March 16, 2017 EARNINGS PREVIEW Tencent Holdings (0700.HK) Buy Equity Research 4Q16 preview: Gaming, ad and payment; end 2016 on a strong note What we expect Investment Profile nd Tencent will announce 4Q16 results on Wednesday, Mar 22 after market Low High close. We see evidence of another strong year, particularly on advertising Growth Growth revenue growth rate being higher than peers, and payments driving other Returns * Returns * revenues up 200% yoy. For 2017 and beyond, we are focused on WeChat Multiple Multiple Mini Program development, games pipeline and WeChat ad load. We Volatility Volatility Percentile 20th 40th 60th 80th 100th forecast revenue of Rmb 44,588mn and EPS of Rmb 1.30 for 4Q16. Tencent Holdings (0700.HK) What could surprise us Asia Pacific Media and Entertainment Peer Group Average * Returns = Return on Capital For a complete description of the investment Online gaming: We expect online gaming revenue to grow 37% yoy in profile measures please refer to the 4Q16, driven by 81% yoy growth in mobile gaming revenue and 9% yoy disclosure section of this document. growth in PC gaming revenue. Mobile game Honour of Kings delivered Key data Current strong performance in 4Q16, with daily active users (DAU) surpassing Price (HK$) 214.60 12 month price target (HK$) 252.30 50mn in Dec 2016, higher than Pokémon Go’s peak in July 2016 per Market cap (HK$ mn / US$ mn) 2,037,831.9 / 262,304.7 Foreign ownership (%) -- Bloomberg report. We saw favorable development for League of Legends, as the threat from Overwatch is receding, and data from Superdata 12/15 12/16E 12/17E 12/18E Research indicates 16% yoy revenue growth in 2016. Online advertising: EPS (HK$) 4.28 5.62 7.51 9.01 EPS growth (%) 32.2 38.6 38.6 20.2 We forecast online advertising revenue to grow 44% yoy in 4Q16, EPS (diluted) (Rmb) 3.05 4.54 6.10 7.00 EPS (basic pre-ex) (Rmb) 3.48 4.85 6.73 8.07 outpacing China Internet peers’ 21% yoy growth rate, but down from P/E (X) 33.8 39.7 28.6 23.8 51%/118% in 3Q16/4Q15 due to continued revenue mix shift from P/B (X) 9.2 11.0 8.2 6.3 EV/EBITDA (X) 21.8 25.2 18.6 15.4 advertising model to subscription model on online video. Other revenues: Dividend yield (%) 0.3 0.3 0.4 0.5 ROE (%) 28.8 30.3 30.1 26.3 We forecast 200% yoy growth in Tencent’s other revenues line, driven by CROCI (%) 30.1 32.1 31.8 27.7 growth in payments (0.1% cash withdraw fee was introduced in Mar 2016, scenarios expansion) and cloud computing. Price performance chart 220 11,500 On Mar 22nd call, we expect management to discuss (i) development on 210 11,000 WeChat Mini Program; (ii) Honour of Kings and new games pipeline; (iii) 200 10,500 video content spending trend and WeChat Moment ad load. Our 12m TP of 190 10,000 HK$252.30 is based on 28X 2018E EPS. Key risks: Macro slowdown, 180 9,500 competition with Alibaba Group and other P4P advertising assets. 