Company deep-dive no 4: Tencent Holdings
Chinese-based Tencent Holdings has been dubbed the 'Berkshire Hathaway of Tech' and is projected to be one of the most important companies in the world for decades to come!
Quick take-aways:
Since reaching its peak in February 2021, Tencent's value has dipped by 60%, largely attributed to decelerating growth and the prevailing business climate influenced by potential interventions from the CCP. Nonetheless, this scenario presents an enticing valuation for Tencent, offering investors the chance to be greedy when others are fearful. Tencent's distinct business approach, complemented by its robust competitive advantages, provides an added margin of safety. I believe Tencent is poised to experience growth over the next decade or so.
Tencent remains relatively unfamiliar to many Westerners due to its dual nature: being a Chinese entity and simultaneously one of the most intricately structured and highly profitable operating businesses globally. It embodies a unique blend of immense profitability and unparalleled ambition in the realm of investment funds.
This deep-dive seeks to give you a better understanding of what Tencent does, what it owns, why it’s one of the most significant companies in the world, and reasons why its current valuation might be an opportune entry point for investment.
Introduction
Tencent was founded in 1998 by Pony Ma (current CEO), Zhang Zhidong, Xu Chenye, Charles Chen, and Zeng Liqing. Tencent is a multifaceted conglomerate that combines the functionalities of Facebook, Instagram, Spotify, Paypal, AWS, Tinder, Youtube, Netflix, Twitch, Zoom, Wolt, Sequoia Capital, and all the biggest games in the world, all under one umbrella. Tencent has evolved from a modest instant messaging platform into a colossal global entity with a diverse portfolio of services and investments. At the core of its offerings lies WeChat, a flagship product with an impressive user base of 1.3 billion individuals who collectively spend more time on the app daily than all Americans do on their combined social media platforms. WeChat acts as a versatile platform accommodating a wide range of activities, including messaging friends, online shopping, news consumption, gaming, and in-store payments. Essentially, WeChat provides a one-stop solution for everything you typically do on your smartphone.
Tencent effectively translated the substantial profits generated from its social networking, e-commerce, and gaming ventures into a diverse global investment portfolio. This portfolio encompasses some of the world's most famous video games, rapidly growing internet businesses in China, substantial ownership interests in companies such as Tesla, Spotify, and Snap, and a collection of international startup unicorns that ranks only second to Sequoia in terms of its expansive reach and significance.
Tencent trades under TCEHY and HKSE: 0700. As of October 2023 Tencent has a market cap of $380.41 billion. This makes Tencent the world's 18th most valuable company by market cap, in between JPMorgan Chase and Johnson & Johnson.
This deep-dive has the following chapters:
Tencent’s core businesses
Tencent’s investment portfolio
Tencent’s competitors
Review of Tencent’s management
Tencent’s capital allocation strategy
Tencent’s moats
Tencent’s financial performance
Tencent valuation
Technical analysis of Tencent
Tencent investors
Tencent’s short- and long-term challenges
Tencent’s opportunities going forward
Final remarks
1. Tencent’s core operations
Tencent operates in several key business segments, each contributing to its diverse portfolio and overall success. Tencent's business segments are circulating mega trends such as gaming, social media, cloud computing, AI, and fintech, and thus have a huge tailwind. Tencent’s primary operating segments are the following:
Value-Added Services (VAS): This segment includes online gaming, which is one of Tencent's major revenue drivers. Tencent offers a wide range of online games, from mobile to PC and console gaming. It also encompasses other value-added services such as digital content subscriptions, music streaming, and video streaming through platforms like Tencent Video and Tencent Music. See below picture highlighting Tencent’s gaming platform.
FinTech and Business Services: This segment includes Tencent's financial technology (FinTech) initiatives, including WeChat Pay and Tenpay, its mobile payment services. It also involves various business services like cloud computing and enterprise solutions offered through Tencent Cloud.
Social Media and Social Networking: Tencent's social media and social networking platforms, including WeChat (known as Weixin in China) and QQ, fall under this segment. These platforms facilitate communication, social networking, and content sharing, making them integral to Tencent's ecosystem.
