Author | Wu Kunyan

Editor | Wu Xianzhi

“How can I turn my money from new to old?”

This question from Wu Qi in the film “Almost There” applies to almost all organizations in transition. However, different businesses face varying industrial landscapes, leading to differing definitions and understandings of what constitutes “old” and “new” money. For instance, cloud vendors transitioning from the mobile internet era to the large model era have been showcasing their AI-related revenues and growth rates through financial statements, using various metrics.

At this juncture, the organization where the transition from old to new is particularly evident is Tencent, which is slowly developing its large language models and WeChat Video Accounts.

On August 14, 2024, Tencent released its second-quarter financial report for 2024. The report revealed that Tencent's revenue for the quarter grew by 8% year-on-year to RMB 161.117 billion, with an operating profit (Non-IFRS) of RMB 58.443 billion and a net profit increase of 82% year-on-year to RMB 47.630 billion. Notably, this quarter marked the first time since the second quarter of 2016 that Tencent's operating profit margin reached 31.5%.

Achieving such results amidst a relatively tight market environment indicates that Tencent is entering a strong upward cycle.

However, the market's response to this performance has been relatively cautious. It's worth noting that the aforementioned high-profit margin was achieved by Tencent's mobile gaming growth engine, built on its “Nationwide” and “Everyday” series, amidst the shifting landscape of the gaming industry.

Disregarding the relatively mediocre performance of TME and China Literature, Tencent's share price fluctuations can be attributed to the market's short-term perception of its growth engine – eight years later, gaming remains Tencent's core revenue source.

The financial report shows that Tencent's value-added services revenue was RMB 78.8 billion this quarter, with both domestic and international gaming revenues growing by 9% year-on-year to RMB 34.6 billion and RMB 13.9 billion, respectively. The high-margin nature of this business is a significant contributor to Tencent's impressive profit performance.

Perhaps, compared to gaming, the market would prefer to see Tencent's progress in the WeChat Video Accounts ecosystem and the AI large models representing a higher ceiling for the future. In other words, Tencent's revenue primarily stems from the old money we are familiar with, rather than the new money that offers a glimpse into the future.

Waiting for a Qualitative Change in Video Accounts

“Optimistic peers have preset this year's GMV for WeChat Video Accounts e-commerce at the trillion-yuan level. However, Tencent did not provide such data, even with the boost from 618, and we have no idea how excellent ‘the hope of the village’ really is.”

Investors' reactions highlight one of the reasons for the market's cautious stance. Besides the lack of disclosure of GMV, which indicates the scale of e-commerce platforms and the upper limit of advertising revenue, Tencent has consistently concealed key metrics such as monthly active users and usage duration, which are crucial for evaluating content ecosystems. Instead, it merely stated that “total user hours on Video Accounts increased significantly year-on-year.”

Therefore, we can only indirectly observe the growth potential of Video Accounts through advertising revenue. Tencent's online advertising revenue grew by 19% year-on-year to RMB 29.871 billion this quarter, with Video Accounts being the primary driver, excluding long-form video.

Considering Video Accounts' strong private domain connections, Kuaishou serves as a reference for its advertising revenue to GMV ratio. During Tencent's Q2 earnings call last year, it was revealed that Video Accounts' advertising revenue exceeded RMB 3 billion at the time. Let's assume Video Accounts' advertising revenue last year was RMB 15 billion based on this information.

According to Kuaishou's 2023 annual report, its advertising revenue was RMB 60.3 billion, while its annual e-commerce GMV was RMB 1.18 trillion. Using the aforementioned metrics and Tencent's disclosed over 100% growth rate in Video Accounts advertising revenue last quarter, we estimate Video Accounts' 2024 GMV to be around RMB 600 billion, significantly short of the trillion-yuan mark.

This explains why many believe that Video Accounts, which launched native advertising capabilities in July 2022 and officially accelerated its commercialization, are still progressing too slowly.

From a product logic perspective, the internal factor hindering Video Accounts' commercialization is the lack of mature e-commerce infrastructure. We observe that before the financial report's release, Video Accounts established strong connections across the WeChat ecosystem, including linking the entire WeChat domain to Video Accounts stores, adding a “Shopping” entry in search, and testing user-liked videos appearing in Moments feeds.

