Tencent 2023 Half Year Earnings Analysis: Revenue Growth Returns to Double Digits Driven by Video Accounts and Mini-Games

  Tencent Holdings (00700.HK) released its financial report for the second quarter of 2023 as scheduled, with many bright spots, and there are also many dry goods in the earnings conference call later. From the data point of view, in the second quarter, the company achieved revenue of 149.2 billion yuan, an increase of 11% year-on-year; under non-IFS, the net profit attributable to the parent company (hereinafter referred to as “non-international net profit”) was 37.5 billion yuan, a year-on-year increase of 33%. It can be said that the performance has fully recovered, slightly exceeding expectations.
  The year-on-year ratios of the company’s revenue, gross profit, main profit, and net profit increased sequentially, which reflects that the net profit exceeded expectations due to the steady growth of the revenue market (games, payments), and the increase in the proportion of high-margin revenue (video number advertisements, mini-games), effective control of costs and expenses (gross profit margin increased, expense ratio decreased) brought about by the synergy of the three.
  Since the third quarter of 2022, Tencent’s non-international net profit has grown positively for four consecutive months, and it has shown a trend of gradually accelerating recovery, and the effect of reducing costs and increasing efficiency is obvious. At the same time, the second quarter of 2023 is also the second consecutive quarter since the third quarter of 2021. Revenue has returned to double-digit growth, and the continuous growth of revenue is more clear than the growth of net profit, indicating that the business has really begun to resume growth.
  This further confirms the judgment I mentioned earlier that the inflection point of Tencent’s performance has arrived, and a moderate recovery will usher in 2023. At the same time, it should also be noted that the double-digit growth in revenue in the first half of the year will also have the impact of a low base in 2022, and it is not appropriate to have too high expectations for the whole year.
Tencent’s AI-based large-scale model will be released within the year

  In the business review and outlook of this financial report, AI-related descriptions have increased significantly, occupying the C position, which shows how much the company attaches importance to it.
  After Baidu, 360, Ali, Huawei, etc. all released their own general-purpose AI models, Tencent released a self-developed industry model in June instead of the mainstream general-purpose model. On July 7, at the 2023 World Artificial Intelligence Conference (WAIC 2023), the first AI large-scale national team was born. The joint team leader units are Baidu, Ali, HKUST Xunfei, 360, Huawei, and China Mobile Research Institute. However, Tencent is not on this list, causing suspicion from the outside world.
  At Tencent’s second-quarter financial report meeting held on August 16, the management disclosed that the development of the general-purpose large-scale model is progressing very smoothly, and has begun internal testing in different businesses, including advertising, games, cloud, etc., and has begun to integrate and improve model performance. And the management also pointed out that according to Tencent’s internal tests, its self-developed large model has already ranked among the top basic models in China and will be released at some point within the year. At the same time, the management also has high hopes for the large-scale industry model launched, believing that it will be a very high value-added and high-profit enterprise customer product.
  In general, the most important factor restricting the development of AI is the lack of high-quality data and application scenarios. Tencent’s WeChat and QQ naturally have massive data, and Tencent also has the most comprehensive application scenarios in China, such as social networking, games, advertising and Office etc. Therefore, the upgrading and transformation of AI in these fields means huge growth opportunities for Tencent, and the ceiling of future growth may be opened again.
Rapid development of small games, creating a casual game platform

