(Bloomberg Gadfly) -- As investors trawl through the fourth-quarter earnings of Tencent Holdings Ltd., one of the most eagerly-anticipated data points they'll be hunting for is performance-based advertising.
Net income for the fourth-quarter climbed 47 percent, missing estimates, while revenue climbed 44 percent, roughly in line with expectations. First to be blamed for the earnings miss is surging operating costs, which is definitely one of the culprits, but the ad business deserves scrutiny.
Best known as China's dominant social networking company, Tencent actually gets most of its revenue from online games. Yet the stickiness of its WeChat and QQ messaging apps has allowed the Shenzhen-based company to connect eyeballs to ads.
When Tencent started ramping up ads, brand displays dominated as clients sought merely to have their name and logo seen by Tencent users. Now measurable, clickable ads -- which are more lucrative -- are the big source of ad dollars, hitting 10 percent of total revenue in the third quarter and almost 12 percent in the most recent period. That's one reason why Tencent has been spending more: to attract users to its products and keep them there to serve up these ads.
On the surface, the results from performance ads look strong, as Tencent's earnings statement Wednesday helps explain:
By improving click-through and sell-through rates of our existing inventory, we achieved satisfactory revenue growth without dramatically increasing advertisement loading rates.
The problem is that the brand display business looks decidedly weak, posting growth of just 10.8 percent and taking overall ads -- brand display plus performance-based -- to growth of 44.6 percent, barely level with the Tencent corporate average for the period.
Performance ads should lift overall revenue by helping make more efficient use of inventory, while the company continues to sell brand display slots that remain favored by some clients. But investors should keep an eye out because it looks like the company actually had to make a trade off between the two categories, a fact that chief strategy officer James Mitchell acknowledged on Wednesday.
Such concern may have hit the stock, with Tencent down the most since November in early Thursday trading on volume more than triple the 20-day average.
While it's too early to panic, Tencent sacrificing its display ads to drive performance ads could indicate limited room for growth in the overall business. If this is true, then display ads may not be the winner everyone had hoped for.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Tim Culpan is a technology columnist for Bloomberg Gadfly. He previously covered technology for Bloomberg News.
To contact the author of this story: Tim Culpan in Taipei at tculpan1@bloomberg.net.
To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net.