Tencent Holdings (700 HK) Tencent H Ol Dings

Home , Honor of Kings, KuGou, Miaopai, Mobile app development

China Information Technology 23 November 2016

Tencent Holdings (700 HK) Tencent H ol dings

Target price: HKD255.00 (from HKD255.00) Share price (22 Nov): HKD195.80 | Up/downside: +30.2%

Thinking big with WeChat Mini Programs John Choi (852) 2773 8730  WeChat is evolving into a de-facto mobile operating system [email protected]  Mini Programs could bring 13% upside to our 2018 revenue forecast Alex Liu (852) 2848 4976  Reiterate Buy (1) and 12-month TP of HKD255; top pick in the sector [email protected]

What's new: Tencent has been testing a new function called WeChat Mini Forecast revisions (%) Programs (小程序), previously known as App Account (应用号), since Year to 31 Dec 16E 17E 18E September 2016. We are excited about this product innovation and believe Revenue change --- Net profit change --- it will further enhance WeChat’s mobile gateway position. By transforming Core EPS (FD) change - - - itself into an indispensable mobile Internet infrastructure platform in China, Source: Daiwa forecasts WeChat has, in our view, greatly reduced the intrinsic risk associated with any social network – that of becoming irrelevant among generations of Share price performance users. We see earnings upside from the launch of Mini Programs from (HKD) (%) 2018E onward, and believe a successful official release of Mini Programs 220 140 would lead to a near-term rerating of the stock. 198 129 175 118

153 106

What's the impact: What are WeChat Mini Programs? Mini Programs 130 95 are a new type of mobile app that allows users to experience a native-app- Nov-15 Feb-16 May-16 Aug-16 like-experience without leaving WeChat. Based on our research, the user Tencent (LHS) Relative to HSI (RHS) experience of Mini Programs closely resembles that for native apps while Mini Programs make it easier for users to discover, access and use 12-month range 133.10-218.20 services vs. native apps. Market cap (USDbn) 236.64 3m avg daily turnover (USDm) 415.47 Shares outstanding (m) 9,374 What are the implications for Tencent? On the user engagement front, Major shareholder Naspers Limited (33.6%) we expect an increase in the time spent on the WeChat platform after the launch of Mini Programs (WeChat could account for 35% of total mobile Financial summary (CNY) time spent in China). On the monetisation front, under our base-case Year to 31 Dec 16E 17E 18E scenario (see page 27), we believe Mini Programs could generate 13% Revenue (m) 152,027 197,657 241,554 additional upside from our current 2018E revenue forecast through paid- Operating profit (m) 58,231 74,146 90,694 Net profit (m) 45,000 60,669 75,722 search (users who look for services will search the relevant keywords Core EPS (fully-diluted) 4.741 6.392 7.978 within WeChat), display ads (service providers could promote their Mini EPS change (%) 37.6 34.8 24.8 Programs through display ads within WeChat), cloud (Mini Program Daiwa vs Cons. EPS (%) 0.6 3.5 1.4 PER (x) 36.7 27.2 21.8 owners will likely adopt Tencent’s public cloud service) and payment Dividend yield (%) 0.4 0.5 0.7 (transactions settled using Mini Programs will need to go through WeChat DPS 0.679 0.930 1.152 Payment). For now, we keep our 2016-18 earnings forecasts unchanged PBR (x) 13.0 9.4 7.0 given the uncertain timing for the potential monetisation of Mini Programs. EV/EBITDA (x) 20.9 16.6 12.8 ROE (%) 36.7 40.6 37.4

Source: FactSet, Daiwa forecasts What we recommend: We reiterate our Buy (1) rating on Tencent and 12- month TP of HKD255, based on an unchanged 35x PER on our 2017E non- GAAP EPS. Key risk: higher-than-expected marketing and content expenses.

How we differ: We believe we are the first on the street to point out and provide a detailed analysis of Mini Programs (also see our China online ads primer). We also conducted a detailed analysis of China’s top-200 apps and offer our analysis on what types of services are likely to shift to Mini Programs.

See important disclosures, including any required research certifications, beginning on page 41

Tencent Holdings (700 HK): 23 November 2016

Table of contents

Let’s talk about WeChat Mini Programs ...... 5 Executive summary ...... 5 What are WeChat Mini Programs? ...... 6 Mini Programs are “apps that run within WeChat” ...... 6 What do we know about Mini Programs so far? ...... 6 Mini Programs is an upgrade to WeChat Official Account ...... 11 Why do Mini Programs matter to Tencent? ...... 13 Our long-held thesis: mobile discovery is broken because apps are “walled garden of information” ...... 13 The mobile world is not flat ...... 13 WeChat is eating into the mobile world ...... 14 Mini Programs could alleviate the mobile discovery bottleneck, especially for long-tail applications ...... 15 Will the user acquisition cost from Mini Programs rise substantially in the future? ...... 15 Who is likely to shift to Mini Programs?...... 17 How can Tencent monetise Mini Programs? ...... 21 Search: likely to be the major monetisation method for Mini Programs ...... 21 Display ads: unlocking the value of Tencent’s vast log-in user base ...... 23 Cloud: Tencent is using Mini Programs to grow cloud services ...... 25 Payments: WeChat Payment — potentially serious competitor to Alipay ...... 26 Quantifying the financial impact from potential monetisation of WeChat Mini Programs ... 26 Online games: long may Tencent reign ...... 28 Mobile gaming: focus on user coverage and quality titles with monetisation longevity ..... 28 PC games: legacy titles keep shining ...... 30 Online ads: letting performance speak for itself ...... 32 Performance ads: Tencent delivers...... 32 Brand ads: controlled deceleration, content investment set to pick up next year ...... 35 Valuation and risks ...... 37

Tencent Holdings (700 HK): 23 November 2016

Financial summary Key assumptions Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Monthly Active Users (MAU) of WeChat n.a. n.a. 355 500 697 880 933 961 (m) WeChat implied revenues (CNYbn) 0 0 3 16 33 61 85 110 Online game revenue (CNYbn) 15.8 22.8 33.2 49.2 64.0 71.3 81.6 89.4 Community value-added services 7.2 9.1 13.0 18.6 24.1 36.4 47.6 58.6 revenue (CNYbn)

Profit and loss (CNYm) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Value-added services (VAS) 26,314 35,718 47,240 63,310 88,124 107,738 129,206 148,019 Online advertising 1,992 3,382 5,034 8,308 17,468 27,284 39,542 54,508 Other Revenue 190 4,793 9,418 7,314 4,726 17,005 28,909 39,026 Total Revenue 28,496 43,894 61,692 78,932 110,318 152,027 197,657 241,554 Other income 890 552 2,219 4,435 4,213 6,077 7,053 7,648 COGS (9,928) (18,207) (27,778) (30,873) (41,631) (66,760) (88,859) (108,506) SG&A (5,265) (8,146) (12,003) (16,736) (21,700) (21,351) (32,218) (39,373) Other op.expenses (1,939) (2,612) (3,590) (4,797) (6,629) (11,762) (9,488) (10,628) Operating profit 12,254 15,479 20,540 30,961 44,571 58,231 74,146 90,694 Net-interest inc./(exp.) 504 836 1,314 494 709 554 1,200 1,300 Assoc/forex/extraord./others (659) (1,264) (2,574) (2,023) (5,120) (5,126) (2,606) (2,173) Pre-tax profit 12,099 15,051 19,281 29,432 40,160 53,659 72,740 89,822 Tax (1,874) (2,266) (3,718) (5,125) (7,108) (11,079) (14,548) (17,964) Min. int./pref. div./others 22 53 61 79 173 453 500 400 Net profit (reported) 10,247 12,838 15,624 24,386 33,225 43,033 58,692 72,257 Net profit (adjusted) 10,940 14,286 17,063 24,224 32,374 45,000 60,669 75,722 EPS (reported)(CNY) 1.127 1.405 1.706 2.642 3.570 4.624 6.306 7.764 EPS (adjusted)(CNY) 1.203 1.563 1.863 2.624 3.478 4.835 6.519 8.136 EPS (adjusted fully-diluted)(CNY) 1.177 1.533 1.827 2.589 3.445 4.741 6.392 7.978 DPS (CNY) 0.150 0.200 0.240 0.360 0.435 0.679 0.930 1.152 EBIT 12,254 15,479 20,540 30,961 44,571 58,231 74,146 90,694 EBITDA 14,192 18,092 24,130 35,758 51,200 69,993 83,633 101,323

Cash flow (CNYm) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 12,099 15,051 19,281 29,432 40,160 53,659 72,740 89,822 Depreciation and amortisation 1,939 2,612 3,590 4,374 5,479 6,733 8,120 9,667 Tax paid (1,836) (2,225) (3,118) (4,481) (5,277) (12,842) (14,067) (17,370) Change in working capital 15,194 21,601 27,492 14,067 57,768 35,414 38,318 36,517 Other operational CF items (14,038) (17,610) (22,871) (10,272) (52,696) (2,471) (747) (1,461) Cash flow from operations 13,358 19,429 24,374 33,120 45,434 80,492 104,364 117,175 Capex (4,060) (3,970) (4,788) (6,033) (7,239) (8,108) (9,081) (10,171) Net (acquisitions)/disposals (6,875) (4,659) 8,059 (23,993) (55,841) (4,885) (5,178) (5,489) Other investing CF items (3,632) (6,772) (21,112) 100 76 76 76 76 Cash flow from investing (14,566) (15,401) (17,841) (29,926) (63,005) (12,917) (14,183) (15,584) Change in debt 2,917 (7,041) 1,334 19,252 17,539 19,143 16,257 16,383 Net share issues/(repurchases) (887) 218 (1,017) 0 0 0 0 0 Dividends paid (895) (1,225) (1,536) (3,323) (2,600) (4,048) (6,364) (8,716) Other financing CF items 3,238 5,662 2,927 8,825 3,589 (1,867) (1,960) (2,058) Cash flow from financing 4,373 (2,386) 1,708 24,754 18,528 13,228 7,933 5,609 Forex effect/others 4,770 (2,424) 1,507 4,899 0 0 0 0 Change in cash 7,935 (782) 9,748 32,846 957 80,803 98,114 107,200 Free cash flow 9,298 15,460 19,586 27,087 38,194 72,383 95,283 107,004 Source: FactSet, Daiwa forecasts

Tencent Holdings (700 HK): 23 November 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment 31,271 29,709 43,982 62,685 135,500 171,644 271,117 379,775 Inventory 0 568 1,384 244 222 260 270 270 Accounts receivable 2,021 2,354 2,955 4,588 7,061 9,731 12,651 15,461 Other current assets 2,212 3,878 5,365 7,804 12,595 17,357 22,566 27,578 Total current assets 35,503 36,509 53,686 75,321 155,378 198,991 306,605 423,084 Fixed assets 5,885 7,899 10,734 11,748 15,879 18,557 20,910 22,897 Goodwill & intangibles 3,780 4,719 4,103 9,304 13,439 12,661 11,793 10,834 Other non-current assets 11,636 26,128 38,712 74,795 128,028 139,510 142,577 144,856 Total assets 56,804 75,256 107,235 171,168 312,724 369,719 481,885 601,671 Short-term debt 8,020 1,077 2,589 3,215 11,429 12,572 13,829 15,212 Accounts payable 2,244 4,212 6,680 8,683 15,700 22,413 29,300 35,571 Other current liabilities 10,919 15,376 23,998 38,137 97,277 133,157 172,728 210,796 Total current liabilities 21,183 20,665 33,267 50,035 124,406 168,142 215,857 261,579 Long-term debt 3,733 7,517 9,141 25,028 37,092 55,092 70,092 85,092 Other non-current liabilities 2,799 4,926 6,364 13,979 23,220 19,153 20,634 21,228 Total liabilities 27,716 33,108 48,772 89,042 184,718 242,387 306,583 367,899 Share capital 0 0 0 0 0 0 0 0 Reserves/R.E./others 28,464 41,297 57,945 80,013 120,035 125,333 173,301 231,772 Shareholders' equity 28,464 41,298 57,945 80,013 120,035 125,333 173,301 231,772 Minority interests 625 851 518 2,111 7,971 2,000 2,000 2,000 Total equity & liabilities 56,804 75,256 107,235 171,166 312,724 369,719 481,885 601,671 EV 1,606,735 1,602,417 1,585,684 1,543,240 1,484,075 1,464,175 1,384,339 1,295,781 Net debt/(cash) (19,517) (21,115) (32,252) (34,442) (86,979) (103,980) (187,196) (279,471) BVPS (CNY) 3.094 4.457 6.224 8.668 12.907 13.371 18.488 24.726

Key ratios (%) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) 45.0 54.0 40.5 27.9 39.8 37.8 30.0 22.2 EBITDA (YoY) 33.7 27.5 33.4 48.2 43.2 36.7 19.5 21.2 Operating profit (YoY) 24.6 26.3 32.7 50.7 44.0 30.6 27.3 22.3 Net profit (YoY) 27.6 30.6 19.4 42.0 33.6 39.0 34.8 24.8 Core EPS (fully-diluted) (YoY) 27.8 30.3 19.1 41.7 33.1 37.6 34.8 24.8 Gross-profit margin 65.2 58.5 55.0 60.9 62.3 56.1 55.0 55.1 EBITDA margin 49.8 41.2 39.1 45.3 46.4 46.0 42.3 41.9 Operating-profit margin 43.0 35.3 33.3 39.2 40.4 38.3 37.5 37.5 Net profit margin 38.4 32.5 27.7 30.7 29.3 29.6 30.7 31.3 ROAE 43.6 41.0 34.4 35.1 32.4 36.7 40.6 37.4 ROAA 23.6 21.6 18.7 17.4 13.4 13.2 14.2 14.0 ROCE 36.0 33.8 34.0 34.3 31.1 31.3 32.6 30.6 ROIC 142.1 85.9 70.2 69.2 82.7 143.5 1,035.3 (252.0) Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 15.5 15.1 19.3 17.4 17.7 20.6 20.0 20.0 Accounts receivable (days) 23.9 18.2 15.7 17.4 19.3 20.2 20.7 21.2 Current ratio (x) 1.7 1.8 1.6 1.5 1.2 1.2 1.4 1.6 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 13.3 14.2 14.1 13.6 12.2 14.7 14.7 14.8 Free cash flow yield 0.6 0.9 1.2 1.7 2.3 4.4 5.8 6.6 Source: FactSet, Daiwa forecasts

Company profile

Tencent is the largest and most used Internet service portal in China. Over the past decade, the company has been able to maintain steady earnings growth under its user-oriented strategy. On 16 June 2004, it was listed on the main board of the Hong Kong Stock Exchange.

Tencent Holdings (700 HK): 23 November 2016

Let’s talk about WeChat Mini Programs

“We are beta-testing Mini Programs in WeChat that will provide native app-like experiences without leaving the WeChat interface, enhancing user convenience for low frequency interactions, freeing up memory space on smartphones, and enabling convenient social sharing.”

