Tencent Holdings Ltd is one conglomerate company in China which has triumphed and dominated so many winners in the past few years that it has become increasingly difficult for investors to buy in and own them simply because they keep on getting better and stronger each year.
In fact, if we look across the past 10 years of making for Tencent, the best time to buy and own the shares is the day the company is making its 52-week high because you know they are just going to beat that record on its own down the road.
The only 2 meaningful times which investors can get in at a reasonable valuation after the huge run-up was back in 2018 due to a regulatory crackdown which they’ve dropped 49% from peak high and then today in 2021 which they’ve dropped about 42% to date.
In this article, we’ll be mainly discussion on the valuation model of the company to see how much they’ve grown over the past few years.
For those who are not familiar with the product offering and services which Tencent is currently offering and how the company is monetizing them, you may want to read here.
In essence, most of the stuff they are offering to their citizens are free in nature, so there is no real agenda push where users might drop off once or twice after using them.
The big 3 – which is Weixin + WeChat + QQ – are essentially your everyday needs from chatting, entertainment, payment and many more. I just don’t think anyone that lives in China can survive without having these apps installed on your phone.
If you look across the monthly active users (MAU) which is a key metrics to how much a company has dominated the market share, you may be appalled to see just how much they’ve grown over the past couple of years.
As of the latest Q1 FY2021 results, MAU for Weixin + WeChat is at 1.24 billion and MAU for QQ is at 606m.
To put things into perspective, China has a population of over 1.4 billion so that gives you an indication of just how much market they’ve captured in China.
Tencent Holdings earned their revenue from a few streams.
One of the biggest chunk of their revenue streams are coming from Games, which they’ve earned over RMB 43.6 billion in the Q1 of this year alone (total revenue is at RMB 135 billion). If you are unfamiliar with some of their monetization model for Games and pipeline, you may want to search for my other articles on Huya or click the link which I’ve provided at the beginning of the earlier paragraph on the business model.
The next big chunk of their revenue comes from social networks and chatting which includes the advertising channel that they earned. In Q1 alone, they’ve earned RMB 50.6 billion in total for the VAS and Advertising segment for their social networks and media.
Other than that, they also other Fintech and Business Services which made up quite a huge chunk of their portfolio as well.
The regulatory crackdown that is impacting businesses across has some but little to impact the fundamentals of the company.
For instance, minors aged 18 and below accounted for just 6% of Tencent’s overall online game receipts. Among which, a subset of those under the age of 16 accounted for just 3.2% of the online game receipts.
If we look across the entire regulatory impact of not allowing minors under the age of 12 to play, or limit the number of hours minors under the age of 18 can play, the impact to the Gaming segment would be limited to within 2-3% at best. To the overall entire revenue segment, this would then make up 3% x 1/3 = less than 1% impact to the entire business stream.
The other regulatory crackdown on the education sectors might have a bit more impact to the advertising as well as its Fintech SaaS business.
In the 2020 annual report, Tencent specifically singled out education, internet services and ecommerce platforms as one of the main revenue generators from online advertising. Given the recent regulatory crackdown on education companies, we can expect this portion of the segment to be significantly hit. Assuming the education business makes up a total of 10% weightage, this would mean a hit of between RMB8-10 billion in advertising revenue in a year.
Impactful but is unlikely to bring down the company.
The base case scenario embeds a model of 20% growth for the next 2 years, then 15% for the next 3 years.
Capex spent is mainly on operating expenses for their media content as well as their non-operating expenses on lease liabilities.
For years, Tencent has a habit of spending and reinvesting their entire free cash flow into new businesses and do not maintain a huge chunk of cash on their balance sheet (Net Cash equivalent is only at RMD11 billion) so we will assume the same in the model.
These businesses are recorded as part of their equity share of profits and not into the organic model of their operating cashflow so we’ll have to add that in at the end of the day.
As of 31 March 2021, the Fair Value of the shareholdings in listed investee companies, excluding subsidiaries, stand at RMB 1.36 trillion, which if we compare into HKD/share, it is approximately worth HKD170 (RMB 1.36 trillion x 1.2 HKD / 9.6 billion outstanding shares).
If you’re interested to look at each of the investment, you may look at this sheet which another blogger has compiled. Do note though that it may not be updated on a daily basis, so I would still look at the fair value from the official financial reports every quarter for better clarity.
To continue with our DCF model, we have input a terminal cashflow multiple sensitivity of 10x, 15x and 20x and a discount rate of between 10 to 15%, with 12% in the middle range. This discount rate is the expected return that we as investors are trying to get or achieve over the longer term.
The base assumption leads us to a share price that’s worth HKD 551.
Together with the earlier fair value investment that we’ve computed which is worth HKD 170, the intrinsic value for the company should be worth HKD 551 + HKD 170 = HKD 721.
Do note that this is the base case scenario.
If you’re trying to project a worsen or better scenario, the number would then also shift accordingly.
So to do a quick one, if we are trying to project a worsen scenario, we would use the assumption that the company will only grow at 15% over the next 2 years and then 10% over the next 3 years.
I have also discounted the fair value investment by 10%.
The intrinsic value that I get out from this assumption is HKD 433 + HKD 153 = HKD 586.
If we’re trying to pull out a stunt and do a best case scenario where the company is able to maintain a 20% growth throughout the next 5 years (not impossible but improbable), we’ll get an intrinsic value of HKD 627 + HKD 170 = HKD 797.
But I’d likely wouldn’t count on that as an investor trying to be conservative.
The DCF model is trying to give a sense of range of just how much can the value of the company be worth even with all the regulatory crackdown impact in place.
As an investor, I try to see what’s my conservative scenario, and then look at what the market is valuing the company today and see if there’s a good opportunity to load into these businesses.
From my personal portfolio point of view, I have since more than 9x the value of my investment in Tencent since last month so it’s becoming a large part of my portfolio. I do really think that while the crackdown provides uncertainty to the businesses in the near term, they are unlikely to severely impact the overall business in the longer run and current valuation is simply to hard to resist at this point.