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Edited Transcript of 700.HK earnings conference call or presentation 13-May-20 12:00pm GMT

Q1 2020 Tencent Holdings Ltd Earnings Call

Shenzhen May 13, 2020 (Thomson StreetEvents) -- Edited Transcript of Tencent Holdings Ltd earnings conference call or presentation Wednesday, May 13, 2020 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chi Ping Lau

Tencent Holdings Limited - President & Executive Director

* Huateng Pony Ma

Tencent Holdings Limited - Co-Founder, Chairman & CEO

* James Gordon Mitchell

Tencent Holdings Limited - Chief Strategy Officer & Senior EVP

* Shek Hon Lo

Tencent Holdings Limited - CFO & Senior VP

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Conference Call Participants

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* Alex C. Yao

JP Morgan Chase & Co, Research Division - Head of Asia Internet and New Media Research

* Eddie Leung

BofA Merrill Lynch, Research Division - MD in Equity Research and Analyst

* Hyungwook Choi

Daiwa Securities Co. Ltd., Research Division - Head of Hong Kong & China Internet and Regional Head of Small/Mid Cap

* Piyush Mubayi

Goldman Sachs Group Inc., Research Division - MD

* Wai Yan Wong

HSBC, Research Division - Head of Internet Research of Asia Pacific & Analyst

* William Henry Packer

Exane BNP Paribas, Research Division - Executive Director of Media Equity Research

* Xiaoguang Zhao

Barclays Bank PLC, Research Division - VP

* Yik Wah Yap

Citigroup Inc, Research Division - MD & Head of Pan-Asia Internet Research

* Yuan Liu

UBS Investment Bank, Research Division - Co Head of HK and China Internet Research

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by and welcome to the Tencent Holdings Limited 2020 First Quarter Result Announcement Call. (Operator Instructions)

Please be advised that today's conference is being recorded.

I will pass the call to [Wendy Huang] from Tencent IR team. Thank you. Please go ahead.

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Unidentified Company Representative, [2]

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Good evening. Welcome to our 2020 first quarter results conference call. Before we start the presentation, we would like to remind you that it includes forward-looking statements, which are underlined by a number of risks and uncertainties and may not be realized in the future for various reasons. Information about general market conditions is coming from a variety of sources outside of Tencent.

This presentation also contains some unaudited non-IFRS financial measures that should be considered in addition to, but not as a substitute for, measures of the company's financial performance prepared in accordance with IFRS.

Non-IFRS measures are intended to reflect our core earnings by excluding certain onetime and all noncash items. For a detailed discussion of risk factors and non-IFRS measures, please refer to our disclosures on the IR section of our website.

Now let me introduce the management team on the call tonight. Our Chairman and CEO, Pony Ma, will kick off with a short overview. President, Martin Lau, and Chief Strategy Officer, James Mitchell, will provide a business review. Chief Financial Officer, John Lo, will conclude with financial review before we open the floor for questions.

I will now turn the call over to Pony.

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Huateng Pony Ma, Tencent Holdings Limited - Co-Founder, Chairman & CEO [3]

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Thank you Wendy. Thank you for joining our call at this difficult time.

First, the world have got COVID-19. Our thoughts and hearts go out to all the people who are suffering from the pandemic. During this difficult period, we seek to provide online services that keep people connected, informed, productive and entertained.

So far, our businesses have proved resilient and cash flow generative, enabling us to increase our investments to fulfill our mission of tech for good.

We are allocating time and resources, including over RMB 2 billion of donation to contribute to COVID-19 relief initiatives in China and globally.

And now I will highlight the results we achieved in the first quarter of 2020. Total revenue was RMB 108 billion, up 26% year-on-year and 2% quarter-on-quarter. Gross profit was RMB 53 billion, up 33% year-on-year and 15% quarter-on-quarter. Our non-IFRS operating profit was RMB 36 billion, up 25% year-on-year and 17% quarter-on-quarter. Non-IFRS net profit attributable to equity holders was RMB 27 billion, up 29% year-on-year and 6% quarter-on-quarter.

Our platforms and products have never been more need and relevant as users stayed at home. We believe this experience will also lead to a realization of digitalization going forward.

In social, users heavily relied on our social platform to stay connected. Combined MAU of Weixin and WeChat increased increased 8% year-on-year to over 1.2 billion.

In games, more players spent more time online, further strengthening our #1 position in China. Our games also continued to grow internationally.

In Media, video views and subscriptions continued to expand as we released the top-tier content. Music subscriptions increased driven by effective content paywall strategy.

In FinTech, we operate the largest mobile payment platform in China by DAU and number of transactions, increasing the efficiency and supporting small business.

In cloud, we are #2 public cloud solutions provider in China, steadily picking up market share amidst intense competition.

In utilities, we maintained our industry leadership in mobile security, mobile browser and Android app store in China.

I will invite Martin and James to discuss business review.

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [4]

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Thank you, Pony, and good evening and good morning to everybody.

For the first quarter of 2020, our total revenue grew 26% year-on-year. VAS represented 58% of our total revenue, within which online games was 35% and social networks was 23%. FinTech and Business Services represented 25% of total revenue and online advertising represented 16% of total revenue.

For Value Added Services, segment revenue was RMB 62.4 billion in the first quarter, up 27% year-on-year and 19% quarter-on-quarter. In social networks, revenue grew both year-on-year and quarter-on-quarter mainly driven by item sales and smart phone games. Total VAS subscriptions increased 19% year-on-year to 197 million, reflecting robust growth in video and music subscriptions as users spent more time online. Our video subscriptions increased 26% year-on-year to 112 million due to popular self-commissioned drama and Chinese anime series such as Sansheng Sanshi Pillow and The Land of Warriors Season 3. Our music services and expanding paid music library contributed to subscriptions growth of 50% year-on-year to 43 million. Online games revenue grew 31% year-on-year and 23% quarter-on-quarter driven by more active users and higher-paying ratio during the stay-at-home period. Consumption will normalize as users return to work.

Total platforms games revenue increased 64% year-on-year to RMB 34.8 billion driven by key titles, including Honour of Kings, Peacekeeper Elite and PUBG Mobile, as well as consolidation of Supercell. Sequentially, revenue grew 33% due to more playing time during the Chinese New Year and stay-at-home period. PC client games revenue decreased 15% year-on-year to RMB 11.8 billion due to temporary closure of internet cafes and soft DnF performance. Revenue increased quarter-on-quarter on favorable seasonality.