- Tencent 3Q16 results announcement, 16 November 2016

Executive summary What are WeChat Mini Programs? WeChat Mini Programs are “apps that can run in WeChat” Mini Programs are still  Mini Programs are new types of mobile apps that allow users to experience a native- mobile apps app-like-experience without ever leaving WeChat  Based on our research, users’ experience on Mini Programs closely resembles that on native apps  Mini Programs greatly enhance the functionality of existing Official Account platforms

Why do Mini Programs matter to Tencent? Mini Programs help users to discover and use services more easily Mini Programs  Mini Programs could potentially solve the broken mobile information discovery (ie, the effectively make WeChat problem of users finding it difficult trying to discover new apps) a mobile OS  By building a platform hosting developers within WeChat, Tencent is making WeChat a device-neutral mobile operating system

How could Tencent monetise Mini Programs? Tencent could start paid-search monetisation from Mini Programs Monetisation models  How to monetise: paid search, display ads, cloud and payment include paid-search, ads,  How long will it take to monetise: likely to make a meaningful revenue contribution payment and cloud from 2018E  How much can it be monetised: under our base case, we estimate 13% revenue upside to our current 2018E revenue forecast from Mini Programs

2017 outlook: online games Premium titles to drive mobile game segment growth into 2017 Strong mobile game  Tencent’s mobile game pipeline looks strong to us pipeline in 2017  Its PC game revenue will continue to rely on legacy titles including League of Legends and CrossFire

2017 outlook: online ads Utilising user insight to improve ads monetisation efficiency Expect a year of strong  Performance-based ads in the sweet spot of monetisation ramp-up; the ads load in ads revenue growth in WeChat Moment is still very low, in our view 2017  The deceleration in brand ads is controllable; content spending may weigh on near- term segment profitability

Recommendation – Buy (1); target price of HKD255 Reiterating Buy (1) rating  Our target price is based on a 35x PER applied to our 2017 non-GAAP EPS forecast. and TP of HKD255  We believe the stock’s current 27x 2017E and 22x 2018E PERs are attractive on the back of our 35% and 25% EPS growth forecasts for 2017 and 2018, respectively.  A successful launch of Mini Programs could be the stock’s biggest near-term catalyst, in our view.

Tencent Holdings (700 HK): 23 November 2016

What are WeChat Mini Programs?

Key highlights  Mini Programs are new types of mobile apps that allow user to experience native-app- like-experience without ever leaving WeChat  Mini Programs greatly enhance the functionality of existing Official Account platforms

Mini Programs are “apps that run within WeChat” Mini Programs are a new Mini Programs, the latest function innovation of WeChat, is a platform that allows programs type of mobile with similar functionalities to individual mobile apps to run within the WeChat platform. In a application nutshell, Mini Programs are “apps that run within WeChat”.

The idea of Mini Programs was revealed for the first time on 11 January 2016. Zhang Xiaolong, Senior VP of Tencent and Head of WeChat Group, announced that Tencent was developing a new WeChat function called App Account (微信应用号), aka Mini Programs:

“We are developing a new type of Official Account, called App Account...in fact for many low-frequency user functions, we don't need to install apps for this …we hope to build a new type of Official Account where, once a user follows an account in WeChat, functionality wise the Official Account would work similarly to an app. A user searching for an Official Account is similar to them searching for an app. Most of the time, the app will not interact with users and will remain quiet, only waiting to be searched by users when needed. We are trying to create a “lighter version” of an app”.

“现在我们将开发一个新的形态，叫做应用号...因为对一些不是很高频度的需求来说不需要再按一个安装...我们希望存在一种新的公众号形态，这种形态下面用户关注了一个公众号，就像安装了一个 APP 一样。他要找这个公众号的时候就像找一个 APP，在平时这个号不会向用户发东西的，所以 APP 就会很安静的存在那里，等用户需要的时候找到它就好了，我们可以尝试做到让更多的 APP 有一种更轻量的形态...”

- Zhang Xiaolong, Senior VP of Tencent & Head of WeChat Group

Some 9 months after Zhang’s announcement, Tencent officially started invitation-only in- house testing for Mini Programs in late September 2016, and rolled out public testing in early November 2016. We expect the latest round of testing to last for at least 1-2 months. After the testing, we expect Tencent to introduce Mini Programs to users in December 2016 or early 2017, likely embedded in the new version of WeChat (7.0 version).

What do we know about Mini Programs so far? On 21 September, Zhang Xiaolong, VP of Tencent, posted the following statement on his WeChat Moment wall:

“What is Mini Programs: Mini Programs are type of applications that do not require installation. It represents the “easy to find” characteristics (for mobile applications) as users could simply open the Mini Programs by scanning QR codes or searching names. It also represents a belief of “use and leave” (for mobile applications) where users do not need to worry about installing too many applications. Mini Programs will be in every use case, will be found at any time, without installation.”

“什么是小程序：小程序是一种不需要下载安装即可使用的应用，它实现了应用 “触手可及”的梦想，用户扫一扫或者搜一下即可打开应用。也体现了“用完即走”的理念，用户不用关心是否安装太多应用的问题。应用将无处不在，随时可用，但又无需安装卸载。”

- Zhang Xiaolong, Senior VP of Tencent & Head of WeChat Group

Tencent Holdings (700 HK): 23 November 2016

Zhang Xiaolong’s description above of Mini Programs is very exciting to us, and makes us wonder how Mini Programs will function after their official release. Given that Mini Programs are still in the closed-testing phase, we contemplated the likely features of Mini Programs after our channel checks with some developers and industry participants. Our key findings are listed below.

Infrastructure: Mini Programs are apps, not web pages Contrary to popular Based on our research, Mini Programs have been developed under mobile app coding belief, Mini Programs are language instead of web page coding language (WXML plus Java instead of HTML). From still a type of native app an infrastructure perspective, Mini Programs are different from web apps (ie, mobile web pages that resemble the functionality of mobile apps, such as Baidu’s Light App). Tencent has created a new set of toolkits and development framework to enable developers to create new Mini Programs from scratch or migrate from existing mobile apps.

We think the fact that Mini Programs have been developed in a native app environment yields some important implications:

 Mini Programs offer users a superior experience to browsing a mobile web page Mini Programs are still within the existing mobile app development framework, despite Tencent opening many Application Programing Interfaces (APIs) allowing developers to easily invoke certain functions (for example, payment). Therefore, we tend to view Mini Programs as an extension of native mobile app development, which should result in a superior user experience when compared to mobile web pages.

An example supporting our argument that Mini Programs feature higher user engagement than mobile web pages is that Mini Programs can store user log-in info with back-end cache support. Recall that PC web pages can store selective user historical browsing data through the use of cookies. Although cookies can still be used on mobile devices, their use is significantly limited (mobile browsers by default limit 3rd party cookies while there are no cookies for mobile applications at all).

 Mini Programs are easier to develop than native mobile apps Based on our discussions with a handful of developers, we believe Mini Programs entail less development labour and time input than native apps. One developer told us that it can take over a month and 10+ developers and UI designers to finish a mobile app, while for Mini Programs, the total development crew could be as small as 6 people and the developing time less than a week.

One of the major reasons explaining why Mini Programs are easier to develop than native mobile apps is that Mini Programs are platform-neutral, meaning that the same code can run on both Android and iOS platforms without having to be modified. For mobile apps, developers are forced to develop 2 suites of codes for the same program simply due the segregation of Android and iOS in terms of mobile OS. From this angle, Mini Programs could reduce upfront development costs considerably without sacrificing too much functionality compared with developing mobile apps.

Tencent Holdings (700 HK): 23 November 2016

Tencent: screenshots of a Mini Programs demo (November 2016) A demo of Mini Programs for Zhihu (知乎)

Screenshot of Zhihu ‘s native mobile app (知乎) Our take: Mini Programs’ functionality, design and use case is very similar to native mobile apps

Source: Github, compiled by Daiwa Note: investors could see testing screenshots at https://github.com/RebeccaHanjw/weapp-wechat-zhihu

Tencent Holdings (700 HK): 23 November 2016

There are no online Content: no online games and live broadcasting games for Mini Based on our market research, we note that Tencent has prohibited certain types of uses Programs for now for Mini Programs development including:

1. No online games For both competitive and user experience reasons, we believe it is understandable that Tencent would not allow developers to develop online games under Mini Programs. For now, the company believes online games that run in the format of individual mobile apps ensure the best user experience.

2. No live broadcasting (eg, Momo, YY, Inke) Tencent also prohibits Mini Programs from providing live broadcasting services to users. We suspect this is due to: 1) regulatory issues (Tencent may need to ensure broadcasting content in compliance with respective regulations which is both labour- intensive and time-consuming), and 2) it is possible that Tencent may consider launching its own live broadcasting service eventually.

Social: Mini Programs won’t be able to be shared with WeChat Moment There are some distinct characteristics on how social factors play a role in the design of WeChat Mini Programs, in our view:

 Mini Programs cannot be shared with WeChat Moment (朋友圈, a function similar to Facebook’s Newsfeed)

 Mini Programs can be shared among conversations within WeChat, to one or a group of contacts

 Mini Programs do not have “follow” functions.

 Mini Programs do not have notification functions.

 Mini Programs are likely to require compulsory WeChat Log-in authentication, although individual Mini Programs will be able to have their own membership system.

Discovery: Mini Programs are found mainly through in-WeChat search & QR code How do users find Mini Programs? Based on our understanding, it is likely that Mini Programs will be able to be accessed in the following ways:

1. In-WeChat Search We believe it is almost certain that In-WeChat search will be one of the most important “entry points” to find Mini Programs, considering Zhang Xiaolong’s comment above. For those investors not familiar with WeChat, In-WeChat search refers to the search function within WeChat (located on the top of the window, as shown below).

We understand WeChat has been enhancing its in-WeChat search capability over the past 2 years, as shown below. We view Tencent’s investment in in-WeChat search as preparation for the upcoming product upgrade, including Mini Programs.

Tencent Holdings (700 HK): 23 November 2016

Tencent: illustration of in-WeChat search Tencent has been Tencent’s WeChat – In-WeChat Search enhancing the search functions within WeChat

“Apple pay ” search result in chatting record

Search bar “Apple pay ” search result in your archived file in Wechat

Search Search Search results results from results for from WeChat WeChat WeChat Official Official Moment Account Account articles Search “Apple pay” in “Moment” and “Official Account”

Source: Tencent, compiled by Daiwa

2. QR code Users will be able to scan a QR code to gain access to specific Mini Programs immediately. This is similar to the current practice of using a QR code to access the WeChat Official Account.

3. “Mini Programs” button on WeChat “Discovery” tab It is also likely that WeChat will add an additional button in its “Discovery” tab as another way for users to find Mini Programs. Again, we suspect that after users click on the “Mini Programs” button, they will be able to see a search bar for them to search Mini Programs and see their favourite Mini Programs (based on our research, one user can only save up to 20 favourite Mini Programs).

Tencent: illustration of how to discover Mini Programs (as of November 2016) Search is likely to become one of the most important ways to find Mini Programs

Entry Point 1: In-WeChat search

小程序 Entry point 2: QR code scan

Entry Point 3: Button on “Discovery” tab

Source: Daiwa

Tencent Holdings (700 HK): 23 November 2016

Mini Programs could be activated even from mobile phone desktops (Android only) On 18 November 2016, Zhang Xiaolong, Head of the WeChat Business Group at Tencent, released a screenshot of his own Android smartphone with icons of WeChat Mini Programs shown on the mobile phone desktop. This screenshot implies that WeChat Mini Programs may be able to be saved as short-cuts on the desktops of mobile phones (Android only), after the official release.

We are impressed by such innovation and believe that if the above functionality is indeed included in the official release, Mini Programs could effectively replace the usage of native apps for many users on the Android platform. However, we see it as extremely unlikely that Apple would allow such a practice for iOS users (ie, adding Mini Programs short cuts to smartphone home pages).

Tencent: screenshot of Zhang Xiaolong’s post on WeChat Moment (18 November 2016) On an Android phone, it is possible for users to activate Mini Programs from the smartphone’s desktop directly

All “apps” on this mobile phone are actually WeChat Mini Programs

A screenshot of Zhang Xiaolong’s post on WeChat Moment

Source: QQ News, compiled by Daiwa

Mini Programs is an upgrade to WeChat Official Account During Tencent’s 3Q16 results conference call, Martin Lau, the president of Tencent, commented on Mini Programs:

“We're still in the beta testing (Mini Programs). There are several hundred developers who are now developing mini programs and we're doing the testing. I think in the next version of the WeChat, it will support Mini Programs.

From a technical perspective, the goal for us is actually to provide to some extent an upgrade experience to our Official Accounts. Official Accounts is ... actually a media and content type of platform whereas Mini Programs actually provide much more flexibility for the developers to develop their services into the WeChat. And it would help the service to actually run like a native app with much faster speed.

Tencent Holdings (700 HK): 23 November 2016

Some ... merchants offline, they can actually promote these Mini Programs. Some of the developers maybe sort of online operators, but their services are infrequently used, but if users want to search for their services and then use it immediately, they can actually do that ... Mini Programs will be used in every case, will be found at any time, without installation.”

- Martin Lau, President of Tencent, Tencent 3Q16 earnings conference call

WeChat Official Account has been a great success in terms of cultivating individual content producers since its launch more than 3 years ago. The drawback of WeChat Official Account is also clear to us: the flexibility of Official Account for developers to customise services is low.

WeChat Mini Programs We think the launch of Mini Programs will be a strong addition to the existing Official and Official Account Account platform, where both content providers and service providers will effectively be could become the new able to reach the over 800m users on WeChat immediately. Eventually, we believe Tencent backbone of the mobile would make it possible to connect Official Account with Mini Programs for content/service business model providers where service providers could engage with users on a constant basis (notification, conversation, etc.), while use Mini Programs to fulfil more complex functionality and complete transactions.

What WeChat wants to accomplish is: in the near future, one probably does not need to set up a web page or develop a mobile app, but simply register a WeChat Official Account and develop a Mini Program to start their online business.

Tencent Holdings (700 HK): 23 November 2016

Why do Mini Programs matter to Tencent?

Key highlights  Mini Programs could potentially solve the broken mobile information discovery  By building a platform hosting developers within WeChat, Tencent is making WeChat a device-neutral mobile operating system

An app-centric mobile Our long-held thesis: mobile discovery is broken Internet world hinders information discovery because apps are “walled garden of information” As detailed in our Primer: decoding Internet discovery and digital advertising (4 March 2016), we conducted a detailed analysis of the current mobile Internet environment and compared it with the PC age. To follow are our major findings:

 Mobile apps are a “walled garden” where information is locked in. Mobile information discovery is becoming increasingly difficult.

 Mobile favours established platforms, as discovery becomes a challenge for smaller and newer platforms; the “winner-takes-all” dynamic is reinforced on mobile.

 User time spent is increasingly concentrated on a few large platforms; “super apps” are set to become a new platform for content creation, distribution and discovery, with user time spent being monetised through digital advertising.

