Saber Capital: Common Denominator of Tencent, Facebook, Google

• There are two types of companies in the investable universe:
  • A: those that are growing their intrinsic value over time
  • B: those that are shrinking their intrinsic value over time
• Within Bucket A, there are two sub-categories:
  • Compounders: growing companies with a long runway
  • Stalwarts: durable, mature companies at a discount
• Large-caps get mispriced (% change between 52-week high/low): Apple (49.4%), Google (53.4%), Microsoft (42.5%), Exxon (37.3%), Amazon (71.6%), Berkshire (19.4%), Facebook (68.1%), Johnson & Johnson (43.9%), GE (68.4%), AT&T (35.5%)
• What do all of these companies have in common? Facebook, Amazon, Netflix, Google, Tencent, jd.com
• Most important moat
  • Technology touches all industries today
  • Change is much more inevitable and occurs much more rapidly
  • The most effective antidote to “disruption” is a management team that is driven by something larger than profits
  • A company that is motivated to provide great value for its users and customers has the potential to establish a long-term advantage over the vast majority of companies that manage their businesses for the short-term
• Why does culture get “mispriced”?
  • Everyone knows that providing value to customers is important, but actually doing this can cause short-term pain
  • Very few companies have the structure for such long-term focus
  • Because of these structural hurdles and near-term incentives that drive behavior, culture can’t be easily copied by competitors
• Network Effects
  • Facebook has 2 billion users and 70 million businesses on its namesake platform
  • WeChat has 1 billion users that are highly engaged (spending over an hour a day)
  • Google has the most comprehensive index and best search product, which has led to billions of users for its search, browser, email, maps, and other products
  • YouTube’s 1.3 billion users watch over 1 billion hours on the platform every day
• Feedback Loops
  • Data Feedback Loop: a good product leads to more users, which provides more data, which improves the product, which leads to more users, and still more data, etc
  • Price/Volume Feedback Loop: low prices lead to more customers, which leads to cost savings from suppliers, which can be passed to customers, which brings in more volumes, and lower prices, etc
• Large Markets
  • All of the companies operate in markets that Buffett would call “inevitables”; dominant positions in fast-growing industries: digital advertising; e-commerce; payments; cloud; media; gaming
• ROIC
  • These companies are making investments in data centers, technology, warehouses and other growth oriented investments, but they require very little capital to grow
  • Ad platforms like WeChat, YouTube, Google, and Facebook have massive incremental margins
• Rapid Growth
  • The combination of strong moats, large and fast-growing markets, and very low capital requirements has led to explosive growth
  • Growth rates will slow down going forward, but will likely continue to be significantly greater than the average company for many years to come
• Under-earning
  • Facebook: Instagram produces only a small portion of FB’s revenue, and WhatsApp & Messenger have over 1 billion users but produce no revenue yet
  • Tencent: very profitable overall, but WeChat only does ~$4Bn in ad revs (compare to $40bn at FB); other areas such as payments, cloud, and media content have lots of potential
  • Google: core search is a 40%+ margin business; YouTube shows over 5 billion videos a day and climbing; Cloud is a $4Bn business in an industry that will be hundreds of billions; Waymo? Health care? AI technology? Hardware and IoT?
  • jd.com: “Rent” their infrastructure (third-party sellers, third-party logistics)

Tencent – A Huge Moat in China

• Buffett’s “Inevitables”
  • Companies that Buffett felt were sure to do well over time due to structural competitive advantages
  • But some of these structural advantages have been eroded, due to unforeseen technology
  • Today’s inevitables are not companies that are resistant to change
  • Today’s inevitables understand change and can adapt, while always focused on customer value
  • Google, Amazon, Facebook exhibit these qualities
  • There are also numerous “inevitable” companies today in China
• Inevitable Trend in China
  • These companies benefited from “walled-garden” internet in China
  • They’ve benefited from a rising middle class that is using the internet more, and spending more online
  • Internet usage will certainly grow and thus online ads, e-commerce, and mobile payments will follow suit
  • Unlike the airlines in the 1950’s, this “inevitable” industry will create massive profits for its winners
• What Does Tencent Do?
  • Digital Advertising: 1 billion highly-engaged users on WeChat
  • Video Game Publishing: high margin, high ROIC business that throws off significant FCF
  • Mobile Payments: WeChat Pay is one of the largest mobile payment platforms in China
  • Media Subscriptions: 135 million people subscribe to Tencent’s news platforms, music, movies, video, and original content
  • E-Commerce: Tencent is a partner & minority owner of jd.com; WeChat is a potential e-commerce hub
• Highly profitable & growing fast: growth has actually accelerated in the past couple years; Revenue: 40% 5-yr CAGR and 56.5% y-o-y growth; Pretax profit: 42.4% 5-yr CAGR and 70.8% y-o-y growth
• Why Tencent is a Great Business to Own
  • WeChat’s Network: used by everyone in China; chat, payments, work groups, social, shopping, money transfers, hailing cabs, paying bills, and much more
  • Massive Runway: leader but still has a very small slice of large, growing markets such as mobile advertising, ecommerce, payments, media content, cloud and games
  • Great Businesses: high margins, fcf, recurring revenue streams, low capex
  • Founder/Operator: focused on creating maximum long-term value
• Tencent’s Long Runway
  • Mobile advertising: $50bn market that is rapidly expanding in China
    • WeChat did roughly $3.5Bn from ad revs in 2017 (FB’s $39Bn or Google’s $95Bn in annual ad rev)
  • Digital content; e-commerce; payments; video games; cloud
  • These are very large and fast-growing markets that Tencent is well-positioned for, but has barely scratched the surface in terms of monetization
• Valuation
  • $475Bn market cap at $50/share
  • $60Bn of excess net cash and investments
  • 2018 P/E (ex-cash): 26x
  • Last year’s earnings growth: 70%
  • Facebook’s valuation: $490Bn market cap at $166/share; 2018 P/E (ex-cash): 20x; last year’s earnings growth: 63%
  • Alphabet’s valuation: $756Bn market cap at $1073/share; 2018 P/E (ex-cash): 23x; last year’s earnings growth: 22%
• Summary
  • Tencent, Facebook, and Google are very reasonably priced given their significant competitive positions and growth potential
  • They have valuation multiples that are similar to firms such as McDonald’s and Coca-Cola
  • Market’s “pendulum” has begun to swung, but hasn’t swung far enough with these stocks

Saber Capital: Discussion with Markel, John Huber

Image Source: Saber Capital Management