Outside of its main business, Tencent is eyeing live e-commerce and AI (4Q22 conference call summary)

Below is $ Tencent Holdings.HK 22Q4 and full-year earnings conference call summary, financial report review can refer to " Tencent: Chinese concept stocks collapsing one after another? Stock king stable on home ground ".

I. Management Remarks

1. General Overview

In 2022, we have improved business efficiency, focused on four activities, and developed new businesses and revenue streams, laying a foundation for a sustainable growth model in the future.

Regarding WeChat, the video account has become the leading online store in China from a video live-streaming platform. The DAU and GMV of WeChat Mini Programs have achieved strong growth, making contributions to the physical economy.

In terms of domestic games, while significantly reducing players' spending time, we maintained the market-leading position. In terms of international games, our VALORANT has been promoted to a globally franchised game, and two games were released among the top three new mobile games of the year.

Regarding advertising, we resumed revenue growth in the fourth quarter. By launching dynamic effect ads for video accounts, we strengthened the transaction-driven force of our ad inventory and improved our machine learning infrastructure.

Regarding cloud business, our business upgrade strategy led to initial revenue decline but pushed up gross profit margin.

We are also committed to promoting the digital transformation of non-internet industries and public services. Throughout the year, we returned capital to shareholders through profit distribution, share repurchase, and cash dividends.

We have made significant progress in creating sustainable social value –

(1) We announced our commitment to achieving carbon neutrality by 2030.

(2) Our digital charity platform raised donations for more than 25,000 projects, attracting over 100 million users.

(3) To support fundamental research, we have committed to investing RMB 10 billion over the next decade to establish a new cornerstone researcher program.

Regarding corporate governance, we welcome Professor Zhang, who joined Tencent's Board of Directors in August last year. Martin will rotate at the upcoming annual shareholders' meeting. This adjustment will clarify the board's responsibilities, increase the proportion of independent directors, and increase the proportion of email directors.

1. Strategic Review

Today, our continuous efforts to invest in strategic areas and pursue value creation opportunities have achieved encouraging results. We have successfully repositioned ourselves and achieved sustainable and high-quality growth. The improvement in financial performance reflects our proactive measures and macro-environmental changes.

First, we have taken measures to improve efficiency to increase profit margin and improve profit quality. These measures include cost reduction and highlighting business priorities.

Second, we have made significant progress in developing new high-quality and high-potential revenue streams, such as dynamic advertising for video accounts and international games. Thirdly, in terms of the macro environment, we have seen positive signals of post-epidemic recovery and regulatory normalization.

Looking ahead, we are confident in our future growth potential for several reasons. First, as the macro environment continues to recover, we see opportunities expanding in advertising, fintech services, and gaming.

Secondly, we are still in the early stages of monetizing video accounts. We are cultivating additional sources of income, such as live streaming and e-commerce.

Thirdly, we will continue to focus on operational efficiency and strict resource allocation.

Fourthly, we have been leveraging our long-term expertise in developing and applying artificial intelligence technology. Recent industry breakthroughs in basic models and generative AI application have provided us with exciting opportunities.

Specific business strategies:

A. Advertising: Although China's macroeconomic recovery is still in its early stages, I am pleased that our advertising revenue recovered double-digit growth in the fourth quarter. Compared with the same period last year, we achieved year-on-year positive growth in the fourth quarter (even if we exclude the new contribution of video accounts in dynamic advertising). To enhance our growth potential in the improving macro environment by 2023, we have been expanding our ad inventory and improving our ability to convert advertising customers.

For new ad inventory, we see strong demand in the market for video accounts in dynamic ads. With rapid user stickiness growth and strong advertiser demand, we have made very good progress in increasing revenue. In addition, we are increasing the ad loading rate of WeChat Official Accounts and strengthening high-quality inventory in the mobile advertising network.

To improve the conversion rate of advertising customers, we have been upgrading our trading capabilities through innovative ad formats, merchant-focused CRM tools, and user-oriented shopping tools. In WeChat's ad revenue, the ratio of click-to-purchase and click-to-message ads has been increasing, exceeding one-third in the fourth quarter. This possible trend indicates that advertisers are increasingly aware of our differentiation capabilities in promoting transactions, positioning, and consumer recovery. In addition, we have been investing in new machine learning infrastructure and launching a new advertising positioning engine, which allows us to improve conversion rates, help advertisers improve return on investment, especially long-term advertisers. The new infrastructure allows us to achieve higher processing efficiency while increasing training speed and reducing unit training costs.

