Tencent: Meet the most valuable company in Asia

History: Early days and growth of main businesses

Tencent Inc. was founded in November 1998 by Pony Ma, Zhang Zhidong, Xu Chenye, Chen Yidan, and Zeng Liqing.

The company was incorporated immediately in the Cayman Islands, and venture capitalists provided initial funding.

In February 1999, the instant messaging service QQ was launched. The platform’s name was OICQ, but following a lawsuit threat from AOL, it was changed quickly to the current.

During the first three years of its existence, Tencent remained unprofitable. In 2001 the company, after several implementations to QQ, reaches the interest of South African internet media company Naspers that acquires a 46.5% stake.

In 2003, Tencent slid into the gaming industry by starting an online game platform, using the popularity reached by QQ among the general public. It’s called QQ Games.

The bet yields excellent results, as in less than a year the gaming platform becomes the #1 casual game portal in China.

Tencent Holding Ltd is listed on the Hong Kong Stock Exchange on 16th June 2004, with an IPO price of 0.779 HKD/share.

2005, Tencent enters other lateral markets: the group launches QZone, a social networking service, and QQ Music. December sees on the market also QQ Fantasy, the first in-house developed MMOG (Massively Multiplayer Online Game).

In this year, the group also seeks other revenue streams from existing platforms.

Until 2005 the only income produced was through advertising and a “premium” subscription model for QQ, where clients paid for extra features.

In 2005 Tencent introduced significant changes: QQ mobile becomes paid, and the iconic penguin (logo of QQ) is licensed for snack food and clothing.

QQ.com is the largest portal in China since 2006. The popularity achievement allows Tencent Holding Ltd to be included as a Hang Seng Index Constituent Stock in 2008, with a high price of 13.826 HKD/share (+1,675% since the initial listing in 2004).

Between 2007 and 2008 the videogame division of Tencent grows exponentially thanks to a more comprehensive offering, reached by licensing games and developing its own.

These efforts lead Tencent to be the largest online game platform in Mainland China in 2009 when it also debuts international markets.

WeChat, the internationally known Chinese WhatsApp, is launched on 21st January 2011. Previously introduced as “Weixin”, the social media app has now over 1 billion monthly active users.

External growth and investment phase

Tencent starts investing in the American videogames developer Riot Games in 2008. On 18th February 2011, the group reached a 92.78% interest with about $230 million. The full acquisition of the company will take place only in December 2015.

In June 2012, the Chinese group bought a minority stake in Epic Games.

In 2013, Tencent reached 18% of Kingsoft Network Technology. In the meantime, the group assists in the splitting of Activision Blizzard from Vivendi as a passive investor.

In September of the same year, the group acquires a minority share in the Chinese search engine Sogou.com, a subsidiary of Sohu, Inc.

Tencent launches Weixin Pay, Tencent Cloud services, and Weixin and QQ mobile game centers, becoming the world’s largest online game developer and publisher by revenue.

2014 is an incredible year for Tencent’s growth.

The month of January opens with an acquisition in the logistics and warehousing sector, China South City Holdings Ltd. The value of the operation reaches $193.45 million.

In February, Tencent purchases a 20% stake in restaurant ratings and group buying website Dianping for $400 million.

The Chinese group buys a 15% interest in JD.com (pre-IPO), handing over its e-commerce businesses Paipai, QQ Wanggou, and Yixun to build a stronger competitor against Alibaba.com.

JD.com benefits from this partnership also by gaining prioritized access to Tencent’s WeChat and QQ. If interested, we recently also analyzed JD.com. Click here and go check it out after this one!

Right after JD’s listing on NASDAQ in May, Tencent grows its stake to a 17.43%.

In March, Tencent buys 28% of South Korean company CJ Games for about $500 million.

The group continues shopping for businesses with a healthy growth outlook: in June the holding acquires a 19.9% stake in 58.com (WUBA), a Chinese e-commerce website, for $736 million. Less than a year after, the company will reach a 25% stake.

