Why Mohnish Pabrai Ditched Alibaba for Tencent

At the end of the day, it has a very talented management team and it has a very dominant footprint in the minds of its consumers. I think the business will do fine, and they’re pretty smart about the way they go about it. I don't think the model is as good, in my opinion, as a Tencent, but both can do very well.

Well, we saw in Monish Bride's most recent 13F that he sold 78% of his Alibaba shares, which at the time threw us all for a loop, especially with his close friend Guy Spear holding on to his position and his idol Charlie Munger adding substantially to his position. But as we got to see more and more interviews from Monish, it soon became clear that he's still a fan of Alibaba, but he likes Tencent a lot better.

While we don't have any official confirmation, all scenarios point to the idea that Monish has been selling down some of his positions to take a stake in Tencent. So in this video, I wanted to hone in on what Monish sees in Tencent because I think his perspective is a very interesting one and I think he absolutely hits the nail on the head with how their business actually works.

So all aboard the Monish Prize school bus! Let's go!

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Alrighty, so what is Tencent? Let's get into it. It's a company that is bigger than Berkshire Hathaway, but honestly, most Westerners don't know a single thing about it. And honestly, that's understandable because we just don't use it.

Tencent is a Chinese tech company that has two parts of their business: number one, their operating businesses, and number two, their investments. This is a good way to think about Tencent, and Monish will explain this more in a clip that I'll play in a minute or two.

In terms of operating businesses, it all stems from WeChat and QQ. These are both broad social media applications, with WeChat being about twice the size of QQ in terms of monthly active users. However, QQ is the OG product launched by Tencent in 1999. Yes, the bulk of Tencent’s users and customers are on WeChat, known as Wei Xin in China.

When you glance at WeChat, it certainly seems just like a Chinese Facebook. But I like how McCormick describes it in his blog post, “Tencent: The Ultimate Outsider.” He says Tencent is like Facebook, Nintendo, Shopify, Netflix, Spotify, Slack, and PayPal rolled into one. WeChat is certainly like that. The 1.2 billion WeChat users run their life off of this app. They don't just send emojis to their friends with it; it's like a super app.

This infographic shows it well: chat, payments, search, games, video streaming, inbuilt business apps. WeChat really is like the super app of China. You can see this graphic showing how they're quickly creating an entire ecosystem. Tencent is using their software prowess to embed their apps deeply into people's daily lives.

As you can see, it starts with WeChat and QQ. Then, there are three pillars to these apps: sharing, communication, and socializing, and that branches out to video content, games, music, reading, payments, and work. Medical—you know it's a big ecosystem, and this giant user base has led them to have very big impacts in many industries: number one in social media, number one in games, number one in long-form video, news, music, literature, number one mobile browser, number one in mobile payments. In fact, they only score number two in cloud, with number one taken, obviously, by Alibaba.

So they have dominant operating businesses. But where do they make their money? Well, when you look at their financial statements, you'll see that 21% of revenue comes from their social networks. This includes video and music subscriptions, live streaming, and in-game item sales.

Then, 31% of revenue comes from games, including Honor of Kings, League of Legends, Brawl Stars, PUBG Mobile, Call of Duty Mobile, Valerian, Clash of Clans, and a lot more. 17% comes from online advertising on WeChat and QQ, as well as their app store browser, their news, video, music offerings. Then, 29% comes from their fintech and business services, including things like payments, wealth management, cloud, and other enterprise-facing services.

So that's their operating businesses. But then the second half of Tencent’s business is their big investment portfolio, packed full of growth companies. On a recent earnings call, they said they now have positions in over 700 companies. Now, I don't think there's a full list of all of these businesses. But we know this includes big stakes such as 5% ownership of Tesla, 12% stake in Snap, 40% in Epic Games, 9% of Shopify, 17% of Pinduoduo, 18% in JD, and so on.

So you can start to understand why this company is sometimes called the Berkshire Hathaway of technology. You know, it's a big conglomerate with a lot of operating businesses, but then also a big equity portfolio.

So overall, that's a bit of a summary of Tencent’s business. But now I wanted to play you a clip of how Monish Pabrai sees Tencent. This will start to give us an indication of why he likes Tencent so much, even more than Alibaba.

Now, this is a long clip; I apologize, but try and pay attention to what he says here.

"I realized that basically Pony Ma has a very simple business model. He has two businesses. One business that he has is his army of software engineers. I don't know how many engineers he has—maybe 25,000, maybe it might be 50,000 now—but it's a large army of software engineers. It's basically a massive bazooka that he has with his army of engineers, and he decides where and how he wants to fire the bazooka.

The way they fire the bazooka is, for the most part, even if they have some misses, they end up with this total dominance. So, for example, they have total dominance in video games. Okay? And I realize that it really doesn't matter what the CCP, or the Chinese government, does regarding video games. It is like a pimple on a camel's butt from Tencent’s perspective. They have almost no profits or revenues from within China in video games. Less than 5% of their video game top line and bottom line is coming from China.

As soon as the Chinese Communist Party started making noise that this is not such a great thing to have all these people playing all these video games, within a femtosecond, that bazooka got completely pointed outside China. He just took his army and said, 'Okay, ignore China; let’s focus on the rest of the world.'