170 9,000 160 8,500 Key metrics for 4Q16 - GSe vs. consensus 150 8,000 Mar-16 Jun-16 Sep-16 Dec-16 Rmb mn GSe Consensus GSe vs. consensus Total revenues 44,588 44,000 1.34% Tencent Holdings (L) Hang Seng China Ent. Index (R) Non-GAAP diluted EPS (Rmb) 1.30 1.26 3.16% Source: Bloomberg, Goldman Sachs Global Investment Research. Share price performance (%) 3 month 6 month 12 month Absolute 16.6 2.3 41.8 INVESTMENT LIST MEMBERSHIP Rel. to Hang Seng China Ent. Index 7.6 (4.5) 18.8 Asia Pacific Buy List Source: Company data, Goldman Sachs Research estimates, FactSet. Price as of 3/15/2017 close. GS SUSTAIN Focus List Coverage View: Neutral Piyush Mubayi +852-2978-1677 [email protected] Goldman Sachs (Asia) L.L.C. Goldman Sachs does and seeks to do business with companies Ronald Keung, CFA covered in its research reports. As a result, investors should be +852-2978-0856 [email protected] Goldman Sachs (Asia) L.L.C. aware that the firm may have a conflict of interest that could Fan Liu, CFA affect the objectivity of this report. Investors should consider +86(10)6627-3192 [email protected] Beijing Gao Hua Securities Company Limited this report as only a single factor in making their investment Elsie Cheng +852-2978-0820 [email protected] Goldman Sachs (Asia) L.L.C. decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non- US affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research March 16, 2017 Tencent Holdings (0700.HK) Tencent Holdings: Summary Financials Profit model (Rmb mn) 12/15 12/16E 12/17E 12/18E Balance sheet (Rmb mn) 12/15 12/16E 12/17E 12/18E Total revenue 102,863.0 152,662.2 211,889.1 258,023.8 Cash & equivalents 43,438.0 103,705.3 211,476.7 312,458.0 Cost of goods sold (41,631.0) (67,181.5) (97,601.1) (125,734.6) Accounts receivable 7,061.0 9,170.1 11,378.4 12,123.2 SG&A (22,062.0) (29,267.3) (40,595.5) (48,815.7) Inventory 0.0 0.0 0.0 0.0 R&D (9,039.0) (11,070.1) (13,062.7) (14,891.4) Other current assets 104,879.0 110,463.2 117,112.0 122,336.2 Other operating profit/(expense) 1,886.0 3,727.0 3,209.0 3,529.9 Total current assets 155,378.0 223,338.7 339,967.2 446,917.4 EBITDA 48,438.0 68,486.7 93,244.2 108,182.4 Net PP&E 14,221.0 18,762.8 23,919.0 28,691.5 Depreciation & amortization (6,674.0) (8,093.9) (9,973.7) (12,249.7) Net intangibles 15,732.0 16,253.4 16,774.8 17,296.2 EBIT 41,764.0 60,392.8 83,270.5 95,932.7 Total investments 104,510.0 125,960.0 123,160.0 120,996.2 Interest income 2,327.0 2,541.2 4,915.9 7,811.4 Other long-term assets 16,977.0 16,977.0 16,977.0 16,977.0 Interest expense 0.0 0.0 0.0 0.0 Total assets 306,818.0 401,291.9 520,798.0 630,878.3 Income/(loss) from uncons. subs. (2,793.0) (2,700.0) (2,800.0) (2,163.8) Others 0.0 0.0 0.0 0.0 Accounts payable 85,899.0 127,487.2 176,963.1 215,507.5 Pretax profits 36,216.0 54,142.2 71,848.0 84,351.0 Short-term debt 11,429.0 11,429.0 11,429.0 11,429.0 Income tax (7,108.0) (10,567.9) (12,932.6) (16,026.7) Other current liabilities 27,078.0 35,738.3 46,462.4 49,855.2 Minorities (302.0) (488.0) (561.6) (673.9) Total current