Robert Hsu has been running this teaser ad for his Asia Edge newsletter for a week or two now, and I’ve gotten enough questions that it seems there’s some demand for the Gumshoe version (ie, the free version) of the answer.
It seems unlikely, by the way, that this tease about the “Facebook of China” is actually coming out at roughly the same time that the arguably more real “Facebook of China” is filing to go public — the tease is about an older company that’s in a different sort of social networking niche, arguably, but, in case you’re curious, what most folks think of when they think of China’s Facebook (Facebook itself was effectively kicked out of China for being too hard to censor) is a company called Renren. More about Renren here if you’re curious, but they’re not yet public so they’re obviously not Robert Hsu’s “next Facebook” that he thinks will double your hard-earned dollars.
So … who is? Well, for that we’ve got to scour Hsu’s clues:
“A little-known Chinese juggernaut whose $2 billion in revenues are growing three times faster than Facebook’s…
“Whose social networking site already claims 600 million paying members…
“Whose publicly traded stock has handed investors 300% profits in two years and is on track to deliver another 50% gain in the next 30 days…”
It may not have jumped out at you, but $2 billion in revenue is huge for a Chinese internet company — that’s almost twice the revenue that Baidu (BIDU), the mega “Chinese Google” reported over the last four quarters, and Baidu is a $40 billion company, the biggest US-listed Chinese internte stock by far, unless you want to include the telecoms like China Mobile.
But this isn’t BIDU, of course, or China Mobile (CHL — which had, by the way, $70 billion in revenue over the last year). No, it’s someone else … and really, in this space there’s only one other “someone else,” but in case you don’t know them I’ll keep the suspense going for a moment while we peruse some more clues:
“China’s Facebook, on the other hand, derives only 12% of its income from ad sales while the balance of its $2 billion in annual revenues comes from subscription-based “Internet value-added services….”
“You see, while millions of users have flocked to Zuckerberg’s Facebook because it was free from the beginning, its users expect it to be free for the rest of their lives and will stage an Internet strike if management ever decides to charge for their service.
“China’s homegrown social networking website, on the other hand, doesn’t have the problem, as it has never been free—which is why its revenue is growing three times faster.”
Aha, so … 12% of income from ad sales. What else?
“… highly profitable subscription-based model that’s only free for a limited period of time. After that, you’re on a recurring revenue cycle that hardly anyone cancels—just like your monthly subscription to cable TV.”
“Our time-proven indicators show that the company is set to repeat its 55% quarterly revenue growth when it declares earnings March 13th.”
“… this company, with its long telecom roots, has been making money for investors since 1998—when Zuckerberg was in high school—all thanks to its highly popular subscription-based Internet Messaging, Chat and Gaming services….
“during the third quarter of 2010, the company’s revenues increased 55% over the year before, while gross profit jumped 68%—thanks to increased popularity of mobile social games and a huge jump in membership.”
Well, I don’t really know what Facebook is worth — I continue to use it on occasion, and to completely ignore the advertising that pays their bills, so I have my doubts about their ability to ever be a high margin business … but certainly having the most popular website in the world, which seems their likely position for a while now, has to be worth a lot.
But I can tell you that I’m almost certain that Robert Hsu here is teasing Tencent, which is indeed the biggest ($46 billion market cap, a little bit bigger than Baidu) and probably least-well-known Chinese internet company for US investors.
That is, of course, because it trades primarily in Hong Kong at ticker 0700 — you can also buy it pretty easily through the pink sheets at TCEHY, where volume and pricing tends to be decent for small investors as long as you’re not intending to trade in and out much. Do remember, if you ever trade this one, to rely on the Hong Kong closing price for the “real” price and do your currency conversion to set fair limit prices.
Now, why do I say “almost certain?” Because Hsu included a couple clues that don’t match — they could be intentional errors to mislead your friendly neighborhood Gumshoe, they could be actual mistakes, or they could mean that there’s some other multi-billion dollar Chinese internet company that I’ve never heard of. I think the first two are more likely, and I’m pretty sure I’m right about this being Tencent, but I can’t tell you that I’m 100% certain this time because of those odd clues.
The $2 billion in revenue is right on — including a solid third quarter of $780 million in revenue. The third quarter also brought a 55% revenue increase over the 2009 Q3, so that’s a match (and a 12% sequential increase from Q2, just FYI — and revenue has just about doubled from 2008 to 2010).
The 12% from advertising? That’s not the case for Tencent, at least in the last quarter — Tencent’s Q3 included $57 million in online advertising revenue, less than 10% of the total, and, though the number is growing, a shrinking piece of the overall revenue pie, the ad revenue particularly took a hit from the prior quarter, when World Cup revenue poured in.
