fired you. You knew you were buying something that ultimately was actually a bad decision, and this is the issue of ‘can markets or pricing stay rational longer than you can stay solvent as a Fund Manager’. In SinoMedia, we think there’s a nice comparison in that if you dig around, you are able to find not equivalent, but businesses that have similar potential markets and similar growth drivers, but at considerably cheaper multiples.
ALEC HOGG: So the easy way, if you’re sitting in South Africa: buy Naspers. You’re getting 34 percent of Tencent, which everyone around the world is in awe of the entrepreneurship, the development, and the growth. There comes a time though, when better value is available in similar companies as you were mentioning in the Chinese Market. Would you look at Baidu – Alibaba, which is now going to be listed in the Chinese Market? Is there a smorgasbord of opportunities?
GEOFF BLOUNT: I think there’s quite a large set of opportunities. The issue again, is ‘what is the pricing’. Alibaba looks like it’s coming to market and it’s going to be expensive, so I wouldn’t look there. That issue at Tencent… Once again, maybe just to revisit that thesis – and I think that is what you need to understand when you buy any of these expensive companies – it’s a great business with great potential. However, Tencent’s current cost of capital is nine-and-a-half percent. Its return on investor capital is in the mid-fifties. I think it’s 55 percent. It means that for every Dollar they have, they invest one Dollar. They make a 55-cent return, but that Dollar only costs them nine cents, so they make a 45-cents profit through a Dollar invested. You need to understand. When you have those types of margins, people come your lunch. We know, in the technology sector in which things evolve dramatically… Incidentally, interestingly enough these numbers are not dissimilar to Microsoft in 2000 – the multiple plus the return on investment capital.
ALEC HOGG: Are they similar to Google? No one has managed to crack Google yet, so if you can’t crack Google, maybe you can’t crack Tencent.
GEOFF BLOUNT: Do you remember those other fantastic search engines that existed…?
ALEC HOGG: Alta Vista…I remember them.
GEOFF BLOUNT: Those were the…
ALEC HOGG: They were never Google though. Buffett says he can’t crack the Google model.
GEOFF BLOUNT: Potentially, if you have a natural monopoly that evolves.
ALEC HOGG: Does Tencent not have that?
GEOFF BLOUNT: It potentially has, but there are two aspects and maybe the one is that people do come for your lunch, but perhaps they don’t so perhaps you maintain those margins. The next thing then is if you look at the valuation you paid for it. You’re paying via Naspers – 60/65 PE for it. What we did is we did an analysis and said ‘well, if you pay that PE – people say it doesn’t matter what PE you pay for it because the earnings will justify it. We said ‘let’s rather reverse engineer that and say ‘what does that PE tell us is priced in the earnings growth’. In other words, what is that 65 PE? If you work out cost-to-capitals and you model the business, it means that Tencent has to grow its earnings every year for the next ten years by a minimum of 25 percent per annum.
ALEC HOGG: And you think that’s not likely.
GEOFF BLOUNT: It’s possible, but remember that’s to break even on the shares. If you buy it now, it’s not necessarily to make a profit.
ALEC HOGG: So if you’re buying the stock today at this level, on the assumption or you believe that the earnings are going to grow 25 percent, it doesn’t look too high.
GEOFF BLOUNT: The trick is if it grows earnings at more than 25 per annum for the next ten years, then perhaps it’s worth looking at. If it’s not going to grow earnings at that level, you’re going to lose money if it grows at any less than 25 percent. It’s a big ask. Funnily enough, I’ll go back to the Microsoft example. In fact, Microsoft’s numbers were actually almost identical. In 2000, the inferred earnings growth for Microsoft for the next ten years was 25 percent per annum…natural monopoly – every computer has one. We know that. We’ve seen that. Microsoft dominates all the computers.
ALEC HOGG: It’s a really good parallel Geoff, and I guess one that people should be having a look at and picking up.
GEOFF BLOUNT: Absolutely.
ALEC HOGG: Thank you for your insights. That was Geoff Blount. He is the Chief Executive of Cannon Asset Management.