Tencent (TCEHY/700.HK)

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Tencent dominates the social media landscape in China and the online gaming market globally. Its WeChat application has 1.3 billion monthly active users and is effectively the mobile operating system of China. It owns the biggest grossing mobile games in China (and the world) and 5 of the top 10 most popular mobile games by daily active users internationally. It also owns the #1 long-form video streaming service and the top music streaming service in China. It is a strong #2 in the rapidly growing mobile payment market and #3 in cloud services in China. Yet it is often misunderstood and overlooked in the West. This is by design. Unlike his outspoken counterpart Jack Ma of Alibaba, Tencent CEO and co-founder Pony Ma intentionally keeps a low profile. This has been a shrewd strategy. If you own a hugely profitable monopoly, you don’t shout about it from the rooftop. You keep your head down and quietly expand your empire while buying up key stakes in rising tech and gaming companies globally.

Tencent stock has historically commanded rich valuations due to the company’s phenomenal growth and solid profitability. However, a couple of times a decade, temporary setbacks crush the stock and present brave investors with a lucrative opportunity to own one of the best tech companies at an attractive valuation. This is one of those times. In the past year, Tencent faced not just one, but four different headwinds. Tough Chinese regulations, increased competition from ByteDance’s Douyin (Chinese TikTok), strict zero-COVID policies, and a weak macro environment have all conspired to bring Tencent shares down more than 60% from its peak.

In the sections that follow, I will breakdown each of Tencent’s main business segments. By studying the success of Tencent’s key products, we can start to identify Tencent’s core competencies: the ability to identify massive secular trends, to make shrewd investments early, and to clone and further improve competitor products to create massive new businesses. Cloning is sometimes frowned upon, but the ability to take an idea, improve upon it, and to localize it so successfully for the Chinese market as to dominate all competitors is a Tencent superpower that should be respected. I will also explain why I think Tencent is about to turn a corner and why its best days are still ahead of it.

Tencent’s revenues have more than doubled from RMB238 billion in 2017 to RMB560 billion in 2021. Earnings has also nearly doubled from RMB6.83 per share in 2017 to RMB12.75 per share in 2021. The stock price, however, is largely unchanged since early 2017. Tencent now trades at attractive valuations and the lowest PE ratio in over a decade.  

Media Platforms

QQ

QQ was the first major product success for Tencent and the result of Pony Ma’s recognition that the future of communications lay in instant messaging, not pagers (which was popular in China in the late 1990s). Inspired by instant messaging platform ICQ, Tencent in 1999 launched the not so originally named Open ICQ (OICQ) for the Chinese market (later renamed to QQ due to intellectual property challenges). QQ was localized for the Chinese language, had a simple user interface, contained no ads, and was free to use. It quickly grew to become the dominant instant messaging platform in China and by 2003 had more than 80 million active user accounts. Tencent would continue to add features, launching Qzone in 2005 to enable robust social networking features. The number of active users would grow to more than 700 million by 2011, the year that Tencent launched WeChat. Although QQ saw some user declines in recent years, what is surprising is that even today the smart device MAUs (Monthly Active Users) of QQ exceed 560 million.

Strong network effects usually make messaging a winner-take-all market. For QQ to retain so many users despite WeChat’s ubiquity suggests QQ has found a niche. Today, QQ is the preferred messaging and social networking platform for China’s youngsters and students. It may seem strange for a 22-year-old platform to appeal to Chinese youths, but QQ has always appealed to a younger and more tech savvy demographic. The youths of every culture seem to want to stand apart from the prior generation and desire a place away from the prying eyes of their parents. In the U.S., Snapchat and Instagram fulfill this need. QQ serves the same demographic for China.    

