Tencent Holdings - · PDF [email protected] +852 2252 1400 ... licensing contract to a Chinese competitor should have limited financial ... Net cashflow . 6,845. 22,485

Tencent Holdings 0700.HK 700 HK

EQUITY: INTERNET & NEW MEDIA

More to play into 2016

Wechat payment could be a new catalyst

A strong challenger in mobile payment service

Global Markets Research 22 January 2016

Rating Remains BuyTarget Price Increased from 170.00 HKD 190.00

Closing price 20 January 2016 HKD 135.40

Potential upside +40.3%

Anchor themesWe believe pan post-90s generation is a more powerful driving force for Chinese online economy which should most benefit ecommerce, online travel and internet finance sectors, among others.

Nomura vs consensusOur FY16F earnings are 8% above consensus on higher revenue forecasts.

Research analysts

China Internet & New Media

Jialong Shi - NIHK [email protected] +852 2252 1409

Andrew Orchard - NIHK [email protected] +852 2252 1400

Liz Guan - NIHK [email protected] +852 2252 1421

Tencent’s Wechat payment gained market share through 2015, on the back of unique social features bundled with the payment service and the partnership with Meituan Dianping, one of the leaders in life O2O space, which helps create lots of scenarios for the use of Wechat payment. Payment is the foundation of any transaction and, therefore, it is a critical piece for the closed loop of service. Despite all the high hopes, we think Apple Pay’s China venture could be disappointed by regulation and the execution of its state-run partner UnionPay.

Resilient online gaming business We forecast Tencent’s online-gaming revenue to grow 18% and 15% y-y in 2016F and 2017F, respectively. We think Tencent’s loss of Crossfire 2 licensing contract to a Chinese competitor should have limited financial impact as Tencent has secured another five-year exclusive license for Crossfire 1. Besides, we believe the phenomenal success of CF1 in China was more attributable to Tencent’s powerful social platform.

Solid outlook for ads service We forecast Tencent’s ad revenue to grow 85%/59% in FY16/17F. The accelerating growth is likely driven by both solid video and P4P (pay for performance) ads service. The online video ads revenue could be fuelled by quite a few exclusive contents that the company has acquired and the Olympics Games in mid-2016. We estimate that P4P could surge 117%/71% in 2016/2017F, driven by enhanced monetisation of Wechat ads.

Maintain Buy; TP raised to HKD190 Tencent is becoming a strong challenger in mobile payment. With robust growth from mobile/PC game and surging growth for online advertising, Tencent looks undemanding at 25x 2016F non-GAAP EPS of HKD5.4, in line with historical average. Our DCF-based TP is HKD190 (HKD170 previously), which implies 28x 2017F P/E.

Year-end 31 Dec FY14 FY15F FY16F FY17F

Currency (CNY) Actual Old New Old New Old New

Revenue (mn) 78,932 99,761 99,761 131,957 133,790 167,582 173,791

Reported net profit (mn) 23,810 29,180 29,180 39,757 40,561 51,610 54,394

Normalised net profit (mn) 25,612 31,928 31,557 43,089 43,893 55,262 58,046

FD normalised EPS 2.74 3.40 3.36 4.53 4.60 5.75 6.01

FD norm. EPS growth (%) 53.4 24.2 22.6 33.4 37.0 26.8 30.7

FD normalised P/E (x) 39.5 N/A 32.9 N/A 25.0 N/A 20.1

EV/EBITDA (x) 31.7 N/A 23.9 N/A 17.9 N/A 13.6

Price/book (x) 12.5 N/A 9.2 N/A 7.0 N/A 5.4

Dividend yield (%) 0.2 N/A na N/A na N/A na

ROE (%) 34.5 30.4 30.5 29.8 30.4 28.3 29.5

Net debt/equity (%) net cash net cash net cash net cash net cash net cash net cash

Source: Company data, Nomura estimates

First published on 22 Jan as part of our Anchor Report: China internet and media - Bucking the trend

Key company data: See next page for company data and detailed price/index chart.

