Tencent conference call: Advertising and gaming benefit from AI deployment, total gaming revenue resumes growth

After the Hong Kong stock market closed on May 14th, Tencent released its first-quarter financial report, with performance exceeding expectations across the board. The gross profit margin increased from 45% in the same period last year to 53%.

During a later conference call, Tencent stated that its advertising business showed strong growth, with platforms such as WeChat Video Accounts, Mini Programs, Official Accounts, and Sogou Search driving a 26% year-on-year increase in first-quarter advertising revenue for Tencent. In terms of advertising technology, Tencent is innovating the advertising targeting process through artificial intelligence to help advertisers manage their ad campaigns, and recently launched the Honewan platform to assist advertisers in creating ad content. These innovations are driving rapid growth in the advertising business.

Tencent believes that over time, the monetization potential of short video streams will eventually surpass traditional social information flows such as Moments. The company is also moving in this direction. In addition, the usage of WeChat search services continues to grow healthily. Tencent began preliminary monetization of this service last year and it is still in the early stages of monetization. The high user engagement of WeChat, the growth in search volume, and the rich content ecosystem provide ample space for the continued growth of WeChat search revenue.

In the gaming sector, Tencent achieved overall revenue growth. International gaming market revenue increased by 3% year-on-year, while domestic gaming revenue decreased by 2% year-on-year in the first quarter but increased by 28% quarter-on-quarter, demonstrating strong recovery momentum. Tencent will continue to drive the development of "evergreen games" and explore large competitive multiplayer games to maintain its leading position in the gaming industry.

Regarding financial technology business, Tencent pointed out that the slowdown in the growth of financial technology business was mainly due to reduced offline consumption. However, with the implementation of various government economic stimulus measures, Tencent expects this trend to gradually reverse, and the financial technology business will resume growth. Tencent has achieved initial results in monetizing SaaS products that were previously provided free of charge, but the commercialization of the SaaS business is still in its early stages, as the software payment habits of Chinese enterprises are still being cultivated. In the future, Tencent will continue to steadily advance the monetization of SaaS services.

Looking ahead, Tencent will continue to leverage AI technology to enhance the efficiency and user experience of its advertising and gaming businesses. The Tencent management remains optimistic about the company's long-term growth prospects and expects that with the optimization of its business portfolio, shifting from low-profit to high-profit revenue, the profit margins of each business segment will continue to rise, and this positive trend will continue for several years.

Below is a transcript of the analyst Q&A session:

Q1: Regarding the gaming business, the previous quarter emphasized a key strategy that revitalized key metrics, showcasing the strong performance of Super Cell games and the recovery of PUBG. Given the rich experience in IP portfolio and executing online games, can the management share with us the potential and growth plans for the gaming business in the future, and how to successfully replicate this success in other IPs and games?

Answer: We have been working to revive the vitality of some key games, and this process is currently progressing smoothly. We have gained some lessons from this experience, and games categorized as "evergreen" seem to have the ability to self-recover A good example is "荒野乱斗" (Brawl Stars), not only has its revenue quadrupled compared to the same period last year, but also doubled its daily active user count.

The second lesson is, if a perennial game is stagnating, the issue usually lies not with the game itself, but with its operation. We need to make changes to the operation team, and when we make these changes, we will quickly see positive results. Large-scale competitive multiplayer games are essentially perennial, just like key sports such as football and basketball. When the game is managed by the right people, the right results will be achieved.

Q2: Last quarter, Tencent pledged to repurchase at least HKD 100 billion worth of shares. Considering that the stock price has risen significantly since last quarter, how should we consider the pace of repurchases? Will repurchases rely more on stock price or other factors?

Answer: We have committed to repurchasing at least HKD 100 billion worth of shares, and the repurchase has been carried out on a fairly consistent basis. We do not believe that repurchases depend on the stock price, as we believe the stock price is still attractive, with significant growth in corporate profits, continuous increase in portfolio value, and very good long-term prospects. Therefore, we will continue to pursue stock repurchases.

