Tencent: Significant progress in addressing gaming challenges (1Q24 conference call minutes)

Below is the summary of Tencent Group's first quarter financial conference call in 2024. For financial report analysis, please refer to " Tencent: Video Number transforms into a money tree, stock king elegantly takes off "

I. Review of Core Financial Information:

II. Detailed Content of Financial Conference Call

2.1 Key Points from Management's Statements:

Overall Operations

• High-quality revenue sources include advertising, Video Number, WeChat search, mini programs, platform service fees, and e-commerce technology service fees, driving growth.
• Total revenue was RMB 116 billion, a year-on-year increase of 6% and a quarter-on-quarter increase of 3%.
• Non-IFRS operating profit was RMB 59 billion, a year-on-year increase of 30% and a quarter-on-quarter increase of 19%.

Main Businesses

• Communication and Social Networks: Monthly active users of WeChat and WeChat reached 1.36 billion.
• Digital Content: Subscriptions for Tencent Video and Tencent Music Entertainment (TME) grew year-on-year.
• Gaming: After proactive adjustments, flagship games domestically and internationally showed initial growth recovery.
• Cloud Services: Tencent Cloud media services are widely adopted by domestic and international media, entertainment, and live broadcasting industries.

Performance by Business Segment

• Value-added Services: Total revenue was RMB 79 billion, a year-on-year decrease of 1%. Domestic game revenue decreased by 2%, but international game revenue grew by 3%.
• Online Advertising: Revenue was RMB 26.5 billion, a year-on-year increase of 26%. WeChat Video Number advertising revenue grew by over 100% year-on-year.
• Financial Technology and Business Services: Total revenue was RMB 52 billion, a year-on-year increase of 7%.

Cost Efficiency

• By improving the cost efficiency of long videos and cloud services, total gross profit increased by 23% year-on-year.
• Gross profit from financial technology and business services increased by 42%, accounting for 28% of total gross profit.

Investment and Technology

• Continued investment in AI technology, platform enhancement, and high-value contracts.
• Launched the "Hunyuan" large model, providing text and image generation AI, and open-sourcing the code.

Financial Indicators

• Total gross profit was RMB 83.9 billion, a year-on-year increase of 23%.
• Non-IFRS net profit was RMB 50.3 billion, a year-on-year increase of 54%.
• Strong cash flow and free cash flow, with a net cash position of RMB 92.5 billion, a year-on-year increase of 69%.

2.2 Management Summary:

(1) High-quality Revenue Driving Growth

Tencent's performance in the first quarter of 2024 was outstanding, benefiting from high-quality revenue sources such as advertising, Video Number, WeChat search, mini-games, platform service fees, and e-commerce technology service feesThe company not only achieved revenue growth but also surpassed operating profit growth. At the same time, Tencent is accelerating its stock buyback plan, expected to repurchase over HKD 100 billion of shares by 2024 and increase dividends, continuing to invest in AI technology, platform enhancement, and high-value contracts.

(2) Financial Data Overview

This quarter, Tencent's total revenue was RMB 116 billion, a year-on-year increase of 6% and a quarter-on-quarter increase of 3%. Gross profit reached RMB 84 billion, a year-on-year increase of 23% and a quarter-on-quarter increase of 8%. Non-IFRS operating profit was RMB 59 billion, a year-on-year increase of 30% and a quarter-on-quarter increase of 19%. Non-IFRS net profit attributable to shareholders was RMB 50 billion, a year-on-year increase of 54% and a quarter-on-quarter increase of 18%.

(3) Key Service Performance

The combined monthly active users (MAU) of WeChat and WeChat grew year-on-year and quarter-on-quarter to 1.36 billion. Subscriptions for Tencent Video and Tencent Music Entertainment Group (TME) increased year-on-year, further solidifying the company's leading position in the long video and music streaming sectors. In terms of gaming, the company made active adjustments, driving the recovery of flagship games in the Chinese and international markets, with several games achieving record growth this quarter. In the cloud business, an increasing number of international and domestic customers from the media, entertainment, and live broadcasting industries are using Tencent Cloud media services. Enterprise SaaS products such as Vical and cancel meeting have been enhanced, increasing adoption rates among enterprise customers.

(4) Performance of Various Business Segments

Value-added services (VAS) accounted for 49% of Tencent's total revenue, with social networks accounting for 19%, domestic games for 22%, and international games for 8%. Online advertising accounted for 17% of total revenue, while financial technology and commercial services accounted for 33%. Gross profit increased by 23% year-on-year, mainly benefiting from the rapid growth of high-margin revenue sources such as video ads on WeChat, wealth management services, mini-games, platform service fees, and e-commerce technology fees.

