Tencent Earnings: Shares Undervalued As Company Sees Conducive Regulatory Environment

Although wide-moat Tencent’s 00700 second-quarter results were slightly behind our estimates (but in line with Refinitiv consensus), we see no reason to alter our long-term growth assumptions, given its growth engines remain intact. We maintain our fair value estimate of HKD 704 per share. With the core business trading at around 7% free cash flow yield, we view Tencent’s shares as very undervalued. We believe the market underestimates the longer-term revenue contribution from Video Accounts and the potential for more operating leverage as the internet giant cements a more efficient cost structure.

The highlight of the second-quarter earnings was the 34% year-over-year advertising revenue growth. This is even more impressive when we consider the tepid macroeconomic conditions in China. Management attributed the above-industry growth to enhancements to advertising technology and increased monetization of its short-video platform Video Accounts. With ad load on Video Accounts running at just a fraction of that on Douyin and Kuaishou, we see room for upside potential.

Tencent’s gaming business slowed in the quarter, dragged by flat revenue from domestic games. We believe the lackluster domestic game revenue is just a timing issue resulting from the company temporarily pausing to release commercially impactful content. Management is on track to release more commercially impactful content in the third quarter (just in time for the summer vacation), so we expect growth to resume. Tencent’s international games delivered a decent performance, with revenue increasing 12% year over year on a constant-currency basis.