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Tencent share price gains despite disappointing Krafton IPO

The Tencent [0700.HK] share price climbed 3.6% last week to close at HK$470.20 on 13 August, following a difficult six months for the stock. The sudden uptick came despite Tencent-backed Krafton’s [259960.KS] disappointing IPO after it dropped dramatically during its market debut on 10 August.

Despite a strong start to the year, when the Tencent share price moved to a 52-week high of HK$775.50 during intraday trading on 18 February, the stock has been on a downward spiral. Since then, shares have plunged 39.4% (through 13 August close).

Tencent, along with other Chinese tech stocks, has been hit by increasing state-led regulation on the sector, which has recently seen the company give up its exclusive music licensing rights and be fined for anti-competition violations over its 2016 purchase of China Music. Tencent was also temporarily forced to suspend new user registrations for its WeChat app.

$3.8billion

Valuation of Krafton at its IPO on 10 August

  

Videogame developer Krafton, the creator of hit game PUBG: Battlegrounds, floated its $3.8bn IPO on 10 August. However, the share price struggled to take off amid uncertainty in relation to the company’s overall offering, with an apparent over-dependence on its headline game. The stock closed down 8.84% from its IPO price on the day, setting an unwanted record as the first South Korean IPO to drop on its first day of trading in 2021, reported Bloomberg.

 

Tencent share price rises as Krafton slides on opening day

The Tencent share price climbed 5.33% on 10 August, despite Krafton shares falling almost 9% on its first day of trading, in South Korea’s biggest IPO in over a decade. Tencent’s 13.58% stake in Krafton makes it the company’s second-largest backer. Throughout the week, Krafton’s shares slid 12.25%, while Tencent’s share price added 5.19%.

Krafton, which dropped as much as 19.58% during intraday trading on 10 August before recovering, cut its offering by more than KRW1trn ($870m) after regulators questioned its valuation, report Bloomberg, with worries of over-dependence on its flagship game, plus tighter scrutiny over China’s gaming arena by regulators.

19.58%

Krafton's share price drop during intraday trading on 10 August

  

Despite an underwhelming debut, Krafton still ended its opening day with a valuation of KRW22trn ($19.3bn), overtaking established industry names like Nexon [3659] and Take-Two Interactive Software [TTWO], reports Bloomberg.

 

Why did Krafton’s IPO fall on debut?

Fears over Beijing’s crackdown on its tech sector has intensified after state media described gaming as “spiritual opium”, reported Bloomberg, while the scale of the IPO may also have put off investors. Heungkuk Securities analyst, Choi Jongkyung, said “the size of the share float was too big”, referencing the fact that the Krafton IPO was over 1.5 times bigger than KakaoBank’s [323410], which launched the previous week.

Krafton’s unusually high reliance on PUBG: Battlegrounds, which accounted for 96.7% of Krafton’s sales in the first quarter, according to Bloomberg, may well have been a significant factor in the early trading disappointment. “Krafton was one of the biggest IPOs, but it wasn’t popular in terms of subscription rate relative to other IPOs because it has so much dependence on one game,” Paul Choi, head of Korea research at CLSA, said.

“Krafton was one of the biggest IPOs, but it wasn’t popular in terms of subscription rate relative to other IPOs because it has so much dependence on one game” - Paul Choi, head of Korea research at CLSA

 

Krafton potential could boost long-term Tencent share price

Choi, however, does see reasons for optimism over Krafton’s long-term potential – reasons which may also offer a boost for Tencent’s share price. Choi says Krafton has “95% of revenue [generated] outside of Korea, unlike other internet and gaming companies that are mostly domestic-focused … so this is a rare, truly global new economy firm in Korea”.

Krafton’s aim is to transition into an entertainment giant, offering animated movies and deep learning-based interactive content relating to the PUBG: Battlegrounds fantasy, reports Bloomberg, with the company also planning to unveil PUBG: New State this year and a survival horror game, The Callisto Protocol, slated for release in 2021.

“95% of revenue [generated] outside of Korea, unlike other internet and gaming companies that are mostly domestic-focused … so this is a rare, truly global new economy firm in Korea” - Paul Choi

 

If these new games can be half as successful as PUBG: Battleground, then the gaming stock ought to benefit. PC and console versions of the game had sold more than 75 million copies by March 2021, while its mobile version was the most downloaded game in more than 150 countries.

While it’s too early yet for analysts to follow Krafton after just four trading days, the outlook for its second-biggest backer, Tencent, is certainly bright. The Tencent share price has 42 buy ratings, eight of which are overweight, four a hold and one sell rating, according to the Wall Street Journal, for an emphatic consensus buy rating, despite a difficult year. With an average price target of HK$603.04, according to Investing.com, the stock has an upside potential of 28.25%.

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