WeChat (Weixin in Chinese)

The story of WeChat is impressive in that it is one of the few times that a company was able to overcome the innovator’s dilemma. The origin of WeChat rose from Tencent’s insight that mobile was going to revolutionize personal computing. The fact that a mobile-first messaging platform would come to dominate a mobile first world is not surprising. What is surprising is that Tencent was willing to risk disrupting its hugely successful QQ platform (whose roots are PC based) to launch mobile-first WeChat. Throughout history, more often than not, the incumbent platform ends up being disrupted by new entrants due to a reluctance to hurt their profitable cash cows. Tencent’s willingness and ability to build the first version of WeChat with a small skunkworks team says a lot about the company’s culture and organization.

Though WeChat took inspiration from existing mobile messaging platforms, it was Tencent’s ability to improve and innovate the product that led to WeChat’s success. WeChat had only limited success out of the gate as Xiaomi’s MiTalk messaging app already had 5 million registered users and a several month head start. WeChat’s growth only exploded when Tencent added a walkie-talkie-like voice messaging feature to WeChat, driven by the insight that Chinese characters are difficult and time consuming to type using the Latin alphabet. Users loved the time-saving feature and WeChat quickly won the mobile messaging app war with 100 million users by 2012. Today, WeChat has 1.3 billion MAUs, effectively the entire population of China. The strong networking effects of messaging and social media suggests that WeChat has a massive moat that is difficult to overcome.

Over the years, WeChat introduced new features and built a sophisticated ecosystem more advanced than any messaging or social media app in the West. WeChat is not only the default communication app for friends, family, and coworkers, it is also the place to keep up with your friends’ updates via WeChat Moments (a photo sharing newsfeed with a very light ad load). You can watch videos and play games with friends. You can also follow and interact with your favorite celebrities, businesses, and brands with WeChat Official Accounts. In 2017, WeChat launched Mini Programs which are effectively apps within WeChat. Consumers can use Mini Programs from third party companies without ever having to deal with the hassle of downloading and maintaining separate apps. For example, you can order food from Meituan, shop on JD, and even buy a plane ticket from Qunar all from within the WeChat app. Before traveling anywhere, you would again pull up WeChat to display your green health code, signifying COVID-free status. The WeChat Health Kit Mini Program is the most-used ePass for verifying health and travel status during the pandemic. And of course, when you finally sit down to grab a meal, you can pay for it directly with WeChat Pay. At this point, WeChat’s all-encompassing utility ecosystem is very much essential to daily life in China.

Tencent Video, Music, and Other Media

Tencent Video is the most popular long-form video streaming service in China (similar to Netflix or Hulu). It has more than 120 million paid subscribers and hundreds of millions more of free, ad-supported users. Similar to the US market, the China long-form video streaming market is crowded with competitors (iQiyi, YouKu, Sohu, Bilibili, etc.) and largely money losing. However, there is reason to believe profitability will improve for Tencent Video as Tencent is introducing more discipline on content spending and raising effective revenuer per user by reducing discounts.

Tencent owns slightly more than 50% of Tencent Music (ticker TME), the dominant market share leader in music streaming in China. TME makes money from both music subscriptions (82 million subscribers) and transactions from live streaming services.

Tencent also owns stakes in other media platforms such as Tencent News (news service), China Literature Limited (online novels), and HUYA (#1 video game live streaming service in China).

Douyin, Kuaishou, and WeChat Video Accounts

In recent years, a serious threat emerged to Tencent’s media and advertising business in the form of ByteDance, which first launched Douyin in 2016 to dominate the short-form video format in China and later replicated its success globally with TikTok (the Western equivalent of Douyin). The 2021 China Internet Advertising Data Report by researcher Zhongguancun Interactive Marketing Lab showed ByteDance in the #2 spot in the online China adverting market with a 21% share, behind leader Alibaba (29% share) and ahead of Tencent (15% share).

Tencent’s reported financials showed limited impact to its social and other advertising revenues (consisting of mobile ad network and WeChat Moments) which still grew revenues at a 24% annual rate from RMB40 billion in 2018 to RMB75 billion in 2021. However, Tencent’s media advertising revenues (from Tencent Video, Tencent News) declined at a 10% rate from RMB18 billion in 2018 to RMB13 billion in 2021. Tencent’s financial disclosures cite delays to content launches and challenging macro conditions. I can’t help but suspect that much of the challenging macro was caused by attention and ad dollars shifting from Tencent’s long-form video to Douyin’s short-form video.

