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Hi friends 👋,
Happy Monday! Thanks to all of you for your feedback! I’ve read through all of it, and I’ll be incorporating a lot of your ideas in the coming weeks.
One of the biggest pieces of feedback you gave was to either a) shorten the essays or b) give a TL;DR upfront. I’m going to try the latter today with a short summary of the essay in slide form. You can check it out here, and I’d love to hear your thoughts.
In Part I, we covered Tencent’s history, its current businesses, and its massive portfolio of investments. Tencent is undervalued based on its current operating businesses and the current value of its portfolio alone.
But Tencent’s positioning for the future is even more compelling, and that’s what we’re going to discuss in Part II today.
Full Disclosure: I own shares in Tencent after doing research on it for this two-parter.
Let’s get to it.
This is the second part in a two-part series. Check out Part 1: Tencent: The Ultimate Outsider.
Tencent’s critics argue that it gave up on its dreams by focusing on investing instead of product innovation. I disagree. Instead of building any specific product, Tencent is building an organization and ecosystem designed to be massively profitable in the short-term with asymmetric upside.
Through its investments, Tencent is in the best position of any company to usher in and profit from the Metaverse, the misunderstood and potentially mega-lucrative evolution of the internet.
I’m not the first person to realize that Tencent is in the lead. In his recent Invest Like the Best interview, investor Matthew Ball said, “So if you said ‘who is closest to the Metaverse today?’ the simple answer is not Fortnite or Minecraft, it’s Tencent.” But Tencent’s advantage extends beyond its lead position in gaming, because the Metaverse will be so much more than games.
Look closely at Tencent’s portfolio and you’ll find a group of companies across gaming, ecommerce, and social that will bring the Metaverse to fruition and share in its massive upside. Tencent’s structure and strategy -- provide capital and traffic -- is the perfect model to profit from the decentralized, competitive, creator-friendly ecosystem that the Metaverse is likely to be.
That’s a big claim, so here’s what we’ll cover to get there:
The Metaverse. What the Metaverse is, which parts of it are here already, and how big the opportunity is.
Tencent’s Strategy. Instead of building everything itself, Tencent invests. Its Capital + Traffic Flywheel is a smart way to bet on the Metaverse because while technologists are nearly certain that it will exist, no one knows exactly what form it will take.
Platform + Content. The Metaverse will comprise the Platforms on top of which it’s built and Content that users interact with for entertainment, socializing, learning, and commerce. Tencent owns leading Platform candidates - Epic’s Unreal Engine (VR), Snap (AR), Spotify (Audio), and WeChat (internet / super app) - plus companies through which people will play, shop, learn, and socialize.
Where Tencent Might Invest Next. Tencent has announced its intention to invest in infrastructure and “Smart Retail,” and it is likely to invest in remote work and collaboration products like Figma and Agora to round out its business offering.
Obstacles. Tencent faces government regulation and well-resourced competitors.
This post is fun speculation combined with practical implications. Tencent’s valuation doesn’t properly price the Metaverse opportunity -- it can’t, it’s so early and so speculative -- which means that with Tencent, you get a business that is undervalued today and a free call option on the future.
I want you to leave this post with a better understanding of the Metaverse, and an appreciation for the opportunity that Tencent has to make it a reality and profit from its rise.
What is the Metaverse?
Oh no, not another Metaverse thinkpiece…
Hear me out. The term, first introduced by sci-fi author Neal Stevenson in his 1992 Snow Crash, makes the idea sound silly and game-like. It sounds a little like talking about the World Wide Web in the early 1990’s. Like the Web back then, the Metaverse is an important idea in need of a rebrand.
So what is it?
In The Metaverse, Matthew Ball says the Metaverse will be an always-on, real-time world in which an unlimited number of people can participate at the same time. It will have a fully functioning economy and span the physical and digital worlds. Data, digital items, content, and intellectual property (“IP”) will work across the Metaverse, and many people and companies will create the content, stores, and experiences that populate it.
Epic Games CEO Tim Sweeney agrees, adding, “it will be a massively participatory medium of a type that we really haven’t seen yet,” with “ a fair economy in which all creators can participate, make money and be rewarded.”
The Metaverse sounds a lot like the real world, layered with digital components at varying degrees of immersion.
