I have just spent the past few days doing a ton of research into Tencent the
largest chinese tech company in the world
and today I'm gonna share with you what I've learned. What's up everyone my name
is Ben and welcome to rareliquid a channel where I draw from my experiences
as a former JP Morgan investment banking analyst
to cover videos about tech investing and career advice. In case you're new around
here I post tech investing related videos on the weekdays and career
related videos on the weekends and today will be the first video of the
Chinese stocks I'll be covering- I posted a video about how
I'm gonna be diving more into the space for these next one to two months
and I did have a schedule in there that I said that I'll be covering certain
companies during certain dates but I said they would be subject to change
and I've already kind of changed that schedule but
if you want to be updated with the latest schedule then check out my
instagram or discord which you can find in the links below. With that said,
today's agenda looks like this: I'll first be discussing what Tencent
does, I'll then talk about the bold case and bear case,
financials and valuation, and lastly what I'm personally doing
As a friendly reminder please remember I am not a financial advisor so please
treat all content as for education and entertainment purposes only. Alright so
first up, let me discuss what Tencent does
Tencent is currently the largest company in China by market cap and so it just
has a ton of different businesses and services it
offers and so it just take way too long to explain everything so I'm just gonna
cover the three main things you need to know as an investor
First up, let's talk about QQ and WeChat Just as a bit of history, Tencent was
founded in 1998 by current CEO Pony Ma and four other founders who were college
friends. Their first product was OICQ which was later renamed to QQ and
was a messaging application that still exists today and boasts more than 606
million monthly active users But the jewel in the crown is WeChat,
which is known as Weixin in China and it was launched in 2011 and now
serves over 1.2 billion users These two applications are at the core
of Tecent's business model and drive the entire ecosystem by enabling Tencent to
launch a suite of other products like you see here
in the outer circle such as games, music, payment transactions, and more
Basically you can think of WeChat as a super app that combines Facebook, Shopify,
Uber, Google maps, Whatsapp, TikTok, and a whole lot more but it's easier if I
also just show you As you can see here, WeChat starts off as
a normal messenger application with messages and contacts
Then if you go into the discover section, the moments section is similar to a
facebook feed where friends can share pictures or even longer form content
articles Then if you click channels you basically
have tiktok which you can see here And then if you go out to mini programs
this is kind of like an app store where merchants or developers can create small
apps and have access to the 1.2 billion users
on WeChat and lastly if you go to the me tab and
click pay there are options to pay people like you
would through Venmo or Cash App and you can also order a card through
China's version of uber which is DD It's really really hard to overstate the
power of WeChat I've read in my research that even
homeless people with smartphones receive donations by scanning their
WeChat and receiving payment that through that
and also when I was doing business with suppliers in China for my previous
business, all the communication I was doing was
only through WeChat. Because of the massive number of users on wechat,
Tencent will always have this competitive advantage where
at any point in time it can just come up with a new product or service like it
did with channels which it did to compete with
ByteDance, Tik Tok, and in addition to that another
important implication is that Tencent has a ton of leverage when
it works with its partners so for example right now from the research that
I've read whenever a gaming company wants to be on
WeChat or on one of Tencent's platforms, currently Tencent is able to take a 50%
to 70% revenue share cut which is just huge and it's able to do
that because it's able to offer its partners a ton of
free marketing to its 1.2 billion users on WeChat. Let's
next talk about the second key component of tencent which is gaming
Though WeChat is the engine that drives Tencent's business,
gaming is actually the real money maker and profit driver for the company
Tencent has been involved in the gaming industry since 2004 and since then has
become the second largest player in the world after sony with 13.9 billion
dollars in revenue The company holds a dominant 43% market
share in China and owns the top three pc games and top
two mobile games published in 2020. Another important thing to note is that
given the pc and console markets have been stalling,
Tencent has been focusing a lot of its attention to mobile gaming
and now owns roughly 70% market share Tencent obviously has a natural
advantage here given that WeChat is a mobile app that can be used to market to
1.2 billion users, but another one of Tencent's advantages
is yin yang bao which is also known as Tencent myapp and
is china's leading android app store with 26%
market share. Android has an 80% market share in China
and so if you're a game creator you're up against a lot if you go against
Tencent- you not only have to compete with
Tencent's resources and team but you also have to compete with
Tencent's ability to just market its game freely to
its 1.2 billion users on WeChat and also whenever
Tencent launches an application or a game, it can just feature it onto
its app store and so regardless of whether or not that game that Tencent
creates standalone is the best game or not, it's going to
get a lot of eyeballs on it, a lot of downloads and
that'll help Tencent's games become basically the number one two three spots
on pretty much every kind of list that you might be able to find
As a result, it may come as no surprise that tencent owns a dominant 52 percent
of China's mobile gaming market And believe it or not this is not where
