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Is Tencent The Top Chinese Stock of 2023?

information technology Jan 17, 2023

Price Target: $58 (21% upside)

Current Price: $46

Target Date: Q1 2024

Stock: Tencent Holdings ADR ($TCEHY)

With China simultaneously softening its stance on COVID and easing into better relations with the US, it's high time to reexamine our Chinese holdings and see if there's any particular stock that's been unfairly undervalued during this weird period of volatility. 

We've been hot on a small selection of Chinese tech firms in the past, but our analysts are pretty cautious when it comes to international volatility.

That's because it's genuinely hard to predict the Chinese government's actions and how cagey the stock market is about even their best firms. 

This is why it delighted us to go over the numbers at Tencent ($TCEHY or HKEX:700) and see a business gearing up for solid international growth and margin expansion. 

We bet that Tencent is the top tech conglomerate that you've never heard of.

Their dominance in Chinese gaming, social media, and advertising has made them one of the biggest and most important companies in the Chinese economy -- EVER. 

But now, after a pretty weird 2022, they are gearing up to utilize their domestic success in gaming to reach international dominance.

International gaming is set to explode in revenue in 2023 over at Tencent and that's only one of several pillars that will drive growth at the stock for the next few years. 

It's all about the margins once you get to the top and Tencent is about to massively expand theirs. 

There's gonna be a big bundle of minutia with this one, so let's get into it 👇  

Tencent Overview:

Tencent is primarily known for social media (via apps like Bilibili) and gaming (via popular titles like League of Legends and their 40% stake in the creator of Fortnite).

But like all massive tech companies, their mandate is a little broader. Besides social media and gaming, their biggest pillars are advertising and Financial/ Business Services (think cloud computing). 

Because of how massive its gaming enterprise has been for the past decade, Tencent has become brilliant at scaling. 

It's really difficult to organize a global operation that works seamlessly, and through their expertise as a gaming conglomerate, Tencent is finally starting to scale much more margin-heavy operations like cloud and fintech.

Macro pressures like a weakening dollar and worldwide inflation getting more under control and China's mild softening on their US stance are only going to accelerate the gains TECHY can make from these improvements.

But in order to justify the risk of 1) the extra fees you get from investing internationally and 2) the higher risk when you deal with any force as inscrutable and powerful as the CCP -- we've got to put some serious numbers behind this pick.

So let's dive deep into each specific area Tencent is gearing up to blow up in 👇 


Tencent Expansion:

As we said, so much of our price target depends on Tencent expanding business styles where they already have success.

The key is expanding those proven successes into areas where they have more limited penetration. So let's go down the list: 

  • Gaming is finally garnering international penetration. Tencent is already the largest videogame company in the world. The Chinese gaming market, and East Asian gaming in general, is just laughably massive compared to the North American market. Games like League of Legends generate more revenue than some national sports leagues in the US (well, like MLS.) But while Tencent is doing great work expanding its footprint in Asia, they have so thoroughly penetrated that market that there aren't that many gains left to make. However, taking their scaled success in China and scaling international games has huge upside potential for them. Tencent has expanded into titles like Valorant, Pokemon Unite, and Lost Ark. Thanks to COVID, the whole AAA gaming industry has been struggling for the past two years. This means a lot of games that were developed for 2021/2022 are finally being shippable here in 2023. With every game in Tencent's 2023 pipeline, we're looking at an easy 18-21% increase in YoY revenue from gaming alone -- with the vast majority of that revenue coming from international game launches.   
  • Online Ads are hitting a critical inflection point.  Tencent owns social media platforms that are more successful than most continents. Weixin and WeChat have 1.3 Billion MAU's (monthly active users) while QQ is cruising past half a billion. The last two years have completely crushed revenue and margins while the entire Chinese economy buckled under their COVID policies. Ads however are already pushing a strong recovery for Tencent. In August, Tencent launched a new format of in-feed video ads for their various social media platforms that are driving strong growth. Furthermore, Tencent also has made deep cuts that are ensuring streamlined growth and better margins moving forward. We're excited that Tencent is anticipating YoY revenue and margin growth by Q3 2023 and based on the trendline we've seen so far, we anticipate ~17% growth there that will only accelerate thanks to additional value-added services in social media and advertising.
  • Fintech and Business have high-margin potential.  We've been really bullish on cloud computing in the past and we're really excited to see that one of the biggest moves being made by Tencent is in cloud services. Cloud is such a margin-heavy business that it's really hard not to get into once you reach Tencent's scale. However, with corporate budgets compressing here in the US in the first half of 2023 -- we're looking into whether or not cloud computing is over-invested. AWS has not been holding Amazon stock up as much as it used to, and Azure margins are decelerating. This could be our analytics team being too conservative, but it's important to monitor capital flows to ensure we're not putting too much investment in places where the market is deciding to pump the brakes. With that said, even our conservative estimates for cloud look awesome at Tencent. With their streamlining and high-margin strategy peaking in Q3 -- we expect a ~16% YoY growth line from the cloud and 14% overall for the entire FBS line. 

These are the main three pillars we're excited about, but domestic gaming, online entertainment, and a good number of Tencent's portfolio companies are also staring down the barrel of solid growth too.

Recovery is the name of the game for 2023 at Tencent. 


Tencent Outlook:

All-in-all, a softer international stance, and a corporate mandate focused on cost-cutting and margin expansion are setting Tencent up for an international breakout.

We're still keeping our PT conservative to help de-risk any curveballs coming from the CCP and old man Xi, but we're really eager to see the Chinese economy continue its more open path. 

Even with shakier relations in 2023, Tencent is set up for modest growth on the back of cost-cutting alone.

They are in a great position to recover revenue and margins in 2023 and that will be enough to drive growth even with international fees and the western markets under-investing out of fear of future crackdowns. 

Scale is hard to contain and we're really excited to see what Tencent can do with it this year. 

Risk/Reward: Medium-high / Medium

Rating: Overweight

Dividend Yield: 0%

Market Cap: $3.5T HKD