March 16, 2017

EARNINGS PREVIEW Tencent Holdings (0700.HK)

Buy Equity Research 4Q16 preview: Gaming, ad and payment; end 2016 on a strong note

What we expect Investment Profile nd Tencent will announce 4Q16 results on Wednesday, Mar 22 after market Low High close. We see evidence of another strong year, particularly on advertising Growth Growth revenue growth rate being higher than peers, and payments driving other Returns * Returns * revenues up 200% yoy. For 2017 and beyond, we are focused on WeChat Multiple Multiple Mini Program development, games pipeline and WeChat ad load. We Volatility Volatility Percentile 20th 40th 60th 80th 100th forecast revenue of Rmb 44,588mn and EPS of Rmb 1.30 for 4Q16. Tencent Holdings (0700.HK) What could surprise us Asia Pacific Media and Entertainment Peer Group Average * Returns = Return on Capital For a complete description of the investment Online gaming: We expect online gaming revenue to grow 37% yoy in profile measures please refer to the 4Q16, driven by 81% yoy growth in mobile gaming revenue and 9% yoy disclosure section of this document. growth in PC gaming revenue. Mobile game Honour of Kings delivered Key data Current strong performance in 4Q16, with daily active users (DAU) surpassing Price (HK$) 214.60 12 month price target (HK$) 252.30 50mn in Dec 2016, higher than Pokémon Go’s peak in July 2016 per Market cap (HK$ mn / US$ mn) 2,037,831.9 / 262,304.7 Foreign ownership (%) -- Bloomberg report. We saw favorable development for League of Legends, as the threat from Overwatch is receding, and data from Superdata 12/15 12/16E 12/17E 12/18E Research indicates 16% yoy revenue growth in 2016. Online advertising: EPS (HK$) 4.28 5.62 7.51 9.01 EPS growth (%) 32.2 38.6 38.6 20.2 We forecast online advertising revenue to grow 44% yoy in 4Q16, EPS (diluted) (Rmb) 3.05 4.54 6.10 7.00 EPS (basic pre-ex) (Rmb) 3.48 4.85 6.73 8.07 outpacing China Internet peers’ 21% yoy growth rate, but down from P/E (X) 33.8 39.7 28.6 23.8 51%/118% in 3Q16/4Q15 due to continued revenue mix shift from P/B (X) 9.2 11.0 8.2 6.3 EV/EBITDA (X) 21.8 25.2 18.6 15.4 advertising model to subscription model on online video. Other revenues: Dividend yield (%) 0.3 0.3 0.4 0.5 ROE (%) 28.8 30.3 30.1 26.3 We forecast 200% yoy growth in Tencent’s other revenues line, driven by CROCI (%) 30.1 32.1 31.8 27.7 growth in payments (0.1% cash withdraw fee was introduced in Mar 2016, scenarios expansion) and cloud computing. Price performance chart 220 11,500 On Mar 22nd call, we expect management to discuss (i) development on 210 11,000 WeChat Mini Program; (ii) Honour of Kings and new games pipeline; (iii) 200 10,500 video content spending trend and WeChat Moment ad load. Our 12m TP of 190 10,000 HK$252.30 is based on 28X 2018E EPS. Key risks: Macro slowdown, 180 9,500 competition with Alibaba Group and other P4P advertising assets. 170 9,000 160 8,500

Key metrics for 4Q16 - GSe vs. consensus 150 8,000 Mar-16 Jun-16 Sep-16 Dec-16 Rmb mn GSe Consensus GSe vs. consensus Total revenues 44,588 44,000 1.34% Tencent Holdings (L) Hang Seng China Ent. Index (R) Non-GAAP diluted EPS (Rmb) 1.30 1.26 3.16%

Source: Bloomberg, Goldman Sachs Global Investment Research. Share price performance (%) 3 month 6 month 12 month Absolute 16.6 2.3 41.8 INVESTMENT LIST MEMBERSHIP Rel. to Hang Seng China Ent. Index 7.6 (4.5) 18.8 Asia Pacific Buy List Source: Company data, Goldman Sachs Research estimates, FactSet. Price as of 3/15/2017 close. GS SUSTAIN Focus List

Coverage View: Neutral Piyush Mubayi +852-2978-1677 [email protected] Goldman Sachs (Asia) L.L.C. Goldman Sachs does and seeks to do business with companies Ronald Keung, CFA covered in its research reports. As a result, investors should be +852-2978-0856 [email protected] Goldman Sachs (Asia) L.L.C. aware that the firm may have a conflict of interest that could Fan Liu, CFA affect the objectivity of this report. Investors should consider +86(10)6627-3192 [email protected] Beijing Gao Hua Securities Company Limited this report as only a single factor in making their investment Elsie Cheng +852-2978-0820 [email protected] Goldman Sachs (Asia) L.L.C. decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non- US affiliates are not registered/qualified as research analysts with FINRA in the U.S.

