Tencent Holdings
By Rebecca Ellis
THUR, JANUARY 18 2018-theG&BJournal-Tencent is a Chinese Internet titan. It runs the largest gaming enterprise worldwide, dominates the Chinese social media scene, and holds investments in numerous companies around the globe. With a USD 537 billion market cap it is nearly on equal footing with Facebook. It also has the potential to grow much larger. Tencent serves a massive audience — including nearly 1 billion monthly active users on its WeChat and Weixin messaging platforms. Tencent was founded in 1998 by a group of technologists, including Pony Ma, who’s still CEO today.
Tencent operates in four main business lines:
-Online Games: Tencent is the largest gaming company in the world, with a massive collection of PC and mobile games. The entire video-game industry is growing as more people play more games more often, and Tencent is riding that wave. We should expect Tencent to begin taking more of its own games international — including the smash hit Honor of Kings.
-Social Networks: QQ has an impressive 850 million monthly active users (MAUs), but the real story is WeChat, with 963 million MAUs. WeChat was created to be Tencent’s dominant mobile platform. It made social networking a feature, rather than the sole function, paving the way for new types of interactions (with businesses, celebrities, friends) with a built-in payments infrastructure. As such, most of WeChat’s revenue is from paid digital content services (live streaming, video, music, virtual items). WeChat is quasi a monopoly.
-Online Advertising: Ads are placed within WeChat, but they are also placed among Tencent’s other popular services, like Tencent Video and Tencent News. The company is attempting to be the leader across video, news, music, literature, and more; as popularity grows, ad dollars will follow. Advertising should also become more effective as Chinese per capita wealth expands.
-Other: This primarily includes Payments and Cloud. For years, Alibaba’s AliPay has dominated China’s mobile-payments industry. However, in just three years, TenPay (or WeChat Pay) has grabbed more than one-third of the market. It is still smaller than AliPay, but it is growing fast, and most everyone uses WeChat. Cloud is also a fascinating business to watch. Companies like Tencent are decently positioned to become truly competitive.
Tencent continues its rapid growth. The WeChat ecosystem is particularly strong. Not only were active users up nearly 16% year-over-year there, but Tencent continues to add features that enhance both usability and monetization. This is reflected in the company better than 30% profit margin, which remains stable despite attempts by competitors to copy some of Tencent’s functionality.This all has the company on track to generate more than USD 12 billion of free cash flow this year — capital it can use to reinvest in future technologies such as AI and Tencent Cloud that will support its next decade or more of growth in China.
Tencent is not cheap. The stock is currently fetching more than 14 times sales and 50 times earnings. But there is little doubt that this is a premium business with a massive market share in China’s online economy — a market that would still have to grow 5 to 10 times in value to catch up to monetization levels in the US. Although paying up for Tencent could lead to volatility down the line, particularly given recent efforts by the Chinese government to further regulate the company and even take an ownership stake, the stock remains a compelling long-term opportunity.
It is reasonable to predict that earnings could nearly double in the next couple of years, and triple within the next five. Non-GAAP net profit to shareholders grew 45% last quarter, and although that pace should slow, there is still plenty of room to rise. In reality, Tencent has what it takes to be one of the first trillion-dollar companies.
The main risk investing in Chinese companies is the standard Chinese government crackdown risk. Tencent is cooperative, but if the government decides to more seriously alter what content it allows across Tencent’s properties, the negative ripple effects could be significant. Still, we expect Tencent’s already dominant position to grow stronger and its sales and earnings to soar higher.
Rebecca Ellis A Personal investment advisor, based in Zurich| REBECCA.ELLIS@POMOMAWEALTH.COM|
