Tencent’s profit beats market as analysts predict stock will climb back above $500 billion in value

Tencent’s headquarters in Shenzhen, China, pictured in August 2016.

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Tencent reported second-quarter earnings on Wednesday that beat market expectations but missed on revenue, as the key gaming division saw a revival and other areas like fintech and cloud helped prop up the numbers.

The Chinese giant reported the following results for the June quarter:

  • 88.82 billion yuan ($12,920 million)in revenue versus estimates of 93.42 billion yuan ($11.9 billion), according to estimates from Refinitiv. That was a 21% year-on-year increase.
  • Profit attributable to shareholders of 24.14 billion versus estimates of 20.74 billion yuan ($2.64 billion), according to Refinitiv. That is a 35% year-on-year rise.

Gaming revival

In the three months to the end of March, Tencent logged its slowest pace of quarterly sales growth since it went public in 2004.

That was because the Chinese government halted game approvals last year. Video games need to be approved by regulators in order to be released and monetized in China. That hurt Tencent’s business, which relies on a large portion — nearly 41% in the first quarter — of revenue from online gaming.

Billions of dollars were wiped off the stock in 2018. China began approving games again at the start of the year and a number of Tencent titles got the green light.

After the game approval freeze was lifted, Tencent was able to release titles like “Peacekeeper Elite,” which is also known as “Game for Peace.” It’s a similar game to “PlayerUnknown’s Battlegrounds Mobile,” a game that Tencent co-developed but that never received approval for monetization. Tencent pulled that game from China, replaced it with “Game for Peace” and migrated users over.

In the second quarter, total online games revenues increased 8% year-on-year to 27.3 billion yuan. That was driven by smartphone games which raked in 22.2 billion yuan in revenue, up 26% year-on-year.

The game grossed $14 million in its first three days of availability in China, according to data from Sensor Tower. There are other signs that Tencent’s gaming business is looking up: The Chinese giant was the top grossing mobile game publisher worldwide in July, Sensor Tower data showed.

New businesses

While gaming is still the biggest revenue driver for Tencent, it has looked to diversify to areas including financial technology and cloud computing.

In the second quarter, that division grew 37% year-on-year to 22.9 billion yuan. It’s Tencent’s second-largest division by revenue share.

The WeChat Pay platform, which is integrated into messaging app WeChat, is looking to become more profitable, according to analysts.

“We have learned from our industry contacts that Tencent’s WeChat Pay has enhanced efforts to improve profitability by phasing out/reducing subsidies,” Nomura said in a recent note before the earnings release.

Tencent pays subsidies to some merchants to use the WeChat Pay platform in order to boost its market share.

WeChat also has a social media function called Moments. Tencent has been slowly increasing the number of ads users see in that feed.

However, Tencent reported slowing growth in its ad division. Online advertising revenues were 16.4 billion yuan, up 16% year-on-year, but showing a slower growth rate than the 25% posted in the first quarter.

China’s advertising market is slowing down. Digital ad spending in the world’s second-largest economy is expected to hit $79.82 billion in 2019, growing 22% from the year before, according to eMarketer. That’s a slowdown from the 28% growth seen last year.

Tencent said the tough macro environment was weighing on its ad business.

“The challenging macro environment and increased supply of short video advertising inventories across the industry. We expect the negative impact from the current business environment will persist in the second half of 2019,” the company said in its earnings release.

That, coupled with stricter online content controls, could present a problem for Tencent going forward.

“Aside from lingering macro impacts, we expect Tencent’s video ads service, which is a big component of media ads, also suffered from tightening content regulation, which has caused delays in the airing of some popular video content and consequently caused disruption to the video ads business,” Nomura said in a note ahead of earnings.

Reasons to be bullish

The company’s stock has staged a small revival and is up over 6% so far this year.

Analysts, meanwhile, have maintained confidence in Tencent. The average 12-month price target on the stock is 428.46 Hong Kong dollars, according to Reuters data. That represents an over 28% upside from Tuesday’s close and a market capitalization of $521.7 billion. If Tencent’s valuation rises above $500 billion, it would be the first time since March 2018.

Tencent’s other business units include content and video streaming as well as advertising. That mix of revenue streams and the company’s push toward diversification is one reason analysts are bullish.

“Leveraging on its highly synergistic social ecosystem, Tencent’s diversified revenue streams from gaming to advertising and Fintech and business services demonstrates its strong execution capabilities,” Jefferies said in a note from earlier this month.

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