Turning to social networks. We are highly motivated by our roles and responsibilities in creating and helping the people to stay in touch with their friends and families and in connecting people to necessary services during this critical period. User engagement on Weixin and QQ increased with daily messages and time spent on each service up double digits year-on-year. We strengthened several functionalities on Weixin and QQ platforms to better service specific use cases. For example, for eLearning, teachers can now customize QQ Group toolbar with relevant Mini Programs, such as online exams and homework collection tools, to better manage online classes. Students can experience (inaudible) study time via virtual study rooms.

With health care services, we connected Weixin users with medical professionals in private group chat initiated via Tencent Health Mini Program or access points embedded in Weixin Pay. To support remote presentations, we expanded QQ's screen sharing function embedded in calls from PC to mobile devices.

On daily services, we increased penetrated in off-line use cases, contributing to Weixin Mini Programs exceeding 400 million DAU. We helped accelerate digital distribution or omnichannel consumption for off-line services, especially grocery shopping and municipal services. We assisted local governments and businesses to disseminate eVouchers, expediting the recovery in off-line consumption after the lockdown is over, especially for retailers and restaurants.

Let's move on online games. During the stay-at-home period, users spent more time on our games for entertainment and social interactions. Leveraging our best-in-class game content and large in-game social communities, we captured incremental entertainment demand. Our smart phone games DAU recorded strong growth year-on-year and quarter-on-quarter. Among our leading mobile titles in China, we upgraded Honour of Kings' game engine last year, which allowed us to enhance audio and visual experiences of the game, enabling more attractive content such as (inaudible) teams games we released during the Chinese New Year. We also introduced location-based teamplay system, which encouraged more interactions among players in the same city. Peacekeeper Elite collaborated with Rocket Girls 101, an idol girl group managed by Tencent, which emerged from our popular TV variety show. This drove user engagement to a new high, demonstrating the success of our cross-IP synergy.

Internationally, PUBG Mobile celebrated its second anniversary with multiple in-game events while we tailored our operations regionally to increase user reach and engagement. For League of Legends, we launched the Teamfight Tactics mobile app as well as new content, contributing to higher user retention and time spent for this longstanding franchise. For Brawl Stars, the high-cadence content updates kept user engaged and optimized player matching mechanism further enhanced user experience.

We do have a substantial new game pipeline. In China, we'll launch more titles across different genres by June. Internationally, licensed mobile RPG, CODE: D-BLOOD, achieved initial success by downloads as well as growth in Japan; launched new PC tactical shooter, VALORANT, into enthusiastic responses from players during closed beta testing and was the most viewed title on Twitch in its first month. Looking forward, we expect in-game consumption activities to dip back toward more normal levels as players go back to work and time spent in games normalizes.

With that, I'll now pass on to James.

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James Gordon Mitchell, Tencent Holdings Limited - Chief Strategy Officer & Senior EVP [5]

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Thank you, Martin. Chinese online advertising revenue was CNY 17.7 billion in the first quarter. The above trend year-on-year growth rate of 32% reflected: a, increased consumer time spent on our apps during the stay-at-home period, which we expect to normalize in future quarters; and b, our platform's ability to deliver attractive returns on investment to advertisers. Sequentially, advertising revenue decreased due to seasonality.

By industry, games, Internet services and online education ad spend rose year-on-year as these categories increased spending in reaction to more traffic and consumption for their services during the stay-at-home period. Fast-moving consumer goods, auto- and travel-related ad spend declined.

Looking forward, we expect the overall China online advertising industry to experience industry-wide headwinds, including: first, consumers normalizing down their time spent online; second, online services advertisers adjusting their customer acquisition budgets as they reflect revised customer lifetime value assumptions; and third, multinational brands reducing their spending significantly as they face the pandemic in their home markets.

For social and others advertising, revenue grew 47% year-on-year driven by increased ad impressions, particularly on Moments. Our mobile ad network revenue also expanded sharply on more traffic and higher eCPMs with video adds now representing over 1/3 of our ad network ad impressions. We expect our social advertising revenue to revert towards its prior trend growth rate from the second quarter as ad impressions normalize somewhat and as some advertising categories review their customer acquisition budgets.

For media advertising, revenue was CNY 3.1 billion for first quarter, down 10% year-on-year, within which sponsorship ad revenue declined year-on-year as well as quarter-on-quarter due to budget cuts, delays in producing and airing certain variety shows and suspension of NBA basketball games.

In-feed advertising revenue grew year-on-year and quarter-on-quarter due to the popularity of several top-tier drama series and demand for reliable news and information during the pandemic. We expect media advertising revenue trends will be more challenging in the second quarter as multinationals reduce their brand budgets.

Looking at FinTech and Business Services. Segment revenue was CNY 26.5 billion, up 22% year-on-year and down 12% quarter-on-quarter. Within FinTech, revenue decreased sequentially as commercial payments, especially off-line payment activities, and cash withdrawals reduced during the Chinese New Year and stay-at-home periods.

FinTech margins were, however, stable sequentially as the higher-margin revenue streams, such as wealth management and lending, continued to grow and as we managed our marketing and subsidy costs.

Looking forward, we've seen a healthy rebound in payments activities across offline and online and QR code as well as point-of-sale transactions. For example, during the last week of April, our average daily commercial transactions value had recovered to late 2019 levels.

Our wealth management business grew at a stable rate in the first quarter as aggregated customer assets increased year-on-year and quarter-on-quarter. And our WeiLiDai loan book remained healthy, reflecting WeBank's prudent risk management policies.

Within business services, the pandemic delayed project deployments and new account acquisition, resulting in a sequential revenue decline. However, our Tencent Meeting software achieved breakout success and became the leading video conference app in China. We strengthened its security measures and introduced new functions to facilitate discussion and conference call management. In late March, we launched an international version of Tencent Meeting called VooV Meeting.

For WeChat Work, we enhanced industry solutions and deepened integration with Weixin, helping us to sign more key accounts, especially in the retail, education and public sectors. Consequently, WeChat Work DAU has grown significantly during the period.