However, recently Tencent has finally found success in short-form video by imbedding it directly into the WeChat app and leveraging its massive user base. Weixin Video Accounts (also called WeChat Channels) is Tencent’s answer to Douyin and Kuaishou (the #2 player in short-form video). Video Accounts have established substantial user engagement with total user time spent now exceeding 80% of the time spent on WeChat Moments. Total video views increased by 200% year-on-year in the second quarter of 2022. As Video Accounts reach critical mass, more viewers attract more content creators and vice versa, allowing Tencent to reduce content procurement spend. Tencent is also just now starting to monetize Video Accounts, launching in-feed ads in mid-July. Based on early ad-pricing data, Tencent believes eCPMs for Video Accounts should be at least on par with eCPMs of Douyin and Kuaishou. Douyin and Kuaishou are able to maintain ad loads of 14%-16% compared to just 2%-3% for WeChat Moments (Tencent only shows 3 to 4 ads per user per day on WeChat Moments). The naturally higher ad intensity of short-form videos also leads Tencent to believe ad revenues on Video Accounts can scale faster than it did for WeChat Moments.

The big picture is that short-form video advertising is currently split between Douyin and Kuaishou, but will soon be split three ways with Tencent. I expect this to significantly boost growth rates for Tencent’s social and other advertising revenues in the coming years.

Online Gaming

As important as advertising revenues (RMB89 billion) are to Tencent, online gaming is an even bigger business with 2021 revenues of RMB174 billion. Gaming is also a higher margin business for Tencent with gross margins in the 50%-60% range compared to advertising gross margins in the 40% area. Tencent’s gaming business is split 75% China games and 25% international games.

For a social networking company to grow to become the most powerful gaming company was by no means preordained. Tencent’s decision to enter the China gaming market was due to management’s understanding of the attractiveness of the gaming industry and its early appreciation for the free-to-play, microtransaction business model. Along the way, Tencent leveraged its massive social networks to distribute games domestically and made shrewd investments in young gaming companies internationally. Today, Tencent owns 30 of the top 100 grossing apps in the Apple app store in China, most of which are games.

What makes the gaming industry attractive is that it is a lot less hit driven than in the past. Many of today’s games are evergreen, with some games able to be sustained indefinitely by new content releases.

Riot Games

Riot Games today is most known for its massively popular League of Legends PC game. League is also the most popular eSports title with its World Championship Finals attracting a record-high 74 million peak concurrent viewers.

Tencent was an early venture investor in Riot games. Serving as the Chinese distributor for League, Tencent quickly recognized the potential of the franchise and made the prescient decision to acquire a 93% stake in Riot for $400 million in 2011 (later acquiring another 7% in 2015). Despite securing full economic ownership, Tencent let Riot retain operating control, a pattern that would playout for most of Tencent’s gaming investments.

Seeing the potential of mobile, Tencent encouraged Riot to produce a mobile version of League. Riot, purists and perfectionists at heart, refused as it felt the mobile platform was inadequate for its competitive games. In response, Tencent flexed its cloning superpower, copied the key features of League, localized it for the Chinese market, and released Honor of Kings in 2015. Honor of Kings became a smashing success and has grown to become the most popular mobile game in China by MAU and the top-grossing mobile game in China (and worldwide).

More recently, Riot Games launched Valorant in 2020, a team-based, first-person shooter for PC that has become another major hit. Valorant has seen steady growth since launch. As of August 2022, worldwide Google search traffic for Valorant has exceeded that of League of Legends.

PlayerUnknown’s Battlegrounds (PUBG)

PUBG is a player versus player shooter game that popularized the battle royale format. The game was developed by Korean game company Bluehole and published in China by Tencent. Following the success of the PC version, Tencent collaborated with Bluehole to release mobile versions. After a delay in getting Chinese gaming approval in 2018, Tencent published the mobile version in China under the title Peacekeeper Elite. Today, Peacekeeper Elite is the second highest grossing mobile game in China. Tencent is also the publisher of PUBG Mobile outside of China, which remains one of the highest grossing mobile games globally.

