Tencent Fourth Quarter: Investing in the Future of AI

Robin Zhu+852 2123 2659robin.zhu@bernsteinsg.com China Internet Tencent Holdings Ltd Charles Gou+852 2123 2618charles.gou@bernsteinsg.comMin-Joo Kang +852 2123 2644minjoo.kang@bernsteinsg.com Price Target 700.HK 790.00 HKD(820.00OLD) Tencent Q4: Investing in an AI future A new direction.Tencent’s Q4 results were low on surprises. Gaming was a touch strongerthan expected, while the opposite was true of Fintech & Business Services. Instead, thefocus on the company’s call was entirely on the company’s AI strategy. The time managementdedicated to (1) arguing the company’s key franchises stand to benefit from AI; (2) revealingnew detail on upcoming AI product roadmaps (HY 3.0, Weixin AI, autonomous AI agents); Close Date18 Mar 2026700.HK Close Price (HKD)550.50Price Target (HKD)790.00Upside/(Downside)44%52-Week Range683.00/419.00ASIAX1,723.55FYEDecDiv Yield1.0%Market Cap (HKD) (B)5,013.05EV (HKD) (B)4,470.78 Investors rarely welcome investment cycles, however…After a few years in whichTencent’s shift to “high quality growth” drove a series of mostly metronomic earnings beats,the company’s messaging signalled a period of higher investment spend. Business miximprovement should continue to drive gross margin expansion. But “substantial front-loaded investments” and a “more than doubling of AI investments” versus RMB18bn in 2025asks investors to believe in jam tomorrow. After hitting a local minimum for sentiment, the Core business momentum remains solid… squaring the earnings impact.Tencentmanagement pointed to operating profit growth likely undershooting revenue growth thisyear. Our back of envelope math around a “more than doubling” of RMB18bn in AI spend in2025 pointed to mid-to-high single digit operating profit growth, which likely explains thenegative reaction in Prosus’ shares. On the other hand, guidance on businesses like gaming Investment Implications DETAILS TENCENT GOES BIG ON AI INVESTMENTS Tencent’s Q4 2025 results were impressively in-line, with more or less the entire P&L coming in within 1% of our estimates andconsensus. RMB194bn of revenue implied 12.7% growth year on year, while gross profit (RMB108bn) grew 19.5%. Non-GAAPoperating profit (our preferred metric for core business momentum) reached RMB69.5bn, which was 16.9% higher year on year,implying modest deleverage on operating expenses. 10% deferred revenue balance growth this quarter was higher than we’d At the segment level, RMB59.3bn of gaming revenue grew 20.5% year on year, and was 2.5% and 4.2% ahead of our estimateand Bloomberg consensus. Domestic and International gaming revenue grew 18% and 33% (the latter 32% constant currency)in Q4. 10% current deferred revenue balance growth year on year felt like a function of both higher comps and Tencent pulling 17.5% ads revenue growth in Q4 came in more or less as expected. FBS revenue (RMB60.8bn) was a little soft versus ourmodeling (RMB62.3bn), but gross margins for all three main segment beat versus our estimates and consensus. WithinTencent’s expenses this quarter, RMB13.0bn of marketing spend was higher than we’d modeled, while RMB23.8bn of R&Dspend was lower. Within the latter, RMB16.7bn of staff R&D expenses were higher than we’d modelled. Non-staff R&D Our updated price target for Tencent is based on lower earnings estimates to reflect higher AI spend, multiplied by anunchanged 20x FY+1 PE multiple, with our valuation horizon rolled over by one quarter. Some back of the envelope math on the investment impact on earnings While we think most investors will agree that Tencent investing more to deploy AI services across its ecosystems represents apositive development, from the standpoint of long-term competitiveness, we heard considerable debate around the implicationsof said investments on Tencent earnings. Management on the call expressed comfort with the idea that AI investments may Assuming either side of 11% top-line growth in 2026, and 100-200bps of gross margin expansion as sensible ball-parkassumptions implies 12-15% gross profit growth year on year, or RMB55-63bn incremental year on year. The extent to whichRMB18bn of AI-related investments will rise in 2026 will likely remain a subject of debate, but assuming between 2.2x and 2.5xgrowth implies as hypothetical guardrails implies RMB22-27bn of incremental spend this year. Tencent non-GAAP operating Depending on which end of the above ranges one leans on, group-level earnings in 2026 could grow in the mid-single digitpercentages… or slightly better. We think the downshift in 2026E earnings expectations was the driver of the negative reactionin Prosus’ shares after Tencent’s print, On the flip side, Tencent management will likely provide investors with ongoing updatesof “AI spend”, versus underlying earnings which we expect will continue to show solid growth. Over time, improved progress Longer term, Tencent’s ecosystem remains one of the most complete venues for agentic AI services to create value, and form