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Tencent (700 HK) Summary Report

Core Content and Key Highlights

• Financial Performance: Tencent's 1Q18 sales and non-GAAP net profit grew by 48% and 29% YoY, respectively, and beat consensus expectations. The company also reported a 59% increase in operating profit and a 61% rise in non-GAAP net profit YoY.
• Revenue Growth: The company revised its 2018/19E revenue forecasts upward by 4‰ and 11%, respectively, due to strong mobile gaming performance and improved online advertising.
• Mobile Gaming: Mobile game revenue rose 68% YoY and 28% QoQ to RMB21.7bn, driven by the success of games like HoK, QQ Speed, and new titles launched in Q1 such as QQ Dancers Mobile and MU Awakening.
• PC Gaming: PC game revenue remained flat YoY but increased 10% QoQ to RMB14.1bn, attributed to seasonal updates and marketing activities.
• Online Advertising: Online advertising revenue grew 55% YoY to RMB10.7bn, with the potential for further monetization from QQ KanDian, which saw video views increase 3x YoY and DAU exceed 80mn.
• Gross Profit Margin (GPM): Q1 GPM rose 2.9pp QoQ to 50.4%, but declined 1.0pp YoY. Others GPM increased to 24.4%, driven by high-margin wealth management and financing products.
• Newsfeed and Content Strategy: Tencent is becoming more proactive in personalized content through key apps like Weixin, Mobile QQ, and browser, and has relaunched WeiShi, a mini video app. It also strengthened content on existing news apps.
• Monetization Potential: The company is optimistic about monetizing its PUBG mobile titles in China, which are awaiting regulatory approval. Fortnite is also in the pre-reg process.

Key Segments and Revenue Breakdown

• Segment Revenue Growth:

  • VAS (Value-Added Services): Revised up by 9% to 18% to RMB94bn/128bn in FY18E/19E.
  • PC Gaming: Revenue is expected to grow 49% to 36% YoY in FY18E/19E.
  • Non-game SNS: Revenue is expected to grow 41% to 37% YoY in FY18E/19E.
  • Online Advertising: Revenue is expected to grow 52% to 44% YoY in FY18E/19E.
  • Others: Revenue is expected to grow 81% to 58% YoY in FY18E/19E, driven by payment and cloud services.

• Non-GAAP Net Income: Revised up by 30% to 35% YoY for FY18E/19E.

• Non-GAAP Diluted EPS: Revised up to RMB11.95 for FY19E.

• Target Price (TP): The new SOTP-based TP is HK$557, implying a 40x FY19E P/E, compared to the current 28x P/E.

Valuation and Multiples

• SOTP Valuation: Based on the following multiples:
  • 13x FY19E EV/EBITDA for online gaming.
  • 25x for SNS and payment & cloud.
  • 1.0x PEG for advertising.
• Investments Valuation: Includes major investments in JD.com (JD US), Didi, 58.com (WUBA US), Spotify (SPOT US), Supercell, Meituan, etc.
• Segment Contributions:
  • Online games: HK$144 (26% of total).
  • SNS (excl. mobile games): HK$142 (26%).
  • Online advertising: HK$143 (26%).
  • Payment & cloud: HK$66 (12%).
  • Net cash: HK$18 (3%).

Risks and Outlook

• Downside Risks:

  • Intensifying competition in mobile gaming and payment.
  • Growth rate volatility in mobile games and advertising.
  • Deceleration in ARPU and MAU growth.
  • Rising content acquisition costs and margin pressures.
  • Regulatory risks in mobile payment and internet finance.

• Outlook: The report maintains a BUY recommendation, with a slightly raised TP to HK$557. The company is expected to continue its growth trajectory with a focus on monetizing mobile games and enhancing online advertising capabilities.