However, these efforts primarily focus on traffic distribution, and there are still many aspects of e-commerce infrastructure that need improvement.

As we all know, before Video Accounts focused on e-commerce, the WeChat ecosystem already had merchant resources linked through mini-programs. To redirect these merchants to Video Accounts, WeChat simply cut off the links between WeChat Mini Stores and Video Accounts showcases and disabled their upgrade, migration, and new store opening functions.

However, the business experience of these merchants after being “forced” to set up stores on Video Accounts is inferior to what they had before. Merchants have reported to us that while they previously paid a 0.6% payment fee for transactions through mini-programs, Video Accounts stores charge a technical service fee ranging from 1% to 5%. Additionally, Video Accounts launched a “buy now, pay later” feature last year, directly impacting merchants by extending payment terms and increasing operational pressure.

More notably, compared to mini-program store notifications, Video Accounts' private domain connections heavily rely on the videos posted by merchants. Merchants have complained that after restocking their products, they cannot directly reach consumers through mini-program notifications like before and must wait for users to stumble upon related videos during their leisure time.

In terms of product offerings, Video Accounts' primary task, inheriting the previous focus on small and medium-sized merchants, is to expand into branded merchants. However, Video Accounts' traffic distribution rules do not seem merchant-friendly for brand entry. Nestlé, which achieved a GMV of millions on the first day of the recent 618 sale, partnered with Video Accounts as early as February this year but did not receive much support from the platform and instead followed a cold start route similar to small and medium-sized merchants.

Undoubtedly, relying solely on the product itself, Video Accounts' e-commerce will struggle to balance pre- and post-sales services and merchant operational experiences without dedicated human and resource support. As for the nascent local services, they may need to retrace the path of e-commerce rising from the cracks between giants, given that their financial report mentions only “increased localized content offerings.”

Even with a guaranteed user base, the fundamental path for Video Accounts' commercialization to enter the next stage lies in building a robust business ecosystem based on the entire WeChat domain. The market eagerly awaits Tencent's answer on how long this “qualitative change” accumulation phase will last.

To B is Insufficient; Ecosystems Must Fill the Gap

While Video Accounts are gradually becoming profitable, large models remain a cash-guzzler for Tencent.

From a timeline perspective, Tencent lags behind in both model foundations and consumer-facing products. “Hunyuan” made its debut at Tencent's Global Digital Ecosystem Conference on September 7, 2023, while the large model app “Yuanbao” was only officially introduced to users on May 30, 2024.

Performance-wise, Tencent has not chosen to disclose AI-related revenues like some of its peers. With e-commerce leading the way, AI can proceed at a more leisurely pace, following Tencent's product logic and establishing its own rhythm.

Compared to new money, Tencent seems more concerned with gradually increasing new costs.

The most tangible manifestation is the year-over-year increase in research and development (R&D) expenditures. The financial report shows that Tencent's R&D expenditures increased by 8% year-on-year to RMB 17.277 billion this quarter, and this expenditure also increased by 6% year-on-year to RMB 32.955 billion over a six-month period. This is evidenced by a 17% increase in bandwidth and server costs, a net increase of 719 employees quarter-on-quarter, and a 6% increase in R&D personnel compensation, all of which underscore Tencent's steadfast commitment to AI investment.

As the saying goes, “Brave warriors cannot fight without food.” For tech giants with ample computing power and data, their determination to pursue AI is evident in their pursuit of talent density. The AI talent recruitment program “Qingyun Plan,” which allows applications from non-AI majors and assigns masters to T9 and doctors to T10 positions, is a testament to this commitment.

As CEO of Cloud and Smart Industries Group (CSIG), Tang Daosheng mentioned in an interview with Tencent News that “for a long-term business, the more intense the initial resource investment, the greater the difficulty and pressure to persist, reducing resilience and patience across cycles.”

However, amidst widespread skepticism about large models' commercial viability and a cooling AI venture capital market, pure investment is akin to “generating power out of love.” Considering other players in the field, we can evaluate Tencent's progress in AI from two dimensions: To B commercialization and ecosystem building.

In fact, as early as June last year, Tencent Cloud released the MaaS technical solution tailored for industry-specific large models, three months before the official release of its base model.