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

http://www.hibor.com.cn/

Nomura | Tencent Holdings 22 January 2016

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Key data on Tencent Holdings Relative performance chart

Source: Thomson Reuters, Nomura research

Notes:

Performance (%) 1M 3M 12MAbsolute (HKD) -10.5 -7.8 9.1 M cap (USDmn) 162,829.1Absolute (USD) -11.3 -8.7 8.2 Free float (%) 56.0Rel to MSCI China 2.5 11.2 30.4 3-mth ADT (USDmn) 323.1 Income statement (CNYmn) Year-end 31 Dec FY13 FY14 FY15F FY16F FY17FRevenue 60,437 78,932 99,761 133,790 173,791Cost of goods sold -27,778 -30,873 -40,268 -54,346 -70,870Gross profit 32,659 48,059 59,492 79,443 102,921SG&A -13,899 -19,455 -21,443 -27,443 -34,902Employee share expense -1,785 -2,497 -2,441 -3,432 -3,775Operating profit 16,975 26,107 35,608 48,569 64,245EBITDA 20,581 30,925 41,196 55,389 73,100Depreciation -2,484 -2,993 -3,284 -3,735 -4,852Amortisation -1,122 -1,825 -2,304 -3,085 -4,003EBIT 16,975 26,107 35,608 48,569 64,245Net interest expense 921 810 602 1,028 2,038Associates & JCEs 170 -347 -1,464 0 0Other income 1,214 2,443 1,533 0 0Earnings before tax 19,281 29,013 36,280 49,597 66,282Income tax -3,718 -5,125 -6,693 -8,479 -11,332Net profit after tax 15,563 23,888 29,587 41,117 54,950Minorities -61 -78 -407 -556 -556Other items 1,167 1,802 2,377 3,332 3,652Preferred dividends

Normalised NPAT 16,669 25,612 31,557 43,893 58,046Extraordinary items -1,167 -1,802 -2,377 -3,332 -3,652Reported NPAT 15,502 23,810 29,180 40,561 54,394Dividends -1,468 -1,761 0 0 0Transfer to reserves 14,034 22,049 29,180 40,561 54,394Valuations and ratios

Reported P/E (x) 63.2 41.9 35.2 26.8 21.2Normalised P/E (x) 58.8 39.0 32.5 24.7 19.9FD normalised P/E (x) 60.0 39.5 32.9 25.0 20.1Dividend yield (%) 0.1 0.2 na na naPrice/cashflow (x) 41.0 30.9 26.3 18.4 15.3Price/book (x) 16.9 12.5 9.2 7.0 5.4EV/EBITDA (x) 39.7 31.7 23.9 17.9 13.6EV/EBIT (x) 48.1 37.6 27.6 20.4 15.4Gross margin (%) 54.0 60.9 59.6 59.4 59.2EBITDA margin (%) 34.1 39.2 41.3 41.4 42.1EBIT margin (%) 28.1 33.1 35.7 36.3 37.0Net margin (%) 25.6 30.2 29.2 30.3 31.3Effective tax rate (%) 19.3 17.7 18.4 17.1 17.1Dividend payout (%) 9.5 7.4 0.0 0.0 0.0ROE (%) 31.2 34.5 30.5 30.4 29.5ROA (pretax %) 23.0 23.9 25.9 34.3 42.6Growth (%)

Revenue 37.7 30.6 26.4 34.1 29.9EBITDA 17.3 50.3 33.2 34.5 32.0Normalised EPS 22.0 52.4 22.2 37.0 30.7Normalised FDEPS 21.9 53.4 22.6 37.0 30.7Source: Company data, Nomura estimates