The Goldman Sachs Group, Inc. Global Investment Research March 16, 2017 Tencent Holdings (0700.HK)

Tencent Holdings: Summary Financials

Profit model (Rmb mn) 12/15 12/16E 12/17E 12/18E Balance sheet (Rmb mn) 12/15 12/16E 12/17E 12/18E

Total revenue 102,863.0 152,662.2 211,889.1 258,023.8 Cash & equivalents 43,438.0 103,705.3 211,476.7 312,458.0 Cost of goods sold (41,631.0) (67,181.5) (97,601.1) (125,734.6) Accounts receivable 7,061.0 9,170.1 11,378.4 12,123.2 SG&A (22,062.0) (29,267.3) (40,595.5) (48,815.7) Inventory 0.0 0.0 0.0 0.0 R&D (9,039.0) (11,070.1) (13,062.7) (14,891.4) Other current assets 104,879.0 110,463.2 117,112.0 122,336.2 Other operating profit/(expense) 1,886.0 3,727.0 3,209.0 3,529.9 Total current assets 155,378.0 223,338.7 339,967.2 446,917.4 EBITDA 48,438.0 68,486.7 93,244.2 108,182.4 Net PP&E 14,221.0 18,762.8 23,919.0 28,691.5 Depreciation & amortization (6,674.0) (8,093.9) (9,973.7) (12,249.7) Net intangibles 15,732.0 16,253.4 16,774.8 17,296.2 EBIT 41,764.0 60,392.8 83,270.5 95,932.7 Total investments 104,510.0 125,960.0 123,160.0 120,996.2 Interest income 2,327.0 2,541.2 4,915.9 7,811.4 Other long-term assets 16,977.0 16,977.0 16,977.0 16,977.0 Interest expense 0.0 0.0 0.0 0.0 Total assets 306,818.0 401,291.9 520,798.0 630,878.3 Income/(loss) from uncons. subs. (2,793.0) (2,700.0) (2,800.0) (2,163.8) Others 0.0 0.0 0.0 0.0 Accounts payable 85,899.0 127,487.2 176,963.1 215,507.5 Pretax profits 36,216.0 54,142.2 71,848.0 84,351.0 Short-term debt 11,429.0 11,429.0 11,429.0 11,429.0 Income tax (7,108.0) (10,567.9) (12,932.6) (16,026.7) Other current liabilities 27,078.0 35,738.3 46,462.4 49,855.2 Minorities (302.0) (488.0) (561.6) (673.9) Total current liabilities 124,406.0 174,654.5 234,854.5 276,791.7 Long-term debt 37,092.0 37,092.0 37,092.0 37,092.0 Net income pre-preferred dividends 32,410.0 45,485.6 63,550.9 76,984.5 Other long-term liabilities 23,220.0 23,220.0 23,220.0 23,220.0 Preferred dividends 0.0 0.0 0.0 0.0 Total long-term liabilities 60,312.0 60,312.0 60,312.0 60,312.0 Net income (pre-exceptionals) 32,410.0 45,485.6 63,550.9 76,984.5 Total liabilities 184,718.0 234,966.5 295,166.5 337,103.7 Post-tax exceptionals (3,604.0) (2,399.3) (5,197.1) (9,334.1) Net income 28,806.0 43,086.3 58,353.8 67,650.4 Preferred shares 0.0 0.0 0.0 0.0 Total common equity 120,035.0 164,260.4 223,566.5 291,709.6 EPS (basic, pre-except) (Rmb) 3.48 4.85 6.73 8.07 Minority interest 2,065.0 2,065.0 2,065.0 2,065.0 EPS (basic, post-except) (Rmb) 3.10 4.59 6.18 7.09 EPS (diluted, post-except) (Rmb) 3.05 4.54 6.10 7.00 Total liabilities & equity 306,818.0 401,291.9 520,798.0 630,878.3 DPS (Rmb) 0.390.550.730.87 Dividend payout ratio (%) 12.4 11.9 11.8 12.3 BVPS (Rmb) 12.73 17.31 23.38 30.20 Free cash flow yield (%) 3.7 5.0 6.4 6.0

Growth & margins (%) 12/15 12/16E 12/17E 12/18E Ratios 12/15 12/16E 12/17E 12/18E Sales growth 30.3 48.4 38.8 21.8 CROCI (%) 30.1 32.1 31.8 27.7 EBITDA growth 37.2 41.4 36.1 16.0 ROE (%) 28.8 30.3 30.1 26.3 EBIT growth 36.9 44.6 37.9 15.2 ROA (%) 12.1 12.2 12.7 11.7 Net income growth 21.0 49.6 35.4 15.9 ROACE (%) 31.5 36.8 69.0 153.5 EPS growth 20.1 48.3 34.4 14.8 Inventory days NM NM NM NM Gross margin 59.5 56.0 53.9 51.3 Receivables days 20.7 19.4 17.7 16.6 EBITDA margin 47.1 44.9 44.0 41.9 Payable days 498.5 579.7 569.3 569.7 EBIT margin 40.6 39.6 39.3 37.2 Net debt/equity (%) (58.5) (79.4) (106.5) (116.3) Interest cover - EBIT (X) NM NM NM NM