Epic Games

Tencent owns a 40% stake in Epic Games, which it acquired in 2012 for just $330 million. Tencent likely saw potential in Epic’s Unreal Engine, which today is one of the most popular game development engines. However, Epic is not a household name today because of Unreal Engine, but because of a game released in 2017—Fortnite. Fortnite adopted the battle royale format popularized by PUBG and made it a cultural phenomenon, reaching 250 million players by 2019.

Supercell

Tencent owns an 84% stake in Finnish mobile gaming company Supercell, which it acquired for $8.6 billion in 2016. Supercell makes the popular mobile games Clash of Clans, Clash Royale, and Brawl Stars. Clash of Clans recently celebrated its 10th anniversary and still remains among the top 30 highest grossing apps in the Apple app store in the United States.

Growth Outlook and Gaming Regulations

Tencent’s online game revenues grew an average 20% per year between 2016 and 2021. However, for the first half of 2022, revenues have been largely flat. Internationally, growth slowed due to tough comparisons against a COVID-boosted 2021. In China, gaming has come under regulatory pressure as part of the government’s broader regulatory crackdown on technology companies. Beginning July 2021, government officials suspended approval of all new gaming licenses. Then in late August 2021, China limited video game time for minors (under 18) to just three hours per week. For Tencent to post flattish gaming revenues despite the complete suspension of new game approvals and ban on minors speaks to the strength of Tencent’s existing games.

With the Chinese economy weakening significantly in 2022, the Chinese government has indicated that the rectification process for tech companies is largely complete. In April 2022, the Chinese government resumed issuing video game licenses after a 9-month suspension. The government has since issued a number of batches of game approvals, but has not yet approved any major games by Tencent. Some may view this as a negative signal. I believe this is simply the Chinese government being practical and issuing gaming approvals to the smallest, most financially unstable gaming companies first. I would do the same considering business data aggregator Tianyancha estimates that more than 14,000 video game companies shuttered in China in just the second half of 2021. Tencent reacted to the regulatory crackdown by developing fewer, higher quality domestic titles and aggressively shifting internal resources towards the development of international titles, which are not limited by regulatory approvals. Game development can be a multi-year process and much of the investment in international games will not show up until 2023 and 2024.

As we look out to 2023 and beyond, I expect Tencent gaming revenues to post a strong rebound. Domestically, Tencent should finally start to receive approvals, allowing for new game launches in the China market. Internationally, the shifting of internal resources towards Western games should also start to pay off. Long term, I believe the gaming industry is a secular growth story capable of double-digit growth.

FinTech & Business Services

WeChat Pay

Due to China’s limited development of credit cards, mobile payments have achieved a higher penetration than any other market. According to People’s Bank of China and Zhiyan Consulting, mobile payments made up 55% of total electronic payments in China in 2021. Tencent’s WeChat Pay is a strong #2 with about 40% of the mobile payment share behind market leader Alipay’s 55% share (iResearch).

Benefiting from its close ties to ecommerce giant Alibaba, Alipay essentially owned the mobile payment market prior to WeChat Pay’s entry in 2013. The fact that Tencent was able to steal 40% market share from a dominant incumbent is a testimony to the power of its social network and the strength of its execution. In a genius marketing move that Jack Ma later called a “Pearl Harbor Attack”, Tencent heavily promoted the giving of red packets via WeChat Pay during Chinese New Year in 2014. By digitizing a cultural tradition around gifting of money, Tencent seeded millions of WeChat Pay accounts with money.

More recently, payment volume growth slowed to low single digits year-on-year in April 2022 due to the COVID lockdowns. Volumes rebounded to high-teens growth in June 2022 and further accelerated in July. 

Tencent Cloud

According to IDC, China’s public cloud market is only one tenth the size of the public cloud market in the United States. Canalys estimates Tencent Cloud grew 55% in 2021 and ranked third in China cloud services with a 16% market share, behind Alibaba Cloud (37% share) and Huawei Cloud (18% share). In the area of SaaS products, Tencent Meeting became the largest standalone app for cloud conferencing in China.

