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Tencent Holdings (Part 2): Ecosystem Financials

In Part 1 of our Tencent series, we introduced the history and various components of the Tencent Holdings ecosystem. In this article, we walk through Tencent's financial statistics and business metrics.

Note: for the purposes of this article and series, we use the terms Weixin and WeChat interchangeably. Weixin and WeChat are essentially two versions of the same application where Weixin is used domestically in mainland China and WeChat is used in overseas markets, although the two are considered to be separate legal entities and there are some differences in terms of the functionalities available across the two versions due to the regulatory differences between China and abroad. Tencent's revenues related to the application mostly come from the domestic version (i.e. Weixin).

Tencent Holdings Series


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Financial Metrics

We first start by looking at Tencent's general financial metrics and revenue breakdown.

#1: Tencent's Revenues Grew At A CAGR of 18.7% During 2017-2021

Tencent's total revenue showed steady growth with a CAGR of 18.7% over the past five years. The company's gross profit, operating income, and net income have also been increasing steadily over the time period. In 2021, Tencent recorded total revenue of RMB560.1 billion and operating income of RMB271.6 billion

Tencent Holdings Revenue and Income
Data Sources: Tencent Annual Reports (click image to enlarge)

*Operating income is higher than gross profit in 2021 due to high net other gains of RMB149 billion, approximately half of which comprises of a gain on deemed disposal of JD Group

#2: Value-Added Services Account For Half Of Tencent's Revenues

Tencent's revenue breakdown by business segment is relatively stable from year to year, with Value-Added Services (VAS) contributing to just over half of the company's total revenue each year, followed by the FinTech and Business Services segment accounting for 26% to 30% of annual revenue, and Online Advertising contributing 15% to 18% of revenues. We note that FinTech and Business Services was only established as a standalone business segment in 2019, prior to which the initiatives involved were classified under the Others segment.

Tencent Revenue Breakdown By Segment
Data Sources: Tencent Annual Reports (click image to enlarge)

Note: minor discrepancies may exist between figures due to rounding.

Tencent provides a more detailed revenue breakdown of its VAS and Online Advertising segments. As mentioned in Part 1, the VAS segment is broken down into: (1) domestic games, (2) international games, (3) communication and social, and (4) digital content, while the Online Advertising segment comprises of the two sub-segments: (1) social and other advertising, and (2) media advertising. We examine this more granular breakdown below.

#3: Domestic Games Contributed To Nearly A Quarter Of Tencent's Total Revenues, In Contrast To 8.1% For International Games

Domestic Games accounted for 23% of Tencent's total revenue and 74% of revenue from the gaming segment in 2021. In contrast, International Games accounted for 8.1% of total revenue and 26% of gaming segment revenue the same year. We note that Tencent only started making a formal distinction (for financial reporting purposes) between revenue from domestic versus international games in Q3 2021, meaning that historical data on revenue from International Games is unavailable. According to management, this distinction was implemented to "[reflect] the increasing scale of Tencent's international games business".

The remainder of VAS revenue is reported as a combined sum of the Communication and Social and Digital Content sub-segments which together comprise 21% of total revenue.

Tencent Detailed Revenue Breakdown
Data Sources: Tencent Annual Reports (click image to enlarge)

Note: slight discrepancies may exist between figures due to rounding.

#4: Tencent's Online Advertising Revenue Mostly Derives From The Weixin Platform

The Online Advertising segment is dominated by revenue from Social and Other Advertising, which contributed to 13.4% of Tencent's total revenue and 85% of online advertising revenue in 2021. In contrast, Media Advertising accounted for only 2.4% of total revenue and 15% of online advertising revenue. Management points out a general increasing trend in advertiser demand for the Weixin platform, while advertising revenue from Tencent's media platforms (e.g. Tencent News and Tencent Video, see Part 1) have declined due to delays in content launches and the changing regulatory environment.

Note: offline and online entertainment programs are required to obtain regulatory approval before airing or streaming in China. Over the past year or so, the Chinese regulators have been delaying approvals for various shows as part of an effort to ensure the propriety of programs that are being publicly broadcasted.

Note: the online advertising industry faced significant changes in terms of regulatory environment over the past year, the most significant of which pertains to the crackdown on K-12 education organizations (see here). Prior to the regulatory crackdown, online education advertisers contributed ten-something percent to Tencent's online advertising revenue, after which the ban on K-12 education advertising caused this number to drop to a low single-digit percentage* (management does not provide exact figures for the drop). We discuss the impact of other regulatory changes further in Part 3 .

*not all forms of online education are banned from advertising (e.g. adult classes and additional interest classes such as sports or music can still be advertised)

#5: Individual Revenue Contributions Remain Undisclosed For FinTech and Cloud Computing

Unfortunately, Tencent does not provide a breakdown of the FinTech and Business Services segment to distinguish between revenue contribution from the company's digital payment business and cloud computing related businesses.

