Despite a solid performance in its Q2 earnings, Tencent, once the top performer in China's internet industry, is struggling with a weakening game business and pressure on its video account, giving the 26-year-old company a sense of midlife crisis.

Tencent's Q2 earnings report showcased robust profit growth and substantial share buybacks, reminiscent of its glory days as an internet giant.

According to Tencent's Q2 financial report, the company's net profit increased by 82% year-on-year. Both domestic and international game businesses achieved 9% growth, while online advertising revenue increased by 19% year-on-year. Tencent has not only escaped the downward spiral of its core businesses but also seemingly found a path to growth.

This path to growth undoubtedly lies in Tencent's video account. According to the financial report, the total user engagement time on the video account increased significantly year-on-year in Q2 2024, while its transaction capabilities were systematically enhanced. James Mitchell, Tencent's Chief Strategy Officer, stated that video account advertising revenue increased by over 80% year-on-year. Third-party research firm Dolphin Investment estimated that the video account's external cycle and e-commerce advertising revenue totaled 6 to 7 billion yuan in this quarter, an increase of 105% year-on-year.

The optimistic atmosphere of positive news has subtly changed investors' attitudes. While people anticipated a substantial surge in the capital market, the muted response fell short of most expectations.

After Tencent released its financial report on August 13, its share price did not rise as expected but instead fell for two consecutive days, in stark contrast to the soaring share prices of internet giants like JD.com and Alibaba after reporting positive earnings. Share prices often reflect short-term sentiment, so why are there increasing controversies surrounding Tencent despite its excellent financial data?

Upon closer inspection, the lack of growth momentum can be seen as the primary reason. Taking the game business as an example, both Honor of Kings and Game for Peace, having been online for many years, serve more as regulators than growth drivers for Tencent. When performance declines, they can quickly alleviate pressure by boosting revenue streams. However, they continue to play a foundational role when the situation reverses, making it difficult to create strong expectations. Although Dungeon & Fighter is growing rapidly, it is more of a realization of 16 years of accumulation. For Tencent, such IP reserves seem to be running low.

Similarly, Tencent's larger social networking revenue and financial payment and enterprise services also show stagnation, with growth rates of 2% and 4%, respectively, indicating that the company is at a standstill in these directions.

From this perspective, among Tencent's various business segments, the video account seems to be the only one with significant potential to increase gross margins and offer vast imagination space. However, for the video account, the e-commerce segment is still relatively small, and local life services have yet to take off, posing challenges for investors. How to break through this impasse remains an urgent question.

Part.1

Games Still Lack Vision

In 2018, an article titled "Tencent Has No Vision" went viral on social media, prompting Tencent's 930 reform and executives' public response to accusations of being overly investment-bank-like. Six years later, a closer look at Tencent's business segments reveals that the company seems to be stuck in a rut.

Taking the game business as an example, Honor of Kings (launched in 2015) and Game for Peace (launched in 2019) remain crucial to Tencent's performance. In its financial report, Tencent stated that it revitalized its flagship games Honor of Kings and Game for Peace, both of which have resumed year-on-year revenue growth.

Meanwhile, Dungeon & Fighter Mobile and League of Legends PC are the primary drivers of domestic game sales recovery. However, both games have been operating for over a decade, with Dungeon & Fighter running for over 16 years and League of Legends since 2009.

While veteran games are resilient, they also slow down Tencent's progress. The company has longed for the next super hit or nationwide game, but the cost has been slow development and excessive reliance on old games. Before this quarter's growth, Tencent's game business had achieved double-digit year-on-year growth only in Q1 2023 (10.8%), with most quarters showing small single-digit or even negative growth, highlighting its cyclical nature.

This year, as Dungeon & Fighter once again performed well, Tencent's expectations for new game growth have reverted to a laid-back attitude.

According to sources close to Tencent, both the industry and the company itself do not anticipate any noteworthy new games for the rest of the year or even next year. Titles like Ace Force 2, Delta Force: Black Hawk Down, and King of Glory: Dawn of Breakthrough do not seem promising. Optimistically, old products still have significant potential. However, Tencent's speed in developing genuinely new games is undoubtedly slowing down.

