Tencent Q2 2021 & Co. – Big trouble in big China.

Tencent remains the most exposed to the sanctions of the state.

• Tencent reported regulation-blighted results and warned that there is more to come highlighting the fact that of all the Chinese technology companies, Tencent is most at risk from regulation despite its good behaviour.
• Q2 2021 revenues / EPS were RMB138.3bn / RMB4.39 compared to consensus at RMB138.9bn / RMB3.28.
• Financial services were the engine of growth increasing 40% YoY and becoming 30% of revenues while the other business struggled with the new regulations.
• Content and games grew by just 10% YoY while advertising growth fell to 20% YoY.
• The shares responded positively to the results initially, but then lost all of the increase when Tencent started talking about more regulation to come.
• This is exactly the right commentary from Tencent as, of all of the technology sector, I think its business is now the most exposed to regulatory curbs meaning that it has the most to lose.
• At the same time, state media highlighted the probability of an increasingly redistributionist tax policy which the CCP believes will help to reduce the income inequality that is present in all successful economies of which China is no exception.
• The CCP seems to be aiming at the wealthy with the potential introduction of inheritance taxes and property taxes neither of which currently exist in China.
• This combined with cautious commentary from Tencent sent the sector into a tailspin again with a further 4% hit to many technology stocks.
• The big question being asked is to what degree will regulation impact Chinese shares and how should one price that in.
• Looking across the spectrum I see a very wide range of sensitivities to further regulation with Tencent at one end and Alibaba and the state-owned banks at the other.
• I think that Tencent is especially exposed due to its hugely successful financial services business that it has grown out of its WeChat ecosystem.
• So far this business has been completely untouched, unlike the hell and fury that has been rained upon Ant Group, transforming it from a dynamic fintech business into a bank that will probably be at the mercy of the legacy sector (see here).
• Beijing went after Ant Group partially to put Jack Ma in his place but also because Fintech threatens to undermine the CCP’s control of the banking sector.
• This is an important piece of any state’s control which is why the greatest risk to the fledgling decentralised banking sector anywhere in the world remains regulation.
• This is why I think that Tencent’s financial business is in for some heavy hits underpinning my view that Tencent is far more to lose than Alibaba.
• Alibaba has already been censured by the regulator and it long ago spun off its financial services business into Ant Group where it has a 30% stake and which I have long valued at $0.
• Furthermore, while it does use consumer data, its e-commerce business relies much less on this data to generate revenues than many of its peers.
• This is why I still think that the regulatory issue has largely passed for Alibaba, but this has not stopped the shares from falling every time the CCP says “Boo!”
• The state-owned banking sector is likely to be a beneficiary of increased regulation as turning nimble and dangerous fintech companies into banks that can’t use deposits for financing hands them a great advantage.
• I still do not think that the CCP wants to destroy the technology sector as it has made a great contribution to the improvements in wealth and prosperity of Chinese citizens which is what underpins the unwritten bargain of wealth for freedom that exists in China.
• Hence, the question is where is the bottom, and what should one do from here.
• I have held Alibaba from RMB220 and now face the difficult choice of either getting out or buying more.
• Everyone else seems to be heading for the hills (see here) which rationally tells me I should buy more, but at the same time regulation represents a change in the fundamentals which needs to be addressed before taking any further steps.
• One thing is clear to me which is I think that Tencent has more regulatory hits to take to its business which could be severe and so I have no desire to bottom fish this one because I think it may have much further to fall.