What did Tencent rely on to get back to the uphill road?

Chief Business Review

2024-05-14 21:50Posted on the official account of Shanghai Chief Business Review

Today, Tencent Holdings announced its performance report for the first quarter of fiscal year 2024, with operating income reaching 159.501 billion yuan, a year-on-year increase of 6%, gross profit reaching 83.870 billion yuan, a year-on-year increase of 23%, and (Non-IFRS) net profit reaching 50.265 billion yuan, a year-on-year increase of 54%, even compared with the previous quarter, the quarter-on-quarter growth reached 18%, which can be said to be a very good result. One might ask, is this a flash in the pan? In fact, looking at the financial reports of the past 1 year or so, this momentum will start in 2023.

From the fourth quarter of 2022, Tencent's V-shaped recovery trajectory has been clearly presented. Throughout 2023, Tencent's annual revenue will reach 609 billion, a year-on-year increase of 9.8%, and gross profit, (Non-IFRS) operating profit, and (Non-IFRS) net profit will increase by 23%, 34%, and 36% year-on-year respectively.

After the industry adjustment period in 2022, Tencent has strengthened "fitness" through strategic focus, increased high-quality new businesses with high gross margins, and reduced low-margin businesses, and is stepping out of a new round of growth.

In this round of growth, ineffective low-quality revenue is shrinking itself, so the growth rate of the overall business scale has declined, but the profitability has run out, and the growth rate of profit far outpaces the growth rate of revenue. We judge that Tencent's follow-up growth has potential potential, why do you say that?

Let's take a closer look at how Tencent's new round of growth is different.

What stage is Tencent at now?

As a leading Hong Kong technology company, Tencent has walked out of a beautiful upward curve after listing, if the timeline is extended, let's take a look at several important "growth" periods in Tencent's history:

After its listing in 2004, Tencent took advantage of QQ to grow rapidly in the PC Internet era. In 2011, WeChat was born, and the era of mobile Internet arrived, with the rapid development of WeChat and mobile payment, Tencent started the "growth" mode.

From 2012 to 2018, Tencent's revenue expanded from 43.9 billion yuan to 312.6 billion yuan, with gross profit growing at an annual rate of 22%-47%, and net profit growth of up to 45%. At this stage, Tencent's revenue began to diversify, and the advertising, cloud, and payment businesses went hand in hand at this stage.

After 2018, Tencent announced a major adjustment of its organizational structure to meet the tide of industrial Internet and start the "C+B" two-wheel drive. Until 2021, Tencent's revenue, gross profit, and net profit maintained rapid growth, with compound annualized growth rates of 32.7%, 28.53%, and 27.11% respectively in the past nine years. In the secondary market, we have also witnessed the market value of Tencent, the king of stocks, approaching a peak of one trillion US dollars.

In the decade from 2012 to 2021, with the development of the industry and strategic opportunities, Tencent seized the mobile Internet ticket - social networking and gaming, and also participated in the industrial Internet feast of all walks of life on the cloud, both growth periods were reflected in the rapid growth of revenue scale and profit scale, and the gross profit margin also remained at an average level of 51.75%.

Looking back on history, we can find that Tencent's new round of growth at this stage is more like "digging a deep well", and the gold content may not be lost to "digging everywhere". The starting point of Tencent's last round of adjustment is also the starting point of the overall adjustment of the Internet industry.

From Q4 2022, the growth rate of Tencent's gross profit, net profit, and operating profit turned positive year-on-year, and began to significantly exceed revenue growth, with gross profit growing by 7%, 19%, 22%, 23%, and 25% quarter-on-quarter, respectively, and gross profit margin rising from 42.65% all the way to 50% in Q4 2023. Until the latest Q1 2024, Tencent's gross profit has increased by more than 20% year-on-year for four consecutive quarters, and its (Non-IFRS) net profit has increased by more than 30% year-on-year.

Such earnings growth has reached the level of Tencent's first two rapid "growth periods". The gross profit growth rate exceeded the historical level in 2018 in the past few years, second only to 2020, and the gross profit margin was at a historical high after 2018, while the year-on-year growth rate of net profit of 54% in Q1 2024 reached the highest level in history in the past decade.

In terms of breakdown, the gross profit margin of Tencent's three main businesses, value-added services, online advertising and financial enterprise services, will reach 54%, 57% and 44% in Q4 of 2023, all of which have reached historically high levels, especially online advertising and financial enterprise services, with a quarterly report showing that the gross profit margin reached 55% and 46%, a year-on-year increase of 66% and 42%.

In this new period of growth, the gold content is not inferior to the past.

In its latest research report, CICC pointed out that historically, there have been two typical states of Tencent's growth:

First, the healthy and rapid development of the platform business (financial enterprise services, Moments advertising, video accounts, mini programs, etc.), and the normal development of games, the investment in Tencent in this state has strong certainty but weak flexibility;

Second, the healthy and rapid development of the platform business, coupled with the rapid growth of games, such as in 2017 and 2020, the investment in Tencent in this state is both certain and flexible.

CICC believes that Tencent's current investment logic is closer to the first state, and the company's main growth logic comes from the high-quality growth strategy, the profit release of Channels advertising & e-commerce, mini games, FBS and other businesses, coupled with the company's active shareholder return strategy, is expected to continue to form a model of "EPS growth> adjusted operating profit growth> gross profit growth > revenue growth".

We believe that in this round of growth, Tencent's overall scale and revenue have maintained stable growth, and the diversified revenue structure is also healthier, and after getting rid of the pursuit of quantity, the pursuit of "quality" has achieved more healthy and sustainable growth, while the new high-quality business and innovative technology have opened a higher "ceiling" for subsequent growth, from the perspective of corporate strategy, this is a high-quality growth period with both cash cow and star business.

So what new "star" businesses does Tencent rely on to continue high-quality growth?

Behind the sprouts of old trees

There was a time in the past when the Internet industry relied on and was obsessed with growing in scale. However, the real competitiveness does not lie in scale, strategic determination, continuous product capability and innovation ability are the magic weapons to go through the cycle.

Tencent has initially demonstrated this capability, and we have seen that while maintaining the moat of the old business, it has gradually cultivated new sprouts from the ecosystem, showing its potential for development. Tencent's "sprout" business comes from several aspects.

(1) The video account deserves to occupy the C position, and its development also comes from the long-term construction and vigorous ecological vitality of the WeChat ecosystem. WeChat has long changed from traffic logic to ecological logic. Now WeChat is more like a tropical rainforest, which not only provides convenient social and life connections for individual users, but also provides more convenient channels for corporate customers to connect with business and industry. In the past year, the total user time spent on Channels has increased by more than 80% year-on-year, which is a new engine for Tencent's advertising revenue growth.

We believe that WeChat's three ecological foundations: Channels, Mini Programs, and WeCom are all connection tools that are constantly iterated based on real demand transaction scenarios. Channels have become an important driver of Tencent's advertising, enterprise services and payment businesses, bringing steady growth in new revenue for several consecutive quarters. Mini Programs, Mini Games, and Soyisou Ads also showed strong growth momentum, with Mini Games increasing by more than 30% year-on-year, making it a leading casual game platform in China. The total user time spent by Mini Programs also increased by more than 20% year-on-year.

The commercialization of the WeChat ecosystem is advancing cautiously, but the potential is huge. It deserves long-term attention.

(2) Input and iteration of large models. Since its launch in September last year, Tencent's hybrid model has been continuously upgraded and accelerated, and has now expanded to a trillion-level parameter scale, and is in a leading position in the domestic mainstream large model in terms of general basic capabilities and professional application capabilities. At present, more than 400 businesses and scenarios within Tencent have been connected to Tencent Mix.