 Universal search engines are likely to face more limitations on mobile; in-app search could potentially be the next monetisation gold mine.

 Growth in display ads is likely to outperform growth in search ads; universal login is likely to be the key user identification method for targeted ads, which again should benefit the large platforms

The mobile world is not flat Similar to the US, mobile usage in China revolves around large platforms, which in China means BAT (Baidu, Alibaba and Tencent). Below we present a set of data showing how skewed the mobile Internet world in China is towards a handful of “super apps”:

 People are using fewer apps On average, each mobile user in China opened only 17.2 apps per month in September 2016 vs. 16.7 in September 2015, according to Questmobile. For reference, the home screen of an iPhone 6/6S contains as many as 30 apps.

 People are more reluctant to try new apps On a monthly basis, around 38% of users in China do not install any new apps on their smartphones, according to Questmobile.

 People’s time spent is concentrated among top apps Top apps not only grab users in their thousands and millions, they also grab the time spent by users. As the chart below shows, the top-10 apps account for over 60% of the total user time spent, according to Questmobile. In other words, the non-top-10 apps combined account for less than 40% of the total mobile time spent in China.

The conclusion: people may have installed many apps on their phones but for the most part, their mobile activities are concentrated on a few top apps right now.

Tencent Holdings (700 HK): 23 November 2016

China: no. of new apps installed (September 2016) China: no. of mobile apps opened per user per month with breakdown into different age groups (September 2016) 18.9 7 8+ 20 18.0 6 17.4 2.1% 6.2% 16.717.2 16.7 15.816.2 15.8 2.9% 15.6 15.015.3 5 15 4.1% 0 38.7% 4 10 5.7%

3 5 8.3%

2 0 12.4% 1 Overall 24 & below 25~30 31~35 36~40 41 & above 19.5% September 2015 September 2016

Source: QuestMobile Source: QuestMobile

China: breakdown of mobile internet time spent in China (September 2016) The top-10 apps account for over 62.5% of mobile time spent in China Others WeChat - 37.5% Tencent 34.5% QQ Browser - Tencent 2.0% QQ - Tencent iQiyi - Baidu 8.3% 2.1% UCWeb - Alibaba Mobile Baidu - Baidu 3.2% 2.2% Toutiao Tencent Video - Tencent Sogou Input - Sohu Mobile Taobao - Alibaba 2.8% 2.3% 2.3% 2.8% Source: QuestMobile

The mobile world We believe one reason for the skew towards a few key apps on mobile is that smartphones resembles a zero-sum generally don’t excel in multi-tasking (ie, having multiple windows open at the same time). game Because users are exposed to a single app at any given time, apps that users spend a lot of time in naturally gain lots of user engagement. As a result, user time spent has become the most important monetisation resource on mobile. More importantly, the fight for mobile time spent is essentially like a zero-sum game, as the amount of user time spent on mobile is only growing. As some apps gain in terms of time spent, others are likely to give up the same amount of time spent.

WeChat is eating into the mobile world In particular, we note that Tencent has been executing the “Super App” approach to bundle multiple functionalities (reading content, mobile games, social networking, etc.) into WeChat. Such a strategy has led to ongoing share gain for WeChat in terms of total user time spent. WeChat’s total mobile time spent almost doubled in one year from September 2015 to September 2016, and now accounts for 35% of total China mobile time spent, according to QuestMobile. It is worthwhile to point out that in the past year, WeChat alone has accounted for an astonishing 50% of the total net additions of total Chinese mobile time spent, suggesting WeChat will continue to gain share in time spent in the next year.

Tencent Holdings (700 HK): 23 November 2016

Tencent: time spent on WeChat vs. total China time spent (September 2015 – September 2016) WeChat alone now (bn min) 5,000 36.3% 35.5% 40% accounts for 35.2% of 34.5% 34.1% 35.2% 33.7% 35.2% 31.5% 31.9% 32.8% total mobile time spent 29.4% 35% 4,000 26.5% 26.7% in China 30% 3,000 25% 20% 2,000 15% 10% 1,000 5% 0 0% Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 WeChat time spent (RHS) Total mobile time spent (RHS) WeChat time spent as % of total mobile time spent (LHS)

Source: QuestMobile

Mini Programs could alleviate the mobile discovery bottleneck, especially for long-tail applications For users, Mini Programs are easier to find and use than native apps without sacrificing much user experience We believe that compared to downloading and installing an app through an app store, Mini Programs are easier to initiate, access and find. A simple analogy would be to consider installing a mobile app on a smartphone as installing a program on a PC, while considering accessing Mini Programs in WeChat as opening up a website on a PC web browser. The hurdle to access Mini Programs is lower from an average user standpoint compared to accessing a mobile app, in our view.

For developers, Mini Programs could be a low-cost user acquisition channel We believe developers are likely to treat Mini Programs as another channel to attract new users in addition to WeChat Official Account, mobile app and mobile website. Specifically, considering the mounting new user acquisition costs (the cost to induce a new user to download your mobile app, which is now around CNY100-200 depending on verticals), we believe any developer would not want to miss out on Mini Programs as a new distribution channel with lower user acquisition costs.

Will the user acquisition cost from Mini Programs rise substantially in the future? We do not think the Mini Programs user acquisition cost will rise to a similar level of user acquisition cost of installing one mobile application. We offer 2 angles to explain our thinking behind this view. But first, let’s define user acquisition cost.

 For mobile applications (which need to be installed through app stores), user acquisition cost is defined as the cost to induce one user to install one mobile application.

 For Mini Programs that run within WeChat, user acquisition cost is defined as the cost to induce one user to run one Mini Program.

First angle: user acquisition cost reflects the level of difficulty for users to find a service organically User acquisition cost effectively measures the willingness of developers to pay for new users. Developers’ willingness is highly correlated with the level of difficulty to expose themselves to potential users. All else equal, we believe developers would be willing to pay more to get one user if users are having a hard time finding their services by themselves (ie, organic growth).

Tencent Holdings (700 HK): 23 November 2016

This is essentially what we are facing on the app-centric world, where users are cut off from trying new services given the discovery experience in app stores is so flawed. We believe the discovery experience for Mini Programs will be easier than in app stores in the sense that users should have an easier time activating and trying Mini Programs compared to installing a mobile app. Therefore, in theory, the user acquisition cost for Mini Programs should be lower than that for a mobile app as it is easier for developers to reach users.

Second angle: user acquisition costs reflect how much revenue paid- traffic could generate For the mobile app developers, the user acquisition cost is usually one-off in nature. In other words, once a user has downloaded an app, all subsequent traffic is 100% organic and free, implying the cost of maintaining existing users is effectively zero, assuming a user churn of 0%. This is contrary to what we observed in the PC Internet age, when the majority of Internet services needed to constantly pay (in most cases, to the search engines) for traffic and user acquisition in order to maintain their existing user base.

Below is an illustration showing why customer acquisition cost (CAC) for a mobile app is one-off in nature.

Tencent: illustration of user acquisition cost for a mobile app vs. Mini Programs After a user installs a Month 1 Month 2 Month 3 Month 4 Month 5 mobile app, all ARPU ARPU ARPU ARPU ARPU subsequent traffic for CNY20 CNY20 CNY20 CNY20 CNY20 the developer is Company A effectively free Mobile application

Paid traffic CNY100 Life Time Value (LTV) = 100 Customer acquisition cost (CAC) = 100

Month 1 Month 2 Month 3 Month 4 Month 5 ARPU ARPU ARPU ARPU ARPU CNY20 CNY20 CNY20 CNY20 CNY20

Company A

Mini Programs

Paid traffic Paid traffic Paid traffic Paid traffic Paid traffic CNY20 CNY20 CNY20 CNY20 CNY20

Life Time Value (LTV) = 100 Customer acquisition cost (CAC) = 100

Source: Daiwa

The CAC is one-off for mobile applications while for Mini Programs, the CAC is the same as for mobile applications but is composed of multiple times of paid traffic (in our above case, 5 times). Therefore, from a unit traffic price perspective, the cost to get a user to visit Mini Programs is much lower than downloading a mobile app. For this reason, we believe the unit price for Mini Programs paid traffic should be much lower than the current unit price of paid traffic for mobile app downloading.

Tencent Holdings (700 HK): 23 November 2016

Who is likely to shift to Mini Programs?

Key highlights  Low-frequency utility apps could be the first to adopt Mini Programs, while in the long term, mobile apps in general are at threat of being “unbundled” by Mini Programs

The mobile business We raised a question in our Primer: decoding internet discovery and digital advertising (4 model is more than March 2016) – in an age when it is becoming increasingly difficult for new apps to be simply developing a discovered through the apps stores, does it still make sense for business owners to mobile app develop native apps to host services (as they are costly to build and maintain), or should they simply host their services on existing platforms where information discovery is easier. This question is best captured as below:

“Do people want to put your icon on their home screen? Do you have the kind of relationship, and proposition, that people will want to engage with enough to put your icon on their phone?”

- Benedict Evans, Partner of VC firm Andreessen Horowitz

Indeed, we wanted to delve a little deeper to see what mobile services might be impacted the most by the launch of Mini Programs. We tackle this question by categorising mobile apps through 2 dimensions: 1) frequency of the service, and 2) the level of information/ content density of the service. In general, we believe that for services that have: 1) higher user frequency, or 2) higher demand for content (ie, less demand for utility) they are less likely to be replaced by Mini Programs.

 In the short term, single-use case low-frequency utility apps are likely to have greater incentive to adopt Mini Programs.

 In the long term, every mobile app (even the ones with high user frequency and information density) could face the threat of functions being “unbundled” into individual Mini Programs gradually.

We also examined the top-200 apps in China in terms of monthly active users (MAU) and evaluated the likelihood of these services shifting to Mini Programs (details on page 18).

Tencent: illustration of Mini Program’s impact on different mobile apps

HIGH frequency • High frequency utility: Meitu, • Map: Baidu Map, AutoNavi (Alibaba) • Personal Financials: Alipay • Browser: UCWeb, QQ Browser, Baidu Browser • High frequency O2O: Car hailing (Didi, Uber), Food • Online video: Tencent Video, iQiyi, Youku Tudou delivery (Baidu Delivery, Meituan Delivery), group-buy • Social Network: Weibo, Momo (Meituan, Dianping, Nuobmi) • Music: QQ Music, Xiami, NetEase Music • Language input: Sogou Input, Baidu Input • Live broadcasting: Inke, YY, Kuaishou • Online games: Tencent, NetEase • Online forum: Zhihu, Baidu Tieba, Xueqiu, Douban • Ecommerce platform: Taobao, JD.com LOW HIGH information/content information/content density density

• Utility: 360 Assistant, Battery Manager, Wifi Manager • App store: Baidu App Store, Yingyongbao • Low frequency O2O: 58 Home, Helijia • Travel: Ctrip, Qunar, eLong, Tuniu • Job: 51 Job • Classified: 58 (WUBA), Ganji • Niche online forum & verticals: Qiongyou (Qyer) • Verticals: Autohome, Bitauto, SouFun, Anjuke

