BOCOM Int’l Research Company Update Internet Last Close Target Price Upside 17 May 2018 HK$396.2 HK$533.00↓ +35% Tencent (700 HK) Solid top-line growth in 1Q18 Revenue beat on payment; profit in line: Total revenue/non-GAAP net profit rose Stock Rating 48%/29% YoY in 1Q18. Revenue was 4% higher than consensus driven by solid BUY performance of payment-related services (triple-digit growth YoY). GPM for VAS was up 4ppts/2ppts QoQ/YoY driven by higher revenue contribution from in-house 1-year stock performance games. GPM of cloud and payment improved to 25.4% (up 3ppts QoQ/YoY). Non- GAAP net margin was 25%, compared with 26%/29% in 4Q17/1Q17. 100% HSI 700 HK 80% Segment review: PC game/mobile game revenue were in line with our expectation, 60% 40% at RMB14.1bn/21.7bn, up 0%/68% YoY. Revenue from DnF reached a record high 20% thanks to seasonal promotion, while total PC game revenue remained flattish YoY. 0% -20% Mobile game revenue was strong, led by HoK, CF, and newly launched MU May-17 Sep-17 Jan-18 May-18 Awakening and QQ Speed, primarily driven by 42% YoY growth of ARPU. Social ads Source: Bloomberg revenue surged 69% YoY to RMB7.4bn, supported by increased ad load from WeChat Moments and higher CPC for mobile ad network. Tencent Video posted Stock data 52w high (HK$) 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 Hong Kong. Source: Company data, BOCOM Int’l estimates ^non-GAAP basis Analyst certifications, disclosures and disclaimer at the back forms part of this report and must be read. Download our reports from Bloomberg: BOCM or https://research.bocomgroup.com 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 Finance (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 Download our reports from Bloomberg: BOCM or https://research.bocomgroup.com 2 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 Download our reports from Bloomberg: BOCM or https://research.bocomgroup.com 3 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.