In fact, I would go even a step further and say you could ban video games globally, and Tencent would still continue to prosper because they would still have the army. So while the financial reports will describe this first half of the business as the operating businesses—WeChat, QQ, video games, payments, etc.—the way Monish sees it is not in the end product but in the talent pool that Tencent has acquired over time: the killer software engineers that can work together and make great products and services.

That's really the competitive advantage, in Monish's eyes, and it also adds a layer of protection to the business because, you know, if one part of their business starts failing, or you know, new rules get applied to them or something like that, that wouldn't crush Tencent. Sure, they may be wounded for a period of time, but they can just redeploy the talent to make another killer app in another industry.

You know, as Monish says, in video games, they've just redeployed the talent to focus on games outside of China, you know, after the CCP recently cracked down on video games. So the idea of the talent being the competitive advantage is definitely something that Monish likes a lot about this business.

I would bet that, given the superiority of the Tencent model, it would not surprise me if we look 10 years or 15 years from now that it's the most valuable business on the planet. To a large extent, I feel that they may even be able to transcend a bunch of stuff that the CCP is throwing at them and continues to throw at them."

So there you go! It's a powerful model, but that's not only why Monish loves Tencent. In fact, I'd argue the most compelling part of this business to him is the management team. More specifically, how the CEO, Pony Ma, is always desperate to put money back into the business into profitable ventures.

Have a listen to this clip where Monish talks about the strategy behind Tencent’s capital allocation, and he actually also describes the second core part of their business in this clip as well. Have a listen.

"The way the software business works is that the productivity difference between an incredible engineer and just a good engineer could be a thousand to one. Pony Ma understands that really well, and he's really good at sifting through, you know, which are the rockstar superstars. He made sure that those guys are well taken care of, etc.

So he's got basically this army which can do a lot of digital stuff in a variety of fields, and they're really good at it. So when Tencent makes, like, for example, they made 15 billion dollars cash flow last year, Pony Ma goes to his digital army and says, 'What do you need?' Okay? So they tell Pony Ma, 'Pony, give me a billion,’ so Pony says, 'Yeah, that's okay; here's your billion. But that's not enough. Can you take five billion?' And they say, 'No, we can't handle that. It's hard for us to hire five or ten thousand engineers. I cannot hire 25,000 great engineers; I just—I don't know what I would do with them and how I would deploy them. So I cannot take more than a billion.’ So Pony says, 'It's so sad, but it's okay; here's your billion.'

Then he goes to his business number two—his business number two is he’s got 30 digital Warren Buffetts, okay? And he says, 'You know, these losers in business number one, they can't use my money, so here's $14 billion; have fun.' Then they go and they invest that in—some of it will be whole acquisitions, but most of it is small minority stakes in a number of businesses, okay?

That digital Warren Buffett, which is not one guy, may be, you know, 20 or 30 guys, put that $14-15 billion to work. And just to make sure that all the money is used, Pony makes sure that they spend a little more than the cash he generates. If he makes $15 billion, he spends $15.5 billion because he wants to borrow at 1%. He doesn't want some checking or savings account giving him 1%.

So he makes sure that when bazooka number one cannot use the money, he puts it into bazooka number two. And when he once he's fired both those bazookas, he's got no money left, and he's very happy."

So there you go! You can see how interested Monish is in this strategy: aggressive reinvestment in profitable ventures. Because ultimately, that's how we make money as investors; that's how a business creates more cash flow down the track.

I think the reason he's so excited about this is because, in today's day and age, you know, not many big companies are doing that. They're parking tens of billions in government bonds earning diddly squat, you know, they're buying back a lot of stock or they're just paying fat dividends, whereas Pony Ma is hell-bent on acquiring more talent and expanding the army.

Then when that side of the business just can't handle any more cash, then it gives it to the second part of the business, the digital Warren Buffetts, that make investments in growing technology. So no wonder Monish is excited by this mentality from the management!

But really, the cherry on top is that these two businesses within Tencent are actually producing big returns. So it's not even a case where a company is just desperately trying to force cash back into itself with little return. Tencent is actually getting a big return from this capital allocation, which, as an investor, is exciting.

So now here’s the economics for the last 20 years, which Pony Ma will never tell you. I have to tell you—I'm the Indian guy in the wonderful blue kurta. Okay, model number one: bazooka number one earns 65% annualized return on capital invested. Okay? Day in and day out, any billion he puts in historically has made 65% a year. Model number two makes 35% a year.

With those numbers, you can understand why Pony Ma tries to force-feed the software engineer army as much as possible. But you can also see why Monish is so intrigued by this business. The moat enables them to be relatively nimble for their size; the management team knows how to allocate capital. And, you know, lastly, the two core businesses generate great returns.

Monish himself says in this talk that, at the end of the day, Alibaba is good, but Tencent is better. So, in my view, I think he sold Alibaba to buy Tencent. I think he just wanted to do whatever was necessary to get on this train.

So overall, guys, that's my thoughts on Monish Pabrai and his recent opinions on Tencent. I'd love to hear what you guys think about Tencent’s business and about Monish Pabrai selling Alibaba for what I believe is to create a position in Tencent.

Let me know that sort of stuff down in the comments section below; I'd love to hear from you guys. Let's start a discussion down there! Leave a like on the video if you did enjoy it or if you found it useful. I really appreciate it. Subscribe to the channel if you're new around here.

If you haven't seen one of my videos before, feel free to stick around. We make lots of value investing content, so definitely subscribe to the channel! But guys, that will just about do us.

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