Stock in Focus: Tencent

Hong Kong-listed tech stock Tencent has lost billions in market value this year, but Morningstar analysts believe its shares are significantly undervalued

Morningstar Analysts 17 August, 2018 | 10:16AM
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Shares in Hong Kong-listed internet messaging and gaming giant Tencent (00700) slid this week after second quarter profits missed forecasts. The Chinese company, which has nearly two billion users, has lost over $170 billion in market value since the January peak in its shares as Beijing hikes regulatory controls on online games, Tencent's key market.

Tencent is one of the so-called BATs technology stocks, which includes Baidu (BIDU), Alibaba (BABA), which are expected to overtake the US FAANGS in the coming decades. Tencent was the first internet company to launch in Hong Kong in 2004 and became part of the MSCI China Index in 2008. Since then, Tencent's market value has risen from $3 billion to $525 billion.

Despite this week's results, the company has a five-star rating from Morningstar analysts, which means that it is significantly undervalued. The fair value estimate is 590 Hong Kong dollars, against a current price of HK$337.

Analysts forecast top-line growth of 29% a year for the next 10 years, driven by new mobile games, expansion of game genres and e-sports, and increased willingness to subscribe to content in China. Online advertising revenue is expected to see a 10-year growth rate of 22%, driven by the continuous shift of marketing budgets to social media and video – in both of which Tencent has a stronghold – improving targeting technologies and an increase in ad inventories and ad formats in the long term.

Tencent Dominates Mobile Gaming

Tencent has the largest social-networking platforms in China. Its two social-networking platforms Weixin/Wechat and QQ have monthly active user, or MAU, bases exceeding one billion and 803 million users, respectively – versus a Chinese population of 1.4 billion. Tencent monetises its social-networking platforms through selling in-game items, virtual items, premium service subscriptions, online advertising, payments, financial products, and others.

The firm's strong distribution capability in the online gaming business via its social platforms is underpinned by a network effect that gives Tencent a sustainable competitive advantage. Network effects mean that the more people use a service, the more consumers are drawn to it.

As a result, Tencent has 58% revenue share in the Chinese online gaming market, versus its nearest rival Netease’s 18% in 2017, according to iResearch. Tencent is also ranked number-one in gaming revenue globally, 72% higher than its next-largest rival Sony.

Through its subsidiary Tenpay, Tencent controls nearly 40% of the mobile payment market, behind leader Alipay, owned by Alibaba. We believe it will gradually convert users to its financial services products, such as wealth management products. Its wealth management platform Licaitong’s assets under management reached 300 billion yuan (£34 billion) as of January 2018.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Alibaba Group Holding Ltd ADR78.31 USD0.53Rating
Baidu Inc ADR94.37 USD0.45Rating
Tencent Holdings Ltd370.80 HKD-0.80Rating

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