Looking forward, we expect business services to remain challenging in the short term due to disruptive sales cycles. But we'll continue increasing our investment, especially in enterprise software and cloud services, as we believe the experience of remote working will ultimately prompt off-line industries in the public sector to accelerate their digitization.

And with that, I'll pass to John to speak to financials.

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Shek Hon Lo, Tencent Holdings Limited - CFO & Senior VP [6]

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Thank you, James. Hello, everybody. For the first quarter of 2020, total revenue was CNY 108.1 billion, up 26% year-on-year or 2% quarter-on-quarter. Gross profit was CNY 52.8 billion, up 33% year-on-year or 15% quarter-on-quarter. Net other gains was CNY 4 billion, down 64% year-on-year or up 11% quarter-on-quarter. This item mainly comprised of non-IFRS adjustment items, including net gains on disposal of certain investee companies as well as net fair value gains on investee companies. It was partially offset by CNY 2.6 billion donations primarily to combat the COVID-19 pandemic globally.

Operating profit was CNY 37.3 billion, up 1% year-on-year or 30% quarter-on-quarter. Net finance costs were CNY 1.7 billion, up 51% year-on-year or down 39% quarter-on-quarter. The year-on-year increase was mainly driven by greater interest expense resulted from higher amount of indebtedness. The quarter-on-quarter decrease was due to the recognition of ForEx gains for Q1 2020 while we recorded a ForEx loss a quarter ago.

Share of losses of associates and joint ventures was CNY 281 million, down 90% year-on-year or 79% quarter-on-quarter mainly due to changes in non-IFRS adjustment items of certain associates. On a non-IFRS basis, we recorded share of profit of CNY 164 million for the first quarter of 2020 comparing to share of losses of CNY 518 million a year ago. The change mainly reflected improved performance of certain investee companies.

Income tax expense were CNY 5.9 billion, CNY 2.1 billion and CNY 4.8 billion for quarter 1 2020, quarter 4 2019 and quarter 1 2019, respectively.

Effective tax rate for the quarter was 16.7%.

IFRS net profit attributable to equity holders was CNY 28.9 billion, up 6% year-on-year or 34% quarter-on-quarter. Diluted EPS was CNY 2.999, up 5% year-on-year and 33% quarter-on-quarter.

Now let me walk you through our non-IFRS financial numbers. For the first quarter, operating profit was CNY 35.6 billion, up 25% year-on-year or 17% quarter-on-quarter. Net profit after NCI was CNY 27.1 billion, up 29% year-on-year or 6% quarter-on-quarter. Diluted EPS was CNY 2.817, up 29% year-on-year and 7% quarter-on-quarter.

Turning to segment gross margin. Gross margin for VAS was 59%, up 1.4 percentage points year-on-year and 8.9 percentage points quarter-on-quarter. The year-on-year growth was mainly due to improved margin for both PC and smartphone games resulting from improved revenue mix towards high-margin in-house games. The sequential increase was -- benefited from revenue mix shift towards high-margin in-house smartphone games; increasing margin of video subscription business as a result of higher subscription revenue and lower content cost due to the pandemic; and the absence of major e-sport events, therefore lower content cost quarter-on-quarter.

Gross margin for online advertising was 49.2%, up 7.3% per -- 7.3 percentage points year-on-year or down 5.1 percentage points quarter-on-quarter. The year-on-year increase reflected lower content cost for video advertising and improved efficiency. Sequential decline mainly reflected revenue decrease due to negative seasonality.

Gross margin for FinTech and Business Services was 27.9%, broadly stable year-on-year and quarter-on-quarter.

On operating expenses. Selling and marketing expenses were CNY 7 billion, up 66% year-on-year or 5% quarter-on-quarter. Marketing spending increased year-on-year, particularly in content platforms, including Weishi's marketing campaigns during the Chinese New Year. As a percentage of revenue, selling and marketing expense increased from 5% in the first quarter of 2019 to 6.5% this quarter.

G&A expenses were CNY 14.2 billion, up 25% year-on-year or down 12% quarter-on-quarter. The year-on-year increase mainly reflected greater R&D expenses and staff costs as we invested in talent and technology to support business development. The Q-on-Q decrease reflected reduced outsourcing activities for R&D projects and reduced traveling and entertainment expenses due to the pandemic. As a result, as a percentage of revenue, G&A and R&D represented 13.1% and 7.4%, respectively. As at quarter-end, we had approximately 64,000 employees, up 18% year-on-year or 2% quarter-on-quarter.

Let's take a look at the margin ratios. For the first quarter 2020, gross margin was 48.9%, up 2.3 percentage points year-on-year or 5.3 percentage points quarter-on-quarter. The year-on-year increase mainly reflected segment gross margin ratios improved and flowed through to our blended gross margin, especially for VAS and online advertising segments. Sequentially, the margin increase was mainly due to revenue mix shift to VAS, which carry a higher margin.

Non-IFRS operating margin was 32.9%, broadly stable year-on-year or up 4.2 percentage points quarter-on-quarter. Non-IFRS net margin was 25.9%, largely stable both year-on-year and quarter-on-quarter.

Finally, I'll share with you some key financial metrics for the quarter. Total CapEx was CNY 6.2 billion, an increase of 37% year-on-year or a decrease of 64% quarter-on-quarter, within which operating CapEx grew 41% year-on-year to CNY 5.5 billion mainly due to more spending on servers to support operation of Tencent Cloud business such as Tencent Meeting. Nonoperating CapEx increased 7% year-on-year to CNY 682 million.

At quarter-end, free cash flow was CNY 39.2 billion, up 133% year-on-year or 25% quarter-on-quarter. Starting from 2020, we adjusted our free cash flow parameters according to the latest market practice by subtracting payments for media content and lease liabilities in addition to subtracting payments for capital expenditure from the operating cash flow. Comparative figures have been restated accordingly.

Net debt position was CNY 5.7 billion, improved sequentially due to stronger operating cash flow, partially offset by payments for M&A initiatives.

The fair value of our shareholdings in listed investee companies, excluding subsidiaries, was approximately CNY 410 billion. That is about USD 58 billion.

Thank you.

Unknown Executive.

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Unidentified Company Representative, [7]

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Thanks, John. We shall now open the floor for questions. (Operator Instructions) Operator?

