August 15, 2012 4:44 pm

Tencent – reality check

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China’s biggest internet company looks unassailable

China’s biggest internet company ($55bn market capitalisation and counting) showed investors again on Wednesday that it looks unassailable. Tencent – China’s equivalent of Facebook, MSN Messenger, Zynga and Blizzard Entertainment all rolled into one – reported first-half revenue growth of 54 per cent from a year earlier. Net income was up one-sixth. And China is supposed to be slowing down.

The key thing about Tencent is its huge user base. It claims 780m accounts on its instant messenger service QQ. Granted, that assumes one and a half accounts for every internet user in China, but QQ still managed to achieve peak concurrent users of 167m in the first half. That kind of coverage allows new fee-charging games and applications to proliferate at lightening speed, which has helped sales grow an average 50 per cent annually for the past five years. One of Tencent’s latest innovations – Weixin, its smartphone messenger application – gained more than 100m users in less than a year.

One problem for Tencent is that gone are the days when revenues came hand in hand with fat margins. Its online games are a cash cow and have helped the company accumulate a net cash pile of Rmb20bn. But now it must move into less profitable online advertising to support growth. As a result, operating margins were down 9 percentage points year-on-year in the first half. Tencent is also turning to ecommerce, but attempts to take on Alibaba group’s online retail giant Taobao will be costly.

All that leaves Tencent trading on 22 times forward earnings. With margins under pressure, this one-fifth discount to its five-year average seems justified. Zynga, meanwhile, surely a riskier internet play, trades on 24 times. And Facebook, which had one-third less revenues globally than Tencent made just in China last quarter, is on 37 times. Investors need a reality check.

Email the Lex team in confidence at lex@ft.com

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