B. Fintech: Although the fourth quarter was temporarily affected by the epidemic, we expect our commercial payment business to benefit from the recovery of Chinese consumption. Since the beginning of 2023, the strong rebound in our total payment volume has proven this point. On the basis of macroeconomic recovery, our commercial payment business benefits structurally from the synergistic effect with mini programs. As China's leading transaction platform, GMV will reach tens of trillions of yuan in 2022. Mini programs provide online + offline solutions for merchants, reducing transaction friction and promoting repeat purchases. Therefore, over time, the proportion of commercial payment volume contributed by mini programs has been increasing and has exceeded 15%. In terms of new business development, with the normalization of China's regulatory environment, we have the ability to seize more opportunities in the field of financial technology. In wealth management, we are expanding our user base through investor education, better service, and broadening our product line. Under the new regulatory framework, consumer loans and online insurance services are exploring new opportunities through close cooperation with licensed financial institutions.

As for the Gaming Division, we are currently preparing for global expansion.

In the domestic market, we have weathered the industry's challenges in 2022 and are now ready for a restart of growth. In January 2023, "King of Glory" had the best total revenue ever during the Chinese New Year period, thanks to the highly successful launch of new content, high-quality equipment, and targeted products offered to players. In addition, "Dungeon and Fighter" had its strongest performance in the past three years in the fourth quarter, attracting players back through the successful evolution of game mechanisms. Additionally, we have benefitted from the normalization of licensing approvals, which enables us to strengthen game releases for 2023 and beyond. Under the new industry regulations, we will focus on releasing new games. We will combine popular IPs with our expertise in shooting and chess games, and will also release leading international games such as "Valorant" and "Lost Ark".

We have made significant progress in enhancing our medium-to long-term growth potential in the international market. In the fourth quarter, our international game revenue increased to $2 billion, accounting for one-third of our game revenue. As "Valorant" users and revenue continue to grow, we have expanded our top-tier licensed franchise portfolio and obtained numerous top-tier casual game licenses.

Our emerging studios have achieved preliminary success in new game releases. In the coming years, we will establish a strong channel to seize multiple opportunities in the international market. It's worth noting that we are expanding regional IPs onto new platforms, markets, and types, such as "Valant" on mobile platforms and "King of Glory" in the international market. We also support emerging studios in launching larger, longer-lived games and introducing more highly acclaimed PC and console IPs to mobile devices.

As for the Video Division, this is a key strategic growth driver. Video accounts continue to experience strong user stickiness growth. In the fourth quarter, its total time spent was 1.2 times that of WeChat Moments, and the number of videos with over 100,000 likes more than doubled year-on-year. We are now leveraging the stickiness of short videos to expand into the live streaming service field. More than 190 million viewers watched the 2023 CCTV Spring Festival Gala through the video accounts to meet the growing transaction needs of businesses and enhance our e-commerce capabilities.

We are now launching the Video Store to provide users with a seamless shopping experience. We are leveraging the rapid expansion of short videos and live streaming to expand the monetization opportunities for the video accounts. Live streaming tipping income experienced strong growth in 2022. Dynamic advertising revenue is growing rapidly, with orders exceeding RMB 1 billion in the fourth quarter. Additionally, we are building infrastructure for live e-commerce to promote GMV growth. Since January 2023, we've been collecting commissions to develop new revenue streams.

AI Division - We expect AI to bring us exponential growth.

We have long-standing experience in developing and adopting AI technology, which has benefited many businesses, including advertising, gaming, short video and cloud computing. The recent breakthroughs in basic models and generative AI applications are very favorable for us because our core social and gaming businesses are user-driven and involve high-quality content that's difficult to disrupt with AI technology but can benefit from its enhancement.

On the other hand, basic models help us introduce users to machine services such as digital assistants and search, which can become our new growth areas.

We have been developing our basic models and plan to gradually roll them out on the backend while introducing use cases across our entire product suite on the frontend. We are leveraging AI technology to enhance our product innovation, monetization capabilities, and operational efficiency. We have advantages throughout the AI value chain, because:

First, we have a wide range of AI use cases. Applications with deep user stickiness, including WeChat, lead in gaming and office productivity software.

