Tencent: A Play On Chinese And Asian Growth (OTCMKTS:TCEHY)

Tencent (OTCPK:TCEHY) has started to come under pressure from the current U.S. administration. It shares this status with other Chinese businesses such as Huawei and the TikTok app from ByteDance (BDNCE). No doubt more will follow. Such measures will arguably do little or no long-term harm to either Tencent or to China.

Such measures may be seen as having little to do with U.S. national security but a lot to do with Chinese strength in secular growth businesses. These include gaming, online payments, the future of electric vehicles (EVs), and AI in its many applications.

Tencent is a good play on these growth areas. My article in March gave details of the strengths and complexity of this giant. These strengths are centred around its WeChat platform and associated WeChat Pay platform. Mobile gaming has been the biggest revenue generator, but AI, online advertising, payments, Cloud Services and music are some of the growing strategic areas.

Its approximately 1.2 billion WeChat users are at the core of the company’s strength. It is a similar strategic advantage to that enjoyed by Apple (AAPL) through its iPhone user core.

Tencent is the world’s largest gaming company and is leading the charge into the growth area of e-sports. It controls over 50% of China’s US$35 billion gaming market. It has been using profits from this to diversify into being a technological giant.

The company’s expansion in recent years throughout Asia (and elsewhere) is a reflection itself of the growing dominance of China in many markets. Much of this new growth is coming from countries around Asia. Tencent is marrying organic growth in China with a sound investment strategy in companies both in China and overseas.

The Big Picture

Attempts by the Trump administration to roll back Chinese economic power are understandable but may be doomed to failure.

The figures from Statistics Times paint the picture, as illustrated below:

(Data source: The Statistics Times)

China, Japan and India already have a combined share of world GDP of 26.42%. This is higher than the USA’s 24.7%. If you add in the other Asian countries on the list, the share of GDP comes to 32.3%. This year is likely to see the USA’s proportion of world GDP fall quite markedly as it is gets hit much more substantially than Asian countries by COVID-19.

The Economist Intelligence Unit (EIU) recently made estimates (subscription required) of how these figures would look by the end of the decade. They saw China’s share of world GDP increasing to 23.3%. Other Asian countries would increase their share at the expense of the West. Indonesia, for instance, would comprise 1.9% of world GDP by 2030.

According to the Financial Times (subscription required), IMF forecasts see Asian GDP at purchasing power parity becoming greater than that of the rest of the world in the next few years:

Already on the basis of PPP, the Chinese economy is larger than that of the USA. At market exchange value, it is only at 38% but is closing the gap quite rapidly. This process can be seen as a reversion in time. Up to the 17th century, Asia was the world’s economic centre and powerhouse. That came to an end with the Enlightenment and the Industrial Revolution in Europe. We may now be seeing an economic revolution of a sort to allow Asia to regain world economic leadership.

Population figures and demographic trends make the point clearly. Figures published by Worldometer illustrate the growing and youthful populations of Asia (with the exception of ageing Japan):

(Source: Worldometer)

Tencent would only have to maintain market share to grow strongly. On a world scale, figures from Statista show the company’s current strength:

(Source: Statista)

One above the rankings from Tencent is Alibaba (BABA). Alibaba indeed has many of the same attractions for investors as Tencent. The company will be having a forthcoming IPO for uts Ant Group financial subsidiary. This could raise US$30 billion, making it the world’s largest ever IPO. This will be launched in Hong Kong. That is a reflection of the strained ties between China and the USA, and is, of course, a blow to the NYSE.

Tencent is a social media giant like Facebook (FB). Arguably, it is in a stronger position than Facebook. As this article argued, Tencent is being more successful in monetising its assets, and the stock price has been appreciating more rapidly than that of Facebook. COVID-19 has strengthened its role in the everyday life of people under lockdown.

Tencent’s WeChat platform has incredible economies of scale and is a formidable barrier to entry for competitors. On average, a Chinese subscriber spends 4 hours a day on the WeChat platform.

China has more people accessing the Internet on mobile devices than the entire population of Europe. Or put another way, over three times the number of people doing so in the USA. There is still future growth in this process. Approximately 500 million Chinese are not currently accessing the Internet on mobile in China. A further boost to Tencent’s huge gaming business is likely to be made by cloud gaming using 5G phones. China’s world lead in 5G will drive this, and Tencent is partnered closely with market leader Huawei in this business.

The company is constantly finding new ways to monetize this. For instance, this year, its Mini Programs have grown at a stunning pace.

Tencent and Alibaba are the driving forces behind much of what is happening in China and Asia. The ubiquitous “Alipay” and “WeChat Pay” systems are everywhere. There has been some speculation recently that the Chinese government may impose some restrictions on antitrust grounds. Between them, Alipay and WeChatPay account for 93% of the country’s mobile payments market. This is more likely to be just a perennial warning from the government. They support these two companies, but they want to remind them that they operate at the government’s behest.

