Tencent posts biggest profit shortfall in 10 years

Tencent Holdings Ltd. posted a slump in fourth-quarter earnings on increased spending as its prized games business showed signs of recovery after a brutal 2018.

Net income fell 32 percent to 14.2 billion yuan ($2.1 billion), missing the 17.55 billion-yuan average of estimates, on investments in content, cloud computing and financial technology. That’s the biggest shortfall on profits in at least a decade. The result also included the costs of share issues and impairments for companies it’s invested in as revenue surpassed projections.

China’s social media leader is emerging from one of its darkest periods, as game approvals slowly resume and the country’s economic slowdown cools demand for advertising. That’s seen the owner of WeChat spend billions to sustain growth with investments in everything from cloud and entertainment to retail, locking horns with Alibaba Group Holding Ltd.

“As it turns out the market was probably worried about the wrong thing,” Bloomberg Intelligence analyst Vey-Sern Ling said in an email. “The unexpected bit is how much cost of revenues and operating expenses have expanded. This is driven by video, payments, cloud, film and TV production.”

Sales from its gaming division were better than feared, suggesting a modest recovery going into 2019, Ling added. Tencent’s shares gained as much as 1.2 percent in Hong Kong Friday. It’s now up more than 16 percent this year, compared with a 32 percent rise for New York-listed Alibaba.

The WeChat operator overhauled its structure in September to capture opportunities in what founder Pony Ma brands the emergence of an “industrial internet.” It set up a cloud and smart industries division to spearhead its investments in areas from retail, connected cities and security to education, manufacturing and healthcare. The spending spree is diversifying its revenue make-up, pushing the contribution from gaming to 36 percent in the quarter.

“Our goal is not just to capture the cloud computing business, it’s to actively prepare for the tremendous opportunities coming from the landmark shift from consumer internet to industrial internet,” Ma told reporters. “China’s internet sector has entered the next phase.”

For now, gaming remains its biggest division. While approvals in China have resumed, Tencent has yet to get a green light to monetize Fortnite or the mobile version of PlayerUnknown’s Battlegrounds, the most popular smartphone game on the planet. It was able to release nine games in the quarter but couldn’t provide an update on when PUBG could start making money in China. “We are working actively to communicate on it” with regulators, President Martin Lau told reporters on Thursday.

After making investments in a number of overseas games firms, including Netmarble Corp. and Ubisoft Entertainment SA, Tencent has built up its own capabilities in mobile titles. It plans to jointly develop and promote new games overseas with partners rather than just distributing content their content in China, Lau said.

“Given that China has now restarted the game approval process we should expect to see accelerating growth for smartphone games going forward,” Neil Campling, an analyst at Mirabaud Securities, said in a report.

Revenue for the quarter was 84.9 billion yuan compared with estimates for 83.4 billion yuan while adjusted earnings-per-share were also above expectations. Sales from the Value Added Services unit, which includes online games and messaging, climbed 9 percent to 43.7 billion yuan. But costs surged 43 percent from a year earlier as content and financial technology bills piled up.

Tencent plans to introduce a new category of sales when it reports first-quarter earnings to reflect its growing diversity. The company will break down specific categories in the “others” revenue section in its financial statement, Lau said.

“Mobile game revenues at 19 billion yuan was actually decent because last quarter was 19.5 and typically the fourth quarter is seasonally slow,” Ling said. “Given they have new games in the first quarter I think the 19 billion number bodes well for a mobile game recovery into 2019.”

Cloud sales more than doubled to 9.1 billion yuan as Tencent’s heavy investment in the sector opens up yet another front in its battle with Alibaba, the leader in China. WeChat, China’s dominant messaging and social network app, saw monthly active users rise to 1.1 billion, while the mobile version of QQ had 699.8 million users at the end of the quarter.

Tencent is also shaking up its management ranks. Lau confirmed a Bloomberg report that the company has put 10 percent of its executives on notice, with poor performers to be weeded out to bring in new blood.

(A previous version of this story corrected the change in profit to show year-on-year movement.)

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Tencent posts biggest profit shortfall in 10 years