Tencent Holdings (TCEHY -1.80%) stock has been a big winner for shareholders, up 3,200% over the last 10 years. The Chinese tech giant has benefited from China's thirst for online entertainment in recent years, including social networks, gaming, streaming services, and cloud services. As a kicker, the company is also one of the largest mobile payment providers.
Tencent is No. 1 in China based on active users across all of these areas, think of the company as a combination of Netflix, PayPal Holdings, Alphabet, Facebook, Spotify Technology, and video game maker Activision Blizzard, all wrapped up in one. That's the kind of exposure you're getting when you buy a share of Tencent; except you're getting that exposure in China, where the middle class is rapidly growing and spending more and more money on digital entertainment.
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Key parts of Tencent's business
China's economy is increasingly becoming very tech-oriented, which has driven tremendous growth across Tencent's social networks and streaming subscription services. Total revenue and profits have increased 294% and 361%, respectively, since 2013.
Tencent operates the largest social network in China called Qzone, which has 550 million monthly active users on mobile devices. Its QQ instant messaging platform has 694 million monthly active users on mobile devices.
Unlike Facebook, Tencent generates the bulk of its social network revenue from digital video and music streaming subscriptions, as opposed to advertising. Online advertising makes up only 17% of Tencent's total revenue, as you can see in this table.
| Segment | 2017 | 2016 | 2015 | 2014 |
|---|---|---|---|---|
| Value added services | 153.9 ($22.7) | 107.8 ($15.9) | 80.7 ($11.9) | 63.3 ($9.3) |
| Online advertising | 40.4 ($5.9) | 26.9 ($3.9) | 17.5 ($2.6) | 8.3 ($1.2) |
| Others | 43.3 ($6.4) | 17.2 ($10.6) | 4.7 ($0.7) | 7.3 ($1.1) |
| Total revenue | 237.8 ($35.0) | 151.9 ($22.4) | 102.9 ($15.1) | 78.9 ($11.6) |
| Net profit | 65.1 ($9.6) | 45.4 ($6.7) | 32.4 ($4.8) | 24.7 ($3.6) |
Amounts in billions. Data source: Tencent Holdings. Amounts are as reported in Chinese Yuan. Currency exchange rate used for USD conversions is 1 Chinese yuan = 0.15 US dollars.
Tencent generated 65% of its revenue in 2017 from value added services (VAS), which includes social networks and online games. Social network revenue grew 52% in 2017, and continues to hum along with 47% growth reported in the first quarter.
Tencent Video and Tencent Music encompass its streaming services, and like Netflix and Spotify in the U.S., both of these have been growing at blistering rates. Total subscribers to these services grew 24% year over year in the first quarter to 147 million in total. And Tencent Video's exclusive content library continues to draw in subscribers -- revenue from video subscriptions surged 85% year over year.
Two other exciting markets
In recent years, China has become the epicenter of mobile payments and video games, and Tencent is perfectly positioned in both of these red hot markets.
In 2016, China surpassed the U.S. to become the largest gaming market in the world. Competitive gaming and watching esports have become very popular activities in China, and Tencent has an economic interest in some of the most played games in the world.
Instead of making games itself, Tencent partners and invests in some of the top game studios in the world. A notable one is Riot Games, the maker of League of Legends, which boasted a player base of 100 million in 2016 and had 80 million unique viewers during its 2017 esport world championship event.
Tencent also has a minority stake in Epic Games, the maker of Fortnite -- the most popular game in the world right now -- which has grossed over $1 billion in revenue less than a year after its release, according to SuperData.
If that weren't enough, Tencent also operates the most popular digital store where players buy and download games to their PC, similar to Steam in the U.S. Through WeGame, Tencent is effectively acting like a tollbooth operator for the estimated $25 billion Chinese gaming market -- the fastest growing game market in the world.
In addition to gaming, Tencent also holds the keys to a humongous $12.7 trillion mobile payments market in China. For perspective, the U.S. market was estimated at only $49.3 billion last year. Tencent's WeChat Pay has a near duopoly with Alibaba Group's AliPay, which, together, control 93% of the Chinese mobile payments market.
Tencent combines its revenue from mobile payments and cloud services into one category, which grew 151% in 2017 and more than doubled year over year in the first quarter of 2018. This source of revenue is only about 20% of total, but it's the tech giant's fastest growing category, which is not surprising given the enormous market it's serving in these crucial areas.
Chinese consumers use their smartphones to pay for just about everything, and the younger consumers are passionate about playing games. Tencent is playing a big role in making both activities part of daily life in China, and that spells big growth potential for the company going forward.
What about valuation?
The company has managed to grow revenue at a compound annual rate of 41% per year over the last four years, and it is incredibly proftiable -- net profits and operating cash flow have grown right in line with revenue over the years.
For that torrid growth, investors usually have to pay up, but the shares of Tencent trade at a forward P/E of 25, more or less in line with the broader stock market.
At that price, investors get a dominant player with exposure to most of tech's megatrends -- social networking, streaming services, gaming, and mobile payments.
