Thread by @jlericson

I used to write a blog detailing my investments. I haven't added anything to it in over a decade because I've shifted to being a passive investor.

But the recent sale of Stack Overflow to Prosus got me thinking about adding a new stock.

4of2.blogspot.com

Now I happen to think Prosus overpaid for Stack Overflow. Not by an irresponsible amount and I think it's probably justified by the strength of the SO brand. As we will see, this is a tiny sliver of the company's value.

prosus.com/news/prosus-to…

So the news is more of a catalyst than a reason to invest. According to Wikipedia, Prosus is less than two years old. It's based in Amsterdam and traded on the Euronext Amsterdam stock market. It's a holding company of many internet service companies.

en.wikipedia.org/wiki/Prosus

As an aside, Wikipedia also tells us it is a naamloze vennootschap (nameless partnership), which is a type of company found in Netherlands, Belgium, Aruba, Curaçao, Suriname, St. Maarten, and Indonesia. (Colonialism foreshadowed.)

en.wikipedia.org/wiki/Naamloze_…

Anyway, Prosus was spun off of a South African company called Naspers Limited. Naspers began as a publishing house after the Boer War. It's first product was an Afrikaner-language newspaper. It later expanded into books and eventually TV.

en.wikipedia.org/wiki/Naspers

Given Nasper's origin, it's not surprising it had a close relationship with South Africa's National Party, including providing funding. As a result, Naspers bears some responsibility for apartheid. I think it's fair to say the company was racist.

en.wikipedia.org/wiki/National_…

I'm starting to drift away from my investment case. It's an uncomfortable topic, but I think it's entirely fair not to invest in companies that have operated unethically in the past. I believe things have changed for the better in South Africa, however.

en.wikipedia.org/wiki/Truth_com…

From a financial standpoint, the biggest thing to happen to Naspers was in 2001 when it invested in Tencent, a Chinese company that has become the second largest company traded on the Hong Kong stock exchange.

en.wikipedia.org/wiki/Tencent

As Tencent increased in value (as measured by its market capitalization), Nasper's shares increased in value too. Over time it came to dominate the Johannesburg stock exchange.

ig.com/za/news-and-tr…

Now past performance does not indicate future success. In particular, Naspers seems to have been very lucky buying the right Chinese stock at the right time. My investment case isn't a bet on new acquisitions being as good as Tencent. Instead, this is an arbitrage opportunity.

A basic principle of economics is supply and demand. The supply of Naspers stock is decreasing because the company is repurchasing it. That should increase the price of the stock. But repurchasing hasn't worked. The reason seems to be index funds.

Another aside. Index funds buy a basket of stocks that are intended to mirror the rate of return of the stock market as a whole. Your 401(k) probably has an S&P index fund with very low costs. It's a very good default diversified investment.

en.wikipedia.org/wiki/John_C._B…

Now there are also funds that invest in South Africa. But Naspers presents a problem. When a quarter of the fund is invested in one company, it's not very diversified. Some funds solve the problem by capping the value of positions. Others buy equal weighting of top companies.

Either way, investors in the funds (and increasingly EFTs) get a more diversified portfolio. If you want to invest in African companies without doing a lot of research, you don't want 23% (or whatever) to be a single company.

So the demand for Naspers among index fund investors is suppressed for reasons having nothing to do with the company itself. This is a classic arbitrage situation. The big question is whether their is any way to unlock the value. And Naspers is trying a few ideas.

Buying back shares is one. Trouble is, the value it gets from purchasing its own undervalued stock drives up its value overall. In other words, that doesn't solve the problem of being the biggest fish in a tiny pond.

Prosus, the Dutch subsidiary, is another attempt to solve the problem. The idea was to spin off all the parts of the company not headquartered in South Africa so that they are traded on a larger stock exchange. But Naspers retains 72.66% of Prosus.

So let's put the numbers together:

* Naspers owns 72.66% of Prosus,
* Prosus owns 31% of Tencent and
* Tencent is worth about $770 billion.

finance.yahoo.com/quote/TCEHY?p=…

Doing a bit of math, the value of those companies just from Tencent is:

* Prosus: $239 billion.
* Naspers $173 billion.

Remember, that doesn't count _any other business_. And both companies control tons of other subsidiaries.

Now the market cap of Prosus (which is to say all the shares of the company times the share price) is $170 billion. That's a 71% discount of just their Tencent investment. Stack Overflow ($1.8 billion) is about 1% of the entire company, by the way.

finance.yahoo.com/quote/PROSY?p=…

Nasper's market cap is $93 billion. If all of their other businesses were worth nothing, that means it's selling at a 54% discount to the value of its Tencent holdings. *54*%!

finance.yahoo.com/quote/NPSNY?p=…

Trouble is: the reason for the massive discount hasn't changed. When Tencent does better on the stock market, it simply deepens the discount. So they are trying something else: Prosus is offering to buy Naspers shares.

share-exchange-offer.com

Remember that Prosus is mostly owned by Naspers. So this move will create a weird cross holding where Prosus owns Naspers and Naspers owns Prosus. Don't ask me how this works. The upshot will be more of the combined company will be traded in Amsterdam and less in Johannesburg.

To quote from the FAQ:

"[We expect the transaction] will lead to enhanced trading dynamics for Naspers by almost halving its weighting on the JSE, providing headroom for future growth while remaining South Africa’s most valuable company on the JSE."

share-exchange-offer.com

Will it work? I don't know. But it does show the company understands the problem and is working to fix it for the benefit of shareholders. There are tons of things that can go wrong, but as a value investor, it's comforting to see such a huge discount. (54%!)

Credit where it's due. I got the big picture from this post on The Motley Fool. Billy Duberstein cleared up a ton of confusion for me. He's written more about the case for Naspers too.

fool.com/investing/2021…

I wrote a bit more about the company that owns the company that is buying Stack Overflow. (Disclosure: I bought shares of Naspers yesterday.)

meta.stackexchange.com/questions/3662…