liabilities 124,406.0 174,654.5 234,854.5 276,791.7 Long-term debt 37,092.0 37,092.0 37,092.0 37,092.0 Net income pre-preferred dividends 32,410.0 45,485.6 63,550.9 76,984.5 Other long-term liabilities 23,220.0 23,220.0 23,220.0 23,220.0 Preferred dividends 0.0 0.0 0.0 0.0 Total long-term liabilities 60,312.0 60,312.0 60,312.0 60,312.0 Net income (pre-exceptionals) 32,410.0 45,485.6 63,550.9 76,984.5 Total liabilities 184,718.0 234,966.5 295,166.5 337,103.7 Post-tax exceptionals (3,604.0) (2,399.3) (5,197.1) (9,334.1) Net income 28,806.0 43,086.3 58,353.8 67,650.4 Preferred shares 0.0 0.0 0.0 0.0 Total common equity 120,035.0 164,260.4 223,566.5 291,709.6 EPS (basic, pre-except) (Rmb) 3.48 4.85 6.73 8.07 Minority interest 2,065.0 2,065.0 2,065.0 2,065.0 EPS (basic, post-except) (Rmb) 3.10 4.59 6.18 7.09 EPS (diluted, post-except) (Rmb) 3.05 4.54 6.10 7.00 Total liabilities & equity 306,818.0 401,291.9 520,798.0 630,878.3 DPS (Rmb) 0.390.550.730.87 Dividend payout ratio (%) 12.4 11.9 11.8 12.3 BVPS (Rmb) 12.73 17.31 23.38 30.20 Free cash flow yield (%) 3.7 5.0 6.4 6.0 Growth & margins (%) 12/15 12/16E 12/17E 12/18E Ratios 12/15 12/16E 12/17E 12/18E Sales growth 30.3 48.4 38.8 21.8 CROCI (%) 30.1 32.1 31.8 27.7 EBITDA growth 37.2 41.4 36.1 16.0 ROE (%) 28.8 30.3 30.1 26.3 EBIT growth 36.9 44.6 37.9 15.2 ROA (%) 12.1 12.2 12.7 11.7 Net income growth 21.0 49.6 35.4 15.9 ROACE (%) 31.5 36.8 69.0 153.5 EPS growth 20.1 48.3 34.4 14.8 Inventory days NM NM NM NM Gross margin 59.5 56.0 53.9 51.3 Receivables days 20.7 19.4 17.7 16.6 EBITDA margin 47.1 44.9 44.0 41.9 Payable days 498.5 579.7 569.3 569.7 EBIT margin 40.6 39.6 39.3 37.2 Net debt/equity (%) (58.5) (79.4) (106.5) (116.3) Interest cover - EBIT (X) NM NM NM NM Cash flow statement (Rmb mn) 12/15 12/16E 12/17E 12/18E Valuation 12/15 12/16E 12/17E 12/18E Net income pre-preferred dividends 32,410.0 45,485.6 63,550.9 76,984.5 D&A add-back 6,674.0 8,093.9 9,973.7 12,249.7 P/E (analyst) (X) 33.8 39.7 28.6 23.8 Minorities interests add-back 0.0 0.0 0.0 0.0 P/B (X) 9.2 11.0 8.2 6.3 Net (inc)/dec working capital 6,389.0 41,772.4 50,807.9 35,268.3 EV/EBITDA (X) 21.8 25.2 18.6 15.4 Other operating cash flow (42.0) 3,919.6 2,548.2 (679.1) EV/GCI (X) 6.9 8.7 6.2 4.6 Cash flow from operations 45,431.0 99,271.5 126,880.8 123,823.4 Dividend yield (%) 0.3 0.3 0.4 0.5 Capital expenditures (5,440.0) (9,159.7) (11,653.9) (13,546.2) Acquisitions 0.0 0.0 0.0 0.0 Divestitures 0.0 0.0 0.0 0.0 Others (58,165.0) (26,260.3) (2,337.1) (2,406.1) Cash flow from investments (63,605.0) (35,420.1) (13,991.0) (15,952.3) Dividends paid (common & pref) (2,640.0) (3,584.2) (5,118.4) (6,889.8) Inc/(dec) in debt 22,184.0 0.0 0.0 0.0 Common stock issuance (repurchase) (483.0) 0.0 0.0 0.0 Other financing cash flows (162.0) 0.0 0.0 0.0 Cash flow from financing 18,899.0 (3,584.2) (5,118.4) (6,889.8) Total cash flow 725.0 60,267.3 107,771.4 100,981.3 Note: Last actual year may include reported and estimated data.