Nintendo (NASDAQOTH:NTDOY) recently partnered with Chinese tech giant Tencent (NASDAQOTH:TCEHY) to bring the latter's hit game, Honor of Kings, to the Switch console. Honor of Kings is the top mobile game in China, with over 200 million monthly active players, and generates over half of Tencent's mobile gaming revenue. Tencent plans to launch the game in Europe and the U.S. later this year.
Nintendo will launch the hit MOBA (multiplayer online battle arena) game under its English title Arena of Valor for the Switch, which complements Tencent's plans to launch the game overseas. However, some industry watchers believe that the partnership could pave the way for Nintendo to launch the Switch in China -- potentially denting sales of Sony's (NYSE:SNE) PS4 and Microsoft's (NASDAQ:MSFT) Xbox One.
Why Tencent teamed up with Nintendo
Tencent is the world's largest video game publisher by annual revenues. Its massive gaming portfolio includes local hits like Honor of Kings, international hits like Clash of Clans and League of Legends, and stakes in big game publishers like Activision Blizzard. It also owns WeChat, the most popular mobile messaging app in China.
Tencent is considered an 800-pound gorilla in both the gaming and social networking industries, but it recently ran into trouble in China after the state-owned People's Daily newspaper called Honor of Kings a "drug" which was harming teenagers. Tencent responded by adding playtime restrictions for younger players, but users quickly circumvented those limits with a black market for "adult" accounts.
To offset that backlash, Tencent took Honor of Kings overseas as Arena of Valor -- and Nintendo seems like a logical partner for that push. The Switch is a hybrid console that resembles a touchscreen gaming tablet in its portable form, making it ideal for ports of mobile games. The Switch's ability to become a full TV-based console also converts Honor of Kings into a console game.
But this doesn't mean the Switch is entering China
However, this partnership doesn't mean that Tencent will help Nintendo launch the Switch in China, a notoriously tough market for video game consoles. A 15-year ban on console sales was lifted two years ago, but the ban had already turned PCs and phones into the country's preferred gaming devices.
As a result, Sony and Microsoft struggled to sell their newest consoles to Chinese gamers. At the end of 2015, Shanghai Oriental Pearl -- which distributes the PS4 and Xbox One -- announced that the combined installed base for both consoles was just 500,000. That figure is expected to hit one million this year, but it pales in comparison to the estimated worldwide sales of 62.4 million PS4s and 30.7 million Xbox Ones.
Meanwhile, the installed base of "gray market" Xbox Ones and PS4s is expected to hit two million this year. Many gray market consoles are modified to play pirated software, so game publishers and console makers can't generate any software revenue. Therefore, the potential benefits of selling the Switch in China might not outweigh the risks.
But let's not count Nintendo out yet...
Tencent and Nintendo haven't said anything about launching the Switch in China, but Nintendo could fare better than Sony and Microsoft, which were both hobbled by a poor selection of localized launch games. If Tencent opens up its massive gaming library to Nintendo, a huge number of popular PC and mobile games could be ported to the Switch in the same manner as Honor of Kings.
It could be argued that PC and mobile device owners wouldn't need an extra device for playing Tencent's existing titles, but if Nintendo combines those games with big first-party games like Mario Kart 8, the Switch could become a viable replacement (or complementary) gaming platform for the PC or smartphone.
Lastly, the Switch is very different from the PS4, Xbox One, and PC platforms, which have similar libraries of games. Recent reports indicate that the Switch is outselling the PS4 in both the U.S. and Japan and that trend could continue in China with Tencent's support.
The key takeaway
The Chinese gaming market is massive, with 600 million gamers generating nearly $25 billion in revenues last year. But consoles account for a tiny sliver of that market, with most gamers playing on PC and mobile games.
Sony and Microsoft don't have much to lose since they never gained much momentum in China. But Nintendo could benefit from deepening its partnership with Tencent -- and winning the Chinese market would significantly boost its global market share against Sony and Microsoft.