A sounds good story with leverage
One of our investment thesis has been the buying of Tencent Music Entertainment(TME), the dominant online music company in China. We proposed the company at 19.22 after a serious drop from 32 USD due to external to the company reasons. Now the stock at 15.78 offers a compelling opportunity for long-term investors & traders as well. With a floor price of 15 USD & a fair price of 22-25 USD the company has nothing to fear except possible US – China deteriorating relations & much bigger regulation scrutiny from Chinese regulators.
Now it’s time to go long, with the use of options in order to put some reasonable leverage on our thesis.
Based on that we propose a Vertical Call Spread executed as follows :
Leg1 -> we buy the Oct15_2021 call with strike price 15 for 210 USD debit per contract (100 shares)
Leg2-> we sell the Oct15_2021 call with strike price 20 for 69 USD credit per contract (100 shares)
Total position cost = 141 USD per spread contract.
If the stock closes above 20 USD on Oct the 15th the spread value will be 5 USD for a 359USD profit (max profit) per spread contract or 254% profit.
If closes below 15 USD 141 USD per contract is the loss (max loss).
The position is profitable when the TME stock price is above 16.41 USD.
Needless to say, the option position needs continuous reevaluation & it’s advisable to close the position some weeks before expiration in order to avoid the time decay of the spread price due to negative theta.
Stay tuned.
Our initial investment analysis, when the stock was at 19.22 USD is below :
The best opportunities come when an excellent & very promising company gets beaten due to reasons not related to its prospects & performance. Tencent is such a case. The Archegos saga sell-off & the possible Chinese regulatory environment tightening has sent the stock from 30 USD to less than 20 USD in almost 2 weeks. Even though the turbulence may hold for some weeks, this will not affect the real business & prospects of the company. The facts show 88% penetration in the expanding Chinese online music market, 3 out of 5 most popular mobile music apps, increasing ARPPUs.
It is not a cheap stock with a forward PE close to 30, EV to Sales around 6, but with a projected sales growth rate of 33% & improving margins, the valuation is not very expensive either.