Cash flow statement (Rmb mn) 12/15 12/16E 12/17E 12/18E Valuation 12/15 12/16E 12/17E 12/18E Net income pre-preferred dividends 32,410.0 45,485.6 63,550.9 76,984.5 D&A add-back 6,674.0 8,093.9 9,973.7 12,249.7 P/E (analyst) (X) 33.8 39.7 28.6 23.8 Minorities interests add-back 0.0 0.0 0.0 0.0 P/B (X) 9.2 11.0 8.2 6.3 Net (inc)/dec working capital 6,389.0 41,772.4 50,807.9 35,268.3 EV/EBITDA (X) 21.8 25.2 18.6 15.4 Other operating cash flow (42.0) 3,919.6 2,548.2 (679.1) EV/GCI (X) 6.9 8.7 6.2 4.6 Cash flow from operations 45,431.0 99,271.5 126,880.8 123,823.4 Dividend yield (%) 0.3 0.3 0.4 0.5

Capital expenditures (5,440.0) (9,159.7) (11,653.9) (13,546.2) Acquisitions 0.0 0.0 0.0 0.0 Divestitures 0.0 0.0 0.0 0.0 Others (58,165.0) (26,260.3) (2,337.1) (2,406.1) Cash flow from investments (63,605.0) (35,420.1) (13,991.0) (15,952.3)

Dividends paid (common & pref) (2,640.0) (3,584.2) (5,118.4) (6,889.8) Inc/(dec) in debt 22,184.0 0.0 0.0 0.0 Common stock issuance (repurchase) (483.0) 0.0 0.0 0.0 Other financing cash flows (162.0) 0.0 0.0 0.0 Cash flow from financing 18,899.0 (3,584.2) (5,118.4) (6,889.8) Total cash flow 725.0 60,267.3 107,771.4 100,981.3 Note: Last actual year may include reported and estimated data. Source: Company data, Goldman Sachs Research estimates.

Analyst Contributors

Piyush Mubayi Elsie Cheng [email protected] [email protected]

Ronald Keung, CFA Yifu Wang [email protected] [email protected]

Fan Liu, CFA Siyuan Wang [email protected] [email protected]

Goldman Sachs Global Investment Research 2 March 16, 2017 Tencent Holdings (0700.HK)

2016 expectations and recent developments

We forecast revenue of Rmb44,588mn (+46% yoy), non-GAAP operating profit of Rmb17,185mn (+49% yoy), and non-GAAP net income of Rmb12,398mn (+38% yoy).

Gaming and advertising: We forecast Tencent’s online gaming and advertising revenue to grow 37% yoy and 44% yoy respectively. Online gaming will be driven again by mobile gaming growth, estimated at 81% yoy, while PC gaming revenue we forecast to grow 9% yoy. 4Q16 will be the first quarter when mobile gaming revenue exceeds PC gaming revenue, based on our estimate.

Margins: For full-year 2016, we forecast gross margin of 56.0%, down 3.5pp yoy mainly due to higher video content spending and partially offset by improved gross margin from the payments business. We expect 39.6% non-GAAP operating margin in 2016, down 1pp yoy, mainly due to lower gross margin and partially offset by operating leverage from G&A expenses.

Mobile games +81% yoy Tencent’s mobile game portfolio is led by in-house developed Honour of Kings (HoK), essentially a mobile version of League of Legend. Tencent reported that HoK surpassed 50mn DAUs in Dec 2016, up from 40mn 3 months ago and exceeding the c.45mn DAUs that Pokémon Go attained at its peak in July 2016, as reported by Bloomberg. Tencent via partners has been taking HoK global since 4Q16. According to App Annie, HoK reached #1 iOS grossing ranking in Taiwan and Thailand, #2 in Vietnam, and was launched in Turkey in Feb 2017. In 2017, Tencent plans to invest Rmb200mn in HoK’s e-sports, including building a professional league and connecting with live-streaming platforms, as per Sohu News.

Tencent published mobile game Dragon Nest with Shanda Games on March 2nd, 2017, and it has risen to #2 in China iOS revenue grossing ranking a day after its launch. Dragon Nest is a Massively multiplayer online role-playing game (MMORPG) based on the established IP of the PC game with the same name that was developed by Korean studio Eyedentity and published by Shanda Games in 2009.

Supercell, 77% owned by a consortium controlled by Tencent, reported revenue of Eu2.1bn (flat yoy) in 2016, with EBITDA improving to Eu917mn from Eu848mn in 2015 as per Reuters. Supercell’s CEO attributed the flat revenue to tighter competition from games including Pokémon Go, offset by the success of Clash Royale. We expect Supercell to achieve higher growth in 2017 through Tencent’s help in distribution channel and customized monetization method appealing to Chinese gamers.

