- Fantastic company to own with great growth prospects
- Wheel-and-spoke model driven by Weixin and synergies from AI
- Fantastic growth in Cloud, Payments, and Online Advertising
- Weixin still showing Monthly Average User (MAU) growth
- Average Analyst Target Price: HK$381 implying 9.2% upside
Tencent Holdings Ltd. engages in the provision of value-added services. It operates through the following segments: Value-added Services, Online Advertising, and Others.
- The Value-added Services segment involves online and mobile games, community value-added services, and applications across various Internet and mobile platforms.
- The Online Advertising segment comprises of display based and performance based advertisements.
- The Other segment consists of trademark licensing, software development services, software sales, and other services.
The company was founded by Yi Dan Chen, Hua Teng Ma, Chen Ye Xu, Li Qing Zeng, and Zhi Dong Zhang on November 23, 1999 and is headquartered in Shenzhen, China.
- QQ // 850MM MAUs
- Weixin/Wechat // 963MM MAUs
- Mobile payment (Weixin/Tenpay/QQpay)
- Tencent Games
Weixin Apps provide businesses with official portals within the Weixin ecosystem. These are the equivalent of company websites and are far more important.
Mini Apps are lighter-weight version of the Weixin Apps. They're designed to handle single purpose needs, rather than be a fully-fledged portal. This could be the gateway to better integration with offline services. As of Jan 2017 the services already has over 2,000 SMEs on the Mini platform.
The Mini Programs will enhance Tencent’s payment ecosystem, drive more time spent with WeChat, and over time improve the user experience as Mini Programs are download-free, have shorter loading time, and require fewer clicks. The low cost of developing Mini Programs should help Tencent to further expand among China’s 70mn+ SMEs and individual merchants, and both SMEs and consumers should gain from a better user experience in Mini Programs compared to Official Accounts as well as a smoother payment solution compared to native apps.
Other Business Lines
In recent years Tencent have been pushing their Tencent Cloud computing business.
They made a ballsy call to bit RMB0.01 for a major government project which annoyed competitors but gives the company a foot in the door. The government has made it clear that they aim to move many major operations to the cloud so this has the potential to be a huge market in the coming years. Getting in early gives Tencent an advantage in this regard.
In the corporate sector, however, they lag behind AWS, Baidu Cloud and a more recent entrant, Huawei Cloud
- JD.com (b2c e-commerce) // 258MM MAUs // Rev RMB260bn
- Meituan (group buying) // Rev USD6.42bn
- Supercell (mobile gaming) // Rev EUR2.1bn, Income EUR916mn // Leage of Legends
- Riot Games (pc gaming) // Rev USD1.6bn // Clash of Clans
Riot games founders have recently handed League of Legends product management/development to the company's COO and CFO. They are allegedly working on a new AAA title, the company's first. Until now the company has only made some smaller titles and table-top games. League of Legends revenues are still growing so it's not in risk of decline. The optionality of a new AAA title to the mix add upside optionality to PC gaming revenues.
Tencent operates a wheel-and-spoke model. In the centre is Weixin and each of its spokes benefit from it.
Tencent is a modern digital conglomerate. Each of its divisions gives it strong synergies with others, especially with its audience reach via Weixin, giving it unprecedented up-selling capabilities. In addition, each of the major digital industries Tencent is making headway in, are still in their infancy. These two factors are at the heart of the long thesis for Tencent.
Weixin as an ecosystem
Weixin remains the crown jewel of the company. The huge user base gives it many options for monetisation and cross-promotion of new products. With the push towards AI based advertising we're likely to see continued growth in revenue from this segment.
Tencent operates a wheel-and-spoke model. In the centre is Weixin and each of its spokes benefit from it. At a very basic level, distributing and promoting its other business lines to its massive Weixin user-base is hugely valuable. However the almost every segment benefits from synergies with Weixin beyond this.
With P2P payments leading the preference for mobile wallets, Weixin is in a dominant position to make WeChat pay the de-facto O2O payment standard by integrating it with TenPay. It face stiff competition from AliPay however there is a one clear differentiator between the two–while AliPay is focused on replacing traditional financial networks, TenPay (enabled by WeChat Pay) is taking a mobile-first approach. As long as there is interoperability it's possible that there is room for both in the market.
O2O / Strategic Partnerships
With strategic partnerships with companies like Didi, JD.com, and Meiuan, Tencent's dominance with Weixin means it can become the de-facto gateway for Online-to-Offline O2O commerce.
