Tencent: Chinese companies' stocks collapsing one after another? The stock king remains stable on home turf.

Hello everyone, I'm Changqiao Dolphin!

After the Hong Kong stock market closed on March 22nd Beijing time, Tencent Holdings Ltd. released its Q4 earnings report for 2022. The market generally has high expectations for the improvement in profits reflected in this report. However, on the revenue side, it is more important to look at expectations beyond the present due to the inevitable impact of the repairing process of the main business on the larger environment.

Generally speaking, the Q4 performance meets expectations and basically reflects that Tencent has a relatively stable core basic plate:

1. Although the Non-IFRS net profit attributable to shareholders was less than expected by 1 billion, the difference between the expectation and the core business's operating profit is quite consistent, showing a YoY growth of 30% in a low base period. There was a slight difference between gross margin and expectations, which may be more related to changes in the business structure, as the growth of higher cost overseas games and video accounts in Q4 exceeded expectations.

Tencent carried out its "efficiency enhancement" target quite well in Q4, especially in terms of shrinking marketing and promotion expenses, which decreased by 60% YoY, as evidenced by the already released financial reports of Tencent Music and Yuewen Group. From the perspective of administrative expenses, we believe that there is still room for improvement in operational efficiency in the future.

2. Total revenue of 145 billion is roughly the same as market estimates and basically the same as last year. However, in terms of details:

(1) The recovery of advertising revenue is a pleasant surprise, a real Beat, and it is Dolphin's belief that this may be due not only to the success of video accounts but also the unexpected return of media advertising to positive growth. Compared to the industry's growth rate of only 6%, Tencent's channel advantage is evident.

(2) The market has underestimated the impact of Covid-19 on Tencent's FinTech business, but Dolphin believes that due to the solid barrier of WeChat Pay, the short-term pressure brought about by the environment is not a problem. The cloud business is also in a transitional period, but it is close to its end. We expect it to resume growth next year.

(3) Revenue from value-added services such as games and digital content was basically in line with expectations. The game is still focusing on "growth" this year, and digital content is still the primary goal of self-sufficiency. After obtaining licenses for several consecutive months, Tencent's game reserves are still quite rich. Digital content businesses such as music, long videos, reading, and news have seen a significant reduction in losses or an increase in profit margins after a year of business model optimization. In an internal speech in December, Ma Huateng mentioned that the core task of these subsidiary companies this year is to continue improving their profitability.

Apart from the core business, here are some points worthy of attention:

**3. The sale of Meituan brought an on-book investment income of 106.5 billion: **Last quarter, Tencent announced that it would distribute Meituan shares to shareholders, leaving only a negligible small position, which is equivalent to selling Meituan indirectly. This quarter, this part of the investment income was recognized on the books. Last year, Tencent issued JD gift packs in March and Meituan gift packs this year. As a shareholder of Tencent, this benefit is still great.

4. Martin Lau will step down as acting CEO and continue as chairman of the investment committee according to the company's statement, but whether this is a signal of returning management rights in the next step may need to be discussed during the conference call. 5. Stock Repurchase and Shareholder Reduction Status:

From June 28th of last year to the end of the year, Tencent spent a total of 33.8 billion yuan repurchasing 107 million shares, which were subsequently cancelled. Since the beginning of this year, Tencent's repurchase actions have continued. We believe that due to the fact that the discount rate of the large shareholders' NAV and stock price is still not low and has recently rebounded, there is still potential selling pressure, and Tencent is expected to continue repurchasing shares after the sensitive period of the financial report to partially smooth out short-term disturbances.

Detailed Comparison of Specific Indicators and Market Expectations:

Long Bridge Dolphin's Viewpoint:

From the perspective of the fourth quarter results, Tencent is basically following the script that the market has anticipated. But the better-than-expected advertising and cost-control efforts also show some information beyond the script - the commercial value of the WeChat ecosystem, centered around Video Accounts, is highly recognized by advertisers; there is still room for further improvement in cost reduction and efficiency enhancement across the entire group.

This year is a year of definite recovery for Tencent, especially in terms of profit rebound, which will far exceed the income side. However, profit recovery represents the lower limit of the current valuation, and from the current market value, it has already been discounted to a considerable extent (Non-IFRS net profit increased by 22%).

To raise the upper limit of the valuation, the income side still needs to perform much better. Considering the current market revenue growth expectations, Dolphin believes that the release of gaming reserves, as well as the commercialization of Video Accounts and the entire WeChat ecosystem, have the potential to continue to bring surprises to the income side.

Dolphin will subsequently share the phone conference summary with Long Bridge App and Dolphin users. Interested users are welcome to add the WeChat account "dolphinR123" to join the Long Bridge Dolphin Research Group and obtain the phone conference summary in the first instance.

Detailed Interpretation of This Financial Report:

User Ecology: Tencent's Stable and Expanding Ecosystem is the Foundation of Growth

In the fourth quarter, WeChat continued to steadily expand with the support of Video Accounts, adding a net of 4 million users in a single season, reaching 1.313 billion monthly active users as of the end of December. According to third-party data, the total usage time of WeChat users increased by as much as 20%, of which most of the growth came from the incremental contributions of mini-programs and Video Accounts (according to the financial report, the usage time of mini-programs and Video Accounts was twice and three times that of the same period last year, respectively). In January of this year, due to the Chinese New Year and the popularity of offline travel, WeChat, which is more focused on daily work and study scenarios, saw a seasonal decline in usage time.

