20 July 2016 Asia Pacific/China Equity Research Consumer Internet Tencent Holdings (0700.HK / 700 HK) Rating OUTPERFORM* Price (18 Jul 16, HK$) 185.00 Target price (HK$) (from 190.00) 230.00¹ Upside/downside (%) 24.3 Mkt cap (HK$ mn) 1,740,423 (US$ 224,452) Enterprise value (Rmb mn) 1,487,974 Number of shares (mn) 9,407.69 Free float (%) 50.8 52-week price range 185.0 - 125.0 ADTO - 6M (US$ mn) 365.7 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Research Analysts Evan Zhou 852 2101 6745 [email protected] Zoe Zhao 852 2101 7201 [email protected] ASSUMING COVERAGE The Penguin Empire: Rock solid ■ Assuming coverage with an OUTPERFORM rating and a target price of HK$230 implying 24% upside. Tencent has been an all-around platform leader in almost all sub-segments: ads, games, fin-tech and portfolio of investments. We expect solid topline delivery and a favourable mix shift to ads to drive gradual margin expansion. Value creation from the maturing star portfolio companies of Didi, CIP, Supercell, WeBank, etc., would also continue to provide catalysts to the share price in the next 2-3 years. ■ Performance-based ad: on an open-ended runway. The key growth story of Tencent is the rise in ad contribution, especially from performance-based native ads. With the gradual opening-up of inventories on Moments, public accounts and upgrade of self-service ad systems, Tencent's performancebased ad is expected to witness a CAGR of 79% over 2015-18. ■ Games, leading global franchise on PC and mobile. Tencent owns the most comprehensive portfolio of PC and mobile titles of various genres both in China and overseas. Recent mobile gaming regulations are likely to slow down releases from small studios which should benefit leading players like Tencent in gaining additional market share; Supercell's value-add to Tencent's stock would come mainly from dividend yield contribution to net profit. We expect PC/ mobile games to witness a three-year CAGR of 8% / 33% over 2015-18. ■ Valuation and TP. Our TP of HK$230, implying 33.4x 2017E dil. adj. P/E, includes: (1) internet finance business' valuation of HK$24.20/sh, and (2) core business valuation of HK$205.8/sh, based on 30x 2017E P/E. We see Tencent's dominance has positioned it on a parallel footing with other global internet giants. Risks: macro and regulation headwind for ads; high base of mobile games, and faster-than-expected slowdown in key PC titles. Share price performance 200 Price (LHS) Rebased Rel (RHS) 180 150 130 100 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 80 The price relative chart measures performance against the MSCI CHINA F IDX which closed at 5901.51 on 18/07/16 On 18/07/16 the spot exchange rate was HK$7.75/US$1 Performance over Absolute (%) Relative (%) 1M 3M 12M 9.5 11.6 20.4 2.5 12.7 37.4 — — Financial and valuation metrics Year Revenue (Rmb mn) EBITDA (Rmb mn) EBIT (Rmb mn) Net profit (Rmb mn) EPS (CS adj.) (Rmb) Change from previous EPS (%) Consensus EPS (Rmb) EPS growth (%) P/E (x) Dividend yield (%) EV/EBITDA (x) P/B (x) ROE (%) Net debt/equity (%) 12/15A 102,863.0 44,261.3 36,414.0 32,002.0 3.40 n.a. n.a. 31.6 47.0 0 33.5 12.5 32.0 Net cash 12/16E 143,294.2 62,656.4 51,234.6 44,358.0 4.68 0.8 4.38 37.5 34.1 0 23.7 9.9 32.6 Net cash 12/17E 177,415.6 77,196.4 64,340.3 57,015.4 6.01 3.3 5.58 28.5 26.6 0 18.7 7.5 32.2 Net cash 12/18E 221,915.8 99,348.0 84,853.4 74,684.6 7.88 7.00 31.0 20.3 0 13.9 5.6 31.7 Net cash Source: Company data, Thomson Reuters, Credit Suisse estimates. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 20 July 2016 Focus charts and tables Figure 1: Solid WeChat MAU growth—the foundation of all 1200 45% 40% 1000 35% 800 30% Figure 2: Ad revenue comparison of leading SNS players 6,000 3.00 2.83 5,000 2.50 4,000 2.00 2.00 25% 600 20% 400 15% 3,000 1.50 2,000 1.00 10% 200 5% 0 0% 0.59 1,000 0.41 0 0.50 - Facebook Twitter WeChat and Weixin MAU (mn) 0.55 Tencent Ad Rev (US$ mn) YoY % WB LINE Ad Rev /MAU (US$) Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Figure 3: Mobile game ranking (by grossing) Figure 4: China mobile payment market share in 1Q16 Name Jan16 Feb16 Mar16 Apr16 May16 Jun16 JX Mobile Wang zhe rong yao Zhengtu Quan min feiji da zhan CrossFire KoF 98 Naruto Mobile Tian tian ku pao Dragonball Z mobile Re xue chuan qi Tian tian ai xiao chu Huan le dou di zhu 5 5 4 3 10 6 9 4 27 4 6 9 8 24 7 5 11 6 23 3 18 20 3 16 21 8 20 22 6 8 12 9 21 7 4 22 24 3 5 9 11 17 6 21 13 10 26 29 2 4 5 7 9 11 14 19 24 25 27 30 Source: Thinkgaming Umpay PinganpayOthers 1.3% 1.2% 4.7% Lianlianpay 1.3% Lakala 1.4% Alipay 51.8% Tenpay 38.3% Source: iResearch Figure 5: Global internet leaders comps table* Mkt cap Company PE Ticker Ccy Price Rating (US$ mn) 2016E 2017E Tencent 0700.HK HKD 185.0 O 224,435 33.8 26.3 Baidu BIDU.US USD 164.8 O 57,059 35.7 23.4 Alibaba BABA.US USD 82.7 O 207,652 33.1 25.8 Facebook Google Netflix Average FB.US USD 119.4 O 341,435 33.3 24.5 GOOGL.US USD 753.2 O 510,444 23.6 19.1 NFLX.US USD 98.8 N 42,320 195.0 71.3 59.1 31.7 Source: Company data, Bloomberg, Credit Suisse estimates. *Closing price of 18 Jul 2016. Tencent Holdings (0700.HK / 700 HK) 2 20 July 2016 The Penguin Empire: Rock solid As one of the best performers in the China internet space year-to-date, Tencent has been an all-around platform winner in almost all sub-segments: ads, games, internet finance and portfolio of investments. This has been supported by (1) a clear strategy of platform positioning, (2) excellent user product design and operations, (3) forward-looking strategic investment and industry cooperation, and (4) a seasoned management to balance internal execution and market expectation. We expect solid topline delivery and a favourable mix shift to ads to drive gradual margin expansion. Value creation from maturing star portfolio companies of Didi, CIP, Supercell, JD, WUBA, WeBank, etc., would also continue to provide catalysts to the share price in the next 2-3 years. Performance-based ad: On an open-ended runway The key growth story of Tencent is the rise of advertising contribution, especially from performance-based native ads. With the gradual opening-up of advertisement inventories on Moments, public accounts and upgrades of self-service ad systems, Tencent's performance-based ads are expected to witness a CAGR of 79% over 2015-2018E. This growth and leverage on expenses would also translate into 44 bp/188 bp of Tencent's net margin expansion in 2017E/18E. Efforts to strike a balance between user experience and monetisation pace might often create visibility concerns on its near-term performance. Games: Leading global franchise on PC and mobile Tencent owns the most comprehensive portfolio of PC and mobile titles of various genres both in China and overseas markets. We breakdown Tencent's games segments by major game titles to analyse the robustness of the portfolio, from referencing game ranks and industry channel checks. We estimate top 5 PC titles account for 65% of total PC gaming revenue and top 5 mobile titles account for 75% of total mobile gaming revenue, which we believe is a healthy level. Recent mobile gaming regulations are likely to slow down releases from small studios which should benefit leading players like Tencent in gaining additional market share. Assuming the run-rate of Supercell's top games remains at the current level, we expect limited contribution to VAS from Tencent's potential publishing cooperation in 2017E. Supercell's value-add to Tencent's stock would come mainly from dividend income contribution to net profit. Investments: Bearing fruits for future Tencent's investment track record has been enriching its service offerings, refueling growth of its core user products, and winning good credit from investor community for management's forward-looking industry insights. Although most investors have not explicitly attributed value to many of Tencent's portfolio assets, we believe upcoming value-unlock events from key assets, especially in eCommerce, O2O and finance, would provide waves of value creation in the coming years. Inclusion of Supercell in the form of dividend payout would also add another layer of optional value for shareholders. Valuation and risks We keep P/E as our main valuation methodology, as we see Tencent's strong earnings power and cash flow are a testimony to the success of its franchise platform business model. Our TP of HK$230 implies 33.4x FY17E adj. P/E. This includes (1) internet finance business' valuation of HK$24.20/sh, and (2) core business valuation of HK$205.8/sh based on 30x FY17E P/E. We see Tencent's dominance has put it on a parallel footing with other global giants. We also performed a SOTP analysis as a reference for future value creation from its investment portfolio, especially for payment. Downside risks include: macro and regulation headwind for ads; high base of mobile games, and fasterthan-expected slowdown in key PC titles. Tencent Holdings (0700.HK / 700 HK) 3 20 July 2016 Tencent Holdings 0700.HK / 700 HK Price (18 Jul 16): HK$185.00, Rating:: OUTPERFORM, Target Price: HK$230.00, Analyst: Evan Zhou Target price scenario Scenario Upside Central Case Downside TP 230.00 Income statement (Rmb mn) Sales revenue Cost of goods sold SG&A Other operating exp./(inc.) EBITDA Depreciation & amortisation EBIT Net interest expense/(inc.) Non-operating inc./(exp.) Associates/JV Recurring PBT Exceptionals/extraordinaries Taxes Profit after tax Other after tax income Minority interests Preferred dividends Reported net profit Analyst adjustments Net profit (Credit Suisse) Cash flow (Rmb mn) EBIT Net interest Tax paid Working capital Other cash & non-cash items Operating cash flow Capex Free cash flow to the firm Disposals of fixed assets Acquisitions Divestments Associate investments Other investment/(outflows) Investing cash flow Equity raised Dividends paid Net borrowings Other financing cash flow Financing cash flow Total cash flow Adjustments Net change in cash Balance sheet (Rmb mn) Cash & cash equivalents Current receivables Inventories Other current assets Current assets