Goldman Sachs Global Investment Research 3 March 16, 2017 Tencent Holdings (0700.HK)

Exhibit 1: Tencent dropped to #3 following strong Exhibit 2: … but recovered to #1 due to strong performance of NetEase’s Onmyoji and Ghost… performance of Honour of Kings… October global iOS + Google Play company ranking November global iOS + Google Play company ranking

# By Revenue Changes # By Revenue Changes 1 NetEase ▲1 1 Tencent ▲2 2 Supercell ▲2 2 Supercell = 3 Tencent ▼2 3 NetEase ▼2 4 MZ ▲1 4 MZ = 5 Activision Blizzard ▼2 5 Activision Blizzard = 6 Mixi ▲2 6 Mixi = 7 BANDAI NAMCO = 7 BANDAI NAMCO = 8 Niantic ▼2 8 LINE ▲2 9 Netmarble = 9 Netmarble = 10 LINE = 10 GungHo Online ▲6

Source: App Annie. Source: App Annie.

Exhibit 3: … and has maintained #1 in December and Exhibit 4: Supercell dipped to #5 in Jan 2017 as Lineage January II: Revolution boosted Netmarble’s revenue December global iOS + Google Play company ranking January global iOS + Google Play company ranking

# By Revenue Changes # By Revenue Changes 1 Tencent = 1 Tencent = 2 NetEase ▲1 2 Mixi ▲2 3 Supercell ▼1 3 NetEase ▼1 4 Mixi ▲2 4 Netmarble ▲1 5 Netmarble ▲4 5 Supercell ▼2 6 MZ ▼2 6 Activision Blizzard ▲1 7 Activision Blizzard ▼2 7 MZ ▼1 8 BANDAI NAMCO ▼1 8 BANDAI NAMCO = 9 Sony ▲9 9 Sony = 10 GungHo Online = 10 SQUARE ENIX ▲1

Source: App Annie. Source: App Annie.

Exhibit 5: Number of top 3 China iOS games by grossing Exhibit 6: Number of top 10 China iOS games by grossing

Top 3: Tencent Top 3: Netease Top 10: Tencent Top 10: Netease 3 9 Q4 Q1 Q2 Q3 Q4 Q1 Q4 Q1 Q2 Q3 Q4 Q1 8

7

2 6

5

4

1 3

2

1

- - Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17

Source: App Annie, Goldman Sachs Global Investment Research. Source: App Annie, Goldman Sachs Global Investment Research.

PC games +9% yoy We estimate League of Legends (LoL) generated US$1.85bn (+16% yoy) in revenue in 2016, and accounts for 27% of Tencent’s PC game revenue. This is based on Superdata Research’s estimate of US$1.7bn revenue in the first 11 months of 2016, compared to US$1.6bn estimated revenue in whole-year 2015.

Riot Games, the developer of LoL, announced their 2017 development plan, which mainly includes the following updates:

Goldman Sachs Global Investment Research 4 March 16, 2017 Tencent Holdings (0700.HK)

 New client terminal: LoL launched the open beta testing of its new client terminal in November 2016, featuring better graphics and exclusive gaming functions. According to LoL’s lead producer, about half of global LoL players have adopted the new client terminal to be their main way of playing LoL, though the stability and performance of the new client still needs to be improved. LoL is aiming to push the retirement of old client in the coming months in order to deliver better gaming experience.

 New honor system: LoL is working on a significant overhaul to its honor system, which is a point system introduced in October 2012 that aims to incentivize positive gaming behavior, including being friendly, helpful, and a good teammate. The new honor system will provide greater incentives for players to act positively, and will reward consistent sportsmanship. This new system will be launched later this year.

 New customization system of runes and masteries: Runes and masteries are pre- game options that gamers can customize to enhance their characters. The new system aims to make the choices of runes and masteries more impactful in game, and drive gamers to think about their pre-game choices strategically. The development of this new system is in progress.

 New team competition mechanism: LoL is exploring a new competition matching mechanism that encourages organized team competition, aiming to make the experience of “team up with friends” similar to entering an amateur LoL tournament. This new mechanism intends to increase the intensity and teamwork of LoL, and is expected to be introduced later this year.

We believe these new developments represent LoL’s ability to bring constant innovation and better gaming experience to its 100mn+ monthly active users (MAUs). The new client terminal has the potential to attract more gamers to LoL with its better graphics, while other innovations could shape a more positive gamer community and drive gamers’ engagement.

We also see limited cannibalization of LoL from HoK. As shown in Exhibit 7, LoL was launched more than 720mn times (+15% vs. peers) in December 2016, a month when HoK dominated iOS grossing ranking.