Cashflow statement (CNYmn) Year-end 31 Dec FY13 FY14 FY15F FY16F FY17FEBITDA 20,581 30,925 41,196 55,389 73,100Change in working capital 8,186 11,376 6,727 9,712 10,265Other operating cashflow -4,393 -9,590 -8,477 -5,610 -7,281CF from operations 24,374 32,711 39,446 59,492 76,084Capital expenditure -5,988 -6,616 -7,165 -8,672 -10,222Free cashflow 18,386 26,095 32,281 50,820 65,862Reduction in investments -7,956 10,371 0 0 0Net acquisitions Dec in other LT assets -12,114 -42,670 -6,359 -6,492 -6,639Inc in other LT liabilities 221 1,953 0 0 0Adjustments 6,704 8,574 1,336 1,469 1,616CF after investing acts 5,240 4,323 27,258 45,797 60,839Cash dividends -1,541 -1,919 0 0 0Equity issue 308 299 0 0 0Debt issue 4,699 2,777 0 0 0Convertible debt issue 0 17,842 12,500 0 0Others -1,861 -837 0 0 0CF from financial acts 1,605 18,162 12,500 0 0Net cashflow 6,845 22,485 39,758 45,797 60,839Beginning cash 13,383 20,228 42,713 82,471 128,268Ending cash 20,228 42,713 82,471 128,268 189,107Ending net debt -5,175 -3,651 -34,387 -80,184 -141,023 Balance sheet (CNYmn) As at 31 Dec FY13 FY14 FY15F FY16F FY17FCash & equivalents 20,228 42,713 82,471 128,268 189,107Marketable securities 23,754 19,972 19,972 19,972 19,972Accounts receivable 2,955 4,588 3,852 7,467 6,284Inventories 1,384 244 0 0 0Other current assets 5,365 7,804 7,804 7,804 7,804Total current assets 53,686 75,321 114,100 163,511 223,167LT investments 11,420 4,831 4,831 4,831 4,831Fixed assets 10,734 11,748 12,896 14,436 15,567Goodwill Other intangible assets 4,103 9,304 9,752 10,084 10,343Other LT assets 27,292 69,962 76,321 82,813 89,452Total assets 107,235 171,166 217,899 275,675 343,360Short-term debt 2,589 5,049 5,049 5,049 5,049Accounts payable 6,680 8,683 11,355 15,688 19,578Other current liabilities 23,998 36,303 39,378 48,372 53,565Total current liabilities 33,267 50,035 55,782 69,109 78,191Long-term debt 12,464 30,535 43,035 43,035 43,035Convertible debt 0 3,478 0 0 0Other LT liabilities 3,041 4,994 4,994 4,994 4,994Total liabilities 48,772 89,042 103,811 117,138 126,220Minority interest 518 2,111 2,518 3,074 3,630Preferred stock Common stock 5,721 5,951 5,951 5,951 5,951Retained earnings 52,224 74,062 105,619 149,512 207,558Proposed dividends Other equity and reserves Total shareholders' equity 57,945 80,013 111,570 155,463 213,509Total equity & liabilities 107,235 171,166 217,899 275,675 343,360

Liquidity (x)Current ratio 1.61 1.51 2.05 2.37 2.85Interest cover na na na na naLeverageNet debt/EBITDA (x) net cash net cash net cash net cash net cashNet debt/equity (%) net cash net cash net cash net cash net cash

Per shareReported EPS (CNY) 1.69 2.58 3.13 4.29 5.69Norm EPS (CNY) 1.82 2.77 3.39 4.64 6.07FD norm EPS (CNY) 1.78 2.74 3.36 4.60 6.01BVPS (CNY) 6.33 8.67 11.98 16.44 22.32DPS (CNY) 0.16 0.19 0.00 0.00 0.00Activity (days)Days receivable 16.0 17.4 15.4 15.5 14.4Days inventory 12.8 9.6 1.1 0.0 0.0Days payable 71.6 90.8 90.8 91.1 90.8Cash cycle -42.7 -63.8 -74.3 -75.6 -76.4Source: Company data, Nomura estimates



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A strong challenger in mobile payment

Tencent gaining market share on mobile payment

Since 2014, Tencent has been competing fiercely against Alipay on mobile payment. The two companies have poured hundreds of millions of CNY subsidising merchants and consumers to encourage the adoption of their respective payment tools. According to iResearch data, Tenpay, which is a collective title for all of Tencent’s payment solutions, including WeChat payment and mobile QQ wallet, saw its market share increase from 13.5% in 1Q15 to 19.2% in 3Q15, whilst Alipay’s market share dropped to 70% from 77% in the same period. We attribute Tencent’s market share gains to the strong social attribute of its payment service bundled with WeChat or mobile QQ.

Fig. 1: Mobile payment market share in 1Q15 by volume*

Source: iResearch. *Excluding payment processed directly by banks or UnionPay.

Fig. 2: Mobile payment market share in 3Q15 by volume

Source: iResearch. *Excluding payment processed directly by banks or UnionPay

WeChat payment likely to gain market share continuously

In our opinion, there are two key elements underpinning a successful expansion of mobile payment services, which are payment scenarios and value proposition to users and merchants. Creating various payment scenarios facilitates the acquisition of new users, while the capability to provide unique value propositions beyond just being a payment channel helps strengthen the moats by enhancing users and merchants’ stickiness.

