Tencent Q1 18 – Expectations management

Reply to this post

Bad guidance is worse than no guidance at all.

• Tencent reported Q1 18 results that beat expectations but increased my concern that Tencent has a problem with managing investor expectations which has arguably already cost the company $60bn.
• Q1 18 revenues / net profit were RMB73.5bn (up 43% YoY) / RMB23.4bn compared to consensus at RMB71.0bn / RMB17.5bn.
• Net profit was boosted by non-operating gains, but gross margins were also comfortably ahead at 50% compared to consensus expectations at 47%.
• The improvement in margin has come from the operating leverage effect of selling greater volumes of digital content as well as an increasing proportion of content being developed in house.
• While these are excellent results, confirming my view that Tencent remains the biggest and strongest of all the Chinese digital ecosystems, they call into question its ability to manage expectations.
• At the Q4 17 results, Tencent spooked investors by stating that it would be sacrificing short-term margins in order to pursue long term gains.
• While there is nothing wrong with this strategy, it spooked the immediate-term obsessed market and cost Tencent $90bn of its capitalisation.
• Three months later it confounds those expectations leading to a $30bn increase in the value of the company but it still remains some $60bn adrift.
• There is nothing in these results that appears to be a great surprise or something that management could not have predicted when it gave its outlook for the coming periods.
• I think that if Tencent had been more explicit about what, where and when in terms of long-term investments at the Q4 17 results, then the valuation of the company would be materially higher than it is today.
• What the market hates more than anything is volatility and uncertainty and I have long believed that unless a company has very good visibility it is often better to give no guidance at all.
• This is because continually missing guidance in both directions gives the impression that the business is not fully under management control, thereby increasing the risk that something goes badly wrong before management notices and can take action.
• I think that this the main reason why Tencent’s valuation is now $60bn lower than it was at the beginning of this year.
• Despite this, Tencent remains in a strong position domestically as it has by far the strongest position on the Chinese Digital Life Pie and is doing extremely well by selling content and games.
• When it comes to ecosystem monetisation Tencent has only just begun to scratch the surface and its strategy to drive engagement in other activities through Weixin / WeChat is going well.
• Hence, Tencent remains one of my favourite ecosystem globally despite my concerns that it has a lot of work to do both in AI (see here) and expectations management.