Your Ma or Mine? What's up with Tencent?

OK, so I wake up this morning and one of my positions increased about 15% in value, with absolutely no particularly relevant news that I'm aware of. Huh?

Tencent, one of the largest internet companies in China (listed in Hong Kong, also traded on the pink sheets at TCEHF.PK), climbed about 15% as those of us in the Western hemisphere rested our weary heads. What's going on?

Well, there are a few things that might have sparked enthusiasm for the shares -- which were already, admittedly, fairly expensive:

1, overall market moves in Hong Kong -- the H shares as a whole (Hong Kong-listed Chinese companies) were up about 2.5%, so that might be part of it. Though the reverse could be true, Tencent's market cap is massive enough, about 12 billion now, that their move might have driven the index.

2, new products or developments -- there weren't any yesterday that I've found, but Tencent does continue to gradually build it's advertising business, and they still make tons of money from selling virtual avatar bling to their IM subscribers. They've also done little things, like make it possible for AIM subscribers to play their QQ games, and helped to integrate their payment systems and platform for buying airline tickets, but none of that is brand new, and it's not what's moving this needle today.

My best guess for the real cause for this move is ...

3, Alibaba.

Alibaba, which has been many folks' favorite Chinese company that they couldn't own for many years, is finally going public this month. This has really caused some hype in Hong Kong, since the IPO will put them in very close competition with Tencent (and Baidu, if you include stocks not listed in China) for the title of "largest market cap Chinese internet company."

Does this make any sense? Not necessarily to me, though I won't argue that Alibaba is an enticing firm. They are in different businesses entirely -- not only product wise (Alibaba is basically a wholesale trade marketplace, Tencent an IM and casual games provider), but also in terms of their markets: Alibaba is focused on B2B and Tencent is pretty strictly aimed at the mass of Chinese young adult consumers.

So maybe investors are mixing up the companies because their CEO's sound similar. Unfortunately, the fact that Jack Ma runs Alibaba and Pony Ma runs Tencent doesn't really do much for anyone, as far as I can tell, since they are not related.

So, perhaps some explanation of this move will come out in the near future and I'll become wiser -- or maybe it was just one of those inexplicable one day blips. All part of the fun of investing in China, and especially of investing in Chinese companies that aren't well covered by the US press.

full disclosure: As of this writing I do own shares of Tencent, and LEAP options on Yahoo (which owns a big chunk of Alibaba).

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Long-Overdue Portfolio Adjustments

I've been remiss in keeping my portfolio up to date here, having spent much more time hacking away at email teasers on my Stock Gumshoe site that many of you have also been kind enough to subscribe to and read.

But still, I always have intended to keep my portfolio holdings and changes an open book -- so I'm sorry that I'm so late in making these changes here for you to see (and hey, many of them have been short term mistakes so far, so it's not like you're missing anything).

So ... without further ado, here's what I've done over the past month or so.

I sold Naspers (NPSNY), and bought Tencent (TCEHF). With Naspers ADRs going to the pink sheets some of the argument for keeping these shares for Tencent exposure has gone -- volume is much thinner now, and information will be a little harder to find. The other argument for keeping Naspers, that they offer a more diversified exposure to international media and technology properties, is still there, and it still may be the correct one ... but personally, what always attracted me most to Naspers was their major holding in Tencent. There is a significant argument against what I've done if you think Naspers will rebound in its other businesses, because by historical measures the share of Tencent that you get in Naspers is now trading at a discount.

But anyway, Tencent entered my portfolio more than a month ago, before I sold Naspers, and then I added more to my holdings when I sold Naspers a week or so ago. I got a little lucky with the timing, since Naspers has been a little bit depressed due to fear of local market competition and a declining South African currency compared to the dollar, and Tencent has had a nice boom of late.

I've written quite a bit about why I like Tencent, and all of that remains true -- but two things stand out for me: First, that their advertising revenue is growing pretty quickly and they're not showing any signs of losing much IM market share even though their competitors are trying hard; and second, that as a Chinese blue chip trading only in Hong Kong they're going to benefit significantly when more Chinese retail investors are able to invest in Hong Kong.

