As at 28 February 2019, Naspers made up just over 18% of the FTSE/JSE All Share Index. Because of its dominance, including or excluding the share will have a significant impact on an investment portfolio. Therefore, it is worthwhile to spend adequate time understanding how the company operates and its underlying entities.
One of the issues often raised with Naspers is its significant shareholding in Chinese technology company, Tencent. Tencent holds its internet operations through a Variable Interest Entity (VIE) in Hong Kong – an opaque ownership structure commonly used by Chinese companies who seek foreign investment but operate in highly regulated industries.
Using a VIE, Tencent effectively operates through a series of contracts which result in foreign ownership of a Chinese business without the usual transfer of equity or voting rights. Tencent has entered into a group of contracts with Tencent Computer and Shiji Kaixuan, which are domiciled in China and own the licences to provide internet content or information services and other telecommunications value-added services. Under these contracts, Tencent is entitled to the full economic benefit of the business and operations of these entities. A VIE is prohibited from distributing profits to registered owners and the registered owner of a VIE is barred from transferring or encumbering their equity interest in the VIEs without prior written consent from Tencent’s board of directors.
While a VIE structure is not without risks, for Tencent it does have several mitigating factors, including:
- Tencent is listed in Hong Kong where listing requirements offer protection to minority investors.
- The company has implemented best practice governance around its VIE structure.
- In 2015, the Chinese government announced a draft of the Foreign Investment Act that incorporates the regulatory framework of VIE structures and may be a precursor to legalising such a structure.
- Many large Chinese technology companies, such as Alibaba, Baidu and Tencent, make use of a VIE structure and have been able to grow by accessing foreign capital. While it is possible for the Chinese government to simply ban VIE structures or take away their licences, the consequences of that would be negative for China and undermine the gradual liberalisation of the Chinese economy.
- Chinese regulators have recently indicated that companies like Tencent, Alibaba and Baidu will be allowed to list in mainland China, which potentially ensures Chinese nationals are aligned with foreigners.
VIE structures are well established, and have encountered few significant issues since they were first introduced in 2000. While this offers a level of comfort, it remains the responsibility of Naspers’ investors to assess the risks and rewards of these factors, amongst others, in determining the value the share could add to their portfolio over the long term.