Many commercial entities in China will no longer accept cash or credit cards. Chinese travelling overseas in Asia have been increasingly using WeChat Pay, and foreigners visiting China can now download and use it.

China as a nation is investing most markedly in semiconductors and integrated circuits to become more self-reliant in its technological strategic targets. This would, in particular, lessen its reliance on manufacturers in Taiwan and South Korea. The typically long-term Chinese strategy regards a Trump administration as a very short-term blip.

AI, Autos and much more in China

Tencent’s 1.2 billion WeChat users give it an enormous database. The company is using this to create AI for advertising, for its chat bots, for autos, and for healthcare. AI for Autos is just one example of AI-driven growth for the company.

My article in September last year detailed Tencent’s substantial investments in autos and in related AI developments. These focus particularly in regard to autonomous driving.

Direct investments in autos include:

  • Tesla (TSLA)
  • Nio (NIO)
  • JD.com (JD)
  • GAC, the state-owned auto producer
  • Didi Chuxing (DIDI), the Chinese ride-hailing leader.
  • Gojek, the Indonesian ride-hailing leader
  • Ola, an Indian ride-hailing company
  • Bitauto (BITA), an online auto market
  • Lyft (LYFT)
  • China Evergrande (EGRNF) New Energy Vehicle Group: Tencent recently was a major participant in a new stock placement

Indirect investments and co-operation deals include:

  • BMW (OTCPK:BMWYY) on various technological developments
  • Hyundai (OTCPK:HYMTF) on various technological developments
  • Baidu (BIDU) for autonomous driving
  • Chongqing Champion Auto Parts for ride-sharing

I detailed much of this in my article from September last year. The company’s WeChat network can be used to call up autonomous vehicles. Payments will be made through WeChat Pay. The cars will have entertainment systems from Tencent Music and Tencent Video. They will negotiate roads using Tencent’s high-definition mapping system.

The government seems to have earmarked Tencent, Alibaba and Baidu as the companies to lead the transformation of the world’s largest auto market from an ICE base to an EV future. This is a huge revenue opportunity for Tencent.

China is, of course, already the largest auto market in the world by some way. As the market transitions rapidly from ICE to EV autos, its market and companies may well dominate world auto manufacturing. The new official line is that China aims to be carbon neutral by 2060. This reinforces the certainty of further moves by the Chinese government to encourage EVs.

Tencent has astutely invested capital in a range of top auto manufacturers. It has allied this with investments in AI for autonomous driving and for technological change. The company is well-positioned for the new auto paradigm. Its co-operation with Tesla, of which it holds about 4%, seems to be growing. In a recent interesting example of synergy, Tencent started selling Tesla “skins” in its mobile gaming hit Peacekeeper Elite. This reflects the company’s strategy of often making its games free but charging users for such virtual purchases. Elon Musk has referred to Tencent as “an investor and adviser.”

Tencent’s drive into AI has been driven internally. The company has made substantial steps in the medical world, into AI-driven self-diagnosis services and medical imaging products.

Cloud services, video conferencing and video services have, of course, become even more central to every day life because of COVID-19. Tencent has been a strong beneficiary of this. Its “Tencent Meeting” is the Chinese equivalent of Zoom Mobile (ZM) and has over 100 million registered users.

The company is very focused on digitilization through AI, through 5G and through blockchain. At a recent conference, senior executive vice-president Dowson Tong affirmed:

Data analytics and efficiency enhancement are the holy grail for industries undergoing digital upgrades. Industries that embrace digitilization will develop and evolve into mutually beneficial ecosystems. Through this process Tencent will become a helpful digital assistant.

Its “Tencent Cloud” business is growing rapidly. It is, though, still some way behind the more established “AliCloud” service from Alibaba. The company’s “Tencent Video” business is buoyant, with mega home-grown hits such as “Joy of Life”.

Tencent Music (TME), floated out into a separate company in an IPO, is the market leader in China with over 700 million monthly users. I detailed this in an article last year. Tencent Music has a joint stock holding with the world’s largest music streaming company Spotify (SPOT). It also has various joint activities with the music division of Sony (SNE), the world’s largest music publisher.

Tencent in Asia

Tencent’s strong position in China is being duplicated across Asia. Much of the substantial profits it has made in its Chinese businesses have been re-invested in international expansion. The process may have speeded up due to the trade conflicts with the USA. Asia is now being seen as providing a more stable base than the USA. For instance, the company recently announced the setting up of a substantial regional office in Singapore. This joins similar S-E Asian offices in Thailand, Malaysia and Indonesia.

