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Regain Tencent, exploring the "bottom" of Tantan's stock king.

Hello everyone, I'm Dolphin Analyst!

In the first two articles of the Pan-Entertainment series, from the perspectives of industry trends, company fundamentals, and valuation elasticity, I, as Dolphin Analyst, selected Tencent and Xindong as the stocks worth focusing on in the short and medium term.

The logic of Xindong is relatively simple. We believe that it is worth focusing on it again because of the marginal improvement in policy, which will continue to promote the steady expansion of the TapTap ecosystem and the low valuation. However, I, as Dolphin Analyst, believe that self-developed/exclusive games are equally important. An excellent self-developed game can not only alleviate the financial pressure of Xindong's operations, but also is key to further breakthroughs in TapTap's user base.

However, considering the uncertainty of game approval, we still recommend investors to pay close attention to the progress of Xindong's self-developed game approval, and I, as Dolphin Analyst, will closely follow it and update in real time on Longbridge app's community homepage.

The current situation of Tencent is a bit complicated. After the mid-year report was released, Tencent's cost reduction and efficiency increase was already reflected in the financial indicators, and the intensity even exceeded market expectations. Rarely, during this conference call, the management gave a relatively positive guidance on the company's short- and long-term development. I, as Dolphin Analyst, also gave a judgment in the review of "360-degree analysis of Tencent: Is it really that bad?" that Tencent's fundamentals are turning around.

However, Tencent only rose nearly 5% on that day, and then oscillated back to HKD 300. Recently, it fell below the previous low again, in the context of hawkish expectations of the US Federal Reserve's interest rate hike and the resurgence of geopolitical friction between Russia and Ukraine.

Undeniably, the short-term factors that disturb the stock price such as external environment and the reduction of major shareholders cannot be ignored. These factors affect the timing of the stock price's rise. However, at the same time, we want to emphasize that long-term value ultimately depends on the fundamentals.

In addition to the low point of performance caused by macro, competition, and regulation, the short-term impact of external environment and the pressure of the reduction of major shareholders, in the long-term, this is a relatively extreme and negative-density stage. Tencent at present has been struck by multiple pessimistic expectations. One possible scenario is that its valuation is already in place, but the best time point for the stock price's rise has not yet arrived.

The likely result of this situation is that, in the future, the stock price will mainly oscillate within a certain range before external factors turn or the pressure of major shareholders decreases significantly.

Therefore, in addition to analyzing the impact of the reduction of major shareholders, this article will mainly focus on the marginal changes in Tencent's fundamentals and give our valuation range for Tencent based on the assumptions of business development, especially the bottom conservative value.

Dolphin Analyst specializes in cross-market interpretation of global core assets for users and grasping deep value and investment opportunities of enterprises. Interested users can add the WeChat account "dolphinR123" to join the Dolphin Analyst investment community to discuss global asset investment views together! 1、How long will the blunted knife-like reduction in shares last?

When it comes to Tencent's "never-ending fall," we cannot avoid the sword of Damocles of the major shareholders' reduction in shares. Therefore, before discussing Tencent's fundamentals, let's first talk about Naspers and Prosus's reduction in shares.

1. The main reason for the sluggish pace of major shareholder reduction is the slight easing of discounts and the low turnover of Hong Kong stocks.

Since the announcement of the public market reduction plan on June 24th, the major shareholders' reduction has been almost three months. According to the official website announcement on September 23, the major shareholders hold a total of 2.693 billion shares through Prosus's subsidiary MIH, which is 76 million shares less than the 2.769 billion shares before this round of reduction, that is, the total amount of reduction in these three months.

Prosus's actual cumulative reduction amount is more than 5% of the turnover (about 60 million shares). If it weren't for the continued slump in Hong Kong's stock market trading, the major shareholders would not have violated their promise again (not exceeding about 3% to 5% of the turnover) and had to "excessively reduce."

In the announcement of this reduction plan released by the major shareholders on June 27, it was explicitly stated that this reduction plan not exceeding 18 months was to repurchase the shares of Naspers and its subsidiary investment company Prosus in order to reduce the discount between the stock price and the net asset value NAV.

Yes, global stock markets are under pressure, and the market value of the major shareholder in South Africa has fallen below net asset value-Naspers's NAV on September 23 was 95.1 Euros/share, and the closing price that day was 53.4 Euros/share, with a discount rate of 43.8%. Compared with the discount rate of 54% before this reduction on June 24, it has dropped by nearly 10%.