Value-added Services and Social Networks

Revenue from the value-added services department was RMB 79 billion, a year-on-year decrease of 1%. Revenue from social networks decreased by 2% year-on-year to RMB 31 billion. Revenue from music subscriptions, video live streaming, mini-games, and video subscriptions increased, but revenue from music and game-related live streaming services decreased significantly. Revenue from long video subscriptions increased by 12% year-on-year, with daily video subscription volume increasing by 8% to RMB 1.16 billion. Revenue from music subscriptions increased by 39% year-on-year.

Recovery of Gaming Business

Domestic gaming revenue decreased by 2% year-on-year to RMB 35 billion, partly affected by the decline in revenue from "King of Glory" and "Peace Elite," but the overall trend shows signs of recovery. International gaming revenue increased by 3% year-on-year to RMB 14 billion.

Development of Communication and Social Networks

WeChat users are increasingly consuming official account and video subscription content recommended by algorithms while engaging in a variety of services through mini-programs. Official accounts and mini-programs have shown strong performance in user interaction and revenue growth, benefiting from the improvement of AI algorithms and the diversification of mini-program servicesVideo account user time increased by 80% year-on-year in the first quarter, and the live e-commerce ecosystem has also been strengthened.

AI Technology and Future Investments

Tencent's management emphasized the importance of AI technology in its business and plans to continue increasing investments to maintain a competitive advantage in the market.

Milestone in Gaming Business

In the first quarter, Tencent's several games achieved significant milestones. "Peacekeeper Elite" set a record for daily active users (DAU) and ranked third in terms of revenue among all mobile games in China this quarter, thanks to new hero updates and customizable arena content. The mobile version of "CrossFire" achieved historical highs in both paying users and total revenue, while "Code: T" reached new milestones in DAU, paying users, and total revenue by introducing expanded maps and armor and weapons inspired by Chinese action culture.

Future Game Release Plans

This year, Tencent plans to release several high-value games, including the mobile version of DNF next week, "TalesWorld," "Need for Speed" mobile version, "One Piece" mobile version, and "Delta Force." In terms of international games, "PUBG MOBILE" saw double-digit percentage growth in DAU and total revenue year-on-year in the first quarter, thanks to the popularity of new modes and special events. The average DAU of "Brawl Stars" more than doubled year-on-year, and total revenue increased more than fourfold. "Honor of Kings" achieved its highest total revenue after introducing new fast-moving battle armor.

Online Advertising Business

In the first quarter, Tencent's online advertising revenue reached RMB 26.5 billion, a 26% year-on-year increase, benefiting from increased engagement in AI-driven ad targeting. Advertising spending increased year-on-year in all major categories except the automotive industry, especially in the gaming, internet services, and consumer goods industries. Tencent upgraded its advertising technology platform and provided all advertisers with AI-driven ad creation tools, enhancing the efficiency of ad creation and targeting.

WeChat and Video Account Advertising Growth

WeChat video account advertising revenue grew by over 100% year-on-year, driven by increased video views and click-through rates. Mini-program advertising revenue increased by over 40% year-on-year, benefiting from the closed-loop effect of mini-games. Long video advertising revenue also grew at a double-digit rate year-on-year, with popular self-produced series attracting a significant marketing budget.

Financial Technology and Business Services

In the first quarter, the revenue of the financial technology and business services division reached RMB 52 billion, a 7% year-on-year increase. Payment business growth slowed down mainly due to reduced offline consumer spending and a decline in withdrawal fee income. However, wealth management income showed strong year-on-year growth, with a rapid increase in the number of users and the average fund investment amount per user.

Cloud Services and Technology Services

Business services saw double-digit year-on-year revenue growth in the first quarter, driven by increased cloud service revenue and technology service fees from the increase in video account e-commerce transactions. The increase in revenue from high-margin sources and improved efficiency led to a more than doubled year-on-year growth in gross profit for business services. Tencent Cloud's media services are increasingly adopted by domestic and international customers, especially in the media, entertainment, and live broadcasting industriesEnterprise SaaS Products

Tencent's enterprise SaaS products such as WeCom and Tencent Meeting have shown significant revenue growth. WeCom's revenue has tripled year-on-year, while Tencent Meeting's revenue has doubled year-on-year. Tencent is also expanding the scale of the "Hybrid" large model, using a hybrid approach of experts and deploying it in more services. The version announced today will make AI for text image generation available in an open-source manner.

