The Financial Times reports that "Alibaba and Tencent account for 40-50% of venture capital flows in mainland China". ![]() Tencent has morphed, together with Alibaba, into somewhat of a venture capital firm in China. This margin compression is likely to be an ongoing theme as growth in gaming revenue (Tencent’s core business) slows and this will likely see negative sentiment persist with further repricing of Tencent shares. Tencent’s heavy investments in new areas like cloud computing, AI, and offline retail are sacrificing margins in the short term but will drive long-term growth and shareholder value. Tencent is a network of complementary businesses, venture capital, social media, gaming, Tencent Cloud, Tencent Music and WeChatPay. Tencent has long-term prospects in payments, AI, cloud computing, advertising and media. In the next five years, gaming revenue is unlikely to be the central revenue driver. It is worth noting that price/book value is still excessive and a 168% premium to Chinese tech peers.Īlthough gaming accounts for 60% of revenue now, there are other areas of the business that provide long-term growth opportunities for Tencent. Trading at 22x forward earnings, as the share price continues to fall, and Tencent’s earnings and equity continues to rise, the trend will not be sustainable. For the quarter ending June 30, Tencent experienced top-line growth of 30.2%. Accelerating revenue growth is indicative of Tencent's increasing ability to monetise its social media, gaming, and advertising product offerings. However, estimated revenue growth is forecast to grow 34% for the next three years, and EPS growth is forecast to expand in excess of 20% for the next three years. This represents an approximate 38% premium. Source: BloombergĪs Garnry says, despite the recent re-rating Tencent still trades at a valuation premium to Facebook when compared FY18 EV/EBITDA ratios 19.6 vs 12. This premium is now the lowest since 2012 which may present an opportunity for long-term investors. As the graph below shows, historically, a basket of Chinese tech companies trades at a valuation premium to US tech when comparing P/E ratios. ![]() The pace of growth is not meeting expectations, highlighting that Chinese economic growth has weakened, so despite Tencent being one of the fastest-growing technology companies in the world the market is repricing the stock. The market is revaluing Chinese tech stocks based on a slowing growth trajectory rather than a structural problem within the sector. Now that actual growth is no longer meeting expectations, we are seeing a repricing across the sector as a whole. The valuation of Chinese tech has been extreme relative to the US. More clarity is needed on the regulatory environment and how this will affect the business model long term before calling a bottom. Without a resolution of the regulatory risks it is likely Tencent will remain under pressure. This highlights the nature of Tencent’s current problems are due to temporary issues as opposed to structural issues. Tencent ranks first in gaming revenue globally and maintains a 52% revenue share of China’s gaming market according to iResearch. Given that this is likely to be a temporary issue, it is prudent to focus on the fundamentals for the business when making a long-term investment decision. It is impossible to predict the timing of regulatory easing without insight into the Chinese regulatory bodies, but it is highly likely resolution will prevail. Given gaming accounts for 60% of Tencent’s revenues and without a resolution enabling Tencent to monetise new games, there is risk of another weaker quarter of growth when Tencent next reports. This was likely the key negative factor, rather than a structural decline in growth due to China’s economic outlook and the trade war, although this has certainly weighed on sentiment.Īuthorities have given little indication of when the ban will end ![]() Tencent’s profit fell 2% to 17.9bn yuan while revenue increased 30% to 73.7bn yuan, failing to meet analyst estimates.Īs Saxo Head of Equity Strategy Peter Garnry noted, the weaker-than-expected numbers came on top of Beijing freezing game approvals nationwide due to the government’s intention to increase oversight over gaming and potential addiction among the population. Tencent has extended losses since posting its first profit drop in 10 years in August 2018.
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