Tencent Conference Call: Mini-program transaction volume reaches 1.5 trillion, double-digit growth in enterprise service revenue, high inventory of high-performance chips.

On November 15th, Tencent Holdings released its third-quarter earnings report. The report showed that Tencent achieved a non-IFRS operating profit of 55.483 billion yuan in the third quarter, a year-on-year increase of 36% and a quarter-on-quarter increase of 11%, thanks to strong advertising business and a rebound in game revenue. The net profit was 44.92 billion yuan, a year-on-year increase of 39% and a quarter-on-quarter increase of 20%, surpassing market expectations of 39.98 billion yuan. The management of Tencent stated that the inventory level of the company's high-performance chip model H800 is relatively high, and the existing inventory level can support the updates of several generations of Tencent's hybrid large models. Therefore, the cloud capabilities will not be affected by the chip ban.

Boosted by Video Account, Mobile Advertising Alliance, and WeChat Search, Tencent's advertising business reached a new high in the third quarter, with a year-on-year growth of 20% to 25.7 billion yuan.

After the financial report was released, Tencent's Chairman and CEO Ma Huateng, Executive Director Liu Chiping, and others attended the subsequent conference call, interpreting the financial report and answering analysts' questions.

Liu Chiping, President of Tencent, stated that in this quarter, the transaction volume of WeChat Mini Programs reached 1.5 trillion yuan, mainly including online and offline services in various scenarios such as catering, retail, transportation, and livelihood payments.

As an effective assistant for businesses operating within the WeChat ecosystem, Mini Programs provide large-scale small and medium-sized businesses with more flexible and consumer-centric digital operation tools, promoting the dual improvement of business efficiency and consumer experience. Liu Chiping pointed out that Mini Program games, as successful examples of vertical applications, have become China's largest casual gaming community.

Regarding Video Account, Liu Chiping stated that as an important new member of the WeChat ecosystem, the use of Video Account is growing rapidly. Video Account has increased the overall usage time of WeChat and is generating revenue at a higher growth rate than Tencent's average level.

He mentioned that the profit margin of Video Account's advertising revenue is high, and the marginal cost is relatively low. Tencent continues to deploy artificial intelligence technology to improve ad click-through rates, so there is still significant room for growth in Video Account's advertising revenue.

In addition, Tencent is cultivating more high-quality sources of revenue within WeChat, such as Mini Program games mentioned in the previous quarter, which have higher profits than basic application games.

Liu Chiping stated that Tencent has entered a high-quality revenue growth mode, in which Tencent can provide greater operating leverage than in the past.

Liu Chiping mentioned that by 2023, Tencent has transitioned from stable revenue growth to faster growth. The biggest driving force behind this significant change is the active transformation of the revenue structure, namely the growth of new high-quality revenue streams and the reduction of certain low-quality activities. In addition, optimizing costs through the divestment of non-core businesses, reducing operational subsidies and excessive marketing expenses, and maintaining a high focus on cost control are also driving factors for Tencent's sustained cash flow.

Regarding games, Liu Chiping stated that Tencent has observed a growing interest in casual games among people and a renewed interest in narrative games. Although this trend has not had a negative impact on Tencent's multiplayer competitive games, Tencent also believes that this trend is a new opportunity that can be seized and is investing in these trends to benefit from them. Q1: Can management share with us the future development strategy of mini-program games? Will there be any changes in the game distribution strategy between mini-program games and program games?

For mini-program games, we believe that Tencent's opportunity lies mainly in the platform. There are now thousands of game development studios that can focus on creating mini-program games. We are happy to cultivate this ecosystem and we do not want to squeeze or put pressure on it.

As for whether we will revive existing games in the product cycle by releasing mini-program games, the reality is that Tencent's game strategy is not built on games that are in the aging stage of the product cycle and require a lot of updates. Tencent's game strategy revolves around content that aims to become evergreen games, making those evergreen games as successful and popular as possible, and then adding more evergreen games that are equally popular and successful.

Tencent is not very focused on small games with product cycles and then revitalizing them through mini-program games or other means.

Q2: How will the US chip spending bill affect Tencent's AI strategy, including product releases, monetization, and focus areas?

In terms of the Mixun and overall AI strategy, we have made great progress in building Mixun. We believe that Tencent is one of the leaders in AI in China, and we are constantly expanding the scale of our models and preparing for our next generation of Mixun models, which will be a hybrid of expert architectures. We believe this will further enhance the performance of our Mixun models.

