Buy Tencent For Its Investment Portfolio

Summary

• The huge value of Tencent's Investment Portfolio may be under-appreciated by analysts.
• Overseas investments reduce the risk of potentially negative political moves within China.
• The company has tremendous resources to continue and build on its investment portfolio.
• Recent results emphasize the company's growth and profitability.

Tencent (OTCPK:TCEHY) is a vast and extremely diverse conglomerate which cannot be explained in a single article. For full details of what the company does, readers can refer to my article in November last year and the links in that.

This article focuses in particular on Tencent's international growth. It has become almost a corporate exemplar of the government's "Belt & Road" initiative.

Put simply, Tencent's rise to being one of the largest companies in the world has been built on its user base of WeChat and WeChatPay users in China. This is similar to Apple (NASDSQ:AAPL) with its iPhone base and Sony (NYSE:SNE) with its PS base.

There are impediments to future growth in China. The company may have become somewhat a victim of its own success. The problems Alibaba (NASDAQ:BABA) is having following comments by its founder Jack Ma show the dangers of becoming too powerful within the realm of the Chinese Communist Party (CCP). There are anti-trust moves afoot throughout the Chinese economy. It seems likely Tencent's founder and chairman Pony Ma will be able to avoid much damage from "friendly fire".

Meanwhile the wide-ranging, profitable and growing investment portfolio of the company overseas may be its best route to future growth and profitability. It is one the CCP will probably be happy to encourage. Much of Tencent's investment is around Asia. Asian countries have 32.3% of world GDP as I outlined here. This is likely to increase as Asian countries grow more rapidly than those elsewhere and as their populations in general are growing.

For those investors tempted by finding investing gems in SPAC's, I think Tencent is a far better bet.

Tencent Stock Price

The stock price has stood up well to the general sell-off in tech stocks. This follows an approximate 50% gain in 2020. The one year stock chart illustrated below from Charles Schwab Inc. illustrates this:

Charles Schwab Inc.

This relatively strong performance is probably due to the fact that one cannot classify the company strictly as a tech stock. It is more a reflection of Tencent's status as a play on the Chinese economy and on China's increasing international reach. The company is China's largest by capital value.

There are of course concerns about possible moves against Tencent by Chinese Authorities. I think this is largely factored into the stock price. The graph above shows the dip in December and January when the Chinese government made Alibaba pull its giant Ant Group IPO. The stock price of Tencent soon recovered.

Tencent Finances

The company's recent results emphasized how well the company is doing by almost every metric. Results as per Q4 2020 show the depth and breadth of the company's growth:

Tencent

Results were generally in line with expectations though online gaming revenues were down somewhat on the expectations of analysts.

Their cash position is healthy and will allow them to continue their buying policy as and when desired:

Tencent

The China Conundrum

Alibaba's problems came primarily from being too brazen in its power in the Chinese market. It could be seen by an arguably paranoid CCP as a threat to its central power.

As my article in October last year detailed, Tencent shares some of these characteristics. It is the world's largest gaming company. It is China's largest messaging provider, its largest social networking site, its largest music streaming provider, and its largest mobile payments provider. The scope of this is evidenced by the fact that China's base of Internet users and its mobile share of e-commerce is far greater than that of the USA. At the same time, the top three e-commerce companies' share of the market in China is much greater than that of the top three in the USA. Commercial power is quite concentrated in China.

That article also detailed another government threat to Tencent, this time from the U.S. government. Under President Biden, the U.S. government will no doubt take a hard line on China as well. However this is likely to be based on more rational criteria than before. In fact Tencent seems to pose no threat to U.S. interests.

Apart from possible government pressures, there is the question of how rapidly Tencent can continue to grow its huge Chinese assets. This is especially so in regard to its 1.2 billion MAU of WeChat. The "law of large numbers" could kick in, as this article examines. WeChatPay and Alipay between them control about 90% of the payments market in China. Others, especially ByteDance (OTC:BDNCE), may make inroads, with or without government help.