Property, plant & equip. Investments Intangibles Other non-current assets Total assets Accounts payable Short-term debt Current provisions Other current liabilities Current liabilities Long-term debt Non-current provisions Other non-current liab. Total liabilities Shareholders' equity Minority interests Total liabilities & equity %Up/Dwn Assumptions 40% CAGR for gross profit from 13-15E 24.32 28.9% CAGR for gross profit from 13-15E 15% CAGR for gross profit from 13-15E 12/15A 102,863 41,631 24,818 (7,847) 44,261 7,847 36,414 (709) 1,886 (2,793) 36,216 — 7,108 29,108 — 302.0 — 28,806 3,196 32,002 12/15A 36,414 (198) (7,108) 14,556 10,676 54,340 (6,844) 47,496 — — — — (56,598) (63,442) 11,243 (2.6) 27,693 (1,375) 37,558 28,456 — 28,456 12/15A 81,967 7,061 222.0 66,128 155,378 9,973 105,054 — 36,413 306,818 15,700 11,429 — 97,277 124,406 50,014 — 12,363 186,783 120,035 — 306,818 12/16E 143,294 60,360 31,699 (11,422) 62,656 11,422 51,235 (771) 2,024 (4,356) 49,674 — 10,499 39,175 — 340.0 — 38,835 5,523 44,358 12/16E 51,235 (1,561) (10,499) (20,644) 14,850 33,381 (10,378) 23,003 — — — — (17,485) (27,863) (2,524) (2.6) 6,618 (7,998) (3,907) 1,612 — 1,612 12/16E 83,579 8,750 — 74,798 167,126 13,085 108,040 — 46,756 335,007 24,142 12,373 — 78,328 114,843 55,688 — 12,222 182,753 152,254 — 335,007 12/17E 177,416 74,020 39,056 (12,856) 77,196 12,856 64,340 (1,846) 2,024 (4,356) 63,854 — 13,416 50,438 — 340.0 — 50,098 6,918 57,015 12/17E 64,340 (486) (13,416) 4,680 16,970 72,087 (12,749) 59,338 — — — — (9,440) (22,189) 942 (2.6) — (5,347) (4,408) 45,490 — 45,490 12/17E 129,069 10,874 — 92,864 232,807 18,062 112,396 — 46,756 410,021 29,991 12,373 — 97,349 139,713 55,688 — 12,222 207,623 202,398 — 410,021 12/18E 221,916 89,625 47,437 (14,495) 99,348 14,495 84,853 (2,526) 2,024 (4,356) 85,048 — 17,764 67,284 — 340.0 — 66,944 7,740 74,685 12/18E 84,853 194 (17,764) 1,845 19,431 88,560 (15,554) 73,006 — — — — (9,440) (24,994) 990 (2.6) — (7,032) (6,044) 57,522 — 57,522 12/18E 186,591 13,294 — 116,004 315,889 24,205 116,752 — 46,756 503,602 35,739 12,373 — 119,006 167,118 55,688 — 12,222 235,028 268,574 — 503,602 Key earnings drivers Number of Premium QQ subscription (Mn) Per share data Shares (wtd avg.) (mn) EPS (Credit Suisse) (Rmb) DPS (Rmb) BVPS (Rmb) Operating CFPS (Rmb) Key ratios and valuation Growth(%) Sales revenue EBIT Net profit EPS Margins (%) EBITDA EBIT Pre-tax profit Net profit Valuation metrics (x) P/E P/B Dividend yield (%) P/CF EV/sales EV/EBITDA EV/EBIT ROE analysis (%) ROE ROIC Asset turnover (x) Interest burden (x) Tax burden (x) Financial leverage (x) Credit ratios Net debt/equity (%) Net debt/EBITDA (x) Interest cover (x) 12/15A 47.5 — — — — 12/15A 9,402 3.40 0.0003 12.8 5.8 12/15A 12/16E 60.0 — — — — 12/16E 9,478 4.68 0.0003 16.1 3.5 12/16E 12/17E 75.0 — — — — 12/17E 9,480 6.01 0.0003 21.3 7.6 12/17E 12/18E 78.8 — — — — 12/18E 9,479 7.88 0.0003 28.3 9.3 12/18E 30.3 39.5 32.1 31.6 39.3 40.7 38.6 37.5 23.8 25.6 28.5 28.5 25.1 31.9 31.0 31.0 43.0 35.4 35.2 31.1 43.7 35.8 34.7 31.0 43.5 36.3 36.0 32.1 44.8 38.2 38.3 33.7 47.0 12.5 — 27.7 14.4 33.5 40.7 34.1 9.9 — 45.4 10.4 23.7 29.0 26.6 7.5 — 21.0 8.1 18.7 22.4 20.3 5.6 — 17.1 6.2 13.9 16.3 32.0 36.6 0.34 0.99 0.80 2.56 32.6 34.2 0.43 0.97 0.79 2.20 32.2 36.5 0.43 0.99 0.79 2.03 31.7 46.1 0.44 1.00 0.79 1.88 (17.1) (0.46) (51.4) (10.2) (0.25) (66.4) (30.1) (0.79) (34.9) (44.1) (1.19) (33.6) Source: Company data, Thomson Reuters, Credit Suisse estimates. 12MF P/E multiple 45 40 35 30 25 20 15 10 5 0 2011 2012 2013 2014 2015 2016 2015 2016 12MF P/B multiple 14 12 10 8 6 4 2 0 2011 2012 2013 2014 Source: IBES Tencent Holdings (0700.HK / 700 HK) 4 20 July 2016 Performance-based ad: On an openended runway Figure 6: Tencent's online ad revenue growth (Rmb mn) 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16E 3Q16E 4Q16E 1Q17E 2Q17E 3Q17E 4Q17E Online ad 2,724 4,073 4,938 5,733 4,701 7,453 8,969 9,941 8,230 12,300 14,085 15,364 606 818 1,300 1,176 840 2,057 1,720 832 2,386 1,997 820 2,916 1,515 654 2,532 2,568 915 3,970 3,132 1,098 4,738 3,195 1,318 5,428 2,364 1,055 4,811 4,138 1,192 6,970 4,965 1,346 7,774 5,213 1,481 8,670 131% 150% 88% 160% 97% 100% 8% 194% 102% 150% -2% 165% 118% 73% 150% 150% 13% -20% 165% 95% 83% 104% 28% 89% 82% 92% 20% 99% 73% 97% 10% 86% 75% 72% 32% 90% 65% 61% 30% 76% 57% 59% 23% 64% 55% 63% 12% 60% -Video -Non-Video Portal -Performance-based ad YoY % Online ad -Video -Non-Video Portal -Performance-based ad Source: Company data, Credit Suisse estimates Although China's online advertising is facing macro headwinds, Tencent's online ad business can hedge better compared with its peers, mainly due to its strong social SNS (social networking service) feature. We expect Tencent's total online ad revenue could reach Rmb31.1 bn in 2016E, up 78% YoY, mainly driven by performance-based native ad on its core mobile apps QQ, WeChat, Qzone, Tencent News, etc. We forecast performance-based ad revenue to grow 91% YoY to Rmb16.7 bn in 2016, accounting for 54% of total online ad revenue (vs. 50% in 2015). We expect this trend will continue and the revenue contribution will likely increase to 62% in 2018. We expect Tencent's total online ad revenue could reach Rmb31.1 bn in 2016E, up 78% YoY, mainly driven by performancebased native ad on its core mobile apps QQ, WeChat, Qzone, Tencent News, etc. Figure 7: Contribution from performance based ad to keep rising 100% 90% 80% 39% 50% 54% 56% 20% 13% 10% 30% 30% 33% 33% 31% 2014 2015 2016E 2017E 2018E 70% 62% 60% 50% 40% 32% 7% 30% 20% 10% 0% Video Non-Video Portal Performance-based ad Source: Company data, Credit Suisse estimates Tencent Holdings (0700.HK / 700 HK) 5 20 July 2016 Figure 8: Improving GPM of online ad due to increasing mix from native ad 70% 60% 50% 44% 40% 50% 49% 60% 55% 30% 20% 10% 0% 2014 2015 2016E 2017E 2018E GPM % of online ad Source: Company data, Credit Suisse estimates As the margin for performance-based ad is higher than overall brand ad, the increasing contribution from performance-based ad would also translate into gradual margin improvement over the next two to three years. We estimate GPM of online ad business to rise to 60% in 2018. WeChat ads: managed pace of monetisation Figure 9: Solid growth in performance-based ad revenue 60,000 As margin for performancebased ad is higher than overall brand ad, increasing contribution from performance-based ad would help improve the overall margin. 200% 180% 50,000 160% 140% 40,000 120% 30,000 100% 80% 20,000 60% 40% 10,000 20% - 0% 2014 2015 2016E Performance base ad (Rmb mn) 2017E 2018E YoY% Source: Company data, Credit Suisse estimates We believe the growth in performance-based revenue mainly comes from improving advertiser inventory, fill rate/ad load, and CPC (cost per click)/eCPM improvement. So far, majority of this is contributed by Qzone advertisements currently (70-80%), as it is most advanced in monetisation which started 2.5 years ago and Qzone has 1 in six or seven feeds in 24 hours. Some of the successful marketing examples include: (1) meguo.com receiving over 100 mn daily views and 200+ effective ads, (2) Mogujie.com launched an official Qzone space, attracting 20 mn fans, and 1 mn PVs. Tencent Holdings (0700.HK / 700 HK) 6 20 July 2016 Figure 10: Tencent's performance-based native ad revenue 10,000 9,000 Rmb mn 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16E 3Q16E 4Q16E 1Q17E 2Q17E 3Q17E 4Q17E Total performance ad rev Wechat ad Qzone mobile Qzone PC Source: Company data, Credit Suisse estimates In addition, Tencent has also integrated WeChat Official Account and WeChat Moment ads into the GDT (Guangdiantong, Tencent's performance-based ad platform to advertisers) engines, which would improve advertisers' experience and increase product offerings and inventory base. Tencent began to test water in launching ad in WeChat Official Account in July 2014 and Moment starting in early 2015. Figure 11: Growth of WeChat MAU 1200 45% 40% 1000 35% 800 30% 25% 600 20% 400 15% 10% 200 5% 0 0% 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16E 3Q16E 4Q16E 1Q17E 2Q17E 3Q17E 4Q17E WeChat and Weixin MAU (mn) YoY % Source: Company data, Credit Suisse estimates WeChat, launched in 2011, expanded rapidly benefiting from the traffic transfer from QQ's large user base and mobile migration. As of end-2015, WeChat MAUs (monthly active users) were 697mn, up 39% from 2014. We believe WeChat MAU will maintain decent growth in 2016 too. WeChat is one of the most successful products post QQ, and now is becoming most-often-used SNS app between friends, family and is even quite popular occupationally. Tencent Holdings (0700.HK / 700 HK) 7 20 July 2016 Figure 12: CS forecast of WeChat ad revenue WeChat MAU (Mn) WeChat DAU (mn) Effective Daily refresh of Moments: Ads per refresh CPC (Rmb) CTR eCPM (Rmb) Revenue per 1,000 refresh (Rmb) Net take rate Net Revenue (Rmb, mn) 1Q15 549.4 2Q15 600.0 3Q15 649.5 4Q15 697.0 1Q16 762.0 2Q16 800.1 3Q16 832.1 384.6 1.4 0.2 0.4 4.0% 17.2 3.4 70% 116.7 420.0 2.4 0.4 0.5 4.0% 20.0 8.0 70% 508.0 454.7 2.4 0.4 0.5 4.0% 21.2 8.5 70% 582.9 487.9 2.4 0.6 0.5 4.0% 21.2 12.7 70% 938.4 533.4 560.1 2.4 2.8 0.7 0.8 0.5 0.6 3.5% 3.0% 18.6 17.1 12.1 14.4 70% 70% 972.4 1,419.1 582.5 3.6 0.9 0.6 2.8% 16.5 14.9 70% 1,964.1 4Q16 865.4 1Q17 908.7 2Q17 945.0 3Q17 978.1 4Q17 1,007.4 605.8 636.1 661.5 684.7 4.4 3.5 4.5 4.5 1.1 1.0 1.6 1.7 0.6 0.6 0.6 0.6 2.5% 2.1% 2.1% 2.1% 15.0 12.8 13.0 13.4 15.8 12.8 21.1 23.0 70% 70% 70% 70% 2,644.7 1,796.6 3,955.5 4,460.8 705.2 4.5 1.8 0.7 2.1% 13.7 24.6 70% 4,912.1 Source: Company data, Credit Suisse estimates So far, Tencent is controlling ad loads in Moment carefully to balance with user experience. Moment has one in ten user feed, or one ad per 48 hours. In the 1Q16 earnings call, the company noted there will not be a very fast release of ad inventories going forward, considering it as a long-term business. That said, we still expect WeChat ads have large potential in the long term, and will grow from Rmb2.1 bn in 2015 to Rmb7.0 bn in 2016 and Rmb15.1 bn in 2017. Overall, we believe performance-based