In the fourth quarter, although there was normal quarterly flow loss due to the end of the summer vacation peak season, QQ started to show signs of recovery in comparison to previous years due to the new feature of "Super QQ Show" (real-time reaction of user's facial expressions and gestures during video calls), indicating a return of QQ's ecosystem.

The stability of ecosystem traffic is the basic foundation for Tencent to maintain its core competitiveness; without this foundation, any monetization plan would be just like a mirage. It is also the stability of the WeChat traffic pool that enables video accounts to still compete with Douyin and Kuaishou.

However, from the perspective of industry time distribution, the short-term user share for Douyin and Kuaishou is still raising during the Chinese New Year period. Looking at the overall situation of last year, Kuaishou recovered slightly after the Chinese New Year, but Douyin still maintained its growth momentum , indicating that the Byte series still poses a strong competition, which is a risk point that requires attention.

II. Gaming: Do not fear the cold winter, rich reserves are valuable assets

In the fourth quarter, the revenue of online gaming was 41.8 billion yuan, down 2.3% on a year-on-year basis, with both mobile and PC games showing a trend of month-on-month improvement.

Although the global gaming market is still experiencing a downturn, it is expected to recover soon in the Chinese region, as the issuance of "game version numbers" has already become a normalized process. Tencent relied solely on "King of Glory" to support its domestic market during the fourth quarter as there were no new game launches. At the end of last year and during the Chinese New Year period this year, "King of Glory" released several new skins, which generated a short-term boost in revenue. Additionally, with most people staying at home due to the pandemic, old games are expected to perform well during the Chinese New Year period.

At the end of February, Tencent's self-developed mobile game "The Awakening of Dawn" was launched; although the user feedback has been average so far, this is a relatively heavy-duty mobile game with room for optimization. If properly and effectively operated for the long-term, it can still generate substantial income.

Last year, domestic gaming companies, including Tencent, stopped investing in or shut down servers for some projects that were not performing well, in order to decrease costs and increase efficiency. We believe that the overall decline in industry revenue is more related to the issue of insufficient supply rather than demand.

As a result, after several months of normal issuance of "game version numbers," the industry's overall supply has improved. Tencent's gaming reserves are also richer than anticipated, and the company's new game releases can now be scheduled with more optimism than before. Key games worth paying attention to (with licenses), such as "Honor of Kings International", "Fearless Contract China", "Arknights", "Illusion Connect" and "Tom Clancy's The Division", etc.

The overseas market is declining sharply, but the trend has shown some signs of easing. Tencent's overseas game revenue growth rate in the fourth quarter further increased compared to the previous quarter, accounting for 33% of the quarterly game revenue and becoming more international. In addition to old games, the new games "Goddess of Victory" and "Warhammer 40K: Darktide" (endgame) also had promotion under the influence of promotional activities of "VALORANT" and "Call of Duty Mobile" new modes and anniversaries.

Short-term game headwinds still exist and Tencent's deferred revenue and cash flow are still declining. Although the fourth quarter did not have the impact of a high base number, it is a fact that the payment demand of global game users has weakened. The pressure on game revenue will also continue to be transmitted to other businesses, especially the revenue release of advertising business.

III. Advertising: Video accounts, Mini Programs, and Traditional Media Channels have surprises

Advertising revenue significantly exceeded expectations again, and the solid Tencent ecosystem is the cornerstone of the commercialization and recovery of advertising. In the fourth quarter, with the widespread outbreak of the national epidemic, the industry growth rate of online ads was 6.5%, and there was no significant improvement on a month-on-month basis.

In addition, Tencent's media advertising has deteriorated in the third quarter, so although the market knows that video accounts will begin to contribute a significant revenue proportion in the fourth quarter, most investment banks' expectations are not too optimistic, and the growth rate expectation is basically around the industry average level, and even some investment banks are more conservative, giving a small decline in the same period.

In fact, Tencent's advertising revenue increased by nearly 15% year-on-year. In addition to the expected increase brought by video accounts and Mini Programs, what is more surprising is that media advertising turned from a 25% decline in the previous quarter under a low base number to positive growth, no longer dragging down overall advertising revenue.

This over-delivery of commercialization to some extent reflects the recognition of the value of Tencent's video, mini-programs and the entire ecosystem by merchants. Even the previously worried issue of internal advertising erosion within Tencent's channels does not seem as serious as imagined when viewed in this way. The recognition of the commercial value of channels by merchants indicates that Tencent's traffic base is very stable. At the same time, their "proactivity" can also make it easier for subsequent video accounts to promote other businesses such as e-commerce.

According to the Q4 report, Tencent's advertising ecosystem has further improved transaction conversion, which refers to e-commerce advertisements that attract businesses to WeChat and mini-program accounts, and now accounts for more than one-third.