I think that's likely a significant part of the boost in Tencent shares over the past week or so, the gradual loosening of restrictions on international investing for mainland Chinese -- but I think we're just at the beginning of that trend, and while it's likely to be good news for many Hong Kong-traded Chinese companies (the Hang Seng is at or near highs right now), I think it will be especially good for popular Chinese consumer brands that are only traded in Hong Kong.

And of course, that fits Tencent to a T. I liken this a little bit to the earlier stages of the internet craze here in the US, to some extent -- what were the popular companies for individual investors? The ones they used ... they bought Dell computers, they used Yahoo email or they surfed on AOL, so those were among the more consistently popular investments. Obviously, the exuberance for these investments got out of hand, but I still think that investor psychology to some extent is universal and that the mainland Chinese are going to want to buy shares of companies that they use every day, but which have been until now forbidden investments.

So in for Tencent, out for Naspers. I won't tell you the prices, since these are old trades and you wouldn't believe me -- it would be too easy for me to say I bought Tencent for $3 and sold Naspers for $27, both of which would be significant exaggerations.

What else has changed for One Guy's Portfolio?

Well, I told you about Ambrian, and that has become a significant holding for me as I've added to it through the Summer at what seem to me to be depressed prices. They release earnings this month that I'm very curious to see, but no real news otherwise. Still a very low PE, and still a nice boost from the strength of the Pound for this commodity-focused investment bank.

And I also bought a few shares in one of Ambrian's major holdings and clients, Centamin Egypt (CELTF.PK). This is a gold exploration firm that is trying to revive the Egyptian gold mining industry -- they have an extremely promising mine site near the Red Sea, and they've got a processing plant that's being disassembled in South America and shipped to their mine so that they can begin processing ore next year. The shares are down from where I purchased them, I bought (again on the pink sheets) for 1.05, but what impresses me are the continual upward revisions in their reserve estimates -- every time they drill a a new test hole, it seems, they upgrade the potential gold content of the mine. This, obviously, is a play on the long term price of gold, and some folks might argue that it's a little pricey for a miner that hasn't yet produced (over a half billion dollars already in market cap). Some significant uncertainty remains, particular on timing as they await equipment and plan their mine, but I'm convinced that the risk/reward ratio is quite promising given the richness of the gold field they're aiming to work.

And aside from these pink sheets foreign holdings -- which I also might add more to in the near future, as I would like to own more Swire Pacific and SeaDrill -- I also bought some "regular" companies during the beating the market took a couple weeks back.

I sold my Chipotle LEAP options and used the profits to pick up some Chipotle shares, because I'm not entirely certain that this company will continue to ramp up rapidly but I am sure that the long term prospects are so excellent that I really want some shares in my portfolio. I expect that Chipotle will be to fast food what Starbucks is to coffee and Whole Foods is to groceries, the socially conscious and better tasting alternative (though their food isn't as premium-priced as those two).

I bought Class B shares, at a hair under $90, because I can't come up with any rational reason why the regular shares will trade at a premium forever (CMG is about $10 more expensive than CMG-B). Right now, they're at a premium because some traders don't know about them, the volume is much lower, and McDonald's has many of the class B shares still locked up ... and the difference is possible because B is no longer redeemable for A There was a nice SeekingAlpha summary of the arbitrage opportunity available for Chipotle shares back in June, and while I wouldn't really arbitrage them (short the Class A and go long the Class B) I can't imagine why a long term investor would buy the Class A. Logic will enter the equation eventually.

I also bought some China Fire and Security (CFSG), because it seems to me to be an appealing small cap that plays off of what I can only assume will be significantly increased needs for security and fire equipment as China continues to upgrade their building standards and, more generally, continues to build whole cities from nothing in the blink of an eye. This is a small position that I'm still researching, but the potential looks really good to me.

