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Tencent's Growth Accelerates, but Challenges Loom on the Horizon

Leo Sun, The Motley Fool

Tencent (OTC: TCEHY) is a divisive stock. The bulls argue that the Chinese tech giant's well-diversified portfolio of games, social media platforms, cloud services, and more will keep growing even as the Chinese economy slows down. The bears believe that Tencent spreads itself across too many markets, and that that lack of focus leaves it exposed to disruptive challengers like ByteDance, which is expanding its family of apps into Tencent's core markets.

A bull and a bear figure attached to rising and falling stock charts.

Image source: Getty Images.

Tencent's latest earnings report, which featured 21% annual sales growth and a 19% increase in adjusted net profits (which excludes investment-related gains), failed to rally the bulls, and its stock tumbled amid a broader market sell-off. Let's take a closer look at the key figures and see if Tencent can finally shake off the bears.

The gaming unit keeps growing

Tencent's core gaming business hit a brick wall last year when the Chinese government suspended new game approvals for nine months. However, that division -- which houses the world's largest game publishing business -- returned to growth this year.

Tencent's online gaming revenue rose 8% annually to 27.3 billion RMB ($3.9 billion) during the quarter and accounted for 31% of its top line. It attributed that growth to higher revenue from mobile games like Honor of Kings, PUBG Mobile (and its rebranded Chinese counterpart, Game for Peace), Red Alert OL, and Perfect World Mobile, which were partly offset by lower revenue from PC games.

Tencent launched Game for Peace as a "patriotic" rebranding of PUBG Mobile earlier this year after regulators blocked the game's monetization. Game for Peace was subsequently approved, and Sensor Tower claims that it generated $860 million in revenue in July, making it the highest-grossing mobile battle royale game in the world.

Tencent CEO Ma Huateng stated that the company accelerated its "innovation in games" and focused on "releasing new games in several different genres, introducing new modes within some of our key titles, and extending our season passes." Tencent currently publishes three of the five highest-grossing iOS games in China, according to App Annie, so the gaming unit should remain healthy throughout the rest of the year.

The advertising business is slowing down

Tencent's monthly active users (MAUs) on WeChat, the top messaging platform in China, rose 7% annually to 1.13 billion. MAUs on QQ, its older messaging service, grew less than 1% to 807.9 million.

Tencent's total online advertising revenue rose 16% annually to 16.4 billion RMB and accounted for 18% of its top line, but that marked a deceleration from its 25% growth in the first quarter. Most of that growth came from WeChat and QQ's news aggregator app Kandian.

Tencent's ad growth decelerated for three reasons. First, the economic slowdown in China reduces ad spending at companies. We've already seen that slowdown hurt ad-dependent companies like Baidu and Weibo in recent quarters. Second, Tencent Video generated less ad revenue due to a tough comparison to the FIFA World Cup last year.

Lastly, other platforms, especially ByteDance's short video app TikTok and news app Toutitao, are pulling advertising dollars away from Tencent. TikTok has over 500 million MAUs worldwide, and Toutiao has at least 170 million MAUs. Both apps are incredibly popular among Gen Z users.

Its "new" growth engine is also losing steam

Earlier this year, Tencent restructured its businesses and introduced the new "fintech and business services" segment to prioritize the growth of WeChat Pay, its wealth management services, and Tencent Cloud, the second largest cloud platform in China after Alibaba (NYSE: BABA) Cloud.

A network of cloud computing connections.

Image source: Getty Images.

Tencent's fintech and business services revenue rose 37% annually to 22.9 billion RMB and accounted for 26% of its top line. However, that marked a deceleration from its 44% growth in the first quarter.

Tencent didn't disclose the exact growth rates of each business. It stated that WeChat Pay and Tencent Cloud were growing, but that growth was partly offset by the absence of interest income after transferring its custodian cash balances (from its fintech services) to the People's Bank of China.

The growth of that unit was especially disappointing compared to Alibaba's 66% growth in cloud revenue last quarter. Alibaba attributed that growth to a higher number of customers and rising revenue per customer, which indicates that Tencent could be losing ground in the cloud market.

Focusing on profits instead of revenue growth

Tencent is focusing on cutting costs and streamlining its business units as its revenue growth decelerates. That's why its operating margin rose one percentage point year-over-year to 31% and lifted its net profits.

Tencent didn't provide any guidance, but investors should expect its revenue to rise at a slower rate than in previous years as its earnings hold steady. Over the next few quarters, it must stabilize its advertising business, prove that it can counter ByteDance and other competitors, and demonstrate better growth in its fintech and business services segment to widen its moat against Alibaba. Until that happens, Alibaba -- which posted much stronger top and bottom line growth last quarter -- remains a safer long-term bet on China than Tencent.


Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Baidu and Tencent Holdings. The Motley Fool recommends Weibo. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com