Tencent Holdings – A Deep Dive
Tencent Holdings, a giant in the Communication Services sector in China, is rated as a ‘BUY’ by OCBC Investment Research. The last close was at HKD 403.80, and the fair value is estimated at HKD 560.00. Tencent’s revenue is in-line with visible growth drivers ahead, bolstered by earnings beat from associates and intact growth drivers. The company is seen as the preferred play in the industry.
Investment Thesis
OCBC Investment Research expects Tencent’s advertising and financial services businesses to be the growth engines over the long term while the domestic gaming business matures. Tencent’s ability to generate sustainable long-term earnings growth is evident amidst the economic recovery in FY23. The development of its own foundational artificial intelligence (AI) model is anticipated to create new business opportunities and sources of cost efficiencies.
Investment Summary
Tencent reported an 8% year-on-year (YoY) revenue rise in 3Q24, aligning with consensus estimates. Key highlights include:
- In-line game revenue growth of +13% YoY.
- A slight beat in marketing (advertising) revenue of +17% YoY, surpassing consensus by 1%.
- A soft Fintech and Business Service (FBS) that increased 2% YoY but missed consensus by 1%.
Advertising revenue was driven by robust growth from Video Account ads (>+60% YoY), Mini Program, and Weixin search (grew more than double YoY). Gross profit margin also met expectations, increasing 3.6ppt YoY to 53.1%. Adjusted net profit and adjusted earnings per share (EPS) rose 33% and 36% YoY respectively, beating consensus estimates by 10% and 11% respectively.
Intact Growth Drivers
Online games revenue rose 9% YoY in 3Q24. The growth of domestic games revenue accelerated from +9% YoY in 2Q24 to +14% in 3Q24, driven by the robust launch of Dungeon & Fighter (DnF) and healthy growth in flagship games such as Honor of Kings and Peacekeeper Elites. Deferred revenue growth further accelerated to 20% in 3Q24. Gross receipts in both domestic and overseas games posted strong momentum. Looking ahead, a strong games pipeline and upcoming updates are expected to support double-digit YoY growth in games in 4Q24 and next year.
The Preferred Play in the Industry
Tencent’s ability to deliver sustainable quality earnings growth amid a challenging macro backdrop is evident. The company has been able to expand margins, suggesting that management’s focus on high-quality revenue streams is effective. Despite robust growth so far year-to-date, growth drivers in games, advertising, and margins are expected to sustain growth into next year. Tencent is on track to achieve the >HKD100b share buyback target, with 3Q24 share buyback amounting to HKD36b. Management is committed to enhancing shareholders’ return. The stock is trading at an undemanding valuation of 15x forward price-to-earnings (P/E), which is below historical average levels since 2023. The fair value estimate is revised to HKD560.00 based on sum of the parts (SOTP) methodology, implying a 21x forward P/E.
ESG Updates
Perceived Risks Tied to 2022 Layoffs
Layoffs in the tech sector surged in 2022 through 2023. Tencent laid off around 7,000 employees in 2022, which may lower morale and lead to perceptions of job insecurity among employees. The company also faces allegations of regulatory lapses related to its payment services in China, resulting in a CNY2.9b fine by the People’s Bank of China in 2023.
Corporate Governance
Tencent’s corporate governance is average relative to global peers. It provides detailed disclosures on executive pay. Following the retirement of a former executive director, the board is no longer flagged for overboarding. However, potential board entrenchment concerns remain, with four directors being long-tenured as of July 2023. Tencent handles large volumes of end-user data and may face data privacy-related risks, particularly in markets like China where data privacy laws can be stringent.
Potential Catalysts and Investment Risks
Potential Catalysts
- Payment/cloud/subscription business could grow faster and be more profitable than anticipated.
- International expansion could reignite growth in users and engagement.
- Advertising could scale faster than projected, resulting in better growth and earnings.
- Shorter/shallower-than-expected investment cycle.
Investment Risks
- Operations in highly sensitive areas could see a clamp down from the Chinese government or other regulatory headwinds.
- Poor performance of legacy games or pipeline disappointment could result in a drastic revenue slowdown.
- Prolonged macro challenges.
