Chinese tech giant Tencent (TCEHY 3.62%) recently posted its third-quarter earnings. Its revenue rose 21% annually to 97.24 billion yuan ($13.75 billion), but still missed estimates by about $100 million. Its net profit dropped 13% to 20.4 billion yuan ($2.97 billion), which also missed expectations by nearly $570 million.
On a non-GAAP basis -- which excludes stock-based compensation, gains and losses from investments, acquisitions and divestments, and other one-time adjustments -- Tencent's net profit rose 24% to 24.4 billion yuan ($3.45 billion).
Those results weren't awful, but they clearly indicated that the 21-year-old tech giant's core growth engines were losing momentum. Let's see why those three core business units -- video games, ads, and cloud and fintech -- are struggling to grow.
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A slight acceleration in the gaming business
Tencent's online gaming revenue rose 11% annually during the quarter and accounted for 29% of its top line. This marked an acceleration from its 8% growth last quarter.
It attributed that growth to the ongoing popularity of its top mobile games -- including Honor of Kings, PUBG Mobile, and Peacekeeper Elite -- in both China and overseas markets. A 24% jump in smartphone gaming revenue offset a 7% drop in its smaller PC gaming business, which continues to lose gamers to mobile devices.
Tencent's gaming business is finally warming up again, but Chinese regulators could curb that growth with a proposed expansion of gaming restrictions for minors. These new rules include tighter checks of real names and ages against a national database, stricter daily playtime restrictions (reduced from 180 to 90 minutes), and spending caps on microtransactions based on the player's age.
Those tighter rules could force Tencent to expand more aggressively overseas with titles like PUBG Mobile, Arena of Valor (the international version of Honor of Kings), and its upcoming mobile version of League of Legends, and boost its stakes in overseas game makers like Activision Blizzard, Ubisoft, and Epic Games. Therefore, investors shouldn't sound the all-clear for the gaming business yet.
Its advertising business is slowing down
Tencent's advertising revenue, which accounted for 19% of its top line, rose 13%. This marked a slowdown from its 16% growth last quarter.
Tencent generates advertising revenue from its social media platforms (like WeChat/Weixin and QQ) and streaming media services like Tencent Video. Its "social media and other" advertising revenue surged 32%, but that growth was partly offset by a 28% drop in its media advertising revenues.
WeChat grew its monthly active users (MAUs) 6% annually to 1.15 billion, and the messaging platform's "mini-programs" reached over 300 million daily active users (DAUs). QQ's MAUs declined 9% annually to 731 million, but that drop can be partly attributed to users switching from the older app to WeChat.
Ad sales on Tencent Video, which primarily competes against Baidu's (BIDU 4.80%) iQiyi, declined due to "macro" challenges (like sluggish ad spending in a slower Chinese economy) and the "unpredictability" of major content releases.
However, Tencent also faces tough competition in the advertising market from entrenched leaders like Baidu and hungry start-ups like ByteDance, which is luring away China's Gen Z users with newer apps like Toutiao and TikTok. Therefore investors shouldn't be surprised if Tencent's ad growth drops to the single digits next quarter.
Image source: Getty Images.
A slight slowdown in its fintech and business services unit
Tencent is leaning heavily on its new fintech and business services unit, which includes Tencent Cloud, WeChat Pay, and other related services, to offset the weaker growth of its gaming and ad businesses.
That unit's revenue rose 36% annually and accounted for 28% of Tencent's revenue, but that also marks a slight dip from its 37% growth last quarter. That deceleration indicates that Tencent is struggling to keep pace with Alibaba (BABA 3.22%) and its partner Ant Financial in the cloud and fintech markets, respectively.
Tencent stated that its cloud revenue grew 80% annually to 4.7 billion yuan ($670 million) during the third quarter. Alibaba's cloud revenue rose 64% annually to 9.3 billion yuan ($1.3 billion) last quarter. If Tencent wants to catch up to Alibaba in the cloud, it needs to grow at a much faster rate -- and it could sacrifice its pricing power and margins to do so.
WeChat Pay and Ant Financial's Alipay share a duopoly in China's digital payments market. That balance is stable, but it also indicates that Tencent's fintech growth could decelerate as the two platforms saturate their home market. In short, Alibaba represents the biggest long-term challenge for Tencent's highest-growth business.
A reasonably valued stock with few near-term catalysts
Analysts expect Tencent's revenue and non-GAAP earnings to grow 23% and 22%, respectively, next year. Those are reasonable growth rates for a stock that trades at 24 times forward earnings.
However, Tencent still faces more near-term headwinds than tailwinds, and it needs to prove that all three of its core growth engines can generate sustainable growth. For now, I think that Alibaba -- which has higher growth rates and a lower valuation -- is a better all-around Chinese tech investment than Tencent.
