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Morningstar | Wide-Moat Tencent's 4Q Net Profit Beats Our Estimate by 2%

Tencent's revenue in the fourth quarter was up 28% year over year to CNY 85 billion while operating profit margin (excluding interest income and other net gains on our calculation) was 21%, up 9%. Net profit was down 32% or CNY 7.6 billion year over year to CNY 14 billion due to other net losses of CNY 2 billion versus other net gains of CNY 8 billion in the same period of 2017. The other net losses primarily consisted of a one-off expense related to the issuance of shares to strategic partners (Spotify) of TME and impairment of certain investees. We do not see any major change in the group’s outlook and maintain our fair value estimate at HKD 499 per share.

Online game revenue in the quarter was down 1% year over year and 6% sequentially, which we think is resilient, given that the resumption of new gaming license approvals only came at the end of December last year and the fourth quarter has weaker seasonality. Internationally, PUBG Mobile has become the highest-grossing game developed and published by a Chinese company, which gives us more confidence in Tencent's expansion into the overseas gaming market. Seven smartphone games and one PC game have been approved since the resumption of approval. Several dozen games are still in the approval pipeline. We continue to expect online game revenue to increase by 16% in 2019.

Online advertising was up 38% year over year, showing some deceleration from 47% in the third quarter, as social and others advertising revenue growth slowed to 44% from 61%. This is due to the introduction of advertising in mini programs late in the second quarter of 2018, less video advertising revenue as key content was pushed out into 2019, and weaker macro. In the long term, we continue to believe advertising revenue growth will remain strong. The second ad in Weixin Moments per day was added to approximately half of Moments daily active users in the quarter. We see upside in increasing ad load to global peers’ around 10 ads per day. After the system revamp in the news advertising business in early 2018, enhanced recommendation algorithms and improved traffic, we expect to see higher ad inventory and news feed advertising revenue.

Others revenue rose 72% year over year in the quarter, showing no signs of slowdown. In 2018, cloud revenue more than doubled to CNY 9.1 billion but still contributed to just 3% of revenue. According to McKinsey, in 2017, the cloud expenditure as a percentage of total IT budget in China was 14.4% versus 29.1% in the United States. Given the low penetration of cloud in China, we believe cloud business growth will continue to be robust. Tencent, the second-largest cloud provider in China with 11% market share in the first half of 2018 according to IDC, should reap the benefits. We see growth coming from increased numbers of paying customers (doubled in the quarter), higher revenue per customer benefiting from high switching costs, and increased product offerings.

Monthly active users of Weixin/Wechat increased 1% sequentially to 1.098 billion in the quarter, and we expect user growth to mature. Tencent Video’s subscriptions reached 89 million, up 58% year on year, compared with iQiyi’s 87 million. LiCaiTong had more than CNY 600 billion of customer assets as of the end of 2018 with 100 million subscribers to money market funds.