Prosus is a South African company with a significant investment portfolio, including 28% ownership of Tencent, the largest company in China.
The 28% ownership of Tencent is over $120 billion on the balance sheet of Prosus. However, the balance sheet shows us only $47 billion in total assets. Where are the rest of the assets? To understand this, we need to look at one of Warren Buffett's investments in 1958, Sanborn Map Co.
Warren Buffett first talks about Sanborn in his 1958 letter to the partnership, mentioning that he invested in a company and they could become the largest shareholder.
Late in the year we were successful in finding a special situation where we could become the largest holder at an attractive price
Warren Buffett did not like to disclose his investments as this would bring copiers that would push the price higher. At the time, he was managing less than $100 million, and SEC disclosure requirements were different than they are today. It was only in 1961 that he mentioned Sanborn Map Co. by name in his annual letter to his partners.
In 1959, he only stated that Sanborn was the largest position in the portfolio at 35% and explains that it is a company that owns other investments.
Last year, I mentioned a new commitment which involved about 25% of assets of the various partnerships. Presently this investment is about 35% of assets. This is an unusually large percentage, but has been made for strong reasons. In effect, this company is partially an investment trust owing some thirty or forty other securities of high quality. Our investment was made and is carried at a substantial discount from asset value based on market value of their securities and a conservative appraisal of the operating business.
We are the company’s largest stockholder by a considerable margin, and the two other large holders agree with our ideas.
It is interesting to note that he hoped to take profits in 1960.
The probability is extremely high that the performance of this investment will be superior to that of the general market until its disposition, and I am hopeful that this will take place this year.
He was right and beat the market by 29 pp, his best yearly performance at the time.
In the 1960 letter, Warren Buffett finally revealed Sanborn Maps Co., explaining the business. Sanborn was (the company is still in existence, but the business is now different) making maps for US cities, with their primary customers being insurance companies. They had a monopoly on the market, but in the early 1950s, a new method of underwriting made the insurance companies less reliant on Sanborn, and the company's profits fell.
In the early 1950’s a competitive method of under-writing known as "carding" made inroads on Sanborn’s business and after-tax profits of the map business fell from an average annual level of over $500,000 in the late 1930's to under $100,000 in 1958 and 1959. Considering the upward bias in the economy during this period, this amounted to an almost complete elimination of what had been sizable, stable earning power.
However, Sanborn started investing in other companies and bonds with its cash, something we commonly call marketable securities today when companies do it.
However, during the early 1930's Sanborn had begun to accumulate an investment portfolio. There were no capital requirements to the business so that any retained earnings could be devoted to this project. Over a period of time, about $2.5 million was invested, roughly half in bonds and half in stocks. Thus, in the last decade particularly, the investment portfolio blossomed while the operating map business wilted.
The market was basing its valuation of Sanborn on the Map business, and as the business declined, so did the stock price.
Let me give you some idea of the extreme divergence of these two factors. In 1938 when the Dow-Jones Industrial Average was in the 100-120 range, Sanborn sold at $110 per share. In 1958 with the Average in the 550 area, Sanborn sold at $45 per share. Yet during that same period the value of the Sanborn investment portfolio increased from about $20 per share to $65 per share. This means, in effect, that the buyer of Sanborn stock in 1938 was placing a positive valuation of $90 per share on the map business ($110 less the $20 value of the investments unrelated to the map business) in a year of depressed business and stock market conditions. In the tremendously more vigorous climate of 1958 the same map business was evaluated at a minus $20 with the buyer of the stock unwilling to pay more than 70 cents on the dollar for the investment portfolio with the map business thrown in for nothing.
The market was saying that the Map business had a negative value, and Warren Buffett also concluded that the investments were undervalued. This was a double market inefficiency.
Warren Buffett became a director of the company and was able to pressure (with the help of the SEC ruling in his favor) the company to exchange the company shares with the investment portfolio at fair value. This is how he was able to make profits. It is not important how he made profits since if we are investing in Prosus, we will certainly not be activists, forcing the management to exchange shares. What's important is the reasoning behind these market inefficiencies.
He realized that the market was missing the real value of the investments because of accounting rules. The investments of Sanborn were at cost value on the balance sheet. This is something similar we can see with Prosus today.
The reason why the assets of Prosus are only $47 billion is because these assets are at cost value. They paid $30 million for shares of Tencent over 20 years ago (by the parent company Naspers), and that's what's on the balance sheet, not the current market value.
This problem goes beyond the balance sheet, as the income and cash flow statements don't include the profits from the holdings.
For today, let's focus on the balance sheet value.
Prosus estimates its NAV to be $171 billion, and it has been declining in recent years with the decline in Tencent stock price.
The necessary corporate action that Warren Buffett forced for Sanborn was already done for Prosus in 2019. Prosus itself is this corporate action as it is a spinoff from the parent company, Naspers. Naspers is listed on the Johannesburg Stock Exchange with low liquidity. They separated the South African businesses and Prosus, with Prosus being listed in Amsterdam. Naspers also owns part of Naspers, and the two companies share the same management and board.
So far, we cannot say that this corporate action has been a success as the stock price of Prosus has been declining, but that's mostly because Tencent's stock price has been dropping. The stocks are correlated, and if Tencent eventually recovers, Prosus will recover too.
Like Sanborn, Prosus has the exact accounting at cost value and double market inefficiencies: Undervalued holdings and discount to NAV.
We cannot know if the same results will come from Prosus as with Sanborn since Prosus is more concentrated, with 80% of its portfolio in Tencent, and the company is much bigger. But it is always interesting to see history rhyming.