It's been a rough year for Tencent Holdings (TCEHY 0.10%) shareholders. The Chinese tech titan's stock has shed more than 20% of its value in 2018. Regulatory challenges for its core gaming business, declining margins, and trade war fears have all contributed to the decline.
Yet this powerful growth story is far from over. In fact, here are two reasons Tencent's stock could rebound sharply in the quarters ahead.
Image source: Getty Images.
1. Investors are underestimating WeChat's profit potential
Tencent-owned WeChat is the No. 1 messaging app in China, with more than 1 billion users. Part of what makes WeChat such a powerful platform is its growing ecosystem of Mini Programs, or apps that operate inside the core WeChat application.
Examples of popular Mini Programs include:
- A scan-to-buy function that's being rapidly adopted by retailers in China.
- A pre-ordering app that's helping restaurants increase throughput and, by extension, sales.
- A transport payment solution called Tencent Smart Transit that's helping public transport operators improve processing efficiency and reduce costs.
In addition, another popular type of Mini Program, known as Mini Games, is helping developers attract players at a rapid clip thanks to quick download speeds and ease of use.
These Mini Programs allow Tencent and its army of third-party developers to deliver more services to more people via the WeChat platform. Incredibly, more than 200 million people use Mini Programs every day.
WeChat's ecosystem is further tied together by Tencent's digital payment system, WeChat Pay. With hundreds of millions of daily users, WeChat Pay is used not only within WeChat, but also by third-party apps and even physical retail stores. This gives Tencent an excellent way to monetize WeChat's massive user base, and a powerful means by which to further extend the app's already vast reach.
Investors, however, appear to be focused more on the People's Bank of China's recent mandate that Tencent hold customer deposits in non-interest-bearing custodian accounts. By January 2019, Tencent will no longer be able to generate interest income on these funds.
Yet this interest income represents only a small fraction of Tencent's revenue, and the company already has initiatives underway to mitigate the impact of these lost profits. As such, investors are likely underestimating the true long-term earning power of WeChat Pay, and Tencent as a whole for that matter. When they realize their mistake, Tencent's stock price is unlikely to remain at its current depressed levels.
2. Regulatory challenges should dissipate soon
In addition to owning the most valuable messaging app in China, Tencent is also the largest gaming company in the world. Recently, however, Tencent's video game business has seen its profits dented by regulatory-related issues that are preventing several of the company's most popular games from being monetized in China.
Yet much of these regulatory delays are the result of a recent reorganization of the department tasked with reviewing and granting gaming licenses, and Tencent's management is confident that these issues will be resolved quickly. "We do believe it's not a matter of whether these games will be approved for monetization, it's a matter of when," President Martin Lau said during Tencent's second-quarter earnings call.
So it might be only a short time until Tencent receives the approvals it needs to begin monetizing its tremendously popular games Fortnite and PlayerUnknown's Battlegrounds in China's mammoth gaming market. And once those profits begin pouring in, investors are likely to start bidding up the price of Tencent's shares once again.
