Investing in China is not for the faint-hearted. Chinese economy is slowing and I dislike the lack of clarity when it comes to their government's stance on business. With U.S. market offering such clear directions, why invest in Asian markets?
That said, Tencent Holdings Ltd, a Chinese internet conglomerate, is pretty tempting. There are some concerns I will point out later, but for all intents and purposes, Tencent is a pretty solid China play.
The markets are awaiting second quarter results on August 15, and I expect them to be in line with the current trends of growth.
Over the past five years, Tencent has posted great revenue results. Thus far 2018 has shown no signs of bucking the trend. The first quarter's revenues jumped 48% year over year. In US dollars, that's $11.693 billion at the time they reported.
Through low increases in costs, these revenues translated to a 59% increase in gross profits of $4.88 billion USD. With operating margins up 42% versus 39% a year prior. When you look at the 65% increase in profits, it's easy to see why investors are drawn to these Chinese firms. That 65% increase and 3% increase in margins, translates to profits of $3.8 billion USD or $3.7 billion attributable to equity holders.
Much of their revenue growth is stemming from smart phone games, contributing greatly to the 28% increase in online gaming revenues. At RMB28.7 billion, it's a large percentage of their value added services revenue. While VAS revenue is the dominant source of cash for the company, online advertising revenues did increase 55% year over year. This will likely continue to become a more important source of income for the company. Remember Facebook (FB) ?
The Fortnite/Battlegrounds exposure
For those looking for a way to invest in the immensely popular Fortnite video game, look no further than Tencent.
The conglomerate owns a 40% stake in Epic Games; the creator of the online king of the hill battle game. This is a huge positive when looking at Tencent's stock. The revenue potential of this game seems astounding. Like all games and niche tech things, it's just a trend. Eventually Fortnite will fall just like every other game. But there's certainly some monetization to be had in the mean time.
The game did $380 million in May sales and it seems primed to do over $1 billion this year. I have very little interest in video games, but clearly there's a big market. Just imagine what those numbers can be like in China; where the game hasn't created much presence. Through a deal with Tencent, the game was released in China back in April. As the Chinese company pushes to increase its online gaming presence, I expect Fortnite to be a strong contributor. Due to their 40% stake, whatever bodes well for Epic Games, bodes well for Tencent.
Ironically, Tencent also has interests/involvement with South Korean based BlueHole, the parent company of PlayerUnkown's Battleground. Battleground is essentially the exact same game minus all the building. The two are ardent competitors, and have already dealt with the lawsuits. I find it interesting and advantageous that Tencent has involvement in both sides. I expect both platforms to coordinate into Tencent's overall esports strategy in China. Pay attention to this front with focus.
The potential headaches
The main sources of drama revolve around a recent government order to remove one of its new games , and the generally deteriorating relationship between China and the United States.
Tencent has become an investment firm of sorts: it has holdings in American companies like Activision (ATVI) and even Tesla (TSLA) . Further issues over foreign investment could in theory hurt their business holdings, but I'm doubtful that gaming will be one of the primary targets. They rely on the income from games and social media in order to get into other facets of business, so government interference in their ability to monetize gaming could become a problem.
Overall, I think this is a small incident. Their cash flow is clear and should continue. The internet company has things like Qzone (the biggest social networker in China), the online payment platform TenPay (the second largest in China), along with news apps, browsers, etc.
By all accounts, an investment in Tencent is an investment in China's consumer base. Tariffs might actually rouse that consumer base to spend more time on Chinese based technology such as Tencent's.
The stock's valuation is a little high, but I think there's earnings potential that will actually live up to it.
What I'd be looking for in the upcoming second quarter results is the move for monetization for their licensing efforts on Battleground, and sales growth on Fortnite.
These are the two big things that can drive revenues higher.