Too Much Love for Tencent’s Success
March 29, 2014 Leave a comment
Too Much Love for Tencent’s Success
AARON BACK
Updated March 19, 2014 7:11 p.m. ET
Tencent Holdings TCEHY -1.24% is collecting mobile users at a rapid pace. But hype about mobile payments is pushing the stock to heights at which investors should brace themselves.
In the fourth quarter, the Chinese Internet giant saw revenue rise 40% year over year, boosted by its dominant position selling virtual paraphernalia in its mobile-games universe. Net profit rose a less impressive 13% due to marketing costs. But that spending is yielding results. Mobile messaging platform WeChat had 355 million users at the end of 2013. QQ, Tencent’s old desktop messaging product, has a mobile version with 426 million monthly users.
The upshot is that Tencent looks better positioned in mobile than any major Chinese rival. Shares have more than doubled in the past year, and Tencent is now valued at $140 billion. Facebook’s market capitalization is $176 billion.
While the underlying business is enviable, the stock is frothy. Analysts have tripped over one another to stay ahead by raising price targets. Although it isn’t currently a big source of revenue, a key rationale for bullish calls has been the huge potential for payments made with smartphones.
Goldman Sachs GS +0.55% last month raised its target from 450 Hong Kong dollars (about $58) to 700, 23% above today’s price. Goldman projects that Tencent’s mobile payments will account for 12% of all retail sales in China by 2017, or $683 billion, up from almost zero today. Assuming that Tencent takes a 1% cut on transactions, earns a 25% operating margin and few other conditions, then slapping a multiple of 35 on those future earnings, Goldman gets a $45 billion valuation for the mobile-payment business, or HK$190 a share.
Tweaking any of these assumptions even slightly would mean huge swings in valuation. Little wonder, then, that investors sent shares down 7% over two days after the Chinese central bank suspended two types of mobile payments last week due to security concerns.
Tencent is working with regulators on a solution, and the potential for mobile payments is big. But with shares trading at 40 times 2014 earnings, investors should be ready for more sharp corrections.
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