Alipay77.2%

Tenpay13.5%

Lakala3.0%

Others6.3%

Alipay69.9%

Tenpay19.2%

Lakala1.4%

Others9.5%



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Fig. 3: Snapshot of Wechat functions

Source: Wechat

Fig. 4: Snapshot of red envelope and money transfer functions on Wechat

Source: Wechat

Tencent has been exploring, both internally and externally, various scenarios for its payment services. Within Tencent’s own ecosystem, WeChat payment or QQ Wallet has been plugged into all of Tencent’s product offerings where there are transactions. For example, WeChat has moved the command for giving red envelope and transferring money to the menu of the user’s chat window, while both used to be tucked deep in sub-menus previously.

Partnering with O2O players and offline merchants Both Alipay and Tenpay are competing fiercely to sign up O2O plays and offline merchants in a bid to promote their respective payment services.

In the O2O space, Tencent appears to be better positioned than Alipay as it is backed by its stake in the merged entity of Meituan & Dianping (MD), which is a leader in several high-frequency local-life related O2O verticals, including food takeout delivery, movie ticketing and dining services. Based on our estimate, MD’s market share was 84%, 46% and 41% in dining, movie ticketing and food takeout delivery segments, respectively.

Tencent’s stake in MD is reported to be 16% based on Chinese Business Daily, which said Ali also holds a 7% stake in MD but is likely considering selling out its stake due to friction with MD management. Consequently, based on our research, MD appears to prioritise Tencent’s WeChat payment over Alipay. According to Bigdata, Tenpay exceeded Alipay in 3Q15 with 45% market share in the food takeout delivery segment compared to Ali’s 44% share.



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Fig. 5: Mobile payment market share by GMV in food takeout delivery segment in 3Q15

Source: Bigdata

Tencent and Ali are tied in the car-booking service with each owning ~15% interest in Didi-Kuaidi, an 82% market share holder in China’s private car booking market in 2Q15. Therefore, both Alipay and Wechat payment show up in users’ choice on Didi-Kuaidi’s payment page.

Unique value proposition to both users and merchants

For merchants, WeChat payment is beyond a payment channel. It also provides an efficient means for merchants to manage customer relationships as users, after they pay a merchant via WeChat, are usually subscribed by default to the merchants’ WeChat service account.

For consumers, WeChat payment offers a seamless experience because: 1) most of them are already WeChat users and therefore do not need to install extra payment apps; 2) the social networking nature of WeChat and its payment service enables convenient (one-tap) sharing of their shopping/dining experience amongst their friends; and 3) last but not least, the virtual envelope that went viral during Chinese New Year (CNY) in February 2015 has become an ingrained culture for WeChat users that amounted to 600mn plus in MAU as of 3Q15. Giving or receiving red envelopes gradually plants the payment notion in the mind of Wechat users. Thus, they feel more comfortable about paying through it in various real transaction scenarios.

Market share gains above monetization

We believe both Tencent and Ali will continue to focus on grabbing market shares as we forecast the overall mobile payment market will continue to grow at a 34% 2017-2020F CAGR in volume terms. Both Tencent and Ali charge merchants service fees at 0.6% of the payment volume for most merchants, compared to the 1.25% charged by China UnionPay. For payment users, Alipay waives all charges for its mobile payment users, while WeChat levies a 0.1% fee for money transfer above RMB20K, compared to a 1% service charge levied by most state-owned big banks for inter-bank transfer.

Both Alipay and Tencent are subsidising their merchants and users by charging little or lower service fees. We think both companies will continue this subsidy strategy into next year to seize market share, an approach that we agree with given the strategic value of payment services.

Based on our industry sources, Tencent’s payment service likely garnered 300mn subscribers as of November compared to 400mn subscribers for Alipay.

Alipay43.7%

Tencent (QQ wallet + Wechat )

44.9%

Baidu wallet10.5%

Others0.9%



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What’s the prospect for Apple Pay’s China venture? We think Apple Pay should be able to achieve a decent market share in China mobile payment market backed by UnionPay’s dominant market share in POS payment and Apple’s huge popularity in China. We estimate that China UnionPay likely has a 50-60% GMV share in China’s POS payment market. The partnership allows users of iPhone 6 and 6 Plus to pay at various offline merchants who use UnionPay’s POS terminals. According to UnionPay, the total merchants on its payment network had reached 4.7mn as of August 2015.

