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Why Credit Suisse Values Tencent With A 52% Potential Upside
Aspire, Hot Picks | 08 January 2015
By: Lim Si Jie
Articles (169) Profile

Music To Investors Ears
Tencent Holdings recently struck a deal with Sony to distribute music labels in China. The exclusive deal with Sony will allow Tencent to mass distribute music labels of various artistes who have signed with Sony in China. The partnership is enabling Tencent to gain a stronger foothold in the battle between Tencent and its longtime rivals Alibaba an Baidu.

Tencent continues to expand on its entertainment portfolio to offer its users new contents such as movies, television shows, music and games on their platforms, including a deal to bring the hit TV show “Game of Thrones” to China after it won exclusive rights to air HBO content online in China. Tencent has also become YG Entertainment’s sole online distributor.

Positive Boost To Video Gaming Segment
These exclusive expansion deals creates positive externalities to Tencent’s current video game segment, which continues to rake in the bulk of its revenue. The Chinese music streaming service industry was only 1% of the $15 billion revenue generated in the world last year by various record labels.

If Tencent successfully aids various record label companies to capture greater market share in China, we are looking at a tidy profit in the future financial years to come.

Diversifying Into China’s Banking Industry
The authorities has given the approval for Tencent to launch a private bank, WeBank, in China as part of broader efforts by the Chinese government to channel more loans to the country’s cash-starved small businesses. WeBank will focus its service on individuals as well as small and medium-sized enterprises with innovative financial products based on its platform WeChat.

WeBank could also target the growing middle class as well as the rising wave of startups in China. As the pioneers entering into China’s private banking sector, WeBank will gain a first mover advantage ahead of its future competitors while keeping pace with Alibaba.

Stake In Ping An Insurance
The venture into private banking comes at the same time when Tencent made an investment in Ping An Insurance, the second-largest insurer in mainland China. Last November, Tencent and Ping An, along with Alibaba, set up an online insurance company Zhong An Online Property Insurance to tap into the fast-growing online finance sector.

Tencent’s technological capabilities will aid its move into the banking and finance sector, creating new sources of revenue in the long run.

Valuation: What Is Tencent Worth?

Source: Credit Suisse Holt

The Holt valuation values Tencent at HKD 170.48, which represents a 52 percent upside from its current price. The forecasted CFROI (Cash Flow Return On Investment) in the next two FY (pink) exceeds the discount rate (green). Tencent has been consistently performing above its expected discount rate since 2001.

Source: Reuters

Tencent’s margins, both its TTM (Trailing Twelve Months) and five year average consistently outperform the industry and sector average. This represents the economic moat that Tencent has over its competitors out there in the market and its ability to sell its services at a higher margin than its peers.

Source: Reuters

Tencent’s strong management effectiveness ratio gives a further confirmation of the value which Tencent potentially possess. ROA, ROI and ROE, both TTM and five year average, are almost 90 percent above the industry and sector average. The consistency in generating returns to shareholders confirms the CFROI analysis using the Holt valuation model.

With a net income CAGR of 24.4 percent for the past five years, Tencent continues to grow at an attractive rate despite its size. There is still much room for growth for Tencent and is definitely a stock worth holding onto, especially for exposure into the Chinese online market.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.


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