Tencent: An Overview Of Its Investment Portfolio And Businesses

Summary

  • Tencent is a highly diversified and global company that often flies under the radar despite being the 10th largest company in the world.
  • This article provides an overview of Tencent’s businesses and investment portfolio.
  • I rate Tencent as a buy despite the risks surrounding it.

Thesis

Tencent is one of the most diversified technology companies in the world. If it operated in the USA, it would probably claim a spot among the tech giants (FAAMG) based on both its size and the type of services it offers to its customers. The company also maintains a huge investment portfolio which has been very successful, in part because of Tencent’s ability to create a moat for its investments. While the company carries more geopolitical risk than its US-based counterparts, I’d argue that having no exposure to emerging markets is taking an even greater risk than investing in emerging market blue chips like Tencent.

Businesses

Business Percent of Revenue Growth (yoy)
Online Games 32% 36%
Social Networks 22% 27%
FinTech 27% 26%
Online Ads 17% 20%
Other 1% -1%

Source: Tencent Annual Report

Tencent’s growth rate is similar to that of the FAAMG stocks’, but it arguably has better revenue diversification than any FAAMG stock; Apple, Google, Facebook, and Amazon all have over 50% of their revenue coming from one segment. Microsoft is better diversified with three segments each accounting for about one third of revenue.

Tencent also has parallel businesses to many of the successful businesses of the western FAAMG stocks.

Like Microsoft, Tencent is very involved in gaming. The online games segment consists of some China-specific titles but also many well known international titles like PUBG Mobile (#9 strategy game on the USA App Store). Their ownership of Supercell and Riot Games also gives them exposure to Clash Royale (#1 strategy), Clash of Clans (#5 strategy), and League of Legends (#28 strategy). Tencent has also partnered with Nintendo to distribute Nintendo’s console and games within China. International gaming revenue now represents 25% of Tencent’s online games revenue and it’s growing faster than domestic games revenue.

We can draw parallels to Microsoft’s business software as well. Although it’s not a major contributor to revenue, Tencent offers cloud computing/data center solutions (they are the third largest cloud computing player in China) and business software solutions like Tencent Meeting (the leading video calling solution in China).

Like Facebook with Instagram and WhatsApp, Tencent also owns multiple social media platforms: WeChat and QQ. There are many reasons to own multiple platforms, with a major one being that each network caters to different demographics and tastes. For example:

  • QQ is an older platform that was designed for desktop, while WeChat is mobile first.
  • QQ makes money from virtual goods (avatars, virtual gifts, etc.) while WeChat makes a lot of its money from advertising.
  • The default privacy settings are different, with WeChat encouraging more intimate (non-public) conversations.

Aside from deriving less revenue from advertising, an important difference between Tencent’s platforms and western social media like Facebook is that Tencent basically created an operating system within its social network apps.

Like Apple, Google, and Microsoft enable within their operating systems, third party developers can create “mini programs” that are basically apps within WeChat. Some mini programs include McDonald’s, Little Red Book (another popular social media app in China), Bilibili (basically Chinese YouTube), and many more. There are also apps made by “influencers” that are used for highly specialized purposes, such as to sell promoted goods. Basically, anything you’d expect to find on Apple’s App Store, Chinese users would expect to find in WeChat.

Like Apple and Google, Tencent also has a suite of first party apps within WeChat that allow users to do things like pay friends/merchants, pay utilities and phone bills, call a taxi, order food delivery, buy movie tickets, do online shopping, talk to a doctor, read news, meet strangers, play games etc.

Like Netflix, Tencent offers a long form video service. They have 123 million video subscribers thanks to the popularity of their intellectual property, in particular anime and drama series. However, their video service is more flexible than Netflix since they also offer ad-supported content, social/co-watching experiences, and bonus purchase options (e.g. pay extra to watch a new episode of a show a couple days early).

Tencent is also a leader in music streaming, and has a Spotify style app called QQ Music. Like with their video service, they monetize this in creative ways; they have some free songs, some subscription songs, and some songs that can be bought separately.

All told, Tencent is a highly diversified company that provides many FAAMG-like services to Chinese and global users. In some ways, Tencent actually looks ahead of its western counterparts, in particular by utilizing its social media platform for payments and many other services, and by finding more ways to monetize its intellectual property than just a subscription service.

Investment Portfolio

Source: The Author

We manage our investment portfolio with a primary objective to strengthen our leading position in core businesses and complement our “Connection” strategy in various industries, particularly in social and digital content, O2O and smart retail sectors. We also invest in transportation, FinTech, cloud and other sectors. -Tencent

Besides being compared to the FAAMG stocks, Tencent can also be compared to companies with a large investment portfolio like Berkshire Hathaway. At the end of 2020, Tencent’s investment portfolio contained RMB691B (~$107B), up a whopping 57% from a year earlier. For reference, this is about 37% as large as Berkshire Hathaway’s portfolio and 17% the size of Tencent’s market cap.

A nice visualization of the portfolio’s holdings can be found here. I also found this (slightly outdated) spreadsheet that sorts the top holdings. The portfolio is well diversified with Snapchat being their largest holding. It’s worth 6% of the portfolio and is the only holding worth more than 5%.