Fig. 6: China iOS user breakdown by smartphone brands

Source: iResearch

According to industry sources, we estimate the number of active iPhone 6 and 6 Plus users likely stood at 108mn in China as of FY15. Users of iPhones, especially the latest models, are generally well-educated, belong to the mid-to-upper class and are tech-savvy with the proclivity to try out something new. Therefore, theoretically, we believe Apple and UnionPay should be able to convert most, if not all, of these 100mn-odd phone users into its payment users, if their execution is good. To put it in perspective, Tenpay reported a total of 260mn users for its WeChat payment and QQ Wallet as of 3Q15, while Alipay reported a total of 400mn subscribers.

However, execution and regulatory risks could disappoint Apple Pay’s ambitions in China. We have heard of very few successful instances in the past of cooperation between a Chinese SOE and a multinational company. We believe that, without seamless cooperation from UnionPay, it is impossible for Apple Pay to gain any meaningful market share in this very competitive market which so far has been dominated by Alibaba and Tencent. Secondly, payment is relatively a green zone in the tightly-regulated financial sector. Regardless, regulators could become nervous if Apple Pay penetrates China’s payment market too fast, due to its foreign-company status.

Android62%

Winphone devices

3%

iPhone 67%

iPhone 6 Plus5%

iPhone 5s6%

iPhone 5s3%

Others14%

iOS devices35%



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Resilient online gaming business

The loss of CF2 license likely having limited impact

We forecast Tencent’s online-gaming revenue to grow 18% and 15% y-y in FY16F and FY17F, respectively. PC gaming revenue will likely register 13% and 12% growth while mobile gaming revenue will likely increase 43% and 30%, on our estimates.

The growth of PC games will be driven by the blockbuster title, League of Legend (LoL) and new titles such as Monster Hunter Online, Maple Story 2, Iron Knight and Sura, among others.

Tencent’s legacy PC titles, Crossfire (CF) and DNF, will likely decline gradually in revenue due to aging. In November 2015, Qihoo (QIHU US, NR) and The9 (NCTY, NR) jointly announced that their JV had signed a 5-year exclusive license for Crossfire 2 with its Korean developer Smilegate. The two companies did not disclose when Crossfire 2 will release in China. We believe this event will have some negative impact on Tencent’s Crossfire but the impact will be quite limited, in our view.

Tencent had renewed another five-year exclusive license for Crossfire in China back in October, which means there will be two versions of the game operating in the China market once Crossfire 2 is released by the JV of The9 and Qihoo. We note that the huge success of Crossfire, which generated RMB6.8bn or 7% of Tencent’s revenue in FY15F, is more attributable to Tencent’s operation and its powerful social platform than anything else. We believe this explains why CF is not as successful in other markets including its home market Korea.

Mobile games benefiting from increased time spent

While the overall Chinese smartphone population is slowing down, the average time spent on and frequency of usage of smartphones have continued to increase (see figure below). This should benefit mobile games, which is one of the most popular categories in mobile apps among Chinese smartphone users.

Fig. 7: Average daily time spent on all apps per person

Source: iResearch

Fig. 8: Average daily usages (times) for all apps

Source: iResearch

We think Tencent’s mobile game business will continue to stick with its shot-gun and blockbuster-title strategy. Wechat and mobile QQ will only publish the highly promising proprietary or third-party games, whilst its open platform, i.e. Myapp app store, has a much lower entry threshold for third-party games.

We think Tencent can drive mobile games growth through publishing innovative titles. Tencent’s strong track record of game publishing positions it well in licensing desired titles from both domestic and global developers. Besides, Tencent has shown strong insight in the popularity trend of Chinese game market in the past years. With this strong insight and powerful social channels, we believe Tencent is capable of launching more mobile blockbuster titles in the future.

1.7

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Unit: HoursAvg. daily time spent on all apps / person

Up 41% YoY

65

78

55

60

65

70

75

80

Dec. 2014 Dec. 2015

Unit: TimesAvg. daily usages (times) for all apps

Up 20% YoY



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Tencent’s mobile app store, Myapp, could be another driver. Myapp has been continuously taking market share from Qihoo’s app store 360 mobile assistant and has become the No. 1 ranked Chinese Android app store, according to data from iResearch.

Fig. 9: Android app store penetration rates comparison

Source: iResearch

We expect the Chinese mobile game market to grow to CNY69bn in 2016F, representing 35% y-y growth, which is mainly driven by the following factors: 1) popular IPs continues to be adapted into mobile games; 2) continuing shift towards mid- to hard-core games which have better monetisation than light casual titles. The anticipated 35% growth is a slowdown from the 80% growth registered in 2015, but we think it is still quite solid growth given the rising base effect.