the dominance ends. Just take a look at all the investments Tencent has made in
some of the world's top gaming companies including Riot Games,
Supercell, Epic Games, and Activision Blizzard. This leads us to the third key
component of Tencent's business, which is its investment portfolio
First of all it's important to note that Tencent's investment philosophy is very
hands-off so meaning that even if they acquire a
majority stake or full outright owned 100% of a company,
they kind of let the company operate and do its own thing and I think this is a
very positive thing for Tencent because most of the time whenever a company
acquires another company, there are usually a lot of issues with
the integration process and if the company is not allowed to kind of
operate on its own, then a lot of the creativity and
innovation that really comes from being a standalone company disappears and so I
think this is a very good thing for Tencent
investors. As you can see here Tencent owns a very impressive portfolio
including twenty percent of Meituan, one hundred percent of Riot Games,
25.6 of Sea, and even five percent of Tesla. I'll
actually be making videos about Meituan, JD, and Pin Duodo
over the coming weeks as part of the Chinese deep dive series that I'm doing
and so if you haven't already, feel free to subscribe and while you're there I'd
really appreciate if you could support the channel by clicking that like button
as I spent a ton of time making this video. But anyway based on the last
calculated market value of these companies, Tencent's ownership is valued
at an estimated 331 billion dollars and later
on in the valuation section I'll explain more as to why this is so
important. But basically what you need to know is that Tencent's growth strategy is
largely inorganic and the company has shown no signs of slowing down
Before moving on to the next part of the video, I do want to quickly share an
investing app I've been using called Moomoo which is owned by FuTu,
which tencent actually owns a 30% sharing Most importantly right now
Moomoo is doing a free giveaway until July 1st where you can get a free Apple stock
if you refer to friends, so an easy way to get a free 130 dollars
which is what Apple is trading at Moomoo is sponsoring this video and I
would say the app is geared more towards those who really like lots of data so
that's why I like it One of the sections I find really useful
is the financials tab where for Tencent here you can see the company's revenue
breakdown in addition to a bunch of key indicators,
and in the summary tab, you can easily find information on who the shareholders
are and find detailed biographies about key
executives. These are data points that I would have to dig through filings to
find so I think having all of this in a
trading app is super helpful and there's way more data
than what I've just showed you if you want to check the app out. You can use my
link in the description below to get a guaranteed free stock and you can also
start referring your friends to get that free Apple stock
Alright let's next talk about the bull case for Tencent
The first is undoubtedly WeChat which has nearly an impenetrable moat
which will probably last around for another one to two decades at least
One key growth driver I'll focus on within wechat are Mini programs which
was launched in 2017 and allows for merchants to cheaply
create an app within WeChat to gain access to its user base
WeChat users spent 115 billion dollars through mini programs in 2019
and exact figures weren't disclosed in Tencent 2020 annual report but as you
can see, annual transaction volume for many programs doubled in 2020.
All of this is important because while WeChat is a dominant force,
user growth has been slowing given that it already penetrates nearly all of
China and so it'll be important for Tencent to
start monetizing on its users to propel further growth
In order to not be too repetitive, I won't go too much into gaming or the
investment portfolio but the second reason to be bullish on Tencent is live
streaming Tencent owns a dominant 37% and
38% stake in china's largest gaming
streaming sites named Huya and DouYu and has been pushing for the two
companies to merge. This would remove a lot of the competition between the two
platforms which control ninety percent of the streaming market
but the deal is uncertain to pass due to the heightened antitrust environment
But either way Tencent still owns a commanding share of the two companies
and live streaming is a really fast growing industry that's a great
complement to Tencent's gaming business The third reason to be bullish on
Tencent is its fintech and business services
This is the fastest growing segment of Tencent's business which probably has a
bit to do with Covid-19 but it grew by 47% year-over-year in the
first quarter of 2021. Regarding fintech, Tencent has been able
to take considerable share away from Alipay through Tenpay
which currently accounts for about 39% of transactions, which is up from about 10
percent in 2014. Tenpay is basically like Venmo
or Paypal on steroids and it allows for cashless transactions amongst peers and
merchants while also providing services like loans
that are approved within three minutes and a whole lot more. Regarding the cloud,
Tencent holds the third place spot in terms of market share and given that the
overall industry grew by 62 percent in Q4
2020. I'm sure tencent will be putting a lot of effort
into this business segment. Next up, let me share with you the bear case for
Tencent. The first and biggest risk is regulatory risk by the Chinese Communist
Party or the CCP. Unlike Jack Ma who spoke out notoriously
against the CCP and caused a lot of trouble for Alibaba,
Tencent is actually known to have a really strong and pretty conservative
relationship with the government Even still, the CCP can at any time
change its policies that can hurt Tencent's business
with one such example being in 2018 when the CCP stopped approving gaming
licenses for nine months There have also been a lot of anti-trust
news recently and Tencent is expected to pay a fine of around 1.5 billion dollars
for anti-competitive practices and the CCP can do things like this out