By building Mixun, Tencent has actually established comprehensive capabilities in general AI, as Mixun, based on Transformer models, involves a large amount of data, training data, large-scale computing clusters, and large-scale computing processing. Mixun is already very good at generating text and messages, which is actually very useful for many SaaS applications and can enhance the capabilities of SaaS services.

For example, in Tencent Meeting, we can actually use Mixun to write meeting summaries and help people who missed the first half of the meeting understand the content, and targeted documents can provide people with a useful tool to create documents more efficiently. These services have already been provided to external customers. We also have a complete set of productivity-enhancing tools, such as customer service APIs, which are now being tested by many users and enterprise users who need to interact with customers in code generation. The test results are very good and provide excellent tools for our programmers as well as external customer programmers to improve their programming efficiency. It also helps in content creation and enables advertisers to create more targeted ads, which can improve ad click-through rates and enhance the quality of art-related content in game production.

In the short video field, by improving our AI capabilities, we can actually increase the number of users at a faster pace. In terms of advertising business, by improving our targeting capabilities, we actually increase advertising revenue and deliver better results to our clients. For our clients, who are generating more content, our AI capabilities are producing tangible results at this time. In fact, Zhitong can provide many tools for enterprise clients, which can further improve the efficiency of our advertising business in the future, truly integrating the advertising and sales stages. If we can really provide excellent customer service capabilities, many businesses can actually combine advertising and sales processes.

We also believe that in the future, when there is actually a consumer-oriented product that is more like people's intelligent agents, there is actually a lot of room for imagination.

As for the US sanctions, in terms of the current chip situation, we are actually one of the Chinese companies with the largest inventory of AI chips. Tencent was the first company to order NVIDIA H800, which gives us a considerable inventory of H800 chips. So we have enough chips to continue developing Zhitong for at least a few generations.

Therefore, the ban has not really affected the development of Zhitong and our short-term AI capabilities. However, we do feel that the ban has indeed affected our ability to resell these AI chips to the entire cloud service business. So this is an area that may be affected, and in the future, we must find ways to make the use of our AI chips more efficient.

We will try to see if we can use lower-performance chips in a large number of inference tasks, so that we can reserve most of the high-performance AI chips for AI training. We will also try to find domestic suppliers for these chips.

Q3: Regarding the game business, two years ago, Tencent determined that games were a key investment area for future growth, and at that time, Tencent estimated that it would take about 2 to 3 years for the production cycle. And due to improved financial performance, Tencent now has more time to work on projects with longer production cycles. So what is the current production cycle for Tencent? How should we view the conversion of these investments in the development pipeline of different types of games and the financial performance in the next few years?

Regarding the game question, overall, we have chosen to sometimes extend our game production cycle by 6 months, and sometimes by 18 months. There are several reasons for this. First, it has been proven that the best games now have a greater chance, especially if the development studio can patiently invest time and resources to bring the best games to their optimal state. Of course, we hope to seize this opportunity and release the best games.

Since we have established a high-quality revenue growth model, we feel that we now have more freedom. With the existence of Video Number, Mini Program Games, Search, and E-commerce, even if we don't release major games in a given three-month period, our business can still maintain a fairly healthy revenue growth rate. Therefore, considering these two points, we believe that it makes sense for us to have a long-term plan and truly focus on maximizing the potential of the games we are developing.

Currently, Tencent has nine games waiting to be released, with one game set to be released in the next few weeks. The other games will be released in the next few months. These games will serve as test cases for the effectiveness of our strategy. But overall, we believe that we now have the flexibility to make long-term plans because we have established a high-quality revenue growth model, and Tencent has the ability to achieve revenue growth regardless of whether games are launched in a quarter.

Q4: Tencent increased dividends and intensified stock repurchases last year. How should we view the opportunities in Tencent's investment portfolio?

In terms of shareholder returns and capital management, first of all, Tencent is very focused on shareholder returns, and we will try different ways to improve investment returns. Secondly, Tencent has a very strong cash flow and a very large investment portfolio, half of which is actually liquid stocks.

Therefore, Tencent will flexibly use different tools to increase shareholder returns, such as repurchases, dividends, the distribution of investor shares that we have executed before, and divestments to generate cash so that we can carry out more stock repurchases and distribute dividends. We will dynamically use these tools and improve shareholder returns and return capital to shareholders in different combinations at different times.

Moreover, the valuation of Chinese internet stocks has almost reached its historical low, so stock repurchases may be more favorable for Tencent shareholders than other methods.

