Northstar’s bottom-up research process focuses on identifying investments that are underappreciated and therefore undervalued by the market. Such investments create an opportunity to benefit from being re-rated once their true value becomes more broadly accepted.
Sometimes, valuable assets reside in some of the most well known and widely followed companies and are disregarded due to a lack of disclosure, inadequate guidance or poor investor perception.
Two notable examples include Amazon and Apple, which have seen parts of their businesses meaningfully undervalued by investors.
Revealing value in global tech
Amazon Web Services (AWS) was founded in 2006 and provides cloud computing infrastructure. Its results were only separately disclosed in the first quarter of 2015, revealing a business generating $5 billion in annual revenue at an operating margin of 20% and growing 50% year-on-year. No surprise that this catalysed a rally in Amazon shares, which had traded in a range of between $300 and $400 over the prior two-year period. Today, AWS generates annual revenues in excess of $50 billion at an operating margin of 28%, growing only modestly below the run rate in 2015. Shares in Amazon have seen a 10-fold rise in their price since then.
Apple’s decision to stop disclosing quarterly handset sales in November 2018 was poorly received by the market and resulted in a 7% decline in the company’s share price on the day of the announcement. On the face of it, the market reaction to the decision to provide less disclosure was entirely understandable, but the subsequent rerating vindicated this decision. Apple’s intention was to shift investor perception from focusing on hardware sales to appreciate its service offering. In the next three years, while handset volumes and revenue declined, services, which feed the ecosystem Apple created by populating the market with handsets, continued to grow meaningfully. Shares in Apple, which had previously traded on a price earnings ratio closer to 10 times, in line with IT hardware peers, now trade on a price earnings multiple of 30 times. As a result, while total revenues only grew at a modest 2% per annum between 2018 and 2020, Apple’s share price more than doubled as investors afforded the higher value and more durable services revenue streams a premium rating.
Closer to home, Multichoice was spun out from Naspers and started trading on the JSE in March 2019. Naspers historically traded at a discount to the intrinsic value of its portfolio of cash-generative internet and media assets due to the disparate nature of the businesses, Naspers’ large size on the JSE and the relative earnings underperformance of their non-Tencent assets. The market underappreciated Multichoice’s ability to deliver on their projected subscriber growth objective to leverage a portfolio of best-in-class local and sports content to appeal to a mass-market African audience. Multichoice listed at a modest implied 12-month forward EV/EBITDA of 3.5 times, largely because most institutional Naspers shareholders are American and European, with a fleeting interest in owning African Pay-TV businesses. Multichoice subsequently rerated 31% to a 4.6 times multiple, before dubious tax claims raised by the Nigerian tax authority caused a subsequent de-rating.
One we missed was Bytes Technology Group, the largest reseller of Microsoft’s Azure cloud computing software in the UK. Bytes spun out of tech conglomerate Altron and listed on the London Stock Exchange in December 2020. Its value was underappreciated by the market due to the complexity of the Altron group structure, the relatively small size of the JSE and the inability to invest in this high-quality developed market asset on its own. Bytes benefitted from a secular shift to cloud computing and digitalisation in an industry we expect to grow at 30% a year into 2030. On listing, it traded at an estimated 12-month forward EV/EBITDA multiple of 23.3 times. Less than a year later, the consensus has it trading at a 12-month forward EV/EBITDA of 35 times, in line with European peers, representing a re-rating return of 50%.
Possible opportunities in streaming media and fintech
Disney’s media networks business is undergoing significant change creating scope for investor misperceptions and opportunities for those investors that are prepared to dig deeper. The Disney+ streaming platform launched in November 2019 and notched up 116 million users in under two years, but the Disney share has not seen a material re-rating. Disney anticipates growth to between 230 and 260 million subscribers by the end of 2024 (five years after launch). To put this in context, Netflix took more than ten years to reach their current 209 million subscriber base. This is a function of Netflix having to establish content franchises while Disney already has a strong portfolio of enduring characters and content that attract a strong user base. If Disney is successful in reaching their target, relatively conservative assumptions of the relative valuation to Netflix, implies that the rest of Walt Disney’s portfolio of Theme Parks and Media assets trades on as little as 5 times EV/EBITDA, roughly half the rating afforded similar businesses.
MTN Group is the largest mobile network operator in Sub-Saharan Africa, boasting #1 and #2 market share positions across several fast-growing underpenetrated mobile telecommunications markets with young data-hungry consumers. Mobile telecommunications operators have struggled to maintain their historically robust returns due to adverse pricing and anti-competitive regulations as well as increased capital investment required to maintain network quality and support consumer demand for data at the expense of higher margin voice revenue.
An exception to this dynamic has been Safaricom (partly owned by Vodacom), which leveraged their dominant market position and innovative mobile payments platform (M-Pesa) to generate industry-leading returns. Safaricom essentially used M-Pesa to benefit from the increased traffic on their network without having to deploy incremental capital, resulting in marginal returns on equity in-line with tech darlings like Google and Facebook.
MTN is focused on building their fintech business using their industry-leading network, scale, exposure to underbanked African consumers and history of improving their customer base ARPU through bundled voice and data offerings. If they can achieve their stated objective of deriving more than 20% of service revenues from fintech by FY2025, that would result in around R40 billion of revenue at a 50% EBITDA margin growing at 35% a year. An illustrative enterprise valuation for MTN’s Fintech business, achieved by applying M-Pesa’s implied EV/Sales multiple to MTN’s future fintech revenue, yields an enterprise value of R73 billion, essentially adding R30 to MTN’s prevailing share price.
Crystalising value over time
Unearthing these opportunities requires lateral thought and assumptions that are reasonable. Execution risk remains high and it can take time for perceptions to shift leading to the crystalisation of value. At Northstar, this is the kind of challenge we relish and we continue to investigate a number of ideas that present good opportunities for outperformance on a risk-adjusted basis.