Why Tencent Has Upside Despite ByteDance Competition

Tencent Holdings Ltd (SEHK: 700) hit a new 52-week high recently. Tencent’s strong performance has helped the Hang Seng Index rally since late March and the company briefly surpassed Alibaba Group Holding Ltd (NYSE: BABA) (SEHK: 9988) as Asia’s largest tech company.

Despite increasing competition from ByteDance, here’s why Tencent has done so well and why it has more upside in the future.

Much more than gaming and social media

Although Tencent faces competition from ByteDance in social networking and gaming, the market thinks Tencent can still do well due to the potential and value in its other divisions.

In areas such as the cloud and payments, many investors think ByteDance will have a hard time gaining a leading market share if the company were to enter. It takes a lot of scale and R&D to do well in the cloud and Tencent’s payments business is protected by network effects.

Tencent’s fintech and cloud divisions are also growing very quickly and are worth a lot. According to its annual report, sales from Tencent’s Fintech and Business Services division rose 39% year-on-year to RMB 101.4 billion (US$14.32 billion) for 2019.

According to the annual report, Tencent’s cloud services’ sales surpassed RMB 17 billion in 2019 as the unit grew over 86% year-on-year.

Tencent’s strong cloud performance in 2019 follows a strong performance in 2018 in which cloud sales more than doubled in 2018 to RMB 9.1 billion.

Tencent sees a lot of growth in the cloud in the future. The company recently announced a huge US$70 billion investment program to upgrade its “new infrastructure” in areas such as the cloud.

If all goes according to plan, its cloud offering could narrow the gap between Alibaba in terms of market share.

Due to Tencent’s fintech and cloud’s fast growth, large size, and high potential, many investors think the businesses are worth a lot.

According to Bernstein estimates last year, Tencent’s fintech division could be worth as much as US$160 billion to US$230 billion. If and when Alibaba-backed Ant Financial goes public, Tencent’s division could benefit from an increase in sentiment which could lift the unit’s valuation estimates even further.

Although it still lags Alibaba, Tencent’s cloud division is also worth a lot and could be worth even more if it continues its growth.

Tencent also has growth potential overseas. If a company like ByteDance can succeed overseas with TikTok, a company like Tencent which has more resources has a shot at eventually developing new popular international apps as well.

Tencent could realise success overseas via smart acquisitions or by expanding organically.

Growth estimates

Another reason for Tencent’s rally is that it is attractively valued versus future earnings estimates.

According to Yahoo Finance, analysts expect Tencent to grow earnings per share (EPS) by an average of around 20.41% over the next five years.

Using Tencent’s 2019 diluted EPS of around HK$10.70 as a base, Tencent would earn around HK$27.08 per share for 2024.

If the analysts are correct, Tencent would trade at a price-to-earnings (PE) ratio of around 17.9x five years later.

Given Tencent’s competitive advantages, Tencent’s stock looks pretty attractive using five-year projections at current prices.

Even if ByteDance were to take more market share in gaming and social media, Tencent’s valuation could still prove cheap five years later if the company continues to execute.

Foolish conclusion

Although Tencent faces increasing competition from ByteDance in social media and gaming, the company’s cloud and fintech operations have so much potential that the stock remains a good investment.

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