Barron's

Jan. 18, 2019 

What does an online company do next after securing a billion regular users? Chinese phenomenon Tencent Holdings is trying to answer that question against the trickiest economic backdrop in China for at least a decade.

The company issued the 7.0 version of its ubiquitous social platform, WeChat, in December, the first “full number” upgrade in four years. WeChat creator Allen Zhang, whose aura among the faithful resembles Steve Jobs’, preached its virtues for four hours at a subsequent developers’ conference, focusing on new video-streaming features that will “let people record what they’re really experiencing.”

But investors are unconvinced that a maturing Tencent (ticker: 700.Hong Kong) can maintain the youthful growth spurt that its stock valuation reflects. U.S. tech titans may be a better buy after their recent selloff. “Everything on WeChat is fine and wonderful,” says Colin Gillis, director of research with hedge fund adviser Chatham Road Partners. “But I would much rather have Amazon (AMZN) or Alphabet (GOOGL) shares.”

WeChat is a dozing giant in terms of actually making money for Tencent. Wary of alienating users with an ad blitz, the platform earns less than one-quarter as much per eyeball as global analog Facebook (FB), says Brian Bandsma, an emerging markets portfolio manager at Vontobel Quality Growth. The upgrade might be expected to narrow that gap and turbocharge Tencent’s bottom line. But aggressive monetization would violate Zhang & Co.’s cultural commitment to being a public utility of sorts that app developers can seamlessly graft onto, says Matthew Brennan, managing director of Beijing-based consultant China Channel. “[E-commerce giant] Alibaba Group Holding (BABA) is like a landlord renting you space in a virtual mall,” he says. “WeChat views itself as a platform where you can build a million followers without being squeezed.” Zhang reiterated this view in his talk, promising, “We have the patience to nurture [WeChat] slowly.”

Chinese authorities, meanwhile, still threaten the business that has been Tencent’s cash cow: online gaming. The government recently ended a 10-month moratorium on approving new games, but has not greenlighted any Tencent products. The industry could see permanent restrictions aimed at saving the eyesight and pocket money of gaming-mad Chinese youth, analysts say.

Nor can Tencent be unaffected by China’s broad economic slowdown. While gaming and social networking are relatively defensive businesses, a hard landing would bite at the company’s hundreds of outside investments, like upscale e-tailer JD.com or ride-share service Didi Chuxing. “China has never experienced a business cycle” under a market system, says Gil Luria, director of research at D.A. Davidson. “We don’t know what the effects might be.”

Comparative valuations have also shifted against Tencent, as its shares rebounded 30% since Nov. 1, while the U.S. FAANGs struggled. No two tech giants are exactly alike, but Tencent’s price-to-forward-earnings ratio of 32 looks rich compared to Facebook’s 20 and Alphabet’s 23. The Chinese company is more than twice as expensive as Amazon on a price-to-sales basis.

None of which spells calamity for Tencent. China’s economic rise continues, and the company’s sway over its online life looks locked in despite feisty new competitors like teen-focused ByteDance. The go-slow approach makes sense long-term as loyal users stick with WeChat for services from watching movies to paying their bills, Vontobel’s Bandsma argues. “The pace of growth is very reasonable at this point in time,” he says. “This is basically a monopoly.”

Monopolies age too, though, and can be buffeted by forces beyond their control. Right now, Tencent is not the best opportunity out there.