Q5: Regarding the sustainability of the improvement in gross profit margin in key advertising and fintech areas in the investment portfolio, can the revenue seen so far continue beyond 2024? Is there further room for growth? Regarding the fluctuating gross profit margin of domestic games in recent years, Tencent seems to have absorbed the impact of epidemic prevention and control, piracy, and other issues and entered a relatively normal period. How should we think about the medium- and long-term growth model in this field? To what extent does it rely on new popular content?

On the issue of gross profit, we have discussed three driving factors that have improved profitability in recent quarters, and two of them we believe have sustainability and recurring characteristics, while the other is more incidental, such as personnel adjustments and restructuring. Overall, the fastest-growing revenue stream in our business is also the one with the highest profit margin. Therefore, we believe that the current gross profit level is sustainable, and we believe that there is room for further improvement in profit margin. For example, the gross profit margin of the advertising business segment has increased from 30% to about 50%, while the gross profit margin of our closest global comparable company in advertising is 80%. Regarding the gaming business, we believe that our existing evergreen games have provided a certain amount of growth. In addition, we have a series of new games in the pipeline. Depending on the timing of the release of these new games and their success, they can provide additional growth.

Q6: When Tencent's games enter the international market, can you provide more details on the further investments Tencent needs to make? For example, Call of Duty Mobile has been launched for four years, but Tencent achieved record-breaking performance in July. Therefore, while balancing the release of new games, how can Tencent extend or revive the popularity of existing games? Another question is about capital expenditure and personnel plans. Tencent had higher capital expenditure this quarter, and the personnel scale has gradually improved. Can you share some relevant information?

Tencent has made significant investments in overseas games. Of course, we have large studios in China, such as Timmy and Quantum, with thousands of developers who are developing games for both the international and domestic markets. Therefore, we believe that we now have the teams to create high-budget, high-production-value games for the international market that will ultimately succeed. We will release these games in the coming quarters.

In terms of operations, operating capital expenditure is expected to account for approximately 3% to 5% of total revenue in 2023, and is projected to remain at a similar level in 2024, around 3% to 3.5%. If we can obtain more graphics processing units (GPUs), that would add an additional 1%. Non-operating capital expenditure is expected to be around 1% to 1.5% annually. In terms of construction, we have spent approximately $1 billion per year in the past few years, excluding any land acquisition costs. If land acquisition costs are included, the additional expenses should not exceed $1 billion.

In terms of personnel scale, we believe that most of the efficiency optimization has been completed, and we have the appropriate personnel scale for our current business size. We are selectively hiring to develop our new businesses. However, we recognize that large teams are not conducive to business focus and efficient execution. In the past, we and possibly many other companies have actually built teams too quickly and on a large scale. Therefore, fiscal discipline in the future is key, and part of that is striving to keep our team size smaller but with higher quality personnel, so that we can help the team focus on truly valuable things, which are often value-creating for the business, and make our business strategically stronger.

Q7: Regarding advertising revenue from Video Accounts, as Tencent begins to move away from a low user base, although Tencent will still have close e-commerce transactions to support the growth of Video Account advertising, what could be the overall online advertising revenue growth rate when it reaches a stable stage in the future?

Video Accounts present a closed-loop opportunity. In fact, domestic short video platforms have been very focused and effective in maximizing closed-loop transactions because these transactions generate the most information, which enables the most powerful ad targeting capabilities. Considering our mini-programs, landing pages, Video Accounts, and Tencent's payment infrastructure, we believe Tencent is in an ideal position to further strengthen our own closed-loop capabilities. Q8: Regarding the mixed reality model, the management has mentioned the possibility of consumer-oriented commercial products in the future. I would like to know when AI systems, for example, can be integrated into WeChat and QQ, and when they will be ready. Is it possible to generate commercial service fees, such as subscription fees?

Regarding the mixed reality model and the potential AI assistant in the future, it can be said that it is still in the very early stage of conceptual design and has not yet reached the product design stage, nor has it considered the monetization stage. However, if you look at any of these generative AI technologies, the cost of inference is a real variable cost that needs to be taken into account throughout the process. To some extent, this also adds to the challenge of product design. So, in fact, it is still in a very early stage, with hope and room for imagination in the future, but it is still too early to talk about it in a very specific way.

Q9: Regarding live e-commerce, considering the highly competitive environment, Video Number is gaining good attention and growing rapidly. Therefore, from the management's perspective, what are Tencent's strategic goals for the next few years, especially in terms of internal advertising and the trend of commission growth or the desired market position to be achieved in the next few years?