Second, with our long-term investment in machine learning, we have strong teams and profound expertise in natural language processing and computer vision.

Third, the breadth and depth of data we've accumulated in our business provide a strong foundation for our model training process.

Fourth, Tencent Cloud is one of China's leading cloud providers, and the scale and complexity of our infrastructure can support the increasing competitive demands not only from our internal products but also from customer applications. Based on these competitive advantages, we are rapidly advancing our proprietary basic model Moat, which has powerful Chinese processing capabilities.

(3) Business Review

VAS: Revenue from the Value-Added Services segment was CNY 70 billion, a decrease of 2% year-on-year. Social network revenue was also down 2% to CNY 29 billion.

Revenue from music and game-related livestreaming services declined, while revenue from video account livestreaming services increased as more paying users enriched our content and improved recommendation efficiency. As we adjust membership prices, our video subscription revenue grew year-on-year, driven by ARPU growth. Video subscription numbers have slightly declined due to content scheduling delays. In January 2023, we launched our self-produced TV series "The Three-Body Problem," which became the highest-rated domestic science fiction drama on Douban's film and TV platform in the past 5 years.

Music subscription revenue grew year-on-year. As we offer additional member privileges (such as improved sound quality and enhanced user participation in music types), both paying users and ARPU have increased. Game:

Domestic game revenue fell 6% YoY to RMB 28 billion, reflecting a decline in revenue in the previous quarters, which led to a decline in confirmed revenue in Q4. However, due to the increase in DAU and spending per paying user, Q4 revenue increased YoY.

International game revenue grew by 5% YoY to USD 14 billion, which excludes exchange rate fluctuations and an 11% YoY increase in revenue adjustments in Q4 2021. Major franchises like "Valorant," "League of Legends," and newly released "Nikki" contributed to revenue growth.

WeChat:

The time spent on both chat and non-chat use cases has increased, resulting in the overall time spent on WeChat by users steadily increasing until 2022. In non-chat use cases, the friend circle content sharing function accounted for the majority of WeChat's non-chat time in Q4 2022 and remains the leader among China's social categories, with overall spending time remaining stable YoY. However, WeChat users' non-chat activities have become more diverse and expanded. As more users activate mini programs more frequently, especially content and work programs, the time users spend on mini-programs almost doubled in Q4 YoY, surpassing that of the friend circle. In Q4, the time users spent on video accounts increased by more than double YoY, surpassing the time spent on the friend circle.

QQ:

We added Super QQ Show, an advertising video chat that uses motion capture technology to provide fun and realistic interactive experiences. These virtual images can reflect users' facial expressions and gestures in real-time during video calls. Mini World is QQ's short video service, which enriches anime content, game content, and introduced AI video creation tools. DAU and time spent per user increased significantly YoY.

Advertising:

Our Q4 advertising revenue was USD 25 billion, an increase of 15% YoY. The reason for the revenue growth was due to the demand for video accounts in dynamic advertising and mini-program advertising, the performance upgrade of mobile advertising networks, and the enhanced machine learning infrastructure, which drove more effective matching between users and advertisers by category. Advertising expenditures from e-commerce platforms, fast-moving consumer goods, and game advertisers grew significantly YoY.

Our Q4 social and other advertising revenue was RMB 21 billion, an increase of 17% YoY. We experienced a huge demand for video account advertising, prompting us to release more inventory, and in-feed video advertising revenue from video accounts exceeded USD 1 billion, which was called key revenue. The revenue from mini-programs increased with the adoption of reward video formats. Due to the improvement of conversion rates and the adoption of bidding mechanisms, the revenue of mobile advertising networks resumed YoY growth. Media advertising revenue in Q4 was USD 3 billion, an increase of 4% YoY compared to the same period last year.

The revenue of our Financial Technology and Business Services department was USD 47 billion, with slight increases both YoY and MoM. Due to the outbreak of COVID-19 temporarily suppressing consumption activities, our average daily business payment amount decreased MoM in Q4, but as of the first quarter so far, benefiting from the recovery of consumption activities, it has rebounded to a strong YoY growth rate. Business service revenue declined YoY, but gross profit increased due to the reduction of loss-making activities, cost optimization, and focus on our self-developed platforms and service products.