In other news, I've sold my holdings in two biotechs and used profits to buy LEAP options in those same companies -- Vertex (VRTX) and PDL Biopharma (PDLI). It has worked out well for Vertex, since the stock profits were considerable when I sold and the options have performed very nicely of late as emotion about their HCV drug Telaprevir has again run hot (it runs cold from time to time, too). It hasn't worked out so well for PDLI, though, I did protect more principal from the train wreck that these shares have been of late, but of course the options fell precipitously and may become worthless if PDL is really re-launching itself on a long road toward building as a research company instead of a producing drug company.

To be fair, if your lead drugs continue to disappoint, as PDL's have, it does look appealing to return to the strategy that built the company -- providing basic antibodies for other drugs and letting others take the risks -- I just don't know how long it's going to take them to "right-size" for that plan and redirect their research efforts.

Also in healthcare, I've upped the stability of my portfolio a bit by adding a big pharma name -- Novartis (NVS), which I picked up shares of at $52.99, right around where it's trading now. I like the big generics and over the counter business, their potential pipeline, and the fairly far-off dates for patent expiration for their biggest drugs. This one has been a favorite of analyts all year and has yet to really perform, in part due to some missteps with approvals that seem to me (a non-expert, believe me) to be fairly minor in the grand scheme of things. I thought about buying Pfizer for this part of my portfolio, I was incredibly tempted by their ridiculously high current dividend, but I opted not to make that contrarian play and bet against the problems they're likely to have with Lipitor patent expiration in the near future (still, they do have an awesome cash hoard ... and I might change my mind).

Finally, I just recently picked up a small entry position in HDFC Bank, one of the two Indian banking firms that you can get as an ADR. I bought shares at $83 a week or two ago and am considering adding more if they dip again. I continue to fear that the shares are a little bit expensive, but I also like the growing consumer banking need in India, and banks can often be good proxies for a growing capitalist society. I also do continue to hold the India iPath Exchange Traded Note, too, which is essentially an index fund for the Sensex.

Enough, huh? Other than that, I just have added a tiny position in a company that I probably shouldn't have touched -- mostly because it's an interesting story that isn't making any money, in Raptor Networks, and I continue to dicker around with some small options trading positions that for the last year or so have more or less broken even -- but they keep me busy, and keep me researching new companies (and provide the occasional 1,000% return that really keeps your investing adrenaline levels up).

Overall, there has been more of a trend to foreign investing in my individual stock holdings -- non-US-based companies now make up just under 50% of my portfolio.

I think that's all of the portfolio adjusting I've done that hasn't yet been reflected on the site here -- I'll try to do a better job of keeping up with my writing in the future. I've also got to take a much closer look at some of the real losers in my portfolio of late and try to figure out what to do with them -- that includes Chico's and MMC Energy, both stocks that several of you have emailed me about in recent months, and Akamai, which is still up 100%+ for me but is down close to 50% on the year. Then again, writing about those guys sounds too much like taking my medicine ...

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Indirect Investing

One of the themes that has come up with several companies I'm thinking about or have recently bought is the notion of the "indirect investment", by which I mean the purchase of a company in order to get access to the earnings (or growth,or whatever) of a subsidiary or related company -- either at a discount, or because the subsidiary isn't separately traded, or just for diversification in getting two significant businesses in one package.

Cypress Semiconductor (CY) fits this idea nicely, and I own a few LEAP options in the shares and remain tempted to buy the common stock -- it's a downtrodden semiconductor company which the market doesn't like at all. They haven't had particularly nice margins of late, or anything else to make the Street stand up and cheer, and short sellers are holding about 10% of the float.

Most importantly in my opinion, though, many years ago they bought a tiny company that had technology and designs for manufacturing solar cells, and built manufacturing capacity for that company. They've since IPO'd part of that solar company, called SunPower Corporation, but they still own about 70%. And today, though Cypress is the parent, Both companies trade at similar market caps, with SunPower's enterprise value of about $2.5 billion and Cypress at about $2.6 billion.

So that means, if you buy Cypress you're getting $1.75 billion of SunPower, which means you get the semiconductor business for substantially less than a billion dollars. Now, whether or not the semiconductor business is worth more than that is another question -- but even though it's not growing as fast as solar, there is certainly a market. The Semiconductor Industry Association (they're unbiased, right?) reported 9.2% growth year over year in January, so if Cypress was a proxy for semis as a whole you might be tempted. They do work in many different segments of the semiconductor marketplace, so perhaps there's an argument to be made there.

