With Strong Results, Who Needs Splashy Chatbots? Not Tencent

Key Takeaways:

• Tencent’s first-quarter revenue and adjusted net profit rose 11% and 27%, respectively, attracting “overweight” recommendations from major banks
• Chairman Pony Ma says his company will invest heavily in AI and cloud infrastructure, but is in no rush to roll out semi-finished products before they are ready

By Fai Pui

The waiting game goes on for China’s anxious gaming industry.

China’s regulator, the National Press and Publication Administration, on Monday published its latest list of approvals for domestically developed online games, with 86 titles getting the nod this time. Tech giant Tencent Holdings Ltd. (0700.HK) made the list, with its “Ace Force 2” becoming the company’s fourth title approved this year.

But making it onto the list isn’t always easy in a country where every online game must get regulatory approval. In the past two years, Beijing has rolled out a slew of policies to curb excessive gaming, and has also suspended approvals of new titles for months at a time.

As China’s largest gaming company, Tencent has become a target for those critical of the gaming pastime, criticized by official media at one point for serving up “spiritual opium.” The company’s stock has fallen sharply since then, from a record high of HK$775.50 to a low point of HK$180.50 at the end of last year, losing three-quarters of its value.

After taking a beating for nearly two years, China’s former “leading internet stock” seems to be finally emerging from the cloud of official regulation, combined with fallout from China’s strict pandemic controls that dampened spending. At least that’s our initial conclusion judging from the WeChat owner’s first quarter results.

Tencent reported its revenue rose 11% in the first quarter year-over-year to about 150 billion yuan ($21.3 billion), ending more than a year of revenue growth that was either flat or negative. Its net profit rose by a similar 10% to 25.8 billion yuan, while its adjusted net profit, which typically excludes employee stock compensation costs, jumped 27% to 32.5 billion yuan.

“I am quite satisfied with Tencent’s quarterly results, its performance was better than market expectations,” said Kenny Wen, KGI Asia’s head of investment strategy, “The worst time for its mobile games business has passed. With the successive approval of new game licenses and positive growth in its international gaming business, I believe its full-year outlook is something to look forward to.”

Investors were preparing for upbeat news even before the announcement, driving up the stock more than 5% in the two days before the results came out. In a classic case of “buy on the rumor, sell on the news,” the stock actually fell 1.5% the day after last week’s actual results came out, as short-term buyers pocketed some quick profits.

Accelerating International Business

Tencent’s value-added services revenue rose 9% in the first quarter to 79.3 billion yuan, while domestic gaming revenue rose 6% to 35.1 billion yuan, mainly benefiting from popular titles like “Honor of Kings,” “Dungeon & Fighter: Innovation Century” and “Cross Fire.” Notably, its international game revenue grew by 25%, or 18% excluding the impact of currency fluctuations.

Its online advertising revenue also grew 17% to 21 billion yuan in the quarter, fueled not only by recovering consumption in China, but, more importantly, by the continued growth of business on Tencent’s WeChat Channels video service tied to its wildly popular WeChat social networking platform.

The number of daily active creators and daily active video uploads in WeChat Channels almost doubled compared to the same period last year, and the length of use and traffic on the platform continued to grow rapidly. Tencent President Martin Lau said that livestreaming and video are great opportunities, and the WeChat e-commerce ecosystem could get a significant boost by bringing together WeChat Channel livestreamers, WeChat mini-app developers and WeChat’s payment functions.

As China’s tech leader, Tencent is committed to opportunities involving artificial intelligence (AI), which Lau said can reduce costs and help build content and improve services. Despite that, Tencent has yet to release an AI-powered chatbot, despite demos of such products by rivals Baidu BIDU, Alibaba BABA and SenseTime (0020.HK), seizing on the huge awareness raised by ChatGPT.

Sources quoted by Chinese media The Paper quoted Pony Ma telling shareholders at a meeting that Tencent won’t follow in the footsteps of its rivals and rush out any “half-baked products,” but instead will continue to invest heavily in building AI and cloud infrastructure.

Some AI insiders say Tencent has an advantage in this area due to its dominant position in gaming and possession of large troves of information that can be used to train future AI. “Apart from its own cloud business, Tencent also owns huge amounts of data generated on WeChat every day, which is very useful for training AI,” one insider told Bamboo Works. “In addition, if Tencent can add AI to the game to give souls to non-player characters (NPC) and have them talked freely with players, sense of immersion will be greatly boosted and thus attract more people to splurge on games.”

Analysts Approve

After two years in the desert, Tencent’s price-to-earnings (P/E) ratio has dropped to about 16 times, even lower than smaller gaming rival NetEase’s NTES 20 times. But its latest impressive results have the investment community saying it may be time to give the stock a second look.

JPMorgan has raised its target price for Tencent from HK$430 to HK$440, with an “overweight” rating. The bank expects continued momentum in gaming revenue growth owing to a shift in Tencent’s revenue structure in the first quarter, and is quite impressed by the company’s continued efforts to operate more efficiently.

Goldman Sachs expects Tencent’s profit growth to outpace revenue growth this year, mainly due to growing contributions from the company’s profitable businesses, as well as better operating leverage and cost controls. It maintains a “buy” rating on the company with a target price of HK$443.

Tencent’s recent share price of about HK$340 is well below most of those target prices. Recent selling of the stock by Naspers, Tencent’s major longtime shareholder, may be partly to blame. The South African company still holds 25.99% of Tencent’s shares even after several reductions, and investors may worry that Naspers will dump more shares if the stock shows renewed strength. Given that uncertainty, the near-term upside for Tencent’s stock may be limited.

At the same time, many have speculated over whether Tencent might break itself up, ever since Alibaba announced a similar plan in March. But KGI Asia’s Wen believes Tencent’s situation is very different from Alibaba’s.

“Since Tencent is mainly focused on equity investments (in other companies), it is expected to still pay out its holdings (in those companies) in the form of dividends to release more value,” he said. He cited Tencent’s recent decisions to distribute its large holdings in JD.com JD and Meituan (3690.HK) as stock-based dividends to its shareholders as examples of how the company is hiving off its various strategic stakes in other companies.