Tencent’s high share price – speculation or fundamentally sound?

With a 19% stock price fall in the last month (price has since recovered), Chinese internet giant Tencent was criticized by a well-known Chinese media. The latter believes that Tencent is gradually becoming an investment firm rather than a product innovation powerhouse. It claimed that Tencent has failed to compete in multiple “key areas” in internet industry in China, namely: search engine, ecommerce, social media, video, and the cloud computing business. It further claims that Tencent only focuses on investing in other startups rather than innovating. By not really having a core competence, Tencent has lost tonnes of traffic to competitors like Toutiao – a popular news aggregator in China.

Is that true? Not really!

Tencent has counter-intuitive strategies

Comparing with its counterpart in US, such as Facebook – who has 98% of its revenue from online advertising, Tencent only generated 17% (of its total revenue in the 2017 fiscal year) from advertising. Meanwhile, 65% of its revenue is from VAS – value added service. What’s more, VAS revenue is mainly generated from smartphone and PC gaming by selling virtual items. Gaming has thus developed into Tencent’s core revenue stream.

So why has Tencent made the most of its revenue from gaming? To answer this, we need to understand Tencent’s monetisation strategy:

Tencent treats QQ and Wechat not as a product, but as a platform. The difference between a product and a platform is whether your product relies more on other products to succeed or the other way around. Tencent is building QQ and Wechat in such a way that they can command a huge user base and empower partners to build their businesses on them.

Tencent opens up its API and payment system, thus making QQ and Wechat a hub for other business to connect to millions (or billions) of mobile users. Being a very effective distribution channel, Wechat and QQ becomes a very valuable asset for its gaming business.

As such, Tencent strengthens its leadership in gaming industry by creating and delivering world-class content to it users. It invests in gaming, video, publishing, IP and event content creation. These content attracts news customers and brings them into the Tencent ecosystem.

In 2017, Tencent’s successful MOBA game Honour of Kings (Arena of Valor) has generated $1.9 billion (out of $59.2 billion world’s mobile games market) according to SuperDara Research. This is undoubtedly an example of Tencent’s excellence in its core business.

Investment to strengthen its dominance

Tencent leverages its funds to extend to other key areas that supports its ecosystem. Through investment, Tencent controls hundreds of subsidiaries and associates in numerous industries and areas, creating a broad portfolio  including e-commerce, retail, video gaming, and many more. We also believe that Tencent will be looking at further opportunities in video, payment, cloud, AI technologies, and smart retail – which may not impact its near-term earnings but can generate long-term value and growth opportunities.

Conclusion

Product failures are common for everyone in the market. Tencent may have lost the war in search engine, ecommerce, social media, video, and cloud computing. However, through a focused approach on its core businesses and investing in other businesses that help grow its ecosystem, Tencent is still on the right track to build its business empire. Therefore, the fluctuations in its share price won’t influence its long term growth.

Disclaimer: we are not recommending anyone to buy/sell Tencent shares.