Tencent (TCEHY 1.14%) was once considered a promising play on China's booming tech sector. The tech giant owned China's largest mobile messaging platform, WeChat, and it locked in those users with integrated Mini Programs that eliminated the need for traditional apps. It's also the largest video game publisher in the world.
Tencent also owns China's third-largest cloud infrastructure platform, its leading streaming music and video platforms, and a long list of other smaller apps. Its digital payment platform, WeChat Pay, also shares a near-duopoly in that booming market with Ant Group's Alipay.
Image source: Getty Images.
Those growth engines are all impressive, but Tencent's stock price has declined a staggering 40% over the past 12 months and wiped out nearly all of its gains from the past two years. The main cause of that steep decline was China's crackdown on its top tech stocks -- which included unpredictable probes, fines, and restrictions on new investments and acquisitions. The government's temporary suspension of new video game approvals and a tightening of playtime restrictions for minors also exacerbated the pain.
However, Tencent and other Chinese tech stocks recently rallied after the Chinese government said it would wrap up its regulatory crackdown, support overseas listings for Chinese companies, and work with U.S. regulators to address auditing and delisting concerns for Chinese ADRs. That sounds like good news for Tencent, but investors should review these three red flags before scooping up shares of its beaten-down stock.
OTC: TCEHY
Key Data Points
1. Another big fine could be looming
Tencent hasn't been hit by a massive antitrust fine comparable to the record $2.75 billion fine against Alibaba (BABA 0.59%) -- yet. Instead, it was slapped with much lower fines related to some previous deals and was forced to abandon its planned merger of Huya (HUYA 2.28%) and DouYu (DOYU 1.82%) to create China's largest video game streaming platform.
However, The Wall Street Journal recently claimed Tencent could be fined at least a few hundred million yuan for money laundering violations on WeChat Pay. That fine probably wouldn't be too meaningful compared to Tencent's projected revenue of 566.65 billion yuan ($89 billion) this year, but it could curb WeChat Pay's future growth with fresh restrictions.
That wouldn't be surprising, since the Chinese government also indefinitely postponed Ant Group's IPO amid concerns that the Alibaba-backed fintech company could overpower the country's state-backed banks.
2. More regulatory red tape in the U.S.
Over the past year, the main regulatory headwind for Tencent in the U.S. was the Securities and Exchange Commission's (SEC) threat to delist shares of Chinese companies that didn't comply with tighter auditing standards. Tencent only trades on the pink sheets in the U.S., but the SEC order could also delist over-the-counter (OTC) Chinese stocks.
However, the U.S. Federal Trade Commission (FTC) also recently added Tencent's WeChat and ByteDance's TikTok to a new antitrust bill that also covers U.S. internet tech giants like Apple, Amazon, Alphabet's Google, and Meta Platforms' Facebook.
WeChat doesn't have as much exposure to the U.S. market as TikTok, but Tencent still owns stakes in U.S. companies like Activision Blizzard, Tesla, and Snap. The FTC's tighter antitrust rules could curb its ability to expand that investment portfolio, which has boosted its profits in recent years.
3. The resurgence of COVID-19 in China
China recently experienced its worst surge in new COVID-19 cases in two years. That rapid outbreak has resulted in the lockdowns of several major cities, including Tencent's hometown of Shenzhen.
New lockdowns might generate tailwinds for Tencent's domestic gaming business, which accounted for 24% of its revenue last quarter. But a resurgent pandemic could also generate headwinds for its advertising business, which brought in 16% of its revenue. Those headwinds could easily overwhelm the tailwinds and throttle Tencent's near-term growth.
Is Tencent's stock still worth buying?
Analysts expect Tencent's revenue to grow 18% in 2021 and 15% in 2022. They expect its earnings per share to dip slightly in both years as it expands its lower-margin cloud and fintech businesses while grappling with the slowing growth of its higher-margin video game business.
Tencent's stock looks reasonably valued at 20 times forward earnings and five times next year's sales, but it probably won't command a higher premium until the regulatory headwinds wane and China contains its latest COVID-19 crisis. Therefore, I'd stay far away from Tencent -- as well as most other Chinese tech stocks -- until all those issues are resolved.