October sees an outflow of the capital of more than $200 million, spread over two deals: Tencent acquires a 7% stake in lottery technology firm China LotSynergy Holdings Ltd for $ 57.4 million and a 10% stake in Chinese mobile shopping portal Koudai Gouwu for $ 145 million.

In November, Tencent reinforces its media coverage by announcing a deal with HBO, an American pay television network, that would give exclusive rights for distribution in China.

To end 2014 coherently, Tencent invests $700 million, together with Singaporean Temasek Holdings, in the Chinese taxi-hailing app Didi Dache.

Snowball effect: Tencent doesn’t stop investing. Globally.

As a clear primer for innovation, the group launches in January 2015 China’s first online-only bank, with the name of WeBank.

On the wave of November 2014’s deal with HBO, Tencent replicates with the NBA. With a $ 700 million contract, the Chinese group gets the exclusive rights for streaming American Basketball games in the Celestial Kingdom from February 2015.

BYD, a Chinese car manufacturer, will become later that year the official sponsor for Tencent’s NBA broadcasts.

The group, to better organize the movie and media businesses, establish Tencent Pictures and Penguin Pictures. While the first one produces movies of any kind, the second focuses on online drama and small investments in feature films.

In June 2016, to ampliate the video games development international coverage, Tencent buys 84.3% of the Finnish Supercell with an $ 8.6 billion transaction. Supercell has developed some of the most successful mobile games of recent years, like Clash of Clans, Hay Day, and others.

The Chinese holding founded the Tencent Music Entertainment Group (TME), officially entering the music industry and reinforcing its position in the market’s amusement segment. This move is primed by the acquisition of a majority stake in China Music Corporation in July 2016.

Tencent enters another business sector, by co-founding WeSure, an insurance platform, in October 2016.

At the end of 2016, the group now turned virtually into a Venture Capital, is involved in another transaction. Together with Foxconn and luxury car dealer Harmony New Energy Auto, Tencent founds Future Mobility, a car startup that aimed to sell all-electric fully autonomous premium cars in 2020.

During the first months of 2017, the company also acquires a 5% interest in the American counterpart Tesla Inc., for $1.78 billion.

May 2017 sets three crucial milestones for Tencent: the first being that WeChat implements a search engine to challenge the “Chinese Google” Baidu. Moreover, the holding enters the world’s top 10 most valuable companies, and the gaming division enters an agreement with the Wuhu City Council to build the world’s first eSports town.

This project comprises an eSports theme park, an eSports university, and a collection of other themed service centers.

China Literature, a subsidiary of Tencent operating as an online publisher and e-book company, is listed on the main board of HKSE with the stock code 0772.HK, with an IPO price of HK$ 55/share.

In July 2017 another acquisition for the gaming department: Tencent buys a 9% stack in Frontier Developments.

After being offered to the market in March 2017, the American social network company Snap Inc. attracted Tencent’s interest after the stock price halved in the first months. During the month of November, the Chinese group took action when it bought a 12% stake in the open market, intending to turn Snapchat into a gaming platform.

Shortly after, Tencent enters the top 5 list of the world’s biggest firms and announces Tencent Video: a Chinese version of Youtube. The total subscriptions of the portal will top 100 million in Sep 2019.

The Lego Group and the Chinese player team up in January 2018 to develop online games and potentially a social network aimed at children.

Then, Tencent led also a $5.2 billion investment in Wanda Commercial, together with JD.com, Sunac, and Suning Group. Then, the group proceeded to buy a 5% to 10% minority stake in Skydance Media.

In January 2018, Tencent and Carrefour reached a strategic cooperation agreement in China. The same happened in September, this time with Luckin Coffee.

In December 2018, Tencent Music Entertainment Group (NYSE: TME) was listed on the NYSE, and the total daily transaction volume of Tencent’s mobile payment services exceed $ 1 billion.

On 29 June 2020, Tencent acquired the Malaysian video-on-demand service iflix.

During the month of September 2020, Tencent picked Singapore as its Asian hub.

Structure of the company

Given the incredible amount of businesses in which Tencent invests, the company structure is fragmented but not disorganized.

