Tencent doesn't want to fall from the throne

Author | Huang Yu

Editor | Zhou Zhiyu

With a strong presence in both gaming and social networking, TENCENT has been the "big brother of the Internet" for over a decade, leaving other companies far behind in terms of market value.

The latest financial report shows that after a performance decline in 2022, TENCENT regained growth in 2023. In the fourth quarter of last year, its Non-IFRS attributable net profit reached approximately 42.68 billion yuan, a year-on-year increase of 44%, marking six consecutive quarters of growth and demonstrating the resilience of the internet market leader's performance.

However, the "big brother" also faces challenges. Last year, ByteDance surpassed TENCENT in revenue, becoming the revenue leader among Chinese tech companies. In the capital market, continuous reduction of holdings by major shareholders has kept TENCENT's stock price under pressure, hovering at a low level for two years.

TENCENT hopes to maintain investor confidence. Pony Ma plans to spend 60% of last year's free cash flow to buy back shares worth hundreds of billions in 2024, which has boosted investor morale. The day after the financial report, TENCENT's stock price jumped 2% to close at 291.2 Hong Kong dollars per share.

However, the buyback plan can only provide temporary support for TENCENT's stock price. More importantly, TENCENT needs to find a new direction to spark growth and tell investors a new story in order to change the company's valuation logic and regain upward momentum in stock price.

In the context of the global AI wave and competition among tech giants, this is a protracted battle, and Pony Ma is far from being able to relax.

Bold Move

This is the boldest move TENCENT has made in the past three years.

On March 20, TENCENT disclosed its annual buyback plan for the first time in its financial report, doubling the amount from last year to 100 billion Hong Kong dollars, equivalent to 60% of TENCENT's free cash flow generated last year.

Meanwhile, against the backdrop of leading companies in the industry strengthening dividends, TENCENT's cash dividend last year was 3.4 Hong Kong dollars per share, totaling approximately 32 billion Hong Kong dollars, a 42% increase year-on-year.

Behind the large-scale buyback is TENCENT's belief that its stock price is undervalued. Over the past three years, TENCENT's P/E ratio has dropped from over 30 times to less than 9 times at its lowest point. The once leading internet giant seems to have lost its imagination, becoming a mobile internet infrastructure service provider similar to telecom companies.

TENCENT President Liu Chiping stated that historically, TENCENT has consistently distributed cash dividends to shareholders and regularly repurchased shares when it believes the stock price is undervalued, especially today when cash flow profits are at historic highs and continuously growing. The management recommends increasing cash dividends and plans to at least double the scale of share buybacks this year Some investors believe that TENCENT's generous dividends and buybacks are aimed at maintaining market confidence in the company. From a performance perspective, although net profit has been good, the overall revenue still faces growth pressure.

In the fourth quarter of last year, TENCENT's revenue was 155.2 billion yuan, a year-on-year increase of 7%, lower than market expectations. Looking at the full year of 2023, although there was a turnaround from decline to growth, the growth rate is significantly lower compared to the over 20% growth before 2021.

Especially, the growth of the gaming business is weak. The financial report shows that TENCENT's domestic and international gaming revenue for the full year of 2023 only saw a slight increase, with declines in the fourth quarter!

TENCENT explained that this is mainly due to the reduced contributions from the old games "King of Glory" and "Peace Elite". This to some extent reflects that the two national games previously created by TENCENT have shown signs of fatigue, while new games lack follow-up strength.

Advertising and financial technology have become the main drivers of revenue growth for TENCENT. TENCENT's financial report shows that last year, revenue from online advertising business increased by 23% year-on-year to 101.5 billion yuan, mainly driven by new ad inventory on Video Number and WeChat Search, as well as continuous upgrades to the advertising platform.

With the combined effect of strengthening advertising and weak gaming, TENCENT had regrets and highlights in 2023, but has not completely impressed investors yet. To maintain the stock price, large-scale buybacks have become a necessary option.

In addition, TENCENT's ROE (Return on Equity) fell below 20% for the first time since its listing, sounding an alarm. Wind data shows that TENCENT's ROE as of the end of 2023 was 15.06%, the first time it dropped below 20% after listing. In 2020-2022, TENCENT's ROE was 28.12%, 29.77%, 24.64% respectively. ROE is an important reference indicator for long-term investors.

The significant reduction in disposal of investment assets last year, as well as the moderate profit from the main business, are the main factors contributing to the decline in TENCENT's ROE. In 2021 and 2022, TENCENT cashed out significantly on JD.com and Meituan shares, maintaining ROE at around 25%; last year, the net gain from disposal of investment income for TENCENT dropped significantly from 172.7 billion yuan in 2022 to 4.3 billion yuan.

