Tencent seeks new growth in year of transition as consumer businesses mature

Depending on whom you talk to, 2018 was either a bumper year for Tencent Holdings or a year to forget.

The first Asian company to breach US$500 billion in market cap, the internet giant’s shares rose to an all-time high in January 2018, powered by its money-minting video games business and ubiquitous WeChat super app. Then came a much-chronicled government crackdown on content and gaming, which abruptly ended the party and wiped out almost half the company’s value by October.

Tencent’s roller-coaster year also took place as China’s technology giants came of age. Baidu, Alibaba Group Holding and Tencent – the trio of internet companies that has come to represent Chinese Big Tech – are all around 20 years old and have expanded their presence beyond China's shores.

“We’re coming to the tail end of a decade of gangbuster high growth due to the mobile revolution,” said Matthew Brennan, managing director of consultancy China Channel. “The incremental increases in number of users and time spent online per person is getting less and less. All the low-hanging fruit is long gone.”

He said the business-to-business market “is an area many technology companies, both in the US and China, feel holds more opportunities for growth”.

Although video game approvals have resumed, Shenzhen-based Tencent has not yet been given the green light to monetise its hugely popular mobile games Fortnite and PlayerUnknown’s Battlegrounds (PUBG). And investors are still waiting for more flesh on the bones of its plan to move into the industrial internet, where it will serve businesses in addition to the millions of consumers it now has on its platform.

In recent months, Tencent has clawed back a large proportion of its stock loss, and was trading at around HK$370 (US$47.13) this week compared with an October low of HK$252.20. On Thursday, shares were down nearly 2 per cent to close at HK$363.

After the close of trading on Thursday, Hong Kong-listed Tencent reported a net profit of 14.2 billion yuan (US$2.1 billion) in the December quarter that missed analysts’ estimates, after the company spent heavily on its cloud and mobile payment businesses to offset a slowdown in its core video games operations. Its quarterly revenue was up 5 per cent to 84.9 billion, which beat the consensus estimate of 83.2 billion yuan. Cost of revenue for its other businesses jumped 75 per cent compared to a year ago.

The company posted a 10 per cent increase in full-year net profit to 78.7 billion yuan, which also missed analysts’ estimates. Revenue was up 32 per cent to 312.7 billion yuan, ahead of the consensus estimate of 311.4 billion yuan.

With Fortnite and PUBG still awaiting monetisation approval, Tencent’s mobile game sales may be headed for a sequential decline in the fourth quarter amid stagnating growth for its maturing blockbuster game Honour of Kings, Bloomberg Intelligence analyst Ling Vey-sern said in a research note, citing a 9 per cent decline sequentially in its iOS game sales projected by Sensor Tower.

Markets, however, are forward-looking and analysts are betting on a reversal of the tide in 2019.

“We expect Tencent to continue to outpace the domestic online gaming market in 2019 and 2020 on the back of [eventual] monetisation of PUBG Mobile, continuous overseas expansion and the company’s rich game pipeline,” Ronnie Ho, an analyst at CCB International, wrote in a research note.

Growing use and monetisation of WeChat, Tencent’s flagship messaging and social media app with more than 1 billion users, should also offer some comfort.

While Moments, a social platform where friends share key life moment posts on WeChat, is still limited to a maximum of two advertisements per day, WeChat is stepping up its ad inventory for mini programs – so-called apps within apps that allow functionality without having to leave the platform – and video games. Moments and mini programs were the main driver of online ad revenue in the previous quarter.

Despite a slowing Chinese economy, social ad sales are expected to grow 55 per cent in the fourth quarter compared to the year before driven by growing time spent on WeChat and the monetisation of mini programs, according to estimates from Jefferies equity analyst Karen Chan.

“We don’t expect fast growth in the gaming sector with the maturing of Honour of Kings and lack of new games,” said Norman Hui, a Hong Kong-based analyst with Zhongtai International Securities. “Tencent could get a boost from the successful IPOs of its portfolio companies, but underperforming stocks, such as Meituan Dianping, could offset gains in this segment.”

Facing criticism for a spate of investments, Tencent executives have come forward to defend their spending spree as a core strategy aimed at building technologies and enhancing its social media platform and ecosystem in future.

“Investing allows us to focus on what is most important, the platform business, and make it the best,” president Martin Lau Chi-ping said at an event in January. “At the same time, we can let our partners do what we’re not good at, and make it complementary.”

Heavyweight Tencent is being challenged by a new crop of Chinese contenders though, such as short video and news app operator ByteDance. Although new competition will help to keep Tencent on its feet in the consumer space – it has already set its strategic sights on tackling the industrial internet and the future connectivity needs of businesses.

“We believe that the first stage of the mobile internet, the consumer internet, is drawing to a close and the second stage, the industrial internet, is kicking off,” Tencent founder, chairman and chief executive Pony Ma Huateng wrote in an open letter last year. “It became clear to us that if objects and services are not fully digitalised, the connection between them and people cannot be improved.”

Tencent is currently positioning itself as a digital assistant, helping companies to revamp their organisation and better integrate smart retail, online medical and educational services along with manufacturing processes. Given the size of China’s economy and the government’s determination for the country to become an innovation-driven artificial intelligence (AI) champion – the potential opportunity is huge. Any update on this area will be keenly watched by investors.

Meanwhile, Tencent has shown it is not averse to revamping its own culture.

Tencent executives have told employees that the company’s silo culture, which helped create its hugely successful WeChat product, will need to change to a more collaborative approach if it is to succeed in the future in other areas, such as AI and cloud computing.

The company has also said it plans to promote more young people to keep up with the times and generate new thinking. It intends to fire or demote 10 per cent of middle to senior managers to help achieve this, according to people familiar with the matter who spoke to the South China Morning Post this week.

New York-listed Alibaba is the parent company of the Post.