Although off from a low key start, Tencent-JD’s Jing-teng Initiative (京腾计划) has great potential. Jing-teng is an initiative in which Tencent opens up its social network intelligence to JD in exchange for JD’s advertising. JD gets the GMV. Jing-teng GMV is estimated to grow at a CAGR of 25% to 2019, making brand social e-commerce the largest sub-segment within social e-commerce. By 2019, 8.7% of JD’s GMV could come from social networks. From JD’s point of view, it probably wants to build its own source of traffic and reduce its reliance on Tencent. But it is probably inevitable that its traffic source will increasingly come from Tencent’s social ads.
AI Driven Advertising
A few years ago Tencent was not a major destination for advertisers. However it has now surpassed both Sina and Youku for portal and video ads respectively. This advantage is only growing as Tencent applies machine learning to its Weixin users to predict user trends and intelligently match more relevant ads to users through its ecosystem. It has been gaining steam across all its segments– from in-game ads to Weixin Moments.
Similar to AI driven advertising, Tencent can use machine learning to find key user trends and forecast digital content demand via Weixin. This means it can license or create its own digital content to match this demand and have a much higher rate of success than traditional digital media.
Major Segments Still in Infancy
Digital/Social Media Advertising
Not unlike Facebook in the West, social media advertising is still in its early stages. As Moments increases in popularity the market will only grow.
In addition, ad revenues from sources such as video and gaming are still growing at a fast pace.
Despite the recent upsurge in activity, mobile payments are still the in the minority of cash transactions. With the blessing of the Government its virtually inevitable that China will move to a cashless society and Tencent are positioned to be one of the big beneficiaries, along with AliPay.
Further, the move to O2O, enabled by its strategic partnerships will accelerate the use of mobile-payments for such services. The more O2O that is conducted through Weixin, the more dominant this position becomes. Again, the market is still in its infancy.
With Tencent increasingly taking a Netflix approach to content, its been consistently growing its revenues from this segment. Compared to the developed world China still has low digital spend per capita and still has plenty of room to grow.
In recent years the professional eSports space has been gradually shifting from PC games to mobile games. Tencent has plenty of knowledge of eSports via Leage of Legends so between its great domestic success and purchase of Supercell, Tencent is well positioned for this shift from desktop to mobile eSports.
The government has made it clear that they aim to move many major operations to the cloud so this has the potential to be a huge market in the coming years. Getting in early gives Tencent an advantage in this regard.
As cloud becomes the de-facto IT solution for both large firms and SMEs this sector has a lot of growth in it. Tencent have good experience rolling cloud application via its other divisions–the major challenge is whether it can successfully tailor its offerings to an enterprise client base.
Risks to thesis
Inability to create new DLC or smash hits in the gaming division. While the foreign market is diversified between Supercell and Riot, the domestic market relies heavily on self-developed games. This is somewhat mitigated by Tencent's willingness to distribute/license 3rd party developed games.
Critically, the eSports market tends to disproportionately rewards the top game in the genre, rather than spread it more evenly across similar titles in the same genre. This means that failure to maintain a top 2 position in any major genre (FPS, RTS, MMORPG) can quickly lead to a drop in revenues.
It really becomes a winner-take-all market. AliPay has always been the market leader.
Social Media Advertising
Inability to use machine learning to improve targeted Ads
Media Investments Failing
In order to keep up the pace of media subscriptions, Tencent will need to make large investments into acquiring or creating media. This is a similar position to Netflix. Failure to acquire media that will drive subscriptions could mean large expenditure with no return. We believe this risk to be tied to Tencent's ability to successfully use machine learning on its Weixin user-base and predict market demand for digital media.
With the exception of respective cash-cow businesses of game and e-commerce, Tencent and Alibaba have been at war in almost every subsector of Chinese Internet. In previous years Alibaba has mounted attacks on Tencent’s Weixin Payment by giving away Rmb600mn of Red Packets during the Chinese New Year.
Given the diverse nature of the businesses, the best way to value Tencent is with Sum-Of-The-Parts (SOTP) methodology. The company provides a good enough breakdown of the individual segments so we can model the segment growth and apply an industry–peer based multiple to each segment to come up with a final valuation. As this is not investment advice we refrain from making a recommendation or target price. The average analyst target price is HK$381 implying a 9.2% upside to its current price.
Tencent has had a fantastic run after beating expectations last quarter. Despite the big run up the stock still trades below average analyst targets as it has a huge moat in Weixin which drives prospects across all business lines. Successfully applying AI to Weixin will amplify these benefits and allow Tencent to stay in a dominant position within the Chinese market.
Consider running a SOTP analysis on individual business lines and apply your own multiples to come up with a fair price vs. the current price.
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