Company Reports

Tencent's fourth-quarter earnings highlighted significant capital returns to shareholders, with the firm promising to distribute about 4.8% of its market cap as of March 20 as buybacks and dividends, affirming our Exemplary Capital Allocation Rating. Although gaming revenue growth has concerned investors, management is taking steps to resolve internal issues by enacting leadership changes, setting the stage for a turnaround. Comments on regulatory development were also reassuring. With earnings broadly in line with our estimates, we retain our fair value estimate of HKD 704 per share.

We are placing NetEase under review following the Chinese government’s release of new draft regulations affecting the gaming sector. Should these rules be put into effect, they could adversely affect the revenue of gaming companies, with NetEase potentially facing considerable challenges. Latest developments have triggered a sharp decline in the stock values of Tencent and NetEase, with shares dropping more than 10% by midday. We believe this market reaction is justified due to the expansive scope of the new draft rules. While these developments could have far-reaching consequences, we are maintaining our current fair value estimates for Tencent and CMGE, as they appear to face a less severe impact from the draft rules. Our position is subject to change as we await further information from gaming companies as to how the new regulations will affect their sales.

Wide-moat Tencent’s third-quarter earnings were ahead of Refinitiv's consensus but in line with our estimates. We maintain our HKD 704 fair value estimate. We continue to view Tencent’s shares as deeply undervalued, trading at about a 50% discount to our valuation. Although our near-term forecasts do not deviate significantly from consensus, we have a much higher valuation on the stock given our view that Tencent’s network effects will generate excess economic returns over a long period. We think the market continues to underestimate how much economies of scale will benefit Tencent’s profitability in the long term. We believe that the current valuation multiple of 12 times 2024 core earnings, offers a very attractive upside to long-term investors.

We left Tencent's Digital Ecosystem Summit with greater confidence in our above-consensus forecasts and positive thesis on the internet giant. Through showcasing the latest cloud offerings, the two-day event accomplished three goals: 1) reinforcing the network effect underpinning our wide-moat rating through crossing the 400-million-user milestone for Tencent Meeting; 2) alleviating concerns about Tencent's ability to capture opportunities in artificial intelligence, or AI; and 3) shedding light on the monetization potential of its array of enterprise solutions. While the event doesn't move our HKD 704 (USD 90) fair value estimate, it reinforces our view that Tencent is one of the most attractively priced names in our internet coverage. The company remains undervalued, trading at a significant discount of 55% to our fair value estimate.

Although wide-moat Tencent's 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.

Over the past decade, Tencent has capitalized on the industry shift toward mobile gaming. The firm owns some of the world's most popular titles, like Honor of Kings and PUBG Mobile. To date, games remain Tencent's primary monetization model--as we estimate more than 40% of the group's operating income comes from this segment. Tencent should continue to leverage its unrivaled access to user data and financial capital to create innovative, high-quality, and long-cycle games with a mobile-first approach.

Wide-moat Tencent’s first-quarter earnings mildly exceeded our and Refinitiv's consensus expectations. Additionally, with China reopening and the latest success of Video Accounts, the good old days of double-digit revenue growth are back. While we fine-tune our near-term forecasts, our fair value estimate of HKD 704 is unchanged. Going into the rest of this year, we expect sales leverage to be the primary driver of earnings growth. We believe the current market valuation of 13 times forward core earnings, as of May 18, 2023, indicates that 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.

We maintain our HKD 704 fair value estimate of wide-moat Tencent following its earnings report for the fourth quarter of 2022. While the results were in line with Refinitiv consensus expectations, management's comments during the earnings call suggest the firm is now pivoting from cost-cutting to fostering growth. With Tencent reigniting growth engines, we fine-tune our near-term forecasts for the firm but keep longer-term assumptions unchanged. We continue to view Tencent shares as undervalued, trading at a 50% discount to our fair value estimate. We believe that the market underestimates the longer-term revenue contribution from video accounts and the potential for margin expansion as Tencent cements a more efficient cost structure.

We expect 2023 to be a better year for Chinese online gaming companies, and we see attractive buying opportunities. Some of these firms struggled in 2022 due to a lack of new gaming licenses, but since mid-2022, the National Press and Publication Administration started handing out more licenses to publishers. In January 2023, the NPPA issued 88 new domestic gaming licenses, marking the highest monthly handouts since May 2021. Based on the latest approval data, we fine-tuned near-term forecasts for three publishers under our coverage (Tencent, NetEase, and CMGE), but maintained their fair value estimates. NetEase is our top pick in the online gaming sector for its strong portfolio of existing and upcoming games.

Over the past decade, Tencent has capitalized on the industry shift toward mobile gaming. The firm owns some of the world's most popular titles, like Honor of Kings and PUBG Mobile. To date, games remain Tencent's primary monetization model--as we estimate more than 40% of the group's operating income comes from this segment. Tencent should continue to leverage its unrivaled access to user data and financial capital to create innovative, high-quality, and long-cycle games with a mobile-first approach.

We believe the latest regulatory announcement from the U.S. should help add investor confidence in Chinese ADRs. The Public Company Accounting Oversight Board in the U.S. said on Dec. 15 it had gained full access to inspect and investigate firms in China. Before this, investors feared the Holding Foreign Companies Accountable Act could force hundreds of Chinese companies listed on U.S. exchanges to delist starting as early as 2023. The news should support recent outperformance by Chinese equities following moves to relax coronavirus testing and quarantine policies in China. Although volatility may persist as COVID-19 cases increase in China, we think the combined news presents a floor in terms of risk premium to China equities. While Chinese stocks have rebounded off lows, wide- and narrow moat-rated ADRs such as NetEase, Alibaba, Yum China, and JD.com are still seeing attractive upsides to our fair value estimates.