In terms of live e-commerce, the strategy is already very clear. Once we have the short video franchise, we can start introducing it into the live streaming field and establish the franchise there. Then, through live streaming, if we can establish tools, connections, and merchant supply chains, we can start developing live e-commerce business. So the strategy is already very mature. What we are doing is building systematically and step by step, which involves many steps, including building a strong operations team to ensure the quality of the products we offer on our platform. Building category teams to manage different categories, and establishing tools and infrastructure to facilitate merchants to conduct more business. We need to integrate the entire ecosystem into our advertising system. And we need to build a KOL ecosystem so that merchants can leverage KOLs to promote live e-commerce business.

So I think if we proceed step by step, we will gradually increase our market share in the short video market. We have short videos that can be live-streamed, and in live streaming, it will actually contribute to the total transaction amount (GMV) of live e-commerce. If we execute well throughout the strategy, it will bring us a considerable market share.

But besides that, Tencent has some very unique capabilities or features that may bring more growth opportunities. This includes Tencent's very powerful mini-program ecosystem, where many merchants and brands have already conducted a lot of business. If we can connect our live e-commerce with mini-programs, adding a layer of integration and business expansion, it will help achieve more business. We have social sharing features within our ecosystem, which can actually help merchants and products be shared with many other friends and contacts, resulting in more sales. In addition, we also have a fairly large group of high-income and affluent customers who may not be accustomed to shopping on short video platforms at this point in time. If we can guide them into the entire live e-commerce ecosystem, it may bring more growth opportunities. Q10: Regarding the factors driving the growth of the advertising business, the management mentioned that they hope search will become one of the driving factors. Can you share more indicators, such as the current status of the business, the proportion of users using search, etc.? More importantly, considering that search advertising is a traditional advertising model that Chinese internet companies have been operating for many years, what is the management's view on long-term profitability opportunities?

In terms of search, the penetration rate is currently quite high. It starts with people searching for new contacts or content within applications, and almost everyone does it regularly every day. However, in addition to this, everyone also needs to search in the open network and ecosystem. Therefore, content search is very common, but what we need to do is to make people use it more frequently.

There are several ways we can increase usage frequency. The first is the search technology within WeChat. We have been continuously improving our technological capabilities, and I believe that search technology has been constantly evolving. After we acquired Pokemon GO, our search technology has also improved.

The second is the user experience of search because WeChat is a tool for people to communicate. Therefore, we need to provide a user experience that allows people to find content faster than usual when they open a browser for search. I think we have made some progress, but there is still more work to be done.

The third is the ecosystem. We have a large amount of content within WeChat, through official accounts, and a growing mini-program ecosystem. Now we also have Video Accounts, and we can use search technology to connect all the content within our ecosystem, which is something we are gradually building. Once we achieve this, now that we can allow people to search on the open network and we have unique content exclusive to WeChat, the value proposition and content of WeChat search will be better.

These are all things we have been doing to increase user frequency in search. We have seen encouraging signs as the viewing volume of content and overall viewing volume have been increasing steadily in recent years. Over time, once we establish a continuous flow of content search traffic within WeChat, we can start considering monetization. Currently, our search advertising load is still very low, so we have great growth potential.

But more importantly, I believe that establishing a transactional ecosystem within WeChat is crucial for the future growth of WeChat search. The more mini-program transactions we can generate, and as time goes on, the more live e-commerce we can generate, this will actually help increase the monetization potential of WeChat search. We believe that there is a very long-term development space for business expansion in this area.

Q11: Regarding mini-games, we have noticed that most of the major game activities are still primarily in app games. What conditions are needed to migrate these core and hardcore game activities to the mini-game ecosystem? Currently, is it limited by technology or bandwidth, or does it involve more user behavior issues?

Regarding mini-games, we believe that there are several limiting factors. We believe that the most important factor is the limitation of technological capabilities. Currently, there is a lack of development tools that can create mini-games comparable to app games. The reason I say this is because if you look at similar concepts, such as Roblox, the range of games available on Roblox has been steadily expanding over time. These games have become more immersive in terms of graphics, with an increasing number of multiplayer games and fast-paced Twitch-based games.

Now we are seeing a similar situation in the mini-game field. Initially, mini-games were usually single-player games, followed by basic multiplayer card games. Now we are moving towards multiplayer role-playing games, and in the future, we expect to see multiplayer first-person action games. As smartphones become more sophisticated and mini-game architecture becomes more powerful, developers are becoming more professional in creating mini-games. As a result, the capabilities and experiences of mini-games and application games will converge in the long term. With this trend, people who are currently playing application games will also start playing mini-games.