Q3: Regarding the advertising business, with the momentum of growth in the first quarter, how should we think about our market share growth story and growth against the backdrop of macroeconomic recovery? In terms of video accounts, how will advertising growth momentum evolve in the coming years and how will the growth of live e-commerce GMV drive advertising revenue?

Answer: Given the complex economic situation, advertisers' sentiments are also quite complex. We expect advertising growth to be slower in the upcoming quarters compared to the first quarter. We are currently in a good position to continue to rapidly gain market share, and we are still in the early stages of increasing advertising revenue from video accounts. Overall, we remain very constructive in terms of advertising revenue growth, and market share will further increase.

Q4: With the positive growth in HRK revenue, server games also achieved record high revenue this quarter. Are there any ongoing adjustments still in progress? Are there any risks or uncertainties in the gaming business?

Answer: Growth in deferred revenue is a positive leading indicator of game revenue growth. We have not seen any particular risks, and we believe that through the structural changes we have made, we have to some extent reduced the risks in the gaming business.

Q5: How do we learn from successful games and apply that to the cultivation of new games, especially upcoming games like DNF Mobile and new games in the international market? Meanwhile, with the general rise in profit margins, is the sustainability of future profit margins and the profit margin trends of different departments?

Answer: Against the backdrop of continuous optimization and enhancement of "perennial games," new games not only need to compete with games released in the same period, but also with all existing games, especially those that have survived and evolved into top "perennial games." This competitive phenomenon exists on PCs, mobile devices, and game consoles, and is increasingly evident in both the Chinese and international markets. Players are spending more and more time on large perennial games like "Fortnite" and "Call of Duty." For the challenge of new games, our strategy is to raise the quality threshold for new games we bring to the market, focusing on fewer but higher quality and more potential games. We realize that not all new games can become "evergreen games." Some games are content-driven, with a predetermined lifecycle, which is reasonable, and these games can also be successful and loved by players. However, for those games we hope to become "evergreen games," we pay more attention to internal indicators such as player engagement and retention rates, rather than external visibility such as hype, download numbers, or first-day revenue. These indicators are key to determining the long-term potential of a game. For example, "Clash of Clans" initially had mediocre performance but has now become the third largest mobile game in China, second only to our other two games. These are some considerations and guidelines we have in launching new games.

Regarding the sustainability of profit margins in various business departments, it involves multiple factors, including competitive conditions, macroeconomic conditions, and seasonal factors. However, in the long term, the most critical factor is the combination of products and businesses within the department. In our three major business departments, especially advertising, financial technology, and commercial services, they are undergoing active transformation in product and business combinations, shifting from low-profit revenue to high-profit revenue. This positive trend will continue for several years. Therefore, we believe that the current profit margins and their upward trend are sustainable.

Q6: What are Tencent's plans in AI? How does Tencent use AI to enhance its advertising business? In the context of AI development, competitors such as ByteDance and Alibaba are also using AI to improve their advertising businesses, how will this affect changes in long-term advertising market share?

Answer: We believe that AI tools like Advantage Plus are crucial for the development of social media companies in the advertising field, as they simplify the advertising process, enabling them to compete with search engines and e-commerce platforms. The advantage of social media platforms lies in user engagement and time spent, far exceeding that of search engines or e-commerce platforms.

Although competitors are also adopting AI, we believe that the biggest beneficiaries will be companies with a large amount of under-monetized user time, which, by adopting AI technology, will be able to more effectively convert this time into revenue, becoming the biggest beneficiaries, and we are one of them. By using AI, these companies can target ads more accurately, increase user engagement, and more effectively convert user time into revenue.

AI improves click-through rates, especially for platforms like social media with initially low click-through rates. In addition, AI allows advertisers to create image and video ads for social media, not just text ads. We expect ad spending to shift towards services that have high user engagement, can provide higher click-through rates, and transaction volumes.

Q7: Meta announced the launch of Meta AI features and will integrate them into all Meta products including WhatsApp, will Tencent leverage its strong network product ecosystem to launch similar features to Meta AI in the future?