Tencent reports its payments and cloud revenues together in the FinTech & Business Services segment, which totaled revenues of RMB172 billion in 2021. This segment saw average annual revenue growth of 33% between 2018 and 2021. More recently, revenue growth slowed to just 1% yoy for the second quarter of 2022, driven by macroeconomic weakness and Tencent’s decision to reposition their cloud business from growth at all costs to quality of growth, which should improve profitability.  

Tencent’s Investment Portfolio

Unlike most of its technology titan peers, Tencent has been able to redeploy nearly all of its free cash flow into investments in public and private companies. Historically, Tencent has had a good investment track record, benefiting from its deep insights into technology and gaming trends. Tencent also has the unfair advantage of being able to boost its investees through its WeChat platform. Some of Tencent’s major investments, such as delivery company Meituan and ecommerce company Pinduoduo, received significant boosts from being integrated heavily into WeChat.

Tencent’s disclosure on its investment portfolio is poor and it is difficult to track specific holdings. However, Tencent did disclose that the value of its listed investee companies (excluding subsidiaries) totaled RMB602 billion (about $90 billion) as of 6/30/2022. Tencent also had another $50 billion of investments in private companies. 

See below for an incomplete list of Tencent’s listed holdings based on public filings. The gap between the total and reported figure by Tencent could be due to Tencent’s stake in Tesla. Tencent acquired a 5% stake in Tesla in March 2017 for $1.8 billion. It is not clear how much Tesla Tencent still holds as Tencent dropped below the 5% ownership threshold required for 13G filings in December 2017.

China’s Regulatory Crackdown

Sentiment towards Chinese tech companies has been extremely poor for the past 18 months due to a series of regulatory crackdowns. The regulatory crackdowns were conducted to further common prosperity, check monopolistic power, and limit unhealthy activities. Some of the major negative developments included the cancellation of Alipay’s IPO, anti-monopoly fines, gaming regulations, elimination of for-profit tutoring, delisting of Didi, and stricter regulations for food delivery companies.

Although these policies were heavy handed, they were not arbitrary and can be understood from the perspective of the Chinese government. Take one of the most drastic examples, the effective elimination of for-profit tutoring in China. Expensive tutoring classes became a necessity for students to be competitive in standardized exams that determine admittance into prestigious schools. This created a serious financial burden for all but the wealthiest families, significantly increased the cost of raising a child, and contributed to the decline in birth rates in China (despite the abandonment of the one-child policy). Taking a broader view, the crackdown on the education industry was really about addressing societal unbalances.

The good news for investors is that the regulatory crackdown at this point seems to be largely complete and behind us. With weak macroeconomic conditions, the Chinese government has shifted to focusing on supporting growth and wrapping up its regulatory actions. A number of developments all point towards this including the March 16th announcement by Vice-Premier Liu He to introduce market-friendly policies, the April 29th announcement by the Politburo (chaired by President Xi) to step up policy support for the economy (including the platform economy), the resumption of gaming license approvals, and the May 17th meeting of Vice-Premier Liu He with tech executives where the government expressed its support for the development of the technology sector and public listings for such companies.

In recent years, there has a been a wave of founder resignations from leadership roles, likely due to regulatory pressure in the background. Jack Ma is no longer chairman of Alibaba and is planning to give up voting control of Ant Group. Richard Liu stepped down as CEO of JD.com. Pinduoduo founder Colin Huang has stepped down as the Chairman of PDD. ByteDance founder Zhang Yiming resigned from both the CEO and chairman roles. Su Hua, co-founder of Kuaishou, stepped down as CEO. It is worth noting Pony Ma remains CEO of Tencent, reflecting Ma’s strategy of keeping a low profile and Tencent’s relatively good relationship with the government.   