LOW Mini Programs frequency

Source: Daiwa

Tencent Holdings (700 HK): 23 November 2016

China: top-200 apps in terms of MAU as of September 2016 Monthly Shift to Monthly Shift to Rank App name (Chinese) App name Category MAU (m) DAU (m) DAU/MAU frequency Mini Programs?* Rank App name (Chinese) App name Category MAU (m) DAU (m) DAU/MAU frequency Mini Programs?* 1 微信 WeChat IM/SNS 817.8 625.2 76% 569.5 41 猎豹清理大师 Clean master Security 87.9 21.1 24% 47.8 LOW 2 QQ QQ IM/SNS 565.4 292.3 52% 229.0 42 Vivo 应用商店 Vivo app store App store 84.5 6.2 7% 4.4 HIGH 3 手机淘宝 Taobao e-commerce 433.3 152.9 35% 63.3 LOW 43 QQ 欢乐斗地主 QQ huanledoudizhu Game 78.0 19.7 25% 34.0 LOW 4 微博 Weibo IM/SNS 390.6 105.3 27% 52.0 LOW 44 滴滴出行 Didi O2O-inter city 74.4 13.0 17% 34.3 HIGH 5 腾讯视频 Tencent video Video 378.5 79.6 21% 36.2 MAYBE 45 陌陌 Momo IM/SNS 74.3 21.6 29% 121.0 LOW 6 支付宝 Alipay Payment 374.1 84.4 23% 21.3 MAYBE 46 MIUI 天气 MIUI weather Small gadget 73.3 12.3 17% 13.3 HIGH 7 手机百度 Baidu Search 358.4 104.6 29% 53.7 LOW 47 贪吃蛇大作战 Gluttonous snake battle Game 69.3 8.5 12% 16.2 HIGH 8 爱奇艺视频 iQiyi Video 347.6 68.7 20% 35.4 LOW 48 网易新闻 NetEase news News 69.3 25.5 37% 68.3 HIGH 9 搜狗手机输入法 Sogou input Language input 294.5 157.6 54% 1,070.7 LOW 49 QQ 邮箱 QQ email Email 67.8 8.6 13% 13.5 LOW 10 优酷视频 Youku Video 292.5 60.1 21% 35.1 LOW 50 大众点评 Dianping O2O-inter city 67.6 7.2 11% 10.7 HIGH 11 QQ 浏览器 QQ browser Browser 281.2 97.8 35% 59.2 LOW 51 百度云 Baidu cloud Cloud 66.5 8.0 12% 17.1 LOW 12 Wifi 万能钥匙 Wifi key Small gadget 263.1 72.8 28% 32.8 HIGH 52 芒果 TV Mango TV Video 66.2 14.0 21% 34.6 LOW 13 UC 浏览器 UCWeb Browser 251.6 87.8 35% 89.7 LOW 53 王者荣耀 WeHero Game 64.9 11.0 17% 39.7 LOW 14 百度地图 Baidu map Map 226.6 25.8 11% 10.8 MAYBE 54 掌阅 iReader Zhangyue iReader Online literature 62.9 9.3 15% 34.4 HIGH 15 酷狗音乐 Kugou music Music 217.9 56.0 26% 52.1 MAYBE 55 天猫 Tmall e-commerce 62.5 10.0 16% 22.5 LOW 16 QQ 音乐 QQ music Music 217.5 40.9 19% 38.9 MAYBE 56 WPS office WPS office OA 57.6 5.7 10% 13.2 LOW 17 腾讯新闻 Tencent news News 207.7 80.5 39% 55.1 LOW 57 搜狐视频 Sohu TV Video 56.5 9.3 16% 25.9 LOW 18 应用宝 Yingyongbao App store 196.1 27.5 14% 10.3 HIGH 58 暴风影音 Baofeng Video 55.9 10.3 18% 35.0 LOW 19 腾讯手机管家 Tencent mobile safe Security 185.4 57.7 31% 30.3 HIGH 59 唯品会 Vipshop e-commerce 55.9 10.1 18% 22.8 MAYBE 20 360 手机卫士 360 mobile safe Security 168.6 73.2 43% 74.2 HIGH 60 QQ 空间 QQ zone IM/SNS 55.1 16.1 29% 44.2 LOW 21 美团 Meituan O2O-inter city 159.6 12.6 8% 15.1 MAYBE 61 百度手机浏览器 Baidu mobile browser Browser 54.8 11.9 22% 38.1 LOW 22 手机京东 JD e-commerce 155.0 22.9 15% 23.5 MAYBE 62 新浪新闻 Sina news News 54.6 15.6 29% 39.6 HIGH 23 高德地图 Autonavi map Map 153.8 19.6 13% 14.1 MAYBE 63 去哪儿旅行 Qunar Travel 50.0 6.7 13% 15.5 HIGH 24 百度手机助手 Baidu mobile assistant App store 149.8 14.8 10% 8.2 HIGH 64 铁路 12306 12306 Travel 49.9 5.7 11% 12.4 HIGH 25 小米视频 Xiaomi video Video 146.6 18.4 13% 15.6 LOW 65 天气通 Tianqitong Small gadget 49.9 12.2 24% 18.8 HIGH 26 美颜相机 Meiyan camera Graphics processing 145.8 23.7 16% 14.0 HIGH 66 QQ 同步助手 QQ account assistant 49.7 3.7 7% 5.6 HIGH 27 今日头条 Toutiao News 145.5 57.5 40% 96.4 LOW 67 携程旅行 Ctrip Travel 49.4 5.1 10% 12.5 HIGH 28 美图秀秀 Meituxiuxiu Graphics processing 143.5 25.2 18% 20.7 HIGH 68 全民 K 歌 Quanmin Karaoke 47.7 7.7 16% 34.8 LOW 29 OPPO 软件商店 OPPO app store App store 133.1 10.9 8% 4.4 HIGH 69 百度手机卫士 Baidu mobile safe Security 46.8 13.1 28% 32.0 LOW 30 华为应用市场 Huawei app store App store 130.4 12.8 10% 9.0 HIGH 70 58 同城 58 O2O-inter city 46.1 6.2 14% 18.4 HIGH 31 开心消消乐 Happy elements Game 127.8 45.1 35% 66.0 LOW 71 中华万年历日历 Zhonghua Wannianli calendar Small gadget 45.9 11.3 25% 41.5 HIGH 32 快手 Kuaishou Graphics processing 125.8 31.7 25% 50.0 HIGH 72 搜狐新闻 Sohu news News 43.1 13.1 30% 44.9 HIGH 33 360 手机助手 360 mobile assistant App store 111.8 18.7 17% 13.1 HIGH 73 中国建设银行 China construction bank Finance 40.3 5.7 14% 12.3 HIGH 34 墨迹天气 Moji weather Small gadget 111.4 36.5 33% 30.1 HIGH 74 360 浏览器 360 browser Browser 39.8 10.7 27% 49.6 LOW 35 酷我音乐 Kuwo music Music 102.4 20.7 20% 37.0 LOW 75 潮自拍 Chao Selfie Graphics processing 39.6 3.9 10% 8.2 HIGH 36 小米应用商店 Xiaomi app store App store 97.1 7.6 8% 4.6 HIGH 76 360 清理大师 360 clean master Security 38.9 4.5 11% 9.1 LOW 37 讯飞输入法手机版 Xunfei input Language input 96.1 37.9 39% 606.5 LOW 77 乐安全 Lenovo safe Security 38.4 9.0 23% 18.1 LOW 38 乐视视频 Letv video Video 92.3 16.8 18% 25.6 LOW 78 网易云音乐 NetEase cloud music Music 37.8 7.4 20% 39.8 LOW 39 百度手机输入法 Baidu input Language input 92.0 47.1 51% 968.8 LOW 79 网易有道词典 NetEase youdao dictionary Education 36.8 5.0 14% 20.7 MAYBE 40 天天快报 Kuaibao News 88.5 22.0 25% 30.9 HIGH 80 KingRoot KingRoot 35.9 11.7 33% 78.6 LOW Source: QuestMobile; Note: *our estimated level of likelihood for a particular service provider to shift/develop Mini Programs

Tencent Holdings (700 HK): 23 November 2016

China: top-200 apps in terms of MAU as of September 2016 (cont’d) Monthly Shift to Monthly Shift to Rank App name (Chinese) App name Category MAU (m) DAU (m) DAU/MAU frequency Mini Programs?* Rank App name (Chinese) App name Category MAU (m) DAU (m) DAU/MAU frequency Mini Programs?* 81 聚力视频 PPTV Video 35.8 5.1 14% 32.8 LOW 121 苏宁易购 Suning e-commerce 23.2 2.3 10% 9.0 MAYBE 82 铃声多多 Lingshengduoduo 33.7 2.6 8% 6.7 LOW 122 YY YY Live broadcast 22.7 4.3 19% 29.6 LOW 83 土豆视频 Tudou Video 33.6 4.9 14% 22.0 LOW 123 掌上生活 Mlife Finance 22.3 3.0 14% 12.9 HIGH 84 Faceu Faceu Graphics processing 33.6 2.6 8% 7.6 HIGH 124 地铁跑酷 Subwaysurfers Game 22.0 2.2 10% 10.8 LOW 85 天天爱消除 Craz3 match Game 33.5 9.9 29% 58.7 LOW 125 宾果消消乐 Binggo crush Game 22.0 5.0 23% 38.7 LOW 86 Uber Uber O2O-inter city 33.1 3.6 11% 20.9 HIGH 126 OPPO 乐园 OPPO leyuan IM/SNS 21.7 1.0 5% 1.9 LOW 87 Wifi 管家 Wifi manager Small gadget 32.8 4.6 14% 12.2 HIGH 127 平安好医生 Ping'an doctor Healthcare 21.4 5.9 28% 71.8 HIGH 88 哔哩哔哩动画 Bilibili Video 31.9 6.6 21% 45.9 LOW 128 美团外卖 Meituan waimai O2O-inter city 21.2 2.7 13% 17.5 HIGH 89 爱奇艺 PPS 影音 PPS Video 30.9 6.5 21% 36.6 LOW 129 网易邮箱大师 NetEase email master Email 21.1 4.5 21% 30.2 HIGH 90 穿越火线-抢战王者 CrossFire Game 30.4 4.5 15% 23.4 LOW 130 猎豹安全大师 CM safe Security 20.9 3.6 17% 18.8 HIGH 91 PP 助手 PP assistant App store 23.0 2.5 11% 7.3 HIGH 131 同花顺 Tonghuashun Finance 20.5 7.5 37% 188.4 HIGH 92 天天酷跑 Tian Tian Run Game 28.7 5.7 20% 28.5 LOW 132 蘑菇街 Mogujie e-commerce 20.3 3.4 17% 21.6 MAYBE 93 触宝电话 Chubao 28.6 10.4 36% 79.8 LOW 133 中国工商银行 Industrial & commercial bank of China Finance 19.5 2.5 13% 9.4 HIGH 94 中国联通手机营业厅 China unicom business hall Operator 28.4 2.9 10% 7.4 HIGH 134 百度外卖 Baidu waimai O2O-inter city 19.1 1.8 9% 11.3 HIGH 95 中国移动手机营业厅 China mobile business hall Operator 28.3 2.8 10% 7.0 HIGH 135 欢乐麻将 Happy mahjong Game 18.4 3.8 21% 24.3 LOW 96 映客直播 Inke live broadcasting Live broadcast 28.2 5.4 19% 32.1 LOW 136 内涵段子 Neihanduanzi Online literature 18.4 4.4 24% 49.2 HIGH 97 掌上英雄联盟 Mobile club for LoL News 28.0 7.3 26% 43.0 HIGH 137 百度音乐 Baidu music Music 18.3 2.4 13% 16.2 MAYBE 98 MIUI 音乐 MIUI music Music 27.9 2.6 9% 10.4 LOW 138 QQ 阅读 QQ read Online literature 18.1 3.6 20% 64.8 MAYBE 99 中国电信营业厅 China telecom business hall Operator 27.8 2.7 10% 6.2 HIGH 139 蜻蜓 FM Qingting FM Audio product 17.8 4.0 23% 46.1 HIGH 100 豌豆荚 Wandoujia App store 27.7 2.5 9% 7.5 HIGH 140 快牙 Kuaiya Download 17.8 1.2 7% 7.6 LOW 101 一点资讯 Yidian News 27.6 7.1 26% 38.5 HIGH 141 360 云盘 360 cloud Cloud 17.4 1.7 10% 11.6 LOW 102 小米游戏 Xiaomi game App store 27.5 1.8 6% 4.3 HIGH 142 驾考宝典 Jiakaobaodian 17.3 2.5 14% 23.5 HIGH 103 唱吧 Changba 27.1 3.9 14% 33.5 LOW 143 91 助手 91 assistant App store 17.3 1.8 10% 8.3 HIGH 104 喜马拉雅 FM Ximalaya Audio product 26.9 6.2 23% 51.5 HIGH 144 卷皮折扣 Juanpi discount 17.2 2.1 12% 14.3 MAYBE 105 百度视频 Baidu video Video 26.9 5.1 19% 28.1 LOW 145 农行掌上银行 Agricultural bank of China Finance 17.1 2.0 12% 11.0 HIGH 106 百度糯米 Nuomi O2O-inter city 26.5 2.9 11% 9.9 HIGH 146 我的世界 Minecraft Game 17.0 2.3 14% 15.0 LOW 107 美拍 Meipai Graphics processing 26.5 3.9 15% 21.7 HIGH 147 迅雷 Xunlei Download 17.0 3.4 20% 43.2 LOW 108 作业帮 Zuoyebang Education 26.4 3.5 13% 18.8 MAYBE 148 凤凰新闻 iFeng News 16.9 7.0 41% 76.4 HIGH 109 酷派应用商店 Coolpad app store App store 26.3 2.0 7% 4.5 HIGH 149 相机 360 Camera 360 Graphics processing 16.5 2.0 12% 12.5 HIGH 110 快看漫画 Kuaikanmanhua Online literature 26.1 4.9 19% 22.1 HIGH 150 360 影视大全 360kan Video 16.5 4.7 28% 51.5 MAYBE 111 百度帖吧 Tieba IM/SNS 25.7 8.5 33% 76.9 LOW 151 安卓市场 Android market App store 16.4 1.5 9% 7.9 HIGH 112 天天 P 图 Tiantian P Tu Graphics processing 25.5 2.3 9% 8.0 HIGH 152 影视大全 Yingshidaquan Video 16.4 3.2 19% 40.4 LOW 113 三星应用商店 Samsung app store App store 25.5 1.3 5% 3.0 HIGH 153 灵犀语音助手 Lingxiyuyinzhushou Language input 16.2 3.5 22% 12.6 LOW 114 净化大师 King master Security 24.5 1.9 8% 4.6 HIGH 154 JJ 斗地主 JJ doudizhu Game 16.2 4.2 26% 31.7 LOW 115 搜狗搜索 Sogou search Search 24.3 4.3 17% 40.0 LOW 155 江苏移动掌厅客户端 China mobile (Jiangsu) - business hall Operator 16.1 2.3 14% 12.9 HIGH 116 饿了么 Eleme O2O-inter city 24.3 3.5 14% 19.5 HIGH 156 节奏大师 Rhythm master Game 16.1 1.6 10% 13.6 LOW 117 钢琴块 2 Piano tiles 2 Game 24.2 2.1 9% 10.2 LOW 157 拼多多 Pinduoduo e-commerce 16.0 1.9 12% 13.3 MAYBE 118 安卓市场 Himarket App store 24.0 2.7 11% 9.8 HIGH 158 米家 Mi app store App store 15.6 1.5 10% 5.8 HIGH 119 球球大作战 Battle of balls Game 24.0 3.4 14% 21.3 LOW 159 最美天气 Zuimeitianqi Small gadget 15.3 3.8 25% 19.2 HIGH 120 Flipboard 中国版 Flipboard 23.7 1.7 7% 3.8 LOW 160 神庙逃亡 2 Temple run 2 Game 15.0 1.3 9% 9.7 LOW Source: QuestMobile; Note: *our estimated level of likelihood for a particular service provider to shift/develop Mini Programs

Tencent Holdings (700 HK): 23 November 2016

How can Tencent monetise Mini Programs?

Key highlights:  Paid search likely to be the major monetisation model for Mini Programs  Other monetisation opportunities include display ads, payments and cloud services  Specifically Tencent is likely to use Mini Programs to promote adoption of Tencent Cloud among SME developers in China

“The WeChat App Account we will launch shortly is for the benefit of users, as many long-tail niche apps are hard to be discovered and downloaded by users. WeChat App Account will be very convenient (to be discovered) as it does not require to download the apps, and can be rapidly distributed on social platform (ie, WeChat). It is also very easy to set up and maintain. In the future, WeChat App Account will also be connected to our social advertising platform. We all know the biggest revenue model of Facebook is digital ads. For us, we believe the social ads in general should link online and offline activities and we do have great ambitions there.”

“所以说我们将要做的应用号也是希望说长尾的这种 APP 其实用户很难下载，成本很高的，应用号的方式是最方便的，它不需要安装，而且可以社交传播，而且可以流转得很快，他只要用其中一小块儿服务，一页就可以用起来了，是非常好的，而且它可以对接我们以后的社交广告体系，大家知道 Facebook 最大的商业模式是社交广告，这个社交广告我们可以相信线上线下是打通起来的，这是一个很大的一盘棋吧.”

- Pony Ma Huateng, CEO and founder of Tencent

Judging by Pony’s comments above, it seems understandable that advertising would be one of the major monetisation models for Mini Programs. Other possible types of monetisation models that we have identified include payment and cloud services. We discuss each possible monetisation model below in detail:

Search: likely to be the major monetisation method for Mini Programs AddSearch is an We see paid search (real-time bidding priority listing) as being the major monetisation important way to find model for Mini Programs as: 1) search is likely to be the major way users find Mini Mini Programs Programs, and 2) paid search is a mature monetisation model already being used by both Google and Apple, while domestic 3rd party Android app stores are also starting to monetise search traffic.

Tencent Holdings (700 HK): 23 November 2016

Tencent: illustration of current app stores search monetisation

Source: Companies, compiled by Daiwa

Mini Programs content is not accessible to universal search engines (eg, Baidu) Tencent could cut ad In the WeChat Mini Programs operation guidelines, we note that Tencent intentionally revenue from Baidu blocks universal search engines (eg, Baidu) from accessing the data and content of Mini Programs, as detailed below:

“10.2.6 Without Tencent’s permission, developers cannot open Mini Programs’ data to universal search engine, or add own search functions.

