Tencent Holdings Ltd:Acquires Supercell,Bonds are not cheap

　　The deal

　　The well broadcasted transaction (in the press) was finally announced today with Tencent acquiring 84.3% stake in Supercell for USD8.6 billion. However, it intends to divest 50% of the voting interest to co-investors within 90 days of the closing date. The consideration is to be paid in three installments - USD4.1 billion on closing, USD4.3 billion within 90 days after that, and the balance USD200 million after 3 years. In terms of funding, Tencent will be investing USD3-4 billion, with the remaining proceeds to come from bank loans at the target level and the co-investors. Supercell won't be consolidated by Tencent, nor equity accounted, implying it will be treated as an investment. The target's full financials haven't been disclosed, but it made PAT of EUR693 million in 2015, a 63% increase yoy. Reuters however, previously reported that 2015 EBITDA was EUR848 million, which leads to an EV/EBITDA multiple of just over 10x. Forward looking EV/EBITDA should be less than 10x versus Tencent's own multiple of 22x (per Bloomberg).

　　Credit implications

　　Tencent's LTM EBITDA, Cash & Debt at the end of March stood at around USD7.7 billion, USD14 billion and USD11 billion, respectively. Let's assume investment in Supercell at USD4 billion is debt funded and proportionate EBITDA share is ~USD400 million. Note that it has recently closed a syndicated loan of USD4.4 billion. Post acquisition, proforma gross leverage will increase from about 1.4x to approx. 1.8x taking it above the downward rating trigger of 1.5x (per Moody's calculations). However, as mentioned in our past notes, we don't expect any immediate rating downgrades (A2/A/A+). Our base case is that S&P should also keep its positive outlook. We believe rating agencies are likely to give the company time to bring leverage down and will see the acquisition as an operational positive. Plus, there is the possibility of Tencent funding part of the acquisition with cash on hand. We highlight that S&P's methodology is more lenient than Moody's as the former gives credit for part of the cash balance while calculating leverage ratios.

　　Bond view - Maintain Hold

　　Tencen't bonds are the tightest trading in the China tech sector, having materially outperformed this year. The 2019s are at G+120bp and 2025s at G+165bp as we write. As detailed in our report on June 15, we see limited upside in them and instead see best value in Alibaba (2019s at G+130bp, 2024s at G+190bp), especially at the long end. Key upside risks for Tencent are continued growth in the mobile gaming business that leads to deleveraging and rating upgrades, while downside risk is further large debt funded acquisitions.

　　What is Supercell?

　　It's a private mobile gaming company in Finland that has brought four main games to the market - Clash of Clans, Clash Royale, Boom Beach and Hay Day.