We have raised Tencent’s fair value estimate by 16% to HKD 800 per share or USD 103 and think the shares are undervalued. The upgrade is due to us lowering our WACC to 8.4% from 9.8% as we upgrade its average systematic risk to equity (cyclicality) from average to below average, mitigated by the 7 percentage points lower fintech revenue five-year CAGR amid new regulatory measures. We conservatively assume the anti-trust fine by the government to be CNY 18 billion this year, this would reduce operating profit for this year by 12%. We think these changes are not significant enough to threaten its wide moat and stable moat trend, as Tencent’s network effect–the strongest moat source that tends to be self-reinforcing as per our methodology–remains strong with its Weixin user base of 1.2 billion.
The financial regulators requested for a reform of the fintech businesses of Tencent, Baidu, JD.com and Trip.com, among others. This is well expected after Ant Financial was requested to conduct a reform, in our view. Fintech businesses will be regulated as other financial institutions in China. We think the financial products of these companies will need to be separated from their main apps, reducing the conversion rate. This should bode well for bank apps. Fintech business is much more important for Tencent compared to the rest of these four companies we cover. We expect the base case valuation impact of the new fintech regulations on Tencent to reduce our fintech revenue CAGR estimate from 2019 to 2024 to 14% from 21% previously, same as the reduction for Ant Financial.