Answer: WeChat and other high user engagement products will be excellent distribution channels for AI products. Currently, everyone is trying different products, although no one has found a universally applicable Q&A application yet (except for OpenAI). We are developing and testing different AI products suitable for our existing products and will launch them in due course.

Q8: Tencent's commercial services and cloud services, such as Tencent's new business revenue growing threefold and Tencent Meeting's revenue doubling, does this indicate that customer adoption of our services is accelerating? Will this continue for the rest of the year? In the wealth management sector, what is Tencent's strategy in the field of financial technology services?

Answer: Tencent has achieved initial success in monetizing SaaS products that have been provided free of charge for a long time. Although the starting point of this achievement is relatively low, it validates the feasibility of charging for SaaS services in China. Unlike mature markets like the United States, the habit of Chinese enterprises paying for software is still developing. Currently, Tencent is starting to introduce and monetize some value-added services to enterprises. However, the commercialization of the SaaS business is still in its early stages, and the current revenue scale is small compared to the achievements of American enterprise software.

Tencent expects that there is still a long way to go to achieve continuous revenue growth. The current progress is an initial validation of the business model rather than an acceleration of monetization speed. In the future, Tencent will continue to steadily advance the monetization process of SaaS services. We have not reached a turning point in the growth of SaaS services, but we will continue to invest in these services as they help establish connections with enterprise customers and drive sales of other cloud services. We aim to be a leader in the SaaS market when it matures.

In terms of wealth management services, we offer money market funds in collaboration with fund management companies. Customers are more inclined to invest funds in money market funds compared to depositing them in bank accounts or spending them. We have observed this trend growing, partly because there are more use cases on our payment platform, making people accustomed to storing more funds on the platform; and partly because consumers are reducing consumption and increasing their willingness to save.

To further develop, we will continue to strengthen the payment platform to make users more willing to entrust more wealth to us and provide them with more usage scenarios. At the same time, we will collaborate with more fund management companies to offer high-quality money market funds and other wealth management products. Additionally, we will focus on risk management to ensure the security of customer funds. If these aspects are handled properly, we believe these measures will collectively drive stable growth in wealth management services.

Q9: Regarding e-commerce, last year we discussed video accounts and mini-programs. In which area are we most innovative currently? Especially in terms of upgrading advertising technology, will we promote ROI-based advertising products through video accounts, live streaming, and mini-programs?

Answer: In terms of advertising technology, Tencent is innovating the advertising targeting process through artificial intelligence to help advertisers manage their advertising campaigns, and recently launched the Honewan platform to assist advertisers in creating ad content. These three areas are the focus of our innovation, and these innovations are driving rapid growth in our advertising business

Q10: Tencent's vast investment portfolio is worth nearly USD 130 billion. After the distribution of shares in JD.com and Meituan, does the company have a continuous or predictable policy regarding share distribution so that the market can more actively assess the value of this part?

Answer: Regarding our investment portfolio, we have been working with invested companies to help them improve their profitability. This quarter, the non-IFRS income from associated companies exceeded RMB 5 billion, showing significant year-on-year growth. This indicates that investors have implicitly valued our investment portfolio at billions of RMB in total revenue. Although there is a gap between this and the intrinsic market value of the portfolio, as the profitability of associated companies like Pinduoduo improves, this gap will narrow with their growing profits directly impacting our advertising revenue.

Currently, we do not have any plans for share distribution. Over the past few years, we have invested most of our free cash flow in our investment portfolio, strategically helping us build an ecosystem and financially rewarding shareholders.

For example, in the gaming sector, we have invested in many game studios, enabling us to enter the international market and gain control over some evergreen and large-scale games. In the music industry, our investments in Spotify and upstream companies have helped establish Tencent Music's strong position in China. Our investments in payments have also facilitated the development of many use cases. From both strategic and financial perspectives, the portfolio has created significant returns for shareholders.

