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Tencent Q3 results: will the company still thrive under China’s new anti-monopoly regulation?

Tencent once again presented a better-than-expected earnings result, with its Q3 total revenue reaching RMB 125 billion, an increase of 29% YoY.

According to the International Financial Reporting standards (IFRS), net profit attributable to their shareholders skyrocketed to RMB 38.5 billion, a huge rise of 89% YoY. Tencent has also maintained a high operating margin of 35%, with the cash on hand increasing to nearly 266 trillion by the end of the September quarter, showing a very strong liquidity position for this tech magnate. On the back of these positive results, dampening news of the anti-monopolistic regulation proposed by the Chinese State Administration for Market Regulation saw a fall in Tencent’s share price to more than 7% on Wednesday 11th Nov. What’s the impact of this new rule in a long run and how can Tencent continue its uninterrupted positive streak?

We will examine Tencent’s Q3 results and key takeaways in this commentary.

Key price levels to watch: (00700.HK)

Enter price: HKD 555 (the recent support level)

Target price: HKD 630 (P/E +53X)

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The gigantic user base paves the way for Tencent’s every-increasing service revenue. Under a backdrop of an already high consumer base, the conversion from free to fee-paid users was crucial. Tencent has performed well in this aspect in Q3.

Though the combined monthly active users (MAU) of WeChat only increased by 0.6% QoQ, the fee-based VAS subscriptions (i.e. online games, video, music and live streaming subscriptions) went up by 4.9% QoQ. Comparing both on a YoY basis, total fee-based users to total MAU of WeChat is at a stark difference of 25.1% vs. 5.4%.

With more mini-apps and advertisement promoted within WeChat, the time spent per user is expected to further rise, and subsequently increasing the opportunity of converting existing registered free users to fee-paying subscribers.

The online games and digital content sector (i.e. the VAS segment) have delivered a continuous and strong growth, though the revenue from online games have dropped following more people resuming work back in their offices. Fintech and Business services sector maintained a moderate growth in Q3.

In the third quarter, the online games revenue surged 45% YoY to hit RMB 41.4 trillion. Revenue from smart phone games was the major contributor to the increase. Tencent’s TiMi Studios and Lightspeed and Quantum Studio continuously improved the gaming experience for renowned games namely the Honor of Kings and PUBG mobile. It was no wonder that these two games were ranked the two paid games apps worldwide since early 2020, according to SensorTower’s statistics.

Digital content revenue, mainly music, video and live streaming services, also risen by 29% YoY to hit RMB 28.3 trillion. Backed by the increased of time spent on online entertainment with more people working from home instead of their offices have contributed to this revenue growth.

However, expectations that by 2H of 2021, many of the employees currently working from home may head back to their offices, which may pose a threat that could negatively impact the online games and digital content revenue. In order to sustain the growth, Tencent would need to have already accumulated a sufficiently large fee-paying subscribers to counteract the potential impact.

Revenues from FinTech and Business Services also showed an increase of 24% to RMB33,255 million. The growth rate may be smaller as compared to online games sector, but considering the negative impact on the food and catering sector during the pandemic, the +20% YoY growth in the Fintech sector is actually encouraging.

The extent of the impact from the new anti-monopolistic regulation will be based on how much it will interfere with Tencent’s online games sector

In the new guideline passed by the State Administration of Market Regulation in China, behaviours like offering different prices to different customers based on user database analysis in the online platform, taking advantage of market power to restrict sales in competitors’ platform, etc. or any monopolistic conduct will be prohibited by the Chinese authority. The ruling is aimed to practice fair competition and to curb tech magnates from using their market dominance that could harm other small and medium online businesses.

Such an implementation were targeted at online shopping giants, especially big e-commerce with dominant positions across segments such as Alibaba and JD. It should have little to do with Tencent’s online games and digital content segment. But the new rule has an emphasis on stopping the abuse of market power in other online businesses. In light of Tencent’s current dominance in the online games market, the new rule is still likely to apply on Tencent’s key business segments. With this ruling in placed, this would be a hurdle for the company’s future to the uninterrupted and continuous growth (like below chart) in the past decade.

Conclusion

Tencent’s growth is still supported by the increasing fee-paying user base, alongside the usership on their social apps and other online platform. But investors need to closely observe the implication of the new anti-monopolistic regulation which may impact Tencent’s online businesses, especially the online games sector which may adversely impact the company.

How to manage risk?

Traders should set a percentage to stop loss (typically at 10% of the buying price). If the short term moving average line (e.g. 20-day) crosses from above the long term moving average line (e.g. 60-day), it is possible that the stock price will continue to drop. It is strongly recommended to place a stop loss to mitigate any potential losses.

Find out more about Tencent share information and Trade Now

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