A participant might walk through a virtual mall and buy a digital Mickey Mouse costume in the Disney store for his avatar to wear, then pop over to the food court to pick something to eat to be delivered to his physical house via Uber Eats, and then pop into a live Beatles concert in the Spotify Performing Arts Center. He can keep the concert going in his AirPods on Spotify when he wants to go for a run in the physical world, racing against his friends in an AR Peloton-like experience. The whole thing feels seamless - his data and purchases carry across and among physical and digital worlds.
Ball, Sweeney, and everyone else I’ve read on the topic agree: the Metaverse won’t happen overnight. There won’t be a clearly demarcated “before the Metaverse” and “after the Metaverse” divide, and it won’t be built and run by one company. The Metaverse will be the result of the evolutionary convergence of many separate tools, platforms, and worlds underpinned by shared infrastructure, standards, and protocols.
In fact, Marc Geffen makes the case that the Minimum Viable Metaverse is already here in games, the democratization of ecommerce, the rise of “premium” social media, and the adoption of decentralized, distributed, and remote productivity tech.
The Metaverse won’t be any one thing. It’s not just one big video game. It’s not just Second Life. It’s not just a huge shopping mall. It’s not the scene from Wall-E that I like to include whenever I talk about the future.
It’s all of those things, and the connections between them, and more. The Metaverse will be a way to blend the physical and digital worlds while allowing us to be fully present in either - it’s the real world, AR, VR, and the internet all rolled into one.
With regards to Tencent’s business, three things are important to realize about the Metaverse:
The Metaverse isn’t science fiction, it’s an inevitability even if its final form is unclear.
Games and game engines are important, but they’re just one piece of the puzzle.
Owning large swaths of the Content and Platforms underpinning the Metaverse and of the content and commerce taking place within it will be highly lucrative.
Ball believes that even in a conservative case, the Metaverse will be worth trillions of dollars. But it’s impossible to quantify, like trying to predict how big the “net” was going to be back in the early 1990s. We knew it was going to happen, and we knew that it was going to be big, but we couldn’t have imagined exactly what it would look like, or that it would spawn multiple trillion dollar companies and many more multi-billion dollar ones.
While we can’t know the exact what or how, the Metaverse represents an unprecedented wealth creation opportunity. And Tencent, through its investments and consolidated assets, is in the driver’s seat. Which brings us back to Tencent’s dreams.
Capital + Traffic
A strategic decision nine years ago accidentally set Tencent up to create more value from the Metaverse than it does from its entire core business by focusing on investment over organic growth.
After reading Part I, Rui Ma pointed me to the Tech Buzz China podcast in which she and Ying Lu discuss Pan Luan’s 2018 piece titled “Tencent Has No Dreams.” In it, he argues that a 2011 decision at a management team offsite caused Tencent to lose sight of its product-focused roots.
Back in 2011, Baidu passed Tencent as the most valuable tech company in China, and Pony Ma called a meeting of his top management to chart a new course for the company. In the meeting, dubbed “The Conference of the Gods,” he asked his 16 top executives to list out Tencent’s core competitive advantages. Two winners emerged: capital and traffic.
Led by President Martin Lau and his former Goldman colleague James Mitchell, who he brought on as Chief Strategy Officer, Tencent built its strategy on this flywheel of capital and traffic.
Attract companies to build on its platform with huge traffic, invest in the winners, give them more traffic, invest more or acquire the winners, generate more traffic, attract more companies, and so on. It runs essentially the same playbook with foreign companies who want access to China.
The strategy seems to be working. Since that 2011 meeting, Tencent’s stock has increased nearly 15x, from $44.5 billion to $660 billion.
Luan warned, though, that “Hidden behind the ten-fold increase in market value is the investment banking thinking that focuses too much on short-term ROI.”
He cites the fact that Tencent missed out on short-term video, kills internal projects quickly based on ROI calculations, and failed to internationalize WeChat. Luan also argues that Tencent’s intolerance of failure leads to a lack of innovation and talent development, painting the picture of Tencent as a place where, “Smart people just make PowerPoints and quarrel with each other.”
Luan’s argument boils down to one that’s familiar to the American tech giants: they can’t innovate anymore, so they just copy and acquire. Facebook’s internal projects are flops, so it acquired Instagram and Oculus and WhatsApp and copied Snap Stories. Google can’t create anything new beyond search (remember Google+??), so it acquired Android and YouTube and DoubleClick.