In recent years, Tencent's game business has faced crises. Games like miHoYo's Genshin Impact and Honkai: Star Rail have achieved remarkable success in terms of quality and commercialization, while their overseas success has opened up new possibilities for Chinese games.

Recently, the breakout success of Black Myth: Wukong has sounded the alarm for Tencent. China's new generation of AAA games has reached world-class standards, but Tencent's cash cows remain stuck in the past, which is detrimental to the industry's long-term development. Tencent controls the industry's top resources but continues to play defense. It remains unclear who will break the status quo.

In fact, cracks have already appeared in Tencent's vast game empire. Early this year, the rivalry between Star Dream Star and Party Animals demonstrated a decline in Tencent's ability to replicate and respond quickly, leading industry insiders to conclude that Tencent is now more comfortable resting on its laurels than engaging in competition.

No wonder many investors concluded after reviewing Tencent's financial report that while the company is stable, it lacks imagination.

Part.2

Video Account's Ascent and Long-Term Concerns

From the data, the most exciting aspect of Tencent's Q2 financial report is undoubtedly the growth in advertising revenue driven by its video account. Citibank's evaluation of Tencent's performance noted that video account advertising revenue increased by 80% year-on-year. While the macro environment has pressured brand advertising and mobile advertising networks, Tencent believes that new video account advertising inventory will partially offset these impacts and increase its advertising market share, which will benefit from improved consumer spending.

However, within Tencent, video account e-commerce is undoubtedly the focus for the company's future growth. According to public information, in March this year, Tencent's video account e-commerce team was consolidated, ending the internal competition between Guangzhou and Shenzhen teams and placing it under the direct leadership of WeChat founder Allen Zhang.

Sources close to Tencent revealed that the video account product team believes its upper limit is 20% of the entire e-commerce market, with a lower limit of 10%. Based on these estimates, the video account's projected GMV ranges from approximately 1.8 trillion to 3.6 trillion yuan.

With a top team and substantial resource injection, Tencent appears poised for a significant battle in the e-commerce sector.

However, from the current development perspective, this battle seems to be still brewing. In 2023, the video account's GMV was only 300 billion yuan. During the earnings call, Tencent officials expressed caution, stating that compared to other short video platforms, they have not seen a slowdown in total GMV growth. The main reason is that, compared to competitors, their e-commerce transaction volume is still relatively small, leaving significant room for growth.

According to sources close to Tencent, the video account's DAU is already comparable to Douyin's and even surpassed it at peak times. According to QuestMobile data, as of June 2022, the video account had 813 million active users, exceeding both Douyin (680 million) and Kuaishou (390 million). Despite this abundant traffic, the pace of video account e-commerce has been slow. After multiple trials, the video account has made initial e-commerce attempts in areas such as knowledge payment and games but is struggling to expand its achievements further.

This struggle was evident in Tencent's financial report. During the earnings call, company management stated that they would reposition their live e-commerce business to be more integrated with WeChat e-commerce. In other words, they aim to build an e-commerce ecosystem within WeChat that connects to the entire WeChat ecosystem rather than relying solely on the video account and live channels.

This indicates that the video account has ambitious plans to not only connect the WeChat ecosystem but also integrate e-commerce into various scenarios such as social networking, mini-programs, and even WeChat Work, forming a vast ecosystem.

This approach can be traced back to Tencent's history. From an e-commerce perspective, many have benefited from the WeChat ecosystem, from early WeChat business to later e-commerce platforms like Pinduoduo and JD.com. WeChat's massive traffic offers immense potential in the e-commerce sector, with mini-program e-commerce alone reaching a scale of 3 trillion yuan. However, these businesses have relatively limited connections to WeChat itself, with WeChat mainly providing initial traffic. Later stages, such as private domain operations and group buying models, show limited strong connections to the WeChat ecosystem. Surviving businesses within the WeChat ecosystem, like WeChat business, often end in disappointment.

To some extent, WeChat has proven that traditional e-commerce models may not be compatible with its ecosystem. Furthermore, from an e-commerce niche perspective, various platforms have already firmly established themselves in users' minds. For WeChat e-commerce to succeed, it must demonstrate the company's ability to integrate and innovate.

