Tencent Holdings Ltd (700:HKG)
Key information
Investment recommendation: Buy
Current price (US$): 55.24
Target price (US$): 60
52-week price range (US$): 23.00 – 56.05
Market cap (US$ bn): 521.394
Tencent Holdings Limited (700:HKG) is an investment holding conglomerate headquartered in Shenzhen, China. Its subsidiaries provide media, entertainment, payment systems, smartphones, internet-related services, value-added services and online advertising services. Tencent has a global presence with a focus on the Asia-Pacific Region. While uncertain global politics will potentially continue to increase market volatility, we are overweight on Tencent and credit it to remain resilient yet capture and take advantage of future sources of growth.
Investment Thesis
Tencent’s biggest asset is its ecosystem consisting of different products and services, which hedges the company against different market risks. Despite facing a slowdown in key user metrics that is inevitable as WeChat, one of Tencent’s key engines for success, reaches saturation in the Chinese market, the company is trying to leverage its ecosystem in order to offset this – through continuing to build out its portfolio of holdings in public companies such as Snap Inc. as well as private firms in the entertainment, technology, online-to-offline, and Internet sectors. These investments are an integral part of the company and fall under operating profit, lumped in with its advertising and gaming businesses. To further highlight their importance, Tencent beat operating profit estimates for a third consecutive quarter. Its most recent quarter, 3Q17, shows a 57% YOY jump in operating profit to $3.43bn.
Secondly, the company revealed that the number of monthly active users of its core operating platforms (Weixin and WeChat) exceeded 899 million in 2016, an increase of 28% from the previous year. Tencent exceeded Facebook's (NASDAQ:FB) peak growth rate of 25% in 2012 that has since then decelerated to 17% in 2016. The company is likely to exceed these figures using its second key success engine, gaming, with its plans to dominate the violent virtual fights gaming market. Tencent’s 3Q17 results point out that gaming revenue had risen to 80% YOY due to the success of ‘Honour of Kings’, the world’s most lucrative video game that attracts up to 80 million players daily. This strong position has also been reflected in the financial markets this November, as Tencent’s market capitalisation reached $500bn and exceeded that of rival Alibaba’s $484.19bn.
Adding to Tencent’s resilience and potential for future growth, it posts strong financials and fundamentals. Tencent has experienced strong revenue growth, with a CAGR of more than 40% between FY2011/12 and FY2015/16. Furthermore, Tencent has a good dividend track record; in 2016 it reported a dividend of 0.55 CNY, which represents a 38.73% increase over last year. While its dividend payout ratio remains at 9%, over the last 5 years Tencent’s average dividend per share growth rate was 31.20% per year. Compared to previous year's figures, revenue grew almost 48% and GAAP diluted EPS increased by almost 42%.
Catalysts
The Chinese music streaming market is a key catalyst for Tencent’s future growth. In 2016, China’s recorded music revenue growth far outpaced the global average of 5.9%. We believe that China presents a music market with vast untapped potential, with a population that is over three times bigger than that of the United States. Also in 2016, China rose up by two positions in the music market rankings since the previous year. Now ranked at 12th place, we believe that it quickly approaches to break into the top 10 of the music market in terms of recorded music revenue. The Chinese government's crackdown on piracy and rising incomes among China’s music users are two factors that are leading to a rise in the national digital music services. Tencent is currently dominating this market, which leads us to believe that it is in a prime position to benefit from this rise.
Investment risks
So far, Tencent and other big and successful Chinese Internet companies have greatly benefited from the communist party’s efforts to exclude Silicon Valley’s champions. However, state protection also brings downsides as it stops Chinese enterprises from being truly competitive. Success within the state-censored ‘intranet’ of China is believed to make Tencent, as well as many other sector champions complacent and liable to hugely overspend on overseas acquisitions. Take Tencent’s WeChat for example, while we recognize that this messenger app is better than most similar services we also recognize that it is not a ‘game-changer’. In Hong Kong, where the political and legal system is separate from the rest of China, residents overwhelmingly prefer WhatsApp to WeChat. We see how this could act a barrier to achieving success in markets abroad as Tencent starts to expand into Southeast Asia and Eastern Europe. Yet we believe that although it is natural for Tencent to face some challenges initially, the company holds the resources that are required in order to overcome these challenges and enhance its competitive position.
Despite the current macroeconomic uncertainty, we feel that there are significant opportunities for returns in Emerging Markets. Tencent is one company that we believe is well positioned and will continue to generate returns due to its dominant position in the gaming market, resilient ecosystem and strong financials. Hence, we are overweight on it.
References:
1.https://www.ft.com/content/94cf0d86-cb71-11e7-ab18-7a9fb7d6163e
2.https://seekingalpha.com/article/4038992-tencent-one-best-chinese-companies-market-right-now
3.https://www.reuters.com/article/us-tencent-results/tencents-focus-on-digital-content-after-stellar-third-quarter-idUSKBN1DF15A?feedType=RSS&feedName=businessNews&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+reuters%2FbusinessNews+%28Business+News%29
4.https://www.ft.com/content/1d9fd50c-cddc-11e7-b781-794ce08b24dc
5.http://www.schroders.com/en/mt/professional-investor/insights/markets/outlook-2017-emerging-market-equities-0004-006/
5.https://www.bloomberg.com/press-releases/2017-11-15/tencent-announces-2017-third-quarter-results
6. https://en.wikipedia.org/wiki/Tencent
7. http://uk.businessinsider.com/chinas-tencent-seeks-growth-abroad-2017-4?r=US&IR=T
8. https://www.bloomberg.com/news/videos/2017-11-16/tencent-posts-61-rise-in-3q-revenue-video
9. https://seekingalpha.com/article/4108443-dominant-tencent-poised-benefit-chinas-growing-music-market
10. https://www.ft.com/content/76bece9a-81a1-11e7-a4ce-15b2513cb3ff