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Tencent Holdings (700 HK) Softer ad outlook; encouraging regulatory perspectives

• Advertising weakness to drag beyond the quarter but unlikely to be structural
• Multiple pathways to capture opportunities relating to the Metaverse
• Encouraging comments on gaming regulatory outlook; FV of HKD605

Results came in slightly under

Tencent’s 3Q21 results came in generally a touch under expectations. Revenue grew 13.5% YoY to RMB142.4b, but was 2.1% below consensus. Advertising revenue growth decelerated to 5.4% YoY in 3Q21 due to weakness from the education, insurance and games sectors and overall reduction in bidding density. Domestic games revenue grew 5% YoY while that of international games grew at a strong clip of 20% YoY (or 28% YoY in constant currency terms), due to robust performance of Valorant and Clash of Clans. Non-IFRS PATMI of RMB31.8b fell 1.7% YoY, or 1.9% below consensus.

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Time spent restrictions for games unlikely to extend to adults

On games, we note that minors (<18yo) accounted for 0.7% of domestic games time spent in Sep’21 (vs. 6.4% in Sep’20). In terms of domestic games grossing receipts, minors accounted for 1.1% in Sep’21, vs. 4.8% in Sep’20. Management shared that limitations around time spent on games are unlikely to extend beyond minors to adults, while the approval suspension is likely to be temporary. On ads, Tencent expects pricing industry-wide to remain soft for several quarters due to macro challenges and regulation affecting certain sectors. Despite the near-term headwinds, we are encouraged that the opt-out rates arising from the introduction of the Personal Information Protection Law (PIPL) in China on 1 Nov have been low (single-digit % per management) while Apple’s IDFA changes have likewise been less impactful. On opening of platforms and interoperability, management believes that they could potentially benefit especially from payments and advertising, but continues to believe that user protection, information & content compliance and impact to ecosystem are still issues that need to be addressed. On cloud, management will continue to grow both the increasing number of long-tail customers, as well as to support and cross-sell various solutions (e.g. PaaS, SaaS) to existing customers.

Metaverse opportunities

Management believes that there are multiple pathways to get into metaverse opportunities, and these will add to growth in the industries that Tencent operates in (e.g. games, social networks). Tencent also believes that it has favourable capabilities and positioning, given its technology and know-how to explore and develop related applications. Management believes that the Chinese government is not fundamentally averse to the development of the metaverse itself as it is technology-driven, as long as developments are in-line with the regulatory framework. Following adjustments, which includes an ESG discount of 5% over governance-related issues, our FV drops from HKD635 to HKD605.

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ESG Updates

With about 39% of China’s mobile payments market share (Q1 2020), WeChat Pay may be subject to stringent scrutiny in light of the regulator’s clampdown on FinTech in China. Nevertheless, Tencent’s expansion into retail microfinance and loans to small-medium enterprises through WeBank, may allow growth opportunities while expanding financial inclusion. Tencent appears to have a robust data privacy framework compared to its peers, despite a diverse portfolio of services. However, with 1.2b monthly active WeChat users (Q3 2020) resulting in substantial personal data management, Tencent’s data practices, including consent, have attracted regulatory criticism. On Corporate Governance, Tencent falls into the lower scoring range relative to global peers, reflecting key areas of concern related to the board and ownership structure. The company has been involved in severe & moderate controversies.. BUY. (Research Team)