As the largest shareholder of TENCENT, South African media giant Naspers' long-term reduction plan initiated since June 2022 has also put pressure on TENCENT's stock price. In fact, over the past year, TENCENT has spent 49 billion Hong Kong dollars on buybacks, to some extent offsetting the impact of the major shareholder's reduction. Now, the 100 billion buyback plan is clearly more conducive to boosting investor confidence.

Huaxi Securities analyst Zhao Lin believes that the high dividends and buyback plan demonstrate the company's long-term confidence in its stock price. The major shareholder's reduction is expected to come to an end, and the selling pressure on the stock price may gradually weaken Turning Point

As the long-time market value leader among Chinese internet and technology companies, TENCENT was once seen as the "needle in the sea" by investors. However, in recent years, constrained by internet regulations and sluggish business growth, TENCENT's stock price has experienced significant fluctuations.

At its peak, TENCENT's market value reached as high as HKD 7 trillion, but in the past two years, it has remained around HKD 3 trillion.

After reaching the peak in its gaming core business, TENCENT underwent a significant transformation to B2B business and sought to rely on investments to sustain revenue and profit growth. However, the path of investment has been almost blocked by policies, making B2B exceptionally challenging.

TENCENT's current predicament is well understood by Pony Ma.

At the 2024 annual meeting, Pony Ma criticized that games cannot rely solely on past achievements and mentioned that TENCENT is at a loss when facing competitors, seeming to have made little progress. He also acknowledged the commercial success of Video Number, giving TENCENT a solid foothold once again.

However, the landscape of internet giants and e-commerce has changed dramatically, leading to a reshuffling of positions. Pinduoduo has surpassed Alibaba, the e-commerce leader, with a market value exceeding a trillion; even Baidu and Robin Li, who have been struggling for a decade, have found their foothold in the AI wave and are ready to make a big impact.

TENCENT and Pony Ma, who firmly hold the top spot in domestic social traffic, are facing challenges from ByteDance, Alibaba, and Pinduoduo in the e-commerce field. Especially after being surpassed by ByteDance in revenue, TENCENT's position as the "big brother of the internet" is no longer secure.

Although TENCENT still has billions of equity assets that can be disposed of to appease investors when needed, it can continue to defend market confidence through astonishing dividends and share buybacks, but this is not a long-term solution.

In terms of gaming and advertising businesses, TENCENT still has room for improvement, which can help its core business continue to recover and restore its valuation.

The TENCENT management pointed out at the performance meeting that the soft gaming revenue situation is expected to improve from the second quarter of 2024. It is reported that one of the heavyweight reserves in TENCENT's gaming pipeline is the mobile game "DNF," which is planned to be launched in the second quarter of this year.

Another business that is expected to boost TENCENT's valuation is Video Number. The commercialization of Video Number started with the most easily monetizable information flow advertising, but obviously, this is not the end. In the medium to long term, with the prosperity of the commercial ecosystem, Video Number is also expected to monetize through various business models, with the biggest highlight being live streaming e-commerce.

However, compared to the over trillion GMV of platforms like Douyin and Kuaishou, Video Number's current e-commerce volume of just over a hundred billion still has a long way to go. TENCENT will fully develop video number live streaming e-commerce this year, but the challenges it faces are also evident.

Gao Dongxu, Chief Analyst of the China Entertainment Industry Research Institute, told Wall Street News that for Video Number to compete in the top tier in the short video and e-commerce fields, it needs to put in more effort. Currently, Video Number not only faces strong competitors but also the challenge of WeChat traffic reaching its peak, requiring more high-quality content to attract users and explore suitable business models for Video Number to achieve profitability and sustainable development In addition, it must make more thorough business reforms as soon as possible to find a breakthrough.

The current global AI wave is surging, and the competition among tech giants has entered a new era. NVIDIA, Microsoft, and Tesla have become the darlings of investors, with even Apple going all-in on AI.

Tencent is also striving to seize the AI trend. In addition to enterprise services and advertising business, Tencent has integrated the capabilities of AI large models into many business scenarios such as Video Number, Tencent Meeting, and Enterprise WeChat, striving to reshape traditional businesses. Ma Huateng and Liu Chiping have repeatedly stated at performance meetings that AI has significantly empowered Tencent's advertising, stimulating Tencent's advertising growth.

Liu Chiping also revealed that Tencent's AI capabilities will be applied to consumer applications next, allowing users to further utilize the mixed-element large models through mini-programs or apps.

The era will eventually eliminate those backward enterprises. If Tencent wants to maintain its "iron throne," it must deepen the moat of traditional businesses while seizing the new opportunities brought by AI, in order to always stay at the forefront.

This is another exciting era. Ma Huateng and Tencent definitely do not want to and cannot afford to miss out