Better buy: Tencent vs. Alibaba

Tencent (OTC: TCEH.Y) and Ali Baba (NYSE: BABA), two of China’s biggest tech companies, recently released quarterly earnings reports that beat analysts’ expectations. Tencent’s revenue and adjusted profit increased by 29% and 28%, respectively. Alibaba’s revenue grew 34% per year while its adjusted profits grew 18%.

These impressive growth rates have not gone unnoticed: Tencent’s stock has risen by over 50% in the past 12 months, while Alibaba’s stock has risen by more than 40%. So, is either stock still worth buying near its all-time high?

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How does Tencent make money?

Tencent generates its revenues in four main businesses: online gaming, social media, digital advertising, and its financial technology and business services unit.

The online gaming unit, which generated 34% of its revenue in the last quarter, is home to the world’s largest video game publishing company. His best games include Honor of kings, Elite Peacekeepers, and PUBG Mobile.

The social media unit – which includes China’s leading messaging platform Weixin (known as WeChat overseas), its social media QQ, the video game streaming platform Huya (NYSE: HUYA), and other media services – generated 23% of Tencent’s revenue through value-added services. The combined monthly active users of Weixin and WeChat grew 6% per year to reach 1.21 billion.

Tencent’s online advertising segment, which generated 16% of its revenue, sells ads on Weixin / WeChat, QQ, its media platforms and its mobile advertising network. The financial technology and business services segment, which generated 26% of its revenue, is home to WeChat Pay, one of the two largest payment platforms in China alongside Alipay, backed by Alibaba; and Tencent Cloud, which ranks second in the Chinese cloud infrastructure market after Alibaba Cloud.

How does Alibaba make money?

Alibaba generates its revenue from four main activities: its core commerce segment, Alibaba Cloud, digital media and entertainment, and innovation initiatives.

Image source: Getty Images.

Alibaba’s main business unit, which generated 87% of its revenue and all profits in the last quarter, houses its Chinese e-commerce markets Taobao and Tmall; its cross-border markets (AliExpress, Tmall Global and Kaola); its business-to-business marketplace Alibaba.com; its Southeast Asian market Lazada; and its Hema supermarkets. The total number of annual active consumers in its Chinese marketplaces increased 2% to 742 million in the quarter.

Alibaba Cloud, which generated 8% of its revenue, is Asia’s largest cloud platform. Its digital media and entertainment unit – which hosts its music and video streaming services, mobile apps and film production unit – generated 4% of its revenue. The innovation initiatives segment, which produces side projects such as smart speakers and experimental applications, generated the remaining 1% of its revenue.

Which business is growing the fastest?

Tencent delivered double-digit revenue growth in its four segments in the last quarter, driven by a 40% increase in gaming revenue.

Its fintech and commercial revenues grew 29% as WeChat Pay, its associated wealth management services and Tencent Cloud all blocked more users. Its social media revenues also increased by 29% as it reaped the rewards of its takeover of Huya in April, Tencent Musicgrowth in subscriptions and robust sales of virtual items in its social media-based games.

In particular, Tencent’s growth accelerated in all of its activities, with the exception of online advertising, which still generated 13% growth, the old platforms Baidu struggled to attract advertisers. Tencent gave no indication, but analysts expect its revenue to grow 29% with profit growth of 31% for the full year.

Alibaba’s core commerce revenue grew 34% per year in the last quarter, as it benefited from a “strong recovery” in online sales after the COVID-19 crisis, and its revenue from the cloud grew 59% securing more public and hybrid cloud customers. Growth in both activities accelerated compared to the previous quarter.

The digital media entertainment unit’s revenue increased 9%, up from 5% in the previous quarter, but it included the mobile games business, which was previously included in its innovation initiatives segment. This change reduced revenue from its innovation initiatives by 6%.

Alibaba reiterated its earlier forecast for revenue growth of at least 28% for the full year, while analysts predict its revenue growth of 32%, with earnings growth of 16%.

Assessments and potential challenges

Tencent and Alibaba are trading at nearly 40 times and 30 times forward earnings, respectively. Neither valuation is cheap, but investors seem willing to pay a premium for their growing businesses and large moats.

But the two companies also face regulatory headwinds. Tencent and Alibaba are both exposed to a new US Senate bill that could force Chinese companies to withdraw their shares listed in the United States if they do not comply with the new regulations.

Tencent’s WeChat could also be banned in the United States for national security reasons, and Alibaba’s Taobao remains on the US Trade Representative’s blacklist of “notorious” counterfeit markets. However, only a small percentage of WeChat users are in the United States, and the commercial blacklist has not yet significantly affected Alibaba’s e-commerce business.

The winner: Tencent

Tencent and Alibaba are still strong long-term investments on China’s growth. However, Tencent’s more diversified business, higher operating margins (34% vs. 23% in their last quarters), and stronger profit growth make it a better overall investment – albeit trading. at a higher multiple than Alibaba.