III. Q&A Analyst Q&A

Growth of Online Games and Stock Repurchase Plan

Q: (1) In the previous quarter, we emphasized a key strategy of revitalizing our core games. This was demonstrated in the strong performance of Supercell games and the resurgence of "PUBG". Given our rich IP portfolio and extensive experience in operating online games, can management share their views on future potential and growth plans, and how we can replicate this success with other IPs and games? (2) In the previous quarter, we completed repurchases of at least RMB 100 billion. Considering the significant increase in our stock price since the last quarter, how should we view the pace of repurchases? Should we rely more on price, or are there other factors to consider?

A: James Mitchell answered the question about online games. He stated that Tencent has made good progress in revitalizing core games and drawn two main lessons from it. Firstly, "evergreen" games have the potential to revitalize, such as a fourfold increase in revenue for "Brawl Stars" and a twofold increase in daily active users. Secondly, when "evergreen" games stagnate, the problem usually lies with the management team, requiring adjustments to the team to achieve positive results.

Liu Chiping answered the question about stock repurchases, mentioning that Tencent has committed to repurchasing at least HKD 100 billion of shares, and the repurchase has been proceeding at a consistent pace. Despite the rise in stock price, the repurchase plan will continue as the company's profit growth, increasing portfolio value, and promising long-term prospects support ongoing share buybacks.

Growth of Advertising Business and High-Quality Growth Strategy

Q: (1) We see good momentum in the first quarter. How should we view the market share growth and the upgrade in the Asia-Pacific region against the backdrop of macroeconomic recovery? As June 18 approaches, what is our sentiment towards the advertising market? Looking ahead in the next few years, what role will the strong performance of video accounts and live e-commerce GMV play in driving our advertising revenue?

(2) Given our high-quality growth strategy and strong profit growth momentum, how should we expect profit growth and profit margin trends in the next few years? Is there a point where we may need to revert to more reinvestment? In terms of operating expenses, with more content and new game releases, how should we view sales and marketing expenses in the coming quarters?

A: James Mitchell answered the question about the advertising business. He mentioned that despite the complex economic situation and varying advertiser sentiments, Tencent still has an advantage in the advertising businessIn the first quarter, due to the special performance of the Spring Festival effect, the annual advertising growth is expected to be slightly slower than the first quarter. Tencent is in the early stages of increasing the advertising load of Video Number and deploying AI in the advertising technology stack, which will help improve click-through rates and advertising revenue. Overall, Tencent is confident in the reasonable growth of advertising revenue and believes it will continue to gain market share.

When discussing high-quality growth strategies, Liu Chiping emphasized that Tencent has always been investing in platforms and user experience, rather than exploiting platforms, thus unleashing many growth drivers. Tencent has pruned low-quality products and services, focusing on core platforms to make growth drivers more prominent. Video Number advertising, WeChat search advertising, payment platform value-added services, etc., all have long-term growth potential. Tencent is also investing in future growth drivers such as AI, new games, WeChat e-commerce, and SaaS products, expecting continued benefits to gross profit margins. Shek Hon Lo summarized the situation of sales and marketing expenses, stating that the year-on-year growth rate in 2024 is expected to be in the low to mid-single-digit percentage range, with advertising expenses being dynamically adjusted as needed and rigorously evaluated within the framework of cost optimization culture and mechanisms.

Growth of Gaming Business and App Store Revenue Sharing

Q: The first question is about the gaming business. (1) With the positive growth of "Honor of Kings" and "Peacekeeper Elite" as well as other games setting new revenue highs this quarter, the strong growth in deferred revenue will also help future revenue growth in the coming quarters. Are there any significant adjustments underway? Or should we pay attention to any risks or uncertainties in the gaming business? (2) The second question is about the revenue sharing arrangement in the app store. In the future quarters, is it possible for Tencent or other developers to see improvements in revenue sharing arrangements for game apps or digital content apps, thereby supporting further improvement in value-added service gross margins?

A: Regarding the first question, James Mitchell stated that deferred revenue growth is a positive leading indicator of game revenue growth and there are no specific risks to highlight. With the implementation of structural changes, risks in the gaming business have been reduced. In the future, the company will focus on executing new strategies for existing games and successfully launching several major new games in the pipeline. As for the second question, James Mitchell believes that the revenue sharing ratio in app stores is too high and harms the interests of app providers, especially in China and internationally. However, Tencent's business plans assume that these revenue sharing arrangements will remain unchanged.