This may be too widely understood an "indirect investment" to make any money from, especially since Cypress has resisted "unlocking the value" of their SunPower subsidiary by selling it or spinning it off ... Cypress is probably already trading primarily on the value of their SunPower holdings.

In solar power, there's another way that I've held on to a somewhat indirect investment, too -- my shares of MEMC Electronic Materials (WFR) were initially bought because they were cheap, the share price didn't reflect the great position they held in the semiconductor wafer business because of their integrated supply chain and good supply of polysilicon in a tight market. But one of the reasons I've held the shares after a huge advance,and in the face of an uncertain balance between burgeoning silicon supply and hopefully booming demand, is their growing exposure to solar power -- including warrants to purchase five percent of Suntech Power (STP) that they received in exchange for a long-term silicon supply agreement. That doesn't yet move the needle at WFR, but it could very well do so in the future -- or at least cushion any blow from a slowdown in semiconductor demand, should it come.

Moving away from silicon, Naspers (NPSN) is another investment along these lines -- I bought shares recently, and while I like the cash generation of their core media (South African newspaper and pay tv) assets, what I really like is the growth potential of their partially owned division, Chinese IM leader (with the QQ product) and portal company Tencent, and their acquisition spree in emerging markets media and internet companies.

The impact on the market cap is big here, too, since Tencent is roughly a $6 billion company and Naspers owns about 36% ... and NPSN itself has a market cap of about $7 billion, so roughly a third of Naspers' market cap is attributable to their not very profitable (in earnings terms) Tencent holdings, which significantly depresses the company's PE ratio and makes them seem a bit more expensive than they really are.

Tight relationships among corporations can give us opportunities to do this kind of investing in nearly any industry -- Ship Finance Limited, a company I've owned in the past, gets an indirect ride on the profits of former parent Frontline. They own Frontline's ships and get a steady lease rate for them, which they churn out as a high, steady dividend yield ... but if the tanker business takes another turn up they'll get a bonus from a profit sharing agreement whereby they get a portion of all profits over a set level on their tankers. Which is probably why the shares are just about at all time highs while the more leveraged Frontline languishes on the currently tepid prognosis for tanker rates.

This kind of investing is not unusual, of course -- a lot of what professional investors do is try to find hidden values in the companies they're interested in, and many arbitrageurs spend their days figuring out which companies are likely to move to unlock those values in a particular time frame.

Other examples abound -- buying Roche a few years back to get a cheaper bid on the future of Genentech comes to my mind as one example ... and in a related way, biotech and other IP-heavy industries also give us the opportunity to invest in companies because of royalties they receive from successful or promising products.

Using the Genentech example again, this might mean buying PDL Biopharma (PDLI) because of the humanized antibody royalties they get from several of Genentech's big products, including Avastin and Lucentis (though PDLI also has its own issues, including a looming fight with a big investor about their spending habits).

Whatever your focus, it sometimes pays to look a little deeper into the companies that interest you -- maybe the companies that don't appear to be publicly traded are really available for investment as subsidiaries of others, or maybe the shares that look a little too pricey are hiding an unusual gem.

full disclosure: I own shares in Naspers, MEMC Electronic Materials, and PDL Biopharma, and call options on Cypress Semiconductor. I have no position in the other companies mentioned.

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Fear Brings Opportunity: Buying Naspers (NPSN)

At times like this, with global markets running in fear of a bubble and bringing market corrections down upon us all, I like to look for companies that I've been interested in but couldn't justify paying up for, and see if bargains are available. Today I did just that and opened a small entry position in Naspers Ltd. (NPSN). I wasn't actually intending to buy today, and had no idea Naspers would fall this far, but had a limit order in at what I considered last week to be a fair price for a small purchase.

I've written about Naspers before, in more detail, and you can review those posts if you like (when I looked at Naspers' history and prospects, and when I talked about their highest-growth partially-owned division, Tencent Holdings).