10.2.6 未经腾讯公司授权或允许，不得将微信小程序的数据加入搜索引擎或目录，或将微信小程序搜索功能加入微信小程序。”

- WeChat Mini Programs operation guideline, 微信小程序运营规范

We suspect Tencent’s emphasis on blocking external search engines could be for competitive reasons. On this front, we could draw a comparison between WeChat and Taobao:

 Both Taobao and WeChat block external search engines.  Both merchants on Taobao and Mini Programs on WeChat are discovered mainly through search.

Considering Taobao (or the entire Alibaba China retail platform) is monetised predominately through advertising (including paid search advertising and display ads), it is intuitive that Taobao’s monetisation model would be replicated for WeChat Mini Programs, which are paid-search and display ads.

Tencent Holdings (700 HK): 23 November 2016

Tencent has increased its equity holding in Sogou, one of the top-3 mobile search companies in China We noted that, based on Sohu’s 2Q16 10-Q filing, as at 30 June 2016 Tencent’s holding in Sogou had reached 45.3% (fully diluted, assuming full conversion of preferred shares and class B ordinary shares to Class A ordinary shares).

Recall that Tencent sold its own search business, Soso.com, to Sogou in exchange for 36.5% of Sogou’s equity ownership. Sogou, after the merger, now ranks among the top-3 mobile search engines in China along with Shenma (owned by Alibaba) and Baidu. In 2015, Sogou and Tencent invested in Zhihu, a leading online Q&A forum in China, and have since extended their search capability to Zhihu. WeChat also opened its Official Account content data to Sogou exclusively in 2015. We see the past collaboration between Sogou and Tencent plus the recent case of increasing investment as signs of deeper cooperation between Tencent and Sogou, perhaps in the area of Mini Programs search in the future.

Sogou: shareholding structure (30 June 2016) Tencent has increased Total no. of outstanding % of equity its equity holding in No. of share in case of a holding after Sogou No. of class A No. of class B preferred qualified IPO of % of voting 2013 Shareholder shares shares shares Sogou* power* transaction^ % delta Sohu (SOHU US) 131,697,750 131,697,750 39.4% 63.5% -8.8%

Charles Zhang (founder 32,000,000 32,000,000 9.6% and CEO of Sohu) Tencent (700 HK) 6,757,875 79,368,421 65,431,579 151,557,875 45.3% 36.5% +8.8% Employees 19,414,557 19,414,557 5.8%

Total 157,870,182 79,368,421 97,431,579 334,670,182 100% 100%

Source: Sohu, compiled by Daiwa Note: *Class B shares have no voting right unless the holders of at least a majority of the then outstanding Class B Ordinary Shares elect, by written notice to Sogou, to convert them into shares with voting rights; *Preferred shares could be converted into Class A shares upon an qualified IPO on a one-to-one basis; ^Sohu’s holding in Sogou include Sohu management holding in Sogou then

Display ads: unlocking the value of Tencent’s vast log-in user base In addition to paid search marketing, display ads are likely to be another revenue pillar for Mini Programs.

In the short term, we believe Tencent would allow developers to promote Mini Programs using WeChat’s existing mobile ad products, including WeChat Official Account ads and WeChat Moment ads.

In the long term, it is likely that Tencent would allow developers to add native ads to Mini Programs within the infrastructure framework provided by Tencent. For example, for a news aggregation, Mini Programs (similar to Jinri Toutiao) developers could eventually add display ads to the news articles in the future; however, the tool kit for developers to deploy ads would be provided by Tencent, and it is almost certain that Tencent would take a cut from the advertising revenue.

Tencent’s monetisation opportunity is similar to Google’s new Accelerated Mobile Page (AMP) initiative, which is a simplified version of a mobile web page that loads more quickly. Google has announced plans to monetise the traffic of AMP by asking developers to deploy Google’s ads code on AMP.

Tencent Holdings (700 HK): 23 November 2016

Tencent: illustration of display ads within WeChat

Source: Google, Tencent, compiled by Daiwa

Tencent has a clear advantage in log-in user coverage in China, which brings higher targeting accuracy for display ads We note that Tencent has made it clear to developers that WeChat users would be identified by one-single ID across services within WeChat:

“For mobile apps, web apps, Official Accounts and Mini Programs that registered with WeChat Open Platform, the identification for each logged-in user (Union ID) is unique. In addition, for the same WeChat logged-in user, the identification code (Union ID) is the same across various mobile applications & Mini Programs within WeChat.

只要是同一个微信开放平台帐号下的移动应用、网站应用和公众帐号（包括小程序），用户的 Union ID 是唯一的。换句话说，同一用户，对同一个微信开放平台下的不同应用，Union ID 是相同的。”

- WeChat Mini Programs developing guideline, 微信小程序开发规范

In our view, it’s important that investors should be aware that after the official launch, WeChat Mini Programs would likely be China’s largest application platform with all logged- in users, as all Mini Programs users would already be WeChat log-in users.

The universal login is Tencent’s vast log-in user coverage has significant implications for its monetisation the most intuitive and capability through digital ads. Compared to other ad-targeting ID systems such as cookies, accurate identification device IDs, and IP addresses, the universal login is the most intuitive and effective method identifier in the digital ad universe, in our view. The universal login is fundamentally different from other tracking methods in the sense that it truly targets real, live users, contrary to the “guessing approach”, resulting in the highest level of accuracy. In fact, the universal login is the best identification method allowing ad platforms to identify a single user’s behaviour across multiple apps.

In our opinion, Tencent is well-positioned in terms of the coverage of log-in users in China. In China, we estimate that Tencent has the highest coverage of login users for both PC and mobile, with its QQ MAU reaching 860m and WeChat MAU reaching 840m by 3Q16. Tencent also has a handful of highly used apps with shared logins, including Tencent

Tencent Holdings (700 HK): 23 November 2016

Video, QQ Browser, Tencent News, Tiantiankuaibao, etc., which are likely to help it trace users across multiple media properties on multiple devices.

China: comparison of different targeting identification methods We believe the universal Identification method PC Mobile Cross device login (eg, WeChat log-in) Level of target accuracy First-party cookie Good (80% above, but only on its Weaker than PC No capability is the most targeted own domain) identification method for Third-party cookie OK (50-80%, but could target across Weaker than PC No capability domains) display ads Device ID: MAC address Good (80% above) Good (80% above) No capability Device ID: IMEI No IMEI on PC Good (80% above) No capability IP address OK (30-70%, easy to use) OK (30-70%, easy to use) No capability Universal login Very good (90% above) Very good (90% above) Good Drawbacks First-party cookies Can only identify its own domain - Can only identify its own domain No capability - Mobile apps do not support cookies Third-party cookies Some PC browsers limit the tracking - Safari blocks third-party cookies No capability of third-party cookies - Mobile apps do not support cookies Device ID: MAC address Hard to get due to privacy issues Hard to get due to privacy issues No capability (Apple blocks developers to retrieve this data) Device ID: IMEI No IMEI on PC - Hard to get due to privacy issues No capability (Apple blocks developers from retrieving this data) - Many white-label phones share the IMEI IP address Low accuracy Low accuracy No capability Universal login Only large platforms are able to Only large platforms are able to Only large platforms are able to provide such a system provide such a system provide such a system

Source: Chinawebanalytics, Daiwa

Cloud: Tencent is using Mini Programs to grow cloud services We expect Tencent to use Mini Programs to push its public cloud services. Tencent is a relative late-comer to the public cloud segment in China. Its cloud revenue is very small (booked under “other revenue” line) but is growing fast (tripled YoY in 3Q16). Similar to Alibaba’s AliCloud and Amazon’s AWS, Tencent focuses on providing a utility-like public cloud infrastructure instead of offering cloud services that compete with developers directly.

Based on our research, Tencent requires all Mini Programs developers to upload the codes to Tencent’s servers for better distribution. Tencent also states that Mini Programs will utilise local storage, as mentioned below:

“Each Mini Program has own local storage with maximum storage of 10MB. Local storage is permanent, but we don’t recommend to store key information in local storage in case a user changes devices.

每个微信小程序都可以有自己的本地缓存...本地缓存最大 10MB...localStorage 是永久存储的，但是我们不建议将关键信息全部存 localStorage，以防用户换设备的情况。”

- WeChat Mini Programs developing guideline, 微信小程序开发规范

Interestingly, the guidelines above mention the possibility of Mini Programs recovering part of the user’s previously stored data if a user changes their mobile device. This makes us wonder that whether Tencent will consider storing part of the Mini Programs data on its own cloud service to enable “multi-device” usage of Mini Programs.

Based on the above point, we note that Tencent’s public cloud service, Tencent Cloud, launched in October 2016, is a dedicated solution targeting Mini Programs developers. The solution includes helping developers set up a domain for Mini Programs operation, elastic cloud-based storage, communication toolkit, etc. We think Tencent may consider pushing its public cloud services to SME developers through the adoption of Mini Programs.

Tencent Holdings (700 HK): 23 November 2016

Payments: WeChat Payment — potentially serious competitor to Alipay We understand that Mini Programs are deeply integrated with WeChat Payment. We also expect Tencent to make WeChat Payment the only payment method for transactions that occur within Mini Programs, which would lead to a greatly expanded addressable market for Tencent’s payment service.

We note that compared with Alibaba’s Alipay, the No.1 player in China’s online payment market, Tencent is at an advantage for: 1) the strong social circle built around WeChat, making it easier to gain market share of person-to-person transactions (money transfers, buying second hand products, WeChat Shop [微商], etc.), and 2) Tencent’s investment in many non-physical goods services, including Meituan and eLong, which enables it to tap into the non-physical goods transaction payment market. We believe Mini Programs could greatly expand WeChat Payment’s transaction volume given the user time spent, and that transactions (online or offline, physical goods or services) would be effectively “locked” within WeChat.

Tencent: reported “other revenue” growth (1Q12-3Q16)

Tencent’s other revenue (CNYm) was up by more than 5,000 300% YoY for 3Q16 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 Source: Company, compiled by Daiwa; Notes: other revenue includes cloud, payment, physical ecommerce revenue etc

Tencent: reported “other revenue” segmental gross margin (1Q12-4Q16) The payment business 90.0% 81.3% has started to show 80.0% 63.0% some operating leverage 70.0% 59.2% 57.8% 60.0% 49.4% 50.0% 40.2% 43.3% 39.0% 36.8% 36.9% 40.0% 33.1% 30.0% 19.1% 20.0% 15.7% 18.1% 20.0% 12.8% 10.6% 9.5% 7.0% 10.0% -1.5% 0.0%

-10.0%

1Q16 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 2Q16 3Q16

4Q16E Source: Company, compiled by Daiwa Notes: other revenue includes cloud, payment, physical ecommerce revenue, etc.

Quantifying the financial impact from potential monetisation of WeChat Mini Programs We believe investors are generally focused on: 1) how WeChat Mini Programs will be monetised, 2) how long will it take to monetise, and 3) how much can be monetised whenever a new function for Internet companies is released. We have already covered the “how to monetise” part in the above discussion, and now discuss “how long will it take to monetise” and “how much can be monetised”.

Tencent Holdings (700 HK): 23 November 2016

On “how long will it take to monetise Mini Programs”, we noted that it took around 1.5 years for Tencent to roll out ad products for WeChat Official Account after its launch, and 3 years for WeChat Moment to start monetising. Therefore, we would not expect an immediate ad revenue stream from Mini Programs in 2017. On the other hand, Mini Programs may help to accelerate near-term payment and cloud service revenue, which are accounted for as “other revenue”.

We see 22% revenue Below, we show our back-of-the-envelope estimate of how much revenue Mini Programs upside for Tencent’s could bring to Tencent in 2018 under 3 different scenarios. We plug in assumptions for 2018E revenue under our search, display ads, cloud and payment separately, while using Tencent’s major bull-case analysis competitors as a benchmark:

 Search: based on percentage of Baidu’s search revenue for 2018E (on our forecast)  Display ads: based on the percentage of Tencent’s performance ad revenue (excluding Mini Programs) for 2018E (based on our forecast)  Cloud: based on percentage of Alibaba’s cloud revenue for 2018E (on our forecast)  Payment: based on the percentage of transaction value per user for WeChat Payment

Tencent: scenario analysis on Mini Programs revenue in 2018 Bear case Base case Bull case Notes Search a Baidu search revenue in 2018E 76.2 76.2 76.2 Daiwa forecasts b Assume: % of revenue could Mini Programs grab from Baidu 5% 10% 20% c=a*b WeChat Mini Programs search revenue in 2018E 3.8 7.6 15.2 Daiwa estimates Display ads d Tencent's performance-based ads revenue in 2018 (CNYbn) 39.3 39.3 39.3 Daiwa forecasts, excluding Mini Programs e Assume: % of incremental revenue could Mini Programs generate 10% 30% 50% f=d*e WeChat Mini Programs display-ads revenue in 2018E 3.9 11.8 19.7 Daiwa estimates Cloud g Alibaba Cloud revenue in 2018E (CNYbn) 25.8 25.8 25.8 Daiwa forecasts, excluding Mini Programs h Assume: % of revenue could Mini Programs generate vs. Alibaba 10% 20% 30% i=h*g WeChat Mini Programs cloud revenue in 2018E 2.6 5.2 7.7 Daiwa estimates Payment j WeChat MAU (m) 961 961 961 Daiwa forecasts k Assume: % of WeChat user that link WeChat Payment with bank account 40% 50% 60% As of 1Q16, WeChat had 300m+ users that l=k*j No. of WeChat user that link WeChat Payment with bank account 384 481 577 linked WeChat Payment to their bank account Alibaba China retail average spending per m Assume: average spending per user per year (CNY) 1,500 2,000 3,000 active buyer per year is over CNY7000 now We do not account for person-to-person n=m*l WeChat Payment total payment transaction volume (CNYbn) 577 961 1,730 transactions into payment volume o Assume: WeChat Payment take rate % 0.6% 0.6% 0.6% p=o*n WeChat Payment total payment revenue (CNYbn) 3.5 5.8 10.4 Daiwa estimates

For reference

China total social retail in 2018E (CNYbn) 40,000 40,000 40,000 Daiwa forecasts

WeChat payment volume as % of total social retail 1.4% 2.4% 4.3%

Total q=c+f+i+p Total revenue potential from Mini Programs (CNYm) 13.8 30.3 53.0 Daiwa estimates r Tencent total revenue 2018E (CNYm) 241.6 241.6 241.6 Daiwa forecasts s=q/r Revenue upside from Mini Programs to Tencent 2018E revenue 6% 13% 22%

Source: Company, Daiwa estimates and forecasts

Under our base case, we estimate that Mini Programs would offer 13% upside to our 2018 revenue forecast, while the revenue upside could be as high as 22% under our bull case.