New Game Release Strategy and Profit Margin Improvement Trends

**Q: (1) What do we learn whenever we see potential new game releases? What strategies does management have to cultivate these games into our next evergreen games? Especially domestically, we have the upcoming "DNF Mobile" release, and internationally, we may have more game releases. How should we view the strategy for future new game releases? (2) For these business segments, considering that profit margin improvement seems to cover a wider range of businesses, how should we view the relative profit margin trends of different segments in the future?A: James Mitchell answered questions about new games, pointing out the challenges the gaming industry faces with new games having to compete not only with other new games released simultaneously, but also with all existing evergreen games. Tencent's strategy is to raise the standards for new game releases, focusing on fewer but larger new games, and paying attention to engagement metrics for new games, such as retention rate, to determine their potential to become evergreen games. For example, "Honor of Kings" started modestly but has now become the third largest mobile game in China.

Liu Chiping answered questions about profit margin improvement, stating that the sustainability of profit margins depends on factors such as the competitive environment, macroeconomic conditions, and seasonality, but the most important factor is the transformation of business portfolio. Tencent's advertising, financial technology, and commercial services are undergoing active business portfolio transformation, shifting from low-profit revenue to high-profit revenue, a trend expected to continue in the coming years and drive sustained profit margin growth.

AI Applications in Advertising Business and Future Product Outlook

Q: (1) We have seen Meta improve their leading advertising tools based on large-scale models. We would like to know if management can share more information about Tencent's plans to use AI to enhance its advertising business. In the future, do you think competitors like ByteDance or Alibaba will also apply AI to their advertising business, and how will AI drive changes in advertising market share in the long term? (2): Recently, Meta announced their Meta-AI feature and will extend it to automated products such as WhatsApp and Facebook Messenger. Do you think Tencent will have similar products in the future?

A: Tools like Meta's Advantage+ are crucial in maximizing the advertising potential of social media companies, as they simplify and automate the ad buying and targeting process, enabling social media companies to offer a more competitive experience. The advantage of social media platforms lies in higher user time spent and engagement, so with the deployment of AI, click-through rates have structurally increased, particularly evident for social media inventory with lower click-through rates. Advertisers can also use generative AI to create ads for social media. Overall, ad spend will be reallocated to services with high time spent and engagement.

Liu Chiping answered the second question, stating that WeChat platform and other products will be excellent distribution channels for AI products. Tencent has the most advanced technology in mixed reality and is actively creating and testing different products, which will be launched on the platform when the timing is right.

Cloud Business Services and Wealth Management Strategy

**Q: (1) Regarding cloud business services. I noticed that your new businesses such as the revenue of Enterprise WeChat has tripled, and the revenue of Tencent Meeting has doubled. Are we seeing an acceleration trend in service adoption? Given that cloud business is very sensitive to macroeconomic conditions, are your customers now more willing to use our services?I hope we can see this accelerating trend in the remaining time of this year. (2) Regarding the rapid growth of financial management. I believe this has always been one of the key drivers of growth in your financial technology services. Could you please elaborate on our strategies in this area, where do we need to invest? And in terms of profits, what further areas can we benefit from in this business, and what kind of investments are needed to further drive development?

A: Liu Chiping answered the question about cloud business services, pointing out that the revenue growth of WeCom and Tencent Meeting started from a relatively low base, indicating the initial validation of Chinese enterprises paying for SaaS services. Although the current monetization is in its early stages, Tencent will continue to invest in these SaaS services to become a market leader when the inflection point arrives in the future. These services not only provide value-added services to enterprises but also create a good foundation for Tencent to connect with enterprise customers, facilitating cross-selling of other cloud and enterprise services.

For wealth management services, Liu Chiping explained Tencent's strategy, mainly by partnering with fund management companies to provide money market funds. Customers deposit money into these funds instead of withdrawing to bank accounts or spending, a trend that is increasing. Tencent will continue to build payment platforms, increasing the likelihood of users entrusting their wealth to Tencent, and partnering with more fund management companies to provide high-quality wealth management products and services. At the same time, Tencent is also investing heavily in risk management to ensure the security of customer wealth. Through these measures, Tencent believes that wealth management services will continue to grow steadily.

Innovations in video account and mini-program advertising technology and investment portfolio strategy

Q: (1) Regarding the innovation of video accounts and mini-programs in e-commerce. I would like to understand our innovation in advertising technology, especially whether the advertising technology upgrade of video account live streaming and mini-programs involves ROI-based advertising products? (2) Regarding the investment portfolio, considering its value close to 130 billion US dollars. Do we have any considerations for a consistent or allocation policy? After the distribution of JD and Meituan in the past, are there any predictable policies that allow the market to more actively assess Tencent's huge intrinsic market value?

