Tencent Q1 20 – The lockdown lift

Tencent waters down expectations to prevent a big miss later in the year.

• Tencent reported good results as it benefitted greatly from millions of Chinese sitting at home, but also moved to temper expectations as much as it could in a sign that it is worried about preserving the recent rally in its shares.
• Q1 2020 revenues / EPS were RMB108bn / RMB3.00 nicely ahead of consensus of RMB101bn (6.7% ahead) and RMB2.28 (31% ahead).
• As expected, games were the main driver of the results growing 31% YoY and making up a total of 35% of overall revenues.
• However, video streaming and social networking also did well as Chinese users on average increased their usage of digital devices by around 30% to while away the long hours trapped at home.
• The big surprise was advertising which grew by 32% YoY as online education and internet service companies filled the space vacated by FMCG, travel and automobile advertising during the lockdown.
• This is a stark contrast to developed markets where all forms of digital advertising are seeing an impact from the economic downturn.
• Chinese Internet is predominantly a mobile-first market and while the West is moving in this direction, it is still quite far behind China when it comes moving all internet to mobile.
• Hence, mobile is by far the dominant medium for digital advertising and this may have been a factor as other forms of advertising were cut and mobile was prioritised.
• However, this is not expected to be sustainable as Chinese users are now back at work and school meaning that there is less time for messing about on mobile phones.
• Hence, engagement will have returned to baseline which is likely to cause a dip in both gaming, advertising and media consumption related revenues.
• Tencent was keen to stress this on its conference call in order to tamper down expectations in order to prevent a big miss from hammering its valuation later in the year.
• That being said, I expect that gaming will remain somewhat elevated as a result of the lockdown as there are a reasonable number of new players who discovered Tencent games during the lockdown and are likely to stick around albeit at a lower level of time spent.
• Although the outlook for Tencent remains pretty good, I think that this is already more than reflected in its valuation.
• Earnings are predicted to grow at 20% for the next three years and for this, investors are being asked to pay 33.6x 2020 PER.
• This is a contrast to Alibaba where the earnings growth is expected to approximately the same, but the investors are only being asked to pay 27.9x 2020 PER (17% discount).
• On the surface, it looks like Alibaba is the better investment, but one also needs to take into account the difference in corporate governance.
• Even on a global comparison (Google, Facebook etc), Tencent has far better corporate governance and fair treatment of smaller investors than almost anyone else.
• By contrast, Alibaba is effectively controlled by a committee whose influence is much greater than its overall economic exposure to the company.
• Hence, smaller investors have no say in how the company is run which (as Yahoo and Softbank found some years ago with Ant Financial) can lead to very unfair treatment.
• If I take this added risk into account, the two companies are roughly equal when it comes to risk/reward based on consensus earnings.
• However, I think that Alibaba has a greater capacity to exceed expectations from here with an accelerating shift to online commerce and growth in cloud computing (an area where Tencent is clearly struggling).
• Hence, I would prefer Alibaba over Tencent if I was investing in the Chinese technology sector.