Tencent opens its wallet to drive growth in slowing economy

[HONG KONG] Tencent Holdings Ltd's growing appetite for spending on new businesses helped fuel a stronger-than-expected rise in revenue despite a weakening Chinese economy.

Asia's largest internet company ratcheted up spending by 69 per cent in the third quarter to bankroll forays into content, cloud computing, online finance and video-streaming. That in turn drove a faster-than-anticipated 52 per cent rise in revenue to 40.4 billion yuan (S$8.354 billion) for the operator of social-media phenomenon WeChat.

Like arch-rival Alibaba Group Holding Ltd, Tencent is intent on exploring new businesses beyond its traditional stronghold, hoping to counter a long-term deceleration of the world's second-largest economy.

It's building data centers to offer cloud services to corporate clients, developing an online finance operation, and amassing a content library to underpin a Netflix-like video streaming site.

All that comes at a cost. Last quarter, overall spending reached 18.6 billion yuan. That helped push gross margins to 54 per cent from more than 58 per cent a year ago, according to Bloomberg calculations. Tencent's shares slid as much as 1.7 per cent to HK$193.50 on Thursday.

"Tencent's margins were weaker mostly because of its expansion into new business, including payments and cloud," said Li Muzhi, a Hong Kong-based analyst at Arete Research Services LLP.

Net income grew 43 per cent to 10.6 billion yuan in the three months ended September, the Shenzhen, China-based company said Wednesday. But that came in slightly below the 10.7 billion-yuan average of analysts' estimates compiled by Bloomberg.

Tencent's efforts are beginning to show. Revenue from its "others" segment - which includes payments and the cloud - more than quadrupled to 4.96 billion yuan in the quarter.

Cloud services alone more than tripled after more enterprise customers signed on, particularly from the games, video and on-demand industries.

This year, Tencent signaled its willingness to spend by agreeing to acquire control of Clash of Clans studio Supercell Oy for US$8.6 billion.

It's said to have budgeted at least US$295 million this year and next to invest in movies in China and Hollywood. It's also buying the rights to anime, comics and novels to convert into movies and mobile games. The company has aspirations to create a Marvel-like movie empire, as it competes with Alibaba and Baidu Inc. for viewers.

"We continue to invest heavily in a number of our strategic products," Tencent President Martin Lau said during an earnings call. The company is pouring money into games, cloud and app-installment promotions, he added.

For now, Tencent's bottom line still depends on engaging a Chinese internet population that's 710 million strong, on selling in-game items and - increasingly - ads to those users.

Its WeChat messaging app has become the dominant force in social media, allowing it to market not just virtual goods and game subscriptions but also online payments and on-demand services like taxi bookings.

WeChat had 846 million monthly active users - more than twice Twitter Inc.'s, for context - and the mobile version of QQ had 647 million users at the end of the quarter.

Sales rose 52 per cent to 40.4 billion yuan, compared with estimates for 39 billion yuan. Of that, revenue from smartphone games jumped to 9.9 billion yuan in the quarter, driven by non-casual titles such as Honour of Kings. But the core business may be slowing: mobile game sales rose just 3 percent from the previous quarter.

"People were worried about smartphone gaming and it only grew three per cent quarter-on-quarter, which is a miss," said Chi Tsang, an analyst at HSBC Securities Asia Ltd. Growth was 87 per cent from a year earlier, also lagging his estimate for 105 per cent.

Big brands have also throttled back on traditional online advertising due to macroeconomic uncertainty and "headwinds," said James Mitchell, Tencent's chief strategy officer.

However, he sees them shifting to performance-based ads that track the effectiveness of campaigns. Tencent has helped brands including BMW run promotions via WeChat Moments, a service similar to Facebook's news-feed where users browse photos, videos and stories posted by friends.

"Revenue exceeded expectation mostly because of robust game and strong content revenue," said Naoshi Nema, an analyst at Cantor Fitzgerald LP in Hong Kong.

"Other business including payment related and cloud services showed strong growth too."

BLOOMBERG