Equities Update: Cindy reviews Tencent's strong Q1 earnings.

Tencent, reported strong first quarter earnings, quelling some concerns about margin pressure and elevated costs.

Tencent: Strong first quarter

Last week, VFTP Thematic Model Portfolio constituent, Tencent, reported strong first quarter earnings, quelling some concerns about margin pressure and elevated costs that have pressured shares this year.

On Wednesday, Tencent reported revenues up 48% y/y equaling 73.53 billion RMB ($11.5 billion) beating the Thomson Reuters consensus of 71.04 billion. Net profit was up 61% y/y to come in at 23.29 billion RMB versus an estimate of 17.5 billion. Encouraging, operating margins increased by 8% on a quarter-on-quarter basis.

The biggest contributor to revenues was from the online gaming segment which saw sales increase by 26% to RMB28,778 billion. The growth was primarily driven by greater mobile gamer participation and continued strength of its “Honor of Kings” title which remains the highest grossing smart phone game in China. Also, the success of new offerings “MU Awakening” and “QQ Speed Mobile” show the company’s ability to introduce additional blockbusters. Finally, the broader game business continues to gain momentum on its two global offerings "PlayerUnknown's Battlegrounds" (PUBG) and “Fortnite”.

“Fortnite”, which is a venture with US company Epic Games, is dubbed “the world’s biggest game” and has a tournament style format that is popular with e-gamers. Game research firm SuperData estimated that “Fortnite” generated sales of $223 million in March alone. The potential of this game is seen to be huge with the companies launching an Android version this Summer and with Tencent recently buying the rights to bring the game to China in the next few months. PUBG is also set for launch on the Mainland as soon as the company gets approval from the relevant authorities. PC gaming revenue was flat but should not be a concern considering the company’s ability to switch users from PC to mobile.

Another closely watched metric of the result was advertising revenue which was up 55% y/y to RMB 10.7 billion. The highlight was social and other sales which grew by 69% to RMB7,390 billion. The company attributes this strength to greater ad fill rates for Wexin Moments and higher cost per click (CPC) for their Mobile Ad Network (MAN). Of note, the company's two main social media offerings, WeChat and Wexin, experienced average monthly user growth of 11%; bringing total users past 1 billion for the first time.

Another point of interest was revenues from “other businesses” that increased by 111% to RMB 15,962 billion. This segment is being driven primarily by the success of their mobile payments business which continues to take market share away from Alipay and cloud services that are expected to be an area of growth.

A final point which got some mention from analysts and from the press was that a quarter of the company’s operating profit came from investment gains in other companies. Sanford Bernstein reports that Tencent spent approximately $30 billion for stakes in other firms between 2015 and 2017. This would include a $9.3bn round in Uber, $1.2bn in Indonesia’s Go-Jek and $1.4bn in Flipkart, amongst others. From 2016 to present, Tencent has participated in 165 deals, outpacing both SoftBank and Alibaba in volume.

We continue to view Tencent as a core Chinese Internet holding. Its ecosystem based on the WeChat platform enables them to launch and monetize other business faster than their competitors.

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