China’s King of All Social Media: Tencent is China’s Facebook, Twitter, Zynga, and Tumblr all rolled into one, and it’s pushing hard into e-commerce. How it stays on top

SATURDAY, MAY 18, 2013

China’s King of All Social Media

By RESHMA KAPADIA | MORE ARTICLES BY AUTHOR

Tencent is China’s Facebook, Twitter, Zynga, and Tumblr all rolled into one, and it’s pushing hard into e-commerce. How it stays on top, and why the shares could climb 20%.

Chinese Internet companies are facing growing pains, as new competitors emerge and new trends like mobile Internet turn their business models upside down. Tencent Holdings (ticker: 700.Hong Kong) is coping better than most, aided by a diversified mix of businesses, among them: China’s dominant, youth-oriented gaming operations; one of the nation’s largest instant-messaging services, QQ; and the wildly popular WeChat, a free mobile social-networking and messaging software that allows users to send photos, videos, and voice messages to each other, walkie-talkie style.

Tencent’s individual businesses put it on par with Facebook (FB), Twitter, Zynga(ZNGA), and Tumblr, but it has more power than these firms because its users, advertisers, and application developers can access them all on a single platform. “Tencent is the winner-take-all social player in China,” says Ravi Sarathy, Citigroup’s head of Asia Pacific entertainment, media, and telecom research.That hasn’t gone unnoticed by investors. While Chinese stocks have been held back by continued uncertainties about the health of China’s economy, Tencent is up 33% in the past year, to 292 Hong Kong dollars (US$37.62), helped by a better-than-expected first-quarter earnings report last week. That’s well ahead of the 20% gain for the Hang Seng Index and the 24% decline in shares of Baidu (BIDU), another big Chinese Internet company trying to navigate the transition.

Analysts expect earnings to grow 22% in 2014, to HK$25 billion, or HK$13.55 a share, on sales of HK$94 billion. Shares trade at 22 times next year’s estimates.

Tencent shares could be volatile in the months ahead, as the company weathers a slowdown in its gaming business and invests in newer areas like e-commerce and mobile. But as it leverages its market power and begins to make money from these investments and newer games, the shares could move toward their historical forward average valuation of 26 times earnings in the next 12 to 18 months, translating into 20% upside in the local shares. While there is a thinly traded Tencent Americandepositary receipt (TCEHY), investors are better off buying the stock on the Hong Kong exchange.

ONE REASON MONEY managers are optimistic about Tencent’s prospects is the success of WeChat, or Weixin as it is known in China. The popular mobile software, which has gained 300 million registered users in just two years, allows users to send texts and voice recordings, much like a walkie-talkie, while also allowing video- and photo-sharing.

Tencent knows how to turn users into profits. Founded in 1998 as an instant-messaging platform, the company quickly gained users for QQ, who now number 800 million. It realized that eyeballs didn’t automatically translate into profits and set out to change that, building on its base to create an online-gaming presence and eventually dominating the industry. “They are putting up the building blocks for the second leg of growth and have a proven record of making money,” says Lewis Kaufman, manager of the Thornburg Developing World fund, which owns the shares.

The Bottom Line

Tencent’s dominance in China’s social media merits a premium valuation. If its forward P/E returns to its long-term average of 26, the stock could climb 20%.

Tencent’s chief executive, Ma Huateng, a perennial name on our annual World’s Best CEOs list, is described as patient and careful, often planting seeds and experimenting before jumping in. He declined to speak with Barron’s, but when analysts asked about those seeds on last week’s conference call, executives cautioned it was still early days for e-commerce and mobile-gaming, stressing that focusing on user experience pays off. The company wants to make sure it has the right infrastructure to link its applications like mobile QQ and Weixin to mobile-gaming, as well as filling the pipeline with “high quality games.”

IT’S EASY TO SEE why Tencent is establishing a foothold. About 80% of China’s population of 1.35 billion is expected to be using the Internet by 2025, according to Jefferies China Internet analyst Cynthia Meng. She notes that mobile and Web gamers range between ages 18 and 60, versus 18 to 24 for the more traditional gaming business. Already, mobile phones have overtaken personal computers as the top device for accessing the Internet in China, and about 57% of mobile users in metropolitan China already buy products on their phones at least monthly, according to a report from Forrester Research.

As gamers migrate to mobile, some of the titles may have shorter life cycles than Tencent’s popular older games, requiring more investments in the business to keep its pipeline full. Gaming makes up about half of the company’s revenue. Tencent is also looking to exploit advantages in e-commerce, where Alibaba Group has long been the leader. For example, the company is tying WeChat together with a payment service, TenPay. Tencent is also trying to boost its overseas business with applications like WeChat.

Tencent has a solid balance sheet, with HK$25 billion, or HK$13.57 a share, in net cash, and it is expected to generate HK$20 billion in free cash flow this year. Though it pays just a small dividend now—the stock yields 0.3%—executives said they will look to a higher dividend and continued share buybacks to return cash to shareholders.

China Online

Tencent’s huge scale in social media gives it a big competitive advantage over its rivals.

Recent Market 2014 E
Company/Ticker Price Val (bil) EPS EPS Growth P/E
Tencent /700.HK HK$292 $70.0 HK$13.55 22% 21.5
Baidu/BIDU $92.69 33.0 $6.23 24 14.9
Sina /SINA $58.81 4.0 1.73 137 34.0
Sohu/SOHU $61.25 2.4 3.38 36 18.1
E=Estimate
Source: Bloomberg

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: