May 19, 2017 / 8:02 AM / 8 months ago

Fitch Affirms Tencent at 'A+', with Stable Outlook

(The following statement was released by the rating agency) HONG KONG/SEOUL, May 19 (Fitch) Fitch Ratings has affirmed China-based Tencent Holdings Limited's (Tencent) Long-Term Foreign-Currency Issuer Default Rating (IDR) and foreign-currency senior unsecured class rating at 'A+'. The Outlook is Stable. A full list of rating actions is at the end of this release. KEY RATING DRIVERS Leadership in Multiple Segments: Tencent's 'A+' rating is underpinned by its leadership in multiple segments, revenue diversity, robust cash generation and abundant liquidity. The company continues to dominate China's social communications market and has established clear leadership in the online gaming sector, both of which should be less sensitive to economic cycles. Tencent is also well-positioned to capture China's fast-growing markets for social advertising, digital content and mobile payment-related services. Its revenue growth accelerated to 55% in 1Q17, reflecting the strength of its multiple platforms and the ability to monetise its products and services. Greater Revenue Diversity: We expect further revenue diversification in the next three years, driven by stronger revenue streams in social advertising, social networks, mobile payment and cloud. Online games should remain the largest segment for both revenue and cash generation in the medium term. Tencent has a strong game portfolio and proven ability to expand the mobile game communities and revenue, making it the publishing partner of choice in China for many game developers. Online games revenue contributed 46% of total revenue in 1Q17, down from 53% in 1Q16, though online game revenue grew by 34% yoy in 1Q17. Robust Growth in Social Advertising: We believe Tencent is well-positioned to capture the benefits of longer-term growth in social advertising, given its dominance in social communications market. iResearch expects China's social advertising market to grow at a compound annual growth rate (CAGR) of 51% in 2016-2019 to reach 55% of China's online advertising market by 2019. According to Analysys International, Tencent held a 57% share of China's social advertising market in 4Q16. This has translated into a 67% yoy growth in the company's social and others advertising revenues in 1Q17. Synergy from Stronger Mobile Payment: We expect Tencent's mobile payment and related services will reinforce the strength of its platform and ecosystem. Its payment services engage its users and enable users to conduct transactions with merchants, allowing many of Tencent's partners to get paid from their users - which in turn benefits Tencent's platform. Tencent's mobile payment services have made significant progress over the past two years; its market share in China's mobile payment market increased to 37% in 4Q16, from 11% in 1Q15, according to Analysys International. Robust Profitability and Cash Generation: Higher content costs and marketing expenses may put some pressure on margins in the short term. However, we expect Tencent to maintain relatively high profitability and strong free cash flow (FCF) generation, due to its solid market leadership and large economies of scale. Operating EBIT grew by 34% yoy in 1Q17, and the operating EBIT margin was 35% (1Q16: 41%). The post-dividend FCF margin remained high, at 29% in 2016. Acquisitive in Nature: We believe Tencent will maintain a high appetite for M&A in the medium term, as it will continue to build and enhance its ecosystems and gain control of key strategic assets in technologies and business innovations. The M&A strategy is part of its "connection strategy" that uses Weixin and QQ to link appropriate content and services to users' everyday lives, and expand the scope of business opportunities. Annual M&A and investment are likely to remain high, while we expect the FCF to be large enough to fund most of its M&A ambitions. We expect Tencent's post-dividend FCF margin will be maintained at around 25%-30%. Regulatory Risks Well Managed: The ratings also reflect Fitch's expectation of Tencent's continued healthy relationships with China's government and regulatory authorities. However, should this position change, it could affect credit strength - particularly considering the rated entity's absence of equity control over its onshore operating companies. These would be Tencent Computer, Shiji Kaixuan and other consolidated affiliated Chinese entities with whom it only has contractual relationships, due to government restrictions on foreign ownership in internet businesses. DERIVATION SUMMARY Tencent's credit profile compares favourably with its internet peers such as eBay Inc. (BBB/Stable), Expedia, Inc. (BBB-/Stable) and Baidu, Inc. (Baidu, A/Stable), but similar to Alibaba Group Holding Limited (Alibaba, A+/Stable). Tencent's cash-generation ability is stronger than that of Baidu, but similar to Alibaba. Tencent's ratings benefit from its diversified - but synergistic and integrated - platforms with market leadership across multiple segments. This is unlike Alibaba and Baidu, whose ratings benefit from their dominance in China's online shopping and search engine markets, respectively. The popularity of Tencent's Weixin/WeChat services has further enhanced Tencent's platform strength in the mobile space, and taken the company to a new level in capturing new business opportunities. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - continued market leadership in online games, social network services and social advertising in China - rapid revenue growth with a CAGR of 26% in 2016-2019 - higher content costs and marketing costs as well as a changing sales mix to reduce the operating EBIT margin, excluding share-based compensation, to 32%-34% in the next two to three years - capex/revenue of 7%-11% in the next two to three years - annual expenditure on M&A and investments to remain high - dividend payout ratio of 10%-15% in the next two to three years RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Positive rating action is unlikely in the medium term, taking into account Fitch's expectation of profit growth. The agency may consider an upgrade if the company develops businesses that diversify cash generation significantly away from operations that are subject to Chinese government and regulatory risk. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Evidence of greater government, regulatory or legal intervention leading to an adverse change in operations, profitability or market share - Substantial loss of market share in key products and services - Significant M&A that has a negative effect on the operations or business profile - Sustained decline in operating cash flow - A shift to more aggressive financial policies, for example a sustained loss of its net cash position or sustained funds flow from operations (FFO)-adjusted leverage above 1.5x (2016: 2.1x). However, FFO-adjusted leverage in itself rising above this target would not be likely to lead to a downgrade should the company retain its strong net cash position (2016: CNY18 billion) and wide post-dividend FCF margins (2016: 29%). LIQUIDITY Strong Liquidity: We expect Tencent to continue to maintain strong liquidity and a net cash position in the medium term. Its readily available cash of CNY141 billion at end-March 2017 exceeded total debt of CNY114 billion. We also expect solid FCF in the medium term. Tencent's post-dividend FCF was CNY45 billion in 2016. In addition, Tencent had significant excess cash invested in listed companies, which amounted to CNY112 billion at end-March 2017, which could provide more liquidity headroom if required. The company has substantial unused credit facilities, and it entered into new five-year syndication loans in March 2017. Mostly US Dollar Unsecured Debt: At end-March 2017, Tencent's gross debt was CNY114 billion with the vast majority were unsecured and denominated in US dollars. Unsecured notes totalled CNY39 billion and were mostly under its USD10 billion global MTN programme, except for the USD600 million 3.375% senior unsecured notes due 2018. Tencent had a staggered debt maturity schedule. FULL LIST OF RATING ACTIONS Tencent Holdings Limited -- Long-Term Foreign-Currency IDR affirmed at 'A+' with a Stable Outlook; -- Foreign-currency senior unsecured class rating affirmed at 'A+'; -- USD10 billion global medium-term note programme affirmed at 'A+' rating; -- USD600 million 3.375% senior unsecured notes due March 2018 affirmed at 'A+' rating; -- USD2 billion 3.375% senior unsecured notes due May 2019 affirmed at 'A+' rating; -- HKD2 billion 3.200% senior unsecured notes due January 2020 affirmed at 'A+' rating; -- HKD1.2 billion 2.900% senior unsecured notes due April 2020 affirmed at 'A+' rating; -- USD1.1 billion 2.875% senior unsecured notes due February 2020 affirmed at 'A+' rating; -- USD900 million 3.800% senior unsecured notes due February 2025 affirmed at 'A+' rating. 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