Tencent: Sluggish Gaming Growth, But Advertising Comes to the Rescue

4Q2023 Earnings Review:

• Tencent’s $TENCENT(00700)$ Revenue increased by 7.07%, and Operating Income rose by 41.96% year-over-year in the latest quarter.

• The Operating Margin stands at 26.28% for FY2023, the highest in the past six years.

• VAS revenue shrank by 1.9% year-over-year, while Online Advertising and Fintech & Business Services grew by 20.82% and 15.1% year-over-year respectively in the latest quarter.

• Moving forward, we expect the weakness in VAS (especially weak gaming revenue) to be offset by margin expansion in Online Advertising and Fintech & Business Services.

• VAS revenue, accounting for 45% of total revenue, continues its lackluster performance mainly due to lower domestic gaming revenue and decreased Social Networks revenue (lower music/games-related live streaming services). More user spending time on short-form videos may potentially pull down VAS revenue.

• Domestic Games revenue continues its muted performance with a 3% decline in growth. International Games, which accounts for 8.9% of total revenue, also see muted 0.6% year-over-year growth. The current forecast suggests domestic gaming should grow in low single digits in 2024 as the China video game market is only forecasted to grow by 6% in 2024.

• Tencent Short Video supports Online Advertising revenue. Ad load remains much lower than industry peers, providing larger ad growth potential.

• FinTech and Business Services witnessed good growth in commercial payment activities, wealth management services, consumer loan services, eCommerce technology service fees within Video Account, and cloud services.

• In 2023, the Combined Monthly Active Users (MAU) of Weixin and WeChat grew by 2% year-over-year to 1.343 billion users, while Fee-based VAS registered subscriptions grew by 2% year-over-year to 248 million users. Its massive user base provides a good monetization story.

• Free Cash Flow of RMB 167 billion (+89%) in FY 2023 was more than enough to conduct share buybacks and dividend distribution to support the share price:

1. Share repurchase: committing to over HKD 100 billion for FY24, up over 100% year-over-year.

2. Dividend: proposing a cash dividend of HKD 3.4 per share, up 42% year-over-year.

3. In comparison, Alibaba( $Alibaba(BABA)$ $Alibaba(09988)$ ) may have a harder time keeping up with the current pace of dividend payout + share buybacks for the next three years if its Free Cash Flow does not improve.

 Technical Analysis:

• The current share price of HKD309.6 has surpassed the 23.6% Fibonacci level at HKD309.38.

• The next significant resistance level is at HKD384.91.

Source: Tiger PC App, 14 Apr 2024

Conclusion

• We foresee little hope for a recovery in domestic game revenue in 2024.

• However, the robust performance in advertising and Fintech and Business Services should continue to support its valuations.

• Tencent may emerge as an attractive investment alternative for gaining exposure to China's short video revenue, akin to Bytedance (which is not publicly listed).

• Like many Chinese companies, China accounts for 90% of Tencent’s total revenue. Consequently, Tencent’s business remains subject to strict regulatory oversight.

• Tencent’s forward PE is currently trading at 15.28x, higher than its 5-year average of 14.8x. As a result, we are neutral in the short term on Tencent but remain bullish in the long term.