Tencent Holdings Ltd. (700 HK) INTERNET
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17 November 2016 EQUITIES Tencent Holdings Ltd. (700 HK) INTERNET Buy: Platform strategy offsets weak game performance China Strong 3Q revenue despite soft mobile games MAINTAIN BUY Performance ads and payment revenue beat expectations TARGET PRICE (HKD) PREVIOUS TARGET (HKD) Maintain Buy and trim TP to HKD245 from HKD256 245.00 256.00 3Q results highlight power of its platform. The key strength of Tencent's strategy, in our view, is the different ways it can monetize the high user base and engagement SHARE PRICE (HKD) UPSIDE/DOWNSIDE on all of its social properties. When one monetization engine slows, it is able to fire 196.90 +24.4% up another engine. In 3Q, total revenue grew 52% y-o-y, beating our estimate by 2%, (as of 16 Nov 2016) as lower than expected smartphone game revenue (its biggest revenue category) MARKET DATA was offset by social subscription, payment and strong performance-based ads Market cap (HKDm) 1,864,046 Free float 52% Market cap (USDm) 240,306 BBG 700 HK revenue. Tencent has the traffic, products and ad inventory to manage through short- 3m ADTV (USDm) 426 RIC 0700.HK term weaknesses in a particular business to maintain very strong revenue growth. FINANCIALS AND RATIOS (CNY) Strong revenue growth with slight miss on EPS. Total revenue grew 52% y-o-y to Year to 12/2015a 12/2016e 12/2017e 12/2018e MB40bn, 3% above consensus. EPS of RMB1.24 was 4% below our estimate but in- HSBC EPS 3.44 4.80 6.84 8.31 HSBC EPS (prev) - 4.86 7.47 9.35 line with consensus. Gross margins of 54% missed our estimate by 133bps, due to Change (%) - -1.2 -8.4 -11.1 channel costs for smartphone gaming and higher video content costs. Adjusted Consensus EPS 3.21 4.63 6.04 7.61 PE (x) 50.7 36.3 25.5 21.0 operating margins of 37% also missed our estimate due to promotional spending on Dividend yield (%) 0.0 0.2 0.4 0.5 games and payment. We expect continued high spending on video content and EV/EBITDA (x) 35.6 25.5 19.6 15.3 ROE (%) 28.8 32.0 37.9 35.9 licensed games to negatively impact gross margins. Sales and marketing costs will also remain elevated due to merchant education for payment adoption, promotion of 52-WEEK PRICE (HKD) mobile utility apps and advertising costs to promote its hit video content. 260.00 Soft mobile games but strong ad and other revenue. Smartphone gaming grew 185.00 87% y-o-y to RMB 9.9bn, 9% lower than our estimate. While Tencent has over 100m 110.00 DAUs for mobile game, including 40m for Honor of Kings, it only released 2 casual 11/15 05/16 11/16 Target price: 245.00 games and 3 mid-core games in 3Q. We point out that Tencent's strategy is to High: 218.20 Low: 133.10 Current: 196.90 amass users and then increase monetization gradually. Rising monetization and new Source: Thomson Reuters IBES, HSBC estimates games will drive mobile game revenue next year. Social revenue increased 58% y-o- y due to digital content subscriptions and the consolidation of China Music Corp. Chi Tsang*, CFA Head of Internet Research, Asia Pacific Tencent had 20m video subscribers in October. Brand advertising only grew 21% y- The Hongkong and Shanghai