Tencent Pair Trade That Earned a Quick 54% Now Looks Crowded

(Bloomberg) -- Betting on the widening split between Asia’s two tech darlings would have been a slam-dunk trade in the third quarter. The question is whether it’s still worth chasing.

Anyone with the foresight to short Tencent Holdings Ltd.’s shares while going long Taiwan Semiconductor Manufacturing Co. could have made as much as 54 percent in the three months through September. The Hong Kong-listed gaming giant had its worst-ever showing relative to global tech, shedding about $84 billion in market value since the end of June, just as the Taiwanese chipmaker added $39 billion. The latter’s outperformance was the widest on record.

Tencent Pair Trade That Earned a Quick 54% Now Looks Crowded

Tencent is struggling to bounce back from this year’s lows after China got stricter on online games, the latest in a string of bad news that included the company’s first profit drop in at least a decade. Meanwhile, investors flocked to TSMC after a U.S. competitor quit trying to develop the most advanced chip production technology, paving the way for Taiwan’s biggest company to solidify its dominance of the market.

While TSMC continues to fare better than Tencent in October, some say that the trade will fade. Both stocks fell more than 1 percent Friday, tracking losses for Asia tech shares after Bloomberg reported that China used a tiny chip to hack almost 30 U.S. companies.

“It’s starting to look like a crowded trade,” said John Tsai, who owns the two stocks for Eastspring Investments Ltd. in Singapore. “I don’t think the rotation from Tencent to TSMC is still accelerating -- it’s probably slowing.”


One reason the trade won’t hold, according to Tsai, is valuations. At 26 times projected earnings, Tencent is about 55 percent more expensive than TSMC despite this year’s divergence, data compiled by Bloomberg show. But long-term investors eyeing Tencent would still be getting one of the best deals since the stock started trading in 2004. Valuations for TSMC, on the other hand, are close to their highest in nine years.

After a stellar 2017, multiples for some Chinese tech companies turned so frothy that the first signs of not-so-good earnings hit the stocks hard. The latest results season offered little in the way of encouragement. In addition to Tencent, AAC Technologies Holdings Inc., Sunny Optical Technology Group Co. and Kingsoft Corp. struggled.

Another View

For Eleanor Creagh, a market strategist for Saxo Capital Markets, uncertainty over the pace of gaming growth will continue to weigh on Tencent, as well as its pricey valuation relative to U.S. Internet shares. TSMC will fare better even though it predicts softer demand for its semiconductors, as it can retain loyal customers and grab market share from retrenching rivals, she said.

“Momentum should continue for this trade,” Creagh said from Sydney. “We expect Tencent to remain under pressure in the near term, therefore incremental appreciation in TSMC’s share price will likely outpace that of Tencent.”

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While the two giants of the emerging-market world are exposed to separate businesses and sell across different geographies, they’re often lumped together by global money managers wanting a slice of fast-growing tech. TSMC and Tencent are the largest stocks on MSCI Inc.’s EM benchmark, which is tracked by almost $2 trillion worldwide.

They’re also among the most owned: some 61 percent of global EM funds featured TSMC in their portfolios, and 51 percent had Tencent shares, according to eVestment data as of June. The positioning after last quarter’s winning trade means that betting against Tencent may be getting too risky now, according to JPMorgan Asset Management’s Howard Wang.

Chinese regulators resuming approvals for online games or a surge in Chinese markets would be two such risky scenarios, said Wang, who oversees JPMorgan Asset’s $536 million Greater China fund from Hong Kong. “It’s more about asset allocation risk than anything to do with the companies themselves.”

©2018 Bloomberg L.P.