Guotou Securities International released a research report stating that TENCENT (00700) possesses robust operating cash flow sufficient to support its strategic transformation, with profit increments from core businesses expected to cover AI investment costs. Based on a 2026 estimated valuation of 15x PE for value-added services, 15x PE for the advertising business, 8x PS for fintech and cloud services, and applying a 0.9x valuation coefficient, the bank set a target price of HKD 680.0. This implies estimated 2026/2027 P/E ratios of 18.9x and 16.0x respectively, representing a potential upside of 47.8% from the recent closing price, leading to a maintained "Buy" rating.

Guotou Securities International's key views are as follows:

For Q1 2026, TENCENT reported total operating revenue of RMB 196.5 billion (+9.1% YoY), Non-IFRS net profit attributable to shareholders of RMB 67.9 billion (+11% YoY), and GAAP net profit attributable to shareholders of RMB 58.093 billion (+21.5% YoY). Revenue was slightly below the market consensus estimate of RMB 199.4 billion by approximately 1.5%, primarily due to the later timing of the Spring Festival, which deferred recognition of in-game item sales revenue to Q2. Non-IFRS net profit was largely in line with expectations (consensus: RMB 67.8 billion; actual: RMB 67.9 billion, a variance of only +0.1%). During the period, AI investments exerted a drag of about 4.5 percentage points (RMB 8.8 billion) on the Non-IFRS operating profit margin, representing a non-black-box expansion. The Hunyuan 3.0 model has ranked among the top on OpenRouter, and the launch of the WeChat AI Agent in H2 2026 is anticipated, with the commercialization pathway becoming clearer.

Domestic games revenue for Q1 2026 was RMB 45.4 billion (+6% YoY). The revenue growth rate significantly lagged behind the growth in gross billings (over +10%). This divergence was primarily due to the later Spring Festival this year, causing substantial revenue from Spring Festival promotional in-game items to be deferred for accounting recognition to Q2. This is a one-off accounting timing issue rather than a weakening of underlying demand. From a gross billing perspective, "Honor of Kings" reached a historical peak, and "Delta Force" continued to contribute, indicating that the fundamentals of the domestic games business remain strong. International games revenue was RMB 18.8 billion (+13% YoY), driven by the revitalized version of "Clash Royale," with continued growth from "Wuthering Waves" and "Valorant." Overall games (including social networks) constituted value-added services revenue of RMB 96.1 billion (+4% YoY); within this, social networks revenue was RMB 31.9 billion (-2% YoY), also impacted by the Spring Festival deferral. Crucially, the gross margin for value-added services improved to 63% (vs. 60% in the same period last year, +3 ppt), mainly due to an increased proportion of self-developed games, which carry higher gross margins than third-party licensed titles. This structural improvement is viewed as sustainable.

Online advertising revenue for Q1 2026 was RMB 38.2 billion (+20% YoY), accelerating significantly from the 17% growth in Q4 2025 and representing the strongest positive surprise this quarter. The driving logic is clear: the company continues to iterate its AI-powered advertising delivery models, while the closed-loop marketing capabilities within the WeChat ecosystem (integration of ads in Search, Channels, and Mini Program e-commerce) continue to deepen. Improved advertiser ROI is driving increases in ad pricing (CPM/CPC) and expansion in inventory utilization. The online advertising gross margin was 55%, slightly down 1 ppt from 56% a year ago, primarily due to increased spending on AI advertising infrastructure (GPU cluster depreciation, inference computing operational costs). This reflects a proactive strategy of "trading margin for growth" rather than passive price reductions under competitive pressure. The acceleration of advertising growth towards a 20% rate validates the commercial conversion path of AI empowerment. It is anticipated that with the launch of the WeChat AI Agent (expected H2 2026) creating a closed-loop between advertising and AI agent content traffic, advertising growth momentum is expected to strengthen further.

Fintech and Business Services revenue for Q1 2026 was RMB 59.9 billion (+9% YoY). Within this, the enterprise services segment (cloud + SaaS) grew +20% YoY, with AI-related cloud demand being a core driver. The gross margin for this segment rose to 52% (vs. 50% in the same period last year, +2 ppt), reflecting scale effects in cloud services and a revenue mix shift within fintech towards higher-margin wealth management and enterprise digitalization. Management has explicitly committed to maintaining TENCENT Cloud's position among the top three hyperscale cloud service providers in China, and AI computing investments are expected to further solidify this competitive position.

Investment Recommendation: TENCENT's Q1 2026 results were largely in line with market expectations, with core businesses demonstrating strong resilience and high-quality growth characteristics. In the short term, AI investments will indeed exert some pressure on profit margins, but from a medium-to-long-term perspective, these are necessary measures to build next-generation core competitiveness. Key areas to monitor include: 1) The sustainability of gross billings for new games; 2) The pace of increase in ad load rates on Video Channels; 3) Iterations of the Hunyuan large model and the commercialization progress of the AI Agent ecosystem.

Risk Factors: Changes in macroeconomic conditions; risks related to the performance of new and existing game products falling short of expectations; risks associated with international operations; regulatory uncertainty risks.