Banking Corporation Limited o-y, due to weak demand but also due to cannibalization from subscription revenue [email protected] +852 2822 2590 and to Tencent changing its news feed ad products from time-based to click based. Qin Wang* This helped performance (P4P) ads beat estimates, growing 83% y-o-y. Given the Associate weak outlook for brand advertising given macro uncertainty, Tencent will see faster The Hongkong and Shanghai Banking Corporation Limited [email protected] growth from P4P ads than brand ads in 2017. While WeChat moments continue to be +852 2822 4393 the biggest driver of P4P ads, ad load will likely remain low at 1/user/day, as management focuses on efficiency and targeting instead of ad inventory. Other * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is revenue was very strong, up 348% y-o-y, reaching 12% of revenue. Cloud revenue not registered/ qualified pursuant to FINRA regulations doubled q-o-q from a small base but payments remained the biggest component and commission revenue from merchants will likely continue to grow rapidly. Disclosures & Disclaimer Issuer of report: The Hongkong and Shanghai Banking Corporation Limited This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. View HSBC Global Research at: https://www.research.hsbc.com EQUITIES ● INTERNET 17 November 2016 Financials & valuation: Tencent Holdings Ltd. Buy Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (CNYm) EV/sales 15.8 10.7 7.4 5.7 Revenue 102,863 152,329 215,293 266,923 EV/EBITDA 35.6 25.5 19.6 15.3 EBITDA 45,805 64,083 81,311 100,437 EV/IC 15.9 12.3 12.4 12.1 Depreciation & amortisation -6,635 -9,836 -8,880 -12,596 PE* 50.7 36.3 25.5 21.0 Operating profit/EBIT 40,627 56,705 74,766 91,635 PB 13.7 12.0 9.7 7.1 Net interest 709 525 433 1,891 FCF yield (%) 5.7 -0.2 3.9 4.6 PBT 36,216 52,354 73,671 91,340 Dividend yield (%) 0.0 0.2 0.4 0.5 HSBC PBT 36,216 52,354 73,671 91,340 * Based on HSBC EPS (diluted) Taxation -7,108 -10,520 -14,734 -18,268 Net profit 28,806 41,367 58,348 72,341 HSBC net profit 28,806 41,373 58,348 72,341 Issuer information Cash flow summary (CNYm) Share price (HKD) 196.90 Free float 52% Cash flow from operations 35,996 -1,909 70,146 77,885 Target price (HKD) 245.00 Sector Internet Capex -7,709 -15,606 -23,668 -27,235 Reuters (Equity) 0700.HK Country China Cash flow from investment -63,605 -15,606 -23,668 -27,235 Bloomberg (Equity) 700 HK Analyst Chi Tsang, CFA Dividends -2,643 -3,774 -5,731 -8,074 Market cap (USDm) 240,306 Contact +852 2822 2590 Change in net debt -1,399 3,388 -35,391 -65,029 FCF equity 93,693 -2,903 64,958 75,580 Balance sheet summary (CNYm) Price relative Intangible fixed assets 15,732 38,394 38,394 38,394 Tangible fixed assets 135,708 162,189 182,994 202,964 266.00 266.00 Current assets 155,378 132,079 178,145 250,897 Cash & others 80,769 100,568 135,960 200,989 216.00 216.00 Total assets 306,818 332,663 399,533 492,256 Operating liabilities 123,275 99,554 135,018 164,200 Gross debt 61,443 84,630 84,630 84,630 166.00 166.00 Net debt -19,326 -15,938 -51,330 -116,359 Shareholders' funds 120,035 138,327 169,734 233,274 116.00 116.00 Invested capital 102,774 132,540 128,556 127,067 66.00 66.00 