Call it the one that got away. Denied loans by Chinese banks in 1999, Ma Huateng, Tencent’s co-founder and chief executive, approached Richard Li, son of Asia’s richest man Li Ka-shing for capital. Li’s company PCCW liked Ma’s instant-messaging software QQ, so it invested $1.1 million for 20% of the Shenzhen start-up. Two years later, Li sold the stake for $10 million when he was forced to reduce PCCW’s debt levels after its takeover of Hong Kong Telecom.
That doesn’t look too shabby a return for an investment held for just two years. But if PCCW still owned that stake today it would be worth $12 billion (based on Tencent’s market valuation of $60 billion). To put that in perspective: PCCW’s current market cap is just $3.5 billion.
We’ve all made investment decisions we’ve rued, but few of us have left almost $12 billion on the table…
South Africa’s Naspers showed a little more foresight. The media company – and largest shareholder in Tencent since 2001 – now holds a 35% stake worth $26 billion, rendering it one of the most profitable private equity investments of all time. Meanwhile, Ma, 41, is China’s seventh richest man, according to the Hurun Rich List, which estimates his personal fortune at $6.5 billion in 2012
Tencent’s road to domination
Tencent made its online debut with an instant-messaging platform that was a precise copy of AOL’s chat service ICQ (Ma originally named it OICQ but changed it to QQ after AOL protested). From an early start as an ICQ clone, the company has grown at a blistering pace. Tencent has capitalised on its strength in chat – over 750 million people used its messaging service at least once a month in the first quarter – to drive traffic to other product areas like online games and social networking sites.
Tencent’s mascot, a winking penguin, has become ubiquitous online, spanning a wide range of products. And thanks to its unique strategy, the firm has no exact equivalent in the US. Imagine rolling Yahoo, Groupon, Facebook, Twitter, Expedia and the game developer Zynga into a single company. As a concept, that’s how Tencent has tried to develop itself, although Ma restructured the company into six business units last year in the hope of more dynamic management.
More impressively, Tencent was China’s most profitable internet business in absolute terms last year, generating operating profits of $2.5 billion on $7 billion in revenues. Search firm Baidu, which came in second, reported profit of $1.7 billion during the same period, on $3.6 billion in sales.
While most of Tencent’s services are free, it makes much of its money from online games. The company charges users for digital wares, like virtual weapons to increase the powers of their avatars in online gaming.
These are acquired with a virtual currency called Q coins, which is purchased for genuine cash. Online gaming now contributes over half of Tencent’s revenues, far ahead of e-commerce, the company’s second-largest revenue source.
Now that it has its own currency, it shouldn’t come as a surprise that Tencent has also ventured into the financial sector. Recently it announced a new partnership with e-commerce conglomerate Alibaba and insurer Ping An to offer insurance coverage for online purchases. It will even be possible for game players to take out insurance safeguarding their avatars’ weapons or special powers, says Nanfang Daily.
Games have served as the bedrock of the firm’s fortunes, but investors are now more excited about Tencent’s progress in its wildly popular mobile messaging application WeChat (known to its users in China as Weixin). The app was launched only two years ago but more than 300 million users had signed up by the end of last year. Promisingly users are spending more time on WeChat than on Sina Weibo, China’s Twitter-equivalent. Bianews, a news portal focused on the Chinese internet, has reported that WeChat fans log on 22 times a day, spending an average of 28 minutes on the app. Sina Weibo users interact almost 10 times daily and spend an average of almost 20 minutes online.
WiC has chronicled the rise of WeChat since its launch (see WiC145 for an early mention). It is most often likened to WhatsApp, a smartphone application popular in the US that allows users to send text, image or audio messages for free. But the Tencent application has moved beyond simpler messaging by introducing a steady stream of new features like voice functions, social networking and more recently, e-commerce.
In fact, Tencent is planning to leverage the popularity of WeChat to promote its e-commerce sites. Already, it has been pushing shops in major cities as well as other e-commerce sites to use QR codes, which can be scanned by customers through WeChat to buy products or get discount coupons. The company also recently released a “voice sales” feature, which allows users to verbally ask the app to find products on the web and then directly purchase the items through WeChat.
