Solid core business growth; investing to accelerate AI development

Solid core business growth; investing toaccelerate AI development Target PriceHK$735.00(Previous TPHK$750.00)Up/Downside59.7%Current PriceHK$460.20 Tencent will report 2Q26Eresults on 12 Aug: we expect total revenue toincrease by 9% YoY to RMB201.3bn, driven by the solid growth of games andmarketing businesses; weestimatenon-IFRS net income to grow by 7% YoY toRMB67.3bn, with non-IFRS NPM down by 0.7pptsYoYmainlydue to AI-relatedinvestment. Overall, we slightly trim our FY26 non-IFRS net income forecast by1% in view of the AI investment. That said, we remain upbeat on the ROI ofTencent’s AI spend,proven by its enhancing HY model performance,acceleratingcloud revenue growth and improving ad solutions. We fine-tunedourSOTP-derived target price to HK$735.0(previous:HK$750.0).Thecompany’s current valuationat13x FY26E non-IFRS PEoffersattractiverisk-reward withmultiplecatalysts ahead, including thelaunch of Weixin AI agentsand upgrade of HY model. Maintain BUY.◼ China Internet SaiyiHE, CFA(852) 3916 1739hesaiyi@cmbi.com.hk Wentao LU, CFAluwentao@cmbi.com.hk Expect solid top-line growth in 2Q26E.For 2Q26E, we forecast: 1)gamesrevenue to grow by 9% YoY to RMB64.8bn, with domestic/internationalgames revenue up by 11%/6% YoY respectively.We expectinternationalgames revenue growth toslightlydeceleratedue to the high-base effect; 2)marketing revenue to rise by 18% YoY to RMB42.2bn, mainly attributableto the increase in ad inventory of Video Account and AI empowerment; 3)fintech andbusinessservices (FBS) revenueto increaseby9% YoY toRMB60.7bn, primarily fuelled by the accelerating cloud revenue growthamid strong demand for AI compute.◼ Ye TAO, CFA(852) 3850 5226franktao@cmbi.com.hk Shuyin GUO(852) 3916 3716guoshuyin@cmbi.com.hk Stock Data OPM dragged by AI investment.We expect overall GPM to improve by0.3pptsYoY to 57.2% in 2Q26E, mainly supported by the strength in gamesand marketing businesses; but we estimate non-IFRS OPM to decline by0.9pptsYoY to 36.6% in 2Q26E, as the companystepsup investment in AI.Weforecast S&M/G&A expenses to increase by 37%/17%YoY toRMB12.9/37.2bn in 2Q26E, due to increase in marketing spend for AIproducts, AI talent expenses and depreciation expenses.◼ SolidprogressonAI front, with more catalysts ahead.Tencent’s AIagenticplatform WorkBuddy maintained its leadership in China’sproductivity AI agentmarket,in terms ofaverageDAUin 2Q26. The officialHY3model,launched on 6 Jul,achieved significant improvement inreasoning and agenticcapabilitiescompared to HY3 preview, thanks to theenhanced dataset quality and the scaling RL. Looking into 2H26E, weexpect several catalysts to support Tencent’s fundamental and valuationrecovery:1)launch of Weixin AI agent“Xiaowei” &iteration ofWorkBuddy,whichenable Tencent to tap into the enormous AI agent market; 2)upgradeof HY model, with larger parameters, more quality datasets and higher-value use cases; 3) acceleration in cloud revenue growth underpinned bythe increase in total AI compute power. Source: FactSet Business forecasts updateand valuation Our SOTP-derived target price of HK$735.0 comprises, per share: 1) HK$345.7for the games business, based ona24x 2026E PE, which isat a premium totheaverage PE for its global gaming peers(17x), mainly due to Tencent’s strong leadershipin China’s games industry and diversified games portfolio. 2) HK$30.6for the SNS business, including the market cap of Tencent’s stake in itssubsidiaries, the valuation of Tencent Video (based on a 3.5x 2026E PS, at a premium tothe1.1x average PS of peers given its content and user traffic leadership), and thevaluation of other membership services (based on a 3.5x 2026E PS). 3) HK$144.4for the marketing services business, based ona22x 2026E PE, which is at apremium to the industry average (17x). This reflects Tencent’s more resilient ad revenuegrowth outlook, supported by the solid performance of Weixin Video Account and MiniProgram. 4) HK$105.6for the fintech business, based on a 4.5x 2026E PS, at a premium to the peeraverage (1.5x). This mainly reflects Tencent’s strong leadership in China’s digital paymentmarket and its potential to capture other fintech business opportunities. 5) HK$35.4for the cloud business, based on a 4.5x 2026E PS, at a discount to the industryaverage (5.2x) as Tencent’s current offerings mainly involve the lower-margin IaaSbusiness. 6) HK$71.1for strategic investments, based on the current market value of Tencent’s listedinvestments and the book value of its unlisted investments. We apply a 30% holdingcompany discount to the fair value of Tencent’s equity investments. 7) HK$2.2for net cash. Disclosures& Disclaimers Analyst CertificationThe research analyst who is primary responsible for the content of this research report, inwhole or in part, certifies that with respect to the securities or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about the subject securiti