#6: Tencent's Gross Profit Margin Is Relatively Constant While Operating Profit Margin Shows Greater Fluctuation

Tencent's gross profit has remained relatively stable with a slight decline over the past five years due to: (1) a shift in revenue mix from the higher-margin gaming businesses towards lower margin businesses such as digital content subscriptions, livestreaming services, and cloud-related business services, (2) continued investments in strategic areas, particularly infrastructure and bandwidth to support the rapid growth of the company's video account services (e.g. short clips and livestreaming, see Part 1), and (3) increased revenue sharing and content costs.

In contrast, operating profit margin shows a greater degree of fluctuation due to higher selling, general, and administrative (SG&A) expenses and marketing expenses in certain years offset by net other gains.

Tencent Holdings Profit Margins
Data Sources: Tencent Annual Reports (click image to enlarge)

Business Metrics

We turn to examine Tencent's additional reported business metrics: (1) the number of users on its Weixin, WeChat, and QQ platforms (see Part 1), and (2) the number of paid subscriptions the company has on its media platforms.

#1: The Weixin/WeChat Market Is Saturated, While QQ is Declining in Popularity

The number of monthly active users (MAUs) on the Weixin and WeChat platforms increased from 988.6 million in 2017 to 1,268.2 million in 2021. We think this market is very close to saturated given China's total 1.4 billion population. In contrast, QQ's smart device MAU has been declining since 2018 from 699.8 million MAUs to 552.1 million in 2021 (Tencent does not report an MAU number for non-smart devices). Management claims that the decline in QQ's smart device MAU is due to Tencent's purging of spam and bot accounts, although we think that consumer switching from QQ to Weixin also plays a role as users migrate from the more PC-oriented QQ platform to mobile-friendly Weixin (see Part 1).

Tencent Holdings - Number of WeChat and QQ Users
Data Sources: Tencent Annual Reports (click image to enlarge)

#2: Fee-Based VAS Subscriptions Grew 75.6% Over The Past Five Years

The number of fee-based VAS subscriptions derived from Tencent's media platforms increased from 134.6 million subscriptions in 2017 to 236.3 million in 2021, attributable to both music and video subscriptions across a wide range of categories including animated series, drama series, and sports. Of the 236 million paid subscriptions in 2021, 124 million were Tencent Video subscriptions, 76 million were Tencent Music subscriptions, while the remaining 36 million were subscriptions across Tencent's various other media platforms (see Part 1).

Tencent Holdings - Number of VAS Subscriptions
Data Sources: Tencent Annual Reports (click image to enlarge)

Investment Portfolio

Lastly, we examine Tencent's investment portfolio. Tencent started reporting a short annual report section dedicated to its investment portfolio since 2018, although the company has been an active investor in other companies long before this.

The evolution of Tencent's investment portfolio (comprising of mostly private but also public companies recorded on the asset side of the balance sheet - see Part 1) and the fair value of the company's holdings in publicly listed companies is consistent with management's historical strategy of acquiring promising private companies and growing them until they become public. Indeed, we see that the fair value of Tencent's holdings in publicly listed companies was initially lower than the value of its investment portfolio until 2019, during which the two converged and the fair value of public holdings eventually exceeded Tencent's balance sheet portfolio amount in subsequent years. Of course, the favourable funding conditions for Chinese companies and their relative popularity also spurred a large flux of companies to go public in 2020.

*Values shown are year-end values

The particularly large discrepancy between investment portfolio value and the fair value of publicly listed shares in 2020 is likely due to the rapid rise in Chinese stock prices that year, as well as significant increases in other stocks which Tencent held and/or still holds (e.g. Tesla). Likewise, the large drop in fair value of listed shares in 2021 is presumably due to the tumble in Chinese stocks following the year's eventful regulatory developments.

#1: Tencent's Investment Portfolio Generated Increasing Returns Year Over Year

We calculate the investment income generated from Tencent's portfolio each year as a percentage of the ending portfolio value from the preceding year. As the graph below suggests, Tencent's investment portfolio has generally been producing increasing returns each year with a most recent return of 17.4% in 2021.

Tencent Holdings Return on Investment Portfolio
Data Sources: Tencent Annual Reports (click image to enlarge)

#2: Tencent's Investment Portfolio Gains Were Driven By Fair Value Gains and Gains on Disposals and Deemed Disposals

Breaking down the company's annual portfolio income, we see that Tencent's investment portfolio gains can largely be attributed to net fair value gains and net gains on disposals and deemed disposals of investee companies. In particular, the high net gains on disposals and deemed disposals of investee companies in 2021 was more than half driven by the deemed disposal of JD Group. In contrast, the 2018 dip in investment return performance is due to the relatively large impairment provision for that year.

Tencent Holdings Investment Portfolio Income Breakdown
Data Sources: Tencent Annual Reports (click image to enlarge)

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