Tencent Had a Better 2018 Than the Story the Stock Told

Chinese tech conglomerate Tencent Holdings (TCEHY -1.67%) turned in another year of strong growth. China's largest social media businesses -- Weixin WeChat and QQ, developed by Tencent -- as well as a fast-expanding cloud computing and digital payments platform easily kept the company afloat. That was in spite of the video game segment stalling out because of a freeze on new game monetization from Chinese regulators.

The overall slowdown at Tencent, paired with the Chinese economy tapping the brakes and a trade war with the U.S., doomed the stock in 2018. Over the last 12 months, shares are down 13% -- even after a 15% rally since the start of the new year. Nevertheless, things are looking pretty good for the internet company as it continues to grow its core business and expand into new markets.

Last year in review

Tencent put up another impressive year of double-digit revenue growth. An increase in monthly average users at WeChat and QQ -- 11% and 3%, respectively -- helped, but big increases in online advertising and other online monetization were the main catalysts. In fact, total users for WeChat reached 1 billion during the year, and QQ had just over 800 million at 2018 year-end. That's a lot of people to advertise to, not to mention a lot of people to tap for new services in online entertainment, banking, and other mobile services.

Mobile gaming revenues grew 24%, although that was offset by an 8% decrease in PC games. Online subscription services for video and music streaming were also bright spots as Tencent continued to build on top of its expansive social platform. Cloud computing is also coming into its own. Though the cloud business is still a small fraction of total revenue at $1.35 billion in sales in 2018, it did double in size over 2017.

YOY = year over year. P.p. = percentage points. Profit from joint ventures and earnings per share calculated using a Chinese renminbi-to-U.S. dollar exchange rate of 0.1489 on March 22, 2019. Data source: Tencent Holdings.

What's next for Tencent?

Though 30%-plus revenue growth is nothing to get upset about, it is a steep slowdown from years past. For point of reference, Tencent's sales were up 54% in 2017. That helps explain the stock's performance as of late. Earnings were up only 10% as the company aggressively reinvested in itself, but with the rate of growth slowing, investors have worried that it might not be money well spent.

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Image source: Getty Images.

Not to worry, though. Tencent is only just getting started finding ways to monetize its massive social media users as it continuously adds new capabilities to WeChat, and the video game freeze in China is over. With the video game segment now back on the table as a contributor to overall expansion, the social and cloud segments won't have to work overtime to tow the gaming juggernaut along anymore.

Plus, Tencent is eyeing new markets -- specifically fast-developing countries in Asia like India. Expect strategic investments in partners and other ventures to increase. Tencent management has said investing this way helps it stay focused on its core base of users while still allowing new partners to tap into the more than 1 billion people using WeChat and QQ. Realized profit from those subsidiaries grew 80% last year to $221 million -- proof that Tencent's strategy is working.

With the overall business going at a double-digit pace, Tencent is still very much a growth-now profit-later stock. However, the trailing 12-month price-to-free cash flow ratio is just 26.9, a pretty good bargain given how fast the Chinese social media empire is growing. Investors remain gloomy on the stock, but in light of a good 2018 performance and a lot of empty space ahead for Tencent to trail blaze, now still looks like a pretty good time to go shopping on this tech giant.