Variable Interest Entity (VIE)

No discussion of Chinese tech companies can be complete without touching on the VIE structure. Chinese regulations restrict foreign ownership of value-added telecommunication services, including those provided by Tencent. This issue affects most Chinese tech companies, and the workaround is to create a foreign holding company that controls the economics of the Chinese operating company through contractual agreements. Shareholders of Tencent own Tencent Holdings Limited, a Cayman Islands company that controls Tencent’s operating businesses in China. The Chinese government has thus far not challenged the VIE structure, but it remains in a grey area.

Between the regulatory crackdown and the VIE structure, increasing numbers of investors have declared all Chinese stocks uninvestable. Uninvestable means not suitable for investment at ANY price. Whenever investors have declared an entire asset class uninvestable, it usually suggests some overreaction and presents a potential area to look for opportunities.

While the VIE structure is a risk, I believe it has a risk with a very low probability. For China to renege on the VIE structure would be akin to dropping an economic nuclear bomb on all sources of foreign capital, with serious repercussions. This is very much against China’s interest as it desires access to foreign investments and is proud of being able to produce tech giants that can match those produced by Silicon Valley. Some investors fear China’s commitment to capitalism. I understand Xi Jinping is not Deng Xiaoping, but the Chinese understand more than anyone the benefits of capitalism. 1.4 billion people have experienced the economic miracle of the past 30 years and many still remember disasters such as the Great Leap Forward under the communist economic regime. I am of the opinion that China may develop in an autocratic way, but it will also remain capitalistic. 

China’s recent agreement with the US to allow for auditors to inspect the audit work papers of U.S.-listed Chinese companies is a strong sign of China’s continued commitment to Western capital markets.

China’s Zero-COVID Policy

China’s strict zero-COVID policy that led to the complete shutdown of a number of major cities this year has been disastrous for its economy and consumer confidence. China is one of the last countries still holding to this unsustainable policy. However, there is reason to believe that COVID policies will be relaxed following the 20th National Congress in mid-October 2022.

The reason China has thus far held to a unsustainable COVID strategy (given the clearly endemic nature of COVID) is due to its unique political situation. President Xi is trying to secure a third term and desires political stability above all else. The zero-COVID policy is very much a Xi Jingping policy and has been long held as a shinning example of China’s superior response to COVID. This was true in 2020 and 2021 when China largely eliminated COVID inside its boarders and most of the population could move about freely. However, with increasingly transmissive strains of COVID in 2022, the costs of the zero-COVID policy now outweigh the benefits. Despite this, to abandon the policy now and risk an overwhelmed hospital system and a surge of deaths is a risk Xi is not willing to take right before the Party Congress.

However, once Xi has secured a third term and firmly consolidated power, the calculus changes again. Xi will have the political breathing room to gradually loosen the zero-COVID policy. There is reason to believe that 2023 could see an economic rebound in China as COVID policies are lifted, much like 2021 was a banner year for the US following the 2020 lockdowns.

Financials

The tables below present Tencent’s historical financials for the years 2016 through 2021 as well as my projections for the years 2022 through 2025.

Key revenue assumptions:

  • Online Games revenues return to double digit growth as China starts granting Tencent new game licenses and Tencent’s investments in international titles start to pay off
  • Social Networks subscription revenues to return to modest growth
  • Online Advertising to rebound in 2023 as macro conditions improve, resumption of new game launches spur advertising demand, and Tencent laps the loss of education advertising
    • To be conservative, I continue to model modest declines in Media Advertising though at some point there should be a rebound as long-form video still retains value
    • Social & Other Advertising revenue to be boosted by WeChat Video Accounts
  • FinTech & Business Services to return to strong double-digit growth given long-term secular trends towards mobile payments and cloud computing

Key gross margin assumptions:

  • Value Added Services—The decline in historical margins is in part due to a mix shift from higher margin game revenue to lower margin social networks subscription & live streaming revenue. A return of game launches and faster game revenue growth should help leverage costs and improve margins.
  • Online Advertising—Margins in 2022 were hurt by weak the macro environment and double-digit declines in ad revenues. As the macro improves and WeChat monetizes Video Accounts, margins should recover.
  • FinTech & Business Services—Margins have steadily expanded with revenues. I am projecting more of the same, especially as Tencent is starting to focus on growing cloud revenues more profitably and there remains significant monetization potential in the SaaS business.

