Talking Point

China’s most admired firm?

How Tencent has become one of the world’s most valuable companies

Pony-Ma-w

Pony Ma’s Tencent is building a dominant (and very profitable) ecosystem around WeChat

For the better part of the twentieth century the American Telephone and Telegraph Company was the world’s most valuable firm. Its grip on the telephone market was so tight that at one point AT&T owned all the wires and all the telephones plugged into them.

When radio emerged as a game-changing medium – in a manner akin to how the internet has reshaped the world more recently – AT&T threw its weight behind that as well. The telco tried to crush competition with its control of key patents in vacuum tubes and radio transmitters. Ma Bell – AT&T’s nickname – was innovative in monetising the airwaves as well and the first ever radio commercial was broadcast by its New York station in 1922.

AT&T’s aggressive expansion into broadcasting was only checked when regulators stepped in to prevent a single corporation controlling America’s phone lines and radio stations, fearing a possible monopoly on access to news and entertainment. Under the antitrust initiatives, Ma Bell was broken up into regional entities, although one of the “Baby Bells” later regrouped into a national giant and renamed itself AT&T once again.

The company rekindled some of its earlier ambitions to combine communication with content last year by agreeing to buy Time Warner for more than $100 billion, including debt. But in China its the internet giant Tencent that is making its own attempt to leverage a virtual monopoly in communication into something greater – in this case via its hugely popular messaging app WeChat. Tencent is using the platform to expand into other digital industries, with its ‘super app’ now offering a bewildering range of features and functions. Baidu and Alibaba, the other players in the so-called BAT internet trio, have been adopting a similar diversification strategy. However, buoyed by a spike in its market value, Tencent has been making some of the boldest strides. Last week, for instance, it made a major push into internet search and e-commerce, habitats long dominated by Baidu and Alibaba respectively. Investors may be betting it is going to emerge as the victor in this clash of the BAT titans.

How much is Tencent worth?

At Berkshire Hathaway’s annual meeting earlier this month Warren Buffett admitted that he had blundered by not buying Google’s shares many years earlier. But spare a thought for Richard Li, son of Asia’s richest man Li Ka-shing, who must be distraught at missing out on Tencent’s incredible rise. According to Chinese media, Li junior acquired a 20% stake in Tencent for about $1.1 million in 1999 only for his cash-strapped telco PCCW to take profit on the investment for $10 million two years later.

In April 2013 we reported that Li had left nearly $12 billion on the table as Tencent’s market capitalisation climbed to $60 billion at the time. But its share price has more than quadrupled since then and, as of Thursday, the Hong Kong-listed firm traded above HK$2.63 trillion ($335 billion). Yes, that’s 75 times what Li’s company PCCW is worth today.

Tencent’s shares have been rewriting their all-time highs throughout the past year. Taking into account a one-into-five share split in 2014, the HK$275.2 closing price on Tuesday is nearly 400 times higher than its IPO price back in June 2004. Even investors that grabbed the stock early this year are sitting on gains of 45%.

The stock’s advance has turned Tencent into a flagbearer for Hong Kong’s stock exchange, where it at one point constituted about 16% of the market value of the Hang Seng Index, no mean feat in a grouping which includes heavyweights such as China Mobile and HSBC.

Hong Kong’s Apple Daily further reports that Tencent’s market value took it into the world’s top 10 companies in April, overtaking the likes of JPMorgan Chase and Wells Fargo, although it still lags behind Apple ($800 billion), Google’s parent firm Alphabet ($683 billion) and Facebook ($446 billion).

“The market cap of global tech giants has become a buzzworthy topic because of Tencent,” Beijing News adds, noting that the firm is also worth 10% of the entire bourse in Shenzhen, the city where it is headquartered.

Alibaba’s market value has climbed 40% so far this year to $307 billion but it still trails in Tencent’s wake. And trading at about $65 billion, Baidu increasingly looks like the junior party in the tech troika.

How profitable is Tencent?

Tencent’s share price performance has been backed by strong earnings growth. In March it reported a 43% surge in last year’s net profit to Rmb41 billion ($5.9 billion). Revenues also climbed 48% to Rmb151 billion.

“Tencent is making more than Rmb100 million a day,” a columnist at Sina Finance observed. “In order to be successful, China’s richest man Wang Jianlin [of Wanda Group] once advised us to set ourselves ‘a small, achievable target’ of earning Rmb100 million to begin with [see WiC339 for Wang’s recipe for success]. Pony Ma [Tencent’s boss] has hit that threshold every evening when he heads home from the office.”

Tencent’s archrival Alibaba has reported very similar revenue numbers for the same period, with sales for 2016 jumping 56% to Rmb158 billion, a record high. The e-commerce giant’s net profit was almost identical at Rmb41 billion. But profit for the year had declined 42%, about the same percentage that Tencent’s had increased.

The results mean Tencent is trading at a price-to-earnings ratio of 56 times versus Alibaba’s 51 times. But its frenetic growth shows little sign of slowing and it has just posted more record numbers for the first quarter, reporting another 58% spike in profit to Rmb14.5 billion on revenue gains of 55% to Rmb49.6 billion for the same period.

Gaming is one of the brightest spots, generating Rmb22.8 billion, or nearly half of Tencent’s revenues. That was a result of strong showing from the likes of Honor of Kings, a self-developed game and China’s top-grossing smartphone title last year, and League of Legends, which it acquired through the purchase of California studio Riot Games in 2011. League of Legends is the world’s most popular battle title for desktops and it topped Apple’s iOS store in March in downloads too.

What is Tencent’s latest move?