native ad as an open-ended runway, and as a long-term growth driver for Tencent. We expect WeChat ads to have large potential in the long term, and will grow from Rmb2.1 bn in 2015 to Rmb7.0 bn in 2016 and Rmb15.1 bn in 2017. Figure 13: WeChat Moment ad sample Figure 14: Qzone mobile performance-based ad sample Source: Company data Source: Company data Tencent Holdings (0700.HK / 700 HK) 8 20 July 2016 Peer comparisons Figure 15: Global comparison of SNS players 6,000 3.00 2.83 5,000 2.50 4,000 2.00 2.00 3,000 1.50 2,000 1.00 0.59 1,000 0.55 0.41 0 0.50 - Facebook Twitter Tencent WB Ad Rev (US$ mn) LINE Ad Rev /MAU (US$) Source: Company data, revenue and MAU based on 4Q15 numbers, Credit Suisse estimates Ad revenue of Tencent is still small compared with global leading players such as Facebook. In 4Q15, Tencent's ad revenue was US$882 mn, only one-sixth of Facebook's ad revenue of US$5.6 bn. In addition, we use quarterly advertising revenue/ MAU ratio to measure the monetisation level of those peers. The monetisation rate for domestic SNS players is still low, with US$0.55 for WB and US$0.59 for Tencent, while it's US$2.83, US$2.00 and US$0.41 for Facebook, Twitter and LINE. We believe there's still great room for further monetisation upside for Tencent. Figure 16: Comparison of leading domestic performance-based ad players 7,000 The monetisation rate for domestic SNS players is still low compared with global leading players. We believe there's still great room for further monetisation upside for Tencent. Rmb mn 6,000 5,000 4,000 3,000 2,000 1,000 0 Toutiao WeChat Weibo 2014 2015 NTES news Sohu news 2016 Source: Company data, Credit Suisse estimates Both SNS players and news apps are the main platforms for in-feed ads. Toutiao (Today's Headline, 今日头条) is one of the most popular news apps in China. It was launched in 2012, and its MAU crossed 125 mn recently. According to ZOL news, Toutiao's ad revenue was about Rmb3 bn in 2015 and it targets revenue of Rmb6 bn in 2016 (up 100% YoY+). In addition, we expect WeChat and Weibo's ad revenue to also grow rapidly due to popularity of the in-feeds ad formats. Tencent Holdings (0700.HK / 700 HK) 9 20 July 2016 Games: Leading global franchise on PC and mobile Figure 17: Online game revenue breakdown (Rmb mn) 1Q15 13,313 2Q15 12,970 -QQ Game Platform -Advanced Casual Games -MMOG Games -Mobile Game YoY % Online game revenue 174 7,789 2,707 2,644 151 7,439 2,672 2,708 28% 17% -QQ Game Platform -Advanced Casual Games -MMOG Games -Mobile Game -52% 25% -1% 151% -27% 15% 1% 55% Online game revenue 3Q15 4Q15 14,333 15,971 1Q16 17,085 2Q16E 16,948 3Q16E 17,628 4Q16E 18,107 1Q17E 18,895 2Q17E 19,082 3Q17E 19,813 4Q17E 20,416 416 8,123 3,180 4,253 319 8,478 3,364 4,924 724 8,215 2,985 5,023 702 8,445 3,146 5,336 681 8,675 3,149 5,602 660 8,829 3,248 6,157 641 8,979 3,142 6,319 621 9,285 3,272 6,635 603 9,577 3,269 6,967 27% 33% 28% 31% 23% 13% 11% 13% 12% 13% 161% 10% 13% 114% 269% 16% 24% 86% 83% 9% 24% 86% 156% 12% 13% 86% 16% 11% 7% 68% -3% 10% 1% 31% -11% 8% 0% 25% -11% 9% 5% 26% -11% 10% 4% 24% -11% 10% 4% 24% 381 7,762 3,009 3,181 Source: Company data, Credit Suisse estimates We see a solid outlook for Tencent's online gaming business. We expect Tencent's online gaming revenue to reach Rmb69.8 bn in 2016, up 23%. Mobile game is still the growth driver and we forecast it to grow 63% to Rmb20.9 bn in 2016. We expect online game revenue to reach Rmb70 bn in 2016, up 23%, driven by mobile game growth. Figure 18: Revenue contribution of key game titles—diversification through mobile portfolio 60,000 Rmb mn Mobile game revenue ramps up since 2014 50,000 40,000 30,000 20,000 10,000 2011 2012 2013 2014 2015 League of Legends Dungeon & Fighter Cross Fire Blade & Soul T-Game Call Of Duty OL Other PC Wang zhe rong yao Zhengtu Naruto Mobile Quan min fei ji da zhan Re xue chuan qi CrossFire Dragonball Z mobile KoF 98 Tian tian ku pao Tian tian ai xiao chu Other mobile Source: Company data, Credit Suisse estimates Before 2014, majority of online gaming revenues came from PC games. The key PC titles included League of Legends, Dungeon & Fighter, Cross Fire, T-Game, etc. We estimate top 5 PC titles contribute 65% of total PC revenue. Mobile gaming revenue began to ramp up in 2014. "Quan min fei ji da zhan" was among the first batch of mobile games operating on WeChat. Then Tencent launched the "Tiantian series" including "Tiantian ku pao", "Tian tian ai xiao chu" and other casual games. With improving technology for mobile games and increasing penetration of largescreen smartphones, mid & hard-core games (mainly MMORGP genre) are becoming more popular and are now the main contributor of Tencent's mobile gaming revenue. Tencent Holdings (0700.HK / 700 HK) 10 20 July 2016 According to our estimates, the top 5 mobile titles account for 75% of total mobile game revenue in 2015. Figure 19: Blended margin trend for online games 68% 67% 66% 64% 63% 62% 60% 59% 58% 58% 57% 56% 54% 52% 2014 2015 2016E 2017E 2018E GPM % of online game Source: Company data, Credit Suisse estimates We estimate the overall GPM for online games will gradually trend down mainly due to the increasing revenue mix from mobile games. So far, the sector GPM for PC games is over 70% while GPM for mobile games is lower at around 50%. Solid growth of mobile gaming portfolio Figure 20: Growth of total mobile game revenue 60,000 We estimate the overall GPM for online games will gradually trend down mainly due to the increasing revenue mix from mobile games. 100% 90% 50,000 80% 70% 40,000 60% 30,000 50% 40% 20,000 30% 20% 10,000 10% - 0% 2014 2015 2016E Mobile game revenue (Rmb mn) 2017E 2018E YoY % Source: Company data, Credit Suisse estimates Mobile games have been growing rapidly during the past two years, since their ramp up in 2014. With the increasing large base and fewer big PC titles untapped, we expect the growth of mobile games will gradually cool down in the next few years, likely to ~16% in 2018. In 2Q16, as of end of Apr/ May/ Jun, Tencent had 10/11/12 titles in the Top 30 in terms of grossing. Tencent is still the player with most titles, followed by NetEase with four. In addition, Tencent has five titles in Top 10. Tencent Holdings (0700.HK / 700 HK) 11 20 July 2016 Figure 21: Grossing ranking of Tencent's mobile games—Tencent accounts for 40-50% of top 30 Name 中文名称 JX Mobile Wang zhe rong yao Zhengtu Quan min fei ji da zhan CrossFire KoF 98 Naruto Mobile Tian tian ku pao Dragonball Z mobile Re xue chuan qi Tian tian ai xiao chu Huan le dou di zhu 剑侠情缘 王者荣耀 征途 全民飞机 穿越火线 拳皇 98 火影忍者 天天酷跑 龙珠激斗 热血传奇 天天爱消除 欢乐斗地主 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 7 6 5 5 4 3 5 6 8 13 5 16 21 10 6 9 4 27 4 6 9 8 24 7 5 11 6 23 3 17 15 3 18 19 3 18 20 3 16 21 8 20 22 6 8 12 9 21 7 4 22 24 3 5 9 11 17 6 21 13 10 26 29 2 4 5 7 9 11 14 19 24 25 27 30 Source: Thinkgaming According to iResearch, Tencent accounted for over 40% of the mobile gaming market share in 2015. Its strong distribution capabilities also help attract cooperation with more successful CPs. The mid and hard core games from successful PC IPs will continue to be the promising titles, including Zhengtu (Giant Interactive), Classic TLBB (Changyou), JX Mobile (Kingsoft/Westhouse) and others. Expect market share expansion from more stringent regulation On 30 June 2016, Apple announced that approval from the State Administration of Press, Publication, Radio, Film and Television of The People's Republic of China (SARFT) is a must for mobile games to publish on iOS platform. SARFT issued a notice on 24 May to strengthen the regulation on mobile game distribution. The regulation states that all mobile games need to be reviewed and approved by SARFT. We believe the new regulation likely puts more pressure on small CPs or individual developers of mobile games. As the application process is complicated, it is likely to drive out smaller players in the mobile gaming market. We believe there will be little impact on big players, due to their greater resources. Therefore, we expect big players like Tencent to benefit from the likely consolidation as they grab more share. PC games: Core base stays resilient We believe the new regulation likely puts more pressure on small CPs, while big players like Tencent to benefit from the likely consolidation. Figure 22: Revenue growth of PC games 60,000 16% 14% 50,000 12% 40,000 10% 30,000 8% 6% 20,000 4% 10,000 2% - 0% 2014 2015 2016E PC game revenue (Rmb mn) 2017E 2018E YoY % Source: Company data, Credit Suisse estimates We expect Tencent will likely invest in more foreign gaming studios to make up for its relatively weak in-house game development team, while NetEase and Perfect World will Tencent Holdings (0700.HK / 700 HK) 12 20 July 2016 still remain focused on in-house developed games. According to 17173, Tencent has eight titles in the Top 30 PC games, among which only two titles are in-house developed games. We forecast PC game revenue to reach Rmb48.9 bn in 2016, up 12% YoY. Figure 23: Tencent's key PC titles stand stable in Top 3 (by power times) Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 0 Mar-16 Apr-16 May-16 Jun-16 5 10 15 20 25 30 League of Legends (T) Dota2 (P) Moonlight blade (T) Cross Fire (T) Hearth Stone (N) Warcraft (N) Dungeon & Fighter (T) Call Of Duty OL (T) T-Game (T) Overwatch (N) Source: Shunwang, "T" short for "Tencent", "N" for "NetEase" and "P" for "Perfect World" According to Shunwang, Tencent's titles League of Legends, Cross Fire and Dungeon & Fighter, have been stable in the Top 3 PC game rankings over the past year. Overall, 7 of the Top 10 titles are from Tencent, in terms of power times. In addition, Blizzard's new FPS title Overwatch (launched on 24 May 2016), made a strong debut on the ranking board. We believe it will have large impact on Crossfire (#1 FPS game in China), as Crossfire users have high loyalty. It appears that LoL may be more directly affected but it's still too early to determine the sustainability of Overwatch. Even if the traffic for LoL is impacted by Overwatch, the monetisation