Tencent is a huge chinese company, with a diverse portfolio of investments and operations. We wouldn’t be able to cover all its businesses in this short post on Tencent stock.
So, we will pick up some of the important highlights in its latest reporting for the full year of 2020. Also, we will emphasise key businesses that we think that you should know as an investor as well.
Tencent Stock Price Trend
Source: Yahoo Finance / Tencent Holdings Limited Share Price Chart
Let’s take a look at its share price over the past year. From the beginning of 2020, at around US$50 a share, it has almost 2x to nearly US$100 in Feb 2021. Since then, it has corrected to the US$80 range.
We know that tech companies have benefited from the Coronavirus pandemic in 2020. With more people working and staying at home, usage of online platforms from ecommerce to online gaming have surged substantially.
The question is if the growth is sustainable for Tencen? And if there’s still upside for investors thinking of entering now?
Tencent Stock Business Overview
Source: Tencent Corporate Overview, March 2021 / Social Networks
For understanding, the key mechanism holding Tencent’s businesses together will be its Weixin services, also known as WeChat. This is the company’s primarily a communication platform that has evolved tremendously to incorporate many content offerings and services integration.
Just to name some, you can message your friends, buy groceries, hail a ride and even book a doctor’s appointment. These can all be done in one app, which is why it earns its title of a “super-app”.
Source: Tencent Corporate Overview, March 2021 / Weixin Reshapes Digital Lifestyle in China
The extent of reach it has in China is insurmountable by others. The application garners more than 1.2 billion monthly active users (MAU).
With such a level of reach to the consumers, Tencent has been able to expand quickly to other businesses.
Source: Tencent Q4 and FY2020 Results Presentation / Key Services Update
Other than being the number 1 messaging app, it holds number 1 positions in online games, media and content services, and increasingly in the FinTech space as well. At the same time, it is coming in at the 2nd place, behind Alibaba, in the Public Cloud business.
Tencent Stock Revenue By Segment
Source: Tencent Q4 and FY2020 Results Presentation / Financial Highlights
The company segregates its business into 4 key segments:
- Value Added Services – made up of its Social Networks and Online Games, contributing more than 50% to the group’s revenue.
- Online Advertising – made up of advertising through its social networks and applications, contributed 17% to the group’s topline.
- FinTech and Business Services – for the Fintech portion it is made up of commercial payment and wealth management businesses. Whereas for the Business Services portion, they are mainly associated with its Cloud business. Together they contribute a good 27% to the group’s revenue.
- Others – which are other bets that the company is working on, contribute only about 1.5% to the group’s topline.
Tencent Stock Performance Review
Revenue By Segment
Source: Tencent Q4 and FY2020 Results Presentation / Revenue by Segment
Observe that Tencent has been increasing its revenue steadily over the last 3 years. In 2020 itself, we saw a 28% increase in revenue compared to the previous year. In fact, all of its operating segments reported growth.
Source: Tencent Q4 and FY2020 Results Presentation / Income Statement
As for its bottom line, Tencent registered strong profit growth numbers as well. The group registered more than 71% increase in its IFRS net profit, and 30% increase in its Non-IFRS profit.
Here we want to highlight the portion on “Other gains, net” which saw a 190% year-on-year increase for FY2020. This portion is related to its net gains on deemed disposals of certain investee companies, as well as net fair value gains resulting from increased valuations of their investment portfolio.
Basically, the group’s investments in listed and unlisted companies have paid off in 2020. It’s an extraordinary year where many tech companies that Tencent has interests in saw their valuation surging. We will discuss more about that later.
Cash Position and Free Cash Flow
Source: Tencent Q4 and FY2020 Results Presentation / CAPEX, FCF and Cash Position
In terms of its financial health, the company is in a net cash position. Meaning, the group has more cash than debt. This implies the strength and ability of its balance sheet to sustain any potential shocks.
More importantly, we saw its Free Cash Flow (FCF) increased by 39% in FY2020 to RMB 123 billion. This will allow the company to continue to invest internally in terms of their own research and development to create more value-added products and services. At the same time, the group can grow further externally through its investments in other companies.
Tencent Stock Growth and Valuation
Source: Tencent Corporate Overview, March 2021 / Our Business Model
Now that you have some ideas of Tencent’s business and its recent performance. Let’s take a look at its growth and valuation.