Exhibit 7: Tencent retains dominant market share in past 3 months, LoL saw strong performance in Dec 2016 China net café online game ranking

% change vs. Rank October Launch (mn) November Launch (mn) December Launch (mn) % change pop peer avg. 1LOL (MOBA) Tencent 480.0 LOL (MOBA) Tencent 413.0 LOL (MOBA) Tencent 721.0 75% 15% 2CF (FPS) Tencent 92.9 CF (FPS) Tencent 77.9 CF (FPS) Tencent 91.7 18% ‐41% 3DnF (Action) Tencent 61.5 DnF (Action) Tencent 58.6 DnF (Action) Tencent 81.8 40% ‐20% 4 QQRace (Racing) Tencent 18.6 QQRace (Racing) Tencent 14.9 NiZhan (FPS) Tencent 19.5 46% ‐13% 5NiZhan (FPS) Tencent 14.9 NiZhan (FPS) Tencent 13.4 QQRace (Racing) Tencent 18.4 24% ‐35% 6 Overwatch (FPS) NetEase 11.6 Overwatch (FPS) NetEase 9.4 Overwatch (FPS) NetEase 10.9 15% ‐44% 7 QQDance (Casual) Tencent 6.1 QQDance (Casual) Tencent 5.9 QQDance (Casual) Tencent 6.2 6% ‐54% 8 WOW(MMORPG) NetEase 5.2 WOW(MMORPG) NetEase 4.2 DOTA2 (MOBA) Perfect World 4.6 47% ‐12% 9DOTA2 (MOBA) Perfect World 3.6 M3Guo (MOBA) Electronic Soul 3.1 WOW(MMORPG) NetEase 4.0 ‐4% ‐64% 10 M3Guo (MOBA) Electronic Soul 3.5 DOTA2 (MOBA) Perfect World 3.1 NBA2KOL (SPG) Tencent 4.0 34% ‐25% 11 NBA2KOL (SPG) Tencent 3.4 NBA2KOL (SPG) Tencent 3.0 M3Guo (MOBA) Electronic Soul 3.5 13% ‐46% 701.2 606.4 965.7 59% 0%

1 MOBA 487.1 MOBA 419.2 MOBA 729.1 74% 2FPS 119.4 FPS 100.6 FPS 122.1 21% Tencent 677.4 Tencent 586.5 Tencent 942.7 61% 1% Market share 97% Market share 97% Market share 98%

Source: Shunwang.

Goldman Sachs Global Investment Research 5 March 16, 2017 Tencent Holdings (0700.HK)

LoL’s Overwatch risk receding We believe the threat from Overwatch has mitigated as evidenced by: 1) Overwatch’s average daily players addition has been slowing down from 127k in Jun and Jul 2016, to 73k in Aug and Sep 2016, and further to 46k from Oct 2016 to Feb 2017; 2) In South Korea, one of the most intense PC gaming market, Overwatch’s share of net café time spent has slipped from 29% in September 2016 to 24% on March 12, 2017, while that of LoL has recovered from 26% to 30%, according to Gametrics.com.

Exhibit 8: Overwatch’s growth is slowing down, with last Exhibit 9: LoL gained market share vs. Overwatch in 5mn players additions taking 108days South Korea cybercafe’s Overwatch number of players Based on net café time spent share

mn Game Sep 2016 Mar 12, 2017 Dif pp 30 25 League of Legends 25.5% 30.1% 4.53 25 20 Overwatch 28.9% 24.3% -4.54 20 15 Sudden Attack 6.1% 7.7% 1.63 15 FIFA Online 3 8.7% 6.2% -2.53 10 7 DNF 4.1% 4.9% 0.88

5 63 days 68 days 108 days StarCraft 2.7% 3.4% 0.66

0 Blade & Soul 1.4% 1.8% 0.38 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Lineage 1.6% 1.6% -0.01

Source: Blizzard. Source: Gametrics.com.

Dungeon & Fighter (D&F), CrossFire (CF) and Korean IPs We believe Nexon’s D&F remains a popular title for Tencent in China, as worldwide D&F revenue in 2016 is estimated by us at US$1.2bn, +14% yoy (based on Superdata Resarch’s estimates of US$1.1bn for Jan-Nov 2016 and US$1.05bn revenue for whole year 2015). SmileGate’s Crossfire also remains resilient, with estimated US$1.2bn worldwide revenue in 2016, up 8% yoy (based on Superdata Research’s estimates of US$1.1bn for Jan-Nov 2016 and US$1.1bn revenue for whole year 2015).

A report by Nikkei on Mar 8th 2017 says that Chinese authority has suspended review of South Korean games for publication in China following heightened geopolitical tension between China and South Korea. We note that no official Chinese source has confirmed the suspension, and the mobile version of D&F has passed review on Feb 8th, 2017 per The State Administration of Press, Publication, Radio, Film and Television (SAPPRFT) disclosure. In Tencent’s pipeline, Korean originated PC game Master x Master and Maple Story 2 have also been approved by SAPPRFT, while Tencent announced in Feb 2017 that Lineage II: Revolution will start testing soon.