The issue is that the MaaS-focused approach adopted by large enterprises has yet to mature since last year, with a tendency to repeat the mistakes of cloud computing project-based orders and integrations. An AIGC salesperson from a major tech company told Photon Star that even agile startups haven't fully navigated this path, so it's unlikely that large enterprises will fare much better if they dive in directly.

“For instance, we organized our entire BD department to spend over a month researching the popular ‘Big Five Models’ (MiniMax, Dark Side of the Moon, Baichuan AI, Zhipu AI, ZeroOne AI) in hopes of finding viable commercialization paths. However, neither they nor we have fully figured it out,” they said.

Similar To B challenges may be even more pronounced within Tencent's organization. During Tencent's annual meeting in 2023, CEO Pony Ma bluntly stated about the To B business, “This model really isn't suitable for us. It's inefficient and opaque, so we'll focus on product development and let others sell our standard products.”

This could explain why Tencent has accelerated its AI investments despite CSIG CEO Tang Daosheng's public skepticism about stimulating cloud revenue through computing power bundling. Tencent needs “middlemen.” As mentioned in our previous article, many cloud vendors are seeking medical SaaS enterprises to leverage their medical AI capabilities, and Tencent is no exception.

In contrast, progress more readily perceived by the market lies in ecosystems. For Tencent, the A-side of its ecosystem is its distribution capabilities based on instant messaging traffic potential, such as the proliferation of new AI apps within WeChat and QQ groups. The B-side is the ecosystem content assets, primarily WeChat Official Accounts, reinvigorated by large models.

Taking Yuanbao as an example, users can directly retrieve articles and images from Official Accounts in their queries and jump to the article pages. “An article I published a few minutes ago hasn't even appeared in WeChat's feed yet, but Yuanbao can already retrieve it,” remarked a content creator.

A clear trend is that Tencent's in-house ecosystem will become increasingly intertwined with AI. Even if the To B direction is relatively lacking, as long as a viable To C business model emerges within the industry, Hunyuan will experience a significant surge in performance.

Finding the Next Benchmark?

The essence of turning new money into old money is a cognitive issue, a process where external perceptions shift from one benchmark to the next.

As previously mentioned, both Video Accounts and AI large models require Tencent to reach and establish business benchmarks. For Video Accounts, it's e-commerce GMV, while for AI large models, it's significant commercialization breakthroughs. Both rely on Tencent's reconstruction based on its existing ecosystem, which we can even define as Tencent's “second entrepreneurship” targeting its instant messaging ecosystem.

While the latter still lacks a clear signal, the dawn for the former has already arrived. This quarter, Tencent's online advertising revenue closely approached that of the social entertainment revenue (RMB 30.3 billion) under the value-added services segment, hinting at a revenue shift between advertising and live streaming. We can also discern subtle changes in Tencent's business strategy from shifts in revenue composition – more dimensions beyond entertainment are being explored.

Overall, this represents an alternative input-output logic: old money supports the family while new money grows. It's evident that Tencent's monetization efforts within the WeChat ecosystem, excluding Video Accounts, are becoming increasingly aggressive. Amidst achieving a monthly active user milestone of 1.371 billion, WeChat mini-games' total revenue grew by over 30% year-on-year, and mini-program user hours increased by 20%.

On the other hand, the challenge of recognizing new benchmarks extends beyond emerging businesses. Following the successful launch and dominance of “Dungeon & Fighter: Origins,” Tencent's “last pearl” in its gaming assets has realized its value. Amidst the ongoing “Apple tax” controversy, even the impressive performance of mini-games must temporarily accept the market's “unobjective” reassessment in the short term.

Since Tencent began narrating the story of its evergreen games in the previous quarter, the task of finding a new benchmark for its gaming business, the old money, has been on the agenda. However, during this quarter's earnings call, when asked about the progress of “Honor of Kings: World,” Tencent focused on IP derivative development and “VALORANT” rather than providing direct updates, suggesting that this heavyweight product may still be in the pre-release stage.

By repurchasing a significant amount of shares, Tencent has demonstrated the profitability of WeChat and its profit-oriented survival philosophy amidst a less-than-ideal environment. Since Tencent can support both Video Accounts and AI, the market needs to provide more patience to one of the best internet stocks.