Tencent is well known for its flagship communication tool, the WeChat app which is used by more than one billion people daily. It also owns some of the world’s most popular video games such as Honor of Kings and League of Legend.
Tencent generates substantial free cash flow from the profitability of these products and reinvests the cash into research and development of technology and investing in other companies during their growth stage.
Over time, Tencent has become an investment powerhouse and have amassed a sizeable portfolio of many well known companies. Some of the more well known Tencent’s investment which have seen its value grow multiple folds includes Sea Ltd, JD.com, Pinduoduo, Bilibili, Nio, Kuaishou and Meituan Dianping.
What has Tencent done recently?
Distribute JD.com shares
On 23rd December 2021, Tencent declared an interim dividend by way of a distribution in specie of shares held in JD.com to shareholders.
JD.com was trading at HK$279.2 before the announcement and the value of the shares distributed amounted to HK$127.7 billion. The shares account for approximately 14.7% of the total number of shares of JD.com. After distribution, Tencent’s stake will be reduced from 17.0% to 2.3%.
Selling Sea Ltd shares & converting to ordinary shares
On 4th January 2022, Tencent announced that it would sell 14.5 million shares in Sea Ltd at $208 each for a total of US$3 billion, reducing its stake from 21.3% to 18.7%. Tencent will be subject to a lockup period that restricts further sale of Sea shares by Tencent during the next six months.
Tencent will also convert all their super-voting shares into ordinary shares thus reducing Tencent’s voting power. After this conversion, Forrest Li, the founder and Chairman of Sea Ltd will be the sole owner of all class B ordinary shares. Concurrently, Sea is also proposing to increase the voting power of each super-voting share by five-folds. If the proposed increase is approved by its shareholders, Forrest Li would have a majority voting power of 57%.
Impact of Tencent’s moves
These two announcements have shaken the financial markets.
JD.com plunged nearly 10% and Sea Ltd dropped more than 11% after the news was released. Sea Ltd is now down about 48% to US$197.80 from its 52-week high of US$372.70.
What is Tencent’s rationale?
Tencent explained its rationale for the JD.com share distribution saying it was adhering to its investment strategy.
Its investment mandate was to invest in companies to support and share in their growth. Investments made during their development stage would allow these investees to benefit from capital provided by Tencent in order to fund their development and expansion.
When the investee become consistently capable of self-financing future initiatives, Tencent would look to exit these investments where appropriate.
Similarly for Sea, it has scaled significantly to become a leading global company and is able to self-finance its future initiatives as proven by its fund raising in September 2021 via share and convertible bonds, raising more than US$6 billion.
Tencent has reiterated that for its positions in both JD.com and Sea Ltd, that notwithstanding the reduction in shareholdings, Tencent will continue to maintain their mutually beneficial business relationship and strategic partnership agreements.
The recycling of funds will provide Tencent with added resources to fund other investments and social initiatives.
Will Sea Ltd, JD.com and other investees sink or swim?
Swim – these investees will do fine
Companies with a strong platform, are either profitable or have the ability to self-finance will continue to do fine on their own.
Sea Ltd has three main business segments, namely Garena, Shopee and SeaMoney. Garena, which is a online game developer and publisher is profitable and has strong cash flows and Sea has been funding its investments in Shopee its e-commerce arm, partially from Garena’s operating cashflow. It also has a proven track record in fund-raising.
Similarly, JD.com’s retail segment which consists of online retail, online marketplace and marketing is highly profitable and generates strong cash flows. These cash flows fund new business initiatives such as JD Logistics, JD Health, JD Property and JD Technology (Formerly JD Digits). JD.com also has a proven track record in fund-raising as it was able to list JD Logistics and JD Health on the Hong Kong stock exchange.
It was also in the midst of listing JD Digits before the crackdown on its fintech rival Ant Group caused it to restructure into JD Technology by adding JD.com’s AI and cloud business into the entity.
Sink – these investees will not survive without Tencent
On the other hand, companies which are in an earlier stage of growth may face issues raising capital at a reasonable valuation or at all. They may also face higher cost of debt without having Tencent as a cornerstone investor.
For example, Nio has continuously made operating losses and relied on share sale to the market. In September 2021, it was able to raise US$2 billion through an At-The-Market Offering which enabled them to sell shares gradually at the current market price instead of a substantial discount. Nio is also planning for a second listing in Hong Kong which has faced delays and is expected to materialise this year.
Pinduoduo generated US$1.9 billion from its operations for 9 months of 2021 as it was profitable but incurred $3.5 billion in investments. It only has US$1.7 billion of cash on hand as at September 2021. This indicates that should Pinduoduo not be able to raise outside funds, they may have to curtail its investment plans and growth will be affected.
What about Tencent – what to look out for?
As Tencent reduces its shareholdings in its investees and hold a smaller stake, the company will be entitled to a smaller share of the profits. Tencent may also have reduced control as the company may not be entitled to a seat on the Board anymore. Tencent will also have a smaller share of the voting rights.
As both Sea Ltd and JD.com have a sizeable e-commerce segment, the market may view this as a retreat by Tencent from the e-commerce sector and concentrating its funds on other sectors which it has a stronghold or where there are more growth opportunities.
Tencent is a company that has the ability to generate nearly US$30 billion of cash flow from its operating activities annually. Generating an additional US$3 billion of cash from its stake sale in Sea Ltd is not momentous by any measure. The crucial point now is to look out for how Tencent deploys its capital.
Historically, Tencent has a track record of deploying capital extremely well, which is why Tencent is able to sell off its investments, reaping substantial profits now.
In line with the Chinese government’s common prosperity plan, Tencent earmarked nearly US$16 billion for this theme. In addition, Tencent has continued making investments overseas and notable investments include Monzo, a UK digital bank and ShareChat, an Indian social media and networking service. Tencent is also investing in its existing operations and are planning a new game development studio in Singapore.
It is worthwhile to monitor the performance and value of these investments to verify if Tencent maintains its successful track record.
Revenue growth is also a key indicator as Tencent continuously reinvests into new initiatives to generate new revenue streams for overall growth.
In conclusion
The news from Tencent’s stake reductions in Sea Ltd and JD.com have caused an immediate knee jerk impact to share prices of not only Sea Ltd and JD.com but also the rest of its investees and the broader market.
Tencent has made statements assuring the market that it is not abandoning its investees and provided strong reasons to explain its statement.
Its other investees may sink or swim depending on their stage of growth and financial strength. It is unlikely for Tencent to abandon investees with high growth potential as these are the companies that Tencent are interested in holding a stake for a longer period.
Tencent is poised to take its growth to the next level with reinvestment plans internally and externally both locally and overseas. On this note, Investors should keep a look out for Tencent’s future revenue growth and the growth of Tencent’s investment portfolio.
Alvin shared his point of view in the Ask Dr Wealth Facebook group, read it here. Or if you’re new to the Chinese stock market, read our Guide to investing in China before you invest.