Q12: Tencent has performed strongly in the advertising field this year, with its platform market share continuously growing. Considering that e-commerce is becoming a bigger contributing factor, it is clear that seasonal factors are also at play, and the contribution of video accounts may be seen in the next year. Can we expect accelerated growth in the next quarter or in 2024?

We see four clear growth drivers for our advertising business, including traffic growth, increasing ad load to narrow the gap with industry peers, deploying artificial intelligence to improve the click-through rate of closed-loop ads. These are all positive aspects. However, macroeconomic factors may be a potential negative factor, and this year has not been particularly outstanding. We do not provide guidance on growth expectations for the next quarter or next year. The theme we are discussing tonight is not a high-income growth model, but a high-quality income growth model. Therefore, we are not overly concerned about maximizing the speed of revenue growth in any given quarter. We are more focused on a healthy and sustainable revenue growth rate. We believe that through sustainable revenue growth, we can drive faster profit growth.

Q13: What factors should be considered for overseas games? There have been reports of layoffs in the industry. How should we consider the impact of factors such as user spending, the speed of new game launches, and industry consolidation? How will these factors come into play?

I don't think there is a simple, single answer to this. It is a complex industry that has experienced rapid growth in the number of practitioners in the past two to three years and is now going through a period of consolidation. This has happened several times in the past and unfortunately may happen again in the future. We just need to effectively deal with this situation.

However, it is important to emphasize that we benefit from many other rapidly growing businesses, so we do not feel pressured to maximize revenue growth from international or domestic games in any given quarter. For example, Microsoft does not feel the need to release a new Halo game on December 31 instead of January 1 because people continue to use Windows, Office, Azure, and all other Microsoft products that contribute to profit growth.

I think we are in a position now where we have a multi-pronged growth model with the improvement of our advertising business profitability, the improvement of financial technology business profitability, the transformation of business services, and new contributions from e-commerce, among others. It is certainly good when overseas games launch significant new products and accelerate growth, but at the same time, overseas games in a particular quarter are not the main factor determining whether we increase profitability. Q14: Regarding fintech and cloud business, there hasn't been much information about the growth in these two areas so far. How should we view these two areas and their growth prospects? Especially in terms of the recovery prospects for business services, apart from e-commerce, what are the overall outlook and prospects for cloud business?

This question has two parts, fintech and business services. As for fintech, Tencent has a very important platform in the payment field. In addition to payments, we actually provide financial services as well. In terms of business itself, the growth this year has been quite good. There are several driving factors. On one hand, it is accompanied by consumption growth. Despite some macroeconomic challenges in the economy, consumption in China is still growing. Our overall fintech business is also growing in this process.

Moreover, we actually provide financial services such as loans and wealth management, which are part of a high-quality revenue growth model. In these businesses, we can achieve high profit margins. They rely on a payment network, the costs of which have already been paid, and their growth actually generates additional marginal profits. However, we manage these businesses very cautiously because we want to ensure that we excel in risk management. We also try to develop in a prudent manner so that we do not take on too much risk and can choose to serve the highest quality customers. In the long run, we actually hope to find more value-added services to bring value to the merchants we serve. If we truly create value, we will charge some additional fees.

As for cloud business services, in the past two years, the entire industry has undergone a lot of capacity adjustments, and access capacity has been fully utilized. Many enterprises have been striving to reduce costs. We have also actively divested from some low-quality businesses.

Looking ahead to 2024, we believe that the dynamics of the market may have reached the end of the squeeze on unused capacity. So if the macroeconomic conditions remain unchanged, there may be moderate growth in cloud usage, but higher economic growth may be needed to bring higher growth rates. In terms of PaaS and SaaS, there may be some growth, which is actually an area we are focusing on. We believe that in the future, we will be more focused on high-quality revenue models and will focus more on the PaaS and SaaS areas. Therefore, fundamentally, this will bring us more gross profit.

Q15: How should we view investment and reinvestment in the portfolio this year, as well as any experiences and lessons learned in investment allocation over the past two years? How should shareholder returns be considered at the front end of the investment portfolio?

Regarding the portfolio, we are very proactive and flexible in increasing investments and divestments. While some activities are visible, many are not. However, considering that we believe there are mispricings in the stock price, the primary use of cash is to repurchase our own shares, which remains the current top priority.