Tencent is hoping that WeChat will be a critical piece of its expansion in e-commerce. Last year it vowed to invest $1 billion in this initiative to bring e-commerce revenue to Rmb200 billion ($32.2 billion) in five years. That’s ambitious, considering in 2012 the division only delivered Rmb4.4 billion in sales.
But Jack Ma, chairman of Alibaba Group, the country’s largest e-commerce firm, is worried. Ma recently expressed his concern that he was being ‘out-innovated’ in mobile due to “the powerful WeChat”.
Can it succeed overseas too?
Tencent is pushing to make WeChat a global mobile messaging application, starting out with a bridgehead in Southeast Asia. Company president Martin Lau claims that WeChat is already topping app stores in Malaysia, the Philippines and Indonesia, with over 40 million overseas users.
That number could increase after Tencent announced in February that it had established a presence in the US market devoted to growing WeChat further. “Mobile internet has indeed given us a chance in a lifetime. Our products still have a fighting chance on the international stage. To Tencent, WeChat is our window of opportunity for Tencent to become an international brand, “ founder Ma told an industry conference in Shenzhen last month.
Duncan Clark, chairman of BDA China, a research firm, also reckons that WeChat has the potential for further international expansion. “Many people are afraid of Chinese products, whether milk, cat food or internet services,” says Clark. “But with the Apple App Store, it’s hard to even know that WeChat is Chinese – it really levels the playing field.”
It helps to have a large war chest too. At the end of last year, Tencent was sitting on a cash pile of $4.4 billion, which should give it plenty of ammunition to target a share of the US market. Ma has also made it known that Tencent is looking at other options to grow in the United States, including acquiring local start-ups.
But trouble on the home front?
Late last month the telecoms regulator MIIT revealed that mobile operators might be allowed to impose new charges on WeChat usage. This follows complaints from China Mobile, the largest telco, that Tencent’s mobile applications are eating into its own messaging traffic and taking up too much bandwidth without generating compensating revenue for carriers (see WiC177).
“The surging data flow created by OTTs (over-the-top applications) has led to rising operational costs for telecom operators, who have found it hard to make ends meet by merely charging users for their data flows,” Wang Jianzhou, the former chairman of China Mobile, was quoted as saying in Beijing Youth Daily.
Rumours about the potential for new fees on WeChat quickly went viral, triggering protests. Worryingly for Tencent, an online poll conducted by Xinhua suggested that 90% of the respondents will cease using WeChat if fees are imposed.
Many also accused the state-owned telecom operators of abusing their position, and that having to pay telcos for use of the service would mean they will be charged twice, as they are already paying for mobile data plans.
NetEase, a portal, slammed the move as suggesting that China is a “mafia economy”. New Century Weekly concurred: “Should the ministry back the Big Three (mobile carriers), this will set a very bad example. What will we see next, road operators being allowed to charge delivery companies for the surge in business they are enjoying from internet retail sales?”
The online backlash took the government by surprise and MIIT and the state-owned carriers appeared to step back from the mooted proposals. At the Boao Forum last week, Tencent’s president Lau told reporters that WeChat will stay free (for now) and the company has indicated that it is working on ways of monetising the platform.
Nevertheless, investors might wonder if the spat with the state-owned telcos is going to reignite if they lose more revenue to WeChat. Indeed, fund managers must ponder whether Tencent will ultimately be able to stop the carriers levying a toll on its service, particularly as WeChat grows more bandwidth hungry. This is the veritable ‘Sword of Damocles’ hanging over Tencent (and its stock).
Tencent has other rivals too?
Last April, security software firm Qihoo 360 filed a lawsuit in Guangdong province accusing Tencent of exploiting its QQ instant messaging platform for an unfair advantage in other product areas (see WiC147). The court eventually rejected Qihoo’s complaints. But as it continues to expand into so many areas of the internet industry, Tencent is likely to face further accusations that it is crowding out the competition. Already, the phrase “life, death or Tencent” is a popular one among entrepreneurs in the sector – meaning the choice is often between cooperating with Tencent or being crushed by it. Others have accused it of ripping off the work of others. “Tencent is a copycat,” Charles Zhang, chief executive of Sohu.com, a rival portal, told BusinessWeek. “It’s a company that doesn’t create anything.”
But for a company that is the fourth largest internet brand globally by market capitalisation (only Google, Amazon and Facebook stand above it), Tencent can afford to ignore the grumbling for now.
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