Key Takeaways:
- Tencent’s first-quarter revenue and adjusted net profit rose by 11% and 27%, respectively, earning “overweight” recommendations from major banks
- Chairman Pony Ma says the company will invest heavily in AI and cloud infrastructure, but is in no rush to release semi-finished products before they are ready
By Fai Pui
China’s gaming industry patiently awaits regulatory approval. China’s regulator, the National Press and Publication Administration, released its latest list of domestically developed online game approvals on Monday, with 86 titles getting the green light this time, including tech giant Tencent Holdings Ltd.’s game “Ace Force 2,” which is the company’s fourth title approved this year. Climbing over regulatory hurdles hasn’t been easy, given that every online game in China needs regulatory approval. In the past two years, the Beijing government has implemented several policies to curb excessive gaming, even suspending new title approvals for months in some cases.
Being China’s largest gaming company, Tencent has become a target for critics who are concerned about the gaming pastime. The company’s stock has fallen dramatically since reaching a record high of HK$775.50, plummeting three-quarters of its value to HK$180.50 at the end of last year due to regulatory challenges combined with the negative impact of China’s COVID-19 pandemic controls. Nonetheless, Tencent’s recent Q1 results indicate that it’s finally passing through the cloud of regulation and negative repercussions.
Tencent’s Q1 earnings report showed its revenue increased 11% year-over-year, totaling RMB 150 billion ($21.3 billion), breaking the flat or negative revenues trend from the previous year. Its net profit increased by approximately 10% to RMB 25.8 billion, while its adjusted net profit, which typically excludes employee stock compensation costs, skyrocketed 27% to RMB 32.5 billion.
Kenny Wen, KGI Asia’s head of investment strategy, said, “I am quite satisfied with Tencent’s quarterly results; its performance was better than market expectations. The worst time for its mobile games business has passed. With the successive approval of new game licenses and positive growth in its international gaming business, I believe its full-year outlook is something to look forward to.”
Investors had already prepared for upbeat news before the announcement, driving the stock up by over 5% in the two days leading up to its earnings report. However, in a classic example of “buy on the rumor, sell on the news,” the stock fell around 1.5% the day after the results were published, as short-term investors reaped quick profits.
Accelerating International Business
Tencent’s value-added services revenue grew 9% over the previous year to RMB 79.3 billion, while domestic gaming revenue increased 6% to RMB 35.1 billion. This growth was primarily due to the enduring popularity of popular titles like “Honor of Kings,” “Dungeon & Fighter: Innovation Century,” and “Cross Fire.” Its international game revenue skyrocketed 25%, or 18% excluding currency fluctuations impact.
Tencent’s online advertising revenue also rose 17% to RMB 21 billion, supported not only by China’s recovering consumption but, more importantly, by the fast-growing business on Tencent’s WeChat Channels video service, tied to its popular WeChat social networking platform. The number of daily active users and daily video uploads in WeChat Channels nearly doubled compared to the same period last year, and the use frequency and traffic on the platform continued to grow rapidly. Tencent President Martin Lau has said that live-streaming and video businesses are great opportunities and the WeChat e-commerce ecosystem can receive a significant boost by connecting WeChat Channel live-streamers, developers of WeChat mini-apps and WeChat’s payment infrastructure.
Despite its focus on opportunities involving artificial intelligence (AI), Tencent has yet to release an AI-powered chatbot, in contrast to rivals Baidu, Alibaba, and SenseTime, benefiting from the increased awareness raised by ChatGPT. However, sources quoted by Chinese media The Paper said, “Tencent won’t follow in the footsteps of its rivals and rush out any ‘half-baked products’ but instead will continue to invest heavily in building AI and cloud infrastructure.”
Some AI insiders believe Tencent has an advantage in this area due to its powerful position in gaming and large amounts of data that can be employed for AI training. “Apart from its cloud business, Tencent also owns huge amounts of data generated on WeChat every day, which is very useful for training AI,” said one insider quoted by Bamboo Works. “In addition, if Tencent can add AI to the game to give souls to non-player characters (NPC) and have them talked freely with players, the sense of immersion will be greatly enhanced, thus attracting more people to splurge on games.”
Analysts Approve
After a two-year slump, Tencent’s price-to-earnings (P/E) ratio has dropped to around 16 times, even lower than smaller gaming rival NetEase’s 20 times. Nonetheless, the company’s impressive Q1 performance is leading investors and analysts to reevaluate its stock. JPMorgan recently raised its target price for Tencent from HK$430 to HK$440, giving it an “overweight” rating on the stock. The bank expects continued momentum in gaming revenue growth due to a shift in Tencent’s revenue structure in the first quarter, and is quite impressed by the company’s continued efforts to operate more efficiently.
Goldman Sachs expects Tencent’s profit growth to surpass revenue growth this year, due primarily to the more substantial contributions from the company’s profitable ventures, as well as improved operating leverage and cost management. It maintains a “buy” rating on the stock with a target price of HK$443.
Tencent’s current stock price of about HK$340 is significantly below most target prices. Naspers, Tencent’s major longtime shareholder, has recently been selling off its holdings, which could explain the lower stock price. Despite this, KGI Asia’s Wen believes it is unlikely that Tencent will break itself up, in contrast to Alibaba, which announced similar plans in March. He said, “Since Tencent is mainly focused on equity investments [in other companies], it is expected to still pay out its holdings [in those companies] in the form of dividends to release more value.”
