What kind of company is Tencent from the business model and revenue split: we split Tencent's revenue structure, and the gaming sector accounts for more than 30%. We believe that revenue fluctuations depend on the game product cycle (primary, affecting growth) and macroeconomic cycle (secondary, affecting payment level); advertising revenue accounts for about 15%. In addition to the increase in the supply of video channels and the alpha increase brought about by AI, we believe that the relationship between Tencent's basic advertising market and macroeconomic recovery is very strong; the payment and financial management business in fintech, which accounts for 26% of revenue, also follows macroeconomic fluctuations. Therefore, we believe that on the basis of steady traffic operation, the product cycle and macroeconomic cycle are Tencent's biggest beta.
Tencent Gaming has sustainable cash flow and is waiting for the “singularity” of overseas products to explode. The Chinese game market has entered the competitive market, and the chances of big single products breaking through have decreased, but based on steady traffic resource endowments and strong social characteristics of the DAU competition category, players' gaming experience comes from interaction and confrontation rather than consumption of game content. The life cycle will be longer than other game types. Combined with Tencent's controllable revenue elasticity for leading games, it determines the stability and sustainability of Tencent's overall game business. In this context, going overseas has become the biggest driver. Tencent Gaming has accumulated 15 years of experience and a global network. We can wait to see the “singularity” of overseas 3A games explode.
Under the stable and basic advertising market, what other surprises can video accounts and AI bring? We estimate that the medium- to long-term annual revenue of video account advertising is around 50 billion yuan. The core variables are user time and ad load rate. Furthermore, as e-commerce matures, there is still some room for improvement in internal circulation advertising. The logic behind this is that user data such as video numbers, DAU, etc. will have a faster growth rate and higher ceiling, while usage time and retention depend on the improvement of video number recommendation algorithm capabilities. It is expected that as the number of users and data increase, the gap between video numbers and Douyin at the recommendation algorithm level will gradually narrow, and the commercial space will gradually match. Furthermore, as Tencent continues to invest and innovate in AI technology, it is expected to drive the advertising business gross margin to continue to increase. Currently, Meta's AI advertising revenue in 2023 is 10 billion US dollars, accounting for 8% of its 2023 advertising revenue. The efficiency increase that advertising brings to Tencent may exceed our expectations of 20%.
Fintech: The mainstay of the moment, a hidden treasure. We estimate revenue of about 168.6 billion yuan in 2023, and gross profit of 77.1 billion yuan, which is Tencent's most important pillar and cash flow business other than gaming. We expect the revenue CAGR to be at the center of 10% for the next three years. Fintech consists of payment business, financial management business, and lending business. Of these, the payment business accounts for about 83% and is a core source of revenue. We believe that the current competitive pattern in the fintech industry is stable. If the macroeconomic economy recovers in the later stages, then this fintech sector, which is closely related to the broader economy, will show greater flexibility.
Enterprise services: The profitability of cloud computing continues to increase, and e-commerce commissions on video accounts are increasing. We estimate that cloud business revenue in 2023 will be 35.2 billion yuan. Commercialization of video e-commerce will begin in 2023, and the revenue is included in the corporate service category. We estimate e-commerce commission revenue of about 430 million yuan in 2023. Based on Alibaba Cloud's net profit margin of 5.8% for FY2024, Tencent Cloud's business can be expected to be profitable under Tencent Cloud's strategy of reducing costs and increasing efficiency+AI. We estimate that the medium- to long-term e-commerce revenue of video accounts is around 15 billion yuan. The core variables are the abundance of product categories and the frequency of user purchases. We believe that after e-commerce is mature, boosting internal circulation advertising revenue is more important than commissions.
Shareholder returns and holdings reduction: a game that takes value stocks to the end. Based on our current market capitalization, Tencent's overall shareholder returns for 2022/2023, including dividends+repurchases, were 5.05% and 7.95% respectively. Furthermore, Tencent's repurchases exceeded the majority shareholders' holdings reduction for three consecutive quarters from 23Q3 to 24Q1, and plans to at least double the share repurchase amount to over HK$100 billion in 2024. We believe that currently Tencent's annual free cash flow is close to 200 billion yuan, and there is still plenty of room for improvement in shareholder returns from the perspective of repurchases.
Valuation and performance: How exactly should we price Tencent. We tried to calculate the valuation of Tencent using the overall method, SOTP, and DCF discount methods.
Currently, we tend to use the overall approach for Tencent's target price. We expect Tencent's revenue CAGR center to be about 10%, Nongaap's net profit CAGR center 15%, and Nongaap's net profit for 24 years. Considering the dividend ratio of about 5% (and considering that there is still room for increase in dividend rates), we have a comprehensive valuation of Tencent Holdings 20X, corresponding to a market value of approximately RMB 410.62 billion, corresponding to the target price of HK$472.
Tencent is back in business for 10 years. What are the opportunities we can seize? As one of the most weighted stocks in the Hang Seng Technology Index, reviewing Tencent's stock price trend in the past ten years, the company's stock price was greatly affected by the beta of Hang Seng Technology as a whole, especially liquidity factors from the parent side, which ultimately determined Tencent's valuation center, we think were fundamental elements on the EPS side, and whether it was a large product cycle from fundamentals, profit increases from cost reduction and efficiency, or potential EPS increases in shareholder returns. It inspired us that as industry individual stock researchers, our research framework for Tencent focuses on changes on the EPS side.
Profit forecasting and valuation analysis. We expect Tencent's net profit from 2024 to 2026 to increase by 30.2%, 14.0%, and 14.2% to 205.3 billion yuan, 234.2 billion yuan, and 267.3 billion yuan, respectively. We comprehensively estimated Tencent Holdings' 20x non-GAAP net profit target for 24 years, corresponding to a market value of approximately RMB 4106.8 billion, corresponding to a target price of HK$472, and gave it a “Highly Recommended” rating.
Risk warning. Game market policies and regulations are becoming stricter; there is a risk that the growth rate of advertising revenue will slow down due to weak macroeconomic recovery; the development of the cloud business falls short of expectations; the risk of uncertain investment returns; and competition in the industry is intensifying.