Goldman Sachs Global Investment Research 6 March 16, 2017 Tencent Holdings (0700.HK)

Exhibit 10: Online gaming revenue comparison (actual 4Q16 numbers except Tencent)

Rmb mn 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16E China Tencent 15,073 14,545 16,188 18,456 19,955 20,484 21,879 25,214 Mobile 4,400 4,500 5,300 7,100 8,200 9,600 9,900 12,836 PC 10,673 10,045 10,888 11,356 11,755 10,884 11,979 12,378

Netease 3,104 3,850 5,488 5,793 6,332 6,778 6,914 9,431 Mobile 683 1,424 2,908 3,302 3,989 4,128 3,941 6,036 PC 2,421 2,425 2,579 2,491 2,343 2,650 2,973 3,395

Global Activision Blizzard (US$ mn) 1,230 983 910 1,186 1,408 1,515 1,501 1,826 Activision Blizzard ex. King (US$ mn) 1,278 1,044 990 1,353 1,248 1,086 1,109 1,578 PC (US$ mn) 386 370 359 385 400 411 609 704 Mobile (US$ mn) 86 54 131 146 243 454 440 536 Console (US$ mn) 758 559 420 655 765 650 452 586

Electronic Arts (US$ mn) 1,156 1,180 796 1,041 1,287 1,254 885 1,131 PC (US$ mn) 221 253 184 182 195 179 158 190 Mobile (US$ mn) 136 145 124 128 151 165 149 148 Console (US$ mn) 799 782 488 731 941 910 578 793

NCSOFT (KRW bn) 145 176 158 194 202 198 178 229 PC (KRW bn) 145 176 158 194 202 198 177 212 Mobile (KRW bn) ------1 17

Nexon (JPY mn) 51,972 42,664 49,811 45,816 57,497 38,123 44,255 43,253 PC (JPY mn) 43,602 32,511 39,481 32,677 45,054 28,915 34,474 31,352 Mobile (JPY mn) 8,370 10,153 10,330 13,139 12,443 9,208 9,781 11,901

% yoy Gaming Revenues Tencent 36% 18% 31% 37% 32% 41% 35% 37% Netease 44% 65% 123% 102% 104% 76% 26% 63% Activision Blizzard 18% 9% 35% -14% 14% 54% 65% 54% Activision Blizzard ex. King 15% 8% 31% -14% -2% 4% 12% 17% Electronic Arts 6% -1% -17% -4% 11% 6% 11% 9% NCSOFT 21%11%-8%4%40%12%12%18% Nexon 9% 16% 9% 7% 11% -11% -11% -6%

PC Tencent 15% 8% 12% 17% 10% 8% 10% 9% Netease 12% 7% 15% 1% -3% 9% 15% 36% Activision Blizzard 28% -2% -3% 4% 4% 11% 70% 83% Electronic Arts -7% 10% -12% -17% -12% -29% -14% 4% NCSOFT 21%11%-8%4%40%12%12%9% Nexon 8% 14% 10% -4% 3% -11% -13% -4%

Mobile Tencent 144% 50% 104% 87% 86% 113% 87% 81% Netease NA 1932% 1214% 724% 484% 190% 36% 83% Activision Blizzard 4% 13% 274% -46% 183% 741% 236% 267% Electronic Arts 18% 18% 1% 5% 11% 14% 20% 16% NCSOFT NA NA NA NA NA NA NA NA Nexon 16% 20% 7% 48% 49% -9% -5% -9%

Source: Company data, Goldman Sachs Global Investment Research.

Online Advertising +44% yoy in 4Q, vs. peer’s 21%

Social networks We see different demographic structure between QQ/Q-Zone and WeChat, with the former being more attractive to the young generation. According to Tencent Big Data’s report in 2015, among kids and teenagers born after 2000s, over 16% use QQ and Q-Zone, while only c.11% choose WeChat. According to Tencent’s Penguin Intelligence, 14% of WeChat’s MAUs were born after 1995, in contrast to the fact that the population group comprised more than 20% of Chinese Internet users in 2016, per China Internet Network Information Center (CNNIC) report.

Goldman Sachs Global Investment Research 7 March 16, 2017 Tencent Holdings (0700.HK)

We believe the following factors contributed to QQ’s greater share of younger users: 1) Students do not want to use the same social media platform as their parents; 2) WeChat’s simplistic user interface caters more to working/mature adults, while younger Chinese are drawn to the greater variety of customization offered by QQ; 3) The preference amongst the younger generation for games, as a QQ account can be used to register Tencent’s games; 4) The preference of younger Chinese to expand their social circles, as WeChat is focused more on existing family and acquaintances.

We view this internal competition between QQ and WeChat as being beneficial to Tencent, as we believe it will drive organic product innovation, and avoid potential fatigue resulting from over-reliance on one product. We also believe that QQ/Q-Zone’s popularity among youngsters reflects Tencent’s understanding of this population, which could help keep them within Tencent’s ecosystem as they grow up.

Exhibit 11: QQ and Q-Zone are more popular in the young population 2000s generation’s choice of social network

18%

16%

14%

12%

10%

8%

6%

4%

2%

0% QQ Q-Zone WeChat Weibo

Source: Tencent Big Data.

Online advertising We forecast 44% yoy growth in Tencent’s advertising revenue in 4Q16, outpacing average growth rate of China Internet peers but decelerating from 51%/118% in 3Q16/4Q15, which is partly contributed by our expectation of a continued revenue mix shift from advertising model to subscription model on online video side.

Tencent Video reported 20mn paid subscribers in 3Q16, and led Chinese online video App measured by MAU in December 2016 per Questmobile. We see Tencent Video as well positioned in the industry given Tencent’s ability to distribute video content through its social network asset, and rights to exclusive contents such as NBA (5-year deal from July 2015).

