(Bloomberg Opinion) -- To understand how different China’s two largest internet companies are, take a look at the revenue breakdown for Tencent Holdings Ltd.
As a provider of social media, games and financial services, Shenzhen-based Tencent merely dabbles in advertising. E-commerce giant Alibaba Group Holding Ltd. is built on it. That divergence could end up being Tencent’s greatest strength as it seeks to climb out of a prolonged funk that’s seen revenue slow and profit fall.
While Alibaba and other Chinese internet companies such as Baidu Inc. and startup ByteDance Inc. battle it out for a share of advertising in an increasingly competitive market, Tencent has the chance to leverage its core strengths of games and social networking. That can make it less beholden to the ad business, which was its largest area of weakness in what was a very tepid quarter for the company.
Tencent posted third-quarter revenue growth of 21% late Wednesday. That’s not the worst on record, but it wasn’t great. Ads contributed 19% of revenue, down from 20.2% a year earlier. In fact, that prior figure was a record. As recently as three years ago, ads accounted for just 12.3% of the top line. Alibaba, on the other hand, gets half its sales from advertising and around 22% from commissions.
Advertising was the biggest area of weakness for Tencent, climbing a relatively lackluster 13%. It was hurt by a slowdown in the auto sector while “uncertain content scheduling and lower sponsorship” brought down revenue from ads placed alongside its various streaming services such as sports and self-produced drama series.
Investors can expect this to turn around, but thankfully they won’t need to rely on it because Tencent is so diversified.
The Alibaba versus Tencent divide worked against the latter’s share price over the past few months because investors remained concerned about its ability to sail through regulatory and economic storms. Clouds hang over the gaming business as the Chinese government continues a campaign against addiction that’s forced companies to implement stricter controls.
Alibaba, on the other hand, benefited from an anticipated Hong Kong IPO and revenue growth that was largely driven by recent acquisitions.
It’s understandable that investors remained gun-shy after last year’s crackdown on games, which prevented companies from monetizing new titles. Tencent management was pragmatic enough to ease up on marketing at that time, recognizing that there wouldn’t be a lot of business to chase as long as Chinese regulators put the brakes on that sector. With online games being the company’s largest division, at a third of revenue, even reduced expenditure couldn’t prevent the fiscal pain.
The social-networks unit, at around 23% of sales, was also affected since it includes mobile games and other offerings such as video subscriptions and sports broadcasts. While controversy over the NBA forced Tencent to halt some basketball broadcasts last month, a bigger risk to Tencent Video is increasing censorship that will encroach on self-developed productions. Management hinted at such troubles by referencing “the unexpected delay of certain top-tier drama series” in its August investor conference, which it pointed to again in this earnings statement.
And yet, Tencent’s management team has become experts in navigating Beijing’s political whims. It implemented the “Healthy Gameplay System” two years ago to combat addiction, which gave it the confidence to claim late Wednesday that “recent regulations that limit younger players’ game play will have limited additional impact to our business.”
Tencent also returned from the games freeze with a new patriotic title called Homeland Dream, which topped the charts within days of its debut at the end of September. That helped push smartphone games revenue 25% higher in the third quarter. Expect the company to show similar pragmatic patriotism when it develops new drama series. I’d go so far as predicting that Tencent will say it wants to broadcast more Chinese sports leagues. Hint: President Xi Jinping is known to be a soccer fan.
Harder to skirt, however, is an economic slowdown in China that’s impacting the advertising sector. This is worsened by increasing competition from upstarts like ByteDance’s Douyin short-video service (its international version is called TikTok).
While many cheered Alibaba’s 40% increase in September-quarter sales, they missed the fact that China customer-management revenue (the company’s code phrase for ads) climbed just 25%. The remaining growth came chiefly from new businesses such as groceries and offline retail. By contrast, Tencent was able to lean not only on smartphone games, but also its fintech and business-services unit, where revenue rose 36%. I argued earlier this week that the company should spin off its fintech division, and these results bolster that thesis.
It’s hard to argue that Tencent’s latest earnings are stellar. But at least its has a unique story to tell, one that doesn’t rely on it competing with a giant.
To contact the editor responsible for this story: Patrick McDowell at pmcdowell10@bloomberg.net, Beth Williams
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Tim Culpan is a Bloomberg Opinion columnist covering technology. He previously covered technology for Bloomberg News.
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