However, the decline in the discount rate is not the way the major shareholders hope— to guide their own stock price to rise (last Friday's stock price of 53.4 Euros was basically flat with the closing price of 53 Euros on June 24), but due to the downward valuation of their investment assets, which led to the decline in NAV.

Here to briefly explain, the net assets mentioned by the major shareholders are not the traditional financial sense of assets minus liabilities (Equity), but calculated by "investment asset value + net cash." 1) The value of investment assets, including the value of listed equity assets and unlisted equity assets. The listed portion is derived from the fair value of the stock price times the number of shares, while the non-listed portion is a consistent expected valuation given by a dozen analysts. As shown in the figure, as of September 23, the value of Tencent's equity held by Prosus was US$94.3 billion, accounting for 75% of the overall NAV, making it the most valuable investment asset.

2) Net cash is obtained by adding cash and cash equivalents on the account, short-term investments, and subtracting short-term and long-term interest-bearing debt.

As the value of non-listed investment assets depends on the expected valuation given by analysts, it often exceeds the book value of the corresponding assets. Therefore, whether it is Naspers or Prosus, the "net assets" disclosed on their official websites are generally larger than the assets minus liabilities on their financial statements, and will be continuously adjusted with the change of analysts' expectations.

As of September 16, Prosus had repurchased a total of 48 million shares, accounting for 18% of the maximum repurchase amount of 265 million shares, using approximately US$3.1 billion or HK$24.3 billion. If calculated based on the average transaction price of HK$323 for Tencent from June 27 to September 23, selling 76 million shares totaled HK$24.5 billion, excluding some exchange rate fluctuations, which is basically equal to the amount of Prosus repurchase.

Compared with what was said in the announcement of the selling plan, the repurchase amount mainly comes from the sale of Tencent stocks, indicating that in addition to this part of the selling profits, the South African major shareholder does not want to spend additional money, and the sale and repurchase are almost synchronized.

If based on the transaction situation of Tencent in the first three months (average price, average transaction volume), and the pace of selling, assuming that the major shareholder will not use other funds (self-owned cash or profits from the sale of other assets) during the repurchase process, the worst situation is that when the repurchase quantity reaches the upper limit of this round of 265 million shares, the discount rate between Prosus NAV and market value has not reached the satisfactory level of management.

_Therefore, (2.65-0.48)/0.48*3≈14 months are still needed. That is to say, unless the trading volume of Tencent Hong Kong stocks continues at the current scale in the next year, the worst situation is that the major shareholder will have to sell until November next year. However, the Dolphin Analyst believes that the probability of this situation occurring is low. On the one hand, the global stock market is expected to continue to recover in the second half of next year (the Fed's interest rate hike is slowing down), and the corresponding market value of Napers and Prosus will increase, which may accelerate the narrowing of the discount rate between their NAVs and market value. On the other hand, Tencent is also expected to attract more long funds due to the gradual improvement of its fundamentals and increase in trading volume, which is conducive to the acceleration of major shareholders' holdings reduction.

2. Can Tencent really avoid selling shares when faced with pressure to buy back shares with limited funds?

During the period of major shareholders' reduction of shares, Tencent's management is also simultaneously buying back its own shares to support stock prices. In the past three months, Tencent's daily repurchase value has been between HKD 300-350 million, corresponding to a range of 830,000-1.3 million shares.

As of September 16th, Tencent has cumulatively repurchased 32.81 million shares, consuming HKD 10.65 billion in funds. However, compared with the 76 million shares that the major shareholders have reduced, there is still a considerable gap. Because the stock price has hit a new low again, although the market turnover is declining, the management's repurchase efforts are gradually increasing from the trend.

However, as the Dolphin Analyst has mentioned earlier, the current sluggish and pessimistic market sentiment is mainly affected by multiple factors such as the current macro environment (interest rate hike, epidemic, war, and Sino-US confrontation), to a certain extent belonging to relatively rare and extreme market conditions. If we calculate the same worst-case scenario (based on the average daily turnover and average repurchase amount of the past three months), Tencent still needs to use approximately HKD 103.2 billion to repurchase its own shares.

In the second quarter report released not long ago, Tencent disclosed that its total cash on hand (including financial assets with fair value changes recorded in the income statement) is CNY 315.9 billion, and short-term interest-bearing debts amount to CNY 30.5 billion. Long-term interest-bearing debts are mainly unsecured US dollar commercial paper borrowed for global investment convenience, most of which have maturity dates after a long period (73% are more than 5 years). If we take the 14 months for major share reduction as the time cycle, the long-term debts will not create pressure on Tencent's cash demand during this period.