And how about the teased 68% gross profit growth number? Yeah, that’s not true either — but interestingly enough, it is close typographically if not numerically. Here’s how the Tencent press release for their third quarter results reads:
“Gross profit was RMB3,550.1 million (USD529.8 million), an increase of 11.4% QoQ or an
increase of 51.4% YoY. Gross margin decreased to 67.9% from 68.2% last quarter”
So the profit growth number was 51.4%, which doesn’t sound as impressive because it’s failing to keep up with sales growth … but you can see how a quick read from a harried copywriter would get you 68% for that number instead. I don’t know if that’s what happened, just guessing.
And the earnings? No, they’re not coming out in March 13 — that’s a Sunday. They are coming out on March 16, so, like I said, either they’re being sneaky, I’m wrong, or they’re making a lot of errors.
Given the huge size of this company, with $2 billion in sales for the last four quarters, I can’t see how it can be anything other than Tencent … but given the odd clue matches I have to leave some room for error. Should you be buying Tencent here?
Well, Tencent is certainly the most profitable big “social networking” company in China — but their social networking is not “Facebook” style, it’s largely online social games and chat, they make most of their money from “value added services” both online and through mobile phones, relying largely on their QQ instant messaging platform that is the source of most of their users. They’ve had their struggles in the past, particularly with competition and government regulation and with being locked out or undercut by the big mobile phone companies, but they have been around for a long time (the 1998 part is a match for the clues), and they are very profitable.
This year might shape up to be somewhat expensive and challenging, particularly as Tencent has to invest more heavily in security — they had a big malware problem, and their huge user base, there are now 636 million users of their QQ IM platform, is arguably one of the most compelling hacker targets in the country. They also face the problem — albeit a nice one — that their biggest sales division, Internet Value Added Services (IVAS), which is where there social offerings and online games live, is so huge that the law of large numbers is hitting them, it’s hard to grow that revenue.
Tencent always has several new initiatives going on, in recent years they’ve also tried to build out their own search engine and advertising platform, build what was a bulletin board-based community at QQ.com into a major media site, and developing newer, more advanced, and stickier games to compete with the hordes of casual gaming companies in China … and keep their users inside their system for as long as possible. They have great leadership from Pony Ma, and they used to have me as a shareholder, which I’m sure made them terribly proud (it makes me terribly embarrassed — I sold for something like a 100-200% gain years ago, it has since gone up about 1,000% more. Arg).
If you’re interested in Facebook, incidentally, there’s also another (expensive) global internet company with both a Facebook and a Tencent connection — the South African newspaper and cable media company Naspers (they gave up their Nasdaq listing with Sarbanes Oxley, now traded at NPSNY on the pink sheets) was an early investor in Tencent and still owns a sizeable chunk of the company, and they also own a big piece of Mail.ru (now Digital Sky), which owns chunks of Groupon, Facebook game maker Zynga, and about 2% of Facebook itself. And yes, I also sold Naspers shares years ago for far less than they’re trading at now. Double arg.
So … Tencent has grown like gangbusters for the past decade, and has a huge installed user base with at least some “stickiness” and loyalty. Of course, that might not mean as much in the internet age as it did 20 years ago (just ask AOL), but they have so far managed this business very well, with continuing flexibility, innovation, and user growth. They even pay a teensy weensy dividend (less than a quarter of a percent, don’t get excited) … but, as I said, they’re also dang expensive, so you have to be pretty sure that they’ll keep the growth engine rolling, and that their margins won’t suffer too much as revenues climb.
What’s the valuation now? For 2009 they reported $755 million in profit, and for the last four quarters (4Q09 through 3Q10) the total profit reported was $1.086 billion, so they’re definitely making money. The market cap is right around $46 billion, so that means the shares are trading for a trailing PE of roughly 45. That’s cheap compared to BIDU (trailing PE 78), but expensive compared to almost anyone else of that size — though the much smaller Sina (SINA), which used to be thought of as the “Chinese Yahoo,” now runs what folks are calling the “Chinese Twitter” (Sina Weibo), and also trades at about 40X 2010’s earnings (SINA was also teased recently, by Nicholas Vardy back in November for good gains so far). I should also note that Hsu has also teased Tencent at least once before, last June when the shares were around $20 (they’re at about $25 now).
Are you interested in Tencent for your hard-earned investing dollars? I obviously can’t answer that question for you, and I’m probably bitter about selling this stock far too early — but you can answer it for all of us, whaddya think? Just use the little comment box below to share your thoughts.