Tencent’s Growth Revival: Navigating the Evolving Landscape of Advertising, Games, and AI

  In the third quarter of 2023, Tencent Holdings (00700.HK) achieved revenue of 154.6 billion yuan, a year-on-year increase of 10%, basically in line with market expectations; non-IFRS net profit attributable to the parent company (hereinafter referred to as “non-international net profit”) 449 billion, a year-on-year increase of 39%, higher than Bloomberg’s consensus estimate.
  In terms of revenue, although the revenue growth rate declined slightly in the third quarter, it has maintained double-digit growth for three consecutive quarters. The revenue in the third quarter also hit a record high in a single quarter, and the direction of business recovery is clear.
  In terms of net profit, since growth resumed in the third quarter of 2022, Tencent’s non-international net profit has grown positively for five consecutive quarters, and the growth rate has accelerated quarter by quarter. The performance in the third quarter of 2023 is also the highest in history, with a decline The effectiveness of this efficiency increase is very obvious, and the business efficiency has been significantly improved.
  The direction of sustained performance recovery has been very clear: the cold winter that lasted for more than a year has ended, and Tencent’s spring has quietly arrived, but for investors, it is far from the harvest season.
  Overall, the third quarter performance exceeded expectations, which is even more commendable in the context of the macroeconomic downturn. In particular, the sustained and stable high growth of net profit indicates that the company has got rid of the extensive growth of the Internet industry that blindly pursued revenue maximization before 2021. In the next few years, it will enter a new stage of high-quality development, with steady revenue growth and faster growth. Profit growth will become the new normal.
Game growth slows down, small games perform well

  Game business revenue in the third quarter was 46 billion yuan, a year-on-year increase of 7%, of which domestic games recovered slightly to grow by 5%, and overseas games increased by 14% year-on-year. The game business has grown at single digits for two consecutive quarters, which will inevitably cause concerns among some investors.
  However, Tencent’s management does not seem to care about this. In the earnings conference call, it said that it now has a “luxury” feeling. I think it is more appropriately translated as “calm”.
  This is mainly due to two points. First, Tencent currently has new businesses such as mini-games, video accounts, e-commerce, and WeChat search, which have brought healthy profit growth. Therefore, the short-term profit pressure of the game business has been reduced, and each studio can spend longer. Time will create better quality games. Secondly, Tencent Games currently has a complete three-level gradient product pipeline: first of all, several evergreen old games such as “Honor of Kings” are old and strong, and will still contribute a solid growth base in the future. At the same time, there are also a number of powerful games that have been launched, such as “Fearless Contract”, “Golden Shovel War”, “Dark Zone Breakout”, “Ark of Destiny”, etc. After several years of operation and development, they are also expected to become evergreen games in the next generation of segmented fields. . Management also revealed that Tencent has 9 new games that will be released in the next few months.
  It is worth mentioning that 2023 was originally thought to be the year of the second generation, but it turned out to be the year of small games. In the third quarter, mini-games continued to perform well and contributed high-quality revenue.
  Since the financial report does not disclose the specific revenue data of small games, according to my analysis of the semi-annual report, the annual revenue of small games has reached 10 billion yuan, and CICC predicts that the revenue scale is as high as 20 billion yuan.
  However, the performance of small games is included in the social network segment and is recorded as net income after sharing. If included in the game business segment, the growth rate of game performance in the third quarter can increase by 4%-6%.
First to introduce the concept of pan-internal circulation advertising, reflecting the ecological value of WeChat

  Online advertising business revenue in the third quarter was 25.7 billion yuan, a year-on-year increase of 20%. Mainly due to the strong demand from video accounts, mobile advertising alliances and WeChat search ads.
  It is worth noting that this financial report proposes the concept of “WeChat’s pan-internal circulation advertising” for the first time, which refers to advertisements that use WeChat mini programs, video accounts, public accounts and corporate WeChat as landing pages.
  The financial report disclosed that “WeChat’s pan-internal circulation advertising” revenue increased by more than 30% year-on-year, and contributed more than half of WeChat’s advertising revenue. This actually reflects the power of the WeChat ecosystem. In the fertile land of WeChat, as long as good seeds (products) are sown, fruitful fruits will be produced:
  Tencent officially disclosed that as of the end of June 2023 , the number of monthly active users of WeChat mini programs has reached an astonishing 1.1 billion, and the transaction volume of mini programs in the third quarter exceeded 1.5 trillion yuan. As of the end of 2022, the monthly active users of “Souyisou” (WeChat internal search) have increased to 800 million, and the search volume has increased by 54% year-on-year. Souyisou has gradually become a new entrance for the traffic growth of official accounts, mini programs, and video accounts. As of the end of 2021, the number of active users of Enterprise WeChat exceeded 180 million, and the number of active users of Connected WeChat exceeded 500 million. Tencent Docs will have more than 200 million monthly active users in 2023, and Tencent Meetings is currently used by 400 million users. The “2022 China Mobile Internet Semi-Annual Report” released by Quest Mobile, a third-party organization, shows that the monthly active scale of WeChat video accounts exceeded 800 million in 2022.
  It is precisely because of the synergy and connection of many of the above-mentioned excellent products and components that customers can complete advertising more efficiently under the WeChat ecosystem, forming a closed loop of the entire business, which is the so-called WeChat internal cycle (the good news does not flow to outsiders) Tian), this is what other friends and businessmen want to do but are unable to achieve.
Fintech is growing well, and corporate service adjustments are showing initial results.

