Why the crackdown in China might actually be a good thing for Tencent shareholders

There is no doubt that China’s regulatory crackdown has not been great for China-based tech stocks. the KraneShares CSI China Internet ETF is down nearly 50% over the year.

Still, could there be a silver lining to the new crackdown? Last Thursday, the tech giant Tencent (OTC: TCEHY) announced that it will divest the majority of its approximately 17% stake in JD.com (NASDAQ: JD) to shareholders. While JD.com stock fell about 6% on Thursday, Tencent was actually up a similar amount.

It’s possible that Tencent’s divestiture was a preemptive move to please regulators, but the action was deemed positive for the stock. If more divestments are on the way, here’s why this could be a boon to Tencent shareholders.

Tencent’s decline made it cheap

Tencent has actually performed better than the Chinese tech index this year and only fell about 20% in 2021 after Thursday’s rise.

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Tencent’s relative outperformance could be due to several factors. Its business is very diverse, with profit centers in video games, the WeChat social network, fintech, cloud computing, streaming and others. It also appears to have a great relationship with regulators, as evidenced by its lower fines and other measures compared to its competitors. Ali Baba.

However, a 20% drop is still significant, as is Tencent’s 42% drop from all-time highs reached in February. After the decline, Tencent only trades around 25 times next year’s profit estimates – and keep in mind that those profit estimates are likely lower than normal as the company increases its investment and spending. operating this year and the Chinese economy has slowed.

Twenty-five times the profit also seems like a pretty good estimate for Tencent’s core business alone. Meanwhile, those profits don’t take into account Tencent’s huge investment portfolio, which the company estimated at around $ 188 billion at the end of the last quarter. That’s about a third of the company’s market capitalization today.

The young woman pumps her fist on her smartphone.

Image source: Getty Images.

JD spin-off could cause investors to re-evaluate Tencent’s sum of parts

The JD.com spin-off can therefore appear as a bonus for Tencent shareholders. Based on the value of the spin-off (or cash equivalent), Tencent shareholders are expected to reap a dividend of around 2.7% based on the market value of JD.com. And if you receive stocks and not cash, those JD stocks themselves are down around 37% from all-time highs, and could appreciate if the fortunes of Chinese tech stocks improve. Of course, this value has always been present within Tencent, but perhaps it has not been appreciated by investors who only look at the operating profits of the company, and not the investment assets which do not. ‘do not appear in the income statement.

While Tencent did not say the spinoff was a preemptive measure to please regulators worried about market concentration and market power, that could very well be the reason for the divestiture. After all, Tencent has never created an asset of this size before.

Paradoxically, if Tencent invests more in its investment portfolio, it is quite possible that Tencent’s own stock value will not move at all, if investors had ignored investment assets anyway. Still, shareholders would receive other assets of significant value, such as JD’s stake.

Amid regulatory pressure here in the United States, some have speculated that if the government ever forces Alphabet Where Amazon to break, their shares would in fact increase, as many investors believe that each of these FAANG shares is worth more than the sum of their individual units. Amazon’s AWS cloud computing unit as a stand-alone company could very well be worth almost all of Amazon’s market capitalization today, while Alphabet appears to be valued on the basis of its advertising business alone. , without much credit given to its own cloud unit or to “other bets.”

It appears Tencent shareholders are on the verge of whether this proposition is true. If Thursday’s stock price action is any indication, it looks like the sum of the parts thesis for large-cap tech conglomerates may very well be correct.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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