Someone asked me about my views on Tencent after I wrote about Alibaba. I have been mulling about it.
I mean how does one actually value a company like Tencent?
It is a Chinese multinational technology conglomerate holding company. Founded in 1998, its subsidiaries globally market various Internet-related services and products, including in entertainment, artificial intelligence, and other technology.
Tencent breaks down its business revenue into three broad categories:
1) Value-added services (VAS)—which consist of the virtual goods the company offers, primarily online video games for smartphones and desktops, such as the hugely popular “Honour of Kings”—as well as the special avatars users can purchase in Tencent’s Qzone social network;
2) Fintech, Business Services, and Others: Mobile Payment Services (Weixin Pay/WeChat Pay), wealth management platform, Licaitong, WeBank, Cloud Services (Tencent Cloud)
3) Online advertising: Social and Other Advertising & Media Advertising.
Tencent Stock Q4 2020 Earnings: What Investors Should Know (read here)
As per the charts below, Tencent Holdings Ltd has been a beneficiary of work-from-home tailwinds for consumers (e.g. playing more games and consuming all forms of entertainment, etc.) and digital transformation initiatives for corporates (e.g. growth in online advertising and increased demand for public cloud services, etc.) last year.
For simplicity’s sake, I will just talk about its VAS revenue ( primarily online video games for smartphones and desktops), which represents approximately 55% of its total revenue. Yes the lion share of its revenue.
Tencent is best known for WeChat, its ubiquitous do-everything app in China, and is the world’s largest videogame company by revenue, with hits such as “League of Legends” and “Honor of Kings.”
It is really technically impossible to break down and discuss about every component of Tencent in a single post.
Incidentally, we can also view Tencent as a tech ‘ETF’ in itself with its many investments in other tech companies. The company has bet extensively on Chinese and overseas startups in areas such as gaming, social media, entertainment and electric vehicles. That strategy has paid off handsomely as investors have bid up stocks in fast-growing tech companies and lapped up initial public offerings.
See below showing Tencent’s expansive portfolio of investments.
Tencent owns 5% of Tesla, 12% of Snap, and 9% of Spotify (including a stake through Tencent Music).
On a recent earnings call, Martin Lau said:
Our M&A strategy has always been trying to invest in up and coming companies which have a great management, who have innovative products, and at the same time, they have synergies with our existing platforms. We now have more than 700 companies.
More than 700 companies!
Tencent has been a major winner for its shareholders in 2020. Its share price rose by +50.7%from HK$375.60 as of December 31, 2019, to HK$566.00 as of December 31, 2020. Tencent Holdings Ltd.’s excellent share price performance in 2020 is understandable, once one looks at the company’s key businesses.
Stock price wise, 2021 is a different story. Year to date, the stock is down approximately 20% from its peak.
In fact, Tencent’s share price has been dropping in the past two months.
Why is Tencent Share Price Dropping?
I personally see it from two angles.
1) Rising interest rates and increased regulatory scrutiny
From how I see it, like most major Chinese tech stocks, especially the dual listed stocks in US and HK markets, their stock prices have been trending down in recent weeks due to a combination of rising interest rates and increased regulatory scrutiny in China and the United States.
China tech stocks down US$732b but may not have hit bottom yet (read here)
To quote the above article: “Tencent Holdings Ltd, Alibaba Group Holding Ltd, Baidu Inc and NetEase Inc – among the earliest Chinese tech companies to enter public markets – still trade at valuations well above levels that marked the bottoms of the last two big downturns. The four stocks fetch an average 23 times projected earnings for the next 12 months, in line with the three-year average, data compiled by Bloomberg show. The ratio dropped to 19 in 2018 and 18 in March 2020.”
Alibaba, Tencent Stocks Dive As US Delisting Threat Joins Crackdown Fears (read here)
On 12 March 2021, the internet giant’s stock fell 4.4% after it was fined by China’s top antitrust regulator for a 2018 investment deal.
2) Lower pace of growth for the company in 2021
This is perhaps a more teething problem.
Tencent acknowledged at the recent earnings call that “all else equal if this year, we’re back in a work-from-office mode, which we seem to be, then I think it will be natural to expect those two trends to temporarily reverse” in 1H 2021. These two trends are “higher game revenue” and “lower revenue for some of our other activities” like “payments and FinTech” due to “work-from-home conditions” in 1H 2020. In other words, Work-from-Home or WFH tailwinds are likely to normalize for Tencent this year, which is a net negative for the company.
In Tencent’s 2020 FIRST QUARTER RESULTS report (released on 13 May 2020): It has highlighted the below.
At first glance, Tencent’s 4Q revenue (released on 24 March 2021) appears great (see below). From a quarter to quarter comparison (4Q2020 vs 4Q2019), VAS business’ revenue actually grew by +28.0% in 4Q 2020.
In fact, Tencent’s overall 4Q 2020 revenue and adjusted earnings met market expectations, but all eyes are on the -6% QoQ decline in revenue for Tencent’s online games business in 4Q 2020.
With respect to performance by business segment, the continued strength in Tencent’s FinTech & Business Services and Online Advertising businesses was partially offset by a slowdown in the growth of its Value-added Services or VAS business. The FinTech & Business Services business saw its segment revenue grow +28.7% YoY and +15.8% QoQ to RMB38.5 billion in 4Q 2020, and the Online Advertising business also did well with its segment revenue up +21.9% YoY and +15.5% QoQ at RMB24.7 billion in the most recent quarter.
In contrast, segment revenue for Tencent Holdings Ltd.’s VAS business, accounting for close to half of the company’s total 4Q 2020 revenue, declined -4.0% QoQ from RMB69.8 billion in 3Q 2020 to RMB67.0 billion in 4Q 2020. On a YoY basis, the VAS business’ revenue growth of +28.0% in 4Q 2020 was inferior as compared to the segment’s top line increase of +37.9% in 3Q 2020. More specifically, the online games and social networks sub-segments of the VAS business witnessed QoQ revenue declines of -6% and -2%, respectively.
Simply put, it is a good set of results, but just not as great as the previous quarters for the VAS business (gaming). There is growth, but not as fast as before. For some, it is just not good enough.
See below: The QoQ VAS revenue growth accelerated in 1Q2020 then decelerated in 4Q2020.
In addition, with the back to work from office theme highlighted since first quarter 2020 (and again in the recent earnings call), the fast growth in VAS segment seems to be stalling (which is also Tencent’s main revenue contributor).
Yeah, for gamers who have been secretly gaming at home during office hours in the weekdays, life is not going to be the same, as more people start to go back to the office full time during the weekdays. Yeah.. probably sucks big time!
Up to 75% of staff can return to office from April 5; working from home no longer default mode (read here)
Actually when I look at the current Price/Earnings ratio and Price/Cash flow ratio of Tencent, it does not appear expensive.
However, when we go down the list and look at the Price/Forward Earnings ratio and PEG Ratio, historically speaking, it is not cheap, rather expensive in fact, relatively speaking – or put it another way – it can do better. I reckon, this is after factoring the lower growth / earnings ahead. Hence, I might think twice before investing a large sum to this stock.
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