In terms of business services, we actively help automobile manufacturers such as NIO, BMW, and GAC Motor enhance their IT infrastructure and products in areas such as intelligent cockpit solutions, digital maps, and data management.

Q&A with Analysts

Q1: What is the trend of advertising business recovery? Which category performs well/worse?

A1: We are cautiously optimistic about the prospects of advertising. Specifically, companies that sell low-priced goods have seen a widespread recovery, while different categories of high-priced goods perform differently - Chinese consumers have accumulated a large amount of excess savings in the past three years, and to a certain extent, they will have the opportunity to use these savings.

There are more opportunities in short video advertising, such as Video Number, which can provide a broader range of short video formats. Many accounts that did not do videos before are now starting to make videos, and some new advertisers such as luxury brands also have the intention to participate and strengthen their connection with users.

In terms of categories, we see particularly strong contributions in e-commerce, gaming, and fast-moving consumer goods. The reason for this phenomenon is partly due to macroeconomic recovery and partly due to the growth of advertising capabilities - for example, mini-programs can further increase user exposure for games.

Q2: What are the opportunities and layout related to ChatGPT, and what are the company's competitive advantages? What are the opportunities and challenges in the B-side and C-side respectively under the limit of computing power?

A2: Our business mainly focuses on social and gaming, both of which require high-quality content for user interaction and can benefit from AI assistance, but are not easily affected by it directly because it is not easy to form habits from users to machines. The strategy we will take is to definitely allocate a lot of resources to build our basic model because we believe it is beneficial to every business line in the future. At the same time, it can also help us launch new businesses and expand from one user to another in the field of machines. We will work hard to do this instead of rushing into it. We hope to ensure that the basic model is truly established correctly and solid.

We have many competitive advantages in this area - we have good infrastructure, users, and use cases for AI. In terms of infrastructure, we have infrastructure to create models, strong cloud business, and chips capable of training models. In terms of business prospects, I think it will improve our existing business in the direction of improving profitability. Actually, advertising can be improved through generative content, which is highly user-centric - this can improve efficiency and is actually very effective in the conversion process.

Imagine that many of our content platforms and content businesses can actually use these tools to generate content for creators and ourselves, and the user experience can be more attractive. We will also seek new business opportunities, and in the continuous development of the business model, we will continue to build better business models. Q3: Is the strategic shift of actively reducing low-profit businesses in cloud services over? Will we see growth gradually normalize with the rapid rebound of business and the acceleration of profit margins in the second half of the year?

A3: We have basically completed the transformation process. This process was painful, but we have conducted our business in a more sustainable and high-quality manner, and we are moving towards high-growth areas. Currently, our business focuses on key areas, and our product portfolio emphasizes high-profit margin and high-added-value services. We are also constantly improving our operations to better manage and deliver better products and services to our users. The overall quality of our business has improved, and we are now in pursuit of the correct mode for high growth, especially in the second half of 2023.

Q4: Are there any plans to integrate artificial intelligence into WeChat and QQ Show?

A4: Naturally integrating AI into our core businesses can optimize the user experience, enable faster development of mini-programs for developers, and enhance the services we offer to our users (especially our flagship products). This is undoubtedly a growth engine worth considering in the future.

Q5: Regarding live streaming e-commerce, what are the company's plans for human capital investment? What is the reason for the decline in OPEX, and what is the space for future cost reductions?

A5: Live-streaming e-commerce is currently a very good opportunity, and it is also a slow development process. E-commerce does require relatively heavy operational investment, but this business is indeed profitable, and the cost investment is relatively small compared to the profits that can be obtained. Of course, the way we promote this business will be considered from all aspects, and it will be more efficient.

Live-streaming e-commerce currently focuses on high-quality merchants and high-quality product categories. AIGC will also play a positive role here, by increasing operational efficiency through the creation of tools. And our infrastructure, such as mini-programs, can also help boost efficiency.

Q6: What is the reason for the decline in OPEX? What is the space for future cost management/reduction?

A6: We believe that we will be more disciplined and cost-conscious in our cost management cycle than ever before.