Fig. 10: Mobile game revenue and growth

Source: Nomura estimates

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Solid outlook for ads service We forecast Tencent’s ad revenue to surge 85%/59% in FY16/17F. The accelerating growth is likely driven by both solid display ads and P4P marketing service growth. According to Analysis, Tencent is China’s third largest ad publisher in terms of overall ad wallet share. The company had grown its ad revenue share to 7.7% by 3Q15 from 5.0% in 1Q15, trailing Baidu and Alibaba. We believe Tencent may continue to gain market share on the back of its Wechat ads service, which we believe has lots of untapped potential as Tencent is very prudent in managing the balance of maintaining good user experience and monetisation.

Fig. 11: Market share for internet ad publisher in 1Q15

Source: Analysis

Fig. 12: Market share for internet ad publisher in 3Q15

Source: Analysis

According to Analysis, Tencent’s online video had a market share of 14% in 1Q15. Tencent’s video ads growth could be fuelled by two influential sports events – the Olympics to be held in August 2016 in Brazil and the NBA matches. Tencent is the exclusive Internet media partner of the Chinese Olympics committee and therefore is better positioned than its competitors in broadcasting this event. Separately, Tencent spent a total of USD500mn to acquire a five-year exclusive online broadcasting right in China for NBA matches since October 2015. These two sports events, especially the NBA matches, are extremely popular in China and boast of hundreds of millions of audience. Tencent’s exclusive broadcasting rights should help the company grab both online audience and ad budget share.

Fig. 13: Video ads market share in 1Q15

Source: Analysis

On top of the ads revenue, Tencent is also exploring other revenue opportunities for video services and paid subscription is one of the new revenue streams for video service, although it’s still small in revenue scale. On top of the premium sports content, Tencent has also purchased exclusive online broadcasting rights for a couple of entertainment shows, TV dramas and movies. For instance, Tencent video has inked

Baidu32.3%

Alibaba20.6%Tencent

5.0%

Sohu4.4%

Google China4.3%

Others33.4%

Baidu31.1%

Alibaba21.0%Tencent

7.7%

Sohu3.9%

Google China3.6%

Others32.7%

YoukuTudou21.2%

iQiyi19.6%

Tencent14.1%

Sohu12.6%

LeTV9.3%

Others23.3%



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partnership with top-tier western movie producers such as Paramount Pictures, HBO etc., making it the exclusive Chinese online broadcaster in 2016 for movies produced by its western partners. With such exclusive and quality content in its library, we believe Tencent will try to promote the paid subscription for its video business next year.

P4P ads has lots of untapped potential

We believe Tencent’s P4P ads service, including ads served on Qzone, WeChat public accounts, WeChat moments and, lastly, third-party app networks, will see 117% growth in FY16F. WeChat ads will likely act as a key driver for the solid growth.

Fig. 14: Tencent’s P4P ads revenue


WeChat ads officially kicked off in 2014 and included ad banners or textual links served within public accounts and banner ads served in the feeds flow of WeChat moments. We expect strong growth on both ad properties driven by more ad inventories and varieties of ad formats available for sale.

Fig. 15: Public accounts types subscribed by WeChat users

Source: Nomura research

WeChat currently has over 8mn public accounts. Nearly 80% of WeChat’s 600mn monthly active users subscribe to at least one public account. WeChat public accounts currently boast of 3bn daily PVs, around 50% of which is contributed by direct visits compared to merely 20% a year ago. This shows increased user engagement with WeChat public accounts, in our view, which will ultimately translate into more ad inventories. Public accounts currently serve one banner or textual links at the top and/or bottom of a few public accounts page. We believe that, going forward, WeChat may explore more ad inventories on public accounts.

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Rmb mn P4P ads P4P ads as % of total ads rev (RHS)

"WE" media29.1%

Verified media25.4%

Not following20.7%

Business accounts

18.9%

Promotional accounts

5.9%



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WeChat Moments, which likely attract most of the Wechat users’ time spent, is largely un-monetised. WeChat began to serve banner ads into Moments’ feeds flow in early 2015. This commercialisation experiment was carried out very meticulously to avoid being intrusive to user experience. It is so far only displayed to selected WeChat users and available for a few high-end multinational brand advertisers such as BMW, P&G, Huawei etc. Besides, in December 2015, WeChat began to test in-feeds-short-video ads on Moments, which are more engaging than the static display ads. In-feeds ads service is a proven and effective ad format for social platforms and contribute a majority of the ad revenue for global social networking leaders such as Facebook and Twitter.



