Tencent - Quality franchise on discount valuations

Tencent is a large internet platform company in China. Over the years, Tencent has constructed a vast digital ecosystem encompassing social media, the world's largest gaming business, leading digital financial services, and rapidly expanding cloud computing and AI ventures. Its platforms, particularly the ubiquitous super-app WeChat, forms the backbone of China's digital economy.

Competitive Moats

Tencent’s moats include:

- Integrated Digital Platform: Tencent's primary competitive advantage lies in its deeply integrated digital ecosystem. WeChat, QQ, gaming, payments, cloud, and content platforms are fully integrated in the ecosystem, creating high user engagement and retention. In turn, the highly engaged userbase offers numerous monetisation avenues like advertising, subscriptions, and transaction fees.

- Global Gaming Leadership: Tencent owns many of the leading games developers and distribution channels for games in China. Their strategic investments and ownership of top global game studios provide significant international revenue to mitigate any domestic regulatory risks.

- Enterprise Solutions Infrastructure: Tencent has built formidable digital infrastructure that enhances productivity of business customers. Their Business Services segment encompasses cloud computing (Tencent Cloud) and SaaS offerings like WeCom (connecting 15+ million enterprises) and Tencent Meeting (over 400 million registered users). Tencent Cloud is a major player, particularly strong in video cloud solutions and databases, with infrastructure spanning 21 regions. Their heavy investments in R&D, particularly in AI, cloud computing, and emerging technologies, keeps it at the forefront.

Fortress Balance Sheet: Tencent maintains a resilient, profitable, and cash-generative business model. Tencent has significantly increased returns to shareholders through distributions of stakes in investees, cash dividends and share repurchases. Prudent capital management is reflected in solid credit metrics. Their robust financial position allows for continued strategic investments and capital return. 

Runway For Growth & AI Value Proposition

Tencent has demonstrated resilient growth through economic cycles and possesses multiple vectors for future expansion, with Artificial Intelligence (AI) acting as a key growth multiplier. AI is central to Tencent's strategy, enhancing efficiency, user engagement, and creating new revenue streams across its ecosystem. By strategically deploying AI across its vast userbase, Tencent is starting to realise significant value across its existing businesses:

For Tencent’s core businesses, AI allows:

- New interaction patterns: Tencent’s consumer-facing AI apps like the Yuanbao assistant is experiencing rapid user growth. China’s content is mostly secured behind walled gardens controlled by the large internet platforms such as Tencent. Hence the quality of AI search results varies based on the content it has access to. Tencent’s platform is the ideal place to develop agentic AI applications given it is seamlessly linked to much of the digital economy and has access to widest audience.

- More efficient marketing: Tencent has been infusing AI capabilities in their ad platform since 2015. Recent advances in larch language models (LLMs) improved user behaviour analysis, ad ranking, click-through rates, content approval speed, and automates ad creation. These leads to higher ROI for advertisers and drove the 20%+ revenue growth in ads.

- More engaging games: AI optimizes player matching and game balance. Integrating AI models to increase 3D content production efficiency and LLMs produces realistic in-game chatbots to increase user engagement.

- Better content production: AI improves production productivity for animation, video, and music, while also providing intelligent recommendations and enhancing content discovery through intelligent recommendations.

For Enterprise solutions, AI has the potential to revolutionise the landscape of enterprise software in China. We’ve already seen higher cloud adoption of enterprises, and many are choosing to partner with Tencent to rapidly deploy consumer facing solutions given its dominance. This leads to:

- Faster cloud growth: Tencent’s AI cloud revenue doubled in FY24. Tencent provides AI infrastructure (HCC, HAI) and platforms (TI Platform, LLM Knowledge Engine) enabling enterprises to build, iterate, and deploy AI solutions rapidly. Their increased GPU purchases are also expected to accelerate overall Cloud Services revenue growth.

- SaaS Enhancement: AI also improves adoption of Tencent’s software applications such as Tencent Meeting (which provides AI transcription and summaries) and Tencent Docs (AI content creation to boost productivity).

Tencent has built a truly remarkable high quality business with durable but importantly long run way for earnings growth at mid teens over the next few years and priced attractively at 16 times price to earnings.