Stock of the Week: Tencent

It's one of the biggest emerging market stocks and a China tech success story, but regulation has got investors nervous

James Gard 30 July, 2021 | 10:05AM
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Stock of the week post-it

As part of our emerging markets week, we asked our Twitter followers to pick a high-flying EM stock. They’ve chosen China’s Tencent (00700) ahead of Alibaba (BABA) and Samsung (005930) as the stock of the week.

Tencent is a technology giant with a wide reach into Chinese consumers’ lives, a poster child for China’s tech success and a staple of many emerging market fund portfolios. It  has interests in video games, social media, e-commerce and payments, music streaming, AI and even film production through its vast range of subsidiaries, many of which are start-ups.

The company’s share price gains since listing in Hong Kong in 2004 have been astonishing, rising 58,000% from HK$0.81 to HK$476. Tencent shares rose nearly 50% in 2020 as the pandemic boosted use of internet services, but have fallen nearly 17% so far this year as Beijing has targeted the country’s tech sector for much tougher regulation.

For a company as successful as Tencent, it’s now in the unusual position of being rated as a 5-star stock by Morningstar analysts, one of just 68 companies worldwide in this most undervalued category (and only three of these companies have a wide economic moat like Tencent and a 5-star rating).

Tencent share price

 

Tencent’s wide moat stems from its vast scale, treasure trove of user data from messaging apps like Weixin/WeChat, which has around 1 billion monthly users (like WhatsApp where you can pay your bills at the same time). The company also benefits from network effects, where a virtuous circle is created the more people use Tencent’s services. “We think the expanding ecosystem, stemming from an expanding user base, can in turn attract more users. The expanding ecosystem leads to more usage per user,” says analyst Chelsey Tam.

Tencent is also heavily invested in two of the biggest winners in the pandemic, video gaming and music streaming. It owns computer gaming studios, producing games like Call of Duty for smartphones, and subsidiary Tencent Music has exlusive agreements with major record labels that puts it on a par with Spotify (SPOT), the New York-listed streaming giant. Tencent Music (TME) was spun off from Tencent and listed in the US in 2018 but has struggled this year in share price terms, falling 45% (for comparison, Spotify shares have fallen 28% this year as the lockdown boost fades).

But Tam says the company has wider ambitions, moving from the consumer age of the internet to the industrial age. What this means in practice is creating collaboration tools for companies such as Tencent Meeting and Tencent Docs, as well as enhancing existing apps for the growing area of telemedicine. Patients can make appointments, see a doctor and pay him or her all without leaving the Tencent ecosystem.

How serious a threat is Beijing’s crackdown on tech companies’ competitive position and use of consumer data? From an anti-trust position, Chelsey Tam says that Tencent’s user base, and ability to monetise it, is so large that any regulatory pressure is unlikely to change the company’s economic moat. While share prices in China tech have sold off sharply, Morningstar analysts don’t see any concrete impact on the changes so far and have left fiar value estimates intact: Tencent has a fair value estimate of HK$800, for example, but is trading around HK$476.

 

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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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James Gard  is content editor for Morningstar.co.uk