Tencent, as the first of China’s technology giants to report financial results, signals the far-reaching impact of the Communist Party’s campaign to curb the power of its private sector. An avalanche of new rules and restrictions have struck at the foundations of its biggest companies, particularly Tencent and e-commerce giant Alibaba Group Holding Ltd.
Executives on Wednesday pledged support for Beijing’s initiatives and offered little hope of relief for investors in the near-term. Ad pricing could remain soft for several quarters after regulations hit the education, insurance and gaming industry, Tencent said. A crackdown on the domestic games industry also saw revenue growth for the business rising just 5%, a fraction of the 20% increase in international gaming sales.
“Stricter regulation is a new normal for the entire industry and that’s not just for China, but also globally,” President Martin Lau said in a conference call after the results.
The company’s outsized influence in the world’s No. 2 economy has left it vulnerable as government scrutiny quickly engulfed everything from finance to education and online entertainment. Among the deadliest blows were July’s tutoring purge that decimated a key source of ad revenue and a cap on kids’ gaming time announced the following month. Regulators have also refrained from approving any new game releases since July as they scrutinize applications more carefully.
What Bloomberg Intelligence Says:
The drag on advertising revenue from macroeconomic and regulatory pressures may lead to a further reduction in Tencent’s sales-growth estimates, but its core online games business remains healthy and positioned for accelerating expansion over the next few quarters. Advertising sales were 9% below consensus in 3Q and grew the slowest since 2009 as clients in key segments pulled back spending amid regulatory crackdowns. With the economic situation in China worsening, we expect more ad pressure in 4Q and 2022.
— Matthew Kanterman and Tiffany Tam, analysts
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The slowdown has revived painful memories of a 10-month freeze on game monetization licenses in 2018, which helped to wipe $200 billion off Tencent’s market value at the time. In response, China’s largest company emphasized the steps it took to comply with regulations, outlining how those efforts have led to a significant decline in both game time and spending by minors on its properties.
Executives stressed they see the domestic gaming challenges as “temporary” and that the company has a big stockpile of titles ready for launch as regulatory uncertainties ease. Meanwhile, Tencent is exploring new drivers, especially in international games as well as in the metaverse, which Lau called a “real opportunity.”
“Anything that really makes the virtual world more real and making the real world more rich with virtual experiences can actually sort of become part of the metaverse,” he said.
Just like Mark Zuckerberg’s Meta Platforms Inc., the Chinese company is prepping for a technological leap into the virtual realm of metaverse, registering relevant trademarks and hiring developers for open-world games. Still, executives cautioned that the concept may take longer than expected to realize.
Tencent is well positioned to explore and capture the future metaverse opportunity, Citigroup analysts led by Alicia Yap wrote in a note, citing the company’s experience in gaming and social networks as well as its technology and artificial intelligence capabilities.
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For now, Tencent’s enduring hits like Honor of Kings continue to be its biggest gaming cash cows. Fully-owned Riot Games Inc. also offers one of the greatest opportunities: its long-anticipated League of Legends mobile game finally debuted in China last month and the franchise’s e-sports tournament and new anime series drew hundreds of millions of views for Tencent and its affiliates over the past weekend.
The company is also making a deeper foray into enterprise software and advanced technologies. Last week, the WeChat owner pledged $3 billion worth of resources over the next three years to its cloud business partners and unveiled its first self-made chips for use cases like search and video-transcoding.
Net income for the September quarter was a better-than-expected 39.5 billion yuan after it booked gains from the disposals of some investments, though non-IFRS profit fell 2%, the first decline since Bloomberg began tracking the data in 2010. Online advertising rose a lower-than-expected 5%, while the fintech and business services division — its fastest-growing segment — slowed expansion for a second straight quarter.
After kicking off a year ago, China’s tech crackdown has left several unresolved issues including data security, the restructuring of fintech operations, and the opening up of walled-off internet platforms. Tencent and arch-foe Alibaba have taken initial steps to open their platforms to each other’s services, while the country’s tech-industry overseer is said to be considering forcing WeChat to make its social articles displayable on search engines like Baidu Inc.’s, Bloomberg News reported last month.
Lau on Wednesday reiterated that Tencent’s platforms are “fundamentally open” and pledged to pro-actively explore cooperation with other platforms.