Tencent – solid but boring?
Talking about Tencent is like talking about the whole China internet market, and thus topic can be extremely complicated. In the investment world, I believe many would agree invest in Tencent can still be quite solid, but whether it can still generate exciting IRR as before? Whether it is becoming boring?
Here I will limit myself in very few and highly debated questions and see if we can solve them.
1. How will the gaming market look like in the future?
2. Who is Tencent’s biggest enemy?
3. What is Tencent’s growth driver?
4. How is the empire structured? And how can it constantly evolve?
5. Valuation- where are the hidden gems?
6. Solid but boring? And my overall recommendation.
Some of the analysts like to analyse the market trend more from the supply side, aka looking into games pipelines and try to guess their billings. This approach is very difficult, as the games’ lifetime can be short and billings trend can be extremely volatile, and games can canniblize each other. And I am certainly not a game expert and thus has no edge guessing those numbers. And to be frank, the very precise number might be helpful for the quarterly trading, but it can not be the valuation foundation for our investment.
My perspective focuses on time consumption and monetization rate. Of course they will be influenced by product cycles, especially the very limited top games actually domite the majority of time comsumption and gross billings, but industry wise monetization rate is more or less stable.
Very limited top games actually domite the majority of time comsumption and gross billings:
Industry wise monetization rate is more or less stable and it may fluctuate from year to year because of some major game monetization rate change. But it in general is quite stable or slightly uptrend (may be 5%? 10%? 15%? Compounding rate in the future?), especially in mid-long term.
· In 2017, Honor of Kings accounted for most of the growth in time consumption.
· In 2018, time consumption expanded on the back of PUBG Mobile, but the blended monetization rate was hit hard by the game’s monetization delay as well as a further mix shift to casual.
And the next question is how will the time consumption grow?
My answer is: there may be some limited growth opportunities from mobile user growth and total time consumption continually to grow. But the real threat is whether the time spend will be cannibalized by other entertainments?
Of course, there might be some space for the daily time spend to grow, but I doubt whether the time spent can grow much, as it is standing at 6hr per day already.
Short video as another form of major entertainment and time consumption is rather clear to be the biggest enemy of gaming industry.
My lucky guess is that the total mobile game gross billings will grow 18% CAGR in the near future, with PC games to be 0 ~ -5% perhaps, however this is only a guess and the market can be erratic and volatile and makes the near term growth lower or higher than this projection.
2. Who is Tencent’s biggest enemy?
Tencent certainly has many enemies, as it engages in many battlefields.
The biggest segment is certainly still the gaming. And thanks to Tencent’s high growth in advertising, fintech, cloud and other segments, even the real gaming share (including those attribute to social segment) has come down to a level of 40% in 2019, highly diversified the concentration in the gaming segment.
With strong pipeline, industry leading IP and production teams, supreme distribution network, Tencent should have no worries in its competance in gaming industry. Even the closest competitor, NetEase, has no chance to present any real challenge to Tencent, except some temporary time being.
Let’s not dive too deeply into how Tencent has became so strong in gaming industry.
It is cleary exmplified that Tencent has almost all of the best IP in the world…
Apart from its world leading IP library, Tencent’s success in gaming industry lies on the dominance in the time spend in everyday’s life, though this dominance has already seen grandually undermined by ByteDance. If ByteDance can keep people staying more and more time on its platform, it can intrude in more and more Tencent’s core entertainment business, for example vedio, music, advertising, gaming, etc. That doesn’t say that Alibaba, Baidu and others are not important competitors for Tencent. The more crucial and possibly life threatening one must be ByteDance. Especially in advertising, ByteDance poses big problem for almost every internet player.
3. What is Tencent’s growth driver?
Let’s have a look at Tencent’s revenue segments. It is clear that apart from social networks (based on various VAS and subscription fees), Fintech is the most promising growth diver, given advertising became disappointment under ByteDance’s assault and Cloud only to be a distant and low margin player behind Alicloud.
*2020: summer LoL mobile (2b rmb/month) ?, 2021 DNF mobile (2b rmb/month);
*2019Q4 supercell consolidation 49->52%, 2b usd/annual;
*以腾讯的当家游戏《王者荣耀》为例，多家券商机构分析该款游戏2020年农历春节期间（1月）流水超90亿人民币，高于去年同期（2月农历春节）的70亿人民币。
As the fintech segment has already became very important to Tencent’s growth, let’s dive deeper in this area.
Tencent Finance enjoys 14 years of history starting as a payment business:
Tencent Finance has a clearer structure after group-level restructuring in 2018:
The fact that Tencent finance empire is built upon its dominating social network platform Wechat and QQ almost guarantees its success and makes it extremely solid and prosperous.
