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Tencent Holdings Ltd (TCEHY) Still Looks Cheap: Saber Capital

Saber Capital is a big fan of Tencent Holdings Ltd (OTCMKTS:TCEHY), which was the third biggest contributor to investment firm’s performance during the last year. In the Saber Capital’s 2017 investor letter, John Huber, the managing member and portfolio manager , discussed his investment thesis on TCEHY, noting that the stock looks very cheap based on his “preferred definition of value.” In this article, we’ll look at Saber Capital’s thoughts on Tencent, which is a China-based investment holding company.

Here is what Huber said about Tencent in the letter:

Tencent (TCEHY) was our third biggest contributor to performance, but our biggest gainer in percentage terms, as the stock more than doubled in 2017. Much of that increase was justified by increasingly dominant operating results, and in terms of business momentum, Tencent continued to stampede ahead.

The company’s growth actually accelerated last year, with revenue and earnings growth topping 50%. Tencent did about $35 billion in revenue last year, but when you look at the businesses that the company participates in (and leads) such as social media, communication, video content, payments, ecommerce, cloud and gaming – industries that collectively make for an addressable market well over $1 trillion – it’s clear that there is still a very long runway ahead for Tencent.

When we invested in Tencent a little over a year ago, the company was valued around $250 billion ($25 per share). We paid roughly 24 times what I estimated the company would earn in the following 12 months, which was a price that I thought was very cheap for a great business that will have far more earning power in the future than it does today.

This price actually turned out to be only around 21 times free cash flow, as earnings grew faster than expected. The free cash flow is growing at more than 50%, and will be $17 or $18 billion or so this year. This means at double the price ($500 billion), the stock still only trades around 28 times the free cash it should generate this year. This doesn’t get value investors excited, but for a business growing at 40-50% (a rate of growth that will slow but will remain above average for many years), I think this actually remains significantly cheap, especially when your average wide-moat, blue-chip stock with a single digit growth rate has a P/E ratio that isn’t much different than Tencent’s. By my preferred definition of value – the present value of the future cash flow – I still think Tencent is very cheap. I used the recent market downturn to add to our position around $51 per share.

Credit: Chris Yunker/Flickr

Credit: Chris Yunker/Flickr

Tencent Holdings Ltd (OTCMKTS:TCEHY) is a Chinese investment holding conglomerate that is involved, through its subsidiaries, in various Internet-related services and products, entertainment, artificial intelligence and technology both in China and globally.

For the third quarter ended September 30, 2017, Tencent had total revenues of RMB 65.21 billion ($9.83 billion), up 61% year-over-year. The company reported a profit attributable to equity holders of RMB 18.01 billion ($2.71 billion), an increase of 69% year-over-year. Revenues from value added services business rose 51% to RMB 42.12 billion for the third quarter on a year-on-year basis.

Meanwhile, Tencent Holdings Ltd (OTCMKTS:TCEHY) has been performing well, gaining more than 90% year-to-date. Over the past 12 months, the stock has moved up more than 108%.

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