EUR 850.00 For Business Accounts Only

Morningstar | Tencent Remains a Strong Buy With a Fair Value Estimate of HKD 499 per Share. See Updated Analyst Note from 15 Nov 2018

We are reducing the fair value estimate of wide-moat Tencent to HKD 499 per share from HKD 590 per share and we continue to think Tencent is undervalued. We now expect a 10-year CAGR of 20% for operating profit, compared with 29% previously, and a 10-year CAGR of 19% for revenue versus 29% previously. The others revenue segment, which is mainly composed of payment and cloud, has slowed down faster than our expectations in recent quarters, leading to a 10% reduction in our 10-year others revenue CAGR to 30%. As a result of a pause in games approval in China, we now assume year-over-year online gaming revenue growth rate to be 6% in 2018. We estimate there will be a rebound in online gaming revenue growth to 16% in both 2019 and 2020 as approval resumes in mid-2019. Our assumption of lower revenue growth is partially offset by higher margin assumptions as margins hold up better than our expectations in recent quarters. We believe operating margin (excluding other gains and interest income) will gradually reduce due to investments to transition to industrial Internet and will bottom at 22.5%, and as scale amasses, we expect operating margin to increase to 30.3% by 2027. Given wide-moat Tencent’s strong network effect with 1.1 billion of monthly active users of Wechat, we believe temporary suspension of game approval and weak macro provides a good opportunity to accumulate this high-quality name. Tencent’s repurchase of 2.8 million shares is a testimonial of our view. We think that smaller game companies will be squeezed out during the regulatory headwinds, and Tencent will be able to gain market share.

Revenue was up 24% year over year, led by payment, advertising, digital content sales, and cloud. Operating profit excluding interest income and other gains was up only 1% year over year. Net income was up 30% year over year as a result of a CNY 8.8 billion higher valuation of investees such as Meituan Dianping, this compares with CNY 3.9 billion in the year-ago period. There was an increase in the monthly active users (MAU) of Weixin and Wechat of 11% year over year and 2% sequentially. More importantly, there was a growth in user engagement as a result of more use cases offered by Mini Programs and Weixin Pay. Mini Programs has penetrated into more industries such as transportation and healthcare. We think user engagement will continue to grow as penetration of mini programs and Weixin Pay deepens.

The online game segment is the spotlight, with smartphone games revenue up 7% year over year and 11% quarter over quarter due to 10 new game releases, and PC client games down 15% year over year and 4% sequentially. Growth is weak as PUBG along with other new games have not been monetized due to a suspension in game approval. Key title Honor of Kings has continued to see sequential increase in revenue driven by higher paying users, which should give added comfort to investors in the near term.

The market is concerned that the slowing economy would put pressure on the online advertising segment, yet the third-quarter results of the segment are very solid. The segment’s revenue was up 47% year over year, an acceleration from 39% in the second quarter, while revenue was up 15% sequentially, similar to the sequential increase in the third quarter of 2017. We believe Tencent still has a lot of room to increase its Weixin Moment ad load to increase advertising revenue, and this will largely offset the impact of the lower advertising budget of customers. Better monetization of its video content, and expanding advertiser base by converting Weixin Pay merchants to advertisers can also lift advertising revenue.

Others revenue, which mainly consists of payment and cloud, slowed to 69% year over year, lower than our expectations. LiCaiTong’s asset under management has grown to CNY 500 billion versus CNY 300 billion in January this year. Gross margin was 22.8% in the quarter, same as the year-ago period.