Unless something unexpected and catastrophic happens, I think the measured management of Pony Ma and his team should be able to negotiate any hurdles placed by the Chinese government. Ma recently stated he was meeting with Chinese authorities to discuss a "broad range of topics". These are likely to focus around the company's strengths in gaming and in fintech. President Xi Jinpeng's foremost priority is probably the maintenance of financial stability

The Investment Growth

The investment spree continues to ramp up. As reported by TechCrunch, last year it continued to grow despite the Covid pandemic:

TechCrunch

In March analyst Sanford C. Bernstein reckoned Tencent's listed and unlisted investments had a worth of a stunning US$259 billion. The company had over 170 funding rounds last year. Its investment portfolio exceeded $66 billion. Returns from investments reached $2 billion in 2019. That represented 12% of the company's total earnings. In my view, this proportion will increase.

In general the company has a strategy to acquire minority stakes rather than gain full control (in contrast to Alibaba). This strategy was outlined at the Q4 2020 earnings call by company President Martin Lau, when he stated:

We aim to support the investees innovation while enabling them to grow and operate independently.

Originally focused on digital entertainment, now the largest sums are going into a host of enterprise services and fintech. There is much else besides though. Because of the political sensitivities of fintech, they have mostly focused this on cross-border payments for Chinese tourists. However, in what seems to be a very smart move, their major investment in Singapore-based SEA (NYSE:SE) may have got them around this problem. Originally a games developer and online shopping portal, SEA was a natural fit for Tencent. Now SEA has been awarded one of the new digital banking licenses in Singapore.

Tencent and SEA are a tremendously powerful and natural fit for each other. I detailed these synergies in an article in 2019. Tencent also has a stake in Australian fintech company Afterpay. In India they have a 5% stake in e-commerce player Flipkart and a stake in fintech player NiYO.

Japanese group Rakuten Inc. (OTCPK:RKUNY) is a substantial recent investment. This is one that is hard to categorize exactly. Its fintech division may have been the prime attraction for Tencent. The company though is well-established in other areas such as e-commerce and telecoms. It shows an interesting recent trend by Tencent of increased investment in Japan. This is a country with whom China has historically had fraught relations.

Tencent has stakes in numerous U.S. companies engaged in a variety of online business. These include Snapchat (NASDAQ:SNAP) and a $150 million stake in privately held Reddit.

Tencent has invested in over 800 companies, 70 of which have gone public. In January company President Lau said there would be increased investment in overseas companies in the future. At the earnings call he outlined the philosophy for overseas investments:

We provide our resources, basically knowhow as well as some capital, and maybe in some cases some access to the Chinese market.

International Music

This is one area not much remarked upon. It is centered around its subsidiary Tencent Music Entertainment Group (NYSE:TME). Apart from its dominant role within China, Tencent's musical reach is stretching around the world through its various tie-ups. I detailed these in an article in March last year.

They include a 10% stake in the Universal Music Group, which is owned by French company Vivendi (OTCPK:VIVEF). They have an option to take a further 10% stake. Tencent Music also has a 7.5% stake in Spotify (NASDAQ:SPOT) which itself has a reciprocal stake in Tencent. They also have a stake in Warner Music (NASDAQ:WMG).

Tencent's musical reach mirrors that somewhat of Sony. Perhaps not surprisingly, Tencent also has a stake in Sony. For both it is a somewhat under-appreciated corporate strength. Music worldwide is growing strongly under the new streaming model. The musical link with Sony may well lead to other joint developments as well.

International Autos

This is another area not much remarked upon. There is little doubt of the future of autos seeing EV's replacing ICE vehicles. Tencent is particularly focused on the future of AI in EV's and in autonomous driving. The company has positioned itself well to take advantage of these secular changes. Its investments include:

* A 5% stake in Tesla (NYSE:TSLA). This is in addition to a stake in Nio (NASDAQ:NIO), a company often seen as China's main competitor to Tesla.

* A stake in Gojek, an Indonesian ride-hailing company.

* A stake in Ola, an Indian ride hailing company.

* A stake in Uber Technologies Inc. (NASDAQ:UBER), the world's most prominent ride-hailing company.

* A stake in Lyft Inc. (NASDAQ:LYFT), the next most prominent U.S. ride-hailing company.

* A technological co-operation deal with BMW (OTCPK:BMWYY).

* A technological co-operation deal with Hyundai (OTCPK:HYMTF).

