Unveiling Tencent: Inside the Tech Giant Shaping China's Digital Future

Chua Minghan, Deputy Head, HQ Dealing | Contract for Differences

Chua Minghan graduated from the National University of Singapore with a Bachelor’s degree in Economics. He is passionate about education and went on to get a post-grad Diploma in teaching. His vision is to educate clients to make informed decisions for their trading and investments.

Minghan enjoys learning fundamental analysis, technical analysis, and strives to use data analysis to improve his trading skills.

Did you know that Tencent Holdings owns a stake in the developer behind 2024’s blockbuster game, Black Myth: Wukong? But the influence of this tech behemoth extends far beyond the gaming industry. What other businesses is Tencent involved in?

In this article, you will discover how Tencent generates revenue, its performance over the years, recent quarterly performance, forward guidance, and what might be a reasonable price for investing in Tencent .

Founded on 11 November 1998 by Yi Dan Chen, Hua Teng Ma, Chen Ye Xu, Li Qing Zeng, and Zhi Dong Zhang, Tencent Holdings Ltd. is headquartered in Shenzhen, China. The company has grown to dominate the digital landscape in China through a broad array of services and innovations.

Tencent Holdings Ltd. has four primary revenue channels. It operates through the following segments: Value-Added Services, FinTech and Business Services, Online Advertising, and Others.

• The Value-Added Services segment is involved in online and mobile games, community value-added services, and applications across various Internet and mobile platforms.
• The FinTech and Business Services segment offers fintech and cloud services, which include commissions from payment, wealth management and other services.
• The Online Advertising segment refers to the display based and performance-based advertisements.
• The Others segment is composed of trademark licensing, software development services, software sales, and other services.

Source: Tencent 3Q24 Earnings Presentation

In every business area it operates, Tencent Holdings consistently holds one of the top two positions, underscoring its competitive edge as a leader across multiple sectors.

Source: Tencent 3Q24 Earnings Presentation

The image above shows the revenue by segments, with at least 50% of the revenue contributed by Fintech and Business Services, along with domestic games.

For clarity, it is worth noting that international games, domestic games, and social networks are categorised under the umbrella of Value-added Services revenue segment.

Revenue is on an uptrend, growing modestly, typical of a strong profitable company.

Source: Tencent 3Q24 Earnings Presentation

Source: Tencent 3Q24 Earnings Presentation

Gross profit has shown strong double-digit growth, indicating effective cost management by Tencent. Gross margin remains high and is increasing for various business segments. The fact that Fintech and Business Services is growing both in margin and contributes largely to the top line is a sign of Tencent being a quality business benefiting from economies of scale.

Source: Tencent 3Q24 Earnings

Above is the flow of its recent quarter performance:

Revenue: +8% Year on Year (YoY)

Gross profit: +16% YoY

Gross margin: +4% YoY

Operating profit: +20% YoY

Operating margin: +3% YoY

Net profit: +47% YoY

Net margin: +9% YoY

Source: Tencent 3Q24 Earnings Presentation

Capital expenditures (CAPEX) have increased by over 100%, driven by investment in GPU. These are essential to the establishment and improvement of Tencent’s artificial intelligence (AI) capabilities, a trend also observed among other large tech firms such as Meta, Microsoft, Amazon, and Google.

Tencent’s balance sheet also remains robust, with total cash exceeding its total debt. In terms of liquidity, it has positive free cash flow, with an increase of 14% year on year. In this quarter, they repurchased 95 million shares, signalling the strength of their cash position.

Going forward, Tencent is  optimistic about their growth and the broader economy.

“We believe, going forward, the economic recovery would take some time. But over the long run, we do believe it would definitely be reaccelerating because we felt there is a very strong resolution by the government to revive the economy. And at the same time, there’s actually positive structural factors in the economy including a very strong work ethics among workers in China, including a very deep engineering talent pool, including entrepreneurism among companies of all sizes, small, medium, and large companies….we believe we’ll be generating significant free cash flow next year that we can engage in dividend and share buyback.” said Martin Lau, President at Tencent

Source: Tencent 3Q24 Earnings Call Transcript

Source: Tencent’s investors page

Share-based compensation is designed to motivate employees as they strive for the company’s success. It is encouraging to see it being held at the CNY 6000 million level as Tencent continues to grow.

According to Glassdoor, Tencent’s employees are content, and happiness among workers often translates into higher motivation and productivity. These motivated employees are crucial in driving the company’s profitability.

Before we move onto valuation, below are the pros and cons of Tencent Holdings.

Key Advantages of Tencent’s Revenue Model:

1. Ecosystem Synergy:

• Tencent’s platforms (e.g., WeChat, QQ, and gaming) are interconnected, boosting user retention and cross-selling opportunities.

2. Recurring Revenue Streams:

• Subscriptions, in-app purchases, and advertising provide steady and predictable income.

Global Reach:

• Through strategic investments, Tencent earns revenue beyond China, particularly in gaming and technology.

4. Innovation and Scalability:

• Tencent frequently adopts emerging trends (e.g., AI, metaverse, cloud computing) to expand its revenue potential.

Challenges and Risks:

1. Regulatory Pressure:

• China’s government has tightened regulations on gaming and tech companies, which may limit Tencent’s growth in certain areas.

2. Competition:

• Tencent faces competition from domestic rivals like Alibaba, ByteDance, as well as international giants like Google, Amazon, and Microsoft.

3. Economic Slowdown:

• A slowdown in China’s economy could impact consumer spending on gaming, advertising, and FinTech services.

4. Blacklisted:

• The US added Tencent to their military blacklist, resulting in a decline. Geopolitics are usually sudden and unpredictable.

Source: TradingView

Over the past 5 years, Tencent’s earnings growth has been approximately 6%. The green line (HKD$395) represents the intrinsic value based on estimated earnings. The advent of AI, the leadership Tencent has, and a positive outlook are factors that encourage market participants to take a bullish stance.

Notice that the price seldom drops to the intrinsic line. This is because market participants place a premium on well-run businesses

Source: TradingView

Another valuation tool I use is assuming Tencent only grows 3% a year until perpetuity. Based on this valuation, Tencent’s intrinsic value is HKD$640. If we consider a 50% margin of safety, HKD$320 can be seen as an attractive price. Most people would wonder “HKD$640 is very different from HKD$395”, how should I approach this investment? This is a valid question because many tend to focus solely on valuation. The truth is valuation is only a small part of the analysis.

A thorough analysis of Tencent’s business dynamics, future prospects, and valuation suggests that a reasonable price range would be between HKD$320 and HKD$390.

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