Valuation Analysis
OCBC Investment Research presents a comparison of Tencent Holdings with its industry peers, including Baidu Inc, Meta Platforms Inc, and Alphabet Inc. The analysis covers various financial metrics such as Price/Earnings, EV/EBITDA, Return on Equity (ROE), and Dividend Yield.
| Company |
Price/Earnings (2024E) |
Price/Earnings (2025E) |
EV/EBITDA (2024E) |
EV/EBITDA (2025E) |
ROE (%) (2024E) |
ROE (%) (2025E) |
Dividend Yield (%) (2024E) |
Dividend Yield (%) (2025E) |
| Tencent Holdings Ltd (700 HK) |
16.7 |
15.1 |
14.7 |
13.4 |
1.1 |
1.3 |
20.8 |
19.9 |
| Baidu Inc-Class A (9888 HK) |
8.0 |
7.9 |
5.0 |
4.1 |
0.0 |
0.0 |
8.6 |
8.2 |
| Meta Platforms Inc-Class A (META US) |
25.3 |
22.6 |
16.1 |
14.0 |
0.3 |
0.4 |
34.7 |
31.1 |
| Alphabet Inc-CL A (GOOGL US) |
22.3 |
20.0 |
15.0 |
13.1 |
0.3 |
0.4 |
31.9 |
29.6 |
Company Overview
Tencent’s communication and social services, Weixin and QQ, connect users with each other and with digital content and services, both online and offline. Its targeted advertising service helps advertisers reach out to hundreds of millions of consumers in China. Its fintech and business services support partners’ business growth and assist their digital upgrade. Tencent invests heavily in talent and technological innovation, actively promoting the development of the Internet industry. Tencent was founded in Shenzhen, China, in 1998. Shares of Tencent (00700.HK) are listed on the Main Board of the Stock Exchange of Hong Kong.
FY23 Revenue Breakdown
Source: Bloomberg
FY23 Gross Profit Breakdown
Source: Bloomberg
Gross Profit Margin by Segment
Source: Bloomberg
Non-GAAP Operating Margin
Source: Bloomberg
Company Financials
Source: Bloomberg
Income Statement
| In Millions of CNY except Per Share |
FY 2019 |
FY 2020 |
FY 2021 |
FY 2022 |
FY 2023 |
| Net Revenue |
377,289 |
482,064 |
560,118 |
554,552 |
609,015 |
| – Cost of revenue |
209,756 |
260,532 |
314,174 |
315,806 |
315,906 |
| Gross Profit |
167,533 |
221,532 |
245,944 |
238,746 |
293,109 |
| + Other operating income |
4,263 |
7,922 |
10,117 |
11,119 |
10,285 |
| – Operating expense |
60,430 |
53,939 |
(8,249) |
139,986 |
143,866 |
| Operating Income or Losses |
111,366 |
175,515 |
264,310 |
109,879 |
159,528 |
| – Net interest expense |
1,299 |
930 |
464 |
760 |
(1,540) |
| – Foreign exchange losses (gains) |
(77) |
438 |
(804) |
(633) |
383 |
| – Net non-operating losses (gains) |
(5,570) |
(12,832) |
9,938 |
(109,065) |
(14,447) |
| Pretax Income |
109,400 |
180,022 |
248,062 |
210,225 |
161,324 |
| – Income tax expense (benefit) |
13,512 |
19,897 |
20,252 |
21,516 |
43,276 |
| Income Before XO Items |
95,888 |
160,125 |
227,810 |
188,709 |
118,048 |
| – Extraordinary loss net of tax |
– |
– |
– |
– |
– |
| – Minority/Non controlling interests (credits) |
2,578 |
278 |
2,988 |
466 |
2,832 |
| Net Income/Net Profit (Losses) |
93,310 |
159,847 |
224,822 |
188,243 |
115,216 |
| Net Inc Avail to Common Shareholders |
93,310 |
159,847 |
224,822 |
188,243 |
115,216 |
| Abnormal losses (gains) |
(15,644) |
(51,877) |
(131,051) |
(119,949) |
8,972 |
| Tax effect on abnormal items |
3,911 |
12,969 |
(4,133) |
(7,979) |
(666) |
| Normalized Income |
102,378 |
118,803 |
90,655 |
57,828 |
123,529 |
| Basic Earnings per Share |
(1.7) |
8.4 |
32.7 |
(2.3) |
6.6 |
Profitability Ratios
| Profitability Ratios |
FY 2019 |
FY 2020 |
FY 2021 |
FY 2022 |
FY 2023 |
| Returns |
Return on Common Equity |
24.7 |
28.1 |
29.8 |
24.6 |
15.1 |
| Return on Assets |
11.1 |
14.0 |
15.3 |
11.8 |
7.3 |
| Return on Capital |
16.3 |
19.0 |
20.9 |
16.8 |
10.6 |
| Return on Invested Capital |
15.4 |
17.5 |
21.5 |
8.4 |
9.7 |
| Margins |
Operating Margin |
29.5 |
36.4 |
47.2 |
19.8 |
26.2 |
| Incremental Operating Margin |
29.4 |
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