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4Q15 results preview We forecast 4Q15 revenue to reach CNY27bn, representing a y-y growth of 30%, and q-q growth of 3%. The strong growth is underpinned by 18% y-y growth in VAS, 118% y-y growth in online advertising. Within VAS, we still see mobile game as the biggest driver. Total mobile game, including revenue from social networking and games, will see a 35% y-y growth to CNY5.5bn, on our estimates. We expect PC game growth to remain stable at 13% to CNY11bn. Within online advertising, we expect video to grow at 135% y-y growth thanks to the quarter’s strong content pipeline. Performance ad is likely to witness 185% y-y growth to reach CNY3.2bn, in our view.

Our GP margin forecast is in line with that in the previous quarter, while we expect operating margin to reach 34%. Our non-GAAP EPS is estimated at HKD1.1, implying a 27% y-y and 0.9% q-q growth.

Fig. 16: 4Q15 results preview

Source: Bloomberg consensus, Nomura estimates

In 2016, we expect revenue to reach CNY134bn, a Y-Y growth of 34%. In our view, growth will accelerate from last year primarily due to the continuing surge of online advertising growth from both online video and Wechat advertisement. In 2016, we expect overall mobile game to grow at 43% y-y, while we estimate PC game to maintain its growth at 13%. Online video will witness a y-y growth of 68% while performance base ad will experience a y-y growth of 117%, on our estimates. We also forecast GP and OP margin to maintain a similar level as last year.

Fig. 17: Nomura vs consensus

Source: Bloomberg consensus, Nomura estimates

4Q15 results previewCNYm 4Q15e 3Q15 4Q14 YoYe QoQe Consensusvs consensusRevenues 27,339 26,594 20,978 30.3% 2.8% 27,744 -1.5%Gross profit 16,040 15,580 12,646 26.8% 3.0%Gross margin 58.7% 58.6% 60.3% -1.6ppt 0.1pptOperating profit 9,184 9,158 6,608 39.0% 0.3%Operating margin 33.6% 34.4% 31.5% 2.1ppt -0.8pptNet profit 7,538 7,445 5,860 28.6% 1.2% 7,590 -0.7%Net margin 27.6% 28.0% 27.9% -0.4ppt -0.4ppt 27.4% 0.2pptNon-GAAP net profit 8,321 8,208 6,355 30.9% 1.4% 8,254 0.8%Non-GAAP net margin 30.4% 30.9% 30.3% 0.1ppt -0.4ppt 29.8% 0.7pptGAAP EPADS (HK$) 1.0 1.0 0.8 24.6% 0.7% 1.0 -1.4%Non-GAAP EPADS (HK$) 1.1 1.1 0.8 26.8% 0.9% 1.0 3.6%

Nomura vs consensus2016e 2017e

CNYm Consensus New vs consensus Consensus New vs consensusRevenues 128,146 133,790 4% 161,435 173,791 8%Net profit 38,001 40,561 7% 48,368 54,394 12%Net margin 30% 30% 0.7ppt 30% 31% 1.3pptNon-GAAP net profit 39,835 43,893 10% 50,687 58,046 15%Non-GAAP net margin 31% 33% 1.7ppt 31% 33% 2.0pptGAAP EPADS (HK$) 4.81 5.01 4% 6.17 6.3 2%Non-GAAP EPADS (HK$) 5.04 5.42 8% 6.45 6.7 5%


Nomura nt Holdings 22 January 2016 | Tence

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Valuation We use DCF as our primary valuation methodology as it could capture the long-term growth profile and reflect the cash outflow related to capital expenditure and acquisitions. SOTP valuation is used as a reference as WeChat’s mobile game, advertisement, and online payment gradually mature and represent different growth characteristics and should be valued using different ranges of multiples.

Our DCF-based TP is HKD190 (40% potential upside), based on the assumption of 8.9% discount rate, 4% terminal growth rate and 27% FCF CAGR growth from 2016-2019F.

Our TP implies and 28x 2017F P/E (EPS of HKD6.7), compared to 21% EPS CAGR for 2016-2019F. As a leading mobile internet player, we believe Tencent deserves a premium compared to its peers.