Besides financial service development, payment also empowers Tencent’s eCommerce and local service ecosystem inside Wechat through offering payment solutions and access points on Wechat Wallet to strategic business partners.
Leveraging the power of social payment, Wechat Pay acquired its first batch of users through the red packet function in 2014. Successful campaigns, including subsidies to merchants and users, supported Wechat Pay to quickly accumulate loyal commercial payment users over the past five years.
I think wechat’s leading position in payment MAUs will be sustainable. First, Wechat Pay is users’ top choice in small volume p2p transfers in China thanks to Wechat’s dominance in the social network. Second, payment by scanning QR-code online and offline offers convenience to users, whose Wechat apps are “always on”.
Wechat Pay is the second-largest mobile payment platform by commercial payment volume in China. Network effect establishes a strong economic moat that ensures Wechat Pay’s leading position.
·The duopoly of mobile payment has been established. The high adoptions of Wechat and Alipay have excluded the possibility of a large third player in the market due to very high costs. We are forecasting the joint market share of Wechat Pay and Alipay will remain above 90%. Alipay is expected to lose market share slightly due to Wechat Pay’s aggressiveness in expanding online payment acceptance.
·Mini Programs assists Wechat Pay to take online payment market share. With more than 200 mln DAUs, Mini Programs have become vital online platforms for O2O and eCommerce services. As the only accepted payment tool, Wechat Pay is monopolistic in mini programs. Per Tencent report, the payment volume on brand self-operated Mini Programs were up by over 2200% during 2019 Singles’ Day.
·Expect new products will increase Wechat Pay’s market share in credit payment. Media reports Wechat Pay is to launch revolving credit and installment services. The in-house product, in our view, will serve near-prime consumers who are not covered by a banking credit service.
Some lessons from duopoly player Visa and Mastercard:
1. Globally the net take rate around 0.26%, a level much higher than China player’s 0.17%, suggesting long term potential under duopoly circumstance. This level of increase might be still too little for customers and business to even notice, especially if it is increased gradually, but huge for Ant Finance and Wechat to enjoy.
2. Payment industry has an extremely high entry barrier, high fixed cost and network effect, thus enjoys a great operating leverage. The net margin of Visa and Mastercard can go as high as 50%-60% and is still climbing. (Wechat pay revenue is gross revenue, thus has lower gross margin and potentially lower net margin)
3. Because of the high barrier to entry, high operating leverage, and high profit margin, the global leaders are long time enjoy a valuation of 15-20PS.
86 research’s estimates of Wechat pay financials:
*Some details: central bank would give back interests and Wechat pay cut back subsidy.
自2019年11月起，央行决定将第三方支付机构的备付金以0.35%的年利率按季结息，该计息政策的实施期长达三年，从2019年8月1日至2022年7月31日。
Standalone valuation for Fintech and Business segment would be at least 10PS (40x PE of potential earning) and 1.3t RMB = around 200b USD, with Fintech alone would be worth 150b USD, even though this segment barely provided any net profit for Tencent so far and largely dragged down Tencent’s net margin.
4. How is the empire structured? And how can it constantly evolve?
I believe it is very unfair to criticize Tencent has lost some battles to BABA in ecommerce, ByteDance in news feeds and short video, etc. It is very easy to ask for more. But for an entity which is already so big and so power as controlling the total time spent of 42.3%, the fact that Tencent can still manage to grow and constantly evolve worth many credits.
Some may also criticize operational wise Tencent is not as efficient as BABA and ByteDance. I believe that’s because their ecosystems are totally different, so these strategies are not easy to compare directly.
It is clear that Tencent is more product based, which means it is not structurally toward to operational efficiency, which BABA focuses on.
And also, because Tencent has the super app Wechat and QQ controlling nearly 50% of the internet time spent, it is very clever to leverage that advantage to build the eco-system. That fact that apart from ByteDance, almost all the powerful new starters are Tencent’s alliances actually says a lot.
5. Valuation- where are the hidden gems?
Been dragged by many investments, Tencent looks to be fairly valued at 7.1 PS, 26 PE, 22 EV/FCF.
However, if you dive deeper and use SOTP, it is easy to find where the gems are. If I attribute 150b to its Fintech business as I discussed earlier, and 50b (8x ps) to its cloud business, Tencent’s core business would worth about 556b and 16% higher than current valuation.
(I did give mini app a valuation. I believe it is crucial for the Wechat ecosystem, and not easy to give standalone valuation)
And if we add its investments, we would come to a target price of 493, 28% higher than current valuation.
6. Solid but boring? And my overall recommendation.
Solid?
Certainly Yes!
Boring?
If Fintech and business segment can revalue, certainly not.
All in all, my projection is that Tencent is likely to provide a CAGR of 15-20% return in the coming 3-5 years, a more than satisfying outcome for a mega size investment target.