impact may lag. Tencent's titles League of Legends, Cross Fire and Dungeon & Fighter, have been stable in the Top 3 PC game rankings over the past year. Figure 24: Ranking of PC games Rank Title 游戏名称 Developer Operator 1 2 3 4 5 6 7 8 9 10 League of Legends Dungeon & Fighter Overwatch Fantasy Westward Journey 2 Cross Fire Hearthstone World of Warcraft JX 3 TLBB Moonlight Blade 英雄联盟 地下城与勇士 守望先锋 梦幻西游 2 穿越火线 炉石传说 魔兽世界 剑网 3 新天龙八部 天涯明月刀 Riot Games Neople Blizzard NetEase Smilegate Blizzard Blizzard Kingsoft Changyou Tencent Tencent Tencent NetEase NetEase Tencent NetEase NetEase Kingsoft Changyou Tencent Source: Company data, 17173, Note:* Ranking date on 4-Jul-2016 In 17173's PC game ranking (measured by a weighted index, including playing users, playing time, searching index, etc.), Tencent has 4 titles in the top 10, namely LoL, Dungeon & Fighter, Cross Fire and Moonlight Blade. In addition, Tencent has 8 out of Top 30. Tencent Holdings (0700.HK / 700 HK) 13 20 July 2016 Global expansion through M&As In June 2016, Tencent announced it would buy up to an 84.3% stake in leading mobile game developer Supercell for ~US$8.6 bn from SoftBank and other previous shareholders, together with potential co-investors. The deal values Supercell at US$10.2 bn. Supercell is one of the most successful game developers globally with games such as Clash Royale, Clash of Clans, Boom Beach and Hay Day. It generated revenue of US$2.3 bn with a profit of US$964 mn in FY2015. With the launch of Clash Royal in 2016, both revenue and profit should be growing decently in 2016E, likely 30%+ YoY if we estimate. Figure 25: Revenue rank in mobile games by company, iOS + Android Rank By Revenue Headquarters Game Apps 1 2 3 4 5 6 7 8 9 10 Supercell Tencent Activision Blizzard Machine Zone NetEase Mixi BANDAI NAMCO Netmarble LINE SQUARE ENIX Finland China US US China Japan Japan Korea Japan Japan 8 405 103 6 307 47 397 188 157 325 Source: App Annie, May 2016 We are positive for the following reasons: (1) adding the global leader Supercell with over 100 mn DAU to seal Tencent’s dominance, (2) “not consolidate or equity-account” gives clarity to existing financial disclosure and enables independence of Supercell’s operation, (3) cooperation to launch Tencent's version of Supercell’s products in China soon; and (4) future outside co-investment to alleviate cash use burden. We believe the deal could help alleviate investor concerns on the recent slowdown in activities of LoL, due to the launch of Overwatch (Blizzard). Tencent should remain the leader of online gaming market, both in China and overseas, especially in mobile games. Before Supercell, Tencent had already had a long list of overseas investment in game companies, like in the US, Korea and Japan, in order to secure its gaming pipeline, especially on mobile. Tencent also owns shares in global big gaming companies. For example, Tencent acquired 100% shares of Riot Game (developer of League of Legend) in 2011. Tencent also owns 6% of Blizzard's (developer of Warcraft) shares. We believe the Supercell deal could help alleviate investor concerns on LoL, due to launch of Overwatch. Tencent should remain the leader of online gaming market, both in China and overseas, especially in mobile games. Figure 26: The world of Tencent Gaming investments Source: Company data Tencent Holdings (0700.HK / 700 HK) 14 20 July 2016 Figure 27: Tencent's investment in gaming companies Year Company 2006 2007 2007 2008 2010 2010 2010 2010 2010 2010 2010 2010 2011 2011 2011 2011 2011 2012 2013 2013 2013 2014 2014 2014 2014 2014 2014 2014 2014 2014 2015 2015 2015 2015 2016 2016 GoPets Yonghang Vina Games Outspark Wangyu GH Hope Island Eyedentity Redduck Nextplay Topping Reloaded Studios Studio Hon Riot Manyougu Epic Games Kingsoft network Yinhan Level Up Blizzard iDreamsky Plain Vanilla 4:33 Creative Lab Playdots Aiming Artillery CJ Games Qingtianzhu TapZen PATI Games Yidongyule Glu Mobile Miniclip Hammer&Chisel Pocket Gems Paradox Interactive Supercell Country Amount % of shares Korea Rmb32.8 mn 17% China n.a 63.90% Korea n.a 30.20% US US$11 mn n.a China Rmb456 mn 100% Korea W2.5 bn n.a Korea W4 bn n.a Korea W1.5 bn n.a Korea W1.5 bn n.a Korea W1.5 bn n.a Korea W5.5 bn n.a Korea W1.45 bn n.a US Rmb1.68 bn 100% China Rmb764 mn 62.50% US Rmb2.09 bn 48.40% China Rmb742 mn 15.30% China n.a 15% Singapore Rmb348 mn 100% US US$1.4 bn 6% China US$15 mn 20.40% Iceland co-invest US$22 mn n.a Korea co-invest US$110 mn n.a US co-invest US$10mn n.a Japan n.a 16.84% US n.a n.a Korea US$500 mn 28% China Rmb150 mn n.a US US$8 mn n.a Korea W20 bn n.a China Over Rmb10 mn n.a US US$126 mn 14.60% Switzerland n.a largest shareholder US n.a n.a US US$60 mn 20% Sweden Rmb138 mn 5% Finland US$8.6 bn 84.30% Source: 17173.com Tencent Holdings (0700.HK / 700 HK) 15 20 July 2016 Investments: Bearing fruits for future Tencent's investment track record has been enriching its service offerings, refuelling growth of its core user products, and winning credit from investor community for management's forward looking industry insights. Although most investors have not explicitly attributed value to many of Tencent's portfolio assets, we believe upcoming value-unlock events from key assets, especially in eCommerce, O2O and finance, would provide waves of value creation in the coming years, which would gradually prompt the investor community to value it on an SOTP basis. Inclusion of Supercell in the form of a dividend payout would also add another layer of optional value for shareholders. Tencent's investment track record has been enriching its service offerings, refuelling growth of its core user products, and winning credit from investor community for management's forward looking industry insights. Figure 28: Tencent's ecosystem E-Commerce JD OTA Finance Social network elong WeBank Wechat Penguin Pictures RRKD LY.com Futu QQ/QQ Zone Tencent Pictures China South City woqu.co Tencent Weibo Tencent Video Mascotte HDS ele.me ZhongAn Insurance China Reading Sinopec 1jiajie Renrendai Kakao Talk 58.co Yixin Capital Kiki China Postal Bank Same O2O CIP Youxin Maima Meike Missfr Huak Koud Wanda ecommerc BitAuto Renrench Didi Zhihu Media Tencent Games Lyft U-Xian Snapchat MJBan Whisper Leju AltspaceVR Guaha WhoSay Dingxiang PPYX Huitong Heirloom Nanjing More categories Scaled Inference Tencent Comic Sanadu QQ Music Tile Tencent Games Weiying Technology Picooc Kingsoft Naviinfo Dian FM Sogou Guagua.cn Magic WiFi Bona / Huayi Huan Source: Company data, Credit Suisse research Tencent is most proactive in exploring and investing in start-ups among BAT. It mainly focuses on minority investments. O2O remains the hottest category in Tencent's investment initiatives. Major landmark transactions include joint investments in Didi Kuaidi, Meituan Dianping and 58.com. Tencent continues to adopt a strategic investment approach by forming firm cooperation with invested companies, instead of taking a controlling stake. This mild approach also allows Tencent to expand its investment coverage faster without paying excessive premium in an acquisition transaction. Tencent Holdings (0700.HK / 700 HK) 16 20 July 2016 Figure 29: Tencent—total equity investment 2010-15 (US$Mn) 8,025 Figure 30: Tencent—investment transactions by category Investment amount (US$Mn) 6,000 5,000 5,522 O2O 4,000 3,000 2,000 1,187 522 2010 1,372 eCommerce Social network 2011 2012 2013 Source: Company data, Credit Suisse research 2014 2015 Healthcare Auto 1,000 684 Game - 2 4 6 Media 8 10 12 Number of transactions 14 16 18 Source: Company data, Credit Suisse research O2O services Tencent focuses on high-frequency O2O services, including investment in Didi Kuaidi and Dianping, etc. Significant offline exposure is needed, which is not the core strength. Tencent likely leverages its capital on a more efficient basis. Didi Kuaidi Didi Kuaidi was merged by two leading taxi hailing companies, Didi and Kuaidi, in February 2015. Since its inception, the competitive landscape of taxi market in China has changed dramatically. By leveraging the mobile internet, DidiKuaidi has bridged offline taxi hailing needs with online information to form an O2O closed loop. It innovatively improves the user experience in taxi hailing, and enables taxi drivers to pick up passengers based on current location and target destination, which reduces the communication cost between drivers and passengers, and improves the utilisation rate of the taxi. According to iResearch, Didi Kuaidi's market share in 2015 reached 88.4%. Tencent focuses on highfrequency O2O services, including investment in Didi Kuaidi and Dianping, etc. Significant offline exposure is needed, which is not the core strength. Meituan Dianping According Analysys, Meituan food delivery had around 33% market share. The merged Meituan-Dianping, now named China Internet Plus (CIP), announced a record-breaking US$3.3 bn financing on 20 January 2016, according to NetEase News. Tencent actively invested at least US$1 bn in the latest round which boosts the new company's valuation to US$18 bn. Meanwhile, Meituan-Dianping confirmed to continue its focus on food delivery services – one of its key product categories after movie-ticket and group-buy – providing financial support on fulfilment improvement and category expansion in the next 1-2 years. Tencent Holdings (0700.HK / 700 HK) 17 20 July 2016 Internet finance Besides the O2O segment, internet finance is also one of the key focuses of Tencent. We believe Tencent's internet finance business will contribute more meaningfully in 2017 with payment and loan-related services. In our valuation for Tencent, we include the value of internet finance-related businesses (Tenpay+WeChat payment, financial product distribution, and micro loan valuation) at US$29.3 bn (or HK$24.2/sh). While the largest value comes from payment, Tencent is making great efforts in non-payment financial businesses, such as Licaitiong (its online wealth management product distribution) and the small-micro lending business conducted by WeBank. We believe the financial