Deep-dive on WeChat: WeChat can be likened to a fusion of Facebook, WhatsApp, Netflix, Spotify, and PayPal all within a single application, boasting a staggering user base of over 1.3 billion monthly active users. It stands as China's ultimate super app, encompassing a multitude of functionalities such as instant messaging, social networking, digital payments, live streaming, short-form videos, a search engine, and an extensive array of mini programs – essentially, apps within an app. To date, there are more than 4 million mini programs available on the platform. WeChat serves as a comprehensive digital ecosystem, offering everything needed for one's digital life without the need to leave the app.
Online Advertising: Tencent generates revenue through online advertising, including display and performance-based advertising across its platforms. This includes advertising on WeChat Moments, WeChat Official Accounts, and more.
Tencent’s strong gaming platform:
The image below from Tencent's website effectively illustrates the extent and dominance of its operations.
#1 globally and in China within games
#1 by paid subscriptions including video, music, literature
#1 by monthly active users within mobile browsers and #2 by mobile security
#1 by monthly- and daily active users within mobile payments
#1 by monthly active mobile community users
#2 by revenue within cloud (AliBaba #1)
Tencent's diverse business segments underscore their strategy of building a comprehensive ecosystem. Leveraging their software expertise, Tencent has strategically integrated their applications deeply into people's daily routines. This process initiates with WeChat and QQ, which form the foundation, and from there, these apps extend into three key pillars: Sharing, Communication, and Social Interaction. This expansive ecosystem encompasses various facets, including video content, gaming, music, reading, payment services, professional use, healthcare, and more. All of this is underpinned by a vast user base, making it a truly immense ecosystem. See below overview of Tencent’s ecosystem:
WeChat (and Weixin) has been growing remarkably past decade, and reached 100 million monthly active users just within 14 months. For comparison, Facebook used 4 years. Extreme rate of adoption of WeChat. That said, growth rates have started to slow down which is a natural effect when reaching mass scale. Around 60% of the Chinese population are using WeChat on a monthly basis (827.2 million), so still room for growth!
MAUs CAGRs:
Combined MAU of Weixin and WeChat: 15.6%
Mobile/Smart device MAU of QQ: 3.1%
Fee-based VAS registered subscriptions: 11.4%
The lower user growth rates is also impacting the revenue generated. See below (in CNY, not USD):
Particularly Fintech and Business Services, Games and Social Networks has had strong uptake since 2019. Value-added services (VAS) and Online Advertising with highest gross margins; and with Fintech and Business Services with increasingly higher margins.
2. Tencent’s investment portfolio
Tencent's investment strategy involves not only financial investments but also strategic partnerships and collaborations. This extensive and diverse investment portfolio allows Tencent to diversify its revenue streams and gain exposure to emerging technologies and markets.
On its most recent earnings call on capital allocation and M&A, Martin Lau said:
“Our M&A strategy has always been trying to invest in up and coming companies which have great management, who have innovative products, and at the same time, they have synergies with our existing platforms. We now have more than 800 companies.”
The investment portfolio today consists of more than 840 companies! I did an extrapolation of the current- and former investments conducted since 2000. See Tencent’s portfolio here:
Here are some key aspects of Tencent's investment portfolio:
Gaming Companies:
Tencent has invested in numerous gaming companies globally, including owning a majority stake in Riot Games (maker of League of Legends), a significant stake in Epic Games (maker of Fortnite), Supercell (maker of Clash of Clans), Bluehole (maker of PUBG), Grinding Gear Games (maker of Path of Exile), minority stake in Activision Blizzard (maker of Call of Duty, World of Warcraft, Starcraft, and Candy Crush), Ubisoft (maker of Assassin’s Creed and Far Cry), and holdings in various other game developers. Tencent also possesses a 1.3% share in Roblox, a platform allowing youngsters to create their own games.
Entertainment and Media:
Tencent holds investments in entertainment and media companies, including ownership of a stake in Universal Music Group and a partnership with Spotify. It has also invested in Hollywood studios and Chinese film production companies.
E-commerce:
Tencent has invested in e-commerce giants like JD.com, helping to expand its presence in the e-commerce sector, as well as in e-commerce giants Meituan Dianping and Pinduoduo. Tencent also has a 18% stake in Sea ltd (also strong in fintech and games).
Tech and Startups:
Tencent actively invests in technology startups worldwide. It holds stakes in companies in areas such as artificial intelligence, autonomous vehicles, cloud computing, and more.
Social Media and Messaging:
Tencent has invested in various social media and messaging platforms outside China, including Snap Inc. (maker of Snapchat), Discord, and Reddit. Also, Tencent acquired stakes in TikTok competitor: Kuaishou.
