‘Owning Naspers shares comes with existential risk’ – Piet Viljoen

Counterpoint’s Piet Viljoen joined the BizNews Power Hour to weight in on the fate of Naspers and Prosus, given that their primary driver – internet giant Tencent – has been one of the worst affected tech companies hit by the muster of the Chinese regulators clamp down on Big Tech. while Viljoen believes that a small allocation to Naspers or Prosus or Tencent can be justified, he finds it ridiculous that people have 20% to 30% to 40% of their portfolio in this one entity, which has existential risk. Viljoen also provides valuable insight into the cyclical nature of the commodities sector and believes that we are in a commodity bull market, which ‘we’ll stay in until we see aggressive supply responses from the commodity companies.’ – Nadya Swart

Piet Viljoen on whether the increase in Naspers share price has to do with insider trading:

I don’t know. I think the central banks and the regulators are very careful when they communicate with the banking counterparts to talk to all of them, or at least the biggest ones. And then they would then disseminate and use them as conduits to disseminate the information out to the public. And they would then probably expect those banks not to trade in the information until they had disseminated to the public. But as you and I know, I think those Chinese walls are probably as leaky as a sieve. So, you know, this sort of thing happens, but that happens everywhere in markets. You can put rules and regulations up until you’re blue in the face. It’s not going to stop that sort of behaviour.

On the reason that the Chinese authorities talk to the elite of the elite as opposed to having a public press conference:

You know, that’s how regulators deal with these sorts of issues. They’re not open to communicate freely with everyone. They think there’s certain channels you follow and the bigger banks get preferential access to that discussion table. Whether it helps or not, at the end of the day, I’m not sure. If you look at the returns from owning bank stocks like Goldman Sachs over the past ten years, it’s been pretty poor. So they might get this sort of information on a preferential basis, but it sure hasn’t helped the shareholders.

On owning Naspers, Prosus or Tencent shares:

So I think my premise for not owning Naspers or Prosus or Tencent, for that matter, historically has basically rested on two legs; the one leg being clear over valuation. Very popular stock, very highly priced. So that makes a decision to not invest in it, based on valuations, fairly simple. However, what added to that conviction was the fact that you owned it through this variable interest entity, which you have now spoken about, which creates an existential risk. In other words, it creates the risk that the value of your investment could be zero. I would ascribe a high probability to that, but there is a non-zero probability that your investment could be worth zero if the Chinese authorities for some reason say ,’These variable interest entities are illegal, we are chopping them off. And the capital sits in China and whatever you thought you owned is worth nothing.’ That is a clear possibility. A non-trivial possibility.

So even if it’s a fantastic business available very cheaply, if you have the possibility of something going to zero, then you cannot invest a lot of money into such a business. So, now what’s happened over the past two days, the valuations have come down to levels where at least, you know, they started out with a fair value and [were] even attractive. But that existential risk has not gone away despite all the press conferences they hold of the banks, whatever.

The regulators decide what the regulators want and what suits them and profits for shareholders is not one of the things that enter into their calculations. So that existential risk is still there. So I think, given current valuations, a small allocation to Naspers or Prosus or Tencent can be justified. I’m not saying it should be done. I’m saying you can justify a small allocation in a portfolio context where, you know, if it goes to zero, it doesn’t wipe out your whole portfolio. What I found ridiculous is that people have 20% to 30% to 40% of their portfolio in this one entity, which has existential risk – based on the fact that it makes up such a large portion of the index.

So you have agents investing other people’s money based on an index and they’re managing their career risk and they’re taking outsize, massive risk to protect their own career risk, because they are just matching the index. But the index weight is so far removed from anything any rational principle would do with their own money – it borders on ridiculous. So to get back, I think the valuations have improved. The price relative to intrinsic value calculation has improved somewhat, but that existential risk is still there. So if you’re inclined to invest in this sort of business, I think you can allocate a small portion of your portfolio to it at these sorts of prices. That’s my current position.