And I made clear that I had some reservations about Naspers, the most significant one of which was that I was afraid their valuation might be too rich given the risk of coming competition in their most profitable division, South African pay tv.

But today, the price cratered by well over 10%, due to the global market decline as well as to some Naspers-specific thing:. They're issuing a secondary offering to raise money for acquisitions, which certainly shouldn't impact shares this much (especially given their past success in this area); one of the competitors that we already knew would be coming last week announced the impending launch of a pay tv service in some of their African markets; and, of more immediate impact most likely, there's probably some fear for what will happen to Tencent Holdings when the market opens in Hong Kong tonight, since Naspers owns more than $2 billion worth of that Chinese company at yesterday's prices (36% of the company, as of the last filings I've seen) ... which translates to mean that roughly a third of Naspers' market cap consists of Tencent shares.

And while it's still not a cheap stock it at least has given back some of the speculative advance it made in the first part of this year, so I'm somewhat comfortable entering a position here. I bought shares this afternoon at $23.85. As you can see if you check the quote, I certainly missed the bottom -- it dipped well under $23 in a closing-hour flurry of selling.

So it's not a shock to say that this may well be a bit too early to be buying, if all the pundits are right about a market calamity being right around the corner -- the shares, after all, have climbed fairly dramatically since last Fall's bargain prices in the mid-teens, which came before I had heard of the company. Naspers has its fingers in emerging markets not only in South Africa and elsewhere on the continent, but around the world in all the hot spots including Russia, Thailand, China, Brazil (and just look at Gol and Sadia to see how my portfolio's getting racked by Brazilian fear today, too). Tencent is by far the largest of those investments, but there are many other fairly big ones ... and if those investments crater, the share price will doubtless follow.

But with a strong position as a leading publisher and tv and internet service provider in South Africa, and diversification in their international investments, I think the company will weather any storm reasonably well -- they're quite large, about a $7 billion company, so even if Tencent or Mail.ru goes bankrupt (neither seems likely to me), the company should survive.

And of course, for a company that's on the lookout for promising investments in media and internet stocks around the world, and a bit frustrated about the high costs of some potential acquisitions, a nice stock market downturn might be just what the doctor ordered. That is, if you've got the patience to wait a few years.

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Looking at Tencent (TCEHF.PK)

A week or two ago I took a long look at Naspers (NPSN), a company I like a lot but that is very dependent on its strong position in the South African pay tv business ... a business that is just entering an era of open competition. So that made me a little nervous, and I'd like to see that competition take a bite out of the share price before I buy in.

But the reason Naspers first came to my attention is that they were major backers of Tencent, and still own about a third of the company. So if Tencent was what I found most intriguing, why not just look into investing in that company itself?

Well, for a wee fish like me investing in a Hong King listed company without a significant US PR presence (or significant US press coverage) is a bit of a pain, especially because their pink sheets volume (TCEHF.pk) is very slim. So that's the first hurdle ... but it's not impossible, and it might be worthwhile.

What do we know about Tencent?

It's by far the leading provider of IM services in China, with its QQ product eclipsing 22 milllion simultaneous users, over 200 million active accounts, and nearly 600 million registered accounts in total. If you think "network effect" means money, QQ.com's online portal and community creates the strongest online community network in China and one of the most visited web pages in the world. Users use the portal not just for instant messenging but for casual games (both free and paid), buying accessories for their online avatars using the internal Q Coins online currency, and other internet activities.

The popularity of Q coins even has the government a little anxious about the impact on the Yuan, though that's perhaps a stretch. Other articles are out there on similar aspects of the Q coins and other valuable online property created by Tencent -- Asia Times did a good story on Q coins in general, the Virtual China blog has a fascinating piece on the value of QQ numbers (the identifier for users, sort of like an email address), and there's a new focus on Q-coin theft, with some interesting concerns about Tencent's responsibility for this, if you want to slog through a machine translated International Finance News article. All that serves primarily, for me at least, to reinforce the importance of this vibrant marketplace to the nascent acceptance of e-commerce in China.

The company has been in operation for about eight years, and public for just over two (not bad for a roughly $7 billion company) ... and as far as I know, they have no plans for a US listing of their stock.