Consolidated results:

  • Selling & marketing: I am projecting an increase of sales and marketing to 7% of sales as macro conditions improve.
  • General and admin expenses: I am modeling Tencent to leverage this line item to 14% of sales by 2025. This is plausible as G&A was in the 13-14% range between 2017 to 2020.
  • Tencent has recently demonstrated a focus on cost control by shutting underperforming businesses, tightening marketing and user acquisition spend, migrating all domestic in-house services to Tencent Cloud for higher cost efficiency, and reducing headcount by over 5,000 in just the second quarter of 2022. Many of these initiatives will not show up in the results until the second half of the year. It is encouraging that Tencent believes it can return to earnings growth in the coming quarters even if revenues don’t rebound.
  • I am projecting for Tencent to resume EPS growth in 2023 and for Non-GAAP EPS to reach RMB21 per share by 2025.

Valuation

Tencent has historically traded for between 20x to 40x its forward earnings. Assuming Tencent trades for 20x its earnings and using my EPS projections for 2025 would yield a stock price of about $60 USD. This equates to a 23% annualized return based on the current price of $32. At 25x earnings, Tencent would be worth close to $75 per share.

Want a Bigger Discount? Buy Prosus (PROSY/PRX)

Those investors who want to own Tencent at a discount and are willing to do some additional research should look into owning Tencent indirectly via Prosus. Prosus is a Dutch company with a primarily listing on the Euronext Amsterdam exchange (Ticker PRX) and also trades in the US under its American depositary receipt PROSY. Prosus owns 28% of Tencent and is the company’s largest shareholder. In additional to Tencent, Prosus also owns a portfolio of fast growing, but largely unprofitable technology companies. A deep dive into Prosus’s portfolio is best saved for a separate post, but the key takeaway is that Prosus trades for a significant discount to its net asset value (NAV).

Tencent currently accounts for $85 billion out of Prosus’s total NAV of $116 billion. The NAV per ADR is a little over $17. PROSY last traded for about $10, equating to a 42% discount from NAV. Prosus’s Tencent stake alone is worth $12.50.

Prosus does have a complicated cross-holding structure with Naspers, a South African company from which it spun out off (part of an effort to reduce the discount to NAV). It is worth noting that Prosus has historically always traded at a pretty significant discount to its NAV. Recently, in June of 2022, Prosus finally announced an open-ended repurchase program to sell Tencent shares and buyback its own stock. There is reason to believe these buybacks could help the discount narrow going forward.

In summary, Prosus allows an investor to own Tencent at a discount and essentially get a portfolio of tech companies for free (option value). There is also a catalyst in the share buyback that could help close the discount.

Risks

  • Increased competition from ByteDance in social and from other gaming companies in mobile
  • Future waves of COVID leading to extended lockdowns
  • Continued deterioration in Chinese economy driven by weak property market
  • VIE entity structure
  • Continued depreciation of RMB vs USD
  • US China geopolitical risk

Catalysts

  • Improved monetization and growth of WeChat Video Accounts
  • China game license approvals for Tencent
  • Launch of successful games for international market
  • Relaxation of China’s Zero-COVID policy
  • Additional monetary and fiscal stimulus by the Chinese government
  • Improvement of macroeconomy in China in 2023

Disclosure:

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I hold a material investment in Prosus shares.

The information in the article is provided for informational purposes only. It should not be construed as investment advice or advice on buying, selling, or other types of transactions relating to an investment in products or services, much less an invitation, an offer or a solicitation to invest.

The information in the article is provided solely by virtue of the fact that everyone will independently make their own investment decisions: the report does not take into account investment objectives, nor specific needs or financial situation. In addition, nothing in the article represents or is intended to express investment, financial, legal, accounting or tax advice. You should consult your own investment or financial advisor before taking any actions.

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