STOCKS: Tencent Builds Empire, Profits on Socializing

Bottom line: Tencent’s sharp focus, strong management and savvy strategic tie-ups make it China’s best Internet investment for the long term, though its shares may feel some short-term pressure due to high valuation.

Tencent builds empire on SNS

This week the series on my favorite Chinese stocks takes us to the “Big 3” of Baidu (Nasdaq: BIDU), Alibaba (NYSE: BABA) and Tencent (HKEx: 700) , sometimes called the BAT super trio because they’re the country’s biggest Internet companies by quite a large margin. I’ll end the suspense right away by saying my favorite among these 3 is Tencent, the only one that’s listed in Hong Kong.

I’ll look briefly soon at some financials comparing this trio, but will openly admit my Tencent attraction is less based on market fundamentals and instead is tied to its corporate personality that differs quite a bit from the others. These “personalities” are a direct reflection of each company’s founder, since all 3 are relatively young and the founder of each is still quite clearly in charge.

Tencent is led by the soft-spoken Pony Ma, who I sometimes like to poke fun at for his shy manner that makes him an awkward public speaker who rarely does media interviews. But that awkward manner hides his true passion, which is his love of tinkering with all things Internet, especially in the virtual realm of online social networking (SNS). The company is famous for its well-designed SNS products, most notably its core QQ and WeChat messaging platforms that have also become big money earners.

By comparison, Alibaba founder Jack Ma is a salesman who is more fond of telling people about his products than actual development. Baidu founder Robin Li is a likable one-trick pony who found early success in online search, but can’t seem to translate that to anything else.

Let’s begin with the biggest-picture number, the market value for all 3 of these companies. Tencent and Alibaba seem to frequently switch places for the spot as China’s most valuable Internet company these days due to their similar size and growth rates. Tencent has recently held the crown thanks to a sell-off of Alibaba’s shares in New York. But a recent rebound for Alibaba has left the pair nearly tied with market values of about $170 billion. Baidu is a distant third at about $60 billion.

All 3 of the BAT are posting similar revenue growth, usually in the 30-35 percent range in their latest quarterly results. But the broader trend has been toward slowing revenue growth as each company’s core business matures. Thus it’s important to look how each is looking for new opportunities outside that core businesses.

Focus on Partnerships

Whereas Alibaba and Baidu are more focused on acquisitions, often unrelated to their core businesses, Tencent stands apart in its strategy of forming strategic alliances as its main growth strategy. The company has one such key alliance with chief Alibaba rival JD.com (Nasdaq: JD) in e-commerce, and is building another with emerging group buying leader Meituan-Dianping. Such tie-ups look like smart, allowing Tencent’s partners to continue running their own operations while helping to boost their business through integration with WeChat and QQ.

While shares of all 3 of the BAT companies have been relatively volatile over the last year, Tencent has been one of the most stable during that period, trading mostly in the HK$140-$160 range. That relative stability is a direct offshoot of Pony Ma’s own low-key style, which makes his company a far less common fixture in the headlines. Such attention can be good for the stock when the news is positive, but can be equally damaging when it involves even the smallest negative news.

Tencent has been relatively scandal-free in its short life, in sharp contrast with Alibaba and even Baidu, which have both been caught up in high-profile tussles with regulators, rivals and even clients over issues like piracy and fraudulent advertising. Of course that could change at any time, and earlier this month Tencent was accused by the powerful Xinhua news agency of abusing WeChat’s dominant market position. (previous post)

We’ll end with a quick look at price-to-earnings (PE) multiples, which show how the broader market sees these 3 companies in comparison to one another. Investors seem to agree with my view based on that measure, and have given Tencent the biggest PE ratio of 44. That’s followed by 32 for Baidu, and a lowly 17 for Alibaba. Some might argue that the premium for Tencent looks a bit high now, and indeed that could lead to some opportunistic profit-taking in the shorter horizon.

But the company really does seem the best positioned for longer-term growth, thanks to its savvy combination of well-designed products and carefully considered strategic tie-ups. That approach has given it the skills and quiet determination to create cutting-edge products that could someday compete on the global stake with the likes of better-known names like Facebook (Nasdaq: FB) and Twitter (NYSE: TWTR).

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