  In the second quarter of 2023, Tencent’s game business revenue will be 44.5 billion yuan, a year-on-year increase of 5%. Local game revenue was 31.8 billion yuan, a year-on-year zero growth. The overseas game revenue was 12.7 billion yuan, a year-on-year increase of 19%.
  According to the “Game Industry Report for January-June 2023” recently released by the Game Working Committee, the actual sales revenue of the domestic game market in the first half of the year was 144.263 billion yuan, a year-on-year decrease of 2.39% and a month-on-month increase of 22.2%, showing obvious signs of recovery.
  Compared with the game market, Tencent’s domestic game revenue in the second quarter fell short of expectations, both year-on-year and quarter-on-quarter. Although Tencent’s new blockbuster games will only gradually contribute to revenue in the third quarter, I have no expectations for game revenue in the second quarter. Low, but the year-on-year zero growth is indeed somewhat surprising.
  However, at a later performance briefing, Tencent Chief Strategy Officer James Mitchell pointed out that the game performance in the second quarter was lower than expected mainly because it actively reduced some commercial content, and domestic game revenue in the third quarter will resume year-on-year growth.
  This kind of explanation can be said in plain language, because in the first quarter, selling skins and items made a lot of money, which far exceeded the KPI. In the second quarter, players took a break, and in the third quarter, they started selling skins and items again.
  One of the highlights of the game business in this financial report is the WeChat mini-game. According to disclosures, the number of monthly active accounts of mini programs exceeds 1.1 billion, of which WeChat Mini Games, the leading casual game platform in China, contributes significantly, and generates distribution and advertising revenues with high gross margins and platform economic effects.
  As early as June 16 at the Mini Game Developers Conference, the WeChat Mini Game team stated that the number of WeChat Mini Game developers exceeded 300,000, the total number of users exceeded 1 billion, and the monthly active users reached 400 million, creating a record high—and Just in the past six months, the scale of WeChat mini-game traffic monetization and advertising promotion has maintained a continuous growth of 30%.
  While the game industry is talking about special 3A-level game masterpieces, thinking that it is the future development direction of the game industry, WeChat mini-games are growing rapidly in everyone’s “blind field of vision”.
  At the performance meeting, Tencent executives pointed out that the WeChat mini-game platform is currently the largest casual game platform in China, and its user base and revenue scale are several times that of other manufacturers.
  But in terms of finance, the revenue of small games is not reflected in the game business revenue, it is recorded in the social network business, and it is only reflected in the net income, not the entire turnover income, and the gross profit of small games is much higher than that of traditional games business. This means that there is a certain underestimation of the real scale of mini-games.
  Combined with the statement made by Tencent executives at the performance meeting that “the contribution of small games to social networks and online advertising is still in the single digits”, based on the 25 billion yuan revenue of the advertising business in this quarter and the low percentage of 4%, the WeChat small game in the second quarter The scale of game revenue is roughly around 1 billion yuan.
  Considering that the caliber of WeChat mini-games included in Tencent’s financial report is net income rather than turnover, according to the conventional 4:6 share ratio with game developers, the annual revenue of WeChat mini-games is estimated to be close to 10 billion yuan, and it is no longer a “small” game , but a big business.
  According to a previous report by senior game media GameLook, the WeChat mini-game team currently has only 20 people. It can be said that the small game business dubbed “WeChat side business” has grown to a scale and volume of tens of billions of dollars by itself. It can be said that it is a surprise for Tencent, and it also shows that the power that WeChat bestows on games is still huge.
  It is also because of the lower share ratio of mini-games, the lower purchase cost and the larger pan-user group of WeChat. Unlike many mini-games that are usually developed by small studios, there are more and more mini-games. Large-scale game manufacturers such as Gigabit, Sanqi Interactive Entertainment, and Giant Network have entered the field of small games, and simultaneously released small game versions of heavy games.
  Due to the short life cycle of mini-games, this also made Tencent realize that using WeChat’s powerful social advantages to build a casual game platform is far more likely to succeed than simply developing a popular mini-game, and it is more in line with long-term interests. .
  Since the birth of mini-games in 2017, after 6 years, WeChat’s mini-game ecology, including video accounts, live broadcasts, communities, development tools, and revenue distribution mechanisms, has been gradually improved. In this way, the necessity of launching apps for casual games will be greatly reduced, and the small game platform will also become another driving force for Tencent’s game growth.
  Tencent has a variety of potential new game products in its hands, and superimposed mini-games are gradually becoming popular. With the overall improvement of the game industry, Tencent’s game business will also resume double-digit growth in the second half of 2023.
Video account helps advertising business

