Tencent Is Investing in Its Future

Tencent Holdings (TCEHY +1.11%) announced fourth-quarter 2017 results on Wednesday morning, detailing higher-than-expected earnings driven by the sustained momentum of its social media platforms, smartphone games, and wildly popular video-streaming services.

But the Chinese tech giant also outlined plans to ramp up strategic investments aimed at taking market share and driving long-term growth, sparking concerns from skittish investors over its near-term profitability.

With shares down around 3% as of this writing, let's take a deeper look at how Tencent ended the year, as well as what we can expect in the coming quarters.

Image source: Getty Images.

Tencent results: The raw numbers

Data source: Tencent Holdings.

What happened with Tencent this quarter?

• On an adjusted (non-GAAP) basis, which excludes non-cash items and acquisition expenses, profit attributable to shareholders grew 42% year over year to RMB 17.454 billion ($2.671 billion), or RMB 1.827 per diluted share ($0.28).
• Tencent doesn't provide specific quarterly guidance. So for perspective -- and while we don't usually pay close attention to Wall Street's demands -- consensus estimates predicted lower adjusted earnings of $0.27 per share on higher revenue of $10.5 billion.
• Fee-based registered subscriptions for Tencent's value-added services (VAS) grew to 135 million for growth of 22.1% year over year -- up from 125 million last quarter.
• Weixin and WeChat monthly average users grew 11.2% year over year to 989 million and exceeded 1 billion following the Chinese New Year.
  • Accelerated growth was driven by a fine-tuned Weixin user interface to more prominently feature Mini Programs and Mini Games. 
• Monthly active user (MAU) accounts on Tencent's QQ instant messaging service fell 9.8% year over year to 783 million. However, smart device MAUs grew 1.7% to 683 million, driven by growth in both time spent by and the number of younger users (aged 21 and below).
• Qzone MAUs declined 11.7% year over year to 563 million, and smart device Qzone MAUs declined 9.1% to 554 million.
• VAS revenue grew 37% year over year to RMB 39.947 billion, including the following:
  
  • Online games revenue grew 32% to RMB 24.367 billion, driven primarily by growth in both existing smartphone games, like Honour of Kings, and new smartphone games, including Kings of Chaos and Legacy TLBB Mobile.
  • Social networks revenue grew 45% to RMB 15.58 billion, driven by growth in subscription video streaming, live broadcast, and in-game virtual item sales.
• Online advertising sales climbed 49% to RMB 12.361 billion, including the following:
  • Media advertising grew 22%, driven by Tencent Video, which is now the largest streaming platform in China, with over 137 million mobile daily active users and 56 million paying subscribers (up from 43 million last quarter).
  • "Social and other" segment ad revenue grew 68%, driven by Weixin and Tencent's ad network.
• Other business revenue grew 121% to RMB 14.084 billion, driven by payment and cloud services.
• Free cash flow grew 41% year over year to RMB 24.17 billion.

What management had to say

Tencent Chairman and CEO Ma Huateng stated the following:

During 2017 and continuing in 2018, Tencent made important strategic moves that reinforced our leadership. Our streaming video service became the China market leader with the most mobile daily active users and monthly subscriptions. Our Weixin Mini Program platform rapidly expanded its developer base and user adoption. Our QQ Speed Mobile racing game and PUBG: Exciting Battleground shooter game achieved absolute leadership in, and grew the audiences of, their respective genres. Looking forward, we are substantially increasing our investment in areas including video, payment, cloud, AI technologies, and smart retail, which will impact our near-term earnings but which we believe can generate long-term value and growth opportunities.

Looking forward

More specifically, Tencent says it will "more aggressively invest" in 2018 with the aim of strengthening its positions in "areas including online video, payment services, cloud services, AI technologies, and smart retail."

Of course, the market is unsurprisingly frowning at the prospect of that growth coming at the expense of Tencent's short-term profitability, which helps explain today's modest pullback. Meanwhile -- and putting aside the fact that forsaking profits in the name of driving top-line growth and securing market share is hardly an uncommon approach -- long-term investors will recognize that Tencent is making these investments from a position of strength.