Among them, Tencent's advertising business has benefited significantly. After the upgrade of the advertising technology platform, it not only provides all advertisers with a one-stop artificial intelligence advertising creative platform based on Tencent's hybrid model, but also significantly improves the recommendation accuracy and delivery efficiency of Tencent's advertising business, providing advertisers with satisfactory ROI (return on delivery). In the first quarter of this year, Tencent's online advertising revenue reached 26.5 billion yuan, and the revenue of this sector has maintained double-digit growth for six consecutive quarters.

Collaborative SaaS products such as Tencent Meeting and WeChat Work have all been connected to Tencent's hybrid model, and generative AI functions have been launched one after another, further enhancing their commercialization potential.

(3) Overseas markets have become an important blue ocean for Tencent Games. According to the first quarterly report, the total turnover of overseas games increased by 34% year-on-year, and the revenue increased by 3% year-on-year to 13.6 billion yuan. In 2023, Tencent's international game revenue will contribute 30% of game revenue, compared to 4 years ago, the single-quarter revenue contribution of international games was only 10%. In fact, there are more "evergreen" key games emerging in domestic games, such as "Valorant", "Ark of Destiny" and "Golden Shovel Battle", Tencent's definition of key games in the last quarter is that the number of games with an average daily activity of more than 5 million mobile games / more than 2 million terminal games in the quarter, and an annual turnover of more than 4 billion yuan, has increased from 6 in 2022 to 8 in 2023.

In short, Tencent will decisively make strategic adjustments in 2022, from reducing costs and increasing efficiency to opening new long-term growth, Tencent's "elephant" turn can be described as fast and effective, and the driving force behind this is where Tencent's real "strength" lies.

Technological long-termism and synergies

This year has been described as a "better-than-expected" year for the global technology industry.

Overseas, technology companies represented by Microsoft, Google, and Amazon have resumed a new round of growth in gross profit and net profit since 2023.

Taking Microsoft as an example, the latest financial report shows that its revenue in the new fiscal quarter increased by 17% year-on-year, a record high in the same quarter, operating profit increased by 23% year-on-year, a record high for five consecutive quarters, and net profit increased by 20% year-on-year, a record high in the same quarter.

Under the new pull of artificial intelligence technology, Microsoft has achieved the "return of the king" and opened a new round of growth mode.

The reason behind this is that technology companies have strategic determination to invest in scientific and technological innovation such as artificial intelligence and focus on long-term development. Once the new technology is broken, it can be quickly applied to the existing ecosystem and business, bringing new growth to the company.

From the earliest QQ to the current WeChat, from the launch of WeChat payment and official account 10 years ago, to the recent years through small programs, video accounts, and mini games, we have built a strong WeChat ecological vitality. All of this is inseparable from Tencent's determination to actively embrace technological change and continue to increase investment in technology. 

The data also shows that since 2018, Tencent has invested more than 253.22 billion yuan in R&D, ranking first among Chinese Internet companies in terms of the total number of patent applications published and the number of patents granted in major countries and regions around the world. Tencent Hybrid has developed into a leading basic large model, with superior performance in mathematical derivation, logical reasoning, and multi-round dialogue.

For technology and Internet companies, different products and technologies need to be broken through in different periods, but the same is that they need to pursue long-termism, adhere to scientific and technological innovation to break the ineffective involution of low differentiation, and achieve real high-quality growth by stimulating profit growth and synergizing with other businesses. Tencent's diversified product matrix provides a broad application direction for AI, and combined with its own AI R&D investment, AI technology is expected to become an important growth multiplier for Tencent in the medium and long term.

summary

Now that the economy is gradually recovering in the big cycle, after China's Internet has experienced a period of brutal growth, all Internet companies need to calm down, get rid of the temptation to rely on low-quality scale, build a moat through real business scenarios and technical strength, and maintain a long-term strategic focus.

Otherwise, every time the tide of the cycle recedes, it will be known who is swimming naked. Since 2022, Tencent has used self-reform to squeeze water, until the past few quarters have responded to market uneasiness and doubts with results, showing Tencent's strong strategic ability and execution, through the pursuit of "quality" to achieve a healthy new development of the enterprise, rejuvenate, and lay a more solid foundation to cope with future cycle changes.

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Personal opinion, for reference only