When will the Tencent share price shake off its regulatory overhang?

This article was originally published on Opto - Invest in the Next Big Idea.

In a statement published on Monday 26 July, the industry minister said the likes of Alibaba [BABA], JD.com [JD] and Tencent [TCHEY] need to address numerous issues. These include apps violating consumer rights, data collection and storage, and what was described as "disturbing market order".

The big tech giants have been coming under increasing pressure in 2021, with particular scrutiny focusing on alleged monopoly practices. This has resulted in billions being wiped off market caps.

Bloomberg data suggests Tencent was the hardest hit of the Chinese companies in July. Nine of the top 10 biggest losers from the MSCI World Index and MSCI Emerging Markets Index were from the country. Between 1 and 29 July, Tencent's market cap dropped $170bn, followed by Alibaba's loss of $103.9bn. Shopping platform Meituan [3690.HK] was in third, with a loss of $87.9bn.

The Tencent share price has tumbled. Year-to-date, the Tencent share price is down 14.70% to $61.32 at the close on 2 August and 10.47% in the last 52 weeks. This despite the low profile of Tencent chairman Pony Ma Huateng (pictured above)

After hitting an all-time high of $99.40 on 12 February, the Tencent share price has gradually slipped. The Tencent share price has lost 23.19% in the last month and 8.51% in the week commencing 26 July. It recorded a 52-week low of $55.77 on 27 July. It stabilised after this only to dip again on Aug 3 after the company self-imposed a restriction on usage of its gaming platform by minors. This was in response to criticism from a state news agency on the excessive influence of gaming on children. 

Yet, the Tencent share price has performed better than the Nasdaq Golden Dragon China Index [HXC], a benchmark for Chinese tech. The index is down 23.38% since the start of the year and down 8.37% in the last 52 weeks.

However, the Tencent share price has underperformed the price of the passively managed Invesco China Technology ETF [CQQQ], which is down 14.88% year-to-date and up 1.39% in the last 52 weeks. The ETF has returned a loss of 12.94% and a gain of 5.66% in the respective periods.

A flurry of fines

So, what has been weighing down the Tencent share price in particular?

On 24 July, the State Administration for Market Regulation (SAMR) ordered Tencent to give up its exclusive music licensing rights and fined it 500,000 yuan ($77,381) for anti-competition violations regarding its 2016 purchase of China Music.

The SAMR had announced a total of 22 fines of 500,000 yuan at the start of the month for years-old acquisition deals. Five were levelled at Tencent, six on Alibaba, Didi [DIDI] was hit with eight - the most - and the rest went to other internet companies.

Tencent has been temporarily forced to suspend new user registrations for its flagship WeChat app to carry out a security update has weighed on the company's performance. Registration is expected to resume in early August and the changes implemented will allow the WeChat business to comply with tighter laws and regulations.

Along with a number of other holding companies, Tencent has also been ordered to address "harassing" pop-up adverts and windows in its ebook app, QQ Reader, by 3 August.

A chance to hold

With regulators expected to apply fresh pressure in the weeks and months ahead, there is arguably a clear and obvious bear case for Chinese tech, whose stocks are likely to continue to sell off.

But there is reason to be positive, if not bullish.

Alibaba founder Jack Ma has previously suggested that the global financial system and regulators are stifling innovation, but Qi Wang, CEO of Hong Kong-based MegaTrust Investment, sees it differently.

Speaking to CNBC, Wang explained that China wasn't trying to suppress big tech and wanted firms to succeed.

"To set the context, remember Chinese internet space was largely unregulated before, and the government has only been adding regulation in the last, maybe five years," Wang told the channel. "We're moving from almost no regulation in internet to more regulation. Of course, during this transition, the pressure may seem high because [of] the low base."

Bernstein analysts believe that a number of the country's big tech stocks are undervalued.

In a note to clients reported by CNBC, they wrote: "We find the case to hold Chinese quality names is quite attractive tactically - higher-quality names are trading at historical discount to lower-quality stocks while providing a very high-quality differential. There is further support from upward earnings revision as momentum in these names continue to pick up."

Looking to the long term

With regard to Tencent, Bernstein's Rupal Agarwal argued in an email to CNBC that the regulatory overhang will be short-term.

"For long-term investors, structural growth stocks in China have given very strong returns over the last five to 10 years and current valuations look compelling for a market leader like Tencent," wrote Agarwal.

The regulatory saga could have many more twists and turns ahead. For instance, Alibaba and Tencent have discussed the possibility of opening up their services.

According to the Wall Street Journal, the idea would be to launch Alibaba's Taobao Deals on Tencent's WeChat, which would allow Taobao Deals merchants to accept WeChat Pay.

Tencent is likely to benefit more from any partnership, says Berstein's Robin Zhu. In a note to clients seen by Barron's, Zhu added the two companies will want to strike "a balance between satisfying regulator demands for interoperability...and maintaining the status quo."

Zhu initiated coverage of the stock in January, assigning an outperform rating. His target for the Tencent share price is HK$880, an increase of 83% from its 30 July closing price.

MyWallSt operates a full disclosure policy. MyWallSt staff currently holds long positions in companies mentioned above. Read our full disclosure policy here. 

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