Tencent's Splurge on Entertainment Pays Off, With Ad Revenue up 60%

China's Internet Giant Logged a Record Profit in the Second Quarter

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The icons for Tencent's messaging applications WeChat, left, and QQ.
The icons for Tencent's messaging applications WeChat, left, and QQ. Credit: Brent Lewin/Bloomberg

Tencent Holdings' shopping spree on premium content from Game of Thrones to NBA broadcasts has again helped defy investors' expectations and a slowing Chinese economy.

Second-quarter sales and profit soared as the operator of the WeChat and QQ social network services splashed out on mobile games and content, including anything from anime and comics to novels. That strategy paid off as user numbers grew and online advertising revenue swelled 60%, confounding fears about marketing cutbacks.

Tencent is paying upfront for rich media titles to tap the purchasing power of its billion-plus users and appeal to advertisers. It's an approach mirrored by Alibaba Group Holding, which -- while making forays into cloud computing and overseas -- is also shelling out for videos, music and games to cater to a domestic audience hungry for high-quality programming. Costs overall for Tencent almost doubled in the quarter.

The question is how long China's largest social media service can keep spending to outpace the decelerating economy.

"Tencent was able to take market share from existing players, thanks to the amount of traffic volume its mobile apps brought in," said Li Yujie, an analyst at RHB Research Institute in Hong Kong. But "the main drivers for cost, like content acquisition and bank handling fees, won't go away any time soon."

Founder Ma Huateng has shown a newfound willingness to go big when it comes to content. It's leading an $8.6 billion investment in Supercell Oy, a signature acquisition that will bring the Clash of Clans studio into the fold. Those blockbusters could anchor the type of tent-pole entertainment that helps it assemble a Marvel-like universe of movies, comic books, online videos and T-shirts. It's already laid the foundations for an emerging entertainment empire by building League of Legends into a domestic powerhouse.

The Supercell deal is something of an anomaly for a company that's previously preferred taking smaller stakes in strategically important businesses. That's because it needs to hold its own against Alibaba and search giant Baidu on digital entertainment. Tencent has merged its QQ Music unit with China Music Corp., combining some of the country's most popular Spotify-like services.

Its Tencent Video goes toe-to-toe with Alibaba's Youku Tudou and Baidu's IQiyi video services. Its online advertising business raked in $980 million, fueled by a video streaming service whose NBA games attracted twice as many unique viewers during the latest season. Tencent is even getting into Periscope-like live-streaming with "Now," a new service designed to capitalize on a phenomenon that's taking China by storm.

While a force in social networking, Tencent is still a relative newcomer to online advertising, with ad revenue that Credit Suisse Group estimates runs at about a sixth of Facebook's. However, investors are keeping a close eye especially on self-service ads on the WeChat, or Weixin, Moments feature (similar to Facebook's news feed). Executives identified that as their single biggest growth opportunity when it comes to advertising. There were five times as many marketers using the self-service option last quarter than in the previous three months.

"It resulted in Weixin Moments becoming our largest ad-revenue generating inventory," Chief Strategy Officer James Mitchell told analysts on a call.

It's in gaming however that Tencent clearly dominates. Reflecting a focus on smartphone titles, mobile gaming revenue alone more than doubled to $1.4 billion. That outpaced a 52% rise in overall revenue to $5.4 billion.

Tencent has now beaten analysts' expectations for profit and revenue in all but one of the past six quarters. On Wednesday, it reported a 47% climb in net income to a record $1.6 billion, handily beating estimates. Revenue from Value Added Services, a category that includes games and messaging, climbed 39% to $3.9 billion.

The Hong Kong-listed stock has gained 27% this year, compared with a 19% rise for New York-listed Alibaba.

WeChat had 805.7 million monthly active users and the mobile version of QQ had 666.5 million users at the end of the quarter. Popular games included shooting title Cross Fire and Naruto Mobile, based on the hit manga series.

--Bloomberg News

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