In overseas games, we are clearly making investments. In fact, we have acquired studios in the past 12 months, and these investments have been quite successful. As you can see, our international game business is now half the size of our Chinese game business. We have released many successful international games, all from larger and better studios. Therefore, we will continue to invest in international games, and this is a normal investment.

From our perspective on AIGC, this is not a disruptive new investment. What is expensive is not providing AIGC itself, but building large language models to support AIGC's decisions (expensive). Microsoft's large language models could cost hundreds of millions of dollars. However, the nature of current costs is very different from the cost nature that China's Internet faced a few years ago. This means that 1-3 years ago, we and our peers in China's Internet participated in most of the high-cost projects. Our actual cost is related to the increase in your user numbers, the more users you have, the higher the absolute cost basis. Large language models are different - we believe this is a fixed cost, which we consider a more desirable cost, because it is fixed rather than increasing marginally. The more users you have, the more your costs will naturally be optimized.

Q7: Regarding fintech, what is the company's view on the new regulatory environment?

A7: Fintech has gone through a rigorous regulatory process, and the previous regulatory authorities have been carefully reviewing fintech businesses, making many guidelines for us to meet compliance requirements. We have also carefully considered whether business development can be carried out and focused on providing value to users. At present, fintech returns to normal regulatory oversight, and related businesses continue to grow steadily. This in turn shows that fintech itself has business advantages.

We believe that our fintech business will continue to expand as macroeconomics develop, as it is a supporter of consumer and merchant activities. We will consider launching value-added services that enable merchants to have better conversion rates and tools that allow them to manage their businesses more effectively. In these cases, we can create better value for merchants, and this will provide us with an additional profit mechanism.

In terms of financial products, we can develop wealth management products such as loans and long-term insurance, while also focusing on risk management in a cautious and compliance-driven manner, while focusing more on existing licensed financial institutions. So we believe that our fintech business has a very good outlook.

Q8: What progress has been made in terms of the video number's monetization capabilities?

A8: In terms of short video monetization, advertisers have given very positive feedback. Currently, the growth of video advertising inventory is higher than revenue growth. Friends circle may regularly increase the ad load rate, and user feedback will be very intuitive, but the video number is more dynamic and smooth, a progressive and constant expansion.

One reason we can do this now is that we have a more powerful machine learning infrastructure in the background of our advertising system that supports our advertising technology. Overall, although the growth of video account fronts is impressive, you can see from the increase in inventory that a large part of our ad revenue improvement is due to our work on machine learning infrastructure in the background.

Q9: Regarding the normalization of game version number issuance, how do you view the growth prospects for domestic games and the company in the future?

A9: In the context of the normal resumption of game version number issuance, we are very optimistic about the future maintaining very good growth prospects for our domestic gaming business. After the Western epidemic, there was a year of stagnation, most people worked at home for a long time, and games had a higher monetization rate during the work-at-home process. However, the situation in China is different. Most people do not work at home for long periods of time. We believe that China's game reopening is different from previous reference experiences, and the overall trajectory is healthy and good.

Q10: How long is the usage time for video numbers? Has the scale of advertising achieved the revenue level of friends circle?

====== A10: The duration of using video accounts has gradually increased, and now it has reached 1.2 times the total usage time of Moments. This is mainly due to the improvement of recommendation algorithms, community expansion, and content quality improvement, which attracts users to spend more time. We are still quite confident about the future. Overall revenue growth is still very good, and monetization still has great potential for growth.

Q11: Regarding regulation, what changes have there been in the domestic regulatory environment since November last year? What are the impacts on the fields of electronic games, short videos, and financial services?

A11: The regulatory direction is relatively healthier and longer-term. I believe that based on the supportive remarks recently made by senior leaders, this trend will continue.

The most likely development in gaming is that license approvals will become more regular and issued on a scheduled basis (there are currently six licenses already).

Similarly, financial regulation will not become our main problem either. We believe it is also a normalization trend. However, returning to the essence, we still need to pay attention to whether our own behavior is compliant, and we should play our platform responsibilities and maintain positive communication with regulators.

Q12: What is the cash situation and investment focus for 2023?

A12: We are very active in terms of capital return. We will issue shares in-kind in the next two days, and we announced today that we will increase our regular annual dividend by 50%. Previously, when we were in an open trading window, we spent most of our time repurchasing shares. So we're busy - as an organization, we're busy investing in the capital returns of other companies.