business will result in greater upside to its valuation. We believe Tencent's internet finance business will contribute more meaningfully in 2017 with payment and loan-related services. Strong mobile payment progress The number of mobile payment users exceeded 400 mn in 2015. This significant increase was mainly driven C2C transactions (such as red envelope and money transfer), offline payment promotions, games, and O2O payments. Figure 31: Mobile payment market share in China (1Q16) Lianlianpay 1.3% Figure 32: Total online payment market share in 2015 Umpay PinganpayOthers 1.3% 1.2% 4.7% Tenpay 20% ChinaPnR 2% Lakala 1.4% Alipay 51.8% Tenpay 38.3% Source: iResearch Alipay 58% China UnionPay Online 6% 99Bill 4% Others 10% Source: iResearch, Credit Suisse estimates According to iResearch, Tenpay was the second-largest player in the mobile payment market, with 38% market share in 1Q16. As for the total online payment market (including PC and mobile), Tenpay took ~20% of the market share in 2015. Due to its lack of a strong e-commerce business historically, Tenpay's business has mainly focused on Tencent's various entertainment-related services (games, red packets, etc.), and newly acquired O2O services, such as taxi-hailing, restaurants, among others. Tencent's aggressive Red Packet campaign during the Spring Festival contributed a lot to the rapid growth of Tenpay and WeChat payment platforms. We expect Tenpay to be able to leverage WeChat's large user base and active user engagement to enable more innovative application scenarios. WeChat Payment uses Tenpay for its back-end payment infrastructure. It has launched various personal financial services, such as AA payment, lottery, mobile phone recharges, utility fee payment, movie ticketing, O2O services, among others. According to Tencent, its mobile payment application has more than 400mn users. In future, Tenpay may launch more new functions through WeChat. The main source of balance in the WeChat Wallet is Red Packet and Money transfer. Tencent disclosed that 516mn WeChat users participated in a total of 32.1bn Red Packets Tencent Holdings (0700.HK / 700 HK) 18 20 July 2016 between 7 and 12 February 2016, Chinese Lunar New Year, compared with 3.27 bn during the same period last year. Figure 33: WeChat wallet features cellphone bill payment Licaitong: Tencent's internet finance platform Uitilities payment services: water, electricity, broadband, and etc City services: such as tax services and gov services Wechat red packet Third party services: Didi Chuxing, Train tickets, Meilishuo, JD, Movie tickets, Dianping Source: Company data, Credit Suisse research In addition, Tenpay has been aggressive on promoting its payments in offline malls or retailers. Tencent has established partnerships with supermarkets, such as Carrefour, Wumei and Yonghui, to grab offline market share. We believe the promotion campaign will continue in 2016 and the competition will intensify. So far, WeChat payment is available with over 300,000 offline retailers and we believe this number will continue to grow rapidly given Tencent's aggressive promotion. According to a survey conducted by Penguin Intelligence, simple process, convenience and discounts are the main factors that affect users' choice for WeChat payment. There are over 500mn transactions daily through WeChat payment. Valuation of Tencent's internet finance businesses For Tencent, we value its internet finance-related business at US$29.3 bn, including payment infrastructure revenue of US$23.5 bn, the financial product distribution business at US$1.1 bn, and WeBank's small and micro loan business at US$4.7 bn. Figure 34: Valuation of Tencent internet finance-related business (Tenpay + WeChat We value its internet finance-related business at US$29.3 bn, including payment infrastructure revenue of US$23.5 bn, the financial product distribution business at US$1.1 bn, and WeBank's small and micro loan business at US$4.7 bn. payment, financial product distribution, and micro loans) Rmb bn Payment infrastructure Financial product distribution Small & micro loans (WeBank) 2018E market size 21,800 Tenpay % 25.0% Amount Economics Rev Net (2018) Margin 5,450.0 0.40% 21.8 35% 396.9 0.25% 0.5 35% 43.7 10.00% 1.6 35% NI P/E Valuation Valuation Valuation (Rmb bn) (US$ bn) (HK$ per share) 7.6 20 152.6 23.5 0.3 20 6.9 1.1 1.5 20 30.6 4.7 Total valuation 190.1 29.3 24.2 Source: Company data, Credit Suisse estimates ■ Payment value of US$23.5 bn We assume Tencent, via Wechat mobile payment and Tenpay, to account for about 25% of the total online payment market share in the long term. We see this as a relatively Tencent Holdings (0700.HK / 700 HK) 19 20 July 2016 conservative estimate of market share for Tencent, considering its recent progress in offline payment. We project the total online payment market to grow to US$21.8 bn in 2018. Tenpay occupied 20% market share in 2015. With it further leveraging its large user base, we expect its market share to grow to 25%. ■ Financial product distribution We conservatively assume Tencent to distribute wealth management products worth Rmb397 bn by 2018. By assuming Tencent could take a distribution fee of 0.25%, total revenue from these products would be Rmb0.5 bn. We believe this number could have further upside opportunities, as it is only 2% of total bank wealth management product market size. ■ Small and micro loan WeBank, founded in late 2014, is the first private internet bank in China. Tencent owns a 30% stake in WeBank. WeBank’s scope covers personal banking, corporate banking and international banking. Its first product 'Weilidai', provides personal credit lines to users without the need for guarantee or collateral, on a limited scale. New challenges that mobile internet faces today: As a result of the rapid development of mobile internet, internet finance companies are feeling increased pressure to deal with the massive amount of customer request simultaneously and to serve a diversified customer base with complex requirements and low loyalty. The traditional financial services cannot provide the user experience that meets the customers' needs. Focus on customer experience, big data analytics and highly effective, low cost solutions: To solve the challenges, internet finance companies should aim for (1) best-inclass user experience that includes personalised, smart, forward-looking and active services; (2) big data capabilities to study and understand customers' past behaviour, financial record and social data; and (3) highly effective, low cost solution to support simultaneous requests, 24-hour service, complex requests and to deal with multi-end, multi-system environment. Weilidai (微粒贷, "Micro Loan") effectively improved user experience, lowered cost and improved revenue: The credit line product was specially designed to optimise customer experience with an effective risk control system, based on multi-dimensional user data. The solid model enables continuously decreasing marginal cost and contribution to revenue. WeBank is expected to make profit from next year. Innovative internet finance product to customers, great outlook ahead: WeBank targets mass individuals between 25 and 35 years of age with an average loan size around Rmb10,000 and an average repayment period of five months. Customers can apply for such micro loans for setting up small businesses or for consumption. WeBank aims to promote personal credit lines to more users in China and expand the market size, as it believes there is a huge potential population to penetrate, and providing best products and services will be the key competiveness. As the lending business is still at an early stage, we apply a US$4.7 bn valuation to this business, using 20x P/E on the back of Rmb1.5 bn profit it could generate in 2018E. We assume WeBank would see loan balances grow from Rmb7.5 bn at end-2015 to Rmb43.7 bn by mid-2018. We expect Tencent, as a referrer of borrowers to WeBank, could be able to generate a net fee of around 3.5% of outstanding loan amount in 2018. Tencent Holdings (0700.HK / 700 HK) 20 20 July 2016 Valuation and risks We maintain our OUTPERFORM rating with a TP of HK$230 (from HK$190) We arrive at our target price using the following methodology: (1) Main valuation methodology: P/E Our main valuation methodology is forward P/E, as we see Tencent's strong earnings power and cash flow are a testimony to the success of its franchise platform business model. Our TP of HK$230, implies 33.4x FY17E dil. adj. P/E. This includes (1) internet finance business valuation of HK$24.2/sh, and (2) core business valuation of HK$205.8/sh, based on 30x FY17E, parallel with other global internet giants. Figure 35: Global internet leaders comps table* Mkt cap Company PE Ticker Ccy Price Rating (US$ mn) 2016E 2017E Tencent 0700.HK HKD 185.0 O 224,435 33.8 26.3 Baidu BIDU.US USD 164.8 O 57,059 35.7 23.4 Alibaba BABA.US USD 82.7 O 207,652 33.1 25.8 FB.US USD 119.4 O 341,435 33.3 24.5 GOOGL.US USD 753.2 O 510,444 23.6 19.1 NFLX.US USD 98.8 N 42,320 195.0 71.3 59.1 31.7 Facebook Google Netflix Average Our TP of HK$230, implies 33.4x FY17E dil. adj. P/E. This includes (1) internet finance business valuation of HK$24.2/sh, and (2) core business valuation of HK$205.8/sh, based on 30x FY17E. Source: Company data, Bloomberg, Credit Suisse estimates. *Closing price of 18 Jul 2016. (2) Sum-of-the-parts (SOTP) We also use SOTP to gauge Tencent's valuation. We arrive at an SOTP value of HK$228/sh. We estimate Tencent investment has a current market value of US$21 bn, including JD.com, 58.com, Meituan Dianping, and other investments. Figure 36: Tencent—SOTP valuation Business lines Community VAS PC game Mobile game Brand & video ad Performance-based ad Tenpay & WeChat Payment Net cash Market value of investments Total Value Price per diluted share (Rmb) Price per diluted share (HK$) Revenue Earnings Multiple (Rmb Mn) Low 21,450 7,507 25x 52,126 23,457 12x 43,465 15,213 25x 21,754 3,916 20x 28,225 9,879 35x -2,640 High 35x 17x 35x 30x 40x Value (Rmb Mn) Low 187,685 281,481 380,320 78,315 345,761 190,143 31,298 141,484 1,636,488 172.8 201.2 High 262,759 398,765 532,448 117,473 395,156 190,143 31,298 141,484 2,069,526 218.6 254.4 Value (Rmb mn) Mid-point 225,222 340,123 456,384 97,894 370,458 190,143 31,298 141,484 1,853,007 195.4 227.5 Value (US$ bn) 33.6 50.8 68.1 14.6 55.3 29.3 4.7 21.1 276.6 Value (HK$) Per share 27.7 41.8 56.0 12.0 45.5 24.2 3.8 16.5 227.5 Source: Company data, Credit Suisse estimates Tencent Holdings (0700.HK / 700 HK) 21 20 July 2016 Share price risks Positive share price drivers and catalysts 1) Stronger-than-expected mobile game pipeline. Tencent's strong R&D and distribution capabilities could help attract cooperation in mobile titles on big IPs. In addition, the strengthened regulation of SARFT might result in further consolidation of the mobile gaming market, which is favourable to big players, like Tencent. 