BOCOM Int’l Research Company Update

Internet Last Close Target Price Upside 17 May 2018 HK$396.2 HK$533.00↓ +35%

Tencent (700 HK)

Solid top-line growth in 1Q18

 Revenue beat on payment; profit in line: Total revenue/non-GAAP net profit rose Stock Rating 48%/29% YoY in 1Q18. Revenue was 4% higher than consensus driven by solid BUY performance of payment-related services (triple-digit growth YoY). GPM for VAS

was up 4ppts/2ppts QoQ/YoY driven by higher revenue contribution from in-house 1-year stock performance games. GPM of cloud and payment improved to 25.4% (up 3ppts QoQ/YoY). Non- GAAP net margin was 25%, compared with 26%/29% in 4Q17/1Q17. 100% HSI 700 HK 80%  Segment review: PC game/mobile game revenue were in line with our expectation, 60% 40% at RMB14.1bn/21.7bn, up 0%/68% YoY. Revenue from DnF reached a record high 20% thanks to seasonal promotion, while total PC game revenue remained flattish YoY. 0% Mobile game revenue was strong, led by HoK, CF, and newly launched MU -20% May-17 Sep-17 Jan-18 May-18 Awakening and QQ Speed, primarily driven by 42% YoY growth of ARPU. Social ads Source: Bloomberg revenue surged 69% YoY to RMB7.4bn, supported by increased ad load from WeChat Moments and higher CPC for mobile ad network. Video posted Stock data 52w high (HK$) 476.60 sound performance with subscription/ad revenue up 85%/64% YoY. 52w low (HK$) 256.2 Market cap (HK$ m) 3,765,361  Strategic development: Mini Games was also encouraging with 500+ games Avg daily vol (m) 25.75 launched and over 1/3 of players being brand-new gamers of Tencent. We think YTD change (%) -2.41 200d MA (HK $) 388.81

this should educate more users to adopt mini program for other uses. Weishi, a mini video app, was relaunched as a strategic product to enrich Tencent’s PUGC Source: Bloomberg

content offering, including the distribution of Tencent’s exclusive content in games, Gu Xinyu (Connie), CPA music, sports and variety shows. [email protected]  2018 outlook and valuation: We expect the solid 1Q18 results to ease market’s (86) 10 8800 9788 – 8045

concern on game revenue growth. PC games remain under pressure given flattish Sun Mengqi (Brandy) YoY revenue growth this quarter, which may be offset by solid mobile game [email protected] performance and new PC game pipeline, including Fortnite and PUBG, in our view. (86) 10 8800 9788 – 8048 Given higher-than-expected payment revenue, we lift 2018/19E revenue estimates

by 1.3%/1.7% but cut 2018E EPS by 4.6% on higher content cost on video, expected Zhou Zhe (Gigi) spending on Weishi, and new game pipeline promotion in 2H18. We fine-tune TP from HK$535 to HK$533, implying 53x/42x 2018/19E P/E. Maintain Buy. [email protected] (86) 10 8800 9788 – 8041 Financial highlights Y/E 31 Dec 2016 2017 2018E 2019E 2020E Revenue (RMB m) 151,938 237,760 338,498 448,457 555,323 YoY growth (%) 48 56 42 32 24 Net profit (RMB m)^ 45,420 65,126 78,626 99,380 117,769 EPS (RMB)^ 4.79 6.86 8.22 10.38 12.27 YoY growth (%) 39 43 20 26 18 BOCOM International is Previous EPS (RMB) 8.62 10.60 12.47 proud to be a Gold Change (%) -5 -2 -2 Sponsor of the 71st CFA P/E (x) 71 50 39 31 27 BVPS (RMB) 20 29 30 39 48 Institute Conference to P/B (x) 17 12 11 8 7 be held in . Source: Company data, BOCOM Int’l estimates ^non-GAAP basis

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17 May 2018 Tencent (700 HK)

Figure 1: 1Q18 results summary (RMB m) BOCOM Y/E 31 Dec 1Q17 4Q17 1Q18 QoQ (%) YoY (%) forecasts Difference Comments Revenue VAS 35,108 39,947 46,877 17 34 46,523 0.8 Mobile game revenue up 68% YoY Online advertising 6,888 12,361 10,689 -14 55 11,025 -3.1 Video ad increased by 64% YoY Others 7,556 14,084 15,962 13 111 13,724 16.3 Driven by offline payment and cash withdrawal fees Total revenue 49,552 66,392 73,528 11 48 71,272 3.2

Cost of revenue -24,109 -34,897 -36,486 5 51 -37,961 -3.9 Increased channel cost for games and content cost

Gross profit 25,443 31,495 37,042 18 46 33,312 11.2 Gross margin (%) 51 47 50 47 QoQ decline due to seasonality of ad

Other operating (exp)/inc 3,999 9,062 8,650 -5 116 2,148 302.8 Gain from FV change of investee companies, excluded under non- GAAP measures Selling and marketing expenses -3,158 -6,022 -5,570 -8 76 -3,991 39.6 Increased promotion activities YoY General and administrative expenses -7,012 -8,811 -9,430 7 34 -8,988 4.9 Increased staff costs and R&D expenses

