The DoD list, first published in 2021, forms part of an annual Section 1260H update required by the National Defense Authorization Act. It consists of companies operating directly or indirectly in the US that are believed to be engaging in providing commercial services, manufacturing, production or exports related to the Chinese military.
It is important to distinguish this list from the more stringent Non-SDN Chinese Military-Industrial Complex Companies (NS-CMIC) list, which includes companies owned or controlled by the Chinese military and providing related business services. The NS-CMIC list prohibits US investors from trading in these stocks and may impact a company’s operations in the US.
In contrast, inclusion on the S1260H list does not impose any direct restrictions on a company’s operations or stock ownership. The primary concern for investors is reputational risk, as well as the possibility that Tencent could be added to stricter lists in future.
In a worst-case scenario, if Tencent were to be added to the NS-CMIC list, it could impact its US-owned interests, most notably Riot Games (the maker of the popular game League of Legends) and its 40% stake in Epic Games (owner of Fortnite). However, these and other US interests contribute less than 5% of Tencent’s total revenue, with the majority of its operations concentrated in mainland China.
ESCALATION UNLIKELY
We don’t hold the view that this situation will escalate into full sanctions, given that Tencent’s likely services to the Chinese military (such as WeChat or Tencent Meeting – equivalent to WhatsApp or Microsoft Teams) are not considered highly sensitive.
Additionally, this is not the first instance of a major Chinese tech company being added to a US blacklist. In 2021, smartphone maker Xiaomi was similarly designated but successfully challenged the decision in US courts, leading to its removal from the list within a few months. Tencent may pursue a similar legal strategy to mitigate the impact of this designation.
Furthermore, just a day after Tencent’s inclusion on the so-called blacklist, the Office of the US Trade Representative – which negotiates trade issues on behalf of the US President – removed WeChat from the Notorious Markets List. This suggests that Tencent is not being systematically targeted, and we believe it is quite possible that, like Xiaomi, Tencent will be able to prove its case for removal from the list.
INVESTMENT CASE
We remain confident in our investment in Tencent (including our indirect investment through Naspers/Prosus) as we continue to see strong operational momentum across its platforms, as well as an attractive valuation – both in absolute terms and compared to global technology peers.
From an operational perspective, we estimate that at least 50% of Tencent’s business will grow revenue by more than 10% annually over the next few years, with profits growing even faster. The remaining business segments are more dependent on China’s broader economic growth and could benefit from potential stimulus measures expected in March.
After several years of fewer new online game licence approvals, 2023/24 saw a resurgence in approvals, placing Tencent in a strong cycle of domestic gaming revenue growth. New game launches and increased monetisation of older evergreen titles are driving this growth. Online gaming accounts for 30% of group revenue and an even larger share of profits due to its high margins.
Similarly, online advertising, which makes up 20% of Tencent’s revenue, is growing rapidly, fuelled by increasing monetisation of its short-video platform (similar to TikTok). The incremental revenue from this segment comes with high profit margins, further boosting overall profitability.
From a valuation perspective, we see significant upside in Tencent’s stock. At the time of writing, Tencent is trading at a forward price-to-earnings (P/E) multiple of just 15 times, while earnings are expected to grow at an average of nearly 20% annually over the next few years. By comparison, major US big tech firms trade at P/E multiples above 20 times, despite having slower expected earnings growth.
Moreover, Tencent’s valuation does not fully account for its vast investment portfolio, which includes stakes in Pinduoduo (owner of Temu), Spotify, Epic Games and Snap. Should these stakes be monetised over time, this would provide additional upside potential for investors.