Fourth quarter was hit by a nationwide epidemic. Although the overall scale of third-party payments accelerated its recovery, WeChat Pay's advantages in offline payment scenes were basically stuck. Therefore, the payment business definitely did not continue the upward trend of the third quarter, and its growth rate declined. Market expectations may still be under the 15% growth guidance given by management at the phone conference in the previous quarter, and the impact of the epidemic was not accurately estimated.

The cloud business is still in the transition period (reducing low-profit custom and subcontracting contracts), and of course, the epidemic has delayed deliveries and business activities. But we expect them to emerge soon from this phase, and they may see growth again this year.

The overall revenue of Jinke and cloud fell by 1.5% year-on-year, reaching 47.244 billion yuan, which is generally expected to grow positively.

The digital content business, which mainly relies on subscription revenue from music, online literature, and long videos, is an optional consumer good. There is more pressure on this part of the business from macro conditions and competition. Therefore, in the cost-reduction and efficiency-raising campaign conducted by the group, digital content is a key target, and it is required to be responsible for its own profits and losses, and will no longer be a drag on the profitability of the group.

The financial reports released by Tencent Music and China Literature both show that in the short term, they are giving up illusions and reducing investment, and instead focusing on exploring the potential for paid services among existing users. The Tencent Video Paying User Number disclosed in this quarter's financial report shows that the entire digital content sector is using scale to exchange for profit. The revenue of digital content in the fourth quarter further declined to 19.7 billion.

Looking ahead to the short-to-medium term future, dolphins expect that the improvement in the profits of digital content will continue to contribute to the overall profitability of the group, while new expansion cycles will have to wait for significant improvements in the economic and content regulatory environment. Investment Returns: Clearing Meituan Confirmed Income, Invested Companies Significantly Reduced Losses

The net amount of other income in the fourth quarter abnormally increased due to the significant increase in income from disposing of investment companies, mainly due to the confirmation of the book income of Meituan's financial assets reclassified as fair value measurement after the distribution of Meituan shares in a clearing manner (only 1.7% equity remaining) by affiliated companies. In addition, Tencent's invested companies are all making operational adjustments to reduce costs and increase efficiency, so the losses borne by Tencent as a shareholder are also declining.

Tencent has always adopted a conservative accounting treatment for its large-scale investment assets. For listed companies with large shareholdings, Tencent mainly classifies them as affiliated company assets, only recognizing the profits of invested companies calculated based on the shareholding proportion (included in the income of affiliated companies), but gains and losses caused by stock price fluctuations are not included in the quarterly profits. They are only recognized when disposed of or deemed disposed of. The disposal losses of JD.com and Sea at the beginning of the year and now Meituan have been confirmed.

Cut Marketing, Increase R&D

Finally, let's take a look at the profit situation. The marketing expenses in the fourth quarter are still the main target for optimization. However, due to the increase in R&D investment in overseas games and the increase in traffic costs and content costs brought by video shorts, the profit margin has not continued to improve month-on-month, and is not as positive as market expectations. However, from the perspective of absolute value changes, the core operating profit which represents the main business operation situation grew by 30% YoY on a low base, which is still in line with expectations. This trend will continue in the first half of this year. As of the end of the year, the group employed a total of 108,400 people, a net decrease of 400 people compared to the previous quarter, and the average compensation and benefits remained stable without seasonal decline, possibly due to the higher labor cost of overseas employees. From the progress of layoffs, there is still room for optimization.

![The bar chart describes the change in profit and loss, interest income, etc. of associated joint ventures, but mainly excludes Non-IFRS net profit attributable to shareholders, which excludes investment income, impairment provision and amortization of intangible assets, and is also a widely concerned profitable indicator in the market. In the fourth quarter, it achieved a profit of 29.7 billion, a YoY increase of 19.4%. It deviated from the market's expectations by 1 billion, mainly reflected in other income of non-core businesses.

Eight: Progress of buyback and reduction

Over the past year, the reduction of major shareholders has had a significant impact on Tencent's short-term stock price performance, but the market has also basically become accustomed to it. However, it is necessary for Delphinus to update the current reduction situation and Tencent's buyback actions at the same time.

From June 28 to the present, Tencent has repurchased more than 98.8 million shares, with a cumulative expenditure of more than HKD 30.3 billion. Compared with the time of the three quarterly report release (November 16), major shareholders quietly sold 39 million shares (from 2.613 billion to 2.575 billion).

As the net asset value discount and potential selling risks of major shareholders are still not low (recently there has been some rebound), Tencent should continue to buy back after the sensitive period of financial statements to partly smooth the short-term fluctuations of its stock price.

![The histogram describes the distribution of Tencent's shareholdings after the reduction of major shareholders. The GUI describes Tencent's "WeChat Pay" application.] (https://pub.lbkrs.com/cms/2023/0/9tvjXv6WB6PWNGy4xrQDPGge7573MVFJ.jpg)![The GUI describes Tencent's "WeChat Pay" application.] (https://pub.lbkrs.com/cms/2023/0/r65pLtyqLHS9urJHXzKHByMUc8kRDRkW.jpg)

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Risk disclosure and statement for this article: Dolphin Research and Analysis disclaimer and general disclosure.