That is to say, in theory, if we only look at the net cash scale after excluding short-term debts, which is CNY 285 billion, Tencent can afford the over HKD 100 billion repurchase fund demand. However, we need to consider the actual situation, which is that Tencent is still increasing its investment in overseas gaming companies due to the urgency of expanding game overseas market. In addition, Tencent is also frequently making moves in corporate services and hard technologies development. If we consider the potential capital requirements for investment activities in the next year, Tencent cannot exclude the possibility of some cash pressure.

Therefore, the Dolphin Analyst believes that if Tencent wants to maintain cash availability and meet the application standards for financial holding licenses (for details, see the Dolphin Analyst's article "The Butterfly Effect of Ant Group: Will Tencent Surpass Meituan and Pinduoduo?"), it may still need to take measures such as issuing bonds to balance its financing structure and maintain its cash flow. In order to maintain its market value, Tencent is likely to sell some of its relatively mature equity assets (the Q2 investment assets' book value totals 686.1 billion yuan, while Dolphin Analyst estimates the fair value of the NAV to be 1.0024 trillion yuan). This would be a two-pronged approach. Moreover, this action would also be more conducive to guiding market funds to focus on the value of these investment assets when valuing Tencent, achieving a boost to its stock price.

In general, the worst-case scenario is that the reduction in holdings will continue until the second half of next year, and Tencent will execute repurchase operations for the long term in order to maintain its market value. To alleviate possible funding pressures and apply for a financial holding company license as required by regulations, Tencent is very likely to sell its equity assets.

Although Tencent recently denied foreign media speculation about selling equity assets, Dolphin Analyst believes that investors in targets such as Meituan (mature assets), Kuaishou (short-video business competitor), and Pinduoduo (mature assets) still need to pay close attention to potential sales risks.

Second, short-term basic expectations: first ease, then recover.

After discussing the reduction in holdings, we can finally talk about Tencent's fundamentals.

Regarding the marginal change expectation of the macro environment, Dolphin Analyst will not elaborate. Changes in the epidemic situation and prevention and control policies will bring about a rebound in the industry's beta. However, since we are choosing the best, we are more concerned about the marginal changes of Tencent's stock alpha.

The market's judgment of Tencent's fundamentals is somewhat uncertain at present. On the one hand, the market has long-term faith in Tencent's social traffic barrier, but on the other hand, it lacks confidence due to the current competition and the sustained impact of supervision on short- and medium-term performance.

For example, there are doubts about the market's three high-profit cash flow businesses:

(1) How long will the impact of Douyin and Kuaishou on Tencent's traffic share continue?

(2) With the restart of game licenses and the "common prosperity" invisible policy, the attractiveness of future growth space has decreased. Can accelerating the layout of overseas markets make up for the gap in the domestic market in the short term?

(3) Will payment become like water, electricity, and gas as a public infrastructure, with the possibility of long-term loss of pricing power?

(4) After the reform of state-owned enterprises, does Tencent Cloud still have room for growth?

These concerns are not just the result of excessively pessimistic expectations. Some of the problems are indeed constraints that Tencent cannot escape in the short, medium, or even long term, and each question needs to be analyzed in depth one by one. Dolphin Analyst will take a neutral and somewhat conservative perspective when discussing each question.

  1. The flow migration of the entire Tencent ecosystem is still ongoing, but the good news is that there has been a clear easing.

Internet platforms all do business based on flow monetization. For Tencent, the two major social platforms, WeChat and QQ, are the flow reservoirs. Games, digital content, advertising, and payment are all ways to monetize the flows in these reservoirs. In the past three years, the overall user time of Tencent's ecosystem has not shown a significant decline in absolute value, but the proportion of it has been significantly impacted by Douyin and Kuaishou. However, since the second half of last year, the Tencent system's total duration ratio has fluctuated in the range of 35% to 36%, and the impact of competition has eased slightly. Since the beginning of this year, Byte's strategic focus has shifted from advertising to e-commerce (including local retail). Of course, the main reason is that its ad loading rate is relatively high, and further improvement would affect the user experience, so the speed of migration of Tencent's duration has also slowed down.

On the other hand, with the daily active users of Video Account surpassing Douyin in the middle of this year (813 million vs 680 million, source Questmobile), the total duration of WeChat has reversed the negative growth trend since the launch of Video Account, and the proportion of WeChat duration has basically remained stable. In the future, we can expect to see Tencent's ecological traffic further stabilize or even recover.

