Tencent (TCEHY 3.56%) once seemed like a promising long-term play on China's booming tech sector. It's the world's largest video game publisher, and its top games dominate China's gaming market. It owns WeChat (also known as Weixin), the leading "super app" in China, which bundles together mobile messages, social networking tools, digital payments, online purchases, integrated games, and other features in a walled garden.
Tencent owns China's third-largest cloud infrastructure platform, after Alibaba Cloud and Huawei Cloud, as well as WeChat Pay -- which holds a near-duopoly in China's digital payments market with Ant Group's AliPay. It also owns the streaming video platform Tencent Video and the streaming music leader Tencent Music (TME 4.76%).
Image source: Getty Images.
But over the past five years, Tencent's stock declined nearly 20%. The tech leader lost its luster as China's regulators cracked down on the video game sector while closely scrutinizing the company's past and planned acquisitions. The pandemic, China's subsequent lockdowns, and the macro headwinds all exacerbated that slowdown.
Should investors buy Tencent now and expect it to recover over the next five years? Or will it remain a lackluster investment as its core businesses mature?
What happened to Tencent over the past five years?
Between 2017 and 2022, Tencent's annual revenue had a compound annual growth rate (CAGR) of 18% as its adjusted net income rose at a CAGR of 12%. Those growth rates look stable, but a closer look reveals a troubling slowdown.
|
Metric |
2017 |
2018 |
2019 |
2020 |
2021 |
2022 |
|---|---|---|---|---|---|---|
|
Revenue growth |
56% |
32% |
21% |
28% |
16% |
(1%) |
|
Adjusted net income growth |
43% |
19% |
22% |
30% |
1% |
(7%) |
Data source: Tencent.
Tencent's growth decelerated over the past two years for three main reasons.
First, China's regulators tightened their video game playtime restrictions for minors and throttled their approvals for new video games. China froze all of its new video game approvals in August 2021 while slowly resuming that process last April, but didn't actually approve any of Tencent's games until last December.
Second, Tencent's advertising business -- which serves up ads across WeChat, its older social networking platform QQ, its media platforms, and its other websites and apps -- faced intense macro and competitive headwinds. On the macro front, China's intermittent COVID lockdowns curbed the market's appetite for new ads. Government crackdowns across the gaming, e-commerce, and online education markets also caused its ad sales to those verticals to slow to a crawl.
As for the competition, Tencent's advertising platforms struggled to stay ahead of Gen Z targeted platforms like ByteDance's Duoyin (known as TikTok overseas) and Bilibili.
Lastly, Tencent's expansion of its "fintech and business services" through WeChat Pay and Tencent Cloud -- which was intended to diversify its business away from games and ads -- ran into regulatory, competitive, and macro challenges.
WeChat Pay struggled with slower consumer spending and tighter restrictions on digital payments. Tencent Cloud struggled as the macro headwinds forced companies to rein in their spending on big cloud upgrades. Intense competition from Alibaba, Huawei, and others also forced Tencent Cloud to slash its prices and abandon some of its loss-leading strategies.
What will happen over the next five years?
The past few years were tough for Tencent, but the next five years might be better. China's regulators are now consistently approving Tencent's new games again, and it continues to diversify its gaming business away from China with overseas hits like Valorant, League of Legends, Triple Match 3D, Goddess of Victory: Nikke, and Warhammer 40,000: Darktide.
Tencent's advertising business still faces a lot of competition, but WeChat will remain China's dominant super app for the foreseeable future, with its 1.32 billion monthly active users. Tencent Video and Tencent Music should also continue to dominate their respective markets.
Therefore, Tencent's total ad revenue should rise as China's economy experiences its post-COVID recovery. That rising tide should also boost consumer spending on WeChat Pay and bring more businesses back to Tencent Cloud. As those headwinds dissipate, analysts expect Tencent's revenue to grow at a CAGR of 12% between 2022 and 2025. However, they only expect its net income to increase at a CAGR of less than 1% as it ramps up its investments in new games, ads, and services.
If Tencent hits those targets and grows its revenue at a CAGR of 10% from 2025 to 2028, it might generate 1.03 trillion yuan ($150 billion) in revenue by the final year -- which would be nearly double its 555 billion yuan in revenue in 2022.
We should take those long-term estimates with a grain of salt, since China's post-COVID recovery remains fragile and the competitive and regulatory challenges are unpredictable. But assuming Tencent still trades at roughly 4 times sales in 2028, its stock could potentially double over the next five years -- so it might be a good time to revisit this Chinese stock.