Tencent: illustration of revenue upside from Mini Programs under Daiwa’s base-case scenario Mini Programs would (CNYbn) 290 5.8 offer 13% upside to our 5.2 2018 revenue forecast 270 11.8 7.6 for Tencent, under our 250 242 base-case scenario 230 210 190 170 150 Current Tencent 2018E Search Ads Cloud Payment total reveue

Source: Daiwa estimates and forecasts

Tencent Holdings (700 HK): 23 November 2016

Online games: long may Tencent reign

Key highlights:  Tencent’s combined mobile game Daily Active Users (DAU) surpassed 100m in 3Q16  Tencent’s mobile game pipeline in 2017 looks strong  Tencent’s PC game revenue will likely continue to rely on legacy titles like League of Legends and CrossFire

Mobile gaming: focus on user coverage and quality titles with monetisation longevity Tencent reported mobile game revenue of CNY9.9bn for 3Q16, up 87% YoY. We believe the strong performance of Tencent’s hard-core titles, such as Honor of Kings (王者荣耀), has supported its overall mobile game revenue growth. The company announced that during 3Q16, the combined DAU of its mobile game portfolio surpassed 100m, a milestone that has yet to be achieved by any other mobile game company in China.

We note that Tencent’s pace of new mobile game launches has slowed in 2016 compared with last year, which may be explained by its “premium games 3.0” mobile game strategy. This strategy was announced in March 2016 and is focused on launching a few high quality games and improving game operational efficiency. As a result, we estimate that Tencent has only launched 23 new mobile games YTD, notably lower than the 33 new mobile games launched in 2015.

Honor of the Kings (王者荣耀) is Tencent’s in-house developed player vs. player (PVP) mobile game, launched on 26 November 2015. The game is considered to be a mobile version of League of Legends, the No.1 PC client game in China, which was developed by Tencent. Honor of Kings has gained a lot of success since being launched with its monthly ranking reaching second overall in terms of total gross revenue in September 2016, according to App Annie.

Honor of Kings adopts League of Legends’ game play while keeping each round of play under 10 minutes. Therefore, it has attracted a much bigger gamer base than League of Legends as users can play it at almost anytime and anywhere (40m DAU for Honor of Kings, according to Tencent). Tencent’s push for mobile game eSports has resulted in a higher gamer life cycle and retention for Honor of Kings, in our view. We expect Honor of Kings to remain a major mobile game revenue generator for Tencent in 4Q16 and 1H17.

MHZX (梦幻诛仙) is Tencent’s latest hit mobile game launched on 3 November 2016. The game is a massively multiplayer online role-playing game (MMORPG) developed by Perfect World and is exclusively published by Tencent. The game was derived from the popular PC game, Zhu Xian (developed by PerfectWorld), based on the popular online fiction novel of the same name. In November 2016, the game was ranked ninth overall on China’s iOS app store. We expect it to start contributing to Tencent’s material revenue in 4Q16.

China: MAU of selected mobile games in June and August 2016 Honor of Kings enjoys Growth (Aug vs. the highest level of user Title Company Genre MAU (m) (Jun 2016) MAU (m) (Aug 2016) June 2016) Honor of Kings (王者荣耀) coverage within China’s Tencent MOBA 52.3 65.1 24.5% Cross Fire (穿越火线) Tencent FPS 32.7 40.2 22.9% mobile game market We Fly(全民飞机大战) Tencent Casual 8.6 6.7 -22.1% JX Online (剑侠情缘) Tencent MMORPG 9.0 3.8 -57.8% FWJ (梦幻西游) NetEase MMORPG 8.1 7.4 -8.6% WWJ (大话西游) NetEase MMORPG 5.3 4.0 -24.5% Ghost (倩女幽魂) NetEase MMORPG 1.0 5.3 430.0%

Source: QuestMobile

Tencent Holdings (700 HK): 23 November 2016

4Q16 and 1H17 mobile game pipeline: Tencent to focus on premium titles We believe Tencent has a strong mobile game pipeline for 4Q16 and 1H17 with a handful of key titles including:

 Dungeon & Fighter Mobile (地下城与勇士) which is a mobile role-playing game (RPG) developed by Nexon and published by Tencent. The game is based on the PC version of Dungeon & Fighter, which is also published by Tencent in China and remains a top-3 contributor for Tencent’s PC game segment. The game is expected to be launched in 4Q16.

 JX3 Mobile (剑网 3 指尖江湖), a mobile RPG developed by Kingsoft. The game is the third mobile game title derived from Kingsoft’s JX series of PC games. JXQY (剑侠情缘), a mobile game developed by Kingsoft that is also based on the JX series PC games, was also published by Tencent and has been well received since its launch in June 2016. JX3 Mobile is expected to be launched in 2017.

 The World of Legend (传奇世界), MMORPG mobile game developed by Shanda. The World of Legend is Shanda’s second mobile game title to be derived from the popular PC game, Legend. The game finished its first round of beta testing in May 2016 and is expected to be launched in 2017.

 TLBB (天龙八部), a mobile RPG game developed by Changyou and published by Tencent. The game is based on the PC version of TLBB and is expected to be launched in 1H17. According to Changyou, the game has already entered the final stage of beta testing.

 Xuyuanjian (轩辕剑), which is a mobile RPG game developed by Changyou and published by Tencent. The game is based on the PC version of Xuanyuanjian, which was very popular in China in the early 2000s. The game is expected to be launched in 1H17.

 Contra Mobile (魂斗罗), a mobile game derived from a very popular family game in China during the 1980s. The game is due to be launched in 2017.

Tencent: mobile game pipeline (4Q16-2017) We believe Tencent has Game Title Launch Time Genre Developer a strong 2017 mobile Hello Fishing (捕鱼来了) 4Q16E Casual Licensed game pipeline Tian Tian Huan Ling (天天幻灵) 4Q16E Card In-house Dungeon & Fighter Mobile (地下城与勇士) 4Q16E-2017E Action Licensed Ensemble Stars (偶像梦幻祭) 4Q16E-2017E EDU Licensed Dragon Nest (龙之谷) 4Q16E-2017E ARPG Licensed DDTank (弹弹堂) 4Q16E-2017E Shooting Licensed Xrazy Arcade (泡泡堂) 4Q16E-2017E Casual Licensed TLBB (天龙八部) 1Q17E MMORPG Licensed Blade & Soul: Hongmoon Rising (剑灵:洪门崛起) 2017E Action Licensed Xuan Yuan Jian (轩辕剑) 1Q17E MMORPG Licensed Jue Ji (爵迹) 1Q17E MMORPG In-house Xian Jian online (仙剑 online) 2017E MMORPG In-house JX3 (剑网 3) 2017E MMORPG Licensed The World of Legend (传奇世界) 2017E MMORPG Licensed Contra (魂斗罗) 2017E Action In-house

Source: Company, compiled by Daiwa

We forecast Tencent’s mobile game revenue to increase by 30% YoY in 2017 and 21% YoY in 2018, reaching CNY50bn and CNY60bn, accounting for 25% and 25% of the company’s total revenue, respectively.

Tencent Holdings (700 HK): 23 November 2016

Tencent: mobile game revenue forecasts (2013-18E)

We forecast Tencent’s (CNYm) mobile game revenue to 70,000 60,264 rise by 30% YoY for 2017 60,000 49,866 50,000 38,359 40,000

30,000 21,300 20,000 11,200 10,000 3,138 0 2013 2014 2015 2016E 2017E 2018E

Source: Company, Daiwa forecasts

PC games: legacy titles keep shining The overall market size for client-based PC games in China has slowed over the past 5 years and is recording around mid-teen revenue growth currently. Tencent, the largest PC game company in China, recorded 10% YoY growth to CNY12bn for PC game revenue in 3Q16.

Tencent’s top-ranked PC game titles, such as League of Legends (英雄联盟), CrossFire (穿越火线) and Dungeon & Fighter (地下城与勇士) showed ongoing engagement strength among Chinese gamers YTD, according to Shunwang. As detailed in the table below, 6 out of the top-10 PC games in China (ranked by internet cafe usage) are operated by Tencent. While we note the strong performance of NetEase’s licensed Blizzard games including Overwatch and WoW: Legion since June 2016, we are not particularly concerned about the competition among these two companies given they are targeting different gamer groups.

China: PC game net cafe usage ranking (January 2016-October 2016) Game names January February March April May June July August September October League of Legends (英雄联盟) 100 100 100 100 100 100 100 100 100 100 Cross Fire (穿越火线) 18.3 15.8 16.4 16.4 21.3 20.5 21.6 24.4 21 19.4 Dungeon and Fighter (地下城与勇士) 12.4 12.1 12.6 12.6 12.1 14.8 15 11.3 11.2 12.8 QQ Speed (QQ 飞车) 4.3 4.8 4 4 4.4 3.9 4.5 4.8 3.6 3.9 Ni Zhan (逆战) 4.6 4.3 4.1 4.1 3.6 3.4 4.3 3.5 3.4 3.1 OverWatch (守望先锋) - - - - - 2.4 3.1 3.1 2.6 2.4 QQ Dance (QQ 炫舞) 1.7 1.4 1.4 1.4 1.5 1.5 1.6 1.4 1.3 1.3 World of Warcraft (魔兽世界) 0.4 0.4 0.4 0.4 - - - - 1.3 1.1 Dota2 1 1 0.9 0.9 0.9 0.9 1 1 0.8 0.8 Dream of Three Ancient Kingdoms2 (梦三国 2) 1.1 1 0.9 0.9 0.8 0.8 0.9 0.9 0.7 0.7 HearthStone (炉石传说) 0.7 0.6 0.6 0.6 0.6 - - - - 0.5 NBA2KOL 1.5 1.4 1 1 1 1.1 1.2 1 - 0.7

Source: Shunwang, compiled by Daiwa; the usage data is indexed to LoL Notes: grey shaded are Tencent games while yellow shaded are NetEase games

We believe Tencent’s PC game pipeline is less exciting than its mobile game pipeline in 2017. Although we expect new PC game titles such as MapleStory2 and Need for Speed OL to see monetisation progress in 2017, we continue to expect legacy titles including League of Legends and CrossFire to support Tencent’s PC-game momentum.

Tencent: PC game pipeline (4Q16-2017) Game Title Launch Time Genre Developer Master * Master (全职大师) 2017E Action NCsoft MapleStory2 (冒险岛 2) 2017E RPG & Sandbox Nexon Yu Long Zai Tian (御龙在天经典版) 2017E Transformer OL (变形金刚 OL) 2017E FPS In-house Need for Speed OL (极品飞车 OL) 2017E Car-chase EA Iron Knight (刀锋铁骑) 2017E RPG In-house Rising Fire (火源计划) 2017E RPG Yingpei games

Source: Company, compiled by Daiwa

Tencent Holdings (700 HK): 23 November 2016

We forecast Tencent’s PC game revenue to increase by 7% YoY in 2017 and 4% YoY in 2018, reaching CNY50bn and CNY52bn, accounting for 25% and 22% of the company’s total revenue, respectively.

Tencent: PC-game revenue (2013-18E)

We forecast Tencent’s (CNYm) PC-game revenue to rise 60,000 52,047 by 7% YoY for 2017 50,230 50,000 46,770 42,742 38,036 40,000 30,083 30,000

20,000

10,000

0 2013 2014 2015 2016E 2017E 2018E

Source: Company, Daiwa forecasts

Tencent Holdings (700 HK): 23 November 2016

Online ads: letting performance speak for itself

Key highlights:  Performance-based ads in the sweet spot of monetisation ramp-up; ads load in WeChat Moments is still very low  Brand ad deceleration is controllable; content spending may weigh on near-term segment profitability

Tencent reported CNY7.4bn in online ad revenue for 3Q16, representing 51% YoY growth. Within its online ad business, performance-based ad revenue was CNY4.4bn, up by 83% YoY while brand-based ad revenue was CNY3.1bn, up by 21% YoY.

Performance ads: Tencent delivers We have long been a believer in Tencent’s performance-based ad business given its vast user coverage in China which benefits the company due to: 1) the large amount of high quality user attention that can be monetised, and 2) deep insights on user behavior which ensures ad targeting accuracy. We are also encouraged to see that Tencent has been constantly improving its ad service/tool offering to advertisers in order to enhance the efficiency of ads over the past 2 years, instead of adding too much ad inventory, arguably an easy but unsustainable growth strategy, in our view.

Tencent: product upgrades for performance-based ads Tencent has been rolling Time What happened … out new ad toolkits and January 2015 WeChat Moments Ads rolled out (picture + text) December 2015 Moments video ads launched formats for its January 2016 Ad self-service tools launched; On February 23 2016 the function was opened to all WeChat advertisers performance-based ads January 2016 e-Membership card ads launched; On May 20 2016 the function was opened to all WeChat advertisers business February 2016 Tencent lowered the spending threshold for WeChat Moments ads to CNY50,000 from CNY200,000 per campaign March 2016 Moments Ads opened to WeChat Official Account promotion and mobile app downloads April 2016 Self-service tools made available to Moments video ads August 2016 Native H5 ad format was launched in Moments Ads September 2016 Local Ads were launched in Moments Ads October 2016 Moments preferred ads function was launched (公众号互选广告)

Source: Company, compiled by Daiwa

Local Ads in WeChat Moments set to expand Tencent’s advertiser coverage and support online-offline integration Local Ads in WeChat Moments (朋友圈本地推广广告) is the latest innovation from Tencent’s performance-based ad business. The service was launched on 21 September 2016. Equipping advertisers with self-service tools, Local Ads allows offline merchants to post ads targeting potential users located in a certain area at a certain time. Currently Local Ads covers 4,400 business districts in 81 cities in 22 provinces as of November 2016.

As illustrated below, a user can see a promoted merchant’s information and location when scrolling down in the WeChat Moments news feed. After clicking on the ad, more details including merchant address, telephone number, business hours, and main products will be shown.

We believe the addition of Local Ads to WeChat Moments is a significant move for Tencent’s performance-based ads business as:

 Local Ads brings in new local advertisers to Tencent Historically Tencent’s WeChat ads revenue was concentrated on large-scale advertisers with high spending thresholds. By introducing local advertisers into the performance-ads business, Tencent is able to meet a new group of advertiser demand, which should result in incremental revenue gains over the longer term.

Tencent Holdings (700 HK): 23 November 2016

 Local Ads could become a new traffic acquisition channel for Tencent’s local service partners including Meituan Dianping We believe there is considerable overlap between Tencent’s Local Ads advertiser base and merchants on Meituan Dianping (China’s leading local service operator in which Tencent has a minority equity investment). We suspect there could be cooperation between Tencent and Meituan Dianping in the future on traffic acquisition through WeChat, ie, a user clicks on a performance-based ad on WeChat and opens a page that is provided by Meituan Dianping within WeChat. If we think one step forward, a user could settle a bill or finish a local service transaction within WeChat after clicking on a Local Ad, benefiting both WeChat’s ads and payment business.

Tencent: illustration of Local Ads in WeChat Moments (as of November 2016)

Detailed Location

Telephone No.

Business Hour

Recommended Bread

Do you want to dial to Bread Talk?.

Location: No Yes Bread Talk, Donghaibinfen shop, Shenzhen

Source: Tencent, compiled by Daiwa

Previously, WeChat Moments Ads required a minimal spend of CNY50,000 per advertising campaign. For WeChat Local Ads, there is no such spending threshold (merchants will only need to set a minimal daily budget of CNY300).

