Tencent posts better-than-expected US$3.4 billion third quarter profit as social ad revenues offset uncertainties in games sector

Tencent Holdings, operator of China’s biggest social media and gaming businesses, reported better than expected profits in the third quarter as social advertising and investment gains helped to offset gaming uncertainties due to government regulation.

Tencent president Martin Lau Chi-ping cautioned in a conference call following the quarterly results announcement on Wednesday of the challenges that lie ahead, including the pace of state approvals necessary to push ahead with the release of new game titles.

“We’re still waiting for the government to start the approval process for games, and when that is announced we’ll have an update for the market,” Lau said.

Tencent released 10 new games in the third quarter, and has 15 games with monetisation approval in the pipeline. The company has added new games by publishing from independent studios who received monetisation approval and licenses before the freeze, said James Mitchell, chief strategy officer at Tencent.

The Hong Kong-listed company reported net income of 23.33 billion yuan (US$3.4 billion) in the quarter ended September 30 compared to the 18.39 billion yuan average estimate of 12 analysts polled by Bloomberg.

Profit increased 30 per cent year on year mainly due to higher gains generated from investment-related items, Tencent said.

Tencent also posted 8.8 billion yuan in other net gains for the third quarter, mainly from increases in valuations of certain investments, including Meituan Dianping which listed in Hong Kong in September.

Revenue increased 24 per cent year on year to 80.6 billion yuan primarily driven by growth in payment-related services, online advertising, digital content sales and cloud services.

The latest results are Tencent’s largest beat since 2016, said Douglas Morton, head of research Asia at Northern Trust Capital Markets in a note. “We believe these results will mitigate further downgrade risk [particularly on revenues],” Morton said.

The results come amid a global tech sell-off and concerns over regulatory pressure on games, which saw Tencent’s market value drop more than one third, or US$240 billion, compared to its January peak.

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“At the end of the quarter, we upgraded our organisation to help enterprises and various industries benefit from the new trend of industrial internet through digitisation and technology innovation, and to provide consumers with better integrated entertainment and social experiences, as well as to unify our advertising sales platforms,” said Tencent chairman and chief executive Pony Ma Huateng. “We believe this strategic organisational upgrade will position us well for future long-term growth.”

Before the results were announced on Wednesday night, Tencent’s shares closed at HK$272.2 in Hong Kong, down 0.8 per cent for the session, compared to a January peak of HK$475.7.

Tencent’s mobile games business reported 11 per cent sequential growth thanks to a seasonal boost over the summer holidays, and a 7 per cent increase in year on year revenue to 19.5 billion yuan.

Personal computer games revenue fell 15 per cent year on year to 12.4 billion yuan as players continue the shift to mobile games.

China’s gaming industry has been impacted by a halt in the approval of new games since March due to a regulatory reshuffle, which delayed new releases and monetisation of Tencent’s flagship mobile game PlayerUnknown’s Battlegrounds. Tencent is cutting the marketing budget of its gaming division to “endure the hard times”, Bloomberg reported last week.

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Tencent’s gaming business has also faced pressure from the central government’s call for gaming companies to do more to protect the nation’s youth from online addiction and myopia. China’s Ministry of Education in August announced a plan to curb the number of new online games and limit playing time in an effort to protect the eyesight of children.

Tencent is now requiring all players of its mobile and personal computer games to verify their identities against police databases and players identified as minors would be included in an anti-addiction programme to limit their play time. “We absolutely take no account of game revenue when it comes to the protection of minors,” Ma Xiaoyi, senior vice-president of the Shenzhen-based company, said last week.

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Online advertising, which accounted for one fifth of the total revenue in the past quarter, posted drastic growth despite regulatory pressure and a weaker macro condition. “To a great extent, our advertising has been supply constrained rather than demand constrained. As we grow our traffic and as we bring new inventory within our traffic, it’s natural to see a flow through to stronger advertising revenues,” Mitchell said.

Advertising revenue was up 47 per cent to 16.2 billion yuan driven by ads on WeChat’s social platform Moments. WeChat currently allows a maximum of two advertisements a day to appear on Moments, a feature similar to Facebook’s timeline, and analysts see huge room for advertising growth when the company steps up its monetisation of social media users.

“On the flip side there are certain advertising categories in China that have been hit hard by regulatory measures,” said Mitchell. “Looking forward, if the macro-environment deteriorates sharply, that will have a negative impact on our advertising revenue growth rates, but given superior performance, we should continue to outperform industry.”

“Advertising sales may expand quickly due to WeChat’s 1.06 billion monthly active users, a high level of engagement and low utilisation of its social ad inventory. Tencent is well-placed to further monetise this user base via a range of online products, including video and music,” Ling Vey-sern, Bloomberg Intelligence analyst, wrote in a separate note last week.

As Tencent celebrates its 20th anniversary this month, it is undergoing a restructuring that will shift its business focus beyond consumers to the huge potential of the industrial internet where it sees a role in supporting the digital transformation of China’s economy by serving enterprises with cloud computing, big data and artificial intelligence capabilities.

Cloud services saw revenues more than double year on year in the latest quarter and are growing at double-digit percentages quarter on quarter, according to the company. Cloud service revenues for the first three quarters of 2018 exceeded 6 billion yuan, it said.

Cloud business is low margin and requires capital expenditure to build infrastructure and buy servers, said Lau. He highlighted the long term monetisation opportunities arising from the industrial internet.

“We look at it as a long-term investment for the future, and we feel that over time, new business opportunities can come out of our cloud and associated industry internet opportunities and when we move to PaaS (platform-as-a-service) and SaaS (software-as-a-service) then we can start generating a higher margin of revenue.”