25 September 2018

Tencent can do no wrong? Not so fast

Tencent shares have been scaling new heights. It’s a recurring theme powered by surging investor confidence in the company’s future.

It seems the online game and social media giant can do no wrong.

With a market value of HK$1 trillion (US$128 billion), Tencent outstrips Bank of China Ltd. (BOC) 03988.HK), which has a market cap of 900 billion yuan, and is neck and neck with Agricultural Bank of China (01288.HK).

Having gained 18 percent this year, Tencent is within striking distance of the two other big four lenders. Industrial and Commercial Bank of China (01398.HK) is worth about HK$1.6 trillion and China Construction Bank (00939.HK) HK$1.3 trillion.

To put this in perspective, we have to examine the big picture.

Banks are facing a knot of problems. Interest rate liberalization is eroding margins and internet finance is an increasing threat as it continues to drain funds away from deposit accounts.

There’s the local government bad-loan problem and signs of a downturn in the property market which are hurting their business. Still, the four leading banks collectively earned more than 700 billion yuan in 2012.

By comparison, Tencent is estimated to have made about 15 billion yuan to 16 billion yuan last year. At that pace, it will take many years before Tencent approaches the 140 billion yuan profit of BOC, the smallest of the big four. 

That’s one way of looking at it, but how does Tencent stack up against its peers?

With Facebook’s blokcbuster buyout of mobile instant messaging platform WhatsApp, Tencent’s stock just got an unexpected boost. 

Mark Zuckerberg is paying US$19 billion for WhatsApp, whose user numbers compare with those of Tencent’s WeChat (half a billion at last count). Facebook is settling 20 percent of the deal in cash, the rest with its own shares which are trading at 100 times price earnings multiple. Zuckerberg probably does not mind paying more.

In fact, some question if the deal makes sense given WhatsApp’s business model which is based on providing quality service for a token fee. Often, such giveaway pricing does not guarantee customer loyalty. WhatsApp could still lose users to the likes of Snapchat, for instance.

In that sense, the deal is not a useful reference for assessing Tencent.

Tencent makes most of its money from games but the big hope is that it will win a big slice of advertising revenue with WeChat by offering a platform for corporate marketing campaigns. In addition, it is expected that Tencent’s new online to offline (O2O) business to produce commission income by directing online traffic to brick-and-mortar vendors, restaurants and service providers.

In the United States, online advertising is growing at the expense of traditional media but television still takes the lion’s share of advertising budgets. In China, the situation is probably not much different.

Hunan TV & Broadcasting Intermediary (000917.CN) earned about 600 million yuan on revenue of 4 billion yuan in 2012. Another big player, Wasu Media Holding (000156.HK), made less than half of Hunan’s revenue and income. The two are worth a combined 50 billion yuan (US$8.2 billion), less than Tencent’s market value gain in the past two months alone.

If these incumbent media players are not making that much, Tencent investors are overly aggressive in pricing in the additional money the company can make from its new business.

Unlike games where Tencent is a clear number one, emerging fields such as O2O is up for grabs. Tencent’s rivals have been piling in with ambitious expansion plans.

Tencent is spending its way in. It the past six months, it bought up restaurant rating site Dianping, logistics firm China South City (01668.HK), taxi hailing app Didi Dache and search engine Sogou. In addition, Tencent is backing Didi Dache with subsidies for taxi drivers and passengers.

But with Alibaba and Baidu snapping at its heels, Tencent won’t have it easy.

So, does Tencent’s share rally reflect solid business fundamentals or is it an anomaly?

A quick look at the superstars of the last IT boom shows how much leading lights can dim if wild expectations are built into stock prices.

Loss-making Alcatel-Lucent (ALU.US) trades at a bit over US$4 against US$86 during its 2000 peak. JDS Uniphase (JDSU.US), which barely broke even in the year to June 2013, was last quoted at 1 percent of its peak value.

Cisco Systems (CSCO.US) has been doing fine business-wise. Its 2013 profit quadrupled from 2000 levels but its share price is about a quarter of its record high more than a decade ago.

During that period, Cisco grew at an 11 percent compounded annual rate which failed to meet investor expectations. The stock was pumelled into a low-teen PE, a long way from 200 plus when it was a tech stock darling.

– Contact the writer at [email protected]



EJ Insight writer

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