Tencent Earnings: Game Content Updates and China Reopening Lift Overall Results

Wide-moat Tencent’s 00700 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.

Key highlights of this quarter were the 11% year-over-year growth in gaming revenue (after three consecutive quarters of declines) and the 45.5% gross margin, which was the highest over the past two years. To us, this quarter’s strong performance is an early indicator that the global gaming industry has finally worked through transitional challenges, such as the post-COVID-19 hangover in the West and the lack of new game licenses in China, and rapid growth should follow over the near term. We remain optimistic about long-term monetization opportunities for Video Accounts and enterprise software, as both functions are closely integrated with the WeChat network, and we expect Tencent to leverage its network effect to drive adoption. We expect these new revenue opportunities to deliver margin-accretive returns, and together with an improving macroeconomic outlook, we expect Tencent to deliver adjusted earnings growth at a low-20s percentage rate over the next five years.