Obviously, WeChat, a huge and still growing sub-ecosystem, has high expectations. At a time when the main businesses of other companies are experiencing varying degrees of headwinds, pressure on the group's performance has also been placed on Zhang Xiaolong. Therefore, we can see that Video Account, which was originally planned to be commercialized by the end of the year, has gradually improved the placement function of public-domain advertising, and has successively introduced the information flow advertising (contract) system, Video Account small store, and information flow advertising (bidding) system in July and August, compared to inter-selection advertising, which was originally of a private domain nature.

Compared with the mature platforms Douyin and Kuaishou, the charm of Video Account naturally comes from the WeChat ecosystem behind it, which is China's largest private domain traffic platform and is also considered the platform with the lowest long-term operating costs for businesses. If we do not consider the possible impact on Tencent's live e-commerce after the completion of Video Account, we expect that the public-domain information flow ads placed on Video Account can reach nearly 20 billion yuan in scale in the medium to long term by 2025, and these budgets allocated to Video Account may mainly come from stealing food from Douyin and Kuaishou.

2. The game logic has indeed changed, and there is short-term pressure

The advantage of major publishers' license quantity has been leveled, which is the main short-term negative for leading companies such as Tencent and NetEase. However, as can be seen from the comparison of Tencent and NetEase's old game revenue in the current consumer downturn, Tencent has better anti-fall performance than NetEase's large DAU game. Therefore, in order to reduce the decline or maintain growth, NetEase's demand for licenses is higher and its willingness to go overseas is stronger. In the first half of this year, it also made unprecedented frequent investments in overseas studios.

So how long will the global game industry's sluggish consumption last?

According to the latest global game report from NewZoo, the global game industry's headwind will continue until the end of 2023. However, for Chinese game companies to go overseas, there is also a relatively positive side to the pessimism.

  1. In the second half of this year, it is not difficult to say that it is related to the decline in the consumption power of its own users. At the same time, the game industry also needs to continue to digest the popularity decline period after the epidemic (high base period of the same period last year).

  2. The growth of the game market in 2023, NewZoo has revised down its original forecast of a 10% growth rate to 2%. This means that although the base period in 2022 is not high, NewZoo believes that the low consumption caused by economic recession will further continue throughout 2023.

  3. Among different types of games, mobile games are still the fastest growing. This is a relatively positive message for Chinese game manufacturers who are good at mobile games to go overseas.

  4. In different countries and regions, the future growth rates of Latin America and the Asia-Pacific region are relatively high in the next three years, and the market size of the Asia-Pacific region accounts for 50% of the global market. The Asia-Pacific market, where consumption habits and cultural environment are more similar, is also the main market for Chinese game manufacturers to go overseas.

3. Future growth expectations for Kingsoft Enterprise Service need to be suppressed

As one of the former gold mines and growth storylines, financial technology and enterprise services are also key to supporting Tencent's valuation going towards trillions of dollars.

However, with the downward adjustment of platform payment rates guided by the central bank last year, and some livelihood guarantees that platform economy needs to play in special times, the future development of commercial payment cannot be compared with the level of current European and American payment companies. However, if we want to further squeeze the profit space of the platform, Dolphin Analyst believes that the possibility is not high, especially in the medium-term. Last year, the central bank required platforms to lower their payment rates for SMEs, primarily in the context of the pandemic and platform economy reform.

However, after the important speeches by the Financial Committee in March and the National Committee in August, we believe that the regulatory authorities' reform of the platform economy has basically come to an end, and future focus will be on normalized regulation and encouragement and support.

At the same time, we must also admit that, under the new regulatory environment, the long-term growth expectations for cloud businesses need to be tempered.

According to the data disclosed by CAICT, China's public cloud business has accelerated again in 2021, with a YoY growth rate of up to 82% compared to 2020. Compared with the proportion of the public cloud market size to the overall GDP in China and the US (0.19% vs 4.05%), China's digital economy still has a lot of room for penetration, and we expect that it will continue to maintain a high growth rate in the coming years.

However, after the reform of government-enterprise cloud, Alibaba and Tencent's original government contracts, public utilities contracts, school and hospital contracts, energy enterprise contracts, and transportation contracts may mostly gradually flow to operators with more government background, thus the market share of Alibaba and Tencent will decrease year by year.

According to JPM's estimation, IT-related spending from the government and utilities sectors accounted for 70% of total domestic IT spending in 2021 (including public cloud spending), while Tencent Cloud has a relatively small share of internet enterprise customers that have a competitive advantage, and the penetration of public cloud is relatively sufficient at present. In the future, the driving force for the high-speed growth of China's public cloud will mainly come from traditional enterprises' transformation into the digital economy, but Tencent Cloud's technological advantage cannot help it gain growth dividends.