  The third quarter revenue of financial technology and enterprise services was 52 billion yuan, a year-on-year increase of 16%. Among them, financial technology revenue maintained high double-digit year-on-year growth, benefiting from the increase in commercial payment activities.
  In the earnings conference call, management mentioned that income from financial services (including consumer loans, fund sales and other businesses) has also contributed a lot to growth, but it also attaches great importance to compliance risks.
  The next thing to watch is whether it can obtain a financial holding license with more than one month left in the year. After obtaining the license, I believe that the financial management business will also develop further and rapidly.
  In terms of enterprise services, after more than a year of major strategic adjustments, thanks to the optimization of the cloud service business structure and the collection of video account technical service fees, revenue in the third quarter of 2023 achieved double-digit year-on-year growth for the first time, and gross profit margin also increased. Significant year-on-year increase.
AI once again opens up Tencent’s growth ceiling

  On September 7, 2023, Tencent officially released the Hunyuan large model. Previously, internal testing has been started in Tencent’s different businesses, including advertising, games, cloud, etc., and integration has been started to improve model performance.
  Currently, the Hunyuan large model supports the generation of meeting minutes for Tencent meetings and the generation of content within Tencent documents. External enterprise customers can also use Hunyuan through API or MaaS to provide functions including code, data analysis, customer service automation, etc.
  It is worth mentioning that Tencent’s advertising business has always been relatively Buddhist and lacks “offensiveness” compared to teams such as Byte and Alibaba. In 2023, the advertising business department expanded the parameters of the advertising AI model through the Hunyuan large model to improve the accuracy of targeting and attribution.
  At the same time, it has also begun to provide advertisers with generative artificial intelligence tools, allowing them to automatically generate advertising creatives through text descriptions and adapt them to each advertising inventory to generate multi-size creatives. This will help advertisers create more engaging ads and increase click-through rates.
  Tencent mentioned in both its second and third quarterly reports of 2023 that the high growth of its advertising business was partly due to AI technology improving the accuracy and click-through rate of advertising. The gross profit margin of the advertising business has increased from about 40% in 2022 to more than 50%.

  The same strategy has also been verified by foreign giant Meta, which has been steadily embedding its artificial intelligence technology into its advertising business to improve the accuracy and effectiveness of advertising. In the quarter ended June 30, the company’s digital advertising business revenue increased by approximately 12%.
  In general, the most important factor restricting the development of AI is the lack of high-quality data and application scenarios, both of which Tencent happens to have.
  Tencent’s WeChat and QQ naturally come with massive amounts of data, and public accounts are known as the highest quality data sources in Chinese. At the same time, Tencent also has the most comprehensive application scenarios in China, such as social networking, games, advertising, and office work.
  Therefore, the upgrading and transformation of AI in these fields means huge growth opportunities for Tencent, and its ceiling for future growth will be opened again.
Strategic contraction comes to an end, releasing growth signal

  Different from simply compressing expenses in previous quarters, Tencent continued to work hard on the revenue and cost side in the third quarter of 2023, achieving a gross profit of 76.5 billion yuan and a gross profit margin of 49.5%, both setting new highs in the past two and a half years.
  The gross profit margins of the company’s value-added services, online advertising, and financial and corporate services businesses have all reached new highs, which also demonstrates the company’s structural changes toward high-quality development. It is expected that the high gross profit margins will continue to be maintained in the future.
  In the third quarter of 2023, administrative expenses decreased by 0.7% year-on-year to 26.3 billion yuan, of which R&D expenses were 16.5 billion yuan, a year-on-year increase of 9%. The results conference call revealed that the main reason was the increase in R&D project personnel. General administrative expenses after deducting research and development expenses were 9.8 billion yuan, a year-on-year decrease of 14%.
  In terms of the number of employees, at the end of the third quarter of 2023, Tencent’s number of employees increased slightly by more than 806 compared to the second quarter. This is the first increase in the number of employees after five consecutive quarters of decline. Quarterly wages were 27.8 billion yuan, a slight increase from the previous quarter, and employee efficiency continued to increase from the previous quarter.
  During the earnings conference call, management also mentioned that most of the staffing optimization has been completed, the current staff size is suitable for the existing business, and employees are being selectively recruited to develop new business. At the same time, management also frankly admitted its mistakes: “We realize that large teams are not helpful to the development and efficiency of the business. In the past, I think we and many other companies formed too large teams too quickly. With our high-quality One of the keys to the consistency we talk about in the revenue growth model is cost discipline, which makes the team smaller and better, allowing the team to focus on real value-added business and create value, making our business stronger.”
  Based on the above information, I believe that Tencent’s two-year strategic contraction has come to an end, and the restart of recruiting new employees also means that Tencent has found a new business growth point and begun to actively seek growth.
  In terms of valuation, the company’s current stock price is around HK$322, with a market value of HK$3.07 trillion, corresponding to a dynamic price-to-earnings ratio of 18.8 times in 2023. If the conservative value of the 811.6 billion yuan investment portfolio held is removed, the core business value is about 2.21 trillion yuan, corresponding to a core price-earnings ratio of 14.5 times in 2023 and a forward-looking price-earnings ratio of 12.4 times in 2024. It is still in the underestimation stage and has good prospects. Long-term investment value.

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