INTERNET: Tencent Debt Load Grows With $10 Bln Bond Program
Bottom line: Tencent, Baidu and other Chinese Internet giants should rein in their appetite for new debt in anticipation of an economic slowdown that could sharply dampen their growth.
Social networking (SNS) giant Tencent (HKEx: 700) shattered Chinese Internet records late last week when it said it would double the size of its already-large bond program to a massive $10 billion, becoming one of the biggest such programs ever for a private Chinese company. The move is part of a broader trend that has seen Chinese Internet firms raise billions of dollars over the last 2 years through a combination of bond offerings and IPOs, tapping strong investor appetite for their high-growth story.
Such sums would have been unthinkable just 2 or 3 years ago, even though China’s economy was growing much faster then and so were the profits and revenues at companies like Tencent. Floating so much debt is normally not a problem in such boom times, and is often used by strong companies like Tencent to fund their growth.
But too much debt can also be a burden, especially if economic conditions or a company’s own fortunes change and such debt becomes harder to manage. To avoid that happening, Tencent and its peers should think carefully each time they consider this kind of major new fund-raising.
Tencent made headlines a year ago when it announced its original bond program to raise up to $5 billion. Late last week it said it has already raised nearly that amount, and would double the size to $10 billion. (company announcement) It said it would use the funds for general corporate purposes, which could include paying off other debt, and growth through organic means and acquisitions.
Tencent didn’t say how it intends to pay off its massive new debt, but companies in similar situations typically rely on their strong cash flow to make such payments without having to tap their savings. Tencent’s cash flow is currently quite strong, with the company posting nearly 80 billion ($13 billion) in revenue last year, up 30 percent from 2012.
That figure may look large, but it was actually much smaller than some of Tencent’s global peers with similar market valuations. One of those is global e-commerce leader Amazon (Nasdaq: AMZN), which posted nearly $90 billion in sales last year, also up by a healthy 20 percent. But while Amazon posted a net loss for the year, Tencent was highly profitable with net earnings of about 24 billion yuan.
Tencent’s high degree of profitability means it now generates plenty of spare money each year that it could use to pay back the massive debt it is now accumulating. The company has additional resources to pay back that debt in its huge cash pile, which totaled nearly 43 billion yuan last year.
Tencent isn’t the only Chinese Internet firm to take advantage of its strong growth story to raise big funds. E-commerce leader Alibaba (NYSE: BABA) announced its own massive $8 billion bond program last November, following its record-breaking $25 billion New York IPO 2 months earlier. (previous post) Search leader Baidu raised $1.5 billion through a bond offer in 2012, and indicated last year it might raise even more. (previous post)
The Chinese Internet companies haven’t been the only ones issuing major new debt. Amazon itself issued $6 billion in bonds late last year, and software titan Microsoft (Nasdaq: MSFT) has also recently launched its own massive plan to raise up to $10.75 billion, again banking on positive market sentiment.
But whereas Amazon and Microsoft are relatively mature companies, with several decades of operating history and large revenue bases, Tencent, Alibaba, Baidu and the other Chinese Internet players are all quite young, with around a decade of history. Their longer history means Amazon, Microsoft and other western names have experience managing debt not only in boom times, but also during times of stress such as the bursting of the dot-com bubble that saw many Internet companies collapse in the early 2000s.
By comparison, Tencent, Baidu and Alibaba know only good times when China’s economy has been growing rapidly, fueling an online boom that saw the Internet grow by tens of millions of users each year to its total of about 650 million. Those growth rates will inevitably slow as the market matures, and a slowdown could even accelerate as China’s economy enters a new phase of slower growth.
To make sure they are prepared for any potential slowdown, Tencent and its peers should think carefully before taking on more debt than they can comfortably handle if such a development occurs. They should develop a longer-term, more balanced borrowing policy, which aims giving them the funds they need to grow and the ability to service their debt in both good and more challenging economic environments.
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