The official website represents Tencent’s structure, as shown above, in a synthetic way.

Here’s an explanation of all the different holding’s business sections, with core investments and characteristics.

• Corporate Development Group (CDG): This department specializes in new business incubation and exploration. CDG is responsible for promoting development and innovation for financial technology and advertising and marketing services, payment, and financial applications.
  This platform also supports the company in strategic planning, investments and mergers, investor relations and corporate communication, marketing, and more.

• Cloud & Smart Industries Group (CSIG): With this business part, Tencent explores the interactions between users and industries to create innovative solutions. It employs several cutting-edge technological advancements, such as cloud, AI, and network security.
• Interactive Entertainment Group (IEG): the part of the group involved in games and e-sports. This group takes care of R&D, operation of the entertainment contents, and development of games. Note that Tencent Music and Tencent Video are technically not in this Group, because they were spun off and listed in 2018.
• Platform & Content Group (PCG): Responsible for the company’s internet platform and content development. This department integrates social media such as QQ and QZone with other traffic platforms, such as Tencent’s app store and browsers and content platforms. In synthesis, PCG promotes the cross-platform development of digital content.
• Technology Engineering Group (TEG): It is responsible for supporting Tencent as a whole with technology and operational platforms. TEG is also involved in constructing and operating R&D management and data while also providing customer service. TEG is the operator of the most extensive networking, devices, and data center in Asia.
• Weixin Group (WXG): the part of the group deputed to the construction and operation of the Weixin ecosystem. WXG provides solutions and connectivity for intelligent upgrades across all industries. It is also responsible for the development and operation of QQ Mall, WeRead, and other products.

Management overview

Above is the outlook of all the critical people for Tencent.

We think it useful, however, to focus on the leading top-tier personalities more than in the whole direction.

Mr. Huateng Ma is a co-founder and the CEO and Chairman of Tencent Holdings. He holds a Bachelor in Computer Science from Shenzhen University. As of January 2021, he is Asia’s second-richest man, after Zhong Shanshan, founder of Nongfu Spring. In 2018, Ma was nominated as one of the most influential people from the magazine Times.

Huateng Ma had the idea of the first instant messaging application of the group, OICQ, after seeing the presentation of a similar product by an Israeli company.

The CEO is to date one of the most influential people in China, both from an economic point of view (he still owns 9.7% of Tencent and has a net worth of $71.8 billion, as of February 2021) and from a political and philanthropic point of view. He recently donated $2.3 billions worth of Tencent Holdings Limited stock towards his own foundation, a very large commitment.

Mr. Chi Ping Lau is Executive Director and President of Tencent Holdings. He joined the company in 2005 as Chief Strategy and Investment Officer, after being an Executive Director at Goldman Sachs (Asia) LLC in the Investment Banking Division and the Chief Operating Officer of the Telecom, Media and Technology Group. Previously to joining Goldman, Lau worked as a management consultant at McKinsey & Company. He holds a Bachelor of Science in Electrical Engineering from the University of Michigan and a Master of Science in Electrical Engineering from Stanford University. Mr. Lau refined his education with an MBA degree from Kellogg Graduate School of Management.

Mr. Chenye Xu is a co-founder and the Chief Information Officer of the group. Chenye worked at Shenzhen Data Telecommunications Bureau, where he gained management experience. He holds a Bachelor of Science in Computer Science from Shenzhen University and a Master of Science in Computer Science from Nanjing University.

Mr. Yuxin Ren serves Tencent Holdings as Chief Operating Officer. He oversees, as President, also the Interactive Entertainment Group and the Platform & Content Group.

Yuxin joined Tencent in 2000, and he worked previously at Huawei Technologies Co., Ltd.

He holds a Bachelor of Science in Computer Science and Engineering from the University of Electronic Science and Technology of China and an EMBA degree from China Europe International Business School (CEIBS).

Mr. James Mitchell joined Tencent in 2011 and serves now as Chief Strategy Officer and Senior Executive Vice President. Before Tencent, he was a Managing Director at Goldman Sachs in New York. He is a CFA© charter holder, and he received a degree from Oxford University.

