Here’s Why I Believe Tencent Stock is Fairly Valued

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It's been some time since I've covered one of the big Chinese companies. In the past I've spoken highly of Alibaba Group Holding Ltd (NYSE: BABA ), JD.Com Inc (ADR) (NASDAQ: JD ) and Baidu Inc (ADR) (NASDAQ: BIDU ). Now, it's my turn to have a look at Tencent Holding/ADR (OTCMKTS: TCEHY ) and Tencent stock.

Like most of the Chinese stocks, I would exercise caution when buying them given the Wild West nature of commerce over there, but, having said this, there's no denying their growth is attractive.

After a quick read of its first-quarter 2018 earnings release along with its annual report, here's what I like about Tencent stock.

It's So Much More than the Facebook of China

As my InvestorPlace colleague Luke Lango pointed out recently, Tencent isn't just the Facebook Inc (NASDAQ: FB ) of China.

"But Tencent is also much more than just China's Facebook," Lango wrote on May 18. "In many senses, it is also China's YouTube, China's Spotify Technology SA (NYSE: SPOT ) and China's Paypal Holdings Inc (NASDAQ: PYPL ).

"Plus, Tencent operates a red-hot online gaming business and an equally hot cloud business. Those businesses are also growing at robust rates."

Lango valued Tencent stock in the low- to mid-$60's, about 30% higher than where it's currently trading.

Rather than travel over the same path, I'm going to use my colleague's words from his above quote to make my own back-of-the-napkin valuation.

Keep an Eye on the 'Others'

Let's assume Tencent's value-added services (VAS) represent Netflix, Inc. (NASDAQ: NFLX ), Spotify and Activision Blizzard, Inc. (NASDAQ: ATVI ); its online advertising revenues represent Facebook; and its "others" revenue represents PayPal and, Inc. (NASDAQ: AMZN ).

Using the price-to-sales ratios of each of those companies, I ought to be able to come up with a reasonable estimation of its share price.

In Q1 2018, Tencent's VAS revenues were $7.5 billion [1 RMB = $0.16 U.S.]. Annualize that and you get $30 billion. The average P/S ratio of NFLX and ATVI is 10.

That suggests the VAS revenue, which accounts for 64% of Tencent's overall sales, is worth approximately $300 billion.

Do the same with online advertising and others and you get annual revenue of $6.8 billion and $10.2 billion respectively. Using the P/S ratios for Facebook, PayPal and Amazon, you get valuations of $84 billion and $58 billion for the two smaller segments of Tencent's business.

Together, the three segments are worth an estimated $442 billion.

What's Not Included

When buying a business, you're not just paying for the stock, you're also paying for the net debt and the investments in public companies.

In Q1 2018, Tencent finished the quarter with $1.9 billion in net debt. Add to that its ownership interests in public companies including (21%), which are valued at $34 billion at the end of March, and you come up with a total value of $478 billion.

Tencent's current market cap on the Hong Kong stock exchange is $493 billion, almost identical to the value above.

At first glance, you might conclude that Tencent stock isn't worth the mid-$60's like my colleague argues.

However, that doesn't take into account the fact Tencent's three operating segments are each growing by at least 33% or more a quarter. That changes the valuation in a hurry. Not to mention it's making 33 cents after tax on every dollar of revenue, up from 29% a year ago.

Bottom Line on Tencent Stock

I'll follow Tencent more closely now that I think it's fairly valued with good potential for growth.

From where I sit, Tencent's a buy if you're planning to hold for 3-5 years.

As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

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The post Here's Why I Believe Tencent Stock is Fairly Valued appeared first on InvestorPlace .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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