Some domestic growth may possibly be impacted in the short term. Long term, Tencent continues to be seen as a champion of China’s new economy companies.
Its position is greatly strengthened by its ever-growing web of inter-linked international interests. Recent macro trends further strengthen this outlook. The new Asian trade agreement and the advent of the Biden presidency are the two most significant of these.
As the Asian economies grow more rapidly than those in Europe or North America, Tencent will ride on this growing wave. On a micro level, its huge user base and diversification are integral strengths.
Tencent in China
A summary of its main areas of interest would include:
- Its WeChat base of 1.2 billion domestic users. This is the central core of the company’s strength. It has been accentuated recently with the successful application of mini programs.
- WeChat Pay.
- Mobile gaming (it is the world’s largest gaming company)
- Online advertising.
- Online payments.
- Cloud Services
A recent report by UBS particularly liked the gaming and fintech growth potential for Tencent in China.
The recent change in Chinese government regulations halted the world’s largest IPO of Ant Financial. This had been due to be floated in November by Alibaba (NYSE:BABA). It is never easy to read the intentions of the CCP (Chinese Communist Party). It is possibly just a slap-down to Alibaba’s founder Jack Ma for comments he had made recently. In this, it can be seen as the CCP reminding everyone, including Tencent, as to who is the boss.
Some observers see this as a slap-down to Alibaba and a pat on the back for Tencent. That is not certain, however. China is proud of its Internet giants and wants them to continue to challenge the world. However, it also wants them to know that they exist at the behest of the CCP.
Tencent executives have unsurprisingly been diplomatic in their response. At the Q3 2020 analyst call, company President Martin Lau affirmed:
I would like to reflect on Tencent’s business and strategy and philosophy. I would actually say it fits very well with the spirit of the regulatory framework. As you can see our platforms are open in nature. We work with a lot of partners… And we also embrace competition. And as a matter of fact we thrive on competition.
Reading between the lines, one can see that Tencent will push the agenda that they are not anti-competitive or oligopolistic in nature.
Further regulation details will be revealed in due course. Much of this may be predicated on anti-monopoly concerns. In that, the Chinese have similar concerns to what we have seen in the USA with the likes of Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR). The threat to the likes of Alibaba and Tencent is probably no more than the threats which Congress may pose to the likes of Facebook or Twitter or Amazon (NASDAQ:AMZN).
There has been some speculation that the government could clamp down on further acquisitions if they are seen to ignore anti-monopoly regulations. That is clearly a potential threat to Tencent’s business model. It could be forced to sell off some of its domestic subsidiary companies. Companies like Tencent and Alibaba have become far bigger than the State’s own giant companies. One possible target that has been considered is that the government may clamp down on so-called VIEs (variable interest entities). These are offshore companies which China’s Internet giants use to attract foreign funds.
The giant players such as Tencent can, in fact, probably adjust to any new regulations more easily than smaller ones. The recent move in regard to Alibaba should not be treated by investors as a big surprise. A similar situation pertained in 2018 when the government clamped down on gaming approvals especially in regard to child addiction. That should have hurt the world’s largest gaming company. In fact, the impact was limited and well-managed.
Similarly, in September this year, the CCP announced that major companies would need to have a certain quota of registered CCP members on their staff. This is seen by many in the private sector as preferable to the CCP actually taking financial stakes in companies. That has also been mooted in recent years.
Tencent’s founder and boss, Pony Ma, seems to have played a good diplomatic game so far. The company’s stock price has been little affected, as the one-year stock chart below illustrates:
Source: Charles Schwab
The stock price has roughly doubled this year. It has not, though, risen over the past few years as rapidly as some of its peers in China. Its free cash flow and operating cash flow are very strong forward-looking indicators.
In historical graph form as provided by Tencent, it can be seen as illustrated:
It is hard to see any roll-back from this growth pattern.
Its recent Q3 results were impressive:
The results make it clear the company will be able to continue its huge investment programmes. Valuations of Tencent and others in the sector in China are also low compared to their American peers. The UBS report saw this as an opportunity to buy Tencent on the dip after a resetting of valuations following the government measures.
The RCED (Regional Comprehensive Economic Partnership) was signed in Hanoi in November. It is the world’s largest multi-lateral trade agreement. It effectively improves and replaces the previous TPP (Trans-Pacific Partnership). That was the agreement that the Trump administration pulled out of and which had been unfavourable to China. So, the Trump administration succeeded in sharply strengthening China’s influence in the region whilst reducing its own. The ASEAN (Association of South-East Asian Nations) region has recently replaced the EU as China’s largest trading partner.
Quite simply, the web of newly signed trading and investment deals under RCED greatly strengthens China’s hand in Asia. As an effective proxy for China in many respects, Tencent’s hand is also greatly strengthened by this.
The absence of both the USA and India from RCED weakens those countries and their companies in Asia. The Biden administration will have much work to do to make up lost ground in the region from the Trump administration’s policies.
To follow up on the RCED success, China’s President Xi Jinping then gave an address at the APEC (Asia Pacific Economic Cooperation) forum. In this, he lauded free trade and China’s role at the forefront of it. This might be seen as ironic by many. However, the USA’s poor diplomacy has lost the country its leading role in Asia and enabled these sorts of claims to be made. This will benefit Chinese companies such as Tencent in the region.
Investments in Asia
My article in October detailed much of this, and I will not repeat it all here. The net of interlinked companies continues to spread. One of the most significant, and successful, investments has been in Singapore-based online games and online shopping company Sea Ltd. (NYSE:SE). I wrote about this in June and have been recommending the stock for some time. Its stock price has boomed and, along with it, the value of Tencent’s investment. Sea is a perfect S-E Asian play for Tencent. Sea itself has first call on Tencent-developed games in the region.
