Goldman Sachs is bullish on Tencent: one of the most promising Chinese internet giants with strong confidence in its management team

Goldman Sachs released a research report on Thursday, stating that the bank recently had discussions with Tencent's Chief Strategy Officer James Mitchell and Tencent's Investor Relations team. Goldman Sachs believes that although Tencent faces short-term pressure in mobile advertising networks, media advertising, and financial technology/commercial payments due to macroeconomic conditions, the accelerated revenue growth in businesses such as gaming, video accounts, wealth management, and SaaS has essentially offset this impact.

Goldman Sachs stated that Tencent remains one of the most visible and sustainably profitable companies among Chinese internet giants. The bank is confident in Tencent's management's clear strategies across various business lines, maintains a buy rating, and sets a 12-month target price of HKD 464, representing a 24.5% upside potential from the current stock price.

Boosting Profitability through Multiple Growth and Monetization Strategies

Goldman Sachs mentioned that Tencent is continuing to address macro challenges by employing various strategies and monetization levers to achieve healthy revenue and strong profit growth.

In terms of revenue, incremental advertising monetization levers include AI advertising technology to increase ad loads on WeChat video accounts. In the payment sector, Tencent will continue to expand new use cases and consumption scenarios outside its ecosystem, such as WeChat Pay recently entering the Taobao ecosystem.

Regarding gross profit, Goldman Sachs noted that Tencent's gross profit growth in the past few quarters has been 2-2.5 times the revenue growth on a year-on-year basis, mainly due to the transformation of revenue structure, especially the decrease in low-profit entertainment live streaming revenue. Additionally, the high-margin profitability of incremental revenue (mini-games, video account technology fees, and WeChat ads) will support structural growth of gross profit at a pace exceeding revenue growth.

Goldman Sachs expects Tencent to achieve healthy year-on-year revenue growth while maintaining strong monetization capabilities in advertising, gaming, and other businesses. Particularly in macro-dependent businesses like advertising, Tencent has various growth levers. Furthermore, as the revenue structure continues to shift towards high-quality revenue sources, the growth rate of gross profit will surpass revenue growth.

Continued Growth in Gaming Business

Goldman Sachs mentioned that Tencent maintains a consistent philosophy in game development and portfolio strategy. The company's game development philosophy remains unchanged, allowing studios to leverage their unique strengths, with different studios possessing different specialized skills. Tencent will continue to adopt a portfolio strategy in gaming, supporting commercial success by extending the lifespan of evergreen games and expanding the boundaries of game development through investments in external studios.

In terms of evergreen games, "Honor of Kings" still has monetization potential as the game's payment rate and average revenue per user (ARPPU) are at relatively low levels. Goldman Sachs stated that there are differences in player behavior between Chinese and Western players and their subsequent evolution, with Chinese players gradually participating more in shooting games, an area where Tencent excels.

Goldman Sachs predicts that Tencent will continue to adopt a portfolio strategy, maintain the longevity of evergreen games as the foundation of commercial success, and expand game development boundaries through investments.

Enhancing Advertising Business through AI

Goldman Sachs revealed that according to Tencent executives, the company's ongoing upgrade of its advertising technology is a multi-year process that will support continuous growth in click-through rates and revenue A research report stated that Tencent's advertising business is still in the early stages of adopting AI and lags behind other global social media peers (the latter's advertising revenue still achieved double-digit year-on-year growth). Improving advertising technology will help enhance customer data insights, thereby improving the precision of ad placements.

Goldman Sachs believes that Tencent is still in the early stages of the advertising technology upgrade cycle and will simplify/automate ad buying and audience targeting processes through AI. This will increase click-through rates, make it easier for advertisers to create ad materials, and ultimately shift more ad spending to the Tencent platform.

E-commerce Business

Tencent's management told Goldman Sachs that Tencent is seeking to build trust between merchants/suppliers, which is a long-term relationship with consumers. This trust is a continuation of the success of WeChat in the content field, where the success of official accounts is based on enduring relationships between creators and consumers.

The company stated that the infrastructure for e-commerce business is already in place, including payment infrastructure, API relationships through the mini-program ecosystem, logistics and delivery solutions. Tencent has investments in high-end logistics company JD Logistics (JDL) and mid-end logistics company J&T.

Goldman Sachs expects Tencent to continue building necessary e-commerce infrastructure and ecosystems to support the long-term growth of video accounts and WeChat e-commerce advertising business, differentiating itself from existing competitors. In addition, Tencent has monetized through e-commerce technology service fees.

Recovery of Social Network Revenue Growth

Goldman Sachs stated that the company's social network segment growth has been suppressed in the past few quarters, mainly due to the decline in live streaming revenue. This revenue segment is expected to complete adjustments in the third quarter of 2024, with future trends showing improvement.

The tendency for users to pay for music and video subscriptions has increased, driving an increase in subscription users and an increase in Average Revenue Per Paying User (ARPPU). Additionally, the growth of the mini-game ecosystem brings in higher profit margin revenue. One of the most successful mobile games in the past 12 months was also released on a Chinese mini-game platform, as mini-games have a higher installation tendency and good monetization effects. Furthermore, Original Equipment Manufacturers (OEMs) collaborate through revenue sharing.

Goldman Sachs believes that with the completion of adjustments in live streaming revenue, Tencent's social network segment overall will resume growth. Supporting factors include healthy growth in video and music subscription users and ARPPU expansion, as well as contributions from mini-games.

Accelerating Investment Return Speed

Tencent's management told Goldman Sachs that as more investments mature, Tencent is recovering capital by exiting mature investments to fund potential stock buybacks, distribute shares to investors, or make more investments in China and other regions.

Goldman Sachs expects Tencent to continue to adopt strict discipline in investment and divestment, maintaining a self-funded investment portfolio. Divestments and dividends received in recent quarters have exceeded total investments, providing capital space for shareholder returns.

Monetization of Generative AI

Tencent's management believes that generative AI has three key enterprise applications, including advertising technology, providing GPU cloud solutions, Tencent's own large language model (LLM) training, as well as consumer-facing chatbots/personal assistants In terms of advertising, the most prominent and highest returning application is using GPU to boost click-through rates (CTR). Tencent has been focusing on this in the past 1-2 years and will continue to do so in the future.

As for consumer-facing chatbots, Tencent has expressed interest in unlocking usage scenarios through digital assistants to provide services and execute transactions. Regarding incremental capital expenditures on AI, the amount may fluctuate quarterly/yearly based on the procurement of advanced GPUs.

Goldman Sachs predicts that Tencent will continue to lead the frontier in using AI as a growth accelerator, driving growth in its existing businesses (including advertising, games, cloud, and social networks) by leveraging its large-scale language model (MixNet) internally