Tencent – The hammer pt. II

There is much worse ahead.

• Although the real regulatory hammer has yet to fall on Tencent, it is being hit far harder than I expected in other areas meaning that when all is said and done, Tencent will be a pale shadow of its former self.
• Chinese regulators summoned the games companies to meetings to discuss their fate in what sounds like a repetition of Jack Ma’s experience after he said things that annoyed the powers that be.
• The result of these meetings was a reiteration of much of what has been demanded before and one very ominous new regulation.
• This new regulation is spelled out by the state-run Xinhua News Agency as a requirement to end “the solitary focus of pursuing profit or attracting fans and other erroneous tendencies, and change game rules and designs inducing addictions.”
• This is an incredibly broad-brushed regulation which I think in plain English means: “if you do things that we don’t like including making fat margins we will hit you very hard with more regulation”.
• The other regulations reinforce what the regulator has said before in terms of unacceptable material in games, time limits on underage gaming, and so on and so it is the impact of this new one that really matters.
• Tencent’s margins are extremely healthy at 45% gross, 38% EBIT, and 31% net in Q2 2021.
• Not only that but the numbers are big with profits attributable to the equity holders of the company at RMB90bn ($13.9bn) and cash generated by operations of RMB83bn ($12.8bn) in H1 2021.
• It is not hard to see how the CCP could easily view this as “a solitary pursuit of profit” and take measures such as it did with after-school tutoring to rein it in.
• I continue to think that the real problems that Tencent faces are only just beginning because there has been no intervention on Tencent’s financial services business while its arch competitor, Ant Group, has been decimated by the state.
• If one takes what happened to Ant Group (see here) and applies it to Tencent’s financial services business, then there could be very serious consequences.
• This is because financial services are nearly 1/3rd of Tencent’s turnover and are currently the engine of growth of the whole company.
• If this is decimated in the same way that Ant Group has been, then there will almost certainly be a further large correction in Tencent’s valuation.
• I think that this is a matter of when not if because control of money is far important to maintaining power in China than the gaming sector is and digital financial services like Tencent’s represent a direct challenge to the financial status-quo of the state-owned banks.
• This is why China hates cryptocurrencies because they are decentralised and represent monetary units (or speculative assets) that are independent of central bank control.
• This is by far the greatest risk that Tencent now faces and as a result, I don’t think we have seen the bottom of Tencent’s share price.
• I continue to think that Alibaba is now in a much better position than Tencent when it comes to regulatory matters.
• This is because:
  • First, already punished: Jack Ma has been severely punished for his indiscretions both in terms of his public profile and his net wealth given what has happened to Ant Group.
  • Alibaba has also been punished with a $2.8bn fine and by and large, the regulatory cloud is raining elsewhere.
  • Secondly and most importantly, B2B: Alibaba is not a consumer company, and its products and services have no real influence on Chinese society.
  • Instead, Alibaba is a marketplace and fulfillment company that charges merchants a commission for bringing buyers to their online stores.
  • It also provides cloud services to companies.
  • Consequently, its activities have very little bearing on societal issues such as gaming addiction, unacceptable content, and so on.
• However, Alibaba has been hit just as hard as Tencent and continues to get hit every time the regulator says boo.
• There is no doubt that the risks of investing in China have risen considerably but I think that the worst is over for Alibaba and that there is upside as I think that the shares have sold off too hard.
• I am considering adding to my battered Alibaba position and if I had Tencent, I would sell it without delay.