But Tencent’s focus on investment over organic innovation is really smart for two reasons. First, building a startup is an exercise in innovation; running a large company is an exercise in capital allocation (recall The Outsiders). At this point, Tencent creating all of its own products would actually be inefficient. The company’s best minds should be focused on building an organization and ecosystem that sets it up to catch the next major wave of growth.
Second, investment versus full ownership is the right way to play the Metaverse opportunity. If the Metaverse is going to be decentralized and more profits will accrue to creators, it makes financial sense to spread bets across both platforms and content creators instead of trying to build one central platform, like a WeChat version of the Metaverse.
Historically, Tencent has evolved its approach to meet evolving tech trends. It launched QQ to capitalize on the rise of the internet in China and it built WeChat to ride the mobile wave. Now it’s building a portfolio of companies that position it to profit from the shift that has the potential to create more economic value than either of the previous two.
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Tencent’s Metaverse Dreams
There are two big components of the Metaverse: Platform (where) and Content (what). Tencent owns stakes in more of the components of each than any company in the world.
The magic of the Metaverse is that it will seamlessly integrate the myriad platforms on which we socialize, work, and consume - merging Augmented Reality (AR), Virtual Reality (VR), audio, the internet, and the physical world. Tencent owns key players in each, including Epic, Snap, Spotify, WeChat, and even physical retail.
VR: Epic (Unreal Engine)
In Tencent’s Metaverse solar system, Epic is the sun. In many ways, its major title, Fortnite, is the closest thing we have to the Metaverse today.
Looks Like the Metaverse We Think Of: It’s a persistent, synchronous, live virtual world, complete with shared group experiences like the Travis Scott concert.
IP Melting Pot: Competing IP co-exists in Fortnite - you can buy both Marvel and DC skins, NFL jerseys and Jordan sneakers, or be John Wick or Ariana Grande (link)
Cross-Platform: Players can play against each other on competing consoles or platforms - players on Mac, Playstation, Xbox, and Android can all play against each other.
Participatory: In Creative Mode, players can build their own worlds, and Epic has partnered with creators from the community to develop and sell their skins.
Epic is running the Traffic side of the Tencent playbook - because all of the players are on Fortnite, it can get consumer-friendly deals out of parties -- like IP holders and game console makers -- that others cannot.
Fortnite is just a trial run for a bigger prize, though. It puts Epic’s Unreal Engine in the prime position to become the Platform on top of which many of the virtual components of the Metaverse are built.
Game developers, filmmakers, and architects alike use its Unreal Engine to build rich, immersive digital renderings and worlds. Popular game Gears of War, Disney+ hit The Mandalorian, and leading architects Foster + Partners and Gensler all build with Unreal.
A shopping mall designed in Unreal Engine, Source
As more games, movies, cities, and buildings are built on the same engine, it becomes easier to stitch together a full virtual world. And more will build with Unreal and Epic, because the company is practically giving away its best-in-class tools for free.
Epic has the lowest store fees of its competitors (12%), the most publisher-friendly publishing tools, and the most open ecosystem. If a competitor wants to work with Epic, Epic will work with it. Epic does all of this in service of the creators, large and small, who it sees as crucial to pulling the Metaverse forward in time, and to creating a massive Total Addressable Market. The more money creators can make, the thinking goes, the more likely they are to create, the more attractive it will be for users to spend time in the Metaverse, and the more lucrative it will be to be the engine building the Metaverse.
Tencent owns 40% of Epic, which recently raised at a $17.3 billion valuation, and looking 10-20 years into the future, that 40% stake could be worth more than all of Tencent today. But it’s just one component of Tencent’s Metaverse Platform play. Another crucially important piece is Snap.
Tencent is Snap’s largest shareholder, with 12% ownership (although no outside investor has voting rights or control). If Epic is a leading contender to build the virtual world components of the Metaverse, Snap is a leading contender to build the AR components, or Mirrorworld. As I wrote in Oh Snap!:
Mirrorworld, according to Kelly, won’t take place in Virtual Reality (VR), but rather in Augmented Reality (AR). It will blend digital and physical, layering bits’ infinite possibilities on top of atoms’ realness.
