EQUITIES UPDATE - Tencent reporting on Q2 today.

Cindy discusses Tencent, that will report on Q2 today. Tencent has shed more than $150 bln in market value since January

Tencent reporting on Q2 today.

Tencent has been the worst-performing stock in our Chinese internet basket year-to-date falling approximately 25%. Most of that decline has come in the last couple of months on increased worries about US-China trade relations, concerns about certain US companies (Facebook, Netflix and Twitter, specifically) and estimate downgrades of about 10% going into the company’s 2q results this week.

China’s gaming and social media giant will report earnings on Wednesday and analysts are expecting second-quarter year-on-year profit growth to slow to about 5%, the weakest pace since 2012. On an EPS basis, Zacks reports an EPS estimate of 0.30 on sales of $12bn.

The biggest concerns from the analyst community, and the largest areas of downgrades, has been in the company’s mobile gaming business. This segment, which is the firm’s core revenue driver, is estimated to decline in the 2q as the Tencent seems to be having trouble monetizing its vast gamer base. Another business line which is expected to show a drop off in revenues is its online payment platform, Tenpay, which has been able to play some degree of catch-up to its main competitor, Alipay, but seems to be stalling. Finally, it seems to be losing market share in some of its digital content services.

However, it is likely that the weakness in gaming is temporary and it is difficult to ignore the potential, and dominance, of Tencent in the global game market. The company is the most prolific publisher in the world. They currently own premier titles such as League of Legends, Arena of Valor, Honor of Kings and Clash of Clans. It also owns large stakes in developers such as Activision Blizzard, Ubisoft, and PUBG developer Bluehole. Tencent also has a 40% stake in North Carolina-based Epic Games, the creator of Fortnite, which has been dubbed the “biggest game in the world”. Fortnite brought in over $300mn in May, which is more than double the amount it took in in February.

Not only does Tencent have a plethora of titles, but many of these games lead in their respective spaces whether its PC, mobile, or console. This steady stream gives it some diversification which is beneficial considering the whims of the gaming sector. Importantly, the global market is a fast-growing business, expected to expand to $137.9 billion for 2018, with 2.3 billion active global gamers.

For Tencent, it is probable that the 2q could mark the bottom in game earnings and the company can see some could improvement, as soon as the 3q, as the firm is likely to see full-year monetization of its PUBG and Fortnite games.

Of course, it is also impossible to ignore the dominance of Tencent’s WeChat, China’s most popular mobile messaging app in China with over a billion monthly active users (MAUs). This internet “ecosystem” not only allows people to text, but to play games, watch videos, shop and do online transactions. WeChat will continue to dominate and will provide a platform to monetize future business areas for the company.

We believe the current weakness in Tencent is an opportunity. The slowdown in the mobile game segment will be temporary with an expected rebound later this year. Also, Tencent will continue to be one of the dominant game companies in the world and WeChat will continue to give it opportunities to monetize other business lines. Also, later this year, the firm will be booking earnings from spin-offs, including Tencent Music, which is set for a US listing.

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