Tencent Bullish Bets Climb to Record Before Earnings

Tencent Holdings Ltd., the best Hong Kong stock bet over the past three years, is getting even more attractive to options traders.

Tencent will extend this year’s 30 percent rally after reporting a surge in quarterly earnings next week and as Alibaba Group Holding Ltd.’s initial public offering shows investors the value of Asian technology stocks, according to analysts. Three-month calls that profit if Tencent shares climb 10 percent traded yesterday at the highest level relative to puts since Bloomberg started compiling daily data in November 2010.

Analysts expect Asia’s biggest Internet company will post a 50 percent jump in profit and a 34 percent increase in sales for the three months through June from a year earlier, according to the median of 12 estimates compiled by Bloomberg. The results will come after Facebook Inc. and Twitter Inc. in the U.S. reported revenue growth that topped estimates. Alibaba is gearing up for what may be the biggest U.S. IPO.

“Facebook results were good, and that can be used as a proxy for Tencent,” said Castor Pang, head of research at Core Pacific-Yamaichi in Hong Kong. “In the second half, Alibaba may get listed in the U.S. and this may positively affect Tencent’s stock price, triggering people to buy call options.”

Shares of Tencent climbed 1.2 percent to HK$129.80 today in Hong Kong, the biggest boost to the benchmark Hang Seng Index. The gauge slid 0.2 percent.

Tencent surged 225 percent over the three years through yesterday, the biggest gain on the Hang Seng Index, on optimism the company will profit from its mobile messaging platform and games as Internet use increases in the world’s most populous nation. The stock was valued yesterday at 40.8 times estimated earnings compared with multiples of 11.3 for Hong Kong’s benchmark index and 13.5 for the MSCI Asia Pacific Index.

Valuation Concern

Investors in Tencent have had a wild ride this year, with the stock plunging as much as 25 percent between March 6 and May 8 amid a global Internet share rout fueled by concern valuations had climbed to excessive levels. Tencent recovered all its losses after reporting better-than-expected quarterly earnings in May.

“Investors are bullish on Tencent, but they are not willing to put up a huge amount of capital,” said Core Pacific-Yamaichi’s Pang. “They want to limit their loss, so they’re using options instead of buying the underlying stock. They’re confident, but they are concerned that if a pullback kicks off, Internet stocks will be the sector that falls much more than others.”

Tencent shares slid 3.5 percent yesterday, the steepest drop since May 7, after the official Xinhua news agency reported that China will require instant messaging applications in the world’s largest Internet market to get permits to provide services that allow users to distribute public information.

Limited Impact

“This may affect the number of instant messaging users but the commercial impact will be limited,” Sam Chi Yung, a strategist at Delta Asia Securities Ltd., said by phone yesterday. “China is trying to regulate political speeches rather than its business.”

Tencent’s first-quarter profit beat analysts’ estimates on rising revenue from online games and advertising through messaging services WeChat and QQ. The company has taken steps this year to bolster its online content as it seeks to compete with Alibaba, announcing plans to purchase stakes in Chinese online retailer JD.com Inc. and a Craigslist-like site 58.com.

“Tencent had a strong first quarter and investors are hoping the momentum will continue into second-quarter results,” Stephen Yang, an analyst at Sun Hung Kai Financial Ltd. in Hong Kong, said by e-mail on Aug. 1. “Tencent could benefit from some mobile monetization efforts that the firm started earlier this year.”

Bullish Calls

Three-month calls betting on a 10 percent increase in Tencent shares cost 5.7 points more than puts protecting against a 10 percent decline yesterday, according to data compiled by Bloomberg. The price difference has averaged 2.5 points this year.

Chen Limin, a spokeswoman for Tencent, declined to comment on whether the company is aware of its stock-options performance and what it has done to develop its businesses, citing restrictions on commenting ahead of the Aug. 13 results.

As Tencent’s earnings increased in the first quarter, so did its marketing costs, which soared 93 percent to 1.9 billion yuan ($308 million) as the company offered subsidies to encourage the adoption of its Weixin Payment service.

Marketing Costs

“For Tencent, there’s always the cost,” Alex Wong, asset-management director at Ample Capital Ltd., said by phone on Aug. 1. “Marketing-related expenses are always the risk. In China, people are keen to spend money for higher active users.”

Competitor Alibaba is helping to boost the share-price outlook for Tencent as it prepares for what may be the biggest IPO in the U.S. The Chinese e-commerce giant will wait until September to move forward with its IPO, a person with knowledge of the matter said in July. Alibaba may set the IPO value at $154 billion, according to the average estimate of five analysts surveyed by Bloomberg. The same analysts see the post-listing valuation at $198 billion.

“If the valuation of Alibaba is high when it gets listed, it might impact the valuation of Tencent” as they are seen as peers, Delta Asia’s Sam said.

The HSI Volatility Index, which measures the cost of options on the Hong Kong gauge, rose 6.9 percent to 16.77 today. Two of the three most-owned options on Tencent yesterday were bullish, with calls betting on a 5.2 percent advance by the end of August accounting for the largest open interest, the data show.

Delivering Earnings

“While investors are conscious that Tencent is trading at a high price-earnings multiples, the long-term fundamentals are pretty solid,” Ng Soo Nam, Singapore-based head of Asian equities at Threadneedle Asset Management, which oversees about $150 billion globally, said by phone on July 31. “During the Internet bubble more than 10 years ago, a lot of the dot.com companies were trading at high price-to-sales ratios without an earnings track record, but these days companies are delivering earnings.”

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