Tencent's game unit likely recorded strong growth

Net profit possibly jump more than 50%, says OSK-DMG.

Tencent is due to announce its 3Q12 results on 14 November 2012, and OSK-DMG expects revenue and non-GAAP net profit to come in at Rmb11.34bn (+51.2% y-o-y) and Rmb3.58bn (+33.3% y-o-y) respectively.

Here's more from OSK-DMG:

Our net profit and EPS forecasts are 3-4% above Bloomberg consensus (as of 6 November 2012).

While no major game titles were released during 3Q12, and we are seeing lower activity from core games, Crossfire and Dungeons and Fighter (DnF), we believe online games revenue could be supported by League of Legends (LoL), which is gaining traction both domestically and overseas.

3Q12 results should be strong from online games, but we fail to justify Tencent’s current valuation of 24.5x FY13F PE and PEG (3yr CAGR) of 1.0x, significantly above its peers average of 13.0x and 0.6x respectively. Development in WeChat has made positive progress in subscribers, but we are doubtful on monetization potential. Maintain SELL with unchanged DCF-derived TP of HKD210.

League of the Legend making headwinds. We note that activity for Crossfire and DnF (accounting for c.70% of online games revenue) was weaker in 3Q12, which we attribute to i) lack of in-game offers and updates, and ii) intensifying competition from new games and cannibalisation from Tencent’s LoL. On that note, we are however seeing strong player interest in LoL, which is now ranked 3rd by popularity in domestic internet cafés. We continue to believe LoL will be able to replace DnF as Tencent’s flagship massively multiplayer online games (MMOG).

WeChat becoming the new open platform. During last month’s Mobile Developer Conference in China, Tencent’s CEO, Mr. Pony Ma, noted the company's plans to extend its open-platform for PC into mobile. We are positive on this development as i) 3rd party applications are becoming more significant in China/Tencent’s platform, and ii) smart phone penetration is increasing rapidly. We note that user base for WeChat has grown significantly with over 200m subscribers in Sep-12 (from 100m in Mar-12). However, WeChat is still a free service. While we agree that mobile messaging platforms such as WeChat could profit from i) advertising, ii) game sales/game item revenue sharing, and iii) vendor fees from location-based services (LBS); we reckon the latter two will be harder to achieve success in China. This is because i) we believe China’s smart phone development is still in its early stages and users are still reluctant to spend heavily on mobile applications, and ii) China’s corporate market is much larger and segmented for LBS to be effective. We have not factored in any revenues from WeChat.

Essentially an overpriced games company. We are still cautious on the domestic advertising market but expect large platforms such as Tencent to benefit from the shift to online media and forecast online ad segment to grow 89.2% y-o-y for 3Q12. Mobile services (MVAS) segment should be weak as it is a sunset industry and we forecast 12.3% growth for the quarter. With over 55% of revenues derived from games, we believe the premium given to the counter for its mobile business is too rich as its online game peers are trading at between 5-9x FY13F PE. Maintain SELL.