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Tencent Rebounds, but Regulatory Risks Remain

Shares of the Chinese tech companies are on the move, gaining from their strong quarterly numbers and attractive valuation. Meanwhile, bullish sentiment on Chinese tech stocks got a boost after Cathie Wood’s Ark Invest increased stake in JD.com’s (JD) ADR (American depositary receipt), following its stellar Q2 numbers. (Read more: JD.com Posts Upbeat Q2 Results; Analysts Remain Bullish)

Thanks to the strong buying, Chinese internet giant Tencent Holdings Limited’s (TCEHY) ADR rebounded and rose about 11.6% in the last two trading days. However, I maintain a Neutral outlook on Tencent, owing to the regulatory risks surrounding the company. 

Notably, regulatory risk is one of the most important factors to consider when investing in Chinese companies. Beijing’s crackdown on the tech and education sectors, and increased regulations, have already eroded billions from the market cap of these companies. 

For instance, Tencent ADR has fallen nearly 31% in the last six months, following the tightening of the regulations in China. (See Tencent Holdings Limited stock charts on TipRanks) 

Tencent’s president Martin Lau said during the Q2 conference call that the regulations on the internet are a global phenomenon. However, he acknowledged that “it’s a bit ahead in terms of the execution of a more structural regulation framework” in China. Furthermore, he expects more regulations in the future. 

However, Lau added that Tencent is “well positioned to embrace the regulatory environment,” and the company is “fully compliant with all regulations.”

While Lau’s comments are reassuring, the regulatory risk is apparent. TipRanks’ Stock Investors tool suggests that investors currently have a Very Negative stance on Tencent holdings, with 4.8% of investors who hold portfolios on TipRanks decreasing their exposure in the last 30 days.

Meanwhile, citing stringent regulations, Erste Group downgraded Tencent stock to Sell from Hold. Erste Group sees heightened restrictions and laws as impacting Tencent strongly. 

However, on the contrary, Goldman Sachs analyst Piyush Mubayi added Tencent stock to “Conviction Buy List” and reiterated his Buy rating. Stocks on Goldman Sachs’ Conviction Buy List are expected to outperform. Mubayi finds Tencent’s risk-reward attractive, following the recent decline in its stock price.

Overall, Tencent stock commands a Moderate Buy consensus rating, based on 2 Buys and 1 Sell. The average Tencent Holdings Limited price target of $90 implies 43.9% upside potential to current levels.

Disclosure: On the date of publication, Amit Singh had no position in any of the companies discussed in this article.

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