TCEHY

Is Tencent Stock a Buy Now?

Tencent (OTC: TCEHY) posted its third-quarter earnings report on Nov. 16. The Chinese tech giant's revenue fell 2% year over year to 140.1 billion yuan ($19.7 billion), which represented its second consecutive quarter of declining revenue since its IPO in 2004. Its net profit rose 1% to 39.9 billion yuan ($5.6 billion). On an adjusted basis, which excludes its investments and other one-time items, its net profit grew 2% to 32.3 billion yuan ($4.5 billion).

Those growth rates seem anemic, but Tencent's stock had already been cut in half over the past two years amid concerns about China's tightening regulations, slowing economic growth, and COVID-19 lockdowns. So is it the right time to take the contrarian view and buy Tencent as a turnaround play? Let's review its core businesses and valuations to decide.

A person works on a laptop at Victoria Harbor in Hong Kong.

Image source: Getty Images.

Its gaming business is still struggling

Tencent generated 31% of its third-quarter revenue from its video game business. Domestic games, which include its blockbuster game Honor of Kings, accounted for 73% of that total. The remaining 27% came from overseas hits like League of Legends, Valorant, and PUBG Mobile.

Its domestic gaming revenue fell 7% year over year, representing its third consecutive quarter of shrinking revenue, as it grappled with tighter playtime restrictions for minors in China over the past year. Those restrictions also coincided with a temporary suspension on new video game approvals in China, which started last July and ended this April.

Its international gaming revenue rose 3% year over year, accelerating from its 1% decline in the second quarter, as new games like Tower of Fantasy and Goddess of Victory: Nikke attracted new players. Unfortunately, its overseas growth still couldn't offset its declining domestic revenue.

As a result, Tencent's total VAS (value-added service) revenue -- which includes its gaming divisions, social media platforms, and streaming media subscriptions -- declined by 3% in the third quarter but still accounted for more than half of its top line. This core business might gradually stabilize as Tencent expands its international gaming business, but it will likely remain under intense pressure as long as the Chinese government continues to scrutinize the gaming industry.

Its advertising business continues to shrink

Tencent generated 15% of its revenue from its advertising business, which sells ads on its core social networking app WeChat (known as Weixin in China), its ad-supported streaming services, and other smaller apps.

Its advertising revenue dropped 5% year over year during the quarter, representing the segment's fourth consecutive quarterly decline, as it experienced "continued weakness in certain ad categories," grappled with softer ad sales on Tencent Video (partly due to a drought of new content), and difficult comparisons to the Olympic Games a year ago.

On the bright side, its advertising revenue rose 16% sequentially. During the conference call, President Martin Lau predicted its advertising business would start growing year over year again in "late 2022" as it monetizes more in-feed video ads and benefits from the gradual stabilization of the gaming, e-commerce, and fast-moving consumer goods markets.

Its fintech and business services business is stabilizing

Tencent generated 32% of its third-quarter revenue from its fintech and business services segment, which houses Tencent Cloud (the third-largest cloud infrastructure platform in China), WeChat/Weixin Pay (one of the country's two largest payment platforms), and its other enterprise apps.

This segment's revenue rose 4% year over year during the quarter and accelerated from its 1% growth in the second quarter. Tencent mainly attributed that recovery to an acceleration in both "online and offline commercial payment activities," and noted that it was scaling back some of Tencent Cloud's unprofitable services to strengthen its margins.

That stabilization should allay some near-term fears regarding the segment, which was initially expanded through a restructuring four years ago to reduce the company's dependence on video games.

However, this segment still faces stiff competition from Alibaba (NYSE: BABA). Alibaba Cloud still dominates China's cloud market, while its affiliate Ant Group's Alipay shares a near-duopoly in digital payments with WeChat/Weixin Pay. That competition, along with the macro headwinds, could prevent it from generating double-digit sales growth anytime soon.

Its cost-cutting measures and valuations

As Tencent's revenue growth stalls out, it's divesting its non-core assets and reining in its operating expenses. That's why it divested most of its stake in JD.com to its investors in the form of a special dividend earlier this year, and why it plans to do the same to its stake in the food delivery giant Meituan. Those divestments could also appease antitrust regulators.

Those divestments could also boost Tencent's profits even as its revenue growth stalls out. But for now, analysts still expect Tencent's revenue and net income to decline by 1% and 55%, respectively, for the full year. Its growth might accelerate in 2023 if its domestic gaming and advertising business stabilize, but I think those are still tall orders in this tough market.

Tencent is barely growing, yet its stock still trades at 20 times next year's earnings. Therefore, I can't consider it a value play -- or an attractive investment at all -- when so many other high-growth stocks are still on sale.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends JD.com and Tencent Holdings. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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