Over the next five years, Tencent [TCEHY] will invest $70 billion in China's digital infrastructure. It's a huge investment and all to aid Tencent's cloud computing, AI and cybersecurity businesses. But if it pays off, Tencent's share price could currently be a bargain.
What's happening with Tencent's share price?
Tencent's share price is up nearly 13% so far this year. The stock hit a year low in March, but has since rallied 24% as China's economy begins to recover from the coronavirus shock. For comparison, cloud rival Alibaba's [BABA] share price is down over 6% this year and has gained just 6% since March. News of Tencent's investment in cloud technology has led to more upwards momentum.
Why should investors care?
Tencent's investment comes after the Chinese government announced an initiative making “tech-driven structural upgrades” throughout its economy. Nicknamed "new infrastructure", these upgrades are in response to the boom in advances like cloud computing and 5G.
The company’s focus will be on building huge data centres with more than a million servers each. It'll also construct industrial parks and innovation centres.
For Tencent, it's an opportunity to strengthen its cloud business. Tencent is largely known for the WeChat messaging service and mobile video gaming, which are huge revenue drivers. Its cloud computing arm, however, languishes behind local player Alibaba. According to research firm Canalys, in the fourth quarter Alibaba held a commanding 46% market share, Tencent Cloud was a distant second with 18%.
Can Tencent's balance sheet take it?
Tencent's balance sheet looks in decent shape. Over the past few years, both revenues and earnings have been steadily increasing. In 2019, Tencent posted earnings of RMB93.1 billion up from the RMB78.32 billion seen in 2018.
In the first quarter of 2020 earnings came in at RMB28.9 billion, up from RMB21.58 billion seen in the previous quarter. Q1 saw a 31% year-on-year rise in online gaming revenue and a 32% bump in advertising sales.
To pay for its new infrastructure investment Tencent said it would issue $20 billion worth of bonds to professional investors. That's a large sum of money in anyone's books, but Tencent's balance sheet is in robust shape.
Tencent's Q1 earnings
Will Tencent’s cloud investment pay off?
China is the second-biggest cloud computing market in the world, with a 10.8% market share in Q4 2019, according to research company Canalys. In that quarter, China's cloud infrastructure market grew 66.9%. Such huge growth rates mean Tencent's investment could well pay off - especially if it compliments its other business areas, such as online gaming.
One area of concern will be any slowdown from the current pandemic. However, Matthew Ball, an analyst at Canalys, says the firm still expects growth in China's cloud sector, in part from new business:
“In addition to the continuation of digital projects once business returns to normality, we anticipate many businesses new to using cloud services during the crisis will continue use and become paying customers.”
“In addition to the continuation of digital projects once business returns to normality, we anticipate many businesses new to using cloud services during the crisis will continue use and become paying customers” - Matthew Ball, Canalys analyst
Analysts, too, are backing Tencent. Of the 37 tracking Tencent’s share price on Yahoo Finance, 13 rate it a Strong Buy and 23 rate it a Buy. However, the share price isn't cheap, with a 38.95 price to earnings ratio for the past 12 months. An average share price target of HK$388.16 would see a 9.8% downside on Tencent's current share price. Investors will need to decide if Tencent's investment in China's digital future will lead to long-term gains.
Disclaimer Past performance is not a reliable indicator of future results.
CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.
CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.
*Tax treatment depends on individual circumstances and can change or may differ in a jurisdiction other than the UK.