  In the second quarter, the company’s advertising business achieved revenue of 25 billion yuan, a year-on-year increase of 34%, which is an excellent performance. This is mainly due to the strong demand for video account advertisements, the improvement of AI technology in advertising delivery efficiency, and the impact of the low base in the same period last year.
  At the performance meeting in the third quarter of 2022, Tencent executives proposed that the video account advertising revenue is expected to achieve 1 billion yuan in the fourth quarter of that year. As the “hope of the whole village”, the video account has lived up to expectations. In the second quarter of 2023, the advertising revenue of the video account exceeded 3 billion yuan, and its contribution to the advertising market also exceeded 10%.
  This kind of income growth seems to be not bad, but it is almost meaningless compared to its peers. Take Kuaishou as an example. In the first quarter of 2023, Kuaishou’s advertising revenue will be about 13.1 billion yuan, a year-on-year increase of 15.1%, which is more than four times that of video accounts. And Douyin’s advertising revenue in 2021 is already about 150 billion yuan, with an average quarterly revenue of 37.5 billion yuan, which is 10 times that of video accounts.
  The financial report for the second quarter also disclosed that the total user duration of the video account has almost doubled year-on-year, but did not disclose the specific figure. Many investors simply understand that the user duration has doubled, which is wrong, because the financial report uses “total user duration”. , which is equal to the number of daily active users multiplied by the usage time of a single user.
  At the performance meeting, Tencent executives revealed that the number of daily active users of the video account in the second quarter increased by double digits year-on-year, so the growth of the usage time of a single user did not double. However, we can roughly guess the current user duration of the video account: Tencent’s 2022 financial report disclosed that the usage duration of Moments is roughly stable year-on-year, and the usage duration of video accounts is three times that of the same period last year, both exceeding the usage duration of Moments. Liu Chiping, President of Tencent, mentioned at the performance meeting that the duration of video accounts is 1.2 times that of Moments. Zhang Xiaolong said in an interview in early 2019: “Everyone spends a fixed amount of time in Moments every day, about 30 minutes.” Based on these statements, it is assumed that the time spent in Moments in 2022 will still be 30 minutes. The duration of the video account is 36 minutes. Considering that the second quarter of 2022 is when the epidemic prevention and control involves a lot, it is speculated that by the end of the second quarter of 2023, the video account should be used for 40-50 minutes. There is still room for doubling the 120-minute duration of Douyin Kuaishou.
  Because the information flow advertising revenue of short videos is mainly related to several factors such as the number of daily active users, average usage time of users, ad loading rate and CPM (charge per thousand playbacks). Among them, CPM Tencent once disclosed that it is roughly the same as Jikukuai, slightly higher. The official number of daily active users of the video account has never been disclosed. In mid-2020, less than half a year after the video account was launched, Zhang Xiaolong revealed once in Moments that the daily activity of the video account exceeded 200 million.
  According to the “White Paper on the Development of Video Accounts in 2021” released by the Visual Light Research Institute, the daily activity of video accounts in that year has exceeded 500 million. In 2023, Tencent executives disclosed that the daily activity of video accounts in the second quarter will still increase by double digits year-on-year, so I think the number will not be too high. high.
  Referring to Kuaishou’s financial report for the first quarter of 2023, the number of daily active users increased by 8.3% year-on-year to 374 million, while the number of daily active users disclosed by Douyin at the end of 2022 was 700 million. Therefore, I estimate that the current number of daily active users of the video account should be between 400 million and 500 million, which is higher than Kuaishou and lower than Douyin. In the future, there is still about double the room for growth, which is not much.
  At present, the biggest room for growth is the advertising loading rate. The research report of Orient Securities predicts that the loading rate of video account advertisements in the fourth quarter of 2023/2024/2025 will be 2.8%, 3.8%, and 4.8%, respectively.
  According to the information disclosed by Tencent executives at the 2022 interim performance meeting, the advertising loading rate of Douyin and Kuaishou is between 14% and 16%. The ad loading rate of Moments is about 3%, and the ad loading rate of video accounts is less than 3%, and there is still room for improvement of more than 3 times.
  According to the above conservative estimates, the ceiling of video account advertising may still be far away.
  Of course, with the increase in usage time, number of daily active users, and ad loading rate in the later period, there will be room for growth of at least 15 times (1 times the number of daily active users, 1 times the duration of use, and 3 times the ad loading rate).
  As far as the second half of 2023 is concerned, on the demand side, with the continuous recovery of the domestic macro economy, the demand for advertisers is expected to further recover; on the supply side, with the further increase in the volume of video account advertisements, the conversion rate will be lowered by the continuous iteration of superimposed AI algorithms In 2023, the growth rate of advertising business is expected to reach 20%-25%.
Financial and cloud businesses return to growth

