Tencent Holdings Limited (TCEHY)

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Tencent Is My Top Chinese Stock Pick, But With Some Concerns
By: Seeking Alpha | September 4, 2019

Summary

• Per my factor-based model, Tencent ranks the highest among all Chinese stocks.

• The business seems to be wonderful and to trade at a reasonable valuation.

• I do have some concerns with the competitive landscape and lack of internal growth opportunities.

Overview

Tencent Holdings (OTCPK:TCEHY) (OTCPK:TCTZF) is one of the most successful companies in China and one of the best-known Chinese companies in the world. The stock earns the top rank among all Chinese companies per our factor-based business quality model. While the business possesses some durable competitive edges and decent long-term growth prospect, I do have some concerns regardings the competitive landscape facing the business and the ongoing deterioration of capital efficiency.

With a simple mission to "build connections," Tencent is now the world's largest gaming company, one of the world's most valuable technology companies, one of the world's largest social media companies, and one of the world's largest venture capital firms and investment corporations. Its many services (see below) include social network, music, e-commerce, online games, FinTech, which are all among the world's biggest and most successful in their respective categories thanks to the huge market they target - China's online population.

Economic Moat

Tencent builds its economic moats mainly through market leadership, broad product offerings, and network effect.

As you can see in the chart above, the company maintains its No.1 and No.2 positions, which strengthens the barrier of entry and fends off competitions in this winner-take-all online space, in many categories, such as gaming, mobile video, social media, mobile payment. It owns a strong portfolio of mobile apps, which adapt well to this mobile-first, mobile-only economy.

In particular, the powerful WeChat ecosystem (see below) touches upon multiple points of one's daily life at multiple times throughout the day, from taxi-hailing in the morning to ordering lunch delivery, to online shopping, then to reserving dinner tables, and to enjoying music/video before bedtime.

As the leader of building connections among people and between consumers and businesses, Tencent owns a quite sticky user base, which is hard to replicate or disrupt.

What even widens the moat here is the so-called same-side network effect inherent in Tencent's social media apps like WeChat and QQ. If you have lived in China for long, the age of text-messaging or phone-calling may sound distant to you already. Even other communication tools like email, facetime (AAPL), skype (MSFT) would appear redundant to Chinese netizens. WeChat (and QQ in many cases among young users) has all the features here with superior quality as well as, more importantly, almost all your contact persons on the same network, including friends, families, and even clients, colleagues and bosses (Tencent launched its WeChat for Work a couple of years ago).

Statistics show that around 95% of the total population in Tier-1 cities and over 70% in Tier-2 cities in China cannot live without WeChat and that the users, on average, check the app over 15 times per day and spend more than 300 hours in total per year. WeChat does not generate the direct revenue for Tencent, but the platform is the important leverage that indirectly contributes to the value creation across multiple business segments, including advertising, business services, FinTech, gaming, and even the company's VC arm.

I would expect the network effect to last for quite some time, while people should certainly not forget the demise almost in no time of MSN, which was once the most popular social network in China.

Long-term Prospect

Based on its gigantic and loyal user base, Tencent has been broadening its service offerings and diversifying into more verticals. As described below, Tencent was mainly a gaming company a couple of years back with almost 50% of its sales coming from online games. Now that segment only represents less than a third of total businesses at the company. Percentage-wise, the FinTech and Business Services segment grew the most, followed by Online Advertising.



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