HunYuan AI And GPU Purchases Will Transform Cloud Services

Key Takeaways

• Strategic AI investments in infrastructure, gaming, and advertising aim to enhance revenue and user engagement across multiple segments, boosting growth prospects.
  
• Share buybacks and higher dividends underscore Tencent's focus on shareholder returns, potentially increasing earnings per share.
  
• Heavy investment in AI and cloud, amid rising competition and constraints, may strain cash flow and compress profits if returns don't meet expectations.

Catalysts

An investment holding company, offers value-added services (VAS), online advertising, fintech, and business services in the People’s Republic of China and internationally.

• Tencent's investment in AI, particularly the development of its proprietary HunYuan foundation model, is expected to drive future revenue growth through enhanced consumer and enterprise-facing AI use cases, improving AI-related revenue streams.
  
• The company's increased allocation of capital towards AI infrastructure, including a significant step up in GPU purchases, indicates a focus on expanding AI capabilities, which is anticipated to support accelerated growth in Tencent's cloud services revenue.
  
• Tencent's strategic investments in AI-powered innovations in gaming and content production aim to enhance user engagement and content offering, potentially leading to higher revenue from its gaming and entertainment segments.
  
• The integration of AI into Tencent’s advertising technology is expected to improve user engagement and campaign efficiency, potentially resulting in an uplift in marketing services revenue and improved net margins through higher click-through rates and better ad targeting.
  
• The significant share buybacks and increased dividends emphasize Tencent's commitment to shareholder returns, potentially driving earnings per share (EPS) growth as the overall share count is reduced.

Tencent Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Tencent Holdings's revenue will grow by 8.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 29.4% today to 31.2% in 3 years time.
• Analysts expect earnings to reach CN¥265.8 billion (and earnings per share of CN¥29.28) by about March 2028, up from CN¥194.1 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting CN¥298.5 billion in earnings, and the most bearish expecting CN¥208.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 22.9x on those 2028 earnings, up from 22.1x today. This future PE is greater than the current PE for the HK Interactive Media and Services industry at 15.2x.
• Analysts expect the number of shares outstanding to decline by 1.95% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.25%, as per the Simply Wall St company report.

Tencent Holdings Future Earnings Per Share Growth

Risks

• The sharp increase in CapEx for AI initiatives, such as the purchase of GPUs, is putting strain on free cash flow and could lead to increased depreciation costs, potentially impacting net margins.
  
• The commercial payment sector's growth is constrained by pricing pressure, which, despite an increase in transaction volumes, may hinder revenue growth for the FinTech segment.
  
• Rising competition in the AI and cloud services market, coupled with supply constraints, could limit Tencent's ability to fully capitalize on these opportunities, affecting future revenue growth.
  
• Allocation of significant resources, such as increased R&D spending and CapEx on AI, may not immediately result in proportional returns, potentially compressing operating profits.
  
• Rapid expansion and significant investments in AI may lead to increased risk if monetization of these initiatives does not meet expectations, impacting earnings and investor confidence.

Valuation

• The analysts have a consensus price target of HK$602.219 for Tencent Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of HK$707.79, and the most bearish reporting a price target of just HK$318.02.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CN¥852.6 billion, earnings will come to CN¥265.8 billion, and it would be trading on a PE ratio of 22.9x, assuming you use a discount rate of 8.2%.
  
• Given the current share price of HK$506.5, the analyst price target of HK$602.22 is 15.9% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.