Goldman Sachs Global Investment Research 8 March 16, 2017 Tencent Holdings (0700.HK)

Exhibit 12: Online advertising revenue comparison (actual 4Q16 number except Tencent)

Rmb mn 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16E Advertising revenue Tencent 2,724 4,073 4,938 5,733 4,701 6,532 7,449 8,271 Baidu 12,519 16,227 17,680 17,610 14,931 16,939 16,490 16,166 Alibaba 7,737 10,237 11,409 18,877 11,873 15,840 16,768 27,840 Weibo 491 545 673 839 665 852 1,081 1,296 Sina (ex Weibo) 441 548 557 608 427 527 551 565 58.com 276 554 738 881 836 1,124 1,206 1,174 NetEase 333 478 508 680 439 593 629 742 Total 24,520 32,661 36,503 45,228 33,872 42,407 44,174 56,054 Global peers Google (US$ mn) 15,508 16,023 16,781 19,078 18,020 19,143 19,821 22,399 Facebook (US$ mn) 3,317 3,827 4,299 5,637 5,201 6,239 6,816 8,629 Naver (KRW bn) 530 559 587 647 673 723 750 822 % yoy Tencent 131% 97% 102% 118% 73% 60% 51% 44% Baidu 33% 37% 32% 27% 19% 4% -7% -8% Alibaba 30% 22% 38% 45% 53% 55% 47% 47% Weibo 52% 47% 68% 54% 35% 56% 61% 54% Sina (ex Weibo) -15% -8% -11% 4% -3% -4% -1% -7% 58.com 117% 204% 245% 252% 203% 103% 63% 33% NetEase 36% 23% 6% 68% 32% 24% 24% 9% Total 38% 37% 41% 45% 38% 30% 21% 24% Global peers % yoy Google 11% 11% 13% 17% 16% 19% 18% 17% Facebook 46% 43% 45% 57% 57% 63% 59% 53% Naver 11% 11% 18% 20% 27% 29% 28% 27%

Source: Company data, Goldman Sachs Global Investment Research.

Exhibit 13: Tencent led online video App in MAU December 2016 online video mobile App MAU

Tencent mn Baidu 388.1 400.0 368.9 350.0 Alibaba 288.6 300.0 250.0 200.0 150.0 95.6 Alibaba 100.0 71.8 63.8 Baidu 50.0 32.3 30.2 27.8 26.6 0.0 Tencent iQiyi Youku Leshi Mango TV Sohu Tudou Bilibli PPS PPTV Video (Youku) (iQiyi)

Source: Questmobile.

Other revenues +200% yoy in 4Q

Payments We believe the high triple-digit yoy growth in other revenues will continue to be driven by payments revenue, due to 0.1% cash withdraw fee introduced in March 2016, good customer conversion and merchants awareness from the Cashless Day promotion on Aug 8th 2016, and expanding offline payment scenarios through WeChat Mini Program. According to Analysys, Tenpay’s WeChat Payment and QQ Wallet have been gaining

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market share in China’s mobile payment market, with market share increasing from 23% in 1Q16 to 38% in 3Q16.

Exhibit 14: Tenpay is gaining market share in mobile payment market Mobile payment market share

Alipay Tenpay Others 100% 13.6% 12.5% 11.5% 90%

80% 23.0% 70% 32.1% 38.1% 60% 50%

40% 30% 63.4% 55.4% 50.4% 20% 10%

0% 1Q16 2Q16 3Q16

Source: Analysys.

Cloud computing Tencent is the second largest cloud computing service provider in China, though still well behind Alibaba. It is expanding rapidly overseas to serve Chinese companies with global ambition, especially in online gaming, live streaming and social networks industry. According to Tencent Cloud’s announcement on Dec 8th, 2016, they will open 11 oversea service nodes by 2016 December end, including Seoul, Sydney, Tokyo, and Chennai in APAC, Frankfurt, London and Amsterdam in Europe, Washington, Dallas and Silicon Valley in North America, and São Paulo in South America. Together with 5 domestic data centers and 3 data centers in Hong Kong, Singapore and Toronto, Tencent Cloud now operates 19 service nodes globally.

In the Sort Benchmark competition in Nov 2016, which is regarded as the annual worldwide computing Olympics, Tencent Cloud set four new world records. One record they broke is GraySort challenge, in which Tencent Cloud sorted 100TB of data in 98.8 seconds, showcasing its capability in large-scale computing.

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Disclosure Appendix Reg AC We, Piyush Mubayi, Ronald Keung, CFA and Fan Liu, CFA, hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report.