Given our view of Chinese consumerism, we are actually quite optimistic about investment. We cannot predict how the market will evaluate enterprises, but we can see what Chinese consumers are doing, and this is becoming more active. Therefore, we are becoming more active in investing in small, early-stage private enterprises in interesting growth areas in China ourselves. Internationally, the environment is clearly very active, and we are very selective, but we are also seeking opportunistic opportunities.

Q13: In terms of international development opportunities, there are mentions of new studios and bringing PC games to mobile games. International game development is relatively slow, what growth potential will there be? Are international games facing regulatory/policy risks?

A13: We do not believe that international games are entering a slow growth mode. Last year was a transitional period, but in fact, we are very active in structure for global gaming business, including international business. Whether it is this year's Call of Duty, Elton Ring, or Harry Potter, there are also many games that have achieved great results internationally, and the development of game service models is also very rapid. Therefore, although our international game market share is still only in the median percentage range, we hope to increase the proportion by improving development capabilities and the new GAAS (Game as a Service) model.

Everything is facing a certain degree of geopolitical risk. I think the risks that the gaming industry faces are completely different from those that social platforms face, for several reasons. Gaming is usually not seeking to collect personal user data and then optimize the user experience based on a very targeted dataset. You're interested in collecting large amounts of anonymous user data, but you don't track the behavior of individual participants. Also, there are concerns about publishing content on media platforms, especially news content for users. For games, you don't distribute news content to users. If people want to watch CNN, they won't play video games. While I can't say that games don't have geopolitical risks, I think the nature of concern for games is different from the nature of concern for media or social platforms.

Q14: Regarding fintech, we've already seen double-digit year-on-year growth, what are the expectations for the future?

A14: As for Q4 growth, looking at the change in China's policies during the epidemic, the first half of Q4 was relatively normal, but the second half was heavily impacted. Payment business and consumer resonance, double-digit growth in payment is pretty good. The growth is mainly in quantity, and the growth brought by consumption recovery.

Q15: What is the long-term investment framework and development direction for fintech?

A15: The focus is mainly on adding service value, really helping merchants and users to communicate and facilitate transactions. Other developments are mainly in the fields of loans, insurance and wealth management.

Q16: How do you expect profitability and expense trends this year? How will consumer behavior in the post-epidemic era impact the company?

A16: We saw positive signs of game payment, payment and advertising in January and February. So we can assume that there is some room for improvement in our profitability. Of course, some parts of us, such as online advertising, even if the industry recovery and high-profit feedback should show positive 2023 full year, there may be continuous fluctuations and profit margin changes.

In terms of expenses, sales and marketing internal promotions and advertising expenses for the full year of 2022 have declined by 40% year-on-year. What I want to say is that this has been pushed to a very low base, so we expect expenses may not be reduced due to new business opportunities. For example, for new revenue, we will be very focused on our ROI, rather than in a more disciplined way as in the past. For R&D expenses, it increased by 18% year-on-year in 2022. We will continue to invest in strategic areas, such as games and artificial intelligence. We expect R&D expenses to increase, but the growth rate will be more moderate.

In addition, as I explained earlier, even for artificial intelligence investment, many investments are in the form of servers, which will be amortized over a period of four years. So the impact is not so material and quantifiable.

As for another major item, employee salary expenses increased by 16% year-on-year, while the number of employees decreased by 4%. Excluding thousands of graduate employees and 2,000 employees from newly acquired subsidiaries, we expect our employee count to grow, but remain cautious in 2023.

As for consumer behavior, some of our paid activities, such as mini program trading activities, etc., that we observe are usually quite positive. There are obviously some subtle differences, as I mentioned earlier, low-priced items sell better and certain high-priced items such as cars also sell well. As far as offline and online are concerned, there are more changes, and they are both growing, but there are more obvious changes offline because offline business was more affected last year, especially in the early second quarter and the end of the fourth quarter last year.

The recovery of offline is more significant than online, but overall, it's a broad consumer recovery, whether it's the payment volume and revenue we see, our mini-program revenue, or our advertising revenue.

Risk disclosure and statement in this article: Disclaimer and General Disclosure of Dolphin Investment Research