Richard Windsor
9 November 2017 · 3 min read

Tencent takes a 12% stake in Snap

Tencent is embarking on a circumnavigation of the Digital Life pie in order to build an ecosystem to challenge the established Google, Apple, Amazon, Facebook dominance of consumer digital services

Following the most difficult set of results after its IPO, Snap has conveniently announced that Tencent has taken a 12% stake in the company. This has awoken take-over speculation that we thought would not really emerge before the shares dropped below $10 and should provide a badly needed boost to sentiment.

In its 10Q Snap stated that it had been notified by Tencent that it has purchased 145.8m shares representing a holding of 12% in Snap Inc. If this had been purchased purely through the exchange it would have consumed 25% of the free float which would have been noticed triggering a rally and speculation. Consequently, the majority of this stake was accumulated by approaching existing holders directly whom were only too happy to sell.

We do not think that this transaction has anything to do with Tencent’s China business but instead is more about Tencent looking at ways of spreading its wings overseas. Digital Life services in developed markets do not work well in China (mostly because they are blocked) while Chinese Digital Life services do not work well in developed markets as they do not fit culturally and also are predominantly in Chinese. Consequently, the BATmen have had to seek other ways to develop overseas other than just spreading their Chinese services into developed markets.

Alibaba is approaching this using the Trojan horse of Alipay, while Tencent is showing signs of assembling a range of assets that would give it good coverage of Digital Life in developed markets. This process began with the acquisition of Supercell in June 2016, continued with an attempt on Spotify that failed and now it seems to be latching onto Snapchat. Tencent is the global market leader when it comes to Digital Life coverage with 77% of the Chinese pie covered and 30% of the developed market pie covered with its position in Supercell.

Adding Snapchat would take this coverage to 44% ahead of both Google and Apple (who have 40% each). However, it is one thing to have good Digital Life coverage and quite another to create a vibrant ecosystem that one can effectively monetise. The vast majority of Tencent’s revenue comes from selling content and games rather than from monetising its community.

It increasingly looks as if Tencent is embarking on a circumnavigation of the Digital Life pie in order to build an ecosystem to challenge the established Google, Apple, Amazon, Facebook dominance of consumer digital services. Consequently, we expect Tencent to actively seek investments or acquisitions in Media Consumption, Search, Social Networking and so on in order to build its coverage. This is likely to prove to be expensive and in my opinion the real challenge for Tencent lies ahead. This will be to assemble and integrate these assets into a vibrant and consistent community which is something is has yet to do with the majority of its assets in China.

Tencent is the strongest of all the Chinese ecosystems and the share price still does not reflect all of the potential upside. Hence, there is still not much very downside in Tencent if it fails to integrate its assets. However, should it do so, there is plenty of further upside from here. Tencent, along with Baidu and Microsoft remain our top picks.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.