We maintain our fair value estimate of HKD 741 for wide-moat Tencent after it reported earnings for the third quarter of 2022. Tencent delivered an above-expectation bottom line in a quarter marred by macroeconomic challenges. Revenue was down 2% year over year, but adjusted net profit grew 2%, marking a turnaround from four consecutive quarters of declines. While the firm’s cost reduction efforts were the main drivers behind the year-over-year growth in earnings, we see revenue opportunities in areas such as video accounts, international games, and enterprise software. We view Tencent shares as very undervalued, trading at a 60% discount to our fair value estimate. We believe the current market valuation of 13 times 2023 core earnings, as at Nov. 17, 2022, and the tepid reaction to these results indicate that the market underestimates the longer-term revenue contribution from video accounts and the potential for more operating leverage as Tencent cements a more efficient cost structure.

The National Press and Publication Administration, or NPPA, issued 73 new game licenses on Sept. 13, marking the highest number of monthly approvals since its resumption in April. We are encouraged by the fact that all the Chinese gaming companies under our coverage (Tencent, NetEase, and CMGE) received one new license this month. We keep our fair value estimates and earnings forecasts unchanged, as we were already expecting the approval of new licenses to return this year, but sequential increases in monthly approval numbers should help improve investor sentiment. Our top pick in the online gaming sector is NetEase, for its strong portfolio of new and existing games.

Wide-moat Tencent's second-quarter results reaffirm our view that recent headwinds are temporary, and the firm's earnings are set for a rapid bounceback. On the back of some initial cost initiatives, the firm delivered second-quarter results that beat consensus estimates. With several other efficiency tools in its arsenal, we believe Tencent will become a more profitable company in a postpandemic China. We maintain Tencent's fair value estimate at HKD 741 and view shares as very undervalued (60% discount to our fair value estimate as of Aug. 17). We believe that the market underestimates the longer-term revenue contribution from Video Accounts and the potential for more operating leverage as Tencent cements a more efficient cost structure.

On Aug. 16, Reuters reported, citing unnamed sources, that Tencent is planning to divest its 17% equity share in Meituan. Based on Meituan’s market cap as of the Aug. 16 close, Tencent’s stake would be worth HKD 176.8 billion. Meituan’s stock fell 9% and Tencent shares rose 1% on the day the news broke. Our fair value estimates for both companies are unchanged as Meituan is now exactly at our fair value while Tencent remains undervalued. Aside from the headline event, this is not an event that is expected to change the intrinsic value of a business nor its future cash flows.

Wide-moat Tencent’s shares fell almost 2% on June 27 (against a 5% increase in the Hang Seng Tech Index) following its largest shareholder Prosus’ announcement to gradually sell down its stake. Prosus holds about a 29% stake after its parent Naspers became an early Tencent investor more than two decades ago. The Dutch technology investor did not specify how many shares it intends to dispose of in total, but it anticipates that the number of Tencent shares that will be sold per day will represent a small percentage of the average daily trading volume of Tencent. The share sale plan came as a surprise as Prosus had agreed not to sell further Tencent shares after the disposal of a 2% stake in 2021. We do not view Prosus’ decision to sell the stock as indicative of any fundamental changes to Tencent’s business. Instead, we believe the decision was made to finance a shares buyback program that aims to narrow a long-standing discount Prosus’ shares trade to its net asset value. With our outlook for the company unchanged, we maintain our HKD 741 per share fair value estimate.

Wide-moat Tencent's first-quarter results again show the continuing impact of macroeconomic headwinds and regulatory changes. The gapping down in the stock shows that the market is still focused on near-term headwinds, and while we acknowledge that there are legitimate questions about earnings declines for the next one to two quarters, we believe a turnaround is in clear sight. We lower our fair value estimate to HKD 741 per share from HKD 837 to reflect changes in the market value of Tencent's investment holdings and recent significant depreciation of the Chinese yuan against the Hong Kong dollar. We remain confident in Tencent's longer-term free cash flow potential and view current share prices as an opportunistic entry point.

Over the past decade, Tencent has capitalized on the industry shift toward mobile gaming. The firm owns some of the world's most popular titles, like Honor of Kings and PUBG Mobile. To date, games remain Tencent's primary monetization model--as we estimate more than 40% of the group's operating income comes from this segment. Tencent should continue to leverage its unrivaled access to user data and financial capital to create innovative, high-quality, and long-cycle games with a mobile-first approach.

Over the past decade, Tencent has capitalized on the industry shift toward mobile gaming. The firm owns some of the world's most popular titles, like Honor of Kings and PUBG Mobile. To date, games remain Tencent's primary monetization model--as we estimate more than 60% of the group's operating income comes from this segment. Tencent should continue to leverage its unrivaled access to user data and financial capital to create innovative, high-quality, and long-cycle games with a mobile-first approach.

After an eight-month freeze, China has finally resumed new game license approvals, according to Bloomberg News. The past license freeze weighed on company earnings and negatively affected investor sentiment, but April 11's positive development should bring much-needed relief to a sector that has been shaken by negative headlines. We keep our fair value estimates and earnings forecasts unchanged for our coverage of the publishers, as we were already expecting new licenses to come back this year. Besides earnings, we think the greater implication here is that the Chinese government is committed to maintaining a vibrant domestic video game sector--a notion that has been questioned by investors over the past year.