We will not go through the growth rates for each of the segments in detail. We have discussed about them in some of the other posts when we talked about Alibaba and Baidu.
But just for reference, here are the growth rates forecast of the various sectors in China, that correspond with Tencent’s operating segments, for the next few years:
- Online gaming: 15%.
- Digital ad spending: 10%.
- Cloud computing: 30%.
- Fintech: 20%.
Source: Seeking Alpha / YoY Revenue Growth Forecast for Tencent, Facebook, Amazon, Alphabet and Microsoft
Therefore, I think that the consensus revenue forecast estimates for Tencent to be around 20%, for the next few years, are quite reasonable.
Valuation of Operating Segments
Source: Yahoo Finance / Tencent Holdings Limited Share Overview
In terms of its valuation, its Price-to-Earnings (P/E) ratio based on the trailing twelve months results, i.e. the FY2020 results, is around 33 at the current price of about US$80 a share.
Source: Tencent Q4 and FY2020 Results Presentation / Income Statement
Again, remember the substantial increase in “Other gains” that Tencent recorded in FY2020. So, for better reflection of the groups operating profit, we will use their adjusted Non-IFRS net profit of RMB 123 billion instead of the reported IFRS net profit of RMB 160 billion.
This will translate to an earnings per share of RMB 12.7. Converting this to US dollar, it will become US$1.94. So at the current share price of US$83, we can derive an adjusted P/E of about 43 instead.
Based on the CAGR of 20%, and assuming the market equilibrates to a P/E multiple of 25 in five years time, we can expect a target price of about US$120.
However, this is excluding most of the potential returns that Tencent will reap from its investment portfolio.
So now let’s take a look at the valuation of the group’s investment portfolio.
Hidden Gems In Tencent Stock Investment Portfolio
Well, Tencent is evolving to be like the Google of China, transforming to an investment company like Google’s parent – Alphabet. Previously, we talked about how Alphabet is becoming the Berkshire Hathaway of technology by investing in up and coming tech companies.
Here we see that Tencent is doing the same thing as well.
Source: Seeking Alpha / Buying Tecent Stock: Is Now The Time
All in all, Tencent has invested in more than 800 companies and 70 of them have gone public so far.
Some of the notable listed companies in its portfolio include Tesla, Nio, Pinduoduo, Meituan, JD.com, Sea and Snapchat.
For those unlisted companies, they include leading US game developer and publisher – Riot Games, one of India’s leading ecommerce players – Flipkart, and Indonesia’s leading ride hailing and on-demand multi-service platform – Gojek.
Valuation of Investment Portfolio
Source: Seeking Alpha / Adapted from Not Boring (data extracted on 11 February 2021)
It is difficult to keep track of all of Tencent’s investee companies.
But it was estimated that for the first 100 of Tencent’s more than 800 over investee companies, the total valuation of just these 100 names is already worth more than US$390 billion as of Feb 2021.
This means that based on the current market cap of Tencent at around US$800 billion, their investment portfolio would have made up about 49% of its valuation.
Well, the valuation of the tech sector may be a bit high at the moment. So, let’s say we shave off 20% from the US$390 billion, and derive a more conservative valuation of Tencent’s portfolio at US$312 billion. This represents 39% of Tencent’s market cap, or about US$32 out of its US$83 share price.
So, assume that this portion of Tencent’s investment portfolio doesn’t grow. Then, add this US$32 to the target price of US$120 based on its operating businesses 5 years later. Therefore, our overall target price will become US$152.
To wrap it up, Tencent stock is still reasonably valued at the moment.
I think that their roots in the tech space, as well as the group’s wealth of experience picking and investing in winning companies in the future, have positioned Tencent to be the Berkshire of tech companies in China.
Source: Tencent Corporate Overview, March 2021 / We Build Connections
In addition, Tencent’s strong core businesses interlinking with one another give the group an edge to create synergy not only among its businesses, but also with new ventures and investee companies.
The symbiotic relationship among its product and service offerings will bring usage and retention to the next level, enhancing the already strong network effects.
But again, the political risks internally within China itself, and externally with the United States, are something that investors should be aware of and monitor.
Without which, overall I think Tecent is a great company. And at the current valuation, we are paying at a reasonable price. Definitely adding it to my watchlist.
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