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Questions and Answers

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Operator [1]

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Our first question comes from Gregory Zhao from Barclays.

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Xiaoguang Zhao, Barclays Bank PLC, Research Division - VP [2]

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Congratulations to a very strong quarter. So first, I have one big-picture question. And so we know COVID-19 is gradually passing in China. So from your point of view, so what kind of structural changes COVID-19 brought to the industry and to Tencent? And also, how shall we think about the changes to the user behaviors and your business strategies? So also a quick one about your overseas gaming business in Q2. So we saw Activision Blizzard and some other gaming companies give very strong guidance for Q2. And we know the corona is still ongoing in the overseas market in Q2. Shall we expect Tencent to deliver stronger overseas gaming performance in Q2?

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [3]

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Yes. Thanks for your question. I think in terms of structural changes, the biggest structural change is really for businesses and organizations to realize that there needs to be an online presence. When everything is actually shut down physically and offline, then it's actually very important for businesses and the organizations to be able to have online access to their consumers and to their users via Internet. So I think that's a big realization, right? I think everybody feel that it's coming, but having experienced the COVID-19 lockdown means that it's real and it's existential. So I think that would translate into many different trends. For example, on retail, there will be more investments by the retail shops and brands to establish direct linkage with the consumers, and I think our Mini Programs is really one key infrastructure for them to be able to do that. I think different government and municipal government and services would need to bring themselves online, and that would increase the overall investment in technology infrastructure and cloud investments on a longer-term basis.

And in terms of specific segments, right, obviously, there will be companies who need to build up a remote working infrastructure, and I think that would benefit tools that enable remote working. And obviously, Tencent Meeting has grown its user significantly during this pandemic period.

And in terms of verticals, I think online education is one area that will definitely benefit going forward because I think a lot of students have been experienced with online education and the parents have also experienced that, and that would drive the adoption of such a mode of education going forward.

Online health care will be another area in which a lot of users would like to have access to more health-related information, and they're getting used to having their disease diagnosed online both through AI or even a connection with medical professionals. And the awareness for health would be much stronger going forward, and I think online health care would be one area that would grow significantly in the future.

So I think these are all the structural changes, right, that COVID-19 brings to the overall society as well as the mindset of businesses. I think a lot of the consumers' mindset is already very much on mobile Internet. But the businesses, there's some sort of inertia for them to make changes. But having experienced COVID-19, I think the impetus for change will be much stronger. And rest assured that there are a lot of investments that we have made in the past and we will be making even more for the future, which help us to take advantage and facilitate and even lead these structural changes.

So on the gaming part, I'll ask James to answer.

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James Gordon Mitchell, Tencent Holdings Limited - Chief Strategy Officer & Senior EVP [4]

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Thank you for the question on the overseas game market, Gregory. So we believe that the game markets outside China are indeed following a somewhat similar path to the market inside China. There's obviously a, roughly, 2-month time lag given the later start of the stay-at-home periods in the rest of the world. And the extent may not be as pronounced in China, first of all, because in some regions, the lockdowns, the stay-at-home periods are less pronounced than in China; and then secondly, because there may be some consumers who are concerned about unemployment risk, which may mitigate their in-game spending. But overall, there is an uplift in user time spent on games.

Again, want to be more granular? The games that are seeing the biggest uplift, again, these are -- that have longer session lengths because people now have more time to play the longer-session-length games and also the games that are somewhat team based in nature, which I think reflects people realizing that perhaps, surprisingly, they actually miss their work colleagues and they want to socialize with them, and one way of doing that is through games, through team-based games. Looking forward, of course, we expect and hope that the situation will normalize in the rest of the world as it has done in China.

But taking a more longer-term view, it's also worth observing that we're in the fortunate position of continuing to launch games globally during this period. And Martin mentioned CODE: D-BLOOD, an RPG that we launched in Japan. Riot has launched its Legends of Runeterra card game on mobile and PC in the last few days. And then as Martin also mentioned, Riot has launched VALORANT, which has had an extremely positive reception from hardcore gamers on PC in the last month.

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Operator [5]

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Your next question comes from Piyush Mubayi from Goldman Sachs.

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Piyush Mubayi, Goldman Sachs Group Inc., Research Division - MD [6]

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Congratulations on your numbers. Hearing your commentary about how strong the quarter was and how you think the second quarter could see a reversal of that, could you just go through that factor about how much traffic is coming off and how quickly that's slowing down, to the extent possible, in the months of April and May?

And just driving further into that question, if you look at advertising, how would advertising, for example, change or slow down from the pace that we've seen in the month of -- in the first quarter? And from -- if you go back and look at the ad load increase that came through, that wasn't a full quarter increase, if I'm not wrong about it. So surely, the second quarter and hereafter, you should see substantial strength in the first quarter play-through into Q2 and the rest of the year. Is there something we're missing here?

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James Gordon Mitchell, Tencent Holdings Limited - Chief Strategy Officer & Senior EVP [7]

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Piyush, sorry, on the first question, which business were you alluding to specifically?

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Piyush Mubayi, Goldman Sachs Group Inc., Research Division - MD [8]

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I'm alluding to the overall business, the strength that you've seen in the first quarter on both advertising and gaming, and your commentary that you're likely to see this reverse into Q2 because your guidance sounds a little bit more subjective.

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [9]

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Yes. I believe -- so whatever benefit that came through in the first quarter because people stayed at home more and does have more time on the screen and spent more time on games and video and Internet services, we are seeing that normalizing basically by and large in April. It started to normalize in March but pretty much normalized in April and all normalized after May 1 holidays. So I think that's sort of the extent that you should think about.

And in terms of advertising, I think James will -- probably will give you some color.

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James Gordon Mitchell, Tencent Holdings Limited - Chief Strategy Officer & Senior EVP [10]

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Yes. I mean this may be reiterating what we said in the prepared remarks, in which case I apologize. We'll try to go a little bit deeper or a little bit clearer in case it wasn't clear.

So the 3 factors that we think will act as headwinds for the industry as we look forward beyond the first quarter, the first is that in the first quarter, because of people staying at home, they spent more time online, and more time results in more impressions. And particularly for the direct response advertisers, if there's more impressions, then, all else equal, they'll mechanically buy more and spend more money with the industry as a whole. And so our assumption is that going into the second quarter, as people return to work and to school, the quantity of salable impressions will normalize.

