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Tencent’s fall from glory and outlook

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Tencent Holdings Limited (HKG: 0700 and TCEHY: OTC US) is among the largest technology companies in China. Founded in the Cayman Islands in 1998 and headquartered in Shenzhen, China, Tencent has close to 30 offices across Asia-Pacific, North America, Europe, the Middle East and Africa.

Tencent functions in various technology-related spheres, including video gaming, entertainment, streaming, social media, cloud services and advertising. The company is also focused on AI and desires to be a leader in the retail, education, healthcare, and transport sectors.

China’s tech crackdown hit Tencent hard, with China’s State Administration for Market Regulation (SAMR) penalizing the company in July 2022 for anti-monopolistic practices for violating disclosure clauses for certain deals. Tencent was involved in 12 such transactions, leading to a penalty of 6.0 m yuan ($843,170). Late last year, the competition watchdog fined Alibaba, Tencent and Baidu a total of 21.5 m yuan ($3 m).

Tencent’s business model

Tencent is a tech conglomerate that offers a range of services but derives the majority of its revenue from gaming and social networking platforms. The majority of Tencent’s customers are Chinese. The instant messaging platform QQ offers services like social games, music shopping, microblogging etc. The company makes money by a subscription for its services and from microtransactions. Unlike Facebook which makes most of its money from advertising, Tencent uses a freemium model along with user data collection for ad-targeting.

Mobile payment is another sector where Tencent shines. China’s largest messaging app and payment services provider WeChat is owned by Tencent. WeChat and Tencent QQ both are super apps which provide a variety of services to its users. The idea is to retain customers on a single application for all their needs and derive revenue by providing value added services.

Tencent’s Cloud business has grown in recent years as the company increased its spending on network infrastructure and R&D projects aiming to deploy new services as well as develop more indigenous network technology. The company builds its own data center servers and develops the key components of the modern data center and server chips. In 2021, Tencent said it is committed to spending $70 bn over five years on Cloud and related infrastructure.

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Partnerships are another crucial aspect of Tencent’s business model. Tencent is invested in e-commerce platform Pinduoduo, food delivery firm Meituan (a stake Tencent is planning to sell) and online insurance provider Waterdrop to expand its reach. The company also provides its partners access to its 1.3 billion-user base. Tencent is invested in over 723 companies, as per Crunchbase data, spread across education, gaming, e-commerce, entertainment, and online healthcare. These investments have attracted regulatory scrutiny from Beijing. As a result, the company has been forced to divest some of its investments in some of the leading tech companies.

Tencent profits recently declining

Tencent’s financial results for the second quarter of 2022 fiscal show that the company’s total revenues were RMB134.03 bn (~$20.0 bn), a decrease of 3% year-on-year. The company’s profit attributable to shareholders was 28.1 bn yuan, a decline of 17% year-on-year. The company’s basic earnings per share were RMB2.949 and diluted earnings per share were RMB2.896. The company missed analyst expectations by a lot and posted its first ever revenue decline. Previously, Tencent had posted a profit decline of over 50% during the first quarter of 2022 due to China’s strict zero-Covid policy.

Stock movement of Tencent

Once a favorite among investors, Tencent has experienced immense selling pressure lately. China’s crackdown on tech companies, a slowdown in Chinese economy and Tencent’s biggest shareholder Prosus reducing its stake in the company are some of the factors pushing its share price lower. Tencent’s focus on its Cloud business is another reason for protracted growth. The company faces tough competition from market leaders such as Alibaba Cloud, Amazon Web Services (AWS), Google Cloud, Microsoft and Oracle.

Tencent’s primary listing is on the Hong Kong Stock Exchange, while depository receipts are sold in the over the counter (OTC) market of the US. The company has a market capitalization of HK$2.45 tn (~$312 bn). The stock has a PE ratio of 15.88, while the forward PE ratio is pegged at 20.05. The company has a price-to-book ratio of 3.15.

Owing to the multiple headwinds at home as well as in the US, the stock price of the company has fallen more than 43% over the past year. Most recently, majority shareholder Prosus decided to cut its stake in the Chinese internet giant, which caused the stock price to plummet to a three-week low. The decline in valuation has robbed the company of its title of China’s biggest company, replaced by liquor giant Kweichow Moutai.

Shares of Tencent have tumbled 64% in Hong Kong since a January 2021 peak, wiping $623 bn off its market value by September 2022.

Overhauling M&A strategy

Refocusing on growth, Tencent acquired a 49.9% stake in Guillemot Brothers Limited in September 2022. In August, Tencent Holdings Ltd. subsidiary Sixjoy Hong Kong acquired a minority stake in Elden Ring developer FromSoftware. Tencent recently also enhanced the performance of the company’s database hosting service, TencentDB for MySQL.

Owing to the regulatory scrutiny and fines over the past two years, Tencent is now realigning its M&A strategy to buy mainly overseas gaming companies, sources told Reuters. Until now the company was investing mainly in startups and up-and-coming businesses in China. With a tightening noose around its business in China, Tencent has turned overseas to increase its revenue. The company is also exploring metaverse investments in Europe.

The internet giant recently completed a review of its expansive portfolio and identified the company’s priorities for viable stake sales based on the returns those investments have generated. The disposals may include online real-estate brokerage KE Holdings Inc., ride-hailing giant Didi Global Inc. and food-delivery company Meituan. However, it is still unclear when the sales will happen. The move is partly due to the company’s desire to make available cash from some matured assets to enable Tencent to invest in other areas like video games and healthcare.

Known for its hefty investment technique, Tencent has made only 80 investments and acquisitions in 2022 compared to 200 deals in 2021. Tencent has now increased its focus on medical companies. The company’s most recent investment was in Xunjie Medical, where Tencent is picking up a 19.5% stake for about $41.5 m. The company is also working with Shenzhen Mindray Bio-Medical Electronics to jointly develop AI-based medical diagnostics tools.

In August, the online gaming giant invested an undisclosed amount in Singlomics, the single-cell sequencing technology provider for antibody discovery. Separately, the internet giant participated in nursing home company Fortune Care’s Series C funding round. Just last week Tencent launched a new hearing aid powered by AI.

“We think, Tencent choosing to invest in medical devices and other hard technology in the medical field would help reduce (or stay away from) the impact of ongoing regulatory crackdown on various industry verticals. Moreover, Tencent also has been investing on companies that are to benefit from growing areas of healthcare such as chronic disease management, pension and elderly care, etc,” said Shifara Samsudeen, equity analyst at LightStream Research, who publishes on Smartkarma.

Company Information

HQ: Shenzhen, China
Industry: Media
Revenue 2021: RMB560.1 bn ($78 bn)
Market Cap: $312 bn
Primary Listing: Stock Exchange of Hong Kong (HKG: 0700)
ISIN: KYG875721634 / US88032Q1094
EBITDA: $6 bn
as of 03/10/2022

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