Profit from operations 19,272 25,724 30,692 19 59 22,480 36.5 (expenses)/income -691 -859 -654 -24 -5 -741 -11.7 Equity investment/share of loss of associates -375 -120 -319 166 -15 -450 -29.1 Equity investment/share of loss of JV 0 0 0 -14 -100.0 Operating margin (%) 39 39 42 32

Profit before taxation 18,206 24,745 29,719 20 63 21,275 39.7 Taxation -3,658 -3,123 -5,746 84 57 -4,210 36.5 Larger withholding tax and higher profit before income tax Net profit 14,548 21,622 23,973 11 65 17,065 40.5 Minority interests -72 -825 -683 -17 849 -120 469.2 Net profit attributable to shareholders of 14,476 20,797 23,290 12 61 16,945 37.4 company Net margin (%) 29 31 32 24

Non-GAAP net profit 14,211 17,454 18,313 5 29 19,300 -5.1 Non-GAAP net margin (%) 29 26 25 27

Diluted EPS (RMB) 1.52 2.21 2.44 10 60 1.75 38.8 Non-GAAP dil. EPS (RMB) 1.49 1.85 1.91 3 28 2.00 -4.2 Source: Company data, BOCOM Int’l

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17 May 2018 Tencent (700 HK)

Figure 2: P&L forecasts (RMB m) 2Q17 1Q18 2Q18E 2017 2018E 2019E 2020E Total Revenue 56,606 73,528 80,030 237,760 338,498 448,457 555,323 YoY (%) 59 48 41 56 42 32 24

VAS 36,804 46,877 48,756 153,983 208,169 260,632 308,849 YoY (%) 43 34 32 43 35 25 19

- Social network revenue 12,943 18,099 19,451 56,100 80,874 103,780 126,290 YoY (%) 51 47 50 52 44 28 22

- Games 23,861 28,778 29,305 97,883 127,295 156,852 182,559 YoY (%) 39 26 23 38 30 23 16

Online advertising 10,148 10,689 14,066 40,439 57,197 83,497 105,763 YoY (%) 55 55 39 50 41 46 27

Others 9,654 15,962 17,208 43,338 73,132 104,328 140,711 YoY (%) 177 111 78 56 42 32 24

Gross profit 28,306 37,042 36,753 116,925 160,714 205,731 247,569 YoY (%) 38 46 30 38 37 28 20 Gross margin (%) 50 50 46 49 47 46 45

Selling and marketing expenses -3,660 -5,570 -6,402 -17,652 -28,644 -38,213 -46,472 R&D -4,241 -5,006 -5,922 -17,456 -24,619 -32,548 -39,552 General and administrative expenses -3,929 -4,424 -4,999 -15,595 -20,341 -25,393 -29,690 Operating profit 22,560 30,692 21,577 90,302 102,203 118,167 140,445 YoY (%) 57 59 -4 61 13 16 19 Operating margin (%) 40 42 27 38 30 26 25

Non-GAAP net profit 16,391 18,313 18,218 65,126 78,626 99,380 117,769 YoY (%) 45 29 11 43 21 26 19 Non-GAAP net margin (%) 29 25 23 27 23 22 21

Diluted EPS (RMB) 1.91 2.44 1.71 7.53 8.13 9.54 11.40 Non-GAAP Diluted EPS (RMB) 1.72 1.91 1.91 6.86 8.22 10.38 12.27 Non-GAAP Diluted EPS (HK$) 1.97 2.36 2.33 7.94 10.05 12.61 14.91 YoY (%) 41 41 19 43 27 25 18 Source: Company data, BOCOM Int’l estimates

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17 May 2018 Tencent (700 HK)

BOCOM International 10/F, Man Yee Building, 68 Des Voeux Road Central, Central, Hong Kong Main: (852) 3766 1899 Fax: (852) 2107 4662

Rating System Analyst Stock Ratings: Analyst Industry Views:

Buy: The stock's total return is expected to exceed that of the Outperform: The analyst expects the industry coverage corresponding industry over the next 12 months. universe to be attractive relative to the relevant broad market benchmark over the next 12 months. Neutral: The stock's total return is expected to be in line with that of the corresponding industry over the next 12 months. Market perform: The analyst expects the industry coverage universe to be in line with the relevant broad market Sell: The stock's total return is expected to be below that of the benchmark over the next 12 months. corresponding industry over the next 12 months. Underperform: The analyst expects the industry coverage Not-Rated: The analyst does not have conviction regarding the universe to be unattractive relative to the relevant broad outlook of the stock's total return relative to that of the market benchmark over the next 12 months. corresponding industry over the next 12 months. Broad market benchmark for Hong Kong is the Hang Seng

Composite Index, for A-shares is the MSCI China A Index, for US-listed Chinese companies is S&P US Listed China 50 (USD) Index.

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17 May 2018 Tencent (700 HK)

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