Financial Services:
Tencent is involved in financial services, with investments in companies like Nubank (a Brazilian neobank) and the Indian digital payments platform NiYo. Also, China’s largest digital bank, WeBank.
Healthcare:
Tencent has made investments in healthcare companies and digital health platforms, aiming to leverage technology for healthcare innovation.
Electric Vehicles (EVs):
Tencent has invested in several electric vehicle companies, including NIO and Li Auto, as part of its interest in the growing electric vehicle market. Tencent actually also acquired a 5% stake in Tesla in 2017 (but sold again).
AI and Cloud Services:
Tencent Cloud, the cloud computing division of Tencent, is a key player in the cloud services industry.
Education:
Tencent has investments in online education companies, capitalizing on the growth of online learning platforms.
Blockchain and Cryptocurrency:
Tencent has shown interest in blockchain technology and cryptocurrency, with investments in related startups.
From Tencent’s annual reports, overall book value of investments have grown with a CAGR of 36.7% since 2014:
The Mainland of China and Hong Kong: 34.9%
North America: 36.9%
Asia excluding the Mainland of China and Hong Kong: 39.9%
Europe: 51.9%
Others: 97.2%
As of 2022, the book value of the investment portfolio amounted to a staggering $122 billion, but this is probably underestimate of the exact value of all the listed- and private companies that goes into this portfolio.
3. Tencent’s competitors
Tencent faces competition from several companies both in China and globally, as it operates in various sectors of the tech and entertainment industries. Here are some of Tencent's key competitors:
In China:
Alibaba Group: Alibaba is one of Tencent's primary competitors in China. It operates in e-commerce, digital payments (through Alipay), cloud computing, and various other tech-related areas.
Baidu: Baidu is a major player in China's search engine and online advertising market. It also has investments in AI, autonomous vehicles, and cloud services, making it a competitor in these areas.
ByteDance: ByteDance, the parent company of TikTok, competes with Tencent in the social media and short-form video content space. ByteDance's products, including Douyin and Toutiao, are rivals to Tencent's offerings.
NetEase: NetEase is a competitor in the gaming industry. It develops and publishes online games that compete with Tencent's gaming portfolio.
Globally:
Facebook: Facebook and its suite of apps, including Facebook Messenger, WhatsApp, and Instagram, compete with Tencent's WeChat and other social media offerings.
Google: Google competes with Tencent in the global search engine market and in the development of AI and cloud computing services.
Amazon: Amazon is a global e-commerce giant and cloud services provider, competing with Tencent in the e-commerce and cloud computing sectors.
Sony and Microsoft: Sony and Microsoft are global competitors of Tencent in the gaming industry. Tencent's gaming investments and titles compete with products like the PlayStation and Xbox.
Netflix: Tencent competes with global streaming platforms like Netflix through its investments in Tencent Video and Tencent Music, as well as its own content creation efforts.
Apple: Tencent's WeChat competes with Apple's iMessage and FaceTime in the messaging and video call space.
PayPal: In the global digital payments space, Tencent's WeChat Pay competes with PayPal and other mobile payment services.
Tencent's broad portfolio of services and investments means it encounters competition from a wide range of companies in various regions and industries. Its ability to navigate and compete in these diverse markets has been a key factor in its success.
4. Review of Tencent’s management
Tencent's management team has been recognized for its ability to adapt to changing market dynamics, world-class capital allocators, and drive innovation within the company. The leadership of (especially) Pony Ma, Martin Lau, and James Mitchell has been crucial in Tencent's evolution from a messaging platform to a global tech conglomerate with a wide-ranging portfolio.
Pony Ma shares the characteristics common among the most successful CEOs in the world. Below list is from Packy McCormick’s analysis of Pony Ma:
President Martin Lau and Chief Strategy Officer James Mitchell both come from Goldman Sachs backgrounds. They have demonstrated exceptional skill as capital allocators, effectively managing substantial investments and seamlessly integrating them into Tencent's operations. Additionally, they have adopted a strategy in line with Warren Buffett's philosophy, repurchasing company shares only when they are trading below their intrinsic value to ensure they do not erode shareholder value. Their track record in these areas has been outstanding.
51-year old Pony Ma owns around 8.5% of Tencent. It is unknown how much Martin Lau and James Mitchell owns. But it is hugely positive for shareholders that Pony Ma has his skin in the game.