The portfolio contains a lot of other international companies such as Tesla, Spotify, and some private companies like Discord and Tile. International investments represent slightly less than half of the portfolio, and that percentage is increasing.

Many investors are reluctant to buy a company for its investment portfolio because they prefer to pick stocks themselves. In my view, there are four major benefits that Tencent’s portfolio offers over individual stock picking:

  1. The investment portfolio isn’t the only reason to buy Tencent; it could still be a good investment without it.
  2. Their track record is very good, with the portfolio returning over 230% in the last 7 years.
  3. Less than 10% of the companies in the portfolio are publicly traded, so it would be difficult for most investors to get direct access to most of the companies.
  4. Tencent can utilize its platform and intellectual property to give its investments a moat and increase the chance that they will be successful.

To further illustrate the final point, here are a few examples:

  • JD – a major e-commerce company in China and one of Tencent’s investments – has been partnered with Tencent since 2014. Tencent basically offers JD first party app placement within its social networks, in exchange for ~$250M per year. The two companies also collaborate in other areas including making joint investments.
  • Pinduoduo has a very similar arrangement. They also utilize Tencent’s cloud computing solutions.
  • Sea Limited – a gaming and e-commerce company in Southeast Asia and one of Tencent’s investments – has exclusive rights to distribute Tencent’s gaming intellectual property in Indonesia, Taiwan, Thailand, the Philippines, Malaysia, and Singapore.

Tencent’s clever use of its social media platform and intellectual property allows it to share its moat with some of its investments, which dramatically boosts the chance that they will succeed. It’s also very likely that Tencent uses data about which WeChat and cloud apps are gaining popularity to choose which companies to invest in, a huge advantage over most other retail – or institutional – investors.

Risks

Source: Tencent Annual Report

If Tencent operated in the USA, it would pretty much be a no brainer buy, especially at its current price. The company’s revenue is arguably more diversified but as fast growing as the tech giants in the USA, and its investment portfolio is one of the largest in the world.

However, Tencent has identified nine main risk factors that are worth considering. All of them are factors that I’d expect to see from a USA company as well: regulatory risk, competition risk, cybersecurity risk, infrastructure/stability risk, public relations risk, and fraud risk.

Reading between the lines, some of these risks are more concerning because of Tencent’s geopolitical situation. Many of these issues also exist with Alibaba and thus have been beaten to death in virtually every trending article on this site. I recommend reading some of those articles for more details (including my article about China e-commerce), but here’s a quick overview for posterity:

  • Tencent is listed in Hong Kong instead of the USA. This means that it doesn’t follow the same reporting standards as US-listed companies, which could make it easier to pad stats or commit fraud. On the other hand, it also means that Tencent doesn’t carry delisting risk like some of its US-listed peers like Alibaba.
  • The variable interest entity structure that results from Chinese laws about foreign ownership of telecom companies carries legal risk, since among other things it can make it more difficult for foreign investors to sue the company in the case of fraud.
  • China’s government is less business friendly than the USA’s government, and it has fewer checks and balances. Alibaba notes in its annual report that “prior court decisions under the civil law system may be cited for reference but have limited precedential value. Moreover, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all and may have retroactive effect.”
  • Geopolitical tensions with the USA could present other risks. For example, Tencent’s stock might take a hit if a big company like Alibaba got delisted, even though Tencent isn’t at risk of being delisted itself.

Source: YCharts

While it’s easy to focus on the downside risks, it’s also important to consider the upside and the risk of not investing in emerging markets. Historically, there have been times where the S&P 500  has outperformed emerging markets, but there have also been long periods where the EEM outperformed SPY.

For example, emerging markets stocks did quite well in the “lost decade” for USA stocks between 2000 and 2010. On the other hand, USA stocks have done very well since then while emerging markets have nearly had a lost decade of their own.

Although history rarely repeats itself so cleanly, when looking at valuations and projected growth rates it’s not hard to imagine a scenario where emerging markets being to outperform again. Tencent is the largest emerging markets company and currently has a P/E of 21, about half of Microsoft’s 37. Microsoft’s P/E is near an all time high (it was less than 15 in 2011/2012) along with the rest of the USA market while Tencent’s is near an all time low (it traded between 30 and 40 for most of the 2010s). Meanwhile, China’s GDP is growing at over 6% per year while the USA grows at just over 2%.

I don’t pretend to know what will happen going forward. Maybe China’s stocks will permanently trade at a lower P/E because of the risk associated with them, and maybe there’s further to fall before a stable P/E is reached. But it’s also possible that the selloff is overdone, that worst-case scenarios won’t manifest and that EEM will outperform SPY in the coming decade.

Given enough time, revenue growth will prove more important to stock returns than multiple expansion, and companies in both the east and west appear well positioned to further grow revenue. For this reason, I want diversified exposure to compelling growth opportunities in both markets.

Conclusion

Looking at a historical chart of SPY or EEM, every dip seems like a great buying opportunity. But at the time of the dip, there was always a reason why there could be further to fall, and very few people timed the bottom of the dip perfectly. I have no reason to believe that this time is different.

So there could certainly be further to fall for Tencent too, which is why it’s important to dollar cost average and maintain a diversified portfolio. But I expect that over the long run, Tencent will recover to new highs.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Author: Kennan Mell, Seeking Alpha

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