Then a second factor is that if you look at how the direct response advertisers operate, then they have a certain customer lifetime value assumption based on historic ARPUs, based on historic churn rates and so forth. And they will bid up the eCPM or eCPC that they're willing to pay to a customer acquisition cost that is derived from that customer lifetime value assumption. And in the very short term, if there's a sudden shock, which was the case with the COVID-19, then they may not have time to fully update their customer lifetime value assumptions. But over the months, as the situation stabilizes, then they may decide to review their customer lifetime value assumptions due to different assumptions about churn rate or different assumptions about retention rates, or they may not. We don't know. But it's a risk.

What we do know is a third factor, which is for certain online advertising properties in China, such as online video, then historically, close to half of the advertising revenue in that industry came from multinationals. And what we've seen in the last few weeks is that the -- half of the revenue that comes from local -- china-based companies has been fairly resilient, but the half of the revenue of long-form video that comes from multinationals has experienced a substantial step down. And our hypothesis is this reflects the fact that these multinationals have a global perspective. And to some extent, what they're seeing in the rest of the world affects how willing they are to spend money in every country, including in China. So those are all headwinds that we think will affect the industry and what may affect us and that you should bear in mind.

But I think that it's important you not forget that in the past, there's always been this sort of a discussion around whether our advertising revenue growth was constrained by a lack of advertiser demand because of the ROIs or audience we were attracting or a limited supply. And I think that what you can see from these results is that when there is a surge in supply, even if it's a surge in supply for reasons outside our control and beyond our expectations, then our revenue experiences a corresponding uplift because fundamentally, our advertising delivers high returns.

Thank you.

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Operator [11]

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Your next question comes from (inaudible) King of Macquarie.

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Unidentified Analyst, [12]

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Great. I think you've mentioned about the structural changes that have been happening for the industry, but I wanted to kind of follow-up on that. I wanted to see how you guys are thinking about your business plan as well. So I suspect you guys started the year with a certain frame in mind that the world has changed. So to the extent of things like CapEx to the things about your business mix between consumer facing and enterprise facing, how do you think the contour of your business changes? How does your investment plans and your financial kind of expectations change alongside that?

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [13]

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Well, I think I would say we have anticipated the structural change. And I think I explained it, right, that structural change is something that everybody sort of anticipated. I think there's an inertia, especially from the side of established businesses, to say how much investment we're going to be making in order to make the change. And if I want to make a change, it requires money, it requires people, it requires a change in my organization and an overhaul on my supply chain. There's a lot that needs to be changed. So there's an inertia. But then I think going through this COVID-19 process, then everybody feels that they have to make the change even though it's painful, it's costly and it's going to be a bit challenging. So I think that's the structural change point.

And as a result, I think we have not been experiencing any structural change in our framework of investment because I think the framework of investment was already there. We were first to reorg our organization in the year of 2018 to establish our CSIG, cloud and industrial Internet service group, right? So that basically set us up to embrace this challenge. And it's actually because of that then we were able to have Tencent Meeting launched right in the midst of COVID-19 and be able to establish ourself to be the by and far #1 stand-alone videoconferencing tool in China, right? So I think from that perspective, there's no structural change in our investment framework. But I think we're excited that we'll be putting more investments into both the consumer Internet as well as the industrial Internet in order to drive and embrace the expedited change.

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Operator [14]

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Your next question comes from Jerry Liu from UBS.

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Yuan Liu, UBS Investment Bank, Research Division - Co Head of HK and China Internet Research [15]

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Yes. First, to follow up on gaming. I appreciate the idea that as people return to work, then they're spending less time in these games. But at the same time, we also heard comments about how we're excited about some upcoming games. So how do we reconcile those 2 things? Could some of these new games bring some upside to grossing this year? Or are some of these big games the kind where it will take time to build that user base? So maybe we should have some patience with monetization.

And then the second, just a question on cloud. Appreciate also that with cloud, as people were at home, a lot of the projects were delayed. But as people go back to work now, I'm still hearing comments about some challenges from management. So I'm just wondering if this is just as people need some time to put these big projects together? Or do we see maybe some of the enterprises being a little bit cautious with CapEx or just some of these bigger budgets?

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James Gordon Mitchell, Tencent Holdings Limited - Chief Strategy Officer & Senior EVP [16]

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I think on the game question then, you summarized the puts and takes very well, and there's not a lot I would add to it. If you're looking for a synthesis of the 2 forces and where it nets out at, then the reality is that we don't have a crystal ball and time will tell. But we wanted to be clear that on the one hand, we did have this unanticipated surge in user time spent and, to some extent, in consumption within some of our existing games and will need to sort of digest and stabilize after that for a little while. But on the other hand, I think that we're very pleased that just as we had the Tencent Meeting launch just before the coronavirus broke out, so on the game side would we have some big, interesting, exciting games that have already been released or are about to be released. And we think, to your point, those games may or may not take some time to feed through into monetization, but it's already clear that the critical reception to those games and the reception of the most demanding players within the card game genre or the competitive first-person shooter genre has already been extremely positive, which are leading indicators -- positive leading indicators for the future no matter how quickly the monetization flows through.

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [17]

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In terms of the cloud business, I think you have also pointed out the right point, which is, number one, as people returned to work, then a lot of these projects which have been put into a halt would be started and it would actually take some time, right, for maybe the bidding process, maybe the -- a negotiation of the contract, maybe sort of the implementation in order for them to enter into production and revenue-generating phase. And actually, I think we'll -- from the enterprises' perspective, I think there is a little bit of, I would say, coming back to the drawing board and revisiting their business plan for some of the businesses which saw their business impacted during the COVID-19. But I think the good thing is I think the Chinese economic activities have returned, rebounded quite nicely, right? So when that happens, then when these businesses start to see their business recover, then we feel that they would then be able to normalize their business plan. And at the same time, because they have gone through the COVID-19 shutdown, their plan for the future in terms of digitization will probably be speeding up. So I think there will be a period where everybody needs to restart and there will be a period of hesitation. But then we hope and we believe that over time, the future digitization wave will start to take off.

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Operator [18]

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Your next question comes from John Choi from Daiwa Capital Markets.

