/ 19 October 2018

China’s uncertainties rattle Tencent

Tricky game: Tencent
Tricky game: Tencent, headquartered in the tallest skyskraper in Shenzhen city, south China, is struggling in current market conditions. (Zhu min)

Chinese conglomerate Tencent is under increasing pressure after losing 40% of its value since the beginning of the year. Mooted causes for the decline range from delayed monetising of its video game business to the market’s self-regulation of e-commerce businesses.

Tencent is not the only tech company suffering from market headwinds. Its tech titan peers Alibaba and the FANG (Facebook, Amazon, Netflix and Google) stocks have also faced choppy waters since last week’s share price fall. The FANG stocks, although they have not lost as much value as Tencent and Alibaba, have fallen by 18% since June this year.

READ MORE: Naspers plans to sell up to 190 million Tencent shares

Facebook’s market capitalisation is $443.3-billion, and Netflix and Google are at $149.7-billion and $785.8-billion respectively. Amazon’s market capitalisation reached $1-trillion in September but has since fallen to $883-billion.

Alibaba, with a market capitalisation of $385.8-billion, falls below Facebook but has a higher market capitalisation than Netflix. Tencent’s market capitalisation is $250-billion.

Economist John Ashbourne, of Capital Economics, says investors are “anticipating much more weakness in the US stock market between now and the end of next year”.

Like its competitors, Tencent has invested in social media (it owns WeChat and QQ) as well as cloud smart technologies and artificial intelligence businesses. A large portion of Tencent’s income comes from its gaming business, which accounts for 34% of its revenue.

Tencent provides web-based news, social media platforms and search engines for China and nations in emerging markets. Facebook-owned social media platforms (Instagram, Twitter, Snapchat) cannot be accessed in China, giving Tencent an advantage.

Facebook has more monthly users on its social media platforms than Tencent, but had similar revenue in the first quarter this year with $12-billion for Facebook and $11.7-billion for Tencent.

These tech giants feature on the list of the world’s top 10 most valuable companies.

Tencent is a noted feature on the JSE where the largest listed company, Naspers, which has a 31% stake in Tencent, weighs in at 23.84% of the Top 40. But, since the beginning of the year, Tencent has lost R3.2-trillion ($250-billion) in shareholder value. Its market value at the end of last year was R7.2-trillion ($500-billion). The company is now ranked 331 in Fortune’s top 500 largest companies and is worth $353-billion.

The forward price-to-earnings ratio of Tencent has reduced from 40 times at the start of the year to 24 times at present.

The decline this year follows exponential growth in the past few years. Fortune reported the conglomerate showed a 67 000% growth since it listed on the Hong Kong stock exchange in 2004.

Reasons for the recent decline in its share prices include the delayed monetisation of Tencent’s new games and the trade war between China and the United States. The falling yuan and other emerging market currencies have not helped in Tencent’s decline, nor has China’s bear market.

Between September 7 and October  10, Tencent repurchased 2.56-million shares for $103-million, the first time since 2014 that the conglomerate has bought back its shares. The move has been seen as an effort to strengthen the share price by minimising the number of shares available on the stock exchange.

The decline in Tencent’s share price means the company’s earnings for the remainder of 2018 and 2019 have been revised downwards by 9% and 12% respectively, according to Momentum securities portfolio manager Francois Strydom.

Tencent has suffered in the US-China trade war, increased regulations on video games and the slide of the Chinese yuan in relation to the dollar. Last Wednesday’s fall on the Hong Kong stock exchange was also attributed to a slump in US tech stocks, which Bloomberg notes was the “worst in seven years”.

The Chinese government’s delayed approval to monetise new games and the nation’s department of education’s aim to decrease the number of hours that Chinese youth spend gaming are reasons that commentators have given for Tencent’s decline over this year.

But, according to Sanlam Private Wealth Investment analyst Renier de Bruyn, the right perspective on the decline (and why Tencent remains a business with good prospects) is the conglomerate’s valuation.

The market extrapolated the growth rate into the future, leading to a high valuation, De Bruyn argues, and the resulting decline in the conglomerate’s value is driven by sentiment as the market now recalculates its estimation of Tencent’s future growth.

“A crackdown on online gaming led to a fall in Tencent’s Q2 profits,” says Ashbourne. “This caused the first fall in profits for ages, which spooked investors.”

Tencent’s most popular social media channels are WeChat and QQ, which have on average 1.040-million and 806-million users a month. Facebook and WhatsApp had 2.1-billion and 1.5-billion monthly users in the first quarter of the year, according to data from market research portal Statista.

According to Momentum Securities’ Stephen Meintjes, the reason China is currently in a bear market, which could last from two to six months, is that it is in the process of reducing the credit given to its citizens. The property market is cooling off and manufacturing exports are moving to Southeast Asian countries with cheaper labour.

Although Tencent is faring better than its peers in the Chinese media market, says Meintjes, “it will take a couple of quarters for Tencent to regain momentum”. He says Tencent has declined 41% since its peak in January compared with AliBaba’s decline of 28%.

The decline in Tencent’s share value has, not surprisingly, brought down Naspers’s shares. “Tencent’s fall has hurt Naspers,” says Meintjes.

The South African media giant is now trading at R2 780 from about R3 190 last month.

The Naspers discount, based on its holding in Tencent, remains at about 40%. “Naspers has been trading at
a discount for a long time, and when Tencent’s share value declines,
so does Naspers’s share,” Meintjes says.

Despite the drop in share price value, Meintjes says Naspers will hold on to its 31% stake in Tencent as it has been investing in successful start-ups, which could lead the
company to become an investment holding company in the next five years.

Tencent is not the only factor in the Naspers’s share price, says head of investor relations at Naspers, Meloy Horn. “Recent market volatility has negatively affected the share prices [and thus market capitalisation] of emerging market stocks in general, as well as technology counters in particular, including counters such as Tencent and Naspers.”

READ MORE: Naspers’s tricky Tencent conundrum

Naspers sold 2% of its stake in Tencent in March, raising $9.8-billion in the process but Horn says Naspers has no intention of selling more of its Tencent shares. The sale was to “create more flexibility” for Naspers’s balance sheet to accelerate growth in its other businesses.

The drop in the fair value of Naspers’s assets is about R4 500 a share, with Tencent valued at about R3 500, MultiChoice at more than R200 and its other assets and cash worth another R800, De Bruyn says.

The decline is not all bad news, he says. “Naspers is still trading at a 40% discount to the fair value of its assets, while the valuation of its largest investment, Tencent, is now offering better value following its share price decline.”