For any investor over the past 10 years, just buying and holding shares of Chinese tech giant Tencent Holdings Ltd (SEHK: 700) would have been rewarding.
That’s because the WeChat operator and online gaming giant has played a massive part in the everyday lives’ of Chinese people.
From their online avatars in hit game Honor of Kings to paying with TenPay (Tencent’s payment app), Tencent’s business has gone from strength to strength.
Of course, that was put to an abrupt stop recently by the Chinese government, which has been clamping down hard on tech giants such as Tencent as well as Alibaba Group Holding Ltd (SEHK: 9988) (NYSE: BABA).
Given the fear among investors, it’s perhaps no surprise that Tencent’s stock price has crashed over 40% from its all-time high of around HK$775 – set in February of this year.
Over the past decade, Tencent shares (even after the massive fall) have delivered a total return of 1,200% versus the Hang Seng Index’s total return of 80% over the same period.
Yet, with all the uncertainty surrounding Tencent, is this a buying opportunity for investors or is the worst yet to come?
Fundamentals strong but…
Tencent as a business has been performing well in 2021. When it released its second-quarter 2021 results, revenue was up 20% year-on-year to RMB 138.3 billion (US$21.3 billion).
Even though free cash flow was down 39% year-on-year, it was still a very respectable RMB 17.3 billion during the quarter while operating cash flow came in at RMB 31.9 billion.
Its online advertising business increased 23% year-on-year to RMB 22.8 billion and this was up 5% quarter-on-quarter as its overall advertiser base expanded.
Meanwhile, its Value Added Services division, which houses its lucrative gaming business, saw revenue up 11% year-on-year to RMB 72 billion.
…does it matter?
Given the gaming business alone makes up nearly a third of Tencent’s overall revenue, the recent restrictions imposed by the government on underage gaming doesn’t bode well.
It’s true, revenue for Tencent from minors under-16 playing online games only accounted for about 3% of its gaming revenue in 2020.
However, the bigger question is whether this turns off a whole generation of gamers in China given it appears that the Chinese government has likened online gaming to “spiritual opium”.
A recent report in the South China Morning Post claimed that new game approvals had been halted.
Tencent shares fell around 9% in response to that news but the Hong Kong-based paper later clarified that gaming approvals had only “slowed” and had not been halted altogether.
Tencent must fall in line
Despite this, the mssage from Beijing is clear to not only Tencent but all tech giants; they must fall in line and dance to the government’s tune.
While my colleague Say Boon has astutely pointed out, this will be positive for the competitive environment in China.
That’s because Tencent and Alibaba had become so powerful that it likely hindered innovation in many areas.
For example, TenPay and AliPay (Ant Group’s payment app) made up nearly 95% of all online payment transactions – with the split between the two being 39% and 55%, respectively, by value.
Returns will likely disappoint
While investors in China’s big tech giants have had it good over the past decade, the next 10 years aren’t likely to be as rewarding.
For one, they’re already giants. Tencent boasts a market cap of US$560 billion and with margins likely to fall in the coming years as sectors open up to competition, it’s not in a position to keep growing at the pace it was.
However, Tencent is still in a better position than Alibaba – which operates in the fiercely competitive Chinese e-commerce space and has to fend off competitors such as Meituan Dianping (SEHK: 3690) and Pinduoduo Inc (NASDAQ: PDD).
Meanwhile, Tencent has a strong international gaming business, a long track record of producing hits and lucrative stakes in numerous international tech companies such as Tesla Inc (NASDAQ: TSLA) and Snap Inc (NYSE: SNAP).
Overall, though, investors will be better off finding Chinese investment opportunities in the mid-cap space, where companies are likely to benefit from the lack of an overbearing tech duopoly, as well as in the domestic A-shares market.
Disclaimer: ProsperUs Head of Content Tim Phillips doesn’t own shares of any companies mentioned.
