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Why Tencent Is a Better Buy Than Alibaba | The Motley Fool

Chinese internet giants have been amazing wealth creators for the last 20 years. Yet this summer, China’s tech favorites fell sharply, more than 50%, as the communist party’s regulatory regime cracked down on the sector.

Now that these stocks are heavily discounted, some may see the sell-off as an opportunity to buy gold. Count Warren Buffett’s long-time business partner Charlie Munger as one of them, as Munger increased his massive bet on e-commerce leader alibaba (drool 1.08%) during the summer.

Reading: Baba vs tencent

alibaba has been a popular way for US investors to get exposure to Chinese tech, but I’d say alibaba’s rival tencent (tcehy -1.05%) is actually the best way to play a Chinese bounce. , for the following reasons.

not. 1: diversity of revenue streams and benefits

In such an uncertain regulatory environment, a company’s diversity and resilience are paramount. this is one of the main reasons for preferring tencent to alibaba. the former has a fairly equal distribution of income; last quarter, tencent received 31% of revenue from video games, 30% of revenue from its fintech and cloud services segment, 21% from social media services and subscriptions, and 17% from online advertising.

That’s a nice diversity, and while Tencent doesn’t break out the profitability of each segment, global peers in gaming, social media, and digital payments tend to be very profitable. So while recent regulatory actions against youth gaming addiction unsettled investors this summer, any regulation is less likely to hurt Tencent’s overall business than Alibaba’s.

That’s because Alibaba makes a much larger proportion of its total revenue from e-commerce. Last quarter, 87% of Alibaba’s revenue came from its e-commerce empire. Although there is a lot of diversity within that general e-commerce basket, the vast majority of Alibaba’s business still comes from selling items to people over the internet.

More concerning, only 39% of revenue comes from the “core” customer management segment, which is essentially highly profitable online advertising. And while Alibaba’s overall revenue growth was 34% last quarter, the profitable customer management segment grew just 14%.

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The remaining 48% of alibaba’s e-commerce revenue is loss-making, resulting in a 14 billion yuan ebita loss for alibaba last quarter. While it is true that these direct sales, wholesale, grocery, international e-commerce, and logistics segments grew at a faster rate than central customer management, it is still unclear what kind of profit margins those segments will have at maturity. they will probably be less profitable than the main business of online advertising.

With a heavy concentration on e-commerce, alibaba’s business is more vulnerable to any particular regulation than tencent might be amid this crackdown. In fact, recent new rules may already affect alibaba’s future results. In April, China’s regulator fined Alibaba $2.8 billion for forcing suppliers into exclusivity deals, and Alibaba will now stop the practice. That could leave it more vulnerable to competition, now that rising e-commerce players like jd.com (jd -1.71%), pinduoduo (pdd -1.43%) , and meituan (mpngf 0.00%) will have access to the same providers.

not. 2: Tencent has better assets and investments outside of China

In addition to each company’s core business, both companies also invest their profits in outside businesses, and both now have impressive investment portfolios. however, tencent is much larger, with stakes in major non-chinese companies such as tesla, snap, activision blizzard and universal group of music. Tencent’s most successful investment outside of China is perhaps its roughly 25% stake in Sea Limited, which appears to be taking market share from Alibaba-owned Lazada in Southeast Asia, although both e-commerce companies in Southeast Asia are growing very well.

In total, Tencent’s investment portfolio totaled more than $224 billion as of June 30. While some of those investments in China, including JD.com, Pinduoduo, and Meituan (all backed by Tencent) and others, have probably gone down since then, Tencent’s international holdings have done much better.

By contrast, alibaba’s total investments were about $83 billion as of June 30, according to the company’s balance sheet. That may be a bit low actually, considering Alibaba owns 33% of Ant Financial, which many financial firms value in the $140 billion to $200 billion range after its scrapped IPO last year. Thus, Alibaba’s stake in Ant could only be between $45 billion and $65 billion.

still, alibaba’s investment portfolio is much smaller than tencent’s and also offers less diversification outside of china. In addition, Tencent has an unfair advantage over Alibaba in promoting the companies it invests in. That’s because Tencent owns the Chinese super app WeChat, which had just over 1.25 billion users as of last quarter. By being able to invest in companies and then promote them on WeChat, Tencent is able to give its beneficiaries instant exposure and an edge that Alibaba may not be able to match.

not. 3: better position with regulators

Finally, another tencent advantage dates back to the start of the regulatory campaign, which began when Alibaba founder Jack Ma criticized the country’s largely state-owned banking system for its lack of innovation.

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We all know what happened next. Regulators have ruled out the IPO of Alibaba-owned Ant Financial, and it appears Chinese authorities will split Ant into three parts, with state-backed companies also holding a stake in each.

By contrast, Tencent appears to have an excellent relationship with regulators, and CEO Pony Ma has a considerably lower public profile than Jack Ma. while regulators also fined tencent for some anti-competitive practices, although mainly within investments such as tencent music (tme -0.22%), which is not its core business, those fines were lower than the from alibaba, even though tencent had a higher market cap.

tencent has also traditionally taken a conservative route to monetize its platforms, including wechat and emerging products such as its new cloud business software products. that is likely to keep regulators relatively at bay. tencent also took the lead in announcing its own $15.5bn equity fund over the summer, only for alibaba to announce its own $15.5bn fund after the fact, an effort likely to do as well like tencent in the eyes of regulators.

Given that much of China’s crackdown appears to be directed at companies exploiting their monopoly power for higher-than-normal profits, tencent’s deliberate approach to monetization and the relative modesty of its management team may keep it out of the woods, or at least more out of the woods than alibaba.

in the midst of great uncertainty, I prefer to pay for the quality of the business

alibaba has several things going for it that tencent doesn’t. For one thing, it is more accessible to foreign investors since it is listed on the New York Stock Exchange. Tencent trades only in Hong Kong, although U.S. Investors can also purchase American Depository Receipts that are traded over the counter in the United States.

alibaba is also undervalued than tencent, based on 2022 earnings estimates. alibaba is trading at just 15.5 times its fiscal 2023 earnings estimates (its fiscal year ends in March), while tencent trades around 23.8 times 2022 earnings estimates.

Still, because tencent’s investment portfolio is so much larger than alibaba’s, the multiple of its core business is actually cheaper than that. and since tencent appears to have a more diversified business and investment track record, and since it appears to be a better corporate player, it would be my go-to for those looking for a Chinese tech bounce.

You may notice in the disclosures that I own shares of alibaba but not tencent. That’s because I chose to own Tencent through its largest shareholder, which is also publicly traded and is currently trading at a significant discount to the value of its Tencent stake, and that stake is significantly larger than my alibaba allocation. However, those looking for more direct and “clean” exposure to Tencent would also be well off owning Tencent shares or ADRs directly.

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