2) Opportunities from internet finance (lending, payment, and product distribution). If Tencent could perform well in promoting its Tenpay and Weilidai businesses, it could make a more meaningful contribution to Tencent, which will be helpful for the valuation upside. 3) Further monetisation on SNS. For SNS, as the user growth likely slows down, ARPU might be the next growth driver the SNS revenue. Tencent's various O2O scenarios could help bring in more monetisation chances. 4) Better growth and profitability in investment initiatives. Tencent has made investments in almost all verticals during past years. If those start-ups or baby tigers could grow healthily, it could contribute to Tencent on both topline and bottomline positively. Downside risks 1) Slower-than-expected MAU growth of SNS due to the existing large user base. There is limited room for further penetration. In addition, the growth in smartphone shipments has also slowed down. 2) Headwinds in China's macro economy, which negatively impact the advertising industry, including online advertising. This would result in decreased advertising budget for advertisement customers. 3) Slower-than-expected performance-based ad growth with Tencent not able to balance user experience with monetisation. Tencent announced that there will not be a very fast release of ad inventories on Moments. The progress might also be delayed if user experience was affected. 4) Competition from other players in online video business. Tencent's video is facing stiff competition from other players, such as iQiyi, Youku Tudou and Sohu video, which might lift the cost in content acquisition. 5) Faster-than-expected slowdown in PC games. PC game growth has slowed down during the past few years to low-single-digit. If no further efforts were made to extend the lifecycle of key PC titles or develop new games, contribution from PC games might shrink going forward. 6) High base of mobile games may make growth rate look soft from 2017E. Tencent would need to introduce another suite of decent mobile titles while keeping current portfolio steadily growing, which is not an easy task, in our view. Tencent Holdings (0700.HK / 700 HK) 22 20 July 2016 Earnings revision We revise up our 16E/17E/18E non-GAAP EPS by 0.8%/3.3%/5.1%, mainly due to: 1) Revised up video revenue meaningfully, to reflect robust contribution from mobile and timeline based offerings in WeChat; 2) Slightly increased performance-based ad growth trajectory, mainly from better WeChat ad growth in 2Q16 and beyond; 3) Increased mix of licensed mobile games title vs in-house to reflect recent trends. Figure 37: Earnings revision table Revised 2016E Prior RMB Mn 2Q16E 3Q16E 4Q16E 2017E 2018E Total Revenue VAS Online Advertising Others Gross Profit Gross Profit Margin Adj. Optg Profit Adj. OPM(%) Reported Net Income Net Income (ex. SBC) Adj. NPM Reported Dil. EPS (RMB) Adj. Dil. EPS (ex. SBC) 34,736 24,907 7,453 2,377 19,955 57.4% 13,448 38.7% 9,575 11,133 32.1% 1.01 1.17 37,399 26,006 8,969 2,424 21,614 57.8% 14,131 37.8% 10,110 11,668 31.2% 1.07 1.23 39,164 143,294 177,416 221,916 26,750 102,627 117,041 130,208 9,941 31,064 49,980 80,456 2,473 9,603 10,395 11,252 22,775 82,934 103,396 132,291 58.2% 57.9% 58.3% 59.6% 14,037 54,663 68,454 89,790 35.8% 38.1% 38.6% 40.5% 9,967 38,835 50,098 66,944 11,525 44,358 57,015 74,685 29.4% 31.0% 32.1% 33.7% 1.05 4.10 5.28 7.06 1.22 4.68 6.01 7.88 2Q16E 2.6% 0.0% 13.5% 0.0% 2.8% 0.14 2.3% (0.12) 1.8% 1.6% (0.33) 0.1% -0.2% 3Q16E 3.8% 1.1% 13.6% 0.0% 4.1% 0.15 4.0% 0.07 5.4% 4.6% 0.25 3.6% 2.8% 4Q16E 4.5% 1.5% 14.7% 0.0% 5.2% 0.39 2.4% (0.71) 2.2% 1.9% (0.74) 0.5% 0.2% 2016E 2.8% 0.7% 11.6% 0.0% 3.1% 0.18 2.2% (0.23) 2.4% 2.1% (0.22) 1.1% 0.8% 2017E 2.6% -1.0% 12.7% 0.0% 2.1% (0.25) 4.6% 0.75 5.6% 4.9% 0.72 3.8% 3.3% 2018E 2.8% -4.8% 18.4% 0.0% 2.0% (0.46) 6.6% 1.45 7.8% 6.9% 1.30 5.9% 5.1% Source: Company data, Credit Suisse estimates Tencent Holdings (0700.HK / 700 HK) 23 20 July 2016 Appendix I: Financial summary Income statements Figure 38: Tencent's revenue growth 250,000 45% 40% 200,000 35% 30% 150,000 25% 20% 100,000 15% 10% 50,000 5% - 0% 2014 2015 2016E 2017E Total revenue (Rmb mn) 2018E YoY % Source: Company data, Credit Suisse estimates In 2015, Tencent's revenue reached Rmb102.9 bn, up 30% YoY. We expect Tencent's revenue to witness a three-year CAGR of 29% and reach Rmb222 bn in 2018E. Figure 39: Tencent—revenue breakdown 100% 90% 17% 80% 8% 9% 5% 11% 17% 7% 6% 22% 28% 70% 5% 36% 60% 50% 53% 57% 55% 40% 49% 44% 39% 30% 20% 10% 22% 24% 23% 23% 22% 20% 2013 2014 2015 2016E 2017E 2018E 0% Social networks Online game Online advertising Others Source: Company data, Credit Suisse estimates Tencent earns 78% revenue from VAS, including Social networks (23%) and online game (55%); 17% from online advertising; 5% from others. Online game is still the largest contributor of Tencent's revenue, over half of its revenue. Revenue contribution from online advertising kept rising for the past few years, and we believe this momentum will continue due to the rapid growth of performance-based ad revenue. Tencent Holdings (0700.HK / 700 HK) 24 20 July 2016 Figure 40: Tencent's margin trend 70.0% 60.9% 60.0% 59.5% 57.9% 58.3% 59.6% 38.2% 38.1% 40.5% 31.1% 31.0% 38.6% 32.1% 54.0% 50.0% 40.0% 35.3% 30.7% 30.0% 28.2% 30.0% 33.7% 20.0% 10.0% 0.0% 2013 2014 2015 GPM 2016E 2017E Adj. OPM 2018E Adj. NPM Source: Company data, Credit Suisse estimates Tencent's gross margin was 59.5% in 2015, vs 60.9% in 2014. Tencent's adj. OP and NP have improved during the past few years, to 38.2% and 31.1% in 2015. We look for a gradual improvement in net margin in the next two years, due to the mix of high margin business like performance-based ad and the leverage on expenses. Balance sheet Tencent had Rmb56.6 bn of cash and cash equivalents as of end-1Q16 vs. Rmb43.4 bn as of end-2015 and Rmb42.7 bn as of end-2014. Figure 41: Balance of cash and cash equivalents 60,000 50,000 40,000 30,000 20,000 10,000 0 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Cash and cash equivalents (Rmb mn) Source: Company data, Credit Suisse estimates Tencent Holdings (0700.HK / 700 HK) 25 20 July 2016 Cash flow statements Net cash from operating activities amounted to Rmb45.4 bn in 2015. Net cash flow used in investing activities was Rmb63.6 bn, net cash from financing activities was Rmb18.5 bn. Tencent incurred capital expenditures of Rmb7.71 bn in 2015. Free cash flow was Rmb37.7 bn in 2015. Revenue booking for online games For online games, it was paid by way of prepaid cards and tokens through channels such as sales agents and eCommerce platforms. The users register the prepaid cards and tokens to their user accounts to buy virtual items. Receipts from the sales of prepaid cards and tokens are deferred and recorded as “Deferred revenue”. The amounts are then recognised as revenue based on the actual utilisation of the respective payment units: (i) when the payment unit is used to purchase virtual items or tools, revenue is recognised when the related services are rendered; (ii) when the payment unit is used to purchase virtual products/items, the revenue is recognised over the estimated lifespan of the respective virtual products/ items or over the expected user relationship. Figure 42: Growth of online game revenue and deferred revenue 30,000 25,000 20,000 15,000 10,000 5,000 1Q14 2Q14 3Q14 4Q14 Online games revenue (Rmb mn) 1Q15 2Q15 3Q15 4Q15 1Q16 Defered Revenue (Rmb mn) Source: Company data, Credit Suisse estimates In addition, for mobile game revenue recognition, Tencent books 40% of net revenue in social networks segment (within VAS) and 60% in games segment. Before 4Q14, revenue booked was NET of revenue sharing and net of channel fee (iOS). From 4Q14 onward, revenue booking includes sharing with third-party developers/channels, and Tencent books these sharing fees as COGS. Tencent Holdings (0700.HK / 700 HK) 26 Tencent Holdings (0700.HK / 700 HK) Figure 43: Quarterly financial forecasts for Tencent 2014 (RMB in M, year-end Dec) 1Q 2Q 3Q Net Revenue 18,400 19,746 19,808 Internet VAS 14,413 15,713 16,047 Social Networks 4,026 4,632 4,723 Games 10,387 11,081 11,324 Online Advertising 1,177 2,064 2,440 eCommerce 2,524 1,324 459 Others 286 645 862 Cost of Revenue -7,800 -7,574 -7,167 Gross Profit 10,600 12,172 12,641 Operating Expenses -4,792 -5,426 -5,696 Sales & Mktg. expenses -1,855 -1,973 -1,906 G&A expenses -2,937 -3,453 -3,790 Share-based compensation -328 -418 -536 EBIT 5,808 6,746 6,945 Adj. EBIT (ex SBC, other losse/gain)6,136 7,164 7,481 EBITDA 7,115 8,468 8,703 Interest Income 375.0 406.0 452.0 Other Gain, Net 1,607.0 691.0 118.0 Finance Cost 238.0 354.0 317.0 Share of profit of associates -45.0 -23.0 139.0 Share of profit of joint ventures 1.0 0.0 0.0 Pre Tax Profit 7,596 7,512 7,059 Tax (Expense)/Credit -1,164 -1,686 -1,383 Minority Interest 25 10 -19 Net Profit 6,457 5,836 5,657 Adj. Net Profit (ex SBC, amort and one-time 5,194 gains) 5,874 6,433 Pre Tax EPS (RMB) 0.82 0.81 0.76 Diluted EPS (RMB) 0.69 0.62 0.60 Adj. Diluted EPS (RMB, ex SBC, Amort 0.55 and one-time 0.63 gains)0.69 Margins (%) Gross Margin 57.6 61.6 63.8 Reported Op. Margin 31.6 34.2 35.1 