Active users of the all-pervasive WeChat, or Weixin in its Chinese version, climbed 23% to 938 million. This is the key to Tencent’s success and it wants to grab a greater share of wallet from its huge pool of social media users. Revenues from social networks are up 56% year-on-year due to music and video subscriptions, for instance. Tencent has been investing heavily in video streaming and bankrolling Hollywood movies such as Kong: Skull Island, with plans to adapt popular films and novels (some already available on its publishing platform) into mobile games that will be sold over WeChat.

“After building the biggest social ecosystem in China, Tencent remains at an early stage of monetisation,” forecast Chi Tsang, HSBC’s head of internet research in Hong Kong, earlier this month.

Last week Tencent also launched a newsfeed and search function, posing a much more direct challenge to Baidu’s search engine, which accounts for 65% of total searches in the Chinese language.

Millions of pages are published every day by WeChat users – from solo blogs through corporate PR to news reports from traditional media – but Baidu has been blocked from indexing the majority of the content. In contrast, WeChat’s newly launched newsfeed and search tools should enjoy an advantage by operating inside Tencent’s ecosystem or ‘walled garden’.

In fact, Tencent already owns a 45% stake in Sogou, another search engine with roughly 10% of the Chinese market. Analysts anticipate that it will eventually offer WeChat users full search functionality on the internet through Sogou, which is targeting a New York IPO later this year. (The function just launched on WeChat can only search material posted within the app, not on the broader web.)

Of course, the fuller search service would pose a mortal threat to Baidu at a time when it has been reporting slower revenue growth as advertisers reallocate their spending to social media platforms.

By keeping its customers inside its ‘walled garden’, WeChat may also end up as China’s biggest online news channel. One of its potential competitors is Jinri Toutiao (or Today’s Headlines). Now five years old (see WiC244), the news aggregating platform has 600 million users and a fundraising round this month valued it at $11 billion. But the unicorn will probably have to fight off a challenge from the social media giant. “Tencent has effectively embedded a ‘Baidu’ in WeChat, and it comes with a ‘Toutiao’ as well,” a tech blogger warned this week on (where else) WeChat. “The search and newsfeed function will give Baidu a punch and Toutiao a kick.”

So Alibaba is playing catch-up?

For years the Chinese internet giants have been venturing into each others’ territory. Alibaba has tried and largely failed to break into China’s messaging business, and still hankers for a similarly powerful presence in social media. But WeChat’s popularity is allowing Tencent to encroach much deeper into Jack Ma’s e-commerce empire. The Chinese are increasingly turning to Tencent’s all-in-one app to shop and pay for everything. WeChat Pay, Tencent’s answer to Alibaba’s payment solution Alipay, allows its users to transfer money to each other with a click or a code scan. Retail outlets across China accept payment from both mobile apps, although the Global Times says that Tencent’s share of payments more than doubled to 37% in the fourth quarter last year, at the expense of Alipay, which saw its slice decline to 54% from 70% the prior year.

WeChat users can already shop on Alibaba’s main e-commerce rival JD.com and commentators expect Tencent to extend its advance into the world of e-commerce. “Tencent is aggressively adding more services and retailers into the mix, such as the online travel agent Ctrip.com. That could – over time – crowd out the attractions of Alibaba,” the Global Times predicts.

What are Tencent’s global ambitions?

Both Alibaba and Tencent want to capitalise on their dominance in China by establishing themselves at the top of the global league.

A year ago Alibaba was hit by a spate of bad news that started with counterfeiting controversies on its online sales platforms and was followed by investor criticism of its accounting practices (see WiC327).

Since then its maverick chairman seems to have adopted a lower-profile at home in China, although Jack Ma has been spending time lobbying overseas governments to buy into his grand strategy: transforming Alibaba into a ‘digital World Trade Organisation’.

“Alibaba is the company that likes to think it’s a country,” the Financial Times suggested in its Big Read this week, noting that Ma has been working “the stage like a seasoned diplomat”. Besides taking on an important role at last year’s G20 meeting in Hangzhou, where Alibaba is headquartered, Ma has also met a host of national leaders this year, and in January he was the first Chinese businessman to meet American President Donald Trump.

Tencent boss Pony Ma plays it much lower key and he’s unlikely to ever admit publicly that his company wants to square up to Apple and Google. However, Reuters reported this month that Tencent has hired 1,500 software developers to work on its Mini Programs feature on WeChat, a newly-delivered function that looks and operates like the app stores on Apple’s iOS and Google’s Android, hosting its own universe of ‘apps within apps’.

Tencent has said that it launched Mini Programs in tribute to Apple’s achievements (see WiC351) but analysts are coming to the conclusion that WeChat is starting to become a smartphone operating system in its own right. In China, at least, WeChat’s ‘stickiness’ is already much greater than anything that iOS and Android can offer. “Given WeChat can be used in nearly all models, there is no reason for Chinese smartphone users to pick iPhones. This is one of the main reasons why iPhone’s market share in China has been eroded,” an article on tech website Huxiu also recently suggested.

In the meantime investors have been trying to predict when Tencent’s stellar share price performance might show signs of losing its lustre. Another warning is that companies like Alibaba and Tencent could become victims of their own success and run into growing regulatory risks as their commercial empires expand. “When one day Tencent or Alibaba’s market value goes past $500 billion, or even $1 trillion, they will become monsters dominating all economic activities. Regulators may then step in to break them up, just as they did with AT&T in the 1980s. Before this happens, the Matthew Effect [that the big get bigger] will persist in the mobile internet market,” another of the bloggers on Huxiu predicted.

As for Baidu, unless some of its investments in new technologies – such as artificial intelligence and self-driving cars – starts to pay off, the search giant could soon lose further ground to Tencent and Alibaba.

If so, WiC suspects we’ll be talking less about the BAT trio and more about the AT (curiously only an ampersand and a letter away from AT&T, the former US monopoly).


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