  In the second quarter of 2023, the revenue of financial technology and enterprise services business increased by 15% year-on-year to 48.6 billion yuan. Realized a gross profit of 18.7 billion yuan, a year-on-year increase of 33%, corresponding to a gross profit rate of 38.4%, a significant increase year-on-year, a record high, and a significant improvement in profit.
  Among them, financial technology service revenue, which accounts for the majority, achieved high double-digit year-on-year growth, thanks to the increase in offline and online commercial payment activities.
  The duopoly competition between Alipay and WeChat Pay in the field of commercial payment is still very stable, but in the context of reducing costs and increasing efficiency, how to improve profitability is the main issue at present.
  In the WeChat public class in 2022, Zhang Ying, a lecturer from Tencent, revealed in her speech that in the past few years, WeChat payment has never achieved profit in the collection business of small and micro merchants, and has always been in a state of loss.

  Some time ago, the news that Tencent decided to charge fees for profit scenarios in colleges and universities caused a wave of waves and caused a joint boycott by many colleges and universities. WeChat then issued a letter of apology and clarified that the adjustment was “only implemented for a small number of profitable scenarios such as e-commerce and wine travel”, and it was also a “preferential rate lower than the market average”. For “non-profit scenarios” on campus , continue with “Keep Zero Rate Policy.” The matter quickly subsided.
  In fact, WeChat payment also has costs. Every time a user completes a transaction through WeChat or Alipay, as a third-party payment institution, they need to pay about 0.3825% of the channel fee to the bank. This part of the cost is currently mainly shared by merchants and WeChat Pay.
  According to the calculations of Longbridge Securities, if the merchant payment rate of WeChat Pay is increased by one ten-thousandth, or the subsidy is reduced by one ten-thousandth, it can squeeze out billions of yuan in pre-tax profits for Tencent. Between word of mouth and profitability, WeChat Pay still needs to find a balance.
  In addition, the implementation of Tenpay’s regulatory penalties this quarter marks the phased completion of Tenpay’s self-inspection and rectification. The regulation has recently shifted to encourage and support the platform economy’s efforts in financial inclusion. It is expected that Tencent is likely to obtain an official financial holding license within the year. Tencent’s wealth management businesses such as fund agency sales, online insurance, and wealth management are expected to return to the right track and contribute to the performance of the financial technology business.
  In terms of enterprise services, revenue in the second quarter of 2023 has improved, achieving a low double-digit year-on-year growth, thanks to the revenue generated by the video account live streaming transactions and the slight growth in cloud services.
  One thing to watch in the second half of the year is whether the introduction of Tencent’s AI industry model can improve the original product strength, and whether the cloud business can achieve breakeven by the end of the year.
  Overall, the financial technology and cloud business sectors will still mainly contribute to revenue growth in the short-term visible two years, maintaining a growth rate of about 15%, while reducing losses, realizing profitability as soon as possible and enhancing profitability.
Treat equity incentives rationally