5. Tencent’s capital allocation strategy
Tencent's capital allocation strategy is characterised by a focus on several key principles and areas:
Organic investments in core operations: Tencent is investing substantial amounts in internal business segments, such as Value-added Services, Online Advertising, Fintech and Business Services, as well as research and innovation (AI, autonomous vehicles, and quantum computing).
Investments in Strategic Businesses: Tencent is known for its strategic investments in a wide range of companies, both within and outside of China. These investments align with Tencent's goal of diversifying its portfolio and gaining exposure to emerging technologies and markets.
Share Buybacks: Tencent has occasionally engaged in share buyback programs, repurchasing its own shares when the stock is perceived to be trading below its intrinsic value. This is in line with a value-oriented capital allocation strategy.
Dividend Payments: Tencent has paid dividends to shareholders, providing returns to investors through dividends as a part of its capital allocation strategy.
Mohnish Pabrai (who suggest Tencent to be superior to Alibaba, sold his stake in Alibaba last year to buy shares in Tencent) describes Tencent’s business model (and capital allocation strategy) to be the following:
“Pony Ma has two businesses consisting of two types of resources and he decides in which one he wants to allocate capital:
Large army of software engineers
30 Warren Buffett-like managers
The order of the strategy (use of free cash flow) then goes in the following steps:
Step 1: See if the army of software engineers have sufficient capital to expand business organically. The rest goes to step 2…
Step 2: 30 Warren Buffett-like managers: They invest remaining free cash flow in 1) whole strategic acquisitions, and/or 2) strategic minority stakes in a number of businesses.”
This approach provides an additional layer of safeguarding for Tencent's business. In the event that one segment of their operations encounters challenges (or faces new regulations), it wouldn't have a detrimental long-term effect on Tencent. They can simply reallocate their resources and refocus on other areas, potentially outside of China. Which is what they are doing.
This capital allocation strategy clearly resonates with Warren Buffett quote on the importance of capital allocation:
“Over time, the skill with which a company's managers allocate capital has an enormous impact on the enterprise's value.”
6. Tencent’s MOATs
Tencent's significant competitive advantage primarily derives from network effects stemming from its vast user base. Moreover, I believe Tencent has additional sources of competitive advantage, such as intangible assets (user data and content/IP ownership), cost efficiencies, and switching costs. Considering Tencent's profitable monetization of its network through gaming, music, advertising, fintech, and other services, I am inclined to believe that the company is well-positioned to generate above-average returns on capital over the next decades.
Some of the the more implicit factors (also interlinked with above MOATs) that also contribute to its strong market position are the following:
Diverse Portfolio: Tencent's extensive portfolio spans gaming, social media, fintech, cloud computing, e-commerce, and more. This diversification minimizes risks through multi-market presence (and internationalization) and generates multiple revenue streams.
Strong Brands: Tencent's ownership of popular franchises like Call of Duty, Fortnite, League of Legends, and others adds significant brand value.
App Store Dominance: Tencent is the biggest supplier of games on e.g., Apple App store, and thus enhancing its market presence.
Tencent's mobile platform is a two-sided market: It not only generates revenue from players through microtransactions and subscriptions, but also get paid by third-party developers to list their games on Tencent's platform.
On the player side, Tencent knows that people like to play their favorite games with friends, so it leverages its substantial presence in social networking to attract gamers.
On the game developer side, Tencent again leverages its dominance in social networks to establish strong bargaining power against the third-party online games developers that want to tap into Tencent's huge network of players.
Tencent's ability to harness network effects, diversify its portfolio, and leverage its brand value across various segments has solidified its competitive position in the global tech industry.
7. Tencent’s financial performance
Tencent, one of the largest technology companies in China and the world, has historically demonstrated strong financial performance. Here's an overview of its financial trajectory leading up to today:
Early Growth (1998-2007): Tencent was founded in 1998 and launched its flagship product, QQ, an instant messaging software. The company saw rapid user growth but initially struggled to monetize. It eventually diversified its revenue streams by introducing value-added services, online games, and advertising.
Expansion Phase (2008-2014): During this period, Tencent diversified its business, stepping into online gaming, social media (with the launch and rapid growth of WeChat), and digital payments. By 2014, Tencent had become a major player in the online gaming market, both in China and globally. WeChat's growth also allowed Tencent to establish a dominant position in China's mobile messaging and social media market.
