Tencent Holdings Ltd. (HKSE:00700, Financial) is a tech investment holding company, which you could call the Facebook/Google of China or even a tech Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial)!
If you had invested $10,000 in Tencent at its initial public offering in 2004, you would have $7.9 million today.
Is the stock still a buy? Could it be undervalued? How do you invest safely? All these questions will be answered.
Business overview
Tencent is essentially a large tech holding company (which specializes in social media and gaming) combined with a driven venture capital investment machine.
The company has three business segments. The first, Value Added Services, or VAS, is mainly involved in the development of online and mobile games.
It boasts the number one mobile chat community (Wechat) in addition to QQ, Tencent Music (51% shareholder) and even major gaming brands such as League of Legends China, Fifa China and Call of Duty.
Tencent also has an online advertising business and an "Other" segmeent dedicated to fintech and cloud. This division includes the number one mobile payment platform Wechat and the number two player in cloud services, Tencent Cloud, which is just behind Alibaba Cloud.
This rivalry draws parallels to Amazon Web Services and the 2nd Player (Microsoft Azure) in the U.S. and rest-of-world cloud industry.
Tencent Investments
Tencent has large investments in a variety of incredible tech companies, including:
- Meituan Dianping at 20%.
- Epic Games at 40%.
- Discord at 2%.
Tencent has 83 companies worth over $1 billion in its portfolio. The amazing thing is 52 of these companies are unicorns (private companies worth over $1 billion).
According to Tencent's investor relations report, referring to the merger and acquisition strategy, the company looks for four things:
- Disruptive companies.
- Great management.
- Innovative products.
- Synergies with their existing platforms.
Is the stock undervalued?
Below I have completed a financial analysis of Tencent’s business using my advanced discounted cash flow model.
I converted the financials over from Chinese yuan and plugged in the numbers.
I then estimated a 20% growth rate on the revenue for next year, which drops to 15% for the next two to five years. The company grew revenue last period at 25%, so this is not optimistic.
From this valuation, I get a fair value of $71 per share. Thus the stock is undervalued by approximately 15%.
Monte Carlo simulation
To offer a range of outcomes and scenarios, I completed a Monte Carlo simulation, estimating the revenue growth from anywhere between 10% and 25% for the next five years.
For this, I get a mean valuation of $77 per share and a range of outcomes between $57 and $111. The stock is currently trading at $61, so close to the bottom of this range. The market may also be discounting the “China risk,” which is embedded into the stock.
A founder-led company
Tencent is still run by the founder and CEO Ma Huateng, also known as Pony Ma. Investing in great companies that are founder-led is a great strategy many successful investors have utilized. A major example is Nick Sleep, whose Nomad Investment Partners averaged 20.8% compounded returns for 12 years with the majority invested in Jeff Bezos' Amazon (AMZN, Financial). Tencent has large insider ownership, with the founder holding 7.46% of shares.
Bullish guru
Legendary value Investor Mohnish Pabrai (Trades, Portfolio) has previously spoken highly of Tencent. He said:
“Given the superiority of the Tencent model, it wouldn’t surprise me if Tencent is the most valuable business on the planet in 10 years.”
Pabrai went on to discuss the founder and the “Two Bazooka” business model, which consists of "an army of software engineers" and "digital Warren Buffett (Trades, Portfolio)s."
The army of software engineers, according to Pabrai, generate a 65% return on capital. This cash flow is then invested by the so-called digital Warren Buffett (Trades, Portfolio)s, which refers to the venture capital business at a 35% return.
However, it must be noted that Pabrai does not have a direct investment in Tencent according to his recent SEC filings. Instead, in a recent interview, he said he invested in the company via Prosus (XAMS:PRX, Financial), which is the tech arm of Naspers and one of the original investors in the company. It still owns around 30% of the company.
Final thoughts
Tencent is a fantastic tech company and arguably the best way to play an investment into China and also venture capital via a public company. The stock is undervalued by approximately 15% to 20%, thus could be a great long-term opportunity.However, some investors may be demanding a higher discount for the “China risk” spurred on by China’s crackdown on tech.
