Daiwa Capital Markets has reaffirmed its "Buy" rating on TENCENT (00700) while revising its 12-month target price downward from HK$710 to HK$700, based on a sum-of-the-parts (SOTP) valuation. This target implies an average forward price-to-earnings ratio of 19.3x for the fiscal years 2026-2027. Potential downside risks identified include weaker-than-anticipated performance in gaming and advertising sales, coupled with higher-than-expected expenditures on artificial intelligence (AI).

TENCENT's first-quarter revenue grew 9% year-over-year, slightly missing market expectations, primarily due to timing differences in recognizing gaming revenue. However, non-IFRS adjusted net profit rose 11% year-over-year, aligning with forecasts, supported by resilient profit margins despite a significant increase in AI investments. The report suggests that while it remains premature to discuss a specific timeline for AI monetization, there is growing confidence in TENCENT's commitment and capacity for aggressive AI investment. The company has reorganized its AI teams, clarified its ecosystem roadmap, and benefits from improved domestic chip supply, supporting a "invest first, monetize later" strategy.

The report noted that value-added services (VAS) revenue fell short of expectations, mainly due to weaker gaming revenue (gross billings). Domestic gaming revenue increased 6% year-over-year but was impacted by a later Lunar New Year, which shortened the revenue recognition window. International gaming revenue grew 13% year-over-year, slightly below expectations, affected by a high comparison base and the normalization of integration benefits. While the sluggish growth in social networks is seen as structural, domestic gaming growth is anticipated to accelerate starting in the second quarter of this year, driven by the recognition of deferred revenue over multiple quarters.

AI investment accelerated in the first quarter, with capital expenditures reaching RMB 31 billion, an 18% year-over-year increase, and R&D expenses totaling RMB 23 billion, up 19% year-over-year. Daiwa expects AI-related expenditures, particularly capital expenditures, to rise significantly, concentrated in the second half of the year. Consequently, Daiwa has marginally reduced its earnings per share forecasts for 2026-2028 by 2% to 4% to reflect the higher projected AI investment levels.