There Are Better Chinese Plays in Digital Than Tencent Stock

Tencent stock isn't as valuable as you might think

About a year ago, mega Chinese Internet operator, Tencent (OTCMKTS:TCEHY), was flying high. The stock price hit nearly $60. But it would be the peak. Tencent stock would go into a grinding bear move, with the shares hitting a low of $33 in October. Although, since then, there has been a bounce back rally.

Tencent stock TCEHY stock
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So where now? Well, when it comes to Chinese Internet stocks, TCEHY is high quality. With a market cap of $402 billion, it is near the valuation of rival Alibaba (NYSE:BABA). Despite this, TCEHY is still not well known in US investment circles.

Keep in mind that the company is kind of like a digital conglomerate.

Here is a sampling of the various businesses:

Communication and Social Tools:

TCEHY is the Facebook (NASDAQ:FB) of China, with several dominant social and messaging platforms. QQ for smart devices has 697.9 million MAUs (Monthly Active Users), which has seen growth with younger demographics. Then there is WeChat, which has over 1 billion MAUs. This platform has proven to be quite versatile with payments, city services and maps.

There has also been growth in business verticals like transportation, and healthcare. Interestingly enough, Tencent may have ambitions to enter the US market. To this end, the company has invested in Snap (NYSE:SNAP) and Reddit, which is an online forum.

Online Games:

TCEHY has a massive library of games for smartphones and PCs. Furthermore, the company has used its hefty cash flows to take equity positions in many top game makers, such as Activision Blizzard (NASDAQ:ATVI), Ubisoft Entertainment (NASDAQOTH:UBSFF) and Supercell.

Yet perhaps the most impactful deal has been for Epic, which is the developer of the red-hot Fortnite. The equity position is 40%.

Digital Content:

This includes premium content like dramas, anime series and so on. And growth has been torrid, with the number of subscriptions jumping 79% on a year-over-year basis to 82 million.

Cloud Business:

In the latest quarter, revenues more than doubled. The focus has been on gaming and broadcast sectors.

Of all these businesses, gaming is the most prominent. Consider that it represents nearly a third of overall revenues.

But this is an issue for Tencent stock. The gaming sector has been under pressure lately. The main reason: Fortnite. Even though Tencent benefits from its equity position in the company, the fact is that the rest of its gaming assets have come under pressure.

Next, the company has had to deal with tough actions from the Chinese government. There have been new censorship requirements, limits on time spent on games and delayed game approvals. While all these are manageable, they have made it tougher to grow the top line.

Bottom Line on Tencent Stock

There are some other nagging issues for Tencent stock. Of course, there remains the uncertainty regarding U.S.-Chinese relations. And yes, the Chinese economy has been decelerating. While secular trends in digital are robust, the macro situation is still a headwind.

Then there is the valuation on Tencent stock, which trades at 30 times forward earnings. This is not particularly cheap since the company is expected to grow at about 25% or so this year.

By comparison, BABA sports a multiple of only 25X  and is growing the top line at 40%+. In fact, as I’ve noted before in, when it comes to a play on China, I think BABA is your best bet right now, not Tencent stock.

Tom Taulli is the author of High-Profit IPO StrategiesAll About Commodities and All About Short SellingFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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