The range of Tencent’s investments and joint ventures can be gauged by examples such as:
- Gojek, an Indonesian ride-hailing company.
- Ola, an Indian ride-hailing company.
- Sony (NYSE:SNE), the diversified Japanese gaming giant.
- Platinum Games of Japan.
Flipkart, the Indian e-commerce player.
Niyo, the Indian fintech player.
CJ Games of South Korea.
And so, the list goes on. Observers saw the RCED as being of particular benefit to China, South Korea, and Japan. Tencent’s investments ride on the back of this. However, the company also has strong interests in India despite poor relations between the Chinese and Indian governments. Indeed, the Chinese government may well see Tencent as a means to discreetly develop commercial interests in India.
Although temporarily stymied by the COVID-19 pandemic, the company’s WeChat base greatly helps the company to spread its web across the region. It is a core in-house expansionary strength. In that, it is similar to the iPhone base for Apple (NASDAQ:AAPL) and the PS base for Sony.
In general, the company is quite wary of disclosing comprehensive breakdowns of revenues between domestic and international operations. However, at the analyst call, company Chief Strategy Officer James Mitchell did disclose some details on their largest business, gaming:
We don’t disclose that percentage on a quarter-by-quarter basis. But I believe the last quarter where we gave a point figure, it was the fourth quarter of last year when we disclosed 23% of our games segment revenue was international…… the ratio in the third quarter was very similar to the ratio in the fourth quarter last year.
He went on to detail how different games did well in different geographies for the company. Additionally, he stressed the company was seeing more of a market overseas now for games developed in China. In fact, many of these are marketed around Asia through Sea Ltd. in Singapore.
Tencent in the USA
The inconsistent policy of the Trump administration towards China made it difficult for companies such as Tencent. Indeed, it posed a risk to their operations. It does not seem that Biden will be “soft” on China. It does seem likely, though, that his policy will be consistent and intelligent. This will benefit Tencent.
The company’s investments in the USA are quite substantial. They include capital investments or joint ventures with:
- Tesla Inc. (NASDAQ:TSLA), of which it owns 5% at a huge investment gain. This is part of the company’s current emphasis on EVs (electric vehicles) and AI applications related to EVs. This should be a core growth area for Tencent in the coming years as the EV revolution rolls out.
- Snap Inc. (NYSE:SNAP).
- Activision Blizzard (NASDAQ:ATVI).
- Lyft (Lyft).
- Riot Games (fully owned).
- Epic Games.
- Glu Mobile Inc. (NASDAQ:GLUU).
The company tends to have a philosophy of allowing subsidiaries to plough their own furrow. For instance, at the analyst call, Mitchell pinpointed how the release of new games by wholly-owned Riot Games was “under Riot’s control”.
There are many more such investments. It is somewhat of an oddity that Tencent has so much investment in the USA yet is so little known. As the chart in my October article illustrated, by market cap, Tencent is the world’s eighth largest company. Just above it are the other Internet giants of Alibaba, Facebook, and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL). The main reason for its low profile may be that the company is not traded directly on U.S. exchanges. It is only available as OTCs.
One of the Trump administration’s ideas had been to ban WeChat in the USA. The only effect of this so far has been a surge in people downloading the app before any ban appears. It seems this contrary and arbitrary idea is now dead in the water under a Biden administration.
It remains to be seen what happens with the U.S. bill threatening to delist stocks if companies do not become more open about their financials and ownership. It would seem this would not directly affect Tencent as it is only an OTC listing. The fact that the proposed Ant Financial IPO had been planned for the Hong Kong and Shanghai exchanges but not for U.S. exchanges tells a tale.
Tencent in Europe
A similar situation pertains in Europe where the company’s interests include:
- Spotify (NYSE:SPOT).
- Universal Music Group through owner Vivendi (OTCPK:VIVEF)
- Ubisoft (OTCPK:UBSFY)
- Fintech plays such as France’s Lydia and Qonto.
However, there is less hostility to Chinese investment there than there has been from U.S. authorities. Further investments in the continent seem likely. This may well come first with the option to buy a further chunk of Universal Music Group from Vivendi.
Some of these investments are made through the successful subsidiary Tencent Music (NYSE:TME). This gets much of its advantages through leveraging the ubiquitous WeChat platform. It is China’s largest music streaming service with tremendous cash flows and relatively low valuations. It has 646 million MAUs (monthly average users). Its social entertainment section has, though, been coming under quite strong competitive pressures. The cross-holdings with Spotify seem to benefit Tencent Music. The division is another good reason to be bullish about Tencent as a whole.
My October article detailed many reasons why this may well be seen as the decade when the “Asian century” finally takes hold. Macroeconomic and political factors seem to be heading that way. The international lead from China in this will greatly benefit Tencent. China’s economic growth outperforms the West. Its handling of the COVID-19 pandemic will accentuate this in the short run.
Recent trade agreements will benefit Tencent. Chinese government policy does represent a potential threat to some aspects of the company’s growth. Investors need to be aware of this. This threat is, however, probably about on a par with the political threats in the U.S. posed to U.S. internet companies. It is something on which investors have to decide whether or not the risks outweigh the rewards.
The Q3 2020 results detailed how the company’s over 700 stakes in other companies, both domestic and international, have surged to a fair value of US$131 billion. Its huge user base and diversification strengths only look set to increase in the favourable macro conditions.
Disclosure: I am/we are long TCEHY, AAPL, SNE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.