Fitch Affirms Tencent at 'A+' with Stable Outlook
OREANDA-NEWS. 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 networks 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 market for social advertising. Tencent's 30% and 43% yoy total revenue growth in 2015 and 1Q16, respectively, reflect the strength of its multiple platforms and the ability to monetise its services.
Greater Revenue Diversity: We expect Tencent's advantages in its markets will translate into stronger online advertising and social network revenue growth, resulting in further revenue diversification away from online games. China's advertising industry may see challenges in 2016, due to slower economic growth. However, we believe Tencent should outperform the market and is well-positioned to capture the secular longer-term growth in social advertising, given its dominance in social networks - which generates the traffic to drive growth.
Tencent is making progress in its social advertising business, which has become a substantial mainstream market globally. The company is improving its technologies and developing new advertising formats to attract a larger share of advertising spend, and will also gradually release more advertising inventory. Online advertising revenue grew by 73% yoy in 1Q16, driven mainly by a greater number of users and higher monetisation through performance-based advertising.
Robust Profitability and Cash Generation: We expect Tencent to maintain high profitability and free cash flow (FCF) generation, due to its solid market leadership and large economies of scale. In addition, operating loss related to Weixin Payment may moderate as Tencent has started to charge for money withdrawals to help cover bank-handling costs. Operating EBIT grew by 46% yoy in 1Q16, and the operating EBIT margin was 39% (2015: 36%). The post-dividend FCF margin remained at over 30% in 2015.
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.
Fitch's key assumptions within the rating case for Tencent include:
- continued market leadership in online games, social media and social network services in China
- rapid revenue growth of around 25% a year in the next two to three years
- robust and steady margins, driven mainly by changes in sales mix
- low capex/revenue of 6%-10% in the next two to three years
- further increase in annual expenditure on M&A and investments
- dividend payout ratio of 10%-15% in the next two to three years
Developments that may individually or collectively lead to negative rating action include:
- evidence of greater government, regulatory or legal intervention leading to an adverse change in the company's operations, profitability or market share
- material loss of market share in key products and services
- significant M&A that negatively affect the operations or the 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 fund flow from operations (FFO)-adjusted leverage above 1.5x (2015: 1.7x). However, in itself, FFO-adjusted leverage rising above this target would not be likely to lead to a downgrade should the company retain its strong net cash position and high FCF margins (2015: 31%).
Positive: Tencent's rating is at its ceiling for the short to medium term, and takes into account Fitch's expectation of profit growth. The agency may consider an upgrade if the company develops businesses that diversifies cash generation significantly away from operations that are subject to Chinese government and regulatory risk.
Abundant Liquidity: We expect Tencent to continue to maintain strong liquidity and a net cash position in the medium term, despite the higher outstanding debt. Its readily available cash of CNY99bn at end-March 2016 exceeded total debt of CNY72bn. Debt due within one year amounted to only CNY16bn. In addition, Tencent had CNY82bn worth of listed equity investments in the form of available-for-sale financial assets and associates, which can be used to provide further liquidity headroom.
FULL LIST OF RATING ACTIONS
Long-Term Foreign-Currency IDR affirmed at 'A+' with Stable Outlook
Foreign-currency senior unsecured class rating affirmed at 'A+'
USD10bn global medium-term note programme affirmed at 'A+' rating
USD600m 4.625% senior unsecured notes due December 2016 affirmed at 'A+' rating
USD600m 3.375% senior unsecured notes due March 2018 affirmed at 'A+' rating
USD500m 2.000% senior unsecured notes due May 2017 affirmed at 'A+' rating
USD2bn 3.375% senior unsecured notes due May 2019 affirmed at 'A+' rating
HKD2bn 3.200% senior unsecured notes due January 2020 affirmed at 'A+' rating
HKD1.2bn 2.900% senior unsecured notes due April 2020 affirmed at 'A+' rating
USD1.1bn 2.875% senior unsecured notes due February 2020 affirmed at 'A+'' rating
USD900m 3.800% senior unsecured notes due February 2025 affirmed at 'A+' rating