A: Tencent has innovated in advertising positioning using artificial intelligence to help advertisers manage ad campaigns and has deployed mixed-element technology to create ad content, these innovations have promoted rapid growth in advertising revenue.

James Mitchell answered the question about the investment portfolio, mentioning Tencent's cooperation with invested companies to enhance their profitability. For example, the revenue growth of non-IFRS associates has been significant. There are currently no plans to distribute any shares, past investments in various areas such as Spotify and upstream companies have established a very strong position for Tencent Music Entertainment Group (TME) and created a strong ecosystem for Tencent, generating significant returns for shareholders. In the future, Tencent plans to use free cash flow for shareholder return activities, such as paying dividends and stock repurchases, rather than continuing large-scale investmentsPotential Applications of Mixun in the Gaming Business

Q: Can we discuss the potential applications of Mixun in the gaming business? How much do management expect it to help in game production?

A: Liu Chiping responded that currently, Mixun's biggest contribution is in customer service. It is used to answer questions and provide customer service for many games, achieving high customer satisfaction. Although AI has been deployed in Tencent's games, it is not necessarily generative AI technology. Over time, as Mixun technology is able to transition to multimodal, especially being able to create high-quality, high-bitrate videos, its role in game production will be greater. Currently, Mixun can be used to create NPCs and some interactive experiences, but it is not yet able to take on a significant role in game content creation. It will need to go through several generations of development before it can play a bigger role in game production.

Slowdown in Financial Technology Business and Monetization Strategy for WeChat Search

Q: (1) Regarding the slowdown in the financial technology business, could you please explain in detail the reasons for the slowdown, perhaps breaking down the business into payment and non-payment parts? Additionally, how should we view the mid-term growth prospects of the financial technology business? (2) About WeChat Search. The monetization momentum of WeChat Search seems to be accelerating in recent quarters. Could you discuss the monetization strategy for WeChat Search activities? It would be great if you could share some operational metrics to help us understand the growth potential.

A: Liu Chiping addressed the questions about the financial technology business, stating that the main reason for the slowdown is the headwinds in offline consumption. Despite the government taking many stimulus measures to revive the economy and boost consumer confidence, revenue growth in financial technology payments is slow. Withdrawal fees are seen as low-quality income because withdrawals mean funds leaving the system, but when withdrawals decrease, funds stay in the system longer, converting into long-term high-value-added income, such as wealth management fees.

Regarding loan generation fees, due to macroeconomic headwinds, Tencent has become more cautious, focusing on risk management.

Regarding WeChat Search, Liu Chiping mentioned that the service has been growing healthily in terms of usage and search volume, and the monetization process started relatively early. WeChat Search began monetization on top of last year's base, considering the high engagement of WeChat and the growth and expansion of the content ecosystem of WeChat Search itself (such as Official Accounts, Mini Programs, and Video Accounts), WeChat Search revenue is expected to continue growing in the long term.

Monetization Potential of Video Accounts and Moments, and Game Development Improvements

**Q: James, I remember you mentioned before that you believe the monetization potential of Video Accounts can rival Moments. Currently, Video Accounts have twice the engagement of Moments. What are your thoughts on the strength of advertising revenue or engagement? What reasons could hinder Video Accounts from surpassing Moments in total monetization potential? (2) Regarding games, I recall that different members of management have criticized the internal game development process. I would like to understand your views on this. We have a fairly robust game release schedule, does this mean that the issues of the past few years have been resolved, and can we expect a more consistent game release schedule in the second half of this year and the coming years?A: James Mitchell first answered questions about the video sector. He mentioned that it can be objectively seen that companies like Meta are operating both traditional information flows and short video information flows, and over time, the monetization of short video information flows will converge with or exceed that of traditional social information flows. Tencent is also moving in this direction.

Regarding the gaming sector, James Mitchell pointed out that Tencent has indeed addressed some more obvious challenges, and while there may be new challenges in the future, the current biggest direct challenge has been resolved, leading to better game engagement and monetization, as well as greater confidence in new game release plans. He explained that Tencent's game development and release process is not uniform, with each team having its unique attributes and best practices. One of Tencent's strengths is its global business and studios in different regions, where sharing experiences and best practices is an important means to improve overall development quality.

Liu Chiping added that the game team has done many things right, but there are no perfect teams or games, so continuous adjustments are needed. He emphasized that Tencent has a large number of evergreen games, which are not simply attributed to the game's lifecycle, but rather by looking at specific issues and making adjustments to make the game evergreen. Tencent has diverse studios that achieve game success in different ways while sharing experiences to promote collective progress.

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