  According to the usual practice, Tencent Holdings issues or grants shares for the share option plan or share award plan on the day after the release of the financial report (the first day of the non-quiet period), and repurchases the shares on the next day.
  However, due to the large number of shares granted this time (44.38 million shares), coupled with the recent continuous decline in Tencent’s stock price, such a routine operation has once again caused dissatisfaction among many investors.
  Let me briefly talk about a few key points: First, since 2017, Tencent has gradually reduced the issuance of options to executives, and instead issued share rewards to core employees at the middle and grassroots levels.
  Secondly, because Tencent gives employees stocks, it first signs a contract (salary package), and then vests the stocks in installments (usually 4 years). The huge number of newly issued/granted shares in 2022 and 2023 is to pay for the wrong decision to issue shares indiscriminately in the 2019/2020 Internet robbing war (similar to high salaries robbing people), not the cost of employee equity incentives in 2022 and 2023. high. Then, based on the calculation of the vesting period of about 4 years, the overall issuance of new shares will remain at a high level in 2023, and it should start to fall in 2024.
  Besides, Tencent’s equity incentives and share repurchases are two different things. Even if they do not repurchase, the shares promised to employees before must be granted as promised.
  As for Tencent’s equity incentives, I agree with Charlie Munger’s point of view at the 1998 shareholders meeting of Visco Financial Corporation: “In some industries, all companies use options, and you really can’t do without options. For example, This is the case for companies in Silicon Valley. The competition in Silicon Valley is very fierce, and it is difficult to compete with competitors as old-fashioned as Stuart.” Tencent’s
  Internet industry is similar to Silicon Valley, with fierce competition for talents. It has lasted for more than 20 years and achieved good results. I am also assured of Ma Huateng’s character, and I believe his team will learn from the experience and lessons of excessive stock issuance in 2020. As for how much and who to distribute in the future, let Ma Huateng and Liu Chiping worry about it.
  In addition, equity incentive expenses will be reflected in the net profit attributable to the parent company, but will not be reflected in the non-international standard net profit, which should be considered during valuation.
Drivers of Future Growth

  At the second-quarter performance meeting, Tencent Chief Strategy Officer Mitchell attributed the performance improvement to three ideas: expanding high-margin businesses (such as video account advertising, small games); reducing low-margin businesses (Tencent Cloud CDN business, Tencent Music and Huya’s live entertainment business); focus on cost discipline and efficiency (cost reduction and efficiency increase).
  It is foreseeable that these three ideas will be used in the company’s operations in the second half of 2023 and will still be valid. Tencent’s performance will still show a weak recovery trend in which net profit growth is faster than revenue.
  In the capital market, with the sharp drop in Tencent’s stock price in 2022, the company has carried out the largest repurchase since its listing.
  According to the financial report, Tencent will repurchase approximately 107 million shares in total in 2022, at a cumulative cost of over 33.8 billion Hong Kong dollars. The cumulative number of repurchase days is 104 days, with an average daily repurchase of 325 million Hong Kong dollars. The average repurchase price was HK$315.6, and the highest repurchase price was HK$477.4.
  However, Tencent’s free cash flow in 2022 will be about 100 billion yuan, and the annual repurchase will cost about 30 billion yuan. The final dividend is expected to cost 20.2 billion yuan, and the total cost will be 50.2 billion yuan. Buybacks and dividends are available.
  At the same time, according to the disclosure in the second quarter report, in the first half of 2023, Tencent has repurchased a total of about 48.35 million shares, costing a total of 16.9 billion Hong Kong dollars.
  In 2023, Tencent’s net profit is expected to increase by about 20% year-on-year, so the annual free cash flow is expected to be around 120 billion yuan. If half of the net profit is used for repurchase, if the repurchase is 110 days in 2023, the daily repurchase can reach 600 million Hong Kong dollars. Compared with the current market value of 3 trillion Hong Kong dollars, it is similar to a 2% dividend rate.
  Since the purchase of Tencent Holdings through Hong Kong Stock Connect requires a 20% dividend tax on dividends, it is better to use all of the dividends for repurchases. Therefore, it is recommended that Tencent learn from Apple and increase repurchases to increase investors’ return on investment.

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