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Hyungwook Choi, Daiwa Securities Co. Ltd., Research Division - Head of Hong Kong & China Internet and Regional Head of Small/Mid Cap [19]

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My question is on the FinTech services. It seems like you guys have done a pretty good job in terms of stabilizing the margins. But going forward, how should we think about the profitability given that -- are we going to continue to be aggressive in your marketing? Or with the COVID-19 situation, how should we think about the cost control and how this will offset with the further diversified revenue stream?

And just a quick follow-up on the Mini Programs. Management did mention 400 million daily active users. How has this really kind of reinforced our other parts of the ecosystem like payments for advertising and -- during this period of time?

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [20]

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Yes. In terms of FinTech services, if you look at the changes through the lockdown, right, during the lockdown, off-line transaction volume pretty much nosedived, but it didn't really hurt our profitability. One is the off-line services were low margin. At the same time, there are a lot of marketing that's related to getting the footprint out on the off-line side. So when you have a lower transaction volume, we also didn't have as much marketing expenses, and that pretty much balanced out each other. I think when the business returns to normal, right, then we'll have pretty much the payment volume returning to the same level as last year's December level. And at the same time, I would say we will be starting to conduct more marketing activities, too, right? So that will be watching out each other pretty much.

So this pretty much reinforces our pretty consistent message, which is, especially on the off-line payment side, it's helping us to build payment as an overall infrastructure. So we're not too much in a rush to create profit out of it, but instead, it's important for us to build market share and to build user behavior as well as coverage of the merchants.

In terms of the Mini Programs, I would say if you look at the Mini Programs, it is a very basic infrastructure for our ecosystem, right? The Mini Programs actually help us to establish relationship with a lot of service providers, and it also helps the service providers to establish relationship with a lot of customers. And I think the ecosystem just gets stronger and stronger as we continue to build out the Mini program infrastructure, and it was actually somewhat expedited during the COVID-19 pandemic as well. And we would see over time that it would actually help our payments. It would also help our advertising business. But it's not going to be an immediate direct impact. But very clearly, when businesses are running more of their services and getting more of their revenue and serving more of the customers on Mini Programs, then they will be more incentivized to run ads on our overall platform in order to drive more traffic into the Mini Programs. And I think over time, it also help us to build stronger relationship with these businesses so that we can get their cloud business better and will also provide SaaS services to them, be it the data analytics, be it helping them to acquire traffic and be it helping them to establish closer link with their customers.

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Operator [21]

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Your next question comes from Alicia Yap from Citigroup.

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Yik Wah Yap, Citigroup Inc, Research Division - MD & Head of Pan-Asia Internet Research [22]

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Also congrats on the strong set of results. Also a follow-up on the advertising. I think with retailers leveraging the Mini Programs, should we actually see over time the increase in the demand for online ad opportunity within the Mini Program or Official Account to help mitigate some of the headwinds that we see from the multinational that you mentioned? And also the in-feed ads, you mentioned experiencing some recovering growth for the media ads. So is that implying media ads to also come out from the declining trend, especially with the easier year-over-year comp as we head into the second half?

Quickly, any last thoughts on the rationale and synergies on the recent investment in Afterpay and the Tim Horton?

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [23]

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Well, the first part is, I think, related to the question before, which is Mini Programs benefit for advertising, and I'll take that question, which is, I think it would definitely benefit advertising, but it would be more like over the longer term rather than shorter term because it's a little like an infrastructure that you would have the retailers first spending a lot of effort in terms of building their expertise on Mini Programs. And it's not just the Mini Program part but also finding ways to which they can drive traffic to the Mini Programs, right? In the past, a lot of them rely on off-line stores and then having people to add to the Official Accounts and then basically leave it at that. But during the COVID-19 lockdown, it looks like a lot of the direct sales effort by their shopkeepers by leveraging the social network was actually very effective. They also started to leverage live broadcast as a way to acquire customers. So a lot of these new ways to which they can acquire traffic and attract users, be it new users or existing users, have been developed, and they need to start building these capabilities. And once these are built, then they could dedicate a portion of their corporate resources to start bringing people into a transaction to Mini Programs, which is something that they own themselves, which is very attractive for them when they think about the overall omnichannel mix. And when that happens, then I think they would start thinking about, oh, we actually need to put in more advertising so that we can drive incremental traffic to Mini Programs. So I think it will take some time before we see the impact, but the structural migration towards Mini Program will definitely help our advertising going forward.

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James Gordon Mitchell, Tencent Holdings Limited - Chief Strategy Officer & Senior EVP [24]

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Alicia, on your question about media advertising then, I think you're asking about the second half of the year, and we're already somewhat swimming against the tide by talking about current quarter conditions at a time when many companies are not guiding at all. So I'll restrict myself to just talking about the second quarter because the second half is still some way away.

But as far as the second quarter is concerned for media advertising, then technically, we still have a fairly difficult comparison period year-on-year. And more importantly, fundamentally, if you look at our video advertising revenue mix, while the in-feed is growing quickly and is an increasing proportion of the total, historically the preponderance of our video advertising was the sponsorships and the 15-second spot ads. And as I mentioned in reply to an earlier question, a big, double-digit chunk of that advertising comes from multinational brand advertisers who, unfortunately, are reviewing or reducing their spending globally. So therefore, you should expect the media advertising revenue to be under pressure in the second quarter of the year.

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Operator [25]

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Your next question comes from Alex Yao from JPMorgan.

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Alex C. Yao, JP Morgan Chase & Co, Research Division - Head of Asia Internet and New Media Research [26]

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Congrats on a strong quarter. First question is regarding your broader digital entertainment strategy. Based on our observation, there seems to be a change in your broader digital entertainment strategy evidenced by the recent management change in China Literature. Can you share with us your latest thoughts on Tencent's broader digital entertainment strategy?

And then secondly, I believe you guys in the past have discussed strategy to increase the payment monetization. Do you still plan to do such monetization increase given the COVID-19 outbreak?

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [27]

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Well, in terms of the digital entertainment strategy, I think we have always been pretty consistent. We feel that we -- digital entertainment is a very important part of our overall business, and we have a number of different platforms. And if you look at the broad strategy, right, we have always been focused on high-quality, high-fidelity, IP-oriented content.

