Author: Jackie Cameron|
30 January 2012 10:02
Article from Money Web
Allan Gray's offshore manager bets big on Chinese internet stock Sohu.
Orbis, part of South Africa's highly rated Allan Gray investment management organisation, is betting big that Chinese consumers will spend increasing amounts of time and money on the internet. It is holding a massive chunk of Nasdaq-listed Sohu (NASDAQ: SOHU), a Chinese internet stock that many large international fund managers have shunned.
Orbis Funds are the second-largest shareholder in Sohu, owning about 18% of the company, after Sohu chairman and CEO, Charles Zhang, who had a 20% stake, as of 31 December. Sohu was the third-largest holding in the Orbis Asia ex-Japan Equity Fund, which had about US$1,273m in assets under management.
Sohu has been trading around US$60/share (about R475/share) and has a market capitalisation of about US$2.3bn.
It is among China's most frequently visited websites. It competes with Baidu and Google in the online search market. Revenue generators include advertising and virtual games' sales, with subsidiary Changyou China's fifth-largest online game company.
The Sohu share price has taken a beating over the past year. It was roughly half of April's value at Christmas and was still trading at about 30% less than some analysts valued it this week.
The hammering on the stock market translated into a disappointing year for investors in the Asia ex-Japan Equity Fund, which is a Luxembourg Sicav. It ended 2011 about 12% in the red. It has fared better since inception in January 2006, with an annualised return of 8.5%.
That's still better than most investors in regional funds like these. The MSCI Asia ex-Japan Index lost over 17% over one year as of December, and other funds lost even more.
Bermuda-based Orbis is set to keep its dominant presence, already around 8% of net asset value, in the Asia ex-Japan Equity fund for the foreseeable future. Stefan Magnusson, of Orbis Investment Advisory (Hong Kong) Ltd, says in Orbis's latest annual report: "The Funds' large stake in the company reflects our high level of conviction."
Orbis reckons Sohu has unfairly borne the brunt of negative sentiment towards US-listed China stocks. Chinese companies have been in the spotlight over allegations of fraudulent accounting.
Adding to investor caution around Sohu are moves by the Chinese government to tighten up regulation of the internet. Political leadership in Beijing has watched the revolutionary mood spread in north Africa and the Middle East through internet communication and has been taking steps to prevent a similar movement from developing in China.
China is moving to eradicate anonymous microblogging. It has made the technological wall blocking China from much of the world's internet more difficult to penetrate in recent weeks.
It is unlikely these moves will be bad for business in the long run. After all, Chinese consumers don't have any choice and excitement about the internet has only just got started.
Orbis concedes, too, that Sohu has disappointed shareholders lately. Changyou's online game - The Duke of Mount Deer - launched in July "failed to meet lofty pre-launch expectations" while investment in search and online video has proved to be a drag on earnings.
Nevertheless, some of Sohu's investments look like they are paying off. Magnusson notes that Sohu is now ranked third in search and online video in China.
He says Sohu is "poised to capitalise on long-term trends". "We believe Sohu's rapid growth can continue. All of its businesses will benefit from rising internet penetration in China (currently half that of the US), but the search and video business will also benefit from a continued shift to online advertising".
Sohu, although an information technology stock, is actually a direct play on the Chinese consumer, says Magnusson. While Sohu is unloved, many Chinese consumer-oriented stocks have been trading at 30 times earnings, he notes.
Orbis is not alone in salivating over China's long-term consumer trend projections. Nick Price, manager of the Fidelity Funds Emerging Markets Fund, points out that internet penetration in China is less than 40% of the total population.
The country is expected to add about 61m users, roughly equivalent to the size of the UK population, each year until 2015. This offers "a huge opportunity" for internet companies as well as smartphone providers, he says.
Price's colleague, Tom Ewing is even more excited about China. Manager of the Fidelity UK Growth Fund, he says his aim has been to give his fund exposure to the "burgeoning Chinese consumer mass market, where there are many opportunities and valuations are often attractive".
Ewing says frequent cynicism and fear about China in the West "obscure a remarkable growth story where 1.3bn people have got considerably richer and their quality of life has improved immeasurably". He says China is the "greatest feel good story out there".
Orbis's investors will, no doubt, be hoping to feel infused with this feel good factor soon. But, if trends don't unfold as expected, they can draw some comfort from the company's financials. Says Magnusson: "Should our thesis prove wrong, the company's strong balance sheet and excellent free cash flow should provide a degree of protection against capital loss."
Other investors also view Sohu's numbers optimistically. More than 17 brokerage analysts in the US had given it positive investment ratings by late January, according to cnanalyst.com, and it remains among the most closely watched listed Chinese stocks in the US.
Allan Gray's Bermuda-based fund management company isn't the only investor South Africans are familiar with that likes Sohu. The Nasdaq shares are also lurking in Coronation Fund Managers' holdings.
Sohu made up more than 4% of the Coronation Global Emerging Markets Flexible fund's top ten holdings as of the end of December. In June, Sohu made up just under 4% of the fund.
Orbis director William Gray is unperturbed by Sohu's dreadful 2011 market performance. He says, in his December President's letter to clients, that it has been "easy to look foolish" as the owner of shares on the basis of long-term fundamental value.
He reminds his clients, most of whom have remained invested with Orbis for close to eight years, that the greatest rewards often accrue to those who make the most uncomfortable or unpopular investments.
Sohu reports on its fourth quarter and 2011 financials next month (February 6). In the meantime, Sohu looks like one to consider for your equity portfolio if you are considering some exposure to Chinese consumers, are prepared to take on some investment risk and want to emulate a contrarian expert.
Article from Money Web