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Why Tencent missed the mark on profit by most in a decade

It is emerging from one of its darkest periods as game approvals resume and China's slowdown cools demand for advertising

Tencent has spent billions to sustain growth with investments in everything from cloud and entertainment to retail, locking horns with Alibaba Group Holding Ltd.

Hong Kong

TENCENT Holdings Ltd posted a slump in fourth-quarter earnings on increased spending as its prized games business showed signs of recovery after a brutal 2018.

Net income fell 32 per cent to 14.2 billion yuan (S$2.9 billion), missing the 17.55 billion yuan average of estimates, on investments in content, cloud computing and financial technology. That is the biggest shortfall on profits in at least a decade. The result also included the costs of share issues and impairments for companies that it has invested in as revenue surpassed projections.

China's social media leader is emerging from one of its darkest periods, as game approvals slowly resume and the country's economic slowdown cools demand for advertising. That has seen the owner of WeChat spend billions to sustain growth with investments in everything from cloud and entertainment to retail, locking horns with Alibaba Group Holding Ltd.

"As it turns out, the market was probably worried about the wrong thing," Bloomberg Intelligence analyst Vey-Sern Ling said. "The unexpected bit is how much cost of revenues and operating expenses have expanded. This is driven by video, payments, cloud, film and TV production." Sales from its gaming division were better than feared, suggesting a modest recovery going into 2019, Mr Ling added.

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Tencent's shares gained as much as 1.2 per cent in Hong Kong on Friday. It is now up more than 16 per cent this year, compared with a 32 per cent rise for New York-listed Alibaba.

The WeChat operator overhauled its structure in September to capture opportunities in what founder Pony Ma brands the emergence of an "industrial Internet". It set up a cloud and smart industries division to spearhead its investments in areas from retail, connected cities and security to education, manufacturing and health care. The spending spree is diversifying its revenue make-up, pushing the contribution from gaming to 36 per cent in the quarter.

"Our goal is not just to capture the cloud computing business, it's to actively prepare for the tremendous opportunities coming from the landmark shift from consumer Internet to industrial Internet," Mr Ma told reporters. "China's Internet sector has entered the next phase."

For now, gaming remains its biggest division. While approvals in China have resumed, Tencent has yet to get a green light to monetise Fortnite or the mobile version of PlayerUnknown's Battlegrounds (PUBG), the most popular smartphone game on the planet. It was able to release nine games in the quarter but could not provide an update on when PUBG could start making money in China. "We are working actively to communicate on it" with regulators, president Martin Lau told reporters on Thursday.

After making investments in a number of overseas games firms, including Netmarble Corp and Ubisoft Entertainment SA, Tencent has built up its own capabilities in mobile titles. It plans to jointly develop and promote new games overseas with partners rather than just distributing their content in China, Mr Lau said.

"Given that China has now restarted the game approval process, we should expect to see accelerating growth for smartphone games going forward," Neil Campling, an analyst at Mirabaud Securities, said in a report.

Revenue for the quarter was 84.9 billion yuan compared with estimates for 83.4 billion yuan while adjusted earnings per share were also above expectations. Sales from the Value Added Services unit, which includes online games and messaging, climbed 9 per cent to 43.7 billion yuan. But costs surged 43 per cent from a year earlier as content and financial technology bills piled up.

Tencent plans to introduce a new category of sales when it reports first-quarter earnings to reflect its growing diversity. The company will break down specific categories in the "others" revenue section in its financial statement, Mr Lau said.

"Mobile game revenues at 19 billion yuan was actually decent because last quarter was 19.5, and typically the fourth quarter is seasonally slow," Mr Ling said. "Given they have new games in the first quarter, I think the 19 billion number bodes well for a mobile game recovery into 2019." BLOOMBERG

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