And if you look at the digital entertainment strategy, I think the key change over the past 2 years was actually sort of the endorsement of short and mini videos, and that's not really related to our China Literature. But I think in the case of China Literature is really consistent with our overall strategy. And what the management change there is really because of the fact that the founding team of China Literature have really started the entire literature platform business a long, long time ago, right? And they have been acquired and then they left and then they started again and then they acquired the -- they reacquired the business that they sold. It has been a long time. So ultimately, they basically decided that they want to go rest, and that's why they passed on the bastion to people at Tencent. And that's why when we picked it up, right, there's a transition, and it's a very smooth transition. What we wanted to do is actually to continue to drive the core value of China Literature going forward. One is to enhance the value of the writers' work. We want to make sure that the value of the writers' work are respected and they would receive the monetization. And part of it is actually fighting piracy. Part of it is actually helping them to get more users and also helping that -- the head IPs to get the monetization through monetizing the IPs and extending IPs into ancillary areas such as animes or videos or games.

And at the same time, we would want to explore free reading model, but that will be only under the writers' consent. And I think if this model will be appealing to some writers, would not be appealing to some other writers. Especially for the up and coming writers, I think the free model supported by ads would be an attractive model for them to get the initial audience and get their writing skills up. But then, we actually support -- as you can see, right, a lot of the business that we run, be it the video and music and games, we always have a free model to attract a lot of users. But then there will be a paid model, right? So I think for China Literature, it's maybe the reverse. We only have the pay model. So if we have the free model, ad supported plus the paid model, I think it would actually be creating even more value for the writers. And we feel we can also have a much tighter integration between China Literature and our traffic platforms and our video platform and our games business, and that will be overall positive for the core value proposition of China Literature, and that will create a lot of value for both the writers as well as the consumers.

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James Gordon Mitchell, Tencent Holdings Limited - Chief Strategy Officer & Senior EVP [28]

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I think on that second question about FinTech monetization, as you can see from this quarter's results, we have a number of different financial services within our ecosystem, including the core payments, including the wealth management business, including the lending business, including other emerging businesses. Those various business lines have different margin profiles, and we are taking a long-term approach of progressively layering on incremental profit streams over time rather than feeding the needs, do everything at once, which means that when conditions are extremely benign, we're not going to grow at a hyper growth, right? But on the other hand, when conditions are challenging, as they were in the first quarter, we can actually sustain what we view as a decent growth rate and also sustain what we view as attractive margins.

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Operator [29]

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Your next question comes from Eddie Leung from Bank of America.

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Eddie Leung, BofA Merrill Lynch, Research Division - MD in Equity Research and Analyst [30]

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I have questions related somewhat to Mini Programs, but perhaps in the bigger scope about Weixin as a whole. We have been seeing development of features within Weixin kind of supportive to eCommerce transactions, right? Live broadcasting, (inaudible), et cetera. So I'm just curious on your thought of the potential of Weixin becoming more prevalent in the eCommerce industry chain going forward. And how would that potentially affect the positioning of Weixin versus some of your eCommerce partners?

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [31]

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I think the Mini Programs, as I said before, is infrastructural, too, and it actually helps all kinds of different services to connect themselves with consumers. And obviously, a big part of economic activities is actually in the form of retail and selling of products, right? So that's why Mini Programs does have an affinity for serving these retailers and people who -- and brands.

Now for -- if we look at eCommerce in the U.S., for example, right, you can see eCommerce platforms accounts for a certain percentage of total eCommerce. But then, more than 50% of the eCommerce activities actually happen with the brands going directly to the consumers, and that's very, very low in China. And we felt that it's a combination of the fact that a lot of brands in China are nascent brands, so it takes time for them to build up their brand franchise. But also, there is a big part of it which is the lack of capabilities, right, to move online. And to some extent, it's also harder in China to do that because in the U.S., most of the sales -- a lot of the sales are actually through websites, which are probably more traditional and easier to manage, but if you are actually doing it on mobile phones, it's probably more difficult, Especially if you want to develop a mobile app which sells a particular brand, it's going to be very, very difficult to get the consumer recognition and even remembrance. And that's where Mini Programs come into play, and we actually want to help a lot of the brands and retailers to establish an online presence which they own and control and they can actually get directly connected to their users and they can also use to acquire new users online. So I think that's the reason why we are actually building up a lot of tools to facilitate that.

Now in terms of how we feel about a lot of the investee companies which are also engaged in eCommerce platforms, we think that what we do here by building a stronger eCommerce ecosystem within WeChat is actually going to be synergistic to them, right, because if there are more users who are more used to buying products and services on WeChat, then the spillover effect will be bigger and people would also be buying from the eCommerce platform. So if they're buying from a particular brand, they will be going to the Mini Programs. If they say, oh, I want to go take a look at a category, then they would be going to the platforms that are working with us, right? And if the consumer habit is actually coming to WeChat and look for products, that will be good for everyone.

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Operator [32]

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Your next question comes -- all right, your next question comes from Binnie Wong from HSBC.

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Wai Yan Wong, HSBC, Research Division - Head of Internet Research of Asia Pacific & Analyst [33]

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I would like to seek your thoughts here on payment and the overall margin. As Tencent competes more in the higher-margin revenue streams like wealth management and lending, where our close competitor has the first-mover advantage and also committed to also grow these streams of revenue, what is our competitive edge here to gain share? And presumably, as there's like savings in the overseas marketing spend maybe this year, is it realistic to say the FinTech margins should improve this year overall?

And if we think about on a group level, right, I think management highlighted near-term challenges in advertising and cloud, and then we'll keep our investment into cloud content, and there might be mix shift to overseas games of lower margin. But yet, there are some positive drivers in margins, say, expansion into higher-margin payment revenue streams along with like probably robust games revenue. Do you see the margins, the positive drag...

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Unidentified Company Representative, [34]

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Thanks for your question. We will address this question first. Thank you.

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Chi Ping Lau, Tencent Holdings Limited - President & Executive Director [35]

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I think -- thinking -- we don't think in terms of a blended margin. So that's a very difficult question to answer because that's not the way we think about our business, right? Our business is always thinking from business by business, product by product, how do we expand the product itself. And if the product actually sort of can generate incremental users and value, and then over time there will be a monetization and then there will be a margin. And the company -- each business line as well as the company overall is actually an aggregation of such drivers. So to some extent, we can't answer the question that you asked. But I will try to answer your question in relation to FinTech, and you probably sort of can get a sense of how we think about it.