Historically, such integration is fraught with contradictions in terms of underlying mechanisms and ecosystem directions. For example, the rapid rise of WeChat business validated the effectiveness of private domains, but short video content platforms emphasize public domains where human connections are crucial. In contrast, public domains prioritize platform algorithms and personal interests. These contradictions, coupled with functional elements like mini-programs and the B2B attributes of WeChat Work, add complexity and difficulty.

The video account must first unify the ecosystem's tone and potentially change user habits before a viable business model can emerge.

Such uniformity poses significant resistance for WeChat, an all-encompassing super app.

Current video account e-commerce efforts focus on marginal improvements like combating fraud or enhancing store features. The future blueprint remains unclear. As stated in the earnings call, if Tencent can systematically build an e-commerce ecosystem within WeChat, leveraging all its strengths, it can create a larger, more meaningful, and higher-ceiling e-commerce ecosystem.

Despite this grand vision, the reality facing video account e-commerce is grim. Domestic mainstream e-commerce platforms have already carved out their niches through fierce competition. With mindshare and boundaries increasingly defined, it will be exceedingly challenging for the video account to make waves.

Part.3

Trimming the Elephant, Navigating Narrow Paths

Behind Tencent's impressive financial report lies a cautious approach to the current environment. Its focus on cost savings and efficiency reflects a strategy of tight growth.

Objectively speaking, Tencent's tight growth strategy has benefited from favorable market conditions. For example, the underperformance of Genshin Impact: Star Rail gave Tencent a respite from miHoYo's aggressive push. Meanwhile, rival NetEase has also faced setbacks this year, with games like The Heaven Sword and Dragon Saber slowing its growth momentum. In the e-commerce sector, platforms like Douyin have seen their growth slow after intense competition.

Declining win rates seem to be the norm across the industry. In this context, Tencent's resilience, exemplified by its reliance on cash cows, stands out. This resilience has allowed Tencent to initiate internal cost-saving and efficiency-enhancing measures.

According to Tencent's Q2 financial report, the significant disparity between adjusted earnings and revenue growth is attributed to strict cost control. Specifically, Tencent had a total workforce of 105,506 employees in Q2, an increase of approximately 1,000 (less than 1%) year-on-year. Total compensation expenses were 54.3 billion yuan, almost unchanged from the same period last year (54.1 billion yuan).

According to insiders close to Tencent, salaries are changing within the company. "At the end of July, Tencent adjusted its salary structure, focusing on hiring more candidates but being more selective in retaining them. It's no longer a secret that layoffs are more frequent. Expenses are also expected to decrease steadily," they said.

In terms of business, Tencent is scaling back unprofitable operations. Although its ToB business continues to grow, industry insiders believe that the main drivers are the increase in income from WeChat Work and technical service fees from video merchants, both of which are essentially ToC services under the ToB banner. As for the video business, which requires significant investment, Tencent has become more cautious with content acquisition, entering an era of living within its means.

While frugal growth is understandable, it also means Tencent is inadvertently entering a narrow path, adopting an increasingly conservative stance and prioritizing profit, making it difficult for the company to make further progress in its business. In the short term, growth may appear impressive, but in the medium to long term, Tencent risks falling into the trap described in "The Innovator's Dilemma," gradually becoming vulnerable and ultimately being disrupted by innovative competitors.

Tencent, like an elephant slimming down, may have achieved impressive numbers, but it will face increasing difficulties in achieving further growth.

It can be predicted that Tencent will continue to maintain a strong growth momentum fueled by the monetization of its games in the coming quarters. However, maintaining frugal growth at the group level will undoubtedly directly impact its innovation capabilities. For example, rapidly expanding its e-commerce business will undoubtedly be more challenging.

Once again, Tencent, as the hope of the industry, has stepped forward, committing its top teams and significant resources. However, it must be acknowledged that the success rate of internet giants breaking into new markets has been unpredictable in recent years. Whether Tencent will be an exception remains unclear, as the outcome is still shrouded in mystery.