Tencent reports unexciting 3Q results

Tencent’s shift from a PC to mobile platform is taking longer and costlier than expected.

Here's from OSK=DMG:

Tencent announced its 3Q12 results yesterday after market close. Revenue came in at Rmb11.57bn (+54.3% y-o-y); 2% above OSK and in line with consensus, while net profit (GAAP) of Rmb3.22bn (+31.6% y-o-y) was 6% and 3% below OSK and street respectively. Non-GAAP net profit of Rmb3.54 (+31.3% y-o-y) was in line with OSK and consensus.

As expected, online games was the main driver of growth in 3Q12, up 43.9% y-o-y on improving ARPU. Advertising revenue was strong (+69.0% y-o-y), but lower than OSK forecasts of 89.2% y-o-y. However, this was offset by stronger e-commerce revenue growth of 32.2% q-o-q.

Consistent with our view, Tencent’s transition from a PC to mobile platform is taking longer and costlier than expected as shown in its much weaker 3Q user base growth q-o-q. Our EPS estimates edges down by 1-3% for FY12-14 on slower ad growth and higher costs, resulting in our DCF-derived TP falling slightly to HKD207 (from HKD210), and implying a PEG of 1.1x (peers: 0.5x). Maintain Sell.

Games business will remain near term growth driver. We believe Tencent’s online games segment, which accounted for 52% of 3Q12 revenue, will continue to be its core revenue driver. The company’s top three games, Crossfire, DnF, and League of Legends are the leading games in China, while its new in-house developed games such as Legends of Yulun are also making good progress. However, we believe this growth could be offset by weaker online ad revenue, which will subdue amid China’s slowing economy, and flat MVAS revenue growth amid a shrinking industry. Tencent’s e-commerce unit, however hand, remains a wild-card as its high growth from a small base could be hampered by potential price-wars.

Transition to mobile hitting a snag. We still hold the view that Tencent’s mobile initiative will take longer than expected as China’s mobile internet development is still in its early stages. Rightly so, we saw weaker growth in Tencent’s overall user base and daily usage, which we attribute to: i) cannibilisation between PC and mobile users and ii) lack of similar services provided on the mobile platform. Further, we also saw weaker operating margins in 3Q12 (34.0% vs. 3Q11: 38.1%) from i) increasing revenue contribution from lower margin e-commerce business and ii) higher spending on mobile and e-commerce.

Unexciting results. Maintain Sell. We believe Tencent’s latest results offered no surprises as strong growth in games and ad was well expected. In fact, analyst downgrades to GAAP earnings are likely on the back of further margin deterioration in our view. On the back of our 1-3% earnings downgrades, we slightly lower our TP to HKD207 from HKD210, which is derived from our DCF valuation assuming WACC: 13.5% and terminal growth at 2.0%. Maintain Sell.