We affirm our O/P recommendation on Tencent. We continue to view Tencent as attractive compared to other Single-A rated Chinese companies and US A-rated tech peers. We see value in extending duration to the belly of Tencent’s curve as it provides a good pickup against its short-end (<5Y).

Tencent’s near-term growth recovery may be volatile, but we expect its balance sheet to remain strong in the next 6-12 months. We expect near-term growth recovery to remain constrained by potential COVID-19 flareups, but we think that its growth has already bottomed in 2Q. We think Tencent’s margins will continue to improve, and its EBITDA generation will be supported by its effective cost control measures, an improving product mix, monetization of its in-feed ads and disciplined marketing expenditures.

Any regulatory clampdowns abroad and domestically (e.g. US SEC delisting, antitrust rules, data security, personal information protection laws) may affect Tencent’s business. Tencent’s gaming, music streaming, and online payment units are among those that have come under regulatory scrutiny in the past. In addition, Tencent uses variable interest entities (VIEs) to circumvent China’s restrictions on foreign ownership of Internet Content Providers, which poses regulatory risks. Specifically, VIE transactions involving “change in control” will be subject to antitrust regulatory processes.

Tencent operates in a competitive market alongside other Chinese tech giants. Failure to continually innovate may result in loss of market share and profitability. Monetization of its social-network base may take time and heavy investment in payments, cloud, AI and retail businesses may weigh on margins.

The potential restructuring and spin-off of Tencent’s finance-related business into a financial holding company as ordered by the Chinese government could be a credit negative event depending on the final structural reorganization.