of thin air The second key risk is the political
unrest between China and the rest of the world
While president trump issued an order to ban WeChat transactions which never
actually took effect and was recently revoked by the Biden
administration. Still the risk remains especially if china
becomes too powerful that countries will work to limit its power
For example if an anti-china US president were to come into power then
Tencent may be forced to sell off its US holdings and that stuff like that
you know it's a really really small chance but
there's always that kind of risk that is out there if you invest in these kind of
large Chinese companies What should be noted though is that
Tencent's business mostly resides in China so there would be
notable but minimal impact anyway A third risk or something to be aware
is that WeChat is dominant but is slowing down in growth
One of the newer and fiercest competitors to Tencent is ByteDance which
is the company behind Dooyin and TikTok. TikTok has over 689 million
monthly active users while Dooyin has over 600 million and
as we've seen with WeChat, once you have the users, your opportunity to create
additional businesses are endless. In a sign of what may be to
come, ByteDance created a hit game and may be starting to encroach upon
Tencent's gaming dominance That said, ByteDance has a long way to
go having earned just 42 million dollars with its top game versus hundreds of
million dollars for Tencent and previous game launches have been unsuccessful
The fourth key risk is that at least for US investors,
Tencent trades as a Level-1 ADR. Level one ADRs trade on OTC markets and don't
need to abide by GAAP accounting rules which result in
less reliability and transparency Now I don't think that Tencent would
commit accounting fraud just because it's such a large company now
but it is operating with looser standards and it's just something kind
of to keep in mind There was also some talk about the US
delisting chinese ADRs so again this is another risk but I think this is a bit
lower due to dividing administration being a
lot more friendly towards Chinese companies
Next up, let me dive a bit into the company's financials and valuation
Starting off with the financials, Tencent is a highly profitable business with an
adjusted EBITDA margin that has hovered around 40%
for the past few years which is extremely solid
The company has just about as much cash as debt and normally you might want to
see a larger cash position but Tencent is generating so much in free cash flow
that it really doesn't matter The company is debt to adjusted EBITDA
is around 1.3 times and for this ratio about 6 times is where you would get
really worried about a company being over leveraged
and so Tencent is just way below that Next up for evaluation, I'll be analyzing
Tencent through trading comps and if you're not familiar with what that
valuation analysis is I highly recommend you check out this video here
Basically what we'll be doing here is comparing Tencent versus its Chinese
peers and US peers and the green is good, yellow means okay,
and red means bad Amongst the Chinese peers, we can see
that Tencent's revenue growth is in the middle of the pack, but its profitability
numbers aka its EBITDA margin, profit margin, and free cash flow yield
lead the pack. This along with Tencent's competitive moat and impressive
investment portfolio is probably why Tencent is trading at a premium versus
its Chinese peers if we look at the multiples here
Amongst the US peers, we see that Tencent is growing the fastest in revenue while
is more in the middle of the pack for profitability. We also see that Tencent
is in the middle of the pack when it comes to multiples versus its US peers
meaning that Tencent is not really cheap here either
So now at this point of the video you might be wondering what does this all
mean That's a good segue into the next part
of the video which is what I'm personally doing
Based on everything that I've researched and shared with you today I think
Tencent is a really really amazing business with a
really impenetrable competitive moat that you would want to see in a company
you invest in but at the same time it's not really
trading at a cheap price and I think that if I were to invest in
a Chinese company, I would want it to have a relatively strong discount
compared to its US peers because that would make me feel a
little bit more comfortable and have a stronger
margin of safety while investing. As we saw from this chart Tencent is not the
cheapest company versus its Chinese peers nor
its US peers and so for me I would want to see Tencent trading at a much lower
multiple before I invest, probably somewhere around 15 times 2022
EBITDA This is because I could simply invest in
US companies at a better valuation while not taking on the risks that come
with investing in Chinese companies. With all
this said I did find a bit of a loophole that allows you to invest into Tencent
at a 30% discount or so but before I do you know
show you guys that information I do want to do more research in that myself and
I'll be making an entire video about it next week and
so you know if you haven't already make sure to subscribe so you don't miss that
video. The financial data you saw with the color coding with the green yellow
and red thing- all of that is part of the financial
database that I personally use myself and send to my Gigabyte and Terabyte
Patrons every week so check out my Patreon in the
description below if you're interested while you're there you can also use my
links to get that free apple stock through Moomoo that I mentioned earlier
and you can also get a free stock if you sign up for Weeble and also get ten
dollars in free bitcoin if you sign up using my links for Coinbase and Gemini
I'm also going to be sending out free investing newsletters in the coming
weeks so you can sign up for that in the description as well and as I've stated
in previous videos, I give away $10 to the first commenter and a random
comment, so these are our winners today just DM me on instagram if that's you
and lastly as always just wanted to say thank you so much for watching
hope to catch you in the next video thanks so much and peace out