In many cases, expansion is through direct investments in overseas companies. There is a complex web of overseas holdings. Tencent is able to move directly into Asian markets on the back of its ubiquitous WeChat and WePay systems.

A notable example of success in Asia has been Singapore’s Sea Limited (SE). Tencent has been investing in capital raising with Sea Limited for several years now. This company has a strong positioning in the region in gaming and online shopping. It can itself can be seen as an extension of Tencent’s interests around Asia and further afield. My article in June detailed some of this growth. This enables Tencent to have a stake in a successful growth company and, in addition, promote its gaming portfolio internationally. SRA has first call on all Tencent games.

Of course, political tensions can be a problem, not just in the U.S. For instance, the company recently had to withdraw control of some mobile games in India following political tensions between China and India. The company, in fact, has a range of interests in India. These include a 5% stake in fast-growing e-commerce play Flipkart and a stake in Indian fintech company NiYO.

Earlier this year, Tencent bought a stake in Japanese games developer Platinum Games. It has a stake in South Korean developer CJ Games. Tencent is believed to have stakes in at least 22 overseas gaming companies and is targeting 50% of its gaming revenue to be outside China. It is moving rapidly into e-sports growth around Asia, particularly in Singapore. Currently, the company’s overseas gaming revenues comprise about 25% of its total gaming revenues. These are forecast to rise rapidly as a share of the gaming revenue whole.

The investments stretch into the USA. The company previously purchased Riot Games and has a big stake in Epic Games. It has a long-standing stake in Activision Blizzard (ATVI) and in Glu Mobile (GLUU). Tencent has a 12% stake in Snap (SNAP) and an investment in Reddit. The company has a games development office in California. The interest goes both ways. For instance, the company has lucrative rights for the very popular NBA in China. Broadcasts famously got stopped some months ago in a political spat. There are believed to be approximately 500 million people who watch NBA in China.

However, as was emphasised by management at the Q2 results analyst call, the U.S. represents less than 2% of the company’s overall revenue. The U.S. government’s action against WeChat is currently stuck in the courts. It will no doubt resume at some point. It seems likely some sort of action will also be taken against the company’s games investments. This will probably be only a minor inconvenience to Tencent’s progress. There is also concern over the pressure that the Chinese government places on the company’s operations within China itself from time to time. However, in general, Tencent is regarded by the Chinese government as a champion of the country’s progress.

At the end of September, it was announced that Sogou Inc. (SOGO) would be taken private by Tencent in a US$3.5 billion deal. This can be seen as another example of Chinese companies delisting from U.S. exchanges.

Tencent has expanded its equity stakes in Europe as well. Prominent amongst these is a 10% stake in Universal Music Group (UMG) from French conglomerate Vivendi (OTCPK:VIVEF). It has the option to buy a further 10%. The synergistic boost for Tencent includes monetisation and control of UMG’s back catalogue in China. Its gaming interests on the continent are represented by stakes in Finnish developer Supercell and a 5% stake in French games developer Ubisoft (UBSFY)

At the Q2 results call, management revealed Tencent now had stakes in over 700 companies. Most of these are left to run themselves. This is on the basis that they were invested in originally because of their entrepreneurial spirit. Tencent has a strategic policy of allowing companies it controls to be autonomous, and even to compete against each other.

The fair value of shareholdings in listed investee companies was put at RMB 726 billion (US$103 billion).

Tencent Growth

The growth of the company mirrors that of China and Asia. Tencent’s Q2 2020 results showed growth in revenues despite the COVID 19 pandemic:

(Source: Tencent)

I have been recommending this stock for quite some time, and this year’s stock chart is impressive:

(Source: Charles Schwab)

Free cash flow in Q2 was RMB 28.5 billion (US$4.04 billion) and net cash was RMB 7.2 billion (US$1.02 billion). These numbers almost guarantee that the investment spending spree will continue.

Conclusion

Tencent’s growth trajectory reflects that of the country. This is illustrated below (from the company website):

(Source: Tencent)

These product areas are all strong secular growth areas. Tencent is the world’s largest gaming company. It is China’s largest messaging provider, its largest social networking site, and its largest mobile payments provider.

The company is at the centre of the country’s AI development. Indeed, its games in some ways represent this. Many regard AI as the new Industrial Revolution. The prizes will go to those companies that have strong cash flow and massive capital resources. Tencent meets those criteria.

What many see as U.S. protectionism may do some short-term damage to the company’s businesses. It may also do some short-term damage to China’s economy. Such policies, though, will have little or no effect on the medium- and long-term trends. These are growth areas in which both Tencent and China are now competing with the USA. In many cases, they are starting to outperform the USA. Tencent is an excellent long-term play on this meaningful change in world socioeconomic power and influence.

Disclosure: I am/we are long TCEHY, AAPL, SNE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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