Please ensure Javascript is enabled for purposes of website accessibility

3 Reasons to Buy Tencent, and 1 Reason to Sell

By Leo Sun – Updated Aug 20, 2021 at 3:50PM

Key Points

  • Tencent’s core businesses are still generating impressive growth.
  • Its stock looks historically cheap relative to its growth.
  • China’s ongoing crackdown on its top tech companies still makes it a tough stock to own.

Motley Fool Issues Rare “All In” Buy Alert

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Its past growth looks healthy, but its future looks murky.

Tencent (TCEHY 2.11%) posted its second-quarter earnings on Wednesday. The Chinese tech giant's revenue rose 20% year over year to 138.3 billion yuan ($21.3 billion), meeting analysts' expectations but decelerating from its 25% growth in the first quarter. Its adjusted net income rose 13% to 34 billion yuan ($5.2 billion), beating estimates by 1.2 billion yuan.

Tencent's stock price rose slightly after the report, but it's still shed over 20% of its value this year amid China's crackdown on its tech sector. Should investors ignore that noise and buy the stock, which looks historically cheap at 26 times next year's earnings, or should they avoid it? To decide, let's examine three reasons to buy Tencent -- and one compelling reason to sell it.

A person reads a tablet while eating breakfast.

Image source: Getty Images.

1. The growth of its gaming business

Tencent is the largest video game publisher in the world. Its top games in China include Honor of Kings, Peacekeeper Elite, and Moonlight Blade Mobile, while its overseas hits include Clash of Clans, League of Legends, PUBG Mobile, and Call of Duty: Mobile.

Tencent also owns stakes in many game publishers, including Fortnite publisher Epic Games, Activision Blizzard, and Ubisoft. It's also Nintendo's partner and distributor in China.

Tencent's gaming revenue rose 12% year over year during the second quarter and accounted for 31% of its top line. The segment faces a post-pandemic slowdown, but it still grew on top of its 40% growth in the prior-year quarter -- so it's still firing on all cylinders.

2. The growth of its advertising business

Tencent is one of the largest advertising companies in China. It sells ads on WeChat (known as Weixin in China), which serves 1.25 billion monthly active users as China's top mobile messaging and Mini Programs platform. It also sells ads through its older social media network QQ, Tencent News, Tencent Video, its mobile app store, and its mobile advertising network.

Tencent's advertising revenue rose 23% year-over-year during the second quarter, compared to its 13% growth during the height of the pandemic a year ago, and accounted for 16% of its top line. Tencent attributed that acceleration to rising demand for ads for internet-based services and consumer staples, as well as its consolidation of the car comparison site Bitauto.

Tencent's advertising business grew at a faster rate than many of China's other leading advertising platforms. For example, Baidu's (BIDU 1.37%) online marketing revenue rose 18% year over year in its latest quarter, but it benefited from an easy comparison to an 8% decline a year ago.

3. The growth of its fintech and business services unit

Tencent's fintech and business services unit -- which houses its payment platform WeChat Pay, Tencent Cloud, and other services -- grew its revenue by 40% year over year during the quarter and accounted for 30% of its top line. The segment's revenue rose 30% in the prior-year quarter.

A laptop linked to cloud-based services.

Image source: Getty images.

Tencent mainly attributed the segment's growth to a rising number of digital payment transactions, and the digitization of public services in China (with its cloud software and other services).

WeChat Pay holds a near-duopoly in China's digital payments market with Alibaba (BABA 0.50%)-backed Alipay. Tencent Cloud ranks third in China's cloud infrastructure market behind Alibaba and Huawei, according to Canalys, with a 13.7% share in the first quarter of 2021.

Both businesses should keep growing as more people in China stop using cash and more companies use public cloud services.

The one reason to sell Tencent: China's crackdown

Tencent's core businesses are strong, but its recent regulatory challenges are overshadowing its strengths.

China's State Administration for Market Regulation (SAMR) recently issued Tencent several small fines of 500,000 yuan ($77,000) apiece for previously unapproved investments and acquisitions, but several reports suggest those lighter fines could precede a much larger fine of up to $1.5 billion.

The SAMR recently blocked Tencent's proposed merger of Huya (HUYA -3.74%) and DouYu (DOYU), which would have created China's largest esports streaming platform, and forced Tencent Music (TME 7.61%) to abandon its exclusive streaming music rights.

Tencent also suspended new user registrations for WeChat in late July, citing a need to review its data security policies. China's Ministry of Industry and Information Technology (MIIT) then rebuked WeChat, along with more than 40 other apps, in mid-August over their data handling practices.

A recent article in the state-backed media outlet Xinhua suggests China's regulators could crack down on its gaming industry soon, even though Tencent recently implemented stricter playtime limits for minors. China's central bank is also reportedly seeking new ways to regulate WeChat Pay and Alipay as financial institutions instead of payment platforms.

All that uncertainty has made it tough to buy Tencent, Alibaba, and other Chinese tech stocks.

The bottom line

Tencent's past growth looks healthy, but its future looks murky. Therefore, I'd rather sell Tencent right now than buy it, since it's unclear when China's government will decide to drop the hammer on its core businesses. If those headwinds dissipate, I might consider buying the stock again.

Leo Sun owns shares of Nintendo. The Motley Fool owns shares of and recommends Activision Blizzard, Alibaba Group Holding Ltd., Baidu, and Tencent Holdings. The Motley Fool recommends HUYA Inc., Nintendo, and Ubisoft Entertainment. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Tencent Holdings Stock Quote
Tencent Holdings
TCEHY
$35.31 (2.11%) $0.73
Baidu Stock Quote
Baidu
BIDU
$94.64 (1.37%) $1.28
Alibaba Group Holding Ltd. Stock Quote
Alibaba Group Holding Ltd.
BABA
$75.88 (0.50%) $0.38
HUYA Inc. Stock Quote
HUYA Inc.
HUYA
$2.06 (-3.74%) $0.08
Tencent Music Entertainment Group Stock Quote
Tencent Music Entertainment Group
TME
$6.22 (7.61%) $0.44
DouYu International Holdings Ltd Stock Quote
DouYu International Holdings Ltd
DOYU
$1.15 (%)

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
356%
 
S&P 500 Returns
118%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/29/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.