Snap is employing the Amazon “First and Best Customer” strategy. It builds products for its own app first - like Lenses, its first AR hit - and then opens up the tools to both its community to create within Snapchat, and third-party developers to incorporate Snapchat’s features into third-party apps.
Snap is building a wide-ranging set of products that build off of each other and work together to lead to a future in which Snap powers the Mirrorworld.
Here’s a glimpse from Snap’s Partner Summit:
Like Epic, Snap isn’t building a closed ecosystem. It’s building the tools that others can use to build and profit from AR experiences, inside or outside of the Snapchat product, so that it becomes the platform on top of which developers build the Mirrorworld.
Camera Kit: Gives any developer the power of Snap’s Camera, the most widely used piece of AR technology in the world.
Bitmoji: Snap owns Bitmoji, which gives everyone their own personalized avatar to use within Snap Games and Minis, and across many external apps, platforms, and OS’s.
Snap Kit: Powers 20 of the top 100 apps in the iOS and Google app stores.
Local Lenses: Allow users and businesses to build digital worlds on top of the physical one.
Snap will be a leader in AR and continue to grow as its user base matures, which will put it among the tech giants in terms of valuation. Today, it’s valued at 1/70th of Apple and 1/30th of Google. If it catches up to where the tech giants are today, Tencent’s stake will be worth over $100 billion. (Insert $100 billion in 10 years meme here)
There’s a version of the Metaverse that looks less like Ready Player One and more like Her. That is to say, audio-based. We are decades or centuries away from being able to do everything we need to do in the virtual world, which means that we will still need to spend plenty of time in the physical world. During much of that time, we will plug in via audio. Today, Americans spend four hours per day listening to audio, including one hour of spoken word content. Tomorrow, we will listen to even more, as the lines between conversation and entertainment blur.
Spotify, of which Tencent owns 9%, is best positioned to capture that earshare. Spotify currently has 286 million monthly active users and is proving out its ability to deliver them different types of audio content beyond music, including podcasts, and soon, audiobooks. According to CEO Daniel Ek, Spotify has 10-15x growth ahead of it. As I wrote in Earshare, it is investing heavily today to ensure that it owns consumers’ ears as audio grows.
In the Metaverse, Spotify will fill the space between - when people are not fully immersed in the digital world, they will be able to continue the conversation with friends who are, interact lightly with AR through audio, or just relax and listen to some music.
At 10x where it is today, Tencent’s investment in Spotify would be worth $35 billion.
Tencent’s core asset today is WeChat. As we discussed in Part I, Chinese consumers do everything on WeChat - message, read the news, shop digitally, interact with businesses, communicate for work, pay for things in the real world, and more. With the launch of its Mini Programs, companies are able to build richer experiences within the WeChat ecosystem. In some ways, WeChat is a mini, 2D Metaverse.
As Tencent quietly orchestrates the adoption of the Metaverse via its minority investments, it will be interesting to watch how much inspiration the Metaverse takes from the WeChat ecosystem. Snap has already started to look more like WeChat with the launch of its own Minis, and the super app’s influence will continue to shape the way that we build new digital economies.
Infrastructure and Smart Retail
Tencent already owns stakes in the platforms of the future, and it has more cash to spend. The company said that it will invest $70 billion in infrastructure including cloud, AI, cybersecurity, blockchain, 5G, and quantum computing over the next five years. It will also be investing heavily in Smart Retail, further bridging the gap between digital and physical retail through payments and other shopping tech. Together, its infrastructure and Smart Retail investments will help build more of the underlying technology and connective tissue the Metaverse will need.
Taken together, Tencent owns stakes in the leading companies building the Platforms on which the Metaverse will be built: VR, AR, Audio, and Internet. Epic, Snap, Spotify, and WeChat are all building true platforms -- on which the majority of the profit is made by creators. For the Metaverse to be interesting enough for people to adopt, creators are key. There need to be games to play, music to listen to, rich social experiences, ways to make money, and things to buy with that money. In other words, there needs to be Content.
Tencent’s Platform investments enable content creation, and it also invests in Content creators. Capital and Traffic for the next wave. When you lay Tencent’s investments on top of Geffen’s graphic, its Content play emerges.
Tencent owns stakes in four of the companies that Geffen included in his original graphic (circled in blue): Snap, Discord, Roblox, and Epic. I’ve added more of Tencent’s holdings to the chart to show that Tencent is already a leader in three of the Minimum Viable Metaverse categories, which are the early Content layer: Games, Premium Social Media, and Democratized Ecommerce.