Ecosystem Building (2015-2019): Tencent started building an extensive ecosystem around its core products. This was driven by strategic investments, partnerships, and product innovations. Its financial arm, Tenpay (which includes WeChat Pay), saw exponential growth, positioning Tencent as a key player in China's digital payments market. The company also solidified its dominance in the gaming sector through acquisitions and in-house development.
2020-2023 (YTD): These years were marked by a combination of continued growth in core sectors and challenges posed by regulatory changes in China. While the gaming, cloud, and fintech sectors continued to grow, the Chinese government began implementing more stringent regulations, particularly in the tech and education sectors. This had implications for Tencent and other tech giants in terms of business operations and market valuation.
These phases led to the following financial performance:
Historically, Tencent's profitability has been strong, driven primarily by its high-margin online gaming segment and value-added services. The company's investment portfolio also contributed to its financial performance.
Moreover, Tencent has historically had a relatively high debt-to-equity ratio, but liquidity ratios (and cash flow margins) prove to be sufficient safety measures on that matter.
In summary, Tencent's financial performance historically can be characterized as robust with significant growth in revenues and profitability over the years. Its ability to diversify its business, leverage its massive user base, and make strategic investments has played a pivotal role in its financial success.
8. Tencent valuation
I've always emphasized a focus on business fundamentals over charts when investing. However, combining chart insights with fundamental analysis helps pinpoint where potential buyers and sellers have historically been located. This merged approach aids in understanding market momentum and future trends. It's not about market timing, but acquiring strong companies at sensible prices. Who wants to invest at peak values, hoping a less discerning buyer appears later?
Current trading multiples/ratios compared to peers
Current multiples of Tencent (price of stock: $39.00) can be seen below. Comparing those multiples to Tencent’s direct and indirect competitors, we get the following trading multiples/ratios:
Tencent seems undervalued to some degree when comparing multiples with peers. Especially when comparing to American peers. It must also be acknowledged that selected peers are not perfectly comparable to Tencent, but serve as proxy.
Historic trading multiples
Tencent is currently trading around all-time low multiples (except on P/FCF), and thus current price levels may serve as a great entry opportunity.
DCF valuation
To triangulate the findings, two DCF valuations have been created to assess Tencent’s attractiveness at current price levels.
Scenario 1: Worst case
From this perspective, Tencent is estimated to be 28% undervalued. The 28% margin of safety is essentially due to the value of the large investment portfolio. If the book value of the portfolio were excluded from the model, then the share price is estimated to be ~$37 and thus ~5% overvalued. I believe the book value of Tencent’s investment portfolio ($122 bn) is undervalued, which then just adds a stronger margin of safety to this case.
Scenario 2: Optimistic case
From this perspective, Tencent is estimated to be 95% undervalued. If the book value of the portfolio were excluded from the model, then the share price is estimated to be ~$63 and thus ~62% undervalued. Again, I believe the book value of Tencent’s investment portfolio ($122 bn) is undervalued, which then just serves a stronger margin of safety.
9. Technical analysis of Tencent
Tencent has essentially been in decline since February 2021 and only few technical indicators are suggesting that a reversal is on its way. Strong, strong, strong resistance from multiples indicators (MAs, anchored VWAPs, etc.) in price ranges $46-$53. Breaking through these levels is vital for the potential (long-term) reversal, and may act as support levels afterwards. Good entry point, through, may be around $33.5 levels where 150 days MA is at the monthly chart OR at current 38.2 fibonacci-levels.
10. Tencent investors
Several prominent superinvestors and institutional investment firms have stakes in Tencent. Some of these investors are well-known for their value investing approach and long-term investment philosophy. Notable superinvestors and institutions that have been known to own shares of Tencent include:
Naspers (and its international internet assets subsidiary, Prosus): One of the most well-known and significant shareholders of Tencent. Naspers, a South African multinational conglomerate, made an early investment in Tencent in 2001 and holds a substantial portion of its shares via Prosus. Guy Spier and Mohnish Pabrai has both invested in Prosus because of its large stake in Tencent.
The Vanguard Group: One of the world's largest asset managers, Vanguard has diversified holdings across many companies, including Tencent.
BlackRock: Another massive global asset manager, BlackRock has also been known to hold a position in Tencent.
Charlie Munger: The legendary investor and vice-chairman of Berkshire Hathaway has praised Tencent and has through Daily Journal Corporation a position in Tencent.
