Facebook or Tencent?

Tencent's (TCEHY) (HKG: 0700) resounding second quarter results prove the stock is not only one of the best large-cap growth picks in China but perhaps the entire world. To snapshot the results; we saw 52.3% y/y revenue growth, and most notably a 34% percent jump in active user accounts on the WeChat platform - a service that already has 806 million active accounts.

Tencent is comparable to Facebook (FB), because of its flagship social media product WeChat - often called the 'Chinese Facebook.' Three years ago both companies sat at around $75 billion market cap, but now they are worth $359 billion and $246 billion respectively.
When looking at these companies three years ago, I expected Tencent to outperform Facebook.

Surprisingly this has not been the case. However, I believe Tencent's value will overtake Facebook with time, just like it overtook Alibaba (BABA) last week.

Tencent is a holding company, which means its primary business is buying controlling interest in already successful companies/technologies instead of developing its own.
Facebook or Tencent?
Image by Simon / Pixabay
The result of this is a revenue stream significantly more diversified than Facebook's - consequently more resistant to the risks of its sources of income.

Each year Tencent becomes more diversified, the minority income streams make up a larger percentage of the total.

Facebook, on the other hand, displays the opposite behavior. Every quarter Facebook gets more and more dominated by a single revenue source. Advertising represented 95.3% of Facebook's total revenue in 2015. Acquisitions have done little to change the core nature of its revenue.

Not only this, but the ad revenue itself is losing diversification. Facebook's desktop revenue has flat-lined and is declining; mobile ad revenue was the source of almost the entirety of growth from 2011 to the present.

As a business that often uses online advertising, my company has experienced this situation first hand. In many of our ad campaigns the click through was over 95% mobile. While mobile usage brings the benefit of convenience and accessibility, the conversion rate is not as good as with traditional desktop mediums.

Smart Insights finds conversions to be almost 4x better on desktops than on smartphones. This is important for businesses using the pay per view model where advertisers pay for exposure instead of click-through.

Digging deeper into the data we see that there are more layers to this onion. Not only is Facebook becoming dominated by mobile ad revenue, its desktop, and dual access MUA numbers are in full retreat. Once again, the entire growth of the business is due to a single revenue segment. Tencent, on the other hand, has a vibrant and diversified revenue stream, in which the minority sectors grow every year. The company is involved in online PC gaming, social media, e-commerce, and advertising.

Each of these segments is growing rapidly - most beating expectations in the 2nd quarter. One of the most important sectors going forward is online gaming, which grew 32% y/y - smartphone gaming almost doubled despite the competition this industry faced from "Pokemon Go" and "Overwatch". Tencent's "League of Legends" is still the most popular online PC game on earth, as it has been for half a decade. "Pokemon Go" and "Overwatch" have not passed the 'fad test' yet, and it is unclear if these new games will pose a real threat to League for years down the line.

Tencent has also acquired a new holding: Supercell, the producer of "Clash of Clans" and "Clash Royal".

Gaming is great, but the area where Tencent and Facebook are most comparable is social media. There are 7.1 billion people on earth, and these two companies serve 806 million and 1.7 billion respectively.

Facebook's user numbers are still growing, beating expectations for the second quarter. However, the vast majority of this new growth comes from low-ARPU developing nations where Facebook makes around $1.5 per customer, compared to over $10 in North America. WeChat is already operating primarily in developing countries, and it yet to fully benefit from the high ARPUs in the West. WeChat may see widening profit margins as it expands, while Facebook's margins begin to slow.

Conclusion:

Both internet companies are running the same race and are similar in market cap and revenue. But while it looks like Facebook is ahead now, I believe Tencent will catch up and eventually win the race.

Unless Facebook starts diversifying its revenue streams, Tencent is the most attractive of the two internet companies because it is more diversified throughout the tech industry while offering comparable levels of growth. It also will see widening profit margins as its operations expand into higher ARPU regions.

Published on Sep 6, 2016
By Will Matte
Will Matte is a skilled content strategist from Chattanooga, TN with over five years of experience. He specializes in creating high-quality copywriting that helps clients meet their business goals. Will spends the majority of his time creating content, driving user engagement and transforming websites into respected authorities in their fields. Visit him at www.willmatte.com

Copyrighted 2016. Content published with author's permission.

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