As shown below, Dolphin Analyst predicts that Tencent's public cloud market share will drop from 11% in 2021 to 5.5% in the long term, but at the same time, with more Tencent Cloud products focusing on high gross margin PaaS and SaaS services, the overall gross margin rate of Tencent Cloud will increase rapidly compared with current levels.

Overall, while the pillar business is no match and gradually recovering, Video Account and overseas games are new long-term growth stories. The commercialization of Video Account has further opened up the imagination of the WeChat ecosystem's commercialization value, while overseas games may not contribute much to performance in the near term due to pressure from the global economic downturn in the past two years, but in the medium and long term, they are expected to gain more market share in international markets to drive performance growth. III. Valuation Update

To conclude the valuation, considering the business growth assumptions in the previous section, Dolphin Analyst predicts that the Non-IFRS net profit attributable to shareholders will be in a clear recovery period in the next two years. On the one hand, this is due to the company's own cost reduction and efficiency improvement, and on the other hand, it is due to the launch of video accounts and the overall recovery of advertising business. By 2024, the global game downturn will end, Tencent's overseas layout will gradually bear fruit, and game revenue is expected to accelerate again.

Under the DCF model, assuming a WACC of 10.35% and a growth rate of 3%, Tencent's neutral valuation is calculated to be nearly HKD 3.6 trillion, corresponding to a PE ratio of 28x for the net profit attributable to shareholders and 24x for Non-IFRS net profit attributable to shareholders in 2023. This is at the historical median valuation level.

Compared with the valuation given by Dolphin Analyst at the beginning of the year, the main adjustments are the downward revision of the game revenue growth rate in the short to medium term, the slower speed of advertising recovery, and the compression of the long-term space for enterprise cloud. In addition, we have also increased the risk-free interest rate to 3.5% to reflect the short- to medium-term interest rate environment.

However, due to the selling pressure from major shareholders, many funds prefer to evaluate Tencent's investment value from a short-term perspective. In Dolphin Analyst's assumptions, there is still pressure for a global economic downturn in 2023, so we choose to use the performance in 2023 to calculate a short-term conservative price as the bottom of the valuation range.

The final result is HKD 263 per share, corresponding to a PE ratio of 17x for the performance in 2023.

From the perspective of the relative valuation, the value of games, financial technology and equity assets are the main factors supporting the valuation. However, in reality, Tencent's advertising revenue is not proportional to its traffic scale, especially when compared with WeChat, Douyin, and Kuaishou. Although there are reasons why the private domain is more important, Tencent's advertising monetization still shows a "restrained" state.

Therefore, in Dolphin Analyst's expected assumptions, we have not opened up more optimistic space based on the original commercialization level. But in fact, here is a gold mine that has not been fully developed. Perhaps when encountering greater growth bottlenecks in the future, Tencent will choose to dig gold. Overall, from the valuation range【263-381】HKD/share given by the two types of results, Tencent is currently in a relatively oversold state. Once the influence of short-term disturbing factors is eased, we believe that the market will quickly move towards the direction of value regression.

Dolphin Analyst's "Tencent" Related Articles

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August 18, 2022 earnings call "Cost Reduction and Efficiency Improvement Will Continue in the Second Half of the Year, and Video Number Will Be Highly Anticipated (Tencent 2Q22 Conference Call Minutes)"

August 17, 2022 earnings review "360-degree No Dead Corner Dismantling Tencent: Is It Really That Bad?"

May 18, 2022 earnings call "This Year's Growth Guidance Depends on the Epidemic (Tencent Conference Call)"

May 18, 2022 earnings review "Tencent: Stock King Is Still Crossing the Tribulation"

March 23, 2022 earnings call "Under the Industry's Deceleration, High-Quality, Healthy Growth Is the Top Priority (Tencent Conference Call Minutes)"

March 23, 2022 earnings review "Tencent: Is the Stock King Still "Deep Squatting"? The Moment of Faith Has Come"


January 5, 2022 "Scared Tencent Little Brothers? Sea's Significance Is Different"

June 28, 2021 "Behind the "Chicken Ribs" Tencent: Ultimately Still Dealing with Payments! | Dolphin Analyst"

June 20, 2021 "Tencent's Next Destination: Trillions of Market Value? (Part 2) | Dolphin Analyst"

June 10, 2021 "Tencent's Next Destination: Trillions of Market Value?"

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