Tencent earnings preview: video’s hot, games not

Images Of Tencent Applications As Second Quarter Earnings Are Released
The icons for Tencent Holdings Ltd.'s messaging applications WeChat, left, and QQ are displayed on an Apple Inc. iPhone 5s smartphone in an arranged photograph in Hong Kong, China, on Wednesday, Aug. 13, 2014. The success of messaging services QQ and WeChat has helped boost Tencents market value to about $161 billion, making it the most valuable Internet company in Asia. Photographer: Brent Lewin/Bloomberg via Getty Images
Photograph by Brent Lewin — Bloomberg via Getty Images

Over the past few months, Tencent Holdings Ltd (TCTZF) has been like a teenage pop star displaced by a twerking Miley Cyrus who grabs all the headlines.

The Cyrus in this case is Alibaba. Alibaba’s IPO, the biggest in human history, garnered non-stop attention from Wall Street—not to mention regular investors in the U.S. trying to understand what the heck is so special about Taobao—and proved there’s only room for one sun in the heavens of the Chinese tech sector. At least as far as collective short-term attention span of the business world is concerned.

No matter that Tencent has had a very, very good year. It’s stock is up 50%, its market cap reached $160 billion, and Tencent’s revenue in the last quarter easily outpaced Alibaba’s– $3.2 billion against $2.5 billion–as the number of users on its social networks grew to over half the population of China.

Tencent will be thrust back into the spotlight Wednesday when it reports third-quarter earnings. It will be a reminder to the world that the race for dominance in China’s tech market includes two: Alibaba and Tencent.

As a refresher, Tencent is a very different company from Alibaba. Its WeChat social network has almost 400 million active monthly users and is so popular in China that businesspeople regularly trade WeChat profiles after business cards. The social network is what ties everything together for Tencent. What makes money is mobile games, which are part of the ecosystem and the biggest story heading into Tencent’s third-quarter earnings.

Fears of a mobile games slowdown are spooking traders.

“We maintain our cautious stance on Tencent’s mobile game revenue in 3Q as the company pulled back monetization, while focusing more on user base expansion and user engagement,” writes J.P. Morgan’s Alex Yao. In other words, like Amazon.com (AMZN), Tencent is more and more focused on the long-term instead of quarterly earnings. It is plowing money into gaining users and building games instead of extracting every last yuan from fans. Yao expects third-quarter mobile game sales to fall 17% from last quarter.

That might be overstated, says Elinor Leung of CLSA. WeChat and Mobile QQ mobile game platforms continue to dominate the market with 40% market share, and Tencent is probably growing by double-digits in total gross billings during the quarter, as the number of gamers expands and Tencent shifts into what Leung calls “mid-to-hard core” games. Tencent owned half of the top 20 mobile games in China, according to AppAnnie, and 70% of the top 10 games with titles like “Thunder Fighter,” “Timi Run Everyday,” and “We Fly.”

Over the past year Tencent has shifted its strategy of games, opting to license games to distribute on its hugely popular social networks instead of developing them itself. According to CLSA, in the first quarter of 2014 all of Tencent games in the top-10 ranking were self-developed; by October, four of seven games of its titles in the top 10 were licensed.

Leung’s estimate of game revenues is closer to consensus, which calls for mobile games revenue to be flat in the third quarter, in large part because new games have been weak. She writes:

“Only five new games were launched on WeChat and Mobile QQ platforms in 3Q, down from eight new launches in 2Q. All the new games hit top-10 ranking at the initial launch but most can’t sustain the popularity.

“MoDoo Marble, developed by CJ E&M, was the only successful new game launched in 3Q. It is designed based on the classic game Monopoly, and the success could be attributed to the popularity of the theme, supplementary social elements, and the lack of similar games in the market.”

Things get better for Tencent: it’s pumping money and manpower into a mobile game pipeline that looks promising for the next couple years.

After games, investors will look at advertising revenues. Tencent is diving into—and succeding in—China’s massive online video market. Youku is the elephant in China, grabbing 40% of online video advertising spend, but Baidu’s iQiyi and Tencent’s video services are growing and competing in a similar way that streaming sites like Amazon’s are challenging Netflix. Tencent’s Video app was No. 1 in the iOS App store in China during July and August, according to AppAnnie. It has the second largest number of active users after Youku.

The breakout show of the quarter was the third season of Voice of China, a copy of the Dutch and American versions which Tencent has exclusive rights to. Viewership doubled this year, which could translate into ad revenue quarterly growth of 60% to surprise Wall Street.

Tencent’s ubiquitous WeChat and QQ —which combined have 700 million active users in China—have engendered tens of millions of users of Tencent’s other apps. One example is its success with a news app that quickly rose to the most popular news app over the summer. With 180 million daily users, the Tencent ecosystem is becoming one from which users never have to stray far.

The earnings, due to be released Wednesday, will be a measure of Tencent’s short-term strength. The market might be expecting sales to fall while it tries to regain momentum, but if Tencent proves those pessimists wrong, it could grab some attention from Alibaba for its own amazing Chinese tale.


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