Tencent may have business model that lets it escape Alibaba's fate

BEIJING • After cracking down on Alibaba Group Holding and its financial services affiliate Ant Group, Beijing looks to have Tencent Holdings in its crosshairs.

Yet, the Chinese social media giant may have a business model that protects it from policy jitters.

There has been a steady drumbeat of new rules and state media commentary over the past five months to indicate the regulatory crackdown will continue.

Yet, shares of Tencent - which spans gaming, social media, mobile payments and online banking - remain remarkably resilient.

The stock is up 11 per cent this year, despite the anti-monopoly clouds that have darkened the skies. Much of Tencent's stock strength is from the mainland.

Through Stock Connect, Chinese fund managers, flush with new subscriptions from retail investors, have been gobbling up Hong Kong-listed tech stocks.

They now own 6.3 per cent of Tencent shares outstanding, versus 4.4 per cent at the beginning of the year. Last Friday, mainlanders did not hold a fire sale of their Tencent holdings despite the bad news about the regulatory bull's-eye. (To be sure, the relative firmness of Tencent's shares may also stem from mainland investors' inertia.)

But perhaps the shares are also buoyed by a new investment thesis emerging for Tencent: It posits the online gaming and social media company as China's best venture capital fund. According to The Information, Tencent's unrealised gains from its minority stakes in roughly 100 publicly listed firms ballooned to US$120 billion (S$161.4 billion) last year, and it was beginning to sell some positions to book gains.

Put another way, you can think of Tencent as a Spac (special purpose acquisition company) listed on a bourse that does not allow such shell companies.

This is where investors need to pay attention.

If China's latest regulatory tightening is merely aimed at reining in monopolies and strengthening the financial system from the risk of fintech, then Tencent the de facto Spac should sail through just fine.

It would then have many advantages. Tencent's name brings with it the kind of cachet enjoyed by Silicon Valley's top venture capitalists - think Sequoia Capital, Andreessen Horowitz or Khosla Ventures. There is some similarity to Naspers or even SoftBank Group.

This matters because being seen as a top-notch venture capitalist can lure big money, as investors Michael Klein and Chamath Palihapitiya witnessed. In the context of Spac - shell companies that help start-ups go public - investors are willing to write billions of dollars in blank cheques, even though they have no idea which companies you will buy or at what valuation, as long as you are seen as a good deal maker. Tencent has the track record to justify this blind faith - and a listing in Hong Kong where no Spacs exist.

But should Beijing dive deeper down the deals stack and curbs those which go beyond shoring up Tencent's core games and content business, then the new investment thesis looks troubled. China's big tech firms sometimes make deals for strategic purposes - for example, to block a rival from entering the cap table. But Tencent has also made speculative bets in true venture capital fashion. Should it be discouraged from the latter, then its strategic advantage and shield against Beijing incursions would be vastly diminished. And its value as a Spac would start to dry up.

Tencent has withstood scrutiny before and remains one of China's biggest and most influential companies. Three years ago, its bread-and-butter games business was struck by regulatory fervour that halted the release of new titles and crimped growth. It rose again by recharging with heavy jolts of patriotic pride. Founder Pony Ma is still in Beijing's good books, as opposed to Alibaba's Jack Ma.

Still, it is time investors read the political tea leaves carefully. Fintech is big for Tencent. Turning that division into a financial holding company may not hurt its revenue and earnings. But if the new set of measures hobbles Tencent as a passive venture capital investor, it is time to flee. The latest thesis that propelled Tencent to a record high earlier in the year would be disproven.

BLOOMBERG