Tencent is profitable, with earnings of about RMB 282 million for the last reported quarter (September of last year -- PDF link) -- not cheap, but profitable. So far, most of their sales come from "internet value added services", which includes everything from avatar upgrades to downloads to paid messenging, including IM voting for Super Girls, the Chinese equivalent of American Idol.

Going down the list, their next biggest inflow is a near tie between "mobile value added" and games -- the mobile value added is mostly SMS service, and messaging is a bit uncertain because it's undergoing a change with a new revenue agreement with China Mobile. The games had a bit of sales slump as they tried to take market share by cutting prices and offering free games, so both of these significant areas are hard for me to gauge moving forward, confident though I am in the size of their market in the long run.

And it's not until you get to the bottom of the list that you get to probably the greatest potential growth engine for Tencent: online advertising, which currently makes up about 10% of sales. If you are at all a believer that online advertising in China has significant potential, it's hard to overstate the impact this could have on Tencent -- with (as of today) the ninth most visited site on the web, second in China only to Baidu and with a much stickier user experience, any advertiser who wants young, wealthy Chinese eyeballs might be expected to be banging down the doors at Tencent's headquarters.

Earnings growth numbers look spectacular, but use very low year-ago comparisons when you look at annual numbers. Gross profit was up 4.4% sequentially and 116.5% year over year in the third quarter ending last September. Operating profit was up 5.6% sequentially and 179.3% YoY. Net profit grew 5.5% sequentially and 263.4% YoY.

They continue to have great margins, no surprise as a very scaleable internet company. Net margins have lately been around 38%, with no significant erosion in recent quarters that I've noticed.

As I said, it ain't cheap -- the company posts a PE of 109 on its quote page. At a net profit of about RMB282 million in the last quarter, we could assume no growth and a steady income run rate of about a billion RMB to be conservative (their business is seasonal, so this is iffy, but it's also growing much faster than the seasonal impact, so I'll still call it conservative) -- that goes with a market cap of about 50 billlion rmb (they report most of this in Hong Kong dollars on their quote page, but the exchange rate with the yuan is pretty much even so I didn't bother messing with conversion).

So for a thumbnail that doesn't take into account growth or seasonal earnings changes, we get a PE of about 50. Which goes with income growth for the last year of well over 200%, so in some measures we've got what you might call an expensive bargain. This is not too far off from the valuation for Baidu, though I can't see how anyone can make a reasonably accurate growth projection for either one at this point.

But of course, any investment in Tencent is based on an uncertain future, so what is there to worry about?

First, we're talking about monetization of something that isn't necessarily a guaranteed money pile -- remember, after all, that though everyone under 30 had an AOL Instant Messenger account for a while there, and many still do, AOL has never really made any money directly from that service. I think Tencent will do better at monetization due to their singleminded focus on the product and a very different audience, but I don't know that for sure.

Second, it's China -- maybe it's an investment bubble, maybe it isn't, but shares have certainly climbed dramatically since they went public and any meltdown of the domestic or HK stock markets would be sure to take Tencent down as well.

Third, competition in some of their businesses is extraordinarily tight -- games and wireless value added services have caused many Chinese companies to rise and fall on the whims of the marketplace and the fast-changing nature of popular games and services. I'm less worried about this because the huge audience of active QQ messenging users gives them a strong tailwind, but it's no guarantee of competitive performance in their other products.

And fourth, I'd be likely to buy on the pink sheets, and getting in and out of a position in these low volume shares, even a small position like I would have, isn't always easy.

Still, given all that, I'm tempted. I might convince myself to take a flier on a few Tencent shares one of these days. Today marks three months exactly since their last quarterly earnings release, so word from the company that moves the shares one way or another could come at any time -- I don't believe they've announced an earnings date (last year's 4Q and annual results were released on March 22, for what it's worth).

full disclosure: though I never bought the Baidu shares I considered last fall, I do own Baidu options. I don't own any other company mentioned here, though Baidu, Tencent and Naspers are all possible purchases for my portfolio in the near future.

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