On the priorities of agents vs principals when investing money:

It depends. It’s more important for agents – not for principals, not for people who invest their own money, but people invest other people’s money, agents. It’s much more important for them to protect their career than it is to look after their clients’ money, whereas a principal who’s investing his or her own money is much more aware of the risks they’re taking with that capital. And if there’s an existential risk of that capital going to zero, they will be much more cautious of it. And that’s my point of departure.

And that’s why I say right now that existential risk is still there. It can still go to zero, but the valuation has improved somewhat so that you can maybe allocate a small portion in a portfolio context to the investment. From an ‘investing like a principal’ [perspective]. It’s just like investing in a highly leveraged property company. It can go to zero, but if things work OK, you can make some money. And, you know, you can justify such an investment in a portfolio context because whatever makes the property investment go to zero is a different thing to what will make Naspers go to zero. So if you put those two together in a portfolio, you’ve diversified your risk somewhat.

On SA Treasury not using the additional tax income to reduce the budget deficit:

Look, it’s the way of the world at the moment. It’s a global phenomenon. And I think our budget deficit before borrowing is big as a percent of GDP, but it’s less big than, say, the USA or most European countries and some Asian countries. Governments worldwide have pumped a lot of money into the system to help ameliorate the effects of government induced lockdowns and other measures to combat the panic around the coronavirus.

So, it’s happening worldwide, and the government can’t sit on one side and say, ‘Well, we’re not going to do this, we’re not going to help the population overcome the hardship that lockdowns have brought upon it. So, I think it finds itself in the same boat as [the] Americans and the Brits and the Europeans; they are putting less money into their economy, but they are putting money into those that have been affected worse by the lockdown.

On reading the commodities situation:

So I think there’s a whole generation of investors who still remember being burnt by the commodities sector in 2008, 2009, 10, 11, 12, and don’t want to touch it because they think it’s a highly cyclical sector and it loses your money on balance, which is true – it is a cyclical sector. But I think the cycle for commodities is determined by supply changes. Demand for commodities is steadily increasing, it grows by sort of slightly less than GDP over time. It’s an inherently deflationary sector, in that costs come down, they mine more efficiently and therefore the demand for the commodities goes up by less than GDP. But supply is a big swing factor and there’s a long lead time to increase supply – and once you increase supply, you can’t switch it off immediately.

So there’s an eight to a 10 year lead from when you say I’m going to build a new mine to when you produce the output from that mine. And then once you decide not to invest anymore, it’s 10 years later only when demand and supply comes back into balance. So it’s the supply that causes the cycle. That’s what happened in 2005 to 2010, we had a massive supply response. Mining companies expanded rapidly and aggressively into the commodity price upswing, so that by the time we had a global financial crisis and the economic downswing after that, the supply was just coming on stream at pace.

At the same time the mining companies took on debt to expand – not only did they spend all their free cash on expansion, they took on debt to expand as well. And so when commodity prices turned down, these guys actually faced… A company like Anglo American was close to being bankrupt at that point because it had too much debt for its income stream to service. So that’s what everyone remembers and even the management of those companies. So where we are today is these companies are paying out all their free cash flow’s dividends and buying back shares. They are not expanding, they are spending as little money as possible in expansion activities. So the supply response is still not being activated. Even though demand is in the background, increasing gradually over time. So I think we’re in a commodity bull market, and I think we’ll stay in this bull market until we see aggressive supply responses from the commodity companies and we’re not seeing that yet.

On realising that the commodities sector is cyclical:

The share prices are volatile, they’re up and down a lot over a short space of time. But from here on out over the next five years, I think the trend will be up. And if you’re not invested, I think you can pick your times when you want to increase your exposure. When there are sell offs like there were the past month or two, and it will happen in future again. It’s not going to be a straight line up. There will be opportunities to increase your exposure to the sector, but my view is that we are in a commodity bull market.

On Sasol:

I think one should have a good look at Sasol. I think they have weathered their existential crisis. It looks like they aren’t going down the tubes. Despite previous management’s best efforts, they’ve survived. And I think it’s one one should have a look at.

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