However, now that the portfolio has reached a considerable size, some companies may consider distribution as they mature. Given the scale of the portfolio, we do not intend to inject additional funds. If we need to pursue new initiatives, we can actually recycle some investments within the portfolio. This way, the company's free cash flow can be used for shareholder value-enhancing activities, such as dividend payments and share buybacks. This is how we consider contributing to shareholder value.

Q11: What are the potential applications of Hun Yuan in the gaming business? And how does it help improve game production efficiency?

Answer: Currently, Hun Yuan primarily enhances customer service quality in the gaming business by answering player questions and providing high-satisfaction AI customer service. Although AI has been applied in games, generative AI technology is not yet widely used. With technological advancements, Hun Yuan is expected to evolve into multimodal AI in the future, capable of creating high-quality video content, further benefiting game production.

Currently, AI can create interactive experiences through NPCs, but it cannot fully replace the heavy lifting in game content creation. It may take several generations of technological evolution for AI to play a more critical role in game development.

Q12: Can you explain in detail the reasons for the slowdown in the growth of the financial technology business, breaking down the payment and non-payment parts? Also, what are the medium to long-term growth prospects for the financial technology business? WeChat Search has recently strengthened its monetization momentum, could you discuss its monetization strategy? Sharing some operational metrics would help us understand its growth potential

Answer: The slowdown in the growth of financial technology businesses is mainly due to the decrease in offline consumption, which is a common phenomenon. The government is implementing multiple stimulus measures to revive the economy and consumer confidence. With the implementation of government stimulus measures, it is expected that this trend will reverse.

Before the reversal, the growth of payment businesses will slow down. Although withdrawal fees are one-time low-quality income, reducing withdrawals will keep funds in the system longer. While it may not generate immediate withdrawal income, it will be transformed into part of asset management and continue to generate wealth management fees over time, thereby transforming into long-term value-added income. Wealth management services are expected to continue growing for the reasons mentioned earlier.

Given the unfavorable macro environment, we are taking a more cautious approach to long-term interest fees, focusing on risk management. This is how we examine the different components of financial technology revenue.

The use and search volume of WeChat search services are growing at a healthy pace. We started monetizing it last year. Due to WeChat's high engagement, search volume growth, and rich content ecosystem within WeChat (including Official Accounts, Mini Programs, and Video Accounts), we are still in the early stages of monetization, providing ample room for continued growth in WeChat search revenue.

Q13: The monetization potential of video accounts may be comparable to Moments. Given that the user engagement of video accounts is twice that of Moments, can you share your views on the strength of advertising revenue based on engagement? Is it possible for the total monetization of video accounts to eventually exceed Moments? Management has criticized internal processes, can we expect to see a more stable product release pipeline in the second half of this year and in the coming years?

Answer: As shown by companies like Meta, over time, the monetization of short video streams will eventually surpass traditional social information streams. We believe we are also moving in that direction.

For game development, although we have addressed some obvious issues, we are aware that new challenges may arise in the future. Game development is a process of continuous iteration and debugging. However, we have overcome some major challenges, which have increased user engagement and monetization of our existing games and enhanced confidence in our new game product line.

You mentioned our internal game development process. External parties may mistakenly assume that Tencent has a unified game development process, but this is as inaccurate as assuming that all studios under Disney operate in the same way. Taking Tencent's five major games as an example, they are developed by teams in Chengdu, Shenzhen, Helsinki, and Los Angeles, each with its unique practices and strengths. While we share best practices, each studio maintains its uniqueness, which is its core strength. We plan to continue strengthening these advantages.

Our attitude towards the game team is not criticism. Our game team has done many things right, but no team or game is perfect. We continue to conduct open and transparent debugging and discuss our efforts and changes more transparently and honestly with the outside world. We believe some of our key games are truly "evergreen games." We do not attribute the lack of success of a game solely to its lifecycle but rather identify and address specific issues to achieve long-term success for the game. This is also why we have many "evergreen games." In addition, diversity is crucial for us. The Tencent gaming family has the most studios in the world. They work independently, share experiences, progress collectively, and move faster than the industry average