2014 2015 2016 Ratio, growth and per share analysis Tencent Holdings Ltd. Rel to HSCEI Year to 12/2015a 12/2016e 12/2017e 12/2018e Source: HSBC Y-o-y % change Note: Priced at close of 16 Nov 2016 Revenue 30.3 48.1 41.3 24.0 EBITDA 40.0 39.9 26.9 23.5 Operating profit 33.0 39.6 31.8 22.6 PBT 24.8 44.6 40.7 24.0 HSBC EPS 30.0 39.6 42.6 21.6 Ratios (%) Revenue/IC (x) 1.2 1.3 1.6 2.1 ROIC 41.0 40.9 45.7 56.4 ROE 28.8 32.0 37.9 35.9 ROA 12.9 13.6 16.6 16.8 EBITDA margin 44.5 42.1 37.8 37.6 Operating profit margin 39.5 37.2 34.7 34.3 EBITDA/net interest (x) Net debt/equity -15.8 -10.7 -28.5 -47.8 Net debt/EBITDA (x) -0.4 -0.2 -0.6 -1.2 CF from operations/net debt Per share data (CNY) EPS Rep (diluted) 3.05 4.36 6.15 7.62 HSBC EPS (diluted) 3.44 4.80 6.84 8.31 DPS 0.00 0.40 0.61 0.86 Book value 12.73 14.57 17.88 24.57 2 EQUITIES ● INTERNET 17 November 2016 3Q16 results RMB millions except HKD EPS __________________ 3Q16 ___________________ _______ Delta ________ Actual HSBC Consensus HSBC Consensus Smartphone gaming 9,900 10,865 -9% PC Game 11,802 11,480 3% Social network 9,809 9,259 6% Online advertising 7,449 7,488 -1% Others 4,964 3,827 30% Total Revenues 40,388 39,442 39,045 2% 3% memo: QoQ growth 13.2% 10.5% 17.1% memo: YoY growth 51.9% 48.3% 46.8% Gross profits 21,828 21,842 22,038 0% -1% memo: QoQ growth 6.7% 6.8% memo: YoY growth 40.1% 40.2% Gross Margins (bps) 54.0% 55.4% 56.4% -133 -240 Gross Margin VAS 65.2% 64.5% 65 Online Advertising 36.3% 44.3% -804 Other 18.1% 10.0% 813 Selling and marketing (3,277) (2,961) 11% memo: QoQ growth 38.6% 25.2% memo: YoY growth 60.5% 45.0% memo: % of revenue 8.1% 7.5% G&A (5,883) (5,694) 3% memo: QoQ growth 11.0% 7.5% memo: YoY growth 34.3% 30.0% memo: % of revenue 14.6% 14.4% Non-GAAP Operating profit 15,037 15,545 -3% Non-GAAP Operating Margins 37.2% 39.4% -218 Non-GAAP net income 11,737 12,152 11,680 -3% 0% Adjusted EPS CNY CNY 1.24 CNY 1.28 CNY 1.23 -4% 0% memo: QoQ growth 3.5% 7.4% memo: YoY growth 40.3% 45.5% Adjusted EPS HKD HKD 1.43 HKD 1.50 HKD 1.41 -4% 2% Source:Company data, Bloomberg, HSBC 3 EQUITIES ● INTERNET 17 November 2016 HSBC estimates changes RMB mn 4Q16e 1Q17e 2016e 2017e Current Revenue 44,255 46,953 152,329 215,293 VAS 30,393 32,724 109,012 142,250 Mobile gaming 11,715 13,530 39,415 62,303 Legacy gaming 11,923 12,257 46,186 48,495 Online advertising 7,905 7,081 26,587 37,502 GM 54.0% 53.7% 55.6% 52.9% Operating profit 14,518 18,087 56,705 74,766 OPM 32.8% 38.5% 37.2% 34.7% Non-GAAP EPS CNY 1.31 CNY 1.66 CNY 4.80 CNY 6.84 Previous Revenue 43,899 46,369 151,027 208,088 VAS 31,401 33,461 110,172 143,295 Mobile gaming 12,780 13,940 41,445 64,576 Legacy gaming 11,923 12,084 45,508 47,783 Online advertising 7,906 7,397 26,627 37,393 GM 54.8% 57.3% 56.2% 56.0% Operating profit 15,229 20,167 57,633 84,406 OPM 34.7% 43.5% 38.2% 40.6% Non-GAAP EPS CNY 1.33 CNY 1.79 CNY 4.86 CNY 7.47 Delta Revenue 1% 1% 1% 3% VAS -3% -2% -1% -1% Mobile gaming -8% -3% -5% -4% Legacy gaming 0% 1% 1% 1% Online advertising 0% -4% 0% 0% E-commerce GM bps (83) (358) (60) (317) Operating profits -5% -10% -2% -11% OPM bps (188) (497) (94) (584) Non-GAAP EPS (CNY) -1% -7% -1% -9% Source:HSBC estimates Estimate changes.