Pricing of WeChat Local Ads is in line with current ad pricing on WeChat. The cost per thousand impressions (CPM) is CNY150, CNY100 and CNY50 for core cities (Beijing and Shanghai), key cities and other cities, respectively.

Tencent: pricing for current ads on WeChat Moments Local Ads pricing is in In which cities (Pricing all in CNY) CPM - Picture Ads CPM - Video Ads CPM - Local Ads line with current ad Core cities (Beijing and Shanghai) 150 180 150 Key cities (Provincial capital and other tier 2 cities, prices on WeChat 100 120 100 around 20 cities) Moments Other cities (around 60 cities) 50 60 50

Source: Daiwa, Company

Current ad loads for WeChat Moments still low One of the most common questions about Tencent we get from investors concerns the ad load for WeChat Moments. Based on our estimates below, the ads load is still very low for WeChat Moments. The number of ad impressions per DAU per day is only 0.4, on our estimates, much lower than the average global Facebook DAU of 10.6 for 3Q16. The company is focusing on bringing in more advertisers to fill the existing ad inventory instead of aggressively adding new ad inventory. Thus, we see long-term upside for the WeChat Moments ads segment in the next 3-5 years.

Tencent Holdings (700 HK): 23 November 2016

Tencent: estimates of current ad load for WeChat Moments In 3Q16, the number of Assumptions 1Q16 2Q16 3Q16 Notes ad impressions per DAU a Total performance-based ads revenue 2,532 3,697 4,368 Reported b Assume: % of Performance ads from WeChat Moments 30% 35% 40% Daiwa estimates per day was only 0.4, c=a*b WeChat Moments Ads Gross Revenue (CNYm) 760 1,294 1,747 based on our estimates D No. of days in the quarter 91 91 92 e=c/d Average daily WeChat Moments revenue (CNYm) 8 14 19 f CPM (cost per thousand impressions) for WeChat Moment ads (CNY) 100 100 100 Daiwa estimates g=e/f*1000 No. of ads impressions per day (m) 83 142 190 h Average WeChat MAU (m) 730 784 826 Reported i Assume: DAU/MAU ratio % 60% 60% 60% Daiwa estimates j=i*h Average WeChat DAU (m) 438 470 496 k=g/j No. of ads impressions per DAU per day 0.2 0.3 0.4 Daiwa estimates

Source: Daiwa estimates

Facebook: estimates of current ad loads in different regions The ad load for WeChat Assumptions 1Q16 2Q16 3Q16 Notes Moments looks to be Global a Facebook Global ads revenue (USDm) 5,201 6,239 6,816 Reported much lower than for Rb No. of days in the quarter 91 91 92 Facebook right now c=a/b Average daily Facebook Global Revenue (USDm) 57 69 74 d Assume: CPM for Facebook ads - Global (USD) 5.9 6.5 5.9 Nanigan estimates e=c/d*1000 No. of ads impressions per day (m) 9,622 10,515 12,473 f Average Facebook MAU - Global (m) 1,654 1,712 1,788 Reported g Average Facebook DAU - Global (m) 1,090 1,128 1,179 Reported h Implied DAU/MAU ratio % 66% 66% 66% i=e/g No. of ads impressions per DAU per day 8.8 9.3 10.6 Daiwa estimates US & Canada a Facebook US & Canada ads revenue (USDm) 2,615 3,077 3,431 Reported b No. of days in the quarter 91 91 92 c=a/b Average daily Facebook US & Canada Revenue (USDm) 29 34 37 d Assume: CPM for Facebook ads - US & Canada (USD) 8.1 8.3 8.2 Nanigan estimates e=c/d*1000 No. of ads impressions per day (m) 3,556 4,059 4,554 f Average Facebook MAU - US & Canada (m) 222 226 229 Reported g Average Facebook DAU - US & Canada (m) 173 175 178 Reported h Implied DAU/MAU ratio % 78% 77% 78% i=e/g No. of ads impressions per DAU per day 20.6 23.2 25.6 Daiwa estimates Asia a Facebook Asia ads revenue (USDm) 849 1,009 1137 Reported b No. of days in the quarter 91 91 92 c=a/b Average daily Facebook Asia Revenue (USDm) 9 11 12 d Assume: CPM for Facebook ads - Asia (USD) 3.0 3.4 2.6 Nanigan estimates e=c/d*1000 No. of ads impressions per day (m) 3069 3271 4681 f Average Facebook MAU - Asia (m) 533 556 587 Reported g Average Facebook DAU - Asia (m) 340 355 377 Reported h Implied DAU/MAU ratio % 64% 64% 64% i=e/g No. of ads impressions per DAU per day 9.0 9.2 12.4 Daiwa estimates

Source: Facebook, Daiwa estimates

We forecast Tencent’s performance-based ad revenue to increase by 65% YoY for 2017 and 50% YoY for 2018, reaching CNY26bn and CNY39bn, accounting for 13% and 16% of the company’s total revenue, respectively.

Tencent: performance-based ad revenue (2013-18E)

We forecast Tencent’s (CNYm) performance-based ad 45,000 39,291 revenue to grow 65% 40,000 YoY in 2017 35,000 30,000 26,194 25,000 20,000 15,875 15,000 8,683 10,000 3,268 5,000 2,134 0 2013 2014 2015 2016E 2017E 2018E

Source: Company, Daiwa forecasts

Tencent Holdings (700 HK): 23 November 2016

Brand ads: controlled deceleration, content investment set to pick up next year Tencent’s brand advertising business includes online ads from its web portal, Tencent Video and selective ads on Tencent’s Mobile News app. The company’s brand advertising revenue was CNY3,081m for 3Q16 (up 21% YoY), compared with 41% YoY growth for 2Q16, which shows decelerating growth in this segment. We are not particularly concerned about this deceleration, as the company is intentionally shifting some brand ad inventory to performance-based ads (by reallocating some news feed inventory from brand to performance formats).

Meanwhile, we have seen an acceleration in Tencent’s video-content investment over the past few quarters. As Tencent does not disclose its exact amount of video content investment, we examined the cost of revenue for its advertising business, which includes its video content amortisation expenses. As the following chart shows, Tencent’s cost of revenue for its online ad business increased by over 100% from 3Q14 to 3Q16, suggesting a likely rapid increase in content investment. We note that Tencent has secured a number of popular TV shows for 2017, which should support video ad revenue growth and overall brand ad revenue growth in the coming year ahead.

Tencent: cost of revenue for its online ads business vs. Baidu content expenses (1Q12-4Q16E)

Tencent and Baidu have (CNYm) significantly increased 6,000 spending on content in 5,000 the past 4 years 4,000 3,000 2,000 1,000

2Q14 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16E Tencent - Cost of Revenue for Online ads segment Baidu - content cost

Source: Companies, compiled by Daiwa, Daiwa forecasts

Tencent: online ad segment gross-profit margin (1Q12-4Q16E)

60.0%

50.0% 53.7% 52.1% 52.4% 51.8% 51.9% 51.3% 49.6% 48.9% 48.9% 40.0% 44.8% 43.7% 45.3% 41.0% 40.7% 40.0% 39.0% 40.0% 30.0% 34.9% 36.3% 32.5% 20.0%

10.0%

0.0%

2Q14 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16E Source: Companies, compiled by Daiwa, Daiwa forecasts

Tencent Holdings (700 HK): 23 November 2016

Tencent: video pipeline in 4Q16 and 2017 Tencent has secured a Airing cable TV Video pipeline Release time Producer Notable celebrity Station number of popular TV Planet earth II (地球脉动) 4Q16 BBC NA shows for 2017 The adventures of three tomb raiders-Jingjue city (鬼吹灯之精绝古城) 4Q16 In-house 靳东/陈乔恩 Dragon TV Ruyi’s royal love (如懿传) 2017E Licensed 周迅/霍建华

Na Nian Hua Kai Yue ZhengYuan (那年花开月正圆) 2017E Licensed 孙俪/陈晓

Fighter of destiny (择天记) 2017E In-house 鹿晗/古力娜扎

Life is a flower that blooms (三生三世十里桃花) 2017E Licensed 杨幂/赵又廷

Ode to joy 2 (欢乐颂 2) 2017E Licensed 王凯/刘涛/蒋欣

Bei Shang Guang Zhi XiangXin Ai Qing (北上广只相信爱情) 2017E Licensed 朱亚文/陈妍希

The message (风声) 2017E Jiangsu TV

The graver robbers’ chronicles-YDTG (盗墓笔记之云顶天宫) 2017E Co-develop 秦俊杰 Beijing TV Da Tang Rong Yao (大唐荣耀) 2017E Co-develop Beijing TV

Feng Shen Tian Qi (封神天启) 2017E Co-develop Beijing TV

Shi Nian Yi Pin Wen Ru Yan (十年一品温如言) 2017E Co-develop Beijing TV

Source: compiled by Daiwa

We forecast Tencent’s brand-ad revenue to increase by 17% YoY for 2017 and 14% YoY for 2018, reaching CNY13bn and CNY15bn, accounting for 7% and 6% of the company’s total revenue, respectively.

Tencent: brand ad revenue (2013-18E)

We forecast Tencent (CNYm) brand ad revenue to 16,000 15,217 13,349 increase 17% YoY for 14,000 11,409 2017 12,000 10,000 8,785 8,000 6,000 5,040 4,000 2,900 2,000 0 2013 2014 2015 2016E 2017E 2018E

Source: Company, Daiwa forecasts

Tencent Holdings (700 HK): 23 November 2016

Valuation and risks

Buy (1) rating with TP of HKD255 Tencent is our top pick We reiterate our Buy (1) rating and 12-month target price of HKD255, based on a PER of in the China Internet 35x applied to our non-GAAP 2017E EPS forecast, implying a 30% valuation premium to its space China Internet peers.

Mini Programs to drive a potential rerating Based on our forecasts, the shares of Tencent are trading currently at 27x and 22x 2017E and 2018E PERs, backed by our assumption of 35% YoY and 25% YoY EPS growth, respectively. As a result, such a valuation does not look demanding to us.

Historically, we note that Tencent usually sees a significant rerating after a new product/service is launched. For example, after Tencent announced plans to monetise WeChat Moments through online ads in January 2015, the stock was rerated from 28x to as high as 37x in 3 months (in terms of consensus forward 12-month PER). We expect a similar rerating after Mini Programs is officially launched, likely before 1Q17.

Tencent: historical 10-year forward 12-month PER (Nov 2006-Nov 2016) 60 Global financial WeChat starts to 55 crisis gain popularity among users WeChat starts to Mobile game 50 WeChat Moments momentum strong Post-GFC rebound monetise through ads launched 45 mobile game European-Debt 40 crisis

20 10 year average = 30.1x 15

Jul-11 Jul-07 Jul-08 Jul-09 Jul-10 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16

Mar-14 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-15 Mar-16

Nov-09 Nov-07 Nov-08 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15 Nov-06 Source: Bloomberg

Tencent: YTD stock performance comparison

240

220

200

180

160

140

120

100

80 Dec-15 Jan-16 Feb-16 Mar-16 Mar-16 Apr-16 May-16 May-16 Jun-16 Jul-16 Jul-16 Aug-16 Sep-16 Sep-16 Oct-16 Nov-16

Tencent Holdings Alibaba Group (Rebased) Baidu (Rebased) NetEase (Rebased) JD.com (Rebased) Ctrip.com International (Rebased)

Source: FactSet; Notes: all stock prices are rebased to Tencent

Tencent Holdings (700 HK): 23 November 2016

Risks to our call  A faster-than-expected decline in core legacy mobile games revenue including for Honor the Kings, Naruto Mobile, JX Mobile, etc  A slower-than-expected performance advertising products roll out may result in advertisers placing more budget on competitive platforms  A slower-than-expected brand ads revenue growth due to weaker macro conditions in China  A faster-than-expected decline in revenue from the company’s core PC games, such as League of Legends, CrossFire and Dungeon & Fighter  Higher-than-expected marketing and content costs.

