China’s anti-monopoly crackdown of more than a year has taken a toll on the nation’s private sector and nowhere is that more apparent than in the share prices of some of its biggest tech names. Many former highflyers have seen their shares tumble by more than half, including gaming and social media giant Tencent Holdings Ltd., (OTCPK:TCEHY) (0700.HK), whose stock is now down by nearly 60% from its 2021 high of HK$770.
Tencent has soared over the past decade by expanding its core gaming business, which is now easily China’s largest. At the same time, it has embarked on a quieter shopping spree backed by its robust cash and access to capital, allowing it to assemble a “league of legends” investment portfolio covering everything from finance to retail, entertainment, hospitality, and travel as well as AI.
That web of companies touches the lives of nearly every Chinese, so much so that some say people can’t function in today’s China without using multiple products and services from within that ecosystem.
But now that web could be unraveling in the face of the latest crackdown on companies with too much influence in too many sectors outside their core areas. And with a major potential sale of one of those investments in the headlines last week, many are speculating Tencent could soon embark on a major divestment wave that could pull the rug from under many of its portfolio companies.
The speculation picked up last week when Reuters, citing an unnamed source, reported Tencent was in discussions with its financial advisor on how to sell some or all of its $24 billion stake in Meituan (OTCPK:MPNGF) (3690.HK), China’s leading group-buying and takeout dining platform. If true, many suspected the move would be aimed at appeasing China’s anti-monopoly regulators who are quietly trying to break up the massive empires assembled by Tencent, Alibaba (BABA; 9988.HK), and some of China’s other tech giants. Word of the potential sale sparked a 9.1% plunge in Meituan’s shares, sending them to a nearly three-month low.
Tencent responded by saying the report was “not fully accurate,” though it stopped short of pointing out specific inaccuracies.
Such a divestment would come less than a year after Tencent offloaded most of one of its other major holdings in JD.com (JD; 9618.HK). That deal saw Tencent lower its stake in China’s No. 2 e-commerce company to 2.3% from 17% by giving its investors $16.4 billion worth of JD.com shares as a dividend. JD.com‘s stock plunged as much as 9% the day Tencent announced the divestment last December.
UOB Kay Hian analyst Curtis Yeung said the possibility of Tencent offloading some Meituan shares should not be ruled out since many companies in the tech giant’s investment portfolio are still in the red. At the same time, Tencent needs funds to buy back its own slumping shares. He added that Meituan’s price-to-earnings (P/E) ratio by 2024 was projected to reach 60 times compared to Tencent’s lowly 16 times, and thus the latter might be looking to cash out while Meituan was highly valued.
$88 billion in equity investments
The more than 70 U.S.- and Hong Kong-listed companies in Tencent’s investment portfolio make up a vast ecosystem that was part of its strategy to compete with Alibaba. For example, it invested in e-commerce up-and-comers Pinduoduo (PDD) and JD.com to take on Alibaba’s dominant Taobao and Tmall online marketplaces. Tencent hoped to attract users to its portfolio companies by giving them preferential portals on its wildly popular WeChat instant message service, creating synergies across platforms.
According to its latest financials, Tencent’s equity investments in those portfolio companies were worth 601.9 billion yuan ($88 billion) at the end of June. In addition to Meituan, its other major holdings in Hong-Kong-listed companies include China Literature (OTCPK:CHLLF) (0772.HK), Kuaishou (OTCPK:KUASF) (1024.HK), Bilibili (BILI; 9626.HK) and Nio (NIO; 9866.HK), which were collectively worth more than HK$100 billion ($12.8 billion). Its major U.S.-listed portfolio companies include Sea Ltd. (SE), Pinduoduo, and Tencent Music (TME), with Tencent’s stakes in those companies worth $7.39 billion, $8.97 billion, and $3.78 billion, respectively. The market is concerned that these stocks may be next on Tencent’s chopping block, potentially depriving them of a key backer.
The biggest concern for investors right now is the sheer uncertainty. The potential for divestment could weigh on any of Tencent’s portfolio stocks, creating a major overhang. The big elephant in the room driving the divestments is Beijing’s relentless efforts to contain the wild investment sprees of recent years. The Covid-induced economic slowdown has also made companies like Tencent that invested across a wide range of industries especially vulnerable. That was partly responsible for the company’s disappointing second-quarter results.
First-ever revenue decline
Tencent’s revenue declined for the first time in the second quarter since its IPO in 2004, falling 1% quarter-on-quarter and 3% year-on-year to 134 billion yuan. It blamed the decline mostly on setbacks for two of its key operations: value-added services and online advertising. The latter’s revenue tumbled 18.4% due to the adverse effects of China’s economic downturn on companies’ advertising budgets.
The weak revenue, combined with rising administrative expenses and tumbling values in its investment portfolio, caused its second-quarter profit to fall 56% year-on-year to 18.6 billion yuan.
UOB Kay Hian’s Yeung believes that investors are most concerned over declining revenue for Tencent’s key games including “Honor of Kings,” “Moonlight Blade” and “League of Legends” which are weighing on its overall gaming revenue.
As Tencent’s gaming business flags after years of breakneck growth, President Martin Lau said the company introduced several cost-cutting measures last quarter, including laying off more than 5,000 employees and lowering the average monthly remuneration of its employees to 82,900 yuan, a reduction of 900 yuan.
With the potential sale of a large stake held by early backer Naspers (OTCPK:NPSNY) as a major overhang, Tencent’s own stock has been struggling at a price of around HK$300 for the last month with a price-to-earnings (P/E) ratio of just 10.7 times. Management emphasized at the latest analyst meeting that the stock was severely undervalued, and thus it would resume share buybacks. Whether that will help to support the sagging stock remains to be seen.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.