Fear of the other

Can it end its reliance on games?

Fear of ‘the other’ is one of humankind’s most deeply rooted psychological tendencies. It is what kept us safe in ancient times, although today it is deemed an emotional rather than rational response.

Stock market investors appear to have had a very similar reaction to Tencent’s fourth quarter results last week, which showed that its “other” revenues had overtaken gaming revenues for the first time.

Since then the Hong Kong-listed company’s shares have fallen 6%, although to be fair the rest of the market has been on a downward turn as well.

The negative interpretation of Tencent’s results is that its dominant gaming business has been badly affected by a regulatory crackdown, which led to a nine-month period during 2018 when no new games were approved.

As we reported in WiC439, the government lifted this pan-industry ban at the turn of the year and since then Tencent has started getting its own product pipeline unblocked.

Net profit for the September-December period fell 32% to Rmb14.2 billion ($2.1 billion), the biggest year-on-year decline since Tencent went public in 2004.

A more positive interpretation points to the fact that the company’s bottom line has been weighed down by a couple of one-off losses from its portfolio firms, and not just its gaming division. The group’s overall revenues still came in 2% ahead of consensus forecasts at Rmb84.9 billion, up 32% from the same period in 2017. ‘Other revenues’, aka mobile payments and cloud, accounted for 28.52%, just pipping online games on 28.5%. Behind that came social networks on 23% (WeChat, QQ) and online advertising on 20%.

This is certainly an about-turn from the beginning of 2018 when games accounted for 39%, followed by social networks 25%, ‘other revenues’ 22% and advertising 22%.

Some analysts believe that Tencent’s latest quarter demonstrates that it is beginning to reduce its dependence on gaming. An HSBC research note also suggests “the market is under-appreciating Tencent’s ability to embrace change”.

Others believe that Tencent’s payment and cloud businesses could account for half of its revenues by 2022, although the group’s margins may fall, particularly if rival Alibaba’s Ant Financial continues to use payments to drive traffic rather than profits.

Tencent’s lead in mini programmes may also come under pressure. These are apps, which run inside WeChat and lock users into its ecosystem. The company revealed last October that the number of mini programmes has grown to one million, prompting rivals Baidu and Alibaba to step up their investments in the sector.

Retail is also growing into a key cog of Tencent’s ‘other’ businesses, and the company is reportedly head-to-head with Alibaba again in a bid to purchase a 10% stake in Asian health and beauty retailer AS Watson for $3 billion. Hong Kong-based Watsons has 3,000 stores across China and would fit into two themes being pushed by both internet giants: Big Health (see WiC397) and online-to-offline distribution.

Tencent has also been shortlisted as a buyer of Korean gaming company Nexon, a target that could help it diversify its gaming business away from China and all the regulatory risks that has recently entailed. According to Bloomberg, Nexon’s founder offered to sell to Tencent last year (the two have an existing partnership). However, Tencent is said to have baulked at the price.

It now finds itself up against Korean social media network Kakao (also backed by Tencent) and a handful of private equity investors. Bidding is set to begin next month, with a $13.3 billion price tag mooted.

If Tencent wins, then Nexon will boost its gaming revenues by about a fifth, making it the dominant revenue generator again. Even without Nexon, gaming is likely to overtake ‘other revenues’ by the end of the first quarter as new licences generate cash.

Meanwhile, Tencent shareholders might want to pay closer attention to a plan announced by South African media group Naspers this week to spin off its $135 billion stake in Tencent on the Amsterdam stock exchange. The move will see Naspers indirectly cutting its 31% stake in the Chinese internet giant and when the listing is completed, it will also offer global investors a proxy to buy into the ‘other’ Tencent.

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