Fig. 18: Key assumptions (CNYmn)


Fig. 19: Tencent P/E band

Source: Bloomberg

Investment risks:

Downside risks:

1) High market expectations

2) Faster-than-expected slowdown in PC games revenue

3) The company's aggressive spending on Weixin payments and overseas marketing

4) Potential disruptive products and business models from its competitors

2012 2013 2014 2015F 2016F 2017F 2018F 2019F 2020FPc game 22,849 30,440 37,764 44,914 50,808 56,938 61,214 63,255 62,837 Y-Y 33% 24% 19% 13% 12% 8% 3% -1%Mobile game 971 1,829 13,959 19,747 28,286 36,636 42,396 48,144 51,830 Y-Y 88% 663% 41% 43% 30% 16% 14% 8%Video ad 440 882 2,347 5,177 8,703 12,526 16,133 19,177 21,625 Y-Y 100% 166% 121% 68% 44% 29% 19% 13%GDT 648 1,699 3,210 9,059 19,616 33,498 44,956 55,256 57,940 Y-Y 162% 89% 182% 117% 71% 34% 23% 5%Others 18,985 25,588 21,652 20,864 26,378 34,193 43,028 52,572 62,446 Y-Y 35% -15% -4% 26% 30% 26% 22% 19%

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

Jan

-06

Jun

-06

Nov

-06

Ap

r-07

Se

p-07

Feb

-08

Jul-0

8

Dec

-08

May

-09

Oct

-09

Mar

-10

Au

g-10

Jan

-11

Jun

-11

Nov

-11

Ap

r-12

Se

p-12

Feb

-13

Jul-1

3

Dec

-13

May

-14

Oct

-14

Mar

-15

Au

g-15

Jan

-16

(X)1-yr forward PE

+1STD=29x

Average=24x

-1STD=18x



14

Appendix A-1

Analyst Certification

I, Jialong Shi, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures Tencent Holdings 700 HK HKD 139.80 19-Jan-2016 Buy N/A A10

A10 The Nomura Group is a registered market maker in the securities / related derivatives of the issuer.

Tencent Holdings (700 HK) HKD 139.80 (19-Jan-2016) Rating and target price chart (three year history)

Buy (Sector rating: N/A)

Date Rating Target price Closing price 14-May-15 170.00 161.30 14-Jan-15 149.00 126.00 13-Nov-14 144.00 129.50 03-Nov-14 145.00 123.80 14-Aug-14 155.00 130.10 21-Jul-14 158.00 121.50 16-May-14 153.00 106.50 05-May-14 154.40 98.52 11-Mar-14 157.40 123.50 05-Mar-14 Buy 124.50 05-Mar-14 150.00 124.50 19-Oct-13 Not Rated 85.96

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology Our DCF-based TP is HKD190, based on the assumption of 8.9% discount rate, 4% terminal growth rate and 27% FCF CAGR growth from 2016-2019F. Our TP implies 28x 2017F P/E (EPS of HKD6.7), compared to 21% EPS CAGR for 2016-2019F. As a leading mobile internet player, we believe Tencent deserves a premium compared to its peers. Risks that may impede the achievement of the target price Risks: high market expectations; faster-than-expected slowdown in PC games revenue; the company's aggressive spending on Weixin payments and overseas marketing; and any potential disruptive products and business models from its competitors.

Important Disclosures Online availability of research and conflict-of-interest disclosures Nomura research is available on www.nomuranow.com/research, Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne. Important disclosures may be read at http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email [email protected] for help.

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mailto:[email protected]



15

The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. Nomura Global Financial Products Inc. (“NGFP”) Nomura Derivative Products Inc. (“NDPI”) and Nomura International plc. (“NIplc”) are registered with the Commodities Futures Trading Commission and the National Futures Association (NFA) as swap dealers. NGFP, NDPI, and NIplc are generally engaged in the trading of swaps and other derivative products, any of which may be the subject of this report. 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Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America, and Japan and Asia ex-Japan from 21 October 2013 The rating system is a relative system, indicating expected performance against a specific benchmark identified for each individual stock, subject to limited management discretion. An analyst’s target price is an assessment of the current intrinsic fair value of the stock based on an appropriate valuation methodology determined by the analyst. Valuation methodologies include, but are not limited to, discounted cash flow analysis, expected return on equity and multiple analysis. Analysts may also indicate expected absolute upside/downside relative to the stated target price, defined as (target price - current price)/current price. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. 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Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Japan/Asia ex-Japan: Sector ratings are not assigned. Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan prior to 21 October 2013 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. 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16

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17

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