Goldman Sachs released a research report on Thursday, stating that the bank had previously had a discussion with Tencent's Chief Strategy Officer, James Mitchell, and Tencent's investor relations team. According to Goldman Sachs, although Tencent faces short-term pressure in mobile advertising networks, media advertising, and fintech/business payment due to macroeconomic conditions, the accelerated growth in revenue from businesses such as gaming, video accounts, wealth management, and SaaS has largely offset this impact. $TENCENT (00700.HK)$ Goldman Sachs released a research report on Thursday, stating that the bank had previously had a discussion with Tencent's Chief Strategy Officer, James Mitchell, and Tencent's investor relations team. According to Goldman Sachs, although Tencent faces short-term pressure in mobile advertising networks, media advertising, and fintech/business payment due to macroeconomic conditions, the accelerated growth in revenue from businesses such as gaming, video accounts, wealth management, and SaaS has largely offset this impact.

Goldman Sachs stated that Tencent remains one of the most visible and sustainably profitable companies among China's internet giants. The bank has confidence in Tencent's management's clear strategies across its various business lines and maintains a buy rating with a 12-month target price of HK$464, representing an upside of 24.5% compared to the current stock price.

Using multiple growth and monetization strategies to boost profit margins

Goldman Sachs stated that Tencent continues to mitigate risks from macro challenges while achieving healthy revenue and strong profit growth by employing various strategies and leveraging monetization opportunities.

In terms of revenue, incremental advertising monetization levers include AI advertising technology and increasing the ad load of WeChat video accounts. In terms of payments, Tencent will continue to expand new use cases and consumption scenarios outside of its ecosystem, such as recent integration of WeChat Pay into the Taobao ecosystem.

In terms of gross profit, Goldman Sachs stated that Tencent's gross profit growth in the past few quarters has been 2-2.5 times higher than its revenue growth, primarily due to a shift in revenue structure, particularly the reduction in lower-profit entertainment live-streaming revenue. Meanwhile, the high-margin profit of incremental revenue (mini-games, WeChat video account fees, and WeChat advertising) will support the structural growth rate of gross profit to exceed revenue growth.

Goldman Sachs expects Tencent to achieve healthy year-on-year revenue growth while maintaining strong monetization capabilities in advertising, games, and other businesses. Specifically, Tencent has various growth levers in macro-dependent businesses such as advertising. Additionally, due to the continued shift in revenue structure towards high-quality revenue sources, the growth rate of gross profit will surpass revenue growth.

The game business continues to grow.

Goldman Sachs stated that Tencent maintains a consistent philosophy in game development and portfolio strategy. The company's game development philosophy has not changed, which allows studios to leverage their unique strengths, with different studios possessing different specialized skills. Tencent will continue to adopt a portfolio strategy in games, supporting commercial success by extending the lifespan of evergreen games, while expanding the boundaries of game development through investments in external studios.

In terms of evergreen games, there is still monetization potential for "Honor of Kings" as both the pay ratio and average revenue per user (ARPPU) of the game are relatively low. Goldman Sachs stated that there are differences and subsequent evolutions in player behavior between China and the West, with Chinese players gradually becoming more involved in shooting games, which happens to be Tencent's forte.

Goldman Sachs predicts that Tencent will continue to adopt a portfolio strategy, maintaining the long lifespan of evergreen games as the foundation for commercial success, while expanding the boundaries of game development through investments.

Enhancing advertising business with AI.

According to Tencent executives, the company's advertising technology upgrade is a multi-year process that will support continuous growth in click-through rates and revenue.

A research report states that Tencent's advertising business is still in the early stages of adopting AI and lags behind other global social media peers (the latter still achieve double-digit year-on-year growth in advertising revenue). The improvement of advertising technology will help improve customer data insights, thereby enhancing the precision of ad targeting.

Goldman Sachs believes that Tencent is still in the early stage of the advertising technology upgrade cycle and will simplify/automate the process of ad purchase and audience targeting through the adoption of AI. Click-through rates will increase, and advertisers will be able to easily create ad materials, ultimately leading to more advertising spending shifting towards Tencent's platform.

E-commerce business.

Tencent management expressed to Goldman Sachs that Tencent seeks to establish trust with merchants/suppliers, which is a long-term and continuous relationship with consumers. This trust relationship is a continuation of the success of WeChat and the content sector, where official accounts are built on the basis of a lasting relationship between creators and consumers.

The company stated that the infrastructure for the e-commerce business is in place, including payment infrastructure, API relationships through the mini-program ecosystem, logistics, and delivery solutions. Tencent has investments in high-end logistics company JD Logistics (JDL) and mid-end logistics company J&T.

Goldman Sachs predicts that Tencent will continue to build the necessary e-commerce infrastructure and ecosystem to support the long-term growth of Video Account and WeChat e-commerce advertising business, forming differentiated competition with existing competitors. In addition, Tencent has achieved monetization through e-commerce technology service fees.

Recovery of social network revenue growth.

Goldman Sachs stated that the growth of the company's social network segment has been limited in the past few quarters, mainly due to the decline in live streaming revenue. This part of the revenue will be adjusted by the third quarter of 2024 and future trends are expected to improve.

Among them, the trend of users paying for music and video subscriptions has increased, driving an increase in the number of subscribers and an increase in average revenue per user (ARPPU). At the same time, the growth of the mini game ecosystem brings in higher profit margin revenue. One of the most successful mobile games in the past 12 months was also released on China's mini game platform, as mini games have a higher installation inclination and good monetization effects. In addition, cooperation with original equipment manufacturers (OEMs) is carried out through revenue sharing.

Goldman Sachs believes that with the completion of the adjustment of live streaming revenue, Tencent's social network segment as a whole is expected to recover its growth. Supporting factors include net additions of healthy video and music subscription users and ARPPU expansion, as well as contributions from mini games.

Accelerate the return on investment.

The Tencent management team has expressed to Goldman Sachs that as more investments mature, Tencent is actively exiting mature investments to recover capital, fund potential share buybacks, distribute physical assets such as stocks to investors, or make more investments in China and other regions.

Goldman Sachs predicts that Tencent will continue to adopt strict discipline in its investment and divestment activities, maintaining a self-funded investment portfolio. Divestments and dividend distributions over the past few quarters have exceeded total investment, providing capital space for shareholder returns.

Monetizing generative AI.

The Tencent management believes that generative AI has three key enterprise-oriented application scenarios, including advertising technology, providing GPU cloud solutions, and training Tencent's own large language model (LLM). In addition, there are chatbots/personal assistants for consumer use.

In terms of advertising, the most prominent and highest return application is using GPU to improve click-through rate (CTR). Tencent has been focusing on this in the past 1-2 years and will continue to do so in the future.

As for chatbots for consumers, Tencent is interested in unlocking usage scenarios through digital assistants to perform services and transactions. The amount of incremental capital expenditure on AI may fluctuate on a quarterly/annual basis depending on the procurement of advanced GPUs.

Goldman Sachs predicts that Tencent will continue to lead the way in using AI as a growth accelerator, driving the growth of its existing businesses (including advertising, gaming, cloud, and social networks) and leveraging its internal large language model (Metaverse).

Editor/Somer