Virtual Worlds and Spatial Software (i.e. Games)
Games are the first Metaverse Content that many people will engage with, and Tencent is the leading video game company in the world.
Its online games segment did $5.5 billion in Q2 revenue, more than any other company.
It owns Riot Games, which makes League of Legends, the most popular esports title in the world by over 4x as judged by Twitch streams and 40% of Epic Games, which makes Fortnite (350 million players). Unreal Engine is Platform, Fortnite is Content.
Matthew Ball talks about games as the “on-ramp” experience for the Metaverse, the thing that will get early adopters to try it out. Tencent owns that on-ramp, and the titles that will keep people engaged and immersed in early versions of the Metaverse.
Democratization of Ecommerce
For the Metaverse to become more than just an immersive game environment, it will need to support a functioning economy. For that to happen, people will need to be able to sell things in the Metaverse, which is to say, in a seamless way across the digital and physical worlds. Try on a shirt with AR, buy a digital version for your avatar, and have the physical version shipped to your door.
Tencent owns stakes in some of the leading ecommerce companies in the world, many of which “arm the rebels” instead of vertically integrating, with publicly stated plans to add more:
WeChat allows companies to easily set up stores and experiences that reach over a billion customers, and WeChat Pay lets people buy things online or in the real world.
Paystack powers digital payments in Africa, Khatabook does the same in India, as do Gojek in Indonesia and SeaMoney in Singapore. Seamless payments will be crucial to power Metaverse stores.
Pinduoduo’s Customer-to-Merchant and social commerce models are reshaping ecommerce in ways that may work even better in the Metaverse than they do on mobile.
Tencent’s current portfolio and future investments in Smart Retail will continue to blur the lines between digital and physical shopping. They will be crucial in defining the shape of the Metaverse economy, and its assets stand to benefit from the Capital and Traffic Flywheel across its Metaverse Platforms.
Premium Social Media
The Metaverse will let friends, family, and colleagues from across the world gather in immersive environments even more easily than walking next door. It will also let strangers with shared interests find and engage with each other.
Tencent has an impressive portfolio of Premium Social companies:
Tencent owns 50.1% of Huya and and 38% of Douyu, China’s versions of Amazon’s game streaming product, Twitch. Game streaming mechanics may underpin broadcast activities beyond gaming.
Discord, of which Tencent owns ~2%, bills itself as a “place to talk and hang out.” It represents a proto-version of persistent hangouts in the Metaverse.
Snap is both a Platform and a Content play, and is a more intimate social network in which young users mainly interact with their closest friends instead of strangers.
Tencent owns ~5% of Indian education platform, Byju’s, the most valuable online learning company in the world.
Like a party or a new social network, people will only hang out in the Metaverse if their friends are there. As the Metaverse comes into focus, these Premium social communities will continue to merge with the other aspects like ecommerce and gaming, making many of the things we do more social. We’ll go to the mall, movies, or concerts with friends, just like the real world pre-Corona.
Through its Capital and Traffic approach, Tencent has built a portfolio of internal and external products, platforms, and services that perfectly position it to own the Platforms on which the Metaverse is built, and the Content with which Metaverse users will engage to play, build communities, learn, and shop. So what is it missing?
Where Tencent Might Invest Next
The one area from Geffen’s map in which Tencent is underweight is “decentralized, distributed, and remote productivity tech,” particularly compared to Metaverse competitors Microsoft and Google. Assuming that remote productivity will be an increasingly important component of the Metaverse, I expect that remote productivity tech will be a main area of focus for Tencent in addition to previously announced infrastructure and Smart Retail plays.
If I were doing corp dev at Tencent, here are a few companies I would be interested in:
Figma. The collaborative design tool that I use to make all of the beautiful graphics in Not Boring would be a strong addition to the portfolio because it is both a work collaboration tool and a potential on-ramp for people to design new worlds and experiences in the Metaverse. People use Figma to synchronously co-create shared environments, like WFH Town.
Agora. Tencent brazenly copied Zoom with VooV, which it launched in 100 countries on March 20th. Agora, which went public in June, allows anyone to embed video or voice in their applications. I think that the future of video will look more like use-case specific video environments versus everyone using Zoom, and Agora is both a good way to play that trend and a way for Tencent to spread into thousands of products as a Platform.