So in terms of the FinTech, I think there are a number of different business components in there. The first one is actually the payment platform. And even within the payment platform, there is a component which is online. There's a component which is offline. And I talked about the off-line part being relatively an infrastructure type of business, right? It doesn't really sort of generate a lot of -- it's not run to generate profit per se because we have very thin margin there to start out with, the monetization scheme. And at the same time, we're actually sort of putting a lot of marketing and promotional costs. But that helps us to build a user case and to get a lot of users, and that would help us to monetize the online traffic. And it also sustains a very strong wallet presence, right, so that it helps us to build our other FinTech businesses in which you talk about, which is wealth management and lending.

And within wealth management and lending, right, I think the way that we think about these businesses are not that, oh, we want to grab market share, we want to build the scale. This is not the way we think about it. The way we think about it is actually, we want to built the best-in-class in terms of product capability, in terms of consumer value, in terms of risk management. And for example, in wealth management, right, it's very easy to say, oh, I just want to build scale, and, as a result, I want to sell as many wealth management products as possible. And believe it or not, right, usually, the wealth management product that sells the best is actually the most toxic. And if you go down that track, then we will not be fulfilling our promise to our users, right? So that's why I think the way we think about wealth management is like how do we create a system in which we have a lot of user education, we have the best product to our best knowledge, a product selection process. And we don't offer all the products. We only offer the products that we felt are high quality, and then we provide a lot of risk explanation to the users. And as a result, hopefully, over time, right, the users are not going to be all users in the world, but the users who are willing to learn, the users who want to understand the risk that they're buying and eventually they can grow with the platform. These are the people that we want to serve. And ultimately, it's a great wealth management platform.

Likewise on lending, you can actually sort of always lend a lot of money outside, right? But then, whether you can collect is a very big question mark, right? And you can also say, oh, we just want to charge more interest so that we can cover on the cost. That's not the way we think about it. We actually want to be exposed to high-quality risks and the credit, high-quality credit. And as a result, we may not be expanding as much in scale, but we definitely sort of have got the best credit in the market. And I think as we see in COVID-19, right, we -- it's actually stress testing our FinTech services, and I think we have passed the stress tests. And that's how we think about these businesses.

It's a long-winded answer to your question, but I hope that you get a taste on how we think about our businesses.

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Operator [36]

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Your last question comes from William Packer from Exane BNP.

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William Henry Packer, Exane BNP Paribas, Research Division - Executive Director of Media Equity Research [37]

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Congrats on the strong results. Firstly, you've talked about video games consumption normalizing as people return to work, but you also talked about structurally expanding the long-term audience. Is there any color or KPIs you could help us on gaming engagement post lockdown for a better feel of those long-term changes?

And then just a quick one on the advertising side. The color you've offered is helpful. Is there any underlying competitive shifts in the digital ad market share which we should be thinking about?

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James Gordon Mitchell, Tencent Holdings Limited - Chief Strategy Officer & Senior EVP [38]

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Well, why don't I start with both of them and Martin or someone else may supplement? But I think on the video games question and specifically the comment about the structural opportunity for video games then, there are various entertainment formats, including radio, television, magazines and so forth, and then there's interactive entertainment, which is what we call video games. We have an interactive entertainment group within Tencent. And the reason why I put interactive entertainment is because to some extent, what we think of as video games are actually sort of a super set rather than a subset of entertainment activities, and there's all sorts of entertainment activities that were traditionally passive and linear in nature, which we think can be enriched as they become interactive and immersive in nature. And so the earliest video games were effectively moving activities like Solitaire or chats online, but over time, you see more team-based, competitive, social activities moving online.

And I think that during this period, you see more and more people engaging with interactive entertainment on a broader pilot, meaning that, for example, people who historically watched physical sports events are now watching Formula 1 basketball or other sports played in any sports format often by the Formula 1 drivers or the basketball professional players, alongside watching games like League of Legends that have become powerful sports in their own right in the past couple of years. So that represents a structured expansion in the market.

Another example would be that historically, there's a gigantic live entertainment business around music concerts, and unfortunately, those are not occurring at the moment. But what is happening if you play Fortnite, it's fairly regular now, music comes within Fortnite with Travis Scott, with Diplo, with a number of other stars recently, and those are attracting gigantic audiences. And so to some extent, the time people are spending in the music concert scene in Fortnite or the time they're spending watching racing car drivers playing a Formula 1 video game is not replacing the time they were previously spending playing World of Warcraft. It's sort Of supplementing that and expanding the breadth of the interactive entertainment into new and newer, broader entertainment categories. So that's an example of structural expansion in a qualitative sense.

And then in a quantitative sense, we have seen that for some of our games, particularly for the more team-based, competitive games, the audience now is structurally larger than it was going into this situation. So the time spent per user is normalizing downward because people are getting busier in China in particular, but the number of people who have found these attractive forms of entertainment is broader than it was in the past. So that's on the video game question.

With regard to the advertising question and the competitive landscape then, I think our view is that we've always been highly competitive within the China online advertising industry by virtue of our traffic, by virtue of the premium nature of some of our content. What's changed in the last year or so is really that we have enhanced our technology, and I think one of the best proof points for that is the very rapid growth, the more than doubling in revenue year-on-year in our ad network business. Because as you know, the ad network business, it's other people's inventory. It's not directly tied to whether Weixin has a white collar user base or whether we're running 3 or 4 ads per day in Weixin. It's tied to how competitive on a real-time basis our ads serving, our ad targeting it versus the other companies providing our ad networks in the market. And so the fact that our ad network business was actually the biggest contributor to our ad revenue growth in recent months, I think, speaks to the fact that it speaks to the reality that our ad tech capabilities are now more competitive than they've ever been.

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Unidentified Company Representative, [39]

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Thanks, James. We are now closing the call. If you wish to check our press release and other financial information, please visit the IR section of our company website at www.tencent.com. A replay of this webcast will be available soon. Thank you and see you next quarter.

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Operator [40]

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Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. You may now disconnect your lines.