Adj. Op. Margin 33.3 36.3 37.8 EBITDA Margin 38.7 42.9 43.9 Net Margin 35.1 29.6 28.6 Adj. Net Margin 28.2 29.7 32.5 Sequential Growth (%) Net Revenue 8.4 7.3 0.3 Gross Profit 20.8 14.8 3.9 Adj. EBIT 44.5 16.8 4.4 Pre Tax Profit 60.3 -1.1 -6.0 Net Profit 65.1 -9.6 -3.1 Adj. Net Profit 15.5 13.1 9.5 Diluted EPS 64.7 -9.6 -3.0 Adj. Diluted EPS 15.2 13.1 9.6 4Q 20,978 17,137 5,173 11,964 2,627 446 768 -8,332 12,646 -6,038 -2,063 -3,975 -488 6,608 7,096 8,526 443.0 343.0 273.0 275.0 0.0 6,846 -892 -94 5,860 6,723 0.74 0.62 0.72 1Q 22,399 18,626 5,313 13,313 2,724 0 1,049 -8,965 13,434 -4,994 -1,326 -3,668 -541 8,440 8,981 10,645 521.0 411.0 433.0 310.0 0.0 8,629 -1,699 -47 6,883 7,119 0.93 0.73 0.76 60.3 31.5 33.8 40.6 27.9 32.0 60.0 37.7 40.1 47.5 30.7 31.8 5.9 0.0 -5.1 -3.0 3.6 4.5 3.3 4.2 6.8 6.2 26.6 26.0 17.5 5.9 17.4 5.8 2015 2Q 23,429 18,428 5,458 12,970 4,073 0 928 -8,991 14,438 -5,612 -1,601 -4,011 -699 8,826 9,525 11,131 598.0 612.0 341.0 452.0 0.0 9,243 -1,847 -82 7,314 7,975 0.99 0.78 0.85 3Q 26,594 20,547 6,214 14,333 4,938 0 1,109 -11,014 15,580 -6,422 -2,042 -4,380 -780 9,158 9,938 11,961 559.0 614.0 481.0 702.0 0.0 9,148 -1,564 -139 7,445 8,101 0.98 0.79 0.86 4Q 30,441 23,068 7,097 15,971 5,733 0 1,640 -12,661 17,780 -7,790 -3,024 -4,766 -809 9,990 10,799 13,352 649.0 249.0 363.0 1,329.0 0.0 9,196 -1,998 -34 7,164 8,807 0.99 0.76 0.93 1Q 31,995 24,964 7,879 17,085 4,701 0 2,330 -13,406 18,589 -6,400 -2,032 -4,368 -857 12,189 13,046 15,725 703.0 506.0 491.0 1,089.0 0.0 11,818 -2,550 -85 9,183 10,032 1.26 0.97 1.06 61.6 37.7 40.7 47.5 31.2 34.0 58.6 34.4 37.4 45.0 28.0 30.5 58.4 32.8 35.5 43.9 23.5 28.9 58.1 38.1 40.8 49.1 28.7 31.4 4.6 7.5 6.1 7.1 6.3 12.0 6.1 11.9 13.5 7.9 4.3 -1.0 1.8 1.6 1.8 1.6 14.5 14.1 8.7 0.5 -3.8 8.7 -4.1 8.3 5.1 4.6 20.8 28.5 28.2 13.9 27.7 13.4 2016E 2QE 34,736 24,907 7,959 16,948 7,453 0 2,377 -14,781 19,955 -7,364 -2,432 -4,933 -857 12,591 13,448 16,271 791.9 506.0 510.5 1,089.0 0.0 12,290 -2,629 -85 9,575 11,133 1.31 1.01 1.17 3QE 37,399 26,006 8,378 17,628 8,969 0 2,424 -15,785 21,614 -8,340 -2,805 -5,535 -857 13,274 14,131 17,060 606.3 506.0 510.5 1,089.0 0.0 12,787 -2,592 -85 10,110 11,668 1.37 1.07 1.23 4QE 39,164 26,750 8,643 18,107 9,941 0 2,473 -16,389 22,775 -9,595 -3,721 -5,875 -857 13,180 14,037 17,029 692.5 506.0 510.5 1,089.0 0.0 12,779 -2,727 -85 9,967 11,525 1.37 1.05 1.22 1QE 38,901 28,149 9,254 18,895 8,230 0 2,522 -16,027 22,874 -7,897 -2,645 -5,252 -1,028 14,977 16,006 18,960 726.5 506.0 425.4 1,089.0 0.0 14,696 -3,145 -85 11,466 13,195 1.57 1.21 1.39 57.4 36.2 38.7 46.8 27.6 32.1 57.8 35.5 37.8 45.6 27.0 31.2 58.2 33.7 35.8 43.5 25.4 29.4 58.8 38.5 41.1 48.7 29.5 33.9 8.6 7.4 3.1 4.0 4.3 11.0 4.1 10.8 7.7 8.3 5.1 4.0 5.6 4.8 5.6 4.8 4.7 5.4 -0.7 -0.1 -1.4 -1.2 -1.4 -1.2 -0.7 0.4 14.0 15.0 15.0 14.5 15.0 14.5 2017E 2QE 43,408 28,536 9,454 19,082 12,300 0 2,573 -18,156 25,252 -9,116 -3,039 -6,077 -1,028 16,136 17,164 20,342 775.6 506.0 425.4 1,089.0 0.0 15,903 -3,386 -85 12,432 14,161 1.70 1.31 1.49 2014 2015 2016E 2017E 2018E 3QE 46,432 29,723 9,910 19,813 14,085 0 2,624 -19,477 26,955 -10,215 -3,482 -6,733 -1,028 16,740 17,769 21,085 976.2 506.0 425.4 1,089.0 0.0 16,708 -3,370 -85 13,253 14,983 1.79 1.40 1.58 4QE 48,674 30,634 10,218 20,416 15,364 0 2,676 -20,360 28,315 -11,828 -4,624 -7,204 -1,028 16,487 17,515 20,924 1,068.8 506.0 425.4 1,089.0 0.0 16,547 -3,515 -85 12,947 14,676 1.77 1.37 1.55 78,932 63,310 18,554 44,756 8,308 4,753 2,561 -30,873 48,059 -21,952 -7,797 -14,155 -1,770 26,107 27,877 32,812 1,676 2,759 1,182 346 1 29,013 -5,125 -78 23,810 24,224 3.14 2.54 2.59 102,863 80,669 24,082 56,587 17,468 0 4,726 -41,631 61,232 -24,818 -7,993 -16,825 -2,829 36,414 39,243 47,090 2,327 1,886 1,618 2,793 0 36,216 -7,108 -302 28,806 32,002 3.90 3.06 3.40 143,294 102,627 32,859 69,768 31,064 0 9,603 -60,360 82,934 -31,699 -10,989 -20,710 -3,428 51,235 54,663 66,084 2,794 2,024 2,022 4,356 0 49,674 -10,499 -340 38,835 44,358 5.31 4.10 4.68 177,416 117,041 38,836 78,205 49,980 0 10,395 -74,020 103,396 -39,056 -13,790 -25,265 -4,114 64,340 68,454 81,310 3,547 2,024 1,702 4,356 0 63,854 -13,416 -340 50,098 57,015 6.82 5.28 6.01 221,916 130,208 44,566 85,642 80,456 0 11,252 -89,625 132,291 -47,437 -17,025 -30,413 -4,936 84,853 89,790 104,284 4,228 2,024 1,702 4,356 0 85,048 -17,764 -340 66,944 74,685 9.09 7.06 7.88 58.2 37.2 39.5 46.9 28.6 32.6 58.1 36.1 38.3 45.4 28.5 32.3 58.2 33.9 36.0 43.0 26.6 30.2 60.9 33.1 35.3 41.6 30.2 30.7 59.5 35.4 38.2 45.8 28.0 31.1 57.9 35.8 38.1 46.1 27.1 31.0 11.6 10.4 7.2 8.2 8.4 7.3 8.4 7.3 7.0 6.7 3.5 5.1 6.6 5.8 6.6 5.8 4.8 5.0 -1.4 -1.0 -2.3 -2.0 -2.3 -2.0 30.6 47.2 53.8 50.5 53.6 42.0 53.1 41.5 30.3 27.4 40.8 24.8 21.0 32.1 20.5 31.6 39.3 35.4 39.3 37.2 34.8 38.6 33.7 37.5 58.3 36.3 38.6 45.8 28.2 32.1 1.18 23.8 24.7 25.2 28.5 29.0 28.5 29.0 28.5 59.6 38.2 40.5 47.0 30.2 33.7 1.52 25.1 27.9 31.2 33.2 33.6 31.0 33.6 31.0 Source: Company data, Credit Suisse estimates 20 July 2016 27 20 July 2016 Appendix II: List of recent investments Figure 44: Major M&A/investments since 2015 Company Target Deal date Invest amt % of Sector (US$ mn)* ownership Notes Tencent Tencent Tencent Tencent Tencent Tencent UCMed Yitiku Chengmi Nanjing line 0 BitAuto YiXin Capital Jan-15 Jan-15 Jan-15 Jan-15 Jan-15 Jan-15 24 3 2 30 150 150 NA NA NA NA 3.3% 26.6% Healthcare Education O2O O2O Auto Auto Tencent Tencent Tencent Tencent Tencent Tencent Tencent ele.me Jan-15 carlife Jan-15 Huakai Feb-15 1jiajie Feb-15 M4JAM Feb-15 Miniclip Feb-15 Robot Feb-15 Entertainment Gangtai Mar-15 Ning Meng Pictures Mar-15 Cyanogen Mar-15 Dianping.com Apr-15 58.com Apr-15 350 1 10 400 NA NA NA NA NA NA NA NA NA NA O2O Auto e-commerce O2O Corporate service Game Game Start-up focusing on mobile hospital service Local life recommendation app strong player in online education market A popular APP for online food delivery Online auto platform Subsidiary of Bitauto engaged in e-commercerelated automotive financing platform business A leading player in O2O food ordering market Online auto price comparison website A flower related e-commerce start-up company A leading housekeeping service O2O platform A South Africa-based mobile job service A leading game developer in Switzerland A western game company NA 16 80 850 400 NA NA NA NA 25% O2O Media Mobile Internet O2O O2O Jewellery e-commerce and entertainment A TV production start-up focused on internet A leading open-source operating system Well known online local life list site To form the largest classified site in China EC Yingtongke Weiying Technology Glu Mobile Scanadu Scout Huan network Pocket Gems Huitong Tianxia Huochebang Tissue Analytics VC mobile Entertainment Lyft Yinyuefm.com Apr-15 Apr-15 NA NA 105 NA Corporate service Media Player in mobile CRM system market A top online movie ticket app in China Apr-15 Apr-15 May-15 May-15 May-15 May-15 May-15 May-15 126 35 8 60 30 16 0.75 4.5 Game Healthcare Media Game Logistics Logistics Healthcare Game A game developer based in San Francisco A medtech building mobile medical products A subsidiary of TCL focusing on internet TV A popular US mobile entertainment company A strong player in online logistics platform A leading O2O logistics firm A US-based wound care start-up Producing and publishing games for iOS and Android May-15 Jun-15 150 NA 2 NA O2O Media Jun-15 Jun-15 Jun-15 Jun-15 Tencent Tencent Tencent MJBang Fengkuang Laoshi NEXTEV Mascotte Holdings Limited U-Xian HomeHero Maimaibao A ridesharing service company A music app enabling users to listen, share pictures and content An O2O interior design platform A mobile education app for ages K-12 A producer of electric vehicles, China's Tesla O2O provider in property management Jun-15 Jun-15 Jul-15 10 NA 20 NA NA NA Tencent Tencent LY.com Didi Kuaidi Jul-15 Jul-15 390 NA 2000 NA Online Travel O2O A menu preview and ordering service app A player in home senior care services market A leading mobile commerce site focusing on 3-4rd tier cities and factory towns The third-largest player in online travel market The largest car-hailing app in China Tencent Tencent Tencent Tencent Meike International 1Jiajie Yingle.com AltspaceVR Jul-15 Jul-15 Jul-15 Jul-15 136 16 1.6 10.3 e-commerce O2O O2O Corporate service A manufacturer and trader of sporting goods Strong player in online housekeeping market A Chinese O2O legal service provider A virtual reality software company Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent 1 20 16 96.74 14.60% NA 7.14% 20% NA NA NA NA NA NA NA 75% 25.30% NA NA NA O2O Education Auto Solar O2O Healthcare e-commerce Tencent Holdings (0700.HK / 700 HK) 28 20 July 2016 Figure 44: Major M&A/investments since 2015 Company Target Deal date Invest amt (US$ mn)* Jul-15 1.6 Aug-15 10 Aug-15 1 Aug-15 85 Aug-15 NA Aug-15 60 Aug-15 90.0 % of ownership NA NA NA NA NA NA NA Sector Tencent Tencent Tencent Tencent Tencent Tencent Tencent Magic Wi-Fi MemBlaze PPYX Renren che eLong Futu Practo Hardware Hardware Social network Auto Online Travel Internet Finance Healthcare Tencent Tencent Tencent Tencent Tencent Tencent Tencent Aug-15 Aug-15 Aug-15 Aug-15 Aug-15 Aug-15 Sep-15 206 50 8.1 1.6 630 10 16 8% NA NA NA NA NA NA Media Social network Media Corporate service O2O Software Media Tencent Tencent Tencent Tencent Tencent Tencent Huayi Brothers Kiki 51yund.com Nanjiquan ele.me Vurb Original Force Animation Medlinker Tiantian Paiche Clinicloud Guahao Artillery Gbcom Sep-15 Sep-15 Sep-15 Sep-15 Oct-15 Oct-15 40 73 5 394 NA 2 NA NA NA NA NA 3% Healthcare Auto Healthcare Healthcare Game Mobile internet Tencent Zhihu Nov-15 55 NA Tencent Tencent Nov-15 Nov-15 31 NA 235 NA Tencent Tencent Tencent Tencent Tencent Missfresh Weiying Technology Guahao China Postal Bank Women.com Lufax Meituan Dianping Nov-15 Dec-15 Jan-16 Jan-16 Jan-16 Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Koolearn.com Parkbees Ibibo Group ABC360 Ningmeng Pictures Soyoung.com "who" app HB Entertainment Yuanbaopu Wesai Xiaohongshu Huoyunren Lianjia.com Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent iCarbonX budejie.com 56QQ Kamcord Weiyingshidai