Zapier. When I wrote that Google should acquire Slack, Schlaf replied that Zapier is more strategic because “it’s plumbing and glue. It ties together a whole ecosystem of applications, services, and developers.” In a Metaverse defined by the connection among platforms, worlds, and content, its connective plumbing may be even more important.
Remix Machines. In The Generalist, Mario Gabriele cited a wave of products unbundling the Microsoft Office Suite with slicker UI and more collaboration. Many of the companies he discusses, like Notion, Coda, Roam, Airtable, Causal, Canva, Projector, Kapwing, and Webflow are well-suited for the Metaverse, which will be largely multiplayer as opposed to one-to-one or solo.
Many of these companies are too early in their lives and their trajectories are too steep for them to sell to one of the American tech giants that would swallow them whole. Tencent’s more passive investment approach is likely preferable to the companies. Within the Tencent portfolio, they can get access to capital, traffic, and a seat in the early Metaverse.
Obstacles to Tencent’s Dream
Tencent’s success in the Metaverse is not a foregone conclusion for three reasons:
Government. Tencent is a Chinese company, and the Trump Administration recently issued an Executive Order to prevent people in the US from using WeChat, which the Administration views as a security threat. Were Tencent to take a leading position in the Metaverse the government would very likely intervene.
This is one of the areas where Tencent’s structure is advantageous. It’s impossible to imagine the American government (or Indian government, or many other governments) allowing its citizens to spend the majority of their waking hours in the Metaverse by Tencent™️, but it will be harder to prevent people from spending time playing Fortnite or League of Legends, interacting with the world through Snap’s AR, or listening to music on Spotify. Even still, world governments could force Tencent to divest ownership in businesses operating in their countries. Even the Chinese government has been an impediment to Tencent’s dream when it imposed restrictions on in-game purchases in 2018, driving Tencent’s stock down 20%.
Competition. Tencent will face opposition from bigger competitors and new entrants alike who have their own designs on controlling the next big platform shift. Facebook bought Oculus to own VR. Microsoft owns Minecraft and the Hololens, and may own TikTok, which is already stealing attention from Tencent’s properties. Google is gunning for cloud gaming with Stadia and won’t give up its place as the home page for the internet easily. Amazon is the world’s largest ecommerce business and its largest cloud provider, owns Twitch, and is the best of the bunch at developing new business lines. Apple is currently engaged in a battle with Epic over its 30% app store fee, and has shown that it is willing to play hardball to hold on to its hard-won place in the content ecosystem.
The Metaverse is Uncertain and Likely Distributed. Ultimately, no one company will own the Metaverse, and it’s important for Tencent to work with competitors, as Epic has done, in order to maintain its advantage. It will have to convince the other major tech companies that accelerating the arrival of the Metaverse will be positive sum for all of them, and then work arm-in-arm with competitors to convince regulators across the world that what they’re building, and how they’re building it, is good for society.
Despite the obstacles, investing in Tencent is the best way to invest in the Metaverse. It is the only way for you and I to invest in Epic, which many believe to be the most important Metaverse builder. If it ends up being more AR than VR, Snap will do well. If audio plays a larger role, Spotify will do well. If it blends multiple media, all three will boom together. Even if another giant or startup builds the infrastructure, many of its Content plays stand to benefit from a richer digital / physical economy.
If Tencent can nudge its portfolio companies to work together, it will accelerate the Metaverse’s development and solidify its own leading role. Even if it can’t, many of its bets stand to perform well independently, and the likelihood of one or more massive winners is high.
And if the Metaverse doesn’t emerge at all? If we continue to use the internet in the way we do today for the next century? Tencent owns a portfolio of companies that stand to benefit from the simple straight line continuation of existing trends towards more gaming, ecommerce, audio, digital communication, and digital healthcare. The more we do online, the better Tencent does.
This feels like the kind of opportunity that most of us missed to buy a basket of Apple, Amazon, Google, and Microsoft in the early 2000s, buffeted by a massive, profitable, and growing core business. Ultimately, Tencent is an undervalued portfolio of many of today’s top internet assets and a free call option on a new world.
That’s all for this week, see you on Thursday!
Thanks for reading,