China Internet: comparable valuation Market Market cap PER (x) P/S (x) EV/EBITDA (x) ROE % price Ticker Short Name Ratings (local curr') (USDm) FY1E FY2E FY3E FY1E FY2E FY3E FY1E FY2E FY3E FY1E China Internet 700 HK TENCENT Buy 195.80 236,647 36.7 27.2 21.8 10.3 8.2 6.7 20.9 16.6 12.8 36.7 BIDU US BAIDU INC-SP ADR Hold 164.47 57,614 33.6 22.9 16.9 5.4 4.6 3.9 24.3 15.7 10.5 13.1 NTES US NETEASE INC-ADR Buy 231.82 30,392 17.4 14.7 12.1 5.4 4.3 3.4 13.0 9.6 7.3 35.8 CTRP US CTRIP.COM-ADR Buy 41.87 19,238 138.2 36.5 23.4 6.6 5.4 4.5 n.a. 24.9 14.7 9.4 WB US WEIBO CORP-ADR Non-rated 48.96 10,415 72.1 41.9 28.0 12.9 11.3 7.8 62.7 35.0 23.5 12.9 SINA US SINA CORP Non-rated 74.05 5,173 60.1 35.5 22.8 4.4 4.1 3.3 24.8 14.6 7.8 9.5 YY US YY INC-ADR Non-rated 45.49 2,506 12.4 9.9 n.a. 1.9 1.5 1.2 8.6 6.9 n.a. 35.2 SFUN US FANG HOLDING-ADR Non-rated 2.94 1,397 n.a. 27.5 9.8 1.1 1.0 0.8 n.a. 18.9 8.8 (31.2) ATHM US AUTOHOME INC-ADR Non-rated 27.23 3,131 17.0 14.8 12.0 2.2 3.3 3.2 13.9 10.5 8.6 22.0 EDU US NEW ORIENTAL-ADR Buy 51.35 8,060 28.5 22.1 17.7 4.5 3.7 3.1 18.3 13.1 9.2 15.7 BITA US BITAUTO HOLD-ADR Non-rated 22.77 1,610 32.2 17.4 10.7 1.8 2.7 2.3 16.8 9.2 7.3 (4.8) WUBA US 58.COM-ADR Non-rated 32.49 4,683 n.a. 35.4 16.4 3.3 3.2 2.5 49.0 19.1 10.6 (3.7) QUNR US QUNAR CAYMAN-ADR Non-rated 29.95 4,438 n.a. 93.8 28.6 5.2 4.3 3.1 n.a. 166.9 30.9 n.a. XRS US TAL EDUCATIO-ADR Buy 76.77 6,223 46.5 29.9 19.8 6.3 4.2 2.8 31.9 18.9 10.8 28.7 SOHU US SOHU.COM INC Non-rated 34.69 1,344 n.a. n.a. n.a. 0.8 0.8 0.7 89.8 6.7 4.1 (16.0) Average 45.0 30.7 18.5 4.8 4.2 3.3 31.2 25.8 11.9 11.7 China E-commerce BABA US ALIBABA GRP-ADR Buy 93.20 230,484 30.0 22.6 17.8 10.0 7.8 6.1 20.2 14.9 10.9 23.5 JD US JD.COM INC-ADR Buy 25.81 37,156 n.a. 97.4 39.0 1.0 0.8 0.6 n.a. 59.0 25.8 0.4 VIPS US VIPSHOP HOLDINGS Buy 12.07 6,992 17.9 15.2 12.6 0.8 0.7 0.6 13.3 9.2 6.7 62.6 JMEI US JUMEI INTERNATIO Non-rated 5.03 738 12.1 8.1 6.6 0.5 0.4 0.3 4.8 3.0 2.3 3.4 Average 20.0 35.8 19.0 3.1 2.4 1.9 12.8 21.5 11.4 22.5 Global Internet AAPL US APPLE INC Outperform 111.80 596,153 12.4 11.2 11.1 2.6 2.5 2.3 6.2 5.8 5.6 36.9 GOOG US ALPHABET INC-C Buy 768.27 534,877 22.4 18.8 16.0 6.5 6.2 5.3 12.7 10.8 9.3 15.2 FB US FACEBOOK INC-A Buy 121.47 350,950 29.6 23.1 18.6 10.3 9.6 7.1 18.4 14.3 11.1 15.7 AMZN US AMAZON.COM INC Outperform 785.33 373,163 80.2 55.2 38.3 2.4 2.2 1.8 24.8 18.8 14.7 13.9 PCLN US PRICELINE GROUP Outperform 1,535.42 75,765 23.8 20.4 18.0 6.3 6.1 5.2 19.3 16.2 14.2 21.4 EBAY US EBAY INC Hold 29.06 32,487 15.4 13.9 12.8 3.5 3.5 3.3 9.7 9.1 8.6 27.2 YHOO US YAHOO! INC Outperform 41.01 39,129 72.1 65.6 63.8 11.5 11.2 11.1 39.5 37.6 38.4 (15.3) TWTR US TWITTER INC Hold 18.63 13,319 35.8 30.5 24.2 4.9 4.7 4.3 15.7 13.3 11.6 (8.5) NFLX US NETFLIX INC Hold 118.04 50,656 174.4 94.9 52.6 4.8 4.6 3.7 88.0 50.2 31.4 6.9 EXPE US EXPEDIA INC Non-rated 127.57 19,139 27.1 20.1 16.0 2.0 1.9 1.7 13.6 11.0 9.2 5.6 TRIP US TRIPADVISOR INC Non-rated 51.34 7,480 33.5 31.8 25.0 4.6 4.5 4.0 18.4 17.2 14.0 8.2 LNKD US LINKEDIN CORP-A Outperform 193.72 26,257 48.2 40.2 32.4 6.1 5.8 4.8 21.2 17.6 15.1 (3.6) 035420 KS NAVER CORP Buy 810,000 22,700 30.3 21.9 18.9 6.4 5.5 4.9 18.2 12.9 10.7 34.6 035720 KS KAKAO CORP Buy 81,800 4,695 82.4 23.3 16.9 3.8 3.0 2.6 24.8 12.3 9.5 2.1 4755 JP RAKUTEN INC Outperform 1,143.00 14,742 25.8 20.3 16.1 1.9 0.0 0.0 2.8 2.3 2.0 7.2 4689 JP YAHOO JAPAN CORP Outperform 410.00 21,030 17.3 15.8 14.4 2.7 2.9 2.7 8.4 7.7 7.1 14.0 Average 45.7 31.7 24.7 5.0 4.6 4.1 21.3 16.1 13.3 11.3 Source: Bloomberg; *Daiwa forecasts; note: prices as of close on 22 November 2016

Tencent Holdings (700 HK): 23 November 2016

Daiwa’s Asia Pacific Research Directory HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Jiro IOKIBE (852) 2773 8702 [email protected] Shipbuilding; Steel Co-head of Asia Pacific Research Mike OH (82) 2 787 9179 [email protected] John HETHERINGTON (852) 2773 8787 [email protected] Banking; Capital Goods (Construction and Machinery) Co-head of Asia Pacific Research Iris PARK (82) 2 787 9165 [email protected] Rohan DALZIELL (852) 2848 4938 [email protected] Consumer/Retail Regional Head of Asia Pacific Product Management SK KIM (82) 2 787 9173 [email protected] Kevin LAI (852) 2848 4926 [email protected] IT/Electronics – Semiconductor/Display and Tech Hardware Chief Economist for Asia ex-Japan; Macro Economics (Regional) Thomas Y KWON (82) 2 787 9181 [email protected] Olivia XIA (852) 2773 8736 [email protected] Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Games Macro Economics (Hong Kong/China) Kevin JIN (82) 2 787 9168 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Small/Mid Cap

Head of Automobiles; Transportation and Industrial (Hong Kong/China) TAIWAN Brian LAM (852) 2532 4341 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Auto Components; Transportation – Railway; Construction and Engineering (China) Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Leon QI (852) 2532 4381 [email protected] (Regional) Banking; Diversified financials; Insurance (Hong Kong/China) Christie CHIEN (886) 2 8758 6257 [email protected] Yan LI (852) 2773 8822 [email protected] Banking; Insurance (Taiwan); Macro Economics (Regional) Banking (China) Steven TSENG (886) 2 8758 6252 [email protected] Anson CHAN (852) 2532 4350 [email protected] IT/Technology Hardware (PC Hardware) Consumer (Hong Kong/China) Kylie HUANG (886) 2 8758 6248 [email protected] Adrian CHAN (852) 2848 4427 [email protected] IT/Technology Hardware (Handsets and Components) Consumer (Hong Kong/China) Helen CHIEN (886) 2 8758 6254 [email protected] Jamie SOO (852) 2773 8529 [email protected] Small/Mid Cap Gaming and Leisure (Hong Kong/China) John CHOI (852) 2773 8730 [email protected] INDIA Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Carlton LAI (852) 2532 4349 [email protected] Head of India Research; Strategy; Banking/Finance Small/Mid Cap (Hong Kong/China) Saurabh MEHTA (91) 22 6622 1009 [email protected] Dennis IP (852) 2848 4068 [email protected] Capital Goods; Utilities Power; Utilities; Renewables and Environment (Hong Kong/China) Jonas KAN (852) 2848 4439 [email protected] SINGAPORE Head of Hong Kong and China Property Ramakrishna MARUVADA (65) 6499 6543 [email protected] Cynthia CHAN (852) 2773 8243 [email protected] Head of Singapore Research; Telecommunications (China/ASEAN/India) Property (China) David LUM (65) 6329 2102 [email protected] Thomas HO (852) 2773 8716 [email protected] Banking; Property and REITs Custom Products Group Royston TAN (65) 6321 3086 [email protected] Oil and Gas; Capital Goods

Shane GOH (65) 64996546 [email protected] Property and REITs; Small/Mid Cap (Singapore) Jame OSMAN (65) 6321 3092 [email protected] Transportation – Road and Rail; Pharmaceuticals and Healthcare; Consumer (Singapore)

Tencent Holdings (700 HK): 23 November 2016

Daiwa’s Offices Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726 Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, United Kingdom (44) 207 320 8000 (44) 207 410 0129 Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

Daiwa Capital Markets America Inc. New York Head Office Financial Square, 32 Old Slip, New York, NY10005, U.S.A. (1) 212 612 7000 (1) 212 612 7100 Daiwa Capital Markets America Inc. San Francisco Branch 555 California Street, Suite 3360, San Francisco, CA 94104, U.S.A. (1) 415 955 8100 (1) 415 956 1935 Daiwa Capital Markets Europe Limited, London Head Office 5 King William Street, London EC4N 7AX, United Kingdom (44) 20 7597 8000 (44) 20 7597 8600 Daiwa Capital Markets Europe Limited, Frankfurt Branch Neue Mainzer Str. 1, 60311 Frankfurt/Main, Germany (49) 69 717 080 (49) 69 723 340 Daiwa Capital Markets Europe Limited, Paris Representative Office 17, rue de Surène 75008 Paris, France (33) 1 56 262 200 (33) 1 47 550 808 Daiwa Capital Markets Europe Limited, Geneva Branch 50 rue du Rhône, P.O.Box 3198, 1211 Geneva 3, Switzerland (41) 22 818 7400 (41) 22 818 7441 Daiwa Capital Markets Europe Limited, Midland Plaza 7th Floor, 10 Arbat Street, Moscow 119002, (7) 495 641 3416 (7) 495 775 6238 Moscow Representative Office Russian Federation Daiwa Capital Markets Europe Limited, Bahrain Branch 7th Floor, The Tower, Bahrain Commercial Complex, P.O. Box 30069, (973) 17 534 452 (973) 17 535 113 Manama, Bahrain Daiwa Capital Markets Hong Kong Limited Level 28, One Pacific Place, 88 Queensway, Hong Kong (852) 2525 0121 (852) 2845 1621 Daiwa Capital Markets Singapore Limited 6 Shenton Way #26-08, OUE Downtown 2, Singapore 068809, (65) 6220 3666 (65) 6223 6198 Republic of Singapore Daiwa Capital Markets Australia Limited Level 34, Rialto North Tower, 525 Collins Street, Melbourne, (61) 3 9916 1300 (61) 3 9916 1330 Victoria 3000, Australia DBP-Daiwa Capital Markets Philippines, Inc 18th Floor, Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, (632) 813 7344 (632) 848 0105 Makati City, Republic of the Philippines Daiwa-Cathay Capital Markets Co Ltd 14/F, 200, Keelung Road, Sec 1, Taipei, Taiwan, R.O.C. (886) 2 2723 9698 (886) 2 2345 3638 Daiwa Securities Capital Markets Korea Co., Ltd. 20 Fl.& 21Fl. One IFC, 10 Gukjegeumyung-Ro, Yeongdeungpo-gu, (82) 2 787 9100 (82) 2 787 9191 Seoul, Korea Daiwa Securities Co. Ltd., Beijing Representative Office Room 301/302，Kerry Center，1 Guanghua Road，Chaoyang District， (86) 10 6500 6688 (86) 10 6500 3594 Beijing 100020, People’s Republic of China Daiwa (Shanghai) Corporate Strategic Advisory Co. Ltd. 44/F, Hang Seng Bank Tower, 1000 Lujiazui Ring Road, Pudong, (86) 21 3858 2000 (86) 21 3858 2111 Shanghai China 200120 , People’s Republic of China Daiwa Securities Co. Ltd., Bangkok Representative Office 18th Floor, M Thai Tower, All Seasons Place, 87 Wireless Road, (66) 2 252 5650 (66) 2 252 5665 Lumpini, Pathumwan, Bangkok 10330, Thailand Daiwa Capital Markets India Private Ltd 10th Floor, 3 North Avenue, Maker Maxity, Bandra Kurla Complex, (91) 22 6622 1000 (91) 22 6622 1019 Bandra East, Mumbai – 400051, India Daiwa Securities Co. Ltd., Hanoi Representative Office Suite 405, Pacific Palace Building, 83B, Ly Thuong Kiet Street, (84) 4 3946 0460 (84) 4 3946 0461 Hoan Kiem Dist. Hanoi, Vietnam

DAIWA INSTITUTE OF RESEARCH LTD HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603 MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021

New York Research Center 11th Floor, Financial Square, 32 Old Slip, NY, NY 10005-3504, U.S.A. (1) 212 612 6100 (1) 212 612 8417 London Research Centre 3/F, 5 King William Street, London, EC4N 7AX, United Kingdom (44) 207 597 8000 (44) 207 597 8550

Tencent Holdings (700 HK): 23 November 2016

Important Disclosures and Disclaimer

This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Group Inc., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person.

Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including market making activities, derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures.

Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, the subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Neo Solar Power Corp (3576 TT). *Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd.

Hong Kong This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司) (“DHK”) which is regulated by the Hong Kong Securities and Futures Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research.

Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage.

Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research.

Australia This research is distributed in Australia by Daiwa Capital Markets Australia Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research.

India This research is distributed in India to Institutional Clients only by Daiwa Capital Markets India Private Limited (Daiwa India) which is an intermediary registered with Securities & Exchange Board of India as a Stock Broker, Merchant Bank and Research Analyst. Daiwa India, its Research Analyst and their family members and its associates do not have any financial interest save as disclosed or other undisclosed material conflict of interest in the securities or derivatives of any companies under coverage. Daiwa India and its associates, may have received compensation for any products other than Investment Banking (as disclosed)or brokerage services from the subject company in this report or from any third party during the past 12 months. Daiwa India and its associates may have debt holdings in the subject company. For information on ownership of equity, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. There is no material disciplinary action against Daiwa India by any regulatory authority impacting equity research analysis activities as of the date of this report. Associates of Daiwa India, registered with Indian regulators, include Daiwa Capital Markets Singapore Limited and Daiwa Portfolio Advisory (India) Private Limited.

Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd. and it may only be distributed in Taiwan to specific customers who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd. and non-customers including (i) professional institutional investors, (ii) TWSE or TPEx listed companies, upstream and downstream vendors, and specialists that offer or seek advice, and (iii) potential customers with an actual need for business development in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Neither Daiwa-Cathay Capital Markets Co., Ltd. nor its personnel who writes or reviews the research report has any conflict of interest in this research. Since Daiwa-Cathay Capital Markets Co., Ltd. does not operate brokerage trading business in foreign markets, this research is “without recommendation” to any foreign securities and Daiwa-Cathay Capital Markets Co., Ltd. does not accept orders from customers to trade in such securities that are without recommendation. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd. in respect of any matter arising from or in connection with the research.

Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Philippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE links at http://www.sec.gov.ph and http://www.pse.com.ph/ respectively.

Thailand This research is distributed to only institutional investors in Thailand primarily by Thanachart Securities Public Company Limited (“TNS”). This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. This report is provided to you for informational purposes only and it is not, and is not to be construed as, an offer or an invitation to make an offer to sell or buy any securities. Neither Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees accept any liability whatsoever for any direct or consequential loss arising from any use of this research or its contents. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable. However, Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees make no representation or warranty, express or implied, as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. The use of any information, forecasts and opinions contained in this report shall be at the sole discretion and risk of the user. Daiwa Securities Group Inc. and/or its non-U.S. affiliates perform and seek to perform business with companies covered in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates, their respective directors, officers, servants and employees may have positions and financial interest in securities mentioned in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this research. Therefore, investors should be aware of conflict of interest that may affect the objectivity of this research.

United Kingdom This research report is produced by Daiwa Securities Co. Ltd. and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital

Tencent Holdings (700 HK): 23 November 2016

Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange and Eurex. This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory.

Germany This document is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany.

Bahrain This research material is distributed in Bahrain by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (Tel no. 212-612-7000).

Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

Disclosure of investment ratings Rating Percentage of total Buy* 64.0% Hold** 21.2% Sell*** 14.8% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 30 September 2016. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.  In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.  In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.  For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.  There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.  There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.  Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association