Tencent Q3 2021 – The overhang

Regulatory overhang remains.  

• A slow down in growth at Tencent was mitigated somewhat by international expansion but could hide the fact that the regulatory spectre still looms large over this company particularly in financial services.
• Q3 2021 revenues / operating profit were RMB142.4 ($22.0bn) / RMB40.8bn a little behind estimates of RMB146.0bn / RMB40.2bn which sent the shares down 2.7%.
• The problem here is growth which has been greatly impeded by the increasing regulatory oversight of the technology sector and gaming in particular for Tencent.
• Revenue for domestic games rose by just 5% YoY compared to 20% YoY overseas as the regulator has limited both the release of new games and the time that under-18s can spend playing them.
• The biggest issue here is game release as, despite their relatively high numbers, under-18s account for only a small fraction of revenue.
• This makes complete sense as under-18s rarely have any money of their own to spend.
• Online advertising slowed down to 5% YoY growth to RMB22.65bn in revenues and Value Added Services (games and content) also managed just 7% YoY.
• This left almost all the growth to be delivered by fintech which showed 30% YoY growth to RMB43.3bn making up 30% of total turnover.
• While Fintech has helped keep Tencent over 10% YoY growth it is also at great risk of regulation.
• The regulator has hammered Ant Group (see here) turning it from one of the fastest-growing and dynamic fintech companies globally into a bank that is unable to take consumer deposits.
• This has utterly decimated the value of Ant Group and there is a very real risk that Tencent’s fintech business gets similar treatment.
• I have long suspected that the severity of Ant Group’s treatment was at least in part to punish Jack Ma for having the temerity to challenge the authority of the CCP.
• Hence, I think it unlikely that the regulator will be as heavy-handed with Tencent.
• Furthermore, Tencent now has a very good history of navigating through regulatory issues and so I think that there is a good chance that Tencent gets away much more lightly than Ant Group did.
• That being said, any interference is going to be pretty detrimental, and given that Fintech is now the engine of growth, I think that there is further downside to Tencent’s estimates.
• There is a strong contrast between Tencent and Alibaba as the regulatory shadow has long since disappeared from Alibaba while it is clearly still a problem for Tencent.
• This is not reflected estimates for either company where Tencent is trading at 34.2x 2021 PER with a forecast of 16.4% 3-year growth while Alibaba is on 22.2x 2021 PER but with just 8.5% 3-year growth.
• China is slowing down and forecasters are getting increasingly cautious on the outlook for consumer spending in 2022, but I think in Alibaba’s case this has gone too far.
• It remains the powerhouse of Chinese e-commerce which under a zero-COVID strategy looks set to accelerate its penetration of retail more generally in the coming years.
• Hence, I continue to think that there is a lot of upside in Alibaba and a lot of downside in Tencent.
• I remain long Alibaba with no exposure to Tencent.