Mr. David Wallerstein joined Tencent in 2001. Before that, he worked for Naspers in China. He holds a Bachelor’s Degree from the University of Washington and a Master’s Degree from UC Berkeley.

Mr. John Lo is Tencent’s Chief Financial Officer and Senior Vice President. Before joining the group, he worked at PricewaterhouseCoopers. Mr. Lo received a Bachelor of Business degree in Accounting from Curtin University and an EMBA degree from Kellogg Graduate School of Management, Northwestern University, and The Hong Kong University of Science and Technology. He is a Fellow of the CPA Australia and other associations.

Business model spotlights

Tencent serves several different customer segments, depending on the business.

However, a common characteristic is that the Chinese group tends to be customer-centric. The value proposition lies precisely in this: being able to satisfy almost any need that a teenager or a young adult might have. Moreover, with some businesses, Tencent reaches the whole Chinese population, both in Mainland and globally.

Above is the indication of the revenues generated per part of the business. It is immediately intelligible how Tencent produces the training portion of sales with the so-called “Value Added Services” (VAS).

These services consist of virtual goods that the company offers, such as online video games for smartphones and desktops, and the unique avatars that users can purchase in Tencent’s QZone social network. Immaterial services like the ones described composed in Q3/2020 a stunning 56% of the group’s sales.

FinTech and business services, instead, refer to payment methods such as WeChat Pay and cloud services like Tencent Cloud. This segment accounts for around a quarter of Tencent’s revenues booked. It’s a fast-growing part of the group, in which the holding is heavily investing to rival Alibaba which competes with AliPay and Alibaba Cloud.

The Online Advertising segment is also critical for Tencent, with a 17% weight on the total sales. This part of the group yielded incredible results during the pandemic outbreak since many advertisers dumped Baidu, the main competitor in this area, favoring Tencent’s WeChat. Analysts estimate that this segment will continue to remain a goldmine for Tencent for the foreseeable future.

Competitors and threats

As already introduced in the last paragraph, the competitors of Tencent lay in different business sectors.

However, the main ones are Alibaba when it comes to cloud and payment services and Baidu for advertising.

The entertainment and gaming business is mostly put in jeopardy by two Chinese peers: ByteDance, the company behind the groundbreaking social network Tik Tok, and NetEase, a competitive and robust player representing one of the biggest videogame companies of Mainland China.

ByteDance, with its social networks, is overperforming Tencent apps’ daily and monthly active users. That’s why, according to the research firm R3, ByteDance claimed 23% of China’s digital ad revenues in H1 2019, second only to Alibaba, which holds a 33% share. Tencent, for reference, ranked fourth with a 14% share.

NetEase, instead, could endanger Tencent’s business because of its new and various catalogs of games. Tencent’s flagship title is four years old, and it could lose its momentum at any time if NetEase can develop and maintain newer games.

Financial performance

Above is an overview of Tencent’s income statement. While revenues grew at a considerable pace, the most crucial difference between Q3 2019 and Q3 2020 is marginality and profits.

The company increased both Gross Profit margin and Operating margin to a more-than-healthy level.

Excellent results also in the comprehensive income for the period. The holding had significant income streams that led the total figure regarding Q3 2020 to more than double than Q3 2019’s.

Balance sheet figures saw a healthy expansion. The company’s good general form can immediately be spotted by considering that it keeps adequate debt-to-equity levels and correctly manages the competitive advantage.

The debt to equity ratio went from a value of 0.95 to a more solid figure of 0.84.

Then, Tencent’s management is leveraging its fantastic outlook to intake inexpensive debt to fuel growth. While current liabilities figures remained almost the same, non-current liabilities went up by around ten billion dollars.

Despite seeing an increase in capital expenditures, the company lowered its liabilities and became a net cash holder. It also allowed Tencent to save on interests and other expenses related to debt.

DCF analysis

The discounted cash flow analysis is a suitable technique for interpreting a grown-up company like Tencent.

This analysis relies heavily on the hypothesis that the analyst chooses to select. That’s why, in this part, we will discuss the assumption made by the team.