Unless otherwise stated, the individuals listed on the cover page of this report are analysts in Goldman Sachs' Global Investment Research division. Investment Profile The Goldman Sachs Investment Profile provides investment context for a security by comparing key attributes of that security to its peer group and market. The four key attributes depicted are: growth, returns, multiple and volatility. Growth, returns and multiple are indexed based on composites of several methodologies to determine the stocks percentile ranking within the region's coverage universe. The precise calculation of each metric may vary depending on the fiscal year, industry and region but the standard approach is as follows: Growth is a composite of next year's estimate over current year's estimate, e.g. EPS, EBITDA, Revenue. Return is a year one prospective aggregate of various return on capital measures, e.g. CROCI, ROACE, and ROE. Multiple is a composite of one-year forward valuation ratios, e.g. P/E, dividend yield, EV/FCF, EV/EBITDA, EV/DACF, Price/Book. Volatility is measured as trailing twelve-month volatility adjusted for dividends. Quantum Quantum is Goldman Sachs' proprietary database providing access to detailed financial statement histories, forecasts and ratios. It can be used for in-depth analysis of a single company, or to make comparisons between companies in different sectors and markets. GS SUSTAIN GS SUSTAIN is a global investment strategy aimed at long-term, long-only performance with a low turnover of ideas. The GS SUSTAIN focus list includes leaders our analysis shows to be well positioned to deliver long term outperformance through sustained competitive advantage and superior returns on capital relative to their global industry peers. Leaders are identified based on quantifiable analysis of three aspects of corporate performance: cash return on cash invested, industry positioning and management quality (the effectiveness of companies' management of the environmental, social and governance issues facing their industry). Disclosures Coverage group(s) of stocks by primary analyst(s) Piyush Mubayi: Asia Pacific Telecoms, China Internet. Ronald Keung, CFA: China Internet, China Logistics. Fan Liu, CFA: China Internet. Asia Pacific Telecoms: Advanced Info Service PCL, Astro Malaysia Holdings, Axiata Group, Chunghwa Telecom, Digi.com, Far EasTone, HKT Trust, Hong Kong Broadband Network Ltd., Indosat, Intouch Holdings, KT Corp., KT Corp. (ADR), LG UPlus, M1 Ltd., Maxis Bhd, PCCW Ltd., PT Link Net Tbk, PT Sarana Menara Nusantara, PT XL Axiata, Singapore Telecommunications, SK Telecom, SK Telecom (ADR), SmarTone, StarHub, Taiwan Mobile, Telekom Malaysia, Telekomunikasi Indonesia, Total Access Communications, Tower Bersama Infrastructure Tbk, True Corp. China Internet: 58.com Inc., Alibaba Group, Baidu.com Inc., Ctrip.com International, Gridsum, JD.com Inc., NetEase Inc., New Oriental Education & Technology, SINA Corp., TAL Education Group, Tarena International Inc., Tencent Holdings, Vipshop Holdings, Weibo Corp.. China Logistics: Kerry Logistics Network Ltd., Sinotrans Air Transportation Dev, Sinotrans Ltd., ZTO Express (Cayman) Inc.. Company-specific regulatory disclosures The following disclosures relate to relationships between The Goldman Sachs Group, Inc. (with its affiliates, "Goldman Sachs") and companies covered by the Global Investment Research Division of Goldman Sachs and referred to in this research. Goldman Sachs has received compensation for investment banking services in the past 12 months: Tencent Holdings (HK$214.60) Goldman Sachs expects to receive or intends to seek compensation for investment banking services in the next 3 months: Tencent Holdings (HK$214.60) Goldman Sachs had an investment banking services client relationship during the past 12 months with: Tencent Holdings (HK$214.60) Goldman Sachs had a non-securities services client relationship during the past 12 months with: Tencent Holdings (HK$214.60) Goldman Sachs makes a market in the securities or derivatives thereof: Tencent Holdings (HK$214.60) Distribution of ratings/investment banking relationships Goldman Sachs Investment Research global Equity coverage universe

Rating Distribution Investment Banking Relationships Buy Hold Sell Buy Hold Sell Global 32% 54% 14% 64% 60% 51% As of January 1, 2017, Goldman Sachs Global Investment Research had investment ratings on 2,902 equity securities. Goldman Sachs assigns stocks as Buys and Sells on various regional Investment Lists; stocks not so assigned are deemed Neutral. Such assignments equate to Buy, Hold and Sell for the purposes of the above disclosure required by the FINRA Rules. See 'Ratings, Coverage groups and views and related definitions' below. The Investment Banking Relationships chart reflects the percentage of subject companies within each rating category for whom Goldman Sachs has provided investment banking services within the previous twelve months.

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Price target and rating history chart(s)

Tencent Holdings (0700.HK) Stock Price Currency : Hong Kong Dollar Goldman Sachs rating and stock price target history 300 16,000 256 177 193 214 15,000 250 202 205 14,000 146 176 195 13,000 148 150 200 12,000 140 144 11,000 150 10,000 9,000 180 100 150 252.3 8,000 7,000 50 6,000 B F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D 2014 2015 2016 Index Price Stock Price Source: Goldman Sachs Investment Research for ratings and price targets; FactSet closing prices as of 12/31/2016. Rating Covered by Piyush Mubayi Pric e tar get Price target at removal Not covered by current analyst Hang Seng China Ent. Index

The price targets show n should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as w ell as developments relating to the company, its industry and financial markets.

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