For South African investors in Naspers and Prosus, it has been a rewarding twelve months, despite recent tariff related valuation pressure, as its core Tencent holding has handsomely outperformed US peers, albeit with a fair bit of volatility along the way. During 2024, Tencent benefited from accelerating growth in its core gaming business, driving consensus earnings and free cash flow upgrades, supporting a re-rating relative to US peers, explaining part of its outperformance. A thawing in government relations, with leading Chinese tech players receiving public support from politicians at the very highest level also helped reduce perceived regulatory risk as the global race for Artificial Intelligence (AI) supremacy accelerated.
Article by: Jonathan Kennedy-Good, Senior Equity Analyst at Prescient Securities
To remain at the forefront of AI technology, the Magnificent Seven made announcements leading to significant increases in AI led capital investment in the years to come, ahead of Chinese peers. At the same time, news headlines are dominated by a global trade war as US policy-makers utilise tariffs in a transactional manner, causing significant policy uncertainty, raising the relative cost of capital for US tech firms. The combination of higher US AI capital investment, with an untested return profile and rising policy uncertainty proved a toxic combination to the Magnificent Seven’s valuations and multiples relative to Chinese peers. As we entered 2025, news that a Chinese AI startup, DeepSeek launched a free to use AI system, which was reportedly much cheaper to train relative to existing models, again pressured US tech valuations lower, given perceived over investment as AI operating costs decline. The relative valuation trend accelerated as we ended 1Q25, given continued Tencent gains (+21%), while the Magnificent Seven declined (-16%) during 1Q25.
So, the question is - where to for the sector?
Perhaps the best departure point is to introspect and look at the trend in global equity analysis. In the fast-moving tech sector, sell side equity analysts have moved to a news-flow model where their stock views are largely driven by quarterly earnings updates, new product launches or even CEO statements delivered on social media. Buy and sell recommendations are being driven by news rather than valuation metrics and a deep understanding of sectoral trends – something we at Prescient Securities believe is key to making informed investment decisions.
While research capacity in the domestic market has shrunk, one of the areas where we believe we add value is offering a more detailed view on trend changes and valuations. Almost a year ago, our bullish view on Tencent’s outlook - and by implication Naspers and Prosus - was based on our view that earnings and free cash flow upgrades would follow in the latter part of 2024 as higher margin gaming revenue growth accelerated, which together with the buyback programme and strong capital discipline, was likely to drive an absolute re-rating of Tencent’s multiples. These fundamental drivers were certainly helped by a bottoming in negative investor sentiment towards China, coupled with improving Chinese regulatory sentiment and innovation, via DeepSeek. Similarly, rising US tech capex was an early signal that Chinese peers, like Tencent, would likely raise investment levels from multiple decade lows to remain contenders in the race for AI leadership. Furthermore, as Tencent’s strong re-rating continued into 2025, while its upgrade cycle may decelerate, together with the risk of significantly higher future capital investment implied rising risk to further valuation upside, at least over medium term. Although we believe Tencent remains the quintessential example of a quality company, we turned neutral prior to its results in mid-March ‘25, due to rising valuation risks and potential downgrades to free cash flow generation as higher capex followed. Given management’s guidance towards significantly higher capital investment, our view has proven correct, at least in the very short run. We nevertheless remain optimistic regarding Tencent’s longer term growth potential, which we believe is likely to result in a consolidation phase as investment tempers free cash flow growth potential.
Our engagement with Naspers and Prosus investors still suggests they view the investment thesis as attractive, despite our more cautious Tencent stance, given the dearth of quality SA listed growth assets. Understandably, investors are unlikely to significantly reduce their Naspers and Prosus weightings on slowing Tencent growth, given a myriad of other potential value unlock scenarios presented by the discount Naspers and Prosus trade to their sum-of-the-parts.
Beyond Tencent, Prosus management are actively seeking to deploy their significant cash resources (c. U$18bn), with acquisition targets Despegar (US$1.7bn) and Just Eat Takeaway (US$4.3bn). During February, Prosus announced it intends to acquire Just Eat Takeaway (JET) to cement its position as a leader in the European food delivery market. The transaction received mixed reactions from the market, given investor concern regarding the likely potential return profile in light of prior management’s chequered mergers and acquisitions (M&A) history.
Nevertheless, long term investors appear more optimistic that current CEO Fabricio Bloisi, whose food delivery track record as iFood CEO is impeccable, may lead to value creation in the battered food delivery space, particularly if Prosus can act as a European consolidator. Although the market’s initial reaction led to a widening of the discount at both Prosus and Naspers, we expect the risk of further significant M&A is lower, reducing the risk of a further widening of the discount. The ongoing sale of Prosus’ Tencent stake to fund its buyback at a significant discount, is likely to provide support to current discount levels and continues to support Prosus’ net asset value (NAV) accretion over time.
Although we expect consolidation in valuation levels for the remainder of 2025, given slowing Tencent growth and Prosus M&A, ultimately both Naspers and Prosus are stalwarts in South African investor portfolios and are key entry points into the global technology market. We believe both offer strong value propositions and unique access to global tech growth trend, which are likely to reward investors biding their time for attractive buying opportunities.