11. Tencent’s short- and long-term challenges
Tencent, like other large tech conglomerates, faces a mixture of short-term and long-term challenges. Here's a breakdown:
Short-Term Challenges:
Regulatory Pressure: In recent years, Chinese regulatory authorities have increased their scrutiny of tech giants, introducing antitrust regulations, data protection rules, and online content restrictions. Tencent, being a significant player, has faced direct impacts from these regulatory shifts. From quarterly call, Martin Lau highlighted regulation on under-aged users specifically impacted less than 0.3% of Tencent's revenue in 2021.
Competition and Market Dominance: Tencent faces stiff competition in many of its business segments. Companies like Alibaba, ByteDance (the parent company of TikTok), and others are constantly challenging Tencent's dominance in various sectors. Furthermore, Tencent's dominant market position poses a risk in the face of competition regulations. If they become too influential in certain markets, there might be regulatory interventions to reduce their strength. Tencent's divestment from companies like JD.com can be viewed as a strategy to counteract this potential issue.
Global Tensions: Geopolitical tensions, especially between China and Western nations like the U.S., could impact Tencent's global operations and investments, given restrictions, sanctions, or bans on Chinese tech companies.
Game Approval Process: Tencent is a major player in the gaming industry. The Chinese government's tightened regulations around online gaming, including stricter approval processes and limits on gaming hours for minors, can impact Tencent's gaming revenues.
Monetary Policy & Interest Rates: Rising interest rates could negatively impact Tencent, especially its investment portfolio filled with unprofitable companies reliant on cheap credit. Historically, unprofitable tech companies tend to struggle during monetary tightening periods.
Long-Term Challenges:
Innovation and Diversification: Tencent has a diverse portfolio, but continuing to innovate and fend off competition in areas like cloud computing, AI, and other emerging tech sectors will be crucial. Ensuring it remains at the forefront of technology and consumer trends is essential.
International Expansion: While Tencent is a giant in China, expanding successfully in international markets has its challenges, from understanding local consumer behavior to navigating different regulatory landscapes.
Data Security and Privacy: As data protection becomes a global concern, Tencent will need to ensure its products and platforms are secure and comply with international data protection standards, especially if it wishes to expand its user base outside China.
Dependence on Core Segments: Historically, Tencent has derived a significant portion of its revenues from online gaming and WeChat. Diversifying its revenue streams will be essential to mitigate risks associated with over-reliance on these core segments.
Reputation Management: Any missteps, be it in data handling, content management, or corporate governance, could impact Tencent's reputation, affecting user trust and potentially leading to user attrition.
Talent Acquisition and Retention: As the tech sector in China and globally becomes more competitive, attracting and retaining top talent becomes crucial. Tencent needs to ensure it remains an attractive employer in the long run.
In conclusion, while Tencent is a formidable player with vast resources and a diverse portfolio, it operates in a dynamic and challenging environment. How it navigates these short- and long-term challenges will determine its future growth trajectory and market position.
12. Tencent’s opportunities going forward
Tencent arguably have several avenues for future growth and opportunities. I personally believe that below potential opportunities serves as the strongest growth opportunities for Tencent:
Monetizing WeChat: Compared to platforms like Meta, Tencent has lower ad loads and uses user data more conservatively. This approach suggests a significant opportunity for Tencent to further monetize WeChat without overwhelming users.
As James Mitchell, the Chief Strategy Officer, stated in Q2-21: “Tencent has historically been more cautious about using data for ad targeting. Therefore, potential regulatory changes on data usage might impact us less compared to our more aggressive Western- and local peers.” Such careful monetization represents an incremental profit opportunity.
International Expansion: Tencent has a unique position to act as a bridge for international companies, especially in gaming, to enter the Chinese market. They strategically invest in international gaming companies, facilitating their introduction to China, which is traditionally challenging due to regulatory reasons. Companies often find it necessary to partner with giants like Tencent or Alibaba to operate successfully in China.
Mergers, Acquisitions, and Strategic Partnerships: Tencent follows a "king-maker" approach in its investment and capital allocation strategies. Historically, they have invested in top-tier companies, positioning them as market leaders. When venturing into strategic partnerships, Tencent not only provides the needed traffic and user base but also typically acquires equity stakes in the partnered companies. This method ensures they capture a portion of the value created through these collaborations.
