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INTERNET: Tencent Rockets Up Global Tech Value Charts

Bottom line: Tencent and Alibaba stocks have become overvalued at current levels compared with global peers, and are due for a pullback of up to 30 percent in 2018.

Tencent looks frothy at current levels

Much ado is being made about the meteoric rise in value for Tencent (HKEx: 700), the Chinese social media giant that is now neck-and-neck with global heavyweight Facebook (Nasdaq: FB). Specifically, the pair now boast nearly identical market values in the $520-$530 billion range, which one report points out is larger than the entire GDP of Taiwan. That makes them the world's fifth and sixth largest companies by market cap.

Such a reality would have been unthinkable just four or five years ago, when the only Chinese companies that ever periodically made the global top 10 were big state-run firms like banking giant ICBC (HKEx: 1398), which were government owned behemoths operating in highly protected sectors. Tencent breaks that pattern, as the company is most decidedly private, and also operates in a highly competitive but also high growth area in the online realm.

All that said, the larger question I want to explore a little more today is whether this company and other tech giants from China's newly minted private sector are really worth as much as investors seem to think, and what could be ahead for their stocks. The other notable case is e-commerce giant Alibaba (NYSE: BABA), whose similarly high market value of around $480 billion also puts it squarely in the global top 10, at number 7 specifically.

The two best places to look for comparisons with global peers seem to lie in price-to-earnings (PE) ratios, which show how over- or undervalued a company is compared to industry peers, and also in revenue growth. I'll be quite frank in that regard and give my personal belief that Tencent and Alibaba are a bit ahead of themselves at current stock prices, and I expect we could see a sizable pullback in the first half of next year.

We'll look a bit closer at the individual company financials shortly, but we should start by noting the meteoric rises in both Tencent and Alibaba stock this year. The former has more than doubled since the beginning of the year, while the latter isn't too far behind with gains of about 90 percent. (English article) The gains marked a big acceleration for Tencent, which was always rising in previous years but at a slower rate. For Alibaba the run-up represented the stock's first major rally since the one shortly after its 2014 IPO in New York.

What's the Growth Story?

Those gains alone aren't really enough to tell if the stocks are overvalued, since some might argue they were previously undervalued, which would explain this year's rally. But a look at their current PE ratios does indeed show that the Chinese pair are quite a bit ahead of Facebook, which I've chosen as representative of the global peers. Tencent and Alibaba now trade at a PE of about 55, compared to a far more modest 35 for Facebook.

That premium might be justified if Alibaba and Tencent were both growing much faster than their US peers, as both post consistently strong double-digit revenue growth despite their huge size. But a look at that metric reveals that the trio of the Chinese pair plus Facebook are all roughly similar, with their latest quarterly reports showing revenue gains in the 50-60 percent range.

All that aside, there's also the diversification factor. While Facebook and other global tech giants like Google (Nasdaq: GOOG) and Microsoft (Nasdaq: MSFT) are quite globally diversified, Tencent and Alibaba derive nearly all their business from China. Some might argue that's a plus, since it means they can continue their breakneck growth by expanding abroad. But I would argue the opposite by pointing out that putting all their eggs in one basket like that makes them extremely vulnerable to downturns in China's economy, not to mention whims of the country's fickle regulators.

That brings us back to the bottom line that I touched on earlier, namely that these stocks look a bit pricey at current levels. I'm a bit of a China bear at the moment, as there are growing signs that the country could be on the cusp of a debt crisis that could put a chill on economic growth, which would directly impact both Tencent and Alibaba. But even absent such a major development, these stocks do appear to be feasting on a bubble of over-excited China euphoria, and I do expect to see big corrections, perhaps of up to 30 percent, in 2018. 

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