Shuidihuzhu Wocloud Yingle.com Notes Social network China's largest Free Wi-Fi provider in industrial Designs and manufactures solid-state drives An SNS app for sharing personal stories increased collective investment in auto market Privatisation proposal from Tencent China's leading internet securities trader A marketplace/ search portal that connects patients with doctors and medical organisations China’s largest private-sector film company Leading messaging application in Canada An O2O platform for sports community Provide HR, entrepreneurship services A leading player in O2O food ordering market A mobile search engine app An animation studio focusing on digital entertainment content making A mobile commination platform for physicians A used car C2B auction platform An Australian start-up An online medical service provider in China A Wireless Broadband service provider PC Game Developer Artillery is a California-based free-to-play developer A Chinese question-and-answer website e-commerce Media An online grocery retailer A top online movie ticket app in China 300 1% NA NA 1.75 NA 1216 NA 3300 NA Healthcare Internet Finance Social network Internet Finance O2O An online medical service provider in China China's largest commercial bank A social networking site for females A comprehensive internet finance platform Largest O2O platform in China Feb-16 Feb-16 Feb-16 Mar-16 Mar-16 Mar-16 Mar-16 Mar-16 Mar-16 Mar-16 Mar-16 Apr-16 Apr-16 50 NA 12 NA 250 NA 15.3 NA 76 NA 50 NA 1.5 NA 36.3 NA 15.3 NA NA 100 NA 45 NA 923 NA Education O2O Online Travel Education Media Healthcare Social network Media Internet Finance Sport eCommerce Logistics Real estate New Oriental's online education platform Car parking apps India's leading online travel group Online language course company Shanghai-based boutique studio firm O2O surgery appointment reservation platform Social network application Korean media company Internet finance big data service platform Online ticketing platform for sports tickets Cross border eCommerce platform Logistics data provider O2O real estate agency Apr-16 Apr-16 Apr-16 Apr-16 Apr-16 May-16 May-16 May-16 153 NA 1.5 NA 35 NA 10 NA 462 NA 7.7 NA 0.2 NA 1.53 NA Healthcare Entertainment Logistics Game Media Healthcare Cloud Cloud Health and medical big data company Mobile content production and distribution platform Truck O2O platform US-based mobile game video recording SDK Online movie ticketing platform Insurance platform One-stop mobile internet VAS service provider Legal services O2O platform Tencent Holdings (0700.HK / 700 HK) 29 20 July 2016 Figure 44: Major M&A/investments since 2015 Company Target Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Tencent Planetary Resources Paradox Interactive Yuantiku Fun in Funding YG Entertainment Sipaiwangluo Yichemall Meta WME IMG Entstudy Supercell Deal date Invest amt % of Sector (US$ mn)* ownership May-16 20.73 NA Cloud Notes May-16 May-16 Jun-16 Jun-16 Jun-16 Jun-16 Jun-16 Jun-16 Jun-16 Jun-16 Swedish game publisher Online tutoring platform Social crowd funding platform Korea's leading talent agency Cancer big data company Auto O2O platform AR technology company Entertainment and sports agency An online platform for K12 education A leading global mobile game developer NA 40 NA 20 NA 85 NA 10 NA 50 NA 50 NA 45 NA 18.5 NA 8,600 84% Game Education Internet Finance Entertainment Healthcare Auto Hardware Entertainment Education Game Asteroid mining company Note: * Investment amount in some cases refers to the aggregate amount invested, as it is difficult to derive the exact portion invested by each company. Source: Company data, Credit Suisse research Tencent Holdings (0700.HK / 700 HK) 30 20 July 2016 Companies Mentioned (Price as of 18-Jul-2016) 58.com Inc. (WUBA.N, $47.76) Alibaba Group Holding Limited (BABA.N, $82.65) Alphabet (GOOGL.OQ, $753.2) Amazon com Inc. (AMZN.OQ, $736.07) Baidu Inc (BIDU.OQ, $164.79) Bitauto Holdings Limited (BITA.N, $27.96) Changyou.com Ltd (CYOU.OQ, $21.03) Facebook Inc. (FB.OQ, $119.37) Google (GOOAV.OQ, $568.67) Kingsoft Corporation Limited (3888.HK, HK$13.28) NetEase.com (NTES.OQ, $199.43) Netflix, Inc. (NFLX.OQ, $98.81) SOHU.COM INC. (SOHU.OQ, $39.53) Supercell (Unlisted) Tencent Holdings (0700.HK, HK$185.0, OUTPERFORM, TP HK$230.0) Twitter (TWTR.N, $18.65) Westhouse Hldg (WHL.L^B13, 9.5p) Disclosure Appendix Important Global Disclosures Evan Zhou and Zoe Zhao each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. 3-Year Price and Rating History for Tencent Holdings (0700.HK) 0700.HK Date 26-Sep-13 16-Jan-14 15-May-14 08-Aug-14 11-Aug-14 13-Nov-14 19-Mar-15 11-May-15 05-Aug-15 13-Aug-15 10-Nov-15 14-Jan-16 15-Feb-16 18-Mar-16 19-May-16 Closing Price (HK$) 81.80 102.50 108.80 129.80 132.30 129.50 145.00 158.60 142.40 144.10 150.40 137.10 138.20 157.90 157.20 Target Price (HK$) 88.00 123.80 650.00 130.00 155.00 150.00 160.00 190.00 180.00 175.00 179.00 173.00 176.00 185.00 190.00 Rating N* O N EU T RA L O U T PERFO RM * Asterisk signifies initiation or assumption of coverage. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected tota l return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Pr ior to 18 Tencent Holdings (0700.HK / 700 HK) 31 20 July 2016 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5% , which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cov er multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is: Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 51% (43% banking clients) Neutral/Hold* 35% (17% banking clients) Underperform/Sell* 13% (38% banking clients) Restricted 1% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdin gs, and other individual factors. Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-andanalytics/disclaimer/managing_conflicts_disclaimer.html Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. Target Price and Rating Valuation Methodology and Risks: (12 months) for Tencent Holdings (0700.HK) Method: Our TP HK$230 implies 33.4x FY17E dil. Adj. P/E. This includes (1) internet finance business value of HK$24.2, and (2) core business value of HK$205.8/sh implies 29.9x FY17E and 22.8x FY18E P/E. With Tencent's long-term potential in internet finance, social ads and other O2O opportunities, we see 25% growth rate is sustainable. This supports our OUTPERFORM rating. Risk: Risks that could impede achievement of our HK$230 target price and Outperform rating for Tencent Holdings include slower-thanexpected online games revenue growth and further delays in social ad launch. Risks also include: (i) slower WeChat user growth, leading to lower long-term growth expectations, and (ii) slowdown in both PC and mobile games. Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names The subject company (BIDU.OQ, BABA.N, AMZN.OQ, FB.OQ, NFLX.OQ, NTES.OQ, 3888.HK, CYOU.OQ, SOHU.OQ, WUBA.N, BITA.N) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (BABA.N, FB.OQ, 3888.HK, CYOU.OQ, SOHU.OQ, WUBA.N, BITA.N) within the past 12 months. Tencent Holdings (0700.HK / 700 HK) 32 20 July 2016 Credit Suisse has received investment banking related compensation from the subject company (BABA.N, FB.OQ, 3888.HK, CYOU.OQ, SOHU.OQ, WUBA.N, BITA.N) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (BIDU.OQ, BABA.N, AMZN.OQ, FB.OQ, NFLX.OQ, NTES.OQ, 3888.HK, CYOU.OQ, SOHU.OQ, WUBA.N, BITA.N) within the next 3 months. As of the date of this report, Credit Suisse makes a market in the following subject companies (AMZN.OQ, FB.OQ, NFLX.OQ, SOHU.OQ, GOOGL.OQ). As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (3888.HK). Credit Suisse beneficially holds >0.5% long position of the total issued share capital of the subject company (GOOGL.OQ). Credit Suisse has a material conflict of interest with the subject company (BABA.N) . Credit Suisse acted as the exclusive financial advisor to Alibaba Group in relation to its investment in Snapdeal.com. Credit Suisse is the financial advisor to Alibaba Group Holding Limited’s acquisition of a controlling stake in Lazada Group S.A.” Credit Suisse has a material conflict of interest with the subject company (FB.OQ) . Credit Suisse has been named as a defendant in various putative shareholder class-action lawsuits relating to Facebook, Inc.’s May 2012 initial public offering. Credit Suisse’s practice is not to comment in research reports on pending litigations to which it is a party. Nothing in this report should be construed as an opinion on the merits or potential outcome of the lawsuits. Credit Suisse has a material conflict of interest with the subject company (BITA.N) . Credit Suisse is acting as financial advisor to Bitauto Holdings Ltd in relation to the investments by JD.com, Inc and Tencent Holdings Ltd in Bitauto. For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.creditsuisse.com/disclosures or call +1 (877) 291-2683. For a history of recommendations for the subject company(ies) featured in this report, disseminated within the past 12 months, please refer to https://rave.credit-suisse.com/disclosures/view/report?i=237072&v=2o2mvbt2jdrlg9en7aayicfby . Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events. Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit https://www.creditsuisse.com/sites/disclaimers-ib/en/canada-research-policy.html. Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (0700.HK, BABA.N, FB.OQ, 3888.HK, WUBA.N, BITA.N, GOOGL.OQ) within the past 3 years. As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. This research report is authored by: Credit Suisse (Hong Kong) Limited ....................................................................................................................................... Evan Zhou ; Zoe Zhao To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse (Hong Kong) Limited ....................................................................................................................................... Evan Zhou ; Zoe Zhao For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.creditsuisse.com/disclosures or call +1 (877) 291-2683. 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