James Mitchell also stated in Q2-21 that: “We strategically invests in international gaming companies and serves as a conduit for bringing their games to the Chinese market. This arrangement underscores our unique advantage, as companies seeking to operate in China typically find it necessary to form partnerships with Tencent or Alibaba.”
Cloud Computing & AI: Tencent can further establish its foothold in the cloud computing space by expanding its services and integrating advanced AI solutions.
Expansion of Financial Services: Tencent can exploit its existing ecosystem to offer diversified financial services such as lending, insurance, and investment products through platforms like WeChat Pay.
Growth in E-commerce: Leveraging the large user base of platforms like WeChat and QQ can drive more e-commerce traffic and enhance integration with associated e-commerce platforms.
Esports and Game Streaming: Tencent can capitalize on the growing esports market, investing more in tournaments, game streaming platforms, and related merchandise.
Entertainment and Content Creation: Platforms under Tencent's umbrella, such as Tencent Music and Tencent Video, have the potential to diversify their offerings by producing original content and hosting exclusive events.
Other (perhaps more far reaching) potential opportunities for Tencent:
Healthcare Tech: Tencent can harness its investments and platforms to spearhead innovations in digital health solutions, telemedicine, and health data analytics.
Expansion in Online Education: The growing EdTech sector provides an opportunity for Tencent to use its technological capabilities and vast user base to offer innovative educational tools and platforms.
5G and IoT: The rollout of 5G networks can enable Tencent to develop new services and applications, particularly in the Internet of Things (IoT) sector.
Sustainability and Green Tech: The global shift towards sustainability can be an avenue for Tencent to invest in green technologies and create platforms catering to an eco-conscious audience.
13. Final remarks
So, what defines Tencent?
Tencent stands as a Chinese holding company that holds a global leadership position in the gaming industry while also operating the largest messaging, social networking, and mobile payments platform in China. Leveraging the substantial earnings generated by these core businesses, Tencent strategically invests in the next wave of influential enterprises both within China and internationally. In essence, Tencent blends the diversification characteristics of traditional conglomerates with the growth and decentralized nature of internet-native enterprises, positioning itself as a contender for the title of the world's largest company.
From its origins as a product-centric entity, Tencent has evolved into an unparalleled capital allocator among non-investment firms globally.
And why is Tencent an attractive investment?
The company seems undervalued on several fronts: Current multiples compared with peer group, historic trading multiples, and on both DCF models (investment portfolio included in both scenarios). Listed, and non-listed companies in their portfolio only considered at book values and thus may represent undervaluation. The reasons for the 60% decline since all-time highs in February 2021 is likely due to the fear and notion that CCP could come in and have a massive negative impact on Chinese businesses. Those same risks are obviously associated with Tencent, but I just believe that it is to a lesser extent than e.g., Alibaba. Tencent’s core business models and portfolio (such as WeChat) are firmly entranced in Chinese culture, and the relationship that Tencent has established with the government is more positive than that of Alibaba. Alibaba has over the past years established a very bad relationship with the government and thus have a very negative track record and going forward, any alight missteps that Alibaba takes are going to viciously addressed by the CCP. Tencent, however, has past 10 years been more friendly with the government; they’ve gotten along and been more subtle with the government. Although, they operate some clear monopolies (like the WeChat-app), they seem to get away pretty much unscathed relative to other companies in this space.
Mohnish Pabrai advocated on his youtube channel in 2023 that:
“Despite the Chinese regulatory risk bearing down the business right now, I do think the business is massively undervalued. Thinking about the nature of the environment that Tencent is operating in and its exemplary financial performance and growth; it’s just a world-class company. And less exposed to regulatory risks than e.g., Alibaba. I would bet that given the superiority of the Tencent model, it would not surprise me that if we 10-15 years ahead that Tencent is the most valuable business on the planet. And to a large extent I feel that they may even be able to transcend a bunch of stuff that the CCP is throwing at them and continues to throw at them.”
In conclusion, there is a lot of fear in the market around investing in Chinese businesses, but I do believe that Tencent current share price represents a great investment opportunity for the next decade. I have thus followed the classic quote from Warren and have been greedy when others have been fearful.
That said, I must highlight the other side of the coin: Tencent is operating the biggest social network in China, a non-democratic country. Thus, Tencent most likely contribute to surveillance of Chinese population on Tencent apps. There is also censorship of content. This is really the other side of this world-class company. A company who is ethically on point (the management, etc.), but has to follow the rules of the game that CCP is issuing.