Reuters: Tencent's woes make case for breakup

Asian Tech Press (Mar. 15) -- A breakup may become a radical but simple way for Tencent (0700.HK) to better manage regulatory risk amid growing industry pressure in China, Reuters opined.

China's cetral bank, found during a routine inspection of WeChat Pay that ended in late 2021 that Tencent failed to fully comply with regulations such as "know your customer" and "know your business," the Wall Street Journal reported Monday.

And WSJ said the mobile payments network was also found to allow the transfer and laundering of funds through illegal transactions such as gambling. Tencent may face a hefty fine, which could be "at least hundreds of millions of yuan," for anti-money-laundering violations.

As China tightened regulations on e-commerce, online education, real estate and other internet companies in 2021, Tencent's Internet peers such as Alibaba, Didi and Meituan have been in trouble.

Amid market turmoil, a conglomerate like Tencent, which owns WeChat, China's most popular social app, WeChat Pay, a ubiquitous mobile payments network, and a sprawling gaming empire built from video games like "Honor of Kings," "Call of Duty: Mobile" and "Moonlight Blade M," has been facing a wider range of regulatory risks than its Chinese counterparts.

Not only are there regulatory risks from fintech sector, for example, the termination of the world's largest IPO by Jack Ma's Ant Group, but the video game business, Tencent's major cash cow, has also been facing offical reviews that are coming at any time.

The Chinese gaming industry has been hit by multiple blows since the second half of 2021, with new anti-addiction rules coming into effect and key gaming companies being called in for talks. The latest batch of approvals for new online games in China was granted in July 2021, and the issuance of game licenses has been stopped for more than half a year so far.

The National Press and Publication Administration (NPPA), China's gaming watchdog, said it is still receiving applications for new video game licences from game companies normally", indicating that the review is ongoing. But the gaming industry is still in "winter" amid a pessimistic atmosphere with a lack of new games.

Tencent's market value has halved in the past year to about $400 billion. And the stock trades at just 17 times forward 12-month earnings, less than half its own five-year average, and below global video-games peers such as Take-Two Interactive and Activision Blizzard, according to Refinitiv data.

Reuters reported that ring-fencing its core business may help Tencent ease some of the uncertainty. Regulatory risk for video games is more predictable than in financial technology, where China's central bank has a track record of outlawing entire industries such as peer-to-peer (P2P) lending and cryptocurrencies.

Tencent has also taken new steps since Sept. 1, 2021, to comply with China's latest rules on preventing minors from getting addicted to games, imposing caps on the amount of time and money kids can spend on online games.

The company's latest earnings report showed that in the third quarter of 2021, its mobile game business achieved revenue of 44.9 billion yuan, up 8% year-on-year. It can be seen that the restrictions imposed on minors have not had much of an impact on Tencent.

Reuters noted that a spinoff would crystallize the value of its video game business rather than allow it to be weighed down by Tencent's sprawling and under-fire empire that spans its WeChat social network, payments, cloud computing and advertising on various platforms.

At the same time, the video game business has limited overlap with Tencent's other businesses, making it more conducive to business unbundling. With the video-games unit operating under a separate business group due to the 2018 restructuring, a split may be the best way forward.

There was also negative news for Tencent, as JPMorgan downgraded the China Internet sector across the board on Monday, including Tencent and Alibaba (9988.HK) to a hold rating.

JPMorgan analyst Alex Yao said that a large number of global investors are reducing their investments in China's Internet sector due to concerns about geopolitical and other risks.

According to the analyst, the China Internet sector lacks attractiveness in the next 6-12 months and the outlook for the stocks is unpredictable. And with the stock prices unlikely to gain valuation support in the near term, a widespread sell-off is likely to continue, leading to significant capital outflows from the sector, which will put pressure on the industry's stocks for an indefinite period of time.

Faced with the market pressure and unpredictable outlook for the stock, a breakup may be one of the best potential ways out for Tencent to avoid further regulatory risk.

Interestingly, Reuters corrected its headline a few hours after publishing the opinion piece, from "Beijing makes case for Tencent breakup" to "Tencent's Beijing woes make case for breakup".

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