Tencent Is A Must Own, But There’s A Big But…

February 14, 2018

Tencent Is A Must Own, But There’s A Big But…

  • Tencent’s WeChat, China’s Facebook, has 800 million active monthly users.
  • The company is investing all across Asia and especially in the next China, India.
  • No one knows where Tencent’s earnings will come from in the next 10 years, but that’s the key to this investment.



Introduction

In today’s article, I’ll discuss investing in Tencent (OTCPK: TCEHY) by first giving you an overview of the company, and then by looking at the factors that could impact the business in the future in addition to comparing the fundamentals (growth) with the current stock price.

Company Overview

Tencent is the social media company in China. It owns China’s Facebook, WeChat, which has 800 million monthly active users and QQ, China’s leading instant messaging app, with more than 800 million users. However, the biggest share of its revenue comes from online gaming where the company is also the leader.

Figure 1: Tencent’s business power and model. Source: Tencent.

When you have such a base, the only thing to do is leverage and monetize it so Tencent is constantly partnering with others to do exactly that, leverage its base.

Figure 2: Tencent’s collaboration activity. Source: Tencent.

However, most of Tencent’s revenues still comes from online gaming, 41%. But that share is declining as other segments contribute more and more to the business.

Figure 3: Tencent’s revenue streams. Source: Tencent.

So this would be a superficial view of what Tencent is, but the company is so much more as it is heavily investing in other various project that could dwarf current revenues which I will discuss it a bit later. Let’s take a look at fundamentals so that all of what is going on can be put into perspective.

Stock & Fundamentals

Tencent has been one of the best performing stocks in the past 5 years.

Figure 4: TCEHY is up 700% in the last 5 years. Source: CNN Money.



The stock price surge is thanks to the extreme growth the company has been achieving. However, as history is history, it’s important to see what TCEHY offers at these levels and to analyze the risk and potential rewards.

All of Tencent’s metrics have been surging in the last few years. Revenue 61%, and net profits 69%.

Figure 5: Tencent’s income statement is all about growth. Source: Tencent.

The current price to earnings (PE) ratio is 54.56 which isn’t bad if the company continues to grow at these rates. If Tencent continues to grow earnings at 40% over the next 5 years, the PE ratio would be just 10 but that is perhaps a little bit too much to expect. Estimates see earnings grow around 24% over the next two years which if extended to five years, would create EPS of $2.81 and a 5-year forward PE ratio of 17.79.

So, as a fair valuation for the company, it all depends on the growth rate they achieve. If it’s higher than 25%, the stock will go significantly higher. If it’ll be lower, the stock could crash. That’s the short-term risk reward and given that Tencent doesn’t issue guidance and its business is complex, it’s practically impossible to know. Therefore, you have to be aware of the risks that go along such a company.

As the future is uncertain, perhaps the best strategy is to rebalance accordingly. As it’s highly unlikely that earnings will drop, we could say that a PE ratio of 20 would really be a bottom. This would be at a price of $20. So you can buy 1/3 of your position now, and if the stock drops to $35 buy the second third and buy the full position only if it falls to $20. Because there is so much more to Tencent, the returns should eventually be positive but this allows you to protect yourself from the possible volatility and at the same time take advantage of the growth and momentum.

More About Tencent

Tencent is leveraging its platforms and one of the most promising ways they are doing so is with WePay.

Figure 6: China’s online payment market. Source: KPCB.

We cannot even possibly grasp what the long term impact can be of such a platform and that is why it’s important to be exposed to such potential even if the numbers are uncertain.

Further, Tencent is investing heavily across Asia and especially in India where it is trying to create a similar online ecosystem as it has in China. Tencent has invested in Flipkart, a growing Indian e-commerce platform, Hike Messenger, a messaging app, an online healthcare platform called Practo, and the cab hailing app Ola. It also has a significant stake in MakeMyTrip (NASDAQ: MMYT), an Indian online travel platform.

Figure 7: Tencent’s investments in India. Source: VCCircle.



If just one of these operations explodes in India like has been the case for Tencent in China, any kind of current valuation or estimate is useless. As it’s impossible to know which one will win, the best thing is to be exposed and rebalance accordingly.

Tencent also owns 12% of Snapchat and 5% of Tesla.

Conclusion

I’ll finish with some food for thought.

Tencent has 800 million monthly users and a market capitalization of almost $500 billion. This means that a user is valued at $625. The earnings per user are, however, already at $13. Given the potential that the internet of things will bring in the future, I am really contemplating having a bite at Tencent. If the current market rout continues and emerging markets get hit, I will happily buy.



By Sven Carlin China India Investiv Daily Tencent Share: