2023Q4 structural optimization drove profit growth beyond expectations. 2023Q4 Tencent achieved revenue of 155.2 billion yuan, yoy +7%. Among them, value-added services, financial enterprise services, and advertising were 691/544/29.8 billion yuan, YOY -2%/+15%/+21%, respectively. 2023Q4 gross margin was 50%, yoy+7.0pct. The improvement in gross margin is mainly driven by an increase in high-quality revenue contributions (such as video ads, delivery technology service fees, and service fees for small game platforms), as well as a decrease in low gross margin revenue contributions such as live music broadcasts and live game broadcasts. On the cost side, the 2023Q4 sales expenses rate and administrative expenses rate were 7.1%/17.5%, yoy+2.9/-1.3pct, respectively. On the profit side, Q4 adjusted net profit to mother was 42.7 billion yuan, yoy +44%. 2023 revenue of 609 billion yuan, yoy +10%, adjusted net profit to mother of 157.7 billion yuan, yoy +36%.
Gaming: The share of games in the international market reached a record high, and the game business may improve starting in 2024Q2. The company's 2023Q4 game revenue in the international market was 13.9 billion yuan, yoy +1% (yoy -1% after excluding exchange rate fluctuations), accounting for 30% of the year's overseas game business. Game revenue in the local market was 27 billion yuan, yoy -3%. Social networking revenue of 28.2 billion yuan, yoy -2%. Due to the decline in revenue from live music streaming and game streaming services, this was partially offset by the increase in service fee revenue for paid music members and mini game platforms.
2023Q4 value-added service gross margin reached 54%, yoy+4 pct.
According to the company's performance report, future games will focus on three strategic directions: 1) Optimizing existing games: improvements such as “Wild Brawl” and “Peace Elite” are already beginning to have an effect. 2) Promote commercialization: The company will commercialize games that have already accumulated a large number of players, such as “Battle of the Golden Shovel,” “League of Legends Mobile Game,” and “Dark Zone Breakthrough.” 3) New game release: In 2024, Tencent has stocked up a variety of new products in the local market, such as “Dungeons and Warriors: Origins” (expected to be released in 2024Q2), “Starbreak”, “Need for Speed”, and “One Piece”; this year's major games in overseas markets include “Wang Zhe Rongyao Overseas Edition”. The company expects game revenue to improve starting 2024Q2.
Advertisements: Video ads performed well, and gross margin increased dramatically. The revenue of the 2023Q4 online advertising business was 29.8 billion yuan, yoy+ 21%, mainly driven by advertising demand from video accounts and the continuous upgrading of the company's advertising platform. From an industry perspective, industries other than automobiles all grew year on year. Among them, the Internet service, health, and consumer goods industries grew significantly. Due to the strong increase in advertising revenue and efficiency of high-margin video accounts, the gross profit margin of the online advertising business is 57%, yoy+13 pct.
Technology: Financial enterprise services continue to grow strongly, and live streaming delivery and cloud services are increasing steadily. The fintech and corporate services business generated 54.4 billion yuan in 2023Q4, yoy+ 15%. Among them, revenue from fintech services maintained double-digit year-on-year growth, mainly due to growth in commercial payment activities, financial services, and consumer loan services. Enterprise service revenue increased by about 20% year-on-year, mainly due to the increase in technical service fees for video channels and the steady increase in cloud service revenue.
AI applications enable acceleration and enhance shareholder returns. According to the company's performance report, First Finance, in terms of the big model, Tencent's mixed model has been expanded to the trillion parameter level. In terms of application, AI supports Tencent's To-B and To-C business and cost reduction and efficiency requirements, such as:
1) Tencent Cloud: Tencent Cloud enables models to be called externally through various infrastructures and APIs. 2) In terms of advertising, AI-driven advertising technology platforms have achieved more accurate ad targeting and higher ad click rates, and ad click rates have increased 100% over the past 18 months. 3) Games: AI is expected to help AI NPCs, graphic content generation, graphic asset generation, etc. 4) Tencent Video: AI accelerates content creation. In terms of shareholder returns, Tencent plans to at least double the share repurchase scale to over HK$100 billion in 2024, and the share repurchase scale to HK$49 billion in 2023.
Investment advice: We forecast the company's revenue for 2024-2026 to be 6631/7318/802.2 billion yuan, respectively, up 9%/10%/10% year-on-year. Non-GAAP net profit was $1851/2107/234.8 billion, respectively, up 17%/14%/11% year over year. Based on value-added services/advertisements of 10x/15x 2024e P/E, financial enterprise services and other 4x/2x2024e P/S, and investment values, a target price of HK$405 was given to maintain the “buy” rating.
Risk warning: WeChat merchants and creators' operations are weaker than expected, advertisers' demand is weaker than expected, game industry policy changes, financial policy regulation changes, and risk of errors in assumptions and calculations.