Between 2018 and 2019, Tencent’s EBIT grew by 21.55%. The same value registered a +25.64% from 2019 to the period Q4/19-Q3/20.

For this reason, we estimate the Earnings Before Interests and Taxes, with prudence, to grow at a 15% pace year on year for the next five years.

Then, we chose a 12.85% tax rate, based on the average of last years, adjusted for the lowering trend, following fiscal restructuring.

The unique WACC rate for Tencent is 5.2%. We obtained this value by considering the cost of debt of 2.07% and a cost of equity of 8.06%. Moreover, the cost of equity was found by selecting a risk-free rate of 3.28%, a country risk premium of 0.68% (Damodaran), an equity risk premium of 5.4% (again, Damodaran), and a Beta of 0.76, industry adjusted.

The debt-to-equity mix is 46%-54%.   

Averaging the results of using a perpetual growth model and an EV/EBITDA exit multiple methods, the terminal value of Tencent at the end of 2024 is estimated to be almost $2.4T. At the moment, not a single company in the world has that kind of valuation.

The equity value per share found with this analysis is between the worst-case figure of $244/share and the best of $299/share, with the most probable value lying in the region of $272/share.

Peter Lynch company category

Following Peter Lynch’s guidelines, we can categorize Tencent Holding as an Asset Plays. It is often not considered by investors that this company contains several others with a promising future. Some of those ventures, however, can be indeed categorized as Fast Growers.

The holding itself, instead, is an Asset Plays which grows at an incredible pace.

Risk 1: Global political relations

China does not have precisely the best relations with all the countries worldwide. In particular, the relationship with the US has been complicated by the Trump mandate. The new President of the United States Joe Biden is seen as more peaceful towards the Celestial Kingdom.

However, Biden recently said to be “prepared to act, as well as impose costs”, over the Chinese government’s intervention on Hong Kong’s pro-democracy movement and the heightened intimidation of Taiwan.

The European Union is in the middle, mediating between the need for democracy worldwide and trade freedom.

It could be the European Union to help resolve the destructive conflicts between the USA and China.

The error here could lay on the US imposing China tariffs and blocking the export of the oriental power, which is mostly directed to the States. That could lead the US in a long and intense correction phase, together with the EU, both terribly hit from the perpetrating of COVID-19.

All this situation could impact Tencent, reducing its power to do business effectively outside China, and it could limit its advertising revenues in the event of a recession.

Risk 2: Competitors leveraging weak spots

There are three competitors to watch out for, as previously mentioned in the Qualitative Analysis.

These are Alibaba (for payment services), BiteDance (for online advertising), and NetEase (for video game development).

Tencent has its focus on several sectors at once. Even though there is the possibility of it managing all of them correctly, it could also happen that one or two industries slip from its hands.

Alibaba is already more significant than Tencent pay, but it could eventually put out of business the holding’s service. However, even if it’s a possibility, the odds seem relatively low.

A slightly more significant threat is BiteDance which is beating Tencent in its central business: BiteDance’s social networks are receiving more visits than Tencent’s. This could slowly bring the holdings services to a state where it is not worth keeping up.

Also, in this case, however, the odds are critically low.

The third and biggest threat is the one brought by NetEase. This company competes fiercely with Tencent and is achieving a newer catalog of games that could put out of business the group.

This is the most severe issue between the three. However, Tencent’s long-term leadership in the gaming market can not fall at the first attempt. At the same time, they will already be at work implementing new games to replace the old ones.

Tencent is a solid company with great fundamentals.

Technical analysis of the charts indicates that the stock is currently in a short bearish phase. The stock is trading around a price of $96.5/share (or HK$745/share), which is already a great price to buy at.

The bearish period should end soon. The buyers will be ready to jump on for another bull run!

Great attention is focused on the next earnings release because the stock has the potential to take off after good news.

The stock is trending up, considering the general chart pattern and several indicators. The Average Direction Index is currently over 35, and both MACD and RSI indicate strong bullish signals.

Tencent is, to sum up, a strong buy, especially before the upcoming earning release.