Tencent Holdings: Improving core business margins offset higher AI investment, maintaining Buy

Overview

This report is HSBC's company research and rating change report on Tencent Holdings. The core conclusion is that Tencent is increasing AI capex and spending on new AI products, but core business margins continue to improve. In particular, scale effects and revenue mix optimization in VAS, FBS, and cloud businesses are expected to largely absorb the pressure from incremental AI spending. HSBC therefore maintains its Buy rating, but lowers its 2026-2028 non-IFRS net profit forecasts by about 3% and cuts its target price from HKD750 to HKD720, based on lower assumptions for contributions from joint ventures and associates, as well as interest income.

Core views

HSBC believes Tencent's core business fundamentals remain healthy. Game revenue in the near term was affected by the timing of Lunar New Year recognition, but domestic game bookings remain strong, with several evergreen titles setting record-high bookings, and domestic game revenue growth is expected to recover later in 2026. Advertising revenue was driven by AI recommendations, closed-loop marketing within the WeChat ecosystem, and longer viewing time on Video Accounts, with 1Q26 revenue up 20% year over year. FBS revenue rose 9% year over year, including 20% growth in business services revenue, supported by Tencent Cloud AI-related demand, international cloud business, and growth in mini-shop GMV. On the AI side, products such as HY, Yuanbao, CodeBuddy, WorkBuddy, and QClaw bring higher capex and opex, but the combination of models and the product ecosystem helps create a feedback loop and improve iteration efficiency.

Analysis framework

The report mainly uses segment operating tracking, margin decomposition, capex and AI investment assumption adjustments, earnings forecast revisions, and valuation multiple analysis. The key focus areas are the gap between 1Q26 results and consensus, the timing of game revenue recognition, domestic and international game bookings, ad monetization efficiency, FBS revenue mix, cloud scale effects, AI product spending, and their impact on group-level non-IFRS operating profit and net profit.

Methodology notes

• equity_researchSegment performance and margin analysis

  Break down revenue, gross margin, and operating margin by business line

  The report analyzes domestic games, international games, social network, marketing services, FBS, and cloud businesses separately to assess whether core business margin improvement can offset higher AI investment.

• Valuation methodsTarget price and upside framework

  Potential return relative to the current share price

  In HSBC's rating framework, a target price more than 20% above the current share price typically corresponds to a Buy rating; this report's target price of HKD720 implies about 55.6% upside versus HKD462.60.

• forecast_revisionEarnings forecast revision

  Adjust earnings forecasts based on capex, AI expenses, associate contributions, and interest income

  The report raises its 2026 capex and AI product expense assumptions, but core business margin expansion offsets part of the impact, leaving non-IFRS operating profit broadly unchanged; non-IFRS net profit forecasts are cut by about 3% due to lower associate profits and interest income.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Tencent Holdings (0700.HK)

  Covered company and recommended stock

  Strengths

  Core business margins are improving, game bookings are strong, advertising and FBS growth are healthy, cloud business is supported by AI demand and international expansion, and the balance sheet is expected to improve gradually.

  Weaknesses

  AI-related capex and opex are increasing, 2026-2028 non-IFRS net profit forecasts are being cut, and social network and some game revenues are short of consensus in the near term.

  Comparison

  Relative to the Hang Seng Index, Tencent significantly outperformed in 2025, but both its share price and relative performance weakened in 2026; valuation multiples are expected to trend down gradually from 2025a to 2028e.

  Risks

  Lower-than-expected AI investment returns, weaker-than-expected conversion of game revenue and bookings, slower ad demand, intensifying cloud competition, regulatory pressure, and macro consumption volatility.

Key data

• RatingBuyThe report maintains a Buy rating.
• Target priceHKD720Cut from HKD750 to HKD720.
• Current share priceHKD462.60Market data as of the close on 2026-05-13.
• 2026e capexRMB134bnRaised from the original forecast of RMB92bn, equal to about 16% of revenue.
• 2026e new AI product costs and expensesRMB40bnRaised from RMB36bn, covering HY, Yuanbao, CodeBuddy, WorkBuddy, and QClaw.
• 1Q26 capexRMB32bnEqual to about 16% of revenue, higher than RMB20bn in 4Q25.
• 1Q26 new AI product expensesRMB8.8bnExcluding this spending, non-IFRS operating profit rose 17% year over year.
• 1Q26 non-IFRS operating margin (excluding new AI products)43.0%Higher than 39.9% a year earlier.
• 1Q26 Tencent share repurchasesHKD7.6bnAmount of shares repurchased by the company in 1Q26 disclosed in the report.
• 2026e HSBC EPSRMB30.62Cut by 2.4% versus the prior forecast.
• 2026e PE13.1xBased on HSBC EPS, the valuation multiple is expected to decline to 10.3x by 2028e.

Impact & implications

The report is mildly positive for Tencent from an investment perspective: AI spending lifts short-term capex and expenses, but core business profitability continues to improve, and the combination of AI capabilities with products such as WeChat, cloud, advertising, and office development tools may further enhance ecosystem efficiency. The target price cut reflects pressure from earnings forecast revisions and cost-of-capital assumptions rather than deterioration in the core operating logic. For investors, the key questions are whether game bookings can continue to convert into revenue, whether AI capabilities can keep improving ad monetization, whether FBS and cloud businesses can expand high-margin scale, and whether AI investment can generate verifiable product returns.

Risks

• AI capex and spending on new AI products may continue to rise, putting pressure on free cash flow and net profit.
• If core business margin expansion is insufficient, incremental AI investment may not be fully absorbed.
• Game revenue is affected by recognition timing, product cycles, and user activity, so strong bookings may not translate into revenue immediately.
• Advertising depends on WeChat ecosystem time spent, ad load, and AI recommendation efficiency; slower demand or pricing would hurt growth.
• FBS and cloud businesses face AI infrastructure costs, competition, and fluctuations in customer demand.
• Profit contributions from associates and joint ventures, as well as lower interest income, have already pressured net profit forecasts.

What to watch

• Whether Tencent's capex rises further after domestic chip supply improves in 2H26.
• User retention, monetization, and the pull on cloud token demand from HY, Yuanbao, CodeBuddy, WorkBuddy, and QClaw.
• The extent of revenue growth recovery in domestic games for the rest of 2026, and the sustainability of bookings for evergreen titles such as Honor of Kings, Peacekeeper Elite, and Delta Force.
• The impact of AI ad recommendations, AIM+, and Video Account ad load in Marketing services on revenue and gross margin.
• Changes in FBS revenue mix, international Tencent Cloud revenue growth, and AI-related GPU/CPU/storage demand.
• Whether non-IFRS operating margin can continue to expand amid higher AI spending.
• The pace of share repurchases and their impact on EPS and shareholder returns.