Is Tencent Holdings Limited Still a Buy Now?


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I intentionally held off writing about Tencent’s earnings. One reason is I want to see market’s reaction to the earnings, and also to allow myself a more objective analysis after much of the media hype and noises had died down.

I will just be comparing year-on-year figures as quarter-on-quarter change is too short a period to form any meaningful analysis. 
For a company that is still growing strongly I will be looking at just the revenue and profit, margin, and cash flow, as I seek to find out if the growth rate is still intact. 
Earnings

Source: Tencent 2Q 2018 Results Presentation
*figures in bracket is 1Q yoy growth
All segments showed healthy growth margin, except for Online Games that increased 6%. Online Games further split into Smart Phone Games and PC Games. For Smart Phone Games, revenue was up 19% yoy (68%), while PC Games revenue was  -5% yoy (flat). 
For Online Advertising, revenue expanded 39%. (55%). In particular under Social and Others which pertains to mainly Wechat/Weixin Moment advertising, revenue increased 55% (69%).
For Operating Profit, I will be looking at Non-GAAP figures as I want to know the true profit attributed to its core, day-to-day operations not affected by one-off, irregular or non materials items. 
Ops profit and Net Profit to Shareholders grew 11% (36%) and 20% (29%) respectively. Ops Margin 30.2% is -5.2% yoy (1Q Ops Margin -3% yoy).
Net Ops Cash Flow for 2Q is still a healthy RMB21.5 billion, compared to RMB19.8 billion in 1Q.
Market Reaction is Negative. Are You Negative Too?
Clearly the top line results, while still showing good yoy growth, has slowed considerably compared to last quarter. Just look at the figures above and those in bracket. 
Market is especially spooked by slowdown in Online Games segment that is the largest revenue contributor. This is mainly due to non-monetisation of key tactical tournament games and delay in new games release. The former is ultimately due to the delay in monetisation approval by China’s regulation body due to a restructuring at the top level. 
So the crux is if such delay in games monetisation approval is a temporary issue or a permanent one. The suspension might come as a surprise to many, but that is a government regulatory issue that is due to restructuring at the top level. And restructuring does not go on forever. Once the seats are warmed up and the new government heads are comfortable in their position, the approval process should restart and things should go back to normal. 
I highly suspect this is a temporary issue, not a structural damage to Tencent’s Gaming segment. Near term outlook could be muted, but the popularity of their games remain intact. I would be worried if the DAU and MAU figures start falling, or their games start falling off the popularity ranking. 
And with market’s propensity to focus all attention on the negatives, neglecting other bright spots in Tencent’s earnings, there seems to still be much growth opportunities in other areas of its business. 
Insights from Earnings Call Transcript
So i read through the earnings call transcript and extracted relevant information below. 
On temporary suspension of approval for games monetisation. Tencent has at least 15 games already approved for monetisation, a mixture of high Average Revenue Per User (ARPU) and low ARPU games. 

On growth prospect of gaming. Fundamentals remain strong, based on solid DAU growth yoy and strong overseas expansion. Arena of Valor has achieved over 15 million DAU overseas and US$200m user spend in first half 2018. Player Unknown Battle Ground, 14m DAU overseas, US$20m user spending per month. Aside, Tencent is still finding ways to deepen player engagement from existing hit title such as Honour of Kings, China’s top gamr in terms of users and revenue. New high ARPU game such as MT4, ranked top three in iOS Top Grossing Chart, has been launched in Jul.  
The only problem is the delayed monetisation of PUBG Mobile, which management is very optimistic about, based on its large DAU base, intensive and cooperative nature of game that historically is a good indicator of monetisation potential. For info, PUBG overseas monetisation rakes in monthly gross billing of US$20m. 
On Monster Hunter blocked-launch in China, one of its expected blockbuster game in 2018. mnagement shared that it is a one-off event as the content did not comply with regulations, and company is working with developer for adjustment. The game has been approved for monetisation. 

On news/media feed under Online Advertising segment, the total daily page views through the two largest platform: QQ Browser and Kandian increased 55% yoy, and number of short video views is up more than 3 times. WeChat Moment ad load had been increased to two per day, just a fraction of its international competitors. Management is taking a moderate approach here to balance between user experience and pricing/advert positioning. 
On Mini Program. This is a ‘sub-app’ smaller than 10mb hosted within WeChat that can be lauched instantly. It has DAU of 200m. Mini Programs offer connection and touch points of 1 billion WeChat users to many more offline businesses and entities that may not have the chance to do so previously, without the hassle of users downloading new apps. And it further perpetuates brand name via the social sharing function. 
So it seems to me that there is this gapping hole in Tencent’s main revenue generator, gaming, while other areas of growth remain well on track, thrown in with clear strategies and upcoming initiatives to reignite revenue growth. 
Latest News
Just late last night came another news that China regulators plan to restrict number of new online games and limit time spent on gaming by minor.

This definitely adds more overhang to the gaming sector outlook, considering that ramifications will be more material as it reduces time spent -hence engagement and monetisation potential- on games, and decrease the number of games that can be launched.

Details are still scant. But without guessing what the actual new policy would be, I try to decipher its impact on Tencent.

Firstly, are young children, teenagers, minor a big component of its gaming customers? I don’t have info on this. And how much gross spending comes from this group, considering their relatively young age and lower earnings? If play time was limited on this group, would there be a big impact on gross spend from perhaps a not so high expense level?

This is also not the first time Tencent come under government criticism and Tencent has been able to respond quite well to government’s request in name of social order and health. For example, earlier on when WeChat was accused of spreading fake news, Tencent blocked 500 million postings. One of its video streaming subsidiary, Kuaishou, was criticised for teenage mom videos. It issued apology the next day and took action to clean up these videos.

The policy stems from a health standpoint – reduce screen exposure time and manage myopia among young children. Can Tencent actually develop healthier games with milder content suitable for the young, and benefit from there?

Conclusion
Disclosure: I hold Tencent shares so I might be biased.

The once seemingly invincible internet giant seem rather weak now. For a company as big, as influential and as intertwined with China people’s daily life, as Tencent, government regulations seem to be the only market force that is able to make or break them.

I really do not think the growth story of Tencent has ended. Far from it. But I do recognise that its turbo-charged growth is probably curtailed in the immediate term of next one or two quarter until there is more clarity on the games approval, and policy on limiting youngsters usage.

Its fundamentals are still intact, and its business moat is still formidable. Opportunity funds are ready for deployment once I sense some light at end of tunnel. But it may come swift and sudden considering the extent of its drop so far, so do catch it. 

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