* Its existing link-up with Sony could be very interesting in light of that company's interest in EV's and its strengths in AI and in semiconductors.

These international developments mirror a network of investments in China's auto industry across a wide range of manufacturers, parts suppliers and AI developers. I detailed these in an earlier article.

Tencent's best strategic position may be in the direction of AI for autos. In this field they are also co-operating with Baidu (NASDAQ:BIDU). That company is China's largest player in this sector.

International Games

This has historically been the most successful sector for Tencent.

* SEA: this company is expanding very rapidly in its core market of S-E Asia through its Garena subsidiary. It has also expanded into the Middle East, South America and Russia. It has first call on Tencent games in its target markets. This benefits both companies. SEA has a flow of new games. Tencent has a marketing company on the ground in many countries.

* Epic Games: their 40% stake in the highly successful U.S. games developer has been a big profit generator for Tencent as "Fortnite" has swept the world.

* Activision Blizzard (NASDAQ:ATVI): Tencent has a long-standing 5% stake in this prominent U.S. gaming company.

* Riot Games: this is wholly owned by Tencent. They own the booming e-sports hit "League of Legends".

* Glu Mobile (NASDAQ:GLUU): they have a stake in the San Francisco company which specializes in mobile games for mobile phone and tablet computers.

* Various e-sports companies in what is a fast-growing sector, especially in Asia. This includes sponsorship of the e-sports "world championship". This is arguably the fastest growing gaming sector.

* Amer Sports of Finland, the manufacturer of Wilson tennis rackets. Tencent is linked to this through a consortium of Chinese companies. It looks to be purely opportunistic rather than strategic.

* Gaming studios such as Digital Extremes, Fatshark and Klein Entertainment. The company has also made strategic gaming moves into anime in another example of its interest in Japan. Its stake in Sony opens its games up to the PS4 and PS5 world. They have a stake in Japanese games developer Platinum Games. They have a 5% stake in French games developer Ubisoft (OTCPK:UBSFY). In all it is thought they have stakes in 22 overseas gaming companies.

* Take-Two Interactive (NASDAQ:TTWO): they have a long-standing partnership with this U.S. gaming giant.

Of course gaming can transcend borders and the line can be blurred between domestic and international. What is constant is the flow of investments in mobile gaming, in console gaming and in PC gaming. At the same time, gaming will become a lower percentage of Tencent's revenues as it expands into new areas.

Risks of the Strategy

* Some observers regards Tencent's strategy as being an unconstructive scatter-gun approach.

* A renewed trade war with the USA, or with Europe, would harm the strategy. The company could get caught between a rock and a hard place. For instance, China is talking about monitoring user data on Internet platforms. At the same time, legislation in the U.S. Congress may delist Chinese companies with ties too close to the Chinese government (although Tencent is not currently listed on U.S. exchanges).

* Too many substantial investments could lead to sudden losses, and a loss in confidence. This happened last year with Masayishi Son's massive Soft Bank fund. Tencent seems though well-diversified against this risk.

* The CCP may decide it does not want its companies to invest so much overseas. The fate recently of the HNA Group and its founder could be a salutary lesson

Conclusion

The Chinese government seems to like Tencent's strategic direction. It sees the company as a domestically produced world-beating company. At the same time Chinese companies need to be careful not to get too powerful or flaunt too many rules domestically. So Tencent's role as a corporate off-shoot of the international "Belt and Road" initiative will be encouraged.

Tencent's investments are mainly in strategic growth industries such as gaming, fintech, online shopping, online advertising and EV's. They offer a clear future growth path for the company. Many of these investments link directly or indirectly to WeChat, the core integral strength of the company.

We live in a time of the growth of SPACs. Investors are pouring money into funds which are investing in as yet undeclared assets. Such stock traders are giving small business groups what are effectively blank checks on the promise of future investments. In contrast Tencent is investing mainly in secular growth areas and mainly in booming Asia.

Tencent offers investors a much more reasoned opportunity to invest in a vast portfolio of investments than does any SPAC. The company can be viewed as a well-ordered venture capital fund. It is one which also has unrealized gains tucked away in its balance sheet. These proved a good long-term asset to a company whose core strengths are well-known.

Analyst’s Disclosure: I am/we are long TCEHY AAPL SE SNE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.