Incidents:

Tencent achieved revenue of 167.2 billion yuan in 24Q3, an increase of 8% over the previous year, which is basically in line with agreed expectations. Adjusted operating profit was 61.3 billion yuan, up 19% year over year. The adjusted net profit to mother was 59.8 billion yuan, an increase of 33% over the previous year, exceeding the agreed forecast of 10%.

By business, local games and advertisements slightly exceeded expectations, while FBS slightly fell short of expectations. Taxes are the main reason why adjusted net profit exceeded expectations.

Key points of investment:

The local game was slightly better than expected, and the 24-year delay would be a solid 25-year guarantee. According to the company's financial report, overseas game revenue in Q3 increased 9% year on year, and local game revenue increased 14% year on year, speeding up as planned. Q3 The core domestic flagship “King” was steady, “Peace” continued to grow, and “DNFM” and “Fearless Contract” contributed significantly. We recommend focusing on deferred changes. 1) Q3 non-current debt caliber deferred revenue yoy +93% /qoq +34%; overseas products such as “Wild Brawl” and “Valorant” contributed relatively smoothly, but deferred reserves were strong; 2) Deferred revenue based on current debt caliber deferred revenue (yoy +20%) is roughly reduced by 15%, which is better than the game industry (yoy +9%).

Looking ahead, thick deferred reserves such as “DNFM” and “Wild Brawl” will be the basic support for game growth in 25 years; “Operation Delta”, which was launched in September, is active/retained, and is expected to become a new Evergreen; “One Piece” is scheduled for December; the pipeline focuses on “Wang Zhe Rongyao: World”, “Dawn of the Stars”, “Fearless Contract Mobile Game”, “NIKKE: Goddess of Victory” and “Rainbow 6” mobile games adapted from global IPs.

The ad slightly exceeded expectations, and the power of AI continued to be reflected. According to the company's financial report, Q3 advertising revenue increased 17% year over year, and the growth rate declined month-on-month due to base+macro impact. Video accounts are still the core growth driver, and Mini Program and WeChat Search also performed well. AI's drive for ad revenue growth continues to be reflected (improving content recommendation and ad targeting efficiency). For example, the big model empowers Search1 to improve its understanding of complex searches and enhance search accuracy.

Payments are affected by the macro, and corporate services are growing steadily. According to the company's financial reports, earnings calls, etc., Q3 fintech and corporate services revenue increased 2% year over year. Payment revenue declined year over year, but it is expected that the increase in share after connecting to Taotian will partially hedge the impact after Q4; the financial management business still achieved year-on-year growth. Among enterprise services, cloud services and merchant technical expenses are growing. AI's drive to cloud business is also beginning to be reflected. Currently, AI computing power has contributed more than 10% to Tencent's IaaS revenue. WeChat e-commerce infrastructure continues to improve. At the end of August, the small video store was upgraded to a WeChat store, opening up the WeChat scene and lowering the merchant threshold.

Q3 Overall gross margin remained high, actual tax rates were low, and capital expenditure increased dramatically. According to the company's financial report, Q3 VAS gross margin increased month-on-month, mainly driven by an increase in the share of games; the month-on-month decline in advertising gross margin was mainly affected by the cost of content related to the Paris Olympics; and FBS's gross margin was high and stable. The Q3 tax rate is 14% (vs 2Q24 17% /3Q 2323%), which may be affected by the withholding income tax of overseas subsidiaries last year. Q3 capital expenditure increased 96% month-on-month to 17.1 billion. AI is actively invested. Hybrid Turbo was released in September, which increased the training and reasoning efficiency of Hybrid Pro by 1 times and reduced inference costs by half; it said it will continue to invest in AI technology, tools, and solutions.

Tencent's fundamentals are still relatively deterministic. The competitive landscape is good, and game and video accounts continue to drive growth; looking at AI and game globalization over the long term, the momentum for increasing valuation is; active buybacks, according to Wind, have accumulated HK$90.6 billion from the beginning of the year to October 9. The total share capital continues to decline, and the buyback will restart after the financial report.

Maintain a buy rating. We raised our 24-26 adjusted net profit forecast to RMB 224.7/245.1/280.3 billion yuan (the original forecast was RMB 215.8/241.6/273.2 billion). After switching to the 25-year valuation, the target market value was raised from RMB 4719 billion to RMB 4801.3 billion, corresponding to the target price of HK$560, maintaining the buying rating based on 40% room for growth.

Risk warning: Macroeconomic recovery falls short of expectations, and changes in game regulation.